** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**FORM 10-K**

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**xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**For the fiscal year ended December 31,2007**

**or**

 

**o TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

** **

**For the transition period from                    to                    .**

** **

**Commissionfile number**333-142188

** **

**DJOFinance LLC**

(Exact name of Registrantas specified in its charter)

 

| **Delaware**                                                                 | ** ** | **20-5653965**         |
|------------------------------------------------------------------------------|------------|------------------------|
| (State or other  jurisdiction of                                             |       | (I.R.S. Employer       |
| incorporation or  organization)                                              |       | Identification Number) |
|                                                                         |       |                   |
| **1430  Decision Street**                                                    | ** ** | **92081**              |
| **Vista,  California**                                                       |       | (Zip Code)             |
| (Address of principal  executive offices)                                    |       |                   |
|                                                                         |       |                   |
| Registrant’s telephone  number, including area code: **(800) 336-5690** |

** **

Securities registeredpursuant to Section 12(b) of the Act:

 

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

 

Securities registeredpursuant to Section 12(g) of the Act:

**None**

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe 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

** **

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes x  No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained 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 check markwhether the Registrant is a large accelerated filer, an accelerated filer, anon-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 check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct).

Yes o  No x

 

As of March 28, 2008,100% of the issuer’s membership interests were owned by DJO Holding LLC.

 

 

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**DJO FINANCE LLC**

**FORM 10-K**

**TABLE OF CONTENTS**

 
| ** **   | ** **                                                                                                              | **Page  No.** |
|--------------|-------------------------------------------------------------------------------------------------------------------------|---------------|
| ** **   | **PART I**                                                                                                         | ** **    |
| ** **   | ** **                                                                                                              | ** **    |
| Item 1.      | Business                                                                                                                | 4             |
| Item 1A.     | Risk Factors                                                                                                            | 22            |
| Item 2.      | Properties                                                                                                              | 41            |
| Item 3.      | Legal Proceedings                                                                                                       | 42            |
| Item 4.      | Submission  of Matters to a Vote of Security Holders                                                                    | 43            |
|         |                                                                                                                    |          |
| ** **   | **PART II**                                                                                                        | ** **    |
| Item 5.      | Market for  the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities | 44            |
| Item 6.      | Selected Financial  Data                                                                                                | 44            |
| Item 7.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             | 45            |
| Item 7A.     | Quantitative  and Qualitative Disclosures About Market Risk                                                             | 62            |
| Item 8.      | Financial  Statements and Supplementary Data                                                                            | 63            |
| Item 9.      | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                                   | 115           |
| Item 9A (T). | Controls and  Procedures                                                                                                | 115           |
| Item 9B.     | Other Information                                                                                                       | 116           |
|         |                                                                                                                    |          |
| ** **   | **PART III**                                                                                                       | ** **    |
| Item 10.     | Directors,  Executive Officers and Corporate Governance                                                                 | 117           |
| Item 11.     | Executive  Compensation                                                                                                 | 119           |
| Item 12.     | Security Ownership  of Certain Beneficial Owners and Management and Related Stockholder Matters                         | 133           |
| Item 13.     | Certain  Relationships and Related Transactions, and Director Independence                                              | 134           |
| Item 14.     | Principal  Accounting Fees and Services                                                                                 | 135           |
|         |                                                                                                                    |          |
| ** **   | **PART IV**                                                                                                        | ** **    |
| Item 15.     | Exhibits,  Financial Statement Schedules                                                                                | 137           |
| SIGNATURES   |                                                                                                                    | 142           |

 

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### ** **

### **FORWARD-LOOKINGSTATEMENTS**

### ** **

This Annual Reporton Form 10-K of DJO Finance LLC (“DJOFL”, or “Successor”), formerly knownas ReAble Therapeutics Finance LLC, for the year ended December 31, 2007 containsforward-looking statements, principally in the sections entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” and “Business.”  Generally, you can identify these statementsbecause they 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 our recentacquisitions.

 

Although we do not make forward-looking statements unless webelieve we have a reasonable basis for doing so, we cannot guarantee theiraccuracy, and actual results may differ materially from those we anticipateddue to a number of uncertainties, many of which are unforeseen, including,among others, the risks we face as described in the paragraph below andelsewhere in this filing.  You should notplace undue reliance on these forward-looking statements, which apply only asof the date of this Annual Report on Form 10-K. These forward-looking statements arewithin the meaning of Section 27A of the Securities Act of 1933, asamended (the “Securities Act”), and Section 21E of the Securities ExchangeAct of 1934, as amended (the “Exchange Act”), and are intended to be covered bythe safe harbors created thereby.  To theextent that such statements are not recitations of historical fact, suchstatements constitute forward-looking statements that, by definition, involverisks and uncertainties.  In anyforward-looking statement, where we express an expectation or belief as tofuture results or events, such expectation or belief is expressed in good faithand believed to have a reasonable basis, but there can be no assurance thatsuch future results or events expressed by the statement of expectation orbelief will be achieved or accomplished.

 

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 on Form 10-K,provide examples of risks, uncertainties and events that may cause our actualresults to differ materially from the expectations we describe in ourforward-looking statements.

 

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**PART I.**

 

## **ITEM 1.  BUSINESS**

## ** **

**Overview**

 

We are a leading global provider ofhigh-quality, orthopedic devices, with a broad range of products used forrehabilitation, pain management and physical therapy. We also develop,manufacture and distribute a broad range of surgical reconstructive implant products.  We are the largest non-surgical orthopedicrehabilitation device company in the United States and among the largestglobally, as measured by revenues. Many of our products have leading marketpositions. We believe that our strong brand names, comprehensive range ofproducts, 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.   Our products are used by orthopedicspecialists, spine surgeons, primary care physicians, pain managementspecialists, physical therapists, podiatrists, chiropractors, athletic trainersand other healthcare professionals to treat patients with musculoskeletalconditions resulting from degenerative diseases, deformities, traumatic eventsand sports-related injuries.  Inaddition, many of our non-surgical medical devices and related accessories areused by athletes and patients for injury prevention and at-home physicaltherapy treatment.

 

Our currentbusiness activities are the result of a combination of two companies with broadorthopedic product offerings in the United States and foreign countries.  One of those companies, ReAble Therapeutics, Inc.(“ReAble”), was a leading manufacturer and distributor of electrotherapyproducts for pain therapy and rehabilitation, a broad range of clinical devicesfor the treatment of patients in physical therapy clinics, and a broad range ofknee, hip and shoulder implant products. In 2006, ReAble was acquired by an affiliate of Blackstone CapitalPartners V L.P. (“Blackstone”). The other company, DJO Opco Holdings, Inc.(“DJO Opco”), formerly named DJO Incorporated, was a leading manufacturer anddistributor of orthopedic rehabilitation products, including rigid kneebracing, orthopedic soft goods, cold therapy systems, vascular systems and bonegrowth stimulation devices. On November 20, 2007, ReAble acquired DJO Opcothrough a merger transaction (the “DJO Merger”).  ReAble then changed its name to DJOIncorporated (“DJO”) and continues to be owned primarily by affiliates ofBlackstone.

 

Historicalfinancial results include results of ReAble and its subsidiaries before andafter its acquisition by Blackstone and include the results of DJO Opco fromthe date of the DJO Merger through December 31, 2007.  Pro forma financial information (unaudited)includes the combined results of operations of DJO Opco and ReAble as thoughthe companies had been combined as of the beginning of each of the periodspresented.  Pro forma information ispresented for informational purposes only and is not indicative of the resultsof operations that would have been achieved if the acquisition had taken placeat the beginning of each of the periods presented.

 

Except asotherwise indicated, references to “us”, “we”, “our”, “DJO”, or “our Company”in this Annual Report on Form10-K refers to DJO Incorporated (formerly named ReAble Therapeutics, Inc.), acompany incorporated in the State of Delaware in March 1995, and itsconsolidated subsidiaries. Each one of the following trademarks, trade names orservice marks, which is used in this Annual Report on Form 10-K, is either (i)our registered trademark, (ii) a trademark for which we have a pendingapplication, (iii) a trade name or service mark for which we claim common lawrights or (iv) a registered trademark or application for registration which wehave been licensed by a third party to use: Encore®, OTI Osteoimplant Technology,Inc®, Cefar®, Empi®, Ormed® Chattanooga GroupTM, Compex®, EmpiCare®, Aircast®,DonJoy®, OfficeCare®, ProCare®, SpinaLogic®, RMETM, CMFTM, OL1000TM, and OL1000SCTM . All other trademarks, trade names or service marks of any other companyappearing in this Annual Report on Form 10-K belong to their respective owners.

 

**The DJOMerger**

 

On November 20, 2007, a subsidiary of ReAble was merged into DJOOpco, with DJO Opco continuing as the surviving corporation.  As a result of the DJO Merger, DJO Opcobecame a subsidiary of ReAble Therapeutics Finance LLC, the entity filing thisAnnual Report on Form 10-K, which was itself a subsidiary of ReAble.  The former stockholders of DJO Opco were paid$50.25 for each share of DJO Opco common stock held on the date of the DJOMerger, constituting a total purchase price for the equity of DJO Opco ofapproximately $1.3 billion. The financing for the DJO Merger involved paymentto the DJO Opco stockholders, refinancing of DJO Opco and ReAble senior debt,debt issue costs, and transaction costs and expenses, all of which amounted toa total of approximately $2.0 billion. The source of this financing was a combination of 

 

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equitycontributed by Blackstone of $434.6 million, a new ReAble Therapeutics FinanceLLC senior secured credit facility (the “New Senior Secured Credit Facility”)of approximately $1.1 billion, and a total of $575.0 million principal amountof new 10.875% senior notes co-issued by ReAble Therapeutics Finance LLC (the “10.875%Notes”). A total of $200.0 million principal amount of 11.75% seniorsubordinated notes (the “11.75% Notes”) co-issued by ReAble TherapeuticsFinance LLC remained outstanding. Following the DJO Merger, ReAble was renamedDJO Incorporated, ReAble Therapeutics Finance LLC was renamed DJO Finance LLC (“DJOFL”)and ReAble Therapeutics Finance Corporation, the co-issuer of both the 10.875%Notes and the 11.75% Notes, was renamed DJO Finance Corporation (“Finco”).

 

**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”). 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, $7.2million related to the fair value of management rollover options that continuedto remain as outstanding options to purchase ReAble common stock after thePrior Transaction (the “Prior Transaction Management Rollover Options”), and$39.5 million in direct acquisition costs. The Prior Transaction was financed through a combination of equitycontributed by Blackstone, cash on hand of ReAble, borrowings under ourprevious senior secured credit facility and proceeds from the 11.75%Notes.  Upon the closing of the PriorTransaction, shares of ReAble’s common stock ceased to be traded on the NASDAQGlobal Market.

 

**Operating Segments**

 

Following the DJO Merger,we provide a broad array of orthopedic rehabilitation and regenerationproducts, as well as implants to customers in the United States andabroad.  Our reportable segments aremanaged separately because each segment requires different sales and marketingstrategies and in some cases offers different products (see Note 11 to ouraudited consolidated financial statements). We currently develop, manufacture anddistribute our products through the following three operating segments:

 

***DomesticRehabilitation***

 

We market our domesticrehabilitation products through the three divisions described below.

 

*DonJoy, ProCare and Aircast.*Our DonJoy, ProCare and Aircast divisionwas acquired with the DJO Merger and offers products in the followingcategories:

 

·                  rigid knee bracing, which includes functional bracing for preventionand rehabilitation of ligament injuries, load shifting braces to relieveosteoarthritis pain and post-operative braces for protecting surgical repair;

 

·                  orthopedic soft goods, which include products that offer immobilizationand support from head to toe;

 

·                  cold therapy products, which assist in the reduction of swelling andpain; and

 

·                  vascular systems, which include products intended to prevent deep veinthrombosis following surgery.

 

This division alsoincludes our OfficeCare business, through which we maintain an inventory ofsoft goods and other products at healthcare facilities, primarily orthopedicpractices, for immediate distribution to patients.

 

*Empi.*Our Empi division offers products in thefollowing categories:

 

·                  home electrotherapy, which includes transcutaneous electrical nervestimulation (“TENS”) for pain management and neuromuscular electrical nervestimulation (“NMES”) devices for rehabilitation;

 

·                  bone growth stimulation products acquired with the DJO Merger, whichpromote the healing of bone tissue through combined magnetic field (“CMF”)technology;

 

·                  iontophoresis, which includes devices and accessories to delivermedication transdermally; and

 

·                  home traction, which includes cervical and lumbar traction devicesdesigned to provide decompression to the spine.

 

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This division alsoincludes our Rehab Med + Equip (‘‘RME’’) and EmpiCare business. RME sells awide range of proprietary and third party rehabilitation products to physicaltherapists and chiropractors through a printed catalog and through an on-linee-commerce site.  Through our EmpiCarebusiness, we maintain an inventory of soft goods and other products athealthcare facilities, primarily orthopedic practices, for immediatedistribution to patients.

 

*Chattanooga.*Our Chattanooga Group offers products inthe clinical rehabilitation market in the following categories:

 

·                  clinical electrotherapy devices (such as TENS, NMES, laser, ultrasoundand light therapy);

 

·                  clinical traction devices; and

 

·                  other clinical products and supplies such as treatment tables,continuous passive motion (‘‘CPM’’) devices and dry heat therapy.

 

***InternationalRehabilitation***

 

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

 

·                  the international sales of our DonJoy, ProCare and Aircast products,including rigid knee bracing products, orthopedic soft goods, cold therapyproducts and vascular systems;

 

·                  our Ormed business, which provides bracing, CPM, electrotherapy andother products primarily in Germany; and

 

·                  our Cefar-Compex business, which provides electrotherapy products formedical and consumer markets and other physical therapy and rehabilitationproducts primarily in Europe.

 

***Surgical Implant***

 

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

 

**Recent Acquisitions**

 

In recent years, our growth has been driven both by the introduction ofproducts facilitated 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 two years.

 

On August 9,2007, a subsidiary of DJOFL acquired IOMED, Inc. (“IOMED”), whichdevelops, manufactures and markets active drug delivery systems used primarilyto treat acute local inflammation in the physical and occupational therapy andsports medicine markets. The purchase price of $23.3 million consisted of$21.1 million in cash payments to former IOMED equity holders at $2.75 pershare, $0.8 million related to the fair value of vested stock options thatwere outstanding at the time of the acquisition, and $1.4 million indirect acquisition costs. The acquisition was primarily financed with borrowingsunder our then existing revolving credit facility.

 

On July 2,2007, a subsidiary of DJOFL completed its purchase of substantially all of theassets of The Saunders Group, Inc. (“Saunders”) for total cashconsideration of $40.9 million, including $0.9 million of acquisitioncosts. Saunders is a supplier of rehabilitation products to physicaltherapists, chiropractors, athletes, athletic trainers, physicians andpatients, with a specialty in patented traction devices, back supports, andequipment for neck and back disorders.

 

On November 7,2006, a subsidiary of DJOFL acquired Cefar AB (“Cefar”), a provider ofelectrotherapy and rehabilitation devices in Europe used for chronic pain, forwomen’s health (labor pain, incontinence, dysmenorrhea), electroacupuncture,and other rehabilitation activities. We have integrated the operations of Cefarwith those of Compex SA, the European subsidiary of Compex Technologies, Inc.(“Compex”).  Our strategy for the mergedcompany is to develop both the professional/medical and consumer markets forelectrostimulation across Europe and internationally, while continuing to sellproducts under both the Cefar and Compex brands.  The purchase price for Cefar of $27.1 millionwas comprised of $16.3 million in cash, issuance of 573,134 shares of ourcommon stock valued at $9.5 million, and approximately $1.3 million inacquisition costs. In addition, we also assumed Cefar’s existing debt ofapproximately $3.8 million.

 

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On February 24, 2006, we completed the acquisition of Compex.Compex manufacturedand sold a broad line of TENS and NMES productsused for pain management, rehabilitation, fitness and sports performanceenhancement in clinical, home healthcare, sports and occupational medicinesettings. We paid a total purchase price of approximately $102.9 million,comprised of approximately 7.3 million shares of our common stock valued atapproximately $90.0 million in exchange for all of the outstanding common stockof Compex, options to purchase approximately 900,000 shares of our common stockvalued at $9.3 million in exchange for all of the outstanding options topurchase common stock of Compex, and $3.6 million in acquisition costs.

 

**Industry Background**

 

**Market Opportunities**

 

We participateglobally in the rehabilitation, pain management, bone growth stimulation andreconstruction segments of the orthopedic device market. In the United States,we estimate these segments accounted for approximately $6.7 billion of totalindustry sales in 2006. We believe that several factors are driving growth inthe 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 2007 United States CensusBureau – International Data Base projection, the aging baby boomer generationwill result in the percentage of the North American population aged 65 and overto grow from 12.0% in 2008 to 16.0% in 2020 and to 20.0% by 2030. In WesternEurope, the population aged 65 and over is expected to grow from 17.0% in2008 to 20.0% in 2020 and to 24.0% by 2030.  In addition, according to a2007 United States Census Bureau – International Data Base projection, theaverage life expectancy in North America increased from 77.9 years in 2005to 78.3 years in 2008 and is expected to grow to 81.3 years by 2030.  In Western Europe, the average life expectancy increased from 79.2years in 2005 to 79.7 years in 2008 and is expected to grow to 82.0 years by2030.  As life expectancy increases, webelieve people will remain active longer, causing the number of injuriesrequiring orthopedic rehabilitation, bone growth stimulation and reconstructiveimplants to increase.

 

·                  *Shift toward non-surgicalrehabilitation devices and at-home physical therapy.* We believe the growing awareness and clinical acceptance by healthcareprofessionals of the benefits of non-surgical, non-pharmaceutical treatment andrehabilitation products, combined with the increasing interest by patients inrehabilitation solutions that minimize risk and recuperation time and providegreater convenience, will continue to drive demand for these products. Forexample, TENS and NMES devices are increasingly being recognized as effectivesolutions for pain management and rehabilitation therapy, respectively. Inaddition, we believe that orthopedic surgeons are increasingly utilizing bracesthat assist in rehabilitation and bone growth stimulation devices that enablein-home treatment 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 tothird 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 rehabilitationdue to increased orthopedic surgical volume.*  Thecombination of increased prevalence of degenerative joint disease (such asosteoarthritis), an increased number of sports-related injuries, an agingpopulation and improvements in orthopedic surgical technique (such asarthroscopy) has contributed to an increase in the number of orthopedicsurgeries. We believe that orthopedic surgical volume will continue toincrease, which should result in an increase in the need for our products.

 

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**Competitive Strengths**

 

We believe that we have anumber of competitive strengths that will enable us to further enhance ourposition in the orthopedic rehabilitation device market:

 

·                  *Leading market positions*. We derived nearly one-half of our net sales in 2007 from products forwhich we estimate we have leading market positions, including soft goods, anklebraces, walking braces, rigid knee braces, clinical electrotherapy, TENS, NMES,iontophoresis, cold therapy, home and clinical traction and CPM devices. Webelieve our orthopedic and physical therapy rehabilitation products marketedunder the DonJoy, Aircast, ProCare, Chattanooga Group, Empi, Cefar, Compex andOrmed brands have a reputation for quality, durability and reliability amonghealthcare professionals. We believe the strength of our brands and our focuson customer service have allowed us to establish market leading positions inthe highly fragmented 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.

 

·                  *Extensive and diverse distribution network.*  We use multiple channels to distribute ourproducts to our customers. We use over 13,000 dealers and distributors and adirect sales force of over 500 employed sales representatives and approximately900 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 1,000 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 OfficeCareand EmpiCare businesses maintain inventory at over 1,300 healthcare facilities,primarily orthopedic practices, which further strengthens our relationshipswith these healthcare providers.

 

·                  *National contracts with group purchasing organizations.*   Following the DJO Merger, we enjoy strongrelationships with a meaningful number of group purchasing organizations (“GPOs”)due to our significant scale. We believe that our broad range of products iswell suited to the goals of these buying groups. Under these nationalcontracts, we provide favorable pricing to the buying group and are designateda preferred purchasing source for the members of the buying group for specifiedproducts. As DJO Opco made acquisitions and expanded its product range, it hasbeen able to add incremental products to its national contracts. During 2007,DJO Opco signed or renewed six significant national contracts, and also addedproducts from its recent acquisitions to a number of these nationalcontracts.  Following the DJO Merger, webelieve we will be able to add additional products to these contracts.

 

·                  *Low cost, high quality manufacturing capabilities.*  Our principal manufacturing facility islocated in Tijuana, Mexico and has been recognized for operational excellence.Our low cost manufacturing principles drive manufacturing efficiencies byemploying lean manufacturing, Six Sigma concepts and continuous improvementprocesses.  Following the DJO Merger, weplan to move additional portions of our manufacturing to Mexico and expect toachieve savings from lower labor costs and implementation of more efficientprocesses. Further, we intend to extend lean manufacturing concepts to ourmanufacturing facilities in Clear Lake, South Dakota and Chattanooga,Tennessee.

 

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·                  *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 24 years of relevant experience.This team has successfully integrated a number of acquisitions in the lastseveral years.

 

**Our Strategy**

 

Our strategy is to increase our leading position inkey products and markets, increase revenues and profitability and enhance cashflow. Our key initiatives to implement this strategy 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 will allow 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 will enable us to capitalize on the growth in the orthopedic productindustry.

 

·                  *Increase sales force productivity.*  We believe that our complementarydistribution channels following the DJO Merger will provide an opportunity toincrease the productivity of our sales force. Our sales representatives will generally have a targeted customer basewith a broader product offering for those customers. We plan to encouragecross-selling and increase the productivity of the entire sales force byfocusing our sales organization and implementing a sales compensation plan toincentivize our sales representatives to sell a broader range of our products.For example, as a result of the DJO Merger, we will combine our strongrelationships with orthopedic surgeons and our strong relationships withphysical therapists. In addition, we intend to market DJO Opco’s bone growthstimulation products through Empi’s extensive distribution network.

 

·                  *Maximize existing and secure additional national accounts.*   We plan to capitalize on the growingpractice in healthcare in which hospitals and other large healthcare providersseek to consolidate their purchasing activities to national buying groups.Contracts with these national accounts represent a significant opportunity forrevenue growth. We believe that our existing relationships with national buyinggroups and our broad range of products position us well not only to pursueadditional national contracts, but also to expand the scope of our existingcontracts.

 

·                  *Continue to develop and launch new products and product enhancements.*  We have a history of developing andintroducing innovative products into the marketplace, and we expect to continuefuture product launches by leveraging our internal research and developmentplatforms. We believe our ability to develop new technology and to advanceexisting technology to create new products will position us to further diversifyour revenues and to expand our target markets by providing viable alternativesto surgery or medication. We believe that product innovation through effectiveand focused research and development, as well as our relationships with anumber of widely recognized orthopedic surgeons and professionals who assist usin product research, development and marketing, will provide a significantcompetitive advantage. During 2007, we launched 38 new products, whichgenerated over $34.1 million in revenues and on a pro forma basis 51 newproducts, which generated $38.2 million in revenues.

 

·                  *Expand international sales.* In recent years, DJO Opco successfully established direct distributioncapabilities in several major international markets. We believe that sales to Europeanand other markets outside the United States continue to represent a significantgrowth opportunity, and we intend to continue to expand our direct andindependent distribution capabilities in attractive foreign markets. 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. For the year endedDecember 31, 2007, we generated approximately 27.0% of our net sales fromcustomers outside the United States as compared to 23.9% for the year ended December 31,2006.  On a pro forma basis, wegenerated international sales of approximately 25.0% for the year ended December 31,2007.

 

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·                  *Maximize cost savings opportunities.*  We expect the DJO Merger to createsignificant opportunities to reduce manufacturing and other operating costs. Weexpect to achieve cost savings by leveraging our low-cost manufacturingcapabilities, rationalizing our combined manufacturing and distributionfootprints, increasing procurement savings and eliminating duplicative overheadfunctions. We also intend to eliminate overlapping operating expenses andexpect to reduce expenses through improved leveraging of our benefits of scalecreated by the DJO Merger.

 

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

 

Our products are used byorthopedic specialists, spine surgeons, primary care physicians, otherspecialist physicians, physical therapists, podiatrists, chiropractors,athletic trainers and other healthcare professionals to treat patients withmusculoskeletal conditions resulting from degenerative diseases, deformities,traumatic events and sports related injuries. In addition, many of ournon-surgical medical devices and related accessories are used by athletes andpatients to prevent injuries and for at-home physical therapy treatment.

 

***Domestic Rehabilitation Segment***

 

Our Domestic Rehabilitation Segment generated netsales of $321.4 million and $242.7 million for the years ended December 31,2007 and 2006 (combined basis), respectively. 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.  Thiscombination does not comply with generally accepted accounting principles butis presented because we believe it provides the most meaningful comparison ofour results.  On a pro forma basis, our Domestic Rehabilitation Segment accounted forapproximately $649.1 million and $574.3 million of our net sales for the yearsended December 31, 2007 and 2006 (combined basis), respectively.

 

The following tablesummarizes many of our Domestic Rehabilitation Segment 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 |

 

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| **Product Category**                      | ** ** | **Description**                                                                                                 |
|------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|
| 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 International Rehabilitation Segment generated netsales of $104.1 million and $60.5 million for the years ended December 31,2007 and 2006 (combined basis), respectively. On a pro forma basis, ourInternational Rehabilitation Segment generated net sales of approximately$212.7 million and $168.1 million for the years ended December 31, 2007and 2006 (combined basis), respectively. The product categories for our International RehabilitationSegment are similar to the product categories for our Domestic RehabilitationSegment but certain products are tailored to international market requirementsand preferences. 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 Implant Segmentgenerated net sales of approximately $66.6 million and $59.1 million for theyears ended December 31, 2007 and 2006 (combined basis),respectively.  These net sales amounts donot change on a pro forma basis because DJO Opco did not conduct anyoperations in the Surgical Implant Segment.

 

Thefollowing table summarizes our Surgical Implant Segment product categories:

 
| **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) |

 

**Research and Development**

 

Ourresearch and development programs focus on the development of new products, aswell as the enhancement of existing products with the latest technology andupdated designs. We seek to develop new technologies to improve durability,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.

 

Weconduct research and development programs at our facilities in Austin, Texas;Chattanooga, Tennessee; St. Paul, Minnesota; Clear Lake, South Dakota; Vista,California; Anglet, France and Ecublens, Switzerland. We invested approximately$18.0 million in 2007 (excluding approximately $3.0 million of acquiredin-process research and development (“IPR&D”), $13.8 million in 2006 (on acombined basis and excluding approximately $29.1 million of acquiredIPR&D), and $9.6 million in 2005 into research and development activities.On a pro forma basis, we invested approximately $26.0 million into research anddevelopment activities for the year ended December 31, 2007.  As of December 31, 2007, we hadapproximately 150 employees in our research and development departments.

 

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

 

Wedistribute our products through several sales and distribution channels thatallow us to sell our products to a variety of treatment settings across new andcomplementary distribution networks.

 

***DomesticRehabilitation Segment***

 

Wemarket and sell our Domestic Rehabilitation Segment products in severaldifferent 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 410 independent commissioned salesrepresentatives who are employed by approximately 45 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 agentfails to achieve specified sales quotas, we have the right to terminate ourrelationship with the agent.  We haverecently converted the Northern California and Pacific Northwest region to adirect sales model for products in the DonJoy channel and for ProCare/Aircastand regeneration products

 

The ProCare/Aircastchannel consists of approximately 100 direct and independent salesrepresentatives that manage over 380 distributors focused on primary andacute care facilities. Six vascular systems specialists are also included inthis channel. Products in this channel consist primarily of our soft goods,vascular systems and other products, which are generally sold in non-exclusiveterritories to third party distributors as well as through our direct salesforce. Our distributors include large, national third party distributors suchas Owens & Minor Inc., McKesson/HBOC, Allegiance Healthcare andPhysician Sales and Service Inc., regional medical and surgicaldistributors, outpatient surgery centers and medical products buying groupsthat consist of a number of health care providers who make purchases throughthe buying group. These distributors and our direct sales force generally sellour products to large hospital chains, primary care networks and orthopedicphysicians for use by the patients. In addition, we sell our products throughGPOs that are a preferred purchasing source for members of a buying group.  Unlike our DonJoy products, our ProCare/Aircastproducts generally do not require significant customer education for their use.Our vascular systems pumps and related equipment are typically consigned tohospitals, and the hospitals then purchase the cuffs that are applied to eachpatient.

 

Our OfficeCare andEmpiCare businesses provide stock and bill arrangements for physicianpractices. Through OfficeCare and EmpiCare, we maintain an inventory of softgoods at 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. EmpiCare manages its locations through a combination of direct andindirect representatives.

 

Through our Empi channel,we market our prescription home therapy products primarily to physicians andphysical therapy clinics, which include hospital physical therapy departments,sports medicine clinics and pain management centers, through our sales force ofover 230 direct and independent sales representatives. In connection with theseproduct lines, we currently have more than 830 managed care contracts. Ourelectrotherapy and orthotics products are generally prescribed to patients by aphysician such as an orthopedic surgeon. The physician will typically directthe patient to a physical therapy clinic to meet with a trained physicaltherapist who provides the patient with the prescribed product from ourconsigned inventory at the clinic. This sales process is facilitated by ourrelationships with third party payors, such as managed care organizations, whoultimately pay us for the products prescribed to patients. For these reasons,we view physical therapists, physicians and third party payors as key decisionmakers in product selection and patient referral. Our home therapy productsgenerally are eligible for third party reimbursement by government payors, suchas Medicare and Medicaid, and private

 

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payors. In addition, wehave an outbound telemarketing sales force of 42 representatives, who sellreimbursed electrotherapy supplies and other products directly to our patients.Our non-union fracture bone growth stimulator devices (OL1000) are soldprimarily by approximately 155 employed and independent sales representativesspecially trained to sell the product. The spine bone growth stimulator device(SpinaLogic) is sold by a few of our direct sales representatives and a networkof independent spine products distributors. Most of our bone growth stimulatorproducts are sold directly to the patient and a third party payor is billed, ifapplicable, on behalf of the patient.

 

Throughour Chattanooga Group, we sell our clinical rehabilitation product lines tophysical therapy clinics, primarily through a worldwide network ofapproximately 4,700 independent distributors, which are managed by our internalsales managers, and through catalogue sales. These distributors sell ourclinical rehabilitation products to a variety of healthcare professionals,including physical therapists, athletic trainers, chiropractors, and sportsmedicine physicians. Except for distributors outside of the United States, wedo not maintain formal distribution contracts for our clinical rehabilitationproducts. These distributors purchase products from us at discounts off ourpublished list price. We maintain an internal marketing and sales supportprogram to support our distributor network. This program comprises a group ofindividuals who provide distributor and end-user training, develop promotionalmaterials, and attend over 36 trade shows each year.   Our Chattanooga channel also includes 17 dedicatedbusiness-to-business sales representatives and catalog sales.

 

Noparticular customer or distributor accounted for 10% or more of product salesfor the year ended December 31, 2007. Medicare and Medicaid together accounted for approximately 7.4% of our2007 net sales. In the United States, in connection with these product lines,we currently have more than 80 preferred provider arrangements with third partypayors included in the over 830 managed care contracts discussed above.

 

***International Rehabilitation Segment***

 

We sell our rehabilitationproducts internationally through a network of wholly-owned subsidiaries andindependent distributors. In Europe, we use sales forces aggregatingapproximately 240 direct and independent salespersons and a network ofindependent 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.

 

***Surgical ImplantSegment***

 

Wecurrently market and sell the products of our Surgical Implant Segment in theUnited States to hospitals and orthopedic surgeons through a network of over160 independent commissioned sales representatives who are employed by approximately50 sales agents. Generally, our independent sales representatives sell a rangeof reconstructive joint products, including our products. We usually enter intoagreements with sales agents for a term of one to five years. Agents aretypically paid a sales commission and are eligible for bonuses if sales exceedcertain preset objectives. Our independent sales representatives work for theseagents. We assign our sales agents to an exclusive sales territory.Substantially all of our sales agents agree not to sell competitive products.Typically we can only terminate our agreements with sales agents prior to theexpiration of the agreements for cause, which includes failure to meetspecified periodic sales targets. We provide our sales agents with productinventories on consignment for their use in marketing our products and fillingcustomer orders. Outside the United States, our surgical implant products aresold through independent distributors, principally in Japan and selectcountries in Europe.

 

To asignificant extent, sales of our surgical implant products depend on thepreference of orthopedic surgeons. We have developed and maintain closecontractual relationships with orthopedic surgeons who assist us in developingour products. These orthopedic surgeons may give demonstrations using ourproducts, speak about our products at medical seminars, train other orthopedicsurgeons in the use of our products, and provide us with feedback on theacceptance of our products. We have also established relationships withsurgeons who perform various consulting services for us, including conductingclinical studies on various products, establishing protocols for use of theproducts and participating at various symposia. Surgeons who assist us indeveloping our products are generally compensated with a royalty payment.Consulting surgeons are paid consulting fees for their services.

 

**M****anufacturing**

 

We use both in-house manufacturing capabilities and relationships withthird party vendors to supply our products. Generally, we use third partyvendors because they have special manufacturing capabilities or because webelieve it is appropriate based on certain factors, including our in-housecapacity, lead time control and cost control. Although we have certain sole sourcesupply agreements, we believe alternate vendors are available, and we believethat adequate capacity exists at our current vendors to meet our anticipatedneeds.

 

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Our manufacturingfacilities are generally certified by the International Organization forStandardization (“ISO”) and generally comply with FDA current GoodManufacturing Practice (“cGMP”) and Quality System Regulations (“QSR”)requirements, which provide standards for safe and consistent manufacturing ofmedical devices and appropriate documentation of the manufacturing anddistribution process. Many of our products carry the European Community MedicalDevice Directive “CE” certification mark.

 

***DomesticRehabilitation Segment***

 

Our manufacturingfacility in Tijuana, Mexico is our principal manufacturing facility. In thefuture we plan to move additional manufacturing to our Mexico facility.  Our Mexico facility has achieved ISO 9001 andISO 13485 certification. These certifications are internationally recognizedquality standards for manufacturing and assist us in marketing our products incertain foreign markets.  Our Vista,California facility has achieved ISO 9001 certification, EN46001 certificationand certification to the Canadian Medical Device Regulation (ISO 13485)and the 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 cleanroompackaging operations and many subassemblies and components can be producedin-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 make Chattanoogadivision products, including electrotherapy devices, patient care products andphysical therapy and chiropractic treatment tables and CPM devices, in ourmanufacturing facilities located in Chattanooga, Tennessee. These facilitiesuse various manufacturing processes, including metal fabrication, coating,electronic assembly, mechanical assembly, woodworking and sewing.  Our Chattanooga, Tennessee facility hasachieved ISO 13485 certification.

 

Our home electrotherapydevices sold in the United States and certain components and relatedaccessories 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 the componentparts and raw materials we use in our manufacturing and assembly operations areavailable from more than one supplier and are generally available on the openmarket.  We source some of our finishedproducts from manufacturers in China as well as other third partymanufacturers.  We also currentlypurchase certain CPM devices from a single supply source, Medireha, which is50% owned by us. Our distribution agreement with Medireha grants us exclusiverights to the distribution of products that Medireha manufactures. Thedistribution agreement, which expires on August 14, 2009, also requiresthat we purchase a certain amount of product annually and that we seek Medireha’sapproval if we choose to manufacture or distribute products that are identicalor similar, or otherwise compete with the products that are the subject of thedistribution agreement.

 

***International Rehabilitation Segment***

 

Many of the products forour International Rehabilitation Segment are manufactured in the samefacilities as our Domestic Rehabilitation Segment.  We operate a manufacturing facility inTunisia that provides bracing products for the French and other Europeanmarkets.  In addition, our Ormed andCefar-Compex businesses source most of the products they sell from third partysuppliers.  Cefar-Compex currentlyutilizes a single vendor for many of its home electrotherapy devices.

 

***Surgical ImplantSegment***

 

Inour Surgical Implant Segment, we manufacture our products in our Austin, Texasfacility. This manufacturing facility includes computer controlled machinetools, belting, polishing, cleaning, packaging and quality control. Weinitially obtained ISO qualification and CE certification for this facility in1996 and updated our ISO qualification to the ISO 13485:2003 standard in2005.  The primary raw materials used inthe manufacture of our surgical implant products are cobalt chromium alloy, stainlesssteel alloys, titanium alloy and ultra high molecular weight polyethylene. AllSurgical Implant Segment products go through in-house quality control, cleaningand packaging operations.

 

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

 

We own or have licensingrights to U.S. and foreign patents covering a wide range of our products andhave filed applications for additional patents. We have numerous trademarksregistered in the United States, a number of which are also registered incountries around the world. We also assert ownership of numerous unregisteredtrademarks, some of which have been submitted for registration in the UnitedStates and foreign countries. In the future, we will continue to apply for suchadditional patents and trademarks as we deem appropriate. However, we cannotguarantee whether our existing or future patents, if any, will afford adequateprotection, whether any existing patent applications will result in issuedpatents, or whether our patents will be circumvented, invalidated or declaredunenforceable.

 

Additionally, we seek toprotect our non-patented know-how, trade secrets, processes and otherproprietary confidential information, through a variety of methods; includinghaving our vendors, employees and consultants sign invention assignmentagreements, proprietary information agreements and confidentiality agreementsand having our independent sales agents and distributors sign confidentialityagreements. However, these methods may not provide us with adequate protection.Because many of our products are regulated, proprietary information createdduring our development of a new or improved product may have to be disclosed tothe FDA or another U.S. or foreign regulatory agency in order for us to havethe lawful right to market such product. Our proprietary information may alsobecome known to, or be independently developed by, our competitors, or ourproprietary rights in intellectual property may be challenged, any of whichcould have a material adverse effect on our business, financial condition andresults of operations.

 

We have distributionrights for certain products that are manufactured by others and hold bothexclusive and nonexclusive licenses under third party patents and trade secretsthat cover some of our existing products and products under development.However, if any of the distribution agreements were terminated or if we lostany of these licenses, we would not be able to manufacture or sell the relatedproducts, which could have an adverse effect on our future business, financialcondition and results of operations.

 

The validity of any ofthe patents or other intellectual property owned by or licensed to us may notbe upheld if challenged by others in litigation. Due to these and other risksdescribed in this Annual Report on Form 10-K, we do not rely solely on ourpatents and other intellectual property to maintain our competitive position.We believe that the development and marketing of new products and improvementof existing ones is, and will continue to be, more important to our competitiveposition than relying solely on existing products and intellectual property.

 

**Competition**

 

The orthopedic devices market ishighly competitive and fragmented. Some of our competitors, either alone or inconjunction with their respective parent corporate groups, have greaterresearch and development, sales, marketing and manufacturing capabilities thanwe do, and thus may have a competitive advantage over us.  Although we believe that the design andquality of our products compare favorably with those of our competitors, if weare unable to offer products with the latest technological advances atcompetitive prices, our ability to compete successfully could be materially andadversely affected.

 

Givenour sales history, 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, ourability to compete is affected by our ability to:

 

·                  develop newproducts and innovative technologies;

 

·                  obtainregulatory clearance and compliance for our products;

 

·                  manufacture andsell our products cost-effectively;

 

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·                  meet allrelevant quality standards for our products and their markets;

 

·                  respond tocompetitive pressures specific to each of our geographic markets, including ourability to enforce non-compete agreements;

 

·                  protect theproprietary technology of our products and manufacturing processes;

 

·                  market ourproducts;

 

·                  attract andretain skilled employees and sales representatives; and

 

·                  maintain andestablish distribution relationships.

 

***DomesticRehabilitation Segment***

 

OurDomestic Rehabilitation Segment competes with large, diversified corporationsand companies that are part of corporate groups that have significantly greaterfinancial, marketing and other resources than we do, as well as numeroussmaller niche companies. The primary competitors of Empi and Chattanooga areDynatronics Corporation, Mettler Electronics Corporation, Richmar Corporation,Patterson Medical, Enraf-Nonius, Gymna-Uniphy, Acorn Engineering, InternationalRehabilitation Sciences, Inc. (d/b/a RS Medical) and Care Rehab. Thephysical therapy products market is highly competitive and fragmented. Ourcompetitors in the CPM devices market include several multi-product companieswith significant market share and numerous smaller niche competitors.  Competition in these markets is basedprimarily on the quality and technical features of products, product pricingand contractual arrangements with third party payors and national accounts.

 

Our primary competitorsin the rigid knee bracing market include companies such as Össur hf., OrthofixInternational, N.V., Bledsoe Brace Systems and Townsend Industries Inc. Inthe soft goods products market, our competitors include Biomet, Inc.,DeRoyal Industries, Össur hf. and Zimmer Holdings, Inc. In the coldtherapy products market, our competitors include Orthofix and StrykerCorporation. Our primary competitor in the dynamic splinting market isDynasplint Systems, Inc. Several competitors have initiated stock and billprograms similar to our OfficeCare and EmpiCare programs, and there arenumerous regional stock and bill competitors. Competition in the rigid kneebrace market is primarily based on product technology, quality and reputation,relationships with customers, service and price. Competition in the soft goodsand pain management markets is less dependent on innovation and technology andis primarily based on product range, quality, service and price.

 

Our competitors forregeneration 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.

 

***International Rehabilitation Segment***

 

Competition for our International Rehabilitationproducts arises from many of the companies and types of companies that competewith our Domestic Rehabilitation segment and from foreign manufacturers whosecosts may be lower due to their ability to manufacture products within their respectivecountries.  Competition is basedprimarily on quality, innovative design and technical capability, breadth ofproduct line, availability of and qualification for reimbursement, and price.

 

***Surgical ImplantSegment***

 

Themarket for orthopedic products similar to those produced by our SurgicalImplant Segment is dominated by a number of large companies, including Biomet, 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.

 

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**Government Regulation**

 

***FDA and Similar Foreign GovernmentRegulations***

 

Ourproducts are subject to rigorous government agency regulation in the UnitedStates and in other countries. In the United States, the FDA regulates thedevelopment, testing, labeling, manufacturing, storage, recordkeeping,premarket clearance or approval, promotion, distribution and marketing ofmedical devices to ensure that medical products distributed in the UnitedStates are safe and effective for their intended uses. The FDA also regulatesthe export of medical devices manufactured in the United States tointernational markets. Our medical devices are subject to such FDA regulation.

 

Underthe Food, Drug and Cosmetic Act, as amended, medical devices are classifiedinto one of three classes depending on the degree of risk to patients using thedevice. Class I devices are those for which safety and effectiveness canbe assured by adherence to General Controls, which include compliance with FDAQSRs, facility and device registrations and listings, reporting of adversemedical events, and appropriate truthful and non-misleading labeling,advertising and promotional materials. Some Class I devices also requirepre-market review and clearance by the FDA through the Pre-market Notification510(k) process described below. Class II devices are subject toGeneral Controls, as well as pre-market demonstration of adherence to certainperformance standards or other special controls as specified by the FDA.Pre-market review and clearance by the FDA is accomplished through thePre-market Notification 510(k) procedure. In the 510(k) procedure,the manufacturer submits certain required information to the FDA in order toestablish that the device is “substantially equivalent” to a device that waslegally marketed prior to May 28, 1976, the date upon which the MedicalDevice Amendments of 1976 were enacted or to another similar commerciallyavailable device subsequently cleared through the 510(k) process. Uponestablishment of such substantial equivalence, the FDA may grant clearance tocommercially market the device. By regulation, the FDA is required to respond to a510(k) pre-market notification within 90 days of submission, but theprocess can take significantly longer. Itgenerally takes three to six months from the date of submission to obtainclearance of a 510(k) Pre-market Notification submission, but the processcould take longer. If the FDA determines that the device, or its intended use,is not “substantially equivalent,” the FDA will automatically place the deviceinto Class III.

 

AClass III device is a product that has a new intended use or is based ontechnology that is not substantially equivalent to a use or technology withrespect to a legally marketed device for which the safety and effectiveness ofthe device cannot be assured solely by the General Controls, performancestandards and special controls applied to Class I and II devices. Thesedevices generally require clinical trials involving human subjects to assesstheir safety and effectiveness. These clinical trials are subject to regulationby the FDA, and if federal funds are involved or if an investigator or site hassigned a federal assurance, by the National Institutes of Health and by theOffice for Human Research Protections. A Pre-Market Approval (“PMA”) from theFDA is required before the manufacturer of a Class III product can proceedin marketing the product. The PMA process is much more extensive than the510(k) process. In order to obtain a PMA, Class III devices, or a particularintended use of any such device, must generally undergo clinical trialspursuant to an application submitted by the manufacturer for an InvestigationalDevice Exemption (“IDE”). An IDE allows the investigational device to be usedin a clinical study in order to collect safety and effectiveness data requiredto support a PMA application or a 510(k) submission to the FDA. Only asmall percentage of 510(k) submissions require clinical data to supportthe application. Investigational use is also required to evaluate clinicallycertain modifications or new intended uses of legally marketed devices. By statute and regulation, the FDA has180 days to review a PMA that is accepted for filing, but the processgenerally takes significantly longer and 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.

 

Ourproducts include both pre-amendment and post-amendment Class I, IIand III medical devices. All our currently marketed devices are either exemptfrom the FDA clearance and approval process (based on our interpretation ofthose regulations) 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. The FDA may disagree with our conclusion thatclearances or approvals were not required for specific products and may requireclearances or approval for such products. In these circumstances, we may berequired to cease distribution of the modified product, the devices may besubject to seizure by the FDA or to a voluntary or mandatory recall, and wealso could be subject to significant fines and penalties.

 

Ourmanufacturing processes are also required to comply with cGMP and QSRrequirements that cover the methods and documentation of the design, testing,production processes, control, quality assurance, labeling, packaging andshipping of our products. Furthermore, our facilities, records andmanufacturing processes are subject to periodic unscheduled inspections by theFDA and other agencies. Failure to comply with applicable QSR or other U.S.medical device regulatory requirements could result in, among other things,warning letters, fines, injunctions, civil penalties, repairs, replacements,refunds, recalls or 

 

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seizures of products, total or partial suspensions ofproduction, refusal of the FDA to grant future pre-market clearances or PMAapprovals, withdrawals or suspensions of current clearances or approvals, andcriminal prosecution. Weare also required to report to the FDA if our products cause or contribute todeath or serious injury or malfunction in a way that would likely cause orcontribute to death or serious injury were the malfunction to recur; the FDA orother agencies may require the recall of products in the event of materialdefects or deficiencies in design or manufacturing. The FDA can also withdrawor limit our product approvals or clearances in the event of serious unanticipatedhealth or safety concerns.

 

Evenif regulatory approval or clearance of a medical device is granted, the FDA mayimpose limitations or restrictions on the use and indications for which thedevice may be labeled or promoted. Medical devices may be marketed only for theuses and indications for which they are cleared or approved. FDA regulationsprohibit a manufacturer from promotion for an unapproved or off-label use.

 

The FDA has broad regulatoryand enforcement powers. If the FDA determines we have failed to comply withapplicable regulatory requirements, it can impose a variety of enforcementactions, from warning letters, fines, injunctions, consent decrees, and civilpenalties, to suspension or delayed issuance of applications, seizure or recallof our products, total or partial shutdowns, withdrawals of approvals orclearances already granted, and criminal prosecution. The FDA can also requireus to repair or replace or refund the costs of devices we manufactured ordistributed.

 

We mustobtain export certificates from the FDA before we can export certain of ourproducts. We are also subject to extensive regulations that are similar tothose of the FDA in many of the foreign countries in which we sell ourproducts, including those in Europe, our largest foreign market. These includeproduct standards, packaging requirements, labeling requirements, importrestrictions, tariff regulations, duties and tax requirements. The regulationof our products in Europe falls primarily within the European Economic Area,which consists of the twenty-seven member states of the European Union, as wellas Iceland, Liechtenstein and Norway. Only medical devices that comply withcertain conformity requirements are allowed to be marketed within the EuropeanEconomic Area. In addition, the national health or social securityorganizations of certain countries other than in Europe require our products tobe qualified before they can be marketed in those countries.

 

We havealso implemented policies and procedures allowing us to position ourselves forthe changing international regulatory environment. Our Surgical Implant Segmenthas received an ISO 13485:2003 certification for its facilities and an ECCertificate for its many products. Receiving ISO 13485:2003 certification assistsus in meeting international regulatory requirements to allow for export ofproducts 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.

 

***Third Party Reimbursement***

 

Ourhome therapy products, rigid knee braces, regeneration products, and certain ofour soft goods are generally prescribed by physicians and are eligible forthird party reimbursement by government payors, such as Medicare and Medicaid,and private payors. Customer selection of our products depends, in part, onwhether third party payment amounts will be adequate. We believe that thirdparty payors will continue to focus on measures to contain or reduce theircosts through managed care and other methods. Medicare policies are importantto our business because private payors often model their policies after theMedicare program’s coverage and reimbursement policies.

 

Healthcare reform legislation in the Medicare area hasfocused on containing healthcare spending in recent years. On December 8,2003, President Bush signed into law the Medicare Prescription Drug,Improvement, and Modernization Act of 2003 (the “Medicare Modernization Act”).Among other things, this legislation provides for revisions to paymentmethodologies and other standards for durable medical equipment and orthoticdevices under the Medicare program. First, the reimbursable amounts for orthoticdevices were frozen through the end of 2006 and such amounts for most durablemedical equipment are frozen through the end of 2008, with annual inflationadjustments thereafter in each case. Second, the Medicare Modernization Act mandated a new competitivebidding program for durable medical equipment, orthotics, prosthetics, andsupplies. In April 2007, the Centers for Medicare & MedicaidServices (“CMS”), the agency responsible for administering the Medicareprogram, issued final regulations in connection with the competitive biddingprogram. Under competitive bidding, Medicare will no longer reimburse forcertain products and services based on the Medicare fee schedule amount indesignated competitive bidding areas. Instead, CMS will provide reimbursementfor these items and services based on a competitive bidding process. Only thosesuppliers selected through the competitive bidding process within eachdesignated region will be eligible to have their products reimbursed byMedicare. Bidding has been conducted for the first phase of competitive biddingin ten metropolitan statistical areas for ten product categories, and bid pricesare scheduled to go into effect July 2, 2008.  In 2009, the program will be expanded to anadditional 70 metropolitan statistical areas and will cover eight of the 10first round product categories. None of our product categories are included incompetitive bidding at the present 

 

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time. The competitivebidding process may reduce the number of suppliers providing certain items andservices to Medicare beneficiaries and the amounts paid for such items andservices within a given geographic area. In addition, CMS may use paymentinformation from regions subject to competitive bidding to reduce Medicarereimbursement in regions not subject to competitive bidding. CMS also hasproposed revising the way Medicare sets payment amounts for all new durablemedical equipment, orthotics, prosthetics, and supplies, under whichreimbursement could be based in part or in whole on functional assessments,price comparisons, and medical benefits assessments, although that methodologyhas not yet been finalized.

 

Inaddition, as mandated by the Medicare Modernization Act, in August 2006,CMS issued quality standards for suppliers, which are being applied byindependent accreditation organizations. Suppliers must be accredited asmeeting supplier standards as a condition of participation in competitivebidding, but all Medicare suppliers eventually must be accredited toparticipate in Medicare, with different deadlines based on when the supplierapplies for enrollment. Those portions of our business that act as Medicaresuppliers have been accredited. Moreover, the Medicare Modernization Actrequires that new clinical conditions for payment of durable medical equipmentbe established. CMS issued a proposed rule to implement this provision inAugust 2004, but the agency to date only has finalized such standards forpower mobility devices. Some of our products could be impacted by thisrequirement in the future. At this time, we cannot predict what clinicalconditions will be adopted, the timing of such adoption, or the impact that thenew quality standards or any new clinical conditions that are adopted may haveon our business.

 

In2005, CMS published a rule finalizing its “inherent reasonableness”authority, which allows adjustments to payment amounts by up to 15% per yearfor certain products and services covered by Medicare when the existing paymentamount is determined to be grossly excessive or grossly deficient. Theregulation lists factors that may be used by CMS and its contractors todetermine whether an existing reimbursement rate is grossly excessive orgrossly deficient and to determine a realistic and equitable payment amount.CMS or a Medicare contractor may make a larger adjustment each year if itundertakes prescribed procedures. The regulation provides that a payment amountwill not be considered grossly excessive or grossly deficient if an overallpayment adjustment of less than 15% would be necessary to produce a realisticand equitable payment amount. The Medicare Modernization Act, however,precludes the use of inherent reasonableness authority for payment amountsestablished under the competitive bidding process. CMS or a Medicare contractorcould invoke its inherent reasonableness authority to reduce reimbursementlevels for certain of our products, which could have a material adverse effecton our results of operations. Similarly, reduction in payment or loss ofcoverage under Medicare could result in similar action by private payors andhave a material adverse effect on our operations.

 

Ourinternational sales also depend in part upon the eligibility of our productsfor reimbursement through third party payors, the amount of reimbursement andthe allocation 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 costcontainment efforts similar to those we face in the United States are prevalentin many of the foreign countries in which our products are sold, and theseefforts are expected to continue in the future, possibly resulting in theadoption of more stringent reimbursement standards. For example, in Germany,our largest foreign market, new regulations generally require adult patients topay a portion of the cost of each medical technical device prescribed. This mayadversely affect our sales and profitability by making it more difficult for patientsin Germany to pay for our products. Any developments in our foreign marketsthat eliminate, reduce or materially modify coverage of, and reimbursementrates for, our products could have an adverse effect on our ability to sell ourproducts.

 

***Fraud and Abuse***

 

We aresubject to various federal and state laws and regulations pertaining tohealthcare fraud and abuse. Violations of these laws are punishable by criminaland civil sanctions, including, in some instances, exclusion from participationin federal and state healthcare programs, including Medicare, Medicaid,Veterans Administration health programs and TRICARE (the health care programfor active duty military, retirees and their families managed by the Departmentof Defense). We have no reason to believe that our operations are not inmaterial compliance with such laws. However, because these laws and regulationsare broad in scope and may change, we may be required to alter one or more ofour practices to be in compliance with these laws. In addition, the occurrenceof one or more violations of these laws or regulations, the challenge of ouroperations by a governmental authority under these laws or regulations or achange in the laws or regulations may have a material adverse effect on ourfinancial condition and results of operations.

 

*Anti-Kickback and Fraud Laws*

 

Our operations are subject to federal and stateanti-kickback laws. Certain provisions of the Social Security Act, commonlyreferred to as the Anti-Kickback Statute, prohibit persons from knowingly andwillfully soliciting, receiving, offering or providing remuneration directly orindirectly to induce either the referral of an individual, or the furnishing,recommending, 

 

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or arranging for a goodor service, for which payment may be made under a federal healthcare programsuch as Medicare and Medicaid. The definition of “remuneration” has beenbroadly interpreted to include anything of value, including such items asgifts, discounts, waiver of payments, and providing anything at less than itsfair market value. The U.S. Department of Health and Human Services (“HHS”) hasissued regulations, commonly known as safe harbors that set forth certainconditions which, if fully met, will assure healthcare providers and otherparties that they will not be prosecuted under the Anti-Kickback Statute.Although full compliance with these provisions ensures against prosecutionunder the Anti-Kickback Statute, the failure of a transaction or arrangement tofit within a specific safe harbor does not necessarily mean that thetransaction or arrangement is illegal or that prosecution under theAnti-Kickback Statute will be pursued. The penalties for violating theAnti-Kickback Statute include imprisonment for up to five years, fines of up to$25,000 per violation and possible exclusion from federal healthcare programssuch as Medicare and Medicaid. Many states have adopted prohibitions similar tothe Anti-Kickback Statute, some of which apply to the referral of patients forhealthcare services reimbursed by any source, not only by the Medicare andMedicaid programs.

 

Recently, certainmanufacturers of implant products entered into monetary settlement agreementsand deferred prosecution agreements with the U.S. Department of Justice (“DOJ”)based upon allegations that, among other things, they entered into consultingagreements with physicians as improper inducements to those physicians to usethe manufacturers’ products in violation of federal anti-kickback laws. Webelieve that remuneration paid to surgeons with which we have agreementsrepresents fair market value for legitimate designing, consulting and advisoryservices rendered on our behalf.

 

Our OfficeCare and EmpiCareprograms are stock and bill arrangements through which we make products andservices available in the offices of physicians or other providers. Inconjunction with the OfficeCare program, we may pay participating physicians afee for rental space and support services provided by such physicians to us. Ina February 2000 Special Fraud Alert, the Office of Inspector General(“OIG”) indicated that it may scrutinize stock and bill programs involvingexcessive rental payments or rental space for possible violation of theAnti-Kickback Statute, but noted that legitimate arrangements, including fairmarket value rental arrangements, will not be considered violations of thestatute. We believe that we have structured our OfficeCare and EmpiCareprograms to comply with the Anti-Kickback Statute.

 

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 mayalso be subject to federal and state physician self-referral laws. Federalphysician 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 person collectingany amounts in connection with an unlawful referral is obligated to refund suchamounts. A person who engages in a scheme to circumvent the Stark Law’sreferral prohibition may be fined up to $100,000 for each such arrangement orscheme. The penalties for violating the Stark Law also include civil monetarypenalties of up to $15,000 per referral and possible exclusion from federalhealthcare programs such as Medicare and Medicaid. Various states havecorollary 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 ofclaims for payment that are “not provided as claimed” may lead to civil moneypenalties, criminal fines and imprisonment and/or exclusion from participationin Medicare, Medicaid and other federally funded state health programs. Thesefalse claims statutes include the federal False Claims Act, which prohibits

 

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the knowing filing of afalse claim or the knowing use of false statements to obtain payment from thefederal government. When an entity is determined to have violated the FalseClaims Act, it must pay three times the actual damages sustained by thegovernment, plus mandatory civil penalties of between $5,500 and $11,000 foreach separate false claim. Suits filed under the False Claims Act, known as“qui tam” actions, can be brought by any individual on behalf of the governmentand such individuals, commonly known as whistleblowers, may share in anyamounts paid by the entity to the government in fines or settlement. Inaddition, certain states have enacted laws modeled after the federal FalseClaims Act. Qui tam actions have increased significantly in recent years,causing greater numbers of healthcare companies to have to defend a false claimaction, pay fines or be excluded from Medicare, Medicaid or other federal orstate healthcare programs as a result of an investigation arising out of suchaction. A number ofmanufacturers have entered settlements, following allegations that they “aidedand abetted” in the submission of false claims, related to pricing, off-labelpromotion, 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 asupplier of medical devices, our operations are subject to periodic surveys andaudits by governmental entities or contractors to assure compliance withMedicare and Medicaid standards and requirements. To maintain our billingprivileges, we are required to comply with certain supplier standards,including licensure and documentation requirements for our claims submissions.From time to time in the ordinary course of business, we, like other healthcarecompanies, are audited by, or receive claims documentation requests from,governmental entities, which may identify certain deficiencies based on ouralleged failure to comply with applicable supplier standards or otherrequirements. Medicare contractors and Medicaid agencies periodically conductpre- and post-payment reviews and other audits of claims and are underincreasing pressure to more closely scrutinize healthcare claims and supportingdocumentation. We have historically been subject to pre-payment andpost-payment reviews as well as audits of claims and may experience suchreviews and audits of claims in the future. We review and assess such audits orreports and attempt to take appropriate corrective action. We are also subjectto surveys of our facilities for compliance with the supplier standards. Thefailure to effect corrective action to address identified deficiencies or toobtain, renew or maintain any of the required regulatory approvals,certifications or licenses could adversely affect our business, results ofoperations or financial condition and could result in our inability to offerour products and services to patients insured by such governmental programs.

 

Wehave not been subject to any governmental audits or claims documentationrequests that have resulted in the identification of any material deficiencieswith respect to our billing operations. We have been subject to periodic audits of our compliance with federalrequirements for our facilities and related quality and manufacturingprocesses.  In January 2007, wereceived a warning letter from the FDA to the effect that they believed thatcertain discrete processes related to our Surgical Implant Segment did notconform with cGMP.  During 2007, weworked with the FDA to resolve all outstanding issues they had identified inthe past as a result of their audits regarding QSR and cGMP compliance.  During the first quarter of 2008, the FDAofficially concluded their investigation and all areas of concern were resolvedsatisfactorily.  Also, in the firstquarter of 2008, we received an FDA Form 483 “Inspectional Observations”in connection with an FDA audit of the Chattanooga division of our DomesticRehabilitation segment, stating that we failed to report certain customercomplaints claiming that our muscle stimulator devices malfunctioned, and thatwe did not adequately implement corrective and preventive action to preventrecurrence of potential product failures relating to our muscle stimulatordevices.  We believe we have correctedthese issues and are implementing a recall of certain devices.  We do not believe that these observations, orany resulting recall, will have a material adverse effect on our financialcondition or results of operations. However, we cannot assure you that the FDA will not take further actionin the future.

 

***Federal Privacy and Transaction Law andRegulations***

 

HIPAA impacts the transmission, maintenance, use anddisclosure of certain individually identifiable health information (referred toas “protected health information” or “PHI”). Certain components of HIPAA, referred to asthe “administrative simplification” provisions, were designed to improve theefficiency and effectiveness of the health care system. Since HIPAA was enactedin 1996, numerous implementing regulations have been issued, including, but notlimited to: (1) standards for the privacy of individually identifiablehealth information (the “Privacy Rule”), (2) security standards (the“Security Rule”), (3) standards for electronic transactions (the“Transactions Rule”), and (4) standard unique national provider identifier(“NPI Rule”). We refer to these rules as the Administrative SimplificationRules. CMS has also issued regulations governing the enforcement of theAdministrative Simplification Rules. Sanctions for violation of HIPAA and /orthe Administrative Simplification Rules include criminal and civilpenalties.

 

HIPAAapplies to “covered entities,” which includes certain health care providers whoconduct certain transactions electronically. As such, HIPAA and theAdministrative Simplification Rules apply to certain aspects of ourbusiness.

 

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Inbrief, the Privacy Rule (1) places restrictions on the use anddisclosure of PHI, (2) requires covered entities to provide individualswith certain “rights” such as the right to access or amend certain PHI, orobtain a list of non-routine disclosures, and (3) mandates that coveredentities implement various administrative requirements to ensure compliancewith the other aspects of the Privacy Rule. The Security Rule requirescovered entities to develop and implement physical, administrative andtechnical safeguards to protect electronic PHI. The Privacy and SecurityRules also require covered entities to contractually bind certain serviceproviders (called “business associates”) to an agreement that requires thebusiness associate to restrict its uses and disclosures of PHI, as well assafeguard PHI. The Transactions Rule mandates the use of uniformelectronic interchange formats in connection with specific health caretransactions, such as payment and remittance advice. The NPI Rule requireshealth care providers to obtain and use a unique identifier in connection withconducting certain standard transactions.

 

Theeffective date for all of the Administrative Simplification Rules outlinedabove has passed, and, as such, all of the Administrative SimplificationRules are in effect. To the extent applicable to our operations, we arecurrently in compliance with HIPAA and the applicable AdministrativeSimplification Rules.

 

**Employees**

 

Asof December 31, 2007, we had approximately 4,875 employees. Of these,approximately 3,100 were engaged in production and production support, 150 inresearch and development, approximately 1,100 in sales and support, andapproximately 525 in various administrative capacities including third partybilling.  Of these employees,approximately 2,300 were located in the United States, approximately 1,950 werelocated in Mexico and approximately 625 were located in various othercountries, primarily in Europe.  Ourworkforce in the United States is not unionized; however, portions of ourworkforce in Europe are unionized.  Wehave not experienced any strikes or work stoppages, and our managementconsiders our relationship with our employees to be good.

 

**Segment and Geographic Information**

 

Informationabout our segments and geographic areas can be found in Note 11 “Segment andGeographic Information” under notes to our audited consolidated financialstatements included in this Annual Report on Form 10-K.

 

**Available Information**

 

Wehave made available free of charge through our website, www.reableinc.com ourannual reports on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K, other Exchange Act reports and all amendments tothose 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“Company-SEC filings” page of our website. Our SEC reports are also available free of charge on the SEC website,www.sec.gov.  Also available free ofcharge on our website are our Business Ethics Policy and Code of Conduct, Codeof Conduct for the Board of Directors, and Code of Ethics for the ChiefExecutive Officer and Senior Executives and Financial Officers found under the“Company-Governance Information” page of our website.

 

## **ITEM 1A.  RISKFACTORS**

## ** **

*Our ability to achieve our operating and financial goals issubject to a number of risks, including risks relating to our businessoperations, our debt level and government regulations.  If any of the following risks actually occur,our business, operating results, prospects or financial condition could bematerially and adversely affected.  Therisks described below are not the only ones that we face. Additional risks notpresently known to us or that we currently deem immaterial may also affect ourbusiness operations.*

 

**Risks Related To Our Indebtedness**

 

***Our substantial leverage could adverselyaffect our ability to raise additional capital to fund our operations, limitour ability to react to changes in the economy or our industry, expose us to interestrate risk to the extent of our variable rate debt and prevent us from meetingour obligations under our indebtedness.***

 

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Due to the DJO Merger, weare highly leveraged. As of December 31, 2007, our total indebtedness was$1,832.8 million. We have an additional $99.1 million available forborrowing under our new revolving credit facility, net of $0.9 million used forletters of credit.

 

Ourhigh degree of leverage could have important consequences, including:

 

·                  making it difficult for us to make paymentson our 10.875% Notes and our 11.75% Notes (the “Notes”) and other debt;

 

·                  increasing our vulnerability to generaleconomic and industry conditions;

 

·                  requiring a substantial portion of cash flowfrom operations to be dedicated to the payment of principal and interest on ourindebtedness, therefore reducing our ability to use our cash flow to fund ouroperations, capital expenditures and future business opportunities;

 

·                  exposing us to the risk of increased interestrates as certain of our borrowings, including certain borrowings under our NewSenior Secured Credit Facility, will be subject to variable rates of interest;

 

·                  limiting our ability to make strategicacquisitions or causing us to make non-strategic divestitures;

 

·                  limiting our ability to obtain additionalfinancing for working capital, capital expenditures, product development, debtservice requirements, acquisitions and general corporate or other purposes; and

 

·                  limiting our ability to adjust to changingmarket conditions and placing us at a competitive disadvantage compared to ourcompetitors who are less highly leveraged.

 

We may be able to incursubstantial additional indebtedness in the future. Although our New 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 for interestfor the year ended December 31, 2007 was $70.2 million compared to $30.0million for the year ended December 31, 2006 (combined basis).  As of December 31, 2007, we had $1,069.2million of debt subject to floating interest rates, including $1,065.0 millionunder the New Senior Secured Credit Facility. Although we currently have interest rate swaps in place to hedge againstrising interest rates (see Note 8 to our audited consolidated financialstatements) any additional borrowings we make under the New Senior SecuredCredit Facility will also be subject to floating interest rates.  Based on our current debt balances, we expectour annual cash payments for interest to increase to approximately $165.2million starting in 2008.

 

***Our debt agreements contain restrictionsthat limit our flexibility in operating our business.***

 

Our New 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:

 

·                  incur additional indebtedness or issuecertain preferred shares;

 

·                  pay dividends on, repurchase or makedistributions in respect of our capital stock or make other restrictedpayments;

 

·                  make certain investments;

 

·                  sell certain assets;

 

·                  create liens;

 

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

 

·                  enter into certain transactions with ouraffiliates.

 

In addition, we are requiredto satisfy and maintain a specified senior secured leverage ratio, whichbecomes 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. Our ability to meet this senior securedleverage ratio can be affected by events beyond our control, including changesin general economic and business conditions, and we cannot assure you that wewill meet the senior secured leverage ratio in the future or at all.

 

A breach of any of thesecovenants 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 New Senior Secured Credit Facility, the lenderscould elect to declare all amounts outstanding under the New Senior SecuredCredit Facility to be immediately due and payable and terminate all commitmentsto extend further credit. Such actions by those lenders could cause crossdefaults under our other indebtedness. If we were unable to repay thoseamounts, the lenders under the New Senior Secured Credit Facility could proceedagainst the collateral granted to them to secure that indebtedness. We havepledged a significant portion of our assets as collateral under the New SeniorSecured Credit Facility. If the lenders under the New Senior Secured CreditFacility accelerate the repayment of borrowings, we cannot assure you that wewill have sufficient assets to repay the amounts borrowed under the New SeniorSecured Credit Facility, as well as our unsecured indebtedness.

 

***We may not be able to generate sufficientcash to service all of our indebtedness, and may be forced to take otheractions to satisfy our obligations under our indebtedness, which may not besuccessful.***

 

Our ability to makescheduled 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 flows andcapital resources are insufficient to fund our debt service obligations, we maybe forced to reduce or delay investments and capital expenditures, or to sell assets,seek additional capital or restructure or refinance our indebtedness. Thesealternative measures could affect the operation and growth of our business andmay not be successful and may not permit us to meet our scheduled debt serviceobligations. If our operating results and available cash are insufficient tomeet our debt service obligations, we could face substantial liquidity problemsand might be required to dispose of material assets or operations to meet ourdebt service and other obligations. In that case, we may not be able toconsummate those dispositions or to obtain the proceeds that we could realizefrom them, and the proceeds from those dispositions may not be adequate to meetany debt service obligations then due. Additionally, our New Senior SecuredCredit Facility and the Indentures governing the Notes limit the use of theproceeds from dispositions of assets; as a result, we may not be permitted,under our New Senior Secured Credit Facility and the Indentures governing theNotes, to use the proceeds from such dispositions to satisfy all current debtservice obligations.

 

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

 

Upon the occurrence ofspecific kinds of change of control events, we will be required to offer torepurchase all outstanding Notes at 101% of their principal amount plus accruedand unpaid interest.  The source of fundsfor any such purchase of the Notes will be our available cash or cash generatedfrom our subsidiaries’ operations or other sources, including borrowings, salesof assets or sales of equity. We may not be able to repurchase the Notes upon achange of control because we may not have sufficient financial resources topurchase all of the Notes that are tendered upon a change of control.  Further, we will be contractually restrictedunder the terms of our New Senior Secured Credit Facility from repurchasing allof the Notes tendered by holders upon a change of control. Accordingly, we maynot be able to satisfy our obligations to purchase the Notes unless we are ableto refinance or obtain waivers under our New Senior Secured Credit Facility.Our failure to repurchase the notes upon a change of control would cause adefault under the Indentures governing the Notes and a cross-default under theNew Senior Secured Credit Facility. Our New Senior Secured Credit Facility alsoprovides that a change of control will be a default that permits lenders toaccelerate the maturity of borrowings thereunder. Any of our future debtagreements may contain similar provisions.

 

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***The lenders under the New Senior SecuredCredit Facility will have the discretion to release the guarantors under thenew senior secured credit agreement in a variety of circumstances, which willcause those guarantors to be released from their guarantees of the Notes.***

 

While any obligations underthe New Senior Secured Credit Facility remain outstanding, any guarantee of theNotes may be released without action by, or consent of, any holder of the Notesor the trustee under the Indentures governing the Notes, at the discretion oflenders under the New Senior Secured Credit Facility, if the related guarantoris no longer a guarantor of obligations under the New Senior Secured Credit Facility.The lenders under the New Senior Secured Credit Facility will have thediscretion to release the guarantees under the New Senior Secured CreditFacility in a variety of circumstances. You will not have a claim as a creditoragainst any subsidiary that is no longer a guarantor of the Notes, and theindebtedness and other liabilities, including trade payables, whether securedor unsecured, of those subsidiaries will effectively be senior to claims ofnoteholders.

 

***Transfer of the Notes may be limited by theabsence of an active trading market, and there is no assurance that any activetrading market will develop for the Notes.***

 

The10.875 % Notes were offered and sold in November 2007 to institutionalinvestors and are eligible for trading in the PORTAL market. The 11.75% Noteswere registered with the Securities and Exchange Commission in 2007 and arepublicly traded.

 

Wedo not intend to apply for a listing of the Notes on a securities exchange oron any automated dealer quotation system. There is currently no establishedmarket for the 10.875% Notes and we cannot make assurances as to the liquidityof markets for the 11.75% Notes or markets that may develop for the 10.875%Notes, the ability to sell the Notes or the price at which a holder may be ableto sell the Notes. If such markets were to exist, the Notes could trade atprices that may be lower than their principal amount or purchase pricedepending on many factors, including prevailing interest rates, the market forsimilar notes, our financial and operating performance and other factors.  We cannot assure you that an active marketfor the 10.875% Notes will develop or, if developed, that it will continue.Historically, the market for non-investment grade debt has been subject todisruptions that have caused substantial volatility in the prices of securitiessimilar to the Notes. The market, if any, for the Notes may experience similardisruptions and any such disruptions may adversely affect the prices at whichyou may sell your Notes.

 

**Risks Related To Our Business**

 

***We may not be able to successfullyintegrate businesses that we have recently acquired, or businesses we mayacquire in the future, and we may not be able to realize the anticipated costsavings, revenue enhancements or other synergies from such acquisitions.***

 

Our ability to successfullyimplement our business plan and achieve targeted financial results is highlydependent on our ability to successfully integrate businesses that we haverecently acquired and other businesses we acquire in the future. The process ofintegrating such acquired businesses involves risks. These risks include, butare not limited to:

 

·                  demands on management related to thesignificant increase in the size of our business;

 

·                  diversion of management’s attention from themanagement of daily operations to the integration of newly acquired operations;

 

·                  difficulties in the assimilation of differentcorporate cultures, practices and sales and distribution methodologies;

 

·                  difficulties in conforming the acquiredcompany’s accounting policies to ours;

 

·                  increased exposure to risks relating tobusiness operations outside the United States;

 

·                  retaining the loyalty and business of thecustomers of acquired businesses;

 

·                  retaining employees that may be vital to theintegration of the acquired business or to the future prospects of the combinedbusinesses;

 

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·                  difficulties and unanticipated expensesrelated to the integration of departments, information technology systems,including accounting systems, technologies, books and records and procedures,and maintaining uniform standards, such as internal accounting controls,procedures and policies; and

 

·                  costs and expenses associated with anyundisclosed or potential liabilities.

 

Failure to successfullyintegrate the operations of ReAble with the operations of DJO Opco or any otheracquired businesses may result in reduced levels of revenue, earnings oroperating efficiency than we have achieved or might have achieved if we had notacquired such businesses, and loss of customers of the acquired businesses.

 

In addition, an importantpart of our strategy is to generate revenue growth by cross selling productsthrough the expanded distribution network achieved following the acquisition ofbusinesses. Our ability to successfully cross sell our products to the extentwe anticipate or at all is subject to considerable uncertainty. To the extentwe are not successful in our cross selling efforts, our revenues and incomewill be adversely affected.

 

Furthermore, even if we areable to integrate successfully the operations of DJO Opco with the operationsof ReAble, as well as other businesses we have recently acquired, or any otheracquired business, we may not be able to realize the potential cost savings,synergies and revenue enhancements that were anticipated from the acquisitions,either in the amount or within the time frame that we expect, and the costs ofachieving these benefits may be higher than, and the timing may differ from,what we expect. Our ability to realize anticipated cost savings, synergies andrevenue enhancements may be affected by a number of factors, including, but notlimited to, the following:

 

·                  the use of more cash or other financialresources on integration and implementation activities than we expect;

 

·                  increases in other expenses unrelated to theacquisitions, which may offset the cost savings and other synergies from theacquisitions;

 

·                  our ability to eliminate effectivelyduplicative back office overhead and overlapping and redundant selling, generaland administrative functions, rationalize manufacturing capacity and shiftproduction to more economical facilities; and

 

·                  our ability to avoid labor disruptions inconnection with any integration, particularly in connection with any headcountreduction.

 

Specifically, we expect theDJO Merger to create significant opportunities to reduce our manufacturing andother costs. We expect 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 these anticipated cost savings reflectestimates 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.

 

Ifwe fail to realize anticipated cost savings, synergies or revenue enhancements,our financial results will be adversely affected, and we may not generate thecash flow from operations that we anticipated, or that is sufficient to repayour indebtedness.

 

***We may experience substantial fluctuationsin our quarterly operating results and you should not rely on them as anindication of our future results.***

 

Our quarterly operatingresults may vary significantly due to a combination of factors, many of whichare beyond our control. These factors include:

 

·                  demand for many of our products, whichhistorically has been higher in the fourth quarter when scholastic sports andski injuries are more frequent;

 

·                  our ability to meet the demand for ourproducts;

 

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·                  the direct distribution of our products inforeign countries that have seasonal variations;

 

·                  the number, timing and significance of newproducts and product introductions and enhancements by us and our competitors,including delays in obtaining government review and clearance of medicaldevices;

 

·                  our ability to develop, introduce and marketnew and enhanced versions of our products on a timely basis;

 

·                  the impact of any acquisitions that occur ina quarter;

 

·                  the impact of any changes in generallyaccepted accounting principles;

 

·                  changes in pricing policies by us and ourcompetitors and reimbursement rates by third party payors, including governmenthealthcare agencies and private insurers;

 

·                  the loss of any of our significantdistributors;

 

·                  changes in the treatment practices oforthopedic and spine surgeons, primary care physicians, and pain-managementspecialists, and their allied healthcare professionals; and

 

·                  the timing of significant orders andshipments.

 

Accordingly,our quarterly sales and operating results may vary significantly in the futureand period-to-period comparisons of our results of operations may not bemeaningful and should not be relied upon as indications of future performance.We cannot assure you that our sales will increase or be sustained in futureperiods or that we will be profitable in any future period.

 

***We operate in a highly competitive businessenvironment, and our inability to compete effectively could adversely affectour business prospects and results of operations.***

 

We operate in highlycompetitive and fragmented markets. Our Domestic Rehabilitation Segment andInternational Rehabilitation Segment compete with both large and small companies,including several large, diversified companies with significant market shareand numerous smaller niche companies, particularly in the physical therapyproducts market. Our Surgical Implant Segment competes with a small number ofvery large companies that dominate the market, as well as other companiessimilar to our size. We may not be able to offer products similar to, or moredesirable than, those of our competitors or at a price comparable to that ofour competitors. Compared to us, many of our competitors have:

 

·                  greater financial, marketing and otherresources;

 

·                  more widely accepted products;

 

·                  a larger number of endorsements fromhealthcare professionals;

 

·                  a larger product portfolio;

 

·                  superior ability to maintain new productflow;

 

·                  greater research and development andtechnical capabilities;

 

·                  patent portfolios that may present anobstacle to the conduct of our business;

 

·                  stronger name recognition;

 

·                  larger sales and distribution networks;and/or

 

·                  international manufacturing facilities thatenable them to avoid the transportation costs and foreign import dutiesassociated with shipping our products manufactured in the United States tointernational customers.

 

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Accordingly, we may be at acompetitive disadvantage with respect to our competitors. These factors maymaterially impair our ability to develop and sell our products.

 

***If we are unable to develop or license newproducts or product enhancements or find new applications for our existingproducts, we will not remain competitive.***

 

The markets for our productsare characterized by continued new product development and the obsolescence ofexisting products. Our future success and our ability to increase revenues andmake payments on our indebtedness will depend, in part, on our ability todevelop, license, acquire and distribute new and innovative products, enhanceour existing products with new technology and find new applications for ourexisting products. However, we may not be successful in developing, licensingor introducing new products, enhancing existing products or finding newapplications for our existing products. We also may not be successful inmanufacturing, marketing and distributing products in a cost-effective manner,establishing relationships with marketing partners, obtaining coverage of andsatisfactory reimbursement for our future products or product enhancements orobtaining required regulatory clearances and approvals in a timely fashion orat all. If we fail to keep pace with continued new product innovation orenhancement or fail to successfully commercialize our new or enhanced products,our competitive position, financial condition and results of operations couldbe materially and adversely affected.

 

In addition, if any of ournew or enhanced products contain undetected errors or design defects,especially when first introduced, or if new applications that we develop forexisting products do not work as planned, our ability to market these and otherproducts could be substantially delayed, and we could ultimately become subjectto product liability litigation, resulting in lost revenues, potential damageto our reputation and/or delays in regulatory clearance. In addition, approvalof our products or obtaining acceptance of our products by physicians, physicaltherapists and other healthcare professionals that recommend and prescribe ourproducts could be adversely affected.

 

***The success of our surgical implantproducts depends on our relationships with leading surgeons who assist with thedevelopment and testing of our products.***

 

A key aspect of thedevelopment and sale of our surgical implant products is the use of designingand consulting arrangements with orthopedic surgeons who are well recognized inthe healthcare community. These surgeons assist in the development and clinicaltesting of new surgical implant products. They also participate in symposia andseminars introducing new surgical implant products and assist in the trainingof healthcare professionals in using our new products. We may not be successfulin maintaining or renewing our current designing and consulting arrangementswith these surgeons or in developing similar arrangements with new surgeons. Inthat event, our ability to develop, test and market new surgical implantproducts could be adversely affected.

 

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

 

In response to pressure fromcertain groups (mostly orthotists), the United States Congress and statelegislatures have periodically considered proposals that limit the types oforthopedic professionals who can fit or sell our orthotic device products orwho can seek reimbursement for them. Several states have adopted legislationwhich imposes certification or licensing requirements on the measuring, fittingand adjusting of certain orthotic devices. Although some of these state lawsexempt manufacturers’ representatives, other states’ laws subject theactivities of such representatives to certification or licensing requirements.Additional states may be considering similar legislation. Such laws couldreduce the number of potential customers by restricting the activities of our salesrepresentatives in those jurisdictions where such legislation or regulationsare enacted. Furthermore, because the sales of orthotic devices are driven inpart by the number of professionals who fit and sell them, laws that limitthese activities could reduce demand for these products. We may not besuccessful in opposing the adoption of such legislation or regulations and,therefore, such laws could have a material adverse effect on our business.

 

In addition, efforts havebeen made to establish similar requirements at the federal level for theMedicare program. For example, in 2000, Congress passed the Medicare, Medicaidand SCHIP Benefits Improvement and Protection Act of 2000 (“BIPA”). BIPAcontained a provision requiring, as a condition for payment by the Medicareprogram, that certain certification or licensing requirements be met forindividuals and suppliers furnishing certain, but not all, custom-fabricatedorthotic devices. Although the CMS Services have not implemented thisrequirement, we cannot predict the effect of implementation of BIPA orimplementation of other such laws will have on our business.

 

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***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 and distribution of certain of ourorthopedic products, regeneration products and our surgical implant productsdepend, in part, on our relationships with a network of third partydistributors and independent commissioned sales representatives. These thirdparty distributors and independent sales representatives maintain therelationships with the hospitals, orthopedic surgeons, physical therapists andother healthcare professionals that purchase, use and recommend the use of ourproducts. Although our internal sales staff trains and manages these thirdparty distributors and independent sales representatives, we do not directlymonitor the efforts that they make to sell our products. In addition, some ofthe independent sales representatives that we use to sell our surgical implantproducts also sell products that directly compete with our core productofferings. These sales representatives may not dedicate the necessary effort tomarket and sell our products. If we fail to attract and maintain relationshipswith third party distributors and skilled independent sales representatives orfail to adequately train and monitor the efforts of the third party distributorsand sales representatives that market and sell our products, or if our existingthird party distributors and independent sales representatives choose not tocarry our products, our results of operations and future growth could beadversely 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 own direct sales force of over 350representatives in the United States and over 170 representatives in Europe tomarket and sell certain of the orthopedic rehabilitation products which areintended for use in the home and in rehabilitation clinics. Some of our competitorsrely predominantly on independent sales agents and third party distributors. Adirect sales force may subject us to higher fixed costs than those of companiesthat market competing products through independent third parties, due to thecosts that we will bear associated with employee benefits, training andmanaging sales personnel. As a result, we could be at a competitivedisadvantage. Additionally, these fixed costs may slow our ability to reducecosts in the face of a sudden decline in demand for our products, which couldhave a material adverse effect on our results of operations.

 

***The success of all of our products depends heavily on ourrelationships with healthcare professionals who prescribe and recommend ourproducts, and our failure to maintain or develop these relationships couldadversely affect our business.***

 

We have developed and maintain close relationshipswith a number of orthopedic surgeons, primary care physicians, other specialistphysicians, physical therapists, athletic trainers, chiropractors and otherhealthcare professionals. We believe that sales of our products dependsignificantly on their recommendations of our products. Acceptance of ourproducts depends on educating the healthcare community as to the distinctivecharacteristics, perceived benefits, clinical efficacy and cost-effectivenessof our products compared to the products offered by our competitors and ontraining healthcare professionals in the proper use and application of ourproducts. Failure to maintain these relationships and develop similarrelationships with other leading healthcare professionals could result in aless frequent recommendation of our products, which may adversely affect oursales and profitability.

 

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

 

The international scope of our operations exposes usto economic, regulatory and other risks in the countries in which we operate.We generated 27.0% of our net revenues from customers outside the United Statesfor the year ended December 31, 2007, and approximately 25.0% on a proforma basis for the year ended December 31, 2007. Doing business inforeign countries exposes us to a number of risks, including the following:

 

·                  fluctuations in currency exchangerates;

 

·                  imposition of investment, currencyrepatriation and other restrictions by foreign governments;

 

·                  potential adverse tax consequences,including the imposition or increase of withholding and other taxes on remittancesand other payments by foreign subsidiaries, which, among other things, maypreclude payments or dividends from foreign subsidiaries from being used forour debt service, and exposure to adverse tax regimes;

 

·                  difficulty in collecting accounts receivableand longer collection periods;

 

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·                  the imposition of additional foreigngovernmental controls or regulations on the sale of our products;

 

·                  intellectual property protectiondifficulties;

 

·                  changes in political and economicconditions;

 

·                  difficulties in attractinghigh-quality management, sales and marketing personnel to staff our foreignoperations;

 

·                  labor disputes;

 

·                  import and export restrictions andcontrols, tariffs and other trade barriers;

 

·                  increased costs of transportation orshipping;

 

·                  exposure to different approaches totreating injuries;

 

·                  exposure to different legal,regulatory and political standards; and

 

·                  difficulties of local governments inresponding to severe weather emergencies, natural disasters or other suchsimilar events.

 

In addition, as we grow our operationsinternationally, we will become increasingly dependent on foreign distributorsand sales agents for our compliance and adherence to foreign laws and regulationsthat we may not be familiar with, and we cannot assure you that thesedistributors and sales agents will adhere to such laws and regulations oradhere to our own business practices and policies. Any violation of laws andregulations by foreign distributors or sales agents or a failure of foreigndistributors or sales agents to comply with our business practices and policiescould result in legal or regulatory sanctions against us or potentially damageour reputation in that respective international market. If we fail to managethese risks effectively, we may not be able to grow our internationaloperations, and our business and results of operations may be materiallyadversely 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.***

 

Our foreign operations expose usto currency fluctuations and exchange rate risks, and the DJO Merger hasincreased that exposure. We are exposed to the risk of currency fluctuationsbetween the U.S. Dollar and the Euro, Pound Sterling, Canadian Dollar, MexicanPeso, Swiss Franc, Norwegian Krone, Danish Krone and Swedish Krona. Salesdenominated in foreign currencies accounted for approximately 21.2% of ourconsolidated net sales for the year ended December 31, 2007, of which18.9% were denominated in the Euro. On a pro forma basis, sales denominated inforeign currencies accounted for approximately 21.5% of our consolidated netsales for the year ended December 31, 2007, of which 16.3% were related tothe Euro. Our exposure to fluctuations in foreign currencies arises becausecertain of our subsidiaries’ results are recorded in these currencies and thentranslated into U.S. Dollars for inclusion in our audited consolidatedfinancial statements and certain of our subsidiaries enter into purchase orsale transactions using a currency other than our functional currency. Inaddition, certain costs associated with our Mexico-based manufacturingoperations are incurred in Mexican Pesos. As of December 31, 2007, we had outstanding hedges in the form offorward contracts to purchase Mexican Pesos aggregating a U.S. dollarequivalent of $10.7 million.  As wecontinue to distribute and manufacture our products in selected foreigncountries, we expect that future sales and costs associated with our activitiesin these markets will continue to be denominated in the applicable foreigncurrencies, which could cause currency fluctuations to materially impact ouroperating results.  Changes in currencyexchange rates may adversely affect our financial condition and results ofoperations and may affect the comparability of our results between reportingperiods.

 

We may not be able to effectively manage our currencytranslation risks, and volatility in currency exchange rates may adverselyaffect our financial condition and results of operations.

 

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***If adequate levels of reimbursement coverage from third partypayors for our products are not obtained, healthcare providers and patients maybe reluctant to use our products, and our sales may decline.***

 

Our sales depend largely on whether there is adequatereimbursement coverage by government healthcare programs, such as Medicare andMedicaid, and by private payors. We believe that surgeons, hospitals, physicaltherapists and other healthcare providers may not use, purchase or prescribeour products and patients may not purchase our products if these third party payorsdo not provide satisfactory reimbursement for the costs of our products or theprocedures involving the use of our products. Consequently, we may be unable tosell our products on a profitable basis if third party payors deny coverage,reduce their current levels of reimbursement or fail to cause their levels ofreimbursement to rise quickly enough to cover cost increases.

 

Changes in the coverage of, and reimbursement for, ourproducts by these third party payors could have a material adverse effect onour results of operations. Third party payors continue to review their coveragepolicies carefully for existing and new therapies and can, without notice,decide not to reimburse for treatments that include the use of our products.They may attempt to control costs by (i) authorizing fewer electivesurgical 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, Medicarefrequently engages in efforts to contain costs, which may result in a reductionof coverage of, and reimbursement for, our products. Because many privatepayors model their coverage and reimbursement policies on Medicare policies,third party payors’ coverage of, and reimbursement for, our products could benegatively impacted by legislative, regulatory or other measures that reduceMedicare coverage and reimbursement generally.

 

Our international sales also depend in part upon thecoverage and eligibility for reimbursement of our products throughgovernment-sponsored healthcare payment systems and third party payors, theamount of reimbursement and the cost allocation of payments between the patientand government-sponsored healthcare payment systems and third party payors.Coverage and reimbursement practices vary significantly by country, withcertain countries requiring products to undergo a lengthy regulatory review inorder to be eligible for third party coverage and reimbursement. In addition,healthcare cost containment efforts similar to those we face in the UnitedStates are prevalent in many of the foreign countries in which our products aresold, and these efforts are expected to continue in the future, possiblyresulting in the adoption of more stringent reimbursement standards. Forexample, in Germany, our largest foreign country market, new regulationsgenerally require adult patients to pay a portion of the cost of each medicaltechnical device purchased. This may adversely affect our sales andprofitability by making it more difficult for patients in Germany to pay forour products.

 

Any developments in the United States or our foreignmarkets that eliminate, reduce or materially modify coverage of, andreimbursement rates for, our products could have an adverse effect on ourability to sell our products.

 

***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. Althoughthese changes affect our products generally, specific products may be affectedby some but not all of the Medicare Modernization Act’s provisions.

 

Prefabricated orthotic devices and certain durablemedical equipment, including many of our products, may be subject to acompetitive bidding process established under the Medicare Modernization Act.In April 2007, CMS issued final regulations in connection with thecompetitive bidding program. Under competitive bidding, Medicare will no longerreimburse for certain products and services based on the Medicare fee scheduleamount in designated competitive bidding areas. Instead, CMS will providereimbursement for these items and services based on a competitive biddingprocess. Only those suppliers selected through competitive bidding processwithin each designated region will be eligible to have their productsreimbursed by Medicare. Competitive bidding will go into effect July 1,2008 initially in ten metropolitan statistical areas and will apply to ten productcategories. In 2009, the program will be expanded to 70 additional metropolitanstatistical areas and apply to eight product categories.  The program is expected to be expanded toadditional areas thereafter, and additional product categories may be selected.The competitive 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 productswere included in the initial round of items subject to bidding; however, thereis no assurance they will not be included in the future. Inclusion of any ofour products in Medicare competitive bidding or 

 

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other Medicarereimbursement or coverage reductions could result in such products being soldin lesser quantities 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.

 

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

 

Our products are subject to extensive regulation inthe United States by the FDA and by similar governmental authorities in theforeign countries where we do business. The FDA regulates virtually all aspectsof a medical device’s development, testing, manufacturing, labeling, promotion,distribution and marketing. In general, unless an exemption applies, a medicaldevice must receive either pre-market approval or pre-market clearance from theFDA before it can be marketed in the United States. While in the past we havereceived such approvals, we may not be successful in the future in receivingsuch approvals in a timely manner or at all. If we begin to have significantdifficulty obtaining such FDA approvals or clearances in a timely manner or atall, we could suffer a material adverse effect 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 market modifications to our existingproducts or market our existing products for new indications, we may berequired to obtain pre-market approvals, pre-market approval supplements orpre-market clearances. The FDA requires device manufacturers themselves to makeand document a determination of whether or not a modification requires a newapproval, supplement or clearance; however, the FDA can review and disagreewith a manufacturer’s decision. We may not be successful in receiving suchapprovals or the FDA may not agree with our decisions not to seek approvals,supplements or clearances for any particular device modification. The FDA mayrequire an approval or clearance for any past or future modification or a newindication for our existing products. Such submissions may require thesubmission of additional clinical or preclinical data and may be time consumingand costly, and may not ultimately be cleared or approved by the FDA. If the FDArequires us to obtain pre-market approvals, pre-market approval supplements orpre-market clearances for any modification to a previously cleared or approveddevice, we may be required to cease manufacturing and marketing the modifieddevice or to recall such modified device until we obtain FDA clearance orapproval, and we may be subject to significant regulatory fines or penalties.In addition, the FDA may not clear or approve such submissions in a timelymanner, if at all. Because a significant portion of our revenues is generatedby products that are modified or used for new treatments, delays or failures inobtaining such approvals could reduce our revenue and adversely affect ouroperating 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 development of new products or new indicationsfor, or modifications to, existing products, we may conduct or sponsor clinicaltrials. Clinical trials are expensive and require significant investment oftime and resources and may not generate the data we need to support asubmission to the FDA. Clinical trials are subject to regulation by the FDAand, if federal funds are involved or if an investigator or site has signed afederal assurance, are subject to further regulation by the Office for HumanResearch Protections and the National Institutes of Health. Failure to complywith such regulation, including, but not limited to, failure to obtain adequateconsent of subjects, failure to adequately disclose financial conflicts orfailure to report data or adverse events accurately, could result in fines, penalties,suspension of trials, and the inability to use the data to support an FDAsubmission. In the international market, we are subject to regulations forclinical 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 foreigncountries in which we market our products, we are subject to extensiveregulations that are similar to those of the FDA, including those in Europe.The regulation of our products in Europe falls primarily within the EuropeanEconomic Area, which consists of the twenty-seven member states of the EuropeanUnion, as well as Iceland, Liechtenstein and Norway. Only medical devices thatcomply with certain conformity requirements are allowed to be marketed withinthe European Economic Area. In addition, the national health or social securityorganizations of certain foreign countries, including those outside Europe,require our products to be qualified before they can be marketed in thosecountries. Failure to receive or delays in the receipt of, relevant foreignqualifications in the European Economic Area or other foreign countries couldhave a material adverse effect on our business.

 

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The FDA regulates theexport of medical devices to foreign countries and certain foreign countriesmay require FDA certification that our products are in compliance with U.S.law.  If we fail to obtain or maintainexport certificates required for the export of our products, we could suffer amaterial adverse effect on our revenues and growth.

 

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

 

Our manufacturingprocesses are required to comply with the FDA’s Quality System Regulation,which covers the procedures concerning (and documentation of) the design,testing, production processes, controls, quality assurance, labeling,packaging, storage and shipping of our devices. We also are subject to staterequirements and licenses applicable to manufacturers of medical devices. Inaddition, we must engage in extensive recordkeeping and reporting and must makeavailable our manufacturing facilities and records for periodic unscheduledinspections by governmental agencies, including the FDA, state authorities andcomparable agencies in other countries. Moreover, if we fail to pass a QualitySystem Regulation inspection or to comply with these and other applicableregulatory requirements, we may receive a warning letter or could otherwise berequired to take corrective action and, in severe cases, suffer a disruption ofour operations and manufacturing delays. If we fail to take adequate correctiveactions we could be subject to certain enforcement actions, including, amongother things, significant fines, suspension of approvals, seizures or recallsof products, operating restrictions and criminal prosecutions. We cannot assureyou that the FDA or other governmental authorities would agree with ourinterpretation of applicable regulatory requirements or that we have in allinstances fully complied with all applicable requirements. Any failure tocomply with applicable requirements could adversely affect our product salesand profitability.

 

We have received FDAwarning letters in the past.  Mostrecently, we received a warning letter in January 2007 in which the FDAinvestigator concluded that we had failed to establish and maintain adequateprocedures for handling and investigating complaints, failed to establish andmaintain procedures for changes to specifications and processes, includingverification or validation of such changes, and found that these failurescaused certain products to be misbranded. In the warning letter, the FDAinformed 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 of 2008, the FDAconcluded their follow-up investigation concerning the January 2007warning letter.  We received noobservations and all areas of concern were addressed 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.  We believe we have corrected these issues andare implementing a recall of certain devices. We do not believe that these observations, or any resulting recall, willhave a material adverse effect on our financial condition or results ofoperations.  However, we cannot assureyou that the FDA will not take further action in the future.

 

***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 andother regulatory agencies actively enforce regulations prohibiting thepromotion of a medical device for a use that has not been cleared or approvedby the FDA. Use of a device outside its cleared or approved indications isknown as “off-label” use. Physicians may use our products for off-label uses,as the FDA does not restrict or regulate a physician’s choice of treatmentwithin the practice of medicine. However, if the OIG or FDA or anotherregulatory agency determines that our promotional materials or trainingconstitutes promotion of an off-label use, it could request that we modify ourtraining or promotional materials or subject us to regulatory enforcementactions, including the issuance of a warning letter, injunction, seizure, civilfine and criminal penalties. Although our policy is to refrain from statementsthat could be considered off-label promotion of our products, the FDA oranother regulatory agency could disagree and conclude that we have engaged inoff-label promotion. In addition, the off-label use of our products mayincrease 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.

 

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***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 intowritten agreements for designing and consulting services with physicians forsurgical implant products, and we compensate them under our designing physicianagreements for services in developing products sold by us.  We also seek the assistance of physicians inthe design and evaluation of bracing and other rehabilitative products. Theform of compensation for such services has historically been a royalty on thesale of our products in the cases where the physician has contributed to thedesign of the product. We compensate the physicians under consulting agreementsfor assistance with product development and clinical efforts. We believe thatin each instance remuneration paid to physicians represents fair market value forthe services provided and is otherwise in compliance with applicable laws. Wealso use an independent sales force for products for which we providecompliance-related training. The sales force has generally been compensated oncommission based on a percentage of revenues generated by products sold as istypical in our industry. We also pay physicians certain rental and officesupport fees under our OfficeCare and EmpiCare programs. Under applicablefederal and state healthcare fraud and abuse, anti-kickback, false claims andself-referral laws, it could be determined that our designing and consultingarrangements with surgeons, our marketing and sales practices, and ourOfficeCare and EmpiCare programs 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 deferred prosecution and corporate integrity agreements withsuch manufacturers. Such investigations and enforcement activities often arisebased on allegations of violations of the federal Anti-Kickback Statute.Although we believe we maintain a satisfactory compliance program, it may not beadequate in the detection or prevention of violations. The form andeffectiveness of our compliance program may be taken into account by thegovernment in assessing sanctions, if any, should it be determined thatviolations of laws have occurred.

 

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

 

As part of our business operations, we submit claimson behalf of patients directly to, and receive payments directly from, theMedicare and Medicaid programs and private payors. Therefore, we are subject toextensive government regulation, including requirements for submittingreimbursement claims under appropriate codes and maintaining certaindocumentation to support our claims. Medicare contractors and Medicaid agenciesperiodically conduct pre- and post-payment reviews and other audits of claimsand are under increasing pressure to more closely scrutinize healthcare claimsand supporting documentation. We have historically been subject to pre-paymentand post-payment reviews as well as audits of claims and may experience suchreviews and audits of claims in the future. Such reviews and/or similar auditsof our claims could result in material delays in payment, as well as materialrecoupments or denials, which would reduce our net sales and profitability, orin exclusion from participation in the Medicare or Medicaid programs. Privatepayors may from time to time conduct similar reviews and audits.

 

Additionally, we participate in the government’sFederal Supply Schedule program for medical equipment, whereby we contract withthe government to supply certain of our products. Participation in this programrequires us to follow certain pricing practices and other contractrequirements. Failure to comply with such pricing practices and/or othercontract requirements could result in delays in payment or 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 clients,subject to various federal and state laws pertaining to healthcare fraud andabuse. These laws, which directly or indirectly affect our ability to operateour business include, but are not limited to, the following:

 

·                  the federal Anti-Kickback Statute,which prohibits persons from knowingly and willfully soliciting, offering,receiving or providing remuneration, directly or indirectly, in cash or inkind, to induce either the referral of an individual, or the furnishing orarranging for or recommending of a good or service, for which payment may bemade under federal healthcare programs, such as Medicare and Medicaid, VeteransAdministration health programs, and TRICARE;

 

·                  several federal False Claimsstatutes, which impose civil and criminal liability on individuals and entitieswho submit, or cause to be submitted, false or fraudulent claims for payment tothe government;

 

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·                  HIPAA prohibits executing a scheme todefraud any healthcare benefit program, and also prohibits false statements,defined as knowingly and willfully falsifying, concealing or covering up amaterial fact or making any materially false statement in connection with thedelivery of or payment for healthcare benefits, items or services;

 

·                  the federal physician self-referralprohibition, commonly known as the Stark Law, which, in the absence of astatutory or regulatory exception, prohibits the referral of Medicare andMedicaid patients by a physician to an entity for the provision of certaindesignated healthcare services, if the physician or a member of the physician’simmediate family has a direct or indirect financial relationship, including anownership interest in, or a compensation arrangement with, the entity and alsoprohibits that entity from submitting a bill to a federal payor for servicesrendered pursuant to a prohibited referral; and

 

·                  state law equivalents to theAnti-Kickback Statute, the false claims provisions, the Stark Law and thephysician self-referral prohibitions, some of which may apply even more broadlythan their federal counterparts because they are not limited to governmentreimbursed items and include items or services reimbursed by any payor.

 

The federal government has significantly increasedinvestigations of and enforcement activity involving medical devicemanufacturers with regard to alleged kickbacks and other forms of remunerationto physicians who use and prescribe their products. Such investigations oftenarise based on allegations of violations of the federal Anti-Kickback Statute.

 

These laws and regulations are complex and even minor,inadvertent irregularities in submissions can potentially give rise to claimsthat the law has been violated. Any violations of these laws or regulationscould result in a material adverse effect on our business, financial conditionand results of operations. If there is a change in law, regulation oradministrative or judicial interpretations, we may have to change one or moreof our business practices to be in compliance with these laws. Required changescould be costly and time consuming. Any failure to make required changes couldresult in our losing business or our existing business practices beingchallenged as unlawful.

 

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

 

Healthcare reform and the healthcare industry’sresponse to rising healthcare costs have resulted in a significant expansion ofmanaged care organizations and buying groups. This growth of managed care andthe advent of buying groups in the United States have caused a shift towardcoverage and payments based on more cost-effective treatment alternatives.Buying groups enter into preferred supplier arrangements with one or moremanufacturers of medical products in return for price discounts to members ofthese buying groups. Our failure to obtain new preferred supplier commitmentsfrom major group purchasing organizations or our failure to retain our existingpreferred supplier commitments could adversely affect our sales andprofitability. In international 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 healthcare reform and managed care to continue to develop inthe United States and these international markets and put further downwardpressure on product pricing, which may adversely affect our sales andprofitability.

 

***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 to ongoing medical device reportingregulations that require us to report to the FDA or similar governmentalauthorities in other countries if our products cause, or contribute to, deathor serious injury, or malfunction in a way that would be likely to cause, orcontribute to, death or serious injury if the malfunction were to recur. TheFDA and similar governmental authorities in other countries have the authorityto require us to recall our products in the event of  actual or potential material deficiencies ordefects in design manufacturing, or labeling, and we have been subject toproduct recalls in the past. In addition, in light of an actual or potentialmaterial deficiency, defect in design, manufacturing, or labeling, we mayvoluntarily elect to recall our products. A government mandated or voluntaryrecall by us could occur as a result of actual or potential component failures,manufacturing errors or design defects, including defects in labeling. Anyrecall would divert managerial and financial resources and could harm ourreputation with our customers and with the healthcare professionals that use,prescribe and recommend our products. We could have product recalls that resultin significant costs to us in the future, and such recalls could have amaterial adverse effect on our business.

 

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

 

The manufacture and sale of orthopedic devices andrelated products exposes us to a significant risk of product liability claims.From time to time, we have been, and we are currently, subject to a number ofproduct liability claims alleging that the use of our products resulted inadverse effects. Even if we are successful in defending against any liabilityclaims, such claims could nevertheless distract our management, result insubstantial costs, harm our reputation, adversely affect the sales of all ourproducts and otherwise harm our business. If there is a significant increase inthe number of product liability claims, our business could be adverselyaffected.

 

We currently carry product liability insurance up to alimit of $25.0 million, subject to aggregate self-insurance retention of$750,000 and a deductible of $50,000 on non-invasive and $250,000 on invasiveproducts. Our insurance policy is subject to annual renewal. Product liability claimsmade against us may exceed the coverage limit of our policy or such insurancecoverage may not continue to be available on commercially reasonable terms orat all. Additionally, we are also subject to the risks that our insurers willexclude from coverage claims made against us or that our insurers may becomeinsolvent. If we do not or cannot maintain adequate product liabilityinsurance, our business and results of operations may be adversely affected.

 

As of December 31, 2007, we exceeded the coveragelimits for certain historical product liability claims.  The estimated exposure related to theseclaims has been accrued in our consolidated balance sheet as of that date.

 

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

 

As a result of the DJO Merger, our most significantmanufacturing facility is our facility in Tijuana, Mexico, and we also have arelatively small manufacturing operation in Tunisia. In addition, during thefirst quarter of 2008, we expect to initiate the transfer of certainmanufacturing operations from our Chattanooga, Tennessee location to Tijuana,Mexico. We also may move portions of our other manufacturing activities toMexico in the future. Our current and future foreign operations are subject torisks of political and economic instability inherent in activities conducted inforeign countries. Because there are no readily accessible alternatives tothese facilities, any event that disrupts manufacturing at or distribution ortransportation from these facilities would materially adversely affect ouroperations. In addition, as a result of this concentration of manufacturingactivities, our sales in foreign markets may be at a competitive disadvantage toproducts manufactured locally due to freight costs, custom and import dutiesand favorable tax rates for local 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 a limited number of foreign and domesticsuppliers for the raw materials and components used in our products. One ormore of our suppliers may decide to cease supplying us with raw materials andcomponents for reasons beyond our control. FDA regulations may requireadditional testing of any raw materials or components from new suppliers priorto our use of those materials or components. In addition, in the case of adevice which is the subject of a pre-market approval, we may be required toobtain prior FDA permission (which may or may not be given), which could delayor prevent our access or use of such raw materials or components. If we areunable to obtain materials we need from our suppliers or our agreements withour suppliers are terminated, and we cannot obtain these materials from othersources, we may be unable to manufacture our products to meet customer ordersin a timely manner or within our manufacturing budget. In that event, ourbusiness and results of operations could be adversely affected.

 

In addition, we rely on third parties to manufacturesome of our products. For example, Medireha GmbH (“Medireha”), which is 50%owned by us, has been a supplier for a significant portion of our CPM devices.CPM devices represented approximately 5% of our net sales for the year ended December 31,2007. If we encounter a cessation, interruption or delay in the supply of theproducts purchased from Medireha, we may be unable to obtain such productsthrough other sources on acceptable terms, within a reasonable amount of timeor at all. We also use a single source for many of the devices Cefar and Compexdistribute. In addition, if our agreements with the manufacturing companieswere terminated, we may not be able to find suitable replacement within areasonable amount of time or at all. Any such cessation, interruption or delaymay impair our ability to meet scheduled deliveries of our products to ourcustomers and may cause our customers to cancel orders. In that event, ourreputation and results of operations may be adversely affected.

 

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Some of our important suppliers are in China and otherparts of Asia and provide predominately finished soft goods products. In fiscalyear 2007, we obtained approximately 16.1% of our total purchased materialsfrom suppliers in China and other parts of Asia and on a pro forma basis 19.9%.Political and economic instability and changes in government regulations inthese areas could affect our ability to continue to receive materials fromsuppliers there. The loss of suppliers in China and other parts of Asia, anyother interruption or delay in the supply of required materials or ourinability to obtain these materials at acceptable prices and within areasonable amount of time could impair our ability to meet scheduled productdeliveries to our customers and could hurt our reputation and cause customersto cancel orders.

 

In addition, we purchase the microprocessor used inthe OL1000 and SpinaLogic devices from a single manufacturer. Although thereare feasible alternate microprocessors that might be used immediately, all areproduced by a single supplier. In addition, there are single suppliers forother components used in the OL1000 and SpinaLogic devices and only twosuppliers for the magnetic field sensor employed in them. Establishment ofadditional or replacement suppliers for these components cannot be accomplishedquickly.

 

***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 a combination of patents, trade secrets,copyrights, trademarks, license agreements and contractual provisions toestablish and protect our intellectual property rights in our products and theprocesses for the development, manufacture and marketing of our products.

 

We use non-patented, proprietary know-how, tradesecrets, processes and other proprietary information and currently employvarious methods to protect this proprietary information, includingconfidentiality agreements, invention assignment agreements and proprietaryinformation agreements with vendors, employees, independent sales agents,distributors, consultants, and others. However, these agreements may bebreached. The FDA or another governmental agency may require the disclosure ofsuch information in order for us to have the right to market a product. Tradesecrets, know-how and other unpatented proprietary technology may alsootherwise become known to or independently developed by our competitors.

 

In addition, we also hold U.S. and foreign patentsrelating to a number of our components and products and have patentapplications pending with respect to other components and products. We alsoapply for additional patents in the ordinary course of our business, as we deemappropriate. However, these precautions offer only limited protection, and ourproprietary information may become known to, or be independently developed by,competitors, or our proprietary rights in intellectual property may bechallenged, any of which could have a material adverse effect on our business,financial condition and results of operations. Additionally, we cannot assureyou that our existing or future patents, if any, will afford us adequateprotection or any competitive advantage, that any future patent applicationswill result in issued patents or that our patents will not be circumvented,invalidated or declared unenforceable. In addition, certain of our subsidiarieshave not always taken commercially reasonable measures to protect theirownership of some of their patents. While such measures are currently employedand have been employed by us in the past, disputes may arise as to theownership, or co-ownership, of certain of our patents. We do not considerpatent protection to be a significant competitive advantage in the marketplacefor electrotherapy devices. However, patent protection may be of significancewith respect to our orthopedic technology.

 

Any proceedings before the U.S. Patent and TrademarkOffice could result in adverse decisions as to the priority of our inventionsand the narrowing or invalidation of claims in issued patents. We could alsoincur substantial costs in any such proceedings. In addition, the laws of someof the countries in which our products are or may be sold may not protect ourproducts and intellectual property to the same extent as U.S. laws, if at all.We may also be unable to protect our rights in trade secrets and unpatentedproprietary technology in these countries.

 

In addition, we hold patent and other intellectualproperty licenses from third parties for some of our products and ontechnologies that are necessary in the design and manufacture of some of ourproducts. The loss of such licenses would prevent us from manufacturing,marketing and selling these products, which in turn could harm our business.

 

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

 

Litigation involving patents and other intellectualproperty rights is common in our industry, and companies in our industry haveused intellectual property litigation in an attempt to gain a competitiveadvantage. We may become a party to lawsuits involving patents or otherintellectual property. Such litigation is costly and time consuming. If we loseany of these proceedings, a court or a similar foreign governing body couldinvalidate or render unenforceable our owned or licensed 

 

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patents, require us topay significant damages, seek licenses and/or pay ongoing royalties to thirdparties, require us to redesign our products, or prevent us from manufacturing,using or selling our products, any of which would have an adverse effect on ourresults of operations and financial condition.

 

We have brought, and may in the future also bring,actions against third parties for an infringement of our intellectual propertyrights. We may not succeed in such actions. The defense and prosecution ofintellectual property suits, proceedings before the U.S. Patent and TrademarkOffice or its foreign equivalents and related legal and administrativeproceedings are both costly and time consuming. Protracted litigation to defendor enforce our intellectual property rights could seriously detract from the timeour management would otherwise devote to running our business. Intellectualproperty litigation relating to our products could cause our customers orpotential customers to defer or limit their purchase or use of the affectedproducts until resolution of 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 to achieve our business objectives issubject to a variety of factors, including the relative increase in the agingof the general population and an increase in participation in exercise andsports and more active lifestyles. In addition, our business strategy relies onan increasing awareness and clinical acceptance of non-invasive, non-systemictreatment and rehabilitation products, such as electrotherapy. We believe thatthese trends will increase the need for our orthopedic, physical therapy,regenerative and surgical implant products. The projected demand for ourproducts could materially differ from actual demand if our assumptionsregarding these trends and acceptance of our products by healthcareprofessionals and patients prove to be incorrect or do not materialize. If ourassumptions regarding these factors prove to be incorrect, we may not be ableto successfully implement our business strategy, which could adversely affectour results of operations. In addition, the perceived benefits of these trendsmay be offset by competitive or business factors, such as the introduction ofnew products by our competitors or the emergence of other countervailingtrends.

 

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

 

We may attempt to expand into new markets through thedevelopment of new product applications based on our existing specializedtechnology and design capabilities. These efforts could require us to makesubstantial investments, including significant research, development,engineering and capital expenditures for new, expanded or improvedmanufacturing facilities which would divert resources from other aspects of ourbusiness. Expansion into new markets may be costly and may not result in anybenefit to us. Specific risks in connection with expanding into new marketsinclude the inability to transfer our quality standards into new products, thefailure of customers in new markets to accept our products and price competitionin new markets. Such expansion efforts into new markets could be unsuccessful.

 

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

 

Many healthcare industry companies, including medicaldevice, orthopedic and physical therapy products companies, are consolidatingto create larger companies. As the healthcare industry consolidates,competition to provide products and services to industry participants maybecome more intense. In addition, many of our customers are also consolidating,and our customers and other industry participants may try to use theirpurchasing power to negotiate price concessions or reductions for the productsthat we manufacture and market. If we are forced to reduce our prices becauseof consolidation in the healthcare industry, our revenues could decrease, andour business, financial condition and results of operations could be adverselyaffected.

 

***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 and development and manufacturingprocesses involve the use of hazardous materials. We are subject to federal,state, local and foreign environmental requirements, including regulationsgoverning the use, manufacture, handling, storage and disposal of hazardousmaterials, discharges to air and water, the clean up of contamination andoccupational health and safety matters. We cannot eliminate the risk ofcontamination or injury resulting from hazardous materials, and we may incurliability as a result of any contamination or injury. Under some environmentallaws and regulations, we could also be held responsible for costs relating toany contamination at our past or present facilities and at third party wastedisposal sites where we have sent workers. These could include costs relatingto contamination that did not result from any violation of law, and in somecircumstances, 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.

 

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

 

Our net sales and profitability are affected bychanges in reserves to account for contractual allowances, rebates, productreturns, rental credits, uncollectible accounts receivable and inventory. Anyincrease in our reserves for contractual allowances, rebates, product returns,rental credits, uncollectible accounts receivable or inventory could adverselyaffect our reported financial results by reducing our net revenues and/orprofitability for the reporting period.

 

We have established reserves to account forcontractual allowances, rebates, product returns and reserves for rentalcredits.  Significant management judgmentmust be used and estimates must be made in connection with establishing the reservesfor contractual allowances, rebates, product returns, rental credits and otherallowances in any accounting period.

 

We maintain provisions forestimated contractual allowances for reimbursement amounts from our third partypayor customers based on negotiated contracts and historical experience fornon-contracted payors. We provide for these reserves by reducing our grossrevenue.  We estimate the amount of thereduction based on historical experience and invoices generated in the period,and we consider the impact of new contract terms or modifications of existingarrangements with our customers.  We havecontracts with certain third party payors for our third party reimbursementbillings, which call for specified reductions in reimbursement of billedamounts based upon contractual reimbursement rates.

 

Our reserve fordoubtful accounts is based upon estimated losses from customers who are billeddirectly and the portion of third party reimbursement billings that ultimatelybecome the financial responsibility of the end user patients. Our third partyreimbursement customers including insurance companies, managed care companiesand certain governmental payors, such as Medicare, include all of ourOfficeCare customers and certain other customers of our Domestic RehabilitationSegment. We estimate bad debt expense based upon historical experience andcurrent relationships with our customers and providers.  If the financial condition of our customerswere to deteriorate resulting in an impairment of their ability to makepayments or if third-party payors were to deny claims for late filings,incomplete information or other reasons, additional provisions may be required.

 

Our reserve for rebates accounts for incentives thatwe offer to certain of our distributors. These rebates generally are attributable to sales volume, sales growthand to reimburse the distributor for certain discounts.  We record estimated reductions to revenue forcustomer rebate programs based upon historical experience and estimated revenuelevels.

 

The reserve for product returns accounts for customerreturns of our products after purchase. These returns are mainly attributableto a third party payor’s refusal to provide a patient release or reimbursementfor the product or the inability of the product to adequately address thepatient’s condition. If we increase the percentage of our sales made pursuantto agreements providing for reimbursement below invoice price or if customersreturn products at a higher than estimated rate, we may be required to increaseour sales allowance and product return reserves beyond their current levels.

 

Our reserve for rental credits recognizes a timingdifference between billing of a purchase and processing of a rental creditassociated with some of our electrotherapy and traction devices. Many insuranceproviders require patients to rent our rehabilitation devices for a period ofone to three months prior to purchase. If the patient has a long-term need forthe device, these insurance companies may authorize purchase of the deviceafter such time period. When the device is purchased, most providers requirethat rental payments previously made on the device be credited toward thepurchase price. These credits are processed at the time the payment is receivedfor the purchase of the device, which creates a time lag between billing of thepurchase and processing of the rental credit. Our rental credit reserveaccounts for unprocessed rental credits based on the number of devicesconverted to purchase. If the frequency of rental to purchase conversionincreases, we may be required to increase our rental credit reserve beyond itscurrent level.

 

The nature of our business requires us to maintainsufficient inventory on hand at all times to meet the requirements of ourcustomers.  We provide reserves forestimated excess or obsolete inventories equal to the difference between thecost of inventories on hand plus future purchase commitments and the estimatedmarket value based upon assumptions about future demand.  If future demand is less favorable thancurrently projected by management, additional inventory write-downs may berequired.  We also provide reserves fornewer product inventories, as appropriate, based on any minimum purchasecommitments and our level of sales of the new products.

 

All of our segmentsconsign a portion of their inventory to allow their products to be immediatelydispensed to patients.  This requires alarge amount of inventory to be 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.

 

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

 

The OfficeCare sales channel maintains a range ofproducts (mostly soft goods) on hand at over 1,200 healthcare facilities,primarily orthopedic practices, for immediate distribution to patients. In theInsurance channel, products are provided, principally custom-made rigid knee braces,directly to patients. In both situations, patients or their third party payorsare billed after the product is provided to the patient. The revenue cycle ofthis program is outsourced, from billing to collections, to an independentthird party contractor. The outsource contractor that we have used hasundergone significant changes in its business operations in the last two years,including relocating some administrative functions overseas, in order toimprove performance from order entry to collections. The contractor may alsoupgrade the software system used in these revenue cycle processes. Theinability of this provider to successfully upgrade its processes or demonstrateacceptable billing and collection results could have an adverse effect on our operationsand financial results in the OfficeCare and Insurance channels. In addition, wemay transition all or part of these administrative functions to internaldepartments in the future and that transition may not 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 significant portion of our rehabilitation productsare manufactured in a facility in Tijuana, Mexico, with a number of productsfor the European market manufactured in a Tunisian facility. In Vista,California we manufacture our custom rigid bracing products, which remain inthe United States to facilitate quick turn-around on custom orders, vascular products,and our regeneration product line. Our clinical electrotherapy devices, patientcare products, physical therapy and chiropractic treatment tables and certainCPM devices are manufactured in our facilities located in Chattanooga,Tennessee. Our home electrotherapy devices sold in the United States as well assome components and related accessories are manufactured at our facility inClear Lake, South Dakota. In our Surgical Implant Segment, we manufacture ourproducts in our manufacturing facility at Austin, Texas. These facilities andthe manufacturing equipment we use to produce our products would be difficultto repair or replace. Our facilities may be affected by natural or man-madedisasters. If one of our facilities were affected by a disaster, we would beforced to rely on third party manufacturers or shift production to anothermanufacturing facility. 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 growth strategy may include the pursuit ofacquisitions, both domestically and internationally. However, we may not beable to identify acceptable opportunities or complete acquisitions of targetsin a timely manner or on acceptable terms. In addition, acquisitions involve anumber of risks, including those set forth under the risk factor captioned “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.” To the extent we are unable to consummateacquisitions, we will experience slower than expected growth.

 

In addition, we may require additional debt or equityfinancing for future acquisitions, and such financing may not be available onfavorable terms, if available at all. We may not be able to successfullyintegrate or operate profitably any new business we acquire, and we cannotassure you that any such acquisition will meet our expectations. Finally, inthe event we decide to discontinue pursuit of a potential acquisition, we willbe required to immediately expense all costs incurred in pursuit of thepossible acquisition that could have an adverse effect on our results ofoperations in the period in which the expense is recognized. If we completeacquisitions, or obtain financing for them, on unfavorable terms, or if we failto properly integrate an acquired business, our financial condition and resultsof 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 we have experienced, and in the futuremay experience, including due to acquisitions, may provide challenges to ourorganization, requiring us to expand our personnel, manufacturing anddistribution operations. Future growth may strain our infrastructure,operations, product development and other managerial and operating resources.If our business resources become strained, we may be unable to increase salesof our products or generate revenue growth.

 

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***The loss of the services of our key management and personnelcould adversely affect our ability to operate our business.***

 

Our future successwill depend, in part, upon the continued service of key managerial, researchand development staff and sales and technical personnel. In addition, ourfuture success will depend on our ability to continue to attract and retainother highly qualified personnel. Our executive officers have substantialexperience and expertise in our industry. Our future success depends, to asignificant extent, on the abilities and efforts of our executive officers andother members of our management team. We compete for such personnel with othercompanies, academic institutions, government entities and other organizations.We may not be successful in retaining our current personnel or in hiring orretaining qualified personnel in the future. Our failure to do so could have amaterial adverse effect on our business.

 

***Affiliates of Blackstone own substantially all of the equityinterest in us and may have conflicts of interest with us or investors in thefuture.***

 

Investment fundsaffiliated with Blackstone collectively beneficially own 98.74% of our capitalstock, and Blackstone designees hold a majority of the seats on our board ofdirectors. As a result, affiliates of Blackstone have control over ourdecisions to enter into any corporate transaction and have the ability toprevent any transaction that requires the approval of stockholders regardlessof whether holders of the Notes believe that any such transactions are in theirown best interests. For example, affiliates of Blackstone could collectivelycause us to make acquisitions that increase the amount of indebtedness or tosell assets, or could cause us to issue additional capital stock or declaredividends. So long as investment funds affiliated with Blackstone continue todirectly or indirectly own a significant amount of the outstanding shares ofour common stock, affiliates of Blackstone will continue to be able to stronglyinfluence or effectively control our decisions. In addition, Blackstone has noobligation to provide us with any additional debt or equity financing.

 

Additionally,Blackstone is in the business of making investments in companies and may fromtime to time acquire and hold interests in businesses that compete directly orindirectly with us. Blackstone may also pursue acquisition opportunities thatmay be complementary to our business and, as a result, those acquisitionopportunities may not be available to us.

 

***If we do not achieve and maintain effective internalcontrols over financial reporting, we could fail to accurately report ourfinancial results.***

 

During the courseof the preparation of our financial statements, we evaluate our internalcontrols to identify and correct deficiencies in our internal controls overfinancial reporting. In the event we are unable to identify and correctdeficiencies in our internal controls in a timely manner, we may not record,process, summarize and report financial information accurately and within thetime periods required for our financial reporting under the terms of theagreements governing our indebtedness.

 

We have completeda significant number of acquisitions in the past several years, and maycontinue to pursue growth through strategic acquisitions. Among the risksassociated with acquisitions are the risks of control deficiencies that resultfrom the integration of the acquired business. In connection with theintegration of our recent acquisitions and our continuous assessment ofinternal controls, including with respect to acquired foreign operations, wehave identified certain internal control deficiencies that we have remedied orfor which we have undertaken steps to remediate.

 

It is possible that control deficiencies could be identified by ourmanagement or independent registered public accounting firm in the future ormay occur without being identified. Such a failure could negatively impact themarket price and liquidity of the Notes, cause security holders to loseconfidence in our reported financial condition, lead to a default under our NewSenior Secured Credit Facility and otherwise materially adversely affect ourbusiness and financial condition.

 

## **ITEM 2. PROPERTIES**

## ** **

Our corporate headquarters are in Vista, California.  The operations of our Domestic RehabilitationSegment are based in Vista, California; Chattanooga, Tennessee and St. Paul,Minnesota. Our International Rehabilitation Segment’s headquarters are in Guildford, England; Freiburg, Germany andMalmo, Sweden. We operate manufacturing facilities in Tijuana, Mexico; Sfax,Tunisia and Clear Lake, South Dakota and warehouse and distribution centers inClear Lake, South Dakota; Chattanooga, Tennessee; Indianapolis, Indiana;Tijuana, Mexico; Freiburg, Germany; Malmo, Sweden, and various other citiesthroughout the world. The manufacturing facilities and operations for ourSurgical Implant Segment are in Austin, Texas. Additional information about ourmaterial facilities is set forth in the following table:

 

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| **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                        |       |
| Austin, Texas             |       | Surgical Implant Segment  Operations and Manufacturing Facility, Warehouse, Research and Development                  |       | Leased             |       | March 2012(a)               |       | 64,600                         |       |
| Chattanooga, Tennessee    |       | Domestic Rehabilitation Segment Operations, Manufacturing and Distribution Facility,  Research and Development        |       | Owned              |       | n/a                              |       | 164,542                        |       |
| Chattanooga, Tennessee    |       | Manufacturing Facility                                                                                                |       | Owned              |       | n/a                              |       | 61,457                         |       |
| Ooltewah, Tennessee       |       | Distribution Facility                                                                                                 |       | Leased             |       | July 2008                   |       | 50,000                         |       |
| Clear Lake, South Dakota  |       | Manufacturing, Distribution and  Refurbishment and Repair Facility, Warehouse                                         |       | Owned              |       | n/a                              |       | 54,000                         |       |
| St. Paul, Minnesota       |       | Domestic Rehabilitation Segment Operations, Research and Development                                                  |       | Leased             |       | October 2011(b)             |       | 93,666                         |       |
| Indianapolis, Indiana     |       | Distribution Facility                                                                                                 |       | Leased             |       | October 2016                |       | 109,782                        |       |
| Freiburg, Germany         |       | International Rehabilitation  Segment Operations, Research and Development, Warehouse and Distribution  Facility      |       | Leased             |       | December 2014               |       | 38,018                         |       |
| Malmö, Sweden        |       | International Rehabilitation  Segment Operations, Warehouse and Distribution Facility                                 |       | Leased             |       | March 2011                  |       | 16,081                         |       |
| Mouguerre, France         |       | Office & Distribution                                                                                        |       | Leased             |       | October 2016                |       | 22,050                         |       |
| Herentals,  Belgium       |       | Warehouse                                                                                                             |       | Leased             |       | December 2013               |       | 25,800                         |       |
| Tijuana, Mexico           |       | Manufacturing and Distribution Facility                                                                               |       | Leased             |       | September 2016              |       | 286,133                        |       |
| Sfax, Tunisia             |       | Manufacturing  Facility                                                                                               |       | Leased             |       | December 2013               |       | 47,300                         |       |
| Sfax, Tunisia             |       | Manufacturing Facility                                                                                                |       | Leased             |       | December 2008               |       | 24,500                         |       |
| Guildford, United Kingdom |       | Office & Distribution                                                                                        |       | Leased             |       | July 2016                   |       | 8,234                          |       |

 

----

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

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

 

We also lease a total of approximately 193,900square feet of aggregate warehouse and office space in various other locations.

 

## **ITEM 3.  LEGALPROCEEDINGS**

## ** **

From time to time, we are plaintiffs or defendantsin various litigation matters in the ordinary course of our business, some ofwhich involve claims for damages that are substantial in amount. We believethat the disposition of claims currently pending will not have a materialadverse effect on our financial position or results of operations.

 

The manufacture and sale of orthopedic devices and related productsexposes us to significant risks of product liability claims, lawsuits andproduct recalls. From time to time, we have been, and we are currently, thesubject of a number of product liability claims and lawsuits relating to ourproducts. We face an inherent business risk of exposure to product liabilityclaims in the event that the use of our products is alleged to have resulted inadverse effects, including injuries or death. If there is a significantincrease in the number or amount of product liability claims, our businesscould be adversely affected. Even if we are successful in defending against anyproduct liability claims, such claims could nevertheless distract ourmanagement, result in substantial costs, harm our reputation, adversely affectthe sales of all our products and otherwise harm our business.

 

We currently carry product liability insurance up to a limit of $25.0million, subject to aggregate self-insurance retention of $750,000 and adeductible of $50,000 on non-invasive and $250,000 on invasive products. Ourinsurance policy is subject to annual renewal.We believe our current product liability insurance coverage is adequate.  As of December 31, 

 

42

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2007, we exceeded the coverage limits for certain historical productliability claims.  The estimated exposurehas been accrued for in our consolidated balance sheet as of that date.  Future product liability claims that could bemade against us could significantly exceed the coverage limit of our policiesor such insurance coverage may not continue to be available on commerciallyreasonable terms or at all. Additionally, we are also subject to the risk thatour insurers will exclude from coverage claims made against us or the risk thatinsurers may become insolvent. If we do not or cannot maintain adequate productliability insurance, our business and results of operations may be adverselyaffected.

 

On July 7, 2006, a purported class action complaint, Louis Dudaset al. v. Encore Medical Corporation et al., was filed against the formercompany and its directors at that time in the District Court of Travis County,Texas, 345th Judicial District (“the Texas Action”). On July 18, 2006, asecond purported class action complaint, Robert Kemp et al. v. Alastair J.Clemow et al. (the “Delaware Action”) was filed by a putative stockholder ofthe former company in the Court of Chancery of the State of Delaware, NewCastle County, against the former company and its directors at that time.Blackstone Capital Partners V L.P. and Grand Slam Holdings, LLC were also namedas defendants in the Delaware Action.

 

The Texas Action is in preliminary stages and we cannot presentlypredict the outcome of the lawsuit, although we believe it is withoutmerit.  The Delaware Action was dismissedby the plaintiffs in February 2007 with no liability accrued to theCompany or the other defendants.

 

The Texas Action complaint alleges that the former company’s directorsbreached their fiduciary duties by, inter alia, agreeing to an allegedlyinadequate acquisition price in connection with the Prior Transaction. Thecomplaint seeks, among other things, to rescind any actions that have alreadybeen taken to consummate the Prior Transaction, rescissory damages, and theplaintiffs’ reasonable costs and attorneys’ fees and expert fees.

 

*PendingStockholder Litigation*

 

On August 31,2007 and September 6, 2007, two purported shareholder class actionlawsuits were filed in California Superior Court, in the County of San Diego,on behalf of DJO Opco’s public stockholders, challenging DJO Opco’s proposedmerger with ReAble. The court ordered the two lawsuits consolidated for allpurposes on September 21, 2007.

 

The two originalcomplaints named DJO Opco, ReAble and the current members of DJO Opco’s boardof directors as defendants. One of the original complaints also namedBlackstone as a defendant. The two substantially similar original complaintsalleged, among other things, that the individual defendants breached theirfiduciary duties of care, good faith and loyalty by approving the proposedmerger with an allegedly inadequate price, without adequately informingthemselves of DJO Opco’s highest transactional value, and without adequatelymarketing DJO Opco to other potential buyers. The original complaints alsoalleged that the individual defendants and DJO Opco failed to make full andadequate disclosures in the preliminary proxy statement regarding the proposedmerger. The original complaints pray for, 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.

 

On November 5,2007, the parties entered into a memorandum of understanding (“MOU”), pursuantto which the parties agreed to settle the consolidated action subject to courtapproval. The MOU provides for dismissal of the consolidated action withprejudice upon approval of a stipulation by the court. Pursuant to the terms ofthe MOU, the defendants acknowledged that the consolidated action resulted in adecision to provide additional information to DJO Opco’s shareholders in thedefinitive proxy statement concerning the proposed merger and to modify certainterms in the merger agreement and to pay certain attorneys’ fees, costs, andexpenses incurred by the plaintiffs. As stated in the MOU, defendants deny allallegations of wrongdoing, fault, liability or damage to the plaintiffs and theputative class in the consolidated action and deny that they are engaged in anywrongdoing or violation of law or breach of duty. Defendants also do not makeany admission that the supplemental disclosures are material. The parties havesigned a settlement agreement and will seek court approval.

 

## **ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

## ** **

None.

 

43

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## ** **

## **PART II.**

## ** **

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

## ** **

As a result of the Prior Transaction, the common stock of DJO isprivately held, and there is no established trading market for our commonstock.  As of March 28, 2008, therewere five holders of DJO’s common stock.

 

## **ITEM 6.  SELECTEDFINANCIAL DATA**

## ** **

Selected financial data set forth below is presented for periods priorto November 3, 2006 (the date of the Prior Transaction) for ReAble (“Predecessor”)and from and after November 4, 2006 for DJOFL (“Successor”).  The following table sets forthselected financial data as of and for the periods indicated and has beenderived from the Predecessor’s and the Successor’s audited historicalconsolidated financial statements.  Theselected financial data for the Predecessor periods represents ReAble’sfinancial data prior to the acquisition of ReAble by Blackstone, and theselected financial data for the Successor periods represents financial data ofDJOFL after the consummation of the Prior Transaction.  For the year ended December 31, 2006, wehave combined the Predecessor period and the Successor period and presented theunaudited financial data on a combined basis for comparative purposes.  This combination does not comply withgenerally accepted accounting principles or the rules for unaudited pro formapresentation, but is presented because we believe it provides the mostmeaningful comparison of our financial results.

 

The selected financial data should be read in conjunction with theaudited consolidated financial statements and related notes thereto, and Item7. “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” in this Annual Report on Form 10-K.

 
| ** **                                         | ** ** | **Successor**                          | ** ** | **Predecessor**                                            | ** ** | **Combined  Basis**                                      | ** ** | **Predecessor**                                     | ** ** |
|----------------------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **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)**                     | ** ** | **2007**                               | ** ** | **2006**                                                   | ** ** | **2006**                                                 | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Statement of Operations Data:**                  |       |                                   |       |                                                       |       |                                                     |       |                                                |       |   |   |   |   |   |   |
| Net sales (1)                                      |       | $                                      | 492,134    |                                                       | $          | 57,902                                                   |       | $                                                   | 304,383    |   | $ | 362,285 |   | $ | 293,726 |   | $ | 148,081 |   | $ | 93,029 |   |
| Gross profit                                       |       | 286,270                                |       | 31,115                                                     |       | 177,103                                                  |       | 208,218                                             |       | 178,353 |   | 81,639 |   | 48,316 |   |
| Income (loss) from continuing operations           |       | (82,422                                | )          | (41,596                                                    | )          | (46,162                                                  | )          | (87,758                                             | )          | 9,347 |   | 5,128 |   | (1,769 | ) |
| Net income (loss).                                 |       | (82,422                                | )          | (41,634                                                    | )          | (46,776                                                  | )          | (88,410                                             | )          | 12,330 |   | 5,527 |   | (2,517 | ) |
|                                               |       |                                   |       |                                                       |       |                                                     |       |                                                |       |   |   |   |   |   |   |
| **Other Financial Data:**                          |       |                                   |       |                                                       |       |                                                     |       |                                                |       |   |   |   |   |   |   |
| Depreciation and amortization                      |       | 48,240                                 |       | 6,404                                                      |       | 14,804                                                   |       | 21,208                                              |       | 13,749 |   | 6,027 |   | 3,468 |   |
| Ratio of earnings to fixed charges (unaudited) (2) |       | —                                 |       |                                                       |       |                                                     |       | —                                              |       | 1.52x |   | 2.12x |   | — |   |
| **Balance Sheet Data (at period end):**            |       |                                   |       |                                                       |       |                                                     |       |                                                |       |   |   |   |   |   |   |
| Cash and cash equivalents                          |       | $                                      | 63,471     |                                                       |       |                                                     |       |                                                | $          | 30,903 |   | $ | 17,200 |   | $ | 19,889 |   | $ | 10,074 |   |
| Total assets                                       |       | 3,086,272                              |       |                                                       |       |                                                     |       | 1,060,636                                           |       | 552,037 |   | 552,139 |   | 136,380 |   |
| Long-term debt, net of current portion             |       | 1,818,598                              |       |                                                       |       |                                                     |       | 548,037                                             |       | 307,794 |   | 307,207 |   | 5,383 |   |
| Stockholders’ equity/membership equity        |       | 704,988                                |       |                                                       |       |                                                     |       | 335,208                                             |       | 167,107 |   | 160,317 |   | 113,109 |   |
|                                                    |            |                                        |            |                                                            |            |                                                          |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          The 2007 data includes $54.2 million in sales of DJO Opco and $2.9million in sales of IOMED as a result of the DJO Merger and the IOMEDacquisition on November 20, 2007 and August 9, 2007,respectively.  Also included is $17.5million in estimated sales as a result of our Saunders acquisition on July 2,2007.  The 2006 (combined basis) dataincludes $43.5 million in estimated sales related to our Compex acquisition on February 24,2006.  Also, included in net sales(combined basis) is $2.9 million related to our Cefar acquisition on November 7,2006.  See Note 2 to our auditedconsolidated financial statements for additional information related to theseacquisitions.  The 2005 data includes$5.3 million in sales as a result of our acquisition of Osteoimplant Technology, Inc.(“OTI”) on February 22, 2005.  The2004 data includes $41.4 million in sales as a result of our acquisition ofEmpi on October 4, 2004.

 

(2)          For purposes of calculating the ratio of earnings to fixed charges, (a) earningsconsist of income (loss) before provision (benefit) for income taxes plus fixedcharges and (b) fixed charges is defined as interest expense (includingcapitalized interest and amortization of debt issuance costs) and the estimatedportion of rent expense deemed by management to represent the interestcomponent of rent expense.  For thesuccessor year ended December 31, 2007 and the period November 4,through December 31, 2006, and the predecessor period January 1, 2006through November 3, 2006 and the year ended December 31, 2003, ourearnings were insufficient to cover fixed charges by $125.1 million, $50.4million, $57.7 million and $2.3 million, respectively.

 

44

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## ** **

## **ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

## ** **

## **ForwardLooking Statements**

## ** **

The following management’s discussion and analysis contains “forwardlooking statements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934 that representour expectations or beliefs concerning future events, including, but notlimited to, statements regarding growth in sales of our products, profitmargins and the sufficiency of our cash flow for future liquidity and capitalresource needs.  These forward-lookingstatements are further qualified by important factors that could cause actualresults to differ materially from those in the forward-looking statements.  Some of these factors are described under theheading “Risk Factors” above.  Resultsactually achieved may differ materially from expected results included in thesestatements as a result of these or other factors.

 

## **Introduction**

## ** **

This management’s discussion and analysis of financial condition andresults of operations is intended to provide an understanding of our results ofoperations, financial condition and where appropriate, factors that may affectfuture performance.

 

The following discussion should be read in conjunction with the auditedconsolidated financial statements and related notes to those financialstatements as well as the other financial data included elsewhere in this Form 10-K.

 

## **Overviewof Business**

## ** **

We are aleading global provider of high-quality, orthopedic devices, with a broad rangeof products used for rehabilitation, pain management and physical therapy. Wealso develop, manufacture and distribute a broad range of surgicalreconstructive implant products.  We arethe largest non-surgical orthopedic rehabilitation device company in the UnitedStates and among the largest globally, as measured by revenues. Many of ourproducts have leading market positions. We believe that our strong brand names,comprehensive range of products, focus on quality, innovation and customerservice, extensive distribution network, and our strong relationships withorthopedic and physical therapy professionals have contributed to our leadingmarket positions. We believe that we are one of only a few orthopedic devicecompanies that offer healthcare professionals and patients a diverse range oforthopedic rehabilitation products addressing the complete spectrum ofpreventative, pre-operative, post-operative, clinical and home rehabilitationcare.   Our products are used by orthopedicspecialists, spine surgeons, primary care physicians, pain managementspecialists, physical therapists, podiatrists, chiropractors, athletic trainersand other healthcare professionals to treat patients with musculoskeletalconditions resulting from degenerative diseases, deformities, traumatic eventsand sports-related injuries.  Inaddition, many of our non-surgical medical devices and related accessories areused by athletes and patients for injury prevention and at-home physicaltherapy treatment.  We currently develop,manufacture and distribute our products through the following three operatingsegments:

 

***Domestic Rehabilitation Segment***

 

We market ourdomestic rehabilitation segment products through the three divisions describedbelow.

 

·                  *DonJoy, ProCare and Aircast.*Our DonJoy,ProCare and Aircast division was acquired with the DJO Merger and offersproducts in the category of rigid knee bracing, orthopedic soft goods, coldtherapy products, and vascular systems. 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. *Our Empidivision offers products in the category of home electrotherapy, bone growthstimulation products, which were acquired with the DJO Merger, iontophoresis,and home traction.  This division alsoincludes our RME  and EmpiCare business.RME sells a wide range of proprietary and third party rehabilitation productsto physical therapists and chiropractors through a printed catalog and throughan on-line e-commerce site.  Through ourEmpiCare business, we maintain an inventory of soft goods and other products athealthcare facilities, primarily orthopedic practices, for immediatedistribution to patients.

 

·                  *Chattanooga. *OurChattanooga Group offers products in the clinical rehabilitation market in thecategory of clinical electrotherapy devices, clinical traction devices, andother clinical products and supplies such as treatment tables, CPM devices anddry heat therapy.

 

45

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***International Rehabilitation Segment***

 

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

 

·                  theinternational sales of our DonJoy, ProCare and Aircast products,

·                  ourOrmed business, which provides bracing, CPM, electrotherapy and other productsprimarily in Germany, and

·                  ourCefar-Compex business, which provides electrotherapy products for medical andconsumer markets and other physical therapy and rehabilitation productsprimarily in Europe.

 

***Surgical Implant Segment***

 

Our SurgicalImplant Segment develops, manufactures and markets a wide variety of knee, hipand shoulder implant products that serve the orthopedic reconstructive jointimplant market.

 

Our three operating segments enable us to reach adiverse customer base through multiple distribution channels and give us theopportunity to provide a wide range of orthopedic devices and related productsto orthopedic specialists operating in a variety of patient treatmentsettings.  These three segmentsconstitute our three reportable segments. See Note 11 to our audited consolidated financial statements for furtherinformation regarding our segments.

 

Set forth below is net revenue, gross profit andoperating income information for our reporting segments for the years ended December 31.This information excludes the impact of certain expenses not allocated tosegments, which are primarily comprised of general corporate expenses for allperiods presented. The segment information includes the impact ofpurchase accounting and related amortization of acquired intangible assetsrelated to our recent acquisitions and the Prior Transaction as described inNote 2 to our audited consolidated financial statements.  All prior periods presented have beenrestated to reflect our current reportable segments.

 
| **($ in thousands)**                                | ** ** | **2007** | ** ** | **Combined  (unaudited)  2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|---------------------------------|------------|----------|------------|
| **Domestic Rehabilitation:**                                  |       |     |       |                            |       |     |       |
| Net revenues                                                  |       | $        | 321,398    |                            | $          | 242,677  |       | $ | 201,163 |   |
| Gross profit                                                  |       | $        | 181,519    |                            | $          | 132,782  |       | $ | 113,906 |   |
| Gross profit margin                                           |       | 56.5     | %          | 54.7                            | %          | 56.6     | %          |
| Operating income (loss)                                       |       | $        | (8,255     | )                               | $          | (13,753  | )          | $ | 36,401 |   |
| Operating income (loss) as a percent of net segment  revenues |       | (2.6     | )%         | (5.7                            | )%         | 18.1     | %          |
| **International Rehabilitation:**                             |       |     |       |                            |       |     |       |
| Net revenues                                                  |       | $        | 104,145    |                            | $          | 60,514   |       | $ | 38,098 |   |
| Gross profit                                                  |       | $        | 57,714     |                            | $          | 34,445   |       | $ | 22,151 |   |
| Gross profit margin                                           |       | 55.4     | %          | 56.9                            | %          | 58.1     | %          |
| Operating income (loss)                                       |       | $        | 888        |                            | $          | (261     | )          | $ | 6,197 |   |
| Operating income (loss) as a percent of net segment  revenues |       | 0.9      | %          | (0.4                            | )%         | 16.3     | %          |
| **Surgical Implant:**                                         |       |     |       |                            |       |     |       |
| Net revenues                                                  |       | $        | 66,591     |                            | $          | 59,094   |       | $ | 54,465 |   |
| Gross profit                                                  |       | $        | 47,037     |                            | $          | 40,991   |       | $ | 42,296 |   |
| Gross profit margin                                           |       | 70.6     | %          | 69.4                            | %          | 77.7     | %          |
| Operating income (loss)                                       |       | $        | 2,322      |                            | $          | (7,236   | )          | $ | 10,708 |   |
| Operating income (loss) as a percent of net segment  revenues |       | 3.5      | %          | (12.2                           | )%         | 19.7     | %          |

 

**Recent Acquisitions, Dispositions and OtherTransactions**

 

***DJO Opco Holdings, Inc. Acquisition(DJO Merger)***

** **

On July 15, 2007, we entered into the DJO MergerAgreement with DJO Opco in a merger transaction pursuant to which DJO Opcobecame a wholly owned subsidiary of DJOFL, the entity filing this Annual Reporton Form 10-K.  The total purchase price for the DJO Merger, whichconsummated on November 20, 2007, was approximately $1.3 billion andconsisted of $1.2 billion paid to former equity holders (or $50.25 (the “pershare merger consideration”) in cash for each share of common stock of DJO Opcothey then held), $15.2 million related to the fair value of management rolloveroptions that were exchanged for options to purchase DJO common stock at theelection of DJO Opco management after the DJO 

 

46

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Merger, and $22.8 million in direct acquisitioncosts.  The DJO Merger was financed through a combination of equitycontributed by Blackstone, borrowings under the New Senior Secured CreditFacility, and proceeds from newly issued 10.875% Notes (see Note 2 for furtherinformation).

 

***The Prior Transaction***

** **

On November 3,2006, an affiliate of Blackstone acquired all of the outstanding shares ofcapital stock of ReAble in a merger transaction (the “Prior Transaction”).ReAble is the parent company of Holdings, DJOFL and Finco. DJOFL, directly orindirectly through its subsidiaries, owns all of the operating assets ofReAble. 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 and options to purchase shares of common stock of ReAble, $7.2million related to the fair value of options held by ReAble executives thatcontinued to remain as outstanding options to purchase ReAble common stockafter the Prior Transaction (the “Prior Transaction Management Rollover Options”),and $39.5 million in direct acquisition costs. The Prior Transaction wasfinanced through a combination of equity contributed by Blackstone, cash onhand of ReAble, borrowings under our prior senior secured credit facility (“OldSenior Secured Credit Facility”), and proceeds from the 11.75% Notes. Upon theclosing of the Prior Transaction, shares of ReAble’s common stock ceased to betraded on the NASDAQ Global Market.

 

The Prior Transaction was accounted for as a purchase under theguidance set forth in Statement of Financial Accounting Standards No. 141 “BusinessCombinations”.  In this Form 10-K,the consolidated statements of operations, changes in stockholders’ equity andcomprehensive income (loss), and cash flows are identified as relating toeither the Predecessor or the Successor, which include accounts and results forperiods preceding the Prior Transaction and periods succeeding the PriorTransaction, respectively.  We haveprepared our discussion of the results of operations by comparing themathematical combination, without making any pro forma adjustments, of theSuccessor and Predecessor periods, which have been consolidated in a materiallyconsistent manner, for the year ended December 31, 2006 to the year ended December 31,2007 and for the year ended December 31, 2005 to the year ended December 31,2006. Although this presentation does not comply with GAAP, we believe itprovides the most meaningful comparison of our results.  The Predecessor and Successor periods havebeen prepared using different bases of presentation due to the application ofpurchase accounting.  The combinedoperating results have not been prepared as pro forma results under applicableregulations, may not reflect the actual results we would have achieved absentthe Prior Transaction and the related transactions and may not be predictive offuture results of operations.   See Note2 to our audited consolidated financial statements for further informationregarding the Prior Transaction.

 

***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 existingrevolving credit facility.

 

***The Saunders Group***

** **

On July 2,2007, a subsidiary of DJOFL completed its purchase of substantially all of theassets of The Saunders Group, Inc. (“Saunders”) for total cashconsideration of $40.9 million, including $0.9 million of acquisition costs(the “Saunders Acquisition”). Saunders is a supplier of rehabilitation productsto physical therapists, chiropractors, athletes, athletic trainers, physiciansand patients, with a specialty in patented traction devices, back supports, andequipment for neck and back disorders. The Saunders Acquisition was financedwith funds borrowed under our Old Senior Secured Credit Facility.

 

***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 the

 

47

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professional/medicaland consumer markets for electrical stimulation across Europe andinternationally while continuing to sell products under both the Cefar andCompex brands. The purchase price for Cefar of $27.1 million was comprised of$16.3 million in cash, issuance of shares of our common stock valued at $9.5million, and approximately $1.3 million in acquisition costs. The cash portionof the acquisition was funded with $10.0 million of term loan borrowings underthe Old Senior Secured Credit Facility and cash on hand.

 

***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 (see Note 13).  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.

 

***Osteoimplant Technology, Inc.***

** **

On February 2005, we acquired substantially all of the assets ofOTI, which added several knee and hip implant products to our Surgical ImplantSegment’s product offerings. The total purchase price for the OTI assetacquisition was approximately $15.7 million and was comprised of approximately$14.5 million payable in cash to OTI and $1.2 million in acquisition costs.

 

***Dispositions***

 

On June 30, 2006, we completed the sale ofour Slendertone product line (which we had acquired in the Compex Acquisition)for $2.4 million, plus the cost of inventory sold.

 

On August 8, 2005, we completed the sale ofour soft goods product line to a subsidiary of DJO Opco for a cash payment ofapproximately $9.5 million, resulting in a gain of $2.4 million.  We re-acquired this product line inconnection with the DJO Merger.

 

For accounting purposes, the gain on sale from thedisposition of our soft goods product line and the operating results of oursoft goods product line and Slendertone prior to their disposition have beenclassified as discontinued operations in our consolidated statements ofoperations for all historical periods presented in this annual report on Form 10-K.

 

48

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**Results of Operations**

 

For the year ended December 31, 2006, we have combined thePredecessor period and the Successor period and presented the unaudited resultsof operations on a combined basis for comparative purposes.  The following table sets forth our statementsof operations as a percentage of sales for the periods indicated:

 
| ** **                                                                           | ** ** | **Successor**                                    | ** ** | **Combined  (unaudited)**                        | ** ** | **Predecessor**                                  | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| **($ in thousands)**                                                       | ** ** | **Year Ended  December 31, 2007** | ** ** | **Year Ended  December 31, 2006** | ** ** | **Year Ended  December 31, 2005** | ** ** |
| Net sales                                                                            |       | $                                                | 492,134    |                                             | 100.0      | %                                                | $          | 362,285 |   | 100.0 | % | $ | 293,726 |   | 100.0 | % |
| Cost of sales                                                                        |       | 205,864                                          |       | 41.8                                             |       | 154,067                                          |       | 42.5 |   | 115,373 |   | 39.3 |   |
| Gross profit                                                                         |       | 286,270                                          |       | 58.2                                             |       | 208,218                                          |       | 57.5 |   | 178,353 |   | 60.7 |   |
| Operating expenses:                                                                  |       |                                             |       |                                             |       |                                             |       |   |   |   |   |   |   |
| Selling, general and administrative                                                  |       | 271,163                                          |       | 55.1                                             |       | 220,263                                          |       | 60.8 |   | 120,036 |   | 40.8 |   |
| Research and development                                                             |       | 21,047                                           |       | 4.3                                              |       | 42,900                                           |       | 11.8 |   | 9,577 |   | 3.3 |   |
| Amortization of acquired intangibles                                                 |       | 33,496                                           |       | 6.8                                              |       | 10,000                                           |       | 2.8 |   | 5,053 |   | 1.7 |   |
| Operating income (loss).                                                             |       | (39,436                                          | )          | (8.0                                             | )          | (64,945                                          | )          | (17.9 | ) | 43,687 |   | 14.9 |   |
| Other income (expense):                                                              |       |                                             |       |                                             |       |                                             |       |   |   |   |   |   |   |
| Interest income                                                                      |       | 1,132                                            |       | 0.2                                              |       | 839                                              |       | 0.2 |   | 393 |   | 0.1 |   |
| Interest expense                                                                     |       | (72,409                                          | )          | (14.7                                            | )          | (34,619                                          | )          | (9.5 | ) | (28,509 | ) | (9.7 | ) |
| Other income (expense), net                                                          |       | 742                                              |       | 0.2                                              |       | 110                                              |       | — |   | (23 | ) | — |   |
| Loss on early extinguishment of debt                                                 |       | (14,539                                          | )          | (3.0                                             | )          | (9,154                                           | )          | (2.5 | ) | — |   | — |   |
| Income (loss) from continuing operations  before income taxes and minority interests |       | (124,510                                         | )          | (25.3                                            | )          | (107,769                                         | )          | (29.7 | ) | 15,548 |   | 5.3 |   |
| Provision  (benefit) for income taxes.                                               |       | (42,503                                          | )          | (8.6                                             | )          | (20,208                                          | )          | (5.6 | ) | 6,061 |   | 2.1 |   |
| Minority interests                                                                   |       | 415                                              |       | —                                           |       | 197                                              |       | 0.1 |   | 140 |   | — |   |
| Income (loss) from continuing operations                                             |       | (82,422                                          | )          | (16.7                                            | )          | (87,758                                          | )          | (24.2 | ) | 9,347 |   | 3.2 |   |
| Discontinued operations:                                                             |       |                                             |       |                                             |       |                                             |       |   |   |   |   |   |   |
| Gain on disposal of discontinued  operations, net of tax                             |       | —                                           |       | —                                           |       | —                                           |       | — |   | 2,445 |   | 0.8 |   |
| Income (loss) from discontinued operations,  net of tax                              |       | —                                           |       | —                                           |       | (652                                             | )          | (0.2 | ) | 538 |   | 0.2 |   |
| Net income (loss)                                                                    |       | $                                                | (82,422    | )                                                | (16.7      | )%                                               | $          | (88,410 | ) | (24.4 | )% | $ | 12,330 |   | 4.2 | % |

##### *** ***

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

##### *** ***

*Net Sales. *Our net sales forthe year ended December 31, 2007 were $492.1 million,representing an increase of 35.8% over net sales of $362.3 million in 2006 (combinedbasis), driven by acquisitions and continued growth in our DomesticRehabilitation, International Rehabilitation and Surgical ImplantSegments.  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 27.0% of our netsales from customers outside the United States as compared to 23.9% 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.

 

Thefollowing table sets forth sales for our three reportable segments.  The 2007 sales data includes $54.2 millionand $2.9 million in the Domestic Rehabilitation Segment as a result of the DJOMerger and the IOMED acquisition on November 20, 2007 and August 9,2007, respectively.  Also included areestimated sales of $17.5 million as a result of the Saunders acquisition on July 2,2007.  Included in the InternationalRehabilitation Segment 2006 sales data is $2.9 million as a result of the Cefaracquisition on November 7, 2006, while a full year of sales revenue for thisbusiness 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        |       | $                           | 321,398    |                             | 65.3       | %                                                  | $          | 242,677 |   | 67.0 | % | $ | 78,721 |   | 32.4 | % |
| International Rehabilitation   |       | 104,145                     |       | 21.2                             |       | 60,514                                             |       | 16.7 |   | 43,631 |   | 72.1 |   |
| Surgical Implant               |       | 66,591                      |       | 13.5                             |       | 59,094                                             |       | 16.3 |   | 7,497 |   | 12.7 |   |
| **Consolidated net revenues**  |       | $                           | 492,134    |                             | 100.0      | %                                                  | $          | 362,285 |   | 100.0 | % | $ | 129,849 |   | 35.8 | % |

##### *** ***

Net sales in our Domestic RehabilitationSegment were $321.4 million for 2007, representing an increase of 32.4% overnet sales of $242.7 million in 2006.  Theincrease in net sales in our Domestic Rehabilitation Segment in 2007 was 

 

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driven bycontinued 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.

 

Net sales in our InternationalRehabilitation Segment were $104.1 million for 2007, representing an increaseof 72.1% over net sales of $60.5 million in 2006.  The increase in net sales in ourInternational Rehabilitation Segment was principally driven by revenuesassociated with the Cefar acquisition, which contributed sales of $27.2 millionin 2007, compared to $2.9 million in 2006, and revenues associated with the DJOMerger which contributed sales of $12.1 in 2007.   In addition, net sales were positivelyimpacted during 2007 by approximately $7.3 million due to favorable changes inforeign exchange rates compared 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 werenegatively impacted on a comparative basis by reduced sales from our spineproduct line of $1.3 million.

 

Sales ofnew products for all segments, which have been on the market less than oneyear, accounted for $34.1 million in 2007, compared to $23.3 million in 2006.

 

*Gross Profit.*  Our consolidated gross profit as a percentageof net sales increased to 58.2% for 2007 compared to a gross profit of 57.5% in2006 and was negatively impacted by $13.9 million, as compared to $4.5million in the prior year, related to the write-up to fair market value ofinventory acquired in connection with recent acquisitions and the PriorTransaction.  Gross profit in ourDomestic Rehabilitation Segment increased to 56.5% of net sales in 2007 from54.7% in 2006.  Gross profit in 2006 wasimpacted by increased sales allowances related to revaluation of accountsreceivable acquired in the Compex acquisition. Gross profit in our International Rehabilitation Segment decreased to55.4% of net sales in 2007 from 56.9% 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 from OTI.

 

*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 whichwe do not believe are reflective of the ongoing operations of our business.  The following table sets forth theseexpenses incurred in connection with our recent acquisitions which we believeare directly 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 based compensation expense in 2006 includes costs incurredrelated to accelerated vesting of outstanding stock options of ReAble in connectionwith the Prior Transaction.  Managementretention bonuses 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 

 

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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.

 

*Research and Development.*Our research and development expense decreased to $21.0 million in 2007compared to $42.9 million in 2006. Excluding the impact of IPR&D costsincurred in the prior year of $3.9 million associated with the Compexacquisition and $25.2 million related to the Prior Transaction, and $3.0million of costs incurred in the current year associated with the DJO Merger,our research and development expense increased $4.2 million to $18.0 millionfor fiscal year 2007 as compared to $13.8 million during 2006 primarily due toexpenses incurred by the operations of our recent acquisitions.  As a percentage of net sales, research anddevelopment expense was 3.6% compared to 3.8% in the prior year (excluding theimpact 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 $72.4million in 2007 from $34.6 million in 2006. The increase in interest expense was principally driven by (1) theimpact of a full year of interest expense on debt associated with the Prior Transaction,which was completed on November 3, 2006, (2) incremental borrowingsof approximately $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 of Debt.*  Werecorded approximately $14.5 million of expense in 2007, compared to $9.2million of expense in 2006.  The expense in2007 includes $9.7 of unamortized debt issuance costs associated with the OldSenior Secured Credit Facility that was repaid in connection with the DJOMerger.  Also included is $4.8 million of expense due to thetermination of interest rate swaps and related refinancing activities inconnection with the DJO Merger.  Theexpense in 2006 is related to the recognition of unamortized debt issuance anddebt discount costs associated with the senior credit facility and 9.75% Notes that were repaid inconnection with the Prior Transaction.

 

*Provision (Benefit) for Income Taxes.*  In 2007, we recorded $42.5 million of incometax benefit on pre-tax loss of $(124.5) million.  For 2006, we recorded $20.2 million of incometax benefit on pre-tax loss of $107.8 million.

 

*Net Income (loss). *We had a net lossof $(82.4) million in 2007 compared to a net loss of $88.4 million in2006 based on the factors discussed above.

 

##### ***Year Ended December 31,2006 (Combined Basis) Compared to Year Ended December 31, 2005***

##### *** ***

*Net Sales. *Our net sales forthe year ended December 31, 2006 (combined basis) were $362.3 million,representing an increase of 23.3% over net sales of $293.7 million in 2005, drivenby acquisitions and continued growth in our Domestic Rehabilitation,International Rehabilitation and Surgical Implant Segments.  Sales in the Domestic Rehabilitation andInternational Rehabilitation Segments benefited from sales of products weacquired in the Compex and Cefar acquisitions, which were completed in February 2006and November 2006, respectively. For the year ended December 31, 2006, we generated 23.9% of our netsales from customers outside the United States as compared to 21.5% for theyear ended December 31, 2005.

 

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The following table sets forth sales for our three reportablesegments.  The amounts shown for theDomestic Rehabilitation Segment in 2006 include $43.5 million of estimatedsales related to products we acquired in the Compex acquisition on February 24,2006.  The amounts shown for theInternational Rehabilitation Segment in 2006 include $2.9 million of salesrelated to products we acquired in the Cefar acquisition.

 
| ** **                     | ** ** | **Years Ended**                                      | ** ** | ** **                       | ** ** | ** **                  | ** ** |
|--------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| **($ in thousands)** | ** ** | **Combined  Basis  December 31,  2006  (unaudited)** | ** ** | **% of Net  Revenues** | ** ** | **December 31,  2005** | ** ** | **% of Net  Revenues** | ** ** | **Increase** | ** ** | **% Increase** | ** ** |
| Domestic Rehabilitation        |       | $                                                         | 242,677    |                             | 67.0       | %                           | $          | 201,163 |   | 68.5 | % | $ | 41,514 |   | 20.6 | % |
| International Rehabilitation   |       | 60,514                                                    |       | 16.7                             |       | 38,098                      |       | 13.0 |   | 22,416 |   | 58.8 |   |
| Surgical Implant               |       | 59,094                                                    |       | 16.3                             |       | 54,465                      |       | 18.5 |   | 4,629 |   | 8.5 |   |
| **Consolidated net revenues**  |       | $                                                         | 362,285    |                             | 100.0      | %                           | $          | 293,726 |   | 100 | % | $ | 68,559 |   | 23.3 | % |

 

Net sales in our Domestic RehabilitationSegment were $242.7 million for 2006, representing an increase of 20.6% overnet sales of $201.2 million in 2005. The increase in net sales in our DomesticRehabilitation Segment was principally driven by revenues associated with theCompex acquisition, which increased sales in the segment’s electrotherapyproduct lines as well as increased sales in its traction and catalogue productlines. Partially offsetting the preceding are decreases in sales resulting fromthe impact of integration activities relating primarily to combining the Empiand Compex sales force and operations. In 2006, we completed several initiatives related to the integration ofthe Compex sales force, including integration of the Compex sales function ontothe information technology systems used by our Empi subsidiary, sales territoryrealignment, and redesigning of compensation and reporting structures and otheractivities related to positioning our sales force to operate efficiently on acombined basis.  We believe that theseintegration activities negatively impacted the Domestic RehabilitationSegments’ net sales in 2006.  Inaddition, in 2006, the Domestic Rehabilitation Segments’ net sales werenegatively impacted by a charge of $11.4 million related to accounts receivableacquired in the Compex acquisition. During the second quarter of 2006, additional information was obtainedregarding the Compex payor mix and its accounts receivable collection rates andtrends, which resulted in a change in our estimate of the value of the acquiredaccounts receivable and a $5.6 million charge to the reserve account. Inaddition, during December 2006, in conjunction with the completion of astrategic review and assessment of ongoing efforts to collect the remainingCompex accounts receivable, the decision was made to outsource the collectioneffort to a third party.  Based oncollection estimates provided by the third party collection company, in thefourth quarter of 2006, we recorded an additional adjustment to the carryingvalue of accounts receivable in the amount of $19.8 million, of which $5.8million was recorded as a reduction of net sales with the remainder recorded asa component of selling, general and administrative expense.

 

Net salesin our International Rehabilitation Segment were $60.5 millionfor 2006, representing an increase of 58.8% over net sales of $38.1 million in2005. The increase in net sales in our International Rehabilitation Segment wasprincipally driven by revenues associated with the Cefar and Compexacquisitions, which increased sales in the segment’s electrotherapy productlines as well as increased sales in its CPM and catalogue product lines.

 

Net sales in ourSurgical Implant Segment for 2006 were $59.1 million, representing an increaseof 8.5% over net sales of $54.5 million in 2005.  The increase in our Surgical ImplantSegment’s net sales in 2006 was driven primarily by growth in our shoulder andknee product lines.

 

Sales ofnew products for all segments, which have been on the market less than oneyear, accounted for $23.3 million in 2006, compared to $12.5 million in 2005.

 

*Gross Profit.*  Our consolidated gross profit as a percentageof net sales decreased to 57.5% for 2006 compared to a gross profit of 60.7% in2005.  Consolidated gross profitin 2006 was negatively impacted by $4.5 million of expense related to thewrite-up to fair market value of inventory in connection with the Compex andCefar acquisitions and the Prior Transaction. Gross profit for our Domestic Rehabilitation Segment decreased to 54.7%of net sales in 2006 from 56.6% in 2005. Gross profit on a consolidated basis and gross profit for the DomesticRehabilitation Segment were negatively impacted by $11.4 million of expense foradditional reserves related to accounts receivable acquired in the Compexacquisition (described above).  Grossprofit for our International Rehabilitation Segment decreased to 56.9% of netsales in 2006 from 58.1% in 2005.  Grossprofit for our Surgical Implant Segment decreased to 69.4% of net sales in 2006compared to a gross profit of 77.7% in 2005. The decrease in our Surgical Implant Segment’s gross profit was dueprimarily to a $1.5 million charge in 2006 for a discontinued product linerelated to our strategic review of inventory acquired in our February 2005acquisition of OTI.

 

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*Selling, General and Administrative.** *Our selling, general and administrativeexpenses increased to $220.3 million in 2006 compared to $120.0 million in2005. As a percentage of net sales, selling, general and administrative expenseincreased to 60.8% in 2006, compared to 40.9% in 2005, primarily due toadditional expenses associated with the addition of Compex and Cefar, highercommissions associated with increased sales, and higher expenses related toacquisition integration. Selling, general and administrative expenses during2006 were impacted by expenses related to the Prior Transaction and ourintegration activities in connection with our acquisitions of Compex and Cefar.We incurred $14.5 million of expenses in connection with the Prior Transaction,$1.2 million of severance expenses related to closure of Compex facilities inTampa, Florida and New Brighton, Minnesota, and $5.7 million of expensesrelated to our ongoing integration of our Compex and Cefar acquisitions.  In conjunction with the Prior Transaction, wealso incurred $5.5 million of expense associated with management bonuses and a$3.0 million monitoring fee paid to an affiliate of Blackstone for advisoryservices rendered from the closing date of the Prior Transaction to December 31,2006.  In addition, we recordedapproximately $10.5 million of employee stock-based compensation expense in2006 in connection with the implementation of Statement of FinancialAccounting Standards No. 123(R), “*Share-BasedPayment”*(“SFAS 123(R)”) as of January 1, 2006, compared with no suchexpense for the same period in 2005. Finally, during December, 2006, the decision was made to outsource thecollection effort related to the remaining Compex accounts receivable to athird party (described above). Based on collection estimates provided by thethird party collection company, an additional $19.8 million charge to thereserve account was taken in the fourth quarter of 2006, of which $14.0 millionrepresented a selling, general and administrative expense.

 

*Research and Development.*Our research and development expense increased to $42.9 million in 2006compared to $9.6 million in 2005. As a percentage of net sales, research anddevelopment expense increased to 11.8% compared to 3.2% in the prior year,primarily driven by IPR&D costs of $29.1 million, comprised of $3.9 millionof IPR&D costs associated with the Compex acquisition and $25.2 million ofIPR&D costs associated with the Prior Transaction, the addition of ongoingCompex and Cefar research and development costs, and higher product developmentcosts.

 

*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 $10.0 million in 2006 compared to $5.1 million in2005.

 

*Interest Expense. *Our interest expense increased to $34.6million in 2006 from $28.5 million in 2005. The comparative increase for 2006 over the prior year was principallydriven by higher variable interest rates on the floating rate portion of ouroutstanding indebtedness, increased borrowings to finance the Compex and Cefaracquisitions and increased borrowings to finance the Prior Transaction andrelated costs.

 

*Loss on Early Extinguishment of Debt.*  Werecorded $9.2 million of expense in 2006 related to the recognition ofunamortized debt issuance and debt discount costs associated with the seniorcredit facility that existed prior tothe Prior Transaction and the 9.75% Notes.

 

*Provision (Benefit) for Income Taxes.*  For 2006, we recorded $20.2 million of incometax benefit on pre-tax loss of $107.8 million, which is substantially lowerthan our statutory tax rate, due in part to the recording of $29.1 million ofIPR&D costs in 2006. The write-off of IPR&D is not deductible for taxpurposes.  In addition to the IPR&Dimpact, our effective tax rate was also negatively impacted by non-deductiblestock-based compensation, transaction costs, and other non-deductible expensesfor 2006.  For 2005, we recorded $6.1million of income tax expense on pre-tax income of $15.5 million.

 

*Discontinued Operations.*In 2006, we reported a loss of $0.7 million from discontinued operations, whichwas attributable to the Slendertone product assets we sold on June 30,2006.  For 2005, we reported income fromdiscontinued operations of approximately $0.5 million. We also reported a $2.4million gain from the disposition of our soft goods product line in 2005.

 

*Net Income (loss). *We had a net lossof $88.4 million in 2006 compared to net income of $12.3 million in 2005based on the factors discussed above.

 

## **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.

 

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## ** **

## **Liquidityand Capital Resources**

## ** **

***CashFlows***

 

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 for comparative purposes.

 

During the year ended December 31,2007, we used $28.8 million of cash for operating activities compared to theyear ended December 31, 2006, when our operating activities provided $0.8million in cash.  The net cash used foroperations in 2007 primarily reflects higher interest and integration costsincurred in connection with the Prior Transaction, the DJO Merger and our otherrecent acquisitions as well as an increase in net accounts receivable.  As required by SFAS No. 123(R), our cashflow provided by operating activities for the year ended December 31, 2007and 2006 is shown net of $0.4 million and $2.5 million, respectively, of excesstax benefits from stock options exercised, the amount deemed to be realized fortax purposes.  These excess tax benefitsare included in cash flows provided by financing activities for the years endedDecember 31, 2007 and 2006, respectively. Cash provided by operations in 2006 primarily reflects negativeoperating results offset by cash provided by the net change in operating assetsand liabilities.

 

Investing activities used $1,323.1 million of cash in2007, compared to $550.7 million in 2006.  Cash used during 2007 relates primarily to theDJO Merger and the acquisition of IOMED and Saunders, net of cash proceeds of$4.6 million during 2007 related to the sale of a building acquired inconnection with the acquisition of Compex and the sale of our former spineproduct line.  Cash used during 2006included $522.1 million in connection with the Prior Transaction and $13.0million (net of cash acquired) for the acquisition of Cefar.  Our acquisition of Compex during 2006 wasprimarily financed through the issuance of common stock.

 

Cash provided by financing activities in 2007 was$1,383.6 million and in 2006 was $562.7 million.  The cash provided during 2007 from financingactivities was primarily related to net borrowings under the New Senior SecuredCredit Facility of $1,052.4 million, proceeds from the issuance of 10.875%Notes of $575.0 million, and Blackstone’s $434.6 million equity investmentrelated to the DJO Merger.  These transactionswere offset by debt payments of $430.9 million and $271.5 million related tothe repayment of our Old Senior Secured Credit Facility and term loan acquiredin connection with the DJO Merger, respectively.  During 2007, we also paid $55.9 million ofdebt issuance costs related to financing for the DJO Merger and $1.2 millionfor the repurchase of Prior Transaction Management Rollover Options.  During 2006, cash from financing activitieswas primarily related to borrowings under our Old Senior Secured CreditFacility of $350.0 million, proceeds from the issuance of 11.75% Notes andBlackstone’s $357.0 million equity investment related to the PriorTransaction.  These transactions wereoffset by debt payments of $361.5 million and the payment of $20.8 million indebt issuance costs incurred in connection with the Old Senior Secured CreditFacility and 11.75% Notes.  During 2006we also received approximately $9.0 million in proceeds from stock optionexercises and $0.8 million in notes receivable payments.

 

## ***Indebtedness***

## ** **

                                                Asof December 31, 2007, we had outstanding approximately $1,832.8 million inaggregate indebtedness, and we had an additional $99.1 million of availableborrowings under our new revolving credit facility, net of $0.9 million used forletters of credit. We believe that our existing cash, plus the amounts weexpect to generate from operations and amounts available through our newrevolving credit facility, will be sufficient to meet our operating needs forthe next twelve months, including working capital requirements, capitalexpenditures, and debt repayment obligations. While we currently believe thatwe will be able to meet all of our financial covenants imposed by our NewSenior 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,waivers of default or amendments to the New Senior Credit Facility in thefuture.

 

We and our subsidiaries, affiliates orsignificant shareholders (including Blackstone and its affiliates) may fromtime to time, in our or their sole discretion, purchase, repay, redeem orretire any of our outstanding debt or equity securities (including any publiclyissued debt or equity securities), in privately negotiated or open markettransactions, by tender offer or otherwise.

 

*New Senior Secured Credit Facility*

 

*Overview. *The New Senior Secured Credit Facility providedsenior secured financing of $1,165.0 million, consisting of a $1,065.0 millionterm loan facility and a $100.0 million revolving credit facility.  Inaddition, we are permitted, subject to receipt of additional commitments fromparticipating lenders and certain other conditions, to incur up to anadditional $150.0 million of borrowings under the New Senior Secured CreditFacility.

 

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Historically,we have used derivative instruments to hedge portions of our exposure relatedto variable interest rates on our outstanding indebtedness.  On November 20, 2007, we entered into anew interest rate swap agreement for a notional amount of $515.0 million at afixed LIBOR rate of 4.205% expiring in 2009.

 

*Interest Rate and Fees.*  Borrowings under the New Senior SecuredCredit Facility bear interest at a rate equal to an applicable margin plus, atour option, either (a) a base rate determined by reference to the higherof (1) the prime rate of Credit Suisse and (2) the federal funds rateplus 0.50% or (b) the Eurodollar rate determined by reference to the costsof funds for deposits in the U.S. dollars for the interest period relevant toeach borrowing adjusted for required reserves. The initial applicable marginfor borrowings under the term loan facility and the revolving credit facilityis 2.00% with respect to base rate borrowings and 3.00% with respect toEurodollar borrowings. The applicable margin for borrowings under the term loanfacility and the revolving credit facility may be reduced subject to usattaining certain leverage ratios.

 

In addition to paying interest on outstanding principal under the NewSenior Secured Credit Facility, we are required to pay a commitment fee to thelenders under the revolving credit facility in respect of the unutilizedcommitments thereunder. The initial commitment fee rate is 0.50% per annum. Thecommitment fee rate may be reduced subject to us attaining certain leverageratios.  We must also pay customaryletter 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 NewSenior Secured Credit Facility, with the remaining amount payable at maturitywhich is six and one-half years from the date of the closing of the New SeniorSecured Credit Facility.  Principalamounts outstanding under the revolving credit facility are due and payable infull at maturity, which is six years from the date of the closing of the NewSenior Secured Credit Facility.

 

*Certain Covenants and Events of Default.*  The New Senior Secured Credit Facilitycontains a number of covenants that, among other things, restrict, subject tocertain exceptions, our and our subsidiaries’ ability to:

 

·                  incuradditional indebtedness;

 

·                  createliens on assets;

 

·                  changefiscal years;

 

·                  enterinto sale and leaseback transactions;

 

·                  engage inmergers or consolidations;

 

·                  sellassets;

 

·                  pay dividendsand make other restricted payments;

 

·                  makeinvestments, loans or advances;

 

·                  repaysubordinated indebtedness (including our Notes);

 

·                  makecertain acquisitions;

 

·                  engagein certain transactions with affiliates;

 

·                  restrictthe ability of restricted subsidiaries that are not Guarantors to pay dividendsor make distributions;

 

·                  amendmaterial agreements governing our subordinated indebtedness (including ourNotes); and

 

·                  changeour lines of business.

 

55

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Pursuant to the terms of the credit agreementrelating to the New Senior Credit Facility, we are required to maintain a ratioof consolidated senior debt to adjusted EBITDA (or senior leverage ratio)starting at a maximum of 5.1:1 and stepping down over time to 3.25:1 by the endof 2011.  Adjusted EBITDA representsEBITDA further adjusted for non-cash items, non-recurring items and otheradjustment items permitted in calculating covenant compliance under our NewSenior Secured Credit Facility and the Indentures (“Adjusted EBITDA”).  We are subject to these financial covenantsbeginning as of June 30, 2008.

 

*10.875% and 11.75% Senior Subordinated Notes*

 

The Indentures governing the$575.0 million principal amount of 10.875% Notes issued in connection with theDJO Merger and the $200.0 million principal amount of 11.75% Notes issued inconnection with the Prior Transaction limit our (and most or all of oursubsidiaries’) ability to:

 

·                  incur additional debt or issuecertain preferred shares;

 

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

 

·                  make certain investments;

 

·                  sell certain assets;

 

·                  create liens on certain assets tosecure debt;

 

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

 

·                  enter into certain transactions withour affiliates; and

 

·                  designate our subsidiaries asunrestricted subsidiaries.

 

Subject to certain exceptions, the Indentures permit us andour restricted subsidiaries to incur additional indebtedness, including securedindebtedness.

 

*Covenant Compliance*

 

As described above, our New Senior SecuredCredit Facility and the Indentures governing the Notes contain variouscovenants that limit our ability to engage in specified types oftransactions.  In addition, under our NewSenior Secured Credit Facility, we are required to satisfy and maintainspecified financial ratios, and under the Indentures, our ability to engage inactivities such as incurring additional indebtedness, making investments andpaying dividends is tied to ratios based on Adjusted EBITDA.

 

Adjusted EBITDA is defined as EBITDA further adjusted for non-cashitems, non-recurring items and other adjustment items permitted in calculatingcovenant compliance under our New Senior Secured Credit Facility andIndentures.  We believe that thepresentation of EBITDA and Adjusted EBITDA is appropriate to provide additionalinformation to investors about the calculation of, and compliance with, certainfinancial covenants in our New Senior Secured Credit Facility and theIndentures.  Adjusted EBITDA is amaterial component of these covenants. We also present EBITDA because we consider it an important supplementalmeasure of DJOFL’s performance and believe it is frequently used by securityanalysts, investors and other interested parties in the evaluation of highyield issuers, many of which present EBITDA when reporting their results.

 

EBITDA andAdjusted EBITDA are presented as supplemental measures of DJOFL’s performanceand are not required by, or presented in accordance with GAAP.  EBITDA and Adjusted EBITDA are notmeasurements of DJOFL’s performance under GAAP and should not be considered asalternatives to net income or other performance measures derived in accordancewith GAAP, or as an alternative to cash flow from operations as a measure ofDJOFL’s liquidity.  Adjusted EBITDA doesnot represent net loss or cash flow from operations as those terms are definedby GAAP and does not necessarily indicate whether cash flows will be sufficientto fund cash needs.  In particular, thedefinition of Adjusted EBITDA in the Indentures and our New Senior SecuredCredit Facility allows us to add back certain non-cash, extraordinary, unusualor non-recurring charges that are deducted in calculating net loss.  However, these are expenses that may recur,vary greatly and are difficult to predict. While Adjusted EBITDA and similarmeasures are frequently used as measures of operations and the ability to meetdebt service requirements, Adjusted EBITDA is not necessarily comparable toother similarly titled captions of other companies due to the potentialinconsistencies in the method of calculation.

 

Our ability to meet the covenants specified above in future periodswill depend on events beyond our control, and we cannot assure you that we willmeet those ratios.  A breach of any ofthese covenants in the future could result in a default under our New SeniorSecured Credit Facility and the Indentures, at which time the lenders couldelect to declare all amounts outstanding under our New Senior Secured CreditFacility to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.

 

56

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The following table provides a reconciliationfrom our net loss to EBITDA and Adjusted EBITDA for the twelve months ending December 31,2007.  The terms and related calculationsare defined in the credit agreement relating to our New Senior Secured CreditFacility and the Indentures.

 
| ** **                                                      | ** ** | **(unaudited)**                 | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                      | ** ** | **Year Ended**             | ** ** |
| **(in thousands)**                                         | ** ** | **December 31, 2007** | ** ** |
| Net loss                                                        |       | $                               | (82,422    | ) |
| Loss on  early extinguishment of debt and interest expense, net |       | 85,816                          |       |
| Income tax  benefit                                             |       | (42,503                         | )          |
| Depreciation  and amortization                                  |       | 48,240                          |       |
| EBITDA                                                          |       | $                               | 9,131      |   |
| Non-cash  items (a)                                             |       | 18,782                          |       |
| Non-recurring  items (b)                                        |       | 39,554                          |       |
| Other  adjustment items (c)                                     |       | 183,333                         |       |
| Adjusted  EBITDA                                                |       | $                               | 250,800    |   |

 

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

 
| ** **                           | ** ** | **(unaudited)**                 | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Year Ended**             | ** ** |
| **(in thousands)**              | ** ** | **December 31, 2007** | ** ** |
| Stock  compensation expense          |       | $                               | 1,541      |   |
| Loss on  disposition of assets       |       | 238                             |       |
| Purchase  accounting adjustments (1) |       | 17,003                          |       |
| Total non-cash items                 |       | $                               | 18,782     |   |

 

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(1)          Includes $4.7 million, $0.6 million, $1.5million, $0.2 million, $2.2 million and $4.8 million of expense related to thewrite-up to fair market value of acquired inventory in connection with the DJOMerger and the IOMED, Saunders, PMI and Cefar acquisitions and the PriorTransaction, respectively.  Also includedis $3.0 million of expense related to the write-off of IPR&D in connectionwith the DJO Merger.

 

(b)      Non-recurring items are comprised of thefollowing:

 
| ** **                             | ** ** | **(unaudited)**                 | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Year Ended**             | ** ** |
| **(in thousands)**                | ** ** | **December 31, 2007** | ** ** |
| Employee  severance and relocation (1) |       | $                               | 16,372     |   |
| Restructuring  expense (2)             |       | 10,917                          |       |
| Reserve  methodology change (3)        |       | 12,997                          |       |
| Other (4)                              |       | (732                            | )          |
| Total non-recurring adjustments        |       | $                               | 39,554     |   |

 

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(1)          Includes severance payments to former ReAbleexecutives in the amount of $13.3 million and $0.7 million related to otherseverance related items and employee relocation.  Also included is $0.7 million, $1.3 million,$0.2 million and $0.2 million of employee severance incurred in connection withthe DJO Merger, the IOMED, Saunders, and Compex acquisitions, respectively.

 

(2)          Restructuring expense includes $0.4 million,$0.5 million, $2.6 million, $0.6 million, $3.3 million, and $1.3 million ofintegration costs incurred in connection with the DJO Merger and the IOMED,Saunders, PMI, Cefar and Compex acquisitions, respectively.  Also included is $2.2 million of integrationcosts related to the Prior Transaction.

 

(3)          Includes $9.8 million related to additionalallowances for doubtful accounts receivable acquired in connection with the DJOMerger due to anticipated integration related collection issues, $1.1 millionrelated to the revaluation of inventory acquired in connection with the DJOMerger, and $2.1 million related to additional allowance for doubtful accountsdue to a change in an accounting reserve methodology in connection with the DJOMerger.

 

(4)          Includes fluctuations in foreign currency.

 

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(c)       Other adjustment items are comprised of thefollowing:

 
| ** **                  | ** ** | **(unaudited)**                 | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **Year Ended**             | ** ** |
| **(in thousands)**     | ** ** | **December 31, 2007** | ** ** |
| Transaction  expenses (1)   |       | $                               | 9,712      |   |
| Minority  interest          |       | 415                             |       |
| Pre-acquisition  EBITDA (2) |       | 106,561                         |       |
| Discontinued  operations    |       | (28                             | )          |
| Subtotal other items        |       | 116,660                         |       |
| Cost savings  (3)           |       | 66,673                          |       |
| Total other items           |       | $                               | 183,333    |   |

 

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(1)          Includes $4.8 million of transaction costsincurred in connection with the DJO Merger, including $0.5 million of retentionbonus expense, $3.0 million for monitoring fees paid to Blackstone, $0.2 millionfor escrow expenses related to the Endeavor acquisition, $1.1 million relatedto the Prior Transaction, $0.2 million in connection with the IOMED andSaunders acquisitions, and $0.4 million related to other merger and acquisitionactivities.

 

(2)          Represents pre-acquisition Adjusted EBITDA of(i) $103.8 million from January 1, 2007 to November 19, 2007 forthe DJO Merger, (ii) $0.4 million from January 1, 2007 to August 9,2007 for the IOMED acquisition, (iii) $2.3 million from January 1,2007 to July 2, 2007 for the Saunders acquisition, and (iv) $0.1million from January 1, 2007 to April 13, 2007 for the EndeavorMedical Inc. (“Endeavor”) acquisition, which are all included in thecalculation of Adjusted EBITDA for the year ended December 31, 2007 pursuantto the definition of Adjusted EBITDA contained in the credit agreement relatingto the New Senior Secured Credit Facility and the Indentures.

 

(3)          Includes projected cost savings of (i) $50.6million related to headcount reductions, facilities consolidation andproduction efficiencies in relation to the DJO Merger, (ii) $6.3 millionrelated to headcount reductions and production efficiencies in relation to theIomed and Saunders acquisitions, (iii) $3.3 million related to facilityand general administrative consolidation in relation to the Cefar acquisition,and (iv) $6.5 million principally from vertical integration andprocurement savings related to purchases of certain product components.

 

Our covenant requirements and pro forma ratios for the year ended December 31,2007 are as follows:

 
| ** **                                                                                                       | ** ** | **Covenant  Requirements** | ** ** | **Actual Ratios** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| **New Senior Credit Facility (1)**                                                                               |       |                       |       |                   |       |
| Consolidated net senior debt to Adjusted  EBITDA                                                                 |       | *                          |       | 4.01:1                 |       |
| **10.875% Notes**                                                                                                |       |                       |       |                   |       |
| Minimum ratio of Adjusted EBITDA to fixed  charges required to incur additional debt pursuant to ratio provision |       | 2.00:1                     |       | 1.58:1                 |       |
| **11.75% Notes**                                                                                                 |       |                       |       |                   |       |
| Minimum ratio of Adjusted EBITDA to fixed  charges required to incur additional debt pursuant to ratio provision |       | 2.00:1                     |       | 1.58:1                 |       |

 

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*      Nocovenant requirement as of December 31, 2007. This covenant requirement willbegin for the quarter ended June 28, 2008.

 

(1)         Beginningwith the twelve months ending June 30, 2008, the New Senior Secured CreditFacility requires us to maintain a consolidated net senior debt to AdjustedEBITDA ratio starting at a maximum of 5.10:1 and stepping down over time to3.25:1 by the end of 2011.  Consolidated seniordebt is defined as aggregate consolidated secured indebtedness of Holdings,DJOFL and the restricted subsidiaries less the aggregate amount of all cash andcash equivalents, free and clear of all liens subject to certain exceptions.

 

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Under the Indentures governing our Notes, our ability to incuradditional debt, subject to specified exceptions, is tied to improving ourAdjusted EBITDA to fixed charges ratio or having a ratio of at least 2.00:1, ona pro forma basis after giving effect to such incurrence.  Additionally, our ability to make certainrestricted payments is also tied to having an Adjusted EBITDA to fixed chargeratio of at least 2.00:1 on a pro forma basis. Our ratio of Adjusted EBITDA to fixed charges for the year ended December 31,2007, measured on that date, would have been 1.58:1.  Notwithstanding these limitations, theaggregate amount of term loan increases and revolving commitment increasesshall not exceed the greater of (i) $150.0 million and (ii) theadditional aggregate amount of secured indebtedness which would be permitted tobe incurred as of any date of determination (assuming for this purpose that thefull amount of any revolving credit increase had been utilized as of such date)such that, after giving pro forma effect to such incurrence (and any othertransactions consummated on such date), the senior secured leverage ratio forthe immediately preceding test period would not be greater than 4.0 to1.0.  Fixed charges is defined in theIndentures as consolidated interest expense plus all cash dividends or otherdistributions paid on any series of preferred stock of any restrictedsubsidiary and all dividends or other distributions accrued on any series ofdisqualified stock.

 

## **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 31,2007 (in thousands):

 
| ** **                  | ** ** | **Payment due by period** | ** ** |
|-----------------------------|------------|------------------------------------------|------------|
| ** **                  | ** ** | **Total**                                | ** ** | **<1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **>5 years** | ** ** |
| Long-term debt obligations  |       | $                                        | 1,832,222  |   | $ | 13,922 |   | $ | 18,860 |   | $ | 18,168 |   | $ | 1,781,272 |   |
| Interest payments (a)       |       | 1,053,357                                |       | 165,154 |   | 329,065 |   | 325,060 |   | 234,078 |   |
| Capital lease obligations   |       | 585                                      |       | 287 |   | 296 |   | 2 |   | — |   |
| Operating lease obligations |       | 74,004                                   |       | 10,205 |   | 16,925 |   | 12,227 |   | 34,647 |   |
| Purchase obligations        |       | 127,619                                  |       | 38,020 |   | 26,599 |   | 14,000 |   | 49,000 |   |
| Total                       |       | $                                        | 3,087,787  |   | $ | 227,588 |   | $ | 391,745 |   | $ | 369,457 |   | $ | 2,098,997 |   |

 

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(a)          $775.0 million principal amount of long-term debt is subject tofixed interest rates and $1,065.0 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 7.83%interest rate which is the effective interest rate for the term loans under theNew Senior Secured Credit Facility at December 31, 2007.  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, 2007, we had entered into purchase commitmentsfor inventory, capital acquisitions and other services totaling approximately$127.6 million in the ordinary course of business.  The purchase obligations shown above include$9.5 million committed in each of 2008 and 2009 to purchase certain suppliesfrom a Minnesota corporation related to our electrotherapy products.  In addition, we are obligated to purchase$7.3 million in 2008 and $3.1 million in 2009 from Medireha, which is 50% ownedby us, under a distribution agreement granting us exclusive rights to thedistribution of products that Medireha manufactures through 2009, theexpiration date of our agreement.  Inaddition, under the amended transaction and monitoring fee agreement enteredinto in connection with the DJO Merger, DJOhas an obligation to pay a $7.0 million annual monitoring fee to BMP through2019. See Item 13. “Certain Relationships and Related Transactions and DirectorIndependence” for more a more detailed description of the amended agreement.

 

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. In addition, due to the uncertainty with respect to the timing of futurecash flows associated with our unrecognized tax benefits at December 31,2007, we are unable to make reasonably reliable estimates of the period of cashsettlement with the respective taxing authority.  Therefore, $3.4 million of unrecognized taxbenefits have been excluded from the contractual obligations table above.  See Note 12 in our audited consolidatedfinancial statements included in this Annual Report on Form 10-K for adiscussion on income taxes.

 

## **CriticalAccounting Policies and Estimates**

## ** **

Our management’s discussion and analysis offinancial condition and results of operations is based upon our financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires us to make estimates and judgments that affect the reported

 

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amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, we evaluate our estimates, including those related to reservesfor contractual allowances, doubtful accounts, rebates, product returns andrental credits, goodwill and intangible assets, deferred tax assets and liabilities,and inventory. We base our estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources. To the extent that actual events differ from our estimates andassumptions, there could be a material impact on our financial statements.

 

We believe thefollowing critical accounting policies affect our more significant judgmentsand estimates used in the preparation of our audited consolidated financialstatements and this discussion and analysis of our financial condition andresults of operations:

 

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

 

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 these reserves.

 

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 report these allowances as reductions in 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, which callfor specified reductions in reimbursement of billed amounts based uponcontractual reimbursement rates. For 2007 and 2006, we reserved for and reducedgross revenues from third party payors by 30% in each year, for estimatedallowances related to these contractual reductions.  Our reserve levels during 2007 were impactedby charges recorded in anticipation of integration related collection issuesrelated to accounts receivable acquired in connection with the DJO Merger.

 

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. Direct-billed customers represented approximately 65% of our netrevenues for the year ended December 31, 2007 and approximately 62% of ournet accounts receivable at December 31, 2007. We have historicallyexperienced write-offs of less than 3% of related net revenues and, for 2007,such write-offs were less than 2%. Our third party reimbursement customersincluding insurance companies, managed care companies and certain governmentalpayors, such as Medicare, include all of our OfficeCare customers, most of ourEmpi customers, and certain other customers of our Domestic RehabilitationSegment. Our third party payor customers represented approximately 35% of ournet revenues for the year ended December 31, 2007 and 38% of our netaccounts receivable at December 31, 2006. For 2007, we estimate bad debtexpense to be approximately 7% of gross revenues from these third partyreimbursement 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 reflected as selling, general andadministrative expense.

 

Our reservefor rebates 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.

 

Our reservefor product returns accounts for estimated customer returns of our productsafter purchase. These returns are mainly attributable to a third party payor’srefusal to provide reimbursement for the product or the inability of theproduct to adequately address the patient’s condition. We provide for thisreserve by reducing gross revenue based on our historical rate of returns.

 

Our reservefor rental credit recognizes a timing difference between billing for a sale andprocessing a rental credit associated with some of our rehabilitation devices.Many insurance providers require patients to rent our rehabilitation devicesfor a period of one to three months prior to purchase. If the patient has along-term need for the device, these insurance companies may authorize purchaseof the device after such time period. When the device is purchased, mostproviders require that rental payments previously made on the device becredited toward the purchase price. These credits are processed at the time thepayment is received for the purchase of the device, which creates a time lag betweenbilling for a sale and processing the rental credit. Our rental credit reserveestimates unprocessed rental credits based on the number of devices convertedto purchase. The reserve is calculated by first assessing the number of ourproducts being rented during the 

 

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relevantperiod and our historical conversion rate of rentals to sales, and thenreducing our revenue by the applicable amount. We provide for these reserves by reducing our gross revenue.  The cost to refurbish rented products isexpensed as incurred as part of cost of sales.

 

***Inventory Reserves***

*** ***

We providereserves for estimated excess and obsolete inventories equal to the differencebetween the cost of inventories on hand plus future purchase commitments andthe estimated market value based upon assumptions about future demand.  If future demand is less favorable thancurrently projected by management, additional inventory write-downs may be required.  We also provide reserves for newer productinventories, as appropriate, based on any minimum purchase commitments and ourlevel of sales of the new products.

 

We consign a portion of our inventory to allow our products to beimmediately dispensed to patients.  Thisrequires a large amount of inventory to be on hand for the products we sellthrough consignment arrangements.  Italso increases the sensitivity of these products to obsolescence reserveestimates. As this inventory is not in our possession, we maintain additionalreserves for estimated shrinkage of these inventories based on the results ofperiodic inventory counts and historical trends.

 

## ***Goodwill and Intangible Assets***

## ** **

In accordance with Statement of Financial Accounting Standards No. 142,or SFAS No. 142, “*Goodwill and Other IntangibleAssets,”* we do not amortize goodwill.  In lieu of amortization, we are required toperform an annual review for impairment. Goodwill is considered to be impaired if we determine that the carryingvalue of the segment or reporting unit exceeds its fair value.  At September 29, 2007, our goodwill wasevaluated for impairment and we determined that no impairment existed at thatdate.

 

At September 29, 2007, other intangibles were evaluated forimpairment as required by SFAS No. 144, *Accountingfor Impairment or Disposal of Long-Lived Assets*.  The determination of the fair value ofcertain acquired assets and liabilities is subjective in nature and ofteninvolves the use of significant estimates and assumptions.  Determining the fair values and useful livesof intangible assets requires the exercise of judgment.  Upon initially recording certain of our otherintangible assets, we used independent valuation firms to assist us indetermining the appropriate values for these assets.  Subsequently, we have used the samemethodology and updated our assumptions. While there are a number of different generally accepted valuationmethods to estimate the value of intangible assets acquired, we primarily usedthe undiscounted cash flows expected to result from the use of these assets.  This method requires significant managementjudgment to forecast the future operating results used in the analysis.  In addition, other significant estimates arerequired such as residual growth rate and discount factors.  The estimates we have used are consistentwith the plans and estimates that we use to manage our business and are basedon available historical information and industry averages.

 

## ***Deferred Tax Asset Valuation Allowance***

## ** **

We recognize deferred tax assets and liabilities based on thedifferences between the financial statement carrying amount and the tax basesof assets, liabilities and net operating loss carry forwards.  We establish valuation allowances when therecovery of a deferred tax asset is not likely based on historical income,projected future income, the expected timing of the reversals of temporarydifferences and the implementation of tax-planning strategies.

 

Our gross deferred tax asset balance was approximately $142.4 millionat December 31, 2007 and primarily related to reserves for accountsreceivable and inventory, accrued expenses, and net operating losscarryforwards (see Note 12).  As of December 31,2007, we recorded a valuation allowance of $16.5 million due to uncertaintiesrelated to our ability to realize certain net operating loss carryforwardsacquired in connection with the IOMED, Empi and Compex acquisitions and thePrior Transaction.

 

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

## ** **

 We are exposed to certain marketrisks as part of our ongoing business operations, primarily risks from changinginterest rates and foreign currency exchange rates that could impact ourfinancial condition, results of operations, and cash flows.

 

***InterestRate Risk***

 

Our primary exposure is to changing interest rates. We havehistorically managed our interest rate risk by balancing the amounts of ourfixed and variable debt. For our fixed rate debt, interest rate changes mayaffect the market value of the debt, but do not impact our earnings or cashflow.  Conversely, for our variable ratedebt, interest rate changes generally do not affect the fair market value ofthe debt, but do impact future earnings and cash flow, assuming other factorsare held constant. We are exposed to interest rate risk as a result of ourborrowings under our New Senior Secured Credit Facility, which bear interest atfloating rates based on a eurodollar rate (“LIBOR”) or the prime rate of CreditSuisse.  As of December 31, 2007, wehad $1,065.0 million of borrowings under our New Senior Secured CreditFacility.  On November 20, 2007, weentered into a new interest rate swap agreement related to the New Senior SecuredCredit Facility for a notional amount of $515.0 million at a fixed LIBOR rateof 4.205% amortizing through an expiration date of 2009.  A hypothetical 1% increase in variableinterest rates for the remaining portion of the New Senior Secured Credit Facilitynot covered by the swap would have impacted our earnings and cash flow, for theyear ended December 31, 2007, by approximately $5.5 million.  All of our other debt of approximately $775.0million was fixed rate debt at December 31, 2007.  We may use additional derivative financialinstruments where appropriate to manage our interest rate risk.  However, as a matter of policy, we do notenter into derivative or other financial investments for trading or speculativepurposes.

 

***ForeignCurrency Risk***

 

Due to the global reachof our business, we are exposed to market risk from changes in foreign currencyexchange rates, particularly with respect to the U.S. dollar compared to theEuro and the Mexican Peso. Our wholly owned foreign subsidiaries are consolidatedinto our financial results and are subject to risks typical of an internationalbusiness including, but not limited to, differing economic conditions, changesin political climate, differing tax structures, other regulations andrestrictions and foreign exchange volatility. To date, DJO has not used international currency derivatives to hedgeagainst its investment in its European subsidiaries or their operating results,which are converted into U.S. Dollars at period-end and average rates,respectively. However, as we continue to expand our business throughacquisitions and organic growth, the sales of our products that are denominatedin foreign currencies has increased as well as the costs associated with ourforeign subsidiaries which operate in currencies other than the U.S.dollar.  Our Mexico-based manufacturingoperations incur costs that are largely denominated in Mexican Pesos.Accordingly, our future results could be materially impacted by changes in foreignexchange rates or other factors. Occasionally, we seek to reduce the potentialimpact of currency fluctuations on our business through hedgingtransactions.  As of December 31,2007, DJO had outstanding hedges in the form of forward contracts to purchaseMexican Pesos aggregating a U.S. dollar equivalent of $10.7 million.

 

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## ** **

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

## ** **

### **DJO Finance LLC**

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

### **For the year endedDecember 31, 2007**

### ** **

**INDEX TOAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

** **
| ** **                                                                                                                                                                                                                     | **Page No.** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------|
| Consolidated Financial Statements:                                                                                                                                                                                             |              |
| Report of Independent  Registered Public Accounting Firm – Ernst & Young LLP                                                                                                                                     | 64                |
| Report of Independent  Registered Public Accounting Firm – KPMG LLP                                                                                                                                                       | 65                |
| Consolidated Balance Sheets at  December 31, 2007 and 2006                                                                                                                                                                | 66                |
| Consolidated Statements of  Operations for the Successor Year Ended December 31, 2007 and for the  Period November 4, 2006 through December 31, 2006                                                            | 67                |
| Consolidated Statements of  Operations for the Predecessor Period January 1, 2006 through  November 3, 2006 and for the Year Ended December 31, 2005                                                            | 67                |
| Consolidated Statements of  Changes in Membership Equity and  Comprehensive Loss for the Successor Year Ended December 31, 2007  and for the Period November 4, 2006 through December 31, 2006                  | 68                |
| Consolidated Statements of  Changes in Stockholders’ Equity and Comprehensive Income (Loss) for the  Predecessor Period January 1, 2006 through November 3, 2006 and for  the Year Ended December 31, 2005 | 68                |
| Consolidated Statements of  Cash Flows for the Successor Year Ended December 31, 2007 and the Period  November 4, 2006 through December 31, 2006                                                                | 69                |
| Consolidated Statements of  Cash Flows for the Predecessor Period January 1, 2006 through  November 3, 2006, and for the Year Ended December 31, 2005                                                           | 69                |
| Notes to Consolidated Financial Statements                                                                                                                                                                                     | 70                |

 

63

----

** **

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

To the Board ofDirectors

DJO Finance LLC

 

We have audited the accompanying consolidated balancesheet of DJO Finance LLC and subsidiaries as of December 31, 2007 and therelated consolidated statements of operations, changes in membership equity andcomprehensive loss, and cash flows for the year then ended.  Our audit also included the financialstatement 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 audit.

 

We conducted our audit 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 audit 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 audit provides 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, 2007 and theconsolidated results of their operations and their cash flows for the year thenended, in conformity with U.S. generally accepted accounting principles.  Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.

 

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

 

 

San Diego,California

March 25,2008

 

64

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

To the Board ofDirectors

DJO Finance LLC

 

We have audited the accompanying consolidated balancesheet of DJO Finance LLC and subsidiaries (formerly ReAble Therapeutics FinanceLLC) (the “Successor”) as of December 31, 2006 and the relatedconsolidated statements of operations, changes in membership equity andcomprehensive loss, and cash flows for the period from November 4, 2006through December 31, 2006 and the consolidated statements of operations,changes in stockholders’ equity and comprehensive income (loss) and cash flowsof ReAble Therapeutics, Inc. (“RTI”) for the period January 1, 2006through November 3, 2006 and for the year ended December 31,2005.  In connection with our audit ofthe consolidated financial statements, we have also audited financial statementschedule II as it relates to 2006 and 2005. These consolidated financial statements and schedule are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial 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.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of the Successor as of December 31, 2006, and theresults of its operations and its cash flows for the period from November 4,2006 through December 31, 2006 in conformity with accounting principlesgenerally accepted in the United States of America.  Further, in our opinion, the consolidatedfinancial statements referred to above present fairly in all material respects,the results of operations and cash flows of RTI for the period from January 1,2006 through November 3, 2006 and for the year ended December 31,2005 in conformity with accounting principles generally accepted in the UnitedStates of America.  Also, in our opinion,the related financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly inall material respects the information set forth therein.

 

As discussed in Note 1 to the consolidated financialstatements, effective November 3, 2006, all of the outstanding stock ofRTI was acquired in a 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 than that for the periods before theacquisition and, therefore, is not comparable.

 

As discussed in Note 1 to the consolidated financialstatements, the Company adopted Statement of Financial Accounting Standards No. 123(R), *Share-Based Payment,* as of January 1,2006.

 

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

 

 

Austin, Texas

March 30,2007, except as to Note 11, which

     is as of March 25, 2008

 

65

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**DJOFinance LLC and Subsidiaries**

**Consolidated Balance Sheets**

### **(in thousands,except share and per share data)**

 
| ** **                                                    | ** ** | **December 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets**                                                    | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Current assets:                                               |       |                        |       |                        |       |
| Cash and cash equivalents                                     |       | $                           | 63,471     |                        | $          | 30,903 |   |
| Accounts receivable, net                                      |       | 154,767                     |       | 68,894                      |       |
| Inventories, net                                              |       | 110,904                     |       | 67,673                      |       |
| Deferred tax assets, net                                      |       | 28,999                      |       | 25,734                      |       |
| Prepaid expenses and other current assets                     |       | 17,319                      |       | 11,607                      |       |
| Total current assets                                          |       | 375,460                     |       | 204,811                     |       |
| Property and equipment, net                                   |       | 81,645                      |       | 41,251                      |       |
| Goodwill                                                      |       | 1,201,282                   |       | 475,722                     |       |
| Intangible assets, net                                        |       | 1,360,361                   |       | 317,242                     |       |
| Other non-current assets                                      |       | 67,524                      |       | 21,610                      |       |
| Total assets                                                  |       | $                           | 3,086,272  |                        | $          | 1,060,636 |   |
|                                                          |       |                        |       |                        |       |
| **Liabilities, Minority Interests, and Membership  Equity**   | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Current liabilities:                                          |       |                        |       |                        |       |
| Accounts payable                                              |       | $                           | 43,576     |                        | $          | 18,895 |   |
| Accrued expenses                                              |       | 103,767                     |       | 37,979                      |       |
| Long-term debt and capital leases, current portion            |       | 14,209                      |       | 6,505                       |       |
| Total current liabilities                                     |       | 161,552                     |       | 63,379                      |       |
| Long-term debt and capital leases, net of current  portion    |       | 1,818,598                   |       | 548,037                     |       |
| Deferred tax liabilities, net                                 |       | 386,659                     |       | 111,232                     |       |
| Other non-current liabilities                                 |       | 13,260                      |       | 1,871                       |       |
| Total liabilities                                             |       | 2,380,069                   |       | 724,519                     |       |
|                                                          |       |                        |       |                        |       |
| Minority  interests                                           |       | 1,215                       |       | 909                         |       |
|                                                          |       |                        |       |                        |       |
| Commitments and contingencies                                 |       |                        |       |                        |       |
|                                                          |       |                        |       |                        |       |
| Membership equity:                                            |       |                        |       |                        |       |
| Additional paid-in capital                                    |       | 822,854                     |       | 373,469                     |       |
| Accumulated deficit                                           |       | (124,056                    | )          | (41,634                     | )          |
| Accumulated other comprehensive income                        |       | 6,190                       |       | 3,373                       |       |
| Total membership equity                                       |       | 704,988                     |       | 335,208                     |       |
| Total liabilities, minority interests, and  membership equity |       | $                           | 3,086,272  |                        | $          | 1,060,636 |   |

 

See accompanyingnotes to consolidated financial statements.

 

66

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**DJOFinance LLC and Subsidiaries**

**Consolidated Statements of Operations**

**(inthousands)**

** **
| ** **                                                                                                                       | ** ** | **Successor**                         | ** ** | **Predecessor**                                           | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                                       | ** ** | **Year Ended December 31, 2007** | ** ** | **November 4, 2006 through  December 31, 2006** | ** ** | **January 1, 2006 through  November 3, 2006** | ** ** | **Year Ended December 31, 2005** | ** ** |
| Net sales                                                                                                                        |       | $                                     | 492,134    |                                                      | $          | 57,902 |   | $ | 304,383 |   | $ | 293,726 |   |
| Cost of sales                                                                                                                    |       | 205,864                               |       | 26,787                                                    |       | 127,280 |   | 115,373 |   |
| Gross profit                                                                                                                     |       | 286,270                               |       | 31,115                                                    |       | 177,103 |   | 178,353 |   |
| Operating expenses:                                                                                                              |       |                                  |       |                                                      |       |   |   |   |   |
| Selling, general and administrative                                                                                              |       | 271,163                               |       | 41,099                                                    |       | 179,164 |   | 120,036 |   |
| Research and development                                                                                                         |       | 21,047                                |       | 28,128                                                    |       | 14,772 |   | 9,577 |   |
| Amortization of acquired intangibles                                                                                             |       | 33,496                                |       | 4,035                                                     |       | 5,965 |   | 5,053 |   |
| Operating income (loss)                                                                                                          |       | (39,436                               | )          | (42,147                                                   | )          | (22,798 | ) | 43,687 |   |
| Other income (expense):                                                                                                          |       |                                  |       |                                                      |       |   |   |   |   |
| Interest income                                                                                                                  |       | 1,132                                 |       | 312                                                       |       | 527 |   | 393 |   |
| Interest expense                                                                                                                 |       | (72,409                               | )          | (8,611                                                    | )          | (26,008 | ) | (28,509 | ) |
| Other income (expense), net                                                                                                      |       | 742                                   |       | 133                                                       |       | (23 | ) | (23 | ) |
| Loss on early extinguishment of debt                                                                                             |       | (14,539                               | )          | —                                                    |       | (9,154 | ) | — |   |
| Income (loss) from continuing operations  before income taxes and minority interests                                             |       | (124,510                              | )          | (50,313                                                   | )          | (57,456 | ) | 15,548 |   |
| Provision (benefit) for income taxes                                                                                             |       | (42,503                               | )          | (8,756                                                    | )          | (11,452 | ) | 6,061 |   |
| Minority interests                                                                                                               |       | 415                                   |       | 39                                                        |       | 158 |   | 140 |   |
| Income (loss) from continuing operations                                                                                         |       | (82,422                               | )          | (41,596                                                   | )          | (46,162 | ) | 9,347 |   |
| Discontinued operations:                                                                                                         |       |                                  |       |                                                      |       |   |   |   |   |
| Gain on disposal of discontinued operations  (net of income tax expense of $1,563 in 2005)                                       |       | —                                |       | —                                                    |       | — |   | 2,445 |   |
| Income (loss) from discontinued operations  (net of income tax provision (benefit) of $0, ($25), ($394) and $341,  respectively) |       | —                                |       | (38                                                       | )          | (614 | ) | 538 |   |
| Net income (loss)                                                                                                                |       | $                                     | (82,422    | )                                                         | $          | (41,634 | ) | $ | (46,776 | ) | $ | 12,330 |   |

 

See accompanying notes to consolidated financial statements.

 

67

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**DJOFinance LLC and Subsidiaries**

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

**(inthousands)**

 
| *** ***                                                                    | *** *** | **Successor**                      | *** *** | **Predecessor**  | ** ** | ** **                       | ** ** | ** **                                   | ** ** | ** **                     | ** ** |
|---------------------------------------------------------------------------------|--------------|------------------------------------|--------------|------------------|------------|----------------------------------|------------|----------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** **   | **Additional   Paid-In   Capital** | ** **   | **Common Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Notes  Received for Sale of Common Stock** | ** ** | **Cost of Repurchased  Stock** | ** ** | **Retained Earnings (Accumulated Deficit)** | ** ** | **Accumulated  Other Comprehensive  Income (Loss)** | ** ** | **Total Stockholders’ Equity and Membership  Equity** | ** ** |
| ** **                                                                      |         |                               |         | **Shares**       |       | **Amount**                       |       |                                         |       |                           |       | **Shares** |   | **Amount** |   |   |   |   |   |   |   |
| ***Predecessor:***                                                              |         |                               |         |             |       |                             |       |                                         |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| **Balance at December 31, 2004**                                           |         |                               |         | 20,777           |       | $                                | 21         |                                         | $          | 154,925                        |       | $ | (948 | ) | (204 | ) | $ | (1,647 | ) | $ | 3,576 |   | $ | 4,390 |   | $ | 160,317 |   |
| Net income                                                                      |         |                               |         | —           |       | —                           |       | —                                       |       | —                         |       | — |   | — |   | 12,330 |   | — |   | 12,330 |   |
| Foreign  currency translation adjustments                                       |         |                               |         | —           |       | —                           |       | —                                       |       | —                         |       | — |   | — |   | — |   | (6,781 | ) | (6,781 | ) |
| Change in  fair value of derivatives                                            |         |                               |         | —           |       | —                           |       | —                                       |       | —                         |       | — |   | — |   | — |   | 634 |   | 634 |   |
| Comprehensive income                                                            |         |                               |         | —           |       | —                           |       | —                                       |       | —                         |       | — |   | — |   | — |   | — |   | 6,183 |   |
| Equity awards                                                                   |         |                               |         | —           |       | —                           |       | 105                                          |       | —                         |       | — |   | — |   | — |   | — |   | 105 |   |
| Exercise  of common stock options                                               |         |                               |         | 64               |       | —                           |       | 355                                          |       | —                         |       | — |   | — |   | — |   | — |   | 355 |   |
| Tax  benefit associated with stock options                                      |         |                               |         | —           |       | —                           |       | 45                                           |       | —                         |       | — |   | — |   | — |   | — |   | 45 |   |
| Note  payments                                                                  |         |                               |         | —           |       | —                           |       | —                                       |       | 102                            |       | — |   | — |   | — |   | — |   | 102 |   |
| **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 |   |

 

See accompanying notes to consolidated financial statements.

 

68

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#  

# **DJOFinance LLC and Subsidiaries**

**Consolidated Statements of Cash Flows**

**(inthousands)**

 
| ** **                                                                                          | ** ** | **Successor**                          | ** ** | **Predecessor**                                             | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **Year Ended December 31,  2007** | ** ** | **November 4, 2006  through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** | **Year Ended December 31,  2005** | ** ** |
| **OPERATING ACTIVITIES:**                                                                           | ** ** | ** **                             | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                   |       | $                                      | (82,422    | )                                                           | $          | (41,634 | ) | $ | (46,776 | ) | $ | 12,330 |   |
| Adjustments to reconcile net income (loss) to net  cash (used in) provided by operating activities: |       |                                   |       |                                                        |       |   |   |   |   |
| Depreciation                                                                                        |       | 14,744                                 |       | 2,369                                                       |       | 8,839 |   | 8,696 |   |
| Amortization of intangibles                                                                         |       | 33,496                                 |       | 4,035                                                       |       | 5,965 |   | 5,053 |   |
| Amortization of debt issuance costs                                                                 |       | 4,862                                  |       | 654                                                         |       | 1,765 |   | 2,177 |   |
| Non-cash loss on early extinguishment of debt                                                       |       | 9,744                                  |       | —                                                      |       | 9,154 |   | — |   |
| Non-cash interest expense                                                                           |       | —                                 |       | —                                                      |       | 91 |   | 100 |   |
| Stock-based compensation                                                                            |       | 1,541                                  |       | 105                                                         |       | 10,631 |   | 160 |   |
| Asset impairments and loss on disposal of assets                                                    |       | 682                                    |       | 1,228                                                       |       | 388 |   | 1,375 |   |
| Deferred income taxes                                                                               |       | (47,221                                | )          | (8,842                                                      | )          | (13,284 | ) | (2,930 | ) |
| Provision for doubtful accounts and sales returns                                                   |       | 22,428                                 |       | 513                                                         |       | 21,763 |   | 6,108 |   |
| Inventory reserves                                                                                  |       | 3,580                                  |       | 957                                                         |       | 7,563 |   | 4,810 |   |
| Minority interests                                                                                  |       | 415                                    |       | 39                                                          |       | 158 |   | 140 |   |
| Excess tax benefit associated with stock option  exercises                                          |       | (370                                   | )          | —                                                      |       | (2,543 | ) | 45 |   |
| 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 |   | (2,382 | ) |
| Changes in operating assets and liabilities, net of  acquired assets and liabilities:               |       |                                   |       |                                                        |       |   |   |   |   |
| Accounts receivable                                                                                 |       | (15,301                                | )          | 6,061                                                       |       | 5,503 |   | (8,365 | ) |
| Inventories                                                                                         |       | 7,075                                  |       | 2,911                                                       |       | (9,734 | ) | (12,570 | ) |
| Prepaid expenses, other assets and liabilities                                                      |       | 1,567                                  |       | 2,642                                                       |       | (1,818 | ) | 2,439 |   |
| Accounts payable and accrued expenses                                                               |       | 13,043                                 |       | (12,524                                                     | )          | 9,958 |   | 2,374 |   |
| Net cash (used in) provided by operating activities                                                 |       | (28,759                                | )          | (15,829                                                     | )          | 16,675 |   | 19,560 |   |
| **INVESTING ACTIVITIES:**                                                                           | ** ** | ** **                             | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Acquisition of businesses, net of cash acquired                                                     |       | (1,313,110                             | )          | (13,008                                                     | )          | (1,793 | ) | (21,648 | ) |
| Acquisition of ReAble (Prior Transaction)                                                           |       | —                                 |       | (522,072                                                    | )          | — |   | — |   |
| Purchases of property and equipment                                                                 |       | (13,962                                | )          | (1,331                                                      | )          | (12,304 | ) | (8,010 | ) |
| Proceeds from sale of assets                                                                        |       | 4,591                                  |       | —                                                      |       | 69 |   | 8 |   |
| Proceeds from sale of discontinued operations                                                       |       | —                                 |       | —                                                      |       | — |   | 9,291 |   |
| Other                                                                                               |       | (583                                   | )          | —                                                      |       | (244 | ) | (5 | ) |
| Net cash used in investing activities                                                               |       | (1,323,064                             | )          | (536,411                                                    | )          | (14,272 | ) | (20,364 | ) |
| **FINANCING ACTIVITIES:**                                                                           | ** ** | ** **                             | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investment by Parent                                                                                |       | 434,599                                |       | 357,000                                                     |       | — |   | — |   |
| Proceeds from long-term obligations                                                                 |       | 1,724,350                              |       | 550,370                                                     |       | 25,300 |   | 14,700 |   |
| Retirement of debt and payments on long-term  obligations                                           |       | (718,421                               | )          | (336,113                                                    | )          | (25,420 | ) | (15,555 | ) |
| Payment of debt issuance costs                                                                      |       | (55,866                                | )          | (20,818                                                     | )          | (10 | ) | (642 | ) |
| 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                                                                 |       | (226                                   | )          | —                                                      |       | — |   | (198 | ) |
| Proceeds from issuance of common stock                                                              |       | —                                 |       | —                                                      |       | 9,002 |   | 355 |   |
| Proceeds from notes received for sale of common  stock                                              |       | —                                 |       | —                                                      |       | 846 |   | 102 |   |
| Net cash provided by (used in) financing activities                                                 |       | 1,383,558                              |       | 550,439                                                     |       | 12,261 |   | (1,238 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                                       |       | 833                                    |       | 274                                                         |       | 566 |   | (647 | ) |
| **Net increase (decrease) in cash and cash  equivalents**                                           |       | 32,568                                 |       | (1,527                                                      | )          | 15,230 |   | (2,689 | ) |
| Cash and cash equivalents at beginning of period                                                    |       | 30,903                                 |       | 32,430                                                      |       | 17,200 |   | 19,889 |   |
| **Cash and cash equivalents at end of period**                                                      |       | $                                      | 63,471     |                                                        | $          | 30,903 |   | $ | 32,430 |   | $ | 17,200 |   |
| **Supplemental disclosures of cash flow  information:**                                             | ** ** | ** **                             | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid for interest                                                                              |       | $                                      | 70,249     |                                                        | $          | 3,446 |   | $ | 26,584 |   | $ | 25,476 |   |
| Cash paid for income taxes                                                                          |       | $                                      | 912        |                                                        | $          | 606 |   | $ | 4,576 |   | $ | 12,377 |   |
| **Non-cash investing and financing activities:**                                                    | ** ** | ** **                             | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital lease obligations related to equipment  leases                                              |       | $                                      | 328        |                                                        | $          | — |   | $ | 384 |   | $ | 255 |   |
| 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.

 

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**DJO FinanceLLC and Subsidiaries**

**Notes to Consolidated Financial Statements**

 

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

 

**Basis of Presentation and Principles of Consolidation. **We are a global provider of high-quality, orthopedic devices, with abroad range of products used for rehabilitation, pain management and physicaltherapy. We also develop, manufacture and distribute a broad range of surgicalreconstructive implant products.  Weoffer healthcare professionals and patients a diverse range of orthopedicrehabilitation products addressing the complete spectrum of preventative,pre-operative, post-operative, clinical and home rehabilitation care.  Our products are used by orthopedicspecialists, spine surgeons, primary care physicians, pain managementspecialists, physical therapists, podiatrists, chiropractors, athletic trainersand other healthcare professionals to treat patients with musculoskeletalconditions resulting from degenerative diseases, deformities, traumatic eventsand sports-related injuries.  Inaddition, many of our non-surgical medical devices and related accessories areused by athletes and patients for injury prevention and at-home physicaltherapy treatment.

 

Wecurrently market and distribute our products through three operating segments,Domestic Rehabilitation, International Rehabilitation, and Surgical Implant.Our Domestic and International Rehabilitation Segments offer non-invasivemedical products that are used before and after surgery to assist in the repairand rehabilitation of soft tissue and bone, and to protect against furtherinjury; electrotherapy devices and accessories used to treat pain and restoremuscle function; iontophoretic devices and accessories used to delivermedication; clinical therapy tables, traction equipment and other clinicaltherapy 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.  Our Surgical Implant Segment offers acomprehensive suite of reconstructive joint products.

 

On November 20, 2007, a subsidiary of ReAble Therapeutics Inc. (“ReAble” or“Parent”) was merged into DJO OpcoHoldings, Inc. (“DJO Opco”), with DJO Opco continuing as the survivingcorporation (the “DJO Merger”).  As aresult of the DJO Merger, DJO Opco became a subsidiary of ReAble TherapeuticsFinance LLC, the entity filing this Annual Report on Form 10-K, which wasitself a subsidiary of ReAble.  Followingthe DJO Merger, ReAble was renamed DJO Incorporated (“DJO”), ReAbleTherapeutics Finance LLC was renamed DJO Finance LLC (“DJOFL” or “Successor”)and ReAble Finance Corporation, the co-issuer of both 10.875% and 11.75% seniorsubordinated notes (See Note 8), was renamed DJO Finance Corporation (“Finco”).

 

OnNovember 3, 2006, an affiliate of Blackstone Capital Partners V L.P.(“Blackstone”) acquired all of the outstanding shares of capital stock ofReAble in a merger transaction (the “Prior Transaction”).  See further description of the PriorTransaction under Note 2.  For purposesof discussing the Prior Transaction in the audited consolidated financialstatements, we refer to DJO as ReAble or “Predecessor”.  Except as otherwise indicated, references to“us”, “we”, “our”, “DJO”, or “our Company”, refers to DJO and its consolidatedsubsidiaries.

 

DJOFLdirectly or indirectly through its subsidiaries, owns all of the operatingassets of DJO.  The accompanyingconsolidated financial statements include the accounts of DJOFL, and its whollyowned subsidiaries and those entities in which we hold a controlling interestfrom the date of the Prior Transaction. Prior to the date of the Prior Transaction, the financial statementsreflect the accounts and activities of the Predecessor.  The Successor period reflects the acquisitionof ReAble using the purchase method of accounting pursuant to the provisions ofStatement of Financial Accounting Standards No. 141, “*Business Combinations*”.  The Predecessor results of ReAble are notcomparable to the Successor results of DJOFL due to the difference in basis ofpresentation incorporating the Prior Transaction purchase accounting ascompared to historical cost for the Predecessor.  Minority interests reflect the 50% separateownership of Medireha GmbH, which we have consolidated due to our controllinginterest in it.  All significantintercompany balances and transactions have been eliminated in consolidation.

 

**Use of Estimates. **The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make certain estimates and assumptions thataffect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  On an ongoing basis, management evaluates itsestimates, including those related to contractual allowances, doubtfulaccounts, inventories, rebates, product returns, warranty obligations, incometaxes, intangible assets and stock-based compensation.  We base our estimates on historicalexperience and on various other assumptions that we believe are reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results could differ from those estimates.

 

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## **Cash andCash Equivalents. **Cash consists of deposits with financialinstitutions.  We consider allshort-term, highly liquid investments and investments in money market funds andcommercial paper with original maturities of less than three months****at the time of purchase to be cashequivalents. While our cash and cash equivalents are on deposit withhigh-quality institutions, such deposits exceed FDIC insured limits.

## ** **

## **Allowancefor Doubtful Accounts. **We make estimates of the collectibilityof accounts receivable.  Managementanalyzes accounts receivable and historical bad debts, customer concentrations,customer credit-worthiness, current economic trends and changes in customerpayment patterns when evaluating the adequacy of the allowance for doubtfulaccounts.

## ** **

## **SalesReturns and Allowances**.  We make estimates of theamount of sales returns 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 or market,with cost generally determined using the average cost method.  We establish reserves for slow moving andexcess inventory, product obsolescence, shrinkage and other valuationimpairments based on future demand and historical experience.

## ** **

**Property and Equipment. **Property andequipment are stated at cost less accumulated depreciation andamortization.  Depreciation is calculatedfor financial reporting purposes using the straight-line method over the estimateduseful lives 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. Maintenance and repairs are expensed as incurred.

 

**Computer Software Costs. **Software isstated at cost less accumulated amortization and is amortized using thestraight-line method over its estimated useful life ranging from three to sevenyears.  During the development stage ofinternally developed software applications, 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 the carryingvalue may not be recoverable over the remaining lives of the assets. Upgradesand enhancements are capitalized if they result in added functionality whichenables the software to perform tasks it was previously incapable ofperforming.  We have unamortizedcapitalized computer software costs aggregating $5.6 million and $0.6 millionat December 31, 2007 and 2006, respectively.  Software maintenance, training and dataconversion costs are expensed in the period in which they are incurred.  Amortization expense related to capitalizedcomputer software was approximately $0.9 million, $0.2 million, $0.7 million,and $0.7 million for the Successor year ended December 31, 2007 and theperiod November 4, 2006 through December 31, 2006, and thePredecessor period January 1, 2006 through November 3, 2006 and theyear ended December 31, 2005, respectively.

 

**Impairment ofLong-Lived Assets**.  Long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof 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 undiscounted 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.** Goodwill represents the excess of the purchase price over the fair valueof tangible and identifiable intangible assets acquired and liabilitiesassumed.  Identifiable intangible assetsconsist of trademarks, trade names, patents, distribution networks,intellectual property, non-compete agreements and customer lists and arecarried at fair value on date of purchase less accumulated amortization.  Amortization of identifiable intangibles iscomputed using the straight-line method over periods ranging from one to twelveyears.  On an annual basis, and betweenannual tests in certain circumstances, we review our goodwill and intangibleassets to determine if there has been any change in the respective useful livesof intangible assets, or whether there has been impairment of these assets.

 

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**Debt Issuance Costs. **Debt issuancecosts are capitalized and are included in other non-current assets on ourconsolidated balance sheet.  We amortizethese costs over the lives of the related debt instruments (currently,approximately seven years) and classify the amortization expense with interestexpense in the accompanying consolidated statements of operations.

 

## **WarrantyCosts. **We provide expressed warranties on certain productsfor periods typically ranging from one to three years.  We estimate our warranty obligations at thetime of sale based upon historical experience and known product issues, if any.

## ** **

Activityin our warranty reserves were as follows (in thousands):

 
|                                                   |       | **Successor**                           |       | **Predecessor**                                            |       |
|--------------------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                             | ** ** | **Year  Ended December 31,  2007** | ** ** | **November 4,  2006 through December 31,  2006** | ** ** | **January 1,  2006  through  November 3,  2006** | ** ** | **Year  Ended December 31,  2005** | ** ** |
| Beginning balance                                      |       | $                                       | 1,348      |                                                       | $          | 1,275 |   | $ | 643 |   | $ | 370 |   |
| Amount charged to expense for estimated warranty costs |       | 509                                     |       | 260                                                        |       | 1,354 |   | 1,079 |   |
| Deductions for actual costs incurred                   |       | (454                                    | )          | (187                                                       | )          | (1,040 | ) | (806 | ) |
| Acquired through business acquisitions                 |       | 317                                     |       | —                                                     |       | 318 |   | — |   |
| Ending balance                                         |       | $                                       | 1,720      |                                                       | $          | 1,348 |   | $ | 1,275 |   | $ | 643 |   |

 

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

 

## **RevenueRecognition.  **We recognize revenue pursuant to StaffAccounting Bulletin No. 104, *RevenueRecognition*. 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.

## ** **

Wereduce revenue by estimates of potential future product returns and otherallowances.  Revenues are also reduced byrebates related to sales transacted through distribution agreements thatprovide the distributors with a right to return inventory or take certainpricing adjustments based on sales mix or volume.  Provisions for product returns and otherallowances are recorded as a reduction to revenue in the period sales arerecognized.

 

## **AdvertisingCosts. **We expense advertising costs as they areincurred.  For the Successor year endedDecember 31, 2007 and the period November 4, 2006 throughDecember 31, 2006, advertising costs were approximately $3.9 million and$0.7 million, respectively.  For thePredecessor period January 1, 2006 through November 3, 2006 and theyear ending December 31, 2005, such costs approximated $5.6 million and$3.1 million, respectively.

## ** **

**Stock Based Compensation. **We maintain astock option plan and account for related compensation expense. EffectiveJanuary 1, 2006, we adopted the Financial Accounting Standards Board’s(“FASB”) Statement of Financial Accounting Standards No. 123(R) “Share-BasedPayment” (“SFAS 123(R)”) using the modified prospective method, in whichcompensation expense was recognized beginning with the effective date(a) based on the requirements of SFAS 123(R) for all share-basedpayments granted after the effective date and (b) based on therequirements of SFAS 123(R) for all awards granted to employees prior tothe effective date of SFAS 123(R) that remain unvested on the effectivedate.

 

Aspermitted under SFAS 123(R), we elected to follow Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and relatedinterpretations in accounting for stock-based awards to employees prior toJanuary 1, 2006. Under APB 25, compensation expense for stock options wasmeasured as the excess, if any, of the market price of common stock at the dateof grant over the exercise price. Historically, we did not recognize anycompensation expense under APB 25.

 

Priorto the adoption of SFAS 123(R), we presented the tax savings related to taxdeductions resulting from the exercise of stock options as operating cashflows, in accordance with Emerging Issues Task Force Issue No. 00-15,“Classification in the Statement of Cash Flows of the Income Tax BenefitReceived by a Company upon Exercise of a Nonqualified Employee Stock Option.”SFAS 123(R) requires recognition of the net tax savings resulting fromsuch tax deductions in the financial statements as financing cash flows.

 

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Withthe adoption of SFAS 123(R), we elected to amortize stock-based compensationfor service-based awards granted on or after the adoption of SFAS123(R) on a straight-line basis over the requisite service (vesting)period for the entire award.  Otherawards vest over a specified performance period from the date of grant upon theachievement of certain pre-determined performance targets over time andcompensation expense is recognized to the extent the achievement of theperformance targets is deemed probable.

 

## Refer to Note 10 for furtherdiscussion.

## ** **

## **IncomeTaxes. **We account for income taxes under the asset andliability method as set forth in Statement of Financial Accounting StandardsNo. 109, *“Accounting for Income Taxes”*(“SFAS109”).  Under this method, deferred taxassets and liabilities are recognized and measured using enacted tax rates ineffect for the year in which the differences are expected to berecognized.  Valuation allowances areestablished when necessary to reduce deferred tax assets to amounts that aremore likely than not to be realized.

## ** **

InJune 2006, the Financial Accounting Standards Board issued InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation ofFASB Statement No. 109 (“FIN 48”)”. This interpretation clarifies the accounting for uncertainty in incometaxes recognized in an enterprise’s financial statements in accordance withSFAS 109.  FIN 48 prescribes arecognition threshold and measurement attribute for the financial statement recognitionand measurement of a tax position taken or expected to be taken in a taxreturn. This interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition.  We adoptedFIN 48 beginning with the year ended December 31, 2006.  The adoption of FIN 48 did not have amaterial effect on our results of operations and financial condition (see Note12 to our audited consolidated financial statements).

 

**Foreign Currency Translation**.  Thefinancial statements of our international subsidiaries, where the localcurrency is the functional currency, are translated into U.S. dollars usingperiod-end exchange rates for assets and liabilities and average exchange ratesduring the period for revenues and expenses. Cumulative translation gains andlosses are excluded from results of operations and recorded as a separatecomponent of consolidated membership equity or stockholders equity forPredecessor periods. Gains and losses resulting from foreign currencytransactions (transactions denominated in a currency other than the entity’slocal currency) are included in the consolidated statements of operations aseither a component of costs of goods sold or other income or expense, dependingon the nature of the transaction.

 

## **Derivativesand Hedging Activities. **We use derivative financial instrumentsto manage the risk of fluctuations in interest rates and foreign currencyexchange rates.  We evaluate the amountat risk, risk tolerance, cost of the derivative, and our targeted mix of fixedand floating rates before entering into hedging activities.  On occasion we use forward contracts to hedgeforeign currency cash flows and interest rate swaps to hedge interest expense.Derivatives are recorded on the balance sheet and measured at fair value.  Gains and losses on cash flow hedges thatqualify for hedge accounting treatment are reported in accumulated othercomprehensive income and are only reported in current income when ratefluctuations of the hedged items are reported. Any ineffective portion of the derivative’s change in fair value isdirectly recognized in current income. We do not enter into derivative instruments for speculative or tradingpurposes.

## ** **

**Comprehensive Income (Loss). **Comprehensive income (loss) includes net income and other comprehensiveincome.  Other comprehensive income(loss) refers to unrealized gains and losses that are excluded from currentearnings and are recorded directly as an adjustment to stockholders’ equity/membershipequity.  These gains and losses oftenfluctuate before being realized, and are often long-term in nature.  Our other comprehensive income (loss) iscomprised of foreign currency translation adjustments and unrealized interestrate hedge gains and losses, net of tax.

 

**Concentration of 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 27.0%, 29.1%,22.9%, and 21.5% of our net revenues for the Successor year endedDecember 31, 2007 and the period November 4, 2006 throughDecember 31, 2006 and for the Predecessor period January 1, 2006through November 3, 2006 and the year ended December 31, 2005,respectively.  International sales aregenerated 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, 2007, we had no individual customer ordistributor that accounted for 10% or more of our total annual revenues.

 

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**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 New Senior Secured Credit Facility, approximatecarrying value due to the variable interest rate features on theseinstruments.  We estimated the fair valueof our long-term fixed rate notes based on trading prices for the notes on ornear December 31, 2007 and 2006 (see Note 8).

 

## **Reclassifications.**The consolidatedfinancial statements and accompanying footnotes reflect certainreclassifications, including (i) the reclassification of certain shippingcosts from selling, general and administrative expenses to cost of sales,(ii) the reclassification of income taxes receivable from accountsreceivable to other current assets, and (iii) the reclassification ofrestricted cash to other non-current assets. These reclassifications have been made to prior year consolidatedfinancial statements to conform to the current year presentation.

## ** **

**Recent Accounting Pronouncements**

 

In December 2007, the FASB issued StatementNo. 160, “Non-controlling Interests in Consolidated Financial Statements”which requires entities to report non-controlling (minority) interests insubsidiaries in the same way as equity in the consolidated financialstatements.  The statement is effectivefor fiscal years beginning after December 5, 2008. We will adopt thisstatement as of the beginning of 2009 and are currently assessing the potentialimpact of adoption.

 

InDecember 2007, the FASB issued Statement No. 141 (Revised), “BusinessCombinations” which requires the acquiring entity in a business combination torecognize all the assets acquired and liabilities assumed in the transaction;establishes the acquisition-date fair value as the measurement objective forall assets acquired and liabilities assumed; and requires the acquirer todisclose to investors and other users all of the information they need toevaluate and understand the nature and financial effect of the businesscombination.  The statement is effectivefor fiscal years beginning after December 13, 2008. We will adopt thisstatement as of the beginning of 2009 and are currently assessing the potentialimpact of adoption.

 

InFebruary 2007, the FASB issued Statement No. 159, “The Fair ValueOption for Financial Assets and Financial Liabilities—Including an amendment toFASB Statement No. 115” which permits entities to choose to measure manyfinancial instruments and certain other items at fair value. The statement iseffective for fiscal years beginning after November 15, 2007. We willadopt this statement as of the beginning of 2008 and are currently assessingthe potential impact of adoption.

 

InSeptember 2006, the FASB issued Statement No. 157, “Fair ValueMeasurement” which defines fair value, establishes a framework for measuringfair value in generally accepted accounting principles (“GAAP”) and expandsdisclosure about fair value measurements.  The statement is effective for fiscal years beginning afterNovember 15, 2007. We will adopt this statement as of the beginning offiscal 2008 and are currently assessing the potential impact of adoption.

 

## **2.            ACQUISITIONS AND OTHER TRANSACTIONS**

## ** **

Since the beginning of 2005, we have completed eightacquisitions. We believe that the acquisition of these businesses has allowedus to serve our patients, and their professional caregivers more effectively.In addition, through the acquisition of these businesses, we have achieved andexpect to continue to achieve certain synergies that should reduce ourmanufacturing costs and selling and distribution costs, and enhance our productoffering and research and development efforts.

 

We account for acquisitions in accordance withStatement of Financial Accounting Standards No. 141, *Business Combinations*(“SFAS 141”).  The results of operations attributable toeach acquisition are included in the audited consolidated financial statementsfrom the date of acquisition.

 

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

 

OnJuly 15, 2007, we entered into an Agreement and Plan of Merger (the “DJOMerger Agreement”) with DJO Opco, formerly known as DJO Incorporated, in amerger transaction (the “DJO Merger”) pursuant to which DJO Opco became awholly owned subsidiary of DJOFL.  The total purchase price for the DJOMerger, which consummated on November 20, 2007, was approximately $1.3billion and consisted of $1.2 billion paid to former equity holders (or $50.25(the “per share merger consideration”) in cash for each share of common stockof DJO Opco they then held), $15.2 million related to the fair value ofrollover options as explained below, and $22.8 million in direct acquisitioncosts.  The DJO Merger was financed through a combination of equitycontributed by Blackstone, borrowings under our new senior secured creditfacility (the “New Senior Secured Credit Facility”), and proceeds from newlyissued 10.875% senior notes due 2014 (the “10.875% Notes”) (see Note 8 forfurther information).

 

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Exceptfor certain options held by certain members of DJO Opco management who chose torollover their options, each outstanding option to purchase common stock of DJOOpco was cancelled in exchange for the right to receive, for each share ofcommon stock of DJO Opco issuable upon exercise of such option, cash in theamount equal to the excess of $50.25 over the exercise price per share of anysuch options, multiplied by the number of shares of common stock for which suchoption was exercisable immediately prior to the effective time of the DJOMerger. Former holders of options to acquire DJO Opco’s common stock receivedan aggregate of $47.8 million in cash in exchange for their options in the DJOMerger, and was included as part of the total purchase consideration of the DJOMerger.  Certain members of DJO Opco management elected to rollovercertain options held by them that had not been exercised at or prior to the effectivetime of the DJO Merger.  Such rolloveroptions were converted to options to purchase 1,912,577 shares of DJO’s commonstock (the “DJO Merger management rollover options”).  The fair value ofthese fully vested options approximated $15.2 million and was recorded as acomponent of the cost of the acquisition.

 

Thefollowing capitalization and financing transactions occurred in connection withthe DJO Merger:

 

·                  Blackstone made a cash equity contribution of$434.6 million;

 

·                  DJOFL entered into the New Senior SecuredCredit Facility, which provided for a senior secured term loan facility of$1,065.0 million, all of which was borrowed at closing of the DJO Merger, and anew revolving loan facility of $100.0 million, of which no amount was drawn atthe closing of the DJO Merger.  The Company issued the new term loan at a1.2% discount resulting in net proceeds of approximately $1,052.4 million (seeNote 8).

 

·                  DJOFL and Finco, as co-issuers, issued $575.0million aggregate principal amount of the 10.875% Notes (see Note 8).

 

Theproceeds from the capitalization and financing transactions described abovewere used to:

 

·                  pay cash of approximately $1.2 billion toholders of the outstanding shares of common stock and outstanding stock optionsof DJO Opco immediately prior to the effective time of the DJO Merger (otherthan the DJO Merger Management Rollover Options);

 

·                  repay approximately $430.9 million of indebtednessunder our then existing credit facility (the “Old Senior Secured CreditFacility”) and accrued interest thereon of $1.3 million.  We recordedapproximately $9.7 million of expense related to the unamortized debt issuancecosts associated with the Old Senior Secured Credit Facility;

 

·                  repay approximately $271.5 million ofoutstanding indebtedness under DJO Opco’s senior secured credit facilitiesexisting at the time of the DJO Merger, including accrued interest thereon of$0.4 million;

 

·                  pay fees and expenses of the DJO Merger andrelated debt financing costs of approximately $25.7 million and $54.7 million,respectively.  The fees and expensesrelated to the DJO Merger were accounted for as part of the merger purchaseconsideration, with the exception of $2.9 million of fees that were expensedrelated to alternative financing that was not used. The fees and expensesrelated to the debt financing have been capitalized as non-current assets inthe consolidated balance sheet at December 31, 2007 and are beingamortized over the terms of the related debt instruments;

 

·                  pay approximately $9.2 million of fees andexpenses incurred by DJO Opco prior to the effective time of the DJO Merger;and

 

·                  pay $4.8 million in cash related to thetermination of interest rate swaps in connection with the repayment of theCompany’s Old Senior Secured Credit Facility, which was recorded as interestexpense in the consolidated statement of operations.

 

In connection with the DJO Merger, we also agreed to payapproximately $5.6 million of retention bonuses to certain of our executiveofficers and senior management team members, of which $2.8 million was paid inJanuary 2008 and the remainder is to be paid in January 2009, subjectto certain conditions.  We are recordingthe expense ratably as selling, general 

 

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and administrative in our consolidated statement ofoperations over the period from the date of the DJO Merger throughDecember 31, 2008, including $0.5 million for the twelve months endedDecember 31, 2007.

 

We are currently integrating the operations of ReAblewith those of DJO Opco.  See Note 13 forfurther details.

 

***Acquisition of IOMED, Inc.***

 

# On August 9,2007, a subsidiary of DJOFL acquired IOMED, Inc. (“IOMED”), whichdevelops, manufactures and markets active drug delivery systems used primarilyto treat acute local inflammation in the physical and occupational therapy andsports medicine markets. The purchase price was $23.3 million and consisted of$21.1 million in cash payments to former IOMED equity holders at $2.75 pershare, $0.8 million related to the fair value of vested stock options that wereoutstanding at the time of the acquisition, and $1.4 million in directacquisition costs. The IOMED acquisition was primarily financed with borrowingsunder our then existing revolving credit facility (see Note 8).

# ** **

***Acquisition of******The Saunders Group, Inc.***

 

On July 2, 2007, a subsidiary of DJOFLcompleted its purchase of substantially all of the assets of The SaundersGroup, Inc. (“Saunders”) for total cash consideration of $40.9 million,including $0.9 million of acquisition costs (the “Saunders Acquisition”).Saunders is a supplier of rehabilitation products to physical therapists,chiropractors, athletes, athletic trainers, physicians and patients, with aspecialty in patented traction devices, back supports, and equipment for neckand back disorders. The Saunders Acquisition was financed with funds borrowedunder our Old Senior Secured Credit Facility (see Note 8).

 

***Acquisition of Cefar AB***

 

On November 7, 2006, a subsidiary of DJOFLacquired all of the issued and outstanding shares of Cefar AB (“Cefar”), aprovider of electrotherapy and rehabilitation devices used for chronic pain,for women’s health, for electroacupuncture, and for other rehabilitationactivities. The purchase price of $27.1 million was comprised of the payment of$16.3 million in cash, issuance of shares of our common stock valued at $9.5million, and $1.3 million of acquisition costs. The fair value of the commonstock issued was determined as $16.46 per share based on the per share priceused in the Prior Transaction. We funded the cash portion of the acquisitionwith $10.0 million of term loan borrowings under the Old Senior Secured CreditFacility and cash on hand.  Pursuant tothe terms of the acquisition agreement, additional amounts may be paid tocertain of the former stockholders of Cefar if certain EBITDA targets are metby December 31, 2008. During the fourth quarter of 2007, we accruedapproximately $4.2 million, with a corresponding increase to goodwill, relatedto payments we expect to pay to the former stockholders of Cefar based onexpected levels of achievement related to the EBITDA targets as specified inthe acquisition agreement.

 

We have integrated the operations of Cefar withthose of Compex SA, the European subsidiary of Compex, acquired inFebruary 2006 (see Note 13).

 

***The Prior Transaction***

 

# On November 3, 2006,Blackstone acquired all of the outstanding shares of capital stock ofReAble.  Under the terms of the Agreementand Plan of Merger dated June 30, 2006 (“Blackstone MergerAgreement”).  The total purchase pricefor the Prior Transaction was approximately $529.2 million and consisted of$482.5 million paid to former holders of shares of common stock, $7.2 millionrelated to the fair value of management rollover options that continued toremain as outstanding options to purchase ReAble common stock after the PriorTransaction (the “Prior Transaction Management Rollover Options”), and $39.5million in direct acquisition costs.  ThePrior Transaction was financed through a combination of equity contributed byan affiliate of Blackstone, cash on hand of ReAble, borrowings under the OldSenior Secured Credit Facility and proceeds from our 11.75% senior subordinatednotes (the “11.75% Notes”, see Note 8). Upon the closing of the Prior Transaction, shares of ReAble’s commonstock ceased to be traded on the NASDAQ Global Market.

# ** **

Thefollowing capitalization and financing transactions occurred in connection withthe Prior Transaction:

 

·                  Blackstone made a cash equity contribution of$357.0 million;

 

·                  DJOFL entered into the Old Senior SecuredCredit Facility that provided for a senior secured term loan facility of $350.0million, all of which was borrowed at closing of the Prior Transaction, and arevolving loan facility of $50.0 million, of which no amount was drawn at theclosing of the Prior Transaction; and

 

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·                  DJOFL and Finco, as co-issuers, issued $200.0million aggregate principal amount of the 11.75% Notes.

 

Theproceeds from the capitalization and financing transactions described abovewere used to:

 

·                  pay cash of approximately $482.5 million toholders of the outstanding shares of common stock and outstanding stock optionsof ReAble immediately prior to the effective time of the Prior Transaction(other than the Prior Transaction Management Rollover Options);

 

·                  repay approximately $170.2 million ofindebtedness under our then existing credit facility and accrued interestthereon of $3.4 million;

 

·                  repurchase $165.0 million aggregate principalamount of 9.75% notes payable (the “9.75% Notes”) and pay the related $20.4million of bond tender premium and consent fees, pursuant to a tender offer andconsent solicitation;

 

·                  pay fees and expenses of the PriorTransaction and related debt financing costs of approximately $54.0 million and$20.8 million, respectively.  Of theapproximate $54.0 million fees and expenses related to the Prior Transaction,$13.4 million and $1.1 million was expensed as selling, general andadministrative expense in our statements of operations for the period fromJanuary 1, 2006 to November 3, 2006 and the period fromNovember 4, 2006 to December 31, 2006, respectively, and $39.5million, including the $20.4 million bond tender premium and consent fees, werecapitalized in purchase accounting and included in the consolidated balancesheet at December 31, 2006.  Thefees and expenses related to the debt financing were capitalized as non-currentassets in the consolidated balance sheet at December 31, 2006 and wereamortized over the terms of the related debt instruments;

 

·                  payment of $5.5 million of bonuses to certainof our former executive officers, which was recorded as a selling, general andadministrative expense in the Successor statement of operations; and

 

·                  fund the $13.7 million cash portion of theCefar acquisition.

 

ThePredecessor financial statements for the period from January 1, 2006through November 3, 2006 reflect certain items related to the closing ofthe Prior Transaction including, but not limited to, the following:

 

·                  recognition of $7.5 million of stock-basedcompensation expense associated with the accelerated vesting of stock optionswhich occurred as a result of the change in control in connection with theconsummation of the Prior Transaction;

 

·                  recognition of $9.2 million of expense forunamortized debt issuance and debt discount costs associated with the repaymentof the then existing senior credit facility and 9.75% Notes;

 

·                  recognition of $0.4 million of gain due tothe termination of an interest rate swap agreement; and

 

·                  recognition of $13.4 million of costsincurred related to the Prior Transaction. Such costs are reflected in selling, general and administrative expensesin the Predecessor’s statement of operations for the period fromJanuary 1, 2006 to November 3, 2006.

 

***Acquisition of CompexTechnologies, Inc.***

 

On February 24, 2006, pursuant to the terms ofa merger agreement dated November 11, 2005, we acquired all of the issuedand outstanding shares of Compex Technologies, Inc. (“Compex”), aMinnesota corporation. Compex manufactured and sold a broad line oftranscutaneous 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 (see Note 13). The totalpurchase price of approximately $102.9 million was comprised of 7.3 millionshares of our common stock valued at $90.0 million, options to purchase 900,000shares of our common stock valued at $9.3 million, and $3.6 million inacquisition costs. We funded the cash portion of the acquisition with $25.3million of borrowings.

 

Included in the liabilities assumed in the Compexacquisition was a contingent liability relating to litigation against Compexregarding a potential incorrect payment of custom duties and VAT on importedgoods prior to the date of the acquisition. On February 6, 2007, ajudgment in the dispute with the custom officials was issued by the court whichresulted 

 

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inpartial unfavorable rulings for each side. Both sides have appealed the rulingand a final judgment is expected to be received in early 2008.  The estimated potential liability in thedispute if the custom officials were to prevail is approximately $1.1 million.Therefore, $1.1 million was recorded as an adjustment to the Compex purchaseprice with a corresponding increase in goodwill during the fourth quarter of2006.

 

Duringthe second quarter of 2006, additional information was obtained regarding theCompex payor mix and its accounts receivable collection rates and trends, whichresulted in a change in our estimate of the value of the acquired accountsreceivable and a $5.6 million charge to the reserve account.  In addition, during December 2006, inconjunction with the completion of a strategic review and assessment of variousoptions related to ongoing efforts to collect the remaining Compex accountsreceivable, the decision was made to outsource the collection effort to a thirdparty.  Based on collection estimatesprovided by the third party collection company, in the fourth quarter of 2006,we recorded an additional adjustment to the carrying value of accountsreceivable in the amount of $19.8 million. These adjustments resulted in a reduction in our net revenues and grossmargin of $11.4 million, a reduction in operating and pre-tax income of $25.4million, and a reduction of our net income by approximately $15.5 million forthe predecessor period January 1, 2006 through November 3, 2006.

 

***Acquisition of OTI***

 

On February 22, 2005, we acquired substantially all of the assetsof OTI, which included a line of spinal implant products and several knee andhip implant products.  The total purchaseprice for the OTI assets of approximately $15.7 million was comprised ofapproximately $14.5 million payable in cash to OTI and $1.2 million inacquisition costs.

 

The acquisition consideration was subject toadjustment based upon the final balance sheet as of the closing date, which wasthe subject of a dispute between the former OTI shareholders and us.  We had also been in a related dispute withOTI and its chief executive officer over certain representations and warrantiesthat were made under the Asset Purchase Agreement that governs the OTIacquisition (the “OTI APA”).  Thisdispute had been the subject of litigation in which each party had assertedcertain claims, including our claim for indemnification from the approximately$1.7 million escrow fund that was established pursuant to the OTI APAspecifically for the purpose of funding indemnification claims.  Previously, we had reflected the costs thatwe had incurred to date related to the litigation for which we believed we wereentitled to indemnification as an account receivable.  During the fourth quarter of 2007, thedispute was settled.  The net effect ofthe various disputes and litigation settlements resulted in the recognition ofapproximately $0.4 million of intangible assets associated with the settlementof a previous patent infringement claim against us and OTI whereby we agreed topay $0.4 million in exchange for a license to use the related technology.

 

***Other Acquisitions***

 

During 2007, we completed the acquisition of variousother businesses, including Endeavor Medical, Inc. (“Endeavor”) andPerformance Modalities, Inc. (“PMI”). On April 13, 2007, we acquiredEndeavor for total consideration of $2.9 million. On February 16, 2007, weacquired certain assets of PMI for total consideration of $4.3 million. Thepreliminary allocation of the aggregate purchase price for both acquisitions,which is subject to change upon our further evaluation of the assets acquiredand liabilities assumed, resulted in the recognition of $2.4 million ofgoodwill.

 

Thefair values of the assets acquired and the liabilities assumed in connectionwith the acquisition of the businesses discussed above were estimated inaccordance with Statement of Financial Accounting Standards No. 141, “*Business Combinations”*(“SFAS 141”) andStatement of Financial Accounting Standards No. 142, “*Goodwill and Other Intangible Assets”*(“SFAS 142”). The purchase price for the 2007 acquisitions remain preliminaryas of December 31, 2007, and may be subject to adjustments as we finalizeour estimates of certain items, including severance amounts for employeesterminated, certain acquired inventories and accounts receivable and accrualsfor certain contingent liabilities that existed on the acquisition dates.

 

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Thepurchase prices for our recent acquisitions and the Prior Transaction wereallocated as follows to the fair values of the net tangible and intangibleassets acquired, including the cumulative impact of adjustments made to suchallocations through December 31, 2007 (see Note 6):

 
| **(in thousands):**                     |   | **DJO Opco** | ** ** | **IOMED** | ** ** | **Saunders** | ** ** | **Cefar** | ** ** | **Prior  Transaction** | ** ** | **Compex** | ** ** | **OTI** | ** ** | **Wtd.  Avg. Useful**

**Life** | ** ** |    |
|----------------------------------------------|--------|-------------------|------------|-----------|------------|--------------|------------|-----------|------------|------------------------|------------|------------|------------|---------|------------|---------------------------------|------------|---------|
| Current assets                               |   | $                 | 172,177    |      | $          | 8,971        |       | $         | 6,783      |                   | $          | 11,342     |       | $       | 209,011    |                            | $          | 69,129  |   | $ | 3,627 |   |   |   |   |
| Tangible non-current assets                  |   | 67,500            |       | 853       |       | 273          |       | 1,036     |       | 49,853                 |       | 8,340      |       | 1,297   |       |                            |       |    |
| Liabilities assumed   (see Note 13)          |   | (685,048          | )          | (6,100    | )          | (628         | )          | (10,697   | )          | (538,526               | )          | (51,092    | )          | (163    | )          |                            |       |    |
| 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      |       | 1,263   |       | 3  – 20 years              |       |    |
| Customer-based                               |   | 328,000           |       | 2,512     |       | 6,369        |       | 3,200     |       | 133,800                |       | 14,610     |       | 2,831   |       | 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                                     |   | 679,104           |       | 8,676     |       | 13,537       |       | 17,036    |       | 472,414                |       | 43,995     |       | 6,834   |       | N/A                             |       |    |
| Purchase price                               |   | $                 | 1,274,733  |      | $          | 23,305       |       | $         | 40,928     |                   | $          | 27,117     |       | $       | 529,252    |                            | $          | 102,863 |   | $ | 15,689 |   |   |   |
|                                              |        |                   |            |           |            |              |            |           |            |                        |            |            |            |         |            |                                 |            |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Goodwill represents the excess of the purchase priceover the fair value of tangible and identifiable intangible assets acquired andliabilities assumed.

 

Thepurchase price allocation for the DJO Opco acquisition included values assignedto certain specific identifiable intangible assets aggregating $1,038.0million. An aggregate value of $354.0 million was assigned to patents andexisting technology, determined primarily by estimating the present value offuture royalty costs that will be avoided due to our ownership of the patentsand technology acquired. An aggregate value of $328.0 million was assigned tocertain DJO Opco customer relationships for group purchase organization (GPO)customers and certain other customers existing on the acquisition date basedupon an estimate of the future discounted cash flows that would be derived fromthose GPO and other customers. A value of $356.0 million was assigned to tradenames and trademarks, determined primarily by estimating the present value offuture royalty costs that will be avoided due to our ownership of the tradenames and trademarks acquired.  A valueof $679.1 million, representing the difference between the total purchase priceand the aggregate fair values assigned to the net tangible assets acquired andliabilities assumed and the identifiable intangible assets acquired, wasassigned to goodwill.

 

We acquired DJO Opco to expand our product offerings, increase ouraddressable market, increase the size of our international business andincrease our revenues.  We also believethere are significant cost reduction synergies that may be realized when theacquired business is integrated.  Theseare among the factors that contributed to a purchase price for the DJO Opcoacquisition that resulted in the recognition of goodwill.

 

Thepurchase price allocation for the Prior Transaction included values assigned tocertain specific identifiable intangible assets aggregating $311.3 million. Anaggregate value of $83.9 million was assigned to patents and existingtechnology, determined primarily by estimating the present value of futureroyalty costs that will be avoided due to our ownership of the patents andtechnology acquired. An aggregate value of $133.8 million was assigned tocertain ReAble customer relationships for hospitals, distributors, third partypayors, and certain other customers existing on the acquisition date based uponan estimate of the future discounted cash flows that would be derived fromthose customers. A value of $92.0 million was assigned to trade names andtrademarks, determined primarily by estimating the present value of futureroyalty costs that will be avoided due to our ownership of the trade names andtrademarks acquired.  A value of $1.6million was assigned to non-compete restrictions included in the employmentagreements of certain of ReAble’s executive officers and seniormanagement.  A value of $472.4 million,representing the difference between the total purchase price and the aggregatefair values assigned to the net tangible assets acquired and liabilitiesassumed and the identifiable intangible assets acquired, was assigned togoodwill.

 

*Pro Forma Financial Information*

 

The unaudited financial information in the tablebelow summarizes the combined results of our operations and those of DJO Opco,IOMED, and Saunders on a pro forma basis, as though the companies acquired hadbeen combined as of the beginning of each of the years presented. The pro formafinancial information excludes the impact of other acquisitions made during2007 with a total purchase price of $7.2 million and is presented forinformational purposes only and is not indicative of the results of operationsthat would have been achieved if the acquisitions had taken place at thebeginning of each of the years presented. The pro forma adjustments include theeffect of purchase accounting adjustments, interest expense, and related taxeffects, among others.

 

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| ** **                                                                  | ** ** | **Unaudited  Pro Forma**            | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------|------------|
| **(in thousands):**                                                    | ** ** | **Year  Ended  December 31,  2007** | ** ** | **Year  Ended  December 31,  2006  (Combined)** | ** ** |
| Net sales                                                                   |       | $                                        | 928,356    |   | $ | 801,426 |   |
|                                                                        |       |                                     |       |   |   |
| Loss from continuing operations before income taxes and minority  interests |       | (240,145                                 | )          | (268,536 | ) |
| Benefit for income taxes                                                    |       | (76,062                                  | )          | (70,866 | ) |
| Minority interests                                                          |       | 415                                      |       | 197 |   |
| Loss from continuing operations                                             |       | $                                        | (164,498   | ) | $ | (197,867 | ) |

 

**3.           ACCOUNTSRECEIVABLE RESERVES**

 

Asummary of activity in our accounts receivable reserves for doubtful accountsand sales returns is presented below (in thousands):

 
| ** **                                        | ** ** | **Successor**                               | ** ** | **Predecessor**                                            | ** ** |
|---------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                        | ** ** | **Year  Ended December 31,**

**2007** | ** ** | **November 4,  2006 through December 31,  2006** | ** ** | **January 1,  2006 through November 3,  2006** | ** ** | **Year  Ended December 31,  2005** | ** ** |
| Balance, beginning of period                      |       | $                                           | 513        |                                                       | $          | — |   | $ | 4,016 |   | $ | 2,735 |   |
| Acquired through business acquisitions            |       | 14,709                                      |       | —                                                     |       | — |   | — |   |
| Provision for doubtful accounts and sales returns |       | 22,521                                      |       | 513                                                        |       | 21,763 |   | 6,108 |   |
| Write-offs, net of recoveries                     |       | (6,789                                      | )          | —                                                     |       | (6,610 | ) | (4,827 | ) |
| Balance, end of period                            |       | $                                           | 30,954     |                                                       | $          | 513 |   | $ | 19,169 |   | $ | 4,016 |   |

 

Reservebalances subsequent to the Prior Transaction were netted against the relatedaccounts receivable as part of the Prior Transaction purchase accounting.

 

**4.           INVENTORIES**

 

Inventoriesat December 31, 2007 and 2006 consist of the following (in thousands):

 
| ** **                     | ** ** | **Successor**               | ** ** |
|--------------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **December 31,  2007** | ** ** | **December 31,  2006** | ** ** |
| Components and raw materials   |       | $                           | 35,534     |   | $ | 19,437 |   |
| Work in process                |       | 6,626                       |       | 3,848 |   |
| Finished goods                 |       | 54,411                      |       | 27,974 |   |
| Inventory held on consignment  |       | 22,159                      |       | 17,332 |   |
|                           |       | 118,730                     |       | 68,591 |   |
| Less – inventory reserves |       | (7,826                      | )          | (918 | ) |
|                           |       | $                           | 110,904    |   | $ | 67,673 |   |

 

Inconnection with the DJO Merger, the carrying value of the acquired DJO Opcoinventory was increased by approximately $9.4 million to its estimated fairvalue as of the acquisition date.  Thisamount will be amortized through cost of sales over a three month period basedupon the estimated turn of the acquired inventory, of which $4.7 million wasrecorded in the year ended December 31, 2007.  In connection with the IOMED, Saunders, theCefar acquisitions, and the Prior Transaction, the carrying value of theacquired inventory was increased by approximately $0.6 million, $1.5 million,$2.2 million and $9.2 million, respectively; of these amounts, $9.0 million wasamortized through cost of sales in the Successor year ended December 31, 2007and $4.5 million was amortized through cost of sales in the Successor periodNovember 4, 2006 through December 31, 2006.

 

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

 
| ** **                             | ** ** | **Successor**                           | ** ** | **Predecessor**                                            | ** ** |
|----------------------------------------|------------|-----------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                             | ** ** | **Year  Ended December 31,  2007** | ** ** | **November 4,  2006 through December 31,  2006** | ** ** | **January 1,  2006 through November 3,  2006** | ** ** | **Year  Ended December 31,  2005** | ** ** |
| Balance, beginning of period           |       | $                                       | 918        |                                                       | $          | — |   | $ | 7,397 |   | $ | 4,993 |   |
| Acquired through business acquisitions |       | 3,867                                   |       | —                                                     |       | — |   | — |   |
| Provision charged to cost of sales     |       | 3,580                                   |       | 957                                                        |       | 7,563 |   | 4,810 |   |
| Write-offs                             |       | (539                                    | )          | (39                                                        | )          | (2,651 | ) | (2,406 | ) |
| Balance, end of period                 |       | $                                       | 7,826      |                                                       | $          | 918 |   | $ | 12,309 |   | $ | 7,397 |   |

 

Thewrite-offs to the reserve were principally related to the disposition of fullyreserved inventory.   Reserve balances existingat the date of the Prior Transaction were netted against the related inventoryas part of the Prior Transaction purchase accounting.

 

**5.           PROPERTYAND EQUIPMENT, NET**

 

Propertyand equipment consists of the following at December 31, 2007 and 2006 (inthousands):

 
| ** **                                       | ** ** | **December 31,  2007** | ** ** | **December 31,  2006** | ** ** | **Depreciable    lives (years)** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| Land                                             |       | $                           | 1,713      |                        | $          | 1,713                            |       | Indefinite |   |
| Buildings and improvements                       |       | 19,788                      |       | 7,421                       |       | 5  to 25                         |       |
| Equipment                                        |       | 45,526                      |       | 17,103                      |       | 3  to 10                         |       |
| Software                                         |       | 11,714                      |       | 4,376                       |       | 3  to 5                          |       |
| Furniture and fixtures                           |       | 7,115                       |       | 3,373                       |       | 3  to 10                         |       |
| Surgical implant instrumentation                 |       | 9,800                       |       | 7,714                       |       | 3  to 5                          |       |
| Construction in progress                         |       | 6,483                       |       | 1,920                       |       | n/a                              |       |
|                                             |       | 102,139                     |       | 43,620                      |       |                             |       |
| Less - accumulated depreciation and amortization |       | (20,494                     | )          | (2,369                      | )          |                             |       |
| Property and equipment, net                      |       | $                           | 81,645     |                        | $          | 41,251                           |       |   |   |

 

Depreciationand amortization expense relating to property and equipment was approximately$14.7 million and $2.4 million for the Successor year ended December 31,2007 and the period November 4, 2006 through December 31, 2006, respectively.  Depreciation expense was $8.8 million and$8.7 million for the Predecessor period January 1, 2006 throughNovember 3, 2006 and the year ended December 31, 2005, respectively.  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 $2.5 million and $0.4million for the Successor year ended December 31, 2007 and the period fromNovember 4, 2006 through December 31, 2006, respectively, and $1.8million and $1.7 million for the Predecessor period from January 1, 2006through November 3, 2006 and the year ended December 31, 2005, respectively.

 

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**6.           GOODWILL AND INTANGIBLE ASSETS**

 

A summary of the activityin goodwill is presented below (in thousands):

 

| ** **                                                                                                       | ** ** | **Successor**                                      | ** ** | **Predecessor**                                                  | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Year Ended  December 31,   2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006   through  November 3, 2006** | ** ** |
| **Balance,  beginning of period**                                                                                |       | $                                                  | 475,722    |                                                             | $          | — |   | $ | 290,255 |   |
| Adjustment  related to resolution of contingencies                                                               |       | —                                             |       | —                                                           |       | (173 | ) |
| Adjustment  related to FIN 48 including acquired businesses                                                      |       | 4,178                                              |       | —                                                           |       | — |   |
| Adjustment  related to tax benefit associated with exercise of stock options rolled over  from acquired business |       | —                                             |       | —                                                           |       | (2,016 | ) |
| Acquisition of  OTI                                                                                              |       | —                                             |       | —                                                           |       | 474 |   |
| Acquisition of  Compex                                                                                           |       | —                                             |       | —                                                           |       | 43,995 |   |
| Prior  Transaction                                                                                               |       | 8,303                                              |       | 459,933                                                          |       | — |   |
| Acquisition of  Cefar                                                                                            |       | 3,863                                              |       | 13,173                                                           |       | — |   |
| Acquisition of  IOMED                                                                                            |       | 8,676                                              |       | —                                                           |       | — |   |
| Acquisition of  Saunders                                                                                         |       | 13,537                                             |       | —                                                           |       | — |   |
| Acquisition of  DJO Opco                                                                                         |       | 679,104                                            |       | —                                                           |       | — |   |
| Acquisition of  other businesses                                                                                 |       | 2,446                                              |       | —                                                           |       | — |   |
| Foreign currency  translation                                                                                    |       | 5,453                                              |       | 2,616                                                            |       | 4,986 |   |
| **Balance,  end of period**                                                                                      |       | $                                                  | 1,201,282  |                                                             | $          | 475,722 |   | $ | 337,521 |   |

 

During the year ended December 31, 2007, goodwill related to the Prior Transaction and the Cefar acquisition was adjusted to reflect changes in our preliminary estimates of the fair market value of the acquired inventory, property and equipment, assets held for sale, deferred tax assets and assumed liabilities related to restructuring activities (see Note 13).  In addition, goodwill related to the Cefar acquisition was adjusted for additional consideration we expect to pay to the former stockholders of Cefar based on expected levels of achievement related to EBITDA targets as specified in the acquisition agreement.

 

We recorded approximately $679.1 million, $8.7 millionand $13.5 million of goodwill during 2007 associated with the acquisition ofDJO Opco, IOMED and Saunders, respectively. We also completed the acquisitionsof various other businesses during the year which resulted in the recognitionof approximately $2.4 million of goodwill in the aggregate. The preliminaryallocation of the aggregate purchase price for these acquisitions is subject tochange upon our further evaluation of the assets acquired and liabilitiesassumed.

 

In 2006, we identified $0.5 million of additionalobsolete inventory related to inventory acquired with our acquisition of OTI,which we recorded as an adjustment to the OTI purchase price.

 

During the fourth quarter of 2007, we performed animpairment test of our goodwill and intangible assets in accordance with SFAS142**and determined that there was no impairmentof these assets.

 

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

 
| ** **                            | ** ** | **Successor**                   | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **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 |   |

 

82

 

Identifiable intangible assets consisted of the following as of December 31, 2006 (in thousands):

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

 

During the twelve months ended December 31, 2007, we acquired approximately $1,072.2 million of identifiable intangible assets in connection with the acquisition of businesses, of which $1,038.0 million, $10.9 million and $21.0 million relates to the acquisition of DJO Opco, IOMED and Saunders, respectively.  In addition, we acquired $1.0 million of other intangible assets related to license and royalty agreements.

 

In connection with the DJO Merger and the Prior Transaction, we recorded charges of $3.0 million and $25.2 million related to acquired in-process research and development (“IPR&D”) for the year ended December 31, 2007 and the period November 4, 2006 through December 31, 2006, respectively.  In connection with the acquisition of Compex, we recorded a charge of $3.9 million related to acquired IPR&D in the Predecessor financial statements for the period January 1, 2006 through November 3, 2006.

 

Our amortizable intangible assets will continue to be amortized over their useful lives ranging from 1 to 20 years.

 

Aggregate amortization expense related to acquired intangible assets was approximately $33.5 million, $4.0 million, $6.0 million and $5.1 million for the Successor year ended December 31, 2007, and the period November 4, 2006 through December 31, 2006, the Predecessor period January 1, 2006 through November 3, 2006, and for the year ended December 31, 2005, 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,** | ** ** |
|---------------------------------------------|------------|
| 2008                                        |       | $ | 88,826 |   |
| 2009                                        |       | 88,501 |   |
| 2010                                        |       | 87,658 |   |
| 2011                                        |       | 85,465 |   |
| 2012                                        |       | 84,365 |   |
| Thereafter                                  |       | 463,859 |   |
|                                             |            |  |  |  |

 

At December 31, 2007and 2006, our goodwill and intangible assets are allocated by segment asfollows (in thousands):

 
| **2007**                              | ** ** | **Goodwill** | ** ** | **Intangibles,  net** | ** ** |
|---------------------------------------|------------|--------------|------------|-----------------------|------------|
| Domestic  Rehabilitation Segment      |       | $            | 961,382    |                  | $          | 1,104,093 |   |
| International  Rehabilitation Segment |       | 192,494      |       | 226,842               |       |
| Surgical Implant  Segment             |       | 47,406       |       | 29,426                |       |
| Total                                 |       | $            | 1,201,282  |                  | $          | 1,360,361 |   |
|                                  |       |         |       |                  |       |
| **2006**                              | ** ** | **Goodwill** | ** ** | **Intangibles,  net** | ** ** |
| Domestic  Rehabilitation Segment      |       | $            | 367,061    |                  | $          | 248,662 |   |
| International Rehabilitation  Segment |       | 63,669       |       | 35,250                |       |
| Surgical Implant  Segment             |       | 44,992       |       | 33,330                |       |
| Total                                 |       | $            | 475,722    |                  | $          | 317,242 |   |

 

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**7.           ACCRUED EXPENSES**

 

Accrued expenses at December 31,2007 and 2006 consist of the following (in thousands):

 
| ** **                         | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Wages and  related expenses        |       | $        | 31,232     |     | $          | 12,807 |   |
| Interest                           |       | 10,131   |       | 8,001    |       |
| Commissions and  royalties         |       | 13,114   |       | 4,865    |       |
| Taxes                              |       | 6,119    |       | 2,803    |       |
| Restructuring  costs (see Note 13) |       | 9,563    |       | 1,735    |       |
| Professional fees                  |       | 6,693    |       | 1,804    |       |
| Warranties                         |       | 1,720    |       | 1,348    |       |
| Deferred revenue                   |       | 1,606    |       | 637      |       |
| Other accrued  liabilities         |       | 23,589   |       | 3,979    |       |
|                               |       | $        | 103,767    |     | $          | 37,979 |   |

** **

**8.           LONG-TERM DEBT ANDCAPITAL LEASES**

** **

Long-term debt (includingcapital lease obligations) at December 31, 2007 and 2006 consists of thefollowing (in thousands):

 
| ** **                                                                                                             | ** ** | **2007**  | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|
| Term loan under  New Senior Secured Credit Facility, net of a 1.2% discount ($12.5 million at  December 31, 2007) |       | $         | 1,052,514  |     | $          | — |   |
|                                                                                                                   |       |      |       |     |       |
| 10.875% Senior  subordinated notes                                                                                     |       | 575,000   |       | —   |       |
|                                                                                                                   |       |      |       |     |       |
| Old Senior  Secured Credit Facility                                                                                    |       | —    |       | 349,125  |       |
|                                                                                                                   |       |      |       |     |       |
| 11.75% Senior  subordinated notes                                                                                      |       | 200,000   |       | 200,000  |       |
|                                                                                                                   |       |      |       |     |       |
| Loans and  revolving credit facilities at various European Banks                                                       |       | 4,239     |       | 4,302    |       |
|                                                                                                                   |       |      |       |     |       |
| Capital lease  obligations and other                                                                                   |       | 1,054     |       | 1,115    |       |
|                                                                                                                   |       | 1,832,807 |       | 554,542  |       |
| Less – current  portion                                                                                           |       | (14,209   | )          | (6,505   | )          |
| Long-term debt  and capital leases, net of current portion                                                             |       | $         | 1,818,598  |     | $          | 548,037 |   |

 

*NewSenior Secured Credit Facility*

 

*Overview. *OnNovember 20, 2007, in connection with the DJO Merger, DJOFL and Holdingsentered into the New Senior Secured Credit Facility.  The New Senior Secured Credit Facilityconsists of a six and a half-year $1,065.0 million term loan facility and asix-year $100.0 million revolving credit facility.  We issued the term loan facility of the NewSenior Secured Credit Facility at a 1.2% discount, resulting in net proceeds of$1,052.4 million, which is included in long-term liabilities in our consolidatedbalance sheet at December 31, 2007. The $12.6 million discount will be amortized as additional interestexpense over the term of the term loan facility and will decrease the reportedoutstanding balance accordingly.  We alsoincurred $54.7 million of related debt financing costs, which have beencapitalized and are included in non-current assets in the consolidated balancesheet at December 31, 2007.  Debtissue costs are being amortized over a period of six and one-half years.  As of December 31, 2007, no amounts weredrawn related to our revolving credit facility; however, $0.9 million was usedto secure outstanding letters of credit.

 

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*InterestRate and Fees.* Borrowings under the New Senior Secured Credit Facility bear interest ata rate equal to an applicable margin plus, at our option, either (a) abase rate determined by reference to the higher of (1) the prime rate ofCredit Suisse and (2) the federal funds rate plus 0.50% or (b) theEurodollar rate determined by reference to the costs of funds for deposits inthe U.S. dollars for the interest period relevant to each borrowing adjustedfor required reserves. The initial applicable margin for borrowings under theterm loan facility and the revolving credit facility is 2.00% with respect tobase rate borrowings and 3.00% with respect to Eurodollar borrowings. Theapplicable margin for borrowings under the term loan facility and the revolvingcredit facility 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 in an effort to hedge ourexposure to fluctuating interest rates related to a portion of our New SeniorSecured Credit Facility (see Note 16). As of December 31, 2007 our weighted average interest rate for allborrowings under the New Senior Secured Credit Facility was 7.53%.

 

In addition to payinginterest on outstanding principal under the New Senior Secured Credit Facility,we are required to pay a commitment fee to the lenders under the revolvingcredit facility in respect of the unutilized commitments thereunder. Theinitial commitment fee rate is 0.50% per annum. The commitment fee rate may bereduced subject to us attaining certain leverage ratios.  We must also pay customary letter of creditfees.

 

*Principalpayments.*  We arerequired to pay annual payments in equal quarterly installments on the loansunder the term loan facility in an amount equal to 1.00% of the funded totalprincipal amount during the first six years and three months following theclosing of the New Senior Secured Credit Facility, with any remaining amountpayable at maturity.  Principal amountsoutstanding under the revolving credit facility are due and payable in full atmaturity.

 

*Prepayments.*  The New Senior Secured Credit Facilityrequires us to prepay outstanding term loans, subject to certain exceptions,with (1) 50% (which percentage can be reduced to 25% or 0% upon ourattaining certain leverage ratios) of our annual excess cash flow, as defined; (2) 100%of the net cash proceeds above an annual amount to be agreed from non-ordinarycourse asset sales (including insurance and condemnation proceeds) by DJOFL andits restricted subsidiaries, subject to exceptions to be agreed upon, includinga 100% reinvestment right if reinvested or committed to reinvest within 15months of such sale or disposition so long as reinvestment is completed within180 days thereafter; and (3) 100% of the net cash proceeds from issuancesor incurrences of debt by DJOFL and its restricted subsidiaries, other thanproceeds from debt permitted to be incurred under the New Senior Secured CreditAgreement.  The foregoing mandatoryprepayments will be applied to the term loan facilities in direct order ofmaturity.  We may voluntarily prepayoutstanding loans under the New Senior Secured Credit Facility at any timewithout premium or penalty, provided that voluntary prepayments of Eurodollarloans made on a date other than the last day of an interest period applicablethereto shall be subject to customary breakage costs.

 

*Guaranteeand Security.*  Allobligations under the New Senior Secured Credit Facility are unconditionallyguaranteed by Holdings and each existing and future direct and indirectwholly-owned domestic subsidiary of DJOFL other than immaterial subsidiaries,unrestricted subsidiaries and subsidiaries that are precluded by law orregulation from guaranteeing the obligations (collectively, the “Guarantors,”see Note 19).

 

All obligations under theNew Senior Secured Credit Facility, and the guarantees of those obligations,are secured by pledges of 100% of the capital stock of DJOFL, 100% of thecapital stock of each wholly owned domestic subsidiary and 65% of the capitalstock of each wholly owned foreign subsidiary that is, in each case, directlyowned by DJOFL or one of the Guarantors; and a security interest in, andmortgages on, substantially all tangible and intangible assets of Holdings,DJOFL and each Guarantor.

 

*CertainCovenants and Events of Default. *TheNew Senior Secured Credit Facility contains a number of covenants that, amongother things, restrict, subject to certain exceptions, our and our subsidiaries’ability to:

 

·                  incur additional indebtedness;

 

·                  create liens on assets;

 

·                  change fiscal years;

 

·                  enter into sale and leasebacktransactions;

 

·                  engagein mergers or consolidations;

 

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·                  sell assets;

 

·                  paydividends and other restricted payments;

 

·                  make investments, loans or advances;

 

·                  repay subordinated indebtedness(including our existing 11.75% and 10.875% Notes (the “Notes”));

 

·                  make certain acquisitions;

 

·                  engage in certain transactions withaffiliates;

 

·                  restrict the ability of restrictedsubsidiaries that are not Guarantors to pay dividends or make distributions;

 

·                  amend material agreements governingour subordinated indebtedness (including our existing Notes); and

 

·                  change our lines of business.

 

In addition, the NewSenior Secured Credit Facility requires us to maintain a maximum senior securedleverage ratio, as defined, of 5.1:1 starting as of the twelve months ended June 30,2008.  The New Senior Secured Credit Facility also contains certaincustomary affirmative covenants and events of default.  Our maximum senior leverage ratio was withinthe initial covenant level as of December 31, 2007.

 

*10.875% Senior Subordinated NotesPayable*

 

On November 20,2007, DJOFL and Finco (collectively, the “Issuers”) issued $575.0 millionaggregate principal amount of 10.875% Notes under an indenture dated as of November 20,2007 (the “10.875% Indenture”) among the Issuers, the guarantors party theretoand The Bank of New York, as trustee. The 10.875% Notes require semi-annual interest payments of approximately$31.3 million each May 15 and November 15 and are due November 15,2014.  The market value of the 10.875%Notes was approximately $560.0 million as of December 31, 2007 and wasdetermined using trading prices for the notes on or near that date.  We believe the trading prices reflect certaindifferences between prevailing market terms and conditions and the actual termsof our 10.875% Notes.

 

*OptionalRedemption. *Under theIndenture Agreement (the “10.875% Indenture”) governing the 10.875% Notes,prior to November 15, 2011, DJOFL has the option to redeem some or all ofthe 10.875% Notes for cash at a redemption price equal to 100% of the thenoutstanding principal balance plus an applicable make-whole premium plusaccrued and unpaid interest. Beginning on November 15, 2011, DJOFL mayredeem some or all of the 10.875% Notes at a redemption price of 105.438% ofthe then outstanding principal balance plus accrued and unpaid interest.  The redemption price decreases to 102.719%and 100.000% of the then outstanding principal balance at November 2012and November 2013, respectively. Additionally, from time to time, before November 15, 2010, DJOFLmay redeem up to 35% of the 10.875% Notes at a redemption price equal to 110.875%of the principal amount then outstanding, in each case, with proceeds raised,or a direct or indirect parent company raises, in certain equity offerings, aslong as at least 65% of the aggregate principal amount of the notes issuedremains 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, 2007, we were in compliance with all applicablecovenants.

 

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*11.75% Senior Subordinated Notes**Payable*

 

During the fourth quarter of 2006, the Issuers issuedand sold $200.0 million aggregate principal amount of 11.75% Notes. The 11.75%Notes require semi-annual interest payments of approximately $11.8 million eachMay 15 and November 15 and are due November 15, 2014.  We filed a registration statement on Form S-4with the Securities and Exchange Commission relating to an exchange offer toexchange these privately issued 11.75% Notes for registered 11.75% Notes. Theregistration statement was declared effective on May 2, 2007.  The exchange offer was completed on June 5,2007.

 

The market value of the11.75% Notes was approximately $180.0 million as of December 31, 2007 andwas determined using trading prices for the notes on or near that date.  We believe the trading prices reflect certaindifferences between prevailing market terms and conditions and the actual termsof our 11.75% Notes.

 

*Optional Redempti*on.  Under the Indenture Agreement governing the11.75% Notes (the “11.75% Indenture”), prior to November 15, 2010, DJOFLhas 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, DJOFL may redeem some or all of the 11.75% Notes at aredemption price of 105.875% of the then outstanding principal balance plusaccrued and unpaid interest.  Theredemption price decreases to 102.938% and 100.000% of the then outstandingprincipal balance at November 2011 and November 2012,respectively.  Additionally, from time totime, before November 15, 2009, DJOFL may redeem up to 35% of the 11.75%Notes at a redemption price equal to 111.75% of the principal amount thenoutstanding, in each case, with proceeds raised, or a direct or indirect parentcompany raises, in certain equity offerings, as long as at least 65% of theaggregate principal amount of the notes 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 11.75%Notes, DJOFL will be required to make an offer to repurchase all of thethen-outstanding 11.75% Notes at 101% of their principal amount, plus accrued andunpaid interest.

 

*Guarantee*.  DJOFL’s subsidiaries that guarantee the NewSenior Secured Credit Facility, jointly and severally, and unconditionallyguarantee the 11.75% Notes on an unsecured senior subordinated basis (see Note19).

 

*Covenants. *The11.75% Indenture contains a number of covenants that restrict, our ability andthe ability of our restricted subsidiaries to incur additional debt or issuecertain preferred and convertible shares, pay dividends on, redeem, repurchaseor make distributions in respect of our capital stock or make other restrictedpayments, make certain investments, sell certain assets, create liens oncertain assets to secure debt, consolidate, merge, sell or otherwise dispose ofall or substantially all of our assets, enter into certain transactions withour affiliates and designate our subsidiaries as unrestrictedsubsidiaries.  As of December 31,2007, we were in compliance with all applicable covenants.  Based upon our adjusted EBITDA (as defined inthe 11.75% Indenture) to fixed charges ratio at December 31, 2007, ourability to incur additional debt and make restricted payments is restricted,except that we may incur certain debt and make certain restricted payments andcertain permitted investments without regard to the ratio, such as our abilityto (i) incur up to an aggregate principal amount of $400.0 million undercredit facilities, plus the lesser of (a) $50 million and (b) anamount equal to the aggregate amount of our EBITDA for the four fiscal quartersfor which internal financial statements are immediately preceding such datetimes five, with appropriate pro forma adjustments to EBITDA on the date onwhich such indebtedness is to be incurred less the amount of our securedindebtedness outstanding on the date of such incurrence, (ii) acquirepersons engaged in a similar business that become restricted subsidiaries and (iii) makeother investments having an aggregate fair market value not to exceed 3.5% ofTotal Assets (as defined in the 11.75% Indenture) provided that the AdjustedEBITDA to fixed charges ratio is less than 6.00:1 on a pro forma basis aftergiving effect to such investment.  Fixedcharges is defined in the 11.75% Indenture as consolidated interest expenseplus all cash dividends or other distributions paid on any series of preferredstock of any restricted subsidiary and all dividends or other distributionsaccrued on any series of disqualified stock.

 

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 New 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 New Senior Secured CreditFacility to be immediately due and payable. Any such acceleration would alsoresult in a default under the Indentures.

 

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At December 31, 2007, the aggregate amounts of annualprincipal maturities of long-term debt and capital leases for the next fiveyears and thereafter is as follows (in thousands):

 

| **Year Ending December 31,** | ** ** |
|---------------------------------------------|------------|
| 2008                                        |       | $ | 14,209 |   |
| 2009                                        |       | 9,731 |   |
| 2010                                        |       | 9,425 |   |
| 2011                                        |       | 9,229 |   |
| 2012                                        |       | 8,941 |   |
| Thereafter                                  |       | 1,781,272 |   |
|                                             |            |  |  |  |

 

*CefarIndebtedness*

 

In connection with the Cefar acquisition, we assumed$2.9 million of revolving credit facilities and $2.7 million of term loans tovarious European banks.  At December 31,2007, the balances outstanding were $2.4 million for the revolving creditfacilities and $1.8 million for the term loans.

 

*OldSenior Secured Credit Facility*

 

In connection with the Prior Transaction, the Issuersentered into the Old Senior Secured Credit Facility.  The Old Senior Secured Credit Facilityprovided senior secured financing of $455.0 million, consisting of a six-year$50.0 million revolving credit facility and a seven-year $405.0 million termloan facility.  On November 20, 2007, werepaid the outstanding balance due, including accrued interest, in connectionwith the DJO Merger.

 

**9.           MEMBERSHIP EQUITY**

 

## **Inconnection with the Prior Transaction, shares of ReAble’s common stock were adjustedsuch that every 62.8 shares of common stock outstanding prior to the PriorTransaction were revalued as 1 share of ReAble’s common stock. Subsequently, on November 8, 2006, following the closing of the PriorTransaction, we effected a 25 for 1 stock split, which resulted in every 1share of ReAble’s common stock becoming 25 shares of ReAble’s commonstock.  The consolidated financial statements have been retroactivelyadjusted to reflect these share adjustments for all periods presented.**

## ** **

In connection with thePrior Transaction, an affiliate of Blackstone acquired all equity interests ofReAble for $357.0 million (see Note 2).  Simultaneously with thistransaction, ReAble, through Holdings, acquired all Membership Equity ofDJOFL.  Options to acquire shares of common stock of ReAble owned by thethen current executive officers that had not been exercised at or prior to theeffective time of the Prior Transaction continued to remain as outstanding andcontinued as options to purchase 805,150 shares of ReAble’s common stock (the “PriorTransaction Management Rollover Options”).  The fair value of theseoptions approximated $7.2 million and was recorded as a component of the costof the acquisition of ReAble.

 

In connection with theDJO Merger, an affiliate of Blackstone made a cash equity contribution of$434.6 million.  Additionally, werepurchased 264,525 of the Prior Transaction Management Rollover Options fromcertain ReAble executives who were terminated in connection with the DJO Mergerat a per share price of $16.46.  At the closing of the DJO Merger, theseformer ReAble executives also forfeited all unvested stock options previouslyissued to them under the 2006 Stock Incentive Plan at the closing of the DJOMerger.  Furthermore, certain members of DJO Opco management chose torollover certain of their DJO Opco options which were exchanged into options topurchase 1,912,577 shares under the 2007 Incentive Stock Plan on a tax-deferredbasis (the “DJO Management Rollover Options”).  The fair value of theseoptions approximated $15.2 million and was recorded as a component of the costof the DJO Merger.  Also, on November 20,2007, we granted an executive officer 24,300 shares (net of taxes) ofrestricted stock under the 2007 Incentive Stock Plan, which will vest on January 1,2009 (See Note 10 for further information).

 

On November 7, 2006,we acquired all of the issued and outstanding shares of Cefar for a total of$27.1 million (see Note 2). Of the total purchase price, $9.5 million was paidthrough the issuance of shares of our common stock.  The fair value of thecommon stock issued was determined to be $16.46 per share based on the pershare price used in the Prior Transaction.

 

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

 

Effective January 1,2006, we adopted SFAS 123(R) using the modified prospective method, inwhich compensation cost was recognized beginning with the effective date (a) basedon the requirements of SFAS 123(R) for all share-based payments grantedafter the effective date and (b) based on the requirements of SFAS 123(R) forall awards granted to employees prior to the effective date of SFAS 123(R) thatremain unvested on the effective date.

 

With the adoption of SFAS123(R), we elected to amortize stock-based compensation for awards granted onor after the adoption of SFAS 123(R) on January 1, 2006 on astraight-line basis over the requisite service (vesting) period for the entireaward.

 

We recorded non-cashcompensation expense of approximately $1.5 and $0.1 million in the consolidatedstatements of operations for the Successor year ended December 31, 2007and for the period November 4, 2006 through December 31, 2006,respectively, associated with stock options issued under the 2006 StockIncentive Plan (the “2006 Plan”). We record compensation cost for awards with aperformance condition only to the extent deemed probable of achievement.  We are required to reassess at each reportingperiod whether achievement of any performance condition is probable, at whichtime we would recognize the related compensation cost over the remainingperformance or service period, if any. To date, no amounts have been recorded for the performance conditionstock option tranches under the 2006 Plan, as achievement of the performancecriteria has not been deemed probable. At December 31, 2007, there were1,087,688 unvested stock options under the 2006 Plan.

 

*2007 Incentive Stock Plan*

 

On November 20,2007, in connection with the DJO Merger, we adopted the 2007 Incentive StockPlan (the “2007 Plan”) which provides for the grant of stock options and otherstock-based awards to key employees, directors and consultants, including theexecutive officers. The total number of shares of common stock of DJO that maybe issued under the 2007 Plan is 5,000,000 subject to adjustment in certainevents, with an additional 2,500,000 shares to be authorized when a pendingamendment is completed. The exercise price of stock options granted under the2007 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. In addition, DJO adopted a formof non-statutory stock option agreement (the “DJO Form Option Agreement”)for awards under the 2007 Plan.  Underthe DJO Form Option Agreement, certain stock options will vest over aspecified period of time (typically five years) contingent solely upon theawardees’ continued employment with us (“service” tranche).  Other stock options will vest over aspecified performance period (typically five years) from the date of grant uponthe achievement of certain pre-determined performance targets based on EBITDAand Free Cash Flow over time (“performance” tranche), as defined in the DJO Form OptionAgreement, while others vest based upon achieving an enhanced pre-determinedperformance target based on EBITDA and Free Cash Flow (“enchanced performancetranche”). The DJO Form Option Agreement includes certain forfeitureprovisions upon an awardees’ separation from service with us.

 

As a result of the DJOMerger, certain members of DJO Opco management elected to rollover theiroptions and were permitted to exchange optionsto purchase DJO Opco shares they held at the closing of the DJO Mergerinto fully vested options to purchase 1,912,577 of our shares under the 2007Plan on a tax-deferred basis. The exercise price and number of sharesunderlying such options were each determined in proportion to the relativemarket values of DJO Opco’s common stock and DJO’s common stock upon theclosing of the DJO Merger.  All of the DJO Merger Management RolloverOptions remained subject to the same terms as was applicable to the rolloveroption and became fully vested.  The fair value of these fully vestedoptions was $15.2 million and was recorded as a component of the cost of theDJO Merger.  The DJO Merger ManagementRollover Options have a weighted-average exercise price of $11.09, aweighted-average contractual term of 8.0 years and an intrinsic value ofapproximately $10.3 million.

 

*2006 Stock Incentive Plan*

 

In connection with thePrior Transaction, the compensation committee of the board of directors ofReAble adopted the 2006 Plan effective November 3, 2006.  The 2006 Plan provided for the grant of stockoptions and other stock-based awards to key employees, directors andconsultants, including executive officers. In connection with the DJO Merger and change in management, weterminated the 2006 Plan and as of that date, outstanding options to purchaseour stock originally issued under the 2006 Plan are now governed by the termsof the 2007 Plan.  Furthermore, formerReAble executives forfeited all stock options previously issued under the 2006Plan.

 

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*Summary of Plans – Predecessor*

 

Before the PriorTransaction, ReAble had a number of stock option plans.  All stock option plans in effect at the dateof the Prior Transaction were terminated. With the exception of 805,150 Prior Transaction Management RolloverOptions held by former ReAble executive officers, outstanding vested options topurchase common stock of ReAble were cancelled in exchange for cash in theamount equal to the excess of $16.46 over the exercise price per sharemultiplied by the number of shares of common stock.  We recorded a charge of $7.5 million for thePredecessor period January 1, 2006 through November 3, 2006 relatedto the accelerated vesting of these shares upon the change in control on November 3,2006.  During the fourth quarter of 2007,in connection with the DJO Merger, we repurchased 264,525 of the PriorTransaction Management Rollover Options at a per share price of $16.46.  The remaining Prior Transaction ManagementRollover Options are fully vested and continue as options to purchase ourcommon stock, have a weighted-average exercise price of $12.22, an averagecontractual term of 7.6 years, and an intrinsic value of approximately $2.2million.

 

Non-employee stock compensationexpense was approximately $0.2 million and $0.2 million for the Predecessorperiod January 1, 2006 through November 3, 2006 and for the yearended December 31, 2005, respectively, which is included in selling,general and administrative expenses in the consolidated statements ofoperations for the respective periods.

 

*Summary of Assumptions andActivity*

 

The fair value of eachoption award is estimated on the date of grant using the Black-Scholes-Mertonoption pricing model for service and performance based awards, and a binomialmodel for market based awards. In estimating fair value related to the DJOMerger Management Rollover Options, expected volatility was based on 100%implied volatility of comparable publicly-traded companies.  Expected volatility rates used by ReAblesubsequent to the Prior Transaction, related to stock options granted under the2006 Plan, were based on the historical volatility of ReAble common stock andother factors such as implied volatility of traded options of a comparable peergroup.  In periods prior to January 1,2006, volatility was estimated based upon historical volatility of ReAblecommon stock and other factors such as implied volatility of traded options.The change in determining the expected volatility assumption in periodssubsequent to January 1, 2006 was based in part upon the guidance providedby the Securities and Exchange Commission in Staff Accounting Bulletin No. 107.The expected life assumptions for all periods were derived from a review ofannual historical employee exercise behavior of option grants with similarvesting periods. Expected life is calculated in two tranches based on theemployment level defined as executive or employee. The risk-free rate used tocalculate the fair value of the market condition stock option tranche is basedon the contractual life of the option, whereas the risk-free rate used incalculating the fair value of the rollover stock options, service andperformance stock option tranches is based on the expected term of the option.In all cases, the risk-free rate is based on the U.S. Treasury yield bond curvein effect at the time of grant.

 

The assumptions used tocalculate the fair value of options granted are evaluated and revised, asnecessary, to reflect market conditions and experience.  The key assumptions used in determining fairvalue of share based payment awards for the Successor year ended December 31,2007, the period November 4, through December 31, 2006 and for thePredecessor period January 1, through November 3, 2006 and the yearended December 31, 2005 were as follows:

 

| ** **                | ** ** | **Successor**                                | ** ** | **Predecessor**                                                  | ** ** |
|---------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** | **Year Ended  December 31,  2005*** | ** ** |
| Expected  dividends       |       | 0.0                                          | %          | 0.0                                                              | %          | 0.0 | % | 0.0 | % |
| Expected  volatility      |       | 27.4% - 60.0                                 | %          | 43.7% - 60.0                                                     | %          | 61.0 | % | 70.1% - 81.7 | % |
| Risk-free rate            |       | 3.5% – 4.7                              | %          | 4.7                                                              | %          | 4.5% - 4.8 | % | 3.7% - 4.4 | % |
| Expected term  (in years) |       | 4.7 – 7.1                               |       | 2.6 – 5.7                                                   |       | 4.5 – 5.6 |   | 4.0 – 4.1 |   |

 

----

*Theassumptions for the year ended December 31, 2005 were used to calculatepro-forma compensation expense per SFAS 123 for disclosure purposes only.

 

90

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A summary of optionactivity under the 2007 Plan for the year ended December 31, 2007 ispresented below:

 
| ** **                                                   | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate Intrinsic  Value** | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                   | ** ** | ** **                 | ** ** | ** **                                  | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Outstanding at  January 1, 2007                         |       | 3,044,650                  |       | $                                           | 15.34      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Repurchase of  Prior Transaction management rollover options |       | (264,525                   | )          | 11.74                                       | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Granted                                                      |       | 252,500                    |       | 16.46                                       | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| DJO Management  Rollover Options                             |       | 1,912,577                  |       | 11.09                                       | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Exercised                                                    |       | —                     |       | —                                      | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Forfeited                                                    |       | (1,394,575                 | )          | 16.43                                       | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Outstanding at  December 31, 2007                       |       | 3,550,627                  |       | $                                           | 12.97      |                                                            | 8.2        |                                | $          | 12,461,487 |   |
| Exercisable at  December 31, 2007                       |       | 2,462,939                  |       | $                                           | 11.43      |                                                            | 7.9        |                                | $          | 12,461,487 |   |

 

The following tablesummarizes information about stock options granted for the Successor year endedDecember 31, 2007, the period November 4, through December 31,2006 and for the Predecessor period January 1, through November 3,2006, and the year ended December 31, 2005 as follows:

 

| ** **                                                                                    | ** ** | **Successor**                                | ** ** | **Predecessor**                                                  | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** |
|                                                                                          |       |                                         |       |                                                             |       |   |   |
| Weighted-average  grant-date fair value of stock options granted during the periods presented |       | $                                            | 8.09       |                                                             | $          | 8.96 |   | $ | 9.25 |   |
|                                                                                               |            |                                              |            |                                                                  |            |  |  |  |  |  |

 

There were no stockoption exercises for the Successor year ended December 31, 2007 or for theperiod November 4, through December 31, 2006.  The total intrinsic value of optionsexercised during the Predecessor period January 1, 2006 through November 3,2006 was $7.5 million.

 

Total unrecognized stock-based compensation expense,related to nonvested stock options under the 2007 Plan, net of expectedforfeitures, was approximately $7.6 million as of December 31, 2007.  We anticipate this expense to be recognizedover a weighted-average period of approximately 4 years.  However, compensation expense associated withperformance-based options under the 2007 Plan will be recognized only to theextent achievement of certain performance targets are deemed probable.

 

The following tablesummarizes the effect of adopting SFAS 123(R) for the Successor year endedDecember 31, 2007 and the period November 4, through December 31,2006 and the Predecessor period January 1, through November 3, 2006(in thousands):

 

| ** **                            | ** ** | **Successor**                                | ** ** | **Predecessor**                                                  | ** ** |
|---------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                            | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3, 2006** | ** ** |
| ** **                            | ** ** | ** **                                   | ** ** | ** **                                                       | ** ** | ** ** | ** ** |
| Stock-based  compensation recognized: |       |                                         |       |                                                             |       |   |   |
| Cost of sales                         |       | $                                            | 36         |                                                             | $          | 2 |   | $ | 228 |   |
| Selling, general  and administrative  |       | 1,484                                        |       | 102                                                              |       | 10,025 |   |
| Research and  development             |       | 21                                           |       | 1                                                                |       | 207 |   |
| Total                                 |       | 1,541                                        |       | 105                                                              |       | 10,460 |   |
| Related deferred  income tax benefit  |       | (603                                         | )          | (41                                                              | )          | (693 | ) |
| Increase in net  loss                 |       | $                                            | 938        |                                                             | $          | 64 |   | $ | 9,767 |   |

 

91

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*Pro-Forma Disclosure for YearEnded December 31, 2005*

 

If the fair value basedmethod prescribed by SFAS 123(R) had been applied in measuring employeestock compensation expense for the Predecessor year ended December 31,2005, the pro-forma effect on net income would have been as follows (in thousands):

** **

| ** **                                                                                                                                    | ** ** | **Year Ended  December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Net income, as reported                                                                                                                       |       | $                                                | 12,330     |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value-based  method for all awards, net of related tax effects |       | (1,291                                           | )          |
| Net income, pro forma                                                                                                                         |       | $                                                | 11,039     |   |

 

*Restricted Stock*

 

On March 13, 2007,we granted 15,189 shares of restricted stock awards to an executive officerpursuant to the terms of a restricted stock agreement under the 2006 Plan. Theshares are subject to a vesting schedule over a period of three years with thefinal vesting on November 3, 2009. On November 20, 2007, we granted24,300 shares of restricted stock awards to the same executive officer pursuantto the terms of a restricted stock agreement under the 2007 Incentive StockPlan, which will all vest on January 1, 2009.

 

A summary of ournonvested restricted stock awards as of December 31, 2007, and changesduring the year ended December 31, 2007, is presented below:

 

| **Nonvested Restricted Stock** | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Grant Date  Fair Value** | ** ** |
|------------------------------------------|------------|----------------------------|------------|----------------------------------------------------------|------------|
| ** **                               | ** ** | ** **                 | ** ** | ** **                                               | ** ** |
| Nonvested at  January 1, 2007       |       | —                     |       | $                                                        | —     |   |
| Granted                                  |       | 39,489                     |       | 16.46                                                    |       |
| Vested                                   |       | (5,062                     | )          | 16.46                                                    |       |
| Forfeited                                |       | —                     |       | —                                                   |       |
| Nonvested at  December 31, 2007     |       | 34,427                     |       | $                                                        | 16.46      |   |

 

The total fair value ofrestricted stock awards that vested during the Successor year ended December 31,2007 was approximately $0.1 million. Compensation expense is recognized on astraight-line basis over the respective vesting period. No restricted stockawards existed prior to 2007. As of December 31, 2007, there wasapproximately $0.5 million of total unrecognized compensation cost related tounvested restricted stock. This cost is expected to be recognized over aweighted-average period of approximately 1.3 years.

 

**11.         SEGMENT AND GEOGRAPHICINFORMATION**

** **

Prior to the fourth quarter of 2007, we operated andaccounted for our results as two reportable segments, including the OrthopedicRehabilitation Segment and the Surgical Implant Segment.  In the fourth quarter of 2007, in connectionwith the DJO Merger and the hiring of a new Chief Executive Officer, who hasbeen identified as the Chief Operating Decision Maker pursuant to SFAS No. 131,“*Disclosures about Segments of an Enterprise andRelated Information*”, we effected an operational reorganization,which resulted in the creation of the three operating segments furtherdescribed below.

 

Following the DJO Merger, we provide a broad array oforthopedic rehabilitation and regeneration products, as well as implants tocustomers in the United States and abroad. Our reportable segments are managed separately because each segmentrequires different sales and marketing strategies and in some cases offersdifferent products.  We currently develop, manufacture and distributeour products through the following three operating segments:

 

92

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***DomesticRehabilitation Segment***

 

We market our domestic rehabilitation segment productsthrough the three divisions described below.

 

*DonJoy, ProCare and Aircast.*OurDonJoy, ProCare and Aircast division was acquired with the DJO Merger andoffers products in the following categories:

 

·                  rigid kneebracing, which includes functional bracing for prevention and rehabilitation ofligament injuries, load shifting braces to relieve osteoarthritis pain andpost-operative braces for protecting surgical repair;

 

·                  orthopedic softgoods, which include products that offer immobilization and support from headto toe;

 

·                  cold therapyproducts, which assist in the reduction of swelling and pain; and

 

·                  vascularsystems, which include products intended to prevent deep vein thrombosisfollowing surgery.

 

This division also includes our OfficeCare business,through which we maintain an inventory of soft goods and other products athealthcare facilities, primarily orthopedic practices, for immediatedistribution to patients.

 

*Empi.*Our Empidivision offers products in the following categories:

 

·                  homeelectrotherapy, which includes transcutaneous electrical nerve stimulation (“TENS”)for pain management and neuromuscular electrical nerve stimulation (“NMES”)devices for rehabilitation;

 

·                  bone growthstimulation products acquired with the DJO Merger, which promote the healing ofbone tissue through combined magnetic field (“CMF”) technology;

 

·                  iontophoresis,which includes devices and accessories to deliver medication transdermally; and

 

·                  home traction,which includes cervical and lumbar traction devices designed to providedecompression to the spine.

 

This division also includes our Rehab Med + Equip (“RME”)and EmpiCare 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.  Through our EmpiCare business, we maintain aninventory of soft goods and other products at healthcare facilities, primarilyorthopedic practices, for immediate distribution to patients.

 

*Chattanooga.*OurChattanooga Group offers products in the clinical rehabilitation market in thefollowing categories:

 

·                  clinicalelectrotherapy devices (such as TENS, NMES, laser, ultrasound and lighttherapy);

 

·                  clinicaltraction devices; and

 

·                  other clinicalproducts and supplies such as treatment tables, continuous passive motion (“CPM”)devices and dry heat therapy.

 

***InternationalRehabilitation Segment***

 

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

 

·                  theinternational sales of our DonJoy, ProCare and Aircast products, includingrigid knee bracing products, orthopedic soft goods, cold therapy products andvascular systems;

 

·                  our Ormedbusiness, which provides bracing, CPM, electrotherapy and other products inGermany; and

 

·                  our Cefar-Compexbusiness, which provides electrotherapy products for medical and consumermarkets and other physical therapy and rehabilitation products primarily inEurope.

 

93

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We sell our Domestic andInternational Rehabilitation Segment products through a variety of distributionchannels.  We sell our home therapyproducts to wholesale customers and directly to patients.  We recognize wholesale revenue when we shipour products to our wholesale customers. We recognize home therapy retail revenue, both rental and purchase, whenour product has been dispensed to the patient and the patient’s insurance hasbeen verified.  We recognize revenue forproduct shipped directly to the patient at the time of shipment.  For retail products that are sold from ourinventories consigned at clinic locations, we recognize revenue when we receivenotice that the device has been prescribed and dispensed to the patient and theinsurance has been verified or preauthorization from the insurance company hasbeen obtained, when required.

 

We sell our DonJoyproducts through a network of independent sales representatives.  We record revenues from sales made by salesrepresentatives, who are paid commissions, when the product is shipped to thecustomer.  For certain of our otherproducts, we sell directly to the patient and bill a third party payor, ifapplicable, on behalf of the patient.

 

We sell our ProCare,Aircast and clinical rehabilitation products to distributors.  We record revenue at the time product isshipped to the distributor.  Distributorstake title to the products, assume credit and product obsolescence risks, mustpay within specified periods regardless of when they sell or use the productsand have no price protection except for distributors who participate in ourrebate program.

 

We sell our products tocustomers outside the United States through wholly owned subsidiaries orindependent distributors.  We recordrevenue from sales to distributors at the time product is shipped to thedistributor.  Our internationaldistributors take title to the products, assume credit and product obsolescencerisks, must pay within specified periods regardless of when they sell theproducts and have no price protection. We record revenue from sales made by our wholly owned subsidiaries atthe time product is shipped to the customer.

 

***Surgical ImplantSegment***

 

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 SurgicalImplant Segment products through a network of independent sales representativesin the United States, as well as distributors outside the United States.  We record revenues from sales made by salesrepresentatives, who are paid commissions at the time the product is used in asurgical procedure (implanted in a patient) and a purchase order is receivedfrom the hospital.  We record revenuesfrom sales to customers outside the United States at the time the product isshipped to the distributor.  We includeamounts billed to customers for freight in revenue.  Our international distributors, who sell theproducts to their customers, take title to the products, have no rights ofreturn and assume the risk for credit and obsolescence.  Distributors are obligated to pay us withinspecified terms, regardless of when they sell the products. In addition, thereis no price protection available to distributors.

 

Information regarding ourreportable business segments is presented below (in thousands).  This information excludes the impact ofcertain expenses not allocated to segments, primarily general corporateexpenses.  All prior periods presentedhave been restated to reflect our current reportable segments.

 

94

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| ** **                                    | ** ** | **Successor**                                | ** ** | **Predecessor**                                                  | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1,  2006 through  November 3,  2006** | ** ** | **Year Ended  December 31,  2005** | ** ** |
| **Net  sales:**                               |       |                                         |       |                                                             |       |   |   |   |   |
| Domestic  Rehabilitation Segment              |       | $                                            | 321,398    |                                                             | $          | 35,766 |   | $ | 206,911 |   | $ | 201,163 |   |
| International Rehabilitation Segment          |       | 104,145                                      |       | 14,373                                                           |       | 46,141 |   | 38,098 |   |
| Surgical Implant Segment                      |       | 66,591                                       |       | 7,763                                                            |       | 51,331 |   | 54,465 |   |
| Consolidated net sales                        |       | $                                            | 492,134    |                                                             | $          | 57,902 |   | $ | 304,383 |   | $ | 293,726 |   |
|                                          |       |                                         |       |                                                             |       |   |   |   |   |
| **Gross profit:**                             |       |                                         |       |                                                             |       |   |   |   |   |
| Domestic Rehabilitation Segment               |       | $                                            | 181,519    |                                                             | $          | 18,698 |   | $ | 114,084 |   | $ | 113,906 |   |
| International Rehabilitation Segment          |       | 57,714                                       |       | 6,638                                                            |       | 27,807 |   | 22,151 |   |
| Surgical Implant Segment                      |       | 47,037                                       |       | 5,779                                                            |       | 35,212 |   | 42,296 |   |
| Consolidated gross profit                     |       | $                                            | 286,270    |                                                             | $          | 31,115 |   | $ | 177,103 |   | $ | 178,353 |   |
|                                          |       |                                         |       |                                                             |       |   |   |   |   |
| **Operating income:**                         |       |                                         |       |                                                             |       |   |   |   |   |
| Domestic Rehabilitation Segment               |       | $                                            | (8,255     | )                                                                | $          | (17,382 | ) | $ | 3,629 |   | $ | 36,401 |   |
| International Rehabilitation Segment          |       | 888                                          |       | (901                                                             | )          | 640 |   | 6,197 |   |
| Surgical Implant Segment                      |       | 2,322                                        |       | (12,640                                                          | )          | 5,404 |   | 10,708 |   |
| Income from operations of reportable segments |       | (5,045                                       | )          | (30,923                                                          | )          | 9,673 |   | 53,306 |   |
| Expenses not allocated to segments            |       | (34,391                                      | )          | (11,224                                                          | )          | (32,471 | ) | (9,619 | ) |
| Consolidated operating income (loss)          |       | $                                            | (39,436    | )                                                                | $          | (42,147 | ) | $ | (22,798 | ) | $ | 43,687 |   |

 

The accounting policies of the reportable segments arethe same as the accounting policies of the Company. We allocate resources andevaluate the performance of segments based on net sales, gross profit,operating income and other non-GAAP measures. Moreover, we do not allocate assets to reportable segments because asignificant portion of assets are shared by the segments.

 

## **GeographicArea**

## ** **

Following are our netsales by geographic area (in thousands):

 
| ** **      | ** ** | **Successor**                                | ** ** | **Predecessor**                                                      | ** ** |
|-----------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **      | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4, 2006  through December 31,  2006** | ** ** | **January 1, 2006  through November 3,  2006** | ** ** | **Year Ended  December 31,  2005** | ** ** |
| **Net  sales:** |       |                                         |       |                                                                 |       |   |   |   |   |
| United States   |       | $                                            | 359,313    |                                                                 | $          | 41,007 |   | $ | 234,791 |   | $ | 230,437 |   |
| France          |       | 24,257                                       |       | 3,575                                                                |       | 6,156 |   | 1,399 |   |
| Germany         |       | 45,418                                       |       | 6,418                                                                |       | 31,982 |   | 41,161 |   |
| Spain           |       | 11,732                                       |       | 1,524                                                                |       | 4,130 |   | 1,116 |   |
| Other           |       | 51,414                                       |       | 5,378                                                                |       | 27,324 |   | 19,613 |   |
|            |       | $                                            | 492,134    |                                                                 | $          | 57,902 |   | $ | 304,383 |   | $ | 293,726 |   |

 

----

*Net sales are attributed to countries based on location of customer.  For the Successor year ended December 31,2007, and the period November 4, 2006 through December 31, 2006 andthe Predecessor period January 1, 2006 through November 3, 2006 andthe year ended December 31, 2005, we had no individual customer ordistributor that accounted for 10% or more of total annual revenues.

 

**F**ollowing are ourlong-lived assets by geographic area as of December 31, 2007 and 2006 (inthousands):

 
| ** **    | ** ** | **December 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------|------------|-----------------------------|------------|-----------------------------|------------|
| United States |       | $                           | 2,592,799  |                        | $          | 751,914 |   |
| International |       | 118,013                     |       | 103,911                     |       |
|          |       | $                           | 2,710,812  |                        | $          | 855,825 |   |

** **

**95**

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** **

**12.          INCOME TAXES**

** **

DJO is the taxpayer inthe U.S., while our foreign subsidiaries are subjected to income tax in theapplicable local jurisdictions.  AlthoughDJOFL is not a U.S. taxpayer, pursuant to the provisions of Statement ofFinancial Accounting Standards No. 109, *“Accountingfor Income Taxes”*, the tax expense of DJO has been pushed down tothe stand alone financial statements of DJOFL.

 

The components of income(loss) from continuing operations before income taxes for the applicableperiods consist of the following (in thousands):

 
| ** **          | ** ** | **Successor**                                | ** ** | **Predecessor**                                                      | ** ** |
|---------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **          | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4, 2006  through December 31,  2006** | ** ** | **January 1,  2006 through  November 3,  2006** | ** ** | **Year Ended  December 31,  2005** | ** ** |
| U.S. operations     |       | $                                            | (123,228   | )                                                                    | $          | (49,380 | ) | $ | (56,905 | ) | $ | 10,788 |   |
| Foreign  operations |       | (1,282                                       | )          | (933                                                                 | )          | (551 | ) | 4,760 |   |
|                |       | $                                            | (124,510   | )                                                                    | $          | (50,313 | ) | $ | (57,456 | ) | $ | 15,548 |   |

 

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

 
| ** **              | ** ** | **Successor**                                | ** ** | **Predecessor**                                                  | ** ** |
|-------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **              | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** | **Year Ended  December 31,  2005** | ** ** |
| Current income  taxes:  |       |                                         |       |                                                             |       |   |   |   |   |
| U.S. Federal and  State |       | $                                            | 1,321      |                                                             | $          | 27 |   | $ | 489 |   | $ | 6,816 |   |
| Foreign                 |       | 3,397                                        |       | 59                                                               |       | 1,343 |   | 2,175 |   |
| Deferred income  taxes: |       |                                         |       |                                                             |       |   |   |   |   |
| U.S. Federal and  State |       | (43,944                                      | )          | (8,474                                                           | )          | (12,325 | ) | (2,724 | ) |
| Foreign                 |       | (3,277                                       | )          | (368                                                             | )          | (959 | ) | (206 | ) |
|                    |       | $                                            | (42,503    | )                                                                | $          | (8,756 | ) | $ | (11,452 | ) | $ | 6,061 |   |

 

Thedifference between the tax expense (benefit) derived by applying the U.S.Federal statutory income tax rate of 35% to net income (loss) and the expense(benefit) recognized in the consolidated financial statements is as follows (inthousands):

 
| ** **                                                                                                         | ** ** | **Successor**                                | ** ** | **Predecessor**                                                  | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1, 2006  through  November 3,  2006** | ** ** | **Year Ended  December 31,  2005** | ** ** |
| Expense  (benefit) derived by applying the Federal statutory income tax rate to income  (loss) before income taxes |       | $                                            | (43,579    | )                                                                | $          | (17,609 | ) | $ | (20,110 | ) | $ | 5,442 |   |
| Add (deduct) the  effect of:                                                                                       |       |                                         |       |                                                             |       |   |   |   |   |
| State tax  provision (benefit), net                                                                                |       | (3,211                                       | )          | (816                                                             | )          | (1,343 | ) | 453 |   |
| Nondeductible  IPR&D                                                                                           |       | 1,050                                        |       | 8,820                                                            |       | 1,364 |   | — |   |
| Nondeductible  transaction costs                                                                                   |       | —                                       |       | 1,426                                                            |       | 4,750 |   | — |   |
| SFAS 123(R),  related to incentive stock options                                                                   |       | —                                       |       | —                                                           |       | 2,561 |   | — |   |
| Change in German  tax laws                                                                                         |       | (1,458                                       | )          | —                                                           |       | — |   | — |   |
| Permanent  differences and other, net                                                                              |       | 4,695                                        |       | (577                                                             | )          | 1,326 |   | 166 |   |
|                                                                                                               |       | $                                            | (42,503    | )                                                                | $          | (8,756 | ) | $ | (11,452 | ) | $ | 6,061 |   |

 

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Thecomponents of deferred income tax assets and liabilities as of December 31,2007 and 2006 are as follows (in thousands):

 

| ** **                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets:             |       |     |       |     |       |
| Net operating  loss carryforwards |       | $        | 112,678    |     | $          | 20,764 |   |
| Inventory                         |       | 5,671    |       | 7,424    |       |
| Receivables                       |       | 15,344   |       | 16,027   |       |
| Accrued  compensation             |       | 1,672    |       | 691      |       |
| Accrued expenses                  |       | 3,050    |       | —   |       |
| Transfer pricing                  |       | 2,373    |       | —   |       |
| Other                             |       | 1,593    |       | 1,592    |       |
|                              |       | 142,381  |       | 46,498   |       |
|                              |       |     |       |     |       |
| Deferred tax  liabilities:        |       |     |       |     |       |
| Property and  equipment           |       | (5,428   | )          | (4,769   | )          |
| Intangible  assets                |       | (454,280 | )          | (115,647 | )          |
| Foreign currency  translation     |       | (7,648   | )          | (1,789   | )          |
| Other                             |       | (16,196  | )          | (4,506   | )          |
| Valuation  allowance              |       | (16,489  | )          | (5,285   | )          |
|                              |       | (500,041 | )          | (131,996 | )          |
| Net deferred tax  liabilities     |       | $        | (357,660   | )        | $          | (85,498 | ) |

 

As a result of the DJOMerger and the Prior Transaction, we recorded significant acquired intangibleassets for which no tax basis exists and, as such, a significant deferred taxliability was recorded under purchase accounting.  Taxable temporary differences will reversewithin the carryforward period for the existing deferred tax assets.

 

At December 31, 2007we maintain approximately $464.2 million of net operating loss carryforwards inthe U.S., which expire over a period of 1 to 20 years.  Our European net operating loss carryforwardsof approximately $27.6 million generally are not subject to expiration dates,unless we trigger certain events. Included in prepaid expenses and other current assets are $1.9 millionand $5.3 of U.S. income tax receivables as of December 31, 2007 and 2006,respectively.

 

At December 31, 2007and 2006, we recorded gross deferred tax assets of $142.4 million and $46.5million and valuation allowances of $16.5 million and $5.3 million,respectively.  We have recorded avaluation allowance against European net operating loss carryforwards due touncertainties regarding our ability to realize these deferred tax assets.  The majority of the valuation allowance wasrecorded as an adjustment to goodwill as these loss carryforwards were acquiredin connection with the Empi, Compex and the Prior Transaction (see Note 2).

 

As a result of the DJOMerger and the Prior Transaction, we no longer intend to permanently reinvestin our foreign operations.  In connectionwith the Prior Transaction, we recorded deferred tax liabilities of $5.3million in purchase accounting and a deferred tax benefit of $0.7 million forthe period November 4, 2006 through December 31, 2006.  In connection with the DJO Merger, deferredtax liabilities of $7.6 million were recorded in purchase accounting.  We recorded a deferred tax expense of $0.9million for the twelve months ended December 31, 2007.

 

We and our subsidiariesfile income tax returns in the U.S. federal jurisdiction, and various statesand 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 2003.  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 the January 1,2007 balance of goodwill. A reconciliation of the beginning and ending amountof gross unrecognized tax benefits is 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     |   |

 

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To the extent our gross unrecognized tax benefits arerecognized in the future, we would also realize an additional $1.4 millionfederal tax benefit for a related state income tax deduction.  Included in the balance at December 31, 2007,is $3.4 million of gross uncertain tax positions that we anticipate willdecrease in the next twelve months related to our Empi acquisition.  This reduction will not impact our effectivetax rate.  We recognize interest accruedand penalties related to unrecognized tax benefits as a component of income taxexpense.  During the Successor year endedDecember 31, 2007, we recognized a reduction of $0.7 million in interest andpenalties.  We have $0.2 million for thepayment of interest and penalties accrued at December 31, 2007.

 

**13.         RESTRUCTURING AND RELATED CHARGES**

 

In 2007 and 2006, we implemented several restructuringand reorganization programs, including workforce reductions and the exit andconsolidation of facilities, related primarily to the integration of businesseswe have acquired. To date, our restructuring efforts have primarily related tothe integration of Compex, which was acquired on February 24, 2006, and theintegration of our Cefar-Compex S.A. operations following the acquisition ofCefar on November 7, 2006. During 2006, our restructuring activities includedthe divestiture of the Compex U.S. consumer product line, the closing of theCompex billing operations located in Tampa, Florida, and the integration ofthose operations into our existing operations in Minnesota, and the closure andsale of the Compex corporate headquarters located in New Brighton, Minnesota.During 2007, we initiated restructuring initiatives to centralize certainresearch and development activities and reorganize certain sales andadministrative functions in our Cefar-Compex S.A. European operations. As ofDecember 31, 2007, these restructuring activities are substantially completeand included in our restructuring reserve is approximately $0.4 million relatedto estimated facility exit costs.

 

In connection with the IOMED and Saundersacquisitions, during the third quarter of 2007, certain positions wereeliminated resulting in involuntary employee termination costs in the amount ofapproximately $1.2 million and $0.3 million, respectively.  Additionally, during the fourth quarter of 2007,management approved a plan to exit the facilities that had housed IOMED’sadministrative, manufacturing, and research and development operations prior toour acquisition on August 9, 2007.  As ofDecember 31, 2007, approximately $1.0 million and $0.8 million has been accruedin our consolidated balance sheet related to estimated severance and facilityexit costs related to the IOMED acquisition, respectively, and we have alsoaccrued $0.1 million related to severance costs related to the Saundersacquisition.

 

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 theconsummation of the DJO Merger.  In thefourth quarter of 2007, we announced the relocation of our headquarters toVista, California.  Activities were alsoinitiated with respect to the relocation of certain manufacturing operationsfrom our Chattanooga, Tennessee location to Tijuana, Mexico.  We also announced the future termination ofcertain employees related to the move of certain activities of our BGS productline operations from Vista, California to Minneapolis.  Internationally, we anticipate facilityclosures in Germany and certain other locations in an effort to integrate andrealize cost synergies in our international operations.  As of December 31, 2007, approximately $5.5 millionhas been accrued related to severance and facility exit costs.  Additionally, we recorded a liability of $2.1million related to purchase of rights to distributor territories and alsoassumed $1.9 million of severance paid to a former executive officer of abusiness acquired by DJO Opco prior to the DJO Merger which was fully paidsubsequent to the end of the year.  Ourrestructuring activities are ongoing and additional charges will be recorded infuture periods.

 

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 and certainintegration costs are expensed as incurred.

 

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A summary of the activity relating to therestructuring for the Successor twelve month period ended December 31, 2007 andfor the period from November 4, through December 31, 2006, and for thePredecessor period from January 1, 2006 through November 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 |   |

 

**14.          COMMITMENTS AND CONTINGENCIES**

 

*Commitments*

 

As of December 31,2007, we had entered into purchase commitments for inventory, capitalacquisitions and other services totaling approximately $127.6 million in theordinary course of business. This amount includes our obligation to purchase$10.4 million from Medireha, which is 50% owned by us, through 2009 under adistribution agreement granting us exclusive rights to the distribution ofproducts that Medireha manufactures.  Inaddition, included is $9.5 million committed in each of 2008 and 2009 topurchase certain supplies from a Minnesota corporation related to our electrotherapyproducts.  Finally, we have a commitmentof $7.0 million for annual monitoring fees to be paid to Blackstone ManagementPartners V L.L.C. (“BMP”) through 2019.

 

The following tablesummarizes our contractual obligations as of December 31, 2007 associatedwith fixed commitments for purchase and service obligations for the next fiveyears and thereafter (in thousands):

 

| **Year Ending December 31,** |
|---------------------------------------------|
| 2008                                        |   | $ | 38,020 |   |
| 2009                                        |   | 19,599 |   |
| 2010                                        |   | 7,000 |   |
| 2011                                        |   | 7,000 |   |
| 2012                                        |   | 7,000 |   |
| Thereafter                                  |   | 49,000 |   |

 

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## ** **

## ***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, 2007, areas follows (in thousands):

 

| **Year Ending December 31,** | ** ** |
|---------------------------------------------|------------|
| 2008                                        |       | $ | 10,205 |   |
| 2009                                        |       | 9,342 |   |
| 2010                                        |       | 7,583 |   |
| 2011                                        |       | 6,302 |   |
| 2012                                        |       | 5,925 |   |
| Thereafter                                  |       | 34,647 |   |
|                                             |            |  |  |  |

 

Rental expense underoperating leases totaled approximately $4.3 million and $0.6 million for the Successoryear ended December 31, 2007 and for the period November 4, 2006through December 31, 2006, respectively. Rent expense was approximately $2.6 million and $2.3 million, for thePredecessor period January 1, 2006 through November 3, 2006 and for theyear ended December 31, 2005, respectively.  Scheduled increases in rent expense areamortized on a straight line basis over the life of the lease.

 

## ***Capital Leases***.  Leasedequipment under capital leases, included in property and equipment in theaccompanying consolidated financial statements, at December 31, 2007 and2006 are as follows (in thousands):

 

| ** **                            | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Equipment                             |       | $        | 550        |     | $          | 409 |   |
| Furniture and  fixtures               |       | 266      |       | 266      |       |
| Less –  accumulated amortization |       | (222     | )          | (33      | )          |
|                                  |       | $        | 594        |     | $          | 642 |   |

 

*Litigation*

 

We have recordedapproximately $1.1 million as a contingent liability and an adjustment togoodwill relating to litigation against Compex regarding a dispute over customduties and VAT on imported goods prior to the date of acquisition. On February 6,2007, a judgment in the dispute with the custom officials was issued by thecourt which resulted in partial unfavorable rulings for each side. Both sideshave appealed the ruling and a final judgment is expected to be received earlyin 2008.  We believe the amount accruedfor in our consolidated balance sheet as of December 31, 2007 is adequateshould a loss occur.

 

On July 7, 2006, apurported 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.

 

The Texas Action is stillin preliminary stages and we cannot presently predict the outcome of thelawsuit, although we believe it is without merit. The Texas Action complaintalleges that DJO’s directors breached their fiduciary duties by, *inter alia*, agreeing to an allegedlyinadequate 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.

 

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 the year, 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 of 2008, the FDAconcluded their follow-up investigation concerning the January 2007warning letter.  We received noobservations and all areas of concern were addressed satisfactorily.

 

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The manufacturing andmarketing of orthopedic medical products entails risk of product liability.From time to time, we have been, and currently we are, subject to productliability claims and litigation. In the future, we may again be subject toadditional product liability claims, which could have a negative impact on ourbusiness. We currently carry product liability insurance up to a limit of $25.0million, subject to aggregate self-insurance retention of $750,000 and adeductible of $50,000 on non-invasive and $250,000 on invasive products. Ourinsurance policy is subject to annual renewal. We believe our current productliability insurance coverage is adequate. If a product liability claim orseries of claims is brought against us for uninsured liabilities or in excessof our insurance coverage, our business could suffer materially. In addition,as a result of a product liability claim, we may have to recall some of ourproducts, which could result in significant costs to us. As of December 31,2007 and December 31, 2006, we have accrued approximately $1.9 million and$2.3 million, respectively, for product liability claims expense based uponprevious claim experience in part due to the fact that we have exceeded thecoverage limits on certain claims.

 

On February 22,2005, we acquired substantially all of the assets of OTI, which included a lineof spinal implant products and several total knee and hip implant designs forapproximately $15.7 million.  The acquisition consideration wassubject to adjustment based upon the final balance sheet as of the closingdate, which was the subject of a dispute between the former OTI shareholdersand us. In 2006 the parties concluded an arbitration that resulted in an awardof approximately $326,000 to DJO to reflect a lower inventory value at the dateof closing than was originally determined by OTI. We were involved in the defenseof a patent infringement claim against us and OTI, which was settled with apayment of $400,000 to the counterparty in 2006.  We had also been in a related dispute withOTI and its chief executive officer over certain representations and warrantiesthat were made under the Asset Purchase Agreement that governs the OTIacquisition (the “OTI APA”). This dispute had been the subject of litigation inwhich each party had asserted certain claims, including our claim forindemnification from the approximately $1.7 million escrow fund that wasestablished pursuant to the OTI APA specifically for the purpose of fundingindemnification claims.  Previously, wehad reflected the costs that we had incurred to date related to the litigationfor which we believed we were entitled to indemnification as an accountreceivable of approximately $1.6 million. During the fourth quarter of 2007, the dispute was settled.  The net effect of the various disputes andlitigation settlements resulted in the recognition of approximately $0.4million of intangible assets associated with the settlement of a previouspatent infringement claim against us discussed above whereby we previously paid$0.4 million in exchange for a license to use the related technology.

 

**15.          RELATED PARTY TRANSACTIONS**

** **

**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, certainof its affiliates, and such members of DJO’s management and current executiveofficers (the “Management Stockholders Agreement”). In conjunction with the DJOMerger, certain incoming executives of DJO (the “new management stockholders”)have become parties to the Management Stockholders Agreement on the same termsand conditions as set forth therein, subject to the following exceptions, whichby amendment (the “Amendment”) will apply only to the new managementstockholders and any other persons becoming a party thereto after November 20,2007.  The Management Stockholders Agreement currently provides that if amanagement stockholder voluntarily resigns from DJO for any reason other than “goodreason” (as defined in the Management Stockholders Agreement) and a BlackstoneParent Stockholder exercises its call rights after such termination, themanagement stockholder would receive the lower of fair market value or “cost”for the management stockholder’s callable shares.  The Amendment providesthat, unless a new management stockholder was terminated by DJO for “cause” (asdefined in 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 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 

 

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Blackstone. If, prior to either the lapse of the transfer restrictionsor a qualified public offering, a management stockholder’s employment isterminated, DJO will have the right to repurchase all shares of its common stockheld by such management stockholder for a period of one year from the date oftermination of employment (or the until the date that is one year following theexercise of the stock options used to acquire such common stock, if later). IfDJO does not exercise this repurchase right during the applicable repurchaseperiod, then Blackstone will generally have the right to repurchase such sharesfor a period of 30 days thereafter. The Management Stockholders Agreement alsoprovides that, after the occurrence of a qualified public offering, themanagement stockholders will receive customary piggyback registration rightswith respect to shares of DJO common 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 arethe same, in all material respects, as the management stockholders agreementdescribed above.

 

**Transaction and Monitoring FeeAgreement**

 

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 transaction and monitoring fee agreement executed in connection with thePrior Transaction (“Old Transaction and Monitoring Fee Agreement”), for anannual monitoring fee which has been increased from $3.0 million to the greaterof $7.0 million and 2.0% of consolidated EBITDA (as defined in the NewTransaction and Monitoring Fee Agreement). At any time in connection with or in anticipation of a change of controlof DJO, a sale of all or substantially all of DJO’s assets or an initial publicoffering of common stock of DJO or its successor, BMP may elect to receive, inlieu of remaining annual monitoring fee payments, a single lump sum cashpayment equal to the then-present value of all then-current and future annualmonitoring fees payable under the transaction and monitoring fee agreement,assuming a hypothetical termination date of the agreement to be the twelfthanniversary of such election. The monitoring fee agreement will continue untilthe earlier of the twelfth anniversary of the date of the agreement or suchdate as DJO and BMP may mutually determine. DJO will agree to indemnify BMP andits affiliates, directors, officers, employees, agents and representatives fromand against all liabilities relating to the services contemplated by thetransaction and monitoring fee agreement and the engagement of BMP pursuant to,and the performance of BMP and its affiliates of the services contemplated by,the transaction and monitoring fee agreement. During the twelve month periodended December 31, 2007, we recorded approximately $3.0 million related tothe monitoring fee under the Old Transaction and Monitoring Fee Agreement,which has been recorded as a component of selling, general and administrativeexpense.

 

**16.         DERIVATIVEINSTRUMENTS**

** **

We make use of debt financing asa source of funds and are therefore exposed to interest rate fluctuations inthe normal course of our business. We operate internationally and are thereforeexposed to foreign currency exchange rate fluctuations in the normal course ofour business, in particular to changes in the Mexican Peso due to ourMexico-based manufacturing operations that incur costs that are largelydenominated in Mexican Pesos. As part of our risk management strategy, we usederivative instruments to hedge portions of our exposure. Before acquiring aderivative instrument to hedge a specific risk, potential natural hedges areevaluated. Derivative instruments are only utilized to manage underlyingexposures that arise from our business operations. Factors considered in thedecision to hedge an underlying market exposure include the materiality of therisk, the volatility of the market, the duration of the hedge, and theavailability, effectiveness and cost of derivative instruments.  As of December 31, 2007, we hadoutstanding hedges in the form of forward contracts to purchase Mexican Pesosaggregating a U.S. dollar equivalent of $10.7 million.

 

The Old Senior Secured Credit Facility, which wasrepaid on November 20, 2007 in connection with the DJO Merger, was subjectto a floating interest rate. We managed the risk of unfavorable movements ininterest rates by hedging a portion of the outstanding loan balance, therebylocking in a fixed rate on a portion of the principal and reducing the effectof rising interest rates and making interest expense more predictable.  In February 2007, we swapped variablerates for fixed rates on $175.0 million of the borrowings under the Old SeniorSecured Credit Facility. We had two agreements in place for a notional amountof $100.0 million and $75.0 million, expiring in 2010 and 2012,respectively.  Under these agreements, we

 

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paid a fixed rateof 5.17% and received a variable rate equal to the then current three monthLIBOR rate.  On November 19, 2007,in anticipation of the DJO Merger and incurrence of new indebtedness, weterminated these swaps and recognized $4.8 million of related interestexpense.  On November 20, 2007, weentered into a new interest rate swap agreement for a notional amount of $515.0million at a fixed LIBOR rate of 4.205% amortizing through an expiration dateof 2009.

 

Thefair value of our interest rate swap agreement recorded on the balance sheet asof December 31, 2007 was a loss of approximately $3.9 million and isrecorded in other non-current liabilities. We believe our interest rate swapsare highly effective. Derivative net gains (losses) on our interest rate swapagreements of $0.7 million, $0.5 million, and $(0.2) million, on a pre-taxbasis, were included in interest expense in the Successor year ended December 31,2007 and in the Predecessor period from January 1, 2006 through November 3,2006, and for the year ended December 31, 2005, respectively.  Included in loss on early extinguishment ofdebt for 2007 is $(4.8) million related to the termination of swaps inconnection with the DJO Merger as discussed above.  Derivative gains and losses on cash flowhedges that qualify as accounting hedges are reported as accumulated other comprehensiveincome net of tax, until such time as they are reported in income along withthe hedged item.

 

**17.         UNAUDITED QUARTERLY CONSOLIDATEDFINANCIAL DATA**

 

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

 

| ** **       | ** ** | **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 |       | 310                                                |       | 333 |   | 2,800 |   | (42,879 | ) |
| Net income       |       | (11,087                                            | )          | (8,078 | ) | (5,939 | ) | (57,318 | ) |
|                  |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **               | ** ** | **Predecessor**                                   | ** ** | **Successor**                                       | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **Jan 1,  2006  through  Apr 1,  2006** | ** ** | **April 2,  2006  through  Jul 1,  2006** | ** ** | **Jul 2,  2006  through  Sep 30,  2006** | ** ** | **Oct 1,  2006  through  Nov 3,  2006** | ** ** | **Nov 4,  2006  through  Dec 31,  2006** | ** ** |
| Net sales                |       | $                                                 | 86,912     |                                                | $          | 95,915 |   | $ | 92,911 |   | $ | 28,645 |   | $ | 57,902 |   |
| Gross Profit             |       | 51,798                                            |       | 57,755                                              |       | 57,424 |   | 10,126 |   | 31,115 |   |
| Operating income  (loss) |       | 6,579                                             |       | 7,350                                               |       | 10,557 |   | (47,284 | ) | (42,147 | ) |
| Net income  (loss)       |       | (2,524                                            | )          | (785                                                | )          | 754 |   | (44,221 | ) | (41,634 | ) |
|                          |            |                                                   |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |

 

**18.         EMPLOYEEBENEFIT 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 ofapproximately $1.2 million to the plan in existence for both the Predecessorperiods January 1, 2006 through November 3, 2006 and the year ended December 31,2005.  We also made matchingcontributions to the plan of approximately $1.6 million and $0.2 million forthe Successor year ended December 31, 2007 and the period from November 4,2006 through December 31, 2006, respectively.  The plans provide for discretionarycontributions by us as approved by the Board of Directors.  There have been no such discretionarycontributions through December 31, 2007.

 

**19.          SUPPLEMENTAL GUARANTOR CONDENSEDCONSOLIDATING FINANCIAL STATEMENTS**

 

On November 20,2007, in connection with the DJO Merger, DJOFL and its direct wholly-ownedsubsidiary, Finco, issued $575.0 million aggregate principal amount of the10.875% Notes.  Finco has only nominalassets and does not conduct

 

103

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any operations.  The 10.875% Indenturegenerally prohibits Finco from holding any assets, becoming liable for anyobligations, 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 notes.  TheGuarantors also unconditionally guarantee the New Senior Secured CreditFacility.

 

On November 3, 2006,in connection with the Prior Transaction, DJOFL and its direct wholly-ownedsubsidiary, Finco, issued $200.0 million aggregate principal amount of the11.75% Notes.  Finco was formed solely toact as a co-issuer of the 11.75% Notes, has only nominal assets and does notconduct any operations.  The 11.75%Indenture generally prohibits Finco from holding any assets, becoming liablefor any obligations, 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 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 notes.  TheGuarantors also unconditionally guarantee the New Senior Secured CreditFacility.

 

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, 2007and 2006 and for the period from November 4, 2006 to December 31,2006.  In addition, the following tablespresent the results of operations and cash flows of the Predecessor, theGuarantors, the Non-Guarantors, and Eliminations for the period from January 1,2006 to November 3, 2006, and for the year ended December 31,2005.  The Guarantors in the tablesrelating to the Predecessor period include EMIHC, a previously wholly owneddirect subsidiary of DJOFL which was liquidated on December 31, 2006.  EMIHC was the borrower under the Old CreditFacility which was fully repaid in connection with the Prior Transaction andthe issuer of the 9.75% Notes, which was repurchased pursuant to a tender offerin connection with the Prior Transaction.

 

104

----

 

**DJO Finance LLC and Subsidiaries**

 

**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                                          |       | —    |       | 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 |   |
| Accrued expenses                                             |       | 10,116    |       | 66,985         |       | 26,666               |       | —           |       | 103,767          |       |
| Long-term debt and capital leases, current portion           |       | 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                                     |       | —    |       | 376,778        |       | 9,881                |       | —           |       | 386,659          |       |
| Intercompany payable                                         |       | —    |       | 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 |   |

 

105

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**DJO Finance LLC and Subsidiaries**

 

**CondensedConsolidating Balance Sheet**

**As of December 31,2006**

**(inthousands)**

** **
| ** **                                                   | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   |       |      |       |           |       |                 |       |             |       |             |       |
| Current assets:                                              |       |      |       |           |       |                 |       |             |       |             |       |
| Cash and cash equivalents                                    |       | $         | 12         |           | $          | 22,650               |       | $                | 8,241      |             | $          | — |   | $ | 30,903 |   |
| Accounts receivable, net                                     |       | —    |       | 50,593         |       | 18,301               |       | —           |       | 68,894           |       |
| Inventories, net                                             |       | —    |       | 58,707         |       | 9,188                |       | (222             | )          | 67,673           |       |
| Deferred tax assets                                          |       | —    |       | 21,598         |       | 4,282                |       | (146             | )          | 25,734           |       |
| Prepaid expenses and other current assets                    |       | 21        |       | 11,103         |       | 483                  |       | —           |       | 11,607           |       |
| Total current assets                                         |       | 33        |       | 164,651        |       | 40,495               |       | (368             | )          | 204,811          |       |
| Property and equipment, net                                  |       | —    |       | 35,141         |       | 8,157                |       | (2,047           | )          | 41,251           |       |
| Goodwill                                                     |       | —    |       | 414,079        |       | 61,643               |       | —           |       | 475,722          |       |
| Intangible assets, net                                       |       | —    |       | 281,992        |       | 35,250               |       | —           |       | 317,242          |       |
| Investment in subsidiaries                                   |       | 387,419   |       | (41,601        | )          | 47,731               |       | (393,549         | )          | —           |       |
| Intercompany receivable                                      |       | 287,144   |       | —         |       | —               |       | (287,144         | )          | —           |       |
| Other non-current assets                                     |       | 19,940    |       | 762            |       | 908                  |       | —           |       | 21,610           |       |
| Total assets                                                 |       | $         | 694,536    |           | $          | 855,024              |       | $                | 194,184    |             | $          | (683,108 | ) | $ | 1,060,636 |   |
| **Liabilities, Minority Interests and Membership  Equity**   |       |      |       |           |       |                 |       |             |       |             |       |
| Current liabilities:                                         |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts payable                                             |       | $         | —     |           | $          | 13,455               |       | $                | 5,440      |             | $          | — |   | $ | 18,895 |   |
| Accrued expenses                                             |       | 7,909     |       | 17,607         |       | 12,463               |       | —           |       | 37,979           |       |
| Long-term debt and capital leases, current portion           |       | 3,500     |       | 332            |       | 2,673                |       | —           |       | 6,505            |       |
| Total current liabilities                                    |       | 11,409    |       | 31,394         |       | 20,576               |       | —           |       | 63,379           |       |
| Long-term debt and capital leases, net of current  portion   |       | 545,625   |       | 783            |       | 1,629                |       | —           |       | 548,037          |       |
| Deferred tax liabilities                                     |       | —    |       | 99,152         |       | 12,080               |       | —           |       | 111,232          |       |
| Intercompany payable                                         |       | —    |       | 192,819        |       | 94,325               |       | (287,144         | )          | —           |       |
| Other non-current liabilities                                |       | —    |       | 1,871          |       | —               |       | —           |       | 1,871            |       |
| Total liabilities                                            |       | 557,034   |       | 326,019        |       | 128,610              |       | (287,144         | )          | 724,519          |       |
| Minority interests                                           |       | —    |       | —         |       | 909                  |       | —           |       | 909              |       |
| Membership equity                                            |       | 137,502   |       | 529,005        |       | 64,665               |       | (395,964         | )          | 335,208          |       |
| Total liabilities, minority interests and membership  equity |       | $         | 694,536    |           | $          | 855,024              |       | $                | 194,184    |             | $          | (683,108 | ) | $ | 1,060,636 |   |

 

106

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**DJO Finance LLC and Subsidiaries**

 

**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          | )          |
| Loss from continuing operations before income taxes  and minority interests |       | (82,422   | )          | (78,248        | )          | (1,233               | )          | 37,393           |       | (124,510         | )          |
| Provision (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 | ) |

 

107

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** **

**DJO Finance LLC and Subsidiaries**

 

**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 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 | ) |

 

108

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**DJO Finance LLC and Subsidiaries**

 

**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:                                                    |       |    |       |           |       |                 |       |             |       |             |       |
| Loss from discontinued operations, net of tax                               |       | —  |       | (614           | )          | —               |       | —           |       | (614             | )          |
| Net loss                                                                    |       | $       | (46,776    | )              | $          | (70,472              | )          | $                | (1,464     | )                | $          | 71,936 |   | $ | (46,776 | ) |

 

109

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**DJO Finance LLC and Subsidiaries**

 

**CondensedConsolidating Statement of Operations**

**For thePredecessor Year Ended December 31, 2005**

**(inthousands)**

** **
| ** **                                                                    | ** ** | **DJO** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|---------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                                     |       | $       | —     |           | $          | 261,487              |       | $                | 41,002     |             | $          | (8,763 | ) | $ | 293,726 |   |
| Cost of sales                                                                 |       | —  |       | 105,262        |       | 18,839               |       | (8,728           | )          | 115,373          |       |
| Gross profit                                                                  |       | —  |       | 156,225        |       | 22,163               |       | (35              | )          | 178,353          |       |
| Operating expenses:                                                           |       |    |       |           |       |                 |       |             |       |             |       |
| Selling, general and administrative                                           |       | —  |       | 106,305        |       | 13,731               |       | —           |       | 120,036          |       |
| Research and development                                                      |       | —  |       | 8,497          |       | 1,080                |       | —           |       | 9,577            |       |
| Amortization  of acquired intangibles                                         |       | —  |       | 3,378          |       | 1,675                |       | —           |       | 5,053            |       |
| Operating income                                                              |       | —  |       | 38,045         |       | 5,677                |       | (35              | )          | 43,687           |       |
| Other income (expense):                                                       |       |    |       |           |       |                 |       |             |       |             |       |
| Interest income                                                               |       | 2       |       | 20,865         |       | 124                  |       | (20,598          | )          | 393              |       |
| Interest expense                                                              |       | —  |       | (49,107        | )          | —               |       | 20,598           |       | (28,509          | )          |
| Other income (expense), net                                                   |       | 12,558  |       | 31,902         |       | (1,041               | )          | (43,442          | )          | (23              | )          |
| Income from continuing operations before income  taxes and minority interests |       | 12,560  |       | 41,705         |       | 4,760                |       | (43,477          | )          | 15,548           |       |
| Provision for income taxes                                                    |       | —  |       | 4,032          |       | 1,956                |       | 73               |       | 6,061            |       |
| Minority interests                                                            |       | —  |       | —         |       | 140                  |       | —           |       | 140              |       |
| Income from continuing operations                                             |       | 12,560  |       | 37,673         |       | 2,664                |       | (43,550          | )          | 9,347            |       |
| Discontinued operations:                                                      |       |    |       |           |       |                 |       |             |       |             |       |
| Gain on disposal of discontinued operations, net of  tax                      |       | —  |       | 2,445          |       | —               |       | —           |       | 2,445            |       |
| Income from discontinued operations, net of tax                               |       | —  |       | 538            |       | —               |       | —           |       | 538              |       |
| Net income                                                                    |       | $       | 12,560     |           | $          | 40,656               |       | $                | 2,664      |             | $          | (43,550 | ) | $ | 12,330 |   |

 

110

----

 

**DJO Finance LLC and Subsidiaries**

 

**Unaudited Condensed Consolidating Statements ofCash 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 |   |

 

111

----

 

**DJO Finance LLC and Subsidiaries**

 

**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 interests                                                                                  |       | —    |       | —         |       | 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 |   |

 

112

----

 

**DJO Finance LLC and Subsidiaries**

 

**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 |   |

 

113

----

 

**DJO Finance LLC and Subsidiaries**

 

**CondensedConsolidating Statement of Cash Flows**

**Year Ended December 31, 2005**

**(Predecessor)**

**(in thousands)**

** **
| ** **                                                                                   | ** ** | **DJO** | ** ** | **Guarantors** | ** ** | **Non- Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------|------------|----------------|------------|--------------------------|------------|------------------|------------|------------------|------------|
| **OPERATING ACTIVITIES:**                                                                    |       |    |       |           |       |                     |       |             |       |             |       |
|                                                                                         |       |    |       |           |       |                     |       |             |       |             |       |
| Net income                                                                                   |       | $       | 12,560     |           | $          | 40,656                   |       | $                | 2,664      |             | $          | (43,550 | ) | $ | 12,330 |   |
|                                                                                         |       |    |       |           |       |                     |       |             |       |             |       |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |    |       |           |       |                     |       |             |       |             |       |
| Depreciation                                                                                 |       | —  |       | 6,586          |       | 3,019                    |       | (909             | )          | 8,696            |       |
| Amortization of intangibles                                                                  |       | —  |       | 3,378          |       | 1,675                    |       | —           |       | 5,053            |       |
| Amortization of debt issuance costs                                                          |       | —  |       | 2,177          |       | —                   |       | —           |       | 2,177            |       |
| Non-cash interest expense                                                                    |       | —  |       | 100            |       | —                   |       | —           |       | 100              |       |
| Stock-based compensation                                                                     |       | 30      |       | 140            |       | (10                      | )          | —           |       | 160              |       |
| Asset impairments and loss on disposal of assets                                             |       | —  |       | 522            |       | 1,181                    |       | (328             | )          | 1,375            |       |
| Deferred income taxes                                                                        |       | —  |       | (2,253         | )          | (764                     | )          | 87               |       | (2,930           | )          |
| Earnings from subsidiaries                                                                   |       | (12,555 | )          | (30,887        | )          | —                   |       | 43,442           |       | —           |       |
| Provision for doubtful accounts and sales returns                                            |       | —  |       | 5,708          |       | 400                      |       | —           |       | 6,108            |       |
| Inventory reserves                                                                           |       | —  |       | 4,687          |       | 123                      |       | —           |       | 4,810            |       |
| Minority interest                                                                            |       | —  |       | —         |       | 140                      |       | —           |       | 140              |       |
| Tax provision associated with stock options                                                  |       | 45      |       | —         |       | —                   |       | —           |       | 45               |       |
| Net effect of discontinued operations, net of gain  on disposal                              |       | —  |       | (2,382         | )          | —                   |       | —           |       | (2,382           | )          |
| Changes in operating assets and liabilities, net of  acquired assets and liabilities:        |       |    |       |           |       |                     |       |             |       |             |       |
| Accounts receivable                                                                          |       | —  |       | (10,461        | )          | 2,096                    |       | —           |       | (8,365           | )          |
| Inventories                                                                                  |       | —  |       | (11,722        | )          | (616                     | )          | (232             | )          | (12,570          | )          |
| Prepaid expenses, other assets and liabilities                                               |       | (1,101  | )          | 3,350          |       | 190                      |       | —           |       | 2,439            |       |
| Accounts payable and accrued expenses                                                        |       | 80      |       | 3,700          |       | (1,476                   | )          | 70               |       | 2,374            |       |
| Net cash provided by (used in) operating activities                                          |       | (941    | )          | 13,299         |       | 8,622                    |       | (1,420           | )          | 19,560           |       |
| **INVESTING ACTIVITIES:**                                                                    |       |    |       |           |       |                     |       |             |       |             |       |
| Acquisition of businesses                                                                    |       | —  |       | (21,648        | )          | —                   |       | —           |       | (21,648          | )          |
| Purchases of property and equipment                                                          |       | —  |       | (8,175         | )          | (3,395                   | )          | 3,560            |       | (8,010           | )          |
| Proceeds from sale of assets                                                                 |       | —  |       | 8              |       | —                   |       | —           |       | 8                |       |
| Proceeds from sale of discontinued operations                                                |       | —  |       | 9,291          |       | —                   |       | —           |       | 9,291            |       |
| Net effect of discontinued operations                                                        |       | —  |       | (5             | )          | —                   |       | —           |       | (5               | )          |
| Net cash used in investing activities                                                        |       | —  |       | (20,529        | )          | (3,395                   | )          | 3,560            |       | (20,364          | )          |
| **FINANCING ACTIVITIES:**                                                                    |       |    |       |           |       |                     |       |             |       |             |       |
| Intercompany                                                                                 |       | 53      |       | 2,464          |       | (377                     | )          | (2,140           | )          | —           |       |
| Intercompany cash dividends                                                                  |       | —  |       | 4,554          |       | (4,554                   | )          | —           |       | —           |       |
| Proceeds from long-term obligations                                                          |       | —  |       | 14,700         |       | —                   |       | —           |       | 14,700           |       |
| Payments on long-term obligations                                                            |       | —  |       | (15,481        | )          | (74                      | )          | —           |       | (15,555          | )          |
| Payment of debt issuance costs                                                               |       | —  |       | (642           | )          | —                   |       | —           |       | (642             | )          |
| Dividends paid to minority interest                                                          |       | —  |       | —         |       | (198                     | )          | —           |       | (198             | )          |
| Proceeds from issuance of common stock                                                       |       | 355     |       | —         |       | —                   |       | —           |       | 355              |       |
| Proceeds from notes received for sale of common  stock                                       |       | 102     |       | —         |       | —                   |       | —           |       | 102              |       |
| Net cash provided by (used in) financing activities                                          |       | 510     |       | 5,595          |       | (5,203                   | )          | (2,140           | )          | (1,238           | )          |
| Effect of exchange rate changes on cash and cash  Equivalents                                |       | —  |       | —         |       | (647                     | )          | —           |       | (647             | )          |
| **Net decrease in cash and cash equivalents**                                                |       | (431    | )          | (1,635         | )          | (623                     | )          | —           |       | (2,689           | )          |
| Cash and cash equivalents at beginning of year                                               |       | 739     |       | 15,223         |       | 3,927                    |       | —           |       | 19,889           |       |
| Cash and cash equivalents at end of year                                                     |       | $       | 308        |           | $          | 13,588                   |       | $                | 3,304      |             | $          | — |   | $ | 17,200 |   |

 

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

 

On November 20, 2007, DJO dismissed KPMG LLP (“KPMG”) as ourindependent registered public accounting firm and engaged Ernst &Young LLP (“E&Y”) as our new independent registered public accounting firmto audit our financial statements for the fiscal year ended December 31, 2007.Our decision to change our independent registered public accounting firm wasthe result of a competitive bidding process subsequent to the DJO Merger. Thedecision to dismiss KPMG and engage E&Y was made and approved by the AuditCommittee of our Board of Directors. The services provided by E&Y consistof auditing financial statements and reviewing filings with the SEC as permittedunder the Sarbanes-Oxley Act of 2002.

 

Thereports of KPMG on our financial statements for the Predecessor period January 1,2006 through November 3, 2006 and the year ended December 31, 2005,and the Successor period November 4, 2006 though December 31, 2006contained no adverse opinion or disclaimer of opinion and were not qualified ormodified as to uncertainty, audit scope or accounting principles with theexception of the following notes contained in the audit report for fiscal yearended December 31, 2006:  (i) Asdiscussed in Note 1 to the audited consolidated financial statements, effectiveNovember 3, 2006, all of the outstanding stock of DJO was acquired in abusiness combination accounted for as a purchase. As a result of theacquisition, the consolidated financial information for the period after theacquisition is presented on a different cost basis than that for the periodsbefore the acquisition and, therefore, is not comparable and (ii) Asdiscussed in Note 1 to the audited consolidated financial statements, weadopted Statement of Financial Accounting Standards No. 123(R), Share-BasedPayment, as of January 1, 2006.

 

Duringour Predecessor period January 1, 2006 through November 3, 2006 andthe year ended December 31, 2005, and during our Successor period November 4,2006 though December 31, 2006, and through November 20, 2007, therewere no disagreements with KPMG on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure,which disagreements if not resolved to the satisfaction of KPMG would havecaused them to make reference thereto in their reports on our financialstatements for such years. During our Predecessor period January 1, 2006through November 3, 2006 and the year ended December 31, 2005, andduring our Successor period November 4, 2006 though December 31,2006, and through November 20, 2007, there were no reportable events (asdefined in Item 304(a)(1)(v) of Regulation S-K).

 

## **Prior to the engagement of E&Y, neither us nor someoneon our behalf had consulted with E&Y during our Predecessor period January 1,2006 through November 3, 2006 and the year ended December 31, 2005,and during our Successor period November 4, 2006 though December 31,2006, and through November 20, 2007, in any matter regarding: (A) eitherthe application of accounting principles to a specified transaction, eithercompleted or proposed, or the type of audit opinion that might be rendered onour financial statements, and neither was a written report provided to us norwas oral advice provided that E&Y concluded was an important factorconsidered by us in reaching a decision as to the accounting, auditing orfinancial reporting issue, or (B) the subject of either a disagreement ora reportable event defined in Item 304(a)(1)(iv) and (v) ofRegulation S-K.**

## ** **

## **ITEM 9A(T). CONTROLS AND PROCEDURES**

## ** **

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

 

We maintaindisclosure controls 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 andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives.  Under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, we conducted an evaluation of the effectiveness of ourdisclosure controls and procedures. Based on this evaluation and subject to the foregoing, our ChiefExecutive Officer and our Chief Financial Officer concluded that, as of December 31,2007, the design and operation of our disclosure controls and proceduresprovide reasonable assurance that the disclosure controls and procedures areeffective to accomplish their objectives.

 

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In addition, there has been no change in our internalcontrol over financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) thatoccurred during the fourth quarter ended December 31, 2007 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

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

 

Our management is responsible for establishing andmaintaining adequate internal control over financial 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 itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree or compliance with thepolicies or procedures may deteriorate.

 

With the participation of our Chief Executive Officer and our ChiefFinancial Officer, our management conducted an evaluation of the effectivenessof our internal control over financial reporting as of December 31, 2007 basedon 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 December31, 2007.

 

On November 20, 2007, the Company acquired all of theoutstanding shares of DJO Opco, a publicly traded company.  The Company has excluded DJO Opco’s internalcontrols over financial reporting for fiscal year 2007 from its assessment of andconclusion on the effectiveness of its internal controls over financialreporting.  Such exclusion was inaccordance with Securities and Exchange Commission guidance that an assessmentof a recently acquired business may be omitted in management’s report oninternal controls over financial reporting in the year of acquisition, if,among other circumstances and factors, there is not adequate time between theconsummation date of the acquisition and the assessment date for assessinginternal controls.  DJO Opco constitutedapproximately 62% and 80% of the Company’s total and net assets, respectively,as of December 31, 2007 and 11% and 10% of the Company’s total revenues and netloss, respectively, for the year then ended.

 

This annual report does not include an attestationreport of our registered public accounting firm regarding internal control overfinancial reporting. Management’s report was not subject to attestation by ourregistered public accounting firm pursuant to temporary rules of the Securitiesand Exchange Commission that permit us to provide only management’s report in thisAnnual Report on Form 10-K.

** **

**ITEM9B.  OTHER INFORMATION**

 

None.

 

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**PART III.**

 

## **ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

## ** **

The following table sets forth information about the directors andexecutive officers of our parent, DJO, as of December 31, 2007.  The executive officers of DJO are alsoexecutive officers of DJOFL.

 
| **Name**             | ** ** | **Age** | ** ** | **Position**                                                     |
|----------------------|------------|---------|------------|------------------------------------------------------------------|
| Leslie H. Cross      |       | 57      |       | Chief Executive Officer  and Director                            |
| Peter W. Baird       |       | 41      |       | President                                                        |
| Vickie L. Capps      |       | 46      |       | Executive Vice  President, Chief Financial Officer and Treasurer |
| Donald M. Roberts    |       | 59      |       | Executive Vice  President, General Counsel and Secretary         |
| Thomas A. Capizzi    |       | 49      |       | Executive Vice  President, Global Human Resources                |
| Luke T. Faulstick    |       | 44      |       | President, Global  Operations                                    |
| Kenneth W. Davidson* |       | 60      |       | Chairman of the Board  of Directors                              |
| Chinh E. Chu*        |       | 41      |       | Director                                                         |
| Julia Kahr*          |       | 29      |       | Director                                                         |
| Sidney Braginsky     |       | 70      |       | Director                                                         |
| Paul D. Chapman      |       | 49      |       | Director                                                         |
| Bruce McEvoy         |       | 30      |       | Director                                                         |

 

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* Messrs. Davidsonand Chu and Ms. Kahr also serve as managers of DJOFL.

 

*Leslie H.Cross—Chief Executive Officer and Director.*  Mr. Cross was appointed Chief ExecutiveOfficer of DJO and DJOFL as of the effective date of the DJO Merger. Prior tothe DJO Merger, Mr. Cross was the Chief Executive Officer and Presidentand a member of the board of directors of DJO Opco since August 2001. Heserved as the Chief Executive Officer and a Manager of DonJoy, L.L.C., from June 1999until November 2001, and has served as President of DJO, LLC, or itspredecessor, the Bracing & Support Systems division of Smith &Nephew, Inc. since June 1995. From 1990 to 1994, Mr. Cross heldthe position of Senior Vice President of Marketing and Business Development ofthe Bracing & Support Systems division of Smith & Nephew. Hewas a Managing Director of two different divisions of Smith & Nephewfrom 1982 to 1990. Prior to that time, he worked at American Hospital SupplyCorporation. Mr. Cross earned a diploma in medical technology from SydneyTechnical College in Sydney, Australia and studied business at the Universityof Cape Town in Cape Town, South Africa.

 

*Peter W.Baird—President.*  Mr. Bairdwas appointed President of DJO and DJOFL as of the effective date of the DJOMerger. Prior to the DJO Merger, Mr. Baird served as ReAble’s GroupPresident-Therapeutic Devices, a position he held since October 2006.Prior to joining ReAble and since January 2004, Mr. Baird was aPrincipal at McKinsey & Company in its Pharmaceuticals and PrivateEquity Practices. From September 1995 to September 1997, and from November 1999to December 2003, Mr. Baird was an Associate at McKinsey &Company. From September 1997 to October 1999, Mr. Baird was aPrincipal at Brait Capital Partners, a South African private-equity investmentfirm. He also holds a M.A. in economics from the University of Cape Town and anM.B.A. from Stanford University. Mr. Baird is also a Chartered FinancialAnalyst.

 

*VickieL.**Capps*—*Executive Vice President, Chief Financial Officer andTreasurer.*  Ms. Capps wasappointed Executive Vice President, Chief Financial Officer and Treasurer ofDJO and DJOFL as of the effective date of the DJO Merger. Ms. Capps isalso responsible for managing our international business.  Prior to the DJO Merger, Ms. Cappsserved as the Executive Vice President, Chief Financial Officer and Treasurerof DJO Opco since July 2002. From September 2001 until July 2002,Ms. Capps was employed by AirFiber, a privately held provider of broadbandwireless solutions, where she served as Senior Vice President, Finance andAdministration and Chief Financial Officer. From July 1999 to July 2001,Ms. Capps served as Vice President of Finance and Administration and ChiefFinancial Officer for Maxwell Technologies, Inc., a publicly tradedtechnology company. From 1992 to 1999, Ms. Capps served in variouspositions, including Chief Financial Officer, with Wavetek Wandel Goltermann, Inc.,a multinational communications equipment company. Ms. Capps also served asa senior audit and accounting professional for Ernst & Young LLP from1982 to 1992. Ms. Capps is a California Certified Public Accountant andreceived a B.S. degree in business administration/accounting from San DiegoState University.  Ms Capps currentlyserves on the board of directors and is a member of the audit committee ofSenoRx, Inc., a publicly traded medical device company.

 

*DonaldM. Roberts**—Executive Vice President, General Counseland Secretary.*  Mr. Robertswas appointed Executive Vice President, General Counsel and Secretary of DJOand DJOFL as of the effective date of the DJO Merger. 

 

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Prior to the DJO Merger, Mr. Robertsserved as Senior Vice President, General Counsel and Secretary of DJO Opcosince December 2002. From 1994 to December 2002, Mr. Robertsserved as Vice President, Secretary and General Counsel for MaxwellTechnologies, Inc., a publicly held technology company. Previous to that,he was with the Los Angeles-based law firm of Parker, Milliken, Clark, O’Hara &Samuelian for 21 years. Mr. Roberts was a shareholder in the firm,having served as partner in a predecessor partnership. Mr. Robertsreceived his undergraduate degree in political science from Yale University andearned his J.D. at the University of California, Berkeley, Boalt Hall School ofLaw.

 

*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.

 

*Luke T.Faulstick—President, Global Operations. *Mr. Faulstickwas appointed President of Global Operations as of the effective date of theDJO Merger.  Previously, Mr. Faulstickserved as Chief Operating Officer of DJO Opco from March 2006 to November 2007,Senior Vice President of Operations from August 2003 to March 2006and Vice President of Operations 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.

 

*KennethW. Davidson—Chairman of the Board of Directors.*  Mr. Davidson is DJO’s Chairman of theBoard.  Prior to the DJO Merger, Mr. Davidsonserved as ReAble’s Chief Executive Officer, President and as manager of DJOFLsince the completion of the Prior Transaction. Prior to the Prior Transaction, Mr. Davidsonserved as ReAble’s Chief Executive Officer since October 2000 and asChairman of the Board of ReAble from February 2001 to November 2006.  Mr. Davidson also served as ReAble’sPresident from October 2000 to May 2003. Mr. Davidson has servedas a member of ReAble’s board of directors since March 1997. Mr. Davidsonserved as Chairman, President and CEO of Maxxim Medical, Inc., a publicly-heldmedical supply company, from 1986 to July 2000. Previously, Mr. Davidsonheld various positions with Intermedics, Inc., a pacemaker equipmentmanufacturer, Baxter Laboratories, a publicly-held healthcare product andservice company, and Merck & Co, a human and animal health careproduct company.

 

*Chinh E.Chu—Director.*  Mr. Chubecame one of DJO’s directors and one of our managers immediately after thecompletion of the Prior Transaction. 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 

 

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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.

 

*Paul D.Chapman—Director.*  Mr. Chapmanbecame one of DJO’s directors immediately after the completion of the DJOMerger. Mr. Chapman served as Chief Operating Officer of ReAble from May 2003to November 2007. Mr. Chapman previously served as Group President—Surgicaland Rehabilitation from October 2006 and as ReAble’s President from May 2003.Previously, Mr. Chapman served as Executive Vice President and asPresident of the Chattanooga Group Division, a position he accepted in February 2002upon ReAble’s acquisition of Chattanooga Group, Inc. From 1995 to February 2002,he served as Chief Executive Officer of Chattanooga Group, Inc. Prior tojoining Chattanooga Group, Inc. in 1994, Mr. Chapman was employed byStryker Corporation, a medical device manufacturer. During his six years atStryker, Mr. Chapman held a variety of positions including Vice Presidentand General Manager, Patient Care Division; Vice President of Marketing and NewBusiness Development; Vice President of Sales, Medical Division; and VicePresident of Operations, Medical Division.

 

*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.

 

**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.reableinc.com*.Please note, however, that the information contained on the website is notincorporated by reference in, or considered part of, this Annual Report on Form 10-K.We will also provide copies of these documents, free of charge, to anystockholder upon written request to: Director, Investor Relations, DJO Incorporated, 1430 Decision Street,Vista, California 92081-8553.

 

*AuditCommittee*.  Our AuditCommittee consists of three appointed Directors, Mr. Sidney Braginsky(Chairman), Ms. Julia Kahr and Mr. Bruce McEvoy.  As a privately held company, our AuditCommittee is not required to be composed of only independent directors.  We believe that Mr. Braginsky would bedeemed an independent director within the definition of independence used inthe Rules of the New York Stock Exchange. Our Board of Directors has not determined that any of the members of ourAudit Committee is an “audit committee financial expert” as defined in SECRegulation S-K Item 401(h). Our Board of Directors believes that thecurrent members of the Audit Committee have requisite levels of financialliteracy and financial sophistication to enable the audit committee to beeffective in relation to the purposes outlined in its charter and in light ofthe scope and nature of our business and financial statements.

 

*Compensation Committee*.  During 2007, the Compensation Committee ofthe DJO Board consisted of two designees of The Blackstone Group, Chinh Chu andJulia Kahr.  Effective February 21,2008, Bruce McEvoy was appointed as member of the Compensation Committee.  Because DJO is a privately held company, theDJO Board is not required to have a majority of independent directors nor isthe Compensation Committee required to be composed of independent directors.

 

**ITEM11.  EXECUTIVE COMPENSATION**

 

**CompensationDiscussion And Analysis**

 

Overview

 

The followingCompensation Discussion and Analysis describes the material elements ofcompensation for our executive officers identified under Item 11. “ExecutiveCompensation – Summary Compensation Table” (the “Named Executive Officers” or “NEOs”).  As more fully described under “—CompensationCommittee” below, the Compensation Committee of the DJO Board of Directors (the“Compensation Committee”) reviews and makes all decisions for our executivecompensation program, including: establishing salaries and reviewing benefitprograms for the Chief Executive 

 

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Officer (“CEO”) and eachof our other executive officers; reviewing, approving, recommending andadministering our annual incentive compensation and stock option plans foremployees and other compensation plans; advising the DJO Board and makingrecommendations with respect to plans that require Board approval; andapproving our employment agreements with our executive officers.

 

*Role of the CompensationCommittee in Establishing Compensation*

 

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 did not meet separately from the rest ofthe DJO Board during 2007, but took all actions by written consent.

 

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 build long-termvalue for our stockholders. We believe that an effective executive compensationprogram is critical to our long-term success. By having an executivecompensation program that is competitive with the market practice and focusedon driving sustained superior performance, we believe we can align theinterests of our executive officers with the interests of stockholders andreward our executive officers for successfully improving stockholder returns.Our compensation program has the following objectives:

 

·                  attract andretain talented senior management to ensure our future success;

·                  encourage apay-for-performance mentality by directly relating variable compensationelements to the achievement of financial and strategic objectives;

·                  promote adirect relationship between executive compensation and our stockholders, withlong-term incentive compensation to link a significant portion of executivecompensation to our performance through stock option and restricted stockawards; and

·                  structure acompensation program that appropriately rewards our executive officers fortheir skills and contributions to our company based on competitive marketpractice.

 

TheElements of Our Executive Compensation Program

 

The elements of ourexecutive compensation program are as follows:

 

·                  Base salary;

·                  Annual and quarterly incentivecompensation (performance-based bonuses);

·                  Equity-based awards;

·                  Other benefits; and

·                  Benefits upon termination ofemployment

 

*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.  The CEO makes salaryrecommendations for executive officers other than him and reviews suchrecommendations with the Compensation Committee.

 

*Annualand Quarterly Incentive Compensation. *Performance-basedincentive compensation is provided to motivate our executive officers for eachquarter and for the full year to pursue objectives that the CompensationCommittee believes are consistent with the overall goals and long-termstrategic direction that the DJO Board has set for our company.

 

In November 2006,the Compensation Committee adopted a multi-year bonus plan which was intendedto remain in effect from year to year through 2011 (the “Prior Bonus Plan”).  The Prior Bonus Plan contained most of theelements of the 2008 plan described below. Following the DJO Merger, the Compensation Committee replaced the PriorBonus Plan with a new bonus plan which reflects the significant increase insize and changes in structure of the Company. This new bonus plan was effective on January 1, 2008 (the “BonusPlan”).  The Bonus Plan is intended toremain in effect from year to year, 

 

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although the targets willbe separately established for each year. The Bonus Plan consists of three separate components as described below:

 

·                  Target Bonus.  For 2008 and each subsequent plan yearthereafter, each NEO is eligible to earn a target bonus amount of up to 60% ofthe NEO’s base salary in effect during the year, calculated on a weightedaverage monthly basis using the base salary in effect on the first day of eachmonth, contingent upon (1) the achievement of free cash flow and AdjustedEBITDA (each as defined below) targets for each quarter and the full year, (2) theNEO’s fulfillment of individual performance goals, and (3) the NEO’scontinued employment with us through the specified payment date for thebonus.  The target bonus is earned andpayable on a quarterly and annual basis, with 12.5% of the target bonusavailable to be earned each quarter based on Adjusted EBITDA and free cash flowresults for the quarter and 50% available to be earned based on annual results,in each case also based on the NEO meeting individual performance goals.  For the quarterly and annual target bonus, partialachievement is available.  For eachquarter and for the year, 40% of the target bonus is payable if at least 90% ofthe performance targets are met, with payout amounts prorated on a pre-determinedscale between 90% and 100% of performance target achievement.

 

·                  Supplemental Bonus.  For 2008 and each subsequent plan yearthereafter, each NEO is eligible to earn a supplemental bonus amount of up to60% of the NEO’s base salary in effect during the year, calculated on aweighted average monthly basis using the base salary in effect on the first dayof each month, contingent upon (1) the achievement of certain higheramounts of free cash flow and Adjusted EBITDA targets for such plan year, (2) theNEOs fulfillment of individual performance goals, and (3) the NEO’scontinued employment with us through the specified payment date for thebonus.  The supplemental bonus is payableonly on an annual basis, with the full 60% of target bonus payable if 110% ormore of the performance targets are achieved and the NEO meets individualperformance goals.  The supplementalbonus payout will be prorated on a pre-determined scale between zero and 60% oftarget bonus for achievement between 100% and 110% of annual performancetargets.

 

·                  Retention Bonus.  In connection with the DJO Merger, each ofour current executive officers entered into an agreement to receive a retentionbonus, of which 50% was paid in January 2008 and 50% will be paid in January 2009.  The retention bonus to Mr. Baird waspaid 50% in cash and 50% in restricted stock. All other retention bonuses were paid in cash.  An executive officer must repay the retentionbonus received if his or her employment with us is terminated prior to January 1,2009, the date through which the bonus is earned, other than by reason ofdeath, disability, or a termination by us without cause.

 

Free cash flow,for the purposes of the Bonus Plan, is calculated as adjusted EBITDA, asdefined below, less capital expenditures, and adjusted for changes in operatingworking capital.  Adjusted EBITDA, forthe purposes of the Bonus Plan, is calculated as earnings before interest,income taxes, depreciation and amortization, further adjusted for non-cashitems, non-recurring items and other adjustment items pursuant to thedefinition of consolidated EBITDA contained in the credit agreement for our NewSenior Secured Credit Facility, excluding forward cost savings as determined bythe Board of Directors.  The CompensationCommittee selected 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.  For determining whether theperformance targets are met, adjusted EBITDA will be weighted at 70% and freecash flow at 30%. The particular targets for these performance metrics selectedfor purposes of the 2008 Bonus Plan are the same targets that apply todetermine whether recipients of stock options vest in part of their stockoptions in 2008, as discussed further in the equity compensation discussion.

 

*EquityCompensation. *Inconnection with the acquisition of ReAble by Blackstone in November 3,2006, the Compensation Committee adopted the 2006 Stock Incentive Plan (the “2006Plan”).  The purpose of the 2006 Plan wasto promote the interests of us and our shareholders by enabling selected keyemployees to participate in our long-term growth by receiving the opportunityto acquire shares of ReAble common stock and to provide for additionalcompensation based on appreciation in ReAble common stock.  In connection with the DJO Merger, weterminated the 2006 Plan and adopted the DJO Incorporated 2007 Incentive StockPlan (the “2007 Plan”) which provides for the grant of stock options and otherstock-based awards to key employees, directors and consultants, including theexecutive officers. Outstanding options to purchase DJO common stock originallyissued under the 2006 Plan are now governed by the terms of the 2007 Plan.  In addition, DJO adopted a form of stockoption agreement (the “DJO Form Option Agreement”) for awards under the2007 Plan.  Under the DJO Form OptionAgreement, one-third of the stock options will vest over a specified period oftime (typically five years) contingent solely upon the awardee’s continuedemployment with us.  Another one-third ofthe stock options will vest over a specified performance period (typically fiveyears) from the grant date upon the achievement of pre-determined performance 

 

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targets over time,consisting of adjusted 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 Plan, providedthat no options may be granted after November 20, 2017 and no option maybe exercisable after ten years from the date of grant.  All option awards granted under the 2007 Planwill have an exercise price equal to the fair market value of DJO’s commonstock on the date of grant. Fair market value is defined under the 2007 Plan tobe the closing market price of a share of DJO’s common stock on the date ofgrant or if no market price is available, the amount as determined by the Boardof Directors subject to confirmation by an outside appraiser.  The Compensation Committee retains thediscretion to make awards at any time in connection with the initial hiring ofa new employee, for retention purposes, or otherwise. We do not have anyprogram, plan or practice to time annual or ad hoc grants of stock options orother equity-based awards in coordination with the release of material non-publicinformation or otherwise. The 2007 Plan may be amended or terminated at anytime by the DJO Board. However, any amendment that would require shareholderapproval in order for the 2007 Plan to continue to meet any applicable legal orregulatory requirements will be effective only if it is approved by DJO’sshareholders. A total of 5,000,000 shares of DJO common stock are authorizedfor issuance under the 2007 Plan, with an additional 2,500,000 shares to beauthorized when a pending amendment is completed. These options can be eitherincentive stock options or non-qualified stock options.

 

In connection withthe DJO Merger, certain members of DJO Opco management were permitted toexchange a portion of their DJO Opco stock options for options to purchase anaggregate of 1,912,577 shares of DJO common stock granted under the 2007 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 (See Item 11. ExecutiveCompensation - “Grants of Plan-Based Awards”).  Following the DJO Merger,an aggregate of 264,525 Prior Transaction Management Rollover Options held byformer executive officers who were dismissed in connection with the DJO Mergerwere cancelled in exchange for payments equal to the intrinsic value of suchoptions (calculated by subtracting the per share exercise price of each optionfrom $16.46 per share).  The former executive officers also forfeited allunvested stock options issued under the 2006 Plan at the closing of the DJOMerger (See Item 11. Executive Compensation – “Option Exercises and StockVested” and “Outstanding Equity Awards at Fiscal Year-End – 2007”).

 

In February 2008, we granted options for a total of 1,860,055 shares(“Options”) under the 2007 Plan to our continuing executive officers who areNEOs, Mr. Cross, Ms. Capps, Mr. Baird, Mr. Roberts and Mr. Faulstick. The Options have a term of ten years from the date of grant and an exerciseprice of $16.46 per share. The Options vest in accordance with the followingschedule: (a) one-third of the Option shares constitute, and may bepurchased pursuant to the provisions of the “Time-Based Tranche” (definedbelow), (b) one-third of the Option shares constitute and may be purchasedpursuant to the provisions of the Performance-Based Tranche (defined below),and (c) one-third of the Option shares constitute and may be purchasedpursuant to the provisions of the Enchanced Performance-Based Tranche (definedbelow).  The Options become exercisable with respect to 25% of the Time-BasedTranche on December 31, 2008, 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 may earn the right to exercise the option to purchase 25% of thePerformance-Based or both the Performance-Based and Enhanced Performance-BasedTranches on December 31, 2008 if the applicable performance targets areachieved, 20% of the Performance-Based or both the Performance-Based andEnhanced Performance-Based Tranches on December 31, 2009 if the applicableperformance targets are achieved, 18.33% of the Performance-Based or both thePerformance-Based and Enhanced Performance-Based Tranches on December 31,2010 and 2011, and 18.34% of the Performance-Based or both the Performance-Basedand Enhanced Performance-Based Tranches on December 31, 2012, if theapplicable performance targets are achieved as of such dates, and provided thatthe optionee remains employed with us or any of our subsidiaries or affiliatesas of each such date. 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 options granted in February 2008 to our executive officers andother members of management contain change-in-control provisions that cause thevesting of a portion of the tranches upon the occurrence of a change-in-control,as follows: 1) the option shares in the Time-Based Tranche will becomeimmediately exercisable upon the occurrence of a change-in-control if theoptionee remains in continuous employment of the Company until the consummationof the change-in-control and 2) the option shares of the Performance-BasedTranche and the Enhanced Performance-Based Tranche for the year in which suchchange-in-control is consummated and for any subsequent performance periodswill become immediately exercisable if the optionee remains in continuousemployment of the Company until the consummation of the change-in-control.

 

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*OtherBenefits.*  Otherbenefits to the executive officers include two 401(k) plans, including a401(k) plan maintained by DJO Opco which covers most of the NEOs. Wemaintain these 401(k) plans 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 2007 plan year, wemade matching contributions equal to up to 50% of the first 6% of compensationdeferred by employees (subject to Internal Revenue Service limits and non-discriminationtesting).  For the 2008 plan year, theemployer contribution percentage will remain unchanged.  DJO Opco maintains a non-qualified deferredcompensation plan for its most senior management, and that plan may be madegenerally 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 “EmploymentAgreements,” prior to the DJO Merger, we entered into employment agreementswith Mr. Baird and certain former executive officers**.**These agreements provide for certain payments and other benefits if theexecutive officer’s employment terminates under specified circumstances,including in the event of a “change in control.” In general, the employmentagreements establish the salary and bonus amounts, and provide for the paymentof amounts, including one year’s base salary and in certain cases, bonuses, inthe event the executive is terminated without cause during the term of theagreement. The executive officer employment agreements also contain provisionsthat prohibit the executive officer from disclosing our confidentialinformation and that prohibit the executive officer from engaging in certaincompetitive activities or soliciting any of our employees, customers, potentialcustomers, or acquisition prospects.  TheCompensation Committee believes that employment agreements help to secure thecontinued employment and dedication of our NEOs, despite any concern that theymight have regarding their own continued employment prior to or following achange in control. The Compensation Committee may extend such agreements toformer DJO Opco executives who are NEOs but has not yet chosen to do so in partbecause those former DJO Opco executives are parties to change-in-controlseverance agreements entered into prior to the DJO Merger that remain ineffect.  Under those severanceagreements, the DJO Merger constituted a change-in-control event.  As a result, in the event that an executivesubject to such agreement is terminated without cause or terminates for goodreason within two years of the DJO Merger, the executive will receive aseverance benefit of 1.5 times (2 times in the case of Mr. Cross) theexecutive’s base salary and target bonus, plus extended health and lifeinsurance benefits.  These agreementsalso contain customary confidentiality and noncompetition covenants.  The narrative and table included in “PotentialPayments Upon Termination or Change-in-Control” reflects potential paymentsupon termination of employment of our NEOs.

 

TheTax and Accounting Considerations

 

Section 162(m) ofthe Internal Revenue Code of 1986 provides that compensation in excess of$1,000,000 paid to the CEO or to any of the other four most highly compensatedexecutive officers of a public company will not be deductible for federalincome tax purposes unless such compensation is paid pursuant to one of theenumerated 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.

 

**SummaryCompensation Table**

 

The followingtable sets forth summary information about the compensation during 2007 and2006 for services rendered in all capacities by our Chief Executive Officer,Chief Financial Officer and each of our three other most highly compensatedexecutive officers.  Also included in thetable below is information regarding Mr. Davidson and Mr. Burke, ourformer CEO and CFO, and for Mr. Chapman and Mr. Zimmerman (the “FormerExecutive Officers”), who were not serving as executive officers as of the endof the year but for whom disclosure would have been provided but for the factthat the individual was not serving as an executive officer as of the end ofthe year.  All of the individuals listedin the following table are referred herein collectively as the “Named ExecutiveOfficers” or “NEOs.”

 

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| **Name and  Principal Position**                                                                              | ** ** | **Year**   | ** ** | **Salary (1)** | ** ** | **Bonus (2)** | ** ** | **Stock  Awards  (3)** | ** ** | **Option  Awards  (4)** | ** ** | **Non-Equity  Incentive Plan  Compensation** | ** ** | **Change in  Pension Value  and  Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation  (5)** | ** ** | **Total ($)** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|---------------------|------------|--------------------|------------|------------------------|------------|-------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------|------------|
| ** **                                                                                                              | ** ** | ** ** | ** ** | ** **          | ** ** | ** **         | ** ** | ** **             | ** ** | ** **              | ** ** | ** **                                        | ** ** | ** **                                                                                  | ** ** | ** **                            | ** ** | ** **         | ** ** |
| Leslie H. Cross,*Chief Executive Officer  and Director*                                                                 |       | 2007       |       | $                   | 60,135     |               | $          | 248,438                |       | $                       | —     |                                              | $          | 1,327,352                                                                                   |       | $                                     | —     |               | $          | — |   | $ | — |   | $ | 1,635,925 |   |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| Vickie L. Capps*, Executive Vice  President, Chief Financial Officer and Treasurer*                                     |       | 2007       |       | 35,740              |       | 118,125            |       | —                 |       | 703,687                 |       | —                                            |       | —                                                                                      |       | —                                |       | 857,552            |       |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| Kenneth W. Davidson,*Chairman  of the Board of Directors and former Chief Executive Officer*(6)                         |       | 2007       |       | 434,297             |       | —             |       | —                 |       | 189,319                 |       | —                                            |       | —                                                                                      |       | 4,231,500                             |       | 4,855,116          |       |
|                                                                                                                    |       | 2006       |       | 458,250             |       | 1,525,000          |       | —                 |       | 8,183,908               |       | —                                            |       | —                                                                                      |       | 419,978                               |       | 10,587,136         |       |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| William W. Burke,*former Executive Vice  President and Chief Financial Officer* (6)                                     |       | 2007       |       | 229,485             |       | —             |       | —                 |       | 77,955                  |       | —                                            |       | —                                                                                      |       | 2,571,123                             |       | 2,878,563          |       |
|                                                                                                                    |       | 2006       |       | 273,000             |       | 1,000,000          |       | —                 |       | 2,814,799               |       | —                                            |       | —                                                                                      |       | 16,062                                |       | 4,103,861          |       |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| Peter W. Baird,*President*                                                                                              |       | 2007       |       | 334,615             |       | 200,000            |       | 136,728                |       | 208,380                 |       | —                                            |       | —                                                                                      |       | 306,750                               |       | 1,186,473          |       |
|                                                                                                                    |       | 2006       |       | 69,231              |       | 500,000            |       | —                 |       | 2,046,488               |       | —                                            |       | —                                                                                      |       | —                                |       | 2,615,719          |       |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| Donald M. Roberts*, Executive Vice  President, General Counsel and Secretary*                                           |       | 2007       |       | 31,202              |       | 103,125            |       | —                 |       | 568,066                 |       | —                                            |       | —                                                                                      |       | —                                |       | 702,393            |       |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| Luke T. Faulstick*, President, Global  Operations*                                                                      |       | 2007       |       | 35,740              |       | 118,125            |       | —                 |       | 544,766                 |       | —                                            |       | —                                                                                      |       | —                                |       | 698,631            |       |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| Paul D. Chapman*, Director and former  Group President—Surgical and Rehabilitation and Chief Operating Officer*(6) |       | 2007       |       | 281,932             |       | —             |       | —                 |       | 100,228                 |       | —                                            |       | —                                                                                      |       | 2,381,199                             |       | 2,763,359          |       |
|                                                                                                                    |       | 2006       |       | 315,000             |       | 700,000            |       | —                 |       | 4,357,989               |       | —                                            |       | —                                                                                      |       | 6,600                                 |       | 5,379,589          |       |
|                                                                                                                    |       |       |       |                |       |               |       |                   |       |                    |       |                                              |       |                                                                                        |       |                                  |       |               |       |
| Harry L. Zimmerman*, former Executive Vice  President and General Counsel*(6)                                           |       | 2007       |       | 204,782             |       | —             |       | —                 |       | 77,955                  |       | —                                            |       | —                                                                                      |       | 2,151,703                             |       | 2,434,440          |       |
|                                                                                                                    |       | 2006       |       | 230,000             |       | 400,000            |       | —                 |       | 3,144,365               |       | —                                            |       | —                                                                                      |       | 6,600                                 |       | 3,780,965          |       |
|                                                                                                                         |            |            |            |                     |            |                    |            |                        |            |                         |            |                                                   |            |                                                                                             |            |                                       |            |                    |            |  |  |  |  |  |  |  |  |

 

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(1)         Amounts represent salary earned up to the date of the DJO Merger in thecase of the Former Executive Officers and from the date of the DJO Mergerthrough December 31, 2007 for the incoming DJO executives.  Mr. Baird was hired in October 2006.

 

(2)         The amounts shown in this column for the Former Executive Officersrepresent retention bonus payments made under the bonus plan adopted inconnection with the closing of the Prior Transaction.  Amounts included for our current executiveofficers include discretionary bonuses that were paid during 2008 related toperformance by DJO Opco under the 2007 DJO Opco bonus plan for the fourth quarterand full fiscal year.  Excluded from thetable are amounts payable under retention bonus agreements entered into in November 2007with each of our current executive officers in connection with the DJO Merger,of which 50% of the retention bonus was paid in January 2008 and 50% willbe paid in January 2009.  Eachexecutive officer forfeits any unpaid retention bonus and must repay theretention bonus received if his or her employment with us is terminated priorto January 1, 2009, the date through which the bonus is earned, other thanby reason of a termination by us without cause.  See “CompensationDiscussion and Analysis – The Elements of Our Executive Compensation Program –Annual Incentive Compensation”.

 

(3)         The amount shown in this column represents the dollar amount recognizedin connection with stock awards for financial statement reporting purposes forthe 2007 and 2006 fiscal years in accordance with SFAS 123(R).  This expense related to two restricted stockawarded to Mr. Baird in 2007, consisting of an award of 15,189 shares of restrictedstock in March 2007 and 24,300 shares of restricted stock in November 2007,vesting over time with the final vesting on November 2009 and January 2009,respectively.

 

(4)         Except as described further below, the amounts shown in this columnrepresent the dollar amounts recognized for the 2007 and 2006 fiscal years forthe fair value of stock options granted in those years as well as prior fiscalyears in accordance with SFAS 123(R). Pursuant to SEC rules, the amounts shown exclude the impact of estimatedforfeitures related to service-based vesting conditions.  These amounts reflect our accounting expenseand do not correspond to the actual value that will be realized by theNEOs.  See Note 10 to the audited consolidatedfinancial statements included in this annual report on Form 10-K for adiscussion of the relevant assumptions. Except for the amounts for Mr. Baird in 2006, the amounts for 2006represent the grant date fair value of the Prior Transaction ManagementRollover Options.  The amounts for Mr. Bairdin 2006 represent options granted under the 2006 Plan in connection with hisinitial employment in October 2006. The amounts in 2007 for Messrs. Cross,Roberts and Faulstick and Ms. Capps represents the grant date fair valueof the DJO Management Rollover Options, less the intrinsic value of vested DJOOpco options that each exchanged for the DJO Management Rollover Options in thefollowing approximate amounts: Mr. Cross: 

 

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$3.0 million, Ms. Capps: $2.0 million, Mr. Roberts:$1.0 million and Mr. Faulstick: $1.0 million. The amounts in 2007 for Messrs. Davidson,Burke, Baird, Chapman and Zimmerman represent amounts recognized in 2007related to options granted in November 2006 in connection with the PriorTransaction that vested during 2007. Additional information regarding grantsawarded in 2007 is presented in the “Grants of Plan Based Awards” tablebelow.  In connection with the DJOMerger, the Former Executive Officers forfeited all unvested stock optionsissued under the 2006 Stock Incentive Plan as of that date.

 

(5)         Perquisites and other personal benefits are valued on the basis of theaggregate incremental cost to the Company of such perquisites and otherpersonal benefits.  Included in theFormer Executive Officers’ total is compensation earned in connection with theDJO Merger and “change of control” clause in each of their respectiveemployment agreements.  A breakdown ofthe amounts shown in this column for 2007 for each of the NEOs is set forth inthe following table:

 
| ** **                        | ** ** | **Mr. Davidson** | ** ** | **Mr. Burke** | ** ** | **Mr. Baird** | ** ** | **Mr. Chapman** | ** ** | **Mr. Zimmerman** | ** ** |
|-----------------------------------|------------|-----------------------|------------|--------------------|------------|--------------------|------------|----------------------|------------|------------------------|------------|
| Automobile allowance              |       | $                     | 22,000     |               | $          | —             |       | $                    | —     |                   | $          | — |   | $ | — |   |
| Severance                         |       | 4,171,773             |       | 2,485,568          |       | —             |       | 2,320,548            |       | 2,086,582              |       |
| Consulting (a)                    |       | —                |       | 46,840             |       | —             |       | 29,671               |       | 29,353                 |       |
| Life insurance premiums           |       | 3,290                 |       | —             |       | —             |       | —               |       | 1,146                  |       |
| Spouse travel reimbursement       |       | 7,260                 |       | —             |       | —             |       | —               |       | —                 |       |
| 401(k) matching contribution |       | 6,750                 |       | 6,750              |       | 6,750              |       | 6,750                |       | 6,750                  |       |
| Other (b)                         |       | 20,427                |       | 31,965             |       | 300,000            |       | 24,230               |       | 27,872                 |       |
| Total                             |       | $                     | 4,231,500  |               | $          | 2,571,123          |       | $                    | 306,750    |                   | $          | 2,381,199 |   | $ | 2,151,703 |   |

 

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(a)          Represents compensation paid to the Former Executive Officers forconsulting services rendered from November 20, 2007 through December 31,2007.

(b)         The amounts shown for Messrs. Davidson, Burke, Chapman andZimmerman represents earned unused vacation paid upon termination of employmentin connection with the DJO Merger.  Theamount for Mr. Baird represents relocation costs paid during 2008 inconnection with moving our Company headquarters to Vista, California.

 

(6)         Messrs. Davidson,Burke, Chapman, and Zimmerman were terminated as employees and executiveofficers on November 20, 2007.  Mr. Davidsoncontinued to serve as a Director of DJO and Mr. Chapman was appointed as aDirector on November 20, 2007.  Messrs. Burkeand Zimmerman were engaged as consultants on November 20, 2007, Mr. Burkewill serve in such capacity through June 30, 2008 and Mr. Zimmermanserved as consultant until January 31, 2008.

 

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**Grants ofPlan-Based Awards in 2007**

 

The following table setsforth certain information with respect to grants of plan-based awards made tothe NEOs during 2007.

** **
|               |   |           |   | ** **                                                           |    | ** **                                                       |   | **All Other  Stock  Awards:  Number**  |   | **All Other  Option  Awards:**                     |    | **Exercise  or Base**                         |   | **Market**                           |   | ** **                                           |   |
|--------------------|--------|----------------|--------|----------------------------------------------------------------------|---------|------------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------------------------------|---------|-----------------------------------------------|--------|--------------------------------------|--------|------------------------------------------------------|--------|
|               |   |           |   | **Estimated Future Payouts Under Non-Equity  Incentive Plan Awards** |    | **Estimated Future Payouts Under Equity  Incentive Plan Awards** |   | **of Shares  of Stock  or Units  (#)** |   | **Number of  Securities  Underlying  Options (#)** |    | **Price of  Option  Awards  ($/Sh) (4)** |   | **Price on  Date of  Grant  ($/Sh)** |   | **Grant Date Fair  Value of Option  Awards ($) (5)** |   |
| **Name**           |   | **Grant Date** |   | **Threshold  ($)**                                                   |    | **Target  ($)**                                                  |   | **Maximum ($)**                        |   | **Threshold  (#)**                                 |    | **Target  (#)**                               |   | **Maximum  (#)**                     |
| ** **         |   | ** **     |   | ** **                                                           |    | ** **                                                       |   | ** **                             |   | ** **                                         |    | ** **                                    |   | ** **                           |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Cross     |   | 11/20/07       | (1)    | $                                                                    | —  |                                                             | $      | —                                 |   | $                                                  | —  |                                          | — |                                 | — |                                                 | — |   | — |   | 193,254 |   | $ | 8.29 |   | $ | 16.46 |   | $ | 1,878,187 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 43,351 |   | 7.00 |   | 16.46 |   | 463,170 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 82,427 |   | 12.91 |   | 16.46 |   | 559,037 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 213,700 |   | 13.10 |   | 16.46 |   | 1,427,472 |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mrs. Capps    |   | 11/20/07       | (1)    | $                                                                    | —  |                                                             | $      | —                                 |   | $                                                  | —  |                                          | — |                                 | — |                                                 | — |   | — |   | 91,585 |   | $ | 8.29 |   | $ | 16.46 |   | $ | 890,095 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 5,343 |   | 7.18 |   | 16.46 |   | 56,343 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 76,315 |   | 7.00 |   | 16.46 |   | 815,375 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 6 |   | 7.00 |   | 16.46 |   | 64 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 48,846 |   | 12.91 |   | 16.46 |   | 331,281 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 91,586 |   |   | 13.10 |   | 16.46 |   | 611,774 |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Davidson  |   | 1/1/07         | (2)    | $                                                                    | 290,979 |                                                             | $      | 290,979                                |   | $                                                  | 725,276 |                                          | — |                                 | — |                                                 | — |   | — |   | — |   | $ | — |   | $ | — |   | $ | — |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Burke     |   | 1/1/07         | (2)    | $                                                                    | 153,755 |                                                             | $      | 153,755                                |   | $                                                  | 383,240 |                                          | — |                                 | — |                                                 | — |   | — |   | — |   | $ | — |   | $ | — |   | $ | — |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Baird     |   | 1/1/07         | (2)    | $                                                                    | 224,192 |                                                             | $      | 224,192                                |   | $                                                  | 558,807 |                                          | — |                                 | — |                                                 | — |   | — |   | — |   | $ | — |   | $ | — |   | $ | — |   |
|               |   | 3/15/07        | (3)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | 15,189                                               |   | — |   | — |   | — |   | — |   |
|               |   | 11/20/07       | (3)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | 24,300                                               |   | — |   | — |   | — |   | — |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Roberts   |   | 11/20/07       | (1)    | $                                                                    | —  |                                                             | $      | —                                 |   | $                                                  | —  |                                          | — |                                 | — |                                                 | — |   | — |   | 35,080 |   | $ | 8.29 |   | $ | 16.46 |   | $ | 340,934 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 30,528 |   | 8.84 |   | 16.46 |   | 284,677 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 48,846 |   | 12.91 |   | 16.46 |   | 331,281 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 91,586 |   | 13.10 |   | 16.46 |   | 611,774 |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Faulstick |   | 11/20/07       | (1)    | $                                                                    | —  |                                                             | $      | —                                 |   | $                                                  | —  |                                          | — |                                 | — |                                                 | — |   | — |   | 45,792 |   | $ | 8.29 |   | $ | 16.46 |   | $ | 445,049 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 10,032 |   | 7.00 |   | 16.46 |   | 107,179 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 48,846 |   | 12.91 |   | 16.46 |   | 331,281 |   |
|               |   | 11/20/07       | (1)    | —                                                               |    | —                                                           |   | —                                 |   | —                                             |    | —                                        |   | —                               |   | —                                               |   | 91,586 |   | 13.10 |   | 16.46 |   | 611,774 |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Chapman   |   | 1/1/07         | (2)    | $                                                                    | 188,894 |                                                             | $      | 188,894                                |   | $                                                  | 470,826 |                                          | — |                                 | — |                                                 | — |   | — |   | — |   | $ | — |   | $ | — |   | $ | — |   |
|               |   |           |   |                                                                 |    |                                                             |   |                                   |   |                                               |    |                                          |   |                                 |   |                                                 |   |   |   |   |   |   |   |   |   |
| Mr. Zimmerman |   | 1/1/07         | (2)    | $                                                                    | 137,204 |                                                             | $      | 137,204                                |   | $                                                  | 341,986 |                                          | — |                                 | — |                                                 | — |   | — |   | — |   | $ | — |   | $ | — |   | $ | — |   |

 

----

(1)         The amounts setforth in these rows under the column “All Other Option Awards:  Number of Securities Underlying Options” foreach of the NEOs reflect the number of shares underlying the DJO ManagementRollover Options which were fully vested upon issuance in connection with theDJO Merger.  The DJO Management RolloverOptions were issued in exchange for options under the DJO Opco option planvalued at the following dollar amounts:  Mr. Cross:  $3.0 million, Ms. Capps:  $2.0 million, Mr. Roberts:  $1.0 million, and Mr. Faulstick:  $1.0 million.

 

(2)         The amounts setforth in these rows under the column “Estimated Future Payouts Under Non-EquityIncentive Plan Awards” for the Former Executive Officers represent thethreshold, target and maximum bonus potential under the 2006 Bonus Plan.  No amounts were paid out under the 2006 BonusPlan for the 2007 fiscal year.

 

126

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(3)         The amounts set forth inthese rows under the column “All Other Stock Awards: Number of Shares of Stockor Units” for Mr. Baird represent restricted stock awards granted in March 2007and in November 2007 in connection with the DJO Merger.

 

(4)         Exercise prices reflect the intrinsic gain (derived from the per share purchaseprice of DJO Opco shares in the DJO Merger) in the DJO Opco options which wereexchanged for the DJO Management Rollover Options.  The aggregate exercise prices for each grantof DJO Management Rollover Options shown in this column, when added to theintrinsic value of the DJO Opco options exchanged therefor, equals theaggregate fair market value of each such grant.

 

(5)   The grant date fair value is the value of awards granted in 2007 asdetermined in accordance with FAS 123(R), which has been recorded for financialreporting purposes as part of the DJO Merger purchase price.  The grant date fair values for these awardsare shown at their gross amounts and have not been reduced by the intrinsicvalue of the DJO Opco options exchanged in return for these awards.  See footnote 4 to the “Summary CompensationTable.”

 

**Employment Agreements**

 

In September 2006,we entered into an employment agreement with Mr. Baird (the “BairdAgreement”) effective on October 1, 2006, providing for a three year term,and renewing for successive one-year periods unless either Mr. Baird or usprovides written notice to the other party of his or our intent not to renewone-hundred eighty (180) days prior to the end of the term. The Baird Agreementprovides for a base salary of $300,000 per year, and provides that Mr. Bairdis entitled to at least a five percent (5%) annual increase in base salary oneach annual anniversary. Through the end of 2007, Mr. Baird was entitledto participate in our compensation and employee benefit plans (other than annualbonus and severance plans) generally made available to our other seniorexecutives. Mr. Baird is eligible to earn (i) an annual bonus awardtargeted at sixty-seven percent (67%) of his base salary, based only upon ourachievement of certain predetermined performance targets and contingent uponhis continued employment through the specified payment date, and (ii) asupplemental bonus award targeted at one hundred percent (100%) of his basesalary, based only upon our achievement of certain predetermined performancetargets, and contingent upon his continued employment with us through thespecified payment date. For 2008 and subsequent years, Mr. Baird willparticipate in the Bonus Plan described in the Compensation Discussion andAnalysis discussion above. On the closing date of the Prior Transaction, wegranted Mr. Baird options to purchase 225,001 shares of our common stock(the “Initial Stock Option Grant”) under the 2006 Incentive Stock Plan. TheInitial Stock Option Grant contains time-based and performance-based stockoption award vesting provisions.  Mr. Baird’semployment may be terminated by either party at any time and for any reason;provided that each party will be required to give the other party at leastthirty (30) days advance written notice of any such termination. Mr. Baird’semployment may be terminated by us for “Cause” (as defined in the BairdAgreement) and shall terminate automatically upon Mr. Baird’s resignationwithout “Good Reason” (as defined in the Baird Agreement). If Mr. Baird’semployment is terminated by us for “Cause”, or if Mr. Baird resignswithout “Good Reason”, Mr. Baird would be entitled to receive (i) alump sum payment equal to his base salary through the date of termination; (ii) reimbursementfor any unreimbursed business expenses; (iii) any earned but unpaid annualbonus and supplemental bonus with respect to the most recently completedcalendar year which has ended prior to the date on which such terminationoccurs; (iv) a lump sum payment to any accrued and unused vacation pay;and (v) employee benefits, if any, as to which Mr. Baird (or hisdependents or beneficiaries, as applicable) may be entitled under our employeebenefit plans (collectively, clause (i) through (v) hereof beingreferred to as the “Accrued Rights”).  The Baird Agreement provides that if Mr. Baird’s employment isterminated by us without “cause” (other than by reason of death or disability)or by Mr. Baird’s resignation for “good reason” (as such terms are definedin the Baird Agreement), Mr. Baird is entitled, in addition to the AccruedRights, to those benefits described in “Potential Payments upon Termination orChange-in-Control” below.

 

127

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**Outstanding Equity Awards at 2007 Fiscal Year-End**

 

The following table sets forth certain informationregarding equity-based awards held by each of the NEOs as of December 31,2007:

 
| ** **           | ** ** | **Option Awards**                                                              | ** ** | **Stock Awards**                                                                 | ** ** |
|----------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| **Name**             | ** ** | **Number of Securities Underlying Unexercised  Options**

**(#)  Exercisable  (1)** | ** ** | **Number of Securities Underlying Unexercised  Options**

**(#)  Unexercisable  (2)** | ** ** | **Equity  Incentive Plan Awards:  Number of Securities Underlying Unexercised Unearned  Options**

**(#) (3)** | ** ** | **Option  Exercise   Price  ($)** | ** ** | **Option  Expiration  Date** | ** ** | **Number  of Shares  or Units of Stock  That Have Not  Vested**

**(#)** | ** ** | **Market  Value of Shares  or Units  of Stock  That  Have  Not  Vested  ($)** | ** ** | **Equity   Incentive Plan   Awards:  Number of Unearned  Shares, Units or  Other Rights  That Have Not  Vested**

**(#)** | ** ** | **Equity Incentive  Plan Awards: Market or  Payout Value of Unearned  Shares, Units or  Other Rights That Have Not Vested**

**($)** | ** ** |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Leslie H. Cross      |       | 193,254                                                                             |       | —                                                                                |       | — |   | $ | 8.29 |   | 12/9/2013 |   | — |   | $ | — |   | — |   | $ | — |   |
|                 |       | 43,351                                                                              |       | —                                                                                |       | — |   | 7.00 |   | 12/8/2014 |   | — |   | — |   | — |   | — |   |
|                 |       | 82,427                                                                              |       | —                                                                                |       | — |   | 12.91 |   | 4/3/2016 |   | — |   | — |   | — |   | — |   |
|                 |       | 213,700                                                                             |       | —                                                                                |       | — |   | 13.10 |   | 5/12/2017 |   | — |   | — |   | — |   | — |   |
| ** **           |       | **532,732**                                                                         |       | —                                                                                |       | — |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Vickie L. Capps      |       | 91,585                                                                              |       | —                                                                                |       | — |   | $ | 8.29 |   | 12/9/2013 |   | — |   | $ | — |   | — |   | $ | — |   |
|                 |       | 5,343                                                                               |       | —                                                                                |       | — |   | 7.18 |   | 2/26/2014 |   | — |   | — |   | — |   | — |   |
|                 |       | 76,321                                                                              |       | —                                                                                |       | — |   | 7.00 |   | 12/8/2014 |   | — |   | — |   | — |   | — |   |
|                 |       | 48,846                                                                              |       | —                                                                                |       | — |   | 12.91 |   | 4/3/2016 |   | — |   | — |   | — |   | — |   |
|                 |       | 91,586                                                                              |       | —                                                                                |       | — |   | 13.10 |   | 5/12/2017 |   | — |   | — |   | — |   | — |   |
| ** **           |       | **313,681**                                                                         |       | —                                                                                |       | — |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Kenneth W.  Davidson |       | 19,900                                                                              |       | —                                                                                |       | — |   | $ | 18.29 |   | 5/18/2014 |   | — |   | $ | — |   | — |   | $ | — |   |
|                 |       | 79,600                                                                              |       | —                                                                                |       | — |   | 9.80 |   | 8/9/2014 |   | — |   | — |   | — |   | — |   |
|                 |       | 9,950                                                                               |       | —                                                                                |       | — |   | 12.36 |   | 10/20/2015 |   | — |   | — |   | — |   | — |   |
|                 |       | 199,025                                                                             |       | —                                                                                |       | — |   | 12.16 |   | 11/17/2015 |   | — |   | — |   | — |   | — |   |
| ** **           |       | **308,475**                                                                         |       | —                                                                                |       | — |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| William W. Burke     | ** ** | **—**                                                                          |       | —                                                                                |       | — |   | $ | — |   | — |   | — |   | $ | — |   | — |   | $ | — |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Peter W. Baird       |       | 12,188                                                                              |       | 44,063                                                                                |       | 168,750 |   | $ | 16.46 |   | 11/4/2016 |   | 34,427 |   | $ | 566,660 |   | — |   | $ | — |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Donald M. Roberts    |       | 35,080                                                                              |       | —                                                                                |       | — |   | $ | 8.29 |   | 12/9/2013 |   | — |   | $ | — |   | — |   | $ | — |   |
|                 |       | 30,528                                                                              |       | —                                                                                |       | — |   | 8.84 |   | 5/25/2015 |   | — |   | — |   | — |   | — |   |
|                 |       | 48,846                                                                              |       | —                                                                                |       | — |   | 12.91 |   | 4/3/2016 |   | — |   | — |   | — |   | — |   |
|                 |       | 91,586                                                                              |       | —                                                                                |       | — |   | 13.10 |   | 5/12/2017 |   | — |   | — |   | — |   | — |   |
| ** **           |       | **206,040**                                                                         |       | —                                                                                |       | — |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Luke T. Faulstick    |       | 45,792                                                                              |       | —                                                                                |       | — |   | $ | 8.29 |   | 12/9/2013 |   | — |   | $ | — |   | — |   | $ | — |   |
|                 |       | 10,032                                                                              |       | —                                                                                |       | — |   | 7.00 |   | 12/8/2014 |   | — |   | — |   | — |   | — |   |
|                 |       | 48,846                                                                              |       | —                                                                                |       | — |   | 12.91 |   | 4/3/2016 |   | — |   | — |   | — |   | — |   |
|                 |       | 91,586                                                                              |       | —                                                                                |       | — |   | 13.10 |   | 5/12/2017 |   | — |   | — |   | — |   | — |   |
| ** **           |       | **196,256**                                                                         |       | —                                                                                |       | — |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Paul D. Chapman      |       | 9,950                                                                               |       | —                                                                                |       | — |   | $ | 18.29 |   | 5/18/2014 |   | — |   | $ | — |   | — |   | $ | — |   |
|                 |       | 122,325                                                                             |       | —                                                                                |       | — |   | 12.16 |   | 11/17/2015 |   | — |   | — |   | — |   | — |   |
| ** **           |       | **132,275**                                                                         |       | —                                                                                |       | — |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                 |       |                                                                                |       |                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Harry L.  Zimmerman  | ** ** | **—**                                                                          |       | —                                                                                |       | — |   | $ | — |   | — |   | — |   | $ | — |   | — |   | $ | — |   |

 

128

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----

(1)         The amounts setforth in this column for the incoming DJO executive officers reflect the numberof shares underlying the DJO Management Rollover Options which were fullyvested upon issuance in connection with the DJO Merger.  Amounts set forth for Mr. Davidson and Mr. Chapmanrepresent options that vested in connection with the Prior Transaction thatcontinue as options to purchase DJO common stock.  Amounts for Mr. Baird represent sharesunderlying the time-based options that are vested and exercisable that weregranted to Mr. Baird under the 2006 Plan in connection with his initialemployment in October 2006.

 

(2)         The amount setforth in this column for Mr. Baird reflects the number of sharesunderlying the time-based options that are not vested that were granted underthe 2006 Plan in connection with his initial employment.  See “Compensation Discussion and Analysis -The Elements of our Executive Compensation Program - Equity Compensation” forfurther information regarding the vesting of these options.

 

(3)         The amounts setforth in this column for Mr. Baird reflect the number of shares underlyingthe performance-based options granted under the 2006 Plan in connection withhis initial employment.  See “CompensationDiscussion and Analysis - The Elements of our Executive Compensation Program -Equity Compensation” for further information regarding the vesting of theseoptions.

 

**OptionExercises and Stock Vested During 2007**

 

The following table setsforth certain information regarding options that were exercised and stock whichvested during the year ended December 31, 2007 for each NEO:

 

**Option Exercises and Stock Vested**

 
| ** **           | ** ** | **Option Awards**                                                       | ** ** | **Stock Awards**                                   | ** ** |
|----------------------|------------|------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Name**             | ** ** | **Number of Shares  Acquired on Exercise  (#) (1)** | ** ** | **Value Realized On  Exercise  ($) (2)** | ** ** | **Number of Shares  Acquired on Vesting  (#)** | ** ** | **Value Realized on  Vesting  ($) (3)** | ** ** |
| Leslie H. Cross      |       | —                                                                       |       | $                                                       | —     |   | — |   | $ | — |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| Vickie L. Capps      |       | —                                                                       |       | —                                                  |       | — |   | — |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| Kenneth W.  Davidson |       | —                                                                       |       | —                                                  |       | — |   | — |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| William W. Burke     |       | 65,525                                                                       |       | 279,768                                                 |       | — |   | — |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| Peter W. Baird       |       | —                                                                       |       | —                                                  |       | 5,062 |   | 83,329 |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| Donald M.  Roberts   |       | —                                                                       |       | —                                                  |       | — |   | — |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| Luke T.  Faulstick   |       | —                                                                       |       | —                                                  |       | — |   | — |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| Paul D. Chapman      |       | —                                                                       |       | —                                                  |       | — |   | — |   |
|                 |       |                                                                         |       |                                                    |       |   |   |   |   |
| Harry L.  Zimmerman  |       | 119,400                                                                      |       | 605,358                                                 |       | — |   | — |   |
|                      |            |                                                                              |            |                                                         |            |  |  |  |  |  |  |

 

----

(1)          Amounts represent Prior Transaction Management Rollover Options thatwere cancelled at closing of the DJO Merger in exchange for payment equal tothe intrinsic value of such options (calculated by subtracting the per shareexercise price of such options from $16.46 per share).

(2)          Amounts calculated based on the fair market value of our common stock($16.46 per shares) on the date of exercise less the exercise price for suchshares.

(3)          Amounts calculated by multiplying number of shares by the fair marketvalue of the shares on the vesting date ($16.46 per share).

 

**Non-Qualified Deferred Compensation for 2007**

 

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 benefit obligationsof the Deferred Plan, and the assets set aside in the trust for those benefitswill be available to creditors of DJO, LLC in the event of bankruptcy orinsolvency. Each participant may elect to defer under the Deferred Plan all ora portion of his or her cash compensation that may otherwise be payable in acalendar year. A participant’s compensation deferrals are credited to theparticipant’s account under the Deferred Plan and the trust. Each participantmay elect to have the amounts in such participant’s account invested in one ormore investment options available under the Deferred Plan, which investmentoptions are substantially the same investment options available to participantsin DJO, LLC’s 401(k) Savings Plan. The Deferred 

 

129

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Plan also permits DJO, LLC to makecontributions to the Deferred Plan, including matching contributions, at itsdiscretion, but no such contributions have been made to date. To the extentthat Company contributions are made to the Deferred Plan, the Committee mayimpose vesting criteria to aid in the employment retention of participants. Aparticipant’s eventual benefit will depend on his or her level ofcontributions, DJO, LLC’s contributions, if any, and the investment performanceof the particular investment options selected. The following table sets forthinformation for each of the Named Executive Officers who participated in DJO,LLC’s Nonqualified Deferred Compensation Plan during 2006.

 
| ** **         | ** ** | **Executive**           | ** ** | **Registrant**       | ** ** | **Aggregate**        | ** ** | ** **        | ** ** | ** **                    | ** ** |
|--------------------|------------|-------------------------|------------|----------------------|------------|----------------------|------------|-------------------|------------|-------------------------------|------------|
| ** **         | ** ** | **Contributions**       | ** ** | **Contributions**    | ** ** | **Earnings**         | ** ** | **Aggregate**     | ** ** | **Aggregate**                 | ** ** |
| ** **         | ** ** | **in Last**        | ** ** | **in Last**     | ** ** | **in Last**     | ** ** | **Withdrawals/**  | ** ** | **Balance at Last** | ** ** |
| **Name**           | ** ** | **Fiscal Year(1)** | ** ** | **Fiscal Year** | ** ** | **Fiscal Year** | ** ** | **Distributions** | ** ** | **Fiscal Year**          | ** ** |
| Donald M.  Roberts |       | $                       | 25,320     |                 | $          | —               |       | $                 | 2,533      |                          | $          | — |   | $ | 48,869 |   |
|                    |            |                         |            |                      |            |                      |            |                   |            |                               |            |  |  |  |  |  |

 

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(1)             Amounts deferred by the executive under the ExecutiveDeferred Compensation Plan have been reported as 2007 compensation to suchofficer in the “Salary” column in the Summary Compensation Table above.

 

**Potential Payments Upon Terminationor Change-in-Control**

 

As described above in the“Compensation Discussion and Analysis” and in “Employment Agreements,” we wereparty to employment agreements with certain executives who were dismissedfollowing the DJO Merger.  The followingtable details the amounts paid in accordance with the respective employmentagreements of such terminated NEOs.

 
| **Executive**        | ** ** | **2.99x Highest  Base Salary  in the last 2  years** | ** ** | **2.99x Avg.  Bonus for the   last 2 years** | ** ** | **Base Salary  plus 5%  merit  increase** | ** ** | **2007  Maximum  Bonus  Opportunity** | ** ** | **Total  Severance  prior to  Gross-up** | ** ** | **Relevant  Excise Tax** | ** ** | **Gross-up** | ** ** | **Total** | ** ** |
|----------------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|-------------------------------|------------|--------------|------------|-----------|------------|
| Kenneth W.  Davidson |       | $                                                                             | 1,438,676  |                                                                       | $          | 657,800                                             |       | $                                     | 481,163    |                                          | $          | 803,541                       |       | $            | 3,381,180  |      | $          | 338,769 |   | $ | 451,824 |   | $ | 4,171,773 |   |
| William W. Burke     |       | 857,084                                                                       |       | 388,700                                                                    |       | 286,650                                             |       | 478,706                               |       | 2,011,140                                     |       | 203,293                       |       | 271,136      |       | 2,485,569 |       |
| Paul D. Chapman      |       | 988,943                                                                       |       | 448,500                                                                    |       | 330,750                                             |       | 552,353                               |       | 2,320,546                                     |       | —                        |       | —       |       | 2,320,546 |       |
| Harry L.  Zimmerman  |       | 722,085                                                                       |       | 328,900                                                                    |       | 241,500                                             |       | 403,305                               |       | 1,695,790                                     |       | 167,454                       |       | 223,338      |       | 2,086,582 |       |
|                      |            |                                                                               |            |                                                                            |            |                                                     |            |                                       |            |                                               |            |                               |            |              |            |           |            |  |  |  |  |  |  |  |  |

 

In September 2007,DJO Opco entered into change-in-control severance agreements (the “Change-in-ControlAgreements”) with Mr. Cross, Ms. Capps, Mr. Faulstick and Mr. Roberts. Following a change-in-control, the Change-in-Control Agreements remain in effectfor a period of two years. The DJO Merger constituted a change-in-control forpurposes of these Change-in-Control Agreements. Pursuant to the Change-in-Control Agreements, if the NEO’s employment isterminated “without cause” or by such executive’s resignation for “good reason”(as such terms are defined in the Change-in-Control Agreements), in each casewithin two years after the DJO Merger, the executive is entitled, in additionto accrued salary and bonus and related benefits, to the following benefits:

 

(1)          A lump sumpayment equal to the sum of the executive’s highest annual rate of base salaryduring the 12 month period preceding the termination date multiplied by 1.5 (or2 in the case of Mr. Cross), plus (a) the executive’s aggregateannual target bonus for the year of termination; and (b) a pro rataportion of the executive’s aggregate annual target bonus for the portion of theyear of termination during which the executive served as an employee, less anyamounts paid from our annual incentive plan for the year of termination;

 

(2)          A lump sumcash payment of an amount equal to (a) 18 (or 24 in the case of Mr. Cross),multiplied by (b) the amount by which the monthly premium the executivewould be required to pay for continued coverage pursuant to COBRA, for suchexecutive and his or her eligible dependents covered under our health plans asof the termination date, exceeds the contributions required by the executiveimmediately prior to the termination date; and

 

(3)        A lump sumcash payment of an amount equal to (a) 18 (or 24 in the case of Mr. Cross),multiplied by (b) the amount by which the total monthly premium paid foraccidental death and dismemberment and life insurance coverage as of thetermination date exceeds the contributions required by the executiveimmediately prior to the termination date.

 

As a conditionto receiving 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.

 

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As discussedin “Employment Agreements” above, the Baird Agreement provides that if Mr. Baird’semployment is terminated by us without “cause” (other than by reason of deathor disability) or by Mr. Baird’s resignation for “good reason” (as suchterms are defined in the Baird Agreement), Mr. Baird is entitled, inaddition to accrued salary and bonus and related benefits, to the followingbenefits: (1) a lump sum equal to the sum of: (A) the most recentannual bonus, if any, awarded to Mr. Baird and (B) the most recentsupplemental bonus, if any, awarded to Mr. Baird; and (2) subject to Mr. Baird’scontinued compliance with the non-competition and confidentiality provisions ofthe Baird Agreement, continued payment of his base salary for twelve (12)months after the date of such termination (provided the aggregate amountdescribed in clauses (1) and (2) are to be reduced by the presentvalue of any other cash severance payable to Mr. Baird under any of ourother plans, programs or arrangements). The Baird Agreement also provides that Mr. Bairdwill be subject to a covenant not to compete and a covenant not to solicit ouremployees at all times during the employment term and for a period of one yearfollowing the date Mr. Baird ceases to be employed by us and a covenantnot to disclose confidential information during and after the employment term.

 

The followingtable shows the amount of potential cash payments and the value of other severancebenefits each of the NEOs would be entitled to if his or her employment wereterminated “without cause” or if he or she resigned for “good reason” as of December 31,2007:

 
| **Name**           | ** ** | **Base  Salary Payment  ($)** | ** ** | **Bonus  Payment  ($)** | ** ** | **Health  Benefits ($)** | ** ** | **Life and Accidental   Death &  Dismemberment  Benefits  ($)** | ** ** | **Total ($)** | ** ** |
|--------------------|------------|------------------------------------|------------|-------------------------|------------|-------------------------------|------------|-----------------------------------------------------------------------------------------|------------|--------------------|------------|
| Leslie H. Cross    |       | $                                  | 1,060,000  |                    | $          | 745,313                       |       | $                                                                                       | 15,417     |               | $          | 1,908 |   | $ | 1,822,638 |   |
| Vickie L. Capps    |       | 472,500                            |       | 354,375                 |       | 11,255                        |       | 851                                                                                     |       | 838,981            |       |
| Peter W. Baird     |       | 360,000                            |       | 200,000                 |       | —                        |       | —                                                                                  |       | 560,000            |       |
| Luke T.  Faulstick |       | 472,500                            |       | 354,375                 |       | 11,255                        |       | 851                                                                                     |       | 838,981            |       |
| Donald M.  Roberts |       | 412,500                            |       | 309,375                 |       | 9,137                         |       | 743                                                                                     |       | 731,755            |       |
|                    |            |                                    |            |                         |            |                               |            |                                                                                         |            |                    |            |  |  |  |  |  |

 

As discussedin “Compensation Disclosure and Analysis” above, in connection with the DJOMerger each of our current executive officers entered into an agreement toreceive a retention bonus, of which 50% was paid in January 2008 and 50%will be paid in January 2009.  Anexecutive officer must repay the retention bonus received if his or heremployment with us is terminated prior to January 1, 2009, the datethrough which the bonus is earned, other than by reason of death, disability,or a termination by us without cause.  Ifthe executive officer’s employment is terminated “without cause” (as defined inthe Change-in-Control Agreement for the NEOs other than Mr. Baird and asdefined in the Baird Agreement for Mr. Baird), then the executive isentitled to receive and retain the entire retention bonus. The amount of theretention bonuses that would be received by each of the NEOs if theiremployment was terminated without cause on December 31, 2007 would be: Mr. Cross:$800,000; Ms. Capps: $800,000; Mr. Baird: $400,000; Mr. Faulstick:$700,000 and Mr. Roberts: $500,000.

 

**Compensationof Directors**

 

The CompensationCommittee of the DJO Board reviews the compensation of our Directors on anannual basis.  During 2007, our Board ofDirectors originally consisted of four persons: 1) Julia Kahr, 2) Chinh E. Chu,3) Sidney Braginsky, and 4) Kenneth W. Davidson, Chairman of the Board.  Mr. Kahr and Mr. Chu are affiliatedwith The Blackstone Group (“Blackstone”) and are not compensated for serving asmembers of our Board of Directors. In August of 2007, Bruce McEvoy wasappointed to serve as a member of our Board of Directors.  Mr. McEvoy is also affiliated withBlackstone and therefore did not receive any compensation during 2007.  On November 20, 2007, in connection withthe DJO Merger, we expanded the Board of Directors to seven persons, includingthe addition of Leslie H. Cross and Paul D. Chapman.  Furthermore, we entered into an agreementwith Mr. Davidson to continue to serve as the Chairman of the Board ofDirectors until the next annual meeting of DJO’s stockholders (the “DirectorAgreement”).  Under the Director Agreement, Mr. Davidson is entitledto a $60,000 annual retainer for each annual term commencing on January 1,2008.  Prior to 2008, because he was an employee, Mr. Davidson didnot receive compensation for his services as a Director.  Mr. Davidson will also be granted optionson an annual basis valued at approximately $25,000 (not to exceed 1,500 sharesper grant) with an exercise price equal to the fair market value of our commonstock on the date of grant.  These options were first granted in February 2008and will be granted in the future on each January 1 for the duration of Mr. Davidson’sterm.  One-third of the shares underlying each option will vest on eachanniversary of the date of grant and any shares issued in connection with theoption will be subject to the Management Stockholders Agreement.  We alsoentered into an agreement with Mr. Chapman, with the same terms as theDirector Agreement discussed above, with the exception of an annual retainer of$50,000.

 

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Mr. Braginsky is anindependent, non-employee director and receives cash compensation in the amountof (1) $50,000 annually, (2) $10,000 per year for serving as Chairmanof the DJO Audit Committee, and (3) $1,500 per day for attending a Boardor Committee meeting other than Audit Committee meetings.  At the DJO Board meetings on March 13,and May 24, 2007, Mr. Braginsky was issued 750 and 1,500 stockoptions, respectively, to purchase shares of DJO common stock at an exerciseprice equal to the fair market value on the date of grant as compensation forthe services performed in 2007.  Theseoptions are subject to a three year vesting period.  In addition, on the date of each DJO annualshareholder meeting, Mr. Braginsky will be granted 1,500 stock options to acquireshares of DJO common stock with terms similar to those stated above.

 

The following table setsforth the compensation paid to our non-employee directors for their service in2007. Compensation information for Messrs. Davidson and Chapman is reportedin the Summary Compensation table above.

 
| **Directors Compensation for 2007** |
|----------------------------------------------------|
| **Name**                                           | ** ** | **Fees  Earned or  Paid in  Cash  ($)** | ** ** | **Stock  Awards ($)** | ** ** | **Option  Awards  ($)** | ** ** | **Non-Equity  Incentive Plan  Compensation  ($)** | ** ** | **Change in  Pension Value  and  Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
| Chinh E. Chu                                       |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Julia Kahr                                         |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Sidney Braginsky  (1)                              |   | 66,000 |   | — |   | 20,022 |   | — |   | — |   | — |   | 86,022 |   |
| Bruce McEvoy                                       |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
|                                                    |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)             Amount shown for the option awards to Mr. Braginsky reflects thedollar value recognized in connection with the option awards for financialstatement purposes for fiscal 2007 in accordance with SFAS 123(R). Pursuant toSEC rules, the amounts shown exclude the impact of estimated forfeituresrelated to service-based vesting conditions. The full grant date fair value of stock options granted to Mr. Braginskyduring the fiscal year ended December 31, 2007 was $22,022 as computed inaccordance with FAS 123(R). A discussion of the relevant assumptions usedin the valuation is contained in Note 10 to our audited consolidated financialstatements contained in this annual report on Form 10-K. As of December 31,2007, Mr. Braginsky had a total of 2,250 stock options outstanding.

 

**CompensationCommittee Interlocks and Insider Participation**

 

During 2007, ourCompensation Committee consisted of two designees of Blackstone, Chinh Chu andJulia Kahr. Effective February 21, 2008, Mr. Bruce McEvoy wasappointed as member of the Compensation Committee. None of the members of theCompensation Committee is or have been an officer or employee of DJO. See “Item13. Certain Relationships and Related Transactions, and Director Independence”below for a description of certain agreements with Blackstone. None of ourexecutive officers has served as 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.

 

**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 on Form 10-K.  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 on Form 10-K.

 

Submittedby the Compensation Committee:

Chinh E. Chu (Chair)

Julia Kahr

Bruce McEvoy

 

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**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS**

 

DJOFL is a wholly owned subsidiary of DJO, which owns allof our issued and outstanding capital stock. The following table sets forth as of March 28, 2008, certain informationregarding the beneficial ownership of the voting securities of DJO by eachperson who beneficially owns more than five percent of DJO’s common stock, andby each of the directors and NEOs of DJO, individually, and by our directorsand executive officers as a group.

 
| ** **                                                                       | ** ** | **Aggregate Number of Shares Beneficially Owned (1)** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **Name and Address of Beneficial Owner**                | ** ** | **Number**                                                                          | ** ** | **Acquirable within  60 days (2)** | ** ** | **Percent of Class** | ** ** |
| Grand Slam  Holdings, LLC (3)                                                    |       | 48,098,209                                                                          |       | — |   | 98.74 | % |
| **Directors  and Executive Officers (4)**                                        |       |                                                                                |       |   |   |   |   |
| Leslie H. Cross  Chief Executive Officer and Director                            |       | —                                                                              |       | 532,732 |   | 1.07 | % |
| Kenneth W.  Davidson (5)  Chairman of the Board of Directors                     |       | —                                                                              |       | 308,475 |   | * |   |
| Vickie L. Capps  Executive Vice President, Chief Financial Officer and Treasurer |       | —                                                                              |       | 313,681 |   | * |   |
| William W. Burke  former Executive Vice President and Chief Financial Officer    |       | —                                                                              |       | — |   | * |   |
| Peter W. Baird,  President                                                       |       | —                                                                              |       | 21,937 |   | * |   |
| Donald M. Roberts, Executive Vice President, General  Counsel and  Secretary     |       | —                                                                              |       | 206,040 |   | * |   |
| Luke T. Faulstick  President – Global Operations                            |       | —                                                                              |       | 196,256 |   | * |   |
| Paul D. Chapman –  Director (5)                                             |       | —                                                                              |       | 132,275 |   | * |   |
| Harry L.  Zimmerman (5)  Former Executive Vice President and General Counsel     |       | —                                                                              |       | — |   | * |   |
| Chinh E. Chu –  Director (6)                                                |       | 48,098,209                                                                          |       | — |   | 98.74 | % |
| Sidney Braginsky  – Director                                                |       | —                                                                              |       | — |   | * |   |
| Julia Kahr –  Director (7)                                                  |       | —                                                                              |       | — |   | * |   |
| Bruce McEvoy –  Director (7)                                                |       | —                                                                              |       | — |   | * |   |
| All Directors  and executive officers as a group                                 |       | 49,810,655                                                                          |       | 1,712,446 |   | 98.79 | % |

 

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* Less than 1%

(1)   Includes shares held in the beneficial owner’s name or jointly withothers, or in the name of a bank, nominee or trustee for the beneficial owner’saccount. Unless otherwise indicated in the footnotes to this table and subjectto community property laws where applicable, we believe that each stockholdernamed in this table has sole voting and investment power with respect to theshares indicated as beneficially owned.

(2)   Includes the number of shares that could be purchased by exercise ofoptions on or within 60 days after March 28, 2008 under DJO’s stock optionplans.

(3)   Shares of common stock of DJO held by Grand SlamHoldings, LLC (“BCP Holdings”) may also be deemed to be beneficially owned bythe following entities and persons: (i) Blackstone Capital Partners VL.P., a Delaware limited partnership (“BCP V”), Blackstone Family InvestmentPartnership V L.P., a Delaware limited partnership (“BFIP”), Blackstone FamilyInvestment Partnership V-A L.P., a Delaware limited partnership (“BFIP-A”), andBlackstone Participation Partnership V L.P., a Delaware limited partnership(together with BCP V, BFIP and BFIP-A, the “Blackstone Partnerships”), whichcollectively own all of the equity in BCP Holdings; (ii) BlackstoneManagement Associates V L.L.C., a Delaware limited liability company (“BMA”),the general partner of the Blackstone Partnerships; (iii) BMA V L.L.C., aDelaware limited liability company (“BMA V”), the sole member of BMA; and (iv) PeterG. Peterson and Stephen A. Schwarzman, the founding members and controllingpersons of BMA V.  Each of Messrs. Petersonand Schwarzman disclaims beneficial ownership of such shares, except to theextent of his pecuniary interest therein. The address of BCP Holdings and each of the entities and individualslisted in this footnote is c/o The Blackstone Group, L.P., 345 Park Avenue, NewYork, New York 10154.

(4)   Except with respect to Chinh Chu, Julia Kahr and Bruce McEvoy, theaddress for all of our directors and executive officers is c/o DJO, 1430Decision Street, Vista, California 92081.

(5)   The number of sharesbeneficially owned by these Former Executive Officers shown in this tablereflect the number of shares underlying their Prior Transaction ManagementRollover Options which are exercisable within 60 days.

(6)   Mr. Chu, a director of DJO, is a member ofBMA V and a senior managing director of The Blackstone Group, L.P.  The number of shares disclosed for Mr. Chuare also included in the above table in the number of shares disclosed for “GrandSlam Holdings, LLC.”  Mr. Chudisclaims beneficial ownership of any shares owned or controlled by BMA V,except to the extent of his pecuniary interest therein.

(7)   Ms. Kahr and Mr. McEvoy, directors ofDJO, are employees of The Blackstone Group, L.P. but do not have any investmentor 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, 2007 with respect to the number ofshares to be issued upon the exercise of outstanding stock options under our2007 Plan, which is our only equity compensation plan and has been approved bythe stockholders:

 

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| **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 |       | 3,550,627                                                                                                                                         |       | $                                                                                                       | 12.97      |                                                                                                                                                                                                             | 1,409,884  |   |
|                                                     |            |                                                                                                                                                   |            |                                                                                                         |            |                                                                                                                                                                                                                  |            |  |

 

**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 terminatedemployment and such termination would have constituted a termination for “cause”if it would have been initiated by DJO, such new management stockholder wouldreceive fair market value for such new management stockholder’s shares callableupon the 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.

 

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 

 

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Merger, DJO paid Blackstone Advisory Services, L.P., an affiliate ofBMP (“BAS”), a $3.0 million advisory fee in consideration of the provision ofcertain strategic and other advice 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 and2.0% 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:

 

·                  at any time in connection with or inanticipation of a change of control of DJO, a sale of all or substantially allof its assets or an initial public offering of common stock of DJO or itssuccessor, BMP may elect to receive, in lieu of remaining annual monitoring feepayments, a single lump sum cash payment equal to the then-present value of allthen-current and future annual monitoring fees payable under the agreement,assuming a hypothetical termination date of the agreement to be the twelfthanniversary of such election;

 

·                  the New Transaction and MonitoringFee Agreement will continue until the earlier of the twelfth anniversary of thedate of the agreement or such date as DJO and BMP 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 of Directorshas not adopted a formal written policy for the review and approval oftransactions 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 only Mr. Braginskywould be deemed an independent director under the definition of independenceused in the Rules of the New York Stock Exchange.

 

**ITEM 14.  PRINCIPALACCOUNTING FEES AND SERVICES**

 

**Fees Paid to the IndependentAuditor**

 

The following table sets forth theaggregate fees billed by Ernst & Young LLP and KPMG LLP for auditservices rendered in connection with the consolidated financial statements andreports for fiscal year 2007 and 2006, respectively, and for other servicesrendered during fiscal 2007 and 2006, respectively, on behalf of DJO and itssubsidiaries, as well as all out-of-pocket costs incurred in connection withthese services, which have been billed to DJO. All audit and audit related services were pre-approved by the auditcommittee.

** **
| ** **          | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
|                |       |     |       |     |       |
| Audit fees          |       | $        | 2,282,000  |     | $          | 2,400,000 |   |
| Audit-related  fees |       | 44,000   |       | 5,000    |       |
| 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, services that are normally provided by auditorsin connection with statutory and regulatory filings, and the audit of internalcontrol over financial reporting. In 2007, audit fees included audit servicesprovided in connection with the offering memorandum related 

 

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to the issuance of 10.875% Notes issued inconnection with the DJO Merger.  Also,during 2007, we incurred audit fees related to the registration of the 11.75%Notes issued in connection with the Prior Transaction.  In 2006, audit fees included audit servicesprovided in connection with the registration statement associated with thecommon stock issued in connection with the acquisition of Compex, and theoffering memorandum related to the 11.75% Notes issued in connection with thePrior Transaction.

 

Audit-Related Fees: Consists of fees billed for assurance and related services that arereasonably related to the performance of the audit or review of DJO’sconsolidated financial statements and are not reported under “Audit Fees”.  During 2007 and 2006, all audit-related feeswere specifically pre-approved pursuant to the Audit Committee Pre-ApprovalPolicy discussed below.

 

Tax Fees: Consists of tax compliance and consultation services. There were no taxfees in 2007 and 2006.

 

All Other Fees: Consists of fees for all other services other than those reportedabove.  There were no other fees in 2007and 2006.

 

**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.

 

136

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** **

**PART IV**

 

**ITEM 15.  EXHIBITS,FINANCIAL STATEMENT SCHEDULES**

 

(a)       The following documents are filed as partof this Annual Report on Form 10-K:

 

1.  The following consolidated financialstatements of DJO Finance LLC, including the reports thereon of Ernst &Young LLP and KPMG LLP, are filed as part of this report under Part II,Item 8. Financial Statements and Supplementary Data:

 

·                  Reports of Independent Registered Public AccountingFirms.

·                  Consolidated Balance Sheets as of December 31,2007 and 2006.

·                  Consolidated Statements of Operations for theSuccessor year ended December 31, 2007 and for the period November 4,2006 through December 31, 2006 and for the Predecessor period January 1,2006 through November 3, 2006 and for the year ended December 31,2005.

·                  Consolidated Statements of Changes in MembershipEquity and Comprehensive Loss for the Successor year ended December 31, 2007and for the period November 4, 2006 through December 31, 2006.

·                  Consolidated Statements of Changes in Stockholders’Equity and Comprehensive Income (Loss) for the Predecessor period January 1,2006 through November 3, 2006 and for the year ended December 31,2005.

·                  Consolidated Statements of Cash Flows for theSuccessor year ended December 31, 2007 and for the period November 4,2006 through December 31, 2006 and for the Predecessor period January 1,2006 through November 3, 2006 and for the year ended December 31,2005.

·                  Notes to Audited Consolidated Financial Statements.

 

2.         Financial Statement Schedules:

 

Schedule II – Valuationand Qualifying Accounts

 

All other financial statement schedules are not required under therelated instructions or are inapplicable 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.                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 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    |   | Credit  Agreement, dated as of November 3, 2006, among DJOFL, as Borrower, DJO  Holdings LLC (f/k/a Encore Medical Holdings LLC ReAble Therapeutics Holdings  LLC) (“DJO Holdings”) and Bank of America, N.A., as administrative agent, and  the other agents and lenders party thereto (incorporated by reference to  Exhibit 4.3 of DJOFL’s Registration Statement on Form S-4, filed on  April 18, 2007 (File No. 333-142188))            |

 

137

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| 4.4    |   | Amendment  No. 1 to Credit Agreement (incorporated by reference herein to  Exhibit 10.1 to DJOFL’s Current Report on Form 8-K filed on  July 5, 2007).                                                                                                                                                                                            |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.5    |   | Incremental  Amendment No. 1 to Credit Agreement (incorporated by reference herein to  Exhibit 10.2 to DJOFL’s Current Report on Form 8-K filed on  July 5, 2007).                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.6    |   | Security  Agreement, dated as of November 3, 2006, among DJOFL, as Borrower, DJO  Holdings, certain subsidiaries of DJO Holdings identified therein and Bank of  America, N.A. as Collateral Agent (incorporated by reference to  Exhibit 4.4 of DJOFL’s Registration Statement on Form S-4, filed on  April 18, 2007 (File No. 333-142188)) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.7    |   | Guaranty, dated  as of November 3, 2006 among DJO Holdings and certain subsidiaries of  DJO Holdings identified therein and Bank of America, N.A., as Collateral  Agent (incorporated by reference to Exhibit 4.6 of DJOFL’s Registration  Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188))                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.8    |   | 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 Form 8-K, filed on  November 27, 2007).                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.9    |   | 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).                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.10   |   | 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).                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.11   |   | 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).                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 4.12   |   | 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*  |   | 1996 Incentive  Stock Plan (incorporated by reference to Exhibit 10.2 to DJO’s Quarterly  Report on Form 10-Q for the quarterly period ended October 2, 2004)                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2*  |   | Form of  Stock Option Agreement - 1996 Incentive Stock Plan Agreement (incorporated by  reference to Exhibit 10.3 to DJO’s Quarterly Report for the quarterly  period ended October 2, 2004)                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3*  |   | 2006 Stock  Incentive Plan (incorporated by reference to Exhibit 10.1 of DJOFL’s  Registration Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188))                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4*  |   | Form of  Nonstatutory Stock Option Agreement for 2006 Stock Incentive Plan  (incorporated by reference to Exhibit 10.2 of DJOFL’s Registration  Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188))                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.5*  |   | 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).                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.6*+ |   | Form of  Nonstatutory Stock Option Agreement under 2007 Incentive Stock Plan                                                                                                                                                                                                                                                                                          |

 

138

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| 10.7*+  |     | Form of DJO  Incorporated Directors’ Nonstatutory Stock Option Agreement under 2007  Incentive Stock Plan                                                                                                                                                                          |
|---------|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.8*+  |     | Form of  Nonstatutory Stock Option Agreement under 2007 Incentive Stock Plan  (Replacement Version)                                                                                                                                                                                     |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.9*+  |     | Form of  Nonstatutory Stock Option Rollover Agreement under 2007 Incentive Stock Plan                                                                                                                                                                                                   |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.10*+ |     | Form of  Incentive Stock Option Rollover Agreement under 2007 Incentive Stock Plan                                                                                                                                                                                                      |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.11*  |     | Employment  Agreement between DJO and Kenneth W. Davidson, dated October 1, 2003  (incorporated by reference to Exhibit 10.1 to DJO’s Current Report on  Form 8-K, filed on December 17, 2003 (Commission File No. 000-26538))                                                     |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.12*  |     | Amendment to  Employment Agreement between DJO and Kenneth W. Davidson, dated September 25,  2006 (incorporated by reference to Exhibit 99.1 to DJO’s Current Report  on Form 8-K, filed on September 26, 2006 (Commission  File No. 000-26538))               |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.13*  |     | Amendment to  Employment Agreement between DJO and Kenneth W. Davidson, dated  November 3, 2006 (incorporated by reference to Exhibit 10.5 of  DJOFL’s Registration Statement on Form S-4, filed on April 18, 2007  (File No. 333-142188))                     |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.14*  |     | Employment  Agreement between DJO and Paul D. Chapman, dated February 8, 2002 (incorporated  by reference to Exhibit 10.23 to DJO’s Annual Report on Form 10-K for  the fiscal year ended December 31, 2002 (Commission File No. 000-26538))                                  |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.15*  |     | Amendment to  Employment Agreement between DJO and Paul D. Chapman, dated November 15, 2003  (incorporated by reference to Exhibit 10.11.1 to DJO's Annual Report on  Form 10-K for the fiscal year ended December 31, 2004 (Commission File  No. 000-26538))                      |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.16*  |     | Amendment to  Employment Agreement between DJO and Paul D. Chapman, dated November 3,  2006 (incorporated by reference to Exhibit 10.8 of DJOFL’s Registration  Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188))                         |
|    | * * | * *                                                                                                                                                                                                                                                                                     |
| 10.17*  | * * | Employment  Agreement between DJO and William W. Burke, dated August 30, 2004  (incorporated by reference to Exhibit 10.1 to DJO's Quarterly Report on  Form 10-Q for the quarterly period ended October 2, 2004 (Commission  File No. 000-26538))                                 |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.18*  |     | Amendment to  Employment Agreement between DJO and William W. Burke, dated November 3,  2006 (incorporated by reference to Exhibit 10.11 of DJOFL’s Registration  Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188))                       |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.19*  |     | Employment  Agreement between DJO and Harry L. Zimmerman, dated June 12, 2001  (incorporated by reference to Exhibit 10.7 to DJO's Annual Report on  Form 10-K for the fiscal year ended December 31, 2001 (Commission File  No. 000-26538))                                       |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.20*  |     | Amendment to  Employment Agreement between DJO and Harry L. Zimmerman, dated November 15,  2003 (incorporated by reference to Exhibit 10.13.1 to DJO's Annual  Report on Form 10-K for the fiscal year ended December 31, 2004  (Commission File No. 000-26538))                   |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.21*  |     | Amendment to  Employment Agreement between DJO and Harry L. Zimmerman, dated  November 3, 2006 (incorporated by reference to Exhibit 10.14 of  DJOFL’s Registration Statement on Form S-4, filed on April 18, 2007  (File No. 333-142188))                     |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.22*  |     | Employment  Agreement between DJO and Jack F. Cahill, dated June 12, 2001 (incorporated  by reference to Exhibit 10.3 to DJO's Annual Report on Form 10-K for the  fiscal year ended December 31, 2001 (Commission File No. 000-26538))                                            |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.23*  |     | Amendment to  Employment Agreement between DJO and Jack F. Cahill, dated November 15, 2003  (incorporated by reference to Exhibit 10.14.1 to DJO's Annual Report on  Form 10-K for the fiscal year ended December 31, 2004 (Commission File  No. 000-26538))                       |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.24*  |     | Amendment to  Employment Agreement between DJO and Jack F. Cahill, dated November 3,  2006 (incorporated by reference to Exhibit 10.17 of DJOFL’s Registration  Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188))                         |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.25*  |     | 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))                                                       |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.26*  |     | 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))                  |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.27*  |     | 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))                    |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.28*  |     | 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)                                                                |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.29*  |     | 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). |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.30*  |     | 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).                                                   |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.31*  |     | 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).                                           |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.32*  |     | Annual Bonus  Plan, dated as of November 3, 2006 (incorporated by reference to  Exhibit 10.23 of DJOFL’s Registration Statement on Form S-4, filed  on April 18, 2007 (File No. 333-142188)).                                                                  |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.33*+ |     | Outline of 2008 Annual  Bonus Plan                                                                                                                                                                                                                                                           |
|    |     |                                                                                                                                                                                                                                                                                         |
| 10.34*  |     | 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).                                            |

 

139

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| 10.35* |   | 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)                        |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.36  |   | 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))                              |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.37  |   | 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).                       |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.38  |   | 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))                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.39  |   | 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).                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.40  |   | 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). |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.41  |   | 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).                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 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.                                                                                                                                                                                                    |

 

----

* constitutesmanagement contract or compensatory arrangement

+ filed herewith

 

140

----

 

**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, 2004** |       | $                                          | 2,591      |                                   | $          | 144                                                                               |       | $ | 8,726 |   |
| Provision                                |       | 5,900                                      |       | 208                                    |       | 49,752                                                                            |       |
| Write-offs, net of recoveries            |       | (4,827                                     | )          | —                                 |       | (48,158                                                                           | )          |
| **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 |   |

 

----

(1) Amounts are excluded from theprovisions included in the consolidated statements of cash flows as theinclusion would not provide meaningful information.

 

141

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
| Date: March 28,  2008 | **DJO  FINANCE LLC** |
|----------------------------|----------------------|
|                       |                 |
|                       | By:                  |        /s/  Leslie H. Cross |
|                       |                 |        Leslie  H. Cross |
| * *                   |                 | *Chief  Executive Officer and Director* |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this Report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **Signature**            | ** ** | **Title**                                               | ** ** | **Date**             |
|--------------------------|------------|---------------------------------------------------------|------------|----------------------|
|                     |       |                                                    |       |                 |
| /s/ Leslie H.  Cross     |       | Chief Executive  Officer and Director                   |       | March 28,  2008 |
| Leslie H. Cross          |       | (Principal  Executive Officer)                          |       |                 |
|                     |       |                                                    |       |                 |
| /s/ Vickie L.  Capps     |       | Executive Vice  President, Chief Financial Officer and  |       | March 28, 2008  |
| Vickie L. Capps          |       | Treasurer  (Principal Financial and Accounting Officer) |       |                 |
|                     |       |                                                    |       |                 |
| /s/ Kenneth W.  Davidson |       | Chairman of the  Board of Directors                     |       | March 28,  2008 |
| Kenneth W.  Davidson     |       |                                                    |       |                 |
|                     |       |                                                    |       |                 |
| /s/ Chinh E. Chu         |       | Director                                                |       | March 28,  2008 |
| Chinh E. Chu             |       |                                                    |       |                 |
|                     |       |                                                    |       |                 |
| /s/ Julia Kahr           |       | Director                                                |       | March 28,  2008 |
| Julia Kahr               |       |                                                    |       |                 |
|                     |       |                                                    |       |                 |
| /s/ Sidney  Braginsky    |       | Director                                                |       | March 28,  2008 |
| Sidney Braginsky         |       |                                                    |       |                 |
|                     |       |                                                    |       |                 |
| /s/ Paul D.  Chapman     |       | Director                                                |       | March 28,  2008 |
| Paul D. Chapman          |       |                                                    |       |                 |
|                     |       |                                                    |       |                 |
| /s/ Bruce McEvoy         |       | Director                                                |       | March 28,  2008 |
| Bruce McEvoy             |       |                                                    |       |                 |

 

142

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