HANGER, INC. Overview of Transaction with
OnJuly 21, 2022 ,Hanger, Inc. entered into an Agreement and Plan of Merger (the "Merger Agreement") withHero Parent, Inc. , aDelaware corporation ("Parent"), andHero Merger Sub, Inc. , aDelaware corporation and a wholly owned subsidiary of Parent ("Merger Sub"). Parent and Merger Sub are indirect subsidiaries of funds managed and advised byPatient Square Capital , a dedicated health care investment firm. The Merger Agreement provides, among other things and subject to the terms and conditions set forth therein, that Merger Sub will be merged with and into the Company, with the Company surviving as a wholly-owned subsidiary of Parent (the "Merger"). At the Effective Time (as defined in the Merger Agreement), by virtue of the Merger, each share of common stock of the Company issued and outstanding immediately prior to the Effective Time will be converted automatically into the right to receive$18.75 per share in cash. After the Merger, Hanger's common stock will no longer be traded on theNew York Stock Exchange and will be deregistered under the Securities Exchange Act of 1934, as amended. The descriptions of the Merger Agreement and the transactions contemplated thereby contained in this Quarterly Report on Form 10-Q are summaries only and are qualified in their entirety by reference to the full text of the Merger Agreement, which was included as Exhibit 2.1 to the Company's Current Report on Form 8-K filed with theSecurities and Exchange Commission onJuly 22, 2022 . The closing of the Merger is subject to various closing conditions, including (i) adoption and approval of the Merger Agreement, including the Merger, by holders of a majority of the Company's shares of common stock then outstanding, (ii) the expiration or early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, or any other similar approvals, (iii) the consummation of the Merger shall not be restrained, enjoined or prohibited by any law or order that is continuing and remains in effect, and (iv) subject to Company Material Adverse Effect (as defined in the Merger Agreement) and other customary materiality qualifications, the accuracy of the representations and warranties contained in the Merger Agreement and compliance with the covenants and agreements contained in the Merger Agreement. The closing of the Merger is not subject to a financing condition.
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.
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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 inability to consummate the Merger within the anticipated
time period, or at all, due to any reason, including the failure to obtain
required regulatory approvals, satisfy the other conditions to the consummation
of the Merger or complete necessary financing arrangements; the risk that the
Merger disrupts our current plans and operations or diverts management's
attention from its ongoing business; the effects of the Merger on our business,
operating results, and ability to retain and hire key personnel and maintain
relationships with customers, suppliers and others with whom we do business; the
risk that our stock price may decline significantly if the Merger is not
consummated; the nature, cost, and outcome of any legal proceedings related to
the Merger, contractual, inflationary, and other general cost increases,
including with regard to costs of labor, raw materials, and freight; labor
shortages and increased turnover in our employee base; the financial and
business impacts of the COVID-19 pandemic on our operations and the operations
of our customers, suppliers, governmental and private payors, 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, 2021 (the "2021 Form 10-K"), as well as those described
in Part II, Item 1A. "Risk Factors" of this Quarterly Report on Form 10-Q, 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 2021 Form 10-K, in Part II, Item 1A. "Risk Factors"
of this Quarterly Report on Form 10-Q, 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 inthe 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.
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. 24 -------------------------------------------------------------------------------- OurPatient Care segment is primarily comprised ofHanger Clinic , which specializes in comprehensive, outcomes-based design, fabrication, and delivery of custom O&P devices through 761 patient care clinics and 117 satellite locations in 48 states, theDistrict of Columbia , and theU.S. Virgin Islands as ofJune 30, 2022 . 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 inthe United States , we engage in the distribution of a broad catalog of branded and private label O&P devices, products, and components 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 3,800 skilled nursing and post-acute providers nationwide. For the three and six months endedJune 30, 2022 , our net revenues were$312.0 million and$573.3 million , respectively, and we recorded net income of$10.1 million and$2.1 million , respectively. For the three and six months endedJune 30, 2021 , our net revenues were$280.8 million and$518.3 million , respectively, and we recorded net income of$10.2 million and$6.8 million , respectively.
Industry Overview
We estimate that approximately$4.3 billion is spent inthe United States each year for prescription-based O&P products and services through O&P clinics. We believe ourPatient Care segment currently accounts for approximately 24% 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 inthe 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 2.5% 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 theU.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 inthe 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 7% of the market for O&P products, components, devices, and supplies (excluding sales to ourPatient 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 theU.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.
Business Description
OurPatient Care segment employs approximately 1,660 clinical prosthetists, orthotists, and pedorthists, which we refer to as clinicians, substantially all of which are certified by either theAmerican Board for Certification ("ABC") or theBoard 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. 25 -------------------------------------------------------------------------------- Patients are typically referred toHanger 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 that 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, health maintenance organizations ("HMOs"), preferred provider
organizations ("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
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.
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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 branded and private label devices, products, and 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 3,800
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 350,000 active SKUs from approximately 750 different suppliers
through SPS or directly to our own clinics within our Patient Care segment. Our
warehousing and distribution facilities provide us with the ability to deliver
products to the vast majority of our customers in the United States within two
business days. In Q2 2022, we closed the warehouse and distribution facilities
in Illinois and Texas , consolidating their operations into our Georgia and
Nevada facilities.
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.
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--------------------------------------------------------------------------------Effects of the COVID-19 Pandemic
We began to see a reduction in business volumes as a result of the COVID-19 pandemic starting in the last weeks ofMarch 2020 . 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 ofMarch 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, our results of operations were adversely affected by COVID throughout 2020, 2021 and into the early months of 2022. The volume effects and our operating responses are discussed further in this section, and the effects of COVID-19 on our financial condition are discussed in the "Financial Condition, Liquidity and Capital Resources" section below. Our results of operations for any quarter during the COVID-19 pandemic may not be indicative of results of operations that may be achieved for a subsequent quarter or the full year, and may not be similar to results of operations experienced in prior years. Additionally, current period comparisons should be viewed in the context of the adverse effects which the COVID-19 pandemic had on comparative prior period results.
Effect on Business Volumes
In the early months of 2021, vaccines for combating COVID-19 were approved by theUS Food and Drug Administration , and the US government began a phased roll out. 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 were most susceptible to the severe effects of COVID-19. The lack of achievement of broad immunity coupled with an increase in infections caused by variants contributed to an increase in the duration and effect of COVID-19 on our business volumes and staffing shortages. Specifically, we experienced increased employee absences, particularly due to the Delta variant in the third quarter of 2021 and the Omicron variant in December of 2021 and January of 2022. We believe our business volumes during those periods were inhibited primarily by reduced medical procedures due to surgical constraints, reduced referral volumes from in-patient and out-patient providers due to decreases in their volumes and the effect of COVID related protocols on their businesses, patient hesitancy to seek care during the pandemic, and increased patient mortality. Additionally, we believe that our patient volumes have been affected by our own labor constraints in technical and administrative positions, employee absences related to COVID-19, as well as decreases in our sales of off-the-shelf orthotic devices. While the emerging variants of the COVID-19 virus continue to contribute to employee absences and our use of temporary labor, we believe the overall adverse impact of the COVID-19 pandemic on our business volumes has diminished and stabilized over time. Patient appointments in our clinics during the second quarter of 2022 increased by approximately 2% as compared to the corresponding period in 2021. During the quarter, our prosthetics and orthotics day-adjusted sales, excluding acquisitions, increased by 6.2% on a per day basis, when compared to the same period in the prior year.
Operating, Cost Reduction, and Other 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 made certain changes to our operating practices in order to promote
safety and to minimize the risk of virus transmission. These included the
implementation of certain patient screening protocols and the relocation of
certain administrative and support personnel to a "work at home" environment.
We recommenced our implementation of supply chain and financial systems, further
discussed in the "New Systems Implementations" section, in the second quarter of
2021, after we elected to temporarily delay these activities in 2020 as part of
our efforts to preserve liquidity. We also recommenced activities related to the
reconfiguration of our distribution facilities in the second quarter of 2021,
after they were suspended in 2020, which are still currently ongoing.
Despite the effects of the COVID-19 pandemic on our business volumes, for the
foreseeable future, we currently believe that our cash flows from operations and
retained cash and cash equivalent balances are sufficient to enable us to fund
our operations, capital expenditures and other financial obligations as they
become due. Please refer to the "Financial Condition, Liquidity and Capital
Resources" section below for a discussion of our liquidity position.
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--------------------------------------------------------------------------------CARES Act
The CARES Act established thePublic Health and Social Services Emergency Fund , also referred to as theCares Act Provider Relief Fund , which set aside$203.5 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. InApril 2020 , theU.S. Department of Health and Human Services ("HHS") began making payments to healthcare providers from the$203.5 billion appropriation. These are grants, rather than loans, to healthcare providers, and will not need to be repaid. During the full year of 2021, we recognized a total benefit of$1.1 million in our consolidated statement of operations within Other operating costs for the Grants we received 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 ourPatient Care segment. The CARES Act also provided for a deferral of the employer portion of payroll taxes incurred during the COVID-19 pandemic throughDecember 2020 . The provisions allowed us to defer half of such payroll taxes untilDecember 2021 and the remaining half untilDecember 2022 . We paid the first half inSeptember 2021 , and deferred the remaining$5.9 million of payroll taxes within Accrued compensation related costs in the condensed consolidated balance sheet as ofJune 30, 2022 .
Other Products & Services Performance Considerations
As discussed in our 2021 Form 10-K, under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", we generally believe our distribution customers encounter reimbursement pressures similar to those we experience in our ownPatient 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. In certain circumstances, we may pursue acquisition of inventory in advance to preserve pricing to offset inflation and potential supply chain constraints. 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. 29 --------------------------------------------------------------------------------
Reimbursement Trends
In ourPatient Care segment, we are reimbursed primarily through employer-based plans offered by commercial insurance carriers, Medicare, Medicaid, and theVA . 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 For the Six Months Ended June 30, June 30, 2022 2021 2022 2021 Medicare 31.2 % 31.4 % 30.7 % 30.4 % Medicaid 18.6 % 18.5 % 18.3 % 18.0 % Commercial insurance / managed care (excluding Medicare and Medicaid managed care) 33.4 % 33.7 % 34.2 % 34.6 % VA 9.6 % 9.1 % 9.6 % 9.6 % Private Pay 7.2 % 7.3 % 7.2 % 7.4 % Patient Care 100.0 % 100.0 % 100.0 % 100.0 %Patient Care constituted 85.1% and 84.7% of our net revenues for the three and six months endedJune 30, 2022 and 84.3% and 83.4% for the three and six months endedJune 30, 2021 . 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 ourPatient 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") has announced verification requirements and code changes that has reduced the reimbursement level for certain prosthetic feet, and theVA 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. In recent years, we have taken a number of actions to manage payor disallowance trends. These initiatives included: (i) the creation of a centralized 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. 30 -------------------------------------------------------------------------------- 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 and six months endedJune 30, 2022 and 2021 are as follows: For the Three Months Ended For the Six Months Ended June 30, June 30, (dollars in thousands) 2022 2021 2022 2021 Gross charges$ 277,870 $ 245,196 $ 507,792 $ 446,648 Less estimated implicit price concessions arising from: Payor disallowances 10,385 6,802 18,770 11,316 Patient non-payments 1,815 1,607 3,534 2,863 Payor disallowances and patient non-payments 12,200 8,409 22,304 14,179 Net revenues$ 265,670 $ 236,787 $ 485,488 $ 432,469 Payor disallowances$ 10,385 $ 6,802 $ 18,770 $ 11,316 Patient non-payments 1,815 1,607 3,534 2,863 Payor disallowances and patient non-payments$ 12,200 $ 8,409 $ 22,304 $ 14,179 Payor disallowances % 3.7 % 2.8 % 3.7 % 2.5 % Patient non-payments % 0.7 % 0.6 % 0.7 % 0.7 % Percent of gross charges 4.4 % 3.4 % 4.4 % 3.2 % Included in the results above, are clinics that have been recently acquired. Acquired clinics typically continue to operate on their legacy systems for the first 90 to 180 day before they are fully integrated over to Hanger's systems and related processes. While operating on their legacy systems, the rate of payor disallowances and patient non-payments run higher than the rates experienced on Hanger's systems. Excluding acquisitions since 2020, the percent of payor disallowances and patient non-payments would have been 4.0% and 3.8% for the three and six months endedJune 30, 2022 , respectively, and 3.2% and 2.8% for the three and six months endedJune 30, 2021 , respectively. During 2021, we benefited from reductions in claims denials and increases in our rates of collection compared to prior periods. 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.
Acquisitions
During 2022, we completed the following acquisitions of O&P clinics with the intention of expanding the geographic footprint of our patient care offerings through the acquisitions of these high quality O&P providers. None of the acquisitions were individually material to our financial position, results of operations, or cash flows. •In the first quarter of 2022, we completed the acquisition of all the outstanding equity interests of an O&P business for total consideration of$5.0 million , of which$4.0 million was cash consideration, net of cash acquired, and$1.0 million was issued in the form of notes to shareholders at fair value. •In the second quarter of 2022, we completed the acquisitions of all the outstanding equity interests of two O&P businesses for total consideration of$11.7 million , of which$8.5 million was cash consideration, net of cash acquired, and$3.2 million was issued in the form of notes to shareholders at fair value. During the third quarter of 2022 to date, we completed the acquisitions of two O&P businesses for a total purchase price of$8.1 million . Total consideration transferred for these acquisitions is comprised of$6.3 million in cash consideration and 31 --------------------------------------------------------------------------------$1.8 million in the form of notes to shareholders at fair value. Due to the proximity in time of these transactions 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 purchased and liabilities assumed in the acquisitions. Acquisition-related expenses related to these transactions were not material. During 2021, we completed the following acquisitions of O&P clinics with the intention of expanding the geographic footprint of our patient care offerings through the acquisition of these high quality O&P providers. None of the acquisitions were individually material to our financial position, results of operations, or cash flows. •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. •In the second quarter of 2021, we completed the acquisitions of all the outstanding equity interests of two O&P businesses for total consideration of$21.0 million , of which$16.0 million was cash consideration, net of cash acquired,$4.9 million was issued in the form of notes to shareholders at fair value, and$0.1 million in additional consideration. •In the third 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$6.2 million , of which$3.9 million was cash consideration, net of cash acquired,$1.5 million was issued in the form of notes to shareholders at fair value, and$0.8 million in additional consideration. •In the fourth quarter of 2021, we completed the acquisitions of all the outstanding equity interests of eight O&P businesses for total consideration of$53.1 million , of which$40.8 million was cash consideration, net of cash acquired, and$12.3 million was issued in the form of notes to shareholders at fair value. Acquisition-related costs associated with Hanger's acquisition of O&P businesses are included in general and administrative expenses in our condensed consolidated statements of operations. Total acquisition-related costs incurred during the three and six months endedJune 30, 2022 were$0.3 million and$0.6 million , respectively, 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 and six months endedJune 30, 2022 were$0.2 million and$0.3 million , respectively. Total acquisition-related costs incurred during the year endedDecember 31, 2021 were$2.1 million , which includes those costs for transactions that were in progress or not completed during the respective period. Acquisition-related costs incurred for acquisitions completed during the year endedDecember 31, 2021 were$1.6 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. We recommenced our New Systems Implementations
activities in the second quarter of 2021, and transitioned our corporate
financial systems to the Oracle Cloud Financials platform in the third quarter
of 2021, after we elected in 2020 to temporarily delay our New Systems
Implementations as part of our efforts to preserve liquidity.
In connection with our New Systems Implementations, for the three and six months
ended June 30, 2022 , we expensed $0.4 million and $0.8 million , respectively,
and for the three and six months ended June 30, 2021 , we expensed $1.7 million
and $2.3 million , respectively. For the year ended December 31, 2021 , we
expensed $5.2 million . We currently anticipate that we will spend approximately
$3 million to $5 million for the full year 2022 on these systems.
As of June 30, 2022 , we capitalized $6.8 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.
32
--------------------------------------------------------------------------------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 are other employers, we are currently finding it difficult to recruit and retain personnel in certain positions, including clinic front office administrative, distribution center, and fabrication center technician positions. In certain cases, we have also found it necessary to make individual market adjustments for clinical and professional staff to attract or retain them. Our inability to successfully recruit and maintain staffing levels for these positions has and could continue to introduce some constraints on our ability to achieve our revenue growth objectives. In cases where we have open clinic administrative or technician positions, or these positions are filled with inexperienced or new personnel, our clinicians find it necessary to augment the activities performed by these roles, which can slow the speed of our patient service. In order to attract and retain personnel, we may find it necessary to further increase wages in these areas. Additionally, when coupled with the generally fixed nature of our reimbursement arrangements, increases in our personnel costs caused by current inflation conditions may put increasing pressure on our ability to maintain or increase our margins. Please refer to Part II, Item 1A. "Risk Factors" contained in our 2021 Form 10-K.
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 of 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, the in-person event was cancelled in the first quarter of 2022, and the event was held virtually in 2021. We anticipate resuming an in-person event in 2023. During the three months endedMarch 31, 2021 , we spent$0.3 million on travel and other costs associated with this event. 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. 33 --------------------------------------------------------------------------------
Critical Accounting Policies and Estimates
Our analysis and discussion of our financial condition and results of operations is based upon the condensed 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 condensed 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. Critical accounting policies and estimates are described in our 2021 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. There have been no material updates to those critical accounting policies and estimates as contained in the 2021 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 immaterial classifications within expense line items in the condensed
consolidated statements of operations.
34
--------------------------------------------------------------------------------Results of Operations
Our results of operations for the three months endedJune 30, 2022 and 2021 were as follows (unaudited): For the Three Months Ended Percent June 30, Change (dollars in thousands) 2022 2021 2022 vs 2021 Net revenues$ 312,033 $ 280,819 11.1 % Material costs 98,433 89,271 10.3 % Personnel costs 110,275 97,549 13.0 % Other operating costs 38,970 32,788 18.9 % General and administrative expenses 35,444 33,110 7.0 % Depreciation and amortization 8,124 8,007 1.5 % Operating expenses 291,246 260,725 11.7 % Income from operations 20,787 20,094 3.4 % Interest expense, net 7,524 7,152 5.2 % Non-service defined benefit plan expense 160 167 (4.2) % Income before income taxes 13,103 12,775 2.6 % Provision for income taxes 2,986 2,616 14.1 % Net income$ 10,117 $ 10,159 (0.4) % During these periods, our operating expenses as a percentage of net revenues were as follows: For the Three Months Ended June 30, 2022 2021 Material costs 31.5 % 31.8 % Personnel costs 35.3 % 34.7 % Other operating costs 12.5 % 11.6 % General and administrative expenses 11.4 % 11.8 % Depreciation and amortization 2.6 % 2.9 % Operating expenses 93.3 % 92.8 %
Three Months Ended
Relevance of Second 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 that continued into 2022. The effects
of this public health emergency on our revenues and earnings 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 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.
35
--------------------------------------------------------------------------------
Net revenues. Net revenues for the three months ended June 30, 2022 were $312.0
million , an increase of $31.2 million , or 11.1%, from $280.8 million for the
three months ended June 30, 2021 . Net revenues by operating segment, after
elimination of intersegment activity, were as follows:
For the Three Months Ended
June 30, Percent
(dollars in thousands) 2022 2021 Change Change
Patient Care $ 265,670 $ 236,787 $ 28,883 12.2 %
Products & Services 46,363 44,032 2,331 5.3 %
Net revenues $ 312,033 $ 280,819 $ 31,214 11.1 %
Patient Care net revenues for the three months ended June 30, 2022 were $265.7
million , an increase of $28.9 million , or 12.2%, from $236.8 million for the
same period in the prior year. Same clinic revenues increased $14.2 million for
the three months ended June 30, 2022 compared to the same period in the prior
year, reflecting an increase of 6.2% on a per-day basis. This increase is driven
primarily by a 3.6% increase in rate with a smaller increase of 3.3% in volume
and mix. The increase is partially offset by a 0.7% increase in disallowed
revenue. Net revenues from acquired clinics increased $13.7 million , and
revenues from consolidations and other services increased $0.9 million .
Net revenue growth was adversely affected during the period by an increase in
the relative rate of disallowed and patient non-payment revenue. As discussed in
"Reimbursement Trends" above, these items constituted 4.4% of gross charges in
the three month period ended June 30, 2022 compared to 3.4% for the three month
period ended June 30, 2021 . During the past twelve month period, disallowed and
patient non-payment amounts have been 4.2% of gross charges, and as such, we
believe the level reported in the second quarter to be more indicative of
current trends.
Prosthetics constituted approximately 55.1% of our total Patient Care revenues
for the three months ended June 30, 2022 and 53.7% for the same period in 2021,
excluding the impact of acquisitions. Prosthetic revenues for the three months
ended June 30, 2022 were 8.9% 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 3.0% on a per-day basis compared to the
same comparative prior periods, excluding the impact of acquisitions.
Products & Services net revenues for the three months ended June 30, 2022 were
$46.4 million , an increase of $2.3 million , or 5.3% from the same period in the
prior year. This was primarily attributable to an increase of $2.7 million , or
8.1%, in the distribution of O&P componentry to independent providers in the
period stemming primarily from lower volumes in the same period of 2021 due to
the COVID-19 pandemic, as discussed in the "Effects of the COVID-19 Pandemic"
section above. The increase is partially offset by a decrease in net revenues
from therapeutic solutions of $0.4 million , or 3.5% primarily as a result of
historical customer lease cancellations and discounts, partially offset by lease
installations.
Material costs. Material costs for the three months ended June 30, 2022 were
$98.4 million , an increase of $9.2 million or 10.3%, from the same period in the
prior year. Total material costs as a percentage of net revenues for the three
months ended June 30, 2022 was 31.5% compared to 31.8% for the three months
ended June 30, 2021 . While we have not experienced significant inflation in our
material costs during the current quarter, we believe the effect of inflation
may increase during the remainder of 2022. Material costs by operating segment,
after elimination of intersegment activity, were as follows:
For the Three Months Ended
June 30, Percent
(dollars in thousands) 2022 2021 Change Change
Patient Care $ 82,085 $ 71,717 $ 10,368 14.5 %
Products & Services 16,348 17,554 (1,206) (6.9) %
Material costs $ 98,433 $ 89,271 $ 9,162 10.3 %
36--------------------------------------------------------------------------------Patient Care material costs increased$10.4 million , or 14.5%, for the three months endedJune 30, 2022 compared to the same period in the prior year as a result of the increase in segment net sales, additional costs as a result of our acquisitions, and freight. Freight cost increases have primarily related to increased fuel surcharges and higher container costs. We currently anticipate that higher freight costs will continue to affect our material costs in future periods.Patient Care material costs as a percent of segment net revenues increased to 30.9% for the three months endedJune 30, 2022 from 30.3% for the three months endedJune 30, 2021 . Products & Services material costs decreased$1.2 million , or 6.9%, for the three months endedJune 30, 2022 compared to the same period in the prior year. As a percent of net revenues in the Products & Services segment, material costs were 35.3% for the three months endedJune 30, 2022 as compared to 39.9% in the same period of 2021. The decrease in cost of materials as a percent of segment net revenues was primarily due to product mix within the segment. However, in a similar fashion to ourPatient Care segment, increases in freight costs have also affected our material costs and margin in this segment, as we rebill only a portion of our freight costs to our third party customers. Personnel costs. Personnel costs for the three months endedJune 30, 2022 were$110.3 million , an increase of$12.7 million , or 13.0%, from$97.5 million for the same period in the prior year. Personnel costs by operating segment were as follows: For the Three Months Ended June 30, Percent (dollars in thousands) 2022 2021 Change Change Patient Care$ 93,838 $ 83,198 $ 10,640 12.8 % Products & Services 16,437 14,351 2,086 14.5 % Personnel costs$ 110,275 $ 97,549 $ 12,726 13.0 % Personnel costs for the Patient Care segment were$93.8 million for the three months endedJune 30, 2022 , an increase of$10.6 million , or 12.8%, from$83.2 million in the same period of the prior year. The increase inPatient Care personnel costs during the three months endedJune 30, 2022 was primarily related to an increase in salary expense of$7.8 million from the three months endedJune 30, 2021 . Additionally, incentive compensation, benefits, and other personnel expenses increased$1.4 million , commissions increased$0.8 million , and payroll taxes increased$0.6 million compared to the three months endedJune 30, 2021 . Personnel costs in the Products & Services segment were$16.4 million for the three months endedJune 30, 2022 , an increase of$2.1 million compared to the same period in the prior year. The increase is primarily related to an increase in salary expense of$1.6 million from the three months endedJune 30, 2021 . Additionally, bonus, commissions, benefits, and other personnel cost increased$0.5 million for the three months endedJune 30, 2022 compared to the same period in the prior year. Other operating costs. Other operating costs for the three months endedJune 30, 2022 were$39.0 million , an increase of$6.2 million , or 18.9%, from$32.8 million for the same period in the prior year. The increase is primarily related to an increase in rent, utilities, occupancy, and office expenses of$2.1 million from the three months endedJune 30, 2021 . Additionally, expenses related to aCalifornia wage and hour litigation settlement increased$1.3 million , travel increased$0.8 million , professional fees increased$0.3 million , bad debt expense increased$0.2 million , and other expenses increased$1.5 million as compared to the same period in the prior year. General and administrative expenses. General and administrative expenses for the three months endedJune 30, 2022 were$35.4 million , an increase of$2.3 million , or 7.0%, from the same period in the prior year. The increase is the result of a$1.3 million increase in severance expense, a$0.8 million increase in salary expense, and a$0.5 million increase in other expenses, partially offset by a$0.3 million decrease in incentive compensation and other personnel costs compared to the three months endedJune 30, 2021 . Depreciation and amortization. Depreciation and amortization for the three months endedJune 30, 2022 were$8.1 million , an increase of$0.1 million , or 1.5% from the same period in the prior year. Amortization expense increased$0.5 million and depreciation expense decreased$0.4 million when compared to the same period in the prior year.
Interest expense, net. Interest expense for the three months ended
37
--------------------------------------------------------------------------------
Provision for income taxes. The provision for income taxes for the three months
ended June 30, 2022 was $3.0 million , or 22.8% of income before income taxes,
compared to a provision of $2.6 million , or 20.5% of income before income taxes
for the three months ended June 30, 2021 . The increase in the effective tax rate
for the three months ended June 30, 2022 compared with the three months ended
June 30, 2021 is primarily attributable to a windfall from share-based
compensation for the three months ended June 30, 2021 compared to a shortfall
from share-based compensation for the three months ended June 30, 2022 . Our
effective tax rate for the three months ended June 30, 2022 is similar to the
federal statutory tax rate of 21%, but the difference consists primarily of
research and development credits offset by non-deductible expenses and shortfall
from share-based compensation. Our effective tax rate for the three months ended
June 30, 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.
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 June 30, 2022 , our valuation allowance was approximately $2.1 million .
For the year ending December 31, 2022 , we estimate a research and development
tax credit of $2.7 million , net of tax reserves. We record the tax benefit, net
of tax reserves, as a deferred tax asset. For the year ended December 31, 2021 ,
we recognized research and development tax credits of $4.3 million , net of tax
reserves.
Our results of operations for the six months ended June 30, 2022 and 2021 were
as follows (unaudited):
For the Six Months Ended Percent
June 30, Change
(dollars in thousands) 2022 2021 2022 vs 2021
Net revenues $ 573,320 $ 518,289 10.6 %
Material costs 184,025 164,441 11.9 %
Personnel costs 211,950 187,429 13.1 %
Other operating costs 75,138 64,286 16.9 %
General and administrative expenses 67,886 64,013 6.1 %
Depreciation and amortization 16,079 16,005 0.5 %
Operating expenses 555,078 496,174 11.9 %
Income from operations 18,242 22,115 (17.5) %
Interest expense, net 14,909 14,492 2.9 %
Non-service defined benefit plan expense 320 334 (4.2) %
Income before income taxes 3,013 7,289 (58.7) %
Provision for income taxes 873 460 89.8 %
Net income $ 2,140 $ 6,829 (68.7) %
During these periods, our operating expenses as a percentage of net revenues
were as follows:
For the Six Months Ended
June 30,
2022 2021
Material costs 32.1 % 31.7 %
Personnel costs 37.0 % 36.2 %
Other operating costs 13.1 % 12.3 %
General and administrative expenses 11.8 % 12.4 %
Depreciation and amortization 2.8 % 3.1 %
Operating expenses 96.8 % 95.7 %
38--------------------------------------------------------------------------------
Six Months Ended
Relevance of Six Months Ended 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 that continued into 2022. The effects of this public health emergency on our revenues and earnings 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 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. Net revenues. Net revenues for the six months endedJune 30, 2022 were$573.3 million , an increase of$55.0 million , or 10.6%, from$518.3 million for the six months endedJune 30, 2021 . Net revenues by operating segment, after elimination of intersegment activity, were as follows: For the Six Months Ended June 30, Percent (dollars in thousands) 2022 2021
Change Change
Patient Care $ 485,488 $ 432,469 $ 53,019 12.3 %
Products & Services 87,832 85,820 2,012 2.3 %
Net revenues $ 573,320 $ 518,289 $ 55,031 10.6 %
Patient Care net revenues for the six months ended June 30, 2022 were $485.5
million , an increase of $53.0 million , or 12.3%, from $432.5 million for the
same period in the prior year. Same clinic revenues increased $27.4 million for
the six months ended June 30, 2022 compared to the same period in the prior
year, reflecting an increase of 6.5% on a per-day basis. Net revenues from
acquired clinics increased $24.9 million , and revenues from consolidations and
other services increased $0.7 million .
Prosthetics constituted approximately 53.7% of our total Patient Care revenues
for the six months ended June 30, 2022 and 52.7% for the same period in 2021,
excluding the impact of acquisitions. Prosthetic revenues for the six months
ended June 30, 2022 were 8.4% 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 4.3% on a per-day basis compared to the
same comparative prior periods, excluding the impact of acquisitions.
Products & Services net revenues for the six months ended June 30, 2022 were
$87.8 million , an increase of $2.0 million , or 2.3% from the same period in the
prior year. This was primarily attributable to an increase of $3.4 million , or
5.4%, in the distribution of O&P componentry in the period to independent
providers stemming primarily from lower volumes in the same period of 2021 due
to the COVID-19 pandemic, as discussed in the "Effects of the COVID-19 Pandemic"
section above. The increase is partially offset by a decrease in net revenues
from therapeutic solutions of $1.4 million , or 6.5% primarily as a result of
historical customer lease cancellations and discounts, partially offset by lease
installations.
Material costs. Material costs for the six months ended June 30, 2022 were
$184.0 million , an increase of $19.6 million or 11.9%, from the same period in
the prior year. Total material costs as a percentage of net revenues increased
to 32.1% in the six months ended June 30, 2022 from 31.7% in the six months
ended June 30, 2021 due to changes in our Patient Care segment business as
discussed further below. While we have not experienced significant inflation in
our material costs during the current year, we believe the effect of inflation
may increase during the remainder of 2022. Material costs by operating segment,
after elimination of intersegment activity, were as follows:
For the Six Months Ended
June 30, Percent
(dollars in thousands) 2022 2021 Change Change
Patient Care $ 153,061 $ 131,639 $ 21,422 16.3 %
Products & Services 30,964 32,802 (1,838) (5.6) %
Material costs $ 184,025 $ 164,441 $ 19,584 11.9 %
39--------------------------------------------------------------------------------Patient Care material costs increased$21.4 million , or 16.3%, for the six months endedJune 30, 2022 compared to the same period in the prior year as a result of the increase in segment net sales, additional costs as a result of our acquisitions, freight, and increase in our use of third-party fabricators. Freight cost increases have primarily related to increased fuel surcharges and higher container costs. We currently anticipate that higher freight costs will continue to affect our material costs in future periods.Patient Care material costs as a percent of segment net revenues increased to 31.5% for the six months endedJune 30, 2022 from 30.4% for the six months endedJune 30, 2021 . Products & Services material costs decreased$1.8 million , or 5.6%, for the six months endedJune 30, 2022 compared to the same period in the prior year. As a percent of net revenues in the Products & Services segment, material costs were 35.3% for the six months endedJune 30, 2022 as compared to 38.2% in the same period of 2021. The decrease in material costs as a percent of segment net revenues was due to a change in business and product mix within the segment as well as cost savings related to certain supply chain initiatives. Personnel costs. Personnel costs for the six months endedJune 30, 2022 were$212.0 million , an increase of$24.5 million , or 13.1%, from$187.4 million for the same period in the prior year. Personnel costs by operating segment were as follows: For the Six Months Ended June 30, Percent (dollars in thousands) 2022 2021 Change Change Patient Care$ 180,247 $ 158,952 $ 21,295 13.4 % Products & Services 31,703 28,477 3,226 11.3 % Personnel costs$ 211,950 $ 187,429 $ 24,521 13.1 % Personnel costs for the Patient Care segment were$180.2 million for the six months endedJune 30, 2022 , an increase of$21.3 million , or 13.4%, from$159.0 million for the same period in the prior year. The increase inPatient Care personnel costs during the six months endedJune 30, 2022 was primarily related to an increase in salary expense of$15.4 million from the six months endedJune 30, 2021 . Additionally, incentive compensation and other personnel costs increased$1.8 million , commissions increased$1.6 million , benefits increased$1.4 million , and payroll taxes increased$1.1 million compared to the six months endedJune 30, 2021 . Personnel costs in the Products & Services segment were$31.7 million for the six months endedJune 30, 2022 , an increase of$3.2 million compared to the same period in the prior year. The increase is primarily related to an increase in salary expense of$3.0 million from the six months endedJune 30, 2021 . Additionally, other personnel cost increased$0.4 million . Bonus and commissions decreased$0.2 million for the six months endedJune 30, 2022 compared to the same period in the prior year. Other operating costs. Other operating costs for the six months endedJune 30, 2022 were$75.1 million , an increase of$10.9 million , or 16.9%, from$64.3 million for the same period in the prior year. Rent, utilities, occupancy, and office expenses increased$4.7 million , travel increased$1.8 million , expenses related to aCalifornia wage and hour litigation settlement increased$1.3 million , professional education and professional fees increased$1.2 million , other expenses increased$1.7 million , and bad debt expense increased$0.2 million as compared to the same period in the prior year. General and administrative expenses. General and administrative expenses for the six months endedJune 30, 2022 were$67.9 million , an increase of$3.9 million , or 6.1%, from the same period in the prior year. The increase is the result of a$1.8 million increase in salary expense, a$1.2 million increase in severance expense, and a$1.3 million increase in other expenses, partially offset by a$0.4 million decrease in equity-based compensation compared to the six months endedJune 30, 2021 . Depreciation and amortization. Depreciation and amortization for the six months endedJune 30, 2022 was$16.1 million , an increase of$0.1 million , or 0.5%, from the same period in the prior year. Amortization expense increased$1.1 million and depreciation expense decreased$1.0 million when compared to the same period in the prior year. Interest expense, net. Interest expense for the six months endedJune 30, 2022 increased 2.9% to$14.9 million from$14.5 million for the same period in the prior year. 40 -------------------------------------------------------------------------------- Provision for income taxes. The provision for income taxes for the six months endedJune 30, 2022 was$0.9 million , or 29.0% of income before income taxes, compared to a provision of$0.5 million , or 6.3% of income before income taxes for the six months endedJune 30, 2021 . The increase in the effective tax rate for the six months endedJune 30, 2022 compared with the six months endedJune 30, 2021 is primarily attributable to a windfall from share-based compensation for the six months endedJune 30, 2021 compared to a shortfall from share-based compensation for the six months endedJune 30, 2022 . Our effective tax rate for the six months endedJune 30, 2022 differed from the federal statutory tax rate of 21% primarily due to research and development credits, non-deductible expenses, and a shortfall from share-based compensation. 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 ofJune 30, 2022 , our valuation allowance approximated$2.1 million . For the year endingDecember 31, 2022 , we estimate a research and development tax credit of$2.7 million , net of tax reserves. We record the tax benefit, net of tax reserves, as a deferred tax asset. For the year endedDecember 31, 2021 , we recognized research and development tax credits of$4.3 million , net of tax reserves.
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." AtJune 30, 2022 , we had total liquidity of$154.2 million , which reflected a decrease of$36.8 million from the$191.0 million in liquidity we had as ofDecember 31, 2021 . Our liquidity atJune 30, 2022 was comprised of cash and cash equivalents of$24.4 million and$129.8 million in available borrowing capacity under our$135.0 million revolving credit facility. This decrease in liquidity primarily related to a decrease in cash of$37.3 million , comprised of net cash from operations of$30.9 million , capital expenditures of$10.6 million , cash paid for acquisitions, net of cash acquired, of$12.5 million , and net cash used in financing activities of$45.2 million . InJune 2022 , we made a prepayment of$33.7 million in borrowings under the Credit Agreement. 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. We were in compliance with our debt covenants as ofJune 30, 2022 .
For additional information, please refer to the Liquidity Outlook section below.
Working Capital and Days Sales Outstanding
AtJune 30, 2022 , we had working capital of$52.4 million compared to working capital of$91.5 million atDecember 31, 2021 . Our working capital decreased$39.2 million during the six months endedJune 30, 2022 due to a decrease in current assets of$35.4 million and an increase in current liabilities of$3.8 million .
The decrease in current assets of
The increase in current liabilities of$3.8 million was primarily attributable to an increase in Accounts payable of$4.1 million . The remainder of the increase is primarily attributable to an increase of accrued incentive compensation related costs of$2.3 million , an increase in Current portion of operating lease liabilities of$0.9 million , and an increase of$0.7 million in Current portion of long-term debt, partially offset by a decrease in Accrued expenses and other current liabilities of$4.2 million . 41 -------------------------------------------------------------------------------- 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 ofJune 30, 2022 , our DSO was 44 days, compared to a DSO of 40 days as ofJune 30, 2021 . The increase is partially attributable to a larger increase in net revenue relative to accounts receivable, as well as the impact of acquisitions completed in the fourth quarter of 2021.
Sources and Uses of Cash for the Six Months Ended
Net cash flows from operating activities were$30.9 million for the six months endedJune 30, 2022 , while net cash flows used in operating activities were$9.3 million for the six months endedJune 30, 2021 . The most significant decreases were due to$23.7 million in Accrued compensation related costs and$11.2 million in Accounts payable. Cash flows used in investing activities decreased$25.2 million to$23.1 million for the six months endedJune 30, 2022 , from$48.2 million for the six months endedJune 30, 2021 . The decrease in cash used in investing activities was due to a decrease of$22.9 million in cash paid for acquisitions, net of cash acquired, and$2.3 million less in capital expenditures, net of proceeds from sale of property, plant and equipment. Cash flows used in financing activities were$45.2 million for the six months endedJune 30, 2022 , as compared to cash used in financing activities of$10.9 million for the six months endedJune 30, 2021 . The increase in cash used in financing activities is primarily due to an increase in payments on outstanding debt and Seller Notes of$36.5 million , offset by a decrease in payment of employee taxes on share-based compensation, payments under vendor financing arrangements and other activities of$2.2 million .
Effect of Indebtedness
As ofJune 30, 2022 , we have a Senior Credit Facility (the "Credit Agreement") which provides for (i) a Term Loan B facility with$449.8 million outstanding which is due in quarterly principal installments with all remaining outstanding principal due at maturity inMarch 2025 and (ii) a revolving credit facility with an availability of$135.0 million which matures onNovember 23, 2026 (subject to a springing maturity if the term loans outstanding under the Credit Agreement are not repaid prior to the date that is 91 days prior to the stated maturity thereof). InJune 2022 , we made a prepayment of$33.7 million in borrowings under the Credit Agreement. Availability under the revolving credit facility is reduced by outstanding letters of credit, which were$5.2 million as ofJune 30, 2022 , resulting in approximately$129.8 million in available borrowing capacity. 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$13.2 million and$13.0 million for the six months endedJune 30, 2022 and 2021, respectively.
Liquidity Outlook
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.
Our primary future cash requirements, as discussed in our 2021 Form 10-K, will
be for acquisitions of O&P providers, debt payments, capital expenditures,
payment of deferred payroll taxes as discussed in the "Effects of the COVID-19
Pandemic" section above, and to fund operations. We expect to continue to invest
in capital expenditures, and in deferred cloud implementation expenditures, in
connection with our planned reconfiguration of distribution facilities and our
related implementation of supply chain and financial systems. We anticipate that
we will continue to pursue acquisitions and other growth initiatives that we
expect to provide value to our shareholders. Additionally, as business volumes
return to more typical pre-pandemic levels, it is likely that we will experience
a natural corresponding increase in our investment in working capital.
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With these factors in mind, we continue to anticipate we will generate positive
operating cash flows that, together with our retained cash and 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.
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