UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

~~Washington,~~WASHINGTON, D.C. 20549

FORM 10-Q

~~(Mark One)~~

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

For the ~~quarterly period ended March 31, 2014~~Quarterly Period Ended June 30, 2018

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

For the transition period from

Commission ~~file number~~File Number 1-10670

HANGER, INC.

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

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


10910 Domain Drive, Suite 300, Austin, TX		~~78758~~
(Address of principal executive offices)		78758 (Zip Code)

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

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

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

Title of class		Name of exchange on which registered
Common Stock, par value $0.01 per share		OTC Pink (operated by OTC Markets Group Inc.)

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:~~days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ~~(232.405~~(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such ~~files.)~~files). Yes x No o

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

Large accelerated filer xo	Accelerated filer ox

Non-accelerated filer o	Smaller reporting company o	Emerging growth company o

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

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

As of ~~May 2, 2014 35,212,424~~August 1, 2018 the registrant had 36,799,320 shares of ~~common stock, $.01 par value per share, were~~its Common Stock outstanding.

Table of Contents

~~INDEX~~TABLE OF CONTENTS

		~~Page No.~~
Hanger, Inc.

Part I.		~~FINANCIAL INFORMATION (unaudited)~~

~~Item 1.~~	~~Consolidated~~I Financial ~~Statements~~
Information
	Item 1. Condensed Consolidated ~~Balance Sheets — March 31, 2014 and December 31, 2013~~Financial Statements (unaudited)		1

	~~Consolidated Statements of Income and Comprehensive Income for the Three Months Ended March 31, 2014 and 2013~~	3

	~~Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013~~	4

	~~Notes to Consolidated Financial Statements~~	5

Item 2.	~~Management’s~~ Management Discussion and Analysis of Financial Condition and Results of Operations	15	26
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		41
	Item 4. Controls and Procedures		42
Part II Other Information
	Item 3.1. Legal Proceedings	~~Quantitative and Qualitative Disclosures about Market Risk~~	2343
	Item 1A. Risk Factors
~~Item 4.~~	~~Controls and Procedures~~	2445
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
~~Part II.~~	~~OTHER INFORMATION~~	45
	Item 3. Defaults Upon Senior Securities
~~Item 1A.~~	~~Risk Factors~~	2445
	Item 4. Mine Safety Disclosures
~~Item 6.~~	~~Exhibits~~	2645

~~SIGNATURES~~Item 5. Other Information		2745
	Item 6. Exhibits		45
Exhibits Index			46
Signatures			47

Table of Contents

PART 1.FINANCIAL INFORMATION

HANGER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(~~Dollars in thousands)~~In thousands, except par value and per share amounts)

(Unaudited)

March 31,

December 31,

2014

2013

ASSETS

CURRENT ASSETS

Cash and cash equivalents

$
55,624

$
9,860

Net accounts receivable, less allowance for doubtful accounts of $10,313 and $10,022 in 2014 and 2013, respectively

183,548

185,769

Inventories

153,952

141,518

Prepaid expenses, other assets, and income taxes receivable

27,678

15,519

Deferred income taxes

30,366

30,298

Total current assets

451,168

382,964

PROPERTY, PLANT AND EQUIPMENT

Land

794

794

Buildings

16,517

15,397

Furniture and fixtures

16,581

15,855

Machinery and equipment

63,379

61,707

Equipment leased to third parties under operating leases

34,198

34,142

Leasehold improvements

88,576

85,176

Computer and software

94,561

88,950

Total property, plant and equipment, gross

314,606

302,021

Less accumulated depreciation and amortization

183,187

175,223

Total property, plant and equipment, net

131,419

126,798

INTANGIBLE ASSETS

Goodwill

702,455

681,547

Other intangible assets, less accumulated amortization of $29,267 and $27,375 in 2014 and 2013, respectively

61,367

58,021

Total intangible assets, net

763,822

739,568

OTHER ASSETS

Debt issuance costs, net

8,134

8,564

Other assets

15,142

13,766

Total other assets

23,276

22,330

TOTAL ASSETS

$
1,369,685

$
1,271,660

	As of June 30,			As of December 31,
	2018			2017
ASSETS
Current assets:
Cash and cash equivalents	$	48,792		$	1,508
Accounts receivable, net	134,079			146,346
Inventories	66,439			69,138
Income taxes receivable	1,389			13,079
Other current assets	21,415			20,888
Total current assets	272,114			250,959

Non-current assets:
Property, plant and equipment, net	91,378			93,615
Goodwill	196,343			196,343
Other intangible assets, net	18,145			21,940
Deferred income taxes	74,897			68,126
Other assets	11,482			9,440
Total assets	$	664,359		$	640,423

LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current liabilities:
Current portion of long-term debt	$	10,384		$	4,336
Accounts payable	50,313			48,269
Accrued expenses and other current liabilities	54,258			66,308
Accrued compensation related costs	31,082			53,380
Total current liabilities	146,037			172,293

Long-term liabilities:
Long-term debt, less current portion	504,157			445,928
Other liabilities	49,465			50,253
Total liabilities	699,659			668,474

Commitments and contingencies (Note O)

Shareholders’ deficit:
Common stock, $0.01 par value; 60,000,000 shares authorized; 36,992,892 shares issued and 36,850,071 shares outstanding in 2018, and 36,515,232 shares issued and 36,372,411 shares outstanding in 2017	370			365
Additional paid-in capital	337,175			333,738
Accumulated other comprehensive loss	(1,928		)	(1,686		)
Accumulated deficit	(370,221		)	(359,772		)
Treasury stock, at cost; 142,821 shares at 2018 and 2017, respectively	(696		)	(696		)
Total shareholders’ deficit	(35,300		)	(28,051		)
Total liabilities and shareholders’ deficit	$	664,359		$	640,423

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

~~Table of Contents~~

HANGER, INC.

CONDENSED CONSOLIDATED ~~BALANCE SHEETS~~STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(~~Dollars in~~In thousands, except share and per share amounts)

(Unaudited)

March 31,

December 31,

2014

2013

LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES

Current portion of long-term debt

$
20,869

$
15,998

Accounts payable

41,789

36,729

Accrued expenses and other current liabilities

22,734

24,923

Accrued interest payable

5,534

1,898

Accrued compensation related costs

21,605

36,331

Total current liabilities

112,531

115,879

LONG-TERM LIABILITIES

Long-term debt, less current portion

541,066

452,261

Deferred income taxes

76,971

76,545

Other liabilities

48,615

46,755

Total liabilities

779,183

691,440

COMMITMENTS AND CONTINGENCIES (Note G)

SHAREHOLDERS’ EQUITY

Common stock, $.01 par value; 60,000,000 shares authorized, 36,346,814 and 36,113,202 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively

363

361

Additional paid-in capital

297,006

292,722

Accumulated other comprehensive loss

(1,020
)
(1,020
)
Retained earnings

294,809

288,813

591,158

580,876

Treasury stock at cost (141,154 shares)

(656
)
(656
)
Total shareholders’ equity

590,502

580,220

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$
1,369,685

$
1,271,660

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Net revenues	$	266,966		$	263,386		$	500,961		$	497,067
Material costs	86,516			83,657			162,872			158,062
Personnel costs	89,554			87,831			175,662			175,786
Other operating costs	30,536			31,861			61,632			64,550
General and administrative expenses	26,523			25,227			52,159			50,613
Professional accounting and legal fees	4,236			8,521			9,082			21,171
Depreciation and amortization	9,272			9,825			18,602			19,962
Income from operations	20,329			16,464			20,952			6,923
Interest expense, net	7,317			14,091			19,580			28,100
Loss on extinguishment of debt	—			—			16,998			—
Non-service defined benefit plan expense	176			184			352			368
Income (loss) before income taxes	12,836			2,189			(15,978		)	(21,545		)
(Benefit) provision for income taxes	(92		)	552			(6,288		)	(5,448		)
Net income (loss)	$	12,928		$	1,637		$	(9,690	)	$	(16,097	)
Other comprehensive income (loss):
Unrealized gain on cash flow hedges (net of tax provision of $710 and $8 for the three and six months ended June 30, 2018, respectively)	$	2,314		$	—		$	24		$	—
Unrealized gain (loss) on defined benefit plan (net of tax benefit of $0 and $0 for the three months and $105 and $0 for the six months ended June 30, 2018 and 2017, respectively)	26			(17		)	(266		)	(34		)
Total other comprehensive income (loss)	2,340			(17		)	(242		)	(34		)
Comprehensive income (loss)	$	15,268		$	1,620		$	(9,932	)	$	(16,131	)

Per share data:
Basic earnings (loss) per share	$	0.35		$	0.05		$	(0.26	)	$	(0.44	)
Weighted average shares outstanding - basic	36,790,401			36,286,528			36,645,248			36,187,340
Diluted earnings (loss) per share	$	0.35		$	0.04		$	(0.26	)	$	(0.44	)
Weighted average shares outstanding - diluted	37,404,360			36,543,740			36,645,248			36,187,340

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

~~Table of Contents~~

HANGER, INC.

CONDENSED CONSOLIDATED ~~STATEMENTS~~STATEMENT OF ~~INCOME~~

~~AND COMPREHENSIVE INCOME~~CHANGES IN SHAREHOLDERS’ DEFICIT

For the ~~Three~~Six Months Ended ~~March 31,~~June 30, 2018

(~~Dollars in thousands, except share and per share amounts)~~In thousands)

(Unaudited)

Three Months Ended

March 31,

2014

2013

Net sales

$
235,605

$
229,350

Material costs

67,345

67,739

Personnel costs

96,431

89,953

Other operating expenses

45,600

39,657

Depreciation and amortization

10,199

9,285

Income from operations

16,030

22,716

Interest expense

6,098

7,777

Income before taxes

9,932

14,939

Provision for income taxes

3,935

5,449

Net income

$
5,997

$
9,490

Other comprehensive income

—

—

Comprehensive income

$
5,997

$
9,490

Basic Per Common Share Data

Net income

$
0.17

$
0.27

Shares used to compute basic per common share amounts

35,076,828

34,598,494

Diluted Per Common Share Data

Net income

$
0.17

$
0.27

Shares used to compute diluted per common share amounts

35,415,018

35,066,032

	Common Shares, Balance	Common Stock, Par Value		Additional Paid-in Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Treasury Stock			Total
Balance, December 31, 2017	36,372	$	365	$	333,738		$	(1,686	)	$	(359,772	)	$	(696	)	$	(28,051	)
Cumulative effect of a change in accounting for revenue recognition (Note A)	—	—		—			—			(759		)	—			(759		)
Balance, January 1, 2018	36,372	365		333,738			(1,686		)	(360,531		)	(696		)	(28,810		)
Net loss	—	—		—			—			(9,690		)	—			(9,690		)
Employee related equity activity:
Shares based compensation expense	—	—		5,905			—			—			—			5,905
Issuance of common stock upon vesting of restricted stock units	478	5		(5		)	—			—			—			—
Effect of shares withheld to cover taxes	—	—		(2,463		)	—			—			—			(2,463		)
Total other comprehensive loss	—	—		—			(242		)	—			—			(242		)
Balance, June 30, 2018	36,850	370		337,175			(1,928		)	(370,221		)	(696		)	(35,300		)

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

~~Table of Contents~~

HANGER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

~~For the Three Months Ended March 31,~~

(~~Dollars in~~In thousands)

(Unaudited)

2014

2013

Cash flows from operating activities:

Net income

$
5,997

$
9,490

Adjustments to reconcile net income to net cash provided by operating activities:

Loss/(gain) on disposal of assets

(547
)
52

Provision for doubtful accounts

3,754

1,657

Provision for deferred income taxes

358

—

Depreciation and amortization

10,199

9,285

Amortization of debt issuance costs

430

864

Compensation expense restricted stock units

2,418

1,667

Changes in operating assets and liabilities, net of effects of acquired companies:

Accounts receivable

1,537

7,216

Inventories

(10,589
)
(5,197
)
Prepaid expenses, other current assets, and income taxes

(12,736
)
(3,860
)
Accounts payable

2,126

(2,006
)
Accrued expenses, accrued interest payable

2,384

3,883

Accrued compensation related costs

(15,040
)
(19,544
)
Other

(253
)
(1,314
)
Net cash provided by/(used in) operating activities

(9,962
)
2,193

Cash flows from investing activities:

Purchase of property, plant and equipment (net of acquisitions)

(8,297
)
(5,110
)
Purchase of equipment leased to third parties under operating leases

(564
)
(288
)
Acquisitions (net of cash acquired)

(19,167
)
—

Purchase of company-owned life insurance investment

(2,294
)
—

Proceeds from sale of property, plant and equipment

522

91

Net cash used in investing activities

(29,800
)
(5,307
)

Cash flows from financing activities:

Borrowings under revolving credit agreement

125,000

—

Repayments under revolving credit agreement

(38,000
)
—

Repayment of term loan

(1,406
)
(750
)
Repayment of seller’s notes and other contingent considerations

(1,594
)
(1,410
)
Repayment of capital lease obligations

(340
)
(180
)
Excess tax benefit from stock based compensation

1,780

1,214

Proceeds from issuance of common stock

86

62

Net cash provided by/(used in) financing activities

85,526

(1,064
)

Increase/(decrease) in cash and cash equivalents

45,764

(4,178
)
Cash and cash equivalents, at beginning of period

9,860

19,211

Cash and cash equivalents, at end of period

$
55,624

$
15,033

SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION:

Cash paid during the period for:

Interest

1,629

3,290

Income taxes (net of refunds)

11,159

5,591

Non-cash financing and investing activities:

Issuance of restricted stock units

8,691

9,617

Issuance of notes in connections with acquistisions

9,300

—

	For the Six Months Ended June 30,
	2018			2017
Cash flows from operating activities:
Net loss	$	(9,690	)	$	(16,097	)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization	18,602			19,962
(Benefit) provision for doubtful accounts	(602		)	4,517
Stock-based compensation expense	5,906			5,080
Deferred income taxes	(6,511		)	(5,548		)
Amortization of debt issuance costs	2,186			3,874
Loss on extinguishment of debt	16,998			—
Gain on sale and disposal of fixed assets	(1,349		)	(1,196		)
Changes in operating assets and liabilities (Note Q)	(8,632		)	(16,925		)
Net cash provided by (used in) operating activities	16,908			(6,333		)

Cash flows from investing activities:
Purchase of property, plant and equipment	(11,322		)	(6,433		)
Purchase of therapeutic program equipment leased to third parties under operating leases	(3,822		)	(1,333		)
Purchase of company-owned life insurance investment	(598		)	(555		)
Proceeds from sale of property, plant and equipment	1,682			3,216
Net cash used in investing activities	(14,060		)	(5,105		)

Cash flows from financing activities:
Borrowings under term loan, net of discount	500,204			—
Repayment of term loan	(431,875		)	(11,250		)
Borrowings under revolving credit agreement	3,000			110,000
Repayments under revolving credit agreement	(8,000		)	(85,000		)
Payment of employee taxes on stock-based compensation	(2,463		)	(1,339		)
Payment on seller notes	(1,765		)	(3,808		)
Payment of capital lease obligations	(682		)	(572		)
Payment of debt issuance costs	(6,487		)	(2,863		)
Payment of debt extinguishment costs	(8,436		)	—
Net cash provided by financing activities	43,496			5,168

Increase (decrease) in cash, cash equivalents and restricted cash	46,344			(6,270		)
Cash, cash equivalents and restricted cash, at beginning of period	4,779			9,412
Cash, cash equivalents and restricted cash, at end of period	$	51,123		$	3,142

	Six Months Ended June 30,
Reconciliation of Cash, Cash Equivalents and Restricted Cash	2018		2017
Cash and cash equivalents, at beginning of period	$	1,508	$	7,157
Restricted cash, at beginning of period	3,271		2,255
Cash, cash equivalents, and restricted cash, at beginning of period	$	4,779	$	9,412

Cash and cash equivalents, at end of period	$	48,792	$	911
Restricted cash, at end of period	2,331		2,231
Cash, cash equivalents, and restricted cash, at end of period	$	51,123	$	3,142

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

~~Table of Contents~~

HANGER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE A — ~~BASIS~~ORGANIZATION AND SUMMARY OF ~~PRESENTATION~~SIGNIFICANT ACCOUNTING POLICIES

Description of Business

Hanger, Inc. (“we,” “our,” or “us”) is a leading national provider of products and services that assist in enhancing or restoring the physical capabilities of patients with disabilities or injuries. We provide orthotic and prosthetic (“O&P”) services, distribute O&P devices and components, manage O&P networks and provide therapeutic solutions to patients and businesses in acute, post-acute and clinic settings. We operate through two segments: Patient Care and Products & Services.

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements ~~as of March 31, 2014 and December 31, 2013 and for the three months ended March 31, 2014 and 2013~~ have been prepared by Hanger, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) considered necessary for a fair statement of the Company’s financial position, results of operations and cash flows for such periods. The year-end consolidated data was derived from audited financial statements but does not include all disclosures required byaccordance with accounting principles generally accepted in the United States of America (“GAAP”)~~. Certain~~ for interim financial information and ~~footnote disclosures normally included in financial statements prepared in accordance~~ with ~~GAAP have been condensed or omitted. The results~~the instructions to Form 10-Q and Article 10 of ~~operations for the three months ended March 31, 2014 are~~Regulation S-X, and, therefore, do not ~~necessarily indicative~~include all of the ~~results to be expected~~information and footnotes required by GAAP for ~~the full fiscal year.~~

complete financial statements. These ~~unaudited consolidated~~ financial statements should be read in conjunction with the audited consolidated financial statements ~~of the Company and notes thereto included~~ in ~~the~~our Annual Report on Form 10-K for the year ended December 31, ~~2013,~~2017 (the “2017 Form 10-K”), as previously filed with the Securities and Exchange Commission (“SEC”).

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

A detailed description of our significant accounting policies and management judgments is contained in our 2017 Form 10-K.

Reclassifications

We have reclassified certain amounts in the prior year consolidated financial statements to be consistent with the current year presentation. These relate to classifications within both the condensed consolidated statements of operations and condensed consolidated statement of cash flows; see “Adoption of New Accounting Standards” for additional information.

Recent Accounting Pronouncements

Adoption of New Accounting Standards

On January 1, 2018, we adopted the following:

· Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) and related clarifying standards (“ASC 606”), on revenue recognition using the modified retrospective method for all contracts in place at January 1, 2018. This new accounting standard outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers. This standard supersedes existing revenue recognition requirements. The core principle of the revenue recognition standard is to require an entity to recognize as revenue the amount that reflects the consideration to which it expects to be entitled in exchange for goods or services as it transfers control to its customers.

The majority of our contracts are generally short term in nature. Revenue is recognized at the point of time when we transfer control of the good or service to the patient. Under ASC 606, estimated uncollectible amounts due from self-pay patients, as well as co-pays, co-insurance and deductibles owed to us by patients with insurance are generally considered implicit price concessions and are now presented as a reduction of net revenue. Under prior guidance, these amounts were recognized as bad debt expense and were included in other operating costs. When estimating the variable consideration, we use historical collection experience to estimate amounts not expected to be collected. Conversely, subsequent changes in collectability due to a change in financial condition (i.e. bankruptcy) continues to be recognized as bad debt expense.

The adoption of this standard did not have a material impact on our results of operations. The cumulative effect of implementing this guidance resulted in an increase of $0.8 million to the opening balance of accumulated deficit from establishing a contract liability of $1.0 million for certain performance obligations that must be recognized over time and an increase in deferred tax assets in the amount of $0.3 million - see “Revenue Recognition” below for additional information.

· ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash and ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments in the statement of cash flows on a retrospective basis. As a result of adoption:

· Amounts generally described as restricted cash and restricted cash equivalents are now presented with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.

· We added a reconciliation of cash, cash equivalents, and restricted cash to the condensed consolidated statements of cash flows. Restricted cash balances are included in “Other Current Assets” in our condensed consolidated balance sheets - see Note G - “Other Current Assets and Other Assets.”

· ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which requires the recognition of the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. It was applied on a modified retrospective basis through a cumulative-effect adjustment directly to accumulated deficit as of the beginning of the period of adoption. As a result of adoption, there was no material impact on our condensed consolidated financial statements.

· ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. As a result of adoption, there was no material impact on our condensed consolidated financial statements and we will apply the guidance to any future acquisitions should they occur.

· ASU No. 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which amends the scope of modification accounting for share-based payment arrangements and provides guidance on the types of changes to the terms or conditions of the share-based payment awards to which an entity would be required to apply modification accounting under Accounting Standards Codification (“ASC”) 718. The amendments in ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. As a result of adoption, there was no material impact on our condensed consolidated financial statements and we will apply the guidance to any future changes to the terms or conditions of stock-based payment awards should they occur.

· ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which amends ASC Topic 715. The amendments in this update require that an employer disaggregate the service cost component from the other components of net benefit cost for an entity’s defined benefit pension and other postretirement plans. The amendments also provide explicit guidance on how to present the service cost component and the other components of net benefit cost in the income statement. The amendments in this update require that an employer report the service cost component in the same line item as other compensation costs arising from services rendered by the ~~Company~~pertinent employees during the period. The other components of net benefit costs are required to be presented in the income statement separately from the service cost component and outside of income from operations. Accordingly, we have made certain reclassifications from “General and administrative expenses” to “Non-service pension expense” of $0.2 million and $0.2 million for the three months ended June 30, 2018 and 2017, respectively and $0.4 million and $0.4 million for the six months ended June 30, 2018 and 2017, respectively. Such reclassifications did not have a material effect on our consolidated statement of operations.

· ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The objective of this new guidance is to improve the financial reporting of hedging relationships by, among other things, eliminating the requirement to separately measure and record hedge ineffectiveness. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years with early adoption permitted. We adopted this guidance effective January 1, 2018. The adoption did not have a material impact on our condensed consolidated financial statements or disclosures.

New Accounting Standards Issued, Not Yet Adopted

In February 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), which allows companies to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), which was signed into law on December 22, 2017, from accumulated other comprehensive income to retained earnings. This new standard is effective for us beginning January 1, 2019, with early adoption permitted. We are currently evaluating the effects that the adoption of this guidance will have on our condensed consolidated financial statements and the related disclosures.

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

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The amendments in ASU 2016-02, and related clarifying standards, revise the accounting for leases. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases that extend beyond 12 months. The asset and liability will initially be measured at the present value of the lease payments. The new lease guidance also simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. The amendments in this ASU are effective for fiscal year 2019 and will be applied using a cumulative effect adjustment transition approach at the adoption date which includes a number of practical expedients for leases existing at, or entered into after, the adoption date. Early adoption is permitted. We have not yet concluded how the new standard will impact our condensed consolidated financial statements. Nonetheless, we anticipate that there will be a material increase to assets and lease liabilities for existing property leases representing our nationwide retail locations that are not already included on our consolidated balance sheet.

Revenue Recognition

Effect of Adoption of ASC 606

On January 1, 2018, we adopted ASC 606 using the modified retrospective method applied to all contracts which were not completed as of January 1, 2018. As a practical expedient, we adopted a portfolio approach in evaluating our sources of revenue for implications of adoption. In accordance with the ~~SEC.~~modified retrospective method, results of operations for the reporting periods after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with ASC 605, Revenue Recognition (“ASC 605”).

We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of accumulated deficit. Upon adoption of ASC 606, the cumulative effect of the changes made to our condensed consolidated balance sheet as of January 1, 2018 was as follows:

	December 31, 2017			Effects of			January 1, 2018
(in thousands)	As reported			Adoption			After adoption
Assets
Deferred income taxes	$	68,126		$	268		$	68,394
Liabilities
Accrued expenses and other current liabilities	$	66,308		$	1,027		$	67,335
Shareholders’ Deficit
Accumulated deficit	$	(359,772	)	$	(759	)	$	(360,531	)

In accordance with the new revenue standard requirements, the disclosure of the impact of adoption on our condensed consolidated statement of operations and condensed consolidated balance sheet is as follows:

	As of and for the Three Months Ended June 30, 2018
(in thousands)	As Reported			Effects of Adoption			Proforma balance without the adoption of ASC 606
Condensed Consolidated Statement of Operations
Net revenues	$	266,966		$	1,322		$	268,288
Other operating costs	30,536			1,332			31,868
Income from operations	20,329			(10		)	20,319
Income (loss) before income taxes	12,836			(10		)	12,826
Net income (loss)	12,928			(10		)	12,918
Comprehensive income (loss)	15,268			(10		)	15,258

Condensed Consolidated Balance Sheet
Assets
Deferred income taxes	$	74,897		$	3		$	74,900
Total assets	664,359			3			664,362
Liabilities
Accrued expenses and other current liabilities	54,258			9			54,267
Total current liabilities	146,037			9			146,046
Total liabilities	699,659			9			699,668
Shareholders’ Deficit
Accumulated deficit	(370,221		)	(6		)	(370,227		)
Total shareholders’ deficit	(35,300		)	(6		)	(35,306		)

	As of and for the Six Months Ended June 30, 2018
(in thousands)	As Reported			Effects of Adoption			Proforma balance without the adoption of ASC 606
Condensed Consolidated Statement of Operations
Net revenues	$	500,961		$	2,220		$	503,181
Other operating costs	61,632			2,200			63,832
Income from operations	20,952			20			20,972
Income (loss) before income taxes	(15,978		)	20			(15,958		)
Net income (loss)	(9,690		)	20			(9,670		)
Comprehensive income (loss)	(9,932		)	20			(9,912		)

Condensed Consolidated Balance Sheet
Assets
Deferred income taxes	$	74,897		$	(273	)	$	74,624
Total assets	664,359			(273		)	664,086
Liabilities
Accrued expenses and other current liabilities	54,258			(1,048		)	53,210
Total current liabilities	146,037			(1,048		)	144,989
Total liabilities	699,659			(1,048		)	698,611
Shareholders’ Deficit
Accumulated deficit	(370,221		)	775			(369,446		)
Total shareholders’ deficit	(35,300		)	775			(34,525		)

The adoption of ASC 606 resulted in deferring $1.0 million of net revenue from our Patient Care segment as of June 30, 2018 and recognizing deferred revenue of $1.0 million from satisfying performance obligations from the previous period. Estimated uncollectible amounts due from self-pay patients for the three and six months ended June 30, 2018 were $1.3 million and $2.2 million, respectively, and are considered implicit price concessions under ASC 606 and are recorded as a reduction to net revenue.

Patient Care Segment

Revenue in our Patient Care segment is primarily derived from contracts with third party payors for the provision of O&P devices and is recognized upon the transfer of control of promised products or services to the patient at the time the patient receives the device. At, or subsequent to delivery, we issue an invoice to the third party payor, which primarily consists of commercial insurance companies, Medicare, Medicaid, the U.S. Department of Veterans Affairs and private or patient pay (“Private Pay”) individuals. We recognize revenue for the amounts we expect to receive from payors based on expected contractual reimbursement rates, which are net of estimated contractual discounts and implicit price concessions. These revenue amounts are further revised as claims are adjudicated, which may result in additional disallowances. As such, these adjustments do not relate to an inability to pay, but to contractual allowances, our failure to ensure that a patient was currently eligible under a payor’s health plan, that the plan provides full O&P benefits, that we received prior authorization, that we filed or appealed the payor’s determination timely, on the basis of our coding, failure by certain classes of patients to pay their portion of a claim or other administrative issues which are considered as part of the transaction price and recorded as a reduction of revenues.

Our products and services are sold with a 90-day labor and 180-day warranty for fabricated components. Warranties are not considered a separate performance obligation. We estimate warranties based on historical trends and include them in accrued expenses and other current liabilities in the condensed consolidated balance sheet.

A portion of our O&P revenue comes from the provision of cranial devices. In addition to delivering the cranial device, there are patient follow up visits where we assist in treating the patient’s condition by adjusting or modifying the cranial device. We conclude that, for these devices, there are two performance obligations and use the expected cost plus margin approach to estimate for the standalone selling price of each performance obligation. The allocated portion associated with the patient’s receipt of the cranial device is recognized when the patient receives the device while the portion of revenue associated with the follow up visits is initially recorded as deferred revenue. On average, the cranial device follow up visits occur within 90 days after the patient receives the device and the deferred revenue is recognized on a straight line basis over this period.

Medicare and Medicaid regulations and the various agreements we have with other third party payors, including commercial healthcare payors under which these contractual adjustments and disallowed revenue are calculated, are complex and are subject to interpretation and adjustment and may include multiple reimbursement mechanisms for different types of services. Therefore, the particular O&P devices and related services authorized and provided, and the related reimbursement, are subject to interpretation and adjustment that could result in payments that differ from our estimates. Additionally, updated regulations and reimbursement schedules, and contract renegotiations occur frequently, necessitating regular review and assessment of the estimation process by management. As a result, there is a reasonable possibility that recorded estimates could change and any related adjustments will be recorded as adjustments to net revenue when they become known.

The following table disaggregates revenue from contracts with customers in our Patient Care segment for the three and six months ended June 30, 2018 and 2017:

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
(in thousands)	2018		2017		2018		2017
Patient Care Segment
Medicare	$	70,469	$	65,737	$	127,781	$	120,872
Medicaid	33,648		34,788		63,400		62,964
Commercial Insurance/Managed Care (excluding Medicare and Medicaid Managed Care)	77,621		80,631		148,432		155,053
Veterans Administration	20,904		18,814		37,547		34,340
Private Pay	15,516		16,251		29,505		30,629
Total	$	218,158	$	216,221	$	406,665	$	403,858

Products & Services Segment

The adoption of ASC 606 did not have a material impact on our Product & Services segment.

Revenue in our Products & Services segment is derived from the distribution of O&P components and the leasing and sale of rehabilitation equipment and ancillary consumable supplies combined with equipment maintenance, education, and training.

Distribution services revenues are recognized when obligations under the terms of a contract with our customers are satisfied, which occurs with the transfer of control of our products. This occurs either upon shipment or delivery of goods, depending on whether the terms are FOB Origin or FOB Destination. Payment terms are typically between 30 to 90 days. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products to a customer (“transaction price”).

To the extent that the transaction price includes variable consideration, such as prompt payment discounts, list price discounts, rebates, and volume discounts, we estimate the amount of variable consideration that should be included in the transaction price utilizing the most likely amount method. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available.

We reduce revenue by estimates of potential future product returns and other allowances. Provisions for product returns and other allowances are recorded as a reduction to revenue in the period sales are recognized. We make estimates of the amount of sales returns and allowances that will eventually be incurred. Management analyzes sales programs that are in effect, contractual arrangements, market acceptance and historical trends when evaluating the adequacy of sales returns and allowance accounts.

Therapeutic program equipment and related services revenue are recognized over the applicable term the customer has the right to use the equipment and as the services are provided. Equipment sales revenue is recognized upon delivery, with any related services revenue deferred and recognized as the services are performed. Sales of consumables are recognized upon delivery.

In addition, we estimate amounts recorded to bad debt expense using historical trends and these are presented as a bad debt expense under the operating expense section of our condensed consolidated financial statements.

The following table disaggregates revenue from contracts with customers in our Product & Services segment for the three and six months ended June 30, 2018 and 2017:

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
(in thousands)	2018		2017		2018		2017
Products & Services Segment
Distribution services, net of intersegment revenue eliminations	$	34,684	$	31,967	$	66,035	$	62,590
Therapeutic solutions	14,124		15,198		28,261		30,619
Total	$	48,808	$	47,165	$	94,296	$	93,209

NOTE B — ~~SIGNIFICANT ACCOUNTING POLICIES~~EARNINGS PER SHARE

~~Principles~~Basic earnings per share is computed using the weighted average number of ~~Consolidation~~common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period plus any potentially dilutive common shares, such as stock options, restricted stock units and performance-based units calculated using the treasury stock method. Total anti-dilutive shares excluded from the diluted earnings per share were 54,467 and 119,881 for the three and six months ended June 30, 2018 and 449,602 and 312,790 for the three and six months ended June 30, 2017.

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

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

For the Three Months Ended
June 30,

For the Six Months Ended
June 30,

(in thousands except per share data)

2018

2017

2018

2017

Net income (loss)

$
12,928

$
1,637

$
(9,690
)
$
(16,097
)

Weighted average shares outstanding - basic

36,790

36,287

36,645

36,187

Effect of potentially dilutive restricted stock units and options (1)

614

257

—

—

Weighted average shares outstanding - diluted

37,404

36,544

36,645

36,187

Basic income (loss) per share

$
0.35

$
0.05

$
(0.26
)
$
(0.44
)

Diluted income (loss) per share

$
0.35

$
0.04

$
(0.26
)
$
(0.44
)
(1) As we are recognizing a loss for the six months periods ended June 30, shares used to compute diluted per share amounts excludes 669,641 shares for 2018 and 330,195 shares for 2017 of potentially dilutive shares related to unvested restricted stock units and unexercised options in accordance with ASC 260 - Earnings Per Share.

NOTE C — ACCOUNTS RECEIVABLE, NET

Accounts receivable, net represent outstanding amounts we expect to collect from the transfer of our products and services. Principally, these amounts are comprised of receivables from Medicare, Medicaid and commercial insurance plans. Under ASC 606, our accounts receivables represent amounts outstanding from our gross billings, net of contractual discounts and other implicit price concessions including estimates for payor disallowances, sales returns and patient non-payments.

Under both ASC 606 and ASC 605, disallowed revenue is considered an adjustment to the transaction price. However, upon adoption of ASC 606, estimated uncollectible amounts due to us by patients are generally considered implicit price concessions and are now presented as a reduction of net revenue. Under prior guidance, these amounts were recognized as bad debt expense in other operating expenses.

An allowance for doubtful accounts is also recorded for our Products & Services segment which is deducted from gross accounts receivable to arrive at “Accounts receivable, net.” Accounts receivable, net as of June 30, 2018, and December 31, 2017 is comprised of the following:

	As of June 30, 2018									As of December 31, 2017
(in thousands)	Patient Care			Products & Services			Consolidated			Patient Care			Products & Services			Consolidated
Accounts receivable, before allowances	$	173,268		$	25,316		$	198,584		$	193,150		$	23,494		$	216,644
Allowances for estimated implicit price concessions arising from:
Payor disallowances	(52,428		)	—			(52,428		)	(56,233		)	—			(56,233		)
Patient non-payments	(8,335		)	—			(8,335		)	—			—			—
Accounts receivable, gross	112,505			25,316			137,821			136,917			23,494			160,411
Allowance for doubtful accounts	—			(3,742		)	(3,742		)	(9,894		)	(4,171		)	(14,065		)
Accounts receivable, net	$	112,505		$	21,574		$	134,079		$	127,023		$	19,323		$	146,346

NOTE D — INVENTORIES

Our inventories are comprised of the following:

(in thousands)	As of June 30, 2018		As of December 31, 2017
Raw materials	$	20,455	$	19,929
Work in process	12,125		8,996
Finished goods	33,859		40,213
Total inventories	$	66,439	$	69,138

NOTE E — PROPERTY PLANT AND EQUIPMENT, NET

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

(in thousands)	As of June 30, 2018			As of December 31, 2017
Land	$	644		$	644
Buildings	26,535			28,180
Furniture and fixtures	13,876			12,968
Machinery and equipment	27,405			26,838
Therapeutic program equipment leased to third parties under operating leases	29,355			31,100
Leasehold improvements	105,396			100,999
Computers and software	67,377			65,455
Total property, plant, and equipment, gross	270,588			266,184
Less: accumulated depreciation	(179,210		)	(172,569		)
Total property, plant, and equipment, net	$	91,378		$	93,615

Total depreciation expense was approximately $7.5 million and $7.4 million for the three months ended June 30, 2018 and 2017, respectively and $14.8 million and $15.1 million for the six months ended June 30, 2018 and 2017, respectively.

NOTE F — GOODWILL AND OTHER INTANGIBLE ASSETS

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

The ~~consolidated financial statements include the accounts~~carrying value of ~~the Company~~goodwill at June 30, 2018 and ~~its wholly-owned subsidiaries. All intercompany transactions~~December 31, 2017 was $196.3 million and ~~balances have been eliminated in the accompanying financial statements.~~

~~Use of Estimates~~related to our Patient Care segment.

The ~~preparation~~balances related to intangible assets as of ~~financial statements in conformity with GAAP requires management to make estimates~~June 30, 2018 and ~~assumptions that affect~~December 31, 2017 are as follows:

	As of June 30, 2018										As of December 31, 2017
(in thousands)	Gross Carrying Amount		Accumulated Amortization			Accumulated Impairment			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Accumulated Impairment			Net Carrying Amount
Customer lists	$	30,976	$	(21,914	)	$	—		$	9,062	$	36,439	$	(24,267	)	$	—		$	12,172
Other intangible assets	15,005		(10,222		)	—			4,783		15,820		(10,352		)	—			5,468
Definite-lived intangible assets	45,981		(32,136		)	—			13,845		52,259		(34,619		)	—			17,640
Indefinite life - trade name	9,070		—			(4,770		)	4,300		9,070		—			(4,770		)	4,300
Total other intangible assets	$	55,051	$	(32,136	)	$	(4,770	)	$	18,145	$	61,329	$	(34,619	)	$	(4,770	)	$	21,940

Total intangible amortization expense was approximately $1.8 million and $2.4 million for the ~~reported amounts of~~three months ended June 30, 2018 and 2017, respectively and $3.8 million and $4.9 million for the six months ended June 30, 2018 and 2017, respectively.

Estimated aggregate amortization expense for definite lived intangible assets ~~and liabilities, disclosure of contingent assets and liabilities at the date~~for each of the ~~financial statements,~~next five years ended December 31st and ~~the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.~~thereafter is as follows:

(in thousands)
2018 (remainder of year)	$	2,944
2019	3,762
2020	3,509
2021	927
2022	860
Thereafter	1,843
Total	$	13,845

~~Cash~~NOTE G — OTHER CURRENT ASSETS AND OTHER ASSETS

Other current assets consist of the following:

(in thousands)

As of June 30, 2018

As of December 31, 2017

Non-trade receivables

$
8,130

$
7,668

Prepaid rent

4,410

4,248

Prepaid maintenance

2,805

3,134

Restricted cash

2,331

3,271

Prepaid insurance

1,124

271

Prepaid benefits

901

368

Other

1,714

1,928

Total other current assets

$
21,415

$
20,888

Other assets consist of the following:
(in thousands)

As of June 30, 2018

As of December 31, 2017

Cash surrender value of company owned life insurance

$
3,003

$
2,340

Non-trade receivables

2,314

2,407

Surety bond

2,500

2,500

Deposits

2,141

2,193

Derivative asset

1,255

—

Other

269

—

Total other assets

$
11,482

$
9,440

NOTE H — ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES AND OTHER LIABILITIES
Accrued expenses and ~~Cash Equivalents~~other current liabilities consist of:
(in thousands)

As of June 30, 2018

As of December 31, 2017

Patient prepayments, deposits and refunds payable

$
25,242

$
30,194

Accrued professional fees

4,260

11,612

Insurance and self-insurance accruals

8,894

8,901

Accrued sales taxes and other taxes

6,055

6,335

Derivative liability

1,222

—

Accrued interest payable

400

845

Other current liabilities

8,185

8,421

Total accrued expenses and other current liabilities

$
54,258

$
66,308

Other liabilities consist of:
(in thousands)

As of June 30, 2018

As of December 31, 2017

Supplemental executive retirement plan obligations

$
20,325

$
21,842

Long-term insurance accruals

9,620

9,531

Deferred tenant improvement allowances

8,363

7,361

Unrecognized tax benefits

5,337

5,219

Deferred rent

4,673

4,909

Other

1,147

1,391

Total other liabilities

$
49,465

$
50,253

NOTE I — INCOME TAXES

We recorded a benefit from income tax of $0.1 million and a provision of $0.6 million for the three months ended June 30, 2018 and 2017, respectively. The effective tax rate was (0.7)% and 25.2% for the three months ended June 30, 2018 and 2017, respectively. We recorded a benefit from income tax of $6.3 million and a benefit of $5.4 million for the six months ended June 30, 2018 and 2017, respectively. The effective tax rate was 39.4% and 25.3% for the six months ended June 30, 2018 and 2017, respectively.

The ~~Company considers all highly liquid investments with original maturities of~~decrease in the effective tax rate for the three months ended June 30, 2018 compared with the three months ended June 30, 2017 is primarily attributable to the changes enacted by the Tax Act and the change from the discrete method for interim reporting used for the three months ended March 31, 2018 to using the annualized effective tax rate method for the six months ended June 30, 2018. Our effective tax rate for the three months ended June 30, 2018 differed from the federal statutory tax rate of 21% primarily due to non-deductible expenses and the windfall from stock-based compensation recorded as a discrete item during the period. Our effective tax rate for the three months ended June 30, 2017 differed from the federal statutory tax rate of 35% primarily due to non-deductible expenses and the windfall from stock-based compensation recorded as a discrete item during the period.

The increase in the income tax benefit for the six months ended June 30, 2018 compared with six months ended June 30, 2017 is largely driven by the increased estimated annual effective tax rate applied to the quarter, partially offset by decreased loss from continuing operations before taxes for the period. The increase in estimated annual effective tax rate was driven by increased estimated permanent differences and decreased estimated loss from continuing operations before taxes. Our effective tax rate for the six months ended June 30, 2018 differed from the federal statutory tax rate of 21% primarily due to non-deductible expenses and the shortfall from stock based compensation recorded as discrete item during the period. Our effective tax rate for the six months ended June 30, 2017 differed from the federal statutory tax rate of 35% primarily due to non-deductible expenses and the shortfall from stock based compensation recorded as a discrete item during the period.

On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in

reasonable detail to complete the accounting for certain income tax effects of the Tax Act. In the fourth quarter of 2017, we recorded a provisional amount of $35.0 million of tax expense related to re-measurement of our deferred tax assets and liabilities.

For the six months ended June 30, 2018, there were no significant adjustments to this amount although it remains provisional. Additional work is still necessary for a more detailed analysis of our deferred tax assets and liabilities. The future issuance of U.S. Treasury Regulations, administrative interpretations or court decisions interpreting the Tax Act may require further adjustments and changes in our estimate. Any subsequent adjustment to these amounts will be recorded to current tax expense in the quarter of 2018 when the analysis is complete.

NOTE J — LONG-TERM DEBT

Long-term debt consists of the following:

(in thousands)	As of June 30, 2018			As of December 31, 2017
Credit Agreement, dated March 6, 2018
Revolving credit facility	$	—		$	—
Term loan B	503,738			—
Prior Credit Agreement, dated August 1, 2016
Term loan B	—			280,000
Prior Credit Agreement, dated June 17, 2013
Revolving credit facility	—			5,000
Term loan	—			151,875
Seller notes	4,148			5,912
Financing leases and other	16,738			18,169
Total debt before unamortized discount and debt issuance costs	524,624			460,956
Unamortized discount and debt issuance costs, net	(10,083		)	(10,692		)
Total debt	514,541			450,264
Current portion of long-term debt	10,384			4,336
Long-term debt	$	504,157		$	445,928

Refinancing of Credit Agreement and Term B Borrowings

On March 6, 2018, we entered into a new $605.0 million Senior Credit Facility (the “Credit Agreement”).

The Credit Agreement provides for (i) a revolving credit facility with an initial maximum aggregate amount of availability of $100.0 million that matures in March 2023 and (ii) a $505.0 million Term loan B facility due in quarterly principal installments commencing June 29, 2018, with all remaining outstanding principal due at maturity in March 2025. Availability under the revolving credit facility is reduced by outstanding letters of credit, which were approximately $5.9 million as of June 30, 2018. We may (a) increase the aggregate principal amount of any outstanding tranche of term loans or add one or more additional tranches of term loans under the loan documents, and/or (b) increase the aggregate principal amount of revolving commitments or add one or more additional revolving loan facilities under the loan documents by an aggregate amount of up to the sum of (1) $125.0 million and (2) an amount such that, after giving effect to such incurrence of such amount (but excluding the cash proceeds of such incremental facilities and certain other indebtedness, and treating all commitments in respect of revolving indebtedness as fully drawn), the consolidated first lien net leverage ratio is equal to or less than 3.80 to 1.00, if certain conditions are satisfied, including the absence of a default or an event of default under the Credit Agreement at the ~~date~~time of ~~purchase~~the increase and that we obtain the consent of each lender providing any incremental facility.

Net proceeds from our initial borrowings under the Credit Agreement, which totaled approximately $501.5 million, were used in part to repay in full all previously existing loans outstanding under our previous credit agreement and Term B credit agreement. Proceeds were also used to pay various transaction costs including fees paid to respective lenders and accrued and unpaid interest. The remainder of the proceeds are being used to provide ongoing working capital and capital for other general corporate purposes.

In connection with the Credit Agreement, we paid debt issuance costs of approximately $6.8 million. As part of the repayment of amounts outstanding under our prior credit agreements, we paid a call premium totaling approximately $8.4 million and expensed outstanding unamortized discount and debt issuance costs totaling approximately $8.6 million. The call premium and unamortized debt issuance costs on the prior credit agreements are included in “Loss on Extinguishment of Debt” in the condensed consolidated statements of operations for the six months ended June 30, 2018.

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

Borrowings under the Credit Agreement bear interest at a variable rate equal to (i) LIBOR plus a specified margin, or (ii) the base rate (which is the highest of (a) Bank of America, N.A.’s prime rate, (b) the federal funds rate plus 0.50% or (c) the sum of 1% plus one-month LIBOR) plus a specified margin. For the three months ended June 30, 2018, the weighted average interest rate on outstanding borrowings under our Term loan B facility was approximately 5.4%. We have entered into interest rate swap agreements to hedge certain of our interest rate exposures, as more fully disclosed in Note L - “Derivative Financial Instruments.”

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

The Credit Agreement contains various ~~times throughout~~restrictions and covenants, including requirements that we maintain certain financial ratios at prescribed levels and restrictions on our ability and certain of our subsidiaries to consolidate or merge, create liens, incur additional indebtedness, dispose of assets, consummate acquisitions, make investments and pay dividends and other distributions. The Credit Agreement includes the ~~year,~~following financial covenants applicable for so long as any revolving loans and/or revolving commitments remain outstanding under the ~~Company maintains cash balances~~Credit Agreement: (i) a maximum consolidated first lien net leverage ratio (defined as, with certain adjustments and exclusions, the ratio of consolidated first-lien indebtedness to consolidated net income before interest, taxes, depreciation, amortization, non-cash charges and certain other items (“EBITDA”) for the most recently ended period of four fiscal quarters for which financial statements are available) of 5.00 to 1.00 for the fiscal quarters ended June 30, 2018, September 30, 2018, December 31, 2018 and March 31, 2019; 4.75 to 1.00 for the fiscal quarters ended June 30, 2019 through March 31, 2020; 4.50 to 1.00 for the fiscal quarters ended June 30, 2020 through March 31, 2021; 4.25 to 1.00 for the fiscal quarters ended June 30, 2021 through March 31, 2022; and 3.75 to 1.00 for the fiscal quarter ended June 30, 2022 and the last day of each fiscal quarter thereafter; and (ii) a minimum interest coverage ratio (defined as, with certain adjustments, the ratio of our EBITDA to consolidated interest expense to the extent paid or payable in cash) of 2.75 to 1.00 as of the last day of any fiscal quarter. We were in compliance with all covenants at June 30, 2018.

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

Scheduled maturities of debt at June 30, 2018 were as follows (in thousands):

2018 (remainder of year)

$
5,999

2019

8,356

2020

7,275

2021

5,936

2022

6,053

Thereafter

491,005

Total debt before unamortized discount and debt issuance costs, net

524,624

Unamortized discount and debt issuance costs, net

(10,083
)
Total debt

$
514,541

~~Credit Risk~~NOTE K — FAIR VALUE MEASUREMENTS

The Company primarily provides O&P (orthotics and prosthetics) devices and services and products throughout the United States of America and is reimbursed by the patients, third-party insurers, governmentally funded health insurance programs, and, for those products distributed through the Products & Services business, from independent O&P providers. The Company also provides advanced rehabilitation technology and clinical programs to skilled nursing facilities in the United States primarily through operating leases. The Company performs ongoing credit evaluations of its customers. Accounts receivable are not collateralized. The ability of the Company’s debtors to meet their obligations is dependent upon their financial stability which could be affected by future economic factors, legislation and regulatory actions. Additionally, the Company maintains reserves for potential losses from these receivables that historically have been within management’s expectations.

~~Inventories~~

Patient Care—Inventories at Hanger Clinic, Dosteon and Cares, which consist of raw materials, work-in-process and finished goods, amounted to $120.1 million and $109.2 million at March 31, 2014 and December 31, 2013, respectively. Inventories in Hanger’s Clinics, which amounted to $110.0 million and $99.0 million at March 31, 2014 and December 31, 2013, respectively, consist principally of raw materials and work-in-process inventory valued based on the gross profit method, which approximates lower of cost or market using the first-in first-out method. Inventories in the Dosteon business amounted to $8.8 million and $8.9 million at March 31, 2014 and December 31, 2013, respectively, and consist principally of raw materials. As of March 31, 2014, the Dosteon inventories were valued based on the gross profit method, which approximates lower of cost or market using the first-in first-out method.

~~Table of Contents~~

Inventories in the Cares business amounted to $1.2 million and $1.3 million as of March 31, 2014 and December 31, 2013, respectively, consisted principally of finished goods and are valued at the lower of cost or market using the first-in first-out method based on perpetual records.

~~Hanger Clinic and Dosteon do not maintain a perpetual inventory system. On October 31~~st of each year the company performs an annual physical inventory of all inventories in Hanger Clinics. Dosteon counted its inventories on December 31, 2013 and October 31, 2012. The Company values the raw materials and work-in-process inventory counted at October 31 at lower of cost or market using the first-in first-out method. Hanger Clinic work-in-process inventory consists of materials, labor and overhead which is valued based on established standards for the stage of completion of each custom order. Material, labor and overhead costs are determined at the individual clinic or groups of clinics level. Adjustments to reconcile the Hanger Clinic and Dosteon physical inventory are treated as changes in accounting estimates and are recorded in the fourth quarter. The Company recorded a fourth quarter adjustment of a decrease to inventory of $2.3 million in 2013.

~~For Hanger Clinics, the October 31~~st inventory is subsequently adjusted at each quarterly and annual reporting period end by applying the gross profit method. As it relates to materials, the Company generally applies the gross profit method to individual clinics or groups of clinics for material costs. Labor and overhead and other aspects of the gross profit method are completed on a Hanger Clinic-wide basis. A similar approach is applied to Dosteon inventory, as applicable.

Products & Services—Inventories consisted principally of finished goods which are stated at the lower of cost or market using the first-in, first-out method for all reporting periods and are valued based on perpetual records.

Fair Value Measurements

~~The Company follows~~We follow the authoritative guidance for financial assets and liabilities, which establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. The authoritative guidance requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy by which these assets and liabilities must be categorized, based on significant levels of inputs as follows:

Level 1 ~~unadjusted~~ consists of securities for which there are quoted prices in active markets for identical securities;

Level 2 consists of securities for which observable inputs other than Level 1 inputs are used, such as quoted prices for similar securities in active markets or quoted prices for identical ~~assets or liabilities~~securities in less active markets ~~accessible~~and model-derived valuations for which the variables are derived from, or corroborated by, observable market data; and

Level 3 consists of securities for which there are no observable inputs to the ~~Company~~

~~Level 2~~ ~~inputs~~valuation methodology that are ~~observable in the marketplace other than those inputs classified as Level 1~~

~~Level 3~~ ~~inputs that are unobservable in the marketplace and~~ significant to the ~~valuation~~measurement of the fair value.

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Financial Instruments

~~Assets~~We hold investments in money market funds which are measured at fair value on a recurring ~~basis as~~basis. As of ~~March 31, 2014~~June 30, 2018 and December 31, ~~2013, are $51.6~~2017, $2.3 million and ~~$7.7~~$3.3 million, respectively, ~~and are composed~~ of ~~cash equivalent~~ money market ~~investments.~~funds which are restricted from general use are presented within “Other current assets.” The fair values of our money market ~~investments~~funds are based on Level 1 observable market prices and are equivalent to one ~~dollar.~~dollar per share. The carrying value of ~~the Company’s short-term financial instruments, such as receivables~~accounts receivable and ~~payables,~~accounts payable approximate their fair values based on the short-term ~~maturities~~nature of these instruments. ~~During the second quarter of 2013, the Company~~

In March 2018, we refinanced ~~its~~our credit facilities ~~by replacing~~with the Credit Agreement. The carrying value of our outstanding term loan as of June 30, 2018 was $503.7 million compared to its ~~$300.0~~fair value of $501.8 million. The carrying value of our outstanding term loan as of December 31, 2017 was $151.9 million compared to its fair value of $149.4 million. The carrying value of our outstanding Term Loan B as of December 31, 2017 was $280.0 million compared to its fair value of $283.5 million. Our estimates of fair value are based on a discounted cash flow model and ~~$100.0 million Revolving Credit Facility with~~indicative quote using unobservable inputs, primarily, our risk-adjusted credit spread, which represents a ~~$225.0 million Term Loan Facility and a $200.0 million Revolving Credit Facility. See Note F for further information.~~Level 3 measurement.

·~~The carrying values~~As of ~~the Company’s~~June 30, 2018, we had no amounts outstanding ~~Term Loans as of March 31, 2014 and December 31, 2013, were $220.8 million and $222.2 million, respectively. The Company has determined the carrying value~~ on ~~these loans approximates fair value for debt with similar terms and remaining maturities based on interest rates currently available and has therefore concluded these are Level 2 measurements.~~

·The carrying values of the Company’s outstanding Revolving Credit Facilities as of March 31, 2014 and December 31, 2013, were $112.0 million and $25.0 million, respectively. The Company has determined the carrying value on these loans approximates fair value for debt with similar terms and remaining maturities based on interest rates currently available and has therefore concluded these are Level 2 measurements.

·our revolving credit facility. The carrying value of the ~~Senior Notes was $200.0 million~~amount outstanding on our revolving credit facilities as of ~~March 31, 2014 and~~ December 31, ~~2013. The fair value of the Senior Notes,~~2017 was ~~$213.0~~$5.0 million ~~and $213.3 million as of March 31, 2014 and December 31, 2013. The Company has determined~~compared to the fair value $4.9 million. Our estimates of ~~the Senior Notes~~fair value are based on ~~market observable inputs and has therefore concluded these are Level 2 measurements.~~

~~Table of Contents~~

·Seller Notes are recorded at contractual carrying values of $29.1 million and $21.1 million as of March 31, 2014 and December 31, 2013, respectively, and carrying value approximates fair value for similar debt in all material respects. The Company estimates fair value of the seller notes with a discounted cash flow model using unobservable ~~rates and has determined these represent~~inputs, primarily, our risk-adjusted credit spread, which represents a Level 3 ~~measurements.~~measurement.

~~Revenue Recognition~~

~~Revenues in~~In March 2018, we entered into interest rate swap agreements with notional values of $325.0 million, at inception, which reduces $12.5 million annually until the ~~Company’s Patient Care segment~~swaps mature on March 6, 2024. The interest rate swap agreements are derived from the sale of O&P devices and the maintenance and repair of existing devices. Revenues from maintenance and repairs are recognized when the service is provided. Revenues from the sale of devices are recorded when the patient has accepted and received the device and recorded net of known and estimated future contractual adjustments and discounts. Contractual adjustments and discounts are recordeddesignated as contra-revenue within net sales on the Consolidated Statement of Income and Comprehensive Income. Medicare and Medicaid regulations and the various agreements we have with other third-party payors under which these contractual adjustments and discounts are calculated are complexcash flow hedges and are ~~subject to interpretation. Therefore, the devices~~measured at fair value based on inputs other than quoted market prices that are observable, which represents a Level 2 measurement. See Note J - “Long-Term Debt” and ~~related services authorized and provided, and the related reimbursement, are subject to interpretation and adjustment that could result~~Note L - “Derivative Financial Instruments” for further information.

The carrying value of our outstanding subordinated promissory notes issued in ~~payments that differ from our estimates. Additionally, updated regulations and pay schedules, and contract renegotiations, occur frequently, necessitating regular review and assessment~~connection with acquisitions (“Seller Notes”) as of ~~the estimation process by management.~~

~~Reserves for future contractual adjustments are estimated utilizing historical trends for such adjustments and are monitored monthly. As of March 31, 2014~~June 30, 2018 and December 31, ~~2013, the Company estimated the reserve for future contractual adjustments and discounts to be $22.7~~2017 was $4.1 million and ~~$20.6~~$5.9 million, respectively. The increase in the estimate is primarily related to both revenue growth resulting from both same clinic sales growth and clinic acquisitions, and from changes in collection trends. Individual patients are generally responsible for deductible and/or co-payments. The reserve for future contractual adjustments and discounts is reflected as a reduction of accounts receivable on the Company’s Consolidated Balance Sheet.

Revenues in the Company’s Products & Services segment are derived from the distribution of O&P devices and the leasing of rehabilitation technology combined with clinical therapy programs, education and training. Distribution revenues are recorded upon the shipment of products, in accordance with the terms of the invoice, net of estimated returns. Discounted sales are recorded at net realizable value. Leasing revenues are recognized based upon the contractual terms of the agreements, which contain negotiated pricing and service levels with terms ranging from one to five years, and are generally billed to the Company’s customers monthly.

~~Net Accounts Receivable~~

The Company reports accounts receivable at estimated net realizable amounts generated for products delivered and services rendered from federal, state, managed care health plans, commercial insurance companies and patients. Collections of these accounts receivable are the Company’s primary source of cash and are critical to the Company’s operating performance. The Company estimates uncollectible patient accounts primarily based upon its experience in historical collections from individual patients. Bad debt expense is reported within Other operating expenses within the Consolidated Statement of Income and Comprehensive Income. At March 31, 2014 and December 31, 2013, net accounts receivable reflected allowance for doubtful accounts, $10.3 million and $10.0 million respectively.

~~Property, Plant and Equipment~~

Property, plant and equipment are recorded at cost less accumulated depreciation, with the exception of assets acquired through acquisitions, which are initially recorded at fair value. Equipment acquired under capital leases is recorded at the lower of fair market value or the present value of the future minimum lease payments. The cost and related accumulated depreciation of assets sold, retired or otherwise disposed of are removed from the respective accounts, and any resulting gains or losses are included in the Consolidated Statements of Income and Comprehensive Income.

Included within the Buildings line item were $12.0 million and $10.9 million of buildings recorded under capital leases, as of March 31, 2014 and December 31, 2013, respectively. Accumulated depreciation on these capital leases were $1.4 million and $0.9 million, as of March 31, 2014 and December 31, 2013, respectively. The annual future minimum lease payments as of March 31, 2014 under the lease agreements are $1.4 million, $2.0 million, $2.1 million, $2.1 million, $2.2 million, $9.5 million for the years ending 2014, 2015, 2016, 2017, 2018 and thereafter. These future minimum lease payments include $6.0 million of interest.

~~Table of Contents~~

~~Goodwill and Other Intangible Assets~~

Goodwill represents the excess of purchase price over the fair value of net identifiable assets of purchased businesses. The Company assesses goodwill for impairment annually during the fourth quarter, or when events or circumstances indicateWe believe that the carrying value of the ~~reporting units may not be recoverable.~~Seller Notes approximates their fair values based on a discounted cash flow model using unobservable inputs, primarily, our credit spread for subordinated debt, which represents a Level 3 measurement.

NOTE L — DERIVATIVE FINANCIAL INSTRUMENTS

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

Cash Flow Hedges of Interest Rate Risk

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish these objectives, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counter-party in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The ~~Company has the option to first assess qualitative factors to determine whether it is more likely than not that~~change in the fair value of ~~a reporting unit~~derivatives designated and that qualify as cash flow hedges is ~~less than its carrying amount as a basis for determining whether it~~recorded on our consolidated balance sheet in accumulated other comprehensive income and is necessary to perform the two-step goodwill impairment test. If the Company determines that a two-step goodwill impairment test is necessary or more efficient than a qualitative approach, it will measure the fair value of the Company’s reporting units using a combination of income, market and cost approaches. Any impairment would be recognized by a charge to operating results and a reductionsubsequently reclassified into earnings in the ~~carrying value of the intangible asset. There were no impairment indicators since the last annual impairment test on October 1, 2013.~~

~~Debt Issuance Costs~~

Debt issuance costs incurred in connection with the Company’s long-term debt are amortized, on a straight-line basis, which is not materially different from the effective interest method, through the maturity of the related debt instrument. Amortization of these costs is included in Interest Expense in the Consolidated Statements of Income and Comprehensive Income.

~~Long-Lived Asset Impairment~~

~~The Company evaluates the carrying value of long-lived assets to be held and used whenever events or changes in circumstance indicate~~period that the carrying amount may not be recoverable. The carrying value of a long-lived asset group is not recoverable and is considered impaired if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. The Company measures impairment as the amount by which the carrying value exceeds the fair market value. Fair market value is determined primarily using the projected future cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose. There were no long-lived asset impairments or indicators of impairment for the periods ended March 31, 2014 and December 31, 2013.

~~Supplemental Executive Retirement Plan (SERP)~~

Effective January 2004, the Company implemented an unfunded noncontributory defined benefit plan (the “Plan”) for certain senior executives. Benefit costs and liabilities balances are calculated based on certain assumptions including benefits earned, discount rates, interest costs, mortality rates and other factors. The Company engages an actuary to calculate the benefit obligation and net benefit costs. The Plan, which is administered by the Company, calls for annual payments upon retirement based on years of service and final average salary. The Company believes the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. Actual results that differ from the assumptions are accumulated and amortized over future periods, affecting the recorded obligation and expense in future periods. For further information, including the significant assumptions used in the estimate, see Note I of the accompanying financial statements.

~~Income Taxes~~

The Company recognizes 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. Deferred income tax liabilities and assets are determined based on the difference between the financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company recognizes a valuation allowance on the deferred tax assets if it is more likely than not that the assets will not be realized in future years. Significant accounting judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities. The Company believes that its tax positions are consistent with applicable tax law, but certain positions may be challenged by taxing authorities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. In addition, the Company is subject to periodic audits and examinations by the Internal Revenue Service and other state and local taxing authorities. Although the Company believes that its estimates are reasonable, actual results could differ from these estimates.

~~Stock-Based Compensation~~

The Company issues under one active stock-based compensation plan restricted stock units that settle in shares common stock. Shares of common stock issued under the stock-based compensation plan are issued from the Company’s authorized and unissued shares. Restricted stock units are granted at the fair market value of the Company’s common stock on the grant date. Restricted stock units vest over a period of time determined in accordance with the terms of the compensation plan, which permits vesting periods ranging from one to four years. All restricted stock units issued under the plan have vested in four years, in the case of employees, and three years in the case of directors.

~~Table of Contents~~

The Company applies the fair value recognition provisions of the authoritative guidance for stock compensation, which require companies to measure and recognize compensation expense for all stock-based payments at fair value.

Stock compensation expense relates to restricted stock units, as all previously granted stock options are now fully vested and all associated compensation expense has been recognized in prior years. The total value of the restricted stock units is expensed ratably over the requisite service period of the employees receiving the awards and is included within Other operating expenses on the Company’s Consolidated Statements of Income and Comprehensive Income.

~~Segment Information~~

The Company applies a “management” approach to disclosure of segment information. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the basis of the Company’s operating segments. During the first quarter of 2013, the Company assessed and updated their operating segments to align with how the business is managed and determined their reportable segments are the same as their operating segments. The description of the Company’s segments and the disclosure of segment information are presented in Note K.

~~Recent Accounting Pronouncements~~

In July 2013, the FASB issued ASU 2013-11, “Income Taxes” that requires unrecognized tax benefits be classified as an offset to deferred tax assets to the extent of any net operating loss carryforwards, similar tax loss carryforwards, or tax credit carryforwards available at the reporting date in the applicable tax jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position. An exception would apply if the tax law of the tax jurisdiction does not require the Company to use, and it does not intend to use, the deferred tax asset for such purpose. This guidance is effective for reporting periods beginning after December 15, 2013. The Company adopted this guidance and its implementation did not have a material impact on the Company’s Condensed Consolidated Financial Statements.

~~NOTE C — GOODWILL AND OTHER INTANGIBLE ASSETS~~

The Company completes its annual goodwill and indefinite lived intangible impairment analysis in the fourth quarter of each year. The Company has the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. If the Company determines that a two-step goodwill impairment test is necessary or more efficient than a qualitative approach, it will measure the fair value of the Company’s reporting units using a combination of income, market and cost approaches. There were no impairment indicators since our last annual impairment test on October 1, 2013.

~~Goodwill allocated to the Company’s operating segments for the three months ended March 31, 2014 and for the year ended 2013 are as follows:~~

(In thousands)

Patient Care

Products &
Services

Total

Balance at December 31, 2013

$
545,265

$
136,282

$
681,547

Additions due to acquisitions

17,130

3,778

20,908

Adjustments

—

—

—

Balance at March 31, 2014

$
562,395

$
140,060

$
702,455

Patient Care

Products &
Services

Total

Balance at December 31, 2012

$
538,492

$
136,282

$
674,774

Additions due to acquisitions

7,317

—

7,317

Adjustments

(544
)
—

(544
)
Balance at December 31, 2013

$
545,265

$
136,282

$
681,547

~~The balances related to intangible assets as of March 31, 2014 and December 31, 2013 are as follows:~~

~~Table of Contents~~

March 31, 2014

December 31, 2013

(In thousands)

Gross
Carrying
Amount

Accumulated
Amortization

Net
Carrying
Amount

Gross
Carrying
Amount

Accumulated
Amortization

Net
Carrying
Amount

Customer Lists

$
50,263

$
(12,715
)
$
37,548

$
46,932

$
(11,627
)
$
35,305

Trade Name

11,825

(380
)
11,445

10,023

(264
)
9,759

Patents and Other Intangibles

28,546

(16,172
)
12,374

28,441

(15,484
)
12,957

$
90,634

$
(29,267
)
$
61,367

$
85,396

$
(27,375
)
$
58,021

Customer lists are amortized over their estimated period of benefit, generally 10 to 14 years. The majority of value associated to trade names is identified as an indefinite lived intangible asset, which is assessed for impairment on an annual basis as discussed in Note B. Trade names not identified as an indefinite lived intangible asset are amortized over their estimated period of benefit of approximately 1 to 3 years. Patents are amortized using the straight-line method over 5 years. Total intangible amortization expenses were $1.8 million and $1.7 million for the three months ended March 31, 2014 and March 31, 2013, respectively. The weighted average life of the additions to customer lists, patents and other intangibles is 6 years.

~~NOTE D~~ — ~~INVENTORIES~~

Inventories recorded using the gross profit method primarily consisted of raw materials and work-in-process held by the Patient Care segment. Inventories using the perpetual method primarily consisted of finished goods held by the Products & Services segment. A description of the Company’s inventory valuation methodologies are presented in Note B.

(In thousands)

March 31, 2014

December 31, 2013

Raw materials

$
43,143

$
40,970

Work in process

75,661

66,832

Finished goods

35,148

33,716

$
153,952

$
141,518

~~NOTE E — ACQUISITIONS~~hedged forecasted transaction affects earnings.

During the three months ended ~~March~~June 30, 2018, such derivatives were used to hedge certain variable cash flows associated with existing variable-rate debt. As of June 30, 2018, our swaps had a notional value outstanding of $325.0 million. We had no swaps outstanding as of December 31, ~~2014,~~2017.

Changes in Net Gain or Loss on Cash Flow Hedges Included in Accumulated Other Comprehensive Loss

The following table presents the ~~Company acquired seven companies, operating~~activity of cash flow hedges included in accumulated other comprehensive loss (“AOCI”) for the three and six months ended June 30, 2018:

(in thousands)	Cash Flow Hedges
Balance as of March 31, 2018	$	2,290
Unrealized gain recognized in other comprehensive income (loss), net of tax	(1,618		)
Reclassification to interest expense, net	(696		)
Balance as of June 30, 2018	$	(24	)

Balance as of December 31, 2017	$	—
Unrealized loss recognized in other comprehensive income (loss), net of tax	920
Reclassification to interest expense, net	(944		)
Balance as of June 30, 2018	$	(24	)

The following table presents the fair value of derivative assets and liabilities within the condensed consolidated balance sheets as of June 30, 2018 and December 31, 2017:

	As of June 30, 2018				As of December 31, 2017
(in thousands)	Assets		Liabilities		Assets		Liabilities
Derivatives designated as cash flow hedging instruments:
Accrued expenses and other current liabilities	$	—	$	1,222	$	—	$	—
Other assets	1,255		—		—		—

NOTE M — STOCK-BASED COMPENSATION

The Hanger, Inc. 2016 Omnibus Incentive Plan (the “2016 Plan”) as amended by our Board of Directors (the “Board”) in May 2018 authorizes the issuance of up to 2,625,000 shares of Common Stock, plus (1) the number of shares available for issuance under our prior equity incentive plan, the Hanger, Inc. 2010 Omnibus Incentive Plan (the “2010 Plan”), that had not been made subject to outstanding awards as of the effective date of the 2016 Plan and (2) any shares that would have become available again for new grants under the terms of the 2010 Plan if such plan were still in effect.

We recognized a total of 22 patient care clinics. The aggregate purchase price for these O&P businesses was $28.9 million. Of this aggregate purchase price, $9.3 million consisted of promissory notes, $0.4 million was made up of contingent consideration payable within the next two years and $19.1 million was paid in cash. The excess of purchase price over the aggregate fair value was recorded as goodwill. The Company preliminarily allocated the purchase price to the individual assets acquired and liabilities assumed, consisting of $2.6 million accounts receivable, $1.8 million inventory, $20.9 million of goodwill, $4.5 million of definite lived intangibles, $1.5 of indefinite lived intangibles, fixed assets and other assets of $1.4approximately $3.3 million and ~~accounts payable and other liabilities~~$2.9 million, respectively, of $3.8 million. The Company’s valuations are subject to adjustment as additional information is obtained. The value of the goodwill from these acquisitions can be attributed to a number of business factors including, but not limited to expected revenue and cash flow growth in future years. Contingent consideration is reported as other liabilities on the Company’s Consolidated Balance Sheet. The Company elected to treat all of these acquisitions as asset acquisitionsstock-based compensation expense for tax purposes resulting in all of the Q1 2014 recorded Goodwill as being amortizable for tax purposes. The expenses incurred related to these acquisitions were insignificant and were included in Other operating expenses on the Company’s Consolidated Statements of Income and Comprehensive Income.

~~During~~ the three months ended ~~March 31, 2013, the Company did not acquire any new O&P companies.~~

The results of operations for the acquisitions are included in the Company’s results of operations from the dates of acquisition. Pro forma results would not be materially different. In connection with contingent consideration agreements, the Company made payments of $0.4 million in the first three months of 2014June 30, 2018 and ~~$0.7 million in the same period 2013. As of March 31, 2014 the Company has accrued~~2017 and a total of ~~$2.6~~approximately $5.9 million ~~related~~and $5.1 million for the six months ended June 30, 2018 and 2017. Stock compensation expense, net of forfeitures, relates to ~~contingent consideration provisions related to acquisitions made in prior periods.~~restricted stock units, performance-based restricted stock units, and stock options.

NOTE ~~F — LONG TERM DEBT~~

~~Long-term debt consists of the following:~~

~~Table of Contents~~

March 31,

December 31,

(In thousands)

2014

2013

Revolving Credit Facility

$
112,000

$
25,000

Term Loan

220,781

222,188

7 1/8% Senior Notes due 2018

200,000

200,000

Subordinated seller notes, non-collateralized, net of unamortized discount with principal and interest payable in either monthly, quarterly or annual installments at effective interest rates ranging from 2.00% to 4.00%, maturing through November 2018

29,154

21,071

Total Debt

561,935

468,259

Less current portion

(20,869
)
(15,998
)
Long Term Debt

$
541,066

$
452,261

~~Revolving Credit Facility~~

The $200.0 million Revolving Credit Facility matures on June 17, 2018 and bears interest at LIBOR plus 1.75%, or the applicable rate (as defined in the Credit Agreement). As of March 31, 2014, the Company had $84.5 million available under this facility. The amounts outstanding under the Revolving Credit Facility as of March 31, 2014 were $115.5 million, net of standby letters of credit of approximately $3.6 million. The obligations under the Revolving Credit Facility are senior obligations, are guaranteed by the Company’s subsidiaries, and are secured by a first priority perfected security interest in all of the Company’s assets, all the assets of the Company’s subsidiaries and the equity interests of the Company’s subsidiaries.

~~Term Loan~~

The Term Loan Facility, of which $220.8 million is outstanding, matures on June 17, 2018 and bears interest at LIBOR plus 1.75%, or the applicable rate (as defined in the Credit Agreement). Quarterly principal payments ranging from 0.625% to 3.750% are required throughout the life of the Term Loan. From time to time, mandatory prepayments may be required as a result of certain additional debt incurrences, certain asset sales, or other events as defined in the Credit Agreement. No mandatory prepayments are required under our Term Loan Agreement. The obligations under the Term Loan Facility are senior obligations, are guaranteed by the Company’s subsidiaries, and are secured by a first priority perfected security interest in all of the Company’s assets, all the assets of the Company’s subsidiaries and the equity interests of the Company’s subsidiaries.

71/8~~% Senior Notes~~

~~The 7~~ 1/8 % Senior Notes mature November 15, 2018 and are senior indebtedness, which is guaranteed on a senior unsecured basis by all of the Company’s subsidiaries. Interest is payable semi-annually on May 15 and November 15 of each year.

Prior to November 15, 2014, the Company may redeem all or some of the notes at a redemption price of 103.6% all to interest that would otherwise have become due from the redemption date through November 15, 2014. On or after November 15, 2014, the Company may redeem all or a part of the notes with a premium, as described in further detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

~~Subsidiary Guarantees~~

~~The Revolving and Term Loan Facilities and the 7~~1/8% Senior Notes are guaranteed by all of the Company’s subsidiaries. Separate condensed consolidating information is not included as the parent company does not have independent assets or operations. The guarantees are full and unconditional and joint and several. There are no restrictions on the ability of our subsidiaries to transfer cash to the Company or to co-guarantors.

~~Debt Covenants~~

The terms of the Senior Notes, the Revolving Credit Facility, and the Term Loan Facility limit the Company’s ability to, among other things, purchase capital assets, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities, and engage in mergers, consolidations and certain sales of assets. The credit agreement requires compliance with various covenants including but not limited to (i) minimum consolidated interest coverage ratio of 3.50:1.00 and (ii) maximum total leverage ratio of 4.00:1.00. As of March 31, 2014, the Company was in compliance with all covenants under these debt agreements.

~~Table of Contents~~

~~NOTE G~~ — ~~COMMITMENTS AND CONTINGENT LIABILITIES~~

~~Contingencies~~

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

The Company is in a highly regulated industry and receives regulatory agency inquiries from time to time in the ordinary course of its business, including inquiries relating to the Company’s billing activities. To date these inquiries have not resulted in material liabilities, but no assurance can be given that future regulatory agencies’ inquiries will be consistent with the results to date or that any discrepancies identified during a regulatory review will not have a material adverse effect on the Company’s consolidated financial statements.

On May 20, 2013, the Staff of the Division of Enforcement of the Securities and Exchange Commission (the “SEC”) informed the Company that it was conducting an investigation of the Company and made a request for a voluntary production of documents and information concerning the Company’s calculations of bad debt expense and allowance for doubtful accounts. The Company cooperated in the investigation. By letter dated April 14, 2014 the Staff informed the Company that it had concluded its investigation, and that based on the information the Staff had as of that date, the Staff did not intend to recommend an enforcement action by the SEC against the Company. The information in the Staff’s letter was provided under the guidelines set out in the final paragraph of Securities Act Release No. 5310.

~~Guarantees and Indemnifications~~

In the ordinary course of its business, the Company may enter into service agreements with service providers in which it agrees to indemnify or limit the service provider against certain losses and liabilities arising from the service provider’s performance of the agreement. The Company has reviewed its existing contracts containing indemnification or clauses of guarantees and does not believe that its liability under such agreements is material to the Company’s operations.

~~NOTE H — NET INCOME PER COMMON SHARE~~

Basic per common share amounts are computed using the weighted average number of common shares outstanding during the year. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and restricted shares and are calculated using the treasury stock method.

~~Net income per share is computed as follows:~~

Three Months Ended

March 31,

(In thousands, except share and per share data)

2014

2013

Net income

$
5,997

$
9,490

Shares of common stock outstanding used to compute basic per common share amounts

35,076,828

34,598,494

Effect of dilutive restricted stock and options (1)

338,190

467,538

Shares used to compute dilutive per common share amounts

35,415,018

35,066,032

Basic income per share

$
0.17

$
0.27

Diluted income per share

$
0.17

$
0.27

~~(1) There were no anti-dilutive options for the three months ended March 31, 2014 and 2013.~~

~~Table of Contents~~

~~NOTE I~~N — SUPPLEMENTAL EXECUTIVE RETIREMENT ~~PLAN (SERP)~~PLANS

~~The Company’s~~Defined Benefit Supplemental Executive Retirement Plan

Our unfunded noncontributory defined benefit plan ~~(the “Plan”~~(“DB SERP”) covers certain senior executives, is administered by ~~the Company~~us and calls for annual payments upon retirement based on years of service and final average salary. Benefit costs and ~~liabilities~~liability balances are calculated based on certain assumptions including benefits earned, discount rates, interest costs, mortality rates and other factors. Actual results that differ from the assumptions are accumulated and amortized over future periods, affecting the recorded obligation and expense in future periods.

~~The following assumptions were used in the calculation of the net benefit cost and obligation at March 31, 2014 and 2013:~~

2014

2013

Discount rate

4.03
%
3.25
%
Average rate of increase in compensation

3.00
%
3.00
%

~~The Company believes~~We believe the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. The DB SERP’s change in ~~the Plan’s~~ net benefit cost and obligation ~~for~~during the three and six months ended ~~March 31, 2014~~June 30, 2018 and ~~2013~~2017 is as follows:

(in thousands)

Net benefit cost accrued at December 31, 2013

$
20,952

Service cost

129

Interest cost

199

Payments

(1,247
)
Net benefit cost accrued at March 31, 2014

$
20,033

Change in Benefit Obligation

	(in thousands)
Net benefit cost accrued at December 31, 2012	$	22,377
(in thousands)				2018			2017
Benefit obligation as of March 31				$	19,158		$	19,745
Service cost	169			92			85
Interest cost	173			150			167
Payments	(705		)	(12		)	(12		)
Net benefit cost accrued at March 31, 2013	$	22,014
Benefit Obligation as of June 30				$	19,388		$	19,985

Benefit obligation as of December 31, 2017 and 2016, respectively				$	20,793		$	21,304
Service cost				184			170
Interest cost				300			334
Payments				(1,889		)	(1,823		)
Benefit obligation as of June 30				$	19,388		$	19,985

~~NOTE J - STOCK-BASED COMPENSATION~~Amounts Recognized in the Condensed Consolidated Balance Sheets:

(in thousands)	June 30, 2018		December 31, 2017
Accrued expenses and other current liabilities	$	1,913	$	1,913
Other liabilities	17,474		18,880
Total accrued liabilities	$	19,387	$	20,793

~~On May 13, 2010,~~

Defined Contribution Supplemental Executive Retirement Plan

We have a defined contribution plan (“DC SERP”) that covers certain of our senior executives. Each participant is given a notional account to manage his or her annual distributions and allocate the ~~shareholders~~funds among various investment options (e.g. mutual

funds). These accounts are tracking accounts only for the purpose of calculating the participant’s benefit. The participant does not have ownership of the ~~Company approved~~underlying mutual funds. When a participant initiates or changes the 2010 Omnibus Incentive Plan (the “2010 Plan”) and suspended future grants under the Amended and Restated 2002 Stock Incentive and Bonus Plan (the “2002 Plan”) and the 2003 Non-Employee Directors’ Stock Incentive Plan (the “2003 Plan”). No new awards have been granted under the 2002 Planallocation of his or ~~the 2003 Plan since that date; however, awards granted under either the 2002 Plan or the 2003 Plan that were outstanding on May 13, 2010 remain outstanding and continue~~her notional account, we will generally make an allocation of our investments, to ~~be subject to all of the terms and conditions of the 2002 Plan or the 2003 Plan, as applicable.~~

The 2010 Plan provides that 2.5 million shares of Common Stock are reserved for issuance, subject to adjustment as set forth in the 2010 Plan; provided, however, that only 1.5 million shares may be issued pursuant to the exercise of incentive stock options. Of these 2.5 million shares, 2.0 million are shares that are newly authorized for issuance under the 2010 Plan and 0.5 million are unissued shares not subject to awards that have been carried over from the shares previously authorized for issuance under the terms of the 2002 Plan and the 2003 Plan. Unless earlier terminatedmatch those chosen by the ~~Board~~participant. While the allocation of ~~Directors,~~our sub accounts is generally intended to mirror the ~~2010 Plan will remain in effect~~participant’s account records (i.e. the distributions and gains or losses on those funds), the employee does not have legal ownership of any funds until ~~the earlier of (i) the date that is ten years from the date the plan is approved~~payout upon retirement. The underlying investments are owned by the ~~Company’s shareholders, which is ten years from the effective date for the 2010 plan, namely May 13, 2020, or (ii) the date all shares reserved for issuance have been issued.~~insurance company (and we own an insurance policy).

As of ~~March 31,~~June 30, 2018 and 2017, the estimated accumulated obligation benefit is $2.7 million and $2.3 million, respectively, of which $2.5 million and $2.1 million is funded and $0.2 million and $0.2 million is unfunded at June 30, 2018 and 2017, respectively.

In connection with the DC SERP benefit obligation, we maintain a company owned policy which is measured at its cash surrender value and is presented within “Other assets” in our consolidated balance sheets. See Note G - “Other Current Assets and Other Assets” for additional information.

NOTE O — COMMITMENTS AND CONTINGENCIES

Commitments

In April 2014, in connection with the settlement of a patent infringement dispute, our wholly-owned subsidiary, Southern Prosthetic Supply, Inc. (“SPS”), entered into a non-cancellable agreement to purchase a total of $4.5 million of prosthetic gel liners in five installments. We determined that a portion of the ~~2.5~~prosthetic gel liners should be reserved as excess and slow-moving inventory, and we accrued a liability and expensed $3.4 million ~~shares~~in 2014. As of ~~common stock authorized~~June 30, 2018, $1.0 million of the non-cancellable purchase commitment was outstanding and is due and payable by April of 2019. As of June 30, 2018, our reserve associated with the non-cancellable purchase commitment was $2.6 million.

Guarantees and Indemnification

In the ordinary course of our business, we may enter into service agreements with service providers in which we agree to indemnify or limit the service provider against certain losses and liabilities arising from the service provider’s performance of the agreement. We have reviewed our existing contracts containing indemnification or clauses of guarantees and do not believe that our liability under such agreements is material.

Legal Proceedings

Securities and Derivative Litigation

In November 2014, a securities class action complaint, City of Pontiac General Employees’ Retirement System v. Hanger, et al., C.A. No. 1:14-cv-01026-SS, was filed against us in the United States District Court for ~~issuance under~~ the ~~Company’s 2010 Plan, approximately 1.8 million shares have~~Western District of Texas. The complaint named us and certain of our current and former officers for allegedly making materially false and misleading statements regarding, inter alia, our financial statements, RAC audit success rate, the implementation of new financial systems, same-store sales growth, and the adequacy of our internal processes and controls. The complaint alleged violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. The complaint sought unspecified damages, costs, attorneys’ fees, and equitable relief.

On April 1, 2016, the court granted our motion to dismiss the lawsuit for failure to state a claim upon which relief can be granted, and permitted plaintiffs to file an amended complaint. On July 1, 2016, plaintiffs filed an amended complaint. On September 15, 2016, we and certain of the individual defendants filed motions to dismiss the lawsuit. On January 26, 2017, the court granted the defendants’ motions and dismissed with prejudice all claims against all defendants for failure to state a claim. On February 24, 2017, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Fifth Circuit. Appellate briefing was completed on August 18, 2017 and the Court of Appeals held oral argument for the appeal on March 5, 2018. On August 6, 2018, the Court of Appeals affirmed in part and reversed in part. The Court of Appeals affirmed the dismissal of the case against individual defendants Vinit Asar, our current President and Chief Executive Officer, and Thomas Kirk, our former President and Chief Executive Officer, but reversed the dismissal of the case against George McHenry, our former Chief Financial Officer, and Hanger, Inc. The case has been ~~issued. During~~remanded back to the ~~first three months~~United States District Court for the Western District of ~~2014,~~Texas for further proceedings with respect to the ~~Company issued approximately 0.3 million shares~~remaining claims. We believe the remaining claims are without merit, and intend to continue to vigorously defend against these claims.

In February and August of ~~restricted stock units under the 2010 Plan. The total fair value of these grants is $9.3 million. Total unrecognized share-based compensation cost~~2015, two separate shareholder derivative suits were filed in Texas state court against us related to ~~unvested restricted stock units~~the announced restatement of certain of our financial statements. The cases were subsequently consolidated into Judy v. Asar, et. al., Cause No. D-1-GN-15-000625. On October 25, 2016, plaintiffs in that action filed an amended complaint, and the case is currently pending before the 459th Judicial District Court of Travis County, Texas.

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

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

On April 14, 2017, we filed a motion to dismiss the consolidated derivative action based on the resolution by the Special Committee that it is not in our best interest to pursue the derivative claims. Counsel for the derivative plaintiffs opposed that motion and moved to compel discovery. In a hearing held on June 12, 2017, the Travis County court denied plaintiffs’ motion to compel, and held that the motion to dismiss would be considered only after appropriate discovery was ~~approximately $18.3 million~~concluded.

The plaintiffs have since subpoenaed counsel for the Special Committee, seeking a copy of the full report prepared by the Special Committee and its independent counsel. Counsel for the Special Committee, as well as our counsel, took the position that the full report is not discoverable under Texas law. Plaintiffs’ counsel filed a motion to compel the Special Committee’s counsel to produce the full report. We opposed the motion. On July 20, 2018, the Travis County court ruled that only a redacted version of ~~March 31, 2014~~the report is discoverable. Upon completion of discovery we intend to file a motion to dismiss the consolidated derivative action.

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

Other Matters

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

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

Favorable Settlements

For the three months ended ~~March 31, 2014~~June 30, 2018, our results of operations and ~~2013,~~net income benefited from the ~~Company has included approximately $2.4 million and~~favorable resolution of two matters.

On May 15, 2018, we received a net favorable settlement of $1.7 million ~~respectively,~~in connection with our long standing damage claims relating to the “Deepwater Horizon” disaster, and the prior adverse effect which it had on our clinic operations along the Gulf Coast in April of 2010. We anticipate the receipt of no further payments in connection with this matter as this settlement constituted a full and final satisfaction of our claims. The benefit of this settlement has been recognized as a reduction to our general and administrative expenses for ~~share-based compensation cost~~the three months and six months ended June 30, 2018.

favorable by $0.5 million to the amount we had previously estimated for these liabilities and had the effect of reducing our general and administrative expenses by this amount for the ~~2010 Plan. Compensation~~quarter and year-to-date. Additionally, under the terms of the agreement, we were not required to pay interest on the previously un-remitted cumulative abandoned or unclaimed property relating to this twelve year period in the amount of $1.5 million, which had the effect of lowering our interest expense ~~relates to restricted stock unit grants under that plan.~~

~~Table of Contents~~in the quarter and for the year-to-date periods ending June 30, 2018 by this accrued interest amount.

NOTE KP — SEGMENT AND RELATED INFORMATION

~~The Company has~~We have identified two operating segments and both performance evaluation and resource allocation decisions are determined based on each operating segment’s income from operations. The operating segments are described further below:

Patient Care -—This segment consists of (i) ~~the Company’s~~our owned and operated patient care clinics, and (ii) ~~its~~our contracting and network management business. The patient care clinics provide services to design and fit O&P devices to patients. These clinics also instruct patients in the use, care and maintenance of the devices. The principal reimbursement sources for ~~the Company’s~~our services are:

· Commercial private payors and other, which consist of individuals, rehabilitation providers, ~~private~~commercial insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers’ compensation programs and similar sources;

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

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

· U.S. Department of Veterans Affairs.

The Company estimates that government reimbursement, comprised of Medicare, Medicaid and the U.S. Department of Veterans Affairs, in the aggregate, accounted for approximately 38.7% and 40.2%, of the Company’s net sales for the three months ended March 31, 2014 and 2013, respectively.

~~The Company’s~~Our contract and network management business, known as Linkia, is the only network management company dedicated solely to serving the O&P market and is focused on managing the O&P services of national and regional insurance companies. ~~It partners~~We partner with healthcare insurance companies by securing a national or regional contract either as a preferred provider or to manage their O&P network of providers. ~~The network now includes approximately 1,170 O&P provider locations, including over 400 independent providers. As of March 31, 2014, it had 58 contracts with national and regional providers.~~

Products & Services - —This segment consists of ~~the Company’s~~our distribution ~~subsidiary,~~services business, which distributes and fabricates O&P products and components ~~for~~to sell to both the O&P industry and ~~the Company’s~~our own patient care clinics, and ~~its rehabilitation~~our therapeutic solutions business. ~~Rehabilitation~~The therapeutic solutions ~~leases~~business provides and sells rehabilitation equipment and ~~provides evidence-based clinical programs to post-acute rehabilitation service providers.~~ancillary consumable supplies combined with equipment maintenance, education, and training. This segment also develops emerging neuromuscular technologies for the O&P and rehabilitation markets.

Corporate & Other — - This consists of corporate overhead and includes unallocated expense such as personnel costs, professional fees and corporate offices expenses.

The accounting policies of the segments are the same as those described in ~~the summary of “Significant Accounting Policies” in~~ Note B ~~to the consolidated financial statements.~~- “Significant Accounting Policies” in our 2017 Form 10-K.

~~Summarized financial information concerning the Company’s operating segments is shown in the following table.~~ Intersegment ~~sales mainly include~~revenue primarily relates to sales of O&P components from the Products & Services segment to the Patient Care ~~segment and were made~~segment. The sales are priced at ~~prices which approximate market values.~~the cost of the related materials plus overhead.

~~Table of Contents~~Summarized financial information concerning our reporting segments is shown in the following tables.

(In thousands)

Patient Care

Products &
Services

Other

Consolidating
Adjustments

Total

Three Months Ended March 31, 2014

Net sales

��

Customers

$
195,630

$
39,975

$
—

$
—

$
235,605

Intersegments

—

49,555

—

(49,555
)
—

Depreciation and amortization

4,879

2,955

2,365

—

10,199

Income (loss) from operations

22,275

10,668

(16,695
)
(218
)
16,030

Interest (income) expense

7,956

3,691

(5,549
)
—

6,098

Income (loss) before taxes

14,319

6,977

(11,146
)
(218
)
9,932

Capital expenditures

4,568

266

4,027

—

8,861

Three Months Ended March 31, 2013

Net sales

Customers

$
189,027

$
40,323

$
—

$
—

$
229,350

Intersegments

—

51,083

—

(51,083
)
—

Depreciation and amortization

4,066

3,203

2,016

—

9,285

Income (loss) from operations

25,389

9,475

(11,885
)
(263
)
22,716

Interest (income) expense

7,750

3,335

(3,308
)
—

7,777

Income (loss) before taxes

17,639

6,140

(8,577
)
(263
)
14,939

Capital expenditures

2,903

107

2,388

—

5,398

Total Assets

March 31, 2014

1,523,088

416,084

—

(569,487
)
1,369,685

December 31, 2013

1,502,721

408,628

—

(639,689
)
1,271,660

Total assets for each of the segments has not materially changed from December 31, 2017.

(in thousands)	Patient Care		Products & Services		Corporate & Other			Consolidating Adjustments			Total
Three Months Ended June 30, 2018
Net revenue
Third party	$	218,158	$	48,808	$	—		$	—		$	266,966
Intersegments	—		49,835		—			(49,835		)	—
Total net revenue	218,158		98,643		—			(49,835		)	266,966
Material costs
Third party suppliers	59,989		26,527		—			—			86,516
Intersegments	5,920		43,915		—			(49,835		)	—
Total material costs	65,909		70,442		—			(49,835		)	86,516
Personnel expenses	76,792		12,762		—			—			89,554
Other expenses	35,439		5,483		20,373			—			61,295
Depreciation & amortization	4,998		2,503		1,771			—			9,272
Income (loss) from operations	35,020		7,453		(22,144		)	—			20,329
Interest expense, net	6,456		3,247		(2,386		)	—			7,317
Loss on extinguishment of debt	—		—		—			—			—
Non-service defined benefit plan expense	—		—		176			—			176
Income (loss) before income taxes	28,564		4,206		(19,934		)	—			12,836
Benefit for income taxes	—		—		(92		)	—			(92		)
Net income (loss)	$	28,564	$	4,206	$	(19,842	)	$	—		$	12,928

(in thousands)	Patient Care		Products & Services		Corporate & Other			Consolidating Adjustments			Total
Three Months Ended June 30, 2017
Net revenue
Third Party	$	216,221	$	47,165	$	—		$	—		$	263,386
Intersegments	—		45,169		—			(45,169		)	—
Total net revenue	216,221		92,334		—			(45,169		)	263,386
Material costs
Third party suppliers	58,322		25,335		—			—			83,657
Intersegments	5,923		39,246		—			(45,169		)	—
Total material costs	64,245		64,581		—			(45,169		)	83,657
Personnel expenses	75,906		11,925		—			—			87,831
Other expenses	35,546		6,061		24,002			—			65,609
Depreciation & amortization	5,370		2,592		1,863			—			9,825
Income (loss) from operations	35,154		7,175		(25,865		)	—			16,464
Interest expense, net	8,124		3,300		2,667			—			14,091
Loss on extinguishment of debt	—		—		—			—			—
Non-service defined benefit plan expense	—		—		184			—			184
Income (loss) before income taxes	27,030		3,875		(28,716		)	—			2,189
Provision for income taxes	—		—		552			—			552
Net income (loss)	$	27,030	$	3,875	$	(29,268	)	$	—		$	1,637

(in thousands)	Patient Care		Products & Services		Corporate & Other			Consolidating Adjustments			Total
Six Months Ended June 30, 2018
Net revenue
Third party	$	406,665	$	94,296	$	—		$	—		$	500,961
Intersegments	—		92,357		—			(92,357		)	—
Total net revenue	406,665		186,653		—			(92,357		)	500,961
Material costs											—
Third party suppliers	112,164		50,708		—			—			162,872
Intersegments	11,644		80,713		—			(92,357		)	—
Total material costs	123,808		131,421		—			(92,357		)	162,872
Personnel expenses	150,405		25,257		—			—			175,662
Other expenses	70,443		11,638		40,792			—			122,873
Depreciation & amortization	9,896		5,005		3,701			—			18,602
Income (loss) from operations	52,113		13,332		(44,493		)	—			20,952
Interest expense, net	14,445		6,512		(1,377		)	—			19,580
Loss on extinguishment of debt	—		—		16,998			—			16,998
Non-service defined benefit plan expense	—		—		352			—			352
Income (loss) before income taxes	37,668		6,820		(60,466		)	—			(15,978		)
Benefit for income taxes	—		—		(6,288		)	—			(6,288		)
Net income (loss)	$	37,668	$	6,820	$	(54,178	)	$	—		$	(9,690	)

(in thousands)	Patient Care		Products & Services		Corporate & Other			Consolidating Adjustments			Total
Six Months Ended June 30, 2017
Net revenue
Third Party	$	403,858	$	93,209	$	—		$	—		$	497,067
Intersegments	—		86,369		—			(86,369		)	—
Total net revenue	403,858		179,578		—			(86,369		)	497,067
Material costs											—
Third party suppliers	108,933		49,129		—			—			158,062
Intersegments	11,745		74,624		—			(86,369		)	—
Total material costs	120,678		123,753		—			(86,369		)	158,062
Personnel expenses	151,421		24,365		—			—			175,786
Other expenses	71,262		12,955		52,117			—			136,334
Depreciation & amortization	10,799		5,262		3,901			—			19,962
Income (loss) from operations	49,698		13,243		(56,018		)	—			6,923
Interest expense, net	16,286		6,633		5,181			—			28,100
Loss on extinguishment of debt	—		—		—			—			—
Non-service defined benefit plan expense	—		—		368			—			368
Income (loss) before income taxes	33,412		6,610		(61,567		)	—			(21,545		)
Benefit for income taxes	—		—		(5,448		)	—			(5,448		)
Net income (loss)	$	33,412	$	6,610	$	(56,119	)	$	—		$	(16,097	)

NOTE Q — SUPPLEMENTAL CASH FLOW INFORMATION

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

	For the Six Months Ended June 30,
(in thousands)	2018			2017
Accounts receivable, net	$	13,029		$	5,061
Inventories	2,699			(4,113		)
Other current assets	(119		)	947
Income taxes	11,690			345
Accounts payable	3,205			(1,267		)
Accrued expenses and other current liabilities	(14,300		)	(8,488		)
Accrued compensation related costs	(22,298		)	(6,234		)
Other liabilities	(2,538		)	(3,176		)
Changes in operating assets and liabilities on cash flows from operating activities	$	(8,632	)	$	(16,925	)

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

	For the Six Months Ended June 30,
(in thousands)	2018		2017
Additions to property, plant and equipment acquired through financing obligations	$	1,354	$	669
Retirements of financed property, plant and equipment and related obligations	2,246		135
Purchase of property, plant and equipment in accounts payable at period end	960		1,100

ITEM 2. ~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

~~Overview~~Forward Looking Statements

~~The following is a discussion~~This report contains statements that are forward-looking statements within the meaning of the federal securities laws. Forward-looking statements include information concerning our liquidity and our possible or assumed future results of operations, ~~and financial condition for the periods described below. This discussion should be read in conjunction with the Consolidated Financial Statements included in this report. Our discussion~~including descriptions of our ~~results of operations and financial condition includes various forward-looking~~business strategies. These statements ~~about our markets, the demand for our products and services and our future results.~~often include words such as “believe,” “expect,” “project,” “potential,” “anticipate,” “intend,” “plan,” “estimate,” “seek,” “will,” “may,” “would,” “should,” “could,” “forecasts” or similar words. These statements are based on certain assumptions that we have made in light of our ~~current expectations, which are inherently subject to risks and uncertainties. Refer to risk factors disclosed~~experience in ~~Part II, Item 1A of this filing~~the industry as well as ~~the risk~~our perceptions of historical trends, current conditions, expected future developments and other factors ~~disclosed~~we believe are appropriate in these circumstances. We believe these judgments are reasonable, but you should understand that these statements are not guarantees of performance or results, and our actual results could differ materially from those expressed in the ~~Company’s~~forward-looking statements due to a variety of important factors, both positive and negative, that may be revised or supplemented in subsequent reports.

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

Readers are cautioned that all forward-looking statements involve known and unknown risks and uncertainties including, without limitation, those described in Item 1A. “Risk Factors” contained in our Annual Report on Form 10-K for the year ended December 31, ~~2013 for further discussion~~2017 (the “2017 Form 10-K”), some of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements contained therein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included in our Quarterly Report on Form 10-Q will prove to be accurate. Actual results could differ materially and adversely from those contemplated by any forward-looking statement. In light of the significant risks and ~~uncertainties. Our actual results and the timing of certain events may differ materially from those indicated~~uncertainties inherent in the ~~forward looking statements.~~forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements in this discussion to reflect events and circumstances occurring after the date hereof or to reflect unanticipated events. Forward-looking statements and our liquidity, financial condition and results of operations may be affected by the risks set forth in Item 1A. “Risk Factors” contained in our 2017 Form 10-K or by other unknown risks and uncertainties.

Non-GAAP Measures

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

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

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

Overview

Business Overview

General

~~The goal of Hanger, Inc. (the “Company”) is to be the world’s premier~~We are a leading national provider of products and services ~~and products~~ that ~~enhance human~~assist in enhancing or restoring the physical ~~capabilities.~~capabilities of patients with disabilities or injuries. Built on the legacy of James Edward Hanger, the first amputee of the American Civil War, ~~Hanger is steeped in~~we and our predecessor companies have provided O&P services for over 150 ~~years of clinical excellence and innovation.~~years. We provide ~~orthotic and prosthetic (O&P) patient care~~O&P services, distribute O&P devices and components, manage O&P networks and provide therapeutic solutions to ~~the broader~~patients and businesses in acute, post-acute ~~market.~~and clinic settings. We ~~have~~operate through two ~~operating~~ segments —- Patient Care and Products & Services.

Our Patient Care segment is primarily comprised of Hanger Clinic, ~~Cares, Dosteon, other related~~which specializes in the design, fabrication and delivery of custom O&P ~~businesses and our contracting network management business. Through this segment, we (i) are the largest owner and operator of orthotic and prosthetic~~devices through 680 patient care clinics and 109 satellite locations in the United States and (ii) manage an O&P provider network of approximately 1,170 clinics that coordinates all aspects of O&P patient care for insurance companies. We operate in excess of 760 O&P patient care clinics located in 4544 states and the District of Columbia ~~and six strategically located distribution facilities. For the three months ended March 31, 2014, net sales~~as of June 30, 2018. We also provide payor network contracting services to ~~customers attributable to our Patient Care segment were $195.6 million.~~other O&P providers through this segment.

Our Products & Services segment is comprised of our distribution ~~business, one of the largest distributors~~services and our therapeutic solutions businesses. As a leading provider of O&P products in the United States, we coordinate, through our distribution services business, the procurement and distribution of a broad catalog of O&P parts, componentry and devices to independent O&P providers nationwide. To facilitate speed and convenience, we deliver these products through our ~~rehabilitative solutions business. Our~~five distribution facilities that are located in ~~California, Florida,~~Nevada, Georgia, Illinois, Pennsylvania and ~~Texas allow us to deliver products to the vast majority of~~Texas. The other business in our ~~distribution customers in the United States within two~~Products & Services segment is our therapeutic solutions business, ~~days.~~

~~Table of Contents~~

~~Our rehabilitative solutions business~~which develops specialized rehabilitation technologies and ~~is a leading provider of~~provides evidence-based clinical programs for post-acute rehabilitation ~~serving more than 5,000 long-term care facilities~~to patients at approximately 4,000 skilled nursing and ~~other sub-acute rehabilitation~~post-acute providers throughout the United States. This segment also develops neuromuscular technologies through independent research. For the three months ended March 31, 2014, net sales to customers attributed to Products & Services segment were $40.0 million. See Note K for our consolidated financial statements contained herein for further information related to our segments.nationwide.

For the three and six months ended ~~March 31, 2014,~~June 30, 2018, our net ~~sales~~revenues were ~~$235.6~~$267.0 million and $501.0 million, respectively, and we recorded net income of ~~$6.0 million.~~$12.9 million and a net loss of $9.7 million, respectively. For the three and six months ended ~~March 31, 2013,~~June 30, 2017, our net ~~sales~~revenues were ~~$229.4~~$263.4 million and $497.1 million, respectively, and we recorded net income of ~~$9.5 million.~~$1.6 million and a net loss of $16.1 million, respectively.

Industry Overview

We estimate that approximately ~~$4.4~~$4.1 billion is spent in the United States each year for orthotic and prosthetic products and services. We estimate that our Patient Care segment currently accounts for approximately 20% market share, providing a comprehensive portfolio of orthotic, prosthetic and post-operative solutions to patients in ~~the~~ acute, post-acute and patient care clinic settings.

The traditional O&P patient care industry is highly fragmented and is characterized by local, independent O&P ~~businesses, with the majority of these businesses generally having a single facility with annual revenues of less than $1.0 million.~~businesses. We do not believe that any single competitor accounts for more than 2% of the country’s total estimated O&P patient care clinic revenues.

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

We estimate that approximately ~~$2.1~~$1.7 billion is spent in the United States each year ~~principally~~ by providers of O&P patient care services for the O&P products, components, devices and supplies used in their businesses. Our Products & Services segment distributes to independent providers of O&P services and to our own patient care clinics. We estimate that our distribution sales account for approximately 8% of the market for O&P products, components, devices and ~~supplies. Our Products & Services segment distributes O&P products, components, devices and~~ supplies ~~to independent customers and~~(excluding sales to our ~~patient care clinics, and our distribution sales account for approximately 5% of the market outside of the Company.~~Patient Care segment).

We estimate the market for rehabilitation technologies, integrated clinical programs and ~~therapist~~clinician training in skilled nursing facilities ~~(SNF)~~(“SNFs”) to be approximately ~~$240~~$150 million annually. We ~~estimate that we~~ currently provide these products and services to approximately ~~30%~~25% of the estimated ~~15,700~~15,000 SNFs located in the U.S. We estimate the market for rehabilitation technologies, clinical programs and training within the broader post-acute rehabilitation markets to be approximately ~~$600 million. Currently, our goods~~$400 million annually. We do not currently provide a meaningful amount of products and services ~~are only provided~~ to ~~a small segment of~~ this ~~larger category; however, we believe significant demand exists for future expansion.~~broader market.

Business Description

Patient Care

Our Patient Care segment ~~is comprised~~employs approximately 1,500 clinical prosthetists, orthotists and pedorthists, which we refer to as clinicians, substantially all of ~~Hanger Clinic, Cares, Dosteon,~~which are certified by either the American Board for Certification (“ABC”) or the Board of Certification of Orthotists and Prosthetists, which are the two boards that certify O&P clinicians. To facilitate timely service to our patients, we also employ technicians, fitters and other ~~related O&P businesses and our contracting network management business.~~ancillary providers to assist its clinicians in the performance of their duties. Through this segment, we ~~(i) are the largest owner and operator of orthotic and prosthetic patient care clinics in the United States and (ii) manage an O&P provider~~additionally provide network ~~of approximately 1,170 clinics that coordinates all aspects~~contracting services to independent providers of O&P ~~patient care for insurance companies. As of March 31, 2014, Hanger Clinic provided O&P patient care services~~ through ~~over 760 patient care clinics and over 1,333 clinicians in 45 states and the District of Columbia. Substantially all of~~ our clinicians are certified, or are candidates for formal certification, by the O&P industry certifying boards. Our patient care clinics also employ highly trained technical personnel who assist in the provision of services to patients and who fabricate various O&P devices, as well as office administrators who schedule patient visits, obtain approvals from payors and bill and collect for services rendered.“Linkia” business.

In our orthotics business, we design, fabricate, fit and maintain a wide range of custom-made braces and other devices (such as spinal, knee and sports-medicine braces) that provide external support to patients suffering from musculoskeletal disorders, such as ailments of the back, extremities or joints. In our prosthetics business, we design, fabricate, fit and maintain custom-made artificial limbs for patients who are without limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders. O&P devices are increasingly becoming more technologically advanced and are custom-designed to add functionality and comfort to patients’ lives, shorten the rehabilitation process and lower the cost of rehabilitation. Patients are typically referred to Hanger Clinic by an attending physician who determines a patient’s treatment and writes a prescription. Our clinicians then consult with both the referring physician and the patient with a view toward assisting in the design of an orthotic or prosthetic device to meet the patient’s needs. O&P devices are increasingly technologically advanced and custom designed to add functionality and comfort to patients’ lives, shorten the rehabilitation process and lower the cost of rehabilitation.

~~Table~~Based on the prescription written by a referring physician, our clinicians examine and evaluate the patient and either design a custom device or, in the case of ~~Contents~~

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

Given the differing physical weight and size characteristics, location of injury or amputation, capability for physical activity and mobility, cosmetic and other needs of each individual patient, each fabricated prosthesis and orthosis is customized for each particular patient. These custom devices are commonly fabricated and fitted by our skilled technicians using plaster castings, measurements and designs made by our clinicians. Frequently, our proprietary Insignia scanning system is used to measure and design devices. The Insignia system scans the patient and produces a very accurate computer generated image of the patient’s residual limb, resulting in a faster turnaround for the patient’s device and a more professional overall experience. In order to provide timely service to our patients, we employ technical personnel and maintain laboratories at ~~many~~one of our ~~patient care clinics.~~ regional or national fabrication facilities.

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

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

The principal reimbursement sources for our services are:

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

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

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

·~~U.S. Department of Veterans Affairs.~~

~~Government reimbursement, comprised of Medicare, Medicaid and~~ the U.S. Department of Veterans Affairs, in the aggregate, accounted for approximately 38.7% and 40.2% of our net sales for the three months ended March 31, 2014 and 2013, respectively. These payors have set maximum reimbursement levels for O&P services and products. Medicare prices are adjusted each year based on the Consumer Price Index-Urban (“CPIU”) unless Congress acts to change or eliminate the adjustment. The CPIU is adjusted further by an efficiency factor (“the Productivity Adjustment” or “the MFP adjustment”) in order to determine the final rate adjustment each year. The Medicare price increases/(decreases) for 2014, 2013 and 2012 were 1.0%, 0.8% and 2.4%, respectively. There can be no assurance that future changes will not reduce reimbursements for O&P services and products from these sources.Affairs.

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

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

We, and the O&P ~~market~~industry in general, are subject to various Medicare compliance audits, including Recovery Audit Contractor (“RAC”) audits, Comprehensive Error Rate Testing (“CERT”) audits, Targeted Probe and Educate (“TPE”) audits and Zone Program Integrity Contractor (“ZPIC”) audits. TPE audits are generally pre-payment audits, while RAC, CERT and ZPIC audits are generally post-payment audits. The recently implemented TPE audits have replaced the previous Medicare Administrative Contractor (“MAC”) audits. Adverse post-payment audit determinations generally require Hanger to reimburse Medicare for ~~national and regional insurance companies. We partner with healthcare insurance companies~~payments previously made, while adverse pre-payment audit determinations generally result in the denial of payment. In either ascase, we can request a ~~preferred provider~~redetermination or appeal, if we believe the adverse determination is unwarranted, which can take an extensive period of time to manage their O&P network of providers. Our network now includes approximately 1,170 O&P provider locations, including over 400 independent providers. As of March 31, 2014, we had 58 contracts with national and regional providers.resolve, currently up to six years or more.

Products & Services

~~Our Products & Services segment was created in the first quarter of 2013 through the combination of our previously reported Distribution segment and Therapeutic Solutions segment.~~ Through our wholly-owned subsidiary, Southern Prosthetic Supply, ~~(SPS)~~Inc. (“SPS”), we distribute O&P components to both to independent customers and to our own ~~patient care clinics. This business maintains~~clinics in the Patient Care segment. SPS purchases, warehouses and distributes over ~~26,000 individual~~400,000 SKUs ~~in inventory which are manufactured by~~from more than ~~375~~300 different ~~suppliers.~~manufacturers. Through our warehousing and distribution facilities in Nevada, Georgia, Illinois, Pennsylvania and Texas, we are able to deliver products to the vast majority of our customers in the United States within two business days. Through its SureFit subsidiary, SPS is also ~~a leading fabricator~~manufactures and ~~distributor of~~sells therapeutic footwear for diabetic patients in the podiatric market, and ~~fabricates~~through its National Labs subsidiary it is a fabricator of O&P devices both for our ~~O&P~~patient care clinics and those of our competitors. Our distribution facilities in California, Florida, Georgia, Illinois, Pennsylvania, and Texas allow us to deliver products to the vast majority of our distribution customers in the United States within two business days.

~~Table of Contents~~competitor clinics.

Our distribution services business enables us to:

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

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

· ~~manage~~improve inventory quality control;

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

· coordinate new product development efforts with key ~~vendor “partners”.~~

Marketing of our services is conducted on a national basis through a dedicated sales force, print and e-commerce catalogues, and exhibits at industry and medical meetings and conventions. We direct specialized catalogues to segments of the healthcare industry, such as orthopedic surgeons, physical and occupational therapists, and podiatrists.vendors.

Through our wholly-owned subsidiary, Accelerated Care Plus ~~(“ACP”)~~Corp., ~~we believe~~ our ~~rehabilitative~~therapeutic solutions business is ~~the nation’s~~a leading provider of rehabilitation technologies and integrated clinical programs to post-acute care and rehabilitation providers. Our unique value proposition is to provide our customers with a full-service “total solutions” approach encompassing proven medical ~~technology; evidence-based~~technology,

evidence based clinical programs, and ~~continuous onsite therapist~~ongoing clinician education and training. Our services support increasingly advanced treatment options for a broader patient population and more medically complex conditions. We serve ~~more than 5,000~~approximately 4,000 skilled nursing ~~facilities nationwide, including 22~~and post-acute providers nationwide.

Effect of Delay in Financial Filings

As discussed in our 2017 Form 10-K, due to prior restatements and related issues, we had been delayed in the preparation and filing of our financial statements in recent years. In connection with our efforts to restate our prior financial statements, remediate our material weaknesses, regain our timely filing status and undertake related activities, we have incurred third party professional fees in excess of the ~~25 largest national providers.~~amounts we estimate that we would have otherwise incurred. The estimated professional fees associated with these efforts are as follows:

(in thousands)

					Balance to be Paid
For the Three Months Ended	Expensed		Paid		in Future Periods
March 31, 2017	$	11,537	$	14,766	$	19,672
June 30, 2017	7,567		13,765		13,474
September 30, 2017	6,839		6,430		13,883
December 31, 2017	6,358		9,956		10,285
March 31, 2018	3,700		7,755		6,230
June 30, 2018	2,940		5,938		3,232

We ~~also~~currently estimate that during 2018, we will expend a total of $13.0 million in excess professional fees, with the primary purpose for future expenditures relating to our focus on the remediation of our continuing material weaknesses in internal controls over financial reporting. Due to the ongoing material weaknesses in our controls over financial reporting, we currently undertake additional substantive procedures to test and verify financial statement amounts in connection with the preparation of our financial statements.

Reimbursement Trends

In our Patient Care segment, we are reimbursed primarily through employer-based plans offered by commercial insurance carriers, Medicare, Medicaid and the VA. Patient Care constitutes 81.2% of our net revenue for both the six months ended June 30, 2018 and 2017. Our remaining net revenue is from our Products & Services segment which derives its net revenue from commercial transactions with independent O&P providers, healthcare facilities and other customers. In contrast to net revenues from our Patient Care segment, payment for these products and services are not directly subject to third party reimbursement from health care payors.

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

To receive reimbursement for our work, we must ensure that our clinical, administrative and billing personnel receive and verify certain medical and health plan information, record detailed documentation regarding the services we provide and accurately and timely perform a number of claims submission and related administrative tasks. Traditionally, we have performed these tasks in a ~~product development business specializing~~manual fashion and on a decentralized basis. In recent years, due to increases in payor pre-authorization processes, documentation requirements, pre-payment reviews and pre- and post-payment audits, our ability to successfully undertake these tasks using our traditional approach has become increasingly challenging. We believe these changes in industry trends have been brought about in part by increased nationwide efforts to reduce health care costs.

A measure of our effectiveness in securing reimbursement for our services can be found in the ~~commercialization~~degree to which payors ultimately disallow payment of ~~emerging products~~our claims. Payors can deny claims due to their determination that a physician who referred a patient to us did not sufficiently document that a device was medically necessary or clearly establish the ambulatory (or “activity”) level of a patient. Claims can also be denied based on our failure to ensure that a patient was currently eligible under a payor’s health plan, that the plan provides full O&P benefits, that we received prior authorization, that we filed or appealed the payor’s determination

timely, on the basis of our coding, failure by certain classes of patients to pay their portion of a claim and for various other reasons. If any portion of, or administrative factor within, our claim is found by the payor to be lacking, then the entirety of the claim amount may be denied reimbursement. Due to the increasing demands of these processes, the level and capability of our staffing, as well as our material weaknesses and other considerations, our consolidated disallowed revenue and its relationship to consolidated adjusted gross revenue increased over historical levels to a peak level in 2014.

Commencing in late 2014 and continuing through today, we have taken a number of actions to halt and reverse these disallowed revenue trends. These initiatives included: (i) the ~~O&P~~retention of consultants and ~~rehabilitation markets. Working with inventors under licensing~~creation of a central revenue cycle management function; (ii) addressing the issues identified in our patient management and ~~consulting agreements,~~electronic health record system; and (iii) the establishment of new clinic-level procedures and training regarding the collection of supporting documentation and the importance of diligence in our claims submission processes. Through 2017, we ~~commercialize~~saw significant improvements in these rates. While we intend to continue to work towards further improvements in our procedures through the ~~design, obtain regulatory approvals, develop clinical protocols~~use of technology within our clinic and revenue cycle functions, we do not currently foresee that future reductions in disallowed revenue will be as achievable or substantial as the improvements realized since 2014.

Under both ASC 606 and the previous revenue recognition guidance ASC 605, Revenue Recognition, disallowed revenue is considered an adjustment to the transaction price. However, upon adoption of ASC 606, estimated uncollectible amounts due to us by patients are generally considered implicit price concessions and are now presented as a reduction of net revenue. Under prior guidance, these amounts were recognized as bad debt expense in other operating expenses.

Implicit price concessions such as payor disallowances and patient non-payments for the technology, and then introduce the devices to the marketplace through a variety of distribution channels. We currently have two commercial products: the V-Hold, which is active vacuum technology used in lower extremity prosthetic devices, and the WalkAide system, which benefits patients with a condition referred to as foot drop. The V-Hold is primarily sold through our patient care clinics. Research and development expenses, which were reported in Other operating expenses on our Consolidated Statements of Income and Comprehensive IncomePatient Care segment for the three months ended ~~March~~June 30, 2018 and 2017 are as follows:

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
(dollars in thousands)	2018			2017			2018			2017
Net revenue	$	218,158		$	216,221		$	406,665		$	403,858
Estimated implicit price concessions arising from:
Payor disallowances	10,461			11,578			18,722			18,694
Patient non-payments	1,332			—			2,200			—
Adjusted gross revenue	$	229,951		$	227,799		$	427,587		$	422,552

Payor disallowances	$	10,461		$	11,578		$	18,722		$	18,694
Patient non-payments	1,332			—			2,200			—
Bad debt expense	—			2,481			—			4,284
Payor disallowances, patient non-payments and bad debt expense	$	11,793		$	14,059		$	20,922		$	22,978

Payor disallowances %	4.5		%	5.1		%	4.4		%	4.4		%
Patient non-payments %	0.6		%	—		%	0.5		%	—		%
Bad debt expense %	—		%	1.1		%	—		%	1.0		%
Percent of adjusted gross revenue	5.1		%	6.2		%	4.9		%	5.4		%

Favorable Settlements

For the three months ended June 30, 2018, our results of operations and net income benefited from the favorable resolution of two matters.

On May 15, 2018, we received a net favorable settlement of $1.7 million in connection with our long standing damage claims relating to the “Deepwater Horizon” disaster, and the prior adverse effect which it had on our clinic operations along the Gulf Coast in April of 2010. We anticipate the receipt of no further payments in connection with this matter as this settlement constituted a full and final satisfaction of our claims. The benefit of this settlement has been recognized as a reduction to our general and administrative expenses for the three months and six months ended June 30, 2018.

On June 28, 2018, we entered into an agreement with the State of Delaware, and made payment, to satisfy all of the State’s abandoned or unclaimed property claims transactions represented within the period of January 1, 2001 through December 31, ~~2014~~2012 which were reportable through December 31, 2017 in the amount of $2.2 million. This agreed upon payment amount was favorable by $0.5 million to the amount we had previously estimated for these liabilities and had the effect of reducing our general and administrative expenses by this amount for the quarter and year-to-date. Additionally, under the terms of the agreement, we were not required to pay interest on the previously un-remitted cumulative abandoned or unclaimed property relating to this twelve year period in the amount of $1.5 million, which had the effect of lowering our interest expense in the quarter and for the ~~year ended December 31, 2013 were $0.1~~year-to-date periods ending June 30, 2018 by this accrued interest amount.

New System Implementation

As discussed in our 2017 Form 10-K, in recent years we have been undertaking the implementation of a new patient management and electronic health record system at our patient care clinics. As of June 30, 2018, we have completed the installation of this system in approximately 83% of our clinic locations. We currently estimate that we will incur approximately $4.7 million in training, travel and other implementation expense in 2018 related to this implementation.

Acquisitions

We did not complete any acquisitions during the first half of 2018. However, we currently believe it is likely that we will commence the acquisition of O&P clinics, which are similar to those that we operate through our Patient Care segment, during the second half of 2018.

Seasonality

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

Our results are also affected, to a lesser extent, by our holding of an education fair in the first quarter of each year. This one week event is conducted to assist our clinicians in maintaining their training and certification requirements and to facilitate a national meeting with our clinical leaders. We also invite manufacturers of the componentry for the devices we fabricate to these annual events so they can demonstrate their products and otherwise assist in our training process. During the first quarters of 2018 and 2017, we spent approximately $2.3 million and ~~$0.5~~$2.0 million, ~~respectively.~~respectively, on travel and other costs associated with this one week event. In addition to the costs we incur associated with this annual event, we also lose the productivity of a significant portion of our clinicians during the one week period in which this event occurs, which contributes to the lower seasonal revenue level we experience during the first quarter of each year.

Critical Accounting Policies ~~and Estimates~~

~~Our analysis and discussion of~~We prepare our financial ~~condition and results of operations is based upon our Consolidated Financial Statements that have been prepared~~statements in accordance with ~~accounting principles generally accepted in the United States of America (“GAAP”).~~GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, ~~and~~ disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. GAAP provides the framework from which to make these estimates, assumptions and disclosures. We have chosen accounting policies within GAAP that management believes are appropriate to ~~accurately and~~ fairly ~~report~~present, in all material respects, our operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. Our accounting policies are stated in Note B to the Consolidated Financial Statements included elsewhere in this report.position. We believe the following accounting policies are critical to understanding our results of operations and the more significant judgments and estimates used in the preparation of our ~~Consolidated Financial Statements.~~consolidated financial statements:

· Revenue ~~Recognition:~~ Revenues in the Company’s Patient Care segment are derived from the sale of O&P devices and the maintenance and repair of existing devices. Revenues from maintenance and repairs are recognized when the service is provided. Revenues from the sale of devices are recorded when the patient has accepted and received the device and recorded net of known and estimated future contractual adjustments and discounts. Contractual adjustments and discounts are recorded as contra-revenue within net sales on the Consolidated Statement of Income and Comprehensive Income. Medicare and Medicaid regulations and the various agreements we have with other third-party payors under which these contractual adjustments and discounts are calculated are complex and are subject to interpretation. Therefore, the devices and related services authorized and provided, and the related reimbursement, are subject to interpretation and adjustment that could result in payments that differ from our estimates. Additionally, updated regulations and pay schedules, and contract renegotiations, occur frequently, necessitating regular review and assessment of the estimation process by management.

Reserves for future contractual adjustments are estimated utilizing historical trends for such adjustments and are monitored monthly. As of March 31, 2014 and December 31, 2013, the Company estimated the reserve for future contractual adjustments and discounts to be $22.7 million and $20.6 million, respectively. The increase in the estimate is primarily related to both revenue growth resulting from both same clinic sales growth and clinic acquisitions, and from changes in collection trends. Individual patients are generally responsible for deductible and/or co-payments.

~~Table of Contents~~

~~The reserve for future contractual adjustments and discounts is reflected as a reduction of accounts receivable on the Company’s Consolidated Balance Sheet.~~

· ~~Net~~ Accounts ~~Receivable:~~ ~~We report accounts~~ receivable, ~~at estimated~~ net realizable amounts generated for products delivered and services rendered from federal, state, managed care health plans, commercial insurance companies and patients. Collections of these accounts receivable are our primary source of cash and are critical to our operating performance. We estimate uncollectible patient accounts primarily based upon its experience in historical collections from individual patients. Bad debt expense is reported within Other operating expenses within the Consolidated Statement of Income and Comprehensive Income. At March 31, 2014 and December 31, 2013, net accounts receivable reflected an allowance for doubtful accounts of $10.3 million and $10.0 million, respectively.

~~The following represents the composition of our accounts receivable balance by type of payor:~~

March 31, 2014

(In thousands)

0-60 days

61-120 days

Over 120 days

Total

Patient Care

Commercial insurance

$
40,276

$
12,870

$
18,593

$
71,739

Private pay

4,595

2,995

6,709

14,299

Medicaid

11,472

3,683

6,691

21,846

Medicare

28,740

5,902

25,860

60,502

VA

2,477

586

668

3,731

Products & Services

Trade accounts receivable

11,579

3,642

6,523

21,744

$
99,139

$
29,678

$
65,044

$
193,861

December 31, 2013

(In thousands)

0-60 days

61-120 days

Over 120 days

Total

Patient Care

Commercial insurance

$
52,899

$
12,092

$
14,507

$
79,498

Private pay

3,991

3,413

5,751

13,155

Medicaid

11,876

4,122

5,282

21,280

Medicare

30,587

7,097

20,918

58,602

VA

2,589

565

463

3,617

Products & Services

Trade accounts receivable

11,541

3,370

4,728

19,639

$
113,483

$
30,659

$
51,649

$
195,791

·~~Inventories~~: Patient Care—Inventories at Hanger Clinics, Dosteon and Cares, which consist of raw materials, work-in-process and finished goods, amounted to $120.1 million and $109.2 million at March 31, 2014 and December 31, 2013, respectively. Inventories in Hanger’s Clinics, which amounted to $110.0 million and $99.0 million at March 31, 2014 and December 31, 2013, respectively, consist principally of raw materials and work-in-process inventory valued based on the gross profit method, which approximates lower of cost or market using the first-in first-out method. Inventories in the Dosteon business amounted to $8.8 million and $8.9 million at March 31, 2014 and December 31, 2013, respectively, and consist principally of raw materials. As of March 31, 2014, the Dosteon inventories were valued based on the gross profit method, which approximates lower of cost or market using the first-in first-out method. Inventories in the Cares business amounted to $1.2 million and $1.3 million as of March 31, 2014 and December 31, 2013, respectively, consists principally of finished goods and are valued at the lower of cost or market using the first-in first-out method based on perpetual records.

~~Table of Contents~~

Adjustments to reconcile the Hanger Clinic and Dosteon physical inventory are treated as changes in accounting estimates and are recorded in the fourth quarter. The Company recorded a fourth quarter adjustment of a decrease to inventory of $2.3 million in 2013.

· ~~Goodwill and Other Intangible Assets:~~ Goodwill represents the excess of purchase price over the fair value of net identifiable assets of purchased businesses. We assess goodwill for impairment annually during the fourth quarter, or when events or circumstances indicate that the carrying value of the reporting units may not be recoverable. The Company has the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. If the Company determines that a two-step goodwill impairment test is necessary or more efficient than a qualitative approach, it will measure the fair value of the Company’s reporting units using a combination of income, market and cost approaches. Any impairment would be recognized by a charge to operating results and a reduction in the carrying value of the intangible asset. There were no impairment indicators since our last annual impairment test on October 1, 2013.

Definite-lived trade name intangible assets are amortized over their estimated period of benefit of approximately 1 to 3 years. Approximately $10.6 million of the value of trade names is identified as an indefinite-lived intangible asset within the Products & Services segment and its fair value is annually assessed for impairment in the Company’s fiscal fourth quarter. The Company estimates fair value utilizing a relief-from-royalty method valuation model and the 2013 assessment estimated the fair value is greater than carrying value. However, the estimated fair value is not substantially in excess of the carrying value. A key assumption in the relief-from-royalty method is projected future revenue. If actual future revenues fall below projection, the estimated fair value could be significantly impacted and an impairment charge may be necessary.

Non-compete agreements are recorded when we enter into the agreement and are amortized, using the straight-line method, over their terms ranging from five to seven years. Other definite-lived intangible assets are recorded at fair value and are amortized, using the straight-line method, over their estimated useful lives of up to 14 years. Whenever the facts and circumstances indicate that the carrying amounts of these intangibles may not be recoverable, we review and assess the future cash flows expected to be generated from the related intangible for possible impairment. Any impairment would be recognized as a charge to operating results and a reduction in the carrying value of the intangible asset.Inventories

· ~~Income taxes:~~ We are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Consolidated Balance Sheet. We then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent that we believe that recovery is not likely, we establish a valuation allowance against the deferred tax asset.Business combinations

We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine if the weight of available evidence indicates that the tax position has met the threshold for recognition; therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized upon ultimate settlement. This measurement step is inherently complex· Goodwill and requires subjective estimations of such amounts to determine the probability of various possible outcomes. We re-evaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, expirations of statutes of limitation, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period.other intangible assets, net

~~Although we believe the measurement~~· Income taxes

The use of ~~our liabilities for uncertain tax positions is reasonable, no assurance can be given that the final outcome of these matters will not be~~ different ~~than what is reflected in the historical income tax provisions and accruals. If additional taxes are assessed as a result of an audit~~estimates, assumptions, or ~~litigation, it~~judgments could have a material effect on reported amounts of assets, liabilities, revenue, expenses, and related disclosures as of the ~~income tax provision~~date of the financial statements and ~~net income~~during the reporting period. These critical accounting policies are described in more detail in our Annual Report on Form 10-K for the ~~period or periods for which that determination is made. We operate~~year ended December 31, 2017, under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note A - “Organization and Summary of Significant Accounting Policies” contained within ~~multiple taxing jurisdictions and are subject to audit in~~ these ~~jurisdictions.~~

~~Table of Contents~~condensed consolidated financial statements.

These audits can involve complex issues which may require an extended period of time to resolve and could result in additional assessments of income tax. We believe adequate provisions for income taxes have been made for all periods.

~~Guidance and Outlook~~

The Company lowered its 2014 full-year adjusted diluted EPS guidance to a range of between $2.01 and $2.11, which represents growth of between 3.1% and 8.2% over the prior year. The Company expects to grow same center sales between 3% and 5% for the remainder of 2014. Taking into account the impact of first quarter 2014 results, the Company has lowered its projected full year 2014 same center sales growth to between 2% and 4%. The reduction in earnings projections in part reflects lower same center sales in the Patient Care segment combined with additional investments the Company is making in its processes and control environment. The Company lowered 2014 full-year net sales guidance to a range of between $1.100 and $1.120 billion. The expectation of lower same center sales growth will be partially offset by accelerated timing of acquisitions which will drive incremental revenues in the remainder of the year, but will not provide significant earnings over that period due to their initial integration costs. Reflecting the lower than expected first quarter results and the reimbursement environment, the Company adjusted its expectation of 2014 cash flow from operations to a range of between $80 and $90 million. The Company continues to anticipate acquiring O&P operations in 2014 with annualized net sales of between $35 and $45 million, and plans to invest between $40 and $50 million in capital additions during the year. The Company’s previous full-year 2014 guidance issued on February 12, 2014 was to achieve revenues of $1.110 to $1.130 billion, adjusted diluted EPS of $2.10 and $2.20, patient care same center sales of 3% to 5%, and cash flow from operations of $90 to $100 million.

Results of Operations

~~The following table sets forth~~Our results of operations for the three months ended June 30, 2018 and 2017 were as follows:

	For the Three Months Ended June 30,					Percent Change
(dollars in thousands)	2018			2017		2018 v 2017
Net revenue	$	266,966		$	263,386	1.4	%
Material costs	86,516			83,657		3.4	%
Personnel costs	89,554			87,831		2.0	%
Other operating costs	30,536			31,861		(4.2	)%
General and administrative expenses	26,523			25,227		5.1	%
Professional accounting and legal fees	4,236			8,521		(50.3	)%
Depreciation and amortization	9,272			9,825		(5.6	)%
Operating expenses	246,637			246,922		(0.1	)%
Income from operations	20,329			16,464		23.5	%
Interest expense, net	7,317			14,091		(48.1	)%
Non-service defined benefit plan expense	176			184		(4.3	)%
Income before income taxes	12,836			2,189		486.4	%
(Benefit) provision for income taxes	(92		)	552		(116.7	)%
Net income	$	12,928		$	1,637	689.7	%

During these periods, ~~indicated certain items from~~ our ~~Consolidated Statements of Income and Comprehensive Income~~operating expenses as a percentage of ~~our~~ net ~~sales:~~revenue were as follows:

Three Months Ended

March 31,

2014

2013

(Unaudited)

(Unaudited)

Net sales

100.0
%
100.0
%
Material costs

28.6

29.5

Personnel costs

40.9

39.2

Other operating expenses

19.4

17.4

Depreciation and amortization

4.3

4.0

Income from operations

6.8

9.9

Interest expense, net

2.6

3.4

Income before taxes

4.2

6.5

Provision for income taxes

1.7

2.4

Net income

2.5
%
4.1
%

	For the Three Months Ended June 30,
	2018		2017
Material costs	32.4	%	31.8	%
Personnel costs	33.5	%	33.3	%
Other operating costs	11.5	%	12.1	%
General and administrative expenses	9.9	%	9.6	%
Professional accounting and legal fees	1.6	%	3.2	%
Depreciation and amortization	3.5	%	3.7	%
Operating expenses	92.4	%	93.7	%

Three Months Ended ~~March 31, 2014~~June 30, 2018 Compared to the Three Months Ended ~~March 31, 2013~~June 30, 2017

Net ~~Sales.~~ revenue. Net ~~sales~~revenue for the three months ended ~~March 31, 2014 increased $6.2~~June 30, 2018 was $267.0 million, an increase of $3.6 million, or ~~2.7%~~1.4%, ~~to $235.6 million~~ from ~~$229.4~~$263.4 million for the three months ended ~~March 31, 2013.~~June 30, 2017. Net revenue by operating segment, after elimination of intersegment activity was as follows:

	For the Three Months Ended June 30,						Percent
dollars in thousands)	2018		2017		Change		Change
Patient Care	$	218,158	$	216,221	$	1,937	0.9	%
Products & Services	48,808		47,165		1,643		3.5	%
Net revenue	$	266,966	$	263,386	$	3,580	1.4	%

Patient Care net revenue for the three months ended June 30, 2018 was $218.2 million, an increase of $1.9 million, or 0.9%, from $216.2 million for the same period in the prior year. Same clinic revenue increased $3.7 million for the three months ended June 30, 2018 compared to the same period in the prior year, reflecting an increase in same clinic revenue per day of 1.7%. This growth was offset by the effect of clinic closures which reflected decreased revenue of $0.5 million as compared with the same period in the prior year. Net revenue was also negatively impacted as compared to the same period in the prior year by $1.3 million from the adoption of the new revenue accounting standard on January 1, 2018.

Revenue growth during the quarter was primarily the result of growth in services to prosthetic patients. Prosthetic revenue constituted 54% of Patient Care’s revenue in the three months ended June 30, 2018 compared with 53% for the same period in the prior year. We believe an increased focus on the demonstration of patient outcomes and related marketing initiatives contributed to this growth in prosthetic revenue.

Products & Services net revenue for the three months ended June 30, 2018 was $48.8 million, an increase of $1.6 million, or 3.5% from $47.2 million for the same period in the prior year. This increase was ~~due~~comprised of $2.7 million from the distribution of O&P componentry to independent providers partially offset by a ~~$6.5 million, or 3.5%, increase in the Patient Care segment, and a $0.3~~$1.1 million decrease in ~~sales in the Products & Services segment. The $6.5 million increase in Patient Care segment sales was composed of a $10.0 million increase in sales~~net revenue from acquisitions, offset by a $3.5 million, or 1.8%, decline in same center sales. The decline in same center sales was driven by the impact of severe weather in the eastern and central parts of the U.S. The severe weather throughout the first quarter resulted in approximately 1,000 closed clinic days in the Company’s Patient Care segment,therapeutic services, which ~~translates~~related primarily to ~~about 5 times more weather related closures than the same period of 2013.~~client cancellations,

Material ~~Costs.~~ costs. Material costs for the three months ended ~~March 31, 2014 decreased to $67.3~~June 30, 2018 were $86.5 million, ~~compared to $67.7~~an increase of $2.9 million or 3.4%, from $83.7 million for the ~~three months ended March 31, 2013. Material~~same period in the prior year. Total material costs as a percentage of net ~~sales decreased 90 basis points~~revenue increased to 32.4% in 2018 from 31.8% in 2017 due primarily to changes in our Patient Care segment product mix. Material costs by operating segment, after elimination of intersegment activity, were as follows:

	For the Three Months Ended June 30,						Percent
(dollars in thousands)	2018		2017		Change		Change
Patient Care	$	65,909	$	64,245	$	1,664	2.6	%
Products & Services	20,607		19,412		1,195		6.2	%
Material costs	$	86,516	$	83,657	$	2,859	3.4	%

Patient Care material costs increased $1.7 million, or 2.6%, for the three months ended June 30, 2018 compared to the same period in the prior year. Excluding the $1.3 million effect on net revenue resulting from the adoption of the new revenue accounting standard, Patient Care material costs as a percent of revenue increased slightly to 30.0% in 2018 from 29.7% in 2017, primarily due to ~~an increase~~increases in the ~~rate~~mix of ~~reimbursement, improved sales mix, a reduction in product cost arising from an effort to further consolidate~~ our ~~purchasing power and the impact of 2013 O&P acquisitions, which had a lower~~business towards higher-cost prosthetic devices.

Products & Services material costs ~~rate than~~increased $1.2 million, or 6.2%, for the ~~consolidated rate.~~three months ended June 30, 2018 compared to the same period in the prior year. As a percent of revenue, material costs grew to 42.2% in the three months ended June 30, 2018 from 41.2% in the same period 2017.

Personnel ~~Costs.~~ costs. Personnel costs for the three months ended ~~March 31, 2014 increased~~June 30, 2018 were $89.6 million, an increase of $1.7 million, or 2.0%, from $87.8 million for the same period in the prior year. Personnel costs by ~~$6.4 million~~operating segment were as follows:

	For the Three Months Ended June 30,						Percent
(dollars in thousands)	2018		2017		Change		Change
Patient Care	$	76,792	$	75,906	$	886	1.2	%
Products & Services	12,762		11,925		837		7.0	%
Personnel costs	$	89,554	$	87,831	$	1,723	2.0	%

During 2018, annual employee salary increases were implemented effective in April 2018 as contrasted with June 2017 in the prior year. which contributed to ~~$96.4 million from $90.0~~a significant increase in salary expense when comparing the second quarter of 2018 with the second quarter of 2017. Personnel costs for the Patient Care segment were $76.8 million for the three months ended ~~March 31, 2013. As~~June 30, 2018, an increase of $0.9 million, or 1.2%, from $75.9 million for the same period in the prior year. Patient Care benefits expense increased $1.2 million from higher employee benefit claim costs and a ~~percentage of net sales, personnel~~$0.6 million increase in salary expense, partially offset by a $0.8 million decrease bonus and commissions. Personnel costs in the Products & Services segment increased $0.8 million, or 7.0% for the three months ended June 30, 2018 compared to ~~40.9%~~the same period in ~~2014 from 39.2% in 2013.~~the prior year. Bonus and commissions increased $0.5 million, benefits expense increased $0.2 million and salary expense increased $0.1 million.

21Other operating costs

~~Table~~. Other operating costs for the three months ended June 30, 2018 were $30.5 million, a decrease of ~~Contents~~

~~The increase~~$1.3 million, or 4.2% from $31.9 million for the same period in the prior year. Bad debt expense decreased $2.7 million, primarily from the adoption of the new revenue accounting standard under which certain of these expenses were re-characterized as implicit price concessions within our Patient Care segment and are now reflected as an adjustment to net revenue. This decrease was ~~primarily due to~~partially offset by a ~~$4.5~~$0.7 million increase ~~related to acquisitions~~in professional fees and ~~the balance due to increased healthcare~~a $0.7 million increase in other operating costs.

~~Other Operating Expenses.~~ General and administrative expenses~~Other operating~~. General and administrative expenses ~~which are comprised primarily~~for the three months ended June 30, 2018 were $26.5 million, an increase of $1.3 million, or 5.1%, from $25.2 million for the same period in the prior year. This increase included $1.2 million of professional ~~fees, facility~~expense relating primarily to growth and other corporate initiatives, $0.9 million in salary and other personnel-related costs, ~~bad debt expense, incentive compensation,~~ and ~~reimbursable employee expenses, increased $5.9~~$1.4 million ~~to $45.6 million, or 19.4% of net revenues,~~ in ~~the first quarter of 2014 compared to $39.7 million, or 17.4% of net revenues,~~other expenses. Salary costs grew in ~~the first quarter of 2013. The increase is primarily attributable to a $1.2 million increase related to acquisitions with the balance due to increased occupancy and utility costs~~part due to the ~~severe weather,~~change in timing of annual employee salary increases which were made effective in April of 2018 as ~~well as an~~compared with June in the prior year. These increases were partially offset by a $1.7 million favorable settlement in connection with our long standing claim relating to the “Deepwater Horizon” disaster and $0.5 million in connection with our favorable resolution of outstanding abandoned and unclaimed property claims with the State of Delaware.

Professional accounting and legal fees. Professional accounting and legal fees for the three months ended June 30, 2018 were $4.2 million, a decrease of $4.3 million from $8.5 million for the same period in the prior year. Advisory and other fees decreased $4.7 million, and legal fees decreased $0.3 million offset, by a $0.7 million increase in ~~bad debt expense.~~audit related fees.

Depreciation and ~~Amortization.~~ amortization. Depreciation and amortization for the three months ended ~~March 31, 2014 increased $0.9 million, to $10.2 million, compared to~~June 30, 2018 was $9.3 million, a decrease of $0.6 million, or 5.6%, from $9.8 million for the same period in the ~~first quarter of 2013. The increase was primarily due to software, leasehold improvements, and machinery and equipment purchased over the last 12 months.~~prior year. Fully amortized intangible assets decreased amortization $0.6 million.

~~Income from Operations.~~Interest expense, net. ~~Income from operations decreased $6.7 million, to $16.0 million,~~Interest expense for the three months ended ~~March 31, 2014 compared to $22.7~~June 30, 2018 was $7.3 million, a decrease of $6.8 million, or 48.1%, from $14.1 million for the ~~three months ended March 31, 2013, due principally by the weather related decline in~~ same ~~center sales~~period in the ~~Patient Care segment~~prior year. This decrease was primarily due to lower interest rates on outstanding borrowings arising from our debt refinancing in March 2018 and ~~costs~~secondarily reflected a $1.5 million decrease related to our settlement of outstanding abandoned and unclaimed property claims with the ~~delayed filing~~State of ~~the Company’s 10-K.~~Delaware in a manner that did not require us to pay interest we had accrued on long standing unpaid claim amounts.

~~Interest Expense.~~ (Benefit) provision for income taxes~~Interest expense decreased $1.7 million, to $6.1 million, for the three months ended March 31, 2014, compared to $7.8 million, for the three months ended March 31, 2013.~~. The ~~decrease resulted from the interest savings from the debt refinancing that occurred in the 2~~nd ~~quarter of 2013.~~

~~Provision for Income Taxes.~~ ~~The provision~~benefit for income taxes for the three months ended ~~March 31, 2014~~June 30, 2018 was ~~$3.9~~$0.1 million, or ~~39.6%~~(0.7)% of ~~pre-tax~~ income from continuing operations before taxes, compared to ~~$5.5~~a provision of $0.6 million, or ~~36.5%~~25.2% of ~~pre-tax~~ income before taxes for the three months ended June 30, 2017. The effective tax rate in 2018 consists principally of the 21% federal statutory tax

rate and the rate impact from state income taxes and permanent tax differences. The federal statutory tax rate in 2017 was 35%. The decrease in the effective tax rate for the three months ended June 30, 2018 compared with the three months ended June 30, 2017 is primarily attributable to the changes enacted by the Tax Act and the change from the discrete method for interim reporting used for the three months ended March 31, ~~2013.~~2018 to using the annualized effective tax rate method for the six months ended June 30, 2018.

Our results of operations for the six months ended June 30, 2018 and 2017 were as follows:

	For the Six Months Ended June 30,						Percent Change
(dollars in thousands)	2018			2017			2018 v 2017
Net revenues	$	500,961		$	497,067		0.8	%
Material costs	162,872			158,062			3.0	%
Personnel costs	175,662			175,786			(0.1	)%
Other operating costs	61,632			64,550			(4.5	)%
General and administrative expenses	52,159			50,613			3.1	%
Professional accounting and legal fees	9,082			21,171			(57.1	)%
Depreciation and amortization	18,602			19,962			(6.8	)%
Operating Expenses	480,009			490,144			(2.1	)%
Income from operations	20,952			6,923			202.6	%
Interest expense, net	19,580			28,100			(30.3	)%
Loss on extinguishment of debt	16,998			—			100.0	%
Non-service defined benefit plan expense	352			368			(4.3	)%
Loss before income taxes	(15,978		)	(21,545		)	(25.8	)%
Benefit for income taxes	(6,288		)	(5,448		)	15.4	%
Net loss	$	(9,690	)	$	(16,097	)	(39.8	)%

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

	For the Six Months Ended June 30,
	2018		2017
Material costs	32.5	%	31.8	%
Personnel costs	35.1	%	35.4	%
Other operating costs	12.3	%	12.9	%
General and administrative expenses	10.4	%	10.2	%
Professional accounting and legal fees	1.8	%	4.3	%
Depreciation and amortization	3.7	%	4.0	%
Operating expenses	95.8	%	98.6	%

Six Months Ended June 30, 2018 Compared to the Six Months Ended June 30, 2017

Net revenue. Net revenue for the six months ended June 30, 2018 was $501.0 million, an increase of $3.9 million, or 0.8%, from $497.1 million for the six months ended June 30, 2017. Net revenue by operating segment, after elimination of intersegment activity was as follows:

	For the Six Months Ended June 30,						Percent
(dollars in thousands)	2018		2017		Change		Change
Patient Care	$	406,665	$	403,858	$	2,807	0.7	%
Products & Services	94,296		93,209		1,087		1.2	%
Net revenue	$	500,961	$	497,067	$	3,894	0.8	%

Patient Care net revenue for the six months ended June 30, 2018 was $406.7 million, an increase of $2.8 million, or 0.7%, from $403.9 million for the same period in the prior year. Same clinic revenue increased $5.7 million reflecting an increase in same clinic revenue per day of 1.4%. This growth was partially offset by the effect of clinic closures which reflected decreased revenue of $0.7 million as compared with the same period in the prior year. Net revenue for the six months ended June 30, 2018 was also negatively impacted as compared to the same period in the prior year by $2.2 million from the adoption of the new revenue accounting standard on January 1, 2018.

Revenue growth for the year-to-date has primarily been the result of increased services to prosthetic patients, which was partially offset by revenue declines in orthotics, shoes and shoe inserts. Prosthetic revenue constituted 53% of Patient Care’s revenue in the first half of 2018 as compared with 51% for the same period in the prior year. We believe this growth in prosthetic revenue has been due in part to an increased focus on the demonstration of patient outcomes and related marketing initiatives. Decreases in shoes and shoe inserts relate generally to our de-emphasis of this lower margin category of care.

Products & Services net revenue for the six months ended June 30, 2018 was $94.3 million, an increase of $1.1 million, or 1.2% from $93.2 million for the same period in the prior year. Distribution of O&P componentry to independent providers increased $3.5 million partially offset by $2.4 million decrease in net revenue from therapeutic services, which related primarily to client cancellations.

Material costs. Material costs for the six months ended June 30, 2018 were $162.9 million, an increase of $4.8 million or 3.0%, from $158.1 million for the same period in the prior year. This underlying increase in cost of materials primarily related to changes in our Patient Care segment product mix, with total material costs as a percentage of net revenue increasing to 32.5% in 2018 from 31.8% in 2017. Material costs by operating segment, after elimination of intersegment activity, were as follows:

	For the Six Months Ended June 30,						Percent
(dollars in thousands)	2018		2017		Change		Change
Patient Care	$	123,808	$	120,678	$	3,130	2.6	%
Products & Services	39,064		37,384		1,680		4.5	%
Material costs	$	162,872	$	158,062	$	4,810	3.0	%

Patient Care material costs increased $3.1 million, or 2.6%, for the six months ended June 30, 2018 compared to the same period in the prior year. Excluding the $2.2 million effect on net revenue resulting from the adoption of the new revenue accounting standard, Patient Care material costs as a percent of revenue increased slightly to 30.3% in 2018 from 29.9% in 2017, primarily due to increases in the mix of our business towards higher-cost prosthetic devices.

Products & Services material costs increased $1.7 million, or 4.5%, for the six months ended June 30, 2018 compared to the same period in the prior year. Material costs increased to 41.4% as a percent of net revenue in the six months ended June 30, 2018 from 40.1% in the same period in 2017.

Personnel costs. Personnel costs for the six months ended June 30, 2018 were $175.7 million, relatively unchanged from $175.8 million for the same period in the prior year. Personnel costs by operating segment were as follows:

	For the Six Months Ended June 30,							Percent
(dollars in thousands)	2018		2017		Change			Change
Patient Care	$	150,405	$	151,421	$	(1,016	)	(0.7	)%
Products & Services	25,257		24,365		892			3.7	%
Personnel costs	$	175,662	$	175,786	$	(124	)	(0.1	)%

Personnel costs for our Patient Care segment were $150.4 million for the six months ended June 30, 2018, a decrease of $1.0 million, or 0.7%, from $151.4 million for the same period in the prior year. Patient Care benefits expense decreased $1.4 million from lower claims, partially offset by a $1.3 million increase in salary expense and a $0.9 decrease in bonus and commissions. Personnel costs in the Products & Services segment increased $0.9 million. The 3.7% increase in personnel costs for the six months ended June 30, 2018 compared to the same period in the prior year included an increase of $0.6 million in salary expense, $0.6 million in compensation and other personnel related costs, partially offset by a $0.3 million decrease in benefits.

Other operating costs. Other operating costs for the six months ended June 30, 2018 were $61.6 million, a decrease of $2.9 million, or 4.5% from $64.6 million for the same period in the prior year. Bad debt expense decreased $5.1 million, primarily from the adoption of the new revenue accounting standard under which certain of these expenses were re-characterized as implicit price concessions within our Patient Care segment and are now reflected as an adjustment to net revenue. This decrease was partially offset by a $1.1 million increase in travel and education related expenses and a $1.1 million increase in other operating costs.

General and administrative expenses. General and administrative expenses for the six months ended June 30, 2018 were $52.2 million, an increase of $1.5 million, or 3.1%, from $50.6 million for the same period in the prior year. This increase included $1.4 million of professional expenses related primarily to growth revenue cycle and other corporate initiatives, and $2.3 million in other expenses. Increases in general and administrative expenses for the year-to-date period were partially offset by a $1.7 million favorable settlement in connection with our long standing claim relating to the “Deepwater Horizon” disaster, and $0.5 million in connection with our favorable resolution of outstanding abandoned and unclaimed property claims with the State of Delaware.

Professional accounting and legal fees. Professional accounting and legal fees for the six months ended June 30, 2018 were $9.1 million, a decrease of $12.1 million from $21.2 million for the same period in the prior year. Advisory and other fees decreased $9.4 million, audit related fees decreased $2.1 million and legal fees decreased $0.6 million.

Depreciation and amortization. Depreciation and amortization for the six months ended June 30, 2018 was $18.6 million, a decrease of $1.4 million, or 6.8%, from $20.0 million for the same period in the prior year. The decrease included lower amortization of $1.1 million as a result of fully amortized intangible assets and $0.3 million of lower therapeutic equipment depreciation.

Interest expense, net. Interest expense for the six months ended June 30, 2018 was $19.6 million, a decrease of $8.5 million, or 30.3%, from $28.1 million for the same period in the prior year. This decrease related primarily to lower interest rates on outstanding borrowings arising from our debt refinancing in March 2018 and secondarily reflected a $1.5 million decrease related to our settlement of outstanding abandoned and unclaimed property claims with the State of Delaware in a manner that did not require us to pay interest we had accrued on long standing unpaid claim amounts.

Loss on extinguishment of debt. Debt extinguishment costs for the six months ended June 30, 2018 totaled $17.0 million and related to our debt refinancing on March 6, 2018 - see Note J - “Long-term Debt.”

Benefit for income taxes. The benefit for income taxes for the six months ended June 30, 2018 was $6.3 million, or 39.4% of loss from continuing operations before taxes, compared to a benefit of $5.4 million, or 25.3% of loss from before taxes for the six months ended June 30, 2017. The effective tax rate in 2018 consists principally of the ~~35%~~21% federal statutory tax rate and the rate impact from state income taxes ~~less~~and permanent tax differences. The ~~2014 period has a higher~~federal statutory tax rate in 2017 was 35%. The increase in the income tax benefit was largely driven by the increased estimated annual effective tax rate ~~primarily due~~applied to the ~~expiration of the federal research and development tax credit.~~

~~Net Income.~~ ~~Net income~~quarter, partially offset by decreased ~~$3.5 million, to $6.0 million, for three months ended March 31, 2014,~~loss from ~~$9.5 million~~continuing operations before taxes for the ~~three months ended March 31, 2013, due to the reasons noted above.~~period. The increase in estimated annual effective tax rate was driven by increased estimated permanent differences and decreased estimated loss from continuing operations before taxes.

Financial Condition, Liquidity and Capital Resources

~~Cash Flows~~Liquidity

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

At June 30, 2018, we had total liquidity of $142.9 million, which reflected an increase of $55.0 million, from the $87.9 million in liquidity we had as of December 31, 2017. Our liquidity at June 30, 2018 was comprised of cash and cash equivalents of $48.8 million and $94.1 million in available borrowing capacity under our $100.0 million revolving credit facility. This increase in liquidity relates primarily to the net proceeds of $49.7 million from the refinancing of our indebtedness on March 6, 2018.

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

Working Capital and Days Sales Outstanding

At June 30, 2018, we had a working capital of $126.1 million compared to working capital of $78.7 million at December 31, 2017. Our working capital ~~at March 31, 2014~~ increased ~~by $72.9~~$47.4 million ~~to $338.6 million,~~in 2018 compared to ~~$265.7~~2017 due to decreases in current liabilities of $26.3 million ~~at March 31, 2013. The increase~~and increases in ~~working capital was~~current assets of $21.2 million.

Our current liabilities decreased primarily due to decreases in the ~~impact~~accrued compensation related costs of ~~acquisitions as well as increases in cash, inventory, and income taxes receivable due~~$22.3 million, largely related to the ~~borrowing of funds under the revolving credit facility, the build-up of work-in-process inventory, and prepayment of estimated 2014 income tax expense,and the payout~~payment of annual ~~bonus plans, respectively. Days sales outstanding (“DSO”), which is~~bonuses during the number of days between the billing date of O&P services and the date of receipt of payment thereof, for the three months ended March 31, 2014 increased to 64 days from 56 days for the same period last year. The increasefirst quarter, a $7.4 million decrease in ~~DSO is related to~~accrued professional fees offset by an increase in ~~Medicare audits, including Recovery Audit Contractor or RAC audits, Comprehensive/Error Rate Testing or CERT audits~~the current portion of long term debt of $6.0 million. When comparing these outflows to the prior period, we paid $16.3 million less in annual bonuses and Medicare Administrative Contractor (MAC) prepayments audits. These audits review claims submitted to Medicare and result in payment delays while the audits are pending. The frequency of these audits significantly increased beginning in 2012, both for us and throughout the medical and healthcare industry, leading to substantial delays401(k) matching contributions in the ~~audit adjudication process, particularly~~first half of 2017 as compared to the amounts we paid in ~~administrative law appeals. At March 31, 2014 and~~the first half of 2018. This was due to our relatively weaker performance for the year ended December 31, ~~2013, we had approximately $17.1~~2016 as compared to our performance for the year ended December 31, 2017.

Our current assets increased primarily due to a $47.3 million increase in cash and ~~$15.2~~cash equivalents offset by a decrease of $12.3 million in net accounts receivable and a decrease of $11.7 million of ~~claims subject to pending Medicare audits, respectively.~~

~~Net cash provided by/(used in) operating activities~~income tax receivables. Cash received for income taxes was ~~($10.0)~~$11.7 million for the ~~three~~six months ended ~~March 31, 2014~~June 30, 2018, compared to ~~$2.2~~$0.3 million for the same period in the prior year. We are anticipating only marginal pre-tax book profitability for the year, and expect to utilize net operating loss carryforwards to offset our tax provision such that we expect cash paid for Federal taxes in 2018 to be minimal. The decrease in ~~cash provided by~~accounts receivable primarily relates to the seasonality of our business, whereby the fourth quarter reflects the highest seasonal quarter. This seasonality of revenue contributes directly to a drop in our accounts receivable balances after December 31st of each year.

Days sales outstanding (“DSO”) is a calculation that approximates the average number of days between the billing for our services and the date of our receipt of payment, which we estimate using a 90 day rolling period of net revenue. This computation can provide a relative measure of the effectiveness of our billing and collections activities. As of June 30, 2018, our DSO was 45 days, which compares to a DSO of 46 days as of June 30, 2017. At December 31, 2017, our DSO was 46 days, which was unchanged from a DSO of 46 days reported as of December 31, 2016.

Sources and Uses of Cash in Six Months Ended June 30, 2018 Compared to June 30, 2017

Cash flows from operating activities increased $23.2 million to an inflow of $16.9 million for the six months ended June 30, 2018 from a use of $6.3 million for the six months ended June 30, 2017. This was due primarily to the changes in ~~the current year resulted primarily from decreased net income, build-up of inventory, and prepayment of estimated 2014 income tax expense.~~working capital in 2018 compared to 2017 which were discussed above.

~~Net~~Cash flows used in investing activities increased $9.0 million to $14.1 million for the six months ended June 30, 2018 from $5.1 million for the six months ended June 30, 2017. The increase in cash used in investing activities ~~was $29.8~~included a $2.5 million ~~for the three months ended March 31, 2014, compared to $5.3 million~~decrease in ~~the prior year. In the first three months~~proceeds of ~~2014, we acquired seven companies for $19.2 million, net~~sale of ~~cash acquired, made~~ property, plant and equipment, $4.9 million increase in purchases of ~~a net $8.3 million, and purchased $2.3 million of company owned life insurance. During the same period in 2013, we did not acquire O&P companies and made~~ property, plant and equipment, and a $1.5 million increase in purchases of ~~a net $5.3 million.~~

~~Net cash provided by/(used in) financing activities was $85.5 million~~therapeutic program equipment. We currently anticipate that we will expend an increased amount for capital expenditures in 2018 as compared with recent years. In addition to general increases in technology and ~~($1.1)~~leasehold improvements, we also plan to increase our purchase of therapy equipment for use in our Products & Services segment. We currently believe that our total capital expenditures related to property, plant and equipment, and therapeutic program equipment purchases will be approximately $30.0 to $35.0 million for the ~~quarters~~year ended ~~March~~December 31, ~~2014 and 2013, respectively. During the first quarter of 2014 we: (i) borrowed $125.0 million from our revolving credit facility; (ii) repaid $38~~2018.

Cash flows provided by financing activities increased $38.3 million to ~~our revolving credit facility; (iii) received $1.9~~$43.5 million ~~of proceeds~~for the six months ended June 30, 2018 from $5.2 million for the exercise of stock options issued under employee stock compensation plans; (iv) made $1.6 million of required repayments of promissory notes issued in connection with acquisitions (“Seller Notes”); and (v) repaid $1.4six months ended June 30, 2017. This increase included $49.6 million related to ~~term loan borrowings under~~ our ~~credit facilities.~~

~~Table~~refinancing of ~~Contents~~

~~During the first quarter of 2013 we: (i) repaid $0.8~~indebtedness and $2.0 million ~~related to term loan borrowings under our credit facilities; (ii) made $1.4~~reduction in payments on seller notes and other contingent consideration, partially offset by $12.1 million of ~~required repayments of promissory notes issued in connection with acquisitions;~~debt issuance costs, extinguishment costs and ~~(iii) received~~fees and $1.2 million ~~of proceeds from the exercise of stock options issued under~~in employee stock based compensation ~~plans.~~and capital lease obligations.

~~General~~Effect of Indebtedness

Due to the then pending June 17, 2018, maturity of our previous credit agreement, on March 6, 2018 we entered into the Credit Agreement in order to refinance our indebtedness. These changes to our indebtedness are disclosed in Note J - “Long-Term Debt,” in the notes to the condensed consolidated financial statements (unaudited) elsewhere in this report. Our new indebtedness bears reduced rates of interest compared with those under our prior indebtedness, and as such, for the year ended December 31, 2018, we anticipate that we will report interest expense of approximately $40.0 million compared with the $57.7 million we reported in 2017. Cash paid for interest totaled $16.6 million and $22.1 million for the six months ended June 30, 2018 and 2017, respectively.

Scheduled maturities of debt as of June 30, 2018 were as follows (in thousands):

2018 (remainder of year)	$	5,999
2019	8,356
2020	7,275
2021	5,936
2022	6,053
Thereafter	491,005
Total debt before unamortized discount and debt issuance costs, net	524,624
Unamortized discount and debt issuance costs, net	(10,083		)
Total debt	$	514,541

Liquidity Outlook and Going Concern Evaluation

Our Credit Agreement has a term loan facility with $505 million in principal outstanding at June 30, 2018, due in quarterly principal installments equal to 0.25% of the original aggregate principal amount of $505 million, commencing June 29, 2018, with all remaining outstanding principal due at maturity in March 2025 and a revolving credit facility with no borrowings and a maximum aggregate amount of availability of $100 million at June 30, 2018 that matures in March 2023. We currently believe that our anticipated operating trends, when coupled with anticipated decreases in our payments of interest expense and professional fees, will provide us with sufficient liquidity to meet our financial obligations during the coming twelve months.

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

Off-Balance Sheet Arrangements

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

As of ~~March 31, 2014, $332.8~~June 30, 2018, we had a combined principal amount of $503.7 million ~~or 59.2%,~~ of ~~our total~~variable rate debt and a notional amount of ~~$561.9~~$325.0 million ~~was subject~~of fixed to variable interest rates. We believe that, based on current levels of operations and anticipated growth, cash generated from operations, together with other available sources of liquidity, including borrowings available under the Revolving Credit Facility, will be sufficient for at least the next twelve months to fund anticipated capital expenditures, to fund our acquisition plans and make required payments of principal and interestrate swap agreements. Based on our ~~debt, including payments due on~~hedged and unhedged positions, a hypothetical increase or decrease in interest rates by 1.0% would impact our ~~outstanding debt.~~annual interest expense by $1.8 million.

ITEM 4. CONTROLS AND PROCEDURES

~~Obligations~~Evaluation of Disclosure Controls and ~~Commercial Commitments~~Procedures

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

Management, under the supervision and with the participation of our ~~contractual obligations~~Chief Executive Officer and ~~commercial commitments~~Chief Financial Officer, conducted an evaluation of the effectiveness of the design and effectiveness of our disclosure controls and procedures as of ~~March 31, 2014 (unaudited):~~

Payments Due by Period

(In thousands)

Remainder of 2014

2015

2016

2017

2018

Thereafter

Total

Long-term debt

$
13,503

$
24,730

$
26,058

$
31,757

$
464,960

$
927

561,935

Interest payments on long-term debt (1)

17,968

19,148

18,842

18,652

15,726

25

90,361

Operating leases

36,057

37,571

29,906

22,949

15,650

27,934

170,067

Capital leases

1,697

2,280

2,290

2,343

2,214

9,536

20,360

Other long-term obligations (2)

12,295

10,013

3,325

3,024

1,907

9,091

39,655

Total contractual cash obligations

$
81,520

$
93,742

$
80,421

$
78,725

$
500,457

$
47,513

$
882,378

~~(1) Interest projections~~June 30, 2018. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were ~~based on the assumptions that the future interest rate for the Term Loan will remain at the current rate~~not effective as of ~~1.9%, which is the Company’s estimate for such period based on current and projected LIBOR rates.~~

(2) Other long-term obligations include commitments under our SERP plan in addition to IT and telephone contracts. Refer to Note K of the Company’s Annual Report on Form 10-K for additional disclosure on the SERP plan.

~~Forward Looking Statements~~

This report contains forward-looking statements setting forth our beliefs or expectations relating to future revenues, contracts and operations, and certain legal proceedings. Actual results may differ materially from projected or expected resultsJune 30, 2018 due to ~~changes~~the material weaknesses in ~~the demand for~~ our ~~O&P products~~internal control over financial reporting described in Item 9A - “Controls and services, our ability to enter into and derive benefits from managed-care contracts, our ability to successfully attract and retain qualified O&P clinicians, federal laws governing the health-care industry, governmental policies affecting O&P operations and other risks and uncertainties generally affecting the health-care industry. Readers are cautioned not to put undue reliance on forward-looking statements. Refer to risk factors disclosed in Part II, Item 1A of this filing as well as the risk factors disclosedProcedures” in our Annual Report on Form 10-K for the year ended December 31, ~~2013~~2017 (the “2017 10-K”).

Changes in Internal Control over Financial Reporting

As part of the adoption of ASC 606, we are implementing changes to our internal controls over financial reporting related to revenue recognition to ensure adequate evaluation of contracts and proper recording of revenue. Additionally, due to our ongoing remediation efforts of the aforementioned material weaknesses, additional changes to our internal control over financial reporting are likely to have occurred during the six months ended June 30, 2018. See Item 9A - “Controls and Procedures” in the 2017 10-K for ~~discussion~~additional information regarding our ongoing remediation efforts.

Therefore, in accordance with Rule 13a-15(d) of ~~risks~~the Exchange Act, management, with the participation of our Chief Executive Officer and ~~uncertainties.~~our Chief Financial Officer, determined that elements of the changes listed above to our internal control over financial reporting occurred during the six months ended June 30, 2018 and have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II.OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Securities and Derivative Litigation

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

On April 1, 2016, the court granted our motion to dismiss the lawsuit for failure to state a claim upon which relief can be granted, and permitted plaintiffs to file an amended complaint. On July 1, 2016, plaintiffs filed an amended complaint. On September 15, 2016, we and certain of the individual defendants filed motions to dismiss the lawsuit. On January 26, 2017, the court granted the defendants’ motions and dismissed with prejudice all claims against all defendants for failure to state a claim. On February 24, 2017, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Fifth Circuit. Appellate briefing was completed on August 18, 2017 and the Court of Appeals held oral argument for the appeal on March 5, 2018. On August 6, 2018, the Court of Appeals affirmed in part and reversed in part. The Court of Appeals affirmed the dismissal of the case against individual defendants Vinit Asar, our current President and Chief Executive Officer, and Thomas Kirk, our former President and Chief Executive Officer, but reversed the dismissal of the case against George McHenry, our former Chief Financial Officer, and Hanger, Inc. The case has been remanded back to the United States District Court for the Western District of Texas for further proceedings with respect to the remaining claims. We ~~disclaim~~believe the remaining claims are without merit, and intend to continue to vigorously defend against these claims.

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

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

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

The plaintiffs have since subpoenaed counsel for the Special Committee, seeking a copy of the full report prepared by the Special Committee and its independent counsel. Counsel for the Special Committee, as well as our counsel, took the position that the full report is not discoverable under Texas law. Plaintiffs’ counsel filed a motion to compel the Special Committee’s counsel to produce the report. We opposed the motion. On July 20, 2018, the Travis County court ruled that only a redacted version of the report is discoverable. Upon completion of discovery we intend to file a motion to dismiss the consolidated derivative action.

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

Other Matters

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

ITEM ~~3. Quantitative and Qualitative Disclosures about Market Risk~~1A. RISK FACTORS

Our ~~future~~business and financial result is subject to a variety of risks, including interest rate risk. As of March 31, 2014, the interest expense arising from the $332.8 million of outstanding borrowings under both our Term loan facility and our Revolverresults are subject to ~~variable interest rates, partially offset by interest income subject to variable interest rates generated~~numerous risks and uncertainties. The risk and uncertainties have not changed materially from ~~our $51.6 million of cash equivalents. As of March 31, 2014, we had $229.1 million of fixed rate debt which includes our 7~~ 1/8 ~~% Senior notes and Subordinated seller notes.~~

~~Presented below is an analysis of our financial instruments as of March 31, 2014 that are sensitive to changes~~those reported in interest rates. The table demonstrates the changes in estimated annual cash flow related to the outstanding balance under the Revolving and Term Loan Facility, calculated for an instantaneous parallel shift in interest rates, plus or minus 50 basis points (“BPS”), 100 BPS and 150 BPS. As of March 31, 2014, the interest rate on the Revolving and Term loan facilities was 1.90% based on a LIBOR rate of 0.15% and the applicable margin of 1.75%.

~~Table of Contents~~

Cash Flow Risk

Annual Interest Expense Given an Interest
Rate Decrease of X Basis Points

No Change
in Interest
Rates

Annual Interest Expense Given an
Interest Rate Increase of X Basis Points

(In thousands)

(150 BPS)

(100 BPS)

(50 BPS)

50 BPS

100 BPS

150 BPS

Interest Expense

$
6,266

$
6,561

$
6,856

$
7,546

$
8,952

$
10,358

$
11,764

~~ITEM 4. Controls and Procedures~~

~~Disclosure Controls and Procedures~~

The Company’s disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in its periodic reports filed with the Securities and Exchange Commission is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms and to ensure that information required to be disclosed in the reports filed under the Exchange Act was accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures. Based on an evaluation of the Company’s disclosure controls and procedures conducted by the Company’s Chief Executive Officer and Chief Financial Officer, such officers concluded that the Company’s disclosure controls and procedures were not effective as of March 31, 2014 as a result of the following material weaknesses in our internal controls over financial reporting. Specifically, the Company did not design and/or maintain effective controls over i) raw materials to ensure items are priced using the first in first out method resulting from the identification of inaccurate prices utilized in the valuation of our inventory quantities on hand based on physical observation; ii) the accuracy of the stage of completion in valuing work-in-process inventory resulting from the identification of data input errors from our physical inventory observation used in the valuation of our work-in-process inventory; and iii) certain key assumptions used in the valuation of work-in-process inventory resulting from the identification of inaccurate or imprecise data used in the development of these assumptions. Additional details are discussedItem 1A in our Annual Report on Form 10-K for the year ended December 31, ~~2013,~~2017, which are incorporated by reference. For additional information regarding risks and uncertainties, see the information provided under the header “Forward Looking Statements” contained in Part ~~II,~~I, Item ~~9-A.~~

2, “~~Status~~Management’s Discussion and Analysis of ~~Remediation~~Financial Condition and Results of ~~Material Weaknesses~~Operations

~~As of March 31, 2014, the material weaknesses disclosed~~” in ~~our Annual~~this Quarterly Report on Form 10-K for the year ended December 31, 2013, as listed above, are not remediated. These material weaknesses relate to the Company’s annual physical inventory, and therefore the Company will not be able to verify remediation until the fourth quarter of 2014 after completion of the annual physical inventory at Hanger Clinic, at the earliest. The Company is working to remediate the material weaknesses and has begun by taking steps to plan and implement additional measures to remediate the underlying causes of the material weaknesses. The additional measures are primarily the continued development and implementation of formal policies, improved processes and documentation of procedures and controls, additional training of finance and operational personnel, the hiring of additional finance personnel and the engagement of external subject matter experts. The Company’s actions are subject to ongoing senior management review, as well as audit committee oversight. As the Company continues to evaluate and work to improve its internal control over financial reporting, management may determine to take additional measures to address this material weaknesses or determine to modify the remediation steps described above.

~~Changes in Internal Control Over Financial Reporting~~

In accordance with Rule 13a-15(d) under the Securities Exchange Act of 1934, management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, determined that there were no changes in the Company’s internal control over financial reporting, beyond those in-process remediation efforts discussed above, that occurred during the three months ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

~~Part II. Other Information~~

~~ITEM 1.~~ ~~LEGAL PROCEEDINGS~~

ITEM ~~1A.~~ ~~RISK FACTORS~~.2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

~~Part I, Item 1A (“Risk Factors”) of~~There has been no share repurchase activity during the ~~Company’s Annual Report on Form 10-K for the year~~quarter ended December 31, 2013 sets forth information relating to important risks and uncertainties that could materially adversely affect the Company’s business, financial condition or operating results. Those risk factors continue to be relevant to an understanding of the Company’s business, financial condition and operating results. Certain of those risk factors have been updated in this Form 10-Q to provide updated information, as set forth below. References to “we,” “our” and “us” in these risk factors refer to the Company.

~~Table of Contents~~June 30, 2018.

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

We derived 38.7% and 40.2% of our net sales for the three months ended March 31, 2014 and 2013, respectively, from reimbursements for O&P services and products from programs administered by Medicare, Medicaid and the U.S. Department of Veterans Affairs. Each of these programs set maximum reimbursement levels for O&P services and products. If these agencies reduce reimbursement levels for O&P services and products in the future, our net sales could substantially decline. In addition, the percentage of our net sales derived from these sources may increase as the portion of the U.S. population over age 65 continues to grow, making us more vulnerable to reimbursement reductions by these organizations. Reduced government reimbursement levels could result in reduced private payor reimbursement levels because fee schedules of certain third-party payors are indexed to Medicare. Furthermore, the healthcare industry is experiencing a trend towards cost containment as government and other third-party payors seek to impose lower reimbursement rates and negotiate reduced contract rates with service providers. This trend could adversely affect our net sales. For example, a number of states have reduced their Medicaid reimbursement rates for O&P services and products, or have reduced Medicaid eligibility, and others are in the process of reviewing Medicaid reimbursement policies generally, including for prosthetic and orthotic devices. Additionally, Medicare provides for reimbursement for O&P products and services based on prices set forth in fee schedules for ten regional service areas. Medicare prices are adjusted each year based on the Consumer Price Index— Urban (“CPIU”) unless Congress acts to change or eliminate the adjustment. The Medicare price increases/(decreases) for 2014, 2013 and 2012 were 1.0%, 0.8%, and 2.4%, respectively. The Patient Protection and Affordable Care Act, Pub. L. No. 111-148, March 23, 2010 (“PPACA”) changed the Medicare inflation factors applicable to O&P (and other) suppliers. The annual updates for years subsequent to 2011 are based on the percentage increase in the CPI-U for the 12-month period ending with June of the previous year. Section 3401(m) of PPACA required that for 2011 and each subsequent year, the fee schedule update factor based on the CPI-U for the 12-month period ending with June of the previous year is to be adjusted by the annual economy-wide private nonfarm business multifactory productivity (“the MFP Adjustment”). The MFP Adjustment may result in that percentage increase being less than zero for a year and may result in payment rates for a year being less than such payment rates for the preceding year. CMS has not yet issued a final rule implementing these adjustments for years beyond 2011, but has indicated in a proposed rule that it will do so as part of the annual program instructions to the O&P fee schedule updates. See 75 Fed. Reg. 40040, 40122, et seq. (July 13, 2010). If the U.S. Congress were to legislate additional modifications to the Medicare fee schedules, our net sales from Medicare and other payors could be adversely and materially affected.

The Budget Control Act of 2011 required, among other things, mandatory across-the-board reductions in Federal spending, or “sequestration.” While delayed by the American Taxpayer Relief Act of 2012, President Obama issued a sequestration order on March 1, 2013. For services provided on or after April 1, 2013, Medicare fee-for-service claim payments, including those for DMEPOS (durable medical equipment (DME), prosthetics, orthotics and supplies) as well as claims under the DME Competitive Bidding Program, are reduced by 2 percent. This is a claims payment adjustment with limited impact on the Company (approximately $0.9 million for three months ending March 31, 2014); no permanent reductions in the Medicare DMEPOS fee schedule have been made as a result of sequestration, therefore reimbursements from Medicaid, the VA and commercial payers who use the Medicare fee schedule as a basis for reimbursement have not been impacted.

In addition to the risks to our Patient Care segment businesses discussed above, changes in government reimbursement levels could also adversely affect the net sales, cash flows and profitability of our Products & Services segment business. In particular, a significant majority of sales at ACP involve devices and related services provided to skilled nursing facilities (SNFs) and similar businesses. Reductions in government reimbursement levels to SNFs could cause such SNFs to reduce or cancel their use of ACP’s devices and modalities, negatively impacting net sales, cash flows and profitability. For example in July 2011 CMS announced an across the board reduction of approximately 10% in SNF reimbursement levels, negatively impacting the demand for ACP’s devices and treatment modalities. We cannot predict whether any other modifications to reimbursement levels will be implemented, or if implemented what form any modifications might take.

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

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

·~~refunding of amounts we have been paid pursuant to our government contracts;~~

·~~imposition of fines, penalties and other sanctions on us;~~

·~~loss of our right to participate in various federal programs;~~

~~Table of Contents~~

·~~damage to our reputation in various markets; or~~

·~~material and/or adverse effects on our business, financial condition and results of operations.~~

In recent years we have seen a significant increase in Medicare audits, including Recovery Audit Contractor or RAC audits, Comprehensive/Error Rate Testing or CERT audits and Medicare Administrative Contractor (MAC) prepayment audits. Additionally, substantial delays have developed in the audit adjudication process, particularly in administrative law appeals. At March 31, 2014 and December 31, 2013, we had approximately $17.1 million and $15.2 million of claims subject to pending Medicare audits, respectively. Through December 31, 2013, our success rate on these audits at final adjudication (the Administrative Law Judge hearing) was approximately 90%. Nevertheless, Medicare audits could have a material and adverse effect on our business financial condition and result of operations, particularly if our success rate at final adjudication were to decline.

ITEM ~~6. Exhibits~~3. DEFAULTS UPON SENIOR SECURITIES

There have been no defaults upon senior securities during the quarter ended June 30, 2018.

~~(a)~~ ~~Exhibits~~. ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None to report.

ITEM 6. EXHIBITS

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

EXHIBITS INDEX

Exhibit No.		Document

~~10.1~~		Letter Agreement, dated April 7, 2014, among George E. McHenry, the Company and Hanger Prosthetics & Orthotics, Inc. (Incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K filed by the Registrant on April 7, 2014).

31.1		Written Statement of the Chief Executive Officer Pursuant to Section 302 of the ~~Sarbanes-Oxley~~Sarbanes Oxley Act of 2002.
		(Filed herewith.)
31.2		Written Statement of the Chief Financial Officer Pursuant to Section 302 of the ~~Sarbanes-Oxley~~Sarbanes Oxley Act of 2002.
		(Filed herewith.)
32		Written Statement of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, ~~As Adopted~~as adopted Pursuant to Section 906 of the ~~Sarbanes-Oxley~~Sarbanes Oxley Act of 2002. (Filed herewith.)
101.INS		XBRL Instance Document. (Filed herewith.)
~~101~~101.SCH		The following financial information from the Company’s Quarterly Report on Form 10-Q, for the period ended March 31, 2014, formatted in eXtensible Business Reporting Language: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Cash Flows, (iv) Notes to Consolidated Financial Statements (1)XBRL Taxonomy Extension Schema. (Filed herewith.)
101.CAL		XBRL Taxonomy Extension Calculation Linkbase. (Filed herewith.)
101.LAB		XBRL Taxonomy Extension Label Linkbase. (Filed herewith.)
101.PRE		XBRL Taxonomy Extension Presentation Linkbase. (Filed herewith.)
101.DEF		XBRL Taxonomy Extension Definition Linkbase. (Filed herewith.)

~~(1)~~Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

~~Table of Contents~~

SIGNATURES

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

	HANGER, INC.


Dated: ~~May~~August 9, ~~2014~~2018	By:	/s/~~Vinit K. Asar~~
	~~Vinit K. Asar~~
	~~President~~ ~~and~~
	~~Chief Executive Officer~~
	~~(Principal Executive Officer)~~ THOMAS E. KIRALY


~~Dated: May 9, 2014~~	~~/s/George~~Thomas E. ~~McHenry~~Kiraly
	~~George E. McHenry~~
	Executive Vice President and Chief Financial Officer
	~~(Principal Financial~~
Dated: August 9, 2018	By:	/s/ GABRIELLE B. ADAMS
		Gabrielle B. Adams
		Vice President and Chief Accounting Officer ~~and Principal Accounting Officer)~~

2747

	March 31,		December 31,
	2014		2013

ASSETS

CURRENT ASSETS
Cash and cash equivalents	$	55,624	$	9,860
Net accounts receivable, less allowance for doubtful accounts of $10,313 and $10,022 in 2014 and 2013, respectively	183,548		185,769
Inventories	153,952		141,518
Prepaid expenses, other assets, and income taxes receivable	27,678		15,519
Deferred income taxes	30,366		30,298
Total current assets	451,168		382,964

PROPERTY, PLANT AND EQUIPMENT
Land	794		794
Buildings	16,517		15,397
Furniture and fixtures	16,581		15,855
Machinery and equipment	63,379		61,707
Equipment leased to third parties under operating leases	34,198		34,142
Leasehold improvements	88,576		85,176
Computer and software	94,561		88,950
Total property, plant and equipment, gross	314,606		302,021
Less accumulated depreciation and amortization	183,187		175,223
Total property, plant and equipment, net	131,419		126,798

INTANGIBLE ASSETS
Goodwill	702,455		681,547
Other intangible assets, less accumulated amortization of $29,267 and $27,375 in 2014 and 2013, respectively	61,367		58,021
Total intangible assets, net	763,822		739,568

OTHER ASSETS
Debt issuance costs, net	8,134		8,564
Other assets	15,142		13,766
Total other assets	23,276		22,330

TOTAL ASSETS	$	1,369,685	$	1,271,660

	Three Months Ended
	March 31,
	2014		2013

Net sales	$	235,605	$	229,350
Material costs	67,345		67,739
Personnel costs	96,431		89,953
Other operating expenses	45,600		39,657
Depreciation and amortization	10,199		9,285
Income from operations	16,030		22,716

Interest expense	6,098		7,777
Income before taxes	9,932		14,939

Provision for income taxes	3,935		5,449
Net income	$	5,997	$	9,490

Other comprehensive income	—		—
Comprehensive income	$	5,997	$	9,490

Basic Per Common Share Data
Net income	$	0.17	$	0.27
Shares used to compute basic per common share amounts	35,076,828		34,598,494

Diluted Per Common Share Data
Net income	$	0.17	$	0.27
Shares used to compute diluted per common share amounts	35,415,018		35,066,032

	2014			2013

Cash flows from operating activities:
Net income	$	5,997		$	9,490
Adjustments to reconcile net income to net cash provided by operating activities:
Loss/(gain) on disposal of assets	(547		)	52
Provision for doubtful accounts	3,754			1,657
Provision for deferred income taxes	358			—
Depreciation and amortization	10,199			9,285
Amortization of debt issuance costs	430			864
Compensation expense restricted stock units	2,418			1,667
Changes in operating assets and liabilities, net of effects of acquired companies:
Accounts receivable	1,537			7,216
Inventories	(10,589		)	(5,197		)
Prepaid expenses, other current assets, and income taxes	(12,736		)	(3,860		)
Accounts payable	2,126			(2,006		)
Accrued expenses, accrued interest payable	2,384			3,883
Accrued compensation related costs	(15,040		)	(19,544		)
Other	(253		)	(1,314		)
Net cash provided by/(used in) operating activities	(9,962		)	2,193

Cash flows from investing activities:
Purchase of property, plant and equipment (net of acquisitions)	(8,297		)	(5,110		)
Purchase of equipment leased to third parties under operating leases	(564		)	(288		)
Acquisitions (net of cash acquired)	(19,167		)	—
Purchase of company-owned life insurance investment	(2,294		)	—
Proceeds from sale of property, plant and equipment	522			91
Net cash used in investing activities	(29,800		)	(5,307		)

Cash flows from financing activities:
Borrowings under revolving credit agreement	125,000			—
Repayments under revolving credit agreement	(38,000		)	—
Repayment of term loan	(1,406		)	(750		)
Repayment of seller’s notes and other contingent considerations	(1,594		)	(1,410		)
Repayment of capital lease obligations	(340		)	(180		)
Excess tax benefit from stock based compensation	1,780			1,214
Proceeds from issuance of common stock	86			62
Net cash provided by/(used in) financing activities	85,526			(1,064		)

Increase/(decrease) in cash and cash equivalents	45,764			(4,178		)
Cash and cash equivalents, at beginning of period	9,860			19,211
Cash and cash equivalents, at end of period	$	55,624		$	15,033

SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION:

Cash paid during the period for:
Interest	1,629			3,290
Income taxes (net of refunds)	11,159			5,591

Non-cash financing and investing activities:
Issuance of restricted stock units	8,691			9,617
Issuance of notes in connections with acquistisions	9,300			—

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
(in thousands except per share data)	2018		2017		2018			2017

Net income (loss)	$	12,928	$	1,637	$	(9,690	)	$	(16,097	)

Weighted average shares outstanding - basic	36,790		36,287		36,645			36,187
Effect of potentially dilutive restricted stock units and options (1)	614		257		—			—
Weighted average shares outstanding - diluted	37,404		36,544		36,645			36,187

Basic income (loss) per share	$	0.35	$	0.05	$	(0.26	)	$	(0.44	)

Diluted income (loss) per share	$	0.35	$	0.04	$	(0.26	)	$	(0.44	)

	March 31, 2014							December 31, 2013
(In thousands)	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Customer Lists	$	50,263	$	(12,715	)	$	37,548	$	46,932	$	(11,627	)	$	35,305
Trade Name	11,825		(380		)	11,445		10,023		(264		)	9,759
Patents and Other Intangibles	28,546		(16,172		)	12,374		28,441		(15,484		)	12,957
	$	90,634	$	(29,267	)	$	61,367	$	85,396	$	(27,375	)	$	58,021

	Three Months Ended
	March 31,
(In thousands, except share and per share data)	2014		2013
Net income	$	5,997	$	9,490

Shares of common stock outstanding used to compute basic per common share amounts	35,076,828		34,598,494
Effect of dilutive restricted stock and options (1)	338,190		467,538
Shares used to compute dilutive per common share amounts	35,415,018		35,066,032

Basic income per share	$	0.17	$	0.27
Diluted income per share	$	0.17	$	0.27

	2014		2013
Discount rate	4.03	%	3.25	%
Average rate of increase in compensation	3.00	%	3.00	%

March 31, 2014
(In thousands)	0-60 days		61-120 days		Over 120 days		Total
Patient Care
Commercial insurance	$	40,276	$	12,870	$	18,593	$	71,739
Private pay	4,595		2,995		6,709		14,299
Medicaid	11,472		3,683		6,691		21,846
Medicare	28,740		5,902		25,860		60,502
VA	2,477		586		668		3,731
Products & Services
Trade accounts receivable	11,579		3,642		6,523		21,744
	$	99,139	$	29,678	$	65,044	$	193,861

	Payments Due by Period
(In thousands)	Remainder of 2014		2015		2016		2017		2018		Thereafter		Total

Long-term debt	$	13,503	$	24,730	$	26,058	$	31,757	$	464,960	$	927	561,935
Interest payments on long-term debt (1)	17,968		19,148		18,842		18,652		15,726		25		90,361
Operating leases	36,057		37,571		29,906		22,949		15,650		27,934		170,067
Capital leases	1,697		2,280		2,290		2,343		2,214		9,536		20,360
Other long-term obligations (2)	12,295		10,013		3,325		3,024		1,907		9,091		39,655
Total contractual cash obligations	$	81,520	$	93,742	$	80,421	$	78,725	$	500,457	$	47,513	$	882,378

Cash Flow Risk	Annual Interest Expense Given an Interest Rate Decrease of X Basis Points						No Change in Interest Rates		Annual Interest Expense Given an Interest Rate Increase of X Basis Points
(In thousands)	(150 BPS)		(100 BPS)		(50 BPS)				50 BPS		100 BPS		150 BPS
Interest Expense	$	6,266	$	6,561	$	6,856	$	7,546	$	8,952	$	10,358	$	11,764