UNITED STATES

~~UNITED STATES~~

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒

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

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

For the ~~Quarterly Period Ended~~ quarterly period ended September 30, ~~2019~~2020

OR

☐

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

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

For the transition period from

Commission File Number 1-10670

HANGER, INC.

(Exact name of registrant as specified in its ~~charter.)~~charter)

Delaware
84-0904275
(State or other jurisdiction of

(I.R.S. Employer
incorporation or organization)

~~84-0904275~~
~~(I.R.S. Employer~~
Identification No.)

10910 Domain Drive, Suite 300, Austin, TX

78758
~~10910 Domain Drive, Suite 300, Austin, TX~~
(Address of principal executive offices)

~~78758~~
(Zip Code)

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

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

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock, par value $0.01 per share

HNGR

New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx⌧ No o◻

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x⌧ No o◻

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

Large accelerated filero◻
Accelerated filer x⌧
Non-accelerated filer o◻
Smaller reporting company o☐
Emerging growth company o☐

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

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

As of October ~~29, 2019~~27, 2020, the registrant had ~~37,337,840~~38,109,387 shares of its Common Stock outstanding.

Table of Contents

TABLE OF CONTENTS

~~Hanger, Inc.~~
Hanger, Inc.
Part I  Financial Information

Item 1. Condensed Consolidated Financial Statements (unaudited)
1
Item 2. ~~Management~~Management’s Discussion and Analysis of Financial Condition and Results of Operations
3427
Item 3. Quantitative and Qualitative Disclosures About Market Risk
5349
Item 4. Controls and Procedures
5449
Part II  Other Information

Item 1.  Legal Proceedings
5551
Item 1A.  Risk Factors
5751
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
5752
Item 3.  Defaults Upon Senior Securities
5752
Item 4.  Mine Safety Disclosures
5752
Item 5.  Other Information
5752
Item 6. Exhibits
5752
Exhibits Index
5853
Signatures
5954

ii

ii
Table of Contents
~~PART 1.~~~~FINANCIAL INFORMATION~~

PART 1.FINANCIALINFORMATION

HANGER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except par value and share amounts)
(Unaudited)

As of September 30,

As of December 31,

2019

2018

ASSETS

Current assets:

Cash and cash equivalents

$
49,947

$
95,114

Accounts receivable, net

145,378

143,986

Inventories

75,693

67,690

Income taxes receivable

—

379

Other current assets

14,615

18,731

Total current assets

285,633

325,900

Non-current assets:

Property, plant and equipment, net

84,490

89,489

Goodwill

226,348

198,742

Other intangible assets, net

17,985

15,478

Deferred income taxes

68,581

65,635

Operating lease right-of-use assets

109,838

—

Other assets

8,537

7,766

Total assets

$
801,412

$
703,010

TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIT

Current liabilities:

Current portion of long-term debt

$
8,619

$
8,583

Accounts payable

53,831

55,797

Accrued expenses and other current liabilities

55,908

51,783

Accrued compensation related costs

39,633

55,111

Current portion of operating lease liabilities

32,437

—

Total current liabilities

190,428

171,274

Long-term liabilities:

Long-term debt, less current portion

488,620

502,090

Operating lease liabilities

88,719

—

Other liabilities

47,851

51,570

Total liabilities

815,618

724,934

Commitments and contingencies (Note R)

Shareholders’ deficit:

Common stock, $0.01 par value; 60,000,000 shares authorized; 37,504,755 shares issued and 37,361,934 shares outstanding in 2019, and 37,063,995 shares issued and 36,921,174 shares outstanding in 2018

375

371

Additional paid-in capital

350,579

343,955

Accumulated other comprehensive loss

(13,777
)
(4,531
)
Accumulated deficit

(350,687
)
(361,023
)
Treasury stock, at cost; 142,821 shares at 2019 and 2018, respectively

(696
)
(696
)
Total shareholders’ deficit

(14,206
)
(21,924
)
Total liabilities and shareholders’ deficit

$
801,412

$
703,010

As of September 30,

As of December 31,


2020

2019
ASSETS

Current assets:

Cash and cash equivalents

$
147,510

$
74,419
Accounts receivable, net

121,409

159,359
Inventories

74,108

68,204
Income taxes receivable

5,945

—
Other current assets

14,489

13,673
Total current assets

363,461

315,655

Non-current assets:

Property, plant, and equipment, net

86,637

84,057
Goodwill

271,701

232,244
Other intangible assets, net

19,106

17,952
Deferred income taxes

70,489

70,481
Operating lease right-of-use assets

125,577

110,559
Other assets

15,710

11,305
Total assets

$
952,681

$
842,253

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:

Current portion of long-term debt

$
27,791

$
8,752
Accounts payable

63,630

48,477
Accrued expenses and other current liabilities

72,434

55,825
Accrued compensation related costs

63,511

61,010
Current portion of operating lease liabilities

32,932

34,342
Total current liabilities

260,298

208,406

Long-term liabilities:

Long-term debt, less current portion

493,600

490,121
Operating lease liabilities

106,405

88,418
Other liabilities

60,077

45,804
Total liabilities

920,380

832,749
Commitments and contingencies (Note Q)

Shareholders’ equity:

Common stock, $0.01 par value; 60,000,000 shares authorized; 38,277,423 shares issued and 38,134,602 shares outstanding at 2020, and 37,602,873 shares issued and 37,460,052 shares outstanding at 2019, respectively

383

376
Additional paid-in capital

363,082

354,326
Accumulated other comprehensive loss

(20,400)

(12,551)
Accumulated deficit

(310,068)

(331,951)
Treasury stock, at cost;142,821 shares at 2020 and 2019, respectively

(696)

(696)
Total shareholders’ equity

32,301

9,504
Total liabilities and shareholders’ equity

$
952,681

$
842,253

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

1
Table of Contents
HANGER, INC.
~~HANGER, INC.~~
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share and per share amounts)
(Unaudited)

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

2019

2018

2019

2018

Net revenues

$
279,638

$
262,946

$
797,155

$
763,907

Material costs

92,034

84,805

261,810

247,677

Personnel costs

94,594

90,853

272,795

266,515

Other operating costs

32,771

30,999

100,067

92,631

General and administrative expenses

29,834

28,308

87,474

80,467

Professional accounting and legal fees

3,629

3,107

9,576

12,189

Depreciation and amortization

9,373

8,950

26,906

27,552

Income from operations

17,403

15,924

38,527

36,876

Interest expense, net

8,954

8,939

25,973

28,519

Loss on extinguishment of debt

—

—

—

16,998

Non-service defined benefit plan expense

173

176

519

528

Income (loss) before income taxes

8,276

6,809

12,035

(9,169
)
Provision (benefit) for income taxes

2,585

2,440

3,260

(3,848
)
Net income (loss)

$
5,691

$
4,369

$
8,775

$
(5,321
)

Basic and Diluted Per Common Share Data:

Basic income (loss) per share

$
0.15

$
0.12

$
0.24

$
(0.14
)
Weighted average shares used to compute basic earnings per common share

37,349,144

36,856,881

37,218,234

36,716,568

Diluted income (loss) per share

$
0.15

$
0.12

$
0.23

$
(0.14
)
Weighted average shares used to compute diluted earnings per common share

37,986,860

37,556,594

37,921,767

36,716,568

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,


2020

2019

2020

2019
Net revenues

$
256,637

$
279,638

$
723,810

$
797,155
Material costs

81,462

92,034

228,675

261,810
Personnel costs

89,727

94,594

252,734

272,795
Other operating costs

29,935

32,771

74,098

100,067
General and administrative expenses

31,371

29,834

91,618

87,474
Professional accounting and legal fees

2,264

3,629

7,409

9,576
Depreciation and amortization

8,803

9,373

26,513

26,906
Income from operations

13,075

17,403

42,763

38,527
Interest expense, net

8,013

8,954

24,918

25,973
Non-service defined benefit plan expense

158

173

474

519
Income before income taxes

4,904

8,276

17,371

12,035
(Benefit) provision for income taxes

(1,911)

2,585

(4,750)

3,260
Net income

$
6,815

$
5,691

$
22,121

$
8,775

Basic and Diluted Per Common Share Data:

Basic income per share

$
0.18

$
0.15

$
0.58

$
0.24
Weighted average shares used to compute basic earnings per common share

38,133,598

37,349,144

37,878,753

37,218,234
Diluted income per share

$
0.18

$
0.15

$
0.57

$
0.23
Weighted average shares used to compute diluted earnings per common share

38,637,536

37,986,860

38,491,965

37,921,767

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

2
Table of Contents
HANGER, INC.
~~HANGER, INC.~~
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(dollars in thousands)
(Unaudited)

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

2019

2018

2019

2018

Net income (loss)

$
5,691

$
4,369

$
8,775

$
(5,321
)

Other comprehensive (loss) income:

Unrealized (loss) gain on cash flow hedges, net of tax (benefit) provision of ($516), $533, ($2,916), and $541, respectively

$
(1,641
)
$
1,738

$
(9,265
)
$
1,762

Unrealized gain (loss) on defined benefit plan, net of tax provision (benefit) of $2, $0, $6, and ($105), respectively

7

26

19

(240
)
Total other comprehensive (loss) income

(1,634
)
1,764

(9,246
)
1,522

Comprehensive income (loss)

$
4,057

$
6,133

$
(471
)
$
(3,799
)

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,


2020

2019

2020

2019
Net income

$
6,815

$
5,691

$
22,121

$
8,775

Other comprehensive income (loss):

Unrealized gain (loss) on cash flow hedges, net of tax provision (benefit) of $488, ($516), ($2,509), and ($2,916), respectively

$
1,542

$
(1,641)

$
(7,933)

$
(9,265)
Unrealized gain on defined benefit plan, net of tax provision of $9, $2, $27, and $6, respectively

28

7

84

19
Total other comprehensive income (loss)

1,570

(1,634)

(7,849)

(9,246)
Comprehensive income (loss)

$
8,385

$
4,057

$
14,272

$
(471)

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

3
Table of Contents
HANGER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ ~~DEFICIT~~EQUITY (DEFICIT)
For the Nine Months Ended September 30, ~~2019~~2020
(dollars and share amounts in thousands)
(Unaudited)

Common
Shares,
Balance

Common
Stock,
Par
Value

Additional
Paid-in
Capital

Accumulated
Other
Comprehensive
Loss

Accumulated
Deficit

Treasury
Stock

Total

Balance, December 31, 2018

36,921

$
371

$
343,955

$
(4,531
)
$
(361,023
)
$
(696
)
$
(21,924
)
Cumulative effect of a change in accounting for leases (Note A)

—

—

—

—

1,561

—

1,561

Balance, January 1, 2019

36,921

371

343,955

(4,531
)
(359,462
)
(696
)
(20,363
)
Net loss

—

—

—

—

(6,951
)
—

(6,951
)
Shares based compensation expense

—

—

3,265

—

—

—

3,265

Issuance of common stock upon vesting of restricted stock units

350

3

(3
)
—

—

—

—

Effect of shares withheld to cover taxes

—

—

(3,626
)
—

—

—

(3,626
)
Total other comprehensive loss

—

—

—

(2,930
)
—

—

(2,930
)
Balance, March 31, 2019

37,271

$
374

$
343,591

$
(7,461
)
$
(366,413
)
$
(696
)
$
(30,605
)
Net income

—

—

—

—

10,035

—

10,035

Shares based compensation expense

—

—

3,450

—

—

—

3,450

Issuance of common stock upon vesting of restricted stock units

64

1

(1
)
—

—

—

—

Effect of shares withheld to cover taxes

—

—

(28
)
—

—

—

(28
)
Total other comprehensive loss

—

—

—

(4,682
)
—

—

(4,682
)
Balance, June 30, 2019

37,335

$
375

$
347,012

$
(12,143
)
$
(356,378
)
$
(696
)
$
(21,830
)
Net income

—

—

—

—

5,691

—

5,691

Shares based compensation expense

—

—

3,374

—

—

—

3,374

Issuance in connection with the exercise of stock options

20

—

249

—

—

—

249

Issuance of common stock upon vesting of restricted stock units

7

—

—

—

—

—

—

Effect of shares withheld to cover taxes

—

—

(56
)
—

—

—

(56
)
Total other comprehensive loss

—

—

—

(1,634
)
—

—

(1,634
)
Balance, September 30, 2019

37,362

$
375

$
350,579

$
(13,777
)
$
(350,687
)
$
(696
)
$
(14,206
)

Common

Accumulated

Common

Stock,

Additional

Other

Shares,

Par

Paid-in

Comprehensive

Accumulated

Treasury


Balance

Value

Capital

Loss

Deficit

Stock

Total
Balance, December 31, 2019

37,460

$
376

$
354,326

$
(12,551)

$
(331,951)

$
(696)

$
9,504
Cumulative effect of a change in accounting for credit losses

—

—

—

—

(238)

—

(238)
Balance, January 1, 2020

37,460

376

354,326

(12,551)

(332,189)

(696)

9,266
Net loss

—

—

—

—

(15,748)

—

(15,748)
Share-based compensation expense

—

—

3,501

—

—

—

3,501
Issuance of common stock upon vesting of restricted stock units

354

4

(4)

—

—

—

—
Effect of shares withheld to cover taxes

—

—

(4,146)

—

—

—

(4,146)
Total other comprehensive loss

—

—

—

(8,873)

—

—

(8,873)
Balance, March 31, 2020

37,814

$
380

$
353,677

$
(21,424)

$
(347,937)

$
(696)

$
(16,000)
Net income

—

—

—

—

31,054

—

31,054
Share-based compensation expense

—

—

8,984

—

—

—

8,984
Issuance in connection with the exercise of stock options

3

—

38

—

—

—

38
Issuance of common stock upon vesting of restricted stock units

316

3

(3)

—

—

—

—
Effect of shares withheld to cover taxes

—

—

(2,682)

—

—

—

(2,682)
Total other comprehensive loss

—

—

—

(546)

—

—

(546)
Balance, June 30, 2020

38,133

$
383

$
360,014

$
(21,970)

$
(316,883)

$
(696)

$
20,848
Net income

—

—

—

—

6,815

—

6,815
Share-based compensation expense

—

—

3,081

—

—

—

3,081
Issuance in connection with the exercise of stock options

—

—

—

—

—

—

—
Issuance of common stock upon vesting of restricted stock units

2

—

—

—

—

—

—
Effect of shares withheld to cover taxes

—

—

(13)

—

—

—

(13)
Total other comprehensive income

—

—

—

1,570

—

—

1,570
Balance, September 30, 2020

38,135

$
383

$
363,082

$
(20,400)

$
(310,068)

$
(696)

$
32,301

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

4
Table of Contents
HANGER, INC.
~~HANGER, INC.~~
CONDENSED CONSOLIDATED ~~STATEMENTS~~STATEMENT OF CHANGES IN SHAREHOLDERS’ ~~DEFICIT~~EQUITY (DEFICIT)
For the Nine Months Ended September 30, ~~2018~~2019
(dollars and share amounts in thousands)
(Unaudited)

Common
Shares,
Balance

Common
Stock,
Par
Value

Additional
Paid-in
Capital

Accumulated
Other
Comprehensive
Loss

Accumulated
Deficit

Treasury
Stock

Total

Balance, December 31, 2017

36,372

$
365

$
333,738

$
(1,686
)
$
(359,772
)
$
(696
)
$
(28,051
)
Cumulative effect of a change in accounting for revenue recognition

—

—

—

—

(759
)
—

(759
)
Balance, January 1, 2018

36,372

365

333,738

(1,686
)
(360,531
)
(696
)
(28,810
)
Net loss

—

—

—

—

(22,618
)
—

(22,618
)
Shares based compensation expense

—

—

2,585

—

—

—

2,585

Issuance of common stock upon vesting of restricted stock units

372

4

(4
)
—

—

—

—

Effect of shares withheld to cover taxes

—

—

(2,150
)
—

—

—

(2,150
)
Total other comprehensive loss

—

—

—

(2,582
)
—

—

(2,582
)
Balance, March 31, 2018

36,744

$
369

$
334,169

$
(4,268
)
$
(383,149
)
$
(696
)
$
(53,575
)
Net income

—

—

—

—

12,928

—

12,928

Shares based compensation expense

—

—

3,320

—

—

—

3,320

Issuance of common stock upon vesting of restricted stock units

106

1

(1
)
—

—

—

—

Effect of shares withheld to cover taxes

—

—

(313
)
—

—

—

(313
)
Total other comprehensive income

—

—

—

2,340

—

—

2,340

Balance, June 30, 2018

36,850

$
370

$
337,175

$
(1,928
)
$
(370,221
)
$
(696
)
$
(35,300
)
Net income

—

—

—

—

4,369

—

4,369

Shares based compensation expense

—

—

3,668

—

—

—

3,668

Issuance of common stock upon vesting of restricted stock units

18

—

—

—

—

—

—

Effect of shares withheld to cover taxes

—

—

(105
)
—

—

—

(105
)
Total other comprehensive income

—

—

—

1,764

—

—

1,764

Balance, September 30, 2018

36,868

$
370

$
340,738

$
(164
)
$
(365,852
)
$
(696
)
$
(25,604
)




Common



Accumulated






Common

Stock,

Additional

Other

Shares,

Par

Paid-in

Comprehensive

Accumulated

Treasury


Balance

Value

Capital

Loss

Deficit

Stock

Total
Balance, December 31, 2018

36,921

$
371

$
343,955

$
(4,531)

$
(361,023)

$
(696)

$
(21,924)
Cumulative effect of a change in accounting for leases

—

—

—

—

1,547

—

1,547
Balance, January 1, 2019

36,921

371

343,955

(4,531)

(359,476)

(696)

(20,377)
Net loss

—

—

—

—

(6,951)

—

(6,951)
Share-based compensation expense

—

—

3,265

—

—

—

3,265
Issuance of common stock upon vesting of restricted stock units

350

3

(3)

—

—

—

—
Effect of shares withheld to cover taxes

—

—

(3,626)

—

—

—

(3,626)
Total other comprehensive loss

—

—

—

(2,930)

—

—

(2,930)
Balance, March 31, 2019

37,271

$
374

$
343,591

$
(7,461)

$
(366,427)

$
(696)

$
(30,619)
Net income

—

—

—

—

10,035

—

10,035
Share-based compensation expense

—

—

3,450

—

—

—

3,450
Issuance of common stock upon vesting of restricted stock units

64

1

(1)

—

—

—

—
Effect of shares withheld to cover taxes

—

—

(28)

—

—

—

(28)
Total other comprehensive loss

—

—

—

(4,682)

—

—

(4,682)
Balance, June 30, 2019

37,335

$
375

$
347,012

$
(12,143)

$
(356,392)

$
(696)

$
(21,844)
Net income

—

—

—

—

5,691

—

5,691
Share-based compensation expense

—

—

3,374

—

—

—

3,374
Issuance in connection with the exercise of stock options

20

—

249

—

—

—

249
Issuance of common stock upon vesting of restricted stock units

7

—

—

—

—

—

—
Effect of shares withheld to cover taxes

—

—

(56)

—

—

—

(56)
Total other comprehensive loss

—

—

—

(1,634)

—

—

(1,634)
Balance, September 30, 2019

37,362

$
375

$
350,579

$
(13,777)

$
(350,701)

$
(696)

$
(14,220)

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

5
Table of Contents
HANGER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)

For the Nine Months Ended
September 30,

2019

2018

Cash flows provided by operating activities:

Net income (loss)

$
8,775

$
(5,321
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:

Depreciation and amortization

26,906

27,552

Amortization of right-of-use assets

27,657

—

Provision (benefit) for doubtful accounts

284

(578
)
Stock-based compensation expense

10,089

9,573

Deferred income taxes

(723
)
(4,114
)
Amortization of debt discounts and issuance costs

1,202

2,453

Loss on extinguishment of debt

—

16,998

Gain on sale and disposal of fixed assets

(1,200
)
(2,537
)
Changes in operating assets and liabilities (Note T)

(53,045
)
(6,867
)
Net cash provided by operating activities

19,945

37,159

Cash flows used in investing activities

Purchase of property, plant, and equipment

(20,262
)
(16,435
)
Purchase of therapeutic program equipment leased to third parties under operating leases

(5,165
)
(6,390
)
Acquisitions, net of cash acquired

(31,585
)
—

Purchase of company-owned life insurance investment

—

(598
)
Proceeds from sale of property, plant and equipment

2,181

3,583

Net cash used in investing activities

(54,831
)
(19,840
)
Cash flows (used in) provided by financing activities

Borrowings under term loan, net of discount

—

501,467

Repayment of term loan

(3,788
)
(434,400
)
Borrowings under revolving credit agreement

—

3,000

Repayments under revolving credit agreement

—

(8,000
)
Payment of employee taxes on stock-based compensation

(3,710
)
(2,568
)
Payment on seller notes

(2,688
)
(2,116
)
Payment of financing lease obligations

(344
)
(942
)
Payment of debt issuance costs

—

(6,757
)
Payment of debt extinguishment costs

—

(8,436
)
Proceeds from exercise of options

249

—

Net cash (used in) provided by financing activities

(10,281
)
41,248

(Decrease) increase in cash, cash equivalents, and restricted cash

(45,167
)
58,567

Cash, cash equivalents, and restricted cash, at beginning of period

95,114

4,779

Cash, cash equivalents, and restricted cash, at end of period

$
49,947

$
63,346

Reconciliation of Cash, Cash Equivalents, and Restricted Cash:

Cash and cash equivalents, at beginning of period

$
95,114

$
1,508

Restricted cash, at beginning of period

—

3,271

Cash, cash equivalents, and restricted cash, at beginning of period

$
95,114

$
4,779

Cash and cash equivalents, at end of period

$
49,947

$
61,035

Restricted cash, at end of period

—

2,311

Cash, cash equivalents, and restricted cash, at end of period

$
49,947

$
63,346

For the Nine Months Ended

September 30,


2020

2019
Cash flows provided by operating activities:

Net income

$
22,121

$
8,775
Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

26,513

26,906
Provision for doubtful accounts

629

284
Share-based compensation expense

15,565

10,089
Deferred income taxes

2,067

(723)
Amortization of debt discounts and issuance costs

1,564

1,202
Gain on sale and disposal of fixed assets

(729)

(1,200)
Changes in operating assets and liabilities:

Accounts receivable, net

39,531

1,914
Inventories

(3,834)

(6,310)
Other current assets and other assets

(3,115)

(1,769)
Income taxes

(6,814)

2,613
Accounts payable

12,912

(1,751)
Accrued expenses and other current liabilities

6,914

(2,144)
Accrued compensation related costs

2,339

(15,583)
Other liabilities

8,016

(1,736)
Operating lease liabilities, net of amortization of right-of-use assets

1,559

(622)
Changes in operating assets and liabilities:

57,508

(25,388)
Net cash provided by operating activities

125,238

19,945
Cash flows used in investing activities:

Acquisitions, net of cash acquired

(16,854)

(31,585)
Purchase of property, plant, and equipment

(19,352)

(20,262)
Purchase of therapeutic program equipment leased to third parties under operating leases

(3,194)

(5,165)
Proceeds from sale of property, plant, and equipment

1,578

2,181
Purchase of company-owned life insurance investment

(250)

—
Net cash used in investing activities

(38,072)

(54,831)
Cash flows used in financing activities:

Borrowings under revolving credit agreement

79,000

—
Repayment of borrowings under revolving credit agreement

(79,000)

—
Repayment of term loan

(3,788)

(3,788)
Payment of employee taxes on share-based compensation

(6,841)

(3,710)
Payment on seller notes

(2,200)

(2,688)
Payments of financing lease obligations

(521)

(344)
Payments under vendor financing arrangements

(550)

—
Payment of debt issuance costs

(214)

—
Proceeds from the exercise of options

39

249
Net cash used in financing activities

(14,075)

(10,281)
Increase (decrease) in cash and cash equivalents

73,091

(45,167)
Cash and cash equivalents at beginning of period

74,419

95,114
Cash and cash equivalents at end of period

$
147,510

$
49,947

Non-cash financing and investing activities:

Seller notes, deferred payment obligations and additional consideration related to acquisitions

$
29,420

$
5,053
Purchase of property, plant, and equipment in accounts payable at period end

4,299

3,492
Purchase of property, plant, and equipment through vendor financing

—

2,200
Right-of-use assets obtained in exchange for finance lease obligations

1,975

282

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

6
Table of Contents
HANGER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note A — Organization and Summary of Significant Accounting Policies

Description of Business

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

Basis of Presentation

The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, and, therefore, do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, ~~2018~~2019 (the ~~“2018~~“2019 Form 10-K”), as previously filed with the Securities and Exchange Commission ~~(“SEC”~~(the “SEC”).

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

A detailed description of our significant accounting policies and management judgments is contained in our ~~2018~~2019 Form 10-K.

~~Recently Adopted Accounting Pronouncements~~Recent Developments Regarding COVID-19
~~Leases~~

We ~~lease~~are subject to risks and uncertainties as a ~~majority~~result of the outbreak of the novel coronavirus (“COVID-19”) pandemic (“COVID-19 pandemic”). The extent and duration of the impact of the COVID-19 pandemic on our operations and financial condition are highly uncertain and difficult to predict, as viral infections continue to increase and information is rapidly evolving. We believe that our patients are deferring visits to our O&P clinics as well as elective surgical procedures, both of which impact our business volumes through decreased patient encounters and physician referrals. Furthermore, capital markets and the economy have been disrupted by the COVID-19 pandemic, and it still remains possible that it could cause a recessionary environment impacting the healthcare industry generally, including the O&P industry. The continuing economic disruption has had and could have a continuing material adverse effect on our business, as the duration and extent of state and local government restrictions impacting our patients’ ability or willingness to visit our O&P clinics and those of our ~~patient care clinics~~customers, is unknown. The United States government has responded with fiscal policy measures intended to support the healthcare industry and warehouses under lease arrangements, certain of which contain renewal options, rent escalation clauses, and/or landlord incentives. Rent expense for noncancellable leases with scheduled rent increases and/or landlord incentives is recognized oneconomy as a ~~straight-line basis over~~whole, including the lease term, including any applicable rent holidays, beginning on the lease commencement date. We exclude leases with a term of one year or less from our balance sheet, and do not separate non-lease components from our real estate leases. Our leases may include variable payments for maintenance, which are expensed as incurred.
In addition, we are the lessor of therapeutic program equipment to patients and businesses in acute, post-acute, and clinic settings. The therapeutic program equipment and related services revenue are recognized over the applicable term the customer has the right to use the equipment and as the services are provided. These operating lease agreements are typically for twelve months and have a 30-day cancellation policy. We do not separate non-lease components, consisting primarily of training, for these leases.
~~Effect of Adoption of ASC 842~~
~~We adopted Accounting Standards Update (“ASU”) No. 2016-02,~~ ~~Leases (ASC 842)~~~~, and related clarifying standards, as of January 1, 2019, using the modified retrospective approach. This approach allows us to apply the standard as~~passage of the ~~adoption date~~Coronavirus Aid, Relief and ~~record a cumulative-effect adjustment~~Economic Security Act (the “CARES Act”) in March 2020. We continue to monitor the opening balance of accumulated deficit at January 1, 2019. The new lease standard requires lessees to recognize a right-of-use (“ROU”) asset and a lease liability on the balance sheet for all leases (with the exception of short-term leases, defined as leases with a term of 12 months or less) at the lease commencement date and recognize expenses on the consolidated statements of operations on a straight-line basis.
~~In addition, we elected the package of practical expedients available under the transition~~ provisions of the ~~new lease standard, including (i) not reassessing whether expired or existing contracts contain leases, (ii) carrying forward lease classification under legacy guidance,~~CARES Act and ~~(iii) not revaluing initial direct costs for existing leases. By electing the modified retrospective approach on adoption date, prior period results will continue~~their application to be presented under legacy guidance based on the accounting standards originally in effect for such period. We have elected to keep leases with an initial term of 12 months or less off the balance sheetus, as well as future governmental policies and recognize those lease payments in the consolidated statements of operations on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, and have elected to utilize the practical expedient to account for lease and non-lease components together as a single combined lease component for real estate and therapeutic program equipment, from both a lessee and lessor perspective. From a lessor perspective, the timing and pattern of transfer are the same for the non-lease components and associated lease component and, the lease component, if accounted for separately, would be classified as an operating lease. The accounting for our finance leases and leases where we are the lessor remained substantially unchanged.
The lease liability was measured as the present value of the unpaid lease payments and the right-of-use asset was derived from the calculation of the lease liability. As the rate implicit in the lease is generally not readily determinable for our operating leases, the discount rates used to determine the present value of our lease liability are based on our incremental borrowing rate at the lease commencement date and commensurate with the remaining lease term. Our incremental borrowing rate for a lease is the rate of interest we would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Our lease term may include options to extend or terminate if the exercise of that option is reasonably certain to occur. We rent or sublease certain real estate to third parties. Our sublease portfolio consists mainly of operating leases on small medical office locations.
The most significant impact of the new lease standard was to the balance sheet, where values were added for real estate operating leases, which increased both assets and liabilities. The capital leases associated with equipment were already reflected on our balance sheet and did not add any incremental assets or liabilities under the new lease standard. The adoption of the new lease standard did not have antheir impact on our ~~compliance with existing debt covenants because~~business; however, the ~~impact~~magnitude and overall effectiveness of ~~changes~~such policies to us and the economy as a whole remains uncertain.

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 $175.0 billion to be administered through grants and other mechanisms to hospitals, public entities, not-for-profit entities and Medicare- and Medicaid- enrolled suppliers and institutional providers. The purpose of these funds is to reimburse providers for lost revenue and health-care related expenses that are attributable to the COVID-19 pandemic. In April 2020, the U.S. Department of Health and Human Services (“HHS”) began making payments to healthcare providers from the $175.0 billion appropriation. These are payments, rather than loans, to healthcare providers, and will not need to be repaid.

7
Table of Contents
During the second and third quarters of 2020, we recognized a total benefit of $20.6 million in ~~accounting standards is excluded from debt covenant calculations. The impact of applying the new lease standard to~~ our ~~results~~condensed consolidated statement of operations within Other operating costs for a portion of the grant proceeds we received under the CARES Act (“Grants”) from HHS. We recognize income related to grants on a systematic and ~~cash flows is not significant.~~
~~Additionally,~~rational basis when it becomes probable that we have ~~determined that~~complied with the ~~leases previously identified as build-to-suit leasing arrangements under legacy lease accounting were to be derecognized pursuant~~terms and conditions of the grant and in the period in which the corresponding costs or income related to the ~~transition guidance provided~~grant are recognized. We recognized the benefit from the Grants within Other operating costs in our Patient Care segment. As of September 30, 2020, we have recorded a liability of $3.4 million within Accrued expenses and other liabilities in the condensed consolidated balance sheet related to proceeds from the Grants for ~~build-to-suit leases~~amounts that have not met the recognition criteria in ~~ASC 842. Accordingly, these leases have been reassessed as operating leases as of January 1, 2019.~~ accordance with our accounting policy.

The ~~legacy guidance was based on~~CARES Act also provides for a risks and rewards model which contained several prescriptive provisions designed to assess lessee ownership during construction. The ASC 842 model has eliminated these prescriptive rules and replaced them with a model based on control. Under ASC 842, we did not demonstrate control as the lessee and therefore the leases were derecognized at January 1, 2019. The resulting cumulative effect recognized at adoption to accumulated deficit was $1.6 million, net of tax.
~~Upon adoption of ASC 842, the cumulative effect~~deferral of the ~~changes made~~employer portion of payroll taxes incurred during the COVID-19 pandemic through December 2020. The provisions allow us to ~~our~~defer half of such payroll taxes until December 2021 and the remaining half until December 2022. We deferred $7.1 million of payroll taxes within Other liabilities in the condensed consolidated balance sheet as of ~~January 1, 2019 was as follows:~~September 30, 2020.

December 31, 2018

Effects of

January 1, 2019

(in thousands)

As reported

adoption

After adoption

Assets

Other current assets

$
18,731

$
(5,770
)
$
12,961

Total current assets

325,900

(5,770
)
320,130

Property, plant and equipment, net

89,489

(8,068
)
81,421

Other intangible assets, net

15,478

(220
)
15,258

Deferred income taxes

65,635

(570
)
65,065

Operating lease right-of-use assets

—

103,378

103,378

Other assets

7,766

538

8,304

Total assets

703,010

89,288

792,298

Liabilities

Current liabilities:

Current portion of long-term debt

8,583

(619
)
7,964

Accrued expenses and other current liabilities

51,783

(1,352
)
50,431

Current portion of operating lease liabilities

—

31,479

31,479

Total current liabilities

171,274

29,508

200,782

Long-term liabilities:

Long-term debt, less current portion

502,090

(12,493
)
489,597

Operating lease liabilities

—

83,662

83,662

Other liabilities

51,570

(12,950
)
38,620

Total liabilities

724,934

87,727

812,661

Shareholders’ deficit

Accumulated deficit

(361,023
)
1,561

(359,462
)
Total shareholders’ deficit

(21,924
)
1,561

(20,363
)
Total liabilities and shareholders’ deficit

$
703,010

$
89,288

$
792,298

~~Cloud Computing Arrangements~~Recently Adopted Accounting Pronouncements

In ~~August 2018,~~June 2016, the Financial Accounting Standards Board ~~(“FASB”~~(the “FASB”) issued ~~ASU 2018-15,~~ ~~Intangibles - Goodwill and Other - Internal-Use Software (Topic 350) - Customer’s~~ Accounting ~~for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract~~. The new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Effective July 1, 2019, we elected to early adopt the requirements of the standard on a prospective basis. As of September 30, 2019, we capitalized $0.3 million of implementation costs for cloud computing arrangements, net of accumulated amortization, which is recorded in other current assets and other assets in the condensed consolidated balance sheet.
~~Recent Accounting Pronouncements, Not Yet Adopted~~
~~In June 2016, the FASB issued ASU~~Standards Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and related clarifying standards, which replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ~~This ASU is effective for public entities for fiscal years beginning after December 15, 2019, with early adoption permitted. We are currently evaluating the effects that the~~The adoption of this ~~guidance will have~~standard on ~~our consolidated financial statements and the related disclosures.~~January 1, 2020 resulted in a cumulative effect adjustment to accumulated deficit of $0.2 million.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), which modifies the disclosures on fair value measurements by removing the requirement to disclose the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy and the policy for timing of such transfers. The ASU expands the disclosure requirements for Level 3 fair value measurements, primarily focused on changes in unrealized gains and losses included in other comprehensive income. ~~The~~There was no material impact on our condensed consolidated financial position, results of operations, or cash flows due to the adoption on January 1, 2020.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. Among other provisions, this ASU removes the exception that limited the income tax benefit recognized in the interim period in cases when the year-to-date loss exceeds the anticipated loss for the year. Adoption of this standard is effective beginning January 1, 2021, but as early adoption is permitted, we have selected to adopt this standard effective January 1, 2020. There was no material impact on our condensed consolidated financial position, results of operations, or cash flows due to the adoption.

Recent Accounting Pronouncements, Not Yet Adopted

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional expedients and exceptions for ~~public entities for fiscal years beginning~~applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update apply only to contracts, hedging relationships, and other transactions that reference London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December ~~15, 2019, with early adoption permitted.~~31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. We are currently evaluating the effects that the adoption of this guidance will have on our consolidated financial statements and the related disclosures.

~~In August 2018, the FASB issued ASU No. 2018-14,~~ ~~Compensation - Retirement Benefits - Defined Benefit Plans - General (Topic 715)~~. This ASU modifies the disclosure requirements for defined benefit and other postretirement plans. This ASU eliminates certain disclosures associated with accumulated other comprehensive income, plan assets, related parties, and the effects of interest rate basis point changes on assumed health care costs; while other disclosures have been added to address significant gains and losses related to changes in benefit obligations. This ASU also clarifies disclosure requirements for projected benefit and accumulated benefit obligations. The amendments in this ASU are effective for public entities for fiscal years ending after December 15, 2020 and for interim periods therein with early adoption permitted. We are currently evaluating the effects that the adoption of this guidance will have on our consolidated financial statements and the related disclosures.

Note B — Earnings Per Share

Basic earnings per common share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed using the weighted average number of common shares outstanding during the period plus any potentially dilutive common shares, such as stock options, restricted stock units, and performance-based units calculated using the treasury stock method. Total anti-dilutive shares excluded from diluted earnings per share were 1034,379 and ~~zero~~20,202 for the three and nine months ended September 30, ~~2019,~~2020, and ~~zero~~10 and ~~48,502~~0 for the three and nine months ended September 30, ~~2018.~~2019.

8
Table of Contents

Our ~~credit agreement~~Credit Agreement (as defined below) restricts the payment of dividends or other distributions to our shareholders ~~with respect to Hanger, Inc.,~~by us or any of ~~its~~our subsidiaries. See Note L - “Debt and Other Obligations” within these condensed consolidated financial statements.

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

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

(in thousands except per share data)

2019

2018

2019

2018

Net income (loss)

$
5,691

$
4,369

$
8,775

$
(5,321
)

Weighted average shares outstanding - basic

37,349

36,857

37,218

36,717

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

638

700

704

—

Weighted average shares outstanding - diluted

37,987

37,557

37,922

36,717

Basic income (loss) per share

$
0.15

$
0.12

$
0.24

$
(0.14
)

Diluted income (loss) per share

$
0.15

$
0.12

$
0.23

$
(0.14
)

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,
(in thousands except share and per share amounts)

2020

2019

2020

2019
Net income

$
6,815

$
5,691

$
22,121

$
8,775

Weighted average shares outstanding - basic

38,133,598

37,349,144

37,878,753

37,218,234
Effect of potentially dilutive restricted stock units and options

503,938

637,716

613,212

703,533
Weighted average shares outstanding - diluted

38,637,536

37,986,860

38,491,965

37,921,767

Basic income per share

$
0.18

$
0.15

$
0.58

$
0.24

Diluted income per share

$
0.18

$
0.15

$
0.57

$
0.23

~~(1)~~ In accordance with ASC 260 - Earnings Per Share, during periods of a net loss, shares used to compute diluted per share amounts exclude potentially dilutive shares related to unvested restricted stock units and unexercised options. For the nine months ended September 30, 2018, potentially dilutive shares of 680,444 were excluded.
Note C — Revenue Recognition

Patient Care Segment

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

The following table disaggregates revenue from contracts with customers in our Patient Care segment for the three and nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:

For the Three Months Ended
September 30,

For the��Nine Months Ended
September 30,

(in thousands)

2019

2018

2019

2018

Patient Care Segment

Medicare

$
72,879

$
69,724

$
206,295

$
197,461

Medicaid

36,140

33,597

103,631

96,993

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

83,384

78,333

232,410

226,761

Veterans Administration

23,816

19,317

64,635

56,873

Private Pay

14,712

13,109

45,729

42,657

Total

$
230,931

$
214,080

$
652,700

$
620,745

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,
(in thousands)

2020

2019

2020

2019
Patient Care Segment








Medicare

$
68,135

$
72,879

$
194,052

$
206,295
Medicaid

34,541

36,140

96,612

103,631
Commercial Insurance / Managed Care (excluding Medicare and Medicaid Managed Care)

75,966

83,384

213,234

232,410
Veterans Administration

19,339

23,816

54,057

64,635
Private Pay

14,683

14,712

40,751

45,729
Total

$
212,664

$
230,931

$
598,706

$
652,700

The impact to revenue related to prior period performance obligations was not material for the three and nine months ended September 30, 2020 and 2019.

Products & Services Segment

Revenue in our Products & Services segment is derived from the distribution of O&P components and from therapeutic solutions, which includes the leasing and sale of rehabilitation equipment and ancillary consumable supplies combined with equipment maintenance, education, and training.
9
Table of Contents

The following table disaggregates revenue from contracts with customers in our Product & Services segment for the three and nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,
(in thousands)

2019

2018

2019

2018


2020

2019

2020

2019
Products & Services Segment





Distribution services, net of intersegment revenue eliminations

$
36,653

$
34,666

$
107,510

$
100,700

$
32,711

$
36,653

$
90,928

$
107,510
Therapeutic solutions

12,054

14,200

36,945

42,462

11,262

12,054

34,176

36,945
Total

$
48,707

$
48,866

$
144,455

$
143,162

$
43,973

$
48,707

$
125,104

$
144,455

Note D — Accounts Receivable, Net

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

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

As part of the new accounting standard discussed in Note A - “Organization and Summary of Significant Accounting Policies,” our expected loss methodology is developed using historical liquidation rates, current and future economic and market conditions, and a review of the current status of our patients and customers' trade accounts receivable balances. We also grouped our receivables into similar risk pools to better measure the risks for each pool. After evaluating the risk for each pool, we determined that additional credit loss risk was immaterial for the Patient Care segment. For the Products & Services segment, an allowance for doubtful accounts is ~~also~~ recorded, ~~for our Products & Services segment~~ which is deducted from gross accounts receivable to arrive at “Accounts receivable, net.” As of September 30, 2020, we have considered the current and future economic and market conditions resulting in an increase to the allowance for doubtful accounts by approximately $0.7 million since December 31, 2019.

Accounts receivable, net as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 is comprised of the following:

As of September 30, 2019

As of December 31, 2018

As of September 30, 2020

As of December 31, 2019

Products &

Products &

(in thousands)

Patient Care

Products &
Services

Consolidated

Patient Care

Products &
Services

Consolidated


Patient Care

Services

Consolidated

Patient Care

Services

Consolidated
Accounts receivable, before allowances

$
185,659

$
27,381

$
213,040

$
182,338

$
24,542

$
206,880

Allowances for estimated implicit price concessions arising from:

Gross charges before estimates for implicit price concessions

$
157,191

$
21,765

$
178,956

$
202,132

$
27,551

$
229,683
Less estimates for implicit price concessions:

Payor disallowances

(56,564
)
—

(56,564
)
(53,378
)
—

(53,378
)

(47,314)

—

(47,314)

(58,094)

—

(58,094)
Patient non-payments

(8,820
)
—

(8,820
)
(7,244
)
—

(7,244
)

(6,916)

—

(6,916)

(9,589)

—

(9,589)
Accounts receivable, gross

120,275

27,381

147,656

121,716

24,542

146,258

102,961

21,765

124,726

134,449

27,551

162,000
Allowance for doubtful accounts

—

(2,278
)
(2,278
)
—

(2,272
)
(2,272
)

—

(3,317)

(3,317)

—

(2,641)

(2,641)
Accounts receivable, net

$
120,275

$
25,103

$
145,378

$
121,716

$
22,270

$
143,986

$
102,961

$
18,448

$
121,409

$
134,449

$
24,910

$
159,359

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Note E — Inventories

Our inventories are comprised of the following:

As of September 30,

As of December 31,

As of September 30,

As of December 31,
(in thousands)

2019

2018


2020

2019
Raw materials

$
20,908

$
19,632

$
20,047

$
20,574
Work in process

14,287

9,278

15,575

10,165
Finished goods

40,498

38,780

38,486

37,465
Total inventories

$
75,693

$
67,690

$
74,108

$
68,204

Note F — Property, Plant, and Equipment, Net

Property, plant, and equipment, net were comprised of the following:

As of September 30,

As of December 31,

As of September 30,

As of December 31,
(in thousands)

2019

2018


2020

2019
Land

$
634

$
644

$
554

$
634
Buildings (1)

4,046

24,558

Buildings

3,756

4,110
Furniture and fixtures

13,332

13,121

14,747

13,835
Machinery and equipment

26,603

27,452

25,826

25,438
Equipment leased to third parties under operating leases

29,943

30,093

27,510

29,217
Leasehold improvements

129,029

111,247

138,450

131,617
Computers and software

74,897

69,173

79,484

75,540
Total property, plant and equipment, gross

278,484

276,288

Less: accumulated depreciation

(193,994
)
(186,799
)
Total property, plant and equipment, net

$
84,490

$
89,489

Total property, plant, and equipment, gross

290,327

280,391
Less: accumulated depreciation and amortization

(203,690)

(196,334)
Total property, plant, and equipment, net

$
86,637

$
84,057
~~(1)~~ ~~As discussed in Note A - “~~~~Organization and Summary of Significant Accounting Policies~~~~”, the new lease standard resulted in the removal of assets associated with build-to-suit leases.~~

Total depreciation expense was approximately ~~$7.8~~$7.0 million and ~~$23.0~~$21.4 million for the three and nine months ended September 30, 2020 and $7.7 million and $22.8 million for the three and nine months ended September 30, 2019, ~~and $7.5~~respectively. Total amortization of finance right-of-use assets was approximately $0.2 million and ~~$22.3~~$0.5 million for the three and nine months ended September 30, ~~2018.~~2020 and $0.1 million and $0.2 million for the three and nine months ended September 30, 2019, respectively.

Note G — Acquisitions

~~2019~~2020 Acquisition Activity

~~During 2019,~~In the second quarter of 2020, we ~~completed the following acquisitions~~acquired all of O&P clinics, none of which were individually material to our financial position, results of operations, or cash flows. Each acquisition is intended to expand our continuum of patient care through the acquisitions of high quality O&P providers in new geographic markets.
·                  ~~In January 2019, we completed the acquisition of all~~ the outstanding equity interests of an O&P business for total consideration of ~~$32.8~~$46.1 million at fair value, of which ~~$27.7~~$16.8 million was cash consideration, net of cash acquired, ~~$4.4~~$21.9 million was issued in the form of notes to the former shareholders, ~~at fair value,~~$3.5 million in the form of a deferred payment obligation to the former shareholders and ~~$0.7~~$4.0 million in additional consideration.
·                  ~~In May 2019, we completed~~ Of the ~~acquisition of all the outstanding equity interests of an O&P business for total consideration of $0.5~~$21.9 million ~~of which $0.2 million was cash consideration, net of cash acquired, and $0.3 million was issued~~ in ~~the form of notes to shareholders at fair value.~~
·                  In July 2019, we completed the acquisition of two O&P businesses for total consideration of $3.3 million, of which $3.0 million was cash consideration, net of cash acquired, and $0.3 million was issued in the form of notes to shareholders at fair value.
~~The~~ 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 ~~unsecured and~~ payable in annual installments over a period of 3three years on the anniversary date of the acquisition. Payments totaling $3.5 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 ~~5 years.~~the shareholders as part of the business combination payable in October 2020 and is included in Accrued expenses and other liabilities in the condensed consolidated balance sheet. The remaining $0.4 million in additional consideration represents the effective settlement of amounts due to us from the acquired O&P business as of the acquisition date. We completed the acquisition with the intention of expanding the geographic footprint of our patient care offerings through the acquisition of high quality O&P providers.

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Table of Contents

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

Acquisition-related costs ~~for the transactions completed above for the three and nine months ended September 30, 2019 were $0.3 million and $0.8 million, respectively, and~~ are included in general and administrative expenses in our consolidated ~~statement~~statements of operations. Total acquisition-related costs incurred during the three and nine months ended September 30, 2020 were $0.1 million and $0.6 million, respectively, which includes those costs for transactions that are in progress or were not completed during the respective period. Acquisition-related costs incurred for the acquisitions completed during the three and nine month periods ended September 30, 2020 were $0.0 million and $0.4 million, respectively.

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

Purchase Price Allocation

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

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

(in thousands)



Cash paid, net of cash acquired

$
30,926

$
16,762
Issuance of seller notes at fair value

5,053

21,941
Additional consideration

659

Deferred payment obligation at fair value

3,468
Additional consideration, net

3,975
Aggregate purchase price

36,638

46,146

Accounts receivable, net

3,630

Accounts receivable

3,182
Inventories

1,693

2,021
Customer relationships (Weighted average useful life of 4.9 years)

5,791

Non-compete agreements (Weighted average useful life of 4.9 years)

349

Other assets

(2,687
)
Customer relationships (Weighted average useful life of 5.0 years)

5,600
Non-compete agreements (Weighted average useful life of 5.0 years)

200
Other assets and liabilities, net

(4,301)
Net assets acquired

8,776

6,702
Goodwill

$
27,862

$
39,444

Right-of-use assets and lease liabilities related to operating leases recognized in connection with the acquisition completed during the nine months ended September 30, 2020 were $4.7 million.

12
Table of Contents

~~Right-of-use~~2019 Acquisition Activity

During 2019, we completed the following acquisitions of O&P clinics, none of which were individually material to our financial position, results of operations, or cash flows. We completed each acquisition with the intention of expanding the geographic footprint of our patient care offerings through the acquisitions of high quality O&P providers.

● In the first quarter of 2019, we completed the acquisition of all the outstanding equity interests of an O&P business for total consideration of $32.8 million, of which $27.7 million was cash consideration, net of cash acquired, $4.4 million was issued in the form of notes to shareholders at fair value, and $0.7 million was additional consideration.

● In the second quarter of 2019, we completed the acquisition of all the outstanding equity interests of an O&P business for total consideration of $0.5 million, of which $0.2 million was cash consideration, net of cash acquired, and $0.3 million was issued in the form of notes to shareholders at fair value.

● In the third quarter of 2019, we completed the acquisition of all the outstanding equity interests of one O&P business and acquired the assets of another O&P business for total consideration of $3.3 million, of which $3.0 million was cash consideration, net of cash acquired, and $0.3 million was issued in the form of notes to shareholders at fair value.

● In the fourth quarter of 2019, we completed the acquisition of all the outstanding equity interests of one O&P business and acquired the assets of another O&P business for total consideration of $7.8 million, of which $5.0 million was cash consideration, net of cash acquired, and $2.8 million was issued in the form of notes to shareholders at fair value.

The aggregate purchase price for these acquisitions was allocated as follows:

(in thousands)


Cash paid, net of cash acquired

$
35,909
Issuance of seller notes at fair value

7,835
Additional consideration, net⁽¹⁾

626
Aggregate purchase price

44,370

Accounts receivable

4,128
Inventories

2,081
Customer relationships (Weighted average useful life of 4.7 years)

7,038
Non-compete agreements (Weighted average useful life of 4.9 years)

350
Other assets and liabilities, net

(2,983)
Net assets acquired

10,614
Goodwill

$
33,756

(1) Approximately $0.7 million of additional consideration represents payments made during the third quarter related to certain tax elections with the seller, offset by an immaterial amount of favorable working capital adjustments.

Right-of-use assets and lease liabilities related to operating leases recognized in connection with acquisitions completed ~~during~~for the ~~three and nine month periods ending September 30,~~year ended December 31, 2019 ~~were $0.6 million and $2.0 million, respectively.~~was $5.2 million.

~~2018 Acquisition Activity~~
In the fourth quarter of 2018, we acquired two O&P businesses for an aggregate purchase price of $3.1 million, net of cash acquired. These acquisitions were accounted for using the acquisition method of accounting whereby assets acquired and liabilities assumed were recognized at fair value on the date of the transaction.
~~The aggregate purchase price for these acquisitions was allocated as follows:~~
(in thousands)

Cash paid, net of cash acquired

$
1,978

Issuance of seller notes

1,120

Aggregate purchase price

3,098

Accounts receivable, net

256

Inventories

302

Customer relationships (Weighted average useful life of 4.0 years)

260

Non-compete agreements (Weighted average useful life of 4.6 years)

214

Other assets

90

Accounts payable

(59
)
Accrued expenses and other liabilities

(364
)
Net assets acquired

699

Goodwill

$
2,399

Note H — Goodwill and Other Intangible Assets

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

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Table of Contents
The following table summarizes the activity in goodwill for the periods indicated:

For the Nine Months Ended September 30, 2019

Patient Care

Products & Services

Consolidated

For the Nine Months Ended September 30, 2020

Patient Care

Products & Services

Consolidated

Goodwill,

Accumulated

Goodwill,

Goodwill,

Accumulated

Goodwill,

Goodwill,

Accumulated

Goodwill,
(in thousands)

Goodwill,
Gross

Accumulated
Impairment

Goodwill,
Net

Goodwill,
Gross

Accumulated
Impairment

Goodwill,
Net

Goodwill,
Gross

Accumulated
Impairment

Goodwill,
Net


Gross

Impairment

Net

Gross

Impairment

Net

Gross

Impairment

Net
As of December 31, 2018

$
627,410

$
(428,668
)
198,742

$
139,299

$
(139,299
)
—

$
766,709

$
(567,967
)
198,742

As of December 31, 2019

$
660,912

$
(428,668)

$
232,244

$
139,299

$
(139,299)

$
—

$
800,211

$
(567,967)

$
232,244
Additions from acquisitions

30,112

—

30,112

—

—

—

30,112

—

30,112

39,386

—

39,386

—

—

—

39,386

—

39,386
Measurement period adjustments (1)

(2,506
)
—

(2,506
)
—

—

—

(2,506
)
—

(2,506
)

71

—

71

—

—

—

71

—

71
As of September 30, 2019

$
655,016

$
(428,668
)
$
226,348

$
139,299

$
(139,299
)
$
—

$
794,315

$
(567,967
)
$
226,348

As of September 30, 2020

$
700,369

$
(428,668)

$
271,701

$
139,299

$
(139,299)

$
—

$
839,668

$
(567,967)

$
271,701

(1) Measurement period adjustments relate to 2020 and 2019 acquisitions and are primarily attributable to adjustments to the preliminary allocations of customer relationship intangibles.
~~(1)~~ Measurement period adjustments relate to 2019 and 2018 acquisitions of approximately $2.2 million and $0.3 million, respectively, and are primarily attributable to adjustments to the preliminary allocations of customer relationship intangibles.

For the Year Ended December 31, 2019

Patient Care

Products & Services

Consolidated

Goodwill,

Accumulated

Goodwill,

Goodwill,

Accumulated

Goodwill,

Goodwill,

Accumulated

Goodwill,
(in thousands)

Gross

Impairment

Net

Gross

Impairment

Net

Gross

Impairment

Net
As of December 31, 2018

$
627,410

$
(428,668)

$
198,742

$
139,299

$
(139,299)

$
—

$
766,709

$
(567,967)

$
198,742
Additions from acquisitions

35,926

—

35,926

—

—

—

35,926

—

35,926
Measurement period adjustments ⁽¹⁾

(2,424)

—

(2,424)

—

—

—

(2,424)

—

(2,424)
As of December 31, 2019

$
660,912

$
(428,668)

$
232,244

$
139,299

$
(139,299)

$
—

$
800,211

$
(567,967)

$
232,244

For the Year Ended December 31, 2018

Patient Care

Products & Services

Consolidated

(in thousands)

Goodwill,
Gross

Accumulated
Impairment

Goodwill,
Net

Goodwill,
Gross

Accumulated
Impairment

Goodwill,
Net

Goodwill,
Gross

Accumulated
Impairment

Goodwill,
Net

As of December 31, 2017

$
625,011

$
(428,668
)
$
196,343

$
139,299

$
(139,299
)
$
—

$
764,310

$
(567,967
)
$
196,343

Additions from acquisitions

2,399

—

2,399

—

—

—

2,399

—

2,399

As of December 31, 2018

$
627,410

$
(428,668
)
$
198,742

$
139,299

$
(139,299
)
$
—

$
766,709

$
(567,967
)
$
198,742

(1) Measurement period adjustments relate to 2019 and 2018 acquisitions of approximately $2.1 million and $0.3 million, respectively, and are primarily attributable to adjustments to the preliminary allocations of customer relationship intangibles.

The balances related to intangible assets as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 are as follows:

As of September 30, 2019

(in thousands)

Gross Carrying
Amount

Accumulated
Amortization

Accumulated
Impairment

Net Carrying
Amount

Customer lists

$
31,525

$
(21,622
)
$
—

$
9,903

Trade name

255

(145
)
—

110

Patents and other intangibles

9,238

(5,383
)
—

3,855

Definite-lived intangible assets

41,018

(27,150
)
—

13,868

Indefinite-lived trade names

9,070

—

(4,953
)
4,117

Total other intangible assets

$
50,088

$
(27,150
)
$
(4,953
)
$
17,985

As of December 31, 2018

As of September 30, 2020

Gross Carrying

Accumulated

Accumulated

Net Carrying
(in thousands)

Gross Carrying
Amount

Accumulated
Amortization

Accumulated
Impairment

Net Carrying
Amount


Amount

Amortization

Impairment

Amount
Customer lists

$
26,036

$
(19,051
)
$
—

$
6,985

$
38,372

$
(26,844)

$
—

$
11,528
Trade name

255

(125
)
—

130

255

(170)

—

85
Patents and other intangibles

9,391

(5,145
)
—

4,246

9,011

(5,635)

—

3,376
Definite-lived intangible assets

35,682

(24,321
)
—

11,361

47,638

(32,649)

—

14,989
Indefinite-lived trade names

9,070

—

(4,953
)
4,117

Indefinite-lived trade name

9,070

—

(4,953)

4,117
Total other intangible assets

$
44,752

$
(24,321
)
$
(4,953
)
$
15,478

$
56,708

$
(32,649)

$
(4,953)

$
19,106

As of December 31, 2019

Gross Carrying

Accumulated

Accumulated

Net Carrying
(in thousands)

Amount

Amortization

Impairment

Amount
Customer lists

$
32,772

$
(22,726)

$
—

$
10,046
Trade name

255

(151)

—

104
Patents and other intangibles

9,188

(5,503)

—

3,685
Definite-lived intangible assets

42,215

(28,380)

—

13,835
Indefinite-lived trade name

9,070

—

(4,953)

4,117
Total other intangible assets

$
51,285

$
(28,380)

$
(4,953)

$
17,952

~~Total~~Amortization expense related to other intangible ~~amortization expense~~assets was approximately $1.6 million and $4.6 million for the three and nine months ended September 30, 2020 and $1.6 million and $3.9 million for the three and nine months ended September 30, ~~2019 and $1.5 million and $5.3 million for the three and nine months ended September 30, 2018.~~2019.

14
Table of Contents

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

(in thousands)



2019 (remainder of the year)

$
1,229

2020

4,836

2020 (remainder of the year)

$
1,406
2021

2,252

3,735
2022

2,185

3,668
2023

2,036

3,424
2024

1,941
Thereafter

1,330

815
Total

$
13,868

$
14,989

Note I — Other Current Assets and Other Assets

Other current assets consist of the following:

As of September 30,

As of December 31,

(in thousands)

2019

2018

Non-trade receivables

$
6,624

$
7,848

Prepaid maintenance

3,471

3,330

Prepaid other

1,509

1,101

Prepaid rent

840

4,442

Prepaid purchase orders

839

998

Prepaid insurance

744

258

Prepaid education and training

379

597

Other

209

157

Total other current assets

$
14,615

$
18,731

As of September 30,

As of December 31,
(in thousands)

2020

2019
Non-trade receivables

$
7,540

$
6,711
Prepaid maintenance

3,277

2,767
Prepaid insurance

909

264
Other prepaid assets

2,763

3,931
Total other current assets

$
14,489

$
13,673

Other assets consist of the following:

As of September 30,

As of December 31,

As of September 30,

As of December 31,
(in thousands)

2019

2018


2020

2019
Implementation costs for cloud computing arrangements

$
4,694

$
1,964
Cash surrender value of company-owned life insurance

$
3,132

$
2,918

3,811

3,253
Finance lease right-of-use assets

2,795

1,488
Deposits

2,145

1,893
Non-trade receivables

2,116

1,904

1,791

2,398
Deposits

1,955

1,698

Finance lease right-of-use assets

613

—

Prepaid cloud implementation costs

314

—

Surety bond collateral

—

1,000

Other

407

246

474

309
Total other assets

$
8,537

$
7,766

$
15,710

$
11,305

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

Accrued expenses and other current liabilities consist of:

As of September 30,

As of December 31,

As of September 30,

As of December 31,
(in thousands)

2019

2018


2020

2019
Patient prepayments, deposits, and refunds payable

$
25,979

$
24,563

$
26,969

$
24,183
Accrued sales taxes and other taxes

8,646

6,810

10,240

8,543
Insurance and self-insurance accruals

8,234

8,886

7,786

8,033
Derivative liability

3,413

724

7,704

3,516
Liabilities incurred to seller in acquisitions

3,656

—
Accrued professional fees

503

3,751

1,547

2,533
Accrued interest payable

344

332

747

266
Other current liabilities

8,789

6,717

13,785

8,751
Total accrued expenses and other current liabilities

$
55,908

$
51,783

Total

$
72,434

$
55,825

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Other liabilities consist of:

As of September 30,

As of December 31,

(in thousands)

2019

2018

Supplemental executive retirement plan obligations

$
19,370

$
20,195

Derivative liability

12,627

3,134

Long-term insurance accruals

8,058

8,713

Unrecognized tax benefits, and related interest and penalties

5,457

5,458

Deferred tenant improvement allowances

—

8,570

Deferred rent

—

4,455

Other

2,339

1,045

Total other liabilities

$
47,851

$
51,570

As of September 30,

As of December 31,
(in thousands)

2020

2019
Supplemental executive retirement plan obligations

$
19,461

$
20,851
Derivative liability

16,075

9,821
Unrecognized tax benefits

7,910

5,296
Long-term insurance accruals

7,539

7,424
Deferred payroll taxes

7,118

—
Other

1,974

2,412
Total

$
60,077

$
45,804

Note K — Income Taxes

We recorded a benefit for income taxes of $1.9 million and $4.8 million for the three and nine months ended September 30, 2020. The effective tax rate was -39.0% and -27.3% for the three and nine months ended September 30, 2020. We recorded a provision for income taxes of $2.6 million and $3.3 million for the three and nine months ended September 30, 2019. The effective tax rate was 31.2% and 27.1% for the three and nine months ended September 30, 2019. We recorded a provision for income tax of $2.4 million and a benefit from income tax of $3.8 million for the three and nine months ended September 30, 2018. The effective rate was 35.8% and 42.0% for the three and nine months ended September 30, 2018.

The decrease in the effective tax rate for the three months ended September 30, ~~2019~~2020 compared with the three months ended September 30, ~~2018~~2019 is primarily attributable to ~~an increased estimated annual income and an increase in pre-tax book income for~~a tax benefit resulting from the ~~three months ended September 30, 2019.~~loss carryback provisions granted under the CARES Act. Our effective tax rate for the three months ended September 30, ~~2019~~2020 differed from the federal statutory tax rate of 21% primarily due to the net tax benefit of the loss carryback claim and non-deductible expenses. Our effective tax rate for the three months ended September 30, ~~2018~~2019 differed from the federal statutory tax rate of 21% primarily due to non-deductible expenses.

The decrease in the effective tax rate for the nine months ended September 30, ~~2019~~2020 compared with the nine months ended September 30, ~~2018~~2019 is primarily attributable to ~~an increased estimated annual income, an increase in pre-tax book income~~the recognition of research and development tax credits for the current and prior years and a tax benefit resulting from the loss carryback provisions granted under the CARES Act, partially offset by a shortfall from share-based compensation. Our effective tax rate for the nine months ended September 30, ~~2019,~~2020 differed from the federal statutory tax rate of 21% primarily due to research and development tax credits, the ~~windfall from stock-based compensation during~~net tax benefit of the ~~period.~~loss carryback claim, and non-deductible expenses. Our effective tax rate for the nine months ended September 30, 2019 ~~and September 30, 2018~~ differed from the federal statutory tax rate of 21% primarily due to non-deductible expenses.

During the ~~windfall~~second quarter of 2020, we completed a study of qualifying research and ~~shortfall from stock-based compensation expense~~development expenses resulting in the ~~respective periods,~~recognition of tax benefits of $2.2 million, net of tax reserves, related to the current year and $6.3 million, net of tax reserves, related to the prior years as of the third quarter of 2020. We recorded the tax benefit, before tax reserves, as a deferred tax asset.

The CARES Act, which was enacted on March 27, 2020, includes changes to certain tax laws related to the deductibility of interest expense and depreciation, as well as ~~non-deductible expenses.~~
~~Note L — Leases~~
~~The information pertaining~~the provision to ~~leases~~carryback net operating losses to five preceding years. ASC 740, Income Taxes, requires the effects of changes in tax rates and laws on ~~the condensed consolidated balance sheet is as follows:~~
(in thousands)

Classification

As of September 30, 2019

Assets

Operating lease right-of-use assets

Operating lease right-of-use assets

$
109,838

Finance lease right-of-use assets

Other assets

613

Total lease assets

$
110,451

Liabilities

Current

Operating

Current portion of operating lease liabilities

$
32,437

Finance

Current portion of long-term debt

261

Noncurrent

Operating

Operating lease liabilities

88,719

Finance

Long-term debt, less current portion

365

Total lease liabilities

$
121,782

~~The components of lease cost~~deferred tax balances to be recognized in the ~~condensed consolidated statement~~period in which the legislation is enacted. As a result of ~~operations are~~the CARES Act provisions, in the third quarter of 2020 we recognized a tax benefit of $4.0 million resulting from the loss carryback claim to a prior period with a higher statutory rate, which also decreased our current income taxes payable by $9.5 million as ~~follows:~~of September 30, 2020.

16
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(in thousands)

For the Three Months Ended
September 30, 2019

For the Nine Months Ended
September 30, 2019

Operating lease cost

$
11,238

$
32,868

Finance lease cost

Amortization of right-of-use assets

75

225

Interest on lease liabilities

6

18

Sublease income

(117
)
(196
)
Short-term lease cost

46

460

Variable lease cost

1,551

4,581

Total lease cost

$
12,799

$
37,956

~~Future minimum rental payments, by year and in the aggregate, under operating and financing obligations with terms of one year or more at September 30, 2019 are as follows:~~
(in thousands)

Finance
Leases

Operating
Leases

Total Leases

2019 (remainder of year)

$
77

$
5,900

$
5,977

2020

263

41,500

41,763

2021

191

32,093

32,284

2022

106

24,128

24,234

2023

26

16,181

16,207

2024

—

8,963

8,963

Thereafter

—

7,271

7,271

Total future minimum lease payments

663

136,036

136,699

Imputed interest

(37
)
(14,880
)
(14,917
)
Total

$
626

$
121,156

$
121,782

~~The lease term and discount rates are as follows:~~
~~September 30, 2019~~
~~Weighted average remaining lease term (years)~~
~~Operating leases~~
~~4.01~~
~~Finance leases~~
~~2.70~~
~~Weighted average discount rate~~
~~Operating leases~~
~~5.45~~
%
~~Finance leases~~
~~4.22~~
%
~~Supplemental cash flow information related to leases is as follows:~~
(in thousands)

For the Nine Months Ended
September 30, 2019

Cash flows for amounts included in the measurement of lease liabilities:

Operating cash flows from operating leases

$
33,523

Operating cash flows from finance leases

18

Financing cash flows from finance leases

233

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

Operating leases

34,355

Finance leases

282

~~Future minimum rental payments, by year and in the aggregate, under operating and financing obligations as of December 31, 2018 are as follows:~~
(in thousands)

Operating
Leases

Capital
Leases

2019

$
39,378

$
249

2020

29,641

175

2021

21,303

109

2022

14,479

28

2023

9,193

—

Thereafter

10,008

—

$
124,002

$
561

In August 2019, we entered into a lease agreement for a distribution facility in Georgia. The commencement date of the lease is expected to be in April 2020. The initial term of the lease is 127 months, with the option to extend the lease for up to two consecutive 60-month terms. The lease provides for annual base rent of approximately $1.0 million in the first year after a seven-month rent-free period following the lease commencement date, with subsequent annual increases of approximately 2%. In connection with the lease, the landlord has provided a tenant improvement allowance of $2.2 million to build-out certain improvements to the distribution facility.
Note ML — Debt and Other Obligations

Debt consists of the following:

As of September 30,

As of December 31,

(in thousands)

2019

2018


As of September 30, 2020

As of December 31, 2019
Debt:

Term Loan B

$
497,425

$
501,213

$
492,375

$
496,163
Seller notes

7,138

4,506

29,208

9,005
Financing leases and other

1,192

14,361

Deferred payment obligation

4,000

—
Finance lease liabilities and other

3,606

2,033
Total debt before unamortized discount and debt issuance costs

505,755

520,080

529,189

507,201
Unamortized discount and debt issuance costs, net

(8,516
)
(9,407
)

(7,798)

(8,328)
Total debt

$
497,239

$
510,673

$
521,391

$
498,873

Current portion of long-term debt:

Term Loan B

$
5,050

$
5,050

$
5,050

$
5,050
Seller notes

3,152

2,513

21,893

3,175
Financing leases and other

417

1,020

Finance lease liabilities and other

848

527
Total current portion of long-term debt

8,619

8,583

27,791

8,752
Long-term debt:

$
488,620

$
502,090

Long-term debt

$
493,600

$
490,121

Refinancing of Credit Agreement and Term B Borrowings

On March 6, 2018, we entered into a $605.0 million Senior Credit Facility (the “Credit Agreement”). The Credit Agreement provides for (i) a revolving credit facility with an initial maximum aggregate amount of availability of $100.0 million that matures in March 2023 and (ii) a $505.0 million Term Loan B facility due in quarterly principal installments commencing June 29, 2018, with all remaining outstanding principal due at maturity in March 2025. Availability under the revolving credit facility is reduced by outstanding letters of credit, which were approximately $5.2 million as of September 30, ~~2019.~~2020. We may (a) increase the aggregate principal amount of any outstanding tranche of term loans or add one or more additional tranches of term loans under the loan documents, and/or (b) increase the aggregate principal amount of revolving commitments or add one or more additional revolving loan facilities under the loan documents by an aggregate amount of up to the sum of (1) $125.0 million and (2) an amount such that, after giving effect to such incurrence of such amount (but excluding the cash proceeds of such incremental facilities and certain other indebtedness, and treating all commitments in respect of revolving indebtedness as fully drawn), the consolidated first lien net leverage ratio is equal to or less than 3.80 to 1.00, if certain conditions are satisfied, including the absence of a default or an event of default under the Credit Agreement at the time of the increase and that we obtain the consent of each lender providing any incremental facility.

In March 2020, we borrowed $79.0 million under our revolving credit facility, which was due in March 2023. In June 2020, we repaid $57.0 million in borrowings under this revolving credit facility, and in September 2020, we repaid the remaining $22.0 million in borrowings under the facility. We had approximately $94.8 million in available borrowing capacity under our $100.0 million revolving credit facility as of September 30, 2020.

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

Borrowings under the Credit Agreement bear interest at a variable rate equal to (i) LIBOR plus a specified margin, or (ii) the base rate (which is the highest of (a) Bank of America, N.A.’s prime rate, (b) the federal funds rate plus 0.50% or (c) the sum of 1% plus one-month LIBOR) plus a specified margin. For the three months ended September 30, ~~2019,~~2020, the weighted average interest rate on outstanding borrowings under our Term Loan B facility was approximately ~~5.7%~~3.6%. We have entered into interest rate swap agreements to hedge certain of our interest rate exposures, as more fully disclosed in Note ~~O - “~~~~Derivative~~N – “Derivative Financial ~~Instruments~~.Instruments.”

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

The Credit Agreement contains various restrictions and covenants, including: i) requirements that we maintain certain financial ratios at prescribed levels, ii) a prohibition on payment of dividends and other distributions and iii) restrictions on our ability and certain of our subsidiaries to consolidate or merge, create liens, incur additional indebtedness, dispose of assets, or consummate acquisitions outside the healthcare industry. The Credit Agreement includes the following financial covenants applicable for so long as any revolving loans and/or revolving commitments remain outstanding under the Credit ~~Agreement:~~Agreement (some of which were amended in May 2020 by the Amendment (as defined and described below)): (i) a maximum consolidated first lien net leverage ratio (“Net Leverage Ratio") (defined as, with certain adjustments and exclusions, the ratio of consolidated first-lien indebtedness to consolidated net income before interest, taxes, depreciation, amortization, non-cash charges and certain other items (“EBITDA”) for the most recently ended period of four fiscal quarters for which financial statements are available) of ~~5.00 to 1.00 for the fiscal quarters ended December 31, 2018 and March 31, 2019; 4.75 to 1.00 for the fiscal quarters ended June 30, 2019 through March 31, 2020;~~ 4.50 to 1.00 for the fiscal quarters ended June 30, 2020 through March 31, 2021; 4.25 to 1.00 for the fiscal quarters ended June 30, 2021 through March 31, 2022; and 3.75 to 1.00 for the fiscal quarter ended June 30, 2022 and the last day of each fiscal quarter thereafter; and (ii) a minimum interest coverage ratio (defined as, with certain adjustments, the ratio of our EBITDA to consolidated interest expense to the extent paid or payable in cash) of 2.75 to 1.00 as of the last day of any fiscal quarter. ~~We were in compliance with all covenants at September 30, 2019.~~

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

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

We were in compliance with all covenants at September 30, 2020.

Seller ~~Notes~~notes and the deferred payment obligation

We typically issue subordinated promissory notes (“Seller ~~Notes”~~notes”) as a part of the consideration transferred when making acquisitions. ~~The Seller Notes are unsecured and are presented net of unamortized discount of $0.3 million and $0.2 million as of September 30, 2019 and December 31, 2018, respectively.~~ We measure these instruments at their estimated fair values as of the respective acquisition dates. The stated interest rates on these instruments range from ~~2.00%~~2.50% to 3.00%. The Seller notes are unsecured and are presented net of unamortized discount of $0.9 million and $0.4 million as of September 30, 2020 and December 31, 2019, respectively. Principal and interest are payable in quarterly or annual installments and mature through ~~July~~October 2024.
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Amounts due under the deferred payment obligation to the former shareholders of an acquired O&P business are unsecured and presented net of unamortized discount of $0.5 million as of September 30, 2020. The deferred payment obligation was measured at its estimated fair value as of the acquisition date and accrues interest at a rate of 3.0%. Principal and interest payments under the deferred payment obligation are due in annual installments beginning in 2024 and for three years thereafter.

Scheduled Maturities of Total Debt

Scheduled maturities of debt at September 30, ~~2019~~2020 were as follows:

(in thousands)



2019 (remainder of year)

$
2,318

2020

8,428

2020 (remainder of year)

$
21,023
2021

7,372

9,759
2022

6,032

8,494
2023

5,489

8,049
2024

7,337
Thereafter

476,116

474,527
Total debt before unamortized discount and debt issuance costs, net

505,755

529,189
Unamortized discount and debt issuance costs, net

(8,516
)

(7,798)
Total debt

$
497,239

$
521,391

Note NM — Fair Value Measurements

Financial Instruments

~~In March 2018, we refinanced our credit facilities with the Credit Agreement.~~ The carrying value ~~(excluding unamortized discounts and debt issuance costs of $8.5 million)~~ of our outstanding term loan as of September 30, ~~2019 approximates the~~2020 (excluding unamortized discounts and debt issuance costs of $6.9 million) was $492.4 million compared to its fair value ~~at $497.4~~of $487.5 million. The carrying value of our outstanding term loan as of December 31, ~~2018~~2019 (excluding unamortized discounts and debt issuance costs of ~~$9.4~~$7.9 million) was ~~$501.2~~$496.2 million compared to its fair value of ~~$491.2~~$497.4 million. Our estimates of fair value are based on a discounted cash flow model and an indicative quote using unobservable inputs, primarily, our risk-adjusted credit spread, which represents a Level 3 measurement.

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

We believe that the carrying value of the Seller notes and the deferred payment obligation approximates their fair values based on a discounted cash flow model using unobservable inputs, primarily, our credit spread for subordinated debt, which represents a Level 3 measurement. The carrying value of our outstanding Seller notes and the deferred payment obligation issued in connection with past acquisitions as of September 30, ~~2019 and December 31, 2018, we had no amounts outstanding on our revolving credit facility.~~2020 was $32.3 million, net of unamortized discounts of $0.9 million.

Note N — Derivative Financial Instruments

Cash Flow Hedges of Interest Rate Risk

In March 2018, we entered into interest rate swap agreements with notional values of $325.0 million at inception, which reduces $12.5 million annually until the swaps mature on March 6, 2024. ~~The notional value outstanding as~~As of September 30, 2019 was $312.5 million. The interest rate swap agreements are designated as cash flow hedges and are measured at fair value based on inputs other than quoted market prices that are observable, which represents a Level 2 measurement. See Note M - “~~Debt~~~~” and Note O - “~~~~Derivative Financial Instruments~~~~” for further information.~~
~~The carrying value of our Seller Notes as of September 30, 2019~~2020 and December 31, 2018 was $7.1 million and $4.5 million, respectively. We believe that the carrying value of the Seller Notes approximates their fair values based on a discounted cash flow model using unobservable inputs, primarily, our credit spread for subordinated debt, which represents a Level 3 measurement.
~~Note O — Derivative Financial Instruments~~
We are exposed to certain risks arising from both our business operations and economic conditions. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash payments principally related to our borrowings.
~~Cash Flow Hedges of Interest Rate Risk~~
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish these objectives, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The change in the fair value of derivatives designated and that qualify as cash flow hedges is recorded on our consolidated balance sheet in accumulated other comprehensive loss and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.
~~As of September 30,~~ 2019, our swaps had a notional value outstanding of $300.0 million and $312.5 ~~million. As~~million, respectively.

19
Table of ~~December 31, 2018, our swaps had a notional value outstanding of $325.0 million.~~Contents

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

The following table presents the activity of cash flow hedges included in accumulated other comprehensive loss for the three months ended September 30, 2020 and 2019, ~~and September 30, 2018:~~respectively:

(in thousands)

Cash Flow Hedges

Balance as of June 30, 2019

$
(10,560
)
Unrealized loss recognized in other comprehensive (loss) income, net of tax

(2,060
)
Reclassification to interest expense, net

419

Balance as of September 30, 2019

$
(12,201
)

Balance as of June 30, 2018

$
24

Unrealized gain recognized in other comprehensive (loss) income, net of tax

1,171

Reclassification to interest expense, net

567

Balance as of September 30, 2018

$
1,762

(in thousands)
Cash Flow Hedges
Balance as of June 30, 2020

$
(19,612)
Unrealized loss recognized in other comprehensive loss, net of tax

(455)
Reclassification to interest expense, net

1,997
Balance as of September 30, 2020

$
(18,070)

Balance as of June 30, 2019

$
(10,560)
Unrealized loss recognized in other comprehensive loss, net of tax

(2,060)
Reclassification to interest expense, net

419
Balance as of September 30, 2019

$
(12,201)

The following table presents the activity of cash flow hedges included in accumulated other comprehensive loss for the nine months ended September 30, 2020 and 2019, ~~and September 30, 2018:~~respectively:

(in thousands)

Cash Flow Hedges

Balance as of December 31, 2018

$
(2,936
)
Unrealized loss recognized in other comprehensive (loss) income, net of tax

(10,135
)
Reclassification to interest expense, net

870

Balance as of September 30, 2019

$
(12,201
)

Balance as of December 31, 2017

$
—

Unrealized gain recognized in other comprehensive (loss) income, net of tax

251

Reclassification to interest expense, net

1,511

Balance as of September 30, 2018

$
1,762

(in thousands)
Cash Flow Hedges
Balance as of December 31, 2019

$
(10,137)
Unrealized loss recognized in other comprehensive loss, net of tax

(12,518)
Reclassification to interest expense, net

4,585
Balance as of September 30, 2020

$
(18,070)

Balance as of December 31, 2018

$
(2,936)
Unrealized loss recognized in other comprehensive loss, net of tax

(10,135)
Reclassification to interest expense, net

870
Balance as of September 30, 2019

$
(12,201)

The following table presents the fair value of derivative assets and liabilities within the condensed consolidated balance sheets as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:

As of September 30, 2019

As of December 31, 2018

As of September 30, 2020

As of December 31, 2019
(in thousands)

Assets

Liabilities

Assets

Liabilities


Assets

Liabilities

Assets

Liabilities
Derivatives designated as cash flow hedging instruments:








Accrued expenses and other current liabilities

$
—

$
3,413

$
—

$
724

$
—

$
7,704

$
—

$
3,516
Other liabilities

—

12,627

—

3,134

—

16,075

—

9,821

Note PO — ~~Stock~~-~~Based~~Share-Based Compensation

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

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

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As of September 30, ~~2019,~~2020, there were ~~1,904,747~~1,564,081 unvested restricted stock awards outstanding. This was comprised of ~~1,201,476~~1,126,361 employee service-based awards with a weighted average grant date fair value of ~~$15.77~~$19.23 per share, ~~647,519~~367,097 employee performance-based awards with a weighted average grant date fair value of ~~$17.90~~$18.94 per share, and ~~55,752~~70,623 director service-based awards with a weighted average grant date value of ~~$20.10~~$17.08 per share. As of September 30, ~~2019,~~2020, there were ~~662,322~~520,105 outstanding options ~~not-yet~~ exercisable with a weighted average exercise price of $12.77 and average remaining contractual term of ~~7.6~~6.6 years.

The 2017 Special Equity Plan was amended in May 2020 to modify the performance period ending date for purposes of the compounded annual growth rate calculation to February 20, 2020, shortening the performance period to approximately 33 months, representing a reduction of three months. This adjustment was considered a modification per Accounting Standards Codification 718, Compensation - Stock Compensation, and, therefore, any incremental fair value arising from the modification of an award with market conditions would be recognized over the remaining service period. As a result of the modification, we recognized an additional $5.9 million in share-based compensation expense during the second quarter of 2020.

We recognized a total of approximately ~~$3.4~~$3.1 million and ~~$10.1~~$15.6 million of ~~stock-based~~share-based compensation expense for the three and nine months ended September 30, ~~2019, respectively,~~2020 and a total of approximately ~~$3.7~~$3.4 million and ~~$9.6~~$10.1 million for the three and nine months ended September 30, ~~2018,~~2019, respectively. ~~Stock~~Share-based compensation expense, net of forfeitures, relates to restricted stock units, performance-based restricted stock units, and stock options.

Note QP — Supplemental Executive Retirement Plans

Defined Benefit Supplemental Executive Retirement Plan

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

We believe the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. The change in net benefit cost and obligation during the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 is as follows:

Change in Benefit Obligation:

(in thousands)

2020

2019
Benefit obligation as of June 30

$
17,763

$
17,535
Service cost

98

84
Interest cost

121

164
Payments

(12)

(12)
Benefit obligation as of September 30

$
17,970

$
17,771

Benefit obligation as of December 31, 2019 and 2018, respectively

$
19,214

$
18,927
Service cost

294

251
Interest cost

363

494
Payments

(1,901)

(1,901)
Benefit obligation as of September 30

$
17,970

$
17,771

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(in thousands)

2019

2018

Benefit obligation as of June 30

$
17,535

$
19,388

Service cost

84

92

Interest cost

164

150

Payments

(12
)
(13
)
Benefit obligation as of September 30

$
17,771

$
19,617

Benefit obligation as of December 31, 2018 and 2017, respectively

$
18,927

$
20,793

Service cost

251

275

Interest cost

494

450

Payments

(1,901
)
(1,901
)
Benefit obligation as of September 30

$
17,771

$
19,617

Amounts Recognized in the Condensed Consolidated Balance Sheets:

As of September 30,

As of December 31,

As of September 30,

As of December 31,
(in thousands)

2019

2018


2020

2019
Accrued expenses and other current liabilities

$
1,913

$
1,913

Other liabilities

15,858

17,014

Current accrued expenses and other current liabilities

$
1,913

$
1,913
Non-current other liabilities

16,057

17,301
Total accrued liabilities

$
17,771

$
18,927

$
17,970

$
19,214

Defined Contribution Supplemental Executive Retirement Plan

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

As of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, the estimated accumulated obligation benefit is ~~$3.5~~$4.2 million and ~~$3.0~~$3.9 million, ~~respectively,~~ of which ~~$3.0~~$3.8 million and ~~$2.4~~$3.3 million is funded and ~~$0.5~~$0.4 million and $0.6 million is unfunded at September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively.

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

Note RQ — Commitments and Contingencies

Guarantees and Indemnification

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

Legal Proceedings

~~Securities and~~ Derivative Litigation
~~In November 2014, a securities class action complaint,~~ ~~City of Pontiac General Employees’ Retirement System v. Hanger, et al.~~, C.A. No. 1:14-cv-01026-SS, was filed against us in the United States District Court for the Western District of Texas. The complaint named us and certain of our current and former officers for allegedly making materially false and misleading statements regarding, inter alia, our financial statements, RAC audit success rate, the implementation of new financial systems, same-store sales growth, and the adequacy of our internal processes and controls. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder. The complaint sought unspecified damages, costs, attorneys’ fees, and equitable relief.
On January 26, 2017, the court granted the defendants’ motions to dismiss for failure to state a claim upon which relief can be granted and dismissed with prejudice all claims against all defendants. On February 24, 2017, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Fifth Circuit. On August 6, 2018, the Court of Appeals affirmed in part and reversed in part. On August 20, 2018, Hanger, Inc. and the remaining individual defendant filed a petition for panel rehearing and a petition for rehearing en banc with the Court of Appeals. On April 10, 2019, the Court of Appeals granted the petition for panel rehearing, withdrew its previous panel decision, and substituted a new panel decision in its place that affirmed the District Court’s dismissal with prejudice of all claims against all the defendants for failure to state a claim. Plaintiffs did not petition the Court of Appeals for a panel rehearing or a rehearing en banc, and did not file a writ of certiorari with the United States Supreme Court. Therefore, the April 10, 2019 Court of Appeals ruling affirming the dismissal of all claims with prejudice against all defendants is now final.

In February and August of 2015, ~~two~~2 separate shareholder derivative suits were filed in Texas state court against us related to the announced restatement of certain of our financial statements. The cases were subsequently consolidated into Judy v. Asar, et. al., Cause No. ~~D-1-GN-15-000625.~~D-1-GN-15-000625. On October 25, 2016, plaintiffs in that action filed an amended complaint, and the case is currently pending before the 345th Judicial District Court of Travis County, Texas.

The amended complaint in the consolidated derivative action names us and certain of our current and former officers and directors as defendants. It alleges claims for breach of fiduciary duty based, inter alia, on the defendants’ alleged failure to exercise good faith to ensure that we had in place adequate accounting and financial controls and that disclosures regarding our business, financial performance and internal controls were truthful and accurate. The complaint ~~seeks~~sought unspecified damages, costs, attorneys’ fees, and equitable relief.

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As disclosed in our Current Report on Form 8-K filed with the SEC on June 6, 2016, the Board of Directors appointed a Special Litigation Committee of the Board (the “Special Committee”). The Board delegated to the Special Committee the authority to (1) determine whether it is in our best interests to pursue any of the allegations made in the derivative cases filed in Texas state court (which cases were consolidated into the Judy case discussed above), (2) determine whether it is in our best interests to pursue any remedies against any of our current or former employees, officers, or directors as a result of the conduct discovered in the Audit Committee investigation concluded on June 6, 2016 (the “Investigation”), and (3) otherwise resolve claims or matters relating to the findings of the Investigation. The Special Committee retained independent legal counsel to assist and advise it in carrying out its duties and reviewed and considered the evidence and various factors relating to our best interests. In accordance with its findings and conclusions, the Special Committee determined that it is not in our best interest to pursue
any of the claims in the Judy derivative case. Also in accordance with its findings and conclusions, the Special Committee determined that it is not in our best interests to pursue legal remedies against any of our current or former employees, officers, or directors.

On April 14, 2017, we filed a motion to dismiss the consolidated derivative action based on the resolution by the Special Committee that it is not in our best interest to pursue the derivative claims. Counsel for the derivative plaintiffs opposed that motion and moved to compel discovery. In a hearing held on June 12, 2017, the Travis County ~~Court~~court denied plaintiffs’ motion to compel, and held that the motion to dismiss would be considered only after appropriate discovery was concluded.

The plaintiffs subsequently subpoenaed counsel for the Special Committee, seeking a copy of the full report prepared by the Special Committee and its independent counsel. Counsel for the Special Committee, as well as our counsel, took the position that the full report is not discoverable under Texas law. Plaintiffs’ counsel filed a motion to compel the Special Committee’s counsel to produce the ~~full~~ report. We opposed the motion. On July 20, 2018, the Travis County ~~Court~~court ruled that only a redacted version of the report is discoverable, and counsel for the Special Committee provided a redacted version of the report to plaintiffs’ counsel. Plaintiffs objected to the redacted version of the report, and on February 4, 2019, the Travis County ~~Court~~court appointed a Special Master to review plaintiffs’ objections to the redacted report. On March 22, 2019, the Special Master submitted a report to the Travis County ~~Court~~court recommending that the court order that the entire Special Committee report be produced. On April 2, 2019 we filed an objection to the Special Master’s report and recommendation, and requested a hearing on the matter. On June 25, 2019, the Travis County ~~Court~~court rejected the recommendation of the Special Master, and instead ordered that only a limited additional portion of the Special Committee report should be ~~made available to plaintiffs.~~unredacted. On July 10, 2019, the updated redacted Special Committee report was provided to plaintiffs through their counsel.

In late October 2019, a non-binding agreement in principle was reached by the parties to settle the consolidated derivative action, ~~subject to finalization and execution of~~the parties entered into a definitive settlement agreement byin late December 2019, and in January 2020 the ~~parties,~~Travis County court issued an order providing preliminary approval of the settlement and ~~subsequent~~ordering that notice of the settlement be made to the Company’s shareholders. On March 10, 2020, the Travis County court issued an order providing final approval of the settlement byand dismissing with prejudice the ~~Travis County Court. The amount of any payment to be made by Hanger pursuant to the non-binding agreement in principle is expected to be covered under our directors & officers insurance.~~
~~Management intends to continue to vigorously defend against the shareholder~~consolidated derivative action. At this time, if the derivative action were to go to trial, we cannot predict how the Travis County Court would rule on the merits of the claims and/or the scope of the potential loss in the event of an adverse outcome. Should we ultimately be found liable, the resulting damages could have a material adverse effect on our consolidated financial position, liquidity or our results of operations.

Other Matters

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

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

Note SR — Segment and Related Information

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

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Patient Care -— This segment consists of (i) our owned and operated patient care ~~clinics.~~clinics, and (ii) our contracting and network management business. The patient care clinics provide services to design and fit O&P devices to patients. These clinics also instruct patients in the use, care, and maintenance of the devices. The principal reimbursement sources for our services are:
·                  Commercial private payors and other, which consist of individuals, rehabilitation providers, commercial insurance companies, health management organizations (“HMOs”), preferred provider organizations (“PPOs”), hospitals, vocational rehabilitation, workers’ compensation programs, and similar sources;
● Commercial private payors and other, which consist of individuals, rehabilitation providers, commercial insurance companies, health management organizations (“HMOs”), preferred provider organizations (“PPOs”), hospitals, vocational rehabilitation, workers’ compensation programs, and similar sources;

● Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain persons with disabilities, which provides reimbursement for O&P products and services based on prices set forth in published fee schedules (generally with either 10 regional pricing areas or state level prices) for prosthetics and orthotics and by state for durable medical equipment (DMEPOS);
·                  Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain disabled persons, which provides reimbursement for O&P products and services based on prices set forth in published fee schedules with 10 regional pricing areas for prosthetics and orthotics and by state for durable medical equipment;
● Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons requiring financial assistance, regardless of age, which may supplement Medicare benefits for persons aged 65 or older requiring financial assistance; and

● the VA.
·                  Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons in financial need, regardless of age, which may supplement Medicare benefits for persons aged 65 or older in financial need; and
·                  ~~U.S. Department of Veterans Affairs.~~

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

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

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

The accounting policies of the segments are the same as those described in Note A - “~~Organization~~“Organization and Summary of Significant Accounting ~~Policies~~”Policies” in our ~~2018~~2019 Form 10-K.

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

24
Table of Contents
Summarized financial information concerning our reporting segments is shown in the following tables. Total assets for each of the segments has not materially changed from December 31, ~~2018.~~2019.

Patient Care

Products & Services

For the Three Months Ended
September 30,

For the Three Months Ended
September 30,

Patient Care

Products & Services

For the Three Months Ended

For the Three Months Ended

September 30,

September 30,
(in thousands)

2019

2018

2019

2018


2020

2019

2020

2019
Net revenues

Third party

$
230,931

$
214,080

$
48,707

$
48,866

$
212,664

$
230,931

$
43,973

$
48,707
Intersegments

—

—

53,670

48,945

—

—

50,011

53,670
Total net revenues

230,931

214,080

102,377

97,811

212,664

230,931

93,984

102,377
Material costs

Third party suppliers

65,055

58,395

26,979

26,410

56,599

65,055

24,863

26,979
Intersegments

6,284

6,300

47,386

42,645

7,339

6,284

42,672

47,386
Total material costs

71,339

64,695

74,365

69,055

63,938

71,339

67,535

74,365
Personnel expenses

81,274

77,806

13,320

13,047

76,989

81,274

12,738

13,320
Other expenses

37,245

34,426

6,858

6,306

34,713

37,245

5,957

6,858
Depreciation & amortization

4,943

4,651

2,723

2,564

4,786

4,943

2,633

2,723
Segment income from operations

$
36,130

$
32,502

$
5,111

$
6,839

$
32,238

$
36,130

$
5,121

$
5,111

Patient Care

Products & Services

For the Nine Months Ended
September 30,

For the Nine Months Ended
September 30,

(in thousands)

2019

2018

2019

2018

Net revenues

Third party

$
652,700

$
620,745

$
144,455

$
143,162

Intersegments

—

—

150,245

141,302

Total net revenues

652,700

620,745

294,700

284,464

Material costs

Third party suppliers

181,358

170,559

80,452

77,118

Intersegments

18,268

17,944

131,977

123,358

Total material costs

199,626

188,503

212,429

200,476

Personnel expenses

233,402

228,211

39,393

38,304

Other expenses

112,014

104,869

20,883

17,944

Depreciation & amortization

13,997

14,547

7,862

7,569

Segment income from operations

$
93,661

$
84,615

$
14,133

$
20,171

Patient Care

Products & Services

For the Nine Months Ended

For the Nine Months Ended

September 30,

September 30,
(in thousands)

2020

2019

2020

2019
Net revenues

Third party

$
598,706

$
652,700

$
125,104

$
144,455
Intersegments

—

—

138,899

150,245
Total net revenues

598,706

652,700

264,003

294,700
Material costs

Third party suppliers

160,212

181,358

68,463

80,452
Intersegments

18,639

18,268

120,260

131,977
Total material costs

178,851

199,626

188,723

212,429
Personnel expenses

216,910

233,402

35,824

39,393
Other expenses

86,462

112,014

18,614

20,883
Depreciation & amortization

14,089

13,997

7,883

7,862
Segment income from operations

$
102,394

$
93,661

$
12,959

$
14,133

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

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,
(in thousands)

2020

2019

2020

2019
Income from operations

Patient Care

$
32,238

$
36,130

$
102,394

$
93,661
Products & Services

5,121

5,111

12,959

14,133
Corporate & other

(24,284)

(23,838)

(72,590)

(69,267)
Income from operations

13,075

17,403

42,763

38,527
Interest expense, net

8,013

8,954

24,918

25,973
Non-service defined benefit plan expense

158

173

474

519
Income before income taxes

4,904

8,276

17,371

12,035
(Benefit) provision for income taxes

(1,911)

2,585

(4,750)

3,260
Net income

$
6,815

$
5,691

$
22,121

$
8,775

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

(in thousands)

2019

2018

2019

2018

Income from operations

Patient Care

$
36,130

$
32,502

$
93,661

$
84,615

Products & Services

5,111

6,839

14,133

20,171

Corporate & other

(23,838
)
(23,417
)
(69,267
)
(67,910
)
Income from operations

17,403

15,924

38,527

36,876

Interest expense, net

8,954

8,939

25,973

28,519

Loss on extinguishment of debt

—

—

—

16,998

Non-service defined benefit plan expense

173

176

519

528

Income (loss) before income taxes

8,276

6,809

12,035

(9,169
)
Provision (benefit) for income taxes

2,585

2,440

3,260

(3,848
)
Net income (loss)

$
5,691

$
4,369

$
8,775

$
(5,321
)
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A reconciliation of the reportable segment net revenues to consolidated net revenues is as follows:

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,
(in thousands)

2019

2018

2019

2018


2020

2019

2020

2019
Net revenues

Patient Care

$
230,931

$
214,080

$
652,700

$
620,745

$
212,664

$
230,931

$
598,706

$
652,700
Products & Services

102,377

97,811

294,700

284,464

93,984

102,377

264,003

294,700
Corporate & other

—

—

—

—

—

—

—

—
Consolidating adjustments

(53,670
)
(48,945
)
(150,245
)
(141,302
)

(50,011)

(53,670)

(138,899)

(150,245)
Consolidated net revenues

$
279,638

$
262,946

$
797,155

$
763,907

$
256,637

$
279,638

$
723,810

$
797,155

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

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,
(in thousands)

2019

2018

2019

2018


2020

2019

2020

2019
Material costs

Patient Care

$
71,339

$
64,695

$
199,626

$
188,503

$
63,938

$
71,339

$
178,851

$
199,626
Products & Services

74,365

69,055

212,429

200,476

67,535

74,365

188,723

212,429
Corporate & other

—

—

—

—

—

—

—

—
Consolidating adjustments

(53,670
)
(48,945
)
(150,245
)
(141,302
)

(50,011)

(53,670)

(138,899)

(150,245)
Consolidated material costs

$
92,034

$
84,805

$
261,810

$
247,677

$
81,462

$
92,034

$
228,675

$
261,810

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Table of Contents
~~Note T — Supplemental Cash Flow Information~~
~~Changes in operating assets and liabilities on cash flows from operating activities is as follows:~~

For the Nine Months Ended
September 30,

(in thousands)

2019

2018

Accounts receivable, net

$
1,914

$
14,464

Inventories

(6,310
)
(3,463
)
Other current assets and other assets

(1,769
)
1,770

Income taxes

2,613

11,356

Accounts payable

(1,751
)
5,680

Accrued expenses and other current liabilities

(2,144
)
(13,061
)
Accrued compensation related costs

(15,583
)
(20,650
)
Other liabilities

(1,736
)
(2,963
)
Operating lease liabilities

(28,279
)
—

Changes in operating assets and liabilities on cash flows from operating activities

$
(53,045
)
$
(6,867
)
~~The supplemental disclosure requirements for the statements of cash flows are as follows:~~

For the Nine Months Ended
September 30,

(in thousands)

2019

2018

Issuance of seller notes in connection with acquisitions

$
5,053

$
—

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

3,492

2,419

Purchase of property, plant and equipment through vendor financing

2,200

—

Additions to property, plant and equipment acquired through financing obligations

—

1,509

Retirements of financed property, plant and equipment and related obligations

—

3,558

~~Note U — Subsequent Events~~
In October 2019, we completed the acquisition of one O&P business for a total purchase price of $8.1 million, of which $5.1 million was cash consideration and $3.0 million was issued in the form of an unsecured note to the seller. The note is payable in annual installments over a period of five years. Due to the proximity of the completion of the acquisitions to the filing of this Form 10-Q, it is not practicable to provide a preliminary purchase price allocation of the fair value of the assets purchased and liabilities assumed in the transactions.
ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

~~Forward Looking~~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”~~“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 ~~judgments~~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,~~report. These uncertainties include, but are not limited to, the financial and ~~any claims, investigations,~~business impacts of the COVID-19 pandemic on our operations and the operations of our customers, suppliers, governmental and private payers, and others in the healthcare industry and beyond; federal laws governing the health care industry; governmental policies affecting O&P operations, including with respect to reimbursement; failure to successfully implement a new enterprise resource planning system or ~~proceedings arising as a result, as well as~~other disruptions to information technology systems; the inability to successfully execute our ~~ability to remediate the material weaknesses in~~acquisition strategy, including integration of recently acquired O&P clinics into our ~~internal control over financial reporting described in Item 4. “Controls and Procedures” contained elsewhere in this report,~~existing business; changes in the demand for our O&P products and services, ~~uncertainties relating~~including additional competition in the O&P services market; disruptions to ~~the results of operations or~~ our ~~acquired O&P patient care clinics,~~supply chain; our ability to enter into and derive benefits from managed-care ~~contracts,~~contracts; our ability to successfully attract and retain qualified O&P ~~clinicians, federal laws governing the health care industry, uncertainties inherent in investigations and legal proceedings, governmental policies affecting O&P operations,~~clinicians; and other risks and uncertainties generally affecting the health care industry.

Readers are cautioned that all forward-looking statements involve known and unknown risks and uncertainties including, without limitation, those described in Item 1A., “Risk Factors”, contained in our Annual Report on Form 10-K for the year ended December 31, ~~2018~~2019 (the ~~“2018~~“2019 Form 10-K”), and in 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 ~~our~~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 ~~2018~~2019 Form 10-K and in this Quarterly Report on Form 10-Q, or by other unknown risks and uncertainties.

~~Effect of Delay in Financial Filings~~Non-GAAP Measures
As discussed in our 2018 Form 10-K, due to prior restatements and related issues, we were delayed in the preparation and filing of our financial statements in recent years. In connection with our efforts to restate our prior financial statements, remediate our material weaknesses, regain our timely filing status, and undertake related activities, we have incurred third party professional fees in excess of the amounts we estimate that we would have otherwise incurred. The estimated professional fees associated with these efforts are as follows (in thousands):

Balance to be Paid

For the Three Months Ended

Expensed

Paid

in Future Periods

March 31, 2018

3,700

(7,755
)
6,230

June 30, 2018

2,940

(5,938
)
3,232

September 30, 2018

2,230

(2,297
)
3,165

December 31, 2018

3,591

(3,561
)
3,195

March 31, 2019

1,649

(2,621
)
2,223

June 30, 2019

1,745

(2,016
)
1,952

September 30, 2019

2,136

(2,168
)
1,920

We currently estimate that during 2019, we will expend a total of approximately $8.0 million in excess professional fees. We expect to continue to incur professional fees as we focus on the remediation of our continuing material weaknesses in internal controls over financial reporting. Due to the ongoing material weaknesses in our controls over financial reporting, we currently undertake additional substantive procedures to test and verify financial statement amounts in connection with the preparation of our financial statements.
~~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 ~~measures~~measure used in this Management’s Discussion and Analysis ~~are~~is as follows:

~~Adjusted Gross Revenue and Disallowed Revenue~~ - “Adjusted gross revenue” reflects our gross billings after their adjustment to reflect estimated discounts established in our contracts with payors of health care claims. Pursuant to our contracts with payors, a portion of our adjusted gross billings may be disallowed based on factors including physician documentation, patient eligibility, plan design, prior authorization, timeliness of filings or appeal, coding selection, failure by certain patients to pay their portion of claims, computational errors associated with sequestration, and other factors. We refer to these and other amounts as being “disallowed revenue” or “payor disallowances.” Our net revenue reflects adjusted gross revenue after reduction for the estimated aggregate amount of disallowed revenue for the applicable period. To facilitate analysis of the comparability of our results, we provide these non-GAAP measures due to the significant changes that we have experienced in recent years in disallowed revenue which are further discussed below.
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~~

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. Built on the legacy of James Edward Hanger, the first amputee of the American Civil War,~~injuries, and we and our predecessor companies have provided O&P services for ~~over 150~~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 ~~695~~704 patient care clinics and ~~106~~110 satellite locations in 46 states and the District of Columbia as of September 30, ~~2019.~~2020. 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 our therapeutic solutions businesses. As a leading provider of O&P products in the United States, we ~~coordinate, through our distribution services business,~~engage in the ~~procurement and~~ distribution of a broad catalog of O&P parts, componentry, and devices to independent O&P providers nationwide. ~~To facilitate speed and convenience, we deliver these products through our five distribution facilities that are located in Nevada, Georgia, Illinois, Pennsylvania, and Texas.~~ The other business in our Products & Services segment is our therapeutic solutions business, which develops specialized rehabilitation technologies and provides evidence-based clinical programs for post-acute rehabilitation to patients at approximately ~~4,100~~4,000 skilled nursing and post-acute providers nationwide.

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. For the three and nine months ended September 30, 2019, our net revenues were $279.6 million and $797.2 million, respectively, and we recorded net income of $5.7 million and $8.8 million, respectively. For the three and nine months ended September 30, 2018, our net revenues were $262.9 million and $763.9 million, respectively, and we recorded net income of $4.4 million and a net loss of $5.3 million, respectively.

Industry Overview

We estimate that approximately ~~$4.2~~$4.3 billion is spent in the United States each year for prescription-based O&P products and ~~services.~~services through O&P clinics. We ~~estimate that~~believe our Patient Care segment currently accounts for approximately ~~20%~~21% of the market, ~~share,~~ providing a comprehensive portfolio of orthotic, prosthetic, and post-operative solutions to patients in acute, post-acute, and patient care clinic settings.

The ~~traditional~~ O&P patient care ~~industry~~services market is highly fragmented and is characterized by regional and local independent O&P ~~businesses.~~businesses operated predominantly by independent operators, but also including two O&P product manufacturers with international patient care services operations. We do not believe that any single competitor accounts for more than approximately 2% of the ~~country’s~~nation’s total estimated O&P ~~patient care~~ 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 $1.7 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 and tosupplies our own patient care clinics. We estimate that our distribution sales account for approximately 8% of the market for O&P products, components, devices, and supplies (excluding sales to our Patient Care segment).

We estimate the market for rehabilitation technologies, integrated clinical programs, and clinician training in skilled nursing facilities (“SNFs”) to be approximately $150 million annually. We currently provide these products and services to
approximately 25% of the estimated 15,000 SNFs located in the U.S. We estimate the market for rehabilitation technologies, clinical programs, and training within the broader post-acute rehabilitation markets to be approximately $400 million annually. We do not currently provide a meaningful amount of products and services to this broader market.

~~Business Description~~28
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Business Description

Patient Care

Our Patient Care segment employs approximately ~~1,500~~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 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. Frequently, our proprietary Insignia scanning system is used in the fabrication process. The Insignia system scans the patient and produces an accurate computer-generated image, resulting in a faster turnaround for the patient’s device and a more professional overall experience.

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

The principal reimbursement sources for our services are:

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

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

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

● the VA.

29
Table of individuals, rehabilitation providers, commercial insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation centers, workers’ compensation programs, third party administrators, and similar sources;
Contents
·                  ~~Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain disabled persons;~~

·                  Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons based upon financial need, regardless of age, which may supplement Medicare benefits for persons aged 65 or older in financial need; and
·                  ~~the U.S. Department of Veterans Affairs.~~
We typically enter into contracts with third party payors that allow us to perform O&P services for a referred patient and to be ~~paid under the contract with the third party payor.~~reimbursed for our services. These contracts usually have a stated term of one to three ~~years. These contracts~~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 ~~U.S. Department of Veterans Affairs.~~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 ~~(the~~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, Zone Program Integrity Contractor (“ZPIC”) audits, ~~and~~ Supplemental Medical Review Contractor (“SMRC”) audits, and Universal Payment Identification Code (“UPIC”) audits. TPE audits are generally pre-payment audits, while RAC, CERT, ZPIC, and SMRC audits are generally post-payment audits. UPIC audits can be both pre- or post-payment audits, with a majority currently being 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 ~~internal “supply chain” organization, we purchase, warehouse,~~wholly-owned subsidiary, Accelerated Care Plus Corp., our therapeutic solutions business is a leading provider of rehabilitation technologies and ~~distribute over 450,000 SKUs from more than 300 different manufacturers through SPS or directly~~integrated clinical programs to ~~our own clinics within our Patient Care segment.~~skilled nursing and post-acute rehabilitation providers. Our ~~warehousing and distribution facilities in Nevada, Georgia, Illinois, Pennsylvania, and Texas,~~value proposition is to provide ~~us with the ability to deliver products to the vast majority of~~ our customers ~~in the United States within two business days.~~with a full-service “total solutions” approach encompassing proven medical technology, evidence-based clinical programs, and ongoing consultative education and training. Our services support increasingly advanced treatment options for a broader patient population and more medically complex conditions. We currently serve approximately 4,000 skilled nursing and post-acute providers nationwide. Through our SureFit subsidiary, we also manufacture and sell therapeutic footwear for diabetic patients in the podiatric market. We also operate the Hanger Fabrication Network, which fabricates custom O&P devices for our patient care clinics, as well as for independent O&P clinics.

Through our internal “supply chain” organization, we purchase, warehouse, and distribute over 450,000 SKUs from more than 300 different manufacturers through SPS or directly to our own clinics within our Patient Care segment. Our warehousing and distribution facilities in Nevada, Georgia, Illinois, Pennsylvania (ceased operations as of September 30, 2020), 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.

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

Beginning in the last weeks of March 2020, our business volumes began to be adversely affected by the COVID-19 pandemic. As federal, state, and local authorities implemented social distancing and suppression measures to respond to an increasing number of nationwide COVID-19 infections, we experienced a decrease in our patient appointments and general business volumes. In response, during the last week of March 2020, we made certain changes to our operations, implemented a broad number of cost reduction measures, and delayed certain capital investment projects. Although our business volumes have shown gradual improvement from their initial significant decline, the adverse impact of the COVID-19 pandemic on our business has continued through the third quarter and into the fourth quarter. These volume effects and our operating responses are discussed further in this section, and the effects of COVID-19 on our financial condition is discussed in the “Financial Condition, Liquidity and Capital Resources” section below.

Effect on Business Volumes

During the months of July, August and September 2020, patient appointments in our Patient Care Clinics declined by approximately 18%, 17%, and 13%, respectively, as compared with the same period in 2019. This constituted an approximate average decrease of 16% in patient appointments during the three months ended September 30, 2020. During the quarter, we experienced a relatively lower decline in prosthetic patient volumes as compared with orthotic patient volumes, although our orthotic volumes did improve as compared to the second quarter. Given the higher relative price of prosthetic devices that resulted in a more favorable product mix, same-clinic revenues within our Patient Care segment declined at a lower rate than patient appointments, reflecting a decrease of 10.3%, on a per day basis, as compared with the comparable period last year. As of the end of September 2020, we had temporarily closed 22 patient care clinics and another 84 clinics were open for reduced hours or by appointment only. We believe the generally more acute nature of conditions that lead to the need for prosthetics, the patient age demographics and the relatively greater impact that the absence of access to these devices can have on a patient’s daily life were the primary reasons that led to the relatively lower decline in prosthetic patients as compared with orthotic patients in our Patient Care Segment during the period. Billings for componentry delivered to independent providers of orthotics and prosthetics by our distribution services business ~~enables us to:~~decreased by approximately 10% during the quarter ended September 30, 2020 as compared to the same period in 2019. Our business volumes associated with therapeutic solutions have also been adversely affected due to access restrictions our skilled nursing facility clients have implemented at their facilities in response to the COVID-19 pandemic. Due to significant geographic product mix and timing differences, there can be no assurance that these volumes or billing amounts will be reflective of our future results and are solely provided for the purposes of giving context to the magnitude of the effect of the COVID-19 pandemic on our business during the third quarter.

Given that the development of a clearly effective medical treatment approach for treating COVID-19 does not appear imminent and that the vast majority of the general population of the United States has not developed natural immunity, we believe that the adverse effects of the COVID-19 pandemic will continue to affect our business volumes for the duration of 2020, and likely into 2021. These adverse effects will primarily be the result of anticipated continuing governmental measures to suppress the virus to address periods and locations of virus re-emergence, the adverse economic consequences to our patients, and the general lack of normalcy in the willingness of individuals to engage in activities that might increase their likelihood of their exposure to the virus.

Nevertheless, we do believe that the overall adverse impact will diminish over time, and that our patient appointment and other business volumes will gradually improve as the prevalence of the virus decreases and social distancing, masking and testing measures become more routine, and the perception of infection risks subside. Additionally, we believe that if a patient is initially unable or unwilling to come to one of our clinics to receive their prosthetic or orthotic device then their ultimate need for that device is not likely to change, and that we could accordingly have some favorable volume recovery effect in future periods as the impacts of the COVID-19 pandemic subsides.

Operating and Cost Reduction Responses

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

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Table of Contents

·                  ~~centralize our purchasing and thus lower~~Normally, only our material costs and portions of our incentive compensation expenses vary directly with changes in our business volumes from one period to the next. This has been due in part to our historical practice of maintaining full-time staffing levels for clinicians and non-exempt employees in our clinic and support operations. This operating practice has been necessitated by ~~negotiating purchasing discounts~~our desire to provide high levels of accessibility and service to our patients.

As a result of the COVID-19 pandemic, we have 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 varies to lower amounts for lower salaried employees up to reduction amounts ranging from ~~manufacturers;~~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. We communicated to our employees that reductions of exempt employee salaries could continue for up to a six month period ending on October 2, 2020 of this year (the “Reduction Period”). Due to the trends in our business volumes discussed in the Effect on Business Volumes section, on June 8, 2020, we announced we had reinstated a portion of the salary reduction for our exempt employees. Effective July 11, 2020, we reinstated an additional portion of the salary reduction for our exempt employees, resulting in an average 11% decrease in salaries for the remainder of the Reduction Period and, finally, effective September 19, 2020, we reinstated the remainder of the salary reduction for our exempt employees. Throughout the Reduction Period, the salary reductions of our senior leadership team ranged from 15% to 100%, depending on the individual, and prior to the full reinstatement of all exempt employees' salaries in September 2020. Our decision to reduce employee wages rather than to implement a more permanent reduction in force was based on our preference to collectively share in the financial hardships caused by the COVID-19 pandemic rather than to subject portions of our workforce to the full financial burden. Additionally, this approach has 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. We have not implemented changes to employee benefits, nor do we currently intend to suspend our annual employer 401(k) match for 2020, which we would typically expect to pay in March of 2021.

We have undertaken other reductions to our other operating expenses. However, our largest category of operating expense, rent, utilities, and facilities maintenance, which amounted to $17.0 million and $49.9 million during the three and nine months ended September 30, 2020, respectively, has proven difficult to meaningfully reduce in the short term.

Excluding reductions in componentry costs, which varied in a corresponding fashion with decreases in revenue, these cost reduction measures provided savings in the approximate amount of $16 million in operating expenses for the three month period ended September 30, 2020. We believe these expense reductions are temporary in nature, and are not sustainable during periods of normal operation. Due to the fact that as of September 2020, we have reinstated the salary reductions and reduced the number of employees on furlough, our personnel costs will increase to normal levels in the fourth quarter of 2020.

In addition to these reductions in operating expenses, we have elected to temporarily delay the implementation of our supply chain and financial systems, further discussed in the “New Systems Implementations” section. We have not established a date for recommencement of this systems initiative, but currently believe it is likely that the project will not recommence until at least early 2021. We have also suspended construction of our new fabrication facility in Tempe, Arizona, and other projects related to the reconfiguration of our distribution facilities. These actions will correspondingly delay our achievement of the financial benefits expected from them into future periods.

We believe these and other related measures will reduce our capital expenditures for the full year, which are comprised of purchases of property, plant and equipment, as well as therapeutic program equipment, to the approximate range of $30 million to $35 million, which compares to the approximately $45 million we originally planned to expend in 2020.

While we have endeavored to rapidly reduce our expenses in response to decreases in patient and business volumes, given that a substantial portion of our operating expenses are nevertheless fixed in nature, and the ongoing interest costs associated with our indebtedness, we do not currently believe we will fully offset the adverse earnings effect associated with lost revenue during the remainder of 2020. Nevertheless, as discussed in the “Financial Condition, Liquidity and Capital Resources” section below, we do believe that our operating expense and capital project reductions, when accompanied by additional cash sources, cost mitigation and liquidity management strategies, will enable us to maintain positive liquidity throughout the remainder of 2020 and the foreseeable future.
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·                  ~~better manage~~
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 $175.0 billion to be administered through grants and other mechanisms to hospitals, public entities, not-for-profit entities and Medicare- and Medicaid- enrolled suppliers and institutional providers. The purpose of these funds is to reimburse providers for lost revenue attributable to the COVID-19 pandemic, such as lost revenues attributable to canceled procedures, as well as to provide support for health-care related expenses. In April 2020, HHS began making payments to healthcare providers from the $175.0 billion appropriation. These are payments, rather than loans, to healthcare providers, and will not need to be repaid.

During the second and third quarters of 2020, we recognized a total benefit of $20.6 million in our ~~patient care clinic inventory levels~~condensed consolidated statement of operations within Other operating costs for a portion of the grant proceeds we received under the CARES Act (“Grants”) from HHS. In addition, as of September 30, 2020, we have recorded a liability of $3.4 million within Accrued expenses and ~~improve inventory turns;~~other liabilities in the condensed consolidated balance sheet for Grant proceeds that have not met the recognition criteria for income.

Other Products & Services Performance Considerations

As discussed in our 2019 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 nine months ended September 30, 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. 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.

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·                  ~~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.~~
Through our wholly-owned subsidiary, Accelerated Care Plus Corp., our therapeutic solutions business is a leading provider of rehabilitation technologies and integrated clinical programs to post-acute care and 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 clinician education and training. Our services support increasingly advanced treatment options for a broader patient population and more medically complex conditions. We currently serve approximately 4,100 skilled nursing and post-acute providers nationwide.
Reimbursement Trends

In our Patient Care segment, we are reimbursed primarily through employer-based plans offered by commercial insurance carriers, Medicare, Medicaid, and the ~~U.S. Department~~VA. The following is a summary of ~~Veterans Affairs.~~ 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,


2020

2019

2020

2019

Medicare

32.0
%
31.6
%
32.4
%
31.6
%
Medicaid

16.2
%
15.6
%
16.1
%
15.9
%
Commercial Insurance / Managed Care (excluding Medicare and Medicaid Managed Care)

35.7
%
36.1
%
35.6
%
35.6
%
Veterans Administration

9.1
%
10.3
%
9.0
%
9.9
%
Private Pay

7.0
%
6.4
%
6.9
%
7.0
%
Patient Care

100.0
%
100.0
%
100.0
%
100.0
%

Patient Care constituted ~~82.6%~~82.9% and ~~81.9%~~82.7% of our net ~~revenue~~revenues for the three and nine months ended September 30, ~~2019~~2020 and ~~81.4%~~82.6% and ~~81.3%~~81.9% for the three and nine months ended September 30, ~~2018.~~2019. Our remaining net ~~revenue was~~revenues were provided by our Products & Services segment, which derives its net ~~revenue~~revenues from commercial transactions with independent O&P providers, healthcare facilities, and other customers. In contrast to net revenues from our Patient Care segment, payment for these products and services are not directly subject to third party reimbursement from health care payors.
~~The following is a summary of our net revenue by payor mix for the Patient Care segment expressed as a percentage of net revenues for the periods indicated:~~

For the Three Months
Ended September 30,

For the Nine Months
Ended September 30,

2019

2018

2019

2018

Patient Care Segment

Medicare

31.6
%
32.6
%
31.6
%
31.8
%
Medicaid

15.6
%
15.7
%
15.9
%
15.6
%
Commercial Insurance/ Managed Care (excluding Medicare and Medicaid Managed Care)

36.1
%
36.6
%
35.6
%
36.5
%
Veterans Administration

10.3
%
9.0
%
9.9
%
9.2
%
Private Pay

6.4
%
6.1
%
7.0
%
6.9
%
Total

100.0
%
100.0
%
100.0
%
100.0
%

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. We believe these changes in industry trends have been brought about in part by increased nationwide efforts to reduce health care costs.

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”)~~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.

Commencing in late 2014 and continuing through today, we have taken a number of actions to manage disallowed revenue trends. These initiatives included: (i) the creation of a central revenue cycle management function; (ii) ~~addressing~~ the resolution of issues identified in our 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.

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Table of Contents
Disallowed revenue 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 ~~revenue.~~revenues. These amounts recorded in net revenues within the Patient Care segment for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 are as follows:

For the Three Months Ended
September 30,

For the Nine Months Ended
September 30,

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,

(dollars in thousands)

2019

2018

2019

2018


2020

2019

2020

2019

Net revenues

$
230,931

$
214,080

$
652,700

$
620,745

Estimated implicit price concessions arising from:

Payor disallowances

11,051

10,584

29,309

29,306

Patient non-payments

3,285

736

7,960

2,937

Adjusted gross revenues

$
245,267

$
225,400

$
689,969

$
652,988

Gross charges

$
222,950

$
245,267

$
625,440

$
689,969

Less estimated implicit price concessions arising from:

Payor disallowances

$
11,051

$
10,584

$
29,309

$
29,306

9,369

11,051

24,020

29,309

Patient non-payments

3,285

736

7,960

2,937

917

3,285

2,714

7,960

Payor disallowances and patient non-payments

$
14,336

$
11,320

$
37,269

$
32,243

10,286

14,336

26,734

37,269

Net revenues

$
212,664

$
230,931

$
598,706

$
652,700

Payor disallowances

$
9,369

$
11,051

$
24,020

$
29,309

Patient non-payments

917

3,285

2,714

7,960

Payor disallowances and patient non-payments

$
10,286

$
14,336

$
26,734

$
37,269

Payor disallowances %

4.5
%
4.7
%
4.2
%
4.5
%

4.2
%

4.5
%

3.8
%

4.2
%
Patient non-payments %

1.3
%
0.3
%
1.2
%
0.4
%

0.4
%

1.3
%

0.4
%

1.2
%
Percent of adjusted gross revenues

5.8
%
5.0
%
5.4
%
4.9
%
Percent of gross charges

4.6
%

5.8
%

4.2
%

5.4
%

Acquisitions
~~Growth Rates and Earnings Effects~~
~~Patient Care~~
During the three and nine month periods ending September 30, 2019, approximately 55% and 54% of our net revenues were derived from the provision of prosthetic devices to our patients. These devices have a significantly higher relative reimbursement as compared with the orthotic devices and other related prosthetic supplies that we provide patients. The volume of prosthetic patients we see from one period to the next varies greatly, and this has a significant effect on our relative rate of net revenue growth we experience. Additionally, with the exception of materials costs and certain incentive compensation amounts, our staffing levels, operating costs, lease costs, depreciation and amortization expenses, and interest costs are essentially fixed in nature. As a result, increases or decreases in our revenue from one period to the next can have a significant effect on our comparative reported earnings for those periods.
~~Products & Services~~
~~As discussed in our 2018 Form 10-K, under Item 7, “~~~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~”, in 2017, several of the larger independent O&P providers we served through the distribution of componentry encountered financial difficulties which resulted in our discontinuing distribution services to them. Generally, we believe our distribution customers encounter reimbursement pressures similar to those we experience in our own Patient Care services and, depending on their ability to adapt to the increased claims documentation standards that have emerged in our industry, this may either limit the rate of growth of some of our customers, or otherwise affect the rate of growth we experience in our distribution of O&P componentry to independent providers. During future periods, 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, began to discontinue their use of our therapeutic services. We believe these discontinuances relate primarily to their overall efforts to reduce the costs they bear for therapy-related services within their facilities. As a part of those terminations of service, in a number of cases, we elected to sell terminating clients the equipment that we had utilized for their locations. In 2019, we anticipate a further decline of approximately $7.0 million in revenue from these services associated with customer discontinuances. Within this portion of our business, we have responded to these trends through increases in our marketing programs which convey the value we believe our services provide to patients at SNFs and other adjacent health services provider markets.
~~Acquisitions~~

In the ~~three months ending September 2019,~~second quarter of 2020, we ~~completed~~acquired all of the ~~acquisitions~~outstanding equity interests of ~~two businesses with four~~an O&P ~~clinics similar to those we operate through our Patient Care segment~~business for ~~an aggregate purchase price~~total consideration of ~~$3.3 million. The purchase price consisted~~$46.1 million at fair value, of ~~$3.0~~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 ~~$0.3~~$4.0 million ~~of unsecured~~in additional consideration. Of the $21.9 million in notes issued to the ~~sellers at fair value.~~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. Payments totaling $3.5 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 condensed consolidated balance sheet. The remaining $0.4 million in additional consideration represents the effective settlement of amounts due to us from the acquired O&P business as of the acquisition date. We completed the acquisition with the intention of expanding the geographic footprint of our patient care offerings through the acquisition of high quality O&P providers.

~~In the three months ending June~~During 2019, we completed the ~~acquisition~~following acquisitions of ~~one business with three~~ O&P clinics, ~~similar~~none of which were individually material to ~~those we operate through~~ our ~~Patient Care segment for an aggregate purchase price~~financial position, results of ~~$0.5 million. The purchase price consisted of $0.2 million~~operations, or cash ~~consideration, net of cash acquired, and $0.3 million of unsecured notes issued to the sellers~~flows:

·
In the first quarter of 2019, we completed the acquisition of all the outstanding equity interests of an O&P business for total consideration of $32.8 million, of which $27.7 million was cash consideration, net of cash acquired, $4.4 million was issued in the form of notes to shareholders at fair value, and $0.7 million was additional consideration.

·
In the second quarter of 2019, we completed the acquisition of all the outstanding equity interests of an O&P business for total consideration of $0.5 million, of which $0.2 million was cash consideration, net of cash acquired, and $0.3 million was issued in the form of notes to shareholders at fair value.

·
In the third quarter of 2019, we completed the acquisition of all the outstanding equity interests of one O&P business and acquired the assets of another O&P business for total consideration of $3.3 million, of which $3.0 million was cash consideration, net of cash acquired, and $0.3 million was issued in the form of notes to shareholders at fair value.

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Table of Contents

·
In fourth quarter of 2019, we completed the acquisition of all the outstanding equity interests of one O&P business and acquired the assets of another O&P business for total consideration of $7.8 million, of which $5.0 million was cash consideration, net of cash acquired, and $2.8 million was issued in the form of notes to shareholders at fair value.
~~In the first three months~~
Acquisition-related costs are included in general and administrative expenses in our consolidated statements of 2019, we completed the acquisition of one business with 25 O&P clinics for an aggregate purchase price of $32.8 million. The purchase price consisted of $27.7 million cash consideration, net of cash acquired, $4.4 million of unsecured notes issued to the sellers at fair value, and $0.7 million in additional consideration.
In the last three months of 2018, we completed the acquisition of two O&P businesses for an aggregate purchase price of $3.1 million. The purchase price consisted of $2.0 million in cash consideration, net of cash acquired, and $1.1 million was issued in unsecured notes to the seller. We made no acquisitions in the first nine months of 2018.
operations. Total acquisition-related costs incurred during the three and nine months ended September 30, ~~2019~~2020 were ~~$0.5~~$0.1 million and ~~$1.4~~$0.6 million, respectively, ~~and~~which includes those costs for transactions that are ~~included~~ in ~~general and administrative expenses in our consolidated statement of operations.~~progress or not completed during the respective period. Acquisition-related costs incurred for acquisitions completed during the three and nine month periods ended September 30, ~~2019~~2020 were ~~$0.3~~$0.0 million and ~~$0.8~~$0.4 million, respectively.
~~New Systems Implementations~~
~~In recent years, we have been undertaking~~ Total acquisition-related costs incurred during the implementation of a new patient management and electronic health record system at our patient care clinics. In the first quarter of 2019, we completed this multi-year implementation. For the three month period ended March 31, 2019, we expensed $0.8 million in training, travel, and related implementation costs. For the yearsyear ended December 31, ~~2018~~2019 were $1.5 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, 2019 were $1.0 million.

In response to the expected economic impact of the COVID-19 pandemic, we implemented certain cost mitigation and ~~2017, we expensed $4.4 million and $4.3 million, respectively, for these implementation expenses. As we undertake~~liquidity management strategies, including the temporary delay of our acquisitions of ~~independent~~ O&P providers, ~~we intend~~subject to ~~convert these acquired clinics to this system~~certain conditions and thresholds in the ~~ordinary course~~first amendment to our Credit Agreement entered into in May 2020, except that certain acquisitions are permitted after September 30, 2020, in the event we maintain certain leverage and liquidity thresholds. During the fourth quarter of 2020, we recommenced our ~~business.~~acquisition of O&P providers. Refer to the “Financial Condition, Liquidity and Capital Resources” section for additional discussion.

New Systems Implementations

During 2019, we ~~have~~ commenced the design, ~~implementation~~ planning, and initial implementation of new financial and supply chain systems (“New Systems Implementations”), and ~~plan~~planned to invest in new servers and software that operate as a part of our technology infrastructure. ~~During 2019, in~~In connection with our new financial and supply chain systems, for the three and nine ~~months~~month period ended September 30, ~~2019,~~2020, we have expensed ~~$2.5~~$0.5 million and $2.0 million, respectively, and for the year ended December 31, 2019, we expensed $2.9 million. We currently anticipate that we will spend ~~$3.8~~$2.7 million for the full year 2020 on these systems.

As discussed in the “Effects of the COVID-19 Pandemic” section, we have elected to temporarily delay our New Systems Implementations as part of our efforts to preserve liquidity. We have not set a date for recommencement of these systems initiatives, but currently believe it likely that the project will not recommence until at least early next year. ~~We are additionally incurring increased capital expenditures in connection with improvements to~~This delay will correspondingly push our ~~systems’ infrastructure. In 2020 and 2021, we currently expect to continue to incur operating expense for~~achievement of the financial and supply chain projects of approximately $5.0 million in each year in connection with this implementation, and to incur further significant cash outlays and capital expenditures in connection with our supply chain, financial systems, and technology infrastructure initiatives. For a further discussion of our current outlook for capital expenditures and systems implementation expenditures, refer tobenefits expected from the ~~Financial Condition, Liquidity and Capital Resources~~ ~~section below.~~New Systems Implementations into subsequent periods.

~~In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-15,~~ ~~Intangibles - Goodwill and Other - Internal-Use Software (Topic 350) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract~~. Effective July 1, 2019, we elected to early adopt the requirements of the standard on a prospective basis. The new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Under the new standard, certain of the implementation costs of our new financial and supply chain system will be capitalized. As of September 30, ~~2019,~~2020, we capitalized ~~$0.3~~$4.9 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.

Effect of Delay in Financial Filings

As discussed in our 2019 Form 10-K, due to prior restatements and related issues, we were delayed in the preparation and filing of our financial statements in recent years. In connection with our efforts to restate our prior financial statements, remediate our material weaknesses, regain our timely filing status, and undertake related activities, we incurred third party professional fees in excess of the amounts we estimate that we would have otherwise incurred. The estimated professional fees associated with these efforts are as follows (in thousands):





Balance to be Paid
For the Three Months Ended

Expensed

Paid

in Future Periods
March 31, 2019

$
1,649

$
(2,621)

$
2,223
June 30, 2019

1,745

(2,016)

1,952
September 30, 2019

2,136

(2,168)

1,920
December 31, 2019

3,018

(2,451)

2,487
March 31, 2020

1,639

(2,819)

1,307
June 30, 2020

—

(1,307)

—

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Table of Contents

During the first quarter of 2020, we incurred approximately $1.6 million in excess professional fees in connection with the completion of our remediation activities related to our material weaknesses. Given that we completed the remediation of our material weaknesses in financial statement controls effective with the filing of our 2019 Form 10-K, we do not currently anticipate that we will incur further excess third party professional fees for these purposes in future periods.

Seasonality

We believe our business is affected by the degree to which patients have otherwise met the ~~annual co-payment and~~ 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 ~~and earnings~~ quarter, followed by the second and third quarters, which are somewhat higher and consistent with one ~~another, and, due~~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 may be impacted by the COVID-19 pandemic and historical seasonal patterns may not be reflective of our prospective financial results and operations for the remainder of 2020. Please refer to the “Effects of the COVID-19 Pandemic” section for further discussion.

Our results are also affected, to a lesser extent, by our holding of an education fair in the first quarter of each year. This ~~one-week~~ 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. During the first ~~quarters~~quarter of ~~2019~~2020 and ~~2018,~~2019, we spent approximately $2.3 million in each of these two years, on travel and other costs associated with this ~~one-week~~ event. In addition to the costs we incur associated with this annual event, we also lose the productivity of a significant portion of our clinicians during the period in ~~and around the timing of~~which this event occurs, which contributes to the lower seasonal revenue level we experience during the first quarter of each year.

Critical Accounting Policies

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

● Revenue recognition

● Accounts receivable, net

● Inventories

● Business combinations

● Goodwill and other intangible assets, net

● Income taxes

·                  ~~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 ~~2018~~2019 Form 10-K, under Item 7, “~~Management’s~~“Management’s Discussion and Analysis of Financial Condition and Results of ~~Operations~~”Operations” and in Note A - “~~Organization~~“Organization and Summary of Significant Accounting ~~Policies~~”Policies” contained within these condensed consolidated financial statements.

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Table of Contents

Results of Operations

Our results of operations for the three months ended September 30, ~~2019~~2020 and ~~2018~~2019 were as follows (unaudited):

For the Three Months Ended
September 30,

Percent
Change

(dollars in thousands)

2019

2018

2019 vs 2018

Net revenues

$
279,638

$
262,946

6.3
%
Material costs

92,034

84,805

8.5
%
Personnel costs

94,594

90,853

4.1
%
Other operating costs

32,771

30,999

5.7
%
General and administrative expenses

29,834

28,308

5.4
%
Professional accounting and legal fees

3,629

3,107

16.8
%
Depreciation and amortization

9,373

8,950

4.7
%
Operating expenses

262,235

247,022

6.2
%
Income from operations

17,403

15,924

9.3
%
Interest expense, net

8,954

8,939

0.2
%
Non-service defined benefit plan expense

173

176

(1.7
)%
Income before income taxes

8,276

6,809

21.5
%
Provision for income taxes

2,585

2,440

5.9
%
Net income

$
5,691

$
4,369

30.3
%

For the Three Months Ended


September 30,

Percent Change

(dollars in thousands)

2020

2019

2020 vs 2019

Net revenues

$
256,637

$
279,638

(8.2)
%
Material costs

81,462

92,034

(11.5)
%
Personnel costs

89,727

94,594

(5.1)
%
Other operating costs

29,935

32,771

(8.7)
%
General and administrative expenses

31,371

29,834

5.2
%
Professional accounting and legal fees

2,264

3,629

(37.6)
%
Depreciation and amortization

8,803

9,373

(6.1)
%
Operating expenses

243,562

262,235

(7.1)
%
Income from operations

13,075

17,403

(24.9)
%
Interest expense, net

8,013

8,954

(10.5)
%
Non-service defined benefit plan expense

158

173

(8.7)
%
Income before income taxes

4,904

8,276

(40.7)
%
(Benefit) provision for income taxes

(1,911)

2,585

(173.9)
%
Net income

$
6,815

$
5,691

19.8
%

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

For the Three Months Ended
September 30,

2019

2018

For the Three Months Ended

September 30,


2020

2019

Material costs

32.9
%
32.3
%

31.7
%
32.9
%
Personnel costs

33.8
%
34.6
%

35.0
%
33.8
%
Other operating costs

11.7
%
11.6
%

11.7
%
11.7
%
General and administrative expenses

10.7
%
10.8
%

12.2
%
10.7
%
Professional accounting and legal fees

1.3
%
1.2
%

0.9
%
1.3
%
Depreciation and amortization

3.4
%
3.4
%

3.4
%
3.4
%
Operating expenses

93.8
%
93.9
%

94.9
%
93.8
%

~~For the~~ Three Months Ended September 30, ~~2019~~2020 Compared to the Three Months Ended September 30, ~~2018~~2019

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, our revenues and operating results began to be adversely affected by the COVID-19 pandemic, a trend which continued through September 2020 and into the fourth quarter. The effects of this public health emergency on our revenues and earnings in the three months ended September 30, 2020 impacted the comparison to our historical financial results. Due to the uncertainty surrounding the future economic and social impacts of the COVID-19 pandemic, such comparison may not be indicative of future results. 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.

38
Table of Contents

Net revenues. Net revenues for the three months ended September 30, ~~2019~~2020 were ~~$279.6~~$256.6 million, ~~an increase~~a decrease of ~~$16.7~~$23.0 million, or ~~6.3%~~8.2%, from ~~$262.9~~$279.6 million for the three months ended September 30, ~~2018.~~2019. Net revenues by operating segment, after elimination of intersegment activity, were as follows:

For the Three Months Ended
September 30,

Change

Percent
Change

For the Three Months Ended



September 30,

Percent

(dollars in thousands)

2019

2018

2019 vs 2018

2019 vs 2018


2020

2019

Change

Change

Patient Care

$
230,931

$
214,080

$
16,851

7.9
%

$
212,664

$
230,931

$
(18,267)

(7.9)
%
Products & Services

48,707

48,866

(159
)
(0.3
)%

43,973

48,707

(4,734)

(9.7)
%
Net revenues

$
279,638

$
262,946

$
16,692

6.3
%

$
256,637

$
279,638

$
(23,001)

(8.2)
%

Patient Care net revenues for the three months ended September 30, ~~2019~~2020 were ~~$230.9~~$212.7 million, ~~an increase~~a decrease of ~~$16.9~~$18.3 million, or 7.9%, from ~~$214.1~~$230.9 million for the same period in the prior year. Same clinic revenues ~~increased $7.9~~decreased $22.5 million for the three months ended September 30, ~~2019~~2020 compared to the same period in the prior year, reflecting ~~an increase~~a decrease of ~~2.1%~~10.3% on a per-day basis. Net revenues from acquired clinics and consolidations ~~net of closures,~~ increased ~~$8.5~~$4.4 million, and ~~growth~~revenues from other services ~~was $0.5~~decreased $0.2 million.

Prosthetics constituted approximately ~~55%~~56% of our total Patient Care revenues for the three months ended September 30, ~~2019~~2020 and ~~54%~~55% for the same period in ~~2018,~~2019, excluding the impact of acquisitions. Prosthetic revenues for the three months ended September 30, ~~2019~~2020 were ~~4.0% higher,~~8.9% lower, on a per-day basis, than the same period in the prior year, excluding the impact of acquisitions. Orthotics, shoes, inserts, and other products ~~remained generally consistent~~decreased by 11.8% on a per-day basis ~~with those of~~compared to the same comparative prior periods, excluding the impact of acquisitions. Revenues were adversely affected during the period due to a decline in patient appointment volumes beginning in the last weeks of March and continuing through the third quarter of 2020 as a result of the continuing spread of COVID-19 viral infections, governmental suppression measures implemented in response to the COVID-19 pandemic, and other factors impacting our business volumes discussed in the “Effects of the COVID-19 Pandemic” section.

Products & Services net revenues for the three months ended September 30, ~~2019~~2020 were ~~$48.7~~$44.0 million, a decrease of ~~$0.2~~$4.7 million, or ~~0.3%~~9.7% from ~~$48.9 million for~~ the same period in the prior year. This was primarily attributable to a decrease ~~was comprised~~ of ~~a $2.1~~$3.9 million, or ~~15.1%~~10.8%, ~~decrease~~ in ~~net revenues from therapeutic solutions as a result of continued net client cancellations, offset by $1.9 million, or 5.7%, growth from~~ the distribution of O&P componentry to independent providers stemming from lower volumes due to the COVID-19 pandemic, as discussed in the “Effects of the COVID-19 Pandemic” section above, and to a lesser extent from a change in the business mix. In addition, net revenues from therapeutic solutions decreased $0.8 million, or 6.6%, primarily as a result of ~~new products added~~the impact of historical customer lease cancellations, partially offset by lease installations in the third quarter of 2020.

Beginning in the latter half of March 2020 and continuing throughout the third quarter of 2020, our business volumes were adversely affected by the COVID-19 pandemic. We believe that the decline in net revenues during the three months ended September 30, 2020 was primarily due to the ~~portfolio~~continuing spread of COVID-19 viral infections, state and ~~an increase in volume. In future periods,~~local government restrictions, social distancing and suppression measures adopted by our patients and customers, and the deferral of elective surgical procedures, all of which we ~~anticipate moderation of near-term Products & Services segment growth due primarily~~believe to have contributed to a ~~continuation~~decline in physician referrals and patient appointments. These adverse volume effects continued throughout the third quarter of ~~these therapeutic solutions revenue trends and secondarily due~~2020. For additional discussion, refer to ~~anticipated declines in~~ the ~~rate~~“Effects of ~~growth~~the COVID-19 Pandemic” section.

39
Table of ~~our distribution business.~~Contents

Material costs. Material costs for the three months ended September 30, ~~2019~~2020 were ~~$92.0~~$81.5 million, ~~an increase~~a decrease of ~~$7.2~~$10.6 million or ~~8.5%~~11.5%, from ~~$84.8 million for~~ the same period in the prior year. Total material costs as a percentage of net revenues ~~increased~~decreased to 31.7% in the three months ended September 30, 2020 from 32.9% in the three months ended September 30, 2019 ~~from 32.3% in the three months ended September 30, 2018~~ primarily due to changes in our Product & Services segment business and product mix. Material costs by operating segment, after elimination of intersegment activity, were as follows:

For the Three Months Ended
September 30,

Change

Percent
Change

For the Three Months Ended


September 30,

Percent

(dollars in thousands)

2019

2018

2019 vs 2018

2019 vs 2018


2020

2019

Change

Change

Patient Care

$
71,339

$
64,695

$
6,644

10.3
%

$
63,938

$
71,339

$
(7,401)

(10.4)
%
Products & Services

20,695

20,110

585

2.9
%

17,524

20,695

(3,171)

(15.3)
%
Material costs

$
92,034

$
84,805

$
7,229

8.5
%

$
81,462

$
92,034

$
(10,572)

(11.5)
%

Patient Care material costs ~~increased $6.6~~decreased $7.4 million, or ~~10.3%~~10.4%, for the three months ended September 30, ~~2019~~2020 compared to the same period in the prior year as a result of ~~acquisitions.~~the reduction in segment net sales, offset by our acquisitions and changes in the segment product mix. Patient Care material costs as a percent of segment net revenues ~~increased~~decreased to 30.1% for the three months ended September 30, 2020 from 30.9% for the three months ended September 30, ~~2019 from 30.2% for the three months ended September 30, 2018.~~2019.

Products & Services material costs ~~increased $0.6~~decreased $3.2 million, or ~~2.9%~~15.3%, for the three months ended September 30, ~~2019~~2020 compared to the same period in the prior year. As a percent of net revenues in the Products & Services segment, material costs were ~~42.5%~~39.9% for the three months ended September 30, ~~2019~~2020 as compared to ~~41.2%~~42.5% in the same period of ~~2018.~~2019. The ~~increase~~decrease in material as a percent of segment net revenues was due to a change in ~~distribution customer~~business and ~~business~~product mix within the segment.

Personnel costs. Personnel costs for the three months ended September 30, ~~2019~~2020 were ~~$94.6~~$89.7 million, ~~an increase~~a decrease of ~~$3.7~~$4.9 million, or ~~4.1%~~5.1%, from ~~$90.9~~$94.6 million for the same period in the prior year. Personnel costs by operating segment were as follows:

For the Three Months Ended
September 30,

Change

Percent
Change

For the Three Months Ended




September 30,

Percent

(dollars in thousands)

2019

2018

2019 vs 2018

2019 vs 2018


2020

2019

Change

Change

Patient Care

$
81,274

$
77,806

$
3,468

4.5
%

$
76,989

$
81,274

$
(4,285)

(5.3)
%
Products & Services

13,320

13,047

273

2.1
%

12,738

13,320

(582)

(4.4)
%
Personnel costs

$
94,594

$
90,853

$
3,741

4.1
%

$
89,727

$
94,594

$
(4,867)

(5.1)
%

Personnel costs for the Patient Care segment were ~~$81.3~~$77.0 million for the three months ended September 30, ~~2019, an increase~~2020, a decrease of ~~$3.5~~$4.3 million, or ~~4.5%~~5.3%, from ~~$77.8~~$81.3 million compared to the same period in the prior year. The ~~increase~~decrease in Patient Care personnel costs during the three months ended September 30, ~~2019~~2020 was primarily related to ~~an increase~~a decrease in salary expense of ~~$1.9~~$7.2 million ~~an increase in benefits~~due to cost mitigation efforts implemented as a result of ~~$0.6~~the COVID-19 pandemic, payroll taxes of $0.2 million, ~~an increase in bonus~~ and commissions of ~~$0.6~~$0.1 million, offset by increases in incentive compensation and benefits of $2.2 million and ~~an increase in payroll taxes~~severance costs of ~~$0.4~~$1.0 million, ~~when~~ compared to the three months ended September 30, ~~2018.~~2019.

Personnel costs in the Products & Services segment were ~~$13.3~~$12.7 million for the three months ended September 30, ~~2019, an increase~~2020, a decrease of ~~$0.3~~$0.6 million compared to the same period in the prior year. Salary expense ~~increased $0.5~~decreased $0.8 million due to cost mitigation efforts implemented as a result of the COVID-19 pandemic, offset by bonus, commissions, and ~~bonuses decreased~~other personnel cost increases of $0.2 million for the three months ended September 30, ~~2019 as~~2020 compared to the same period in the prior ~~year primarily as a result of the transfer of personnel between segments.~~year.

Other operating costs. Other operating costs for the three months ended September 30, ~~2019~~2020 were ~~$32.8~~$29.9 million, ~~an increase~~a decrease of ~~$1.8~~$2.8 million, or ~~5.7%~~8.7%, from ~~$31.0~~$32.8 million for the same period in the prior year. ~~Professional fees increased $0.6~~Travel and other expenses decreased $3.4 million due to ~~investments made~~cost mitigation efforts as a result of the COVID-19 pandemic, and bad debt expense decreased $0.4 million primarily due to a moderation of forecast assumptions used in ~~certain revenue cycle management initiatives,~~the estimate. The decreases were offset by a $1.0 million increase in rent expense ~~increased $0.5 million~~ from new, renewed, and acquired leases ~~and $0.3 million as a result of the adoption of ASC 842, further described in Note A — “~~~~Organization and~~
~~Summary of Significant Accounting Policies~~~~”, and other expenses increased $0.4 million~~ as compared to the same period in the prior year.

40
Table of Contents
General and administrative expenses. General and administrative expenses for the three months ended September 30, ~~2019~~2020 were ~~$29.8~~$31.4 million, an increase of $1.5 million, or ~~5.4%~~5.2%, from the same period in the prior year. ~~Salary expense increased $0.8~~The increase was primarily attributable to $2.5 million of qualified disaster relief payments to employees, additional severance costs of $1.9 million, and increases in other personnel-related costs ~~increased $0.3~~of $1.2 million, ~~advertising & selling~~offset by decreases in salary expense of $2.1 million and other expenses ~~increased $0.8 million, and equity-based compensation decreased $0.4~~of $2.0 million, as compared to the same period in the prior year.

Professional accounting and legal fees. Professional accounting and legal fees for the three months ended September 30, ~~2019~~2020 were ~~$3.6~~$2.3 million, ~~an increase~~a decrease of ~~$0.5~~$1.4 million, or ~~16.8%~~37.6%, from ~~$3.1~~$3.6 million for the same period in the prior year primarily ~~attributable~~due to targeted efforts ~~during the third quarter~~ to remediate material weaknesses in our internal controls over financial ~~reporting.~~reporting that occurred in the three months ended September 30, 2019 that did not recur in the same period of 2020.

Depreciation and amortization. Depreciation and amortization for the three months ended September 30, ~~2019~~2020 was ~~$9.4~~$8.8 million, ~~an increase~~a decrease of ~~$0.4~~$0.6 million, or ~~4.7%~~6.1%, from the same period in the prior year. Depreciation expense decreased $0.8 million and amortization expense increased $0.2 million when compared to the same period in the prior year.

Interest expense, net. Interest expense for the three months ended September 30, 2020 decreased 10.5% to $8.0 million from $9.0 million for the same period in the prior year. ~~Depreciation expense increased $0.4 million when compared to the prior period as a result of additions to certain fixed assets.~~

~~Interest expense, net.~~ ~~Interest expense for the three months ended September 30, 2019 increased 0.2% to $9.0 million from $8.9 million for the same period in the prior year.~~
~~Provision~~(Benefit) provision for income taxes. The ~~provision~~benefit for income taxes for the three months ended September 30, ~~2019~~2020 was ~~$2.6~~$1.9 million, or ~~31.2%~~-39.0% of income before income taxes, compared to a provision of ~~$2.4~~$2.6 million, or ~~35.8%~~31.2% of income before income taxes for the three months ended September 30, ~~2018.~~2019. The effective tax rate ~~in 2019~~for the three months ended September 30, 2020 consisted principally of the 21% federal statutory tax rate, the tax benefit from the loss carryback claim, the rate impact from state income taxes, ~~the windfall from stock-based compensation,~~ and permanent tax differences. The ~~increase~~decrease in the effective tax rate for the three months ended September 30, ~~2019~~2020 compared with the three months ended September 30, ~~2018 was~~2019 is primarily attributable to ~~an increased estimated annual income and an increase in pre-tax book income for~~ the ~~three months ended September 30, 2019.~~tax benefit from the loss carryback claim to a prior period with a higher statutory rate granted under the CARES Act.

~~On a quarterly basis, we assess the likelihood of realization of~~We evaluate our deferred tax assets considering all available evidence, both positive and negative. Our most recent operating performance, the scheduled reversal of temporary differences, our forecast of taxable income in future periods, and the availability of prudent tax planning strategies are important considerations in our assessment. While we recognize our recent earnings history is an example of positive evidencequarterly to be considered in our assessment, at this time, management continues to believe it is more-likely-than-not we will not realize a portion of our deferred tax assets due to our consideration of all positive and negative evidence available. Adjustmentsdetermine whether adjustments to the valuation allowance ~~may be made~~are appropriate in light of changes in facts or circumstances, such as changes in expected future ~~periods if there is a change~~pre-tax earnings, tax law, interactions with taxing authorities, and developments in ~~management’s assessment~~case law. Our material assumptions include forecasts of future pre-tax earnings and the ~~amount~~nature and timing of future deductions and income represented by the deferred ~~income~~ tax assets ~~that is realizable.~~and liabilities, all of which involve the exercise of significant judgment. As of September 30, ~~2019,~~2020, our valuation allowance ~~approximated $8.6~~was approximately $2.1 million.

The CARES Act, which was enacted on March 27, 2020, includes changes to certain tax laws related to the deductibility of interest expense and depreciation. ASC 740, Income Taxes, requires the effects of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As a result of the CARES Act provisions, in the third quarter of 2020 we recognized a tax benefit of $4.0 million resulting from the loss carryback claim to a prior period with a higher statutory rate, which also decreased our current income taxes payable by $9.5 million as of September 30, 2020.

41
Table of Contents
Our results of operations for the nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 were as follows (unaudited):

For the Nine Months Ended
September 30,

Percent
Change (1)

For the Nine Months Ended

Percent

September 30,

Change

(dollars in thousands)

2019

2018

2019 vs 2018


2020

2019

2020 vs 2019

Net revenues

$
797,155

$
763,907

4.4
%

$
723,810

$
797,155

(9.2)
%
Material costs

261,810

247,677

5.7
%

228,675

261,810

(12.7)
%
Personnel costs

272,795

266,515

2.4
%

252,734

272,795

(7.4)
%
Other operating costs

100,067

92,631

8.0
%

74,098

100,067

(26.0)
%
General and administrative expenses

87,474

80,467

8.7
%

91,618

87,474

4.7
%
Professional accounting and legal fees

9,576

12,189

(21.4
)%

7,409

9,576

(22.6)
%
Depreciation and amortization

26,906

27,552

(2.3
)%

26,513

26,906

(1.5)
%
Operating expenses

758,628

727,031

4.3
%

681,047

758,628

(10.2)
%
Income from operations

38,527

36,876

4.5
%

42,763

38,527

11.0
%
Interest expense, net

25,973

28,519

(8.9
)%

24,918

25,973

(4.1)
%
Loss on extinguishment of debt

—

16,998

(100.0
)%
Non-service defined benefit plan expense

519

528

(1.7
)%

474

519

(8.7)
%
Income (loss) before income taxes

12,035

(9,169
)
NM

Provision (benefit) for income taxes

3,260

(3,848
)
NM

Net income (loss)

$
8,775

$
(5,321
)
NM

Income before income taxes

17,371

12,035

44.3
%
(Benefit) provision for income taxes

(4,750)

3,260

(245.7)
%
Net income

$
22,121

$
8,775

152.1
%
~~(1)~~ ~~NM - Not Meaningful~~

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

For the Nine Months Ended
September 30,

2019

2018

For the Nine Months Ended

September 30,


2020

2019

Material costs

32.8
%
32.4
%

31.6
%
32.8
%
Personnel costs

34.2
%
34.9
%

34.9
%
34.2
%
Other operating costs

12.6
%
12.2
%

10.2
%
12.6
%
General and administrative expenses

11.0
%
10.5
%

12.7
%
11.0
%
Professional accounting and legal fees

1.2
%
1.6
%

1.0
%
1.2
%
Depreciation and amortization

3.4
%
3.6
%

3.7
%
3.4
%
Operating expenses

95.2
%
95.2
%

94.1
%
95.2
%

~~For the~~ Nine Months Ended September 30, ~~2019~~2020 Compared to the Nine Months Ended September 30, ~~2018~~2019

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, our revenues and operating results began to be adversely affected by the COVID-19 pandemic, a trend which continued through September 2020. The effects of this public health emergency on our revenues and earnings in the nine months ended September 30, 2020 impacted the comparison to our historical financial results. Due to the uncertainty surrounding the future economic and social impacts of the COVID-19 pandemic, the comparison may not be indicative of future results. 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.

42
Table of Contents

Net revenues. Net revenues for the nine months ended September 30, ~~2019~~2020 were ~~$797.2~~$723.8 million, ~~an increase~~a decrease of ~~$33.3~~$73.3 million, or ~~4.4%~~9.2%, from ~~$763.9~~$797.2 million for the nine months ended September 30, ~~2018.~~2019. Net revenues by operating segment, after elimination of intersegment activity, were as follows:

For the Nine Months Ended
September 30,

Change

Percent
Change

(dollars in thousands)

2019

2018

2019 vs 2018

2019 vs 2018

Patient Care

$
652,700

$
620,745

$
31,955

5.1
%
Products & Services

144,455

143,162

1,293

0.9
%
Net revenues

$
797,155

$
763,907

$
33,248

4.4
%

For the Nine Months Ended




September 30,

Percent

(dollars in thousands)

2020

2019

Change

Change

Patient Care

$
598,706

$
652,700

$
(53,994)

(8.3)
%
Products & Services

125,104

144,455

(19,351)

(13.4)
%
Net revenues

$
723,810

$
797,155

$
(73,345)

(9.2)
%

Patient Care net revenues for the nine months ended September 30, ~~2019~~2020 were ~~$652.7~~$598.7 million, ~~an increase~~a decrease of ~~$32.0~~$54.0 million, or ~~5.1%~~8.3%, from ~~$620.7~~$652.7 million for the same period in the prior year. ~~Net revenues from acquired clinics and consolidations, net of closures, increased $19.1 million.~~ Same clinic revenues ~~increased $11.3~~decreased $66.8 million for the nine months ended September 30, ~~2019~~2020 compared to the same period in the prior year, reflecting ~~an increase in same clinic revenues~~a decrease of ~~1.8%~~11.2% on a per-day basis. ~~Patient care~~Net revenues from acquired clinics and consolidations increased $13.4 million, and revenues from other services ~~contributed to $1.6 million in growth.~~decreased $0.6 million.

Prosthetics constituted approximately ~~54%~~56% of our total Patient Care revenues for the nine months ended September 30, ~~2019~~2020 and ~~53%~~54% for the same period in ~~2018,~~2019, excluding the impact of acquisitions. Prosthetic revenues for the nine months ended September 30, ~~2019~~2020 were ~~2.7% higher,~~6.6% lower, on a per-day basis, than the same period in the prior year, excluding the impact of acquisitions. Orthotics, shoes, inserts, and other products ~~increased~~decreased by ~~0.7%~~16.3% on a per-day basis ~~for~~compared to the same comparative prior periods, excluding the impact of acquisitions. Revenues were adversely affected during the period due to a decline in patient appointment volumes beginning in the last weeks of March and continuing through the third quarter of 2020 as a result of the continuing spread of COVID-19 viral infections, governmental suppression measures implemented in response to the COVID-19 pandemic, and other factors impacting our business volumes discussed in the “Effects of the COVID-19 Pandemic” section.

Products & Services net revenues for the nine months ended September 30, ~~2019~~2020 were ~~$144.5~~$125.1 million, ~~an increase~~a decrease of ~~$1.3~~$19.4 million, or ~~0.9%,~~13.4% from ~~$143.2 million for~~ the same period in the prior year. This ~~increase~~ was ~~comprised~~primarily attributable to a decrease of ~~$6.8~~$16.6 million, ~~from~~or 15.4%, in the distribution of O&P componentry to independent providers ~~as the result of new products added~~stemming from lower volumes due to the ~~portfolio,~~COVID-19 pandemic, as discussed in the “Effects of the COVID-19 Pandemic” section above, and ~~an increase in volume, offset by~~ a ~~$5.5~~$2.8 million, or 7.5%, decrease in net revenues from therapeutic solutions as a result of ~~continued net client cancellations. We anticipate moderation~~the impact of ~~near-term Products & Services segment growth due primarily to a continuation of these therapeutic solutions revenue trends and anticipate a decrease~~historical customer lease cancellations, partially offset by lease installations.

Beginning in the ~~rate~~latter half of ~~growth~~March 2020, our business volumes began to be adversely affected by the COVID-19 pandemic, and business volumes were adversely impacted throughout the second and third quarter of 2020. We believe that the decline in net revenues in the nine months ended September 30, 2020 was primarily due to the continuing spread of COVID-19 viral infections, state and local government restrictions, social distancing and suppression measures adopted by our ~~distribution business.~~patients and customers, and deferral of elective surgical procedures, all of which resulted in a decline in physician referrals and patient appointments. These adverse volume effects have continued into October 2020. For additional discussion, refer to the “Effects of the COVID-19 Pandemic” section.

Material costs. Material costs for the nine months ended September 30, ~~2019~~2020 were ~~$261.8~~$228.7 million, ~~an increase~~a decrease of ~~$14.1~~$33.1 million or ~~5.7%~~12.7%, from ~~$247.7 million for~~ the same period in the prior year. Total material costs as a percentage of net revenues ~~increased~~decreased to 31.6% in the nine months ended September 30, 2020 from 32.8% in the nine months ended September 30, 2019 ~~from 32.4% in the nine months ended September 30, 2018,~~ primarily due to changes in our Product & Services segment business and product mix. Material costs by operating segment, after elimination of intersegment activity, were as follows:

For the Nine Months Ended
September 30,

Change

Percent
Change

For the Nine Months Ended




September 30,

Percent

(dollars in thousands)

2019

2018

2019 vs 2018

2019 vs 2018


2020

2019

Change

Change

Patient Care

$
199,626

$
188,503

$
11,123

5.9
%

$
178,851

$
199,626

$
(20,775)

(10.4)
%
Products & Services

62,184

59,174

3,010

5.1
%

49,824

62,184

(12,360)

(19.9)
%
Material costs

$
261,810

$
247,677

$
14,133

5.7
%

$
228,675

$
261,810

$
(33,135)

(12.7)
%

Patient Care material costs ~~increased $11.1~~decreased $20.8 million, or ~~5.9%~~10.4%, for the nine months ended September 30, ~~2019~~2020 compared to the same period in the prior year as a result of ~~acquisitions.~~the reduction in segment net sales, offset by our acquisitions and changes in the segment product mix. Patient Care material costs as a percent of segment net revenues isincreased to 29.9% for the three months ended September 30, 2020 from 30.6% for the nine months ended September 30, ~~2019 and 30.4% for the nine months ended September 30, 2018.~~2019.
43
Table of Contents

Products & Services material costs ~~increased $3.0~~decreased $12.4 million, or ~~5.1%~~19.9%, for the nine months ended September 30, ~~2019~~2020 compared to the same period in the prior year. As a percent of net revenues in the Products & Services segment, material costs were ~~43.0%~~39.8% for the nine months ended September 30, ~~2019~~2020 as compared to ~~41.3% for~~43.0% in the same period ~~2018.~~of 2019. The ~~increase~~decrease in material ~~costs~~ as a ~~percentage~~percent of segment net revenues was due to a change in ~~the distribution customer~~business and ~~business~~product mix within the segment.

Personnel costs. Personnel costs for the nine months ended September 30, ~~2019~~2020 were ~~$272.8~~$252.7 million, ~~an increase~~a decrease of ~~$6.3~~$20.1 million, or ~~2.4%~~7.4%, from ~~$266.5~~$272.8 million for the same period in the prior year. Personnel costs by operating segment were as follows:

For the Nine Months Ended
September 30,

Change

Percent
Change

For the Nine Months Ended




September 30,

Percent

(dollars in thousands)

2019

2018

2019 vs 2018

2019 vs 2018


2020

2019

Change

Change

Patient Care

$
233,402

$
228,211

$
5,191

2.3
%

$
216,910

$
233,402

$
(16,492)

(7.1)
%
Products & Services

39,393

38,304

1,089

2.8
%

35,824

39,393

(3,569)

(9.1)
%
Personnel costs

$
272,795

$
266,515

$
6,280

2.4
%

$
252,734

$
272,795

$
(20,061)

(7.4)
%

Personnel costs for the Patient Care segment were ~~$233.4~~$216.9 million for the nine months ended September 30, ~~2019, an increase~~2020, a decrease of ~~$5.2~~$16.5 million, or ~~2.3%~~7.1%, from ~~$228.2~~$233.4 million ~~for~~compared to the same period in the prior year. The ~~increase~~decrease in Patient Care personnel costs ~~for~~during the nine months ended September 30, ~~2019~~2020 was primarily related to ~~an increase of $1.9 million in benefits expense relating to higher health claims experience and higher 401(k) match, an increase of $1.8 million~~a decrease in salary expense ~~an increase~~ of ~~$1.3~~$20.7 million due to cost mitigation efforts implemented as a result of the COVID-19 pandemic, and a decrease in ~~bonus expense,~~benefits costs of $1.7 million due to reduced claims experience, payroll taxes of $0.9 million, and ~~an increase of~~commissions by $0.3 million, offset by increases in incentive compensation and other personnel costs of ~~$0.6~~$6.1 million ~~offset by $0.4~~and severance costs of $1.0 million ~~in lower commission expense, when~~ compared to the nine months ended September 30, ~~2018.~~2019.

Personnel costs ~~for~~in the Products & Services segment were ~~$39.4~~$35.8 million for the nine months ended September 30, ~~2019, an increase~~2020, a decrease of ~~$1.1~~$3.6 million compared to the same period in the prior year. Salary expense ~~increased $1.0~~decreased $3.5 million ~~benefits expense increased $0.3 million,~~due to cost mitigation efforts as a result of the COVID-19 pandemic, and bonus, ~~expense~~commissions, and other personnel costs decreased ~~$0.2~~$0.1 million for the nine months ended September 30, ~~2019 as~~2020 compared to the same period in the prior year.

Other operating costs. Other operating costs for the nine months ended September 30, ~~2019~~2020 were ~~$100.1~~$74.1 million, ~~an increase~~a decrease of ~~$7.5~~$26.0 million, or ~~8.0%~~26.0%, from ~~$92.6~~$100.1 million for the same period in the prior year. ~~Rent~~Other expenses decreased by $20.3 million due to the benefit associated with the recognition of $20.6 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. Travel and other expenses decreased $9.0 million due to cost mitigation efforts as a result of the COVID-19 pandemic. The decreases are offset by a $3.0 million increase in rent expense ~~increased an additional $1.4 million~~ from new, renewed, and acquired leases and ~~$0.9~~a $0.3 million ~~as a result of the adoption of ASC 842, further described~~increase in ~~Note A — “~~~~Organization and Summary of Significant Accounting Policies~~”. In addition, professional fees increased $1.5 million for the nine months ended September 30, 2019 due to investments made in certain revenue cycle management initiatives. Other operating expenses increased $1.5 million from higher sales and use tax, and additional costs from acquisitions. Badbad debt expense increased by $0.9 million due to recoveries in the same period of the prior year. Other occupancy costs and all other operating costs increased $1.3 million for the nine months ended September 30, 2019 as compared to the ~~nine months ended September 30, 2018.~~same period in the prior year.

General and administrative expenses. General and administrative expenses for the nine months ended September 30, ~~2019~~2020 were ~~$87.5~~$91.6 million, an increase of ~~$7.0~~$4.1 million, or ~~8.7%~~4.7%, from the same period in the prior year. ~~This includes a $2.3 million~~The increase was primarily the result of an increase in ~~other expenses, largely~~share-based compensation of $4.9 million, due to ~~favorable settlements~~the modification recognized in the ~~prior year, a $2.4~~second quarter of certain equity awards granted in 2017, and from an increase of $4.5 million ~~increase~~in incentive compensation and other personnel-related costs, $2.5 million of qualified disaster relief payments to employees, and additional severance costs of $1.9 million, offset by decreases in salary expense ~~a $0.9~~of $5.6 million ~~increase in benefits related to higher claim costs, and a $0.5 million increase in equity-based compensation, and a $0.9 million increase in office~~ and other ~~expenses.~~expenses of $4.1 million.

Professional accounting and legal fees. Professional accounting and legal fees for the nine months ended September 30, ~~2019~~2020 were ~~$9.6~~$7.4 million, a decrease of ~~$2.6~~$2.2 million, or ~~21.4%~~22.6%, from ~~$12.2~~$9.6 million for the same period in the prior ~~year. Advisory and other fees decreased~~year primarily due to ~~decreased utilization of professional services as compared~~targeted efforts to remediate material weaknesses in our internal controls over financial reporting that occurred in the nine months ended September 30, 2019 that did not recur in the same period ~~in 2018. This change related primarily to reductions in the use~~ of ~~third-party professionals to assist us in the remediation of our material weaknesses, to regain our timely filing status in August of 2018, and to undertake related activities.~~2020.

Depreciation and amortization. Depreciation and amortization for the nine months ended September 30, ~~2019~~2020 was ~~$26.9~~$26.5 million, a decrease of ~~$0.6~~$0.4 million, or ~~2.3%~~1.5%, from ~~$27.6~~the same period in the prior year. Depreciation expense decreased $1.5 million and amortization expense increased $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, 2020 decreased 4.1% to $24.9 million from $26.0 million for the same period in the prior year. ~~Amortization expense decreased $1.5 million when compared to the prior period as a result~~

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Table of certain intangible assets becoming fully amortized. Depreciation expense increased $0.7 million when compared to the prior period as a result of additions to certain fixed assets, and finance lease amortization increased $0.2 million.
Contents
~~Interest expense, net.~~ Interest expense for the nine months ended September 30, 2019 was $26.0 million, a decrease of $2.5 million, or 8.9%, from $28.5 million for the same period in the prior year. This decrease was primarily due to lower interest rates on outstanding borrowings as a result of our debt refinancing in March 2018.

~~Provision~~(Benefit) provision for income taxes. The ~~provision~~benefit for income taxes for the nine months ended September 30, ~~2019~~2020 was ~~$3.3~~$4.8 million, or ~~27.1%~~-27.3% of income before income taxes, compared to a ~~benefit~~provision of ~~$3.8~~$3.3 million, or ~~42.0%~~27.1% of ~~loss~~income before income taxes for the nine months ended September 30, ~~2018.~~2019. The effective tax rate in ~~2019~~2020 consisted principally of the 21% federal statutory tax rate, the recognition of research and development tax credits, the tax benefit from the loss carryback claim, the rate impact from state income taxes, the ~~windfall~~shortfall from ~~stock-based~~share-based compensation, and permanent tax differences. The decrease in the effective tax rate for the nine months ended September 30, ~~2019~~2020 compared with the nine months ended September 30, ~~2018~~2019 is primarily attributable to ~~an increased estimated annual income, an increase in pre-tax book loss~~the recognition of research and development tax credits for the ~~nine months ended September 30, 2018~~current and prior years and a tax benefit from the loss carryback claim to ~~pre-tax book income for~~a prior period with a higher statutory rate granted under the ~~nine months ended September 30, 2019, and the windfall~~CARES Act, partially offset by a shortfall from ~~stock-based compensation recorded as a discrete item during the period.~~share-based compensation.

~~On a quarterly basis, we assess the likelihood of realization of~~We evaluate our deferred tax assets considering all available evidence, both positive and negative. Our most recent operating performance, the scheduled reversal of temporary differences, our forecast of taxable income in future periods, and the availability of prudent tax planning strategies are important considerations in our assessment. While we recognize our recent earnings history is an example of positive evidencequarterly to be considered in our assessment, at this time, management continues to believe it is more-likely-than-not we will not realize a portion of our deferred tax assets due to our consideration of all positive and negative evidence available. Adjustmentsdetermine whether adjustments to the valuation allowance ~~may be made~~are appropriate in light of changes in facts or circumstances, such as changes in expected future ~~periods if there is a change~~pre-tax earnings, tax law, interactions with taxing authorities, and developments in ~~management’s assessment~~case law. Our material assumptions include forecasts of future pre-tax earnings and the ~~amount~~nature and timing of future deductions and income represented by the deferred ~~income~~ tax assets ~~that is realizable.~~and liabilities, all of which involve the exercise of significant judgment. As of September 30, ~~2019,~~2020, our valuation allowance approximated ~~$8.6~~$2.1 million.

During the second quarter of 2020, we completed a study of qualifying research and development expenses resulting in the recognition of tax benefits of $2.2 million, net of tax reserves, related to the current year and $6.3 million, net of tax reserves, related to prior years as of the third quarter of 2020. We recorded the tax benefit, before tax reserves, as a deferred tax asset.

The CARES Act, which was enacted on March 27, 2020, includes changes to certain tax laws related to the deductibility of interest expense and depreciation. ASC 740, Income Taxes, requires the effects of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As a result of the CARES Act provisions, in the third quarter of 2020 we recognized a tax benefit of $4.0 million resulting from the loss carryback claim to a prior period with a higher statutory rate, which also decreased our current income taxes payable by $9.5 million as of September 30, 2020.

Financial Condition, Liquidity, and Capital Resources

Liquidity

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

At September 30, ~~2019,~~2020, we had total liquidity of ~~$144.8~~$242.3 million, which reflected ~~a decrease~~an increase of ~~$44.4~~$73.1 million from the ~~$189.2~~$169.2 million in liquidity we had as of December 31, ~~2018.~~2019. Our liquidity at September 30, ~~2019~~2020 was comprised of cash and cash equivalents of ~~$49.9~~$147.5 million and $94.8 million in available borrowing capacity under our $100.0 million revolving credit facility. This ~~decrease~~increase in liquidity primarily related to ~~our use~~an increase in cash of ~~$31.6~~$73.1 million, comprised of net cash provided by operations of $125.2 million, which includes approximately $24.0 million in ~~cash for~~Grants from the ~~purposes of acquisitions, and secondarily due to capital expenditures of $25.4 million exceeding our operating~~federal government under the CARES Act, partially offset by investing cash flows for purchases of ~~$19.9~~property plant and equipment, and purchases of therapeutic program equipment, of $22.5 million, ~~by $5.5 million. We have also utilized $6.1~~cash paid for acquisitions, net of cash acquired, of $16.9 million, ~~of our liquidity~~and net cash used in ~~the reduction of our net indebtedness and outstanding letters of credit. Other investing and~~ financing activities ~~resulted~~of $14.1 million. As of September 30, 2020, we have repaid in ~~a net use of $1.2~~full all $79.0 million toin borrowings under our ~~liquidity.~~revolving credit facility.

Our Credit Agreement contains customary representations and warranties, as well as financial covenants, including that we maintain compliance with certain leverage and interest coverage ratios. If we are not compliant with our debt covenants in any period, absent a waiver or amendment of our Credit Agreement, we may be unable to access funds under our revolving credit facility. Due to the additional borrowings under our revolving credit facility in March 2020, which were repaid in full during the third quarter of 2020, and in anticipation of the potential economic impact of the COVID-19 pandemic, we entered into an amendment to the Credit Agreement that provided for, among other things, increases in the allowable level of indebtedness we may carry relative to our earnings, changes in the definition of EBITDA used to compute certain financial ratios, certain restrictions regarding investments and payments we may make until the completion of the first quarter of 2021 and increases in the interest costs associated with borrowings under our revolving credit facility. We were in compliance with our debt covenants as of September 30, 2020.

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

Working Capital and Days Sales Outstanding

At September 30, ~~2019,~~2020, we had working capital of ~~$95.2~~$103.2 million compared to working capital of ~~$154.6~~$107.2 million at December 31, ~~2018.~~2019. Our working capital decreased ~~$59.4~~$4.0 million ~~for~~during the nine months ended September 30, ~~2019~~2020 due to ~~a decrease in current assets of $40.3 million and~~ an increase in current liabilities of ~~$19.2 million.~~
~~The decrease in current assets was primarily attributable to a decrease in cash and cash equivalents of $45.2~~$51.9 million, and the reclassification of prepaid rent of $3.8 million to the current portion of long-term debt upon adoption of ASC 842, historically recorded in other current assets. The decrease in cash primarily relates to the uses of cash discussed in the liquidity section above. The decreases wereonly partially offset by an increase in ~~inventory~~current assets of ~~$8.0 million, which was partially attributable to acquisitions, and other individually immaterial changes in current assets.~~$47.8 million.

The increase in current liabilities of $51.9 million was primarily attributable to an increase of i) $19.0 million in the ~~adoption~~Current portion of ~~ASC 842~~long-term debt primarily related to $19.6 million in Seller Notes issued in connection with the acquisition of an O&P business in the second quarter of 2020, of which $18.4 million was paid in October 2020, ii) $16.6 million in Accrued expenses and ~~the resulting recognition of operating lease~~other current liabilities, of ~~$32.4~~which $4.2 million ~~at September 30, 2019,~~relates to changes in the fair value of our interest rate swap, $3.7 million relates to liabilities incurred in the acquisition of an O&P business in the second quarter of 2020, $3.4 million relates to deferred grant income under the CARES Act, $2.8 million relates to increases in patient prepayments and deposits and $2.5 million in other activity and iii) $15.2 million in Accounts payable. The increase also reflects $2.5 million in additional Accrued compensation related costs attributable to current year increases in incentive compensation, severance and accrued vacation liabilities, partially offset by ~~a net decrease in accrued incentive compensation related costs of $15.5 million due to~~ the payment of $34.2 million in annual ~~inventive~~incentive compensation ~~tax payments on stock vesting,~~ and the employer 401(k) matching contribution made during the first quarter of 2020.

The increase in current assets of $47.8 million was primarily attributable to an increase in Cash and cash equivalents of $73.1 million discussed in the ~~year,~~“Liquidity” section above, an increase in Income taxes receivable of $5.9 million, which relates to income tax relief under the CARES Act, an increase in Inventories of $5.9 million and approximately $0.8 million in Other current assets. These increases were offset by ~~current year incentive compensation accruals. The remainder~~decreases in Accounts receivable, net of ~~the increase is attributable to other changes in current liabilities.~~$38.0 million.

Days sales outstanding (“DSO”) is a calculation that approximates the average number of days between the billing for our services and the date of our receipt of payment, which we estimate using a 90-day rolling period of net revenue. This computation can provide a relative measure of the effectiveness of our billing and collections activities. Clinics acquired during the past 90-day period are excluded from the calculation. As of September 30, ~~2019,~~2020, our DSO was 4743 days, ~~compared~~which compares favorably to a DSO of 4547 days as of September 30, ~~2018.~~2019. We believe that one-time administrative billing changes ~~to our collections operations made in the first quarter of this year, increases in the rates of initial Medicare claim denials,~~ and the impact of implementing our patient management and electronic health system in certain of our largest operating regions ~~in the first quarter have~~ contributed to collection delays ~~and the increase in~~impacting our ~~DSO. As~~comparative prior year DSO as of ~~March 31,~~September 30, 2019 ~~the implementation~~by approximately two days. The remainder of the ~~new patient~~reduction is attributable to improved collections experience due to the targeted efforts of our centralized revenue cycle management ~~and electronic health record system was complete.~~function.

Sources and Uses of Cash for the Nine Months Ended September 30, ~~2019~~2020 Compared to September 30, ~~2018~~2019

Net cash flows provided by operating activities ~~decreased $17.2~~increased $105.3 million to $125.2 million for the nine months ended September 30, 2020 from net cash provided by operating activities of $19.9 million for the nine months ended September 30, ~~2019 from net~~2019. The most significant increase in cash provided by operating activities was due to a $37.6 million increase in cash provided by Accounts receivable, net which is largely attributable to the effect of ~~$37.2~~decreases in our revenue on the related amount of accounts receivable we would otherwise carry associated with those billings, as well as improvements in our collection activities, consistent with the decrease in DSO to 43 days as of September 30, 2020, compared to a DSO of 47 days as September 30, 2019. In addition, we recognized approximately $20.6 million in proceeds from the Grants received under the CARES Act within Net income. The remaining increase in cash flows provided by operations is primarily attributable to favorable changes in working capital in Accrued compensation and related costs, Accounts payable, Accrued expenses and other current liabilities, Other liabilities and Inventories of $53.8 million. Increases in Accrued compensation and related costs is primarily attributable to higher levels of accrued incentive compensation relative to the annual payout of the prior year accrual in the nine months ended September 30 2020 when compared to the same period in 2019, as well as higher levels of accrued vacation and accrued severance expenses. Increases in Accounts payable include the temporary benefit of approximately $9.3 million associated with more lenient credit terms provided to us by vendors. Other liability increases include $7.1 million in deferred payroll tax liabilities associated with the CARES Act. These increases in cash flows provided by operating activities were partially offset by changes in Income taxes of approximately $9.4 million, primarily due to the temporary relief provided under the CARES Act and changes in Other current assets and other assets of $1.3 million.

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We believe the favorable working capital trends experienced in the second and third quarter to be largely temporary, as they related primarily to a reduction in the amount of our required working capital resulting from decreases in our business volumes associated with the onset of the COVID-19 pandemic, and, to a lesser extent, our temporary actions to further reduce our net working capital through reductions in inventory and negotiated changes in payment terms. Given these factors, we are unlikely to experience similar favorable contributions to operating cash flow from working capital improvements in the fourth quarter of 2020 and early 2021. Further, as the COVID-19 pandemic subsides and our business volumes return to more normal levels, we anticipate the favorable working capital trends observed in the third quarter to reverse in the form of increases to our accounts receivable, inventory, and cash paid to vendors as our credit terms return to previous arrangements, as well as further reductions as other temporary working capital benefits subside. For these reasons, and the reasons discussed in the “Liquidity Outlook” section below, we currently believe that we will experience a net consumption of cash during at least the next six month period.

Cash flows used in investing activities decreased $16.8 million to $38.1 million for the nine months ended September 30, ~~2018. This comparative decrease was primarily due to a $12.6 million reduction in cash provided by net accounts receivable. During 2018, we benefited~~2020, from an improvement in our collections experience, particularly during the first quarter of the prior year. This year, in addition to not having a similar benefit in collections experience, we have also experienced some increased difficulties in collections as discussed above. Our operating cash flows have also decreased on a comparative basis due to our receipt of a $12.3 million tax refund in the first quarter of 2018 and due to $7.4 million in timing effect related to our payments of accounts payables which benefited our comparative cash flows in 2018 and has created an offsetting decrease to our current year cash flows from operations. These factors were partially offset by a beneficial reduction of $10.9 million in cash used for the satisfaction of accrued expenses and other liabilities, as well as a $4.2 million net reduction relating primarily to the payment of accrued compensation and secondarily to the net effect of other factors. These changes are further discussed in the ~~Working Capital and Days Sales Outstanding~~ ~~section above.~~
~~Cash flows used in investing activities increased $35.0 million to~~ $54.8 million for the nine months ended September 30, ~~2019,~~2019. The decrease in cash used in investing activities was primarily due to lower cash outflows of $14.7 million for acquisitions, net of cash acquired, and lower capital expenditures of $2.9 million during the nine months ended September 30, 2020, partially offset by $0.6 million less in proceeds from ~~$19.8~~the sale of property, plant and equipment.

Cash flows used in financing activities increased $3.8 million to $14.1 million for the nine months ended September 30, ~~2018. The increase in~~2020, from cash used in ~~investing activities was due to $31.6 million in cash consideration for acquisitions, net of cash acquired, and a $3.8 million increase in purchases of property, plant and equipment.~~
~~Cash flows used in~~ financing activities ~~increased by $51.5 million to a use of cash~~ of $10.3 million for the nine months ended September 30, ~~2019, from~~2019. The increase in cash ~~provided by~~used financing activities was primarily due to higher cash outflows of ~~$41.2 million for the nine months ended September 30, 2018. Cash flows provided by financing activities during the nine months ended September 30, 2018 included $46.9~~$3.1 million related to ~~the refinancing of our indebtedness, net of payment of $15.2~~employee taxes on stock-based compensation and $0.6 million in ~~debt issuance and extinguishment costs, whereas~~payments under vendor financing arrangements that occurred solely in ~~the nine months ended September 30, 2019, cash flows used in debt financing activities was $3.8 million.~~2020.

Effect of Indebtedness

On March 6, 2018, we entered into a ~~new~~$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 ~~order to refinance our indebtedness, as disclosed~~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 ML - “~~Debt~~,“Debt and Other Obligations,” in the notes to the condensed consolidated financial statements contained elsewhere in this report. Our indebtedness bears reduced rates of interest compared with the indebtedness under our prior credit agreement, and as such, interest expense was lower for the nine months ended September 30, 2019 as compared to the same period in the prior year. Cash paid for interest totaled ~~$22.4~~$22.2 million and ~~$23.7~~$22.4 million for the nine months ended September 30, 2020 and 2019, respectively.

In May 2020, we entered into an amendment to the Credit Agreement (the “Amendment”) that provided for, amongst other things, an increase in the maximum Net Leverage Ratio to 5.25 to 1.00 for the fiscal quarters ended June 30, 2020 through March 31, 2021; 5.00 to 1.00 for the fiscal quarters ended June 30, 2021 through September 30, 2021; and ~~2018, respectively.~~4.75 to 1.00 for the quarter ended December 31, 2021 and the last day of each fiscal quarter thereafter. In addition, the Amendment changed the definition of EBITDA used in the Net Leverage Ratio and minimum interest coverage ratio to adjust for declines in net revenue attributable to the COVID-19 pandemic. Borrowings under the revolving credit facility will bear interest at a variable rate equal to the greater of LIBOR or 1.00%, plus 3.75%. In addition, the Amendment contained certain restrictions and covenants that further limit our ability, and certain of our subsidiaries’ ability, to consolidate or merge, create liens, incur additional indebtedness, dispose of assets, or consummate acquisitions not financed with the proceeds of an equity offering, except that certain acquisitions are permitted after September 30, 2020, in the event we maintain certain leverage and liquidity thresholds. During the fourth quarter of 2020, we recommenced our acquisition of O&P providers.

Scheduled maturities of debt as of September 30, ~~2019~~2020 were as follows:

(in thousands)



2019 (remainder of year)

$
2,318

2020

8,428

2020 (remainder of year )

$
21,023
2021

7,372

9,759
2022

6,032

8,494
2023

5,489

8,049
2024

7,337
Thereafter

476,116

474,527
Total debt before unamortized discount and debt issuance costs, net

505,755

529,189
Unamortized discount and debt issuance costs, net

(8,516
)

(7,798)
Total debt

$
497,239

$
521,391

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Liquidity Outlook ~~and Going Concern Evaluation~~

Our Credit Agreement has a term loan facility with ~~$497.4~~$492.4 million in principal outstanding at September 30, ~~2019,~~2020, 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, 2020, a revolving credit facility with no borrowings and ~~a maximum aggregate amount~~available borrowing capacity of ~~availability of $100.0~~$94.8 million ~~at September 30, 2019~~ that matures in March 2023.
We ~~currently anticipate that,~~chose to borrow $79.0 million from our revolving credit facility in ~~connection with our planned reconfiguration~~March 2020 to preserve access to these funds in the event of ~~distribution facilities~~further instability in ~~2020 and related implementation of supply chain and~~ financial systems, we will incur an increase in capital expenditures and deferred systems implementation expenditures during 2020. The amounts of these expenditures have not been firmly established at this time. However, we preliminarily believe that we could expend approximately $13 million to $15 million in increased capital expenditures and $9 million to $12 million in incremental expenditures relatedmarkets due to the ~~implementation~~COVID-19 pandemic, all of ~~the supply chain~~which has been repaid as of September 30, 2020.

Historically, our primary sources of liquidity are cash and ~~financial systems during 2020. We anticipate that these incremental systems related expenses will be deferred in accordance with ASU 2018-15~~cash equivalents, and included in future expense over the periods of operation of the systems. These expenditures are also anticipated to be separate from and additional to the approximately $5 million in expenses we believe we will incur related to this project during 2020. With the exception of an additional $6 million to $8 million of similar capital and incremental expenditures in 2021, these rates of expenditure are currently anticipated to subside and return to levels similar to those of the current year during 2022.
Nevertheless, based on our range of estimates of the costs for our reconfiguration of distribution facilities and our financial and supply chain systems implementations, as well as our estimates of potential expenditures for the acquisition of O&P providers, we currently believe that our anticipated operating trends when combined with available borrowings under our revolving credit ~~facility~~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 adverse impact on our operations, financial condition, and results of operations. While we believe the business disruption will be temporary, we cannot predict the extent or duration of the COVID-19 pandemic, when state and local restrictions will be lifted, the impact of increasing viral infections, or when patients will resume their normal healthcare treatment activities. In response to the expected decline in cash flows from operations, in March 2020, we implemented certain cost mitigation and liquidity management strategies including, but not limited to, reductions in componentry purchases, salary reductions for all exempt employees, the furloughing of certain employees, reductions in non-exempt employee hours, reductions in bonus and commission expenses, the temporary reduction in operating hours and days of clinics, reducing other operating expenses, deferring the implementation of our New Systems Implementations, temporarily delaying our acquisition of O&P providers, and extending the payment terms for certain vendors. These measures were taken in an effort to preserve liquidity in a manner sufficient to provide for our ability to respond to the adverse cash flow pressures likely to be caused by the COVID-19 pandemic. While some of our cost mitigation and liquidity strategies remain in place, as of the start of the fourth quarter, we have fully reinstated the salary reductions for exempt employees and have eliminated all but a small number of employee furloughs. Further, we recommenced our acquisition of O&P providers in the fourth quarter of 2020. Please refer to the “Effects of the COVID-19 Pandemic” section above for our current estimates of the amounts of operating and capital expenditure reductions provided through these measures.

In connection with an acquisition we completed in April of 2020, we paid $18.4 million in short term seller notes and $3.6 million in liabilities incurred in the transaction in October 2020. Additionally, as discussed above, the favorable working capital trends we experienced in the third quarter are largely temporary. As our business volumes return to more normal levels, we will experience a consumption of cash associated with the funding of accounts receivable and componentry inventories associated with those increases in revenue. Additionally, as our credit terms with vendors return to normal, we would expect to consume approximately $9.3 million in additional cash associated with a reduction of accounts payable. In addition to these amounts, we anticipate other uses of cash to fund the reduction of increases in accrued compensation associated with employee bonus, commissions, and payroll taxes.

While we currently do not anticipate the need to do so, if the COVID-19 pandemic causes adverse cash flow and liquidity trends greater than those we currently expect and have planned for, we may find it necessary to seek additional borrowings to fund our operations. If we were to do so, given current credit market conditions, we may find that such additional borrowings are not available at that time, and if they are available, that the interest costs of such borrowings and effects on the costs of our existing borrowings could be significantly higher than the costs we currently pay under our existing Credit Agreement. Additionally, while we do not currently have the need or intention to do so, if necessary, we may extend our accounts payable and payment of other obligations to address any such funding shortage. While we cannot forecast with certainty the ultimate extent of the impacts from or the duration of the COVID-19 pandemic, we believe that our operating expense and capital project reductions, when accompanied by additional cash sources, cost mitigation and liquidity management strategies, will enable us to maintain positive liquidity throughout the remainder of 2020 and the foreseeable future.

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 $175.0 billion to be administered through grants and other mechanisms to hospitals, public entities, not-for-profit entities and Medicare- and Medicaid- enrolled suppliers and institutional providers. The purpose of these funds is to reimburse providers for lost revenue and health-care related expenses that are attributable to the COVID-19 pandemic. In April 2020, the U.S. Department of Health and Human Services (“HHS”) began making payments to healthcare providers from the $175.0 billion appropriation. These are payments, rather than loans, to healthcare providers, and will not need to be repaid.

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During the second and third quarters of 2020, we recognized a total benefit of $20.6 million in our condensed consolidated statement of operations within Other operating costs for a portion of the Grants from HHS. We recognize income related to grants on a systematic and rational basis when it becomes probable that we have complied with ~~sufficient liquidity~~the terms and conditions of the grant and in the period in which the corresponding costs or income related to ~~meet~~the grant are recognized. We recognized the benefit from the Grants within Other operating costs in our ~~financial obligations~~Patient Care segment. As of September 30, 2020, we have recorded a liability of $3.4 million within Accrued expenses and other liabilities in the condensed consolidated balance sheet related to proceeds from the Grants for amounts that have not met the recognition criteria in accordance with our accounting policy.

The CARES Act also provides for a deferral of the employer portion of payroll taxes incurred during the ~~coming twelve months.~~COVID-19 pandemic through December 2020. The provisions allow us to defer half of such payroll taxes until December 2021 and the remaining half until December 2022. We deferred $7.1 million of payroll taxes within Other liabilities in the condensed consolidated balance sheet as of September 30, 2020.

Going Concern Evaluation

ASU 2014-15 Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concernrequires that we evaluate whether there is substantial doubt about our ability to meet our financial obligations when they become due during the twelve month period from the date these financial statements are available to be issued. We have performed such an evaluation considering the financial and operational effects of the COVID-19 pandemic and, based on the results of that assessment, we are not aware of any relevant conditions or events that raise substantial doubt regarding our ability to continue as a going concern within one year of the date the financial statements are issued.

Off-Balance Sheet Arrangements

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

As of September 30, ~~2019,~~2020, we had a combined principal amount of ~~$497.4~~$492.4 million of variable rate debt under our Term Loan B and revolving credit facility and a notional amount of ~~$312.5~~$300.0 million of fixed to variable interest rate swap agreements. Based on our hedged and unhedged positions, a hypothetical increase or decrease in interest rates byof 1.0% would impact our annual interest expense by ~~$1.8~~$2.5 million.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

Management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and effectiveness of our disclosure controls and procedures as of September 30, ~~2019.~~2020. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were ~~not~~ effective as of September 30, ~~2019 because~~2020.

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Table of ~~the material weaknesses in our internal control over financial reporting described in Item 9A., “~~~~Controls and Procedures~~~~” of our Annual Report on Form 10-K for the year ending December 31, 2018, our “2018 Form 10-K.”~~Contents

Although we have not fully remediated the material weaknesses described in our 2018 Form 10-K, we believe that we have made substantial progress on the remediation plans described in our 2018 Form 10-K, under Item 9A., “~~Controls and Procedures.~~”
During the period ending September 30, 2019, we continued to make improvements to controls in the areas of inventory; accounts payable; information technology general controls; revenue; and accounts receivable and are continuing our evaluation of the design and operating effectiveness of these controls. The material weaknesses cannot be considered remediated until the applicable remedial controls operate for a period of time sufficient for management to conclude, through testing, that these controls are operating effectively.
Changes in Internal Control over Financial Reporting

~~With the exception of ongoing remediation activities, there~~There have been no material changes to our internal controls over financial ~~reporting.~~reporting during the three month period ended September 30, 2020.

Therefore, in accordance with Rule 13a-15(d) of the Exchange Act and with the participation of our Chief Executive Officer and our Chief Financial Officer, management determined there have been no material changes to our internal control over financial reporting during the three month period ended September 30, ~~2019.~~2020.

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PART II.OTHER INFORMATION

~~PART II.~~~~OTHER INFORMATION~~
ITEM 1. LEGAL PROCEEDINGS

Not applicable.

ITEM 1A. RISK FACTORS

~~Derivative Litigation~~
In ~~February and August of 2015, two separate shareholder derivative suits were filed in Texas state court against us related~~addition to the ~~announced restatement of certain of~~other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our ~~financial statements. The cases were subsequently consolidated into~~ ~~Judy v. Asar, et. al.,~~ ~~Cause No. D-1-GN-15-000625~~. ~~On October 25, 2016, plaintiffs in that action filed an amended complaint, and~~Annual Report on Form 10-K for the ~~case is currently pending before the 345th Judicial District Court of Travis County, Texas.~~
~~The amended complaint in the consolidated derivative action names us and certain of our current and former officers and directors as defendants. It alleges claims for breach of fiduciary duty based,~~ ~~inter alia~~~~, on the defendants’ alleged failure to exercise good faith to ensure that we had in place adequate accounting and financial controls and that disclosures regarding~~year ended December 31, 2019, which could materially affect our business, financial ~~performance and internal controls were truthful and accurate. The complaint seeks unspecified damages, costs, attorneys’ fees, and equitable relief.~~
~~As disclosed~~condition or results of operations. We have also identified the following additional risk factor, which supplements those discussed in our ~~Current Report~~Form 10-K:

The Company’s financial condition and results of operations for fiscal year 2020 and beyond may continue to be materially adversely affected by the ongoing coronavirus (“COVID-19”) outbreak.

The outbreak of COVID-19 evolved into a global pandemic in the first quarter of 2020. The full extent to which the COVID-19 outbreak will continue to impact our business and operating results will depend on ~~Form 8-K filed~~future developments that are highly uncertain and cannot be accurately predicted, including new medical and other information that may emerge concerning COVID-19 and the actions by governmental entities or others to contain it or mitigate its impact.

The COVID-19 pandemic continued to have a significant negative impact on our business and results of operations in the third quarter of 2020. We experienced a continued reduction in revenue due to a decline in the number of patients that we treated in our patient care clinics, as well as a reduction in sales to independent O&P clinics by our distribution business. A significant portion of this decline was due to O&P patients determining voluntarily to wait for various reasons, including concerns regarding their own health and safety, for appointments and procedures, both with us and with their referring physicians, that the ~~SEC on June 6, 2016,~~patient deems to be non-urgent or otherwise able to be deferred or postponed. Although we have seen some recovery in patient volume since April of 2020, and sequentially since the ~~Board~~second quarter of ~~Directors appointed a Special Litigation Committee~~2020, the progress of the ~~Board (the “Special Committee”). The Board delegated~~COVID-19 pandemic has been erratic, with infection rates fluctuating and recently continuing to rise significantly in many regions throughout the United States, and we are unable to predict when the COVID-19 pandemic will no longer significantly impact our patient volumes, both in our own clinics and at independent O&P providers.

Nevertheless, we continue to believe that these patient volume declines primarily reflect a deferral of healthcare services utilization to a later period, rather than a permanent reduction in demand for our services. Given the general necessity of the services that our patient care clinics provide, we anticipate that this deferral of services may create a backlog of demand in the future, in addition to the ~~Special Committee the authority to (1) determine whether it~~resumption of historically normal levels of patient activity; however, there is ~~in our best interests to pursue any of the allegations made in the derivative cases filed in Texas state court (which cases were consolidated into the~~ ~~Judy~~ ~~case discussed above), (2) determine whether it is in our best interests to pursue any remedies against any of our current or former employees, officers or directors~~no assurance that either will occur. To date, we have not experienced significantly extended billing and collection cycles as a result of displaced employees, delayed reimbursement by governmental or private payers, or delayed revenue cycle management procedures; however, we cannot predict the ~~conduct discovered~~impact the ongoing COVID-19 pandemic may have on these areas of our operations in future periods. We may also face a shortage in products within our supply chain in the ~~Audit Committee investigation concluded~~future, which could impact our ability to service our patients in our clinics on ~~June 6, 2016 (the “Investigation”), and (3) otherwise resolve claims~~a timely basis or ~~matters relating to the findings~~at all.

Our management of the ~~Investigation. The Special Committee retained independent legal counsel~~impact of COVID-19 has and will continue to ~~assist~~require significant investment of time from our management and advise it in carrying out its duties and reviewed and considered the evidence and various factors relating to our best interests. In accordance with its findings and conclusions, the Special Committee determined that it is not in our best interest to pursue any of the claims in the ~~Judy~~ derivative case. Also in accordance with its findings and conclusions, the Special Committee determined that it is not in our best interests to pursue legal remedies against any of our current or former employees, ~~officers, or directors.~~
On April 14, 2017, we filed a motion to dismiss the consolidated derivative action based on the resolution by the Special Committee that it is not in our best interest to pursue the derivative claims. Counsel for the derivative plaintiffs opposed that motion and moved to compel discovery. In a hearing held on June 12, 2017, the Travis County Court denied plaintiffs’ motion to compel, and held that the motion to dismiss would be considered only after appropriate discovery was concluded.
The plaintiffs subsequently subpoenaed counsel for the Special Committee, seeking a copy of the full report prepared by the Special Committee and its independent counsel. Counsel for the Special Committee, as well as resources across our ~~counsel, took~~enterprise. The focus on managing and mitigating the ~~position that~~impacts of COVID-19 on our business may cause us to divert or delay the ~~full report is not discoverable under Texas law. Plaintiffs’ counsel filed~~application of our resources toward existing or new initiatives or investments, which could have a ~~motion~~material adverse impact on our results of operations.

Further, the impacts of COVID-19 have caused significant uncertainty and volatility in the credit markets. If our access to ~~compel~~capital were to become significantly constrained, or if costs of capital increased significantly due the ~~Special Committee’s counsel~~impact of COVID-19 including, volatility in the capital markets, a reduction in our credit ratings or other factors, then our financial condition, results of operations and cash flows could be materially adversely affected.

The foregoing and other continued disruptions to ~~produce the report. We opposed the motion. On July 20, 2018, the Travis County Court ruled that only~~our business as a ~~redacted version~~result of ~~the report is discoverable,~~COVID-19 has had, and counsel for the Special Committee provided a redacted version of the report to plaintiffs’ counsel. Plaintiffs objected to the redacted version of the report, and on February 4, 2019, the Travis County Court appointed a Special Master to review plaintiffs’ objections to the redacted report. On March 22, 2019, the Special Master submitted a report to the Travis County Court recommending that the court order that the entire Special Committee report be produced. On April 2, 2019 we filed an objection to the Special Master’s report and recommendation, and requested a hearing on the matter. On June 25, 2019, the Travis County Court rejected the recommendation of the Special Master, and instead ordered that only a limited additional portion of the Special Committee report should be made available to plaintiffs. On July 10, 2019, the updated redacted Special Committee report was provided to plaintiffs through their counsel.
In late October 2019, a non-binding agreement in principle was reached by the parties to settle the consolidated derivative action, subject to finalization and execution of a definitive settlement agreement by the parties, and subsequent final approval
~~of the settlement by the Travis County Court. The amount of any payment to be made by Hanger pursuant to the non-binding agreement in principle~~ is expected to ~~be covered under our directors & officers insurance.~~
~~Management intends to~~ continue to vigorously defend against the shareholder derivative action. At this time, if the derivative action were to go to trial, we cannot predict how the Travis County Court will rule on the merits of the claims and/or the scope of the potential loss in the event of an adverse outcome. Should we ultimately be found liable, the resulting damages could have, a material adverse effect on our ~~consolidated financial position, liquidity or our~~business, results of ~~operations.~~operations, and financial condition during the remainder of 2020, and potentially into 2021 and beyond.
~~Other Matters~~
From time to time we are subject to legal proceedings and claims which arise in the ordinary course of our business. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on our consolidated financial position, liquidity or results of our operations.
We are in a highly regulated industry and receive regulatory agency inquiries from time to time in the ordinary course of our business, including inquiries relating to our billing activities. No assurance can be given that any discrepancies identified during a regulatory review will not have a material adverse effect on our consolidated financial statements.
~~ITEM 1A.~~ ~~RISK FACTORS~~51
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~~Our business and financial results are subject to numerous risks and uncertainties. The risk and uncertainties have not changed materially from those reported in Item 1A., “~~~~Risk Factors~~~~”, in our~~
~~2018 Form 10-K, which are incorporated by reference. For additional information regarding risks and uncertainties, see the information provided under the header “~~~~Forward Looking Statements~~~~” contained in Part I, Item 2, “~~~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~~~” in this Quarterly Report on Form 10-Q.~~
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

There has been no share repurchase activity during the three months ended September 30, ~~2019.~~2020.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

There have been no defaults upon senior securities during the three months ended September 30, ~~2019.~~2020.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None to report.

ITEM 6. EXHIBITS

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

~~EXHIBITS INDEX~~52
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EXHIBITS INDEX

Exhibit

No.

Document
31.1

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

31.2

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

32

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

101.INS

XBRL Instance Document.  (Filed herewith.)

101.SCH

XBRL Taxonomy Extension Schema.  (Filed herewith.)

101.CAL

XBRL Taxonomy Extension Calculation Linkbase.  (Filed herewith.)

101.LAB

XBRL Taxonomy Extension Label Linkbase.  (Filed herewith.)

101.PRE

XBRL Taxonomy Extension Presentation Linkbase.  (Filed herewith.)

101.DEF

XBRL Taxonomy Extension Definition Linkbase.  (Filed herewith.)

104

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

~~SIGNATURES~~53
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SIGNATURES

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

HANGER, INC.

Dated: November ~~7, 2019~~4, 2020
By:
/s/ THOMAS E. KIRALY

Thomas E. Kiraly

Executive Vice President and Chief Financial Officer

Dated: November ~~7, 2019~~4, 2020
By:
/s/ GABRIELLE B. ADAMS

Gabrielle B. Adams

Vice President and Chief Accounting Officer

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