SIGNIFICANT ACCOUNTING POLICIES (Policies)

12 Months Ended

Dec. 31, 2013

SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in the accompanying financial statements.

Revision of Previously Reported Consolidated Financial Information

Revision of Previously Reported Consolidated Financial Information

During the third quarter 2013, the Company corrected an error in the classification of certain components of bad debt expense (the "2013 Revision"). Hanger previously classified the reserves related to the write-off of older accounts receivable balances due from commercial and government payors as bad debt expense, which was reported as Other Operating Expense in its financial statements, instead of as a reduction of sales. Management has assessed the materiality of the errors on previously reported periods and concluded the impact was not material to any of the prior annual or quarterly consolidated financial statements. The errors had no impact on previously reported net income, balance sheet totals or the operating cash flows for any of the periods. The impact of the adjustment lowers sales and reduces Other Operating Expenses by equal and offsetting amounts in the Consolidated Statements of Income and Comprehensive Income and the Provision for doubtful accounts and Change in accounts receivable by equal and offsetting amounts in the Consolidated Statements of Cash Flows. Further, the Company has historically included the reserve for contra revenue in its presentation of the Allowance for doubtful accounts on the Consolidated Balance Sheets and the net change in the reserve for contra revenue in the Provision for doubtful accounts on the Consolidated Statements of Cash Flows and the Schedule II Valuation and Qualifying Accounts included in the Company's Annual Report on Form 10-K. The Company has revised that presentation to only include the reserve for doubtful accounts and the related activity in the reserve for doubtful accounts in those respective balances. The impacts of the revisions on Net sales are included in the results of the Patient Care segment in Note O.

The impact of the 2013 Revision on the Consolidated Statements of Income and Comprehensive Income and the Consolidated Statements of Cash Flows for the annual periods ended 2011 and 2012, and Schedule II Valuation and Qualifying Accounts for the annual periods 2011 and 2012 are shown below.

Impact of 2013 Revision to previously reported consolidated annual results
(In thousands)

	Year Ended December 31, 2012						Year Ended December 31, 2011
	As Previously Reported			As Revised			As Previously Reported			As Revised
Consolidated Statements of Income and Comprehensive Income
Net Sales	$	985,550		$	974,429		$	918,539		$	907,794
Other operating expenses*	$	188,868		$	178,918		$	177,910		$	169,131
Consolidated Statements of Cash Flows
Provision for doubtful accounts	$	19,773		$	9,589		$	24,837		$	9,396
Change in accounts receivable	$	(40,443	)	$	(30,259	)	$	(42,024	)	$	(26,583	)

*

The Other operating expenses balance includes $1.2 million of acquisition expense for the year ended December 31, 2012 and $1.2 million of relocation expense and $0.8 million of acquisition expense for the year ended December 31, 2011 previously reported as a separate caption in the presentation of the Consolidated Statements of Income and Comprehensive Income.

Impact of 2013 Revision to previously reported Schedule II Allowance for doubtful accounts table
(In thousands)

Year		Classification	Balance at beginning of year		Additions Charged to Costs and Expenses		Write-offs		Balance at end of year
	2012	Allowance for doubtful accounts
		Previously reported	$	22,028	$	19,773	$	20,422	$	21,379
		Revised	$	7,236	$	9,589	$	9,299	$	7,526
	2011	Allowance for doubtful accounts
		Previously reported	$	16,686	$	22,101	$	16,759	$	22,028
		Revised	$	5,153	$	9,396	$	7,313	$	7,236

Use of Estimates

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. The Company maintains cash balances in excess of Federal Deposit Insurance Corporation limits at certain financial institutions.

Restricted Cash

Restricted Cash

Restricted cash has statutory or contractual restrictions that prevent it from being used in the Company's operations. As of December 31, 2013, the Company had no restricted cash. At December 31, 2012, the Company had agreed to restrict $3.1 million of cash to serve as collateral for its Workers' Compensation program. In August of 2013, the Company substituted a letter of credit for the restricted cash to serve as collateral for its Worker's Compensation program, and the cash balances used as collateral were transferred to the Company's operating accounts.

Credit Risk

Credit Risk

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, by 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 Products & Services segment 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 legislation and regulatory actions. Additionally, the Company maintains reserves for potential losses from these receivables that historically have been within management's expectations.

Inventories

Inventories

Patient Care—Inventories at Hanger Clinics, Dosteon and Cares, which consists of raw materials, work-in-process and finished goods, amounted to $109.2 million and $98.3 million as of December 31, 2013 and 2012, respectively. Inventories in Hanger's Clinics, which amounted to $99.0 million and $86.9 million at December 31, 2013 and 2012, 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 $8.9 million and $9.7 million at December 31, 2013 and 2012, respectively, consists principally of raw materials. As of December 31, 2013, the Dosteon inventories were valued at the lower of cost or market using the first-in first-out method based on a physical count as of December 31, 2013. As of December, 31, 2012, the Dosteon inventories were valued based on the gross profit method, which approximated lower of cost or market using the first-in first-out method. Inventories in the Cares business amounted to $1.3 million and $1.7 million as of December 31, 2013 and 2012 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.

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 Clinic. 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 fourth quarter adjustments of a decrease to inventory of $2.3 million, a decrease to inventory of $0.5 million and an increase to inventory of $2.3 million in 2013, 2012, and 2011, respectively.

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 consist 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

Fair Value Measurements

The Company follows 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 quoted prices for identical assets or liabilities in active markets accessible by the Company
Level 2	inputs 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

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

Financial Instruments

Assets measured at fair value on a recurring basis as of December 31, 2013 and 2012, are $7.7 million and $11.0 million, respectively, and are comprised of cash equivalent money market investments. The money market investments are based on Level 1 observable market prices and are equivalent to one dollar. The carrying value of the Company's short-term financial instruments, such as receivables and payables, approximate their fair values based on the short-term maturities of these instruments. During the second quarter of 2013, the Company refinanced its credit facilities by replacing its $300.0 million Term Loan and $100.0 million Revolving Credit Facility with a $225.0 million Term Loan Facility and a $200.0 million Revolving Credit Facility. See Note G for further information regarding our outstanding debt.

•

The carrying values of the Company's outstanding Term Loans as of December 31, 2013 and December 31, 2012, were $222.2 million and $293.3 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 December 31, 2013 and December 31, 2012, were $25.0 million and $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.

•

The carrying value of the Senior Notes was $200.0 million as of December 31, 2013 and December 31, 2012. The fair value of the Senior Notes was $213.3 million and $211.5 million as of December 31, 2013 and December 31, 2012. The Company has determined the fair value of the Senior Notes based on market observable inputs and has therefore concluded these are Level 2 measurements.

•

Seller Notes are recorded at contractual carrying values of $21.1 million and $27.3 million as of December 31, 2013 and December 31, 2012, 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 Level 3 measurements.

Revenue Recognition

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 December 31, 2013 and 2012, the Company estimated the reserve for future contractual adjustments and discounts to be $20.6 million and $13.9 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 leasing 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

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 December 31, 2013 and 2012, net accounts receivable reflected allowance for doubtful accounts of $10.0 million and $7.5 million, respectively.

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

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

December 31, 2012

(In thousands)	0 - 60 days		61 - 120 days		Over 120 days		Total
Patient Care
Commercial insurance	$	51,658	$	10,468	$	12,249	$	74,375
Private pay		5,437		4,545		5,783		15,765
Medicaid		11,812		3,181		3,228		18,221
Medicare		27,433		5,611		9,029		42,073
VA		2,082		558		324		2,964
Products & Services
Trade accounts receivable		12,556		3,149		4,091		19,796
	$	110,978	$	27,512	$	34,704	$	173,194

Property, Plant and Equipment

Property, Plant and Equipment

Property, plant and equipment are recorded at cost less accumulated depreciation and amortization, 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. Depreciation is computed for financial reporting purposes using the straight-line method over the estimated useful lives of the related assets, which generally follows:

Asset class	Estimated life (in years)
Furniture and fixtures	5
Machinery and equipment	5
Computers and software	5
Buildings	10 - 40
Assets under capital leases	Shorter of 10 or lease term
Leasehold improvements	Shorter of 10 or lease term
Equipment leased to third parties under operating leases	Up to 10

The following table outlines the investment in equipment leased to third parties under operating leases:

(In thousands)
Program equipment	$	34,142
Less: Accumulated depreciation		(14,184	)
Net book value at December 31, 2013		19,958

Depreciation expense related to property, plant and equipment was approximately $30.8 million, $29.2 million and $26.2 million for the years ended December 31, 2013, 2012 and 2011, respectively, which is included in Depreciation and amortization on the Company's Consolidated Statements of Income and Comprehensive Income.

Included within Buildings were $10.9 million and $4.4 million of buildings recorded under a capital lease, as of December 31, 2013 and 2012, respectively. Accumulated depreciation on these capital leases were $0.9 million and $0.4 million, as of December 31, 2013 and 2012, respectively. The annual future minimum lease payments as of December 31, 2013 under the lease agreements are $1.6 million, $1.6 million, $1.6 million, $1.7 million, $1.7 million, $6.2 million for the years ending December 31, 2014, 2015, 2016, 2017, 2018 and thereafter. These future minimum lease payments include $4.3 million of interest.

Goodwill and Other Intangible Assets

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 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 the last annual impairment test as of October 1, 2013.

Non-compete agreements are recorded based on agreements entered into by the Company and are amortized, using the straight-line method, over their estimated term ranging from two to seven years. Trade names are primarily comprised of an indefinite-lived intangible asset in the Company's Products & Services segment, which is annually assessed for impairment in the Company's fourth quarter using a relief-from-royalty method valuation model to estimate its fair value. Trade names not identified as an indefinite-lived intangible asset are amortized over their estimated period of benefit of approximately one to three years. Other definite-lived intangible assets are recorded at cost and are amortized, using the straight-line method, over their estimated useful lives of up to 20 years. The Company periodically evaluates the recoverability of intangible assets and takes into account events or circumstances that may warrant revised estimates of useful lives or that indicate that impairment had occurred. Refer to Note D for further discussion.

Debt Issuance Costs

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

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 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 years ended December 31, 2013 or 2012.

Supplemental Executive Retirement Plan (SERP)

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 K of the accompanying financial statements.

Marketing

Marketing

Marketing costs, including advertising, are expensed as incurred. The Company incurred $4.5 million, $4.2 million, and $3.9 million in marketing costs during the years ended December 31, 2013, 2012 and 2011, respectively, which is reported in Other operating expenses on the Company's Consolidated Statements of Income and Comprehensive Income.

Income Taxes

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

Stock-Based Compensation

The Company issues restricted stock units of common stock under one active stock-based compensation plan. At December 31, 2013, 1.1 million shares of common stock were available for issuance under the Company's stock-based compensation plan. 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 by the compensation plan, ranging from one to four years.

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 stock options are 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

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 reportable segments. The description of the Company's reportable segments and the disclosure of segment information are presented in Note O.

Recently Adopted Accounting Guidance

Recently Adopted Accounting Guidance

In July 2012, the FASB issued ASU 2012-02, "Testing Indefinite-Lived Intangibles for Impairment". This ASU amended guidance that simplifies how entities test indefinite-lived intangible assets other than goodwill for impairment. After assessment of certain qualitative factors, if it is determined to be more likely than not that an indefinite-lived asset is impaired, entities must perform the quantitative impairment test. Otherwise, the quantitative test becomes optional. The amended guidance was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The Company adopted this new guidance in the first quarter of 2013, and the adoption did not have a material impact on the Company's condensed consolidated financial statements.

In February 2013, the FASB issued ASU 2013-2, "Other Comprehensive Income." This ASU amends ASC 220, "Comprehensive Income," and supersedes ASU 2011-05 "Presentation of Comprehensive Income" and ASU 2011-12 "Comprehensive Income," to require reclassification adjustments from other comprehensive income to be presented either in the financial statements or in the notes to the financial statements. The standard does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the guidance requires an entity to provide enhanced disclosures to present separately by component reclassifications out of accumulated other comprehensive income. The amendments in this ASU were effective prospectively for reporting periods beginning after December 15, 2012. The Company has adopted this guidance and its implementation did not have a material impact on its consolidated financial statements.

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 does not expect the adoption of these provisions to have a material effect on the consolidated financial statements.