**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-Q**
| x          | ** ** | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                             |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       | ** ** | ** **                                                                                                                                                                                                                                                                                                                               |
|       | ** ** | **For the quarterly period ended June 30, 2007**                                                                                                                                                                                                                                                                                         |
| ** ** |       | ** **                                                                                                                                                                                                                                                                                                                               |
| **OR**     |
|       | ** ** | ** **                                                                                                                                                                                                                                                                                                                               |
| o          | ** ** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                            |
|       |       |                                                                                                                                                                                                                                                                                                                                     |
|       |       | **For the transition period from                           to                         ** |

 

**Commissionfile number: 333-142188**

**ReAbleTherapeutics Finance LLC**

(Exact name ofRegistrant as specified in its charter)

| **Delaware**                     |   | **20-5653965**       |
|----------------------------------|--------|----------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer     |
| incorporation or  organization)  |   | Identification  No.) |

 

**9800 Metric Boulevard**

**Austin, Texas 78758**

(Address ofprincipal executive offices) (Zip code)

**512-832-9500**

(Registrant’stelephone number including area code)

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

Yes xNo o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).

Large accelerated filer o          Accelerated filer o           Non-accelerated filer x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes oNo x

As of August 14, 2007, 100% of the issuer’s membershipinterests were owned by ReAble Therapeutics Holdings LLC

 

----

**ReAble Therapeutics Finance LLC**

**Quarterly Report on Form 10-Q**

**For theperiod ended June 30, 2007**

**Index toCondensed Consolidated Financial Statements**
|                                                                                                                                                                                                       | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I — Financial Information**                                                                                                                                                               |       |     |
| Item 1. Financial Statements                                                                                                                                                                          |       |     |
| Unaudited condensed  consolidated balance sheets as of June 30, 2007 and December 31, 2006                                                                                                            |       | 3        |
| Unaudited condensed  consolidated statements of operations for the Successor three and six month  periods ended June 30, 2007 and for the Predecessor three and six month  periods ended July 1, 2006 |       | 4        |
| Unaudited condensed  consolidated statements of cash flows for the Successor six month period  ended June 30, 2007 and for the Predecessor six month period ended July 1,  2006                       |       | 5        |
| Notes to unaudited condensed  consolidated financial statements                                                                                                                                       |       | 6        |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                                                                                  |       | 30       |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                                                                                                                   |       | 45       |
| Item 4. Controls  and Procedures                                                                                                                                                                      |       | 46       |
| **PART II — Other  Information**                                                                                                                                                                 |       |     |
| Item 1. Legal  Proceedings                                                                                                                                                                            |       | 47       |
| Item  1A. Risk Factors                                                                                                                                                                                |       | 47       |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                                  |       | 48       |
| Item 3.  Defaults Upon Senior Securities                                                                                                                                                              |       | 48       |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                                                                                                          |       | 48       |
| Item 5. Other  Information                                                                                                                                                                            |       | 48       |
| Item  6. Exhibits                                                                                                                                                                                     |       | 48       |
| Signatures                                                                                                                                                                                            |       | 49       |

 

2

----

**Part I. FINANCIAL INFORMATION**

**ITEM 1.FINANCIAL STATEMENTS**

**ReAble Therapeutics Finance LLCand Subsidiaries**

**UnauditedCondensed Consolidated Balance Sheets**

**(inthousands)**
| ** **                                                    | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Assets**                                                    |       |                    |       |                        |       |
| Current assets:                                               |       |                    |       |                        |       |
| Cash and cash  equivalents                                    |       | $                       | 22,867     |                        | $          | 30,903 |   |
| Accounts  receivable, net                                     |       | 84,654                  |       | 74,155                      |       |
| Inventories, net                                              |       | 59,413                  |       | 67,673                      |       |
| Deferred tax  assets                                          |       | 23,830                  |       | 25,734                      |       |
| Prepaid expenses  and other current assets                    |       | 8,176                   |       | 5,966                       |       |
| Assets of  discontinued operations                            |       | —                  |       | 380                         |       |
| Total current  assets                                         |       | 198,940                 |       | 204,811                     |       |
| Property and equipment,  net                                  |       | 43,968                  |       | 41,251                      |       |
| Goodwill                                                      |       | 489,089                 |       | 475,722                     |       |
| Intangible assets, net                                        |       | 306,352                 |       | 317,242                     |       |
| Other non-current  assets                                     |       | 20,828                  |       | 21,610                      |       |
| Total assets                                                  |       | $                       | 1,059,177  |                        | $          | 1,060,636 |   |
| **Liabilities, Minority  Interests, and Membership Equity**   |       |                    |       |                        |       |
| Current liabilities:                                          |       |                    |       |                        |       |
| Long-term debt  and capital leases, current portion           |       | $                       | 6,624      |                        | $          | 6,505 |   |
| Accounts payable                                              |       | 25,980                  |       | 18,895                      |       |
| Accrued expenses                                              |       | 41,016                  |       | 37,979                      |       |
| Total current  liabilities                                    |       | 73,620                  |       | 63,379                      |       |
| Long-term debt and  capital leases, net of current portion    |       | 558,581                 |       | 548,037                     |       |
| Deferred tax  liabilities                                     |       | 101,037                 |       | 111,232                     |       |
| Other non-current  liabilities                                |       | 6,690                   |       | 1,871                       |       |
| Total  liabilities                                            |       | 739,928                 |       | 724,519                     |       |
| Minority interests                                            |       | 859                     |       | 909                         |       |
| Commitments and  contingencies                                |       |                    |       |                        |       |
| Membership equity:                                            |       |                    |       |                        |       |
| Membership  equity                                            |       | 374,770                 |       | 373,469                     |       |
| Accumulated  deficit                                          |       | (60,800                 | )          | (41,634                     | )          |
| Accumulated  other comprehensive income:                      |       |                    |       |                        |       |
| Foreign currency  translation adjustments                     |       | 3,887                   |       | 3,373                       |       |
| Change in  hedging gains and losses, net of tax               |       | 533                     |       | —                      |       |
| Total membership  equity                                      |       | 318,390                 |       | 335,208                     |       |
| Total liabilities,  minority interests, and membership equity |       | $                       | 1,059,177  |                        | $          | 1,060,636 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

3

----

**ReAble Therapeutics Finance LLCand Subsidiaries**

**UnauditedCondensed Consolidated Statements of Operations**

**(inthousands)**
| ** **                                                                                                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                        | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                                                                                                        | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| Net sales                                                                                                                         |       | $                                | 106,253    |                           | $          | 95,915 |   | $ | 212,960 |   | $ | 182,828 |   |
| Cost of sales                                                                                                                     |       | 43,749                           |       | 38,011                         |       | 88,872 |   | 72,971 |   |
| Gross margin                                                                                                                      |       | 62,504                           |       | 57,904                         |       | 124,088 |   | 109,857 |   |
| Operating expenses:                                                                                                               |       |                             |       |                           |       |   |   |   |   |
| Selling, general  and administrative                                                                                              |       | 58,065                           |       | 47,265                         |       | 115,705 |   | 85,790 |   |
| Research and  development                                                                                                         |       | 4,106                            |       | 3,289                          |       | 7,741 |   | 10,137 |   |
| Operating income                                                                                                                  |       | 333                              |       | 7,350                          |       | 642 |   | 13,930 |   |
| Other income (expense):                                                                                                           |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                                                                                   |       | 210                              |       | 119                            |       | 427 |   | 240 |   |
| Interest expense                                                                                                                  |       | (14,051                          | )          | (7,962                         | )          | (28,072 | ) | (15,480 | ) |
| Other income  (expense), net                                                                                                      |       | (114                             | )          | 72                             |       | 28 |   | (44 | ) |
| Loss from continuing  operations before income taxes and minority interests                                                       |       | (13,622                          | )          | (421                           | )          | (26,975 | ) | (1,354 | ) |
| Provision (benefit) for  income taxes                                                                                             |       | (5,604                           | )          | (1                             | )          | (7,946 | ) | 1,399 |   |
| Minority interests                                                                                                                |       | 87                               |       | 53                             |       | 165 |   | 112 |   |
| Loss from continuing  operations                                                                                                  |       | (8,105                           | )          | (473                           | )          | (19,194 | ) | (2,865 | ) |
| Discontinued  operations:                                                                                                         |       |                             |       |                           |       |   |   |   |   |
| Income (loss) from  discontinued operations (net of income tax provision (benefit) of $20,  $(289), $20 and $(410), respectively) |       | 28                               |       | (312                           | )          | 28 |   | (444 | ) |
| Net loss                                                                                                                          |       | $                                | (8,077     | )                              | $          | (785 | ) | $ | (19,166 | ) | $ | (3,309 | ) |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

4

----

**ReAble Therapeutics Finance LLCand Subsidiaries**

**UnauditedCondensed Consolidated Statements of Cash Flows**

**(inthousands)**
| ** **                                                                                 | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                 | ** ** | **Successor**                  | ** ** | **Predecessor** | ** ** |
| ** **                                                                                 | ** ** | **June 30,  2007**        | ** ** | **July 1,  2006** | ** ** |
| **OPERATING ACTIVITIES:**                                                                  |       |                           |       |   |   |
| Net loss                                                                                   |       | $                              | (19,166    | ) | $ | (3,309 | ) |
| Adjustments to  reconcile net loss to net cash (used in) provided by operating activities: |       |                           |       |   |   |
| Depreciation                                                                               |       | 6,179                          |       | 5,064 |   |
| Amortization of  intangibles                                                               |       | 13,178                         |       | 3,369 |   |
| Amortization of  debt issuance costs                                                       |       | 1,906                          |       | 1,073 |   |
| Non-cash  interest expense                                                                 |       | —                         |       | 54 |   |
| Stock-based  compensation                                                                  |       | 1,004                          |       | 1,971 |   |
| Loss on disposal  of assets                                                                |       | 418                            |       | 225 |   |
| Deferred income  taxes                                                                     |       | (9,750                         | )          | (263 | ) |
| Provision for  bad debt expense and sales returns                                          |       | 4,144                          |       | 4,352 |   |
| Inventory  reserves                                                                        |       | 649                            |       | 1,731 |   |
| Minority  interests                                                                        |       | 165                            |       | 112 |   |
| Excess tax  benefit associated with stock option exercises                                 |       | (17                            | )          | (984 | ) |
| In-process  research and development                                                       |       | —                         |       | 3,897 |   |
| Net effect of  discontinued operations                                                     |       | 378                            |       | (659 | ) |
| Changes in operating  assets and liabilities, net of acquired assets and liabilities:      |       |                           |       |   |   |
| Accounts  receivable                                                                       |       | (13,226                        | )          | (2,304 | ) |
| Inventories                                                                                |       | 4,273                          |       | (8,301 | ) |
| Prepaid  expenses, other assets and liabilities                                            |       | (5,096                         | )          | 2,790 |   |
| Accounts payable  and accrued expenses                                                     |       | 7,037                          |       | (3,356 | ) |
| Net cash (used  in) provided by operating activities                                       |       | (7,924                         | )          | 5,462 |   |
| **INVESTING ACTIVITIES:**                                                                  |       |                           |       |   |   |
| Acquisition of  businesses, net of cash acquired                                           |       | (7,678                         | )          | (1,480 | ) |
| Acquisition of  intangible assets                                                          |       | —                         |       | (244 | ) |
| Proceeds from  sale of assets held for sale and property and equipment                     |       | 4,487                          |       | 64 |   |
| Purchases of  property and equipment                                                       |       | (7,145                         | )          | (6,983 | ) |
| Net cash used in  investing activities                                                     |       | (10,336                        | )          | (8,643 | ) |
| **FINANCING ACTIVITIES:**                                                                  |       |                           |       |   |   |
| Proceeds from  issuance of common stock                                                    |       | —                         |       | 2,618 |   |
| Proceeds from  long-term obligations                                                       |       | 12,500                         |       | 25,300 |   |
| Payments on  long-term obligations                                                         |       | (1,863                         | )          | (20,995 | ) |
| Payment of debt  issuance costs                                                            |       | (370                           | )          | (10 | ) |
| Dividend paid to  minority interests                                                       |       | (226                           | )          | — |   |
| Excess tax  benefit associated with stock option exercises                                 |       | 17                             |       | 984 |   |
| Net cash  provided by financing activities                                                 |       | 10,058                         |       | 7,897 |   |
| Effect of exchange rate  on cash and cash equivalents                                      |       | 166                            |       | 336 |   |
| **Net (decrease) increase in cash  and cash equivalents**                                  |       | (8,036                         | )          | 5,052 |   |
| Cash and cash  equivalents at beginning of year                                            |       | 30,903                         |       | 17,200 |   |
| **Cash and cash equivalents at  end of period**                                            |       | $                              | 22,867     |   | $ | 22,252 |   |
| **Supplemental disclosures of  cash flow information:**                                    |       |                           |       |   |   |
| Cash paid for  interest                                                                    |       | $                              | 26,848     |   | $ | 14,113 |   |
| Cash (received)  paid for income taxes                                                     |       | (1,463                         | )          | 3,581 |   |
| **Non-cash investing and  financing activities:**                                          |       |                           |       |   |   |
| Capital lease  obligations related to equipment leases                                     |       | $                              | —     |   | $ | 384 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

5

----

**ReAble Therapeutics Finance LLCand Subsidiaries**

**Notes to Unaudited Condensed ConsolidatedFinancial Statements**

**1. SUMMARY OF SIGNIFICANT ACCOUNTINGPRINCIPLES**

**Basis ofPresentation and Principles of Consolidation.**

On November 3, 2006, anaffiliate of Blackstone Capital Partners V L.P. (“Blackstone”), acquired all ofthe outstanding shares of capital stock of ReAble Therapeutics, Inc. (“RTI”, “Parent”or “Predecessor”), in a merger transaction (“the Merger”). RTI is the parentcorporation of ReAble Therapeutics Holdings, LLC (“Holdings”), ReAbleTherapeutics Finance LLC (“RTFL” or “Successor”), and ReAble TherapeuticsFinance Corporation (“Finco”). RTFL directly or indirectly through itssubsidiaries, owns all of the operating assets owned by RTI prior to theMerger. (See further description of the Merger under Note 3).

The Merger was accountedfor as a purchase under the guidance set forth in Statement of FinancialAccounting Standards No. 141 “Business Combinations” (“SFAS 141”). In addition,the fair value basis of the acquired assets and assumed liabilities was “pusheddown” to the financial statements of RTI, and ultimately to these unauditedcondensed consolidated financial statements of RTFL. The unaudited condensedconsolidated statements of operations and cash flows of RTI are presented forthe three and six month periods ended July 1, 2006 (the “Predecessor financialstatements”), and the unaudited condensed consolidated statements of operationsand cash flows of RTFL are presented for the three and six month periods endedJune 30, 2007 (the “Successor financial statements”). Finco and Holdings didnot have any operations during the six month period ended June 30, 2007.

The accompanyingunaudited condensed consolidated financial statements include the accounts ofRTFL, and its wholly owned subsidiaries and those entities in which we hold acontrolling interest from the date of the Merger. Predecessor financialstatements are presented prior to the date of the Merger, with Successorfinancial statements presented thereafter. The Predecessor results of RTI arenot comparable to the Successor results of RTFL due to the difference in basisof presentation of purchase accounting as compared to historical cost. Minorityinterests reflect the 50% separate ownership of Medireha GmbH, which we haveconsolidated due to our controlling interest in it. All significantintercompany balances and transactions have been eliminated in consolidation.

Unless the contextindicates otherwise, all share information in this quarterly report on Form10-Q reflects the 62.8 to 1 share recomputation that occurred in connectionwith the Merger and the subsequent 25 for 1 stock split that was effected onNovember 8, 2006, following the closing of the Merger. We refer to theseadjustments as the “share adjustments” in this quarterly report on Form 10-Q.

The unaudited condensedconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles for interim financial information andwith the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.Accordingly, they do not include all of the information and notes required bygenerally accepted accounting principles for complete financial statements. Inthe opinion of management, all adjustments consisting of normal recurringaccruals considered necessary for a fair presentation have been included.Operating results for the three and six month periods ended June 30, 2007 arenot necessarily indicative of the results that may be expected for the yearending December 31, 2007. For further information, refer to the consolidatedfinancial statements and footnotes thereto included in our Form S-4 filed withthe Securities and Exchange Commission on May 1, 2007 (File No. 333-142188), asamended.

The terms “we”, “us”, andthe “Company” refer to the Predecessor for the period prior to the Merger andthe Successor for the period after the Merger.

**Use of Estimates**

The preparation ofunaudited condensed consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, the disclosure of contingent assets and liabilitiesat the date of the unaudited condensed consolidated financial statements, andthe reported amounts of revenue and expenses during the reporting period.Actual results could differ from those estimates.

6

----

**Reclassifications**

Certainreclassifications have been made to prior year consolidated financialstatements to conform to the current year presentation.  Thesereclassifications had no impact on previously reported net loss.

**2. RECENT ACCOUNTING PRONOUNCEMENTS**

In July 2006, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No. (“FIN”)48*, “*Accounting for Uncertaintyin Income Taxes”. FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an enterprise’s financial statements in accordance withStatement of Financial Accounting Standards No. 109, “Accounting for IncomeTaxes”. This interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. FIN 48 also providesguidance on derecognition of tax benefits, classification on the balance sheet,interest and penalties, accounting in interim periods, disclosure, andtransition. We adopted FIN 48 effective January 1, 2007. In accordance with FIN48, we elected to continue to classify interest and penalties as a component oftax expense. As a result of the implementation of FIN 48, we recognized a $5.0million increase in liabilities for unrecognized tax benefits, which wasaccounted for as an increase to the January 1, 2007 balance of goodwill.

We had unrecognized taxbenefits of approximately $7.0 million as of January 1, 2007, of which none, ifrecognized, would result in a reduction to our effective tax rate. Interest andpenalties were approximately $1.0 million at the date of adoption and areincluded in the unrecognized tax benefits. We recorded an increase of ourunrecognized tax benefits of approximately $150,000 and $300,000 during thethree and six month period ended June 30, 2007, respectively.

We are subject to auditin Germany by Finanzamt Freiburg for the years 2000 through 2004. We are alsosubject to audit by the New York State Department of Taxation and Finance forthe years 2002 through 2004. As we have operations in most other U.S. states,other state tax authorities may assess deficiencies related to prior yearactivities; however, the years open to assessment vary with each state. We alsofile income tax returns for non-U.S. jurisdictions; the most significant ofwhich are Germany, Sweden, and Switzerland.

In September 2006, theFASB issued FAS 157, “Fair Value Measurements” which defines fair value,establishes a framework for measuring fair value in generally accepted accountingprinciples (“GAAP”) and expands disclosure about fair value measurements. Thestatement is effective for fiscal years beginning after November 15, 2007. TheCompany will adopt this statement as of the beginning of fiscal year 2008 andis currently assessing the potential impact of adoption.

In February 2007, theFASB issued FAS 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—Including an amendment to FASB Statement No. 115” which permitsentities to choose to measure many financial instruments and certain otheritems at fair value that are not currently required to be measured at fairvalue. The statement is effective for fiscal years beginning after November 15,2007. The Company will adopt this statement as of the beginning of fiscal year2008 and is currently assessing the potential impact of adoption of thisstatement.

**3. MERGER TRANSACTION**

On November 3, 2006, anaffiliate of Blackstone acquired all of the outstanding shares of capital stockof RTI. Under the terms of the Agreement and Plan of Merger dated June 30, 2006(“Merger Agreement”), upon the consummation of the Merger, the formerstockholders of RTI received an aggregate of $476.8 million in cash (or $16.46($6.55 before giving effect to the share adjustments) in cash for each share ofcommon stock of RTI they then held). The Merger was financed through acombination of equity contributed by an affiliate of Blackstone, cash on handof RTI, borrowings under a senior secured credit facility (the “Senior CreditFacility”) and proceeds from our 11.75% senior subordinated notes (see Note 7).Upon the closing of the Merger, shares of RTI’s common stock ceased to betraded on the NASDAQ Global Market.

The total purchase pricefor the Merger was approximately $529.2 million and consisted of $482.5 millioncash payments to former equity holders, $7.2 million related to the fair valueof rollover options that continued to remain as outstanding options to purchaseRTI common stock after the Merger, and $39.5 million in direct acquisitioncosts. The purchase price was allocated to the Company’s net tangible andidentifiable intangible assets based on their estimated fair values as ofNovember 3, 2006 as set forth below. The excess of purchase price over the nettangible and identifiable intangible assets was recorded as goodwill. Thepreliminary

7

----

allocation of the purchase price was based in partupon third party estimates of fair value for certain tangible and intangibleassets and upon preliminary data estimates and assumptions that are subject tochange.  

During the second quarterof 2007, we finalized a plan to centralize certain research and developmentactivities and reorganize certain sales and administrative functions in ourCefar-Compex S.A. European operations. In connection with this plan, during the second quarter of 2007, weinitiated the exit of certain administrative facilities and workforcereductions.  The estimated severance andfacility exit costs have been accrued as a liability with a correspondingincrease to goodwill in accordance with the guidance specified in EmergingIssues Task Force Issue Number 95-3, “Recognition of Liabilities in Connectionwith a Purchase Business Combination.” Our restructuring activities are ongoing and are expected to becompleted over the course of 2007.

A summary of therestructuring charges and related activity for the six month period ended June30, 2007 is as follows (in thousands):
|                              | ** ** | **Severance and  Related** | ** ** | **Facilities  Related** | ** ** | **Total** | ** ** |
|------------------------------|------------|---------------------------------|------------|-------------------------|------------|-----------|------------|
| Balance December 31,  2006   |       | $                               | —     |                    | $          | —    |       | $ | — |   |
| Additions during  period     |       | 293                             |       | 394                     |       | 687       |       |
| Payments made  during period |       | —                          |       | —                  |       | —    |       |
| Balance June 30, 2007        |       | $                               | 293        |                    | $          | 394       |       | $ | 687 |   |

 

During the six monthperiod ended June 30, 2007, changes were made to the initial purchase priceallocation (see Note 6).  The followingvaluations are preliminary and are subject to change upon our furtherevaluation of the assets acquired and liabilities assumed (in thousands):
|                                        | ** ** | **Fair Value** | ** ** | **Useful Life** | ** ** |
|----------------------------------------|------------|---------------------|------------|----------------------|------------|
| Current assets                         |       | $                   | 209,011    |                 |       |   |
| Tangible and  other non-current assets |       | 49,853              |       |                 |       |
| Liabilities  assumed                   |       | (536,045            | )          |                 |       |
| In-process  research and development   |       | 25,200              |       |                 |       |
| Identifiable  intangible assets        |       |                |       |                 |       |
| Technology-based                       |       | 83,900              |       | 3 – 11 years    |       |
| Customer based                         |       | 133,800             |       | 11 – 12 years   |       |
| Trademarks                             |       | 92,000              |       | Indefinite           |       |
| Non-compete                            |       | 1,600               |       | 1 year               |       |
| Goodwill                               |       | 469,933             |       | N/A                  |       |
| Purchase price                         |       | $                   | 529,252    |                 |       |   |

 

Goodwill represents theexcess of the purchase price over the fair value of tangible and identifiableintangible assets acquired and liabilities assumed, and is not tax deductible.

**4. ACCOUNTS RECEIVABLE**

A summary of activity inour accounts receivable reserves for doubtful accounts and sales returns ispresented below (in thousands):
|                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                               | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| Balance,  beginning of period            |       | $                                | 2,820      |                           | $          | 3,718 |   | $ | 513 |   | $ | 4,016 |   |
| Provision for bad debt and sales returns |       | 1,822                            |       | 2,273                          |       | 4,144 |   | 4,352 |   |
| Write-off charges and recoveries         |       | (840                             | )          | (2,292                         | )          | (855 | ) | (4,669 | ) |
| Balance, end of period                   |       | $                                | 3,802      |                           | $          | 3,699 |   | $ | 3,802 |   | $ | 3,699 |   |

 

8

----

**5. INVENTORIES**

Inventories consist ofthe following (in thousands):
|                                 | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Components and  raw materials   |       | $                       | 15,114     |                        | $          | 19,437 |   |
| Work in process                 |       | 4,721                   |       | 3,848                       |       |
| Finished goods                  |       | 26,468                  |       | 27,974                      |       |
| Inventory held  on consignment  |       | 14,303                  |       | 17,332                      |       |
|                            |       | 60,606                  |       | 68,591                      |       |
| Less – inventory  reserves |       | (1,193                  | )          | (918                        | )          |
|                            |       | $                       | 59,413     |                        | $          | 67,673 |   |

 

A summary of the activityin our inventory reserve for slow moving, excess, product obsolescence andvaluation is presented below (in thousands):
|                                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                 | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| Balance,  beginning of period              |       | $                                | 1,349      |                           | $          | 7,479 |   | $ | 918 |   | $ | 7,397 |   |
| Provision charged to cost of sales         |       | 381                              |       | 669                            |       | 649 |   | 1,731 |   |
| Recoveries (write-offs) charged to reserve |       | (537                             | )          | (377                           | )          | (374 | ) | (1,357 | ) |
| Balance, end of period                     |       | $                                | 1,193      |                           | $          | 7,771 |   | $ | 1,193 |   | $ | 7,771 |   |

 

The write-offs to thereserve were principally related to the disposition of fully reservedinventory.

**6. GOODWILL AND INTANGIBLE ASSETS**

A summary of the activityin goodwill is presented below (in thousands): 
|                                                                                              | ** ** | **Successor**                                       | ** ** | **Predecessor**                                                  | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **Six months ended  June 30,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1,  2006 through  November 3,  2006** | ** ** |
| **Balance,  beginning of period**                                                            |       | $                                                   | 475,722    |                                                             | $          | — |   | $ | 290,255 |   |
| Adjustment  related to resolution of contingencies                                           |       | —                                              |       | —                                                           |       | (173 | ) |
| Adjustment  related to adoption of FIN 48                                                    |       | 5,039                                               |       | —                                                           |       | — |   |
| Adjustment  related to tax benefit associated with stock option exercises                    |       | —                                              |       | —                                                           |       | (2,016 | ) |
| Goodwill  associated with the acquisition of Osteoimplant Technology, Inc. (“OTI”) |       | —                                              |       | —                                                           |       | 474 |   |
| Goodwill  associated with the acquisition of Compex Technologies, Inc. (“Compex”)  |       | —                                              |       | —                                                           |       | 43,995 |   |
| Goodwill  associated with the Merger                                                         |       | 4,961                                               |       | 459,933                                                          |       | — |   |
| Goodwill  associated with the acquisition of Cefar AB (“Cefar”)                    |       | (589                                                | )          | 13,173                                                           |       | — |   |
| Goodwill  associated with the acquisition of businesses                                      |       | 3,317                                               |       | —                                                           |       | — |   |
| Foreign currency  translation                                                                |       | 639                                                 |       | 2,616                                                            |       | 4,986 |   |
| **Balance, end of period**                                                                   |       | $                                                   | 489,089    |                                                             | $          | 475,722 |   | $ | 337,521 |   |

 

During the six monthperiod ended June 30, 2007, goodwill related to the Merger was adjusted toreflect additional adjustments related to the fair market value of the acquiredinventory, property plant and equipment, assets held for sale and assumedliabilities

9

----

(see Note 3). In addition, during the quarter ended June 30, 2007, we recorded certainout of period adjustments not deemed material to our projected fiscal year end2007 results related to the value of the acquired inventory in conjunction withthe Merger, which resulted in an increase to cost of sales of approximately$1.5 million for the three months ended June 30, 2007 with an associatedreduction to goodwill.  On April 13,2007, we acquired Endeavor Medical, Inc. (“Endeavor”) for total considerationof $2.9 million. On February 16, 2007, we acquired certain assets ofPerformance Modalities, Inc. (“PMI”) for total consideration of $4.2million.  The preliminary allocation ofthe aggregate purchase price for both acquisitions, which is subject to changeupon our further evaluation of the assets acquired, resulted in the recognitionof $3.3 million of goodwill.  The assetspurchased relate to our Orthopedic Rehabilitation Division’s products. 

During the fourth quarterof 2006, we revalued our goodwill associated with the Merger (See Note 3).

Intangibles consisted ofthe following as of June 30, 2007 (in thousands):

|                                      | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Intangibles,  Net** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|-----------------------|------------|
| Amortizable  intangible assets:      |       |                            |       |                          |       |                  |       |
| Technology-based                     |       | $                               | 85,700     |                          | $          | (8,412                | )          | $ | 77,288 |   |
| Customer-based                       |       | 140,526                         |       | (8,801                        | )          | 131,725               |       |
|                                 |       | $                               | 226,226    |                          | $          | (17,213               | )          | 209,013 |   |
| Indefinite-lived  intangible assets: |       |                            |       |                          |       |                  |       |
| Trademarks                           |       |                            |       |                          |       | 95,488                |       |
| Foreign currency  translation        |       |                            |       |                          |       | 1,851                 |       |
| Total intangible  assets             |       |                            |       |                          |       | $                     | 306,352    |   |

 

Intangibles consisted of thefollowing as of December 31, 2006 (in thousands):
|                                      | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Intangibles,  Net** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|-----------------------|------------|
| Amortizable  intangible assets:      |       |                            |       |                          |       |                  |       |
| Technology-based                     |       | $                               | 85,754     |                          | $          | (1,990                | )          | $ | 83,764 |   |
| Customer-based                       |       | 138,796                         |       | (2,045                        | )          | 136,751               |       |
|                                 |       | $                               | 224,550    |                          | $          | (4,035                | )          | 220,515 |   |
| Indefinite-lived  intangible assets: |       |                            |       |                          |       |                  |       |
| Trademarks                           |       |                            |       |                          |       | 95,396                |       |
| Foreign currency  translation        |       |                            |       |                          |       | 1,331                 |       |
| Total intangible  assets             |       |                            |       |                          |       | $                     | 317,242    |   |

 

During the six monthsended June 30, 2007, we acquired approximately $1.8 million of intangibleassets related primarily to acquired customer relationships in connection withthe acquisition of businesses.  

Our amortizable assetswill continue to be amortized over their useful lives ranging from 1 to 12years.

Aggregate amortizationexpense was approximately $6.7 million and $13.2 million for the Successorthree and six month periods ended June 30, 2007, respectively, and $1.9 millionand $3.4 million for the Predecessor three and six month periods ended July 1,2006, respectively.

Our estimatedamortization expense for the six months ending December 31, 2007 and for thenext five years is as follows (in thousands):
| For six months ending  December 31, 2007 |   | $      | 13,000 |   |
|------------------------------------------|--------|--------|--------|--------|
| For year ended  December 31, 2008        |   | 25,000 |   |
| For year ended  December 31, 2009        |   | 24,000 |   |
| For year ended  December 31, 2010        |   | 24,000 |   |
| For year ended  December 31, 2011        |   | 23,000 |   |
| For year ended December  31, 2012        |   | 22,000 |   |

 

10

----

At June 30, 2007, we havegoodwill and intangible assets as follows (in thousands):
|                                     | ** ** | **Goodwill** | ** ** | **Intangibles,  net** | ** ** |
|-------------------------------------|------------|--------------|------------|-----------------------|------------|
| Orthopedic  Rehabilitation Division |       | $            | 442,099    |                  | $          | 275,200 |   |
| Surgical Implant  Division          |       | 46,990       |       | 31,152                |       |
| Total                               |       | $            | 489,089    |                  | $          | 306,352 |   |

 

**7. LONG-TERM DEBT AND CAPITAL LEASES**

Long-term debt (includingcapital lease obligations) consists of the following (in thousands):
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| $400.0 million  Senior Credit Facility to a syndicate of financial institutions; composed of  a seven-year $350.0 million term loan and a six-year $50 million revolving  credit facility; collateralized by all domestic assets of RTFL and pledge of  100% of the membership interest of RTFL, 100% of the capital stock of each  domestic subsidiary of RTFL and 65% of the stock of first-tier foreign  subsidiaries of RTFL; interest at Bank of America’s prime rate plus 0.50% or  Eurodollar rate adjusted for maximum reserves; $37.5 million available under  the revolving credit facility as of June 30, 2007; term loan subject to  quarterly principal payments of 0.25% of original principal balance with the  last payment due November 3, 2013; interest rate of 7.71% and 7.87% at June  30, 2007 and December 31, 2006, respectively |       | $                       | 359,875    |                        | $          | 349,125 |   |
| $200.0 million  senior subordinated notes payable to institutional investors; interest at  11.75%; interest payable semi-annually on May 15 and November 15 of each year  through November 15, 2014; effectively and contractually subordinated to the  $400.0 million Senior Credit Facility                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |       | 200,000                 |       | 200,000                     |       |
| $2.9 million  revolving credit facilities at various European Banks; collateralized by  certain of Cefar’s assets, interest rates ranging from 4.0% to 4.7% and 4.0%  to 6.6% at June 30, 2007 and December 31, 2006, respectively; interest added  to outstanding balance quarterly; $300,000 available under the credit  facilities as of June 30, 2007                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       | 2,583                   |       | 2,265                       |       |
| $2.7 million  term loans from various European banks; collateralized by certain of Cefar’s  assets, interest rates based on various floating market rates; principal and  interest payments due quarterly through February 2013; interest rates ranging  from 4.0% to 4.9% and 3.5% to 4.9% at June 30, 2007 and December 31, 2006,  respectively                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       | 1,873                   |       | 2,037                       |       |
| Note payable to  a corporation, which is principally owned by an employee of the Company, in  connection with the acquisition of Rehab Med+Equip by Empi in 2002; balance  due July 2008; interest at higher of 5% or prime on the first business day of  each calendar quarter; interest rate of 8.25% at June 30, 2007 and December  31, 2006                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       | 469                     |       | 469                         |       |
| Capital lease  obligations, collateralized by related equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       | 405                     |       | 646                         |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       | 565,205                 |       | 554,542                     |       |
| Less – current  portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       | (6,624                  | )          | (6,505                      | )          |
| Long-term debt and  capital lease, net of current portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       | $                       | 558,581    |                        | $          | 548,037 |   |

 

*Senior Secured Credit Facility*

In connection with theMerger, RTFL and Holdings (“co-issuers”) entered into the Senior CreditFacility with Banc of America Securities LLC and Credit Suisse Securities LLC.The Senior Credit Facility provides senior secured financing of $400.0 million,consisting of a $50.0 million revolving credit facility and a $350.0 millionterm loan facility. In addition, we are permitted, subject to receipt ofadditional commitments from participating lenders and certain other conditions,to incur up to an additional $150.0 million of borrowings under the SeniorCredit Facility, of which $55.0 million was drawn subsequent to the end of thequarter and converted to a term loan in connection with the acquisition of TheSaunders Group, Inc. (see Note 17).  Ofthe total net proceeds received, $41.5

11

----

million was used to fund the acquisition and relatedexpenses, $12.5 million was used to pay off the balance due on our revolvingcredit facility which is classified as long-term on our unauited condensedconsolidated balance sheet, with the remaining proceeds used for generalcorporate purposes.

*InterestRate and Fees.*Borrowings under the Senior Credit Facilitybear interest at a rate equal to an applicable margin plus, at our option,either (a) a base rate determined by reference to the higher of (1) the primerate of Bank of America and (2) the federal funds rate plus 0.50% or (b) theEurodollar rate determined by reference to the costs of funds for deposits inU.S. Dollars for the interest period relevant to each borrowing adjusted formaximum reserves. The applicable margin for borrowings under the term loanfacility and the revolving credit facility may be reduced subject to ourattaining certain leverage ratios. In addition to paying interest onoutstanding principal under the Senior Credit Facility, we are required to paya commitment fee to the lenders under the revolving credit facility in respectof the unutilized commitments thereunder. The initial commitment fee rate was0.50% per annum. The commitment fee rate may be reduced subject to ourattaining certain leverage ratios.

*Prepayments.*The Senior Credit Facility requires us to prepay outstandingterm loans, subject to certain exceptions, with (1) 50% (which percentage willbe reduced to 25% and 0% upon our attaining certain leverage ratios) of ourannual excess cash flow, (2)100% of the net cash proceeds above an annualamount to be agreed from non-ordinary course asset sales by Holdings and itssubsidiaries, subject to exceptions to be agreed upon, including a 100%reinvestment right if reinvested or committed to reinvest within 15 months ofsuch sale or disposition so long as reinvestment is completed within 180 daysthereafter, and (3)100% of the net cash proceeds from issuances of debt byHoldings and its subsidiaries, other than proceeds from debt permitted to beincurred under the Senior Credit Facility. The foregoing mandatory prepaymentswill be applied to the term loan facilities in direct order of maturity. We mayvoluntarily repay outstanding loans under the Senior Credit Facility at anytime without premium or penalty, provided that voluntary prepayments ofEurodollar loans made on a date other than the last day of an interest periodapplicable thereto shall be subject to customary breakage costs.

*Amortization.*We are required to pay annual amortization (payable in equalquarterly installments) on the loans under the term loan facility in an amountequal to 1.00% of our funded total principal amount during the first six yearsand nine months following the closing of the Senior Credit Facility, with theremaining amount payable at maturity which is seven years from the date of theclosing of the Senior Credit Facility. Principal amounts outstanding under therevolving credit facility are due and payable in full at maturity, which is sixyears from the date of the closing of the Senior Credit Facility.

*Guaranteeand Security.*All obligations under the Senior CreditFacility are unconditionally guaranteed by Holdings and each existing andfuture direct and indirect wholly-owned domestic subsidiary of RTFL, other thanimmaterial subsidiaries and subsidiaries that are precluded by law orregulation from guaranteeing the obligations (see Note 18).

*Covenants.*The Senior Credit Facility contains a number of covenantsthat, among other things, restrict, subject to certain exceptions, our abilityto incur additional indebtedness or issue preferred stock, create liens onassets, enter into sale and leaseback transactions, engage in mergers orconsolidations, sell assets, pay dividends and other restricted payments, makeinvestments, loans or advances, make capital expenditures, repay subordinatedindebtedness, make certain acquisitions, engage in certain transactions withaffiliates, amend material agreements governing our subordinated indebtedness,enter into certain burdensome agreements, change our lines of business andchange the status of Holdings as a passive holding company. As of June 30,2007, we were in compliance with all of these covenants. In addition, theSenior Credit Facility requires us to maintain a consolidated total debt toAdjusted EBITDA ratio (or total leverage ratio) starting at a maximum of 8.00:1and stepping down over time to 4.75:1 by the end of 2013 and an Adjusted EBITDAto consolidated interest expense ratio (or interest coverage ratio) starting ata minimum of 1.25:1 and stepping up over time to 1.80:1 by the end of 2013. Asof the twelve month period ending June 30, 2007, our total leverage and interestcoverage ratios were 7.52:1 and 1.41:1, respectively.

*11.75% Senior Subordinated Notes*

During the fourth quarterof 2006, RTFL and Finco, as co-issuers, issued and sold $200.0 millionaggregate principal amount of 11.75% senior subordinated notes due 2014 (the “11.75%Notes”). We filed a registration statement on Form S-4 with the Securities andExchange Commission relating to an exchange offer to exchange these privatelyissued 11.75% Notes for registered 11.75% Notes. The registration statement wasdeclared effective on May 2, 2007 and we launched the exchange offer on May 2,2007. The exchange offer was completed on June 5, 2007.

12

----

The market value of the11.75% Notes is approximately $206.0 million as of June 30, 2007. This wasdetermined using factors that included recent trade prices on fixed rate notes,prevailing interest rates and the variable rate feature of our Senior Credit Facility.

*OptionalRedemption*. Under the indenture (the “Indenture”) governingthe 11.75% Notes, prior to November 15, 2010, RTFL has the option to redeemsome or all of the 11.75% Notes for cash at a redemption price equal to 100% ofthe then outstanding principal balance plus an applicable make-whole premiumplus accrued and unpaid interest. Beginning on November 15, 2010, RTFL mayredeem some or all of the 11.75% Notes at a redemption price of 105.875% of thethen outstanding principal balance plus accrued and unpaid interest. Theredemption price decreases to 102.938% and 100.000% of the then outstandingprincipal balance at November 2011 and November 2012, respectively.Additionally, from time to time, before November 15, 2009, RTFL may redeem upto 35% of the 11.75% Notes at a redemption price equal to 111.75% of theprincipal amount then outstanding, in each case, with proceeds raised, or adirect or indirect parent company raises, in certain equity offerings, as longas at least 65% of the aggregate principal amount of the notes issued remainsoutstanding.

*Changeof Control*. Upon the occurrence of a change of control,unless RTFL has previously sent or concurrently sends a notice exercising itsoptional redemption rights with respect to all of the then-outstanding 11.75%Notes, RTFL will be required to make an offer to repurchase all of thethen-outstanding 11.75% Notes at 101% of their principal amount, plus accruedand unpaid interest.  

*Guarantees*.Under the terms of the Indenture, RTFL’s subsidiaries that guarantee the SeniorCredit Facility, jointly and severally, and unconditionally guarantee the11.75% Notes on an unsecured senior subordinated basis (see Note 18).

*Covenants.*The Indenture contains a number of covenants that restrictour ability, and the ability of our restricted subsidiaries, to incuradditional debt or issue certain preferred and convertible shares, paydividends on, redeem, repurchase or make distributions in respect of ourcapital stock or make other restricted payments, make certain investments, sellcertain assets, create liens on certain assets to secure debt, consolidate,merge, sell or otherwise dispose of all or substantially all of our assets,enter into certain transactions with our affiliates and designate our subsidiariesas unrestricted subsidiaries. As of June 30, 2007, we were in compliance withall applicable covenants. Based upon our adjusted EBITDA (as defined in theIndenture) to fixed charges ratio at June 30, 2007, our ability to incuradditional debt and make restricted payments is restricted, except that we mayincur certain debt and make certain restricted payments and certain permittedinvestments without regard to the ratio, such as our ability to (i) incur up toan aggregate principal amount of $400.0 million under credit facilities, plusthe lesser of (a) $50.0 million and (b) an amount equal to the aggregate amountof our EBITDA for the four fiscal quarters for which internal financialstatements are immediately preceding such date times five, with appropriate proforma adjustments to EBITDA on the date on which such indebtedness is to beincurred less the amount of our secured indebtedness outstanding on the date ofsuch incurrence, (ii) acquire persons engaged in a similar business that becomerestricted subsidiaries and (iii) make other investments having an aggregatefair market value not to exceed 3.5% of Total Assets (as defined in theIndenture) provided that the adjusted EBITDA to fixed charges ratio is lessthan 6.00:1 on a pro forma basis after giving effect to such investment. Fixedcharges is defined in the Indenture as consolidated interest expense plus allcash dividends or other distributions paid on any series of preferred stock ofany restricted subsidiary and all dividends or other distributions accrued onany series of disqualified stock.

Our ability to continueto meet the covenants specified above in future periods will depend on eventsbeyond our control, and we cannot assure you that we will continue to meetthose ratios. A breach of any of these covenants in the future could result ina default under the Senior Credit Facility and the Indenture, at which time thelenders could elect to declare all amounts outstanding under the Senior CreditFacility to be immediately due and payable. Any such acceleration would alsoresult in a default under the Indenture.

**8. STOCK OPTION PLANS AND STOCK-BASEDCOMPENSATION**

Effective January 1,2006, we adopted the FASB Statement of Financial Accounting Standards No.123(R) “Share-Based Payment” (“SFAS 123(R)”) using the modified prospectivemethod, in which compensation cost was recognized beginning with the effectivedate (a) based on the requirements of SFAS 123(R) for all share-based paymentsgranted after the effective date and (b) based on the requirements of SFAS123(R) for all awards granted to employees prior to the effective date of SFAS123(R) that remain unvested on the effective date.

With the adoption of SFAS123(R), we elected to amortize stock-based compensation for awards granted onor after the adoption of SFAS 123(R) on January 1, 2006 on a straight-linebasis over the requisite service (vesting) period for the entire award.

13

----

*Summary of Plan – Post-Merger*

After the Merger, thecompensation committee of the board of directors of RTI adopted a new 2006Stock Incentive Plan (the “2006 Plan”). The 2006 Plan provides for the grant ofstock options and other stock-based awards to key employees, directors andconsultants, including executive officers. The total number of shares that maybe issued under the 2006 Plan is 2,500,000 subject to adjustment in certainevents. The exercise price of stock options granted under the 2006 Plan willnot be less than 100% of the fair market value of the underlying shares on thedate of grant, as determined under the 2006 Plan. The pool of shares availableunder the 2006 Plan may be increased in the event of acquisitions. In addition,RTI also adopted a form of non-statutory stock option agreement (the “FormOption Agreement”) for awards under the 2006 Plan. Under the Form OptionAgreement, certain stock options will vest over a specified period of time(typically five years) contingent solely upon the awardees’ continuedemployment with the Company (“service” tranche). Other stock options will vestover a specified performance period from the grant date upon the achievement ofpre-determined performance targets over time (“performance” tranche), whileothers vest based upon achieving a pre-determined performance target calculatedusing Blackstone’s internal rate of return on it’s investment in RTI (“marketcondition” tranche), as defined in the Agreement.  The Form Option Agreement includes certainforfeiture provisions upon an awardees’ separation from service with theCompany. RTFL recorded non-cash compensation expense of approximately $0.6million and $1.0 million in the condensed consolidated statement of operationsfor the three and six month periods ended June 30, 2007 associated with theservice and market condition stock option tranches under the 2006 Plan.

*Summary of Plans – Pre-Merger*

Prior to the Merger, RTIhad a number of stock option plans. All options granted under these plans wereexercisable for shares of common stock in RTI. The stock options granted underthese plans were granted at fair value on the date of grant, vested ratablyover a predefined period and expired no more than ten years from the date ofgrant.  With the exception of certainoptions held by executive officers, outstanding options to purchase commonstock of RTI which were vested or which by its terms would have become vestedat the effective time of the Merger, were cancelled in exchange for the rightto receive, for each share of common stock of RTI issuable upon exercise ofsuch option, cash in the amount equal to the excess, if any, of $16.46 ($6.55before giving effect to the share adjustments) over the exercise price pershare of any such options, multiplied by the number of shares of common stockfor which such option was exercisable immediately prior to the effective time ofthe Merger.  RTI recorded non-cashcompensation expense of approximately $1.1 million and $2.0 million in thePredecessor financial statements for the three and six month periods ended July1, 2006.

*Summary of Assumptions and Activity*

The calculated fair valueof each option award is estimated on the date of grant using theBlack-Scholes-Merton option pricing model for service and performance basedawards, and a binomial model for market based awards. In estimating fair value,expected volatilities used by RTI in 2006 prior to the Merger were based on thehistorical volatility of the underlying common stock, and other factors such asimplied volatility of traded options. Expected volatility used by RTFLsubsequent to the Merger is based on the historical volatility of RTI’s commonstock, and other factors such as implied volatility of traded options of acomparable peer group. In periods prior to January 1, 2006, volatility wasestimated based upon historical volatility of RTI common stock. The change indetermining the expected volatility assumption in periods subsequent to January1, 2006 was based in part upon the guidance provided by the Securities andExchange Commission in Staff Accounting Bulletin No. 107. The expected lifeassumptions for all periods were derived from a review of annual historicalemployee exercise behavior of option grants with similar vesting periods.Expected life is calculated in two tranches based on the employment leveldefined as management or non-management. The risk-free rate for the expectedterm of the option is based on the U.S. Treasury yield bond curve in effect atthe time of grant.

The assumptions used tocalculate the fair value of options granted are evaluated and revised, asnecessary, to reflect market conditions and experience. The key assumptionsused in determining fair value of share based payment awards for the Successorsix month period ended June 30, 2007 and for the Predecessor six month periodended July 1, 2006 were as follows:
|                                  | ** ** | **Six Months Ended** | ** ** |
|----------------------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | **Successor**                  | ** ** | **Predecessor** | ** ** |
| ** **                       | ** ** | **June 30,  2007**        | ** ** | **July 1,  2006** | ** ** |
| Expected  dividend yield         |       | 0.0                            | %          | 0.0 | % |
| Expected stock  price volatility |       | 56.0 – 60.0               | %          | 61.0 | % |
| Risk-free  interest rate         |       | 4.70                           | %          | 5.00 | % |
| Expected option life             |       | 5.2 – 7.1 years           |       | 4.5 – 5.6 years |   |

 

14

----

A summary of stock optionactivity during the Successor six month period ended June 30, 2007, ispresented below:
|                               | ** ** | **Number of Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate Intrinsic  Value** | ** ** |
|-------------------------------|------------|--------------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | ** **                     | ** ** | ** **                                  | ** ** | ** **                                                           | ** ** | ** **                          | ** ** |
| Balance at  January 1, 2007   |       | 3,044,650                      |       | $                                           | 15.34      | ** **                                                           | ** ** | ** **                          | ** ** | ** ** |
| Granted                       |       | 54,750                         |       | 16.46                                       | ** ** | ** **                                                           | ** ** | ** **                          | ** ** |
| Exercised                     |       | —                         |       | —                                      | ** ** | ** **                                                           | ** ** | ** **                          | ** ** |
| Cancelled                     |       | (207,050                       | )          | 16.17                                       | ** ** | ** **                                                           | ** ** | ** **                          | ** ** |
| Balance at June  30, 2007     |       | 2,892,350                      |       | $                                           | 15.30      |                                                                 | 9.0        |                                | $          | 3,440,534 |   |
| Exercisable at June 30,  2007 |       | 778,600                        |       | $                                           | 12.15      |                                                                 | 8.1        |                                | $          | 3,440,534 |   |

 

The weighted averagegrant date calculated fair value of stock options granted during the Successorthree and six month periods ended June 30, 2007 was $9.38 and $9.36,respectively. The weighted average grant date calculated fair value of stockoptions granted during the Predecessor three and six month periods ended July1, 2006 was $6.81 and $9.25, respectively. The total intrinsic value of options exercised during the Predecessorthree and six month periods ended July 1, 2006 was $0.1 million and $2.8million, respectively. Upon the exercise of options, we issue new common stockfrom our authorized shares. There were no stock option exercises during theSuccessor three and six month periods ended June 30, 2007.

Total unrecognizedstock-based compensation expense related to nonvested stock options, net ofexpected forfeitures, was approximately $15.5 million as of June 30, 2007. Weanticipate this expense to be recognized over a weighted average period ofapproximately 5 years. However, compensation expense associated withperformance based options will be recognized only to the extent achievement ofcertain performance targets are deemed probable.

The following tablesummarizes the effect of adopting SFAS 123(R) for the three and six monthperiods presented (in thousands):
|                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                    | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| Stock-based  compensation expense recognized: |       |                             |       |                           |       |   |   |   |   |
| Cost of sales                                 |       | $                                | 16         |                           | $          | 22 |   | $ | 24 |   | $ | 37 |   |
| Selling, general and administrative           |       | 597                              |       | 1,064                          |       | 969 |   | 1,899 |   |
| Research and development                      |       | 7                                |       | 27                             |       | 11 |   | 35 |   |
| Total                                         |       | 620                              |       | 1,113                          |       | 1,004 |   | 1,971 |   |
| Related deferred  income tax benefit          |       | (242                             | )          | (118                           | )          | (392 | ) | (228 | ) |
| Increase in net loss                          |       | $                                | 378        |                           | $          | 995 |   | $ | 612 |   | $ | 1,743 |   |

 

*Restricted Stock*

On March 13, 2007, wegranted 15,189 shares of restricted stock awards to an executive officerpursuant to the terms of a restricted stock agreement. The shares are subjectto a vesting schedule over a period of three years with the final vesting onNovember 3, 2009. The calculated fair value of the stock awards, whichapproximated $250,000, was determined using the fair value of RTI’s common stockon the date of grant of $16.46 per share. Compensation expense is recognized ona straight-line basis over the respective vesting period. As of June 30, 2007,there was approximately $210,000 of total unrecognized compensation costrelated to unvested restricted stock. This cost is expected to be recognizedover a weighted average period of approximately 3 years.

**9. SEGMENT AND GEOGRAPHIC INFORMATION**

We have two reportablesegments as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information” (“SFAS 131”). Our reportable segments are businessunits that offer different products that are managed separately because eachbusiness requires different manufacturing and marketing strategies. TheOrthopedic Rehabilitation Division offers non-invasive medical products thatare used before and after surgery to assist in the repair and rehabilitation ofsoft tissue and bone, and to

15

----

protect against further injury; electrotherapy devicesand accessories used to treat pain and restore muscle function; iontophoreticdevices and accessories used to deliver medication; clinical therapy tables andtraction equipment; and orthotics devices used to treat joint and spineconditions. The Surgical Implant Division sells reconstructive productsincluding knee, hip and shoulder implants.

Information regarding ourreportable business segments is as follows (in thousands):
|                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                         | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                         | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| **Net  sales:**                    |       |                             |       |                           |       |   |   |   |   |
| Orthopedic Rehabilitation Division |       | $                                | 89,609     |                           | $          | 80,628 |   | $ | 179,515 |   | $ | 152,116 |   |
| Surgical Implant Division          |       | 16,644                           |       | 15,287                         |       | 33,445 |   | 30,712 |   |
| Total                              |       | $                                | 106,253    |                           | $          | 95,915 |   | $ | 212,960 |   | $ | 182,828 |   |
|                               |       |                             |       |                           |       |   |   |   |   |
|                               |       |                             |       |                           |       |   |   |   |   |
| **Gross  margin:**                 |       |                             |       |                           |       |   |   |   |   |
| Orthopedic Rehabilitation Division |       | $                                | 51,890     |                           | $          | 45,999 |   | $ | 101,705 |   | $ | 86,163 |   |
| Surgical Implant Division          |       | 10,614                           |       | 11,905                         |       | 22,383 |   | 23,694 |   |
| Total                              |       | $                                | 62,504     |                           | $          | 57,904 |   | $ | 124,088 |   | $ | 109,857 |   |

 

We allocate resources andevaluate the performance of our segments based on gross margin and thereforehave not disclosed certain other items, such as depreciation, operating income,interest and income taxes as permitted by SFAS 131.

**Geographic Area**

Following are our netsales by geographic area (in thousands): 
|                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                             | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| **Net  sales*:**                       |       |                             |       |                           |       |   |   |   |   |
| United States                          |       | $                                | 75,464     |                           | $          | 74,681 |   | $ | 153,277 |   | $ | 143,481 |   |
| Germany                                |       | 9,574                            |       | 9,076                          |       | 19,368 |   | 16,393 |   |
| Other Europe,  Middle East, and Africa |       | 17,118                           |       | 9,401                          |       | 32,362 |   | 17,054 |   |
| Asia Pacific                           |       | 1,810                            |       | 1,747                          |       | 3,324 |   | 4,160 |   |
| Other                                  |       | 2,287                            |       | 1,010                          |       | 4,629 |   | 1,740 |   |
| Total                                  |       | $                                | 106,253    |                           | $          | 95,915 |   | $ | 212,960 |   | $ | 182,828 |   |

 

----

*Net sales are attributed to countries based on location of customer.

Following are ourlong-lived assets by geographic area as of June 30, 2007 and December 31, 2006(in thousands):
|                  | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------|------------|-------------------------|------------|-----------------------------|------------|
| United States    |       | $                       | 756,871    |                        | $          | 751,914 |   |
| Europe and other |       | 103,366                 |       | 103,911                     |       |
|             |       | $                       | 860,237    |                        | $          | 855,825 |   |

 

**10. INCOME TAXES**

Income taxes for theinterim periods presented have been included in the accompanying unauditedcondensed consolidated financial statements on the basis of an estimated annualeffective tax rate, adjusted for discrete items. We recorded approximately $5.6and $7.9 million of income tax benefit on a pre-tax loss of approximately $13.6and $27.0 million for the Successor three and six month periods ended June 30,2007.  The tax benefit for these periodsdiffered from that, which would have been recorded using the U.S. statutory taxrate due primarily to the recording of foreign taxes and deferred taxes on theassumed repatriation of foreign earnings.

16

----

During the Predecessorthree and six month periods ended July 1, 2006, we recorded $1,000 and $1.4million of income tax benefit and expense respectively, on a pre-tax loss ofapproximately $0.4 million and $1.4 million due to the recording, in connectionwith the Compex acquisition, of approximately $4.0 million of in-processresearch and development (“IPR&D”) costs, which are not deductible, and tonon-deductible stock based compensation expense.

**11. ACQUISTION OF COMPEX**

On February 24, 2006,pursuant to the terms of a merger agreement dated November 11, 2005, weacquired all of the issued and outstanding shares of Compex Technologies, Inc.(“Compex”), a Minnesota corporation. Compex manufactured and sold a broad line of transcutaneous electricalnerve stimulation (“TENS”) and neuromuscular electrical nerve stimulation (“NMES”)products used for pain management, rehabilitation, fitness and sportsperformance enhancement in clinical, home healthcare, sports and occupationalmedicine settings.  The total purchaseprice of approximately $102.9 million was comprised of 7.3 million shares ofRTI common stock valued at $90.0 million, options to purchase 900,000 shares ofRTI common stock valued at $9.3 million, along with $3.6 million in acquisitioncosts. We funded the acquisition, which we refer to as the Compex acquisition,with RTI common stock and $25.3 million of borrowings under our $200.0 millionsenior credit facility to a syndicate of financial institutions originally dueon 2010 but which was repaid in full in conjunction with the Merger. Theresults of Compex have been included within our unaudited condensedconsolidated statement of operations since February 24, 2006, the date ofacquisition.

Included in theliabilities assumed in the Compex acquisition is a $1.1 million contingentliability relating to litigation against Compex regarding a potential incorrectpayment of custom duties and VAT on imported goods prior to the date of theacquisition. On February 6, 2007, a judgment in the dispute with the customofficials was issued by the court which resulted in partial unfavorable rulingsfor each side. Both sides have appealed the ruling and a final judgment isexpected to be received in early 2008. Our current potential liability in thedispute if the custom officials were to prevail is approximately $1.1 million.Therefore, judgment settlement fees of approximately $1.1 million were recordedas an adjustment to the purchase price to increase goodwill during the fourthquarter of 2006.

During 2006, weimplemented certain restructuring and reorganization programs designed tointegrate the acquired Compex operations. Our restructuring efforts includedthe divestiture of the U.S. consumer product line, the closing of the Compex billingoperations located in Tampa, Florida, and the integration of those operationsinto our existing operations in Minnesota, and the closure of the Compexcorporate headquarters located in New Brighton, Minnesota.

A summary of the activityrelating to the restructuring for the Successor three and six month periodsended June 30, 2007 is as follows (in thousands):
|                             | ** ** | **Lease  Termination  Costs** | ** ** | **Severance** | ** ** | **Total** | ** ** |
|-----------------------------|------------|-------------------------------|------------|---------------|------------|-----------|------------|
| Balance at  January 1, 2007 |       | $                             | 346        |          | $          | 1,389     |       | $ | 1,735 |   |
| Expensed during period      |       | —                        |       | 155           |       | 155       |       |
| Payments made during period |       | (346                          | )          | (1,025        | )          | (1,371    | )          |
| Balance at March  31, 2007  |       | —                        |       | 519           |       | 519       |       |
| Expensed during period      |       | —                        |       | —        |       | —    |       |
| Payments made during period |       | —                        |       | (175          | )          | (175      | )          |
| Balance at June 30,  2007   |       | $                             | —     |          | $          | 344       |       | $ | 344 |   |

 

**12. ACQUISTION OF CEFAR**

On November 7, 2006, weacquired all of the issued and outstanding shares of Cefar, a leading Europeanprovider of electrotherapy and rehabilitation devices for a purchase price of$23.3 million. Cefar markets electrotherapy devices indicated for chronic pain,for women’s health, for electroacupuncture, and for other rehabilitationactivities. We are integrating the operations of Cefar with those of Compex SA,the European subsidiary of Compex. Our strategy for the merged company is todevelop both the

17

----

professional/medical and consumer markets for electrostimulation across Europe and internationally, continuing to trade under boththe Cefar and Compex brands. The purchase price of $23.3 million was comprisedof the payment of $12.5 million in cash, issuance of shares of RTI’s commonstock valued at $9.5 million, and payment of $1.3 million of acquisition costs.The fair value of RTI common stock issued was determined as $16.46 per share($6.55 before giving effect to the share adjustments) based on the per shareprice used in the recently completed Merger. We funded the acquisition with RTIcommon stock, $10.0 million of term loan borrowings under the Senior CreditFacility, and cash on hand. Pursuant to the terms of the acquisition agreement,$800,000 of the purchase price was placed in escrow subject to finalcalculations of net working capital and net debt as defined in the acquisitionagreement. Additional amounts may be paid to certain of the former stockholdersof Cefar if certain EBITDA targets for the combined Cefar-Compex SA entitiesare met by December 31, 2008. These payments, if any, would be recorded as anincrease to the purchase price of Cefar. The results of Cefar have beenincluded in our unaudited condensed consolidated statement of operations sincethe date of acquisition.

The following representsthe preliminary allocation of the aggregate purchase price. Fair value forcertain of the assets acquired (inventory, fixed assets and intangible assets)was estimated based upon preliminary evaluations and third party appraisals.For the majority of the remaining assets and liabilities, book value was deemedto approximate fair value due to the nature of the assets and liabilities. Thefollowing valuations are preliminary and are subject to change upon our furtherevaluation of the assets acquired and liabilities assumed (in thousands):
|                                        | ** ** | **Fair Value** | ** ** | **Wtd. Avg. Useful Life** | ** ** |
|----------------------------------------|------------|---------------------|------------|------------------------------------------|------------|
| Current assets                         |       | $                   | 11,865     |                                     |       |   |
| Tangible and  other non-current assets |       | 1,036               |       |                                     |       |
| Liabilities assumed                    |       | (10,630             | )          |                                     |       |
| Identifiable  intangible assets:       |       |                |       |                                     |       |
| Trade names and trademarks             |       | 3,400               |       | Indefinite                               |       |
| Electrotherapy technology              |       | 1,800               |       | 6  years                                 |       |
| Customer  relationships                |       | 3,200               |       | 10  years                                |       |
| Goodwill                               |       | 12,584              |       |                                     |       |
| Purchase Price                         |       | $                   | 23,255     |                                     |       |   |

 

**13. DISCONTINUED OPERATIONS**

We account for ourdiscontinued operations under the provisions of SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets.” Accordingly, we classifiedresults of operations and the related charges for discontinued operations as “Incomefrom discontinued operations, net of tax” in the accompanying unauditedcondensed consolidated statements of operations. We reclassified assets andliabilities of the discontinued operations and reflected them on theaccompanying unaudited condensed consolidated balance sheets as “Assets ofdiscontinued operations” and “Liabilities of discontinued operations.”

On June 30, 2006, wecompleted the sale of our Slendertone® U.S. consumer product line (“U.S.Consumer product line”) for a purchase price of $2.4 million, plus the cost ofinventory acquired. The assets sold were previously included in our OrthopedicRehabilitation Division and comprised our entire Slendertone consumer productinventory and all of our rights to distribute Slendertone products in theUnited States. In addition, pursuant to the transition services agreement datedJune 8, 2006 that we entered into with the buyer, we provided transitionservices for the Slendertone business in the U.S. through December 31, 2006. Weused the net proceeds from this sale to invest in our core OrthopedicRehabilitation and Surgical Implant businesses.

For accounting purposes,the operating results of the U.S. Consumer product line have been classified asdiscontinued operations in the condensed consolidated statements of operationsfor all periods presented.

18

----

Discontinued operationsare as follows (in thousands): 
|                                                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                                      | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| Net sales                                                       |       | $                                | —     |                           | $          | 2,766 |   | $ | — |   | $ | 3,978 |   |
| Income (loss)  from operations                                  |       | 48                               |       | (601                           | )          | 48 |   | (854 | ) |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  before income taxes from discontinued operations |       | 48                               |       | (601                           | )          | 48 |   | (854 | ) |
| Income tax  provision (benefit)                                 |       | 20                               |       | (289                           | )          | 20 |   | (410 | ) |
| Income (loss)  from discontinued operations                     |       | $                                | 28         |                           | $          | (312 | ) | $ | 28 |   | $ | (444 | ) |

 

**14. COMMITMENTS AND CONTINGENCIES**

Approximately $1.1million has been recorded as a contingent liability and an adjustment togoodwill relating to litigation against Compex regarding a dispute over customduties and VAT on imported goods prior to the date of acquisition. On February6, 2007, a judgment in the dispute with the custom officials was issued by thecourt which resulted in partial unfavorable rulings for each side. Both sideshave appealed the ruling and a final judgment is expected to be received earlyin 2008.

On July 7, 2006, apurported class action complaint, *LouisDudas et al. v.**Encore MedicalCorporation et al.,*was filed against RTI and its directors in theDistrict Court of Travis County, Texas, 345th Judicial District (“the TexasAction”). Recently, Blackstone was added as a defendant.  On July 18, 2006, a second purported classaction complaint, *Robert**Kemp et al. v. Alastair J. Clemow et al.*(the“Delaware Action”) was filed by a putative stockholder of RTI in the Court ofChancery of the State of Delaware, New Castle County, against RTI and itsdirectors. Blackstone and Grand Slam Holdings, LLC were also named asdefendants in the Delaware Action.  TheDelaware Action was dismissed in February 2007 with no liability accruing toRTI or the other defendants.

The Texas Action is inpreliminary stages and we cannot presently predict the outcome of the lawsuit,although we believe it is without merit. The Texas Action complaint allegesthat RTI’s directors breached their fiduciary duties by, *inter alias*, agreeing to an allegedlyinadequate acquisition price in connection with the Merger. The complaintseeks, among other things, to rescind any actions that have already been takento consummate the Merger, rescissory damages and the plaintiffs’ reasonablecosts and attorneys’ fees and expert fees.

Due to the nature of ourbusiness, we are subject to a variety of audits by government agencies andother private interests.  In connectionwith audits of our compliance with federal requirements for our facilities andrelated quality and manufacturing processes, the FDA has informed us that theybelieve that certain discrete processes related to our Surgical ImplantDivision did not conform with Current Good Manufacturing Practices (“CGMP”). Wehave been working with the FDA to resolve all outstanding issues they haveidentified in the past as a result of their audits regarding Quality System Regulations(“QSR”) and CGMP compliance. These issues have not caused any material adverseeffect on us to date and we do not believe the resolution of these issues willhave a material adverse effect on us in the future. However, if the FDA doesnot agree with us with respect to the resolution of these issues, our financialposition and results of operations could be materially impacted.

The manufacturing andmarketing of orthopedic medical products entails risk of product liability.From time to time, we have been, and currently we are, subject to productliability claims and litigation. In the future, we may again be subject toadditional product liability claims, which could have a negative impact on ourbusiness. We currently carry product liability insurance up to a limit of $20.0million, subject to an aggregate self-insurance deductible of $750,000. Ourinsurance policy is subject to annual renewal. We believe our current productliability insurance coverage is adequate. If a product liability claim orseries of claims is brought against us for uninsured liabilities or in excessof our insurance coverage, our business could suffer materially and cause ourstock price to fall. In addition, as a result of a product liability claim, wemay have to recall some of our products, which could result in significantcosts to us. As of June 30, 2007 and December 31, 2006, we have accruedapproximately $1.8 million and $2.3 million, respectively, for productliability claims expense based upon previous claim experience.

On February 22,2005, we acquired substantially all of the assets of OTI, which included a lineof spinal implant products and several total knee and hip implant designs forapproximately $15.7 million.  The acquisition consideration is subjectto adjustment

19

----

based upon the final balance sheet as of the closingdate, which remains the subject of a dispute between the former OTIshareholders and us. We do not anticipate the resolution of the dispute willhave a material impact on our financial position or results of operations.Recently the parties concluded an arbitration that resulted in an award ofapproximately $326,000 to ReAble to reflect a lower inventory value at the dateof closing than was originally determined by OTI. We have also been involved inthe defense of a patent infringement claim against us and OTI, which werecently settled with a payment of $400,000 to the counterparty in exchange fora license to use the related technology. We are also in a related dispute withOTI and its chief executive officer over certain representations and warrantiesthat were made under the Asset Purchase Agreement that governs the OTIacquisition (the “OTI APA”). This dispute is currently the subject oflitigation in which each party has asserted certain claims, including our claimfor indemnification from the approximately $1.7 million escrow fund thatwas established pursuant to the OTI APA specifically for the purpose of fundingindemnification claims. We have reflected the costs that we have incurred to daterelated to the litigation for which we believe we are entitled toindemnification as an account receivable. At June 30, 2007, the receivableapproximated $1.8 million.

**15. RELATED PARTY TRANSACTIONS**

In connection with theMerger, Blackstone Management Partners V L.L.C. (“BMP”) has agreed to providecertain monitoring, advisory and consulting services to us for an annualmonitoring fee equal to $3.0 million payable in the first quarter of each year.At any time in connection with or in anticipation of a change of control ofRTI, a sale of all or substantially all of RTI’s assets or an initial publicoffering of common stock of RTI or its successor, BMP may elect to receive, inlieu of remaining annual monitoring fee payments, a single lump sum cash paymentequal to the then-present value of all then-current and future annualmonitoring fees payable under the transaction and monitoring fee agreement,assuming a hypothetical termination date of the agreement to be the twelfthanniversary of such election. The monitoring fee agreement will continue untilthe earlier of the twelfth anniversary of the date of the agreement or suchdate as RTI and BMP may mutually determine. RTI will agree to indemnify BMP andits affiliates, directors, officers, employees, agents and representatives fromand against all liabilities relating to the services contemplated by thetransaction and monitoring fee agreement and the engagement of BMP pursuant to,and the performance of BMP and its affiliates of the services contemplated by,the transaction and monitoring fee agreement. During the six month period endedJune 30, 2007, we recorded approximately $1.5 million related to the monitoringfee, which has been recorded as a component of selling, general andadministrative expense.

**16. DERIVATIVE INSTRUMENTS**

We make use of debtfinancing as a source of funds and are therefore exposed to interest ratefluctuation in the normal course of our business. We operate internationallyand are therefore exposed to foreign currency exchange rate fluctuations in thenormal course of our business. As part of our risk management strategy, we usederivative instruments to hedge portions of our exposure. Before acquiring aderivative instrument to hedge a specific risk, potential natural hedges are evaluated.Derivative instruments are only utilized to manage underlying exposures thatarise from our business operations and are not used for speculative purposes.Factors considered in the decision to hedge an underlying market exposureinclude the materiality of the risk, the volatility of the market, the durationof the hedge, and the availability, effectiveness and cost of derivativeinstruments.

The Senior CreditFacility is subject to a floating interest rate. We manage the risk ofunfavorable movements in interest rates by hedging a portion of the outstandingloan balance. In February 2007, we swapped variable rates for fixed rates on$175.0 million of the borrowings under the Senior Credit Facility, therebylocking in a fixed rate on this portion of the principal. This reduces theeffect of rising interest rates, thereby making interest expense morepredictable. As of June 30, 2007, we had two agreements in place for a notionalamount of $100.0 million and $75.0 million, expiring in 2010 and 2012, respectively.Under these agreements, RTI paid a fixed rate of 5.17% and received a variablerate equal to the current three month LIBOR rate.

The fair value of ourinterest rate swap agreements recorded on the balance sheet as of June 30, 2007was $0.9 million and is recorded in other non-current assets. We believe ourinterest rate swaps are highly effective. Derivative gains and losses on cashflow hedges that qualify as accounting hedges are reported as accumulated othercomprehensive income net of tax, until such time as they are reported in incomealong with the hedged item. We recognized derivative net gains of approximately$80,000 and $130,000 in interest expense along with the hedged item during thethree and six month periods ended June 30, 2007.

20

----

**17. SUBSEQUENT EVENTS**

On August 9, 2007, RTIacquired IOMED, Inc. (“IOMED”), a leader in developing, manufacturing andmarketing active drug delivery systems used primarily to treat acute localinflammation in the physical and occupational therapy and sports medicinemarkets. Under the terms of the merger agreement dated May 17, 2007, IOMED wasmerged with Spartan Acquisition Corp., a newly formed subsidiary of RTI (the “IOMEDMerger”), and each share of IOMED common stock outstanding immediately prior tothe IOMED Merger was exchanged for $2.75 per share, as adjusted; for total cashconsideration of approximately $22.0 million. Direct acquisition costs for the transaction are estimated to beapproximately $1.0 million.  

OnJuly 15, 2007, RTI entered into an Agreement and Plan of Merger (the “DJOMerger Agreement”) with DJO Incorporated (“DJO”), a global provider ofsolutions for musculoskeletal and vascular health, specializing inrehabilitation and regeneration products for the non-operative orthopedic, spineand vascular markets.  Under the terms ofthe DJO Merger Agreement, an affiliate of RTI will acquire all outstandingshares of DJO in a transaction valued at approximately $1.6 billion, includingthe assumption of debt. The DJO Merger Agreement provides for a cash payment of$50.25 per share, as adjusted, for each outstanding share of DJO common stockoutstanding immediately prior to the DJO Merger. An affiliate of Blackstone,the controlling shareholder of RTI,  hascommitted to provide the equity financing needed to complete thetransaction.  Credit Suisse, CreditSuisse Securities (USA) LLC, Bank of America, N.A., Banc of America Bridge LLC,and Banc of America Securities LLC have committed to provide the debt financingneeded to complete the transaction. Closing of the transaction is subject to conditions customary in atransaction of this type, including approval of the DJO Merger by thestockholders of DJO. Under the DJO Merger Agreement, DJO may solicit superiorproposals from third parties during the 50 calendar days ending on September 3,2007. To the extent that a superior proposal solicited during this period leadsto the execution of a definitive agreement, DJO would be obligated to pay abreak-up fee to RTI of $18.7 million.  Wecurrently expect to close the transaction in the fourth quarter of 2007.  

On July 2, 2007, asubsidiary of RTFL completed its purchase of substantially all of the assets ofThe Saunders Group, Inc. for total cash consideration of $41.5 million,including $1.5 million of acquisition costs (the “Saunders Acquisition”). TheSaunders Group, Inc. is a supplier of rehabilitation products to physicaltherapists, chiropractors, athletes, athletic trainers, physicians andpatients, with a specialty in patented traction devices, back supports, andexercise equipment for neck and back disorders. 

In connection with theSaunders Acquisition, RTFL entered into two amendments to the Senior CreditFacility. The first amendment is a technical amendment intended to clarifycertain portions of the Senior Credit Facility related to financial statementreporting requirements and to covenant compliance reporting requirements.  The second amendment is an incremental termloan amendment to borrow an additional $55.0 million term loan under the SeniorCredit Facility. RTFL borrowed the funds on July 2, 2007 in connection with theSaunders Acquisition. Approximately $41.5 million of the total proceeds wasused to fund the acquisition and related expenses, $12.5 million was used topay off the balance due on our revolving credit facility as of June 30, 2007,and the remaining proceeds will be used for general corporate purposes. 

**18. SUPPLEMENTAL GUARANTOR CONDENSEDCONSOLIDATING FINANCIAL STATEMENTS**

On November 3, 2006, inconnection with the Merger, RTFL and its direct wholly-owned subsidiary, Finco,issued $200.0 million aggregate principal amount of the 11.75% Notes. Finco wasformed solely to act as a co-issuer of the 11.75% Notes, has only nominalassets and does not conduct any operations. The Indenture generally prohibitsFinco from holding any assets, becoming liable for any obligations, or engagingin any business activity. The 11.75% Notes are jointly and severally, fully andunconditionally guaranteed, on an unsecured senior subordinated basis by all ofRTFL’s domestic subsidiaries (other than the co-issuer) that are 100% owned,directly or indirectly, by RTFL (the “Guarantors”). Our foreign subsidiaries(the “Non-Guarantors”) do not guarantee the notes. The Guarantors alsounconditionally guarantee the Senior Credit Facility.

The following tablespresent the financial position, results of operations and cash flows of RTFL,the Guarantors, the Non-Guarantors and Eliminations as of June 30, 2007 andDecember 31, 2006 and for the three and six month periods ended June 30, 2007.In addition, the following tables present the results of operations and cashflows of RTI, the Guarantors, the Non-Guarantors, and Eliminations for thethree and six month periods ended July 1, 2006. The Guarantors in the tablesrelating to the Predecessor period include EMIHC, a previously wholly owneddirect subsidiary of RTFL which was liquidated on December 31, 2006. EMIHC wasthe borrower under our old senior secured credit facility which was fullyrepaid in connection with the Merger and the issuer of the 9.75% Notes, whichwere repurchased pursuant to a tender offer in connection with the Merger.

21

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingBalance Sheets**

**As of June 30, 2007**

**(inthousands)**
| ** **                                                   | ** ** | **RTFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   |       |     |       |           |       |                 |       |             |       |             |       |
| Current assets:                                              |       |     |       |           |       |                 |       |             |       |             |       |
| Cash and cash equivalents                                    |       | $        | 27         |           | $          | 13,972               |       | $                | 8,868      |             | $          | — |   | $ | 22,867 |   |
| Accounts receivable, net                                     |       | —   |       | 65,020         |       | 19,634               |       | —           |       | 84,654           |       |
| Inventories, net                                             |       | —   |       | 50,335         |       | 9,438                |       | (360             | )          | 59,413           |       |
| Deferred tax assets                                          |       | —   |       | 20,685         |       | 3,291                |       | (146             | )          | 23,830           |       |
| Prepaid expenses and other current assets                    |       | 496      |       | 6,320          |       | 1,360                |       | —           |       | 8,176            |       |
| Assets of discontinued operations                            |       | —   |       | —         |       | —               |       | —           |       | —           |       |
| Total current assets                                         |       | 523      |       | 156,332        |       | 42,591               |       | (506             | )          | 198,940          |       |
| Property and  equipment, net                                 |       | —   |       | 38,106         |       | 7,734                |       | (1,872           | )          | 43,968           |       |
| Goodwill                                                     |       | —   |       | 427,089        |       | 62,000               |       | —           |       | 489,089          |       |
| Intangible  assets, net                                      |       | —   |       | 271,794        |       | 34,558               |       | —           |       | 306,352          |       |
| Investment in  subsidiaries                                  |       | 594,505  |       | 25,848         |       | 48,932               |       | (669,285         | )          | —           |       |
| Intercompany  receivable                                     |       | 271,325  |       | —         |       | —               |       | (271,325         | )          | —           |       |
| Other  non-current assets                                    |       | 19,503   |       | 379            |       | 946                  |       | —           |       | 20,828           |       |
| Total assets                                                 |       | $        | 885,856    |           | $          | 919,548              |       | $                | 196,761    |             | $          | (942,988 | ) | $ | 1,059,177 |   |
| **Liabilities,  Minority Interests and Membership Equity**   |       |     |       |           |       |                 |       |             |       |             |       |
| Current  liabilities:                                        |       |     |       |           |       |                 |       |             |       |             |       |
| Long-term debt and capital leases, current portion           |       | $        | 3,500      |           | $          | 185                  |       | $                | 2,939      |             | $          | — |   | $ | 6,624 |   |
| Accounts payable                                             |       | 543      |       | 19,097         |       | 6,340                |       | —           |       | 25,980           |       |
| Accrued expenses                                             |       | 7,048    |       | 21,275         |       | 12,693               |       | —           |       | 41,016           |       |
| Total current liabilities                                    |       | 11,091   |       | 40,557         |       | 21,972               |       | —           |       | 73,620           |       |
| Long-term debt  and capital leases, net of current portion   |       | 556,375  |       | 689            |       | 1,517                |       | —           |       | 558,581          |       |
| Deferred tax  liabilities                                    |       | —   |       | 90,495         |       | 10,542               |       | —           |       | 101,037          |       |
| Intercompany  payable                                        |       | —   |       | 173,382        |       | 97,943               |       | (271,325         | )          | —           |       |
| Other non-current  liabilities                               |       | —   |       | 6,690          |       | —               |       | —           |       | 6,690            |       |
| Total liabilities                                            |       | 567,466  |       | 311,813        |       | 131,974              |       | (271,325         | )          | 739,928          |       |
| Minority  interests                                          |       | —   |       | —         |       | 859                  |       | —           |       | 859              |       |
| Membership  equity                                           |       | 318,390  |       | 607,735        |       | 63,928               |       | (671,663         | )          | 318,390          |       |
| Total  liabilities, minority interests and membership equity |       | $        | 885,856    |           | $          | 919,548              |       | $                | 196,761    |             | $          | (942,988 | ) | $ | 1,059,177 |   |

 

22

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingBalance Sheets**

**As of December 31, 2006**

**(inthousands)**
| ** **                                                    | ** ** | **RTFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                    |       |     |       |           |       |                 |       |             |       |             |       |
| Current assets:                                               |       |     |       |           |       |                 |       |             |       |             |       |
| Cash and cash  equivalents                                    |       | $        | 12         |           | $          | 22,650               |       | $                | 8,241      |             | $          | — |   | $ | 30,903 |   |
| Accounts  receivable, net                                     |       | —   |       | 55,854         |       | 18,301               |       | —           |       | 74,155           |       |
| Inventories, net                                              |       | —   |       | 58,707         |       | 9,188                |       | (222             | )          | 67,673           |       |
| Deferred tax  assets                                          |       | —   |       | 21,598         |       | 4,282                |       | (146             | )          | 25,734           |       |
| Prepaid expenses  and other current assets                    |       | 21       |       | 5,462          |       | 483                  |       | —           |       | 5,966            |       |
| Assets of  discontinued operations                            |       | —   |       | 380            |       | —               |       | —           |       | 380              |       |
| Total current  assets                                         |       | 33       |       | 164,651        |       | 40,495               |       | (368             | )          | 204,811          |       |
| Property and equipment,  net                                  |       | —   |       | 35,141         |       | 8,157                |       | (2,047           | )          | 41,251           |       |
| Goodwill                                                      |       | —   |       | 414,079        |       | 61,643               |       | —           |       | 475,722          |       |
| Intangible assets, net                                        |       | —   |       | 281,992        |       | 35,250               |       | —           |       | 317,242          |       |
| Investment in  subsidiaries                                   |       | 387,419  |       | (41,601        | )          | 47,731               |       | (393,549         | )          | —           |       |
| Intercompany receivable                                       |       | 287,144  |       | —         |       | —               |       | (287,144         | )          | —           |       |
| Other non-current  assets                                     |       | 19,940   |       | 762            |       | 908                  |       | —           |       | 21,610           |       |
| Total assets                                                  |       | $        | 694,536    |           | $          | 855,024              |       | $                | 194,184    |             | $          | (683,108 | ) | $ | 1,060,636 |   |
| **Liabilities, Minority Interests  and Membership Equity**    |       |     |       |           |       |                 |       |             |       |             |       |
| Current liabilities:                                          |       |     |       |           |       |                 |       |             |       |             |       |
| Long-term debt  and capital leases, current portion           |       | $        | 3,500      |           | $          | 332                  |       | $                | 2,673      |             | $          | — |   | $ | 6,505 |   |
| Accounts payable                                              |       | —   |       | 13,455         |       | 5,440                |       | —           |       | 18,895           |       |
| Accrued expenses                                              |       | 7,909    |       | 17,607         |       | 12,463               |       | —           |       | 37,979           |       |
| Total current  liabilities                                    |       | 11,409   |       | 31,394         |       | 20,576               |       | —           |       | 63,379           |       |
| Long-term debt and  capital leases, net of current portion    |       | 545,625  |       | 783            |       | 1,629                |       | —           |       | 548,037          |       |
| Deferred tax  liabilities                                     |       | —   |       | 99,152         |       | 12,080               |       | —           |       | 111,232          |       |
| Intercompany payable                                          |       | —   |       | 192,819        |       | 94,325               |       | (287,144         | )          | —           |       |
| Other non-current  liabilities                                |       | —   |       | 1,871          |       | —               |       | —           |       | 1,871            |       |
| Total  liabilities                                            |       | 557,034  |       | 326,019        |       | 128,610              |       | (287,144         | )          | 724,519          |       |
| Minority interests                                            |       | —   |       | —         |       | 909                  |       | —           |       | 909              |       |
| Membership equity                                             |       | 137,502  |       | 529,005        |       | 64,665               |       | (395,964         | )          | 335,208          |       |
| Total liabilities,  minority interests, and membership equity |       | $        | 694,536    |           | $          | 855,024              |       | $                | 194,184    |             | $          | (683,108 | ) | $ | 1,060,636 |   |

 

23

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingStatement of Operations**

**For the Successor Three MonthPeriod Ended June 30, 2007**

**(inthousands)**
| ** **                                                                           | ** ** | **RTFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                            |       | $        | —     |           | $          | 82,685               |       | $                | 24,596     |             | $          | (1,028 | ) | $ | 106,253 |   |
| Cost of sales                                                                        |       | —   |       | 34,825         |       | 10,020               |       | (1,096           | )          | 43,749           |       |
| Gross margin                                                                         |       | —   |       | 47,860         |       | 14,576               |       | 68               |       | 62,504           |       |
| Operating  expenses:                                                                 |       |     |       |           |       |                 |       |             |       |             |       |
| Selling, general and administrative                                                  |       | —   |       | 46,523         |       | 11,542               |       | —           |       | 58,065           |       |
| Research and development                                                             |       | —   |       | 3,003          |       | 1,103                |       | —           |       | 4,106            |       |
| Operating income  (loss)                                                             |       | —   |       | (1,666         | )          | 1,931                |       | 68               |       | 333              |       |
| Other income  (expense):                                                             |       |     |       |           |       |                 |       |             |       |             |       |
| Interest income                                                                      |       | 3,915    |       | 2,007          |       | 71                   |       | (5,783           | )          | 210              |       |
| Interest expense                                                                     |       | (13,988  | )          | (4,154         | )          | (1,692               | )          | 5,783            |       | (14,051          | )          |
| Other income (expense), net                                                          |       | 1,996    |       | (91            | )          | (26                  | )          | (1,993           | )          | (114             | )          |
| Income (loss)  from continuing operations before income taxes and minority interests |       | (8,077   | )          | (3,904         | )          | 284                  |       | (1,925           | )          | (13,622          | )          |
| Provision  (benefit) for income taxes                                                |       | —   |       | (5,828         | )          | 224                  |       | —           |       | (5,604           | )          |
| Minority  interests                                                                  |       | —   |       | —         |       | 87                   |       | —           |       | 87               |       |
| Income (loss)  from continuing operations                                            |       | (8,077   | )          | 1,924          |       | (27                  | )          | (1,925           | )          | (8,105           | )          |
| Discontinued  operations:                                                            |       |     |       |           |       |                 |       |             |       |             |       |
| Income from  discontinued operations, net of tax                                     |       | —   |       | 28             |       | —               |       | —           |       | 28               |       |
| Net income (loss)                                                                    |       | $        | (8,077     | )              | $          | 1,952                |       | $                | (27        | )                | $          | (1,925 | ) | $ | (8,077 | ) |

 

24

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingStatement of Operations**

**For the Successor Six MonthPeriod Ended June 30, 2007**

**(inthousands)**
| ** **                                                                  | ** ** | **RTFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------|------------|----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                   |       | $        | —     |           | $          | 167,676              |       | $                | 47,610     |             | $          | (2,326 | ) | $ | 212,960 |   |
| Cost of sales                                                               |       | —   |       | 68,582         |       | 22,654               |       | (2,364           | )          | 88,872           |       |
| Gross margin                                                                |       | —   |       | 99,094         |       | 24,956               |       | 38               |       | 124,088          |       |
| Operating  expenses:                                                        |       |     |       |           |       |                 |       |             |       |             |       |
| Selling, general and administrative                                         |       | —   |       | 93,817         |       | 21,888               |       | —           |       | 115,705          |       |
| Research and development                                                    |       | —   |       | 5,758          |       | 1,983                |       | —           |       | 7,741            |       |
| Operating income  (loss)                                                    |       | —   |       | (481           | )          | 1,085                |       | 38               |       | 642              |       |
| Other income  (expense):                                                    |       |     |       |           |       |                 |       |             |       |             |       |
| Interest income                                                             |       | 7,874    |       | 2,744          |       | 134                  |       | (10,325          | )          | 427              |       |
| Interest expense                                                            |       | (27,930  | )          | (8,352         | )          | (2,115               | )          | 10,325           |       | (28,072          | )          |
| Other income (expense), net                                                 |       | 890      |       | (30            | )          | 58                   |       | (890             | )          | 28               |       |
| Loss from  continuing operations before income taxes and minority interests |       | (19,166  | )          | (6,119         | )          | (838                 | )          | (852             | )          | (26,975          | )          |
| Provision  (benefit) for income taxes                                       |       | —   |       | (8,475         | )          | 529                  |       | —           |       | (7,946           | )          |
| Minority  interests                                                         |       | —   |       | —         |       | 165                  |       | —           |       | 165              |       |
| Income (loss)  from continuing operations                                   |       | (19,166  | )          | 2,356          |       | (1,532               | )          | (852             | )          | (19,194          | )          |
| Discontinued  operations:                                                   |       |     |       |           |       |                 |       |             |       |             |       |
| Income from  discontinued operations, net of tax                            |       | —   |       | 28             |       | —               |       | —           |       | 28               |       |
| Net income (loss)                                                           |       | $        | (19,166    | )              | $          | 2,384                |       | $                | (1,532     | )                | $          | (852 | ) | $ | (19,166 | ) |

 

25

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingStatement of Operations**

**For the Predecessor Three MonthPeriod Ended July 1, 2006**

**(inthousands)**
| ** **                                                                           | ** ** | **RTI** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                            |       | $       | —     |           | $          | 79,677               |       | $                | 17,216     |             | $          | (978 | ) | $ | 95,915 |   |
| Cost of sales                                                                        |       | —  |       | 31,822         |       | 7,200                |       | (1,011           | )          | 38,011           |       |
| Gross margin                                                                         |       | —  |       | 47,855         |       | 10,016               |       | 33               |       | 57,904           |       |
| Operating  expenses:                                                                 |       |    |       |           |       |                 |       |             |       |             |       |
| Selling, general and administrative                                                  |       | 36      |       | 38,695         |       | 8,534                |       | —           |       | 47,265           |       |
| Research and development                                                             |       | —  |       | 1,020          |       | 2,269                |       | —           |       | 3,289            |       |
| Operating income  (loss)                                                             |       | (36     | )          | 8,140          |       | (787                 | )          | 33               |       | 7,350            |       |
| Other income  (expense):                                                             |       |    |       |           |       |                 |       |             |       |             |       |
| Interest income                                                                      |       | —  |       | 3,878          |       | 17                   |       | (3,776           | )          | 119              |       |
| Interest expense                                                                     |       | —  |       | (11,699        | )          | (39                  | )          | 3,776            |       | (7,962           | )          |
| Other income (expense), net                                                          |       | 788     |       | 5,385          |       | (347                 | )          | (5,754           | )          | 72               |       |
| Income (loss)  from continuing operations before income taxes and minority interests |       | 752     |       | 5,704          |       | (1,156               | )          | (5,721           | )          | (421             | )          |
| Provision  (benefit) for income taxes                                                |       | —  |       | (433           | )          | 424                  |       | 8                |       | (1               | )          |
| Minority  interests                                                                  |       | —  |       | —         |       | 53                   |       | —           |       | 53               |       |
| Income (loss)  from continuing operations                                            |       | 752     |       | 6,137          |       | (1,633               | )          | (5,729           | )          | (473             | )          |
| Discontinued  operations:                                                            |       |    |       |           |       |                 |       |             |       |             |       |
| Loss from discontinued operations, net of tax                                        |       | —  |       | (312           | )          | —               |       | —           |       | (312             | )          |
| Net income (loss)                                                                    |       | $       | 752        |           | $          | 5,825                |       | $                | (1,633     | )                | $          | (5,729 | ) | $ | (785 | ) |

 

26

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingStatement of Operations**

**For the Predecessor Six MonthPeriod Ended July 1, 2006**

**(inthousands)**
| ** **                                                                           | ** ** | **RTI** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                            |       | $       | —     |           | $          | 155,205              |       | $                | 30,025     |             | $          | (2,402 | ) | $ | 182,828 |   |
| Cost of sales                                                                        |       | —  |       | 62,316         |       | 13,041               |       | (2,386           | )          | 72,971           |       |
| Gross margin                                                                         |       | —  |       | 92,889         |       | 16,984               |       | (16              | )          | 109,857          |       |
| Operating expenses:                                                                  |       |    |       |           |       |                 |       |             |       |             |       |
| Selling, general  and administrative                                                 |       | 36      |       | 71,777         |       | 13,977               |       | —           |       | 85,790           |       |
| Research and  development                                                            |       | —  |       | 7,492          |       | 2,645                |       | —           |       | 10,137           |       |
| Operating income (loss)                                                              |       | (36     | )          | 13,620         |       | 362                  |       | (16              | )          | 13,930           |       |
| Other income (expense):                                                              |       |    |       |           |       |                 |       |             |       |             |       |
| Interest income                                                                      |       | —  |       | 7,761          |       | 31                   |       | (7,552           | )          | 240              |       |
| Interest expense                                                                     |       | —  |       | (22,982        | )          | (50                  | )          | 7,552            |       | (15,480          | )          |
| Other income  (expense), net                                                         |       | 2,778   |       | 11,278         |       | (651                 | )          | (13,449          | )          | (44              | )          |
| Income (loss) from  continuing operations before income taxes and minority interests |       | 2,742   |       | 9,677          |       | (308                 | )          | (13,465          | )          | (1,354           | )          |
| Provision for income  taxes                                                          |       | —  |       | 653            |       | 762                  |       | (16              | )          | 1,399            |       |
| Minority interests                                                                   |       | —  |       | —         |       | 112                  |       | —           |       | 112              |       |
| Income (loss) from  continuing operations                                            |       | 2,742   |       | 9,024          |       | (1,182               | )          | (13,449          | )          | (2,865           | )          |
| Discontinued  operations:                                                            |       |    |       |           |       |                 |       |             |       |             |       |
| Loss from  discontinued operations, net of tax                                       |       | —  |       | (444           | )          | —               |       | —           |       | (444             | )          |
| Net income (loss)                                                                    |       | $       | 2,742      |           | $          | 8,580                |       | $                | (1,182     | )                | $          | (13,449 | ) | $ | (3,309 | ) |

 

27

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingStatement of Cash Flows**

**For the Successor Six MonthPeriod Ended June 30, 2007**

**(inthousands)**
| ** **                                                                                           | ** ** | **RTFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING ACTIVITIES:**                                                                            |       |     |       |           |       |                 |       |             |       |             |       |
| Net income (loss)                                                                                    |       | $        | (19,166    | )              | $          | 2,384                |       | $                | (1,532     | )                | $          | (852 | ) | $ | (19,166 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |     |       |           |       |                 |       |             |       |             |       |
| Depreciation                                                                                         |       | —   |       | 4,813          |       | 1,742                |       | (376             | )          | 6,179            |       |
| Amortization of  intangibles                                                                         |       | —   |       | 11,818         |       | 1,360                |       | —           |       | 13,178           |       |
| Amortization of  debt issuance costs                                                                 |       | 1,906    |       | —         |       | —               |       | —           |       | 1,906            |       |
| Stock-based  compensation                                                                            |       | —   |       | 1,004          |       | —               |       | —           |       | 1,004            |       |
| Loss on disposal  of assets                                                                          |       | —   |       | 113            |       | 353                  |       | (48              | )          | 418              |       |
| Deferred income  taxes                                                                               |       | —   |       | (8,801         | )          | (949                 | )          | —           |       | (9,750           | )          |
| Non-cash income  from subsidiaries                                                                   |       | (890     | )          | —         |       | —               |       | 890              |       | —           |       |
| Provision for  bad debt expense and sales returns                                                    |       | —   |       | 3,902          |       | 242                  |       | —           |       | 4,144            |       |
| Inventory  reserves                                                                                  |       | —   |       | 602            |       | 47                   |       | —           |       | 649              |       |
| Minority  interests                                                                                  |       | —   |       | —         |       | 165                  |       | —           |       | 165              |       |
| Excess tax  benefit associated with stock option exercises                                           |       | —   |       | (17            | )          | —               |       | —           |       | (17              | )          |
| Net effect of  discontinued operations                                                               |       | —   |       | 378            |       | —               |       | —           |       | 378              |       |
| Changes in operating  assets and liabilities, net of acquired assets and liabilities:                |       |     |       |           |       |                 |       |             |       |             |       |
| Accounts receivable                                                                                  |       | —   |       | (11,996        | )          | (1,230               | )          | —           |       | (13,226          | )          |
| Inventories                                                                                          |       | —   |       | 3,227          |       | 908                  |       | 138              |       | 4,273            |       |
| Prepaid  expenses, other assets and liabilities                                                      |       | (395     | )          | (3,822         | )          | (879                 | )          | —           |       | (5,096           | )          |
| Accounts payable  and accrued expenses                                                               |       | (319     | )          | 7,245          |       | 111                  |       | —           |       | 7,037            |       |
| Net cash  provided by (used in) operating activities                                                 |       | (18,864  | )          | 10,850         |       | 338                  |       | (248             | )          | (7,924           | )          |
| **INVESTING ACTIVITIES:**                                                                            |       |     |       |           |       |                 |       |             |       |             |       |
| Acquisition of  businesses, net of cash acquired                                                     |       | —   |       | (7,246         | )          | (432                 | )          | —           |       | (7,678           | )          |
| Proceeds from  sale of assets held for sale                                                          |       | —   |       | 4,480          |       | 7                    |       | —           |       | 4,487            |       |
| Purchases of  property and equipment                                                                 |       | —   |       | (5,942         | )          | (1,451               | )          | 248              |       | (7,145           | )          |
| Net cash used in  investing activities                                                               |       | —   |       | (8,708         | )          | (1,876               | )          | 248              |       | (10,336          | )          |
| **FINANCING ACTIVITIES:**                                                                            |       |     |       |           |       |                 |       |             |       |             |       |
| Intercompany                                                                                         |       | 8,499    |       | (10,597        | )          | 2,098                |       | —           |       | —           |       |
| Payments on  long-term obligations                                                                   |       | (1,750   | )          | (240           | )          | 127                  |       | —           |       | (1,863           | )          |
| Proceeds on  long-term obligations                                                                   |       | 12,500   |       | —         |       | —               |       | —           |       | 12,500           |       |
| Payment of debt  issuance costs                                                                      |       | (370     | )          | —         |       | —               |       | —           |       | (370             | )          |
| Excess tax  benefit associated with stock option exercises                                           |       | —   |       | 17             |       | —               |       | —           |       | 17               |       |
| Dividend paid to  minority interests                                                                 |       | —   |       | —         |       | (226                 | )          | —           |       | (226             | )          |
| Net cash  provided by (used in) financing activities                                                 |       | 18,879   |       | (10,820        | )          | 1,999                |       | —           |       | 10,058           |       |
| Effect of exchange rate  on cash and cash equivalents                                                |       | —   |       | —         |       | 166                  |       | —           |       | 166              |       |
| **Net increase (decrease) in cash  and cash equivalents**                                            |       | 15       |       | (8,678         | )          | 627                  |       | —           |       | (8,036           | )          |
| Cash and cash  equivalents at beginning of period                                                    |       | 12       |       | 22,650         |       | 8,241                |       | —           |       | 30,903           |       |
| Cash and cash equivalents at end of period                                                           |       | $        | 27         |           | $          | 13,972               |       | $                | 8,868      |             | $          | — |   | $ | 22,867 |   |

 

28

----

**ReAbleTherapeutics Finance LLC and Subsidiaries**

**Unaudited Condensed ConsolidatingStatement of Cash Flows**

**For the Predecessor Six MonthPeriod Ended July 1, 2006**

**(inthousands)**
| ** **                                                                                | ** ** | **RTI** | ** ** | **Guarantors** | ** ** | **Non -  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------|------------|----------------|------------|-----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING  ACTIVITIES:**                                                                |       |    |       |           |       |                  |       |             |       |             |       |
| Net income  (loss)                                                                        |       | $       | 2,742      |           | $          | 8,580                 |       | $                | (1,182     | )                | $          | (13,449 | ) | $ | (3,309 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |    |       |           |       |                  |       |             |       |             |       |
| Depreciation                                                                              |       | —  |       | 3,648          |       | 1,605                 |       | (189             | )          | 5,064            |       |
| Amortization of intangibles                                                               |       | —  |       | 2,515          |       | 854                   |       | —           |       | 3,369            |       |
| Amortization of debt issuance costs                                                       |       | —  |       | 1,073          |       | —                |       | —           |       | 1,073            |       |
| Non-cash interest expense                                                                 |       | —  |       | 54             |       | —                |       | —           |       | 54               |       |
| Stock-based compensation                                                                  |       | —  |       | 1,971          |       | —                |       | —           |       | 1,971            |       |
| Loss on disposal of assets                                                                |       | —  |       | 221            |       | 214                   |       | (210             | )          | 225              |       |
| Deferred income taxes                                                                     |       | —  |       | 93             |       | (341                  | )          | (15              | )          | (263             | )          |
| Non-cash income from subsidiaries                                                         |       | (2,778  | )          | (10,481        | )          | —                |       | 13,259           |       | —           |       |
| Provision for bad debt expense and sales returns                                          |       | —  |       | 4,200          |       | 152                   |       | —           |       | 4,352            |       |
| Inventory reserves                                                                        |       | —  |       | 1,700          |       | 31                    |       | —           |       | 1,731            |       |
| Minority interests                                                                        |       | —  |       | —         |       | 112                   |       | —           |       | 112              |       |
| Excess tax benefit associated with stock option  exercises                                |       | (984    | )          | —         |       | —                |       | —           |       | (984             | )          |
| In-process research and development                                                       |       | —  |       | 2,198          |       | 1,699                 |       | —           |       | 3,897            |       |
| Net effect of discontinued operations                                                     |       | —  |       | (659           | )          | —                |       | —           |       | (659             | )          |
| Changes in  operating assets and liabilities, net of acquired assets and liabilities:     |       |    |       |           |       |                  |       |             |       |             |       |
| Accounts receivable                                                                       |       | —  |       | (2,541         | )          | 237                   |       | —           |       | (2,304           | )          |
| Inventories                                                                               |       | —  |       | (9,324         | )          | 843                   |       | 180              |       | (8,301           | )          |
| Prepaid expenses, other assets and liabilities                                            |       | 974     |       | 2,317          |       | (501                  | )          | —           |       | 2,790            |       |
| Accounts payable and accrued expenses                                                     |       | 1,042   |       | (2,556         | )          | (1,842                | )          | —           |       | (3,356           | )          |
| Net cash provided by operating activities                                                 |       | 996     |       | 3,009          |       | 1,881                 |       | (424             | )          | 5,462            |       |
| **INVESTING  ACTIVITIES:**                                                                |       |    |       |           |       |                  |       |             |       |             |       |
| Acquisition of businesses, net of cash acquired                                           |       | —  |       | (1,480         | )          | —                |       | —           |       | (1,480           | )          |
| Acquisition of intangible assets                                                          |       | —  |       | (110           | )          | (134                  | )          | —           |       | (244             | )          |
| Proceeds from sale of assets                                                              |       | —  |       | 64             |       | —                |       | —           |       | 64               |       |
| Purchases of property and equipment                                                       |       | —  |       | (5,654         | )          | (1,753                | )          | 424              |       | (6,983           | )          |
| Net cash used in investing activities                                                     |       | —  |       | (7,180         | )          | (1,887                | )          | 424              |       | (8,643           | )          |
| **FINANCING  ACTIVITIES:**                                                                |       |    |       |           |       |                  |       |             |       |             |       |
| Proceeds from issuance of common stock                                                    |       | 2,618   |       | —         |       | —                |       | —           |       | 2,618            |       |
| Intercompany                                                                              |       | (3,512  | )          | 1,281          |       | 2,231                 |       | —           |       | —           |       |
| Proceeds from long-term obligations                                                       |       | —  |       | 25,300         |       | —                |       | —           |       | 25,300           |       |
| Payments on long-term obligations                                                         |       | —  |       | (20,985        | )          | (10                   | )          | —           |       | (20,995          | )          |
| Payment of debt  issuance costs                                                           |       | —  |       | (10            | )          | —                |       | —           |       | (10              | )          |
| Excess tax benefit associated with stock option  exercises                                |       | 984     |       | —         |       | —                |       | —           |       | 984              |       |
| Net cash provided by financing activities                                                 |       | 90      |       | 5,586          |       | 2,221                 |       | —           |       | 7,897            |       |
| Effect of  exchange rate on cash and cash equivalents                                     |       | —  |       | —         |       | 336                   |       | —           |       | 336              |       |
| **Net  increase in cash and cash equivalents**                                            |       | 1,086   |       | 1,415          |       | 2,551                 |       | —           |       | 5,052            |       |
| Cash and cash  equivalents at beginning of period                                         |       | 308     |       | 13,588         |       | 3,304                 |       | —           |       | 17,200           |       |
| Cash and cash  equivalents at end of period                                               |       | $       | 1,394      |           | $          | 15,003                |       | $                | 5,855      |             | $          | — |   | $ | 22,252 |   |

 

29

----

**ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

**Introduction**

This management’sdiscussion and analysis of financial condition and results of operations isintended to provide an understanding of our results of operations, financialcondition and where appropriate, factors that may affect future performance.

The following discussionshould be read in conjunction with the condensed consolidated financialstatements and related notes to those financial statements included elsewherein this quarterly report on Form 10-Q and in conjunction with our Annual Reporton Form S-4 which was declared effective on May 1, 2007 with the Securities andExchange Commission.

For purposes of thissection, the terms “we”, “us”, or the “Company” refer to RTI (as defined below)and its subsidiaries for the period prior to the consummation of the Merger andRTFL (as defined below) and its subsidiaries for the period after theconsummation of the Merger.

**Overview of Business**

We are a diversifiedorthopedic device company that develops, manufactures and distributes acomprehensive range of high-quality orthopedic devices used for rehabilitation,pain management and physical therapy. We also develop, manufacture anddistribute a wide range of surgical reconstructive implant products. Ourproducts are used by orthopedic specialists, physicians, physical therapists,and other healthcare professionals to treat patients with musculoskeletalconditions resulting from degenerative diseases, deformities, traumatic eventsand sports-related injuries. In addition, many of our non-invasive medicaldevices and related accessories are used primarily by patients for at-homephysical therapy. We currently develop, manufacture and distribute our productsthrough the following two operating divisions:

·             *OrthopedicRehabilitation Division*. We market our orthopedic rehabilitationproducts through two brands in the United States: Chattanooga Group and Empi;and three brands in Europe: Compex, Cefar and Ormed. These products are non-invasivemedical devices that are used before and after surgery to assist in the repairand rehabilitation of soft tissue and bone and to protect against injury, suchas at-home and clinical electrotherapy, continuous passive motion devices (“CPM”)used to treat pain and restore muscle function, physical therapy tables, homeand clinical traction products, iontophoretic devices and chiropractictreatment tables used to treat joint and spine conditions. Our OrthopedicRehabilitation Division accounted for approximately 84.3% and 84.3% of our netsales, as well as 83.0% and 82.0% of our gross profit, for the three and sixmonth periods ended June 30, 2007, respectively. 

·             *SurgicalImplant Division*. Our Surgical Implant Division develops,manufactures and markets a wide variety of products that serve the orthopedicreconstructive joint implant market. These products include knee, hip andshoulder reconstructive products, along with the instruments used by surgeonsto perform orthopedic reconstructive surgery. Our Surgical Implant Divisionaccounted for approximately 15.7% and 15.7% of our net sales, as well as 17.0%and 18.0% of our gross profit, for the three and six month periods ended June30, 2007, respectively.

Our two divisions enableus to reach a diverse customer base through multiple distribution channels andgive us the opportunity to provide a wide range of orthopedic devices andrelated products to orthopedic specialists operating in a variety of patienttreatment settings. These two divisions constitute our two reportable segments.See Note 9 to our condensed consolidated financial statements for furtherinformation regarding our reportable business segments.

We are subject toregulation by the FDA with respect to sales of our products in the United States,and we must, in many cases, obtain FDA authorization to market our productsbefore they can be sold in the United States. Additionally, we are subject tosimilar regulations in many of the foreign countries in which we sell ourproducts.

The nature of ourbusiness requires significant allocation of resources to investment in accountsreceivable, inventory, new product development and debt servicing. We have adiverse group of customers to whom we sell our products. In order to collectour revenues, we employ a variety of processes tailored to meet the needs ofour customers. In addition, our customers expect us to maintain sufficientinventory on hand at all times to meet their needs. Many of our domesticcustomers require consignment product to be placed at or near their respectivelocations. Our remaining customers across all product lines demand shortdelivery schedules for their orders. Finally, we place an emphasis on ourresearch and development efforts for new products.

30

----

**The Merger**

On November 3, 2006 anaffiliate of Blackstone Capital Partners L.P. acquired all of the outstandingshares of capital stock of ReAble Therapeutics, Inc. (“RTI”) in the Merger (seeNote 3 to our condensed consolidated financial statements). RTI is the parentcompany of ReAble Therapeutics Holdings, LLC (“Holdings”), ReAble TherapeuticsFinance LLC (“RTFL”) and ReAble Therapeutics Finance Corporation (“Finco”).RTFL, directly or indirectly through its subsidiaries, owns all of theoperating assets owned by RTI prior to the Merger. The total purchase price forthe Merger was approximately $529.2 million and consisted of $482.5 millionpaid to former holders of shares of common stock and options to purchase sharesof common stock of RTI, $7.2 million related to the fair value of themanagement rollover options that continued to remain as outstanding shares topurchase RTI common stock after the Merger, and $39.5 million in directacquisition costs. The Merger was financed through a combination of equitycontributed by Blackstone, cash on hand of RTI, borrowings under the SeniorCredit Facility, and proceeds from the newly issued 11.75% Notes. Upon theclosing of the Merger, shares of RTI’s common stock ceased to be traded on theNASDAQ Global Market.

The Merger was accountedfor as a purchase under the guidance set forth in Statement of FinancialAccounting Standards No. 141 “Business Combinations”. In addition, the fairvalue basis of the acquired assets and assumed liabilities was “pushed down” tothe financial statements of RTI, and ultimately to the condensed consolidatedfinancial statements of RTFL. The condensed consolidated statements ofoperations and cash flows of RTI are presented for the three and six monthperiods ended July 1, 2006 (the “Predecessor financial statements”), and thecondensed consolidated financial statements of RTFL are presented for the threeand six month periods ended June 30, 2007 (the “Successor financial statements”).The Predecessor and Successor periods have been prepared using a different basisof presentation due to the application of purchase accounting. Finco andHoldings did not have any operations during the six month period ended June 30,2007.

In addition, inconnection with the Merger, we recomputed the shares of RTI’s common stock toreflect the 62.8 to 1 share recomputation such that every 62.8 shares of RTI’scommon stock outstanding prior to the Merger was recomputed as 1 share of RTI’scommon stock. Subsequently, on November 8, 2006, following the closing of theMerger, we effected a 25 for 1 stock split, which resulted in every 1 share ofRTI’s common stock becoming 25 shares of RTI’s common stock. All shareinformation in this quarterly report on Form 10-Q for all periods presentedretroactively reflect these adjustments.

**Recent Acquisitions**

On November 7, 2006, weacquired Cefar, a leading European provider of electrotherapy andrehabilitation devices. Cefar markets electrotherapy devices used for chronicpain, for women’s health (labor pain, incontinence, dysmenorrhea), for electroacupuncture,and for other rehabilitation activities. We are integrating the operations ofCefar with those of Compex SA, the European subsidiary of Compex. Our strategyfor the merged company is to develop both the professional/medical and consumermarkets for electrical stimulation across Europe and internationally whilecontinuing to sell products under both the Cefar and Compex brands. Thepurchase price for Cefar of $23.3 million was comprised of $12.5 million incash, issuance of 575,134 shares of RTI’s common stock valued at $9.5 million,and payment of approximately $1.3 million in acquisition costs. In addition, wealso assumed Cefar’s existing debt of approximately $3.8 million. The cashportion of the acquisition was funded with $10.0 million of term loanborrowings under the Senior Credit Facility and cash on hand.

On February 24, 2006, wecompleted the acquisition of Compex. Compex manufactured and sold a broad lineof transcutaneous electrical nerve stimulation (“TENS”) and neuromuscular electricalnerve stimulation (“NMES”) products used for pain management, rehabilitation,fitness and sports performance enhancement in clinical, home healthcare, sportsand occupational medicine settings. The purchase price of approximately $102.9million included approximately 7.3 million shares of RTI’s common stock valuedat approximately $90.0 million in exchange for all of the outstanding commonstock of Compex, options to purchase approximately 900,000 shares of RTI’scommon stock valued at $9.3 million in exchange for all of the outstandingoptions to purchase common stock of Compex, and $3.6 million in acquisitioncosts. We also borrowed approximately $25.3 million under our $200.0 millionSenior Credit Facility to a syndicate of financial institutions originally dueon 2010 but which was repaid in full in conjuction with the Merger and used$17.3 million for repayment of Compex’s existing debt with the balance used forworking capital.

31

----

**Results of Operations**

The following table setsforth our statements of operations as a percentage of sales for the periodsindicated:
|                                                                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **Successor**                    | ** ** | **Predecessor**                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                                                      | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
| Net sales                                                                       |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                                                   |       | 41.2                             |       | 39.6                           |       | 41.7 |   | 39.9 |   |
| Gross margin                                                                    |       | 58.8                             |       | 60.4                           |       | 58.3 |   | 60.1 |   |
| Operating  expenses:                                                            |       |                             |       |                           |       |   |   |   |   |
| Selling, general and administrative                                             |       | 54.6                             |       | 49.3                           |       | 54.3 |   | 46.9 |   |
| Research and development                                                        |       | 3.9                              |       | 3.4                            |       | 3.6 |   | 5.5 |   |
| Operating income                                                                |       | 0.3                              |       | 7.7                            |       | 0.4 |   | 7.7 |   |
| Other income (expense):                                                         |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                                 |       | 0.2                              |       | 0.1                            |       | 0.2 |   | 0.1 |   |
| Interest expense                                                                |       | (13.2                            | )          | (8.3                           | )          | (13.2 | ) | (8.5 | ) |
| Other income (expense), net                                                     |       | (0.1                             | )          | 0.1                            |       | 0.0 |   | 0.0 |   |
| Loss from continuing   operations before income tax and minority interests |       | (12.8                            | )          | (0.4                           | )          | (12.6 | ) | (0.7 | ) |
| Provision  (benefit) for income taxes                                           |       | (5.3                             | )          | (0.0                           | )          | (3.7 | ) | 0.8 |   |
| Minority  interests                                                             |       | 0.1                              |       | 0.1                            |       | 0.1 |   | 0.0 |   |
| Loss from  continuing operations                                                |       | (7.6                             | )          | (0.5                           | )          | (9.0 | ) | (1.5 | ) |
| Discontinued  operations:                                                       |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  from discontinued operations, net of tax                         |       | 0.0                              |       | (0.3                           | )          | 0.0 |   | (0.2 | ) |
| Net loss                                                                        |       | (7.6                             | )%         | (0.8                           | )%         | (9.0 | )% | (1.7 | )% |

 

***Three Months EndedJune 30, 2007, compared to Three Months Ended July 1, 2006***

*NetSales.*Our net sales for the three month period ended June30, 2007 were $106.3 million, representing an increase of 10.8% over net salesof $95.9 million for the three month period ended July 1, 2006, driven bycontinued growth in both our Orthopedic Rehabilitation and Surgical ImplantDivisions. Sales in our Orthopedic Rehabilitation Division and our overall netsales benefited from sales of products we acquired in the Cefar acquisition,which was completed in November 2006. 

The following table setsforth the geographic mix of our net sales for the three month period ended June30, 2007 compared to the three month period ended July 1, 2006:
|                                             | ** ** | **Domestic**  | ** ** | **International** | ** ** | **Total**  | ** ** |
|---------------------------------------------|------------|---------------|------------|-------------------|------------|------------|------------|
| ** **                                  | ** ** | **Successor** | ** ** | **Predecessor**   | ** ** | **%**      | ** ** | **Successor** | ** ** | **Predecessor** | ** ** | **%** | ** ** | **Successor** | ** ** | **Predecessor** | ** ** | **%** | ** ** |
| **(In thousands, except %)** | ** ** | **2007**      | ** ** | **2006**          | ** ** | **Growth** | ** ** | **2007** | ** ** | **2006** | ** ** | **Growth** | ** ** | **2007** | ** ** | **2006** | ** ** | **Growth** | ** ** |
| Orthopedic  Rehabilitation Division         |       | $             | 61,643     |              | $          | 60,907     |       | 1.2 | % | $ | 27,966 |   | $ | 19,721 |   | 41.8 | % | $ | 89,609 |   | $ | 80,628 |   | 11.1 | % |
| Surgical Implant  Division                  |       | 13,821        |       | 13,774            |       | 0.4        | %          | 2,823 |   | 1,513 |   | 86.6 | % | 16,644 |   | 15,287 |   | 8.9 | % |
| Total                                       |       | $             | 75,464     |              | $          | 74,681     |       | 1.0 | % | $ | 30,789 |   | $ | 21,234 |   | 45.0 | % | $ | 106,253 |   | $ | 95,915 |   | 10.8 | % |
|                                             |            |               |            |                   |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales in ourOrthopedic Rehabilitation Division of $89.6 million during the three monthperiod ended June 30, 2007 increased 11.1% over net sales of $80.6 millionduring the three month period ended July 1, 2006, led by continued growthacross our Rehabilitation product lines and the impact of three months ofrevenue contribution from our Cefar acquisition.  For the three month period ended July 1,2006, both our consolidated net sales and our Orthopedic RehabilitationDivision net sales were impacted by a charge of $5.6 million related toaccounts receivable acquired in the Compex acquisition.

Net sales in our SurgicalImplant Division increased to $16.6 million from $15.3 million during the threemonth period ended June 30, 2007, representing an 8.9% increase over the prioryear period, driven primarily by growth in our international business. DomesticSurgical Implant Division net sales for the three months ended June 30, 2007 of$13.8 million approximated sales results for the three months ended July 1,2006, and was negatively impacted on a comparative basis by reduced sales fromour cyclone product line that was

32

----

sold during the first quarter of 2007.  International net sales of $2.8 million forthe three months ended June 30, 2007 increased 86.6% over net sales of $1.5million during the three month period ended July 1, 2006 due to increasingpenetration of existing and new international markets.

For the three monthsended June 30, 2007, sales of new products, which are products that have beenon the market less than one year, were $8.7 million compared to new productsales of $8.6 million during the three months ended July 1, 2006.

*GrossMargin.*Our consolidated gross margin as a percentage of netsales decreased to 58.8% during the three month period ended June 30, 2007 from60.4% during the three month period ended July 1, 2006 and was negativelyimpacted by $3.1 million of expense related to the write up to fair marketvalue of inventory in connection with the Merger. Our Orthopedic RehabilitationDivision gross margin of 57.9% for the three months ended June 30, 2007,compared to gross margin of 57.1% in the prior year period was negativelyimpacted by $1.1 million of expense related to the write up to fair marketvalue of inventory in connection with the Merger.  Both our consolidated gross margin and ourOrthopedic Rehabilitation Division gross margin for the three month periodended July 1, 2006 were impacted by a charge of $5.6 million related toaccounts receivable acquired in the Compex acquisition and by $565,000 ofexpense related to the write up to fair market value of inventory acquired inthe Compex acquisition.  Our SurgicalImplant Division gross margin decreased to 63.8% during the three months endedJune 30, 2007 compared to a gross margin of 77.9% for the three months endedJuly 1, 2006, primarily due to $2.0 million of expense related to the write upto fair market value of inventory in connection with the Merger and to anincrease in international sales, which generate comparatively lower grossmargins than domestic sales.

*Selling,General and Administrative.*Our selling, general andadministrative expenses increased to $58.1 million during the three monthperiod ended June 30, 2007 from $47.3 million during the three month periodended July 1, 2006. As a percentage of net sales, selling, general andadministrative expense increased to 54.6% from 49.3% in the prior year quarterprimarily due to additional expenses associated with the addition of Cefar,higher commissions due to increased sales and changes to compensation plansrelated to ongoing integration, higher intangible amortization expense incurredin connection with the Merger, and higher expenses related to acquisitionintegration activities.

*Researchand Development.*Our research and development expenseincreased to $4.1 million during the three month period ended June 30, 2007from $3.3 million for the three month period ended July 1, 2006. As apercentage of net sales, research and development expense increased to 3.9%during the three month period ended June 30, 2007 as compared to 3.4% for thethree months ended July 1, 2006 due to increased spending for new productdevelopment.

*InterestExpense.*Our interest expense increased to $14.1 millionduring the three month period ended June 30, 2007 compared to interest expenseof $8.0 million during the three month period ended July 1, 2006. This increasein interest expense is principally driven by increased borrowings to financethe Merger and Cefar acquisition and higher interest rates on our outstandingindebtedness.

*Provision(Benefit) for Income Taxes.*During the three month periodended June 30, 2007, we recorded approximately $5.6 million of income taxbenefit on pre-tax loss of approximately $13.6 million.  The tax benefit for these periods differedfrom that, which would have been recorded using the U.S. statutory tax rate duein part to the recording of foreign taxes and deferred taxes on the assumedrepatriation of foreign earnings.

*DiscontinuedOperations.*During the three month period ended June 30,2007, we recorded income from discontinued operations of approximately $28,000,which was attributable to our Slendertone®U.S. Consumer product line (“U.S. Consumer Product Line”) that was sold on June30, 2006.  During the three month periodended July 1, 2006, we reported a loss from discontinued operations ofapproximately $0.3 million.

*Netloss.*We had a net loss of $8.1 million during the threemonth period ended June 30, 2007 compared to a net loss of $0.8 million duringthe three month period ended July 1, 2006 due to the factors discussed above.

***Six Months EndedJune 30, 2007, compared to Six Months Ended July 1, 2006***

*NetSales.*Our net sales for the six month period ended June 30,2007 were $213.0 million, representing an increase of 16.5% from net sales of$182.8 million for the six month period ended July 1, 2006, driven by continuedgrowth in both our Orthopedic Rehabilitation and Surgical Implant Divisions andfrom sales of products we acquired in the Compex and Cefar acquisitions.

33

----

The following table setsforth the geographic mix of our net sales for the six month period ended June30, 2007 compared to the six month period ended July 1, 2006:
|                                             | ** ** | **Domestic**  | ** ** | **International** | ** ** | **Total**  | ** ** |
|---------------------------------------------|------------|---------------|------------|-------------------|------------|------------|------------|
| ** **                                  | ** ** | **Successor** | ** ** | **Predecessor**   | ** ** | **%**      | ** ** | **Successor** | ** ** | **Predecessor** | ** ** | **%** | ** ** | **Successor** | ** ** | **Predecessor** | ** ** | **%** | ** ** |
| **(In thousands, except %)** | ** ** | **2007**      | ** ** | **2006**          | ** ** | **Growth** | ** ** | **2007** | ** ** | **2006** | ** ** | **Growth** | ** ** | **2007** | ** ** | **2006** | ** ** | **Growth** | ** ** |
| Orthopedic  Rehabilitation Division         |       | $             | 124,634    |              | $          | 116,665    |       | 6.8 | % | $ | 54,881 |   | $ | 35,451 |   | 54.8 | % | $ | 179,515 |   | $ | 152,116 |   | 18.0 | % |
| Surgical Implant  Division                  |       | 28,643        |       | 26,816            |       | 6.9        | %          | 4,802 |   | 3,896 |   | 23.3 | % | 33,445 |   | 30,712 |   | 8.9 | % |
| Total                                       |       | $             | 153,277    |              | $          | 143,481    |       | 6.8 | % | $ | 59,683 |   | $ | 39,347 |   | 51.7 | % | $ | 212,960 |   | $ | 182,828 |   | 16.5 | % |

 

Net sales in ourOrthopedic Rehabilitation Division of $179.5 million during the six monthperiod ended June 30, 2007 represents an increase of 18.0% over net sales of$152.1 million during the six month period ended July 1, 2006, led by continuedgrowth across our rehabilitation product lines. During the six month periodended June 30, 2007, the division also benefited from six months of revenuecontribution from our Cefar acquisition and an additional two months of revenuefrom our Compex acquisition during the six month period ended June 30, 2007, ascompared to the prior year period.

Net sales in our SurgicalImplant Division increased to $33.4 million from $30.7 million during the sixmonth period ended June 30, 2007, representing an 8.9% increase over the prioryear period, driven primarily by growth in our international business. DomesticSurgical Implant Division net sales for the six months ended June 30, 2007increased 6.9% to $28.6 million compared to $26.8 million for the six monthsended July 1, 2006 and were negatively impacted by reduced sales from our cycloneproduct line that was sold during the first quarter of 2007. Internationalsales of $4.8 million for the six months ended June 30, 2007 increased 23.3%compared to the same period in the prior year when sales were $3.9 million dueto increasing penetration of existing and new international markets.

For the six months endedJune 30, 2007, sales of new products, which are products that have been on themarket less than one year, were $11.6 million compared to new product sales of$13.2 million during the six months ended July 1, 2006.

*GrossMargin.*Our consolidated gross margin as a percentage of netsales decreased to 58.3% during the six month period ended June 30, 2007compared to 60.1% during the six month period ended July 1, 2006 and wasnegatively impacted by $7.1 million of expense related to the write up to fairmarket value of inventory in connection with the Merger.  Our Orthopedic Rehabilitation Division grossmargin of 56.7% compared to gross margin of 56.6% for the six months ended July1, 2006 was negatively impacted by $3.8 million of expense related to the writeup to fair market value of inventory in connection with the Merger. Both ourconsolidated gross margin and our Orthopedic Rehabilitation Division grossmargin for the six month period ended July 1, 2006 were impacted by a charge of$5.6 million related to accounts receivable acquired in the Compex acquisitionand by $846,000 of expense related to the write up to fair market value ofinventory acquired in the Compex acquisition. Our Surgical Implant Division gross margin decreased to 66.9% during thesix months ended June 30, 2007 compared to a gross margin of 77.1% for the sixmonths ended July 1, 2006, due primarily to $3.3 million of expense related tothe write up to fair market value of inventory in connection with the Mergerand an increase in international sales, which generate comparatively lowergross margins than domestic sales.

*Selling,General and Administrative.*Our selling, general andadministrative expenses increased to $115.7 million during the six month periodended June 30, 2007 from $85.8 million during the six month period ended July1, 2006. As a percentage of net sales, selling, general and administrativeexpense increased to 54.3% from 46.9% in the prior year primarily due toadditional expenses associated with the addition of Compex and Cefar, highercommissions due to increased sales and changes to compensation plans related toongoing integration, higher intangible amortization expense incurred inconnection with the Merger, and higher expenses related to acquisitionintegration activities.

*Researchand Development.*Our research and development expense of $7.7million during the six month period ended June 30, 2007 decreased from $10.1million of research and development expense during the six month period endedJuly 1, 2006. The decrease in research and development expense is driven byin-process research and development (“IPR&D”) costs of $4.0 millionassociated with the Compex acquisition in the prior year.  Excluding the impact of this expense,research and development costs increased $1.6 million as compared to the prioryear period.  In addition, as apercentage of net sales, research and development expense increased to 3.6%during the six month period ended June 30, 2007 as compared to 3.3% (excludingthe impact of IPR&D) for the six months ended July 1, 2006. The increase isdue to the addition of Compex and Cefar research and development expense alongwith increased spending for new product development.

34

----

*InterestExpense.*Our interest expense increased to $28.1 millionduring the six month period ended June 30, 2007 compared to interest expense of$15.5 million during the six month period ended July 1, 2006. This increase ininterest expense was principally driven by increased borrowings to finance theMerger and Cefar acquisition and higher interest rates on our outstandingindebtedness.

*Provision(Benefit) for Income Taxes.*During the six month period endedJune 30, 2007, we recorded approximately $7.9 million of income tax benefit onpre-tax loss of approximately $27.0 million. The tax benefit for these periods differed from that, which would havebeen recorded using the U.S. statutory tax rate due in part to the recording offoreign taxes and deferred taxes on the assumed repatriation of foreignearnings.

*DiscontinuedOperations.*During the six month period ended June 30, 2007,we reported income from discontinued operations of approximately $28,000 whichwas attributable to our U.S. Consumer Product Line that was sold on June 30,2006.  During the six month period endedJuly 1, 2006, we reported a loss from discontinued operations of approximately$0.4 million.

*Netloss.*We had a net loss of $19.2 million during the six monthperiod ended June 30, 2007 compared to a net loss of $3.3 million during thesix month period ended July 1, 2006 due to the factors discussed above.

**Critical Accounting Policies andEstimates**

Our management’sdiscussion and analysis of financial condition and results of operations isbased upon our financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, we evaluate our estimates, including those related to revenuerecognition, goodwill and intangible assets, deferred tax assets andliabilities, and inventory. We base our estimates on historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. To the extent that actual events differ from our estimatesand assumptions, there could be a material impact to our financial statements.

***Revenue Recognition***

We recognize revenue when(1) persuasive evidence of an arrangement exists, (2) the price is fixed ordeterminable, (3) delivery has occurred and (4) collectibility is reasonablyassured.

We sell our OrthopedicRehabilitation Division products through a variety of distribution channels. Wesell our clinical rehabilitation products to dealers. We record sales at thetime the product is shipped to the dealer. Dealers take title to the products,assume credit and product obsolescence risks, must pay within specified periodsregardless of when they sell or use the products and have no price protection.We sell our home therapy products to wholesale customers and directly topatients. We recognize wholesale revenue when we ship our products to ourwholesale customers. We recognize home therapy retail revenue, both rental andpurchase, when our product has been dispensed to the patient and the patient’sinsurance has been verified. We recognize revenue for product shipped directlyto the patient at the time of shipment. For retail products that are sold fromour inventories consigned at clinic locations, we recognize revenue when wereceive notice that the device has been prescribed and dispensed to thepatient, and the insurance has been verified or preauthorization from theinsurance company has been obtained, when required.

We sell our SurgicalImplant Division products through a network of independent salesrepresentatives in the United States and through distributors outside theUnited States. We record revenues from sales made by sales representatives, whoare paid commissions upon the ultimate sale of the products, at the time theproduct is used in a surgical procedure (implanted in a patient). We recordrevenues from sales to customers outside the United States at the time theproduct is shipped to the distributor. Our international distributors, who sellthe products to their customers, take title to the products, have no rights ofreturn and assume the risk for credit and obsolescence. Our internationaldistributors are obligated to pay us within specified terms, regardless of whenthey sell the products. In addition, there is no price protection available todistributors.

*Reservesfor Sales Allowances, Product Returns and Rental Credits*. Wehave established reserves to account for sales allowances, product returns andreserves for rental credits. Significant management judgment must be used andestimates must be made in connection with establishing the reserves for salesallowances, product returns, rental credits and other allowances in anyaccounting period.

35

----

Our reserves for salesallowances account for sales of our products below the invoice price. Thesesales generally result from agreements that we enter into with certaincustomers that permit them to pay us for our products in amounts that are belowthe invoice price of the product. We estimate the amount of the reduction basedon historical experience and invoices generated in the period, and we considerthe impact of new contract terms or modifications of existing arrangements withour customers. We provide for these reserves by reducing our gross revenue.

Our reserve for productreturns accounts for customer returns of our products after purchase. Thesereturns are mainly attributable to a third-party payor’s refusal to provide apatient release or reimbursement for the product or the inability of the productto adequately address the patient’s condition. We provide for this reserve byreducing gross revenue by an amount based on our historical rate of returns.

Our reserve for rentalcredit recognizes a timing difference between billing of a purchase and processingof a rental credit associated with some of our rehabilitation devices. Manyinsurance providers require patients to rent our rehabilitation devices for aperiod of one to three months prior to purchase. If the patient has a long-termneed for the device, these insurance companies may authorize purchase of thedevice after such time period. When the device is purchased, most providersrequire that rental payments previously made on the device be credited towardthe purchase price. These credits are processed at the time the payment isreceived for the purchase of the device, which creates a time lag betweenbilling of the purchase and processing of the rental credit. Our rental creditreserve accounts for unprocessed rental credits based on the number of devicesconverted to purchase. The reserve is calculated by first assessing the numberof our products being rented during the relevant period and our historicalconversion rate of rentals to sales, and then reducing our revenue by theapplicable amount. We provide for these reserves by reducing our gross revenue.The cost to refurbish rented products is expensed as incurred as part of costof sales.

*Reservefor Uncollectible Accounts Receivable.*In addition to thereserves for sales allowances, returns and rental credits, we have alsoestablished a reserve for the portion of accounts receivable that we estimatewill not be collected because of our customers’ and patients’ nonpayment. Thereserve is based on historical trends and current relationships with ourcustomers and providers. Changes in our collection rates can result from anumber of factors, including turnover in personnel, changes in the paymentpolicies or practices of payors or changes in industry rates or pace ofreimbursement. Additions to this reserve are reflected in selling, general andadministrative expense.

***Goodwill andIntangible Assets***

We must make estimatesrelated to the initial recognition and measurement of intangible assetsacquired in connection with a business combination or asset acquisition, aswell as the ongoing measurement of the useful life and value of intangibleassets and goodwill. With respect to valuations of intangible assets acquiredin connection with a business combination or asset acquisition, we use externalthird-party evaluations in determining the respective fair values and relativeallocations of acquisition cost to the assets acquired and liabilities assumed.We periodically evaluate whether events and circumstances have occurred whichmay affect the estimated useful life, or the recoverability of the remainingbalances of our goodwill and other intangible assets. If such events orcircumstances were to indicate that the carrying amount of those assets wouldnot be recoverable, we would estimate the future cash flows expected to resultfrom the use of the assets and their eventual disposition. In the fourthquarter of each year we will perform an annual test of our goodwill andintangible assets for potential impairment. The process of evaluating the potentialimpairment is subjective and requires us to exercise judgment in makingassumptions related to future cash flows and discount rates. If the sum of theexpected future cash flows (undiscounted and without interest charges) are lessthan the carrying amount of goodwill and other long-lived assets, we wouldrecognize an impairment loss.

Any impairment of anintangible asset or goodwill would require a reduction in the value of theasset on our consolidated balance sheet and a charge to operating income on ourconsolidated statement of operations. The nature of the charge to operatingincome would be determined based upon the nature of the intangible asset orgoodwill requiring the adjustment.

36

----

***Deferred Tax AssetValuation Allowance***

We recognize deferred taxassets and liabilities based on the differences between the financial statementcarrying amount and the tax bases of assets, liabilities and net operating losscarry forwards. We establish valuation allowances when the recovery of adeferred tax asset is not likely based on historical income, projected futureincome, the expected timing of the reversals of temporary differences and theimplementation of tax-planning strategies.

Our gross deferred taxasset balance was approximately $50.7 million at June 30, 2007 and primarilyrelates to receivable and inventory reserves, accrued compensation, and netoperating loss carry forwards. As of June 30, 2007, we recorded a valuationallowance of $6.1 million due to uncertainties related to our ability torealize certain foreign net operating loss carry forwards.

***Inventory Reserves***

The nature of ourbusiness requires us to maintain sufficient inventory on hand at all times tomeet the requirements of our customers. We record inventory at the lower ofcost or market, with cost based upon average actual cost. We maintain inventoryreserves for slow moving or excess inventory, product obsolescence and declinesin value. In each division, we use a specific identification methodology,adjustments to which can occur whenever there is a change in strategy. Inaddition, we review sales performance on at least a quarterly basis todetermine the amounts that we should add to the existing reserve. We monitorreserves on a quarterly basis and make changes when necessary. To determine theadequacy of our reserves at each reporting period, we analyze the following,among other factors:

·             current inventory quantities on hand;

·             product acceptance in the marketplace;

·             customer demand;

·             historical sales;

·             forecasted sales;

·             product obsolescence; and

·             technological innovations.

If there is a materialchange due to the factors listed above, the current level of the reserve forinventory may not be adequate and would result in our increasing the reservelevel. Any modifications to our estimates of our reserves are reflected in costof sales within the statement of operations during the period in which suchmodifications are determined necessary by management.

Our OrthopedicRehabilitation Division consigns a portion of its inventory to clinics andother healthcare provider locations to allow its products to be immediatelydispensed to patients. Our Surgical Implant Division products are sold in theUnited States at the time the product is used in a surgical procedure. As such,this division also consigns product at many locations throughout the country.This requires a large amount of inventory to be on hand for the products wesell on consignment. It also increases the sensitivity of these products toobsolescence reserve estimates. As this inventory is not in our possession, wealso reserve for these products based on the results of periodic inventorycounts and historical trends.

**Recent Accounting Pronouncements**

In June 2006, the FASBissued FIN 48. This interpretation clarifies the accounting for uncertainty inincome taxes recognized in an enterprise’s financial statements in accordancewith FAS 109, “Accounting for Income Taxes.” This interpretation prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. This interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. The interpretation is effective for fiscal yearsbeginning after December 15, 2006. The Company has adopted this interpretationas of the beginning of fiscal 2007 (see Note 2).

37

----

In September 2006, theFASB issued FAS 157, “Fair Value Measurements” which defines fair value,establishes a framework for measuring fair value in GAAP and expands disclosureabout fair value measurements. The statement is effective for fiscal yearsbeginning after November 15, 2007. The Company will adopt this statement as ofthe beginning of fiscal 2008 and is currently assessing the potential impact ofadoption.

In February 2007, theFASB issued FAS 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—Including an amendment to FASB Statement No. 115” which permitsentities to choose to measure many financial instruments and certain otheritems at fair value that are not currently required to be measured at fairvalue. The statement is effective for fiscal years beginning after November 15,2007. The Company will adopt this statement as of the beginning of fiscal 2008and is currently assessing the potential impact of adoption.

**Liquidity and Capital Resources**

Cash flows for the sixmonths ended June 30, 2007 and July 1, 2006 are as follows (in thousands):
| ** **                                            | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                            | ** ** | **Successor**                  | ** ** | **Predecessor** | ** ** |
| ****                                                  | ** ** | **June 30,  2007**        | ** ** | **July 1,  2006** | ** ** |
| Cash (used in)  provided by operating activities      |       | $                              | (7,924     | ) | $ | 5,462 |   |
| Cash used in  investing activities                    |       | (10,336                        | )          | (8,643 | ) |
| Cash provided by  financing activities                |       | 10,058                         |       | 7,897 |   |
| Effect of  exchange rate on cash and cash equivalents |       | 166                            |       | 336 |   |
| Net (decrease)  increase in cash and cash equivalents |       | $                              | (8,036     | ) | $ | 5,052 |   |

 

***Cash Flows***

During the six monthperiod ended June 30, 2007, our operating activities used $7.9 million of cashas compared to the six months ended July 1, 2006, when our operating activitiesprovided cash of $5.5 million, resulting in a decrease in cash of $13.4million. The decrease in cash used by operations during the first six months of2007 as compared to the same period in the prior year is primarily due tointerest payments on newly issued debt and increased expenses related toacquisition integration. Our net loss, adjusted for non-cash items, used $1.3million of cash during 2007, which represents a decrease of $18.6 millioncompared to our net loss for the first six months ended July 1, 2006, adjustedfor non-cash items, which provided $17.3 million of operating cash flow.Discontinued operations provided $0.4 million of cash during the six monthperiod ended June 30, 2007 as compared to $0.7 million of cash used during thesix month period ended July 1, 2006, resulting in a net increase in cash flowfrom discontinued operations of $1.1 million in 2007 as compared to 2006. Ourgross accounts receivable used $13.2 million of cash during the six monthsended June 30, 2007 while in the same period in the prior year our grossaccounts receivable used $2.3 million of cash, resulting in a net decrease incash flow of $10.9 million. Our gross inventory provided $4.3 million of cashduring the six month period ended June 30, 2007 compared to a use of $8.3million of cash during the six month period ended July 1, 2006, resulting in anet increase in cash flow of $12.6 million. In addition, our prepaid expenses,other assets and liabilities used $5.1 million of cash during the six monthperiod ended June 30, 2007 compared to the six month period ended July 1, 2006when prepaid expenses, other assets and liabilities provided $2.8 million ofcash, resulting in a decrease in cash flow of $7.9 million. Finally, ouroutstanding balances of accounts payable and accrued liabilities provided cashof $7.0 million during the six month period ended June 30, 2007, compared toour outstanding balances of accounts payable and accrued liabilities using $3.4million of cash during the six month period ended July 1, 2006, resulting in anincrease in cash flow of $10.4 million.

Investing activities used$10.3 million of cash during the six months ended June 30, 2007, compared to$8.6 million during the six months ended July 1, 2006, representing a $1.7million increase in cash used for investing activities. During the six monthsended June 30, 2007 we used $7.7 million of cash for acquisition activitiescompared to $1.5 million during the six months ended July 1, 2006. We alsoreceived $4.5 million of cash as proceeds primarily from the sale of assetsheld for sale during the six months ended June 30, 2007 compared to $0.1million during the six months ended July 1, 2006. In addition, we used $7.1million to purchase property and equipment during the six months ended June 30,2007 while during the six months ended July 1, 2006 we used $7.0 million,representing an increase of $0.1 million.

38

----

Cash provided byfinancing activities during the six month period ended June 30, 2007 of $10.1million increased by $2.2 million compared to the six month period ended July1, 2006, when cash provided by financing activities was $7.9 million. Our netborrowings or the difference between proceeds from borrowings and related debtpayments, provided $10.6 million of cash during the six month period ended June30, 2007, resulting in a net increase in cash from net borrowings of $6.3million compared to net proceeds of $4.3 million for the six months ended July1, 2006. During the six month period ended June 30, 2007, we drew $12.5 millionon our revolving credit agreement and also repaid $1.9 million of long-termdebt. During the six month period ended July 1, 2006, we borrowed $25.3 millionunder our revolving credit facility in connection with our Compex acquisition,and we paid $21.0 million on long-term borrowings, $17.3 million of whichrepresented a retirement of bank debt acquired from Compex. In addition, duringthe six month period ended July 1, 2006, we received approximately $2.6 millionin proceeds from stock option exercises principally by former Compexexecutives. We also received $1.0 million of excess tax benefit associated withthe exercise of these stock options. Finally, our partially owned subsidiary,Medereha GmbH paid a dividend of $0.2 million to minority interests during thesix months ended June 30, 2007.

***Indebtedness***

As of June 30, 2007, wehad outstanding total indebtedness of approximately $565.2 million, and we hadan additional $37.5 million of available borrowings under our Senior CreditFacility. On July 2, 2007, in conjunction with the acquisition of The SaundersGroup, Inc. (see Note 17), we incurred additional term borrowings under ourSenior Credit Facility in the amount of $55.0 million.  Of the total net proceeds received, $41.5million was used to fund the acquisition and related expenses, $12.5 millionwas used to pay off the balance due on our revolving credit facility as of June30, 2007 which is classified as long-term on our unaudited condensedconsolidated balance sheet, and the remaining proceeds will be used for generalcorporate purposes.

We believe that ourexisting cash, plus the cash we expect to generate from operations andborrowings available under our Senior Credit Facility, will be sufficient tomeet our operating needs for the next twelve months, including working capitalrequirements, capital expenditures, debt repayment obligations and potentialnew product or business acquisitions. While we currently are in compliance withall of our financial covenants imposed by our Senior Credit Facility, there isno assurance that we will continue to remain in compliance in the future.  If we do not remain in compliance, there isno assurance that we will be able to obtain from our lenders, waivers ofdefault or amendments to the Senior Credit Facility in the future.

We have continued toexpand our business through selected acquisitions of businesses or products inthe orthopedic industry. We have completed eight acquisitions since 2001 thathave allowed us to expand our business in the orthopedic devices market toinclude rehabilitation equipment, to expand our business in the Europeanorthopedic rehabilitation market and to expand our surgical implant productofferings. We have a history of raising capital through a combination of debtand equity offerings to finance these acquisitions. As additional financingneeds arise, we may consider sources of financing to include a combination ofdebt or equity. We may issue debt or equity in anticipation of future financingneeds, to position our capital structure towards a certain debt-to-equity rangeor to replace existing borrowing agreements.

Weand our subsidiaries, affiliates or significant shareholders (including TheBlackstone Group L.P. and its affiliates) may from time to time, in our ortheir sole discretion, purchase, repay, redeem or retire any of our outstandingdebt or equity securities (including any publicly issued debt or equitysecurities), in privately negotiated or open market transactions, by tenderoffer or otherwise.

*Senior Credit Facility*

*Overview.*Our Senior Credit Facility consists of a $350.0 million termloan facility and a $50.0 million revolving credit facility. The revolvingcredit facility includes borrowing capacity available for letters of credit andfor borrowings on same-day notice, referred to as the swing line loans. Inaddition, we are permitted, subject to receipt of additional commitments fromparticipating lenders and certain other conditions, to incur up to anadditional $150.0 million of borrowings under our Senior Credit Facility, ofwhich $55.0 million was drawn subsequent to the end of the quarter andconverted to a term loan in connection with the Saunders acquisition.

*InterestRate and Fees.*Borrowings under the Senior Credit Facilitybear interest at a rate equal to an applicable margin plus, at our option,either (a) a base rate determined by reference to the higher of (1) the primerate of Bank of America, N.A. and (2) the federal funds rate plus 0.50% or (b)the Eurodollar rate determined by reference to the costs of funds for depositsin U.S. Dollars for the interest period relevant to such borrowing adjusted formaximum reserves. The initial applicable margin for borrowings under the term 

39

----

loan facility and the revolving credit facility are1.50% with respect to base rate borrowings and 2.50% with respect to Eurodollarborrowings. The applicable margin for borrowings under each facility may bereduced subject to our attaining certain leverage ratios.

In addition to payinginterest on outstanding principal under the Senior Credit Facility, we arerequired to pay a commitment fee to the lenders under the revolving creditfacility in respect of the unutilized commitments thereunder. The initial commitmentfee rate is 0.50% per annum. The commitment fee rate may be reduced subject toour attaining certain leverage ratios. We must also pay customary letter ofcredit fees.

*Amortization.*We are required to pay annual amortization (payable in equalquarterly installments) on the loans under the term loan facility in an amountequal to 1.00% of our funded total principal amount during the first six yearsand nine months following the closing of the Senior Credit Facility, with theremaining amount payable at maturity which is November 3, 2013.

Principal amountsoutstanding under the revolving credit facility are due and payable in full atmaturity, which is November 3, 2012.

*CertainCovenants and Events of Default.*The Senior Credit Facilitycontains a number of covenants that, among other things, restrict, subject tocertain exceptions, our (and most or all of our subsidiaries’) ability to:

·             incur additional indebtedness or issuepreferred stock;

·             create liens on assets;

·             enter into sale and leasebacktransactions;

·             engage in mergers or consolidations;

·             sell assets;

·             pay dividends and other restrictedpayments;

·             make investments, loans or advances;

·             make capital expenditures;

·             repay subordinated indebtedness (includingthe 11.75% Notes);

·             make certain acquisitions;

·             engage in certain transactions withaffiliates;

·             amend material agreements governing oursubordinated indebtedness (including the 11.75% Notes);

·             enter into certain burdensome agreements;

·             change our lines of business; and

·             change the status of Holdings as a passiveholding company.

In addition, pursuant tothe terms of the credit agreement relating to the Senior Credit Facility, weare required to maintain a consolidated total debt to Adjusted EBITDA ratio (ortotal leverage ratio) starting at a maximum of 8.00:1 and stepping down overtime to 4.75:1 by the end of 2013 and an Adjusted EBITDA to consolidatedinterest expense ratio (or interest coverage ratio) starting at a minimum of1.25:1 and stepping up over time to 1.80:1 by the end of 2013. We are subjectto these financial covenants beginning as of the twelve month period endingJune 30, 2007.

40

----

The Senior CreditFacility also contains certain customary affirmative covenants and events ofdefault.

*11.75% Senior Subordinated Notes*

The Indenture limits our(and most or all of our subsidiaries’) ability to:

·             incur additional debt or issue certain preferredshares;

·             pay dividends on or make otherdistributions in respect of our capital stock or make other restrictedpayments;

·             make certain investments;

·             sell certain assets;

·             create liens on certain assets to securedebt;

·             consolidate, merge, sell or otherwisedispose of all or substantially all of our assets;

·             enter into certain transactions with ouraffiliates; and

·             designate our subsidiaries as unrestrictedsubsidiaries.

Subject to certainexceptions, the Indenture permits us and our restricted subsidiaries to incuradditional indebtedness, including secured indebtedness.

*Covenant Compliance*

As described above, theSenior Credit Facility and the Indenture contain various covenants that limitour ability to engage in specified types of transactions. In addition, underthe Senior Credit Facility, we are required to satisfy and maintain specifiedfinancial ratios, and under the Indenture, our ability to engage in activitiessuch as incurring additional indebtedness, making investments and paying dividendsis tied to ratios based on Adjusted EBITDA. As of June 30, 2007, we were in compliance with all applicablecovenants.

Adjusted EBITDA isdefined as EBITDA further adjusted to exclude non-cash items, non-recurringitems and other adjustment items permitted in calculating covenant complianceunder the Senior Credit Facility and the Indenture. We believe that theinclusion of supplementary adjustments to EBITDA applied in presenting AdjustedEBITDA is appropriate to provide additional information to investors todemonstrate compliance with our financing covenants.

Adjusted EBITDA does notrepresent net loss or cash flow from operations as those terms are defined byGAAP and does not necessarily indicate whether cash flows will be sufficient tofund cash needs. In particular, the definition of Adjusted EBITDA in theIndenture and the Senior Credit Facility allows us to add back certainnon-cash, extraordinary, unusual or non-recurring charges that are deducted incalculating net loss. However, these are expenses that may recur, vary greatlyand are difficult to predict. While Adjusted EBITDA and similar measures arefrequently used as measures of operations and the ability to meet debt servicerequirements, Adjusted EBITDA is not necessarily comparable to other similarlytitled captions of other companies due to the potential inconsistencies in themethod of calculation.

Our ability to continueto meet the covenants specified above in future periods will depend on eventsbeyond our control, and we cannot assure you that we will continue to meetthose ratios. A breach of any of these covenants in the future could result ina default under the Senior Credit Facility and the Indenture, at which time thelenders could elect to declare all amounts outstanding under the Senior CreditFacility to be immediately due and payable. Any such acceleration would alsoresult in a default under the Indenture.

The following tableprovides a reconciliation from our net loss to EBITDA and Adjusted EBITDA forthe three and twelve months ended June 30, 2007. The terms and relatedcalculations are defined in the credit agreement relating to the Senior CreditFacility and the Indenture.

41

----

 
|                                | ** ** | **(unaudited)**                                       | ** ** |
|--------------------------------|------------|-------------------------------------------------------|------------|
| **(in thousands)**        | ** ** | **Three Months  Ended June 30,  2007** | ** ** | **Twelve Months  Ended June 30,  2007** | ** ** |
| Net loss                       |       | $                                                     | (8,077     | ) | $ | (104,266 | ) |
| Interest  expense, net         |       | 13,841                                                |       | 46,214 |   |
| Income tax  benefit            |       | (5,604                                                | )          | (29,580 | ) |
| Depreciation and  amortization |       | 9,770                                                 |       | 32,132 |   |
| EBITDA                         |       | 9,930                                                 |       | (55,500 | ) |
| Non-cash items  (a)            |       | 3,804                                                 |       | 56,466 |   |
| Non-recurring  items (b)       |       | 1,911                                                 |       | 16,129 |   |
| Other adjustment  items (c)    |       | 7,844                                                 |       | 54,885 |   |
| Adjusted EBITDA                |       | $                                                     | 23,489     |   | $ | 71,980 |   |

 

 (a) Non-cash items are comprised of thefollowing:
|                                       | ** ** | **(unaudited)**                                       | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|
| ****                                  | ** ** | **Three Months  Ended June 30,  2007** | ** ** | **Twelve Months  Ended June 30,  2007** | ** ** |
| Stock  compensation expense           |       | $                                                     | 620        |   | $ | 9,761 |   |
| Loss on  disposition of assets        |       | 125                                                   |       | 481 |   |
| Loss on early  extinguishment of debt |       | —                                                |       | 9,154 |   |
| Purchase  accounting adjustments (1)  |       | 3,059                                                 |       | 36,004 |   |
| Loss on asset  impairment (2)         |       | —                                                |       | 1,066 |   |
| Total non-cash  items                 |       | $                                                     | 3,804      |   | $ | 56,466 |   |

 

----

(1)         Represents $3.1 millionof expense related to the write-up to fair market value of acquired inventoryin connection with the Merger and the Cefar acquisition for the three monthsended June 30, 2007. Represents $25.1 million of expense related to thewrite-off of IPR&D and $10.9 million of expense related to the write-up tofair market value of inventory acquired in connection with the Compexacquisition, Cefar acquisition and the Merger during the twelve months endedJune 30, 2007.

(2)          Represents$1.1 million of expense related to the impairment of certain applicationsoftware that will not be placed in service.

 (b)   Non-recurring items arecomprised of the following:
|                                  | ** ** | **(unaudited)**                                       | ** ** |
|----------------------------------|------------|-------------------------------------------------------|------------|
| ** **                       | ** ** | **Three Months  Ended June 30,  2007** | ** ** | **Twelve Months  Ended June 30,  2007** | ** ** |
| Employee  severance (1)          |       | $                                                     | 75         |   | $ | 1,247 |   |
| Restructuring  expense (2)       |       | 1,846                                                 |       | 11,685 |   |
| Other (3)                        |       | (10                                                   | )          | 3,197 |   |
| Total  non-recurring adjustments |       | $                                                     | 1,911      |   | $ | 16,129 |   |

 

----

(1)         Represents employeeseverance expense incurred by RTI in connection with the Compex acquisition andthe Merger.

(2)         Expense for the threemonths ended June 30, 2007 includes $0.7 million of integration costs incurredin connection with the Compex acquisition and $1.1 million of integration costsincurred in connection with the Cefar acquisition. Expense for the twelvemonths ended June 30, 2007 represents (i) $6.5 million of expense related tofield selling, information technology, operations and product line consolidationincurred in connection with the integration of Compex, (ii) $1.5 million ofinventory reserves related to the discontinuation of certain products acquiredfrom Osteoimplant Technology, Inc. (“OTI”) in February 2005, (iii) $2.8 millionof integration expenses related to the Cefar acquisition, and (iv) $0.9 millionfor restructuring advisory fees related to the Merger.

42

----

(3)         Other expenses for thetwelve months ended June 30, 2007 includes $3.2 million of other non-recurringexpenses, including provisions made for litigation settlements and additionalproduct liability claims.

 (c)     Other adjustment items arecomprised of the following:
|                                     | ** ** | **(unaudited)**                                       | ** ** |
|-------------------------------------|------------|-------------------------------------------------------|------------|
| ****                                | ** ** | **Three Months  Ended June 30,  2007** | ** ** | **Twelve Months  Ended June 30,  2007** | ** ** |
| Transaction  expenses (1)           |       | $                                                     | 1,290      |   | $ | 26,123 |   |
| Compex  acquisition adjustments (2) |       | —                                                |       | 20,986 |   |
| Minority  interest                  |       | 88                                                    |       | 250 |   |
| Pre-acquisition  EBITDA (3)         |       | —                                                |       | 853 |   |
| Discontinued  operations            |       | (28                                                   | )          | 179 |   |
| Subtotal other items                |       | 1,350                                                 |       | 48,391 |   |
| Cost savings (4)                    |       | 6,494                                                 |       | 6,494 |   |
| Total other  items                  |       | $                                                     | 7,844      |   | $ | 54,885 |   |

 

----

(1)         Expenses for the threemonths ended June 30, 2007 include $0.8 million for monitoring fees paid toBlackstone and $0.5 million for legal, advisory, and consulting expensesrelated to the Merger. Expenses for the twelve months ended June 30, 2007include $15.8 million of legal, advisory, consulting, and related expensesincurred in connection with the closing of the Merger, $4.6 million formonitoring fees paid to Blackstone, $5.5 million of management retentionbonuses paid at the closing of the Merger, and $0.2 million of merger andacquisition related expenses.

(2)         Represents adjustmentsand additional reserves related to the Compex acquisition and operations. Theamounts principally include $19.8 million of additional accounts receivablereserves.  During December 2006, thedecision was made to outsource the Compex accounts receivable collection effortto a third party. Based on collection estimates provided by the third partycollection company, in the fourth quarter of 2006, we recorded an additionaladjustment to the carrying value of accounts receivable in the amount of $19.8million.

(3)         Represents EBITDA of (i)$0.2 million from June 30, 2006 to February 16, 2007 related to the PerformanceModalities, Inc. (“PMI”) acquisition, (ii) $0.2 million from June 30, 2006 toApril 13, 2007 for the Endeavor Medical Inc. (“Endeavor”) acquisition, and(iii) $0.5 million of EBITDA from June 30, 2006 to November 7, 2006 primarilyrelated to the Cefar acquisition, which is included in the calculation ofAdjusted EBITDA for the twelve months ended June 30, 2007 pursuant to thedefinition of Adjusted EBITDA contained in the credit agreement relating to theSenior Credit Facility and the Indenture.

(4)         Includes projected costsavings of $1.2 million related to actions already taken in connection with theCompex acquisition. Such savings primarily relate to the consolidation ofmanufacturing, general and administrative and related operations. Also includes(i) projected cost savings of $4.7 million related to actions initiated inconnection with the Cefar acquisition, principally related to facility andgeneral and administrative consolidation and (ii) $0.6 million of projectedcost savings, principally from actions initiated in connection with theEndeavor acquisition and procurement savings related to purchases of certainproduct components, freight, and copier equipment.

43

----

Our covenant requirements and ratios as of June 30,2007 are as follows:
|                                                                                                                 | ** ** | **Covenant  Requirements** | ** ** | **Actual Ratios** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| **Senior  Credit Facility (1)**                                                                                 |       |                       |       |                   |       |
| Consolidated total debt to Adjusted EBITDA                                                                      |       | 8.00:1                     |       | 7.52:1                 |       |
| Adjusted EBITDA to consolidated interest expense                                                                |       | 1.25:1                     |       | 1.41:1                 |       |
| **11.75%  Notes (2)**                                                                                           |       |                       |       |                   |       |
| Minimum Adjusted  EBITDA to fixed charges ratio required to incur additional debt pursuant to  ratio provisions |       | 2.00:1                     |       | 1.41:1                 |       |

 

----

(1)         Beginning with the twelvemonth period ending June 30, 2007, the Senior Credit Facility requires us tomaintain a consolidated total debt to Adjusted EBITDA ratio starting at amaximum of 8.00:1 and stepping down over time to 4.75:1 by the end of 2013 andan Adjusted EBITDA to consolidated interest expense ratio starting at a minimumof 1.25:1 and stepping up over time to 1.80:1 by the end of 2013. Consolidatedtotal debt is defined as aggregate consolidated indebtedness of Holdings, RTFL andthe restricted subsidiaries less the aggregate amount of all cash and cashequivalents, free and clear of all liens subject to certain exceptions, andconsolidated interest expense is defined as consolidated cash interest expenseless cash interest income and further adjusted for certain noncash ornonrecurring interest expense, under the Senior Credit Facility.

(2)         Our ability to incuradditional debt and make certain restricted payments under the Indenture,subject to specified exceptions, is tied to an Adjusted EBITDA to fixed chargesratio of at least 2.00:1, except that we may incur certain debt and makecertain restricted payments and certain permitted investments without regard tothe ratio, such as our ability to (i) incur up to an aggregate principal amountof $400.0 million under credit facilities, plus the lesser of (a) $50.0 millionand (b) an amount equal to the aggregate amount of our EBITDA for the fourfiscal quarters for which internal financial statements are availableimmediately preceding such date times five, with appropriate pro formaadjustments to EBITDA on the date on which such indebtedness is to be incurredless the amount of our secured indebtedness outstanding on the date of suchincurrence, (ii) acquire persons engaged in a similar business that becomesrestricted subsidiaries and (iii) make other investments having an aggregatefair market value not to exceed 3.5% of total assets provided that the AdjustedEBITDA to fixed charges ratio is less than 6.00:1 on a pro forma basis aftergiving effect to such investment. Fixed charges is defined in the Indenture asconsolidated interest expense plus all cash dividends or other distributions paidon any series of preferred stock of any restricted subsidiary and all dividendsor other distributions accrued on any series of disqualified stock.

**Forward Looking Statements**

The foregoing management’sdiscussion and analysis contains “forward looking statements” within themeaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934 that represent our expectations or beliefsconcerning future events, including, but not limited to, statements regardinggrowth in sales of our products, profit margins and the sufficiency of our cashflow for future liquidity and capital resource needs. These forward-lookingstatements are further qualified by important factors that could cause actualresults to differ materially from those in the forward-looking statements.These factors include, without limitation, the effect of competitive pricing,our dependence on the ability of our third-party manufacturers to producecomponents on a basis that is cost-effective to us, market acceptance of ourproducts, the ability to attract and retain competent employees, technologicalobsolescence of one or more products, changes in product strategies, theability to locate acceptable acquisition candidates and then finance andintegrate those acquisitions and effects of government regulation. Resultsactually achieved may differ materially from expected results included in thesestatements as a result of these or other factors.

**Recent Developments**

On August 9, 2007, RTIacquired IOMED, Inc. (“IOMED”), a leader in developing, manufacturing andmarketing active drug delivery systems used primarily to treat acute localinflammation in the physical and occupational therapy and sports medicinemarkets. Under the terms of the merger agreement dated May 17, 2007, IOMED wasmerged with Spartan Acquisition Corp., a newly formed subsidiary of RTI (the “IOMEDMerger”), and each share of IOMED common stock outstanding immediately prior tothe 

44

----

IOMED Merger was exchanged for $2.75 per share, fortotal cash consideration of approximately $22.0 million.  Direct acquisition costs for the transactionare estimated to be approximately $1.0 million.

OnJuly 15, 2007, RTI entered into an Agreement and Plan of Merger (the “DJOMerger Agreement”) with DJO Incorporated (“DJO”), a global provider ofsolutions for musculoskeletal and vascular health, specializing inrehabilitation and regeneration products for the non-operative orthopedic,spine and vascular markets.  Under theterms of the DJO Merger Agreement, an affiliate of RTI will acquire alloutstanding shares of DJO in a transaction valued at approximately $1.6billion, including the assumption of debt. The DJO Merger Agreement providesfor a cash payment of $50.25 per share, as adjusted, for each outstanding shareof DJO common stock outstanding immediately prior to the DJO Merger. Anaffiliate of Blackstone, the controlling shareholder of RTI,  has committed to provide the equity financingneeded to complete the transaction. Credit Suisse, Credit Suisse Securities (USA) LLC, Bank of America,N.A., Banc of America Bridge LLC, and Banc of America Securities LLC havecommitted to provide the debt financing needed to complete thetransaction.  Closing of the transactionis subject to conditions customary in a transaction of this type, includingapproval of the DJO Merger by the stockholders of DJO. Under the DJO MergerAgreement, DJO may solicit superior proposals from third parties during the 50calendar days ending on September 3, 2007. To the extent that a superiorproposal solicited during this period leads to the execution of a definitiveagreement, DJO would be obligated to pay a break-up fee to RTI of $18.7million.  We currently expect to closethe transaction in the fourth quarter of 2007.

On July 2, 2007, asubsidiary of RTFL completed its purchase of substantially all of the assets ofThe Saunders Group, Inc. for total cash consideration of $41.5 million,including $1.5 million of acquisition costs (the “Saunders Acquisition”). TheSaunders Group, Inc. is a supplier of rehabilitation products to physicaltherapists, chiropractors, athletes, athletic trainers, physicians andpatients, with a specialty in patented traction devices, back supports, andexercise equipment for neck and back disorders.

In connection with theSaunders Acquisition, RTFL entered into two amendments to the Senior CreditFacility. The first amendment is a technical amendment intended to clarifycertain portions of the Senior Credit Facility related to financial statementreporting requirements and to covenant compliance reporting requirements.  The second amendment is an incremental termloan amendment to borrow an additional $55.0 million term loan under the SeniorCredit Facility. RTFL borrowed the funds on July 2, 2007 in connection with theSaunders Acquisition. Approximately $41.5 million of the total proceeds wasused to fund the acquisition and related expenses, $12.5 million was used topay off the balance due on our revolving credit facility as of June 30, 2007,and the remaining proceeds will be used for general corporate purposes.

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

We are exposed to certainmarket risks as part of our ongoing business operations, primarily risks fromchanging interest rates and foreign currency exchange rates that could impactour financial condition, results of operations, and cash flows.

***Interest Rate Risk***

Our primary exposure isto changing interest rates. We are exposed to interest rate risk in connectionwith our Senior Credit Facility, which bears interest at floating rates basedon Bank of America’s prime rate plus 0.5% or Eurodollar rate adjusted formaximum reserves. Our outstanding balance under the Senior Credit Facility was$359.9 million as of June 30, 2007. We have historically managed our interestrate risk by balancing the amount of fixed and variable debt. For fixed ratedebt, interest rate changes affect the market value, but do not impact earningsor cash flow. Conversely, for variable rate debt, interest rate changesgenerally do not affect the fair market value, but do impact future earningsand cash flow, assuming other factors are held constant. In February 2007, weswapped variable rates for fixed rates on $175.0 million of the borrowingsunder the Senior Credit Facility, thereby locking in a fixed rate on thisportion of the principal. A hypothetical 1% increase in variable interest ratesfor the Senior Credit Facility would have impacted our earnings and cash flow,for the quarter ending June 30, 2007, by approximately $460,000. We may useadditional derivative financial instruments where appropriate to manage ourinterest rate risk. However, as a matter of policy, we do not enter intoderivative or other financial investments for trading or speculative purposes.

***Foreign CurrencyRisk***

As we continue to expandour business through acquisitions and organic growth, the sales of our productsin European markets that are denominated in foreign currencies has increased.As a result, the impact of currency fluctuations on our operating results has 

45

----

increased. During the first six months of 2007, ouraverage monthly sales denominated in foreign currencies was approximately $8.3million of which $7.9 million was derived from Euro denominated sales.

In addition, our exposureto fluctuations in foreign currencies arises because certain of oursubsidiaries’ results are recorded in currencies other than the U.S. Dollar,primarily Euros, and then translated into U.S. Dollars for inclusion in ourconsolidated financial statements and certain of our subsidiaries enter intopurchase or sale transactions using a currency other than its functionalcurrency. For example, our principal German subsidiary records the majority ofits revenues and certain of its expenses in Euros. Our German subsidiary’sresults are reflected in our consolidated financial statements in U.S. Dollars.Therefore, our reported results are exposed to fluctuations in the exchangerates between the U.S. Dollar and the Euro. During a period in which the U.S.Dollar strengthens versus the Euro, our reported consolidated net sales will belower than they might otherwise have been because net sales earned in Euroswill translate into fewer U.S. Dollars. The assets and liabilities of ourforeign subsidiaries that are reflected on our consolidated balance sheet aretranslated into U.S. Dollars at the exchange rate in effect at the balancesheet date, while the net sales and operating expenses of our foreignsubsidiaries that are reflected on our consolidated statements of operationsare translated into U.S. Dollars at the weighted-average exchange rate for thereporting period. The resulting translation adjustments are recorded inmembership equity as accumulated other comprehensive income or loss.Accordingly, changes in currency exchange rates will cause membership equity tofluctuate from period to period.

Finally, our Germansubsidiary purchases the majority of its product inventories in U.S. Dollars,with the purchase translated into Euros at the time of payment, and theinventory expense recognized in Euros at the time of sale. In addition, ourSwiss subsidiary whose functional currency is Euros must pay a portion of itsoperating expenses in Swiss Francs. Our November 2006 acquisition of Cefar hasincreased our foreign currency risk by expanding our exposure to the Euro andhas added the Swedish Krona and Norwegian Krona to our portfolio of foreigncurrencies. Our U.S. operations are also subject to risk associated withinternational currency exchange rates on purchases of inventory from a smallnumber of foreign suppliers in foreign currencies. Our German subsidiaryperiodically utilizes international currency derivatives to limit its risk tocurrency fluctuations. These derivatives are typically in the form of forwardcurrency contracts used to manage currency fluctuation on purchases ofinventory denominated in U.S. Dollars. We did not have any foreign currencyderivatives outstanding as of June 30, 2007.

To date, we have not usedinternational currency derivatives to hedge against our investment in ourEuropean subsidiaries or their operating results, which are converted into U.S.Dollars at period-end and average rates, respectively.

**ITEM 4.CONTROLS AND PROCEDURES**

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules and forms,and that such information is accumulated and communicated to management,including our Chief Executive Officer and our Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure.

As indicated in thecertifications in Exhibit 32 of this report, our Chief Executive Officer andour Chief Financial Officer, with the assistance of other members of ourmanagement, have evaluated our disclosure controls and procedures (as definedin the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)). Basedupon the evaluation of our disclosure controls and procedures required bySecurities Exchange Act Rules 13a-15(b) or 15d-15(b), our Chief ExecutiveOfficer and Chief Financial Officer have concluded that as of the end of theperiod covered by this report, our disclosure controls and procedures wereeffective.

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Our internal control system was designed to providereasonable assurance to the Company’s management and board of directorsregarding the preparation and fair presentation of published financialstatements.

All internal controlsystems, no matter how well designed, have inherent limitations. Therefore,even those systems determined to be effective can provide only reasonableassurance with respect to financial statement preparation and presentation.

46

----

**Changes in Internal Control OverFinancial Reporting**

We are involved inongoing evaluations of internal controls. In anticipation of the filing of thisquarterly report, our Chief Executive Officer and Chief Financial Officer, withthe assistance of other members of our management, reviewed our internalcontrols and have determined, based on such review, that there have been nochanges in internal control over financial reporting during the quarter endedJune 30, 2007 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

**Part II.OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS**

From time to time, we areplaintiffs or defendants in various litigation matters in the ordinary courseof our business, some of which involve claims for damages that are substantialin amount. We believe that the disposition of claims currently pending will nothave a material adverse effect on our financial position or results ofoperations.

The manufacture and saleof orthopedic devices and related products exposes us to significant risks ofproduct liability claims, lawsuits and product recalls. From time to time, wehave been, and we are currently, the subject of a number of product liabilityclaims and lawsuits relating to our products. We face an inherent business riskof exposure to product liability claims in the event that the use of ourproducts is alleged to have resulted in adverse effects, including injuries ordeath. If there is a significant increase in the number or amount of productliability claims, our business could be adversely affected. Even if we aresuccessful in defending against any product liability claims, such claims couldnevertheless distract our management, result in substantial costs, harm ourreputation, adversely affect the sales of all our products and otherwise harmour business.

We currently carryproduct liability insurance up to a limit of $20.0 million, subject to anaggregate self-insurance deductible of $750,000. Our insurance policy issubject to annual renewal. We believe our current product liability insurancecoverage is adequate. As of June 30, 2007, we exceeded the coverage limits forcertain type of product liability claims. However, our estimate of the excessloss has been accrued for in our consolidated balance sheet as of June 30,2007. Other product liability claims that could be made against us couldsignificantly exceed the coverage limit of such policy or such insurancecoverage may not continue to be available on commercially reasonable terms orat all. Additionally, we are also subject to the risk that our insurers willexclude from coverage claims made against us or the risk that insurers maybecome insolvent. If we do not or cannot maintain adequate product liabilityinsurance, our business and results of operations may be adversely affected.

On July 7, 2006, apurported class action complaint, *LouisDudas et al. v.**Encore MedicalCorporation et al.,*was filed against RTI and its directors in theDistrict Court of Travis County, Texas, 345th Judicial District (the “TexasAction”). On July 18, 2006, a second purported class action complaint, *Robert**Kempet al. v. Alastair J. Clemow et al.*(the “Delaware Action”) wasfiled by a putative stockholder of RTI in the Court of Chancery of the State ofDelaware, New Castle County, against RTI and its directors. Blackstone CapitalPartners V L.P. and Grand Slam Holdings, LLC were also named as defendants inthe Delaware Action and the Texas Action. The Delaware Action was dismissed by the plaintiffs in February 2007with no liability accrued to RTI or the other defendants.

The Texas Action is inpreliminary stages and we cannot presently predict the outcome of the lawsuit,although we believe it is without merit. The Texas Action complaint allegesthat RTI’s directors breached their fiduciary duties by, *inter alia*, agreeing to an allegedlyinadequate acquisition price in connection with the Merger transaction. Thecomplaint seeks, among other things, to rescind any actions that have alreadybeen taken to consummate the Merger, rescissory damages, and the plaintiffs’reasonable costs and attorneys’ fees and expert fees.

**ITEM 1A.RISK FACTORS**

There have been nomaterial changes to our risk factors as previously disclosed in ourRegistration Statement on Form S-4 as filed with the Securities and ExchangeCommission on May 1, 2007 (File No. 333-142188), as amended.

47

----

**ITEM 2.****UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF****PROCEEDS**

(a)       Notapplicable.

(b)      Notapplicable.

(c)       Notapplicable.

**ITEM 3.****DEFAULTS UPON SENIOR SECURITIES**

None.

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

None.

**ITEM 5.****OTHER INFORMATION**

(a)       None.

(b)      None.

**ITEM 6.****EXHIBITS**

(a)       Exhibits.
| 3.1  | Certificate of  Formation of ReAble Therapeutics Finance LLC (incorporated by reference to  Exhibit 3.1 of RTFL’s Registration Statement on Form S-4, filed on April 18,  2007 (File No. 333-142188)).            |
|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2  | Limited Liability  Company Agreement of ReAble Therapeutics Finance LLC (incorporated by  reference to Exhibit 3.2 of RTFL’s Registration Statement on Form S-4, filed  on April 18, 2007 (File No. 333-142188)). |
| 10.1 | Amendment No. 1  to Credit Agreement (incorporated by reference herein to Exhibit 10.1 to RTFL’s  Current Report on Form 8-K filed on July 5, 2007).                                                              |
| 10.2 | Incremental  Amendment No. 1 to Credit Agreement (incorporated by reference herein to  Exhibit 10.2 to RTFL’s Current Report on Form 8-K filed on July 5,  2007).                                            |
| 31.1 | Certification  (pursuant to Securities Exchange Act Rule 13a-14a) by Chief Executive  Officer.                                                                                                                         |
| 31.2 | Certification  (pursuant to Securities Exchange Act Rule 13a-14a) by Chief Financial  Officer.                                                                                                                         |
| 32.1 | Section 1350 –  Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) by  Chief Executive Officer.                                                                                            |
| 32.2 | Section 1350 –  Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) by  Chief Financial Officer.                                                                                            |

 

48

----

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
| August 14, 2007 |   | By:                                                                                                                   | /s/ Kenneth W. Davidson |
|-----------------|--------|-----------------------------------------------------------------------------------------------------------------------|-------------------------|
| Date            |   | Kenneth W. Davidson,                                                                                                  |
|            |   | Chief Executive  Officer                                                                                              |
|            |   | (Principal  Executive Officer)                                                                                        |
|            |   |                                                                                                                  |
| August 14, 2007 |   | By:                                                                                                                   | /s/ William W. Burke    |
| Date            |   | William W. Burke,                                                                                                     |
|            |   | Executive Vice President and Chief Financial Officer  (Principal Financial Officer and Principal Accounting  Officer) |

 

49

----