HANGER, INC. - Quarter Report: 2019 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended March 31, 2019

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

For the transition period from

Commission File Number 1-10670

HANGER, INC.

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

Delaware
(State or other jurisdiction of
incorporation or organization)

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

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

78758
(Zip Code)

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

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

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

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

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Smaller reporting company o

Emerging growth company o

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

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

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

Title of each class		Trading Symbol		Name of each exchange on which registered
Common Stock, par value $0.01 per share		HNGR		New York Stock Exchange

As of April 30, 2019 the registrant had 37,239,511 shares of its Common Stock outstanding.

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TABLE OF CONTENTS

Hanger, Inc.
Part I Financial Information
	Item 1. Condensed Consolidated Financial Statements (unaudited)	1
	Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations	29
	Item 3. Quantitative and Qualitative Disclosures About Market Risk	44
	Item 4. Controls and Procedures	45
Part II Other Information
	Item 1. Legal Proceedings	46
	Item 1A. Risk Factors	48
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	48
	Item 3. Defaults Upon Senior Securities	48
	Item 4. Mine Safety Disclosures	48
	Item 5. Other Information	48
	Item 6. Exhibits	48
Exhibits Index		49
Signatures		50

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PART 1. FINANCIAL INFORMATION

HANGER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except par value and share amounts)

(Unaudited)

	As of March 31,			As of December 31,
	2019			2018
ASSETS
Current assets:
Cash and cash equivalents	$	20,511		$	95,114
Accounts receivable, net	136,891			143,986
Inventories	70,036			67,690
Income taxes receivable	734			379
Other current assets	17,058			18,731
Total current assets	245,230			325,900
Non-current assets:
Property, plant and equipment, net	81,951			89,489
Goodwill	226,632			198,742
Other intangible assets, net	16,415			15,478
Deferred income taxes	69,738			65,635
Operating lease right-of-use assets	103,676			—
Other assets	8,392			7,766
Total assets	$	752,034		$	703,010
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current liabilities:
Current portion of long-term debt	$	8,677		$	8,583
Accounts payable	50,173			55,797
Accrued expenses and other current liabilities	53,311			51,783
Accrued compensation related costs	22,228			55,111
Current portion of operating lease liabilities	33,675			—
Total current liabilities	168,064			171,274
Long-term liabilities:
Long-term debt, less current portion	490,623			502,090
Operating lease liabilities	83,693			—
Other liabilities	40,259			51,570
Total liabilities	782,639			724,934
Commitments and contingencies (Note R)
Shareholders’ deficit:
Common stock, $0.01 par value; 60,000,000 shares authorized; 37,413,845 shares issued and 37,271,024 shares outstanding in 2019, and 37,063,995 shares issued and 36,921,174 shares outstanding in 2018	374			371
Additional paid-in capital	343,591			343,955
Accumulated other comprehensive loss	(7,461		)	(4,531		)
Accumulated deficit	(366,413		)	(361,023		)
Treasury stock, at cost; 142,821 shares at 2019 and 2018, respectively	(696		)	(696		)
Total shareholders’ deficit	(30,605		)	(21,924		)
Total liabilities and shareholders’ deficit	$	752,034		$	703,010

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

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HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except share and per share amounts)

(Unaudited)

	For the Three Months Ended March 31,
	2019			2018
Net revenues	$	236,419		$	233,995
Material costs	78,377			76,356
Personnel costs	86,711			86,108
Other operating costs	33,555			31,096
General and administrative expenses	28,282			25,636
Professional accounting and legal fees	2,700			4,846
Depreciation and amortization	8,773			9,330
(Loss) income from operations	(1,979		)	623
Interest expense, net	8,538			12,263
Loss on extinguishment of debt	—			16,998
Non-service defined benefit plan expense	173			176
Loss before income taxes	(10,690		)	(28,814		)
Benefit for income taxes	(3,739		)	(6,196		)
Net loss	$	(6,951	)	$	(22,618	)

Basic and Diluted Per Common Share Data:
Basic and diluted loss per share	$	(0.19	)	$	(0.62	)
Weighted average shares used to compute basic and diluted earnings per common share	37,001,977			36,498,482

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

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HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(dollars in thousands)

(Unaudited)

	For the Three Months Ended March 31,
	2019			2018
Net loss	$	(6,951	)	$	(22,618	)

Other comprehensive loss:
Unrealized loss on cash flow hedges (net of tax benefit of $924 for three months ended March 31, 2019 and tax benefit of $702 for three months ended March 31, 2018)	$	(2,936	)	$	(2,290	)
Unrealized gain (loss) on defined benefit plan (net of tax provision of $2 for three months ended March 31, 2019 and tax benefit of $105 for three months ended March 31, 2018)	6			(292		)
Total other comprehensive loss	(2,930		)	(2,582		)
Comprehensive loss	$	(9,881	)	$	(25,200	)

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

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HANGER, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ DEFICIT

(dollars and share amounts in thousands)

(Unaudited)

	Common Shares, Balance	Common Stock, Par Value		Additional Paid-in Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Treasury Stock			Total
Balance, December 31, 2018	36,921	$	371	$	343,955		$	(4,531	)	$	(361,023	)	$	(696	)	$	(21,924	)
Cumulative effect of a change in accounting for leases (Note A)	—	—		—			—			1,561			—			1,561
Balance, January 1, 2019	36,921	371		343,955			(4,531		)	(359,462		)	(696		)	(20,363		)
Net loss	—	—		—			—			(6,951		)	—			(6,951		)
Shares based compensation expense	—	—		3,265			—			—			—			3,265
Issuance of common stock upon vesting of restricted stock units	350	3		(3		)	—			—			—			—
Effect of shares withheld to cover taxes	—	—		(3,626		)	—			—			—			(3,626		)
Total other comprehensive loss	—	—		—			(2,930		)	—			—			(2,930		)
Balance, March 31, 2019	37,271	$	374	$	343,591		$	(7,461	)	$	(366,413	)	$	(696	)	$	(30,605	)

	Common Shares, Balance	Common Stock, Par Value		Additional Paid-in Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Treasury Stock			Total
Balance, December 31, 2017	36,372	$	365	$	333,738		$	(1,686	)	$	(359,772	)	$	(696	)	$	(28,051	)
Cumulative effect of a change in accounting for revenue recognition	—	—		—			—			(759		)	—			(759		)
Balance, January 1, 2018	36,372	365		333,738			(1,686		)	(360,531		)	(696		)	(28,810		)
Net loss	—	—		—			—			(22,618		)	—			(22,618		)
Shares based compensation expense	—	—		2,585			—			—			—			2,585
Issuance of common stock upon vesting of restricted stock units	372	4		(4		)	—			—			—			—
Effect of shares withheld to cover taxes	—	—		(2,150		)	—			—			—			(2,150		)
Total other comprehensive loss	—	—		—			(2,582		)	—			—			(2,582		)
Balance, March 31, 2018	36,744	$	369	$	334,169		$	(4,268	)	$	(383,149	)	$	(696	)	$	(53,575	)

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

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HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(Unaudited)

	For the Three Months Ended March 31,
	2019			2018
Cash flow used in operating activities:
Net loss	$	(6,951	)	$	(22,618	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	8,773			9,330
Amortization of right-of-use assets	9,161			—
Benefit for doubtful accounts	(20		)	(94		)
Stock-based compensation expense	3,265			2,585
Deferred income taxes	(3,749		)	(6,355		)
Amortization of debt discounts and issuance costs	375			1,701
Loss on extinguishment of debt	—			16,998
Gain on sale and disposal of fixed assets	(481		)	(594		)
Changes in operating assets and liabilities (Note T)	(43,173		)	(9,426		)
Net cash used in operating activities	(32,800		)	(8,473		)
Cash flows used in investing activities
Purchase of property, plant and equipment	(6,897		)	(4,388		)
Purchase of therapeutic program equipment leased to third parties under operating leases	(1,429		)	(2,034		)
Acquisitions, net of cash acquired	(27,679		)	—
Purchase of company-owned life insurance investment	—			(598		)
Proceeds from sale of property, plant and equipment	980			840
Net cash used in investing activities	(35,025		)	(6,180		)
Cash flows (used in) provided by financing activities
Borrowings under term loan, net of discount	—			501,467
Repayment of term loan	(1,263		)	(431,875		)
Borrowings under revolving credit agreement	—			3,000
Repayments under revolving credit agreement	—			(8,000		)
Payment of employee taxes on stock-based compensation	(3,626		)	(2,150		)
Payment on seller notes	(1,773		)	(1,749		)
Payment of financing lease obligations	(116		)	(364		)
Payment of debt issuance costs	—			(6,757		)
Payment of debt extinguishment costs	—			(8,436		)
Net cash (used in) provided by financing activities	(6,778		)	45,136
(Decrease) increase in cash, cash equivalents and restricted cash	(74,603		)	30,483
Cash, cash equivalents, and restricted cash, at beginning of period	95,114			4,779
Cash, cash equivalents, and restricted cash, at end of period	$	20,511		$	35,262

Reconciliation of Cash, Cash Equivalents, and Restricted Cash:
Cash and cash equivalents, at beginning of period	$	95,114		$	1,508
Restricted cash, at beginning of period	—			3,271
Cash, cash equivalents, and restricted cash, at beginning of period	$	95,114		$	4,779

Cash and cash equivalents, at end of period	$	20,511		$	32,913
Restricted cash, at end of period	—			2,349
Cash, cash equivalents, and restricted cash, at end of period	$	20,511		$	35,262

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

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HANGER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE A — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

Hanger, Inc. (“we,” “our,” or “us”) is a leading national provider of products and services that assist in enhancing or restoring the physical capabilities of patients with disabilities or injuries. We provide orthotic and prosthetic (“O&P”) services, distribute O&P devices and components, 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.

Basis of Presentation

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

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

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

Recent Accounting Pronouncements Adopted

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. We do not separate non-lease components, consisting primarily of training, for these leases.

Effect of Adoption of ASC 842

We adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (ASC 842), and related clarifying standards, as of January 1, 2019, using the modified retrospective approach. This approach allows us to apply the standard as of the adoption date and record a cumulative-effect adjustment to the opening balance of Accumulated deficit at January 1, 2019. The new lease standard requires lessees to recognize a right-of-use (“ROU”) asset and a lease liability on the balance sheet for all leases (with the exception of short-term leases, defined as leases with a term of 12 months or less) at the lease commencement date and recognize expenses on the consolidated statement of income on a straight-line basis.

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In addition, we elected the package of practical expedients available under the transition provisions of the new lease standard, including (i) not reassessing whether expired or existing contracts contain leases, (ii) carrying forward lease classification under legacy guidance, and (iii) not revaluing initial direct costs for existing leases. By electing the modified retrospective approach on adoption date, prior period results will continue to be presented under legacy guidance based on the accounting standards originally in effect for such period. We have elected to keep leases with an initial term of 12 months or less off of the balance sheet and recognize those lease payments in the consolidated statements of income on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, and have elected to utilize the practical expedient to account for lease and non-lease components together as a single combined lease component for real estate and therapeutic program equipment, from both a lessee and lessor perspective. From a lessor perspective, the timing and pattern of transfer are the same for the non-lease components and associated lease component and, the lease component, if accounted for separately, would be classified as an operating lease. The accounting for our finance leases and leases where we are the lessor remained substantially unchanged.

The lease liability was measured as the present value of the unpaid lease payments and the right-of-use asset was derived from the calculation of the lease liability. As the rate implicit in the lease is generally not readily determinable for our operating leases, the discount rates used to determine the present value of our lease liability are based on our incremental borrowing rate at the lease commencement date and commensurate with the remaining lease term. Our incremental borrowing rate for a lease is the rate of interest we would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Our lease term may include options to extend or terminate if the exercise of that option is reasonably certain to occur. We rent or sublease certain real estate to third parties. Our sublease portfolio consists mainly of operating leases on small medical office locations.

The most significant impact of the new lease standard will be on the balance sheet, where values have been added for real estate operating leases, which increases both assets and liabilities. The capital leases associated with equipment were already reflected on our balance sheet and did not add any incremental assets or liabilities under the new lease standard. The adoption of the new lease standard did not have an impact on our compliance with existing debt covenants because the impact of changes in accounting standards is excluded from debt covenant calculations. The impact of applying the new lease standard to our results of operations and cash flows is not significant.

Additionally, we have determined that the leases previously identified as build-to-suit leasing arrangements under legacy lease accounting were to be derecognized pursuant to the transition guidance provided for build-to-suit leases in ASC 842. Accordingly, these leases have been reassessed as operating leases as of January 1, 2019. The legacy guidance was based on a risks and rewards model which contained several prescriptive provisions designed to assess lessee ownership during construction. The ASC 842 model has eliminated these prescriptive rules and replaced them with a model based on control. Under ASC 842, we did not demonstrate control as the lessee and therefore the leases were derecognized at January 1, 2019. The resulting cumulative effect recognized at adoption to Accumulated deficit was $1.6 million, net of tax.

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Upon adoption of ASC 842, the cumulative effect of the changes made to our condensed consolidated balance sheet as of January 1, 2019 was as follows:

	December 31, 2018			Effects of			January 1, 2019
(in thousands)	As reported			adoption			After adoption
Assets
Other current assets	$	18,731		$	(3,987	)	$	14,744
Total current assets	325,900			(3,987		)	321,913
Property, plant and equipment, net	89,489			(8,068		)	81,421
Other intangible assets, net	15,478			(220		)	15,258
Deferred income taxes	65,635			(570		)	65,065
Operating lease right-of-use assets	—			103,378			103,378
Other assets	7,766			538			8,304
Total assets	703,010			91,071			794,081
Liabilities
Current liabilities:
Current portion of long-term debt	8,583			(619		)	7,964
Accrued expenses and other current liabilities	51,783			(1,352		)	50,431
Current portion of operating lease liabilities	—			33,393			33,393
Total current liabilities	171,274			31,422			202,696
Long-term liabilities:
Long-term debt, less current portion	502,090			(12,493		)	489,597
Operating lease liabilities	—			83,662			83,662
Other liabilities	51,570			(13,081		)	38,489
Total liabilities	724,934			89,510			814,444
Shareholders’ deficit:
Accumulated deficit	(361,023		)	1,561			(359,462		)
Total shareholders’ deficit	(21,924		)	1,561			(20,363		)
Total liabilities and shareholders’ deficit	$	703,010		$	91,071		$	794,081

Recent Accounting Pronouncements, Not Yet Adopted

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and related clarifying standards, which replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This new standard is effective for us beginning December 15, 2019, with early adoption permitted. We are currently evaluating the effects that the adoption of this guidance will have on our consolidated financial statements and the related disclosures.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), which modifies the disclosures on fair value measurements by removing the requirement to disclose the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy and the policy for timing of such transfers. The ASU expands the disclosure requirements for Level 3 fair value measurements, primarily focused on changes in unrealized gains and losses included in other comprehensive income. The ASU is effective for public entities for fiscal years beginning after December 15, 2019, with early adoption permitted. We are currently evaluating the effects that the adoption of this guidance will have on our consolidated financial statements and the related disclosures.

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

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Topic 220). The ASU is intended to improve the recognition and measurement of financial instruments. The new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). This ASU is effective for public entities for fiscal years beginning after December 15, 2019, with early adoption permitted. We are currently evaluating the effects that the adoption of this guidance will have on our consolidated financial statements and the related disclosures.

NOTE B — EARNINGS PER SHARE

Basic earnings per common share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed using the weighted average number of common shares outstanding during the period plus any potentially dilutive common shares, such as stock options, restricted stock units, and performance-based units calculated using the treasury stock method. Total anti-dilutive shares excluded from the diluted earnings per share were zero as of March 31, 2019 and 208,510 as of March 31, 2018.

Our credit agreement restricts the payment of dividends or other distributions to our shareholders with respect to Hanger, Inc., or any of its subsidiaries.

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

	For the Three Months Ended March 31,
(in thousands except per share data)	2019			2018
Net loss	$	(6,951	)	$	(22,618	)

Weighted average shares outstanding - basic	37,001,977			36,498,482
Effect of potentially dilutive restricted stock units and options (1)	—			—
Weighted average shares outstanding - diluted	37,001,977			36,498,482

Basic and diluted loss per share	$	(0.19	)	$	(0.62	)

(1) In accordance with ASC 260 - Earnings Per Share, during periods of a net loss, shares used to compute diluted per share amounts exclude potentially dilutive shares related to unvested restricted stock units and unexercised options. For the three months ended March 31, 2019, shares excluded were 889,093. For the three months ended March 31, 2018, shares excluded were 537,497.

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NOTE C — REVENUE RECOGNITION

Patient Care Segment

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

The following table disaggregates revenue from contracts with customers in our Patient Care segment for the three months ended March 31, 2019 and 2018:

	For the Three Months Ended March 31,
(in thousands)	2019		2018
Patient Care Segment
Medicare	$	57,776	$	57,531
Medicaid	30,147		29,711
Commercial Insurance/ Managed Care (excluding Medicare and Medicaid Managed Care)	70,218		70,582
Veterans Administration	18,322		16,731
Private Pay	14,138		13,952
Total	$	190,601	$	188,507

The impact to revenue related to prior period performance obligations was not material for the three months ended March 31, 2019.

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.

The following table disaggregates revenue from contracts with customers in our Product & Services segment for the three months ended March 31, 2019 and 2018:

	For the Three Months Ended March 31,
(in thousands)	2019		2018
Products & Services Segment
Distribution services, net of intersegment revenue eliminations	$	33,195	$	31,351
Therapeutic solutions	12,623		14,137
Total	$	45,818	$	45,488

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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 billings, net of contractual discounts and other implicit price concessions including estimates for payor disallowances, sales returns, and patient non-payments.

An allowance for doubtful accounts is also recorded for our Products & Services segment which is deducted from gross accounts receivable to arrive at “Accounts receivable, net.” Accounts receivable, net as of March 31, 2019 and December 31, 2018 is comprised of the following:

	As of March 31, 2019									As of December 31, 2018
(in thousands)	Patient Care			Products & Services			Consolidated			Patient Care			Products & Services			Consolidated
Accounts receivable, before allowances	$	176,705		$	24,981		$	201,686		$	182,338		$	24,542		$	206,880
Allowances for estimated implicit price concessions arising from:
Payor disallowances	(55,385		)	—			(55,385		)	(53,378		)	—			(53,378		)
Patient non-payments	(7,245		)	—			(7,245		)	(7,244		)	—			(7,244		)
Accounts receivable, gross	114,075			24,981			139,056			121,716			24,542			146,258
Allowance for doubtful accounts	—			(2,165		)	(2,165		)	—			(2,272		)	(2,272		)
Accounts receivable, net	$	114,075		$	22,816		$	136,891		$	121,716		$	22,270		$	143,986

NOTE E — INVENTORIES

Our inventories are comprised of the following:

	As of March 31,		As of December 31,
(in thousands)	2019		2018
Raw materials	$	20,401	$	19,632
Work in process	12,711		9,278
Finished goods	36,924		38,780
Total inventories	$	70,036	$	67,690

NOTE F — PROPERTY PLANT AND EQUIPMENT, NET

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

	As of March 31,			As of December 31,
(in thousands)	2019			2018
Land	$	634		$	644
Buildings (1)	3,979			24,558
Furniture and fixtures	13,273			13,121
Machinery and equipment	26,568			27,452
Equipment leased to third parties under operating leases	29,402			30,093
Leasehold improvements	125,280			111,247
Computers and software	69,579			69,173
Total property, plant, and equipment, gross	268,715			276,288
Less: accumulated depreciation	(186,764		)	(186,799		)
Total property, plant, and equipment, net	$	81,951		$	89,489

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

Total depreciation expense was approximately $7.5 million and $7.4 million for the three months ended March 31, 2019 and 2018, respectively.

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NOTE G — ACQUISTIONS

2019 Acquisition Activity

On January 28, 2019, we acquired all of the outstanding equity interests of an O&P business for a total aggregate purchase price of $32.5 million, of which $27.7 million was cash consideration, net of cash acquired, $4.5 million was issued in the form of notes to the shareholders at fair value, and $0.3 million of estimated additional consideration expected to be paid in the second quarter of 2019. The notes to shareholders are unsecured and payable in quarterly installments over a period of three years. The primary reason for the acquisition was to expand our continuum of patient care through the acquisition of high quality O&P providers in new geographic markets.

We accounted for this transaction under the acquisition method of accounting and have reported the results of operations of the acquisition as of the date of the acquisition. The estimated fair values of intangible assets was based on an income approach utilizing primarily discounted cash flow techniques for non-compete agreements and an income approach utilizing the excess earnings method for customer relationships. The income approach utilizes management’s estimates of future operating results and cash flows using a weighted average cost of capital that reflects market participant assumptions. Other significant judgments used in the valuation of tangible assets acquired in the acquisition include estimated selling price of inventory and estimated replacement cost for acquired property, plant and equipment. For all other assets acquired and liabilities assumed, the fair value reflects the carrying value of the asset or liability due to their short maturity. The excess of the fair value of the consideration transferred in the acquisition over the fair value of net assets acquired was recorded as goodwill. The goodwill reflects our expectations of favorable future growth opportunities, anticipated synergies through the scale of our O&P operations, and the assembled workforce. We expect that substantially all of the Goodwill, which has been assigned to our Patient Care reporting unit, will be deductible for federal income tax purposes.

Acquisition-related costs of $0.2 million for the three months ended March 31, 2019 related to the acquisition are included in General and administrative expenses in our consolidated statement of operations.

We have not presented pro forma combined results for this acquisition because the impact on previously reported statements of operations would not have been material.

Purchase Price Allocation

The Company has performed a preliminary valuation analysis of the fair market value of the assets and liabilities acquired in the acquisition. The final purchase price allocation will be determined when we have completed and fully reviewed the detailed valuation and could differ materially from the preliminary allocation. The final allocation 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.

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

	For the Three Months Ended
(in thousands)	March 31, 2019
Cash paid, net of cash acquired	$	27,679
Issuance of seller notes	4,451
Additional consideration (1)	345
Aggregate purchase price	32,475

Accounts receivable, net	3,318
Inventories	1,466
Customer relationships (Useful life of 3.0 years)	1,963
Non-compete agreements (Weighted average useful life of 4.9 years)	349
Other assets	329
Accounts payable	(1,191		)
Accrued expenses and other liabilities	(1,649		)
Net assets acquired	4,585
Goodwill	$	27,890

(1) Represents additional consideration payable to the seller in the second quarter of 2019, subject to agreement of certain tax elections with the seller.

2018 Acquisition Activity

In the fourth quarter of 2018, we acquired two O&P businesses for an aggregate purchase price of $3.1 million, net of cash acquired. These acquisitions were accounted for using the acquisition method of accounting whereby assets acquired and liabilities assumed were recognized at fair value on the date of the transaction.

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

(in thousands)	For The Year Ended December 31, 2018
Cash paid, net of cash acquired	$	1,978
Issuance of seller notes	1,120
Aggregate purchase price	3,098

Accounts receivable, net	256
Inventories	302
Customer relationships (Weighted average useful life of 4.0 years)	260
Non-compete agreements (Weighted average useful life of 4.6 years)	214
Other assets	90
Accounts payable	(59		)
Accrued expenses and other liabilities	(364		)
Net assets acquired	699
Goodwill	$	2,399

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NOTE H — GOODWILL AND OTHER INTANGIBLE ASSETS

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

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

	For the Three Months Ended March 31, 2019
	Patient Care							Products & Services							Consolidated
(in thousands)	Goodwill, Gross		Accumulated Impairment			Goodwill, Net		Goodwill, Gross		Accumulated Impairment			Goodwill, Net		Goodwill, Gross		Accumulated Impairment			Goodwill, Net
As of December 31, 2018	$	627,410	$	(428,668	)	198,742		$	139,299	$	(139,299	)	—		$	766,709	$	(567,967	)	198,742
Additions from acquisitions	27,890		—			27,890		—		—			—		27,890		—			27,890
As of March 31, 2019	$	655,300	$	(428,668	)	$	226,632	$	139,299	$	(139,299	)	$	—	$	794,599	$	(567,967	)	$	226,632

	For the Year Ended December 31, 2018
	Patient Care							Products & Services							Consolidated
(in thousands)	Goodwill, Gross		Accumulated Impairment			Goodwill, Net		Goodwill, Gross		Accumulated Impairment			Goodwill, Net		Goodwill, Gross		Accumulated Impairment			Goodwill, Net
As of December 31, 2017	$	625,011	$	(428,668	)	$	196,343	$	139,299	$	(139,299	)	$	—	$	764,310	$	(567,967	)	$	196,343
Additions from acquisitions	2,399		—			2,399		—		—			—		2,399		—			2,399
As of December 31, 2018	$	627,410	$	(428,668	)	$	198,742	$	139,299	$	(139,299	)	$	—	$	766,709	$	(567,967	)	$	198,742

The balances related to intangible assets as of March 31, 2019 and December 31, 2018 are as follows:

	As of March 31, 2019
(in thousands)	Gross Carrying Amount		Accumulated Amortization			Accumulated Impairment			Net Carrying Amount
Customer lists	$	27,420	$	(19,443	)	$	—		$	7,977
Trade name	255		(132		)	—			123
Patents and other intangibles	9,238		(5,040		)	—			4,198
Definite-lived intangible assets	36,913		(24,615		)	—			12,298
Indefinite-lived trade names	9,070		—			(4,953		)	4,117
Total other intangible assets	$	45,983	$	(24,615	)	$	(4,953	)	$	16,415

	As of December 31, 2018
(in thousands)	Gross Carrying Amount		Accumulated Amortization			Accumulated Impairment			Net Carrying Amount
Customer lists	$	26,036	$	(19,051	)	$	—		$	6,985
Trade name	255		(125		)	—			130
Patents and other intangibles	9,391		(5,145		)	—			4,246
Definite-lived intangible assets	35,682		(24,321		)	—			11,361
Indefinite-lived trade names	9,070		—			(4,953		)	4,117
Total other intangible assets	$	44,752	$	(24,321	)	$	(4,953	)	$	15,478

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Total intangible amortization expense was approximately $1.2 million and $2.0 million for the three months ended March 31, 2019 and 2018, respectively.

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

(in thousands)
2019 (remainder of the year)	$	3,652
2020	4,601
2021	1,118
2022	964
2023	855
Thereafter	1,108
Total	$	12,298

NOTE I — OTHER CURRENT ASSETS AND OTHER ASSETS

Other current assets consist of the following:

	As of March 31,		As of December 31,
(in thousands)	2019		2018
Non-trade receivables	$	8,561	$	7,848
Prepaid rent	657		4,442
Prepaid maintenance	3,554		3,330
Prepaid insurance	1,723		258
Prepaid other	994		1,101
Prepaid purchase orders	934		998
Prepaid education and training	518		597
Prepaid benefits	117		157
Total other current assets	$	17,058	$	18,731

Other assets consist of the following:

	As of March 31,		As of December 31,
(in thousands)	2019		2018
Cash surrender value of company owned life insurance	$	3,045	$	2,918
Non-trade receivables	1,822		1,904
Deposits	1,753		1,698
Surety bond collateral	1,000		1,000
Finance lease right-of-use assets	541		—
Other	231		246
Total other assets	$	8,392	$	7,766

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NOTE J — ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES AND OTHER LIABILITIES

Accrued expenses and other current liabilities consist of:

	As of March 31,		As of December 31,
(in thousands)	2019		2018
Patient prepayments, deposits and refunds payable	$	24,187	$	24,563
Insurance and self-insurance accruals	8,610		8,886
Accrued sales taxes and other taxes	7,283		6,810
Accrued professional fees	3,685		3,751
Education expenses	2,315		—
Derivative liability	1,205		724
Accrued interest payable	487		332
Other current liabilities	5,539		6,717
Total accrued expenses and other current liabilities	$	53,311	$	51,783

Other liabilities consist of:

	As of March 31,		As of December 31,
(in thousands)	2019		2018
Supplemental executive retirement plan obligations	$	18,661	$	20,195
Long-term insurance accruals	8,437		8,713
Derivative liability	6,515		3,134
Unrecognized tax benefits, and related interest and penalties	5,523		5,458
Asset retirement obligations	1,113		980
Deferred tenant improvement allowances	—		8,570
Deferred rent	—		4,455
Other	10		65
Total other liabilities	$	40,259	$	51,570

NOTE K — INCOME TAXES

We recorded a benefit from income tax of $3.7 million and $6.2 million for the three months ended March 31, 2019 and 2018, respectively. The effective tax rate was 35.0% and 21.5% for the three months ended March 31, 2019 and 2018, respectively.

The increase in the effective tax rate for the three months ended March 31, 2019 compared with the three months ended March 31, 2018 is primarily attributable to the change from the discrete method in the three months ended March 31, 2018 to the annual effective tax rate for the three months ended March 31, 2019, an increased estimated annual income, and the windfall from stock-based compensation recorded as a discrete item during the period. Our effective tax rate for the three months ended March 31, 2019 differed from the federal statutory tax rate of 21% primarily due to non-deductible expenses and the windfall from stock-based compensation recorded as a discrete item during the period. Our effective tax rate for the three months ended March 31, 2018 differed from the federal statutory tax rate of 21% primarily due to non-deductible expenses and the shortfall from stock-based compensation recorded as a discrete item during the period.

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NOTE L — LEASES

The information pertaining to leases on the condensed consolidated balance sheet is as follows:

		As of March 31,
(in thousands)	Classification	2019
Assets
Operating lease right-of-use assets	Operating lease right-of-use assets	$	103,676
Finance lease right-of-use assets	Other assets	541
Total lease assets		$	104,217
Liabilities
Current
Operating	Current portion of operating lease liabilities	$	33,675
Finance	Current portion of long-term debt	246
Noncurrent
Operating	Operating lease liabilities	83,693
Finance	Long-term debt, less current portion	321
Total lease liabilities		$	117,935

The components of lease cost recognized in the condensed consolidated statement of operations are as follows:

(in thousands)	For the Three Months Ended March 31, 2019
Operating lease cost	$	10,836
Finance lease cost
Amortization of right-of-use assets	75
Interest on lease liabilities	6
Sublease income	(33		)
Short-term lease cost	368
Variable lease cost	1,217
Total lease cost	$	12,469

Future minimum rental payments, by year and in the aggregate, under operating and financing obligations with terms of one year or more at March 31, 2019 are as follows:

(in thousands)	Finance Leases			Operating Leases			Total Leases
2019 (remainder of year)	$	206		$	29,609		$	29,815
2020	208			35,411			35,619
2021	136			26,294			26,430
2022	50			18,741			18,791
2023	2			12,019			12,021
2024	—			5,826			5,826
Thereafter	—			4,593			4,593
Total future minimum lease payments	602			132,493			133,095
Imputed interest	(35		)	(15,125		)	(15,160		)
Total	$	567		$	117,368		$	117,935

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The lease term and discount rates are as follows:

	For the Three Months Ended March 31, 2019
Weighted average remaining lease term (years)
Operating leases	3.98
Finance leases	2.60
Weighted average discount rate
Operating leases	5.73	%
Finance leases	4.20	%

Supplemental cash flow information related to leases is as follows:

(in thousands)	For the Three Months Ended March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	11,787
Operating cash flows from finance leases	6
Financing cash flows from finance leases	80
Right-of-use assets obtained in exchange for lease obligations:
Operating leases	10,394
Finance leases	76

Future minimum rental payments, by year and in the aggregate, under operating and financing obligations with terms of one year or more at December 31, 2018 are as follows:

(in thousands)	Operating Leases		Capital Leases
2019	$	39,378	$	249
2020	29,641		175
2021	21,303		109
2022	14,479		28
2023	9,193		—
Thereafter	10,008		—
	$	124,002	$	561

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NOTE M — DEBT AND OTHER OBLIGATIONS

Debt consists of the following:

	As of March 31,			As of December 31,
(in thousands)	2019			2018
Debt:
Term Loan B	$	499,950		$	501,213
Seller notes	7,402			4,506
Financing leases and other	1,212			14,361
Total debt before unamortized discount and debt issuance costs	508,564			520,080
Unamortized discount and debt issuance costs, net	(9,264		)	(9,407		)
Total debt	$	499,300		$	510,673

Current portion of long-term debt:
Term Loan B	$	5,050		$	5,050
Seller notes	3,288			2,513
Financing leases and other	339			1,020
Total current portion of long-term debt	8,677			8,583
Long-term debt:	$	490,623		$	502,090

Refinancing of Credit Agreement and Term B Borrowings

On March 6, 2018, we entered into a $605.0 million Senior Credit Facility (the “Credit Agreement”). The Credit Agreement provides for (i) a revolving credit facility with an initial maximum aggregate amount of availability of $100.0 million that matures in March 2023 and (ii) a $505.0 million Term Loan B facility due in quarterly principal installments commencing June 29, 2018, with all remaining outstanding principal due at maturity in March 2025. Availability under the revolving credit facility is reduced by outstanding letters of credit, which were approximately $5.2 million as of March 31, 2019. 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.

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

Borrowings under the Credit Agreement bear interest at a variable rate equal to (i) LIBOR plus a specified margin, or (ii) the base rate (which is the highest of (a) Bank of America, N.A.’s prime rate, (b) the federal funds rate plus 0.50% or (c) the sum of 1% plus one-month LIBOR) plus a specified margin. For the three months ended March 31, 2019, the weighted average interest rate on outstanding borrowings under our Term Loan B facility was approximately 6.0%. 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.”

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

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

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

Seller Notes

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 $0.3 million and $0.2 million as of March 31, 2019 and December 31, 2018, respectively. We measure these instruments at their estimated fair values as of the respective acquisition dates. The stated interest rates on these instruments range from 2.00% to 3.00%. Principal and interest are payable in monthly, quarterly, or annual installments and mature through November 2023.

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Scheduled maturities of debt at March 31, 2019 were as follows:

(in thousands)
2019 (remainder of year)	$	5,974
2020	8,220
2021	7,193
2022	5,849
2023	5,329
Thereafter	475,999
Total debt before unamortized discount and debt issuance costs, net	508,564
Unamortized discount and debt issuance costs, net	(9,264		)
Total debt	$	499,300

NOTE N — FAIR VALUE MEASUREMENTS

Financial Instruments

In March 2018, we refinanced our credit facilities with the Credit Agreement. The carrying value (excluding unamortized discounts and debt issuance costs of $9.3 million) of our outstanding term loan as of March 31, 2019 was $500.0 million compared to its fair value of $498.7 million. The carrying value of our outstanding term loan as of December 31, 2018 (excluding unamortized discounts and debt issuance costs of $9.4 million) was $501.2 million compared to its fair value of $491.2 million. Our estimates of fair value are based on a discounted cash flow model and indicative quote using unobservable inputs, primarily, our risk-adjusted credit spread, which represents a Level 3 measurement.

As of March 31, 2019 and December 31, 2018, we had no amounts outstanding on our revolving credit facility.

In March 2018, we entered into interest rate swap agreements with notional values of $325.0 million at inception, which reduces $12.5 million annually until the swaps mature on March 6, 2024. The notional value outstanding as of March 31, 2019 was $312.5 million. The interest rate swap agreements are designated as cash flow hedges and are measured at fair value based on inputs other than quoted market prices that are observable, which represents a Level 2 measurement. See Note M - “Debt” and Note O - “Derivative Financial Instruments” for further information.

The carrying value of our Seller Notes as of March 31, 2019 and December 31, 2018 was $7.4 million and $4.5 million, respectively. We believe that the carrying value of the Seller Notes approximates their fair values based on a discounted cash flow model using unobservable inputs, primarily, our credit spread for subordinated debt, which represents a Level 3 measurement.

NOTE O — DERIVATIVE FINANCIAL INSTRUMENTS

We are exposed to certain risks arising from both our business operations and economic conditions. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash payments principally related to our borrowings.

Cash Flow Hedges of Interest Rate Risk

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish these objectives, we primarily use interest rate swaps as part of our interest rate risk

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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. 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 income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.

As of March 31, 2019, our swaps had a notional value outstanding of $312.5 million. As of December 31, 2018, our swaps had a notional value outstanding of $325.0 million.

Change in Net Loss on Cash Flow Hedges Including Accumulated Other Comprehensive Loss

The following table presents the activity of cash flow hedges included in accumulated other comprehensive loss for the three months ended March 31, 2019 and March 31, 2018:

(in thousands)	Cash Flow Hedges
Balance as of December 31, 2018	$	2,936
Unrealized loss recognized in other comprehensive loss, net of tax	3,151
Reclassification to interest expense, net	(215		)
Balance as of March 31, 2019	$	5,872

Balance as of December 31, 2017	$	—
Unrealized loss recognized in other comprehensive loss, net of tax	2,538
Reclassification to interest expense, net	(248		)
Balance as of March 31, 2018	$	2,290

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

	As of March 31, 2019				As of December 31, 2018
(in thousands)	Assets		Liabilities		Assets		Liabilities
Derivatives designated as cash flow hedging instruments:
Accrued expenses and other current liabilities	$	—	$	1,205	$	—	$	724
Other liabilities	—		6,515		—		3,134

NOTE P — STOCK-BASED COMPENSATION

The Hanger, Inc. 2016 Omnibus Incentive Plan (the “2016 Plan”), as amended by our Board of Directors (the “Board”) in May 2018 authorizes the issuance of up to 2,625,000 shares of Common Stock, plus (i) the number of shares available for issuance under our prior equity incentive plan, the Hanger, Inc. 2010 Omnibus Incentive Plan (the “2010 Plan”), that had not been made subject to outstanding awards as of the effective date of the 2016 Plan and (ii) any shares that would have become available again for new grants under the terms of the 2010 Plan if such plan were still in effect.

We recognized a total of approximately $3.3 million and $2.6 million, respectively, of stock-based compensation expense for the three months ended March 31, 2019 and 2018. Stock compensation expense, net of forfeitures, relates to restricted stock units, performance-based restricted stock units, and stock options.

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NOTE Q — SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS

Defined Benefit Supplemental Executive Retirement Plan

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

We believe the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. The DB SERP’s change in net benefit cost and obligation during the three months ended March 31, 2019 and 2018 is as follows:

Change in Benefit Obligation:

(in thousands)	2019			2018
Benefit obligation as of December 31, 2018 and 2017, respectively	$	18,927		$	20,793
Service cost	84			92
Interest cost	165			150
Payments	(1,877		)	(1,877		)
Benefit Obligation as of March 31	$	17,299		$	19,158

Amounts Recognized in the Condensed Consolidated Balance Sheets:

	As of March 31,		As of December 31,
(in thousands)	2019		2018
Accrued expenses and other current liabilities	$	1,913	$	1,913
Other liabilities	15,386		17,014
Total accrued liabilities	$	17,299	$	18,927

Defined Contribution Supplemental Executive Retirement Plan

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

As of March 31, 2019 and December 31, 2018, the estimated accumulated obligation benefit is $3.1 million and $3.0 million, respectively, of which $3.0 million and $2.4 million is funded and $0.1 million and $0.6 million is unfunded at March 31, 2019 and December 31, 2018, respectively.

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

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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.

Legal Proceedings

Securities and Derivative Litigation

In November 2014, a securities class action complaint, City of Pontiac General Employees’ Retirement System v. Hanger, et al., C.A. No. 1:14-cv-01026-SS, was filed against us in the United States District Court for the Western District of Texas. The complaint named us and certain of our current and former officers for allegedly making materially false and misleading statements regarding, inter alia, our financial statements, RAC audit success rate, the implementation of new financial systems, same-store sales growth, and the adequacy of our internal processes and controls. The complaint alleged violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. The complaint sought unspecified damages, costs, attorneys’ fees, and equitable relief.

On April 1, 2016, the court granted our motion to dismiss the lawsuit for failure to state a claim upon which relief can be granted, and permitted plaintiffs to file an amended complaint. On July 1, 2016, plaintiffs filed an amended complaint. On September 15, 2016, we and certain of the individual defendants filed motions to dismiss the lawsuit. On January 26, 2017, the court granted the defendants’ motions and dismissed with prejudice all claims against all defendants for failure to state a claim. On February 24, 2017, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Fifth Circuit. On August 6, 2018, the Court of Appeals affirmed in part and reversed in part. The Court of Appeals affirmed the dismissal of the case against individual defendants Vinit Asar, our current President and Chief Executive Officer, and Thomas Kirk, our former President and Chief Executive Officer, but reversed the dismissal of the case against George McHenry, our former Chief Financial Officer, and Hanger, Inc. On August 20, 2018, Hanger, Inc. and George McHenry filed a petition for panel rehearing and a petition for rehearing en banc with the Court of Appeals. On April 10, 2019 the Court of Appeals granted the petition for panel rehearing, withdrew its previous panel decision, and substituted a new panel decision in its place that affirmed the District Court’s dismissal with prejudice of all claims against all the defendants for failure to state a claim. Plaintiffs did not petition the Court of Appeals for a panel rehearing or a rehearing en banc. Should plaintiffs decide to continue the litigation, their sole remaining option is to petition the United States Supreme Court to review the new Fifth Circuit panel decision issued on April 10, 2019. The deadline for such petition is July 9, 2019.

In February and August of 2015, two separate shareholder derivative suits were filed in Texas state court against us related to the announced restatement of certain of our financial statements. The cases were subsequently consolidated into Judy v. Asar, et. al., Cause No. D-1-GN-15-000625. On October 25, 2016, plaintiffs in that action filed an amended complaint, and the case is currently pending before the 459th Judicial District Court of Travis County, Texas.

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

As disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on June 6, 2016, the Board of Directors appointed a Special Litigation Committee of the Board (the “Special Committee”). The Board delegated to the Special Committee the authority to (1) determine whether it is in our best interests to pursue any of the allegations made

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

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

The plaintiffs subsequently subpoenaed counsel for the Special Committee, seeking a copy of the full report prepared by the Special Committee and its independent counsel. Counsel for the Special Committee, as well as our counsel, took the position that the full report is not discoverable under Texas law. Plaintiffs’ counsel filed a motion to compel the Special Committee’s counsel to produce the full report. We opposed the motion. On July 20, 2018, the Travis County court ruled that only a redacted version of the report is discoverable, and counsel for the Special Committee provided a redacted version of the report to plaintiffs’ counsel. Plaintiffs objected to the redacted version of the report, and on February 4, 2019, the Travis County court appointed a Special Master to review plaintiffs’ objections to the redacted report. On March 22, 2019, the Special Master submitted a report to the Travis County Court recommending that the Court order that the entire Special Committee report be produced. On April 2, 2019 we filed an objection to the Special Master’s report and recommendation, and requested a hearing on the matter. The Travis County Court scheduled a hearing for May 15, 2019 regarding our objection. Upon completion of discovery, we intend to file a motion to dismiss the consolidated derivative action.

Management intends to continue to vigorously defend against the shareholder derivative action. At this time, if the derivative action were to go to trial, we cannot predict how the Travis County Court would rule on the merits of the claims and/or the scope of the potential loss in the event of an adverse outcome. Should we ultimately be found liable, the resulting damages could have a material adverse effect on our consolidated financial position, liquidity or our results of operations.

Other Matters

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

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

NOTE 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 our owned and operated patient care clinics. 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:

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· Commercial private payors and other, which consist of individuals, rehabilitation providers, commercial insurance companies, health management organizations (“HMOs”), preferred provider organizations (“PPOs”), hospitals, vocational rehabilitation, workers’ compensation programs, and similar sources;

· Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain disabled persons, which provides reimbursement for O&P products and services based on prices set forth in published fee schedules with 10 regional pricing areas for prosthetics and orthotics and by state for durable medical equipment;

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

· U.S. Department of Veterans Affairs.

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

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

Corporate & Other - This consists of corporate overhead and includes unallocated expenses 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” in our 2018 Form 10-K.

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

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

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	Patient Care				Products & Services
	For the Three Months Ended March 31,				For the Three Months Ended March 31,
(in thousands)	2019		2018		2019		2018
Net revenues
Third party	$	190,601	$	188,507	$	45,818	$	45,488
Intersegments	—		—		44,879		42,522
Total net revenue	190,601		188,507		90,697		88,010
Material costs
Third party suppliers	53,355		52,175		25,022		24,181
Intersegments	5,795		5,724		39,084		36,798
Total material costs	59,150		57,899		64,106		60,979
Personnel expenses	73,709		73,613		13,002		12,495
Other expenses	37,433		35,004		6,948		6,155
Depreciation & amortization	4,552		4,898		2,543		2,502
Segment income from operations	$	15,757	$	17,093	$	4,098	$	5,879

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

	For the Three Months Ended March 31,
(in thousands)	2019			2018
(Loss) income from operations:
Patient Care	$	15,757		$	17,093
Products & Services	4,098			5,879
Corporate & other	(21,834		)	(22,349		)
(Loss) income from operations	(1,979		)	623
Interest expense, net	8,538			12,263
Loss on extinguishment of debt	—			16,998
Non-service defined benefit plan expense	173			176
Loss before income taxes	(10,690		)	(28,814		)
Benefit for income taxes	(3,739		)	(6,196		)
Net loss	$	(6,951	)	$	(22,618	)

A reconciliation of the reportable segment net revenue to consolidated net revenue is as follows:

	For the Three Months Ended March 31,
(in thousands)	2019			2018
Net revenues
Patient Care	$	190,601		$	188,507
Products & Services	90,697			88,010
Corporate & other	—			—
Consolidating adjustments	(44,879		)	(42,522		)
Consolidated net revenue	$	236,419		$	233,995

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

	For the Three Months Ended March 31,
(in thousands)	2019			2018
Material costs
Patient Care	$	59,150		$	57,899
Products & Services	64,106			60,979
Corporate & other	—			—
Consolidating adjustments	(44,879		)	(42,522		)
Consolidated material costs	$	78,377		$	76,356

NOTE T — SUPPLEMENTAL CASH FLOW INFORMATION

Changes in operating assets and liabilities on cash flows from operating activities is as follows:

	For the Three Months Ended March 31,
(in thousands)	2019			2018
Accounts receivable, net	$	10,395		$	19,425
Inventories	(880		)	1,085
Other current assets and other assets	(1,433		)	650
Income taxes	(355		)	12,255
Accounts payable	(6,511		)	552
Accrued expenses and other current liabilities	492			(5,067		)
Accrued compensation related costs	(32,970		)	(35,789		)
Other liabilities	(1,829		)	(2,537		)
Operating lease liabilities	(10,082		)	—
Changes in operating assets and liabilities on cash flows from operating activities	$	(43,173	)	$	(9,426	)

The supplemental disclosure requirements for the statements of cash flows are as follows:

	For the Three Months Ended March 31,
(in thousands)	2019		2018
Issuance of seller notes in connection with acquisitions	$	4,451	$	—
Additions to property, plant and equipment acquired through financing obligations	—		1,208
Retirements of financed property, plant and equipment and related obligations	—		2,246
Purchase of property, plant and equipment in accounts payable at period end	4,443		545

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

This report contains statements that are forward-looking statements within the meaning of the federal securities laws. Forward-looking statements include information concerning our liquidity and our possible or assumed future results of operations, including descriptions of our business strategies. These statements often include words such as “believe,” “expect,” “project,” “potential,” “anticipate,” “intend,” “plan,” “estimate,” “seek,” “will,” “may,” “would,” “should,” “could,” “forecasts” or similar words. These statements are based on certain assumptions that we have made in light of our experience in the industry as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate in these circumstances. We believe these judgments are reasonable, but you should understand that these statements are not guarantees of performance or results, and our actual results could differ materially from those expressed in the forward-looking statements due to a variety of important factors, both positive and negative, that may be revised or supplemented in subsequent reports.

These statements involve risks, estimates, assumptions, and uncertainties that could cause actual results to differ materially from those expressed in these statements and elsewhere in this report, and any claims, investigations, or proceedings arising as a result, as well as our ability to remediate the material weaknesses in our internal control over financial reporting described in Item 4. “Controls and Procedures” contained elsewhere in this report, changes in the demand for our O&P products and services, uncertainties relating to the results of operations or our acquired O&P patient care clinics, our ability to enter into and derive benefits from managed-care contracts, our ability to successfully attract and retain qualified O&P clinicians, federal laws governing the health care industry, uncertainties inherent in investigations and legal proceedings, governmental policies affecting O&P operations, and other risks and uncertainties generally affecting the health care industry.

Readers are cautioned that all forward-looking statements involve known and unknown risks and uncertainties including, without limitation, those described in Item 1A. “Risk Factors” contained in our Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”), some of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements contained therein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included in our Quarterly Report on Form 10-Q will prove to be accurate. Actual results could differ materially and adversely from those contemplated by any forward-looking statement. In light of the significant risks and uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements in this discussion to reflect events and circumstances occurring after the date hereof or to reflect unanticipated events. Forward-looking statements and our liquidity, financial condition, and results of operations may be affected by the risks set forth in Item 1A. “Risk Factors” contained in our 2018 Form 10-K or by other unknown risks and uncertainties.

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Effect of Delay in Financial Filings

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

(in thousands)						Balance to be Paid
For the Three Months Ended	Expensed		Paid			in Future Periods
March 31, 2018	$	3,700	$	(7,755	)	$	6,230
June 30, 2018	2,940		(5,938		)	3,232
September 30, 2018	2,230		(2,297		)	3,165
December 31, 2018	3,591		(3,561		)	3,195
March 31, 2019	1,649		(2,621		)	2,223

We currently estimate that during 2019, we will expend a total of $6.3 million in excess professional fees. We expect to continue to incur professional fees as we focus on the remediation of our continuing material weaknesses in internal controls over financial reporting. Due to the ongoing material weaknesses in our controls over financial reporting, we currently undertake additional substantive procedures to test and verify financial statement amounts in connection with the preparation of our financial statements.

Non-GAAP Measures

We refer to certain financial measures and statistics that are not in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We utilize these non-GAAP measures in order to evaluate the underlying factors that affect our business performance and trends. These non-GAAP measures should not be considered in isolation and should not be considered superior to, or as a substitute for, financial measures calculated in accordance with GAAP. We have defined and provided a reconciliation of these non-GAAP measures to their most comparable GAAP measures. The non-GAAP measures used in this Management’s Discussion and Analysis are as follows:

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

Same Clinic Revenues Per Day - measures the year-over-year change in revenue from clinics that have been open a full calendar year or more. Examples of clinics not included in the same center population are closures and acquisitions. Day-adjusted growth normalizes sales for the number of days a clinic was open in each comparable period.

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Business Overview

General

We are a leading national provider of products and services that assist in enhancing or restoring the physical capabilities of patients with disabilities or injuries. Built on the legacy of James Edward Hanger, the first amputee of the American Civil War, we and our predecessor companies have provided O&P services for over 150 years. We provide O&P services, distribute O&P devices and components, manage O&P networks, and provide therapeutic solutions to patients and businesses in acute, post-acute, and clinic settings. We operate through two segments - Patient Care and Products & Services.

Our Patient Care segment is primarily comprised of Hanger Clinic, which specializes in the design, fabrication, and delivery of custom O&P devices through 697 patient care clinics and 104 satellite locations in 45 states and the District of Columbia as of March 31, 2019. We also provide payor network contracting services to other O&P providers through this segment.

Our Products & Services segment is comprised of our distribution services and our therapeutic solutions businesses. As a leading provider of O&P products in the United States, we coordinate, through our distribution services business, the procurement and distribution of a broad catalog of O&P parts, componentry, and devices to independent O&P providers nationwide. To facilitate speed and convenience, we deliver these products through our five distribution facilities that are located in Nevada, Georgia, Illinois, Pennsylvania and Texas. The other business in our Products & Services segment is our therapeutic solutions business, which develops specialized rehabilitation technologies and provides evidence-based clinical programs for post-acute rehabilitation to patients at approximately 3,900 skilled nursing and post-acute providers nationwide.

For the three months ended March 31, 2019, our net revenues were $236.4 million and we recorded net loss of $7.0 million. For the three months ended March 31, 2018, our net revenues were $234.0 million and we recorded net loss of $22.6 million.

Industry Overview

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

The traditional O&P patient care industry is highly fragmented and is characterized by local, independent O&P businesses. We do not believe that any single competitor accounts for more than 2% of the country’s total estimated O&P patient care clinic revenues.

The industry is characterized by stable, recurring revenues, primarily resulting from new patients as well as the need for periodic replacement and modification of O&P devices. We anticipate that the demand for O&P services will continue to grow as the nation’s population increases, and as a result of several trends, including the aging of the U.S. population, there will be an increase in the prevalence of disease-related disability and the demand for new and advanced devices. We believe the typical replacement time for prosthetic devices is three to five years, while the typical replacement time for orthotic devices varies, depending on the device.

We estimate that approximately $1.7 billion is spent in the United States each year by providers of O&P patient care services for the O&P products, components, devices, and supplies used in their businesses. Our Products & Services segment distributes to independent providers of O&P services and to our own patient care clinics. We estimate that our distribution sales account for approximately 8% of the market for O&P products, components, devices, and supplies (excluding sales to our Patient Care segment).

We estimate the market for rehabilitation technologies, integrated clinical programs, and clinician training in skilled nursing facilities (“SNFs”) to be approximately $150 million annually. We currently provide these products and services to approximately 24% of the estimated 15,000 SNFs located in the U.S. We estimate the market for rehabilitation technologies, clinical programs, and training within the broader post-acute rehabilitation markets to be approximately $400 million annually. We do not currently provide a meaningful amount of products and services to this broader market.

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Business Description

Patient Care

Our Patient Care segment employs approximately 1,500 clinical prosthetists, orthotists, and pedorthists, which we refer to as clinicians, substantially all of which are certified by either the American Board for Certification or the Board of Certification of Orthotists and Prosthetists, which are the two boards that certify O&P clinicians. To facilitate timely service to our patients, we also employ technicians, fitters, and other ancillary providers to assist its clinicians in the performance of their duties. Through this segment, we additionally provide network contracting services to independent providers of O&P.

Patients are typically referred to Hanger Clinic by an attending physician who determines a patient’s treatment and writes a prescription. Our clinicians then consult with both the referring physician and the patient with a view toward assisting in the design of an orthotic or prosthetic device to meet the patient’s needs. O&P devices are increasingly technologically advanced and custom designed to add functionality and comfort to patients’ lives, shorten the rehabilitation process, and lower the cost of rehabilitation.

Based on the prescription written by a referring physician, our clinicians examine and evaluate the patient and either design a custom device or, in the case of certain orthotic needs, utilize a non-custom device, including, in appropriate circumstances, an “off the shelf” device, to address the patient’s needs. When fabricating a device, our clinicians ascertain the specific requirements, componentry, and measurements necessary for the construction of the device. Custom devices are constructed using componentry provided by a variety of third party manufacturers who specialize in O&P, coupled with sockets and other elements that are fabricated by our clinicians and technicians, to meet the individual patient’s physical and ambulatory needs. Our clinicians and technicians typically utilize castings, electronic scans, and other techniques to fabricate items that are specialized for the patient. After fabricating the device, a fitting process is undertaken and adjustments are made to ensure the achievement of proper alignment, fit, and patient comfort. The fitting process often involves several stages to successfully achieve desired functional and cosmetic results.

Given the differing physical weight and size characteristics, location of injury or amputation, capability for physical activity and mobility, cosmetic and other needs of each individual patient, each fabricated prosthesis and orthosis is customized for each particular patient. These custom devices are commonly fabricated at one of our regional or national fabrication facilities.

We have earned a reputation within the O&P industry for the development and use of innovative technology in our products, which has increased patient comfort and capability and can significantly enhance the rehabilitation process. Frequently, our proprietary Insignia scanning system is used in the fabrication process. The Insignia system scans the patient and produces an accurate computer-generated image, resulting in a faster turnaround for the patient’s device and a more professional overall experience.

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

The principal reimbursement sources for our services are:

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

· Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain disabled persons;

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· Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons based upon financial need, regardless of age, which may supplement Medicare benefits for financially needy persons aged 65 or older; and

· the U.S. Department of Veterans Affairs.

We typically enter into contracts with third party payors that allow us to perform O&P services for a referred patient and to be paid under the contract with the third party payor. These contracts usually have a stated term of one to three years. These contracts generally may be terminated without cause by either party on 60 to 90 days’ notice or on 30 days’ notice if we have not complied with certain licensing, certification, program standards, Medicare or Medicaid requirements, or other regulatory requirements. Reimbursement for services is typically based on a fee schedule negotiated with the third party payor that reflects various factors, including market conditions, geographic area, and number of persons covered. Many of our commercial contracts are indexed to the commensurate Medicare fee schedule that relates to the products or services being provided.

Government reimbursement is comprised of Medicare, Medicaid, and the U.S. Department of Veterans Affairs. These payors set maximum reimbursement levels for O&P services and products. Medicare prices are adjusted each year based on the Consumer Price Index for All Urban Consumers (“CPI-U”) unless Congress acts to change or eliminate the adjustment. The CPI-U is adjusted further by an efficiency factor (the “Productivity Adjustment” or the “Multi-Factor Productivity Adjustment”) in order to determine the final rate adjustment each year. There can be no assurance that future adjustments will not reduce reimbursements for O&P services and products from these sources.

We, and the O&P industry in general, are subject to various Medicare compliance audits, including Recovery Audit Contractor (“RAC”) audits, Comprehensive Error Rate Testing (“CERT”) audits, Targeted Probe and Educate (“TPE”) audits, and Zone Program Integrity Contractor (“ZPIC”) audits. TPE audits are generally pre-payment audits, while RAC, CERT, and ZPIC audits are generally post-payment audits. TPE audits replaced the previous Medicare Administrative Contractor audits. Adverse post-payment audit determinations generally require Hanger to reimburse Medicare for payments previously made, while adverse pre-payment audit determinations generally result in the denial of payment. In either case, we can request a redetermination or appeal, if we believe the adverse determination is unwarranted, which can take an extensive period of time to resolve, currently up to six years or more.

Products & Services

Through our wholly-owned subsidiary, Southern Prosthetic Supply, Inc. (“SPS”), we distribute O&P components to independent O&P clinics and other customers. Through our internal “supply chain” organization, we purchase, warehouse and distribute over 400,000 SKUs from more than 300 different manufacturers through SPS or directly to our own clinics within our Patient Care segment. Our warehousing and distribution facilities in Nevada, Georgia, Illinois, Pennsylvania, and Texas, provide us with the ability to deliver products to the vast majority of our customers in the United States within two business days. Through our SureFit subsidiary, we also manufacture and sell therapeutic footwear for diabetic patients in the podiatric market. We also operate the Hanger Fabrication Network, which fabricates custom O&P devices for our patient care clinics as well as for independent O&P clinics.

Our distribution services business enables us to:

· centralize our purchasing and thus lower our material costs by negotiating purchasing discounts from manufacturers;

· better manage our patient care clinic inventory levels and improve inventory turns;

· improve inventory quality control;

· encourage our patient care clinics to use the most clinically appropriate products; and

· coordinate new product development efforts with key vendors.

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Through our wholly-owned subsidiary, Accelerated Care Plus Corp., our therapeutic solutions business is a leading provider of rehabilitation technologies and integrated clinical programs to post-acute care and rehabilitation providers. Our value proposition is to provide our customers with a full-service “total solutions” approach encompassing proven medical technology, evidence based clinical programs, and ongoing clinician education and training. Our services support increasingly advanced treatment options for a broader patient population and more medically complex conditions. We serve approximately 3,900 skilled nursing and post-acute providers nationwide.

Reimbursement Trends

In our Patient Care segment, we are reimbursed primarily through employer-based plans offered by commercial insurance carriers, Medicare, Medicaid, and the U.S. Department of Veterans Affairs. Patient Care constituted 80.6% of our net revenue for the three months ended March 31, 2019 and 2018. Our remaining net revenue was provided by our Products & Services segment which derives its net revenue from commercial transactions with independent O&P providers, healthcare facilities, and other customers. In contrast to net revenues from our Patient Care segment, payment for these products and services are not directly subject to third party reimbursement from health care payors.

The following is a summary of our net revenue by payor mix for the Patient Care segment expressed as a percentage of net revenues for the periods indicated:

	For the Three Months Ended March 31,
	2019		2018
Patient Care Segment
Medicare	30.3	%	30.5	%
Medicaid	15.8	%	15.8	%
Commercial Insurance/ Managed Care (excluding Medicare and Medicaid Managed Care)	36.8	%	37.4	%
Veterans Administration	9.6	%	8.9	%
Private Pay	7.5	%	7.4	%
Total	100.0	%	100.0	%

The amount of our reimbursement varies based on the nature of the O&P device we fabricate for our patients. Given the particular physical weight and size characteristics, location of injury or amputation, capability for physical activity and mobility, cosmetic and other needs of each individual patient, each fabricated prostheses and orthoses is customized for each particular patient. The nature of this customization and the manner by which our claims submissions are reviewed by payors makes our reimbursement process administratively difficult.

To receive reimbursement for our work, we must ensure that our clinical, administrative, and billing personnel receive and verify certain medical and health plan information, record detailed documentation regarding the services we provide, and accurately and timely perform a number of claims submission and related administrative tasks. It is our belief the increased nationwide efforts to reduce health care costs has driven changes in industry trends with increases in payor pre-authorization processes, documentation requirements, pre-payment reviews and pre- and post-payment audits,

A measure of our effectiveness in securing reimbursement for our services can be found in the degree to which payors ultimately disallow payment of our claims. Payors can deny claims due to their determination that a physician who referred a patient to us did not sufficiently document that a device was medically necessary or clearly establish the ambulatory (or “activity”) level of a patient. Claims can also be denied based on our failure to ensure that a patient was currently eligible under a payor’s health plan, that the plan provides full O&P benefits, that we received prior authorization, that we filed or appealed the payor’s determination timely, on the basis of our coding, failure by certain classes of patients to pay their portion of a claim and for various other reasons. If any portion of, or administrative factor within, our claim is found by the payor to be lacking, then the entirety of the claim amount may be denied reimbursement.

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Commencing in late 2014 and continuing through today, we have taken a number of actions to manage disallowed revenue trends. These initiatives included: (i) the retention of consultants and creation of a central revenue cycle management function; (ii) addressing the issues identified in our patient management and electronic health record system; and (iii) the establishment of new clinic-level procedures and training regarding the collection of supporting documentation and the importance of diligence in our claims submission processes.

Disallowed revenue is considered an adjustment to the transaction price. Estimated uncollectible amounts due to us by patients are generally considered implicit price concessions and are presented as a reduction of net revenue. These amounts recorded in net revenue within the Patient Care segment for the three months ended March 31, 2019 and 2018 are as follows:

	For the Three Months Ended March 31,
(dollars in thousands)	2019			2018
Net revenue	$	190,601		$	188,507
Estimated implicit price concessions arising from:
Payor disallowances	8,474			8,262
Patient non-payments	1,368			869
Adjusted gross revenue	$	200,443		$	197,638

Payor disallowances	$	8,474		$	8,262
Patient non-payments	1,368			869
Payor disallowances and patient non-payments	$	9,842		$	9,131

Payor disallowances %	4.2		%	4.2		%
Patient non-payments %	0.7		%	0.4		%
Percent of adjusted gross revenue	4.9		%	4.6		%

Growth Rates and Earnings Effects

Patient Care

During the three month period ending March 31, 2019, approximately 51% of our net revenue was derived from the provision of prosthetic devices to our patients. These devices have a significantly higher relative reimbursement as compared with the orthotic devices and other related prosthetic supplies that we provide patients. The volume of prosthetic patients we see from one period to the next varies greatly, and this has a significant effect on our relative rate of net revenue growth we experience. Additionally, with the exception of materials costs and certain incentive compensation amounts, our staffing levels, operating costs, lease costs, depreciation and amortization expenses, and interest costs, are essentially fixed in nature. As a result, increases or decreases in our revenue from one period to the next can have a significant effect on our comparative reporting earnings for those periods.

Products & Services

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2018, under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in 2017, several of the larger independent O&P providers we served through the distribution of componentry encountered financial difficulties which resulted in our discontinuing distribution services to them. Generally, we believe our distribution customers encounter reimbursement pressures similar to those we experience in our own Patient Care services and, depending on their ability to adapt to the increased claims documentation standards that have emerged in our industry, this may either limit the rate of growth of some of our customers, or otherwise affect the rate of growth we experience in our distribution of O&P componentry to independent providers.

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Within our Products & Services segment, in addition to our distribution of products, we provide therapeutic equipment and services to patients at SNFs and other healthcare provider locations. Since 2016, a number of our clients, including several of our larger SNF clients, began to discontinue their use of our therapeutic services. We believe these discontinuances relate primarily to their overall efforts to reduce the costs they bear for therapy-related services within their facilities. As a part of those terminations of service, in a number of cases, we elected to sell terminating clients the equipment that we had utilized for their locations. In 2019, we anticipate a further decline of approximately $5.0 million to $7.0 million in revenue from these services associated with customer discontinuances. Within this portion of our business, we have responded to these trends through increases in our marketing programs which convey the value we believe our services have to patients at SNFs and other adjacent health services provider markets.

Acquisitions

In the first three months of 2019, we completed the acquisition of one business with 25 O&P clinics similar to those we operate through our Patient Care segment for an aggregate purchase price of $32.5 million. The purchase price consists of $27.7 million cash consideration, net of cash acquired, $4.5 million of unsecured notes issued to the sellers at fair value and $0.3 million of estimated additional consideration expected to be paid in the second quarter of 2019. In the last three months of 2018, we completed the acquisition of two O&P businesses for a combined purchase price of $3.1 million, of which $2.0 million was net cash consideration and $1.1 million was issued in an unsecured note to the seller. We do not believe these acquisitions undertaken in the first three months of 2019 and the last three months of 2018 have a material impact on our consolidated financial statements or our results from operations. We made no acquisitions in the first nine months of 2018.

New System Implementations

In recent years we have been undertaking the implementation of a new patient management and electronic health record system at our patient care clinics. In the first quarter of 2019, we completed this multi-year implementation. For the three month period ended March 31, 2019, we expensed $0.8 million in training, travel and related implementation costs. For the years ended December 31, 2018 and 2017, we expensed $4.4 million and $4.3 million, respectively, for these implementation expenses. In future periods we intend to convert acquired clinics to this system in the ordinary course of our business.

During 2019, we intend to commence the design, implementation planning and initial implementation of new financial and supply chain systems, and to invest in new servers and software that operate as a part of our technology infrastructure. During 2019, we currently anticipate that we will spend $3.5 million in operating expenses associated with the new financial and supply chain systems and that we will incur $6.0 million in incremental capital expenditures associated with our investments in technology infrastructure. In 2020 and 2021, we currently expect to continue to incur operating expense for the financial and supply chain projects similar in amount to our 2019 expenses levels in connection with this implementation.

Seasonality

We believe our business is affected by the degree to which patients have otherwise met the deductibles for which they are responsible in their medical plans during the course of the year. The first quarter is normally our lowest relative net revenue and earnings quarter, followed by the second and third quarters, which are somewhat higher and consistent with one another, and, due to the general fulfillment by patients of their health plan co-payments and deductible requirements towards the year’s end, our fourth quarter is normally our highest revenue producing quarter.

Our results are also affected, to a lesser extent, by our holding of an education fair in the first quarter of each year. This one-week event is conducted to assist our clinicians in maintaining their training and certification requirements and to facilitate a national meeting with our clinical leaders. We also invite manufacturers of the componentry for the devices we fabricate to these annual events so they can demonstrate their products and otherwise assist in our training process. During the first quarter of 2019 and 2018, we spent approximately $2.3 million and $2.3 million, respectively, on travel and other costs associated with this one-week event. In addition to the costs we incur associated with this annual event, we also lose the productivity of a significant portion of our clinicians during the period in and around the timing of this event, which contributes to the lower seasonal revenue level we experience during the first quarter of each year.

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Our first quarter cash flows from operations are also adversely affected as compared with other quarters due to the payment of our annual incentive compensation and 401(k) match during that period.

Critical Accounting Policies

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

· Revenue recognition

· Accounts receivable, net

· Inventories

· Business combinations

· Goodwill and other intangible assets, net

· Income taxes

The use of different estimates, assumptions, or judgments could have a material effect on reported amounts of assets, liabilities, revenue, expenses, and related disclosures as of the date of the financial statements and during the reporting period. These critical accounting policies are described in more detail in our Annual Report on Form 10-K for the year ended December 31, 2018, under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note A - “Organization and Summary of Significant Accounting Policies” contained within these condensed consolidated financial statements.

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Results of Operations

Our results of operations for the three months ended March 31, 2019 and 2018 were as follows (unaudited):

	For the Three Months Ended March 31,						Percent Change (1)
(dollars in thousands)	2019			2018			2019 vs 2018
Net revenues	$	236,419		$	233,995		1.0	%
Material costs	78,377			76,356			2.6	%
Personnel costs	86,711			86,108			0.7	%
Other operating costs	33,555			31,096			7.9	%
General and administrative expenses	28,282			25,636			10.3	%
Professional accounting and legal fees	2,700			4,846			(44.3	)%
Depreciation and amortization	8,773			9,330			(6.0	)%
Operating expenses	238,398			233,372			2.2	%
(Loss) income from operations	(1,979		)	623			NM
Interest expense, net	8,538			12,263			(30.4	)%
Loss on extinguishment of debt	—			16,998			(100.0	)%
Non-service defined benefit plan expense	173			176			(1.7	)%
Loss before income taxes	(10,690		)	(28,814		)	62.9	%
Benefit for income taxes	(3,739		)	(6,196		)	39.7	%
Net loss	$	(6,951	)	$	(22,618	)	69.3	%

(1) NM - Not Meaningful

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

	For the Three Months Ended March 31,
	2019		2018
Material costs	33.2	%	32.6	%
Personnel costs	36.7	%	36.8	%
Other operating costs	14.1	%	13.2	%
General and administrative expenses	12.0	%	11.0	%
Professional accounting and legal fees	1.1	%	2.1	%
Depreciation and amortization	3.7	%	4.0	%
Operating expenses	100.8	%	99.7	%

For the Three Months Ended March 31, 2019 Compared to the Three Months Ended March 31, 2018

Net revenue. Net revenue for the three months ended March 31, 2019 was $236.4 million, an increase of $2.4 million, or 1.0%, from $234.0 million for the three months ended March 31, 2018. Net revenue by operating segment, after elimination of intersegment activity, was as follows:

	For the Three Months Ended March 31,						Percent
(dollars in thousands)	2019		2018		Change		Change
Patient Care	$	190,601	$	188,507	$	2,094	1.1	%
Products & Services	45,818		45,488		330		0.7	%
Net revenue	$	236,419	$	233,995	$	2,424	1.0	%

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Patient Care net revenue for the three months ended March 31, 2019 was $190.6 million, an increase of $2.1 million, or 1.1%, from $188.5 million for the same period in the prior year. Net revenue from clinics acquired after March 31, 2018 was $4.8 million offset by $0.2 million of lower net revenue associated with clinic closures. Patient care revenue from ecommerce increased $0.6 million. Same clinic revenue decreased $3.1 million for the three months ended March 31, 2019 compared to the same period in the prior year, reflecting a decrease in same clinic revenue of 0.1% on a per day basis.

Prosthetics constituted approximately 51% of our total Patient Care revenue for the three months ended March 31, 2019 and 52% for the same period in 2018 excluding the impact of acquisitions. Prosthetic revenue for the three months ended March 31, 2019 was 0.7% lower, on a per day basis, than the same period in the prior year excluding the impact of acquisitions. We believe this decrease in prosthetic revenues was primarily due to timing of deliveries. Orthotics, shoes, inserts, and other products increased by 0.9% on a per day basis for the same comparative periods excluding the impact of acquisitions.

Products & Services net revenue for the three months ended March 31, 2019 was $45.8 million, an increase of $0.3 million, or 0.7% from $45.5 million for the same period in the prior year. This increase was comprised of $1.8 million from the distribution of O&P componentry to independent providers offset by a $1.5 million decrease in net revenue from therapeutic solutions, as a result of continued net client cancellations. We anticipate moderation of near-term Products & Services segment growth due primarily to a continuation of these therapeutic solutions revenue trends.

Material costs. Material costs for the three months ended March 31, 2019 were $78.4 million, an increase of $2.0 million or 2.6%, from $76.4 million for the same period in the prior year. Total material costs as a percentage of net revenue increased to 33.2% in the three months ended March 31, 2019 from 32.6% in the three months ended March 31, 2018 primarily due to changes in our Product & Services segment business mix. Material costs by operating segment, after elimination of intersegment activity, were as follows:

	For the Three Months Ended March 31,						Percent
(dollars in thousands)	2019		2018		Change		Change
Patient Care	$	59,150	$	57,899	$	1,251	2.2	%
Products & Services	19,227		18,457		770		4.2	%
Material costs	$	78,377	$	76,356	$	2,021	2.6	%

Patient Care material costs increased $1.3 million, or 2.2%, for the three months ended March 31, 2019 compared to the same period in the prior year as a result of acquisitions. Patient Care material costs as a percent of net revenue increased to 31.0% in the three months ended March 31, 2019 from 30.7% in the three months ended March 31, 2018, primarily due to increases in sales of higher-cost prosthetic devices when compared to orthotics.

Products & Services material costs increased $0.8 million, or 4.2%, for the three months ended March 31, 2019 compared to the same period in the prior year. As a percent of net revenue, material costs were 42.0% in the three months ended March 31, 2019 as compared to 40.6% in the same period 2018. The increase in material as a percent of net revenue was due to a change in business mix within the segment. For the three months ended March 31, 2019, distribution services was 72.4% of net revenue with 53.2% material costs as a percent of net revenue. For the three months ended March 31, 2018, distribution services was 68.9% of net revenue with a 53.3% material costs as a percent of net revenue. Therapeutic solutions, the other business in the Product & Services segment, had material costs as a percent of net revenue at 12.5% for both three months ended March 31, 2019 and 2018.

Personnel costs. Personnel costs for the three months ended March 31, 2019 were $86.7 million, an increase of $0.6 million, or 0.7%, from $86.1 million for the same period in the prior year. Personnel costs by operating segment were as follows:

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	For the Three Months Ended March 31,						Percent
(dollars in thousands)	2019		2018		Change		Change
Patient Care	$	73,709	$	73,613	$	96	0.1	%
Products & Services	13,002		12,495		507		4.1	%
Personnel costs	$	86,711	$	86,108	$	603	0.7	%

Personnel costs for the Patient Care segment were $73.7 million for the three months ended March 31, 2019, an increase of $0.1 million, or 0.1%, from $73.6 million compared to the same period in the prior year. The increase in Patient Care personnel costs during the three months ended March 31, 2019 was primarily related to an increase of $1.4 million in benefits expense relating to higher health claims experience and higher 401(k) match offset by $0.8 million lower salary expense and $0.5 million lower commission expense when compared to the three months ended March 31, 2018. Within General and Administrative expenses, as discussed below, the Patient Care segment also incurred an additional increase of $0.1 million in benefits expenses, for a total $1.5 million increase within this segment as compared with the prior year period.

Personnel costs in the Products & Services segment were $13.0 million for the three months ended March 31, 2019, an increase of $0.5 million compared to the same period in the prior year. Benefits expense increased $0.3 million and salary expense increased $0.2 million for the three months ended March 31, 2019 as compared to the same period in the prior year.

Other operating costs. Other operating costs for the three months ended March 31, 2019 were $33.6 million, an increase of $2.5 million, or 7.9%, from $31.1 million for the same period in the prior year. Other operating expenses increased $1.1 million from higher sales and use tax and additional costs from the acquisition in January 2019. Rent expense increased an additional $0.6 million from new, renewed, and acquired leases and $0.3 million as a result of the adoption of ASC 842, further described in Note A — “Organization and Summary of Significant Accounting Policies”. In addition, professional fees increased $0.5 million for the three months ended March 31, 2019 due to investments made in certain revenue cycle management initiatives.

General and administrative expenses. General and administrative expenses for the three months ended March 31, 2019 were $28.3 million, an increase of $2.6 million, or 10.3%, from the same period in the prior year. This increase includes a $0.7 million increase in equity-based compensation and $0.3 million in deferred compensation primarily due to an executive forfeiture in the prior year period. Increases in general and administrative expenses also include approximately $0.6 million related to new system implementations and acquisitions, $0.5 million in temporary staffing to assist with material weakness remediation, $0.3 million related to increase in franchise and other business taxes, and $0.2 million in benefits related to higher claim costs.

Professional accounting and legal fees. Professional accounting and legal fees for the three months ended March 31, 2019 were $2.7 million, a decrease of $2.1 million, or 44.3%, from $4.8 million for the same period in the prior year. Advisory and other fees decreased $2.1 million primarily due to decreased utilization of professional fees to assist in the remediation of our material weaknesses, to regain our timely filing status and to undertake related activities.

Depreciation and amortization. Depreciation and amortization for the three months ended March 31, 2019 was $8.8 million, a decrease of $0.6 million, or 6.0%, from $9.3 million for the same period in the prior year. Amortization expense decreased $0.6 million when compared to the prior period as a result of certain intangible assets becoming fully amortized prior to the first quarter of 2019.

Interest expense, net. Interest expense for the three months ended March 31, 2019 was $8.5 million, a decrease of $3.7 million, or 30.4%, from $12.3 million for the same period in the prior year. This decrease was primarily due to lower interest rates on outstanding borrowings arising from our debt refinancing in March 2018.

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Benefit for income taxes. The benefit for income taxes for the three months ended March 31, 2019 was $3.7 million, or 35.0% of loss before income taxes, compared to a benefit of $6.2 million, or 21.5% of loss before income taxes for the three months ended March 31, 2018. The effective tax rate in 2019 consists principally of the 21% federal statutory tax rate and the rate impact from state income taxes and permanent tax differences. The increase in the effective tax rate for the three months ended March 31, 2019 compared with the same period in the prior year is primarily attributable to the change from the discrete method in the three months ended March 31, 2018 to the annual effective tax rate method in the three months ended March 31, 2019, an increased estimated annual income, a decreased loss before income taxes for the three months ended March 31, 2019 as compared to three months ended March 31, 2018, and the windfall from stock-based compensation recorded as a discrete item during the period.

Financial Condition, Liquidity, and Capital Resources

Liquidity

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

At March 31, 2019, we had total liquidity of $115.3 million, which reflected a decrease of $73.9 million from the $189.2 million in liquidity we had as of December 31, 2018. Our liquidity at March 31, 2019 was comprised of cash and cash equivalents of $20.5 million and $94.8 million in available borrowing capacity under our $100.0 million revolving credit facility. This decrease in liquidity primarily relates to the use of cash of $36.5 million for the payment of annual incentive bonus, tax payments on stock vesting, and the employer 401(k) matching contribution, $27.7 million for an acquisition consummated in January 2019, net of cash acquired, a net reduction of $5.6 million of accounts payable, and the remainder attributable to our operational results and changes in working capital.

As discussed in “Seasonality” above, the first quarter is our lowest revenue-producing quarter and, combined with the annual incentive bonus and 401(k) employer matching contributions discussed above, has historically resulted in a reduction in our liquidity during the first quarter of each year.

If we are not compliant with our debt covenants in any period, absent a waiver or amendment of our Credit Agreement, we may be unable to access funds in our revolving credit facility.

Working Capital and Days Sales Outstanding

At March 31, 2019, we had working capital of $77.2 million compared to working capital of $154.6 million at December 31, 2018. Our working capital decreased $77.4 million in the three months ended March 31, 2019 due to a decrease in current assets of $80.6 million and a decrease in current liabilities of $3.2 million.

The decrease in current assets was primarily attributable to a decrease in cash and cash equivalents of $74.6 million, a decrease in accounts receivable, net of $7.1 million, and the reclassification of prepaid rent of $3.8 million to the Current portion of long-term debt upon adoption of ASC 842, historically recorded in Other current assets. The decrease in cash primarily relates to the uses of cash discussed in the liquidity section above. Further, as discussed in “Seasonality” above, due to the typical resetting of patient deductibles at year end, the fourth quarter is normally our highest revenue-producing quarter and the first quarter is our lowest, resulting in a decline in accounts receivable in the first quarter of the following year. The decreases were offset by an increase of $2.3 million in inventory, primarily related to acquisitions, and a $2.1 million increase in other current assets excluding the reclassification of prepaid rent upon adoption of ASC 842 discussed above.

The decrease in current liabilities was primarily attributable to the payment of $36.5 million for the distribution of the annual incentive bonus, tax payments on stock vesting, and the employer 401(k) matching contribution and a decrease in accounts payable of $5.6 million. The decrease was offset by the adoption of ASC 842 and additional operating lease liabilities assumed in the quarter, resulting in an increase of $33.7 million at March 31, 2019, an increase in Accrued compensation related costs of $3.6 million for current year activity, and $2.3 million in education expenses related to the education fair held in the first quarter of 2019.

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Days sales outstanding (“DSO”) is a calculation that approximates the average number of days between the billing for our services and the date of our receipt of payment, which we estimate using a 90-day rolling period of net revenue. This computation can provide a relative measure of the effectiveness of our billing and collections activities. Clinics acquired during the past 90-day period are excluded from the calculation. As of March 31, 2019, our DSO was 52 days, which compares to a DSO of 49 days as of March 31, 2018. One-time administrative billing changes and the impact of implementing our patient management and electronic health system in certain of our largest operating regions contributed to collection delays during the quarter, which we believe to be temporary. As of March 31, 2019, the implementation of the new patient management and electronic health record system was complete.

Sources and Uses of Cash for the Three Months Ended March 31, 2019 Compared to March 31, 2018

Net cash flows used in operating activities increased $24.3 million to $32.8 million for the three months ended March 31, 2019 from $8.5 million for the three months ended March 31, 2018. This was due primarily to the uses of cash and changes in working capital in the three months ended March 31, 2019 as compared to the three months ended March 31, 2018 discussed in the Working Capital and Days Sales Outstanding section above.

Cash flows used in investing activities increased $28.8 million to $35.0 million for the three months ended March 31, 2019 from $6.2 million for the three months ended March 31, 2018. The increase in cash used in investing activities was due to $27.7 million in cash consideration for acquisitions, net of cash acquired, and a $2.5 million increase in purchases of property, plant and equipment.

Cash flows provided by financing activities decreased by $51.9 million to a use of cash of $6.8 million for the three months ended March 31, 2019 from cash provided by financing activities of $45.1 million for the three months ended March 31, 2018. Cash flows provided by financing activities during the three months ended March 31, 2018 included $49.4 million related to the refinancing of our indebtedness, including payment of $15.2 million in debt issuance and extinguishment costs, whereas in the three months ended March 31, 2019, cash flows used in debt financing activities was $1.3 million.

Effect of Indebtedness

On March 6, 2018 we entered into the Credit Agreement in order to refinance our indebtedness and is disclosed in Note M - “Debt,” in the notes to the condensed consolidated financial statements elsewhere in this report. Our indebtedness bears reduced rates of interest compared with those under our prior indebtedness, and as such interest expense is lower for the three months ended March 31, 2019 as compared to the same period in the prior year. Cash paid for interest totaled $7.7 million and $10.6 million for the three months ended March 31, 2019 and 2018, respectively.

Scheduled maturities of debt as of March 31, 2019 were as follows:

(in thousands)
2019 (remainder of year)	$	5,974
2020	8,220
2021	7,193
2022	5,849
2023	5,329
Thereafter	475,999
Total debt before unamortized discount and debt issuance costs, net	508,564
Unamortized discount and debt issuance costs, net	(9,264		)
Total debt	$	499,300

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Liquidity Outlook and Going Concern Evaluation

Our Credit Agreement has a term loan facility with $500 million in principal outstanding at March 31, 2019, due in quarterly principal installments equal to 0.25% of the original aggregate principal amount of $505 million, commencing June 29, 2018, with all remaining outstanding principal due at maturity in March 2025 and a revolving credit facility with no borrowings and a maximum aggregate amount of availability of $100 million at March 31, 2019 that matures in March 2023. We currently believe that our anticipated operating trends with the level of acquisitions anticipated will provide us with sufficient liquidity to meet our financial obligations during the coming twelve months.

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

Off-Balance Sheet Arrangements

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

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

As of March 31, 2019, we had a combined principal amount of $500.0 million of variable rate debt and a notional amount of $312.5 million of fixed to variable interest rate swap agreements. Based on our hedged and unhedged positions, a hypothetical increase or decrease in interest rates by 1.0% would impact our annual interest expense by $1.9 million.

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

Management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and effectiveness of our disclosure controls and procedures as of March 31, 2019. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of March 31, 2019 because of the material weaknesses in our internal control over financial reporting described in Item 9A Controls and Procedures of the Form 10-K for the year-ending December 31, 2018.

Although we have not fully remediated the material weaknesses described in our Form 10-K for the year ended December 31, 2018, we believe that we have made substantial progress on the remediation plans described in our 2018 Form 10-K, Item 9A Controls and Procedures.

The following remediation steps were taken by the Company during the quarter:

Inventory

We have implemented new controls related to the accurate valuation of Work In Process (“WIP”) Inventory. We have also improved controls to identify unusual trends, material inaccuracies in calculations and/or any potential updates needed to key inputs into the valuation of raw materials and WIP.

We have made improvements to controls in the areas of accounts payable; information technology general controls; revenue; and accounts receivable and are currently evaluating the design and operating effectiveness of these controls. The material weaknesses cannot be considered remediated until the applicable remedial controls operate for a period of time sufficient for management to conclude, through testing, that these controls are operating effectively.

Changes in Internal Control over Financial Reporting

With the exception of ongoing remediation activities, there have been no material changes to our internal controls over financial reporting.

Therefore, in accordance with Rule 13a-15(d) of the Exchange Act, management, with the participation of our Chief Executive Officer and our Chief Financial Officer, determined there have been no material changes to our internal control over financial reporting during the period ended March 31, 2019.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Securities and Derivative Litigation

In November 2014, a securities class action complaint, City of Pontiac General Employees’ Retirement System v. Hanger, et al., C.A. No. 1:14-cv-01026-SS, was filed against us in the United States District Court for the Western District of Texas. The complaint named us and certain of our current and former officers for allegedly making materially false and misleading statements regarding, inter alia, our financial statements, RAC audit success rate, the implementation of new financial systems, same-store sales growth, and the adequacy of our internal processes and controls. The complaint alleged violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. The complaint sought unspecified damages, costs, attorneys’ fees, and equitable relief.

In February and August of 2015, two separate shareholder derivative suits were filed in Texas state court against us related to the announced restatement of certain of our financial statements. The cases were subsequently consolidated into Judy v. Asar, et. al., Cause No. D-1-GN-15-000625. On October 25, 2016, plaintiffs in that action filed an amended complaint, and the case is currently pending before the 459th Judicial District Court of Travis County, Texas.

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

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

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any of the claims in the Judy derivative case. Also in accordance with its findings and conclusions, the Special Committee determined that it is not in our best interests to pursue legal remedies against any of our current or former employees, officers, or directors.

The plaintiffs subsequently subpoenaed counsel for the Special Committee, seeking a copy of the full report prepared by the Special Committee and its independent counsel. Counsel for the Special Committee, as well as our counsel, took the position that the full report is not discoverable under Texas law. Plaintiffs’ counsel filed a motion to compel the Special Committee’s counsel to produce the report. We opposed the motion. On July 20, 2018, the Travis County court ruled that only a redacted version of the report is discoverable, and counsel for the Special Committee provided a redacted version of the report to plaintiffs’ counsel. Plaintiffs objected to the redacted version of the report, and on February 4, 2019, the Travis County court appointed a Special Master to review plaintiffs’ objections to the redacted report. On March 22, 2019, the Special Master submitted a report to the Travis County Court recommending that the Court order that the entire Special Committee report be produced. On April 2, 2019 we filed an objection to the Special Master’s report and recommendation, and requested a hearing on the matter. The Travis County Court scheduled a hearing for May 15, 2019 regarding our objection. Upon completion of discovery, we intend to file a motion to dismiss the consolidated derivative action.

Management intends to continue to vigorously defend against the shareholder derivative action. At this time, if the derivative action were to go to trial, we cannot predict how the Travis County Court will rule on the merits of the claims and/or the scope of the potential loss in the event of an adverse outcome. Should we ultimately be found liable, the resulting damages could have a material adverse effect on our consolidated financial position, liquidity or our results of operations.

Other Matters

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

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

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ITEM 1A. RISK FACTORS

Our business and financial results are subject to numerous risks and uncertainties. The risk and uncertainties have not changed materially from those reported in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2018, which are incorporated by reference. For additional information regarding risks and uncertainties, see the information provided under the header “Forward Looking Statements” contained in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

There has been no share repurchase activity during the three months ended March 31, 2019.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

There have been no defaults upon senior securities during the three months ended March 31, 2019.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None to report.

ITEM 6. EXHIBITS

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

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EXHIBITS INDEX

Exhibit No.		Document
10.1		Amended and Restated Employment Agreement, dated as of March 19, 2019, by and between the Company and Vinit K. Asar. (Incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K filed by the Company on March 20, 2019.)*
10.2		Amended and Restated Employment Agreement, dated as of March 19, 2019, by and between the Company and Thomas E. Kiraly. (Incorporated herein by reference to Exhibit 10.2 to the Current Report on Form 8-K filed by the Company on March 20, 2019.)*
10.3		Amended and Restated Employment Agreement, dated as of March 19, 2019, by and between the Company and Samuel M. Liang. (Incorporated herein by reference to Exhibit 10.3 to the Current Report on Form 8-K filed by the Company on March 20, 2019.)*
10.4		Amended and Restated Employment Agreement, dated as of March 19, 2019, by and between the Company and Thomas E. Hartman. (Incorporated herein by reference to Exhibit 10.4 to the Current Report on Form 8-K filed by the Company on March 20, 2019.)*
31.1		Written Statement of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002. (Filed herewith.)
31.2		Written Statement of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002. (Filed herewith.)
32		Written Statement of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes Oxley Act of 2002. (Filed herewith.)
101.INS		XBRL Instance Document. (Filed herewith.)
101.SCH		XBRL Taxonomy Extension Schema. (Filed herewith.)
101.CAL		XBRL Taxonomy Extension Calculation Linkbase. (Filed herewith.)
101.LAB		XBRL Taxonomy Extension Label Linkbase. (Filed herewith.)
101.PRE		XBRL Taxonomy Extension Presentation Linkbase. (Filed herewith.)
101.DEF		XBRL Taxonomy Extension Definition Linkbase. (Filed herewith.)

*Management contract or compensatory plan

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SIGNATURES

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

	HANGER, INC.


Dated: May 8, 2019	By: /s/ THOMAS E. KIRALY
	Thomas E. Kiraly
	Executive Vice President and Chief Financial Officer


Dated: May 8, 2019	By: /s/ GABRIELLE B. ADAMS
	Gabrielle B. Adams
	Vice President and Chief Accounting Officer