NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the Years Ended December 31, 2021, 2020, and 2019
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, 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 760 patient care clinics and 115 satellite locations in 47 states and the District of Columbia as of December 31, 2021. On a regular basis, we have been opening, closing, and merging patient care locations and satellite locations. During the year ended December 31, 2021, we have opened or acquired 91 and closed or consolidated 32 patient care locations.
Our Products & Services segment is comprised of our distribution services and therapeutic solutions businesses. As a leading provider of O&P products in the United States, we engage in the distribution of a broad catalog of O&P parts, componentry, and devices to independent O&P providers nationwide. The other business in our Products & Services segment is our therapeutic solutions business, which develops specialized rehabilitation technologies and provides evidence-based clinical programs for post-acute rehabilitation to patients at approximately 4,000 skilled nursing and post-acute providers nationwide.
Principles of Consolidation
Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in the accompanying consolidated financial statements.
Use of Estimates and Assumptions
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires the use of estimates and assumptions that affect the reported amounts of revenues, expenses, assets, liabilities, and contingencies. Although actual results in subsequent periods may differ from these estimates, such estimates are developed based on the best information available to management and based on management’s best judgments at the time. We base our estimates on historical experience, observable trends, and various other assumptions that we believe are reasonable under the circumstances. All significant assumptions and estimates underlying the amounts reported in the consolidated financial statements and accompanying notes are regularly reviewed and updated when necessary. Changes in estimates are reflected prospectively in the consolidated financial statements based upon on-going actual trends, or subsequent settlements and realizations depending on the nature and predictability of the estimates and contingencies. Interim changes in estimates related to annual operating costs are applied prospectively within annual periods. Although we believe that our estimates are reasonable, actual results could differ from these estimates.
The most significant assumptions and estimates underlying these consolidated financial statements and accompanying notes involve revenue recognition and accounts receivable valuation, inventories, accounts payable and accrued liabilities, impairments of long-lived assets including goodwill, income taxes, business combinations, leases, and stock-based compensation.
Reclassifications
We have reclassified certain amounts in the prior year condensed consolidated financial statements to be consistent with the current year presentation. These relate to classifications within the condensed consolidated statements of operations.
Revenue Recognition
Patient Care Segment
Revenue in our Patient Care segment is primarily derived from contracts with third party payors for the provision of O&P devices and is recognized upon the transfer of control of promised products or services to the patient at the time the patient receives the device. At, or subsequent to delivery, we issue an invoice to the third party payor, which primarily consists of commercial insurance companies, Medicare, Medicaid, the VA, and private or patient pay (“Private Pay”) individuals. We recognize revenue for the amounts we expect to receive from payors based on expected contractual reimbursement rates, which are net of estimated contractual discounts and implicit price concessions. These revenue amounts are further revised as claims are adjudicated, which may result in additional disallowances. These are recorded as a reduction of revenues because they are not caused by an inability of the payor or patient to pay, but rather internal administrative issues such as adjustments to contractual allowances, adjustments to coding, failure to ensure that a patient was currently eligible under a payor’s health plan or that their plan provides full O&P benefits, failure to receive prior authorization, failure to file or appeal the payor’s determination timely, failure by certain classes of patients to pay their portion of a claim, or other such administrative issues.
Our products and services are sold with a 90-day labor and 180-day warranty for fabricated components. Warranties are not considered a separate performance obligation. We estimate warranties based on historical trends and include them in accrued expenses and other current liabilities in the consolidated balance sheet. The warranty liability was $2.9 million at December 31, 2021 and $2.2 million at December 31, 2020.
A portion of our O&P revenue comes from the provision of cranial devices. In addition to delivering the cranial device, there are patient follow-up visits where we assist in treating the patient’s condition by adjusting or modifying the cranial device. We conclude that, for these devices, there are two performance obligations and use the expected cost plus margin approach to estimate for the standalone selling price of each performance obligation. The allocated portion associated with the patient’s receipt of the cranial device is recognized when the patient receives the device while the portion of revenue associated with the follow-up visits is initially recorded as deferred revenue. On average, the cranial device follow-up visits occur less than 90 days after the patient receives the device and the deferred revenue is recognized on a straight-line basis over the period.
Medicare and Medicaid regulations and the various agreements we have with other third party payors, including commercial healthcare payors under which these contractual adjustments and payor disallowances are calculated, are complex and are subject to interpretation and adjustment and may include multiple reimbursement mechanisms for different types of services. Therefore, the particular O&P devices and related services authorized and provided, and the related reimbursement, are subject to interpretation and adjustment that could result in payments that differ from our estimates. Additionally, updated regulations and reimbursement schedules, and contract renegotiations occur frequently, necessitating regular review and assessment of the estimation process by management. As a result, there is a reasonable possibility that recorded estimates could change and any related adjustments will be recorded as adjustments to net revenue when they become known.
Products & Services Segment
Revenue in our Products & Services segment is derived from the distribution of O&P components and the leasing and sale of rehabilitation equipment and ancillary consumable supplies combined with equipment maintenance, education, and training.
Distribution services revenues are recognized when obligations under the terms of a contract with our customers are satisfied, which occurs with the transfer of control of our products. This occurs either upon shipment or delivery of goods, depending on whether the terms are FOB Origin or FOB Destination. Payment terms are typically between 30 to 90 days. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products to a customer (“transaction price”).
To the extent that the transaction price includes variable consideration, such as prompt payment discounts, list price discounts, rebates, and volume discounts, we estimate the amount of variable consideration that should be included in the transaction price utilizing the most likely amount method. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current, and forecasted) that is reasonably available.
We reduce revenue by estimates of potential future product returns and other allowances. Provisions for product returns and other allowances are recorded as a reduction to revenue in the period sales are recognized. We make estimates of the amount of sales returns and allowances that will eventually be incurred. Management analyzes sales programs that are in effect, contractual arrangements, market acceptance, and historical trends when evaluating the adequacy of sales returns and allowance accounts.
Therapeutic program equipment and related services revenue are recognized over the applicable term the customer has the right to use the equipment and as the services are provided. Equipment sales revenue is recognized upon shipment, with any related services revenue deferred and recognized as the services are performed. Sales of consumables are recognized upon shipment.
In addition, we estimate amounts recorded to bad debt expense using historical trends and these are presented as a bad debt expense under the operating costs section of our consolidated financial statements.
Material Costs
Material costs in our Patient Care segment reflect purchases of orthotics and prosthetic componentry and other related costs in connection with the delivery of care through our clinics and other patient care operations. Material costs in our Products & Services segment reflect purchases of orthotics and prosthetic materials and other related costs in connection with the distribution of products and services to third party customers.
Personnel Costs
Personnel costs reflect salaries, benefits, incentive compensation, contract labor, and other personnel costs we incur in connection with our delivery of care through our clinics and other patient care operations, or distribution of products and services, and exclude similar costs incurred in connection with general and administrative activities.
Other Operating Costs
Other operating costs reflect costs we incur in connection with our delivery of care through our clinics and other patient care operations or distribution of products and services. Marketing costs, including advertising, are expensed as incurred and are presented within this financial statement caption. We incurred approximately $2.1 million, $1.9 million, and $3.8 million in advertising costs during the years ended December 31, 2021, 2020, and 2019, respectively. Other costs include rent, utilities, and other occupancy costs, general office expenses, bad debt expense, and travel and clinical professional education costs, and exclude similar costs incurred in connection with general and administrative activities.
During 2021 and 2020, we recognized a total benefit of $1.1 million and $24.0 million, respectively, in our consolidated statement of operations within Other operating costs for the grant proceeds we received under the CARES Act (“Grants”) from HHS. We recognize income related to grants on a systematic and rational basis when it becomes probable that we have complied with the terms and conditions of the grant and in the period in which the corresponding costs or income related to the grant are recognized. We recognized the benefit from the Grants within Other operating costs in our Patient Care segment.
General and Administrative Expenses
General and administrative expenses reflect costs we incur in the management and administration of our businesses that are not directly related to the operation of our clinics or provision of products and services. These include personnel costs and other operating costs supporting our general and administrative functions. We incurred approximately $0.6 million, $0.3 million, and $0.9 million in advertising costs during the years ended December 31, 2021, 2020, and 2019, respectively.
Depreciation and Amortization
Depreciation and amortization expenses reflect all depreciation and amortization expenses, whether incurred in connection with our delivery of care through our clinics, our distribution of products and services, or in the general management and administration of our business.
Cash and Cash Equivalents
We consider all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. We maintain cash balances in excess of Federal Deposit Insurance Corporation (“FDIC”) limits at certain financial institutions. We manage this credit risk by concentrating our cash balances in high quality financial institutions and by periodically evaluating the credit quality of the primary financial institutions holding such deposits. With short maturities, the investments present insignificant risk of changes in value because of interest rate changes and are readily convertible to cash. Historically, no losses have been incurred due to such cash concentrations.
Accounts Receivable, Net
Patient Care Segment
We establish allowances for accounts receivable to reduce the carrying value of such receivables to their estimated net realizable value. The Patient Care segment’s accounts receivables are recorded net of unapplied cash and estimated implicit price concessions, such as payor disallowances and patient non-payments, as described in the revenue recognition accounting policy above.
Our estimates of payor disallowances utilize the expected value method by considering historical collection experience by each of the Medicare and non-Medicare primary payor class groupings. For each payor class grouping, liquidation analyses of historical period end receivable balances are performed to ascertain collections experience by aging category. In the absence of an evident adverse trend, we use historical experience rates calculated using an average of four quarters of data with at least twelve months of adjudication. We will modify the time periods analyzed when significant trends indicate that adjustments should be made.
Estimates for patient non- payments are calculated utilizing historical collection experience of patient receivables, as well as current and future economic conditions. A liquidation analysis of historical period end receivable balances for patients is performed to ascertain collection experience by aging category over the same time horizons as payor disallowances.
Products & Services Segment
Our Products & Services segment’s allowance for doubtful accounts is estimated based on the analysis of the segment’s historical write-offs experience, accounts receivable aging and economic status of its customers. Accounts receivable that are deemed uncollectible are written off to the allowance for doubtful accounts. Accounts receivable are also recorded net of an allowance for estimated sales returns.
Inventories
Inventories are valued at the lower of estimated cost or net realizable value with cost determined on a first-in, first-out (“FIFO”) basis. Provisions have also been made to reduce the carrying value of inventories for excess, obsolete, or otherwise impaired inventory on hand at period end. The reserve for excess and obsolete inventory is $7.5 million and $6.1 million at December 31, 2021 and 2020, respectively.
Patient Care Segment
Substantially all of our Patient Care segment inventories are recorded through a periodic approach whereby inventory quantities are adjusted on the basis of a quarterly physical count. Segment inventories relate primarily to raw materials and work-in-process (“WIP”) at Hanger Clinics. Inventories at Hanger Clinics totaled $36.7 million and $30.5 million at December 31, 2021 and 2020, respectively, with WIP inventory representing $15.8 million and $12.0 million of the total inventory, respectively.
Raw materials consist of purchased parts, components, and supplies which are used in the assembly of O&P devices for delivery to patients. In some cases, purchased parts and components are also sold directly to patients. Raw materials are valued based on recent vendor invoices, reduced by estimated vendor rebates. Such rebates are recognized as a reduction of cost of materials in the consolidated statements of operations when the related devices or components are delivered to the patient. Approximately 77% of raw materials at December 31, 2021 and 2020, respectively, were purchased from our Products & Services segment. Raw material inventory was $20.9 million and $18.4 million at December 31, 2021 and 2020, respectively.
WIP consists of devices which are in the process of assembly at our clinics or fabrication centers. WIP quantities were determined by the physical count of patient orders at the end of every quarter of 2021 and 2020 while the related stage of completion of each order was established by clinic personnel. We do not have an inventory costing system and as a result, the identified WIP quantities were valued on the basis of estimated raw materials, labor, and overhead costs. To estimate such costs, we develop bills of materials for certain categories of devices that we assemble and deliver to patients. Within each bill of material, we estimate (i) the typical types of component parts necessary to assemble each device; (ii) the points in the assembly process when such component parts are added; (iii) the estimated cost of such parts based on historical purchasing data; (iv) the estimated labor costs incurred at each stage of assembly; and (v) the estimated overhead costs applicable to the device.
Products & Services Segment
Our Product & Service segment inventories consist primarily of finished goods at its distribution centers as well as raw materials at fabrication facilities, and totaled $50.8 million and $45.9 million as of December 31, 2021 and 2020, respectively. Finished goods include products that are available for sale to third party customers as well as to our Patient Care segment as described above. Such inventories were determined on the basis of perpetual records and a physical count at year end. Inventories in connection with therapeutic services are valued at a weighted average cost.
Fair Value Measurements
We follow the authoritative guidance for financial assets and liabilities, which establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. The authoritative guidance requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy by which these assets and liabilities must be categorized, based on significant levels of inputs. The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Level 1 consists of securities for which there are quoted prices in active markets for identical securities;
Level 2 consists of securities for which observable inputs other than Level 1 inputs are used, such as quoted prices for similar securities in active markets or quoted prices for identical securities in less active markets and model-derived valuations for which the variables are derived from, or corroborated by, observable market data; and
Level 3 consists of securities for which there are no observable inputs to the valuation methodology that are significant to the measurement of the fair value.
The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
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.
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 counter party in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. In accordance with ASC 815, “Derivatives and Hedging,” we record all derivatives in the consolidated balance sheets as either assets or liabilities measured at fair value. 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 net of tax and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the years ended December 31, 2021 and 2020, such derivatives were used to hedge certain variable cash flows associated with existing variable-rate debt.
Insurance Recoveries Receivable
We incur legal and other costs with respect to a variety of issues on an ongoing basis. We record a related receivable when costs are reimbursable under applicable insurance policies, we believe it is probable such costs will be reimbursed and such reimbursements can be reasonably estimated. We record the benefit of related receivables from the insurer as a reduction of costs in the same financial statement caption in which the related loss was recognized in our consolidated statements of operations. Loss contingency reserves, which are recorded within accrued liabilities, are not reduced by estimated insurance recoveries.
Property, Plant, and Equipment, Net
Property, plant, and equipment are recorded at cost less accumulated depreciation and amortization. The cost and related accumulated depreciation of assets sold, retired, or otherwise disposed of are removed from the respective accounts, and any resulting gains or losses are included in the consolidated statements of operations. Depreciation is computed for financial reporting purposes using the straight-line method over the useful lives of the related assets estimated as follows: furniture and fixtures, equipment, and information systems, principally five years, buildings ten to forty years, finance leases over the shorter of the useful life or lease term, and leasehold improvements over the shorter of ten years or the lease term. We record maintenance and repairs, including the cost of minor replacements, to maintenance expense which is included within “Other operating costs” in our consolidated statements of operations. Costs of major repairs that extend the effective useful life of property are capitalized and depreciated accordingly.
We capitalize the costs of obtaining or developing internal use software, including external direct costs of materials and services and directly related payroll costs. Amortization begins when the internal use software is ready for its intended use. Costs incurred during the preliminary project and post-implementation stages, as well as maintenance and training costs, are expensed as incurred.
Business Combinations
We record tangible and intangible assets acquired and liabilities assumed in business combinations under the acquisition method of accounting. Acquisition consideration typically includes cash payments, the issuance of Seller Notes and in certain instances contingent consideration with payment terms based on the achievement of certain targets of the acquired business. Amounts paid for each acquisition are allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition inclusive of identifiable intangible assets. The estimated fair value of identifiable assets and liabilities, including intangibles, are based on valuations that use information and assumptions available to management. We allocate any excess purchase price over the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed to goodwill. We allocate goodwill to our reporting units based on the reporting unit that is expected to benefit from the acquired goodwill. Significant management judgments and assumptions are required in determining the fair value of assets acquired and liabilities assumed, particularly acquired intangible assets, including estimated useful lives. The valuation of purchased intangible assets is based upon estimates of the future performance and discounted cash flows of the acquired business. Each asset acquired or liability assumed is measured at estimated fair value from the perspective of a market participant. Subsequent changes in the estimated fair value of contingent consideration are recognized as general and administrative expenses within the consolidated statements of operations.
Goodwill and Other Intangible Assets, Net
Goodwill represents the excess of the purchase price over the estimated fair value of net identifiable assets acquired and liabilities assumed from purchased businesses. We assess goodwill for impairment annually during the fourth quarter, and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We have the option to first assess qualitative factors for a reporting unit to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the quantitative goodwill impairment test. If we choose to bypass this qualitative assessment or alternatively determine that a quantitative goodwill impairment test is required, our annual goodwill impairment test is performed by comparing the estimated fair value of a reporting unit with its carrying amount (including attributed goodwill). We measure the fair value of the reporting units using a combination of income and market approaches. Any impairment would be recognized by a charge to income from operations and a reduction in the carrying value of the goodwill. As of October 1, 2021, we performed a qualitative assessment of the Patient Care reporting unit, which resulted in no indicators of goodwill impairment.
We apply judgment in determining the fair value of our reporting units and the implied fair value of goodwill which is dependent on significant assumptions and estimates regarding expected future cash flows, terminal value, changes in working capital requirements, and discount rates.
We did not have any goodwill impairment during 2021, 2020, and 2019. We did not have any indefinite-lived trade name impairment during 2021, 2020, and 2019. See Note H - “Goodwill and Other Intangible Assets” to our consolidated financial statements in this Annual Report on Form 10-K for additional information.
As described, we apply judgment in the selection of key assumptions used in the goodwill impairment test and as part of our evaluation of intangible assets tested annually and at interim testing dates as necessary. If these assumptions differ from actual, we could incur additional impairment charges and those charges could be material.
Long-Lived Asset Impairment
We evaluate the carrying value of long-lived assets to be held and used for impairment whenever events or changes in circumstance indicate that the carrying amount may not be recoverable. The carrying value of a long-lived asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. We measure impairment as the amount by which the carrying value exceeds the estimated fair value. Estimated fair value is determined primarily using the projected future cash flows discounted at a rate commensurate with the risk involved. Long-lived assets to be disposed of by sale are classified as held for sale when the applicable criteria are met, and recognized within the consolidated balance sheet at the lower of carrying value or fair value less cost to sell. Depreciation on such assets is ceased.
Long-Term Debt
Long-term debt is recorded on our consolidated balance sheets at amortized cost, net of discounts and issuance expenses. Debt issuance costs incurred in connection with long-term debt are amortized utilizing the effective interest method, through the maturity of the related debt instrument. Discounts and costs incurred pertaining to the long-term debt are classified as a reduction of debt, and the costs incurred to obtain the revolving credit facility are recorded as deferred charges and are classified within other assets in the consolidated balance sheets. Amortization of these costs is included within “Interest expense, net” in the consolidated statements of operations.
Accounts Payable and Accrued Liabilities
Accounts payable relating to goods or services received is based on various factors including payments made subsequent to period end, vendor invoice dates, shipping terms confirmed by certain vendors or other third party documentation. Accrued liabilities are recorded based on estimates of services received or amounts expected to be paid to third parties. Accrued legal costs for legal contingencies are recorded when they are probable and estimable.
Self-Insurance Reserves
We maintain insurance programs which include employee health insurance; workers’ compensation; and product, professional, and general liability. Our employee health insurance program is self-funded, with a stop-loss coverage on claims that exceed $0.8 million for any individually covered claim. We are responsible for workers’ compensation, product, professional and general liability claims up to $0.5 million per individual incident. The insurance and self-insurance accruals reflect the estimate of incurred but not reported losses, historical claims experience, and expected costs to settle unpaid claims and are undiscounted. We record amounts due from insurance policies in “Other current assets” and “Other assets” while recording the estimated liability in “Accrued expenses and other current liabilities” and “Other liabilities” in our consolidated balance sheets.
Leases
We lease a majority of our patient care clinics 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 on a straight-line basis over 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. Equipment acquired under a finance lease is recorded at the present value of the future minimum lease payments. We do not separate non-lease components, consisting primarily of training, for these leases.
Income Taxes
We recognize deferred tax assets and liabilities for net operating loss and other credit carry forwards and the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The evaluation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns, and future profitability by tax jurisdiction.
We provide a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We evaluate our deferred tax assets quarterly to determine whether adjustments to the valuation allowance are appropriate in light of changes in facts or circumstances, such as changes in expected future pre-tax earnings, tax law, interactions with taxing authorities, and developments in case law. Our material assumptions include forecasts of future pre-tax earnings and the nature and timing of future deductions and income represented by the deferred tax assets and liabilities, all of which involve the exercise of significant judgment. We have experienced losses from 2014 to 2017 due to impairments of our intangible assets, increased professional fees in relation to our restatement and related remediation procedures for identified material weaknesses, and increased interest and bank fees. These losses have necessitated that we evaluate the sufficiency of our valuation allowance.
We are in a taxable income position in 2021 and are able to utilize net operating losses. We have $1.6 million and $4.6 million of U.S. federal and $139.1 million and $153.0 million of state net operating loss carryforwards available at December 31, 2021 and 2020, respectively. These carryforwards will be used to offset future income but may be limited by the change in ownership rules in Section 382 of the Internal Revenue Code. These net operating loss carryforwards will expire in varying amounts through 2041. We expect to generate income before taxes in future periods at a level that would allow for the full realization of the majority of our net deferred tax assets. As of December 31, 2021 and 2020, we have recorded a valuation allowance of approximately $2.1 million related to various state jurisdictions.
We believe that our tax positions are consistent with applicable tax law, but certain positions may be challenged by taxing authorities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. In addition, we are subject to periodic audits and examinations by the Internal Revenue Service and other state and local taxing authorities. In these cases, we record the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. We record the largest amount of tax benefit that is greater than fifty percent likely of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. If not paid, the liability for uncertain tax positions is reversed as a reduction of income tax expense at the earlier of the period when the position is effectively settled or when the statute of limitations has expired. Although we believe that our estimates are reasonable, actual results could differ from these estimates. Interest and penalties, when applicable, are recorded within the income tax provision.
Interest Expense, Net
We record interest expense net of interest income. In our consolidated statements of operations, interest income was $0.4 million in the year ended December 31, 2021 and not material in the years ended December 31, 2020, and 2019.
Share-Based Compensation
We primarily issue restricted common stock units under one active share-based compensation plan. Shares of common stock issued under this plan are issued from our authorized and unissued shares.
We measure and recognize compensation expense, net of actual forfeitures, for all shares based payments at fair value. Prior to the adoption of ASU 2016-09, compensation expense was measured and recognized net of estimated forfeitures. Our outstanding awards are comprised of restricted stock units, performance-based restricted stock units, and stock options. The
restricted stock units are subject to a service condition or vesting period ranging from one to four years. The performance-based restricted stock units include performance or market and service conditions. The performance conditions are primarily based on annual earnings per share targets and the market condition utilized in the Special Equity Plan is based on the three year absolute Common Stock price compounded annual growth rate (“CAGR”).
The fair value of each employee stock option award is estimated on the date of grant using the Black-Scholes option-pricing model. The expected dividend yield is derived from the annual dividend rate on the date of grant. The expected stock volatility is based on an assessment of our historical weekly stock prices as well as implied volatility. The risk-free interest rate is based on U.S. government zero coupon bonds with maturities similar to the expected holding period. The expected holding period was determined by examining historical and projected post-vesting exercise behavior activity. Forfeitures are recognized as they occur.
Compensation expense associated with restricted stock units and options is recognized on a straight-line basis over the requisite service period. Compensation expense associated with performance-based restricted stock units is primarily recognized on a graded vesting over the requisite service period when the performance condition is probable of being achieved. The compensation expense associated with the performance-based restricted stock subject to market conditions is recognized on a straight-line basis over the requisite service period.
Segment Information
We have two segments: Patient Care and Products & Services. Except for the segment specific policies described above, the segments follow the same accounting policies as followed in the consolidated financial statements. We apply the “management approach” to disclosure of segment information. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the basis of our reportable segments. The description of our reportable segments and the disclosure of segment information are presented in Note S - “Segment and Related Information” to these consolidated financial statements.
Intersegment revenue represents sales of O&P components from our Products & Services segment to our Patient Care segment and are recorded at prices that approximate material cost plus overhead.
Recent Developments Regarding COVID-19
We are subject to risks and uncertainties as a result of the outbreak of the novel coronavirus (“COVID-19”) pandemic (“COVID-19 pandemic”). The extent and duration of the impact of the COVID-19 pandemic on our operations and financial condition remain uncertain and difficult to predict. As a result of the COVID-19 pandemic, we believe that our patients are continuing to defer 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. Nevertheless, the overall adverse impact of the COVID-19 pandemic on our business volumes has diminished and stabilized over time, and our patient appointment and other business volumes continue to gradually improve as the prevalence of the virus decreases and COVID-19 vaccines become more widely available and accepted. It remains possible that further outbreaks of COVID-19, including the spread of variants such as the Delta and Omicron variants, or reinstitution of restrictive measures by federal, state, and local governments could cause a recessionary environment impacting the healthcare industry generally, including the O&P industry. The United States government has responded with fiscal policy measures intended to support the healthcare industry and economy as a whole, including the passage of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) in March 2020.
CARES Act
The CARES Act established the Public Health and Social Services Emergency Fund, also referred to as the Cares Act Provider Relief Fund, which set aside $203.5 billion to be administered through grants and other mechanisms to hospitals, public entities, not-for-profit entities and Medicare- and Medicaid- enrolled suppliers and institutional providers. The purpose of these funds is to reimburse providers for lost revenue and health-care related expenses that are attributable to the COVID-19 pandemic. In April 2020, the U.S. Department of Health and Human Services (“HHS”) began making payments to healthcare providers from the $203.5 billion appropriation. These are grants, rather than loans, to healthcare providers, and will not need to be repaid.
During 2021 and 2020, we recognized a total benefit of $1.1 million and $24.0 million, respectively in our consolidated statement of operations within Other operating costs in our Patient Care segment for the grant proceeds we received under the
CARES Act (“Grants”) from HHS. We accounted for the proceeds from the Grants by analogy to International Accounting Standard (“IAS 20”), Accounting for Government Grants and Disclosure of Government Assistance and its principles surrounding the recognition of grants related to income. We recognize income related to grants on a systematic and rational basis when it becomes probable that we have complied with the terms and conditions of the grant and in the period in which the corresponding costs or income related to the grant are recognized. We are using the Grants for their intended purpose, and are compliant to the reporting and audit requirements set by the terms and conditions of the grant.
The CARES Act also provided for a deferral of the employer portion of payroll taxes incurred during the COVID-19 pandemic through December 2020. The provisions allowed us to defer half of such payroll taxes until December 2021 and the remaining half until December 2022. We paid the current portion of $5.9 million in September 2021, and deferred $5.9 million of payroll taxes within Accrued compensation related costs in the consolidated balance sheet as of December 31, 2021.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
During 2021 we adopted the following:
•Accounting Standards Update (“ASU”) No. 2021-10, Government Assistance (Topic 832): Disclosures by Entities about Government Assistance, which requires entities to provide disclosures on material government assistance transactions for annual reporting periods. The disclosures include information around the nature of the assistance, the related accounting policies used to account for government assistance, the effect of government assistance, the effect of government assistance on the entity’s financial statements, and any significant terms and conditions of the agreements, including commitments and contingencies. The new standard is effective on a prospective basis for fiscal years beginning after December 15, 2021, but as early adoption is permitted, we have selected to adopt this standard for the year ended December 31, 2021.
During 2020 we adopted the following:
•ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and related clarifying standards, as of January 1, 2020, using the modified retrospective approach. This approach allows us to apply the standard as of the adoption date and record a cumulative-effect adjustment to the opening balance of accumulated deficit at January 1, 2020. The new standard replaces the incurred loss impairment methodology 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. The resulting cumulative effect recognized at adoption to accumulated deficit was $0.2 million, net of tax.
•ASU No. 2018-13, Fair Value Measurement (Topic 820), as of January 1, 2020. The new standard 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. There was no material impact on our consolidated financial position, results of operations, or cash flows due to the adoption.
•ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, as of January 1, 2020. Among other provisions, the new standard 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. There was no material impact on our consolidated financial position, results of operations, or cash flows due to the adoption.
Recent Accounting Pronouncements, Not Yet Adopted
In March 2020, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU, effective beginning on March 12, 2020, provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update apply only to contracts, hedging relationships, and other transactions that reference London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. We are currently evaluating the effects that the adoption of this guidance, and related clarifying standards, will have on our consolidated financial statements and the related disclosures.
Note B — Earnings Per Share
Basic earnings per common share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed using the weighted average number of common shares outstanding during the period plus any potentially dilutive common shares, such as stock options, restricted stock units, and performance-based units calculated using the treasury stock method. Total anti-dilutive shares excluded from the diluted earnings per share were 5,378 as of December 31, 2021, 3,831 as of December 31, 2020, and zero as of December 31, 2019.
Our Credit Agreement (as defined below) restricts the payment of dividends or other distributions to our shareholders by us or any of our subsidiaries. See Note M - “Debt and Other Obligations” within these consolidated financial statements.
The reconciliation of the numerators and denominators used to calculate basic and diluted net income per share are as follows:
| | | | | | | | | | | | | | | | | | | | |
| | For the Years Ended December 31, |
(in thousands, except per share data) | | 2021 | | 2020 | | 2019 |
Net income | | $ | 41,982 | | | $ | 38,192 | | | $ | 27,525 | |
| | | | | | |
Weighted average shares outstanding - basic | | 38,599,300 | | | 37,948,796 | | | 37,267,188 | |
Effect of potentially dilutive restricted stock units and options | | 626,316 | | | 649,534 | | | 797,429 | |
Weighted average shares outstanding - diluted | | 39,225,616 | | | 38,598,330 | | | 38,064,617 | |
| | | | | | |
Basic income per share | | $ | 1.09 | | | $ | 1.01 | | | $ | 0.74 | |
| | | | | | |
Diluted income per share | | $ | 1.07 | | | $ | 0.99 | | | $ | 0.72 | |
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 VA, or 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 years ended December 31, 2021, 2020, and 2019:
| | | | | | | | | | | | | | | | | | | | |
| | For the Years Ended December 31, |
(in thousands) | | 2021 | | 2020 | | 2019 |
Patient Care Segment | | | | | | |
Medicare | | $ | 296,327 | | | $ | 268,226 | | | $ | 289,099 | |
Medicaid | | 166,411 | | | 135,134 | | | 143,438 | |
Commercial Insurance / Managed Care (excluding Medicare and Medicaid Managed Care) | | 327,836 | | | 296,738 | | | 323,499 | |
Veterans Administration | | 89,358 | | | 76,769 | | | 89,035 | |
Private Pay | | 63,396 | | | 54,736 | | | 60,620 | |
Total | | $ | 943,328 | | | $ | 831,603 | | | $ | 905,691 | |
The impact to revenue related to prior period performance obligations was not material for the years ended December 31, 2021, 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.
The following table disaggregates revenue from contracts with customers in our Product & Services segment for the years ended December 31, 2021, 2020, and 2019:
| | | | | | | | | | | | | | | | | | | | |
| | For the Years Ended December 31, |
(in thousands) | | 2021 | | 2020 | | 2019 |
Products & Services Segment | | | | | | |
Distribution services, net of intersegment revenue eliminations | | $ | 133,636 | | | $ | 124,045 | | | $ | 143,400 | |
Therapeutic solutions | | 43,524 | | | 45,502 | | | 48,955 | |
Total | | $ | 177,160 | | | $ | 169,547 | | | $ | 192,355 | |
Note D — Accounts Receivable, Net
Accounts receivable, net represents outstanding amounts we expect to collect from the transfer of our products and services. Principally, these amounts are comprised of receivables from Medicare, Medicaid, and commercial insurance plans. Our accounts receivable represent amounts outstanding from our gross charges, net of contractual discounts, sales returns, and other implicit price concessions including estimates for payor disallowances and patient non-payments.
We are exposed to credit losses primarily through our accounts receivable. These receivables are short in nature because their due date varies between due upon receipt of invoice and 90 days. We assess our receivables, divide them into similar risk pools, and monitor our ongoing credit exposure through active review of our aging buckets. Our activities include timely account reconciliations, dispute resolution, and payment confirmations. We also employ collection agencies and legal counsel to pursue recovery of defaulted receivables.
Our expected loss methodology is developed using historical liquidation rates, current and future economic and market conditions, and a review of the current status of our patients and customers’ trade accounts receivable balances. We also grouped our receivables into similar risk pools to better measure the risks for each pool. After evaluating the risk for each pool, we determined that additional credit loss risk was immaterial for the Patient Care segment. For the Products & Services segment, an allowance for doubtful accounts is recorded, which is deducted from gross accounts receivable to arrive at “Accounts receivable, net.” As of December 31, 2021, we have considered the current and future economic and market conditions resulting in a decrease to the allowance for doubtful accounts by approximately $0.8 million since December 31, 2020.
Accounts receivable, net as of December 31, 2021 and 2020 is comprised of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As of December 31, 2021 | | As of December 31, 2020 |
(in thousands) | | Patient Care | | Products & Services | | Consolidated | | Patient Care | | Products & Services | | Consolidated |
Gross charges before estimates for implicit price concessions | | $ | 173,115 | | | $ | 21,459 | | | $ | 194,574 | | | $ | 156,504 | | | $ | 21,300 | | | $ | 177,804 | |
Less estimates for implicit price concessions: | | | | | | | | | | | | |
Payor disallowances | | (33,007) | | | — | | | (33,007) | | | (39,343) | | | — | | | (39,343) | |
Patient non-payments | | (7,500) | | | — | | | (7,500) | | | (7,042) | | | — | | | (7,042) | |
Accounts receivable, gross | | 132,608 | | | 21,459 | | | 154,067 | | | 110,119 | | | 21,300 | | | 131,419 | |
Allowance for doubtful accounts | | — | | | (2,009) | | | (2,009) | | | — | | | (2,823) | | | (2,823) | |
Accounts receivable, net | | $ | 132,608 | | | $ | 19,450 | | | $ | 152,058 | | | $ | 110,119 | | | $ | 18,477 | | | $ | 128,596 | |
Approximately 46.3% and 46.8% of gross charges before estimates for payor disallowances and patient non-payments, is due from the Federal Government (Medicare, Medicaid, and the VA) at December 31, 2021 and 2020, respectively.
The following table summarizes activities by year for the allowance for doubtful accounts:
| | | | | | | | |
(in thousands) | | Allowance for Doubtful Accounts |
Balance at December 31, 2018 | | $ | 2,272 | |
Additions | | 1,877 | |
Reductions | | (762) | |
Recoveries | | (746) | |
Balance at December 31, 2019 | | 2,641 | |
Additions | | 1,869 | |
Reductions | | (114) | |
Recoveries | | (1,573) | |
Balance at December 31, 2020 | | 2,823 | |
Additions | | 907 | |
Reductions | | (759) | |
Recoveries | | (962) | |
Balance at December 31, 2021 | | $ | 2,009 | |
The following tables represent gross charges before estimates for payor disallowances and patient non-payments, by major payor classification and by aging categories reduced by implicit price concessions and allowance for doubtful accounts to accounts receivable, net as of December 31, 2021 and 2020, respectively:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2021 | | | | | | | | | | |
(in thousands) | | 0-60 Days | | 61-120 Days | | 121-180 Days | | Over 180 Days | | Total |
Patient Care | | | | | | | | | | |
Commercial insurance (excluding Medicare and Medicaid Managed Care) | | $ | 50,397 | | | $ | 12,559 | | | $ | 6,512 | | | $ | 11,869 | | | $ | 81,337 | |
Private pay | | 938 | | | 392 | | | 284 | | | 121 | | | 1,735 | |
Medicaid | | 15,595 | | | 3,404 | | | 1,698 | | | 4,135 | | | 24,832 | |
VA | | 4,345 | | | 868 | | | 517 | | | 453 | | | 6,183 | |
Non-Medicare | | 71,275 | | | 17,223 | | | 9,011 | | | 16,578 | | | 114,087 | |
Medicare | | 35,354 | | | 6,100 | | | 3,923 | | | 13,651 | | | 59,028 | |
| | | | | | | | | | |
Products & Services accounts receivable, before allowance | | 14,301 | | | 5,071 | | | 901 | | | 1,186 | | | 21,459 | |
Gross charges before estimates for implicit price concessions and allowance for doubtful accounts | | 120,930 | | | 28,394 | | | 13,835 | | | 31,415 | | | 194,574 | |
Less estimates for implicit price concessions | | | | | | | | | | (40,507) | |
Accounts receivable, before allowance | | | | | | | | | | 154,067 | |
Allowance for doubtful accounts | | | | | | | | | | (2,009) | |
Accounts receivable, net | | | | | | | | | | $ | 152,058 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2020 | | | | | | | | | | |
(in thousands) | | 0-60 Days | | 61-120 Days | | 121-180 Days | | Over 180 Days | | Total |
Patient Care | | | | | | | | | | |
Commercial insurance (excluding Medicare and Medicaid Managed Care) | | $ | 43,069 | | | $ | 10,743 | | | $ | 5,335 | | | $ | 12,316 | | | $ | 71,463 | |
Private pay | | 850 | | | 401 | | | 309 | | | 281 | | | 1,841 | |
Medicaid | | 13,569 | | | 2,705 | | | 1,390 | | | 3,771 | | | 21,435 | |
VA | | 4,291 | | | 692 | | | 263 | | | 279 | | | 5,525 | |
Non-Medicare | | 61,779 | | | 14,541 | | | 7,297 | | | 16,647 | | | 100,264 | |
Medicare | | 27,572 | | | 5,169 | | | 2,915 | | | 20,585 | | | 56,241 | |
| | | | | | | | | | |
Products & Services accounts receivable, before allowance | | 14,091 | | | 4,598 | | | 841 | | | 1,769 | | | 21,299 | |
Gross charges before estimates for implicit price concessions and allowance for doubtful accounts | | 103,442 | | | 24,308 | | | 11,053 | | | 39,001 | | | 177,804 | |
Less estimates for implicit price concessions | | | | | | | | | | (46,385) | |
Accounts receivable, before allowance | | | | | | | | | | 131,419 | |
Allowance for doubtful accounts | | | | | | | | | | (2,823) | |
Accounts receivable, net | | | | | | | | | | $ | 128,596 | |
Note E — Inventories
Our inventories are comprised of the following:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Raw materials | | $ | 22,759 | | | $ | 19,716 | |
Work in process | | 15,807 | | | 12,040 | |
Finished goods | | 48,896 | | | 44,673 | |
Total inventories | | $ | 87,462 | | | $ | 76,429 | |
Note F — Property, Plant, and Equipment, Net
Property, plant, and equipment, net were comprised of the following:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Land | | $ | 454 | | | $ | 454 | |
Buildings | | 3,031 | | | 3,044 | |
Furniture and fixtures | | 14,737 | | | 15,079 | |
Machinery and equipment | | 27,429 | | | 25,759 | |
Equipment leased to third parties under operating leases | | 35,408 | | | 40,137 | |
Leasehold improvements | | 149,337 | | | 139,322 | |
Computers and software | | 83,641 | | | 80,790 | |
Total property, plant, and equipment, gross | | 314,037 | | | 304,585 | |
Less: accumulated depreciation and amortization | | (231,603) | | | (219,712) | |
Total property, plant, and equipment, net | | $ | 82,434 | | | $ | 84,873 | |
Total depreciation expense was approximately $26.9 million, $28.2 million, and $30.6 million for the years ended December 31, 2021, 2020, and 2019, respectively.
The following table summarizes our investment in equipment leased to third parties under operating leases:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Program equipment | | $ | 35,408 | | | $ | 40,137 | |
Less: Accumulated depreciation | | (22,826) | | | (25,430) | |
Net book value | | $ | 12,582 | | | $ | 14,707 | |
Note G — Acquisitions
2021 Acquisition Activity
During 2021, we completed the following acquisitions of O&P clinics with the intention of expanding the geographic footprint of our patient care offerings through the acquisitions of these high quality O&P providers. None of the acquisitions were individually material to our financial position, results of operations, or cash flows.
•In the first quarter of 2021, we completed the acquisitions of all the outstanding equity interests of three O&P businesses and the assets of one O&P business for total consideration of $24.2 million, of which $19.2 million was
cash consideration, net of cash acquired, $4.0 million was issued in the form of notes to shareholders at fair value, and $1.0 million in additional consideration.
•In the second quarter of 2021, we completed the acquisitions of all the outstanding equity interests of two O&P businesses for total consideration of $21.0 million, of which $16.0 million was cash consideration, net of cash acquired, $4.9 million was issued in the form of notes to shareholders at fair value, and $0.1 million in additional consideration.
•In the third quarter of 2021, we completed the acquisitions of all the outstanding equity interests of three O&P businesses and the assets of one O&P business for total consideration of $6.2 million, of which $3.9 million was cash consideration, net of cash acquired, $1.5 million was issued in the form of notes to shareholders at fair value, and $0.8 million in additional consideration.
•In the fourth quarter of 2021, we completed the acquisitions of all the outstanding equity interests of eight O&P businesses for total consideration of $53.1 million, of which $40.8 million was cash consideration, net of cash acquired, and $12.3 million was issued in the form of notes to shareholders at fair value.
The notes issued to shareholders are unsecured and payable in installments over a period of 2 to 5 years.
We accounted for these transactions under the acquisition method of accounting and have reported the results of operations of each acquisition as of the respective dates of the acquisitions. We based the estimated fair values of intangible assets on an income approach utilizing the excess earnings method for customer relationships. The income approach utilizes management’s estimates of future operating results and cash flows using a weighted average cost of capital that reflects market participant assumptions. Other significant judgments used in the valuation of tangible assets acquired in the acquisition include estimated selling price of inventory and estimated replacement cost for acquired property, plant, and equipment. For all other assets acquired and liabilities assumed, the fair value reflects the carrying value of the asset or liability due to their short maturity. We recorded the excess of the fair value of the consideration transferred in the acquisitions over the fair value of net assets acquired 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 the majority of the goodwill acquired in the first quarter of 2021, which has been assigned to our Patient Care reporting unit, will not be deductible for federal income tax purposes. We expect that substantially all of the goodwill acquired in the second, third, and fourth quarters of 2021, which has been assigned to our Patient Care reporting unit, will be deductible for federal income tax purposes.
Acquisition-related costs are included in general and administrative expenses in our consolidated statements of operations. Total acquisition-related costs incurred during the years ended December 31, 2021 and 2020 were $2.1 million and $0.9 million, respectively, which includes those costs for transactions that are in progress or not completed during the respective period. Acquisition-related costs incurred for acquisitions completed during the years ended December 31, 2021 and 2020 were $1.6 million and $0.6 million, respectively.
We have not presented pro forma combined results for these acquisitions because the impact on previously reported statements of operations would not have been material individually or in the aggregate.
Purchase Price Allocation
For acquisitions that occurred after the second quarter of 2021, we have performed a preliminary valuation analysis of the fair market value of the assets acquired and liabilities assumed in the acquisitions. The final purchase price allocations will be determined when we have completed and fully reviewed the detailed valuations and could differ materially from the preliminary allocations. The final allocations may include changes in allocations of acquired intangible assets as well as goodwill and other changes to assets and liabilities, including deferred taxes. The estimated useful lives of acquired intangible assets are also preliminary. We have finalized the purchase price allocation within the measurement period for acquisitions that have been completed prior to the third quarter of 2020.
The aggregate purchase price of these acquisitions was allocated on a preliminary basis as follows:
| | | | | | | | |
(in thousands) | | |
Cash paid, net of cash acquired | | $ | 79,927 | |
Issuance of Seller Notes at fair value | | 22,706 | |
Additional consideration, net | | 1,925 | |
Aggregate purchase price | | 104,558 | |
| | |
Accounts receivable | | 6,569 | |
Inventories | | 4,683 | |
Customer relationships (Weighted average useful life of 5.0 years) | | 11,745 | |
Non-compete agreements (Weighted average useful life of 5.0 years) | | 558 | |
Other assets and liabilities, net | | (5,121) | |
Net assets acquired | | 18,434 | |
Goodwill | | $ | 86,124 | |
Right-of-use assets and lease liabilities related to operating leases recognized in connection with acquisitions completed for the year ended December 31, 2021 was $8.9 million.
2020 Acquisition Activity
During 2020, we completed the following acquisitions of O&P clinics with the intention of expanding the geographic footprint of our patient care offerings through the acquisitions of these high quality O&P providers. None of the acquisitions were individually material to our financial position, results of operations, or cash flows.
•In the second quarter of 2020, we acquired all of the outstanding equity interests of an O&P business for total consideration of $46.2 million at fair value, of which $16.8 million was cash consideration, net of cash acquired, $21.9 million was issued in the form of notes to the former shareholders, $3.5 million in the form of a deferred payment obligation to the former shareholders, and $4.0 million in additional consideration. Of the $21.9 million in notes issued to the former shareholders, approximately $18.1 million of the notes were paid in October 2020 in a lump sum payment and the remaining $3.8 million of the notes are payable in annual installments over a period of three years on the anniversary date of the acquisition. Total payments of $4.0 million under the deferred payment obligation are due in annual installments beginning in the fourth year following the acquisition and for three years thereafter. Additional consideration includes approximately $3.6 million in liabilities incurred to the shareholders as part of the business combination payable in October 2020 and is included in Accrued expenses and other liabilities in the consolidated balance sheet. The remaining $0.4 million in additional consideration represents the effective settlement of amounts due to us from the acquired O&P business as of the acquisition date.
•In the fourth quarter of 2020, we completed the acquisitions of all the outstanding equity interests of four O&P businesses for total consideration of $7.1 million, of which $4.9 million was cash consideration, net of cash acquired, $1.9 million was issued in the form of notes to shareholders at fair value, and $0.3 million in additional consideration.
The notes issued to shareholders are unsecured and payable in installments over a period of 3 to 5 years.
The aggregate purchase price of these acquisitions was allocated as follows:
| | | | | | | | |
(in thousands) | | |
Cash paid, net of cash acquired | | $ | 21,709 | |
Issuance of Seller Notes at fair value | | 23,766 | |
Deferred payment obligation at fair value | | 3,468 | |
Additional consideration, net | | 4,319 | |
Aggregate purchase price | | 53,262 | |
| | |
Accounts receivable | | 4,224 | |
Inventories | | 2,276 | |
Customer relationships (Weighted average useful life of 5.0 years) | | 6,358 | |
Non-compete agreements (Weighted average useful life of 5.0 years) | | 200 | |
Other assets and liabilities, net | | (4,561) | |
Net assets acquired | | 8,497 | |
Goodwill | | $ | 44,765 | |
Right-of-use assets and lease liabilities related to operating leases recognized in connection with acquisitions completed for the year ended December 31, 2020 was $5.5 million.
Note H — Goodwill and Other Intangible Assets
Goodwill
Under the provisions of ASC 350-10, Intangibles-Goodwill and Other, goodwill is not amortized. Rather, an entity’s goodwill is subject to periodic impairment testing. ASC 350 requires that an entity assign its goodwill to reporting units and test each reporting unit’s goodwill for impairment at least on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Accordingly, we perform our goodwill test annually as of October 1 and between annual tests whenever we identify certain triggering events or circumstances that would more likely than not reduce the fair value of any of our reporting units below its respective carrying value. Additionally, we consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable.
The goodwill impairment test compares a reporting unit’s fair value to its carrying amount to identify any potential impairment. We apply judgment in determining the fair value of our reporting units for purposes of performing the goodwill impairment test. We rely on widely accepted valuation techniques, including discounted cash flow and market multiple analysis approaches, which capture both the future income potential of the reporting unit and the market behaviors and actions of market participants in the industry that includes the reporting unit. These types of analyses require us to make assumptions and estimates regarding future cash flows, industry-specific economic factors, and the profitability of future business strategies. The discounted cash flow approach uses a projection of estimated operating results and cash flows that are discounted using a weighted average cost of capital. Under the discounted cash flow approach, the projection uses management’s best estimates of the amount and timing of expected future cash flows impacted by economic and market conditions over the projected period for each reporting unit. Significant estimates and assumptions include terminal value growth rates, changes in working capital requirements, and weighted average cost of capital. The market multiple analysis estimates fair value by applying revenue and earnings multiples to the reporting unit’s operating results. The multiples are derived from comparable publicly traded companies with similar operating and investment characteristics to the reporting units.
We evaluate the reasonableness of the estimated fair value of our reporting units by reconciling the aggregate fair value of our reporting units to our total market capitalization as of our impairment testing date, taking into account an appropriate control premium. The determination of a control premium requires the use of judgment and is based upon control premiums observed in comparable market transactions.
The changes in the carrying value of goodwill of the Patient Care operating segment for the years ended December 31, 2021 and 2020 are as follows:
| | | | | | | | | | | | | | | | | | | | |
(in thousands) | | Goodwill, Gross | | Accumulated Impairment | | Goodwill, Net |
Balance at December 31, 2019 | | $ | 660,912 | | | $ | (428,668) | | | $ | 232,244 | |
Additions from acquisitions | | 45,144 | | | — | | | 45,144 | |
Measurement period adjustments (1) | | (165) | | | — | | | (165) | |
Balance at December 31, 2020 | | 705,891 | | | (428,668) | | | 277,223 | |
Additions from acquisitions | | 86,124 | | | — | | | 86,124 | |
Measurement period adjustments (2) | | 207 | | | — | | | 207 | |
Balance at December 31, 2021 | | $ | 792,222 | | | $ | (428,668) | | | $ | 363,554 | |
(1) Measurement period adjustments relate to 2020 and prior years acquisitions of approximately $(0.2) million and are primarily attributable to adjustments to the preliminary allocations of acquired assets.
(2) Measurement period adjustments relate to 2021 and prior years acquisitions of approximately $0.2 million and are primarily attributable to adjustments to the preliminary allocations of acquired assets.
As of December 31, 2017, goodwill of approximately $139.3 million within the Products and Services operating segment was impaired in full.
See Note G - “Acquisitions” within these consolidated financial statements for details surrounding goodwill acquired during the years ended December 31, 2021 and 2020.
As of October 1, 2021 and 2019, we performed a qualitative assessment of goodwill impairment for the Patient Care reporting unit, which resulted in our determination that it was more likely than not that the carrying value of the reporting unit was less than its fair value. As of October 1, 2020, we performed a quantitative assessment of goodwill impairment for the Patient Care reporting unit, which resulted in our determination that it was more likely than not that the carrying value of the reporting unit was less than its fair value.
Other Intangible Assets
Under the provisions of ASC 360-10, Property, plant, and equipment, an intangible asset that has a finite life should be amortized over its estimated useful life and should be tested for recoverability by comparing the net carrying value of the asset or asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset or asset group when events or changes in circumstances indicate that its carrying amount may not be recoverable. If the carrying amount of a definite-lived asset or asset group is not recoverable, the fair value of the asset or asset group is measured and if the carrying amount exceeds the fair value, an impairment loss is recognized.
Under the provisions of ASC 350, Intangibles-goodwill and other, an indefinite-lived intangible asset is not amortized but should be tested for impairment annually and between annual tests if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. The indefinite-lived intangible asset impairment standard allows an entity first to assess qualitative factors to determine if a quantitative impairment test is necessary. Further testing is only required if the entity determines, based on the qualitative assessment, that it is more likely than not that an indefinite-lived intangible asset’s fair value is less than its carrying amount. We perform our annual test for recoverability as of October 1.
The balances related to other intangible assets as of December 31, 2021 and 2020 are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As of December 31, 2021 |
(in thousands) | | Gross Carrying Amount | | Accumulated Amortization | | Accumulated Impairment | | Net Carrying Amount |
Customer lists | | $ | 28,624 | | | $ | (9,973) | | | $ | — | | | $ | 18,651 | |
Trade name | | 255 | | | (202) | | | — | | | 53 | |
Patents and other intangibles | | 9,572 | | | (6,501) | | | — | | | 3,071 | |
Definite-lived intangible assets | | 38,451 | | | (16,676) | | | — | | | 21,775 | |
Indefinite-lived trade name | | 9,070 | | | — | | | (4,953) | | | 4,117 | |
Total other intangible assets | | $ | 47,521 | | | $ | (16,676) | | | $ | (4,953) | | | $ | 25,892 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As of December 31, 2020 |
(in thousands) | | Gross Carrying Amount | | Accumulated Amortization | | Accumulated Impairment | | Net Carrying Amount |
Customer lists | | $ | 16,879 | | | $ | (5,845) | | | $ | — | | | $ | 11,034 | |
Trade name | | 255 | | | (176) | | | — | | | 79 | |
Patents and other intangibles | | 9,011 | | | (5,810) | | | — | | | 3,201 | |
Definite-lived intangible assets | | 26,145 | | | (11,831) | | | — | | | 14,314 | |
Indefinite-lived trade name | | 9,070 | | | — | | | (4,953) | | | 4,117 | |
Total other intangible assets | | $ | 35,215 | | | $ | (11,831) | | | $ | (4,953) | | | $ | 18,431 | |
The fair value of acquired customer list intangibles is estimated using an excess earnings model. Key assumptions utilized in the valuation model include pro-forma projected cash flows adjusted for market-participant assumptions, forecasted customer retention rates, and discount rates. Existing customer intangibles are amortized using the straight-line method over an estimated useful life of four to ten years. The fair value of non-compete agreements are estimated at management’s discretion using a discounted cash flow model or using potential loss exposure of acquired clinicians based on an average amount of revenue generated by clinicians utilizing internal data. Due to the inherent judgmental nature of these assumptions, management will perform a sensitivity analysis on an acquisition by acquisition basis, considering the facts and circumstances of each acquisition. The related intangible assets are amortized, using the straight-line method, over their contractual term which ranges from two to twelve years. Other definite-lived intangible assets are recorded at cost and are amortized, using the straight-line method, over their estimated useful lives of up to nineteen years. The fair value associated with trade names is estimated using the relief-from-royalty method with the primary assumptions being the royalty rate and expected revenues associated with the trade names. These assets, some of which have indefinite lives, are primarily included in the Products & Services segment. Indefinite-lived trade name intangible assets are assessed for impairment in the fourth quarter of each year, or more frequently if events or changes in circumstances indicate that the asset might be impaired. There was no impairment on our indefinite-lived trade name for the years ended December 31, 2021, 2020, and 2019, respectively. Trade name intangible assets with definite lives are amortized over their estimated useful lives of up to ten years.
Amortization expense related to other intangible assets was approximately $4.9 million, $6.0 million, and $5.0 million for the years ended December 31, 2021, 2020, and 2019, respectively.
Estimated aggregate amortization expense for definite-lived intangible assets for each of the next five years ended December 31, and thereafter is as follows:
| | | | | | | | |
(in thousands) | | |
2022 | | $ | 6,307 | |
2023 | | 6,045 | |
2024 | | 4,554 | |
2025 | | 3,366 | |
2026 | | 1,500 | |
Thereafter | | 3 | |
Total | | $ | 21,775 | |
Note I — Other Current Assets and Other Assets
Other current assets consist of the following:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Non-trade receivables | | $ | 7,725 | | | $ | 6,063 | |
Prepaid maintenance | | 4,553 | | | 2,942 | |
Prepaid insurance | | 510 | | | 266 | |
Other prepaid assets | | 3,748 | | | 3,086 | |
Total other current assets | | $ | 16,536 | | | $ | 12,357 | |
Non-trade receivables primarily relate to vendor rebate receivables, tenant improvement allowance receivables under previous lease accounting guidance, and other non-trade receivables. Prepaid maintenance primarily relates to prepaid software and hardware maintenance and software license fees. Prepaid insurance is for product and general liability insurance. Other prepaid assets includes future rent expense paid in advance of the rental period, employer’s portion of health savings accounts, board member fees, tax and accounting services, unit commitments to fulfill our obligation with one of our product suppliers, education and training for our annual Hanger LIVE event generally held in the first quarter of each fiscal year, telecommunication, broker fees, and other miscellaneous prepaid expenses.
Other assets consist of the following:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Implementation costs for cloud computing arrangements | | $ | 6,459 | | | $ | 4,811 | |
Cash surrender value of company-owned life insurance | | 4,471 | | | 3,973 | |
Finance lease right-of-use assets | | 2,732 | | | 3,016 | |
Deposits | | 2,178 | | | 2,144 | |
Non-trade receivables | | 1,172 | | | 1,274 | |
Other | | 933 | | | 516 | |
Total other assets | | $ | 17,945 | | | $ | 15,734 | |
Implementation costs for cloud computing arrangements relate to capitalized costs of our new financial and supply chain systems. The cash surrender value of company-owned life insurance (“COLI”) funded our Defined Contribution Supplemental Executive Retirement Plan (“DC SERP”) at December 31, 2021 and December 31, 2020. See Note Q - “Employee Benefits” for additional information. Finance lease right-of-use assets relate to the recognition of right-of-use assets in connection with finance leases. Deposits primarily relate to security deposits made in connection with property leases. Non-trade receivables primarily relate to estimated receivables due from our various business insurance policies. Other relates to prepaid maintenance fees, prepaid license fees, and revolver facility fees.
Note J — Accrued Expenses and Other Current Liabilities and Other Liabilities
Accrued expenses and other current liabilities consist of:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Patient prepayments, deposits, and refunds payable | | $ | 26,475 | | | $ | 27,195 | |
Insurance and self-insurance accruals | | 8,943 | | | 7,651 | |
Accrued sales taxes and other taxes | | 7,803 | | | 9,863 | |
Derivative liability | | 6,425 | | | 7,686 | |
Accrued professional fees | | 750 | | | 1,016 | |
Accrued interest payable | | 707 | | | 440 | |
Other current liabilities | | 9,296 | | | 9,010 | |
Total | | $ | 60,399 | | | $ | 62,861 | |
Patient prepayment deposits and refunds includes funds received for devices not yet delivered to a patient and refunds for overpayments. Accrued insurance primarily relates to accruals for estimated losses for certain self-insured risks including property, professional and general liability, and employee health care costs. Taxes primarily includes accrued sales, property, and franchise tax liabilities. Derivative liability relates to our cash flow hedge; refer to Note O - “Derivative Financial Instruments.” Accrued professional fees primarily relate to accruals for professional accounting and legal fees. Accrued interest payable relates to interest on our debt obligation. Other current liabilities are primarily related to accruals for deferred revenue and warranty liabilities.
Other liabilities consist of:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Supplemental executive retirement plan obligations | | $ | 20,779 | | | $ | 21,503 | |
Long-term insurance accruals | | 7,112 | | | 7,326 | |
Derivative liability | | 4,664 | | | 14,388 | |
Deferred payroll taxes | | — | | | 5,918 | |
Unrecognized tax benefits | | — | | | 5,465 | |
Other | | 2,285 | | | 1,993 | |
Total | | $ | 34,840 | | | $ | 56,593 | |
Supplemental executive retirement plan obligations include obligations due on both the Defined Benefit Supplemental Executive Retirement Plan (“DB SERP”) and DC SERP. See Note Q - “Employee Benefits” within these consolidated financial statements. Derivative liability relates to our cash flow hedge; refer to Note O - “Derivative Financial Instruments.” Deferred payroll taxes represents deferred liabilities associated with the CARES Act. Unrecognized tax benefits represent the difference between tax positions that we expect to take, or take on our income tax returns and the benefit we recognize on our financial statements. Other includes asset retirement obligations, which is the liability to return a leased building to the state before it was occupied, fair market value lease differential liability, and other long-term accrued expenses.
Note K — Income Taxes
Components of provision for income taxes are as follows:
| | | | | | | | | | | | | | | | | | | | |
| | Years Ended December 31, |
(in thousands) | | 2021 | | 2020 | | 2019 |
Current: | | | | | | |
Federal | | $ | (4,937) | | | $ | (16,986) | | | $ | 5,461 | |
State | | 483 | | | 192 | | | 719 | |
Total current | | (4,454) | | | (16,794) | | | 6,180 | |
Deferred: | | | | | | |
Federal | | 4,065 | | | 15,169 | | | 1,803 | |
State | | 1,547 | | | 2,263 | | | (5,029) | |
Total deferred | | 5,612 | | | 17,432 | | | (3,226) | |
Total provision for income taxes | | $ | 1,158 | | | $ | 638 | | | $ | 2,954 | |
A reconciliation of the federal statutory tax rate to our effective tax rate applicable to continuing operations is as follows:
| | | | | | | | | | | | | | | | | | | | |
| | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Federal statutory tax rate | | 21.0 | % | | 21.0 | % | | 21.0 | % |
State and local income taxes | | 5.3 | % | | 4.5 | % | | 6.0 | % |
Research and development credits | | (17.2) | % | | (28.0) | % | | — | % |
Change in uncertain tax positions | | (6.3) | % | | 6.9 | % | | 0.2 | % |
Tax benefit from net operating loss carryback | | — | % | | (10.2) | % | | — | % |
Permanent items | | 1.4 | % | | 5.4 | % | | 2.3 | % |
State tax rate change effect on deferred balance | | (0.8) | % | | 1.7 | % | | — | % |
Other tax credits | | (0.2) | % | | (0.1) | % | | (0.1) | % |
Tax audit adjustments | | (0.1) | % | | — | % | | 0.9 | % |
Change in valuation allowance | | — | % | | — | % | | (22.5) | % |
Other | | (0.4) | % | | 0.4 | % | | 1.9 | % |
Tax provision | | 2.7 | % | | 1.6 | % | | 9.7 | % |
The significant components of our deferred tax assets and liabilities are presented in the following table:
| | | | | | | | | | | | | | |
| | As of December 31, |
(in thousands) | | 2021 | | 2020 |
Deferred tax assets: | | | | |
Lease liabilities | | $ | 40,389 | | | $ | 35,801 | |
Research and development credits | | 13,332 | | | 9,637 | |
Accrued expenses | | 13,260 | | | 15,611 | |
Provision for doubtful accounts and implicit price concessions | | 12,154 | | | 13,291 | |
Deferred benefit plan compensation | | 8,316 | | | 11,199 | |
Net operating loss carryforwards | | 7,714 | | | 8,907 | |
Inventory reserves | | 3,425 | | | 2,945 | |
Share-based compensation | | 2,998 | | | 3,437 | |
Refund liabilities | | 2,169 | | | 2,518 | |
Other | | 2,857 | | | 3,378 | |
Deferred tax assets | | 106,614 | | | 106,724 | |
Less: Valuation allowance | | (2,075) | | | (2,112) | |
Total deferred tax assets | | 104,539 | | | 104,612 | |
Deferred tax liabilities: | | | | |
Lease assets | | 37,095 | | | 32,069 | |
Goodwill | | 12,116 | | | 9,368 | |
Property, plant, and equipment | | 6,731 | | | 7,198 | |
Prepaid expenses | | 3,103 | | | 1,100 | |
Total deferred tax liabilities | | 59,045 | | | 49,735 | |
Net deferred tax assets | | $ | 45,494 | | | $ | 54,877 | |
We provide a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have $1.6 million and $4.6 million of U.S. federal net operating loss carryforwards available as of December 31, 2021 and 2020, respectively. We have $139.1 million and $153.0 million of state net operating loss carryforwards available as of December 31, 2021 and 2020, respectively. These carryforwards will be used to offset future income but may be limited by the change in ownership rules in Section 382 of the Internal Revenue Code. These net operating loss carryforwards will expire in varying amounts through 2041.
We establish valuation allowances when necessary to reduce deferred tax assets to amounts expected to be realized. As of December 31, 2021 and 2020, we have recorded a valuation allowance of approximately $2.1 million related to various state jurisdictions. In our assessment of the valuation allowance, we consider a number of types of evidence on a taxing jurisdiction and legal entity basis in each reporting period, including the nature, frequency, and severity of current and cumulative financial reporting income and losses, sources of future taxable income, future reversals of existing taxable temporary differences, and prudent and feasible tax planning strategies, weighted by objectivity. The Company’s valuation allowance position in 2021 has not changed based on assessment of all available positive and negative evidence.
The following schedule presents the activity in the valuation allowance:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) Year | | Balance at Beginning of Year | | Acquisitions | | Provision | | Released | | Balance at End of Year |
2021 | | $ | 2,112 | | | $ | — | | | $ | (37) | | | $ | — | | | $ | 2,075 | |
2020 | | $ | 2,065 | | | $ | — | | | $ | 47 | | | $ | — | | | $ | 2,112 | |
2019 | | $ | 8,930 | | | $ | — | | | $ | 238 | | | $ | 7,103 | | | $ | 2,065 | |
A reconciliation of our liability for unrecognized tax benefits is as follows:
| | | | | | | | | | | | | | | | | | | | |
(in thousands) | | 2021 | | 2020 | | 2019 |
Unrecognized tax benefits, at beginning of the year | | $ | 6,896 | | | $ | 4,331 | | | $ | 4,765 | |
Additions for tax positions related to the current year | | 1,489 | | | 1,026 | | | 247 | |
Increase related to prior year positions | | 546 | | | 1,891 | | | — | |
Decrease related to prior year positions | | (400) | | | (352) | | | (337) | |
Decrease for lapse of applicable statute of limitations | | (3,979) | | | — | | | (344) | |
Unrecognized tax benefits, at end of the year | | $ | 4,552 | | | $ | 6,896 | | | $ | 4,331 | |
As of December 31, 2021, the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is approximately $4.6 million. During the year ended December 31, 2021, we released $4.0 million of unrecognized tax benefits and $1.3 million of interest expense due to lapse of statute of limitations for the applicable tax years. We do not anticipate further significant release of unrecognized tax benefits within the next twelve months. We recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of December 31, 2021, 2020, and 2019, the amount of accrued interest and penalties was approximately $0.0 million, $1.2 million, and $1.0 million, respectively.
We are subject to income tax in the U.S. federal, state, and local jurisdictions. We are no longer subject to U.S. federal income tax examinations for years prior to 2017. However, due to net operating loss carryforwards, tax authorities have the ability to adjust those net operating losses related to closed years. We believe the ultimate resolution of income tax examinations will not have a material adverse effect on our consolidated financial position, results of operations, or liquidity.
For the year ended December 31, 2020, we completed a formal study to identify qualifying research and development expenses resulting in the recognition of tax benefits of $3.3 million, net of tax reserves, related to 2020 and $6.1 million, net of tax reserves, relating to the prior years. For the year ended December 31, 2021, we recorded a federal tax benefit of $4.3 million, net of tax reserves, as a deferred tax asset.
Note L — Leases
The information pertaining to leases on the consolidated balance sheet is as follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | As of December 31, |
(in thousands) | | Classification | | 2021 | | 2020 |
Assets | | | | | | |
Operating lease right-of-use assets | | Operating lease right-of-use assets | | $ | 144,491 | | | $ | 124,741 | |
Finance lease right-of-use assets | | Other assets | | 2,732 | | | 3,016 | |
Total lease assets | | | | $ | 147,223 | | | $ | 127,757 | |
Liabilities | | | | | | |
Current | | | | | | |
Operating | | Current portion of operating lease liabilities | | $ | 33,438 | | | $ | 35,002 | |
Finance | | Current portion of long-term debt | | 739 | | | 707 | |
Noncurrent | | | | | | |
Operating | | Operating lease liabilities | | 124,016 | | | 104,589 | |
Finance | | Long-term debt, less current portion | | 2,177 | | | 2,472 | |
Total lease liabilities | | | | $ | 160,370 | | | $ | 142,770 | |
The components of lease cost recognized in the consolidated statement of operations are as follows:
| | | | | | | | | | | | | | |
| | For the Years Ended |
(in thousands) | | 2021 | | 2020 |
Operating lease cost | | $ | 48,130 | | | $ | 47,242 | |
Finance lease cost | | | | |
Amortization of right-of-use assets | | 750 | | | 615 | |
Interest on lease liabilities | | 117 | | | 99 | |
Sublease income | | (157) | | | (248) | |
Short-term lease cost | | 862 | | | 472 | |
Variable lease cost | | 5,755 | | | 5,590 | |
Total lease cost | | $ | 55,457 | | | $ | 53,770 | |
Maturities of our lease liabilities, by year and in the aggregate, under operating and financing obligations with terms of one year or more at December 31, 2021 are as follows:
| | | | | | | | | | | | | | | | | | | | |
(in thousands) | | Finance Leases | | Operating Leases | | Total Leases |
2022 | | $ | 835 | | | $ | 42,754 | | | $ | 43,589 | |
2023 | | 777 | | | 35,346 | | | 36,123 | |
2024 | | 741 | | | 26,853 | | | 27,594 | |
2025 | | 572 | | | 19,179 | | | 19,751 | |
2026 | | 215 | | | 13,082 | | | 13,297 | |
Thereafter | | — | | | 52,826 | | | 52,826 | |
Total lease payments | | 3,140 | | | 190,040 | | | 193,180 | |
Imputed interest | | (224) | | | (32,586) | | | (32,810) | |
Total | | $ | 2,916 | | | $ | 157,454 | | | $ | 160,370 | |
The lease term and discount rates are as follows:
| | | | | | | | | | | | | | |
| | December 31, |
| | 2021 | | 2020 |
Weighted average remaining lease term (years) | | | | |
Operating leases | | 6.69 | | 5.91 |
Finance leases | | 4.01 | | 4.72 |
Weighted average discount rate | | | | |
Operating leases | | 4.59 | % | | 5.16 | % |
Finance leases | | 3.87 | % | | 4.03 | % |
Supplemental cash flow information related to leases is as follows:
| | | | | | | | | | | | | | |
| | For the Years Ended December 31, |
(in thousands) | | 2021 | | 2020 |
Cash flows for amounts included in the measurement of lease liabilities: | | | | |
Operating cash flows from operating leases | | $ | 50,497 | | | $ | 44,814 | |
Operating cash flows from finance leases | | 104 | | | 99 | |
Financing cash flows from finance leases | | 832 | | | 556 | |
Right-of-use assets obtained in exchange for lease obligations: | | | | |
Operating leases | | 52,937 | | | 49,380 | |
Finance leases | | 477 | | | 2,393 | |
Right-of-use assets acquired and lease liabilities assumed in acquisitions | | 8,968 | | | 5,469 | |
Note M — Debt and Other Obligations
Debt consists of the following:
| | | | | | | | | | | | | | |
(in thousands) | | As of December 31, 2021 | | As of December 31, 2020 |
Debt: | | | | |
Term Loan B | | $ | 486,063 | | | $ | 491,113 | |
Seller Notes | | 29,812 | | | 11,510 | |
Deferred payment obligation | | 4,000 | | | 4,000 | |
Finance lease liabilities and other | | 3,344 | | | 3,869 | |
Total debt before unamortized discount and debt issuance costs | | 523,219 | | | 510,492 | |
Unamortized discount and debt issuance costs, net | | (5,974) | | | (7,395) | |
Total debt | | 517,245 | | | 503,097 | |
| | | | |
Current portion of long-term debt: | | | | |
Term Loan B | | 5,050 | | | 5,050 | |
Seller Notes | | 8,969 | | | 4,060 | |
Finance lease liabilities and other | | 919 | | | 975 | |
Total current portion of long-term debt | | 14,938 | | | 10,085 | |
Long-term debt | | $ | 502,307 | | | $ | 493,012 | |
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 $5.7 million as of December 31, 2021. We may (a) increase the aggregate principal amount of any outstanding tranche of term loans or add one or more additional tranches of term loans under the loan documents, and/or (b) increase the aggregate principal amount of revolving commitments or add one or more additional revolving loan facilities under the loan documents by an aggregate amount of up to the sum of (1) $125.0 million and (2) an amount such that, after giving effect to such incurrence of such amount (but excluding the cash proceeds of such incremental facilities and certain other indebtedness, and treating all commitments in respect of revolving indebtedness as fully drawn), the consolidated first lien net leverage ratio is equal to or less than 3.80 to 1.00, if certain conditions are satisfied, including the absence of a default or an event of default under the Credit Agreement at the time of the increase and that we obtain the consent of each lender providing any incremental facility. In connection with the Credit Agreement, we paid debt issuance costs of approximately $6.8 million.
Net proceeds from our initial borrowings under the Credit Agreement, which totaled approximately $501.5 million, were used in part to repay in full all previously existing loans outstanding under our previous credit agreement and Term B credit agreement during the first quarter of 2018. Proceeds were also used to pay various transaction costs including fees paid to respective lenders and accrued and unpaid interest. The remainder of the proceeds are being used to provide ongoing working capital and capital for other general corporate purposes.
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 $129.3 million in available borrowing capacity under our $135.0 million revolving credit facility as of December 31, 2021.
Our obligations under the Credit Agreement are currently guaranteed by our material domestic subsidiaries and will from time to time be guaranteed by, subject in each case to certain exceptions, any domestic subsidiaries that may become material in the future. Subject to certain exceptions, the Credit Agreement is secured by first-priority perfected liens and security interests in substantially all of our personal property and each subsidiary guarantor.
Borrowings under the Credit Agreement bear interest at a variable rate equal to (i) LIBOR plus a specified margin, or (ii) the base rate (which is the highest of (a) Bank of America, N.A.’s prime rate, (b) the federal funds rate plus 0.50% or (c) the sum of 1% plus one-month LIBOR) plus a specified margin. For the years ended December 31, 2021 and 2020, the weighted average interest rate on outstanding borrowings under our Term Loan B facility was approximately 3.6% and 4.1%, respectively. We have entered into interest rate swap agreements to hedge certain of our interest rate exposures, as more fully disclosed in Note O - “Derivative Financial Instruments.”
We must also pay (i) an unused commitment fee ranging from 0.375% to 0.500% per annum of the average daily unused portion of the aggregate revolving credit commitments under the Credit Agreement, and (ii) a per annum fee equal to (a) for each performance standby letter of credit outstanding under the Credit Agreement with respect to nonfinancial contractual obligations, 50% of the applicable margin over LIBOR under the revolving credit facility in effect from time to time multiplied by the daily amount available to be drawn under such letter of credit, and (b) for each other letter of credit outstanding under the Credit Agreement, the applicable margin over LIBOR under the revolving credit facility in effect from time to time multiplied by the daily amount available to be drawn for such letter of credit.
The Credit Agreement contains various restrictions and covenants, including: i) requirements that we maintain certain financial ratios at prescribed levels, ii) a prohibition on payment of dividends and other distributions and iii) restrictions on our ability and certain of our subsidiaries to consolidate or merge, create liens, incur additional indebtedness, dispose of assets, or consummate acquisitions outside the healthcare industry. The Credit Agreement includes the following financial covenants applicable for so long as any revolving loans and/or revolving commitments remain outstanding under the Credit Agreement (some of which were amended in May 2020 by the Amendment (as defined and described below)): (i) a maximum consolidated first lien net leverage ratio (“Net Leverage Ratio”) (defined as, with certain adjustments and exclusions, the ratio of consolidated first-lien indebtedness to consolidated net income before interest, taxes, depreciation, amortization, non-cash charges and certain other items (“EBITDA”) for the most recently ended period of four fiscal quarters for which financial statements are available) of 4.25 to 1.00 for the fiscal quarters ended June 30, 2021 through March 31, 2022; and 3.75 to 1.00 for the fiscal quarter ended June 30, 2022 and the last day of each fiscal quarter thereafter; and (ii) a minimum interest coverage ratio (defined as, with certain adjustments, the ratio of our EBITDA to consolidated interest expense to the extent paid or payable in cash) of 2.75 to 1.00 as of the last day of any fiscal quarter.
The Credit Agreement also contains customary events of default. If an event of default under the Credit Agreement occurs and is continuing, then the lenders may declare any outstanding obligations under the Credit Agreement to be immediately due and payable; provided, however, that the occurrence of an event of default as a result of a breach of a financial covenant under the Credit Agreement does not constitute a default or event of default with respect to any term facility under the Credit Agreement unless and until the required revolving lenders shall have terminated their revolving commitments and declared all amounts outstanding under the revolving credit facility to be due and payable. In addition, if we or any subsidiary guarantor becomes the subject of voluntary or involuntary proceedings under any bankruptcy, insolvency or similar law, then any outstanding obligations under the Credit Agreement will automatically become immediately due and payable. Loans outstanding under the Credit Agreement will bear interest at a rate of 2.00% per annum in excess of the otherwise applicable rate (i) upon acceleration of such loans, (ii) while a payment event of default exists or (iii) upon the lenders’ request, during the continuance of any other event of default.
In May 2020, we entered into an amendment to the Credit Agreement (the “Amendment”) that provided for, amongst other things, an increase in the maximum Net Leverage Ratio to 5.25 to 1.00 for the fiscal 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.
On November 23, 2021, we entered into a Second Amendment to Credit Agreement (the “Second Amendment”) among us, the subsidiary guarantors party thereto, the revolving lenders party thereto and Bank of America, N.A., as agent (the “Agent”), which amends the Credit Agreement, dated as of March 6, 2018, among us, the lenders from time to time party thereto and the Agent (as amended by the First Amendment to Credit Agreement dated as of May 4, 2020, the “Existing Credit Agreement”; the Existing Credit Agreement as amended by the Second Amendment, the “Credit Agreement”).
The Second Amendment revises certain provisions of the Existing Credit Agreement to, among other things, (i) increase the aggregate amount of the revolving loan commitments by $35 million to an aggregate total amount of $135 million, (ii) extend the scheduled maturity date of the revolving loan facility to November 23, 2026 (subject to a springing maturity if the term loans outstanding under the Existing Credit Agreement are not repaid prior to the date that is 91 days prior to the stated maturity thereof), (iii) decrease the applicable margin on LIBOR and base rate revolving loan borrowings by 0.75% per annum, (iv) decrease the LIBOR interest rate floor in respect of revolving loan borrowings to 0.00% per annum, (v) decrease the revolving loan facility commitment fee to 0.30% per annum, (vi) increase the maximum allowable leverage ratio for covenant purposes such that the maximum consolidated first lien net leverage ratio shall be up to (a) 5.00 to 1.00 for the fiscal quarters ending December 31, 2021, March 31, 2022, June 30, 2022, and September 30, 2022 and (b) 4.75 to 1.00 for the fiscal quarter ending December 31, 2022 and the last day of each fiscal quarter thereafter, and (vii) permit, at our election and up to three times during the term of the Credit Agreement, the maximum allowable leverage ratio for covenant purposes to be temporarily increased by an additional 0.50 to 1.00 for four consecutive fiscal quarters in connection with certain material acquisitions. We capitalized debt issuance costs of $0.6 million in connection with the Second Amendment, which were recorded in Other assets.
We were in compliance with all covenants at December 31, 2021.
Subsidiary Guarantees
The obligations under the Credit Agreement are guaranteed by our material domestic subsidiaries, which incorporates subsidiaries that both make up no less than 90% of our total net revenues and make up no less than 90% of our total assets. Separate condensed consolidating information is not included as the parent company does not have independent assets or operations, and the guarantees are full and unconditional and joint and several.
Other Restrictions
The Credit Agreement limits our ability to, among other things, purchase capital assets, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities, and engage in mergers, consolidations, and certain sales of assets.
Seller Notes and the Deferred Payment Obligation
We typically issue subordinated promissory notes (“Seller Notes”) as a part of the consideration transferred when making acquisitions. The Seller Notes are unsecured and are presented net of unamortized discount of $0.9 million as of December 31, 2021 and 2020. We measure these instruments at their estimated fair values as of the respective acquisition dates. The stated interest rates on these instruments range from 2.50% to 3.00%. Principal and interest are payable in quarterly or annual installments and mature through November 2026.
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 $0.4 million and $0.5 million as of December 31, 2021 and December 31, 2020, respectively. The deferred payment obligation was measured at its estimated fair value as of the acquisition date and accrues interest at a rate of 3.0%. Principal and interest payments under the deferred payment obligation are due in annual installments beginning in 2024 and for three years thereafter.
Scheduled Maturities of Total Debt
Scheduled maturities of debt at December 31, 2021 were as follows:
| | | | | | | | |
(in thousands) | | |
2022 | | $ | 15,281 | |
2023 | | 15,243 | |
2024 | | 14,703 | |
2025 | | 474,246 | |
2026 | | 2,603 | |
Thereafter | | 1,143 | |
Total debt before unamortized discount and debt issuance costs, net | | 523,219 | |
Unamortized discount and debt issuance costs, net | | (5,974) | |
Total debt | | $ | 517,245 | |
Note N — Fair Value Measurements
Financial Instruments
The carrying value of our outstanding term loan as of December 31, 2021 (excluding unamortized discounts and debt issuance costs of $5.1 million) was $486.1 million compared to its fair value of $484.8 million. The carrying value of our outstanding term loan as of December 31, 2020 (excluding unamortized discounts and debt issuance costs of $6.5 million) was $491.1 million compared to its fair value of $489.9 million. Our estimates of fair value are based on a discounted cash flow model and an indicative quote using unobservable inputs, primarily, our risk-adjusted credit spread, which represents a Level 3 measurement.
We have interest rate swap agreements designated as cash flow hedges and are measured at fair value based on inputs other than quoted market prices that are observable, which represents a Level 2 measurement. See Note M - “Debt and Other Obligations” and Note O - “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 December 31, 2021 and December 31, 2020 was $32.9 million and $14.6 million, respectively, net of unamortized discounts of $0.9 million.
Note O — Derivative Financial Instruments
Cash Flow Hedges of Interest Rate Risk
In March 2018, we entered into interest rate swap agreements with notional values of $325.0 million, at inception, which reduces $12.5 million annually until the swaps mature on March 6, 2024. As of December 31, 2021 and December 31, 2020, our swaps, had a notional value outstanding of $287.5 million and $300.0 million, respectively.
Changes in Net Loss on Cash Flow Hedges Included in Accumulated Other Comprehensive Loss
The following table presents the activity of cash flow hedges included in accumulated other comprehensive loss for the years ended December 31, 2021 and 2020:
| | | | | | | | |
(in thousands) | | Cash Flow Hedges |
Balance as of December 31, 2019 | | $ | (10,137) | |
Unrealized loss recognized in other comprehensive income, net of tax | | (13,230) | |
Reclassification to interest expense, net of tax | | 6,596 | |
Balance as of December 31, 2020 | | $ | (16,771) | |
Unrealized gain recognized in other comprehensive income, net of tax | | 400 | |
Reclassification to interest expense, net of tax | | 7,867 | |
Balance as of December 31, 2021 | | $ | (8,504) | |
The following table presents the fair value of derivative liabilities within the consolidated balance sheets as of December 31, 2021 and December 31, 2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As of December 31, 2021 | | As of December 31, 2020 |
(in thousands) | | Assets | | Liabilities | | Assets | | Liabilities |
Derivatives designated as cash flow hedging instruments: | | | | | | | | |
Accrued expenses and other current liabilities | | $ | — | | | $ | 6,425 | | | $ | — | | | $ | 7,686 | |
Other liabilities | | — | | | 4,664 | | | — | | | 14,388 | |
Note P — Share-Based Compensation
On May 17, 2019, the shareholders approved the Hanger, Inc. 2019 Omnibus Incentive Plan (the “2019 Plan”). The 2019 Plan authorizes the issuance of (a) up to 2,025,000 shares of Common Stock, plus (b) 243,611 shares available for issuance under the Hanger, Inc. 2016 Omnibus Incentive Plan (the “2016 Plan”). Upon approval of the 2019 Plan, the 2016 Plan was no longer available for future awards.
On May 19, 2017, the Board of Directors approved the Hanger, Inc. Special Equity Plan (the “Special Equity Plan”). The Special Equity Plan authorized up to 1.5 million shares of Common Stock and operates completely independent from our 2016 Omnibus Incentive Plan. All awards under the Special Equity Plan were made on May 19, 2017 which consisted of 0.8 million stock options and 0.3 million performance-based stock awards. No further grants of awards will be authorized or issued under the Special Equity Plan.
As of December 31, 2021, approximately 1.1 million shares were available for future issuance under the 2019 Plan. The available shares consisted of (a) 2.0 million shares of common stock originally authorized for issuance under the amended 2019 Plan, plus (b) 0.2 million shares rolled forward from the 2016 Plan, plus (c) 0.3 million shares forfeited and added back to the pool, less (d) 1.4 million shares issued for awards. In 2021, shares issued under equity plans were issued from authorized and unissued shares.
For the years ended December 31, 2021, 2020, and 2019, we recognized share-based compensation expense of approximately $12.3 million, $18.4 million, and $13.4 million. Share-based compensation expense, net of forfeitures, relates to restricted stock units, performance-based restricted stock units, and options.
Restricted Stock Units
The summary of restricted stock units, performance-based stock units, and weighted average grant date fair values are as follows: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Employee Service-Based Awards | | Employee Performance-Based Awards | | Director Awards |
| | Units | | Weighted Average Grant Date Fair Value | | Units | | Weighted Average Grant Date Fair Value | | Units | | Weighted Average Grant Date Fair Value |
Nonvested at December 31, 2019 | | 1,164,224 | | | $ | 16.32 | | | 599,484 | | | $ | 17.82 | | | 55,752 | | | $ | 20.10 | |
Granted | | 427,851 | | | 21.81 | | | 523,972 | | | 25.95 | | | 70,623 | | | 17.07 | |
Vested | | (489,026) | | | 14.18 | | | (541,923) | | | 24.36 | | | (55,752) | | | 20.09 | |
Forfeited | | (21,289) | | | 18.97 | | | (260,852) | | | 19.29 | | | — | | | — | |
Nonvested at December 31, 2020 | | 1,081,760 | | | 18.90 | | | 320,681 | | | 18.86 | | | 70,623 | | | 17.07 | |
Granted | | 462,316 | | | 23.28 | | | 121,809 | | | 23.66 | | | 49,356 | | | 25.53 | |
Vested | | (433,499) | | | 17.55 | | | (132,095) | | | 17.47 | | | (70,623) | | | 17.07 | |
Forfeited | | (91,370) | | | 20.88 | | | — | | | — | | | — | | | — | |
Nonvested at December 31, 2021 | | 1,019,207 | | | $ | 21.28 | | | 310,395 | | | $ | 21.61 | | | 49,356 | | | $ | 25.53 | |
During the years ended December 31, 2021, 2020, and 2019, approximately 0.6 million, 1.1 million, and 0.6 million of restricted common stock units with an intrinsic value of $15.1 million, $21.3 million, and $12.3 million, respectively, became fully vested. As of December 31, 2021, total unrecognized compensation expense related to unvested restricted stock units and unvested performance based restricted stock units for which we have concluded the performance condition was probable of achievement was approximately $18.5 million and the related weighted-average period over which it is expected to be recognized is approximately 2.4 years. The aggregate granted units have vesting dates through June 2022. The 2021, 2020, and 2019 aggregate grants had total estimated grant date fair values of $15.7 million, $24.1 million, and $12.9 million, respectively.
A special equity grant of performance-based restricted stock units was granted on May 19, 2017 under the Special Equity Plan and was initially granted to vest 100% three years after the date of issuance, assuming the performance goal is achieved. The financial target for this grant was originally to achieve a compounded annual growth rate (“CAGR”) of our common stock price of 20% as of market close on May 18, 2020. This equated to a share price on that date of $22.07 compared to the closing price on the eve of grant of $12.77. The grant provided for the vesting of 50% of the original targeted shares if a CAGR of 10% (a stock price of $17.00) is achieved. The grant also provided for the vesting of up to 200% of the original targeted shares if a CAGR of 30% (a stock price of $28.06) or more is achieved. The percentage of vested shares will be interpolated on a linear basis between 50% and 200% for a CAGR between 10% and 30%. The stock price at time of award was $12.77, but given market condition performance criteria, the Monte Carlo Simulation valuation was used to calculate a fair value of $19.29 per share. The key assumptions used were a volatility rate of 109.5%, a risk-free interest rate of 1.44%, and a performance period of 3 years.
In November 2019, the special equity grant was amended by adjusting the calculation of the CAGR of our common stock price from the third anniversary of the grant date to the average closing price for the 25 trading days ending on and including the last day of the three year performance period (i.e., May 18, 2020). This adjustment was considered a modification per ASC 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. The valuation concluded there was an additional $34.0 thousand in incremental fair value that will be expensed ratably over the remainder of the service period.
In May 2020, the special equity grant was amended 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 ASC 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.
Performance-based restricted stock units were granted on March 9, 2020. The grants were made prior to knowing the impact of the COVID-19 pandemic on the company’s business and industry. The stock units would only be earned if we achieved the adjusted earnings per share (“Adjusted EPS”) performance goal for 2020. If earned, they would vest 25% annually over four years on the anniversary of the grant date, commencing on the first anniversary. In November 2020, the performance-based grant was amended by adjusting the Adjusted EPS performance goal for these awards to reflect our July 2020 revised financial forecast for the year, which gave consideration to the challenges we faced during the first half of the year and the expected performance for the remainder of the year, taking into account the expected impact of the COVID-19 pandemic. In addition, it also reduced the number of shares the participants could receive pursuant to their previously granted awards to 85% of the original target number.
Options
Certain options were granted in 2017 under the Special Equity Plan. The fair value of each employee stock option award was estimated on the date of grant of May 19, 2017 using the Black-Scholes option-pricing model and calculated a grant date fair value of $8.67 per option. The key assumptions used were an expected dividend yield of zero, an expected stock volatility of 92.48%, a risk-free interest rate of 1.68%, and an expected term of 4.38 years.
The summary of option activity and weighted average exercise prices are as follows: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Shares | | Weighted Average Exercise Price | | Aggregate Intrinsic Value | | Weighted Average Remaining Contractual Term (Years) |
Outstanding at December 31, 2019 | | 523,105 | | | $ | 12.77 | | | $ | 7,762,878 | | | |
Granted | | — | | | — | | | | | |
Terminated | | — | | | — | | | | | |
Exercised | | (7,193) | | | 12.77 | | | | | |
Outstanding at December 31, 2020 | | 515,912 | | | 12.77 | | | 4,756,709 | | | 5.6 |
Granted | | — | | | — | | | | | |
Terminated | | — | | | — | | | | | |
Exercised | | (240,129) | | | 12.77 | | | | | |
Outstanding at December 31, 2021 | | 275,783 | | | $ | 12.77 | | | $ | 1,478,197 | | | 5.4 |
At December 31, 2021, 0.3 million options were outstanding but not yet exercisable with a weighted average exercise price of $12.77, average remaining contractual terms of 5.4 years and aggregate intrinsic values of approximately $1.5 million. At December 31, 2020, 0.5 million options were outstanding but not yet exercisable with a weighted average exercise price of $12.77, average remaining contractual terms of 5.6 years and aggregate intrinsic values of approximately $4.8 million.
Note Q — Employee Benefits
Savings Plan
We maintain a 401(k) Savings and Retirement plan that covers all of our employees. Under the plan, employees may defer a portion of their compensation up to the levels permitted by the Internal Revenue Service. We recorded matching contributions of approximately $7.0 million, $6.5 million, and $6.1 million under this plan during 2021, 2020, and 2019, respectively, which were included within “Personnel costs” and “General and administrative expenses” in our consolidated statements of operations.
Defined Benefit Supplemental Executive Retirement Plan
Effective January 2004, we implemented an unfunded noncontributory DB SERP for certain senior executives. The DB SERP, which we administer, calls for fifteen 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. We engaged an actuary to calculate the related benefit obligation at December 31, 2021 and 2020 as well as net periodic benefit plan expense for the years ended December 31, 2021, 2020, and 2019. As of December 31, 2021 and 2020, the average remaining service period of plan
participants is 7.5 and 8.5 years, respectively. We believe the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. Actual results that differ from the assumptions are accumulated and amortized over future periods, affecting the recorded obligation and expense in future periods.
The DB SERP’s net benefit obligation is as follows:
| | | | | | | | |
Change in Benefit Obligation | | |
(in thousands) | | |
Benefit obligation as of December 31, 2018 | | $ | 18,927 | |
Service cost | | 335 | |
Interest cost | | 658 | |
Payments | | (1,913) | |
Actuarial loss | | 1,207 | |
Benefit obligation as of December 31, 2019 | | 19,214 | |
Service cost | | 392 | |
Interest cost | | 485 | |
Payments | | (1,913) | |
Actuarial loss | | 1,568 | |
Benefit obligation as of December 31, 2020 | | 19,746 | |
Service cost | | 493 | |
Interest cost | | 349 | |
Payments | | (1,913) | |
Actuarial gain | | (740) | |
Benefit obligation as of December 31, 2021 | | $ | 17,935 | |
The funded status of the DB SERP’s net benefit obligation is as follows:
| | | | | | | | | | | | | | |
| | December 31, |
(in thousands) | | 2021 | | 2020 |
Unfunded status | | $ | 14,374 | | | $ | 15,125 | |
Unamortized net loss | | 3,561 | | | 4,621 | |
Net amount recognized | | $ | 17,935 | | | $ | 19,746 | |
| | | | | | | | | | | | | | |
Amounts Recognized in the Consolidated Balance Sheets: | | | | |
| | December 31, |
(in thousands) | | 2021 | | 2020 |
Current accrued expenses and other current liabilities | | $ | 1,913 | | | $ | 1,913 | |
Non-current other liabilities | | 16,022 | | | 17,833 | |
Total accrued liabilities | | $ | 17,935 | | | $ | 19,746 | |
We recorded gross actuarial (gains) losses under the DB SERP of approximately $(0.7) million, $1.6 million, and $1.2 million in 2021, 2020, and 2019, respectively, in other comprehensive income (loss). There were no other components such as prior service costs or transition obligations relating to the DB SERP costs recorded within other comprehensive loss during 2021, 2020, or 2019.
The following weighted average assumptions were used to determine the benefit obligation as of December 31 of each year. Net periodic benefit cost for each year was determined using the weighted average assumptions as of the prior year. We used a third party actuarial specialist to assist in determining, among other things, the discount rate for all three years presented.
Our assumed weighted average discount rate for the defined benefit plan reflects the hypothetical rate at which the projected benefit obligation could be effectively settled or paid out to participants. We determine our discount rate based on a range of factors, including a yield curve composed of rates of return on high-quality, fixed income corporate bonds.
| | | | | | | | | | | | | | | | | | | | |
| | 2021 | | 2020 | | 2019 |
Discount rate | | 2.6 | % | | 2.0 | % | | 2.9 | % |
Average rate of increase in compensation | | 3.0 | % | | 3.0 | % | | 2.5 | % |
At December 31, 2021, the estimated accumulated benefit obligation is $17.9 million. Future payments under the DB SERP are as follows:
| | | | | | | | |
(in thousands) | | |
2022 | | $ | 1,913 | |
2023 | | 1,913 | |
2024 | | 1,913 | |
2025 | | 1,913 | |
2026 | | 1,913 | |
Thereafter | | 8,370 | |
| | $ | 17,935 | |
Defined Contribution Supplemental Executive Retirement Plan
In 2013, we established a defined contribution plan 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 December 31, 2021 and 2020, the estimated accumulated benefit obligation is $4.8 million and $4.5 million, respectively, of which $4.1 million and $4.0 million is funded and $0.6 million and $0.5 million is unfunded at December 31, 2021 and 2020, respectively.
In connection with the DC SERP benefit obligation, we maintain a COLI policy. The carrying value of the COLI is measured at its cash surrender value and is presented within “Other assets” in our consolidated balance sheets. See Note I - “Other Current Assets and Other Assets” for additional information.
Note R — Commitments and Contingencies
Guarantees and Indemnification
In the ordinary course of our business, we may enter into service agreements with service providers in which we agree to indemnify or limit the service provider against certain losses and liabilities arising from the service provider’s performance of the agreement. We have reviewed our existing contracts containing indemnification or clauses of guarantees and do not believe that our liability under such agreements is material.
Other Matters
From time to time we are subject to legal proceedings and claims which arise in the ordinary course of our business, and are also subject to additional payments under business purchase agreements. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on our consolidated financial position, liquidity, or results of our operations.
We operate in a highly regulated industry and receive regulatory agency inquiries from time to time in the ordinary course of our business, including inquiries relating to our billing activities. No assurance can be given that any discrepancies identified during a regulatory review will not have a material adverse effect on our consolidated financial statements.
Note S — Segment and Related Information
We have identified two operating 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:
Patient Care - This segment consists of (i) our owned and operated patient care clinics, and (ii) our contracting and network management business. The patient care clinics provide services to design and fit O&P devices to patients. These clinics also instruct patients in the use, care, and maintenance of the devices. The principal reimbursement sources for our services are:
•Commercial private payors and other, which consist of individuals, rehabilitation providers, commercial insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers’ compensation programs, and similar sources;
•Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain persons with disabilities, which provides reimbursement for O&P products and services based on prices set forth in published fee schedules (generally with either 10 regional pricing areas or state level prices) for prosthetics and orthotics and by state for durable medical equipment (DMEPOS);
•Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons requiring financial assistance, regardless of age, which may supplement Medicare benefits for persons aged 65 or older requiring financial assistance; and
•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 business, which distributes and fabricates O&P products and components to sell to both the O&P industry and our own patient care clinics, and our therapeutic solutions business. The therapeutic solutions business leases and sells rehabilitation equipment and ancillary consumable supplies combined with equipment maintenance, education, and training.
Corporate & Other - This consists of corporate overhead and includes unallocated expense such as personnel costs, professional fees, and corporate offices expenses.
The accounting policies of the segments are the same as those described in Note A - “Organization and Summary of Significant Accounting Policies.”
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.
We had no foreign and export sales or assets for the years ended December 31, 2021, 2020, and 2019.
For the Patient Care segment, government reimbursement, comprised of Medicare, Medicaid, and the VA, in the aggregate, accounted for approximately, 58.5%, 57.7%, and 57.5% of their net revenue in 2021, 2020, and 2019, respectively.
Additionally, for the Products & Services segment, no single customer accounted for more than 10% of net revenues in 2021, 2020, or 2019, respectively.
Summarized financial information concerning our reporting segments is shown in the following tables.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Patient Care | | Products & Services |
| | For the Year Ended December 31, | | For the Year Ended December 31, |
(in thousands) | | 2021 | | 2020 | | 2019 | | 2021 | | 2020 | | 2019 |
Net revenue | | | | | | | | | | | | |
Third party | | $ | 943,328 | | | $ | 831,603 | | | $ | 905,691 | | | $ | 177,160 | | | $ | 169,547 | | | $ | 192,355 | |
Intersegments | | — | | | — | | | — | | | 220,792 | | | 189,604 | | | 203,496 | |
Total net revenue | | 943,328 | | | 831,603 | | | 905,691 | | | 397,952 | | | 359,151 | | | 395,851 | |
Material costs | | | | | | | | | | | | |
Third party suppliers | | 248,961 | | | 221,566 | | | 250,407 | | | 105,381 | | | 93,844 | | | 107,364 | |
Intersegments | | 38,243 | | | 25,818 | | | 24,394 | | | 182,549 | | | 163,786 | | | 179,102 | |
Total material costs | | 287,204 | | | 247,384 | | | 274,801 | | | 287,930 | | | 257,630 | | | 286,466 | |
Personnel expenses | | 339,578 | | | 302,206 | | | 319,633 | | | 57,996 | | | 48,985 | | | 52,592 | |
Other expenses | | 152,947 | | | 115,924 | | | 151,140 | | | 26,951 | | | 24,638 | | | 28,178 | |
Depreciation & amortization | | 19,622 | | | 18,892 | | | 18,541 | | | 7,860 | | | 10,173 | | | 10,650 | |
Segment income from operations | | $ | 143,977 | | | $ | 147,197 | | | $ | 141,576 | | | $ | 17,215 | | | $ | 17,725 | | | $ | 17,965 | |
| | | | | | | | | | | | |
Purchase of property, plant and equipment | | $ | 10,242 | | | $ | 10,607 | | | $ | 16,102 | | | $ | 9,215 | | | $ | 11,040 | | | $ | 2,368 | |
Purchase of therapeutic program equipment leased to third parties under operating leases | | $ | — | | | $ | — | | | $ | — | | | $ | 2,280 | | | $ | 3,592 | | | $ | 6,672 | |
A reconciliation of the total of the reportable segment’s income (loss) from operations to consolidated income from operations is as follows:
| | | | | | | | | | | | | | | | | | | | |
(in thousands) | | 2021 | | 2020 | | 2019 |
Income from operations | | | | | | |
Patient Care | | $ | 143,977 | | | $ | 147,197 | | | $ | 141,576 | |
Products & Services | | 17,215 | | | 17,725 | | | 17,965 | |
Corporate & other | | (88,521) | | | (93,015) | | | (94,113) | |
Income from operations | | 72,671 | | | 71,907 | | | 65,428 | |
Interest expense, net | | 28,864 | | | 32,445 | | | 34,258 | |
Non-service defined benefit plan expense | | 667 | | | 632 | | | 691 | |
Income before income taxes | | 43,140 | | | 38,830 | | | 30,479 | |
Provision for income taxes | | 1,158 | | | 638 | | | 2,954 | |
Net income | | $ | 41,982 | | | $ | 38,192 | | | $ | 27,525 | |
A reconciliation of the reportable segment’s net revenue (loss) to consolidated net revenue is as follows:
| | | | | | | | | | | | | | | | | | | | |
(in thousands) | | 2021 | | 2020 | | 2019 |
Net Revenue | | | | | | |
Patient Care | | $ | 943,328 | | | $ | 831,603 | | | $ | 905,691 | |
Products & Services | | 397,952 | | | 359,151 | | | 395,851 | |
Corporate & other | | — | | | — | | | — | |
Consolidating adjustments | | (220,792) | | | (189,604) | | | (203,496) | |
Consolidated net revenue | | $ | 1,120,488 | | | $ | 1,001,150 | | | $ | 1,098,046 | |
A reconciliation of the reportable segment’s material costs to consolidated material costs is as follows:
| | | | | | | | | | | | | | | | | | | | |
(in thousands) | | 2021 | | 2020 | | 2019 |
Material costs | | | | | | |
Patient Care | | $ | 287,204 | | | $ | 247,384 | | | $ | 274,801 | |
Products & Services | | 287,930 | | | 257,630 | | | 286,466 | |
Corporate & other | | — | | | — | | | — | |
Consolidating adjustments | | (220,792) | | | (189,604) | | | (203,496) | |
Consolidated material costs | | $ | 354,342 | | | $ | 315,410 | | | $ | 357,771 | |
A reconciliation of the reportable segment’s purchase of property, plant and equipment to consolidated purchase of property, plant and equipment, including purchases of therapeutic program equipment leased to third parties under operating leases, is as follows:
| | | | | | | | | | | | | | | | | | | | |
(in thousands) | | 2021 | | 2020 | | 2019 |
Purchase of property, plant and equipment and therapeutic program equipment leased to third parties under operating leases | | | | | | |
Patient Care | | $ | 10,242 | | | $ | 10,607 | | | $ | 16,102 | |
Products & Services | | | | | | |
Property, plant and equipment | | 9,215 | | | 11,040 | | | 2,368 | |
Therapeutic program equipment leased to third parties under operating leases | | 2,280 | | | 3,592 | | | 6,672 | |
Corporate & other | | 3,122 | | | 2,853 | | | 7,963 | |
Total consolidated purchase of property, plant and equipment and therapeutic program equipment leased to third parties under operating leases | | $ | 24,859 | | | $ | 28,092 | | | $ | 33,105 | |
A reconciliation of the total of the reportable segment’s assets to consolidated assets is as follows:
| | | | | | | | | | | | | | |
(in thousands) | | 2021 | | 2020 |
Assets | | | | |
Patient Care | | $ | 705,614 | | | $ | 578,319 | |
Products & Services | | 133,075 | | | 121,564 | |
Corporate & other | | 159,450 | | | 250,868 | |
Total consolidated assets | | $ | 998,139 | | | $ | 950,751 | |
Note T — Subsequent Events
During the first quarter of 2022 to date, we completed the acquisition of one O&P business for a total purchase price of $5.0 million. Total consideration transferred for this acquisition is comprised of $4.0 million in cash consideration, $1.0 million in the form of notes to the former shareholders. Due to the proximity in time of this transaction to the filing of this Form 10-K, it is not practicable to provide a preliminary purchase price allocation of the fair value of the assets purchased and liabilities assumed in the acquisition. Acquisition-related expenses related to this transaction were not material.