Table ofContents

** **

 

** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-K**

** **

**x****  ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thefiscal year ended December 31, 2008**

 

**or**

 

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

 

**For thetransition period from                    to                    .**

 

**Commission file number**333-142188

** **

**DJO 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  Number) |
|                                      |       |                    |
| **1430 Decision Street**                  | ** ** | ** **              |
| **Vista,  California**                    |       | **92081**               |
| (Address of  principal executive offices) |       | (Zip Code)              |

 

Registrant’s telephonenumber, including area code: **(800) 336-5690**

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

| **Title of each class** | ** ** | **Name of each exchange on which registered** |
|-------------------------|------------|-----------------------------------------------|
| **None**                | ** ** | **None**                                      |

 

Securitiesregistered pursuant to Section 12(g) of the Act:

**None**

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.

**Yes**o  No x

** **

**Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.**

**Yes**o  No x

** **

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

Yes x  No o

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 
| Large  accelerated filer o |                                           | Accelerated  filer o         |
|----------------------------|------------------------------------------------|------------------------------|
|                       |                                           |                         |
| Non-accelerated  filer x   | (Do not check if  a smaller reporting company) | Smaller  reporting company o |

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Act).

Yes o  No x

 

As of March 11,2009, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

 

 

 

----

Table of Contents

 

**DJOFINANCE LLC**

**FORM 10-K**

**TABLE OFCONTENTS**

 
| ** **    | ** **                                                                                                              | **Page  No.** |
|---------------|-------------------------------------------------------------------------------------------------------------------------|---------------|
| ** **    | **PART I**                                                                                                         | ** **    |
| Item 1.       | Business                                                                                                                | 4             |
| Item 1A.      | Risk Factors                                                                                                            | 22            |
| Item 2.       | Properties                                                                                                              | 43            |
| Item 3.       | Legal Proceedings                                                                                                       | 44            |
| Item  4.      | Submission  of Matters to a Vote of Security Holders                                                                    | 44            |
|          |                                                                                                                    |          |
| ** **    | **PART II**                                                                                                        | ** **    |
| Item  5.      | Market  for the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities | 45            |
| Item 6.       | Selected Financial  Data                                                                                                | 45            |
| Item  7.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             | 46            |
| Item  7A.     | Quantitative  and Qualitative Disclosures About Market Risk                                                             | 63            |
| Item  8.      | Financial  Statements and Supplementary Data                                                                            | 65            |
| Item  9.      | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                                   | 113           |
| Item  9A (T). | Controls and  Procedures                                                                                                | 113           |
| Item 9B.      | Other Information                                                                                                       | 113           |
|          |                                                                                                                    |          |
| ** **    | **PART III**                                                                                                       | ** **    |
| Item  10.     | Directors,  Executive Officers and Corporate Governance                                                                 | 114           |
| Item  11.     | Executive  Compensation                                                                                                 | 116           |
| Item 12.      | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        | 128           |
| Item 13.      | Certain  Relationships and Related Transactions, and Director Independence                                              | 129           |
| Item 14.      | Principal  Accounting Fees and Services                                                                                 | 130           |
|          |                                                                                                                    |          |
| ** **    | **PART IV**                                                                                                        | ** **    |
| Item  15.     | Exhibits,  Financial Statement Schedules                                                                                | 132           |
| SIGNATURES    | 137                                                                                                                     |

 

2

----

Table of Contents

 

### **FORWARD-LOOKINGSTATEMENTS**

### ** **

This Annual Report on Form 10-K (“Annual Report”) of DJO FinanceLLC (“DJOFL”, or “the Company”) for the year ended December 31, 2008 contains forward-lookingstatements, principally in the sections entitled “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and “Business.”  These statements can be identified becausethey use words like “anticipates,” “believes,” “estimates,” “expects,” “forecasts,”“future,” “intends,” “plans,” and similar terms.  These statements reflect only our currentexpectations.  Forward-looking statementsinclude statements concerning our plans, objectives, goals, strategies, futureevents, capital expenditures, future results, our competitive strengths, ourbusiness strategy, the trends in our industry and the benefits of ouracquisitions.

 

Although we do not makeforward-looking statements unless we believe we have a reasonable basis fordoing so, we cannot guarantee their accuracy, and actual results may differmaterially from those we anticipated due to a number of uncertainties, many ofwhich are unforeseen, including, among others, the risks we face as describedin the paragraph below and elsewhere in this filing.  You should not place undue reliance on theseforward-looking statements, which apply only as of the date of this AnnualReport. These forward-looking statements are within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934, and are intended to be covered by the safe harbors createdthereby.  To the extent that suchstatements are not recitations of historical fact, such statements constituteforward-looking statements that, by definition, involve risks and uncertainties.  In any forward-looking statement, where weexpress an expectation or belief as to future results or events, suchexpectation or belief is expressed in good faith and believed to have areasonable basis, but there can be no assurance that such future results orevents expressed by the statement of expectation or belief will be achieved oraccomplished.

 

We believe it isimportant to communicate our expectations to our security holders.  There may be events in the future, however,that we are unable to predict accurately or over which we have no control.  The risk factors listed in Item 1A below, aswell as any cautionary language in this Annual Report, provide examples ofrisks, uncertainties and events that may cause our actual results to differ materiallyfrom the expectations we describe in our forward-looking statements.

 

3

----

Tableof Contents

 

**PART I.**

 

## **ITEM 1.  BUSINESS**

## ** **

**Overview**

 

We are a global provider of high-quality, orthopedicdevices, with a broad range of products used for rehabilitation, painmanagement and physical therapy. We also develop, manufacture and distribute abroad range of surgical reconstructive implant products. We are the largestnon-surgical orthopedic rehabilitation device company in the United States andamong the largest globally, as measured by revenues. Many of our products haveleading market positions. We believe that our strong brand names, comprehensiverange of products, focus on quality, innovation and customer service, extensivedistribution network, and our strong relationships with orthopedic and physicaltherapy professionals have contributed to our leading market positions. Webelieve that we are one of only a few orthopedic device companies that offerhealthcare professionals and patients a diverse range of orthopedicrehabilitation products addressing the complete spectrum of preventative,pre-operative, post-operative, clinical and home rehabilitation care. Ourproducts are used by orthopedic specialists, spine surgeons, primary carephysicians, pain management specialists, physical therapists, podiatrists,chiropractors, athletic trainers and other healthcare professionals to treatpatients with musculoskeletal conditions resulting from degenerative diseases,deformities, traumatic events and sports-related injuries. In addition, many ofour non-surgical medical devicesand relatedaccessories are used by athletes and patients for injury prevention and at-homephysical therapy treatment.

 

Our current business activities are the result of acombination of two companies with broad orthopedic product offerings in theUnited States and foreign countries.  Oneof those companies, ReAble Therapeutics, Inc. (“ReAble”), was a leadingmanufacturer and distributor of electrotherapy products for pain therapy andrehabilitation, a broad range of clinical devices for the treatment of patientsin physical therapy clinics, and a broad range of knee, hip and shoulderimplant products.  In 2006, ReAble wasacquired by an affiliate of Blackstone Capital Partners V L.P. (“Blackstone”).The other company, DJO Opco Holdings, Inc. (“DJO Opco”), formerly namedDJO Incorporated, was a leading manufacturer and distributor of orthopedicrehabilitation products, including rigid knee bracing, orthopedic soft goods,cold therapy systems, vascular systems and bone growth stimulation devices. On November 20,2007, ReAble acquired DJO Opco through a merger transaction (the “DJO Merger”).  ReAble then changed its name to DJOIncorporated (“DJO”) and continues to be owned primarily by affiliates ofBlackstone. ReAble Therapeutics Finance LLC was renamed DJO Finance LLC (“DJOFL”)and ReAble Finance Corporation, the co-issuer of both the 10.875% senior notesdue 2014 (the “10.875% Notes”) and 11.75% senior subordinated notes due 2014(the “11.75% Notes”) (see Note 8 in our audited consolidated financialstatements in this Annual Report), was renamed DJO Finance Corporation (“Finco”).  DJO is a Delaware corporation incorporated onMarch 21, 1995.  DJOFL is a Delawarelimited liability company organized on September 27, 2006.

 

Historical financial results include results of ReAble and itssubsidiaries before and after its acquisition by Blackstone and include theresults of DJO Opco from the date of the DJO Merger through December 31,2008.

 

Except as otherwise indicated, references to “us”,“we”, “our”, “our Company”, or “the Company” in this Annual Report refers toDJO and its consolidated subsidiaries. Each one of the followingtrademarks, trade names or service marks, which is used in this Annual Report, is either (i) our registered trademark, (ii) atrademark for which we have a pending application, (iii) a trade name orservice mark for which we claim common law rights or (iv) a registeredtrademark or application for registration which we have been licensed by athird party to use: Cefar®, Empi®, Ormed®, Compex®, EmpiCare®, Aircast®,DonJoy®, OfficeCare®, ProCare®, SpinaLogic®, RMETM, CMFTM, OL1000TM, and OL1000SCTM.  All other trademarks, trade namesor service marks of any other company appearing in this Annual Report belong totheir respective owners.

 

**The DJOMerger**

 

On July 15, 2007, we entered into an Agreement and Plan of Mergerwith DJO Opco providing for the DJO Merger pursuant to which DJO Opco became awholly owned subsidiary of DJOFL, the entity filing this Annual Report. Thetotal purchase price for the DJO Merger, which was consummated on November 20,2007, was approximately $1.3 billion and consisted of $1.2 billionpaid to former equity holders (or $50.25 in cash for each share of common stockof DJO Opco they then held), $15.2 million related to the fair value ofstock options held by DJO Opco management that were exchanged for options topurchase DJO common stock, and $22.8 million in direct acquisition costs.The DJO Merger was financed through a combination of equity contributed by ourprimary shareholder, Blackstone, borrowings under our senior secured creditfacility (the “Senior Secured Credit Facility”) and proceeds from the newlyissued 10.875% Notes (see Note 8 in our audited consolidated financialstatements in this Annual Report).

 

4

----

Table of Contents

 

**ThePrior Transaction**

 

On November 3, 2006, Blackstone acquired all of the outstandingshares of capital stock of ReAble in a merger transaction (the “PriorTransaction”). The total purchase price for the Prior Transaction wasapproximately $529.2 million and consisted of $482.5 million paid to formerholders of shares of common stock, $7.2 million related to the fair value ofmanagement options that continued to remain as outstanding options to purchaseReAble common stock after the Prior Transaction, and $39.5 million in directacquisition costs.  The Prior Transactionwas financed through a combination of equity contributed by Blackstone, cash onhand of ReAble, borrowings under our previous senior secured credit facilityand proceeds from the 11.75% Notes.  Uponthe closing of the Prior Transaction, shares of ReAble’s common stock ceased tobe traded on the NASDAQ Global Market.

 

**OperatingSegments**

 

We classify our operations, pursuant to SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information” (“SFAS131”), into the three operating segments further described below.

 

***Domestic Rehabilitation Segment***

 

We market our Domestic Rehabilitation Segment productsthrough the four main businesses described below.

 

·                  *Bracing and Supports. *Our Bracing and Supports business unit was acquired with theDJO Merger and offers DonJoy, ProCare, and Aircast products, including rigidknee bracing, orthopedic soft goods, cold therapy products, and vascularsystems. This division also includes our OfficeCare business, through which wemaintain an inventory of soft goods and other products at healthcarefacilities, primarily orthopedic practices, for immediate distribution topatients.

 

·                  *Empi. *OurEmpi business unit offers products in the category of home electrotherapy,iontophoresis, and home traction. This division also includes our RehabMed + Equip business (“RME”) and until the end of 2008, included ourEmpiCare business. RME sells a wide range of proprietary and third partyrehabilitation products to physical therapists and chiropractors through aprinted catalog and through an on-line e-commerce site. Our EmpiCare businessmaintained an inventory of soft goods and other products at healthcarefacilities, primarily orthopedic practices, for immediate distribution topatients and was consolidated into the OfficeCare business during the fourthquarter of 2008.

 

·                  *Regeneration. *OurRegeneration business unit consists of our bone growth stimulationproducts.  These products are soldthrough a combination of DonJoy sales representatives and additionalindependent and employed sales representatives dedicated to selling theseproducts either directly to patients or independent distributors.  We arrange billing to these third partypayors or patients for products directly sold to the patients.

 

·                  *Chattanooga. *OurChattanooga business unit offers products in the clinical rehabilitation marketin the category of clinical electrotherapy devices, clinical traction devices,and other clinical products and supplies such as treatment tables, continuouspassive motion (“CPM”) devices and dry heat therapy.

 

***International Rehabilitation Segment***

 

Our International Rehabilitation Segment, whichgenerates most of its revenues in Europe, is divided into three mainbusinesses:

 

·                  *Bracing and Supports. *The international sales of our Bracing and Supports businessunit, which offers DonJoy, ProCare, and Aircast products.

 

·                  *Ormed.DJO. *OurOrmed.DJO business, which provides bracing, CPM, electrotherapy and otherproducts primarily in Germany.

 

·                  *Cefar-Compex. *OurCefar-Compex business provides electrotherapy products for medical and consumermarkets and other physical therapy and rehabilitation products primarily inEurope.

 

5

----

Table of Contents

 

***Surgical Implant Segment***

 

Our Surgical Implant Segment develops, manufacturesand markets a wide variety of knee, hip and shoulder implant products thatserve the orthopedic reconstructive joint implant market.

 

**Material Acquisitions**

 

Our growth has been driven both by the introduction of productsfacilitated by our research and development efforts and by selectedacquisitions of businesses or products primarily related to our DomesticRehabilitation and International Rehabilitation Segments.  In addition to the DJO Merger, which morethan doubled our size and product range, we completed the followingacquisitions in the last three years:

 

On August 9, 2007, a subsidiary of DJOFL acquiredIOMED Inc. (“IOMED”), which develops, manufactures and markets active drugdelivery systems used primarily to treat acute local inflammation in thephysical and occupational therapy and sports medicine markets. The purchaseprice was $23.3 million and consisted of $21.1 million in cashpayments to former IOMED equity holders at $2.75 per share, $0.8 millionrelated to the fair value of vested stock options that were outstanding at thetime of the acquisition, and $1.4 million in direct acquisition costs. Theacquisition was primarily financed with borrowings under our then existingrevolving credit facility.

 

On July 2, 2007, a subsidiary of DJOFL completedits purchase of substantially all of the assets of The Saunders Group, Inc.(“Saunders”) for total cash consideration of $40.9 million, including$0.9 million of acquisition costs (“The Saunders Acquisition”). Saundersis a supplier of rehabilitation products to physical therapists, chiropractors,athletes, athletic trainers, physicians and patients, with a specialty in patentedtraction devices, back supports, and equipment for neck and back disorders. TheSaunders Acquisition was financed with funds borrowed under our then existingsenior credit facilities.

 

On November 7,2006, a subsidiary of DJOFL acquired all of the issued and outstanding sharesof Cefar AB (“Cefar”), a provider of electrotherapy and rehabilitation devicesin Europe used for chronic pain, for women’s health (labor pain, incontinence,dysmenorrhea), electroacupuncture, and other rehabilitation activities. We haveintegrated the operations of Cefar with those of Compex SA, the Europeansubsidiary of Compex Technologies, Inc. (“Compex”).  Our strategy for the merged company is todevelop both the professional/medical and consumer markets for electrostimulationacross Europe and internationally, while continuing to sell products under boththe Cefar and Compex brands.  Thepurchase price for Cefar of $27.1 million was comprised of $16.3 million incash, issuance of 573,134 shares of our common stock valued at $9.5 million,and approximately $1.3 million in acquisition costs. In addition, we alsoassumed Cefar’s existing debt of approximately $3.8 million, which wassubsequently paid in the third quarter of 2008.

 

On February 24, 2006, pursuant to the terms of a merger agreementdated November 11, 2005, we acquired all of the issued and outstandingshares of Compex Technologies, Inc., a Minnesota corporation (“Compex”).  Compex manufactured and sold a broad line oftranscutaneous electrical nerve stimulation (“TENS”) and neuromuscularelectronic nerve stimulation (“NMES”) products used for pain management,rehabilitation, fitness and sports performance enhancement in clinical, homehealthcare, sports and occupational medicine settings. We paid a total purchaseprice of approximately $102.9 million, comprised of approximately 7.3 millionshares of our common stock valued at approximately $90.0 million in exchangefor all of the outstanding common stock of Compex, options to purchaseapproximately 900,000 shares of our common stock valued at $9.3 million inexchange for all of the outstanding options to purchase common stock of Compex,and $3.6 million in acquisition costs.

 

**IndustryBackground**

 

**MarketOpportunities**

 

We participate globally in the rehabilitation, pain management, bonegrowth stimulation and reconstruction segments of the orthopedic device market.In the United States, we estimate these segments accounted for approximately$7.9 billion of total industry sales in 2007. We believe that several factors aredriving growth in the orthopedic products industry, including the following:

 

·                  *Favorable demographics.* An aging population is driving growth in the orthopedic products market.Many conditions that result in rehabilitation, physical therapy or orthopedicsurgery are more likely to affect people in middle age or later in life.  According to a 2008 United States CensusBureau — International Data Base projection, the aging baby boomer generationwill result in the percentage of the North American 

 

6

----

Table of Contents

 

population aged 65 and over to grow from 13.1% in 2009to 16.6% in 2020 and to 20.1% by 2030. In Western Europe, the population aged65 and over is expected to grow from 18.0% in 2009 to 20.9% in 2020 and to24.8% by 2030.  In addition, according to a 2007 United States CensusBureau — International Data Base projection, the average life expectancy inNorth America increased from 78.0 years in 2005 to 78.5 years in 2009and is expected to grow to 81.3 years by 2030.  In Western Europe, theaverage life expectancy increased from 79.2 years in 2005 to 79.8 years in 2009and is expected to grow to 82.0 years by 2030. As life expectancy increases, we believe people will remain activelonger, causing the number of injuries requiring orthopedic rehabilitation,bone growth stimulation and reconstructive implants to increase.

 

·                  *Shift toward non-surgical rehabilitation devices and at-home physicaltherapy.*  We believe thegrowing awareness and clinical acceptance by healthcare professionals of thebenefits of non-surgical, non-pharmaceutical treatment and rehabilitationproducts, combined with the increasing interest by patients in rehabilitationsolutions that minimize risk and recuperation time and provide greaterconvenience, will continue to drive demand for these products. For example,TENS and NMES devices are increasingly being recognized as effective solutionsfor pain management and rehabilitation therapy, respectively. In addition, webelieve that orthopedic surgeons are increasingly utilizing braces that assistin rehabilitation and bone growth stimulation devices that enable in-hometreatment as viable alternatives to surgery. Many of our orthopedicrehabilitation products are designed for at-home use, which we believe shouldallow us to benefit from the market shift toward these treatment alternatives.

 

·                  *Lower cost alternatives appeal to third party payors.*  With the cost of healthcare rising in theUnited States and internationally, third party payors are seeking morecost-effective therapies without reducing quality of care. For example, thirdparty payors seek to reduce clinic visits and accommodate patients’ preferencefor therapies that can be conveniently administered at home. We believe thatmany of our orthopedic rehabilitation products offer cost-effectivealternatives to surgery, pharmaceutical and other traditional forms of physicaltherapy and pain management.

 

·                  *Increased need for rehabilitation due to increased orthopedic surgicalvolume.*  The combination ofincreased prevalence of degenerative joint disease (such as osteoarthritis), anincreased number of sports-related injuries, an aging population and improvementsin orthopedic surgical technique (such as arthroscopy) has contributed to anincrease in the number of orthopedic surgeries. We believe that orthopedicsurgical volume will continue to increase, which should result in an increasein the need for our products.

 

**CompetitiveStrengths**

 

We believe that we have a number of competitive strengths that willenable us to further enhance our position in the orthopedic rehabilitationdevice market:

 

·                  *Leading market positions*. We derived over 60% of our net sales in 2008 from products for which weestimate we have leading market positions, including soft goods, ankle braces,walking braces, rigid knee braces, clinical electrotherapy, TENS, NMES, iontophoresis,cold therapy, home and clinical traction and CPM devices. We believe ourorthopedic and physical therapy rehabilitation products marketed under theDonJoy, Aircast, ProCare, Chattanooga, Empi, Cefar, Compex and Ormed brandshave a reputation for quality, durability and reliability among healthcareprofessionals. We believe the strength of our brands and our focus on customerservice have allowed us to establish market leading positions in the highlyfragmented and growing orthopedic rehabilitation market.

 

·                  *Comprehensive range of orthopedic products.*  We offer a diverse range of orthopedicdevices, including orthopedic rehabilitation, pain management and physicaltherapy products, bone growth stimulation and surgical reconstructive implantproducts, to orthopedic specialists and patients for hospital, clinical andat-home therapies. Our broad product offering meets many of the needs oforthopedic professionals and patients and enables us to leverage our brandloyalty with our customer and distributor base. Our products are availableacross various stages of the orthopedic patient’s continuum of care.

 

7

----

Table of Contents

 

·                  *Extensive and diverse distribution network.*  We use multiple channels to distribute ourproducts to our customers. We use nearly 14,000 dealers and distributors and adirect sales force of over 500 employed sales representatives and approximately800 independent sales representatives to supply our products to physicaltherapy clinics, orthopedic surgeons and practices, orthotic and prostheticcenters, hospitals, surgery centers, athletic trainers, chiropractors, otherhealthcare professionals and retail outlets. We believe that our distributionnetwork provides us with a significant competitive advantage in selling ourexisting products and in introducing new products.

 

·                  *Strong relationships with managed care organizations and rehabilitationhealthcare providers.*  Ourleading market positions in many of our orthopedic rehabilitation product linesand the breadth of our product offerings have enabled us to secure importantpreferred provider and managed care contracts. We have developed a third partybilling system.  Our database includesapproximately 9,000 different insurance companies and other payors, includingover 1,500 active payor contracts. Our proprietary third party billing systemis designed to reduce our reimbursement cycles, improve relationships withmanaged care organizations and physicians and track patients to improve qualityof care and create subsequent selling opportunities. Further, our OfficeCare businessmaintains inventory at over 1,300 healthcare facilities, primarily orthopedicpractices, which further strengthens our relationships with these healthcareproviders.

 

·                  *National contracts with group purchasing organizations.*  We enjoy strong relationships with ameaningful number of group purchasing organizations (“GPOs”) due to oursignificant scale. We believe that our broad range of products is well suitedto the goals of these buying groups. Under these national contracts, we providefavorable pricing to the buying group and are designated a preferred purchasingsource for the members of the buying group for specified products. As we havemade acquisitions and expanded our product range, we have been able to addincremental products to our national contracts. During 2008, we signed orrenewed over 30 national contracts.

 

·                  *Low cost, high quality manufacturing capabilities.*  We have a major manufacturing facility inTijuana, Mexico that has been recognized for operational excellence. The Mexicofacility and our other manufacturing facilities employ lean manufacturing, SixSigma concepts and continuous improvement processes to drive manufacturingefficiencies and lower costs.

 

·                  *Ability to generate significant cash flow.*Historically,our strong competitive position, brand awareness and high quality products andservice as well as our low cost manufacturing have allowed us to generateattractive operating margins. These operating margins, together with limitedcapital expenditures and modest working capital requirements, significantlybenefit our ability to generate free cash flow.

 

·                  *Experienced management team*. The membersof our management team have an average of over 28 years of relevant experience.This team has successfully integrated a number of acquisitions in the lastseveral years.

 

**OurStrategy**

 

Our strategy is toincrease our leading position in key products and markets, increase revenuesand profitability and enhance cash flow. Our key initiatives to implement thisstrategy include the following:

 

·                  *Increase our leading market positions.*  We believe we are the market leader in manyof the markets in which we compete. We intend to continue to increase ourmarket share by leveraging the cross-selling and other opportunities created bythe DJO Merger and by implementing the initiatives described below. The DJOMerger has allowed us to offer customers a more comprehensive range of productsto better meet their evolving needs. We believe our size, scale, brandrecognition, comprehensive and integrated product offerings and leading marketpositions enables us to capitalize on the growth in the orthopedic productindustry.

 

·                  *Focus sales force on entire rangeof DJO products*.  Our products address the full continuum of apatient’s care, from preventative measures to pre-operative steps topost-operative care and rehabilitation. Our strategy is to train and incentivize our sales force, which consistsof agents and representatives familiar with a particular set of products, towork cooperatively and collaboratively with all segments of our sales force tointroduce their customers to the full range of our products of which thecustomer is typically using only a portion. We believe that this represents a significant opportunity to expand ourbusiness among customers who are already satisfied with the performance of someof our products.

 

8

----

Table of Contents

 

·                  *Continue to develop and launch new products and product enhancements.*  We have a history of developing and introducinginnovative products into the marketplace, and we expect to continue futureproduct launches by leveraging our internal research and development platforms.We believe our ability to develop new technology and to advance existingtechnology to create new products will position us to further diversify ourrevenues and to expand our target markets by providing viable alternatives tosurgery or medication. We believe that product innovation through effective andfocused research and development, as well as our relationships with a number ofwidely recognized orthopedic surgeons and professionals who assist us inproduct research, development and marketing, will provide a significantcompetitive advantage. During 2008, we launched 27 new products, whichgenerated over $27.2 million in revenues.

 

·                  *Maximize existing and secure additional national accounts.*  We plan to capitalize on the growing practicein healthcare in which hospitals and other large healthcare providers seek toconsolidate their purchasing activities to national buying groups. Contractswith these national accounts represent a significant opportunity for revenuegrowth. We believe that our existing relationships with national buying groupsand our broad range of products position us well not only to pursue additionalnational contracts, but also to expand the scope of our existing contracts.

 

·                  *Expand international sales.* In recent years, DJO Opco successfully established direct distributioncapabilities in several major international markets. We believe that sales toEuropean and other markets outside the United States continue to represent asignificant growth opportunity, and we intend to continue to expand our directand independent distribution capabilities in attractive foreign markets. Forexample, in February 2009, we acquired Donjoy Orthopaedics Pty. Ltd., anunaffiliated Australian distributor of our products, for approximately $3.0million as part of our strategy to expand our international sales. The recentDJO Merger and several of the acquisitions we made in 2006 have substantiallyincreased our international revenues and operating infrastructure and haveprovided us with opportunities to expand our international product offerings.

 

·                  *Drive operating efficiency.* We plan to continue to apply the principles of lean operations to ourmanufacturing sites as well as in our operating and administrative functions toincrease speed and efficiency and reduce waste. We have instilled a culture of continuous improvement throughout theCompany and are pursuing a regular schedule of addressing operations andprocesses in the Company to improve efficiency. In addition to achieving the cost saving targets that were identified inthe DJO Merger, we believe these lean principles and continuous improvementefforts will enhance our operating efficiencies and our ability to compete inan increasingly price-sensitive health care industry.

 

**O****ur********Products**

 

Our products are used by orthopedic specialists, spine surgeons,primary care physicians, other specialist physicians, physical therapists,podiatrists, chiropractors, athletic trainers and other healthcareprofessionals to treat patients with musculoskeletal conditions resulting fromdegenerative diseases, deformities, traumatic events and sports relatedinjuries. In addition, many of our non-surgical medical devices and relatedaccessories are used by athletes and patients to prevent injuries and forat-home physical therapy treatment.

 

***Domestic Rehabilitation Segment***

 

Our DomesticRehabilitation Segment generated net sales of $700.1 million,$331.6 million, and $248.4 million for the years ended December 31,2008, 2007, and 2006 (combined basis), respectively.  For the year ended December 31, 2006, wehave combined the Predecessor period and the Successor period and presented theunaudited results of operations on a combined basis because we believe it isuseful to compare our financial results on an annualized basis.  The Successor period reflects the acquisitionof ReAble by Blackstone using the purchase method of accounting pursuant to theprovision of Statement of Financial Accounting Standards No. 141, “BusinessCombinations.”  Accordingly, thecomparability of the results of the Successor for the full year 2007 to thecombined results of the Successor and the Predecessor for the full year 2006 isaffected by differences in the basis of presentation, which reflects purchaseaccounting in the Successor periods historical cost in the Predecessorperiod.  In addition, the comparabilityof the combined results is impacted by changes in our capital structure whichoccurred on the date the Prior Transaction was completed (See note 11 in ourconsolidated financial statements in this Annual Report for net sales, grossprofit and operating income for each segment).

 

9

----

Table of Contents

 

The following table summarizes many of our Domestic RehabilitationSegment product categories:

 
| **Product  Category**                          | ** ** | **Description**                                                                                                                                                                                              |   |
|------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Home  Electrotherapy Devices                   |       | Transcutaneous  electrical nerve stimulation (TENS)

Neuromuscular  electrical nerve stimulation (NMES)

Interferential  electrical nerve stimulation                                                        |   |
| Clinical  Electrotherapy                       |       | TENS  NMES  Ultrasound  Laser  Light therapy                                                                                                                                                                 |   |
| Patient Care                                   |       | Nutritional  supplements

Patient safety  devices

Pressure care  products

Vascular systems  products

Continuous  passive motion devices                                                                   |   |
| Rigid Bracing  and Soft Goods                  |       | Soft goods

Lower extremity  fracture boots

Dynamic  splinting

Ligament braces

Post-operative  braces

Osteoarthritic  braces

Ankle bracing

Shoulder, elbow  and wrist braces

Back braces

Neck braces |   |
| Hot, Cold and  Compression Therapy             |       | Dry heat therapy

Hot/cold therapy

Paraffin wax  therapy

Moist heat  therapy

Cold therapy

Compression  therapy                                                                                           |   |
| Physical Therapy  Tables and Traction Products |       | Treatment tables

Traction

Cervical  traction

Lumbar traction                                                                                                                                              |   |
| Iontophoresis                                  |       | Needle-free  transdermal drug delivery                                                                                                                                                                       |   |
| Regeneration                                   |       | Non-union  fracture bone growth stimulation devices

Spine bone  growth stimulation devices                                                                                                                  |   |

 

***International Rehabilitation Segment***

 

Our InternationalRehabilitation Segment generated net sales of $228.5 million, $113.0million, and $64.2 million for the years ended December 31, 2008, 2007,and 2006 (combined basis), respectively. The product categories for our International Rehabilitation Segment aresimilar to the product categories for our Domestic Rehabilitation Segment butcertain products are tailored to international market requirements andpreferences. In addition, our International Rehabilitation Segment sells anumber of product categories, none of which are individually significant, thatwe do not sell domestically.

 

***Surgical Implant Segment***

 

Our Surgical ImplantSegment generated net sales of approximately $73.4 million, $66.6 million, and$59.1 million for the years ended December 31, 2008, 2007 and 2006 (combinedbasis), respectively.

 

10

----

Table of Contents

 

The following table summarizes our Surgical Implant Segment productcategories:

 
| **Product  Categories** | ** ** | **Description**                                                                                                           |   |
|-------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|--------|
| Knee implant            |       | Primary total  joint replacement

Revision total  joint replacement

Unicondylar  joint replacement                       |   |
|                    |       |                                                                                                                      |   |
| Hip implants            |       | Primary  replacement stems

Acetabular cup  system

Revision joint  replacement                                           |   |
|                    |       |                                                                                                                      |   |
| Shoulder  implants      |       | Primary total  joint replacement

Fracture repair  system

Revision total  joint replacement (including reverse shoulder) |   |

 

**Researchand Development**

 

Our research and development programs focus on the development of newproducts, as well as the enhancement of existing products with the latesttechnology and updated designs. We seek to develop new technologies to improvedurability, performance and usability of existing products, and to develop ourmanufacturing process to improve product performance and reduce manufacturingcosts. In addition to our own research and development, we receive new productand invention ideas from orthopedic surgeons and other healthcareprofessionals. We also seek to obtain rights to ideas we consider promisingfrom a clinical and commercial perspective through entering into eitherassignment or licensing agreements.

 

We conduct research and development programs at our facilities inAustin, Texas; Chattanooga, Tennessee; Vista, California; and Ecublens,Switzerland. We invested approximately $26.9 million, $18.0 million, and $13.6million in 2008, 2007 (excluding approximately $3.0 million of acquiredin-process research and development (“IPR&D”), and 2006 (on a combinedbasis and excluding approximately $29.1 million of acquired IPR&D) intoresearch and development activities, respectively. As of December 31,2008, we had approximately 45 employees in our research and developmentdepartments.

 

**M****arketing********and********Sales**

 

Our products reach our customers, including hospitals or otherhealthcare facilities, physicians or other healthcare providers and end userpatients, through several sales and distribution channels.

 

***Domestic Rehabilitation Segment***

*** ***

We market and sell our Domestic Rehabilitation Segment products inseveral different ways. The DonJoy sales channel is responsible for sellingrigid knee braces, cold therapy products, and certain soft goods. CertainDonJoy sales representatives also sell our Regeneration products. The DonJoychannel consists of approximately 460 independent commissioned salesrepresentatives who are employed by approximately 33 independent salesagents.  The DonJoy channel is primarilydedicated to the sale of our products to orthopedic surgeons, podiatrists,orthopedic and prosthetic centers, hospitals, surgery centers, physicaltherapists, athletic trainers and other healthcare professionals. Because theDonJoy product lines generally require customer education in the applicationand use of the product, our sales representatives are technical specialists whoreceive extensive training both from us and the agent and use their expertiseto help fit the patient with the product and assist the orthopedic professionalin choosing the appropriate product to meet the patient’s needs. After a salesrepresentative receives a product order, we generally ship and bill the productdirectly to the orthopedic professional, paying a sales commission to theagent. For certain custom rigid braces and other products, we sell directly tothe patient and bill a third party payor, if applicable, on behalf of thepatient. We enjoy long-standing relationships with most of our agents and salesrepresentatives. Under the arrangements with the agents, each agent is grantedan exclusive geographic territory for sales of our products and is notpermitted to market products, or represent competitors who sell or distributeproducts, that compete with our existing products. The agents receive acommission, which varies based on the type of product being sold.  If an agent fails to achieve specified salesquotas, we have the right to terminate our relationship with the agent.  In the first half of 2008, we converted theNorthern and Southern California and Pacific Northwest regions to a directsales model for products in the DonJoy channel and Regeneration products.  We now cover those regions with employedsales representatives.

 

11

----

Table of Contents

 

The ProCare/Aircast channel consists of approximately 100 direct andindependent sales representatives that manage over 310 distributors focused onprimary and acute care facilities. Seven vascular systems specialists are alsoincluded in this channel. Products in this channel consist primarily of oursoft goods, vascular systems and other products, which are generally sold innon-exclusive territories to third party distributors as well as through ourdirect sales force. Our distributors include large, national third partydistributors such as Owens & Minor Inc., McKesson/HBOC,Allegiance Healthcare and Physician Sales and Service Inc., regionalmedical and surgical distributors, outpatient surgery centers and medicalproducts buying groups that consist of a number of health care providers whomake purchases through the buying group. These distributors and our directsales force generally sell our products to large hospital chains, primary carenetworks and orthopedic physicians for use by the patients. In addition, wesell our products through GPOs that are a preferred purchasing source formembers of a buying group.  Unlike ourDonJoy products, our ProCare/Aircast products generally do not requiresignificant customer education for their use. Our vascular systems pumps andrelated equipment are typically consigned to hospitals, and the hospitals then purchasethe cuffs that are applied to each patient.

 

Our OfficeCare business provides stock and bill arrangements forphysician practices. Through OfficeCare, we maintain an inventory of soft goodsat over 1,300 orthopedic practices and other healthcare facilities forimmediate distribution to patients. We then bill the patient or, if applicable,a third party payor. For certain facilities, we provide on-site technicalrepresentatives.  The OfficeCare channelis managed by our DonJoy sales force.

 

Through our Empi channel, we market our prescription home therapyproducts primarily to physicians and physical therapy clinics, which includehospital physical therapy departments, sports medicine clinics and painmanagement centers, through our sales force of over 250 direct and independentsales representatives. In connection with these product lines, we currentlyhave more than 630 managed care contracts. Our electrotherapy and orthoticsproducts are generally prescribed to patients by a physician such as an orthopedicsurgeon. The physician will typically direct the patient to a physical therapyclinic to meet with a trained physical therapist who provides the patient withthe prescribed product from our consigned inventory at the clinic. This salesprocess is facilitated by our relationships with third party payors, such asmanaged care organizations, who ultimately pay us for the products prescribedto patients. For these reasons, we view physical therapists, physicians andthird party payors as key decision makers in product selection and patientreferral. Our home therapy products generally are eligible for third partyreimbursement by government payors, such as Medicare and Medicaid, and privatepayors. In addition, we have an outbound telemarketing sales force of 35representatives, who sell reimbursed electrotherapy supplies and other productsdirectly to our patients.

 

Through our Regeneration business, our non-union fracture bone growthstimulator devices (“OL1000”) are sold primarily by approximately 150 employedand independent sales representatives specially trained to sell the product.The spine bone growth stimulator device (“SpinaLogic”) is sold by a few of ourdirect sales representatives and a network of independent spine productsdistributors. Most of our bone growth stimulator products are sold directly tothe patient and a third party payor is billed, if applicable, on behalf of thepatient.

 

Through our Chattanooga business, we sell our clinical rehabilitationproduct lines to physical therapy clinics, primarily through a worldwidenetwork of approximately 4,800 independent distributors, which are managed byour internal sales managers, and through catalogue sales. These distributorssell our clinical rehabilitation products to a variety of healthcareprofessionals, including physical therapists, athletic trainers, chiropractors,and sports medicine physicians. Except for distributors outside of the UnitedStates, we do not maintain formal distribution contracts for our clinicalrehabilitation products. These distributors purchase products from us atdiscounts off our published list price. We maintain an internal marketing andsales support program to support our distributor network. This programcomprises a group of individuals who provide distributor and end-user training,develop promotional materials, and attend over 30 trade shows each year.

 

No particular customer or distributor accounted for 10% or more ofproduct sales in the Domestic Rehabilitation Segment for the year ended December 31,2008.  Medicare and Medicaid togetheraccounted for approximately 5.9% of our 2008 net sales.

 

***International Rehabilitation Segment***

*** ***

We sell ourrehabilitation products internationally through a network of wholly-ownedsubsidiaries and independent distributors. In Europe, we use sales forcesaggregating approximately 220 direct and independent salespersons and a networkof independent distributors who call on healthcare professionals, as well asconsumer retail stores, such as sporting equipment providers, and pharmacies,to sell our products.  We intend tocontinue to expand our direct and indirect distribution capabilities inattractive foreign markets. One recent example of our strategy to expand ourinternational sales is our acquisition of DonJoy Orthopaedics Pty., Ltd. in February 2009.

 

12

----

Table ofContents

 

***Surgical Implant Segment***

*** ***

We currently market and sell the products of our Surgical ImplantSegment in the United States to hospitals and orthopedic surgeons through anetwork of over 170 independent commissioned sales representatives who areemployed by approximately 50 sales agents. Generally, our independent salesrepresentatives sell a range of reconstructive joint products, including ourproducts. We usually enter into agreements with sales agents for a term of oneto five years. Agents are typically paid a sales commission and are eligiblefor bonuses if sales exceed certain preset objectives. Our independent salesrepresentatives work for these agents. We assign our sales agents to anexclusive sales territory. Substantially all of our sales agents agree not tosell competitive products. Typically we can only terminate our agreements withsales agents prior to the expiration of the agreements for cause, whichincludes failure to meet specified periodic sales targets. We provide our salesagents with product inventories on consignment for their use in marketing ourproducts and filling customer orders. Outside the United States, our surgicalimplant products are sold through independent distributors, principally inJapan and select countries in Europe.

 

To a significantextent, sales of our surgical implant products depend on the preference oforthopedic surgeons. We maintain contractual relationships with orthopedicsurgeons who assist us in developing our products and provide consultingservices in connection with our products. In addition to providing design andconducive input into our new products, some of these orthopedic surgeons maygive demonstrations using our products, speak about our products at medicalseminars, train other orthopedic surgeons in the use of our products, andprovide us with feedback on the acceptance of our products. We have alsoestablished relationships with surgeons who conduct clinical studies on variousproducts, establish protocols for use of the products and participate atvarious symposia. Surgeons who assist us in developing our products are generallycompensated with a royalty payment. Consulting surgeons are paid consultingfees for their services.

 

**M****anufacturing**

** **

We use bothin-house manufacturing capabilities and relationships with third party vendorsto supply our products. Generally, we use third party vendors only when theyhave special manufacturing capabilities or when we believe it is appropriatebased on certain factors, including our in-house capacity, lead time controland cost. Although we have certain sole source supply agreements, we believealternate vendors are available, and we believe that adequate capacity existsat our current vendors to meet our anticipated needs.

 

Our manufacturing facilities are generally certified by theInternational Organization for Standardization (“ISO”) and generally complywith the U.S. Food and Drug Administration (“FDA”) current Good ManufacturingPractice (“cGMP”) and Quality System Regulations (“QSR”) requirements, whichprovide standards for safe and consistent manufacturing of medical devices andappropriate documentation of the manufacturing and distribution process. Manyof our products carry the European Community Medical Device Directive (“CE”)certification mark.

 

***Domestic Rehabilitation Segment***

*** ***

Our manufacturing facility in Tijuana, Mexico is our largestmanufacturing facility. Our Mexico facility has achieved ISO 9001 and ISO 13485certification. These certifications are internationally recognized qualitystandards for manufacturing and assist us in marketing our products in certainforeign markets.  Our Vista, Californiafacility has achieved ISO 9001 certification, EN46001 certification andcertification to the Canadian Medical Device Regulation (ISO 13485) andthe European Medical Device Directive. Products manufactured at the Vista, California facility include ourcustom rigid knee bracing products, the pump portion of our vascular systemsproducts and our regeneration products. Within both our Vista and Tijuanafacilities, we operate vertically integrated manufacturing and cleanroom packagingoperations and many subassemblies and components can be produced in-house.These include metal stamped parts, injection molding components andfabric-strapping materials. We also have extensive in-house tool and diefabrication capabilities, which typically provide savings in the development oftools and molds as well as flexibility to respond to and capitalize on marketopportunities as they are identified.

 

We makeChattanooga division products, including electrotherapy devices, patient careproducts and physical therapy and chiropractic treatment tables and CPMdevices, in our manufacturing facilities located in Chattanooga, Tennessee.These facilities use various manufacturing processes, including metalfabrication, coating, electronic assembly, mechanical assembly, woodworking andsewing.  Our Chattanooga, Tennesseefacility has achieved ISO 13485 certification.

 

13

----

Table ofContents

 

Our homeelectrotherapy devices sold in the United States and certain components andrelated accessories are manufactured at our Clear Lake, South Dakota facility.Manufacturing activities at the Clear Lake facility include electronic andmechanical assembly, electrode fabrication and assembly and fabric sewingprocesses. Our electrotherapy products comprise a variety of components,including die cast metal parts, injection molded plastic parts, printed circuitboards, electronic components, lead wires, electrodes and other components.Parts for these components are purchased from outside suppliers and are, insome instances, manufactured on a custom basis. Our Clear Lake facility hasachieved the ISO 13485:2003 certification. Our home electrotherapy deviceswhich are sold outside the United States are primarily manufactured by outsidethird party vendors.

 

Many of thecomponent parts and raw materials we use in our manufacturing and assemblyoperations are available from more than one supplier and are generallyavailable on the open market.  We sourcesome of our finished products from manufacturers in China as well as otherthird party manufacturers.  We alsocurrently purchase certain CPM devices from a single supply source, MedirehaGmbh (“Medireha”), which is 50% owned by us. Our distribution agreement withMedireha grants us exclusive rights to the distribution of products thatMedireha manufactures. The distribution agreement, which expires on August 14,2009, also requires that we purchase a certain amount of product annually andthat we seek Medireha’s approval if we choose to manufacture or distributeproducts that are identical or similar, or otherwise compete with the productsthat are the subject of the distribution agreement.

 

***International Rehabilitation Segment***

*** ***

Many of the products for our International Rehabilitation Segment aremanufactured in the same facilities as our Domestic RehabilitationSegment.  We operate a manufacturingfacility in Tunisia that provides bracing products for the French and otherEuropean markets.  In addition, our Ormedand Cefar-Compex businesses source most of the products they sell from thirdparty suppliers.  Cefar-Compex currentlyutilizes a single vendor for many of its home electrotherapy devices.

 

***Surgical Implant Segment***

*** ***

In our Surgical Implant Segment, we manufacture our products in ourAustin, Texas facility. This manufacturing facility includes computercontrolled machine tools, belting, polishing, cleaning, packaging and qualitycontrol. We initially obtained ISO qualification and CE certification for thisfacility in 1996 and updated our ISO qualification to the ISO 13485:2003standard in 2005.  The primary rawmaterials used in the manufacture of our surgical implant products are cobaltchromium alloy, stainless steel alloys, titanium alloy and ultra high molecularweight polyethylene. All Surgical Implant Segment products go through in-housequality control, cleaning and packaging operations.

 

**I****ntellectual********Property**

** **

We own or have licensing rights to U.S. and foreign patents covering awide range of our products and have filed applications for additional patents.We have numerous trademarks registered in the United States, a number of whichare also registered in countries around the world. We also assert ownership ofnumerous unregistered trademarks, some of which have been submitted forregistration in the United States and foreign countries. In the future, we willcontinue to apply for such additional patents and trademarks as we deem appropriate.Additionally, we seek to protect our non-patented know-how, trade secrets,processes and other proprietary confidential information, through a variety ofmethods, including having our vendors, employees and consultants sign inventionassignment agreements, proprietary information agreements and confidentialityagreements and having our independent sales agents and distributors signconfidentiality agreements. Because many of our products are regulated,proprietary information created during our development of a new or improvedproduct may have to be disclosed to the FDA or another U.S. or foreignregulatory agency in order for us to have the lawful right to market suchproduct.  We have distribution rights forcertain products that are manufactured by others and hold both exclusive andnonexclusive licenses under third party patents and trade secrets that coversome of our existing products and products under development.

 

The validity ofany of the patents or other intellectual property owned by or licensed to usmay not be upheld if challenged by others in litigation. Due to these and otherrisks described in this Annual Report, we do not rely solely on our patents andother intellectual property to maintain our competitive position. We believethat the development and marketing of new products and improvement of existingones is, and will continue to be, more important to our competitive positionthan relying solely on existing products and intellectual property.

 

**Competition**

** **

The orthopedicdevices market is highly competitive and fragmented. Some of our competitors,either alone or in conjunction with their respective parent corporate groups,have greater research and development, sales, marketing and manufacturingcapabilities than we do, and thus may have a competitive advantage overus.  Although we believe that the designand quality of our products compare favorably with those of our competitors, ifwe are unable to offer products with the latest technological advances atcompetitive prices, our ability to compete successfully could be materially andadversely affected.

 

14

----

Table of Contents

 

Given our saleshistory, our history of product development and the experience of ourmanagement team, we believe we are capable of effectively competing in theorthopedic devices market in the future. Further, we believe the comprehensiverange of products we offer enables us to reach a diverse customer base and touse multiple distribution channels in an attempt to increase our growth acrossthe orthopedic devices market. In addition, we believe the acquisition of thevarious companies and product lines which primarily now comprise our DomesticRehabilitation Segment continues to improve the name recognition of our companyand our products.

 

Among other things, our ability to compete is affected by our abilityto:

 

·                  develop new products and innovativetechnologies;

 

·                  obtain regulatory clearance andcompliance for our products;

 

·                  manufacture and sell our productscost-effectively;

 

·                  meet all relevant quality standardsfor our products and their markets;

 

·                  respond to competitive pressuresspecific to each of our geographic markets, including our ability to enforcenon-compete agreements;

 

·                  protect the proprietary technology ofour products and manufacturing processes;

 

·                  market our products;

 

·                  attract and retain skilled employeesand sales representatives; and

 

·                  maintain and establish distributionrelationships.

 

***Domestic Rehabilitation Segment***

*** ***

Our Domestic Rehabilitation Segment competes with large, diversifiedcorporations and companies that are part of corporate groups that havesignificantly greater financial, marketing and other resources than we do, aswell as numerous smaller niche companies. The primary competitors of Empi andChattanooga are Dynatronics Corporation, Mettler Electronics Corporation,Rich-Mar, Patterson Medical, Enraf-Nonius, Gymna-Uniphy, Acorn Engineering,International Rehabilitation Sciences, Inc. (d/b/a RS Medical) and CareRehab. The physical therapy products market is highly competitive andfragmented. Our competitors in the CPM devices market include severalmulti-product companies with significant market share and numerous smallerniche competitors.  Competition in thesemarkets is based primarily on the quality and technical features of products,product pricing and contractual arrangements with third party payors andnational accounts.

 

Our primary competitors in the rigid knee bracing market includecompanies such as Össur hf., Orthofix International, N.V., Bledsoe BraceSystems and Townsend Industries Inc. In the soft goods products market,our competitors include Biomet, Inc., DeRoyal Industries, Össur hf. andZimmer Holdings, Inc. In the cold therapy products market, our competitorsinclude Orthofix and Stryker Corporation. Our primary competitor in the dynamicsplinting market is Dynasplint Systems, Inc. Several competitors haveinitiated stock and bill programs similar to our OfficeCare and EmpiCareprograms, and there are numerous regional stock and bill competitors.Competition in the rigid knee brace market is primarily based on producttechnology, quality and reputation, relationships with customers, service andprice. Competition in the soft goods and pain management markets is lessdependent on innovation and technology and is primarily based on product range,quality, service and price.

 

Our competitorsfor regeneration products are large, diversified orthopedic companies. In thenonunion bone growth stimulation market, our competitors include OrthofixInternational, N.V., Biomet, Inc. and Smith & Nephew, and in thespinal fusion market, we compete with Biomet, Inc. and OrthofixInternational, N.V. Competition in bone growth stimulation devices is limitedas higher regulatory thresholds provide a barrier to market entry.

 

15

----

Table of Contents

 

***International Rehabilitation Segment***

 

Competition forour International Rehabilitation products arises from many of the companies andtypes of companies that compete with our Domestic Rehabilitation Segment andfrom foreign manufacturers whose costs may be lower due to their ability tomanufacture products within their respective countries.  Competition is based primarily on quality,innovative design and technical capability, breadth of product line, availabilityof and qualification for reimbursement, and price.

 

***Surgical Implant Segment***

 

The market for orthopedic products similar to those produced by ourSurgical Implant Segment is dominated by a number of large companies, includingBiomet, Inc., DePuy, Inc. (a Johnson & Johnson company), Smith &Nephew plc, Stryker Corporation and Zimmer Holdings, Inc., which are muchlarger and have significantly greater financial resources than we do. OurSurgical Implant Segment also faces competition from U.S.-based companiessimilar in size to ours, such as Wright Medical Group, Inc. and Exactech, Inc.Competition in the market in which our Surgical Implant Segment participates isbased primarily on price, quality, innovative design and technical capability,breadth of product line, scale of operations and distribution capabilities. Ourcurrent and future competitors may have greater resources, more widely acceptedand innovative products, less-invasive therapies, greater technicalcapabilities, and stronger name recognition than we do.

 

**G****overnment****R****egulation**

** **

***FDA and Similar Foreign Government Regulations***

*** ***

Our products aresubject to rigorous government agency regulation in the United States and inother countries. In the United States, the FDA regulates the development,testing, labeling, manufacturing, storage, recordkeeping, premarket clearanceor approval, promotion, distribution and marketing of medical devices to ensurethat medical products distributed in the United States are safe and effectivefor their intended uses. The FDA also regulates the export of medical devicesmanufactured in the United States to international markets. Our medical devicesare subject to such FDA regulation.

 

Under the Food,Drug and Cosmetic Act, as amended, medical devices are classified into one ofthree classes depending on the degree of risk to patients using the device. Class Idevices are those for which safety and effectiveness can be assured byadherence to General Controls, which include compliance with FDA QSRs, facilityand device registrations and listings, reporting of adverse medical events, andappropriate truthful and non-misleading labeling, advertising and promotionalmaterials. Some Class I devices also require pre-market review andclearance by the FDA through the Pre-market Notification 510(k) processdescribed below. Class II devices are subject to General Controls, as wellas pre-market demonstration of adherence to certain performance standards orother special controls as specified by the FDA. Pre-market review and clearanceby the FDA is accomplished through the Pre-market Notification 510(k) procedure.In the 510(k) procedure, the manufacturer submits certain requiredinformation to the FDA in order to establish that the device is “substantiallyequivalent” to a device that was legally marketed prior to May 28, 1976,the date upon which the Medical Device Amendments of 1976 were enacted or toanother similar commercially available device subsequently cleared through the510(k) process. Upon establishment of such substantial equivalence, theFDA may grant clearance to commercially market the device. If the FDAdetermines that the device, or its intended use, is not “substantiallyequivalent,” the FDA will automatically place the device into Class III.

 

A Class III device is a product that has a new intended use or isbased on technology that is not substantially equivalent to a use or technologywith respect to a legally marketed device for which the safety andeffectiveness of the device cannot be assured solely by the General Controls,performance standards and special controls applied to Class I and IIdevices. These devices generally require clinical trials involving humansubjects to assess their safety and effectiveness. A Pre-Market Approval (“PMA”)from the FDA is required before the manufacturer of a Class III productcan proceed in marketing the product. The PMA process is much more extensivethan the 510(k) process. In order to obtain a PMA, Class III devices,or a particular intended use of any such device, must generally undergoclinical trials pursuant to an application submitted by the manufacturer for anInvestigational Device Exemption (“IDE”). An IDE allows the investigationaldevice to be used in a clinical study in order to collect safety andeffectiveness data required to support a PMA application or a 510(k) submissionto the FDA. The PMA process generally takes significantly longer than the 510(k) processand can take up to several years.  Inapproving a PMA application, the FDA may require additional clinical data andmay also require some form of post-market surveillance whereby the manufacturerfollows certain patient groups for a number of years, making periodic reportsto the FDA on the clinical status of those patients.

 

16

----

Table ofContents

 

Our productsinclude both pre-amendment and post-amendment Class I, II and IIImedical devices. All our currently marketed devices are either exempt from theFDA clearance and approval process (based on our interpretation of thoseregulations) or we have obtained the requisite clearances or approvals(including all modifications, amendments and changes), or pre-market clearancesor approvals, as appropriate, required under federal medical device law. TheFDA may disagree with our conclusion that clearances or approvals were notrequired for specific products and may require clearances or approval for suchproducts. In these circumstances, we may be required to cease distribution ofthe modified product, the devices may be subject to seizure by the FDA or to avoluntary or mandatory recall, and we also could be subject to significantfines and penalties.

 

Our manufacturingprocesses are also required to comply with cGMP and QSR requirements that coverthe methods and documentation of the design, testing, production processes,control, quality assurance, labeling, packaging and shipping of our products.Furthermore, our facilities, records and manufacturing processes are subject toperiodic unscheduled inspections by the FDA and other agencies. Failure tocomply with applicable QSR or other U.S. medical device regulatory requirementscould result in, among other things, warning letters, fines, injunctions, civilpenalties, repairs, replacements, refunds, recalls or seizures of products,total or partial suspensions of production, refusal of the FDA to grant futurepre-market clearances or PMA approvals, withdrawals or suspensions of currentclearances or approvals, and criminal prosecution. We are also required toreport to the FDA if our products cause or contribute to death or seriousinjury or malfunction in a way that would likely cause or contribute to deathor serious injury were the malfunction to recur; the FDA or other agencies mayrequire the recall of products in the event of material defects or deficienciesin design or manufacturing. The FDA can also withdraw or limit our productapprovals or clearances in the event of serious unanticipated health or safetyconcerns.

 

In January 2007, we received a warning letter from the FDA to theeffect that they believed that certain discrete processes related to ourSurgical Implant Segment did not conform with cGMP.  During 2007, we worked with the FDA toresolve all outstanding issues they had identified in the past as a result oftheir audits regarding QSR and cGMP compliance. During the first quarter of 2008, the FDA officially concluded theirinvestigation and all areas of concern were resolved satisfactorily.  Also, in the first quarter of 2008, wereceived an FDA Form 483 “Inspectional Observations” in connection with anFDA audit of the Chattanooga division of our Domestic Rehabilitation Segment,stating that we failed to report certain customer complaints claiming that ourmuscle stimulator devices malfunctioned, and that we did not adequatelyimplement corrective and preventive action to prevent recurrence of potentialproduct failures relating to our muscle stimulator devices.  The FDA issued a warning letter in the secondquarter of 2008 related to the issues at our Chattanooga operation.  We believe we have corrected these issues andare implementing a recall of certain devices. We do not believe that this warning letter and recall will have amaterial adverse effect on our financial condition or results ofoperations.  However, we cannot assureyou that the FDA will not take further action in the future.

 

Even if regulatory approval or clearance of a medical device isgranted, the FDA may impose limitations or restrictions on the use andindications for which the device may be labeled or promoted. Medical devicesmay be marketed only for the uses and indications for which they are cleared orapproved. FDA regulations prohibit a manufacturer from promotion for an unapprovedor off-label use.

 

The FDA has broadregulatory and enforcement powers. If the FDA determines we have failed tocomply with applicable regulatory requirements, it can impose a variety ofenforcement actions, from warning letters, fines, injunctions, consent decrees,and civil penalties, to suspension or delayed issuance of applications, seizureor recall of our products, total or partial shutdowns, withdrawals of approvalsor clearances already granted, and criminal prosecution. The FDA can also requireus to repair or replace or refund the costs of devices we manufactured ordistributed.

 

We must obtainexport certificates from the FDA before we can export certain of our products.We are also subject to extensive regulations that are similar to those of theFDA in many of the foreign countries in which we sell our products, includingthose in Europe, our largest foreign market. These include product standards,packaging requirements, labeling requirements, import restrictions, tariffregulations, duties and tax requirements. The regulation of our products inEurope falls primarily within the European Economic Area, which consists of thetwenty-seven member states of the European Union, as well as Iceland,Liechtenstein and Norway. Only medical devices that comply with certainconformity requirements are allowed to be marketed within the European EconomicArea. In addition, the national health or social security organizations ofcertain countries other than in Europe require our products to be qualified beforethey can be marketed in those countries.

 

We have alsoimplemented policies and procedures allowing us to position ourselves for thechanging international regulatory environment. Our Surgical Implant Segment hasreceived an ISO 13485:2003 certification for its facilities and an ECCertificate for its many products. Receiving ISO 13485:2003 certificationassists us in meeting international regulatory requirements to allow for exportof products to Japan, countries in Europe, Australia and Canada. Our SurgicalImplant Segment has also met the requisites for the Canadian Medical DeviceRequirements.  Our DomesticRehabilitation Segment has received ISO 9001 certification, EN46001certification and certification to the Canadian Medical Device Regulation (ISO13485) and the European Medical Device Directive.

 

17

----

Table ofContents

 

***Third Party Reimbursement***

*** ***

Our home therapy products, rigid knee braces, regeneration products,and certain of our soft goods are generally prescribed by physicians and areeligible for third party reimbursement by government payors, such as Medicareand Medicaid, and private payors. Customer selection of our products depends,in part, on coverage of our products and whether third party payment amountswill be adequate. We believe that Medicare and other third party payors willcontinue to focus on measures to contain or reduce their costs through managedcare and other methods. Medicare policies are important to our business becauseprivate payors often model their policies after the Medicare program’s coverageand reimbursement policies.  In December 2008,Medicare issued a notice to its contractors responsible for reimbursement oforthotics, among other products, to the effect that elastic braces that are notrigid or semi-rigid are not considered “braces” for Medicare coverage purposesand will no longer be reimbursed, effective January 1, 2009.  We are seeking a redetermination by Medicareof the application of this notice to several braces we sell that, while notcomposed of rigid material, operate to support and correct physical issues,particularly relating to the knee cap, and should be continued to be classifiedas braces for coverage purposes.  Thisdecision by Medicare is likely to eventually be adopted by private third-partypayers and, subject to our success in seeking the redetermination, couldadversely impact our sales in the bracing and soft goods product line of our DomesticRehabilitation Segment.

 

Healthcare reform legislation in the Medicare area has focused oncontaining healthcare spending in recent years. The Medicare Prescription Drug,Improvement, and Modernization Act of 2003 (the “Medicare Modernization Act”)provides for revisions to payment methodologies and other standards for durablemedical equipment and orthotic devices under the Medicare program. The MedicareModernization Act mandated a new competitive bidding program for durable medicalequipment, orthotics, prosthetics, and supplies. In April 2007, theCenters for Medicare & Medicaid Services (“CMS”), the agencyresponsible for administering the Medicare program, issued final regulations inconnection with the competitive bidding program. Under competitive bidding,Medicare will no longer reimburse for certain products and services based onthe Medicare fee schedule amount in designated competitive bidding areas.Instead, CMS will provide reimbursement for these items and services based on acompetitive bidding process. Only those suppliers selected through thecompetitive bidding process within each designated region will be eligible tohave their products reimbursed by Medicare. Bidding was conducted in 2007 forthe first phase of competitive bidding in ten metropolitan statistical areasfor ten product categories, and bid prices briefly went into effect on effect July 2,2008.  The program was scheduled to beexpanded to an additional 70 areas in 2009, and additional areas thereafter.  Due to widespread concerns aboutimplementation of the program, however, on July 15, 2008, the U.S.Congress enacted the Medicare Improvements for Patients and Providers Act of2008 (“MIPPA”), which terminated round one contracts and requires CMS to rebidthose areas in 2009.  The legislationalso delays round two bidding until 2011 and makes a series of changes toprogram requirements.  The delay inbidding is financed by nationwide reductions in Medicare DMEPOS fee schedulepayments for items that were subject to the first round of bidding.  While none of our product categories isincluded in the first round of competitive bidding, off-the-shelf orthoticscould eventually be subject to the bidding process. The competitive biddingprocess may reduce the number of suppliers providing certain items and servicesto Medicare beneficiaries and the amounts paid for such items and serviceswithin a given geographic area. In addition, CMS may use payment informationfrom regions subject to competitive bidding to reduce Medicare reimbursement inregions not subject to competitive bidding. CMS also has proposed revising theway Medicare sets payment amounts for all new durable medical equipment,orthotics, prosthetics, and supplies, under which reimbursement could be basedin part or in whole on functional assessments, price comparisons, and medicalbenefits assessments, although that methodology has not yet beenfinalized.  While the program iscurrently delayed, once it is back in effect, we expect it will be expanded toadditional areas and additional product categories may be selected.

 

In addition, asmandated by the Medicare Modernization Act, in August 2006, CMS issuedquality standards for suppliers, which are being applied by independentaccreditation organizations. Suppliers must be accredited as meeting supplierstandards as a condition of participation in competitive bidding, but allMedicare suppliers eventually must be accredited to participate in Medicare,with different deadlines based on when the supplier applies for enrollment.Those portions of our business that act as Medicare suppliers have beenaccredited. Moreover, the Medicare Modernization Act requires that new clinicalconditions for payment of durable medical equipment be established. CMS issueda proposed rule to implement this provision in August 2004, but theagency to date only has finalized such standards for power mobility devices.Some of our products could be impacted by this requirement in the future. Atthis time, we cannot predict what clinical conditions will be adopted, thetiming of such adoption, or the impact that the new quality standards or anynew clinical conditions that are adopted may have on our business.

 

18

----

Table ofContents

 

CMS also published a rule on January 2, 2009 requiring mostMedicare suppliers of durable medical equipment, prosthetics, orthotics andsupplies to post a $50,000 surety bond from an authorized surety, with higheramounts required for certain “high-risk” suppliers.  The rule provides an exception from thesurety bond requirement for the provision of orthotics, prosthetics, andsupplies by (1) state-licensed orthotic and prosthetic personnel and (2) state-licensedphysical and occupational therapists providing such items to their ownpatients. This exception applies only to personnel and therapists operating inprivate practice; medical supply companies employing such personnel or therapistsdo not qualify for this exception.  The rule iseffective March 3, 2009.  Existingsuppliers must comply with the surety bond requirement by October 2,2009), while new enrolling suppliers or suppliers seeking to change ownershipafter the effective date must meet this requirement by May 4, 2009.

 

Our internationalsales also depend in part upon the eligibility of our products forreimbursement through third party payors, the amount of reimbursement and theallocation of payments between the patient and third party payors.Reimbursement practices vary significantly by country, with certain countriesrequiring products to undergo a lengthy regulatory review in order to beeligible for third party reimbursement. In addition, healthcare cost containmentefforts similar to those we face in the United States are prevalent in many ofthe foreign countries in which our products are sold, and these efforts areexpected to continue in the future, possibly resulting in the adoption of morestringent reimbursement standards. For example, in Germany, our largest foreignmarket, new regulations generally require adult patients to pay a portion ofthe cost of each medical technical device prescribed. This may adversely affectour sales and profitability by making it more difficult for patients in Germanyto pay for our products. Any developments in our foreign markets thateliminate, reduce or materially modify coverage of, and reimbursement ratesfor, our products could have an adverse effect on our ability to sell ourproducts.

 

***Fraud and Abuse***

*** ***

We are subject to various federal and state laws and regulationspertaining to healthcare fraud and abuse. Violations of these laws arepunishable by criminal and civil sanctions, including, in some instances,exclusion from participation in federal and state healthcare programs,including Medicare, Medicaid, Veterans Administration health programs andTRICARE (the health care program for active duty military, retirees and theirfamilies managed by the Department of Defense). We have no reason to believethat our operations are not in material compliance with such laws. However,because these laws and regulations are broad in scope and may change, we may berequired to alter one or more of our practices to be in compliance with theselaws. In addition, the occurrence of one or more violations of these laws orregulations, a challenge to our operations by a governmental authority underthese laws or regulations or a change in the laws or regulations may have amaterial adverse effect on our financial condition and results of operations.

 

*Anti-Kickback and Other-Fraud Laws*

* *

Our operations are subject to federal and state anti-kickback laws.Certain provisions of the Social Security Act, commonly referred to as theAnti-Kickback Statute, prohibit persons from knowingly and willfullysoliciting, receiving, offering or providing remuneration directly orindirectly to induce either the referral of an individual, or the furnishing,recommending, or arranging for a good or service, for which payment may be madeunder a federal healthcare program such as Medicare and Medicaid. Thedefinition of “remuneration” has been broadly interpreted to include anythingof value, including such items as gifts, discounts, waiver of payments, andproviding anything at less than its fair market value. The U.S. Department ofHealth and Human Services (“HHS”) has issued regulations, commonly known assafe harbors, that set forth certain conditions which, if fully met, willassure healthcare providers and other parties that they will not be prosecutedunder the Anti-Kickback Statute. Although full compliance with these provisionsensures against prosecution under the Anti-Kickback Statute, the failure of atransaction or arrangement to fit within a specific safe harbor does notnecessarily mean that the transaction or arrangement is illegal or thatprosecution under the Anti-Kickback Statute will be pursued. The penalties forviolating the Anti-Kickback Statute include imprisonment for up to five years,fines of up to $25,000 per violation and possible exclusion from federalhealthcare programs such as Medicare and Medicaid. Many states have adoptedprohibitions similar to the Anti-Kickback Statute, some of which apply to thereferral of patients for healthcare services reimbursed by any source, not onlyby the Medicare and Medicaid programs.

 

Recently, certain manufacturers of implant products entered intomonetary settlement agreements, corporate integrity agreements and deferredprosecution agreements with the U.S. Department of Justice (“DOJ”) based uponallegations that, among other things, they entered into a variety of consultingand other agreements with physicians as improper inducements to thosephysicians to use the manufacturers’ products in violation of federalanti-kickback laws. We believe that remuneration paid to surgeons with which wehave agreements represents fair market value for legitimate designing,consulting and advisory services rendered on our behalf.

 

Our OfficeCare program is a stock and bill arrangement through which wemake products and services available in the offices of physicians or otherproviders. In conjunction with the OfficeCare program, we may pay participatingphysicians a fee for rental space and support services provided by suchphysicians to us. In a February 2000 Special Fraud Alert, the Office ofInspector General (“OIG”) indicated that it may scrutinize stock andbill programs involving excessive rental payments or rental space for possibleviolation of the Anti-Kickback Statute, but noted that legitimate arrangements,including fair market value rental arrangements, will not be consideredviolations of the statute. We believe that we have structured our OfficeCareprogram to comply with the Anti-Kickback Statute.

 

19

----

Table ofContents

 

The HealthInsurance Portability and Accountability Act of 1995 (“HIPAA”) created two newfederal crimes effective as of August 21, 1996, relating to healthcarefraud and false statements regarding healthcare matters. The healthcare fraudstatute prohibits knowingly and willfully executing or attempting to execute ascheme or artifice to defraud any healthcare benefit program, including privatepayors. The false statements statute prohibits knowingly and willfullyfalsifying, concealing or covering up a material fact or making any materiallyfalse, fictitious or fraudulent statement or representation in connection withthe delivery of or payment for healthcare benefits, items or services. HIPAAapplies to any healthcare benefit plan, not just Medicare and Medicaid.Additionally, HIPAA granted expanded enforcement authority to HHS and the DOJand provided enhanced resources to support the activities and responsibilitiesof the HHS, OIG and DOJ by authorizing large increases in funding forinvestigating fraud and abuse violations relating to healthcare delivery andpayment. In addition, HIPAA mandates the adoption of standards for theelectronic exchange of health information, as described below in greater detailunder “Federal Privacy and Transaction Law and Regulations.”

 

*Physician Self-Referral Laws*

* *

We may also be subject to federal and state physician self-referral laws.Federal physician self-referral legislation, commonly known as the Stark Law, prohibits, subject to certainexceptions, physician referrals of Medicare and Medicaid patients to an entityproviding certain “designated health services” if the physician or an immediatefamily member of the physician or a physician organization in which thephysician participates has any financial relationship with the entity. Durablemedical equipment and orthotics are included as designated health services. TheStark Law also prohibits the entity receiving the referral from billing anygood or service furnished pursuant to an unlawful referral, and any personcollecting any amounts in connection with an unlawful referral is obligated torefund such amounts. A person who engages in a scheme to circumvent the StarkLaw’s referral prohibition may be fined up to $100,000 for each sucharrangement or scheme. The penalties for violating the Stark Law also includecivil monetary penalties of up to $15,000 per referral and possible exclusionfrom federal healthcare programs such as Medicare and Medicaid. Various stateshave corollary laws to the Stark Law, including laws that require physicians todisclose any financial interest they may have with a healthcare provider totheir patients when referring patients to that provider. Both the scope andexceptions for such laws vary from state to state.

 

*False Claims Laws*

* *

Under multiple state and federal statutes, submissions of claims forpayment that are “not provided as claimed” may lead to civil money penalties,criminal fines and imprisonment and/or exclusion from participation inMedicare, Medicaid and other federally funded state health programs. Thesefalse claims statutes include the federal False Claims Act, which prohibits theknowing filing of a false claim or the knowing use of false statements toobtain payment from the federal government. When an entity is determined tohave violated the False Claims Act, it must pay three times the actual damagessustained by the government, plus mandatory civil penalties of between $5,500and $11,000 for each separate false claim. Suits filed under the False ClaimsAct, known as “qui tam” actions, can be brought by any individual on behalf ofthe government and such individuals, commonly known as whistleblowers, mayshare in any amounts paid by the entity to the government in fines orsettlement. In addition, certain states have enacted laws modeled after thefederal False Claims Act. Qui tam actions have increased significantly inrecent years, causing greater numbers of healthcare companies to have to defenda false claim action, pay fines or be excluded from Medicare, Medicaid or otherfederal or state healthcare programs as a result of an investigation arisingout of such action. A number of manufacturers have entered settlements,following allegations that they “aided and abetted” in the submission of falseclaims, related to pricing, off-label promotion, and other issues. Under theDeficit Reduction Act of 2006, additional requirements related to theestablishment and dissemination of written policies regarding the False ClaimsAct were placed on certain providers of Medicare services.

 

***Governmental Audits***

*** ***

Because we participate in governmental programs as a supplier ofmedical devices, our operations are subject to periodic surveys and audits bygovernmental entities or contractors to assure compliance with Medicare andMedicaid standards and requirements. To maintain our billing privileges, we arerequired to comply with certain supplier standards, including licensure anddocumentation requirements for our claims submissions. From time to time in theordinary course of business, we, like other healthcare companies, are auditedby, or receive claims documentation requests from, governmental entities, whichmay identify certain deficiencies based on our alleged failure to comply withapplicable supplier standards or other requirements. Medicare contractors andMedicaid agencies periodically conduct pre- and post-payment reviews and otheraudits of claims and are under increasing pressure to more closely scrutinizehealthcare claims and supporting documentation. We have

 

20

----

Table of Contents

 

historically beensubject to pre and post-payment reviews as well as audits of claims and mayexperience such reviews and audits of claims in the future. We review andassess such audits or reports and attempt to take appropriate correctiveaction. We are also subject to surveys of our facilities for compliance withthe supplier standards. In November 2008, we were advised that theMedicare Administrative Contractor in the Western Region for our type ofproducts, CIGNA Governmental Services (“CIGNA”), had conducted an audit of ouroperations.  As a result of that audit,CIGNA has asserted that we have been overpaid in the amount of approximately$6.0 million from January 1, 2006 to April 9, 2007.  The reason asserted by CIGNA that Medicarewas not obligated to provide reimbursement on these claims is that we failed tomaintain a California Home Medical Device Retail Exemptee License during such15 month period.  We believe that thislicensing program does not apply to our business and have appealed theassessment of the overpayment.  Duringthe pendency of the appeal, we are not required to pay the assessed $6.0million overpayment, but interest at the rate of 11.375% per annum will run onthe amount, if any, eventually determined to be due. The $6.0 million isaccrued in our consolidated balance sheet as of December 31, 2008.

 

We have also been subject to periodic audits of our compliance withother federal requirements for our facilities and related quality andmanufacturing processes.  Our SurgicalImplant facility in Austin, Texas resolved in 2008 an FDA warning letterreceived in 2007 and our facility in Chattanooga received a warning letterfollowing an FDA audit in early 2008. Both of these warning letters are described above in the section “FDAand Similar Foreign Government Regulations”.

 

***Federal Privacy and Transaction Law and Regulations***

 

HIPAA impacts the transmission, maintenance, use and disclosure of certainindividually identifiable health information (referred to as “protected healthinformation” or “PHI”). Since HIPAA was enacted in 1996, numerous implementingregulations have been issued, including, but not limited to: (1) standardsfor the privacy of individually identifiable health information (the “PrivacyRule”), (2) security standards (the “Security Rule”), (3) standardsfor electronic transactions (the “Transactions Rule”), and (4) standardunique national provider identifier (“NPI Rule”). We refer to these rules asthe Administrative Simplification Rules. CMS has also issued regulationsgoverning the enforcement of the Administrative Simplification Rules. Sanctionsfor violation of HIPAA and /or the Administrative Simplification Rules includecriminal and civil penalties.

 

HIPAA applies to “covered entities,” which includes certain health careproviders who conduct certain transactions electronically. As such, HIPAA andthe Administrative Simplification Rules apply to certain aspects of ourbusiness.  The effective date for all ofthe Administrative Simplification Rules outlined above has passed, and, assuch, all of the Administrative Simplification Rules are in effect. To theextent applicable to our operations, we are currently in compliance with HIPAAand the applicable Administrative Simplification Rules.

 

On February 17, 2009, President Obama signed into law the AmericanRecovery and Reinvestment Act (the “ARRA”). This economic stimulus package includes many health care policyprovisions, including strengthened federal privacy and security provisions toprotect personally-identifiable health information, including notificationrequirements for health data security breaches. Many of the details of the new requirements will be implemented throughfuture regulations.  We are reviewing thenew law to assess the potential impact on our operations.

 

**E****mployees**

 

As of December 31,2008, we had approximately 4,690 employees. Of these, approximately 3,100 wereengaged in production and production support, 45 in research and development,approximately 1,120 in sales and support, and approximately 425 in variousadministrative capacities including third party billing.  Of these employees, approximately 2,200 werelocated in the United States, approximately 1,860 were located in Mexico andapproximately 630 were located in various other countries, primarily inEurope.  Our workforce in the UnitedStates is not unionized; however, portions of our workforce in Europe are unionized.  We have not experienced any strikes or workstoppages, and our management considers our relationship with our employees tobe good.

 

**S****egment and****G****eographic****Information**

 

Information about our segments andgeographic areas can be found in Note 11 “Segment and Geographic Information”under notes to our audited consolidated financial statements in this AnnualReport.

 

21

----

Table ofContents

 

**Available Information**

 

We have made available free of charge through our website,www.DJOglobal.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, other Exchange Act reports and all amendmentsto those reports as soon as reasonably practicable after such material iselectronically filed with the Securities and Exchange Commission (“SEC”).  This information can be found under the “Investors-SECReports” page of our website.  DJOuses its website as a channel of distribution of material Companyinformation.  Financial and othermaterial information regarding the Company is routinely posted and accessibleon our website. Our SEC reports are also available free of charge on the SECwebsite at, www.sec.gov.  Our Code ofBusiness Conduct and Ethics is available free of charge on our website.  It may be found under the “CorporateGovernance” page of our website.

 

## **ITEM 1A.  RISKFACTORS**

## ** **

*Ourability to achieve our operating and financial goals is subject to a number ofrisks, including risks arising from the current economic downturn and risksrelating to our business operations, our debt level and governmentregulations.  If any of the followingrisks actually occur, our business, operating results, prospects or financialcondition could be materially and adversely affected.  The risks described below are not the onlyones that we face. Additional risks not presently known to us or that wecurrently deem immaterial may also affect our business operations.*

 

**RisksRelated To the Economic Downturn**

 

***Thecurrent US and global economic downturn and related credit and financial marketproblems may pose additional risks and exacerbate existing risks to ourbusiness.***

 

The seriousslowdown in the US and global economy, as well as the dramatic problems in thecurrent credit and financial markets, could have a negative effect on demandfor our products, availability and reliability of vendors and third partycontract manufacturers, our ability to timely collect our accounts receivableand the availability of financing for acquisitions and working capitalrequirements.

 

The slowing ofeconomic activity and lack of available financing could impact our business ina variety of ways, including the following:

 

·      Loss of jobs and lack of health insurance as aresult of the economic slowdown could depress demand for health care servicesand demand for our products.

 

·      Weakened demand for health care services,reduction in the number of insureds and lack of available credit could resultin the inability of private insurers to satisfy their reimbursementobligations, lead to delays in payment or cause the insurers to increase theirscrutiny of our claims.

 

·      Shortage of available credit for working capitalcould lead customers who buy capital goods from us to curtail their purchasesor have difficulty meeting payment obligations.

 

·      Tightening of credit and disruption in thefinancial markets could disrupt or delay performance by our third party vendorsand contractors and adversely affect our business.

 

·      Problems in the credit and financial marketscould limit the availability and size of alternative or additional financingfor our working capital or other corporate needs and could make it moredifficult and expensive to obtain waivers under or make changes to our existingcredit arrangements.

 

Any of theserisks, among others, could adversely affect our business and operating results,and the risks could become more pronounced if the problems in the US and globaleconomies and the credit and financial markets continue or become worse.

 

22

----

Table ofContents

 

**RisksRelated To Our Indebtedness**

 

***Our substantial leverage could adversely affect our abilityto raise additional capital to fund our operations, limit our ability to reactto changes in the economy or our industry, expose us to interest rate risk tothe extent of our variable rate debt and prevent us from meeting ourobligations under our indebtedness.***

 

Due to the DJOMerger, we are highly leveraged. As of December 31, 2008, our totalindebtedness was $1,843.6 million. We have an additional$100.0 million available for borrowing under our new revolving creditfacility, of which $24.0 million was outstanding as of December 31, 2008.

 

Our high degree of leverage could have important consequences,including:

 

·                  makingit difficult for us to make payments on our 10.875% Notes and our 11.75% Notes(collectively, the “Notes”) and other debt;

 

·                  increasingour vulnerability to general economic and industry conditions;

 

·                  requiringa substantial portion of cash flow from operations to be dedicated to thepayment of principal and interest on our indebtedness, therefore reducing ourability to use our cash flow to fund our operations, capital expenditures andfuture business opportunities;

 

·                  exposingus to the risk of increased interest rates as certain of our borrowings,including certain borrowings under our Senior Secured Credit Facility, will besubject to variable rates of interest;

 

·                  limitingour ability to make strategic acquisitions or causing us to make non-strategicdivestitures;

 

·                  limitingour ability to obtain additional financing for working capital, capitalexpenditures, product development, debt service requirements, acquisitions andgeneral corporate or other purposes; and

 

·                  limitingour ability to adjust to changing market conditions and placing us at acompetitive disadvantage compared to our competitors who are less highlyleveraged.

 

We may not be ableto incur substantial additional indebtedness in the future. Although our SeniorSecured Credit Facility and each of the indentures governing the Notes, whichwe refer to as the 10.875% Indenture and the 11.75% Indenture (or collectively,the “Indentures”), contain restrictions on the incurrence of additionalindebtedness, these restrictions are subject to a number of significantqualifications and exceptions, and under certain circumstances, the amount ofindebtedness that could be incurred in compliance with these restrictions couldbe substantial. If new indebtedness is added to our current debt levels, therelated risks that we now face could intensify. In addition, the Indentureswill not prevent us from incurring obligations that do not constituteindebtedness under the Indentures.

 

Our cash paid forinterest for the Successor years ended December 31, 2008 and 2007 was$158.8 million and $70.2 million, respectively. As of December 31, 2008, we had $1,079.3 million of debt subject tofloating interest rates, including $1,078.3 million under the Senior SecuredCredit Facility.  Although we currently haveinterest rate swaps in place to hedge against rising interest rates (see Note 8to our audited consolidated financial statements in this Annual Report), anyadditional borrowings we make under the Senior Secured Credit Facility willalso be subject to floating interest rates.

 

***Our debt agreements contain restrictions that limit ourflexibility in operating our business.***

 

Our Senior SecuredCredit Facility and the Indentures governing the Notes contain variouscovenants that limit our ability to engage in specified types of transactions.These covenants limit our and our restricted subsidiaries’ ability to, amongother things:

 

·                  incuradditional indebtedness or issue certain preferred shares;

 

·                  paydividends on, repurchase or make distributions in respect of our capital stockor make other restricted payments;

 

·                  makecertain investments;

 

·                  sellcertain assets;

 

23

----

Table of Contents

 

·                  createliens;

 

·                  consolidate,merge, sell or otherwise dispose of all or substantially all of our assets; and

 

·                  enterinto certain transactions with our affiliates.

 

In addition, weare required to satisfy and maintain a specified senior secured leverage ratio,which becomes more restrictive over time. This covenant could materially andadversely affect our ability to finance our future operations or capital needs.Furthermore, it may restrict our ability to conduct and expand our business andpursue our business strategies.  Ourability to meet this senior secured leverage ratio can be affected by eventsbeyond our control, including changes in general economic and businessconditions, and we cannot assure you that we will meet the senior securedleverage ratio in the future or at all.

 

A breach of any ofthese covenants could result in a default under one or more of these agreements,including as a result of cross default provisions. Upon the occurrence of anevent of default under the Senior Secured Credit Facility, the lenders couldelect to declare all amounts outstanding under the Senior Secured CreditFacility to be immediately due and payable and terminate all commitments toextend further credit. Such actions by those lenders could cause cross defaultsunder our other indebtedness. If we were unable to repay those amounts, thelenders under the Senior Secured Credit Facility could proceed against thecollateral granted to them to secure that indebtedness. We have pledged asignificant portion of our assets as collateral under the Senior Secured CreditFacility. If the lenders under the Senior Secured Credit Facility acceleratethe repayment of borrowings, we cannot assure you that we will have sufficientassets to repay the amounts borrowed under the Senior Secured Credit Facility,as well as our unsecured indebtedness.

 

***We may not be able to generate sufficient cash to serviceall of our indebtedness, and may be forced to take other actions to satisfy ourobligations under our indebtedness, which may not be successful.***

 

Our ability tomake scheduled payments on or to refinance our debt obligations depends on ourfinancial condition and operating performance, which is subject to prevailingeconomic and competitive conditions and to certain financial, business andother factors beyond our control. We cannot assure you that we will maintain alevel of cash flows from operating activities sufficient to permit us to paythe principal, premium, if any, and interest on our indebtedness.

 

If our cash flowsand capital resources are insufficient to fund our debt service obligations, wemay be forced to reduce or delay investments and capital expenditures, or tosell assets, seek additional capital or restructure or refinance ourindebtedness. These alternative measures could affect the operation and growthof our business and may not be successful and may not permit us to meet our scheduleddebt service obligations. If our operating results and available cash areinsufficient to meet our debt service obligations, we could face substantialliquidity problems and might be required to dispose of material assets oroperations to meet our debt service and other obligations. In that case, we maynot be able to consummate those dispositions or to obtain the proceeds that wecould realize from them, and the proceeds from those dispositions may not beadequate to meet any debt service obligations then due. Additionally, ourSenior Secured Credit Facility and the Indentures governing the Notes limit theuse of the proceeds from dispositions of assets; as a result, we may not bepermitted, under our Senior Secured Credit Facility and the Indenturesgoverning the Notes, to use the proceeds from such dispositions to satisfy allcurrent debt service obligations.

 

***We may not be able to repurchase the Notes upon a change of control.***

 

Upon theoccurrence of specific kinds of change of control events, we will be requiredto offer to repurchase all outstanding Notes at 101% of their principal amountplus accrued and unpaid interest.  Thesource of funds for any such purchase of the Notes will be our available cashor cash generated from our subsidiaries’ operations or other sources, includingborrowings, sales of assets or sales of equity. We may not be able torepurchase the Notes upon a change of control because we may not havesufficient financial resources to purchase all of the Notes that are tendered upona change of control.  Further, we will becontractually restricted under the terms of our Senior Secured Credit Facilityfrom repurchasing all of the Notes tendered by holders upon a change ofcontrol. Accordingly, we may not be able to satisfy our obligations to purchasethe Notes unless we are able to refinance or obtain waivers under our SeniorSecured Credit Facility. Our failure to repurchase the notes upon a change ofcontrol would cause a default under the Indentures governing the Notes and a cross-defaultunder the Senior Secured Credit Facility. Our Senior Secured Credit Facilityalso provides that a change of control will be a default that permits lendersto accelerate the maturity of borrowings thereunder. Any of our future debtagreements may contain similar provisions.

 

24

----

Table of Contents

 

***Thelenders under the Senior Secured Credit Facility will have the discretion to releasethe guarantors under the senior secured credit agreement in a variety ofcircumstances, which will cause those guarantors to be released from theirguarantees of the Notes.***

 

While anyobligations under the Senior Secured Credit Facility remain outstanding, anyguarantee of the Notes may be released without action by, or consent of, anyholder of the Notes or the trustee under the Indentures governing the Notes, atthe discretion of lenders under the Senior Secured Credit Facility, if therelated guarantor is no longer a guarantor of obligations under the SeniorSecured Credit Facility. The lenders under the Senior Secured Credit Facilitywill have the discretion to release the guarantees under the Senior SecuredCredit Facility in a variety of circumstances. You will not have a claim as acreditor against any subsidiary that is no longer a guarantor of the Notes, andthe indebtedness and other liabilities, including trade payables, whethersecured or unsecured, of those subsidiaries will effectively be senior toclaims of noteholders.

 

***Transferof the Notes may be limited by the absence of an active trading market, andthere is no assurance that any active trading market will develop for theNotes.***

 

The 10.875% Notesand the 11.75% Notes were registered with the SEC in July 2008 and May 2007,respectively, and are publicly traded.

 

We do not intendto apply for a listing of the Notes on a securities exchange or on anyautomated dealer quotation system. We cannot make assurances as to theliquidity of markets for the Notes, the ability to sell the Notes or the priceat which a holder may be able to sell the Notes. If such markets were to exist,the Notes could trade at prices that may be lower than their principal amountor purchase price depending on many factors, including prevailing interestrates, the market for similar notes, our financial and operating performanceand other factors. Historically, the market for non-investment grade debt hasbeen subject to disruptions that have caused substantial volatility in theprices of securities similar to the Notes. The market, if any, for the Notesmay experience similar disruptions and any such disruptions may adverselyaffect the prices at which you may sell your Notes.

 

**RisksRelated To Our Business**

 

***Recent changes in coverage and reimbursement policies forour products by Medicare or reductions in reimbursement rates for our productscould adversely affect our business and results of operations.***

 

The Medicare Modernization Act mandates a number ofchanges in the Medicare payment methodology and conditions for coverage oforthotic devices and durable medical equipment, including many of our products.These changes include a temporary freeze in annual increases in payments fordurable medical equipment from 2004 through 2008, competitive biddingrequirements, new clinical conditions for payment and quality standards.Although these changes affect our products generally, specific products may beaffected by some, but not all, of the Medicare Modernization Act’s provisions.

 

Prefabricated orthoticdevices and certain durable medical equipment, including many of our products,may be subject to a competitive bidding process established under the MedicareModernization Act. In April 2007, CMS issued final regulations inconnection with the competitive bidding program. Under competitive bidding,Medicare will no longer reimburse for certain products and services based onthe Medicare fee schedule amount in designated competitive bidding areas.Instead, CMS will provide reimbursement for these items and services based on acompetitive bidding process. Only those suppliers selected through acompetitive bidding process within each designated region will be eligible tohave their products reimbursed by Medicare. Bidding was conducted in 2007 forthe first phase of competitive bidding in ten metropolitan statistical areasfor ten product categories, and bid prices briefly went into effect on July 1,2008.  The program was scheduled to beexpanded to 70 additional areas in 2009, and additional areas thereafter.  On July 15, 2008, the U.S. Congressenacted the Medicare Improvements for Patients and Providers Act of 2008(MIPPA), which terminated round one contracts and requires CMS to rebid thoseareas in 2009.  The legislation alsodelays round two bidding until 2011 and makes a series of changes to programrequirements.  The delay in bidding isfinanced by nationwide reductions in Medicare DMEPOS fee schedule payments foritems that were subject to the first round of bidding.  When it is eventually implemented, thecompetitive bidding process may reduce the number of suppliers providingcertain items and services to Medicare beneficiaries and the amounts paid forsuch items and services within a given geographic area. None of our products isincluded in the initial round of items subject to bidding; however, there is noassurance they will not be included in the future. Inclusion of any of ourproducts in Medicare competitive bidding or other Medicare reimbursement orcoverage reductions could result in such products being sold in lesserquantities or for a lower price, or coverage for such products beingdiscontinued altogether. Any of these developments could have a materialadverse effect on our results of operations. In addition, if we are notselected to participate in the competitive bidding program in a particularregion, it could have a material adverse effect on our sales and profitability.

 

25

----

Table of Contents

 

***If we fail to comply with the FDA’s Quality SystemRegulation, our manufacturing could be delayed, and our product sales andprofitability could suffer.***

 

Our manufacturing processes are required to complywith the FDA’s Quality System Regulation, which covers the proceduresconcerning (and documentation of) the design, testing, production processes,controls, quality assurance, labeling, packaging, storage and shipping of ourdevices. We also are subject to state requirements and licenses applicable tomanufacturers of medical devices. In addition, we must engage in extensiverecordkeeping and reporting and must make available our manufacturingfacilities and records for periodic unscheduled inspections by governmentalagencies, including the FDA, state authorities and comparable agencies in othercountries. Moreover, if we fail to pass a Quality System Regulation inspectionor to comply with these and other applicable regulatory requirements, we mayreceive a warning letter or could otherwise be required to take correctiveaction and, in severe cases, we could suffer a disruption of our operations andmanufacturing delays. If we fail to take adequate corrective actions, we couldbe subject to certain enforcement actions, including, among other things,significant fines, suspension of approvals, seizures or recalls of products,operating restrictions and criminal prosecutions. We cannot assure you that theFDA or other governmental authorities would agree with our interpretation ofapplicable regulatory requirements or that we have in all instances fullycomplied with all applicable requirements. Any failure to comply withapplicable requirements could adversely affect our product sales and profitability.

 

We have received FDA warning letters in the past. OurSurgical Implant business received a warning letter in January 2007 inwhich the FDA investigator concluded that we had failed to establish andmaintain adequate procedures for handling and investigating complaints, failedto establish and maintain procedures for changes to specifications andprocesses, including verification or validation of such changes, and found thatthese failures caused certain products to be misbranded. In the warning letter,the FDA informed us that we would not receive premarket approval for Class IIIdevices to which these issues are reasonably related until the issues have beencorrected. During 2007, we submitted a response and met with FDArepresentatives, and instituted the necessary changes and improvements in ourpolicies and procedures to correct these issues. During the first quarter of2008, the FDA concluded their follow-up investigation concerning the January 2007warning letter. We received no observations and all areas of concern wereaddressed satisfactorily. Also, in the first quarter of 2008, we received FDA Form 483“Inspectional Observations” in connection with an FDA audit of the Chattanoogadivision of our Domestic Rehabilitation Segment, stating that we failed toreport certain customer complaints claiming that our muscle stimulator devicesmalfunctioned, and that we did not adequately implement corrective andpreventive action to prevent recurrence of potential product failures relatingto our muscle stimulator devices. The auditor also recommended that we recall aseries of ultrasound devices that had experienced operating issues in 2005, andwe are implementing such a recall. We received a warning letter from the FDA inJune 2008 relating to reporting issues on the muscle stimulator devicecomplaints and requesting software verification and validation plans andreports regarding the correction of problems associated with the ultrasoundproduct. We believe that we are in a position to address these areas of concernadequately. However, we cannot assure you that the FDA will not take furtheraction along these lines in the future.

 

***Wemay not be able to successfully integrate businesses that we have recentlyacquired, or businesses we may acquire in the future, and we may not be able torealize the anticipated cost savings, revenue enhancements or other synergiesfrom such acquisitions.***

 

Our ability tosuccessfully implement our business plan and achieve targeted financial resultsis highly dependent on our ability to successfully integrate businesses that wehave recently acquired and other businesses we acquire in the future. Theprocess of integrating such acquired businesses involves risks. These risksinclude, but are not limited to:

 

·                  demandson management related to the significant increase in the size of our business;

 

·                  diversionof management’s attention from the management of daily operations to theintegration of newly acquired operations;

 

·                  difficultiesin the assimilation of different corporate cultures, practices and sales anddistribution methodologies;

 

·                  difficultiesin conforming the acquired company’s accounting policies to ours;

 

·                  increasedexposure to risks relating to business operations outside the United States;

 

·                  retainingthe loyalty and business of the customers of acquired businesses;

 

26

----

Table of Contents

 

·                  retainingemployees who may be vital to the integration of the acquired business or tothe future prospects of the combined businesses;

 

·                  difficultiesand unanticipated expenses related to the integration of departments,information technology systems, including accounting systems, technologies,books and records and procedures, and maintaining uniform standards, such asinternal accounting controls, procedures and policies; and

 

·                  costsand expenses associated with any undisclosed or potential liabilities.

 

Failure tosuccessfully integrate the operations of ReAble with the operations of DJO Opcoor any other acquired businesses may result in reduced levels of revenue,earnings or operating efficiency than we have achieved or might have achievedif we had not acquired such businesses, and loss of customers of the acquiredbusinesses.

 

In addition, animportant part of our strategy is to generate revenue growth by cross sellingproducts through the expanded distribution network achieved following theacquisition of businesses. Our ability to successfully cross sell our productsto the extent we anticipate or at all is subject to considerable uncertainty.To the extent we are not successful in our cross selling efforts, our revenuesand income will be adversely affected.

 

Furthermore, evenif we are able to integrate successfully the operations of DJO Opco with theoperations of ReAble, as well as other businesses we have recently acquired, orany other acquired business, we may not be able to realize the potential costsavings, synergies and revenue enhancements that were anticipated from theacquisitions, either in the amount or within the time frame that we expect, andthe costs of achieving these benefits may be higher than, and the timing maydiffer from, what we expect. Our ability to realize anticipated cost savings,synergies and revenue enhancements may be affected by a number of factors,including, but not limited to, the following:

 

·                  theuse of more cash or other financial resources on integration and implementationactivities than we expect;

 

·                  increasesin other expenses unrelated to the acquisitions, which may offset the costsavings and other synergies from the acquisitions;

 

·                  ourability to eliminate effectively duplicative back office overhead andoverlapping and redundant selling, general and administrative functions,rationalize manufacturing capacity and shift production to more economicalfacilities; and

 

·                  ourability to avoid labor disruptions in connection with any integration,particularly in connection with any headcount reduction.

 

Specifically, theDJO Merger created significant opportunities to reduce our manufacturing andother costs. We took steps to achieve cost savings by leveraging newly acquiredlow-cost manufacturing capabilities, rationalizing our combined manufacturingand distribution footprints, increasing procurement savings and eliminatingduplicative overhead functions. We also expect to receive cost savings frominitiatives we have undertaken in connection with a number of our previouslycompleted acquisitions. However, while we anticipate cost savings based onestimates and assumptions made by our management as to the benefits andassociated expenses with respect to our cost savings initiatives, it ispossible that these estimates and assumptions may not ultimately reflect actualresults. In addition, these estimated cost savings are only estimates and maynot actually be achieved in the timeframe anticipated or at all.

 

If we fail to realize anticipated cost savings, synergies or revenueenhancements, our financial results will be adversely affected, and we may notgenerate the cash flow from operations that we anticipated, or that issufficient to repay our indebtedness.

 

***We may experience substantial fluctuations in our quarterlyoperating results and you should not rely on them as an indication of ourfuture results.***

 

Our quarterlyoperating results may vary significantly due to a combination of factors, manyof which are beyond our control. These factors include:

 

27

----

Table ofContents

 

·                  demandfor many of our products, which historically has been higher in the fourthquarter when scholastic sports and ski injuries are more frequent;

 

·                  ourability to meet the demand for our products;

 

·                  thedirect distribution of our products in foreign countries that have seasonalvariations;

 

·                  thenumber, timing and significance of new products and product introductions andenhancements by us and our competitors, including delays in obtaininggovernment review and clearance of medical devices;

 

·                  ourability to develop, introduce and market new and enhanced versions of ourproducts on a timely basis;

 

·                  theimpact of any acquisitions that occur in a quarter;

 

·                  theimpact of any changes in generally accepted accounting principles;

 

·                  changesin pricing policies by us and our competitors and reimbursement rates by thirdparty payors, including government healthcare agencies and private insurers;

 

·                  theloss of any of our significant distributors;

 

·                  changesin the treatment practices of orthopedic and spine surgeons, primary carephysicians, and pain-management specialists, and their allied healthcareprofessionals; and

 

·                  thetiming of significant orders and shipments.

 

Accordingly, our quarterly sales and operating results may varysignificantly in the future and period-to-period comparisons of our results ofoperations may not be meaningful and should not be relied upon as indicationsof future performance. We cannot assure you that our sales will increase or besustained in future periods or that we will be profitable in any future period.

 

***We operate in a highly competitive business environment, andour inability to compete effectively could adversely affect our businessprospects and results of operations.***

 

We operate inhighly competitive and fragmented markets. Our Domestic Rehabilitation Segmentand International Rehabilitation Segment compete with both large and smallcompanies, including several large, diversified companies with significantmarket share and numerous smaller niche companies, particularly in the physicaltherapy products market. Our Surgical Implant Segment competes with a smallnumber of very large companies that dominate the market, as well as othercompanies similar to our size. We may not be able to offer products similar to,or more desirable than, those of our competitors or at a price comparable tothat of our competitors. Compared to us, many of our competitors have:

 

·                  greaterfinancial, marketing and other resources;

 

·                  morewidely accepted products;

 

·                  alarger number of endorsements from healthcare professionals;

 

·                  alarger product portfolio;

 

·                  superiorability to maintain new product flow;

 

·                  greaterresearch and development and technical capabilities;

 

·                  patentportfolios that may present an obstacle to the conduct of our business;

 

·                  strongername recognition;

 

28

----

Table of Contents

 

·                  largersales and distribution networks; and/or

 

·                  internationalmanufacturing facilities that enable them to avoid the transportation costs andforeign import duties associated with shipping our products manufactured in theUnited States to international customers.

 

Accordingly, wemay be at a competitive disadvantage with respect to our competitors. Thesefactors may materially impair our ability to develop and sell our products.

 

***If we are unable to develop or license new products orproduct enhancements or find new applications for our existing products, wewill not remain competitive.***

 

The markets forour products are characterized by continued new product development and theobsolescence of existing products. Our future success and our ability toincrease revenues and make payments on our indebtedness will depend, in part,on our ability to develop, license, acquire and distribute new and innovativeproducts, enhance our existing products with new technology and find newapplications for our existing products. However, we may not be successful indeveloping, licensing or introducing new products, enhancing existing productsor finding new applications for our existing products. We also may not besuccessful in manufacturing, marketing and distributing products in acost-effective manner, establishing relationships with marketing partners,obtaining coverage of and satisfactory reimbursement for our future products orproduct enhancements or obtaining required regulatory clearances and approvalsin a timely fashion or at all. If we fail to keep pace with continued newproduct innovation or enhancement or fail to successfully commercialize our newor enhanced products, our competitive position, financial condition and resultsof operations could be materially and adversely affected.

 

In addition, ifany of our new or enhanced products contain undetected errors or designdefects, especially when first introduced, or if new applications that wedevelop for existing products do not work as planned, our ability to marketthese and other products could be substantially delayed, and we couldultimately become subject to product liability litigation, resulting in lostrevenues, potential damage to our reputation and/or delays in regulatoryclearance. In addition, approval of our products or obtaining acceptance of ourproducts by physicians, physical therapists and other healthcare professionalsthat recommend and prescribe our products could be adversely affected.

 

***The success of our surgical implant products depends on ourrelationships with leading surgeons who assist with the development and testingof our products.***

 

A key aspect ofthe development and sale of our surgical implant products is the use ofdesigning and consulting arrangements with orthopedic surgeons who are wellrecognized in the healthcare community. These surgeons assist in thedevelopment and clinical testing of new surgical implant products. They alsoparticipate in symposia and seminars introducing new surgical implant productsand assist in the training of healthcare professionals in using our newproducts. We may not be successful in maintaining or renewing our currentdesigning and consulting arrangements with these surgeons or in developingsimilar arrangements with new surgeons. In that event, our ability to develop,test and market new surgical implant products could be adversely affected. Inaddition, federal legislation has been proposed that would increase disclosurerequirements regarding financial arrangements between manufacturers andphysicians, including physicians who serve as consultants.  We cannot determine at this time the impact,if any, of such requirements on our relationships with surgeons, but there canbe no assurances that such requirements would not impose additional costs on usand/or adversely impact our consulting and other arrangements with surgeons.

 

***Proposed laws that would limit the types of orthopedicprofessionals, who can fit, sell or seek reimbursement for our products could,if adopted, adversely affect our business.***

 

In response topressure from certain groups (mostly orthotists), the United States Congressand state legislatures have periodically considered proposals that limit thetypes of orthopedic professionals who can fit or sell our orthotic deviceproducts or who can seek reimbursement for them. Several states have adoptedlegislation which imposes certification or licensing requirements on themeasuring, fitting and adjusting of certain orthotic devices. Although some ofthese state laws exempt manufacturers’ representatives, other states’ lawssubject the activities of such representatives to certification or licensingrequirements. Additional states may be considering similar legislation. Suchlaws could reduce the number of potential customers by restricting theactivities of our sales representatives in those jurisdictions where suchlegislation or regulations are enacted. Furthermore, because the sales oforthotic devices are driven in part by the number of professionals who fit andsell them, laws that limit these activities could reduce demand for theseproducts. We may not be successful in opposing the adoption of such legislationor regulations and, therefore, such laws could have a material adverse effecton our business.

 

29

----

Table ofContents

 

In addition,efforts have been made to establish similar requirements at the federal levelfor the Medicare program. For example, in 2000, Congress passed the Medicare,Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 (“BIPA”).BIPA contained a provision requiring, as a condition for payment by theMedicare program, that certain certification or licensing requirements be metfor individuals and suppliers furnishing certain, but not all,custom-fabricated orthotic devices. Although CMS has not implemented thisrequirement, Medicare follows state requirements in those states that requirethe use of an orthotist or prosthetist for furnishing of orthotics orprosthetics. We cannot predict the effect of implementation of BIPA orimplementation of other such laws will have on our business.

 

***If we fail to establish new sales and distributionrelationships or maintain our existing relationships, or if our third partydistributors and independent sales representatives fail to commit sufficienttime and effort or are otherwise ineffective in selling our products, ourresults of operations and future growth could be adversely impacted.***

 

The sales anddistribution of certain of our orthopedic products, regeneration products andour surgical implant products depend, in part, on our relationships with anetwork of third party distributors and independent commissioned salesrepresentatives. These third party distributors and independent salesrepresentatives maintain the customer relationships with the hospitals,orthopedic surgeons, physical therapists and other healthcare professionalsthat purchase, use and recommend the use of our products. Although our internalsales staff trains and manages these third party distributors and independentsales representatives, we do not directly monitor the efforts that they make tosell our products. In addition, some of the independent sales representativesthat we use to sell our surgical implant products also sell products thatdirectly compete with our core product offerings. These sales representativesmay not dedicate the necessary effort to market and sell our products. If wefail to attract and maintain relationships with third party distributors andskilled independent sales representatives or fail to adequately train andmonitor the efforts of the third party distributors and sales representativesthat market and sell our products, or if our existing third party distributorsand independent sales representatives choose not to carry our products, ourresults of operations and future growth could be adversely affected.

 

***We rely on our own direct sales force for certain of ourproducts, which may result in higher fixed costs than our competitors and mayslow our ability to reduce costs in the face of a sudden decline in demand forour products.***

 

We rely on our owndirect sales force of over 400 representatives in the United States andapproximately 220 representatives in Europe to market and sell certain of theorthopedic rehabilitation products which are intended for use in the home andin rehabilitation clinics. Some of our competitors rely predominantly onindependent sales agents and third party distributors. A direct sales force maysubject us to higher fixed costs than those of companies that market competingproducts through independent third parties, due to the costs that we will bearassociated with employee benefits, training and managing sales personnel. As aresult, we could be at a competitive disadvantage. Additionally, these fixedcosts may slow our ability to reduce costs in the face of a sudden decline indemand for our products, which could have a material adverse effect on ourresults of operations.

 

***The success of all of our products depends heavily onacceptance by healthcare professionals who prescribe and recommend ourproducts, and our failure to maintain a high level of confidence by keyhealthcare professionals in our products could adversely affect our business.***

 

We have maintainedcustomer relationships with numerous orthopedic surgeons, primary carephysicians, other specialist physicians, physical therapists, athletictrainers, chiropractors and other healthcare professionals. We believe thatsales of our products depend significantly on their confidence in, and recommendationsof, our products. Acceptance of our products depends on educating thehealthcare community as to the distinctive characteristics, perceived benefits,clinical efficacy and cost-effectiveness of our products compared to theproducts offered by our competitors and on training healthcare professionals inthe proper use and application of our products. Failure to maintain thesecustomer relationships and develop similar relationships with other leadinghealthcare professionals could result in a less frequent recommendation of ourproducts, which may adversely affect our sales and profitability.

 

***Our international operations expose us to risks related toconducting business in multiple jurisdictions outside the United States.***

 

The internationalscope of our operations exposes us to economic, regulatory and other risks inthe countries in which we operate. We generated 26.0% of our net revenues fromcustomers outside the United States for the year ended December 31, 2008.Doing business in foreign countries exposes us to a number of risks, includingthe following:

 

·                  fluctuationsin currency exchange rates;

 

30

----

Table of Contents

 

·                  impositionof investment, currency repatriation and other restrictions by foreigngovernments;

 

·                  potentialadverse tax consequences, including the imposition or increase of withholdingand other taxes on remittances and other payments by foreign subsidiaries,which, among other things, may preclude payments or dividends from foreignsubsidiaries from being used for our debt service, and exposure to adverse taxregimes;

 

·                  difficultyin collecting accounts receivable and longer collection periods;

 

·                  theimposition of additional foreign governmental controls or regulations on thesale of our products;

 

·                  intellectualproperty protection difficulties;

 

·                  changesin political and economic conditions;

 

·                  difficultiesin attracting high-quality management, sales and marketing personnel to staffour foreign operations;

 

·                  labordisputes;

 

·                  importand export restrictions and controls, tariffs and other trade barriers;

 

·                  increasedcosts of transportation or shipping;

 

·                  exposureto different approaches to treating injuries;

 

·                  exposureto different legal, regulatory and political standards; and

 

·                  difficultiesof local governments in responding to severe weather emergencies, naturaldisasters or other such similar events.

 

In addition, as wegrow our operations internationally, we will become increasingly dependent onforeign distributors and sales agents for our compliance and adherence toforeign laws and regulations that we may not be familiar with, and we cannotassure you that these distributors and sales agents will adhere to such lawsand regulations or adhere to our own business practices and policies. Anyviolation of laws and regulations by foreign distributors or sales agents or afailure of foreign distributors or sales agents to comply with our businesspractices and policies could result in legal or regulatory sanctions against usor potentially damage our reputation in that respective international market.If we fail to manage these risks effectively, we may not be able to grow ourinternational operations, and our business and results of operations may bematerially adversely affected.

 

***Fluctuations in foreign exchange rates may adversely affectour financial condition and results of operations and may affect thecomparability of our results between financial periods.***

 

Ourforeign operations expose us to currency fluctuations and exchange rate risks.We are exposed to the risk of currency fluctuations between the U.S. Dollar andthe Euro, Pound Sterling, Canadian Dollar, Mexican Peso, Swiss Franc,Australian Dollar, Yen, Norwegian Krone, Danish Krone and Swedish Krona. Salesdenominated in foreign currencies accounted for approximately 26.0% of ourconsolidated net sales for the year ended December 31, 2008, of which14.4% were denominated in the Euro. Our exposure to fluctuations in foreigncurrencies arises because certain of our subsidiaries’ results are recorded inthese currencies 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 our functionalcurrency. In addition, certain costs associated with our Mexico-basedmanufacturing operations are incurred in Mexican Pesos.  As of December 31, 2008, we hadoutstanding hedges in the form of forward contracts to purchase Mexican Pesosaggregating a U.S. dollar equivalent of $16.1 million.  As we continue to distribute and manufacture ourproducts in selected foreign countries, we expect that future sales and costsassociated with our activities in these markets will continue to be denominatedin the applicable foreign currencies, which could cause currency fluctuationsto materially impact our operating results. Changes in currency exchange rates may adversely affect our financialcondition and results of operations and may affect the comparability of ourresults between reporting periods.

 

31

----

Tableof Contents

 

We may not be ableto effectively manage our currency translation risks, and volatility incurrency exchange rates may adversely affect our financial condition andresults of operations.

 

***If adequate levels of reimbursement coverage from thirdparty payors for our products are not obtained, healthcare providers andpatients may be reluctant to use our products, and our sales may decline.***

 

Our sales dependlargely on whether there is adequate reimbursement coverage by governmenthealthcare programs, such as Medicare and Medicaid, and by private payors. Webelieve that surgeons, hospitals, physical therapists and other healthcareproviders may not use, purchase or prescribe our products and patients may notpurchase our products if these third party payors do not provide satisfactorycoverage of and reimbursement for the costs of our products or the proceduresinvolving the use of our products. Consequently, we may be unable to sell ourproducts on a profitable basis if third party payors deny coverage, reducetheir current levels of reimbursement or fail to cause their levels ofreimbursement to rise quickly enough to cover cost increases.

 

Changes in the coverageof, and reimbursement for, our products by these third party payors could havea material adverse effect on our results of operations. Third party payorscontinue to review their coverage policies carefully for existing and newtherapies and can, without notice, decide not to reimburse for treatments thatinclude the use of our products. They may attempt to control costs by (i) authorizingfewer elective surgical procedures, including joint reconstructive surgeries, (ii) requiringthe use of the least expensive product available or (iii) reducing thereimbursement for or limiting the number of authorized visits forrehabilitation procedures. For example, in the United States, Congress and theCenters for Medicare & Medicaid Services, which administers theMedicare program, frequently engages in efforts to contain costs, which mayresult in a reduction of coverage of, and reimbursement for, our products.Because many private payors model their coverage and reimbursement policies onMedicare policies, third party payors’ coverage of, and reimbursement for, ourproducts could be negatively impacted by discussions like this one or elasticbraces and by legislative, regulatory or other measures that reduce Medicarecoverage and reimbursement generally.

 

Our internationalsales also depend in part upon the coverage and eligibility for reimbursementof our products through government-sponsored healthcare payment systems andthird party payors, the amount of reimbursement and the cost allocation ofpayments between the patient and government-sponsored healthcare paymentsystems and third party payors. Coverage and reimbursement practices varysignificantly by country, with certain countries requiring products to undergoa lengthy regulatory review in order to be eligible for third party coverageand reimbursement. In addition, healthcare cost containment efforts similar tothose we face in the United States are prevalent in many of the foreigncountries in which our products are sold, and these efforts are expected tocontinue in the future, possibly resulting in the adoption of more stringentreimbursement standards. For example, in Germany, our largest foreign countrymarket, new regulations generally require adult patients to pay a portion ofthe cost of each medical technical device purchased. This may adversely affectour sales and profitability by making it more difficult for patients in Germanyto pay for our products.

 

Any developmentsin the United States or our foreign markets that eliminate, reduce or materiallymodify coverage of, and reimbursement rates for, our products could have anadverse effect on our ability to sell our products.

 

***Our success depends on receiving regulatory approval for ourproducts, and failure to do so could adversely affect our growth and operatingresults.***

 

Our products aresubject to extensive regulation in the United States by the FDA and by similargovernmental authorities in the foreign countries where we do business. The FDAregulates virtually all aspects of a medical device’s development, testing,manufacturing, labeling, promotion, distribution and marketing. In general,unless an exemption applies, a medical device must receive either pre-marketapproval or pre-market clearance from the FDA before it can be marketed in theUnited States. While in the past we have received such approvals, we may not besuccessful in the future in receiving such approvals in a timely manner or atall. If we begin to have significant difficulty obtaining such FDA approvals orclearances in a timely manner or at all, we could suffer a material adverseeffect on our revenues and growth.

 

***If we fail to obtain regulatory approval for themodification of, or new uses for, our products, our growth and operatingresults could suffer.***

 

In order to marketmodifications to our existing products or market our existing products for newindications, we may be required to obtain pre-market approvals, pre-marketapproval supplements or pre-market clearances. The FDA requires devicemanufacturers themselves to make and document a determination of whether or nota modification requires a new approval, supplement or clearance; however, theFDA can review and disagree with a manufacturer’s decision. We may not besuccessful in receiving such approvals or the FDA may not agree with ourdecisions not to seek approvals, 

 

32

----

Table of Contents

 

supplements or clearancesfor any particular device modification. The FDA may require an approval orclearance for any past or future modification or a new indication for ourexisting products. Such submissions may require the submission of additionalclinical or preclinical data and may be time consuming and costly, and may notultimately be cleared or approved by the FDA. If the FDA requires us to obtainpre-market approvals, pre-market approval supplements or pre-market clearancesfor any modification to a previously cleared or approved device, we may be requiredto cease manufacturing and marketing the modified device or to recall suchmodified device until we obtain FDA clearance or approval, and we may besubject to significant regulatory fines or penalties. In addition, the FDA maynot clear or approve such submissions in a timely manner, if at all. Because asignificant portion of our revenues is generated by products that are modifiedor used for new treatments, delays or failures in obtaining such approvalscould reduce our revenue and adversely affect our operating results.

 

***We may fail to receive positive clinical results for ourproducts in development that require clinical trials, and even if we receivepositive clinical results, we may still fail to receive the necessary clearanceor approvals to market our products.***

 

In the developmentof new products or new indications for, or modifications to, existing products,we may conduct or sponsor clinical trials. Clinical trials are expensive andrequire significant investment of time and resources and may not generate thedata we need to support a submission to the FDA. Clinical trials are subject toregulation by the FDA and, if federal funds are involved or if an investigatoror site has signed a federal assurance, are subject to further regulation by theOffice for Human Research Protections and the National Institutes of Health.Failure to comply with such regulation, including, but not limited to, failureto obtain adequate consent of subjects, failure to adequately disclosefinancial conflicts or failure to report data or adverse events accurately,could result in fines, penalties, suspension of trials, and the inability touse the data to support an FDA submission. In addition, the American Recovery and Reinvestment Act expands federalefforts to compare the effectiveness of different medical treatments; researchsupported by these efforts eventually could be used to guide public and privatecoverage and reimbursement policies. In the international market, we aresubject to regulations for clinical studies in each respective country.

 

***If we fail to comply with the various regulatory regimes forthe foreign markets in which we operate, our operational results could beadversely affected.***

 

In many of the foreign countries in which we market our products, weare subject to extensive regulations that are similar to those of the FDA,including those in Europe. The regulation of our products in Europe fallsprimarily within the European Economic Area, which consists of the twenty-sevenmember states of the European Union, as well as Iceland, Liechtenstein andNorway. Only medical devices that comply with certain conformity requirementsare allowed to be marketed within the European Economic Area. In addition, thenational health or social security organizations of certain foreign countries,including those outside Europe, require our products to be qualified beforethey can be marketed in those countries. Failure to receive or delays in thereceipt of, relevant foreign qualifications in the European Economic Area orother foreign countries could have a material adverse effect on our business.

 

The FDA regulates the export of medical devices to foreign countriesand certain foreign countries may require FDA certification that our productsare in compliance with U.S. law.  If wefail to obtain or maintain export certificates required for the export of ourproducts, we could suffer a material adverse effect on our revenues and growth.

 

***If the OIG, the FDA or another regulatory agency determinesthat we have promoted off-label use of our products, we may be subject tovarious penalties, including civil or criminal penalties, and the off-label useof our products may result in injuries that lead to product liability suits,which could be costly to our business.***

 

The OIG, the FDA and other regulatory agencies actively enforceregulations prohibiting the promotion of a medical device for a use that hasnot been cleared or approved by the FDA. Use of a device outside its cleared orapproved indications is known as “off-label” use. Physicians may use ourproducts for off-label uses, as the FDA does not restrict or regulate aphysician’s choice of treatment within the practice of medicine. However, ifthe OIG or the FDA or another regulatory agency determines that our promotionalmaterials or training constitutes improper promotion of an off-label use, itcould request that we modify our training or promotional materials or subjectus to regulatory enforcement actions, including the issuance of a warningletter, injunction, seizure, civil fine and criminal penalties. Although ourpolicy is to refrain from statements that could be considered off-labelpromotion of our products, the FDA, another regulatory agency, or the DOJ could disagree and conclude thatwe have engaged in off-label promotion and, potentially, aided and abetted inthe submission of false claims. In addition, the off-label use of our productsmay increase the risk of injury to patients, and, in turn, the risk of productliability claims. Product liability claims are expensive to defend and coulddivert our management’s attention and result in substantial damage awardsagainst us.

 

33

----

Table ofContents

 

***Our compensation, marketing and sales practices may containcertain risks with respect to the manner in which these practices werehistorically conducted that could have a material adverse effect on us.***

 

We have entered into written agreements for designing and consultingservices with physicians for surgical implant products, and we compensate themunder our designing physician agreements for services in developing productssold by us.  We also seek the assistanceof physicians in the design and evaluation of bracing and other rehabilitativeproducts. The form of compensation for such services has historically been aroyalty on the sale of our products in the cases where the physician hascontributed to the design of the product. We compensate the physicians underconsulting agreements for assistance with product development and clinicalefforts. We believe that in each instance remuneration paid to physiciansrepresents fair market value for the services provided and is otherwise incompliance with applicable laws. We also use an independent sales force forproducts for which we provide compliance-related training. The sales force hasgenerally been compensated on commission based on a percentage of revenuesgenerated by products sold as is typical in our industry. We also payphysicians certain rental and office support fees under our OfficeCare program.Under applicable federal and state healthcare fraud and abuse, anti-kickback,false claims and self-referral laws, it could be determined that our designingand consulting arrangements with surgeons, our marketing and sales practices,and our OfficeCare program fall outside permitted arrangements, therebysubjecting us to possible civil and/or criminal sanctions (including exclusionfrom the Medicare and Medicaid programs), which could have a material adverseeffect on our surgical implant business and possibly on our other lines ofbusiness. The federal government has significantly increased investigations ofmedical device manufacturers with regards to alleged kickbacks and other formsof remuneration to physicians who use and prescribe their products and recentlyhas entered into settlement, deferred prosecution and corporate integrityagreements with such manufacturers. Such investigations and enforcementactivities often arise based on allegations of violations of the federalAnti-Kickback Statute, and sometimes of civil False Claims Act. Although webelieve we maintain a satisfactory compliance program, it may not be adequatein the detection or prevention of violations. The form and effectiveness of ourcompliance program may be taken into account by the government in assessingsanctions, if any, should it be determined that violations of laws haveoccurred.

 

***Audits or denials of our claims by government agencies couldreduce our revenues or profits.***

 

As part of ourbusiness operations, we submit claims on behalf of patients directly to, andreceive payments directly from, the Medicare and Medicaid programs and privatepayors. Therefore, we are subject to extensive government regulation, includingrequirements for submitting reimbursement claims under appropriate codes andmaintaining certain documentation to support our claims. Medicare contractorsand Medicaid agencies periodically conduct pre- and post-payment reviews andother audits of claims and are under increasing pressure to more closelyscrutinize healthcare claims and supporting documentation. We have historicallybeen subject to pre-payment and post-payment reviews as well as audits ofclaims and may experience such reviews and audits of claims in the future. Forexample, as discussed above in “Item 1. Business-GovernmentRegulation-Government Audits,” as a result of an audit in November 2008,CIGNA has asserted that we were overpaid in the amount of $6.0 million from January 1,2006 to April 9, 2007 due to our failure to maintain a California HomeMedical Device Exemptee License during such 15 month period.  We believe that this licensing program doesnot apply to our business and have appealed the assessment of theoverpayment.  However, such reviewsand/or similar audits of our claims could result in material delays in payment,as well as material recoupments or denials, which would reduce our net salesand profitability, or in exclusion from participation in the Medicare orMedicaid programs. Private payors may from time to time conduct similar reviewsand audits.

 

Additionally, weparticipate in the government’s Federal Supply Schedule program for medicalequipment, whereby we contract with the government to supply certain of ourproducts. Participation in this program requires us to follow certain pricingpractices and other contract requirements. Failure to comply with such pricingpractices and/or other contract requirements could result in delays in paymentor fines or penalties, which could reduce our revenues or profits.

 

***We could be subject to governmental investigations undervarious healthcare “fraud and abuse” laws with respect to our businessarrangements with prescribing physicians and other health care professionals.***

 

We are directly,or indirectly through our customers, subject to various federal and state lawspertaining to healthcare fraud and abuse. These laws, which directly orindirectly affect our ability to operate our business include, but are notlimited to, the following:

 

·                  thefederal Anti-Kickback Statute, which prohibits persons from knowingly andwillfully soliciting, offering, receiving or providing remuneration, directlyor indirectly, in cash or in kind, to induce either the referral of anindividual, or the furnishing or arranging for or recommending of a good orservice, for which payment may be made under federal healthcare programs, suchas Medicare and Medicaid, Veterans Administration health programs, and TRICARE;

 

34

----

Table of Contents

 

·                  severalfederal False Claims statutes, which impose civil and criminal liability onindividuals and entities who submit, or cause to be submitted, false orfraudulent claims for payment to the government;

 

·                  HIPAA,which prohibits executing a scheme to defraud any healthcare benefit program,and also prohibits false statements, defined as knowingly and willfullyfalsifying, concealing or covering up a material fact or making any materiallyfalse statement in connection with the delivery of or payment for healthcarebenefits, items or services;

 

·                  thefederal physician self-referral prohibition, commonly known as the Stark Law,which, in the absence of a statutory or regulatory exception, prohibits thereferral of Medicare and Medicaid patients by a physician to an entity for theprovision of certain designated healthcare services, if the physician or amember of the physician’s immediate family has a direct or indirect financialrelationship, including an ownership interest in, or a compensation arrangementwith, the entity and also prohibits that entity from submitting a bill to afederal payor for services rendered pursuant to a prohibited referral; and

 

·                  statelaw equivalents to the Anti-Kickback Statute, the false claims provisions, theStark Law and the physician self-referral prohibitions, some of which may applyeven more broadly than their federal counterparts because they are not limitedto government reimbursed items and include items or services reimbursed by anypayor.

 

The federalgovernment has significantly increased investigations of and enforcementactivity involving medical device manufacturers with regard to allegedkickbacks and other forms of remuneration to physicians who use and prescribetheir products. Such investigations often arise based on allegations ofviolations of the federal Anti-Kickback Statute and sometimes allege violationsof the civil False Claims Act, in connection with off-label marketing ofproducts to physicians and others.

 

These laws andregulations are complex and even minor, inadvertent irregularities insubmissions can potentially give rise to claims that the law has been violated.Any violations of these laws or regulations could result in a material adverseeffect on our business, financial condition and results of operations. If thereis a change in law, regulation or administrative or judicial interpretations,we may have to change one or more of our business practices to be in compliancewith these laws. Required changes could be costly and time consuming. Anyfailure to make required changes could result in our losing business or ourexisting business practices being challenged as unlawful.

 

***Healthcare reform, managed care and buying groups have putdownward pressure on the prices of our products.***

 

Healthcare reformand the healthcare industry’s response to rising healthcare costs have resultedin a significant expansion of managed care organizations and buying groups.This growth of managed care and the advent of buying groups in the UnitedStates have caused a shift toward coverage and payments based on morecost-effective treatment alternatives. Buying groups enter into preferredsupplier arrangements with one or more manufacturers of medical products inreturn for price discounts to members of these buying groups. Our failure toobtain new preferred supplier commitments from major group purchasingorganizations or our failure to retain our existing preferred suppliercommitments could adversely affect our sales and profitability. Ininternational markets where we sell our products, we have historicallyexperienced downward pressure on product pricing and other effects ofhealthcare reform similar to that which we have experienced in the UnitedStates. We expect a continued emphasis on healthcare reform and managed care inthe United States and in these international markets, which could put furtherdownward pressure on product pricing, which, in turn may adversely affect oursales and profitability.

 

***Our products are subject to recalls even after receiving FDAor foreign regulatory clearance or approval. Product recalls could harm ourreputation and business.***

 

We are subject toongoing medical device reporting regulations that require us to report to theFDA or similar governmental authorities in other countries if our productscause, or contribute to, death or serious injury, or malfunction in a way thatwould be likely to cause, or contribute to, death or serious injury if themalfunction were to recur. The FDA and similar governmental authorities inother countries have the authority to require us to recall our products in theevent of actual or potential material deficiencies or defects in designmanufacturing, or labeling, and we have been subject to product recalls in thepast. In addition, in light of an actual or potential material deficiency,defect in design, manufacturing, or labeling, we may voluntarily elect torecall our products. A government mandated or voluntary recall by us couldoccur as a result of actual or potential component failures, manufacturingerrors or design defects, including defects in labeling. Any recall woulddivert managerial and financial resources and could harm our reputation withour customers and with the healthcare professionals that use, prescribe andrecommend our products. We could have product recalls that result insignificant costs to us in the future, and such recalls could have a materialadverse effect on our business.

 

35

----

Table ofContents

 

***Product liability claims may harm our business, particularlyif the number of claims increases significantly or our product liabilityinsurance proves inadequate.***

 

The manufactureand sale of orthopedic devices and related products exposes us to a significantrisk of product liability claims. From time to time, we have been, and we arecurrently, subject to a number of product liability claims alleging that theuse of our products resulted in adverse effects. Even if we are successful indefending against any liability claims, such claims could nevertheless distractour management, result in substantial costs, harm our reputation, adverselyaffect the sales of all our products and otherwise harm our business. If thereis a significant increase in the number of product liability claims, ourbusiness could be adversely affected.

 

We currently carryproduct liability insurance up to a limit of $25.0 million, subject toaggregate self-insurance retention of $750,000 and a deductible of $50,000 onnon-invasive and $250,000 on invasive products. Our insurance policy is subjectto annual renewal. Product liability claims made against us may exceed thecoverage limit of our policy or such insurance coverage may not continue to beavailable on commercially reasonable terms or at all. Additionally, we are alsosubject to the risks that our insurers will exclude from coverage claims madeagainst us or that our insurers may become insolvent. If we do not or cannotmaintain adequate product liability insurance, our business and results ofoperations may be adversely affected.

 

As of December 31,2008, we exceeded the coverage limits for certain historical product liabilityclaims.  The estimated exposure relatedto these claims is approximately $1.3 million and has been accrued in ourconsolidated balance sheet as of that date.

 

***As a result of the DJO Merger, our concentration ofmanufacturing operations in Mexico increases our business and competitiverisks.***

 

Our mostsignificant manufacturing facility is our facility in Tijuana, Mexico, and wealso have a relatively small manufacturing operation in Tunisia. Our currentand future foreign operations are subject to risks of political and economicinstability inherent in activities conducted in foreign countries. Becausethere are no readily accessible alternatives to these facilities, any eventthat disrupts manufacturing at or distribution or transportation from thesefacilities would materially adversely affect our operations. In addition, as aresult of this concentration of manufacturing activities, our sales in foreignmarkets may be at a competitive disadvantage to products manufactured locallydue to freight costs, custom and import duties and favorable tax rates forlocal businesses.

 

***If we lose one of our key suppliers or one of our contractmanufacturers stops making the raw materials and components used in ourproducts, we may be unable to meet customer orders for our products in a timelymanner or within our budget.***

 

We rely on alimited number of foreign and domestic suppliers for the raw materials andcomponents used in our products. One or more of our suppliers may decide tocease supplying us with raw materials and components for reasons beyond ourcontrol. FDA regulations may require additional testing of any raw materials orcomponents from new suppliers prior to our use of those materials orcomponents. In addition, in the case of a device which is the subject of apre-market approval, we may be required to obtain prior FDA permission (whichmay or may not be given), which could delay or prevent our access or use ofsuch raw materials or components. If we are unable to obtain materials we needfrom our suppliers or our agreements with our suppliers are terminated, and wecannot obtain these materials from other sources, we may be unable tomanufacture our products to meet customer orders in a timely manner or within ourmanufacturing budget. In that event, our business and results of operationscould be adversely affected.

 

In addition, werely on third parties to manufacture some of our products. For example,Medireha, which is 50% owned by us, has been a supplier for a significantportion of our CPM devices. CPM devices represented approximately 5% of our netsales for the year ended December 31, 2008. If we encounter a cessation,interruption or delay in the supply of the products purchased from Medireha, wemay be unable to obtain such products through other sources on acceptableterms, within a reasonable amount of time or at all. We also use a singlesource for many of the devices Cefar and Compex distribute. In addition, if ouragreements with the manufacturing companies were terminated, we may not be ableto find suitable replacements within a reasonable amount of time or at all. Anysuch cessation, interruption or delay may impair our ability to meet scheduleddeliveries of our products to our customers and may cause our customers tocancel orders. In that event, our reputation and results of operations may beadversely affected.

 

36

----

Table of Contents

 

Some of ourimportant suppliers are in China and other parts of Asia and providepredominately finished soft goods products. In fiscal year 2008, we obtainedapproximately 22.7% of our total purchased materials from suppliers in Chinaand other parts of Asia. Political and economic instability and changes ingovernment regulations in these areas could affect our ability to continue toreceive materials from suppliers there. The loss of suppliers in China andother parts of Asia, any other interruption or delay in the supply of requiredmaterials or our inability to obtain these materials at acceptable prices andwithin a reasonable amount of time could impair our ability to meet scheduledproduct deliveries to our customers and could hurt our reputation and causecustomers to cancel orders.

 

In addition, wepurchase the microprocessor used in the OL1000 and SpinaLogic devices from asingle manufacturer. Although there are feasible alternate microprocessors thatmight be used immediately, all are produced by a single supplier. In addition,there are single suppliers for other components used in the OL1000 andSpinaLogic devices and only two suppliers for the magnetic field sensoremployed in them. Establishment of additional or replacement suppliers forthese components cannot be accomplished quickly.

 

***If our patents and other intellectual property rights do notadequately protect our products, we may lose market share to our competitorsand may not be able to operate our business profitably.***

 

We rely on acombination of patents, trade secrets, copyrights, trademarks, licenseagreements and contractual provisions to establish and protect our intellectualproperty rights in our products and the processes for the development,manufacture and marketing of our products.

 

We usenon-patented, proprietary know-how, trade secrets, processes and otherproprietary information and currently employ various methods to protect thisproprietary information, including confidentiality agreements, inventionassignment agreements and proprietary information agreements with vendors,employees, independent sales agents, distributors, consultants, and others.However, these agreements may be breached. The FDA or another governmentalagency may require the disclosure of such information in order for us to havethe right to market a product. Trade secrets, know-how and other unpatentedproprietary technology may also otherwise become known to or independentlydeveloped by our competitors.

 

In addition, wealso hold U.S. and foreign patents relating to a number of our components andproducts and have patent applications pending with respect to other componentsand products. We also apply for additional patents in the ordinary course ofour business, as we deem appropriate. However, these precautions offer onlylimited protection, and our proprietary information may become known to, or beindependently developed by, competitors, or our proprietary rights inintellectual property may be challenged, any of which could have a material adverseeffect on our business, financial condition and results of operations.Additionally, we cannot assure you that our existing or future patents, if any,will afford us adequate protection or any competitive advantage, that anyfuture patent applications will result in issued patents or that our patentswill not be circumvented, invalidated or declared unenforceable. In addition,certain of our subsidiaries have not always taken commercially reasonablemeasures to protect their ownership of some of their patents. While suchmeasures are currently employed and have been employed by us in the past,disputes may arise as to the ownership, or co-ownership, of certain of ourpatents. We do not consider patent protection to be a significant competitiveadvantage in the marketplace for electrotherapy devices. However, patentprotection may be of significance with respect to our orthopedic technology.

 

Any proceedingsbefore the U.S. Patent and Trademark Office could result in adverse decisionsas to the priority of our inventions and the narrowing or invalidation ofclaims in issued patents. We could also incur substantial costs in any suchproceedings. In addition, the laws of some of the countries in which ourproducts are or may be sold may not protect our products and intellectualproperty to the same extent as U.S. laws, if at all. We may also be unable toprotect our rights in trade secrets and unpatented proprietary technology inthese countries.

 

In addition, wehold patent and other intellectual property licenses from third parties forsome of our products and on technologies that are necessary in the design andmanufacture of some of our products. The loss of such licenses would prevent usfrom manufacturing, marketing and selling these products, which in turn couldharm our business.

 

***Our operating results and financial condition could beadversely affected if we become involved in litigation regarding our patents orother intellectual property rights.***

 

Litigationinvolving patents and other intellectual property rights is common in ourindustry, and companies in our industry have used intellectual propertylitigation in an attempt to gain a competitive advantage. We may become a partyto lawsuits involving patents or other intellectual property. Such litigationis costly and time consuming. If we lose any of these proceedings, a court or asimilar foreign governing body could invalidate or render unenforceable ourowned or licensed patents, require us to pay significant damages, seek licensesand/or pay ongoing royalties to third parties, require us to redesign ourproducts, or prevent us from manufacturing, using or selling our products, anyof which would have an adverse effect on our results of operations andfinancial condition.

 

37

----

Table ofContents

 

We have brought,and may in the future also bring, actions against third parties forinfringement of our intellectual property rights. We may not succeed in suchactions. The defense and prosecution of intellectual property suits,proceedings before the U.S. Patent and Trademark Office or its foreignequivalents and related legal and administrative proceedings are both costlyand time consuming. Protracted litigation to defend or enforce our intellectualproperty rights could seriously detract from the time our management wouldotherwise devote to running our business. Intellectual property litigationrelating to our products could cause our customers or potential customers todefer or limit their purchase or use of the affected products until resolutionof the litigation.

 

***Our business strategy relies on certain assumptionsconcerning demographic and other trends that impact the market for ourproducts. If these assumptions prove to be incorrect, demand for our productsmay be lower than we currently expect.***

 

Our ability toachieve our business objectives is subject to a variety of factors, includingthe relative increase in the aging of the general population and an increase inparticipation in exercise and sports and more active lifestyles. In addition,our business strategy relies on an increasing awareness and clinical acceptanceof non-invasive, non-systemic treatment and rehabilitation products, such aselectrotherapy. We believe that these trends will increase the need for ourorthopedic, physical therapy, regenerative and surgical implant products. Theprojected demand for our products could materially differ from actual demand ifour assumptions regarding these trends and acceptance of our products byhealthcare professionals and patients prove to be incorrect or do notmaterialize. If our assumptions regarding these factors prove to be incorrect,we may not be able to successfully implement our business strategy, which couldadversely affect our results of operations. In addition, the perceived benefitsof these trends may be offset by competitive or business factors, such as theintroduction of new products by our competitors or the emergence of othercountervailing trends.

 

***We may expand into new markets through the development ofnew products and our expansion may not be successful.***

 

We may attempt toexpand into new markets through the development of new product applicationsbased on our existing specialized technology and design capabilities. Theseefforts could require us to make substantial investments, including significantresearch, development, engineering and capital expenditures for new, expandedor improved manufacturing facilities which would divert resources from otheraspects of our business. Expansion into new markets may be costly and may notresult in any benefit to us. Specific risks in connection with expanding intonew markets include the inability to transfer our quality standards into newproducts, the failure of customers in new markets to accept our products andprice competition in new markets. Such expansion efforts into new markets couldbe unsuccessful.

 

***Consolidation in the healthcare industry could have anadverse effect on our revenues and results of operations.***

 

Many healthcareindustry companies, including medical device, orthopedic and physical therapyproducts companies, are consolidating to create larger companies. As thehealthcare industry consolidates, competition to provide products and servicesto industry participants may become more intense. In addition, many of ourcustomers are also consolidating, and our customers and other industryparticipants may try to use their purchasing power to negotiate priceconcessions or reductions for the products that we manufacture and market. Ifwe are forced to reduce our prices because of consolidation in the healthcareindustry, our revenues could decrease, and our business, financial conditionand results of operations could be adversely affected.

 

***We could incur significant costs complying withenvironmental and health and safety requirements, or as a result of liabilityfor contamination or other harm caused by hazardous materials that we use.***

 

Our research anddevelopment and manufacturing processes involve the use of hazardous materials.We are subject to federal, state, local and foreign environmental requirements,including regulations governing the use, manufacture, handling, storage anddisposal of hazardous materials discharge to air and water, the clean up ofcontamination and occupational health and safety matters. We cannot eliminatethe risk of contamination or injury resulting from hazardous materials, and wemay incur liability as a result of any contamination or injury. Under someenvironmental laws and regulations, we could also be held responsible for costsrelating to any contamination at our past or present facilities and at thirdparty waste disposal sites where we have sent workers. These could includecosts relating to contamination that did not result from any violation of law,and in some circumstances, contamination that we did not cause.  We may incur significant expenses in thefuture relating to any failure to comply with environmental laws. Any suchfuture expenses or liability could have a significant negative impact on ourfinancial condition. The enactment of stricter laws or regulations, thestricter interpretation of existing laws and regulations or the requirement toundertake the investigation or remediation of currently unknown environmentalcontamination at our own or third party sites may require us to make additionalexpenditures, which could be material.

 

38

----

Table ofContents

 

***Our reported results may be adversely affected by increasesin reserves for contractual allowances, rebates, product returns, rentalcredits, uncollectible accounts receivable and inventory.***

 

Our net sales andprofitability are affected by changes in reserves to account for contractualallowances, rebates, product returns, rental credits, uncollectible accountsreceivable and inventory. Any increase in our reserves for contractualallowances, rebates, product returns, rental credits, uncollectible accountsreceivable or inventory could adversely affect our reported financial resultsby reducing our net revenues and/or profitability for the reporting period.

 

We haveestablished reserves to account for contractual allowances, rebates, productreturns and reserves for rental credits. Significant management judgment must be used and estimates must be madein connection with establishing the reserves for contractual allowances,rebates, product returns, rental credits and other allowances in any accountingperiod.

 

We maintainprovisions for estimated contractual allowances for reimbursement amounts fromour third party payor customers based on negotiated contracts and historicalexperience for non-contracted payors.  We provide for these reserves by reducing our gross revenue.  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 have contracts withcertain third party payors for our third party reimbursement billings, whichcall for specified reductions in reimbursement of billed amounts based uponcontractual reimbursement rates.

 

Our reserve for doubtful accounts is based upon estimated losses fromcustomers who are billed directly and the portion of third party reimbursementbillings that ultimately become the financial responsibility of the end userpatients. Our third party reimbursement customers including insurancecompanies, managed care companies and certain governmental payors, such asMedicare, include all of our OfficeCare customers and certain other customersof our Domestic Rehabilitation Segment. We estimate bad debt expense based uponhistorical experience and current relationships with our customers andproviders.  If the financial condition ofour customers were to deteriorate resulting in an impairment of their abilityto make payments or if third-party payors were to deny claims for late filings,incomplete information or other reasons, additional provisions may be required.

 

Our reserve forrebates accounts for incentives that we offer to certain of ourdistributors.  These rebates generallyare attributable to sales volume, sales growth and to reimburse the distributorfor certain discounts.  We recordestimated reductions to revenue for customer rebate programs based uponhistorical experience and estimated revenue levels.

 

The reserve forproduct returns accounts for customer returns of our products after purchase.These returns are mainly attributable to a third party payor’s refusal toprovide a patient release or reimbursement for the product or the inability ofthe product to adequately address the patient’s condition. If we increase thepercentage of our sales made pursuant to agreements providing for reimbursementbelow invoice price or if customers return products at a higher than estimatedrate, we may be required to increase our sales allowance and product returnreserves beyond their current levels.

 

Our reserve forrental credits recognizes a timing difference between billing of a purchase andprocessing of a rental credit associated with some of our electrotherapy andtraction devices. Many insurance providers require patients to rent ourrehabilitation devices for a period of one to three months prior to purchase.If the patient has a long-term need for the device, these insurance companiesmay authorize purchase of the device after such time period. When the device ispurchased, most providers require that rental payments previously made on thedevice be credited toward the purchase price. These credits are processed atthe time the payment is received for the purchase of the device, which createsa time lag between billing of the purchase and processing of the rental credit.Our rental credit reserve accounts for unprocessed rental credits based on thenumber of devices converted to purchase. If the frequency of rental to purchaseconversion increases, we may be required to increase our rental credit reservebeyond its current level.

 

The nature of ourbusiness requires us to maintain sufficient inventory on hand at all times tomeet the requirements of our customers. We provide reserves for estimated excess or obsolete inventories equalto the difference between the cost of inventories on hand plus future purchasecommitments and the estimated market value based upon assumptions about futuredemand.  If future demand is lessfavorable than currently projected by management, additional inventorywrite-downs may be required.  We alsoprovide reserves for newer product inventories, as appropriate, based on anyminimum purchase commitments and our level of sales of the new products.

 

All of our segments consign a portion of their inventory to allow theirproducts to be immediately dispensed to patients.  This requires a large amount of inventory tobe on hand for the products we sell on consignment.  It also increases the sensitivity of theseproducts to obsolescence reserve estimates. As this inventory is not in ourpossession, we maintain additional reserves for these products based on theresults of periodic inventory counts and historical trends.

 

39

----

Table ofContents

 

***Certain administrative functions relating to the OfficeCareand Insurance channels have been outsourced to a third party contractor andthis arrangement may not prove successful.***

 

The OfficeCaresales channel maintains a range of products (mostly soft goods) on hand at over1,300 healthcare facilities, primarily orthopedic practices, for immediatedistribution to patients. In the Insurance channel, products primarilyincluding custom-made rigid knee braces are provided directly to patients. Inboth situations, patients or their third party payors are billed after theproduct is provided to the patient. The revenue cycle of this program isoutsourced, from billing to collections, to an independent third partycontractor. The outsource contractor that we have used has undergonesignificant changes in its business operations in the last two years, includingrelocating some administrative functions overseas, in order to improveperformance from order entry to collections. The contractor may also upgradethe software system used in these revenue cycle processes. The inability ofthis provider to successfully upgrade its processes or demonstrate acceptablebilling and collection results could have an adverse effect on our operationsand financial results in the OfficeCare and Insurance channels. In addition, weare terminating these administrative functions for the Insurance channel tointernal departments during the first quarter of 2009 and that transition maynot be successful.

 

***If a natural or man-made disaster strikes our manufacturingfacilities, we will be unable to manufacture our products for a substantialamount of time and our sales will decline.***

 

A significantportion of our rehabilitation products are manufactured in a facility inTijuana, Mexico, with a number of products for the European market manufacturedin a Tunisian facility. In Vista, California we manufacture our custom rigidbracing products, which remain in the United States to facilitate quickturn-around on custom orders, vascular products, and our regeneration productline. Our clinical electrotherapy devices, patient care products, physicaltherapy and chiropractic treatment tables and certain CPM devices aremanufactured in our facilities located in Chattanooga, Tennessee. Our homeelectrotherapy devices sold in the United States as well as some components andrelated accessories are manufactured at our facility in Clear Lake, SouthDakota. In our Surgical Implant Segment, we manufacture our products in ourmanufacturing facility at Austin, Texas. These facilities and the manufacturingequipment we use to produce our products would be difficult to repair orreplace. Our facilities may be affected by natural or man-made disasters. Ifone of our facilities were affected by a disaster, we would be forced to relyon third party manufacturers or shift production to another manufacturingfacility. In such an event, we would face significant delays in manufacturingwhich would prevent us from being able to sell our products. In addition, ourinsurance may not be sufficient to cover all of the potential losses and maynot continue to be available to us on acceptable terms, or at all.

 

***We may pursue, but may not be able to identify, finance orsuccessfully complete, other strategic acquisitions.***

 

Our growthstrategy may include the pursuit of acquisitions, both domestically andinternationally. However, we may not be able to identify acceptableopportunities or complete acquisitions of targets in a timely manner or onacceptable terms. In addition, acquisitions involve a number of risks,including those set forth under the risk factor captioned “We may not be ableto successfully integrate businesses that we have recently acquired, orbusinesses we may acquire in the future, and we may not be able to realize theanticipated cost savings, revenue enhancements or other synergies from such acquisitions.”To the extent we are unable to consummate acquisitions, we will experienceslower than expected growth.

 

In addition, wemay require additional debt or equity financing for future acquisitions, andsuch financing may not be available on favorable terms, if available at all. Wemay not be able to successfully integrate or operate profitably any newbusiness we acquire, and we cannot assure you that any such acquisition willmeet our expectations. Finally, in the event we decide to discontinue pursuitof a potential acquisition, we will be required to immediately expense allcosts incurred in pursuit of the possible acquisition that could have anadverse effect on our results of operations in the period in which the expenseis recognized. If we complete acquisitions, or obtain financing for them, onunfavorable terms, or if we fail to properly integrate an acquired business,our financial condition and results of operations would be adversely affected.

 

***If we do not effectively manage our growth, our existinginfrastructure may become strained, and we may be unable to increase sales ofour products or generate revenue growth.***

 

The growth that wehave experienced, and in the future may experience, including due toacquisitions, may provide challenges to our organization, requiring us toexpand our personnel, manufacturing and distribution operations. Future growthmay strain our infrastructure, operations, product development and othermanagerial and operating resources. If our business resources become strained,we may be unable to increase sales of our products or generate revenue growth.

 

40

----

Table of Contents

 

***The loss of theservices of our key management and personnel could adversely affect our abilityto operate our business.***

 

Our future success will depend, in part, upon thecontinued service of key managerial, research and development staff and salesand technical personnel. In addition, our future success will depend on ourability to continue to attract and retain other highly qualified personnel. Ourexecutive officers have substantial experience and expertise in our industry.Our future success depends, to a significant extent, on the abilities andefforts of our executive officers and other members of our management team. Wecompete for such personnel with other companies, academic institutions,government entities and other organizations. We may not be successful inretaining our current personnel or in hiring or retaining qualified personnelin the future. Our failure to do so could have a material adverse effect on ourbusiness.

 

***Affiliates ofBlackstone own substantially all of the equity interest in us and may haveconflicts of interest with us or investors in the future.***

 

Investment funds affiliated with Blackstonecollectively beneficially own 98.82% of our capital stock, and Blackstonedesignees hold a majority of the seats on our board of directors. As a result,affiliates of Blackstone have control over our decisions to enter into anycorporate transaction and have the ability to prevent any transaction thatrequires the approval of stockholders regardless of whether holders of theNotes believe that any such transactions are in their own best interests. Forexample, affiliates of Blackstone could collectively cause us to makeacquisitions that increase the amount of indebtedness or to sell assets, orcould cause us to issue additional capital stock or declare dividends. So longas investment funds affiliated with Blackstone continue to directly orindirectly own a significant amount of the outstanding shares of our commonstock, affiliates of Blackstone will continue to be able to strongly influenceor effectively control our decisions. In addition, Blackstone has no obligationto provide us with any additional debt or equity financing.

 

Additionally, Blackstone is in the business of makinginvestments in companies and may from time to time acquire and hold interestsin businesses that compete directly or indirectly with us. Blackstone may alsopursue acquisition opportunities that may be complementary to our business and,as a result, those acquisition opportunities may not be available to us.

 

***If we do notachieve and maintain effective internal controls over financial reporting, wecould fail to accurately report our financial results.***

 

During the course of the preparation of our financialstatements, we evaluate our internal controls to identify and correctdeficiencies in our internal controls over financial reporting. In the event weare unable to identify and correct deficiencies in our internal controls in atimely manner, we may not record, process, summarize and report financialinformation accurately and within the time periods required for our financialreporting under the terms of the agreements governing our indebtedness.

 

We have completed a significant number of acquisitionsin the past several years, and may continue to pursue growth through strategicacquisitions. Among the risks associated with acquisitions are the risks ofcontrol deficiencies that result from the integration of the acquired business.In connection with the integration of our recent acquisitions and ourcontinuous assessment of internal controls, including with respect to acquiredforeign operations, we have identified certain internal control deficienciesthat we have remedied or for which we have undertaken steps to remediate.

 

It is possible that control deficiencies could beidentified by our management or independent registered public accounting firmin the future or may occur without being identified. Such a failure couldnegatively impact the market price and liquidity of the Notes, cause securityholders to lose confidence in our reported financial condition, lead to adefault under our Senior Secured Credit Facility and otherwise materiallyadversely affect our business and financial condition.

 

***We may not be successful in the design and implementation of aCompany-wide ERP system.***

 

In 2008 we launched a major software design andinstallation project to replace six legacy accounting and finance systems andnumerous other software systems with a single-entry ERP system that will beused by all locations and functions of the Company. This project is scheduledto be completed in three years and will require the dedication of significantfinancial and human resources. Our ability to complete this projectsuccessfully is subject to a variety of risks and uncertainties, among whichare the following:

 

·      we may have underestimatedthe time it will take to complete the design and installation and the projectcould extend on past the expected completion date;

 

41

----

Tableof Contents

 

·      we may have underestimatedthe aggregate cost of the design and installation of the ERP system, whetherdue to the need for additional scope to the project, a requirement foradditional consulting assistance, the extension of the completion date, orother similar issues;

 

·      we may have underestimatedthe extent and difficulty in adapting the Company’s business processes tofunction within and use effectively the new ERP system;

 

·      we may discover that thefunctionality of the new ERP system is not adequate to process and manage theextensive and varied functions, operations and processes within the Companythat we use to conduct our current and future business;

 

If the ERP project were to become subject to any oneof these or similar risks, the result could be a significant increase in thecosts of the project, a significant delay in completion of the project, withthe resultant delay our realization of the operational and financial benefitsof the new system, or even the risk that the project would ultimately fail inits basic goal of a Company-wide, single-entry system. Any of these outcomescould have a material, adverse impact on our business operations, operatingresults and financial condition.

 

42

----

Table of Contents

 

## **ITEM 2. PROPERTIES**

 

Our corporate headquarters are in Vista, California. Theoperations of our Domestic Rehabilitation Segment are based in Vista,California; Chattanooga, Tennessee; and St. Paul, Minnesota. Our InternationalRehabilitation Segment’s headquarters are in Guildford, United Kingdom andFreiburg, Germany. We operate manufacturing facilities in Tijuana, Mexico;Sfax, Tunisia; Chattanooga, Tennessee; Clear Lake, South Dakota; and Austin,Texas. Our warehouse and distribution centers are in Clear Lake, South Dakota;Chattanooga, Tennessee; Indianapolis, Indiana; Tijuana, Mexico; Freiburg,Germany; Guildford, United Kingdom; Malmo, Sweden; Herentals, Belgium;Mouguerre, France; and various other cities throughout the world. Themanufacturing facilities and operations for our Surgical Implant Segment are inAustin, Texas. Additional information about our material facilities and certainother foreign facilities is set forth in the following table:

 
| **Location**               | ** ** | **Use**                                                                                                                | ** ** | **Owned/  Leased** | ** ** | **Lease Termination  Date** | ** ** | **Size in  Square  Feet** |   |
|----------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------|--------|
| Vista,  California         |       | Corporate Headquarters,  Domestic Rehabilitation Segment Operations, Manufacturing Facility, Research  and Development |       | Leased             |       | August 2021            |       |  

111,639           |   |
| Tijuana, Mexico            |       | Manufacturing and  Distribution Facility                                                                               |       | Leased             |       | September 2016         |       | 286,133                   |   |
| Chattanooga,  Tennessee    |       | Domestic Rehabilitation  Segment Operations, Manufacturing and Distribution Facility, Research and  Development        |       | Owned              |       | n/a                         |       | 164,542                   |   |
| Indianapolis,  Indiana     |       | Distribution Facility                                                                                                  |       | Leased             |       | October 2016           |       | 109,782                   |   |
| St. Paul,  Minnesota       |       | Domestic Rehabilitation  Segment Operations, Research and Development                                                  |       | Leased             |       | October 2011(a)        |       | 93,666                    |   |
| Austin, Texas              |       | Surgical Implant  Segment Operations and Manufacturing Facility, Warehouse, Research and  Development                  |       | Leased             |       | March 2012(b)          |       | 64,600                    |   |
| Clear Lake,  South Dakota  |       | Manufacturing,  Distribution and Refurbishment and Repair Facility, NDC Shipping and  Warehouse                        |       | Owned              |       | n/a                         |       | 54,000                    |   |
| Mouguerre,  France         |       | Office &  Distribution                                                                                        |       | Leased             |       | October 2016           |       | 29,500                    |   |
| Freiburg,  Germany         |       | International  Rehabilitation Segment Distribution Facility                                                            |       | Leased             |       | November 2014          |       | 26,479                    |   |
| Herentals,  Belgium        |       | Warehouse                                                                                                              |       | Leased             |       | December 2013          |       | 25,800                    |   |
| Sfax, Tunisia              |       | Manufacturing Facility                                                                                                 |       | Leased             |       | December 2013          |       | 24,500                    |   |
| Freiburg,  Germany         |       | International Rehabilitation  Segment Operations                                                                       |       | Leased             |       | December 2014          |       | 22,195                    |   |
| Chantonnay, France         |       | Administration Facility &  Warehouse                                                                          |       | Leased             |       | May 2009               |       | 16,932                    |   |
| Malmö, Sweden         |       | International  Rehabilitation Segment Operations, Warehouse and Distribution Facility                                  |       | Leased             |       | March 2011             |       | 16,081                    |   |
| Guildford, United  Kingdom |       | International Office and Distribution Facility                                                                         |       | Leased             |       | July 2016              |       | 8,234                     |   |
| Other various  locations   |       |                                                                                                                   |       | Leased             |       | Various                     |       | 173,530                   |   |

 

----

(a)                                  Renewable,at our option, for one additional five-year term.

(b)                                 Renewable,at our option, for two additional five-year terms.

 

43

----

Table of Contents

 

## **ITEM 3. LEGALPROCEEDINGS**

 

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 are currently defendants inapproximately 30 product liability cases related to a disposable drug infusionpump product manufactured by two third party manufacturers that we distributedthrough our Bracing and Supports business unit of our Domestic RehabilitationSegment. We intend to discontinue our sale of these products in the secondquarter of 2009. These cases have been brought against the manufacturers andcertain distributors of these pumps, the manufacturers of the anesthetics usedin these pumps, and the healthcare professionals involved in providing thepumps to their patients. All of these lawsuits allege that the use of thesepumps with certain anesthetics in certain shoulder surgeries over prolongedperiods have resulted in cartilage damage to the plaintiffs. We have soughtindemnity and tendered the defense of these cases both to the manufacturers whohave supplied these pumps to us and to our product liability carrier. Bothmanufacturers have indicated they would accept our tender of defense andindemnity, subject to certain reservation of rights, and the product liabilitycarrier of those two manufacturers is providing us a defense in these cases.Our product liability carrier has also accepted coverage of these cases,subject to customary reservations, and was providing the Company with defenseuntil the time that the manufacturers’ carrier took up the Company’s defense.The lawsuits allege damages ranging from unspecified amounts to claims between$1.0 million and $10.0 million. These cases are in the early stagesof discovery.

 

We currently carryproduct liability insurance up to a limit of $25.0 million, subject to adeductible of $50,000 on non-invasive products and a deductible of $250,000 oninvasive products and an aggregate deductible of $750,000 for all productliability claims. Our insurance policy is subject to annual renewal. We believeour current product liability insurance coverage is adequate. In 2003, weexceeded the coverage limits in effect at that time for certain historicalproduct liability claims involving one of the discontinued products in ourSurgical Implant Segment and such products are excluded from coverage under ourcurrent policies. The estimated exposure for these claims has been accrued forin our condensed consolidated balance sheet as of that date. While we believethat our product liability coverage is adequate for the exposure we face today,future product liability claims that could be made against us couldsignificantly exceed the coverage limit of our policies 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.

 

We are an authorizedMedicare supplier and provide a variety of our products directly to Medicarebeneficiaries and seek reimbursement from the applicable MedicareAdministrative Contractor. CIGNA Government Services (“CIGNA”) is thatcontractor in the western region of the United States. As a Medicare supplier,we are subject to periodic audits of our operations, and, in November 2008,we were advised that as a result of such an audit, CIGNA was asserting that wehave been overpaid in the amount of approximately $6 million from January 1,2006 to April 9, 2007. This figure represents Medicare reimbursements forclaims we submitted on behalf of Medicare beneficiaries for our bone growthstimulator product during that period of time. The reason asserted by CIGNAthat Medicare was not obligated to provide reimbursement on these claims isthat we failed to maintain a California Home Medical Device Retail ExempteeLicense during such 15 month period. We believe that this licensing program doesnot apply to our business and have appealed the assessment of the overpayment. Duringthe pendency of the appeal, we are not required to pay the assessed $6.0million overpayment, but interest at the rate of 11.375% per annum will run onthe amount, if any, eventually determined to be due.

 

## **ITEM 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

44

----

Table of Contents

 

## **PART II.**

 

## **ITEM 5. MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASESOF EQUITY SECURITIES**

## ** **

As a result of the Prior Transaction, the common stockof DJO is privately held, and there is no established trading market for ourcommon stock. As of March 9, 2009, there were four holders of DJO’s commonstock.

 

## **ITEM 6. SELECTEDFINANCIAL DATA**

## ** **

Selected financial data set forth below is presentedfor the five years ended December 31, 2008. Thefollowing table sets forth selected financial data as of and for the periodsindicated and has been derived from the Predecessor’s and the Successor’saudited historical consolidated financial statements. The selected financialdata for the Predecessor period represents ReAble’s financial data prior to theacquisition of ReAble by Blackstone, and the selected financial data for theSuccessor periods represents financial data of DJOFL after the consummation ofthe Prior Transaction. For the year ended December 31, 2006, wehave combined the Predecessor period and the Successor period and presented theunaudited results of operations on a combined basis because we believe it isuseful to compare our financial results on an annualized basis. The Successorperiod reflects the acquisition of ReAble by Blackstone using the purchasemethod of accounting pursuant to the provision of Statement of FinancialAccounting Standards No. 141, “Business Combinations.”  Accordingly, the comparability of the resultsof the Successor for the full year 2007 to the combined results of theSuccessor and the Predecessor for the full year 2006 is affected by differencesin the basis of presentation, which reflects purchase accounting in theSuccessor periods and historical cost in the Predecessor period. In addition,the comparability of the combined results is impacted by changes in our capitalstructure which occurred on the date the Prior Transaction was completed.

 

The selectedfinancial data should be read in conjunction with the audited consolidatedfinancial statements and related notes thereto, and Item 7. “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inthis Annual Report.

 
| ** **                                          | ** ** | **Successor**                          | ** ** | **Predecessor**                        | ** ** | **Combined  Basis**                                        | ** ** | **Predecessor**                                          | ** ** |
|-----------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                          | ** ** | **Year Ended  December 31,** | ** ** | **Year Ended  December 31,** | ** ** | **November 4,  2006 through  December 31,** | ** ** | **January 1,  2006 through  November 3,** | ** ** | **(unaudited)  Year Ended  December 31,** | ** ** | **Year Ended  December 31,** | ** ** |
| **($ in thousands)**                           | ** ** | **2008**                               | ** ** | **2007**                               | ** ** | **2006**                                                   | ** ** | **2006**                                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Statement of Operations Data:**                   |       |                                   |       |                                   |       |                                                       |       |                                                     |       |   |   |   |   |   |   |
| Net sales (1)                                       |       | $                                      | 980,194    |                                   | $          | 492,134                                                    |       | 57,902                                                   |       | $ | 304,383 |   | $ | 362,285 |   | $ | 293,726 |   | $ | 148,081 |   |
| Gross profit                                        |       | 606,114                                |       | 286,270                                |       | 31,115                                                     |       | 177,103                                                  |       | 208,218 |   | 178,353 |   | 81,639 |   |
| Income (loss) from  continuing operations           |       | (97,786                                | )          | (82,422                                | )          | (41,596                                                    | )          | (46,162                                                  | )          | (87,758 | ) | 9,347 |   | 5,128 |   |
| Net income (loss)                                   |       | (97,786                                | )          | (82,422                                | )          | (41,634                                                    | )          | (46,776                                                  | )          | (88,410 | ) | 12,330 |   | 5,527 |   |
|                                                |       |                                   |       |                                   |       |                                                       |       |                                                     |       |   |   |   |   |   |   |
| **Other Financial Data:**                           |       |                                   |       |                                   |       |                                                       |       |                                                     |       |   |   |   |   |   |   |
| Depreciation and  amortization (2)                  |       | 122,551                                |       | 48,240                                 |       | 6,404                                                      |       | 14,804                                                   |       | 21,208 |   | 13,749 |   | 6,027 |   |
| Ratio of earnings to fixed  charges (unaudited) (3) |       | —                                 |       | —                                 |       | —                                                     |       | —                                                   |       | — |   | 1.52x |   | 2.12x |   |
|                                                |       |                                   |       |                                   |       |                                                       |       |                                                     |       |   |   |   |   |   |   |
| **Balance Sheet Data (at period  end):**            |       |                                   |       |                                   |       |                                                       |       |                                                     |       |   |   |   |   |   |   |
| Cash and cash equivalents                           |       | $                                      | 30,483     |                                   | $          | 63,471                                                     |       | $                                                        | 30,903     |   | NA |   | NA |   | $ | 17,200 |   | $ | 19,889 |   |
| Total assets                                        |       | 2,940,130                              |       | 3,086,272                              |       | 1,060,636                                                  |       | NA                                                       |       | NA |   | 552,037 |   | 552,139 |   |
| Long-term debt, net of  current portion             |       | 1,832,044                              |       | 1,818,598                              |       | 548,037                                                    |       | NA                                                       |       | NA |   | 307,794 |   | 307,207 |   |
| Stockholders’  equity/membership equity        |       | 598,366                                |       | 704,988                                |       | 335,208                                                    |       | NA                                                       |       | NA |   | 167,107 |   | 160,317 |   |
|                                                     |            |                                        |            |                                        |            |                                                            |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          The data reported for each period includes net sales from businessesacquired in such period from the effective date of the acquisition. See Note 2to our audited consolidated financial statements in this Annual Report foradditional information related to these acquisitions.

 

(2)          The 2008 data includes intangible assetimpairment charges of approximately $22.4 million.

 

(3)          For purposes of calculating the ratio ofearnings to fixed charges, (a) earnings consist of income (loss) beforeprovision (benefit) for income taxes plus fixed charges and (b) fixedcharges is defined as interest expense (including capitalized interest andamortization of debt issuance costs) and the estimated portion of rent expensedeemed by management to represent the interest component of rent expense. Forthe Successor years ended December 31, 2008 and 2007 and the period November 4,through December 31, 2006, and the Predecessor period January 1, 2006through November 3, 2006, our earnings were insufficient to cover fixedcharges by $146.9 million, $125.1 million, $50.4 million, and $57.7 million,respectively.

 

45

----

Table of Contents

 

## **ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

## ** **

## **Forward LookingStatements**

## ** **

The following management’sdiscussion and analysis contains “forward looking statements” within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934 that represent our expectations orbeliefs concerning future events, including, but not limited to, statementsregarding growth in sales of our products, profit margins and the sufficiencyof our cash flow for future liquidity and capital resource needs. Theseforward-looking statements are further qualified by important factors thatcould cause actual results to differ materially from those in theforward-looking statements. These factors are described in Item 1A, RiskFactors, noted above. Results actually achieved may differ materially fromexpected results included in these statements as a result of these or otherfactors.

 

## **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 discussion should be read in conjunctionwith the consolidated financial statements and related notes to those financialstatements as well as the other financial data included elsewhere in thisAnnual Report.

 

## **Overview of Business**

## ** **

We are a leading globalprovider of high-quality, orthopedic devices, with a broad range of productsused for rehabilitation, pain management and physical therapy. We also develop,manufacture and distribute a broad range of surgical reconstructive implantproducts. We are the largest non-surgical orthopedic rehabilitation devicecompany in the United States and among the largest globally, as measured byrevenues. Many of our products have leading market positions. We believe thatour strong brand names, comprehensive range of products, focus on quality,innovation and customer service, extensive distribution network, and our strongrelationships with orthopedic and physical therapy professionals havecontributed to our leading market positions. We believe that we are one of onlya few orthopedic device companies that offer healthcare professionals andpatients a diverse range of orthopedic rehabilitation products addressing thecomplete spectrum of preventative, pre-operative, post-operative, clinical andhome rehabilitation care. Our products are used by orthopedic specialists,spine surgeons, primary care physicians, pain management specialists, physicaltherapists, podiatrists, chiropractors, athletic trainers and other healthcareprofessionals to treat patients with musculoskeletal conditions resulting fromdegenerative diseases, deformities, traumatic events and sports-relatedinjuries. In addition, many of our non-surgical medical devices and relatedaccessories are used by athletes and patients for injury prevention and at-homephysical therapy treatment.

 

We classify ouroperations, pursuant to SFAS 131 into three operating segments furtherdescribed below:

 

***Domestic Rehabilitation Segment***

 

We market our DomesticRehabilitation Segment products through the four main businesses describedbelow.

 

·                  *Bracing and Supports.*Our Bracing andSupports business unit was acquired with the DJO Merger and offers DonJoy,ProCare, and Aircast products, including rigid knee bracing, orthopedic softgoods, cold therapy products, and vascular systems. This division also includesour OfficeCare business, through which we maintain an inventory of soft goodsand other products at healthcare facilities, primarily orthopedic practices,for immediate distribution to patients.

 

·                  *Empi.*Our Empi business unit offers productsin the category of home electrotherapy, iontophoresis, and home traction. Thisdivision also includes our Rehab Med + Equip business (“RME”) anduntil the end of 2008, included our EmpiCare business. RME sells a wide rangeof proprietary and third party rehabilitation products to physical therapistsand chiropractors through a printed catalog and through an on-line e-commercesite. Our EmpiCare business maintained an inventory of soft goods and otherproducts at healthcare facilities, primarily orthopedic practices, forimmediate distribution to patients and was consolidated into the OfficeCarebusiness during the fourth quarter of 2008.

 

46

----

Table of Contents

 

·                  *Regeneration.*Our Regeneration businessunit consists of our bone growth stimulation products. These products are soldthrough a combination of DonJoy sales representatives and additionalindependent and employed sales representatives dedicated to selling theseproducts either directly to patients or independent distributors. We arrangebilling to these third party payors or patients for products directly sold tothe patients.

 

·                  *Chattanooga.*Our Chattanooga business unitoffers products in the clinical rehabilitation market in the category ofclinical electrotherapy devices, clinical traction devices, and other clinicalproducts and supplies such as treatment tables, continuous passive motion (“CPM”)devices and dry heat therapy.

 

***International Rehabilitation Segment***

 

Our InternationalRehabilitation Segment, which generates most of its revenues in Europe, isdivided into three main businesses:

 

·                  *Bracing and Supports.*The internationalsales of our Bracing and Supports business unit, which offers DonJoy, ProCare,and Aircast products.

 

·                  *Ormed.DJO.*Our Ormed.DJO business, whichprovides bracing, CPM, electrotherapy and other products primarily in Germany.

 

·                  *Cefar-Compex.*Our Cefar-Compex business,which provides electrotherapy products for medical and consumer markets andother physical therapy and rehabilitation products primarily in Europe.

 

***Surgical Implant Segment***

 

Our Surgical ImplantSegment develops, manufactures and markets a wide variety of knee, hip andshoulder implant products that serve the orthopedic reconstructive jointimplant market.

 

Our three operatingsegments enable us to reach a diverse customer base through multiple distributionchannels and give us the opportunity to provide a wide range of orthopedicdevices and related products to orthopedic specialists operating in a varietyof patient treatment settings. These three segments constitute our threereportable segments. See Note 11 to our consolidated financial statementsin this Annual Report for additional information regarding our segments.

 

Set forth below is netrevenue, gross profit and operating income information for our reportingsegments for the years ended December 31. This information excludesintersegment revenues and certain expenses not allocated to segments (which areprimarily comprised of general corporate expenses for all periods presented).The segment information includes the impact of purchase accounting and relatedamortization of acquired intangible assets related to our acquisitions asdescribed in Note 2 to our audited consolidated financial statements inthis Annual Report, as well as, certain integration costs and restructuringcosts as described in Note 13 to our audited consolidated financialstatements in this Annual Report. All prior periods presented have beenreclassified to reflect these reportable segments.

 
| **($ in thousands)**                                | ** ** | **2008** | ** ** | **2007** | ** ** | **Combined  (unaudited) 2006** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|-------------------------------------|------------|
| **Domestic Rehabilitation:**                                  |       |     |       |     |       |                                |       |   |   |   |
| Net revenues                                                  |       | $        | 700,129    |     | $          | 331,550                             |       | $ | 248,437 |   |
| Gross profit                                                  |       | $        | 417,574    |     | $          | 182,763                             |       | $ | 133,108 |   |
| Gross profit margin                                           |       | 59.6     | %          | 55.1     | %          | 53.6                                | %          |
| Operating income (loss)                                       |       | $        | 66,065     |     | $          | (7,540                              | )          | $ | (14,403 | ) |
| Operating income (loss) as a percent of net segment  revenues |       | 9.4      | %          | (2.3     | )%         | (5.8                                | )%         |
| **International Rehabilitation:**                             |       |     |       |     |       |                                |       |   |   |   |
| Net revenues                                                  |       | $        | 228,539    |     | $          | 113,034                             |       | $ | 64,203 |   |
| Gross profit                                                  |       | $        | 135,427    |     | $          | 57,467                              |       | $ | 34,115 |   |
| Gross profit margin                                           |       | 59.3     | %          | 50.8     | %          | 53.1                                | %          |
| Operating income (loss)                                       |       | $        | 29,232     |     | $          | 1,133                               |       | $ | 116 |   |
| Operating income (loss) as a percent of net segment  revenues |       | 12.8     | %          | 1.0      | %          | 0.2                                 | %          |
| **Surgical Implant:**                                         |       |     |       |     |       |                                |       |   |   |   |
| Net revenues                                                  |       | $        | 73,429     |     | $          | 66,591                              |       | $ | 59,094 |   |
| Gross profit                                                  |       | $        | 54,857     |     | $          | 47,037                              |       | $ | 40,991 |   |
| Gross profit margin                                           |       | 74.7     | %          | 70.6     | %          | 69.4                                | %          |
| Operating income (loss)                                       |       | $        | 8,217      |     | $          | 2,322                               |       | $ | (7,236 | ) |
| Operating income (loss) as a percent of net segment  revenues |       | 11.2     | %          | 3.5      | %          | (12.2                               | )%         |

 

47

----

Tableof Contents

 

**Recent Acquisitions, Dispositions andOther Transactions**

 

***DJO Merger***

 

On July 15, 2007, weentered into the Agreement and Plan of Merger with DJO Opco providing for amerger transaction pursuant to which DJO Opco became a wholly owned subsidiaryof DJOFL, the entity filing this Annual Report. The total purchase price forthe DJO Merger, which was consummated on November 20, 2007, wasapproximately $1.3 billion and consisted of $1.2 billion (at $50.25 ashare) paid to former equity holders of DJO Opco, $15.2 million related tothe fair value of stock options held by DJO Opco management that were exchangedfor options to purchase DJO common stock, and $22.8 million in directacquisition costs. The DJO Merger was financed through a combination of equitycontributed by Blackstone, borrowings under the Senior Secured Credit Facility,and proceeds from the newly issued 10.875% Notes (see Note 2 to ouraudited consolidated financial statements in this Annual Report for furtherinformation).

 

***The Prior Transaction***

** **

On November 3,2006, Blackstone acquired all of the outstanding shares of capital stock ofReAble in a merger transaction (the “Prior Transaction”). ReAble is the parentcompany of Holdings, DJOFL and Finco. DJOFL, directly or indirectly through itssubsidiaries, owns all of the operating assets of ReAble. The total purchaseprice for the Prior Transaction was approximately $529.2 million and consistedof $482.5 million paid to former holders of shares of common stock and optionsto purchase shares of common stock of ReAble, $7.2 million related to the fairvalue of options held by ReAble executives that continued to remain asoutstanding options to purchase ReAble common stock after the Prior Transaction(the “Prior Transaction Management Rollover Options”), and $39.5 million indirect acquisition costs. The Prior Transaction was financed through acombination of equity contributed by Blackstone, cash on hand of ReAble,borrowings under our prior senior secured credit facility (“Old Senior SecuredCredit Facility”), and proceeds from the 11.75% Notes. Upon the closing of thePrior Transaction, shares of ReAble’s common stock ceased to be traded on theNASDAQ Global Market.

 

The Prior Transaction was accounted for as a purchaseunder the guidance set forth in Statement of Financial Accounting Standards No. 141“Business Combinations”. In this Annual Report, the consolidated statements ofoperations, changes in stockholders’ equity and comprehensive income (loss),and cash flows are identified as relating to either the Predecessor or theSuccessor, which include accounts and results for periods preceding the PriorTransaction and periods succeeding the Prior Transaction, respectively. We haveprepared our discussion of the results of operations by comparing themathematical combination, without making any adjustments, of the Successor andPredecessor periods, which have been consolidated in a materially consistentmanner, for the year ended December 31, 2006 to the year ended December 31,2007. When we refer to combined basis in this Annual Report, we refer to themathematical computation of adding the Predecessor results with those of theSuccessor for comparative purposes. Thismathematical combination does not comply with generally accepted accountingprinciples or with the rules for unaudited pro forma presentation, but ispresented because we believe it is useful to compare our financial results onan annualized basis. The Successor period reflects the acquisition of ReAble byBlackstone using the purchase method of accounting pursuant to the provisionsof Statement of Financial Accounting Standards No. 141, ‘‘BusinessCombinations’’. Therefore, the comparability of the results of ReAble and DJOFLare affected by the difference in basis of presentation of purchaseaccounting as compared to historical cost.

 

***Other Recent Acquisitions***

** **

***IOMED, Inc.***

** **

On August 9,2007, a subsidiary of DJOFL acquired IOMED, which develops, manufactures andmarkets active drug delivery systems used primarily to treat acute localinflammation in the physical and occupational therapy and sports medicinemarkets. The purchase price was $23.3 million and consisted of $21.1 million incash payments to former IOMED equity holders at $2.75 per share, $0.8 millionrelated to the fair value of vested stock options that were outstanding at thetime of the acquisition, and $1.4 million in direct acquisition costs. Theacquisition was primarily financed with borrowings under our then existing revolvingcredit facility (see Note 2 to our audited consolidated financialstatements in this Annual Report for further information).

 

***The Saunders Group***

** **

On July 2,2007, a subsidiary of DJOFL completed its purchase of substantially all of theassets of Saunders for total cash consideration of $40.9 million, including$0.9 million of acquisition costs. Saunders is a supplier of rehabilitationproducts to physical therapists, chiropractors, athletes, athletic trainers,physicians and patients, with a specialty in patented traction devices, backsupports, and equipment for neck and back disorders. The Saunders Acquisitionwas financed with funds borrowed under our Old Senior Secured Credit Facility(see Note 2 to our audited consolidated financial statements in thisAnnual Report for further information).

 

48

----

Table of Contents

 

***Cefar AB***

** **

On November 7,2006, a subsidiary of DJOFL acquired all of the issued and outstanding sharesof Cefar, a provider of electrotherapy and rehabilitation devices used forchronic pain, for women’s health (labor pain, incontinence, dysmenorrhea), forelectroacupuncture, and for other rehabilitation activities. We have integratedthe operations of Cefar with those of Compex SA, the European subsidiary ofCompex. Our strategy for the merged company is to develop both theprofessional/medical and consumer markets for electrical stimulation acrossEurope and internationally while continuing to sell products under both theCefar and Compex brands. The purchase price for Cefar of $27.1 million wascomprised of $16.3 million in cash, issuance of shares of our common stockvalued at $9.5 million, and approximately $1.3 million in acquisition costs.The cash portion of the acquisition was funded with $10.0 million of term loanborrowings under the Old Senior Secured Credit Facility and cash on hand (seeNote 2 to our audited consolidated financial statements in this Annual Reportfor further information).

 

***Compex Technologies, Inc.***

** **

On February 24,2006, we completed the acquisition of Compex. Compex manufactured and sold abroad line of TENS and NMES products used for pain management, rehabilitation,fitness and sports performance enhancement in clinical, home healthcare, sportsand occupational medicine settings. The domestic Compex operations have beenintegrated into our Empi division. The purchase price of approximately $102.9million included shares of our common stock valued at approximately $90.0million in exchange for all of the outstanding common stock of Compex, optionsto purchase shares of our common stock valued at $9.3 million in exchange forall of the outstanding options to purchase common stock of Compex, and $3.6million in acquisition costs (see Note 2 to our audited consolidatedfinancial statements in this Annual Report for further information).

 

49

----

Tableof Contents

 

**Results of Operations**

 

For the year ended December 31, 2006, we havecombined the Predecessor period and the Successor period and presented theunaudited results of operations on a combined basis because we believe it isuseful to compare our financial results on an annualized basis. The Successorperiod reflects the acquisition of ReAble by Blackstone using the purchasemethod of accounting pursuant to the provision of Statement of FinancialAccounting Standards No. 141, “Business Combinations”. Accordingly, thecomparability of the results of the Successor for the full year 2007 to thecombined results of the Successor and the Predecessor for the full year 2006 isaffected by differences in the basis of presentation, which reflects purchaseaccounting in the Successor periods historical cost in the Predecessor period. Inaddition, the comparability of the combined results is impacted by changes inour capital structure which occurred on the date the Prior Transaction wascompleted. The following table sets forth our statements of operations as apercentage of sales for the periods indicated:

 
| ** **                                                                  | ** ** | **Successor**                                    | ** ** | **Combined (unaudited)**                    | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| **($ in thousands)**                                              | ** ** | **Year Ended  December 31, 2008** | ** ** | **Year Ended  December 31, 2007** | ** ** | **Year Ended  December 31, 2006** | ** ** |
| Net sales                                                                   |       | $                                                | 980,194    |                                             | 100.0      | % | $ | 492,134 |   | 100.0 | % | $ | 362,285 |   | 100.0 | % |
| Cost of sales                                                               |       | 374,080                                          |       | 38.2                                             |       | 205,864 |   | 41.8 |   | 154,067 |   | 42.5 |   |
| Gross profit                                                                |       | 606,114                                          |       | 61.8                                             |       | 286,270 |   | 58.2 |   | 208,218 |   | 57.5 |   |
| Operating expenses:                                                         |       |                                             |       |                                             |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative                                         |       | 445,396                                          |       | 45.4                                             |       | 271,163 |   | 55.1 |   | 220,263 |   | 60.8 |   |
| Research and development                                                    |       | 26,938                                           |       | 2.7                                              |       | 21,047 |   | 4.3 |   | 42,900 |   | 11.8 |   |
| Amortization and impairment of acquired intangibles                         |       | 98,954                                           |       | 10.1                                             |       | 33,496 |   | 6.8 |   | 10,000 |   | 2.8 |   |
| Operating income (loss)                                                     |       | 34,826                                           |       | 3.5                                              |       | (39,436 | ) | (8.0 | ) | (64,945 | ) | (17.9 | ) |
| Other income (expense):                                                     |       |                                             |       |                                             |       |   |   |   |   |   |   |   |   |
| Interest income                                                             |       | 1,662                                            |       | 0.2                                              |       | 1,132 |   | 0.2 |   | 839 |   | 0.2 |   |
| Interest expense                                                            |       | (173,162                                         | )          | (17.7                                            | )          | (72,409 | ) | (14.7 | ) | (34,619 | ) | (9.5 | ) |
| Other (expense) income, net                                                 |       | (9,134                                           | )          | (0.9                                             | )          | 742 |   | 0.2 |   | 110 |   | — |   |
| Loss on early extinguishment of debt                                        |       | —                                           |       | —                                           |       | (14,539 | ) | (3.0 | ) | (9,154 | ) | (2.5 | ) |
| Loss from continuing operations before income taxes  and minority interests |       | (145,808                                         | )          | (14.9                                            | )          | (124,510 | ) | (25.3 | ) | (107,769 | ) | (29.7 | ) |
| Benefit for income taxes                                                    |       | (49,071                                          | )          | (5.0                                             | )          | (42,503 | ) | (8.6 | ) | (20,208 | ) | (5.6 | ) |
| Minority interests                                                          |       | 1,049                                            |       | 0.1                                              |       | 415 |   | — |   | 197 |   | 0.1 |   |
| Loss from continuing operations                                             |       | (97,786                                          | )          | (10.0                                            | )          | (82,422 | ) | (16.7 | ) | (87,758 | ) | (24.2 | ) |
| Discontinued operations:                                                    |       |                                             |       |                                             |       |   |   |   |   |   |   |   |   |
| Loss from discontinued operations, net of tax                               |       | —                                           |       | —                                           |       | — |   | — |   | (652 | ) | (0.2 | ) |
| Net loss                                                                    |       | $                                                | (97,786    | )                                                | (10.0      | )% | $ | (82,422 | ) | (16.7 | )% | $ | (88,410 | ) | (24.4 | )% |

 

***Year Ended December 31, 2008 Compared to Year Ended December 31,2007***

 

*NetSales.*Our net sales for the year ended December 31,2008 were $980.2 million, representing an increase of 99.2% from net sales of$492.1 million for the year ended December 31, 2007. The increase wasprimarily driven by business acquisitions, including the DJO Merger (November 2007),IOMED (August 2007) and Saunders (July 2007) and continued growthacross our product lines. Revenues associated with business acquisitions wereapproximately $458.9 million for the year ended December 31, 2008.Net sales were also positively impacted for the year ended December 31,2008 by $11.7 million due to favorable changes in foreign exchange ratescompared to rates in effect for the year ended December 31, 2007. For theyear ended December 31, 2008 and December 31, 2007, we generated26.0% and 27.4%, respectively, of our net sales from customers outside theUnited States.

 

Sales of new products,which include products that have been on the market less than one year, were$27.2 million for the year ended December 31, 2008, compared to newproduct sales of $34.1 million for the year ended December 31, 2007.

 

50

----

Table of Contents

 

The following table sets forth the mix of our net sales for the yearsended December 31, 2008 and 2007:

 
| ** **                           | ** ** | **Years Ended**        | ** ** | ** **                       | ** ** | ** **                  | ** ** |
|--------------------------------------|------------|-----------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| **($ in thousands)**       | ** ** | **December 31,  2008** | ** ** | **% of Net  Revenues** | ** ** | **December 31,  2007** | ** ** | **% of Net  Revenues** | ** ** | **Increase** | ** ** | **% Increase** | ** ** |
| Domestic Rehabilitation Segment      |       | $                           | 700,129    |                             | 71.4       | %                           | $          | 331,550 |   | 67.4 | % | $ | 368,579 |   | 111.2 | % |
| International Rehabilitation Segment |       | 228,539                     |       | 23.3                             |       | 113,034                     |       | 23.0 |   | 115,505 |   | 102.2 |   |
| Surgical Implant Segment             |       | 73,429                      |       | 7.5                              |       | 66,591                      |       | 13.5 |   | 6,838 |   | 10.3 |   |
| Intersegment revenues                |       | (21,903                     | )          | (2.2                             | )          | (19,041                     | )          | (3.9 | ) | (2,862 | ) | 15.0 |   |
| **Consolidated net sales**           |       | $                           | 980,194    |                             | 100.0      | %                           | $          | 492,134 |   | 100.0 | % | $ | 488,060 |   | 99.2 | % |

 

Net sales in our Domestic Rehabilitation Segment were$700.1 million for the year ended December 31, 2008, reflecting anincrease of 111.2% over net sales of $331.6 million for the year ended December 31,2007. The increase was driven primarily by the addition of sales from the DJOMerger and the IOMED and Saunders acquisitions as discussed above and growth inour core product lines.

 

Net sales in our International Rehabilitation Segmentfor the year ended December 31, 2008 were $228.5 million, reflectingan increase of 102.2% from net sales of $113.0 million for the year ended December 31,2007. The increase was driven primarily by the addition of sales from the DJOMerger and continued growth in our core international markets. Net sales werealso positively impacted by $11.7 million for the year ended December 31,2008 due to favorable changes in foreign exchange rates compared to rates ineffect for the year ended December 31, 2007.

 

Net sales in our Surgical Implant Segment increased to$73.4 million from $66.6 million for the year ended December 31,2008, representing a 10.3% increase over the prior year. The increase wasdriven primarily by growth in our knee, shoulder and hip implant product lines.

 

*Gross Profit.*  Consolidated gross profit as a percentage ofnet sales increased to 61.8% for the year ended December 31, 2008 from58.2% for the year ended December 31, 2007. The increase in our grossprofit margin is primarily attributable to cost improvement initiativesimplemented in the past year, favorable changes in the mix of products we sellas a result of our recent acquisitions of businesses with higher marginproducts, and favorable changes in foreign exchange rates of approximately$3.8 million. Additionally, the increase in consolidated gross profit wasdriven by reduced amortization of purchased inventory fair value adjustmentsrelated to prior year acquisitions. The amortization of purchased inventoryfair value adjustments included in cost of sales was $4.7 million and$14.0 million for the years ended December 31, 2008 and 2007,respectively.

 

Gross profit in our Domestic Rehabilitation Segment asa percentage of net sales increased to 59.6% for the year ended December 31,2008 from 55.1% for the year ended December 31, 2007. The increase in ourgross margin was primarily attributable to cost improvement initiativesimplemented in the past year and favorable changes in the mix of products wesell as a result of our recent acquisitions of businesses with higher marginproducts. Additionally, the increase in domestic rehabilitation gross profitwas driven by reduced amortization of purchased inventory fair valueadjustments related to prior year acquisitions. The amortization of purchased inventory fair value adjustments includedin cost of sales was $4.7 million and $8.6 million for the yearsended December 31, 2008 and 2007, respectively.

 

Gross profit in our International RehabilitationSegment as a percentage of net sales increased to 59.3% for the year ended December 31,2008 from 50.8% for the year ended December 31, 2007. The increase wasprimarily driven by cost improvement initiatives implemented in the past year,favorable changes in the mix of products we sell as a result of our recentacquisitions of businesses with higher margin products, and favorable changesin foreign exchange rates of approximately $3.8 million. Additionally, theincrease in international rehabilitation gross profit was driven by reducedamortization of purchased inventory fair value adjustments related to prioryear acquisitions. The amortization of purchased inventory fair valueadjustments included in cost of sales was $2.1 million for the year ended December 31,2007 and we had no such amortization in 2008.

 

Gross profit in our Surgical Implant Segment as apercentage of net sales increased to 74.7% for the year ended December 31,2008 from 70.6% for the year ended December 31, 2007. The increase wasprimarily driven by cost improvement initiatives implemented in the past yearand reduced amortization of purchased inventory fair value adjustments relatedto prior year acquisitions of $3.3 million. The amortization of purchasedinventory fair value adjustments included in cost of sales was$3.3 million for the year ended December 31, 2007.

 

51

----

Table of Contents

 

*Selling, General and Administrative.*  Our selling, general and administrativeexpenses increased to $445.4 million for the year ended December 31,2008 from $271.2 million for the year ended December 31, 2007 primarilydue to approximately $166.0 million of expenses, including wages, commissions,professional fees, and other expenses incurred by businesses we acquired,partially offset by a $1.5 million decrease in non-recurring incremental costsassociated with the integration of our acquisitions and a favorable $1.1million settlement of a litigation contingency related to one of our foreignsubsidiaries. The following table sets forth certain non-recurring selling,general and administrative costs associated with the integration of our recentacquisitions:

 
| ** **                                                                                                                       | ** ** | **Years Ended**        | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| **($ in thousands)**                                                                                                   | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** | **Increase  (Decrease)** | ** ** | **% Increase  (Decrease)** | ** ** |
|                                                                                                                             |       |                        |       |   |   |   |   |   |   |
| Management retention bonuses                                                                                                     |       | $                           | 5,775      |   | $ | 542 |   | 5,233 |   | NM |   |
| Severance and relocation expenses                                                                                                |       | 11,237                      |       | 16,372 |   | (5,135 | ) | (31.4 | ) |
| Integration expenses                                                                                                             |       | 27,313                      |       | 17,087 |   | 10,226 |   | 59.8 |   |
| Charges to bad debt expense related to revaluation  of accounts receivable and anticipated integration related collection issues |       | —                      |       | 11,870 |   | (11,870 | ) | NM |   |
|                                                                                                                             |       | $                           | 44,325     |   | $ | 45,871 |   | $ | (1,546 | ) | (3.4 | )% |
|                                                                                                                                  |            |                             |            |  |  |  |  |  |  |  |  |  |

 

For the year ended December 31, 2008, severanceand relocation consisted of $5.7 million of severance expenses related tothe DJO Merger, $2.7 million of severance payments to employees inconnection with other acquisitions, and $2.8 million of separation expensein connection with the termination of one of the Company’s executive officers. Severance expenses for the year ended December 31,2007 include $13.3 million of payments made to former executives ofReAble.  Remaining severance expenses arerelated to restructuring activities in connection with the IOMED, Saunders andCefar acquisitions.  Integrationexpenses for the year ended December 31, 2008 included $17.8 million,$1.6 million and $2.7 million of integration costs incurred in connectionwith the DJO Merger, the IOMED acquisition and other recent acquisitions,respectively. Also included within integration expense for the year ended December 31,2008 is a $5.2 million expense related to the planned implementation ofour new global ERP system.  Integration expense for the year ended December 31,2007 included costs incurred with the DJO Merger, Prior Transaction and otheracquisitions.  Management retentionbonuses related to the DJO Merger were recorded and amortized over the periodfrom the close of the transaction to December 31, 2008, resultingin expenses of $5.8 million and $0.5 million in 2008 and 2007,respectively.  Furthermore, the yearended December 31, 2007 included a $11.9 million charge related to theimpact of changes in methodologies used to estimate accounts receivablereserves, primarily in connection with the DJO Merger.

 

*Research and Development.*  Our research and development expenseincreased to $26.9 million for the year ended December 31, 2008 from$21.0 million for the year ended December 31, 2007. The increase wasprimarily due to increased wages, facility and project costs incurred bybusinesses we acquired. As a percentage of net sales, research and developmentexpense decreased to 2.7% compared to 4.3% in the year ended December 31,2007.

 

*Amortization and Impairment ofAcquired Intangibles.* Amortization and Impairment of Acquired intangible assets increased to$98.9 million for the year ended December 31, 2008 from $33.5 million forthe year ended December 31, 2007. Included within the year ended December 31, 2008 are write-offs of approximately $10.1 million related to anindefinite lived intangible asset which was impaired and approximately $12.3million resulting from the abandonment of a trade name. We test intangible assets with indefinite livesannually in accordance with SFAS 142. This test compares the fair value of the intangible with its carryingamount.  To determine the fair value, weapplied the relief from royalty method (“RFR”). Under the RFR method, the value of the trade name is determined bycalculating the present value of the after-tax cost savings associated withowning the asset and therefore not being required to pay royalties for its useduring the asset’s indefinite life. Significant judgments inherent in this analysis include the selection ofappropriate discount rates, estimating the amount and timing of estimatedfuture cash flows and the identification of appropriate terminal growth rateassumptions. Discount rate assumptions are based on an assessment of the riskinherent in the projected future cash flows generated by the respectiveintangible assets. Also subject to judgment are assumptions about royaltyrates, which are based on the estimated rates at which similar brands andtrademarks are being licensed in the marketplace.

 

Amortization of acquired intangibles includesamortization expense related to intangible assets acquired in connection withour acquisitions. The intangible assets are being amortized over the estimatedlives ranging from two to twenty years. Our amortization of acquiredintangibles increased to $76.5 million for the year ended December 31,2008 compared to $33.5 million for the year ended December 31, 2007. At December 31, 2008, we expectthe future amortization of intangibles to be approximately $76.1 millionin 2009, $75.2 million in 2010, $73.8 million in 2011,$72.4 million in 2012, $67.5 million in 2013, and $458.1 million for theperiods thereafter. Future acquisitions of businesses or intangible assets maycause these estimates to differ materially.

 

52

----

Table ofContents

 

*Interest Expense.*  Our interest expense increased to$173.2 million for the year ended December 31, 2008 compared tointerest expense of $72.4 million for the year ended December 31,2007. The increase was principally driven by incremental borrowings of$1,209.0 million to fund the DJO Merger and $77.0 million to fund theIOMED and Saunders acquisitions.

 

*Other Expense.*  Our other expense increased to$9.1 million for the year ended December 31, 2008 compared to otherincome of $0.7 million for the year ended December 31, 2007. Theincrease was principally driven by increased losses in the second half of 2008on foreign currency exchange and the write-off of a strategic investmentdetermined to have no value during the fourth quarter of 2008.

 

*Benefit for Income Taxes.*  The effective tax rate for the years ended December 31,2008 and December 31, 2007 was 33.7% and 34.1%, respectively.  For the year ended December 31, 2008, werecorded a $49.1 million income tax benefit on a pre-tax loss of$145.8 million, net of offsetting tax expense related to foreign taxes,deferred taxes on the assumed repatriation of foreign earnings, and othernon-deductible items. For the year ended December 31, 2007, we recorded a$42.5 million income tax benefit on a pre-tax loss of $124.5 million,net of offsetting tax expense related to foreign taxes, deferred taxes on theassumed repatriation of foreign earnings, and other non-deductible items.

 

##### ***Year Ended December 31,2007 Compared to Year Ended December 31, 2006 (Combined Basis)***

##### *** ***

*Net Sales. *Our net sales for the year ended December 31,2007 were $492.1 million, representing an increase of 35.8% over net sales of $362.3million in 2006 (combined basis), driven by acquisitions and continued growthin our Domestic Rehabilitation, International Rehabilitation and SurgicalImplant Segments.  Sales in the DomesticRehabilitation and International Rehabilitation Segments benefited from salesof products we acquired in the DJO Merger and the IOMED, Saunders, and Cefaracquisitions, which were completed in November 2007, August 2007, July 2007,and November 2006, respectively. For the year ended December 31, 2007, we generated 27.4% of our netsales from customers outside the United States as compared to 23.4% for theyear ended December 31, 2006.  Withthe recent DJO Merger and the Cefar acquisition, we anticipate that ourinternational sales will continue to increase in future periods.  International revenues for 2007 included$12.1 million and $27.2 million related to the DJO Merger and the Cefaracquisition, respectively.

 

The followingtable sets forth sales for our three reportable segments.  The 2007 sales data for the DomesticRehabilitation Segment includes $54.2 million and $2.9 million as a result ofthe DJO Merger and as a result of the IOMED acquisition on November 20,2007 and August 9, 2007, respectively. Also included are estimated sales of $17.5 million as a result of theSaunders acquisition on July 2, 2007. Included in the International Rehabilitation Segment 2006 sales data is$2.9 million as a result of the Cefar acquisition on November 7, 2006,while a full year of sales revenue for this business is included in 2007.

 
| ** **                     | ** ** | **Years Ended**        | ** ** | ** **                       | ** ** | ** **                                         | ** ** |
|--------------------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------------------------------|------------|
| **($ in thousands)** | ** ** | **December 31,  2007** | ** ** | **% of Net  Revenues** | ** ** | **Combined  December 31,  2006  (unaudited)** | ** ** | **% of Net  Revenues** | ** ** | **Increase** | ** ** | **% Increase** | ** ** |
| Domestic Rehabilitation        |       | $                           | 331,550    |                             | 67.4       | %                                                  | $          | 248,437 |   | 68.6 | % | $ | 83,113 |   | 33.5 | % |
| International Rehabilitation   |       | 113,034                     |       | 23.0                             |       | 64,203                                             |       | 17.7 |   | 48,831 |   | 76.1 |   |
| Surgical Implant               |       | 66,591                      |       | 13.5                             |       | 59,094                                             |       | 16.3 |   | 7,497 |   | 12.7 |   |
| Intersegment revenues          |       | (19,041                     | )          | (3.9                             | )          | (9,449                                             | )          | (2.6 | ) | (9,592 | ) | NM |   |
| Consolidated net sales         |       | $                           | 492,134    |                             | 100.0      | %                                                  | $          | 362,285 |   | 100.0 | % | $ | 129,849 |   | 35.8 | % |

 

Net sales in our Domestic RehabilitationSegment were $331.6 million for 2007, representing an increase of 33.5% overnet sales of $248.4 million in 2006.  Theincrease in net sales in our Domestic Rehabilitation Segment in 2007 was drivenby continued growth across our rehabilitation product lines which contributedapproximately $4.1 million in net sales during 2007 and the impact of revenuecontribution from our recent acquisitions as discussed above, which contributedapproximately $74.6 million of total net sales during 2007.  In addition, during 2006 sales in ourDomestic Rehabilitation Segment were negatively impacted by increased salesallowances aggregating $11.4 million related to revaluation of accountsreceivable acquired in the Compex acquisition. Excluding the factors discussed above, sales in our DomesticRehabilitation Segment increased 1.7% over the prior year.

 

53

----

Table of Contents

 

Net sales in our InternationalRehabilitation Segment were $113.0 million for 2007, representing an increaseof 76.1% over net sales of $64.2 million in 2006.  The increase in net sales in ourInternational Rehabilitation Segment was principally driven by revenues associatedwith the Cefar acquisition, which contributed sales of $27.2 million in 2007,compared to $2.9 million in 2006, and revenues associated with the DJO Mergerwhich contributed sales of $12.1 in 2007. In addition, net sales were positively impacted during 2007 byapproximately $7.3 million due to favorable changes in foreign exchange ratescompared to rates in effect in 2006.

 

Net sales in our Surgical Implant Segment for2007 were $66.6 million, representing an increase of 12.7% over net sales of$59.1 million in 2006.  The increase inour Surgical Implant Segment’s net sales in 2007 was driven primarily by growthin our shoulder and hip product lines of 32.2% and 18.8%, respectively.  Sales in this segment were negativelyimpacted on a comparative basis by reduced sales from our spine product line of$1.3 million.

 

Sales of newproducts for all segments, which have been on the market less than one year,accounted for $34.1 million in 2007, compared to $23.3 million in 2006.

 

*GrossProfit.*  Our consolidated gross profitas a percentage of net sales increased to 58.2% for 2007 compared to a grossprofit of 57.5% in 2006 and was negatively impacted by $13.9 million, ascompared to $4.5 million in the prior year, related to the write-up to fairmarket value of inventory acquired in connection with recent acquisitions andthe Prior Transaction.  Gross profit inour Domestic Rehabilitation Segment increased to 55.1% of net sales in 2007from 53.6% in 2006.  Gross profit in 2006was impacted by increased sales allowances related to revaluation of accountsreceivable acquired in the Compex acquisition. Gross profit in our International Rehabilitation Segment decreased to50.8% of net sales in 2007 from 53.1% in 2006 and was negatively impacted by$2.1 million, as compared to $1.1 million in the prior year, related to thewrite-up to fair market value of inventory in connection with the Cefaracquisition and the Prior Transaction. Gross profit in our Surgical Implant Segment increased to 70.6% of netsales in 2007 compared to 69.4% in 2006 and was negatively impacted in 2007 by$3.3 million of expense, as compared to $0.5 million in the prior year, relatedto the write-up to fair market value of inventory in connection with the PriorTransaction.  Gross profit in 2006 wasnegatively impacted by a $1.5 million charge for a discontinued product linerelated to inventory acquired in 2005 from Osteoimplant Technology, Inc..

 

*Selling, General and Administrative.** *Our selling, general and administrativeexpenses increased to $271.2 million in 2007 compared to $220.3 million in 2006due to additional expenses associated with the operations of our recentacquisitions. In addition, in both 2007 and 2006, we incurred certain non-cashand non-recurring expenses in connection with those acquisitions which we do not believe are reflective of theongoing operations of our business.  The following table sets forth these expensesincurred in connection with our recent acquisitions which we believe aredirectly attributable to the acquisitions.

 
| **($ in thousands)**                                                                                                   | ** ** | **December 31,  2007** | ** ** | **Combined  December 31,  2006  (unaudited)** | ** ** | **Increase  (Decrease)** | ** ** | **% Increase  (Decrease)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------------------------------|------------|--------------------------|------------|---------------------------------|------------|
|                                                                                                                             |       |                        |       |                                               |       |                     |       |                            |       |
| Stock based compensation                                                                                                         |       | $                           | 1,541      |                                               | $          | 10,736                   |       | $                               | (9,195     | ) | (85.6 | )% |
| Management retention bonuses                                                                                                     |       | 542                         |       | 5,500                                              |       | (4,958                   | )          | (90.1                           | )          |
| Severance expenses                                                                                                               |       | 16,372                      |       | 1,232                                              |       | 15,140                   |       | 1,228.9                         |       |
| Restructuring expenses                                                                                                           |       | 10,917                      |       | 7,143                                              |       | 3,774                    |       | 52.8                            |       |
| Transaction expenses                                                                                                             |       | 6,170                       |       | 14,500                                             |       | (8,330                   | )          | (57.4                           | )          |
| Charges to bad debt expense related to revaluation  of accounts receivable and anticipated integration related collection issues |       | 11,870                      |       | 14,000                                             |       | (2,130                   | )          | (15.2                           | )          |
|                                                                                                                             |       | $                           | 47,412     |                                               | $          | 53,111                   |       | $                               | (5,699     | ) | (10.7 | )% |

 

Stock basedcompensation expense in 2006 includes costs incurred related to acceleratedvesting of outstanding stock options of ReAble in connection with the PriorTransaction.  Management retentionbonuses related to the Prior Transaction were expensed in 2006.  Management retention bonuses related to theDJO Merger are being amortized over the period from the close of thetransaction to December 31, 2008 (expected service period).  Severance expenses in 2007 include $13.3million of payments made to former executives of ReAble.  Remaining severance expenses are related torestructuring activities in connection with the IOMED, Saunders and Cefaracquisitions.  Transaction expenses in2006 include $14.5 million of costs incurred by ReAble in connection with thePrior Transaction.  Finally, we recorded$9.8 million in 2007 and $14.0 million in 2006 as additional bad debt expense,primarily related to revaluation of accounts receivable acquired in connectionwith the DJO Merger and the Compex acquisition, respectively, due in part toanticipated integration related collection issues. Excluding these factors, ourselling, general and administrative expenses increased to $223.8 million in2007 compared to $167.2 million in 2006. As a percentage of net sales, selling, general and administrativeexpense decreased to 45.5% in 2007 compared to 46.1% in 2006.

 

54

----

Table ofContents

 

*Research and Development.* Ourresearch and development expense decreased to $21.0 million in 2007 compared to$42.9 million in 2006. Excluding the impact of IPR&D costs incurred in theprior year of $3.9 million associated with the Compex acquisition and $25.2million related to the Prior Transaction, and $3.0 million of costs incurred inthe current year associated with the DJO Merger, our research and developmentexpense increased $4.2 million to $18.0 million for fiscal year 2007 ascompared to $13.8 million during 2006, primarily due to expenses incurred bythe operations of our recent acquisitions. As a percentage of net sales, research and development expense was 3.6%compared to 3.8% in the prior year (excluding the impact of IPR&D).

 

*Amortization of Acquired Intangibles.*Amortization of acquired intangibles includes amortization expense related tointangible assets acquired in connection with recent acquisitions and the PriorTransaction, which are being amortized over lives ranging from one to twentyyears.  Our amortization of acquiredintangibles increased to $33.5 million in 2007 compared to $10.0 million in2006.

 

*Interest Expense. *Our interest expense increased to $72.4 million in 2007 from $34.6million in 2006.  The increase ininterest expense was principally driven by (1) the impact of a full yearof interest expense on debt associated with the Prior Transaction, which wascompleted on November 3, 2006, (2) incremental borrowings ofapproximately $77.0 million to fund the IOMED and Saunders acquisitions and$1,209.0 million to fund the DJO Merger, and (3) higher variable interestrates on our outstanding indebtedness resulting in an average interest rate of8.8% in 2007 as compared to 8.4% in 2006.

 

*Loss on Early Extinguishment ofDebt.*  We recorded approximately $14.5 million ofexpense in 2007, compared to $9.2 million of expense in 2006.  The expense in 2007 includes $9.7 ofunamortized debt issuance costs associated with the Old Senior SecuredCredit Facility that was repaid in connection with the DJO Merger.  Also included is $4.8 million of expense due to the termination of interest rate swapsand related refinancing activities in connection with the DJO Merger.  The expense in 2006 is related to therecognition of unamortized debt issuance and debt discount costs associatedwith the senior credit facility and the 9.75% senior subordinated notes due 2012 (the “9.75% Notes”) thatwere repaid in connection with the Prior Transaction.

 

*Benefit for Income Taxes.*  In 2007, we recorded $42.5 million of incometax benefit on a pre-tax loss of $124.5 million, resulting in an effective rateof 34.1%.  In 2006, we recorded $20.2million of income tax benefit on a pre-tax loss of $107.8 million, resulting inan effective rate of 18.8%, which is substantially lower than our statutory taxrate, due in part to the impact of a charge of $29.1 million for IPR&Dcosts in 2006.  Expense related toIPR&D is not deductible for tax purposes and is treated as a permanentdifference for tax accounting purposes. In addition to the IPR&D impact, our 2006 effective tax rate wasalso negatively impacted by non-deductible stock-based compensation,transaction costs, and other non-deductible expenses.

 

## **RecentAccounting Pronouncements**

## ** **

For information on recent accounting pronouncements impacting ourbusiness, see Note 1 of the notes to the audited consolidated financialstatements included in Part II. Item 8, herein.

 

## **Liquidityand Capital Resources**

## ** **

As of December 31, 2008, our primary source ofliquidity consisted of cash and cash equivalents totaling $30.5 millionand $76.0 million of available borrowings under our revolving credit facilitydescribed below. Working capital at December 31, 2008 was$179.6 million. We believe that our existing cash, plus the amounts weexpect to generate from operations and amounts available through our revolvingcredit facility, will be sufficient to meet our operating needs for the nexttwelve months, including working capital requirements, capital expenditures,and debt and interest repayment obligations. While we currently believe that wewill be able to meet all of our financial covenants imposed by our SeniorSecured Credit Facility, there is no assurance that we will in fact be able todo so or that, if we do not, we will be able to obtain from our lenders waiversof default or amendments to the Senior Secured Credit Facility in the future.We and our subsidiaries, affiliates or significant shareholders (includingBlackstone and its affiliates) may from time to time, in our or their solediscretion, purchase, repay, redeem or retire any of our outstanding debt orequity securities (including any publicly issued debt securities), in privatelynegotiated or open market transactions, by tender offer or otherwise.

 

55

----

Table of Contents

 

A summary of our changes in cash and cash equivalents for the yearsended December 31, 2008 and 2007 is as follows (in thousands):

 
| ** **                                                    | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
| Cash used in operating activities                             |       | $                                           | (12,061    | ) | $ | (28,759 | ) |
| Cash used in investing activities                             |       | (29,596                                     | )          | (1,323,064 | ) |
| Cash provided by financing activities                         |       | 8,865                                       |       | 1,383,558 |   |
| Effect of exchange rate changes on cash and cash  equivalents |       | (196                                        | )          | 833 |   |
| Net (decrease) increase in cash and cash equivalents          |       | $                                           | (32,988    | ) | $ | 32,568 |   |

 

***Cash Flows***

 

Operating activities used $12.1 million of cash forthe year ended December 31, 2008, compared to $28.8 million for theyear ended December 31, 2007. Cash used for operating activities for theyear ended December 31, 2008 primarily reflected an unfavorable net changein operating assets and liabilities mostly offset by our net income afteradjustment for non-cash charges. Cash used in operating activities for the yearended December 31, 2007 primarily reflected our net loss and a negativenet change in operating assets and liabilities. Cash paid for interest was$158.8 million for the year ended December 31, 2008 and$70.2 million for the year ended December 31, 2007.

 

Investing activities used $29.6 million of cashfor the year ended December 31, 2008, compared to $1,323.1 millionfor the year ended December 31, 2007. Cash used in investing activitiesfor the year ended December 31, 2008 primarily consisted of purchases ofproperty and equipment totaling $25.9 million and the acquisition ofbusinesses and intangibles for a total of $3.9 million. Cash used ininvesting activities for the year ended December 31, 2007 principallyconsisted of the acquisition of businesses for $1,313.1 million mainlyrelated to the DJO Merger, and the acquisitions of IOMED and Saunders.

 

Financing activities provided for $8.9 million ofcash for the year ended December 31, 2008, compared to$1,383.6 million for the year December 31, 2007. Cash provided byfinancing activities for the year ended December 31, 2008 represented netproceeds of $9.2 million on long-term debt and revolving lines of credit,including $24.0 million of proceeds related to our revolving lines of credit ascompared to cash provided by financing activities for the year ended December 31,2007, which included net proceeds of $1,005.9 million from long-term debtand revolving credit lines mainly related to net borrowings under the newSenior Secured Credit Facility of $1,052.4 million.

 

## ***Indebtedness***

 

As of December 31, 2008, we had approximately$1,843.6 million in aggregate indebtedness outstanding.

 

*SeniorSecured Credit Facility*

 

*Overview.*  The Senior Secured Credit Facility providessenior secured financing of $1,165.0 million, consisting of a$1,065.0 million term loan facility and a $100.0 million revolvingcredit facility. We issued the term loan facility of the Senior Secured CreditFacility at a 1.2% discount, resulting in net proceeds of $1,052.4 million.In addition, we are permitted, subject to receipt of additional commitmentsfrom participating lenders and certain other conditions, to incur up to anadditional $150.0 million of borrowings under the Senior Secured CreditFacility.

 

*Interest Rate and Fees.*  Borrowings under the Senior Secured CreditFacility bear interest at a rate equal to an applicable margin plus, at ouroption, either (a) a base rate determined by reference to the higher of (1) theprime rate of Credit Suisse 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 forrequired reserves. The initial applicable margins for borrowings under the termloan facility and the revolving credit facility is 2.00% with respect to baserate borrowings and 3.00% with respect to Eurodollar borrowings. The applicablemargin for borrowings under the term loan facility and the revolving creditfacility may be reduced subject to us attaining certain leverage ratios.

 

Historically, we have used derivative instruments tohedge portions of our exposure related to variable interest rates on ouroutstanding indebtedness. On November 20, 2007, we entered into an interestrate swap agreement for a notional amount of $515.0 million at a fixedLIBOR rate of 4.205% expiring in 2009. The swap agreement amortizes through adate in 2009. As of December 31, 2008, the remaining notional amount ofthe swap was $470.0 million. As of December 31, 2008, our weighted averageinterest rate for all borrowings under the Senior Secured Credit Facility was3.91%.

 

56

----

Tableof Contents

 

In February 2009, weentered into two interest rate swap agreements. One agreement is for a notional amount of $550.0 million with a term of February 2009through December 2009.  The secondagreement is for a notional amount of $750.0 million with a term of January 2010through December 2010.  Under theseagreements we have LIBOR fixed rates of 1.04% and 1.88%, respectively.

 

In addition to paying interest on outstandingprincipal under the Senior Secured Credit Facility, we are required to pay acommitment fee to the lenders under the revolving credit facility in respect ofthe unutilized commitments thereunder. The initial commitment fee rate is 0.50%per annum. The commitment fee rate may be reduced subject to us attaining certainleverage ratios. We must also pay customary letter of credit fees.

 

*Amortization.*  We are required to pay annual amortization(payable in equal quarterly installments) on the loans under the term loanfacility in an amount equal to 1.00% of the funded total principal amountduring the first six years and three months following the closing of the SeniorSecured Credit Facility, with the remaining amount payable at maturity, whichis six and one-half years from the date of the closing of the Senior SecuredCredit Facility. Principal amounts outstanding under the revolving creditfacility are due and payable in full at maturity, which is six years from thedate of the closing of the Senior Secured Credit Facility.

 

*Certain Covenants and Events ofDefault.*  The SeniorSecured Credit Facility contains a number of covenants that, among otherthings, restrict, subject to certain exceptions, our and our subsidiaries’ability to:

 

·                  incur additionalindebtedness;

 

·                  create liens onassets;

 

·                  change fiscalyears;

 

·                  enter into saleand leaseback transactions;

 

·                  engage inmergers or consolidations;

 

·                  sell assets;

 

·                  pay dividendsand make other restricted payments;

 

·                  make investments,loans or advances;

 

·                  repaysubordinated indebtedness;

 

·                  make certainacquisitions;

 

·                  engage incertain transactions with affiliates;

 

·                  restrict theability of restricted subsidiaries that are not Guarantors to pay dividends ormake distributions;

 

·                  amend materialagreements governing our subordinated indebtedness; and

 

·                  change our linesof business.

 

Pursuant to the terms of the credit agreement relatingto the Senior Secured Credit Facility, we are required to maintain a ratio ofconsolidated senior secured debt to Adjusted EBITDA (or senior secured leverageratio) starting at a maximum of 5.1:1 and stepping down over time to 3.25:1 bythe end of 2011. Adjusted EBITDA represents net income (loss) plus interestexpense, net, provision (benefit) for income taxes and depreciation andamortization, further adjusted for non-cash items, non-recurring items andother adjustment items permitted in calculating covenant compliance under ourSenior Secured Credit Facility and the Indentures (“Adjusted EBITDA”). As of December 31,2008, we were required to maintain a senior secured leverage ratio not toexceed 4.75:1. At December 31, 2008 our senior secured leverage ratio was4.00:1.

 

*10.875%Notes and 11.75% Notes*

 

The Indentures governing the $575.0 million principalamount of 10.875% Notes and the $200.0 million principal amount of 11.75%Notes limit our (and most or all of our subsidiaries’) ability to:

 

·                  incur additionaldebt or issue certain preferred shares;

 

57

----

Table ofContents

 

·                  pay dividends onor make other distributions in respect of our capital stock or make otherrestricted payments;

 

·                  make certaininvestments;

 

·                  sell certainassets;

 

·                  create liens oncertain assets to secure debt;

 

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

 

·                  enter intocertain transactions with our affiliates; and

 

·                  designate oursubsidiaries as unrestricted subsidiaries.

 

Under the Indentures governing our 10.875% Notes andour 11.75% Notes, our ability to incur additional debt, subject to specifiedexceptions, is tied to improving our Adjusted EBITDA to fixed charges ratio orhaving a ratio of at least 2.00:1 on a pro forma basis after giving effect tosuch incurrence. Additionally, our ability to make certain restricted paymentsis also tied to having an Adjusted EBITDA to fixed charge ratio of at least2.00:1 on a pro forma basis. Our ratio of Adjusted EBITDA to fixed charges forthe twelve months ended December 31, 2008, measured on that date, was1.47:1. Notwithstanding these limitations, the aggregate amount of term loanincreases and revolving commitment increases shall not exceed the greater of (i) $150.0 millionand (ii) the additional aggregate amount of secured indebtedness whichwould be permitted to be incurred as of any date of determination (assuming forthis purpose that the full amount of any revolving credit increase had beenutilized as of such date) such that, after giving pro forma effect to suchincurrence (and any other transactions consummated on such date), the seniorsecured leverage ratio for the immediately preceding test period would not begreater than 4.0:1. Fixed charges is defined in the Indentures as consolidatedinterest expense plus all cash dividends or other distributions paid on anyseries of preferred stock of any restricted subsidiary and all dividends orother distributions accrued on any series of disqualified stock.

 

*CovenantCompliance*

 

The following is a summary of our covenantrequirements and pro forma ratios as of December 31, 2008:

 
| ** **                                                                                                       | ** ** | **Covenant  Requirements** | ** ** | **Actual Ratios** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| **Senior Secured Credit Facility**                                                                               |       |                       |       |                   |       |
| Maximum ratio of consolidated net senior secured debt  to Adjusted EBITDA                                        |       | 4.75:1                     |       | 4.00:1                 |       |
| **10.875% Notes and 11.75% Notes**                                                                               |       |                       |       |                   |       |
| Minimum ratio of Adjusted EBITDA to fixed charges  required to incur additional debt pursuant to ratio provision |       | 2.00:1                     |       | 1.47:1                 |       |

 

As described above, our Senior Secured Credit Facilityconsisting of a $1,065.0 million term loan facility and a$100.0 million revolving credit facility and the Indentures governing the$575.0 million of senior notes and the $200.0 million of seniorsubordinated notes represent significant components of our capital structure.Under our Senior Secured Credit Facility, we are required to maintain specifiedsenior secured leverage ratios, which become more restrictive over time, andwhich are determined based on our Adjusted EBITDA. If we fail to comply withthe senior secured leverage ratio under our Senior Secured Credit Facility, wewould be in default under the credit facility. Upon the occurrence of an eventof default under the Senior Secured Credit Facility, the lenders could elect todeclare all amounts outstanding under the Senior Secured Credit Facility to beimmediately due and payable and terminate all commitments to extend furthercredit. If we were unable to repay those amounts, the lenders under the SeniorSecured Credit Facility could proceed against the collateral granted to them tosecure that indebtedness. We have pledged a significant portion of our assetsas collateral under the Senior Secured Credit Facility. Any acceleration underthe Senior Secured Credit Facility would also result in a default under theIndentures governing the notes, which could lead to the noteholders electing todeclare the principal, premium, if any, and interest on the then outstandingnotes immediately due and payable. In addition, under the Indentures governingthe notes, our ability to engage in activities such as incurring additionalindebtedness, making investments, refinancing subordinated indebtedness, payingdividends and entering into certain merger transactions is governed, in part,by our ability to satisfy tests based on Adjusted EBITDA.

 

Adjusted EBITDA is defined as net income (loss) plusinterest expense, net, provision (benefit) for income taxes and depreciationand amortization, further adjusted for non-cash items, non-recurring items andother adjustment items permitted in calculating covenant compliance under ourSenior Secured Credit Facility and Indentures. We believe that the presentationof Adjusted EBITDA is appropriate to provide additional information toinvestors about the calculation of, and compliance with, certain financialcovenants in our Senior Secured Credit Facility and the Indentures. AdjustedEBITDA is a material component of these covenants.

 

58

----

Tableof Contents

 

Adjusted EBITDA should not be considered as analternative to net income or other performance measures presented in accordancewith GAAP, or as an alternative to cash flow from operations as a measure ofour liquidity. Adjusted EBITDA does not represent net loss or cash flow fromoperations as those terms are defined by GAAP and does not necessarily indicatewhether cash flows will be sufficient to fund cash needs. In particular, thedefinition of Adjusted EBITDA in the Indentures and our Senior Secured CreditFacility allows us to add back certain non-cash, extraordinary, unusual ornon-recurring charges that are deducted in calculating net loss. However, theseare expenses that may recur, vary greatly and are difficult to predict. WhileAdjusted EBITDA and similar measures are frequently used as measures ofoperations and the ability to meet debt service requirements, Adjusted EBITDAis not necessarily comparable to other similarly titled captions of othercompanies due to the potential inconsistencies in the method of calculation.

 

Our ability to meet the covenants specified above willdepend on future events, many of which are beyond our control, and we cannotassure you that we will meet those covenants. A breach of any of thesecovenants in the future could result in a default under our Senior SecuredCredit Facility and the Indentures, at which time the lenders could elect todeclare all amounts outstanding under our Senior Secured Credit Facility to beimmediately due and payable. Any such acceleration would also result in adefault under the Indentures.

 

The following table provides a reconciliation from ournet loss to Adjusted EBITDA for the year ended December 31, 2008. Theterms and related calculations are defined in the credit agreement relating toour Senior Secured Credit Facility and the Indentures.

 

| **(in thousands)**                                    | ** ** | **Year Ended  December 31, 2008** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                 | ** ** | **(unaudited)**                                  | ** ** |
| Net loss                                                   |       | $                                                | (97,786    | ) |
| Interest expense, net                                      |       | 171,500                                          |       |
| Income tax benefit                                         |       | (49,071                                          | )          |
| Depreciation and amortization                              |       | 122,551                                          |       |
| Non-cash items (a)                                         |       | 6,081                                            |       |
| Non-recurring items (b)                                    |       | 44,325                                           |       |
| Other adjustment items, before projected cost  savings (c) |       | 16,817                                           |       |
| Other adjustment items—projected cost savings (d)     |       | 45,200                                           |       |
| Adjusted EBITDA                                            |       | $                                                | 259,617    |   |

 

----

(a)                                  Non-cashitems are comprised of the following:

 

| **(in thousands)**            | ** ** | **Year Ended  December 31, 2008** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **(unaudited)**                                  | ** ** |
| Stock compensation expense         |       | $                                                | 1,381      |   |
| Purchase accounting adjustments(1) |       | 4,700                                            |       |
| Total non-cash items               |       | $                                                | 6,081      |   |

 

----

(1)                                  Forthe year ended December 31, 2008, the $4.7 million represents expenserelated to the write-up to fair market value of acquired inventory inconnection with the DJO Merger.

 

(b)                                 Non-recurringitems are comprised of the following:

 

| **(in thousands)**              | ** ** | **Year Ended  December 31, 2008** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **(unaudited)**                                  | ** ** |
| Employee severance and relocation(1) |       | $                                                | 11,237     |   |
| Integration expense(2)               |       | 33,088                                           |       |
| Total non-recurring items            |       | $                                                | 44,325     |   |

 

----

(1)                                  Severancefor the year ended December 31, 2008, included $2.8 million ofseparation expense in connection with the termination of one of the Company’sexecutive officers, and $5.7 million and $2.7 million of employeeseverance incurred in connection with the DJO Merger and other recentacquisitions, respectively.

 

59

----

Table ofContents

 

(2)                                  Integrationexpense for the year ended December 31, 2008 included $23.1 million,$1.6 million, and $2.7 million of integration costs incurred in connectionwith the DJO Merger, the IOMED acquisition, and other recent acquisitions,respectively. Also included for the year ended December 31, 2008 was$5.2 million related to the implementation of our new global ERP system.

 

(c)                                  Otheradjustment items, before cost savings, are comprised of the following:

 

| **(in thousands)**                           | ** ** | **Twelve Months Ended  December 31, 2008** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **(unaudited)**                                                | ** ** |
| Transaction expenses(1)                           |       | $                                                              | 7,525      |   |
| Minority interest                                 |       | 1,049                                                          |       |
| Other(2)                                          |       | 8,243                                                          |       |
| Total other adjustment items, before cost savings |       | $                                                              | 16,817     |   |

 

----

(1)                                  Included$7.0 million of Blackstone monitoring fees for the year ended December 31,2008.

 

(2)                                  Includednet foreign currency transaction losses, a settlement of a litigationcontingency related to one of our foreign subsidiaries, and the write-off of aninvestment.

 

(d)                                 Includesprojected cost savings related to headcount reductions, facilitiesconsolidation and production efficiencies in connection with the DJO Merger.

 

## **ContractualObligations, Commercial Commitments, and Leases**

## ** **

The following table summarizes our contractual obligations associatedwith our long-term debt, lease obligations and purchase obligations as of December 31,2008 (in thousands):

 
| ** **                  | ** ** | **Payment due by period** | ** ** |
|-----------------------------|------------|------------------------------------------|------------|
| ** **                  | ** ** | **Total**                                | ** ** | **<1 year** | ** ** | **1—3 years** | ** ** | **3-5 years** | ** ** | **>5 years** | ** ** |
| Long-term debt obligations  |       | $                                        | 1,843,296  |   | $ | 11,359 |   | $ | 21,449 |   | $ | 45,334 |   | $ | 1,765,154 |   |
| Interest payments (a)       |       | 673,369                                  |       | 140,544 |   | 246,120 |   | 191,682 |   | 95,023 |   |
| Capital lease obligations   |       | 298                                      |       | 190 |   | 108 |   | — |   | — |   |
| Operating lease obligations |       | 62,901                                   |       | 11,235 |   | 16,927 |   | 12,404 |   | 22,335 |   |
| Purchase obligations        |       | 120,132                                  |       | 37,666 |   | 26,466 |   | 14,000 |   | 42,000 |   |
| Total                       |       | $                                        | 2,699,996  |   | $ | 200,994 |   | $ | 311,070 |   | $ | 263,420 |   | $ | 1,924,512 |   |

 

----

(a)          $775.0 million principal amount of long-term debt is subject tofixed interest rates and $1,078.3 million of principal amount of long-termdebt is subject to a floating interest rate. The interest payments in the abovetable for the floating rate debt were based primarily on an assumed 3.461%interest rate which is the effective interest rate for the term loans under theSenior Secured Credit Facility at December 31, 2008.  Also included is the effect on interestexpense related to our interest rate swap for a notional amount of $515.0million at a fixed LIBOR rate of 7.205% expiring in 2009.

 

As of December 31, 2008, we had entered into purchase commitmentsfor inventory, capital acquisitions and other services totaling approximately$120.1 million in the ordinary course of business.  The purchase obligations shown above,includes $20.4 million committed in 2009 related to purchase orders at ourfacilities in Chattanooga and Austin.  Inaddition, under the amended transaction and monitoring fee agreement enteredinto in connection with the DJO Merger, the purchase obligations shown aboveincludes DJO’s obligation to pay a $7.0 million annual monitoring fee toBlackstone Management Partners V L.L.C. through 2019.  See Item 13. “Certain Relationships andRelated Transactions and Director Independence” for a more detailed descriptionof the amended agreement.  In addition tocontractual obligations noted above, we expect to spend up to an additional$30.7 million implementing our new ERP system capital project overapproximately the next two years.

 

The amountspresented in the table above may not necessarily reflect our actual future cashfunding requirement because the actual timing of future payments made may varyfrom the stated contractual obligation.

 

**CriticalAccounting Policies and Estimates**

 

Our management’s discussion and analysis of financialcondition and results of operations is based upon our financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported

 

60

----

Table of Contents

 

amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. On an on-going basis, we evaluate our estimates, includingthose related to reserves for contractual allowances, doubtful accounts,rebates, product returns and rental credits, goodwill and intangible assets,deferred tax assets and liabilities, and inventory. We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. To the extent that actual eventsdiffer from our estimates and assumptions, there could be a material impact onour financial statements.

 

We believe the following critical accounting policiesaffect our more significant judgments and estimates used in the preparation ofour consolidated financial statements and this discussion and analysis of ourfinancial condition and results of operations.

 

***Reserves for Contractual Allowances, Doubtful Accounts,Rebates, Product Returns and Rental Credits***

 

We have established reserves to account forcontractual allowances, doubtful accounts, rebates, product returns and rentalcredits. Significant management judgment must be used and estimates must bemade in connection with establishing these reserves.

 

We maintain provisions for estimated contractualallowances for reimbursement amounts from our third party payor customers basedon negotiated contracts and historical experience for non-contracted payors. Wereport these allowances as reductions in our gross revenue. We estimate theamount of the reduction based on historical experience and invoices generatedin the period, and we consider the impact of new contract terms ormodifications of existing arrangements with our customers. We have contractswith certain third party payors for our third party reimbursement billings,which call for specified reductions in reimbursement of billed amounts basedupon contractual reimbursement rates. For the years ended December 31,2008 and 2007, we reserved for and reduced gross revenues from third partypayors by 32% and 30%, respectively, for estimated allowances related to thesecontractual reductions.

 

Our reserve for doubtful accounts is based uponestimated losses from customers who are billed directly and the portion ofthird party reimbursement billings that ultimately become the financialresponsibility of the end user patients. Direct-billed customers representedapproximately 72% and 65% of our net revenues for the years ended December 31,2008 and 2007, respectively, and approximately 64% and 62% of our net accountsreceivable at December 31, 2008 and 2007, respectively. We experiencedwrite-offs of less than 1% of related net revenues for the years ended December 31,2008. Our third party reimbursement customers including insurance companies,managed care companies and certain governmental payors, such as Medicare,include all of our OfficeCare customers, most of our Empi customers, andcertain other customers of our Domestic Rehabilitation Segment. Our third-partypayor customers represented approximately 28% and 35% of our net revenues forthe years ended December 31, 2008 and 2007, respectively, andapproximately 36% and 38% of our net accounts receivable at December 31,2008 and 2007, respectively. For the years ended December 31, 2008 and2007, we estimate bad debt expense to be approximately 6% and 7%, respectively,of gross revenues from these third party reimbursement customers. If thefinancial condition of our customers were to deteriorate resulting in animpairment of their ability to make payments or if third party payors were todeny claims for late filings, incomplete information or other reasons,additional provisions may be required. Additions to this reserve are reflectedas selling, general and administrative expense.

 

Our reserve for rebates accounts for incentives thatwe offer to certain of our distributors. These rebates generally areattributable to sales volume, sales growth and to reimburse the distributor forcertain discounts. We record estimated reductions to revenue for customerrebate programs based upon historical experience and estimated revenue levels.

 

Our reserve for product returns accounts for estimatedcustomer returns of our products after purchase. These returns are mainlyattributable to a third party payor’s refusal to provide reimbursement for theproduct or the inability of the product to adequately address the patient’scondition. We provide for this reserve by reducing gross revenue based on ourhistorical rate of returns.

 

Our reserve for rental credit recognizes a timingdifference between billing for a sale and processing a rental credit associatedwith some of our rehabilitation devices. Many insurance providers requirepatients to rent our rehabilitation devices for a period of one to three monthsprior to purchase. If the patient has a long-term need for the device, theseinsurance companies may authorize purchase of the device after such timeperiod. When the device is purchased, most providers require that rentalpayments previously made on the device be credited toward the purchase price.These credits are processed at the time the payment is received for thepurchase of the device, which creates a time lag between billing for a sale andprocessing the rental credit. Our rental credit reserve estimates unprocessedrental credits based on the number of devices converted to purchase. Thereserve is calculated by first assessing the number of our products beingrented during the relevant period and our historical conversion rate of rentalsto sales, and then reducing our revenue by the applicable amount. We providefor these reserves by reducing our gross revenue. The cost to refurbish rentedproducts is expensed as incurred as part of cost of sales.

 

61

----

Table of Contents

 

***Inventory Reserves***

 

We provide reserves for estimated excess and obsoleteinventories equal to the difference between the costs of inventories on handplus future purchase commitments and the estimated market value based uponassumptions about future demand. If future demand is less favorable thancurrently projected by management, additional inventory write-downs may berequired. We also provide reserves for newer product inventories, asappropriate, based on any minimum purchase commitments and our level of salesof the new products.

 

We consign a portion of our inventory to allow ourproducts to be immediately dispensed to patients. This requires a large amountof inventory to be on hand for the products we sell through consignmentarrangements. It also increases the sensitivity of these products toobsolescence reserve estimates. As this inventory is not in our possession, wemaintain additional reserves for estimated shrinkage of these inventories basedon the results of periodic inventory counts and historical trends.

 

***Goodwill and Intangible Assets***

 

In accordance with SFAS No. 142, “Goodwill andOther Intangible Assets”, we do not amortize goodwill. In lieu of amortization,we are required to perform an annual review for impairment. Goodwill isrecorded as the difference, if any, between the aggregate consideration paidfor an acquisition and the fair value of the net tangible and intangible assetsacquired. The amounts and useful lives assigned to intangible assets acquired,other than goodwill, impact the amount and timing of future amortization, andthe amount assigned to in-process research and development which is expensedimmediately. The value of our intangible assets, including goodwill, could beimpacted by future adverse changes such as: (i) any future declines in ouroperating results, (ii) a further decline in the valuation of comparablecompany stocks, (iii) a further significant slowdown in the worldwideeconomy or our industry or (iv) any failure to meet the performanceprojections included in our forecasts of future operating results. We estimatedthe fair values of our reporting units primarily using the income approach valuationmethodology that includes the discounted cash flow method, taking intoconsideration the market approach and certain market multiples as a validationof the values derived using the discounted cash flow methodology. Thediscounted cash flows for each reporting unit were based on discrete financialforecasts developed by management for planning purposes. Cash flows beyond thediscrete forecasts were estimated using a terminal value calculation, whichincorporated historical and forecasted financial trends for each identifiedreporting unit and considered long-term earnings growth rates for publiclytraded peer companies. Future cash flows were discounted to present value byincorporating the present value techniques discussed in FASB Concepts Statement7, “Using Cash Flow Information andPresent Value in Accounting Measurements,” or Concepts Statement 7.Specifically, the income approach valuations included reporting unit cash flowdiscount rates ranging from 10.8% to 11.6% and terminal value growth rates of3%. Publicly available information regarding the market capitalization was alsoconsidered in assessing the reasonableness of the cumulative fair values of ourreporting units estimated using the discounted cash flow methodology.  Significant management judgment is requiredin the forecasts of future operating results that are used in the discountedcash flow method of valuation. The estimates we have used are consistent withthe plans and estimates that we use to manage our business. It is possible, however,that the plans may change and estimates used may prove to be inaccurate. If ouractual results, or the plans and estimates used in future impairment analyses,are lower than the original estimates used to assess the recoverability ofthese assets, we could incur significant impairment charges.

 

We perform an impairment analysis on our goodwill onan annual basis in the fourth quarter and in certain other circumstances whenimpairment indicators are present. Our annual impairment test related to goodwilldid not indicate any impairment.

 

62

----

Table ofContents

 

Furthermore, SFAS 142 statesthat intangible assets with indefinite lives should be tested annually in lieuof being amortized.  This testworkcompares the fair value of the intangible with its carrying amount.  To determine the fair value we applied therelief from royalty method (“RFR”). Under the RFR method, the value of the trade name is determined bycalculating the present value of the after-tax cost savings associated withowning the asset and therefore not being required to pay royalties for its useduring the asset’s indefinite life. Significant judgments inherent in this analysis include the selection ofappropriate discount rates, estimating future cash flows and the identificationof appropriate terminal growth rate assumptions.  Discount rate assumptions are based on anassessment of the risk inherent in the projected future cash generated by therespective intangible assets.  Alsosubject to judgment are assumptions about royalty rates, which are based on theestimated rates at which similar brands and trademarks are being licensed inthe marketplace. In the fourth quarter fiscal 2008, we determined that the fairvalue of our Chattanooga Group trade name was less than the carrying amount,resulting in an approximate $10.1 million impairment which was written off inamortization and impairment of intangibles within the consolidated statement ofoperations for the year ended December 31, 2008.  In addition, we determined that the EncoreMedical trade name was abandoned in the fourth quarter of 2008.  As a result we recorded a $12.3 million writeoff within the consolidated statement of operations for the year ended December 31,2008.

 

***Deferred Tax Asset Valuation Allowance***

 

We recognize deferred tax assets and liabilities basedon the differences between the financial statement carrying amount and the taxbases of assets, liabilities and net operating loss carryforwards. We establishvaluation allowances when the recovery of a deferred tax asset is not likelybased on historical income, projected future income, the expected timing of thereversals of temporary differences and the implementation of tax-planningstrategies.

 

Our gross deferred tax asset balance was approximately$171.0 million at December 31, 2008 and primarily related to reservesfor accounts receivable and inventory, accrued expenses, and net operating losscarryforwards (see Note 12 to our consolidated financial statements). Asof December 31, 2008, we maintained a valuation allowance of$7.1 million due to uncertainties related to our ability to realizecertain net operating loss carryforwards acquired in connection with recentacquisitions and the Prior Transaction.

 

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

## ** **

 We are exposedto certain market risks as part of our ongoing business operations, primarilyrisks from changing interest rates and foreign currency exchange rates thatcould impact our financial condition, results of operations, and cash flows.

 

***Interest Rate Risk***

 

Our primary exposure isto changing interest rates. We have historically managed our interest rate riskby balancing the amounts of our fixed and variable debt. For our fixed ratedebt, interest rate changes may affect the market value of the debt, but do notimpact our earnings or cash flow. Conversely, for our variable rate debt,interest rate changes generally do not affect the fair market value of thedebt, but do impact future earnings and cash flow, assuming other factors areheld constant. We are exposed to interest rate risk as a result of ourborrowings under our Senior Secured Credit Facility, which bear interest atfloating rates based on the LIBOR or the prime rate of Credit Suisse. As of December 31,2008, we had $1,054.4 million of borrowings under our Senior SecuredCredit Facility. On November 20, 2007, we entered into an interest rateswap agreement related to the Senior Secured Credit Facility for a notionalamount of $515.0 million at a fixed LIBOR rate of 4.205% amortizingthrough an expiration date of 2009 (the notional amount was $470.0 millionas of December 31, 2008). The fair value of our interest rate swapagreement recorded in the accompanying condensed consolidated balance sheets asof December 31, 2008 and 2007 was a loss of approximately$13.3 million and $3.9 million, respectively, and is recorded inother non-current liabilities. A hypothetical 1% increase in variable interestrates for the remaining portion of the Senior Secured Credit Facility notcovered by the swap would have impacted our earnings and cash flow, for thethree months and year ended December 31, 2008, by approximately $1.5million and $6.1 million, respectively. Our senior debt of approximately $775.0 million consisted of fixedrate debt at December 31, 2008.  In February 2009,we entered into two interest rate swap agreements.  One agreement is for a notional amount of$550.0 million with a term of February 2009 through December 2009.  The second agreement is for a notional amountof $750.0 million with a term of January 2010 through December 2010.  Under these agreements we have LIBOR fixedrates of 1.04% and 1.88%, respectively. We may use additional derivative financial instruments where appropriateto manage our interest rate risk. However, as a matter of policy, we do notenter into derivative or other financial investments for trading or speculativepurposes.

 

63

----

Table ofContents

 

***Foreign Currency Risk***

 

Due to the global reach of our business, we areexposed to market risk from changes in foreign currency exchange rates,particularly with respect to the U.S. dollar compared to the Euro and theMexican Peso. Our wholly owned foreign subsidiaries are consolidated into ourfinancial results and are subject to risks typical of an international businessincluding, but not limited to, differing economic conditions, changes inpolitical climate, differing tax structures, other regulations and restrictionsand foreign exchange volatility. To date, we have not used internationalcurrency derivatives to hedge against our investment in our Europeansubsidiaries or their operating results, which are converted into U.S. Dollarsat period-end and average rates, respectively. However, as we continue toexpand our business through acquisitions and organic growth, the sales of ourproducts that are denominated in foreign currencies has increased as well asthe costs associated with our foreign subsidiaries which operate in currenciesother than the U.S. dollar. Accordingly, our future results could be materiallyimpacted by changes in these or other factors. For the year December 31,2008, our average monthly sales denominated in foreign currencies wasapproximately $19.0 million, of which $15.1 million was derived from Eurodenominated sales. In addition, our exposure to fluctuations in foreigncurrencies arises because certain of our subsidiaries enter into purchase orsale transactions using a currency other than its functional currency. OurMexico-based manufacturing operations incur costs that are largely denominatedin Mexican Pesos. Accordingly, our future results could be materially impactedby changes in foreign exchange rates or other factors. Occasionally, we seek toreduce the potential impact of currency fluctuations on our business throughhedging transactions. As of December 31, 2008, we had outstanding hedgesin the form of forward contracts to purchase Mexican Pesos aggregating a U.S.dollar equivalent of $16.1 million. For the year ended December 31,2008, we recognized a loss in the statement of operations on Mexico Pesoforward contracts of approximately $4.2 million.  For the year ended December 31, 2007, werecognized a gain in the statement of operations on Mexico Peso forwardcontracts of approximately $0.1 million.

 

64

----

Table of Contents

 

## **ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

## ** **

### **DJO Finance LLC**

### **Annual Report on Form 10-K**

### **For the year endedDecember 31, 2008**

### ** **

**INDEX TOAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                                                                                                                                                                                              | ** ** | **Page No.** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| Consolidated  Financial Statements:                                                                                                                                                                                     |       |              |
| Report of Independent Registered Public Accounting  Firm — Ernst & Young LLP                                                                                                                              |       | 66                |
| Report of Independent Registered Public Accounting  Firm — KPMG LLP                                                                                                                                                |       | 67                |
| Consolidated Balance Sheets at December 31, 2008  and 2007                                                                                                                                                         |       | 68                |
| Consolidated Statements of Operations for the Years  Ended December 31, 2008 and 2007 and for the Successor Period  November 4, 2006 through December 2006                                               |       | 69                |
| Consolidated Statement of Operations for the  Predecessor Period January 1, 2006 through November 3, 2006                                                                                                     |       | 69                |
| Consolidated Statements of Changes in Membership  Equity and Comprehensive Loss  for the Years Ended December 31, 2008 and 2007 and for the Successor  Period November 4, 2006 through December 31, 2006 |       | 70                |
| Consolidated Statement of Changes in Stockholders’  Equity and Comprehensive Income (Loss) for the Predecessor Period  January 1, 2006 through November 3, 2006                                          |       | 70                |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2008 and 2007 and the Successor Period  November 4, 2006 through December 31, 2006                                               |       | 71                |
| Consolidated Statement of Cash Flows for the Predecessor  Period January 1, 2006 through November 3, 2006                                                                                                     |       | 71                |
| Notes to Consolidated Financial Statements                                                                                                                                                                              |       | 72                |

 

65

----

Table of Contents

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

To the Board ofDirectors

DJO Finance LLC

 

We have audited the accompanying consolidated balancesheets of DJO Finance LLC and subsidiaries as of December 31, 2008 and2007, and the related consolidated statements of operations, changes inmembership equity and comprehensive loss, and cash flows for the years thenended.  Our audits also included thefinancial statement schedule listed in the Index at Item 15(a).  These consolidated financial statements andschedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements and schedule based on our audits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  We were not engaged to perform an audit ofthe Company’s internal control over financial reporting.  Our audits included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting.  Accordingly, we express nosuch opinion.  An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of DJO Finance LLC and subsidiaries at December 31, 2008 and December 31,2007 and the consolidated results of their operations and their cash flows forthe years then ended, in conformity with U.S. generally accepted accountingprinciples.  Also, in our opinion, therelated financial statement schedule, when considered in relation to the basicfinancial statements taken as a whole, presents fairly in all material respectsthe information set forth therein.

 

 
|   | /s/  ERNST & YOUNG LLP |
|--------|---------------------------------|

 

 

San Diego,California

March 10,2009

 

66

----

Table ofContents

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

** **

The Board ofDirectors

DJO Finance LLC

 

We have audited the accompanying consolidated statements of operations,changes in membership equity and comprehensive loss, and cash flows of DJOFinance LLC and subsidiaries (formerly ReAble Therapeutics Finance LLC) (the“Successor”) for the period from November 4, 2006 through December 31, 2006 andthe consolidated statements of operations, changes in stockholders’ equity andcomprehensive income (loss) and cash flows of ReAble Therapeutics, Inc. (“RTI”)for the period January 1, 2006 through November 3, 2006.  In connection with our audit of theconsolidated financial statements, we have also audited the financial statementschedule II as it relates to 2006. These consolidated financial statements andfinancial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the results of operations and cashflows of the Successor for the period from November 4, 2006 through December31, 2006, in conformity with accounting principles generally accepted in theUnited States of America.  Further, inour opinion, the consolidated financial statements referred to above presentfairly in all material respects, the results of operations and cash flows ofRTI for the period from January 1, 2006 through November 3, 2006 in conformitywith accounting principles generally accepted in the United States ofAmerica.  Also, in our opinion, therelated financial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein.

 

As discussed in Note 1 to the consolidated financial statements,effective November 3, 2006, all of the outstanding stock of RTI was acquired ina business combination accounted for as a purchase.  As a result of the acquisition, theconsolidated financial information for the period after the acquisition ispresented on a different cost basis that that for the periods before theacquisition and, therefore, is not comparable.

 
|   | /s/  KPMG LLP |
|--------|---------------|

 

Austin, Texas

March 30, 2007, except as to Note 11,

which is as of March 6, 2009

 

67

----

Table ofContents

 

**DJOFinance LLC**

**Consolidated Balance Sheets**

### **(in thousands)**

 
| ** **                                                    | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets**                                                    |       |                        |       |                        |       |
| Current assets:                                               |       |                        |       |                        |       |
| Cash and cash equivalents                                     |       | $                           | 30,483     |                        | $          | 63,471 |   |
| Accounts receivable, net                                      |       | 164,618                     |       | 154,767                     |       |
| Inventories, net                                              |       | 103,166                     |       | 110,904                     |       |
| Deferred tax assets, net                                      |       | 34,039                      |       | 28,999                      |       |
| Prepaid expenses and other current assets                     |       | 16,923                      |       | 17,319                      |       |
| Total current assets                                          |       | 349,229                     |       | 375,460                     |       |
| Property and equipment, net                                   |       | 86,262                      |       | 81,645                      |       |
| Goodwill                                                      |       | 1,191,566                   |       | 1,201,282                   |       |
| Intangible assets, net                                        |       | 1,260,472                   |       | 1,360,361                   |       |
| Other non-current assets                                      |       | 52,601                      |       | 67,524                      |       |
| Total assets                                                  |       | $                           | 2,940,130  |                        | $          | 3,086,272 |   |
|                                                          |       |                        |       |                        |       |
| **Liabilities, Minority Interests, and Membership  Equity**   |       |                        |       |                        |       |
| Current liabilities:                                          |       |                        |       |                        |       |
| Accounts payable                                              |       | $                           | 42,752     |                        | $          | 43,576 |   |
| Accrued interest                                              |       | 10,966                      |       | 10,131                      |       |
| Long-term debt and capital leases, current portion            |       | 11,549                      |       | 14,209                      |       |
| Other current liabilities                                     |       | 104,401                     |       | 93,636                      |       |
| Total current liabilities                                     |       | 169,668                     |       | 161,552                     |       |
| Long-term debt and capital leases, net of current  portion    |       | 1,832,044                   |       | 1,818,598                   |       |
| Deferred tax liabilities, net                                 |       | 329,503                     |       | 386,659                     |       |
| Other non-current liabilities                                 |       | 8,806                       |       | 13,260                      |       |
| Total liabilities                                             |       | 2,340,021                   |       | 2,380,069                   |       |
|                                                          |       |                        |       |                        |       |
| Minority  interests                                           |       | 1,743                       |       | 1,215                       |       |
|                                                          |       |                        |       |                        |       |
| Commitments and contingencies                                 |       |                        |       |                        |       |
|                                                          |       |                        |       |                        |       |
| Membership equity:                                            |       |                        |       |                        |       |
| Additional paid-in capital                                    |       | 824,235                     |       | 822,854                     |       |
| Accumulated deficit                                           |       | (221,842                    | )          | (124,056                    | )          |
| Accumulated other comprehensive income (loss)                 |       | (4,027                      | )          | 6,190                       |       |
| Total membership equity                                       |       | 598,366                     |       | 704,988                     |       |
| Total liabilities, minority interests, and  membership equity |       | $                           | 2,940,130  |                        | $          | 3,086,272 |   |

 

See accompanying notes to consolidated financial statements.

 

68

----

Table of Contents

 

**DJO Finance LLC**

**Consolidated Statements of Operations**

**(inthousands)**

** **
| ** **                                                                                    | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                    | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** |
| Net sales                                                                                     |       | $                                            | 980,194    |                                         | $          | 492,134 |   | $ | 57,902 |   | $ | 304,383 |   |
| Cost of sales                                                                                 |       | 374,080                                      |       | 205,864                                      |       | 26,787 |   | 127,280 |   |
| Gross profit                                                                                  |       | 606,114                                      |       | 286,270                                      |       | 31,115 |   | 177,103 |   |
| Operating expenses:                                                                           |       |                                         |       |                                         |       |   |   |   |   |
| Selling, general and administrative                                                           |       | 445,396                                      |       | 271,163                                      |       | 41,099 |   | 179,164 |   |
| Research and development                                                                      |       | 26,938                                       |       | 21,047                                       |       | 28,128 |   | 14,772 |   |
| Amortization and impairment of acquired  intangibles                                          |       | 98,954                                       |       | 33,496                                       |       | 4,035 |   | 5,965 |   |
| Operating income (loss)                                                                       |       | 34,826                                       |       | (39,436                                      | )          | (42,147 | ) | (22,798 | ) |
| Other income (expense):                                                                       |       |                                         |       |                                         |       |   |   |   |   |
| Interest income                                                                               |       | 1,662                                        |       | 1,132                                        |       | 312 |   | 527 |   |
| Interest expense                                                                              |       | (173,162                                     | )          | (72,409                                      | )          | (8,611 | ) | (26,008 | ) |
| Other income (expense), net                                                                   |       | (9,134                                       | )          | 742                                          |       | 133 |   | (23 | ) |
| Loss on early extinguishment of debt                                                          |       | —                                       |       | (14,539                                      | )          | — |   | (9,154 | ) |
| Loss from continuing operations before  income taxes and minority interests                   |       | (145,808                                     | )          | (124,510                                     | )          | (50,313 | ) | (57,456 | ) |
| Benefit for income taxes                                                                      |       | (49,071                                      | )          | (42,503                                      | )          | (8,756 | ) | (11,452 | ) |
| Minority interests                                                                            |       | 1,049                                        |       | 415                                          |       | 39 |   | 158 |   |
| Loss from continuing operations                                                               |       | (97,786                                      | )          | (82,422                                      | )          | (41,596 | ) | (46,162 | ) |
| Discontinued operations:                                                                      |       |                                         |       |                                         |       |   |   |   |   |
| Loss from discontinued operations (net of  income tax benefit of $25, and $394, respectively) |       | —                                       |       | —                                       |       | (38 | ) | (614 | ) |
| Net loss                                                                                      |       | $                                            | (97,786    | )                                            | $          | (82,422 | ) | $ | (41,634 | ) | $ | (46,776 | ) |

** **

See accompanying notes to consolidated financial statements.

 

69

----

Table ofContents

 

**DJOFinance LLC**

**Consolidated Statements of Changes in Stockholders’Equity, Membership Equity, and Comprehensive Income (Loss)**

**(inthousands)**

 
| *** ***                                                                    |   |           |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           |    |                   |   | **Total**  |    |
|---------------------------------------------------------------------------------|--------|----------------|---------|-----------------------|------------|--------------|--------|---------------------------|--------|-------------------------|--------|-----------------------------------|------------|-------------------|--------|----------------|---------|------------------------|--------|------------|---------|
| *** ***                                                                    |   | **Successor**  |    | **Predecessor**       |       | **Retained** |   | **Accumulated**           |   | **Stockholders’**  |   |
| *** ***                                                                    |   | **Additional** |    |                  |       |         |   | **Additional**            |   | **Notes Received** |   | **Cost of Repurchased** |       | **Earnings**      |   | **Other**      |    | **Equity and**    |   |
| *** ***                                                                    |   | **Paid-In**    |    | **Common Stock** |       | **Paid-In**  |   | **for Sale of** |   | **Stock**               |   | **(Accumulated**                  |       | **Comprehensive** |   | **Membership** |    |
| *** ***                                                                    |   | **Capital**    |    | **Shares**            | ** ** | **Amount**   |   | **Capital**               |   | **Common Stock**   |   | **Shares**                        | ** ** | **Amount**        |   | **Deficit)**   |    | **Income (Loss)** |   | **Equity** |    |
| ***Predecessor:***                                                              |   |           |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           |    |                   |   |       |    |
| **Balance at December 31, 2005**                                           |   |           |    | 20,841                |       | $            | 21     |                      | $      | 155,430                 |   | $                                 | (846       | )                 | (204   | )              | $       | (1,647                 | )      | $          | 15,906  |   | $ | (1,757 | ) | $ | 167,107 |   |
| Net loss                                                                        |   |           |    | —                |       | —       |   | —                    |   | —                  |   | —                            |       | —            |   | (46,776        | )       | —                 |   | (46,776    | )       |
| Change in  fair value of derivatives                                            |   |           |    | —                |       | —       |   | —                    |   | —                  |   | —                            |       | —            |   | —         |    | (464                   | )      | (464       | )       |
| Foreign  currency translation adjustment                                        |   |           |    | —                |       | —       |   | —                    |   | —                  |   | —                            |       | —            |   | —         |    | 5,077                  |   | 5,077      |    |
| Comprehensive loss                                                              |   |           |    | —                |       | —       |   | —                    |   | —                  |   | —                            |       | —            |   | —         |    | —                 |   | (42,163    | )       |
| Issuance of common stock and options in connection  with the Compex acquisition |   |           |    | 7,267                 |       | 7            |   | 99,308                    |   | —                  |   | —                            |       | —            |   | —         |    | —                 |   | 99,315     |    |
| Equity  awards                                                                  |   |           |    | —                |       | —       |   | 10,460                    |   | —                  |   | —                            |       | —            |   | —         |    | —                 |   | 10,460     |    |
| Exercise  of common stock options                                               |   |           |    | 1,070                 |       | 1            |   | 9,001                     |   | —                  |   | —                            |       | —            |   | —         |    | —                 |   | 9,002      |    |
| Tax  benefit associated with stock options                                      |   |           |    | —                |       | —       |   | 524                       |   | —                  |   | —                            |       | —            |   | —         |    | —                 |   | 524        |    |
| Note  payments                                                                  |   |           |    | —                |       | —       |   | —                    |   | 846                     |   | —                            |       | —            |   | —         |    | —                 |   | 846        |    |
| **Balance at November 3, 2006**                                            |   |           |    | 29,178                |       | $            | 29     |                      | $      | 274,723                 |   | $                                 | —     |              | (204   | )              | $       | (1,647                 | )      | (30,870    | )       | 2,856 |   | 245,091 |   |
| ***Successor:***                                                                |   |           |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           |    |                   |   |       |    |
| Net loss                                                                        |   | $              | —  |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           | (41,634 | )                      | — |       | (41,634 | ) |
| Foreign  currency translation adjustments                                       |   | —         |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | 3,373                  |   | 3,373      |    |
| Comprehensive loss                                                              |   | —         |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | (38,261    | )       |
| Equity awards                                                                   |   | 105            |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | 105        |    |
| Capital contribution - Cefar acquisition                                        |   | 9,464          |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | 9,464      |    |
| Investment by Parent                                                            |   | 363,900        |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | 363,900    |    |
| **Balance at December 31, 2006**                                           |   | 373,469        |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | (41,634        | )       | 3,373                  |   | 335,208    |    |
| Net loss                                                                        |   | —         |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | (82,422        | )       | —                 |   | (82,422    | )       |
| Change in  fair value of derivatives, net of tax of $1,529                      |   | —         |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | (2,383                 | )      | (2,383     | )       |
| Foreign  currency translation adjustments                                       |   | —         |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | 5,200                  |   | 5,200      |    |
| Comprehensive loss                                                              |   | —         |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | (79,605    | )       |
| Repurchase  of Prior Transaction Management Rollover Options                    |   | (1,248         | )       |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | (1,248     | )       |
| Equity awards                                                                   |   | 1,541          |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | 1,541      |    |
| Reversal  of tax benefit associated with stock options                          |   | (985           | )       |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | (985       | )       |
| Investment by Parent                                                            |   | 450,077        |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | —         |    | —                 |   | 450,077    |    |
| **Balance at December 31, 2007**                                           |   | 822,854        |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | (124,056       | )       | 6,190                  |   | 704,988    |    |
| Net loss                                                                        |   |           |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   | (97,786        | )       |                   |   | (97,786    | )       |
| Change in  fair value of derivatives, net of tax of $3,660                      |   |           |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           |    | (5,699                 | )      | (5,699     | )       |
| Foreign  currency translation adjustments                                       |   |           |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           |    | (4,518                 | )      | (4,518     | )       |
| Comprehensive loss                                                              |   |           |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           |    |                   |   | (108,003   | )       |
| Equity awards                                                                   |   | 1,381          |    |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           |    |                   |   | 1,381      |    |
| **Balance at December 31, 2008**                                           |   | $              | 824,235 |                  |       |         |   |                      |   |                    |   |                              |       |              |   |           | $       | (221,842               | )      | $          | (4,027  | ) | $ | 598,366 |   |

 

See accompanying notes to consolidated financial statements.

 

70

----

Table of Contents

 

# **DJO Finance LLC**

**Consolidated Statements of Cash Flows**

**(inthousands)**

** **
| ** **                                                                                                  | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006  through  December 31,  2006** | ** ** | **January 1,  2006  through  November 3,  2006** | ** ** |
| **OPERATING ACTIVITIES:**                                                                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                                                    |       | $                                            | (97,786    | )                                            | $          | (82,422 | ) | $ | (41,634 | ) | $ | (46,776 | ) |
| Adjustments to reconcile net loss to net cash (used  in) provided by operating activities:                  |       |                                         |       |                                         |       |   |   |   |   |
| Depreciation                                                                                                |       | 23,597                                       |       | 14,744                                       |       | 2,369 |   | 8,839 |   |
| Amortization and impairment of intangibles                                                                  |       | 98,954                                       |       | 33,496                                       |       | 4,035 |   | 5,965 |   |
| Amortization of debt issuance costs and non-cash  interest expense                                          |       | 13,177                                       |       | 4,862                                        |       | 654 |   | 1,856 |   |
| Non-cash loss on early extinguishment of debt                                                               |       | —                                       |       | 9,744                                        |       | — |   | 9,154 |   |
| Stock-based compensation                                                                                    |       | 1,381                                        |       | 1,541                                        |       | 105 |   | 10,631 |   |
| Asset impairments and loss on disposal of assets                                                            |       | 3,069                                        |       | 682                                          |       | 1,228 |   | 388 |   |
| Deferred income taxes                                                                                       |       | (42,157                                      | )          | (47,221                                      | )          | (8,842 | ) | (13,284 | ) |
| Provision for doubtful accounts and sales returns                                                           |       | 26,277                                       |       | 22,428                                       |       | 513 |   | 21,763 |   |
| Inventory reserves                                                                                          |       | 8,637                                        |       | 3,580                                        |       | 957 |   | 7,563 |   |
| Minority interests                                                                                          |       | 1,049                                        |       | 415                                          |       | 39 |   | 158 |   |
| Excess tax benefit associated with stock option  exercises                                                  |       | —                                       |       | (370                                         | )          | — |   | (2,543 | ) |
| Acquired in-process research and development                                                                |       | —                                       |       | 3,000                                        |       | 25,200 |   | 3,897 |   |
| Net effect of discontinued operations, net of gain  on disposal                                             |       | —                                       |       | 378                                          |       | 457 |   | 5,155 |   |
| Changes in operating assets and liabilities, net of  acquired assets and liabilities:                       |       |                                         |       |                                         |       |   |   |   |   |
| Accounts receivable                                                                                         |       | (37,064                                      | )          | (15,301                                      | )          | 6,061 |   | 5,503 |   |
| Inventories                                                                                                 |       | (1,609                                       | )          | 7,075                                        |       | 2,911 |   | (9,734 | ) |
| Prepaid expenses, other assets and liabilities                                                              |       | 68                                           |       | 1,567                                        |       | 2,642 |   | (1,818 | ) |
| Accounts payable and accrued expenses                                                                       |       | (9,654                                       | )          | 13,043                                       |       | (12,524 | ) | 9,958 |   |
| Net cash (used in) provided by operating activities                                                         |       | (12,061                                      | )          | (28,759                                      | )          | (15,829 | ) | 16,675 |   |
| **INVESTING ACTIVITIES:**                                                                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Acquisition of businesses and intangibles, net of  cash acquired                                            |       | (5,095                                       | )          | (1,313,110                                   | )          | (535,080 | ) | (1,793 | ) |
| Purchases of property and equipment                                                                         |       | (25,905                                      | )          | (13,962                                      | )          | (1,331 | ) | (12,304 | ) |
| Proceeds from sale of assets                                                                                |       | 14                                           |       | 4,591                                        |       | — |   | 69 |   |
| Other                                                                                                       |       | 1,390                                        |       | (583                                         | )          | — |   | (244 | ) |
| Net cash used in investing activities                                                                       |       | (29,596                                      | )          | (1,323,064                                   | )          | (536,411 | ) | (14,272 | ) |
| **FINANCING ACTIVITIES:**                                                                                   |       |                                         |       |                                         |       |   |   |   |   |
| Investment by parent                                                                                        |       | —                                       |       | 434,599                                      |       | 357,000 |   | — |   |
| Proceeds from long-term debt and revolving line of  credit                                                  |       | 46,540                                       |       | 1,724,350                                    |       | 550,370 |   | 25,300 |   |
| Retirement of debt and payments on long-term debt  and revolving line of credit                             |       | (37,294                                      | )          | (718,421                                     | )          | (336,113 | ) | (25,420 | ) |
| Payment of debt issuance costs                                                                              |       | —                                       |       | (55,866                                      | )          | (20,818 | ) | (10 | ) |
| Excess tax benefit associated with stock option  exercises                                                  |       | —                                       |       | 370                                          |       | — |   | 2,543 |   |
| Repurchase of prior transaction management rollover  options                                                |       | —                                       |       | (1,248                                       | )          | — |   | — |   |
| Dividend paid to minority interests of subsidiary                                                           |       | (381                                         | )          | (226                                         | )          | — |   | — |   |
| Proceeds from issuance of common stock                                                                      |       | —                                       |       | —                                       |       | — |   | 9,002 |   |
| Proceeds from notes received for sale of common  stock                                                      |       | —                                       |       | —                                       |       | — |   | 846 |   |
| Net cash provided by financing activities                                                                   |       | 8,865                                        |       | 1,383,558                                    |       | 550,439 |   | 12,261 |   |
| Effect of exchange rate changes on cash and cash  equivalents                                               |       | (196                                         | )          | 833                                          |       | 274 |   | 566 |   |
| **Net (decrease) increase in cash and cash  equivalents**                                                   |       | (32,988                                      | )          | 32,568                                       |       | (1,527 | ) | 15,230 |   |
| Cash and cash equivalents at beginning of period                                                            |       | 63,471                                       |       | 30,903                                       |       | 32,430 |   | 17,200 |   |
| **Cash and cash equivalents at end of period**                                                              |       | $                                            | 30,483     |                                         | $          | 63,471 |   | $ | 30,903 |   | $ | 32,430 |   |
| **Supplemental disclosures of cash flow  information:**                                                     |       |                                         |       |                                         |       |   |   |   |   |
| Cash paid for interest                                                                                      |       | $                                            | 158,798    |                                         | $          | 70,249 |   | $ | 3,446 |   | $ | 26,584 |   |
| Cash paid for income taxes                                                                                  |       | $                                            | 2,497      |                                         | $          | 912 |   | $ | 606 |   | $ | 4,576 |   |
| **Non-cash investing and financing activities:**                                                            |       |                                         |       |                                         |       |   |   |   |   |
| Increases in property and equipment and in other  liabilities in connection with capitalized software costs |       | $                                            | 4,066      |                                         | $          | — |   | $ | — |   | $ | — |   |
| Issuance of management rollover options                                                                     |       | $                                            | —     |                                         | $          | 15,478 |   | $ | 6,900 |   | $ | — |   |
| Issuance of common stock in connection with  acquisition of businesses                                      |       | $                                            | —     |                                         | $          | — |   | $ | 9,464 |   | $ | 99,315 |   |

 

See accompanying notes to consolidated financial statements.

 

71

----

Table ofContents

 

**DJOFinance LLC**

 

**Notes to Consolidated Financial Statements**

 

**1.**                                      **SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES**

 

**Basis of Presentation and Principles ofConsolidation. **We area global provider of high-quality orthopedic devices, with a broad range ofproducts used for rehabilitation, pain management and physical therapy. We alsodevelop, manufacture and distribute a broad range of surgical reconstructiveimplant products. We offer healthcare professionals and patients a diverserange of orthopedic rehabilitation products addressing the complete spectrum ofpreventative, pre-operative, post-operative, clinical and home rehabilitationcare. Our products are used by orthopedic specialists, spine surgeons, primarycare physicians, pain management specialists, physical therapists, podiatrists,chiropractors, athletic trainers and other healthcare professionals to treatpatients with musculoskeletal conditions resulting from degenerative diseases,deformities, traumatic events and sports-related injuries. In addition, many ofour non-surgical medical devices and related accessories are used by athletesand patients for injury prevention and at-home physical therapy treatment.

 

We market and distribute our products through threeoperating segments: Domestic Rehabilitation, International Rehabilitation, andSurgical Implant. Our Domestic and International Rehabilitation Segments offernon-invasive medical products that are used before and after surgery to assistin the repair and rehabilitation of soft tissue and bone, and to protectagainst further injury; electrotherapy devices and accessories used to treatpain and restore muscle function; iontophoretic devices and accessories used todeliver medication; clinical therapy tables, traction equipment and otherclinical therapy equipment; orthotic devices used to treat joint and spine conditions;orthopedic soft goods; rigid knee braces; and vascular systems which includeproducts intended to prevent deep vein thrombosis following surgery. OurSurgical Implant Segment offers a comprehensive suite of reconstructive jointproducts.

 

On November 20, 2007, a subsidiary of ReAbleTherapeutics, Inc. (“ReAble”) was merged into DJO Opco Holdings, Inc.(“DJO Opco”), with DJO Opco continuing as the surviving corporation (the “DJOMerger”). As a result of the DJO Merger, DJO Opco became a subsidiary of ReAbleTherapeutics Finance LLC, the entity filing this Annual Report on Form 10-K,which is itself a subsidiary of ReAble. Following the DJO Merger, ReAble wasrenamed DJO Incorporated (“DJO”), ReAble Therapeutics Finance LLC wasrenamed DJO Finance LLC (“DJOFL”) and ReAble Finance Corporation, theco-issuer of both the 10.875% senior notes and 11.75% senior subordinated notes(see Note 8), was renamed DJO Finance Corporation (“Finco”).

 

Except as otherwise indicated, references to “us,” “we,”“DJOFL,” “our,” or “our Company,” refers to DJOFL and its consolidatedsubsidiaries.

 

On November 3, 2006, an affiliate ofBlackstone Capital Partners V L.P. (“Blackstone”) acquired all of theoutstanding shares of capital stock of ReAble in a merger transaction (the “PriorTransaction”).  See further descriptionof the Prior Transaction under Note 2. For purposes of discussing the Prior Transaction in the auditedconsolidated financial statements, we refer to DJO as ReAble or “Predecessor.”

 

DJOFL directly or indirectly through its subsidiaries,owns all of the operating assets of DJO. The accompanying consolidated financial statements include the accountsof DJOFL, and its wholly owned subsidiaries and those entities in which we holda controlling interest from the date of the Prior Transaction.  Prior to the date of the Prior Transaction,the financial statements reflect the accounts and activities of thePredecessor.  The Successor periodreflects the acquisition of ReAble using the purchase method of accountingpursuant to the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 141, “Business Combinations”. The Predecessor results of ReAble are not comparable to the Successorresults of DJOFL due to the difference in basis of presentation incorporatingthe Prior Transaction purchase accounting as compared to historical cost forthe Predecessor. Minority interests reflect the 50% separate ownership ofMedireha GmbH (“Medireha”) not owned by us, which we have consolidated dueto our controlling interest. Our controlling interest consists of our 50%ownership and our control of one of the two director seats, our rights toprohibit certain business activities that are not consistent with our plans forthe business and our exclusive distribution rights for products manufactured byMedireha. All significant intercompany balances and transactions have beeneliminated in consolidation.

 

**Use of Estimates. **The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make certain estimates and assumptions that affect thereported amounts of assets and liabilities, the disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. On an ongoingbasis, management evaluates its estimates, including those related tocontractual allowances, doubtful accounts, inventories, rebates, productreturns, warranty obligations, self insurance, income taxes, goodwill andintangible assets valuations and stock-based compensation. We base ourestimates on historical experience and on various other assumptions that webelieve are reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources. Actual results could differfrom those estimates.

 

72

----

Table ofContents

 

## **Cash and CashEquivalents. **Cash consists of deposits with financialinstitutions. We consider all short-term, highly liquid investments andinvestments in money market funds and commercial paper with original maturitiesof less than three months at the time of purchase to be cash equivalents. Whileour cash and cash equivalents are on deposit with high-quality institutions,such deposits exceed Federal Deposit Insurance Corporation insured limits.

## ** **

## **Allowance for DoubtfulAccounts. **We make estimates of the collectability of accountsreceivable.  Management analyzes accountsreceivable historical collection rates and bad debts write-offs, customerconcentrations, customer credit-worthiness, and current economic trends whenevaluating the adequacy of the allowance for doubtful accounts.

## ** **

## **Sales Returns andAllowances**.  We make estimates of the amount of salesreturns and allowances that will eventually be incurred.  Management analyzes sales programs that arein effect, contractual arrangements, market acceptance and historical trendswhen evaluating the adequacy of sales returns and allowance accounts.  We estimate contractual discounts andallowances for reimbursement amounts from our third-party payor customers basedon negotiated contracts and historical experience.

## ** **

## **Inventories. **Inventory is valued at the lower of cost (determined on a first-in,first-out basis) or market.  We establishreserves for slow moving and excess inventory, product obsolescence, shrinkageand other valuation impairments based on future demand and historicalexperience.

## ** **

**Property and Equipment. **Property and equipment arestated at cost less accumulated depreciation and amortization.  Depreciation is calculated for financialreporting purposes using the straight-line method over the estimated usefullives of the assets that range from three to twenty-five years.  Leasehold improvements and assets subject tocapital leases are amortized using the straight-line method over the terms ofthe leases or lives of the assets, if shorter. We capitalize surgical implant instruments that we provide to surgeons,free of charge, for use while implanting our products and the relateddepreciation expense is recorded as a component of selling, general andadministrative expense.  We alsocapitalize electrotherapy devices that we rent to patients and record therelated depreciation expense in cost of sales.

 

**ComputerSoftware Costs. **Software is stated at cost less accumulatedamortization and is amortized using the straight-line method over its estimateduseful life ranging from three to seven years. In accordance with AICPA Statement of Position 98-1, “Accounting for theCosts of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”)we capitalize costs of internally developed software during the developmentstage of internally developed software applications.  Additionally, we capitalize related costsincluding external consulting costs, cost of software licenses, and internalpayroll and payroll-related costs for employees who are directly associatedwith a software project.  Software assetsare reviewed for impairment when events or circumstances indicate that thecarrying value may not be recoverable over the remaining lives of the assets.Upgrades and enhancements are capitalized if they result in addedfunctionality.  Recently we beganimplementing a new ERP system resulting in approximately $4.5 million of capitalizedsoftware costs as of December 31, 2008.

 

******Impairment of Long-Lived Assets**. In accordance with SFAS 144, “Accountingfor the Impairment of Long-Lived Assets” (“SFAS 144”) we test long-livedassets for impairment when events or changes in circumstances may indicate thatthe carrying amount of an asset may not be recoverable.  Recoverability of long-lived assets ismeasured by a comparison of the carrying amount of an asset to the undiscountedfuture net cash flows expected to be generated by the asset.  If such assets are considered to be impaired,the impairment to be recognized is measured as amount by which the carryingamount of the assets exceed the discounted future net cash flows.  Assets to be disposed of are reported at thelower of the carrying amount or estimated sale value less estimated costs tosell.

 

**Goodwill and Intangible Assets.**  Goodwillrepresents the excess of the purchase price over the fair value of tangible andidentifiable intangible assets acquired and liabilities assumed.  In accordance with SFAS No. 142, “Goodwilland Other Intangible Assets,” we do not amortize goodwill. In lieu ofamortization, we are required to perform an annual review for impairment.Goodwill is recorded as the difference, if any, between the aggregateconsideration paid for an acquisition and the fair value of the net tangibleand intangible assets acquired. The amounts and useful lives assigned tointangible assets acquired, other than goodwill, impact the amount and timingof future amortization, and the amount assigned to in-process research anddevelopment which is expensed immediately. The value of our intangible assets,including goodwill, could be impacted by future adverse changes such as: (i) anyfuture declines in our operating results, (ii) a further decline in thevaluation of comparable company stocks, (iii) a further significantslowdown in the worldwide economy or our industry or (iv) any failure tomeet the performance projections included in our forecasts of future operatingresults. We estimated the fair values of our reporting units primarily usingthe income approach valuation methodology that 

 

73

----

Table of Contents

 

includes the discounted cash flow method, taking into consideration themarket approach and certain market multiples as a validation of the valuesderived using the discounted cash flow methodology. The discounted cash flowsfor each reporting unit were based on discrete financial forecasts developed bymanagement for planning purposes. Cash flows beyond the discrete forecasts wereestimated using a terminal value calculation, which incorporated historical andforecasted financial trends for each identified reporting unit and consideredlong-term earnings growth rates for publicly traded peer companies. Future cashflows were discounted to present value by incorporating the present valuetechniques discussed in FASB Concepts Statement 7, “Using Cash Flow Information and Present Value in AccountingMeasurements,” or Concepts Statement 7. Specifically, the incomeapproach valuations included reporting unit cash flow discount rates rangingfrom 10.8% to 11.6% and terminal value growth rates of 3%. Publicly availableinformation regarding the market capitalization was also considered inassessing the reasonableness of the cumulative fair values of our reportingunits estimated using the discounted cash flow methodology.   Significant management judgment is requiredin the forecasts of future operating results that are used in the discountedcash flow method of valuation. The estimates we have used are consistent withthe plans and estimates that we use to manage our business. It is possible,however, that the plans may change and estimates used may prove to beinaccurate. If our actual results, or the plans and estimates used in futureimpairment analyses, are lower than the original estimates used to assess therecoverability of these assets, we could incur significant impairment charges.

 

We perform an impairment analysis on our goodwill onan annual basis in the fourth quarter and in certain other circumstances whenimpairment indicators are present. Our annual impairment test related togoodwill did not indicate any impairment.

 

Identifiableintangible assets consist of trademarks, trade names, patents, distributionnetworks, intellectual property, non-compete agreements and customer lists andare carried at fair value on date of purchase less accumulated amortization.  Amortization of identifiable intangibles iscomputed using the straight-line method over their estimated useful lives.  Our customer and technology based intangibleshave weighted average periods of 9 and 10 years, respectively. Our trade nameswere determined to have an indefinite life.

 

We test intangible assets withindefinite lives in accordance with SFAS 142, which states that intangible assets with indefinitelives should be tested annually in lieu of being amortized.  This test compares the fair value of theintangible with its carrying amount.  Todetermine the fair value we applied the relief from royalty method (“RFR”).  Under the RFR method, the value of the tradename is determined by calculating the present value of the after-tax costsavings associated with owning the asset and therefore not being required topay royalties for its use during the asset’s indefinite life.  Significant judgments inherent in thisanalysis include the selection of appropriate discount rates, estimating futurecash flows and the identification of appropriate terminal growth rateassumptions.  Discount rate assumptionsare based on an assessment of the risk inherent in the projected future cashgenerated by the respective intangible assets. Also subject to judgment are assumptions about royalty rates, which arebased on the estimated rates at which similar brands and trademarks are beinglicensed in the marketplace. During the fourth quarter 2008, we determined thatthe fair value of our Chattanooga Group trade name was less than the carryingamount, resulting in an approximate $10.1 million impairment charge for theyear ended December 31, 2008.  Inaddition, we determined that the Encore Medical trade name was abandoned in thefourth quarter of 2008.  As a result werecorded a $12.3 million write off within the consolidated statement ofoperations for the year ended December 31, 2008.

 

## **Debt Issuance Costs. **Debt issuance costs are capitalized and are includedin other non-current assets on our consolidated balance sheet.  We amortize these costs over the lives of therelated debt instruments (currently, approximately seven years) and classifythe amortization expense with interest expense in the accompanying consolidatedstatements of operations.  At December 31,2008 and 2007, we have unamortized debt issuance costs of $49.9 million and$61.6 million, respectively.

 

74

----

Table of Contents

 

## **Warranty Costs. **We provide expressed warranties on certain products for periodstypically ranging from one to three years. We estimate our warranty obligations at the time of sale based uponhistorical experience and known product issues, if any.

## ** **

A summary of the activity in our warranty reserves is as follows (inthousands):

 
| ** **                                              | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                              | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** |
| Beginning balance                                       |       | $                                            | 1,720      |                                         | $          | 1,348 |   | $ | 1,275 |   | $ | 643 |   |
| Amount charged to expense for estimated warranty  costs |       | 1,258                                        |       | 509                                          |       | 260 |   | 1,354 |   |
| Deductions for actual costs incurred                    |       | (1,217                                       | )          | (454                                         | )          | (187 | ) | (1,040 | ) |
| Acquired through business acquisitions                  |       | —                                       |       | 317                                          |       | — |   | 318 |   |
| Ending balance                                          |       | $                                            | 1,761      |                                         | $          | 1,720 |   | $ | 1,348 |   | $ | 1,275 |   |

 

**Self Insurance.**  We are partially self insured for certainemployee health benefits and product liability claims.  Accruals for losses are provided based uponclaims experience and actuarial assumptions, including provisions for incurredbut not reported losses.

 

## **Revenue Recognition.  **We recognize revenue pursuant to Staff Accounting Bulletin No. 104,Revenue Recognition. Accordingly, revenue is recognized when all four of thefollowing criteria are met: (i) persuasive evidence that an arrangementexists; (ii) shipment of goods and passage of title; (iii) theselling price is fixed or determinable; and (iv) collectibility isreasonably assured.  We reduce revenue byestimates of potential future product returns and other allowances.  Revenues are also reduced by rebates relatedto sales transacted through distribution agreements that provide thedistributors with a right to return inventory or take certain pricingadjustments based on sales mix or volume. Provisions for product returns and other allowances are recorded as areduction to revenue in the period sales are recognized.

## ** **

## **Advertising Costs. **We expense advertising costs as they are incurred.  For the Successor years ended December 31, 2008 and2007 and the period November 4, 2006 through December 31, 2006,advertising costs were approximately $6.4 million, $3.9 million and $0.7million, respectively.  For thePredecessor period January 1, 2006 through November 3, 2006, suchcosts approximated $5.6 million.

## ** **

**Shipping and Handling Expenses. **Shipping and handlingexpenses are included with cost of sales in our consolidated statement ofoperations.

 

## **Stock BasedCompensation. **We maintain a stock option plan under which stockoptions have been granted to employees and non-employee members of the Board ofDirectors.  Effective January 1,2006, we adopted SFAS 123(R), which requires all share based payments toemployees to be recognized in the financial statements based upon theirrespective grant date fair values.  Withthe adoption of SFAS 123(R), we elected to amortize stock-based compensationfor service-based awards granted on a straight-line basis over the requisiteservice (vesting) period for the entire award.  Other awards vest over aspecified performance period from the date of grant upon the achievement ofcertain pre-determined performance targets over time and compensation expenseis recognized to the extent the achievement of the performance targets isdeemed probable.    Refer to Note 10 for further discussion.

## ** **

## **Income Taxes. **We account for income taxes under the asset and liability method as setforth in SFAS No. 109, *“*Accounting forIncome Taxes*”*(“SFAS 109”).  Under this method, deferred tax assets andliabilities are recognized and measured using enacted tax rates in effect forthe year in which the differences are expected to be recognized.  Valuation allowances are established whennecessary to reduce deferred tax assets to amounts that are more likely thannot to be realized. In addition, we adopted Financial Accounting StandardsBoard issued Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes — an Interpretation of FAB Statement No. 109 (“FIN 48”) on January 1,2007 (see Note 12 to our audited consolidated financial statements).

## ** **

**Foreign Currency Translation.**  The financialstatements of our international subsidiaries, where the local currency is thefunctional currency, are translated into U.S. dollars using period-end exchangerates for assets and liabilities and average exchange rates during the periodfor revenues and expenses. Cumulative translation gains and losses are excludedfrom results of operations and recorded as a separate component of consolidatedmembership equity. Gains and losses resulting from foreign currencytransactions (transactions denominated in a currency other than the entity’slocal currency) are included in the condensed consolidated statements ofoperations.

 

75

----

 

Table of Contents

 

**Derivative Financial Instruments.**  We useforeign exchange forward contracts to hedge expense commitments that aredenominated in currencies other than the US dollar. The purpose of our foreigncurrency hedging activities is to fix the dollar value of specific commitmentsand payments to foreign vendors. We account for derivatives pursuant to SFASNo. 133, “Accounting for Derivative Instruments and Hedging Activities” which requires that all derivative instrumentsbe recognized in the financial statements and measured at fair value regardlessof the purpose or intent for holding them. The classification of gains andlosses resulting from changes in the fair values of derivatives is dependent onthe intended use of the derivative and its resulting designation.  The change in fair value of the ineffectiveportion of a hedge, and changes in fair values of derivatives that are not consideredhighly effective hedges are immediately recognized in earnings. If thederivative is designated as a cash flow hedge, the effective portions ofchanges in the fair value of the derivative are recorded in other comprehensiveincome and are subsequently recognized in earnings when the hedged item affectsearnings.

 

**Comprehensive Income (Loss). **Comprehensive income (loss) includes net income andother comprehensive income.  Othercomprehensive income (loss) refers to unrealized gains and losses that areexcluded from current earnings and are recorded directly as an adjustment tostockholders’ equity/membership equity. These gains and losses often fluctuate before being realized, and areoften long—term in nature.  Our othercomprehensive income (loss) is comprised of foreign currency translationadjustments and unrealized interest rate hedge gains and losses, net of tax.

 

**Concentrationof Credit Risk.**  Wesell the majority of our products in the United States to orthopedicprofessionals, hospitals, distributors, specialty dealers, insurance companies,managed care companies and certain governmental payors such as Medicare.  International sales comprised 26.0%, 27.4%,29.0%, and 22.3% of our net revenues for the Successor years ended December 31,2008 and 2007, the period November 4, 2006 through December 31, 2006and for the Predecessor period January 1, 2006 through November 3,2006, respectively.  International salesare generated from a diverse group of customers through our wholly ownedsubsidiaries and certain independent distributors. Credit is extended based onan evaluation of the customer’s financial condition and generally collateral isnot required. We provide a reserve for estimated bad debts.  Management reviews and revises its estimatesfor credit losses from time to time and such credit losses have generally beenwithin management’s estimates.

 

Duringthe three years ending December 31, 2008, we had no individual customer ordistributor that accounted for 10% or more of our total annual revenues.

 

**Fair Value of Financial Instruments. **The carrying amounts of our short—term financial instruments, includingcash and cash equivalents, accounts receivable and accounts payable,approximate fair values due to their short—term nature.  The fair values of our variable rate debt,including borrowings under our Senior Secured Credit Facility, are currentlybelow the carrying value.  We estimatedthe fair value of our long—term fixed rate notes based on trading prices forthe notes on or near December 31, 2008 and 2007 (see Note 8).

 

## **Reclassifications.**The consolidated financial statements andaccompanying footnotes reflect certain reclassifications to prior yearconsolidated financial statements to conform to the current year presentation.

## ** **

**Recent Accounting Pronouncements**

 

In March 2008,the FASB issued SFAS No. 161, “Disclosures about Derivative Instrumentsand Hedging Activities” which requires entities to disclose the fair values ofderivative instruments and their gains and losses in a tabular format and todisclose derivative features that are credit risk—related. The statement iseffective for fiscal years beginning after November 15, 2008. We willadopt this statement as of the beginning of 2009 and are currently assessingthe potential impact of adoption.

 

In December 2007, the FASB issued SFAS No. 160,“Non—controlling Interests in Consolidated Financial Statements” which requiresentities to report non—controlling (minority) interests in subsidiaries in thesame way as equity in the consolidated financial statements. The statement iseffective for fiscal years beginning after December 15, 2008. We willadopt this statement as of the beginning of 2009 and are currently assessingthe potential impact of adoption.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141 (R)”)  which requires the acquiring entity in abusiness combination to recognize all the assets acquired and liabilitiesassumed in the transaction; establishes the acquisition—date fair value as themeasurement objective for all assets acquired and liabilities assumed; andrequires the acquirer to disclose to investors and other users all of theinformation they need to evaluate and understand the nature and financialeffect of the business combination. The statement is effective for businesscombinations commencing subsequent to December 15, 2008.

 

76

----

Table of Contents

 

In February 2007, the FASB issued SFAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities—Including anamendment to FASB Statement No. 115” which permits entities to choose tomeasure many financial instruments and certain other items at fair value. Weadopted this statement during 2008.  Theprovisions of SFAS 159 did not have a material impact in our consolidatedfinancial statements.

 

In September 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurement” which defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles (“GAAP”) and expandsdisclosure about fair value measurements. We adopted this statement during 2008. The provisions of SFAS 157 did not have a material impact in ourconsolidated financial statements.

 

## **2.**                                      ACQUISITIONS ANDOTHER TRANSACTIONS

## ** **

We account for acquisitions in accordance with SFAS141 (R) with the results of operations attributable to each acquisitionincluded in the consolidated financial statements from the date of acquisition.

 

***Acquisition of DJO Opco Holdings, Inc.***

 

On July 15, 2007, we entered into an Agreementand Plan of Merger (the “DJO Merger Agreement”) with DJO Opco, formerly knownas DJO Incorporated, providing for the DJO Merger pursuant to which DJO Opcobecame a wholly owned subsidiary of DJOFL. The total purchase price for the DJOMerger, which was consummated on November 20, 2007, was approximately$1.3 billion and consisted of $1.2 billion paid to former equityholders (or $50.25 in cash for each share of common stock of DJO Opco they thenheld), $15.2 million related to the fair value of stock options held byDJO Opco management that were exchanged for options to purchase DJO commonstock, and $22.8 million in direct acquisition costs. The DJO Merger wasfinanced through a combination of equity contributed by our primaryshareholder, an affiliate of Blackstone Capital Partners V, L.P. (“Blackstone”),borrowings under our senior secured credit facility (the “Senior Secured CreditFacility”), and proceeds from the newly issued 10.875% senior notes due 2014(the “10.875% Notes”) (see Note 8 for further information).

 

***Acquisitionof IOMED, Inc.***

 

On August 9, 2007, a subsidiary of DJOFL acquiredIOMED, Inc. (“IOMED”), which develops, manufactures and markets activedrug delivery systems used primarily to treat acute local inflammation in thephysical and occupational therapy and sports medicine markets. The purchaseprice was $23.3 million and consisted of $21.1 million in cashpayments to former IOMED equity holders at $2.75 per share, $0.8 millionrelated to the fair value of vested stock options that were outstanding at thetime of the acquisition, and $1.4 million in direct acquisition costs. TheIOMED acquisition was primarily financed with borrowings under our thenexisting revolving credit facility.

 

***Acquisitionof******The Saunders Group, Inc.***

 

On July 2, 2007, a subsidiary of DJOFL completedits purchase of substantially all of the assets of The Saunders Group, Inc.(“Saunders”) for total cash consideration of $40.9 million, including$0.9 million of acquisition costs (the “Saunders Acquisition”). Saundersis a supplier of rehabilitation products to physical therapists, chiropractors,athletes, athletic trainers, physicians and patients, with a specialty inpatented traction devices, back supports, and equipment for neck and backdisorders. The Saunders Acquisition was financed with funds borrowed under ourthen existing senior credit facilities.

 

***Acquisitionof Cefar AB***

 

On November 7,2006, a subsidiary of DJOFL acquired all of the issued and outstanding sharesof Cefar AB (“Cefar”), a provider of electrotherapy and rehabilitation devicesused for chronic pain, for women’s health, for electroacupuncture, and forother rehabilitation activities. The purchase price of $27.1 million wascomprised of the payment of $16.3 million in cash, issuance of shares of ourcommon stock valued at $9.5 million, and $1.3 million of acquisition costs. Thefair value of the common stock issued was determined as $16.46 per share basedon the per share price used in the Prior Transaction. We funded the cashportion of the acquisition with $10.0 million of term loan borrowings under theOld Senior Secured Credit Facility and cash on hand.  Pursuant to the terms of the acquisitionagreement, additional amounts were payable to certain of the formerstockholders of Cefar if certain EBITDA targets were met by December 31,2008. During 2008, $1.8 million was paid to the former stockholders ofCefar.  As of December 31, 2008, wehad a remaining accrual of $1.8 million, which was subsequently paid to theshareholders of Cefar in January 2009.

 

77

----

Table ofContents

 

***ThePrior Transaction***

 

**On November 3, 2006, Blackstoneacquired all of the outstanding shares of capital stock of ReAble in a mergertransaction (the “Prior Transaction”). The total purchase price for the Prior Transaction was approximately$529.2 million and consisted of $482.5 million paid to former holders of sharesof common stock, $7.2 million related to the fair value of management rolloveroptions that continued to remain as outstanding options to purchase ReAblecommon stock after the Prior Transaction (the “Prior Transaction ManagementRollover Options”), and $39.5 million in direct acquisition costs.  The Prior Transaction was financed through acombination of equity contributed by an affiliate of Blackstone, cash on handof ReAble, borrowings under the Old Senior Secured Credit Facility and proceedsfrom our 11.75% senior subordinated notes (the “11.75% Notes”, see Note8).  Upon the closing of the PriorTransaction, shares of ReAble’s common stock ceased to be traded on the NASDAQGlobal Market.**

** **

***Acquisitionof Compex Technologies, Inc.***

 

On February 24,2006, pursuant to the terms of a merger agreement dated November 11, 2005,we acquired all of the issued and outstanding shares of Compex Technologies, Inc.(“Compex”), a Minnesota corporation. Compex manufactured and sold a broad lineof transcutaneous electrical nerve stimulation (“TENS”) and neuromuscularelectrical nerve stimulation (“NMES”) products used for pain management,rehabilitation, fitness and sports performance enhancement in clinical, homehealthcare, sports and occupational medicine settings. The domestic Compexoperations were integrated into our Empi division. The total purchase price ofapproximately $102.9 million was comprised of 7.3 million shares of our commonstock valued at $90.0 million, options to purchase 900,000 shares of our commonstock valued at $9.3 million, and $3.6 million in acquisition costs. We fundedthe cash portion of the acquisition with $25.3 million of borrowings.

 

***OtherAcquisitions***

 

During2007, we completed the acquisition of various other businesses, includingEndeavor Medical, Inc. (“Endeavor”) and Performance Modalities, Inc.(“PMI”). On April 13, 2007, we acquired Endeavor for total considerationof $2.9 million. On February 16, 2007, we acquired certain assets of PMIfor total consideration of $4.3 million. The preliminary allocation of theaggregate purchase price for both acquisitions, which is subject to change uponour further evaluation of the assets acquired and liabilities assumed, resultedin the recognition of $2.4 million of goodwill.

 

The fair values of the assets acquired and theliabilities assumed were estimated in accordance with SFAS 141. Thepurchase prices for our acquisitions were allocated as follows to the fairvalues of the net tangible and intangible assets acquired, including thecumulative impact of adjustments made to such allocations through December 31,2008 (see Note 6):

 
| **(in thousands):**                     | ** ** | **DJO Opco** | ** ** | **IOMED** | ** ** | **Saunders** | ** ** | **Cefar** | ** ** | **Prior  Transaction** | ** ** | **Compex** | ** ** | **Wtd. Avg. Useful Life** | ** ** |
|----------------------------------------------|------------|-------------------|------------|-----------|------------|--------------|------------|-----------|------------|------------------------|------------|------------|------------|------------------------------------------|------------|
| Current assets                               |       | $                 | 171,929    |      | $          | 8,971        |       | $         | 6,783      |                   | $          | 11,342     |       | $                                        | 209,011    |   | $ | 69,129 |   |   |   |
| Tangible non-current assets                  |       | 67,385            |       | 853       |       | 273          |       | 1,036     |       | 49,853                 |       | 8,340      |       |                                     |       |
| Liabilities assumed (see Note 13)            |       | (697,465          | )          | (6,679    | )          | (628         | )          | (10,697   | )          | (538,526               | )          | (51,092    | )          |                                     |       |
| Acquired in-process research and development |       | 3,000             |       | —    |       | —       |       | —    |       | 25,200                 |       | 3,897      |       |                                     |       |
| Identifiable intangible assets:              |       |              |       |      |       |         |       |      |       |                   |       |       |       |                                     |       |
| Technology-based                             |       | 354,000           |       | 6,616     |       | 10,171       |       | 1,800     |       | 83,900                 |       | 8,213      |       | 3 – 20 years                        |       |
| Customer-based                               |       | 328,000           |       | 2,512     |       | 6,369        |       | 3,200     |       | 133,800                |       | 14,610     |       | 10 – 16 years                       |       |
| Trademarks and tradenames                    |       | 356,000           |       | 1,777     |       | 4,423        |       | 3,400     |       | 92,000                 |       | 5,771      |       | Indefinite                               |       |
| Non-compete                                  |       | —            |       | —    |       | —       |       | —    |       | 1,600                  |       | —     |       | 1 year                                   |       |
| Goodwill                                     |       | 691,884           |       | 9,255     |       | 13,537       |       | 17,036    |       | 472,414                |       | 43,995     |       | N/A                                      |       |
| Purchase price                               |       | $                 | 1,274,733  |      | $          | 23,305       |       | $         | 40,928     |                   | $          | 27,117     |       | $                                        | 529,252    |   | $ | 102,863 |   |   |   |

 

Goodwillrepresents the excess of the purchase price over the fair value of tangible andidentifiable intangible assets acquired and liabilities assumed.

 

The purchase price allocation for the DJO Mergerincluded values assigned to certain specific identifiable intangible assetsaggregating $1,038.0 million. An aggregate value of $354.0 millionwas assigned to patents and existing technology, determined primarily by estimatingthe present value of future royalty costs that will be avoided due to ourownership of the patents and technology acquired. An aggregate value of$328.0 million was assigned to certain DJO Opco customer relationships forgroup purchase organization (“GPO”) customers and certain other customersexisting on the acquisition date based upon an estimate of the futurediscounted cash flows that would be derived from those GPOs and othercustomers. A value of $356.0 million was assigned to tradenames and trademarks,determined primarily by estimating the present value of future royalty coststhat will be avoided due to our ownership of the tradenames and trademarksacquired.

 

78

----

Table ofContents

 

Goodwill represents the excess of the purchase priceover the fair value of tangible and identifiable intangible assets acquired andliabilities assumed. A value of $691.9 million, representing thedifference between the total purchase price and the aggregate fair valuesassigned to the net tangible assets acquired and liabilities assumed and theidentifiable intangible assets acquired, was assigned to goodwill. We acquiredDJO Opco to expand our product offerings, increase our addressable market,increase the size of our international business and increase our revenues. Wealso believe there are significant cost reduction synergies that may berealized as we integrate the acquired business. These are among the factorsthat contributed to a purchase price for the DJO Merger acquisition thatresulted in the recognition of goodwill.

 

The purchase price allocation for the PriorTransaction included values assigned to certain specific identifiable intangibleassets aggregating $311.3 million. An aggregate value of $83.9 million wasassigned to patents and existing technology, determined primarily by estimatingthe present value of future royalty costs that will be avoided due to ourownership of the patents and technology acquired. An aggregate value of $133.8million was assigned to certain ReAble customer relationships for hospitals,distributors, third party payors, and certain other customers existing on theacquisition date based upon an estimate of the future discounted cash flowsthat would be derived from those customers. A value of $92.0 million wasassigned to trade names and trademarks, determined primarily by estimating thepresent value of future royalty costs that will be avoided due to our ownershipof the trade names and trademarks acquired. A value of $1.6 million was assigned to non—compete restrictionsincluded in the employment agreements of certain of ReAble’s executive officersand senior management.  A value of $472.4million, representing the difference between the total purchase price and theaggregate fair values assigned to the net tangible assets acquired andliabilities assumed and the identifiable intangible assets acquired, wasassigned to goodwill.

 

**3.****                                      ACCOUNTSRECEIVABLE RESERVES**

 

A summary of activity in our accounts receivable reserves for doubtfulaccounts and sales returns is presented below (in thousands):

 

| ** **                                         | ** ** | **Successor**                            | ** ** | **Predecessor**                              | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                         | ** ** | **Year  Ended  December  31, 2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1,  2006  through  November  3, 2006** | ** ** |
| ** **                                         | ** ** | ** **                               | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance, beginning of period                       |       | $                                        | 30,954     |                                         | $          | 513 |   | $ | — |   | $ | 4,016 |   |
|                                               |       |                                     |       |                                         |       |   |   |   |   |
| Acquired through business acquisitions             |       | —                                   |       | 14,709                                       |       | — |   | — |   |
|                                               |       |                                     |       |                                         |       |   |   |   |   |
| Provision for  doubtful accounts and sales returns |       | 26,277                                   |       | 22,521                                       |       | 513 |   | 21,763 |   |
|                                               |       |                                     |       |                                         |       |   |   |   |   |
| Write-offs, net  of recoveries                     |       | (21,885                                  | )          | (6,789                                       | )          | — |   | (6,610 | ) |
|                                               |       |                                     |       |                                         |       |   |   |   |   |
| Balance, end of  period                            |       | $                                        | 35,346     |                                         | $          | 30,954 |   | $ | 513 |   | $ | 19,169 |   |

 

Reserve balances subsequent to the Prior Transaction were nettedagainst the related accounts receivable as part of the Prior Transactionpurchase accounting.

 

79

----

Table of Contents

 

**4.****                                      INVENTORIES**

 

Inventories consist of the following (in thousands):

 
| ** **                     | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Components and raw materials   |       | $                           | 34,138     |                        | $          | 35,534 |   |
| Work in process                |       | 5,187                       |       | 6,626                       |       |
| Finished goods                 |       | 54,776                      |       | 54,411                      |       |
| Inventory held on consignment  |       | 21,804                      |       | 22,159                      |       |
|                           |       | 115,905                     |       | 118,730                     |       |
| Less – inventory reserves |       | (12,739                     | )          | (7,826                      | )          |
|                           |       | $                           | 103,166    |                        | $          | 110,904 |   |

 

A summary of the activity in our reserves for estimated slow moving,excess, obsolete and otherwise impaired inventory is presented below (inthousands):

 
| ** **                             | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|----------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                             | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1,  2006  through  November  3, 2006** | ** ** |
| Balance, beginning of period           |       | $                                            | 7,826      |                                         | $          | 918 |   | $ | — |   | $ | 7,397 |   |
| Acquired through business acquisitions |       | —                                       |       | 3,867                                        |       | — |   | — |   |
| Provision charged to cost of sales     |       | 8,637                                        |       | 3,580                                        |       | 957 |   | 7,563 |   |
| Write-offs                             |       | (3,724                                       | )          | (539                                         | )          | (39 | ) | (2,651 | ) |
| Balance, end of period                 |       | $                                            | 12,739     |                                         | $          | 7,826 |   | $ | 918 |   | $ | 12,309 |   |

 

The write-offs to the reserve wereprincipally related to the disposition of fully reserved inventory.  Reserves existing at the date of the PriorTransaction were netted against the related inventory as part of the PriorTransaction purchase accounting.

 

**5.****                                      PROPERTYAND EQUIPMENT, NET**

 

Property and equipment consists of the following (in thousands):

 
| ** **                                       | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** | **Depreciable lives  (years)** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-------------------------------------|------------|
| Land                                             |       | $                           | 1,442      |                        | $          | 1,713                               |       | Indefinite |   |
| Buildings and improvements                       |       | 21,179                      |       | 19,788                      |       | 5 to 25                             |       |
| Equipment                                        |       | 54,943                      |       | 45,526                      |       | 3 to 8                              |       |
| Software                                         |       | 13,974                      |       | 11,714                      |       | 3 to 5                              |       |
| Furniture and fixtures                           |       | 7,647                       |       | 7,115                       |       | 3 to 10                             |       |
| Surgical implant instrumentation                 |       | 13,662                      |       | 9,800                       |       | 5                                   |       |
| Construction in progress                         |       | 15,432                      |       | 6,483                       |       | n/a                                 |       |
|                                             |       | 128,279                     |       | 102,139                     |       |                                |       |
| Less - accumulated depreciation and amortization |       | (42,017                     | )          | (20,494                     | )          |                                |       |
| Property and equipment, net                      |       | $                           | 86,262     |                        | $          | 81,645                              |       |   |   |

 

Depreciation and amortization expense relating to property andequipment was approximately $23.6 million, $14.7 million and $2.4 million forthe Successor years ended December 31, 2008 and 2007 and the period November 4,2006 through December 31, 2006, respectively.  Depreciation expense was $8.8 million for thePredecessor period January 1, 2006 through November 3, 2006.  Depreciation expense includes amountsassociated with surgical implant instruments that we provide to surgeons, freeof charge, for use while implanting our products, and is reported as a selling,general and administrative expense in the amounts of $2.9 million, $2.5million, and $0.4 million for the Successor years ended December 31, 2008and 2007 and the period from November 4, 2006 through December 31,2006, respectively, and $1.8 million for the Predecessor period from January 1,2006 through November 3, 2006.  Wealso capitalize electrotherapy devices that we rent to patients and record therelated depreciation expense in cost of sales.

 

80

----

Table of Contents

 

**6.****                                      GOODWILLAND INTANGIBLE ASSETS**

 

A summary of the activity in goodwill is presented below (inthousands):

 

| ** **                      | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Balance, beginning of period    |       | $                                            | 1,201,282  |                                         | $          | 475,722 |   |
| Tax Adjustments                 |       | (18,118                                      | )          | 4,178                                        |       |
| Prior Transaction               |       | —                                       |       | 8,303                                        |       |
| Acquisition of Cefar            |       | (73                                          | )          | 3,863                                        |       |
| Acquisition of IOMED            |       | 579                                          |       | 8,676                                        |       |
| Acquisition of Saunders         |       | —                                       |       | 13,537                                       |       |
| Acquisition of DJO Opco         |       | 12,780                                       |       | 679,104                                      |       |
| Acquisition of other businesses |       | —                                       |       | 2,446                                        |       |
| Foreign currency translation    |       | (5,737                                       | )          | 5,453                                        |       |
| Other                           |       | 853                                          |       | —                                       |       |
| Balance, end of period          |       | $                                            | 1,191,566  |                                         | $          | 1,201,282 |   |

 

For the year ended December 31, 2008, we recordedapproximately $12.8 million related to the DJO Opco acquisition to reflectchanges in our preliminary estimates of approximately $8.1 million of deferredtax assets and liabilities assumed, including approximately $6.0 million forMedicare reimbursement claims.  The fairvalues of the assets acquired and the liabilities assumed were estimated inaccordance with SFAS 141. Goodwill represents the excess of the purchaseprice over the fair value of tangible and identifiable intangible assetsacquired and liabilities assumed. Additionally, we reduced goodwill by $18.1 million related to varioustax adjustments (refer to Note 12).

 

For the year ended December 31,2007, we recorded approximately $679.1 million, $8.7 million and $13.5 millionof goodwill associated with the acquisition of DJO Opco, IOMED and Saunders,respectively. We also completed the acquisitions of various other businessesduring the year which resulted in the recognition of approximately $2.4 millionof goodwill in the aggregate.

 

Duringthe fourth quarter 2008, we performed an impairment test of our goodwilland indefinite lived intangible assets in accordance with SFAS 142 we determined that the fair value of ourChattanooga Group trade name was less than the carrying amount, resulting in anapproximate $10.1 million impairment charge within the consolidated statementof operations for the year ended December 31, 2008.  In addition, we determined that the EncoreMedical trade name was abandoned in the fourth quarter of 2008.  As a result, we recorded a $12.3 millionimpairment charge within the consolidated statement of operations for the yearended December 31, 2008.

 

Identifiable intangible assets consisted of the following as of December 31, 2008 (in thousands):

 
| ** **                           | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Intangibles,  Net** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|-----------------------|------------|
| Amortizable intangible assets:       |       |                        |       |                          |       |                  |       |
| Technology-based                     |       | $                           | 458,612    |                          | $          | (56,501               | )          | $ | 402,111 |   |
| Customer-based                       |       | 478,387                     |       | (57,537                       | )          | 420,850               |       |
|                                 |       | $                           | 936,999    |                          | $          | (114,038              | )          | 822,961 |   |
| Indefinite-lived intangible assets:  |       |                        |       |                          |       |                  |       |
| Trademarks                           |       |                        |       |                          |       | 435,267               |       |
| Foreign currency translation         |       |                        |       |                          |       | 2,244                 |       |
| Total identifiable intangible assets |       |                        |       |                          |       | $                     | 1,260,472  |   |

 

81

Table of Contents

 

Identifiable intangible assets consisted of the following as of December 31, 2007 (in thousands):

 
| ** **                           | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Intangibles,  Net** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|-----------------------|------------|
| Amortizable intangible assets:       |       |                            |       |                          |       |                  |       |
| Technology-based                     |       | $                               | 457,463    |                          | $          | (18,484               | )          | $ | 438,979 |   |
| Customer-based                       |       | 477,942                         |       | (19,047                       | )          | 458,895               |       |
|                                 |       | $                               | 935,405    |                          | $          | (37,531               | )          | 897,874 |   |
| Indefinite-lived intangible assets:  |       |                            |       |                          |       |                  |       |
| Trademarks                           |       |                            |       |                          |       | 457,686               |       |
| Foreign currency translation         |       |                            |       |                          |       | 4,801                 |       |
| Total identifiable intangible assets |       |                            |       |                          |       | $                     | 1,360,361  |   |

 

Our amortizable intangible assets will continue to be amortized over their useful lives of 10 and 9 years on a weighted average basis for Technology and Customer based intangibles, respectively.

 

Our estimated amortization expense related to acquired intangible assets for the next five years and thereafter is as follows (in thousands):

 
| **Year Ending December 31,** |   |    |   |   |
|---------------------------------------------|--------|---------|--------|--------|
| 2009                                        |   | $       | 76,094 |   |
| 2010                                        |   | 75,155  |   |
| 2011                                        |   | 73,788  |   |
| 2012                                        |   | 72,387  |   |
| 2013                                        |   | 67,474  |   |
| Thereafter                                  |   | 458,063 |   |

 

At December 31, 2008 and 2007, our goodwill and intangible assetsare allocated by segment as follows (in thousands):

 
| **2008**                             | ** ** | **Goodwill** | ** ** | **Intangibles, Net** | ** ** |
|--------------------------------------|------------|--------------|------------|---------------------------|------------|
| Domestic Rehabilitation Segment      |       | $            | 1,073,284  |                      | $          | 1,202,329 |   |
| International Rehabilitation Segment |       | 70,876       |       | 31,600                    |       |
| Surgical Implant Segment             |       | 47,406       |       | 26,543                    |       |
| Total                                |       | $            | 1,191,566  |                      | $          | 1,260,472 |   |
|                                 |       |         |       |                      |       |
| **2007**                             | ** ** | **Goodwill** | ** ** | **Intangibles,  Net**     | ** ** |
| Domestic Rehabilitation Segment      |       | $            | 1,084,982  |                      | $          | 1,294,765 |   |
| International Rehabilitation Segment |       | 68,894       |       | 36,170                    |       |
| Surgical Implant Segment             |       | 47,406       |       | 29,426                    |       |
| Total                                |       | $            | 1,201,282  |                      | $          | 1,360,361 |   |

 

82

----

Table of Contents

 

**7.****                                      OTHERCURRENT LIABILITIES**

 

Other current liabilities consist of the following (inthousands):

 
| ** **                             | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Wages and related expenses             |       | $                           | 21,695     |                        | $          | 31,232 |   |
| Commissions and royalties              |       | 13,799                      |       | 13,114                      |       |
| Taxes                                  |       | 4,943                       |       | 6,119                       |       |
| Restructuring costs (see Note 13) |       | 1,742                       |       | 9,563                       |       |
| Professional fees                      |       | 2,453                       |       | 6,693                       |       |
| Rebates                                |       | 4,812                       |       | 4,328                       |       |
| Accrued ERP costs                      |       | 6,763                       |       | —                      |       |
| Interest rate swap derivative          |       | 13,272                      |       | —                      |       |
| Reimbursement claims                   |       | 6,012                       |       | —                      |       |
| Other accrued liabilities              |       | 28,910                      |       | 22,587                      |       |
|                                   |       | $                           | 104,401    |                        | $          | 93,636 |   |

** **

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

** **

Long-term debt (including capital lease obligations) at December 31,2008 and 2007 consists of the following (in thousands):

 
| ** **                                                                                                        | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan under Senior Secured Credit Facility, net  of a 1.2% discount ($10.9 million at December 31, 2008) |       | $                           | 1,043,404  |                        | $          | 1,052,514 |   |
| Revolving loans outstanding under Senior Secured  Credit Facility                                                 |       | 24,000                      |       | —                      |       |
| 10.875% Senior notes                                                                                              |       | 575,000                     |       | 575,000                     |       |
| 11.75% Senior subordinated notes                                                                                  |       | 200,000                     |       | 200,000                     |       |
| Loans and revolving credit facilities at various  European Banks                                                  |       | 891                         |       | 4,239                       |       |
| Capital lease obligations and other                                                                               |       | 298                         |       | 1,054                       |       |
|                                                                                                              |       | 1,843,593                   |       | 1,832,807                   |       |
| Less — current portion                                                                                       |       | (11,549                     | )          | (14,209                     | )          |
| Long-term debt and capital leases, net of current  portion                                                        |       | $                           | 1,832,044  |                        | $          | 1,818,598 |   |

 

*SeniorSecured Credit Facility*

 

On November 20, 2007, in connection with the DJOMerger, DJOFL and DJO Holdings LLC (“Holdings”) entered into the SeniorSecured Credit Facility. The Senior Secured Credit Facility consists of a sixand a half-year $1,065.0 million term loan facility and a six-year$100.0 million revolving credit facility. We issued the term loan facilityof the Senior Secured Credit Facility at a 1.2% discount, resulting in netproceeds of $1,052.4 million. The $12.6 million discount is beingamortized as additional interest expense over the term of the term loanfacility. As of December 31, 2008, $24.0 million is outstanding related toour revolving credit facility.

 

*Interest Rate and Fees.*  Borrowings under the Senior Secured CreditFacility bear interest at a rate equal to an applicable margin plus, at ouroption, either (a) a base rate determined by reference to the higher of (1) theprime rate of Credit Suisse 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 forrequired reserves. The initial applicable margin for borrowings under the termloan facility and the revolving credit facility is 2.00% with respect to baserate borrowings and 3.00% with respect to Eurodollar borrowings. The applicablemargin for borrowings under the term loan facility and the revolving creditfacility may be reduced subject to us attaining certain leverage ratios.

 

On November 20, 2007, we entered into an interestrate swap agreement for a notional amount of $515.0 million in an effortto hedge our exposure to fluctuating interest rates related to a portion of ourSenior Secured Credit Facility. The swap agreement amortizes through a date in2009. As of December 31, 2008, the remaining notional amount of the swapwas $470.0 million. As of December 31, 2008, our weighted average interestrate for all borrowings under the Senior Secured Credit Facility was 3.91%.

 

83

----

Table of Contents

 

In February 2009, weentered into two interest rate swap agreements. One agreement is for a notional amount of $550.0 million with a term of February of2009 through December 2009.  Thesecond agreement is for a notional amount of $750.0 million with a term of January 2010through December 2010.  Under theseagreements we have LIBOR fixed rates of 1.04% and 1.88%, respectively.

 

In addition to paying interest on outstandingprincipal under the Senior Secured Credit Facility, we are required to pay acommitment fee to the lenders under the revolving credit facility with respectto the unutilized commitments thereunder. The initial commitment fee rate is0.50% per annum. The commitment fee rate may be reduced subject to us attainingcertain leverage ratios. We must also pay customary letter of credit fees.

 

*Principal Payments.*  We are required to pay annual payments inequal quarterly installments on the loans under the term loan facility in anamount equal to 1.00% of the funded total principal amount during the first sixyears and three months following the closing of the Senior Secured CreditFacility, with any remaining amount payable at maturity. Principal amountsoutstanding under the revolving credit facility are due and payable in full atmaturity.

 

*Prepayments.*  The Senior Secured Credit Facility requiresus to prepay outstanding term loans, subject to certain exceptions, with (1) 50%(which percentage can be reduced to 25% or 0% upon our attaining certainleverage ratios) of our annual excess cash flow, as defined; (2) 100% of thenet cash proceeds above an annual amount to be agreed from non-ordinary courseasset sales (including insurance and condemnation proceeds) by DJOFL and itsrestricted subsidiaries, subject to exceptions to be agreed upon, including a100% reinvestment right if reinvested or committed to reinvest within15 months of such sale or disposition so long as reinvestment is completedwithin 180 days thereafter; and (3) 100% of the net cash proceedsfrom issuances or incurrences of debt by DJOFL and its restricted subsidiaries,other than proceeds from debt permitted to be incurred under the Senior SecuredCredit Agreement. The foregoing mandatory prepayments will be applied to theterm loan facilities in direct order of maturity. We may voluntarily prepayoutstanding loans under the Senior Secured Credit Facility at any time withoutpremium or penalty, provided that voluntary prepayments of Eurodollar loansmade on a date other than the last day of an interest period applicable theretoshall be subject to customary breakage costs.

 

*Guarantee and Security.*  All obligations under the Senior SecuredCredit Facility are unconditionally guaranteed by Holdings and each existingand future direct and indirect wholly-owned domestic subsidiary of DJOFL otherthan immaterial subsidiaries, unrestricted subsidiaries and subsidiaries thatare precluded by law or regulation from guaranteeing the obligations(collectively, the “Guarantors”).

 

All obligations under the Senior Secured CreditFacility, and the guarantees of those obligations, are secured by pledges of100% of the capital stock of DJOFL, 100% of the capital stock of each whollyowned domestic subsidiary and 65% of the capital stock of each wholly ownedforeign subsidiary that is, in each case, directly owned by DJOFL or one of theGuarantors; and a security interest in, and mortgages on, substantially alltangible and intangible assets of Holdings, DJOFL and each Guarantor.

 

*Certain Covenants and Events ofDefault.*  The SeniorSecured Credit Facility contains a number of covenants that, among otherthings, restrict, subject to certain exceptions, our and our subsidiaries’ability to:

 

·                  incur additionalindebtedness;

 

·                  create liens onassets;

 

·                  change fiscalyears;

 

·                  enter into saleand leaseback transactions;

 

·                  engage inmergers or consolidations;

 

·                  sell assets;

 

·                  pay dividendsand other restricted payments;

 

·                  makeinvestments, loans or advances;

 

·                  repaysubordinated indebtedness;

 

·                  make certainacquisitions;

 

·                  engage incertain transactions with affiliates;

 

·                  restrict theability of restricted subsidiaries that are not Guarantors to pay dividends ormake distributions;

 

84

----

Table ofContents

 

·                  amend materialagreements governing our subordinated indebtedness; and

 

·                  change our linesof business.

 

In addition, the Senior Secured Credit Facilityrequires us to maintain a declining maximum senior secured leverage ratio of4.75:1 as of the twelve months ended December 31, 2008 and stepping downover time to 3.25:1 by the end of 2011. The Senior Secured Credit Facility alsocontains certain customary affirmative covenants and events of default. Ourmaximum senior secured leverage ratio was within the covenant level as of December 31,2008.

 

*10.875%Senior Notes Payable*

 

On November 20, 2007, DJOFL and Finco (collectively,the “Issuers”) issued $575.0 million aggregate principal amount of 10.875%Senior Notes under an agreement dated as of November 20, 2007 (the “10.875%Indenture”) among the Issuers, the guarantors party thereto and The Bank of NewYork Mellon (formerly known as The Bank of New York), as trustee. On July 2,2008, our amended registration statement, filed in June 2008 on Form S-4with the Securities and Exchange Commission (the “Commission”) relating to anoffer to exchange these privately issued 10.875% Notes, for registered 10.875%Notes was declared effective. The exchange offer was completed July 31,2008.

 

The 10.875% Notes require semi-annual interestpayments of approximately $31.3 million each May 15 and November 15and are due November 15, 2014.  Themarket value of the 10.875% Notes was approximately $402.5 million as of December 31,2008 and was determined using trading prices for the 10.875% Notes on or nearthat date. We believe the trading prices reflect certain differences betweenprevailing market terms and conditions and the actual terms of our 10.875%Notes.

 

*Optional Redemption.*  Under the 10.875% Indenture, prior to November 15,2011, the Issuers have the option to redeem some or all of the 10.875% Notesfor cash at a redemption price equal to 100% of the then outstanding principalbalance plus an applicable make-whole premium plus accrued and unpaid interest.Beginning on November 15, 2011, the Issuers may redeem some or all of the10.875% Notes at a redemption price of 105.438% of the then outstandingprincipal balance plus accrued and unpaid interest. The redemption pricedecreases to 102.719% and 100% of the then outstanding principal balance at November 2012and November 2013, respectively. Additionally, from time to time, before November 15,2010, the Issuers may redeem up to 35% of the 10.875% Notes at a redemptionprice equal to 110.875% of the principal amount then outstanding, in each case,with proceeds we raise, or a direct or indirect parent company raises, incertain offerings of equity of DJOFL or its direct or indirect parentcompanies, as long as at least 65% of the aggregate principal amount of thenotes issued remains outstanding.

 

*Change of Control.*  Upon the occurrence of a change of control,unless DJOFL has previously sent or concurrently sends a notice exercising itsoptional redemption rights with respect to all of the then-outstanding 10.875%Notes, DJOFL will be required to make an offer to repurchase all of thethen-outstanding 10.875% Notes at 101% of their principal amount, plus accruedand unpaid interest.

 

*Covenants.*  The 10.875% Indenture contains covenantslimiting, among other things, our and our restricted subsidiaries’ ability toincur additional indebtedness or issue certain preferred and convertibleshares, pay dividends on, redeem, repurchase or make distributions in respectof the capital stock of DJO or make other restricted payments, make certaininvestments, sell certain assets, create liens on certain assets to securedebt, consolidate, merge, sell or otherwise dispose of all or substantially allof our assets, enter into certain transactions with affiliates, and designateour subsidiaries as unrestricted subsidiaries. As of December 31, 2008, wewere in compliance with all applicable covenants.

 

*11.75%Senior Subordinated Notes Payable*

 

The Issuers issued $200.0 million aggregateprincipal amount of 11.75% Senior Subordinated Notes in November 2006 (the“11.75% Notes”). The 11.75% Notes require semi-annual interest payments ofapproximately $11.8 million each May 15 and November 15 and aredue November 15, 2014.

 

The market value of the 11.75% Notes was approximately$132.0 million as of December 31, 2008 and was determined usingtrading prices for the 11.75% Notes on or near that date. We believe thetrading prices reflect certain differences between prevailing market terms andconditions and the actual terms of our 11.75% Notes.

 

85

----

Table of Contents

 

The 11.75% Notescontain similar provisions as the 10.875% Notes with respect to change ofcontrol and covenant requirements. Under the Indenture governing the 11.75%Notes (the “11.75% Indenture”), prior to November 15, 2010, the Issuershave the option to redeem some or all of the 11.75% Notes for cash at aredemption price equal to 100% of the then outstanding principal balance plusan applicable make-whole premium plus accrued and unpaid interest. Beginning onNovember 15, 2010, the Issuers may redeem some or all of the 11.75% Notesat a redemption price of 105.875% of the then outstanding principal balanceplus accrued and unpaid interest on the 11.75% Notes. The redemption pricedecreases to 102.938% and 100% of the then outstanding principal balance at November 2011and November 2012, respectively. Additionally, from time to time, before November 15,2009, the Issuers may redeem up to 35% of the 11.75% Notes at a redemptionprice equal to 111.75% of the principal amount then outstanding, in each case,with proceeds we raise, or a direct or indirect parent company raises, incertain offerings of equity of DJOFL or its direct or indirect parentcompanies, as long as at least 65% of the aggregate principal amount of thenotes issued remains outstanding.

 

Our ability to continue to meet the covenants relatedto our indebtedness specified above in future periods will depend, in part, onevents beyond our control, and we may not continue to meet those ratios. Abreach of any of these covenants in the future could result in a default underthe Senior Secured Credit Facility, the 11.75% Indenture and the 10.875%Indenture (collectively, the “Indentures”), at which time the lenders couldelect to declare all amounts outstanding under the Senior Secured CreditFacility to be immediately due and payable. Any such acceleration would alsoresult in a default under the Indentures.

 

At December 31,2008, the aggregate amounts of annual principal maturities of long-term debtand capital leases for the next five years and thereafter is as follows (inthousands):

 

| **Years Ending December 31,** |   |      |   |   |
|----------------------------------------------|--------|-----------|--------|--------|
| 2009                                         |   | $         | 11,549 |   |
| 2010                                         |   | 10,828    |   |
| 2011                                         |   | 10,729    |   |
| 2012                                         |   | 10,677    |   |
| 2013                                         |   | 34,657    |   |
| Thereafter                                   |   | 1,765,153 |   |
| Total                                        |   | 1,843,593 |   |

 

*DebtIssue Costs*

 

We incurred $30.7 million, $24.5 million, and$10.2 million of debt issue costs in connection with the Senior SecuredCredit Facility, the 10.875% Notes, and the 11.75% Notes, respectively. Thesecosts have been capitalized and are included in other non-current assets in theconsolidated balance sheets at December 31, 2008 and 2007. Debt issuecosts are being amortized over the terms of the respective debt instrumentsthrough November 2014.

 

**9.****                                      MEMBERSHIPEQUITY**

 

## **In connection with the Prior Transaction, shares ofReAble’s common stock were adjusted such that every 62.8 shares of common stockoutstanding prior to the Prior Transaction were revalued as one share of ReAble’scommon stock.  Subsequently, on November 8, 2006, following theclosing of the Prior Transaction, we effected a 25 for one stock split, whichresulted in every one share of ReAble’s common stock becoming 25 shares ofReAble’s common stock.  The consolidated financial statements have beenretroactively adjusted to reflect these share adjustments for all periodspresented.**

## ** **

In connection with the Prior Transaction, an affiliate of Blackstoneacquired all equity interests of ReAble for $357.0 million (see Note 2). Simultaneously with this transaction, ReAble, through Holdings, acquired allMembership Equity of DJOFL.  Options to acquire shares of common stock ofReAble owned by the then current executive officers that had not been exercisedat or prior to the effective time of the Prior Transaction continued to remainas outstanding and continued as options to purchase 805,150 shares of ReAble’scommon stock (the “Prior Transaction Management Rollover Options”).  Thefair value of these options approximated $7.2 million and was recorded as acomponent of the cost of the acquisition of ReAble.

 

On November 7, 2006, we acquired all of the issued and outstandingshares of Cefar for a total of $27.1 million (see Note 2). Of the totalpurchase price, $9.5 million was paid through the issuance of shares of ourcommon stock.  The fair value of the common stock issued was determined tobe $16.46 per share based on the per share price used in the Prior Transaction.

 

86

----

Table ofContents

 

In connection with the DJO Merger, an affiliate of Blackstone made acash equity contribution of $434.6 million. Additionally, we repurchased 264,525 of the Prior Transaction ManagementRollover Options from certain ReAble executives who were terminated inconnection with the DJO Merger at a per share price of $16.46.  At theclosing of the DJO Merger, these former ReAble executives also forfeited allunvested stock options previously issued to them under the 2006 Stock IncentivePlan at the closing of the DJO Merger.  Furthermore, certain members ofDJO Opco management chose to rollover certain of their DJO Opco options whichwere exchanged into options to purchase 1,912,577 shares under the 2007Incentive Stock Plan on a tax-deferred basis (the “DJO Management RolloverOptions”).  The fair value of these options approximated $15.2 million andwas recorded as a component of the cost of the DJO Merger.  Also, on November 20, 2007, we grantedan executive officer 24,300 shares (net of taxes) of restricted stock under the2007 Incentive Stock Plan, which were subsequently cancelled during the thirdquarter of 2008 as a result of his Separation of Employment Agreement (See Note10 for further information).

 

**10.****                               STOCKOPTION PLANS AND STOCK-BASED COMPENSATION**

 

*2006Stock Incentive Plan*

 

In connection with the Prior Transaction, the compensation committee ofthe board of directors of ReAble adopted the 2006 Stock Incentive Plan (the “2006Plan”) effective November 3, 2006. The 2006 Plan provided for the grant of stock options and otherstock-based awards to key employees, directors and consultants, includingexecutive officers.  In connection withthe DJO Merger and change in management, we terminated the 2006 Plan and as ofthat date, outstanding options to purchase our stock originally issued underthe 2006 Plan are now governed by the terms of the DJO Incorporated 2007Incentive Stock Plan (“the 2007 Plan”). Furthermore, former ReAble executives forfeited all stock optionspreviously issued under the 2006 Plan.

 

*Summaryof Plans — Predecessor*

 

Before the Prior Transaction, ReAble had a number of stock optionplans.  All stock option plans in effectat the date of the Prior Transaction were terminated.  With the exception of 805,150 PriorTransaction Management Rollover Options held by former ReAble executiveofficers, outstanding vested options to purchase common stock of ReAble werecancelled in exchange for cash in the amount equal to the excess of $16.46 overthe exercise price per share multiplied by the number of shares of commonstock.  We recorded a charge of $7.5million for the Predecessor period January 1, 2006 through November 3,2006 related to the accelerated vesting of these shares upon the change incontrol on November 3, 2006.  Duringthe fourth quarter of 2007, in connection with the DJO Merger, we repurchased264,525 of the Prior Transaction Management Rollover Options at a per shareprice of $16.46.  The remaining PriorTransaction Management Rollover Options are fully vested and continue asoptions to purchase our common stock, have a weighted-average exercise price of$12.22, an average contractual term of 7.6 years, and an intrinsic value ofapproximately $2.2 million.

 

Non-employee stock compensation expense was approximately $0.2 millionfor the Predecessor period January 1, 2006 through November 3, 2006,which is included in selling, general and administrative expenses in theconsolidated statements of operations for the respective period.

 

*2007Incentive Stock Plan*

 

In connection with the DJO Merger, we terminated the2006 Plan and adopted the 2007 Plan, which provides for the grant of stockoptions and other stock-based awards to key employees, directors andconsultants. Outstanding options to purchase ReAble common stock originallyissued under the 2006 Plan are now governed by the terms of the 2007 Plan. Thetotal number of shares of common stock of DJO that may be issued under the 2007Plan is 7,500,000 shares, subject to adjustment in certain events. Optionsissued under the 2007 Plan can be either incentive stock options ornon-qualified stock options. The exercise price of stock options granted underthe 2007 Plan will not be less than 100% of the fair market value of the underlyingshares on the date of grant, as determined under the 2007 Plan, and will expireno more than ten years from the date of grant.

 

*EmployeeStock Options*

 

During the year ended December 31, 2008 wegranted 4,490,414 stock options under the 2007 Plan to our executive officers,senior management, and certain other employees. DJO adopted a form ofnon-statutory stock option agreement (the “DJO Form Option Agreement”) foremployee stock option awards under the 2007 Plan. Under the DJO Form OptionAgreement, one-third of stock options will vest over a specified period of time(typically five years) contingent solely upon the awardees’ continuedemployment with us (“Time-Based Tranche”). Another one-third of stock optionswill vest over a specified performance period (typically four to five years)from the date of grant upon the achievement of certain pre-determinedperformance targets based on Adjusted EBITDA and free cash flow on an annualbasis (“Performance-Based Tranche”), as defined in the DJO Form OptionAgreement, while the final one-third vests based upon achieving enhancedpre-determined performance targets based on Adjusted EBITDA and free cash flow(“Enhanced Performance-Based Tranche”). The DJO Form Option Agreementincludes certain forfeiture provisions upon an awardees’ separation fromservice with us.

 

87

----

Table ofContents

 

In addition, in an effort to align our objectives followingthe DJO Merger with vesting requirements for previously issued stock optionsunder the 2006 Plan, we cancelled all stock options originally granted underthe 2006 Plan, except for 63,806 vested Time-Based Tranche options held by 72employees, and concurrently issued the same or a greater number of options toeach 2006 Plan participant under the 2007 Plan (the “Replacement Options”).These Replacement Options were valued in accordance with the modificationprovisions pursuant to SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”),whereby the fair value of the options immediately prior to the date ofmodification is compared to the fair value of the options at the date ofmodification, with the incremental fair value, if any, being recognized as futurecompensation expense. However, under no circumstances can compensation expensebe reduced to an amount lower than the original fair value at the date ofgrant. Replacement Options have an exercise price of $16.46 per share, vestratably over a predefined period as further described below, and have acontractual term of ten years from the date of modification. The assumptionsutilized to determine fair value for Replacement Options were the same as thoseused to compute the fair value of new options granted during the current year.We did not recognize any additional compensation expense for the year ended December 31,2008 as a result of the modification.

 

Both new options granted and Replacement Optionscontain change-in-control provisions that cause the vesting of a portion of thetranches upon the occurrence of a change-in-control, as follows: 1) theoption shares in the Time-Based Tranche will become immediately exercisableupon the occurrence of a change-in-control if the optionee remains in continuousemployment of the Company until the consummation of the change-in-control and2) the option shares of the Performance-Based Tranche and the EnhancedPerformance-Based Tranche for the year in which such change-in-control isconsummated and for any subsequent performance periods will become immediatelyexercisable if the optionee remains in continuous employment of the Companyuntil the consummation of the change-in-control.

 

We record compensation expense for awards with aperformance condition only to the extent deemed probable of achievement, withthe exception of expense related to market-based options originally issuedunder the 2006 Plan which were exchanged for performance based options duringthe first quarter of 2008, which is recognized ratably over the expected termregardless of the probability of achieving the performance conditions. Wereassess at each reporting period whether achievement of the pre-determinedperformance targets based on Adjusted EBITDA and free cash flow is probable forthe options related to the Performance Based Tranche to vest. The Company didnot meet 2008 performance targets and therefore the Performance-Based trancheand Enhanced Performance-Based Tranche options did not vest during 2008.

 

For the Successor years ended December 31, 2008and 2007 and the Period November 4, 2006 through December 31, 2006,we recognized approximately $1.3 million, $1.5 million, and $0.1 million ofnon-cash compensation stock based expense, respectively.  For the Predecessor period January 1,2006 through November 3, 2006, we recognized approximately $10.5 millionof non-cash compensation expense.

 

The fair value of each option award is estimated onthe date of grant, or modification, using the Black-Scholes-Merton optionpricing model for service and performance based awards, and a binomial modelfor market based awards. In estimating fair value for both new options issuedunder the 2007 Plan and Replacement Options, expected volatility was basedcompletely on implied volatility of comparable publicly-traded companies.Expected life assumptions were derived from a review of annual historicalemployee exercise behavior of option grants with similar vesting periods,modified to consider our current status as a privately-owned company. Expectedlife is calculated in two tranches based on the employment level defined asexecutive or employee. The risk-free rate used in calculating fair value ofservice and performance-based stock options for periods within the expectedterm of the option is based on the U.S. Treasury yield bond curve in effect atthe time of grant.

 

88

----

Table ofContents

 

The assumptions used to calculate the fair value ofoptions granted are evaluated and revised, as necessary, to reflect marketconditions and experience. The following table presents the assumptions we usedin calculating the fair value of employee stock options for the Successor yearsended December 31, 2008 and 2007, and the period November 4, 2006through December 31, 2006 and for the Predecessor period January 1,2006 through November 3, 2006:

 
| ** **               | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|--------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **               | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** |
| Expected dividends       |       | 0.0                                          | %          | 0.0                                          | %          | 0.0 | % | 0.0 | % |
| Expected volatility      |       | 27.4% - 60.0                                 | %          | 27.4% - 60.0                                 | %          | 43.7% - 60.0 | % | 61.0 | % |
| Risk-free rate           |       | 2.8% - 4.7                                   | %          | 3.5% - 4.7                                   | %          | 4.7 | % | 4.5% - 4.8 | % |
| Expected term (in years) |       | 4.7 - 7.1                                    |       | 4.7 - 7.1                                    |       | 2.6 - 5.7 |   | 4.5 - 5.6 |   |

 

*Non-EmployeeStock Options*

 

On May 22, 2008, we granted 37,800 stock optionsunder the 2007 Plan to non-employees (“non-employee options”). Thenon-statutory stock option agreement for the non-employees states that theoptions have an exercise price of $16.46 per share, which was equal to 100% ofthe estimated fair market value of the stock and will become effective upon thedefined effective date and expire ten years from that date. A number of sharesequal to 25% of the options granted become vested and exercisable at the end ofeach of the first four years subsequent to the effective date, provided theoptionee is still affiliated with and providing services to the Company. The non-employeeoption agreement does not include any performance requirements on the optionee’spart in order for the options granted to vest.

 

Non-employee options are accounted for in accordancewith the guidance in Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accountingfor Equity Instruments That are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services” (“EITF 96-18”). Inaccordance with EITF 96-18, the fair value of each option will bere-measured at the end of each reporting period until vested, when the finalfair value of the vesting of the option is determined.

 

In estimating fair value for options issued, expectedvolatility was based completely on implied volatility of comparablepublicly-traded companies. A contractual life of ten years was used in place ofthe expected term. The risk-free rate used in calculating the fair value of thenon-employee stock options for periods within the contractual life is based onthe U.S. Treasury yield bond curve in effect at the time of grant.

 

The assumptions used to calculate the fair value ofoptions granted are evaluated and revised, as necessary, to reflect marketconditions and experience. The following table presents the assumptions we usedin calculating the fair value of the non-employee stock options for the yearended December 31, 2008:

 
| ** **                  | ** ** | **Year Ended  December 31, 2008** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| Expected dividends          |       | 0.0                                              | %          |
| Expected volatility         |       | 27.41                                            | %          |
| Risk-free rate              |       | 3.92                                             | %          |
| Contractual term (in years) |       | 10 years                                    |       |

 

We recorded non-cash compensation expense ofapproximately $0.1 million for the year ended December 31, 2008,associated with non-employee stock options issued under the 2007 IncentiveStock Plan.

 

89

----

Table ofContents

 

A summary ofoption activity under the 2007 Plan for the years ended December 31, 2007and 2008 is presented below:

 
| ** **                                                   | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate Intrinsic  Value** | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                   | ** ** | ** **                 | ** ** | ** **                                  | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Outstanding at January 1, 2006                          |       | 3,044,650                  |       | $                                           | 15.34      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Repurchase of Prior Transaction management rollover  options |       | (264,525                   | )          | $                                           | 11.74      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Granted, including Replacement Options                       |       | 252,500                    |       | $                                           | 16.46      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| DJO Management Rollover Options                              |       | 1,912,577                  |       | $                                           | 11.09      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Exercised                                                    |       | —                     |       | —                                      | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Forfeited, including options cancelled                       |       | (1,394,575                 | )          | $                                           | 12.97      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Outstanding at December 31, 2007                        |       | 3,550,627                  |       | $                                           | 12.97      |                                                            | 8.2        |                                | $          | 12,461,487 |   |
| Granted, including Replacement Options                       |       | 4,528,214                  |       | $                                           | 16.46      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Exercised                                                    |       | —                     | ** ** | ** **                                  | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Forfeited, including options cancelled                       |       | (2,003,927                 | )          | $                                           | 16.35      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Outstanding at December 31, 2008                        |       | 6,074,914                  |       | $                                           | 14.46      |                                                            | 8.18       |                                | $          | 12,221,730 |   |
| Exercisable at December 31, 2008                        |       | 2,683,942                  |       | $                                           | 11.93      |                                                            | 7.13       |                                | $          | 12,221,730 |   |

 

For the Successor years ended December 31, 2008and 2007 and the Period November 4, 2006 through December 31, 2006,and the Predecessor period January 1, 2006 through December 31, 2006,the weighted-average grant-date fair value of stock options granted was $5.36,$8.09, $8.96, and $9.25, respectively.

 

Total unrecognized stock-based compensation expense,related to nonvested stock options under the 2007 Plan, net of expectedforfeitures, was $11.3 million as of December 31, 2008. We anticipate thisexpense to be recognized over a weighted-average period of approximatelyfour years. However, compensation expense associated withperformance-based options under the 2007 Plan, with the exception of those thatwere issued in connection with a modification, will be recognized only to theextent achievement of certain performance targets are deemed probable.

 

*RestrictedStock*

 

On March 13, 2007, we granted 15,189 shares ofrestricted stock options to an executive officer pursuant to the terms of arestricted stock agreement under the 2006 Plan. The shares were subject to avesting schedule over a period of three years with the final vesting on November 3,2009. On November 20, 2007, we granted 24,300 shares of restricted stockawards to the same executive officer pursuant to the terms of a restrictedstock agreement under the 2007 Incentive Stock Plan, which would vest on January 1,2009. On August 14, 2008, we entered into a Separation of EmploymentAgreement and General Release with this executive officer which waived any andall of his rights to any stock option or equity grants, including but notlimited to restricted stock (refer to Note 12 for more detail). As such, allrestricted stock options were cancelled during the third quarter and wereversed approximately $244,000 of previously recorded compensation expenserelated to the restricted stock.

 

**11.**                               SEGMENT AND GEOGRAPHIC INFORMATION

** **

We classify our operations, pursuant to SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” intothree operating segments further described below.

 

***Domestic Rehabilitation Segment***

 

Our Domestic Rehabilitation Segment, which generatesmost of its revenues in the United States, is divided into four mainbusinesses:

 

·                  *Bracing and Supports. *Our Bracing and Supports business unit offers our DonJoy,ProCare and Aircast products, including rigid knee bracing, orthopedic softgoods, cold therapy products, and vascular systems.

 

·                  *Empi. *OurEmpi business unit offers products in the category of home electrotherapy,iontophoresis, and home traction.

 

·                  *Regeneration. *OurRegeneration business unit consists of our bone growth stimulation products.

 

90

----

Table of Contents

 

·                  *Chattanooga. *OurChattanooga Group business unit offers products in the clinical rehabilitationmarket in the category of clinical electrotherapy devices, clinical tractiondevices, and other clinical products and supplies such as treatment tables,continuous passive motion (“CPM”) devices and dry heat therapy.

 

***International Rehabilitation Segment***

 

Our International Rehabilitation Segment, whichgenerates most of its revenues in Europe, is divided into three mainbusinesses:

 

·                  *Bracing and Supports. *The international sales of our Bracing and Supports businessunit offers DonJoy, ProCare and Aircast products, including rigid knee bracing,orthopedic soft goods, cold therapy products, and vascular systems.

 

·                  *Ormed.DJO. *OurOrmed.DJO business provides bracing, CPM, electrotherapy and other productsprimarily in Germany.

 

·                  *Cefar-Compex. *OurCefar-Compex business provides electrotherapy products for medical and consumermarkets and other physical therapy and rehabilitation products primarily inEurope.

 

We sell our Domestic and International Rehabilitation Segment productsthrough a variety of distribution channels. We sell our home therapy products to wholesale customers and directly topatients.  We recognize wholesale revenuewhen we ship our products to our wholesale customers.  We recognize home therapy retail revenue,both rental and purchase, when our product has been dispensed to the patientand the patient’s insurance has been verified. We recognize revenue for product shipped directly to the patient at thetime of shipment.  For retail productsthat are sold from our inventories consigned at clinic locations, we recognizerevenue when we receive notice that the device has been prescribed anddispensed to the patient and the insurance has been verified orpreauthorization from the insurance company has been obtained, when required.

 

We sell our DonJoy products through a network of independent salesrepresentatives.  We record revenues fromsales made by sales representatives, who are paid commissions, when the productis shipped to the customer.  For certainof our other products, we sell directly to the patient and bill a third partypayor, if applicable, on behalf of the patient.

 

We sell our ProCare, Aircast and clinical rehabilitation products todistributors.  We record revenue at thetime product is shipped to the distributor. Distributors take title to the products, assume credit and productobsolescence risks, must pay within specified periods regardless of when theysell or use the products and have no price protection except for distributorswho participate in our rebate program.

 

We sell our products to customers outside the United States throughwholly owned subsidiaries or independent distributors.  We record revenue from sales to distributorsat the time product is shipped to the distributor.  Our international distributors take title tothe products, assume credit and product obsolescence risks, must pay withinspecified periods regardless of when they sell the products and have no priceprotection.  We record revenue from salesmade by our wholly owned subsidiaries at the time product is shipped to thecustomer.

 

***Surgical Implant Segment***

 

Our Surgical Implant Segment develops, manufacturesand markets a wide variety of knee, hip and shoulder implant products thatserve the orthopedic reconstructive joint implant market. We currently marketand sell our Surgical Implant Segment products to hospitals and orthopedicsurgeons through independent commissioned sales representatives in the UnitedStates and through independent distributors outside the United States.

 

We sell our Surgical Implant Segment products through a network ofindependent sales representatives in the United States, as well as distributorsoutside the United States.  We recordrevenues from sales made by sales representatives, who are paid commissions atthe time the product is used in a surgical procedure (implanted in a patient)and a purchase order is received from the hospital.  We record revenues from sales to customersoutside the United States at the time the product is shipped to thedistributor.  We include amounts billedto customers for freight in revenue.  Ourinternational distributors, who sell the products to their customers, take titleto the products, have no rights of return and assume the risk for credit andobsolescence.  Distributors are obligatedto pay us within specified terms, regardless of when they sell the products. Inaddition, there is no price protection available to distributors.

 

91

----

Table of Contents

 

Information regarding our reportable business segments is presentedbelow (in thousands).  This informationexcludes the impact of certain expenses not allocated to segments, primarilygeneral corporate expenses.   All priorperiods presented have been restated to reflect our current reportablesegments.

 
| ** **                                      | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                      | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4, 2006  through December  31, 2006** | ** ** | **January 1, 2006  through November 3,  2006** | ** ** |
| **Net sales:**                                  |       |                                         |       |                                         |       |   |   |   |   |
| Domestic Rehabilitation Segment                 |       | $                                            | 700,129    |                                         | $          | 331,550 |   | $ | 36,963 |   | $ | 211,474 |   |
| International Rehabilitation Segment            |       | 228,539                                      |       | 113,034                                      |       | 14,626 |   | 49,577 |   |
| Surgical Implant Segment                        |       | 73,429                                       |       | 66,591                                       |       | 7,763 |   | 51,331 |   |
| Intersegment revenues (a)                       |       | (21,903                                      | )          | (19,041                                      | )          | (1,450 | ) | (7,999 | ) |
| Consolidated net sales                          |       | $                                            | 980,194    |                                         | $          | 492,134 |   | $ | 57,902 |   | $ | 304,383 |   |
| ** **                                      |       |                                         |       |                                         |       |   |   |   |   |
| **Gross profit:**                               |       |                                         |       |                                         |       |   |   |   |   |
| Domestic Rehabilitation Segment                 |       | $                                            | 417,574    |                                         | $          | 182,763 |   | $ | 18,841 |   | $ | 114,267 |   |
| International Rehabilitation Segment            |       | 135,427                                      |       | 57,467                                       |       | 6,517 |   | 27,598 |   |
| Surgical Implant Segment                        |       | 54,857                                       |       | 47,037                                       |       | 5,779 |   | 35,212 |   |
| Expenses not allocated to segments/Eliminations |       | (1,744                                       | )          | (997                                         | )          | (22 | ) | 26 |   |
| Consolidated gross profit                       |       | $                                            | 606,114    |                                         | $          | 286,270 |   | $ | 31,115 |   | $ | 177,103 |   |
| ** **                                      |       |                                         |       |                                         |       |   |   |   |   |
| **Operating income:**                           |       |                                         |       |                                         |       |   |   |   |   |
| Domestic Rehabilitation Segment                 |       | $                                            | 66,065     |                                         | $          | (7,540 | ) | $ | (17,713 | ) | $ | 3,310 |   |
| International Rehabilitation Segment            |       | 29,232                                       |       | 1,133                                        |       | (548 | ) | 664 |   |
| Surgical Implant Segment                        |       | 8,217                                        |       | 2,322                                        |       | (12,640 | ) | 5,404 |   |
| Expenses not allocated to segments/Eliminations |       | (68,688                                      | )          | (35,351                                      | )          | (11,246 | ) | (32,176 | ) |
| Consolidated operating income (loss)            |       | $                                            | 34,826     |                                         | $          | (39,436 | ) | $ | (42,147 | ) | $ | (22,798 | ) |

 

----

(a) Includes amounts of $11.5 million, $2.0 million $1.2 million,and $6.1 million for the Successor years ended December 31, 2008 and 2007and Successor period from November 4, 2006 through December 31, 2006and the Predecessor period January 1, 2006, through November 3, 2006,respectively, for intrasegment revenues.

 

The accounting policies of the reportable segments are the same as theaccounting policies of the Company. We allocate resources and evaluate theperformance of segments based on net sales, gross profit, operating income andAdjusted EBITDA as defined.  Moreover, we do notallocate assets to reportable segments because a significant portion of assetsare shared by the segments.

 

## **Geographic Area**

## ** **

Following are our net sales by geographic area (in thousands):

 
| ** **                            | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|---------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                            | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4, 2006  through  December 31,  2006** | ** ** | **January 1, 2006  through November  3, 2006** | ** ** |
| **Net sales:**                        |       |                                         |       |                                         |       |   |   |   |   |
| United States                         |       | $                                            | 742,007    |                                         | $          | 371,077 |   | $ | 42,135 |   | $ | 242,790 |   |
| Germany                               |       | 73,296                                       |       | 47,332                                       |       | 6,740 |   | 31,982 |   |
| Other Europe, Middle East, and Africa |       | 144,760                                      |       | 61,613                                       |       | 7,768 |   | 18,858 |   |
| Asia Pacific                          |       | 12,595                                       |       | 5,435                                        |       | 164 |   | 4,273 |   |
| Other                                 |       | 29,439                                       |       | 25,718                                       |       | 2,545 |   | 14,479 |   |
| Intersegment revenues                 |       | (21,903                                      | )          | (19,041                                      | )          | (1,450 | ) | (7,999 | ) |
|                                  |       | $                                            | 980,194    |                                         | $          | 492,134 |   | $ | 57,902 |   | $ | 304,383 |   |

 

92

----

Table ofContents

 

----

* Net sales are attributed to countries based on location ofcustomer.  For the Successor years ended December 31,2008 and 2007, and the period November 4, 2006 through December 31,2006 and the Predecessor period January 1, 2006 through November 3,2006, we had no individual customer or distributor that accounted for 10% ormore of total annual revenues.

 

**F**ollowing are ourlong-lived assets by geographic area as of December 31, 2008 and 2007 (inthousands):

 
| ** **    | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------|------------|-----------------------------|------------|-----------------------------|------------|
| United States |       | $                           | 2,423,171  |                        | $          | 2,537,968 |   |
| International |       | 167,730                     |       | 172,844                     |       |
|          |       | $                           | 2,590,901  |                        | $          | 2,710,812 |   |

 

**12.**                               INCOME TAXES

 

DJO is the taxpayer in the U.S., while our foreign subsidiaries aresubjected to income tax in the applicable local jurisdictions.  Although DJOFL is not a U.S. taxpayer,pursuant to the provisions of Statement of Financial Accounting Standards No. 109,“Accounting for Income Taxes,” the tax expense of DJO has been pushed down to thestand alone financial statements of DJOFL.

 

The components of losses from continuing operations before income taxesfor the applicable periods consist of the following (in thousands):

 
| ** **         | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|--------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **         | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1,  2006 through  November 3,  2006** | ** ** |
| U.S. operations    |       | $                                            | (152,600   | )                                            | $          | (123,228 | ) | $ | (49,380 | ) | $ | (56,905 | ) |
| Foreign operations |       | 6,792                                        |       | (1,282                                       | )          | (933 | ) | (551 | ) |
|               |       | $                                            | (145,808   | )                                            | $          | (124,510 | ) | $ | (50,313 | ) | $ | (57,456 | ) |

 

The income tax benefit for the applicable periods consists of thefollowing (in thousands):

 
| ** **             | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **             | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** |
| Current income taxes:  |       |                                         |       |                                         |       |   |   |   |   |
| U.S. Federal and State |       | $                                            | (6,103     | )                                            | $          | 1,321 |   | $ | 27 |   | $ | 489 |   |
| Foreign                |       | 3,303                                        |       | 3,397                                        |       | 59 |   | 1,343 |   |
| Deferred income taxes: |       |                                         |       |                                         |       |   |   |   |   |
| U.S. Federal and State |       | (45,195                                      | )          | (43,944                                      | )          | (8,474 | ) | (12,325 | ) |
| Foreign                |       | (1,076                                       | )          | (3,277                                       | )          | (368 | ) | (959 | ) |
|                   |       | $                                            | (49,071    | )                                            | $          | (42,503 | ) | $ | (8,756 | ) | $ | (11,452 | ) |

 

93

----

Table ofContents

 

The difference between the income tax benefit derivedby applying the U.S. Federal statutory income tax rate of 35% to net loss andthe income tax benefit recognized in the consolidated financial statements isas follows (in thousands):

 
| ** **                                                                                              | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                              | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** |
| Benefit derived by applying the Federal statutory  income tax rate to income (loss) before income taxes |       | $                                            | (51,033    | )                                            | $          | (43,579 | ) | $ | (17,609 | ) | $ | (20,110 | ) |
| Add (deduct) the effect of:                                                                             |       |                                         |       |                                         |       |   |   |   |   |
| State tax benefit, net                                                                                  |       | (2,369                                       | )          | (3,211                                       | )          | (816 | ) | (1,343 | ) |
| Nondeductible IPR&D                                                                                 |       | —                                       |       | 1,050                                        |       | 8,820 |   | 1,364 |   |
| Nondeductible transaction costs                                                                         |       | —                                       |       | —                                       |       | 1,426 |   | 4,750 |   |
| SFAS 123(R), related to incentive stock options                                                         |       | 106                                          |       | —                                       |       | — |   | 2,561 |   |
| Change in German tax laws                                                                               |       | —                                       |       | (1,458                                       | )          | — |   | — |   |
| Permanent differences and other, net                                                                    |       | 4,225                                        |       | 4,695                                        |       | (577 | ) | 1,326 |   |
|                                                                                                    |       | $                                            | (49,071    | )                                            | $          | (42,503 | ) | $ | (8,756 | ) | $ | (11,452 | ) |

 

The components of deferred income tax assets andliabilities as of December 31, 2008 and 2007 are as follows (inthousands):

 
| ** **                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:             |       |     |       |     |       |
| Net operating loss carryforwards |       | $        | 118,237    |     | $          | 112,678 |   |
| Inventory reserve                |       | 7,648    |       | 5,671    |       |
| Receivables reserve              |       | 17,449   |       | 15,344   |       |
| Accrued compensation             |       | 1,724    |       | 1,672    |       |
| Accrued expenses                 |       | 9,025    |       | 3,050    |       |
| Interest rate Swap               |       | 5,189    |       | 1,530    |       |
| Transfer pricing                 |       | 2,823    |       | 2,373    |       |
| Other                            |       | 8,922    |       | 63       |       |
| Gross deferred tax assets        |       | 171,017  |       | 142,381  |       |
| Valuation allowance              |       | (7,129   | )          | (16,489  | )          |
| Net deferred tax assets          |       | 163,888  |       | 125,892  |       |
|                             |       |     |       |     |       |
| Deferred tax liabilities:        |       |     |       |     |       |
| Property and equipment           |       | (3,661   | )          | (5,428   | )          |
| Intangible assets                |       | (437,938 | )          | (454,280 | )          |
| Foreign currency translation     |       | (2,222   | )          | (7,648   | )          |
| Repatriation                     |       | (12,504  | )          | (13,755  | )          |
| Other                            |       | (3,027   | )          | (2,441   | )          |
|                             |       | (459,352 | )          | (483,552 | )          |
| Net deferred tax liabilities     |       | $        | (295,464   | )        | $          | (357,660 | ) |

 

As a result of the DJO Merger and the Prior Transaction, we recordedsignificant acquired intangible assets for which no tax basis exists and, assuch, a significant deferred tax liability was recorded under purchaseaccounting.  Taxable temporarydifferences will reverse within the carryforward period for the existingdeferred tax assets.

 

At December 31, 2008, we maintain approximately $441.9 million ofnet operating loss carryforwards in the U.S., which expire over a period of 1to 20 years.  Our European net operatingloss carryforwards of approximately $26.8 million generally are not subject toexpiration dates, unless we trigger certain events.  Included in prepaid expenses and othercurrent assets are $8.4 million and $1.9 million of income tax receivables asof December 31, 2008 and 2007, respectively.

 

94

----

Table ofContents

 

At December 31, 2008 and 2007, we recorded deferred tax assets of$171.0 million and $142.4 million and valuation allowances of $7.1 million and$16.5 million, respectively.   We haverecorded a valuation allowance against European net operating losscarryforwards due to uncertainties regarding our ability to realize thesedeferred tax assets.  The majority of thevaluation allowance was recorded as an adjustment to goodwill as these losscarryforwards were acquired in connection with the Empi, Compex and the PriorTransaction (see Note 2).

 

As a result of the DJO Merger and the Prior Transaction, we no longerintend to permanently reinvest in our foreign operations.  In connection with the Prior Transaction, werecorded deferred tax liabilities of $5.3 million in purchase accounting and adeferred tax benefit of $0.7 million for the period November 4, 2006through December 31, 2006.  Inconnection with the DJO Merger, deferred tax liabilities of $6.4 million wererecorded in purchase accounting.  Werecorded a deferred tax expense of $0.6 million and $0.9 million for the twelvemonths ended December 31, 2008 and 2007, respectively.

 

We andour subsidiaries file income tax returns in the U.S. federal, state and local,and foreign jurisdictions.  With fewexceptions, we are no longer subject to U.S. federal, state and local, ornon-U.S. income tax examinations by tax authorities for years before 2004.  We adopted the provisions of FIN 48 on January 1,2007.  As a result of the implementationof FIN 48, we recognized a $5.9 million increase in liabilities for grossunrecognized tax benefits, which was accounted for as an increase to thebalance of goodwill. A reconciliation of the beginning and ending amount ofgross unrecognized tax benefits for the years ended December 31, 2007 and2008 are as follows:

 
| **(in thousands)**                                       | ** ** | ** ** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** |
| Balance at January 1, 2007                               |       | $          | 6,979      |   |
| Additions based on tax positions related to the current  year |       | 458        |       |
| Additions for tax positions of prior years                    |       | 8,016      |       |
| Additions due to acquisition of businesses                    |       | 1,829      |       |
| Reductions for tax  positions of prior years                  |       | (1,059     | )          |
| Balance at December 31, 2007                             |       | 16,223     |       |
| Additions based on tax positions related to the  current year |       | 1,054      |       |
| Additions for tax positions of prior years                    |       | 2,570      |       |
| Reductions for tax positions of prior years                   |       | (93        | )          |
| Reductions due to lapse  of statue of limitations             |       | (4,187     | )          |
| Reductions for  settlements of tax positions                  |       | (159       | )          |
| Balance at December 31, 2008                             |       | $          | 15,408     |   |

 

To the extent our gross unrecognized tax benefits are recognized in thefuture, a reduction of $2.2 million of federal tax benefit for related stateincome tax deductions would result. Included in the balance at December 31, 2008, is $0.6 million ofgross uncertain tax positions that we anticipate will decrease in the nexttwelve months related to our Compex acquisition.  In addition, we anticipate that $0.3 millionof our currently remaining unrecognized tax positions, each of which areindividually immaterial, may be recognized by December 31, 2009 as aresult of a lapse of the statute of limitations.  Due to the adoption of SFAS 141R on January 1,2009, all unrecognized tax benefits listed above will impact the effective taxrate upon recognition.  We believe thatit is reasonably possible that an increase of $0.4 million in unrecognized taxbenefits related to state exposures may be necessary within the next 12 months.  We recognize interest accrued and penalties relatedto unrecognized tax benefits as a component of income tax expense.  During the Successor year ended December 31,2008, we recognized an increase of $0.4 million in interest and penalties.  During the Successor year ended December 31,2007, we recognized a reduction of $0.7 million in interest and penalties.  We accrued for $1.3 million and $0.9 millionfor the payment of interest and penalties at December 31, 2008 and 2007,respectively.

 

**13.****                               RESTRUCTURING ANDRELATED CHARGES**

 

We have implemented several restructuring andreorganization programs, including workforce reductions and the exit andconsolidation of facilities, related primarily to the integration of businesseswe have acquired. At present, our restructuring efforts are primarily related tothe integration of DJO Opco following the DJO Merger. As of December 31,2008, these restructuring activities are ongoing and additional expenses areexpected to be incurred in future periods.

 

At the time of the DJO Merger, management had begun toassess and formulate plans to restructure the operations of DJO to eliminatecertain duplicative activities, reduce the cost structure and better alignproduct and operating expenses with the existing markets in which we compete.The plan was approved and initiated after the consummation of the DJO Merger.In the fourth quarter of 2007, we announced the relocation of our headquartersto Vista, California. Activities were also initiated with respect to therelocation of certain manufacturing operations from our Chattanooga, Tennesseelocation to Tijuana, Mexico. We also announced the future termination ofcertain employees related to the move of certain activities of

 

95

----

Table of Contents

 

our Bone GrowthStimulation (“BGS”) product line operations from Vista, California toSt. Paul, Minnesota. Internationally, we closed a facility in Germany andanticipate facility closures in certain other locations in an effort tointegrate and realize cost synergies in our international operations. As of December 31,2008, approximately $1.6 million was accrued related to severance andfacility exit costs that has not yet been paid. Additionally, approximately$0.2 million has been accrued as of December 31, 2008 related to thepurchase of rights to distributor territories in connection with the DJOMerger. We also assumed $1.9 million of severance due to a formerexecutive officer of a business acquired by DJO prior to the DJO Merger, whichwas paid in the first quarter of 2008.

 

In certain cases, estimated severance and facilityexit costs have been accrued as a liability with a corresponding increase togoodwill in accordance with the guidance specified in Emerging Issues TaskForce Issue Number 95-3, “Recognition of Liabilities in Connection with aPurchase Business Combination” (“EITF 95-3”). However, not all of ourrestructuring costs meet the accrual requirements of EITF 95-3, andcertain integration costs are expensed as incurred.

 

A summary of theactivity relating to the restructuring for the Successor twelve month periodsended December 31, 2008 and 2007 and for the period from November 4, throughDecember 31, 2006, and for the Predecessor period from January 1, 2006 throughNovember 3, 2006 is as follows (in thousands):

 
| ** **                        | ** ** | **Lease  Termination  Costs** | ** ** | **Severance** | ** ** | **Purchase of  Rights to  Distributor  Territories** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|-------------------------------|------------|---------------|------------|----------------------------------------------------------------|------------|------------|------------|
| ***Predecessor***                 | ** ** | ** **                    | ** ** | ** **    | ** ** | ** **                                                     | ** ** | ** ** | ** ** |
| Balance at January 1, 2006   |       | $                             | —     |          | $          | —                                                         |       | $          | —     |   | $ | — |   |
| Expensed during period            |       | —                        |       | 751           |       | —                                                         |       | 751        |       |
| Compex acquisition costs          |       | 391                           |       | 457           |       | —                                                         |       | 848        |       |
| Payments made during period       |       | —                        |       | (124          | )          | —                                                         |       | (124       | )          |
| Balance at November 3, 2006  |       | 391                           |       | 1,084         |       | —                                                         |       | 1,475      |       |
| ***Successor***                   |       |                          |       |          |       |                                                           |       |       |       |
| Expensed during period            |       | (45                           | )          | 430           |       | —                                                         |       | 385        |       |
| Adjustments to goodwill           |       | —                        |       | —        |       | —                                                         |       | —     |       |
| Payments made during period       |       | —                        |       | (125          | )          | —                                                         |       | (125       | )          |
| Balance at December 31, 2006 |       | 346                           |       | 1,389         |       | —                                                         |       | 1,735      |       |
| Expensed during period            |       | —                        |       | 1,953         |       | —                                                         |       | 1,953      |       |
| Adjustments to goodwill           |       | 1,331                         |       | 5,131         |       | 2,127                                                          |       | 8,589      |       |
| Payments made during period       |       | (385                          | )          | (2,325        | )          | —                                                         |       | (2,710     | )          |
| Adjustments to reserve            |       | 24                            |       | (53           | )          | —                                                         |       | (29        | )          |
| Foreign currency translation      |       | 33                            |       | (8            | )          | —                                                         |       | 25         |       |
| Balance at December 31, 2007 |       | 1,349                         |       | 6,087         |       | 2,127                                                          |       | 9,563      |       |
| Expensed during period            |       | —                        |       | 3,998         |       | —                                                         |       | 3,998      |       |
| Adjustments to goodwill           |       | 625                           |       | (769          | )          | (458                                                           | )          | (602       | )          |
| Payments made during period       |       | (739                          | )          | (8,543        | )          | (1,366                                                         | )          | (10,648    | )          |
| Adjustments to reserve            |       | (312                          | )          | (35           | )          | (123                                                           | )          | (470       | )          |
| Foreign currency translation      |       | (45                           | )          | (54           | )          | —                                                         |       | (99        | )          |
| Balance at December 31, 2008 |       | $                             | 878        |          | $          | 684                                                            |       | $          | 180        |   | $ | 1,742 |   |

 

**14.****                               COMMITMENTSAND CONTINGENCIES**

 

*Commitments*

 

As of December 31, 2008, we had entered into purchase commitmentsfor inventory, capital acquisitions and other services totaling approximately$120.1 million in the ordinary course of business. This amount includes acommitment of $7.0 million for annual monitoring fees to be paid to BlackstoneManagement Partners V L.L.C. (“BMP”) through 2019.

 

The following table summarizes our contractual obligations as of December 31,2008 associated with fixed commitments for purchase and service obligations forthe next five years and thereafter (in thousands):

 
| **Years Ending December 31,** |   |    |   |   |
|----------------------------------------------|--------|---------|--------|--------|
| 2009                                         |   | $       | 37,666 |   |
| 2010                                         |   | 15,751  |   |
| 2011                                         |   | 10,715  |   |
| 2012                                         |   | 7,000   |   |
| 2013                                         |   | 7,000   |   |
| Thereafter                                   |   | 42,000  |   |
| Total                                        |   | 120,132 |   |

 

96

----

Table of Contents

 

## ***Operating Leases***.  We leasebuilding space, manufacturing facilities and equipment under non-cancelableoperating lease agreements that expire at various dates.  We record rent incentives as deferred rentand amortize as reductions to lease expense over the lease term in accordancewith FASB Statement No. 13, “Accounting for Leases (as amended)”.  The aggregate minimum rental commitmentsunder non-cancelable leases for the periods shown at December 31, 2008,are as follows (in thousands):

 
| **Years Ending December 31** |   |   |   |   |
|---------------------------------------------|--------|--------|--------|--------|
| 2009                                        |   | $      | 11,235 |   |
| 2010                                        |   | 9,389  |   |
| 2011                                        |   | 7,538  |   |
| 2012                                        |   | 6,340  |   |
| 2013                                        |   | 6,065  |   |
| Thereafter                                  |   | 22,334 |   |
|                                        |   | 62,901 |   |

 

Rental expense under operating leases totaled approximately $12.4million, $4.3 million and $0.6 million for the Successor years ended December 31,2008 and 2007 and for the period November 4, 2006 through December 31,2006, respectively.  Rent expense wasapproximately $2.6 million for the Predecessor period January 1, 2006through November 3, 2006.  Scheduledincreases in rent expense are amortized on a straight line basis over the lifeof the lease.

 

## ***Capital Leases***.  Leasedequipment under capital leases, included in property and equipment in theaccompanying consolidated financial statements are as follows (in thousands):

 
| ** **                           | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Equipment                            |       | $                           | 505        |                        | $          | 550 |   |
| Furniture and fixtures               |       | 51                          |       | 266                         |       |
| Less — accumulated amortization |       | (244                        | )          | (222                        | )          |
|                                 |       | $                           | 312        |                        | $          | 594 |   |

 

*Litigation*

 

In December 2006, we recorded approximately$1.1 million as a contingent liability with an offsetting adjustment togoodwill relating to litigation against Compex Technologies, Inc. (“Compex”)regarding a dispute over custom duties and VAT on imported goods as part of thepurchase accounting of Compex. In February 2007, a judgment in the disputewith the custom officials was issued by the court which resulted in partialunfavorable rulings for each side. In June 2008, the Appeal Court of Parisannounced a preliminary judgment in our favor. In August 2008, we receivedwritten notice that the French custom would not appeal the ruling. As such, wereversed our contingent liability previously accrued for and recorded it as areduction to expense within the condensed consolidated statements of operationsin the third quarter of 2008.

 

In August 2007 and September 2007, twopurported shareholder class action lawsuits were filed in California SuperiorCourt, in the County of San Diego, on behalf of DJO Opco’s public stockholders,challenging DJO Opco’s proposed merger with ReAble. The court ordered the twolawsuits consolidated for all purposes in September 2007.

 

The two original complaints named DJO Opco, ReAble andthe current members of DJO Opco’s board of directors as defendants. One of theoriginal complaints also named Blackstone as a defendant. The two substantiallysimilar original complaints alleged, among other things, that the individualdefendants breached their fiduciary duties of care, good faith and loyalty byapproving the proposed merger with an allegedly inadequate price, withoutadequately informing themselves of DJO Opco’s highest transactional value, andwithout adequately marketing DJO Opco to other potential buyers. The originalcomplaints also alleged that the individual defendants and DJO Opco failed tomake full and adequate disclosures in the preliminary proxy statement regardingthe proposed merger. The original complaints request, among other things, classcertification, declaratory relief, an injunction of the proposed merger or arescission order, corrective disclosures to the proxy statement, damages,interest, attorneys’ fees, expert fees and other costs; and such other reliefas the court may find just and proper.

 

In November 2007, the parties entered into amemorandum of understanding, pursuant to which the parties agreed to settle theconsolidated action subject to court approval. In March 2008, the partiesentered into a settlement agreement which provided for dismissal of theconsolidated action with prejudice upon approval of a stipulation by the court.Pursuant to the terms of the settlement agreement, the defendants acknowledgedthat the consolidated action resulted in a decision to provide 

 

97

----

Table of Contents

 

additional information to DJO Opco’s shareholders in the definitiveproxy statement concerning the proposed merger and to modify certain terms inthe merger agreement and to pay certain attorneys’ fees, costs, and expensesincurred by the plaintiffs. As stated in the settlement agreement, defendantsdenied all allegations of wrongdoing, fault, liability or damage to theplaintiffs and the putative class in the consolidated action and denied thatthey were engaged in any wrongdoing or violation of law or breach of duty.Defendants also did not make any admission that the supplemental disclosureswere material. On June 13, 2008, the court entered an order granting finalapproval of the settlement after providing notice and opportunity to be heardto the members of the class. The order and settlement became final and notsubject to appeal on August 20, 2008.

 

On July 7,2006, a purported class action complaint, *LouisDudas et al. v.**Encore MedicalCorporation et al.,*was filed against DJO 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 class action complaint, *Robert**Kemp et al. v. Alastair J. Clemow et al.*(the“Delaware Action”) was filed by a putative stockholder of DJO in the Court ofChancery of the State of Delaware, New Castle County, against DJO and itsdirectors. Blackstone and Grand Slam Holdings, LLC were also named asdefendants in the Delaware Action. The Delaware Action was dismissed in February 2007with no liability accruing to DJO or the other defendants.

 

TheTexas Action is still in preliminary stages and we cannot presently predict theoutcome of the lawsuit, although we believe it is without merit. The TexasAction complaint alleges that DJO’s directors breached their fiduciary dutiesby, *inter alia*, agreeing to anallegedly inadequate acquisition price in connection with the Blackstone MergerAgreement. The complaint seeks, among other things, to rescind any actions thathave already been taken to consummate the Blackstone Merger Agreement,rescissory damages and the plaintiffs’ reasonable costs and attorneys’ andexperts’ fees.

 

The manufacture and sale of orthopedic devices andrelated products exposes us to significant risks of product liability claims,lawsuits and product recalls. From time to time, we have been, and we arecurrently, the subject of a number of product liability claims and lawsuitsrelating to our products. We are defendants in approximately 30 productliability cases related to a disposable drug infusion pump product manufacturedby two third party manufacturers that we distributed through our Bracing andSupports business unit of our Domestic Rehabilitation Segment. We intend todiscontinue our sale of these products in the second quarter of 2009. Thesecases have been brought against the manufacturers and certain distributors ofthese pumps, the manufacturers of the anesthetics used in these pumps, and thehealthcare professionals involved in providing the pumps to their patients. Allof these lawsuits allege that the use of these pumps with certain anestheticsin certain shoulder surgeries over prolonged periods have resulted in cartilagedamage to the plaintiffs. We have sought indemnity and tendered the defense ofthese cases both to the manufacturers who have supplied these pumps to us andto our product liability carrier. Both manufacturers have indicated they wouldaccept our tender of defense and indemnity, subject to certain reservation ofrights, and the product liability carrier of those two manufacturers isproviding us a defense in these cases. Our product liability carrier has also accepted coverage of these cases,subject to customary reservations, and was providing the Company with defenseuntil the time that the manufacturers’ carrier took up the Company’s defense.The lawsuits allege damages ranging from unspecified amounts to claims between$1.0 million and $10.0 million. These cases are in the early stagesof discovery.

 

We currently carry product liability insurance up to alimit of $25.0 million, subject to a deductible of $50,000 on non-invasiveproducts and a deductible of $250,000 on invasive products and an aggregatedeductible of $750,000 for all product liability claims. Our insurance policyis subject to annual renewal. We believe our current product liabilityinsurance coverage is adequate. If a product liability claim or series ofclaims is brought against us for uninsured liabilities or in excess of ourinsurance coverage, our business could suffer materially. In addition, incertain instances a product liability claim could also result in our having torecall some of our products, which could result in significant costs to us. Asof December 31, 2008 and 2007, we have accrued approximately$1.8 million and $1.9 million, respectively, for product liabilityclaims expense based upon previous claim experience in part due to the factthat we have exceeded the coverage limits on certain historical productliability claims involving our Surgical Implant Segment.

 

Dueto the nature of our business, we are subject to a variety of audits bygovernment agencies and other private interests. In connection with audits ofour compliance with federal requirements for our facilities and related qualityand manufacturing processes, the U.S. Food and Drug Administration (the “FDA”)had previously informed us in January 2007 that they believed that certaindiscrete processes related to our Surgical Implant Segment did not conform withCurrent Good Manufacturing Practices (“CGMP”). During 2007, we submitted a response and met with FDA representatives,and instituted the necessary changes and improvements in our policies andprocedures to correct these issues. During the first quarter of 2008, the FDA concluded their follow-upinvestigation concerning the January 2007 warning letter.  We received no observations and all areas ofconcern were addressed satisfactorily.

 

98

----

Table of Contents

 

We are an authorized Medicare supplier and provide a variety of ourproducts directly to Medicare beneficiaries and seek reimbursement from theapplicable Medicare Administrative Contractor. CIGNA Governmental Services (“CIGNA”) is that contractor in the westernregion of the United States.  As aMedicare supplier, we are subject to periodic audits of our operations, and in November 2008we were advised that as a result of such an audit, CIGNA was asserting that wehave been overpaid in the amount of approximately $6 million from January 1,2006 to April 9, 2007.  This figurerepresents Medicare reimbursements for claims we submitted on Medicarebeneficiaries for our bone growth stimulator product during that period oftime.  The reason asserted by CIGNA thatMedicare was not obligated to provide reimbursement on these claims is that wefailed to maintain a California Home Medical Device Retail Exemptee Licenseduring such 15 month period.  We believethat this licensing program does not apply to our business and have appealedthe assessment of the overpayment. During the pendency of the appeal, we are not required to pay theassessed $6 million overpayment, but interest at the rate of 11.375% per annumwill run on the amount, if any, eventually determined to be due. The $6.0million is accrued in our consolidated balance sheet as of December 31, 2008.

 

**15.**                               RELATED PARTY TRANSACTIONS

** **

**Management Stockholder’s Agreement**

 

Certain members of DJO’s management are parties to DJO’s managementstockholders agreement, dated November 3, 2006, among DJO, Grand SlamHoldings, LLC (“BCP Holdings”), Blackstone, certain of its affiliates, and suchmembers of DJO’s management and current executive officers (the “ManagementStockholders Agreement”). In conjunction with the DJO Merger, certain incomingexecutives of DJO (the “new management stockholders”) have become parties tothe Management Stockholders Agreement on the same terms and conditions as setforth therein, subject to the following exceptions, which by amendment (the “Amendment”)will apply only to the new management stockholders and any other personsbecoming a party thereto after November 20, 2007.  The ManagementStockholders Agreement currently provides that if a management stockholdervoluntarily resigns from DJO for any reason other than “good reason” (asdefined in the Management Stockholders Agreement) and a Blackstone ParentStockholder exercises its call rights after such termination, the managementstockholder would receive the lower of fair market value or “cost” for themanagement stockholder’s callable shares.  The Amendment provides that,unless a new management stockholder was terminated by DJO for “cause” (as definedin the Amendment) or unless the new management stockholder voluntarilyterminated employment and such termination would have constituted a terminationfor “cause” if it would have been initiated by DJO, such new managementstockholder would receive fair market value for such new management stockholder’sshares callable upon the exercise of a call right.

 

The Management Stockholders Agreement imposes significant restrictionson transfers of shares of DJO’s common stock held by management stockholdersand provides a right of first refusal to DJO (or Blackstone), if DJO fails toexercise such right) on any proposed sale of DJO’s common stock held by amanagement stockholder following the lapse of the transfer restrictions andprior to the occurrence of a ‘‘qualified public offering’’ (as such term isdefined in that agreement) of DJO.  Inaddition, prior to a qualified public offering, Blackstone will have drag-alongrights, and management stockholders will have tag-along rights, in the event ofa sale of DJO’s common stock by Blackstone to a third party (or in the event ofa sale of BCP Holdings’ equity interests to a third party) in the sameproportion as the shares or equity interests sold by Blackstone. If, prior toeither the lapse of the transfer restrictions or a qualified public offering, amanagement stockholder’s employment is terminated, DJO will have the right torepurchase all shares of its common stock held by such management stockholderfor a period of one year from the date of termination of employment (or theuntil the date that is one year following the exercise of the stock optionsused to acquire such common stock, if later). If DJO does not exercise thisrepurchase right during the applicable repurchase period, then Blackstone willgenerally have the right to repurchase such shares for a period of 30 daysthereafter. The Management Stockholders Agreement also provides that, after theoccurrence of a qualified public offering, the management stockholders willreceive customary piggyback registration rights with respect to shares of DJOcommon stock held by them.

 

On December 13,2006, DJO, BCP Holdings, Blackstone and certain of its affiliates entered intoa stockholders agreement with Sidney Braginsky, one of DJO’s directors. Theterms and conditions of the stockholders agreement with Mr. Braginsky are thesame, in all material respects, as the management stockholders agreementdescribed above.  As new directors jointhe Board and receive stock options, they are required to enter into a similaragreement.

 

**Transactionand Monitoring Fee Agreement**

 

Under the Transaction and Monitoring Fee Agreement, wepaid Blackstone Management Partners V L.L.C. (“BMP”), at the closing of the DJOMerger, a $15.0 million transaction fee and $0.6 million for relatedexpenses.  Also, pursuant to thisagreement, at the closing of the DJO Merger, we paid Blackstone AdvisoryServices, L.P., an affiliate of BMP, a $3.0 million advisory fee inconsideration of the provision of certain strategic and other advice and assistanceby BAS on behalf of BMP.

 

99

----

Table ofContents

 

In connection with the DJO Merger, BMP has agreed toprovide certain monitoring, advisory and consulting services to us for anannual monitoring fee equal to the greater of $7.0 million or 2% ofconsolidated EBITDA as defined in the Transaction and Monitoring Fee Agreement,payable in the first quarter of each year. Prior to the DJO Merger, the annualBMP monitoring fee was equal to $3.0 million. At any time in connectionwith or in anticipation of a change of control of DJOFL, a sale of all orsubstantially all of DJOFL’s assets or an initial public offering of commonstock of DJOFL, BMP may elect to receive, in lieu of remaining annualmonitoring fee payments, a single lump sum cash payment equal to thethen-present value of all then-current and future annual monitoring feespayable under the transaction and monitoring fee agreement, assuming ahypothetical termination date of the agreement to be the twelfth anniversary ofsuch election. The monitoring fee agreement will continue until the earlier ofthe twelfth anniversary of the date of the agreement or such date as DJOFL andBMP may mutually determine. DJOFL will agree to indemnify BMP and itsaffiliates, directors, officers, employees, agents and representatives from andagainst 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. For the Successor years ended December 31,2008 and 2007, we expensed $7.0 million and $3.0 million,respectively, related to the annual monitoring fee. This is recorded as acomponent of selling, general and administrative expense in the auditedconsolidated statements of operations.

 

**16.**                               DERIVATIVE INSTRUMENTS

** **

We operate internationally and are therefore exposedto foreign currency exchange rate fluctuations in the normal course of ourbusiness, in particular to changes in the Mexican Peso due to our Mexico-basedmanufacturing operations that incur costs that are largely denominated in MexicanPesos. As part of our risk management strategy, we use derivative instrumentsto hedge portions of our exposure. Before acquiring a derivative instrument tohedge a specific risk, potential natural hedges are evaluated. Derivativeinstruments are only utilized to manage underlying exposures that arise fromour business operations. Factors considered in the decision to hedge anunderlying market exposure include the materiality of the risk, the volatilityof the market, the duration of the hedge, and the availability, effectivenessand cost of derivative instruments. As of December 31, 2008, we hadoutstanding hedges in the form of forward contracts to purchase Mexican Pesosaggregating a U.S. dollar equivalent based on the fair market value of the$16.1 million.  For the Successoryear ended December 31, 2008, we recognized a loss in the statement ofoperations on Mexico Peso forward contracts of approximately $4.2 million.  For the Successor year ended December 31,2007, we recognized a gain in the statement of operations on Mexico Pesoforward contracts of approximately $0.1 million.

 

We make use of debt financing as a source of funds andare therefore exposed to interest rate fluctuations in the normal course of ourbusiness. Our credit facilities are subject to floating interest rates. Wemanage the risk of unfavorable movements in interest rates by hedging a portionof the outstanding loan balance, thereby locking in a fixed rate on a portionof the principal, reducing the effect of possible rising interest rates andmaking interest expense more predictable. In February 2007, we swappedvariable rates for fixed rates on $175.0 million of the borrowings underthe then existing revolving credit facility. We had two agreements in place fora notional amount of $100.0 million and $75.0 million, expiring in2010 and 2012, respectively. Under these agreements, we paid a fixed rate of5.17% and received a variable rate equal to the then current three month LIBORrate. On November 19, 2007, in anticipation of the DJO Merger andincurrence of new indebtedness, we terminated these swaps and recognized$4.8 million of related interest expense. On November 20, 2007, weentered into a new interest rate swap agreement for a notional amount of$515.0 million at a fixed LIBOR rate of 4.205% amortizing through anexpiration date in 2009 (the notional amount was $470.0 million as of December 31,2008).

 

The fair value of our interest rate swap agreementrecorded in the accompanying condensed consolidated balance sheets as of December 31,2008 and 2007 was a loss of approximately $13.3 million and$3.9 million, respectively, and is recorded in other non-currentliabilities. For these derivatives, we report the after-tax gain or loss fromthe effective portion of the hedge as a component of accumulated othercomprehensive income (loss) and reclassify it into earnings in the same periodor periods in which the hedged transaction affects earnings, and within thesame income statement line item as the impact of the hedged transaction.  Derivative net gains (losses) on our interestrate swap agreement of ($3.4) million and $0.7 million, on a pre-tax basis,were included in interest expense for the Successor years ended December 31,2007 and 2008, respectively.

 

In accordance with SFAS No. 157, “Fair ValueMeasurement”, we follow the three levels of the fair value hierarchy fordisclosure of the inputs to valuation. This hierarchy prioritizes the inputsinto three broad levels as follows. Level 1 inputs are quoted prices(unadjusted) in active markets for identical assets or liabilities.Level 2 inputs are quoted prices for similar assets and liabilities inactive markets or inputs that are observable for the asset or liability, eitherdirectly or indirectly

 

100

----

Tableof Contents

 

through marketcorroboration, for substantially the full term of the financial instrument.Level 3 inputs are unobservable inputs based on our own assumptions usedto measure assets and liabilities at fair value. A financial asset or liability’sclassification within the hierarchy is determined based on the lowest levelinput that is significant to the fair value measurement. At December 31,2008, the fair value of our interest rate swap agreement was determined throughthe use of models that consider various assumptions, including time value,yield curves, as well as other relevant economic measures, which are inputsthat are classified as Level 2 in the valuation hierarchy. The fair valueof our Mexican Peso forward contracts was determined based on market rates tosettle the instruments. These values represent the estimated amounts we wouldreceive or pay to terminate the contracts, taking into consideration currentmarket rates.

 

**17.****                               UNAUDITEDQUARTERLY CONSOLIDATED FINANCIAL DATA**

 

Thefollowing represents the unaudited quarterly consolidated financial data forthe periods presented (in thousands):

 
| ** **               | ** ** | **Successor**                                      | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|
| ** **               | ** ** | **For the three months ended** | ** ** |
| ** **               | ** ** | **Mar 29,  2008**                             | ** ** | **Jun 28,  2008** | ** ** | **Sep 27,  2008** | ** ** | **Dec 31,  2008** | ** ** |
| Net sales                |       | $                                                  | 239,728    |   | $ | 249,801 |   | $ | 243,637 |   | $ | 247,028 |   |
| Gross Profit             |       | 144,644                                            |       | 157,970 |   | 150,669 |   | 152,831 |   |
| Operating income  (loss) |       | 8,240                                              |       | 15,063 |   | 19,352 |   | (7,829 | ) |
| Net loss                 |       | (24,162                                            | )          | (20,798 | ) | (14,429 | ) | (38,397 | ) |
|                          |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **               | ** ** | **Successor**                                      | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|
| ** **               | ** ** | **For the three months ended** | ** ** |
| ** **               | ** ** | **Mar 31,  2007**                             | ** ** | **Jun 30,  2007** | ** ** | **Sep 29,  2007** | ** ** | **Dec 31,  2007** | ** ** |
| Net sales                |       | $                                                  | 106,707    |   | $ | 106,253 |   | $ | 108,431 |   | $ | 170,743 |   |
| Gross Profit             |       | 61,425                                             |       | 62,392 |   | 66,149 |   | 96,304 |   |
| Operating income  (loss) |       | 310                                                |       | 333 |   | 2,800 |   | (42,879 | ) |
| Net loss                 |       | (11,087                                            | )          | (8,077 | ) | (5,939 | ) | (57,319 | ) |
|                          |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 

**18.**                               EMPLOYEE BENEFIT PLANS

** **

Wehave multiple qualified defined contribution plans, which allow for voluntarypre-tax contributions by employees.  Wepay all general and administrative expenses of the plans and may makecontributions to the plans.  Based on 50%of the first 6% of employee contributions, we made matching contributions of$3.3 million, $1.6 million and $0.2 million to the plan for the Successor yearsended December 31, 2008 and 2007 and the period from November 4, 2006through December 31, 2006, respectively. We also made a contribution of approximately $1.2 million to the plan inexistence for both the Predecessor period January 1, 2006 through November 3,2006.  The plans provide fordiscretionary contributions by us as approved by the Board of Directors.  There have been no such discretionarycontributions through December 31, 2008. In addition, we made pension contributions of approximately $0.6 millionrelated to our international pension plans.

 

**19.****                               SUBSEQUENTEVENTS**

 

In February 2009,we acquired Donjoy Orthopaedics Pty., Ltd., an unaffiliated Australiandistributor of our products, as part of our strategy to expand ourinternational sales for approximately $3.0 million.  We are still evaluating allocation of thepurchase price.

 

In February 2009,we entered into two interest rate swap agreements.  One agreement is for a notional amount of$550.0 million with a term of February 2009 through December 2009.  The second agreement is for a notional amountof $750.0 million with a term of January 2010 through December 2010.  Under these agreements we have LIBOR fixedrates of 1.04% and 1.88%, respectively.

 

101

----

Table of Contents

 

**20.****                               SUPPLEMENTALGUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS**

 

On November 20, 2007, in connection with the DJOMerger, DJOFL and its direct wholly-owned subsidiary, Finco, issued $575.0million aggregate principal amount of the 10.875% Notes.  Finco has only nominal assets and does notconduct any operations.  The 10.875%Indenture generally prohibits Finco from holding any assets, becoming liablefor any obligations, or engaging in any business activity.  The 10.875% Notes are jointly and severally,fully and unconditionally guaranteed, on an unsecured senior subordinated basisby all of the DJOFL’s domestic subsidiaries (other than the co-issuer) that are100% owned, directly or indirectly, by DJOFL (the “Guarantors”).  Our foreign subsidiaries (the “Non-Guarantors”),do not guarantee the 10.875% notes.  TheGuarantors also unconditionally guarantee the Senior Secured Credit Facility.

 

On November 3, 2006, in connection with the PriorTransaction, DJOFL and its direct wholly-owned subsidiary, Finco, issued $200.0million aggregate principal amount of the 11.75% Notes.  Finco was formed solely to act as a co-issuerof the 11.75% Notes, has only nominal assets and does not conduct anyoperations.  The 11.75% Indenturedgenerally prohibit Finco from holding any assets, becoming liable for anyobligations, or engaging in any business activity.  The 11.75% Notes are jointly and severally,fully and unconditionally guaranteed, on an unsecured senior subordinated basisby all of the Guarantors.  TheNon-Guarantors, do not guarantee the 11.75% Notes.  The Guarantors also unconditionally guaranteethe Senior Secured Credit Facility.

 

The following tables present the financial position,results of operations and cash flows of DJOFL, the Guarantors, theNon-Guarantors and Eliminations as of the years ended December 31, 2008and 2007.   In addition, the followingtables present the results of operations and cash flows of DJOFL, theGuarantors, the Non-Guarantors and certain eliminations of the Successor yearsended December 31, 2008 and 2007 and the period from November 4, 2006through December 31, 2006 and the Predecessor period from January 1,2006 through November 3, 2006.  TheGuarantors in the tables relating to the Predecessor period include EMIHC, apreviously wholly owned direct subsidiary of DJOFL which was liquidated on December 31,2006.  Encore medical, Inc. (“EMIHC’)was the borrower under the credit facility in place to the Old Senior SecuredCredit Facility which was fully repaid in connection with the Prior Transactionand the issuer of the 9.75% Notes, which was repurchased pursuant to a tenderoffer in connection with the Prior Transaction.

 

102

----

Tableof Contents

 

**DJOFinance LLC**

 

**CondensedConsolidating Balance Sheets**

**As of December 31, 2008**

**(in thousands)**

 
| ** **                                                   | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   |       |      |       |           |       |                 |       |             |       |             |       |
| Current assets:                                              |       |      |       |           |       |                 |       |             |       |             |       |
| Cash and cash  equivalents                                   |       | $         | —     |           | $          | 14,373               |       | $                | 16,110     |             | $          | — |   | $ | 30,483 |   |
| Accounts  receivable, net                                    |       | —    |       | 130,151        |       | 34,467               |       | —           |       | 164,618          |       |
| Inventories, net                                             |       | —    |       | 86,533         |       | 21,183               |       | (4,550           | )          | 103,166          |       |
| Deferred tax  assets, net                                    |       | —    |       | 34,756         |       | —               |       | (717             | )          | 34,039           |       |
| Prepaid expenses  and other current assets                   |       | 303       |       | 13,516         |       | 1,388                |       | 1,716            |       | 16,923           |       |
| Total current  assets                                        |       | 303       |       | 279,329        |       | 73,148               |       | (3,551           | )          | 349,229          |       |
| Property and equipment,  net                                 |       | —    |       | 75,875         |       | 12,316               |       | (1,929           | )          | 86,262           |       |
| Goodwill                                                     |       | —    |       | 1,120,690      |       | 70,876               |       | —           |       | 1,191,566        |       |
| Intangible  assets, net                                      |       | —    |       | 1,228,872      |       | 31,600               |       | —           |       | 1,260,472        |       |
| Investment in  subsidiaries                                  |       | 1,119,504 |       | 1,119,058      |       | 52,461               |       | (2,291,023       | )          | —           |       |
| Intercompany  receivable                                     |       | 1,295,225 |       | —         |       | —               |       | (1,295,225       | )          | —           |       |
| Other  non-current assets                                    |       | 49,951    |       | 2,173          |       | 477                  |       | —           |       | 52,601           |       |
| Total assets                                                 |       | $         | 2,464,983  |           | $          | 3,825,997            |       | $                | 240,878    |             | $          | (3,591,728 | ) | $ | 2,940,130 |   |
| **Liabilities,  Minority Interests and Membership Equity**   |       |      |       |           |       |                 |       |             |       |             |       |
| Current  liabilities:                                        |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts payable                                             |       | $         | —     |           | $          | 33,566               |       | $                | 9,100      |             | $          | 86 |   | $ | 42,752 |   |
| Long-term debt  and capital leases, current portion          |       | 10,650    |       | 187            |       | 712                  |       | —           |       | 11,549           |       |
| Other current  liabilities                                   |       | 24,213    |       | 69,249         |       | 22,243               |       | (338             | )          | 115,367          |       |
| Total current  liabilities                                   |       | 34,863    |       | 103,002        |       | 32,055               |       | (252             | )          | 169,668          |       |
| Long-term debt  and capital leases, net of current portion   |       | 1,831,754 |       | 100            |       | 190                  |       | —           |       | 1,832,044        |       |
| Deferred tax  liabilities, net                               |       | —    |       | 318,826        |       | 9,195                |       | 1,482            |       | 329,503          |       |
| Intercompany  payable, net                                   |       | —    |       | 1,209,321      |       | 85,904               |       | (1,295,225       | )          | —           |       |
| Other  non-current liabilities                               |       | —    |       | 8,716          |       | 90                   |       | —           |       | 8,806            |       |
| Total  liabilities                                           |       | 1,866,617 |       | 1,639,965      |       | 127,434              |       | (1,293,995       | )          | 2,340,021        |       |
| Minority  interests                                          |       | —    |       | —         |       | 1,743                |       | —           |       | 1,743            |       |
| Membership  equity                                           |       | 598,366   |       | 2,186,032      |       | 111,701              |       | (2,297,733       | )          | 598,366          |       |
| Total  liabilities, minority interests and membership equity |       | $         | 2,464,983  |           | $          | 3,825,997            |       | $                | 240,878    |             | $          | (3,591,728 | ) | $ | 2,940,130 |   |

 

103

----

Table of Contents

 

**DJO Finance LLC ,**

 

**CondensedConsolidating Balance Sheet**

**As of December 31,2007**

**(inthousands)**

** **
| ** **                                                   | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   |       |      |       |           |       |                 |       |             |       |             |       |
| Current assets:                                              |       |      |       |           |       |                 |       |             |       |             |       |
| Cash and cash  equivalents                                   |       | $         | 519        |           | $          | 44,694               |       | $                | 18,258     |             | $          | — |   | $ | 63,471 |   |
| Accounts  receivable, net                                    |       | —    |       | 120,949        |       | 33,818               |       | —           |       | 154,767          |       |
| Inventories, net                                             |       | —    |       | 94,908         |       | 22,868               |       | (6,872           | )          | 110,904          |       |
| Deferred tax  assets, net                                    |       | —    |       | 29,145         |       | —               |       | (146             | )          | 28,999           |       |
| Prepaid expenses  and other current assets                   |       | 9         |       | 13,669         |       | 3,641                |       | —           |       | 17,319           |       |
| Total current  assets                                        |       | 528       |       | 303,365        |       | 78,585               |       | (7,018           | )          | 375,460          |       |
| Property and  equipment, net                                 |       | —    |       | 70,413         |       | 12,949               |       | (1,717           | )          | 81,645           |       |
| Goodwill                                                     |       | —    |       | 1,132,388      |       | 68,894               |       | —           |       | 1,201,282        |       |
| Intangible  assets, net                                      |       | —    |       | 1,324,191      |       | 36,170               |       | —           |       | 1,360,361        |       |
| Investment in  subsidiaries                                  |       | 1,140,111 |       | 184,420        |       | 53,114               |       | (1,377,645       | )          | —           |       |
| Intercompany  receivable                                     |       | 1,344,358 |       | —         |       | —               |       | (1,344,358       | )          | —           |       |
| Other  non-current assets                                    |       | 61,587    |       | 4,220          |       | 1,717                |       | —           |       | 67,524           |       |
| Total assets                                                 |       | $         | 2,546,584  |           | $          | 3,018,997            |       | $                | 251,429    |             | $          | (2,730,738 | ) | $ | 3,086,272 |   |
| **Liabilities,  Minority Interests and Membership Equity**   |       |      |       |           |       |                 |       |             |       |             |       |
| Current  liabilities:                                        |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts payable                                             |       | $         | 54         |           | $          | 34,722               |       | $                | 8,800      |             | $          | — |   | $ | 43,576 |   |
| Long-term debt  and capital leases, current portion          |       | 10,116    |       | 66,985         |       | 26,666               |       | —           |       | 103,767          |       |
| Other current  liabilities                                   |       | 10,650    |       | 752            |       | 2,807                |       | —           |       | 14,209           |       |
| Total current  liabilities                                   |       | 20,820    |       | 102,459        |       | 38,273               |       | —           |       | 161,552          |       |
| Long-term debt  and capital leases, net of current portion   |       | 1,816,864 |       | 287            |       | 1,447                |       | —           |       | 1,818,598        |       |
| Deferred tax  liabilities, net                               |       | —    |       | 376,778        |       | 9,881                |       | —           |       | 386,659          |       |
| Intercompany  payable, net                                   |       | —    |       | 1,255,008      |       | 89,350               |       | (1,344,358       | )          | —           |       |
| Other  non-current liabilities                               |       | 3,912     |       | 9,348          |       | —               |       | —           |       | 13,260           |       |
| Total  liabilities                                           |       | 1,841,596 |       | 1,743,880      |       | 138,951              |       | (1,344,358       | )          | 2,380,069        |       |
| Minority  interests                                          |       | —    |       | —         |       | 1,215                |       | —           |       | 1,215            |       |
| Membership  equity                                           |       | 704,988   |       | 1,275,117      |       | 111,263              |       | (1,386,380       | )          | 704,988          |       |
| Total  liabilities, minority interests and membership equity |       | $         | 2,546,584  |           | $          | 3,018,997            |       | $                | 251,429    |             | $          | (2,730,738 | ) | $ | 3,086,272 |   |

 

104

----

Table of Contents

 

**DJOFinance LLC**

 

**CondensedConsolidating Statements of Operations**

**For the Successor Year Ended December 31,2008**

**(in thousands)**

 
| ** **                                                                           | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non- Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------|------------|----------------|------------|--------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                            |       | $         | —     |           | $          | 821,685                  |       | $                | 255,414    |             | $          | (96,905 | ) | $ | 980,194 |   |
| Cost of sales                                                                        |       | —    |       | 322,669        |       | 151,650                  |       | (100,239         | )          | 374,080          |       |
| Gross profit                                                                         |       | —    |       | 499,016        |       | 103,764                  |       | 3,334            |       | 606,114          |       |
| Operating  expenses:                                                                 |       |      |       |           |       |                     |       |             |       |             |       |
| Selling, general  and administrative                                                 |       | —    |       | 359,801        |       | 85,601                   |       | (6               | )          | 445,396          |       |
| Research and  development                                                            |       | —    |       | 23,965         |       | 2,973                    |       | —           |       | 26,938           |       |
| Amortization and  impairment of acquired intangibles                                 |       | —    |       | 96,894         |       | 2,060                    |       | —           |       | 98,954           |       |
| Operating income                                                                     |       | —    |       | 18,356         |       | 13,130                   |       | 3,340            |       | 34,826           |       |
| Other income  (expense):                                                             |       |      |       |           |       |                     |       |             |       |             |       |
| Interest income                                                                      |       | 45,032    |       | 4,230          |       | 808                      |       | (48,408          | )          | 1,662            |       |
| Interest expense                                                                     |       | (172,286  | )          | (45,193        | )          | (4,091                   | )          | 48,408           |       | (173,162         | )          |
| Other income  (expense), net                                                         |       | 29,468    |       | (6,324         | )          | (2,810                   | )          | (29,468          | )          | (9,134           | )          |
| Income (loss)  from continuing operations before income taxes and minority interests |       | (97,786   | )          | (28,931        | )          | 7,037                    |       | (26,128          | )          | (145,808         | )          |
| Provision  (benefit) for income taxes                                                |       | —    |       | (51,533        | )          | 2,462                    |       | —           |       | (49,071          | )          |
| Minority  interests                                                                  |       | —    |       | —         |       | 1,049                    |       | —           |       | 1,049            |       |
| Net income  (loss)                                                                   |       | $         | (97,786    | )              | $          | 22,602                   |       | $                | 3,526      |             | $          | (26,128 | ) | $ | (97,786 | ) |

 

105

----

Tableof Contents

 

**DJO Finance LLC**

 

**CondensedConsolidating Statement of Operations**

**For theSuccessor Year Ended December 31, 2007**

**(inthousands)**

** **
| ** **                                                                           | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                            |       | $         | —     |           | $          | 396,302              |       | $                | 113,057    |             | $          | (17,225 | ) | $ | 492,134 |   |
| Cost of sales                                                                        |       | —    |       | 165,789        |       | 57,073               |       | (16,998          | )          | 205,864          |       |
| Gross profit                                                                         |       | —    |       | 230,513        |       | 55,984               |       | (227             | )          | 286,270          |       |
| Operating  expenses:                                                                 |       |      |       |           |       |                 |       |             |       |             |       |
| Selling, general  and administrative                                                 |       | 2,942     |       | 220,969        |       | 47,304               |       | (52              | )          | 271,163          |       |
| Research and  development                                                            |       | —    |       | 16,998         |       | 4,049                |       | —           |       | 21,047           |       |
| Amortization of  acquired intangibles                                                |       | —    |       | 30,803         |       | 2,693                |       | —           |       | 33,496           |       |
| Operating income  (loss)                                                             |       | (2,942    | )          | (38,257        | )          | 1,938                |       | (175             | )          | (39,436          | )          |
| Other income  (expense):                                                             |       |      |       |           |       |                 |       |             |       |             |       |
| Interest income                                                                      |       | 21,590    |       | 5,101          |       | 344                  |       | (25,903          | )          | 1,132            |       |
| Interest expense                                                                     |       | (72,085   | )          | (22,216        | )          | (4,011               | )          | 25,903           |       | (72,409          | )          |
| Other income  (expense), net                                                         |       | (14,446   | )          | (22,876        | )          | 496                  |       | 37,568           |       | 742              |       |
| Loss on early extinguishment of debt                                                 |       | (14,539   | )          | —         |       | —               |       | —           |       | (14,539          | )          |
| Income (loss)  from continuing operations before income taxes and minority interests |       | (82,422   | )          | (78,248        | )          | (1,233               | )          | 37,393           |       | (124,510         | )          |
| Benefit for  income taxes                                                            |       | —    |       | (42,262        | )          | (241                 | )          | —           |       | (42,503          | )          |
| Minority  interests                                                                  |       | —    |       | —         |       | 415                  |       |             |       | 415              |       |
| Loss from  continuing operations                                                     |       | (82,422   | )          | (35,986        | )          | (1,407               | )          | 37,393           |       | (82,422          | )          |
| Discontinued  operations:                                                            |       |      |       |           |       |                 |       |             |       |             |       |
| Income from  discontinued operations, net of tax                                     |       | —    |       | —         |       | —               |       | —           |       | —           |       |
| Net loss                                                                             |       | $         | (82,422    | )              | $          | (35,986              | )          | $                | (1,407     | )                | $          | 37,393 |   | $ | (82,422 | ) |

 

106

----

Table of Contents

 

**DJO Finance LLC**

 

**CondensedConsolidating Statement of Operations**

**For theSuccessor Period November 4, 2006 through December 31, 2006**

**(inthousands)**

** **
| ** **                                                                  | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                   |       | $         | —     |           | $          | 43,556               |       | $                | 14,626     |             | $          | (280 | ) | $ | 57,902 |   |
| Cost of sales                                                               |       | —    |       | 18,959         |       | 8,113                |       | (285             | )          | 26,787           |       |
| Gross profit                                                                |       | —    |       | 24,597         |       | 6,513                |       | 5                |       | 31,115           |       |
| Operating  expenses:                                                        |       |      |       |           |       |                 |       |             |       |             |       |
| Selling, general  and administrative                                        |       | 1,088     |       | 33,707         |       | 6,304                |       | —           |       | 41,099           |       |
| Research and  development                                                   |       | —    |       | 27,377         |       | 751                  |       | —           |       | 28,128           |       |
| Amortization of  acquired intangibles                                       |       | —    |       | 3,608          |       | 427                  |       | —           |       | 4,035            |       |
| Operating income  (loss)                                                    |       | (1,088    | )          | (40,095        | )          | (969                 | )          | 5                |       | (42,147          | )          |
| Other income  (expense):                                                    |       |      |       |           |       |                 |       |             |       |             |       |
| Interest income                                                             |       | 2,517     |       | 751            |       | 43                   |       | (2,999           | )          | 312              |       |
| Interest expense                                                            |       | (8,560    | )          | (2,776         | )          | (274                 | )          | 2,999            |       | (8,611           | )          |
| Other income  (expense), net                                                |       | (34,503   | )          | 87             |       | 46                   |       | 34,503           |       | 133              |       |
| Loss from  continuing operations before income taxes and minority interests |       | (41,634   | )          | (42,033        | )          | (1,154               | )          | 34,508           |       | (50,313          | )          |
| Benefit for  income taxes                                                   |       | —    |       | (8,513         | )          | (243                 | )          | —           |       | (8,756           | )          |
| Minority  interests                                                         |       | —    |       | —         |       | 39                   |       | —           |       | 39               |       |
| Loss from  continuing operations                                            |       | (41,634   | )          | (33,520        | )          | (950                 | )          | 34,508           |       | (41,596          | )          |
| Discontinued  operations:                                                   |       |      |       |           |       |                 |       |             |       |             |       |
| Loss from discontinued  operations, net of tax                              |       | —    |       | (38            | )          | —               |       | —           |       | (38              | )          |
| Net loss                                                                    |       | $         | (41,634    | )              | $          | (33,558              | )          | $                | (950       | )                | $          | 34,508 |   | $ | (41,634 | ) |

 

107

----

Table of Contents

 

**DJO Finance LLC**

 

**CondensedConsolidating Statement of Operations**

**For thePredecessor Period January 1, 2006 through November 3, 2006**

**(inthousands)**

 
| ** **                                                                  | ** ** | **DJO** | ** ** | **Guarantors** | ** ** | **Non- Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------|------------|---------|------------|----------------|------------|--------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                   |       | $       | —     |           | $          | 256,744                  |       | $                | 49,579     |             | $          | (1,940 | ) | $ | 304,383 |   |
| Cost of sales                                                               |       | —  |       | 107,259        |       | 21,984                   |       | (1,963           | )          | 127,280          |       |
| Gross profit                                                                |       | —  |       | 149,485        |       | 27,595                   |       | 23               |       | 177,103          |       |
| Operating  expenses:                                                        |       |    |       |           |       |                     |       |             |       |             |       |
| Selling, general  and administrative                                        |       | —  |       | 157,191        |       | 21,973                   |       | —           |       | 179,164          |       |
| Research and  development                                                   |       | —  |       | 11,482         |       | 3,290                    |       | —           |       | 14,772           |       |
| Amortization of  acquired intangibles                                       |       | —  |       | 4,150          |       | 1,815                    |       | —           |       | 5,965            |       |
| Operating income  (loss)                                                    |       | —  |       | (23,338        | )          | 517                      |       | 23               |       | (22,798          | )          |
| Other income  (expense):                                                    |       |    |       |           |       |                     |       |             |       |             |       |
| Interest income                                                             |       | —  |       | 14,741         |       | 113                      |       | (14,327          | )          | 527              |       |
| Interest expense                                                            |       | —  |       | (40,077        | )          | (258                     | )          | 14,327           |       | (26,008          | )          |
| Other income  (expense), net                                                |       | (46,776 | )          | (24,293        | )          | (926                     | )          | 71,972           |       | (23              | )          |
| Loss on early extinguishment of debt                                        |       | —  |       | (9,154         | )          | —                   |       | —           |       | (9,154           | )          |
| Loss from  continuing operations before income taxes and minority interests |       | (46,776 | )          | (82,121        | )          | (554                     | )          | 71,995           |       | (57,456          | )          |
| Provision  (benefit) for income taxes                                       |       | —  |       | (12,263        | )          | 752                      |       | 59               |       | (11,452          | )          |
| Minority  interests                                                         |       | —  |       | —         |       | 158                      |       | —           |       | 158              |       |
| Loss from  continuing operations                                            |       | (46,776 | )          | (69,858        | )          | (1,464                   | )          | 71,936           |       | (46,162          | )          |
| Discontinued  operations:                                                   |       |    |       |           |       |                     |       |             |       |             |       |
| Income from  discontinued operations, net of tax                            |       | —  |       | (614           | )          | —                   |       | —           |       | (614             | )          |
| Net loss                                                                    |       | $       | (46,776    | )              | $          | (70,472                  | )          | $                | (1,464     | )                | $          | 71,936 |   | $ | (46,776 | ) |

 

108

----

Table ofContents

 

**DJOFinance LLC**

 

**CondensedConsolidating Statements of Cash Flows**

**For the Successor Year Ended December 31,2008**

**(in thousands)**

 
| ** **                                                                                           | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING  ACTIVITIES:**                                                                           |       |      |       |           |       |                 |       |             |       |             |       |
| Net income  (loss)                                                                                   |       | $         | (97,786    | )              | $          | 23,418               |       | $                | 3,526      |             | $          | (26,944 | ) | $ | (97,786 | ) |
|                                                                                                 |       |      |       |           |       |                 |       |             |       |             |       |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |      |       |           |       |                 |       |             |       |             |       |
| Depreciation                                                                                         |       | —    |       | 20,113         |       | 4,189                |       | (705             | )          | 23,597           |       |
| Amortization and  impairment of intangibles                                                          |       | —    |       | 96,894         |       | 2,060                |       | —           |       | 98,954           |       |
| Amortization of  debt issuance costs                                                                 |       | 13,177    |       | —         |       | —               |       | —           |       | 13,177           |       |
| Stock-based  compensation                                                                            |       | —    |       | 1,381          |       | —               |       | —           |       | 1,381            |       |
| Loss on disposal  of assets                                                                          |       | —    |       | 2,610          |       | 602                  |       | (143             | )          | 3,069            |       |
| Deferred income  taxes                                                                               |       | —    |       | (41,927        | )          | (230                 | )          | —           |       | (42,157          | )          |
| Non-cash income  from subsidiaries                                                                   |       | (29,468   | )          | 11,980         |       | —               |       | 17,488           |       | —           |       |
| Provision for  doubtful accounts and sales returns                                                   |       | —    |       | 25,421         |       | 856                  |       | —           |       | 26,277           |       |
| Inventory  reserves                                                                                  |       | —    |       | 7,922          |       | 715                  |       | —           |       | 8,637            |       |
| Minority  interests                                                                                  |       | —    |       | —         |       | 1,049                |       | —           |       | 1,049            |       |
| Changes in  operating assets and liabilities, net of acquired assets and liabilities:                |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts  receivable                                                                                 |       | —    |       | (34,543        | )          | (2,521               | )          | —           |       | (37,064          | )          |
| Inventories                                                                                          |       | —    |       | 972            |       | 136                  |       | (2,717           | )          | (1,609           | )          |
| Prepaid expenses,  other assets and liabilities                                                      |       | (293      | )          | (2,760         | )          | 3,125                |       | (4               | )          | 68               |       |
| Accounts payable  and accrued expenses                                                               |       | 770       |       | (9,188         | )          | (1,325               | )          | 89               |       | (9,654           | )          |
| Net cash provided  by (used in) operating activities                                                 |       | (113,600  | )          | 102,293        |       | 12,182               |       | (12,936          | )          | (12,061          | )          |
| **INVESTING  ACTIVITIES:**                                                                           |       |      |       |           |       |                 |       |             |       |             |       |
| Acquisition of  businesses and intangibles, net of cash acquired                                     |       | —    |       | (3,234         | )          | (1,861               | )          | —           |       | (5,095           | )          |
| Proceeds from  sale of assets held for sale                                                          |       | —    |       | 2              |       | 12                   |       | —           |       | 14               |       |
| Purchases of  property and equipment                                                                 |       | —    |       | (22,412        | )          | (4,502               | )          | 1,009            |       | (25,905          | )          |
| Other                                                                                                |       | —    |       | 1,696          |       | (306                 | )          | —           |       | 1,390            |       |
| Net cash used in  investing activities                                                               |       | —    |       | (23,948        | )          | (6,657               | )          | 1,009            |       | (29,596          | )          |
| **FINANCING  ACTIVITIES:**                                                                           |       |      |       |           |       |                 |       |             |       |             |       |
| Intercompany                                                                                         |       | 99,731    |       | (107,914       | )          | (3,744               | )          | 11,927           |       | —           |       |
| Payments on  long-term debt and revolving line of credit                                             |       | (29,650   | )          | (752           | )          | (6,892               | )          | —           |       | (37,294          | )          |
| Proceeds from  long- debt and revolving line of credit                                               |       | 43,000    |       | —         |       | 3,540                |       | —           |       | 46,540           |       |
| Dividend paid to  minority interests of subsidiary                                                   |       | —    |       | —         |       | (381                 | )          | —           |       | (381             | )          |
| Net cash  provided by financing activities                                                           |       | 113,081   |       | (108,666       | )          | (7,477               | )          | 11,927           |       | 8,865            |       |
| Effect of  exchange rate changes on cash and cash equivalents                                        |       | —    |       | —         |       | (196                 | )          | —           |       | (196             | )          |
| **Net  increase (decrease) in cash and cash equivalents**                                            |       | (519      | )          | (30,321        | )          | (2,148               | )          | —           |       | (32,988          | )          |
| Cash and cash  equivalents at beginning of period                                                    |       | 519       |       | 44,694         |       | 18,258               |       | —           |       | 63,471           |       |
| Cash and cash  equivalents at end of period                                                          |       | $         | —     |           | $          | 14,373               |       | $                | 16,110     |             | $          | — |   | $ | 30,483 |   |

 

109

----

Table of Contents

 

**DJO Finance LLC**

 

**Condensed Consolidating Statements of Cash Flows**

**For the Successor Year Ended December 31,2007**

**(in thousands)**

** **
| ** **                                                                                           | ** ** | **DJOFL**  | ** ** | **Guarantors** | ** ** | **Non- Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------------------|------------|------------------|------------|------------------|------------|
| **OPERATING  ACTIVITIES:**                                                                           |       |       |       |           |       |                     |       |             |       |             |       |
| Net loss                                                                                             |       | $          | (82,422    | )              | $          | (35,986                  | )          | $                | (1,407     | )                | $          | 37,393 |   | $ | (82,422 | ) |
|                                                                                                 |       |       |       |           |       |                     |       |             |       |             |       |   |   |   |   |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |       |       |           |       |                     |       |             |       |             |       |
| Depreciation                                                                                         |       | —     |       | 11,430         |       | 4,072                    |       | (758             | )          | 14,744           |       |
| Amortization of  intangibles                                                                         |       | —     |       | 30,802         |       | 2,694                    |       | —           |       | 33,496           |       |
| Amortization of  debt issuance costs                                                                 |       | 4,862      |       | —         |       | —                   |       | —           |       | 4,862            |       |
| Loss on early  extinguishment of debt                                                                |       | 9,744      |       | —         |       | —                   |       | —           |       | 9,744            |       |
| Stock-based  compensation                                                                            |       | —     |       | 1,541          |       | —                   |       | —           |       | 1,541            |       |
| Loss on disposal  of assets                                                                          |       | —     |       | 252            |       | 544                      |       | (114             | )          | 682              |       |
| Deferred income  taxes                                                                               |       | —     |       | (43,134        | )          | (4,087                   | )          | —           |       | (47,221          | )          |
| Non-cash income  from subsidiaries                                                                   |       | 14,447     |       | 23,122         |       | —                   |       | (37,569          | )          | —           |       |
| Provision for  doubtful accounts and sales returns                                                   |       | —     |       | 21,581         |       | 847                      |       | —           |       | 22,428           |       |
| Inventory  reserves                                                                                  |       | —     |       | 2,975          |       | 605                      |       | —           |       | 3,580            |       |
| Minority  interests                                                                                  |       | —     |       | —         |       | 415                      |       | —           |       | 415              |       |
| Excess tax  benefit associated with stock option exercises                                           |       | —     |       | (370           | )          | —                   |       | —           |       | (370             | )          |
| Acquired  in-process research and development                                                        |       | —     |       | 3,000          |       | —                   |       | —           |       | 3,000            |       |
| Net effect of  discontinued operations                                                               |       | —     |       | 378            |       | —                   |       | —           |       | 378              |       |
| Changes in  operating assets and liabilities, net of acquired assets and liabilities:                |       |       |       |           |       |                     |       |             |       |             |       |
| Accounts  receivable                                                                                 |       | —     |       | (14,442        | )          | (859                     | )          | —           |       | (15,301          | )          |
| Inventories                                                                                          |       | —     |       | 5,278          |       | 1,289                    |       | 508              |       | 7,075            |       |
| Prepaid expenses,  other assets and liabilities                                                      |       | 92         |       | 1,111          |       | 364                      |       | —           |       | 1,567            |       |
| Accounts payable  and accrued expenses                                                               |       | 2,258      |       | 11,616         |       | (831                     | )          | —           |       | 13,043           |       |
| Net cash  provided by (used in) operating activities                                                 |       | (51,019    | )          | 19,154         |       | 3,646                    |       | (540             | )          | (28,759          | )          |
| **INVESTING  ACTIVITIES:**                                                                           |       |       |       |           |       |                     |       |             |       |             |       |
| Acquisition of  businesses, net of cash acquired                                                     |       | —     |       | (1,312,678     | )          | (432                     | )          | —           |       | (1,313,110       | )          |
| Proceeds from  sale of assets held for sale                                                          |       | —     |       | 4,500          |       | 91                       |       | —           |       | 4,591            |       |
| Purchases of  property and equipment                                                                 |       | —     |       | (10,622        | )          | (3,880                   | )          | 540              |       | (13,962          | )          |
| Other                                                                                                |       | —     |       | (583           | )          | —                   |       | —           |       | (583             | )          |
| Net cash used in  investing activities                                                               |       | —     |       | (1,319,383     | )          | (4,221                   | )          | 540              |       | (1,323,064       | )          |
| **FINANCING  ACTIVITIES:**                                                                           |       |       |       |           |       |                     |       |             |       |             |       |
| Intercompany                                                                                         |       | (1,170,504 | )          | 1,160,126      |       | 10,378                   |       | —           |       | —           |       |
| Investment by  Parent                                                                                |       | —     |       | 434,599        |       | —                   |       | —           |       | 434,599          |       |
| Payments on  long-term obligations                                                                   |       | (446,126   | )          | (271,868       | )          | (427                     | )          | —           |       | (718,421         | )          |
| Proceeds from  long-term obligations                                                                 |       | 1,724,022  |       | 294            |       | 34                       |       | —           |       | 1,724,350        |       |
| Payment of debt  issuance costs                                                                      |       | (55,866    | )          | —         |       | —                   |       | —           |       | (55,866          | )          |
| Excess tax  benefit associated with stock option exercises                                           |       | —     |       | 370            |       | —                   |       | —           |       | 370              |       |
| Repurchase of  Prior Transaction Management Rollover Options                                         |       |       |       | (1,248         | )          |                     |       |             |       | (1,248           | )          |
| Dividend paid to  minority interests                                                                 |       | —     |       | —         |       | (226                     | )          | —           |       | (226             | )          |
| Net cash provided  by financing activities                                                           |       | 51,526     |       | 1,322,273      |       | 9,759                    |       | —           |       | 1,383,558        |       |
| Effect of  exchange rate changes on cash and cash equivalents                                        |       | —     |       | —         |       | 833                      |       | —           |       | 833              |       |
| **Net  increase (decrease) in cash and cash equivalents**                                            |       | 507        |       | 22,044         |       | 10,017                   |       | —           |       | 32,568           |       |
| Cash and cash  equivalents at beginning of period                                                    |       | 12         |       | 22,650         |       | 8,241                    |       | —           |       | 30,903           |       |
| Cash and cash  equivalents at end of period                                                          |       | $          | 519        |           | $          | 44,694                   |       | $                | 18,258     |             | $          | — |   | $ | 63,471 |   |

 

110

----

Tableof Contents

 

**DJO Finance LLC**

 

**CondensedConsolidating Statement of Cash Flows**

**For the Successor Period November 4,2006 through December 31, 2006**

**(in thousands)**

 
| ** **                                                                                           | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING  ACTIVITIES:**                                                                           |       |      |       |           |       |                 |       |             |       |             |       |
| Net loss                                                                                             |       | $         | (41,634    | )              | $          | (33,558              | )          | $                | (950       | )                | $          | 34,508 |   | $ | (41,634 | ) |
|                                                                                                 |       |      |       |           |       |                 |       |             |       |             |       |   |   |   |   |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |      |       |           |       |                 |       |             |       |             |       |
| Depreciation                                                                                         |       | —    |       | 1,721          |       | 627                  |       | 21               |       | 2,369            |       |
| Amortization of  intangibles                                                                         |       | —    |       | 3,608          |       | 427                  |       | —           |       | 4,035            |       |
| Amortization of  debt issuance costs                                                                 |       | 654       |       | —         |       | —               |       | —           |       | 654              |       |
| Stock-based  compensation                                                                            |       | —    |       | 105            |       | —               |       | —           |       | 105              |       |
| Asset impairment                                                                                     |       | —    |       | 1,282          |       | 134                  |       | (188             | )          | 1,228            |       |
| Deferred income  taxes                                                                               |       | —    |       | (8,427         | )          | (415                 | )          | —           |       | (8,842           | )          |
| Non-cash income  from subsidiaries                                                                   |       | 34,503    |       | (259           | )          | —               |       | (34,244          | )          | —           |       |
| Provision for  doubtful accounts and sales returns                                                   |       | —    |       | 492            |       | 21                   |       | —           |       | 513              |       |
| Inventory reserves                                                                                   |       | —    |       | 944            |       | 13                   |       | —           |       | 957              |       |
| Minority                                                                                             |       | —    |       | —         |       | 39                   |       | —           |       | 39               |       |
| In process  research and development                                                                 |       | —    |       | 25,200         |       | —               |       | —           |       | 25,200           |       |
| Net effect of  discontinued operations                                                               |       | —    |       | 457            |       | —               |       | —           |       | 457              |       |
| Changes in  operating assets and liabilities, net of acquired assets and liabilities:                |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts  receivable                                                                                 |       | —    |       | 6,043          |       | 18                   |       | —           |       | 6,061            |       |
| Inventories                                                                                          |       | —    |       | 1,346          |       | 1,726                |       | (161             | )          | 2,911            |       |
| Prepaid  expenses, other assets and liabilities                                                      |       | (21       | )          | 2,340          |       | 323                  |       | —           |       | 2,642            |       |
| Accounts payable  and accrued expenses                                                               |       | 1,631     |       | (12,691        | )          | (1,464               | )          | —           |       | (12,524          | )          |
| Net cash  provided by (used in) operating activities                                                 |       | (4,867    | )          | (11,397        | )          | 499                  |       | (64              | )          | (15,829          | )          |
| **INVESTING  ACTIVITIES:**                                                                           |       |      |       |           |       |                 |       |             |       |             |       |
| Acquisition of  businesses, net of cash acquired                                                     |       | —    |       | —         |       | (13,008              | )          | —           |       | (13,008          | )          |
| Acquisition of  ReAble (Prior Transaction)                                                           |       | —    |       | (522,072       | )          | —               |       | —           |       | (522,072         | )          |
| Purchases of  property and equipment                                                                 |       | —    |       | (1,046         | )          | (349                 | )          | 64               |       | (1,331           | )          |
| Net cash used in  investing activities                                                               |       | —    |       | (523,118       | )          | (13,357              | )          | 64               |       | (536,411         | )          |
| **FINANCING  ACTIVITIES:**                                                                           |       |      |       |           |       |                 |       |             |       |             |       |
| Investment by  Blackstone                                                                            |       | —    |       | 357,000        |       | —               |       | —           |       | 357,000          |       |
| Intercompany                                                                                         |       | (523,428  | )          | 508,702        |       | 14,726               |       | —           |       | —           |       |
| Proceeds from  long-term obligations                                                                 |       | 550,000   |       | —         |       | 370                  |       | —           |       | 550,370          |       |
| Payments on  long-term obligations                                                                   |       | (875      | )          | (335,238       | )          | —               |       | —           |       | (336,113         | )          |
| Payment of debt  issuance costs                                                                      |       | (20,818   | )          | —         |       | —               |       | —           |       | (20,818          | )          |
| Net cash  provided by financing activities                                                           |       | 4,879     |       | 530,464        |       | 15,096               |       | —           |       | 550,439          |       |
| Effect of  exchange rate changes on cash and cash equivalents                                        |       | —    |       | 824            |       | (550                 | )          | —           |       | 274              |       |
| **Net  increase (decrease) in cash and cash equivalents**                                            |       | 12        |       | (3,227         | )          | 1,688                |       | —           |       | (1,527           | )          |
| Cash and cash  equivalents at beginning of period                                                    |       | —    |       | 25,101         |       | 7,329                |       | —           |       | 32,430           |       |
| Cash and cash  equivalents at end of period                                                          |       | $         | 12         |           | $          | 21,874               |       | $                | 9,017      |             | $          | — |   | $ | 30,903 |   |

 

111

----

Table of Contents

 

**DJO Finance LLC**

 

**CondensedConsolidating Statement of Cash Flows**

**For the Predecessor Period January 1,2006 through November 3, 2006**

**(in thousands)**

 
| ** **                                                                                           | ** ** | **DJO** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|---------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING  ACTIVITIES:**                                                                           |       |    |       |           |       |                 |       |             |       |             |       |
| Net loss                                                                                             |       | $       | (46,776    | )              | $          | (70,472              | )          | $                | (1,464     | )                | $          | 71,936 |   | $ | (46,776 | ) |
|                                                                                                 |       |    |       |           |       |                 |       |             |       |             |       |   |   |   |   |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |    |       |           |       |                 |       |             |       |             |       |
| Depreciation                                                                                         |       | —  |       | 6,471          |       | 2,804                |       | (436             | )          | 8,839            |       |
| Amortization of  intangibles                                                                         |       | —  |       | 4,150          |       | 1,815                |       | —           |       | 5,965            |       |
| Amortization of debt  issuance costs                                                                 |       | —  |       | 1,765          |       | —               |       | —           |       | 1,765            |       |
| Loss on early  extinguishment of debt                                                                |       | —  |       | 9,154          |       | —               |       | —           |       | 9,154            |       |
| Non-cash  interest expense                                                                           |       | —  |       | 91             |       | —               |       | —           |       | 91               |       |
| Stock-based  compensation                                                                            |       | —  |       | 10,631         |       | —               |       | —           |       | 10,631           |       |
| Asset impairment  and loss on disposal of assets                                                     |       | —  |       | 321            |       | 317                  |       | (250             | )          | 388              |       |
| Deferred income  taxes                                                                               |       | 335     |       | (12,856        | )          | (822                 | )          | 59               |       | (13,284          | )          |
| Non-cash income  from subsidiaries                                                                   |       | 46,777  |       | 25,474         |       | —               |       | (72,251          | )          | —           |       |
| Provision for  doubtful accounts and sales returns                                                   |       | —  |       | 21,604         |       | 159                  |       | —           |       | 21,763           |       |
| Inventory  reserves                                                                                  |       | —  |       | 7,473          |       | 90                   |       | —           |       | 7,563            |       |
| Excess tax  benefit associated with stock option exercises                                           |       | —  |       | (2,543         | )          | —               |       | —           |       | (2,543           | )          |
| Minority  interests                                                                                  |       | —  |       | —         |       | 158                  |       | —           |       | 158              |       |
| Acquired in-process  research and development                                                        |       | —  |       | 2,103          |       | 1,794                |       | —           |       | 3,897            |       |
| Net effect of  discontinued operations                                                               |       | —  |       | 5,155          |       | —               |       | —           |       | 5,155            |       |
| Changes in  operating assets and liabilities, net of acquired assets and liabilities:                |       |    |       |           |       |                 |       |             |       |             |       |
| Accounts  receivable                                                                                 |       | —  |       | 3,116          |       | 2,387                |       | —           |       | 5,503            |       |
| Inventories                                                                                          |       | —  |       | (10,457        | )          | 294                  |       | 429              |       | (9,734           | )          |
| Prepaid  expenses, other assets and liabilities                                                      |       | 3,299   |       | (5,009         | )          | (108                 | )          | —           |       | (1,818           | )          |
| Accounts payable  and accrued expenses                                                               |       | 1,215   |       | 10,869         |       | (2,126               | )          | —           |       | 9,958            |       |
| Net cash  provided by (used in) operating activities                                                 |       | 4,850   |       | 7,040          |       | 5,298                |       | (513             | )          | 16,675           |       |
| **INVESTING  ACTIVITIES:**                                                                           |       |    |       |           |       |                 |       |             |       |             |       |
| Acquisition of  businesses, net of cash acquired                                                     |       | —  |       | (4,340         | )          | 2,547                |       | —           |       | (1,793           | )          |
| Acquisition of  intangible assets                                                                    |       | —  |       | (110           | )          | (134                 | )          | —           |       | (244             | )          |
| Purchases of  property and equipment                                                                 |       | —  |       | (10,297        | )          | (2,520               | )          | 513              |       | (12,304          | )          |
| Proceeds from  sale of assets                                                                        |       | —  |       | 69             |       | —               |       | —           |       | 69               |       |
| Net cash used in  investing activities                                                               |       | —  |       | (14,678        | )          | (107                 | )          | 513              |       | (14,272          | )          |
| **FINANCING  ACTIVITIES:**                                                                           |       |    |       |           |       |                 |       |             |       |             |       |
| Intercompany                                                                                         |       | (9,477  | )          | 7,330          |       | 2,147                |       | —           |       | —           |       |
| Proceeds from  long-term obligations                                                                 |       | —  |       | 25,300         |       | —               |       | —           |       | 25,300           |       |
| Payments on long-term  obligations                                                                   |       | —  |       | (20,791        | )          | (4,629               | )          | —           |       | (25,420          | )          |
| Payment of debt  issuance costs                                                                      |       | —  |       | (10            | )          | —               |       | —           |       | (10              | )          |
| Excess tax  benefit associated with stock options                                                    |       | —  |       | 2,543          |       | —               |       | —           |       | 2,543            |       |
| Proceeds from  issuance of common stock                                                              |       | 9,002   |       | —         |       | —               |       | —           |       | 9,002            |       |
| Proceeds from  notes received for sale of common stock                                               |       | 846     |       | —         |       | —               |       | —           |       | 846              |       |
| Net cash  provided by (used in) financing activities                                                 |       | 371     |       | 14,372         |       | (2,482               | )          | —           |       | 12,261           |       |
| Effect of  exchange rate changes on cash and cash equivalents                                        |       | —  |       | —         |       | 566                  |       | —           |       | 566              |       |
| **Net  increase in cash and cash equivalents**                                                       |       | 5,221   |       | 6,734          |       | 3,275                |       | —           |       | 15,230           |       |
| Cash and cash  equivalents at beginning of period                                                    |       | 308     |       | 13,588         |       | 3,304                |       | —           |       | 17,200           |       |
| Cash and cash  equivalents at end of period                                                          |       | $       | 5,529      |           | $          | 20,322               |       | $                | 6,579      |             | $          | — |   | $ | 32,430 |   |

 

112

----

Table of Contents

 

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

 

## **None.**

## ** **

## **ITEM9A(T).  CONTROLS AND PROCEDURES**

## ** **

**MANAGEMENT’SEVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES**

 

We maintain disclosurecontrols and procedures (as the term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934) that are designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to management, including our Chief Executive Officer and our ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.

 

Any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives.  Under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, we conducted an evaluation ofthe effectiveness of our disclosure controls and procedures.  Based on this evaluation and subject to theforegoing, our Chief Executive Officer and our Chief Financial Officer concludedthat, our disclosure controls and procedures were effective at December 31,2008, to accomplish their objectives at the reasonable assurance level.

 

In addition, there hasbeen no change in our internal control over financial reporting (as that termis defined in Rules 13a-15(f) and 15d-15(f) under the SecuritiesExchange Act of 1934) that occurred during the fourth quarter ended December 31,2008 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**MANAGEMENT’SREPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting.  The Company’s internal control over financialreporting is designed to provide reasonable assurances regarding thereliability of financial reporting and the preparation of the consolidatedfinancial statements of the Company in accordance with U.S. generally acceptedaccounting principles. Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree or compliance with the policies or procedures may deteriorate.

 

 With the participation of our Chief ExecutiveOfficer and our Chief Financial Officer, our management conducted an evaluationof the effectiveness of our internal control over financial reporting as of December 31,2008 based on the framework in *InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission.  Based on our evaluation under the framework in *InternalControl—Integrated Framework,*our management has concluded that theCompany’s internal control over financial reporting is effective as of December 31,2008.

 

This annual report doesnot include an attestation report of our registered public accounting firmregarding internal control over financial reporting. Management’s report wasnot subject to attestation by our registered public accounting firm pursuant totemporary rules of the Securities and Exchange Commission that permit usto provide only management’s report in this Annual Report.

 

**ITEM9B.  OTHER INFORMATION**

 

None.

 

113

----

Table ofContents

 

**PART III.**

 

## **ITEM10.  DIRECTORS, EXECUTIVE OFFICERS ANDCORPORATE GOVERNANCE**

## ** **

The following table setsforth information about our directors and executive officers of our parent,DJO.  The executive officers of DJO arealso the executive officers of DJOFL.

 
| **Name**              | ** ** | **Age** | ** ** | **Position**                                                     |
|-----------------------|------------|---------|------------|------------------------------------------------------------------|
| Leslie H. Cross       |       | 58      |       | President, Chief  Executive Officer and Director                 |
| Vickie L. Capps       |       | 47      |       | Executive Vice  President, Chief Financial Officer and Treasurer |
| Luke T. Faulstick     |       | 45      |       | Executive Vice  President and Chief Operating Officer            |
| Donald M. Roberts     |       | 60      |       | Executive Vice  President, General Counsel and Secretary         |
| Thomas A. Capizzi     |       | 50      |       | Executive Vice  President, Global Human Resources                |
| Chinh E. Chu          |       | 42      |       | Chairman of the Board                                            |
| Julia Kahr            |       | 30      |       | Director                                                         |
| Sidney Braginsky      |       | 71      |       | Director                                                         |
| Bruce McEvoy          |       | 31      |       | Director                                                         |
| Phillip J. Hildebrand |       | 56      |       | Director                                                         |
| Lesley Howe           |       | 64      |       | Director                                                         |
| Paul LaViolette       |       | 51      |       | Director                                                         |

 

*Leslie H.Cross—President, Chief Executive Officer and Director.*  Mr. Cross was appointed Chief ExecutiveOfficer of DJO and DJOFL as of the effective date of the DJO Merger and wasappointed President in May 2008. Prior to the DJO Merger, Mr. Crosswas the Chief Executive Officer and President and a member of the board ofdirectors of DJO Opco since August 2001. He served as the Chief ExecutiveOfficer and a Manager of DonJoy, L.L.C., from June 1999 until November 2001,and has served as President of DJO, LLC, or its predecessor, the Bracing &Support Systems division of Smith & Nephew, Inc., since June 1995.From 1990 to 1994, Mr. Cross held the position of Senior Vice President ofMarketing and Business Development of the Bracing & Support Systemsdivision of Smith & Nephew. He was a Managing Director of twodifferent divisions of Smith & Nephew from 1982 to 1990. Prior to thattime, he worked at American Hospital Supply Corporation. Mr. Cross earneda diploma in medical technology from Sydney Technical College in Sydney,Australia and studied business at the University of Cape Town in Cape Town,South Africa.

 

*VickieL. Capps—Executive Vice President, Chief Financial Officer and Treasurer.*  Ms. Capps was appointed Executive VicePresident, Chief Financial Officer and Treasurer of DJO and DJOFL as of theeffective date of the DJO Merger. Ms. Capps is also responsible formanaging our international business. Prior to the DJO Merger, Ms. Capps served as the Executive VicePresident, Chief Financial Officer and Treasurer of DJO Opco since July 2002.From September 2001 until July 2002, Ms. Capps was employed byAirFiber, a privately held provider of broadband wireless solutions, where sheserved as Senior Vice President, Finance and Administration and Chief FinancialOfficer. From July 1999 to July 2001, Ms. Capps served as VicePresident of Finance and Administration and Chief Financial Officer for MaxwellTechnologies, Inc., a publicly traded technology company. From 1992 to1999, Ms. Capps served in various positions, including Chief FinancialOfficer, with Wavetek Wandel Goltermann, Inc., a multinationalcommunications equipment company. Ms. Capps also served as a senior audit andaccounting professional for Ernst & Young LLP from 1982 to 1992. Ms. Cappsis a California Certified Public Accountant and received a B.S. degree inbusiness administration/accounting from San Diego State University.  Ms Capps currently serves on the board ofdirectors and is a member of the audit committee of SenoRx, Inc., apublicly traded medical device company.

 

*Luke T.Faulstick—Executive Vice President and Chief Operating Officer. *Mr. Faulstick wasappointed President, Global Operations as of the effective date of the DJOMerger and his title was changed to Executive Vice President and ChiefOperating Officer in May 2008. Previously, Mr. Faulstick served as Chief Operating Officer of DJOOpco from March 2006 to November 2007, Senior Vice President ofOperations from August 2003 to March 2006 and Vice President ofOperations from August 2001 to August 2003.  From 1998 to June 2001, Mr. Faulstickserved as General Manager for Tyco Healthcare. From 1996 to 1998, Mr. Faulstickserved as Plant Manager for Mitsubishi Consumer Electronics. In 1994, hestarted a contract manufacturing business that supplied products to themedical, electronic and photographic industries. Mr. Faulstick began hiscareer in 1985 working for Eastman Kodak Company in Rochester New York where heheld various positions in Engineering, Marketing, and Product Research andDevelopment.  He currently serves on theboard of directors of Power Partners, Inc., a privately held powertransmission manufacturer. Mr. Faulstick received a B.S. in engineeringfrom Michigan State University and an M.S. in engineering from RochesterInstitute of Technology.

 

114

----

Table of Contents

 

*DonaldM. Roberts—Executive Vice President, General Counsel and Secretary.*  Mr. Roberts was appointed Executive VicePresident, General Counsel and Secretary of DJO and DJOFL as of the effectivedate of the DJO Merger. Prior to the DJO Merger, Mr. Roberts served asSenior Vice President, General Counsel and Secretary of DJO Opco since December 2002.From 1994 to December 2002, Mr. Roberts served as Vice President,Secretary and General Counsel for Maxwell Technologies, Inc., a publiclyheld technology company. Previous to that, he was with the Los Angeles—basedlaw firm of Parker, Milliken, Clark, O’Hara & Samuelian for21 years. Mr. Roberts was a shareholder in the firm, having served aspartner in a predecessor partnership. Mr. Roberts received his undergraduatedegree in political science from Yale University and earned his J.D. at theUniversity of California, Berkeley, Boalt Hall School of Law.

 

*Thomas A.Capizzi—Executive Vice President, Global Human Resources.*  Mr. Capizzi was appointed Executive VicePresident, Global Human Resources of DJO and DJOFL as of the effective date ofthe DJO Merger. Prior to the DJO Merger, Mr. Capizzi served as Senior VicePresident, Human Resources of DJO Opco since July 2007. From 2001 to July 2007,Mr. Capizzi served as Vice President, Worldwide Human Resources &Administration for Magellan GPS a Consumer Electronics Company. Previous tothat from 1999 to 2001, he was Vice President, HR, Chief Administrative Officerfor PCTEL a publicly held Telecommunications and Modem Technology Company. From1997 to 1999 he served as Corporate Vice President, Human Resources forMcKesson a Medical Distribution and Pharmaceutical Solution company. Mr. Capizzihas held various other Human Resources Management positions in companies suchas Charles Schwab, Genentech, PepsiCo and The Hertz Corporation. Mr. Capizzibrings well over 25 years of Human Resources experience. Mr. Capizzireceived his undergraduate degree in Psychology and Philosophy from CathedralCollege/St. John University and his post graduate work in OrganizationalDevelopment from the New School.

 

*Chinh E.Chu—Chairman of the Board.* Mr. Chu became one of DJO’s directors and one of our managersimmediately after the completion of the Prior Transaction and became Chairmanof the Board in January 2009. Mr. Chu is a senior managing directorof The Blackstone Group. Since joining Blackstone in 1990, Mr. Chu has ledthe execution of Blackstone’s investments in Healthmarkets, Inc., SunGuardData Systems Inc., Nalco, Celanese, Nycomed and LIFFE. He has also beeninvolved in the execution of Blackstone’s investments in Graham Packaging,Sirius Satellite Radio, StorageApps, Haynes International, PrimeSuccession/Rose Hills, Interstate Hotels, HFS and Alco Holdings. Before joiningBlackstone, Mr. Chu worked at Salomon Brothers in the Mergers &Acquisitions Department. Mr. Chu currently serves on the boards ofdirectors of Catalent, Celanese Corporation, Financial Guaranty InsuranceCompany, Graham Packaging, SunGard Data Systems Inc. and Healthmarkets, Inc.

 

*JuliaKahr—Director.*  Ms. Kahrbecame one of DJO’s directors and one of our managers immediately after thecompletion of the Prior Transaction. Ms. Kahr is currently a principal ofThe Blackstone Group. Before joining Blackstone in 2004, Ms. Kahr was aProject Leader at the Boston Consulting Group, where she worked with companiesin a variety of industries, including financial services, pharmaceuticals,media and entertainment, and consumer goods. Ms. Kahr is also the soleauthor of Working Knowledge, a book published by Simon & Schuster in1998.

 

*SidneyBraginsky—Director.*  Mr. Braginskybecame one of DJO’s directors on December 14, 2006. Mr. Braginsky hasbeen President, Chief Executive Officer and Chairman of the Board of AtroposTechnology, LLC since July 2000. Mr. Braginsky also serves aschairman and managing Director of Double D (Devices and Diagnostics) a VentureCapital Fund and is Chairman and CEO of Digilab LLC, a molecular spectroscopydivision acquired by Atropos in 2001. Double D and Digilab LLC are bothaffiliated with Atropos Technology, LLC. Before joining Atropos, Mr. Braginskyserved as President of Olympus America, Inc. where he built a largebusiness focused on optical products. Prior to Olympus America, Mr. Braginskyserved as President and Chief Operating Officer of Mediscience TechnologyCorp., a designer and developer of diagnostic medical devices for cancerdetection.  Mr. Braginsky currentlyserves on the board of directors and audit committees of Noven Pharmaceuticals, Inc.,Diomed Holdings, Inc., Electro—Optical Sciences, Inc. and GenevaAcquisition Corp.

 

*BruceMcEvoy—Director.*  Mr. McEvoybecame one of DJO’s directors in August 2007. Mr. McEvoy has been anAssociate at The Blackstone Group since 2006. Before joining Blackstone, Mr. McEvoyworked as an Associate at General Atlantic from 2002 to 2004 and was aconsultant at McKinsey & Company from 1999 to 2002. Mr. McEvoyreceived an M.B.A. from Harvard Business School in 2006. Mr. McEvoycurrently serves on the boards of directors of Catalent, RGIS InventoryServices and Vistar.

 

*Phillip J.Hildebrand — Director*. Mr. Hildebrand became one of DJO’s directors in December 2008.  Mr. Hildebrand serves as President,Chief Executive Officer and a director of HealthMarkets, Inc., a companyin which affiliates of The Blackstone Group own a 55.6% equity interest.  An affiliate of The Blackstone Group ownssubstantially all of the capital stock of DJO Incorporated. Mr. Hildebrandis also Chairman, President and Chief Executive Officer of The MEGA Life andHealth Insurance Company, Mid—West National Life Insurance Company ofTennessee, The Chesapeake Life Insurance Company and Fidelity First InsuranceCompany.  Before joining HealthMarkets, Mr. Hildebrandspent 33 years at the New York Life Insurance Company, retiring in 2008 as ViceChairman.

 

115

----

Tableof Contents

 

*Lesley Howe– Director*.  Mr. Howebecame one of DJO’s directors in January 2009.  Mr. Howe has over 40 years of financialaccounting and management experience.  He was with KPMGfor 30 years until his retirement as Area Managing Partner/Managing Partner ofthat firm’s Los Angeles office.  From2001 until its sale in 2007, Mr. Howe served as CEO of Consumer NetworksLLC, a privately owned San Diego based internet marketing firm.  Mr. Howe served on the Board ofDirectors of DJO Opco from October 2002 to the date of the DJOMerger.  Mr. Howe currently serveson the boards of directors of NuVasive, Inc.,Volcano Corporation, P.F.Chang’s China Bistro Inc. and Jamba Inc.

 

*PaulLaViolette – Director*. Mr. LaViolette became one of DJO’s directors in January 2009.  Mr. LaViolette is a Venture Partner withSV Life Sciences, a capital advisor and manger in the human life sciencessector.  Mr. LaViolette served as Chief OperatingOfficer of Boston Scientific Corporation, a worldwide leader in less invasivemedical devices, from 2004 until the end of 2008.  Prior to 2004, Mr. LaViolette heldmarketing and general management positions at CR Bard, and various marketingroles at The Kendall Company, at that time a subsidiary of ColgatePalmolive.  He currently serves on the boards of directors of TranS1, Inc.(public), DirectFlow Medical, Inc. (private) and Conceptus Incorporated(private).  He previously served on theboard of directors and on the Executive Committee of the Advanced MedicalTechnology Association (ADVAMED), the world’s largest medical technologyassociation as well as on the boards of directors of Urologix, Inc.(public) and Percutaneous Valve Technologies, Inc. (private).

 

**CORPORATEGOVERNANCE MATTERS**

 

*Code ofEthics.* OurBusiness Ethics Policy and Code of Conduct, Code of Conduct for the Board ofDirectors, and Code of Ethics for the Chief Executive Officer and SeniorExecutives and Financial Officers are available, free of charge, on the Company’swebsite at *www.DJOglobal.com*.Please note, however, that the information contained on the website is notincorporated by reference in, or considered part of, this Annual Report.  We will post any amendments to the Code of Ethics,and any waivers that are required to be disclosed by the SEC rules on ourwebsite within the required time period. We will also provide copies of these documents, free of charge, to any securityholderupon written request to:  Director,Investor Relations, DJO Incorporated, 1430 Decision Street, Vista, California92081-8553.

 

*AuditCommittee*.  Until January 2009,our Audit Committee consisted of three appointed Directors, Mr. SidneyBraginsky (Chairman), Ms. Kahr and Mr. McEvoy.  In January 2009, Mr. Howe wasappointed to the Audit Committee and as Chairman of that Committee.  As a privately held company, our AuditCommittee is not required to be composed of only independent directors.  We believe that Messrs. Howe andBraginsky each meet the definition of an independent director under the Rules ofthe New York Stock Exchange.  Our Boardof Directors has determined that Mr. Howe is an “audit committee financialexpert” as defined in SEC Regulation S-K Item 407 (d)(5). Our Boardof Directors also believes that the other members of the Audit Committee haverequisite levels of financial literacy and financial sophistication to enablethe Audit Committee to be effective in relation to the purposes outlined in itscharter and in light of the scope and nature of our business and financialstatements.

 

*Compensation Committee*.  The Compensation Committee of the DJO Boardconsists of three appointed Directors,  Mr. Chu,Ms. Kahr, and Mr. McEvoy. Because DJO is a privately held company, the Compensation Committee isnot required to be composed of independent directors.

 

**ITEM11.  EXECUTIVE COMPENSATION**

 

**CompensationDiscussion and Analysis**

 

Overview

 

The followingCompensation Discussion and Analysis describes the objectives of our executiveCompensation Program and the material elements of compensation for ourexecutive officers identified under Item 11. “Executive Compensation — SummaryCompensation Table” (the “Named Executive Officers” or “NEOs”), along with therole the Compensation Committee of the DJO Board of Directors (the “CompensationCommittee”) in reviewing and making decisions regarding our executivecompensation program.

 

116

----

Table ofContents

 

*Role of the Compensation Committee in EstablishingCompensation*

 

The CompensationCommittee establishes salaries and reviews benefit programs for the ChiefExecutive Officer (“CEO”) and each of our other executive officers; reviews, approves,recommends and administers our annual incentive compensation and stock optionplans for employees and other compensation plans; advises the DJO Board andmakes recommendations with respect to plans that require Board approval; andapproves employment agreements with our executive officers. The CompensationCommittee establishes and maintains our executive compensation program throughinternal evaluations of performance, consultation with various executivecompensation consultants, and analysis of compensation practices in industrieswhere we compete for experienced senior management.  The Compensation Committee reviews ourcompensation programs and philosophy regularly, particularly in connection withits evaluation and approval of changes in the compensation structure for agiven year. The Compensation Committee met five times during 2008.  Three of the five meetings were not separatefrom the DJO Board and the other two meetings included only Compensation Committeemembers.  The CEO makes recommendationsfor the salaries for executive officers other than himself and reviews suchrecommendations with the Compensation Committee.

 

Objectivesof Our Compensation Program

 

Our executivecompensation program is designed to attract, retain, and reward talented seniormanagement who can contribute to our growth and success and thereby buildlong-term value for our stockholders. We believe that an effective executivecompensation program is critical to our long-term success. By having anexecutive compensation program that is competitive with current market practiceand focused on driving superior and enduring performance, we believe we canalign the interests of our executive officers with the interests ofstockholders and reward our executive officers for successfully improvingstockholder returns. Our compensation program has the following objectives:

 
| · |   | attract and  retain talented senior management to ensure our future success;                                                                                                                                                                                                                |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · |   | encourage a  pay-for-performance mentality by directly relating variable compensation  elements to the achievement of financial and strategic objectives;                                                                                                                                   |
| · |   | promote a  direct relationship between executive compensation and the interests of our  stockholders, with long-term incentive compensation that links a significant  portion of executive compensation to our sustained performance through stock  option and restricted stock awards; and |
| · |   | structure a  compensation program that appropriately rewards our executive officers for  their skills and contributions to our company based on competitive market  practice.                                                                                                               |

 

TheElements of Our Executive Compensation Program

 

The elements of ourexecutive compensation program are as follows:

 
| · |   | Base salary;                                                                   |
|--------|--------|--------------------------------------------------------------------------------|
| · |   | Annual and quarterly  cash incentive compensation (performance-based bonuses); |
| · |   | Equity-based awards;                                                           |
| · |   | Other benefits; and                                                            |
| · |   | Benefits upon  termination of employment                                       |

 

*BaseSalary.*Basesalaries provide a fixed form of compensation designed to reward our executiveofficer’s core competence in his or her role. The Compensation Committee determines base salaries by takinginto consideration such factors as competitive industry salaries; the nature ofthe position; the contribution and experience of the officers; and the lengthof service.

 

*Annualand Quarterly Cash Incentive Compensation. *Performance-based cash incentive compensation isprovided to motivate our executive officers for each quarter and for the fullyear to pursue objectives that the Compensation Committee believes areconsistent with the overall goals and long-term strategic direction that theDJO Board has set for our company.

 

In November 2006,the Compensation Committee adopted a multi-year bonus plan (“the “Prior BonusPlan”).  The Prior Bonus Plan containedmost of the elements of the 2008 bonus plan described below.  Following the DJO Merger in 2007, theCompensation Committee replaced the Prior Bonus Plan with a new bonus planwhich reflected the significant increase in size and changes in structure ofthe Company.  This new bonus plan waseffective on January 1, 2008 (the “2008 Bonus Plan”).   The basic structure of the 2008 Bonus Planwas intended to remain in effect from year to year, although the

 

117

----

Table of Contents

 

targets would beseparately established for each year.  InFebruary 2009, the Compensation Committee approved modifications to the2008 Bonus Plan applicable to the NEOs for the fiscal year 2009, as describedin “2009 Changes to Bonus Plan” below. The 2008 Bonus Plan in effect for 2008 consisted of two separatecomponents as described below:

 

·                              TargetBonus.  For 2008, each NEO waseligible to earn a target bonus amount of up to 60% of the NEO’s base salary ineffect during the year, calculated on a weighted average monthly basis usingthe base salary in effect on the first day of each month, based upon theachievement of free cash flow and Adjusted EBITDA (each as defined below)targets for each quarter and the full year. Payment of the target bonus is contingent upon (1) the NEO’sfulfillment of individual performance goals, and (2) the NEO’s continuedemployment with us through the specified payment date for the bonus.  Subject to these contingencies the targetbonus is earned and payable on a quarterly and annual basis, with 12.5% of thetarget bonus available to be earned each quarter based on Adjusted EBITDA andfree cash flow results for the quarter and 50% available to be earned based onannual results.  For the quarterly and annualtarget bonus, partial achievement is available. For each quarter and for the year, 40% of the target bonus is payable ifat least 90% of the performance targets are met, with payout amounts proratedon a pre-determined scale between 90% and 100% of performance targetachievement.

 

·                              SupplementalBonus.  For 2008, each NEO waseligible to earn a supplemental bonus amount of up to an additional 60% of theNEO’s base salary in effect during the year, calculated on a weighted averagemonthly basis using the base salary in effect on the first day of each month,based upon the achievement of certain higher amounts of free cash flow andAdjusted EBITDA targets for such plan year. As with the target bonus, paymentof the supplemental bonus is contingent upon the NEO’s fulfillment ofindividual performance goals, and the NEO’s continued employment with usthrough the specified payment date for the bonus.  The supplemental bonus is payable only on anannual basis, with the full 60% supplemental bonus payable if 110% or more ofthe performance targets are achieved and the NEO meets individual performancegoals.  The supplemental bonus payoutwill be prorated on a pre-determined scale between zero and 60% of target bonusfor achievement between 100% and 110% of annual performance targets.

 

For determining whetherthe performance targets are met, Adjusted EBITDA will be weighted at 70% andfree cash flow at 30%. Free cash flow, for the purposes of the 2008 Bonus Plan,is calculated as Adjusted EBITDA, as defined below, less capital expenditures,and adjusted for changes in operating working capital.  Adjusted EBITDA, for the purposes of theBonus Plan, is calculated as earnings before interest, income taxes,depreciation and amortization, further adjusted for non-cash items,non-recurring items and other adjustment items pursuant to the definition ofconsolidated EBITDA contained in the credit agreement for our Senior SecuredCredit Facility, excluding forward cost savings as determined by the Board ofDirectors.  The Compensation Committeeselected Adjusted EBITDA and free cash flow as the relevant company-wideperformance criteria because the Compensation Committee believes that thesecriteria are consistent with the overall goals and long-term strategicdirection that the DJO Board has set for DJO. Further, these criteria areclosely related to or reflective of DJO’s financial and operationalimprovements, growth and return to shareholders. Adjusted EBITDA is animportant non-GAAP valuation tool that potential investors use to measure ourcompany’s profitability and liquidity against other companies in our industry.Free cash flow is another non-GAAP measurement tool that our management uses toassess how well we are achieving our goal of reducing our outstanding debt overtime, which also contributes to creation of value for our shareholders andcreditors.   The particular targets forthese performance metrics selected for purposes of the 2008 Bonus Plan were thesame targets that apply to determine whether recipients of stock options vestin part of their stock options in 2008, as discussed further in the equitycompensation discussion.  We have notdisclosed the specific performance targets because the Compensation Committeebelieves such information constitutes confidential financial information, thedisclosure of which would cause competitive harm to DJO.  As a result of the actual performance in2008, approximately 70% of the target bonus was achieved and no portion of thesupplemental bonus was achieved.

 

118

----

Table of Contents

 

*2009Changes to Bonus Plan*. In February 2009, the Compensation Committee approved the bonusplan for 2009 (“2009 Bonus Plan”) for the executive officers of the Companybased upon the structure of the 2008 Bonus Plan, with certain modifications tothe financial metrics used for determining whether the performance bonusportion has been met.  As with the 2008Bonus Plan, each executive officer will have the opportunity to earn up to 60%of such executive’s annual base salary as a target bonus, and 50% of the annualbonus can be earned based on certain quarterly financial results and theremaining 50% can be earned based on the overall 2009 financial results.  The portion of the bonus that can be earnedin each of the fiscal quarters will be divided among the four quarters inproportion to the budgeted quarterly contribution of the particular quarter tothe annual 2009 budgeted amount of each of the financial performance goalsdescribed below.  The 2009 Bonus Plancontains quarterly and annual Adjusted EBITDA goals that will determine whether60% of the applicable bonus opportunity is earned; quarterly and annualoperating free cash flow goals that will determine whether 20% of theapplicable bonus opportunity is earned; and quarterly and annual revenue goalsthat will determine whether the remaining 20% of the applicable bonusopportunity is earned.  At the end ofeach quarter and the full year, the bonus opportunity will be determined basedon whether the applicable financial targets have been met, and if one or moresuch targets have been met, the available portion of the target bonus will bepaid if the individual executive officer has otherwise met individualperformance goals.  The 2009 Bonus Planprovides for the payment of as little as 40% of the target bonus if the Company’sfinancial performance falls short of the applicable goal by less than 2.5% forrevenue, 5% for operating free cash flow and 6.5% for Adjusted EBITDA.  Likewise, the 2009 Plan provides for thepayment of an additional supplemental bonus of up to the amount of the targetbonus if the Company’s financial performance exceeds the applicable goal by upto 2.5% of revenue, 5% of operating free cash flow and 6.5% of AdjustedEBITDA.  The effects of foreign currencytranslation are excluded from the financial calculations under the 2009 BonusPlan, and if one or more quarterly bonuses have been paid but the Company’sannual adjusted EBITDA for 2009 falls below a minimum threshold, the executiveofficers will be required to repay all such quarterly bonuses that hadpreviously been paid during 2009.  TheCompensation Committee’s decision to include the level of revenues as aperformance metric reflects the Committee’s view that it is important to theCompany to provide additional focus on revenue growth in 2009.

 

*RetentionBonus*.  In connectionwith the DJO Merger, each of our executive officers entered into an agreementto receive a retention bonus, of which 50% was paid in January 2008 and50% was paid in January 2009. The terms of the retention bonus agreementrequired each executive officer to repay the retention bonus received if his orher employment with us was terminated prior to January 1, 2009, the datethrough which the bonus was earned, other than by reason of death, disability,or a termination by us without cause. Except for Peter Baird, the Company’s former President whose employmentwas terminated in May 2008, all the NEOs served until December 31,2008 and received their full retention bonus. Mr. Baird received certain severance benefits pursuant to aSeparation Agreement and General Release, including the right to retain theretention bonus previously paid to him.

 

*EquityCompensation. *Inconnection with the acquisition of ReAble by Blackstone in November 3,2006, the Compensation Committee adopted the 2006 Stock Incentive Plan (the “2006Stock Incentive Plan”).  The purpose ofthe 2006 Stock Incentive Plan was to promote the interests of us and ourshareholders by enabling selected key employees to participate in our long-termgrowth by receiving the opportunity to acquire shares of ReAble common stockand to provide for additional compensation based on appreciation in ReAblecommon stock.  In connection with the DJOMerger, we terminated the 2006 Stock Incentive Plan and adopted the DJOIncorporated 2007 Incentive Stock Plan (the “2007 Incentive Stock Plan”) whichprovides for the grant of stock options and other stock-based awards to keyemployees, directors and consultants, including the executive officers.Outstanding options to purchase DJO common stock originally issued under the2006 Stock Incentive Plan are now governed by the terms of the 2007 Incentive StockPlan.  In addition, DJO adopted a form ofstock option agreement (the “DJO Form Option Agreement”) for awards underthe 2007 Incentive Stock Plan.  Under theDJO Form Option Agreement, one-third of the stock options will vest over aspecified period of time (typically five years) contingent solely upon theawardee’s continued employment with us. Another one-third of the stock options will vest over a specifiedperformance period (typically five years) from the grant date upon theachievement of pre-determined performance targets over time, consisting ofAdjusted EBITDA and free cash flow as defined in the DJO Form OptionAgreement, while the final one-third vests based upon achieving a higher levelof such Adjusted EBITDA and free cash flow performance targets.  The DJO Form Option Agreement includescertain forfeiture provisions upon an awardee’s separation from service withus.  The Compensation Committeedetermines whether to grant options and the exercise price of the optionsgranted. The Committee has broad discretion in determining the terms,restrictions and conditions of each award granted under the 2007 Incentive StockPlan, provided that no options may be granted after November 20, 2017 andno option may be exercisable after ten years from the date of grant.  All option awards granted under the 2007Incentive Stock Plan will have an exercise price equal to the fair market valueof DJO’s common stock on the date of grant. Fair market value is defined underthe 2007 Incentive Stock Plan to be the closing market price of a share of DJO’scommon stock on the date of grant or if no market price is available, the fairmarket value as determined by the Board of Directors.  The Compensation Committee retains thediscretion to make equity awards at any time in connection with the initialhiring of a new employee, for retention purposes, or otherwise. We do not haveany program, plan or practice to time annual or ad hoc grants of stock optionsor other equity-based awards in coordination with the release of materialnon-public information or otherwise. The 2007 Incentive Stock Plan may beamended or terminated at any time by the DJO Board. However, any amendment thatwould require shareholder approval in order for the 2007 Incentive Stock Planto continue to meet any applicable legal or regulatory requirements will beeffective only if it is approved by DJO’s shareholders. A total of 7,500,000shares of DJO common stock are authorized for issuance under the 2007 IncentiveStock Plan.  Equity awards under the 2007Incentive Stock Plan may be in the form of options or other stock-basedawards.  Options can be either incentivestock options or non-qualified stock options.

 

In connection with theDJO Merger, certain members of DJO Opco management were permitted to exchange aportion of their DJO Opco stock options for options to purchase an aggregate of1,912,577 shares of DJO common stock granted under the 2007 Incentive Stock Planon a tax-deferred basis (the “DJO Management Rollover Options”).  The exerciseprice and number of shares underlying such options were each adjusted inproportion to the relative market values of DJO Opco’s and DJO’s common stockupon the closing of the DJO Merger.  All of the DJO Management RolloverOptions were fully vested and the replacement options remained subject to thesame terms as were applicable to the original options.

 

119

----

Table of Contents

 

InFebruary 2008, we granted options for a total of 1,860,055 shares (“Options”)under the 2007 Stock Incentive Plan to our executive officers who are NEOs, Mr. Cross,Ms. Capps, Mr. Roberts, Mr. Faulstick, Mr. Capizzi, as wellas to Mr. Baird, our former President.  The Options have a term often years from the date of grant and an exercise price of $16.46 per share. TheOptions vest in accordance with the following schedule: (a) one-third ofthe Option shares constitute, and may be purchased pursuant to the provisionsof the Time-Based Tranche (defined below), (b) one-third of the Optionshares constitute and may be purchased pursuant to the provisions of thePerformance-Based Tranche (defined below), and (c) one-third of the Optionshares constitute and may be purchased pursuant to the provisions of theEnhanced Performance-Based Tranche (defined below).  The Options becameexercisable with respect to 25% of the Time-Based Tranche on December 31,2008, and become exercisable with respect to 20% of the Time-Based Tranche on December 31,2009, 18.33% of the Time-Based Tranche on December 31, 2010 and 2011, and18.34% on December 31, 2012 if such optionee remains employed with us orany of our subsidiaries or affiliates as of each such date.  Each of thePerformance-Based and Enhanced Performance-Based Tranches contain AdjustedEBITDA and Free Cash Flow targets, with the Enhanced Performance-Based Trancherequiring greater performance than the Performance-Based Tranche.  Theoptionee was entitled to earn the right to exercise the Option to purchase 25%of the Performance-Based or both the Performance-Based and EnhancedPerformance-Based Tranches on December 31, 2008 if the applicableperformance targets were achieved, and may earn the right to exercise theoption to purchase 20% of the Performance-Based or both the Performance-Basedand Enhanced Performance-Based Tranches on December 31, 2009 if theapplicable performance targets are achieved, 18.33% of the Performance-Based orboth the Performance-Based and Enhanced Performance-Based Tranches on December 31,2010 and 2011, and 18.34% of the Performance-Based or both thePerformance-Based and Enhanced Performance-Based Tranches on December 31,2012, if the applicable performance targets are achieved as of such dates, andprovided that the optionee remains employed with us or any of our subsidiariesor affiliates as of each such date.  The optionee may earn 90% of theannual portion of a given performance Tranche, upon acheivement of anestablished threshold “base case” for the Adjusted EBITDA and free cashflow.  The Adjusted EBITDA and free cash flowtargets established by the Compensation Committee for vesting purposes asdescribed above represent, as to the target levels, reasonably challengingperformance criteria in the judgment of the Compensation Committee,particularly in light of the significant integration challenges and synergygoals relating to the DJO Merger. Meeting the enhanced performance criteria will be difficult and willrequire superior performance by the Company’s management.  The financial targets for thePerformance-Based and Enhanced Performance-Based Tranches were not met for2008.

 

*Changes to 2008 Option Awards*.  In March 2009, the Compensation Committeedetermined that it would be in the best interests of the Company and itsshareholders to make certain modifications to the options that were granted in2008 to the NEOs and other members of management to reflect the significantchallenges faced by management and the Company in connection with theintegration activities associated with the DJO Merger and as a result of thesevere economic environment.  TheCompensation Committee also desired to broaden management’s focus to includecertain measures of longer-term shareholder value. As a result, theCompensation Committee made the following modifications to the outstandingoptions and to the 2007 Incentive Stock Plan:

 

1.              Nochanges were made to the Time-Based Tranche.

 

2.              Theperformance conditions for the portion of the options within the Performance-BasedTranche that vest based on 2009 financial performance were modified to requireachievement of the levels of Adjusted EBITDA and free cash flow that wererecently established in February 2009 in connection with the Company’s 2009budget process. As with the original terms of such options, the optionees mayearn 80% or more of such portion of options upon achievement of at least 93.5%of the budgeted Adjusted EBITDA and 95% of the free cash flow targets for 2009.The financial targets for the Performance-Based Tranches for years 2010-2012remain unchanged. 

 

3.              Thevesting provisions of the Performance-Based Tranche were modified to providethat upon achievement of the annual target for a given year, the annual portionof the tranche associated with all prior years will also vest to the extent notpreviously vested.  For example, thefinancial targets for 2008 were not met and if the financial performancetargets for 2009 and 2010 are not met, but the financial target for 2011 ismet, then the portion of the Performance-Based Tranche that did not previouslyvest for years 2008, 2009 and 2010 would also vest at that time.  The provisions that allow for 80% of theannual component to vest upon achieving the established lower thresholdsrelated to each target shall also apply to this provision.  

 

4.              Thefinancial performance targets for the entire Enhanced Performance-Based Tranchewere replaced by targets with different financial metrics.  These new targets require achievement of aminimum internal rate of return (IRR) and money on invested capital (MOIC) tobe achieved by Blackstone following a complete liquidation of its investment inthe Company’s capital stock.  Both theIRR and MOIC requirements must be achieved or none of the options in the EnhancedPerformance-Based Tranche will vest. Achievement of the IRR and MOIC targets will also result in vesting ofthe portion of the tranche related to the 2008 annual targets which did notvest at the end of 2008.

 

5.              Theterms described above will also apply to any new options awarded under the 2007Incentive Stock Plan; provided, however, the Compensation Committee shallestablish additional financial targets for succeeding years to allow forvesting of such options over a five year period.  

 

TheOptions granted in 2008 to our executive officers and other members ofmanagement contain change-in-control provisions that cause the vesting of aportion of the tranches upon the occurrence of a change-in-control, as follows:1) the Option shares in the Time-Based Tranche will become immediatelyexercisable upon the occurrence of a change-in-control if the optionee remainsin continuous employment of the Company until the consummation of thechange-in-control and 2) the Option shares of the Performance-Based Tranche forthe year in which such change-in-control is consummated and for any subsequentperformance periods will become immediately exercisable if the optionee remainsin continuous employment of the Company until the consummation of thechange-in-control.  This provision doesnot operate to vest the Enhanced Performance-Based tranche which requires theachievement of the IRR and MOIC targets following a complete liquidation byBlackstone of its equity investment in the Company.

 

*OtherBenefits.*  Other benefitsto the executive officers include a 401(k) plan,which covers the NEOs. Wemaintain this 401(k) plan for our employees, including our NEOs, becausewe wish to encourage our employees to save some percentage of their cashcompensation, through voluntary deferrals, for their eventual retirement. Wemay, in our discretion, match employee deferrals. For the 2008 plan year, wemade matching contributions equal to up to 50% of the first 6% of compensationdeferred by employees (subject to Internal Revenue Service limits andnon-discrimination testing).  For the2009 plan year, the employer contribution percentage will remainunchanged.  DJO Opco maintains anon-qualified deferred compensation plan for its most senior management, andthat plan may be made generally available to senior management of DJO.  Under this non-qualified plan, an eligibleexecutive may contribute up to 100% of his or her salary and bonuses to theplan, and the amounts are held in trust and invested in a portfolio of mutualfunds which correspond to the funds available under the 401(k) plan.  DJO Opco has the discretion to contributematching contributions, but no such matching contributions have yet been made.

 

*BenefitsUpon Termination of Employment.*  As discussed more fully below in “PotentialPayments Upon Termination or Change-in-Control,” prior to the DJO Merger, weentered into employment agreements with Mr. Baird and certain other formerexecutive officers**.** All suchemployment agreements have terminated and none of the NEOs currently areparties to employment agreements with the Company.  The Compensation Committee does notcontemplate entering into employment agreements with the NEOs at thistime.  However, the current NEOs, whowere former executives of DJO Opco, are parties to change-in-control severanceagreements entered into prior to the DJO Merger that remain in effect.  Under those severance agreements, the DJOMerger constituted a change-in-control event. As a result, in the event that an executive subject to such agreement isterminated without cause or terminates for good reason within two years of theDJO Merger, the executive will receive a severance benefit of 1.5 times (2times in the case of Mr. Cross) the executive’s base salary and targetbonus, plus extended health and life insurance benefits.  These agreements also contain customaryconfidentiality and noncompetition covenants. The narrative and table included in “Potential Payments Upon Terminationor Change-in-Control” reflects potential payments upon termination ofemployment of our NEOs.

 

TheTax and Accounting Considerations

 

Section 162(m) ofthe Internal Revenue Code of 1986, as amended, provides that compensation inexcess of $1,000,000 paid to the CEO or to any of the other four most highlycompensated executive officers of a public company will not be deductible forfederal income tax purposes unless such compensation is paid pursuant to one ofthe enumerated exceptions set forth in Section 162(m). As a privately heldcompany, we are no longer required to comply with Section 162 (m) toensure tax deductibility of executive compensation.

 

120

----

Tableof Contents

 

**SummaryCompensation Table**

 

The following table setsforth summary information about the compensation during 2008, 2007 and 2006 forservices rendered in all capacities by our Chief Executive Officer, ChiefFinancial Officer and each of our three other most highly compensated executiveofficers.  Also included in the tablebelow is information regarding Mr. Baird, who was not serving as anexecutive officer as of the end of 2008 but for whom disclosure would have beenprovided but for the fact that he was not serving as an executive officer as ofthe end of 2008.  All of the individualslisted in the following table are referred herein collectively as the “NamedExecutive Officers” or “NEOs.”

 
| **Name and  Principal Position**                         | ** ** | **Year**   | ** ** | **Salary (1)** | ** ** | **Bonus (2)** | ** ** | **Stock  Awards  (3)** | ** ** | **Option  Awards  (4)** | ** ** | **Non-Equity  Incentive  Plan  Compensation  (5)** | ** ** | **Change in  Pension Value   and  Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation  (6)** | ** ** | **Total $( )** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|---------------------|------------|--------------------|------------|------------------------|------------|-------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **                                                         | ** ** | ** ** | ** ** | ** **          | ** ** | ** **         | ** ** | ** **             | ** ** | ** **              | ** ** | ** **                                         | ** ** | ** **                                                                                        | ** ** | ** **                            | ** ** | ** **               | ** ** |
| Leslie H. Cross                                                    |       | 2008       |       | $                   | 625,000    |               | $          | 800,000                |       | $                       | —     |                                               | $          | 139,538                                                                                           |       | $                                     | 336,511    |                     | $          | — |   | $ | 8,050 |   | $ | 1,909,099 |   |
| *Chief  Executive Officer and  Director*                           |       | 2007       |       | 60,135              |       | 248,438            |       | —                 |       | 1,327,352               |       | —                                             |       | —                                                                                            |       | —                                |       | 1,635,925                |       |
|                                                               |       |       |       |                |       |               |       |                   |       |                    |       |                                               |       |                                                                                              |       |                                  |       |                     |       |
| Vickie L. Capps                                                    |       | 2008       |       | 450,000             |       | 800,000            |       | —                 |       | 114,681                 |       | 181,538                                            |       | —                                                                                            |       | 8,050                                 |       | 1,554,269                |       |
| *Executive  Vice President, Chief Financial Officer and Treasurer* |       | 2007       |       | 35,740              |       | 118,125            |       | —                 |       | 703,687                 |       | —                                             |       | —                                                                                            |       | —                                |       | 857,552                  |       |
|                                                               |       |       |       |                |       |               |       |                   |       |                    |       |                                               |       |                                                                                              |       |                                  |       |                     |       |
| Luke T. Faulstick                                                  |       | 2008       |       | 400,000             |       | 700,000            |       | —                 |       | 101,939                 |       | 174,492                                            |       | —                                                                                            |       | 8,050                                 |       | 1,384,481                |       |
| *Executive Vice President and Chief Operating  Officer*            |       | 2007       |       | 35,740              |       | 118,125            |       | —                 |       | 544,766                 |       | —                                             |       | —                                                                                            |       | —                                |       | 698,631                  |       |
|                                                               |       |       |       |                |       |               |       |                   |       |                    |       |                                               |       |                                                                                              |       |                                  |       |                     |       |
| Donald M. Roberts                                                  |       | 2008       |       | 300,000             |       | 500,000            |       | —                 |       | 62,119                  |       | 145,400                                            |       | —                                                                                            |       | 8,050                                 |       | 1,015,569                |       |
| *Executive  Vice President, General Counsel and Secretary*         |       | 2007       |       | 31,202              |       | 103,125            |       | —                 |       | 568,066                 |       | —                                             |       | —                                                                                            |       | —                                |       | 702,393                  |       |
|                                                               |       |       |       |                |       |               |       |                   |       |                    |       |                                               |       |                                                                                              |       |                                  |       |                     |       |
| Thomas A. Capizzi                                                  |       | 2008       |       | 270,000             |       | 500,000            |       | —                 |       | 62,119                  |       | 94,504                                             |       | —                                                                                            |       | 8,050                                 |       | 934,673                  |       |
| *Executive  Vice President, Global Human Resources*                |       | 2007       |       | 31,250              |       | 56,456             |       | —                 |       | —                  |       | —                                             |       | —                                                                                            |       | —                                |       | 87,706                   |       |
|                                                               |       |       |       |                |       |               |       |                   |       |                    |       |                                               |       |                                                                                              |       |                                  |       |                     |       |
| Peter W. Baird (7)                                                 |       | 2008       |       | 301,453             |       | 200,000            |       | (136,728               | )          | —                  |       | —                                             |       | —                                                                                            |       | 2,100,000                             |       | 2,464,725                |       |
| *Former  President*                                                |       | 2007       |       | 334,615             |       | 200,000            |       | 136,728                |       | 208,380                 |       | —                                             |       | —                                                                                            |       | 306,750                               |       | 1,186,473                |       |
|                                                               |       | 2006       |       | 69,231              |       | 500,000            |       | —                 |       | 2,046,448               |       | —                                             |       | —                                                                                            |       | —                                |       | 2,615,679                |       |
|                                                                    |            |            |            |                     |            |                    |            |                        |            |                         |            |                                                    |            |                                                                                                   |            |                                       |            |                          |            |  |  |  |  |  |  |  |  |

 

----

| (1) |   | Except  for Mr. Baird, amounts for the year ended 2007 represent salary earned  from the date of the DJO Merger through December 31, 2007. Amounts for  Mr. Baird for 2006 reflect his date of hire in October 2006. |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

121

----

Tableof Contents

 
| (2)    |   | The  amounts shown in this column for 2007 for all persons except Mr. Baird  consist of bonuses that were paid during 2008 related to performance by DJO  Opco under the 2007 DJO Opco bonus plan for the fourth quarter and full  fiscal year. Amounts shown in this column for 2008 consist of retention  bonuses which were entered into in November 2007 with each of our  executive officers in connection with the DJO Merger, of which 50% of the  retention bonus was paid in January 2008 and 50% was paid in January 2009  and were contingent upon the executive’s continued service through  December 31, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (3)    |   | The  amount shown in this column for 2007 represents the dollar amount recognized  in connection with stock awards for financial statement reporting purposes  for the 2007 fiscal year in accordance with SFAS 123(R). This expense related  to two restricted stock awards granted to Mr. Baird in 2007, consisting  of an award of 15,189 shares of restricted stock in March 2007 and  24,300 shares of restricted stock in November 2007, vesting over time  with the final vesting in November 2009 and January 2009,  respectively. The amount shown in this column for 2008 represents the  reversal of SFAS 123(R) expense in the amount of $136,728 in connection  with the repurchase and cancellation, pursuant to Mr. Baird’s Separation  Agreement and General Release, of these 39,489 shares of restricted stock  that were granted in 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (4)    |   | Except  as described further below, the amounts shown in this column represent the  dollar amounts recognized for the 2008, 2007 and 2006 fiscal years for the  fair value of stock options granted in those years as well as prior fiscal  years in accordance with SFAS 123(R). Pursuant to SEC rules, the amounts  shown exclude the impact of estimated forfeitures related to service-based  vesting conditions. These amounts reflect our accounting expense and do not  correspond to the actual value that will be realized by the NEOs. See Note 10  to the audited consolidated financial statements included in this Annual Report  for a discussion of the relevant assumptions. The amounts for Mr. Baird  in 2006 represent options granted under the 2006 Incentive Stock Plan in  connection with his initial employment in October 2006. The amounts in  2007 for Messrs. Cross, Roberts and Faulstick and Ms. Capps  represents the grant date fair value of the DJO Management Rollover Options,  less the intrinsic value of vested DJO Opco options that each exchanged for  the DJO Management Rollover Options in the following approximate amounts:  Mr. Cross: $3.0 million, Ms. Capps: $2.0 million, Mr. Roberts:  $1.0 million and Mr. Faulstick: $1.0 million. The amounts in 2007 for  Baird represent amounts recognized in 2007 related to options granted in  November 2006 in connection with the Prior Transaction that vested  during 2007. Additional information regarding grants awarded in 2008 is  presented in the “Grants of Plan Based Awards in 2008” table below. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (5)    |   | The  amounts shown in this column represent amounts earned in 2008 based on the  results of the 2008 Bonus Plan, some of which was paid in 2009.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (6)    |   | Perquisites  and other personal benefits are valued on the basis of the aggregate  incremental cost to the Company of such perquisites and other personal  benefits. A breakdown of the amounts shown in this column for 2008 for each  of the NEOs is set forth in the following table:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

 

**For the Year Ended December 31, 2008**

 
| ** **                         | ** ** | **Mr. Cross** | ** ** | **Ms. Capps** | ** ** | **Mr. Faulstick** | ** ** | **Mr. Roberts** | ** ** | **Mr. Capizzi** | ** ** | **Mr. Baird** | ** ** |
|------------------------------------|------------|--------------------|------------|--------------------|------------|------------------------|------------|----------------------|------------|----------------------|------------|--------------------|------------|
| Severance (a)                      |       | $                  | —     |               | $          | —                 |       | $                    | —     |                 | $          | —             |       | $ | — |   | $ | 2,100,000 |   |
| 401(k) matching  contribution |       | 8,050              |       | 8,050              |       | 8,050                  |       | 8,050                |       | 8,050                |       | —             |       |
| Total                              |       | $                  | 8,050      |               | $          | 8,050                  |       | $                    | 8,050      |                 | $          | 8,050              |       | $ | 8,050 |   | $ | 2,100,000 |   |

 
|   |   | (a)    |   | Represents  payments pursuant to the Separation Agreement and General Release entered  into with Mr. Baird, consisting of $750,000 for provision of certain  transition services and continued cooperation, $900,000 in satisfaction of  employment and other agreements and rights under stock options and other  equity grants, and payment of $450,000 in consideration of continued  confidentiality and non-compete obligations. |
|--------|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   | (7)    |   | Mr. Baird’s  employment terminated effective August 2008.                                                                                                                                                                                                                                                                                                                                                                   |

 

122

----

Table of Contents

 

**Grants of Plan-Based Awards in2008**

 

The following table setsforth certain information with respect to grants of plan-based awards made tothe NEOs during 2008.

 
| ** **         | ** ** | ** **      | ** ** | **Estimated  Future Payouts Under Non-Equity** | ** ** | **Estimated  Future Payouts Under Equity** | ** ** | **All  Other** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   |       |
|--------------------|------------|-----------------|------------|------------------------------------------------|------------|--------------------------------------------|------------|----------------|------------|----------------|------------|--------------|------------|--------------|------------|
| ** **         | ** ** | ** **      | ** ** | **Incentive  Plan Awards**                     | ** ** | **Incentive  Plan Awards**                 | ** ** | **Stock**      | ** ** | **All  Other** | ** ** | ** **   | ** ** | ** **   |       |
| ** **         | ** ** | ** **      | ** ** | ** **                                     | ** ** | ** **                                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | **Awards:** | ** ** | **Option** | ** ** | **Exercise** | ** ** | ** ** |   |
| ** **         | ** ** | ** **      | ** ** | ** **                                     | ** ** | ** **                                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | **Number** | ** ** | **Awards:** | ** ** | **or Base** | ** ** | ** ** |   |
| ** **         | ** ** | ** **      | ** ** | ** **                                     | ** ** | ** **                                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | **of  Shares** | ** ** | **Number  of** | ** ** | **Price of** | ** ** | ** ** |   |
| ** **         | ** ** | ** **      | ** ** | ** **                                     | ** ** | ** **                                 | ** ** | ** **     | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | **of Stock** | ** ** | **Securities** | ** ** | **Option** | ** ** | **Grant  Date Fair** |   |
| ** **         | ** ** | ** **      | ** ** | **Threshold**                                  | ** ** | **Target**                                 | ** ** | **Maximum**    | ** ** | **Threshold**  | ** ** | **Target**   | ** ** | **Maximum**  | ** ** | **or Units** | ** ** | **Underlying** | ** ** | **Awards** | ** ** | **Value of  Option** |   |
| **Name**           | ** ** | **Grant  Date** | ** ** | **($)**                                        | ** ** | **($)**                                    | ** ** | **($)**        | ** ** | **(#)**        | ** ** | **(#)**      | ** ** | **(#)**      | ** ** | **(#)** | ** ** | **Options  (#)** | ** ** | **($/Sh)** | ** ** | **Awards  ($) (3)** |   |
| Mr. Cross     |       | 1/1/2008        | (1)        | $                                              | 150,000    |                                       | $          | 375,000        |       | $              | 750,000    |         | —     |         | —     |   | — |   | — |   | — |   | $ | — |   | $ | — |   |
|               |       | 2/21/2008       | (2)        |  —                                   |       |  —                               |       |  —   |       | 129,866        |       | 162,333      |       | 324,666      |       | — |   | 162,333 |   | 16.46 |   | 2,366,377 |   |
|               |       |            |       |                                           |       |                                       |       |           |       |           |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Ms. Capps     |       | 1/1/2008        | (1)        | 108,000                                        |       | 270,000                                    |       | 540,000        |       |  —   |       |  — |       |  — |       | — |   |  — |   |  — |   |  — |   |
|               |       | 2/21/2008       | (2)        |  —                                   |       |  —                               |       |  —   |       | 106,731        |       | 133,414      |       | 266,828      |       | — |   | 133,415 |   | 16.46 |   | 1,944,821 |   |
|               |       |            |       |                                           |       |                                       |       |           |       |           |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Mr. Faulstick |       | 1/1/2008        | (1)        | 96,000                                         |       | 240,000                                    |       | 480,000        |       |  —   |       |  — |       |  — |       |  — |   |  — |   |  — |   |  — |   |
|               |       | 2/21/2008       | (2)        |  —                                   |       |  —                               |       |  —   |       | 94,873         |       | 118,591      |       | 237,182      |       |  — |   | 118,590 |   | 16.46 |   | 1,728,732 |   |
|               |       |            |       |                                           |       |                                       |       |           |       |           |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Mr. Roberts   |       | 1/1/2008        | (1)        | 72,000                                         |       | 180,000                                    |       | 360,000        |       |  —   |       |  — |       |  — |       |  — |   |  — |   |  — |   |  — |   |
|               |       | 2/21/2008       | (2)        |  —                                   |       |  —                               |       |  —   |       | 57,813         |       | 72,266       |       | 144,532      |       |  — |   | 72,266 |   | 16.46 |   | 1,053,443 |   |
|               |       |            |       |                                           |       |                                       |       |           |       |           |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Mr. Capizzi   |       | 1/1/2008        | (1)        | 64,800                                         |       | 162,000                                    |       | 324,000        |       |  —   |       |  — |       |  — |       |  — |   |  — |   |  — |   |  — |   |
|               |       | 2/21/2008       | (2)        |  —                                   |       |  —                               |       |  —   |       | 57,813         |       | 72,266       |       | 144,532      |       | — |   | 72,266 |   | 16.46 |   | 1,053,443 |   |
|               |       |            |       |                                           |       |                                       |       |           |       |           |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Mr. Baird     |       | 1/1/2008        | (1)        | 72,000                                         |       | 180,000                                    |       | 360,000        |       |  —   |       |  — |       |  — |       | — |   |  — |   |  — |   |  — |   |
|               |       | 2/21/2008       | (2)        |  —                                   |       |  —                               |       |  —   |       | 102,982        |       | 128,727      |       | 257,454      |       |  — |   | 128,728 |   | 16.46 |   | 2,316,495 |   |
|                    |            |                 |            |                                                |            |                                            |            |                |            |                |            |              |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

| (1)  |   | The amounts set forth in these rows under the  column “Estimated Future Payouts Under Non-Equity Incentive Plan Awards”  represent the threshold, target and maximum bonus potential under the 2008  Bonus Plan. See discussion of “Target Bonus” and “Supplemental Bonus” in  “Compensation Discussion and Analysis” above for a description of the vesting  conditions for the 2008 Bonus Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|-----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (2)       |   | The share amounts set forth in these rows under the  column “Estimated Future Payouts under Equity Incentive Plan Awards”  represent the Performance- Based and Enhanced Performance-Based Tranches of  the options granted to the NEOs in February 2008, with the “Threshold”  amounts representing 80% of the Performance-Based Tranche, the “Target”  amount representing the Performance-Based Tranche and the “Maximum” amount  representing the sum of the Performance-Based Tranche and the Enhanced Performance-Based  Tranches. The share amounts set forth in these rows under the column “All  Other Option Awards” represent the “Time-Based Tranche” of the options  granted to the NEOs in February 2008. See “Compensation Discussion and  Analysis — The Elements of Our Compensation Program — Equity Compensation”  for a description of the vesting conditions for these options. |
|      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (3)  |   | The  grant date fair value is the value of awards granted in 2008 as determined in  accordance with SFAS 123(R).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

123

----

Table ofContents

 

**Outstanding Equity Awards at 2008 Fiscal Year-End**

 

The following table sets forth certain informationregarding options held by each of the NEOs as of December 31, 2008.  There were no stock awards outstanding as of December 31,2008.

 
| ** **          | ** ** | **Option Awards**                                                                 | ** ** |
|---------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **          | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#) Exercisable** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#) Unexercisable  (3)** | ** ** | **Equity Incentive  Plan Awards:  Number of  Securities  Underlying  Unexercised  Unearned Options  (#) (4)** | ** ** | **Option  Exercise Price  ($)** | ** ** | **Option  Expiration Date** | ** ** |
|                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Leslie H. Cross     |       | 40,584                                                                                 | (1)        | 121,749 |   | 243,498 |   | 16.46 |   | 2/21/2018 |   |
|                |       | 213,700                                                                                | (2)        | — |   | — |   | 13.10 |   | 5/12/2017 |   |
|                |       | 82,427                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|                |       | 193,254                                                                                | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|                |       | 43,351                                                                                 | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|                | ** ** | **573,316**                                                                            | ** ** | **121,749** | ** ** | **243,498** |   |   |   |   |   |
|                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Vickie L. Capps     |       | 33,354                                                                                 | (1)        | 100,061 |   | 200,120 |   | 16.46 |   | 2/21/2018 |   |
|                |       | 91,586                                                                                 | (2)        | — |   | — |   | 13.10 |   | 5/12/2017 |   |
|                |       | 48,846                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|                |       | 91,585                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|                |       | 76,321                                                                                 | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|                |       | 5,343                                                                                  | (2)        | — |   | — |   | 7.18 |   | 2/26/2014 |   |
|                | ** ** | **347,035**                                                                            | ** ** | **100,061** | ** ** | **200,120** |   |   |   |   |   |
|                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Luke T.  Faulstick  |       | 29,648                                                                                 | (1)        | 88,942 |   | 177,886 |   | 16.46 |   | 2/21/2018 |   |
|                |       | 91,586                                                                                 | (2)        | — |   | — |   | 13.10 |   | 5/12/2017 |   |
|                |       | 48,846                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|                |       | 45,792                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|                |       | 10,032                                                                                 | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|                | ** ** | **225,904**                                                                            | ** ** | **88,942** | ** ** | **177,886** |   |   |   |   |   |
|                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Donald M.  Roberts  |       | 18,067                                                                                 | (1)        | 54,199 |   | 108,398 |   | 16.46 |   | 2/21/2018 |   |
|                |       | 91,586                                                                                 | (2)        | — |   | — |   | 13.10 |   | 5/12/2017 |   |
|                |       | 48,846                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|                |       | 30,528                                                                                 | (2)        | — |   | — |   | 8.84 |   | 5/25/2015 |   |
|                |       | 35,080                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|                | ** ** | **224,107**                                                                            | ** ** | **54,199** | ** ** | **108,398** |   |   |   |   |   |
|                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Tom Capizzi         |       | 18,067                                                                                 | (1)        | 54,199 |   | 108,398 |   | 16.46 |   | 2/21/2018 |   |
|                | ** ** | **18,067**                                                                             | ** ** | **54,199** | ** ** | **108,398** |   |   |   |   |   |
|                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Peter W. Baird  (5) |       | —                                                                                 |       | — |   | — |   | — |   | — |   |

 

----

| (1)    |   | These amounts reflect the number of shares  underlying the “Time-Based Tranche” of options that are vested and  exercisable that were granted in 2008 under the 2007 Stock Incentive Plan.  These options represent 25% of the options granted in 2008 and became vested  and exercisable on December 31, 2008.                                                                                                                                                                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (2)    |   | These amounts reflect the number of shares  underlying the DJO Management Rollover Options which were fully vested upon  issuance in connection with the DJO Merger.                                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (3)    |   | The amounts set forth in this column reflect the  number of shares underlying the “Time-Based Tranche” of options that are not  vested and not exercisable that were granted in 2008 under the 2007 Stock  Incentive Plan. These options represent the remaining 75% of the grant made  in 2008 and vest as follows: 20% of the original grant vest on  December 31, 2009, 18.33% of the original grant vest on  December 31, 2010 and 2011, and 18.34% of the original grant vest on  December 31, 2012. |

 

124

----

Tableof Contents

 
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (4)    |   | The amounts set forth in this column reflect the  number of shares underlying the “Performance-Based Tranche” of options that  have not been earned (i.e., their performance conditions have not been  satisfied) that were granted in 2008 under the 2007 Incentive Stock Plan.  These options vest on December 31, 2009-2012 in the same percentages as  the Time-Based Tranche of options if the performance requirements are  achieved for such years. See “Compensation Discussion and Analysis — The  Elements of our Executive Compensation Program — Equity Compensation” for  further information regarding the vesting of these options. These amounts  exclude the 25% of the “Performance-Based Tranche” and the “Enhanced  Performance-Based Tranche” of options that did not vest on December 31,  2008 and cannot be earned in the future due to the failure to meet the 2008  performance targets. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (5)    |   | Mr. Baird’s employment terminated in  August 2008 and all restricted stock and all options were cancelled  pursuant to the terms of his Separation Agreement and General Release.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

**OptionExercises and Stock Vested During 2008**

 

No options were exercisedand no stock vested during the year ended December 31, 2008 for our NEOs.

 

**Non-Qualified Deferred Compensation for 2008**

 

Certainexecutives may defer receipt of part or all of their cash compensation underthe DJO, LLC Executive Deferred Compensation Plan (the “Deferred Plan”), a planestablished by DJO, LLC, a subsidiary of DJO Opco. The Deferred Plan allowsexecutives to save for retirement in a tax-effective way at minimal cost toDJO, LLC. Under this program, amounts deferred by the executive are depositedinto a trust for investment and eventual benefit payment. The obligations ofDJO, LLC under the Deferred Plan are unsecured obligations to pay deferredcompensation in the future from the assets of the trust. Participants will havethe status of unsecured general creditors with respect to the benefitobligations of the Deferred Plan, and the assets set aside in the trust forthose benefits will be available to creditors of DJO, LLC in the event ofbankruptcy or insolvency. Each participant may elect to defer under theDeferred Plan all or a portion of his or her cash compensation that mayotherwise be payable in a calendar year. A participant’s compensation deferralsare credited to the participant’s account under the Deferred Plan and thetrust. Each participant may elect to have the amounts in such participant’saccount invested in one or more investment options available under the DeferredPlan, which investment options are substantially the same investment optionsavailable to participants in DJO, LLC’s 401(k) Savings Plan. TheDeferred Plan also permits DJO, LLC to make contributions to the Deferred Plan,including matching contributions, at its discretion, but no such contributionshave been made to date. To the extent that Company contributions are made tothe Deferred Plan, the Committee may impose vesting criteria to aid in theemployment retention of participants. A participant’s eventual benefit willdepend on his or her level of contributions, DJO, LLC’s contributions, if any,and the investment performance of the particular investment options selected.The following table sets forth information for each of the Named ExecutiveOfficers who participated in DJO, LLC’s Nonqualified Deferred Compensation Planduring 2008.

 
| **Name**           | ** ** | **Executive  Contributions  in Last  Fiscal Year(1)** | ** ** | **Registrant  Contributions  in Last**

**Fiscal Year** | ** ** | **Aggregate  Earnings/  (Losses)  in Last  Fiscal Year** | ** ** | **Aggregate  Withdrawals/  Distributions** | ** ** | **Aggregate  Balance at Last  Fiscal Year** | ** ** |
|--------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------------------------|------------|
| Donald M.  Roberts |       | $                                                               | 54,792     |                                                              | $          | —                                                             |       | $                                          | (33,721    | )                                                          | $          | — |   | $ | 69,940 |   |
|                    |            |                                                                 |            |                                                                   |            |                                                                    |            |                                            |            |                                                            |            |  |  |  |  |  |

 

----

| (1) |   | Amounts deferred by the executive under the Deferred  Plan have been reported as 2008 compensation to such executive in the  “Salary” column in the Summary Compensation Table above. Amounts in the  aggregate balance include amounts earned as compensation prior to the DJO  Merger when Mr. Roberts was an executive officer of DJO Opco. |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Potential Payments UponTermination or Change-in-Control**

 

DJO enteredinto an Employment Agreement with Mr. Baird in October 2006 whichprovided for certain payments and other benefits if his employment terminatedunder specific circumstances.  In August 2008,DJO entered into a Separation Agreement and General Release with Mr. Bairdwhich provided for a severance payment of $2.1 million, all as described inmore detail in footnote (a) to Footnote (6) of the “SummaryCompensation Table” above.

 

In September 2007,DJO Opco entered into change-in-control severance agreements (the “Change-in-ControlAgreements”) with Mr. Cross, Ms. Capps, Mr. Faulstick, Mr. Capizzi,and Mr. Roberts.  Following a change-in-control, theChange-in-Control Agreements remain in effect for a period of two years. TheDJO Merger constituted a change-in-control for purposes of theseChange-in-Control Agreements.  Pursuantto the Change-in-Control Agreements, if the NEO’s employment is terminated “withoutcause” or by such executive’s resignation for “good reason” (as such terms aredefined in the Change-in-Control Agreements), in each case within two yearsafter the DJO Merger, the executive is entitled, in addition to accrued salaryand bonus and related benefits, to the following benefits:

 

125

----

Tableof Contents

 

(1)   A lump sum payment equal to the sum of theexecutive’s highest annual rate of base salary during the 12 month periodpreceding the termination date multiplied by 1.5 (or 2 in the case of Mr. Cross),plus (a) the executive’s aggregate annual target bonus for the year oftermination; and (b) a pro rata portion of the executive’s aggregateannual target bonus for the portion of the year of termination during which theexecutive served as an employee, less any amounts paid from our annualincentive plan for the year of termination;

 

(2)   A lump sum cash payment of an amount equal to(a) 18 (or 24 in the case of Mr. Cross), multiplied by (b) theamount by which the monthly premium the executive would be required to pay forcontinued coverage pursuant to COBRA, for such executive and his or hereligible dependents covered under our health plans as of the termination date,exceeds the contributions required by the executive immediately prior to thetermination date; and

 

(3)   A lump sum cash payment of an amount equal to(a) 18 (or 24 in the case of Mr. Cross), multiplied by (b) theamount by which the total monthly premium paid for accidental death anddismemberment and life insurance coverage as of the termination date exceedsthe contributions required by the executive immediately prior to thetermination date.

 

Pursuant tothe Change-in-Control Agreements, the termination of employment as a result ofthe death or disability of the executive is not considered a qualifyingtermination and does not result in the payment of the amounts described aboveother than the accrued salary and related benefits the executive would beentitled to absent the Change-in-Control Agreements. As a condition toreceiving the severance benefits under the Change-in-Control Agreements, anexecutive must execute a waiver and release of any claims he or she may haveagainst DJO Opco. The Change-in-Control Agreements also provide that during theterm of the agreement and for a period of two years following any qualifyingtermination, the executive will not solicit any customer of DJO Opco or itssubsidiaries and not solicit any employee of DJO Opco or its subsidiaries.

 

The Options granted in February 2008to our executive officers and other members of management containchange-in-control provisions that cause the vesting of a portion of thetranches upon the occurrence of a change-in-control, as follows: 1) the Optionshares in the Time-Based Tranche will become immediately exercisable upon theoccurrence of a change-in-control if the optionee remains in continuousemployment of the Company until the consummation of the change-in-control and2) the Option shares of the Performance-Based Tranche and the EnhancedPerformance-Based Tranche for the year in which such change-in-control isconsummated and for any subsequent performance periods will become immediatelyexercisable if the optionee remains in continuous employment of the Companyuntil the consummation of the change-in-control.

 

The followingtable shows the amount of potential cash payments and the value of otherseverance benefits each of the NEOs would be entitled to if his or heremployment were terminated “without cause” or if he or she resigned for “goodreason” as of December 31, 2008:

 
| **Name**           | ** ** | **Base  Salary Payment  ($)** | ** ** | **Bonus  Payment  ($)** | ** ** | **Health  Benefits ($)** | ** ** | **Life and Accidental  Death &  Dismemberment  Benefits  ($)** | ** ** | **Total ($)** | ** ** |
|--------------------|------------|------------------------------------|------------|-------------------------|------------|-------------------------------|------------|-----------------------------------------------------------------------------------|------------|--------------------|------------|
| Leslie H. Cross    |       | $                                  | 1,250,000  |                    | $          | 750,000                       |       | $                                                                                 | 16,100     |               | $          | 1,908 |   | $ | 2,018,008 |   |
| Vickie L. Capps    |       | 675,000                            |       | 540,000                 |       | 12,075                        |       | 851                                                                               |       | 1,227,926          |       |
| Luke T.  Faulstick |       | 600,000                            |       | 480,000                 |       | 12,075                        |       | 851                                                                               |       | 1,092,926          |       |
| Donald M.  Roberts |       | 450,000                            |       | 360,000                 |       | 12,075                        |       | 743                                                                               |       | 822,818            |       |
| Tom Capizzi        |       | 405,000                            |       | 324,000                 |       | 12,075                        |       | 743                                                                               |       | 741,818            |       |
|                    |            |                                    |            |                         |            |                               |            |                                                                                   |            |                    |            |  |  |  |  |  |

 

**Compensationof Directors**

 

The CompensationCommittee of the DJO Board reviews the compensation of our Directors on anannual basis.  Until December 4,2008, our Board of Directors consisted of seven persons: 1) Chinh E. Chu 2)Julia Kahr, 3) Bruce McEvoy, 4) Sidney Braginsky, 5) Kenneth W. Davidson, 6)Leslie H. Cross, and 7) Paul D. Chapman. In January 2009, Mr. Davidson and Mr. Chapman resignedfrom the Board of Directors and  PhillipHildebrand, Lesley Howe and Paul LaViolette were appointed to the Board ofDirectors in their place.  Mr. Kahr,Mr. Chu, and Mr. McEvoy, are affiliated with Blackstone and are notcompensated for serving as members of our Board of Directors.

 

126

----

Table of Contents

 

During the first twoquarters of 2008, the standard compensation package for directors who are notemployed by the Company or by any Blackstone-controlled entity (“Eligible Directors”),namely Messrs. Davidson, Braginsky and Chapman, consisted of an annual feefor each such director, a per meeting fee and stock option grants. As Chairmanof the Board, Mr. Davidson was entitled to receive an annual fee of$60,000 and Messrs. Braginsky and Chapman received an annual fee of$50,000. Mr. Braginsky also was entitled to receive a $10,000 fee for hisservices as Audit Committee Chairman during 2008 and a meeting fee of $1,500per day for attending Board meetings.  The Eligible Directors were alsoeligible for annual option awards under the 2007 Incentive Stock Plan.  InFebruary 2008, the Compensation Committee awarded Messrs. Davidson,Braginsky and Chapman options to purchase 1,500 shares of Common Stock with anexercise price of $16.46 per share, which was determined to be the fair marketvalue of such shares on the date of grant.  One-third of these optionswere scheduled to vest on each anniversary of the date of grant and any sharesissued on exercise of such options will be subject to the ManagementStockholders Agreement. In May 2008, the Compensation Committee approvedchanges to the director compensation program, effective as of the beginning ofthe third quarter, increasing the annual retainer payable to the EligibleDirectors to $75,000, providing for an annual retainer of $25,000 to theChairman of the Board and to the Chairman of the Audit Committee and providingfor an annual retainer of $15,000 to the other Eligible Directors who aremembers of the Audit Committee. In August 2008, the Compensation Committeeawarded options to purchase 4,600 shares to each of Messrs. Davidson,Braginsky and Chapman with the same exercise price and vesting schedule.Effective upon their resignations in January 2009, all unvested optionsissued to Messrs. Davidson and Chapman terminated and the CompensationCommittee approved an amendment to their outstanding vested options to providethat such options would continue in effect until their original exercise dateand not terminate early due to the terminations of Messrs. Davidson andChapman as directors.

 

The following table setsforth the compensation earned by our non-employee directors for their servicesin 2008:

 
| ** **            | ** ** | **Directors Compensation for 2008** | ** ** |
|-----------------------|------------|----------------------------------------------------|------------|
| **Name**              | ** ** | **Fees  Earned or  Paid in  Cash  ($)**  | ** ** | **Stock  Awards ($)** | ** ** | **Option  Awards  ($) (1)** | ** ** | **Non-Equity  Incentive Plan  Compensation  ($)** | ** ** | **Change in  Pension Value  and  Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total ($)** | ** ** |
| Chinh E. Chu          |       | $                                                  | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Julia Kahr            |       |  —                                       |       |  — |   |  — |   |  — |   |  — |   |  — |   |  — |   |
| Sidney Braginsky  (2) |       | 81,500                                             |       |  — |   | 4,171 |   |  — |   |  — |   |  — |   | 85,671 |   |
| Bruce McEvoy          |       |  —                                       |       |  — |   |  — |   |  — |   |  — |   |  — |   |  — |   |
| Kenneth W.  Davidson  |       | 80,000                                             |       |  — |   | 4,171 |   |  — |   |  — |   |  — |   | 84,171 |   |
| Paul D. Chapman       |       | 65,500                                             |       |  — |   | 4,171 |   |  — |   |  — |   |  — |   | 69,671 |   |
|                       |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

| (1)    |   | Amounts shown for the option  awards to Messrs. Davidson, Chapman, and Braginsky reflect the dollar  value recognized in connection with the option awards for financial statement  purposes for fiscal 2008 in accordance with SFAS 123(R). Pursuant to SEC  rules, the amounts shown exclude the impact of estimated forfeitures related  to service-based vesting conditions. The full grant date fair value of stock  options granted to Messrs. Davidson, Chapman and Braginsky during the  fiscal year ended December 31, 2008 was $22,767 for each as computed in  accordance with FAS 123(R). A discussion of the relevant assumptions  used in the valuation is contained in Note 10 to our audited consolidated  financial statements contained in this Annual Report. As of December 31,  2008, Messrs. Davidson, Chapman and Braginsky had a total of 313,075,  137,175, and 6,850 stock options outstanding, respectively. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (2)    |   | Messrs. Davidson and  Chapman resigned as directors in January 2009.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |

 

**CompensationCommittee Interlocks and Insider Participation**

 

During2008, our Compensation Committee consisted of three designees of Blackstone, Mr. Chu,Ms. Kahr and Mr. McEvoy. None of the members of the CompensationCommittee is or have been an officer or employee of DJO. See “Item 13. CertainRelationships and Related Transactions, and Director Independence” below for adescription of certain agreements with Blackstone. None of our executiveofficers has served as a director or a member of the compensation committee (orother committee serving an equivalent function) of any other entity, which hasone or more executive officers serving as a director of DJO or member of ourCompensation Committee.

 

127

----

Table of Contents

 

**CompensationCommittee Report**

 

The CompensationCommittee of the DJO Board of Directors oversees our company’s compensationprogram on behalf of the Board. In fulfilling its oversight responsibilities,the Compensation Committee reviewed and discussed with management theCompensation Discussion and Analysis set forth in this Annual Report.  Based upon the review and discussionsreferred to above, the Compensation Committee recommended to the DJO Board thatthe Compensation Discussion and Analysis be included in this Annual Report.

 

Submittedby the Compensation Committee:

Chinh E. Chu (Chair)

Julia Kahr

Bruce McEvoy

 

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS**

 

DJOFLis a wholly owned subsidiary of DJO, which owns all of our issued andoutstanding capital stock.  The followingtable sets forth as of March 11, 2009, certain information regarding thebeneficial ownership of the voting securities of DJO by each person whobeneficially owns more than five percent of DJO’s common stock, and by each ofthe directors and NEOs of DJO, individually, and by our directors and executiveofficers as a group.

 
| ** **                                                                       | ** ** | ** **                                                                          |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|
| ** **                                                                       | ** ** | **Aggregate Number of Shares Beneficially Owned (1)** | ** ** |
| **Name and Address of Beneficial Owner**                | ** ** | **Number of Issued  Shares**                                              | ** ** | **Acquirable within  60 days (2)** | ** ** | **Percent of Class** | ** ** |
| Grand Slam  Holdings, LLC (3)                                                    |       | 48,098,209                                                                          |   |  — |   | 98.82 | % |
| **Directors  and Executive Officers**                                            |       |                                                                                |   |   |   |   |   |
| Leslie H. Cross  President, Chief Executive Officer and Director                 |       |  —                                                                        |   | 573,316 |   | 1.16 | % |
| Vickie L. Capps  Executive Vice President, Chief Financial Officer and Treasurer |       |  —                                                                        |   | 347,035 |   |   |   |
| Donald M. Roberts,  Executive Vice President, General Counsel and Secretary      |       |  —                                                                        |   | 224,107 |   |   | * |
| Luke T.  Faulstick  Executive Vice President and Chief Operating Officer         |       |  —                                                                        |   | 225,904 |   |   | * |
| Tom Capizzi  Executive Vice President, Global Human Resources                    |       |  —                                                                        |   | 18,067 |   |   | * |
| Chinh E. Chu  Chairman of the Board (4)                                          |       | 48,098,209                                                                          |   |  — |   | 98.82 | % |
| Julia Kahr  Director (5)                                                         |       |  —                                                                        |   |  — |   |  — |   |
| Sidney Braginsky  Director                                                       |       |  —                                                                        |   | 1,495 |   |   | * |
| Bruce McEvoy  Director (5)                                                       |       |  —                                                                        |   |  — |   |  — |   |
| Phillip J.  Hildebrand  Director (5)                                             |       |  —                                                                        |   |  — |   |  — |   |
| Lesley Howe  Director                                                            |       |  —                                                                        |   |  — |   |  — |   |
| Paul LaViolette  Director                                                        |       |  —                                                                        |   |  — |   |  — |   |
| Peter W. Baird  Former President                                                 |       |  —                                                                        |   |  — |   |  — |   |
| All Directors  and executive officers as a group                                 |       | 48,098,209                                                                          |   | 1,389,924 |   | 98.85 | % |

 

----

* Less than 1%

 
| (1)    |   | Includes shares held in the  beneficial owner’s name or jointly with others, or in the name of a bank,  nominee or trustee for the beneficial owner’s account. Unless otherwise  indicated in the footnotes to this table and subject to community property  laws where applicable, we believe that each stockholder named in this table  has sole voting and investment power with respect to the shares indicated as  beneficially owned.                                                                                                                                                                        |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (2)    |   | Includes the number of shares  that could be purchased by exercise of options on or within 60 days after  March 11, 2009 under DJO’s stock option plans. For the NEOs, this number  includes the “DJO Management Rollover Options” which are fully vested and the  portion of the “Time-Based Tranche” of options that have vested or will vest  in 60 days, but no portion of the “Performance-Based Tranche” or “Enhanced  Performance-Based Tranche.”                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (3)    |   | Shares  of common stock of DJO held by Grand Slam Holdings, LLC (“BCP Holdings”) may  also be deemed to be beneficially owned by the following entities and  persons: (i) Blackstone Capital Partners V L.P., a Delaware limited  partnership (“BCP V”), Blackstone Family Investment Partnership V L.P., a  Delaware limited partnership (“BFIP”), Blackstone Family Investment  Partnership V-A L.P., a Delaware limited partnership (“BFIP-A”), and  Blackstone Participation Partnership V L.P., a Delaware limited partnership  (together with BCP V, BFIP and BFIP-A, the |

 

128

----

Table of Contents

 
|   |   | “Blackstone Partnerships”),  which collectively own all of the equity in BCP Holdings; (ii) Blackstone  Management Associates V L.L.C., a Delaware limited liability company (“BMA”),  the general partner of the Blackstone Partnerships; (iii) BMA V L.L.C.,  a Delaware limited liability company (“BMA V”), the sole member of BMA; and (iv) Peter  G. Peterson and Stephen A. Schwarzman, the founding members and controlling  persons of BMA V.  Each of Messrs. Peterson  and Schwarzman disclaims beneficial ownership of such shares, except to the  extent of his pecuniary interest therein.   The address of BCP Holdings and each of the entities and individuals  listed in this footnote is c/o The Blackstone Group, L.P., 345 Park Avenue,  New York, New York 10154. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (4)    |   | Mr. Chu, a director of  DJO, is a member of BMAV and a senior managing director of The Blackstone  Group, L.P.  The number of shares  disclosed for Mr. Chu are also included in the above table in the number  of shares disclosed for “Grand Slam Holdings, LLC.”  Mr. Chu disclaims beneficial ownership  of any shares owned or controlled by BMA V, except to the extent of his  pecuniary interest therein.                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (5)    |   | Ms. Kahr and Mr. McEvoy  are employees of The Blackstone Group, L.P. but do not have any investment or  voting control over the shares beneficially owned by BCP Holdings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

 

**Securities Authorized forIssuance Under Equity Compensation Plans**

 

The following tableprovides information as of December 31, 2008 with respect to the number ofshares to be issued upon the exercise of outstanding stock options under our2007 Incentive Stock Plan, which is our only equity compensation plan and hasbeen approved by the stockholders:

 
| **Plan Category**                              | ** ** | **(a) Number of  securities to be  issued upon  exercise of  outstanding  options, warrants  and rights** | ** ** | **Weighted-average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by stockholders |       | 6,074,914                                                                                                                                         |       | 14.46                                                                                                   |       | 1,425,086                                                                                                                                                                                                        |       |

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTORINDEPENDENCE**

 

**ManagementStockholder’s Agreement**

 

Certain members of DJO’smanagement are parties to DJO’s Management Stockholders Agreement, dated November 3,2006, among DJO, Grand Slam Holdings, LLC (“BCP Holdings”), Blackstone CapitalPartners V L.P. (“Blackstone”), certain of its affiliates, and such members ofDJO’s management and current executive officers (the “Management StockholdersAgreement”). In conjunction with the DJO Merger, certain incoming executives ofDJO (the “new management stockholders”) have become parties to the ManagementStockholders Agreement on the same terms and conditions as set forth therein,subject to the following exceptions, which by amendment (the “Amendment”) willapply only to the new management stockholders and any other persons becoming aparty thereto after November 20, 2007.  The Management StockholdersAgreement currently provides that if a management stockholder voluntarilyresigns from DJO for any reason other than “good reason” (as defined in theManagement Stockholders Agreement) and a Blackstone Parent Stockholderexercises its call rights after such termination, the management stockholderwould receive the lower of fair market value or “cost” for the managementstockholder’s callable shares.  The Amendment provides that, unless a newmanagement stockholder was terminated by DJO for “cause” (as defined in theAmendment) or unless the new management stockholder voluntarily terminated employmentand such termination would have constituted a termination for “cause” if itwould have been initiated by DJO, such new management stockholder would receivefair market value for such new management stockholder’s shares callable uponthe exercise of a call right.

 

The ManagementStockholders Agreement imposes significant restrictions on transfers of sharesof DJO’s common stock held by management stockholders and provides a right offirst refusal to DJO (or Blackstone), if DJO fails to exercise such right) onany proposed sale of DJO’s common stock held by a management stockholderfollowing the lapse of the transfer restrictions and prior to the occurrence ofa ‘‘qualified public offering’’ (as such term is defined in that agreement) ofDJO.  In addition, prior to a qualifiedpublic offering, Blackstone will have drag-along rights, and managementstockholders will have tag-along rights, in the event of a sale of DJO’s commonstock by Blackstone to a third party (or in the event of a sale of BCP Holdings’equity interests to a third party) in the same proportion as the shares orequity interests sold by Blackstone. If, prior to either the lapse of thetransfer restrictions or a qualified public offering, a management stockholder’semployment is terminated, DJO will have the right to repurchase all shares ofits common stock held by such management stockholder for a period of one yearfrom the date of termination of employment (or the until the date that is oneyear following the exercise of the stock options used to acquire such commonstock, if later). If DJO does not exercise this repurchase right during theapplicable repurchase period, then Blackstone will generally have the right torepurchase such shares for a period of 30 days thereafter. The ManagementStockholders Agreement also provides that, after the occurrence of a qualifiedpublic offering, the management stockholders will receive customary piggybackregistration rights with respect to shares of DJO common stock held by them.

 

129

----

Table of Contents

 

On December 13, 2006, DJO, BCP Holdings,Blackstone and certain of its affiliates entered into a stockholders agreementwith Sidney Braginsky, one of DJO’s directors. The terms and conditions of thestockholders agreement with Mr. Braginsky are the same, in all materialrespects, as the management stockholders agreement described above.

 

**Transactionand Monitoring Fee Agreement**

 

In connection with theDJO Merger, on November 20, 2007, DJO and Blackstone Management Partners VL.L.C. (“BMP”) amended and restated the transaction and monitoring feeagreement in existence at that time (the “Old Transaction and Monitoring FeeAgreement”) between them, with effect from and after the closing of the DJOMerger (such agreement, as amended and restated, the “New Transaction andMonitoring Fee Agreement”).

 

Under the New Transactionand Monitoring Fee Agreement, DJO paid BMP, at the closing of the DJO Merger, a$15.0 million transaction fee and $0.6 million for related expenses. Alsopursuant to this agreement, at the closing of the DJO Merger, DJO paidBlackstone Advisory Services, L.P., an affiliate of BMP (“BAS”), a $3.0 millionadvisory fee in consideration of the provision of certain strategic and otheradvice and assistance by BAS on behalf of BMP.

 

Under the New Transactionand Monitoring Fee Agreement, BMP (including through its affiliates andrepresentatives) will continue to provide certain monitoring, advisory andconsulting services to DJO, on substantially the same terms and conditions asthe Old Transaction and Monitoring Fee Agreement, for an annual monitoring feewhich has been increased from $3.0 million to the greater of $7.0 million or2.0% of consolidated EBITDA (as defined in the New Transaction and MonitoringFee Agreement).

 

The New Transaction andMonitoring Fee Agreement also provides, on substantially the same terms andconditions as the Old Transaction and Monitoring Fee Agreement, that:

 

·                  atany time in connection with or in anticipation of a change of control of DJO, asale of all or substantially all of its assets or an initial public offering ofcommon stock of DJO or its successor, BMP may elect to receive, in lieu ofremaining annual monitoring fee payments, a single lump sum cash payment equalto the then-present value of all then-current and future annual monitoring feespayable under the agreement, assuming a hypothetical termination date of theagreement to be the twelfth anniversary of such election;

 

·                  theNew Transaction and Monitoring Fee Agreement will continue until the earlier ofthe twelfth anniversary of the date of the agreement or such date as DJO andBMP may mutually agree; and

 

·                  DJOwill indemnify BMP and its affiliates, and their respective partners, members,shareholders, directors, officers, employees, agents and representatives fromand against all liabilities relating to the services performed under the OldTransaction and Monitoring Fee Agreement or by the New Transaction and MonitoringFee Agreement and the engagement of BMP pursuant to, and the performance of BMPand its affiliates and their respective representatives of the servicescontemplated by, each such agreement.

 

**Policyand Procedures with Respect to Related Person Transactions**

 

**               **The Board ofDirectors has not adopted a formal written policy for the review and approvalof transactions with related persons. However, all such transactions will be reviewed by the Board on anas-needed basis.

 

**DirectorIndependence**

 

As a privately held company, theDJO Board is not required to have a majority of its directors beindependent.  We believe that Messrs. Braginsky,Howe and LaViolette would be deemed independent directors according to theindependence definition promulgated under the New York Stock Exchange listingstandards.

 

**ITEM 14.  PRINCIPALACCOUNTING FEES AND SERVICES**

 

**Fees Paid to the IndependentAuditor**

 

The following table sets forth theaggregate fees billed by Ernst & Young LLP for audit services renderedin connection with the consolidated financial statements and reports for fiscalyears 2008 and 2007 and for other services rendered during fiscal years 2008and 2007 on behalf of DJO and its subsidiaries, as well as all out-of-pocketcosts incurred

 

130

----

Table of Contents

 

in connection with these services, which have been billed to DJO.  All audit and audit related services werepre-approved by the audit committee.

** **
| ** **          | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
|                |       |     |       |     |       |
| Audit fees          |       | $        | 1,276,123  |     | $          | 2,282,000 |   |
| Audit-related  fees |       | 31,245   |       | 44,000   |       |
| Tax fees            |       | —   |       | —   |       |
| All other fees      |       | —   |       | —   |       |
|                     |            |          |            |          |            |  |  |

 

AuditFees:  Consists of fees billed forprofessional services rendered for the audit of DJO’s consolidated financialstatements, review of interim condensed consolidated financial statementsincluded in quarterly reports and services that are normally provided byauditors in connection with statutory and regulatory filings. In 2008, auditfees included fees related to the registration of the 10.875% Notes issued inconnection with the DJO Merger.  In 2007,audit fees included audit services provided in connection with the offeringmemorandum related to the issuance of 10.875% Notes issued in connection withthe DJO Merger and related to the registration of the 11.75% Notes issued inconnection with the Prior Transaction.

 

Audit-RelatedFees:  Consists of fees billed forassurance and related services that are reasonably related to the performanceof the audit or review of DJO’s consolidated financial statements and are notreported under “Audit Fees”.  During 2008and 2007 all audit-related fees were specifically pre-approved pursuant to theAudit Committee Pre-Approval Policy discussed below.

 

TaxFees:  Consists of tax compliance andconsultation services. There were no tax fees in 2008 and 2007.

 

AllOther Fees:  Consists of fees for allother services other than those reported above. There were no other fees in 2008 and 2007.

 

**Audit Committee Pre-Approval Policy**

 

All services to be performed for us by our independentauditors must be pre-approved by the audit committee, or a designated member ofthe audit committee, to assure that the provision of such services does notimpair the auditor’s independence.

 

The annual audit services engagement terms and feesare subject to the specific pre-approval of the audit committee.  The audit committee will approve, ifnecessary, any changes in terms, conditions, and fees resulting from changes inaudit scope or other matters.  All otheraudit services not otherwise included in the annual audit services engagementmust be specifically pre-approved by the audit committee.

 

Audit-related services are services that arereasonably related to the performance of the audit or review of our financialstatements or traditionally performed by the independent auditors.  Examples of audit-related services includeemployee benefit and compensation plan audits, due diligence related to mergersand acquisitions, attestations by the auditors that are not required by statuteor regulation, consulting on financial accounting/reporting standards andinternal controls, and consultations related to compliance with Section 404 ofthe Sarbanes-Oxley Act of 2002.  Allaudit-related services must be specifically pre-approved by the auditcommittee.

 

The audit committee may grant pre-approval of otherservices that are permissible under applicable laws and regulations and thatwould not impair the independence of the auditors.  All of such permissible services must bespecifically pre-approved by the audit committee.

 

Requests or applications for the independent auditorsto provide services that require specific approval by the audit committee areconsidered after consultation with management and the auditors.  Questions about whether the scope of aproposed service requires specific pre-approval, or is permitted by applicablelaws and regulations, are to be referred to our legal department.

 

131

----

Table of Contents

 

**PART IV**

 

**ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES**

 

(a)       The following documents arefiled as part of this Annual Report:

 

1.  Thefollowing consolidated financial statements of DJO Finance LLC, including thereports thereon of Ernst & Young LLP and KPMG LLP, are filed as partof this report under Part II, Item 8. Financial Statements andSupplementary Data:

 

·                  Reportsof Independent Registered Public Accounting Firms.

 

·                  ConsolidatedBalance Sheets as of December 31, 2008 and 2007.

 

·                  Consolidated Statements of Operationsfor the Successor years ended December 31, 2008 and 2007 and for theperiod November 4, 2006 through December 31, 2006 and for thePredecessor period January 1, 2006 through November 3, 2006.

 

·                  ConsolidatedStatements of Changes in Membership Equity and Comprehensive Loss for theSuccessor years ended December 31, 2008 and 2007 and for the period November 4,2006 through December 31, 2006.

 

·                  ConsolidatedStatements of Changes in Stockholders’ Equity and Comprehensive Income (Loss)for the Predecessor period January 1, 2006 through November 3, 2006.

 

·                  ConsolidatedStatements of Cash Flows for the Successor years ended December 31, 2008and 2007 and for the period November 4, 2006 through December 31,2006 and for the Predecessor period January 1, 2006 through November 3,2006.

 

·                  Notesto Audited Consolidated Financial Statements.

 

2.         FinancialStatement Schedules:

 

Schedule II – Valuation and Qualifying Accounts

 

All other financialstatement schedules are not required under the related instructions or areinapplicable and therefore have been omitted.

 

3.               Exhibits:

** **
| 2.1    |   | Agreement  and Plan of Merger, dated as of July 15, 2007, among DJO Finance LLC  (f/k/a ReAble Therapeutics Finance LLC) (“DJOFL”), Reaction Acquisition  Merger Sub, Inc., and DJO Opco Holdings Inc. (f/k/a DJO Incorporated)  (“DJO Opco”) (incorporated by reference to Exhibit 2.1 to DJOFL’s  Current Report on Form 8-K, filed on July 20, 2007).                                                                            |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 3.1    |   | Certificate of  Formation of DJOFL and amendments thereto (incorporated by reference to  Exhibit 3.1 to DJOFL’s Annual Report on Form 10-K for the fiscal  year ended December 31, 2007).                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 3.2    |   | Limited  Liability Company Agreement of DJOFL (incorporated by reference to  Exhibit 3.2 of DJOFL’s Registration Statement on Form S-4, filed on  April 18, 2007 (File No. 333-142188)).                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.1    |   | Indenture, dated as of  November 3, 2006, among DJOFL, DJO Finance Corporation (f/k/a Encore  Medical Finance Corp. and ReAble Therapeutics Finance Corporation) (“DJO  Finco”), the Guarantors named therein and The Bank of New York as Trustee,  governing the 113/4  Senior Subordinated Notes (incorporated by reference to Exhibit 4.1 of  DJOFL’s Registration Statement on Form S-4, filed on April 18, 2007  (File No. 333-142188)). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.2    |   | Registration Rights  Agreement, dated as of November 3, 2006, by and among DJOFL, DJO Finco,  the Guarantors named therein, Banc of America Securities LLC and Credit  Suisse Securities (USA) LLC (incorporated by reference to Exhibit 4.2 of  DJOFL’s Registration Statement on Form S-4, filed on April 18, 2007  (File No. 333-142188)).                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.3    |   | Indenture,  dated November 20, 2007, among DJOFL, DJO Finco, the Guarantors party  thereto and The Bank of New York, as trustee (incorporated by reference to  Exhibit 4.1 to DJOFL’s Current Report on                                                                                                                                                                                                                                                                |

 

132

----

Tableof Contents

 
|   |   | Form 8-K,  filed on November 27, 2007).                                                                                                                                                                                                                                                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 4.4    |   | Registration  Rights Agreement, dated November 20, 2007, among DJOFL, DJO Finco, the  Guarantors party thereto and Credit Suisse Securities (USA) LLC and Banc of  America Securities LLC (incorporated by reference to Exhibit 4.2 to  DJOFL’s Current Report on Form 8-K, filed on November 27, 2007).                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 4.5    |   | Credit  Agreement, dated November 20, 2007, among DJOFL, as borrower, DJO  Holdings, Credit Suisse, as administrative agent, the lenders from time to  time party thereto and the other agents named therein (incorporated by  reference to Exhibit 4.3 to DJOFL’s Current Report on Form 8-K,  filed on November 27, 2007). |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 4.6    |   | Security  Agreement, dated November 20, 2007, among DJOFL, as borrower, DJO  Holdings and certain subsidiaries named therein, and Credit Suisse, as  collateral agent (incorporated by reference to Exhibit 4.5 to DJOFL’s  Current Report on Form 8-K, filed on November 27, 2007).                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 4.7    |   | Guaranty  Agreement, dated November 20, 2007, among DJOFL, as borrower, DJO  Holdings and certain subsidiaries named therein, and Credit Suisse, as  collateral agent (incorporated by reference to Exhibit 4.4 to DJOFL’s  Current Report on Form 8-K, filed on November 27, 2007).                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.1*  |   | 2007  Incentive Stock Plan, dated November 20, 2007 (incorporated by reference  to Exhibit 10.7 to DJOFL’s Current Report on Form 8-K, filed on  November 27, 2007).                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.2*  |   | Amendment to 2007  Incentive Stock Plan, dated April 25, 2008 (incorporated by reference to  Exhibit 10.1 to DJOFL’s Current Report on Form 8-K, filed on  May 1, 2008).                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.3*  |   | Form of  Nonstatutory Stock Option Agreement under 2007 Incentive Stock Plan  (incorporated by reference to Exhibit 10.6 to DJOFL’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2007).                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.4*  |   | Form of DJO  Incorporated Directors’ Nonstatutory Stock Option Agreement under 2007  Incentive Stock Plan (incorporated by reference to Exhibit 10.7 to  DJOFL’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2007).                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.5*  |   | Form of  Nonstatutory Stock Option Agreement under 2007 Incentive Stock Plan  (Replacement Version) (incorporated by reference to Exhibit 10.8 to  DJOFL’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2007).                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.6*  |   | Form of  Nonstatutory Stock Option Rollover Agreement under 2007 Incentive Stock Plan  (incorporated by reference to Exhibit 10.9 to DJOFL’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2007).                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.7*  |   | Form of Incentive  Stock Option Rollover Agreement under 2007 Incentive Stock Plan (incorporated  by reference to Exhibit 10.10 to DJOFL’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2007).                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.8*  |   | Restricted  Stock Award Agreement, granted pursuant to the 2007 Incentive Stock Plan,  dated November 20, 2007, by and between DJO and Peter Baird  (incorporated by reference to Exhibit 10.5 to DJOFL’s Current Report on  Form 8-K, filed on November 27, 2007).                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.9*  |   | Term  Sheet for Paul D. Chapman, dated November 20, 2007, by and between DJO  and Paul D. Chapman (incorporated by reference to Exhibit 10.3 to  DJOFL’s Current Report on Form 8-K, filed on November 27, 2007).                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                  |
| 10.10* |   | Term  Sheet for Kenneth W. Davidson, dated November 20, 2007, by and between  DJO and Kenneth W. Davidson (incorporated by reference to Exhibit 10.4  to DJOFL’s Current Report on Form 8-K, filed on November 27, 2007).                                                                                                    |

 

133

----

Tableof Contents

 
| 10.11* |   | Outline of 2008 Incentive  Bonus Plan (incorporated by reference to Exhibit 10.33 to DJOFL’s Annual  Report on Form 10-K for the fiscal year ended December 31, 2007).                                                                                                                                               |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.12* |   | Forms  of Retention Bonus Agreement, dated November 20, 2007, by and between  certain executives and DJO (incorporated by reference to Exhibit 10.6 to  DJOFL’s Current Report on Form 8-K, filed on November 27, 2007).                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.13* |   | Forms of Change in  Control and Severance Agreements, dated September 19, 2007, between DJO  Opco and executive officers and certain members of management (incorporated  by reference to Exhibits 10.1 and 10.2 to DJO Opco’s Current Report on  Form 8-K, filed on September 25, 2007).                       |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.14  |   | Management Stockholders  Agreement, dated as of November 3, 2006, by and among DJO and the management  stockholders party thereto (incorporated by reference to Exhibit 10.22  of DJOFL’s Registration Statement on Form S-4, filed on April 18,  2007 (File No. 333-142188)).                             |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.15  |   | First  Amendment to Management Stockholders Agreement, dated November 20, 2007,  by and between DJO, certain Blackstone stockholders and certain management  stockholders (incorporated by reference to Exhibit 10.2 to DJOFL’s  Current Report on Form 8-K, filed on November 27, 2007).                       |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.16  |   | Transaction and  Monitoring Fee Agreement, dated November 3, 2006, between DJO and  Blackstone Management Partners V L.L.C. (incorporated by reference to  Exhibit 10.24 of DJOFL’s Registration Statement on Form S-4, filed  on April 18, 2007 (File No. 333-142188)).                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.17  |   | Amended  and Restated Transaction and Monitoring Fee Agreement, dated  November 20, 2007, between DJO and Blackstone Management Partners V  L.L.C. (incorporated by reference to Exhibit 10.1 to DJOFL’s Current  Report on Form 8-K, filed on November 27, 2007).                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.18  |   | Debt  Commitment Letter from Credit Suisse, Credit Suisse Securities (USA) LLC,  Bank of America, N.A., Banc of America Bridge LLC, and Banc of America  Securities LLC, dated as of July 15, 2007 (incorporated by reference to  Exhibit 10.1 to DJOFL’s Current Report on Form 8-K, filed on  July 20, 2007). |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.19  |   | Equity  Commitment Letter from Blackstone Capital Partners V L.P., dated as of  July 15, 2007 (incorporated by reference to Exhibit 10.2 to DJOFL’s  Current Report on Form 8-K, filed on July 20, 2007).                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.20* |   | Transition Agreement,  dated August 14, 2008, and Separation of Employment Agreement and  General Release, dated as of August 31, 2008, between DJO and Peter  Baird (incorporated by reference to Exhibit 10.1 to DJOFL’s Quarterly  Report on Form 10-Q for the quarter ended September 27, 2008).       |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.21* |   | Employment Agreement  between DJO and Scott A. Klosterman, dated June 2, 2003 (incorporated by  reference to Exhibit 10.24 to DJO’s Registration Statement on  Form S-1, filed on July 3, 2003 (Commission File No. 333-106821)).                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.22* |   | Amendment to Employment  Agreement between DJO and Scott A. Klosterman, dated November 15, 2003  (incorporated by reference to Exhibit 10.15.1 to DJO’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2004 (Commission  File No. 000-26538)).                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.23* |   | Amendment to Employment  Agreement between DJO and Scott A. Klosterman, dated November 3, 2006  (incorporated by reference to Exhibit 10.20 of DJOFL’s Registration  Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188)).                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.24* |   | Employment Agreement  between DJO and Peter W. Baird, executed effective October 1, 2006  (incorporated by reference to Exhibit 10.1 to DJO’s Current Report on  Form 8-K, filed on October 4, 2006)                                                                                                            |

 

134

----

Tableof Contents

 
| 10.25  |   | Lease  Agreement between Professional Real Estate Services, Inc. and dj  Orthopedics, LLC (now known as DJO, LLC), dated October 20, 2004 (Vista  facility) (Incorporated by reference to Exhibit 10.1 to DJO Opco’s  Current Report on Form 8-K filed on October 26, 2004). |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                       |
| 10.26  |   | Lease  Agreement, dated February 17, 2006, between MetroAir Partners, LLC, and  dj Orthopedics, LLC (Indianapolis facility) (Incorporated by reference to  Exhibit 10.2 to DJO Opco’s Quarterly Report on Form 10-Q for the  quarter ended April 1, 2006)                         |
|   |   |                                                                                                                                                                                                                                                                                                       |
| 10.27+ |   | Lease Agreement, dated  June 11, 1996, between Met 94, Ltd. and Encore Orthopedics, Inc.  covering 52,800 sq. ft. facility in Austin, Texas, together with amendments  thereto.                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                       |
| 10.28+ |   | Office/Light  Manufacturing Lease, dated June 14, 2996, between Cardigan Investments  Limited Partnership and EMPI, Inc., covering 93,666 sq. ft. facility in  St. Paul, Minnesota, together with amendments thereto.                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                       |
| 10.29+ |   | Lease Agreement, dated  December 10, 2003, between BBVA Bancomer Servicios, S.A. and DJ  Orthopedics de Mexico, S.A. de C.V., covering 200,000 sq. ft. facility in  Tijuana, Mexico.                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                       |
| 10.30+ |   | Agreement, dated  April 4, 2006, between BBVA Bancomer Servicios, S.A. and DJ Orthopedics  de Mexico, S.A. de C.V., amending Leases covering 200,000 sq. ft., 58,400 sq.  ft. and 27,733 sq. ft. facilities in Tijuana Mexico.                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                       |
| 12.1+  |   | Computation of Ratio of  Earnings to Fixed Charges                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                       |
| 21.1+  |   | Subsidiaries of DJO  Finance LLC                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                       |
| 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.                                                                                                                                                                      |

 

----

| * |   | constitutes management contract or compensatory  arrangement |
|---|--------|--------------------------------------------------------------|
| + |   | filed herewith                                               |

 

135

----

Tableof Contents

 

**DJOFINANCE LLC**

 

**SCHEDULEII—VALUATION AND QUALIFYING ACCOUNTS**

**(inthousands)**

 
| ** **                                | ** ** | **Allowance for  Doubtful  Accounts** | ** ** | **Allowance  for Sales  Returns** | ** ** | **Allowance for  Sales  Discounts and  Other Allowances (1)** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ***Predecessor:***                        | ** ** | ** **                                 | ** ** | ** **                             | ** ** | ** **                                                                   | ** ** |
| **Balance  as of December 31, 2005** |       | 3,664                                      |       | 352                                    |       | 10,320                                                                       |       |
| Provision                                 |       | 21,832                                     |       | (69                                    | )          | 72,872                                                                       |       |
| Write-offs, net  of recoveries            |       | (6,610                                     | )          | —                                 |       | (56,882                                                                      | )          |
| **Balance  as of November 3, 2006**  |       | $                                          | 18,886     |                                   | $          | 283                                                                          |       | $ | 26,310 |   |
| ***Successor:***                          |       |                                       |       |                                   |       |                                                                         |       |
| Provision                                 |       | 329                                        |       | 184                                    |       | 11,313                                                                       |       |
| Write-offs, net  of recoveries            |       | —                                     |       | —                                 |       | —                                                                       |       |
| **Balance  as of December 31, 2006** |       | 329                                        |       | 184                                    |       | 11,313                                                                       |       |
| Provision                                 |       | 21,971                                     |       | 550                                    |       | 99,803                                                                       |       |
| Acquired through  business acquisitions   |       | 14,229                                     |       | 480                                    |       | 39,186                                                                       |       |
| Write-offs, net  of recoveries            |       | (6,654                                     | )          | (135                                   | )          | (99,138                                                                      | )          |
| **Balance  as of December 31, 2007** |       | 29,875                                     |       | 1,079                                  |       | 51,164                                                                       |       |
| Provision                                 |       | 26,022                                     |       | 255                                    |       | 161,524                                                                      |       |
| Write-offs, net  of recoveries            |       | (21,615                                    | )          | (270                                   | )          | (147,004                                                                     | )          |
| **Balance  as of December 31, 2008** |       | $                                          | 34,282     |                                   | $          | 1,064                                                                        |       | $ | 65,684 |   |

 

----

(1) Amounts are excluded from theprovisions included in the consolidated statements of cash flows as theinclusion would not provide meaningful information.

 

136

----

Table ofContents

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| Date:  March 11, 2009 | **DJO FINANCE LLC** |
|----------------------------|---------------------|
|                       |                |   |
|                       | By:                 | /s/ Leslie H. Cross |
|                       |                | Leslie H. Cross |
|                       |                | *President, Chief Executive Officer and Director* |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**              | ** ** | **Title**                                               | ** ** | **Date**             |
|----------------------------|------------|---------------------------------------------------------|------------|----------------------|
| ** **                 | ** ** | ** **                                              | ** ** | ** **           |
| /s/ Leslie H.  Cross       |       | President, Chief  Executive Officer and Director        |       | March 11,  2009 |
| Leslie H. Cross            |       | (Principal Executive  Officer)                          |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Vickie L.  Capps       |       | Executive Vice  President, Chief Financial Officer and  |       | March 11,  2009 |
| Vickie L. Capps            |       | Treasurer (Principal  Financial and Accounting Officer) |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Chinh E. Chu           |       | Chairman of the Board  of Directors                     |       | March 11,  2009 |
| Chinh E. Chu               |       |                                                    |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Julia Kahr             |       | Director                                                |       | March 11,  2009 |
| Julia Kahr                 |       |                                                    |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Sidney  Braginsky      |       | Director                                                |       | March 11,  2009 |
| Sidney Braginsky           |       |                                                    |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Bruce McEvoy           |       | Director                                                |       | March 11,  2009 |
| Bruce McEvoy               |       |                                                    |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Phillip J.  Hildebrand |       | Director                                                |       | March 11,  2009 |
| Phillip J.  Hildebrand     |       |                                                    |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Lesley Howe            |       | Director                                                |       | March 11,  2009 |
| Lesley Howe                |       |                                                    |       |                 |
|                       |       |                                                    |       |                 |
| /s/ Paul  LaViolette       |       | Director                                                |       | March 11,  2009 |
| Paul LaViolette            |       |                                                    |       |                 |

 

137

----