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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------
FORM 10-Q
(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to

Commission file number 1-10670

HANGER ORTHOPEDIC GROUP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Delaware 84-0904275
- --------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

Two Bethesda Metro Center, Suite 1200, Bethesda, MD 20814
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code:
(301) 986-0701
- --------------------------------------------------------------------------------

- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.

Indicate by check 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 .

APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares
outstanding of each of the issuer's classes of common stock, as of November 12,
2002; 20,240,398 shares of common stock, $.01 par value per share.


HANGER ORTHOPEDIC GROUP, INC.

INDEX

Page No.

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets - September 30, 2002
(unaudited) and December 31, 2001 1


Consolidated Statements of Operations for the three and nine
months ended September 30, 2002 and 2001 (unaudited) 3

Consolidated Statements of Cash Flows for the nine
months ended September 30, 2002 and 2001 (unaudited) 4

Notes to Consolidated Financial Statements 5

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 26


Item 3. Quantitative and Qualitative Disclosures About Market Risk 35


Item 4. Controls and Procedures 36



Part II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K 37


SIGNATURES 38

CERTIFICATIONS 39



HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)

September 30, December 31,
2002 2001
-------------- -------------
(unaudited)
ASSETS
CURRENT ASSETS

Cash and cash equivalents $ 22,002 $ 10,043
Accounts receivable, less allowances for doubtful accounts
of $16,057 and $17,625 in 2002 and 2001, respectively 104,994 104,040
Inventories 54,526 55,946
Prepaid, other assets, and income taxes receivable 5,070 4,901
Deferred income taxes 20,957 20,957
-------- --------
Total current assets 207,549 195,887
-------- --------

PROPERTY, PLANT AND EQUIPMENT
Land 3,743 4,078
Buildings 6,700 8,629
Machinery and equipment 33,409 28,675
Furniture and fixtures 10,259 9,967
Leasehold improvements 18,002 18,027
-------- --------
72,113 69,376
Less accumulated depreciation and amortization 36,932 31,598
-------- --------
35,181 37,778
-------- --------

INTANGIBLE ASSETS
Excess cost over net assets acquired 450,745 440,874
Assembled workforce -- 4,812
Patents and other intangible assets, $10,134 and
$10,124 less accumulated amortization of $4,162
and $3,430 in 2002 and 2001, respectively 5,972 6,694
-------- --------
456,717 452,380
-------- --------

OTHER ASSETS
Debt issuance costs, net 14,316 10,846
Other assets 10,062 3,016
-------- --------
Total other assets 24,378 13,862
-------- --------

TOTAL ASSETS $723,825 $699,907
======== ========


The accompanying notes are an integral part of the consolidated
financial statements.

1


HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)

September 30, December 31,
2002 2001
--------------- --------------
(unaudited)
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND SHAREHOLDERS' EQUITY


CURRENT LIABILITIES
Current portion of long-term debt $ 6,888 $ 30,512
Accounts payable 9,827 16,901
Accrued expenses 9,475 8,196
Accrued interest payable 7,679 2,017
Accrued compensation related cost 33,798 29,045
Accrued income taxes 6,890 --
--------- ---------
Total current liabilities 74,557 86,671

Long-term debt, less current portion 386,934 367,315
Deferred income taxes 26,495 26,495
Other liabilities 1,729 3,013
--------- ---------
Total liabilities 489,715 483,494
--------- ---------

7% Redeemable Convertible Preferred stock, liquidation preference
$1,000 per share 74,607 70,739
--------- ---------

Commitments and contingent liabilities (See Note I)

SHAREHOLDERS' EQUITY
Common stock, $.01 par value; 60,000,000 shares authorized,
19,742,163 and 19,057,876 shares issued and
outstanding in 2002 and 2001, respectively 197 191
Additional paid-in capital 147,342 146,674
Retained earnings (accumulated deficit) 12,620 (535)
--------- ---------
160,159 146,330
Treasury stock, cost -- (133,495 shares) (656) (656)
--------- ---------
159,503 145,674
--------- ---------

TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK
AND SHAREHOLDERS' EQUITY $ 723,825 $ 699,907
========= =========


The accompanying notes are an integral part of the consolidated
financial statements.

2


HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Nine Months Ended September 30,
(Dollars in thousands, except share and per share amounts)


Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
(unaudited) (unaudited)

Net sales $ 133,980 $ 129,605 $ 390,546 $ 379,365
Cost of goods sold (exclusive of depreciation and
amortization) 59,971 61,606 180,806 188,014
------------ ------------ ------------ ------------
Gross profit 74,009 67,999 209,740 191,351

Selling, general and administrative 48,541 45,791 139,900 131,118
Depreciation and amortization 2,400 3,091 7,478 9,045
Amortization of excess cost over net assets acquired -- 3,306 -- 9,863
Unusual charges -- 1,381 -- 16,220
------------ ------------ ------------ ------------
Income from operations 23,068 14,430 62,362 25,105

Interest expense, net 9,870 10,768 28,926 34,059
------------ ------------ ------------ ------------
Income (loss) before taxes 13,198 3,662 33,436 (8,954)

Provision (benefit) for income taxes 5,368 3,679 13,602 (4,328)
------------ ------------ ------------ ------------
Income (loss) before extraordinary item 7,830 (17) 19,834 (4,626)

Extraordinary loss on early extinguishment of debt,
net of tax benefit -- -- 2,811 --
------------ ------------ ------------ ------------
Net income (loss) $ 7,830 $ (17) $ 17,023 $ (4,626)
============ ============ ============ ============
Income (loss) before extraordinary item applicable
to common stock $ 6,519 $ (1,242) $ 15,966 $ (8,239)
============ ============ ============ ============
Net income (loss) applicable to common stock $ 6,519 $ (1,242) $ 13,155 $ (8,239)
============ ============ ============ ============

Basic Per Common Share Data
Income (loss) before extraordinary item $ 0.33 $ (0.07) $ 0.82 $ (0.44)
Extraordinary item, net of tax benefit -- -- (0.14) --
------------ ------------ ------------ ------------
Net income (loss) $ 0.33 $ (0.07) $ 0.68 $ (0.44)
============ ============ ============ ============
Shares used to compute basic per common share
amounts 19,554,942 18,910,002 19,353,827 18,910,002
============ ============ ============ ============

Diluted Per Common Share Data
Income (loss) before extraordinary item $ 0.30 $ (0.07) $ 0.74 $ (0.44)
Extraordinary item, net of tax benefit -- -- (0.13) --
------------ ------------ ------------ ------------
Net income (loss) $ 0.30 $ (0.07) $ 0.61 $ (0.44)
============ ============ ============ ============
Shares used to compute diluted per common share
amounts 21,913,967 18,910,002 21,502,115 18,910,002
============ ============ ============ ============


The accompanying notes are an integral part of the consolidated
financial statements.

3


HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30,
(Dollars in thousands)

2002 2001
------------ -----------
Cash flows from operating activities: (unaudited)

Net income (loss) $ 17,023 $ (4,626)
Adjustments to reconcile net income (loss) to
net cash provided by operating
activities:
Extraordinary loss on extinguishment of debt 2,811 --
Loss on disposal of assets 998 8,029
Provision for bad debts 16,333 16,143
Depreciation and amortization 7,478 9,046
Amortization of excess cost over net assets acquired -- 9,862
Amortization of debt issuance costs 1,700 1,931
Deferred income taxes -- 191
Restructuring costs -- 3,688
Changes in assets and liabilities:
Accounts receivable (17,288) (16,785)
Inventories 1,421 8,733
Prepaid, other assets, and income taxes receivable (1,201) 1,188
Other assets (191) 375
Accounts payable (7,910) (6,773)
Accrued expenses, interest and income taxes 16,682 (8,404)
Accrued compensation related costs 4,753 4,383
Other liabilities (1,287) 1,685
--------- ---------
Net cash provided by operating activities 41,322 28,666
--------- ---------

Cash flows from investing activities:
Purchase of property, plant and equipment (6,638) (4,902)
Acquisitions, net of cash acquired, and earnouts (4,230) (4,732)
Proceeds from sale of property, plant and equipment 1,492 634
--------- ---------
Net cash used in investing activities (9,376) (9,000)
--------- ---------

Cash flows from financing activities:
Borrowings under revolving credit agreement 43,975 4,000
Repayments under revolving credit agreement (92,775) (10,900)
Proceeds from sale of Senior Notes 200,000 --
Repayment and termination of bank loans (153,587) (18,500)
Scheduled repayment of long-term debt (8,474) (10,416)
Increase in financing costs (9,800) (1,060)
Proceeds from issuance of Common Stock 3,067 --
Repurchase of outstanding stock options (2,393) --
--------- ---------
Net cash used in financing activities (19,987) (36,876)
--------- ---------
Increase (decrease) in cash and cash equivalents 11,959 (17,210)
Cash and cash equivalents at beginning of period 10,043 20,669
--------- ---------
Cash and cash equivalents at end of period $ 22,002 $ 3,459
========= =========


The accompanying notes are an integral part of the consolidated financial
statements.

4

HANGER ORTHOPEDIC GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A - BASIS OF PRESENTATION

The accompanying unaudited financial statements have been prepared in accordance
with Rule 10-01 of Regulation S-X. They do not include all of the information
and notes required by generally accepted accounting principles ("GAAP") for
complete financial statements. In the opinion of management, all adjustments
considered necessary (consisting solely of normal recurring adjustments) for a
fair presentation of the financial statements have been included. Certain
reclassifications of the prior year's data have been made to improve
comparability.

These financial statements should be read in conjunction with the financial
statements of Hanger Orthopedic Group, Inc. (the "Company") and notes thereto
included in the Annual Report on Form 10-K for the year ended December 31, 2001,
filed by the Company with the Securities and Exchange Commission.

NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES

Use of Estimates

The preparation of 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 financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

Inventories

Inventories, which consist principally of purchased parts and work in process,
are stated at the lower of cost or market using the first-in, first-out (FIFO)
method. The Company calculates cost of goods sold in accordance with the gross
profit method. The Company bases the estimates used in applying the gross profit
method on the actual results of the most recently completed fiscal year and
other factors affecting cost of goods sold during the current reporting periods.
Estimated cost of goods sold during the period is adjusted when the annual
physical inventory is taken.

Change in Accounting for Goodwill and Certain Other Intangibles

Effective July 1, 2001 the Company adopted certain provisions of SFAS No. 141,
and effective January 1, 2002, the Company adopted the full provisions of SFAS
No. 141 and SFAS No. 142.


5


NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED)

Change in Accounting for Goodwill and Certain Other Intangibles (Continued)

SFAS No. 141 requires business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting, and broadens the criteria
for recording intangible assets apart from goodwill. The Company evaluated its
goodwill and intangibles acquired prior to June 30, 2001 using the criteria of
SFAS No. 141, which resulted in other intangibles with an unamortized balance of
$4.8 million (comprised entirely of assembled workforce intangibles) being
combined into goodwill at January 1, 2002.

SFAS No. 142 requires that purchased goodwill and certain indefinite-lived
intangibles no longer be amortized, but instead be tested for impairment at
least annually. The Company evaluated its intangible assets, other than
goodwill, and determined that all such assets have determinable lives.

SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill.
The first phase, required to be completed by June 30, 2002, screened for
impairment; while the second phase (if necessary), required to be completed by
December 31, 2002, measures the impairment. The Company has completed the
transitional impairment test, which did not result in the impairment of recorded
goodwill. In completing the analysis, the Company determined that it had two
reporting units, which were the same as its reportable segments: (i)
patient-care centers and (ii) distribution. The Company has chosen October 1,
2002 as the date of its next impairment test and will report the results of that
test in the fourth quarter. As of September 30, 2002, the patient-care center
segment had goodwill of $450.7 million, an increase of $5.1 million over
December 31, 2001.

In accordance with SFAS No. 142, the effect of this accounting change is
reflected prospectively. Supplemental comparative disclosure as if the change
had been retroactively applied to the prior year period is as follows (in
thousands, except per share amounts):



6


NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED)

Change in Accounting for Goodwill and Certain Other Intangibles (Continued)



Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001

Net income (loss):
Reported net income (loss) $ 7,830 $ (17) $ 17,023 $ (4,626)
Goodwill amortization, net
of tax benefit (1) -- 2,950 -- 5,009
----------- --------- ---------- ----------
Adjusted net income (loss) $ 7,830 $ 2,933 $ 17,023 $ 383
=========== ========= ========== ==========

Per share info:

Basic income (loss):
Reported income (loss) $ 0.33 $ (0.07) $ 0.68 $ (0.44)
Goodwill amortization, net
of tax benefit (1) $ -- $ 0.16 $ -- $ 0.27
----------- --------- ---------- ----------
Adjusted basic income (loss) $ 0.33 $ 0.09 $ 0.68 $ (0.17)
=========== ========= ========== ==========

Diluted income (loss):
Reported income (loss) $ 0.30 $ (0.07) $ 0.61 $ (0.44)
Goodwill amortization, net
of tax benefit (1) $ -- $ 0.16 $ -- $ 0.27
----------- --------- ---------- ----------
Adjusted diluted income (loss) $ 0.30 $ 0.09 $ 0.61 $ (0.17)
=========== ========= ========== ==========


(1) For the three months ended September 30, 2001, consists of $3.3 million
in amortization and a reduction in the tax expense of $0.3 million
based on the revised effective tax rate for 2001. For the nine months
ended September 30, 2001, consists of $9.9 million in amortization,
offset by the reduction in the tax benefit of $4.9 million based on the
revised effective tax rate for 2001. Amortization includes amortization
related to assembled workforce, which was combined with goodwill at
January 1, 2002.

Amortization expense related to definite-lived intangible assets was $0.2
million and $0.7 million for the three and nine months ended September 30, 2002,
respectively. Estimated aggregate amortization expense for such assets for each
of the five years ended December 31, 2006 is as follows (in thousands):

2002 $ 963
2003 $ 839
2004 $ 768
2005 $ 762
2006 $ 751


7

NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED)

New Accounting Pronouncements

On April 30, 2002, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS No.
145"). Under SFAS No. 145, gains and losses from the early extinguishment of
debt would no longer be extraordinary items, unless they satisfied the criteria
in Accounting Principles Board Opinion No. 30 ("APB 30") where extraordinary
items are stated to be distinguishable by their unusual nature and by the
infrequency of their occurrence. Any gain or loss on extinguishment of debt that
was classified as an extraordinary item in prior periods presented that does not
meet the criteria in APB 30 for classification as an extraordinary item shall be
reclassified. In addition, under SFAS No. 145, certain lease modifications that
have economic effects similar to sale-leaseback transactions be accounted for in
the same manner as sale-leaseback transactions. SFAS No. 145 is effective for
fiscal years beginning after May 15, 2002. SFAS No. 145 will be adopted by us on
January 1, 2003 and may result in a reclassification of existing extraordinary
losses on the early extinguishment of debt from an extraordinary item to a
non-operating item.

On July 30, 2002, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 146, Accounting for Costs Associated with
Exit or Disposal Activities ("SFAS No. 146"). Under SFAS No. 146, costs
associated with exit or disposal activities would be recognized when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Such costs would include lease termination costs and certain employee severance
costs that are associated with a restructuring, discontinued operation, plant
closing, or other exit or disposal activity. SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The Company does not expect SFAS No. 146 to have a material effect on its
financial statements.

NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION

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

2002 2001
(in thousands)
Cash paid during the period for:
Interest $ 31,465 $ 34,113
Income taxes $ 3,809 $ 976

Non-cash financing and investing activities:
Preferred stock dividends declared and accretion $ 3,868 $ 3,613


8

NOTE D - ACQUISITIONS

The Company has not acquired any companies during the three or nine months ended
September 30, 2001 or 2002.

In connection with the acquisition of NovaCare Orthotics & Prosthetics, Inc.
("NovaCare O&P") in July 1999, the Company assumed responsibility for payments
of earnouts and working capital provisions related to acquisitions made by
NovaCare O&P prior to July 1, 1999. In connection with these agreements and the
Company's acquisitions prior to 2001, the Company paid $4.2 million and $4.7
million in the nine-month periods ended September 30, 2002, and 2001,
respectively. The Company has accounted for these amounts as additional purchase
price, resulting in an increase in goodwill. The Company estimates that it may
pay an additional $1.4 million related to earnout provisions that are expected
to be paid by December 31, 2005.

NOTE E - UNUSUAL CHARGES

Summary

Unusual charges for the three and nine months ended September 30, 2001 consist
of the following costs, which are explained below:

Three Nine
(in thousands) Months Months

Restructuring and asset impairment costs $ - $ 3,688
Performance improvement costs 1,528 4,503
Impairment loss on assets held for sale (147) 8,029
----------- -----------
Unusual charges $ 1,381 $ 16,220
=========== ===========

Restructuring Costs

In the second quarter of 2001, in connection with the implementation of the
AlixPartners, LLC (formerly Jay Alix & Associates, Inc.; "JA&A") initiatives,
the Company recorded approximately $3.7 million in restructuring and asset
impairment costs. The plan of initiatives, as amended in December 2001, called
for the closure of 44 facilities and the termination of approximately 135
employees. As of September 30, 2002, all contemplated properties had been
vacated and all contemplated employees had been terminated. All payments under
the plan for severance costs have been paid as of September 30, 2002 and all
payments for lease costs are expected to be paid by December 31, 2004.


9


NOTE E - UNUSUAL CHARGES (CONTINUED)

Restructuring Costs (Continued)

The previously adopted 1999 and 2000 plans contemplated lease termination and
severance costs associated with the closure of certain redundant patient-care
centers and corporate functions of the Company and NovaCare O&P. All
contemplated employees have been terminated and all contemplated patient-care
centers have been closed. Lease payments on those closed patient-care centers
are expected to be paid through 2003.

Components of the restructuring reserves, spending during the periods, and
remaining reserve balances are as follows:


Lease
Employee Termination Total
Severance and other Exit Restructuring
Costs Costs Reserve
- ----------------------------------------------------------------------------------------
(in thousands)

1999 & 2000 Restructuring Reserve
Balance at December 31, 2001 $ -- $ 329 $ 329
Spending -- (56) (56)
------- ------- -------
Balance at September 30, 2002 -- 273 273
------- ------- -------

2001 Restructuring Reserve
Balance at December 31, 2001 50 1,886 1,936
Spending (50) (919) (969)
------- ------- -------
Balance at September 30, 2002 -- 967 967
------- ------- -------

1999, 2000, and 2001 Restructuring Reserves
Balance at September 30, 2002 $ -- $ 1,240 $ 1,240
======= ======= =======




Performance Improvement Costs

Performance improvement costs for the three and nine months ended September 30,
2001 amounted to $1.5 million and $4.5 million, respectively, consisting
primarily of fees paid to JA&A in connection with the execution of the Company's
performance improvement plan.

JA&A's work with the Company was substantially completed as of December 31,
2001. In the fourth quarter of 2001, the Company was invoiced for and accrued a
success fee based upon identified savings and operational improvements. In
accordance with our contract with JA&A, the invoices were satisfied by the
payment of $1.1 million in cash and the issuance of a nonqualified option to
purchase 1,202,436 shares of the Company's stock at an exercise price of $1.40
per share. The option was valued using a Black-Scholes option-pricing model, and
an expense of $4.8 million was recorded.


10


NOTE E - UNUSUAL CHARGES (CONTINUED)

Performance Improvement Costs (Continued)

On July 23, 2002, the Company agreed to repurchase 601,218 of the shares
underlying such previously granted option for a payment of $3.98 per share, or a
total of $2,392,704, which was paid during the third quarter of 2002 and
recorded as a reduction in additional paid-in capital. On July 23, 2002, shares
of the Company's common stock opened for trading at $12.00 per share. In
accordance with our agreement with JA&A, the Company filed a Registration
Statement on Form S-3 with the Securities and Exchange Commission to register
the remaining 601,218 shares underlying the outstanding option in order to
permit JA&A to sell the shares of the Company's stock that it may acquire upon
exercise of the option. Under the agreement with the Company on July 23, 2002,
in accordance with the sale of any shares that JA&A may acquire by exercise of
the option, JA&A has agreed to limit such sales to 40,000 shares in any calendar
week.

The Company's original contract with JA&A provides for one potential additional
success fee, which will be based on the realization of further savings from
initiatives that were not fully implemented by December 31, 2001. Under the
agreement with the Company on July 23, 2002, JA&A also agreed to permanently
amend its contract with the Company so that the payment of future success fees,
if any, would be made only in cash. As of September 30, 2002, JA&A has measured
all savings generated and the Company believes that no further payments will be
required under the contract.

Impairment Loss on Assets Held for Sale
During the nine months ended September 30, 2001, the Company recognized an
impairment loss of $8.0 million on the planned sale of substantially all of the
manufacturing assets of Seattle Orthopedic Group, Inc. to United States
Manufacturing Company, LLC ("USMC"). The amount of the loss represented the
excess of the net book value of the assets held for sale over the estimated
proceeds for the assets. The sale of the assets was ultimately completed on
October 9, 2001.

NOTE F - NET INCOME (LOSS) PER COMMON SHARE

Basic per common share amounts are computed using the weighted average number of
common shares outstanding during the period. Diluted per common share amounts
are computed using the weighted average number of common shares outstanding
during the period and dilutive potential common shares. Dilutive potential
common shares consist of stock options, stock warrants, redeemable convertible
preferred stock and are calculated using the treasury stock method.


11


NOTE F - NET INCOME (LOSS) PER COMMON SHARE (CONTINUED)

Earnings per share for the three months ended September 30, 2002 and 2001 and
for the nine months ended September 30, 2002 and 2001 are computed based on the
following amounts:


Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
(in thousands, except share amounts) 2002 2001 2002 2001
---- ---- ---- ----

Income (loss) before extraordinary item $ 7,830 $ (17) $ 19,834 $ (4,626)
Less preferred stock dividends declared and accretion (1,311) (1,225) (3,868) (3,613)
------------ ------------ ------------ ------------
Income (loss) before extraordinary item available to
common stockholders used to compute basic
and diluted per common share amounts $ 6,519 $ (1,242) $ 15,966 $ (8,239)
============ ============ ============ ============

Net income (loss) $ 7,830 $ (17) $ 17,023 $ (4,626)
Less preferred stock dividends declared and accretion (1,311) (1,225) (3,868) (3,613)
------------ ------------ ------------ ------------
Net income (loss) available to common stockholders
used to compute basic and diluted per common
share amounts $ 6,519 $ (1,242) $ 13,155 $ (8,239)
============ ============ ============ ============

Shares of common stock outstanding used to compute
basic per common share amounts 19,554,942 18,910,002 19,353,827 18,910,002
Effect of dilutive options 2,120,226 -- 1,935,846 --
Effect of dilutive warrants 238,799 -- 212,442 --
------------ ------------ ------------ ------------
Shares used to compute dilutive per common share
amounts (1) 21,913,967 18,910,002 21,502,115 18,910,002
============ ============ ============ ============


(1) Excludes the effect of the conversion of the 7% Redeemable
Convertible Preferred Stock into Common Stock as it is
considered anti-dilutive. For 2001, excludes the effect of all
dilutive options and warrants as a result of the Company's net
loss before extraordinary item available to common
shareholders for the three and nine months ended September 30,
2001.

Options, outstanding at September 30, 2002, to purchase 280,500 and 1,006,313
shares of common stock are not included in the computation of diluted income per
share for the three and nine months ended September 30, 2002, respectively, as
these options are anti-dilutive.

Options and warrants to purchase 4,252,460 and 830,650 shares, respectively, of
common stock were outstanding at September 30, 2001 and are not included in the
computation of diluted income per share for the three and nine months ended
September 30, 2001 due to the Company's net loss during these periods.


12


NOTE G - INVENTORY

Inventories at September 30, 2002 and December 31, 2001 consist of the
following:

September 30, December 31,
(in thousands) 2002 2001
-------------- ---- ----

Raw materials $25,174 $27,224
Work in process 19,908 19,908
Finished goods 9,444 8,814
------- -------
$54,526 $55,946
======= =======


NOTE H - LONG TERM DEBT

Long-term debt consisted of the following at September 30, 2002 and December 31,
2001:


September 30, December 31,
(in thousands) 2002 2001
- -------------- ---- ----

Revolving Credit Facility $ 26,000 $ 74,800
10 3/8% Senior Notes due 2009 206,856 --
A Term Loan Commitment -- 63,995
B Term Loan Commitment -- 89,592
11 1/4% Senior Subordinated Notes due 2009 150,000 150,000
Subordinated seller notes, non-collateralized net
of unamortized discount of $0.1 million with principal
and interest payable in either monthly, quarterly or
annual installments at effective interest rates
ranging from 6% to 12.287%, maturing through December 2011 10,966 19,440
--------- ---------
393,822 397,827
Less current portion (6,888) (30,512)
--------- ---------
$ 386,934 $ 367,315
========= =========


On February 15, 2002, the Company sold $200.0 million principal amount of its 10
3/8% Senior Notes due 2009 (the "Senior Notes") and established a new $75.0
million senior secured revolving line of credit (the "Revolving Credit
Facility"). The Senior Notes mature on February 15, 2009, are senior
indebtedness and are guaranteed by all of the Company's domestic subsidiaries.
Interest is payable semi-annually on February 15 and August 15, commencing
August 15, 2002. The Revolving Credit Facility carries an interest rate of LIBOR
plus 3.50% and matures on February 15, 2007. The Company used the $194.0 million
net proceeds from the sale of the Senior Notes, along with approximately $36.5
million from the Revolving Credit Facility, to retire approximately $228.4
million of indebtedness, plus related fees and expenses, outstanding under the
Company's previously existing revolving credit and term loan facilities.

13


NOTE H - LONG TERM DEBT (CONTINUED)

The Revolving Credit Facility requires compliance with various financial
covenants, including a minimum consolidated interest coverage ratio, minimum
consolidated EBITDA, a maximum total leverage ratio, a maximum senior secured
leverage ratio and a minimum fixed charge coverage ratio, as well as other
covenants. As of September 30, 2002, the Company was in compliance with these
covenants. The Company assesses, on a quarterly basis, its compliance with these
covenants and monitors any matters critical to continue its compliance.

As a result of retiring the previously existing indebtedness, the Company wrote
off $4.6 million in unamortized debt issuance costs that had previously been
included in other assets. The extraordinary item for the nine months ended
September 30, 2002 consists of such costs, offset by a tax benefit of $1.8
million.

In March 2002, the Company entered into two fixed-to-floating interest rate
swaps with an aggregate notional amount of $100.0 million in connection with the
sale of the Senior Notes and in order to mitigate its interest rate risk. Under
the interest rate swap agreements, the Company will receive amounts based on a
fixed interest rate of 10 3/8% per annum. In return, the Company will pay
amounts based on a variable interest rate based on the six-month LIBOR plus a
spread between 492 and 497 basis points. The Company will receive and pay these
amounts semiannually through the maturity date of February 15, 2009. The terms
of these agreements are identical to the Senior Notes. The Company has
designated its interest rate swaps as fair value hedges and they qualify for the
short-cut method of accounting under the provisions of Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities. The Company has adjusted the carrying amount of the Senior Notes and
the swaps by $6.9 million to reflect the fair value of the swaps as of September
30, 2002. The fair value of interest rate swaps are included in other assets.

The Company uses derivative financial instruments for the purpose of hedging
interest rate exposures that exist as part of ongoing business operations. The
Company's derivative financial instruments are designated as and qualify as fair
value flow hedges. The Company's policy requires that the Company formally
document all relationships between hedging instruments and hedged items, as well
as the Company's risk management objective and strategy for undertaking various
hedge transactions. As a policy, the Company does not engage in speculative or
leveraged transactions, nor does the Company hold or issue financial instruments
for trading purposes.


14


NOTE I - COMMITMENTS AND CONTINGENT LIABILITIES

Commitments

In October 2001, the Company entered into a Supply Agreement with USMC, under
which it agreed to purchase certain products and components for use solely by
the Company's patient-care centers during a five-year period following the date
of the agreement. The Company satisfied its obligation to purchase from USMC at
least $7.5 million of products and components during the first year following
the date of the agreement. Accordingly, on November 1, 2002, the escrow agent
released $1.0 million in escrowed funds to the Company for the satisfaction of
such first-year purchase obligations.

In addition, the Company is obligated to purchase from USMC at least $8.5
million and $9.5 million of products and components during the second and third
years following the agreement, respectively, subject to certain adjustments.
However, in the event purchases during each of the fourth and fifth years are
less than approximately $8.7 million, the Company shall pay USMC an amount equal
to $0.1 million multiplied by the number of $1.0 million units by which actual
purchases during each of the fourth and fifth years are less than approximately
$8.7 million.

Contingencies

The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business, including claims related to alleged contingent
additional payments under business purchase agreements. Many of these legal
proceedings and claims existed in the NovaCare O&P business prior to the
Company's acquisition of NovaCare O&P. 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 the financial position, liquidity or results of
operations of the Company.



15


NOTE I - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)

Contingencies (Continued)

On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger
Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No.
00CV3508) was filed against the Company in the United States District Court for
the District of Maryland on behalf of all purchasers of our common stock from
November 8, 1999 through and including January 6, 2000. The complaint also names
as defendants Ivan R. Sabel, the Company's Chairman of the Board and Chief
Executive Officer (and then President), and Richard A. Stein, the Company's
former Chief Financial Officer, Secretary and Treasurer (the "Class Action
Lawsuit").

The complaint alleges that during the above period of time, the defendants
violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 by,
among other things, knowingly or recklessly making material misrepresentations
concerning the Company's financial results for the quarter ended September 30,
1999, and the progress of the Company's efforts to integrate the
recently-acquired operations of NovaCare O&P. The complaint further alleges that
by making those material misrepresentations, the defendants artificially
inflated the price of the Company's common stock. The plaintiff seeks to recover
damages on behalf of all of the class members.

The Class Action Lawsuit has been dismissed by the District Court for failure to
comply with statutory requirements. On November 5, 2002, plaintiffs filed a
notice of appeal to the United States Court of Appeals for the Fourth Circuit.

The Company believes that the allegations have no merit and is vigorously
defending the Class Action Lawsuit.

NOTE J - SEGMENT AND RELATED INFORMATION

The Company has identified two reportable segments in which it operates based on
the products and services it provides. The Company evaluates segment performance
and allocates resources based on the segments' EBITDA. EBITDA is defined as net
income (loss) before extraordinary item, interest, taxes, depreciation and
amortization, and unusual charges consisting of impairment loss on assets held
for sale, and integration, impairment, restructuring, and performance
improvement costs. EBITDA, as used by management to evaluate segment
performance, is not a measure of performance under GAAP. While EBITDA should not
be considered in isolation or as a substitute for net income, cash flows from
operating activities and other income or cash flow statement data prepared in
accordance with GAAP, or as a measure of profitability or liquidity, management
understands that EBITDA is customarily used as a criteria in evaluating health
care companies. Moreover, substantially all of the Company's financing
agreements contain covenants in which EBITDA is used as a measure of financial
performance. Our definition of EBITDA may not be comparable to the definition of
EBITDA used by other companies. Other EBITDA not directly attributable to
reportable segments is primarily related to corporate general and administrative
expenses.



16


NOTE J - SEGMENT AND RELATED INFORMATION (CONTINUED)

The two reportable segments are: (i) patient-care centers and (ii) distribution.
A third segment that was previously reportable, manufacturing, was sold on
October 9, 2001. On June 1, 2001, in anticipation of the sale of the
manufacturing segment, the Company transferred its central fabrication
operations from the manufacturing segment to the patient-care centers segment.
Accordingly, all prior periods have been recast to be consistent with 2001
reporting. The reportable segments are described further below:

Patient-care centers - This segment consists of the Company's owned and operated
O&P patient-care centers, fabrication centers of O&P components and OPNET. The
patient-care centers provide services to design and fit orthotic and prosthetic
devices to patients. These centers also instruct patients in the use, care and
maintenance of the devices. Fabrication centers are involved in the fabrication
of O&P components for both the O&P industry and the Company's own patient-care
practices. OPNET is a national managed care agent for O&P services and a patient
referral clearing house.

Distribution - This segment distributes O&P products and components to both the
O&P industry and the Company's own patient-care practices.

Manufacturing - This previously reportable segment consisted of the manufacture
of components and finished patient-care products for both the O&P industry and
the Company's own patient-care practices.

Summarized financial information concerning the Company's reportable segments is
shown in the following table. Intersegment sales mainly include sales of O&P
components from the manufacturing and distribution segments to the patient-care
centers segment and were made at prices which approximate market values.


17


NOTE J - SEGMENT AND RELATED INFORMATION (CONTINUED)



Patient-Care Other and
Centers Distribution Manufacturing Eliminations Total
------- ------------ ------------- ------------ -----
(in thousands)

Three Months Ended September 30, 2002
Net sales
Customers $ 126,006 $ 7,974 $ - $ - $ 133,980
=================================================================================
Intersegment $ - $ 13,723 $ - $ (13,723) $ -
=================================================================================
EBITDA $ 25,854 $ 3,121 $ - $ (3,507) $ 25,468
Depreciation and amortization 1,994 72 - 334 2,400
Interest expense, net 9,870 - - - 9,870
Provision for income taxes - - - 5,368 5,368
---------------------------------------------------------------------------------
Net income (loss) $ 13,990 $ 3,049 $ - $ (9,209) $ 7,830
=================================================================================

Three Months Ended September 30, 2001
Net sales
Customers $ 120,893 $ 7,177 $ 1,535 $ - $ 129,605
=================================================================================
Intersegment $ - $ 13,598 $ 1,323 $ (14,921) $ -
=================================================================================
EBITDA $ 25,891 $ 1,367 $ (415) $ (4,635) $ 22,208
Depreciation and amortization 5,315 116 438 528 6,397
Unusual charges 244 101 (142) 1,178 1,381
Interest expense, net 12,590 - 16 (1,838) 10,768
Provision for income taxes - - - 3,679 3,679
---------------------------------------------------------------------------------
Net income (loss) $ 7,742 $ 1,150 $ (727) $ (8,182) $ (17)
=================================================================================

Nine Months Ended September 30, 2002
Net sales
Customers $ 369,076 $ 21,470 $ - $ - $ 390,546
================================================================================
Intersegment $ - $ 38,918 $ - $ (38,918) $ -
=================================================================================
EBITDA $ 76,751 $ 6,129 $ - $ (13,040) $ 69,840
Depreciation and amortization 6,236 235 - 1,007 7,478
Interest expense, net 28,926 - - - 28,926
Provision for income taxes - - - 13,602 13,602
Extraordinary item - - - 2,811 2,811
---------------------------------------------------------------------------------
Net income (loss) $ 41,589 $ 5,894 $ - $ (30,460) $ 17,023
=================================================================================

Nine Months Ended September 30, 2001
Net sales
Customers $ 351,927 $ 22,689 $ 4,749 $ - $ 379,365
=================================================================================
Intersegment $ - $ 40,318 $ 3,562 $ (43,880) $ -
=================================================================================
EBITDA $ 71,519 $ 4,731 $ (191) $ (15,826) $ 60,233
Depreciation and amortization 15,938 335 1,292 1,343 18,908
Unusual charges 4,295 190 8,118 3,617 16,220
Interest expense, net 35,627 - 270 (1,838) 34,059
Benefit for income taxes - - - (4,328) (4,328)
---------------------------------------------------------------------------------
Net income (loss) $ 15,659 $ 4,206 $ (9,871) $ (14,620) $ (4,626)
=================================================================================



18


NOTE K - CONSOLIDATING FINANCIAL INFORMATION

The Company's Senior Notes, Senior Subordinated Notes and Revolving Credit
Facility are guaranteed fully, jointly and severally, and unconditionally by all
of the Company's current and future domestic subsidiaries. The following is
summarized condensed consolidating financial information, as of September 30,
2002 and December 31, 2001, for the three-month periods ended September 30, 2002
and 2001, and for the nine-month periods ended September 30, 2002 and 2001 of
the Company, segregating the parent company (Hanger Orthopedic Group, Inc.) and
its guarantor subsidiaries, as each of the Company's subsidiaries is
wholly-owned.




19


NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)



Hanger
Orthopedic
Group
(Parent Guarantor Consolidating Consolidated
BALANCE SHEET - September 30, 2002 Company) Subsidiaries Adjustments Totals
- ---------------------------------- -------- ------------ ----------- ------
(in thousands)
------------------------------------------------------------------

ASSETS
Cash and cash equivalents $ 14,028 $ 7,974 $ - $ 22,002
Accounts receivable - 104,994 - 104,994
Inventories - 54,526 - 54,526
Prepaid expenses and other assets (1) 38,241 3,432 (36,603) 5,070
Intercompany receivable 59,734 (59,734) - -
Deferred income taxes 20,957 - - 20,957
-----------------------------------------------------------------
Total current assets 132,960 111,192 (36,603) 207,549

Property, plant and equipment, net 4,838 30,343 - 35,181
Intangible assets, net (154) 456,871 - 456,717
Investment in subsidiaries 99,831 - (99,831) -
Other assets (1) 428,214 2,864 (406,700) 24,378
----------------------------------------------------------------
Total assets $ 665,689 $ 601,270 $(543,134) $ 723,825
================================================================

LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND SHAREHOLDERS' EQUITY
Current portion of long-term debt $ - $ 6,888 $ - $ 6,888
Accounts payable 4 9,823 - 9,827
Accrued expenses 3,912 5,563 - 9,475
Accrued interest payable (1) 7,335 36,947 (36,603) 7,679
Accrued compensation related cost 1,518 32,280 - 33,798
Income taxes payable 9,419 (2,529) - 6,890
----------------------------------------------------------------
Total current liabilities 22,188 88,972 (36,603) 74,557

Long-term debt, less current portion (1) 382,856 410,778 (406,700) 386,934
Deferred income taxes 26,495 - - 26,495
Other liabilities 40 1,689 - 1,729
----------------------------------------------------------------
Total liabilities 431,579 501,439 (443,303) 489,715
----------------------------------------------------------------
Redeemable preferred stock 74,607 - - 74,607
----------------------------------------------------------------

Common stock 197 35 (35) 197
Additional paid-in capital 147,343 7,461 (7,461) 147,343
Retained earnings 12,619 92,875 (92,875) 12,619
Treasury stock (656) (540) 540 (656)
----------------------------------------------------------------
Total shareholders' equity 159,503 99,831 (99,831) 159,503
----------------------------------------------------------------

Total liabilities, redeemable preferred stock,
and shareholders' equity $ 665,689 $ 601,270 $ (543,134) $ 723,825
================================================================



(1) Other assets of the parent company and long-term debt of the
guarantor subsidiaries include a $406.7 million note payable
from a subsidiary to the parent. At September 30, 2002,
prepaid expenses and other assets of the parent company and
accrued interest payable of the guarantor subsidiaries include
$36.6 million in interest accrued under the note payable.

20

NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONSOLIDATED)



Hanger
Orthopedic
Group
(Parent Guarantor Consolidating Consolidated
BALANCE SHEET - December 31, 2001 Company) Subsidiaries Adjustments Totals
- --------------------------------- -------- ------------ ----------- ------
(in thousands)
-----------------------------------------------------------------

ASSETS
Cash and cash equivalents $ (212) $ 10,255 $ - $ 10,043
Accounts receivable - 104,040 - 104,040
Inventories - 55,946 - 55,946
Prepaid expenses and other assets 591 4,310 - 4,901
Intercompany receivable 126,124 (126,124) - -
Deferred income taxes 20,957 - - 20,957
---------------------------------------------------------------
Total current assets 147,460 48,427 - 195,887

Property, plant and equipment, net 4,767 33,011 - 37,778
Intangible assets, net (156) 452,536 - 452,380
Investment in subsidiaries 60,673 - (60,673) -
Other assets (1) 417,672 2,890 (406,700) 13,862
---------------------------------------------------------------
Total assets $ 630,416 $ 536,864 $ (467,373) $ 699,907
===============================================================

LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND SHAREHOLDERS' EQUITY
Current portion of long-term debt $ 19,199 $ 11,313 $ - $ 30,512
Accounts payable 520 16,381 - 16,901
Accrued expenses 4,586 3,610 - 8,196
Accrued interest payable 1,577 440 - 2,017
Accrued compensation related cost 2,438 26,607 - 29,045
---------------------------------------------------------------
Total current liabilities 28,320 58,351 - 86,671

Long-term debt, less current portion (1) 359,188 414,827 (406,700) 367,315
Deferred income taxes 26,495 - - 26,495
Other liabilities - 3,013 - 3,013
---------------------------------------------------------------
Total liabilities 414,003 476,191 (406,700) 483,494
---------------------------------------------------------------

Redeemable preferred stock 70,739 - - 70,739
---------------------------------------------------------------

Common stock 191 35 (35) 191
Additional paid-in capital 146,674 7,461 (7,461) 146,674
Accumulated deficit (535) 53,717 (53,717) (535)
Treasury stock (656) (540) 540 (656)
---------------------------------------------------------------
Total shareholders' equity 145,674 60,673 (60,673) 145,674
---------------------------------------------------------------

Total liabilities, redeemable preferred stock,
and shareholders' equity $ 630,416 $ 536,864 $ (467,373) $ 699,907
===============================================================



(1) Other assets of the parent company and long-term debt of the
guarantor subsidiaries include a $406.7 million note payable
from a subsidiary to the parent.

21


NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)



Hanger
Orthopedic
Group
(Parent Guarantor Consolidating Consolidated
STATEMENTS OF OPERATIONS Company) Subsidiaries Adjustments Totals
- ------------------------ -------- ------------ ----------- ------
(in thousands)
-----------------------------------------------------------------

Three months ended September 30, 2002

Net sales $ - $ 147,703 $ (13,723) $ 133,980
Cost of goods sold (exclusive of depreciation and
amortization) - 73,692 (13,721) 59,971
---------------------------------------------------------------
Gross profit - 74,011 (2) 74,009

Selling, general and administrative 3,507 45,036 (2) 48,541
Depreciation and amortization 334 2,066 - 2,400
---------------------------------------------------------------
Income (loss) from operations (3,841) 26,909 - 23,068

Interest income (expense), net 2,447 (12,317) - (9,870)
Equity in earnings of subsidiaries 14,592 - (14,592) -
---------------------------------------------------------------
Income (loss) before taxes 13,198 14,592 (14,592) 13,198

Provision for income taxes 5,368 - - 5,368
---------------------------------------------------------------
Net income (loss) $ 7,830 $ 14,592 $ (14,592) $ 7,830
===============================================================


Three months ended September 30, 2001

Net sales $ - $ 144,526 $ (14,921) $ 129,605
Cost of goods sold (exclusive of depreciation and
amortization) - 76,527 (14,921) 61,606
---------------------------------------------------------------
Gross profit - 67,999 - 67,999

Selling, general and administrative 4,635 41,156 - 45,791
Depreciation and amortization 528 2,563 - 3,091
Amortization of excess cost over net assets acquired - 3,306 - 3,306
Unusual charges 1,178 203 - 1,381
---------------------------------------------------------------
Income (loss) from operations (6,341) 20,771 - 14,430

Interest income (expense), net 1,838 (12,606) (10,768)
Equity in earnings of subsidiaries 8,165 - (8,165) -
---------------------------------------------------------------
Income (loss) before taxes 3,662 8,165 (8,165) 3,662

Provision for income taxes 3,679 - - 3,679
---------------------------------------------------------------
Net income (loss) $ (17) $ 8,165 $ (8,165) $ (17)
===============================================================



22


NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)



Hanger
Orthopedic
Group
(Parent Guarantor Consolidating Consolidated
STATEMENTS OF OPERATIONS Company) Subsidiaries Adjustments Totals
- ------------------------ -------- ------------ ----------- ------
(in thousands)
-----------------------------------------------------------------

Nine months ended September 30, 2002

Net sales $ - $ 429,464 $ (38,918) $ 390,546
Cost of goods sold (exclusive of depreciation and
amortization) - 219,713 (38,907) 180,806
----------------------------------------------------------------
Gross profit - 209,751 (11) 209,740

Selling, general and administrative 13,040 126,871 (11) 139,900
Depreciation and amortization 1,007 6,471 - 7,478
----------------------------------------------------------------
Income (loss) from operations (14,047) 76,409 - 62,362

Interest income (expense), net 8,325 (37,251) - (28,926)
Equity in earnings of subsidiaries 39,158 - (39,158) -
----------------------------------------------------------------
Income (loss) before taxes 33,436 39,158 (39,158) 33,436

Provision for income taxes 13,602 - - 13,602
----------------------------------------------------------------
Income (loss) before extraordinary item 19,834 39,158 (39,158) 19,834

Extraordinary item (2,811) - - (2,811)
----------------------------------------------------------------
Net income (loss) $ 17,023 $ 39,158 $ (39,158) $ 17,023
================================================================


Nine months ended September 30, 2001

Net sales $ - $ 423,255 $ (43,890) $ 379,365
Cost of goods sold (exclusive of depreciation and
amortization) - 231,904 (43,890) 188,014
----------------------------------------------------------------
Gross profit - 191,351 - 191,351

Selling, general and administrative 15,826 115,292 - 131,118
Depreciation and amortization 1,343 7,702 - 9,045
Amortization of excess cost over net assets acquired - 9,863 - 9,863
Unusual charges 3,617 12,603 - 16,220
----------------------------------------------------------------
Income (loss) from operations (20,786) 45,891 - 25,105

Interest income (expense), net 4,143 (38,202) - (34,059)
Equity in earnings of subsidiaries 7,689 - (7,689) -
----------------------------------------------------------------
Income (loss) before taxes (8,954) 7,689 (7,689) (8,954)

Benefit for income taxes (4,328) - - (4,328)
----------------------------------------------------------------
Net income (loss) $ (4,626) $ 7,689 $ (7,689) $ (4,626)
================================================================





23


NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)



Hanger
Orthopedic
Group
(Parent Guarantor Consolidating Consolidated
STATEMENTS OF CASH FLOWS Company) Subsidiaries Adjustments Totals
- ------------------------ -------- ------------ ----------- ------
(in thousands)
-----------------------------------------------------------------

Nine months ended September 30, 2002

Cash flows from operating activities:
Net cash provided by operating activities $ 26,927 $ 14,395 $ - $ 41,322
---------------------------------------------------------------

Cash flows from investing activities:
Purchase of property, plant and equipment (1,174) (5,464) - (6,638)
Acquisitions, net of cash acquired, and earnouts - (4,230) - (4,230)
Proceeds from sale of property, plant and equipment - 1,492 - 1,492
---------------------------------------------------------------
Net cash used in investing activities (1,174) (8,202) - (9,376)
---------------------------------------------------------------

Cash flows from financing activities:
Borrowings under revolving credit agreement 43,975 - - 43,975
Repayments under revolving credit agreement (92,775) - - (92,775)
Proceeds from sale of Senior Notes 200,000 - - 200,000
Repayment and termination of bank loans (153,587) - - (153,587)
Scheduled repayment of long-term debt - (8,474) - (8,474)
Increase in financing costs (9,800) - - (9,800)
Proceeds from issuance of Common Stock 3,067 - - 3,067
Repurchase of outstanding stock options (2,393) - - (2,393)
---------------------------------------------------------------
Net cash used in financing activities (11,513) (8,474) - (19,987)
---------------------------------------------------------------

Net increase (decrease) in cash and cash equivalents 14,240 (2,281) - 11,959
Cash and cash equivalents, beginning of period (212) 10,255 - 10,043
---------------------------------------------------------------
Cash and cash equivalents, end of period $ 14,028 $ 7,974 $ - $ 22,002
===============================================================




24



NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)


Hanger
Orthopedic
Group
(Parent Guarantor Consolidating Consolidated
STATEMENTS OF CASH FLOWS Company) Subsidiaries Adjustments Totals
- ------------------------ -------- ------------ ----------- ------
(in thousands)
-----------------------------------------------------------------

Nine months ended September 30, 2001

Cash flows from operating activities:
Net cash provided by operating activities $ 7,282 $ 21,384 $ - $ 28,666
----------------------------------------------------------------

Cash flows from investing activities:
Purchase of property, plant and equipment (1,028) (3,874) - (4,902)
Acquisitions, net of cash acquired, and earnouts - (4,732) - (4,732)
Proceeds from sale of property, plant and equipment - 634 - 634
----------------------------------------------------------------
Net cash used in investing activities (1,028) (7,972) - (9,000)
----------------------------------------------------------------

Cash flows from financing activities:
Borrowings under revolving credit agreement 4,000 - - 4,000
Repayments under revolving credit agreement (10,900) - - (10,900)
Proceeds from sale of Senior Notes - - - -
Repayment and termination of bank loans (18,500) - - (18,500)
Scheduled repayment of long-term debt - (10,416) - (10,416)
Increase in financing costs (1,060) - - (1,060)
Proceeds from issuance of Common Stock - - - -
Repurchase of outstanding stock options - - - -
----------------------------------------------------------------
Net cash used in financing activities (26,460) (10,416) - (36,876)
----------------------------------------------------------------

Net increase (decrease) in cash and cash equivalents (20,206) 2,996 - (17,210)
Cash and cash equivalents, beginning of period 10,829 9,840 - 20,669
----------------------------------------------------------------
Cash and cash equivalents, end of period $ (9,377) $ 12,836 $ - $ 3,459
================================================================




25


ITEM 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations

Results of Operations

The following table sets forth for the periods indicated certain items of the
Company's Statements of Operations and their percentage of the Company's net
sales:



Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----

Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold 44.8 47.5 46.3 49.6
Gross profit 55.2 52.5 53.7 50.4
Selling, general and administrative 36.2 35.3 35.8 34.5
Depreciation and amortization 1.8 2.4 1.9 2.4
Amortization of excess cost over net assets acquired - 2.6 - 2.6
Unusual charges - 1.1 - 4.2
Income from operations 17.2 11.1 16.0 6.7
Interest expense, net 7.4 8.3 7.4 9.0
Income (loss) before taxes 9.8 2.8 8.6 (2.3)
Provision (benefit) for income taxes 4.0 2.8 3.5 (1.1)
Net income (loss) before extraordinary item 5.8 - 5.1 (1.2)
Extraordinary item - - 0.7 -
Net income (loss) 5.8 - 4.4 (1.2)



Three Months Ended September 30, 2002 Compared to the Three Months Ended
September 30, 2001

Net Sales. Net sales for the quarter ended September 30, 2002, were $134.0
million, an increase of $4.4 million, or 3.4%, versus net sales of $129.6
million for the quarter ended September 30, 2001. The sales growth was primarily
the result of a 4.6% increase in same center sales in the Company's O&P
patient-care practices and a $0.8 million, or 0.6%, increase in outside sales of
the distribution segment offset by a $1.5 million, or 1.2%, reduction in sales
due to the sale of Seattle Orthopedic Group, Inc. ("SOGI"), the Company's
manufacturing segment, in the fourth quarter of 2001.

Gross Profit. Gross profit in the quarter ended September 30, 2002 was $74.0
million, an increase of $6.0 million, or 8.8%, versus $68.0 million for the
quarter ended September 30, 2001. Gross profit as a percentage of net sales
increased to 55.2% in the third quarter of 2002 versus 52.5% in the third
quarter of 2001. Specifically, the gross profit, as a percentage of sales, for
the patient-care segment increased to 55.3% in the third quarter of 2002 versus
53.5% in the third quarter of 2001; similarly, the gross profit, as a percentage
of sales, for the distribution segment


26


increased to 20.2% in the third quarter of 2002 versus 13.0% in the third
quarter of 2001. The improvement in gross profit, in both dollars and as a
percentage of sales, was due to a reduction in labor and material costs as well
as the increase in net sales.

Selling, General and Administrative. Selling, general and administrative
expenses in the quarter ended September 30, 2002 increased by $2.8 million, or
6.0%, compared to the quarter ended September 30, 2001. Selling, general and
administrative expenses as a percentage of net sales increased to 36.2% in the
third quarter of 2002 compared to 35.3% for same period in 2001. The increase in
selling, general and administrative expenses in both dollars and as a percentage
of sales was primarily due to a $2.3 million increase in our accrual for the
practitioners' performance-based bonus program costs that resulted from the
Company's increased collections and decreased labor and material costs.

Depreciation and Amortization. Depreciation and amortization for the three
months ended September 30, 2002 were $2.4 million, a 62.5% decrease in such
costs versus the $6.4 million for the three months ended September 30, 2001. The
decrease was due principally to the discontinuation of amortization related to
goodwill commencing January 1, 2002 pursuant to SFAS No. 142, which had been
$3.3 million during the third quarter of 2001, and also to the sale of SOGI in
the fourth quarter of 2001.

Unusual Charges. Unusual charges for the three months ended September 30, 2001
amounted to $1.4 million in charges primarily related to fees paid to
AlixPartners, LLC (formerly Jay Alix & Associates, Inc.; "JA&A") in connection
with development of the Company's performance improvement plan. JA&A's work with
the Company was substantially completed as of December 31, 2001. In the fourth
quarter of 2001, we were invoiced for and accrued a success fee based upon
identified savings and operational improvements. Our contract with JA&A provides
for one potential additional success fee, which will be based on the realization
of further savings from initiatives that were not fully implemented by December
31, 2001. As of September 30, 2002, JA&A has measured all savings generated and
the Company believes that no further payments will be required under the
contract.

Income from Operations. Principally as a result of the above, income from
operations for the quarter ended September 30, 2002 was $23.1 million, an
increase of $8.6 million, or 60.0%, compared to the quarter ended September 30,
2001. Income from operations as a percentage of net sales increased by 6.1
percentage points to 17.2% of net sales in the third quarter of 2002 versus
11.1% for the prior year's comparable period.

Interest Expense, Net. Interest expense in the third quarter of 2002 was $9.9
million, a decrease of $0.9 million from the $10.8 million incurred in the third
quarter of 2001. The decrease in interest expense was primarily attributable to
a decrease in average borrowings and a reduction in LIBOR.

Income Taxes. The provision for income taxes for the three months ended
September 30, 2002 was $5.4 million compared to $3.7 million for the three
months ended September 30, 2001. The change in the income tax provision was due
to the Company's increased profitability.

27


Net Income (Loss). As a result of the above, we recorded net income of $7.8
million for the three months ended September 30, 2002, compared to a small loss
in the comparable quarter in the prior year, an improvement of $7.8 million.

Nine months Ended September 30, 2002 Compared to the Nine months Ended September
30, 2001

Net Sales. Net sales for the nine months ended September 30, 2002, were $390.5
million, an increase of $11.1 million, or 2.9%, versus net sales of $379.4
million for the nine months ended September 30, 2001. The sales growth was
primarily the result of a 5.1% increase in same center sales in the Company's
O&P patient-care practices offset by a $1.2 million, or 0.3%, decrease in
outside sales of the distribution segment and a $4.7 million, or 1.2%, reduction
in sales due to the sale of SOGI, the Company's manufacturing segment, in the
fourth quarter of 2001.

Gross Profit. Gross profit in the nine months ended September 30, 2002 was
$209.7 million, an increase of $18.3 million, or 9.6%, versus $191.4 million for
the nine months ended September 30, 2001. Gross profit as a percentage of net
sales increased to 53.7% in the first nine months of 2002 versus 50.4% in the
first nine months of 2001. Specifically, the gross profit, as a percentage of
sales, for the patient-care segment increased to 54.1% in the first nine months
of 2002 versus 51.1% in the comparable period of 2001; similarly, the gross
profit, as a percentage of sales, for the distribution segment increased to
16.9% in the first nine months of 2002 versus 13.8% in the comparable period of
2001. The improvement in gross profit, in both dollars and as a percentage of
sales, was due to a reduction in labor and material costs as well as the
increase in net sales.

Selling, General and Administrative. Selling, general and administrative
expenses in the nine months ended September 30, 2002 increased by $8.8 million,
or 6.7%, compared to the nine months ended September 30, 2001. Selling, general
and administrative expenses as a percentage of net sales increased to 35.8% in
the first nine months of 2002 compared to 34.5% for the same period in 2001. The
increase in selling, general and administrative expenses in both dollars and as
a percentage of sales was primarily due to a $9.8 million increase in our
accrual for the practitioners' performance-based bonus program costs that
resulted from the Company's increased collections and decreased labor and
material costs.

Depreciation and Amortization. Depreciation and amortization for the nine months
ended September 30, 2002 were $7.5 million, a 60.3% decrease in such costs
versus the $18.9 million for the nine months ended September 30, 2001. The
decrease was due principally to the discontinuation of amortization related to
goodwill commencing January 1, 2002 pursuant to SFAS No. 142, which had been
$9.9 million during the first nine months of 2001, and also to the sale of SOGI
in the fourth quarter of 2001.

Unusual Charges. Unusual charges for the nine months ended September 30, 2001
amounted to $16.2 million, which consisted of the following one-time costs: (i)
restructuring charges of $3.7 million principally related to severance and lease
termination expenses; (ii) an $8.0 million loss


28


on the disposal of substantially all the manufacturing assets of SOGI; and (iii)
$4.5 million in other charges primarily related to fees paid to JA&A in
connection with development of the Company's performance improvement plan.

Income from Operations. Principally as a result of the above, income from
operations for the nine months ended September 30, 2002 was $62.4 million, an
increase of $37.3 million, or 148.6%, compared to the nine months ended
September 30, 2001. Income from operations as a percentage of net sales
increased by 9.3 percentage points to 16.0% of net sales in the first nine
months of 2002 versus 6.7% for the prior year's comparable period.

Interest Expense, Net. Interest expense in the first nine months of 2002 was
$28.9 million, a decrease of $5.2 million from the $34.1 million incurred in the
first nine months of 2001. The decrease in interest expense was primarily
attributable to a decrease in average borrowings and a reduction in LIBOR.

Income Taxes. The provision for income taxes for the nine months ended September
30, 2002 was $13.6 million compared to a benefit of $4.3 million for the nine
months ended September 30, 2001. The change in the income tax provision was due
to the Company's return to profitability.

Income (Loss) before Extraordinary Item. As a result of the above, we recorded
income before extraordinary item of $19.8 million for the nine months ended
September 30, 2002, compared to a loss before extraordinary item of $4.6 million
in the comparable period in the prior year, an improvement of $24.4 million.

Extraordinary Item. The extraordinary item of $2.8 million ($4.6 million
pre-tax) in the nine months ended September 30, 2002, represents the write-off
of debt issuance costs as a result of extinguishing $228.4 million of bank debt
in connection with the Company's issuance of the $200.0 million principal amount
of its 10 3/8% Senior Notes due 2009 (the "Senior Notes") and the establishment
of a $75.0 million senior secured revolving line of credit (the "Revolving
Credit Facility").

Net Income (Loss). As a result of the above, we recorded net income of $17.0
million for the nine months ended September 30, 2002, compared to net loss of
$4.6 million in the comparable period in the prior year, an improvement of $21.6
million.

Financial Condition, Liquidity And Capital Resources

Our working capital at September 30, 2002 was $133.0 million compared to $109.2
million at December 31, 2001. Our cash and cash equivalents amounted to $22.0
million at September 30, 2002, and $10.0 million at December 31, 2001. The
current ratio improved to 2.8 to 1 at September 30, 2002, compared to 2.3 to 1
at December 31, 2001. Available cash under our Revolving Credit Facility
increased to $49.0 million at September 30, 2002 compared to $25.2 million at
December 31, 2001.

29


Net cash provided by operating activities for the nine months ended September
30, 2002 was $41.3 million, compared to $28.7 million provided by operating
activities in the nine months ended September 30, 2001. The $12.6 million
increase was primarily due to the increase in the Company's net income.

Net cash used in investing activities was $9.4 million for the nine months ended
September 30, 2002, versus $9.0 million for the same period in the prior year.
The increase in net cash used was primarily due to expenditures made on
development of the Company's new billing system.

Net cash used in financing activities was $20.0 million for the nine months
ended September 30, 2002. During that period, the Company received $200.0
million in proceeds from the sale of the Senior Notes, which were offset by (i)
principal payments of $153.6 million to retire our Tranche A & B Term
Facilities, (ii) a net paydown of $38.3 million of our prior revolving line of
credit, and (iii) payment of $8.1 million in financing costs related to the
issuance of the Senior Notes and the establishment of the Revolving Credit
Facility. In addition to the aforementioned proceeds, the Company received $3.1
million in proceeds from the exercise of stock options, offset by: (i) payment
of approximately $2.4 million to JA&A to repurchase 601,218 shares underlying an
outstanding option to purchase shares of the Company's common stock, as
discussed below, (ii) scheduled principal payments of $8.5 million on our
long-term debt, (iii) a net paydown of $10.5 million of our Revolving Credit
Facility and (iv) payment of $1.7 million in financing costs related to the
issuance of the Senior Notes and the establishment of the Revolving Credit
Facility.

On February 15, 2002, we issued $200.0 million aggregate principal amount of
Senior Notes in a private placement exempt from registration under the
Securities Act of 1933, as amended. We also established, concurrent with the
sale of the Senior Notes, the Revolving Credit Facility. The Senior Notes mature
on February 15, 2009 and do not require any prepayments of principal prior to
maturity. Interest on the Senior Notes accrues from February 15, 2002 and is
payable semi-annually on February 15 and August 15 of each year, commencing
August 15, 2002. Payment of principal and interest on the Senior Notes is
guaranteed on a senior unsecured basis by all of our current and future domestic
subsidiaries. The indenture underlying the Senior Notes limits our ability to,
among other things, incur additional indebtedness, create liens, pay dividends
on or redeem capital stock, make certain investments, make restricted payments,
make certain dispositions of assets, engage in transactions with affiliates,
engage in certain business activities and engage in mergers, consolidations and
certain sales of assets.

On May 13, 2002, we commenced an offer to exchange the privately-placed,
unregistered Senior Notes with new Senior Notes that had been registered under
the Securities Act of 1933, as amended, on the Company's Registration Statement
on Form S-4 filed with the Securities and Exchange Commission. The exchange
offer expired on June 11, 2002. All of the previously issued unregistered Senior
Notes were exchanged for registered Senior Notes. The new notes are
substantially identical to the previously issued unregistered notes except that
the new notes are free of the transfer restrictions that applied to the
unregistered notes.

The Revolving Credit Facility, which was provided by a syndicate of banks and
other financial institutions, is a senior secured revolving credit facility
providing for loans of up to $75.0 million


30


and will terminate on February 15, 2007. Borrowings under the Revolving Credit
Facility will bear interest, at our option, at an annual rate equal to LIBOR
plus 3.50% or the Base Rate (as defined in the Revolving Credit Facility) plus
2.50% in each case, subject to adjustments based on financial performance. Our
obligations under the Revolving Credit Facility are guaranteed by our
subsidiaries and are secured by a first priority perfected security interest in
our subsidiaries' shares, all of our assets and all of the assets of our
subsidiaries. Borrowings under the Revolving Credit Facility are prepayable at
any time without premium or penalty. The Revolving Credit Facility requires
compliance with various financial covenants, including a minimum consolidated
interest coverage ratio, minimum consolidated EBITDA, a maximum total leverage
ratio, a maximum senior secured leverage ratio and a minimum fixed charge
coverage ratio, as well as other covenants. As of September 30, 2002, we were in
compliance with these covenants. We assess, on a quarterly basis, our compliance
with these covenants and monitor any matters critical to continue its
compliance. The Revolving Credit Facility contains customary events of default
and is subject to various mandatory prepayments and commitment reductions.

During the fourth quarter of 2001, the Company approved for payment two invoices
from JA&A for success fees. In accordance with our contract with JA&A, the
invoices were satisfied by the payment of $1.1 million in cash and the issuance
of a nonqualified option to purchase 1,202,436 shares of the Company's common
stock at an exercise price of $1.40 per share. The option was valued using a
Black-Scholes option-pricing model, and an expense of $4.8 million was recorded.

On July 23, 2002, the Company agreed to repurchase 601,218 of the shares
underlying such previously granted option for a payment of $3.98 per share, or a
total of $2,392,704, which was paid during the third quarter of 2002 and
recorded as a reduction in additional paid-in capital. On July 23, 2002, the
Company's common stock opened for trading at $12.00 per share. In accordance
with our agreement with JA&A, the Company filed a Registration Statement on Form
S-3 with the Securities and Exchange Commission to register the remaining
601,218 shares underlying the outstanding option in order to permit JA&A to sell
the shares of the Company's stock that it may acquire upon exercise of the
option.

In accordance with the sale of any shares that JA&A may acquire by exercise of
the option, JA&A has agreed to limit sales of such shares to 40,000 shares in
any calendar week. JA&A also agreed to permanently amend its contract with the
Company so that the payment of future success fees, if any, would be made only
in cash.

We believe that, based on current levels of operations and anticipated growth,
cash generated from operations, together with other available sources of
liquidity, including borrowings available under the Revolving Credit Facility,
will be sufficient for the foreseeable future to fund anticipated capital
expenditures and make required payments of principal and interest on our debt,
including payments due on the Senior Notes and obligations under the Revolving
Credit Facility. In addition, we continually evaluate potential acquisitions and
expect to fund such acquisitions from our available sources of liquidity, as
discussed above.

31


Market Risk

We are exposed to the market risk that is associated with changes in interest
rates. To manage that risk, in March 2002, we entered into interest rate swaps
to modify our exposure to interest rate movements and reduce borrowing costs. We
entered into $100.0 million fixed-to-floating interest rate swaps, consisting of
floating rate instruments benchmarked to LIBOR. We are exposed to potential
losses in the event of nonperformance by the counterparties to the swap
agreements.

New Accounting Pronouncements

On April 30, 2002, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS No.
145"). Under SFAS No. 145, gains and losses from the early extinguishment of
debt would no longer be extraordinary items, unless they satisfied the criteria
in Accounting Principles Board Opinion No. 30 ("APB 30") where extraordinary
items are stated to be distinguishable by their unusual nature and by the
infrequency of their occurrence. Any gain or loss on extinguishment of debt that
was classified as an extraordinary item in prior periods presented that does not
meet the criteria in APB 30 for classification as an extraordinary item shall be
reclassified. In addition, under SFAS No. 145, certain lease modifications that
have economic effects similar to sale-leaseback transactions be accounted for in
the same manner as sale-leaseback transactions. SFAS No. 145 is effective for
fiscal years beginning after May 15, 2002. SFAS No. 145 will be adopted by us on
January 1, 2003 and may result in a reclassification of existing extraordinary
losses on the early extinguishment of debt from an extraordinary item to a
non-operating item.

On July 30, 2002, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 146, Accounting for Costs Associated with
Exit or Disposal Activities ("SFAS No. 146"). Under SFAS No. 146, costs
associated with exit or disposal activities would be recognized when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Such costs would include lease termination costs and certain employee severance
costs that are associated with a restructuring, discontinued operation, plant
closing, or other exit or disposal activity. SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The Company does not expect SFAS No. 146 to have a material effect on its
financial statements.

Critical Accounting Estimates

The Company's analysis and discussion of its financial condition and results of
operations are based upon its consolidated financial statements that have been
prepared in accordance with generally accepted accounting principles in the
United States ("U.S. GAAP"). The preparation of financial statements in
conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. U.S.
GAAP provides the framework from which to make these estimates, assumptions and
disclosures. The Company chooses accounting policies


32


within U.S. GAAP that management believes are appropriate to accurately and
fairly report the Company's operating results and financial position in a
consistent manner.

Management regularly assesses these policies in light of current and forecasted
economic conditions. The Company's accounting principles are stated in Note B to
the Consolidated Financial Statements as presented in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001. In connection with the
adoption of SFAS No. 142; Goodwill and Other Intangible Assets, the Company
believes the following accounting policy is critical to understanding the
results of operations and affect the more significant judgments and estimates
used in the preparation of the consolidated financial statements.

o Intangible Assets: Excess cost over net assets acquired represents the
excess of purchase price over the value assigned to net identifiable
assets of purchased businesses. Other definite-lived intangible assets
include non-compete agreements which are recorded based on agreements
entered into by the Company and are amortized over their estimated
useful lives ranging from 5 to 7 years using the straight-line method.
The remainder of the other definite-lived intangible assets, including
patents, are recorded at cost and are amortized over their estimated
useful lives of up to 16 years using the straight-line method. SFAS 142
requires that excess cost over net assets acquired and indefinite-lived
intangibles be tested for impairment annually. In connection with the
impairment assessment, management reviews and assesses future cash
flows, the market value of the Company's stock price as well as other
market valuation indicators. Further changes in these items could
result in an impairment. Impairment would be recognized by a charge to
operating results and a reduction in the carrying value of the asset.

Class Action

On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger
Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No.
00CV3508) was filed against us in the United States District Court for the
District of Maryland on behalf of all purchasers of our common stock from
November 8, 1999 through and including January 6, 2000. The complaint also names
as defendants Ivan R. Sabel, our Chairman of the Board and Chief Executive
Officer (and then President), and Richard A. Stein, our former Chief Financial
Officer, Secretary and Treasurer (the "Class Action Lawsuit").

The complaint alleges that during the above period of time, the defendants
violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 by,
among other things, knowingly or recklessly making material misrepresentations
concerning the Company's financial results for the quarter ended September 30,
1999, and the progress of the Company's efforts to integrate the
recently-acquired operations of NovaCare O&P. The complaint further alleges that
by making those material misrepresentations, the defendants artificially
inflated the price of the Company's common stock. The plaintiff seeks to recover
damages on behalf of all of the class members.

33


The Class Action Lawsuit has been dismissed by the District Court for failure to
comply with statutory requirements. On November 5, 2002, plaintiffs filed a
notice of appeal to the United States Court of Appeals for the Fourth Circuit.

The Company believes that the allegations have no merit and is vigorously
defending the Class Action Lawsuit.

Other

Inflation has not had a significant effect on the Company's operations, as
increased costs to the Company generally have been offset by increased prices of
products and services sold. The Company primarily provides services and
customized devices throughout the United States and is reimbursed, in large
part, by the patients' third-party insurers or governmentally-funded health
insurance programs. The ability of the Company's debtors to meet their
obligations is principally dependent upon the financial stability of the
insurers of the Company's patients and future legislation and regulatory
actions.

Forward Looking Statements

This report contains forward-looking statements setting forth the Company's
beliefs or expectations relating to future revenues. Actual results may differ
materially from projected or expected results due to changes in the demand for
the Company's O&P services and products, uncertainties relating to the results
of operations or recently acquired and newly acquired O&P patient care
practices, the Company's ability to successfully integrate the operations of
NovaCare O&P and to attract and retain qualified O&P practitioners, federal laws
governing the health-care industry, governmental policies affecting O&P
operations and other risks and uncertainties affecting the health-care industry
generally. Readers are cautioned not to put undue reliance on forward-looking
statements. The Company disclaims any intent or obligation to publicly update
these forward-looking statements, whether as a result of new information, future
events or otherwise.


34


ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

We have existing obligations relating to our Senior Notes, Senior Subordinated
Notes, subordinated seller notes, and outstanding redeemable preferred stock. We
do not have cash flow exposure to changing interest rates on these obligations
because the interest and dividend rates of these securities are fixed. However,
as discussed below, we entered into two fixed-to-floating interest rate swaps,
in connection with the sale of our Senior Notes, whereby the aggregate notional
amount of the swaps equaled one-half of the principal amount of the Senior
Notes.

We have a $75 million Revolving Credit Facility, with an outstanding balance of
$26 million at September 30, 2002, as discussed in Note H to Hanger's
Consolidated Financial Statements ("Note H"). The rates at which interest
accrues under the entire outstanding balance are variable.

In addition, in the normal course of business, we are exposed to fluctuations in
interest rates. We address this risk by using interest rate swaps from time to
time. At December 31, 2001 there were no interest rate swaps outstanding. In
March 2002, we entered into two fixed-to-floating interest rate swaps with an
aggregate notional amount of $100 million in connection with the sale of our
Senior Notes, as discussed in Note H. Variable rate debt and fixed-to-floating
interest rate swaps subject us to cash flow exposure resulting from changing
interest rates, as illustrated in the table below.

Presented below is an analysis of our financial instruments as of September 30,
2002 that are sensitive to changes in interest rates. The table demonstrates the
change in cash flow related to the Senior Notes, as affected by the related
fixed-to-floating interest rate swaps, and the outstanding balance under the
Revolving Credit Facility, calculated for an instantaneous parallel shift in
interest rates, plus or minus 50 basis points ("BPS"), 100 BPS, and 150 BPS.



Annual Interest Expense Given an No Change Annual Interest Expense Given an
Interest Rate Decrease of X Basis in Interest Interest Rate Increase of X Basis
Cash Flow Risk Points Rates Points
- -------------------------------- --------------------------------- ----------- ---------------------------------
(in thousands) (150 BPS) (100 BPS) (50 BPS) Fair Value 50 BPS 100 BPS 150 BPS


Senior Notes (as affected by
related interest-rate swaps) $ 15,548 $ 16,048 $ 16,548 $ 17,048 $ 17,548 $ 18,048 $ 18,548
Revolving Credit Facility $ 988 $ 1,118 $ 1,248 $ 1,378 $ 1,508 $ 1,638 $ 1,768
--------------------------------------------------------------------------------------
$ 16,536 $ 17,166 $ 17,796 $ 18,426 $ 19,056 $ 19,686 $ 20,316
======================================================================================




35


ITEM 4. Controls and Procedures

Based upon an evaluation within the 90 days prior to the filing date of this
report, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's internal controls
subsequent to the date of the evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.









36


PART II OTHER INFORMATION

ITEM 6. Exhibits and Reports on Form 8-K

Exhibits and Reports on Form 8-K

(a) Exhibits. The following exhibits are filed herewith:

Exhibit No. Document

99.1 Written Statement of the Chief Executive Officer
Pursuant to 18 U.S.C.ss.1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002

99.2 Written Statement of the Chief Financial Officer
Pursuant to 18 U.S.C. ss.1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Forms 8-K. Current Report on Form 8-K dated August 22, 2002,
providing the disclosures required by paragraph 61
of Statement of Financial Accounting Standards No.
142--"Goodwill And Other Intangible Assets".


37


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 ORTHOPEDIC GROUP, INC.



Dated: November 13, 2002 /s/ Ivan R. Sabel
--------------------------------------
Ivan R. Sabel, CPO
Chairman and Chief Executive Officer
(Principal Executive Officer)


Dated: November 13, 2002 /s/ George E. McHenry
---------------------------------------
George E. McHenry
Chief Financial Officer
(Principal Financial Officer)



Dated: November 13, 2002 /s/ Glenn M. Lohrmann
---------------------------------------
Glenn M. Lohrmann
Controller
(Chief Accounting Officer)


38

CERTIFICATIONS

I, Ivan R. Sabel, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Hanger Orthopedic
Group, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 13, 2002 /s/ Ivan R. Sabel
-------------------------------------
Ivan R. Sabel, CPO
Chairman and Chief Executive Officer


39

I, George E. McHenry, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Hanger Orthopedic
Group, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 13, 2002 /s/ George E. McHenry
------------------------------
George E. McHenry
Chief Financial Officer

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