Hanger Orthopedic Group Inc · 10-K · For 12/31/96

Filed On 3/31/97   ·   SEC File 1-10670   ·   Accession Number 904456-97-30

Annual Report   ·   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report                                         57    274K 
 2: EX-10.P     Material Contract                                      8     41K 
 3: EX-10.Q     Material Contract                                     10     45K 
 4: EX-10.R     Material Contract                                     10     44K 
 5: EX-11       Statement re: Computation of Earnings Per Share        1      5K 
 6: EX-22       Published Report Regarding Matters Submitted to        1      6K 
                          Vote of Security Holders                               
 7: EX-27       Financial Data Schedule                                1      7K 

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SECURITIES AND EXCHANGE COMMISSION  
WASHINGTON, D.C. 20549  
FORM 10-K 

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES           
EXCHANGE ACT OF 1934.                                               

For the fiscal year ended December 31, 1996                                 

OR  

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

For the transition period from _______ to _______.                          

Commission File Number 1-10670  

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

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

7700 Old Georgetown Road, Bethesda, MD          20814         
----------------------------------------       ----------       
(Address of principal executive offices)       (Zip Code)       

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

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

Common Stock, par value $.01 per share  
--------------------------------------  
(Title of Class)  

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: Yes [X] No [ ]                   

   The aggregate  market value of the  registrant's  Common Stock, par value
$.01  per  share,  held  as of  February  21,  1997 by  non-affiliates  of the  
registrant was $63,181,823 based on the $6.75 closing sale price of the Common  
Stock on the American Stock Exchange on such date.                              

   As of March 21, 1996, the  registrant had 9,360,270  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. [ ]                                                

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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.                                                    

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ITEM 1.  BUSINESS.                                                              

INTRODUCTION                                                                    

   Hanger Orthopedic  Group, Inc.  ("Hanger" or the "Company") is one of the
nation's largest practice management  companies in the orthotic and prosthetic  
("O&P")  rehabilitation  industry.  In addition to providing  O&P patient care  
services  through its operating  subsidiaries,  Hanger also  manufactures  and  
distributes components and finished patient care products to the O&P industry.  
Hanger's largest  subsidiary,  Hanger Prosthetics & Orthotics,  Inc., formerly  
known as J. E.  Hanger,  Inc.  ("HPO"),  was  founded  in 1861 by a Civil  War  
amputee and is the oldest company in the O&P industry in the United States.     

   Orthotics  is the  design,  fabrication,  fitting and  supervised  use of
custom-made braces and other devices such as knee,  spinal,  neck and cervical  
braces  and  foot   orthoses,   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.          

   The Company is a  vertically  integrated  provider of O&P  services  that
offers its own  manufacturing,  distribution  and  provision  of patient  care  
services.  The Company  manufactures  O&P components and finished patient care  
products  for  both  the O&P  industry  and the  Company's  own  patient  care  
practices   through   its   wholly-owned   subsidiary,    DOBI-Symplex,   Inc.  
("DOBI-Symplex").  The Company  manufactures  components and finished products  
under  various  name  brands such as Lenox Hill,  CASH Brace,  Ortho-Mold  and  
Charleston Bending Brace. The Company  distributes O&P components and finished  
patient care  products to the O&P industry and the  Company's own patient care  
practices through the Company's wholly-owned  subsidiary,  Southern Prosthetic  
Supply, Inc. ("SPS").                                                           

   The  Company  also  manages O&P patient  care  practices  through its HPO
subsidiary.  Care of O&P  patients  is part of a continuum  of  rehabilitation  
services from  diagnosis to treatment and  prevention of future  injury.  This  
continuum involves the integration of several medical  disciplines that begins  
with the  attending  physician's  diagnosis.  Once a course  of  treatment  is  
determined,  the physician,  generally an orthopedic surgeon, vascular surgeon  
or physiatrist,  refers a patient to one of Hanger's  patient care centers for  
treatment.  A Hanger  practitioner  then  consults  with  both  the  referring  
physician and the patient to formulate the prescription for, and design of, an  
orthotic or prosthetic device to meet the patient's needs.                      

   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. All of the prosthetic  devices  fitted by Hanger's  practitioners  
are custom  designed and fabricated by skilled  practitioners  who can balance  

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fit,  support  and  comfort.  Of the  orthotic  devices  provided  by  Hanger,  
approximately 79% are custom designed, fabricated and fitted and the other 21%  
are prefabricated but custom fitted.                                            

   Custom devices are fabricated by the Company's skilled  technicians using
the castings,  measurements and designs made by the practitioner.  Technicians  
use advanced  materials  and  technologies  to fabricate a custom device under  
stringent quality assurance guidelines.  After final adjustments to the device  
by  the  practitioner,  the  patient  is  instructed  in  the  use,  care  and  
maintenance of the device.  A program of scheduled  follow-up and  maintenance  
visits is used to provide  post-fitting  treatment,  including  adjustments or  
replacements  as the  patient's  physical  condition  and  lifestyle  changes.  
Generally,  the useful life of most custom designed and fabricated O&P devices  
ranges from three to five years.                                                

   A substantial  portion of Hanger's O&P services  involves  treatment of a
patient  in a  non-hospital  setting,  such as one of  Hanger's  patient  care  
centers, a physician's  office, an out-patient clinic or other facilities.  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 prostheses.  Hanger's distribution capability allows its  
personnel  faster  access to the  products  needed to  fabricate  devices  for  
patients.  This is accomplished at competitive  prices,  as a result of either  
manufacturing   by  DOBI-Symplex  or  direct   purchases  by  SPS  from  other  
manufacturers.  As a result of  faster  access to  products,  the  length of a  
patient's  treatment in the hospital can be reduced,  thereby  contributing to  
healthcare cost containment.                                                    

   Each of the Company's  patient care centers is closely  supervised by one
or more  certified  practitioners,  which  enables  the  Company to assure the  
highest quality of services and patient care  satisfaction.  Hanger  currently  
employs  562  patient   care   practitioners,   of  whom  230  are   certified  
practitioners or candidates for formal  certification by the American Board of  
Certification  in  Orthotics  and  Prosthetics.  The balance of the  Company's  
patient care  practitioners are highly trained technical  personnel who assist  
in the provision of services to patients and fabricate various O&P devices.     

   The  Company  currently  manages  178 O&P  patient  care  centers  in the
following  29   jurisdictions:   Alabama,   Arizona,   California,   Colorado,  
Connecticut,  Delaware,  District  of  Columbia,  Florida,  Georgia,  Indiana,  
Kentucky, Louisiana, Maryland, Massachusetts,  Michigan, Mississippi, Montana,  
New Hampshire, New Mexico, New York, North Carolina, Ohio, Pennsylvania, South  
Carolina,  Tennessee,  Texas, Virginia, West Virginia and Wyoming. Hanger also  
manufactures a number of specialized O&P components and finished  patient care  
products at its manufacturing facilities in Florida and Illinois and maintains  
distribution facilities in California,  Florida, Georgia,  Illinois,  Maryland  
and Texas.                                                                      

   The Company,  which was formed in March 1983, is a Delaware  corporation.
Its  executive  offices are  located at 7700 Old  Georgetown  Road,  Bethesda,  
Maryland 20814.  Its telephone number is  (301)-986-0701.  Hanger is a holding  
company which transacts business through its subsidiaries.  Unless the context  
otherwise requires, all references herein to Hanger include its subsidiaries.   

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THE MARKET FOR ORTHOPEDIC REHABILITATION SERVICES                               

   The Company is engaged in O&P patient care practice  management,  as well
as O&P product manufacturing and distribution activities.  The O&P industry in  
the  United  States,  including  patient  care  services,   manufacturing  and  
distribution,  is estimated to generate $2 billion in sales annually.  Of that  
amount,  an estimated  $700 million is attributed to the patient care services  
sector, a highly fragmented market with over 2,740 certified practitioners and  
1,230 certified O&P facilities,  generally  operated as small group practices.  
The  Company  believes  that  the  demand  for  orthopedic  rehabilitation  is  
increasing at a rapid rate due to a combination of the following factors:       

        o    GROWING ELDERLY POPULATION.  The growth rate of the over-65 age
             group is nearly  triple  that of the  under-65  age group.  The
             elderly require orthopedic  rehabilitation more frequently than
             younger age groups.  With broader medical  insurance  coverage,
             increasing disposable income,  longer life expectancy,  greater
             mobility and improved  technology and devices they are expected
    to seek orthopedic rehabilitation services more often.

        o    COST-EFFECTIVE  REDUCTION  IN  HOSPITALIZATION.  As public  and
             private  payors  encourage  reduced  hospital   admissions  and
             reduced  length  of  stay,  out-patient  rehabilitation  is  in
             greater demand.  O&P services and devices have enabled patients
             to become  ambulatory  more  quickly  after  receiving  medical
             treatment  in  the   hospital.   The  Company   believes   that
             significant  cost savings can be achieved through the early use
             of O&P  services.  The  provision of O&P services in many cases
             reduces the need for more expensive treatment modalities,  thus
   representing a cost savings to the third-party payor.

        o    GROWING  PHYSICAL  HEALTH  CONSCIOUSNESS.  There  is a  growing
             emphasis on physical fitness,  leisure sports and conditioning,
             such as  running  and  aerobics,  which  has  led to  increased
             injuries  requiring  orthopedic   rehabilitative  services  and
             products.  In addition,  as the current  middle-age  population
             ages,  it brings its more active  life-style  and  accompanying
             emphasis  on physical  fitness to the over-65 age group.  These
             trends are evidenced by the  increasing  demand for new devices
             which  provide  support for  injuries,  prevent  further or new
injuries or enhance physical performance.         

        o    ADVANCING TECHNOLOGY.  The range and effectiveness of treatment
             options 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 the  industry to produce  more new O&P
             products, which provide greater comfort, protection and patient
             acceptability.  Therefore,  treatment can be more effective and
             of shorter  duration,  contributing  to greater  mobility and a
             more active  lifestyle  for the patient.  Orthotic  devices are
             more  prevalent  and visible in many sports,  including but not
limited to skiing.                                

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        o    NEED FOR  REPLACEMENT AND CONTINUING  CARE.  Because the useful
             life of most  custom  fitted  and  fabricated  O&P  devices  is
             approximately   three  to  five  years,   such   devices   need
             retrofitting and  replacement.  There is also an attendant need
             for continuing patient care services,  which contributes to the
increasing demand for orthopedic rehabilitation.  

BUSINESS STRATEGY                                                               

   The  Company's  business  strategy  is to  significantly  expand  its O&P
practice  management  presence in the patient care services segment of the O&P  
industry,  which is a highly  fragmented  market  with  over  2,740  certified  
practitioners and 1,230 certified O&P facilities in the United States. Most of  
these  facilities  operate as small group  practices.  The Company's  strategy  
involves:  (i) broadening the Company's presence in targeted  geographic areas  
through a program of selected  acquisitions;  (ii) expanding and improving O&P  
practice   management   operations  at  existing  and  acquired  patient  care  
facilities  through  more  efficient   operating  practices  and  the  use  of  
professional  marketing  programs not generally  utilized in the O&P industry;  
(iii)  increasing the  manufacturing  and  distribution  of O&P components and  
products used by others in the O&P industry as well as by its own patient care  
centers;  (iv) opening new patient care centers in existing markets  including  
centers within rehabilitation hospitals; (v) developing contract business with  
managed  care  organizations,   including  health  maintenance   organizations  
("HMOs") and  preferred  provider  organizations  ("PPOs"),  and a proprietary  
referral network between selected O&P service  providers and such managed care  
organizations through its wholly-owned subsidiary, OPNET, Inc., which operates  
the Company's  Orthotic and Prosthetic  Network  ("OPNET").  See  "Acquisition  
Strategy" and "Management's Discussion and Analysis of Financial Condition and  
Results of Operations - Liquidity and Capital Resources."                       

   In December 1996,  following the Company's  acquisition  of J.E.  Hanger,
Inc. of Georgia ("SEH"),  the Company  consolidated its business operations by  
merging many of its  subsidiaries  and  otherwise  combining  similar lines of  
business  within  certain   continuing   subsidiaries.   The  result  of  this  
consolidation  is that  patient-care  services  are  consolidated  under  HPO,  
manufacturing  activities are consolidated  under  DOBI-Symplex,  distribution  
activities are consolidated  under SPS, and managed care contract services are  
concentrated under OPNET.                                                       

ACQUISITION STRATEGY                                                            

   The Company's  primary growth strategy is pursued  through  acquisitions.
The Company  considers  both  operating  and  financial  factors in evaluating  
prospective acquisitions.  Operating factors include Hanger's emphasis on high  
standards  of  professionalism  and patient care and the presence of certified  
practitioners at each of its facilities.  Financial factors include historical  
earnings and cash flow history and the projected benefits of applying Hanger's  
management,  marketing,  information  systems and other operational  programs,  
such as access to its manufacturing and wholesale distribution facilities,  to  
the acquired company's business.  Hanger's  acquisition  criteria also include  
the retention and support of the existing  management of the acquired company,  
typically through the use of employment contracts,  non-compete agreements and  
incentive programs.  In evaluating  acquisitions in geographic areas where the  
Company has an established presence, Hanger targets businesses that complement  
its existing  network of patient care centers.  In locations where the Company  

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has not yet established a presence,  the Company  generally  focuses on strong  
regional  businesses  which have multiple patient care centers and experienced  
practitioners.                                                                  

   The  Company   also  plans  to   continue   to  expand  its   contractual
relationships  with large managed care  organizations for the provision of O&P  
services.  In 1995, the Company formed OPNET which serves as a referral source  
of O&P  services  for  managed  care  providers  at a reduced  cost for claims  
administration  due to OPNET's  prenegotiated fee structure with payor groups.  
OPNET   has   successfully   established   contractual    relationships   with  
approximately  374 patient care centers and 221 insurance  payors.  OPNET also  
provides  incentives to independent O&P service  provider  members to purchase  
their O&P  products  from SPS and  DOBI-Symplex.  OPNET  further  provides the  
Company with opportunities for future  acquisitions by allowing the Company to  
evaluate the financial and clinical performance of the OPNET member clinics.    

   The Company also maintains contractual  relationships with rehabilitation
hospitals  pursuant to which Hanger operates such facilities' O&P patient care  
centers.  This includes The Rusk Institute of  Rehabilitation  Medicine at the  
New York  University  Medical Center in New York, New York, the Rocky Mountain  
Regional Spinal Injury Center of the Craig Hospital in Denver,  Colorado,  and  
the Harmarville Rehabilitation Center in Pittsburgh, Pennsylvania.              

OPERATIONAL STRATEGY                                                            

   The Company's O&P practice management  operational  strategy includes the
continued  development and  implementation of programs designed to enhance the  
efficiency of its consolidated  clinical practices.  These programs permit its  
certified practitioners to allocate a greater portion of their time to patient  
care activities by reducing the administrative  responsibilities  of operating  
the business.  Such  programs  include:  (i) sales and  marketing  initiatives  
designed to attract new patient  referrals through  established  relationships  
with physicians,  therapists,  employers, managed care organizations,  such as  
HMOs and PPOs,  hospitals,  rehabilitation  centers,  out-patient  clinics and  
insurance  companies;  (ii)  professional  management and information  systems  
designed to improve  efficiencies of administrative and operational  functions  
under  guidelines of the Company's  patient care centers;  (iii)  professional  
educational   programs   for   practitioners   emphasizing    state-of-the-art  
developments in the increasingly  sophisticated field of O&P clinical therapy;  
(iv) the regional  centralization  of fabrication  and  purchasing  activities  
which provides overnight access to component parts and products at prices that  
are  typically 25% lower than  traditional  procurement  methods;  and (v) the  
acquisition of state-of-the-art  equipment which is financially more difficult  
for smaller,  independent  facilities to obtain.  Management believes that the  
programs  which have been  created by the Company to enhance  its  operational  
strategy  have  made the  Company  attractive  to  clinical  practices,  which  
enhances the Company's ability to expand through acquisitions and maximize the  
retention of practitioners.                                                     

SALES AND MARKETING                                                             

   The Company  believes that the  application of modern sales and marketing
techniques is a key element of its O&P practice  management business strategy.  
While  patient   referrals   have  always  been  a  source  of  new  business,  
historically there has been an absence of a comprehensive  sales and marketing  

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effort in the patient care segment of the O&P industry.  The success of an O&P  
business  has been largely a function of its local  reputation  for quality of  
care,  responsiveness  and  length of service  in the  community.  This is due  
primarily  to  the  fragmented   nature  of  the  industry,   with  individual  
practitioners relying almost exclusively on referrals from local physicians or  
physical therapists.                                                            

   Hanger's  patient care marketing  efforts are managed by a Vice President
of  Marketing  and  are  directed  toward  referring  physicians,  therapists,  
employers, HMOs, PPOs, hospitals,  rehabilitation centers, out-patient clinics  
and insurance  companies on both a local,  regional and national basis.  While  
specialized   physicians,   such  as  orthopedic  and  vascular  surgeons  and  
physiatrists,  have been  principal  referral  sources,  regional and national  
third-party  payors such as managed  care  organizations,  including  HMOs and  
PPOs,  have become  important  sources of patient  referrals.  Hanger has also  
targeted other  rehabilitation  professionals in the continuum of care for O&P  
patients, including physical therapists, orthopedic nurses and technicians and  
other professionals.  Hanger employs personnel whose responsibilities  include  
the solicitation of new business from these referral sources.  The Company has  
been  successful in procuring the approval of  broad-based  managed care plans  
and other  institutional  healthcare  providers  and  payors.  As part of this  
effort,  the  Company  formed  OPNET which  employs  personnel  whose  primary  
responsibility is to develop and implement new marketing  techniques  directed  
toward such managed-care plans and other  institutional  healthcare  providers  
and payors.                                                                     

   Although referrals are instrumental in establishing  initial contact with
patients, the Company's O&P practice management policies continue to emphasize  
the primary importance of its service to its patients. Hanger believes that it  
is important to develop the  doctor/patient  relationship in order to properly  
meet the needs of the patient,  ensure the patient's satisfaction with the O&P  
device and establish a long-term  relationship  between the doctor and patient  
in order for the patient to understand adequately the rehabilitation  program,  
which is attendant to regaining  mobility,  and the proper  maintenance of the  
O&P device to ensure ongoing  performance of the brace or device.  The patient  
orientation of Hanger's  services are designed to ensure the patient's  return  
to Hanger for his or her orthotic or prosthetic needs.                          

ACQUISITIONS                                                                    

   Since 1986, the Company has acquired over 40 businesses  representing 178
offices in 29 jurisdictions,  with the most recent of these acquisitions being  
the acquisition in November 1996 of SEH, a Georgia  corporation which operated  
93  patient  care  offices  in  15  states,  and  was  the  country's  largest  
distributor of O&P products. The Company has entered into letters of intent to  
effect  three  acquisitions  in  Tennessee,   Ohio  and  Florida,   which,  if  
consumated,  would be expected to add  approximately  $9 million in annual net  
sales.  The Company  continues to be engaged in discussions with several other  
O&P companies relating to the Company's possible  acquisition of their patient  
care centers.  The Company's  investigations of such other companies'  affairs  
are in their formative stages and no final  representations  can be made as to  
whether, when or on what terms such possible acquisitions may be effected.      

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MANUFACTURING AND DISTRIBUTION                                                  

   In addition to on-site  fabrication of custom  devices  incidental to the
services rendered at its O&P patient care centers,  Hanger also manufactures a  
number  of  non-customized  orthotic  components  and  finished  patient  care  
products at DOBI-Symplex,  a facility in Orlando,  Florida at which Lenox Hill  
and  Ortho-Mold  products  are also  manufactured,  and a Ralph  Storrs,  Inc.  
("Storrs") facility in Kankakee, Illinois. The principal products manufactured  
are  pre-fabricated  and  custom-made  spinal  orthoses  as well as custom and  
off-the-shelf  derotation knee braces. These products are supplied to Hanger's  
patient  care  centers,  as  well as sold to  unaffiliated  O&P  patient  care  
facilities.  For the years ended December 31, 1992, 1993, 1994, 1995 and 1996,  
sales of products manufactured by the Company accounted for 10%, 18%, 18%, 16%  
and 12%,  respectively,  of Hanger's  historical net sales. As a result of the  
business mix of SEH, which included no manufacturing  revenues,  the Company's  
manufacturing  revenues as a percentage of sales is  anticipated to be only 7%  
of net sales in 1997.                                                           

   SPS is primarily engaged in the distribution of O&P products,  a majority
of which are manufactured by others and distributed by SPS primarily to others  
in the O&P industry.  SPS inventories  over 20,000 items.  After the Company's  
acquisition of SPS in November 1996, the Company consolidated its distribution  
business,  O&P Express, into SPS. For the years ended December 31, 1992, 1993,  
1994, 1995 and 1996, revenues  attributable to distribution  accounted for 6%,  
5%, 4%, 5% and 10%,  respectively,  of  Hanger's  historical  net sales.  As a  
result of the business mix of SEH, which  included a substantial  distribution  
business,  the  Company's  distribution  revenues as a percentage  of sales is  
anticipated to be 18% of net sales in 1997.                                     

   Marketing of Hanger's  manufactured products and distribution services is
conducted  on  a  national  basis,   primarily   through   independent   sales  
representatives  and an internal sales force,  catalogues and through exhibits  
at industry and medical meetings and conventions.  Hanger directs  specialized  
catalogues to segments of the healthcare industry, such as orthopedic surgeons  
and physical and  occupational  therapists,  and also directs its  broad-based  
marketing to the O&P industry.                                                  

   Storrs'  revenues are derived  primarily from the manufacture of orthotic
devices.  One such device is a  hyperextension  brace for lumbar and  thoracic  
spinal support.  Storrs also  manufactures  the brace components for the Lenox  
Hill derotation knee orthosis, a business which Hanger,  through DOBI-Symplex,  
acquired on December 31, 1992 from Minnesota Mining and Manufacturing  Company  
("3M").                                                                         

   DOBI-Symplex is engaged  primarily in the manufacture and distribution of
plastic spinal orthotic devices.  Its activities include:  (i) the fabrication  
of   custom-made   plastic   orthotic   devices  from  patient   molds  and/or  
measurements, which account for approximately 61% of its annual revenues; (ii)  
the  manufacture  of   prefabricated   plastic   orthotic   devices  that  are  
mass-produced  and sold to  distributors  and patient  care  providers,  which  
account  for  approximately  38%  of  its  annual  revenues;   and  (iii)  the  
fabrication of custom-made prosthetic devices, which account for approximately  
1% of its annual  revenues.  A significant  product  manufactured  and sold by  
DOBI-Symplex is the custom-made  Charleston  Bending Brace, an orthotic device  
designed for nocturnal use to correct spinal curvature in adolescents.          

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   On December 31, 1992,  DOBI-Symplex,  as a wholly-owned subsidiary of the
Company,  acquired from 3M  substantially  all of 3M's assets  relating to the  
custom  derotation knee brace business  primarily known in the O&P industry as  
the "Lenox  Hill"  derotation  knee  brace.  The  purchase  of 3M's Lenox Hill  
derotation  knee brace business  complements the  manufacturing  activities of  
DOBI-Symplex,  which include the fabrication of custom-made  plastic  orthotic  
devices and the manufacture of  pre-fabricated  plastic orthotic  devices.  In  
June 1996, the Company  developed the LH Custom 2 derotation  knee brace which  
has replaced the Lenox Hill custom derotation knee brace.                       

   On September 1, 1993, DOBI-Symplex purchased from 3M substantially all of
3M's assets relating to its off-the-shelf  Precision-Fit  knee brace business.  
The  purchase  of  the   off-the-shelf   Precision-Fit   knee  brace  business  
complements the custom Lenox Hill derotation knee brace business.               

   On  April  15,  1994,  the  Company   acquired  from  Brunswick   Medical
Corporation  substantially  all  the  assets  relating  to the  custom  fitted  
thermo-plastic  spinal  brace  business  primarily  known as  Ortho-Mold.  The  
purchase of the Ortho-Mold business  complements the manufacturing  activities  
of  DOBI-Symplex,  which  includes the  pre-fabricated  plastic  insert to the  
Ortho-Mold product.                                                             

   To provide  timely custom  fabrication  and service to its patients,  the
Company employs technical personnel and maintains  laboratories at each of its  
patient care centers.  Hanger also  maintains  several  larger,  fully staffed  
central  fabrication  facilities  to service its patient care  centers.  These  
centrally-located  facilities  enable  Hanger to fabricate  those O&P products  
which  are more  easily  produced  in  larger  quantities  and in a more  cost  
effective  manner,  as well as serving as an auxiliary  production  center for  
products normally  fabricated at individual patient care centers.  The Company  
believes  that the  laboratories  in its patient care centers are critical for  
the provision of patient care services.                                         

PATIENT REIMBURSEMENT SOURCES                                                   

   The  principal  reimbursement  sources for Hanger's O&P services are: (i)
private  payor/third-party  insurer  sources  which  consist  of  individuals,  
private insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation,  
workers' compensation and similar sources; (ii) Medicare, which is a federally  
funded  health  insurance  program  providing  health  insurance  coverage for  
persons age 65 or older and certain disabled persons, and Medicaid, which is a  
health  insurance  program  jointly  funded by Federal  and state  governments  
providing  health  insurance  coverage for certain  persons in financial need,  
regardless of age, and which may supplement  Medicare benefits for financially  
needy  persons  aged  65 or  older;  and  (iii)  the  United  States  Veterans  
Administration,  with which Hanger has entered  into  contracts to provide O&P  
services.                                                                       

   Medicare, Medicaid, the United States Veterans Administration and certain
state  agencies  have set maximum  reimbursement  levels for  payments for O&P  
services and products.  The healthcare policies and programs of these agencies  
have been  subject to changes in  payment  and  methodologies  during the past  

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several  years.  There can be no assurance that future changes will not reduce  
reimbursements for O&P services and products from these sources.                

   The  Company  provides  O&P  services to  eligible  veterans  pursuant to
several contracts with the United States Veterans  Administration.  The United  
States  Veterans  Administration   establishes  rates  for  reimbursement  for  
itemized  products and  services  under  contracts,  which expire in September  
1997,  with the option to renew for a one or two year period.  The  contracts,  
awarded on a non-exclusive basis, establish the amount of reimbursement to the  
eligible  veteran if the veteran  should choose to use the Company's  products  
and  services.   The  Company  has  been  awarded   United   States   Veterans  
Administration  contracts  in  the  past  and  expects  that  it  will  obtain  
additional contracts when its present agreements expire.                        

   The Omnibus Budget  Reconciliation  Act of 1990 ("OBRA 1990"),  which was
enacted on  November  5, 1990,  provides  for the  separate  treatment  of O&P  
reimbursement  and the general category of durable medical  equipment  ("DME")  
reimbursement  for Medicare  purposes.  Previously,  O&P devices were included  
within the DME category which failed to acknowledge  the fact that O&P devices  
are custom  fabricated  and subjected O&P to the same budget  reductions  that  
were  applicable  to  DME.  The  separate  recognition  of  O&P  for  Medicare  
reimbursement  purposes  will enable O&P to have its own budget  estimates and  
administration  process in connection  with the  regulatory  activities of the  
United States Health Care Financing Administration ("HCFA").  Pursuant to OBRA  
1990,  HCFA has  established  separate  professional  O&P fee  schedules  that  
generally  reflect the cost of O&P services.  Effective  January 1, 1992, HCFA  
commenced  the  regionalization  of O&P fee  schedules  whereby  regional  fee  
schedule  averages may not exceed 125% of the  national fee schedule  average.  
OBRA 1990's separation of O&P from DME for Medicare reimbursement purposes has  
not adversely affected the Company.                                             

COMPETITION                                                                     

   The O&P industry is highly fragmented, with approximately 1,230 certified
facilities  providing  patient care services in the United  States.  There are  
also several regional and multi-regional competitors which operate a number of  
patient  care  centers.  The  competition  among O&P patient  care  centers is  
primarily for referrals from physicians,  therapists,  employers,  HMOs, PPOs,  
hospitals, rehabilitation centers, out-patient clinics and insurance companies  
on both a local and  regional  basis.  In addition to O&P  facilities,  Hanger  
competes with other providers of O&P services,  such as hospitals,  physicians  
and therapists.  The Company believes that distinguishing  competitive factors  
in the O&P industry are quality and timeliness of patient care, service to the  
customer and referring  source and, to a lesser degree,  charges for services.  
While the Company believes it is one of the largest  suppliers of O&P services  
in the U.S.,  certain  competitors  may have greater  financial  and personnel  
resources than Hanger. Hanger competes with others in the industry for trained  
personnel.  To date,  however,  Hanger has been able to achieve  its  staffing  
needs and has experienced a relatively low turnover rate of employees.          

   The  Company  has  not  encountered  significant  competition  to date in
connection with its acquisition of other O&P businesses. However, no assurance  
can be given that such competition will not be encountered in the future.       

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GOVERNMENT REGULATIONS AND O&P CERTIFICATION                                    

   Certain state and Federal agencies require that  practitioners  providing
services to such agencies be certified by the American Board for Certification  
in Orthotics and Prosthetics  (the "ABC").  Hanger's  practitioners  currently  
comply with all such  requirements.  Hanger  provides  services  under various  
contracts to such Federal agencies. These contracts are subject to regulations  
governing  Federal  contracts,  including  the  ability of the  government  to  
terminate for its convenience.  Revenue from such contracts is not material to  
Hanger.                                                                         

   The  Company's  manufactured  or  fabricated  devices  are not subject to
approval or review of the U.S. Food and Drug  Administration nor are there any  
requirements for  governmental  certification of orthotists or prosthetists or  
accreditation of Hanger's facilities.                                           

   The  ABC  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 year of staff experience at a patient care center under  
the  supervision  of a certified  practitioner  and  successful  completion of  
certain examinations.  Minimum requirements for an ABC-accredited patient care  
center include the presence of a certified practitioner and specific plant and  
equipment requirements.                                                         

EMPLOYEES                                                                       

   As of March  21,  1997,  Hanger  had 996  full-time  employees.  Of these
employees,  562 are patient  care  practitioners.  The balance are  executive,  
sales and administrative personnel. None of the Company's employees is subject  
to a collective bargaining  agreement.  The Company considers its relationship  
with its employees to be good.                                                  

INSURANCE                                                                       

   The Company currently  maintains  insurance of the type and in the amount
customary in the orthopedic  rehabilitation  industry,  including coverage for  
malpractice liability,  product liability,  workers' compensation and property  
damage. Hanger's general liability insurance coverage is at least $500,000 per  
incident. Based on the Company's experience and prevailing industry practices,  
Hanger believes its coverage is adequate as to risks and amount.                

ITEM 2.  PROPERTIES.                                                            

   As of December  31,  1996,  Hanger  operated 178 patient care centers and
facilities in 28 states and in Washington, D.C. Of these, 25 centers are owned  
by Hanger.  The remaining  centers are occupied under leases expiring  between  
the years of 1997 and 2007.  Hanger  believes that the centers leased or owned  
by it are adequate for carrying on its current O&P  operations at its existing  
locations, as well as its anticipated future needs at those locations.  Hanger  
believes  it will be  able  to  renew  such  leases  as  they  expire  or find  
comparable or additional space on commercially suitable terms.                  

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   Hanger also owns distribution facilities in Georgia and Texas, and leases
manufacturing and distribution facilities in Illinois,  Maryland,  Florida and  
California.  The  Company  leases  its  corporate  headquarters  in  Bethesda,  
Maryland and owns its corporate office in Alpharetta,  Georgia.  Substantially  
all of Hanger's properties are pledged to collateralize bank indebtedness. See  
Notes H and L to Hanger's Consolidated Financial Statements.                    

ITEM 3.  LEGAL PROCEEDINGS.                                                     

   Legal proceedings to which Hanger is subject arise in the ordinary course
of  business.  Currently,  Hanger  is  not  a  party  to  any  material  legal  
proceedings.                                                                    

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  the  Company's
current executive officers:                                                     

                                                                · Download Table

                                   Office with                      Appointed 
         Name           Age        the Company                      to Office 
        ------         -----      -------------                    -----------
                                                                              
Ivan R. Sabel, CPO      52         Chairman of the Board,             1987    
                                   President, Chief Executive                 
                                   Officer and Director                       

Richard A. Stein        37         Vice President-Finance,            1987    
                                   Secretary and Treasurer                    

   IVAN R. SABEL has been Chairman of the Board and Chief Executive  Officer
of Hanger since August 1995 and President  since November 1987. Mr. Sabel also  
served as Chief Operating Officer of Hanger from November 1987 to August 1995.  
Prior to that time, Mr. Sabel was Vice President - Corporate  Development from  
September 1986 to November  1987.  From 1968 until joining Hanger in 1986, Mr.  
Sabel was the founder and President of Capital Orthopedics,  Inc. Mr. Sabel is  
a Certified  Prosthetist  and  Orthotist  ("CPO"),  a clinical  instructor  in  
orthopedics at Georgetown  University  Medical  School in Washington,  D.C., a  
member of the Board of  Directors  of the  American  Orthotic  and  Prosthetic  
Association,   a  former  Chairman  of  the  National  Commission  for  Health  
Certifying Agencies, a former member of the Strategic Planning Committee and a  
current  member  of  the  Veterans  Administration  Affairs  Committee  of the  
American  Orthotic and Prosthetic  Association  and a former  President of the  
American Board for Certification in Orthotics and Prosthetics.                  

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   RICHARD  A.  STEIN has been  Vice  President  -  Finance,  Secretary  and
Treasurer  of Hanger  since April 1987.  Mr.  Stein was also the  President of  
Greiner & Saur  Orthopedics,  Inc., a former  subsidiary of the Company,  from  
April 1987 until November 1989. Mr. Stein is a Certified Public Accountant and  
was  employed by Coopers & Lybrand,  LLP from  September  1982 until he joined  
Hanger in 1987.                                                                 

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PART II 

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. 

   The following table sets forth for the periods indicated the high and low
closing sales prices per share for the Common Stock on the AMEX:                

                                                                · Download Table

      1996                     High                     Low    
---------------------------------------------------------------
                                                               
First Quarter                 $ 4.625                 $ 2.6875 
Second Quarter                  6.3125                  4.0625 
Third Quarter                   7.250                   5.000  
Fourth Quarter                  7.125                   5.9375 

                                                                · Download Table

      1995                     High                     Low    
---------------------------------------------------------------
                                                               
First Quarter                 $ 3.250                 $ 2.500  
Second Quarter                  3.500                   2.190  
Third Quarter                   3.875                   2.750  
Fourth Quarter                  3.500                   2.560  

   As of March 21,  1997  there  were 814  holders  of record of the  Common
Stock.                                                                          

DIVIDEND POLICY                                                                 

   The Company has never paid cash dividends on its Common Stock and intends
to continue  this policy for the  foreseeable  future.  Hanger plans to retain  
earnings for use in its business.  The terms of Hanger's  agreements  with its  
financing  sources  and  certain  other  agreements  prohibit  the  payment of  
dividends on its 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 the Board of  
Directors  of the  Company  and  will be  dependent  on  Hanger's  results  of  
operations,  financial  condition,  contractual and legal restrictions and any  
other factors deemed to be relevant.                                            

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ITEM 6.  SELECTED CONSOLIDATED FINANCIAL INFORMATION.                           

   The selected financial  information presented below has been derived from
the consolidated financial statements of the Company.                           

                                                        · Enlarge/Download Table
                                                            SELECTED FINANCIAL STATEMENTS                     
                                                        (In thousands, except per share data)                 


                                                                Years Ended December 31,                      
                                          ------------------------------------------------------------------  
                                           1992           1993           1994           1995           1996   
                                           ----           ----           ----           ----           ----   
                                                                                                              
Statement of Operations Data:                                                                                 
Net sales                                 $32,406        $43,877        $50,300        $52,468        $66,806 
Gross profit                               17,277         24,207         27,091         27,896         34,572 
Selling, general & administrative          13,064         17,124         21,340         19,362         24,550 
Depreciation and amortization               2,100          2,655          3,137          2,691          2,848 
Acquisition and Integration Costs (1)         ---            ---            ---            ---          2,479 
Restructuring cost (1)                        ---            ---            460            ---            --- 
Loss from disposal of assets (1)              ---            ---          2,150            ---            --- 
Income from operations                      2,113          4,428              4          5,843          4,695 
Interest expense                           (1,279)        (1,167)        (1,746)        (2,056)        (2,546)
Income (loss) from continuing operations                                                                      
   before taxes, extraordinary item and                                                                       
   accounting change                          807          3,221         (1,922)         3,680          1,971 
Provision for income taxes                    487          1,626            358          1,544            890 
Income (loss) from continuing operations                                                                      
   before extraordinary item and                                                                              
   accounting change                          320          1,595         (2,280)         2,135          1,081 
Loss from discontinued operations (2)         (35)          (105)          (407)           ---            --- 
Income (loss) before extraordinary                                                                            
   item and accounting change                 285          1,490         (2,687)           ---          1,081 
Extraordinary loss on early                                                                                   
   extinguishment of debt                  (1,139)           (23)           ---            ---            (83)
Cumulative effect of change in                                                                                
   accounting for income taxes                ---          1,190            ---            ---            --- 
Net income (loss)                         $  (854)       $ 2,655        $(2,687)       $ 2,135        $   998 
Income (loss) per common share:                                                                               
Income (loss) from continuing operations                                                                      
    before extraordinary item and                                                                             
    accounting change                     $  0.03        $  0.19        $ (0.28)       $  0.26        $  0.12 
Loss from discontinued                                                                                        
   operations                                 ---          (0.01)         (0.05)           ---            --- 
Extraordinary loss on early                                                                                   
   extinguishment of debt                   (0.15)           ---            ---            ---          (0.01)
Cumulative effect of change in                                                                                
   accounting for income taxes                ---           0.14            ---            ---            --- 

Net income (loss) per share (3)           $ (0.12)       $  0.32        $ (0.33)       $  0.26        $  0.11 

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                                                        · Enlarge/Download Table
                                                1992           1993           1994     1995     1996  
                                                ----           ----           ----     ----     ----  
                                                                                                      
Balance Sheet Data:                                                                                   
Working capital                                $11,887        $15,738        $18,412  $20,622  $25,499
Total assets                                    47,996         56,571         61,481   61,800  134,941
Long-term debt                                  14,970         19,153         24,330   22,925   64,298
Redeemable preferred stock                         194            212            232      254      278
Shareholders' equity                            28,564         31,681         29,178   31,291   39,734

<FN>                                                                                                  

     (1) The 1994 results includes  restructuring costs of $460,000 associated                        
         with the closing of unprofitable patient care centers and a loss from                        
         the disposal of assets of $2,150,000  resulting from the 1995 sale of                        
         the Company's  southern  California  patient care  centers.  The 1996                        
         results  includes  acquisition  and  integration  costs of $2,479,000                        
         incurred in connection with the purchase of SEH. See Notes F and D to                        
         the Company's Consolidated Financial Statements, respectively.                               

     (2) Loss  from  discontinued   operations   consists  of  the  loss  from                        
         discontinued operations and the sale of the discontinued operation of                        
         the Company's Apothecaries, Inc. subsidiary, the assets of which were                        
         sold in 1994.  See  Note E to the  Company's  Consolidated  Financial                        
         Statements.                                                                                  

     (3) Income (loss) per common share has been adjusted for preferred  stock                        
         dividends.                                                                                   
</FN>                                                                                                 

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ITEM 7.  MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND  
RESULTS OF OPERATIONS.                                        

   Set  forth  below  is a  discussion  of  the  results  of  the  Company's
operations  for the years ended  December  31,  1994,  1995 and 1996,  and the  
Company's liquidity and capital resources at December 31, 1996. The discussion  
which  follows   should  be  read  in  conjunction   with  Hanger's   Selected  
Consolidated  Financial  Statements and the Consolidated  Financial Statements  
included elsewhere herein.                                                      

RESULTS OF OPERATIONS                                                           

   On November 1, 1996, the Company  acquired SEH in a transaction  that was
accounted for under the purchase method.  Therefore,  the  acquisition,  which  
increased  the number of the  Company's  patient  care  centers  from 93 in 15  
states and the  District of  Columbia to 178 in 28 states and the  District of  
Columbia  and  significantly  expanded  its  distribution  capabilities,  only  
impacted  two months of  reported  1996  results of  operations.  The  Company  
believes  that its  results  of  operations  for 1997 will fully  reflect  the  
increased level of revenues experienced during the last two months of 1996. In  
addition,  the Company believes that as a result of the Company's  recognition  
in late 1996 of certain  non-recurring  costs incurred in connection  with the  
SEH  acquisition  and  integration  of the companies'  operations,  as well as  
certain  post-acquisition cost savings expected to be realized,  the Company's  
1997 profitability is expected to be enhanced.                                  

   Growth  in net  sales  during  the last  three  fiscal  periods  has been
achieved principally through acquisitions and growth in net sales attributable  
to patient care centers and facilities that were in operation during the three  
periods.  Gross  profit as a  percent  of net  sales  has  fluctuated  between  
approximately 52% and 54% during these periods. The decline in gross profit as  
a  percent  of net  sales  in 1996  was  primarily  attributable  to  Hanger's  
acquisition,  effective  November  1,  1996,  of SEH which  operated  not only  
patient care centers,  but a large distribution  division that had lower gross  
profit margins than patient care services. Selling, general and administrative  
expenses have  fluctuated  between 37% and 42% as a percent of net sales.  The  
decrease in general and  administrative  expenses as a percent of net sales in  
1995 and 1996 is primarily a result of executing the 1994  restructuring  plan  
discussed below.                                                                

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

                                                        · Enlarge/Download Table

                                                                       Historical                 
                                                             For the Years Ended December 31      
                                                      --------------------------------------------
                                                      1994 (1)           1995 (2)         1996 (3)
                                                      ----               ----             ----    
                                                                                                  
Net Sales                                             100.0%             100.0%           100.0%  
Cost of products and services sold                     46.1               46.8             48.2   
Gross profit                                           53.9               53.2             51.8   
Selling, general and administrative expenses           42.4               36.9             36.7   
Depreciation and amortization                           4.8                3.8              3.0   
Acquisition and Integration Costs                                                           3.7   
Amortization of excess cost over net                                                              
  assets acquired                                       1.4                1.3              1.2   
Restructuring cost                                       .9                                       
Loss from disposal of assets                            4.3                                       
Income from operations                                   .0               11.1              7.0   
Interest expense                                        3.5                3.9              3.8   
Income (loss) from continuing operations               (3.8)               7.0              3.0   
Income taxes                                             .7                2.9              1.3   
Loss from discontinued operations                       (.8)                                      
Net income (loss)                                      (5.3)               4.1              1.5   

<FN>                                                                                              

     (1) Includes all companies  listed for the entire period:  Columbia Brace                    
         Shop from January 3, 1994,  Orthotic and  Prosthetic  Division of M-D                    
         Medical, a Division of Health Industries,  Inc. from January 7, 1994,                    
         Pedi-Mac Shoe Company,  Inc. from January 31, 1994,  Ortho-Mold  from                    
         April 15, 1994 and J.E.  Hanger,  Inc. of New England from October 7,                    
         1994.                                                                                    

     (2) Includes all companies  listed in footnote (1) for the entire period,                    
         as well as Summit  Prosthetics  and  Orthotics  from January 5, 1995,                    
         Gulf Coast Orthopaedic  Supply, Inc. from March 17, 1995 and excludes                    
         the nine patient care centers sold or closed during 1994.                                

     (3) Includes all companies  listed in footnote (1) and (2) for the entire                    
         period, as well as SEH from November 1,1996.                                             
</FN>                                                                                             

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995           

   Net sales for the year ended December 31, 1996 amounted to  approximately
$66,806,000,  an increase of approximately $14,338,000, or 27%, over net sales  
of  approximately  $52,468,000  for the year  ended  December  31,  1995.  The  
increase  was   primarily  a  result  of:  (i)  an  increase  of   $12,257,000  
attributable to O&P patient care centers and facilities acquired in late 1996,  
and (ii) an  increase  of  $2,081,000,  or an  increase  of 5%,  in net  sales  
attributable  to patient  care centers and  facilities  that were in operation  
during both periods ("Internal Base Net Sales"). Of the $2,081,000 increase in  
Internal Base Net Sales, $1,900,000, or an increase of 5%, was attributable to  
patient  care  centers and  $181,000 was  attributable  to  manufacturing  and  
distribution activities.                                                        

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   Gross profit in 1996 increased approximately $6,677,000, or 24%, over the
prior year.  Gross profit as a percent of net sales decreased from 53% in 1995  
to 52% in 1996.  The 1% decrease in gross  profit as a percent of net sales is  
primarily  attributable to the acquisition  effective November 1, 1996, of SEH  
which  operated a large  distribution  division  that had lower  gross  profit  
margins than patient care services. The cost of products and services sold for  
the year  ended  December  31,  1996,  amounted  to  $32,234,000  compared  to  
$24,572,000 in 1995.                                                            

   Selling,   general  and   administrative   expenses  in  1996   increased
approximately  $5,188,000,  or 27%, compared to 1995. The increase in selling,  
general and administrative  expenses was primarily a result of the acquisition  
of SEH in November 1996.  Selling,  general and  administrative  expenses as a  
percent of net sales stayed approximately the same at 37%.                      

   Non-recurring  acquisition and integration  costs totaling  $2,479,000 in
1996   consisted  of:  (i)   $1,300,000   of  bonuses  and   non-capitalizable  
professional  acquisition  advisory  support service costs incurred to acquire  
SEH; and (ii)  $1,200,000 of costs to integrate the operations of SEH with the  
Company.                                                                        

   Principally  as a result of the above,  income  from  operations  in 1996
totalled  approximately  $4,695,000,  a decrease of $1,148,000 below the prior  
year. Income from operations as a percent of net sales in 1996 decreased to 7%  
from 11% in 1995.                                                               

   Interest  expense  for the year  ended  December  31,  1996  amounted  to
approximately  $2,546,000,  which is an increase of $490,000, or 24%, over the  
$2,056,000 of interest  expense  incurred  during the year ended  December 31,  
1995.  The  increase in interest  expense was  primarily  attributable  to the  
increase in bank debt resulting from the  acquisition of SEH in November 1996.  
Interest  expense  as a  percent  of net  sales  was 3.8%  for the year  ended  
December 31, 1996, compared to 3.9% for 1995.                                   

   The Company's  effective tax rate was 42.3% in 1996 versus 41.9% in 1995.
The increase in 1996 reflects  both the  recognition  of a state  deferred tax  
benefit in 1995, which did not occur in 1996 and the disproportional impact of  
permanent differences in relation to taxable income.                            

   As a result of the above,  the Company  reported  income from  operations
before  extraordinary  item and  accounting  change of $1,081,000 for the year  
ended  December 31, 1996,  compared to $2,135,000 for the prior year. A pretax  
$139,000 (after tax $83,000)  extraordinary  loss on early  extinguishment  of  
debt was  recognized in 1996 in connection  with the Company's  refinancing of  
bank indebtedness.                                                              

   As a result of the above, the Company reported net income of $998,000, or
$.11 per share,  for the year ended  December  31,  1996,  as  compared to net  
income of $2,135,000, or $.26 per share, for the year ended December 31, 1995.  

YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994           

   Net sales for the year ended December 31, 1995 amounted to  approximately
$52,468,000,  an increase of approximately $2,168,000, or 4.3%, over net sales  
of  approximately  $50,300,000  for the year  ended  December  31,  1994.  The  

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increase was primarily a result of an increase of  $2,059,000,  or an increase  
of 5%, in net sales  attributable  to patient care centers and facilities that  
were in operation  during both  periods  ("Internal  Base Net Sales").  Of the  
$2,059,000 increase in Internal Base Net Sales, $1,704,000,  or an increase of  
5%, was  attributable to patient care centers and $355,000 was attributable to  
the Company's  manufacturing and distribution  activities.  The balance of the  
increase  in net  sales was  attributable  to O&P  patient  care  centers  and  
facilities  acquired  by the  Company in late 1994 and 1995.  The  increase of  
$2,168,000 in net sales occurred  notwithstanding  the sale or closure of nine  
patient  care  centers  during  late  1994 and the  first  quarter  of 1995 in  
connection  with the  restructuring  (the  "Restructuring")  undertaken by the  
Company in 1994 and  consummated in March 1995.  These nine centers  accounted  
for net sales of $1,770,000  during the year ended  December 31, 1994 compared  
with only $74,000 during the year ended December 31, 1995.                      

   Gross profit increased by approximately $805,000, or 3.0%, over the prior
year.  Gross profit as a percent of net sales  decreased from 53.9% in 1994 to  
53.2% in 1995.  The cost of  products  and  services  sold for the year  ended  
December 31, 1995 amounted to $24,572,000 compared to $23,209,000 for the year  
ended  December 31,  1994.  Gross profit as a percent of net sales for patient  
care services remained the same during 1994 and 1995 at 53%. Gross profit as a  
percent of net sales for manufacturing  and distribution  declined from 37% in  
1994 to 36% in 1995. This decline resulted  principally from pricing pressures  
in the distribution and manufacturing divisions.                                

   Selling,  general  and  administrative  expenses  in  1995  decreased  by
approximately $1,978,000, or 9.3%, compared to 1994. In addition to decreasing  
in dollar amount, selling, general and administrative expenses as a percent of  
net sales  decreased to 36.9% for the year ended  December 31, 1995 from 42.4%  
of net sales for the year ended  December 31,  1994.  The decrease in selling,  
general and  administrative  expenses  was  primarily a result of the sale and  
closure of nine patient care centers during late 1994 and the first quarter of  
1995 in connection with the  Restructuring  undertaken by the Company in 1994,  
and  consummated  in March 1995.  These nine  centers  accounted  for selling,  
general  and  administrative  expenses  of  $1,043,000  during  the year ended  
December 31, 1994  compared with only $67,000  during the year ended  December  
31,  1995.  The  remaining  reduction in selling,  general and  administrative  
expenses was primarily a result of additional cost cutting at the patient care  
center level.                                                                   

   Principally  as a result of the above,  income  from  operations  in 1995
totalled  approximately  $5,843,000,  an increase of $5,839,000 over the prior  
year.  Income from  operations as a percent of net sales increased 11% in 1995  
as compared to 1994.                                                            

   Interest  expense  for the year  ended  December  31,  1995  amounted  to
approximately $2,056,000, which is an increase of $310,000, or 17.8%, over the  
$1,746,000 of interest  expense  incurred  during the year ended  December 31,  
1994. The increase in interest expense was primarily attributable to the facts  
that (i) average  borrowings in 1995 were $1.8 million higher than the average  
borrowing  during 1994, and (ii) borrowing  rates from the bank were 1% higher  
in 1995 when compared to 1994.                                                  

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   The  provision  for  income  taxes  in  1995  amounted  to  approximately
$1,544,000,  as compared to $358,000 in 1994.  The increase of $1,186,000  was  
primarily a result of a $5,839,000  increase in income from  operations  and a  
reduction  in the  non-tax  deductible  amortization  of excess  cost over net  
assets acquired, offset by the reversal of the valuation allowance relating to  
state net operating loss carryforwards.                                         

   As a result of the above,  the Company reported net income of $2,135,000,
or $.26 per share,  for the year ended December 31, 1995, as compared to a net  
loss of $2,687,000, or $.33 per share, for the year ended December 31, 1994.    

LIQUIDITY AND CAPITAL RESOURCES                                                 

   The  Company's  consolidated  working  capital at  December  31, 1996 was
approximately  $25,499,000.  Cash and cash equivalents  available at that date  
was approximately  $6,572,000.  The Company's cash resources were satisfactory  
to meet its  obligations  during the year ended  December 31, 1996. It is also  
anticipated  that such  cash  resources  will  adequately  meet the  Company's  
obligations during 1997.                                                        

   The  Company's  total  long-term  debt at December 31, 1996,  including a
current portion of approximately  $4,903,000,  was approximately  $69,200,000.  
Such  indebtedness   included:   (i)  $57,000,000  borrowed  under  term  loan  
agreements with Banque Paribas;  (ii)  $6,000,000,  net of discount,  borrowed  
under 8% Senior  Subordinated  Notes; and (iii) a total of $6,200,000 of other  
indebtedness.                                                                   

   On November 1, 1996, the Company repaid the outstanding balance under its
$13.0  million  revolving  credit  agreement  and its  senior  term loans with  
NationsBank,  N.A. and $5.0 million of Convertible Junior  Subordinated Notes,  
with a portion of the proceeds  received from new term loans  provided on that  
date by Banque Paribas (the "Bank"), as agent for a syndication of banks.       

   Under the terms of a new  Financing  and Security  Agreement  between the
Bank and the Company,  the Bank provided up to $90.0 million  principal amount  
of senior financing (the "Senior Financing Facilities") that includes: (i) $57  
million of term loans (the "Term Loans") for use in  connection  with Hanger's  
acquisition  of  SEH,  (ii)  a  $8.0  million  revolving  loan  facility  (the  
"Revolver"),  and (iii) up to $25 million  principal  amount of loans under an  
acquisition loan facility (the "Acquisition Loans") for use in connection with  
future  acquisitions.  As of December 31, 1996 the Company had no  outstanding  
balances under the Revolver or the Acquisition Loan Facilities.                 

   Of the Term Loans,  approximately  $29.0 million principal amount (the "A
Term Loan") will be amortized in quarterly amounts and will mature on December  
31,  2001,  and $28.0  million  principal  amount  (the "B Term Loan") will be  
amortized in quarterly amounts and will mature on December 31, 2003. The final  
maturity of any loans under the Revolver and Acquisition  Loans will mature on  
November 1, 2001.  The Senior  Financing  Facilities  provided  for an initial  
commitment  fee of .5% on the total  $90,000,000  facility.  In  addition,  an  
unused  commitment  fee of .5% of 1% per  year on the  unused  portion  of the  

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Revolver and the  Acquisition  Loan  facilities  will be payable  quarterly in  
arrears.                                                                        

   The above  Senior  Financing  Facilities  are  collateralized  by a first
priority security interest in all of the common stock of Hanger's subsidiaries  
and all assets of Hanger and its subsidiaries.  At Hanger's option, the annual  
interest  rate will be adjusted  to be either  LIBOR plus 2.75% or a Base Rate  
(as  defined  below)  plus 1.75% in the case of the A Term  Loan,  Acquisition  
Loans and Revolver  borrowings,  and adjusted  LIBOR plus 3.25% or a Base Rate  
plus 2.25% in the case of the B Term Loan.  The "Base  Rate" is defined as the  
higher of (i) the federal  funds rate plus .5%,  or (ii) the prime  commercial  
lending rate of Chase Manhattan Bank, N.A., as announced from time to time.     

   All or any portion of outstanding loans under any of the Senior Financing
Facilities  may be prepaid at any time and  commitments  may be  terminated in  
whole or in part at the option of Hanger  without  premium or penalty,  except  
that  LIBOR  - based  loans  may  only  be  paid at the end of the  applicable  
interest  period.  Mandatory  prepayments  will be  required  in the  event of  
certain  sales of assets,  debt or equity  financings  and under certain other  
circumstances.                                                                  

   In addition,  on November 1, 1996, the Company borrowed $8.0 million from
the Bank and  Chase  Venture  Capital  Associates  L.P.  in the form of Senior  
Subordinated Notes ("Subordinated Notes") with detachable Warrants.             

   Cash interest on the Subordinated Notes, which will mature on November 1,
2004, will be payable  quarterly at an annual rate of 8%;  provided,  however,  
that Hanger will be permitted,  in lieu of cash interest, to pay interest in a  
combination of cash and additional  Subordinated  Notes ("PIK Interest Notes")  
at the above interest rate. In that event, interest paid in cash will be at an  
annual rate of 3.2% and interest  paid in the form of PIK Interest  Notes will  
be paid at an annual rate of 4.8%. The Subordinated Notes will be subordinated  
to loans under the Senior Financing Facilities. Hanger will, at its option, be  
entitled  to redeem the  Subordinated  Notes at any time at their  liquidation  
value. Hanger must use 100% of the proceeds from any future public offering of  
its equity securities to repurchase the Subordinated Notes, if permitted under  
the Senior Financing Facilities.                                                

   The  detachable  Warrants  issued  by  Hanger  in  conjunction  with  the
Subordinated Notes represent 1.6 million shares of Hanger Common Stock with an  
exercise price equal to: (a) $4.01 as to 929,700 shares,  and (b) $6.375 as to  
670,300 shares.  Up to 50% of the Warrants  (representing up to 800,000 shares  
of Hanger Common  Stock) will be terminated  upon the repayment of 100% of the  
Subordinated  Notes  on or  prior  to May 1,  1998.  An  additional  5% of the  
Warrants  (representing  up to 80,000  shares of Hanger  Common Stock) will be  
terminated upon the repayment of 100% of the Subordinated Notes on or prior to  
November 1, 1997.  Warrants will be terminated  pro-rata  across the above two  
exercise prices.                                                                

   The  Company  plans to finance  future  acquisitions  through  internally
generated  funds or borrowings  under the Acquisition  Loans,  the issuance of  
notes or shares of  common  stock of the  Company,  or  through a  combination  
thereof.                                                                        

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   The Company is actively  engaged in ongoing  discussions with prospective
acquisition candidates. The Company plans to continue to expand its operations  
aggressively through acquisitions.                                              

   On  November  1,  1996,  Hanger  acquired  SEH,  in a merger  transaction
effected  pursuant to an  Agreement  and Plan of Merger,  dated as of July 29,  
1996 (the "Merger  Agreement"),  by and among Hanger,  SEH and JEH Acquisition  
Corporation, a Georgia corporation ("Acquisition") wholly-owned by Hanger. The  
Merger Agreement provided for the merger of Acquisition with and into SEH (the  
"Merger"),  as a result  of which  SEH  became a  wholly-owned  subsidiary  of  
Hanger,  effective November 1, 1996. Pursuant to the Merger Agreement,  Hanger  
paid a total of $44  million and issued a total of  approximately  one million  
shares of Hanger common stock in exchange for all of SEH's outstanding  common  
stock on November 1, 1996,  and paid an  additional  $1,783,000  to former SEH  
shareholders on March 27, 1997 pursuant to provisions in the Merger  Agreement  
calling for a post-closing adjustment.                                          

OTHER                                                                           

   Inflation has not had a significant  effect on the Company's  operations,
as  increased  costs to the Company  generally  have been offset by  increased  
prices of products and services sold.                                           

   The Company has entered  into an interest  rate swap  agreement to reduce
the impact of  changes in  interest  rates on its A Term Loan  Commitment.  At  
December 31, 1996, the Company had an outstanding interest rate swap agreement  
with  a  commercial  bank,  having  a  total  notional   principal  amount  of  
$28,500,000.  The agreement  effectively minimizes the Company's base interest  
rate exposure between a floor of 5.32% and a cap of 7%. The interest rate swap  
agreement matures on September 30, 1999. The Company is exposed to credit loss  
in the event of  non-performance  by the other party to the interest rate swap  
agreement.  However,  the Company does not anticipate  non-performance  by the  
counterparty.  All other debt  accrues  interest  at a fixed rate except the B  
Term Loan  Commitment  which accrues  interest at a floating  rate. A material  
change in interest  rates  could have a  significant  impact on the  Company's  
operating results.                                                              

   This  report  contains  forward-looking   statements  setting  forth  the
Company's   beliefs  or   expectations   relating  to  future   revenues   and  
profitability. Actual results may differ materially from projected or expected  
results  due to  changes  in the demand for the  Company's  O&P  services  and  
products,  uncertainties  relating  to the results of  operations  or recently  
acquired and newly acquired O&P patient care practices,  the Company's ability  
to attract  and retain  qualified  O&P  practitioners,  governmental  policies  
affecting  O&P  operations  and other risks and  uncertainties  affecting  the  
health-care industry generally.                                                 

   The  preparation  of financial  statements in conformity  with  generally
accepted  accounting  principles  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. Actual results could differ from those estimates.             

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   The Company primarily provides  customized devices or services throughout
the United States and is  reimbursed,  in large part,  by the patients'  third  
party insurers or governmentally funded health insurance programs. The ability  
of the Company's  debtors to meet their  obligations is principally  dependent  
upon the  financial  stability of the insurers of the  Company's  patients and  
future legislation and regulatory actions.                                      

   In March 1997, the Financial  Accounting Standards Board issued Statement
of Financial  Accounting  Standards  ("SFAS") 128,  "Earnings Per Share." This  
statement  established  standards for computing  and  presenting  earnings per  
share  (EPS) and  applies to  entities  with  publicly  held  common  stock or  
potential common stock.  This statement is effective for financial  statements  
issued for periods ending after December 15, 1997. Earlier  application is not  
permitted.  This statement requires reinstatement of all prior-period EPS data  
presented. The Company is currently evaluating the impact, if any, adoption of  
SFAS 128 will have on its financial statements.                                 

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ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.                           

   The consolidated  financial  statements and schedules  required hereunder
and  contained  herein are listed under Item 14(a)  below.  The Company is not  
subject to the  requirement  to file selected  quarterly  financial data under  
Item 302 of Regulation S-K.                                                     

ITEM 9.  CHANGES IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND  
FINANCIAL DISCLOSURE.                                         

None.                                                         

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PART III  

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.                   

   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  
the  Company's  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 the  Company's  executive  
officers is set forth under Item 4A of this Form 10-K.                          

ITEM 11.  EXECUTIVE COMPENSATION.                                               

   Pursuant to General Instruction G(3) of Form 10-K, the information called
for by this  item is  hereby  incorporated  by  reference  from the  Company's  
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.                                                         

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.        

   Pursuant to General Instruction G(3) of Form 10-K, the information called
for by this  item is  hereby  incorporated  by  reference  from the  Company's  
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.                                                         

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.                        

   Pursuant to General Instruction G(3) of Form 10-K, the information called
for by this  item is  hereby  incorporated  by  reference  from the  Company's  
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.                                                         

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K.       

(a)  Financial Statements and Financial Statement Schedule:   

(1)    Financial Statements:                        

HANGER ORTHOPEDIC GROUP, INC.                                                   

Report of Independent Accountants                                               

Consolidated Balance Sheets as of December 31, 1995                             
and 1996                                                                      

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Consolidated Statements of Operations for the years                             
ended December 31, 1994, 1995 and 1996                                      

Consolidated Statements of Changes in Shareholders' Equity for the years ended  
December 31, 1994, 1995 and 1996                                            

Consolidated Statements of Cash Flows for the years                             
ended December 31, 1994, 1995 and 1996                                      

Notes to Consolidated Financial Statements                                      

(2)    Financial Statements Schedule:             

Report of Independent Accountants                                               

Schedule II - Valuation and qualifying accounts                                 

All other  schedules  are omitted  either  because they are not  applicable or  
required,  or because the required  information  is included in the  financial  
statements or notes thereto:                                                    

                                                                · Download Table

Exhibit No.                         Document                                  
                                                                              
            (b)  Reports on Form 8-K:                                         

                 A Form 8-K reporting  the  Registrant's  acquisition  of J.E.
                 Hanger,  Inc. of  Georgia,  effective  November 1, 1996,  was
                 filed on November 12, 1996.                                  

            (c)  Exhibits:  The  following  exhibits  are  filed  herewith  or
                 incorporated herein by reference:                            

           3(a)  Certificate of Incorporation,  as amended, of the Registrant.
                 (Incorporated  herein  by  reference  to  Exhibit  3.1 to the
                 Registrant's  Annual  Report on Form 10-K for the fiscal year
                 ended September 30, 1988.)                                   

           3(b)  Certificate of Amendment of the  Registrant's  Certificate of
                 Incorporation   (which,  among  other  things,   changed  the
                 Registrant's corporate name from Sequel Corporation to Hanger
                 Orthopedic Group, Inc.), as filed on August 11, 1989 with the
                 Office of the  Secretary of State of Delaware.  (Incorporated
                 herein  by  reference  to  Exhibit  3(b) to the  Registrant's
                 Current Report on Form 10-K dated February 13, 1990.)        

           3(c)  Certificate of Agreement of Merger of Sequel  Corporation and
                 Delaware   Sequel   Corporation.   (Incorporated   herein  by
                 reference to Exhibit 3.1(a) to the Registrant's Annual Report
                 on Form 10-K for the fiscal year ended September 30, 1988.)  

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           3(d)  Certificate  of  Ownership  and Merger of Hanger  Acquisition
                 Corporation  and J. E. Hanger,  Inc. as filed with the Office
                 of the  Secretary of the State of Delaware on April 11, 1989.
                 (Incorporated  herein by  reference  to  Exhibit  2(f) to the
                 Registrant's Current Report on Form 8-K dated May 15, 1989.) 

           3(e)  Certificate  of   Designation,   Preferences  and  Rights  of
                 Preferred  Stock of the  Registrant  as filed on February 12,
                 1990 with the Office of the  Secretary  of State of Delaware.
                 (Incorporated  herein by  reference  to  Exhibit  3(a) to the
                 Registrant's  Current  Report on Form 8-K dated  February 13,
                 1990.)                                                       

           3(f)  By-Laws of the Registrant,  as amended.  (Incorporated herein
                 by reference to Exhibit 3 to the Registrant's  Current Report
                 on Form 8-K dated May 15, 1989.)                             

          10(a)  Registration  Agreement,  dated May 15, 1989,  between Sequel
                 Corporation, First Pennsylvania Bank, N.A., Gerald E. Bisbee,
                 Jr., Ivan R. Sabel,  Richard A. Stein, Ronald J. Manganiello,
                 Joseph M. Cestaro and Chemical  Venture  Capital  Associates.
                 (Incorporated  herein by  reference  to Exhibit  10(l) to the
                 Registrant's Current Report on Form 8-K dated May 15, 1989.) 

          10(b)  First  Amendment  dated  as of  February  12,  1990,  to  the
                 Registration  Agreement,  dated  as of May 15,  1989,  by and
                 among Hanger Orthopedic Group, Inc., First Pennsylvania Bank,
                 N.A., Ivan R. Sabel, Richard A. Stein, Ronald J. Manganiello,
                 Joseph M. Cestaro and Chemical  Venture  Capital  Associates.
                 (Incorporated  herein by  reference  to Exhibit  10(m) to the
                 Registrant's  Current  Report on Form 8-K dated  February 13,
                 1990.)                                                       

          10(c)  Fifth  Amendment,  dated as of November 8, 1990, to the Stock
                 and Note  Purchase  Agreement,  dated as of February 28, 1989
                 and as amended on May 9, 1989,  May 15,  1989,  February  12,
                 1990,  and June 19, 1990 by and among J. E. Hanger,  Inc., as
                 successor  to  Hanger  Acquisition  Corporation,   Ronald  J.
                 Manganiello,  Joseph M.  Cestaro,  Chemical  Venture  Capital
                 Associates  and  Chemical  Equity  Associates.  (Incorporated
                 herein by  reference  to  Exhibit  10(f) to the  Registrant's
                 Current Report on Form 8-K filed on November 21, 1990.)      

          10(d)  Form of Stock Option Agreements, dated as of August 13, 1990,
                 between Hanger  Orthopedic  Group, Inc. and Thomas P. Cooper,
                 James G. Hellmuth, Walter F. Abendschein, Jr., Norman Berger,
                 Bruce B. Grynbaum and Joseph S. Torg. (Incorporated herein by
                 reference to Exhibit 10(rrr) to the Registrant's Registration
                 Statement on Form S-2, File No. 33-37594.) *                 

* Management contract or compensatory plan                                    

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          10(e)  Convertible Junior  Subordinated Note Agreement,  dated as of
                 March 1, 1992, from Hanger  Orthopedic  Group,  Inc. to R. S.
                 Lauder,   Gaspar  &  Co.,  L.P.  regarding   $4,000,000  8.5%
                 Convertible  Junior  Subordinated  Notes due March 31,  1999.
                 (Incorporated  herein by reference to Exhibit 10(jjjj) of the
                 Registrant's  Annual  Report on Form 10-K for the year  ended
                 December 31, 1991.)                                          

          10(f)  Convertible  Junior  Subordinated  Note Agreement dated as of
                 May 7, 1993,  from  Hanger  Orthopedic  Group,  Inc.  to R.S.
                 Lauder,   Gaspar  &  Co.,  L.P.  regarding  $1,000,000  8.25%
                 Convertible  Junior  Subordinated  Notes due March 31,  1999.
                 (Incorporated  herein by  reference  to Exhibit 10 (x) of the
                 Registrant's  Annual  Report on Form 10-K for the year  ended
                 December 31, 1993.)                                          

          10(g)  Amendment No. 1, dated as of May 7, 1993, to the  Convertible
                 Junior Subordinated Note Agreement referred to in Exhibit (x)
                 above. (Incorporated herein by reference to Exhibit 10 (y) of
                 the  Registrant's  Annual  Report  on Form  10-K for the year
                 ended December 31, 1993.)                                    

          10(h)  Employment  and  Non-Compete  Agreement,  dated as of May 16,
                 1994,  between  Hanger  Orthopedic  Group,  Inc.  and Ivan R.
                 Sabel.  (Incorporated  herein by reference to Exhibit 10 (xx)
                 of the  Registrant's  Annual Report on Form 10-K for the year
                 ended December 31, 1994.) *                                  

          10(i)  Employment  and  Non-Compete  Agreement,  dated as of May 16,
                 1994,  between Hanger  Orthopedic  Group, Inc. and Richard A.
                 Stein.  (Incorporated  herein by reference to Exhibit 10 (yy)
                 of the  Registrant's  Annual Report on Form 10-K for the year
                 ended December 31, 1994.) *                                  

          10(j)  Agreement  and Plan of  Merger,  dated  as of July 29,  1996,
                 among  Hanger   Orthopedic   Group,   Inc.,  SEH  Acquisition
                 Corporation and J.E. Hanger,  Inc. of Georgia.  (Incorporated
                 herein by reference to Exhibit 2 to the Registrant's  Current
                 Report on Form 8-K filed on November 12, 1996.)              

          10(k)  Credit  Agreement,  dated  November  1,  1996,  among  Hanger
                 Orthopedic Group, Inc., various banks and Banque Paribas,  as
                 agent.  (Incorporated herein by reference to Exhibit 10(a) to
                 the Registrant's Current Report on Form 8-K filed on November
                 12, 1996.)                                                   

          10(l)  Senior  Subordinated  Note  Purchase  Agreement,  dated as of
                 November 1, 1996, among Hanger Orthopedic Group, Inc. and the
                 purchasers listed therein.  (Incorporated hereby by reference
                 to Exhibit 10(b) to the  Registrant's  Current Report on Form
                 8-K filed on November 12, 1996.)                             

* Management contract or compensatory plan                                    

                                      28                                      

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          10(m)  Warrants to purchase Common Stock of Hanger Orthopedic Group,
                 Inc.  issued  November  1,  1996.   (Incorporated  herein  by
                 reference to Exhibit 10(c) to the Registrant's Current Report
                 on Form 8-K filed on November 12, 1996.)                     

          10(n)  1991  Stock  Option  Plan  of the  Registrant.  (Incorporated
                 herein  by  reference  to  Exhibit  4(b) to the  Registrant's
                 Registration Statement on Form S-8 (File No. 33-48265).)*    

          10(o)  1993   Non-Employee   Directors  Stock  Option  Plan  of  the
                 Registrant. (Incorporated herein by reference to Exhibit 4(b)
                 to the Registrant's  Registration Statement on Form S-8 (File
                 No. 33-63191).)*                                             

          10(p)  Employment and Non-Compete Agreement, dated as of November 1,
                 1996,  and  Amendment  No. 1 thereto,  dated January 1, 1997,
                 between   the   Registrant   and  H.E.   Thranhardt.   (Filed
                 herewith.)*                                                  

          10(q)  Employment and Non-Compete Agreement, dated as of November 1,
                 1996,  between  the  Registrant  and  John  McNeill.   (Filed
                 herewith.)*                                                  

          10(r)  Employment and Non-Compete Agreement, dated as of November 1,
                 1996,  between  the  Registrant  and  Alice  Tidwell.  (Filed
                 herewith.)*                                                  

          11     Computation of earnings per share.                           
          22     List of Subsidiaries of the Registrant.                      
          24     Consent of Coopers & Lybrand L.L.P.                          
          27     Financial Data Schedule.                                     

* Management contract or compensatory plan                                      

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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.                     

                                         HANGER ORTHOPEDIC GROUP, INC.

                                                                · Download Table
                                                                               
Dated:  March 28, 1997                        By: /s/IVAN R. SABEL             
                                                  --------------------------   
                                                  Ivan R. Sabel, CPO           
                                                  Chief Executive Officer      
                                                  (Principal Executive Officer)

Dated:  March 28, 1997                        By: /s/RICHARD A. STEIN          
                                                  --------------------------   
                                                  Richard A. Stein             
                                                  Vice President - Finance     
                                                  (Principal Financial and     
                                                  Accounting Officer)          

   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.                    

                                                                · Download Table
                                                                            
Dated:  March 28, 1997                            /s/IVAN R. SABEL          
                                                  --------------------------
                                                  Ivan R. Sabel, CPO        
                                                  Chief Executive Officer   
                                                  and Director (Principal   
                                                  Executive Officer)        

Dated:  March 28, 1997                            /s/RICHARD A. STEIN       
                                                  --------------------------
                                                  Richard A. Stein          
                                                  Vice President - Finance  
                                                  (Principal Financial and  
                                                  Accounting Officer)       

Dated:  March 28, 1997                            /s/MITCHELL J. BLUTT      
                                                  --------------------------
                                                  Mitchell J. Blutt, M.D.   
                                                  Director                  

                                      30                                    

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Dated:  March 28, 1997                            /s/EDMOND E. CHARRETTE    
                                                  --------------------------
                                                  Edmond E. Charrette, M.D. 
                                                  Director                  

Dated:  March 28, 1997                            /s/THOMAS P. COOPER       
                                                  --------------------------
                                                  Thomas P. Cooper, M.D.    
                                                  Director                  

Dated:  March 28, 1997                            /s/ROBERT J. GLASER       
                                                  --------------------------
                                                  Robert J. Glaser, M.D.    
                                                  Director                  

Dated:  March 28, 1997                            /s/JAMES G. HELLMUTH      
                                                  --------------------------
                                                  James G. Hellmuth         
                                                  Director                  

Dated:  March 28, 1997                            /s/WILLIAM L. MCCULLOCH   
                                                  --------------------------
                                                  William L. McCulloch      
                                                  Director                  

Dated:  March 28, 1997                            /s/DANIEL A. MCKEEVER     
                                                  --------------------------
                                                  Daniel A. McKeever. CP    
                                                  Director                  

Dated:  March 28, 1997                                                      
                                                  --------------------------
                                                  Walter J. McNerney        
                                                  Director                  

Dated:  March 28, 1997                                                      
                                                  --------------------------
                                                  H.E. Tranhardt, CPO       
                                                  Director                  

31  

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                                                                · Download Table
                         INDEX TO FINANCIAL STATEMENTS                   

HANGER ORTHOPEDIC GROUP, INC.                                            

                                                                         
Report of Independent Accountants                                     F-1

Consolidated Balance Sheets as of December 31, 1995                      
 and 1996                                                             F-2

Consolidated Statements of Operations for the years                      
  ended December 31, 1994, 1995 and 1996                              F-4

Consolidated Statements of Changes in Shareholders'                      
  Equity for the years ended December 31, 1994,                          
  1995 and 1996                                                       F-5

Consolidated Statements of Cash Flows for the years                      
  ended December 31, 1994, 1995 and 1996                              F-6

Notes to Consolidated Financial Statements                            F-7

FINANCIAL STATEMENT SCHEDULE                                             

Report of Independent Accountants                                     S-1

Schedule II - Valuation and Qualifying Accounts                       S-2

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REPORT OF INDEPENDENT ACCOUNTANTS 

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

We have  audited  the  accompanying  consolidated  balance  sheets  of  Hanger  
Orthopedic  Group,  Inc. and Subsidiaries as of December 31, 1995 and 1996 and  
the related  consolidated  statements of operations,  changes in shareholders'  
equity and cash flow for each of the three years in the period ended  December  
31, 1996. These financial  statements are the  responsibility of the Company's  
management.  Our  responsibility  is to express an opinion on these  financial  
statements based on our audits.                                                 

We  conducted  our  audits in  accordance  with  generally  accepted  auditing  
standards.  Those  standards  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.  An audit  
also  includes  assessing  the  accounting  principles  used  and  significant  
estimates  made by  management,  as well as evaluating  the overall  financial  
statement presentation.  We believe that our audits provide a reasonable basis  
for our opinion.                                                                

In our opinion,  the financial statements referred to above present fairly, in  
all  material  respects,   the  consolidated   financial  position  of  Hanger  
Orthopedic Group, Inc., and Subsidiaries as of December 31, 1995 and 1996, and  
the  consolidated  results of their operations and their cash flow for each of  
the three years in the period  ended  December 31, 1996,  in  conformity  with  
generally accepted accounting principles.                                       

Coopers & Lybrand L.L.P.                                                        

2400 Eleven Penn Center                                                         
Philadelphia, Pennsylvania                                                      
March 21, 1997, except as to the                                                
information presented in Note D, for                                            
which the date is March 27, 1997                                                

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HANGER ORTHOPEDIC GROUP, INC. 
CONSOLIDATED BALANCE SHEETS 

                                                        · Enlarge/Download Table

                                                                        December 31,          
                                                              --------------------------------
                                                                  1995             1996       
                                                              -------------   ----------------

                                               ASSETS                                         

                                                                                              
CURRENT ASSETS                                                                                
     Cash and cash equivalents                                  $1,456,305         $6,572,402 
     Accounts receivable, less allowances for doubtful                                        
     accounts of $1,144,000 and $2,478,800 in 1995 and 1996,                                  
         respectively                                           13,324,991         24,321,872 
     Inventories                                                10,312,289         15,916,638 
     Prepaid and other assets                                    1,040,914          1,595,169 
     Deferred income taxes                                         804,499          3,159,280 
                                                              -------------      -------------
         Total current assets                                   26,938,998         51,565,361 
                                                              -------------      -------------

PROPERTY, PLANT AND EQUIPMENT                                                                 
     Land                                                        2,991,245          4,269,045 
     Buildings                                                   2,592,214          8,017,547 
     Machinery and equipment                                     3,654,780          6,275,307 
     Furniture and fixtures                                      1,575,493          2,095,900 
     Leasehold improvements                                      1,184,782          2,139,207 
                                                              -------------      -------------
                                                                11,998,514         22,797,006 
     Less accumulated depreciation and amortization              4,232,858          5,497,809 
                                                              -------------      -------------
                                                                 7,765,656         17,299,197 
                                                              -------------      -------------

INTANGIBLE ASSETS                                                                             
     Excess cost over net assets acquired                       27,133,528         63,935,447 
     Non-compete agreements                                      4,786,371          1,981,329 
     Other intangible assets                                     3,825,240          6,152,607 
                                                              -------------      -------------
                                                                35,745,139         72,069,383 
     Less accumulated amortization                               9,035,394          6,917,960 
                                                              -------------      -------------
                                                                26,709,745         65,151,423 
                                                              -------------      -------------

OTHER ASSETS                                                                                  
     Other                                                         385,662            925,446 
                                                              -------------      -------------

TOTAL ASSETS                                                   $61,800,061       $134,941,427 
                                                              =============      =============


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

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HANGER ORTHOPEDIC GROUP, INC. 
CONSOLIDATED BALANCE SHEETS 

                                                        · Enlarge/Download Table

                                                                                      December 31,          
                                                                            --------------------------------
                                                                                1995             1996       
                                                                            -------------   ----------------

                            LIABILITIES AND SHAREHOLDERS' EQUITY                                            

                                                                                                            
CURRENT LIABILITIES                                                                                         
      Current portion of long-term debt                                     $ 1,828,953        $  4,902,572 
      Accounts payable                                                        1,612,401           4,141,993 
      Accrued expenses                                                          710,510           7,815,028 
      Customer deposits                                                         489,758             578,219 
      Accrued compensation related cost                                       1,495,013           8,321,395 
      Deferred revenue                                                          180,587             306,998 
                                                                            ------------       -------------
           Total current liabilities                                          6,317,222          26,066,205 
                                                                            ------------       -------------
Long-term debt                                                               22,925,124          64,297,801 
Deferred income taxes                                                           706,965           2,377,627 
Other liabilities                                                               305,499           2,188,278 
Mandatorily redeemable preferred stock class C, 300 shares authorized,                                      
      liquidation preference of $500 per share (See Note N)                     253,886             277,701 
Mandatorily redeemable preferred stock class F, 100,000 shares authorized,                                  
      liquidation preference of $1,000 per share (See Note N)                                               
Commitments and contingent liabilities                                                                      
SHAREHOLDERS' EQUITY                                                                                        
      Common stock, $.01 par value; 25,000,000 shares authorized,                                           
           8,424,039 and 9,449,129 shares issued and 8,290,544 and                                          
           9,315,634 shares outstanding in 1995 and 1996, respectively           84,241              94,492 
      Additional paid-in capital                                             33,574,058          41,008,363 
      Accumulated deficit                                                    (1,711,372)           (713,478)
                                                                            ------------       -------------
                                                                             31,946,927          40,389,377 
      Treasury stock, cost --(133,495 shares)                                  (655,562)           (655,562)
                                                                            ------------       -------------
                                                                             31,291,365          39,733,815 
                                                                            ------------       -------------
TOTAL LIABILITES & SHAREHOLDERS' EQUITY                                     $61,800,061        $134,941,427 
                                                                            ============       =============

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

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                        HANGER ORTHOPEDIC GROUP, INC.                                                                
                     CONSOLIDATED STATEMENTS OF OPERATIONS                                                           
                       For the Years Ended December 31,                                                              


                                                                         1994             1995             1996      
                                                                    ---------------  ---------------  ---------------

                                                                                                                     
Net sales                                                             $50,300,297      $52,467,899      $66,805,944  
Cost of products and services sold                                     23,208,944       24,572,089       32,233,373  
                                                                    ---------------  ---------------  ---------------
Gross profit                                                           27,091,353       27,895,810       34,572,571  
Selling, general and administrative                                    21,340,148       19,361,701       24,549,802  
Depreciation and amortization                                           2,435,727        2,005,113        2,016,390  
Amortization of excess cost over net assets acquired                      701,018          686,275          832,075  
Restructuring cost                                                       459,804                                     
Loss from disposal of assets                                           2,150,310                                     
Acquisition costs                                                                                         1,297,819  
Integration costs                                                                                         1,181,694  
                                                                    ---------------  ---------------  ---------------
Income from continuing operations                                           4,346        5,842,721        4,694,791  
Interest expense                                                       (1,745,781)      (2,056,140)      (2,546,561) 
Other expense, net                                                       (180,940)        (106,644)        (177,216) 
                                                                    ---------------  ---------------  ---------------
Income (loss) from continuing operations before                                                                      
  taxes and extraordinary item                                         (1,922,375)       3,679,937        1,971,014  
Provision for income taxes                                                358,029        1,544,498          889,886  
                                                                    ---------------  ---------------  ---------------
Income (loss) from continuing operations before                                                                      
  extraordinary item                                                   (2,280,404)       2,135,439        1,081,128  
Loss from discontinued operations                                        (247,655)                                   
Loss from sale of discontinued operations                                (159,379)                                   
                                                                    ---------------  ---------------  ---------------
Income (loss) before extraordinary item                                (2,687,438)       2,135,439        1,081,128  
Extraordinary loss on early extinguishment of debt, net of tax                                              (83,234) 
                                                                    ---------------  ---------------  ---------------
Net income (loss)                                                     ($2,687,438)      $2,135,439         $997,894  
                                                                    ===============  ===============  ===============
Income (loss) from continuing operations before extraordinary                                                        
  item applicable to common stock                                     ($2,300,286)      $2,113,640       $1,057,313  
                                                                    ===============  ===============  ===============
INCOME (LOSS) PER COMMON SHARE:                                                                                      
Income (loss) from continuing operations before extraordinary item          ($.28)           $0.26           ($0.12) 
Loss from discontinued operations                                           (0.03)                                   
Loss from sale of discontinued operations                                   (0.02)                                   
Extraordinary loss on early extinguishment of debt                                                            (0.01) 
                                                                    ---------------  ---------------  ---------------
Net income (loss) per share                                                ($0.33)           $0.26            $0.11  
                                                                    ===============  ===============  ===============
Weighted average number of common shares outstanding                                                                 
  used in computing net income (loss) per share                         8,290,276        8,290,544        8,663,161  

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

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                         HANGER ORTHOPEDIC GROUP, INC                                                                           
          CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY                                                            
             For the Years Ended December 31, 1994, 1995 and 1996                                                               



                                                              Additional                                                        
                                      Common       Common       Paid in     Accumulated    Treasury     Deferred                
                                      Shares       Stock        Capital        Deficit      Stock     Compensation      Total   
                                    -----------  ---------   -------------  ------------  ----------  ------------  ------------
                                                                                                                                
Balance, December 31, 1993           8,257,891    $83,914     $33,416,066   ($1,159,373)  ($655,562)    ($4,197)    $31,680,848 
Issuance of Common Stock for                                                                                                    
 purchase of Columbia Brace             32,653        327         199,673                                               200,000 
Amortization of                                                                                                                 
 deferred compensation                                                                                    4,197           4,197 
Preferred dividends declared                                      (19,882)                                              (19,882)
Net Loss                                                                     (2,687,438)                             (2,687,438)
                                    -----------  ---------   -------------  ------------  ----------  ------------  ------------
Balance, December 31, 1994           8,290,544     84,241      33,595,857    (3,846,811)   (655,562)                 29,177,725 
Preferred dividends declared                                      (21,799)                                              (21,799)
Net Income                                                                    2,135,439                               2,135,439 
                                    -----------  ---------   -------------  ------------  ----------  ------------  ------------
Balance, December 31, 1995           8,290,544     84,241      33,574,058    (1,711,372)   (655,562)                 31,291,365 
                                    -----------  ---------   -------------  ------------  ----------  ------------  ------------
Preferred dividends declared                                      (23,815)                                              (23,815)
Issuance of Common Stock in                                                                                                     
    connection with the exercise                                                                                                
    of Stock Options                    13,758        138          46,733                                                46,871 
Issuance of Common Stock in                                                                                                     
    connection with the exercise                                                                                                
    of Stock Warrants                   11,332        113            (113)                                                      
Issuance of Common Stock in                                                                                                     
    connection with the purchase                                                                                                
    of SEH                           1,000,000     10,000       5,240,000                                             5,250,000 
Issuance of Warrants in                                                                                                         
    connection with the purchase                                                                                                
    of SEH                                                        133,000                                               133,000 
Issuance of Warrants in                                                                                                         
    connection  with the Senior                                                                                                 
    Subordinated Note Agreement                                 2,038,500                                             2,038,500 
Net Income                                                                      997,894                                 997,894 
                                    -----------  ---------   -------------  ------------  ----------  ------------  ------------
Balance, December 31, 1996           9,315,634    $94,492     $41,008,363     ($713,478)  ($655,562)                $39,733,815 
                                    ===========  =========   =============  ============  ==========  ============  ============

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

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                         HANGER ORTHOPEDIC GROUP, INC.                                                                            
                     CONSOLIDATED STATEMENTS OF CASH FLOW                                                                         
                       For the Years Ended December 31,                                                                           


                                                                                      1994             1995             1996      
                                                                                                                                  
                                                                                 ---------------  ---------------  ---------------
Cash flow from operating activities:                                                                                              
        Net income (loss)                                                          ($2,687,438)      $2,135,439         $997,894  
Adjustments to reconcile net income (loss) to net cash provided by                                                                
        (used in) continuing operations:                                                                                          
        Discontinued operations                                                        426,991                                    
        Loss from sale of discontinued operations                                      274,791                                    
        Loss from sale of disposal of assets                                         2,150,310                                    
        Provision for bad debt                                                         973,678        1,008,731        1,629,065  
        Amortization of deferred compensation                                            4,197                                    
        Depreciation and amortization                                                2,435,727        2,005,113        2,016,390  
        Amortization of excess cost over net assets acquired                           701,018          686,275          832,075  
        Amortization of debt discount                                                                                     42,469  
        Deferred taxes                                                                (629,674)         631,899         (684,119) 
        Extraordinary loss on early extinguishment of debt                                                               138,724  
        Changes in assets and liabilities, net of effects from acquired companies:                                                
                Accounts receivable                                                 (3,639,274)      (1,922,572)      (2,772,619) 
                Inventories                                                         (1,169,232)        (800,933)         737,104  
                Prepaid and other assets                                               131,714          108,112         (199,638) 
                Other assets                                                             3,782          151,367           27,342  
                Accounts payable                                                       (54,555)          48,462          361,441  
                Accrued expenses                                                       776,860         (618,105)         709,638  
                Accrued wages & payroll taxes                                         (116,852)          72,272        1,942,581  
                Customer deposits                                                      143,070           97,036           88,461  
                Deferred revenue                                                       (22,691)          82,897          126,411  
                Other liabilities                                                      156,884           35,628          (66,459) 
                                                                                 ---------------  ---------------  ---------------
Net cash provided by (used in) continuing operations                                  (140,694)       3,721,621        5,926,760  
Net cash used in discontinued operations                                              (172,146)                                   
                                                                                 ---------------  ---------------  ---------------
Net cash provided by (used in) operating activities                                   (312,840)       3,721,621        5,926,760  
                                                                                 ---------------  ---------------  ---------------

Cash flow from investing activities:                                                                                              
        Purchase of fixed assets                                                    (1,114,551)        (934,798)      (1,239,364) 
        Acquisitions, net of cash                                                   (2,599,133)        (273,939)     (37,671,754) 
        Purchase of patent                                                             (59,382)         (70,552)         (31,840) 
        Proceeds from sale of certain assets                                           180,806                                    
        Purchase of non-compete agreements                                            (480,500)         (35,000)        (200,000) 
        Decrease in other intangibles                                                 (265,624)         (24,321)          (7,596) 
                                                                                 ---------------  ---------------  ---------------
Net cash used in investing activities                                               (4,338,384)      (1,338,610)     (39,150,554) 
                                                                                 ---------------  ---------------  ---------------
Cash flow from financing activities:                                                                                              
        Net borrowings (repayments) under revolving credit agreement                 2,635,449         (100,000)     (12,700,000) 
        Proceeds from the sale of common stocks                                                                           46,871  
        Proceeds from long-term debt                                                 5,000,000                        65,000,000  
        Repayment of debt                                                           (3,276,608)      (1,882,706)     (11,040,029) 
        (Increase) decrease in financing costs                                         (63,393)           7,619       (2,966,951) 
                                                                                 ---------------  ---------------  ---------------
Net cash provided by (used in) financing activities                                  4,295,448       (1,975,087)      38,339,891  
                                                                                 ---------------  ---------------  ---------------
Increase (decrease) in cash and cash equivalents                                      (355,776)         407,924        5,116,097  
Cash and cash equivalents at beginning of year                                       1,404,157        1,048,381        1,456,305  
                                                                                 ---------------  ---------------  ---------------
Cash and cash equivalents at end of year                                            $1,048,381       $1,456,305       $6,572,402  
                                                                                 ===============  ===============  ===============

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

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HANGER ORTHOPEDIC GROUP, INC. 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  

NOTE A - THE COMPANY                                                            

   Hanger  Orthopedic  Group,  Inc.  (the  "Company") is one of the nation's
largest practice  management  companies in the orthotic and prosthetic ("O&P")  
rehabilitation  industry.  In addition to providing  O&P patient care services  
through  its  operating  subsidiaries,   the  Company  also  manufactures  and  
distributes  components and finished patient care products to the O&P industry  
primarily  in  the  United  States.   Hanger's  largest   subsidiary,   Hanger  
Prosthetics & Orthotics, Inc. formerly known as J.E. Hanger, Inc., was founded  
in 1861 by a Civil War amputee and is the oldest  company in the O&P  industry  
in the United  States.  Orthotics  is the  design,  fabrication,  fitting  and  
supervised use of custom-made  braces and other devices that provide  external  
support  to  treat  musculoskeletal  disorders.  Prosthetics  is  the  design,  
fabrication and fitting of custom-made artificial limbs.                        

NOTE B - SIGNIFICANT ACCOUNTING POLICIES                                        

   PRINCIPLES  OF  CONSOLIDATION:   The  consolidated  financial  statements
include the  accounts of the Company and its  wholly-owned  subsidiaries.  All  
significant intercompany transactions and balances have been eliminated.        

   USE OF ESTIMATES:  The preparation of financial  statements in conformity
with generally  accepted  accounting  principles  requires  management to make  
estimates  and  assumptions  that  affect the  reported  amounts of assets and  
liabilities,  disclosure of contingent  assets and  liabilities at the date of  
the financial  statements,  and the reported  amounts of revenues and expenses  
during the reporting period. Actual results could differ from those estimates.  

   CASH AND CASH  EQUIVALENTS:  Cash  includes  currency  on hand and demand
deposits with high quality financial  institutions.  Management  considers all  
highly liquid investments with original  maturities of three months or less at  
the date of purchase to be cash  equivalents.  At various times throughout the  
year, the Company maintains cash balances in excess of FDIC limits.             

   FAIR VALUE OF FINANCIAL  INSTRUMENTS:  At December 31, 1995 and 1996, the
carrying  value of financial  instruments  such as cash and cash  equivalents,  
trade receivables, trade payables, and debt approximates fair value.            

   INVENTORIES:  Inventories,  which consist principally of purchased parts,
are stated at the lower of cost or market using the first-in, first-out (FIFO)  
method.                                                                         

   LONG-LIVED  ASSET  IMPAIRMENT:  Effective  January 1, 1996,  the  Company
adopted SFAS No. 121,  "Accounting for the Impairment of Long-Lived Assets and  
for  Long-Lived  Assets to be Disposed  of." The  provisions  of  Statement of  
Financial  Accounting Standards ("SFAS") 121 require the Company to review its  
long lived assets for  impairment  on an exception  basis  whenever  events or  

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changes in  circumstances  indicate that the carrying amount of the assets may  
not be  recoverable  through  future cash flows.  If it is determined  that an  
impairment  loss has occurred  based on expected cash flows,  then the loss is  
recognized in the income  statement.  The adoption of SFAS 121 did not have an  
effect on the Company's consolidated financial statements.                      

   PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are recorded
at cost. The cost and related accumulated depreciation of assets sold, retired  
or otherwise  disposed of are removed from the  respective  accounts,  and any  
resulting  gains or  losses  are  included  in the  statement  of  operations.  
Depreciation   is  computed  for  financial   reporting   purposes  using  the  
straight-line  method over the estimated  useful lives of the related  assets.  
Depreciation expense was approximately  $1,090,000,  $1,136,000 and $1,288,000  
for the years ended December 31, 1994, 1995 and 1996, respectively.             

   INTANGIBLE ASSETS:  Intangible assets,  including non-compete agreements,
are  recorded  based on  agreements  entered into by the Company and are being  
amortized  over their  estimated  useful lives ranging from 5 to 7 years using  
the straight-line method. Other intangible assets are recorded at cost and are  
being amortized over their estimated  useful lives of up to 16 years using the  
straight-line  method.  Excess cost over net assets  acquired  represents  the  
excess of purchase price over the value assigned to net identifiable assets of  
purchased  businesses and is being  amortized using the  straight-line  method  
over 40 years. It is the Company's policy to periodically  review and evaluate  
whether there has been a permanent impairment in the value of excess cost over  
net assets acquired and other  intangible  assets.  Factors  considered in the  
evaluation   include  current  operating   results,   trends,   prospects  and  
anticipated  undiscounted future cash flows. Fully amortized intangible assets  
amounting  to  approximately   $3,225,000  were  removed  from  the  financial  
statements at December 31, 1996.                                                

   PRE-OPENING COSTS: The Company  capitalizes certain costs relating to the
pre-opening  of new patient care  centers.  These costs are  amortized  over a  
twelve-month  period using the straight-line  method commencing on the date in  
which the patient care center opens.                                            

   REVENUE  RECOGNITION:  Revenue  on the sale of  orthotic  and  prosthetic
devices is recorded when the device is accepted by the patient.  Revenues from  
referral  service  contracts  is  recognized  over the  term of the  contract.  
Deferred  revenue  represents  billings  made prior to the final  fitting  and  
acceptance by the patient and unearned  service contract  revenue.  Revenue is  
recorded  at  its  net  realizable   value  taking  into   consideration   all  
governmental and contractual discounts.                                         

   CREDIT  RISK:  The  Company  primarily  provides  customized  devices  or
services  throughout  the United  States and is  reimbursed  by the  patients'  
third-party insurers or governmentally  funded health insurance programs.  The  
Company performs ongoing credit evaluations of its distribution customers. The  
accounts  receivable  are not  collateralized.  The  ability of the  Company's  
debtors to meet their obligations is dependent upon the financial stability of  
the insurers of the Company's  customers and future legislation and regulatory  
actions.  Additionally,  the Company  maintains  reserves for potential losses  
from  these  receivables  that  historically  have  been  within  management's  
expectations.                                                                   

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   INCOME TAXES:  Income taxes are  determined in accordance  with SFAS 109,
which requires  recognition of deferred  income tax liabilities and assets for  
the expected future tax  consequences of events that have been included in the  
financial  statements or tax returns.  Under this method,  deferred income tax  
liabilities  and  assets  are  determined  based  on  the  difference  between  
financial  statement and tax bases of assets and liabilities using enacted tax  
rates in effect for the year in which the differences are expected to reverse.  
SFAS 109 also  provides  for the  recognition  of deferred tax assets if it is  
more likely than not that the assets will be realized in future years.          

   NET INCOME  (LOSS) PER SHARE:  Net income per common share is  calculated
using the weighted average of common and common-equivalent  shares outstanding  
during the year.  Common-equivalent  shares are  attributable  to  unexercised  
stock options and warrants. In 1994, 1995 and 1996,  common-equivalents  which  
would be considered in a fully diluted calculation are not included in the per  
share calculation as the effect is not material. Income (loss) from continuing  
operations  before  extraordinary  item  applicable  to common  stock has been  
adjusted  for  the  dividends  declared   applicable  to  certain  classes  of  
cumulative preferred stock.                                                     

   STOCK-BASED COMPENSATION: Compensation costs attributable to stock option
and similar plans are recognized  based on any  difference  between the quoted  
market  price of the  stock  on the date of the  grant  over  the  amount  the  
employee is required to pay to acquire the stock (the  intrinsic  value method  
under Accounting Principles Board Opinion 25). Such amount, if any, is accrued  
over the related vesting period,  as  appropriate.  SFAS 123,  "Accounting for  
Stock-Based  Compensation," requires companies electing to continue to use the  
intrinsic  value  method  to make pro  forma  disclosures  of net  income  and  
earnings  per share as if the fair value based method of  accounting  had been  
applied. The Company has adopted the disclosure only provisions of SFAS 123.    

   NEW  ACCOUNTING  STANDARDS:  In  March  1997,  the  Financial  Accounting
Standards  Board  issued  SFAS  128,  "Earnings  Per  Share."  This  statement  
established  standards for computing and  presenting  earnings per share (EPS)  
and applies to entities with  publicly  held common stock or potential  common  
stock. This statement is effective for financial statements issued for periods  
ending after December 15, 1997.  Earlier  application  is not permitted.  This  
statement requires  reinstatement of all prior-period EPS data presented.  The  
Company is currently  evaluating the impact, if any, adoption of SFAS 128 will  
have on its financial statements.                                               

   RECLASSIFICATIONS:   Certain   previously   reported  amounts  have  been
reclassified to conform with the current year presentation.                     

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NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION                           

                                                        · Enlarge/Download Table
          The following are the supplemental  disclosure  requirements for the                                  
statements of cash flows:                                                                                       


                                                                         For the Years Ended December 31        
                                                                  --------------------------------------------  
                                                                  1994               1995             1996      
                                                                  ----               ----             ----      

                                                                                                                
Cash paid during the period for:                                                                                

   Interest                                                      $1,690,742          $2,166,877       $2,273,629
   Income taxes                                                     212,000             712,800        1,893,990
Non-cash financing and investing activities:                                                                    
Preferred dividends declared                                         19,882              21,799           23,815
Issuance of notes in connection with acquisition                  1,925,000             175,000                 
Issuance  of  common  stock in  connection with acquisition         200,000                            5,250,000
Issuance of warrants in connection with  acquisition                                                     133,000
Issuance of warrants in  connection  with Senior                                                       2,038,500
Issuance of common stock in connection with Subordinated Notes                                                  
 exercise of warrants                                                                                        113

NOTE D - ACQUISITIONS AND SALE OF ASSETS                                        

   During 1994, the Company  acquired the net assets of several orthotic and
prosthetic  companies and one manufacturer of orthotic  devices.  The purchase  
price for these companies was $2,780,000 in cash, plus $1,925,000 in notes and  
32,653  shares of common stock valued at $200,000.  The notes are payable over  
one to five years with interest from 6% to 7%.                                  

   During 1995, the Company acquired two orthotic and prosthetic  companies.
The aggregate  purchase  price was $385,000  comprised of $210,000 in cash and  
$175,000 in  promissory  notes.  The cash portion of the  purchase  prices for  
these acquisitions was borrowed under the Company's revolving credit facility.  

   During 1996, the Company  acquired one orthotic and  prosthetic  company,
J.E.  Hanger,  Inc.  of  Georgia  ("SEH"),  pursuant  to the terms of a Merger  
Agreement.  As of the  acquisition  date,  SEH,  headquartered  in Alpharetta,  
Georgia,  operated 93 patient care centers and 5 warehouses  located primarily  
in the  Mid-Atlantic and  Southeastern  United States.  Under the terms of the  
agreement  which became  effective  on November 1, 1996,  the Company paid SEH  
shareholders  $44  million in cash and issued  one  million  shares of Company  
common stock and paid an additional  $1,783,000 to former SEH  shareholders on  
March 27, 1997 pursuant to provisions  in the Merger  Agreement  calling for a  
post-closing adjustment. In addition the Company issued 35,000 warrants to one  
SEH  noteholder in order to facilitate  assumption of this debt under the same  
terms and conditions  that had existed prior to the  acquisition.  Included in  
accrued  expenses  at December  31,  1996,  is  approximately  $3,119,000  and  
$1,554,000 of severence and relocation  costs incurred in connection  with the  
acquisition of SEH.                                                             

   All of  the  above  acquisitions  have  been  accounted  for as  business
combinations in accordance with the purchase method. The results of operations  
for these  acquisitions  are included in the  Company's  results of operations  
from their date of acquisition.  Excess cost over net assets acquired in these  

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acquisitions  amounting to approximately  $376,000 and $36,699,000 in 1995 and  
1996,  respectively,  are  amortized  using the  straight-line  method over 40  
years.                                                                          

   The  following  table  summarizes  the unaudited  consolidated  pro forma
information,  assuming the  acquisitions had occurred at the beginning of each  
of the following periods:                                                       

                                                                · Download Table

                                           1995         1996     
                                           ----         ----     

                                                                 
Net sales                              $112,292,000  $122,946,000
Income from operations                   10,938,243     8,728,783
Net income                                2,535,567     1,225,925
Primary income per common share                $.27          $.12
Fully diluted income per common share          $.27          $.12

   The pro forma results do not  necessarily  represent  results which would
have  occurred if the  acquisitions  had taken place at the  beginning of each  
period, nor are they indicative of the results of future combined operations.   

   During 1994 the Company commenced  discussions and on March 23, 1995, the
Company  entered  into an  agreement  to sell  certain  assets  related to its  
operations in southern California for $288,000 under a 10-year promissory note  
bearing  interest at 8%. As a result,  the Company  recorded a loss in 1994 of  
$2,150,000,  which  primarily  consisted  of  the  write-off  of  the  related  
goodwill.                                                                       

NOTE E - DISCONTINUED OPERATIONS                                                

   In the fourth quarter of 1993, the Company  declared its intent to seek a
buyer for the assets of its subsidiary,  Apothecaries,  Inc. ("Apothecaries").  
On September 30, 1994,  the Company sold those assets for $181,000 in cash and  
reported a loss on the sale of $159,379  (net of a tax  benefit of  $115,412).  
Apothecaries has been classified in the Consolidated  Statements of Operations  
as a  discontinued  operation,  with all  revenue,  expenses  and other income  
having been excluded from continuing operations.                                

   The operating results of Apothecaries for the nine months ended September
30, 1994, was as follows:                                                       

                                                                · Download Table

                                          1994    
                                          ----    
                                                  
Sales                                  $1,294,341 
Loss before taxes                        (426,991)
Tax benefit                              (179,336)
                                       -----------
Loss from discontinued                 $ (247,655)
operations                             ===========

NOTE F - RESTRUCTURING COSTS                                                    

        Results of  operations  for 1994 include a charge of $460,000  which
was recorded in the fourth  quarter for costs  associated  with the closing of  
several  patient  care  centers  in  conjunction  with  management's  plan  to  

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consolidate the Company's operations. The restructuring charges include future  
rental  payments on buildings  that the Company has  abandoned,  for which the  
leases cannot be cancelled and subleasing attempts have been unsuccessful.      

NOTE G - INVENTORY                                                              

Inventories at December 31, 1995 and 1996 consist of the following:   

                                                                · Download Table

                                                   1995              1996     
                                                   ----              ----     
                                                                              

Raw materials                                  $ 6,603,619        $ 7,504,442 
Work in-process                                  1,107,289            831,632 
Finished goods                                   2,601,381          7,580,564 
                                               ------------       ------------
                                               $10,312,289        $15,916,638 
                                               ============       ============

NOTE H- LONG-TERM DEBT                                                          

        Long-term  debt  consists of the  following at December 31, 1995 and
1996:                                                                           

                                                                · Download Table

                                                    1995          1996        
                                                    ----          ----        

                                                                              

A  Term  Loan  Commitment   payable  in  quarterly                            
installments  through  December 2001 with interest                            
payable monthly at the Company's  option of either                            
the  Bank's  prime  rate plus  1.75%,  or the one,                            
three or six month  LIBOR  plus  2.75%.  (8.31% at                            
December 31, 1996)                                                            
The base  interest  rate is  subject to a floor of                            
5.32%  and a cap  of  7.0%  by an  agreement  that                            
became   effective   on  December   31,  1996  and                            
terminates on September 30, 1999.                                  $29,000,000

B  Term  Loan  Commitment   payable  in  quarterly                            
installments  through  December 2003 with interest                            
payable monthly at the Company's  option of either                            
the  Bank's  prime  rate plus  2.25%,  or the one,                            
three or six  month  LIBOR  plus  3.25%  (8.81% at                            
December 31, 1996)                                                  28,000,000

8%  Senior   Subordinated  Notes  with  detachable                            
warrants due  November  2004,  net of  unamortized                            
discount of  $1,996,031,  11.19%  effect  interest                            
rate                                                                 6,003,969

Revolving  credit facility  expiring in June, 1997                            
with  interest  payable  monthly at the  Company's                            
option of either the  Bank's  prime rate plus .25%                            
or the three  month  LIBOR plus 2.50%  (8.175% and                            
8.75% at December 31, 1995)                         $12,700,000               

Senior term loans,  with  principal  and  interest                            
payable  monthly  and with one loan at the  Bank's                            
prime rate plus .75%,  with the remaining loans at                            
the  Company's  option of either the Bank's  prime                            
rate plus .50% or the three-month LIBOR plus 2.75%                            
(9.25%  and  8.44%  at  December  31,  1995)  with                            
balloon payments due in November and December 1998    4,596,663               

8.5% Convertible Junior Subordinated Note             4,000,000               

                                F-12                                          

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8.25% Convertible Junior Subordinated Note            1,000,000               

Subordinated seller notes,  non-collateralized net                            
of   unamortized   discount  of   $612,696,   with                            
principle and interest  payable in either  monthly                            
or quarterly  installments  at effective  interest                            
rates  ranging  from 6% to 11%,  maturing  through                            
January 2009                                           2,375,609     5,574,793

Other miscellaneous obligations with principle and                            
interest  payable  in  either  monthly  or  annual                            
installments  at interest rates ranging from 6% to                            
10% maturing through December 2007                       81,805        621,611
                                                    -----------    -----------
                                                     24,754,077     69,200,373
     Less current portion                             1,828,953      4,902,572
                                                    -----------    -----------
                                                    $22,925,124    $64,297,801
                                                    ===========    ===========

   In November  1996,  the Company  entered  into a new  $90,000,000  Credit
Agreement  with a syndication  of banks which provides for (i) a "A Term Loan"  
in the principal  amount of $29,000,000 with scheduled  incrementally  varying  
quarterly  repayments  commencing  March 1997 through December 2001, (ii) a "B  
Term Loan" in the  principal  amount of  $28,000,000  with  scheduled  varying  
quarterly  repayments  commencing  March 1997 through  December 2003,  (iii) a  
$25,000,000  Acquisition Loan Commitment and, (iv) a $8,000,000 Revolving Loan  
Commitment.                                                                     

   The  Acquisition  Loan  Commitment  and Revolving  Loan  Commitment  bear
interest at the Company's  option of either the Prime Lending Rate plus 1.75%,  
or the one,  three or six month  LIBOR plus  2.75%.  The Credit  Agreement  is  
collateralized  by  substantially  all the assets of the Company and  contains  
certain  affirmative and negative covenants  customary in an agreement of this  
nature.                                                                         

   The Credit Agreement  provides for an initial commitment fee of 2.625% on
the  total  $90,000,000  facility  and an  annual  fee of .5% per  year on the  
aggregate unused portion of the Credit Agreement. As of December 31, 1996, the  
Company had no outstanding balances on both the Acquisition and Revolving Loan  
Commitments.                                                                    

   The Company has entered  into an interest  rate swap  agreement to reduce
the impact of  changes in  interest  rates on its A Term Loan  Commitment.  At  
December 31, 1996, the Company had an outstanding interest rate swap agreement  
with  a  commercial  bank,  having  a  total  notional   principle  amount  of  
$28,500,000.  The agreement  effectively minimizes the Company's base interest  
rate exposure between a floor of 5.32% and a cap of 7%. The interest rate swap  
agreement matures on September 30, 1999. The Company is exposed to credit loss  
in the event of  non-performance  by the other party to the interest rate swap  
agreement.  However,  the Company does not anticipate  non-performance  by the  
counterparties.                                                                 

   In November  1996,  the Company also  entered into a Senior  Subordinated
Note Purchase  Agreement in the principal amount of $8,000,000 which is due in  
its entirety  November  2004 bearing  interest at 8%. Upon  entering into this  
Agreement,  the  Company  issued  1,600,000  warrants  to  noteholders.   This  
transaction  resulted in the Company  recording a debt  discount of $2,038,500  
which is being amortized ratably over the life of the notes. The Note Purchase  

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Agreement  is  subordinate  to the Credit  Agreement  and  contains  covenants  
restricting the payment of dividends,  the incurrence of indebtedness  and the  
making of  acquisitions  and  other  transactions.  It should be noted  that a  
shareholder owns 50% of the Senior Subordinated Notes.                          

   The Company  used the proceeds of the A Term Loan, B Term Loan and Senior
Subordinated  Notes to finance the acquisition of SEH and to repay all amounts  
then outstanding  under the Revolving credit facility,  Senior term loans, the  
8.5% Convertible  Junior  Subordinated Note and the 8.25%  Convertible  Junior  
Subordinate Note. In connection with this transaction, the Company recorded an  
extraordinary charge of $138,724 pre-tax, $83,234 after tax, or $.01 per share  
for the write-off of unamortized discounts and financing costs, in 1996.        

Maturities of long-term debt, at December 31, 1996, are as follows:   

                                                                · Download Table
                                     
1997                     $ 4,902,572 
1998                       7,141,513 
1999                       7,774,296 
2000                       8,628,500 
2001                       9,388,507 
Thereafter                31,364,985 
                         ------------
                         $69,200,373 
                         ============

NOTE I - INCOME TAXES                                                           

   The  provisions  for income taxes for the years ended  December 31, 1994,
1995 and 1996 consisted of the following:                                       

                                                                · Download Table

                                      1994          1995          1996      
                                      ----          ----          ----      
                                                                            
Current:                                                                    
      Federal                       $   454,955   $   541,626   $ 1,146,564 
      State                             238,000       370,973       427,441 
                                    ------------  ------------  ------------
Total                                   692,955       912,599     1,574,005 
Deferred:                                                                   
      Federal and State                (334,926)      631,899      (684,119)
                                    ------------  ------------  ------------
Provision for income taxes on                                               
 income before discontinued                                                 
 operations and extraordinary item      358,029     1,544,498       889,886 
Tax benefit from                                                            
 discontinued operations               (179,336)                            
Tax benefit from                                                            
 sale of discontinued operations       (115,412)                            
Tax benefit from extra-                                                     
 ordinary item                                                      (55,489)
                                    ------------  ------------  ------------
Provision for income taxes          $    63,281   $ 1,544,498   $   834,397 
                                    ============  ============  ============

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        A reconciliation  of the federal statutory tax rate to the effective
tax rate for the years ended December 31, 1994, 1995 and 1996 is as follows:    

                                                                · Download Table

                                           1994          1995           1996      
                                           ----          ----           ----      
                                                                                  

Federal statutory tax rate               $  (653,608)  $ 1,251,349    $  670,145  
Increase (reduction) in taxes                                                     
 resulting from:                                                                  
State income taxes (net of                                                        
 federal effect)                             151,080       249,047        98,573  
Amortization of the excess cost                                                   
 over net assets acquired                    178,160        92,777        92,777  
Disposal of assets                           459,340                              
Valuation allowance                           70,000       (70,000)               
Other, net                                   153,057        21,325        28,391  
                                         ------------  ------------   ------------
Provision for income taxes on                                                     
 income before extraordinary item            358,029     1,544,498        889,886 
Tax benefit from discontinued                                                     
 operations                                 (179,336)                             
Tax benefit from sale of discontinued                                             
 operations                                 (115,412)                             
Tax benefit from extraordinary                                                    
 item                                                                     (55,489)
                                         ------------  ------------   ------------
Provision for income taxes             $      63,281   $ 1,544,498   $    834,397 
                                         ============  ============   ============

   Temporary  differences and carryforwards  which give rise to deferred tax
assets and liabilities as of December 31, 1995 and 1996 are as follows:         

                                                                · Download Table

                                             1995              1996    
                                             ----              ----    

                                                                       
Deferred Tax Liabilities:                                              
Book basis in excess of tax              $  775,838         $  775,838 
Depreciation and amortization               666,920          2,498,527 
                                         -----------        -----------
                                          1,442,758          3,274,365 
                                         -----------        -----------
Deferred Tax Assets:                                                   
Net operating loss, Federal                 369,624            319,039 
Net operating loss, States                  211,165            281,051 
Accrued expenses                            334,790          1,554,907 
Reserve for bad debts                       393,322            965,116 
Inventory capitalization                    218,086            664,371 
Restructuring                               13,305                     
Acquisition Costs                                              271,534 
                                         -----------        -----------
Gross deferred tax assets                 1,540,292          4,056,018 
                                         -----------        -----------
                                         -----------        -----------
Net deferred tax assets                  $   97,534         $  781,653 
                                         ===========        ===========

F-15

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   For Federal and State tax purposes at December 31, 1996,  the Company has
available  approximately $938,000 of net operating loss carryforwards expiring  
from 1998 through 2007 and are subject to a limitation in their utilization of  
approximately  $149,000 per year as a result of several changes in shareholder  
control.                                                                        

   At December 31, 1995,  the Company  evaluated  the  realizability  of the
state net operating  losses and,  based upon  projections of taxable income by  
state,  concluded that a valuation allowance was not necessary.  The remaining  
balance of the deferred tax assets should be realized  through  future taxable  
income and the reversal of taxable temporary differences.                       

NOTE J - DEFERRED COMPENSATION                                                  

   In conjunction with the SEH acquisition, the Company assumed the unfunded
deferred  compensation  plan that had been  established  for  certain  key SEH  
officers.  The plan  accrues  benefits  ratably  over  the  period  of  active  
employment  from  the  time  the  contract  is  entered  into to the  time the  
participant  retires.  Participation  had been  determined  by SEH's  Board of  
Directors.  The Company has purchased individual life insurance contracts with  
respect to each  employee  covered by this plan.  The Company is the owner and  
beneficiary of the insurance  contracts.  The accrual  related to the deferred  
compensation arrangements amounted to approximately $1,985,000 at December 31,  
1996.                                                                           

NOTE K - COMMITMENTS AND CONTINGENT LIABILITIES                                 

   The  Company  is  engaged in legal  proceedings  in the normal  course of
business.  The Company believes that any unfavorable  outcome from these suits  
not  covered  by  insurance  would not have a material  adverse  effect on the  
financial statements of the Company.                                            

NOTE L - OPERATING LEASES                                                       

   The Company leases office space under  noncancellable  operating  leases.
Certain of these leases contain escalation clauses based on the consumer price  
index.  Future minimum rental  payments,  by year and in the aggregate,  under  
operating  leases with terms of one year or more  consist of the  following at  
December 31, 1996:                                                              

                                                                · Download Table
                                     
1997                     $ 3,925,000 
1998                       3,064,000 
1999                       2,401,000 
2000                       1,932,000 
2001                       1,432,000 
Thereafter                 1,974,000 
                         ------------
                         $14,728,000 

   Rent expense was approximately $2,499,000,  $2,144,000 and $2,554,000 for
the years ended December 31, 1994, 1995 and 1996, respectively.                 

NOTE M- PENSION AND PROFIT SHARING PLANS                                        

   Previously,  the Company  had a 401(k)  Saving and  Retirement  Plan (the
"Plan")  available  to  all  employees  of  J.E.  Hanger,   Inc.  ("JEH"),   a  
wholly-owned  subsidiary of the Company. The Company matched the participant's  
contributions and made  discretionary  matching  contributions.  On January 1,  
1993,  the Company  froze the Plan such that no new employees of JEH were able  

F-16  

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to participate.  On December 31, 1995, the Company  terminated the Plan. There  
was no employer  contribution  made to the Plan in 1995.  Benefit  expense was  
$130,000 for the year ended December 31, 1994.                                  

   The Company maintains a separate defined  contribution profit sharing and
401(k)  plan  ("SEH  Plan")  covering  all the  employees  of SEH,  a recently  
acquired  wholly-owned  subsidiary  of the Company.  On November 1, 1996,  the  
Company  froze  the SEH Plan such  that no new  employees  of SEH were able to  
participate. The Company did not make any contributions to the SEH Plan during  
1996.                                                                           

   The Company  maintains a 401(k) Savings and Retirement  plan to cover all
of  the  employees  of  the  Company.   The  Company  may  make  discretionary  
contributions.  Under this 401(k)  plan,  employees  may defer such amounts of  
their compensation up to the levels permitted by the Internal Revenue Service.  
The Company has not made any contributions to this plan.                        

NOTE N - REDEEMABLE PREFERRED STOCKS                                            

   The Company has  10,000,000  authorized  shares of preferred  stock,  par
value $.01 per share,  which may be issued in various  classes with  different  
characteristics.                                                                

   The 300  issued and  outstanding  shares of  non-voting,  non-convertible
Class C preferred stock have an aggregate  liquidation value equal to $150,000  
plus  accrued  dividends  at 9% and are required to be redeemed on February 1,  
2000.  Accrued  dividends  at  December  31, 1995 and 1996,  were  $21,799 and  
$23,815, respectively.                                                          

   The  100,000  authorized  shares  of  Class F  preferred  stock,  accrues
dividends  cumulatively  at 16.5% and is required to be redeemed  prior to any  
other class of preferred  stock,  before  September  1998,  for the  aggregate  
liquidation value of $1,000 per share, plus accrued dividends.  As of December  
31,  1995  and  1996,  none of the  Class F  preferred  stock  was  issued  or  
outstanding.                                                                    

NOTE O - WARRANTS AND OPTIONS                                                   

WARRANTS                                                                        

   In  November  1990,  the Company  entered  into a  $2,450,000  Note which
required the Company,  based on certain repayment  provisions,  to issue to an  
affiliate in 1991  warrants to purchase  297,883 and 322,699  shares of common  
stock  at  $4.16  and  $7.65  per  share,  respectively.  These  warrants  are  
exercisable  through  December 31, 2001.  In May 1996,  71,969  warrants  were  
exercised at $4.16 per share which resulted in the issuance of 11,332 shares.   

   In November 1996,  the Company issued  warrants for 1.6 million shares of
common  stock to the holders of the Senior  Subordinated  Notes.  The warrants  
provide that the  noteholders  may purchase  929,700 shares and 670,300 shares  
for $4.01 and $6.375,  respectively.  If the Company repays 100% of the Senior  
Subordinated  Notes within 18 or 12 months, 50% or 55%,  respectively,  of the  
warrants will terminate.  Warrants will terminate pro-rata across the exercise  
prices.                                                                         

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   In November 1996, the Company issued warrants for 35,000 shares of common
stock as an incentive to one SEH  noteholder  to allow the notes to be assumed  
by the Company under the same terms and  conditions  that had existed prior to  
the acquisition.  The warrants provide that the noteholder may purchase common  
stock at an exercise price of $2.44 per share. The warrants are exercisable at  
any time during the eight year term. In January 1997, the noteholder exercised  
the warrants and purchased 35,000 shares of common stock for $2.44 per share.   

OPTIONS                                                                         

   Under the Company's 1991 Stock Option Plan ("SOP"),  1,500,000  shares of
common stock are  authorized for issuance under options that may be granted to  
employees.  The number of shares that remain  available  for grant at December  
31, 1995 and 1996,  were  892,790 and  113,501,  respectively.  Under the SOP,  
options  may be granted  at an  exercise  price not less than the fair  market  
value of the common stock on the date of grant. Vesting and expiration periods  
are  established by the  Compensation  Committee of the Board of Directors and  
generally vest three years following  grant and generally  expire eight to ten  
years after grant.                                                              

   In  addition  to the  SOP,  non-qualified  options  may be  granted  with
exercise  prices that are less than the  current  market  value.  Accordingly,  
compensation  expense for the  difference  between  current  market  value and  
exercise price is recorded at the date of grant.                                

                                                        · Enlarge/Download Table
   The following is a summary of option transactions and exercise prices:                                      


                                               Stock                                    Non-qualified          
                                               Option Plan                              Stock Options          
                                               Price           Weighted                 Price          Weighted
                               Shares          Per Share       Average      Shares      Per Share      Average 
                                                                                                               
Outstanding at                                                                                                 
 December 31, 1993            473,434       $4.76 to $14.08     6.17        47,693   $6.00 to $14.08    9.42   
                            ----------                                     --------                            

Granted                        82,000          $ 6.00           6.00        30,000      $ 4.38          4.38   
Terminated                    (17,833)      $6.00 to $12.25     6.72           ---                             
Expired                        (3,559)         $14.08          14.08        (5,191)     $14.08         14.08   
                            ----------                                     --------                            
Outstanding at                                                                                                 
 December 31, 1994            534,042       $6.00 to $12.25     6.57        72,502    $4.38 to $6.00    7.78   
                            ----------                                     --------                            

Granted                       171,918        $2.75 to $3.25     2.83        37,500      $ 3.00          3.00   
Terminated                    (57,291)      $6.00 to $12.25     7.20           ---                             
                            ----------                                     --------                            

Outstanding at                                                                                                 
 December 31 1995             648,669      $2.75 to  $12.25     5.49       110,002    $3.00 to $6.00    6.81   
                            ==========                                     ========                            

Granted                       802,250       $3.50 to $6.125     5.54        30,000      $ 5.875         5.875  
Terminated                     22,961       $2.81 to $12.25     4.93           ---                             
Exercised                       7,508           $2.81           2.81         6,250    $3.00 to $6.00    4.75   
                            ----------                                     --------                            

Outstanding at                                                                                                 
 December 31, 1996          1,420,450      $2.75 to  $12.25     5.54       133,752    $3.00 to $6.00    6.74   
                            ==========                                     ========                            

Vested at                                                                                                      
 December 31, 1996            467,782                                       57,500                             
                            ==========                                     ========                            

F-18  

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   The  Company  applies  APB  Opinion  25 and  related  Interpretations  in
accounting for its plans.  Historically,  the Company granted stock options at  
exercise  prices  equal to the fair  market  value of the stock on the date of  
grant for fixed stock  options.  Accordingly,  no  compensation  cost has been  
recognized  for its fixed stock option plans.  Had  compensation  cost for the  
Company's  stock-based  compensation  plans been determined  based on the fair  
value at the grant  dates for awards  under those  plans  consistent  with the  
method of SFAS 123, the Company's net income and earnings per share would have  
been reduced to the unaudited pro forma amounts indicated below:                

                                                                · Download Table

                                        1995              1996      
                                        ----              ----      

                                                                    
Net Income:       As reported           $2,135,439        $  997,894
                  Pro Forma              2,017,179           745,714
Income Per Share: As reported               $  .26              $.11
                  Pro Forma                 $  .24              $.08

   The weighted-average  fair value of stock options granted during 1995 was
$2.51 and $5.03 during 1996.                                                    

   The following is a summary of stock options  exercisable  at December 31,
1994, 1995 and 1996, and their respective weighted-average share prices:        

                                                                · Download Table

                                                                Weighted-
                                                                 Average 
                                                Number of        Exercise
                                                 Shares           Price  

                                                                         
Options exercisable December 31, 1994            262,484          $7.31  
Options exercisable December 31, 1995            396,043           6.83  
Options exercisable December 31, 1996            525,282           6.45  

   The pro forma information  regarding net income and earnings per share is
required by SFAS 123, and has been  determined as if the Company had accounted  
for its employee  stock  options  under the fair value method of SFAS 123. The  
fair  value for  these  options  was  estimated  at the date of grant  using a  
Black-Scholes  option  pricing  model  with  the  following  weighted  average  
assumptions for 1995 and 1996: a risk-free interest rate ranging from 5.83% to  
7.6%, 0% dividend yield, volatility factor of the expected market price of the  
Company's  common stock of 120% and a weighted average life of the option of 7  
years.                                                                          

   The  Black-Scholes  option  valuation  model  was  developed  for  use in
estimating the fair value of traded options which have no vesting restrictions  
and are fully transferable.  In addition,  option valuation models require the  
input of highly  subjective  assumptions  including  the expected  stock price  
volatility.  Because the Company's employee stock options have characteristics  
significantly  different from those of traded options,  and because changes in  
the  subjective  input  assumptions  can  materially  affect  the  fair  value  
estimate,  in  management's  opinion,  the existing  models do not necessarily  

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provide a reliable  single  measure of the fair  value of its  employee  stock  
options.                                                                        

        The following table summarizes  information  concerning  outstanding
and exercisable options as of December 31, 1996:                                

                                                        · Enlarge/Download Table

                                     Options Outstanding                        Options Exercisable           
                      -------------------------------------------------  -------------------------------------
   Range of Exercise  Number of Options       Weighted Average           Number of Options   Weighted Average 
        Prices           and Awards        Remaining     Exercise Price     and Awards        Exercise Price  
                                           Life (Years)                                                       
--------------------    ---------            ----      --------            --------          -------          
                                                                                                              
$  2.750 to $  3.000      175,199            8.30       $  2.82              77,699          $  2.82          
$  3.250 to $  4.125      229,878            8.67       $  3.77              25,375          $  3.75          
$  4.375 to $  5.875       63,750            7.78       $  5.12              18,750          $  4.50          
$  6.000 to $  6.000      168,750            6.69       $  6.00             138,083          $  6.00          
$  6.125 to $  6.125      600,000            9.84       $  6.13                   0          $  0.00          
$  6.250 to $  6.250      205,000            6.70       $  6.25             153,750          $  6.25          
$  6.520 to $  8.000       10,000            0.98       $  7.27              10,000          $  7.27          
$  8.125 to $  8.125       25,000            5.75       $  8.13              25,000          $  8.13          
$ 12.000 to $ 12.000       50,000            5.52       $ 12.00              50,000          $ 12.00          
$ 12.250 to $ 12.250       26,625            5.17       $ 12.25              26,625          $ 12.25          
--------------------    ---------            ----      --------            --------          -------          
$  2.750 to $ 12.250    1,554,202            8.31       $  5.69             525,282          $  6.45          

   In  a  series  of  transactions   beginning   August  1990,  a  principal
shareholder  (the  "Grantor")  granted  options to members of management  (the  
"Managers") of the Company to purchase  577,912 shares of Company Common Stock  
owned by the Grantor at  exercise  prices that ranged from $3.875 to $8.00 per  
share. In five related  transactions  during August 1996 and January 1997, the  
Managers  exchanged  their  entire  rights to the total  number of shares  for  
229,672  shares of common stock owned by the Grantor.  These events  satisfied  
the  Grantor's  obligations  under  the  agreement.   As  a  result  of  those  
transactions, none of such options remain outstanding.                          

   Under the Company's 1993 Non-Employee Director Stock Option Plan, 250,000
shares of common stock are authorized for issuance to directors of the Company  
who are not employed by the Company or any  affiliate  of the  Company.  Under  
this  plan,  an option to  purchase  5,000  shares of common  stock is granted  
automatically  on an  annual  basis to each  eligible  director  on the  third  
business day following the date of each Annual Meeting of  Stockholders of the  
Company at which the eligible director is elected.  The exercise price of each  
option will be equal to 100% of the fair market  value of the common  stock on  
the date of grant.  Each option will vest at the rate of 25% each year for the  
first  four years  after the date of grant of the option and each such  option  
will expire ten years from the date of grant;  provided,  however, that in the  
event of termination of a director's service other than by reason of total and  
permanent  disability or death,  then the  outstanding  options of such holder  
will expire three months after such  termination.  Outstanding  options remain  
exercisable  for one year after  termination of service by reason of total and  
permanent  disability or death. The number of shares that remain available for  
grant at December 31, 1995 and 1996 were 160,000 and 130,000, respectively.     

F-20  

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NOTE P - OTHER EVENTS                                                           

   On December 2, 1996 and January 23, 1997,  the Company  signed letters of
intent to purchase the net assets of two companies. The total consideration to  
acquire these companies,  excluding potential earn-out provisions, is expected  
to  total  approximately  $9,200,000.  The  acquisitions  are  expected  to be  
finalized during the second quarter of 1997.                                    

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REPORT OF INDEPENDENT ACCOUNTANTS 

   Our report on the consolidated  financial statements of Hanger Orthopedic
Group,  Inc. and  Subsidiaries  is included on Page F-1 of this Form 10-K.  In  
connection with our audits of such financial statements,  we have also audited  
the related  financial  statement  schedule  listed in the index on Page 32 of  
this Form 10-K.                                                                 

   In our opinion,  the financial statement schedule referred to above, when
considered  in relation to the basic  financial  statements  taken as a whole,  
present  fairly,  in all material  respects,  the  information  required to be  
included therein.                                                               

Coopers & Lybrand L.L.P.                                                        

2400 Eleven Penn Center                                                         
Philadelphia, Pennsylvania                                                      
March 21, 1997, except as to the                                                
information presented in Note D, for                                            
which the date is March 27, 1997                                                

S-1 

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HANGER ORTHOPEDIC GROUP, INC. 

                                                        · Enlarge/Download Table
       SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS                                        


                                              ADDITIONS                                     
                            BALANCE AT        CHARGED TO  IMPACT OF               BALANCE AT
                            BEGINNING         COSTS AND   ACQUIRED                END OF    
YEAR  CLASSIFICATION        OF YEAR           EXPENSES    COMPANIES   DEDUCTIONS  YEAR      
----  --------------        -------           ----------  ---------   ----------  ----------
                                                                                            
1996  Allowance for                                                                         
      doubtful                                                                              
      accounts              $1,144,000        $1,629,000  $1,220 000  $1,514,000  $2,479,000
1995  Allowance for                                                                         
      doubtful                                                                              
      accounts              $  976,000        $1,009,000              $  841,000  $1,144,000
1994  Allowance for                                                                         
      doubtful                                                                              
      accounts              $  662,000        $  974,000              $  660,000  $  976,000

S-2 

Dates Referenced Herein   and   Documents Incorporated By Reference

				Referenced-On Page
This 10-K Filing		Date		First		Last			Other Filings
		1/1/92		11
		3/1/92		30
		12/31/92		9		10
		1/1/93		50
		5/7/93		30
		9/1/93		10
		12/31/93		9		30
		1/3/94		19
		1/7/94		19
		1/31/94		19
		4/15/94		10		19
		5/16/94		30
		9/30/94		45
		10/7/94		19
		12/31/94		9		53
		1/5/95		19
		3/17/95		19
		3/23/95		45
		12/31/95		9		54			10-K, 10-Q
		1/1/96		41
		3/21/96		1
		7/29/96		24		30			8-K
		11/1/96		18		51			8-K
		11/12/96		28		31			8-K
		12/2/96		55
For The Period Ended		12/31/96		1		54
		1/1/97		31
		1/23/97		55
		2/21/97		1
		3/21/97		12		56
		3/27/97		24		56
		3/28/97		32		33
Filed On / Filed As Of		3/31/97							10-Q
		11/1/97		23
		12/15/97		25		43
		5/1/98		23
		3/31/99		30					10-Q
		9/30/99		24		47			10-Q
		2/1/0		51
		11/1/1		22
		12/31/1		22		51			4, 10-K
		12/31/3		22					10-K, 10-K/A
		11/1/4		23					8-K
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