HANGER, INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements
This report contains statements that are forward-looking statements within the
meaning of the federal securities laws. Forward-looking statements include
information concerning our liquidity and our possible or assumed future results
of operations, including descriptions of our business strategies. These
statements often include words such as "believe," "expect," "project,"
"potential," "anticipate," "intend," "plan," "estimate," "seek," "will," "may,"
"would," "should," "could," "forecasts," or similar words. These statements are
based on certain assumptions that we have made in light of our experience in the
industry as well as our perceptions of historical trends, current conditions,
expected future developments, and other factors we believe are appropriate in
these circumstances. We believe these assumptions are reasonable, but you should
understand that these statements are not guarantees of performance or results,
and our actual results could differ materially from those expressed in the
forward-looking statements due to a variety of important factors, both positive
and negative, that may be revised or supplemented in subsequent reports.
These statements involve risks, estimates, assumptions, and uncertainties that
could cause actual results to differ materially from those expressed in these
statements and elsewhere in this report. These uncertainties include, but are
not limited to, the financial and business impacts of the COVID-19 pandemic on
our operations and the operations of our customers, suppliers, governmental and
private payors, and others in the healthcare industry and beyond; federal laws
governing the health care industry; governmental policies affecting O&P
operations, including with respect to reimbursement; failure to successfully
implement a new enterprise resource planning system or other disruptions to
information technology systems; the inability to successfully execute our
acquisition strategy, including integration of recently acquired O&P clinics
into our existing business; changes in the demand for our O&P products and
services, including additional competition in the O&P services market;
disruptions to our supply chain; our ability to enter into and derive benefits
from managed-care contracts; our ability to successfully attract and retain
qualified O&P clinicians; labor shortages and increased turnover in our employee
base; contractual, inflationary and other general cost increases, including with
regard to costs of labor, raw materials and freight; and other risks and
uncertainties generally affecting the health care industry.
Readers are cautioned that all forward-looking statements involve known and
unknown risks and uncertainties including, without limitation, those described
in Item 1A. "Risk Factors", contained in our Annual Report on Form 10-K for the
year ended December 31, 2020 (the "2020 Form 10-K"), as well as those described
in Part II, Item 1A. "Risk Factors" of this Quarterly Report on Form 10-Q, some
of which are beyond our control. Although we believe that the assumptions
underlying the forward-looking statements contained therein are reasonable, any
of the assumptions could be inaccurate. Therefore, there can be no assurance
that the forward-looking statements included in this Quarterly Report on Form
10-Q will prove to be accurate. Actual results could differ materially and
adversely from those contemplated by any forward-looking statement. In light of
the significant risks and uncertainties inherent in the forward-looking
statements included herein, the inclusion of such information should not be
regarded as a representation by us or any other person that our objectives and
plans will be achieved. We undertake no obligation to publicly release any
revisions to any forward-looking statements in this discussion to reflect events
and circumstances occurring after the date hereof or to reflect unanticipated
events. Forward-looking statements and our liquidity, financial condition, and
results of operations may be affected by the risks set forth in Item 1A. "Risk
Factors", contained in our 2020 Form 10-K, in Part II, Item 1A. "Risk Factors"
of this Quarterly Report on Form 10-Q, or by other unknown risks and
uncertainties.
Non-GAAP Measures
We refer to certain financial measures and statistics that are not in accordance
with accounting principles generally accepted 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.
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Business Overview
General
We are a leading national provider of products and services that assist in
enhancing or restoring the physical capabilities of patients with disabilities
or injuries, and we and our predecessor companies have provided O&P services for
nearly 160 years. We provide O&P services, distribute O&P devices and
components, manage O&P networks, and provide therapeutic solutions to patients
and businesses in acute, post-acute, and clinic settings. We operate through two
segments - Patient Care and Products & Services.
Our Patient Care segment is primarily comprised of Hanger Clinic, which
specializes in the design, fabrication, and delivery of custom O&P devices
through 725 patient care clinics and 111 satellite locations in 47 states and
the District of Columbia as of September 30, 2021. We also provide payor network
contracting services to other O&P providers through this segment.
Our Products & Services segment is comprised of our distribution services and
therapeutic solutions businesses. As a leading provider of O&P products in the
United States, we engage in the distribution of a broad catalog of O&P parts,
componentry, and devices to independent O&P providers nationwide. The other
business in our Products & Services segment is our therapeutic solutions
business, which develops specialized rehabilitation technologies and provides
evidence-based clinical programs for post-acute rehabilitation to patients at
approximately 3,900 skilled nursing and post-acute providers nationwide.
For the three and nine months ended September 30, 2021, our net revenues were
$289.8 million and $808.1 million, respectively, and we recorded net income of
$21.1 million and $27.9 million, respectively. For the three and nine months
ended September 30, 2020, our net revenues were $256.6 million and $723.8
million, respectively, and we recorded net income of $6.8 million and $22.1
million, respectively.
Industry Overview
We estimate that approximately $4.3 billion is spent in the United States each
year for prescription-based O&P products and services through O&P clinics. We
believe our Patient Care segment currently accounts for approximately 21% of the
market, providing a comprehensive portfolio of orthotic, prosthetic, and
post-operative solutions to patients in acute, post-acute, and patient care
clinic settings.
The O&P patient care services market in the United States is highly fragmented
and is characterized by regional and local independent O&P businesses operated
predominantly by independent operators, but also including two O&P product
manufacturers with substantial international patient care services operations.
We do not believe that any single competitor accounts for 2% or more of the
nation's total estimated O&P clinic revenues.
The industry is characterized by stable, recurring revenues, primarily resulting
from new patients as well as the need for periodic replacement and modification
of O&P devices. We anticipate that the demand for O&P services will continue to
grow as the nation's population increases, and as a result of several trends,
including the aging of the U.S. population, there will be an increase in the
prevalence of disease-related disability and the demand for new and advanced
devices. We believe the typical replacement time for prosthetic devices is three
to five years, while the typical replacement time for orthotic devices varies,
depending on the device.
We estimate that approximately $1.8 billion is spent in the United States each
year by providers of O&P patient care services for the O&P products, components,
devices, and supplies used in their businesses. Our Products & Services segment
distributes to independent providers of O&P services. We estimate that our
distribution sales account for approximately 9% of the market for O&P products,
components, devices, and supplies (excluding sales to our Patient Care segment).
We estimate the market for rehabilitation technologies, integrated clinical
programs, and clinician training in skilled nursing facilities ("SNFs") to be
approximately $150 million annually. We currently provide these products and
services to approximately 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.
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Business Description
Patient Care
Our Patient Care segment employs approximately 1,600 clinical prosthetists,
orthotists, and pedorthists, which we refer to as clinicians, substantially all
of which are certified by either the American Board for Certification ("ABC") or
the Board of Certification of Orthotists and Prosthetists, which are the two
boards that certify O&P clinicians. To facilitate timely service to our
patients, we also employ technicians, fitters, and other ancillary providers to
assist our clinicians in the performance of their duties. Through this segment,
we additionally provide network contracting services to independent providers of
O&P.
Patients are typically referred to Hanger Clinic by an attending physician who
determines a patient's treatment and writes a prescription. Our clinicians then
consult with both the referring physician and the patient with a view toward
assisting in the selection of an orthotic or prosthetic device to meet the
patient's needs. O&P devices are increasingly technologically advanced and
custom designed to add functionality and comfort to patients' lives, shorten the
rehabilitation process, and lower the cost of rehabilitation.
Based on the prescription written by a referring physician, our clinicians
examine and evaluate the patient and either design a custom device or, in the
case of certain orthotic needs, utilize a non-custom device, including, in
appropriate circumstances, an "off the shelf" device, to address the patient's
needs. When fabricating a device, our clinicians ascertain the specific
requirements, componentry, and measurements necessary for the construction of
the device. Custom devices are constructed using componentry provided by a
variety of third party manufacturers who specialize in O&P, coupled with sockets
and other elements that are fabricated by our clinicians and technicians, to
meet the individual patient's physical and ambulatory needs. Our clinicians and
technicians typically utilize castings, electronic scans, and other techniques
to fabricate items that are specialized for the patient. After fabricating the
device, a fitting process is undertaken and adjustments are made to ensure the
achievement of proper alignment, fit, and patient comfort. The fitting process
often involves several stages to successfully achieve desired functional and
cosmetic results.
Given the differing physical weight and size characteristics, location of injury
or amputation, capability for physical activity and mobility, cosmetic, and
other needs of each individual patient, each fabricated prosthesis and orthosis
is customized for each particular patient. These custom devices are commonly
fabricated at one of our regional or national fabrication facilities.
We have earned a reputation within the O&P industry for the development and use
of innovative technology in our products, which has increased patient comfort
and capability and can significantly enhance the rehabilitation process. We
utilize multiple scanning and imaging technologies in the fabrication process,
depending on the patient's individual needs, including our proprietary Insignia
scanning system. The Insignia system scans the patient and produces an accurate
computer-generated image, resulting in a faster turnaround for the patient's
device and a more professional overall experience.
In recent years, we have established a centralized revenue cycle management
organization that assists our clinics in pre-authorization, patient eligibility,
denial management, collections, payor audit coordination, and other accounts
receivable processes.
The principal reimbursement sources for our services are:
•Commercial private payors and other non-governmental organizations, which
consist of individuals, rehabilitation providers, commercial insurance
companies, HMOs, PPOs, hospitals, vocational rehabilitation centers, workers'
compensation programs, third party administrators, and similar sources;
•Medicare, a federally funded health insurance program providing health
insurance coverage for persons aged 65 or older and certain persons with
disabilities;
•Medicaid, a health insurance program jointly funded by federal and state
governments providing health insurance coverage for certain persons requiring
financial assistance, regardless of age, which may supplement Medicare benefits
for persons aged 65 or older requiring financial assistance; and
•the U.S. Department of Veterans Affairs (the "VA").
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We typically enter into contracts with third party payors that allow us to
perform O&P services for a referred patient and to be reimbursed for our
services. These contracts usually have a stated term of one to three years and
generally may be terminated without cause by either party on 60 to 90 days'
notice, or on 30 days' notice if we have not complied with certain licensing,
certification, program standards, Medicare or Medicaid requirements, or other
regulatory requirements. Reimbursement for services is typically based on a fee
schedule negotiated with the third party payor that reflects various factors,
including market conditions, geographic area, and number of persons covered.
Many of our commercial contracts are indexed to the commensurate Medicare fee
schedule that relates to the products or services being provided.
Government reimbursement is comprised of Medicare, Medicaid, and the VA. These
payors set maximum reimbursement levels for O&P services and products. Medicare
prices are adjusted each year based on the Consumer Price Index for All Urban
Consumers ("CPI-U") unless Congress acts to change or eliminate the adjustment.
The CPI-U is adjusted further by an efficiency factor known as the "Productivity
Adjustment" or the "Multi-Factor Productivity Adjustment" in order to determine
the final rate adjustment each year. There can be no assurance that future
adjustments will not reduce reimbursements for O&P services and products from
these sources.
We, and the O&P industry in general, are subject to various Medicare compliance
audits, including Recovery Audit Contractor ("RAC") audits, Comprehensive Error
Rate Testing ("CERT") audits, Targeted Probe and Educate ("TPE") audits,
Supplemental Medical Review Contractor ("SMRC") audits, and Unified Program
Integrity Contractor ("UPIC") audits. TPE audits are generally pre-payment
audits, while RAC, CERT, and SMRC audits are generally post-payment audits. UPIC
audits can be both pre- or post-payment audits, with a majority currently
pre-payment. TPE audits replaced the previous Medicare Administrative Contractor
audits. Adverse post-payment audit determinations generally require Hanger to
reimburse Medicare for payments previously made, while adverse pre-payment audit
determinations generally result in the denial of payment. In either case, we can
request a redetermination or appeal, if we believe the adverse determination is
unwarranted, which can take an extensive period of time to resolve, currently up
to six years or more.
Products & Services
Through our wholly-owned subsidiary, Southern Prosthetic Supply, Inc. ("SPS"),
we distribute O&P components to independent O&P clinics and other customers.
Through our wholly-owned subsidiary, Accelerated Care Plus Corp. ("ACP"), our
therapeutic solutions business is a leading provider of rehabilitation
technologies and integrated clinical programs to skilled nursing and post-acute
rehabilitation providers. Our value proposition is to provide our customers with
a full-service "total solutions" approach encompassing proven medical
technology, evidence-based clinical programs, and ongoing consultative education
and training. Our services support increasingly advanced treatment options for a
broader patient population and more medically complex conditions. We currently
serve approximately 3,900 skilled nursing and post-acute providers nationwide.
Through our SureFit subsidiary, we also manufacture and sell therapeutic
footwear for diabetic patients in the podiatric market. We also operate the
Hanger Fabrication Network, which fabricates custom O&P devices for our patient
care clinics, as well as for independent O&P clinics.
Through our internal "supply chain" organization, we purchase, warehouse, and
distribute over 475,000 SKUs from approximately 400 different manufacturers
through SPS or directly to our own clinics within our Patient Care segment. Our
warehousing and distribution facilities in Nevada, Georgia, Illinois, and Texas
provide us with the ability to deliver products to the vast majority of our
customers in the United States within two business days. The distribution
facility we formerly operated in Pennsylvania ceased operations in September
2020.
Our supply chain organization enables us to:
•centralize our purchasing and thus lower our material costs by negotiating
purchasing discounts from manufacturers;
•better manage our patient care clinic inventory levels and improve inventory
turns;
•improve inventory quality control;
•encourage our patient care clinics to use the most clinically appropriate
products; and
•coordinate new product development efforts with key vendors.
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Effects of the COVID-19 Pandemic
As disclosed previously, 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 has
continued through the third quarter of 2021. As a result, our comparative
financial and operational results when viewed as a whole for the periods
impacted by the COVID-19 pandemic, including temporary 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 and our operating responses are discussed further in this section, and
the effects of COVID-19 on our financial condition is discussed in the
"Financial Condition, Liquidity and Capital Resources" section below. Our
results of operations for any quarter during the COVID-19 pandemic may not be
indicative of results of operations that may be achieved for a subsequent
quarter or the full year, and may not be similar to results of operations
experienced in prior years. In addition, results in any given period in 2021 may
be different than 2020 as a result of the depressed conditions in 2020 stemming
from the COVID-19 pandemic.
Effect on Business Volumes
Patient appointments in our clinics during the third quarter of 2021 increased
by approximately 10% as compared to the corresponding period in 2020. During the
quarter, our prosthetics and orthotics day-adjusted sales, excluding
acquisitions, increased by approximately 10.5% and 11.0%, respectively, with
same clinic revenues increasing by 10.7% on a per day basis, when compared to
the same period in the prior year. Patient appointments in our clinics during
the third quarter of 2021 were approximately 92% of the volumes experienced in
the third quarter of 2019 and same clinic revenues were 99% of those reported in
the third quarter of 2019.
Throughout the COVID-19-affected periods of 2020 through the third quarter of
2021, revenues from orthotics have generally dropped more significantly than
revenues from prosthetics. While prosthetic revenues seem to have recovered, the
recovery in orthotics has been more gradual when comparing 2021 over the 2019
periods.
Billings for componentry delivered to independent providers of orthotics and
prosthetics by our distribution services business were similar during the third
quarter of 2021, as compared to the same period in 2019. Due to significant
geographic product mix and timing differences, there can be no assurance that
these volumes or billing amounts will be reflective of our future results and
are solely provided for the purposes of giving context to the effect of the
COVID-19 pandemic on our business during the periods impacted by the COVID-19
pandemic.
In the early months of 2021, vaccines for combating COVID-19 were authorized by
the US Food and Drug Administration, and the US government commenced a phased
roll out. However, the initial quantities of the vaccines were limited, and the
US government prioritized distribution to front-line health care workers and
other essential workers, followed by individual populations that were most
susceptible to the severe effects of COVID-19. 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 new "Delta"
variant in the third quarter contributed to an increase in the duration and
effect of COVID-19 on our business volumes. 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 to a lessor
extent that our patient volumes are being affected by our own labor constraints
in technician and office administrative positions as well as decreases in our
sales of off-the-shelf orthotic devices.
Given these factors, we believe that the COVID-19 pandemic will continue to
affect our business volumes for at least the remainder of 2021 when compared to
pre-pandemic levels. Nevertheless, the overall adverse impact of the COVID-19
pandemic on our business volumes has diminished and stabilized over time, and
our patient appointment and other business volumes continue to gradually improve
as the prevalence of the virus decreases and COVID-19 vaccines become more
widely available and accepted.
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Operating, Cost Reduction, and Other Responses
Throughout the periods affected by the COVID-19 pandemic, given that our
services are considered essential, we have continued to operate our businesses.
However, due to the risks posed to our clinicians, other employees, and
patients, we made certain changes to our operating practices in order to promote
safety and to minimize the risk of virus transmission. These included the
implementation of certain patient screening protocols and the relocation of
certain administrative and support personnel to a "work at home" environment.
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 employees' salaries being effective on September 19,
2020. We believe this approach allowed us to retain as many employees as
possible to preserve the experience, culture, and patient service capabilities
of our workforce for periods subsequent to the COVID-19 pandemic.
In addition to these reductions in operating expenses, we temporarily delayed
the implementation of our supply chain and financial systems, further discussed
in the "New Systems Implementations" section. We also suspended construction of
our new fabrication facility in Tempe, Arizona, and other projects related to
the reconfiguration of our distribution facilities. We resumed construction of
the Tempe, Arizona fabrication facility in the first quarter of 2021, and
recommenced the remaining activities in the second quarter of 2021.
While it's not yet a requirement that all Hanger employees be vaccinated, we are
strongly encouraging it. We are already seeing that federal, state, and local
regulations are starting to require certain employees, particularly those who
provide healthcare services, to be vaccinated. We are closely monitoring the
evolving and growing requirements to ensure we as a company are continuing to
take the appropriate actions to ensure our impacted employees are compliant.
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 2020, we recognized a total benefit of $24.0 million in our consolidated
statement of operations within Other operating costs for the grant proceeds we
received under the CARES Act from HHS. In April 2021, we received approximately
$0.7 million in additional grant proceeds under the CARES Act from HHS.
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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 Three Months Ended                       For the Nine Months Ended
                                                              September 30,                                    September 30,
                                                       2021                    2020                     2021                    2020
Medicare                                                   32.6  %                 32.0  %                  31.2  %                 32.4  %
Medicaid                                                   17.5  %                 16.2  %                  17.8  %                 16.1  %
Commercial Insurance / Managed Care
(excluding Medicare and Medicaid Managed
Care)                                                      34.1  %                 35.7  %                  34.4  %                 35.6  %
Veterans Administration                                     9.4  %                  9.1  %                   9.5  %                  9.0  %
Private Pay                                                 6.4  %                  7.0  %                   7.1  %                  6.9  %
Patient Care                                              100.0  %                100.0  %                 100.0  %                100.0  %


Patient Care constituted 84.3% and 83.8% of our net revenues for the three and
nine months ended September 30, 2021 and 82.9% and 82.7% for the three and nine
months ended September 30, 2020. Our remaining net revenues were provided by our
Products & Services segment which derives its net revenues from commercial
transactions with independent O&P providers, healthcare facilities, and other
customers. In contrast to net revenues from our Patient Care segment, payment
for these products and services are not directly subject to third party
reimbursement from health care payors. 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. 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.
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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
three and nine months ended September 30, 2021 and 2020 are as follows:
                                                       For the Three Months Ended                      For the Nine Months Ended
                                                              September 30,                                  September 30,
(dollars in thousands)                                2021                       2020                 2021                     2020
Gross charges                                   $     253,824                $ 222,950          $    700,471               $ 625,440
Less estimated implicit price concessions
arising from:
Payor disallowances                                     7,349                    9,369                18,665                  24,020
Patient non-payments                                    2,119                      917                 4,981                   2,714
Payor disallowances and patient
non-payments                                            9,468                   10,286                23,646                  26,734
Net revenues                                    $     244,356                $ 212,664          $    676,825               $ 598,706

Payor disallowances                             $       7,349                $   9,369          $     18,665               $  24,020
Patient non-payments                                    2,119                      917                 4,981                   2,714
Payor disallowances and patient
non-payments                                    $       9,468                $  10,286          $     23,646               $  26,734

Payor disallowances %                                     2.9   %                  4.2  %                2.7   %                 3.8  %
Patient non-payments %                                    0.8   %                  0.4  %                0.7   %                 0.4  %
Percent of gross charges                                  3.7   %                  4.6  %                3.4   %                 4.2  %


                                       32

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During 2020 and through the third quarter of 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.
Acquisitions
During 2021, we completed the following acquisitions of O&P clinics with the
intention of expanding the geographic footprint of our patient care offerings
through the acquisition of these high quality O&P providers. None of the
acquisitions were individually material to our financial position, results of
operations, or cash flows.
•In the first quarter of 2021, we completed the acquisitions of all the
outstanding equity interests of three O&P businesses and the assets of one O&P
business for total consideration of $24.2 million, of which $19.2 million was
cash consideration, net of cash acquired, $4.0 million was issued in the form of
notes to shareholders at fair value, and $1.0 million in additional
consideration.
•In the second quarter of 2021, we completed the acquisitions of all the
outstanding equity interests of two O&P businesses for total consideration of
$21.0 million, of which $16.0 million was cash consideration, net of cash
acquired, $4.9 million was issued in the form of notes to shareholders at fair
value, and $0.1 million in additional consideration.
•In the third quarter of 2021, we completed the acquisitions of all the
outstanding equity interests of three O&P businesses and the assets of one O&P
business for total consideration of $6.2 million, of which $3.9 million was cash
consideration, net of cash acquired, $1.5 million was issued in the form of
notes to shareholders at fair value, and $0.8 million in additional
consideration.
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 acquisition of these high quality O&P providers. None of the
acquisitions were individually material to our financial position, results of
operations, or cash flows.
•In the 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.
                                       33
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Acquisition-related costs are included in general and administrative expenses in
our condensed consolidated statements of operations. Total acquisition-related
costs incurred during the three and nine months ended September 30, 2021 were
$0.6 million and $1.4 million, respectively, which includes those costs for
transactions that are in progress or were not completed during the respective
period. Acquisition-related costs incurred for the acquisitions completed during
the three and nine months ended September 30, 2021 were $0.2 million and
$0.7 million, respectively. Total acquisition-related costs incurred during the
year ended December 31, 2020 were $0.9 million, which includes those costs for
transactions that are in progress or not completed during the respective period.
Acquisition-related costs incurred for acquisitions completed during the year
ended December 31, 2020 were $0.6 million.
New Systems Implementations
During 2019, we commenced the design, planning, and initial implementation of
new financial and supply chain systems ("New Systems Implementations"), and
planned to invest in new servers and software that operate as a part of our
technology infrastructure. As discussed in the "Effects of the COVID-19
Pandemic" section, we elected in 2020 to temporarily delay our New Systems
Implementations as part of our efforts to preserve liquidity. We recommenced
these activities in the second quarter of 2021, and transitioned our corporate
financial systems to the Oracle Cloud Financials platform in the third quarter
of 2021.
In connection with our new financial and supply chain systems, for the three and
nine month period ended September 30, 2021, we have expensed $1.8 million and
$4.1 million, respectively, and for the three and nine month period ended
September 30, 2020, we expensed $0.5 million and $2.0 million, respectively. For
the year ended December 31, 2020, we expensed $2.6 million. We currently
anticipate that we will spend $5.4 million for the full year 2021 on these
systems.
As of September 30, 2021, we capitalized $7.7 million of implementation costs
for cloud computing arrangements, net of accumulated amortization, and recorded
in other current assets and other assets in the condensed consolidated balance
sheet.
Personnel

While we have traditionally been able to recruit and retain adequate staffing to
operate and support our business, our ability to support growth is dependent on
our ability to add new personnel. Nevertheless, like many 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 could introduce
constraints on our ability to achieve our revenue growth objectives in coming
quarters. We may find it necessary to further increase wages in these areas in
coming quarters if we find that we are unable to attract a sufficient number of
personnel. Additionally, when coupled with the generally fixed nature of our
reimbursement arrangements, increases in our personnel costs caused by current
inflation conditions may put increasing pressure on our ability to maintain or
increase our margins. Please refer to Part II, Item 1A. "Risk Factors" 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.
                                       34
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Our results are also affected, to a lesser extent, by our holding of an
education fair in the first quarter of each year. This event is conducted to
assist our clinicians in maintaining their training and certification
requirements and to facilitate a national meeting with our clinical leaders. We
also invite manufacturers of the componentry for the devices we fabricate to
these annual events so they can demonstrate their products and otherwise assist
in our training process. Due to the COVID-19 pandemic, we conducted our first
virtual education fair in 2021. During the three months ended March 31, 2021 and
2020 we spent $0.3 million and $2.3 million on travel and other costs associated
with this event, respectively. In addition to the costs we incur associated with
this annual event, we also lose the productivity of a significant portion of our
clinicians during the period in which this event occurs, which contributes to
the lower seasonal revenue level we experience during the first quarter of each
year.
Critical Accounting Policies
Our analysis and discussion of our financial condition and results of operations
is based upon the condensed consolidated financial statements that have been
prepared in accordance with GAAP. The preparation of consolidated financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements, and the reported amounts of revenues and expenses during
the reporting period. GAAP provides the framework from which to make these
estimates, assumptions, and disclosures. We have chosen accounting policies
within GAAP that management believes are appropriate to fairly present, in all
material respects, our operating results, and financial position. We believe the
following accounting policies are critical to understanding our results of
operations and the more significant judgments and estimates used in the
preparation of our condensed consolidated financial statements:
•Revenue recognition
•Accounts receivable, net
•Inventories
•Business combinations
•Goodwill and other intangible assets, net
•Income taxes
The use of different estimates, assumptions, or judgments could have a material
effect on reported amounts of assets, liabilities, revenue, expenses, and
related disclosures as of the date of the financial statements and during the
reporting period. These critical accounting policies are described in more
detail in our 2020 Form 10-K, under Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and in Note A -
"Organization and Summary of Significant Accounting Policies" contained within
these condensed consolidated financial statements.
Reclassifications
We have reclassified certain amounts in the prior year condensed consolidated
financial statements to be consistent with the current year presentation. These
relate to classifications within the condensed consolidated statements of
operations.
                                       35
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Results of Operations
Our results of operations for the three months ended September 30, 2021 and 2020
were as follows (unaudited):
                                                      For the Three Months Ended September                Percent
                                                                       30,                                 Change
(dollars in thousands)                                      2021                  2020                  2021 vs 2020
Net revenues                                          $     289,827          $   256,637                           12.9  %
Material costs                                               92,561               81,462                           13.6  %
Personnel costs                                              98,948               89,727                           10.3  %
Other operating costs                                        34,871               29,979                           16.3  %
General and administrative expenses                          29,620               33,591                          (11.8) %
Depreciation and amortization                                 8,159                8,803                           (7.3) %
Operating expenses                                          264,159              243,562                            8.5  %
Income from operations                                       25,668               13,075                           96.3  %
Interest expense, net                                         7,313                8,013                           (8.7) %
Non-service defined benefit plan expense                        167                  158                            5.7  %
Income before income taxes                                   18,188                4,904                          270.9  %
Benefit for income taxes                                     (2,929)              (1,911)                         (53.3) %
Net income                                            $      21,117          $     6,815                          209.9  %

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

                                                                   For the 

Three Months Ended September 30,

                                                                       2021                         2020
Material costs                                                                31.9  %                     31.7  %
Personnel costs                                                               34.1  %                     35.0  %
Other operating costs                                                         12.1  %                     11.7  %
General and administrative expenses                                           10.2  %                     13.1  %
Depreciation and amortization                                                  2.8  %                      3.4  %
Operating expenses                                                            91.1  %                     94.9  %


Three Months Ended September 30, 2021 Compared to the Three Months Ended
September 30, 2020
Relevance of Third Quarter Results to Comparative and Future Periods. As
discussed in "Effects of the COVID-19 Pandemic" above, commencing late in the
first quarter of 2020, our revenues and operating results began to be adversely
affected by the COVID-19 pandemic, a trend that continued 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.
                                       36
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Net revenues. Net revenues for the three months ended September 30, 2021 were
$289.8 million, an increase of $33.2 million, or 12.9%, from $256.6 million for
the three months ended September 30, 2020. Net revenues by operating segment,
after elimination of intersegment activity, were as follows:
                                                          For the Three Months Ended
                                                                 September 30,                                         Percent
(dollars in thousands)                                      2021           

    2020              Change               Change
Patient Care                                           $   244,356          $ 212,664          $  31,692                    14.9  %
Products & Services                                         45,471             43,973              1,498                     3.4  %
Net revenues                                           $   289,827          $ 256,637          $  33,190                    12.9  %


Patient Care net revenues for the three months ended September 30, 2021 were
$244.4 million, an increase of $31.7 million, or 14.9%, from $212.7 million for
the same period in the prior year. Same clinic revenues increased $21.9 million
for the three months ended September 30, 2021 compared to the same period in the
prior year, reflecting an increase of 10.7% on a per-day basis. Net revenues
from acquired clinics increased $9.7 million, and revenues from consolidations
and other services increased $0.1 million. During the third quarter, we estimate
that our same clinic net revenues were approximately 99% of the level we
reported in the third quarter of 2019, prior to the pandemic, while our patient
appointment volumes during the quarter were 92% of those in the 2019 period.
This increase in revenue relative to patient volumes related primarily to
reductions in patient encounters for lower value "off the shelf" orthotic
devices as well as increases in the volume of technology-related prosthetic
devices during the third quarter.
Prosthetics constituted approximately 55% of our total Patient Care revenues for
the three months ended September 30, 2021 and 56% for the same period in 2020,
excluding the impact of acquisitions. Prosthetic revenues for the three months
ended September 30, 2021 were 10.5% 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 11.0% on a per-day basis
compared to the same comparative prior periods, excluding the impact of
acquisitions. Revenues in the third quarter of 2020, particularly orthotic
revenues, were adversely affected due to a decline in patient appointment
volumes as a result of the onset of the COVID-19 pandemic and other factors
impacting our business volumes discussed in the "Effects of the COVID-19
Pandemic" section.
Products & Services net revenues for the three months ended September 30, 2021
were $45.5 million, an increase of $1.5 million, or 3.4% from the same period in
the prior year. This was primarily attributable to an increase of $1.9 million,
or 5.9%, in the distribution of O&P componentry to independent providers in the
period stemming primarily from lower volumes in the same period of 2020 due to
the COVID-19 pandemic, as discussed in the "Effects of the COVID-19 Pandemic"
section above. In addition, net revenues from therapeutic solutions decreased
$0.4 million, or 4.0%, primarily as a result of historical customer lease
cancellations and discounts, partially offset by lease installations.
Material costs. Material costs for the three months ended September 30, 2021
were $92.6 million, an increase of $11.1 million or 13.6%, from the same period
in the prior year. Total material costs as a percentage of net revenues
increased to 31.9% in the three months ended September 30, 2021 from 31.7% in
the three months ended September 30, 2020 primarily due to changes in our
Products & Services segment business and product mix. While we have not
experienced significant inflation in our material costs during the current year,
we believe the effect of inflation may increase during 2022. Material costs by
operating segment, after elimination of intersegment activity, were as follows:
                                                          For the Three Months Ended
                                                                 September 30,                                         Percent
(dollars in thousands)                                      2021                2020              Change               Change
Patient Care                                           $    74,764          $  63,938          $  10,826                    16.9  %
Products & Services                                         17,797             17,524                273                     1.6  %
Material costs                                         $    92,561          $  81,462          $  11,099                    13.6  %


Patient Care material costs increased $10.8 million, or 16.9%, for the three
months ended September 30, 2021 compared to the same period in the prior year as
a result of the increase in segment net sales, additional costs as a result of
our acquisitions, and changes in the segment product mix. Patient Care material
costs as a percent of segment net revenues increased to 30.6% for the three
months ended September 30, 2021 from 30.1% for the three months ended
September 30, 2020.
                                       37
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Products & Services material costs increased $0.3 million, or 1.6%, for the
three months ended September 30, 2021 compared to the same period in the prior
year. As a percent of net revenues in the Products & Services segment, material
costs were 39.1% for the three months ended September 30, 2021 as compared to
39.9% in the same period of 2020. The decrease in cost of materials as a percent
of segment net revenues was primarily due to a change in business volume and
product mix within the segment.
Personnel costs. Personnel costs for the three months ended September 30, 2021
were $98.9 million, an increase of $9.2 million, or 10.3%, from $89.7 million
for the same period in the prior year. Personnel costs by operating segment were
as follows:
                                                          For the Three Months Ended
                                                                 September 30,                                         Percent
(dollars in thousands)                                      2021                2020              Change               Change
Patient Care                                           $    84,479          $  76,989          $   7,490                     9.7  %
Products & Services                                         14,469             12,738              1,731                    13.6  %
Personnel costs                                        $    98,948          $  89,727          $   9,221                    10.3  %


Personnel costs for the Patient Care segment were $84.5 million for the three
months ended September 30, 2021, an increase of $7.5 million, or 9.7%, from
$77.0 million in the same period of the prior year. The increase in Patient Care
personnel costs during the three months ended September 30, 2021 was primarily
related to an increase in salary expense of $11.1 million from the prior period
due to the personnel cost reductions implemented as a result of the COVID-19
pandemic during the three months ended September 30, 2020. Additionally, payroll
taxes increased $0.5 million and commissions increased $0.1 million compared to
the three months ended September 30, 2020. These increases were offset by a
decrease in incentive compensation and other personnel costs of $2.9 million and
a $1.3 million decrease in benefits compared to the same period in the prior
year.
Personnel costs in the Products & Services segment were $14.5 million for the
three months ended September 30, 2021, an increase of $1.7 million compared to
the same period in the prior year. The increase is primarily related to an
increase in salary expense of $2.2 million due to the personnel cost reductions
implemented as a result of the COVID-19 pandemic during the three months ended
September 30, 2020. Bonus, commissions, benefits, and other personnel cost
decreased $0.5 million for the three months ended September 30, 2021 compared to
the same period in the prior year.
Other operating costs. Other operating costs for the three months ended
September 30, 2021 were $34.9 million, an increase of $4.9 million, or 16.3%,
from $30.0 million for the same period in the prior year. Travel increased $1.8
million, rent, utilities, occupancy, office expenses increased $0.9 million,
professional fees increased $0.8 million, bad debt expense increased $0.6
million, and other expenses increased $0.8 million as compared to the same
period in the prior year.
General and administrative expenses. General and administrative expenses for the
three months ended September 30, 2021 were $29.6 million, a decrease of $4.0
million, or 11.8%, from the same period in the prior year. The decrease is the
result of a $5.5 million decrease in incentive compensation and other
personnel-related costs and a $2.4 million decrease in other compensation costs
related to the qualified disaster relief payments to employees in the prior year
quarter, partially offset by increases in salary expense of $1.1 million and
other operating expenses of $2.8 million compared to the three months ended
September 30, 2020.
Depreciation and amortization. Depreciation and amortization for the three
months ended September 30, 2021 was $8.2 million, a decrease of $0.6 million, or
7.3%, from the same period in the prior year. Amortization expense decreased
$0.3 million and depreciation expense decreased $0.3 million when compared to
the same period in the prior year.
Interest expense, net. Interest expense for the three months ended September 30,
2021 decreased 8.7% to $7.3 million from $8.0 million for the same period in the
prior year.
                                       38
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Benefit for income taxes. The benefit for income taxes for the three months
ended September 30, 2021 was $2.9 million, or (16.1)% of income before income
taxes, compared to a benefit of $1.9 million, or (39.0)% of income before income
taxes for the three months ended September 30, 2020. The increase in the
effective tax rate for the three months ended September 30, 2021 compared with
the three months ended September 30, 2020 is primarily attributable to the net
tax benefit of the loss carryback claim recognized in the three months ended
September 30, 2020, as well as an increase in pre-tax book income for the three
months ended September 30, 2021 partially offset by the release of reserves for
uncertain tax positions for the three months ended September 30, 2021. Our
effective tax rate for the three months ended September 30, 2021 differed from
the federal statutory tax rate of 21% primarily due to an accrual true-up for
actual research and development costs included on our recently filed tax return,
non-deductible expenses, and the release of reserves for uncertain tax
positions.
We evaluate our deferred tax assets quarterly to determine whether adjustments
to the valuation allowance are appropriate in light of changes in facts or
circumstances, such as changes in expected future pre-tax earnings, tax law,
interactions with taxing authorities, and developments in case law. Our material
assumptions include forecasts of future pre-tax earnings and the nature and
timing of future deductions and income represented by the deferred tax assets
and liabilities, all of which involve the exercise of significant judgment. As
of September 30, 2021, our valuation allowance was approximately $2.1 million.
For the year ending December 31, 2021, we estimate a research and development
tax credit of $4.6 million, net of tax reserves. We record the tax benefit, net
of tax reserves, as a deferred tax asset. For the year ended December 31, 2020,
we recognized research and development tax credits of $3.8 million, net of tax
reserves, related to 2020, and $6.1 million, net of tax reserves, related to
prior years.
Our results of operations for the nine months ended September 30, 2021 and 2020
were as follows (unaudited):
                                                       For the Nine Months Ended September                Percent
                                                                       30,                                 Change
(dollars in thousands)                                      2021                  2020                  2021 vs 2020
Net revenues                                          $     808,116          $   723,810                           11.6  %
Material costs                                              257,002              228,675                           12.4  %
Personnel costs                                             286,377              252,734                           13.3  %
Other operating costs                                        99,157               74,207                           33.6  %
General and administrative expenses                          93,633               98,918                           (5.3) %
Depreciation and amortization                                24,164               26,513                           (8.9) %
Operating expenses                                          760,333              681,047                           11.6  %
Income from operations                                       47,783               42,763                           11.7  %
Interest expense, net                                        21,805               24,918                          (12.5) %
Non-service defined benefit plan expense                        501                  474                            5.7  %
Income before income taxes                                   25,477               17,371                           46.7  %
Benefit for income taxes                                     (2,469)              (4,750)                          48.0  %
Net income                                            $      27,946          $    22,121                           26.3  %

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

                                                                       For 

the Nine Months Ended September 30,

                                                                            2021                      2020
Material costs                                                                   31.8  %                  31.6  %
Personnel costs                                                                  35.4  %                  34.9  %
Other operating costs                                                            12.3  %                  10.2  %
General and administrative expenses                                              11.6  %                  13.7  %
Depreciation and amortization                                                     3.0  %                   3.7  %
Operating expenses                                                               94.1  %                  94.1  %


                                       39

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Nine Months Ended September 30, 2021 Compared to the Nine Months Ended
September 30, 2020
Relevance of Nine Months Ended Results to Comparative and Future Periods. As
discussed in "Effects of the COVID-19 Pandemic" above, commencing late in the
first quarter of 2020, our revenues and operating results began to be adversely
affected by the COVID-19 pandemic, a trend that continued throughout 2020 and
into 2021. The effects of this public health emergency on our revenues and
earnings in the, 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 nine months ended September 30, 2021 were
$808.1 million, an increase of $84.3 million, or 11.6%, from $723.8 million for
the nine months ended September 30, 2020. Net revenues by operating segment,
after elimination of intersegment activity, were as follows:
                                                           For the Nine Months Ended
                                                                 September 30,                                         Percent
(dollars in thousands)                                      2021           

    2020              Change               Change
Patient Care                                           $   676,825          $ 598,706          $  78,119                    13.0  %
Products & Services                                        131,291            125,104              6,187                     4.9  %
Net revenues                                           $   808,116          $ 723,810          $  84,306                    11.6  %


Patient Care net revenues for the nine months ended September 30, 2021 were
$676.8 million, an increase of $78.1 million, or 13.0%, from $598.7 million for
the same period in the prior year. Same clinic revenues increased $52.9 million
for the nine months ended September 30, 2021 compared to the same period in the
prior year, reflecting an increase of 10.2% on a per-day basis. Net revenues
from acquired clinics increased $24.7 million, and revenues from consolidations
and other services increased $0.5 million. For the year-to-date, we estimate
that our same clinic net revenues were approximately 98% of the level we
reported for the first nine months of 2019, prior to the pandemic. Given this,
we are not currently operating in a manner that utilizes our capacity at the
same levels as we did prior to the pandemic, and this has been a primary
contributing factor to the decrease in our earnings and margins when compared to
that pre-pandemic period.
Prosthetics constituted approximately 54% of our total Patient Care revenues for
the nine months ended September 30, 2021 and 56% for the same period in 2020,
excluding the impact of acquisitions. Prosthetic revenues for the nine months
ended September 30, 2021 were 5.5% 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 16.3% on a per-day basis
compared to the same comparative prior periods, excluding the impact of
acquisitions. Revenues through the third quarter of 2020, particularly orthotic
revenues, were adversely affected due to a decline in patient appointment
volumes as a result of the onset of the COVID-19 pandemic, governmental
suppression measures implemented in response to the COVID-19 pandemic, and other
factors impacting our business volumes discussed in the "Effects of the COVID-19
Pandemic" section.
Products & Services net revenues for the nine months ended September 30, 2021
were $131.3 million, an increase of $6.2 million, or 4.9% from the same period
in the prior year. This was primarily attributable to an increase of $7.7
million, or 8.4%, in the distribution of O&P componentry in the period to
independent providers stemming primarily from lower volumes in the same period
of 2020 due to the COVID-19 pandemic, as discussed in the "Effects of the
COVID-19 Pandemic" section above, and a $1.5 million, or 4.3%, decrease in net
revenues from therapeutic solutions primarily as a result of historical customer
lease cancellations and discounts, partially offset by lease installations.
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Material costs. Material costs for the nine months ended September 30, 2021 were
$257.0 million, an increase of $28.3 million or 12.4%, from the same period in
the prior year. Total material costs as a percentage of net revenues increased
to 31.8% in the nine months ended September 30, 2021 from 31.6% in the nine
months ended September 30, 2020 due to changes in our Products & Services
segment business and product mix. While we have not experienced significant
inflation in our material costs during the current year, we believe the effect
of inflation may increase during 2022. Material costs by operating segment,
after elimination of intersegment activity, were as follows:
                                                           For the Nine Months Ended
                                                                 September 30,                                         Percent
(dollars in thousands)                                      2021                2020              Change               Change
Patient Care                                           $   206,403          $ 178,851          $  27,552                    15.4  %
Products & Services                                         50,599             49,824                775                     1.6  %
Material costs                                         $   257,002          $ 228,675          $  28,327                    12.4  %


Patient Care material costs increased $27.6 million, or 15.4%, for the nine
months ended September 30, 2021 compared to the same period in the prior year as
a result of the increase in segment net sales, additional costs as a result of
our acquisitions, and changes in the segment product mix. Patient Care material
costs as a percent of segment net revenues increased to 30.5% for the nine
months ended September 30, 2021 from 29.9% for the nine months ended
September 30, 2020.
Products & Services material costs increased $0.8 million, or 1.6%, for the nine
months ended September 30, 2021 compared to the same period in the prior year.
As a percent of net revenues in the Products & Services segment, material costs
were 38.5% for the nine months ended September 30, 2021 as compared to 39.8% in
the same period of 2020. The decrease in material costs as a percent of segment
net revenues was due to a change in business and product mix within the segment,
as well as cost savings related to certain supply chain initiatives.
Personnel costs. Personnel costs for the nine months ended September 30, 2021
were $286.4 million, an increase of $33.6 million, or 13.3%, from $252.7 million
for the same period in the prior year. Personnel costs by operating segment were
as follows:
                                                           For the Nine Months Ended
                                                                 September 30,                                         Percent
(dollars in thousands)                                      2021                2020              Change               Change
Patient Care                                           $   243,431          $ 216,910          $  26,521                    12.2  %
Products & Services                                         42,946             35,824              7,122                    19.9  %
Personnel costs                                        $   286,377          $ 252,734          $  33,643                    13.3  %


Personnel costs for the Patient Care segment were $243.4 million for the nine
months ended September 30, 2021, an increase of $26.5 million, or 12.2%, from
$216.9 million for the same period in the prior year. The increase in Patient
Care personnel costs during the nine months ended September 30, 2021 was
primarily related to an increase in salary expense of $31.1 million from the
prior year period due to the personnel cost reductions implemented as a result
of the COVID-19 pandemic during the nine months ended September 30, 2020.
Additionally, payroll taxes increased $1.7 million, commissions increased $0.5
million, and benefits increased $0.4 million compared to the nine months ended
September 30, 2020. These increases were offset by a $7.2 million decrease in
incentive compensation and other personnel costs compared to the same period in
the prior year.
Personnel costs in the Products & Services segment were $42.9 million for the
nine months ended September 30, 2021, an increase of $7.1 million compared to
the same period in the prior year. The increase is primarily related to an
increase in salary expense of $6.5 million due to the personnel cost reductions
implemented as a result of the COVID-19 pandemic during the nine months ended
September 30, 2020. Bonus, commissions, and other personnel cost increased $0.6
million for the nine months ended September 30, 2021 compared to the same period
in the prior year.
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Other operating costs. Other operating costs for the nine months ended
September 30, 2021 were $99.2 million, an increase of $25.0 million, or 33.6%,
from $74.2 million for the same period in the prior year. Other operating costs
increased by $21.4 million, largely due to the benefit associated with the
recognition of $20.5 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, in the nine months ended September 30, 2020. Additionally
rent, utilities, occupancy, and office expenses increased $3.2 million and
travel, professional education, professional fees, and other expenses increased
$1.2 million, partially offset by a decrease in bad debt expense of $0.8
million, as compared to the same period in the prior year. In general, the
increase in other operating costs are the result of the cost mitigation efforts
implemented in the prior year period as a result of the COVID-19 pandemic, and
to a lesser extent due to new, renewed, and acquired leases in the current year.
General and administrative expenses. General and administrative expenses for the
nine months ended September 30, 2021 were $93.6 million, a decrease of $5.3
million, or 5.3%, from the same period in the prior year. The decrease is the
result of incremental share-based compensation expense of $5.9 million
recognized during the comparative period of 2020 due to the modification of
certain equity awards granted in 2017, a decrease in incentive compensation and
other personnel-related costs of $6.3 million, and a decrease in other
compensation costs of $2.4 million related to the qualified disaster relief
payments made in the prior year, offset by increases in salary expense of $5.4
million and other expenses of $3.9 million compared to the nine months ended
September 30, 2020 largely as the result of cost mitigation efforts implemented
in the prior year period as a result of the COVID-19 pandemic.
Depreciation and amortization. Depreciation and amortization for the nine months
ended September 30, 2021 was $24.2 million, a decrease of $2.3 million, or 8.9%,
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 nine months ended September 30,
2021 decreased 12.5% to $21.8 million from $24.9 million for the same period in
the prior year. This is largely due to a decrease in LIBOR as compared to the
prior year period, as well as interest payments made in the prior year on the
revolving debt balance, which was undrawn during the nine months ended September
30, 2021.
Benefit for income taxes. The benefit for income taxes for the nine months ended
September 30, 2021 was $2.5 million, or (9.7)% of income before income taxes,
compared to a benefit of $4.8 million, or (27.3)% of income before income taxes
for the nine months ended September 30, 2020. The increase in the effective tax
rate for the nine months ended September 30, 2021 compared with the nine months
ended September 30, 2020 is primarily attributable to the 2017 through 2019
research and development tax credits recognized in the nine months ended
September 30, 2020, partially offset by a windfall from share-based compensation
and the release of reserves for uncertain tax positions for the nine months
ended September 30, 2021. Our effective tax rate for the nine months ended
September 30, 2021 differed from the federal statutory tax rate of 21% primarily
due to an accrual true-up for actual research and development costs included on
our recently filed tax return, non-deductible expenses, a windfall from
share-based compensation and the release of reserves for uncertain tax
positions.
We evaluate our deferred tax assets quarterly to determine whether adjustments
to the valuation allowance are appropriate in light of changes in facts or
circumstances, such as changes in expected future pre-tax earnings, tax law,
interactions with taxing authorities, and developments in case law. Our material
assumptions include forecasts of future pre-tax earnings and the nature and
timing of future deductions and income represented by the deferred tax assets
and liabilities, all of which involve the exercise of significant judgment. As
of September 30, 2021, our valuation allowance approximated $2.1 million.
For the year ending December 31, 2021, we estimate a research and development
tax credit of $4.6 million, net of tax reserves. We record the tax benefit, net
of tax reserves, as a deferred tax asset. For the year ended December 31, 2020,
we recognized research and development tax credits of $3.8 million, net of tax
reserves, related to 2020, and $6.1 million, net of tax reserves, related to
prior years.
Financial Condition, Liquidity, and Capital Resources
Liquidity
Our cash and cash equivalents, and any amounts we have available for borrowing
under our revolving credit facility, are immediately available to provide cash
for our operations and capital expenditures. We refer to the sum of these two
amounts as our "liquidity."
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At September 30, 2021, we had total liquidity of $170.5 million, which reflected
a decrease of $68.9 million from the $239.4 million in liquidity we had as of
December 31, 2020. Our liquidity at September 30, 2021 was comprised of cash and
cash equivalents of $75.6 million and $94.9 million in available borrowing
capacity under our $100.0 million revolving credit facility. This decrease in
liquidity primarily related to a decrease in cash of $69.0 million, comprised of
cash paid for acquisitions, net of cash acquired, of $39.3 million, capital
expenditures of $18.9 million, and net cash used in financing activities of
$13.3 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 September 30, 2021.
For additional information, please refer to the Liquidity Outlook section below.
Working Capital and Days Sales Outstanding
At September 30, 2021, we had working capital of $110.7 million compared to
working capital of $129.3 million at December 31, 2020. Our working capital
decreased $18.6 million during the nine months ended September 30, 2021 due to a
decrease in current assets of $53.4 million, partially offset by a decrease in
current liabilities of $34.8 million.
The decrease in current assets of $53.4 million was primarily attributable to a
decrease in Cash and cash equivalents of $69.0 million discussed in the
"Liquidity" section above, and a decrease in Income taxes receivable of $4.7
million. The decreases were offset by an increase of approximately $8.3 million
in Inventories, $7.5 million in Accounts receivable, net, and $4.5 million in
Other current assets.
The decrease in current liabilities of $34.8 million was primarily attributable
to a net decrease in accrued incentive compensation related costs of $30.7
million, primarily due to the payment of $42.9 million in annual incentive
compensation and the employer 401(k) matching contribution made during the first
quarter of the year. The remainder of the decrease is primarily attributable to
a decrease of $3.7 million in Accrued expenses and other current liabilities and
$3.4 million in Accounts payable.
Days sales outstanding ("DSO") is a calculation that approximates the average
number of days between the billing for our services and the date of our receipt
of payment, which we estimate using a 90-day rolling period of net revenue. This
computation can provide a relative measure of the effectiveness of our billing
and collections activities. Clinics acquired during the past 90-day period are
excluded from the calculation. As of September 30, 2021, our DSO was 42 days,
which compares favorably to a DSO of 43 days as of September 30, 2020. The
reduction is attributable to improved collections experience due to the targeted
efforts of our centralized revenue cycle management function.
Sources and Uses of Cash for the Nine Months Ended September 30, 2021 Compared
to September 30, 2020
Net cash flows provided by operating activities decreased $124.6 million to $0.6
million for the nine months ended September 30, 2021 from $125.2 million for the
nine months ended September 30, 2020. The most significant decrease in cash
provided by operating activities was due to a $44.7 million increase in cash
used in Accounts receivable, net as revenue volumes increased. The remaining
decrease in cash flows provided by operations is largely attributable to cash
used in the satisfaction of Accounts payable and Accrued expenses and other
current liabilities of $31.6 million, and a change in Accrued compensation
related costs of $33.2 million.
Cash flows used in investing activities increased $18.3 million to $56.4 million
for the nine months ended September 30, 2021, from $38.1 million for the nine
months ended September 30, 2020. The increase in cash used in investing
activities was due to an increase of $22.4 million in cash paid for
acquisitions, net of cash acquired, partially offset by $3.6 million less in
capital expenditures.
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Cash flows used in financing activities was $13.3 million for the nine months
ended September 30, 2021, as compared to cash used in financing activities of
$14.1 million for the nine months ended September 30, 2020. The decrease in cash
used in financing activities is primarily due to a decrease in payments of
employee taxes on stock-based compensation of $2.3 million, offset by an
increase in payments on Seller Notes and other activities of $1.5 million.
Effect of Indebtedness
On March 6, 2018, we entered into a $605.0 million Credit Agreement, which
provides for (i) a revolving credit facility with an initial maximum aggregate
amount of availability of $100.0 million that matures in March 2023 and (ii) a
$505.0 million Term Loan B facility due in quarterly principal installments
commencing June 29, 2018, with all remaining outstanding principal due at
maturity in March 2025. For additional discussion surrounding the Credit
Agreement, see Note K - "Debt and Other Obligations," in the notes to the
condensed consolidated financial statements contained elsewhere in this report.
Cash paid for interest totaled $19.7 million and $22.2 million for the nine
months ended September 30, 2021 and 2020, 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 through the third quarter of 2020. 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 limited our ability, and certain
of our subsidiaries' ability, to consolidate or merge, create liens, incur
additional indebtedness, or dispose of assets. 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.
Scheduled maturities of debt as of September 30, 2021 were as follows:
 (in thousands)
 2021 (remainder of year)                                                   $   2,405
 2022                                                                          12,155
 2023                                                                          11,818
 2024                                                                          11,181
 2025                                                                         473,069
 Thereafter                                                                     2,552

Total debt before unamortized discount and debt issuance costs, net

513,180

 Unamortized discount and debt issuance costs, net                             (6,201)
 Total debt                                                                 $ 506,979


Liquidity Outlook
Our Credit Agreement has a term loan facility with $487.3 million in principal
outstanding at September 30, 2021, due in quarterly principal installments equal
to 0.25% of the original aggregate principal amount of $505.0 million, with all
remaining outstanding principal due at maturity in March 2025, and, as of
September 30, 2021, a revolving credit facility with no borrowings and available
borrowing capacity of $94.9 million that matures in March 2023.
Our primary sources of liquidity are cash and cash equivalents, and available
borrowings under our revolving credit facility. Due to the economic and social
activity impacts outlined in the "Effects of the COVID-19 Pandemic" section
above, we expect the continuing disruption to have an unfavorable impact on our
operations, financial condition, and results of operations. While the duration
and extent of the impact from the COVID-19 pandemic on our operations and
liquidity depends on future developments which cannot be predicted with
certainty, we believe that our existing sources of liquidity, when combined with
our operating cash flows and other measures taken to enhance our liquidity
position and cost structure, will continue to allow us to finance our operations
for the foreseeable future. Please refer to the "Effects of the COVID-19
Pandemic" section above for additional discussion.
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As business volumes return to more typical pre-pandemic levels, it is likely
that we will experience a natural corresponding increase in our investment in
working capital. Additionally, during 2021, we currently estimate that we will
expend $25 million to $30 million for capital expenditures. We also anticipate
that we will continue to pursue acquisitions and other growth initiatives that
provide value to our shareholders.
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 2020, we recognized a total benefit of $24.0 million in our condensed
consolidated statement of operations within Other operating costs Grants from
HHS. We recognize income related to grants on a systematic and rational basis
when it becomes probable that we have complied with the terms and conditions of
the grant and in the period in which the corresponding costs or income related
to the grant are recognized. We recognized the benefit from the Grants within
Other operating costs in our Patient Care segment. In April 2021, we recognized
an additional $0.7 million in proceeds received from grants under the CARES Act.
The CARES Act also provided for a deferral of the employer portion of payroll
taxes incurred during the COVID-19 pandemic through December 2020. The
provisions allowed 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
Other liabilities in the condensed consolidated balance sheet as of
September 30, 2021.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that may or could have a current or
future material effect on our financial condition, revenues or expenses, results
of operations, liquidity, capital expenditures, or capital resources.
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