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HNGR Hanger

Filed: 5 May 21, 4:11pm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2021

OR

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

For the transition period from

to

Commission File Number 1-10670

HANGER, INC.

(Exact name of registrant as specified in its charter)

Delaware

    

84-0904275

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

10910 Domain Drive, Suite 300, Austin, TX

    

78758

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (512) 777-3800

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

    

Trading Symbol

    

Name of each exchange on which registered

Common Stock, par value $0.01 per share

HNGR

New York Stock Exchange

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. Yes No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes No 

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

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

Smaller reporting company 

Emerging growth company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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

As of April 27, 2021, the registrant had 38,541,339 shares of its Common Stock outstanding.

PART 1.FINANCIAL INFORMATION

HANGER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except par value and share amounts)

(Unaudited)

As of March 31, 

As of December 31, 

    

2021

    

2020

ASSETS

Current assets:

Cash and cash equivalents

$

70,316

$

144,602

Accounts receivable, net

 

118,162

 

128,596

Inventories

 

78,622

 

76,429

Income taxes receivable

12,863

12,888

Other current assets

 

15,489

 

12,357

Total current assets

 

295,452

 

374,872

Non-current assets:

Property, plant, and equipment, net

84,761

84,873

Goodwill

298,166

277,223

Other intangible assets, net

 

19,844

 

18,431

Deferred income taxes

 

55,482

 

54,877

Operating lease right-of-use assets

124,663

124,741

Other assets

 

16,204

 

15,734

Total assets

$

894,572

$

950,751

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:

Current portion of long-term debt

$

11,064

$

10,085

Accounts payable

 

51,002

 

65,091

Accrued expenses and other current liabilities

 

62,491

 

62,861

Accrued compensation related costs

 

35,665

 

72,541

Current portion of operating lease liabilities

35,005

35,002

Total current liabilities

 

195,227

 

245,580

Long-term liabilities:

Long-term debt, less current portion

 

494,326

 

493,012

Operating lease liabilities

104,030

104,589

Other liabilities

 

51,745

 

56,593

Total liabilities

 

845,328

 

899,774

Commitments and contingencies (Note P)

Shareholders’ equity:

Common stock, $0.01 par value; 60,000,000 shares authorized; 38,715,640 shares issued and 38,572,819 shares outstanding at 2021, and 38,321,796 shares issued and 38,178,975 shares outstanding at 2020, respectively

 

387

 

383

Additional paid-in capital

 

364,524

 

365,503

Accumulated other comprehensive loss

 

(17,643)

 

(20,215)

Accumulated deficit

(297,328)

(293,998)

Treasury stock, at cost; 142,821 shares at 2021 and 2020, respectively

 

(696)

 

(696)

Total shareholders’ equity

 

49,244

 

50,977

Total liabilities and shareholders’ equity

$

894,572

$

950,751

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

1

HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except share and per share amounts)

(Unaudited)

For the Three Months Ended
March 31, 

    

2021

    

2020

Net revenues

$

237,470

$

233,739

Material costs

 

75,170

 

77,241

Personnel costs

 

89,880

 

89,185

Other operating costs

31,460

35,886

General and administrative expenses

30,941

31,769

Depreciation and amortization

 

7,998

 

8,831

Income (loss) from operations

 

2,021

 

(9,173)

Interest expense, net

 

7,340

 

8,269

Non-service defined benefit plan expense

 

167

 

158

Loss before income taxes

 

(5,486)

 

(17,600)

Benefit for income taxes

(2,156)

(1,852)

Net loss

$

(3,330)

$

(15,748)

Basic and Diluted Per Common Share Data:

Basic and diluted loss per share

$

(0.09)

$

(0.42)

Weighted average shares used to compute basic and diluted earnings per common share

38,268,332

37,541,452

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

2

HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(dollars in thousands)

(Unaudited)

For the Three Months Ended
March 31, 

    

2021

    

2020

Net loss

$

(3,330)

$

(15,748)

Other comprehensive income (loss):

 

 

Unrealized gain (loss) on cash flow hedges, net of tax provision (benefit) of $796 and ($2,815), respectively

$

2,512

$

(8,902)

Unrealized gain on defined benefit plan, net of tax provision of $19 and $9, respectively

 

60

 

29

Total other comprehensive income (loss)

 

2,572

 

(8,873)

Comprehensive loss

$

(758)

$

(24,621)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3

HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (DEFICIT)

(dollars and share amounts in thousands)

(Unaudited)

Common

Accumulated

Common

Stock,

Additional

Other

Shares,

Par

Paid-in

Comprehensive

Accumulated

Treasury

    

Balance

    

Value

    

Capital

    

Loss

    

Deficit

    

Stock

    

Total

Balance, December 31, 2020

38,179

$

383

$

365,503

$

(20,215)

$

(293,998)

$

(696)

$

50,977

Net loss

(3,330)

(3,330)

Share-based compensation expense

 

 

 

3,179

 

 

 

 

3,179

Issuance in connection with the exercise of stock options

29

366

366

Issuance of common stock upon vesting of restricted stock units

 

365

 

4

 

(4)

 

 

 

 

Effect of shares withheld to cover taxes

(4,520)

(4,520)

Total other comprehensive income

2,572

2,572

Balance, March 31, 2021

 

38,573

$

387

$

364,524

$

(17,643)

$

(297,328)

$

(696)

$

49,244

    

    

Common

    

    

Accumulated

    

    

    

Common

Stock,

Additional

Other

Shares,

Par

Paid-in

Comprehensive

Accumulated

Treasury

    

Balance

    

Value

    

Capital

    

Loss

    

Deficit

    

Stock

    

Total

Balance, December 31, 2019

 

37,460

$

376

$

354,326

$

(12,551)

$

(331,951)

$

(696)

$

9,504

Cumulative effect of a change in accounting for credit losses

 

 

 

 

 

(238)

 

 

(238)

Balance, January 1, 2020

 

37,460

 

376

 

354,326

 

(12,551)

 

(332,189)

 

(696)

 

9,266

Net loss

 

 

 

 

 

(15,748)

 

 

(15,748)

Share-based compensation expense

 

 

 

3,501

 

 

 

 

3,501

Issuance of common stock upon vesting of restricted stock units

 

354

 

4

 

(4)

 

 

 

 

Effect of shares withheld to cover taxes

 

 

 

(4,146)

 

 

 

 

(4,146)

Total other comprehensive loss

 

 

 

 

(8,873)

 

 

 

(8,873)

Balance, March 31, 2020

 

37,814

$

380

$

353,677

$

(21,424)

$

(347,937)

$

(696)

$

(16,000)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4

HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(Unaudited)

For the Three Months Ended
March 31, 

    

2021

    

2020

Cash flows used in operating activities:

Net loss

$

(3,330)

$

(15,748)

Adjustments to reconcile net loss to net cash used in operating activities:

Depreciation and amortization

7,998

8,831

(Benefit) provision for doubtful accounts

 

(211)

 

1,928

Share-based compensation expense

 

3,179

 

3,501

Deferred income taxes

 

(1,795)

 

3,476

Amortization of debt discounts and issuance costs

 

472

 

409

Gain on sale and disposal of fixed assets

 

(524)

 

(411)

Changes in operating assets and liabilities, net of acquisitions:

 

 

Accounts receivable, net

11,093

28,229

Inventories

(1,437)

949

Other current assets and other assets

(3,492)

(3,989)

Income taxes

25

(5,303)

Accounts payable

(14,055)

(4,757)

Accrued expenses and other current liabilities

(1,299)

(385)

Accrued compensation related costs

(36,936)

(38,175)

Other liabilities

(1,576)

(1,153)

Operating lease liabilities, net of amortization of right-of-use assets

(478)

628

Changes in operating assets and liabilities:

(48,155)

(23,956)

Net cash used in operating activities

(42,366)

(21,970)

Cash flows used in investing activities:

 

 

Acquisitions, net of cash acquired

 

(19,377)

 

(26)

Purchase of property, plant, and equipment

 

(6,541)

 

(6,526)

Purchase of therapeutic program equipment leased to third parties under operating leases

(395)

(2,286)

Proceeds from sale of property, plant, and equipment

796

595

Purchase of company-owned life insurance investment

(250)

Net cash used in investing activities

 

(25,517)

 

(8,493)

Cash flows (used in) provided by financing activities:

 

 

Borrowings under revolving credit agreement

79,000

Payment of employee taxes on share-based compensation

(4,520)

(4,146)

Repayment of term loan

 

(1,263)

 

(1,263)

Payment on Seller Notes

(446)

(1,446)

Payments under vendor financing arrangements

(275)

Payments of financing lease obligations

 

(265)

 

(152)

Proceeds from the exercise of options

 

366

 

Net cash (used in) provided by financing activities

 

(6,403)

 

71,993

(Decrease) increase in cash and cash equivalents

(74,286)

41,530

Cash and cash equivalents at beginning of period

144,602

74,419

Cash and cash equivalents at end of period

$

70,316

$

115,949

Non-cash financing and investing activities:

Seller Notes and other non-cash consideration related to acquisitions

$

4,865

$

36

Purchase of property, plant, and equipment in accounts payable at period end

3,458

6,244

Right-of-use assets obtained in exchange for finance lease obligations

82

730

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5

HANGER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note A — Organization and Summary of Significant Accounting Policies

Description of Business

Hanger, Inc. (“we,” “our,” or “us”) is a leading national provider of products and services that assist in enhancing or restoring the physical capabilities of patients with disabilities or injuries. We provide orthotic and prosthetic (“O&P”) services, distribute O&P devices and components, manage O&P networks, and provide therapeutic solutions to patients and businesses in acute, post-acute, and clinic settings. We operate through 2 segments, Patient Care and Products & Services.

Basis of Presentation

The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, and, therefore, do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Form 10-K”), as previously filed with the Securities and Exchange Commission (the “SEC”).

In our opinion, the information contained herein reflects all adjustments necessary for a fair statement of our results of operations, financial position, and cash flows. All such adjustments are of a normal, recurring nature. The results of operations for the interim periods are not necessarily indicative of those to be expected for the full year.

A detailed description of our significant accounting policies and management judgments is contained in our 2020 Form 10-K.

Reclassifications

We have reclassified certain amounts in the prior year condensed consolidated financial statements to be consistent with the current year presentation. These relate to classifications within the condensed consolidated statements of operations.

Recent Developments Regarding COVID-19

We are subject to risks and uncertainties as a result of the outbreak of the novel coronavirus (“COVID-19”) pandemic (“COVID-19 pandemic”). The extent and duration of the impact of the COVID-19 pandemic on our operations and financial condition remain uncertain and difficult to predict. As a result of the COVID-19 pandemic, we believe that our patients are deferring visits to our O&P clinics, as well as elective surgical procedures, both of which impact our business volumes through decreased patient encounters and physician referrals. It remains possible that further outbreaks of COVID-19, or reinstitution of restrictive measures by federal, state and local governments could cause a recessionary environment impacting the healthcare industry generally, including the O&P industry. The United States government has responded with fiscal policy measures intended to support the healthcare industry and economy as a whole, including the passage of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) in March 2020.

CARES Act

The CARES Act established the Public Health and Social Services Emergency Fund, also referred to as the Cares Act Provider Relief Fund, which set aside $178.0 billion to be administered through grants and other mechanisms to hospitals, public entities, not-for-profit entities and Medicare- and Medicaid- enrolled suppliers and institutional providers. The purpose of these funds is to reimburse providers for lost revenue and health-care related expenses that are attributable to the COVID-19 pandemic. In April 2020, the U.S. Department of Health and Human Services (“HHS”) began making payments to healthcare providers from the $178.0 billion appropriation. These are grants, rather than loans, to healthcare providers, and will not need to be repaid.

6

During 2020, we recognized a total benefit of $24.0 million in our consolidated statement of operations within Other operating costs for the grant proceeds we received under the CARES Act (“Grants”) from HHS. We recognize income related to grants on a systematic and rational basis when it becomes probable that we have complied with the terms and conditions of the grant and in the period in which the corresponding costs or income related to the grant are recognized. We recognized the benefit from the Grants within Other operating costs in our Patient Care segment.

The CARES Act also provides for a deferral of the employer portion of payroll taxes incurred during the COVID-19 pandemic through December 2020. The provisions allow us to defer half of such payroll taxes until December 2021 and the remaining half until December 2022. We deferred $11.8 million of payroll taxes within Accrued compensation related costs and Other liabilities in the condensed consolidated balance sheet as of March 31, 2021.

Recent Accounting Pronouncements, Not Yet Adopted

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU, effective beginning on March 12, 2020, provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update apply only to contracts, hedging relationships, and other transactions that reference London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. We are currently evaluating the effects that the adoption of this guidance, and related clarifying standards, will have on our condensed consolidated financial statements and the related disclosures.

Note B — Earnings Per Share

Basic earnings per common share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed using the weighted average number of common shares outstanding during the period plus any potentially dilutive common shares, such as stock options, restricted stock units, and performance-based units calculated using the treasury stock method. Total anti-dilutive shares excluded from the diluted earnings per share were 3,471 and 0 for the three months ended March 31, 2021 and 2020, respectively.

Our Credit Agreement (as defined below) restricts the payment of dividends or other distributions to our shareholders by us or any of our subsidiaries. See Note K - “Debt and Other Obligations” within these condensed consolidated financial statements.

The reconciliation of the numerators and denominators used to calculate basic and diluted net income per share are as follows:

For the Three Months Ended
March 31, 

(in thousands except share and per share amounts)

    

2021

    

2020

Net loss

$

(3,330)

$

(15,748)

Weighted average shares outstanding - basic

38,268,332

37,541,452

Effect of potentially dilutive restricted stock units and options (1)

Weighted average shares outstanding - diluted

 

38,268,332

 

37,541,452

 

 

Basic and diluted loss per share

$

(0.09)

$

(0.42)

(1)In accordance with ASC 260 - Earnings Per Share, during periods of a net loss, shares used to compute diluted per share amounts exclude potentially dilutive shares related to unvested restricted stock units and unexercised options. For the three months ended March 31, 2021 and 2020, potentially dilutive shares of 906,116 and 983,884 shares were excluded, respectively, as we were in a net loss position.

7

Note C — Revenue Recognition

Patient Care Segment

Revenue in our Patient Care segment is primarily derived from contracts with third party payors for the provision of O&P devices and is recognized upon the transfer of control of promised products or services to the patient at the time the patient receives the device. At, or subsequent to delivery, we issue an invoice to the third party payor, which primarily consists of commercial insurance companies, Medicare, Medicaid, the U.S. Department of Veterans Affairs (the “VA”), or private or patient pay (“Private Pay”) individuals. We recognize revenue for the amounts we expect to receive from payors based on expected contractual reimbursement rates, which are net of estimated contractual discounts and implicit price concessions. These revenue amounts are further revised as claims are adjudicated, which may result in additional disallowances.

The following table disaggregates revenue from contracts with customers in our Patient Care segment for the three months ended March 31, 2021 and 2020:

For the Three Months Ended
March 31, 

(in thousands)

    

2021

    

2020

Patient Care Segment

 

  

 

  

Medicare

$

57,335

$

61,725

Medicaid

 

34,048

 

30,828

Commercial Insurance / Managed Care (excluding Medicare and Medicaid Managed Care)

 

69,663

 

66,440

Veterans Administration

 

19,764

 

17,892

Private Pay

 

14,872

 

13,298

Total

$

195,682

$

190,183

The impact to revenue related to prior period performance obligations was not material for the three months ended March 31, 2021 and 2020.

Products & Services Segment

Revenue in our Products & Services segment is derived from the distribution of O&P components and from therapeutic solutions which includes the leasing and sale of rehabilitation equipment and ancillary consumable supplies combined with equipment maintenance, education, and training.

The following table disaggregates revenue from contracts with customers in our Product & Services segment for the three months ended March 31, 2021 and 2020:

For the Three Months Ended
March 31, 

(in thousands)

    

2021

    

2020

Products & Services Segment

  

 

Distribution services, net of intersegment revenue eliminations

$

30,660

$

31,690

Therapeutic solutions

 

11,128

 

11,866

Total

$

41,788

$

43,556

Note D — Accounts Receivable, Net

Accounts receivable, net represents outstanding amounts we expect to collect from the transfer of our products and services. Principally, these amounts are comprised of receivables from Medicare, Medicaid, and commercial insurance plans. Our accounts receivable represent amounts outstanding from our gross charges, net of contractual discounts, sales returns, and other implicit price concessions including estimates for payor disallowances and patient non-payments.

8

We are exposed to credit losses primarily through our accounts receivable. These receivables are short in nature because their due date varies between due upon receipt of invoice and 90 days. We assess our receivables, divide them into similar risk pools, and monitor our ongoing credit exposure through active review of our aging buckets. Our activities include timely account reconciliations, dispute resolution, and payment confirmations. We also employ collection agencies and legal counsel to pursue recovery of defaulted receivables.

Our expected loss methodology is developed using historical liquidation rates, current and future economic and market conditions, and a review of the current status of our patients and customers’ trade accounts receivable balances. We also grouped our receivables into similar risk pools to better measure the risks for each pool. After evaluating the risk for each pool, we determined that additional credit loss risk was immaterial for the Patient Care segment. For the Products & Services segment, an allowance for doubtful accounts is recorded, which is deducted from gross accounts receivable to arrive at “Accounts receivable, net.” As of March 31, 2021, we have considered the current and future economic and market conditions resulting in a decrease to the allowance for doubtful accounts by approximately $0.2 million since December 31, 2020.

Accounts receivable, net as of March 31, 2021 and December 31, 2020 is comprised of the following:

 

As of March 31, 2021

As of December 31, 2020

Products &

Products &

(in thousands)

    

Patient Care

    

Services

    

Consolidated

    

Patient Care

    

Services

    

Consolidated

Gross charges before estimates for implicit price concessions

$

143,007

$

21,056

$

164,063

$

156,504

$

21,300

$

177,804

Less estimates for implicit price concessions:

 

 

 

 

 

 

Payor disallowances

(36,816)

(36,816)

(39,343)

(39,343)

Patient non-payments

(6,499)

(6,499)

(7,042)

(7,042)

Accounts receivable, gross

 

99,692

 

21,056

 

120,748

 

110,119

 

21,300

 

131,419

Allowance for doubtful accounts

 

 

(2,586)

 

(2,586)

 

 

(2,823)

 

(2,823)

Accounts receivable, net

$

99,692

$

18,470

$

118,162

$

110,119

$

18,477

$

128,596

Note E — Inventories

Our inventories are comprised of the following:

As of March 31, 

As of December 31, 

(in thousands)

    

2021

    

2020

Raw materials

$

20,251

$

19,716

Work in process

 

15,808

 

12,040

Finished goods

 

42,563

 

44,673

Total inventories

$

78,622

$

76,429

Note F — Acquisitions

2021 Acquisition Activity

In the first quarter of 2021, we completed the acquisitions of all the outstanding equity interests of three O&P businesses and the assets of one O&P business for total consideration of $24.2 million, of which $19.2 million was cash consideration, net of cash acquired, $4.0 million was issued in the form of notes to shareholders at fair value, and $1.0 million in additional consideration.

9

We accounted for these transactions under the acquisition method of accounting and have reported the results of operations of each acquisition as of the respective dates of the acquisitions. We based the estimated fair values of intangible assets on an income approach utilizing the excess earnings method for customer relationships. The income approach utilizes management’s estimates of future operating results and cash flows using a weighted average cost of capital that reflects market participant assumptions. Other significant judgments used in the valuation of tangible assets acquired in the acquisition include estimated selling price of inventory and estimated replacement cost for acquired property, plant, and equipment. For all other assets acquired and liabilities assumed, the fair value reflects the carrying value of the asset or liability due to their short maturity. We recorded the excess of the fair value of the consideration transferred in the acquisitions over the fair value of net assets acquired as goodwill. The goodwill reflects our expectations of favorable future growth opportunities, anticipated synergies through the scale of our O&P operations, and the assembled workforce. We expect that the majority of Goodwill, which has been assigned to our Patient Care reporting unit, will not be deductible for federal income tax purposes. The amount of tax deductible Goodwill acquired in these transactions was not material.

Acquisition-related costs are included in general and administrative expenses in our condensed consolidated statements of operations. Total acquisition-related costs incurred during the three months ended March 31, 2021 was $0.4 million, which includes those costs for transactions that are in progress or were not completed during the respective period. Acquisition-related costs incurred for the acquisitions completed during the three months ended March 31, 2021 was $0.2 million.

We have not presented pro forma combined results for these acquisitions because the impact on previously reported statements of operations would not have been material individually or in the aggregate.

Purchase Price Allocation

We have performed a preliminary valuation analysis of the fair market value of the assets acquired and liabilities assumed in the acquisitions. The final purchase price allocations will be determined when we have completed and fully reviewed the detailed valuations and could differ materially from the preliminary allocations. The final allocations may include changes in allocations of acquired intangible assets as well as goodwill and other changes to assets and liabilities, including deferred taxes. The estimated useful lives of acquired intangible assets are also preliminary.

The aggregate purchase price of these acquisitions were allocated on a preliminary basis as follows:

(in thousands)

    

Cash paid, net of cash acquired

$

19,238

Issuance of Seller Notes at fair value

 

3,956

Additional consideration, net

 

998

Aggregate purchase price

24,192

Accounts receivable

805

Inventories

756

Customer relationships (Weighted average useful life of 5.0 years)

2,460

Other assets and liabilities, net

(589)

Net assets acquired

3,432

Goodwill

$

20,760

Right-of-use assets and lease liabilities related to operating leases recognized in connection with the acquisitions completed during the three months ended March 31, 2021 were $1.5 million.

10

2020 Acquisition Activity

During 2020, we completed the following acquisitions of O&P clinics, none of which were individually material to our financial position, results of operations, or cash flows:

In the second quarter of 2020, we acquired all of the outstanding equity interests of an O&P business for total consideration of $46.2 million at fair value, of which $16.8 million was cash consideration, net of cash acquired, $21.9 million was issued in the form of notes to the former shareholders, $3.5 million in the form of a deferred payment obligation to the former shareholders, and $4.0 million in additional consideration. Of the $21.9 million in notes issued to the former shareholders, approximately $18.1 million of the notes were paid in October 2020 in a lump sum payment and the remaining $3.8 million of the notes are payable in annual installments over a period of three years on the anniversary date of the acquisition. Total payments of $4.0 million under the deferred payment obligation are due in annual installments beginning in the fourth year following the acquisition and for three years thereafter. Additional consideration includes approximately $3.6 million in liabilities incurred to the shareholders as part of the business combination payable in October 2020 and is included in Accrued expenses and other liabilities in the consolidated balance sheet. The remaining $0.4 million in additional consideration represents the effective settlement of amounts due to us from the acquired O&P business as of the acquisition date. We completed the acquisition with the intention of expanding the geographic footprint of our patient care offerings through the acquisition of this high quality O&P provider.

In the fourth quarter of 2020, we completed the acquisitions of all the outstanding equity interests of four O&P businesses for total consideration of $7.1 million, of which $4.9 million was cash consideration, net of cash acquired, $1.9 million was issued in the form of notes to shareholders at fair value, and $0.3 million in additional consideration.

The aggregate purchase price of these acquisitions was allocated on a preliminary basis as follows:

(in thousands)

    

Cash paid, net of cash acquired

$

21,709

Issuance of Seller Notes at fair value

 

23,766

Deferred payment obligation at fair value

3,468

Additional consideration, net

4,319

Aggregate purchase price

 

53,262

Accounts receivable

 

4,224

Inventories

 

2,276

Customer relationships (Weighted average useful life of 5.0 years)

 

6,358

Non-compete agreements (Weighted average useful life of 5.0 years)

 

200

Other assets and liabilities, net

(4,561)

Net assets acquired

 

8,497

Goodwill

$

44,765

Right-of-use assets and lease liabilities related to operating leases recognized in connection with acquisitions completed for the year ended December 31, 2020 were $5.5 million.

Note G — Goodwill and Other Intangible Assets

We assess goodwill and indefinite-lived intangible assets for impairment annually as of October 1st, and between annual tests if an event occurs, or circumstances change, that would more-likely-than-not reduce the fair value of a reporting unit below its carrying value.

11

The following table summarizes the activity in goodwill of the Patient Care operating segment for the periods indicated:

For the Three Months Ended March 31, 2021

Goodwill,

Accumulated

Goodwill,

(in thousands)

  

Gross

  

Impairment

  

Net

As of December 31, 2020

$

705,891

$

(428,668)

$

277,223

Additions from acquisitions

20,760

20,760

Measurement period adjustments (1)

183

183

As of March 31, 2021

$

726,834

$

(428,668)

$

298,166

(1)Measurement period adjustments increasing goodwill relate to acquisitions in the prior year of approximately $0.2 million and are primarily attributable to adjustments to the preliminary allocations of customer relationship intangibles.

For the Year Ended December 31, 2020

Goodwill,

Accumulated

Goodwill,

(in thousands)

  

Gross

  

Impairment

  

Net

As of December 31, 2019

$

660,912

$

(428,668)

$

232,244

Additions from acquisitions

45,144

45,144

Measurement period adjustments (1)

(165)

(165)

As of December 31, 2020

$

705,891

$

(428,668)

$

277,223

(1)Measurement period adjustments reducing goodwill relate to acquisitions in the current and prior year of approximately $0.2 million and are primarily attributable to adjustments to the preliminary allocations of customer relationship intangibles.

As of December 31, 2017, goodwill of approximately $139.3 million within the Products and Services operating segment was impaired in full.

The balances related to intangible assets as of March 31, 2021 and December 31, 2020 are as follows:

As of March 31, 2021

Gross

Carrying

Accumulated

Accumulated

Net Carrying

(in thousands)

    

Amount

    

Amortization

    

Impairment

    

Amount

Customer lists

$

19,339

$

(6,712)

$

$

12,627

Trade name

 

255

 

(183)

 

72

Patents and other intangibles

 

8,994

 

(5,966)

 

3,028

Definite-lived intangible assets

28,588

(12,861)

15,727

Indefinite-lived trade name

9,070

(4,953)

4,117

Total other intangible assets

$

37,658

$

(12,861)

$

(4,953)

$

19,844

As of December 31, 2020

Gross

Carrying

Accumulated 

Accumulated

Net Carrying

(in thousands)

    

Amount

    

Amortization

    

Impairment

    

Amount

Customer lists

$

16,879

$

(5,845)

$

$

11,034

Trade name

 

255

 

(176)

 

79

Patents and other intangibles

 

9,011

 

(5,810)

 

3,201

Definite-lived intangible assets

 

26,145

(11,831)

14,314

Indefinite-lived trade name

 

9,070

(4,953)

4,117

Total other intangible assets

$

35,215

$

(11,831)

$

(4,953)

$

18,431

Amortization expense related to other intangible assets was approximately $1.0 million and $1.4 million for the three months ended March 31, 2021 and 2020.

12

Estimated aggregate amortization expense for definite-lived intangible assets for each of the next five years ended December 31, and thereafter is as follows:

(in thousands)

    

2021 (remainder of the year)

$

3,290

2022

 

4,319

2023

 

4,076

2024

 

2,586

2025

 

1,397

Thereafter

 

59

Total

$

15,727

Note H — Other Current Assets and Other Assets

Other current assets consist of the following:

As of March 31, 

As of December 31, 

(in thousands)

    

2021

   

2020

Non-trade receivables

 

$

6,411

$

6,063

Prepaid maintenance

 

4,057

 

2,942

Prepaid insurance

2,424

266

Other prepaid assets

 

2,597

 

3,086

Total other current assets

 

$

15,489

 

$

12,357

Other assets consist of the following:

As of March 31, 

As of December 31, 

(in thousands)

    

2021

    

2020

Implementation costs for cloud computing arrangements

$

5,187

$

4,811

Cash surrender value of company-owned life insurance

 

4,159

3,973

Finance lease right-of-use assets

2,906

3,016

Deposits

2,156

2,144

Non-trade receivables

1,310

1,274

Other

 

486

516

Total other assets

$

16,204

$

15,734

Note I — Accrued Expenses and Other Current Liabilities and Other Liabilities

Accrued expenses and other current liabilities consist of:

As of March 31, 

As of December 31, 

(in thousands)

    

2021

    

2020

Patient prepayments, deposits, and refunds payable

$

25,823

 

$

27,195

Accrued sales taxes and other taxes

9,837

9,863

Insurance and self-insurance accruals

 

7,912

 

7,651

Derivative liability

7,585

7,686

Accrued professional fees

916

1,016

Accrued interest payable

 

542

 

440

Other current liabilities

 

9,876

 

9,010

Total

$

62,491

 

$

62,861

13

Other liabilities consist of:

As of March 31, 

As of December 31, 

(in thousands)

    

2021

    

2020

Supplemental executive retirement plan obligations

$

20,133

 

$

21,503

Derivative liability

11,182

14,388

Long-term insurance accruals

7,444

7,326

Deferred payroll taxes

5,918

5,918

Unrecognized tax benefits

 

5,050

 

5,465

Other

 

2,018

 

1,993

Total

$

51,745

 

$

56,593

Note J — Income Taxes

We recorded a benefit for income taxes of $2.2 million and $1.9 million for the three months ended March 31, 2021 and March 31, 2020. The effective tax rate was 39.3% and 10.5% for the three months ended March 31, 2021 and March 31, 2020, respectively.

The increase in the effective tax rate for the three months ended March 31, 2021 compared with the three months ended March 31, 2020 is primarily attributable to a higher estimated annual pre-tax income impacted less proportionally by nondeductible permanent items for the three months ended March 31, 2021 as compared to the prior period. Our effective tax rate for the three months ended March 31, 2021 differed from the federal statutory tax rate of 21% primarily due to research and development credits, non-deductible expenses, and windfall from share-based compensation. Our effective tax rate for the three months ended March 31, 2020 differed from the federal statutory tax rate of 21% primarily due to non-deductible expenses and windfall from share-based compensation.

For the year ended December 31, 2020, we completed a formal study to identify qualifying research and development expenses resulting in the recognition of Federal tax benefits of $2.2 million, net of tax reserves, related to 2020 and $6.1 million, net of tax reserves, related to prior years. We recorded the tax benefit, before tax reserves, as a deferred tax asset. For the year ended December 31, 2021, we estimate a Federal tax benefit of $3.0 million, net of tax reserves.

The CARES Act, which was enacted on March 27, 2020, includes changes to certain tax laws related to the deductibility of interest expense and depreciation, as well as the provision to carryback net operating losses to five preceding years. ASC 740, Income Taxes, requires the effects of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As a result of the CARES Act provisions, for the year ended December 31, 2020, we recognized a tax benefit of $4.0 million resulting from the loss carryback claim to a prior period with a higher statutory rate, which also decreased our current income taxes payable by $17.2 million as of December 31, 2020.

14

Note K — Debt and Other Obligations

Debt consists of the following:

As of March 31, 

As of December 31, 

(in thousands)

    

2021

    

2020

Debt:

Term Loan B

$

489,850

$

491,113

Seller Notes

14,876

11,510

Deferred payment obligation

4,000

4,000

Finance lease liabilities and other

3,712

3,869

Total debt before unamortized discount and debt issuance costs

512,438

510,492

Unamortized discount and debt issuance costs, net

(7,048)

(7,395)

Total debt

$

505,390

$

503,097

Current portion of long-term debt:

Term Loan B

$

5,050

$

5,050

Seller Notes

5,043

4,060

Finance lease liabilities and other

971

975

Total current portion of long-term debt

11,064

10,085

Long-term debt

$

494,326

$

493,012

Refinancing of Credit Agreement and Term B Borrowings

On March 6, 2018, we entered into a new $605.0 million Senior Credit Facility (the “Credit Agreement”). The Credit Agreement provides for (i) a revolving credit facility with an initial maximum aggregate amount of availability of $100.0 million that matures in March 2023 and (ii) a $505.0 million Term Loan B facility due in quarterly principal installments commencing June 29, 2018, with all remaining outstanding principal due at maturity in March 2025. Availability under the revolving credit facility is reduced by outstanding letters of credit, which were approximately $5.2 million as of March 31, 2021. We may (a) increase the aggregate principal amount of any outstanding tranche of term loans or add one or more additional tranches of term loans under the loan documents, and/or (b) increase the aggregate principal amount of revolving commitments or add one or more additional revolving loan facilities under the loan documents by an aggregate amount of up to the sum of (1) $125.0 million and (2) an amount such that, after giving effect to such incurrence of such amount (but excluding the cash proceeds of such incremental facilities and certain other indebtedness, and treating all commitments in respect of revolving indebtedness as fully drawn), the consolidated first lien net leverage ratio is equal to or less than 3.80 to 1.00, if certain conditions are satisfied, including the absence of a default or an event of default under the Credit Agreement at the time of the increase and that we obtain the consent of each lender providing any incremental facility.

We had approximately $94.8 million in available borrowing capacity under our $100.0 million revolving credit facility as of March 31, 2021.

Our obligations under the Credit Agreement are currently guaranteed by our material domestic subsidiaries and will from time to time be guaranteed by, subject in each case to certain exceptions, any domestic subsidiaries that may become material in the future. Subject to certain exceptions, the Credit Agreement is secured by first-priority perfected liens and security interests in substantially all of our personal property and each subsidiary guarantor.

Borrowings under the Credit Agreement bear interest at a variable rate equal to (i) LIBOR plus a specified margin, or (ii) the base rate (which is the highest of (a) Bank of America, N.A.’s prime rate, (b) the federal funds rate plus 0.50% or (c) the sum of 1% plus one-month LIBOR) plus a specified margin. For the three months ended March 31, 2021, the weighted average interest rate on outstanding borrowings under our Term Loan B facility was approximately 3.6%. We have entered into interest rate swap agreements to hedge certain of our interest rate exposures, as more fully disclosed in Note M – “Derivative Financial Instruments.”

15

We must also pay (i) an unused commitment fee ranging from 0.375% to 0.500% per annum of the average daily unused portion of the aggregate revolving credit commitments under the Credit Agreement, and (ii) a per annum fee equal to (a) for each performance standby letter of credit outstanding under the Credit Agreement with respect to nonfinancial contractual obligations, 50% of the applicable margin over LIBOR under the revolving credit facility in effect from time to time multiplied by the daily amount available to be drawn under such letter of credit, and (b) for each other letter of credit outstanding under the Credit Agreement, the applicable margin over LIBOR under the revolving credit facility in effect from time to time multiplied by the daily amount available to be drawn for such letter of credit.

The Credit Agreement contains various restrictions and covenants, including: (i) requirements that we maintain certain financial ratios at prescribed levels, (ii) a prohibition on payment of dividends and other distributions and (iii) restrictions on our ability and certain of our subsidiaries to consolidate or merge, create liens, incur additional indebtedness, dispose of assets, or consummate acquisitions outside the healthcare industry. The Credit Agreement includes the following financial covenants applicable for so long as any revolving loans and/or revolving commitments remain outstanding under the Credit Agreement (some of which were amended in May 2020 by the Amendment (as defined and described below)): (i) a maximum consolidated first lien net leverage ratio (“Net Leverage Ratio”) (defined as, with certain adjustments and exclusions, the ratio of consolidated first-lien indebtedness to consolidated net income before interest, taxes, depreciation, amortization, non-cash charges and certain other items (“EBITDA”) for the most recently ended period of four fiscal quarters for which financial statements are available) of 4.50 to 1.00 for the fiscal quarter ended March 31, 2021; 4.25 to 1.00 for the fiscal quarters ended June 30, 2021 through March 31, 2022; and 3.75 to 1.00 for the fiscal quarter ended June 30, 2022 and the last day of each fiscal quarter thereafter; and (ii) a minimum interest coverage ratio (defined as, with certain adjustments, the ratio of our EBITDA to consolidated interest expense to the extent paid or payable in cash) of 2.75 to 1.00 as of the last day of any fiscal quarter.

The Credit Agreement also contains customary events of default. If an event of default under the Credit Agreement occurs and is continuing, then the lenders may declare any outstanding obligations under the Credit Agreement to be immediately due and payable; provided, however, that the occurrence of an event of default as a result of a breach of a financial covenant under the Credit Agreement does not constitute a default or event of default with respect to any term facility under the Credit Agreement unless and until the required revolving lenders shall have terminated their revolving commitments and declared all amounts outstanding under the revolving credit facility to be due and payable. In addition, if we or any subsidiary guarantor becomes the subject of voluntary or involuntary proceedings under any bankruptcy, insolvency, or similar law, then any outstanding obligations under the Credit Agreement will automatically become immediately due and payable. Loans outstanding under the Credit Agreement will bear interest at a rate of 2.00% per annum in excess of the otherwise applicable rate (i) upon acceleration of such loans, (ii) while a payment event of default exists or (iii) upon the lenders’ request, during the continuance of any other event of default.

In May 2020, we entered into an amendment to the Credit Agreement (the “Amendment”) that provided for, amongst other things, an increase in the maximum Net Leverage Ratio to 5.25 to 1.00 for the fiscal quarter ended March 31, 2021; 5.00 to 1.00 for the fiscal quarters ended June 30, 2021 through September 30, 2021; and 4.75 to 1.00 for the quarter ended December 31, 2021 and the last day of each fiscal quarter thereafter. In addition, the Amendment changed the definition of EBITDA used in the Net Leverage Ratio and minimum interest coverage ratio to adjust for declines in net revenue attributable to the COVID-19 pandemic. Borrowings under the revolving credit facility will bear interest at a variable rate equal to the greater of LIBOR or 1%, plus 3.75%. In addition, the Amendment contained certain restrictions and covenants that further limit our ability, and certain of our subsidiaries’ ability, to consolidate or merge, create liens, incur additional indebtedness, dispose of assets, or consummate acquisitions not financed with the proceeds of an equity offering, except that certain acquisitions are permitted after September 30, 2020, in the event we maintain certain leverage and liquidity thresholds. We capitalized debt issuance costs of $0.2 million in connection with the Amendment, which were recorded in Other assets.

We were in compliance with all covenants at March 31, 2021.

Seller Notes and the Deferred Payment Obligation

We typically issue subordinated promissory notes (“Seller Notes”) as a part of the consideration transferred when making acquisitions. The Seller Notes are unsecured and are presented net of unamortized discount of $0.9 million as of March 31, 2021 and December 31, 2020, respectively. We measure these instruments at their estimated fair values as of the respective acquisition dates. The stated interest rates on these instruments range from 2.70% to 3.00%. Principal and interest are payable in quarterly or annual installments and mature through February 2026.

16

Amounts due under the deferred payment obligation to the former shareholders of an acquired O&P business are unsecured and presented net of unamortized discount of $0.5 million as of March 31, 2021 and December 31, 2020, respectively. The deferred payment obligation was measured at its estimated fair value as of the acquisition date and accrues interest at a rate of 3.0%. Principal and interest payments under the deferred payment obligation are due in annual installments beginning in 2024 and for three years thereafter.

Scheduled Maturities of Total Debt

Scheduled maturities of debt at March 31, 2021 were as follows:

(in thousands)

    

2021 (remainder of year)

$

8,273

2022

 

10,040

2023

 

9,641

2024

 

8,979

2025

 

473,009

Thereafter

 

2,496

Total debt before unamortized discount and debt issuance costs, net

512,438

Unamortized discount and debt issuance costs, net

(7,048)

Total debt

$

505,390

Note L — Fair Value Measurements

Financial Instruments

The carrying value of our outstanding term loan as of March 31, 2021 (excluding unamortized discounts and debt issuance costs of $6.1 million) was $489.9 million compared to its fair value of $488.0 million. The carrying value of our outstanding term loan as of December 31, 2020 (excluding unamortized discounts and debt issuance costs of $6.5 million) was $491.1 million compared to its fair value of $489.9 million. Our estimates of fair value are based on a discounted cash flow model and an indicative quote using unobservable inputs, primarily, our risk-adjusted credit spread, which represents a Level 3 measurement.

We have interest rate swap agreements designated as cash flow hedges and are measured at fair value based on inputs other than quoted market prices that are observable, which represents a Level 2 measurement. See Note K - “Debt and Other Obligations” and Note M - “Derivative Financial Instruments” for further information.

We believe that the carrying value of the Seller Notes and the deferred payment obligation approximates their fair values based on a discounted cash flow model using unobservable inputs, primarily, our credit spread for subordinated debt, which represents a Level 3 measurement. The carrying value of our outstanding Seller Notes and the deferred payment obligation issued in connection with past acquisitions as of March 31, 2021 and December 31, 2020 was $18.0 million and $14.6 million, net of unamortized discounts of $0.9 million, respectively.

Note M — Derivative Financial Instruments

Cash Flow Hedges of Interest Rate Risk

In March 2018, we entered into interest rate swap agreements with notional values of $325.0 million at inception, which reduces $12.5 million annually until the swaps mature on March 6, 2024. As of March 31, 2021 and December 31, 2020, our swaps, had a notional value outstanding of $287.5 million and $300.0 million, respectively.

17

Change in Net Loss on Cash Flow Hedges Including Accumulated Other Comprehensive Income (Loss)

The following table presents the activity of cash flow hedges included in accumulated other comprehensive loss for the three months ended March 31, 2021 and 2020, respectively:

(in thousands)

    

Cash Flow Hedges

Balance as of December 31, 2020

$

(16,771)

Unrealized gain recognized in other comprehensive loss, net of tax

529

Reclassification to interest expense, net

1,983

Balance as of March 31, 2021

$

(14,259)

Balance as of December 31, 2019

$

(10,137)

Unrealized loss recognized in other comprehensive loss, net of tax

(9,773)

Reclassification to interest expense, net

 

871

Balance as of March 31, 2020

$

(19,039)

The following table presents the fair value of derivative liabilities within the condensed consolidated balance sheets as of March 31, 2021 and December 31, 2020:

As of March 31, 2021

As of December 31, 2020

(in thousands)

    

Assets

    

Liabilities

    

Assets

    

Liabilities

Derivatives designated as cash flow hedging instruments:

  

  

  

  

Accrued expenses and other current liabilities

 

$

 

$

7,585

$

$

7,686

Other liabilities

 

 

11,182

14,388

Note N — Share-Based Compensation

On May 17, 2019, the shareholders approved the Hanger, Inc. 2019 Omnibus Incentive Plan (the “2019 Plan”). The 2019 Plan authorizes the issuance of (a) up to 2,025,000 shares of Common Stock, plus (b) 243,611 shares available for issuance under the Hanger, Inc. 2016 Omnibus Incentive Plan (the “2016 Plan”). Upon approval of the 2019 Plan, the 2016 Plan was no longer available for future awards.

On May 19, 2017, the Board of Directors approved the Hanger, Inc. Special Equity Plan (the “Special Equity Plan”). The Special Equity Plan authorized up to 1.5 million shares of Common Stock and operates completely independent from our 2016 Omnibus Incentive Plan. All awards under the Special Equity Plan were made on May 19, 2017, which consisted of 0.8 million stock options and 0.3 million performance-based stock awards. No further grants of awards will be authorized or issued under the Special Equity Plan.

As of March 31, 2021, there were 1,459,779 unvested restricted stock awards outstanding. This was comprised of 1,058,024 employee service-based awards with a weighted average grant date fair value of $21.26 per share, 331,132 employee performance-based awards with a weighted average grant date fair value of $21.51 per share, and 70,623 director service-based awards with a weighted average grant date value of $17.07 per share. As of March 31, 2021, there were 487,264 outstanding options exercisable with a weighted average exercise price of $12.77 and average remaining contractual term of 5.3 years.

We recognized a total of approximately $3.2 million and $3.5 million of share-based compensation expense for the three months ended March 31, 2021 and 2020, respectively. Share-based compensation expense, net of forfeitures, relates to restricted stock units, performance-based restricted stock units, and stock options.

18

Note O — Supplemental Executive Retirement Plans

Defined Benefit Supplemental Executive Retirement Plan

Effective January 2004, we implemented an unfunded noncontributory defined benefit plan (“DB SERP”) for certain senior executives. The DB SERP, which we administer, calls for 15 annual payments upon retirement with the payment amount based on years of service and final average salary. Benefit costs and liability balances are calculated based on certain assumptions including benefits earned, discount rates, interest costs, mortality rates, and other factors. Actual results that differ from the assumptions are accumulated and amortized over future periods, affecting the recorded obligation and expense in future periods.

We believe the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. The change in net benefit cost and obligation during the three months ended March 31, 2021 and 2020 is as follows:

Change in Benefit Obligation:

(in thousands)

    

2021

    

2020

Benefit obligation as of December 31, 2020 and 2019, respectively

$

19,746

$

19,214

Service cost

 

123

 

98

Interest cost

 

87

 

121

Payments

 

(1,877)

 

(1,877)

Benefit obligation as of March 31 

$

18,079

$

17,556

Amounts Recognized in the Condensed Consolidated Balance Sheets:

As of March 31, 

As of December 31, 

(in thousands)

    

2021

    

2020

Current accrued expenses and other current liabilities

$

1,913

$

1,913

Non-current other liabilities

 

16,166

 

17,833

Total accrued liabilities

$

18,079

$

19,746

Defined Contribution Supplemental Executive Retirement Plan

In 2013, we established a defined contribution plan (“DC SERP”) that covers certain of our senior executives. Each participant is given a notional account to manage his or her annual distributions and allocate the funds among various investment options (e.g. mutual funds). These accounts are tracking accounts only for the purpose of calculating the participant’s benefit. The participant does not have ownership of the underlying mutual funds. When a participant initiates or changes the allocation of his or her notional account, we will generally make an allocation of our investments to match those chosen by the participant. While the allocation of our sub accounts is generally intended to mirror the participant’s account records (i.e. the distributions and gains or losses on those funds), the employee does not have legal ownership of any funds until payout upon retirement. The underlying investments are owned by the insurance company with which we own an insurance policy.

As of March 31, 2021 and December 31, 2020, the estimated accumulated obligation benefit is $4.9 million and $4.5 million, of which $4.7 million and $4.0 million is funded and $0.2 million and $0.5 million is unfunded at March 31, 2021 and December 31, 2020, respectively.

In connection with the DC SERP benefit obligation, we maintain a company-owned life insurance policy (“COLI”). The carrying value of the COLI is measured at its cash surrender value and is presented within “Other assets” in our condensed consolidated balance sheets. See Note H - “Other Current Assets and Other Assets” for additional information.

19

Note P — Commitments and Contingencies

Guarantees and Indemnification

In the ordinary course of our business, we may enter into service agreements with service providers in which we agree to indemnify or limit the service provider against certain losses and liabilities arising from the service provider’s performance of the agreement. We have reviewed our existing contracts containing indemnification or clauses of guarantees and do not believe that our liability under such agreements is material.

Other Matters

From time to time we are subject to legal proceedings and claims which arise in the ordinary course of our business, and are also subject to additional payments under business purchase agreements. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on our consolidated financial position, liquidity or results of our operations.

We operate in a highly regulated industry and receive regulatory agency inquiries from time to time in the ordinary course of our business, including inquiries relating to our billing activities. No assurance can be given that any discrepancies identified during a regulatory review will not have a material adverse effect on our consolidated financial statements.

Note Q — Segment and Related Information

We have identified 2 operating segments and both performance evaluation and resource allocation decisions are determined based on each segment’s income from operations. The operating segments are described further below.

Patient Care — This segment consists of (i) our owned and operated patient care clinics, and (ii) our contracting and network management business. The patient care clinics provide services to design and fit O&P devices to patients. These clinics also instruct patients in the use, care, and maintenance of the devices. The principal reimbursement sources for our services are:

Commercial private payors and other, which consist of individuals, rehabilitation providers, commercial insurance companies, health management organizations (“HMOs”), preferred provider organizations (“PPOs”), hospitals, vocational rehabilitation, workers’ compensation programs, and similar sources;

Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain persons with disabilities, which provides reimbursement for O&P products and services based on prices set forth in published fee schedules (generally with either 10 regional pricing areas or state level prices) for prosthetics and orthotics and by state for durable medical equipment (DMEPOS);

Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons requiring financial assistance, regardless of age, which may supplement Medicare benefits for persons aged 65 or older requiring financial assistance; and

the VA.

Our contract and network management business, known as Linkia, is the only network management company dedicated solely to serving the O&P market and is focused on managing the O&P services of national and regional insurance companies. We partner with healthcare insurance companies by securing a national or regional contract either as a preferred provider or to manage their O&P network of providers.

Products & Services - This segment consists of our distribution business, which distributes and fabricates O&P products and components to sell to both the O&P industry and our own patient care clinics, and our therapeutic solutions business. The therapeutic solutions business leases and sells rehabilitation equipment and ancillary consumable supplies combined with equipment maintenance, education, and training.

20

Corporate & Other - This consists of corporate overhead and includes unallocated expense such as personnel costs, professional fees, and corporate offices expenses.

The accounting policies of the segments are the same as those described in Note A - “Organization and Summary of Significant Accounting Policies” in our 2020 Form 10-K.

Intersegment revenue primarily relates to sales of O&P components from the Products & Services segment to the Patient Care segment. The sales are priced at the cost of the related materials plus overhead.

Summarized financial information concerning our reporting segments is shown in the following tables. Total assets for each of the segments has not materially changed from December 31, 2020.

Patient Care

Products & Services

For the Three Months Ended

For the Three Months Ended

March 31, 

March 31, 

(in thousands)

    

2021

    

2020

    

2021

    

2020

Net revenues

Third party

$

195,682

$

190,183

$

41,788

$

43,556

Intersegments

47,047

46,022

Total net revenues

195,682

190,183

88,835

89,578

Material costs

 

 

Third party suppliers

51,617

53,124

23,553

24,117

Intersegments

8,305

6,553

38,742

39,469

Total material costs

59,922

59,677

62,295

63,586

Personnel expenses

75,754

76,345

14,126

12,840

Other expenses

 

36,141

 

38,148

5,803

8,320

Depreciation & amortization

 

4,815

 

4,476

1,935

2,752

Segment income from operations

$

19,050

$

11,537

$

4,676

$

2,080

A reconciliation of the total of the reportable segments’ income from operations to consolidated net loss is as follows:

For the Three Months Ended
March 31, 

(in thousands)

    

2021

    

2020

Income (loss) from operations

Patient Care

$

19,050

$

11,537

Products & Services

 

4,676

 

2,080

Corporate & other

 

(21,705)

 

(22,790)

Income (loss) from operations

 

2,021

 

(9,173)

Interest expense, net

 

7,340

 

8,269

Non-service defined benefit plan expense

 

167

 

158

Loss before income taxes

 

(5,486)

 

(17,600)

Benefit for income taxes

 

(2,156)

 

(1,852)

Net loss

$

(3,330)

$

(15,748)

21

A reconciliation of the reportable segments’ net revenues to consolidated net revenues is as follows:

For the Three Months Ended
March 31, 

(in thousands)

    

2021

    

2020

Net revenues

Patient Care

$

195,682

$

190,183

Products & Services

 

88,835

 

89,578

Corporate & other

 

 

Consolidating adjustments

 

(47,047)

 

(46,022)

Consolidated net revenues

$

237,470

$

233,739

A reconciliation of the reportable segments’ material costs to consolidated material costs is as follows:

For the Three Months Ended
March 31, 

(in thousands)

    

2021

    

2020

Material costs

Patient Care

$

59,922

$

59,677

Products & Services

 

62,295

 

63,586

Corporate & other

 

 

Consolidating adjustments

 

(47,047)

 

(46,022)

Consolidated material costs

$

75,170

$

77,241

Note R — Subsequent Events

In April 2021, we entered into a definitive share purchase agreement in connection with the acquisition of an O&P business for a total purchase price of $22.0 million. Due to the proximity of this transaction to the filing of this Form 10-Q, it is not practicable to provide a preliminary purchase price allocation of the fair value of the assets acquired and liabilities assumed in this acquisition.

In April 2021, we recognized an additional $0.7 million in proceeds received from grants under the CARES Act.

22

ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This report contains statements that are forward-looking statements within the meaning of the federal securities laws. Forward-looking statements include information concerning our liquidity and our possible or assumed future results of operations, including descriptions of our business strategies. These statements often include words such as “believe,” “expect,” “project,” “potential,” “anticipate,” “intend,” “plan,” “estimate,” “seek,” “will,” “may,” “would,” “should,” “could,” “forecasts,” or similar words. These statements are based on certain assumptions that we have made in light of our experience in the industry as well as our perceptions of historical trends, current conditions, expected future developments, and other factors we believe are appropriate in these circumstances. We believe these assumptions are reasonable, but you should understand that these statements are not guarantees of performance or results, and our actual results could differ materially from those expressed in the forward-looking statements due to a variety of important factors, both positive and negative, that may be revised or supplemented in subsequent reports.

These statements involve risks, estimates, assumptions, and uncertainties that could cause actual results to differ materially from those expressed in these statements and elsewhere in this report. These uncertainties include, but are not limited to, the financial and business impacts of the COVID-19 pandemic on our operations and the operations of our customers, suppliers, governmental and private payers, and others in the healthcare industry and beyond; federal laws governing the health care industry; governmental policies affecting O&P operations, including with respect to reimbursement; failure to successfully implement a new enterprise resource planning system or other disruptions to information technology systems; the inability to successfully execute our acquisition strategy, including integration of recently acquired O&P clinics into our existing business; changes in the demand for our O&P products and services, including additional competition in the O&P services market; disruptions to our supply chain; our ability to enter into and derive benefits from managed-care contracts; our ability to successfully attract and retain qualified O&P clinicians; and other risks and uncertainties generally affecting the health care industry.

Readers are cautioned that all forward-looking statements involve known and unknown risks and uncertainties including, without limitation, those described in Item 1A. “Risk Factors”, contained in our Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Form 10-K”), some of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements contained therein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate. Actual results could differ materially and adversely from those contemplated by any forward-looking statement. In light of the significant risks and uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements in this discussion to reflect events and circumstances occurring after the date hereof or to reflect unanticipated events. Forward-looking statements and our liquidity, financial condition, and results of operations may be affected by the risks set forth in Item 1A. “Risk Factors”, contained in our 2020 Form 10-K, or by other unknown risks and uncertainties.

Non-GAAP Measures

We refer to certain financial measures and statistics that are not in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We utilize these non-GAAP measures in order to evaluate the underlying factors that affect our business performance and trends. These non-GAAP measures should not be considered in isolation and should not be considered superior to, or as a substitute for, financial measures calculated in accordance with GAAP. We have defined and provided a reconciliation of these non-GAAP measures to their most comparable GAAP measures. The non-GAAP measure used in this Management’s Discussion and Analysis is as follows:

Same Clinic Revenues Per Day - measures the year-over-year change in revenue from clinics that have been open a full calendar year or more. Examples of clinics not included in the same center population are closures and acquisitions. Day-adjusted growth normalizes sales for the number of days a clinic was open in each comparable period.

23

Business Overview

General

We are a leading national provider of products and services that assist in enhancing or restoring the physical capabilities of patients with disabilities or injuries, and we and our predecessor companies have provided O&P services for nearly 160 years. We provide O&P services, distribute O&P devices and components, manage O&P networks, and provide therapeutic solutions to patients and businesses in acute, post-acute, and clinic settings. We operate through two segments - Patient Care and Products & Services.

Our Patient Care segment is primarily comprised of Hanger Clinic, which specializes in the design, fabrication, and delivery of custom O&P devices through 718 patient care clinics and 107 satellite locations in 46 states and the District of Columbia as of March 31, 2021. We also provide payor network contracting services to other O&P providers through this segment.

Our Products & Services segment is comprised of our distribution services and therapeutic solutions businesses. As a leading provider of O&P products in the United States, we engage in the distribution of a broad catalog of O&P parts, componentry, and devices to independent O&P providers nationwide. The other business in our Products & Services segment is our therapeutic solutions business, which develops specialized rehabilitation technologies and provides evidence-based clinical programs for post-acute rehabilitation to patients at approximately 3,900 skilled nursing and post-acute providers nationwide.

For the three months ended March 31, 2021, our net revenues were $237.5 million and we recorded net loss of $3.3 million. For the three months ended March 31, 2020, our net revenues were $233.7 million and we recorded net loss of $15.7 million.

Industry Overview

We estimate that approximately $4.3 billion is spent in the United States each year for prescription-based O&P products and services through O&P clinics. We believe our Patient Care segment currently accounts for approximately 21% of the market, providing a comprehensive portfolio of orthotic, prosthetic, and post-operative solutions to patients in acute, post-acute, and patient care clinic settings.

The O&P patient care services market in the United States is highly fragmented and is characterized by regional and local independent O&P businesses operated predominantly by independent operators, but also including two O&P product manufacturers with substantial international patient care services operations. We do not believe that any single competitor accounts for 2% or more of the nation’s total estimated O&P clinic revenues.

The industry is characterized by stable, recurring revenues, primarily resulting from new patients as well as the need for periodic replacement and modification of O&P devices. We anticipate that the demand for O&P services will continue to grow as the nation’s population increases, and as a result of several trends, including the aging of the U.S. population, there will be an increase in the prevalence of disease-related disability and the demand for new and advanced devices. We believe the typical replacement time for prosthetic devices is three to five years, while the typical replacement time for orthotic devices varies, depending on the device.

We estimate that approximately $1.8 billion is spent in the United States each year by providers of O&P patient care services for the O&P products, components, devices, and supplies used in their businesses. Our Products & Services segment distributes to independent providers of O&P services. We estimate that our distribution sales account for approximately 9% of the market for O&P products, components, devices, and supplies (excluding sales to our Patient Care segment).

We estimate the market for rehabilitation technologies, integrated clinical programs, and clinician training in skilled nursing facilities (“SNFs”) to be approximately $150 million annually. We currently provide these products and services to approximately 24% of the estimated 15,000 SNFs located in the U.S. We estimate the market for rehabilitation technologies, clinical programs, and training within the broader post-acute rehabilitation markets to be approximately $400 million annually. We do not currently provide a meaningful amount of products and services to this broader market.

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Business Description

Patient Care

Our Patient Care segment employs approximately 1,600 clinical prosthetists, orthotists, and pedorthists, which we refer to as clinicians, substantially all of which are certified by either the American Board for Certification (“ABC”) or the Board of Certification of Orthotists and Prosthetists, which are the two boards that certify O&P clinicians. To facilitate timely service to our patients, we also employ technicians, fitters, and other ancillary providers to assist our clinicians in the performance of their duties. Through this segment, we additionally provide network contracting services to independent providers of O&P.

Patients are typically referred to Hanger Clinic by an attending physician who determines a patient’s treatment and writes a prescription. Our clinicians then consult with both the referring physician and the patient with a view toward assisting in the selection of an orthotic or prosthetic device to meet the patient’s needs. O&P devices are increasingly technologically advanced and custom designed to add functionality and comfort to patients’ lives, shorten the rehabilitation process, and lower the cost of rehabilitation.

Based on the prescription written by a referring physician, our clinicians examine and evaluate the patient and either design a custom device or, in the case of certain orthotic needs, utilize a non-custom device, including, in appropriate circumstances, an “off the shelf” device, to address the patient’s needs. When fabricating a device, our clinicians ascertain the specific requirements, componentry, and measurements necessary for the construction of the device. Custom devices are constructed using componentry provided by a variety of third party manufacturers who specialize in O&P, coupled with sockets and other elements that are fabricated by our clinicians and technicians, to meet the individual patient’s physical and ambulatory needs. Our clinicians and technicians typically utilize castings, electronic scans, and other techniques to fabricate items that are specialized for the patient. After fabricating the device, a fitting process is undertaken and adjustments are made to ensure the achievement of proper alignment, fit, and patient comfort. The fitting process often involves several stages to successfully achieve desired functional and cosmetic results.

Given the differing physical weight and size characteristics, location of injury or amputation, capability for physical activity and mobility, cosmetic, and other needs of each individual patient, each fabricated prosthesis and orthosis is customized for each particular patient. These custom devices are commonly fabricated at one of our regional or national fabrication facilities.

We have earned a reputation within the O&P industry for the development and use of innovative technology in our products, which has increased patient comfort and capability and can significantly enhance the rehabilitation process. We utilize multiple scanning and imaging technologies in the fabrication process, depending on the patient’s individual needs, including our proprietary Insignia scanning system. The Insignia system scans the patient and produces an accurate computer-generated image, resulting in a faster turnaround for the patient’s device and a more professional overall experience.

In recent years, we have established a centralized revenue cycle management organization that assists our clinics in pre-authorization, patient eligibility, denial management, collections, payor audit coordination, and other accounts receivable processes.

The principal reimbursement sources for our services are:

Commercial private payors and other non-governmental organizations, which consist of individuals, rehabilitation providers, commercial insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation centers, workers’ compensation programs, third party administrators, and similar sources;

Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain persons with disabilities;

Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons requiring financial assistance, regardless of age, which may supplement Medicare benefits for persons aged 65 or older requiring financial assistance; and

the VA.

25

We typically enter into contracts with third party payors that allow us to perform O&P services for a referred patient and to be reimbursed for our services. These contracts usually have a stated term of one to three years and generally may be terminated without cause by either party on 60 to 90 days’ notice, or on 30 days’ notice if we have not complied with certain licensing, certification, program standards, Medicare or Medicaid requirements, or other regulatory requirements. Reimbursement for services is typically based on a fee schedule negotiated with the third party payor that reflects various factors, including market conditions, geographic area, and number of persons covered. Many of our commercial contracts are indexed to the commensurate Medicare fee schedule that relates to the products or services being provided.

Government reimbursement is comprised of Medicare, Medicaid, and the VA. These payors set maximum reimbursement levels for O&P services and products. Medicare prices are adjusted each year based on the Consumer Price Index for All Urban Consumers (“CPI-U”) unless Congress acts to change or eliminate the adjustment. The CPI-U is adjusted further by an efficiency factor known as the “Productivity Adjustment” or the “Multi-Factor Productivity Adjustment” in order to determine the final rate adjustment each year. There can be no assurance that future adjustments will not reduce reimbursements for O&P services and products from these sources.

We, and the O&P industry in general, are subject to various Medicare compliance audits, including Recovery Audit Contractor (“RAC”) audits, Comprehensive Error Rate Testing (“CERT”) audits, Targeted Probe and Educate (“TPE”) audits, Supplemental Medical Review Contractor (“SMRC”) audits, and Unified Program Integrity Contractor (“UPIC”) audits. TPE audits are generally pre-payment audits, while RAC, CERT, and SMRC audits are generally post-payment audits. UPIC audits can be both pre- or post-payment audits, with a majority currently pre-payment. TPE audits replaced the previous Medicare Administrative Contractor audits. Adverse post-payment audit determinations generally require Hanger to reimburse Medicare for payments previously made, while adverse pre-payment audit determinations generally result in the denial of payment. In either case, we can request a redetermination or appeal, if we believe the adverse determination is unwarranted, which can take an extensive period of time to resolve, currently up to six years or more.

Products & Services

Through our wholly-owned subsidiary, Southern Prosthetic Supply, Inc. (“SPS”), we distribute O&P components to independent O&P clinics and other customers. Through our wholly-owned subsidiary, Accelerated Care Plus Corp. (“ACP”), our therapeutic solutions business is a leading provider of rehabilitation technologies and integrated clinical programs to skilled nursing and post-acute rehabilitation providers. Our value proposition is to provide our customers with a full-service “total solutions” approach encompassing proven medical technology, evidence-based clinical programs, and ongoing consultative education and training. Our services support increasingly advanced treatment options for a broader patient population and more medically complex conditions. We currently serve approximately 3,900 skilled nursing and post-acute providers nationwide. Through our SureFit subsidiary, we also manufacture and sell therapeutic footwear for diabetic patients in the podiatric market. We also operate the Hanger Fabrication Network, which fabricates custom O&P devices for our patient care clinics, as well as for independent O&P clinics.

Through our internal “supply chain” organization, we purchase, warehouse, and distribute over 475,000 SKUs from more than 300 different manufacturers through SPS or directly to our own clinics within our Patient Care segment. Our warehousing and distribution facilities in Nevada, Georgia, Illinois, and Texas provide us with the ability to deliver products to the vast majority of our customers in the United States within two business days. The distribution facility we formerly operated in Pennsylvania ceased operations in September 2020.

Our supply chain organization enables us to:

centralize our purchasing and thus lower our material costs by negotiating purchasing discounts from manufacturers;

better manage our patient care clinic inventory levels and improve inventory turns;

improve inventory quality control;

encourage our patient care clinics to use the most clinically appropriate products; and

coordinate new product development efforts with key vendors.

26

Effects of the COVID-19 Pandemic

Beginning in the last weeks of March 2020, our business volumes began to be adversely affected by the COVID-19 pandemic. As federal, state, and local authorities implemented social distancing and suppression measures to respond to an increasing number of nationwide COVID-19 infections, we experienced a decrease in our patient appointments and general business volumes. In response, during the last week of March 2020, we made certain changes to our operations, implemented a broad number of cost reduction measures, and delayed certain capital investment projects. Although our business volumes have shown gradual improvement from their initial significant decline in mid- 2020, the adverse impact of the COVID-19 pandemic on our business has continued through the first quarter of 2021. As a result, our comparative financial and operational results when viewed as a whole for the periods impacted by the COVID-19 pandemic, including temporary cost reduction measures largely in place during the second and third quarters of 2020, may not be indicative of future financial and operational performance. The volume effects and our operating responses are discussed further in this section, and the effects of COVID-19 on our financial condition is discussed in the “Financial Condition, Liquidity and Capital Resources” section below.

Effect on Business Volumes

Patient appointments in our clinics during the first quarter of 2021 declined by approximately 3% as compared to the corresponding period in 2020. During the quarter, our prosthetics and orthotics day-adjusted sales, excluding acquisitions, increased by approximately 1.0% and 1.9% respectively, with same clinic revenues increasing by 1.4% on a per day basis, when compared to the same period in the prior year. As of the end of March 2021, we re-opened all of our patient care clinics, although 38 clinics were open for reduced hours or by appointment only. We believe the generally more acute nature of conditions that lead to the need for prosthetics and orthotics, the patient age demographics and the relatively greater impact that the absence of access to these devices can have on a patient’s daily life were the primary reasons that have led to the graduated improvement in our business results. Billings for componentry delivered to independent providers of orthotics and prosthetics by our distribution services business remained flat during the first quarter of 2021, as compared to the same period in 2020. Due to significant geographic product mix and timing differences, there can be no assurance that these volumes or billing amounts will be reflective of our future results and are solely provided for the purposes of giving context to the magnitude of the effect of the COVID-19 pandemic on our business during the periods impacted by the COVID-19 pandemic.

In the early months of 2021, vaccines for combating COVID-19 were authorized by the US Food and Drug Administration, and the US government commenced a phased roll out of these vaccines. However, the initial quantities of the vaccines were limited, and the US government prioritized distribution to front-line health care workers and other essential workers, followed by individual populations that are most susceptible to the severe effects of COVID-19. Given the continuing impact of restrictions to mitigate the spread of COVID-19 and unknown challenges with regards to the effectiveness, distribution, and acceptance of COVID-19 vaccines, we believe that the COVID-19 pandemic will continue to affect our business volumes in 2021 when compared to pre- pandemic levels.

Nevertheless, the overall adverse impact of the COVID-19 pandemic on our business volumes has diminished over time, and our patient appointment and other business volumes continue to gradually improve as the prevalence of the virus decreases and COVID-19 vaccines become more widely available. Additionally, we believe that if a patient is initially unable or unwilling to come to one of our clinics to receive their prosthetic or orthotic device, then their ultimate need for that device is not likely to change, and we could accordingly have some favorable volume recovery effect in future periods as the impacts of the COVID-19 pandemic subsides.

Operating and Cost Reduction Responses

Throughout the periods affected by the COVID-19 pandemic, given that our services are considered essential, we have continued to operate our businesses. However, due to the risks posed to our clinicians, other employees, and patients, we have made certain changes to our operating practices in order to promote safety and to minimize the risk of virus transmission. These have included the implementation of certain patient screening protocols and the relocation of certain administrative and support personnel to a “work at home” environment.

27

As a result of the COVID-19 pandemic, we found it necessary to reduce our personnel costs in response to significant decreases in business volumes. Commencing at the start of April 2020, personnel cost reductions were implemented through (i) an average 32% decrease in the salaries of all of our exempt employees, the percentage of which varied from lower amounts for lower salaried employees up to reduction amounts ranging from 47% to 100% for our senior leadership team; (ii) the furloughing of certain employees on a voluntary and involuntary basis; (iii) the reduction of work hours for non-exempt employees; (iv) modification of bonus, commission, and other variable incentive plans; (v) the reduction of overtime expenses; (vi) the elimination of certain open positions; (vii) a reduction in the use of contract employees, and (viii) the temporary suspension of certain auto allowances. During the period April 2020 through September 2020, salaries were gradually reinstated, with full reinstatement of all exempt employees’ salaries being effective on September 19, 2020. We believe this approach allowed us to retain as many employees as possible to preserve the experience, culture, and patient service capabilities of our workforce for periods subsequent to the COVID-19 pandemic.

In addition to these reductions in operating expenses, we temporarily delayed the implementation of our supply chain and financial systems, further discussed in the “New Systems Implementations” section. We also suspended construction of our new fabrication facility in Tempe, Arizona, and other projects related to the reconfiguration of our distribution facilities. We resumed construction of the Tempe, Arizona fabrication facility in the first quarter of 2021, and anticipate that we will recommence the remaining activities in the second quarter of 2021. These actions to delay activities during 2020 will correspondingly delay our achievement of the financial benefits expected from them into future periods.

CARES Act

The CARES Act established the Public Health and Social Services Emergency Fund, also referred to as the Cares Act Provider Relief Fund, which set aside $178.0 billion to be administered through grants and other mechanisms to hospitals, public entities, not-for-profit entities and Medicare- and Medicaid- enrolled suppliers and institutional providers. The purpose of these funds is to reimburse providers for lost revenue attributable to the COVID-19 pandemic, such as lost revenues attributable to canceled procedures, as well as to provide support for health-care related expenses. In April 2020, HHS began making payments to healthcare providers from the $178.0 billion appropriation. These are grants, rather than loans, to healthcare providers, and will not need to be repaid.

During 2020, we recognized a total benefit of $24.0 million in our consolidated statement of operations within Other operating costs for the grant proceeds we received under the CARES Act from HHS. In April 2021, we received approximately $0.7 million in additional grant proceeds under the CARES Act from HHS.

Other Products & Services Performance Considerations

As discussed in our 2020 Form 10-K, under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, several of the larger independent O&P providers we served through the distribution of componentry encountered financial difficulties during the three months ended March 31, 2021, which resulted in our discontinuing distribution services to these customers. Generally, we believe our distribution customers encounter reimbursement pressures similar to those we experience in our own Patient Care segment and, depending on their ability to adapt to the increased claims documentation standards that have emerged in our industry, this may either limit the rate of growth of some of our customers, or otherwise affect the rate of growth we experience in our distribution of O&P componentry to independent providers. During future periods, in addition to the adverse effects of the COVID-19 pandemic discussed above, we currently believe our rate of revenue growth in this segment may decrease as we choose to limit the extent to which we distribute certain low margin orthotic products. Additionally, to the extent that we acquire independent O&P providers who are pre-existing customers of our distribution services, our revenue growth in this segment would be adversely affected as we would no longer recognize external revenue from the components we provide them.

Within our Products & Services segment, in addition to our distribution of products, we provide therapeutic equipment and services to patients at SNFs and other healthcare provider locations. Since 2016, a number of our clients, including several of our larger SNF clients, have been discontinuing their use of our therapeutic services. We believe these discontinuances relate primarily to their overall efforts to reduce the costs they bear for therapy-related services within their facilities. As a part of those terminations of service, in a number of cases, we elected to sell terminating clients the equipment that we had utilized for their locations. Within this portion of our business, we have and continue to respond to these historical trends through the expansion of our products and services offerings.

28

Reimbursement Trends

In our Patient Care segment, we are reimbursed primarily through employer-based plans offered by commercial insurance carriers, Medicare, Medicaid, and the VA. The following is a summary of our payor mix, expressed as an approximate percentage of net revenues for the periods indicated:

For the Three Months Ended
March 31, 

    

2021

    

2020

    

Medicare

29.3

%

32.5

%

Medicaid

17.4

%

16.2

%

Commercial Insurance / Managed Care (excluding Medicare and Medicaid Managed Care)

35.6

%

34.9

%

Veterans Administration

10.1

%

9.4

%

Private Pay

7.6

%

7.0

%

Patient Care

100.0

%

100.0

%

Patient Care constituted 82.4% and 81.4% of our net revenues for the three months ended March 31, 2021 and 2020, respectively. Our remaining net revenues were provided by our Products & Services segment which derives its net revenues from commercial transactions with independent O&P providers, healthcare facilities, and other customers. In contrast to net revenues from our Patient Care segment, payment for these products and services are not directly subject to third party reimbursement from health care payors.

The amount of our reimbursement varies based on the nature of the O&P device we fabricate for our patients. Given the particular physical weight and size characteristics, location of injury or amputation, capability for physical activity, and mobility, cosmetic, and other needs of each individual patient, each fabricated prostheses and orthoses is customized for each particular patient. The nature of this customization and the manner by which our claims submissions are reviewed by payors makes our reimbursement process administratively difficult.

To receive reimbursement for our work, we must ensure that our clinical, administrative, and billing personnel receive and verify certain medical and health plan information, record detailed documentation regarding the services we provide, and accurately and timely perform a number of claims submission and related administrative tasks. It is our belief the increased nationwide efforts to reduce health care costs has driven changes in industry trends with increases in payor pre-authorization processes, documentation requirements, pre-payment reviews, and pre- and post-payment audits, and our ability to successfully undertake these tasks using our traditional approach has become increasingly challenging.

For example, the Medicare contractor for Pricing, Data Analysis and Coding (referred to as “PDAC”) recently announced verification requirements and code changes that has reduced the reimbursement level for certain prosthetic feet, and the VA is in the process of reassessing the method it uses to determine reimbursement levels for O&P services and products provided under certain miscellaneous codes.

A measure of our effectiveness in securing reimbursement for our services can be found in the degree to which payors ultimately disallow payment of our claims. Payors can deny claims due to their determination that a physician who referred a patient to us did not sufficiently document that a device was medically necessary or clearly establish the ambulatory (or”activity”) level of a patient. Claims can also be denied based on our failure to ensure that a patient was currently eligible under a payor’s health plan, that the plan provides full O&P benefits, that we received prior authorization, or that we filed or appealed the payor’s determination timely, as well as on the basis of our coding, failure by certain classes of patients to pay their portion of a claim, or for various other reasons. If any portion of, or administrative factor within, our claim is found by the payor to be lacking, then the entirety of the claim amount may be denied reimbursement.

29

In recent years, we have taken a number of actions to manage payor disallowance trends. These initiatives included: (i) the creation of a central revenue cycle management function; (ii) the implementation of a patient management and electronic health record system; and (iii) the establishment of new clinic-level procedures and training regarding the collection of supporting documentation and the importance of diligence in our claims submission processes.

Payor disallowances is considered an adjustment to the transaction price. Estimated uncollectible amounts due to us by patients are generally considered implicit price concessions and are presented as a reduction of net revenues. These amounts recorded in net revenues within the Patient Care segment for the three months ended March 31, 2021 and 2020 are as follows:

For the Three Months Ended
March 31, 

(dollars in thousands)

    

2021

    

2020

    

Gross charges

$

201,452

$

199,953

Less estimated implicit price concessions arising from:

 

 

Payor disallowances

 

4,514

 

8,075

Patient non-payments

 

1,256

 

1,695

Payor disallowances and patient non-payments

5,770

9,770

Net revenues

$

195,682

$

190,183

Payor disallowances

$

4,514

$

8,075

Patient non-payments

 

1,256

 

1,695

Payor disallowances and patient non-payments

$

5,770

$

9,770

Payor disallowances %

 

2.3

%

 

4.0

%

Patient non-payments %

 

0.6

%

 

0.9

%

Percent of gross charges

 

2.9

%

 

4.9

%

Payor disallowances and patient non-payments as percentage of gross charges both decreased significantly in the first quarter as compared with the first quarter of the prior year. During 2020 and the first quarter of 2021, we benefited from reductions in claims denials and increases in our rates of collection. This has been due to a variety of factors, including increases in our revenue cycle management staffing and an increased focus on collections and liquidity during a period of reduced business volumes, a possible temporary relaxing of payor review procedures during the COVID-19 pandemic, the benefit of CARES Act funds on the ability of patients to pay their portion of claims and other factors relating to our pre-authorization and documentation procedures for devices. We do not believe this favorable trend will necessarily be sustainable in future periods as the COVID-19 pandemic subsides and patient volumes and resulting revenues increase.

Acquisitions

In the first quarter of 2021, we completed the acquisitions of all the outstanding equity interests of three O&P businesses and the assets of one O&P business for total consideration of $24.2 million, of which $19.2 million was cash consideration, net of cash acquired, $4.0 million was issued in the form of notes to shareholders at fair value, and $1.0 million in additional consideration.

30

During 2020, we completed the following acquisitions of O&P clinics, none of which were individually material to our financial position, results of operations, or cash flows:

In the second quarter of 2020, we acquired all of the outstanding equity interests of an O&P business for total consideration of $46.2 million at fair value, of which $16.8 million was cash consideration, net of cash acquired, $21.9 million was issued in the form of notes to the former shareholders, $3.5 million in the form of a deferred payment obligation to the former shareholders, and $4.0 million in additional consideration. Of the $21.9 million in notes issued to the former shareholders, approximately $18.1 million of the notes were paid in October 2020 in a lump sum payment and the remaining $3.8 million of the notes are payable in annual installments over a period of three years on the anniversary date of the acquisition. Total payments of $4.0 million under the deferred payment obligation are due in annual installments beginning in the fourth year following the acquisition and for three years thereafter. Additional consideration includes approximately $3.6 million in liabilities incurred to the shareholders as part of the business combination payable in October 2020 and is included in Accrued expenses and other liabilities in the consolidated balance sheet. The remaining $0.4 million in additional consideration represents the effective settlement of amounts due to us from the acquired O&P business as of the acquisition date. We completed the acquisition with the intention of expanding the geographic footprint of our patient care offerings through the acquisition of this high quality O&P provider.

·

In the fourth quarter of 2020, we completed the acquisitions of all the outstanding equity interests of four O&P businesses for total consideration of $7.1 million, of which $4.9 million was cash consideration, net of cash acquired, $1.9 million was issued in the form of notes to shareholders at fair value, and $0.3 million in additional consideration.

Acquisition-related costs are included in general and administrative expenses in our consolidated statements of operations. Total acquisition-related costs incurred during the three month period ended March 31, 2021 were $0.4 million, which includes those costs for transactions that are in progress or not completed during the respective period. Acquisition-related costs incurred for acquisitions completed during the three month period ended March 31, 2021 were $0.2 million. Total acquisition-related costs incurred during the year ended December 31, 2020 were $0.9 million, which includes those costs for transactions that are in progress or not completed during the respective period. Acquisition-related costs incurred for acquisitions completed during the year ended December 31, 2020 were $0.6 million.

New Systems Implementations

During 2019, we commenced the design, planning, and initial implementation of new financial and supply chain systems (“New Systems Implementations”), and planned to invest in new servers and software that operate as a part of our technology infrastructure.

As discussed in the “Effects of the COVID-19 Pandemic” section, we elected in 2020 to temporarily delay our New Systems Implementations as part of our efforts to preserve liquidity. We recommenced these activities in the second quarter of 2021.

In connection with our new financial and supply chain systems, for the three month period ended March 31, 2021 and March 31, 2020, we expensed $0.6 million and $0.9 million, respectively. For the year ended December 31, 2020, we expensed $2.6 million. We currently anticipate that we will spend $5.6 million for the full year 2021 on these systems.

As of March 31, 2021, we capitalized $5.5 million of implementation costs for cloud computing arrangements, net of accumulated amortization, and recorded in other current assets and other assets in the condensed consolidated balance sheet.

Personnel

While we have traditionally been able to recruit and retain adequate staffing to operate and support our business, our ability to support growth is dependent on our ability to add new personnel. Nevertheless, as many employers are experiencing, we are currently finding it difficult to recruit and retain personnel in certain positions, including clinic front office administrative, distribution center, and fabrication center positions. We may find it necessary to increase wages in these areas in coming quarters if we find that we are unable to attract a sufficient number of personnel.

31

Seasonality

We believe our business is affected by the degree to which patients have otherwise met the deductibles for which they are responsible in their medical plans during the course of the year. The first quarter is normally our lowest relative net revenue quarter, followed by the second and third quarters, which are somewhat higher and consistent with one another. Due to the general fulfillment by patients of their health plan co-payments and deductible requirements towards the year’s end, our fourth quarter is normally our highest revenue producing quarter. However, historical seasonality patterns have been impacted by the COVID-19 pandemic and may not be reflective of our prospective financial results and operations. Please refer to the “Effects of the COVID-19 Pandemic” section for further discussion.

Our results are also affected, to a lesser extent, by our holding of an education fair in the first quarter of each year. This event is conducted to assist our clinicians in maintaining their training and certification requirements and to facilitate a national meeting with our clinical leaders. We also invite manufacturers of the componentry for the devices we fabricate to these annual events so they can demonstrate their products and otherwise assist in our training process. Due to the COVID-19 pandemic, we conducted our first virtual education fair in 2021. During the three months ended March 31, 2021 and 2020 we spent $0.3 million and $2.3 million on travel and other costs associated with this event, respectively. In addition to the costs we incur associated with this annual event, we also lose the productivity of a significant portion of our clinicians during the period in which this event occurs, which contributes to the lower seasonal revenue level we experience during the first quarter of each year.

Critical Accounting Policies

Our analysis and discussion of our financial condition and results of operations is based upon the consolidated financial statements that have been prepared in accordance with GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. GAAP provides the framework from which to make these estimates, assumptions, and disclosures. We have chosen accounting policies within GAAP that management believes are appropriate to fairly present, in all material respects, our operating results, and financial position. We believe the following accounting policies are critical to understanding our results of operations and the more significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue recognition

Accounts receivable, net

Inventories

Business combinations

Goodwill and other intangible assets, net

Income taxes

The use of different estimates, assumptions, or judgments could have a material effect on reported amounts of assets, liabilities, revenue, expenses, and related disclosures as of the date of the financial statements and during the reporting period. These critical accounting policies are described in more detail in our 2020 Form 10-K, under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note A - “Organization and Summary of Significant Accounting Policies” contained within these condensed consolidated financial statements.

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Results of Operations

Our results of operations for the three months ended March 31, 2021 and 2020 were as follows (unaudited):

For the Three Months Ended

    

 

March 31, 

Percent Change

(dollars in thousands)

    

2021

    

2020

    

2021 vs 2020

 

Net revenues

$

237,470

$

233,739

 

1.6

%

Material costs

 

75,170

 

77,241

 

(2.7)

%

Personnel costs

 

89,880

 

89,185

 

0.8

%

Other operating costs

 

31,460

 

35,886

 

(12.3)

%

General and administrative expenses

 

30,941

 

31,769

 

(2.6)

%

Depreciation and amortization

 

7,998

 

8,831

 

(9.4)

%

Operating expenses

 

235,449

 

242,912

 

(3.1)

%

Income (loss) from operations

 

2,021

 

(9,173)

 

122.0

%

Interest expense, net

 

7,340

 

8,269

 

(11.2)

%

Non-service defined benefit plan expense

 

167

 

158

 

5.7

%

Loss before income taxes

 

(5,486)

 

(17,600)

 

68.8

%

Benefit for income taxes

 

(2,156)

 

(1,852)

 

(16.4)

%

Net loss

$

(3,330)

$

(15,748)

 

78.9

%

During these periods, our operating expenses as a percentage of net revenues were as follows:

For the Three Months Ended
March 31, 

    

2021

    

2020

 

Material costs

31.7

%  

33.0

%

Personnel costs

37.8

%  

38.2

%

Other operating costs

13.2

%  

15.3

%

General and administrative expenses

13.0

%  

13.6

%

Depreciation and amortization

3.4

%  

3.8

%

Operating expenses

99.1

%  

103.9

%

Three Months Ended March 31, 2021 Compared to the Three Months Ended March 31, 2020

Relevance of First Quarter Results to Comparative and Future Periods. As discussed in “Effects of the COVID-19 Pandemic” above, commencing late in the first quarter of 2020, our revenues and operating results began to be adversely affected by the COVID-19 pandemic, a trend which continued throughout 2020 and into 2021. The effects of this public health emergency on our revenues and earnings in the three months ended March 31, 2021 impacted the comparison to our historical financial results. As a result, our comparative financial and operational results when viewed as a whole for the periods impacted by the COVID-19 pandemic, including temporary cost reduction measures largely in place during the second and third quarters of 2020, may not be indicative of future financial and operational performance. Please refer to the “Effects of the COVID-19 Pandemic” section above and the “Financial Condition, Liquidity and Capital Resources” section below for additional forward-looking information concerning our current expectations regarding the effect of the COVID-19 pandemic on our prospective results and financial condition.

33

Net revenues. Net revenues for the three months ended March 31, 2021 were $237.5 million, an increase of $3.7 million, or 1.6%, from $233.7 million for the three months ended March 31, 2020. Net revenues by operating segment, after elimination of intersegment activity, were as follows:

For the Three Months Ended

    

 

March 31, 

Percent

(dollars in thousands)

    

2021

    

2020

    

Change

    

 Change

 

Patient Care

$

195,682

$

190,183

$

5,499

 

2.9

%

Products & Services

 

41,788

 

43,556

 

(1,768)

 

(4.1)

%

Net revenues

$

237,470

$

233,739

$

3,731

 

1.6

%

Patient Care net revenues for the three months ended March 31, 2021 were $195.7 million, an increase of $5.5 million, or 2.9%, from $190.2 million for the same period in the prior year. Same clinic revenues decreased $3.3 million for the three months ended March 31, 2021. However, on a day-adjusted basis, excluding acquisitions, same clinic revenues increased by 1.4%, as there were two fewer business days in the first quarter of 2021 as compared to 2020. Net revenues from acquired clinics and consolidations increased $9.0 million, and revenues from other services decreased $0.2 million.

Prosthetics constituted approximately 52% of our total Patient Care revenues for the three months ended March 31, 2021 and 2020, excluding the impact of acquisitions. Prosthetic revenues for the three months ended March 31, 2021 were 1.0% higher, on a per-day basis, than the same period in the prior year, excluding the impact of acquisitions. Orthotics, shoes, inserts, and other products increased by 1.9% on a per-day basis compared to the same comparative prior periods, excluding the impact of acquisitions. Revenue growth in the quarter was benefited by decreases in disallowance and patient non-payment rates as compared to the prior year period, please refer to the “Reimbursement Trends” section above for a discussion of these favorable trends. Revenues in the latter half of March 2020 were adversely affected due to a decline in patient appointment volumes as a result of the onset of the COVID-19 pandemic, governmental suppression measures implemented in response to the COVID-19 pandemic, and other factors impacting our business volumes discussed in the “Effects of the COVID-19 Pandemic” section.

Products & Services net revenues for the three months ended March 31, 2021 were $41.8 million, a decrease of $1.8 million, or 4.1% from the same period in the prior year. This was primarily attributable to a decrease of $1.0 million, or 3.3%, in the distribution of O&P componentry to independent providers stemming primarily from there being two fewer business days in the first quarter of 2021 as compared with that of 2020. Within our distribution services, decreases in revenue associated with the discontinuance of providing certain off-the-shelf orthotics to podiatry distributors and reductions in revenue associated with our acquisition of independent orthotics and prosthetic providers were offset by increases in volumes to new customers and the expansion of sales to existing customers of additional componentry items added to our product offerings. In addition, net revenues from therapeutic solutions decreased $0.8 million, or 6.2%, primarily as a result of the impact of historical customer lease cancellations and discounts.

Material costs. Material costs for the three months ended March 31, 2021 were $75.2 million, a decrease of $2.1 million or 2.7%, from the same period in the prior year. Total material costs as a percentage of net revenues decreased to 31.7% in the three months ended March 31, 2021 from 33.0% in the three months ended March 31, 2020 primarily due to changes in our Product & Services segment business and product mix. Material costs by operating segment, after elimination of intersegment activity, were as follows:

For the Three Months Ended

    

 

March 31, 

Percent

(dollars in thousands)

    

2021

    

2020

    

Change

    

 Change

 

Patient Care

$

59,922

$

59,677

$

245

0.4

%

Products & Services

15,248

 

17,564

 

(2,316)

 

(13.2)

%

Material costs

$

75,170

$

77,241

$

(2,071)

 

(2.7)

%

Patient Care material costs increased $0.2 million, or 0.4%, for the three months ended March 31, 2021 compared to the same period in the prior year as a result of the reduction in segment net sales, offset by additional costs as a result of our acquisitions and changes in the segment product mix. Patient Care material costs as a percent of segment net revenues decreased to 30.6% for the three months ended March 31, 2021 from 31.4% for the three months ended March 31, 2020.

34

Products & Services material costs decreased $2.3 million, or 13.2%, for the three months ended March 31, 2021 compared to the same period in the prior year. As a percent of net revenues in the Products & Services segment, material costs were 36.5% for the three months ended March 31, 2021 as compared to 40.3% in the same period of 2020. The decrease in cost of materials as a percent of segment net revenues was primarily due to cost savings related to certain supply chain initiatives and a change in business volume and product mix within the segment.

Personnel costs. Personnel costs for the three months ended March 31, 2021 were $89.9 million, an increase of $0.7 million, or 0.8%, from $89.2 million for the same period in the prior year. Personnel costs by operating segment were as follows:

For the Three Months Ended

    

    

 

March 31, 

Percent

(dollars in thousands)

    

2021

    

2020

    

Change

    

 Change

 

Patient Care

$

75,754

$

76,345

$

(591)

(0.8)

%

Products & Services

14,126

 

12,840

 

1,286

 

10.0

%

Personnel costs

$

89,880

$

89,185

$

695

 

0.8

%

Personnel costs for the Patient Care segment were $75.8 million for the three months ended March 31, 2021, a decrease of $0.6 million, or 0.8%, from $76.3 million in the same period of the prior year. The decrease in Patient Care personnel costs during the three months ended March 31, 2021 was primarily related to the release of the vacation accrual of $0.9 million, as well as decreases in salary expense of $0.2 million, commissions of $0.2 million, and payroll taxes of $0.1 million. These decreases were offset by an increase of $0.7 million in benefits and an increase in variable compensation and other personnel costs of $0.1 million, compared to the three months ended March 31, 2020.

Personnel costs in the Products & Services segment were $14.1 million for the three months ended March 31, 2021, an increase of $1.3 million compared to the same period in the prior year. Salary expense increased $0.5 million and bonus, commissions, and other personnel cost increased $0.8 million for the three months ended March 31, 2021 compared to the same period in the prior year.

Other operating costs. Other operating costs for the three months ended March 31, 2021 were $31.5 million, a decrease of $4.4 million, or 12.3%, from $35.9 million for the same period in the prior year. Travel, professional education, and other expenses decreased $4.4 million due to cost mitigation efforts as a result of the COVID-19 pandemic, and bad debt expense decreased $2.1 million primarily due to favorable collection experience. During the quarter we benefited by $2.0 million in travel and professional education expenses through conducting our annual provider meeting and education event as a “virtual” event. In future years, we currently believe that this first quarter meeting will be conducted as it has in prior years, as a physical meeting, and these expenses will resume in those periods. The decreases were offset by a $1.5 million increase in other expenses and a $0.6 million increase in rent expense from new, renewed, and acquired leases as compared to the same period in the prior year.

General and administrative expenses. General and administrative expenses for the three months ended March 31, 2021 were $30.9 million, a decrease of $0.8 million, or 2.6%, from the same period in the prior year. Professional accounting and legal fees decreased $1.5 million primarily due to targeted efforts to remediate material weaknesses in our internal controls over financial reporting that occurred in the three months ended March 31, 2020 that did not recur in the same period of 2021, and salary and other expenses decreased $0.7 million as compared to the same period in the prior year. The decreases were offset by an increase in incentive and other personnel costs of $1.4 million compared to the three months ended March 31, 2020.

Depreciation and amortization. Depreciation and amortization for the three months ended March 31, 2021 was $8.0 million, a decrease of $0.8 million, or 9.4%, from the same period in the prior year. Depreciation expense decreased $0.6 million and amortization expense decreased $0.2 million when compared to the same period in the prior year.

Interest expense, net. Interest expense for the three months ended March 31, 2021 decreased 11.2% to $7.3 million from $8.3 million for the same period in the prior year.

35

Benefit for income taxes. The benefit for income taxes for the three months ended March 31, 2021 was $2.2 million, or 39.3% of loss before income taxes, compared to a benefit of $1.9 million, or 10.5% of loss before income taxes for the three months ended March 31, 2020. The effective tax rate for the three months ended March 31, 2021 consisted principally of the 21% federal statutory tax rate, research and development credits, and permanent tax differences. The increase in the effective tax rate for the three months ended March 31, 2021 compared with the three months ended March 31, 2020 is primarily attributable to a higher estimated annual pre-tax income impacted less proportionally by nondeductible permanent items for the three months ended March 31, 2021 as compared to the prior period.

We evaluate our deferred tax assets quarterly to determine whether adjustments to the valuation allowance are appropriate in light of changes in facts or circumstances, such as changes in expected future pre-tax earnings, tax law, interactions with taxing authorities, and developments in case law. Our material assumptions include forecasts of future pre-tax earnings and the nature and timing of future deductions and income represented by the deferred tax assets and liabilities, all of which involve the exercise of significant judgment. As of March 31, 2021, our valuation allowance was approximately $2.1 million.

For the year ended December 31, 2020, we completed a formal study to identify qualifying research and development expenses resulting in the recognition of Federal tax benefits of $2.2 million, net of tax reserves, related to 2020 and $6.1 million, net of tax reserves, related to prior years. We recorded the tax benefit, before tax reserves, as a deferred tax asset. For the year ended December 31, 2021, we estimate a Federal tax benefit of $3.0 million, net of tax reserves. We record the tax benefit, before tax reserves, as a deferred tax asset.

The CARES Act, which was enacted on March 27, 2020, includes changes to certain tax laws related to the deductibility of interest expense and depreciation, as well as the provision to carryback net operating losses to five preceding years. ASC 740, Income Taxes, requires the effects of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As a result of the CARES Act provisions, for the year ended December 31, 2020, we recognized a tax benefit of $4.0 million resulting from the loss carryback claim to a prior period with a higher statutory rate, which also decreased our current income taxes payable by $17.2 million as of December 31, 2020.

Financial Condition, Liquidity, and Capital Resources

Liquidity

Our cash and cash equivalents, and any amounts we have available for borrowing under our revolving credit facility, are immediately available to provide cash for our operations and capital expenditures. We refer to the sum of these two amounts as our “liquidity.”

At March 31, 2021, we had total liquidity of $165.1 million, which reflected a decrease of $74.3 million from the $239.4 million in liquidity we had as of December 31, 2020. Our liquidity at March 31, 2021 was comprised of cash and cash equivalents of $70.3 million and $94.8 million in available borrowing capacity under our $100.0 million revolving credit facility. This decrease in liquidity primarily related to a decrease in cash of $74.3 million, comprised of net cash used in operations of $42.4 million, cash paid for acquisitions, net of cash acquired, of $19.4 million, capital expenditures of $6.9 million, and net cash used in financing activities of $6.4 million. Due to the seasonality of our business and our payment of annual incentive compensation and related compensatory items, we usually experience significant first quarter uses of cash in operations.

On a comparable period basis, our liquidity of $165.1 million as of March 31, 2021 reflected an increase of $33.3 million as compared with the liquidity of $131.8 million reported as of March 31, 2020.

Our Credit Agreement contains customary representations and warranties, as well as financial covenants, including that we maintain compliance with certain leverage and interest coverage ratios. If we are not compliant with our debt covenants in any period, absent a waiver or amendment of our Credit Agreement, we may be unable to access funds under our revolving credit facility. Due to the additional borrowings under our revolving credit facility in March 2020, which were repaid in full during the third quarter of 2020, and in anticipation of the potential economic impact of the COVID-19 pandemic, we entered into an amendment to the Credit Agreement that provided for, among other things, increases in the allowable level of indebtedness we may carry relative to our earnings, changes in the definition of EBITDA used to compute certain financial ratios, certain restrictions regarding investments and payments we may make until the completion of the first quarter of 2021 and increases in the interest costs associated with borrowings under our revolving credit facility. We were in compliance with our debt covenants as of March 31, 2021.

36

For additional discussion, please refer to the Liquidity Outlook section below.

Working Capital and Days Sales Outstanding

At March 31, 2021, we had working capital of $100.2 million compared to working capital of $129.3 million at December 31, 2020. Our working capital decreased $29.0 million during the three months ended March 31, 2021 due to a decrease in current assets of $79.4 million, partially offset by a decrease in current liabilities of $50.4 million.

The decrease in current assets of $79.4 million was primarily attributable to a decrease in Cash and cash equivalents of $74.3 million discussed in the “Liquidity” section above, and a decrease in Accounts receivable, net of $10.4 million. The decreases were offset by an increase of approximately $3.1 million in Other current assets and Inventories of $2.2 million.

The decrease in current liabilities of $50.4 million was primarily attributable to a net decrease in accrued incentive compensation related costs of $36.9 million, primarily due to the payment of $42.9 million in annual incentive compensation and the employer 401(k) matching contribution made during the first quarter of the year. The remainder of the decrease is primarily attributable to a decrease of $14.1 million in Accounts payable.

Days sales outstanding (“DSO”) is a calculation that approximates the average number of days between the billing for our services and the date of our receipt of payment, which we estimate using a 90-day rolling period of net revenue. This computation can provide a relative measure of the effectiveness of our billing and collections activities. Clinics acquired during the past 90-day period are excluded from the calculation. As of March 31, 2021, our DSO was 45 days, which compares favorably to a DSO of 50 days as of March 31, 2020. The reduction is attributable to improved collections experience due to the targeted efforts of our centralized revenue cycle management function.

Sources and Uses of Cash for the Three Months Ended March 31, 2021 Compared to March 31, 2020

Net cash flows used in operating activities increased $20.4 million to $42.4 million for the three months ended March 31, 2021 from net cash used in operating activities of $22.0 million for the three months ended March 31, 2020. The comparative increase in operating cash flows is primarily attributable to a combination of lower revenues and the acceleration of cash collections of Accounts receivable of $17.1 million, when compared to the same periods in the prior year. This is consistent with the decline in DSO from 50 days as of March 31, 2020 to 45 days as of March 31, 2021. The remaining increase in cash used from operating activities primarily related to cash used in the satisfaction of Accounts payable of $9.3 million and changes in Inventories of $2.4 million, partially offset by an increase in income of $12.4 million during the quarter.

Cash flows used in investing activities increased $17.0 million to $25.5 million for the three months ended March 31, 2021, from $8.5 million for the three months ended March 31, 2020. The increase in cash used in investing activities was due to an increase of $19.4 million in cash paid for acquisitions, net of cash acquired, partially offset by $1.9 million less in capital expenditures.

Cash flows used in financing activities decreased to $6.4 million for the three months ended March 31, 2021, from cash provided by financing activities of $72.0 million for the three months ended March 31, 2020. The decrease in cash used in financing activities is primarily due to $79.0 million in proceeds from borrowings under our revolving credit facility in March 2020, offset by the net effect of activities of $0.6 million.

Effect of Indebtedness

On March 6, 2018, we entered into a $605.0 million Credit Agreement, which provides for (i) a revolving credit facility with an initial maximum aggregate amount of availability of $100.0 million that matures in March 2023 and (ii) a $505.0 million Term Loan B facility due in quarterly principal installments commencing June 29, 2018, with all remaining outstanding principal due at maturity in March 2025. For additional discussion surrounding the Credit Agreement, see Note K - “Debt and Other Obligations,” in the notes to the condensed consolidated financial statements contained elsewhere in this report. Cash paid for interest totaled $6.6 million and $7.5 million for the three months ended March 31, 2021 and 2020, respectively.

37

In May 2020, we entered into an amendment to the Credit Agreement (the “Amendment”) that provided for, amongst other things, an increase in the maximum Net Leverage Ratio to 5.25 to 1.00 for the fiscal quarter ended March 31, 2021; 5.00 to 1.00 for the fiscal quarters ended June 30, 2021 through September 30, 2021; and 4.75 to 1.00 for the quarter ended December 31, 2021 and the last day of each fiscal quarter thereafter. In addition, the Amendment changed the definition of EBITDA used in the Net Leverage Ratio and minimum interest coverage ratio to adjust for declines in net revenue attributable to the COVID-19 pandemic. Borrowings under the revolving credit facility will bear interest at a variable rate equal to the greater of LIBOR or 1.00%, plus 3.75%. In addition, the Amendment contained certain restrictions and covenants that further limit our ability, and certain of our subsidiaries’ ability, to consolidate or merge, create liens, incur additional indebtedness, dispose of assets, or consummate acquisitions if we do not maintain certain leverage and liquidity thresholds. During the fourth quarter of 2020, we recommenced our acquisition of O&P providers.

Scheduled maturities of debt as of March 31, 2021 were as follows:

(in thousands)

    

2021 (remainder of year )

$

8,273

2022

 

10,040

2023

 

9,641

2024

 

8,979

2025

 

473,009

Thereafter

 

2,496

Total debt before unamortized discount and debt issuance costs, net

 

512,438

Unamortized discount and debt issuance costs, net

 

(7,048)

Total debt

$

505,390

Liquidity Outlook

Our Credit Agreement has a term loan facility with $489.9 million in principal outstanding at March 31, 2021, due in quarterly principal installments equal to 0.25% of the original aggregate principal amount of $505.0 million, with all remaining outstanding principal due at maturity in March 2025, and, as of March 31, 2021, a revolving credit facility with no borrowings and available borrowing capacity of $94.8 million that matures in March 2023.

Our primary sources of liquidity are cash and cash equivalents, and available borrowings under our revolving credit facility. Due to the economic and social activity impacts outlined in the “Effects of the COVID-19 Pandemic” section above, we expect the continuing disruption to have an unfavorable impact on our operations, financial condition, and results of operations. While the duration and extent of the impact from the COVID-19 pandemic on our operations and liquidity depends on future developments which cannot be predicted with certainty, we believe that our existing sources of liquidity, when combined with our operating cash flows and other measures taken to enhance our liquidity position and cost structure, will continue to allow us to finance our operations for the foreseeable future. Please refer to the “Effects of the COVID-19 Pandemic” section above for additional discussion.

We anticipate that we will continue to pursue acquisitions and other growth initiatives that provide value to our shareholders. We expect to continue to generate positive operating cash flows that, together with our revolving credit facility, will allow us to invest in acquisitions and other growth opportunities to provide value to our shareholders. From time to time, we may seek additional funding through the issuance of debt or equity securities to provide additional liquidity to fund acquisitions aligned with our strategic priorities and for other general corporate purposes.

CARES Act

The CARES Act established the Public Health and Social Services Emergency Fund, also referred to as the Cares Act Provider Relief Fund, which set aside $178.0 billion to be administered through grants and other mechanisms to hospitals, public entities, not-for-profit entities and Medicare- and Medicaid- enrolled suppliers and institutional providers. The purpose of these funds is to reimburse providers for lost revenue and health-care related expenses that are attributable to the COVID-19 pandemic. In April 2020, the U.S. Department of Health and Human Services (“HHS”) began making payments to healthcare providers from the $178.0 billion appropriation. These are payments, rather than loans, to healthcare providers, and will not need to be repaid.

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During 2020, we recognized a total benefit of $24.0 million in our condensed consolidated statement of operations within Other operating costs Grants from HHS. We recognize income related to grants on a systematic and rational basis when it becomes probable that we have complied with the terms and conditions of the grant and in the period in which the corresponding costs or income related to the grant are recognized. We recognized the benefit from the Grants within Other operating costs in our Patient Care segment. In April 2021, we recognized an additional $0.7 million in proceeds received from grants under the CARES Act.

The CARES Act also provides for a deferral of the employer portion of payroll taxes incurred during the COVID-19 pandemic through December 2020. The provisions allow us to defer half of such payroll taxes until December 2021 and the remaining half until December 2022. We deferred $11.8 million of payroll taxes within Accrued compensation related costs and Other liabilities in the condensed consolidated balance sheet as of March 31, 2021.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that may or could have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our future financial results are subject to a variety of risks, including interest rate risk. Our interest expense is sensitive to changes in market interest rates. To manage the impact of the interest rate risk associated with our Credit Agreement, we enter into interest rate swaps from time to time, effectively converting a portion of the cash flows related to variable-rate debt into fixed-rate cash flows.

As of March 31, 2021, we had a combined principal amount of $489.9 million of variable rate debt under our Term Loan B and revolving credit facility and a notional amount of $287.5 million of fixed to variable interest rate swap agreements. Based on our hedged and unhedged positions, a hypothetical increase or decrease in interest rates of 1.0% would impact our annual interest expense by $2.5 million.

ITEM 4.     CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.

Management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and effectiveness of our disclosure controls and procedures as of March 31, 2021. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2021.

Changes in Internal Control over Financial Reporting

There have been no material changes to our internal controls over financial reporting during the period ended March 31, 2021.

Therefore, in accordance with Rule 13a-15(d) of the Exchange Act and with the participation of our Chief Executive Officer and our Chief Financial Officer, management determined there have been no material changes to our internal control over financial reporting during the period ended March 31, 2021.

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PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

Not applicable.

ITEM 1A.  RISK FACTORS

Not applicable.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

There has been no share repurchase activity during the three months ended March 31, 2021.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

There have been no defaults upon senior securities during the three months ended March 31, 2021.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.  OTHER INFORMATION

None to report.

ITEM 6.   EXHIBITS

The documents in the accompanying Exhibits Index are filed, furnished, or incorporated by reference as part of this report and such Exhibits Index is incorporated herein by reference.

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EXHIBITS INDEX

Exhibit
No.

    

Document

 

31.1

Written Statement of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002.  (Filed herewith.)

31.2

Written Statement of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002.  (Filed herewith.)

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Written Statement of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes Oxley Act of 2002.  (Filed herewith.)

101.INS

XBRL Instance Document.  (Filed herewith.)

101.SCH

XBRL Taxonomy Extension Schema.  (Filed herewith.)

101.CAL

XBRL Taxonomy Extension Calculation Linkbase.  (Filed herewith.)

101.LAB

XBRL Taxonomy Extension Label Linkbase.  (Filed herewith.)

101.PRE

XBRL Taxonomy Extension Presentation Linkbase.  (Filed herewith.)

101.DEF

XBRL Taxonomy Extension Definition Linkbase.  (Filed herewith.)

104

Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101.)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

HANGER, INC.

 

 

 

 

 

 

Dated: May 5, 2021

By:

/s/ THOMAS E. KIRALY

 

 

Thomas E. Kiraly

 

 

Executive Vice President and Chief Financial Officer

 

 

(Principal Financial Officer)

 

 

 

Dated: May 5, 2021

By:

/s/ GABRIELLE B. ADAMS

 

 

Gabrielle B. Adams

 

 

Vice President and Chief Accounting Officer

(Principal Accounting Officer)

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