ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Forward-Looking Statements
This Annual Report on Form 10-K including this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (or “Management’s Discussion and Analysis”) 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, 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 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 this Annual Report on Form 10-K, some of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included in this report 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” 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.
Overview
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 comprehensive, outcomes-based design, fabrication, and delivery of custom O&P devices through 760 patient care clinics and 115 satellite locations in 47 states and the District of Columbia, as of December 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 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 4,000 skilled nursing and post-acute providers nationwide.
For the years ended December 31, 2021, 2020, and 2019, our net revenues were $1,120.5 million, $1,001.2 million, and $1,098.0 million, respectively. We recorded net income of $42.0 million, $38.2 million, and $27.5 million for the years ended December 31, 2021, 2020, and 2019, respectively.
Industry Overview
As of 2019, 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 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 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 2.5% 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 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 7% 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 25% 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.
Business Description
Patient Care
Our Patient 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 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 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 VA.
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 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 4,000 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 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. In January 2022, we announced plans to close the warehouse and distribution facilities in Illinois and Texas in the second quarter of 2022, 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.
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 of March 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 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 continued through the fourth quarter of 2021, and into 2022. 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 labor and 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, our operating responses, and the effects of COVID-19 on our financial condition are discussed in Item 1A. “Risk Factors,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the “Financial Condition, Liquidity and Capital Resources” sections below. Our results of operations for any quarter during the COVID-19 pandemic may not be indicative of results of operations that may be for a subsequent quarter or the full year, and may not be similar to results of operations experienced in prior years. In addition, results in any given period in 2021 may be different than 2020 as a result of the conditions in 2020 stemming from the COVID-19 pandemic.
Effect on Business Volumes
Patient appointments showed some recovery in our clinics during the full year of 2021 increasing 11% over the prior year period, but remaining down by 7% from the level reported in 2019.
Same clinic revenue per day grew by 9.1% for the full year of 2021. For the three-month period ending March 31, 2021, June 30, 2021, September 30, 2021, and December 31, 2021 same clinic revenue per day increased by approximately 1.4%, 18.2%, 10.7%, and 5.8%, respectively, as compared to their corresponding periods in 2020. However, the progress of the COVID-19 Pandemic has been erratic, with infection rates fluctuating as new variants, including the Delta and Omicron variants, have emerged. When compared to each of the quarters in 2019, same clinic revenue in our clinics was approximately 99%, 96%, 99%, and 95%, of each respective period in that pre-COVID-19 year. For the full year, same clinic revenue was 97% of the level reported during 2019.
Throughout the COVID-19 affected periods of 2020 through the fourth quarter of 2021, revenues from orthotics have generally dropped more significantly than revenues from prosthetics. During the year, our prosthetics and orthotics day-adjusted sales, excluding acquisitions, increased by approximately 6.1% and 13.0%, respectively. While prosthetic revenues seem to have recovered, the recovery in orthotics has been more gradual when comparing 2021 over the 2019 periods.
In the early months of 2021, vaccines for combating COVID-19 were approved by the US 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 has 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. As vaccines became more readily available, social adversity to vaccination and other factors affected the achievement of nationwide vaccination goals. The lack of achievement of broad immunity coupled with an increase in infections caused by the “Delta” variant in the third quarter of 2021 and the “Omicron” variant in the fourth quarter of 2021 contributed to an increase in the duration and effect of COVID-19 on our business volumes and staffing shortages. Currently, we believe our business volumes are primarily being inhibited 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 are being affected by our own labor constraints in technical and administrative positions, employee related to COVID-19, as well as decreases in our sales of off-the-shelf orthotic devices.
Nevertheless, the overall adverse impact of the COVID-19 pandemic on our business volumes has diminished and stabilized over time, and while our patient appointment and other business volumes have improved, they have not reached the levels experienced prior to the pandemic. We currently anticipate volumes to increase by approximately 2% over 2021 in the coming year.
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 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.
As a result of the COVID-19 pandemic in 2020, 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 employee’s 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, in 2020, 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 recommenced the remaining activities in the second quarter of 2021.
While it is not yet a requirement that all Hanger employees be vaccinated, we are strongly encouraging it. As a policy, we adhere to federal, state, and local regulations which increasingly require certain employees, particularly those who provide healthcare services, to be vaccinated. We are closely monitoring the evolving and growing requirements to ensure we are continuing to take the appropriate actions to ensure our impacted employees are compliant.
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.
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 $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. In April 2020, 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 2021 and 2020, we recognized a total benefit of $1.1 million and $24.0 million, respectively, in our consolidated statement of operations within Other operating costs for the grant proceeds we received under the CARES Act (“Grants”) 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 year ended December 31, 2020, 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. 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.
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 Years Ended December 31,
Medicare
Medicaid
Commercial Insurance / Managed Care (excluding Medicare and Medicaid Managed Care)
Veterans Administration
Private Pay
Patient Care
Patient Care constituted 84.2%, 83.1%, and 82.5% of our net revenues for the years ended December 31, 2021, 2020, and 2019, 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, workers’ compensation, 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. Our reimbursement from Medicare is normally updated by the Centers for Medicare and Medicaid Studies (“CMS”) annually, and that update is currently based on changes in the consumer price index, adjusted for increases in productivity. Within the Medicare caption of the table above, approximately 13.6%, 12.4%, and 10.9% of the segment’s net revenues for the years ended December 31, 2021, 2020, and 2019, respectively is Managed Medicare which is administered through Commercial Insurance Plans and therefore is not necessarily directly tied to the Medicare reimbursement rate. Similarly within the Medicaid caption of the table above, approximately 12.9%, 11.5%, and 11.2% of the segment’s net revenues for the years ended December 31, 2021, 2020, and 2019, respectively is Managed Medicaid which is administered through Commercial Insurance Plans.
Our contracts with Commercial and other payors are based on negotiated rates, or fixed fee schedules, and do not generally provide for automatic increases based on changes in inflation. Overall, approximately half of our reimbursement arrangements have an inherent reference to inflation, or can be adjusted by us to reflect increases in inflation, while the other half do not have such accommodations. While we endeavor to work with Commercial and other payors to advocate rate adjustments that provide for inflationary increases, such payors have been generally reluctant to provide increases commensurate with inflation, which exposes us to potential margin pressures if we are unable to manage our material, personnel and other costs, or otherwise increase the productivity of our personnel in a commensurate fashion.
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.
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 years ended December 31, 2021, 2020, and 2019 are as follows:
For the Years Ended December 31,
(dollars in thousands)
Gross charges
Less estimated implicit price concessions arising from:
Payor disallowances
Patient non-payments
Payor disallowances and patient non-payments
Net revenues
Payor disallowances
Patient non-payments
Payor disallowances, patient non-payments, and bad debt expense
Payor disallowances %
Patient non-payments %
Percent of gross charges
During 2020 and 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. 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.
Our accounts receivable balances for 2019 through 2021 were as follows:
As of December 31,
(dollars in thousands)
Gross charges before estimates for implicit price concessions
Less estimates for implicit price concessions:
Payor disallowances
Patient non-payments
Accounts receivable, gross
Allowance for doubtful accounts
Accounts receivable, net
Payor disallowances %
Patient non-payments %
Allowance for doubtful accounts %
Total allowance %
Acquisitions
During the first quarter of 2022 to date, we completed the acquisition of one O&P business for a total purchase price of $5.0 million. Total consideration transferred for this acquisition is comprised of $4.0 million in cash consideration, $1.0 million in the form of notes to the former shareholders.
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 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 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.
During 2020, 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 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.
• 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 years ended December 31, 2021 and 2020 were $2.1 million and $0.9 million, respectively, 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 years ended December 31, 2021 and 2020 were $1.6 million and $0.6 million, respectively.
In response to the expected economic impact of the COVID-19 pandemic, we implemented certain cost mitigation and liquidity management strategies, including the temporary delay of our acquisitions of O&P providers, subject to certain conditions and thresholds in the first amendment to our Credit Agreement entered into in May 2020, except that certain acquisitions are permitted after September 30, 2020, in the event we maintain certain leverage and liquidity thresholds. During the fourth quarter of 2020, we recommenced our acquisition of O&P providers. Refer to the “Financial Condition, Liquidity, and Capital Resources” section for additional discussion.
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, and transitioned our corporate financial systems to the Oracle Cloud Financials platform in the third quarter of 2021.
In connection with our New Systems Implementations, for the years ended December 31, 2021 and 2020, we expensed $5.2 million and $2.6 million, respectively. We are additionally incurring increased capital expenditures in connection with improvements to our systems’ infrastructure. In 2022, we currently expect to incur technology-related implementation expenses for the financial and supply chain projects of approximately $4 to $5 million and approximately $1 million in lease termination and related facility transition expenses. In addition, we expect to incur further significant cash outlays and capital expenditures in connection with our supply chain, financial systems, and technology infrastructure initiatives. For a further discussion of our current outlook for capital expenditures and systems implementation expenditures, refer to the “Financial Condition, Liquidity, and Capital Resources” section below.
In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Topic 350) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract . Effective July 1, 2019, we elected to early adopt the requirements of the standard on a prospective basis. The new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Under the new standard, certain of the implementation costs of our new financial and supply chain system will be capitalized. As of December 31, 2021, we capitalized $7.0 million of implementation costs for cloud computing arrangements, net of accumulated amortization, and recorded in other current assets and other assets in the consolidated balance sheet.
Business Environment and Outlook
Patient Care
In our Patient Care segment, we have a positive view of the long-term need for prosthetic and orthotic devices and services within the markets that we serve. To address the debilitating effects of injuries and medical conditions such as diabetes, vascular disease, cancer, and congenital disorders, we believe patients will have a continuing need for the O&P services that we provide. As the population grows and ages, we also believe there will be a gradual underlying increase in market demand.
To ensure we maintain and grow our share of this market, we believe that it will be necessary for us to find effective means to automate and better organize our business processes, further improve our reimbursement capabilities, and lower our cost structure in the longer term. Our size may afford us the ability to achieve economies of scale through purchasing and process automation initiatives that could be difficult for our smaller competitors. However, our size can work against us if we do not succeed in effectively serving our referring physicians and in competing with our individual competitors in each of the markets that we serve.
Products & Services
Generally, we believe our distribution customers encounter reimbursement pressures similar to those that we do in our own Patient Care services and, depending on their ability to adapt to the increased claims documentation standards that have emerged in our industry, that 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. Additionally, during 2020, we discontinued our distribution of certain low-margin orthotics products to podiatrists.
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, began to discontinue 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, which resulted in our recognition of $2.5 million in equipment sales in 2021, as compared with $1.9 million in 2020 and $2.4 million in 2019. For the year ended December 31, 2021, due to customer discontinuances, we experienced a decrease of $2.6 million in therapeutic services and supplies revenue and an increase of $0.6 million in therapeutic equipment sales, for a total reduction of $2.0 million in revenues we received from therapeutic equipment and services. We recognized a total of $43.5 million in revenues from therapeutic equipment and services in 2021. Within this portion of our business, we have and continue to respond to these trends through the expansion of our products and services offerings.
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 I, Item 1A. “Risk Factors” in this report for further discussion.
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 first quarter of 2021, 2020, and 2019, we spent approximately $0.3 million, $2.3 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. Due to the Omicron variant, the in-person event was cancelled in Q1 2022, resulting in much lower expenses for the event in 2022. We anticipate resuming an in-person event in 2023.
Critical Accounting Policies and Estimates
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. Our significant accounting policies are stated in Note A - “Organization and Summary of Significant Accounting Policies” to the consolidated financial statements included in this Annual Report on Form 10-K. 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
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 VA, and 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. These are recorded as a reduction of revenues because they are not caused by an inability of the payor or patient to pay, but rather internal administrative issues such as adjustments to contractual allowances, adjustments to coding, failure to ensure that a patient was currently eligible under a payor’s health plan, that their plan provides full O&P benefits, failure to receive prior authorization, failure to file or appeal the payor’s determination timely, by certain classes of patients to pay their portion of a claim, or other such administrative issues.
Our products and services are sold with a 90-day labor and 180-day warranty for fabricated components. Warranties are not considered a separate performance obligation. We estimate warranties based on historical trends and include them in accrued expenses and other current liabilities in the consolidated balance sheet. The warranty liability was $2.9 million at December 31, 2021 and $2.2 million at December 31, 2020.
A portion of our O&P revenue comes from the provision of cranial devices. In addition to delivering the cranial device, there are patient follow-up visits where we assist in treating the patient’s condition by adjusting or modifying the cranial device. We conclude that, for these devices, there are two performance obligations and use the expected cost plus margin approach to estimate for the standalone selling price of each performance obligation. The allocated portion associated with the patient’s receipt of the cranial device is recognized when the patient receives the device while the portion of revenue associated with
the follow-up visits is initially recorded as deferred revenue. On average, the cranial device follow-up visits occur less than 90 days after the patient receives the device and the deferred revenue is recognized on a straight-line basis over the period.
Medicare and Medicaid regulations and the various agreements we have with other third party payors, including commercial healthcare payors under which these contractual adjustments and payor disallowances are calculated, are complex and are subject to interpretation and adjustment and may include multiple reimbursement mechanisms for different types of services. Therefore, the particular O&P devices and related services authorized and provided, and the related reimbursement, are subject to interpretation and adjustment that could result in payments that differ from our estimates. Additionally, updated regulations and reimbursement schedules, and contract renegotiations occur frequently, necessitating regular review and assessment of the estimation process by management. As a result, there is a reasonable possibility that recorded estimates could change and any related adjustments will be recorded as adjustments to net revenue when they become known.
Products & Services Segment
Revenue in our Products & Services segment is derived from the distribution of O&P components and the leasing and sale of rehabilitation equipment and ancillary consumable supplies combined with equipment maintenance, education, and training.
Distribution services revenues are recognized when obligations under the terms of a contract with our customers are satisfied, which occurs with the transfer of control of our products. This occurs either upon shipment or delivery of goods, depending on whether the terms are FOB Origin or FOB Destination. Payment terms are typically between 30 to 90 days. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products to a customer (“transaction price”).
To the extent that the transaction price includes variable consideration, such as prompt payment discounts, list price discounts, rebates, and volume discounts, we estimate the amount of variable consideration that should be included in the transaction price utilizing the most likely amount method. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current, and forecasted) that is reasonably available.
We reduce revenue by estimates of potential future product returns and other allowances. Provisions for product returns and other allowances are recorded as a reduction to revenue in the period sales are recognized. We make estimates of the amount of sales returns and allowances that will eventually be incurred. Management analyzes sales programs that are in effect, contractual arrangements, market acceptance, and historical trends when evaluating the adequacy of sales returns and allowance accounts.
Therapeutic program equipment and related services revenue are recognized over the applicable term the customer has the right to use the equipment and as the services are provided. Equipment sales revenue is recognized upon shipment, with any related services revenue deferred and recognized as the services are performed. Sales of consumables are recognized upon shipment.
In addition, we estimate amounts recorded to bad debt expense using historical trends and these are presented as a bad debt expense under the operating costs section of our consolidated financial statements.
Accounts Receivable, Net
Patient Care Segment
We establish allowances for accounts receivable to reduce the carrying value of such receivables to their estimated net realizable value. The Patient Care segment’s accounts receivables are recorded net of unapplied cash and estimated implicit price concessions, such as payor disallowances and patient non-payments, as described in the revenue recognition accounting policy above.
Our estimates of payor disallowances utilize the expected value method by considering historical collection experience by each of the Medicare and non-Medicare primary payor class groupings. For each payor class grouping, liquidation analyses of historical period end receivable balances are performed to ascertain collections experience by aging category. In the absence of an evident adverse trend, we use historical experience rates calculated using an average of four quarters of data
with at least twelve months of adjudication. We will modify the time periods analyzed when significant trends indicate that adjustments should be made.
Products & Services Segment
Our Products & Services segment’s allowance for doubtful accounts is estimated based on the analysis of the segment’s historical write-offs experience, accounts receivable aging and economic status of its customers. Accounts receivable that are deemed uncollectible are written off to the allowance for doubtful accounts. Accounts receivable are also recorded net of an allowance for estimated sales returns.
Inventories
Inventories are valued at the lower of estimated cost or net realizable value with cost determined on a first-in, first-out (“FIFO”) basis. Provisions have also been made to reduce the carrying value of inventories for excess, obsolete, or otherwise impaired inventory on hand at period end. The reserves for excess and obsolete inventory and WIP cancellations total $7.5 million and $6.1 million at December 31, 2021 and 2020, respectively.
Patient Care Segment
Substantially all of our Patient Care segment inventories are recorded through a periodic approach whereby inventory quantities are adjusted on the basis of a quarterly physical count. Segment inventories relate primarily to raw materials and work-in-process at Hanger Clinics. Inventories at Hanger Clinics totaled $36.7 million and $30.5 million at December 31, 2021 and 2020, respectively, with WIP inventory representing $15.8 million and $12.0 million of the total inventory, respectively. The increase in inventories, including the increase in WIP, is due in part to acquisitions as well as a build in undelivered devices resulting in part from our inability to deliver devices at the end of 2021 due to the Omicron variant. Refer to the “Effects of the COVID-19 Pandemic” section above for further discussion.
Raw materials consist of purchased parts, components, and supplies which are used in the assembly of O&P devices for delivery to patients. In some cases, purchased parts and components are also sold directly to patients. Raw materials are valued based on recent vendor invoices, reduced by estimated vendor rebates. Such rebates are recognized as a reduction of cost of materials in the consolidated statements of operations when the related devices or components are delivered to the patient. Approximately 77% of raw materials at December 31, 2021 and 2020, respectively, were purchased from our Products & Services segment. Raw material inventory was $20.9 million and $18.4 million at December 31, 2021 and 2020, respectively.
WIP consists of devices which are in the process of assembly at our clinics or fabrication centers. WIP quantities were determined by the physical count of patient orders at the end of every quarter of 2021 and 2020 while the related stage of completion of each order was established by clinic personnel. We do not have an inventory costing system and as a result, the identified WIP quantities were valued on the basis of estimated raw materials, labor, and overhead costs. To estimate such costs, we develop bills of materials for certain categories of devices that we assemble and deliver to patients. Within each bill of material, we estimate (i) the typical types of component parts necessary to assemble each device; (ii) the points in the assembly process when such component parts are added; (iii) the estimated cost of such parts based on historical purchasing data; (iv) the estimated labor costs incurred at each stage of assembly; and (v) the estimated overhead costs applicable to the device.
Products & Services Segment
Our Product & Service segment inventories consist primarily of finished goods at its distribution centers as well as raw materials at fabrication facilities, and totaled $50.8 million and $45.9 million as of December 31, 2021 and 2020, respectively. Finished goods include products that are available for sale to third party customers as well as to our Patient Care segment as described above. Such inventories were determined on the basis of perpetual records and a physical count at year end. Inventories in connection with therapeutic services are valued at a weighted average cost.
Business Combinations
We record tangible and intangible assets acquired and liabilities assumed in business combinations under the acquisition method of accounting. Acquisition consideration typically includes cash payments, the issuance of Seller Notes and in certain instances contingent consideration with payment terms based on the achievement of certain targets of the acquired business. Amounts paid for each acquisition are allocated to the assets acquired and liabilities assumed based on their
estimated fair values at the date of acquisition inclusive of identifiable intangible assets. The estimated fair value of identifiable assets and liabilities, including intangibles, are based on valuations that use information and assumptions available to management. We allocate any excess purchase price over the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed to goodwill. We allocate goodwill to our reporting units based on the reporting unit that is expected to benefit from the acquired goodwill. Significant management judgments and assumptions are required in determining the fair value of assets acquired and liabilities assumed, particularly acquired intangible assets, including estimated useful lives. The valuation of purchased intangible assets is based upon estimates of the future performance and discounted cash flows of the acquired business. Each asset acquired or liability assumed is measured at estimated fair value from the perspective of a market participant. Subsequent changes in the estimated fair value of contingent consideration are recognized as general and administrative expenses within the consolidated statements of operations.
Goodwill and Other Intangible Assets, Net
Goodwill represents the excess of the purchase price over the estimated fair value of net identifiable assets acquired and liabilities assumed from purchased businesses. We assess goodwill for impairment annually during the fourth quarter, 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 amount. We have the option to first assess qualitative factors for a reporting unit to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the quantitative goodwill impairment test. If we choose to bypass this qualitative assessment or alternatively determine that a quantitative goodwill impairment test is required, our annual goodwill impairment test is performed by comparing the estimated fair value of a reporting unit with its carrying amount (including attributed goodwill). We measure the fair value of the reporting units using a combination of income and market approaches. Any impairment would be recognized by a charge to income from operations and a reduction in the carrying value of the goodwill. As of October 1, 2021, we performed a qualitative assessment of the Patient Care reporting unit. The qualitative assessment did not result in the carrying value of the reporting unit exceeding its fair value.
We apply judgment in determining the fair value of our reporting units and the implied fair value of goodwill which is dependent on significant assumptions and estimates regarding expected future cash flows, terminal value, changes in working capital requirements, and discount rates.
We did not have any goodwill impairment during 2021, 2020, and 2019. We also did not have any indefinite-lived trade name impairment during 2021, 2020, and 2019. See Note H - “Goodwill and Other Intangible Assets” to our consolidated financial statements in this Annual Report on Form 10-K for additional information.
As described, we apply judgment in the selection of key assumptions used in the goodwill impairment test and as part of our evaluation of intangible assets tested annually and at interim testing dates as necessary. If these assumptions differ from actual, we could incur additional impairment charges and those charges could be material.
We consider the assessment of the occurrence of triggering events or substantive changes in circumstances that may indicate the fair value of goodwill may be impaired to be a critical estimate. Additionally, we consider the assumptions discussed above pertaining to the income and market approaches we use in the testing of impairment to be critical estimates. Changes in these estimates and assumptions could materially affect the determination of fair value and the goodwill impairment test result.
Income Taxes
We recognize deferred tax assets and liabilities for net operating loss and other credit carry forwards and the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The evaluation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns, and future profitability by tax jurisdiction.
We provide a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. 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. We have experienced losses from 2014 to 2017 due to impairments of our intangible assets, increased professional fees in relation to our restatement and related remediation procedures for identified material weaknesses, and increased interest and bank fees. These losses have necessitated that we evaluate the sufficiency of our valuation allowance.
We are in a taxable income position in 2021 and are able to utilize net operating losses. We have $1.6 million and $4.6 million of U.S. federal and $139.1 million and $153.0 million of state net operating loss carryforwards available at December 31, 2021 and 2020, respectively. These carryforwards will be used to offset future income but may be limited by the change in ownership rules in Section 382 of the Internal Revenue Code. These net operating loss carryforwards will expire in varying amounts through 2041. We expect to generate income before taxes in future periods at a level that would allow for the full realization of the majority of our net deferred tax assets. As of December 31, 2021 and 2020, we have recorded a valuation allowance of approximately $2.1 million related to various state jurisdictions.
We believe that our tax positions are consistent with applicable tax law, but certain positions may be challenged by taxing authorities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. In addition, we are subject to periodic audits and examinations by the Internal Revenue Service and other state and local taxing authorities. In these cases, we record the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. We record the largest amount of tax benefit that is greater than fifty percent likely of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. If not paid, the liability for uncertain tax positions is reversed as a reduction of income tax expense at the earlier of the period when the position is effectively settled or when the statute of limitations has expired. Although we believe that our estimates are reasonable, actual results could differ from these estimates. Interest and penalties, when applicable, are recorded within the income tax provision. During the year ended December 31, 2021, we released $4.0 million of unrecognized tax benefits and $1.3 million of interest expense due to of statute of for the applicable tax years. We do not anticipate further significant release of unrecognized tax benefits within the next twelve months.
Reclassifications
We have reclassified certain amounts in the prior year consolidated financial statements to be consistent with the current year presentation. These relate to classifications with the consolidated statements of operations.
Recent Accounting Pronouncements
Refer to the “Recent Accounting Pronouncements” section in Note A - “Organization and Summary of Significant Accounting Policies” in this Annual Report on Form 10-K for disclosure of recent accounting pronouncements that are either expected to have more than a minimal impact on our consolidated financial position and results of operation, or that we are still assessing to determine their impact.
Results of Operations - Year Ended December 31, 2021 Compared to Year Ended December 31, 2020
For the years ended December 31, 2021 and 2020, our consolidated results of operations were as follows:
For the Years Ended
December 31,
Percent
Change
(dollars in thousands)
Net revenues
Material costs
Personnel costs
Other operating costs
General and administrative expenses
Depreciation and amortization
Operating expenses
Income from operations
Interest expense, net
Non-service defined benefit plan expense
Income before income taxes
Provision for income taxes
Net income
Material costs, personnel costs, and other operating costs reflect expenses we incur in connection with our delivery of care through our clinics and other patient care operations, or through the distribution of products and services, and exclude general and administrative activities. General and administrative activities reflect expenses we incur that are not directly related to the operation of our clinics or provision of products and services.
During 2021 and 2020, our operating expenses as a percentage of net revenues were as follows:
For the Years Ended
December 31,
Material costs
Personnel costs
Other operating costs
General and administrative expenses
Depreciation and amortization
Operating expenses
During the previous two years, the number of patient care clinics and satellite locations we operated or leased have been as follows:
As of December 31,
Patient care clinics
Satellite locations
Total
Patient care clinics reflect locations that are licensed as a primary location to provide O&P services and which are fully staffed and open throughout a typical operating week. To facilitate patient convenience, we also operate satellite clinics. These are remote locations associated with a primary care clinic, utilized to see patients, and are open for operation on less than a full-time basis during a typical operating week.
Relevance of Year 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 throughout 2020 and into 2021. The effects of this public health emergency on our revenues and earnings, particularly in 2020, 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 labor and other 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.
Net revenues . Net revenues for the year ended December 31, 2021 were $1,120.5 million, an increase of $119.3 million, or 11.9%, from $1,001.2 million for the year ended December 31, 2020. Net revenues by operating segment, after elimination of intersegment activity, were as follows:
For the Years Ended
December 31,
Change
Percent
Change
(dollars in thousands)
Patient Care
Products & Services
Net revenues
Patient Care net revenues for the year ended December 31, 2021 were $943.3 million, an increase of $111.7 million, or 13.4%, from $831.6 million for the same period in the prior year. Same clinic revenues increased $69.9 million for the year ended December 31, 2021 compared to the same period in the prior year, reflecting an increase in same clinic revenues of 9.1% on a per-day basis. We estimate that approximately 8.3% of this increase related to growth in volume, primarily associated with the recovery from the COVID-19 related impact on 2020 volumes, and the remaining 0.8% related to price growth and improvements in disallowed and patient non-payment rates. Net revenues from acquired clinics and consolidations increased $42.3 million, and revenues from other services decreased $0.5 million. For the year ended December 31, 2021, we estimate that our same clinic net revenues were approximately 97% of the level we reported for the same period of 2019, prior to the pandemic, while our patient appointment volumes were 93% of those we reported in the 2019 period. This increase in revenue relative to patient volumes related primarily to reductions in patient encounters for lower “off-the-shelf” orthotic devices, as well as increases in volume of technology-related prosthetic devices during the year.
Prosthetics constituted approximately 55% of our total Patient Care revenues for the year ended December 31, 2021 and 56% for the same period in the prior year, excluding the impact of acquisitions. Prosthetic revenues were 6.1% 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 13.0% on a per-day basis for the same comparative period, excluding the impact of acquisitions. Revenues throughout 2020, particularly orthotic revenues, were adversely affected due to a decline in patient appointment volumes as a result of the COVID-19 pandemic, governmental suppression measures implemented in response to the COVID-19 pandemic, and other factors impacting our business volumes as discussed in the “Effects of the COVID-19 Pandemic” section.
Products & Services net revenues for the year ended December 31, 2021 were $177.2 million, an increase of $7.6 million, or 4.5%, from $169.5 million for the same period in the prior year. This was primarily attributable to an increase of $9.6 million, or 7.7%, in the distribution of O&P componentry to independent providers stemming largely from lower volumes in the comparative period due to the COVID-19 pandemic, as discussed in the “Effects of the COVID-19 Pandemic” section above, and a $2.0 million, or 4.3%, decrease in net revenues from therapeutic solutions as a result of the impact of customer lease cancellations, partially offset by lease installations.
Material costs . Material costs for the year ended December 31, 2021 were $354.3 million, an increase of $38.9 million or 12.3%, from $315.4 million for the same period in the prior year. Total material costs as a percentage of net revenues increased to 31.6% in 2021 from 31.5% in 2020 due primarily to changes in our Patient Care segment business mix. Material costs by operating segment, after elimination of intersegment activity, were as follows:
For the Years Ended
December 31,
Change
Percent
Change
(dollars in thousands)
Patient Care
Products & Services
Material costs
Patient Care material costs increased $39.8 million, or 16.1%, for the year ended December 31, 2021 compared to the same period in the prior year as a result of the increase in segment net sales and changes in the segment product mix. Patient Care material costs as a percent of segment net revenues was 30.4% in 2021 and 29.7% in 2020. Our operations and clinic throughput were not adversely affected due to the lack of availability of componentry in 2021.
Products & Services material costs decreased $0.9 million, or 1.3%, for the year ended December 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 37.9% in the year ended December 31, 2021 as compared to 40.1% in the same period 2020. The decrease in material costs as a percentage of segment net revenues was due to a change in business and product mix within the segment, in part due to the discontinuation of our distribution of certain low-margin orthotics products to podiatrists during 2020.
Personnel costs . Personnel costs for the year ended December 31, 2021 were $397.6 million, an increase of $46.4 million, or 13.2%, from $351.2 million for the same period in the prior year. Personnel costs by operating segment were as follows:
For the Years Ended
December 31,
Change
Percent
Change
(dollars in thousands)
Patient Care
Products & Services
Personnel costs
Personnel costs for the Patient Care segment were $339.6 million for the year ended December 31, 2021, an increase of $37.4 million, or 12.4%, from $302.2 million for the same period in the prior year. The increase in Patient Care personnel costs during the year was primarily due to an increase in salary expense of $40.3 million due to cost mitigation efforts in the prior year period as a result of the COVID-19 pandemic as well as from acquisitions, and related increases in benefits costs of $2.3 million, payroll taxes of $2.1 million, and commissions by $1.0 million, offset by a decrease in incentive compensation and other personnel costs of $8.3 million compared to the same period in the prior year.
Personnel costs in the Products & Services segment were $58.0 million for the year ended December 31, 2021, an increase of $9.0 million, or 18.4% compared to the same period in the prior year. Salary expense increased $7.7 million primarily due to cost mitigation efforts implemented in 2020 as a result of the COVID-19 pandemic, and benefits, payroll taxes, and other personnel costs increased $1.7 million, offset by a decrease in incentive compensation of $0.4 million for the year ended December 31, 2021 compared to the same period in the prior year.
Other operating costs . Other operating costs for the year ended December 31, 2021 were $135.6 million, an increase of $35.6 million, or 35.6%, from $100.0 million for the same period in the prior year. Other expenses increased by $26.4 million primarily due to the benefit in the prior year period associated with the recognition of $24.0 million in proceeds from Grants under the CARES Act included in Other operating costs, as discussed in the “Effects of the COVID-19 Pandemic” section, and an approximate $1.9 million gain on the sale of property. Professional fees increased $2.7 million, travel expenses increased $1.9 million, and other expenses increased $3.7 million primarily due to cost mitigation efforts in the prior year as a result of the COVID-19 pandemic, and an increase of $1.3 million in rent expense from new, renewed, and acquired leases. The increases are partially offset by a decrease in bad debt expense of $0.4 million as compared to the same period in the prior year.
General and administrative expenses . General and administrative expenses for the year ended December 31, 2021 were $127.8 million, which is unchanged from the same period in the prior year. This was primarily the result of an increase in salary expense of $7.6 million and an increase in travel and other expenses of $5.9 million, offset by decreases in share-based compensation of $5.7 million due to the modification recognized in the prior year period of certain equity awards granted in 2017, a decrease of $5.4 million in incentive compensation and benefits, and a decrease of $2.4 million of qualified disaster relief payments to employees in the prior year.
Depreciation and amortization . Depreciation and amortization for the year ended December 31, 2021 was $32.5 million, a decrease of $2.3 million, or 6.7%, from the same period in the prior year. Depreciation expense decreased $1.2 million and amortization expense decreased $1.1 million when compared to the same period in the prior year.
Interest expense, net. Interest expense for the year ended December 31, 2021 was $28.9 million, a decrease of $3.6 million, or 11.0%, from $32.4 million for the same period in the prior year.
Provision for income taxes . The provision for income taxes for the year ended December 31, 2021 was $1.2 million, or 2.7% of income before taxes, compared to a provision of $0.6 million, or 1.6% of income before taxes for the year ended December 31, 2020. The effective tax rate in 2021 consisted principally of the 21% federal statutory tax rate and non-deductible expenses, offset by research and development tax credits and the release of reserves for uncertain tax positions. The increase in the effective tax rate for the year ended December 31, 2021 compared with the year ended December 31, 2020 is primarily attributable to the net tax benefit resulting from the loss carryback provisions granted under the CARES Act for the year ended December 31, 2020, partially offset by the release of reserves for uncertain tax positions for the year ended December 31, 2021.
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 $3.3 million, net of tax reserves, related to 2020 and $6.1 million, net of tax reserves, related to prior years. For the year ended December 31, 2021, we recorded a federal tax benefit of $4.3 million, net of tax reserves, as a deferred tax asset.
During the year ended December 31, 2021, we released $4.0 million of unrecognized tax benefits and $1.3 million of interest expense due to lapse of statute of limitations for the applicable tax years. We do not anticipate further significant release of unrecognized tax benefits within the next twelve months.
Net income . Our net income for year ended December 31, 2021 was $42.0 million as compared to net income of $38.2 million for year ended December 31, 2020.
Results of Operations - Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
For the years ended December 31, 2020 and 2019, our consolidated results of operations were as follows:
For the Years Ended
December 31,
Percent
Change
(dollars in thousands)
Net revenues
Material costs
Personnel costs
Other operating costs
General and administrative expenses
Depreciation and amortization
Operating expenses
Income from operations
Interest expense, net
Non-service defined benefit plan expense
Income before income taxes
Provision for income taxes
Net income
Material costs, personnel costs, and other operating costs reflect expenses we incur in connection with our delivery of care through our clinics and other patient care operations, or through the distribution of products and services, and exclude general and administrative activities. General and administrative activities reflect expenses we incur that are not directly related to the operation of our clinics or provision of products and services.
During 2020 and 2019, our operating expenses as a percentage of net revenues were as follows:
For the Years Ended
December 31,
Material costs
Personnel costs
Other operating costs
General and administrative expenses
Depreciation and amortization
Operating expenses
During the previous two years, the number of patient care clinics and satellite locations we operated or leased have been as follows:
As of December 31,
Patient care clinics
Satellite locations
Total
Patient care clinics reflect locations that are licensed as a primary location to provide O&P services and which are fully staffed and open throughout a typical operating week. To facilitate patient convenience, we also operate satellite clinics. These are remote locations associated with a primary care clinic, utilized to see patients, and are open for operation on less than a full-time basis during a typical operating week.
Relevance of Year 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 throughout 2020 and into 2021. The effects of this public health emergency on our revenues and earnings in the year ended December 31, 2020 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 labor and other 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.
Net revenues . Net revenues for the year ended December 31, 2020 were $1,001.2 million, a decrease of $96.9 million, or 8.8%, from $1,098.0 million for the year ended December 31, 2019. Net revenues by operating segment, after elimination of intersegment activity, were as follows:
For the Years Ended
December 31,
Change
Percent
Change
(dollars in thousands)
Patient Care
Products & Services
Net revenues
Patient Care net revenue for the year ended December 31, 2020 was $831.6 million, a decrease of $74.1 million, or 8.2%, from $905.7 million for the same period in the prior year. Same clinic revenues decreased $91.9 million for the year ended
December 31, 2020 compared to the same period in the prior year, reflecting a decrease in same clinic revenues of 11.0% on a per-day basis. We estimate that volumes decreased 12.8% and this decline was partially mitigated by a 0.7% increase in pricing and a 1.1% increase from the improvement in disallowed claims and patient non-payment. Net revenues from acquired clinics and consolidations increased $18.6 million, and revenues from other services decreased $0.8 million.
Prosthetics constituted approximately 56% of our total Patient Care revenues for the year ended December 31, 2020 and 55% for the same period in the prior year, excluding the impact of acquisitions. Prosthetic revenues were 8.3% lower on a per-day basis than the same period in the prior year, excluding the impact of acquisitions. Orthotics, shoes, inserts, and other products decreased by 14.2% on a per-day basis for the same comparative period, excluding the impact of acquisitions. Revenues were adversely affected during the period due to a decline in patient appointment volumes beginning in the last two weeks of March and continuing throughout 2020 as a result of the continuing spread of COVID-19 viral infections, 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 year ended December 31, 2020 were $169.5 million, a decrease of $22.8 million, or 11.9%, from $192.4 million for the same period in the prior year. This was primarily attributable to a decrease of $19.4 million, or 13.5% in the distribution of O&P componentry to independent providers stemming primarily from lower volumes due to the COVID-19 pandemic, as discussed in the “Effects of the COVID-19 Pandemic” section above, and a $3.4 million, or 7.1%, decrease in net revenues from therapeutic solutions as a result of the impact of historical customer lease cancellations, partially offset by lease installations.
Beginning in the latter half of March 2020, our business volumes began to be adversely affected by the COVID-19 pandemic, and business volumes were adversely impacted throughout 2020. We believe that the decline in net revenues in the year ended December 31, 2020 was primarily due to the continuing spread of COVID-19 viral infections, state and local government restrictions, social distancing and suppression measures adopted by our patients and customers, and deferral of elective surgical procedures, all of which resulted in a decline in physician referrals and patient appointments. For additional discussion, refer to the “Effects of the COVID-19 Pandemic” section.
Material costs . Material costs for the year ended December 31, 2020 were $315.4 million, a decrease of $42.4 million, or 11.8%, from $357.8 million for the same period in the prior year. Total material costs as a percentage of net revenue decreased to 31.5% in 2020 from 32.6% in 2019 due primarily to changes in our Patient Care segment business mix. Material costs by operating segment, after elimination of intersegment activity, were as follows:
For the Years Ended
December 31,
Change
Percent
Change
(dollars in thousands)
Patient Care
Products & Services
Material costs
Patient Care material costs decreased $27.4 million, or 10.0%, for the year ended December 31, 2020 compared to the same period in the prior year as a result of the reduction in segment net sales, offset by our acquisitions and changes in the segment product mix. Patient Care material costs as a percent of segment net revenues was 29.7% in 2020 from 30.3% in 2019.
Products & Services material costs decreased $14.9 million, or 18.0%, for the year ended December 31, 2020 compared to the same period in the prior year. As a percent of net revenues in the Products & Services segment, material costs were 40.1% in the year ended December 31, 2020 as compared to 43.1% in the same period 2019. The decrease in material costs as a percentage of segment net revenues was due to a change in business and product mix within the segment.
Personnel costs . Personnel costs for the year ended December 31, 2020 were $351.2 million, a decrease of $21.0 million, or 5.7%, from $372.2 million for the same period in the prior year. Personnel costs by operating segment were as follows:
For the Years Ended
December 31,
Change
Percent
Change
(dollars in thousands)
Patient Care
Products & Services
Personnel costs
Personnel costs for the Patient Care segment were $302.2 million for the year ended December 31, 2020, a decrease of $17.4 million, or 5.5%, from $319.6 million for the same period in the prior year. The decrease in Patient Care personnel costs during the year was primarily due to a decrease in salary expense of $21.5 million due to cost mitigation efforts implemented as result of the COVID-19 pandemic, and decreases in benefits costs of $1.5 million due to reduced claims experience, payroll taxes of $0.9 million, and commissions by $0.7 million, offset by increases in incentive compensation and other personnel costs of $6.1 million and severance costs of $1.1 million compared to the same period in the prior year.
Personnel costs in the Products & Services segment were $49.0 million for the year ended December 31, 2020, a decrease of $3.6 million, or 6.9% compared to the same period in the prior year. Salary expense decreased $3.2 million due to cost mitigation efforts as a result of the COVID-19 pandemic, and bonus, commissions, and other personnel costs decreased $0.4 million for the year ended December 31, 2020 compared to the same period in the prior year.
Other operating costs . Other operating costs for the year ended December 31, 2020 were $100.0 million, a decrease of $35.2 million, or 26.0%, from $135.2 million for the same period in the prior year. Other expenses decreased by $26.3 million due to the benefit associated with the recognition of $24.0 million in proceeds from Grants under the CARES Act included in Other operating costs, as discussed in the “Effects of the COVID-19 Pandemic” section, and an approximate $1.9 million gain on the sale of property. Travel and other expenses decreased $11.9 million due to cost mitigation efforts as a result of the COVID-19 pandemic, and bad debt expense decreased $0.8 million. The decreases are offset by a $3.8 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 year ended December 31, 2020 were $127.8 million, a decrease of $3.7 million, or 2.8%, from $131.5 million for the same period in the prior year. This was primarily the result of a decrease in salary expense of $6.2 million, as well as a decrease in professional fees of $5.7 million and travel and other expenses of $1.9 million, offset by increases in share-based compensation of $4.4 million due to the modification recognized in the second quarter of certain equity awards granted in 2017, and from an increase of $1.4 million in incentive compensation and benefits costs, $2.4 million of qualified disaster relief payments to employees, and additional severance costs of $1.9 million.
Depreciation and amortization . Depreciation and amortization for the year ended December 31, 2020 was $34.8 million, a decrease of $1.1 million, or 3.0%, from the same period in the prior year. Depreciation expense decreased $2.5 million and amortization expense increased $1.4 million when compared to the same period in the prior year.
Interest expense, net. Interest expense for the year ended December 31, 2020 was $32.4 million, a decrease of $1.8 million, or 5.3%, from $34.3 million for the same period in the prior year.
Provision for income taxes . The provision for income taxes for the year ended December 31, 2020 was $0.6 million, or 1.6% of income before taxes, compared to a provision of $3.0 million, or 9.7% of income before taxes for the year ended December 31, 2019. The effective tax rate in 2020 consisted principally of the 21% federal statutory tax rate and non-deductible expenses, offset by research and development tax credits and the net tax benefit of the loss carryback claim granted under the CARES Act. The decrease in the effective tax rate for the year ended December 31, 2020 compared with the year ended December 31, 2019 is primarily attributable to the recognition of research and development tax credits for the current and prior years and the tax benefit resulting from the loss carryback provisions granted under the CARES Act.
For the year ended December 31, 2020, we completed a formal study to identify qualifying research and development expenses resulting in the recognition of tax benefits of $2.2 million, net of tax reserves, related to the current year 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.
The CARES Act, which was enacted on March 27, 2020, included 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. Accounting Standards Codification (“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.
During the year ended December 31, 2019, we determined that it was more likely than not that we would be able to realize the benefit of certain state deferred tax assets after we achieved twelve quarters of cumulative pretax income adjusted for permanent differences, as well as forecasted future taxable income and other positive evidence, and released $7.1 million of the valuation allowance related to certain state deferred tax assets in the fourth quarter of 2019.
Net income. Our net income for year ended December 31, 2020 was $38.2 million as compared to a net income of $27.5 million for year ended December 31, 2019.
Financial Condition, Liquidity, and Capital Resources
Liquidity
To provide cash for our operations and capital expenditures, our immediate source of liquidity is our cash and investment balances and any amounts we have available for borrowing under our revolving credit facility. We refer to the sum of these two amounts as our “liquidity.”
As of December 31, 2021, we had total liquidity of $191.0 million, which reflected a decrease of $48.4 million, from the $239.4 million in liquidity we had as of December 31, 2020. Our liquidity as of December 31, 2021 was comprised of cash and cash equivalents of $61.7 million and $129.3 million in available borrowing capacity under our $135.0 million revolving credit facility. This decrease in liquidity primarily relates to a decrease in cash of $82.9 million, comprised of cash paid for acquisitions, net of cash acquired, of $80.1 million, capital expenditures of $24.9 million, and net cash used in financing activities of $16.6 million, partially offset by cash provided by operating activities of $36.2 million.
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 made 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 December 31, 2021.
For additional discussion, please refer to the Liquidity Outlook section below.
Working Capital and Days Sales Outstanding
As of December 31, 2021, we had working capital of $91.5 million compared to working capital of $129.3 million as of December 31, 2020. Our working capital decreased $37.8 million in 2021 when compared to 2020 due to a decrease in current assets of $56.5 million and a decrease in current liabilities of $18.8 million.
The decrease in current assets was primarily attributable to a decrease in Cash and cash equivalents of $82.9 million discussed in the “Liquidity” section above and a decrease in Income taxes receivable of $12.3 million, which relates to income tax relief under the CARES Act. The decreases were offset by increases in Accounts receivable, net of $23.5 million, discussed further below, Inventories of $11.0 million, and Other current assets of $4.2 million.
The decrease in current liabilities was primarily attributable to a decreases of $18.1 million in Accrued compensation related costs attributable to current year decreases in incentive compensation, $2.5 million in Accrued expenses and other current
liabilities, $1.5 million in Accounts payable, and $1.6 million in the Current portion of operating lease liabilities, partially offset by an increase in the Current portion of long-term debt of $4.9 million.
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 December 31, 2021, our DSO was 43 days, as compared to 42 days and 48 days as of December 31, 2020 and 2019, respectively. The increase compared to the December 31, 2020 DSO is primarily attributable to an increase in sales at the end of 2021 as compared to 2020.
Sources and Uses of Cash in the Year Ended December 31, 2021 Compared to December 31, 2020
Cash flows provided by operating activities decreased $119.4 million to $36.2 million for the year ended December 31, 2021 from $155.6 million for year ended December 31, 2020. The most significant decrease in cash provided by operating activities was due to a $51.7 million decrease in cash provided by Accounts receivable, net which is largely attributable to an increase in revenue in 2021 as compared to 2020, as discussed in the “Effects of the COVID-19 Pandemic” section above. In addition, operating cash flows have also decreased on a comparative basis due to a decrease in Accrued compensation related costs of $29.8 million, a decrease in Accounts payable and Accrued expenses and other current liabilities of $23.2 million, and other decreases in working capital of $25.6 million; offset by an increase in operating cash flows resulting from income taxes of $14.2 million.
Cash flows used in investing activities increased $56.6 million to $102.5 million for the year ended December 31, 2021 from $45.9 million for the year ended December 31, 2020. The increase in cash used in investing activities was primarily due to higher cash outflows of $58.3 million for acquisitions, net of cash acquired, partially offset by lower capital expenditures of $3.2 million during the year ended December 31, 2021.
Cash flows used in financing activities decreased $22.9 million to $16.6 million for the year ended December 31, 2021 from $39.5 million for the year ended December 31, 2020. This decrease in cash used in financing activities was primarily due to lower cash outflows of $21.0 million related to payments on sellers notes and additional consideration, of which $22.0 million relates to acquisitions that closed in 2020, and a $2.7 million decrease from employee taxes on stock-based compensation.
Capital Expenditures and Deferred Cloud Implementation Expenditures
During 2021, we expended a combined total of $24.9 million for the purchase of property, plant, and equipment, and the purchase of therapeutic program equipment. Our capital expenditures relate primarily to our investment in leasehold and other machinery and equipment for our patient care clinics, for equipment we use in providing therapeutic solutions, as well as for the purchase or development of information technology assets that support our businesses and corporate activities. In addition to this capital expenditure amount, we incurred approximately $2 million in incremental expenditures related to the implementation of cloud-based supply chain and financial systems that will be deferred in accordance with ASU 2018-15 and will be included in future expense over the periods of operation of these systems. These expenditures are anticipated to be separate from and additional to the operating expenses discussed in “New Systems Implementations” section above.
Effect of Indebtedness
On March 6, 2018, we entered into a new Credit Agreement in order to refinance our indebtedness, as disclosed in Note M - “Debt and Other Obligations,” in the notes to the consolidated financial statements contained elsewhere in this report. Our indebtedness bears reduced rates of interest compared with those under our prior agreement, and as such, for the year ended December 31, 2021, we incurred interest expense of $28.9 million compared with the $32.4 million incurred in 2020 and the $34.3 million incurred in 2019. Cash paid for interest totaled $25.7 million, $28.4 million, and $29.2 million for the years ended December 31, 2021, 2020, and 2019 respectively.
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 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. During the fourth quarter of 2020, we recommenced our acquisition of O&P providers as we met certain Amendment parameters around leverage and liquidity thresholds.
On November 23, 2021, we entered into a Second Amendment to Credit Agreement (the “Second Amendment”) that revised certain provisions of the Existing Credit Agreement to, among other things, (i) increase the aggregate amount of the revolving loan commitments by $35 million to an aggregate total amount of $135 million, (ii) extend the scheduled maturity date of the revolving loan facility to November 23, 2026 (subject to a springing maturity if the term loans outstanding under the Existing Credit Agreement are not repaid prior to the date that is 91 days prior to the stated maturity thereof), (iii) decrease the applicable margin on LIBOR and base rate revolving loan borrowings by 0.75% per annum, (iv) decrease the LIBOR interest rate floor in respect of revolving loan borrowings to 0.00% per annum, (v) decrease the revolving loan facility commitment fee to 0.30% per annum, (vi) increase the maximum allowable leverage ratio for covenant purposes such that the maximum consolidated first lien net leverage ratio shall be up to (a) 5.00 to 1.00 for the fiscal quarters ending December 31, 2021, March 31, 2022, June 30, 2022 and September 30, 2022 and (b) 4.75 to 1.00 for the fiscal quarter ending December 31, 2022 and the last day of each fiscal quarter thereafter, and (vii) permit, at our election and up to three times during the term of the Credit Agreement, the maximum allowable leverage ratio for covenant purposes to be temporarily increased by an additional 0.50 to 1.00 for four consecutive fiscal quarters in connection with certain material acquisitions.
Scheduled maturities of debt as of December 31, 2021 were as follows (in thousands):
(in thousands)
Thereafter
Total debt before unamortized discount and debt issuance costs, net
Unamortized discount and debt issuance costs, net
Total debt
Future Cash Requirements
Our primary future cash requirements will be for acquisitions of O&P providers, debt payments, capital expenditures, payment of deferred payroll taxes, and to fund operations.
We expect our primary cash requirements for 2022 to be as follows:
• Acquisitions of O&P providers - Our strategy is to achieve long-term growth through disciplined diversification of our revenue streams, including geographic expansion or the broadening of our continuum of care through the acquisitions of high quality O&P providers. We anticipate that we will continue to pursue acquisitions and other growth initiatives that provide value to our shareholders.
• Debt - We are contractually obligated to make payments of $15.3 million on principal and of $26.6 million in interest in 2022 associated with our Credit Agreement and Seller Notes. In the ordinary course of business, we may from time to time borrow and repay amounts under our revolving credit facility, as well as make voluntary prepayments on Term Loan B.
• Capital expenditures and deferred cloud implementation expenditures - During 2022, 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. In 2022, due to these projects, we currently estimate that our capital expenditures will increase to approximately $33 million. Of this amount, we estimate that approximately $4 million to $5 million will relate to our distribution and
fabrication facility leasehold and equipment expenditures. In addition to this capital expenditure amount, we estimate that we will incur $4 million to $6 million in incremental expenditures related to the New Systems Implementations that will be deferred in accordance with ASU 2018-15 and will be included in future expense over the periods of operation of these systems. We currently expect similar levels of expenditures related to our supply chain and financial systems implementations through 2023.
• Deferred payroll taxes - We expect to make a payment of $5.9 million of deferred payroll taxes in 2022. Refer to the CARES Act discussion below for further discussion.
• Working capital - As business volumes return to more normal levels, it is likely that we will experience a natural corresponding increase in our investment in working capital.
Liquidity Outlook and Going Concern Evaluation
Our Credit Agreement has a term loan facility with $486.1 million in principal outstanding at December 31, 2021, due in quarterly principal installments equal to 0.25% of the original aggregate principal amount of $505 million, with all remaining outstanding principal due at maturity in March 2025, and, as of December 31, 2021, a revolving credit facility with no borrowings and a maximum aggregate amount of availability of $135 million that matures in November 2026.
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 throughout 2022 and the foreseeable future. Please refer to the “Effects of the COVID-19 Pandemic” section above for additional discussion.
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.
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 $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 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 $203.5 billion appropriation. These are payments, rather than loans, to healthcare providers, and will not need to be repaid.
During 2021 and 2020, we recognized a total benefit of $1.1 million and $24.0 million, respectively, in our consolidated statement of operations within Other operating costs for the 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 paid the current portion of $5.9 million in September 2021, and deferred $5.9 million of payroll taxes within Accrued compensation related costs in the consolidated balance sheet as of December 31, 2021.
Going Concern Evaluation
ASU 2014-15 Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern requires that we evaluate whether there is substantial doubt about our ability to meet our financial obligations when they become due during the twelve month period from the date these financial statements are available to be issued. We have performed such an evaluation considering the financial and operational effects of the COVID-19 pandemic and, based on the results of that assessment, we are not aware of any relevant conditions or events that raise substantial doubt regarding our ability to continue as a going concern within one year of the date the financial statements are issued.
Dividends
It is our policy to not pay cash dividends on our common stock, and, given our capital needs, we currently do not foresee a change in this policy. Our Credit Agreement limits our ability to pay dividends, and we currently anticipate that these restrictions will continue to exist in future debt agreements that we may enter.
