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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

Commission file number   1-10670

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

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

Securities registered pursuant to Section 12(b) of the Act:   Common Stock, par value $0.01 per share

Securities registered pursuant to Section 12(g) of the Act:   None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

        The aggregate market value of the registrant’s Common Stock, par value $0.01 per share, held as of June 30, 2003 by non-affiliates of the registrant was $236,309,325 based on the $11.45 closing sale price per share of the Common Stock on the New York Stock Exchange on such date.

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2):

        As of March 10, 2004, the registrant had 21,211,526 shares of its Common Stock issued and outstanding.

        Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [   ]

DOCUMENTS INCORPORATED BY REFERENCE

        The information called for by Part III of the Form 10-K is incorporated by reference from the registrant's definitive proxy statement or amendment hereto which will be filed not later than 120 days after the end of the fiscal year covered by this report.

ITEM 1.   BUSINESS.

Business Overview

        We are the largest owner and operator of orthotic and prosthetic (“O&P”) patient-care centers in the United States. In our orthotics business, we design, fabricate, fit and maintain a wide range of standard and custom-made braces and other devices (such as spinal, knee and sports-medicine braces) that provide external support to patients suffering from musculoskeletal disorders, such as ailments of the back, extremities or joints and injuries from sports or other activities. In our prosthetics business, we design, fabricate, fit and maintain custom-made artificial limbs for patients who are without limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders. O&P devices are increasingly technologically advanced and are custom-designed to add functionality and comfort to patients’ lives, shorten the rehabilitation process and lower the cost of rehabilitation. We are also a leading distributor of branded and private label O&P devices and components in the United States, all of which are manufactured by third parties.

        At December 31, 2003, we operated 585 O&P patient-care centers (“patient-care centers”) in 44 states and the District of Columbia and employed 955 revenue-generating O&P practitioners (“practitioners”). Patients are referred to our local patient-care centers directly by physicians as a result of our relationships with them or through our agreements with managed care providers. Practitioners, technicians and office administrators staff our patient-care centers. Our practitioners generally design and fit patients with, and the technicians fabricate, O&P devices as prescribed by the referring physician. Following the initial design, fabrication and fitting of our O&P devices, our technicians conduct regular, periodic maintenance of O&P devices as needed. Our practitioners are also responsible for managing and operating our patient-care centers and are compensated, in part, based on their success in managing costs and collecting accounts receivable. We provide centralized administrative, marketing and materials management services to take advantage of economies of scale and to increase the time practitioners have to provide patient care. In areas where we have multiple patient-care centers, we also utilize shared fabrication facilities where technicians fabricate devices for practitioners in that area.

        We have increased our net sales through acquisitions, by opening new patient-care centers and through same-center net sales growth, the latter being achieved primarily through physician referral marketing initiatives. We strive to improve our local market position to enhance operating efficiencies and generate economies of scale. We generally acquire small and medium-sized O&P patient-care businesses and open new patient-care centers to achieve greater density in our existing markets.

        We acquired NovaCare Orthotics and Prosthetics, Inc. (“NovaCare O&P”) in July 1999, which at that time more than doubled our number of patient-care centers and practitioners and made us the largest operator of patient-care centers in the United States. Our acquisition of NovaCare O&P also significantly expanded our presence in the western United States and allowed us to achieve a greater density of operations in the eastern United States.

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Industry Overview

        We estimate the O&P patient-care market in the United States represented approximately $2.2 billion in revenues in 2003, of which we accounted for approximately 23.3%. The O&P patient-care services market is highly fragmented and is characterized by local, independent O&P businesses, with the majority generally having annual revenues of less than $1.0 million and a single facility. According to the most recent American Orthotic and Prosthetic Association study, which was conducted in 1999, there are an estimated 3,300 certified prosthestists and/or orthotists and approximately 2,850 O&P patient-care centers in the United States. We do not believe that any of our competitors account for a market share of more than 2.0% of the country’s total estimated O&P patient-care services revenue.

        The care of O&P patients is part of a continuum of rehabilitation services including diagnosis, treatment and prevention of future injury. This continuum involves the integration of several medical disciplines that begins with the attending physician’s diagnosis. A patient’s course of treatment is generally determined by an orthopedic surgeon, vascular surgeon or physiatrist, who writes a prescription and refers the patient to an O&P patient-care services provider for treatment. A practitioner then, using the prescription, consults with both the referring physician and the patient to formulate the design of an orthotic or prosthetic device to meet the patient’s needs.

        The O&P industry is characterized by stable, recurring revenues, primarily resulting from the need for periodic replacement and modification of O&P devices. Based on our experience, the average replacement time for orthotic devices is one to three years, while the average replacement time for prosthetic devices is three to five years. There is also an attendant need for continuing O&P patient-care services. In addition to the inherent need for periodic replacement and modification of O&P devices and continuing care, we expect the demand for O&P services will continue to grow as a result of several key trends, including:

        Aging U.S. Population. The growth rate of the over-65 age group is nearly triple that of the under-65 age group. There is a direct correlation between age and the onset of diabetes and vascular disease, which is the leading cause of amputations. With broader medical insurance coverage, increasing disposable income, longer life expectancy, greater mobility expectations and improved technology of O&P devices, we believe the elderly will seek orthopedic rehabilitation services and products more often.

        Growing Physical Health Consciousness. The emphasis on physical fitness, leisure sports and conditioning, such as running and aerobics is growing, which has led to increased injuries requiring orthopedic rehabilitative services and products. These trends are evidenced by the increasing demand for new devices that provide support for injuries, prevent further or new injuries or enhance physical performance.

        Increased Efforts to Reduce Healthcare Costs. O&P services and devices have enabled patients to become ambulatory more quickly after receiving medical treatment in the hospital. We believe that significant cost savings can be achieved through the early use of O&P services and products. The provision of O&P services and products in many cases reduces the need for more expensive treatments, thus representing a cost savings to third-party payors.

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        Advancing Technology. The range and effectiveness of treatment options for patients requiring O&P services have increased in connection with the technological sophistication of O&P devices. Advances in design technology and lighter, stronger and more cosmetically acceptable materials have enabled patients to replace older O&P devices with new O&P products that provide greater comfort, protection and patient acceptability. As a result, treatment can be more effective or of shorter duration, giving the patient greater mobility and a more active lifestyle. Advancing technology has also increased the prevalence and visibility of O&P devices in many sports, including skiing, running and tennis.

Competitive Strengths

        The combination of the following competitive strengths will enable us to continue to increase our net sales, net income and market share:

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Business Strategy

        Our goal is to continue to provide superior patient care and to be the most cost-efficient, full service, national O&P operator. The key elements of our strategy to achieve this goal are to:

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Business Description

Patient-Care Services

        As of December 31, 2003, we provided O&P patient care services through 585 patient-care centers and 955 practitioners in 44 states and the District of Columbia. Substantially all of our practitioners are certified, or candidates for formal certification, by the O&P industry certifying boards. One or more practitioners closely supervise each of our patient-care centers. Our patient-care centers also employ highly trained technical personnel who assist in the provision of services to patients and who fabricate various O&P devices, as well as office administrators who schedule patient visits, obtain approvals from payors and bill and collect for services rendered.

        An attending physician determines a patient’s treatment, writes a prescription and refers the patient to one of our patient-care centers. Our practitioners then consult with both the referring physician and the patient with a view toward assisting in the formulation of the prescription for, and design of, an orthotic or prosthetic device to meet the patient’s need.

        The fitting process involves several stages in order to successfully achieve desired functional and cosmetic results. The practitioner creates a cast and takes detailed measurements of the patient to ensure an anatomically correct fit. Prosthetic devices are custom fabricated by technicians and fit by skilled practitioners. The majority of the orthotic devices provided by us are custom designed, fabricated and fit and the balance is prefabricated but custom fit.

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        Custom devices are fabricated by our skilled technicians using the plaster castings, measurements and designs made by our practitioners. The Company has recently developed and begun rolling out the Insignia system, which replaces plaster casting of a patient’s residual limb with the generation of a computer scanned image. Insignia provides a very accurate image, faster turnaround for the patient, and a more professional overall experience. Technicians use advanced materials and technologies to fabricate a custom device under quality assurance guidelines. Custom designed devices that cannot be fabricated at the patient-care centers are fabricated at one of several central fabrication facilities. After final adjustments to the device by the practitioner, the patient is instructed in the use, care and maintenance of the device. A program or scheduled follow-up and maintenance visits are used to provide post-fitting treatment, including adjustments or replacements as the patient’s physical condition and lifestyle change.

        To provide timely service to our patients, we employ technical personnel and maintain laboratories at many of our patient-care centers. We have earned a strong reputation within the O&P industry for the development and use of innovative technology in our products, which has increased patient comfort and capability, and can significantly shorten the rehabilitation process. The quality of our products and the success of our technological advances have generated broad media coverage, enhancing our brand equity among payors, patients, and referring physicians.

        We offer technologically advanced O&P products, including: (i) the Otto Bock C-Leg^TM, an advanced computerized prosthetic knee system that allows patients to walk and to ascend or descend stairs with a normal stride; (ii) Comfort-Flex^TM sockets, which are flexible sockets that are more comfortable for patients to wear; and (iii) a myo-electric upper extremity prosthesis, which is a neuromuscular-activated prosthesis.

        A substantial portion of our O&P services involves treatment of a patient in a non-hospital setting, such as our patient-care centers, a physician’s office, an out-patient clinic or other facility. In addition, O&P services are increasingly rendered to patients in hospitals, nursing homes, rehabilitation centers and other alternate-site healthcare facilities. In a hospital setting, the practitioner works with a physician to provide either orthotic devices or temporary prosthetic devices that are later replaced by permanent prosthetic devices.

Patient-Care Center Administration

        We provide all senior management, accounting, accounts payable, payroll, sales and marketing, management information systems, real estate, acquisitions and human resources services for our patient-care centers on either a centralized or out-sourced basis. As a result, we are able to provide these services more efficiently and cost-effectively than if these services had to be generated at each patient-care center. Moreover, the centralization or out-sourcing of these services permits our revenue-generating practitioners to allocate a greater portion of their time to patient-care activities by reducing their administrative responsibilities. Each individual patient-care center is responsible for its own billing and collections of accounts receivable, which is monitored centrally. On a case-by-case basis, we assume responsibility for collecting past due receivables, either by pursuing collections ourselves or outsourcing collections to a third-party.

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        We also develop and implement programs designed to enhance the efficiency of our patient-care centers. These programs include: (i) sales and marketing initiatives to attract new-patient referrals by establishing relationships with physicians, therapists, employers, managed care organizations, hospitals, rehabilitation centers, out-patient clinics and insurance companies; (ii) professional management and information systems to improve efficiencies of administrative and operational functions; (iii) professional education programs for practitioners emphasizing new developments in the increasingly sophisticated field of O&P clinical therapy; (iv) the establishment of shared fabrication and centralized purchasing activities, which provides access to component parts and products within two business days at prices that are typically lower than traditional procurement methods; (v) the accumulation of vendor pricing data and Company-wide distribution of a vendor pricing analysis; and (vi) access to expensive, state-of-the-art equipment that is financially more difficult for smaller, independent businesses to obtain.

Distribution Services

        We distribute O&P components to the O&P market as a whole and to our own patient-care centers through our wholly-owned subsidiary, Southern Prosthetic Supply, Inc. (“SPS”), which is one of the nation’s leading O&P distributors. For the year ended December 31, 2003, 36.7% or approximately $35.3 million of SPS’ distribution sales were to third-party O&P services providers, and the balance of approximately $60.8 million represented intercompany sales to our patient-care centers. SPS inventories approximately 15,000 items, all of which are manufactured by other companies. SPS maintains distribution facilities in California, Georgia, and Texas, which allows us to deliver products via ground shipment to anywhere in the United States within two business days.

        Our distribution business enables us to:

        This is accomplished at competitive prices as a result of our direct purchases from manufacturers.

        Marketing of our distribution services is conducted on a national basis through a dedicated sales force, catalogues and exhibits at industry and medical meetings and conventions. We direct specialized catalogues to segments of the healthcare industry, such as orthopedic surgeons and physical and occupational therapists. We own certain patents and trademarks relating to our O&P products and services. Among them is the Comfort-Flex^TM Socket, which is a patented design that presently is only available at our patient-care centers. A socket is the connecting point between a prosthetic device and the body of the patient. The Comfort-Flex^TM Socket is a highly contoured flexible socket which has revolutionized both above-knee and below-knee prosthetic devices. It features anatomically designed channels to accommodate various muscle, bone, tendon, vascular and nerve areas. This unique approach to socket design is generally accepted as superior to previous socket systems. We also hold exclusive rights to the Charleston Bending Brace^TM, a custom-designed and fitted brace used to correct spinal curvatures in young children.

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Satellite Patient-Care Center Development

        In addition to growth generated by our acquisition of patient-care centers, we have historically developed new satellite patient-care centers in existing markets with underserved demand for O&P services. These satellite patient-care centers require less capital to develop than complete patient-care centers because the satellite patient-care centers usually consist of only a waiting room and patient fitting rooms, but without a fabrication laboratory for creating O&P devices. A practitioner will spend one or two days each week in a satellite patient-care center treating patients from that area.

        These newly developed satellite patient-care centers also tend to receive new patient referrals from nearby hospitals and physicians. While a partial revenue shift occurs from the practitioner’s main patient-care center to the satellite patient-care center because the practitioner is now seeing some of the same patients out of a new satellite patient-care center, the additional patient volume in the satellite patient-care center increases the practitioner’s overall revenue. If demand for O&P services at a satellite patient-care center increases beyond the ability of the practitioner to service it one or two days a week, we will staff the satellite office on a full-time basis.

Sources of Payment

        The principal reimbursement sources for our O&P services are:

        We estimate that Medicare, Medicaid and the U.S. Veterans Administration, in the aggregate, accounted for approximately 44.8%, 43.9%, and 40.5% of our net sales in 2003, 2002 and 2001, respectively. These payors have set maximum reimbursement levels for O&P services and products. In November 2003, Congress enacted legislation that freezes reimbursement levels from Medicare for all O&P services at current levels for all of calendar 2004, 2005, and 2006. The healthcare policies and programs of these agencies have been subject to changes in payment methodologies during the past several years. There can be no assurance that future changes will not reduce reimbursements for O&P services and products from these sources.

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        We provide O&P services and products to eligible veterans pursuant to several contracts with the U.S. Veterans Administration. The U.S. Veterans Administration establishes its reimbursement rates for itemized services and products on a competitive bidding basis. The contracts, awarded on a non-exclusive basis, establish the amount of reimbursement to the eligible veteran if the veteran should choose to use our services and products. We have been awarded U.S. Veterans Administration contracts in the past and expect that we will obtain additional contracts when our present agreements expire. Net sales from our contracts with the U.S. Veterans Administration represent less than 5% of total net sales.

        In addition to referrals from physicians, we enter into contracts with third-party payors that allow us to perform O&P services for a referred patient and be paid under the contract with the third-party payor. These contracts typically have a stated term of one year and automatically renew annually. These contracts generally may be terminated without cause by either party on 60 to 90 days’ notice or on 30 days’ notice if we have not complied with certain licensing, certification, program standards, Medicare or Medicaid requirements or other regulatory requirements. Reimbursement for services is typically based on a fee schedule negotiated with the third-party payor that reflects various factors, including geographic area and number of persons covered.

Suppliers

        We purchase prefabricated O&P devices, components and materials that our technicians use to fabricate O&P products from approximately 2,640 suppliers across the country. These devices, components and materials are used in the products we offer in our patient-care centers throughout the country. Currently, only three of our third-party suppliers account for more than 5% of our total patient care purchases.

Sales and Marketing

        The individual practitioners in the local patient-care centers historically have conducted our sales and marketing efforts. Due primarily to the fragmented nature of the O&P industry, the success of a particular patient-care center has been largely a function of its local reputation for quality of care, responsiveness and length of service in the local communities. Individual practitioners have relied almost exclusively on referrals from local physicians or physical therapists and typically are not involved in more advanced marketing techniques.

        We have developed a centralized marketing department whose goal is to remove the majority of the sales and marketing responsibilities from the individual practitioner, enabling the practitioner to focus his or her efforts on patient care. Our marketing department targets the following:

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Acquisitions

        In 2003, we continued with our acquisitions, acquiring five additional O&P companies operating a total of 19 patient-care centers located in California, Virginia, Washington and Texas. The aggregate purchase price paid by us for the 2003 acquisitions, excluding potential earn-out provisions, was $14.9 million. During 2002, we acquired two O&P companies that had a total of seven patient-care centers located in Maryland, Ohio, and Pennsylvania, for a total of $6.1 million, excluding potential earn-out provisions.

Competition

        The O&P services industry is highly fragmented, consisting mainly of local O&P patient-care centers. The business of providing O&P patient-care services is highly competitive in the markets in which we operate. We compete with independent O&P businesses for referrals from physicians, therapists, employers, HMOs, PPOs, hospitals, rehabilitation centers, out-patient clinics and insurance companies on both a local and regional basis. We believe that we compete with other patient-care service providers on the basis of quality and timeliness of patient care and location of patient-care centers, and, to a lesser degree, charges for services.

        We also compete for the retention and recruitment of qualified practitioners. In certain markets, the demand for practitioners exceeds the supply of qualified personnel. If the availability of these practitioners begins to decline in our markets it may be more difficult for us to attract qualified practitioners to staff our patient-care centers or to expand our operations.

Special Note On Forward-Looking Statements

        Some of the statements contained in this report discuss our plans and strategies for our business or make other forward-looking statements, as this term is defined in the Private Securities Litigation Reform Act. The words “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends” and similar expressions are intended to identify these forward-looking statements, but are not the exclusive means of identifying them. These forward-looking statements reflect the current views of our management; however, various risks, uncertainties and contingencies could cause our actual results, performance or achievements to differ materially from those expressed in, or implied by, these statements, including the following:

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        For a discussion of important risks of an investment in our securities, including factors that could cause actual results to differ materially from results referred to in the forward-looking statements, see “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below. We do not have any obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Risk Factors

We incurred net losses in the fourth quarter of 2003 and for the years ended December 31, 2001 and 2000, and could incur net losses in the future.

Following the NovaCare O&P acquisition, we incurred net losses of $14.0 million and $8.9 million for the years ended December 31, 2000 and 2001, respectively. For the years ended December 31, 2002 and 2003, however, we generated net income of $23.6 million and $16.2 million, respectively. We incurred a net loss in the fourth quarter of 2003, principally due to the loss on the purchase of our Senior Subordinated Notes and the premium paid and resulting loss on the repurchase of our Redeemable Convertible Preferred Stock. We cannot assure that we will not incur net losses in the future.

Changes in government reimbursement levels could adversely affect our net sales, cash flows and profitability.

We derived 44.8%, 43.9%, and 40.5% of our net sales for the years ended December 31, 2003, 2002 and 2001, respectively, from reimbursements for O&P services and products from programs administered by Medicare, Medicaid and the U.S. Veterans Administration. Each of these programs sets maximum reimbursement levels for O&P services and products. If these agencies reduce reimbursement levels for O&P services and products in the future, our net sales could substantially decline. In addition, the percentage of our net sales derived from these sources may increase as the portion of the U.S. population over age 65 continues to grow, making us more vulnerable to maximum reimbursement level reductions by these organizations. Reduced government reimbursement levels could result in reduced private payor reimbursement levels because fee schedules of certain third-party payors are indexed to Medicare. Furthermore, the healthcare industry is experiencing a trend towards cost containment as government and other third-party payors seek to impose lower reimbursement rates and negotiate reduced contract rates with service providers. This trend could adversely affect our net sales. Medicare provides for reimbursement for O&P products and services based on prices set forth in fee schedules for ten regional service areas. Additionally, if the U.S. Congress were to legislate modifications to the Medicare fee schedules, our net sales from Medicare and other payors could be adversely and materially affected. We cannot predict whether any such modifications to the fee schedules will be enacted or what the final form of any modifications might be. See previous discussion under “Sources of Payment” and later discussion under “Government Regulation.” In November 2003 Congress legislated a three-year freeze on Medicare reimbursement levels beginning January 1, 2004 on all O&P services.

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If we cannot collect our accounts receivable and effectively manage our inventory, our business, results of operations, financial condition and ability to satisfy our obligations under our indebtedness could be adversely affected.

As of December 31, 2003 and 2002, our accounts receivable over 120 days represented approximately 19.2% and 25.0% of total accounts receivable outstanding in each period, respectively. If we cannot collect our accounts receivable, our business, results of operations, financial condition and ability to satisfy our obligations under our indebtedness could be adversely affected. In addition, our principal means of control with respect to accounting for inventory and costs of goods sold is a physical inventory conducted on an annual basis. This accepted method of accounting controls and procedures may result in an understatement or overstatement, as the case may be, of inventory between our annual physical inventories. In conjunction with our physical inventory performed on October 1, 2003 and 2002, we recorded a $1.0 million decrease and a $0.2 million increase in inventory, respectively. Because our gross profit percentage is based on our inventory levels, adjustments to inventory during interim periods following our physical inventory could adversely affect our results of operations and financial condition.

If we are unable to effectively implement our new billing system, O/P/S, it could affect our ability to properly generate bills for our services and our ability to collect our accounts receivable.

During 2003 and 2002, we incurred substantial costs in the development and testing of our new billing system, O/P/S. We will implement O/P/S across substantially all of our patient-care centers by the end of the second quarter of 2004. There are no guarantees that O/P/S will work as designed or as intended. If we are unable to effectively implement O/P/S, it could have a material adverse effect on our ability to properly generate bills for our services and our ability to collect our accounts receivable.

If we are unable to maintain good relations with our suppliers, our existing purchasing discounts may be jeopardized, which could adversely affect our net sales.

We currently enjoy significant purchasing discounts with most of our suppliers, and our ability to sustain our gross margins has been, and will continue to be, dependent, in part, on our ability to continue to obtain favorable discount terms from our suppliers. These terms may be subject to changes in suppliers’ strategies, from time to time, which could adversely affect our gross margins over time. The profitability of our business depends, in part, upon our ability to maintain good relations with these suppliers.

We depend on the continued employment of our orthotists and prosthetists who work at our patient-care centers and their relationships with referral sources and patients. Our ability to provide O&P services at our patient-care centers would be impaired and our net sales reduced if we were unable to maintain these employment and referral relationships.

Our net sales would be reduced if a significant number of our practitioners leave us. In addition, any failure of these practitioners to maintain the quality of care provided or to otherwise adhere to certain general operating procedures at our facilities or any damage to the reputation of a significant number of our practitioners could damage our reputation, subject us to liability and significantly reduce our net sales. A substantial amount of our business is derived from patient referrals by orthopedic surgeons and other healthcare providers. If the quality of our services and products declines in the opinion of these sources, the number of their patient referrals may decrease, which would adversely affect our net sales.

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If the non-competition agreements we have with our key executive officers and key practitioners were found by a court to be unenforceable, we could experience increased competition resulting in a decrease in our net sales.

We generally enter into employment agreements with our executive officers and a significant number of our practitioners which contain non-compete and other provisions. The laws of each state differ concerning the enforceability of non-competition agreements. State courts will examine all of the facts and circumstances at the time a party seeks to enforce a non-compete covenant. We cannot predict with certainty whether or not a court will enforce a non-compete covenant in any given situation based on the facts and circumstances at that time. If one of our key executive officers and/or a significant number of our practitioners were to leave us and the courts refused to enforce the non-compete covenant, we might be subject to increased competition, which could materially and adversely affect our business, financial condition and results of operations.

We face periodic reviews, audits and investigations under our contracts with federal and state government agencies, and these audits could have adverse findings that may negatively impact our business.

We contract with various federal and state governmental agencies to provide O&P services. Pursuant to these contracts, we are subject to various governmental reviews, audits and investigations to verify our compliance with the contracts and applicable laws and regulations. Any adverse review, audit or investigation could result in:

We may be unable to successfully integrate and operate other O&P businesses that we acquire in the future.

Part of our business strategy involves the acquisition and integration of small and medium-sized O&P businesses. We may not be able to successfully consummate and/or integrate future acquisitions. We continuously review acquisition prospects that would complement our existing operations, increase our size and allow us to expand into under-served geographic areas or otherwise offer growth opportunities. The financing for these acquisitions could significantly dilute our investors or result in an increase in our indebtedness. We may acquire or make investments in businesses or products in the future. Acquisitions may entail numerous integration risks and impose costs on us, including:

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Our failure to successfully complete the integration of future acquisitions could have a material adverse effect on our results of operations, business and financial condition.

Government Regulation

        We are subject to a variety of federal, state and local governmental regulations. We make every effort to comply with all applicable regulations through compliance programs, manuals and personnel training. Despite these efforts, we cannot guarantee that we will be in absolute compliance with all regulations at all times. Failure to comply with applicable governmental regulations may result in significant penalties, including exclusion from the Medicare and Medicaid programs, which could have a material adverse effect on our business. In November 2003 Congress legislated a three-year freeze on reimbursement levels for all O&P services starting January 1, 2004.

        Medical Device Regulation. We distribute products that are subject to regulation as medical devices by the U.S. Food and Drug Administration (“FDA”) under the Federal Food, Drug and Cosmetic Act and accompanying regulations. We believe that the products we distribute, including O&P devices, accessories and components, are exempt from the FDA’s regulations for pre-market clearance of approval requirements and from requirements relating to quality system regulation (except for certain recordkeeping and complaint handling requirements). We are required to adhere to regulations regarding adverse event reporting, and are subject to inspection by the FDA for compliance with all applicable requirements. Labeling and promotional materials also are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Although we have never been challenged by the FDA for non-compliance with FDA requirements, we cannot assure that we would be found to be or to have been in compliance at all times. Non-compliance could result in a variety of civil and/or criminal enforcement actions, which could have a material adverse effect on our business and results or operations.

        Fraud and Abuse. Violations of fraud and abuse laws are punishable by criminal and/or civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal healthcare programs, including Medicare, Medicaid, U.S. Veterans Administration health programs and the Department of Defense’s TRICARE program, formerly known as CHAMPUS. These laws, which include but are not limited to, antikickback laws, false claims laws, physician self-referral laws, and federal criminal healthcare fraud laws, are discussed in further detail below. We believe our billing practices, operations, and compensation and financial arrangements with referral sources and others materially comply with applicable federal and state requirements. However, we cannot assure that such requirements will not be interpreted by a governmental authority in a manner inconsistent with our interpretation and application. The failure to comply, even if inadvertent, with any of these requirements could require us to alter our operations and/or refund payments to the government. Such refunds could be significant and could also lead to the imposition of significant penalties. Even if we successfully defend against any action against us for violation of these laws or regulations, we would likely be forced to incur significant legal expenses and divert our management’s attention from the operation of our business. Any of these actions, individually or in the aggregate, could have a material adverse effect on our business and financial results.

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        Antikickback Laws. Our operations are subject to federal and state antikickback laws. The federal Antikickback Statute (Section 1128B(b) of the Social Security Act) prohibits persons or entities from knowingly and willfully soliciting, offering, receiving, or paying any remuneration in return for, or to induce, the referral of persons eligible for benefits under a federal healthcare program (including Medicare, Medicaid, the U.S. Veterans Administration health programs and TRICARE), or the ordering, purchasing, leasing, or arranging for, or the recommendation of purchasing, leasing or ordering of, items or services that may be paid for, in whole or in part, by a federal healthcare program. Some courts have held that the statute may be violated when even one purpose (as opposed to a primary or sole purpose) of a payment is to induce referrals or other business.

        Recognizing that the law is broad and may technically prohibit beneficial arrangements, the Office of Inspector General of the Department of Health and Human Services developed regulations addressing a small number of business arrangements that will not be subject to scrutiny under the law. These “Safe Harbors” describe activities that may technically violate the act, but which are not considered to be illegal provided that they meet all the requirements of the applicable Safe Harbor. For example, the Safe Harbors cover activities such as offering discounts to healthcare providers and contracting with physicians or other individuals or entities that have the potential to refer business to us that would ultimately be billed to a federal healthcare program. Failure to qualify for Safe Harbor protection does not mean that an arrangement is illegal. Rather, the arrangement must be analyzed under the antikickback statute to determine whether there is an intent to pay or receive remuneration in return for referrals. Conduct and business arrangements that do not fully satisfy one of the Safe Harbors may result in increased scrutiny by government enforcement authorities. In addition, some states also have antikickback laws that vary in scope and may apply regardless of whether a federal healthcare program is involved.

        Our operations and business arrangements include, for example, discount programs for individuals or entities that purchase our products and services and financial relationships with potential and actual purchasers and referral sources, such as lease arrangements with hospitals and certain participation agreements. Therefore, our operations and business arrangements are required to comply with the antikickback laws. Although our business arrangements and operations may not always satisfy all the criteria of a Safe Harbor, we believe that our operations are in material compliance with federal and state antikickback statutes.

        HIPAA Violations. The Health Insurance Portability and Accountability Act (“HIPAA”) provides for criminal penalties for, among other offenses, healthcare fraud, theft or embezzlement in connection with healthcare, false statements related to healthcare matters, and obstruction of criminal investigation of healthcare offenses. Unlike the federal antikickback laws, these offenses are not limited to federal healthcare programs.

        In addition, HIPAA authorizes the imposition of civil monetary penalties where a person offers or pays remuneration to any individual eligible for benefits under a federal healthcare program that such person knows or should know is likely to influence the individual to order or receive covered items or services from a particular provider, practitioner or supplier. Excluded from the definition of “remuneration” are incentives given to individuals to promote the delivery of preventive care (excluding cash or cash equivalents), incentives of nominal value and certain differentials in or waivers of coinsurance and deductible amounts.

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        These laws may apply to certain of our operations. As noted above, we have established various types of discount programs or compensation or other financial arrangements with individuals and entities who purchase our products and services and/or refer patients to our patient-care centers. We also bill third-party payors and other entities for items and services provided at our patient-care centers. While we endeavor to ensure that our discount programs, compensation and other financial arrangements, and billing practices comply with applicable laws, such programs, arrangements and billing practices could be subject to scrutiny and challenge under HIPAA.

        False Claims Laws. We are also subject to federal and state laws prohibiting individuals or entities from knowingly presenting, or causing to be presented, claims for payment to third-party payors (including Medicare and Medicaid) that are false or fraudulent, are for items or services not provided as claimed, or otherwise contain misleading information. Each of our patient-care centers is responsible for preparation and submission of reimbursement claims to third-party payors for items and services furnished to patients. In addition, our personnel may, in some instances, provide advice on billing and reimbursement to purchasers of our products. While we endeavor to assure that our billing practices comply with applicable laws, if claims submitted to payors are deemed to be false, fraudulent, or for items or services not provided as claimed, we could face liability for presenting or causing to be presented such claims.

        Physician Self-Referral Laws. We are also subject to federal and state physician self-referral laws. With certain exceptions, the federal Medicare/Medicaid physician self-referral law (the “Stark II” law) (Section 1877 of the Social Security Act) prohibits a physician from referring Medicare and Medicaid beneficiaries to an entity for “designated health services” – including prosthetic and orthotic devices and supplies – if the physician or the physician’s immediate family member has a financial relationship with the entity. A financial relationship includes both ownership or investment interests and compensation arrangements. A violation occurs when any person presents or causes to be presented to the Medicare or Medicaid program a claim for payment in violation of Stark II.

        With respect to ownership/investment interests, there is an exception under Stark II for referrals made to a publicly traded entity in which the physician has an investment interest if the entity’s shares are traded on certain exchanges, including the New York Stock Exchange, and had shareholders’ equity exceeding $75.0 million for its most recent fiscal year, or as an average during the three previous fiscal years. We meet these tests and, therefore, believe that referrals from physicians that have ownership interests in our business should not trigger liability under Stark II.

        With respect to compensation arrangements, there are exceptions under Stark II that permit physicians to maintain certain business arrangements, such as personal service contracts and equipment or space leases, with healthcare entities to which they refer. We believe that our compensation arrangements comply with Stark II, either because the physician’s relationship fits within a regulatory exception or does not generate prohibited referrals. Because we have financial arrangements with physicians and possibly their immediate family members, and because we may not be aware of all those financial arrangements, we must rely on physicians and their immediate family members to avoid making referrals to us in violation of Stark II or similar state laws. If, however, we receive a prohibited referral without knowing that the referral was prohibited, our submission of a bill for services rendered pursuant to a referral could subject us to sanctions under Stark II and applicable state laws.

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        Certification and Licensure. Most states do not require separate licensure for practitioners. However, several states currently require practitioners to be certified by an organization such as the American Board for Certification.

        The American Board for Certification conducts a certification program for practitioners and an accreditation program for patient-care centers. The minimum requirements for a certified practitioner are a college degree, completion of an accredited academic program, one to four years of residency at a patient-care center under the supervision of a certified practitioner and successful completion of certain examinations. Minimum requirements for an accredited patient-care center include the presence of a certified practitioner and specific plant and equipment requirements. While we endeavor to comply with all state licensure requirements, we cannot assure that we will be in compliance at all times with these requirements. Failure to comply with state licensure requirements could result in civil penalties, termination of our Medicare agreements, and repayment of amounts received from Medicare for services and supplies furnished by an unlicensed individual or entity.

        Confidentiality and Privacy Laws. The Administrative Simplification Provisions of HIPAA, and their implementing regulations, set forth privacy standards and implementation specifications concerning the use and disclosure of individually identifiable health information (referred to as “protected health information”) by health plans, healthcare clearinghouses and healthcare providers that transmit health information electronically in connection with certain standard transactions (“Covered Entities”). HIPAA further requires Covered Entities to protect the confidentiality of health information by meeting certain security standards and implementation specifications. In addition, under HIPAA, Covered Entities that electronically transmit certain administrative and financial transactions must utilize standardized formats and data elements (“the transactions/code sets standards”). HIPAA imposes civil monetary penalties for non-compliance, and, with respect to knowing violations of the privacy standards, or violations of such standards committed under false pretenses or with the intent to sell, transfer or use individually identifiable health information for commercial advantage, criminal penalties. The privacy standards and transactions/code sets standards went into effect on April 16, 2003 and we must comply with the security standards by April 21, 2005. We believe that we are subject to the Administrative Simplification Provisions of HIPAA and are taking steps to meet applicable standards and implementation specifications. The new requirements have had significant effect on the manner in which we handle health data and communicate with payors. Our new billing system, O/P/S, which is scheduled to be substantially integrated by the end of the second quarter of 2004, is designed to meet these requirements.

        In addition, state confidentiality and privacy laws may impose civil and/or criminal penalties for certain unauthorized or other uses or disclosures of individually identifiable health information. We are also subject to these laws. While we endeavor to assure that our operations comply with applicable laws governing the confidentiality and privacy of health information, we could face liability in the event of a use or disclosure of health information in violation of one or more of these laws.

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Personnel and Training

        None of our employees are subject to a collective-bargaining agreement. We believe that we have satisfactory relationships with our employees and strive to maintain these relationships by offering competitive benefit packages, training programs and opportunities for advancement. During the year ended December 31, 2003, we had an average of 3,007 employees. The following table summarizes our average number of employees for the year:

        We have established an affiliation with the University of Connecticut pursuant to which we own and operate a school at the Newington, Connecticut campus that offers a certificate in orthotics and/or prosthetics after the completion of a nine-month course. We believe there are only seven schools of this kind in the United States. The program director is a Hanger employee, and our practitioners teach most of the courses. After completion of the nine-month course, graduates receive a certificate and go on to complete a residency in their area of specialty. After their residency is complete, graduates can choose to complete a course of study in the other area of specialty. Most graduates will then sit for a certification exam to either become a certified prosthetist or certified orthotist. We offer exam preparation courses for graduates who agree to become our practitioners to help them prepare for those exams.

We also provide a series of ongoing training programs to improve the professional knowledge of our practitioners. For example, we have an annual Education Fair which is attended by over 800 of our practitioners and consists of lectures and seminars covering many clinical topics including the latest technology and process improvements, basic accounting and business courses and other courses which allow the practitioners to fulfill their ongoing continuing education requirements.

Insurance

We currently maintain insurance coverage for malpractice liability, product liability, workers’ compensation and property damage. Our general liability insurance coverage is $2.0 million per incident, with a $25.0 million umbrella insurance policy. Based on our experience and prevailing industry practices, we believe our coverage is adequate as to risks and amount. We have not incurred a material amount of expenses in the past as a result of uninsured O&P claims.

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Our Website

Our website is http://www.hanger.com. We make available free of charge, on or through our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and Section 16 filings (i.e. Forms 4 and 5) as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission (“SEC”). Our website also contains the charters of the Audit Committee, Corporate Governance and Nominating Committee and Compensation Committee of our board of directors; our Code of Business Conduct and Ethics for Directors and Employees, which includes our principal executive, financial and accounting officers; as well as our Corporate Governance Guidelines, as required by the Sarbanes-Oxley Act of 2002 and the rules of the New York Stock Exchange. Information contained on our website is not part of this report.

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ITEM 2.   PROPERTIES.

        As of December 31, 2003, we operated 585 patient-care centers and facilities in 44 states and the District of Columbia. Of these, 23 buildings that house a patient-care center are owned by us. We also own real estate in New York and Pennsylvania that currently are not in use. The remaining centers are occupied under leases expiring between the years of 2004 and 2017. We believe our leased or owned centers are adequate for carrying on our current O&P operations at our existing locations, as well as our anticipated future needs at those locations. We believe we will be able to renew such leases as they expire or find comparable or additional space on commercially suitable terms.

The following table sets forth the number of our patient-care centers located in each state:

We also own one distribution facility in Texas, and lease two distribution facilities in California and Georgia. We lease our corporate headquarters in Bethesda, Maryland. Substantially all of our properties are pledged to collateralize bank indebtedness. See Note H to our Consolidated Financial Statements.

ITEM 3.   LEGAL PROCEEDINGS.

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 alleged that the defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and through these material misrepresentations, artificially inflated the price of our common stock. The Class Action Lawsuit was initially dismissed by the District Court for failure to comply with statutory requirements but an appeal was subsequently filed by the plaintiff. On January 5, 2004, the United States Court of Appeals for the Fourth Circuit affirmed its dismissal of the class action lawsuit.

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ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

        No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of stockholders.

ITEM 4A.  EXECUTIVE OFFICERS OF THE REGISTRANT.

        The following table sets forth information regarding our current executive officers and certain of our subsidiaries:

        Ivan R. Sabel, CPO has been our Chairman of the Board of Directors and Chief Executive Officer since August 1995 and was our President from November 1987 to January 2002. Mr. Sabel also served as the Chief Operating Officer from November 1987 until August 1995. Prior to that time, Mr. Sabel had been Vice President, Corporate Development from September 1986 to November 1987. Mr. Sabel was the founder, owner and President of Capital Orthopedics, Inc. from 1968 until that company was acquired by us in 1986. Mr. Sabel is a Certified Prosthetist and Orthotist (“CPO”), a former clinical instructor in orthopedics at the Georgetown University Medical School in Washington, D.C., a member of the Government Relations Committee of the American Orthotic and Prosthetic Association (“AOPA”), a former Chairman of the National Commission for Health Certifying Agencies, a former member of the Strategic Planning Committee, a current member of the U.S. Veterans Administration Affairs Committee of AOPA and a former President of the American Board for Certification in Orthotics and Prosthetics. Mr. Sabel also serves on the Board of Directors of Mid-Atlantic Medical Services, Inc., a company engaged in the healthcare management services business, and a member of the Medical Advisory Board of DJ Orthopedics, Inc., a manufacturer of knee braces. Mr. Sabel has been a director since 1986.

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        Thomas F. Kirk has been our President and Chief Operating Officer since January 2002. From September 1998 to January 2002, Mr. Kirk was a principal with AlixPartners, LLC (formerly Jay Alix & Associates, Inc.), a management consulting company retained by Hanger to facilitate its reengineering process. From May 1997 to August 1998, Mr. Kirk served as Vice President, Planning, Development and Quality for FPL Group, a full service energy provider located in Florida. From April 1996 to April 1997, he served as Vice President and Chief Financial Officer for Quaker Chemical Corporation in Pennsylvania. From December 1987 to March 1996, he served as Senior Vice President and Chief Financial Officer for Rhone-Poulenc, S.A. in Princeton, New Jersey and Paris, France. From March 1977 to November 1988, he was employed by St. Joe Minerals Corp., a division of Fluor Corporation. Prior to this he held positions in sales, commercial development, and engineering with Koppers Co., Inc. Mr. Kirk holds a Ph.D. degree in strategic planning/marketing, and an M.B.A. degree in finance, from the University of Pittsburgh. He also holds a Bachelor of Science degree in mechanical engineering from Carnegie Mellon University. He is a registered professional engineer and a member of the Financial Executives Institute.

        Richmond L. Taylor is our Executive Vice President, and the President and Chief Operating Officer of Hanger Prosthetics & Orthotics, Inc. and HPO, Inc., our two wholly-owned subsidiaries which operate all of our patient-care centers. Previously, Mr. Taylor served as the Chief Operating Officer of NovaCare O&P from June 1996 until July 1999, and held the positions of Region Vice-President and Region President of NovaCare O&P for the West Region from 1989 to June 1996. Prior to joining NovaCare O&P, Mr. Taylor spent 20 years in the healthcare industry in a variety of management positions including Regional Manager at American Hospital Supply Corporation, Vice President of Operations at Medtech, Vice President of Sales at Foster Medical Corporation and Vice President of Sales at Integrated Medical Systems.

        George E. McHenry has been our Executive Vice President and Chief Financial Officer since October 2001. From 1987 until he joined us in October 2001, Mr. McHenry served as Executive Vice President, Chief Financial Officer and Secretary of U.S. Vision, Inc., an optical company with 600 locations in 47 states. Prior to joining U.S. Vision, Inc., he was employed principally as a Senior Manager by the firms of Touche Ross & Co. (now Deloitte & Touche) and Main Hurdman (now KPMG LLP) from 1974 to 1987. Mr. McHenry is a Certified Public Accountant and received a Bachelor of Science degree in accounting from St. Joseph’s University.

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        Ron N. May has been our President and Chief Operating Officer of Southern Prosthetic Supply, Inc., our wholly-owned subsidiary that distributes orthotic and prosthetic products, since December 1998. From January 1984 to December 1998, Mr. May was Executive Vice President of the distribution division of J.E. Hanger, Inc. of Georgia until that company was acquired by us in November 1996. Mr. May also currently serves as a Board Member of the O&P Athletic Fund.

        Glenn M. Lohrmann has been our Vice President, Secretary and Controller since July 2001, and is the Vice President and Secretary of each of Hanger Prosthetics & Orthotics, Inc., OPNET, Inc., Southern Prosthetic Supply, Inc. and HPO, Inc. From August 1985 to July 2001, Mr. Lohrmann served in senior financial positions with a large medical faculty practice, various teaching hospitals, an HMO, and the corporate office of Inova Health System. Mr. Lohrmann also worked for Ernst & Young from January 1978 to August 1985, including service at their National Health Care Office. Mr. Lohrmann is a Certified Public Accountant and holds a B.S. degree in Accounting and a M.B.A. degree from the University of Maryland.

        Jason P. Owen has been our Treasurer since August 2001. Previously, Mr. Owen served as our Vice President Strategic Planning from 2000 to 2001. Mr. Owen also served as our Director of Business Development from 1998 to 1999, during which time he was jointly responsible for our small to medium-sized acquisitions. Prior to joining us, Mr. Owen spent five years in the banking industry with GE Capital and SunTrust Bank, during which time he held positions responsible for portfolio management, origination, capital markets and treasury management services. Mr. Owen holds an M.B.A. degree in finance from Georgia State University. He also holds a Bachelor of Business Administration degree in finance from Georgia Southern University.

        Edward L. Mitzel has been our Vice President and Chief Information Officer since April 2002. Prior to joining Hanger, he was Director of Information Technology at Provident Mutual Financial Services and has held senior information technology positions with an international construction/marketing company and a long-term care development/management company. Mr. Mitzel holds a B.S. degree in Business Administration and a Masters degree in Economics from the University of Baltimore and a M.A.S. degree in Information Technology from Johns Hopkins University.

        Michael F. Murphy has been our Vice President, Marketing and Business Development since December 2002.  Prior to joining Hanger, he held senior healthplan operations leadership positions with CIGNA Healthcare and was Chief Marketing Officer for two leading ancillary managed care companies. Mr. Murphy holds a B.A. degree in History from Holy Cross College.

        Brian A. Wheeler has been our Vice President, Human Resources since November, 2002. Prior to joining Hanger, he was the Vice President of Human Resources for Rhodia Inc., a wholly-owned U.S. subsidiary of the French Specialty Chemicals Company. Mr. Wheeler holds a B.A. degree in Political Science from the University of Florida.

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PART II

        Our Common Stock has been listed and traded on the New York Stock Exchange since December 15, 1998, under the symbol “HGR.” The following table sets forth the high and low closing sale prices for the Common Stock for the periods indicated as reported on the New York Stock Exchange:

        At March 10, 2004, there were approximately 401 holders of record of our Common Stock.

Dividend Policy

        We have never paid cash dividends on our Common Stock and intend to continue this policy for the foreseeable future. We plan to retain earnings for use in our business. The terms of our agreements with our financing sources and certain other agreements prohibit the payment of dividends on our Common Stock and Preferred Stock and such agreements will continue to prohibit the payment of dividends in the future. Any future determination to pay cash dividends will be at the discretion of our Board of Directors and will be dependent on our results of operations, financial condition, contractual and legal restrictions and any other factors deemed to be relevant.

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Equity Compensation Plan

        The following table sets forth information as of December 31, 2003 regarding our equity compensation plans:

Unregistered Sales of Securities.

        During the years ended December 31, 2003, 2002 and 2001, we issued no securities without registration under the Securities Act of 1933 (“Securities Act”), except as set forth below.

        On February 15, 2002, we sold $200.0 million principal amount of 10 3/8% Senior Notes due 2009 (“Senior Notes”) to four institutional investors in connection with an offering of the Senior Notes to qualified institutional buyers in reliance on Rule 144A under the Securities Act and to other persons outside the U.S. in reliance on Regulation S under the Securities Act. Issuance of the Senior Notes to the four initial purchasers was exempt from registration under Section 4(2) of the Securities Act. The four initial purchasers were Lehman Brothers Inc., J. P. Morgan Securities Inc., Salomon Smith Barney Inc. and BNP Paribas Securities Corp. The Senior Notes were sold for cash to the initial purchasers at 97% of the principal amount thereof. The approximately $194.0 million net proceeds from the sale of the Senior Notes, along with approximately $36.9 million borrowed under our Revolving Credit Facility, were used to pay related fees and expenses and to retire the approximately $228.4 million outstanding indebtedness under our previously existing credit facility as of February 15, 2002.

        In connection with the aforementioned sale of the Senior Notes, we entered into a Registration Rights Agreement that required us to file with the SEC an Exchange Offering Registration Statement with respect to the Senior Notes within ninety days of closing the sale. 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 our Registration Statement on Form S-4 filed with the SEC. 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.

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On July 23, 2002, we agreed to repurchase 601,218 of the shares underlying the option issued to AlixPartners, LLC (formerly Jay Alix & Associates, Inc., “JA&A”) for a payment of $3.98 per share, or a total of $2.4 million, which was paid during the third quarter of 2002 and recorded as a reduction in additional paid-in capital. On July 23, 2002, our Common Stock opened for trading at $12.00 per share. In accordance with our agreement with JA&A, we 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 our stock that it may acquire upon exercise of the option. JA&A also agreed to permanently amend its contract with us so that the payment of future success fees, if any, would be made only in cash. We concluded our relationship with JA&A in 2002 without the payment of any additional success fees.

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ITEM 6.   SELECTED FINANCIAL DATA.

        The selected consolidated financial data presented below is derived from the audited Consolidated Financial Statements and Notes thereto.

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Balance Sheet Data:

Other Financial Data:

Overview

The following is a discussion of our results of operations and financial position for the periods described below. This discussion should be read in conjunction with the Consolidated Financial Statements included in this report. Our discussion of our results of operations and financial condition includes various forward-looking statements about our markets, the demand for our products and services and our future results. These statements are based on certain assumptions that we consider reasonable. Our actual results may differ materially from those indicated forward looking statements.

We are the largest operator and developer of orthotic and prosthetic (“O&P”) patient-care centers in the United States. Orthotics is the design, fabrication, fitting and device maintenance of custom-made braces and other devices (such as spinal, knee and sports-medicine braces) that provide external support to treat musculoskeletal disorders. Musculoskeletal disorders are ailments of the back, extremities or joints caused by traumatic injuries, chronic conditions, diseases, congenital disorders or injuries resulting from sports or other activities. Prosthetics is the design, fabrication and fitting of custom-made artificial limbs for patients who have lost limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders. We have two segments, the patient-care services segment, which generated approximately 93.6% of our net sales in 2003, and the distribution of O&P components segment, which accounted for 6.4% of our net sales. Our operations are located in 44 states and the District of Columbia, with a substantial presence in California, Florida, Georgia, Illinois, New York, Ohio, Pennsylvania and Texas.

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Patient Care

We generate sales primarily from patient-care services related to the fabrication, fitting and maintenance of O&P devices. Same-center sales growth represents the aggregate increase or decrease of our patient-care centers’ sales in the current year compared to the preceding year. Patient-care centers that have been owned by the Company for at least one full year are included in the computation. During 2003, same-center sales increased by 1.6% over 2002. Our net sales growth in 2002 was also principally driven by 4.6% same-center sales growth. We acquired five additional patient-care centers during 2003. We operated 585 and 583 patient-care centers at December 31, 2003 and 2002, respectively, and three distribution facilities at both December 31, 2003 and 2002.

Our revenues and results of operations are affected by seasonal considerations. The adverse weather conditions often experienced in certain geographical areas of the United States during the first quarter of each year, together with a greater degree of patients’ sole responsibility for their insurance deductible payment obligations during the beginning of each calendar year, have generally contributed to lower net sales in the first quarter.

In our patient-care segment, we calculate cost of goods sold in accordance with the gross profit method. We base 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. Estimated cost of goods sold is adjusted in the fourth quarter after the annual physical inventory is taken and compiled and a new accrual rate is established.

We believe that the expansion of our business through a combination of continued same-center sales growth, which has averaged 4.3% over the last three years, the addition of new facilities and a program of selective acquisitions are critical to the continued improvement in our profitability.

Distribution

Southern Prosthetic Supply, Inc. (“SPS”), our distribution segment, is the largest distributor of O&P devices in the United States. SPS had net sales of $96.1 million in 2003 with $60.8 million, or 63.3%, of total net sales made to our patient-care centers, and $35.3 million, or 36.7%, made to our competitors.

SPS has three distribution centers strategically located in the United States. SPS is able to fill virtually any order within 48 hours of receipt. The ability to quickly fill orders allows us to maintain much lower levels of inventory in our patient-care centers.

Results and Outlook

Net income did not meet management’s expectations in 2003 due principally to disappointing sales growth in our patient-care centers. However, for the third consecutive year, we generated in excess of $45.0 million in cash flows from operations and had available over $30.0 million to pay down debt. We also completed two finance transactions in the fourth quarter of 2003 that we expect will reduce interest expense and accreted dividends on our Redeemable Convertible Preferred Stock, and increase earnings per share in 2004.

Looking ahead, we expect to complete a major infrastructure project by the third quarter of 2004 with the rollout of our new billing system, O/P/S. We also will continue to roll out our new Insignia scanning system, which we believe will improve operations in our patient-care centers.

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We expect our continued investment in marketing, both in local sales force and in personnel and systems to support national contracts, will enable us to increase our market share in 2004.

Critical Accounting Estimates

Our analysis and discussion of our financial condition and results of operations is based upon our Consolidated Financial Statements that have been prepared in accordance with accounting principles generally accepted in the United States of America (“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. We have chosen accounting policies within U.S. GAAP that management believes are appropriate to accurately and fairly report our operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. Our accounting policies are stated in Note B to the Consolidated Financial Statements as presented elsewhere in this Annual Report on Form 10-K. We believe the following accounting policies are critical to understanding the results of operations and affect the more significant judgments and estimates used in the preparation of the Consolidated Financial Statements.

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Results of Operations

The following table sets forth for the periods indicated certain items of our statements of operations as a percentage of our net sales:

Year ended December 31, 2003 compared with the year ended December 31, 2002

Note: Certain 2002 costs have been reclassified between Cost of Goods Sold and Selling, General and Administrative costs to conform to the current year presentation.

Net Sales. Net sales for the year ended December 31, 2003 were $547.9 million, an increase of $22.4 million, or 4.3%, versus net sales of $525.5 million for the year ended December 31, 2002. The net sales growth was primarily the result of an $8.0 million, or 1.6%, increase in same-center sales in our patient-care centers, a $10.8 million, or 2.1%, increase as a result of sales from newly acquired practices and a $5.8 million, or 19.6%, increase in outside sales of the distribution segment. The increase in same center sales in our patient-care centers was principally due to an increase in the sale of prosthetic devices. Sales of orthotic devices in our existing practices were flat compared to the prior year. Sales in fiscal 2003 were negatively impacted by budget issues in several states that resulted in the reduction or in some cases termination of Medicaid benefits. The increase in outside sales by our distribution segment was principally the result of the addition of new product lines and an increase in the number of outside sales personnel.

Gross Profit. Gross profit for the year ended December 31, 2003 was $289.5 million, an increase of $11.0 million, or 3.9%, compared to gross profit of $278.5 million for the year ended December 31, 2002. Gross profit as a percentage of net sales remained relatively unchanged at 52.8% in 2003 versus 53.0% in 2002. The percentage decrease was the result of the decrease in gross profit as a percentage of net sales for the distribution segment to 18.5% in 2003 versus 18.8% in 2002. Gross profit for the patient-care segment remained constant at 53.0% for both 2003 and 2002. During 2003, material and labor costs increased $8.5 million, or 6.0%, and $2.8 million, or 2.7%, respectively, from the prior year, principally due to the increase in net sales.

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Selling, General and Administrative. Selling, general and administrative expenses for the year ended December 31, 2003 increased by $10.4 million, or 5.7%, compared to the year ended December 31, 2002. Selling, general and administrative expenses as a percentage of net sales increased to 35.4% in 2003 from 35.0% in 2002. The increase in selling, general and administrative expenses was primarily due to (i) a $5.7 million increase in salaries, travel, and selling expense primarily associated with staffing our marketing initiative, corporate governance costs, and staffing related to recently acquired practices; (ii) a $1.7 million increase in bad debt expense related to the increase in net sales; and (iii) $2.7 million in increased rent and occupancy costs associated principally with acquired patient-care centers.

Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2003 amounted to $10.7 million, an 8.1% increase in such costs versus $9.9 million for the year ended December 31, 2002.

Other Charges. Other charges for the year ended December 31, 2003, amounted to income of $0.2 million compared to expenses of $1.9 million in 2002. See “Other Charges” below for additional information regarding other charges incurred in 2003 and 2002.

Income from Operations. Principally as a result of the above, income from operations for the year ended December 31, 2003 was $84.6 million, an increase of $1.9 million, or 2.3%, from the year ended December 31, 2002. Income from operations as a percentage of net sales decreased by 0.3 percentage points to 15.4% for the year ended December 31, 2003 from 15.7% for the year ended December 31, 2002.

Interest Expense, Net. Net interest expense for the year ended December 31, 2003 was $36.3 million, a decrease of $2.0 million from the $38.3 million incurred in 2002. The decrease in interest expense was primarily attributable to a reduction in market interest rates.

Extinguishment of Debt. Costs recorded in connection with the extinguishment of debt in 2003 amounted to $20.1 million, a $15.4 million increase over prior year. The 2003 charge includes costs related to the repurchase of the Senior Subordinated Notes and a $4.1 million write-off of debt issuance costs previously capitalized relating to the Senior Subordinated Notes. The 2002 charge of $4.7 million ($2.8 million net of tax) for the year ended December 31, 2002, represented the write-off of debt issuance costs as a result of extinguishing $228.4 million of bank debt in connection with the issuance of 10 3/8% Senior Notes with a principal amount of $200.0 million due 2009 and the establishment of a $75.0 million senior secured revolving line of credit.

Income Taxes. The provision for income taxes for the year ended December 31, 2003 was $12.0 million compared to $16.1 million for the year ended December 31, 2002. The decrease in the income tax provision was primarily due to the $20.1 extinguishment of debt charge recognized in 2003. The effective tax rate for 2003 increased to 42.4% compared to 40.5% for 2002 due to the impact of the $20.1 million in tender fees.

Net Income. As a result of the above, we recorded net income of $16.2 million for the year ended December 31, 2003, compared to $23.6 million in the prior year.

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Year ended December 31, 2002 compared with the year ended December 31, 2001

Note: Certain 2002 and 2001 costs have been reclassified between Cost of Goods Sold and Selling, General and Administrative costs to conform to the current year presentation.

Net Sales. Net sales for the year ended December 31, 2002 were $525.5 million, an increase of $17.4 million, or 3.4%, versus net sales of $508.1 million for the year ended December 31, 2001. The net sales growth was primarily the result of a 4.6% increase in same-center sales in our patient-care practices and a $0.2 million, or 0.7%, increase in outside sales of the distribution segment offset by a $4.9 million, or 0.9%, reduction in net sales due to the sale of Seattle Orthopedic Group, Inc. (“SOGI”), our manufacturing segment, in October 2001.

Gross Profit. Gross profit for the year ended December 31, 2002 was $278.5 million, an increase of $15.7 million, or 6.0%, compared to gross profit of $262.8 million for the year ended December 31, 2001. Gross profit as a percentage of net sales increased to 53.0% in 2002 versus 51.7% in 2001. Specifically, for the patient-care segment, gross profit, as a percentage of net sales remained relatively constant at 53.0% in 2002 versus 53.4% in 2001. Gross profit, as a percentage of net sales, for the distribution segment increased to 18.8% in 2002 versus 14.0% in 2001. The improvement in gross profit, in both dollars and as a percentage of net sales, in both segments was due to a reduction in labor, improved efficiency of operations, and lower material costs, due to a concentration of purchasing which resulted in larger discounts, as well as to the increase in net sales. During 2002, labor costs decreased $1.4 million over the prior year. Material costs increased $3.2 million in terms of absolute dollars, however, as a percentage of net sales, material costs decreased to 27.1% compared to 27.4% in the prior year.

Selling, General and Administrative. Selling, general and administrative expenses for the year ended December 31, 2002 increased by $5.5 million, or 3.1%, compared to the year ended December 31, 2001. Selling, general and administrative expenses as a percentage of net sales decreased to 35.0% in 2002 compared to 35.1% in 2001. The dollar increase in selling, general and administrative expenses was primarily due to a $5.8 million increase in our practitioners’ performance-based bonus program resulting from increased collections and decreased labor and material costs.

Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2002 amounted to $9.9 million, a 59.9% decrease in such costs versus the $24.7 million for the year ended December 31, 2001. The decrease was due primarily to the discontinuation of amortization related to excess cost over net assets acquired commencing January 1, 2002 pursuant to Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which had been $13.1 million during 2001, and secondarily, the sale of SOGI in 2001 which was $0.9 million.

Other Charges. Other charges for the year ended December 31, 2002, amounted to $1.9 million compared to $24.4 million in 2001. The other charges in 2002 consisted of the following costs: (i) payments of approximately $1.3 million made to a prior workman’s compensation carrier related to claims for the 1995 through 1998 policy years, and (ii) a non-cash charge of approximately $0.6 million related to the write-off of abandoned leaseholds. See “Other Charges” below for additional information regarding other charges incurred in 2002 and 2001.

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Income from Operations. Principally as a result of the above, income from operations for the year ended December 31, 2002 was $82.6 million, an increase of $47.6 million, or 135.5%, from the year ended December 31, 2001. Income from operations as a percentage of net sales increased by 8.8 percentage points to 15.7% for the year ended December 31, 2002 from 6.9% for the year ended December 31, 2001.

Interest Expense, Net. Net interest expense for the year ended December 31, 2002 was $38.3 million, a decrease of $4.8 million from the $43.1 million incurred in 2001. The decrease in interest expense was primarily attributable to a decrease in average borrowings and a reduction in market interest rates.

Extinguishment of Debt. The 2002 balance of $4.7 million ($2.8 million net of tax) represented the write-off of debt issuance costs as a result of extinguishing $228.4 million of bank debt in connection with the issuance of 10 3/8% Senior Notes with a principal amount of $200.0 million due 2009 and the establishment of a $75.0 million senior secured revolving line of credit.

Income Taxes. The provision for income taxes for the year ended December 31, 2002 was $16.1 million compared to $0.9 million for the year ended December 31, 2001. The change in the income tax provision was due to our profitability.

Net income. As a result of the above, we recorded net income of $23.6 million for the year ended December 31, 2002, compared to net loss of $8.9 million in the prior year, an improvement of $32.5 million.

Other Charges

Restructuring and Integration Costs

In connection with the acquisition of NovaCare O&P on July 1, 1999, we implemented a restructuring plan that contemplated lease termination and severance costs associated with the closure of certain patient-care centers and corporate functions made redundant after the NovaCare O&P acquisition. As of December 31, 2000, the planned reduction in work force had been completed and we closed all patient-care centers that were identified for closure in 1999. During the year ended December 31, 2001, management reversed $0.8 million of the lease termination restructuring reserve as a result of favorable lease buyouts and subleasing activity. The remaining lease payments on these closed patient-care centers were paid through 2003. See Note E to the Consolidated Financial Statements for restructuring and integration costs rollforward table.

In January 2001, we developed, with the assistance of AlixPartners, LLC (formerly Jay Alix & Associates, Inc.; “JA&A”), a comprehensive performance improvement program aimed at improving cash collections, reducing working capital requirements and improving operating performance. In connection with these initiatives, we recorded $4.5 million in restructuring and asset impairment costs. These initiatives called for the closure of certain patient-care centers and the termination of 135 employees. During 2001, the lease restructuring component of the plan was amended and additional properties, which were originally contemplated but not finalized, were added to the list of restructured facilities. As of December 31, 2002, all of the contemplated employee terminations and property closures had taken place. During 2003, we reduced our accrual for lease payments related to the restructured facilities by $0.2 million as a result of favorable renegotiations of the lease terms. All payments have been made under the severance initiative and all payments for lease costs are expected to be paid by December 31, 2012.

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Performance Improvement Costs

In 2001, we recorded $12.7 million in cash and non-cash charges associated with performance improvement initiatives. These charges were comprised of $7.9 million in fees and costs, primarily related to payments of $5.7 million made to JA&A for consulting and success fees, and a $4.8 million non-cash charge related to stock compensation paid JA&A for their services.

During 2002, these initiatives became part of our normal operations and the savings associated with their implementation are reflected in our financial performance. These and other new initiatives related to accounts receivable, material and labor efficiencies, and information systems continue to be evaluated and implemented to improve our operations and financial position.

Impairment Loss on Assets Held for Sale

In connection with the analysis of our continuing business, we determined that the manufacture of orthotic and prosthetic components and devices was not one of our core businesses as it represented only 0.9% of our net sales for the year ended December 31, 2001. In July 2001, we agreed to the general terms of a sale of substantially all of the manufacturing assets of Seattle Orthopedic Group, Inc. to United States Manufacturing Company, LLC (“USMC”) for $20.0 million. The sale resulted in our recording an asset impairment loss of $8.1 million, as the net book value of the assets was $26.2 million, while net proceeds from the sale of the assets were $18.1 million.

Financial Condition, Liquidity and Capital Resources

We generated strong cash flows in 2003, with over $57.0 million in cash from operations. Approximately $17.0 million was used to reinforce and improve our infrastructure. We also utilized our excess cash reserves to repurchase $30.0 million of our Redeemable Convertible Preferred Stock and to refinance our 11¼% Senior Subordinated Notes in the fourth quarter. We expect that these transactions will reduce interest expense and accreted dividends on our Redeemable Convertible Preferred Stock, and improve cash flows in 2004.

Our working capital at December 31, 2003 was approximately $143.3 million compared to $126.7 million at December 31, 2002. The $16.6 million increase in working capital was attributable principally to an increase in (i) cash and cash equivalents, (ii) accounts receivable due to the high sales volume in December 2003 compared to the prior year, and (iii) inventory due to acquisitions and increased inventory at SPS to support their new product lines. Our cash and cash equivalents amounted to $15.4 million at December 31, 2003 and $6.6 million at December 31, 2002. The ratio of current assets to current liabilities was 3.1 to 1 at December 31, 2003 compared to 2.9 to 1 at December 31, 2002. Availability under our revolving line of credit increased to $64.0 million at December 31, 2003 compared to $60.0 million at December 31, 2002.

Net cash provided by operating activities for the year ended December 31, 2003 was $57.1 million, compared to $47.5 million in the prior year. The increase was due principally to the collection of an $8.4 million income tax receivable.

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Net cash used in investing activities was $27.5 million for the year ended December 31, 2003, versus $18.0 million in the prior year. Cash used in investing activities consisted principally of $3.6 million related to the cost of our new billing system, $0.1 million related to the Insignia scanning system, $4.8 million in renovations in our leased patient-care centers and $10.5 million related to acquisitions and earn-outs.

Net cash used in financing activities was $20.8 million for the year ended December 31, 2003 compared to $33.0 million for the year ended December 31, 2002. Cash was used principally for the repurchase of $30.0 million of our outstanding Redeemable Convertible Preferred Stock, a $20.1 million tender fee paid in connection with the refinancing of our 11¼% Senior Subordinated Notes and scheduled payments of Subordinated Seller Notes. As mentioned previously, the Company also tendered for $134.4 million of its Senior Subordinated Notes principally with the proceeds of a new $150.0 million Term Loan.

Term Loan

In October 2003, we obtained a variable interest $150.0 million credit facility maturing September 30, 2009 (“Term Loan”). Payments on the Term Loan commenced December 31, 2003 and continue on a quarterly basis until maturity. The Term Loan incurs interest, at our option, of LIBOR plus a variable margin rate or a Base Rate (as defined in the debt agreement) plus a variable margin rate. At December 31, 2003, the interest rates have been adjusted to LIBOR plus 2.75%. The covenants of the Term Loan mirror those under the Revolving Credit Facility in addition to (i) requiring us to apply cash proceeds from certain activities toward the repayment of debt and (ii) increasing the maximum senior secured leverage ratio used in the calculation of one of the covenants. The Term Loan permitted us to repurchase up to $30.0 million of outstanding Redeemable Convertible Preferred Stock in November 2003 when certain criteria were met. The obligations under the Term Loan are guaranteed by our subsidiaries and by a first priority perfected security interest in our subsidiaries’ shares, all of our assets and all of the assets of our subsidiaries.

Senior Notes

On February 15, 2002, we received $200.0 million in proceeds from the sale of the 10 3/8% Senior Notes due 2009 (“Senior Notes”) in a private placement exempt from registration under the Securities Act of 1933, as amended. The Senior Notes were issued under an indenture, dated as of February 15, 2002, with Wilmington Trust Company, as trustee. We also closed, concurrent with the sale of Senior Notes, a new $75.0 million senior secured revolving line of credit (“Revolving Credit Facility”). The proceeds from the sale of Senior Notes and the Revolving Credit Facility 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, we received $3.9 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 our Common Stock, (ii) scheduled principal payments of $11.3 million on our long-term debt, (iii) an additional net pay down of $21.5 million of our Revolving Credit Facility and (iv) an additional payment of $1.7 million in financing costs related to the issuance of the Senior Notes and the establishment of the Revolving Credit Facility.

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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. On and after February 15, 2006, we may redeem all or part of the Senior Notes at 105.188% of principal amount during the 12 month period commencing on February 15, 2006, at 102.594% of principal amount if redeemed during the 12-month period commencing on February 15, 2007, and at 100% of principal amount if redeemed on or after February 15, 2008. Before February 15, 2005, we may redeem up to 35% of the aggregate principal amount of the Senior Notes at a redemption price of 110.375% of the principal amount thereof, plus interest, with the cash proceeds of certain equity offerings, provided that at least 65% of the aggregate principal amount of Senior Notes remains outstanding after the redemption. Upon the occurrence of certain specified change of control events, unless we have exercised our option to redeem all the Senior Notes and Senior Subordinated Notes as described above, each holder of a Senior Note will have the right to require us to repurchase all or a portion of such holder’s Senior Notes at a purchase price in cash equal to 101% of the principal amount, plus accrued and unpaid interest, if any, to the date of repurchase. The terms of the Senior Notes, Senior Subordinated Notes, and the Revolving Credit Facility limit 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.

Revolving Credit Facility

The Revolving Credit Facility, which was provided by a syndicate of banks and other financial institutions led by GE Capital, is a senior secured revolving credit facility providing for loans of up to $100.0 million 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 a variable margin rate or the Base Rate (as defined in the debt agreement) plus a variable margin rate. In each case, the variable margin rate is subject to adjustments based on financial performance. At December 31, 2003, the interest rates have been adjusted to LIBOR plus 3.00%. 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. We can prepay borrowings under the Revolving Credit Facility at any time without premium or penalty. The Revolving Credit Facility requires compliance with various financial covenants, including a minimum consolidated interest coverage ratio, a maximum total leverage ratio, a maximum senior secured leverage ratio and a minimum fixed charge coverage ratio, as well as other covenants. We assess, on a quarterly basis, our compliance with these covenants and monitor any matters critical to continue our compliance. The Revolving Credit Facility contains customary events of default and is subject to various mandatory prepayments and commitment reductions. As of December 31, 2003, we were in compliance with these covenants.

Redeemable Convertible Preferred Stock

During November 2003, we repurchased 22,119 shares of our outstanding Redeemable Convertible Preferred Stock for a total price of $31.7 million, and paid a premium of $1.7 million and incurred a loss of $0.4 million.

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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, Senior Subordinated Notes, Term Loan 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.

Obligations and Commercial Commitments

The following table sets forth our contractual obligations and commercial commitments as of December 31, 2003:

Supply Commitments

In October 2001, we entered into a supply agreement with USMC, under which we agreed to purchase certain products and components for use solely by the patient-care centers during a five-year period following the date of the agreement. In connection with the supply agreement, $3.0 million was placed in escrow. We satisfied our obligation to purchase from USMC at least $8.5 million and $7.5 million of products and components in 2003 and 2002, respectively, which were the first two years following the date of the agreement. Accordingly, in October 2003 and November 2002, the escrow agent released $1.0 million in escrowed funds to the Company for the satisfaction of such purchase obligations, leaving $1.0 million in escrow at December 31, 2003.

In addition, we were obligated to purchase from USMC at least $9.5 million of products and components during the third year following the agreement, subject to certain adjustments. Furthermore, in the event purchases from USMC during each of the fourth and fifth years of the agreement were less than approximately $8.7 million, we would have been obligated to 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 under the agreement were less than approximately $8.7 million. The penalties in the fourth and fifth years of the agreement would have been capped at $0.9 million per year.

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We have executed a Master Amendment with Seattle Systems (as the successor of USMC), dated as of October 9, 2003, pursuant to which the supply agreement and escrow arrangement relating thereto between us and USMC/Seattle Systems have been amended in the following material ways: (i) to reduce the remaining life under the supply agreement from three years to two years, with the new termination date now being October 8, 2005, (ii) to require that minimum annual purchases aggregate at least $9.0 million for each of the two new purchase years under the Master Amendment, (iii) to reflect that all purchases of products and components from Seattle Systems by us and all of our affiliates, including our distribution subsidiary, Southern Prosthetic Supply, Inc. (“SPS”), for use by our patient-care centers and/or for resale by SPS to third-party users in the O&P industry, are counted towards our satisfaction of the minimum annual purchases required to be made by us under the Master Amendment, (iv) to reflect that $1.0 million still remains in escrow, and that we will receive $0.5 million of that escrow amount if we make minimum annual purchases of at least $9.0 million for the first new purchase year and that we will receive the remaining $0.5 million of that escrow amount if we make minimum annual purchases of at least $9.0 million for the second new purchase year under the Master Amendment, and (v) to amend provisions relating to shipping terms and discounts. If we do not make such minimum annual purchases for any such purchase year, then the $0.5 million escrow payment for that purchase year shall be released from escrow to Seattle Systems.

Selected Operating Data

The following table sets forth selected operating data as of the end of the years indicated:

Market Risk

We are exposed to the market risk that is associated with changes in interest rates. In 2002, we entered into $100.0 million fixed-to-floating interest rate swaps, consisting of floating rate instruments benchmarked to LIBOR. The swaps were entered into in connection with the consummation of our $200.0 million Senior Notes obligation in order to balance our exposure to fixed rate debt instruments. During 2003, we terminated the interest rate swaps and as a result, received $2.8 million, which we will recognize as a reduction of interest expense, using the effective interest rate method, over the remaining term of the Senior Subordinated Notes.

New Accounting Standards

Refer to our discussion of new accounting standards in Note B of the audited consolidated financial statements.

Other

Inflation has not had a significant effect on our operations, as increased costs to us generally have been offset by increased prices of products sold.

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ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We have existing obligations relating to our Senior Notes, Senior Subordinated Notes, Term Loan, Subordinated Seller Notes, and Redeemable Convertible Preferred Stock. As of December 31, 2003 we have cash flow exposure to the changing interest rates on the Term Loan and Revolving Credit Facility, the other obligations have fixed interest or dividend rates.

We have a $100 million revolving line of credit, with an outstanding balance of $30.0 million at December 31, 2003, as discussed in Note H to our Consolidated Financial Statements. 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. From time to time, we execute LIBOR contracts to fix interest rate exposure for specific periods of time. At December 31, 2003, we had three contracts outstanding which fixed LIBOR at 1.2%, 1.6%, and 1.2%, and were set to expire on March 22, 2004, February 4, 2004, and March 15, 2004, respectively.

Presented below is an analysis of our financial instruments as of December 31, 2003 that are sensitive to changes in interest rates. The table demonstrates the change in cash flow related to the outstanding balance under the Term Loan and 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.

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        The consolidated financial statements and schedules required hereunder and contained herein are listed under Item 15(a) below.

Quarterly Financial Data

         None.

        We maintain “disclosure controls and procedures” within the meaning of Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Our disclosure controls and procedures (“Disclosure Controls”), are designed to ensure that information required to be disclosed by the Company in the reports filed under the Exchange Act, such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms. Our Disclosure Controls are also designed to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our Disclosure Controls, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures.

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        Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this Annual Report on the Form 10-K, we evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, which was done under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer. Immediately following the Signatures section of this Annual Report on Form 10-K are certifications of our Chief Executive Officer and Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Exchange Act. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented. Based on the controls evaluation, our Chief Executive Officer and Chief Financial Office have concluded that, as of the date of their evaluation, our Disclosure Controls and Procedures were effective to ensure that material information is made known to management, including our Chief Executive Officer and Chief Financial Officer, particularly during the period when our periodic reports are being prepared.

        Changes in Internal Control Over Financial Reporting. There has been no change in the Company’s internal control over financial reporting that occurred during the Company’s fourth fiscal quarter of 2003 that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

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PART III

        Pursuant to General Instruction G(3) of Form 10-K, the information called for by this item regarding directors is hereby incorporated by reference from our definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. Information regarding our executive officers is set forth under Item 4A of this Form 10-K.

        Pursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from our definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.

        Pursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from our definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.

        Pursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from our definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.

        Pursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from our definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) 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.

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

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INDEX TO FINANCIAL STATEMENTS

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and
Shareholders of Hanger Orthopedic Group, Inc.:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Hanger Orthopedic Group, Inc. and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note B to the consolidated financial statements, the Company adopted the Financial Accounting Standards Board Statement No. 142, (Goodwill and Other Intangible Assets), effective January 1, 2002.

F-1

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

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

F-2

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