Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-K**

 

| **x**                                                | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                 |
| **For the fiscal year ended December 31, 2009** |
|                                                 |
| **or**                                               |
|                                                 |
| **o**                                                | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                    to                    ..**

 

**Commission file number**333-142188

 

**DJO Finance LLC**

(Exact name of Registrant as specified in its charter)

 

| **Delaware**                             | ** ** | **20-5653965**         |
|------------------------------------------|------------|------------------------|
| (State or other jurisdiction of          |       | (I.R.S. Employer       |
| incorporation or organization)           |       | Identification Number) |
|                                     |       |                   |
| **1430 Decision Street**                 |       |                   |
| **Vista, California**                    | ** ** | **92081**              |
| (Address of principal executive offices) |       | (Zip Code)             |

 

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

 

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

 

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

 

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

**None**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.  Yes o  No x

 

**Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.  Yes**o  No x

 

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yeso No o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

 

Indicateby check mark whether the Registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “largeaccelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

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

 

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

 

Asof March 5, 2010, 100% of the issuer’s membership interests were owned byDJO Holdings LLC.

 

 

 

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**DJO FINANCE LLC**

**FORM 10-K**

**TABLE OF CONTENTS**

 
| ** ** | ** **                                                                                                              | **Page  No.** |
|------------|-------------------------------------------------------------------------------------------------------------------------|---------------|
| ** ** | **PART I**                                                                                                         | ** **    |
| Item 1.    | Business                                                                                                                | 3             |
| Item 1A.   | Risk Factors                                                                                                            | 20            |
| Item 2.    | Properties                                                                                                              | 41            |
| Item 3.    | Legal Proceedings                                                                                                       | 41            |
| Item 4.    | (Removed and Reserved)                                                                                                  | 42            |
|       |                                                                                                                    |          |
| ** ** | **PART II**                                                                                                        | ** **    |
| Item 5.    | Market for  the Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities | 43            |
| Item 6.    | Selected Financial  Data                                                                                                | 43            |
| Item 7.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             | 44            |
| 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                                   | 107           |
| Item 9A.   | Controls and Procedures                                                                                                 | 107           |
| Item 9B.   | Other Information                                                                                                       | 107           |
|       |                                                                                                                    |          |
| ** ** | **PART III**                                                                                                       | ** **    |
| Item 10.   | Directors, Executive Officers  and Corporate Governance                                                                 | 108           |
| Item 11.   | Executive  Compensation                                                                                                 | 111           |
| Item 12.   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        | 122           |
| Item 13.   | Certain  Relationships and Related Transactions, and Director Independence                                              | 123           |
| Item 14.   | Principal  Accounting Fees and Services                                                                                 | 124           |
|       |                                                                                                                    |          |
| ** ** | **PART IV**                                                                                                        | ** **    |
| Item 15.   | Exhibits,  Financial Statement Schedules                                                                                | 125           |
| SIGNATURES |                                                                                                                    | 130           |

 

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### **FORWARD-LOOKINGSTATEMENTS**

 

ThisAnnual Report on Form 10-K (“Annual Report”) of DJO Finance LLC (“DJOFL”,or “the Company”) for the year ended December 31, 2009 contains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended (the “Securities Act”) and Section 21Eof the Securities Exchange Act of 1934, as amended (the “Exchange Act”), whichare intended to be covered by the safe harbors created thereby. To the extent that any statements are notrecitations of historical fact, such statements constitute forward-lookingstatements that, by definition, involve risks and uncertainties.  Specifically,the sections entitled “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and “Business”  may contain forward-looking statements.  These statements can be identified becausethey use words like “anticipates,” “believes,” “estimates,” “expects,” “forecasts,”“future,” “intends,” “plans,” and similar terms.  These statements reflect only our currentexpectations.  Forward-looking statementsinclude statements concerning our plans, objectives, goals, strategies, futureevents, capital expenditures, future results, our competitive strengths, ourbusiness strategy, the trends in our industry and the benefits of ouracquisitions.

 

Although we do not make forward-lookingstatements unless we believe we have a reasonable basis for doing so, we cannotguarantee their accuracy, and actual results may differ materially from thosewe anticipated due to a number of uncertainties, many of which are unforeseen,including, among others, the risks we face as described elsewhere in thisfiling.  You should not place unduereliance on these forward-looking statements, which apply only as of the dateof this Annual Report.  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 is believed to have a reasonable basis, but there can be no assurance thatany 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, provide examples of risks,uncertainties and events that may cause our actual results to differ materiallyfrom the expectations we describe in our forward-looking statements.

 

**PART I.**

 

## **ITEM 1.  BUSINESS**

## ** **

**Overview**

 

We are a global provider ofhigh-quality orthopedic devices, with a broad range of products used for rehabilitation,pain management and physical therapy. We also develop, manufacture anddistribute a broad range of surgical reconstructive implant products. We areone of the largest non-surgical orthopedic rehabilitation device companies inthe world, 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 orthopedic rehabilitationproducts addressing the complete spectrum of preventative, pre-operative,post-operative, clinical and home rehabilitation care. Our products are used byorthopedic specialists, primary care physicians, pain management specialists,physical therapists, podiatrists, chiropractors, athletic trainers and otherhealthcare professionals to treat patients with musculoskeletal conditionsresulting from degenerative diseases, deformities, traumatic events andsports-related injuries. In addition, many of our non-surgical medical devicesand related accessories are used by athletes and patientsfor injury prevention and at-home physical therapy treatment.

 

Our current business activities are the result of a combination of twocompanies with broad orthopedic product offerings in the United States andforeign countries.  One of thosecompanies, ReAble Therapeutics, Inc. (“ReAble”), was a leadingmanufacturer and distributor of electrotherapy products for pain therapy andrehabilitation, a broad range of clinical devices for the treatment of patientsin physical therapy clinics, and a broad range of knee, hip and shoulderimplant products.  In 2006, ReAble wasacquired by an affiliate of Blackstone Capital Partners V L.P. (“Blackstone”).The other company, DJO Opco Holdings, Inc. (“DJO Opco”), formerly namedDJO Incorporated, was a leading manufacturer and distributor of orthopedicrehabilitation products, including rigid knee bracing, orthopedic soft goods,cold therapy systems, vascular systems and bone growth stimulation devices. On November 20,2007, ReAble acquired DJO Opco through a merger transaction (the “DJO Merger”).  ReAble then changed its name to DJOIncorporated (“DJO”) and continues to be owned primarily by affiliates ofBlackstone.

 

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, 2009.

 

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Exceptas otherwise indicated, references to “us”, “we”, “our”, or “our Company” inthis Annual Report refers to DJOFL and its consolidated subsidiaries. Each oneof the following trademarks, trade names or service marks, which is used in this Annual Report, is either(i) our registered trademark, (ii) a trademark for whichwe have a pending application, (iii) a trade name or service mark forwhich we claim common law rights or (iv) a registered trademark orapplication for registration which we have been licensed by a third party touse: Cefar®, Empi®, Ormed®, Compex®, Aircast®, DonJoy®, OfficeCare®,ProCare®, SpinaLogic®, CMFTM, OL1000TM, and OL1000 SCTM.  All other trademarks, trade names or servicemarks of any other company appearing in this Annual Report belong to theirrespective owners.

 

Noncontrolling interests on our consolidated balance sheets as of December 31,2009 and 2008 reflect a 50% separate ownership interest in Medireha GmbH (“Medireha”)which is not attributable, directly or indirectly, to us.  We have consolidated Medireha for financialreporting purposes due to our controlling interest, which consists of our 50%ownership interest, our control of one of the two director seats, our rights toprohibit certain business activities that are not consistent with our plans forthe business and our exclusive distribution rights for products manufactured byMedireha. All significant intercompany balances and transactions have beeneliminated in consolidation.

 

**The DJOMerger**

 

OnJuly 15, 2007, we entered into an Agreement and Plan of Merger with DJOOpco providing for the DJO Merger pursuant to which DJO Opco became a whollyowned subsidiary of DJOFL. The total purchase price for the DJO Merger, whichwas consummated on November 20, 2007, was approximately $1.3 billionand consisted of $1.2 billion paid to former equity holders (or $50.25 incash for each share of common stock of DJO Opco sold), $15.2 million relatedto the fair value of stock options held by DJO Opco management that wereexchanged for options to purchase DJO common stock, and $22.8 million indirect acquisition costs. The DJO Merger was financed through a combination ofequity contributed by our primary shareholder, Blackstone, borrowings under oursenior secured credit facility (the “Senior Secured Credit Facility”) andproceeds from the 10.875% Senior Notes due 2014 issued by DJOFL and DJO FinanceCorporation (“Finco”) (see Note 9 of the notes to the audited consolidatedfinancial statements included in Part II, Item 8, herein).

 

**DiscontinuedOperations**

 

On June 12, 2009 we sold our Empi Therapy Solutions (“ETS”)catalog business, formerly known as Rehab Medical Equipment, or RME, toPatterson Medical Supply, Inc. for approximately $21.8 million. As such,results of the ETS business for periods prior to the date of sale have beenpresented as discontinued operations in our consolidated financial statementsand the accompanying notes.

 

**Operating Segments**

 

We provide a broad array of orthopedic rehabilitation and regenerationproducts, as well as implants to customers in the United States andabroad.  In the first quarter of 2009, wechanged how we report financial information to senior management.  Prior to 2009, we included the internationalcomponents of the Surgical Implant, Chattanooga, and Empi businesses in eitherthe Surgical Implant or Domestic Rehabilitation segments, as their operationswere managed domestically.  During thefourth quarter of 2008, we effected an operational reorganization whichresulted in the non-U.S. components of all of our businesses being managedabroad.  As a result, the segmentfinancial data for the year ended December 31, 2009 reflects this newsegmentation and the data for the years ended December 31, 2008 and 2007,has been restated to reflect this change. We currently develop, manufacture and distribute our products throughthe following three operating segments:

 

***Domestic Rehabilitation Segment***

 

Our Domestic Rehabilitation Segment, which generates its revenues inthe United States, is divided into five main businesses:

 

·                  *Bracingand Supports. *Our Bracing andSupports business unit offers our DonJoy, ProCare and Aircast products,including rigid knee bracing, orthopedic soft goods, cold therapy products, andvascular systems. This business unit 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 Empi business unitoffers our home electrotherapy, iontophoresis, and home traction products. Weprimarily sell these products directly to patients or to physical therapyclinics. For products sold to patients, we arrange billing to the patients andtheir third party payors.

 

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·                  *Regeneration*.  Our Regeneration business unit sells our bonegrowth stimulation products. We sell these products either directly to patientsor to independent distributors. For products sold to patients, we arrangebilling to the patients and their third party payors.

 

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

 

·                  *AthleteDirect.*  Our Athlete Direct business unit offers our Compexelectrostimulation device to consumers, which range from people interested inimproving their fitness to competitive athletes, to assist in athletic trainingprograms through muscle development and to accelerate muscle recovery aftertraining sessions.

 

***International Segment***

 

Our International Segment, which generates most of its revenues inEurope, sells all of our products and certain third party products through acombination of direct sales representatives and independent distributors.

 

***Domestic Surgical Implant Segment***

 

Our Domestic Surgical Implant Segment develops, manufactures andmarkets a wide variety of knee, hip and shoulder implant products that servethe orthopedic reconstructive joint implant market in the United States.

 

**Acquisitions**

 

Ourgrowth has been driven both by the introduction of products facilitated by ourresearch and development efforts and by selected acquisitions of businesses orproducts primarily related to our Domestic Rehabilitation and InternationalSegments.  We completed the followingacquisitions in 2009, each of which represents an expansion of ourinternational business:

 

OnAugust 4, 2009 we acquired Chattanooga Group Inc., a Canadian distributorof certain of our products (“Chattanooga Canada”), for $7.2 million.  Pursuant to the terms of the acquisitionagreement and included within the purchase price, is a $1.4 million holdbackand a $1.4 million promissory note. The holdback provides security forpotential indemnification claims and, if not used for that purpose, will bepaid to the sellers. The holdback amount accrues interest at an annual rate of2.5% for the first 18 months and a variable rate thereafter. Half of anyholdback amount not used to cover indemnification claims will be paid withinterest in January 2011 and the remainder of the balance with interest isdue approximately three years after closing, upon expiration of a statutoryperiod provided for under relevant tax law. The promissory note accrues interest at an annual rate of 6% with theprincipal and interest due in August 2010.

 

OnAugust 4, 2009 we acquired Empi Canada Inc., a Canadian distributor ofcertain of our products (“Empi Canada”), for $7.4 million. Pursuant to theterms of the acquisition agreement and included within the purchase price, is a$1.4 million holdback and a $1.4 million promissory note. The holdback providessecurity for potential indemnification claims and, if not used for thatpurpose, will be paid to the sellers. The holdback amount accrues interest atan annual rate of 2.5% for the first 18 months and a variable rate thereafter.Half of any holdback amount not used to cover indemnification claims will bepaid with interest in January 2011 and the remainder of the balance withinterest is due approximately three years after closing, upon expiration of astatutory period provided for under relevant tax law. The promissory noteaccrues interest at an annual rate of 6% with the principal and interest due inAugust 2010.

 

OnFebruary 3, 2009 we acquired DonJoy Orthopaedics Pty., Ltd., an Australiandistributor of certain of our products (“DJO Australia”), for a total cashcompensation of $3.4 million. Pursuant to the terms of the acquisitionagreement and included within the purchase price, is $0.8 million, theacquisition date fair value of the additional amount expected to be paid to theselling shareholder of DJO Australia if certain revenue targets were met by December 31,2009. Such revenue targets were met, and the additional amount of $0.8 million,which was included in accrued liabilities in the consolidated balance sheet at December 31,2009, was paid in the first quarter of fiscal year 2010.

 

**2010 Debt Offering**

 

On January 20, 2010,we issued $100.0 million aggregate principal amount of new 10.875%Senior Notes which mature on November 15,2014, pursuant to the indenture governing our existing 10.875%Senior Notes due 2014 that were issued onNovember 20, 2007 (collectively, the “10.875% Notes”). The net proceeds ofthe issuance (excluding approximately $2.0 million of interest accrued from November 16,2009 to January 19, 2010, which will be included in the first interestpayment to be made on May 15, 2010), along with cash on hand, were used torepay $101.5 million aggregate principal amount of existing term loans underthe Senior Secured Credit Facility.

 

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**IndustryBackground**

 

**MarketOpportunities**

 

Weparticipate globally in the rehabilitation, pain management, bone growthstimulation and reconstruction segments of the orthopedic device market. In theUnited States, we estimate these segments accounted for approximately $8.4billion of total industry sales in 2008. We believe that several factors aredriving growth in the orthopedic products industry, including the following:

 

·                  *Favorable demographics.*  An aging population is driving growth in theorthopedic products market. Many conditions that result in rehabilitation,physical therapy or orthopedic surgery are more likely to affect people inmiddle age or later in life.  Accordingto a 2009 United States Census Bureau — International Data Base projection, theaging baby boomer generation will result in the percentage of the NorthAmerican population aged 65 and over to grow from 13.2% in 2010 to 16.4% in2020 and to 19.8% by 2030. In Western Europe, the population aged 65 and overis expected to grow from 18.2% in 2010 to 20.9% in 2020 and to 24.7% by2030.  In addition, according to the 2009 United States Census Bureau —International Data Base projection, the average life expectancy in North Americais 78.5 years in 2010 and is expected to grow to 80.9 years by 2030.  InWestern Europe, the average life expectancy is 79.9 years in 2010 and isexpected to grow to 82.0 years by 2030. As life expectancy increases, we believe people will remain activelonger, causing the number of injuries requiring orthopedic rehabilitation,bone growth stimulation and reconstructive implants to increase.

 

·                  *Shift toward non-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, Transcutaneous electrical nerve stimulation (“TENS”) and Neuromuscularelectrical nerve stimulation (“NMES”) devices are increasingly being recognizedas effective solutions for pain management and rehabilitation therapy,respectively. In addition, we believe that orthopedic surgeons are increasinglyutilizing braces that assist in rehabilitation and bone growth stimulationdevices that enable in-home treatment as viable alternatives to surgery. Manyof our orthopedic rehabilitation products are designed for at-home use, whichwe believe should allow us to benefit from the market shift toward thesetreatment 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.

 

**CompetitiveStrengths**

 

Webelieve that we have a number of competitive strengths that will enable us tofurther enhance our position in the orthopedic rehabilitation device market:

 

·                  *Leading market positions*. We estimate we have leading market positions for many of our products.We believe our orthopedic and physical therapy rehabilitation products marketedunder the DonJoy, Aircast, ProCare, Chattanooga, Empi, Cefar, Compex and Ormedbrands 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 orthopedicproducts.*  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.

 

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·                  *Extensive and diversedistribution network.*  We use multiple channels todistribute our products to our customers. We use over 9,700 dealers anddistributors and a direct sales force of over 500 employed salesrepresentatives and approximately 700 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 managedcare organizations and rehabilitation healthcare providers.* Our leading market positions in many of our orthopedic rehabilitationproduct lines and the breadth of our product offerings have enabled us tosecure important preferred provider and managed care contracts. Our databaseincludes over 8,700 different insurance companies and other payors, includingapproximately 1,400 active payor contracts. We have developed a proprietarythird party billing system that is designed to reduce our reimbursement cycles,improve relationships with managed care organizations and physicians and trackpatients to improve quality of care and create subsequent sellingopportunities. Further, our OfficeCare business maintains inventory at over1,350 healthcare facilities, primarily orthopedic practices, which furtherstrengthens our relationships with these healthcare providers.

 

·                  *National contracts with grouppurchasing organizations.*  We enjoy strong relationshipswith a meaningful number of group purchasing organizations (“GPOs”) due to oursignificant scale. We believe that our broad range of products is well suitedto the goals of these buying groups. Under these national contracts, we providefavorable pricing to the buying group and are designated a preferred purchasingsource for the members of the buying group for specified products. As we havemade acquisitions and expanded our product range, we have been able to addincremental products to our national contracts. During 2009, we signed orrenewed over 25 national contracts.

 

·                  *Low cost, high qualitymanufacturing capabilities.*  We have amajor manufacturing facility in Tijuana, Mexico that has been recognized foroperational excellence. The Mexico facility and our other manufacturingfacilities employ lean manufacturing, Six Sigma concepts and continuousimprovement processes to drive manufacturing efficiencies and lower costs.

 

·                  *Ability to generatesignificant cash flow.*Historically, our strong competitive position, brand awareness and highquality products and service as well as our low cost manufacturing have allowedus to generate attractive operating margins before non-cash amortizationexpense. These operating margins, together with limited capital expendituresand modest working capital requirements, significantly benefit our ability togenerate cash flow.

 

·                  *Experienced managementteam*. The membersof our management team have an average of over 26 years of relevant experience.This team has successfully integrated a number of acquisitions in the lastseveral years.

 

**OurStrategy**

 

Our strategy is to increase ourleading position in key products and markets, increase revenues andprofitability and enhance cash flow. Our key initiatives to implement thisstrategy include the following:

 

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

 

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

 

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·                  *Continue to develop and launchnew products and product enhancements.*  We have ahistory of developing and introducing innovative products into the marketplace,and we expect to continue future product launches by leveraging our internalresearch and development platforms. We believe our ability to develop newtechnology and to advance existing technology to create new products willposition us to further diversify our revenues and to expand our target marketsby providing viable alternatives to surgery or medication. We believe thatproduct innovation through effective and focused research and development, as wellas our relationships with a number of widely recognized orthopedic surgeons andprofessionals who assist us in product research, development and marketing,will provide a significant competitive advantage. During 2009, we launched 18new products, which generated over $12.3 million in revenues.

 

·                  *Maximize existing and secureadditional national accounts.*  We plan tocapitalize on the growing practice in healthcare in which hospitals and otherlarge healthcare providers seek to consolidate their purchasing activities tonational buying groups. Contracts with these national accounts represent asignificant opportunity for revenue growth. We believe that our existingrelationships with national buying groups and our broad range of productsposition us well not only to pursue additional national contracts, but also toexpand the scope of our existing contracts.

 

·                  *Expand international sales.* In recent years, we have successfully established direct distributioncapabilities in several major international markets. We believe that sales toEuropean and 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. Forexample, in 2009, we acquired an unaffiliated Australian distributor and twounaffiliated Canadian distributors, for approximately $3.4 million, $7.2 and$7.4 million, respectively as part of our strategy to expand our internationalsales. The DJO Merger and several of the acquisitions we made havesubstantially increased our international revenues and operating infrastructureand have provided us with opportunities to expand our international productofferings.

 

·                  *Drive operating efficiency.* We plan to continue to apply the principles of lean operations to ourmanufacturing sites as well as in our operating and administrative functions toincrease speed and efficiency and reduce waste. We have instilled a culture ofcontinuous improvement throughout the Company and are pursuing a regularschedule of addressing operations and processes in the Company to improveefficiency. We believe these lean principles and continuous improvement effortswill enhance our operating efficiencies and our ability to compete in anincreasingly price-sensitive health care industry.

 

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

 

Ourproducts are used by orthopedic specialists, primary care physicians, painmanagement specialists, 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 for injury prevention and at-home physical therapy treatment.

 

***Domestic Rehabilitation Segment***

 

Our Domestic RehabilitationSegment generated net sales of $640.8 million, $634.6 million, and $273.6million for the years ended December 31, 2009, 2008, and 2007,respectively.  (See Note 12 of the notesto the audited consolidated financial statements included in Part II, Item8, herein for net sales, gross profit and operating income for each segment).

 

Thefollowing table summarizes many of our Domestic Rehabilitation Segment productcategories:

 

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| **Product  Category**                          | ** ** | **Description**                                                                                                                                                                                          |
|------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Home  Electrotherapy Devices                   |       | Transcutaneous  electrical nerve stimulation (TENS)  Neuromuscular electrical stimulation (NMES)  Interferential electrical nerve stimulation                                                            |
| Clinical  Electrotherapy                       |       | TENS  NMES  Ultrasound  Laser  Light therapy  Shortwave Diathermy                                                                                                                                        |
| Patient  Care                                  |       | Nutritional  supplements  Patient safety devices  Pressure care products  Vascular systems products  Continuous passive motion devices  Hyalauronic acid medical devices                                 |
| Rigid  Bracing and Soft Goods                  |       | Soft  goods  Lower extremity fracture boots  Dynamic splinting  Ligament braces  Post-operative braces  Osteoarthritic braces  Ankle bracing  Shoulder, elbow and wrist braces  Back braces  Neck braces |
| Hot,  Cold and Compression Therapy             |       | Dry  heat therapy  Hot/cold therapy  Paraffin wax therapy  Moist heat therapy  Cold therapy  Compression therapy                                                                                         |
| Physical  Therapy Tables and Traction Products |       | Treatment  tables  Traction  Cervical traction  Lumbar traction                                                                                                                                          |
| Iontophoresis                                  |       | Needle-free  transdermal drug delivery                                                                                                                                                                   |
| Regeneration                                   |       | Non-union  fracture bone growth stimulation devices  Spine bone growth stimulation devices                                                                                                               |

 

***International Segment***

 

Our International Segmentgenerated net sales of $241.5 million, $252.3 million, and $133.8 million forthe years ended December 31, 2009, 2008, and 2007, respectively.  The product categories for our InternationalSegment are similar to the product categories for our domestic segments butcertain products are tailored to international market requirements andpreferences. In addition, our International Segment sells a number of productcategories, none of which are individually significant, that we do not selldomestically.

 

***Domestic Surgical Implant Segment***

 

Our Domestic SurgicalImplant Segment generated net sales of approximately $63.9 million, $61.6million, and $57.5 million for the years ended December 31, 2009, 2008 and2007, respectively.

 

The following tablesummarizes our Domestic 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) |

 

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**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;Vista, California; and Ecublens, Switzerland. The research and developmentactivities conducted in our facility in Chattanooga, Tennessee will be moved toVista and Ecublens in the first part of 2010, in connection with the closure ofthe Chattanooga facility. We spent approximately $23.5 million, $26.9 million,and $18.0 million in 2009, 2008 and 2007 (excluding approximately $3.0 millionof acquired in-process research and development (“IPR&D”)) for research anddevelopment activities, respectively. As of December 31, 2009, we hadapproximately 40 employees in our research and development departments.

 

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

 

Ourproducts reach our customers, including hospitals and other healthcarefacilities, physicians and other healthcare providers and end user patients,through several sales and distribution channels.

 

***Domestic Rehabilitation Segment***

 

Wemarket and sell our Domestic Rehabilitation Segment products in severaldifferent ways. The DonJoy sales channel is responsible for selling rigid kneebraces, cold therapy products, and certain soft goods. Certain DonJoy salesrepresentatives also sell our Regeneration products. The DonJoy channelconsists of approximately 260 independent commissioned sales representativeswho are employed by approximately 29 independent sales agents.  In the first half of 2008, we converted theNorthern and Southern California and Pacific Northwest regions to a directsales model for products in the DonJoy channel and Regeneration products.  We now cover those regions with approximately45 employed sales representatives. The DonJoy channel is primarily dedicated tothe sale of our products to orthopedic surgeons, podiatrists, orthotic andprosthetic centers, hospitals, surgery centers, physical therapists, athletictrainers and other healthcare professionals. Because the DonJoy product linesgenerally require customer education in the application and use of the product,our sales representatives are technical specialists who receive extensivetraining both from us and the agent, and use their expertise to help fit thepatient with the product and assist the orthopedic professional in choosing theappropriate product to meet the patient’s needs. After a sales representativereceives a product order, we generally ship and bill the product directly tothe orthopedic professional, and pay a sales commission to the agent. Forcertain custom rigid braces and other products, we sell directly to the patientand bill a third party payor, if applicable, on behalf of the patient. We enjoylong-standing relationships with most of our agents and sales representatives.Under the arrangements with the agents, each agent is granted an exclusivegeographic territory for sales of our products and is not permitted to marketproducts, or represent competitors who sell or distribute products, thatcompete with our existing products. The agents receive a commission, whichvaries based on the type of product being sold. If an agent fails to achieve specified sales quotas, we have the rightto terminate our relationship with the agent.

 

TheProCare/Aircast channel consists of approximately 120 direct and independentsales representatives that manage approximately 260 distributors focused onprimary and acute care facilities. Eight vascular systems specialists are alsoincluded in this channel. Products in this channel consist primarily of oursoft goods, vascular systems and other products, which are generally sold innon-exclusive territories to third party distributors as well as through ourdirect sales force. Our distributors include large, national third partydistributors such as Owens & Minor Inc., McKesson/HBOC,Allegiance Healthcare and Physician Sales and Service Inc., regionalmedical and surgical distributors, outpatient surgery centers and medicalproducts buying groups that consist of a number of health care providers whomake purchases through the buying group. These distributors and our directsales force generally sell our products to large hospital chains, primary carenetworks and orthopedic physicians for use by the patients. In addition, wesell our products through GPOs that are a preferred purchasing source formembers of a buying group.  Unlike ourDonJoy products, our ProCare/Aircast products generally do not requiresignificant customer education for their use. Our vascular systems pumps andrelated equipment are typically consigned to hospitals, and the hospitals thenpurchase the cuffs that are applied to each patient.

 

OurOfficeCare business provides stock and bill arrangements for physicianpractices. Through OfficeCare, we maintain an inventory of soft goods at over1,350 orthopedic practices and other healthcare facilities for immediatedistribution to patients. We then bill the patient or, if applicable, a thirdparty payor. For certain facilities, we provide on-site technicalrepresentatives.  The OfficeCare channelis managed by our DonJoy sales force.

 

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Throughour Empi channel, we market our prescription home therapy products primarily tophysicians and physical therapy clinics, which include hospital physicaltherapy departments, sports medicine clinics and pain management centers,through our sales force of over 200 direct and independent salesrepresentatives. In connection with these product lines, we currently have morethan 660 managed care contracts. Our electrotherapy and orthotics products aregenerally prescribed to patients by a physician such as an orthopedic surgeon.The physician will typically direct the patient to a physical therapy clinic tomeet with a trained physical therapist who provides the patient with theprescribed product from our consigned inventory at the clinic. This salesprocess is facilitated by our relationships with third party payors, such asmanaged care organizations, who ultimately pay us for the products prescribedto patients. For these reasons, we view physical therapists, physicians andthird party payors as key decision makers in product selection and patientreferral. Our home therapy products generally are eligible for third partyreimbursement by government payors, such as Medicare and Medicaid, and privatepayors. In addition, we have an outbound telemarketing sales force of sixrepresentatives, who sell reimbursed electrotherapy supplies and other productsdirectly to our patients.

 

Throughour Regeneration business, our non-union fracture bone growth stimulatordevices (“OL1000”) are sold primarily by approximately 180 employed andindependent sales representatives specially trained to sell the product. Thespine bone growth stimulator device (“SpinaLogic”) is sold by a few of ourdirect sales representatives and a network of independent spine productsdistributors. Most of our bone growth stimulator products are sold directly tothe patient and a third party payor is billed, if applicable, on behalf of thepatient.

 

Throughour Chattanooga business, we sell our clinical rehabilitation product lines tophysical therapy clinics, primarily through a national network of approximately3,800 independent distributors, which are managed by our internal salesmanagers. These distributors sell our clinical rehabilitation products to avariety of healthcare professionals, including physical therapists, athletictrainers, chiropractors, and sports medicine physicians. Except fordistributors outside of the United States, we do not maintain formaldistribution contracts for our clinical rehabilitation products. Thesedistributors purchase products from us at discounts off our published listprice. We maintain an internal marketing and sales support program to supportour distributor network. This program comprises a group of individuals whoprovide distributor and end-user training, develop promotional materials, andattend approximately 35 trade shows each year.

 

Noparticular customer or distributor accounted for 10% or more of product salesin the Domestic Rehabilitation Segment for the year ended December 31,2009.  Medicare and Medicaid togetheraccounted for approximately 10.0% of our 2009 net sales in the DomesticRehabilitation Segment.

 

***International Segment***

 

Wesell our rehabilitation products internationally through a network ofwholly-owned subsidiaries and independent distributors. In Europe, we use salesforces aggregating approximately 150 direct and independent salespersons and anetwork of independent distributors who call on healthcare professionals, aswell as consumer retail stores, such as sporting equipment providers, andpharmacies, to sell our products.  Weintend to continue to expand our direct and indirect distribution capabilitiesin attractive foreign markets. Our surgical implant products are sold outsidethe United States through independent distributors, principally in Japan andselect countries in Europe. Recent examples of our strategy to expand ourinternational sales are our acquisitions of our two unaffiliated Canadiandistributors in August 2009 and the acquisition of our unaffiliatedAustralian distributor in February 2009.

 

***Domestic Surgical Implant Segment***

 

Wecurrently market and sell the products of our Domestic Surgical Implant Segmentto hospitals and orthopedic surgeons through a network of approximately180independent commissioned sales representatives who are employed byapproximately 40 sales agents. Generally, our independent sales representativessell a range of reconstructive joint products, including our products. Weusually enter into agreements with sales agents for a term of one to fiveyears. Agents are typically paid a sales commission and are eligible for bonusesif sales exceed certain preset objectives. Our independent salesrepresentatives work for these agents. We assign our sales agents to anexclusive sales territory. Substantially all of our sales agents agree not tosell competitive products. Typically we can only terminate our agreements withsales agents prior to the expiration of the agreements for cause, whichincludes failure to meet specified periodic sales targets. We provide our salesagents with product inventories on consignment for their use in marketing ourproducts and filling customer orders.

 

Toa significant extent, sales of our surgical implant products depend on thepreference of orthopedic surgeons. We maintain contractual relationships withorthopedic surgeons who assist us in developing our products and provideconsulting services in connection with our products. In addition to providingdesign input into our new products, some of these orthopedic surgeons may givedemonstrations using our products, speak about our products at medical seminars,train other orthopedic surgeons in the use of our products, and provide us withfeedback on the acceptance of our products. We have also establishedrelationships with surgeons who conduct clinical studies on various products,establish protocols for use of the products and participate at varioussymposia. Surgeons who assist us in developing our products are generallycompensated with a royalty payment. Consulting surgeons are paid consultingfees for their services.

 

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**M****anufacturing**

 

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

 

Ourmanufacturing facilities are generally certified by the InternationalOrganization for Standardization (“ISO”) and generally comply with the U.S.Food and Drug Administration (“FDA”) current Good Manufacturing Practice (“cGMP”)and Quality System Regulations (“QSR”) requirements, which provide standardsfor safe and consistent manufacturing of medical devices and appropriatedocumentation of the manufacturing and distribution process. Many of ourproducts carry the European Community Medical Device Directive (“CE”)certification mark.

 

***Domestic Rehabilitation Segment***

 

Ourmanufacturing facility in Tijuana, Mexico is our largest manufacturingfacility. Our Mexico facility has achieved ISO 9001 and ISO 13485certification. These certifications are internationally recognized qualitystandards for manufacturing and assist us in marketing our products in certainforeign markets.  Our Vista, Californiafacility has achieved ISO 9001 certification, and certification to the CanadianMedical Device Regulation (ISO 13485) and the European Medical DeviceDirective.  Products manufactured at theVista, California facility include our custom rigid knee bracing products, thepump portion of our vascular systems products and our regeneration products.Within both our Vista and Tijuana facilities, we operate vertically integratedmanufacturing and cleanroom packaging operations and many subassemblies andcomponents can be produced in-house. These include metal stamped parts,injection molding components and fabric-strapping materials. We also haveextensive in-house tool and die fabrication capabilities, which typically providesavings in the development of tools and molds as well as flexibility to respondto and capitalize on market opportunities as they are identified.

 

Wemake Chattanooga division products, including electrotherapy devices, patientcare products and physical therapy 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.   In June 2009,we announced our plans to close our Chattanooga manufacturing and distributionfacility and to integrate the operations of the Chattanooga site into our otherexisting sites, mainly our Mexico facility. The transition of Chattanoogaactivities is expected to be completed during the first six months of 2010.

 

Ourhome electrotherapy devices sold in the United States and certain componentsand related accessories are manufactured at our Clear Lake, South Dakotafacility. Manufacturing activities at the Clear Lake facility includeelectronic and mechanical assembly, electrode fabrication and assembly andfabric sewing processes. Our electrotherapy products comprise a variety ofcomponents, including die cast metal parts, injection molded plastic parts,printed circuit boards, electronic components, lead wires, electrodes and othercomponents. Parts for these components are purchased from outside suppliers andare, in some instances, manufactured on a custom basis. Our Clear Lake facilityhas achieved the ISO 13485:2003 certification. Our home electrotherapy deviceswhich are sold outside the United States are primarily manufactured by outsidethird party vendors.

 

Manyof the component parts and raw materials we use in our manufacturing andassembly operations are available from more than one supplier and are generallyavailable on the open market.  We sourcesome of our finished products from manufacturers in China as well as otherthird party manufacturers.  We alsocurrently purchase certain CPM devices from a single supply source, Medireha,which is 50% owned by us. Our distribution agreement with Medireha grants us exclusiverights to the distribution of products that Medireha manufactures. Thedistribution agreement also requires that we purchase a certain amount ofproduct annually and that we seek Medireha’s approval if we choose tomanufacture or distribute products that are identical or similar, or otherwisecompete with the products that are the subject of the distribution agreement.

 

***International Segment***

 

Manyof the products for our International Segment are manufactured in the samefacilities as our domestic segments.  Weoperate a manufacturing facility in Tunisia that provides bracing products forthe French and other European markets. In addition, our Ormed and Cefar-Compex businesses source certain of theproducts they sell from third party suppliers. Cefar-Compex currently utilizesa single vendor for many of its home electrotherapy devices.

 

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***Domestic Surgical Implant Segment***

 

Inour Domestic Surgical Implant Segment, we manufacture our products in ourAustin, Texas facility. This manufacturing facility includes computercontrolled machine tools, belting, polishing, cleaning, packaging and qualitycontrol. Our Austin facility has achieved the ISO 13485:2003 certification. Theprimary raw materials used in the manufacture of our surgical implant productsare cobalt chromium alloy, stainless steel alloys, titanium alloy and ultrahigh molecular weight polyethylene. All Domestic Surgical Implant Segment productsgo through in-house quality control, cleaning and packaging operations.

 

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

 

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

 

Thevalidity of any of the patents or other intellectual property owned by orlicensed to us may not be upheld if challenged by others in litigation. Due tothese and other risks described in this Annual Report, we do not rely solely onour patents and other intellectual property to maintain our competitiveposition. We believe that the development and marketing of new products andimprovement of existing ones is, and will continue to be, more important to ourcompetitive position than relying solely on existing products and intellectualproperty.

 

**Competition**

 

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

 

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.

 

Amongother things, our ability to compete is affected by our ability to:

 

·                  develop new products and innovativetechnologies;

 

·                  obtain regulatory clearance and compliancefor our products;

 

·                  manufacture and sell our productscost-effectively;

 

·                  meet all relevant quality standards for ourproducts and their markets;

 

·                  respond to competitive pressures specific toeach of our geographic markets, including our ability to enforce non-competeagreements;

 

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·                  protect the proprietary technology of ourproducts and manufacturing processes;

 

·                  market our products;

 

·                  attract and retain skilled employees andsales representatives; and

 

·                  maintain and establish distributionrelationships.

 

***Domestic Rehabilitation 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, Rich-Mar, PattersonMedical, 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.

 

Ourprimary competitors in the rigid knee bracing market include companies such asÖssur hf., Orthofix International, N.V., Bledsoe Brace Systems and TownsendIndustries Inc. In the soft goods products market, our competitors includeBiomet, Inc., DeRoyal Industries, Össur hf. and Zimmer Holdings, Inc.In the cold therapy products market, our competitors include Orthofix, BledsoeBrace Systems and Stryker Corporation. Our primary competitor in the dynamicsplinting market is Dynasplint Systems, Inc. Several competitors haveinitiated stock and bill programs similar to our OfficeCare program, and thereare numerous 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.

 

Ourcompetitors for regeneration products are large, diversified orthopediccompanies. In the nonunion bone growth stimulation market, our competitorsinclude Orthofix International, N.V., Biomet, Inc. and Smith &Nephew, and in the spinal fusion market, we compete with Biomet, Inc. andOrthofix International, N.V. Competition in bone growth stimulation devices islimited as higher regulatory thresholds provide a barrier to market entry.

 

***International Segment***

 

Competition for ourInternational products arises from many of the companies and types of companiesthat compete with our domestic segments and from foreign manufacturers whosecosts may be lower due to their ability to manufacture products within theirrespective countries.  Competition isbased primarily on quality, innovative design and technical capability, breadthof product line, availability of and qualification for reimbursement, andprice.

 

***Domestic Surgical Implant Segment***

 

Themarket for orthopedic products similar to those produced by our DomesticSurgical Implant Segment is dominated by a number of large companies, includingBiomet, Inc., DePuy, Inc. (a Johnson & Johnson company),Smith & Nephew plc, Stryker Corporation and Zimmer Holdings, Inc.,which are much larger and have significantly greater financial resources thanwe do. Our Domestic Surgical Implant Segment also faces competition fromU.S.-based companies similar in size to ours, such as Wright Medical Group, Inc.and Exactech, Inc. Competition in the market in which our DomesticSurgical Implant Segment participates is based primarily on price, quality,innovative design and technical capability, breadth of product line, scale ofoperations and distribution capabilities. Our current and future competitorsmay have greater resources, more widely accepted and innovative products,less-invasive therapies, greater technical capabilities, and stronger namerecognition than we do.

 

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

 

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

 

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.

 

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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 to GeneralControls, 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. If the FDA determines that the device, or itsintended use, is not “substantially equivalent,” the FDA will automaticallyplace the device into 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. A Pre-Market Approval (“PMA”) from the FDA isrequired before the manufacturer of a Class III product can proceed inmarketing the product. The PMA process is much more extensive than the 510(k) process.In order to obtain a PMA, Class III devices, or a particular intended useof any such device, must generally undergo clinical trials pursuant to anapplication submitted by the manufacturer for an Investigational DeviceExemption (“IDE”). An IDE allows the investigational device to be used in aclinical study in order to collect safety and effectiveness data required tosupport a PMA application or a 510(k) submission to the FDA. The PMAprocess generally takes significantly longer than the 510(k) process andcan 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. TheFDA may disagree with our conclusion that clearances or approvals were notrequired for specific products and may require clearances or approval for suchproducts. In these circumstances, we may be required to cease distribution ofthe product, the devices may be subject to seizure by the FDA or to a voluntaryor mandatory recall, and we also could be subject to significant fines andpenalties.

 

Ourmanufacturing processes are also required to comply with the FDA’s current GoodManufacturing Practice (“cGMP”) and Quality System Regulation (“QSR”)requirements 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. medicaldevice regulatory requirements could result in, among other things, warningletters, fines, injunctions, civil penalties, repairs, replacements, refunds,recalls or seizures of products, total or partial suspensions of production,refusal of the FDA to grant future pre-market clearances or PMA approvals,withdrawals or suspensions of current clearances or approvals, and criminalprosecution. We are also required to report to the FDA if our products cause orcontribute to death or serious injury or malfunction in a way that would likelycause or contribute to death or serious injury were the malfunction to recur;the FDA or other agencies may require the recall of products in the event ofmaterial defects or deficiencies in design or manufacturing. The FDA can alsowithdraw or limit our product approvals or clearances in the event of seriousunanticipated health or safety concerns.

 

Inthe first quarter of 2008, we received a Form FDA-483 “InspectionalObservations” in connection with an FDA audit of the Chattanooga division ofour Domestic Rehabilitation Segment, stating that we failed to report certaincustomer complaints claiming that our muscle stimulator devices malfunctioned,and that we did not adequately implement corrective and preventive action toprevent recurrence of potential product failures relating to our musclestimulator devices.  The auditor alsorecommended that we recall a series of ultrasound devises that had experiencedoperating issues in 2005, and we are implementing such a recall. We received awarning letter from the FDA in June 2008 relating to reporting issues onthe muscle stimulator device complaints and requesting software verificationand validation plans and reports regarding the correction of problemsassociated with the ultrasound product. We believe we have addressed these areas of concern adequately.  In a recent FDA audit of our Chattanoogafacility, as a follow-up to the warning letter we received in June 2008,the FDA issued no Form FDA 483 “Inspectional Observations” and the FDA hasformally withdrawn the warning letter.

 

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In the third quarter of 2009, we received a Form FDA-483“Inspectional Observations” in connection with an FDA audit of our DomesticSurgical Implant Segment, stating that: (1) we failed to follow ourstandard operating procedures to ensure that the designs of certain productswere correctly transferred into production; (2) we failed to adequatelyanalyze certain quality data to identify existing and potential causes ofnonconforming product and quality problems, resulting in disposal or reworkingof certain nonconforming parts in the later stages of our production processes;(3) our complaint handling procedures were not well defined to ensure thatall complaints are processed in a uniform and timely manner; and (4) wefailed to follow our standard operating procedures related to procurement tominimize receipt of nonconforming materials from suppliers. We promptlyimplemented corrective actions that we believe adequately address eachInspectional Observation and submitted a timely response to the FDA. We arereviewing these inspectional observations to determine the appropriate remedialaction. We cannot assure you that the FDA will agree with our actions or willnot take further action in the future, including issuing a warning letterrelated to these observations, seeking injunction, initiating seizure, or delayingreview of pending applications.

 

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.

 

TheFDA has broad regulatory and enforcement powers. If the FDA determines we havefailed to comply with applicable regulatory requirements, it can impose avariety of enforcement actions, from warning letters, fines, injunctions,consent decrees, and civil penalties, to suspension or delayed issuance ofapplications, seizure or recall of our products, total or partial shutdowns,withdrawals of approvals or clearances already granted, and criminalprosecution. The FDA can also require us to repair or replace or refund thecosts of devices we manufactured or distributed.

 

Wemust obtain export certificates from the FDA before we can export certain ofour products. 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 the European Economic Area (which consists of thetwenty-seven member states of the European Union, as well as Iceland,Liechtenstein and Norway) is governed by various directives and regulationspromulgated by the European Commission and national governments. Only medicaldevices that comply with certain conformity requirements are allowed to bemarketed within the European Economic Area. In addition, the national health orsocial security organizations of certain countries, including certain countriesoutside Europe, require our products to be qualified before they can bemarketed in those countries.

 

Wehave also implemented policies and procedures allowing us to position ourselvesfor the changing international regulatory environment. Our internationalsurgical implant activities received an ISO 13485:2003 certification for itsfacilities and an EC Certificate for its many products. Receiving ISO13485:2003 certification assists us in meeting international regulatoryrequirements to allow for export of products to Japan, countries in Europe, Australiaand Canada. Our international surgical implant activities have also met therequisites for the Canadian Medical Device Requirements.  Our International Segment has received ISO9001 certification, EN46001 certification and certification to the CanadianMedical Device Regulation (ISO 13485) and the European Medical DeviceDirective.

 

***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, oncoverage of our products and whether third party payment amounts will beadequate. We believe that Medicare and other third party payors will continueto focus on measures to contain or reduce their costs through managed care andother methods. Medicare policies are important to our business because privatepayors often model their policies after the Medicare program’s coverage andreimbursement policies.  In December 2008,Medicare issued a notice to its contractors responsible for reimbursement oforthotics, among other products, to the effect that elastic braces that are notrigid or semi-rigid are not considered “braces” for Medicare coverage purposesand will no longer be reimbursed, effective January 1, 2009.  We are seeking a redetermination by Medicareof the application of this notice to several braces we sell that, while notcomposed of rigid material, operate to support and correct physical issues,particularly relating to the knee cap, and should be continued to be classifiedas braces for coverage purposes.  Thisdecision by Medicare is likely to eventually be adopted by private third-partypayers and, subject to our success in seeking the redetermination, couldadversely impact our sales in the bracing and soft goods product line of ourDomestic Rehabilitation Segment.

 

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Inrecent years, Congress has enacted a number of laws that impact Medicarereimbursement for and coverage of durable medical equipment, prosthetics,orthotics and supplies (“DMEPOS”), including many of our products. Forinstance, the Medicare Prescription Drug, Improvement and Modernization Act of2003 (“Medicare Modernization Act”) mandated a temporary freeze in annualincreases in payments for durable medical equipment from 2004 through 2008, andestablished new clinical conditions for payment and quality standards. Under acompetitive bidding structure provided in the Medicare Modernization Act,Medicare no longer reimburses for certain products and services based on the Medicarefee schedule amount in designated competitive bidding areas. Instead, theMedicare program will provide reimbursement for these items and services basedon a competitive bidding process. Only those suppliers selected through thecompetitive bidding process within each designated region will be eligible tohave their products reimbursed by Medicare. Bidding was conducted in 2007 forthe first phase of competitive bidding in ten metropolitan statistical areasfor ten product categories, and bid prices briefly went into effect on effect July 1,2008. The program was scheduled to be expanded to an additional 70 areas in2009, and additional areas thereafter. On July 15, 2008, the U.S. Congressenacted the Medicare Improvements for Patients and Providers Act of 2008 (“MIPPA”),which terminated round one contracts and required the Centers for Medicare andMedicaid services (“CMS”), the agency responsible for administering theMedicare program, to rebid those areas in 2009. The legislation also delaysround two bidding until 2011 and makes a series of changes to programrequirements. The delay in bidding is financed by nationwide reductions inMedicare DMEPOS fee schedule payments for 2009 for items that were subject tothe first round of bidding. CMS conducted the rebidding of the first round ofthe competitive bidding program in 2009, with the program scheduled to go intoeffect January 1, 2011. While none of our products are included in theinitial round of items subject to bidding, off-the-shelf orthotics couldeventually be subject to the bidding process. The competitive bidding processmay reduce the number of suppliers providing certain items and services toMedicare beneficiaries and the amounts paid for such items and services withina given geographic area. In addition, CMS may use payment information fromregions subject to competitive bidding to reduce Medicare reimbursement inregions not subject to competitive bidding. CMS also has proposed revising theway Medicare sets payment amounts for all new durable medical equipment,orthotics, prosthetics, and supplies, under which reimbursement could be basedin part or in whole on functional assessments, price comparisons, and medicalbenefits assessments, although that methodology has not yet been finalized.  While the program is currently delayed, onceit is back in effect, we expect it will be expanded to additional areas andadditional product categories may be selected.

 

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 Act requiresthat new clinical conditions for payment of durable medical equipment beestablished. CMS issued a proposed rule to implement this provision in August 2004,but the agency to date only has finalized such standards for power mobilitydevices. Some of our products could be impacted by this requirement in thefuture. At this time, we cannot predict what clinical conditions will beadopted, the timing of such adoption, or the impact that the new qualitystandards or any new clinical conditions that are adopted may have on ourbusiness.

 

CMSalso published a rule on January 2, 2009 requiring most Medicaresuppliers of durable medical equipment, prosthetics, orthotics and supplies topost a $50,000 surety bond from an authorized surety, with higher amounts requiredfor certain “high-risk” suppliers.  The rule providesan exception from the surety bond requirement for the provision of orthotics,prosthetics, and supplies by (1) state-licensed orthotic and prostheticpersonnel and (2) state-licensed physical and occupational therapistsproviding such items to their own patients. This exception applies only topersonnel and therapists operating in private practice; medical supplycompanies employing such personnel or therapists do not qualify for thisexception.  The rule becameeffective March 3, 2009.  Existingsuppliers were required to comply with the surety bond requirement by October 2,2009), while new enrolling suppliers or suppliers seeking to change ownershipafter the effective date must meet this requirement by May 4, 2009.

 

On August 7, 2009, CMS issued Transmittal 297entitled ‘‘Compliance Standards for Consignment Closets and Stock and BillArrangements’’ (the ‘‘Transmittal’’), requiring a change in procedures in stockand bill arrangements for Medicare beneficiaries. When implemented, theTransmittal will require products dispensed to a Medicare beneficiary from theinventory in our OfficeCare accounts in physician office settings to be fittedand billed to Medicare by the physician rather than by us. Title to the productmust pass to the physician at the time the product is dispensed to the patient.The effect of this change in most instances would be to convert a billingopportunity by us into a sale to the physician at a wholesale price. The Transmittalwas originally scheduled to go into effect on September 8, 2009. CMS firstdelayed the effective date until March 1, 2010, and on February 4,2010 CMS rescinded the Transmittal in order to consider other implementationdates. If the Transmittal goes into effect as written, it could adverselyaffect the revenue and, to a lesser extent, profitability of our OfficeCarebusiness.

 

Our international sales alsodepend in part upon the eligibility of our products for reimbursement throughthird party payors, the amount of reimbursement and the allocation of paymentsbetween the patient and third party payors. Reimbursement practices varysignificantly by country, with certain countries requiring products to undergoa lengthy regulatory review in order to be eligible for third partyreimbursement. In addition, healthcare cost containment efforts similar tothose we face in the United States are

 

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prevalent in many of theforeign countries in which our products are sold, and these efforts areexpected to continue in the future, possibly resulting in the adoption of morestringent reimbursement standards. For example, in Germany, our largest foreignmarket, new regulations generally require adult patients to pay a portion ofthe cost of each medical technical device prescribed. This may adversely affectour sales and profitability by making it more difficult for patients in Germanyto pay for our products. Any developments in our foreign markets thateliminate, reduce or materially modify coverage of, and reimbursement ratesfor, our products could have an adverse effect on our ability to sell ourproducts.

 

***Fraud and Abuse***

 

Weare subject 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, a challenge to 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 Other-Fraud Laws*

 

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

 

Recently,certain manufacturers of implant products entered into monetary settlementagreements, corporate integrity agreements and deferred prosecution agreementswith the U.S. Department of Justice (“DOJ”) based upon allegations that, amongother things, they entered into a variety of consulting and other agreementswith physicians as improper inducements to those physicians to use themanufacturers’ products in violation of federal anti-kickback laws. We believethat remuneration paid to surgeons with which we have agreements representsfair market value for legitimate designing, consulting and advisory servicesrendered on our behalf.

 

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

 

TheHealth Insurance Portability and Accountability Act of 1995 (“HIPAA”) createdtwo new federal crimes effective as of August 21, 1996, relating tohealthcare fraud and false statements regarding healthcare matters. Thehealthcare fraud statute prohibits knowingly and willfully executing orattempting to execute a scheme or artifice to defraud any healthcare benefitprogram, including private payors. The false statements statute prohibitsknowingly and willfully falsifying, concealing or covering up a material factor making any materially false, fictitious or fraudulent statement orrepresentation in connection with the delivery of or payment for healthcarebenefits, items or services. HIPAA applies to any healthcare benefit plan, notjust Medicare and Medicaid. Additionally, HIPAA granted expanded enforcementauthority to HHS and the DOJ and provided enhanced resources to support theactivities and responsibilities of the HHS, OIG and DOJ by authorizing largeincreases in funding for investigating fraud and abuse violations relating tohealthcare delivery and payment. In addition, HIPAA mandates the adoption ofstandards for the electronic exchange of health information, as described belowin greater detail under “Federal Privacy and Transaction Law and Regulations.”

 

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*Physician Self-Referral Laws*

 

Wemay also be subject to federal and state physician self-referral laws. Federalphysician self-referral legislation, commonly known as the Stark Law,prohibits, subject to certain exceptions, physician referrals of Medicare andMedicaid patients to an entity providing certain “designated health services”if the physician or an immediate family member of the physician or a physicianorganization in which the physician participates has any financial relationshipwith the entity. Durable medical equipment and orthotics are included asdesignated health services. The Stark Law also prohibits the entity receivingthe referral from billing any good or service furnished pursuant to an unlawfulreferral, and any person collecting any amounts in connection with an unlawfulreferral is obligated to refund such amounts. A person who engages in a schemeto circumvent the Stark Law’s referral prohibition may be fined up to $100,000for each such arrangement or scheme. The penalties for violating the Stark Lawalso include civil monetary penalties of up to $15,000 per referral andpossible exclusion from federal healthcare programs such as Medicare andMedicaid. Various states have corollary laws to the Stark Law, including lawsthat require physicians to disclose any financial interest they may have with ahealthcare provider to their patients when referring patients to that provider.Both the scope and exceptions for such laws vary from state to state.

 

*False Claims Laws*

 

Undermultiple state and federal statutes, submissions of claims for payment that are“not provided as claimed” may lead to civil money penalties, criminal fines andimprisonment and/or exclusion from participation in Medicare, Medicaid andother federally funded state health programs. These false claims statutesinclude the federal False Claims Act, which prohibits 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 “quitam” actions, can be brought by any individual on behalf of the government andsuch individuals, commonly known as whistleblowers, may share in any amountspaid by the entity to the government in fines or settlement. In addition,certain states have enacted laws modeled after the federal False Claims Act.Qui tam actions have increased significantly in recent years, causing greaternumbers of healthcare companies to have to defend a false claim action, payfines or be excluded from Medicare, Medicaid or other federal or statehealthcare programs as a result of an investigation arising out of such action.

 

***Governmental Audits***

 

Becausewe participate in governmental programs as a supplier of medical devices, ouroperations are subject to periodic surveys and audits by governmental entitiesor contractors to assure compliance with Medicare and Medicaid standards andrequirements. To maintain our billing privileges, we are required to complywith certain supplier standards, including licensure and documentationrequirements for our claims submissions. From time to time in the ordinarycourse of business, we, like other healthcare companies, are audited by, orreceive claims documentation requests from, governmental entities, which mayidentify certain deficiencies based on our alleged failure to comply withapplicable supplier standards or other requirements. Medicare contractors andMedicaid agencies periodically conduct pre- and post-payment reviews and otheraudits of claims and are under increasing pressure to more closely scrutinizehealthcare claims and supporting documentation. We have historically beensubject to pre and post-payment reviews as well as audits of claims and mayexperience such reviews and audits of claims in the future. We review andassess such audits or reports and attempt to take appropriate correctiveaction. We are also subject to surveys of our facilities for compliance with thesupplier standards.

 

Wehave also been subject to periodic audits of our compliance with other federalrequirements for our facilities and related quality and manufacturingprocesses.  Our Surgical Implant facilityin Austin, Texas received an FDA warning letter received in 2009 and ourfacility in Chattanooga received a warning letter following an FDA audit inearly 2008.  Both of these warningletters are described above in the section “FDA and Similar Foreign GovernmentRegulations”.

 

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

 

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

 

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HIPAAapplies to “covered entities,” which includes certain health care providers whoconduct certain transactions electronically. As such, HIPAA and the AdministrativeSimplification Rules apply to certain aspects of our business. Theeffective date for all of the Administrative Simplification Rules outlinedabove has passed, and, as such, all of the Administrative Simplification Rules arein effect. To the extent applicable to our operations, we are currently incompliance with HIPAA and the applicable Administrative Simplification Rules.

 

OnFebruary 17, 2009, President Obama signed into law the Health InformationTechnology for Economic and Clinical Health Act (“HITECH Act”) as part of theAmerican Recovery and Reinvestment Act. This economic stimulus package includes many health care policyprovisions, including strengthened federal privacy and security provisions toprotect personally-identifiable health information, such as notificationrequirements for health data security breaches. Many of the details of the new requirements are being implementedthrough regulations, including an interim final rule on the HITECH healthinformation security enforcement provisions published October 30, 2009. Weare reviewing these new requirements to assess the potential impact on ouroperations.

 

**E****mployees**

 

As of December 31,2009, we had approximately 4,480 employees. Of these, approximately 3,040 wereengaged in production and production support, approximately 40 in research anddevelopment, approximately 1,020 in sales and support, and approximately 380 invarious administrative capacities including third party billing.  Of these employees, approximately 1,970 werelocated in the United States, approximately 1,920 were located in Mexico andapproximately 590 were located in various other countries, primarily inEurope.  Our workforce in the UnitedStates is not unionized; however, portions of our workforce in Europe are unionized.  We have not experienced any strikes or workstoppages, and our management considers our relationship with our employees tobe good.

 

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

 

Information about our segments andgeographic areas can be found in Note 12 “Segment and Geographic Information”of the  notes to the audited consolidatedfinancial statements included in Part II, Item 8, herein.

 

**Available Information**

 

Wehave made available free of charge through our website, www.DJOglobal.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 “Investors-SECReports” page of our website.  DJOuses its website as a channel of distribution of material Companyinformation.  Financial and othermaterial information regarding the Company is routinely posted and accessibleon our website. Our SEC reports are also available free of charge on the SECwebsite at, www.sec.gov.  Our Code ofBusiness Conduct and Ethics is available free of charge on our website.  It may be found under the “Investors-CorporateGovernance” page of our website.

 

## **ITEM 1A.  RISKFACTORS**

## ** **

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

 

**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 tointerest rate risk to the extent of our variable rate debt and prevent us frommeeting our obligations under our indebtedness.***

 

Weare highly leveraged. As of December 31, 2009, our total indebtedness was$1,812.9 million. We have an additional $100.0 million available forborrowing under our revolving credit facility, for which no amounts were drawnas of December 31, 2009.

 

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Ourhigh degree of leverage could have important consequences, including:

 

·                  making it difficult for us to makepayments on our 10.875% Notes and our 11.75% Notes (collectively, the “Notes”)and other debt;

 

·                  increasing our vulnerability to generaleconomic and industry conditions;

 

·                  requiring a substantial portion of cashflow from operations to be dedicated to the payment of principal and intereston our indebtedness, therefore reducing our ability to use our cash flow tofund our operations, capital expenditures and future business opportunities;

 

·                  exposing us to the risk of increasedinterest rates as certain of our borrowings, including certain borrowings underour Senior Secured Credit Facility, will be subject to variable rates ofinterest;

 

·                  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 tochanging market conditions and placing us at a competitive disadvantagecompared to our competitors who are less highly leveraged.

 

Wemay be able to incur substantial additional indebtedness in the future.Although our Senior Secured Credit Facility and each of the indenturesgoverning the Notes, which we refer to as the 10.875% Indenture and the 11.75%Indenture (or collectively, the “Indentures”), contain restrictions on theincurrence of additional indebtedness, these restrictions are subject to anumber of significant qualifications and exceptions, and under certaincircumstances, the amount of indebtedness that could be incurred in compliancewith these restrictions could be substantial. If new indebtedness is added toour current debt levels, the related risks that we now face could intensify. Inaddition, the Indentures will not prevent us from incurring obligations that donot constitute indebtedness under the Indentures.

 

Ourcash paid for interest for the years ended December 31, 2009 and 2008 was$144.2 million and $158.8 million, respectively.  As of December 31, 2009, we had$1,044.1million of debt subject to floating interest rates, including $1,043.7million under the Senior Secured Credit Facility.  Although we currently have interest rateswaps in place to hedge against rising interest rates (see Note 9 of the notesto the audited consolidated financial statements included in Part II, Item8, herein), any additional borrowings we make under the Senior Secured CreditFacility will also be subject to floating interest rates.

 

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

 

OurSenior Secured Credit Facility and the Indentures governing the Notes containvarious covenants that limit our ability to engage in specified types oftransactions. These covenants limit our and our 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;

 

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

 

·                  enter into certain transactions with ouraffiliates.

 

Inaddition, we are required to satisfy and maintain a specified senior securedleverage ratio, which becomes more restrictive over time. This covenant couldmaterially and adversely affect our ability to finance our future operations orcapital needs. Furthermore, it may restrict our ability to conduct and expandour business and pursue 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.

 

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Abreach of any of these covenants could result in a default under one or more ofthese agreements, including as a result of cross default provisions. Upon theoccurrence of an event of default under the Senior Secured Credit Facility, thelenders could elect to declare all amounts outstanding under the 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 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 SeniorSecured Credit Facility. If the lenders under the Senior Secured CreditFacility accelerate the repayment of borrowings, we cannot assure you that wewill have sufficient assets to repay the amounts borrowed under the 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.***

 

Ourability to make scheduled payments on or to refinance our debt obligationsdepends on our financial condition and operating performance, which is subjectto prevailing economic and competitive conditions and to certain financial,business and other factors beyond our control. We cannot assure you that wewill maintain a level of cash flows from operating activities sufficient topermit us to pay the principal, premium, if any, and interest on ourindebtedness.

 

Ifour cash flows and capital resources are insufficient to fund our debt serviceobligations, we may be forced to reduce or delay investments and capitalexpenditures, or to sell assets, seek additional capital or restructure orrefinance our indebtedness. These alternative measures could affect theoperation and growth of our business and may not be successful and may notpermit us to meet our scheduled debt service obligations. If our operatingresults and available cash are insufficient to meet our debt serviceobligations, we could face substantial liquidity problems and might be requiredto dispose of material assets or operations to meet our debt service and otherobligations. In that case, we may not be able to consummate those dispositionsor to obtain the proceeds that we could realize from them, and the proceedsfrom those dispositions may not be adequate to meet any debt service obligationsthen due. Additionally, our Senior Secured Credit Facility and the Indenturesgoverning the Notes limit the use of the proceeds from dispositions of assets;as a result, we may not be permitted, under our Senior Secured Credit Facilityand the Indentures governing the Notes, to use the proceeds from suchdispositions to satisfy all current debt service obligations.

 

**Risks Related To Our Business**

 

***The current US and global economic downturn and related credit andfinancial market problems may pose additional risks and exacerbate existingrisks to our business.***

 

Theserious slowdown in the US and global economy, as well as the dramatic problemsin the current credit and financial markets, had and may continue to have anegative effect on demand for our products, availability and reliability ofvendors and third party contract manufacturers, our ability to timely collectour accounts receivable and the availability of financing for acquisitions andworking capital requirements. We experienced an overall slowing of our revenuegrowth in 2009 from prior years and significant slowdown in sales of ourproducts that our customers consider to be included in their discretionarycapital spending. Continued or renewed deterioration of the general economicslowdown in the United States and overseas could contribute to those trendsremaining a problem or becoming worse.

 

Theslowing of economic activity and lack of available financing has impacted andcould continue to impact our business in a variety of ways, including thefollowing:

 

·      Loss of jobsand lack of health insurance as a result of the economic slowdown could depressdemand for health care services and demand for our products.

 

·      Weakened demandfor health care services, reduction in the number of insured patients and lackof available credit could result in the inability of private insurers tosatisfy their reimbursement obligations, lead to delays in payment or cause theinsurers to increase their scrutiny of our claims.

 

·      Shortage ofavailable credit for working capital could lead customers who buy capital goodsfrom us to curtail their purchases or have difficulty meeting paymentobligations.

 

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·      Tightening ofcredit and disruption in the financial markets could disrupt or delayperformance by our third party vendors and contractors and adversely affect ourbusiness.

 

·      Problems in thecredit and financial markets could limit the availability and size ofalternative or additional financing for our working capital or other corporateneeds and could make it more difficult and expensive to obtain waivers under ormake changes to our existing credit arrangements.

 

Anyof these risks, among others, could adversely affect our business and operatingresults, and the risks could become more pronounced if the problems in the USand global economies and the credit and financial markets continue or becomeworse.

 

***Changes in Medicare coverage andreimbursement policies for our products by Medicare or reductions inreimbursement rates for our products could adversely affect our business andresults of operations.***

 

In recent years, Congress has enacted a number of lawsthat impact Medicare reimbursement for and coverage of DMEPOS, including manyof our products. For instance, the Medicare Modernization Act mandated atemporary freeze in annual increases in payments for durable medical equipmentfrom 2004 through 2008, and established new clinical conditions for payment andquality standards.

 

The Medicare Modernization Act also established a newcompetitive bidding program for DMEPOS, which eventually could impactprefabricated orthotic devices and other of our products. Undercompetitive bidding, Medicarewill no longer reimburse for certain products and services based on theMedicare fee schedule amount in designated competitivebidding areas. Instead, theMedicare program will provide reimbursement for these items and services basedon a competitive bidding process. Onlythose suppliers selected through acompetitive bidding process within each designated region will be eligible tohave their productsreimbursed byMedicare. Bidding was conducted in 2007 for the first phase of competitivebidding in ten metropolitan statistical areasfor ten product categories, and bid pricesbriefly went into effect on July 1, 2008. The program was scheduled to beexpanded to 70additionalareas in 2009 and additional areas thereafter. On July 15, 2008, the U.S.Congress enacted MIPPA, which terminated round one contracts and required CMSto rebid those areas in 2009.The legislation also delays round two bidding until 2011 and makes aseries of changes to program requirements. The delay inbidding is financed bynationwide reduction in Medicare DMEPOS for 2009 fee schedule payments foritems that were subject to the firstround of bidding. CMS conducted the rebiddingof the first round of the competitive bidding program in 2009, with the programscheduled to go into effect January 1, 2011. While none of our products isincluded in the initial round of items subject to bidding; there is noassurance they will not beincluded in the future. When it is eventually implemented, thecompetitive bidding process may reduce the number of suppliers providingcertain items and servicesto Medicare beneficiaries and the amounts paid for such items and serviceswithin a given geographic area. Inclusion of any of our products in Medicarecompetitive bidding or other Medicare reimbursement or coveragereductions could result insuch products being sold in lesser quantities or for a lower price. Further,CMS may use competitive bid pricing information to adjust the payment amountsotherwise in effect for an area that is not a competitive acquisition area. Anyof these developments could have a material adverse effect on our results ofoperations. In addition, ifwe are not selected to participate in the competitive bidding programin a particular region, it could have a material adverse effect onour sales and profitability.

 

Initiatives sponsored by government agencies,legislative bodies and the private sector to limit the growth of healthcarecosts, including price regulation and competitive pricing, are ongoing inmarkets where we do business. We could experience a negative impact on ouroperating results due to increased pricing pressure in the United States andcertain other markets. Governments, hospitals and other third party payorscould reduce the amount of approved payment for the company’s products.Reductions in reimbursement levels or coverage, or other cost-containmentmeasures could unfavorably affect our future operating results.

 

***Future federal andstate health reform and cost control efforts could include provisions thatadversely impact our business and results of operations.***

 

The U.S. House of Representatives and the U.S. Senatehave approved separate health reform bills designed to expand access toaffordable health insurance, control health care spending, and improve healthcare quality. Specific provisions of the legislation vary, but both versionsinclude a number of provisions that could, if enacted, impact manufacturers andsuppliers of DMEPOS.  Provisions adoptedby the House and/or Senate would, among other things: establish a public healthinsurance plan to compete with private insurers; impose a new annual federalfee on certain medical device manufacturers and importers; require medicalsupply and device manufacturers to report certain payments made to physiciansand other referral sources; reduce Medicare DMEPOS fee schedule updates andapply a new ‘‘productivity adjustment’’ to Medicare DMEPOS payments; expand andaccelerate the Medicare DMEPOS competitive bidding program; study theestablishment of a competitive bidding program for manufacturers of durablemedical equipment and supplies; and establish new Medicare and Medicaid programintegrity provisions, including a number of safeguards focusing on Medicareorders for DMEPOS.  Although the timingand ultimate outcome of the health reform efforts are still uncertain, it ispossible that provisions of the pending health reform legislation, if enacted,could have a material adverse impact on our business.

 

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Likewise, many states have adopted or are consideringchanges in state health care legislative and regulatory policies as a result ofstate budgetary shortfalls. These changes have included reductions in providerand supplier reimbursement levels under state Medicaid programs, including insome cases reduced reimbursement for DMEPOS items, and/or other Medicaidcoverage restrictions. As states continue to face significant financial pressures,it is possible that state health policy changes will adversely affect ourprofitability.

 

***If we fail to meetMedicare accreditation and surety bond requirements, it could negatively impactour business operations.***

 

Medicare DMEPOS suppliers (other than certain exemptedprofessionals) must be accredited by an approved accreditation organization asmeeting DMEPOS Quality Standards adopted by CMS including specific requirementsfor suppliers of custom-fabricated and custom-fitted orthoses and certain prosthetics.Medicare suppliers also are required to meet surety bond requirements. Webelieve we are in compliance with current requirements in this area. If in thefuture we fail to maintain our Medicare accreditation status and/or do notcomply with Medicare surety bond requirements, or if these requirements areexpanded in the future, it could adversely impact our profits and results ofoperation.

 

***If we fail to comply with the FDAQuality System Regulation, our manufacturing could be delayed, and our productsales and profitability could suffer.***

 

Our manufacturing processes are required to comply with the FDA’sQuality System Regulation, which covers current Good Manufacturing Practicerequirements and 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, we could suffer adisruption of our operations and manufacturing delays. If we fail to takeadequate corrective actions, we could be subject to certain enforcementactions, including, among other things, significant fines, suspension ofapprovals, seizures or recalls of products, operating restrictions and criminalprosecutions. We cannot assure you that the FDA or other governmentalauthorities would agree with our interpretation of applicable regulatoryrequirements or that we have in all instances fully complied with allapplicable requirements. Any failure to comply with applicable requirementscould adversely affect our product sales and profitability.  We have received FDA warnings letters in thepast and we cannot assure you that the FDA will not take further action in thefuture.

 

***We may not be able to successfully integrate businesses that we haverecently acquired, or businesses we may acquire in the future, and we may notbe able to realize the anticipated cost savings, revenue enhancements or othersynergies from such acquisitions.***

 

Ourability to successfully implement our business plan and achieve targetedfinancial results is highly dependent on our ability to successfully integratebusinesses that we have recently acquired and other businesses we acquire inthe future. The process of integrating such acquired businesses involves risks.These risks include, but are not limited to:

 

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

 

·                  diversion of management’s attention fromthe management of daily operations to the integration of newly acquiredoperations;

 

·                  difficulties in the assimilation ofdifferent corporate cultures, practices and sales and distributionmethodologies;

 

·                  difficulties in conforming the acquired company’saccounting 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 who may be vital tothe integration of the acquired business or to the future prospects of thecombined businesses;

 

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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;

 

·                  maintaining uniform standards, such asinternal accounting controls, procedures and policies; and

 

·                  costs and expenses associated with anyundisclosed or potential liabilities.

 

We have announced theclosure of our facility in Chattanooga, Tennessee, and the transfer of itsproduction operations principally to our Mexico facility. The administrativeactivities formerly carried on in the Chattanooga facility will be moved to ouroperations in Vista, California and Indianapolis, Indiana. Failure tosuccessfully transfer these business operations and to otherwise integrate theformer 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.

 

Inaddition, an important part of our strategy is to generate revenue growth bycross selling products through the expanded distribution network achievedfollowing the acquisition of businesses. Our ability to successfully cross sellour products to the extent we anticipate or at all is subject to considerableuncertainty. To the extent we are not successful in our cross selling efforts,our revenues and income will be adversely affected.

 

Furthermore,even if we are able to integrate successfully the operations of DJO Opco withthe operations of ReAble, including the closure of the Chattanooga facility andthe transfer of operations,  we may notbe able to realize the potential cost savings, synergies and revenue enhancementsthat were anticipated from the integration, either in the amount or within thetime frame that we expect, and the costs of achieving these benefits may behigher than, and the timing may differ from, what we expect. Our ability torealize anticipated cost savings, synergies and revenue enhancements may beaffected by a number of factors, including, but not limited to, the following:

 

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

 

·                  increases in other expenses unrelated tothe acquisitions, which may offset the cost savings and other synergies fromthe acquisitions;

 

·                  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,the DJO Merger created significant opportunities to reduce our manufacturingand other costs. We took steps to achieve cost savings by leveraging newlyacquired low-cost manufacturing capabilities, rationalizing our combinedmanufacturing and distribution footprints, increasing procurement savings andeliminating duplicative overhead functions. We also expect to receive costsavings from initiatives we have undertaken in connection with a number of ourpreviously completed acquisitions. However, while we anticipate cost savingsbased on estimates and assumptions made by our management as to the benefitsand associated 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.***

 

Ourquarterly operating results may vary significantly due to a combination offactors, many of which are 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;

 

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·                  our ability to meet the demand for ourproducts;

 

·                  the direct distribution of our productsin foreign countries that have seasonal variations;

 

·                  the number, timing and significance ofnew products and product introductions and enhancements by us and ourcompetitors, including delays in obtaining government review and clearance ofmedical devices;

 

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

 

·                  the impact of any acquisitions that occurin a 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.***

 

Weoperate in highly competitive and fragmented markets. Our DomesticRehabilitation Segment and International Segment compete with both large andsmall companies, including several large, diversified companies withsignificant market share and numerous smaller niche companies, particularly inthe physical therapy products market. Our Surgical Implant Segment competeswith a small number of very large companies that dominate the market, as wellas other companies similar to our size. We may not be able to offer productssimilar to, or more desirable than, those of our competitors or at a pricecomparable to that of our competitors. Compared to us, many of our competitorshave:

 

·                  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 facilitiesthat enable 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 a competitive disadvantage with respect to our competitors. Thesefactors may materially impair our ability to develop and sell our products.

 

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

 

Themarkets for our products are characterized by continued new product developmentand the obsolescence of existing products. Our future success and our abilityto increase revenues and make payments on our indebtedness will depend, inpart, on our ability to develop, license, acquire and distribute new andinnovative products, enhance our existing products with new technology and findnew applications for our existing products. However, we may not be successfulin developing, licensing or introducing new products, enhancing existingproducts or finding new applications for our existing products. We also may notbe successful in manufacturing, marketing and distributing products in acost-effective manner, establishing relationships with marketing partners,obtaining coverage of and satisfactory reimbursement for our future products orproduct enhancements or obtaining required regulatory clearances and approvalsin a timely fashion or at all. If we fail to keep pace with continued newproduct innovation or enhancement or fail to successfully commercialize our newor enhanced products, our competitive position, financial condition and resultsof operations could be materially and adversely affected.

 

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

 

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

 

Akey aspect of the development and sale of our surgical implant products is theuse of designing and consulting arrangements with orthopedic surgeons who arewell recognized in the healthcare community. These surgeons assist in thedevelopment and clinical testing of new surgical implant products. They alsoparticipate in symposia and seminars introducing new surgical implant productsand assist in the training of healthcare professionals in using our newproducts. We may not be successful in maintaining or renewing our currentdesigning and consulting arrangements with these surgeons or in developingsimilar arrangements with new surgeons. In that event, our ability to develop,test and market new surgical implant products could be adversely affected.

 

Inaddition, federal legislation has been proposed and is included in currenthealth reform bills that would increase disclosure requirements regardingfinancial arrangements between manufacturers and physicians, includingphysicians who serve as consultants.  Anumber of states also have enacted specific marketing and payment disclosurerequirements and other may do so in the future. Likewise, voluntary industryguidelines have been adopted regarding device manufacturer financialarrangements with physicians and other health care professionals. We cannotdetermine at this time the impact, if any, of such requirements or voluntaryguidelines on our relationships with surgeons, but there can be no assurancesthat such requirements and guidelines would not impose additional costs on usand/or adversely impact our consulting and other arrangements with surgeons.

 

***Implementation ofCMS’s ‘‘Consignment Closet’’ policy could require changes in our OfficeCarebusiness model that could adversely affect our business.***

 

On August 7, 2009,CMS issued the Transmittal, requiring a change in procedures in stock and billarrangements for Medicare beneficiaries. When implemented, the Transmittal willrequire products dispensed to a Medicare beneficiary from the inventory in ourOfficeCare accounts in physician office settings to be fitted and billed toMedicare by the physician rather than by us. Title to the product must pass tothe physician at the time the product is dispensed to the patient. The effectof this change in most instances would be to convert a billing opportunity byus into a sale to the physician at a wholesale price. The Transmittal wasoriginally scheduled to go into effect on September 8, 2009.  CMS first delayed the effective date until March 1,2010, and on February 4, 2010 CMS rescinded the Transmittal in order toconsider other implementation dates. If the Transmittal goes into effect aswritten, it could adversely affect the revenue and, to a lesser extent,profitability of our OfficeCare business.

 

***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.***

 

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

 

Inaddition, efforts have been made to establish similar requirements at thefederal level for the Medicare program. For example, in 2000, Congress passedthe Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of2000 (“BIPA”). BIPA contained a provision requiring, as a condition for paymentby the Medicare program, that certain certification or licensing requirementsbe met for individuals and suppliers furnishing certain, but not all,custom-fabricated orthotic devices. Although CMS has not implemented thisrequirement to date, Medicare follows state requirements in those states thatrequire the use of an orthotist or prosthetist for furnishing of orthotics orprosthetics. We cannot predict the effect of implementation of BIPA orimplementation of other such laws will have on our business.

 

***If we fail to establish new sales anddistribution relationships or maintain our existing relationships, or if ourthird party distributors and independent sales representatives fail to commitsufficient time and effort or are otherwise ineffective in selling ourproducts, our results of operations and future growth could be adverselyimpacted.***

 

Thesales and distribution of certain of our orthopedic products, regenerationproducts and our surgical implant products depend, in part, on ourrelationships with a network of third party distributors and independentcommissioned sales representatives. These third party distributors andindependent sales representatives maintain the customer relationships with thehospitals, orthopedic surgeons, physical therapists and other healthcareprofessionals that purchase, use and recommend the use of our products.Although our internal sales staff trains and manages these third partydistributors and independent sales representatives, we do not directly monitorthe efforts that they make to sell our products. In addition, some of theindependent 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 partydistributors and sales representatives that market and sell our products, or ifour existing third party distributors and independent sales representativeschoose not to carry our products, our results of operations and future growthcould be adversely affected.

 

***We rely on our own direct sales force forcertain of our products, which may result in higher fixed costs than ourcompetitors and may slow our ability to reduce costs in the face of a suddendecline in demand for our products.***

 

Werely on our own direct sales force of approximately 390 representatives in theUnited States and approximately 110 representatives in Europe to market andsell certain of the orthopedic rehabilitation products which are intended foruse in the home and in rehabilitation clinics. Some of our competitors relypredominantly 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 dependsheavily on acceptance by healthcare professionals who prescribe and recommendour products, and our failure to maintain a high level of confidence by keyhealthcare professionals in our products could adversely affect our business.***

 

Wehave maintained customer relationships with numerous orthopedic surgeons,primary care physicians, other specialist physicians, physical therapists,athletic trainers, chiropractors and other healthcare professionals. We believethat sales of our products depend significantly on their confidence in, andrecommendations of, our products. Acceptance of our products depends oneducating the healthcare community as to the distinctive characteristics,perceived benefits, clinical efficacy and cost-effectiveness of our productscompared to the products offered by our competitors and on training healthcareprofessionals in the proper use and application of our products. Failure tomaintain these customer relationships and develop similar relationships withother leading healthcare professionals could result in a less frequentrecommendation of our products, which may adversely affect our sales and profitability.

 

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***Our international operations expose us torisks related to conducting business in multiple jurisdictions outside theUnited States.***

 

Theinternational scope of our operations exposes us to economic, regulatory andother risks in the countries in which we operate. We generated 25.5% of our netrevenues from customers outside the United States for the year ended December 31,2009. Doing business in foreign countries exposes us to a number of risks,including the following:

 

·                  fluctuations in currency exchange rates;

 

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

 

·                  potential adverse tax consequences,including the imposition or increase of withholding and other taxes onremittances and other payments by foreign subsidiaries, which, among otherthings, may preclude payments or dividends from foreign subsidiaries from beingused for our debt service, and exposure to adverse tax regimes;

 

·                  difficulty in collecting accountsreceivable and longer collection periods;

 

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

 

·                  intellectual property protectiondifficulties;

 

·                  changes in political and economicconditions;

 

·                  difficulties in attracting high-qualitymanagement, sales and marketing personnel to staff our foreign operations;

 

·                  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, regulatoryand political standards; and

 

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

 

Inaddition, as we grow our operations internationally, we will becomeincreasingly dependent on foreign distributors and sales agents for ourcompliance and adherence to foreign laws and regulations that we may not befamiliar with, and we cannot assure you that these distributors and salesagents will adhere to such laws and regulations or adhere to our own businesspractices and policies. Any violation of laws and regulations by foreigndistributors or sales agents or a failure of foreign distributors or salesagents to comply with our business practices and policies could result in legalor regulatory sanctions against us or potentially damage our reputation in thatrespective international market. If we fail to manage these risks effectively,we may not be able to grow our international operations, and our business andresults of operations may be materially adversely affected.

 

***Fluctuations in foreign exchange rates mayadversely affect our financial condition and results of operations and mayaffect the comparability of our results between financial periods.***

 

Ourforeign operations expose us to currency fluctuations and exchange rate risks.We are exposed to the risk of currency fluctuations between the U.S. Dollar andthe Euro, Pound Sterling, Canadian Dollar, Mexican Peso, Swiss Franc,Australian Dollar, Yen, Norwegian Krone, Danish Krone and Swedish Krona. Salesdenominated in foreign currencies accounted for approximately 22.8% of ourconsolidated net sales for the year ended December 31, 2009, of which17.9% were denominated in the Euro. Our exposure to fluctuations in foreigncurrencies arises because certain of our subsidiaries’ results are recorded inthese currencies and then translated into U.S. Dollars for inclusion in ourconsolidated financial statements and certain of our subsidiaries enter intopurchase or sale transactions using a currency other than our functionalcurrency. In addition, certain costs associated with our Mexico-basedmanufacturing operations are incurred in Mexican Pesos.  As of December 31, 2009, we hadoutstanding hedges in the form of forward contracts to purchase Mexican Pesosaggregating a U.S. dollar equivalent of $14.3 million.  As we continue to distribute and manufactureour products in selected foreign countries, we expect that future sales andcosts associated with our activities in these markets will continue to bedenominated in the applicable foreign currencies, which could cause currencyfluctuations to materially impact our operating results.  Changes in currency exchange rates mayadversely affect our financial condition and results of operations and mayaffect the comparability of our results between reporting periods.

 

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Wemay not be able to effectively manage our currency translation risks, andvolatility in currency exchange rates may adversely affect our financialcondition and results of operations.

 

***If adequate levels of reimbursementcoverage from third party payors for our products are not obtained, healthcareproviders and patients may be reluctant to use our products, and our sales maydecline.***

 

Our sales depend largely onwhether there is adequate reimbursement coverage by government healthcareprograms, such as Medicare and Medicaid, and by private payors. We believe thatsurgeons, hospitals, physical therapists and other healthcare providers may notuse, purchase or prescribe our products and patients may not purchase ourproducts if these third party payors do not provide satisfactory coverage ofand reimbursement for the costs of our products or the procedures involving theuse of our products. Consequently, we may be unable to sell our products on aprofitable basis if third party payors deny coverage, reduce their currentlevels of reimbursement or fail to cause their levels of reimbursement to risequickly enough to cover cost increases.

 

Changesin the coverage of, and reimbursement for, our products by these third partypayors could have a material adverse effect on our results of operations. Thirdparty payors continue to review their coverage policies carefully for existingand new therapies and can, without notice, decide not to reimburse fortreatments that include the use of our products. They may attempt to controlcosts by (i) authorizing fewer elective surgical procedures, includingjoint reconstructive surgeries, (ii) requiring the use of the leastexpensive product available or (iii) reducing the reimbursement for orlimiting the number of authorized visits for rehabilitation procedures. Forexample, in the United States, Congress and CMS, frequently engage in effortsto contain costs, which may result in a reduction of coverage of, andreimbursement for, our products. Because many private payors model theircoverage and reimbursement policies on Medicare policies, third party payors’coverage of, and reimbursement for, our products could be negatively impactedby discussions like this one and by legislative, regulatory or other measuresthat reduce Medicare coverage and reimbursement generally.

 

Ourinternational sales also depend in part upon the coverage and eligibility forreimbursement of our products through government-sponsored healthcare paymentsystems and third party payors, the amount of reimbursement and the costallocation of payments between the patient and government-sponsored healthcarepayment systems and third party payors. Coverage and reimbursement practicesvary significantly by country, with certain countries requiring products toundergo a lengthy regulatory review in order to be eligible for third partycoverage and reimbursement. In addition, healthcare cost containment effortssimilar to those we face in the United States are prevalent in many of theforeign countries in which our products are sold, and these efforts areexpected to continue in the future, possibly resulting in the adoption of morestringent reimbursement standards. For example, in Germany, our largest foreigncountry market, new regulations generally require adult patients to pay aportion of the cost of each medical technical device purchased. This mayadversely affect our sales and profitability by making it more difficult forpatients in Germany to pay for our products.

 

Anydevelopments in the United States or our foreign markets that eliminate, reduceor materially modify coverage of, and reimbursement rates for, our productscould have a material effect on our ability to sell our products.

 

***Our success depends on receiving regulatoryapproval for our products, and failure to do so could adversely affect ourgrowth and operating results.***

 

Our products are subject toextensive regulation in the United States by the FDA and by similargovernmental authorities in the foreign countries where we do business. The FDAregulates virtually all aspects of a medical device’s development, testing,manufacturing, labeling, promotion, distribution and marketing. In general,unless an exemption applies, a medical device must receive either pre-marketapproval or pre-market clearance from the FDA before it can be marketed in theUnited States. While in the past we have received such approvals andclearances, we may not be successful in the future in receiving such approvalsand clearances in a timely manner or at all. The FDA recently asked the Institute of Medicine (‘‘IOM’’)to conduct a two-year study of the clearance process for devices under § 501(k) ofthe Food Drug, and Cosmetic Act, as amended, and to provide recommendations forchanges, if necessary. In addition, the FDA has implemented an internal reviewprocess of the clearance process, which could lead to changes in the review ofmedical device products seeking clearance for marketing before the IOMcompletes its study in 2012. Many of our products are cleared for marketingunder the 501(k) process that the FDA and the IOM are reviewing. If we begin tohave significant difficulty obtaining such FDA approvals or clearances in a timelymanner or at all, it could have a material adverse effect on our revenues andgrowth.

 

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***If we fail to obtain regulatory approvalfor the modification of, or new uses for, our products, our growth andoperating results could suffer.***

 

Inorder to market modifications to our existing products or market our existingproducts for new indications, we may be required to obtain pre-marketapprovals, pre-market supplement approvals or pre-market clearances. The FDArequires device manufacturers themselves to make and document a determinationof whether or not a modification requires a new approval or clearance; however,the FDA can review and disagree with a manufacturer’s decision. We may not besuccessful in receiving such approvals or clearances or the FDA may not agreewith our decisions not to seek approvals or clearances for any particulardevice modification. The FDA may require an approval or clearance for any pastor future modification or a new indication for our existing products. The FDAmay also require additional clinical or preclinical data in such submissions,which may be time consuming and costly, and may not ultimately approve or clearone or more of our products for marketing. If the FDA requires us to obtainpre-market approvals, pre-market supplement approvals or pre-market clearancesfor any modification to a previously cleared or approved device, we may berequired to cease manufacturing and marketing the modified device or to recallsuch modified device until we obtain FDA clearance or approval, and we may besubject to significant regulatory fines or penalties. In addition, the FDA maynot clear or approve such submissions in a timely manner, if at all. Because asignificant portion of our revenues is generated by products that are modifiedor used for new treatments, delays or failures in obtaining such approvalscould reduce our revenue and adversely affect our operating results.

 

***We may fail to receive positive clinicalresults for our products in development that require clinical trials, and evenif we receive positive clinical results, we may still fail to receive thenecessary clearance or approvals to market our products.***

 

Inthe development of new products or new indications for, or modifications to,existing products, we may conduct or sponsor clinical trials. Clinical trialsare expensive and require significant investment of time and resources and maynot generate the data we need to support a submission to the FDA. Clinicaltrials are subject to regulation by the FDA and, if federal funds are involvedor if an investigator or site has signed a federal assurance, are subject tofurther regulation by the Office for Human Research Protections and theNational Institutes of Health. Failure to comply with such regulation,including, but not limited to, failure to obtain adequate consent of subjects,failure to adequately disclose financial conflicts or failure to report data oradverse events accurately, could result in fines, penalties, suspension oftrials, and the inability to use the data to support an FDA submission.  In addition, the American Recovery andReinvestment Act expands federal efforts to compare the effectiveness ofdifferent medical treatments, which could include some element of explicit costor cost-effectiveness comparisons; research supported by these effortseventually could be used to guide public and private coverage and reimbursementpolicies. In the international market, we are subject to regulations forclinical studies in each respective country.

 

***If we fail to comply with the variousregulatory regimes for the foreign markets in which we operate, our operationalresults could be adversely affected.***

 

Inmany of the foreign countries in which we market our products, we are subjectto extensive regulations, including those in Europe. The regulation of ourproducts in the European Economic Area (which consists of the twenty-sevenmember states of the European Union, as well as Iceland, Liechtenstein andNorway) is governed by various directives and regulations promulgated by theEuropean Commission and national governments. Only medical devices that complywith certain conformity requirements are allowed to be marketed within theEuropean Economic Area. In addition, the national health or social securityorganizations of certain foreign countries, including certain countries outsideEurope, require our products to be qualified before they can be marketed inthose countries. Failure to receive or delays in the receipt of, relevantforeign qualifications in the European Economic Area or other foreign countriescould have a material adverse effect on our business.

 

TheFDA regulates the export of medical devices to foreign countries and certainforeign countries may require FDA certification that our products are incompliance with U.S. law.  If we fail toobtain or maintain export certificates required for the export of our products,we could suffer a material adverse effect on our revenues and growth.

 

We are subject to lawsconcerning our marketing activities in foreign countries where we conductbusiness. For example, within the EU, the control of unlawful marketing activitiesis a matter of national law in each of the member states of the EU. The memberstates of the EU closely monitor perceived unlawful marketing activity bycompanies. We could face civil, criminal and administrativesanctions if any member state determinesthat we have breached our obligations under its national laws. Industryassociations also closely monitor the activities of member companies. If theseorganizations or authorities name us as having breached our obligations undertheir regulations, rules or standards, our reputation would suffer and ourbusiness and financial condition could be adverselyaffected. We are also subject to the U.S. ForeignCorrupt Practices Act (the ‘‘FCPA’’), antitrust and anticompetition laws, andsimilar laws in foreign countries, any violation of which could create asubstantial liability for us and also cause a loss of reputation in the market.The FCPA prohibits U.S. companies and their officers, directors, employees,shareholders acting on their behalf and agents from offering, promising,authorizing or making payments to foreign officials for the purpose ofobtaining or

 

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retaining business abroador otherwise obtaining favorable treatment. Companies must also maintain records that fairly and accurately reflecttransactions and maintain internal accounting controls. In many countries, hospitalsand clinics are government-owned and healthcare professionals employed by suchhospitals and clinics, with whom we regularly interact, may meet the definitionof a foreign official for purposesof the FCPA. If we are found to have violated theFCPA, we may face sanctions including fines, criminal penalties, disgorgementof profits and suspension or debarment of our ability to contract withgovernment agencies or receive export licenses. From time to time, we may faceaudits or investigations by one or more domestic or foreign government agencies,compliance with which could be costly and time-consuming, and could divert ourmanagement and key personnel from our business operations. An adverse outcomeunder any such investigation or audit could subject us to fines or otherpenalties, which could adversely affect our business and financial results.

 

***If the HHS, Office of Inspector General (“OIG”),the FDA or another regulatory agency determines that we have promoted off-labeluse of our products, we may be subject to various penalties, including civil orcriminal penalties, and the off-label use of our products may result ininjuries that lead to product liability suits, which could be costly to ourbusiness.***

 

TheOIG, the FDA and other regulatory agencies actively enforce regulationsprohibiting the promotion of a medical device for a use that has not beencleared or approved by the FDA. Use of a device outside its cleared or approvedindications is known as “off-label” use. Physicians may use our products foroff-label uses, as the FDA does not restrict or regulate a physician’s choiceof treatment within the practice of medicine. However, if the OIG or the FDA oranother regulatory agency determines that our promotional materials; trainingor activities constitutes improper promotion of an off-label use, it couldrequest that we modify our promotional materials; training, or activities, orsubject us to regulatory enforcement actions, including the issuance of awarning letter, injunction, seizure, civil fine and criminal penalties.Although our policy is to refrain from statements and activities that could beconsidered off-label promotion of our products, the FDA, another regulatoryagency, or the U.S. Department of Justice could disagree and conclude that wehave engaged in off-label promotion and, potentially, aided and abetted in thesubmission of false claims. 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.

 

***Our compensation, marketing and salespractices may contain certain risks with respect to the manner in which thesepractices were historically conducted that could have a material adverse effecton us.***

 

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

 

***Audits or denials of our claims bygovernment agencies could reduce our revenues or profits.***

 

Aspart of our business operations, we submit claims on behalf of patientsdirectly to, and receive payments directly from, the Medicare and Medicaidprograms and private payors. Therefore, we are subject to extensive governmentregulation, including requirements for submitting reimbursement claims underappropriate codes and maintaining certain documentation to support our claims.Medicare contractors and Medicaid agencies periodically conduct pre- andpost-payment reviews and other audits of claims and are under increasingpressure to more closely scrutinize healthcare claims and supporting documentation.We have historically been subject to pre-payment and post-payment reviews aswell as audits of claims and may experience such reviews and audits of claimsin the future. Such reviews and/or similar audits of our claims could result inmaterial delays in payment, as well as material recoupments or denials, whichwould reduce our net sales and profitability, or in exclusion fromparticipation in the Medicare or Medicaid programs. Private payors may fromtime to time conduct similar reviews and audits.

 

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

 

***Various federal and state agencies havebecome increasingly vigilant in recent years in their investigation of variousbusiness practices under various healthcare “fraud and abuse” laws with respectto our business arrangements with prescribing physicians and other health careprofessionals.***

 

Weare directly or indirectly through our customers, subject to various federaland state laws pertaining to healthcare fraud and abuse. These laws, whichdirectly or indirectly affect our ability to operate our business include, butare not limited to, the following:

 

·                  the federal Anti-Kickback Statute, whichprohibits persons from knowingly and willfully soliciting, offering, receivingor providing remuneration, directly or indirectly, in cash or in kind, toinduce either the referral of an individual, or the furnishing or arranging foror recommending of a good or service, for which payment may be made under federalhealthcare programs, such as Medicare and Medicaid, Veterans Administrationhealth programs, and TRICARE;

 

·                  several federal False Claims statutes,which impose civil and criminal liability on individuals and entities whosubmit, or cause to be submitted, false or fraudulent claims for payment to thegovernment;

 

·                  HIPAA, which prohibits executing a schemeto defraud 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.

 

Thefederal government has significantly increased investigations of andenforcement activity involving medical device manufacturers with regard toalleged kickbacks and other forms of remuneration to physicians who use andprescribe their products. Such investigations often arise based on allegationsof violations of the federal Anti-Kickback Statute and sometimes allegeviolations of the civil False Claims Act, in connection with off-labelmarketing of products to physicians and others.

 

We, like other companiesin the orthopedic industry, are involved in ongoing governmentalinvestigations, the results of which may adversely impact our business andresults of operations. Defendants determined to be liable under the FalseClaims Act may be required to pay three times the actualdamages sustained by the government, plusmandatory civil penalties ranging between $5,500 and $11,000 for each falseclaim.

 

Thefraud and abuse laws and regulations are complex and even minor, inadvertentirregularities in submissions can potentially give rise to investigations andclaims that the law has been violated. Any violations of these laws orregulations could result in a material adverse effect on our business,financial condition and results of operations. If there is a change in law,regulation or administrative or judicial interpretations, we may have to changeone or more of our business practices to be in compliance with these laws.Required changes could be costly and time consuming. Any failure to makerequired changes could result in our losing business or our existing businesspractices being challenged as unlawful.

 

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***Our activities aresubject to Federal Privacy and Transaction Law and Regulations, which couldhave an impact on our operations.***

 

HIPAA impacts thetransmission, maintenance, use and disclosure of certain individuallyidentifiable health information (referred to as ‘‘protected health information’’or ‘‘PHI’’). Since HIPAA was enacted in 1996, numerous implementing regulationshave been issued, including, but not limited to: (1) standards for theprivacy of individually identifiable health information (the ‘‘Privacy Rule’’),(2) security standards (the ‘‘SecurityRule’’), (3) standards for electronic transactions (the ‘‘TransactionsRule’’), and (4) standard unique national provider identifier (‘‘NPI Rule’’).We refer to these rules as the Administrative Simplification Rules. CMShas also issued regulations governing the enforcement of the AdministrativeSimplification Rules. Sanctions for violation of HIPAA and /or theAdministrative Simplification Rules include criminal and civil penalties.

 

HIPAA applies to ‘‘coveredentities,’’ which includes certain health care providers who conduct certaintransactions electronically. As such, HIPAA and the AdministrativeSimplification Rules apply to certain aspects of our business. Theeffective date for all of the Administrative Simplification Rules outlinedabove has passed, and, as such, all of the Administrative Simplification Rules arein effect. To the extent applicable to our operations, we believe we arecurrently in compliance with HIPAA and the applicable AdministrativeSimplification Rules.  Any failure tocomply with applicable requirements could adversely affect our profitability.

 

On February 17,2009, President Obama signed into law the HITECH Act as part of the AmericanRecovery and Reinvestment Act. This economic stimulus package includes manyhealth care policy provisions, including strengthened federal privacy andsecurity provisions to protect personally-identifiable health information, suchas notification requirements for health data security breaches. Many of thedetails of the new requirements are being implemented through regulations,including an interim final rule on the HITECH health information securityenforcement provisions published October 30, 2009. We are reviewing thesenew requirements to assess the potential impact on our operations. Any failureto comply with applicable requirements could adversely affect ourprofitability.

 

***Managed care and buying groups have put downwardpressure on the prices of our products.***

 

Thegrowth of managed care and the advent of buying groups in the United Stateshave caused a shift toward coverage and payments based on more cost-effectivetreatment alternatives. Buying groups enter into preferred supplierarrangements with one or more manufacturers of medical products in return forprice discounts to members of these buying groups. Our failure to obtain newpreferred supplier commitments from major group purchasing organizations or ourfailure to retain our existing preferred supplier commitments could adverselyaffect our sales and profitability. In international markets where we sell ourproducts, we have historically experienced downward pressure on product pricingand other effects of healthcare cost control efforts that are similar to thatwhich we have experienced in the United States. We expect a continued emphasison healthcare cost controls and managed care in the United States and in theseinternational markets, which could put further downward pressure on productpricing, which, in turn may adversely affect our sales and profitability.

 

***Our marketed, approved, or cleared productsare subject to the recall authority of U.S. and foreign regulatory bodies.Product recalls could harm our reputation and business.***

 

Weare subject to ongoing medical device reporting regulations that require us toreport to the FDA and similar governmental authorities in other countries if wereceive a report or otherwise learn that any of our products may have caused,or contributed to death or serious injury, or that any of our products hasmalfunctioned in a way that would be likely to cause, or contribute to, deathor serious injury if the malfunction were to recur. The FDA and similargovernmental authorities in other countries have the authority to require us torecall our products in the event of actual or potential material deficienciesor defects 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 or defect in design, manufacturing, or labeling, we mayvoluntarily elect to recall our products. A government mandated recall or avoluntary recall initiated by us could occur as a result of actual or potentialcomponent failures, manufacturing errors, or design defects, including defectsin labeling. Any recall would divert managerial and financial resources andcould harm our reputation with our customers and with the healthcareprofessionals that use, prescribe and recommend our products. We could haveproduct recalls that result in significant costs to us in the future, and suchrecalls could have a material adverse effect on our business.

 

***Product liability claims may harm ourbusiness, particularly if the number of claims increases significantly or ourproduct liability insurance proves inadequate.***

 

Themanufacture and sale of orthopedic devices and related products exposes us to asignificant risk of product liability claims. From time to time, we have been,and we are currently, subject to a number of product liability claims allegingthat the use of our products resulted in adverse effects. Even if we aresuccessful in defending against any liability claims, such claims couldnevertheless distract our management, result in substantial costs, harm ourreputation, adversely affect the sales of all our products and otherwise harmour business. If there is a significant increase in the number of productliability claims, our business could be adversely affected.

 

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We maintain product liability insurance that issubject to annual renewal. Our current policy covers claims made between July 1,2009 and June 30, 2010 and provides for coverage (together with excesspolicies) of up to a limit of $80 million, provided that the top layer of $25million excess over $55 million covers only claims reported after February 25,2010 and the next layer down of $10 million excess over $45 million covers onlyclaims reported after February 18, 2010. This coverage is subject to aself-insured retention of $500,000 for pain pumps and the IceMan cold therapyproduct, a self-insured retention of $250,000 on all other invasive productsand a self-insured retention of $50,000 on all of the non-invasive products,with an aggregate self-insured retention of $1.0 million for all productliability claims.  In addition, the toplayer of $25 million excess over $55 million has a separate self-insuredretention of $50,000 per claim.  If aproduct liability claim or series of claims is brought against us for uninsuredliabilities or in excess of our insurance coverage, our business could suffermaterially. In addition, in certain instances, a product liability claim couldalso result in our having to recall some of our products, which could result insignificant costs to us. As of December 31, 2009, we have accruedapproximately $2.0 million for expenses related to product liability claimsbased upon previous claim experience in part due to the fact that in 2003 weexceeded the coverage limits in effect at that time for certain historicalproduct liability claims involving one of our discontinued surgical implantproducts and such products are excluded from coverage under our currentpolicies.

 

***As a result of the DJO Merger, ourconcentration of manufacturing operations in Mexico increases our business andcompetitive risks.***

 

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

 

***If we lose one of our key suppliers or oneof our contract manufacturers stops making the raw materials and componentsused in our products, we may be unable to meet customer orders for our productsin a timely manner or within our budget.***

 

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

 

Inaddition, we rely on third parties to manufacture some of our products. Forexample, Medireha, which is 50% owned by us, has been a supplier for asignificant portion of our CPM devices. CPM devices represented approximately 3% of our net sales for the year ended December 31,2009. 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 replacements 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.

 

Someof our important suppliers are in China and other parts of Asia and providepredominately finished soft goods products. In fiscal year 2009, we obtainedapproximately 20.2% of our totalpurchased materials from suppliers in China and other parts of Asia. Politicaland economic instability and changes in government regulations in these areascould affect our ability to continue to receive materials from suppliers there.The loss of suppliers in China and other parts of Asia, any other interruptionor delay in the supply of required materials or our inability to obtain thesematerials at acceptable prices and within a reasonable amount of time couldimpair our ability to meet scheduled product deliveries to our customers andcould hurt our reputation and cause customers to cancel orders.

 

Inaddition, we purchase the microprocessor used in the OL1000 and SpinaLogicdevices from a single manufacturer. Although there are feasible alternatemicroprocessors that might be used immediately, all are produced by a singlesupplier. In addition, there are single suppliers for other components used inthe OL1000 and SpinaLogic devices and only two suppliers for the magnetic fieldsensor employed in them. Establishment of additional or replacement suppliersfor these components cannot be accomplished quickly.

 

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***If our patents and other intellectualproperty rights do not adequately protect our products, we may lose marketshare to our competitors and may not be able to operate our businessprofitably.***

 

We rely on a combination ofpatents, trade secrets, copyrights, trademarks, license agreements andcontractual provisions to establish and protect our intellectual propertyrights in our products and the processes for the development, manufacture andmarketing of our products.

 

Weuse non-patented, proprietary know-how, trade secrets, processes and otherproprietary information and currently employ various methods to protect thisproprietary information, including confidentiality agreements, inventionassignment agreements and proprietary information agreements with vendors,employees, independent sales agents, distributors, consultants, and others.However, these agreements may be breached. The FDA or another governmentalagency may require the disclosure of such information in order for us to havethe right to market a product. The FDA may also disclose such information onits own initiative if it should decide that such information is notconfidential business or trade secret information. Trade secrets, know-how andother unpatented proprietary technology may also otherwise become known to orindependently developed by our competitors.

 

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

 

Anyproceedings before the U.S. Patent and Trademark Office could result in adversedecisions as to the priority of our inventions and the narrowing orinvalidation of claims in issued or pending patents. We could also incursubstantial costs in any such proceedings. In addition, the laws of some of thecountries in which our products are or may be sold may not protect our productsand intellectual property to the same extent as U.S. laws, if at all. We mayalso be unable to protect our rights in trade secrets, trademarks andunpatented proprietary technology in these countries.

 

Inaddition, we hold patent, trademark and other intellectual property licensesfrom third parties for some of our products and on technologies that arenecessary in the design and manufacture of some of our products. The loss of suchlicenses could prevent us from manufacturing, marketing and selling theseproducts, which in turn could harm our business.

 

***Our operating results and financialcondition could be adversely affected if we become involved in litigationregarding our patents or other intellectual property rights.***

 

Litigationinvolving patents and other intellectual property rights is common in ourindustry, and companies in our industry have used intellectual propertylitigation in an attempt to gain a competitive advantage. We may become a partyto lawsuits involving patents or other intellectual property. Such litigationis costly and time consuming. If we lose any of these proceedings, a court or asimilar foreign governing body could invalidate or render unenforceable ourowned or licensed patents, require us to pay significant damages, seek licensesand/or pay ongoing royalties to third parties (which may not be available underterms acceptable to us, or at all), require us to redesign our products, orprevent us from manufacturing, using or selling our products, any of whichwould have an adverse effect on our results of operations and financialcondition.

 

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

 

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***Our business strategy relies on certainassumptions concerning demographic and other trends that impact the market forour products. If these assumptions prove to be incorrect, demand for ourproducts may be lower than we currently expect.***

 

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

 

***We may expand into new markets through thedevelopment of new products and our expansion may not be successful.***

 

Wemay attempt to expand into new markets through the development of new productapplications based on our existing specialized technology and designcapabilities. These efforts could require us to make substantial investments,including significant research, development, engineering and capitalexpenditures for new, expanded or improved manufacturing facilities which woulddivert resources from other aspects of our business. Expansion into new marketsmay be costly and may not result in any benefit to us. Specific risks inconnection with expanding into new markets include the inability to transferour quality standards into new products, the failure of customers in newmarkets to accept our products and price competition in new markets. Suchexpansion efforts into new markets could be unsuccessful.

 

***Consolidation in the healthcare industrycould have an adverse effect on our revenues and results of operations.***

 

Manyhealthcare industry companies, including medical device, orthopedic andphysical therapy products companies, are consolidating to create largercompanies. As the healthcare industry consolidates, competition to provideproducts and services to industry participants may become more intense. Inaddition, many of our customers are also consolidating, and our customers andother industry participants may try to use their purchasing power to negotiateprice concessions or reductions for the products that we manufacture andmarket. If we are forced to reduce our prices because of consolidation in thehealthcare industry, our revenues could decrease, and our business, financialcondition and results of operations could be adversely affected.

 

***We could incur significant costs complyingwith environmental and health and safety requirements, or as a result ofliability for contamination or other harm caused by hazardous materials that weuse.***

 

Ourresearch and development and manufacturing processes involve the use ofhazardous materials. We are subject to federal, state, local and foreignenvironmental requirements, including regulations governing the use,manufacture, handling, storage and disposal of hazardous materials, dischargeto air and water, the clean up of contamination and occupational health andsafety matters. We cannot eliminate the risk of contamination or injuryresulting from hazardous materials, and we may incur liability as a result ofany contamination or injury. Under some environmental laws and regulations, wecould also be held responsible for costs relating to any contamination at ourpast or present facilities and at third party waste disposal sites where wehave sent wastes. These could include costs relating to contamination that didnot result from any violation of law, and in some circumstances, contaminationthat we did not cause.  We may incursignificant expenses in the future relating to any failure to comply withenvironmental laws. Any such future expenses or liability could have asignificant negative impact on our financial condition. The enactment ofstricter laws or regulations, the stricter interpretation of existing laws andregulations or the requirement to undertake the investigation or remediation ofcurrently unknown environmental contamination at our own or third party sitesmay require us to make additional expenditures, which could be material.

 

***Our reported results may be adverselyaffected by increases in reserves for contractual allowances, rebates, productreturns, rental credits, uncollectible accounts receivable and inventory.***

 

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

 

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Wehave established reserves to account for contractual allowances, rebates,product returns and reserves for rental credits.  Significant management judgment must be usedand estimates must be made in connection with establishing the reserves forcontractual allowances, rebates, product returns, rental credits and otherallowances in any accounting period.

 

Wemaintain provisions for estimated contractual allowances for reimbursementamounts from our third party payor customers based on negotiated contracts andhistorical experience for non-contracted payors.  We provide for these reserves by reducing ourgross revenue.  We estimate the amount ofthe reduction based on historical experience and invoices generated in theperiod, and we consider the impact of new contract terms or modifications ofexisting arrangements with our customers. We have contracts with certain third party payors for our third partyreimbursement billings, which call for specified reductions in reimbursement ofbilled amounts based upon contractual reimbursement rates.

 

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

 

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

 

Thereserve for product returns accounts for estimated customer returns of ourproducts after purchase. These returns are mainly attributable to a third partypayor’s refusal to provide a patient release or reimbursement for the productor the inability of the product to adequately address the patient’s condition.If we increase the percentage of our sales made pursuant to agreementsproviding for reimbursement below invoice price or if customers return productsat a higher than estimated rate, we may be required to increase our salesallowance and product return reserves beyond their current levels.

 

Ourreserve for rental credits recognizes a timing difference between billing of apurchase and processing of a rental credit associated with some of ourelectrotherapy and traction devices. Many insurance providers require patientsto rent our rehabilitation devices for a period of one to three months prior topurchase. If the patient has a long-term need for the device, these insurancecompanies may authorize purchase of the device after such time period. When thedevice is purchased, most providers require that rental payments previouslymade on the device be credited toward the purchase price. These credits areprocessed at the time the payment is received for the purchase of the device,which creates a time lag between billing of the purchase and processing of therental credit. Our rental credit reserve accounts for unprocessed rentalcredits based on the number of devices converted to purchase. If the frequencyof rental to purchase conversion increases, we may be required to increase ourrental credit reserve beyond its current level.

 

Thenature of our business requires us to maintain sufficient inventory on hand atall times to meet the requirements of our customers.  We provide reserves for estimated excess orobsolete inventories equal to the difference between the cost of inventories onhand plus future purchase commitments and the estimated market value based uponassumptions about future demand.  Iffuture demand is less favorable than currently 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.

 

Allof our segments consign a portion of their inventory to allow their products tobe immediately dispensed to patients. This requires a large amount of inventory to be on hand for the productswe sell on consignment.  It alsoincreases the sensitivity of these products to obsolescence reserve estimates.As this inventory is not in our possession, we maintain additional reserves forthese products based on the results of periodic inventory counts and historicaltrends.

 

***Certain administrative functions relatingto the OfficeCare sales channel have been outsourced to a third partycontractor and this arrangement may not prove successful.***

 

TheOfficeCare sales channel maintains a range of products (mostly soft goods) onhand at over 1,350 healthcare facilities, primarily orthopedic practices, forimmediate distribution to patients. In the OfficeCare sales channel, patientsor their third party payors are billed after the product is provided to thepatient. The revenue cycle of this program is outsourced, from billing tocollections, to an independent third party contractor. The outsource contractorthat we have used has undergone significant changes in its business operationsin the last two years, including relocating some administrative functionsoverseas, in order to improve performance from order entry to collections. Thecontractor may also upgrade the software system used in these revenue cycleprocesses. The inability of this provider to successfully upgrade its processesor demonstrate acceptable billing and collection results could have an adverseeffect on our operations and financial results in the OfficeCare sales channel.

 

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***If a natural or man-made disaster strikesour manufacturing facilities, we will be unable to manufacture our products fora substantial amount of time and our sales will decline.***

 

Asignificant portion of our rehabilitation products are manufactured in afacility in Tijuana, Mexico, with a number of products for the European marketmanufactured in a Tunisian facility. In Vista, California we manufacture ourcustom rigid bracing products, which remain in the United States to facilitatequick turnaround on custom orders, vascular products, and our regenerationproduct line. Our clinical electrotherapy devices, patient care products,physical therapy and chiropractic treatment tables and certain CPM devices aremanufactured in our facilities located in Chattanooga, Tennessee, and theproduction of these products with the exception of physical therapy treatmenttables, is being moved to our facility in Tijuana, Mexico, in connection withour closure of the Chattanooga facility, which is expected to be completed inthe first half of 2010. Our home electrotherapy devices sold in the UnitedStates as well as some components and related accessories are manufactured atour facility in Clear Lake, South Dakota. In our Surgical Implant Segment, wemanufacture our products in our manufacturing facility at Austin, Texas. Thesefacilities and the manufacturing equipment we use to produce our products wouldbe difficult to repair or replace. Our facilities may be affected by natural orman-made disasters. If one of our facilities were affected by a disaster, wewould be forced to rely on third party manufacturers or shift production toanother manufacturing facility. In such an event, we would face significantdelays in manufacturing which would prevent us from being able to sell ourproducts. In addition, our insurance may not be sufficient to cover all of thepotential losses and may not continue to be available to us on acceptable terms,or at all.

 

***We may pursue, but may not be able toidentify, finance or successfully complete, other strategic acquisitions.***

 

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

 

Inaddition, we may require additional debt or equity financing for futureacquisitions, and such financing may not be available on favorable terms, ifavailable at all. We may not be able to successfully integrate or operateprofitably any new business we acquire, and we cannot assure you that any suchacquisition will meet our expectations. Finally, in the event we decide todiscontinue pursuit of a potential acquisition, we will be required toimmediately expense all costs incurred in pursuit of the possible acquisitionthat could have an adverse effect on our results of operations in the period inwhich the expense is recognized. If we complete acquisitions, or obtain financingfor them, on unfavorable terms, or if we fail to properly integrate an acquiredbusiness, our financial condition and results of operations would be adverselyaffected.

 

***If we do not effectively manage our growth,our existing infrastructure may become strained, and we may be unable toincrease sales of our products or generate revenue growth.***

 

Thegrowth that we have experienced, and in the future may experience, includingdue to acquisitions, may provide challenges to our organization, requiring usto expand our personnel, manufacturing and distribution operations. Futuregrowth may strain our infrastructure, operations, product development and othermanagerial and operating resources. If our business resources become strained,we may be unable to increase sales of our products or generate revenue growth.

 

***The loss of the services of our keymanagement and personnel could adversely affect our ability to operate ourbusiness.***

 

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

 

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***Affiliates of Blackstone own substantially all of the equity interestin us and may have conflicts of interest with us or investors in the future.***

 

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

 

Additionally, Blackstone is in the business ofmaking investments in companies and may from time to time acquire and holdinterests in businesses that compete directly or indirectly with us. Blackstonemay also pursue acquisition opportunities that may be complementary to ourbusiness and, as a result, those acquisition opportunities may not be availableto us.

 

***If we do not achieve and maintaineffective internal controls over financial reporting, we could fail toaccurately report our financial results.***

 

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

 

We have completed a significant number ofacquisitions in the past several years, and may continue to pursue growththrough strategic acquisitions. Among the risks associated with acquisitionsare the risks of control deficiencies that result from the integration of theacquired business. In connection with the integration of our recentacquisitions and our continuous assessment of internal controls, including withrespect to acquired foreign operations, we have identified certain internalcontrol deficiencies that we have remedied or for which we have undertakensteps to remediate.

 

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

 

***We may not be successful in the design andimplementation of a Company-wide ERP system.***

 

In 2008 we launched a major software design andinstallation project to replace six legacy accounting and finance systems andnumerous other software systems with a single-entry ERP system that will beused by all locations and functions of the Company. This project is scheduledto be completed in three years and will require the dedication of significantfinancial and human resources. While we have designed the system and completedour first installation in our Surgical operation in Austin, Texas, our abilityto complete this project in all of our operations successfully is subject to avariety of risks and uncertainties, among which are the following:

 

·      we may have underestimated the time it will take tocomplete the design and installation and the project could extend on past theexpected completion date;

 

·      we may have underestimated the aggregate cost of thedesign and installation of the ERP system, whether due to the need foradditional scope to the project, a requirement for additional consultingassistance, the extension of the completion date, or other similar issues;

 

·      we may have underestimated the extent and difficultyin adapting the Company’s business processes to function within and useeffectively the new ERP system; and

 

·      we may discover that the functionality of the newERP system is not adequate to process and manage the extensive and variedfunctions, operations and processes within the Company that we use to conductour current and future business;

 

If the ERP project were to become subject to any oneof these or similar risks, the result could be a significant increase in thecosts of the project, a significant delay in completion of the project, withthe resultant delay in our realization of the operational and financialbenefits of the new system, or even the risk that the project would ultimatelyfail in its basic goal of a companywide, single-entry system. Any of theseoutcomes could have a material, adverse impact on our business operations,operating results and financial condition.

 

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## **ITEM 2. PROPERTIES**

## ** **

Our corporate headquarters are in Vista, California.The operations of our Domestic Rehabilitation Segment are based in Vista,California; Chattanooga, Tennessee; and Shoreview, Minnesota. Our InternationalSegment headquarters is in Guildford, United Kingdom. We operate manufacturingfacilities in Tijuana, Mexico; Sfax, Tunisia; Chattanooga, Tennessee; ClearLake, South Dakota; and Austin, Texas. Our warehouse and distribution centersare in Clear Lake, South Dakota; Chattanooga, Tennessee (c); Indianapolis,Indiana; Tijuana, Mexico; Freiburg, Germany; Guildford, United Kingdom; Malmo,Sweden; Herentals, Belgium; Mouguerre, France; and various other citiesthroughout the world. The manufacturing facilities and operations for ourDomestic Surgical Implant Segment are in Austin, Texas. Additional informationabout our material facilities and certain other foreign facilities is set forthin the following table:

 
| **Location**              | ** ** | **Use**                                                                                                               | ** ** | **Owned/  Leased** | ** ** | **Lease  Termination  Date** | ** ** | **Size  in  Square  Feet** | ** ** |
|---------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------------|------------|----------------------------|------------|
| Vista, California         |       | Corporate Headquarters, Domestic Rehabilitation  Segment Operations, Manufacturing Facility, Research and Development |       | Leased             |       | August 2021             |       | 123,398                    |       |
| Tijuana, Mexico           |       | Manufacturing and Distribution Facility                                                                               |       | Leased             |       | September 2016          |       | 286,133                    |       |
| Chattanooga, Tennessee    |       | Domestic Rehabilitation Segment Operations,  Manufacturing and Distribution Facility, Research and Development (c)    |       | Owned              |       | n/a                          |       | 164,542                    |       |
| Indianapolis, Indiana     |       | Distribution Facility                                                                                                 |       | Leased             |       | October 2016            |       | 109,782                    |       |
| Shoreview, Minnesota      |       | Domestic Rehabilitation Segment Operations,  Medical Billing                                                          |       | Leased             |       | October 2011(a)         |       | 93,666                     |       |
| Austin, Texas             |       | Domestic Surgical Implant Segment Operations and  Manufacturing Facility, Warehouse, Research and Development         |       | Leased             |       | March 2012(b)           |       | 52,800                     |       |
| Clear Lake, South Dakota  |       | Manufacturing, Distribution and Refurbishment and  Repair Facility                                                    |       | Owned              |       | n/a                          |       | 54,000                     |       |
| Mouguerre, France         |       | Office and Distribution                                                                                          |       | Leased             |       | October 2016            |       | 22,050                     |       |
| Freiburg, Germany         |       | International Segment Distribution Facility                                                                           |       | Leased             |       | November 2014           |       | 26,479                     |       |
| Freiburg, Germany         |       | International Segment Operations                                                                                      |       | Leased             |       | December 2014           |       | 22,195                     |       |
| Herentals, Belgium        |       | Warehouse                                                                                                             |       | Leased             |       | December 2013           |       | 25,800                     |       |
| Sfax, Tunisia             |       | Manufacturing Facility                                                                                                |       | Leased             |       | December 2013           |       | 47,300                     |       |
| Malmö, Sweden        |       | International Segment Operations, Warehouse and  Distribution Facility                                                |       | Leased             |       | March 2011              |       | 16,081                     |       |
| Guildford, United Kingdom |       | International Segment Headquarters and  Distribution Facility                                                         |       | Leased             |       | July 2016               |       | 8,234                      |       |
| Other various locations   |       |                                                                                                                  |       | Leased             |       | Various                      |       | 156,085                    |       |

 

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

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

(c) Ongoing operationsof our Chattanooga facility were ended in connection with the transition of ourChattanooga activities into other existing sites. We plan to exit the facilityin mid-2010.  The buildings are currentlylisted for sale.

 

## **ITEM 3. LEGALPROCEEDINGS**

## ** **

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

 

Themanufacture and sale of orthopedic devices and related products exposes us to asignificant risk of product liability claims. From time to time, we have been,and we are currently, subject to a number of product liability claims allegingthat the use of our products resulted in adverse effects. Even if we aresuccessful in defending against any liability claims, such claims couldnevertheless distract our management, result in substantial costs, harm ourreputation, adversely affect the sales of all our products and otherwise harmour business. If there is a significant increase in the number of productliability claims, our business could be adversely affected.

 

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We are currently defendants in approximately 80product liability cases, including lawsuits in Canada and Texas seeking classaction status, related to a disposable drug infusion pump product manufacturedby two third party manufacturers that we distributed through our Bracing andSupports business unit of our Domestic Rehabilitation segment. We discontinuedour sale of these products in the second quarter of 2009. These cases have beenbrought against the manufacturers and certain distributors of these pumps, andin some cases, the manufacturers of the anesthetics used in these pumps. All ofthese lawsuits allege that the use of these pumps with certain anesthetics incertain shoulder surgeries over prolonged periods have resulted in cartilagedamage to the plaintiffs. We have sought indemnity and tendered the defense ofthese cases to the two manufacturers who supplied these pumps to us, to theirproducts liability carriers and to our products liability carriers. Theproducts liability carriers for both manufacturers has accepted coverage forour defense of these claims; however, both manufacturers have rejected ourtenders of indemnity. The base policy for one of the manufacturers has beenexhausted and the excess liability carriers for that manufacturer are notobligated to provide a defense until a $5 million self-insured retention hasbeen paid. Our products liability carrier has accepted coverage of these cases,subject to a reservation of the right to deny coverage for customary matters,including punitive damages and off-label promotion. The lawsuits allege damagesranging from unspecified amounts to claims between $1.0 million and $10.0million. These cases are in varying stages of discovery. We could be exposed tomaterial liabilities if our insurance coverage is not available or inadequateand the resources of the two manufacturers, including their respective productsliability insurance policies, are insufficient to pay the defense costs and settlementsor judgments in these cases.

 

We maintain products liability insurance that issubject to annual renewal. Our current policy covers claims reported between July 1,2009 and June 30, 2010 and provides for coverage (together with excesspolicies) of up to a limit of $80 million, provided that the top layer of $25million excess over $55 million covers only claims reported after February 25,2010 and the next layer down of $10 million excess over $45 million covers onlyclaims reported after February 18, 2010. This coverage is subject to aself-insured retention of $500,000 for claims related to pain pumps describedabove and claims related to the IceMan cold therapy product, a self-insuredretention of $250,000 on claims related to all other invasive products and aself-insured retention of $50,000 on claims related to all other non-invasiveproducts, with an aggregate self-insured retention of $1.0 million for allproducts liability claims. In addition, the top layer of $25 million excessover $55 million has a separate self-insured retention of $50,000 perclaim.  Our prior two products liabilitypolicies cover claims reported between July 1, 2007 and February 15,2008 and between February 15, 2008 and July 1, 2009,respectively.  The 2007-2008 policy providesfor coverage (together with excess policies) of up to a limit of $20 millionand the 2008-2009 policy provides for coverage (together with excess policies)of up to a limit of $25 million.  Certainof the pain pump cases described above were reported under and are covered bythese two policies.  If a productsliability claim or series of claims is brought against us for uninsuredliabilities or in excess of our insurance coverage, our business could suffermaterially. In addition, in certain instances, a products liability claim couldalso result in our having to recall some of our products, which could result insignificant costs to us. On our consolidated balance sheet of December 31,2009, we have accrued approximately $2.0 million for expenses related toproducts liability claims.  The amountaccrued is based upon previous claim experience in part due to the fact that in2003 we exceeded the coverage limits in effect at that time for certainhistorical product liability claims involving one of our discontinued surgicalimplant products and such products are excluded from coverage under our currentpolicies.

 

On April 15, 2009, we became aware of a *qui tam*action filed in Federal Court inBoston, Massachusetts in March 2005 and amended in December 2007 thatnames us as a defendant along with each of the other companies thatmanufactures and sells external bone growth stimulators, as well as ourprincipal stockholder, The Blackstone Group, and the principal stockholder ofone of the other companies in the bone growth stimulation business. This caseis captioned United States *ex rel.*Beirmanv. Orthofix International, N.V., *et al.*,Civil Action No. 05-10557 (D. Mass.). The case was sealed when originallyfiled and unsealed in March 2009. The plaintiff, or relator, alleges thatthe defendants have engaged in Medicare fraud and violated Federal and statefalse claims acts from the time of the original introduction of the devices byeach defendant to the present by seeking reimbursement for bone growth stimulatorsas a purchased item rather than a rental item. The relator also alleges thatthe defendants are engaged in other marketing practices constituting violationsof the Federal and various state anti-kickback statutes. On December 4,2009, we filed a motion to dismiss the relator’s complaint, and we arecurrently awaiting a response from the relator. Shortly before becoming awareof the *qui**tam*action, we were advised that our bonegrowth stimulator business was the subject of an investigation by the DOJ, andon April 10, 2009, we were served with a subpoena under HIPAA seekingnumerous documents relating to the marketing and sale by us of bone growthstimulators. On September 21, 2009, we were served with a second HIPAAsubpoena related to this DOJ investigation seeking additional documentsrelating to the marketing and sale by us of bone growth stimulators. We believethat these subpoenas are related to the DOJ’s investigation of the allegationsin the *qui tam*action, althoughthe DOJ has decided not to intervene in the *quitam*action at this time. We believe that our marketing practices inthe bone growth stimulation business are in compliance with applicable legalstandards and intend to defend this case and investigation vigorously. We canmake no assurance as to the resources that will be needed to respond to thesematters or the final outcome.

 

**ITEM 4.(REMOVED AND RESERVED)**

 

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## **PART II.**

## ** **

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

## ** **

As a result of the acquisition of ReAble byBlackstone on November 4, 2006 (“the Prior Transaction”), the common stock ofDJO is privately held, and there is no established trading market for ourcommon stock. As of March 5, 2010, there were four holders of DJO’s commonstock.

 

## **ITEM 6. SELECTEDFINANCIAL DATA**

## ** **

Selected financial data set forth below is presentedfor the five years ended December 31, 2009. Thefollowing table sets forth selected financial data as of and for the periodsindicated and has been derived from the audited historical consolidatedfinancial statements. The selected financial data for the predecessor periodrepresents ReAble’s financial data prior to the Prior Transaction, and theselected financial data for the successor periods represents financial data ofDJOFL after the consummation of the Prior Transaction. For the yearended December 31, 2006, we have combined the predecessor period and thesuccessor period and presented the unaudited results of operations on acombined basis because we believe it is useful to compare our financial resultson an annualized basis. The successor period reflects the acquisition of ReAbleby Blackstone using the purchase method of accounting pursuant to the provisionof Statement of the Financial Accounting Standards Board’s (“FASB”) AccountingStandards Codification (“ASC”) Topic 805 (formerly referred to as FASB No. 141,“Business Combinations”).  Accordingly,the comparability of the results of the successor period for the full year 2007to the combined results of the successor and the predecessor periods for thefull year 2006 is affected by differences in the basis of presentation, whichreflects purchase accounting in the successor periods and historical cost inthe predecessor periods. In addition, the comparability of the combined resultsis impacted by changes in our capital structure which occurred on the date thePrior Transaction was completed. Furthermore, on June 12, 2009 we sold our Empi Therapy Solutions (“ETS”)catalog business.  As such, the resultsof the ETS business for periods prior to the date of the sale have beenpresented as discontinued operations.

 

Theselected financial data should be read in conjunction with the auditedconsolidated financial statements and related notes thereto, and Item 7. “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” in thisAnnual Report.

 
| ** **                                          | ** ** | **Successor**                                | ** ** | **Predecessor**                              | ** ** | **Combined  Basis**                          | ** ** | **Predecessor**                                                  | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| **($ in thousands) **                     |       | **Year Ended  December 31,  2009** | ** ** | **Year Ended  December 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** | **November 4,  2006 through  December 31,  2006** | ** ** | **January 1,  2006 through  November 3,  2006** |   | **(unaudited)  Year Ended  December 31,** | ** ** | **Year Ended  December 31,** | ** ** |
| **2006**                                            | ** ** | **2005**                                     | ** ** |
| **Statement of Operations Data:**                   |       |                                         |       |                                         |       |                                         |       |                                                             |       |   |   |   |   |   |   |
| Net  sales (1)                                      |       | $                                            | 946,126    |                                         | $          | 948,469                                      |       | $                                                                | 464,811    |   | $ | 55,104 |   | $ | 287,124 |   | $ | 342,228 |   | $ | 274,909 |   |
| Gross  profit                                       |       | 607,407                                      |       | 598,292                                      |       | 279,613                                      |       | 30,569                                                           |       | 173,384 |   | 203,953 |   | 174,659 |   |
| Income  (loss) from continuing operations           |       | (49,391                                      | )          | (97,683                                      | )          | (83,455                                      | )          | (41,663                                                          | )          | (46,953 | ) | (88,616 | ) | 8,217 |   |
| Net  income (loss) attributable to DJO Finance LLC  |       | (50,433                                      | )          | (97,786                                      | )          | (82,422                                      | )          | (41,634                                                          | )          | (46,776 | ) | (88,410 | ) | 12,330 |   |
|                                                |       |                                         |       |                                         |       |                                         |       |                                                             |       |   |   |   |   |   |   |
| **Other Financial Data:**                           |       |                                         |       |                                         |       |                                         |       |                                                             |       |   |   |   |   |   |   |
| Depreciation  and amortization (2)                  |       | 112,148                                      |       | 122,447                                      |       | 48,141                                       |       | 6,402                                                            |       | 14,772 |   | 21,174 |   | 13,719 |   |
| Ratio  of earnings to fixed charges (unaudited) (3) |       | —                                       |       | —                                       |       | —                                       |       | —                                                           |       | — |   | — |   | 1.45x |   |
|                                                |       |                                         |       |                                         |       |                                         |       |                                                             |       |   |   |   |   |   |   |
| **Balance Sheet Data (at period end):**             |       |                                         |       |                                         |       |                                         |       |                                                             |       |   |   |   |   |   |   |
| Cash  and cash equivalents                          |       | $                                            | 44,611     |                                         | $          | 30,483                                       |       | $                                                                | 63,471     |   | $ | 30,903 |   | NA |   | NA |   | $ | 17,200 |   |
| Total  assets                                       |       | 2,850,179                                    |       | 2,940,130                                    |       | 3,086,272                                    |       | 1,060,636                                                        |       | NA |   | NA |   | 552,037 |   |
| Long-term  debt, net of current portion             |       | 1,796,944                                    |       | 1,832,044                                    |       | 1,818,598                                    |       | 548,037                                                          |       | NA |   | NA |   | 307,794 |   |
| DJO  Finance LLC membership equity                  |       | 555,860                                      |       | 598,366                                      |       | 704,988                                      |       | 335,208                                                          |       | NA |   | NA |   | 167,107 |   |
|                                                     |            |                                              |            |                                              |            |                                              |            |                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          The datareported for each period includes net sales from businesses acquired in suchperiod from the effective date of the acquisition. See Note 2 of the notes tothe audited consolidated financial statements included in Part II, Item 8,herein for additional information related to these acquisitions.

 

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(2)          The 2009 and 2008 dataincludes intangible asset impairment charges of approximately $7.0 million, and$22.4 million, respectively.

 

(3)          For purposes of calculatingthe ratio of earnings to fixed charges, (a) earnings consist of income(loss) before provision (benefit) for income taxes plus fixed charges and (b) fixedcharges is defined as interest expense (including capitalized interest andamortization of debt issuance costs) and the estimated portion of rent expensedeemed by management to represent the interest component of rent expense. Forthe successor years ended December 31, 2009, 2008 and 2007 and the period November 4,through December 31, 2006, and the predecessor period January 1, 2006through November 3, 2006, our earnings were insufficient to cover fixedcharges by $71.8 million, $148.4 million, $127.5 million, $50.6 million, and$59.3 million, respectively.

 

## **ITEM 7. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

## ** **

## **Forward LookingStatements**

## ** **

The following management’sdiscussion and analysis contains “forward looking statements” within themeaning of Section 27A of the Securities Act and Section 21E of theExchange Act that represent our expectations or beliefs concerning futureevents, including, but not limited to, statements regarding growth in sales ofour products, profit margins and the sufficiency of our cash flow for futureliquidity and capital resource needs. These forward-looking statements arefurther qualified by important factors that could cause actual results todiffer materially from those in the forward-looking statements. These factorsare described in Item 1A, Risk Factors, noted above. Results actually achievedmay differ materially from expected results included in these statements as aresult of these or other factors.

 

## **Introduction**

## ** **

This management’s discussionand analysis of financial condition and results of operations is intended toprovide an understanding of our results of operations, financial condition andwhere appropriate, factors that may affect future performance.

 

The following discussion should be read inconjunction with the audited consolidated financial statements and relatednotes to those financial statements as well as the other financial dataincluded elsewhere in this Annual Report.

 

**Overview of Business**

 

We are a leading global provider of high-quality orthopedic devices,with a broad range of products used for rehabilitation, pain management andphysical therapy. We also develop, manufacture and distribute a broad range ofsurgical reconstructive implant products. We are one of the largestnon-surgical orthopedic rehabilitation device companies in the world, asmeasured by revenues. Many of our products have leading market positions. Webelieve that our strong brand names, comprehensive range of products, focus onquality, innovation and customer service, extensive distribution network, andour strong relationships with orthopedic and physical therapy professionalshave contributed to our leading market positions. We believe that we are one ofonly a few orthopedic device companies that offer healthcare professionals andpatients a diverse range of orthopedic rehabilitation products addressing thecomplete spectrum of preventative, pre-operative, post-operative, clinical andhome rehabilitation care. Our products are used by orthopedic specialists,primary care physicians, pain management specialists, physical therapists,podiatrists, chiropractors, athletic trainers and other healthcareprofessionals to treat patients with musculoskeletal conditions resulting fromdegenerative diseases, deformities, traumatic events and sports-relatedinjuries. In addition, many of our non-surgical medical devices and relatedaccessories are used by athletes and patients for injury prevention and at-homephysical therapy treatment.

 

On June 12, 2009 we sold our Empi Therapy Solutions (“ETS”) catalog business toPatterson Medical Supply, Inc. for approximately $21.8 million. As such,results of the ETS business for periods prior to the date of sale have beenpresented as discontinued operations.

 

We provide a broad array of orthopedic rehabilitation and regenerationproducts, as well as implants to customers in the United States andabroad.  In the first quarter of 2009, wechanged how we report financial information to our senior management.  Prior to 2009, we included the internationalcomponents of the Surgical Implant, Chattanooga, and Empi businesses in eitherthe Surgical Implant or Domestic Rehabilitation segments, as their operationswere managed domestically.  During thefourth quarter of 2008, we effected an operational reorganization whichresulted in the non-U.S. components of all of our businesses being managedabroad.  As a result, the segmentfinancial data for the year ended December 31, 2009 reflects this newsegmentation and the data for the years ended December 31, 2008 and 2007has been restated to reflect this change. We currently develop, manufacture anddistribute our products through the following three operating segments:

 

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***Domestic Rehabilitation Segment***

 

Our Domestic Rehabilitation Segment, which generates its revenues inthe United States, is divided into five main businesses:

 

·                  *Bracingand Supports. *Our Bracing andSupports business unit offers our DonJoy, ProCare and Aircast products,including rigid knee bracing, orthopedic soft goods, cold therapy products, andvascular systems.  This business unitalso includes our OfficeCare business, through which we maintain an inventoryof soft goods and other products at healthcare facilities, primarily orthopedicpractices, for immediate distribution to patients.

 

·                  *Empi. *Our Empi business unitoffers our home electrotherapy, iontophoresis, and home traction products. Weprimarily sell these products directly to patients or to physical therapyclinics. For products sold to patients, we arrange billing to the patients andtheir third party payors.

 

·                  *Regeneration*.  Our Regeneration business unit sells our bonegrowth stimulation products. We sell these products either directly to patientsor to independent distributors. For products sold to patients, we arrange billingto the patients and their third party payors.

 

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

 

·                  *AthleteDirect.*  Our Athlete Direct business unit offers our Compexelectrostimulation device to consumers, which range from people interested in improvingtheir fitness to competitive athletes, to assist in athletic training programsthrough muscle development and to accelerate muscle recovery after trainingsessions.

 

***International Segment***

 

Our International Segment, which generates most of its revenues inEurope, sells all of our products and certain third party products through acombination of direct sales representatives and independent distributors.

 

***Domestic Surgical Implant Segment***

 

Our Domestic Surgical Implant Segment develops, manufactures andmarkets a wide variety of knee, hip and shoulder implant products that servethe orthopedic reconstructive joint implant market in the United States.

 

Our three operating segmentsenable us to reach a diverse customer base through multiple distributionchannels and give us the opportunity to provide a wide range of orthopedicdevices and related products to orthopedic specialists operating in a varietyof patient treatment settings. These three segments constitute our threereportable segments. See Note 12 of the notes to the audited consolidatedfinancial statements included in Part II, Item 8, herein for additionalinformation regarding our segments.

 

Set forth below is netrevenue, gross profit and operating income information for our reporting segmentsfor the years ended December 31. This information excludes the impact ofcertain expenses not allocated to segments, primarily general corporateexpenses and non-recurring charges related to our integration activities.  All prior periods presented have beenreclassified to reflect our current reportable segments.

 

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| **($ in thousands)**                         | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Domestic Rehabilitation:**                           |       |     |       |     |       |     |       |
| Net revenues                                           |       | $        | 640,785    |     | $          | 634,559  |       | $ | 273,562 |   |
| Gross profit                                           |       | $        | 425,475    |     | $          | 403,740  |       | $ | 167,092 |   |
| Gross profit margin                                    |       | 66.4     | %          | 63.6     | %          | 61.1     | %          |
| Operating income                                       |       | $        | 177,962    |     | $          | 138,556  |       | $ | 11,772 |   |
| Operating income as a percent of net segment  revenues |       | 27.8     | %          | 21.8     | %          | 4.3      | %          |
| **International:**                                     |       |     |       |     |       |     |       |
| Net revenues                                           |       | $        | 241,464    |     | $          | 252,313  |       | $ | 133,757 |   |
| Gross profit                                           |       | $        | 137,142    |     | $          | 151,901  |       | $ | 70,225 |   |
| Gross profit margin                                    |       | 56.8     | %          | 60.2     | %          | 52.5     | %          |
| Operating income                                       |       | $        | 49,051     |     | $          | 55,295   |       | $ | 9,422 |   |
| Operating income as a percent of net segment  revenues |       | 20.3     | %          | 21.9     | %          | 7.0      | %          |
| **Domestic Surgical Implant:**                         |       |     |       |     |       |     |       |
| Net revenues                                           |       | $        | 63,877     |     | $          | 61,597   |       | $ | 57,492 |   |
| Gross profit                                           |       | $        | 49,799     |     | $          | 50,469   |       | $ | 46,172 |   |
| Gross profit margin                                    |       | 78.0     | %          | 81.9     | %          | 80.3     | %          |
| Operating income                                       |       | $        | 12,955     |     | $          | 12,815   |       | $ | 11,656 |   |
| Operating income as a percent of net segment  revenues |       | 20.3     | %          | 20.8     | %          | 20.3     | %          |

 

**Recent Acquisitions, Dispositions and OtherTransactions**

 

***Acquisition of Chattanooga Group Inc. (Canada)***

 

OnAugust 4, 2009 we acquired Chattanooga Group Inc., a Canadian distributorof certain of our products (“Chattanooga Canada”), for $7.2 million. Pursuantto the terms of the acquisition agreement and included within the purchaseprice, is a $1.4 million holdback and a $1.4 million promissory note. The holdbackprovides security for potential indemnification claims and, if not used forthat purpose, will be paid to the sellers. The holdback amount accrues interestat an annual rate of 2.5% for the first 18 months and a variable ratethereafter. Half of any holdback amount not used to cover indemnificationclaims will be paid with interest in January 2011 and the remainder of thebalance with interest is due approximately three years after closing, uponexpiration of a statutory period for under relevant tax law. The promissorynote accrues interest at an annual rate of 6% with the principal and interestdue in August 2010 (see Note 2 of the notes to the auditedconsolidated financial statements included in Part II, Item 8, herein).

 

***Acquisition of Empi Canada Inc.***

 

OnAugust 4, 2009 we acquired Empi Canada Inc., a Canadian distributor ofcertain of our products (“Empi Canada”), for $7.4 million.  Pursuant to the terms of the acquisitionagreement and included within the purchase price, is a $1.4 million holdbackand a $1.4 million promissory note. The holdback provides security forpotential indemnification claims and, if not used for that purpose, will bepaid to the sellers. The holdback amount accrues interest at an annual rate of2.5% for the first 18 months and a variable rate thereafter. Half of anyholdback amount not used to cover indemnification claims will be paid withinterest in January 2011 and the remainder of the balance with interest isdue approximately three years after closing, upon expiration of a statutoryperiod for under relevant tax law. The promissory note accrues interest at anannual rate of 6% with the principal and interest due in August 2010 (seeNote 2 of the notes to the audited consolidated financial statementsincluded in Part II, Item 8, herein).

 

***Sale of Empi Therapy Solutions***

 

On June 12, 2009 we sold our ETS catalog business to PattersonMedical Supply, Inc. for approximately $21.8 million. As such, results ofthe ETS business for periods prior to the date of sale have been presented asdiscontinued operations (see Note 3 of the notes to the auditedconsolidated financial statements included in Part II, Item 8, herein).

 

***Acquisition of DonJoy OrthopaedicsPty. Ltd****.*

 

OnFebruary 3, 2009 we acquired DonJoy Orthopaedics Pty., Ltd., an Australiandistributor of certain of our products (“DJO Australia”), for a total cashcompensation of $3.4 million. Pursuant to the terms of the acquisitionagreement and included within the purchase price, is $0.8 million, representingthe acquisition date fair value of the additional amount expected to be paid tothe selling shareholder of DJO Australia if certain revenue targets were met byDecember 31, 2009. Such revenue targets were met, and the additionalamount of $0.8 million, which was included in accrued liabilities in theconsolidated balance sheet at December 31, 2009, was paid in the firstquarter of fiscal year 2010.

 

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***Sale of Other Product Lines***

 

During the fourth quarter of 2009 we sold all rights, title andinterest to our spinal implant business and related property for $2.9million.  In addition, also during thefourth quarter of 2009, we sold our line of chiropractic tables known as theErgostyle line, and the TE-CH3 product (together referred to as “product line”)and other assets used in or otherwise related to the manufacture, sale andmarketing of the product line for approximately $0.8 million.

 

***DJO Merger***

 

On July 15, 2007, weentered into the Agreement and Plan of Merger with DJO Opco providing for amerger transaction pursuant to which DJO Opco became a wholly owned subsidiaryof DJOFL, the entity filing this Annual Report. The total purchase price forthe DJO Merger, which was consummated on November 20, 2007, wasapproximately $1.3 billion and consisted of $1.2 billion (at $50.25 ashare) paid to former equity holders of DJO Opco, $15.2 million related tothe fair value of stock options held by DJO Opco management that were exchangedfor options to purchase DJO common stock, and $22.8 million in directacquisition costs. The DJO Merger was financed through a combination of equitycontributed by Blackstone, borrowings under the Senior Secured Credit Facility,and proceeds from the newly issued 10.875% senior Notes due 2014 (“10.875%Notes”) issued by DJOFL and DJO Finance Corporation (see Note 2 of thenotes to the audited consolidated financial statements included in Part II,Item 8, herein).

 

***Acquisitionof IOMED, Inc.***

 

OnAugust 9, 2007, we acquired IOMED, which develops, manufactures andmarkets active drug delivery systems used primarily to treat acute localinflammation in the physical and occupational therapy and sports medicine markets.The purchase price was $23.3 million and consisted of $21.1 million in cashpayments to former IOMED equity holders at $2.75 per share, $0.8 millionrelated to the fair value of vested stock options that were outstanding at thetime of the acquisition, and $1.4 million in direct acquisition costs. Theacquisition was primarily financed with borrowings under our then existingsenior secured credit facility (see Note 2 of the notes to the auditedconsolidated financial statements included in Part II, Item 8,herein).  The IOMED business has beencompletely integrated with our Empi and Chattanooga business units.

 

***Acquisitionof The Saunders Group***

** **

OnJuly 2, 2007, we completed the purchase of substantially all of the assetsof The Saunders Group (“Saunders”) for total cash consideration of $40.9million, including $0.9 million of acquisition costs. Saunders is a supplier ofrehabilitation products to physical therapists, chiropractors, athletes,athletic trainers, physicians and patients, with a specialty in patentedtraction devices, back supports, and equipment for neck and back disorders. Theacquisition was financed with funds borrowed under our then existing seniorsecured credit Facility (see Note 2 of the notes to the auditedconsolidated financial statements included in Part II, Item 8, herein).The Saunders business has been completely integrated with our Empi andChattanooga business units.

 

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**Results of Operations**

 

The following table sets forth our statements ofoperations as a percentage of sales for the periods indicated:

 
| ** **                                                | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|
| **($ in thousands)**                            | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                                 |       | $                                | 946,126    |   | 100.0 | % | $ | 948,469 |   | 100.0 | % | $ | 464,811 |   | 100.0 | % |
| Cost of sales                                             |       | 338,719                          |       | 35.8 |   | 350,177 |   | 36.9 |   | 185,198 |   | 39.8 |   |
| Gross profit                                              |       | 607,407                          |       | 64.2 |   | 598,292 |   | 63.1 |   | 279,613 |   | 60.2 |   |
| Operating expenses:                                       |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                       |       | 420,758                          |       | 44.5 |   | 439,059 |   | 46.3 |   | 266,907 |   | 57.4 |   |
| Research and development                                  |       | 23,540                           |       | 2.5 |   | 26,938 |   | 2.8 |   | 21,047 |   | 4.5 |   |
| Amortization and impairment of  acquired intangibles |       | 84,252                           |       | 8.9 |   | 98,954 |   | 10.4 |   | 33,496 |   | 7.2 |   |
| Operating income (loss)                                   |       | 78,857                           |       | 8.3 |   | 33,341 |   | 3.5 |   | (41,837 | ) | (9.0 | ) |
| Other income (expense):                                   |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Interest income                                           |       | 1,033                            |       | 0.1 |   | 1,662 |   | 0.2 |   | 1,132 |   | 0.2 |   |
| Interest expense                                          |       | (157,032                         | )          | (16.6 | ) | (173,162 | ) | (18.3 | ) | (72,409 | ) | (15.6 | ) |
| Other (expense) income, net                               |       | 6,073                            |       | 0.6 |   | (9,205 | ) | (1.0 | ) | 742 |   | 0.2 |   |
| Loss on early extinguishment of debt                      |       | —                           |       | 0.0 |   | — |   | 0.0 |   | (14,539 | ) | (3.1 | ) |
| Loss from continuing operations before income  taxes      |       | (71,069                          | )          | (7.5 | ) | (147,364 | ) | (15.5 | ) | (126,911 | ) | (27.3 | ) |
| Benefit for income taxes                                  |       | (21,678                          | )          | (2.3 | ) | (49,681 | ) | (5.2 | ) | (43,456 | ) | (9.4 | ) |
| Income (loss) from discontinued operations, net           |       | (319                             | )          | 0.0 |   | 946 |   | 0.1 |   | 1,448 |   | 0.3 |   |
| Net loss                                                  |       | (49,710                          | )          | (5.3 | ) | (96,737 | ) | (10.2 | ) | (82,007 | ) | (17.6 | ) |
| Less: Income attributable to noncontrolling  interest     |       | 723                              |       | 0.1 |   | 1,049 |   | 0.1 |   | 415 |   | 0.1 |   |
| Net loss attributable to DJO Finance LLC                  |       | $                                | (50,433    | ) | (5.3 | )% | $ | (97,786 | ) | (10.3 | )% | $ | (82,422 | ) | (17.7 | )% |

 

***Year Ended December 31, 2009 Compared to Year Ended December 31,2008***

 

*Net Sales.*Our net sales for the year ended December 31, 2009 were $946.1million, compared to net sales of $948.5 million for the year ended December 31,2008.  Net sales for the year ended December 31,2009 were negatively impacted by $13.9 million of unfavorable changes inforeign exchange rates compared to the rates in effect for the year ended December 31,2008. On the basis of constant currency rates, net sales increased 1.2% for theyear ended December 31, 2009 compared to the year ended December 31,2008.

 

For the year ended December 31,2009, we generated 25.5% of our net sales from customers outside the UnitedStates as compared to 26.6% for the year ended December 31, 2008.  Additionally, sales of new products, whichinclude products that have been on the market less than one year, were $12.3million for the year ended December 31, 2009, compared to new productsales of $27.2 million for the year ended December 31, 2008.

 

The following table setsforth the mix of our net sales for the years ended December 31, 2009 and2008:

 
| ** **                        | ** ** | **Years Ended**        | ** ** | ** **                       | ** ** | ** **                  | ** ** |
|-----------------------------------|------------|-----------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| **($ in thousands)**    | ** ** | **December 31,  2009** | ** ** | **% of Net  Revenues** | ** ** | **December 31,  2008** | ** ** | **% of Net  Revenues** | ** ** | **Increase  (Decrease)** | ** ** | **% Increase  (Decrease)** | ** ** |
| Domestic Rehabilitation Segment   |       | $                           | 640,785    |                             | 67.7       | %                           | $          | 634,559 |   | 66.9 | % | $ | 6,226 |   | 1.0 | % |
| International Segment             |       | 241,464                     |       | 25.5                             |       | 252,313                     |       | 26.6 |   | (10,849 | ) | (4.3 | ) |
| Domestic Surgical Implant Segment |       | 63,877                      |       | 6.8                              |       | 61,597                      |       | 6.5 |   | 2,280 |   | 3.7 |   |
| **Consolidated net sales**        |       | $                           | 946,126    |                             | 100.0      | %                           | $          | 948,469 |   | 100.0 | % | $ | (2,343 | ) | (0.2 | )% |

 

Net sales in our Domestic Rehabilitation Segment were$640.8 million for the year ended December 31, 2009, reflecting an increaseof 1.0% over net sales of $634.6 million for the year ended December 31,2008. The increase was driven primarily by growth across the majority of ourproduct lines, offset primarily by declines in revenues in our Chattanoogabusiness due to the economic downturn and constraints in the credit marketswhich compelled customers to reduce purchases of capital equipment itemssupplied by our Chattanooga business unit, and a slowdown in certain customerpurchasing during the first quarter due to the overall global economic decline.

 

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Net sales in our International Segment for the year ended December 31,2009 were $241.5 million, reflecting a decrease of 4.3% from net sales of$252.3 million for the year ended December 31, 2008. The decrease wasdriven primarily by $13.9 million of unfavorable changes in foreign exchangerates compared to rates in effect for the year ended December 31, 2008 andreduced sales of consumer products and clinical physical therapy equipment,partially offset by revenues from distributors acquired in 2009 in Australiaand Canada.  On the basis of constantcurrency rates, sales in our International Segment increased 1.2% for the yearended December 31, 2009 compared to the year ended December 31, 2008.

 

Net sales in our Domestic Surgical Implant Segment increased to$63.9 million from $61.6 million for the year ended December 31,2009, representing a 3.7% increase over the prior year. The increase was drivenprimarily by an increase in sales of our shoulder products.

 

*Gross Profit.*  Consolidated gross profit as a percentage ofnet sales increased to 64.2% for the year ended December 31, 2009 from63.1% for the year ended December 31, 2008. The increase in our grossprofit margin is primarily attributable to cost improvement initiativesimplemented in 2008 and 2009 and the benefits of a more favorable mix ofproducts sold, partially offset by unfavorable changes in foreign exchangerates of approximately $10.5 million. Additionally, the increase inconsolidated gross profit was partially driven by a reduction of $4.7 millionin amortization of purchased inventory fair value adjustments related to acquisitions.

 

Gross profit in our Domestic Rehabilitation Segment as a percentage ofnet sales increased to 66.4% for the year ended December 31, 2009 from63.6% for the year ended December 31, 2008. The increase in our grossmargin was primarily attributable to cost improvement initiatives implementedin 2008 and 2009 and the benefits of a more favorable mix of products sold, anda reduction of $4.7 million in amortization of purchased inventory fair valueadjustments related to acquisitions.

 

Gross profit in our International Segment as a percentage of net salesdecreased to 56.8% for the year ended December 31, 2009 from 60.2% for theyear ended December 31, 2008. The decrease was primarily driven byunfavorable changes in foreign exchange rates of approximately $10.5 millionand the impact of a less favorable mix of products sold.

 

Gross profit in our Domestic Surgical Implant Segment as a percentageof net sales decreased to 78.0% for the year ended December 31, 2009 from81.9% for the year ended December 31, 2008. The decrease was primarilydriven by lower margin mix of products sold and higher inventory obsolescencecosts.

 

*Selling, General and Administrative.*  Our selling, general and administrativeexpenses decreased to $420.8 million for the year ended December 31, 2009from $439.1 million for the year ended December 31, 2008 primarily due tooverall cost savings initiatives, lower non-recurring costs as a result of ourintegration activities, decreases in overall wage expenses related to headcountreductions and facilities consolidations and reduced commissions expense.Additionally, 2009 was favorably impacted by the reversal of a $6.0 millionaccrual made in 2008 as part of purchase accounting related to the DJO Mergerfor alleged over payment to Medicare claims due to the favorable settlement ofthe dispute. These expense decreases were partially offset by $12.8 million ofincreased costs related to the implementation of our new global ERP system. Thefollowing table sets forth certain non-recurring costs associated with ourintegration and ERP implementation:

 
| **($ in thousands)**             | ** **                  | **Years Ended** | ** **                  |
|--------------------------------------------|-----------------------------|----------------------|-----------------------------|
| ** **                                 | **December 31,  2009** | ** **           | **December 31,  2008** | ** ** | **Increase  (Decrease)** | ** ** | **% Increase  (Decrease)** | ** ** |
|                                       |                        |                 |                        |   |   |   |   |   |   |
| Employee severance and relocation expenses |                        | $                    | 8,619                       |   | $ | 11,237 |   | $ | (2,618 | ) | (23.3 | )% |
| Integration expenses                       |                        | 26,827               |                        | 27,750 |   | (923 | ) | (3.3 | ) |
| Reversal of reimbursement claims           |                        | (6,000               | )                           | — |   | (6,000 | ) | NM |   |
| ERP implementation                         |                        | 18,074               |                        | 5,247 |   | 12,827 |   | NM |   |
|                                       |                        | $                    | 47,520                      |   | $ | 44,234 |   | $ | 3,286 |   | 7.4 | % |

 

Employee severance and relocation expenses for the year ended December 31,2009 included $5.4 million of severance and retention in connection with ourChattanooga integration, $1.8 million of severance in connection with ourrecent company-wide headcount reduction, $1.1 million related to the DJOMerger, and $0.4 million related to restructuring at our internationallocations.  Employee severance andrelocation expenses for the year ended December 31, 2008 consisted of $5.7million of severance related to the DJO Merger, $2.7 million of severance inconnection with other acquisitions and $2.8 million of payments and otherexpenses in connection with the termination of a former executive officer.  Integration expenses for the year ended December 31,2009 included $20.3 million of integration costs incurred in connection withthe DJO Merger, and $6.4 million related to the restructuring at ourinternational locations. Integration expenses for the year ended December 31,2008 included $23.1 million and $4.3 million of integration costs accrued inconnection with the DJO Merger and other recent acquisitions, respectively.

 

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*Research and Development.*  Our research and development expensedecreased to $23.5 million for the year ended December 31, 2009 from$26.9 million for the year ended December 31, 2008, primarilyreflecting cost savings initiatives, and lower wages from reduced headcount. Asa percentage of net sales, research and development expense decreased to 2.5%compared to 2.8% in the year ended December 31, 2008.

 

*Amortization and Impairment of Acquired Intangibles.*  Amortization and impairment of acquiredintangible assets decreased to $84.3 million for the year ended December 31,2009 from $99.0 million for the year ended December 31, 2008.  Included within the year ended December 31,2009 are charges of approximately $7.0million related to two indefinite lived intangible assets which were determinedto be impaired. In the year ended December 31, 2008, there werecharges of approximately $10.1 millionrelated to an indefinite lived intangible asset which was deemed to be impairedand approximately $12.3 million resulting from the abandonment of a trade name.We test intangible assets with indefinite lives annually in accordancewith ASC Topic 350 (formerly SFAS No. 142, “Goodwill and Other IntangibleAssets”). This test compares the fair value of the intangible with its carryingamount.  To determine the fair value, weapplied the relief from royalty method (“RFR”). Under the RFR method, the valueof the trade name is determined by calculating the present value of theafter-tax cost savings associated with owning the asset and therefore not beingrequired to pay royalties for its use during the asset’s indefinite life.Significant judgments inherent in this analysis include the selection ofappropriate discount rates, estimating the amount and timing of estimatedfuture cash flows and the identification of appropriate terminal growth rateassumptions. Discount rate assumptions are based on an assessment of the riskinherent in the projected future cash flows generated by the respectiveintangible assets. Also subject to judgment are assumptions about royaltyrates, which are based on the estimated rates at which similar brands andtrademarks are being licensed in the marketplace.

 

Amortization of acquired intangibles includes amortization expenserelated to intangible assets recognized in the Prior Transaction and acquiredin connection with our acquisitions. The intangible assets are being amortizedover the estimated lives ranging from two to twenty years. Our amortization ofacquired intangibles increased slightly to $77.3 million for the year ended December 31,2009 compared to $76.5 million for the year ended December 31, 2008. At December 31, 2009, we expectthe future amortization of intangibles to be approximately $77.2 millionin 2010, $75.7 million in 2011, $74.4 million in 2012, $69.2 million in2013, $67.4 million in 2014, and $391.6 million for the periods thereafter.Future acquisitions of businesses or intangible assets may cause theseestimated future expenses to differ materially.

 

*Interest Expense.*  Our interest expense decreased to$157.0 million for the year ended December 31, 2009 compared tointerest expense of $173.2 million for the year ended December 31,2008. The decrease is primarily related to lower debt levels and reducedinterest rates on our variable rate debt. Additionally, we manage the risk of unfavorable movements in interestrates by hedging a portion of the outstanding loan balance.

 

*Other Income and Expense.*  We generated other income of $6.1 million forthe year ended December 31, 2009 compared to other expense of$9.2 million for the year ended December 31, 2008. Included in theyear ended December 31, 2009 is a $3.1 million gain related to the salesof certain immaterial product lines, as well as net foreign currencytranslation gains. For the year ended December 31, 2008, the amountprimarily reflects net foreign currency transaction losses.

 

*Benefit for Income Taxes.*  The effective tax rate for the years ended December 31,2009 and December 31, 2008 was 30.5% and 33.7%, respectively.  For the year ended December 31, 2009, werecorded a $21.7 million income tax benefit, net of tax expense related toforeign operations, deferred taxes on the assumed repatriation of foreignearnings, and other non-deductible items. For the year ended December 31,2008, we recorded a $49.7 million income tax benefit, net of tax expenserelated to foreign operations, deferred taxes on the assumed repatriation offoreign earnings, and other non-deductible items.

 

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

 

*Net Sales.*Our net sales for the year ended December 31, 2008 were $948.5million, representing an increase of 104.1% from net sales of $464.8 millionfor the year ended December 31, 2007. The increase was primarily driven bybusiness acquisitions, including the DJO Merger (November 2007), IOMED (August 2007)and Saunders (July 2007) and continued growth across our product lines.Revenues associated with these business acquisitions were approximately$458.9 million for the full year ended December 31, 2008 compared to$54.2 million for post-closing period of 2007. Net sales were also positivelyimpacted for the year ended December 31, 2008 by $11.7 million due tofavorable changes in foreign exchange rates compared to rates in effect for theyear ended December 31, 2007. For the year ended December 31, 2008and December 31, 2007, we generated 26.6% and 28.8%, respectively, of ournet sales from customers outside the United States.

 

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

 

The following table setsforth the mix of our net sales for the years ended December 31, 2008 and2007:

 
| ** **                        | ** ** | **Years Ended**        | ** ** | ** **                       | ** ** | ** **                  | ** ** |
|-----------------------------------|------------|-----------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| **($ in thousands)**    | ** ** | **December 31,  2008** | ** ** | **% of Net  Revenues** | ** ** | **December 31,  2007** | ** ** | **% of Net  Revenues** | ** ** | **Increase** | ** ** | **% Increase** | ** ** |
| Domestic Rehabilitation Segment   |       | $                           | 634,559    |                             | 66.9       | %                           | $          | 273,562 |   | 58.9 | % | $ | 360,997 |   | 132.0 | % |
| International Segment             |       | 252,313                     |       | 26.6                             |       | 133,757                     |       | 28.8 |   | 118,556 |   | 88.6 |   |
| Domestic Surgical Implant Segment |       | 61,597                      |       | 6.5                              |       | 57,492                      |       | 12.3 |   | 4,105 |   | 7.1 |   |
| **Consolidated net sales**        |       | $                           | 948,469    |                             | 100.0      | %                           | $          | 464,811 |   | 100 | % | $ | 483,658 |   | 104.1 | % |

 

Net sales in our Domestic Rehabilitation Segment were$634.6 million for the year ended December 31, 2008, reflecting anincrease of 132.0% over net sales of $273.6 million for the year ended December 31,2007. The increase was driven primarily by the addition of sales from the DJOMerger and the IOMED and Saunders acquisitions as discussed above and growth inour core product lines.

 

Net sales in our International Segment for the year ended December 31,2008 were $252.3 million, reflecting an increase of 88.6% from net salesof $133.8 million for the year ended December 31, 2007. The increase wasdriven primarily by the addition of sales from the DJO Merger and continuedgrowth in our core international markets. Net sales were also positivelyimpacted by $11.7 million for the year ended December 31, 2008 due tofavorable changes in foreign exchange rates compared to rates in effect for theyear ended December 31, 2007.

 

Net sales in our Domestic Surgical Implant Segment increased to$61.6 million from $57.5 million for the year ended December 31, 2008,representing a 7.1% increase over the prior year. The increase was drivenprimarily by growth in our knee, shoulder and hip implant product lines.

 

*Gross Profit.*  Consolidated gross profit as a percentage ofnet sales increased to 63.1% for the year ended December 31, 2008 from60.2% for the year ended December 31, 2007. The increase in our grossprofit margin is primarily attributable to cost improvement initiativesimplemented in the past year, favorable changes in the mix of products we sellas a result of our recent acquisitions of businesses with higher marginproducts, and favorable changes in foreign exchange rates of approximately$3.8 million. Additionally, the increase in consolidated gross profit wasdriven by reduced amortization of purchased inventory fair value adjustmentsrelated to acquisitions. The amortization of purchased inventory fair valueadjustments included in cost of sales was $4.7 million and$14.0 million for the years ended December 31, 2008 and 2007,respectively.

 

Gross profit in our Domestic Rehabilitation Segment as a percentage ofnet sales increased to 63.6% for the year ended December 31, 2008 from61.1% for the year ended December 31, 2007. The increase in our grossmargin was primarily attributable to cost improvement initiatives implementedin the past year and favorable changes in the mix of products we sell as aresult of our recent acquisitions of businesses with higher margin products.Additionally, the increase in domestic rehabilitation gross profit was driven byreduced amortization of purchased inventory fair value adjustments related toacquisitions.  The amortization ofpurchased inventory fair value adjustments included in cost of sales was$4.7 million and $8.6 million for the years ended December 31,2008 and 2007, respectively.

 

Gross profit in our International Segment as a percentage of net salesincreased to 60.2% for the year ended December 31, 2008 from 52.5% for theyear ended December 31, 2007. The increase was primarily driven by costimprovement initiatives implemented in the past year, favorable changes in themix of products we sell as a result of our recent acquisitions of businesseswith higher margin products, and favorable changes in foreign exchange rates ofapproximately $3.8 million. Additionally, the increase in internationalrehabilitation gross profit was driven by reduced amortization of purchasedinventory fair value adjustments related to acquisitions. The amortization ofpurchased inventory fair value adjustments included in cost of sales was$2.1 million for the year ended December 31, 2007 and we had no suchamortization in 2008.

 

Gross profit in our Domestic Surgical Implant Segment as a percentageof net sales increased to 81.9% for the year ended December 31, 2008 from80.3% for the year ended December 31, 2007. The increase was primarilydriven by cost improvement initiatives implemented in the past year and reducedamortization of purchased inventory fair value adjustments related toacquisitions of $3.3 million. The amortization of purchased inventory fairvalue adjustments included in cost of sales was $3.3 million for the yearended December 31, 2007.

 

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*Selling, General and Administrative.*  Our selling, general and administrativeexpenses increased to $439.1 million for the year ended December 31,2008 from $266.9 million for the year ended December 31, 2007 primarilydue to approximately $166.0 million of expenses, including wages, commissions,professional fees, and other expenses incurred by businesses we acquired and$4.1 million increase in non-recurring costs associated with the integration ofour acquisitions partially offset by a favorable $1.1 million settlement of alitigation contingency related to one of our foreign subsidiaries. Thefollowing table sets forth certain non-recurring selling, general andadministrative costs associated with the integration of our recent acquisitions:

 
| ** **                                                                                                                                            | ** ** | **Years Ended**        | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| **($ in thousands)**                                                                                                                        | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** | **Increase  (Decrease)** | ** ** | **% Increase  (Decrease)** | ** ** |
|                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| Management retention bonuses                                                                                                                          |       | $                           | 5,775      |   | $ | 542 |   | $ | 5,233 |   | NM |   |
| Severance and relocation expenses                                                                                                                     |       | 11,237                      |       | 16,372 |   | (5,135 | ) | (31.4 | ) |
| Integration expenses                                                                                                                                  |       | 32,997                      |       | 17,087 |   | 15,910 |   | 93.1 |   |
| Charges to bad debt expense related to  revaluation of accounts receivable and  anticipated integration related collection issues |       | —                      |       | 11,870 |   | (11,870 | ) | NM |   |
|                                                                                                                                                  |       | $                           | 50,009     |   | $ | 45,871 |   | $ | 4,138 |   | 9.0 | % |

 

Management retention bonuses related to the DJO Merger were recordedand amortized over the period from the close of the transaction to December 31,2008, resulting in expenses of $5.8 million and $0.5 million in 2008 and 2007,respectively. For the year ended December 31, 2008, severance andrelocation consisted of $5.7 million of severance expenses related to theDJO Merger, $2.7 million of severance payments to employees in connectionwith other acquisitions, and $2.8 million of payments and other expensesin connection with the termination of a former executive officer. Severanceexpenses for the year ended December 31, 2007 include $13.3 million ofpayments made to former executives of ReAble. Remaining severance expenses are related to restructuring activities inconnection with recent acquisitions. Integration expenses for the year ended December 31, 2008 included$23.1 million and $4.3million of integration costs incurred in connectionwith the DJO Merger and other recent acquisitions, respectively. Also includedwithin integration expense for the year ended December 31, 2008 is$5.2 million related to the implementation of our new global ERPsystem.  Integration expense for the yearended December 31, 2007 included costs incurred with the DJO Merger, PriorTransaction and other recent acquisitions. The year ended December 31, 2007 included a $11.9 million chargerelated to the impact of changes in methodologies used to estimate accountsreceivable reserves, primarily in connection with the DJO Merger.

 

*Research and Development.*  Our research and development expenseincreased to $26.9 million for the year ended December 31, 2008 from$21.0 million for the year ended December 31, 2007. The increase wasprimarily due to wages, facility and project costs incurred by businesses weacquired. As a percentage of net sales, research and development expensedecreased to 2.8% compared to 4.5% in the year ended December 31, 2007.

 

*Amortization and Impairment of Acquired Intangibles.*  Amortization and impairment of acquiredintangible assets increased to $99.0 million for the year ended December 31,2008 from $33.5 million for the year ended December 31, 2007.  Included within the year ended December 31,2008 are charges of approximately $10.1million related to an indefinite lived intangible asset which was deemed to beimpaired and approximately $12.3 million resulting from the abandonment of atrade name.  Amortization ofacquired intangibles includes amortization expense related to intangible assetsacquired in connection with our acquisitions. The intangible assets are beingamortized over the estimated lives ranging from two to twenty years. Ouramortization of acquired intangibles increased to $76.5 million for the yearended December 31, 2008 compared to $33.5 million for the year ended December 31,2007.

 

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

 

*Other Income and Expense.*  Other expense was $9.2 million for theyear ended December 31, 2008 compared to other income of $0.7 millionfor the year ended December 31, 2007. The 2008 expense was principallycomprised of foreign currency transaction losses and the write-off of astrategic investment determined to have no value.

 

*Benefit for Income Taxes.*  The effective tax rate for the years ended December 31,2008 and December 31, 2007 was 33.7% and 34.2%, respectively.  For the year ended December 31, 2008, werecorded a $49.7 million income tax benefit, net of tax expense related toforeign operations, deferred taxes on the assumed repatriation of foreign earnings,and other non-deductible items. For the year ended December 31, 2007, werecorded a $43.5 million income tax benefit, net of tax expense related toforeign operations, deferred taxes on the assumed repatriation of foreignearnings, and other non-deductible items.

 

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*ProForma Financial Information.  *The unaudited financial information inthe table below summarizes the combined results of our operations and those ofDJO Opco, IOMED, and The Saunders Group on a pro forma basis, as though thecompanies acquired had been combined as of the beginning of 2007. 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 the beginningof each of the years presented. The pro forma adjustments include the effect ofpurchase accounting adjustments, interest expense, and related tax effects,among others. In addition, on June 12, 2009 we sold our EmpiTherapy Solutions catalog business.  Assuch, results of the ETS business for periods prior to the date of sale havebeen presented as discontinued operations.

 
| ** **                                           | ** ** | **Years Ended**        | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|
| **($ in thousands)**                       | ** ** | **December 31,  2008** | ** ** | **December 31,  2007** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                                                 |       |                        |       |   |   |   |   |   |   |
| Net sales                                            |       | $                           | 948,469    |   | $ | 901,033 |   | $ | 47,436 |   | 5.3 | % |
| Loss from continuing operations before income  taxes |       | (147,364                    | )          | (242,545 | ) | 95,181 |   | 39.2 |   |
| Benefit for income taxes                             |       | (49,681                     | )          | (77,016 | ) | 27,335 |   | 35.5 |   |
| Noncontrolling interest                              |       | 946                         |       | 415 |   | 531 |   | 128.0 |   |
| Loss from continuing operations                      |       | $                           | (96,737    | ) | $ | (165,114 | ) | $ | 68,377 |   | 41.4 | % |

 

## **RecentAccounting Pronouncements**

## ** **

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

 

## **Liquidityand Capital Resources**

## ** **

On January 20, 2010,we issued $100.0 million aggregate principal amount of new 10.875% Senior Notes due 2014. The net proceeds ofthe issuance (excluding approximately $2.0 million of interest accrued from November 16,2009 to January 19, 2010 which will be included in the first interestpayment to be made on May 15, 2010), along with cash on hand, were used torepay $101.5 million aggregate principal amount of existing term loans underthe Senior Secured Credit Facility.

 

As of December 31, 2009, our primary source of liquidity consistedof cash and cash equivalents totaling $44.6 million and $100 million ofavailable borrowings under our revolving credit facility, described below.Working capital at December 31, 2009 was $182.2 million. We believethat our existing cash, plus the amounts we expect to generate from operationsand amounts available through our revolving credit facility, will be sufficientto meet our operating needs for the next twelve months, including workingcapital requirements, capital expenditures, and debt and interest repaymentobligations. While we currently believe that we will be able to meet all of ourfinancial covenants imposed by our Senior Secured Credit Facility, there is noassurance that we will in fact be able to do so or that, if we do not, we willbe able to obtain from our lenders waivers of default or amendments to theSenior Secured Credit Facility in the future. We and our subsidiaries,affiliates or significant shareholders (including Blackstone and itsaffiliates) may from time to time, in our or their sole discretion, purchase,repay, redeem or retire any of our outstanding debt or equity securities(including any publicly issued debt securities), in privately negotiated oropen market transactions, by tender offer or otherwise.

 

Asummary of our changes in cash and cash equivalents for the years ended December 31,2009 and 2008 is as follows (in thousands):

 
| ** **                                                    | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                    | ** ** | **2009**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| Cash provided by (used in) operating activities               |       | $                                           | 67,794     |   | $ | (12,061 | ) | $ | (28,759 | ) |
| Cash used in investing activities                             |       | (16,000                                     | )          | (29,596 | ) | (1,323,064 | ) |
| Cash (used in) provided by financing activities               |       | (35,261                                     | )          | 8,865 |   | 1,383,558 |   |
| Effect of exchange rate changes on cash and cash  equivalents |       | (2,405                                      | )          | (196 | ) | 833 |   |
| Net increase (decrease) in cash and cash  equivalents         |       | $                                           | 14,128     |   | $ | (32,988 | ) | $ | 32,568 |   |

 

***Cash Flows***

 

Operating activities provided $67.8 million of cash for the year ended December 31,2009, compared to $12.1 million of cash used for the year ended December 31,2008. Cash provided by operating activities for the year ended December 31,2009 primarily reflected our net income after adjustment for non-cash chargespartially offset by a favorable net change in operating assets and liabilities.Cash used for operating activities for the year ended December 31, 2008primarily reflected an unfavorable net change in operating assets andliabilities, substantially offset by our net income after adjustment fornon-cash charges. Cash used in operating activities for the year ended December 31,2007 primarily reflected our net loss and a negative net change in operatingassets and liabilities.  Cash paid forinterest was $144.2 million for the year ended December 31, 2009, $158.8 millionfor the year ended December 31, 2008, and $70.2 million for the year endedDecember 31, 2007.

 

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Investing activities used $16.0 million of cash for the year endedDecember 31, 2009, compared to $29.6 million for the year ended December 31,2008. Cash used in investing activities for the year ended December 31,2009 primarily consisted of $28.9 million of purchases of property andequipment, including $7.8 million for our new ERP system, and the acquisitionof businesses for a total of $13.1 million, net of cash,  partially offset by $25.7 million of proceedsfrom the sales of assets, primarily ETS. Cash used in investing activities for the year ended December 31,2008 primarily consisted of purchases of property and equipment totaling$25.9 million, including $5.3 million for our new ERP system and theacquisition of businesses, including payments for 2007 acquisitions, totaling$5.1 million.   Cash used ininvesting activities for the year ended December 31, 2007 principallyconsisted of the acquisition of businesses for $1,313.1 million, mainly relatedto the DJO Merger.

 

Financing activities used $35.3 million of cash for the year ended December 31,2009, compared to $8.9 million of cash provided by financing activitiesfor the year ended December 31, 2008. Cash used in financing activitiesfor the year ended December 31, 2009 primarily represented net payments onlong-term debt and revolving lines of credit. Cash provided by financing activities for the year ended December 31,2008 represented net proceeds of $9.2 million on long-term debt andrevolving lines of credit.  Cash providedby financing activities for the year ended December 31, 2007 included netproceeds of $1,005.9 million from long-term debt and revolving credit linesmainly related to net borrowings under the Senior Secured Credit Facility.

 

## ***Indebtedness***

## ** **

As of December 31, 2009, we had approximately $1,812.9 million inaggregate indebtedness outstanding.

 

*Senior Secured Credit Facility*

 

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

 

*Interest Rate and Fees.*  Borrowings under the Senior Secured CreditFacility bear interest at a rate equal to an applicable margin plus, at ouroption, either (a) a base rate determined by reference to the higher of (1) theprime rate of Credit Suisse and (2) the federal funds rate plus 0.50% or (b) theEurodollar rate determined by reference to the costs of funds for deposits inU.S. dollars for the interest period relevant to each borrowing adjusted forrequired reserves. The current applicable margins for borrowings under the termloan facility and the revolving credit facility is 2.00% with respect to baserate borrowings and 3.00% with respect to Eurodollar borrowings. The applicablemargin for borrowings under the term loan facility and the revolving creditfacility may be reduced subject to us attaining certain leverage ratios.

 

We use interest rate swap agreements in an effort to hedge our exposureto fluctuating interest rates related to a portion of our Senior Secured CreditFacility (See Note 9 of the notes to the audited consolidated financialstatements included in Part II, Item 8, herein).  On November 20, 2007, we entered into aninterest rate swap agreement for a notional amount of $515.0 million at afixed LIBOR rate of 4.205% which expired at December 31, 2009. In February 2009,we entered into two additional non-amortizing interest rate swap agreements.The first agreement was for a notional amount of $550.0 million at a fixedLIBOR rate of 1.04% beginning February 2009 and expired December 31,2009. The second is for a notional amount of $750.0 million at a fixed LIBORrate of 1.88% beginning January 2010 through December 2010.  In August 2009, we entered into four newnon-amortizing interest swap agreements with notional amounts aggregating$300.0 million.  Each of the fouragreements has a term beginning January 2011 through December 2011.The four agreements are at a weighted average fixed LIBOR rate of 2.5825%.   As of December 31, 2009, our weightedaverage interest rate for all borrowings under the Senior Secured CreditFacility was 4.42%.

 

In addition to paying interest on outstanding principal under theSenior 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 customary letter of credit fees.

 

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*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 amountthrough February 2014 with the remaining amount payable in May 2014.Principal amounts outstanding under the revolving credit facility are due andpayable in full at maturity, which is six years from the date of the closing ofthe Senior Secured Credit Facility.

 

*Prepayments.*  The Senior Secured Credit Facility requires usto prepay outstanding term loans, subject to certain exceptions, with(1) 50% (which percentage can be reduced to 25% or 0% upon our attainingcertain leverage ratios) of our annual excess cash flow, as defined;(2) 100% of the net cash proceeds above an annual amount of $25.0 millionfrom non-ordinary course asset sales (including insurance and condemnationproceeds) by DJOFL and its restricted subsidiaries, subject to certainexceptions, including a 100% reinvestment right if reinvested or committed toreinvest within 15 months of such sale or disposition so long asreinvestment is completed within 180 days thereafter; and (3) 100% ofthe net cash proceeds from issuances or incurrences of debt by DJOFL and itsrestricted subsidiaries, other than proceeds from debt permitted to be incurredunder the Senior Secured Credit Agreement. The foregoing mandatory prepaymentswill be applied to the term loan facilities in direct order of maturity.  

 

*Certain Covenants and Events of Default.*  The Senior Secured Credit Facility contains anumber of covenants that, among other things, restrict, subject to certainexceptions, our and our subsidiaries’ ability to:

 

·      incur additionalindebtedness;

 

·      create liens on assets;

 

·      change fiscal years;

 

·      enter into sale andleaseback transactions;

 

·      engage in mergers orconsolidations;

 

·      sell assets;

 

·      pay dividends and make otherrestricted payments;

 

·      make investments, loans oradvances;

 

·      repay subordinatedindebtedness;

 

·      make certain acquisitions;

 

·      engage in certaintransactions with affiliates;

 

·      restrict the ability ofrestricted subsidiaries that are not Guarantors to pay dividends or makedistributions;

 

·      amend material agreementsgoverning our subordinated indebtedness; and

 

·      change our lines ofbusiness.

 

Pursuant to the terms of the credit agreement relating to the SeniorSecured Credit Facility, we are required as of December 31, 2009 tomaintain a ratio of consolidated senior secured debt to Adjusted EBITDA (orsenior secured leverage ratio) of a maximum of 4.25:1 stepping down over timeto 3.25:1 by the end of 2011. Adjusted EBITDA represents net income (loss)attributable to DJOFL, plus losses from discontinued operations, interestexpense, net, provision (benefit) for income taxes and depreciation andamortization, further adjusted for non-cash items, non-recurring items andother adjustment items permitted in calculating covenant compliance under ourSenior Secured Credit Facility and the Indentures (“Adjusted EBITDA”). As of December 31,2009 our actual senior secured leverage ratio was within the required ratio at3.88:1.

 

*10.875% Notes and 11.75% Notes*

 

The Indentures governing the $675.0 million principal amount of10.875% Notes and the $200.0 million principal amount of 11.75% Noteslimit our (and most or all of our subsidiaries’) ability to:

 

·      incur additional debt orissue certain preferred shares;

 

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

 

·      make certain investments;

 

·      sell certain assets;

 

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·      create liens on certainassets to secure debt;

 

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

 

·      enter into certaintransactions with our affiliates; and

 

·      designate our subsidiariesas unrestricted subsidiaries.

 

Under the Indentures governing our 10.875% Notes and our 11.75% Notes,our ability to incur additional debt, subject to specified exceptions, is tiedto either improving the ratio of our Adjusted EBITDA to fixed charges or havingthis ratio be at least 2.00:1 on a pro forma basis after giving effect to suchincurrence. Additionally, our ability to make certain restricted payments isalso tied to having an Adjusted EBITDA to fixed charges of at least 2.00:1 on apro forma basis. Our ratio of Adjusted EBITDA to fixed charges for the twelvemonths ended December 31, 2009, measured on that date, was 1.78:1.Notwithstanding these limitations, the aggregate amount of term loan increasesand revolving commitment increases shall not exceed the greater of (i) $150.0 millionand (ii) the additional aggregate amount of secured indebtedness whichwould be permitted to be incurred as of any date of determination (assuming forthis purpose that the full amount of any revolving credit increase had beenutilized as of such date) such that, after giving pro forma effect to suchincurrence (and any other transactions consummated on such date), the senior securedleverage ratio for the immediately preceding test period would not be greaterthan 4.0:1. Fixed charges is defined in the Indentures as consolidated interestexpense plus all cash dividends or other distributions paid on any series ofpreferred stock of any restricted subsidiary and all dividends or otherdistributions accrued on any series of disqualified stock.

 

On January 20,2010, we issued $100.0 million aggregate principal amount of new 10.875% Senior Notes which mature on November 15,2014, pursuant to the indenture, governing our existing 10.875% Senior Notes due 2014 that were issued on November 20,2007 (collectively the “10.875% Notes”). The net proceeds of the issuance(excluding approximately $2.0 million of interest accrued from November 16,2009 to January 19, 2010, which amount will be included in the firstinterest payment to be made on May 15, 2010), along with cash on hand,were used to repay $101.5 million aggregate principal amount of existing termloans under the Senior Secured Credit Facility.

 

*Covenant Compliance*

 

The following is a summary of our covenant requirements and pro formaratios as of December 31, 2009:

 
| ** **                                                                                                       | ** ** | **Covenant  Requirements** | ** ** | **Actual Ratios** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| **Senior Secured Credit Facility**                                                                               |       |                       |       |                   |       |
| Maximum ratio of consolidated net senior secured  debt to Adjusted EBITDA                                        |       | 4.25:1                     |       | 3.88:1                 |       |
| **10.875% Notes and 11.75% Notes**                                                                               |       |                       |       |                   |       |
| Minimum ratio of Adjusted EBITDA to fixed charges  required to incur additional debt pursuant to ratio provision |       | 2.00:1                     |       | 1.78:1                 |       |

 

As described above, our Senior Secured Credit Facility consisting of a$1,065.0 million term loan facility and a $100.0 million revolvingcredit facility and the Indentures governing the $675.0 million of seniornotes and the $200.0 million of senior subordinated notes representsignificant components of our capital structure. Under our Senior SecuredCredit Facility, we are required to maintain specified senior secured leverageratios, which become more restrictive over time, and which are determined basedon our Adjusted EBITDA. If we fail to comply with the senior secured leverageratio under our Senior Secured Credit Facility, we would be in default underthe credit facility. Upon the occurrence of an event of default under theSenior Secured Credit Facility, the lenders could elect to declare all amountsoutstanding under the Senior Secured Credit Facility to be immediately due andpayable and terminate all commitments to extend further credit. If we wereunable to repay those amounts, the lenders under the Senior Secured CreditFacility could proceed against the collateral granted to them to secure thatindebtedness. We have pledged a significant portion of our assets as collateralunder the Senior Secured Credit Facility. Any acceleration under the SeniorSecured Credit Facility would also result in a default under the Indenturesgoverning the Notes, which could lead to the noteholders electing to declarethe principal, premium, if any, and interest on the then outstanding Notesimmediately due and payable. In addition, under the Indentures governing the Notes,our ability to engage in activities such as incurring additional indebtedness,making investments, refinancing subordinated indebtedness, paying dividends andentering into certain merger transactions is governed, in part, by our abilityto satisfy tests based on Adjusted EBITDA.

 

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Adjusted EBITDA is defined as net income (loss) attributable to DJOFL,plus losses from discontinued operations, interest expense, net, provision(benefit) for income taxes and depreciation and amortization, further adjustedfor non-cash items, non-recurring items and other adjustment items permitted incalculating covenant compliance under our Senior Secured Credit Facility andIndentures. We believe that the presentation of Adjusted EBITDA is appropriateto provide additional information to investors about the calculation of, andcompliance with, certain financial covenants in our Senior Secured CreditFacility and the Indentures. Adjusted EBITDA is a material component of thesecovenants.

 

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

 

Our ability to meet the covenants specified above will depend on futureevents, many of which are beyond our control, and we cannot assure you that wewill meet those covenants. A breach of any of these covenants in the futurecould result in a default under our Senior Secured Credit Facility and theIndentures, at which time the lenders could elect to declare all amountsoutstanding under our Senior Secured Credit Facility to be immediately due andpayable. Any such acceleration would also result in a default under theIndentures.

 

The following table provides a reconciliation from our net loss toAdjusted EBITDA for the years ended December 31, 2009, 2008, and 2007. Theterms and related calculations are defined in the credit agreement relating toour Senior Secured Credit Facility and the Indentures.

 
| ** **                                          | ** ** | **(unaudited)**                  | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
| **(in thousands)**                             | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net loss attributable to DJO Finance LLC            |       | $                                | (50,433    | ) | $ | (97,786 | ) | $ | (82,422 | ) |
| Loss from discontinued operations, net              |       | 319                              |       | (946 | ) | (1,476 | ) |
| Interest expense, net                               |       | 155,999                          |       | 171,500 |   | 71,277 |   |
| Loss on early extinguishment of debt                |       | —                           |       | — |   | 14,539 |   |
| Income tax benefit                                  |       | (21,678                          | )          | (49,681 | ) | (43,456 | ) |
| Depreciation and amortization                       |       | 112,148                          |       | 122,451 |   | 48,140 |   |
| Non-cash items (a)                                  |       | 4,208                            |       | 6,081 |   | 18,782 |   |
| Non-recurring items (b)                             |       | 53,520                           |       | 44,234 |   | 40,286 |   |
| Other adjustment items, before cost savings (c)     |       | (2,280                           | )          | 16,887 |   | 115,957 |   |
| Other adjustment items—future cost savings (d) |       | 3,600                            |       | 45,200 |   | 66,673 |   |
| Adjusted EBITDA                                     |       | $                                | 255,403    |   | $ | 257,940 |   | $ | 248,300 |   |

 

----

(a)           Non-cash items are comprisedof the following:

 
| ** **                          | ** ** | **(unaudited)**                  | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **Year Ended December 31,** | ** ** |
| **(in thousands)**             | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Stock compensation expense          |       | $                                | 3,382      |   | $ | 1,381 |   | $ | 1,541 |   |
| Purchase accounting adjustments (1) |       | —                           |       | 4,700 |   | 17,003 |   |
| Loss on disposal of assets          |       | 826                              |       | — |   | 238 |   |
| Total non-cash items                |       | $                                | 4,208      |   | $ | 6,081 |   | $ | 18,782 |   |

 

----

(1)   Purchase accountingadjustments for the year ended December 31, 2008 included expense relatedto the write-up to fair market value of acquired inventory in connection withthe DJO Merger. Purchase accounting adjustments for the year ended December 31,2007 included $4.7 million, $4.8 million and $4.5 million related to thewrite-up to fair market value of acquired inventory in connection with the DJOMerger, the Prior Transaction, and certain other acquisitions, respectively.Also included for the year ended December 31, 2007 is $3.0 million ofexpense related to the write-off of in-process research and development inconnection with the DJO Merger.

 

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(b)           Non-recurring items arecomprised of the following:

 
| ** **                            | ** ** | **(unaudited)**                  | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
| **(in thousands)**               | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Employee severance and relocation (1) |       | $                                | 8,619      |   | $ | 11,237 |   | $ | 16,372 |   |
| Integration expense (2)               |       | 26,827                           |       | 27,750 |   | 10,917 |   |
| Reserve methodology change (3)        |       | —                           |       | — |   | 12,997 |   |
| ERP implementation                    |       | 18,074                           |       | 5,247 |   | — |   |
| Total non-recurring items             |       | $                                | 53,520     |   | $ | 44,234 |   | $ | 40,286 |   |

 

----

(1)           Employee severance andrelocation for the year ended December 31, 2009 included $5.4 million ofseverance and retention in connection with our Chattanooga integration,$1.8 million of severance in connection with our company-wide headcountreduction, $1.1 million related to the DJO Merger, and $0.4 million relatedto restructuring at our international locations. Employee severance andrelocation for the year ended December 31, 2008 included $2.8 million inconnection with the termination of a former executive officer, and $5.7 millionand $2.7 million of employee severance incurred in connection with the DJOMerger and other acquisitions, respectively. Employee severance and relocationfor the year ended December 31, 2007 included severance payments to formerReAble executives in the amount of $13.3 million and $0.7 million related toother severance related items and employee relocation.  Also included for the year ended December 31,2007 is $0.7 million and $1.7 million related to the DJO Merger and otheracquisitions, respectively.

 

(2)           Integration expense for theyear ended December 31, 2009 included $20.3 million of integration costsincurred in connection with the DJO Merger and $6.4 million related torestructuring at our international locations. Integration expense for the yearended December 31, 2008 included $23.1 million and $4.3 millionof integration costs incurred in connection with the DJO Merger and otherrecent acquisitions, respectively. Integration expense for the year ended December 31,2007 includes $2.2 million, $0.4 million, and $8.3 million incurred in connectionwith the Prior Transaction, the DJO Merger and other acquisitions,respectively.

 

(3)           Represents $9.8 millionrelated to additional allowances for doubtful accounts receivable acquired inconnection with the DJO Merger due to anticipated integration relatedcollection issues, $1.1 million related to the revaluation of inventoryacquired in connection with the DJO Merger, and $2.1 million related toadditional allowance for doubtful accounts due to a change in an accountingreserve methodology in connection with the DJO Merger.

 

(c)           Other adjustment items,before future cost savings, are comprised of the following:

 
| ** **                                        | ** ** | **(unaudited)**                           | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **For  the Year Ended December 31,** | ** ** |
| **(in  thousands)**                               | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Blackstone monitoring fee                         |       | $                                         | 7,000      |   | $ | 7,000 |   | $ | 3,000 |   |
| Noncontrolling interest                           |       | 723                                       |       | 1,049 |   | 415 |   |
| Pre-acquisition EBITDA (1)                        |       | 1,709                                     |       | — |   | 106,561 |   |
| Pre-disposition EBITDA (2)                        |       | (348                                      | )          | — |   | — |   |
| Other (3)                                         |       | (11,364                                   | )          | 8,838 |   | (731 | ) |
| Transaction Expenses (4)                          |       | —                                    |       | — |   | 6,712 |   |
| Total other adjustment items, before cost savings |       | $                                         | (2,280     | ) | $ | 16,887 |   | $ | 115,957 |   |

 

----

(1)   For the year ended December 31,2009 included pre-acquisition Adjusted EBITDA for an Australia subsidiaryacquired in February 2009 and two Canada subsidiaries acquired in August 2009.For the year ended December 31, 2007 included pre-acquisition EBITDA of$103.8 million from January 1, 2007 to November 19, 2007 for the DJOMerger, and $2.8 million of pre-acquisition EBITDA from other acquisitions.

 

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(2)   Represents pre-closingAdjusted EBITDA related to certain immaterial product lines sold in the yearended December 31, 2009.

 

(3)   For the year ended December 31,2009, included $3.1 million gain related to the sale of certain product lines,and net foreign currency transaction losses. In addition to these items, theyear ended December 31, 2009 also included a gain of approximately $6.0million related to the resolution of previously asserted reimbursement claims.For the year ended December 31, 2008 included net foreign currencytransaction losses of $7.9 million, the settlement of a litigation contingencyof $1.2 million, and the write-off of an investment of $1.5 million. For theyear ended December 31, 2007, included net foreign currency transactiongains.

 

(4)   Represents $4.8 million oftransaction costs incurred in connection with the DJO Merger, $1.1 millionrelated to the Prior Transaction, and $0.8 million related to otheracquisitions.

 

(d)           For the year ended December 31,2009 included projected cost savings of $2.4 million in connection with the DJOMerger, and $1.2 million in connection with our two Canada subsidiariesacquired in August 2009. For the year ended December 31, 2008included projected cost savings of $45.2 million related to headcountreductions, facilities consolidation and production efficiencies in connectionwith the DJO Merger. For the year ended December 31, 2007 includedprojected cost savings of $50.6 million and $16.1 million related to headcountreductions, facilities consolidation and production efficiencies in connectionwith the DJO Merger, and other recent acquisitions, respectively.

 

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

## ** **

Thefollowing table summarizes our contractual obligations associated with ourlong-term debt, lease obligations and purchase obligations as of December 31,2009 (in thousands):

 
| ** **                  | ** ** | **Payment due by period** | ** ** |
|-----------------------------|------------|------------------------------------------|------------|
| ** **                  | ** ** | **Total**                                | ** ** | **<1 year** | ** ** | **1—3 years** | ** ** | **3-5 years** | ** ** | **>5 years** | ** ** |
| Long-term debt obligations  |       | $                                        | 1,812,641  |   | $ | 15,782 |   | $ | 21,300 |   | $ | 1,775,559 |   | $ | — |   |
| Interest payments (a)       |       | 698,724                                  |       | 135,612 |   | 285,446 |   | 277,666 |   | — |   |
| Capital lease obligations   |       | 229                                      |       | 144 |   | 82 |   | 3 |   | — |   |
| Operating lease obligations |       | 58,303                                   |       | 10,472 |   | 15,082 |   | 12,123 |   | 20,626 |   |
| Purchase obligations        |       | 92,091                                   |       | 25,645 |   | 17,446 |   | 14,000 |   | 35,000 |   |
| Total                       |       | $                                        | 2,661,988  |   | $ | 187,655 |   | $ | 339,356 |   | $ | 2,079,351 |   | $ | 55,626 |   |

 

----

(a)   $775.0 million principalamount of long-term debt is subject to fixed interest rates and$1,043.7 million of principal amount of long-term debt is subject to afloating interest rate. The interest payments in the above table for thefloating rate debt were based primarily on an assumed 3.461% interest ratewhich is the effective interest rate for the term loans under the SeniorSecured Credit Facility at December 31, 2009.  Also included is the effect on interestexpense related to our interest rate swap agreements.

 

Asof December 31, 2009, we had entered into purchase commitments forinventory, capital acquisitions and other services totaling approximately $92.1 million in theordinary course of business.  Thepurchase obligations shown above, includes $15.0 millioncommitted in 2010 related to purchase orders at our facilities in Chattanoogaand Freiburg.  In addition, under theamended transaction and monitoring fee agreement entered into in connectionwith the DJO Merger, the purchase obligations shown above includes DJO’sobligation to pay a $7.0 million annual monitoring fee to Blackstone ManagementPartners V L.L.C. through 2019.  See Item13. “Certain Relationships and Related Transactions and Director Independence”for a more detailed description of the amended agreement.  In addition to contractual obligations notedabove, we expect to spend up to an additional $16.2 millionimplementing our new ERP system capital project over approximately the nextyear.

 

Theamounts presented in the table above may not necessarily reflect our actualfuture cash funding requirement because the actual timing of future paymentsmade may vary from the stated contractual obligation.

 

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**Critical Accounting Policies and Estimates**

 

Our management’s discussion and analysis of financial condition andresults of operations is based upon our financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets, liabilities,revenues and expenses, and related disclosure of contingent assets andliabilities. On an on-going basis, we evaluate our estimates, including thoserelated to reserves for contractual allowances, doubtful accounts, rebates,product returns and rental credits, goodwill and intangible assets, deferredtax assets and liabilities and inventory. We base our estimates on historicalexperience and on various other assumptions that are believed to be 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. To the extent that actual events differfrom our estimates and assumptions, there could be a material impact on ourfinancial statements.

 

We believe the following critical accounting policies affect our moresignificant judgments and estimates used in the preparation of our consolidatedfinancial statements and this discussion and analysis of our financialcondition and results of operations.

 

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

 

We have established reserves to account for contractual allowances,doubtful accounts, rebates, product returns and rental credits. Significantmanagement judgment must be used and estimates must be made in connection withestablishing these reserves.

 

We maintain provisions for estimated contractual allowances forreimbursement amounts from our third party payor customers based on negotiatedcontracts and historical experience for non-contracted payors. We report theseallowances as reductions in our gross revenue. 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 have contracts with certain third partypayors for our third party reimbursement billings, which call for specifiedreductions in reimbursement of billed amounts based upon contractualreimbursement rates. For the years ended December 31, 2009, 2008, and 2007we reserved for and reduced gross revenues from third party payors by 31%, 32%, and 30%respectively, for estimated allowances related to these contractual reductions.

 

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 67%, 72%, and 65%of our net revenues for the years ended December 31, 2009, 2008, and 2007,respectively, and approximately 64% at both December 31, 2009 and 2008 and62% at December 31, 2007 of our net accounts receivable. We experiencedwrite-offs related to direct-billed customers of less than 1% of related netrevenues for the years ended December 31, 2009, 2008, and 2007. Our thirdparty reimbursement customers including insurance companies, managed carecompanies and certain governmental payors, such as Medicare, include all of ourOfficeCare customers, most of our Empi customers, and certain other customersof our Domestic Rehabilitation Segment. Our third-party payor customersrepresented approximately 33%, 28%, and 35% of our netrevenues for the years ended December 31, 2009, 2008, and 2007,respectively, and approximately 36% of our net accounts receivable at both December 31,2009 and 2008 and 38% of our net accounts receivable at December 31, 2007.For the years ended December 31, 2009, 2008, and 2007, we estimate baddebt expense to be approximately 7%, 6%, and 7%, respectively,of gross revenues from these third party reimbursement customers. If thefinancial condition of our customers were to deteriorate resulting in animpairment of their ability to make payments or if third party payors were todeny claims for late filings, incomplete information or other reasons,additional provisions may be required. Additions to this reserve are reflectedas selling, general and administrative expense.

 

Our reserve for rebates accounts for incentives that we offer tocertain of our distributors. These rebates are substantially attributable tosales volume, sales growth or to reimburse the distributor for certaindiscounts. We record estimated reductions to revenue for customer rebateprograms based upon historical experience and estimated revenue levels.

 

Our reserve for product returns accounts for estimated customer returnsof our products after purchase. These returns are mainly attributable to athird party payor’s refusal to provide reimbursement for the product or theinability of the product to adequately address the patient’s condition. Weprovide for this reserve by reducing gross revenue based on our historical rateof returns.

 

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Our reserve for rental credit recognizes a timing difference betweenbilling for a sale and processing a rental credit associated with some of ourrehabilitation devices. Many insurance providers require patients to rent ourrehabilitation devices for a period of one to three months prior to purchase.If the patient has a long-term need for the device, these insurance companiesmay authorize purchase of the device after such time period. When the device ispurchased, most providers require that rental payments previously made on thedevice be credited toward the purchase price. These credits are processed atthe time the payment is received for the purchase of the device, which createsa time lag between billing for a sale and processing the rental credit. Ourrental credit reserve estimates unprocessed rental credits based on the numberof devices converted to purchase. The reserve is calculated by first assessingthe number of our products being rented during the relevant period and ourhistorical conversion rate of rentals to sales, and then reducing our revenueby the applicable amount. We provide for these reserves by reducing our grossrevenue. The cost to refurbish rented products is expensed as incurred as partof cost of sales.

 

***Inventory Reserves***

 

We provide reserves for estimated excess and obsolete inventories equalto the difference between the costs of inventories on hand plus future purchasecommitments and the estimated market value based upon assumptions about futuredemand. If future demand is less favorable than currently projected bymanagement, additional inventory write-downs may be required. We also providereserves for newer product inventories, as appropriate, based on any minimumpurchase commitments and our level of sales of the new products.

 

We consign a portion of our inventory to allow our products to be immediatelydispensed to patients. This requires a large amount of inventory to be on handfor the products we sell through consignment arrangements. It also increasesthe sensitivity of these products to obsolescence reserve estimates. As thisinventory is not in our possession, we maintain additional reserves forestimated shrinkage of these inventories based on the results of periodicinventory counts and historical trends.

 

***Goodwill and Intangible Assets***

 

In accordance with ASC Topic 350 (formerly SFAS No. 142, “Goodwilland Other Intangible Assets” (“SFAS No. 142”)), we do not amortizegoodwill. In lieu of amortization, we are required to perform an annual reviewfor impairment. Goodwill is recorded as the difference, if any, between theaggregate consideration paid for an acquisition and the fair value of the nettangible and intangible assets acquired. The amounts and useful lives assignedto intangible assets acquired, other than goodwill, impact the amount andtiming of future amortization, and the amount assigned to in-process researchand development. The value of our intangible assets, including goodwill, couldbe impacted by future adverse changes such as: (i) any future declines inour operating results, (ii) a further decline in the valuation ofcomparable company stocks, (iii) a further significant slowdown in theworldwide economy or our industry or (iv) any failure to meet theperformance projections included in our forecasts of future operating results.We estimated the fair values of our reporting units using the income approachvaluation methodology that includes the discounted cash flow method, and themarket approach valuation methodology that includes the use of marketmultiples.  The discounted cash flows foreach reporting unit were based on discrete financial forecasts developed bymanagement for planning purposes. Cash flows beyond the discrete forecasts wereestimated using a terminal value calculation, which incorporated historical andforecasted financial trends for each identified reporting unit and consideredlong-term earnings growth rates for publicly traded peer companies. Future cashflows were discounted to present value by incorporating the present valuetechniques discussed in FASB Concepts Statement 7, “Using Cash Flow Information and Present Value in AccountingMeasurements,” or Concepts Statement 7. Specifically, the incomeapproach valuations included reporting unit cash flow discount rates rangingfrom 10.5% to 12.6% and terminal value growth rates of 3%. Publicly availableinformation regarding comparable market capitalization was also considered inassessing the reasonableness of the cumulative fair values of our reportingunits estimated using the discounted cash flow methodology.  Significant management judgment is requiredin the forecasts of future operating results that are used in the discountedcash flow method of valuation. The estimates we have used are consistent withthe plans and estimates that we use to manage our business. It is possible,however, that the plans may change and estimates used may prove to beinaccurate. If our actual results, or the plans and estimates used in future impairmentanalyses, are lower than the original estimates used to assess therecoverability of these assets, we could incur significant impairment charges.

 

We perform an impairment analysis on our goodwill on an annual basis inthe fourth quarter and in certain other circumstances when impairmentindicators are present. Our annual impairment test related to goodwill did notindicate any impairment.

 

Furthermore, ASC Topic 350 (formerly SFAS No. 142)states that intangible assets with indefinite lives should be tested annuallyin lieu of being amortized.  Thistestwork compares the fair value of the intangible with its carrying amount.  To determine the fair value we applied therelief from royalty (“RFR”) method. Under the RFR method, the value of thetrade name is determined by calculating the present value of the after-tax costsavings associated with owning the asset and therefore not being required topay royalties for its use during the asset’s indefinite life.  Significant judgments inherent in thisanalysis include the selection of appropriate discount rates, estimating futurecash flows and the identification of appropriate terminal growth rateassumptions.  Discount rate assumptionsare based on an assessment of the risk inherent in the projected future cashgenerated by the respective intangible assets. Also subject to judgment are assumptions about royalty rates, which arebased on the estimated rates at which similar brands and trademarks are beinglicensed in the marketplace.  In thefourth quarter fiscal 2009, we determined that the fair 

 

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value of two of our trade names were less than thecarrying amount, resulting in an aggregate impairment charge of $7.0 million,which is included in amortization and impairment of intangibles within theconsolidated statement of operations for the year ended December 31, 2009.During the fourth quarter 2008, we determined that the fair value of a tradename was less than its carrying amount and another trade name was abandoned,resulting in an aggregate impairment charge of $22.4 million which was includedin amortization of intangibles within the consolidated statement of operationsfor the year ended December 31, 2008.

 

***Deferred Tax Asset ValuationAllowance***

 

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

 

Our gross deferred tax asset balance was approximately $168.0million at December 31,2009 and primarily related to reserves for accounts receivable and inventory,accrued expenses, and net operating loss carryforwards (see Note 13 of thenotes to the audited consolidated financial statements included in Part II,Item 8, herein). As of December 31, 2009, we maintained a valuationallowance of $7.1 million due to uncertaintiesrelated to our ability to realize certain net operating loss carryforwardsacquired in connection with prior year acquisitions.

 

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

## ** **

We are exposed to certain market risks as part of our ongoing businessoperations, primarily risks from changing interest rates and foreign currencyexchange rates that could impact our financial condition, results of operations,and cash flows.

 

***Interest Rate 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 may affectthe market value of the debt, but do not impact our earnings or cash flow.Conversely, for our variable rate debt, interest rate changes generally do notaffect the fair market value of the debt, but do impact future earnings andcash flow, assuming other factors are held constant. We are exposed to interestrate risk as a result of our borrowings under our Senior Secured CreditFacility, which bear interest at floating rates based on the LIBOR or the primerate of Credit Suisse. As of December 31, 2009, we had $1,043.7 million ofborrowings under our Senior Secured Credit Facility. On November 20, 2007,we entered into an interest rate swap agreement related to the Senior SecuredCredit Facility for a notional amount of $515.0 million at a fixed LIBOR rateof 4.205% which expired at December 31, 2009.  In February 2009, we entered into twoadditional non-amortizing interest rate swap agreements. The first was for anotional amount of $550.0 million at a fixed LIBOR rate of 1.04% beginning February 2009and expired at December 31, 2009. The second is for a notional amount of $750.0 million at a fixed LIBORrate of 1.88% beginning January 2010 amortizing through December 2010.In August 2009, we entered into four new non-amortizing interest swapagreements with notional amounts aggregating $300.0 million.  Each of the four agreements has a termbeginning January 2011 through December 2011. The four agreements areat a weighted average fixed LIBOR rate of 2.5825%.  The fair value of our interest rate swap agreementrecorded in the accompanying condensed consolidated balance sheets as of December 31,2009 and 2008 was a loss of approximately $11.2 million and$13.3 million, respectively, and is recorded in other current andnon-current liabilities. A hypothetical 1% increase in variable interest ratesfor the remaining portion of the Senior Secured Credit Facility not covered bythe swap would have impacted our earnings and cash flow, for year ended December 31,2009 by approximately $2.9 million.  Our senior debt of approximately $775.0 millionconsisted of fixed rate debt at December 31, 2009.  We may use additional derivative financialinstruments where appropriate to manage our interest rate risk. However, as amatter of policy, we do not enter into derivative or other financialinvestments for trading or speculative purposes.

 

***Foreign Currency Risk***

 

Due to the global reach of our business, we are exposed to market riskfrom changes in foreign currency exchange rates, particularly with respect tothe U.S. dollar compared to the Euro and the Mexican Peso. Our wholly ownedforeign subsidiaries are consolidated into our financial results and aresubject to risks typical of an international business including, but notlimited to, differing economic conditions, changes in political climate,differing tax structures, other regulations and restrictions and foreignexchange volatility. To date, we have not used international currencyderivatives to hedge against our investment in our European subsidiaries ortheir operating results, which are converted into U.S. Dollars at period-endand average rates, respectively. However, as we continue to expand our businessthrough acquisitions and organic growth, the sales of our products that aredenominated in foreign currencies has increased as well as the costs associatedwith our foreign subsidiaries which operate in currencies other than the U.S.dollar. Accordingly, our future results could be materially impacted by changesin these or other factors. Sales denominated in foreign currencies accountedfor approximately 22.8% of our consolidated net sales for the year ended December 31,2009, of which 17.9% were denominated in the Euro. In addition, our exposure tofluctuations in foreign currencies arises because certain of our subsidiariesenter into purchase or sale transactions using a currency other than itsfunctional currency. Our Mexico-based manufacturing operations incur costs thatare largely denominated in Mexican Pesos. Accordingly, our future results couldbe materially impacted by changes in foreign exchange rates or other factors.Occasionally, we seek to reduce the potential impact of currency fluctuationson our business through hedging transactions. At December 31, 2009, we hadforeignexchange forward contracts to purchase Mexican Pesos, with an aggregatenotional amount of $14.2 million and an aggregate fair market value ofapproximately $14.3 million. For the years ended December 31, 2009and 2008, we recognized unrealized losses of approximately $2.9 million and$3.2 million, respectively, related to these contracts, which is included inother income (expense) in the statement of operations.

 

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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, 2009**

 

**INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                                                                                                                 | **Page No.** |
|--------------------------------------------------------------------------------------------------------------------------------------------|-------------------|
| Consolidated Financial  Statements:                                                                                                        |              |
| Report  of Independent Registered Public Accounting Firm                                                                                   | 64                |
| Consolidated Balance Sheets at December 31, 2009  and 2008                                                                            | 65                |
| Consolidated Statements of Operations for the Years  Ended December 31, 2009, 2008 and 2007                                           | 66                |
| Consolidated Statements of Changes in Membership  Equity and Comprehensive Loss  for the Years Ended December 31, 2009, 2008 and 2007 | 67                |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2009, 2008 and 2007                                           | 68                |
| Notes to Consolidated Financial Statements                                                                                                 | 69                |

 

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors

DJOFinance LLC

 

We have audited theaccompanying consolidated balance sheets of DJO Finance LLC as of December 31,2009 and 2008, and the related consolidated statements of operations, changes inmembership equity and comprehensive loss, and cash flows for each of the threeyears in the period ended December 31, 2009.  Our audits also included the financialstatement schedule listed in the Index at Item 15(a).  These financial statements and schedule arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements and schedule based on our audits.

 

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

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of DJO Finance LLC at December 31,2009 and 2008 and the consolidated results of its operations and its cash flowsfor each of the three years in the period ended December 31, 2009, inconformity 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 5, 2010     |                            |

 

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**DJO Finance LLC**

**Consolidated Balance Sheets**

### **(in thousands)**

 
| ** **                                                 | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets**                                                 |       |                        |       |                        |       |
| Current assets:                                            |       |                        |       |                        |       |
| Cash and cash equivalents                                  |       | $                           | 44,611     |                        | $          | 30,483 |   |
| Accounts receivable, net                                   |       | 146,212                     |       | 164,618                     |       |
| Inventories, net                                           |       | 95,880                      |       | 103,166                     |       |
| Deferred tax assets, net                                   |       | 40,448                      |       | 34,039                      |       |
| Prepaid expenses and other current assets                  |       | 14,725                      |       | 16,923                      |       |
| Total current assets                                       |       | 341,876                     |       | 349,229                     |       |
| Property and equipment, net                                |       | 86,714                      |       | 86,262                      |       |
| Goodwill                                                   |       | 1,191,497                   |       | 1,191,566                   |       |
| Intangible assets, net                                     |       | 1,187,677                   |       | 1,260,472                   |       |
| Other non-current assets                                   |       | 42,415                      |       | 52,601                      |       |
| Total assets                                               |       | $                           | 2,850,179  |                        | $          | 2,940,130 |   |
|                                                       |       |                        |       |                        |       |
| **Liabilities and Membership  Equity**                     |       |                        |       |                        |       |
| Current liabilities:                                       |       |                        |       |                        |       |
| Accounts payable                                           |       | $                           | 42,144     |                        | $          | 42,752 |   |
| Accrued interest                                           |       | 10,968                      |       | 10,966                      |       |
| Long-term debt and capital leases, current portion         |       | 15,926                      |       | 11,549                      |       |
| Other current liabilities                                  |       | 90,608                      |       | 104,401                     |       |
| Total current liabilities                                  |       | 159,646                     |       | 169,668                     |       |
| Long-term debt and capital leases, net of current  portion |       | 1,796,944                   |       | 1,832,044                   |       |
| Deferred tax liabilities, net                              |       | 321,131                     |       | 329,503                     |       |
| Other non-current liabilities                              |       | 14,089                      |       | 8,806                       |       |
| Total liabilities                                          |       | 2,291,810                   |       | 2,340,021                   |       |
|                                                       |       |                        |       |                        |       |
| Commitments and contingencies                              |       |                        |       |                        |       |
|                                                       |       |                        |       |                        |       |
| Membership equity:                                         |       |                        |       |                        |       |
| Paid-in capital                                            |       | 827,617                     |       | 824,235                     |       |
| Accumulated deficit                                        |       | (272,275                    | )          | (221,842                    | )          |
| Accumulated other comprehensive income (loss)              |       | 518                         |       | (4,027                      | )          |
| DJO Finance LLC membership equity                          |       | 555,860                     |       | 598,366                     |       |
| Noncontrolling  interests                                  |       | 2,509                       |       | 1,743                       |       |
| Total membership equity                                    |       | 558,369                     |       | 600,109                     |       |
| Total liabilities and membership equity                    |       | $                           | 2,850,179  |                        | $          | 2,940,130 |   |

 

See accompanying notes to consolidated financial statements.

 

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**DJO Finance LLC**

**Consolidated Statements ofOperations**

**(in thousands)**

 
| ** **                                                        | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                        | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net Sales                                                         |       | $                                | 946,126    |   | $ | 948,469 |   | $ | 464,811 |   |
| Cost of sales (exclusive of amortization shown  separately below) |       | 338,719                          |       | 350,177 |   | 185,198 |   |
| Gross profit                                                      |       | 607,407                          |       | 598,292 |   | 279,613 |   |
| Operating expenses:                                               |       |                             |       |   |   |   |   |
| Selling, general and administrative                               |       | 420,758                          |       | 439,059 |   | 266,907 |   |
| Research and development                                          |       | 23,540                           |       | 26,938 |   | 21,047 |   |
| Amortization and impairment of acquired intangibles               |       | 84,252                           |       | 98,954 |   | 33,496 |   |
| Operating income (loss)                                           |       | 78,857                           |       | 33,341 |   | (41,837 | ) |
| Other income (expense):                                           |       |                             |       |   |   |   |   |
| Interest income                                                   |       | 1,033                            |       | 1,662 |   | 1,132 |   |
| Interest expense                                                  |       | (157,032                         | )          | (173,162 | ) | (72,409 | ) |
| Other income (expense), net                                       |       | 6,073                            |       | (9,205 | ) | 742 |   |
| Loss on early extinguishment of debt                              |       | —                           |       | — |   | (14,539 | ) |
| Loss from continuing operations before income taxes               |       | (71,069                          | )          | (147,364 | ) | (126,911 | ) |
| Benefit for income taxes                                          |       | (21,678                          | )          | (49,681 | ) | (43,456 | ) |
| Loss from continuing operations                                   |       | (49,391                          | )          | (97,683 | ) | (83,455 | ) |
| Income (loss) from discontinued operations, net of  tax           |       | (319                             | )          | 946 |   | 1,448 |   |
| Net loss                                                          |       | (49,710                          | )          | (96,737 | ) | (82,007 | ) |
| Less: Net income attributable to noncontrolling  interests        |       | 723                              |       | 1,049 |   | 415 |   |
| Net loss attributable to DJO Finance LLC                          |       | $                                | (50,433    | ) | $ | (97,786 | ) | $ | (82,422 | ) |

 

See accompanying notes to consolidated financial statements.

 

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**DJOFinance LLC**

**Consolidated Statements ofChanges in Membership Equity and Comprehensive Loss**

**(in thousands)**

 
| ** **                                                      | ** ** | **DJO Finance LLC** | ** ** | ** **      | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|------------------------|------------|
| ** **                                                      | ** ** | ** **          | ** ** | ** **      | ** ** | **Accumulated**        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | ** **          | ** ** | ** **      | ** ** | **Other**              | ** ** | **Total** | ** ** | **Non-** | ** ** | **Total** | ** ** |
| ** **                                                      | ** ** | **Paid-In**         | ** ** | **Accumulated** | ** ** | **Comprehensive**      | ** ** | **Membership** | ** ** | **Controlling** | ** ** | **Membership** | ** ** |
| ** **                                                      | ** ** | **Capital**         | ** ** | **Deficit**     | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** | **Interests** | ** ** | **Equity** | ** ** |
| *** ***                                                    |       |                |       |            |       |                   |       |   |   |   |   |   |   |
| Balance at December 31, 2006                               |       | $                   | 373,469    |            | $          | (41,634                | )          | 3,373 |   | $ | 335,208 |   | $ | 909 |   | $ | 336,117 |   |
| Net loss                                                        |       | —              |       | (82,422         | )          | —                 |       | (82,422 | ) | 415 |   | (82,007 | ) |
| Change in fair value of derivatives, net of tax  of $1,529 |       | —              |       | —          |       | (2,383                 | )          | (2,383 | ) | — |   | (2,383 | ) |
| Foreign currency translation adjustments                        |       | —              |       | —          |       | 5,200                  |       | 5,200 |   | (109 | ) | 5,091 |   |
| Comprehensive loss                                              |       | —              |       | —          |       | —                 |       | (79,605 | ) |   |   | (79,299 | ) |
| Repurchase of Prior Transaction Management Rollover  Options    |       | (1,248              | )          | —          |       | —                 |       | (1,248 | ) | — |   | (1,248 | ) |
| Stock-based compensation                                        |       | 1,541               |       | —          |       | —                 |       | 1,541 |   | — |   | 1,541 |   |
| Reversal of tax benefit associated with stock  options          |       | (985                | )          | —          |       | —                 |       | (985 | ) | — |   | (985 | ) |
| Investment by Parent                                            |       | 450,077             |       | —          |       | —                 |       | 450,077 |   | — |   | 450,077 |   |
| Balance at December 31, 2007                               |       | $                   | 822,854    |            | $          | (124,056               | )          | 6,190 |   | $ | 704,988 |   | $ | 1,215 |   | $ | 706,203 |   |
| Net loss                                                        |       | —              |       | (97,786         | )          | —                 |       | (97,786 | ) | 1,049 |   | (96,737 | ) |
| Change in fair value of derivatives, net of tax  of $3,660 |       | —              |       | —          |       | (5,699                 | )          | (5,699 | ) | — |   | (5,699 | ) |
| Foreign currency translation adjustments                        |       | —              |       | —          |       | (4,518                 | )          | (4,518 | ) | (521 | ) | (5,039 | ) |
| Comprehensive loss                                              |       | —              |       | —          |       | —                 |       | (108,003 | ) |   |   | (107,475 | ) |
| Stock-based compensation                                        |       | 1,381               |       | —          |       | —                 |       | 1,381 |   |   |   | 1,381 |   |
| Balance at December 31, 2008                               |       | $                   | 824,235    |            | $          | (221,842               | )          | (4,027 | ) | $ | 598,366 |   | $ | 1,743 |   | $ | 600,109 |   |
| Net loss                                                        |       | —              |       | (50,433         | )          | —                 |       | (50,433 | ) | 723 |   | (49,710 | ) |
| Change in fair value of derivatives, net of tax  of $737   |       | —              |       | —          |       | (3,973                 | )          | (3,973 | ) | — |   | (3,973 | ) |
| Foreign currency translation adjustments                        |       | —              |       | —          |       | 8,518                  |       | 8,518 |   | 43 |   | 8,561 |   |
| Comprehensive loss                                              |       | —              |       | —          |       | —                 |       | (45,888 | ) |   |   | (45,122 | ) |
| Stock-based compensation                                        |       | 3,382               |       | —          |       | —                 |       | 3,382 |   | — |   | 3,382 |   |
| Balance at December 31, 2009                               |       | $                   | 827,617    |            | $          | (272,275               | )          | 518 |   | $ | 555,860 |   | $ | 2,509 |   | $ | 558,369 |   |

 

See accompanying notes to consolidated financial statements.

 

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# **DJO Finance LLC**

**Consolidated Statements of Cash Flows**

**(inthousands)**

 
| ** **                                                                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                       | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| **OPERATING ACTIVITIES:**                                                                                        | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                                                         |       | $                                | (49,710    | ) | $ | (96,737 | ) | $ | (82,007 | ) |
| Adjustments to reconcile net loss to net cash (used  in) provided by operating activities:                       |       |                             |       |   |   |   |   |
| Depreciation                                                                                                     |       | 27,896                           |       | 23,597 |   | 14,744 |   |
| Amortization and impairment of intangibles                                                                       |       | 84,252                           |       | 98,954 |   | 33,496 |   |
| Amortization of debt issuance costs and non-cash  interest expense                                               |       | 12,679                           |       | 13,177 |   | 4,862 |   |
| Non-cash loss on early extinguishment of debt                                                                    |       | —                           |       | — |   | 9,744 |   |
| Stock-based compensation                                                                                         |       | 3,382                            |       | 1,381 |   | 1,541 |   |
| Asset impairments and net (gain) loss on disposal  of assets                                                     |       | (2,094                           | )          | 3,069 |   | 682 |   |
| Deferred income taxes                                                                                            |       | (23,690                          | )          | (42,157 | ) | (47,221 | ) |
| Provisions for doubtful accounts and sales returns                                                               |       | 34,904                           |       | 26,277 |   | 22,428 |   |
| Inventory reserves                                                                                               |       | 7,462                            |       | 8,637 |   | 3,580 |   |
| Acquired in-process research and development                                                                     |       | —                           |       | — |   | 3,000 |   |
| Net effect of discontinued operations, net of  (gain) loss on disposal                                           |       | (393                             | )          | — |   | 378 |   |
| Changes in operating assets and liabilities, net of  acquired assets and liabilities:                            |       |                             |       |   |   |   |   |
| Accounts receivable                                                                                              |       | (15,156                          | )          | (37,064 | ) | (15,301 | ) |
| Inventories                                                                                                      |       | (1,868                           | )          | (1,609 | ) | 7,075 |   |
| Prepaid expenses, other assets and liabilities                                                                   |       | 3,438                            |       | 68 |   | 1,567 |   |
| Accrued interest                                                                                                 |       | 2                                |       | 835 |   | 2,130 |   |
| Accounts payable and other current liabilities                                                                   |       | (13,310                          | )          | (10,489 | ) | 10,543 |   |
| Net cash provided by (used in) operating activities                                                              |       | 67,794                           |       | (12,061 | ) | (28,759 | ) |
| **INVESTING ACTIVITIES:**                                                                                        | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Acquisition of businesses and intangibles, net of  cash acquired                                                 |       | (13,086                          | )          | (5,095 | ) | (1,313,110 | ) |
| Purchases of property and equipment                                                                              |       | (28,872                          | )          | (25,905 | ) | (13,962 | ) |
| Proceeds from sales of assets                                                                                    |       | 25,617                           |       | 14 |   | 4,591 |   |
| Other                                                                                                            |       | 341                              |       | 1,390 |   | (583 | ) |
| Net cash used in investing activities                                                                            |       | (16,000                          | )          | (29,596 | ) | (1,323,064 | ) |
| **FINANCING ACTIVITIES:**                                                                                        |       |                             |       |   |   |   |   |
| Investment by parent                                                                                             |       | —                           |       | — |   | 434,599 |   |
| Proceeds from long-term debt and revolving line of  credit                                                       |       | 68,260                           |       | 46,540 |   | 1,724,350 |   |
| Retirement of debt and payments on long-term debt  and revolving line of credit                                  |       | (103,521                         | )          | (37,294 | ) | (718,421 | ) |
| Payment of debt issuance costs                                                                                   |       | —                           |       | — |   | (55,866 | ) |
| Excess tax benefit associated with stock option  exercises                                                       |       | —                           |       | — |   | 370 |   |
| Repurchase of prior transaction management rollover  options                                                     |       | —                           |       | — |   | (1,248 | ) |
| Dividend paid to minority interests of subsidiary                                                                |       | —                           |       | (381 | ) | (226 | ) |
| Net cash (used in) provided by financing activities                                                              |       | (35,261                          | )          | 8,865 |   | 1,383,558 |   |
| Effect of exchange rate changes on cash and cash  equivalents                                                    |       | (2,405                           | )          | (196 | ) | 833 |   |
| **Net increase (decrease) in cash  and cash equivalents**                                                        |       | 14,128                           |       | (32,988 | ) | 32,568 |   |
| Cash and cash equivalents at beginning of period                                                                 |       | 30,483                           |       | 63,471 |   | 30,903 |   |
| **Cash and cash equivalents at  end of period**                                                                  |       | $                                | 44,611     |   | $ | 30,483 |   | $ | 63,471 |   |
| **Supplemental disclosures of  cash flow information:**                                                          |       |                             |       |   |   |   |   |
| Cash paid for interest                                                                                           |       | $                                | 144,215    |   | $ | 158,798 |   | $ | 70,249 |   |
| Cash paid for income taxes                                                                                       |       | $                                | 3,777      |   | $ | 2,497 |   | $ | 912 |   |
| **Non-cash investing and  financing activities:**                                                                |       |                             |       |   |   |   |   |
| Increases in property and equipment and in other  liabilities in connection with capitalized software costs |       | $                                | 3,876      |   | $ | 4,066 |   | $ | — |   |
| Issuance of notes payable in connection with  acquisitions                                                       |       | $                                | 2,860      |   | $ | — |   | $ | — |   |
| Issuance of management rollover options                                                                          |       | $                                | —     |   | $ | — |   | $ | 15,478 |   |

 

See accompanying notes to consolidated financial statements.

 

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**Notes to Consolidated FinancialStatements**

 

**1.****                                    ****SUMMARYOF SIGNIFICANT ACCOUNTING PRINCIPLES**

 

**Basis of Presentation and Principles of Consolidation. **We are a 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 implantproducts. We 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 orthopedic specialists, primary care physicians,pain management specialists, 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 for injury prevention and at-home physical therapy treatment.

 

In the first quarter of 2009, we changed how we report our segmentedfinancial information in accordance with the Financial Accounting Standards Board’s (“FASB”)Accounting Standards Codification (“ASC”) topic 280 (formerlyFinancial Accounting Standards Statement (“SFAS”) No.131, “Disclosures aboutSegments of an Enterprise and Related Information”).  Prior to 2009, we included the internationalcomponents of the Surgical, Chattanooga, and Empi businesses in either theSurgical or Domestic Rehabilitation segments, as their operations were manageddomestically.  During the fourth quarterof 2008, we effected an operational reorganization which resulted in thenon-U.S. components of all of our businesses being managed abroad.  Our segment information now reflects theinternational components of all of our businesses within our Internationalsegment.  Prior year segment informationhas been reclassified to conform with our 2009 segmentation.

 

On June 12,2009 we sold our Empi Therapy Solutions (“ETS”) catalog business, formerlyknown as Rehab Medical Equipment, or RME, to Patterson Medical Supply, Inc.for approximately $21.8 million.  Assuch, results of our ETS business for periods prior to the date of sale havebeen presented as discontinued operations (see Note 3).

 

We market and distribute our products through three operating segments,Domestic Rehabilitation, International, and Domestic Surgical Implant. OurDomestic Rehabilitation Segment offers to customers in the United States,non-invasive medical products that are used before and after surgery to assistin the repair and rehabilitation of soft tissue and bone, and to protectagainst further injury; electrotherapy devices and accessories used to treatpain and restore muscle function; iontophoretic devices and accessories used todeliver medication; clinical therapy tables, traction equipment and otherclinical therapy equipment; orthotic devices used to treat joint and spineconditions; orthopedic soft goods; rigid knee braces; and vascular systemswhich include products intended to prevent deep vein thrombosis followingsurgery. Our Domestic Surgical Implant Segment offers a comprehensive suite ofreconstructive joint products to customers in the United States.  Our International segment offers all of ourproducts to customers outside the United States.

 

On November 20, 2007, a subsidiary of ReAble Therapeutics, Inc.(“ReAble”) was merged into DJO Opco Holdings, Inc. (“DJO Opco”), with DJOOpco continuing as the surviving corporation (the “DJO Merger”). As a result ofthe DJO Merger, DJO Opco became a subsidiary of ReAble TherapeuticsFinance LLC, the entity filing this Annual Report on Form 10-K, whichis itself a subsidiary of ReAble. Following the DJO Merger, ReAble was renamedDJO Incorporated (“DJO”), ReAble Therapeutics Finance LLC was renamed DJOFinance LLC (“DJOFL”) and ReAble Finance Corporation, the co-issuer ofboth the 10.875% Senior Notes and 11.75% Senior Subordinated Notes (seeNote 9), was renamed DJO Finance Corporation (“Finco”).

 

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

 

Noncontrolling interests reflect the 50% separate ownership ofMedireha GmbH (“Medireha”) which is not attributable to us. We haveconsolidated Medireha for financial reporting purposes due to our controllinginterest. Our controlling interest consists of our 50% ownership and ourcontrol of one of the two director seats, our rights to prohibit certainbusiness activities that are not consistent with our plans for the business andour exclusive distribution rights for products manufactured by Medireha. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

**Use of Estimates. **The preparationof financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make certainestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. On an ongoing basis, management evaluates itsestimates, including those related to contractual allowances, doubtful accounts,inventories, rebates, product returns, warranty obligations, self insurance,income taxes, goodwill and intangible assets and stock-based compensation. Webase our estimates on historical experience and on various other assumptionsthat we believe are reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultscould differ from those estimates.

 

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## **Cash and CashEquivalents. **Cash consists ofdeposits with financial institutions. We consider all short-term, highly liquidinvestments and investments in money market funds and commercial paper withremaining maturities of less than three months at the time of purchase to becash equivalents. While our cash and cash equivalents are on deposit withhigh-quality institutions, such deposits exceed Federal Deposit InsuranceCorporation insured limits.

## ** **

## **Allowance for DoubtfulAccounts. **We make estimates ofthe collectability of accounts receivable. Management analyzes accounts receivable historical collection rates andbad debts write-offs, customer concentrations, customer credit-worthiness, andcurrent economic trends when evaluating the adequacy of the allowance fordoubtful accounts.

## ** **

## **Sales Returns andAllowances**.  We make estimatesof the amount of sales returns and allowances that will eventually beincurred.  Management analyzes salesprograms that are in effect, contractual arrangements, market acceptance andhistorical trends when evaluating the adequacy of sales returns and allowanceaccounts.  We estimate contractualdiscounts and allowances for reimbursement amounts from our third-party payorcustomers based on negotiated contracts and historical experience.

## ** **

## **Inventories. **Inventory is valued at the lower ofcost (determined on a first-in, first-out basis) or market.  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 and equipment are stated at cost less accumulated depreciationand amortization.  Depreciation iscalculated for financial reporting purposes using the straight-line method overthe estimated useful lives of the assets that range from three to 25 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 implantinstruments that we provide to surgeons, free of charge, for use whileimplanting our products and the related depreciation expense is recorded as acomponent of selling, general and administrative expense.  We also capitalize electrotherapy devicesthat we rent to patients and record the related depreciation expense in cost ofsales.

 

**Computer Software Costs. **Software is stated at cost less accumulated amortization and isamortized using the straight-line method over its estimated useful life rangingfrom three to seven years.  In accordancewith Financial Accounting Standards Board’s (“FASB”) Accounting StandardsCodification (“ASC”) Topic 350 (formerly American Institute of Certified PublicAccountants Statement of Position (“SOP”) 98-1, “Accounting for  the Costs of Computer Software Developed orObtained for Internal Use”), we capitalize costs of internally developedsoftware during the development stage. Additionally, we capitalize relatedcosts including external consulting costs, cost of software licenses, andinternal payroll and payroll-related costs for employees who are directlyassociated with a software project. Software assets are reviewed for impairment when events or circumstancesindicate that the carrying value may not be recoverable over the remaininglives of the assets. Upgrades and enhancements are capitalized if they resultin added functionality. In 2008, we began implementing a new ERP system.  As a result we had approximately $11.7million and $4.5 million of capitalized software costs as of December 31,2009, and 2008, respectively.

 

**Impairment of Long-Lived Assets**.  In accordance with ASC Topic 350-30 (formerlySFAS 144, “Accounting for theImpairment of Long-Lived Assets”) we test long-lived assets forimpairment when events or changes in circumstances may indicate that thecarrying amount of an asset may not be recoverable.  Recoverability of long-lived assets ismeasured by a comparison of the carrying amount of an asset to the undiscountedfuture net cash flows expected to be generated by the asset.  If such assets are considered to be impaired,the impairment to be recognized is measured as an amount by which the carryingamount of the assets exceed the discounted future net cash flows. Assets to bedisposed of are reported at the lower of the carrying amount or estimated salevalue less estimated costs to sell.

 

**Goodwill and Intangible Assets.**  Goodwill represents the excess of thepurchase price over the fair value of tangible and identifiable intangibleassets acquired and liabilities assumed. In accordance with ASC Topic 350 (formerly SFAS No. 142, “Goodwilland Other Intangible Assets,”) we do not amortize goodwill. In lieu ofamortization, we are required to perform an annual review for impairment.Goodwill is recorded as the difference, if any, between the aggregateconsideration paid for an acquisition and the fair value of the net tangibleand intangible assets acquired. The amounts and useful lives assigned tointangible assets acquired, other than goodwill, impact the amount and timingof future amortization, and the amount assigned to in-process research and developmentwhich is expensed immediately. The value of our intangible assets, includinggoodwill, could be impacted by future adverse changes such as: (i) anyfuture declines in our operating results, (ii) a decline in the valuationof comparable company stocks, (iii) a further slowdown in the worldwideeconomy or our industry or (iv) any failure to meet the performanceprojections included in our forecasts of future operating results. We performan impairment analysis on our goodwill on an annual basis in the fourth quarterand in certain 

 

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othercircumstances when impairment indicators are present.  We estimated the fair values of our reportingunits using the income approach valuation methodology that includes thediscounted cash flow method, and the market approach valuation methodology thatincludes the use of market multiples. The discounted cash flows for each reportingunit were based on discrete financial forecasts developed by management forplanning purposes. Cash flows beyond the discrete forecasts were estimatedusing a terminal value calculation, which incorporated historical andforecasted financial trends for each identified reporting unit and consideredlong-term earnings growth rates for publicly traded peer companies. Future cashflows were discounted to present value. Specifically, the income approachvaluations included reporting unit cash flow discount rates ranging from 10.5%to 12.6% and terminal value growth rates of 3%. Publicly available informationregarding comparable market capitalization was also considered in assessing thereasonableness of the cumulative fair values of our reporting units estimatedusing the discounted cash flow methodology. Significant management judgment isrequired in the forecasts of future operating results that are used in thediscounted cash flow method of valuation. Our annual impairment test related togoodwill did not indicate any impairment. The estimates we have used are consistent with the plans and estimatesthat we use to manage our business. It is possible, however, that the plans maychange and estimates used may prove to be inaccurate. If our actual results, orthe plans and estimates used in future impairment analyses, are lower than theoriginal estimates used to assess the recoverability of these assets, we couldincur significant impairment charges.

 

Identifiableintangible assets consist of trademarks, trade names, patents, distributionnetworks, intellectual property, non-compete agreements and customer lists andare carried at fair value on date of purchase less accumulatedamortization.  Amortization of identifiableintangibles is computed using the straight-line method over their estimateduseful lives.  Our customer andtechnology based intangibles have a weighted average amortization period of 10years. Our trade names were determined to have an indefinite life.

 

We test intangible assets with indefinite lives in accordance with ASC Topic350, which states that intangibleassets with indefinite lives should be tested annually in lieu of beingamortized.  This test compares the fairvalue of the intangible with its carrying amount.  To determine the fair value we applied therelief from royalty method (“RFR”). Under the RFR method, the value of the trade name is determined bycalculating the present value of the after-tax cost savings associated withowning the asset and therefore not being required to pay royalties for its useduring the asset’s indefinite life. Significant judgments inherent in this analysis include the selection ofappropriate discount rates, estimating future cash flows and the identificationof appropriate terminal growth rate assumptions.  Discount rate assumptions are based on anassessment of the risk inherent in the projected future cash generated by therespective intangible assets.  Alsosubject to judgment are assumptions about royalty rates, which are based on theestimated rates at which similar brands and trademarks are being licensed inthe marketplace. In the fourth quarter fiscal 2009, we determined that the fairvalue of two of our trade names were less than the carrying amount, resultingin an aggregate impairment charge of $7.0 million, which was included inamortization and impairment of intangibles within the consolidated statement ofoperations for the year ended December 31, 2009.  During the fourth quarter of 2008, wedetermined that the fair value of a trade name was less than its carryingamount and another trade name was abandoned, resulting in an aggregateimpairment charge of $22.4 million, which was included in amortization andimpairment of intangibles within the consolidated statement of operations for theyear ended December 31, 2008.

 

**Debt Issuance Costs.**  Debt issuance costs are capitalized and areincluded in other non-current assets on our consolidated balance sheet.  We amortize these costs over the lives of therelated debt instruments (currently, approximately seven years) and classifythe amortization expense with interest expense in the accompanying consolidatedstatements of operations.  At December 31,2009 and 2008, we had unamortized debt issuance costs of $38.9 million and$49.9 million, respectively.

## ** **

## **Warranty Costs. **We provide expressed warranties oncertain products for 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.

## ** **

Asummary of the activity in our warranty reserves is as follows (in thousands):

 
| ** **                                                   | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning balance                                            |       | $                                | 1,761      |   | $ | 1,720 |   | $ | 1,348 |   |
| Amount charged to expense for estimated  warranty costs |       | 952                              |       | 1,258 |   | 509 |   |
| Deductions for actual costs incurred                         |       | (777                             | )          | (1,217 | ) | (454 | ) |
| Acquired through business acquisitions                       |       | —                           |       | — |   | 317 |   |
| Ending balance                                               |       | $                                | 1,936      |   | $ | 1,761 |   | $ | 1,720 |   |

 

**Self Insurance.**  Weare partially self insured for certain employee health benefits and product liabilityclaims.  Accruals for losses are providedbased upon claims experience and actuarial assumptions, including provisionsfor incurred but not reported losses.

 

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## **Revenue Recognition.  **We recognize revenue pursuant toASC Topic 605 (Staff Accounting Bulletin No. 104, Revenue Recognition).Accordingly, revenue is recognized when all four of the following criteria aremet: (i) persuasive evidence that an arrangement exists; (ii) shipmentof goods and passage of title; (iii) the selling price is fixed ordeterminable; and (iv) collectibility is reasonably assured.  We reduce revenue by estimates of potentialfuture product returns and other allowances. Revenues are also reduced by rebates related to sales transacted throughdistribution agreements that provide the distributors with a right to returninventory or take certain pricing adjustments based on sales mix orvolume.  Provisions for product returnsand other allowances are recorded as a reduction to revenue in the period salesare recognized.

## ** **

**AdvertisingCosts.**  We expense advertising costs asthey are incurred. For the years ended December 31, 2009, 2008 and 2007,advertising costs were approximately $5.4 million, $7.0 million and $3.9million, respectively.

## ** **

**Shipping and Handling Expenses. **Shipping andhandling expenses are included within cost of sales in our consolidatedstatement of operations.

 

## **Stock BasedCompensation. **We maintain a stockoption plan under which stock options have been granted to employees andnon-employee members of the Board of Directors. We record stock options pursuant to ASC Topic 718 (formerly SFAS No. 123(R) “Share Based Payments”) which requires that all share based paymentsto employees be recognized in the financial statements based upon theirrespective grant date fair values.  Assuch we amortize stock-based compensation for service-based awards granted on astraight-line basis over the requisite service (vesting) period for the entireaward.  Other awards vest over a specified performance period from thedate of grant upon the achievement of certain pre-determined performancetargets over time and compensation expense is recognized to the extent theachievement of the performance targets is deemed probable. Refer to Note11 for further discussion.

## ** **

## **Income Taxes. **We account for income taxes underthe asset and liability method as set forth in ASC Topic 740 (formerly SFAS No. 109,*“*Accounting for Income Taxes*”*).  Under thismethod, deferred tax assets and liabilities are recognized and measured usingenacted tax rates in effect for the year in which the differences are expectedto be recognized.  Valuation allowancesare established when necessary to reduce deferred tax assets to amounts thatare more likely than not to be realized.

## ** **

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

 

**Derivative Financial Instruments.**  We account for derivatives pursuant to ASC Topic815 (formerly SFAS No. 133, “Accounting for Derivative Instruments andHedging”), which requires that all derivative instruments be recognized in thefinancial statements and measured at fair value regardless of the purpose orintent for holding them.

 

*Foreign Exchange Forward Contracts*

 

We use foreign exchange forward contracts to hedge expense commitmentsthat are denominated in currencies other than the U.S. dollar. The purpose ofour foreign currency hedging activities is to fix the dollar value of specificcommitments and payments to foreign vendors. Before acquiring a derivativeinstrument to hedge a specific risk, potential natural hedges are evaluated.  While our foreign exchange contracts act aseconomic hedges, we have not designated such instruments as hedges. Theclassification of gains and losses resulting from changes in the fair values ofderivatives is dependent on the intended use of the derivative and itsresulting designation. The change in fair value of the effective portion of ahedge, and changes in the fair values of the derivative are recorded in othercomprehensive income and are subsequently recognized in earnings when thehedged item affects earnings.  At December 31,2009, the fair value of our foreign exchange forward contracts was a gain of$0.1 million and was determined through the use of models that consider variousassumptions, including time value, yield curves, as well as other relevanteconomic measures, which are inputs that are classified as Level 2 in thevaluation hierarchy.

 

*Interest Rate Swap Agreements*

 

We make use of debt financing as a source of funds and are thereforeexposed to interest rate fluctuations in the normal course of business. Ourcredit facilities are subject to floating interest rates. We manage the risk ofunfavorable movements in interest rates by hedging the interest rates on aportion of the outstanding loan balance, thereby locking in a fixed rate on aportion of the principal, reducing the effect of possible rising interest ratesand making interest expense more predictable. We have designated these interest rate swap agreements as cash flowhedges. At December 31, 2009, the fair value of our interest rate swapagreements was a loss of $11.2 million and was determined through the use ofmodels that consider various assumptions, including time value, yield curves,as well as other relevant economic measures, which are inputs that areclassified as Level 2 in the valuation hierarchy.

 

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**ComprehensiveIncome (Loss). **Comprehensiveincome (loss) includes net income and other comprehensive income.  Other comprehensive income (loss) refers tounrealized gains and losses that are excluded from current earnings and arerecorded directly as an adjustment to membership equity.  These gains and losses often fluctuate beforebeing 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.**  We sell the majority of our products in theUnited States to orthopedic professionals, hospitals, distributors, specialtydealers, insurance companies, managed care companies and certain governmentalpayors such as Medicare.  Internationalsales comprised 25.5%, 26.6%, and 28.8% of our net revenues for the years endedDecember 31, 2009, 2008 and 2007, respectively.  International sales are generated from adiverse group of customers through our wholly owned subsidiaries and certainindependent distributors. Credit is extended based on an evaluation of thecustomer’s financial condition and generally collateral is not required. Weprovide a reserve for estimated bad debts. Management reviews and revises its estimates for credit losses from timeto time and such credit losses have generally been within management’sestimates.

 

Duringthe three years ending December 31, 2009, we had no individual customer ordistributor that accounted for 10% or more of our total annual revenues.

 

**Fair Value of Financial Instruments. **The carrying amounts of ourshort-term financial instruments, including cash and cash equivalents, accountsreceivable and accounts payable, approximate fair values due to theirshort-term nature.  The fair values ofour variable rate debt, including borrowings under our Senior Secured CreditFacility, approximate carrying value due to the variable interest rate featureson these instruments. We estimated the fair value of our long-term fixed ratenotes based on trading prices for the notes on or near December 31, 2009and 2008 (see Note 9).

 

## **Reclassifications.**The consolidatedfinancial statements and accompanying footnotes reflect certainreclassifications to prior year consolidated financial statements to conform tothe current year presentation.

## ** **

**Discontinued Operations**.  In determining whether a group of assetsdisposed of (or to be disposed of) should be presented as a discontinuedoperation, we make a determination of whether the group of assets beingdisposed of comprises a component of the entity; that is, whether it hashistoric operations and cash flows that can be clearly distinguished (bothoperationally and for financial reporting purposes). We also determine whetherthe cash flows associated with the group of assets have been significantly (orwill be significantly) eliminated from our ongoing operations as a result ofthe disposal transaction and whether we have no significant continuinginvolvement in the operations of the group of assets after the disposaltransaction. If these determinations can be made affirmatively, the results ofoperations of the group of assets being disposed of (as well as any gain orloss on the disposal transaction) are aggregated for separate presentationapart from our continuing operating results in our consolidated financialstatements. See Note 3 for a summary of discontinued operations.

 

**Recent Accounting Pronouncements.**  In September 2009, we adopted ASC Topic 105 (formerly SFAS No. 168,“The FASB Accounting Standards Codification and the Hierarchy of GenerallyAccepted Accounting Principles”), which makes the Codification the source ofauthoritative US Generally Accepted Accounting Principles recognized by theFASB, and applied to non-governmental entities. ASC Topic 105 does not changepreviously issued Accounting Standards, but reorganizes the AccountingStandards into topics. In circumstances where previous Accounting Standardsrequire a revision, FASB will issue an Accounting Standards Update (“ASU”) onthe topic.

 

InSeptember 2009, the FASB issued ASU 2009-13, which amends ASC Topic 605 (formerly EITFIssue No. 08-1, “Revenue Arrangements with Multiple Deliverables.”). ASU2009-13 provides guidance concerning (1) the determination of whether anarrangement involving multiple deliverables contains more than one unit of accounting,and (2) the manner in which consideration should be measured and allocatedto the separate units of accounting in the multiple-element arrangement and iseffective for fiscal years beginning on or after June 15, 2010. We arecurrently evaluating the impact, if any; this issue will have on ourconsolidated financial statements. However, we do not expect that this issuewill result in a change in current practice.

 

In June 2009, theFASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)”(“SFAS 167”), now included within ASC topic 810. ASC topic 810 amends theevaluation criteria to identify the primary beneficiary of a variable interestentity and requires ongoing reassessment of whether an enterprise is theprimary beneficiary of the variable interest entity. ASC Topic 810 is effectivefor fiscal years beginning after November 15, 2009, and interim periodswithin those years. We will adopt this statement as of the beginning of 2010and are currently assessing the potential impact of adoption.

 

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In June 2009, theFASB issued SFAS No. 166, “Accounting for the Transfers of FinancialAssets as amendment of FASB Statement No. 140” (“SFAS 166”), now includedwithin ASC Topic 860,  which amends SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets” (“SFAS 140”). ASC Topic860 makes the following amendments to SFAS 140: 1) removes concept ofqualifying special-purpose entities from SFAS 140; 2) modifies the financialcomponents approach used and limits the circumstances in which a transferor hasnot transferred the original financial asset to an entity that is notconsolidated with the transferor in the financial statements; 3) establishesconditions for reporting a transfer of a portion of a financial asset as asale; 4) redefines a participating interest; 5) clarifies that an entity mustconsider all arrangements or agreements made contemporaneously with, or incontemplation of, a transfer, even if not entered into at the time of thetransfer; 6) clarifies that the transferor must evaluate whether it, itsconsolidated affiliates included in the financial statements being presented,or its agency effectively control the transferred financial asset directly orindirectly; 7) requires that the transferor recognize and initially measure atfair value all assets obtained and liabilities incurred as a result of the atransfer of an entire asset or group of financial assets accounted for as asale; 8) removes special provisions for guaranteed mortgage securitizations torequire them to be treated that same as any other transfer of financial assets;9) Removes fair value practicability exception from measuring the proceedsreceived by a transferor in a transfer that meet the conditions for saleaccounting at fair value; and 10) requires enhanced disclosures. We will adoptthis statement as of the beginning of 2010 and are currently assessing thepotential impact of adoption.

 

In May 2009, theFASB issued, and we adopted, ASC Topic 855 (formerly SFAS No. 165, “SubsequentEvents”), which requires entities to disclose certain events that occur afterthe balance sheet date but before the financial statements are issued (See Note20).

 

As of January 1, 2009, we adopted ASC topic 815 (formerly SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities”), whichrequires entities to disclose the fair values of derivative instruments andtheir gains and losses in a tabular format and to provide enhanced disclosuresabout (a) how and why they use derivative instruments, (b) howderivative instruments and related hedged items are accounted for under ASC Topic815 and its related interpretations, and (c) how derivative instrumentsand related hedged items affect their financial performance, and cashflows.  Except for adding the requireddisclosures (see Note 17), the adoption of ASC Topic 815 had no impact on ourconsolidated financial statements.

 

We have adopted ASC topic 810 (formerly SFAS No. 160, “Non-controllingInterests in Consolidated Financial Statements-an amendment of ARB No. 51,Consolidated Financial Statements”) which amends Accounting Research Bulletin No. 51,“Consolidated Financial Statements”, to establish accounting and reportingstandards for the noncontrolling interest in a subsidiary.  This standard defines a noncontrollinginterest, previously called a minority interest, as the portion of equity in asubsidiary not attributable, directly or indirectly, to a parent.  ASC Topic 810 requires, among other items,that a noncontrolling interest be included in the consolidated statement offinancial position within equity separate from the parent’s equity;consolidated net income to be reported at amounts inclusive of both the parent’sand noncontrolling interest’s shares; and if a subsidiary is deconsolidated,any retained noncontrolling equity investment in the former subsidiary bemeasured at fair value and a gain or loss be recognized in net income based onsuch fair value.  We have applied thepresentation and disclosure requirements of ASC Topic 810 retrospectively.

 

As of January 1, 2009, we have adopted ASC Topic 805 (formerlySFAS No. 141R, “Business Combinations”), which requires the acquiringentity in a business combination to recognize all the assets acquired andliabilities assumed in the transaction; establishes the acquisition-date fairvalue as the measurement objective for all assets acquired and liabilities assumed;and requires the acquirer to disclose to investors and other users all of theinformation they need to evaluate and understand the nature and financialeffect of the business combination (see Note 2).

 

Weadopted ASC topic 825 (formerly SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities—Including an amendment to FASBStatement No. 115”) in 2008, which permits entities to choose to measuremany financial instruments and certain other items at fair value. The provisionsof ASC Topic 825 did not have a material impact on our consolidated financialstatements.

 

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

## ** **

We account for acquisitions in accordance with ASC Topic 805, with theresults of operations attributable to each acquisition included in theconsolidated financial statements from the date of acquisition.

 

During 2009 we made three acquisitions of active distributors of ourproducts.  Our primary reason for theseacquisitions was to move from an indirect sales model (i.e., sales todistributors at a discount) to a direct sales model, resulting in increasedgross profit and operating income.

 

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***Acquisition of Chattanooga GroupInc. (Canada)***

 

OnAugust 4, 2009 we acquired Chattanooga Group Inc., a Canadian distributorof certain of our products (“Chattanooga Canada”), for $7.2 million. Pursuantto the terms of the acquisition agreement and included within the purchaseprice, is a $1.4 million holdback and a $1.4 million promissory note. Theholdback provides security for potential indemnification claims and, if notused for that purpose, will be paid to the sellers. The holdback amount accruesinterest at an annual rate of 2.5% for the first 18 months and a variable ratethereafter.  Half of any holdback amountnot used to cover indemnification claims will be paid with interest in January 2011and the remainder of the balance with interest is due approximately three yearsafter closing, upon expiration of a statutory period provided for under relevant tax law.  The promissory notes accrues interest at anannual rate of 6% with the principal and interest due in August 2010.

 

***Acquisition of Empi Canada Inc.***

 

OnAugust 4, 2009 we acquired Empi Canada Inc., a Canadian distributor ofcertain of our products (“Empi Canada”), for $7.4 million. Pursuant to theterms of the acquisition agreement and included within the purchase price, is a$1.4 million holdback and a $1.4 million promissory note. The holdback providessecurity for potential indemnification claims and, if not used for thatpurpose, will be paid to the sellers. The holdback amount accrues interest atan annual rate of 2.5% for the first 18 months and a variable rate thereafter.Half of any holdback amount not used to cover indemnification claims will bepaid with interest in January 2011 and the remainder of the balance withinterest is due approximately three years after closing, upon expiration of a statutory period provided for under relevanttax law. The promissory notes accrues interest at an annual rate of 6%with the principal and interest due in August 2010.

 

***Acquisition of DonJoy OrthopaedicsPty., Ltd.***

 

On February 3, 2009 we acquired DonJoy Orthopaedics Pty., Ltd. anAustralian distributor of certain of our products (“DJO Australia”), for $3.4million. Pursuant to the terms of the acquisition agreement and included withinthe purchase price, is $0.8 million, representing the acquisition date fairvalue of the additional amount expected to be paid to the selling shareholderof DJO Australia if certain revenue targets were met by December 31, 2009.Such revenue targets were met, and the additional amount of $0.8 million, whichwas included in accrued liabilities in the consolidated balance sheet at December 31,2009, was paid in the first quarter of fiscal year 2010.

 

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

 

On July 15, 2007, we entered into an Agreement and Plan of Merger(the “DJO Merger Agreement”) with DJO Opco, formerly known as DJO Incorporated,providing for the DJO Merger pursuant to which DJO Opco became a wholly ownedsubsidiary of DJOFL. The total purchase price for the DJO Merger, which wasconsummated on November 20, 2007, was approximately $1.3 billion andconsisted of $1.2 billion paid to former equity holders (or $50.25 in cashfor each share of common stock of DJO Opco they then held), $15.2 millionrelated to the fair value of stock options held by DJO Opco management thatwere exchanged for options to purchase DJO common stock, and $22.8 millionin direct acquisition costs. The DJO Merger was financed through a combinationof equity contributed by our primary shareholder, an affiliate of BlackstoneCapital Partners V, L.P. (“Blackstone”), borrowings under our seniorsecured credit facility (the “Senior Secured Credit Facility”), and proceedsfrom the newly issued 10.875% Senior Notes due 2014 (the “10.875% Notes”) (seeNote 9 for further information).

 

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

 

On August 9, 2007, we 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 andconsisted of $21.1 million in cash payments to former IOMED equity holdersat $2.75 per share, $0.8 million related to the fair value of vested stockoptions that were outstanding at the time of the acquisition, and $1.4 millionin direct acquisition costs. The IOMED acquisition was primarily financed withborrowings under our then existing revolving credit facility.

 

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

 

On July 2, 2007, we completed the purchase of substantially all ofthe assets of The Saunders Group, Inc. (“Saunders”) for total cashconsideration of $40.9 million, including $0.9 million of acquisitioncosts (the “Saunders Acquisition”). Saunders is a supplier of rehabilitationproducts to physical therapists, chiropractors, athletes, athletic trainers,physicians and patients, with a specialty in patented traction devices, backsupports, and equipment for neck and back disorders. The Saunders Acquisitionwas financed with funds borrowed under our then existing senior creditfacilities.

 

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The purchase prices for our acquisitions were allocated as follows tothe fair values of the net tangible and intangible assets acquired, includingthe cumulative impact of adjustments made to such allocations through December 31,2009 (see Note 7):

 
| **(in thousands):**                      | ** ** | **Chattanooga  Canada** | ** ** | **Empi  Canada** | ** ** | **DJO  Australia** | ** ** | **DJO Opco** | ** ** | **IOMED** | ** ** | **Saunders** | ** ** | **Wtd. Avg. Useful Life** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------------|------------|--------------------|------------|-------------------|------------|-----------|------------|--------------|------------|------------------------------------------|------------|
| Current  assets                               |       | $                       | 743        |             | $          | 884                |       | $                 | 2,046      |      | $          | 171,929      |       | $                                        | 8,971      |   | $ | 6,783 |   |   |   |
| Tangible  non-current assets                  |       | —                  |       | —           |       | —             |       | 67,385            |       | 853       |       | 273          |       |                                     |       |
| Liabilities  assumed                          |       | (2,254                  | )          | (1,033           | )          | (1,120             | )          | (697,465          | )          | (6,679    | )          | (628         | )          |                                     |       |
| Acquired  in-process research and development |       | —                  |       | —           |       | —             |       | 3,000             |       | —    |       | —       |       |                                     |       |
| Identifiable  intangible assets:              |       |                    |       |             |       |               |       |              |       |      |       |         |       |                                     |       |
| Technology-based                              |       | —                  |       | —           |       | —             |       | 354,000           |       | 6,616     |       | 10,171       |       | 14 years                                 |       |
| Customer-based                                |       | 5,058                   |       | 2,512            |       | 1,614              |       | 328,000           |       | 2,512     |       | 6,369        |       | 10 years                                 |       |
| Trademarks  and trade names                   |       | —                  |       | —           |       | —             |       | 356,000           |       | 1,777     |       | 4,423        |       | Indefinite                               |       |
| Non-compete                                   |       | 253                     |       | 174              |       | —             |       | —            |       | —    |       | —       |       | 5 years                                  |       |
| Goodwill                                      |       | 3,354                   |       | 4,902            |       | 899                |       | 691,884           |       | 9,255     |       | 13,537       |       | N/A                                      |       |
| Purchase  price                               |       | $                       | 7,154      |             | $          | 7,439              |       | $                 | 3,439      |      | $          | 1,274,733    |       | $                                        | 23,305     |   | $ | 40,928 |   |   |   |

 

Thepurchase price allocation for the Chattanooga Canada and Empi Canadaacquisitions included approximately $5.0 million and $2.5 million,respectively, assigned to intangible assets related to certain customerrelationships existing on the acquisition date and $0.3 million and $0.2million, respectively, assigned to intangible assets related to a five yearnoncompetition agreement with the seller. The value of the customerrelationships was based upon an estimate of the difference in future discountedcash flows that would be derived from sales to those customers.  The value of the noncompetition agreementswas based on an estimate of the future discounted cash flows with and withoutthe noncompetition agreements in place. Goodwill represents the excess of the purchase price over the fair valueof tangible and identifiable intangible assets acquired and liabilitiesassumed. For the Chattanooga Canada and Empi Canada acquisitions, a value ofapproximately $3.4 million and $4.9 million, respectively, representing thedifference between the total purchase price and the aggregate fair valueassigned to the net tangible assets acquired and the liabilities assumed andthe identifiable intangible assets acquired, was assigned to goodwill. As aresult of the acquisition, we anticipate future cost savings driven byestimated synergies from operating efficiencies as we combine these businesseswith our existing business in Canada. This is the primary reason the purchaseprices for Chattanooga Canada and Empi Canada resulted in the recognition ofgoodwill.

 

Thepurchase price allocation for the DJO Australia acquisition includedapproximately $1.6 million assigned to intangible assets related to certaincustomer relationships existing on the acquisition date. This value was basedupon an estimate of the future discounted cash flows that would be derived fromthose customers.  For the DJO Australiaacquisition, a value of approximately $0.9 million, representing the differencebetween the total purchase price and the aggregate fair value assigned to thenet tangible assets acquired and the liabilities assumed and the identifiableintangible assets acquired, was assigned to goodwill.

 

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

 

Goodwill represents the excess of the purchase price over the fairvalue of tangible and identifiable intangible assets acquired and liabilitiesassumed. A value of $691.9 million, representing the difference betweenthe total purchase price and the aggregate fair values assigned to the nettangible assets acquired and liabilities assumed and the identifiableintangible assets acquired, was assigned to goodwill. We acquired DJO Opco to expandour product offerings, increase our addressable market, increase the size ofour international business and increase our revenues. We also believed therewould be significant cost reduction synergies that would be realized as weintegrated the acquired business. These are among the factors that contributedto a purchase price for the DJO Merger acquisition that resulted in therecognition of goodwill.

 

***Sale of Other Product Lines***

 

During the fourth quarter of 2009 we also sold all rights, title andinterest to our spinal implant business and related property for $2.9million.  In addition, also during thefourth quarter of 2009, we sold our line of chiropractic tables known as theErgostyle line, and the TE-CH3 product (together referred to as “product line”)and other assets used in or otherwise related to the manufacture, sale andmarketing of the product line for approximately $0.8 million.

 

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***Other Acquisitions***

 

During2007, we completed the acquisition of Endeavor Medical, Inc. (“Endeavor”)and Performance Modalities, Inc. (“PMI”). On April 13, 2007, weacquired Endeavor for total consideration of $2.9 million. On February 16,2007, we acquired certain assets of PMI for total consideration of $4.3million. The allocation of the aggregate purchase price for both acquisitionsresulted in the recognition of $2.4 million of goodwill,

 

**3.****                                     ****DISCONTINUED OPERATIONS**

 

On June 12, 2009 wesold our Empi Therapy Solutions (“ETS”) catalog business, formerly known asRehab Medical Equipment, or RME, to Patterson Medical Supply, Inc. forapproximately $21.8 million. Our ETS business, which was included within ourDomestic Rehabilitation Segment, sold a wide range of proprietary and thirdparty rehabilitation products to physical therapists and chiropractors throughprinted catalog and an on-line e-commerce site. As such, results of the ETS business for periods prior to the date ofsale have been presented as discontinued operations.  Financial data for years ended December 31,2009, 2008, and 2007 related to discontinued operations includes the following(in thousands):

 
| ** **           | ** ** | **Year Ended December 31,** | ** ** |
|----------------------|------------|----------------------------------|------------|
| ** **           | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Total revenues       |       | $                                | 13,450     |   | $ | 31,725 |   | $ | 27,323 |   |
|                 |       |                             |       |   |   |   |   |
| Pre-tax income       |       | $                                | 6,590      |   | $ | 1,556 |   | $ | 2,401 |   |
| Income tax provision |       | 6,909                            |       | 610 |   | 953 |   |
| Net income (loss)    |       | $                                | (319       | ) | $ | 946 |   | $ | 1,448 |   |

 

Included withindiscontinued operations for the year ended December 31, 2009 is a pre-taxgain on disposal of discontinued operations of $6.6 million, which includesapproximately $12.0 million of goodwill associated with the ETS business based on the relative fair values of ETS and theportion of the reporting unit that will remain. The effective tax ratefor the discontinued operations for the year ended December 31, 2009 is105%, and differs from the amount which would have been recorded using the USstatutory tax rate due primarily to a large difference in the book and taxbasis of goodwill sold.

 

**4.****                                    ****ACCOUNTSRECEIVABLE RESERVES**

 

A summary of activity in ouraccounts receivable reserves for doubtful accounts and sales returns ispresented below (in thousands):

 
| ** **                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                 | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                 | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance, beginning of period                                               |       | $                                | 36,521     |   | $ | 32,417 |   | $ | 6,971 |   |
| Acquired through business acquisitions                                     |       | —                           |       | — |   | 14,591 |   |
| Provision for contractual allowances, doubtful  accounts and sales returns |       | 34,904                           |       | 26,277 |   | 22,428 |   |
| Write-offs, net of recoveries                                              |       | (23,119                          | )          | (22,173 | ) | (11,573 | ) |
| Balance, end of period                                                     |       | $                                | 48,306     |   | $ | 36,521 |   | $ | 32,417 |   |

 

**5.****                                    ****INVENTORIES**

 

Inventoriesconsist of the following (in thousands):

 
| ** **                     | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Components and raw materials   |       | $                           | 29,967     |                        | $          | 34,015 |   |
| Work in process                |       | 3,745                       |       | 5,310                       |       |
| Finished goods                 |       | 50,558                      |       | 59,835                      |       |
| Inventory held on consignment  |       | 24,121                      |       | 21,804                      |       |
|                           |       | 108,391                     |       | 120,964                     |       |
| Less — inventory reserves |       | (12,511                     | )          | (17,798                     | )          |
|                           |       | $                           | 95,880     |                        | $          | 103,166 |   |

 

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

 
| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Balance, beginning of period           |       | $                                | 17,798     |   | $ | 18,996 |   | $ | 19,434 |   |
| Acquired through business acquisitions |       | —                           |       | — |   | 3,867 |   |
| Provision charged to costs of sales    |       | 7,462                            |       | 8,637 |   | 3,580 |   |
| Disposal of reserved inventory         |       | (12,749                          | )          | (9,835 | ) | (7,885 | ) |
| Balance, end of period                 |       | $                                | 12,511     |   | $ | 17,798 |   | $ | 18,996 |   |

 

The write-offs to the reserve were principallyrelated to the disposition of fully reserved inventory.

 

**6.****                                    ****PROPERTYAND EQUIPMENT, NET**

 

Property and equipmentconsists of the following (in thousands):

 
| ** **                                       | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** | **Depreciable lives  (years)** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-------------------------------------|------------|
| Land                                             |       | $                           | 1,448      |                        | $          | 1,442                               |       | Indefinite |   |
| Buildings and improvements                       |       | 22,714                      |       | 21,179                      |       | 5 to 25                             |       |
| Equipment                                        |       | 66,658                      |       | 52,160                      |       | 3 to 8                              |       |
| Software                                         |       | 17,213                      |       | 13,974                      |       | 3 to 5                              |       |
| Furniture and fixtures                           |       | 8,624                       |       | 7,647                       |       | 3 to 8                              |       |
| Surgical implant instrumentation                 |       | 22,192                      |       | 16,445                      |       | 5                                   |       |
| Construction in progress                         |       | 15,586                      |       | 15,432                      |       | n/a                                 |       |
|                                             |       | 154,435                     |       | 128,279                     |       |                                |       |
| Less - accumulated depreciation and amortization |       | (67,721                     | )          | (42,017                     | )          |                                |       |
| Property and equipment, net                      |       | $                           | 86,714     |                        | $          | 86,262                              |       |   |   |

 

Depreciationand amortization expense relating to property and equipment was approximately$27.9 million, $23.6 million and $14.7 million for the years ended December 31,2009, 2008 and 2007, respectively. Depreciation expense includes amounts associatedwith surgical implant instruments that we provide to surgeons, free of charge,for use while implanting our products, and is reported as a selling, generaland administrative expense in the amounts of $3.7 million, $2.9 million, and$2.5 million for the years ended December 31, 2009, 2008 and 2007,respectively.  We also capitalizeelectrotherapy devices that we rent to patients and record the relateddepreciation expense in cost of sales.

 

**7.****                                    ****GOODWILL AND INTANGIBLEASSETS**

 

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

 
| ** **                    | ** ** | **Year Ended  December 31,  2009** | ** ** | **Year Ended  December 31,  2008** | ** ** |
|-------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Balance, beginning of period  |       | $                                            | 1,191,566  |                                         | $          | 1,201,282 |   |
| Tax adjustments               |       | —                                       |       | (18,118                                      | )          |
| Sale of business (see Note 3) |       | (11,986                                      | )          | —                                       |       |
| Acquisitions (see Note 2)     |       | 9,155                                        |       | 13,286                                       |       |
| Foreign currency translation  |       | 2,762                                        |       | (5,737                                       | )          |
| Other                         |       | —                                       |       | 853                                          |       |
| Balance, end of period        |       | $                                            | 1,191,497  |                                         | $          | 1,191,566 |   |

 

For the year ended December 31, 2009, we recorded goodwill ofapproximately $3.4 million, $4.9 million, and $0.9 million related to theacquisitions of Chattanooga Canada, Empi Canada, and DJO Australia,respectively (refer to Note 2). The fair values of the assets acquired and theliabilities assumed were estimated in accordance with ASC Topic 805. Goodwillrepresents the excess of the purchase price over the fair value of tangible andidentifiable intangible assets acquired and liabilities assumed.  In addition, we disposed of approximately $12.0 million of goodwillassociated with the sale of our ETS business (refer to Note 3).

 

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For the year ended December 31, 2008, we recorded goodwill ofapproximately $12.8 million related to the DJO Opco acquisition to reflectchanges in our preliminary estimates of deferred tax assets and liabilitiesassumed, including approximately $6.0 million for Medicare reimbursementclaims.  We also completed theacquisitions of various other businesses during the year which resulted in therecognition of approximately $0.5 million of goodwill in the aggregate.Additionally, we reduced goodwill by $18.1 million related to variousacquisition related tax adjustments.

 

Identifiable intangible assets consisted of the following as of December 31, 2009 (in thousands):

 
| ** **                                            | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Intangible Assets,  Net** | ** ** |
|-------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| Amortizable intangible assets:                        |       |                       |       |                          |       |                        |       |
| Technology-based                                      |       | $                          | 458,726    |                          | $          | (94,385                     | )          | $ | 364,341 |   |
| Customer-based                                        |       | 487,998                    |       | (96,906                       | )          | 391,092                     |       |
|                                                  |       | $                          | 946,724    |                          | $          | (191,291                    | )          | 755,433 |   |
| Indefinite-lived intangible assets:                   |       |                       |       |                          |       |                        |       |
| Trademarks and trade names                            |       |                       |       |                          |       | 428,269                     |       |
| Accumulated foreign currency translation  adjustments |       |                       |       |                          |       | 3,975                       |       |
| Net identifiable intangible assets                    |       |                       |       |                          |       | $                           | 1,187,677  |   |

 

During the fourth quarter 2009, we determinedthat the fair value of two of our trade names were less than the carryingamount, resulting in an aggregate $7.0 million impairment charge, which wasincluded in amortization and impairment of intangibles within the consolidatedstatement of operations for the year ended December 31, 2009.

 

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

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

 

During the fourth quarter 2008, we determinedthat the fair value of a trade name was less than its carrying amount andanother trade name was abandoned, resulting in an aggregate $22.4 millionimpairment charge, which was included in the consolidated statement ofoperations for the year ended December 31, 2008.

 

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

 

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

 
| **Year Ending December 31,** |   |    |   |
|---------------------------------------------|--------|---------|--------|
| 2010                                        |   | $       | 77,199 |   |
| 2011                                        |   | 75,678  |   |
| 2012                                        |   | 74,392  |   |
| 2013                                        |   | 69,184  |   |
| 2014                                        |   | 67,368  |   |
| Thereafter                                  |   | 391,612 |   |
|                                             |        |         |        |  |

 

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AtDecember 31, 2009 and 2008, our goodwill and intangible assets areallocated by segment as follows (in thousands):

 
| **December 31,  2009**       | ** ** | **Goodwill** | ** ** | **Intangibles, Net** | ** ** |
|-----------------------------------|------------|--------------|------------|---------------------------|------------|
| Domestic Rehabilitation Segment   |       | $            | 1,061,297  |                      | $          | 1,124,483 |   |
| International Segment             |       | 82,794       |       | 40,173                    |       |
| Domestic Surgical Implant Segment |       | 47,406       |       | 23,021                    |       |
| Total                             |       | $            | 1,191,497  |                      | $          | 1,187,677 |   |
|                              |       |         |       |                      |       |

 
| **December 31, 2008**        | ** ** | **Goodwill** | ** ** | **Intangibles,  Net** | ** ** |
|-----------------------------------|------------|--------------|------------|-----------------------|------------|
| Domestic Rehabilitation Segment   |       | $            | 1,073,284  |                  | $          | 1,202,329 |   |
| International Segment             |       | 70,876       |       | 31,600                |       |
| Domestic Surgical Implant Segment |       | 47,406       |       | 26,543                |       |
| Total                             |       | $            | 1,191,566  |                  | $          | 1,260,472 |   |

 

Duringthe fourth quarter of 2008, we effected an operational reorganization whichresulted in the non-U.S. components of all of our businesses being managedabroad.  As a result, the segmentfinancial data for the years ended December 31, 2009 and 2008 reflect thisnew segmentation.

 

**8.             OTHERCURRENT LIABILITIES**

 

Other current liabilities consist of the following (in thousands):

 
| ** **                    | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|-------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Wages and related expenses    |       | $                           | 20,668     |                        | $          | 21,695 |   |
| Commissions and royalties     |       | 12,953                      |       | 13,799                      |       |
| Taxes                         |       | 3,061                       |       | 4,943                       |       |
| Integration costs             |       | 6,779                       |       | 2,505                       |       |
| Professional fees             |       | 5,529                       |       | 2,453                       |       |
| Rebates                       |       | 4,482                       |       | 4,812                       |       |
| Accrued ERP costs             |       | 5,800                       |       | 6,763                       |       |
| Interest rate swap derivative |       | 9,701                       |       | 13,272                      |       |
| Other accrued liabilities     |       | 21,635                      |       | 34,159                      |       |
|                          |       | $                           | 90,608     |                        | $          | 104,401 |   |

** **

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

** **

Long-termdebt (including capital lease obligations) at December 31, 2009 and 2008consists of the following (in thousands):

 
| ** **                                                                                                                                                 | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan under Senior Secured Credit Facility,  net of a 1.2% discount ($9.3 million and $10.9 million at December 31,  2009 and 2008, respectively) |       | $                           | 1,034,427  |                        | $          | 1,043,404 |   |
| Revolving loans outstanding under Senior Secured  Credit Facility                                                                                          |       | —                      |       | 24,000                      |       |
| 10.875% senior notes                                                                                                                                       |       | 575,000                     |       | 575,000                     |       |
| 11.75% senior subordinated notes                                                                                                                           |       | 200,000                     |       | 200,000                     |       |
| Loans and revolving credit facilities at various  European Banks                                                                                           |       | 355                         |       | 891                         |       |
| Capital lease obligations                                                                                                                                  |       | 228                         |       | 298                         |       |
| Notes payable for acquisitions                                                                                                                             |       | 2,860                       |       | —                      |       |
|                                                                                                                                                       |       | 1,812,870                   |       | 1,843,593                   |       |
| Less — current portion                                                                                                                                |       | (15,926                     | )          | (11,549                     | )          |
| Long-term debt and capital leases, net of current  portion                                                                                                 |       | $                           | 1,796,944  |                        | $          | 1,832,044 |   |

 

*Senior Secured Credit Facility*

 

On November 20, 2007, we entered into the Senior Secured CreditFacility which consists of a $1,065.0 million term loan facility maturing May 2014and a $100.0 million revolving credit facility maturing November 2013.We issued the term loan facility at a 1.2% discount, resulting in net proceedsof $1,052.4 million. The original $12.6 million discount is beingamortized as additional interest expense over the term of the term loanfacility and increases the reported outstanding balance accordingly. The marketvalue of our term loan facility was approximately $975.9 million as of December 31,2009 and was determined using trading prices for our term loan on or near thatdate. As of December 31, 2009, no amounts were drawn related to ourrevolving credit facility.

 

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*Interest Rate and Fees.*  Borrowings under the Senior Secured CreditFacility bear interest at a rate equal to an applicable margin plus, at ouroption, either (a) a base rate determined by reference to the higher of (1) theprime rate of Credit Suisse and (2) the federal funds rate plus 0.50% or (b) theEurodollar rate determined by reference to the costs of funds for deposits inU.S. dollars for the interest period relevant to each borrowing adjusted forrequired reserves. The current applicable margin for borrowings under the termloan facility and the revolving credit facility is 2.00% with respect to baserate borrowings and 3.00% with respect to Eurodollar borrowings. The applicablemargin for borrowings under the term loan facility and the revolving creditfacility may be reduced subject to us attaining certain leverage ratios.

 

We use interest rate swap agreements in an effort to hedge our exposureto fluctuating interest rates related to a portion of our Senior Secured CreditFacility (See Note 17). On November 20, 2007, we entered into an interestrate swap agreement for a notional amount of $515.0 million at a fixedLIBOR rate of 4.205% which expired at December 31, 2009. In February 2009,we entered into two additional non-amortizing interest rate swap agreements.The first agreement was for a notional amount of $550.0 million at a fixedLIBOR rate of 1.04% beginning February 2009 and expired December 31,2009. The second is for a notional amount of $750.0 million at a fixed LIBORrate of 1.88% beginning January 2010 through December 2010.  In August 2009, we entered into four newnon-amortizing interest swap agreements with notional amounts aggregating $300.0million. Each of the four agreements has a term beginning January 2011through December 2011. The four agreements are at a weighted average fixedLIBOR rate of 2.5825%.  As of December 31,2009, our weighted average interest rate for all borrowings under the SeniorSecured Credit Facility was 4.42%.

 

In addition to paying interest on outstanding principal under theSenior Secured Credit Facility, we are required to pay a commitment fee to thelenders under the revolving credit facility with respect to the unutilizedcommitments thereunder. The current commitment fee rate is 0.50% per annum. Thecommitment fee rate may be reduced subject to us attaining certain leverageratios. We must also pay customary letter of credit fees.

 

*Principal Payments.*  We are required to pay annual payments inequal quarterly installments on the loans under the term loan facility in anamount equal to 1.00% of the funded total principal amount through February 2014,with any remaining amount payable in May 2014. Principal amountsoutstanding under the revolving credit facility are due and payable in full atmaturity.

 

*Prepayments.*  The Senior Secured Credit Facility requiresus to prepay outstanding term loans, subject to certain exceptions, with (1) 50%(which percentage can be reduced to 25% or 0% upon our attaining certainleverage ratios) of our annual excess cash flow, as defined; (2) 100% ofthe net cash proceeds above an annual amount of $25.0 million from non-ordinarycourse asset sales (including insurance and condemnation proceeds) by DJOFL andits restricted subsidiaries, subject to certain exceptions, including a 100%reinvestment right if reinvested or committed to reinvest within 15 monthsof such sale or disposition so long as reinvestment is completed within 180 daysthereafter; and (3) 100% of the net cash proceeds from issuances orincurrences of debt by DJOFL and its restricted subsidiaries, other thanproceeds from debt permitted to be incurred under the Senior Secured CreditAgreement. The foregoing mandatory prepayments will be applied to the term loanfacilities in direct order of maturity. We have not been required to make any mandatory pre-payments through December 31,2009.  Based on estimated excess cashflows for the year ended December 31, 2009, we will be required to make aprepayment of the term loan outstanding under our senior secured creditfacilities of approximately $1.9 million, which we expect to pay in March 2010. Such amount has been classified with the current portion of our long-term debtwithin our consolidated balance sheet as of December 31, 2009. We expectto reinvest the net proceeds from our 2009 asset sales during 2010 as permittedby our credit agreement and, as such, our calculation of estimated excess cashflows excludes those net proceeds.  Wemay voluntarily prepay outstanding loans under the Senior Secured CreditFacility at any time without premium or penalty, provided that voluntaryprepayments of Eurodollar loans made on a date other than the last day of aninterest period applicable thereto shall be subject to customary breakagecosts.

 

*Guarantee and Security.*  All obligations under the Senior SecuredCredit Facility are unconditionally guaranteed by DJO Holdings LLC (“Holdings”)and each existing and future direct and indirect wholly-owned domesticsubsidiary of DJOFL other than immaterial subsidiaries, unrestrictedsubsidiaries and subsidiaries that are precluded by law or regulation fromguaranteeing the obligations (collectively, the “Guarantors”).

 

All obligations under the Senior Secured Credit Facility, and theguarantees of those obligations, are secured by pledges of 100% of the capitalstock of DJOFL, 100% of the capital stock of each wholly owned domesticsubsidiary and 65% of the capital stock of each wholly owned foreign subsidiarythat is, in each case, directly owned by DJOFL or one of the Guarantors; and asecurity interest in, and mortgages on, substantially all tangible andintangible assets of Holdings, DJOFL and each Guarantor.

 

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*Certain Covenants and Events of Default.*  The Senior Secured Credit Facility contains anumber of covenants that, among other things, restrict, subject to certainexceptions, our and our subsidiaries’ ability to:

 

·                  incur additionalindebtedness;

·                  create liens on assets;

·                  change fiscal years;

·                  enter into sale andleaseback transactions;

·                  engage in mergers orconsolidations;

·                  sell assets;

·                  pay dividends and otherrestricted payments;

·                  make investments, loans oradvances;

·                  repay subordinatedindebtedness;

·                  make certain acquisitions;

·                  engage in certaintransactions with affiliates;

·                  restrict the ability ofrestricted subsidiaries that are not Guarantors to pay dividends or makedistributions;

·                  amend material agreementsgoverning our subordinated indebtedness; and

·                  change our lines ofbusiness.

 

In addition, the Senior Secured Credit Facility requires us to maintaina maximum senior secured leverage ratio of 4.25:1 as of the twelve months endedDecember 31, 2009, stepping down over time to 3.25:1 by the end of 2011.The Senior Secured Credit Facility also contains certain customary affirmativecovenants and events of default. Our maximum senior secured leverage ratio waswithin the covenant level as of December 31, 2009.

 

*10.875% Senior Notes Payable*

 

On November 20, 2007, DJOFL and DJO Finance Corporation (“Finco”)(collectively, the “Issuers”) issued $575.0 million aggregate principalamount of 10.875% Senior Notes under an agreement dated as of November 20,2007 (the “10.875% Indenture”) among the Issuers, the guarantors party theretoand The Bank of New York Mellon (formerly known as The Bank of New York), astrustee.

 

The 10.875% Notes require semi-annual interest payments ofapproximately $31.3 million each May 15 and November 15 and aredue November 15, 2014. The market value of the 10.875% Notes wasapproximately $603.8 million as of December 31, 2009 and was determinedusing trading prices for the 10.875% Notes on or near that date. We believe thetrading prices reflect certain differences between prevailing market terms andconditions and the actual terms of our 10.875% Notes.

 

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

 

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

 

*Covenants.*  The 10.875% Indenture contains covenantslimiting, among other things, our and our restricted subsidiaries’ ability toincur additional indebtedness or issue certain preferred and convertibleshares, pay dividends on, redeem, repurchase or make distributions in respectof the capital stock of DJO or make other restricted payments, make certaininvestments, sell certain assets, create liens on certain assets to securedebt, consolidate, merge, sell or otherwise dispose of all or substantially allof our assets, enter into certain transactions with affiliates, and designateour subsidiaries as unrestricted subsidiaries. As of December 31, 2009, wewere in compliance with all applicable covenants.

 

On January 20,2010, we issued $100.0 million aggregate principal amount of new 10.875%Senior Notes which mature on November 15,2014, pursuant to the 10.875% indenture, governing our existing 10.875%Senior Notes due 2014 that were issued onNovember 20, 2007. The net proceeds of the issuance (excludingapproximately $2.0 million of interest accrued from November 16, 2009 to January 19,2010, which amount will be included in the interest payment we will make tonoteholders on May 15, 2010, the first interest payment date), along with cashon hand, were used to repay $101.5 million aggregate principal amount ofexisting term loans under the Senior Secured Credit Facility (see Note 20).

 

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*11.75% Senior Subordinated Notes Payable*

 

In November 2006, theIssuers issued $200.0 million aggregate principal amount of 11.75% seniorsubordinated notes (the “11.75% Notes”). The 11.75% Notes require semi-annualinterest payments of approximately $11.8 million each May 15 and November 15and are due November 15, 2014.

 

The market value of the 11.75% Notes was approximately $206.0 millionas of December 31, 2009 and was determined using trading prices for the11.75% Notes on or near that date. We believe the trading prices reflectcertain differences between prevailing market terms and conditions and theactual terms of our 11.75% Notes.

 

The 11.75% Notes contain similar provisions as the 10.875% Notes withrespect to change of control and covenant requirements. Under the Indenturegoverning the 11.75% Notes (the “11.75% Indenture”), prior to November 15,2010, the Issuers have the option to redeem some or all of the 11.75% Notes forcash at a redemption price equal to 100% of the then outstanding principalbalance plus an applicable make-whole premium plus accrued and unpaid interest.Beginning on November 15, 2010, the Issuers may redeem some or all of the11.75% Notes at a redemption price of 105.875% of the then outstandingprincipal balance plus accrued and unpaid interest on the 11.75% Notes. Theredemption price decreases to 102.938% and 100% of the then outstandingprincipal balance at November 2011 and November 2012, respectively.Additionally, from time to time, before November 15, 2009, the Issuers mayredeem up to 35% of the 11.75% Notes at a redemption price equal to 111.75% ofthe principal amount then outstanding, in each case, with proceeds we raise, ora direct or indirect parent company raises, in certain offerings of equity ofDJOFL or its direct or indirect parent companies, as long as at least 65% ofthe aggregate principal amount of the notes issued remains outstanding.

 

Our ability to continue to meet the covenants related to ourindebtedness specified above in future periods will depend, in part, on eventsbeyond our control, and we may not continue to meet those ratios. A breach ofany of these covenants in the future could result in a default under the SeniorSecured Credit Facility, the 11.75% Indenture and the 10.875% Indenture(collectively, the “Indentures”), at which time the lenders could elect todeclare all amounts outstanding under the Senior Secured Credit Facility to beimmediately due and payable. Any such acceleration would also result in adefault under the Indentures.

 

All of our long-term debtand capital leases mature within the next five years.  At December 31, 2009, the aggregateamounts of annual principal maturities of long-term debt and capital leases areas follows (in thousands):

 
| **Years Ending December 31,** |   |      |   |
|----------------------------------------------|--------|-----------|--------|
| 2010                                         |   | $         | 15,926 |   |
| 2011                                         |   | 10,692    |   |
| 2012                                         |   | 10,690    |   |
| 2013                                         |   | 10,653    |   |
| 2014                                         |   | 1,764,909 |   |
| Total                                        |   | 1,812,870 |   |
|                                              |        |           |        |  |

 

*Debt Issue Costs*

 

We incurred $30.7 million, $24.5 million, and $10.2 million of debtissue costs in connection with the Senior Secured Credit Facility, the 10.875%Notes, and the 11.75% Notes, respectively. These costs have been capitalizedand are included in other non-current assets in the condensed consolidatedbalance sheets at December 31, 2009 and 2008. Debt issue costs are beingamortized over the terms of the respective debt instruments through November 2014.

 

**10.          MEMBERSHIP EQUITY**

 

Inconnection with the DJO Merger, an affiliate of Blackstone made a cash equitycontribution of $434.6 million. Additionally, we repurchased 264,525 shares of ReAble’s common stock (“PriorTransaction Management Rollover Options”) from certain ReAble executives whowere terminated in connection with the DJO Merger at a per share price of$16.46.  At the closing of the DJO Merger, these former ReAble executivesforfeited all unvested stock options previously issued to them under the 2006Stock Incentive Plan at the closing of the DJO Merger.  Furthermore,certain members of DJO Opco management chose to rollover certain

 

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oftheir DJO Opco options which were exchanged into options to purchase 1,912,577shares under the 2007 Incentive Stock Plan on a tax-deferred basis (the “DJOManagement Rollover Options”).  The fair value of these options approximated$15.2 million and was recorded as a component of the cost of the DJOMerger.  Also, on November 20, 2007,we granted an executive officer 24,300 shares (net of taxes) of restrictedstock under the 2007 Incentive Stock Plan, which were subsequently cancelledduring the third quarter of 2008 as a result of his termination (See Note 11for further information).

 

**11.          STOCK OPTION PLANSAND STOCK-BASED COMPENSATION**

 

*2007 Stock Incentive Plan*

 

We have one active equityincentive plan, the DJO Incorporated 2007 Incentive Stock Plan (the “2007 Plan”),under which we are authorized to grant options and awards up to 7,500,000shares, subject to adjustment in certain events. Options issued under the 2007Plan can be either incentive stock options or non-qualified stock options. Theexercise price of stock options granted will not be less than 100% of the fairmarket value of the underlying shares on the date of grant, and will expire nomore than ten years from the date of grant. In addition, we adopted a form ofnon-statutory stock option agreement (the “DJO Form Option Agreement”) foremployee stock option awards under the 2007 Plan. Under the DJO Form OptionAgreement, one-third of each stock option grant will vest over a specifiedperiod of time (typically five years) contingent solely upon the awardees’continued employment with us (“Time-Based Tranche”). Another one-third of eachstock option grant will vest over a specified performance period (typicallyfour to five years) from the date of grant upon the achievement of certainpre-determined performance targets based on Adjusted EBITDA and adjusted freecash flow on an annual basis, as defined in the DJO Form Option Agreement(“Performance-Based Tranche”).  The finalone-third of each stock option grant was originally determined to vest basedupon achieving enhanced pre-determined performance targets based on AdjustedEBITDA and adjusted free cash flow, but was modified as described below (“EnhancedPerformance-Based Tranche”).

 

During March 2009, we made modifications to the terms of theoutstanding options and the 2007 Plan. The performance conditions for theportion of the options within the Performance-Based Tranche that vest based on2009 financial performance were modified to require achievement of AdjustedEBITDA and adjusted free cash flow targets that were established in connectionwith our 2009 budget process. As with the original terms of such options, theoptionees may earn 80% or more of such portion of options upon achievement ofat least a minimum threshold amount of the budgeted Adjusted EBITDA and of thefree cash flow targets for 2009. The financial targets for thePerformance-Based Tranches for the years 2010-2012 remain unchanged and weadded financial targets for 2013-2015. The vesting provisions of thePerformance-Based Tranche were modified to provide that upon achievement of thepartial or total annual target for a given year resulting in partial or fullvesting for that year, any portion of the tranche associated with prior yearswill also vest up to the percentage vested in the given year, to the extent notpreviously vested. The financial performance targets for the entire EnhancedPerformance-Based Tranche were replaced by targets with different financialmetrics. These new targets require achievement of a minimum internal rate ofreturn (“IRR”) and multiple of invested capital (“MOIC”), each measured withrespect to Blackstone’s aggregate investment in our capital stock, to beachieved by Blackstone following a liquidation of all or a portion of itsinvestment in our capital stock. As a result of this modification, the EnhancedPerformance-Based Tranche has both a performance component and a marketcondition component and will now be referred to as the “Market Return Tranche”.

 

Options granted under the 2007 Plan contain change-in-controlprovisions that cause the vesting of a portion of the tranches upon theoccurrence of a change-in-control, as follows: 1) the option shares in theTime-Based Tranche will become immediately exercisable upon the occurrence of achange-in-control if the optionee remains in continuous employment of theCompany until the consummation of the change-in-control and 2) the optionshares of the Performance-Based Tranche for the year in which such change-in-controlis consummated and for any subsequent performance periods will becomeimmediately exercisable if the optionee remains in continuous employment of theCompany until the consummation of the change-in-control. This provision doesnot operate to vest the Market Return Tranche which requires the achievement ofthe IRR and MOIC targets by Blackstone on its equity investment in us. The DJO Form OptionAgreement includes certain forfeiture provisions upon an awardees’ separationfrom service with us.

 

*Employee Stock Options*

 

During the year ended December 31, 2009 we granted 1,048,146 stockoptions under the 2007 Plan to our executive officers, senior management, andcertain other employees.

 

For the years ended December 31, 2009, 2008 and 2007, we recordednon-cash compensation expense of approximately $3.3 million, $1.3 million and$1.5 million, respectively, associated with stock options issued under the 2007Plan.  We record expense for awards witha performance condition only to the extent deemed probable of achievement, withthe exception of market-based options previously modified during the firstquarter of 2009 and reallocated to the Time-Based and Performance-BasedTranches.  The expense related to thepreviously modified options is recognized ratably over the expected term of thestock options using the original grant-date fair value regardless of theprobability of achieving the performance conditions.  We are required to reassess at each 

 

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reportingperiod whether the achievement of any performance condition is probable, atwhich time we would recognize the related compensation expense over theremaining performance or service period, if any. During 2008 we did notrecognize compensation expense associated with our Performance-Based Tranche asthe performance targets under the original grant were not achieved.  As a result of the modification of the 2009targets and our actual results for the year ended December 31, 2009, weexceeded the minimum threshold amounts related to our 2009 performancetargets.  As such, for the year ended December 31, 2009, we recognizedcompensation expense for the modified options and the annual portion of thetranche associated with the 2008 options that were not previously vested.  To date, no amount has been recorded for theMarket Return Tranche, as achievement of the performance component is notdeemed probable at this time.

 

The fair value of each option award is estimated on the date of grant,or modification, using the Black-Scholes-Merton option pricing model forservice and performance based awards, and a binomial model for market basedawards. In estimating fair value for new options issued under the 2007 Plan,expected volatility was based completely on historical volatility of comparablepublicly-traded companies. As our historical share option exercise experiencedoes not provide a reasonable basis upon which to estimate the expected term,we used the simplified approach to calculate the expected term. Expected lifeis calculated in two tranches based on the employment level defined asexecutive or employee. The risk-free rate used in calculating fair value ofservice and performance-based stock options for periods within the expectedterm of the option is based on the U.S. Treasury yield bond curve in effect atthe time of grant.  As a result of the2009 modification, we will no longer use the original grant date fair value to measurecompensation cost and have re-assessed the assumptions used to determine thefair value of options at the date of modification and at subsequent grantdates.

 

The assumptions used to calculate the fair value of options granted areevaluated and revised, as necessary, to reflect market conditions andexperience. The following table presents the assumptions we used in calculatingthe fair value of employee stock options for the years ended December 31,2009, 2008 and 2007:

 
| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected dividends       |       | 0.0                              | %          | 0.0 | % | 0.0 | % |
| Expected volatility      |       | 34.4 — 34.7                 | %          | 27.4% - 60.0 | % | 27.4% - 60.0 | % |
| Risk-free rate           |       | 2.3 — 2.79                  | %          | 2.8% - 4.7 | % | 3.5% - 4.7 | % |
| Expected term (in years) |       | 5.83 — 6.3                  |       | 4.7 - 7.1 |   | 4.7 - 7.1 |   |

 

*Non-Employee Stock Options*

 

During the year ended December 31, 2009 we granted 3,200 stockoptions under the 2007 Plan to non-employees (“non-employee options”). Thenon-statutory stock option agreement for the non-employees states that theoptions have an exercise price of $16.46 per share, which was equal to 100% ofthe estimated fair market value of the stock and will become effective upon thedefined effective date and expire ten years from that date. A number of sharesequal to 25% of the options granted become vested and exercisable at the end ofeach of the first four years subsequent to the effective date, provided theoptionee is still affiliated with and providing services to the Company. Thenon-employee option agreement does not include any performance requirements onthe optionee’s part in order to vest in the options granted.  Non-employee options are accounted for inaccordance with ASC Topic 505 (formerly Emerging Issues Task Force Issue No. 96-18,“Accounting for Equity Instruments That are Issued to Other Than Employees forAcquiring, or in Conjunction with Selling Goods or Services”) which states thatthe fair value of each option will be re-measured at the end of each reportingperiod until vested, when the final fair value of the vesting of the option isdetermined.

 

In estimating fair value for options issued, expected volatility wasbased completely on historical volatility of comparable publicly-tradedcompanies. A contractual life of ten years was used in place of the expectedterm. The risk-free rate used in calculating the fair value of the non-employeestock options for periods within the contractual life is based on the U.S.Treasury yield bond curve in effect at the time of grant.

 

The assumptions used to calculate the fair value of options granted areevaluated and revised, as necessary, to reflect market conditions andexperience. The following table presents the assumptions we used in calculatingthe fair value of the non-employee stock options for the years ended December 31,2009 and 2008:

 
| ** **                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| Expected dividends          |       | 0.0                              | %          | 0.0 | % |
| Expected volatility         |       | 34.4 — 34.7                 | %          | 27.41 | % |
| Risk-free rate              |       | 2.3 — 2.797                 | %          | 3.92 | % |
| Contractual term (in years) |       | 10 years                    |       | 10 years |   |

 

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Werecorded non-cash compensation expense of approximately $0.1 million for eachyear ended December 31, 2009 and 2008, associated with non-employee stockoptions issued under the 2007 Incentive Stock Plan.

 

Asummary of option activity under the 2007 Plan for the years ended December 31,2009 and 2008 is presented below:

 
| ** **                             | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate Intrinsic  Value** | ** ** |
|----------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | ** **                 | ** ** | ** **                                  | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Outstanding at December 31, 2007  |       | 3,550,627                  |       | $                                           | 12.97      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Granted, including Replacement Options |       | 4,528,214                  |       | $                                           | 16.46      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Exercised                              |       | —                     |       |                                        | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Forfeited, including options cancelled |       | (2,003,927                 | )          | $                                           | 16.35      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Outstanding at December 31, 2008  |       | 6,074,914                  |       | $                                           | 14.46      |                                                            | 8.18       |                                | 12,221,730 |   |
| Granted,                               |       | 1,051,346                  |       | $                                           | 16.46      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Exercised                              |       | —                     | ** ** | ** **                                  | ** ** | ** **                                                      | ** ** | ** **                          | ** ** |
| Forfeited, including options cancelled |       | (245,918                   | )          | $                                           | 16.46      | ** **                                                      | ** ** | ** **                          | ** ** | ** ** |
| Outstanding at December 31, 2009  |       | 6,880,342                  |       | $                                           | 14.69      |                                                            | 7.51       |                                | 12,221,730 |   |
| Exercisable at December 31, 2009  |       | 3,403,728                  |       | $                                           | 12.64      |                                                            | 6.71       |                                | 12,221,730 |   |

 

For the years ended December 31, 2009, 2008 and 2007, theweighted-average grant-date fair value of stock options granted was $5.55,$5.36, and $8.09, respectively.

 

Total unrecognized stock-based compensation expense, related tononvested stock options under the 2007 Plan, net of expected forfeitures, was$8.0 million as of December 31, 2009. We anticipate this expense to berecognized over a weighted-average period of approximately three years.However, compensation expense associated with performance-based options underthe 2007 Plan, with the exception of those that were issued in connection witha modification, will be recognized only to the extent achievement of certainperformance targets are deemed probable.

 

*Restricted Stock*

 

On March 13, 2007, we granted 15,189 shares of restricted stockoptions to an executive officer pursuant to the terms of a restricted stockagreement under the 2006 Plan. The shares were subject to a vesting scheduleover a period of three years with the final vesting on November 3, 2009.On November 20, 2007, we granted 24,300 shares of restricted stock awardsto the same executive officer pursuant to the terms of a restricted stockagreement under the 2007 Incentive Stock Plan, which would vest on January 1,2009. On August 14, 2008, we entered into a Separation of EmploymentAgreement and General Release with this executive officer which waived any andall of his rights to any stock option or equity grants, including but notlimited to restricted stock. As such, all restricted stock options werecancelled during the third quarter and we reversed approximately $244,000 ofpreviously recorded compensation expense related to the restricted stock.

 

**12.**                               SEGMENT AND GEOGRAPHIC INFORMATION

** **

Weprovide a broad array of orthopedic rehabilitation and regeneration products,as well as implants to customers in the United States and abroad.  In the first quarter of 2009, we changed howwe report financial information to senior management.  Prior to 2009, we included the internationalcomponents of the Surgical, Chattanooga, and Empi businesses in either theSurgical or Domestic Rehabilitation segments, as their operations were manageddomestically.  During the fourth quarterof 2008, we effected an operational reorganization which resulted in thenon-U.S. components of all of our businesses being managed abroad.  As a result, the segment financial data forthe year ended December 31, 2009 reflects this new segmentation and thedata for the years ended December 31, 2008 and 2007, as noted below, hasbeen restated to reflect this change.  Wecurrently develop, manufacture and distribute our products through thefollowing three operating segments.

 

***Domestic Rehabilitation Segment***

 

Our Domestic Rehabilitation Segment, which generates its revenues inthe United States, is divided into five main businesses:

 

·                  *Bracingand Supports. *Our Bracing andSupports business unit offers our DonJoy, ProCare and Aircast products,including rigid knee bracing, orthopedic soft goods, cold therapy products, andvascular systems.  This business unitalso includes our OfficeCare business, through which we maintain an inventoryof soft goods and other products at healthcare facilities, primarily orthopedicpractices, for immediate distribution to patients.

 

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·                  *Empi. *Our Empi business unitoffers our home electrotherapy, iontophoresis, and home traction products. Weprimarily sell these products directly to patients or to physical therapyclinics. For products sold to patients, we arrange billing to the patients andtheir third party payors.

 

·                  *Regeneration*.  Our Regeneration business unit primarilysells our bone growth stimulation products. We sell these products either directly to patients or to independentdistributors. For products sold to patients, we arrange billing to the patientsand their third party payors.

 

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

 

·                  *AthleteDirect.*  Our Athlete Direct business unit offers our Compexelectrostimulation device to consumers, which range from people interested inimproving their fitness to competitive athletes, to assist in athletic trainingprograms through muscle development and to accelerate muscle recovery aftertraining sessions.

 

***International Segment***

 

Our International Segment, which generates most of its revenues inEurope, sells all of our products and certain third party products through acombination of direct sales representatives and independent distributors.

 

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

 

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

 

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

 

Wesell our products to customers outside the United States through wholly ownedsubsidiaries or independent distributors. We record revenue from sales to distributors at the time product isshipped to the distributor.  Ourinternational distributors take title to the products, assume credit andproduct obsolescence risks, must pay within specified periods regardless ofwhen they sell the products and have no price protection.  We record revenue from sales made by ourwholly owned subsidiaries at the time product is shipped to the customer.

 

***Domestic Surgical Implant Segment***

 

Our Domestic Surgical Implant Segment develops, manufactures andmarkets a wide variety of knee, hip and shoulder implant products that servethe orthopedic reconstructive joint implant market in the United States.

 

Wesell our Domestic Surgical Implant Segment products through a network ofindependent sales representatives in 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 include amountsbilled to customers for freight in revenue.

 

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Informationregarding our reportable business segments is presented below (in thousands).This information excludes the impact of certain expenses not allocated tosegments, primarily general corporate expenses and non-recurring chargesrelated to our integration activities. All prior periods presented have beenrestated to reflect our current reportable segments.

 
| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Net sales:**                                  |       |                             |       |   |   |   |   |
| Domestic Rehabilitation Segment                 |       | $                                | 640,785    |   | $ | 634,559 |   | $ | 273,562 |   |
| International Segment                           |       | 241,464                          |       | 252,313 |   | 133,757 |   |
| Domestic Surgical Implant Segment               |       | 63,877                           |       | 61,597 |   | 57,492 |   |
| Consolidated net sales                          |       | $                                | 946,126    |   | $ | 948,469 |   | $ | 464,811 |   |
|                                            |       |                             |       |   |   |   |   |   |   |   |
| **Gross profit:**                               |       |                             |       |   |   |   |   |
| Domestic Rehabilitation Segment                 |       | $                                | 425,475    |   | $ | 403,740 |   | $ | 167,092 |   |
| International Segment                           |       | 137,142                          |       | 151,901 |   | 70,225 |   |
| Domestic Surgical Implant Segment               |       | 49,799                           |       | 50,469 |   | 46,172 |   |
| Expenses not allocated to segments/Eliminations |       | (5,009                           | )          | (7,818 | ) | (3,876 | ) |
| Consolidated gross profit                       |       | $                                | 607,407    |   | $ | 598,292 |   | $ | 279,613 |   |
|                                            |       |                             |       |   |   |   |   |   |   |   |
| **Operating income:**                           |       |                             |       |   |   |   |   |
| Domestic Rehabilitation Segment                 |       | $                                | 177,962    |   | $ | 138,556 |   | $ | 11,772 |   |
| International Segment                           |       | 49,051                           |       | 55,295 |   | 9,422 |   |
| Domestic Surgical Implant Segment               |       | 12,955                           |       | 12,815 |   | 11,656 |   |
| Expenses not allocated to segments/Eliminations |       | (161,111                         | )          | (173,325 | ) | (74,687 | ) |
| Consolidated operating income (loss)            |       | $                                | 78,857     |   | $ | 33,341 |   | $ | (41,837 | ) |

 

The accounting policies of the reportable segments are the same as theaccounting policies of the Company. We allocate resources and evaluate theperformance of segments based on net sales, gross profit, operating income andother non-GAAP measures as defined. Moreover, we do not allocate assets toreportable segments because a significant portion of assets are shared by thesegments.

 

## **Geographic Area**

## ** **

Followingare our net sales by geographic area (in thousands):

 
| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Net sales:**                        |       |                             |       |   |   |   |   |
| United States                         |       | $                                | 704,954    |   | $ | 696,156 |   | $ | 331,053 |   |
| Germany                               |       | 74,185                           |       | 65,228 |   | 45,418 |   |
| Other Europe, Middle East, and Africa |       | 110,140                          |       | 143,018 |   | 57,187 |   |
| Asia Pacific                          |       | 15,541                           |       | 12,595 |   | 5,435 |   |
| Other                                 |       | 41,306                           |       | 31,472 |   | 25,718 |   |
|                                  |       | $                                | 946,126    |   | $ | 948,469 |   | $ | 464,811 |   |

 

Netsales are attributed to countries based on location of customer.  For the years ended December 31, 2009,2008 and 2007, we had no individual customer or distributor that accounted for10% or more of total annual revenues

 

**F**ollowing are ourlong-lived assets by geographic area as of December 31, 2009 and 2008 (inthousands):

 
| ** **    | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|---------------|------------|-----------------------------|------------|-----------------------------|------------|
| United States |       | $                           | 2,295,577  |                        | $          | 2,423,171 |   |
| International |       | 212,726                     |       | 167,730                     |       |
|          |       | $                           | 2,508,303  |                        | $          | 2,590,901 |   |

 

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**13.                   INCOME TAXES**

** **

DJOis the taxpayer in the U.S., while our foreign subsidiaries are subjected toincome tax in the applicable local jurisdictions.  Although DJOFL is not a U.S. taxpayer,pursuant to the provisions of ASC Topic 740 (formerly****SFASNo. 109, “Accounting for Income Taxes,”) the tax expense of DJO has beenpushed down to the stand alone financial statements of DJOFL.

 

Thecomponents of losses from continuing operations before income taxes for theapplicable periods consist of the following (in thousands):

 
| ** **         | ** ** | **Year Ended December 31,** | ** ** |
|--------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| U.S. operations    |       | $                                | (76,881    | ) | $ | (154,156 | ) | $ | (125,629 | ) |
| Foreign operations |       | 5,812                            |       | 6,792 |   | (1,282 | ) |
|               |       | $                                | (71,069    | ) | $ | (147,364 | ) | $ | (126,911 | ) |

 

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

 
| ** **             | ** ** | **Year  Ended December 31,** | ** ** |
|------------------------|------------|-----------------------------------|------------|
| ** **             | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Current income taxes:  |       |                              |       |   |   |   |   |
| U.S. Federal and State |       | $                                 | 3,465      |   | $ | (6,672 | ) | $ | 432 |   |
| Foreign                |       | (2,147                            | )          | 3,303 |   | 3,397 |   |
| Deferred income taxes: |       |                              |       |   |   |   |   |
| U.S. Federal and State |       | (28,335                           | )          | (45,236 | ) | (44,008 | ) |
| Foreign                |       | 5,339                             |       | (1,076 | ) | (3,277 | ) |
|                   |       | $                                 | (21,678    | ) | $ | (49,681 | ) | $ | (43,456 | ) |

 

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

 
| ** **                                                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                         | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| Benefit derived by applying the  Federal statutory income tax rate to income (loss) before income  taxes |       | $                                | (24,874    | ) | $ | (51,577 | ) | $ | (44,419 | ) |
| Add (deduct) the effect of:                                                                                        |       |                             |       |   |   |   |   |
| State tax benefit, net                                                                                             |       | (1,071                           | )          | (2,482 | ) | (3,362 | ) |
| Nondeductible IPR&D                                                                                            |       | —                           |       | — |   | 1,050 |   |
| Change in state effective tax rates                                                                                |       | (3,859                           | )          | — |   | — |   |
| Change in German tax laws                                                                                          |       | (379                             | )          | — |   | (1,458 | ) |
| Gain on subsidiary stock sale                                                                                      |       | 2,609                            |       | — |   | — |   |
| Unrecognized tax benefits                                                                                          |       | 2,460                            |       | 720 |   | 226 |   |
| Foreign exchange gain                                                                                              |       | 1,816                            |       | — |   | — |   |
| Permanent differences and other, net                                                                               |       | 1,620                            |       | 3,658 |   | 4,507 |   |
|                                                                                                               |       | $                                | (21,678    | ) | $ | (49,681 | ) | $ | (43,456 | ) |

 

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The components of deferred income tax assets and liabilitiesas of December 31, 2009 and 2008 are as follows (in thousands):

 
| ** **                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:             |       |     |       |     |       |
| Net operating loss carryforwards |       | $        | 112,782    |     | $          | 118,237 |   |
| Inventory reserve                |       | 5,175    |       | 7,648    |       |
| Receivables reserve              |       | 21,575   |       | 17,449   |       |
| Accrued compensation             |       | 3,991    |       | 1,724    |       |
| Accrued expenses                 |       | 6,504    |       | 9,025    |       |
| Interest rate swaps              |       | 4,397    |       | 5,189    |       |
| Foreign earnings repatriation    |       | 4,155    |       | 2,823    |       |
| Other                            |       | 9,381    |       | 8,922    |       |
| Gross deferred tax assets        |       | 167,960  |       | 171,017  |       |
| Valuation allowance              |       | (7,130   | )          | (7,129   | )          |
| Net deferred tax assets          |       | 160,830  |       | 163,888  |       |
|                             |       |     |       |     |       |
| Deferred tax liabilities:        |       |     |       |     |       |
| Property and equipment           |       | (1,769   | )          | (3,661   | )          |
| Intangible assets                |       | (418,762 | )          | (437,938 | )          |
| Foreign currency translation     |       | (3,038   | )          | (2,222   | )          |
| Foreign earnings repatriation    |       | (13,051  | )          | (12,504  | )          |
| Other                            |       | (4,893   | )          | (3,027   | )          |
|                             |       | (441,513 | )          | (459,352 | )          |
| Net deferred tax liabilities     |       | $        | (280,683   | )        | $          | (295,464 | ) |

 

As a result of the DJO Merger we recorded significant acquiredintangible assets for which no tax basis exists and, as such, a significantdeferred tax liability was recorded under purchase accounting. Taxabletemporary differences will reverse within the carryforward period for theexisting deferred tax assets.

 

During the first quarter of 2009, the state of California enactedlegislation which will allow corporate taxpayers to elect to use a single salesfactor apportionment formula to apportion business income to California for taxyears beginning on or after January 1, 2011. We anticipate making thiselection in fiscal year 2011 and thereafter. In the first quarter of 2009, werecorded a tax benefit of $3.9 million related to the enactment of thislegislation which represents a reduction in our net deferred tax liabilitiesdue to a lower effective state tax rate.

 

AtDecember 31, 2009, we maintain approximately $416.6 million of netoperating loss carryforwards in the U.S., which expire over a period of one to20 years. Our European net operating loss carryforwards of approximately $25.8million generally are not subject to expiration dates, unless we triggercertain events.

 

AtDecember 31, 2009 and 2008, we recorded gross deferred tax assets of$168.0 million and $171.0 million, respectively, which we reduced by valuationallowances of $7.1 million for both years. We have recorded a valuationallowance against certain 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 acquisitions and the Prior Transaction.

 

Asa result of the DJO Merger we no longer intend to permanently reinvest in ourforeign operations.  In connection withthe DJO Merger, deferred tax liabilities of $6.4 million were recorded inpurchase accounting, representing estimated U.S. and foreign taxes oncumulative unrepatriated foreign earnings. We recorded a deferred tax expense of $0.5 million and $0.6 million,respectively, for the years ended December 31, 2009 and 2008 forunrepatriated foreign earnings in those years.

 

Weand our subsidiaries file income tax returns in the U.S. federal, state andlocal, and foreign jurisdictions.  Withfew exceptions, we are no longer subject to U.S. federal, state and local, ornon-U.S. income tax examinations by tax authorities for years before 2005.  The Internal Revenue Service (“IRS”) iscurrently examining the 2005 and 2006 tax years. It is anticipated that theexamination will be completed during 2010. We adopted the provisions of ASC Topic740-10 (formerly FASB Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes — an Interpretation of FASB Statement No. 109”) on January 1,2007. As a result of the implementation of ASC Topic 740-10, we recognized a$5.9 million increase in liabilities for gross unrecognized tax benefits, whichwas accounted for as an increase to the balance of goodwill. A reconciliationof the beginning and ending amount of gross unrecognized tax benefits for theyears ended December 31, 2007, 2008 and 2009 are as follows in thousands:

 

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| Balance at January 1, 2007                               |   | $      | 6,979  |   |
|---------------------------------------------------------------|--------|--------|--------|--------|
| Additions based on tax positions related to  current year     |   | 458    |   |
| Additions for tax positions related to prior years            |   | 8,016  |   |
| Additions due to acquisition of businesses                    |   | 1,829  |   |
| Reductions for tax positions related to prior  years          |   | (1,059 | )      |
| Balance at December 31, 2007                             |   | 16,223 |   |
| Additions based on tax positions related to the  current year |   | 1,054  |   |
| Additions for tax positions related to prior years            |   | 2,570  |   |
| Reductions for tax positions related to prior  years          |   | (93    | )      |
| Reductions due to lapse of statue of limitations              |   | (4,187 | )      |
| Reductions for settlements of tax positions                   |   | (159   | )      |
| Balance at December 31, 2008                             |   | 15,408 |   |
| Additions based on tax positions related to the  current year |   | 3,225  |   |
| Additions for tax positions related to prior years            |   | 1,217  |   |
| Reductions due to lapse of statue of limitations              |   | (635   | )      |
| Reductions for settlements of tax positions                   |   | (126   | )      |
| Balance  at December 31, 2009                            |   | $      | 19,089 |   |

 

Tothe extent our gross unrecognized tax benefits are recognized in the future, areduction of $2.5 million of federal tax benefit for related state income taxdeductions would result.  There is areasonable possibility that the closing of the IRS examination could result ina material reduction to our unrecognized tax benefits within the next twelvemonths.  Due to the fact that the audithas not been finalized, the amount of the unrecognized tax benefits that may bereduced can not be reasonably estimated. Due to our adoption of ASC Topic 805 (formerly SFAS 141R, “BusinessCombinations”) on January 1, 2009, all unrecognized tax benefits willimpact the effective tax rate upon recognition. We recognize accrued interestand penalties related to unrecognized tax benefits as a component of income taxexpense.  We recognized an increase of$0.5 and $0.4 million, respectively, in accrued interest and penalties for theyears ended December 31, 2009 and 2008, respectively. Since adoption weaccrued $1.6 million and $1.1 million, respectively, for the payment ofinterest and penalties at December 31, 2009 and 2008.

 

**14.          RESTRUCTURINGAND RELATED CHARGES**

 

*2009 Chattanooga*

 

In June 2009, we announced our plans to close ourChattanooga manufacturing and distribution facility, located in Hixson,Tennessee, and to integrate the operations of the Chattanooga site into ourother existing sites. The transition of our Chattanooga activities was expectedto take approximately nine to 12 months to complete. As a result of thistransition, we expect to incur approximately $5.0 million to $6.0 million ofcash expenses, mainly related to one-time termination benefits and employeeretention.

 

A summary of the activity relating to therestructuring for the period from June 1, 2009 through December 31,2009 is as follows (in thousands):

 
| ** **                        | ** ** | **Severance &  Employee  Retention** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|-----------|------------|-----------|------------|
| Balance, beginning of period      |       | $                                             | —     |      | $          | —    |       | $ | — |   |
| Expensed during period            |       | 4,896                                         |       | 479       |       | 5,375     |       |
| Payments made during period       |       | (847                                          | )          | (74       | )          | (921      | )          |
| Balance at December 31, 2009 |       | $                                             | 4,049      |      | $          | 405       |       | $ | 4,454 |   |

 

Expenses incurred related to the transitionof our Chattanooga activities are recorded within selling, general andadministrative expense on our consolidated statement of operations for the yearended December 31, 2009.

 

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*2007DJO Merger*

 

At the time of the DJO Merger, management had begun to assess andformulate plans to restructure the operations of DJO to eliminate certainduplicative activities, reduce the cost structure and better align product andoperating expenses with the existing markets in which we compete. The plan wasapproved and initiated after the consummation of the DJO Merger. In the fourthquarter of 2007, we announced the relocation of our headquarters to Vista,California. Activities were also initiated with respect to the relocation ofcertain manufacturing operations from our Chattanooga, Tennessee location toTijuana, Mexico. We also announced the future termination of certain employeesrelated to the move of certain activities of our Bone Growth Stimulation (“BGS”)product line operations from Vista, California to St. Paul, Minnesota.Internationally, we closed a facility in Germany and anticipated facilityclosures in certain other locations in an effort to integrate and realize costsynergies in our international operations. At December 31, 2008,approximately $1.6 million was accrued related to severance and facilityexit costs, and approximately $0.2 million was accrued related to thepurchase of rights to distributor territories in connection with the DJOMerger. We also assumed $1.9 million of severance due to a formerexecutive officer of a business acquired by DJO prior to the DJO Merger, whichwas paid in the first quarter of 2008.

 

In certain cases, estimated severance and facility exit costs have beenaccrued as a liability with a corresponding increase to goodwill in accordancewith the guidance specified in ASC Topic 805 (formerly SFAS No. 141(R), “BusinessCombinations”).  However, not all of ourrestructuring costs meet the accrual requirements of ASC Topic 805, and certainintegration costs are expensed as incurred.

 

Asummary of the activity relating to the restructuring year ended December 31,2008 is as follows (in thousands):

 
| ** **                        | ** ** | **Lease  Termination  Costs** | ** ** | **Severance** | ** ** | **Purchase of  Rights to  Distributor  Territories** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|---------------|------------|----------------------------------------------------------------|------------|-----------|------------|
| Balance at December 31, 2007 |       | 1,349                         |       | 6,087         |       | 2,127                                                          |       | 9,563     |       |
| Expensed during period            |       | —                        |       | 3,998         |       | —                                                         |       | 3,998     |       |
| Adjustments to goodwill           |       | 625                           |       | (769          | )          | (458                                                           | )          | (602      | )          |
| Payments made during period       |       | (739                          | )          | (8,543        | )          | (1,366                                                         | )          | (10,648   | )          |
| Adjustments to reserve            |       | (312                          | )          | (35           | )          | (123                                                           | )          | (470      | )          |
| Foreign currency translation      |       | (45                           | )          | (54           | )          | —                                                         |       | (99       | )          |
| Balance at December 31, 2008 |       | $                             | 878        |          | $          | 684                                                            |       | $         | 180        |   | $ | 1,742 |   |
|                                   |            |                               |            |               |            |                                                                |            |           |            |  |  |  |  |

 

Materiallyall amounts accrued for as of December 31, 2008 were paid in 2009.

 

**15.          COMMITMENTS ANDCONTINGENCIES**

 

*Commitments*

 

As of December 31,2009, we had entered into future purchase commitments for inventory, capitalacquisitions and other services totaling approximately $92.1 million in theordinary course of business. This amount includes an annual commitment of $7.0million for monitoring fees to be paid to Blackstone Management Partners VL.L.C. (“BMP”) through 2019.

 

Thefollowing table summarizes our contractual obligations excluding operatingleases as of December 31, 2009 associated with fixed commitments forpurchase and service obligations for the next five years and thereafter (inthousands):

 
| **Years Ending December 31,** |   |   |   |
|----------------------------------------------|--------|--------|--------|
| 2010                                         |   | $      | 25,645 |   |
| 2011                                         |   | 10,446 |   |
| 2012                                         |   | 7,000  |   |
| 2013                                         |   | 7,000  |   |
| 2014                                         |   | 7,000  |   |
| Thereafter                                   |   | 35,000 |   |
| Total                                        |   | $      | 92,091 |   |

 

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## ***Operating Leases***.  We lease building space, manufacturingfacilities and equipment under non-cancelable operating lease agreements thatexpire at various dates.  We record rentincentives as deferred rent and amortize as reductions to lease expense overthe lease term in accordance with ASC topic 840 (formerly FASB Statement No. 13,“Accounting for Leases (as amended)”). The aggregate minimum rental commitments under non-cancelable leases forthe periods shown at December 31, 2009, are as follows (in thousands):

 
| **Years Ending December 31,** |   |   |   |
|----------------------------------------------|--------|--------|--------|
| 2010                                         |   | $      | 10,472 |   |
| 2011                                         |   | 8,204  |   |
| 2012                                         |   | 6,878  |   |
| 2013                                         |   | 6,169  |   |
| 2014                                         |   | 5,954  |   |
| Thereafter                                   |   | 20,626 |   |
|                                         |   | $      | 58,303 |   |

 

Rentalexpense under operating leases totaled approximately $13.4 million, $12.4million, and $4.3 million for the years ended December 31, 2009, 2008 and2007, respectively.  Scheduled increasesin rent expense are amortized on a straight line basis over the life of thelease.

 

## ***Capital Leases***.  Leased equipment under capital leases,included in property and equipment in the accompanying consolidated financialstatements are as follows (in thousands):

 
| ** **                           | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Equipment                            |       | $                           | 678        |                        | $          | 556 |   |
| Less — accumulated amortization |       | (393                        | )          | (244                        | )          |
|                                 |       | $                           | 285        |                        | $          | 312 |   |

 

*Litigation*

 

Themanufacture and sale of orthopedic devices and related products exposes us to asignificant risk of product liability claims. From time to time, we have been,and we are currently, subject to a number of product liability claims allegingthat the use of our products resulted in adverse effects. Even if we aresuccessful in defending against any liability claims, such claims couldnevertheless distract our management, result in substantial costs, harm ourreputation, adversely affect the sales of all our products and otherwise harmour business. If there is a significant increase in the number of productliability claims, our business could be adversely affected.

 

We are currently defendants in approximately 80product liability cases, including lawsuits in Canada and Texas seeking classaction status, related to a disposable drug infusion pump product manufacturedby two third party manufacturers that we distributed through our Bracing andSupports business unit of our Domestic Rehabilitation segment. We discontinuedour sale of these products in the second quarter of 2009. These cases have beenbrought against the manufacturers and certain distributors of these pumps, andin some cases, the manufacturers of the anesthetics used in these pumps. All ofthese lawsuits allege that the use of these pumps with certain anesthetics incertain shoulder surgeries over prolonged periods have resulted in cartilagedamage to the plaintiffs. We have sought indemnity and tendered the defense ofthese cases to the two manufacturers who supplied these pumps to us, to theirproducts liability carriers and to our products liability carriers. Theproducts liability carriers for both manufacturers have accepted coverage forour defense of these claims; however, both manufacturers have rejected ourtenders of indemnity. The base policy for one of the manufacturers has beenexhausted and the excess liability carriers for that manufacturer are notobligated to provide a defense until a $5 million self-insured retention hasbeen paid. Our products liability carrier has accepted coverage of these cases,subject to a reservation of the right to deny coverage for customary matters,including punitive damages and off-label promotion. The lawsuits allege damagesranging from unspecified amounts to claims between $1.0 million and $10.0million. These cases are in varying stages of discovery. We could be exposed tomaterial liabilities if our insurance coverage is not available or inadequateand the resources of the two manufacturers, including their respective productsliability insurance policies, are insufficient to pay the defense costs andsettlements or judgments in these cases.

 

We maintain products liability insurance that issubject to annual renewal. Our current policy covers claims reported between July 1,2009 and June 30, 2010 and provides for coverage (together with excesspolicies) of up to a limit of $80 million, provided that the top layer of $25million excess over $55 million covers only claims reported after February 25,2010 and the next layer down of $10 million excess over $45 million covers onlyclaims reported after February 18, 2010. This coverage is subject to aself-insured retention of $500,000 for claims related to pain pumps describedabove and claims related to the IceMan cold therapy product, a self-insuredretention of $250,000 on claims related to all other invasive products and aself-insured retention of $50,000 on claims related to all other non-invasiveproducts, with an aggregate self-insured retention of $1.0 million for allproducts liability claims. In addition, the top layer of $25 million excessover $55 million has a separate self-insured retention of $50,000 perclaim.  Our prior two products liabilitypolicies cover claims reported between July 1, 2007 and February 15,2008 and between February 15, 2008 and July 1, 2009,respectively.  The 2007-2008 policyprovides for coverage (together with excess policies) of up to a limit of $20million and the 2008-2009 policy provides for coverage (together with excesspolicies) of up to a limit of $25 million. Certain of the pain pump cases

 

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describedabove were reported under and are covered by these two policies.  If a products liability claim or series ofclaims is brought against us for uninsured liabilities or in excess of ourinsurance coverage, our business could suffer materially. In addition, incertain instances, a products liability claim could also result in our havingto recall some of our products, which could result in significant costs to us.On our consolidated balance sheet of December 31, 2009, we have accruedapproximately $2.0 million for expenses related to products liabilityclaims.  The amount accrued is based uponprevious claim experience in part due to the fact that in 2003 we exceeded thecoverage limits in effect at that time for certain historical product liabilityclaims involving one of our discontinued surgical implant products and suchproducts are excluded from coverage under our current policies.

 

Due tothe nature of our business, we are subject to a variety of audits by governmentagencies and other private interests.  Inthe first quarter of 2008, we received Form FDA-483 “InspectionalObservations” in connection with an FDA audit of the Chattanooga business unitof our Domestic Rehabilitation Segment, stating that we failed to reportcertain customer complaints claiming that our muscle stimulator devicesmalfunctioned, and that we did not adequately implement corrective andpreventive action to prevent recurrence of potential product failures relatingto our muscle stimulator devices. The FDA auditor also recommended that werecall a series of ultrasound devices that had experienced operating issues in2005, and we are implementing such a recall. We received a warning letter fromthe FDA in June 2008 relating to reporting issues on the muscle stimulatordevice complaints and requesting software verification and validation plans andreports regarding the correction of problems associated with the ultrasoundproduct. We believe that we have addressed these areas of concern adequately.In a recent FDA audit of our Chattanooga facility, as a follow-up to thewarning letter we received in June 2008, the FDA issued no Form FDA-483“Inspectional Observations”, and the FDA has formally withdrawn the warningletter.

 

In the third quarter of 2009, we received a Form FDA-483“Inspectional Observations” in connection with an FDA audit of our SurgicalImplant Segment, stating that: (1) we failed to follow our standardoperating procedures to ensure that the designs of certain products werecorrectly transferred into production; (2) we failed to adequately analyzecertain quality data to identify existing and potential causes of nonconformingproduct and quality problems, resulting in disposal or reworking of certainnonconforming parts in the later stages of our production processes; (3) ourcomplaint handling procedures were not well defined to ensure that allcomplaints are processed in a uniform and timely manner; and (4) we failedto follow our standard operating procedures related to procurement to minimizereceipt of nonconforming materials from suppliers. We promptly implementedcorrective action that we believe adequately address each InspectionalObservation and submitted a timely response to the FDA. We cannot assure youthat the FDA will agree with our actions or will not take further action in thefuture, including issuing a warning letter related to these observations,seeking injunction, initiating seizure, or delaying review of pendingapplications.

 

On April 15, 2009, we became aware of a *qui tam*action filed in Federal Court inBoston, Massachusetts in March 2005 and amended in December 2007 thatnames us as a defendant along with each of the other companies thatmanufactures and sells external bone growth stimulators, as well as ourprincipal stockholder, The Blackstone Group, and the principal stockholder ofone of the other companies in the bone growth stimulation business. This caseis captioned United States *ex rel.*Beirmanv. Orthofix International, N.V., *et al.*,Civil Action No. 05-10557 (D. Mass.). The case was sealed when originallyfiled and unsealed in March 2009. The plaintiff, or relator, alleges thatthe defendants have engaged in Medicare fraud and violated Federal and statefalse claims acts from the time of the original introduction of the devices byeach defendant to the present by seeking reimbursement for bone growthstimulators as a purchased item rather than a rental item. The relator alsoalleges that the defendants are engaged in other marketing practicesconstituting violations of the Federal and various state anti-kickbackstatutes. On December 4, 2009, we filed a motion to dismiss the relator’scomplaint, and we are currently awaiting a response from the relator. Shortlybefore becoming aware of the *qui**tam*action, we were advised that our bonegrowth stimulator business was the subject of an investigation by the DOJ, andon April 10, 2009, we were served with a subpoena under HIPAA seekingnumerous documents relating to the marketing and sale by us of bone growthstimulators. On September 21, 2009, we were served with a second HIPAAsubpoena related to this DOJ investigation seeking additional documentsrelating to the marketing and sale by us of bone growth stimulators. We believethat these subpoenas are related to the DOJ’s investigation of the allegationsin the *qui tam*action, althoughthe DOJ has decided not to intervene in the *quitam*action at this time. We believe that our marketing practices inthe bone growth stimulation business are in compliance with applicable legalstandards and intend to defend this case and investigation vigorously. We canmake no assurance as to the resources that will be needed to respond to these mattersor the final outcome.

 

In December 2006, we recorded approximately $1.1 million as acontingent liability with an offsetting adjustment to goodwill relating tolitigation against Compex Technologies, Inc. (“Compex”) regarding adispute over custom duties and VAT on imported goods as part of the purchaseaccounting of Compex. In February 2007, a judgment in the dispute with thecustom officials was issued by the court which resulted in partial unfavorablerulings for each side. In June 2008, the Appeal Court of Paris announced apreliminary judgment in our favor. In August 2008, we received writtennotice that the French custom would not appeal the ruling. As such, we reversedour contingent liability previously accrued for and recorded it as a reductionto expense within the condensed consolidated statements of operations in thethird quarter of 2008.

 

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OnJuly 7, 2006, a purported class action complaint, *Louis Dudas et al. v.**Encore Medical Corporation et al.,*wasfiled against DJO and its directors in the District Court of Travis County,Texas, 345th Judicial District (the “Texas Action”). Recently, Blackstone wasadded as a defendant. On July 18, 2006, a second purported class actioncomplaint, *Robert**Kemp et al. v. Alastair J. Clemow et al.*(the“Delaware Action”) was filed by a putative stockholder of DJO in the Court ofChancery of the State of Delaware, New Castle County, against DJO and itsdirectors. Blackstone and Grand Slam Holdings, LLC were also named asdefendants in the Delaware Action. The Delaware Action was dismissed in February 2007with no liability accruing to DJO or the other defendants.

 

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

 

**16.          RELATEDPARTY TRANSACTIONS**

** **

**Management Stockholder’s Agreement**

 

Certainmembers of DJO’s management are parties to DJO’s management stockholdersagreement, dated November 3, 2006, among DJO, Grand Slam Holdings, LLC (“BCPHoldings”), Blackstone, certain of its affiliates, and such members of DJO’smanagement and current executive officers (the “Management StockholdersAgreement”). In conjunction with the DJO Merger, certain incoming executives ofDJO (the “new management stockholders”) became 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 management stockholder’scallable shares.  The Amendment provides that, unless a new managementstockholder was terminated by DJO for “cause” (as defined in the Amendment) orunless the new management stockholder voluntarily terminated employment andsuch termination would have constituted a termination for “cause” if it wouldhave been initiated by DJO, such new management stockholder would receive fairmarket value for such new management stockholder’s shares callable upon theexercise of a call right.

 

TheManagement Stockholders Agreement imposes significant restrictions on transfersof shares of DJO’s common stock held by management stockholders and provides aright of first refusal to DJO or Blackstone, if DJO fails to exercise suchright) on any proposed sale of DJO’s common stock held by a managementstockholder following the lapse of the transfer restrictions and prior to theoccurrence of a ‘‘qualified public offering’’ (as such term is defined in thatagreement) of DJO.  In addition, prior toa qualified public offering, Blackstone will have drag-along rights, andmanagement stockholders will have tag-along rights, in the event of a sale ofDJO’s common stock by Blackstone to a third party (or in the event of a sale ofBCP Holdings’ equity interests to a third party) in the same proportion as theshares or equity interests sold by Blackstone. If, prior to either the lapse ofthe transfer restrictions or a qualified public offering, a managementstockholder’s employment is terminated, DJO will have the right to repurchaseall shares of its common stock held by such management stockholder for a periodof one year from the date of termination of employment (or the until the datethat is one year following the exercise of the stock options used to acquiresuch common stock, if later). If DJO does not exercise this repurchase rightduring the applicable repurchase period, then Blackstone will generally havethe right to repurchase such shares for a period of 30 days thereafter. TheManagement Stockholders Agreement also provides that, after the occurrence of aqualified public offering, the management stockholders will receive customarypiggyback registration rights with respect to shares of DJO common stock heldby them.

 

OnDecember 13, 2006, DJO, BCP Holdings, Blackstone and certain of itsaffiliates entered into a stockholders agreement with Sidney Braginsky, one ofDJO’s directors. The terms and conditions of the stockholders agreement with Mr. Braginskyare the same, in all material respects, as the management stockholdersagreement described above.  As newdirectors join the Board and receive stock options, they are required to enterinto a similar agreement.  In addition,all parties receiving an award of stock options including all DJO directors whohave been granted options, automatically become parties to the ManagementStockholders Agreement.

 

**Transactionand Monitoring Fee Agreement**

 

Under the Transaction and Monitoring Fee Agreement, we paid BlackstoneManagement Partners V L.L.C. (“BMP”), at the closing of the DJO Merger, a $15.0million transaction fee and $0.6 million for related expenses.  Also, pursuant to this agreement, at theclosing of the DJO Merger, we paid Blackstone Advisory Services, L.P. (“BAS”),an affiliate of BMP, a $3.0 million advisory fee in consideration of theprovision of certain strategic and other advice and assistance by BAS on behalfof BMP.

 

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In connection with the DJO Merger, BMP has agreed to provide certainmonitoring, advisory and consulting services to us for an annual monitoring feeequal to the greater of $7.0 million or 2% of consolidated EBITDA asdefined in the Transaction and Monitoring Fee Agreement, payable in the firstquarter of each year. Prior to the DJO Merger, the annual BMP monitoring feewas equal to $3.0 million. At any time in connection with or inanticipation of a change of control of DJOFL, a sale of all or substantiallyall of DJOFL’s assets or an initial public offering of common stock of DJOFL,BMP may elect to receive, in lieu of remaining annual monitoring fee payments,a single lump sum cash payment equal to the then-present value of allthen-current and future annual monitoring fees payable under the transactionand monitoring fee agreement, assuming a hypothetical termination date of theagreement to be the twelfth anniversary of such election. The monitoring feeagreement will continue until the earlier of the twelfth anniversary of thedate of the agreement or such date as DJOFL and BMP may mutually determine.DJOFL will agree to indemnify BMP and its affiliates, directors, officers,employees, agents and representatives from and against all liabilities relatingto the services contemplated by the transaction and monitoring fee agreementand the engagement of BMP pursuant to, and the performance of BMP and itsaffiliates of the services contemplated by, the transaction and monitoring feeagreement. For the years ended December 31, 2009, 2008 and 2007, weexpensed $7.0 million, $7.0 million, and $3.0 million, respectively,related to the annual monitoring fee. This is recorded as a component ofselling, general and administrative expense in the audited consolidatedstatements of operations.

 

**17.**                              DERIVATIVE INSTRUMENTS

** **

We operate internationally and are therefore exposed to foreigncurrency exchange rate fluctuations in the normal course of our business, inparticular to changes in the Mexican Peso due to our Mexico-based manufacturingoperations that incur costs that are largely denominated in Mexican Pesos. Aspart of our risk management strategy, we use derivative instruments to hedgeportions of our exposure. While our foreign exchange contracts act as economichedges, we have not designated such instruments as hedges under ASC Topic815.  Before acquiring a derivativeinstrument to hedge a specific risk, potential natural hedges are evaluated.Derivative instruments are only utilized to manage underlying exposures thatarise from our business operations. Factors considered in the decision to hedgean underlying market exposure include the materiality of the risk, thevolatility of the market, the duration of the hedge, and the availability,effectiveness and cost of derivative instruments.  At December 31, 2009, we had foreignexchange forward contracts to purchase Mexican Pesos, with a notional amount of$190.7 million Mexican Pesos, or approximately $14.7 million and an aggregatefair market value of approximately $0.1 million.  These foreign exchange forward contractsexpire weekly throughout fiscal year 2010.

 

Additionally, we make use of debt financing as a source of funds andare therefore exposed to interest rate fluctuations in the normal course ofbusiness. Our credit facilities are subject to floating interest rates. Wemanage the risk of unfavorable movements in interest rates by hedging theinterest rates on a portion of the outstanding loan balance, thereby locking ina fixed rate on a portion of the principal, reducing the effect of possiblerising interest rates and making interest expense more predictable. On November 20,2007, we entered into an interest rate swap agreement related to the SeniorSecured Credit Facility for a notional amount of $515.0 million at a fixedLIBOR rate of 4.205% which expired at December 31, 2009. In February 2009,we entered into two new non-amortizing interest rate swap agreements. The firstagreement was for a notional amount of $550.0 million at a fixed LIBOR rate of1.04% beginning February 2009 and expired at December 31, 2009.  The second agreement is for a notional amountof $750.0 million at a fixed LIBOR rate of 1.88% with a term beginning January 2010through December 2010. In August 2009, we entered into four new non-amortizinginterest swap agreements with notional amounts aggregating $300.0 million. Eachof the four agreements has a term beginning January 2011 through December 2011.The four agreements are at a weighted average fixed LIBOR rate of 2.5825%.  We have designated these interest rate swapagreements as cash flow hedges under ASC Topic 815.

 

In accordance with ASC Topic 820 (formerly SFAS No. 157, “FairValue Measurements”), we follow the three levels of the fair value hierarchyfor disclosure of the inputs to valuation. This hierarchy prioritizes theinputs into three broad levels as follows. Level 1 inputs are quotedprices (unadjusted) in active markets for identical assets or liabilities.Level 2 inputs are quoted prices for similar assets and liabilities inactive markets or inputs that are observable for the asset or liability, eitherdirectly or indirectly through market corroboration, for substantially the fullterm of the financial instrument. Level 3 inputs are unobservable inputsbased on our own assumptions used to measure assets and liabilities at fairvalue. A financial asset or liability’s classification within the hierarchy isdetermined based on the lowest level input that is significant to the fairvalue measurement. At December 31, 2009, the fair value of our interestrate swap agreements and our foreign currency exchange forward contracts weredetermined through the use of models that consider various assumptions,including time value, yield curves, as well as other relevant economic measures,which are inputs that are classified as Level 2 in the valuationhierarchy.

 

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The following table summarizes our derivative instruments, which, sincethe fair values reflect gains and losses are, included within our assets andother current and non-current liabilities in our audited consolidated balancesheets (in thousands):

 
| ** **                   | ** ** | **December 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets:**                  | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Foreign exchange contracts   |       | $                           | 89         |                        | $          | — |   |
| Total derivative assets      |       | $                           | 89         |                        | $          | — |   |
| ** **                   | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| **Liabilities:**             | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Foreign exchange contracts   |       | $                           | —     |                        | $          | 4,162 |   |
| Interest rate swaps          |       | 11,244                      |       | 13,272                      |       |
| Total derivative liabilities |       | $                           | 11,244     |                        | $          | 17,434 |   |

 

The following table summarizes the effect our derivative instrumentshave on our audited consolidated statements of operations (in thousands):

 
| ** **                 | ** ** | **Location of Gain or**      | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **(Loss)**                   | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|                       | ** ** | ** **                   | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Foreign exchange contracts |       | Other  income (expense), net |       | $                                | (2,856     | ) | $ | (3,248 | ) | $ | 108 |   |
| Interest rate swaps        |       | Interest  expense            |       | (18,164                          | )          | (3,440 | ) | (4,069 | ) |
| Total net loss             |       |                         |       | $                                | (21,020    | ) | $ | (6,688 | ) | $ | (3,961 | ) |

 

**18.          UNAUDITED QUARTERLYCONSOLIDATED FINANCIAL DATA**

 

The following represents the unaudited quarterlyconsolidated financial data for the periods presented (in thousands):

 
| ** **                               | ** ** | **For the three months ended** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                               | ** ** | **Mar 28,  2009**                             | ** ** | **Jun 27,  2009** | ** ** | **Sep 26,  2009** | ** ** | **Dec 31,  2009** | ** ** |
| Net sales                                |       | $                                                  | 217,653    |   | $ | 235,112 |   | $ | 236,186 |   | $ | 257,175 |   |
| Gross profit                             |       | 138,653                                            |       | 152,956 |   | 150,147 |   | 165,651 |   |
| Operating income                         |       | 13,119                                             |       | 19,018 |   | 23,558 |   | 23,162 |   |
| Net loss attributable to DJO Finance LLC |       | (14,308                                            | )          | (13,085 | ) | (11,374 | ) | (11,666 | ) |
| Net loss                                 |       | (14,169                                            | )          | (12,950 | ) | (11,280 | ) | (11,311 | ) |
|                                          |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **For the three months ended** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                               | ** ** | **Mar 29,  2008**                             | ** ** | **Jun 28,  2008** | ** ** | **Sep 27,  2008** | ** ** | **Dec 31,  2008** | ** ** |
| Net sales                                |       | $                                                  | 232,034    |   | $ | 241,352 |   | $ | 235,515 |   | $ | 239,568 |   |
| Gross profit                             |       | 142,570                                            |       | 155,516 |   | 148,569 |   | 151,637 |   |
| Operating income (loss)                  |       | 7,862                                              |       | 14,119 |   | 18,859 |   | (7,499 | ) |
| Net loss attributable to DJO Finance LLC |       | (24,162                                            | )          | (20,798 | ) | (14,429 | ) | (38,397 | ) |
| Net loss                                 |       | (23,962                                            | )          | (20,503 | ) | (14,131 | ) | (38,141 | ) |
|                                          |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 

**19.**                              EMPLOYEE BENEFIT PLANS

** **

We have multiple qualified defined contributionplans, which allow for voluntary pre-tax contributions by employees.  We pay all general and administrative expensesof the plans and may make contributions to the plans. Based on 100% of thefirst 1% and 50% of the next 5% of compensation deferred by employees (subjectto Internal Revenue Service limits and non-discrimination testing), we madematching contributions of $3.7 million, $3.3 million, and $1.6 million,respectively,  to the plan for the yearsended December 31, 2009, 2008 and 2007. The plans provide fordiscretionary contributions by us as approved by the Board of Directors.  There have been no such discretionarycontributions through December 31, 2009. In addition, we made pension contributions of approximately $0.4 millionrelated to our international pension plans.

 

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**20.          SUBSEQUENT EVENTS**

 

On January 20, 2010, we issued $100.0 millionaggregate principal amount of new 10.875%Senior Notes which mature on November 15, 2014,pursuant to the indenture governing our existing 10.875%Senior Notes due 2014 that were issued onNovember 20, 2007. Interest on the Notes will be payable in cash on May 15and November 15 of each year, commencing on May 15, 2010, and  will accrue from and including November 16,2009, the first day of the current interest period of the existing Notes.

 

The Notes are guaranteed jointly and severally and onan unsecured senior basis by each of DJOFL’s existing and future direct andindirect wholly owned domestic subsidiaries that guarantees any of DJOFL’sindebtedness or any indebtedness of DJOFL’s domestic subsidiaries or is anobligor under DJOFL’s senior secured credit facilities.

 

The net proceeds from the issuance (excludingapproximately $2.0 million of interest accrued from November 16, 2009 to January 19,2010, which will be included in the first interest payment to be made on May 15,2010), along with cash on hand, were used to prepay $101.5 million aggregateprincipal amount of existing term loans under the Senior Secured CreditFacility.

 

**21.          SUPPLEMENTALGUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS**

 

On November 20, 2007, DJOFL and its direct wholly-ownedsubsidiary, Finco, issued the 10.875% Notes with an aggregate principal amountof $575.0 million. On November 3, 2006, DJOFL and Finco issued the11.75% Notes with an aggregate principal amount of $200.0 million. Fincowas formed solely to act as a co-issuer of the notes, has only nominal assetsand does not conduct any operations. The Indentures generally prohibit Fincofrom holding any assets, becoming liable for any obligations, or engaging inany business activity. The 10.875% Notes are jointly and severally, fully andunconditionally guaranteed, on an unsecured senior basis by all of the DJOFL’sdomestic subsidiaries (other than the co-issuer) that are 100% owned, directlyor indirectly, by DJOFL (the “Guarantors”). The 11.75% Notes are jointly andseverally, fully and unconditionally guaranteed, on an unsecured seniorsubordinated basis by the Guarantors. Our foreign subsidiaries (the “Non-Guarantors”)do not guarantee the notes. The Guarantors also unconditionally guarantee theSenior Secured Credit Facility.

 

The following tables present the financial position, results ofoperations and cash flows of DJOFL, the Guarantors, the Non-Guarantors andcertain eliminations as of December 31, 2009 and 2008 and for the yearsended December 31, 2009, 2008 and 2007.

 

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**DJO Finance LLC**

 

**Condensed Consolidating Balance Sheets**

**As of December 31,2009**

**(inthousands)**

 
| ** **                                                     | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                     |       |      |       |           |       |                 |       |             |       |             |       |
| Current assets:                                                |       |      |       |           |       |                 |       |             |       |             |       |
| Cash and cash equivalents                                      |       | $         | 6,999      |           | $          | 17,389               |       | $                | 20,223     |             | $          | — |   | $ | 44,611 |   |
| Accounts receivable, net                                       |       | —    |       | 113,258        |       | 32,954               |       | —           |       | 146,212          |       |
| Inventories, net                                               |       | —    |       | 80,491         |       | 23,705               |       | (8,316           | )          | 95,880           |       |
| Deferred tax assets, net                                       |       | —    |       | 40,474         |       | 993                  |       | (1,019           | )          | 40,448           |       |
| Prepaid expenses and other current assets                      |       | 162       |       | 11,368         |       | 3,195                |       | —           |       | 14,725           |       |
| Total current assets                                           |       | 7,161     |       | 262,980        |       | 81,070               |       | (9,335           | )          | 341,876          |       |
| Property and equipment, net                                    |       | —    |       | 76,883         |       | 12,811               |       | (2,980           | )          | 86,714           |       |
| Goodwill                                                       |       | —    |       | 1,108,703      |       | 82,794               |       | —           |       | 1,191,497        |       |
| Intangible assets, net                                         |       | —    |       | 1,147,504      |       | 40,173               |       | —           |       | 1,187,677        |       |
| Investment in subsidiaries                                     |       | 1,275,652 |       | 2,362,165      |       | 71,566               |       | (3,709,383       | )          | —           |       |
| Intercompany receivable                                        |       | 1,065,693 |       | —         |       | —               |       | (1,065,693       | )          | —           |       |
| Other non-current assets                                       |       | 38,946    |       | (1,913         | )          | 5,382                |       | —           |       | 42,415           |       |
| Total assets                                                   |       | $         | 2,387,452  |           | $          | 4,956,322            |       | $                | 293,796    |             | $          | (4,787,391 | ) | $ | 2,850,179 |   |
| **Liabilities and Membership  Equity**                         |       |      |       |           |       |                 |       |             |       |             |       |
| Current liabilities:                                           |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts payable                                               |       | $         | —     |           | $          | 34,750               |       | $                | 7,393      |             | $          | 1 |   | $ | 42,144 |   |
| Long-term debt and capital leases, current portion             |       | 12,568    |       | 140            |       | 3,218                |       | —           |       | 15,926           |       |
| Other current liabilities                                      |       | 22,165    |       | 60,992         |       | 18,419               |       | —           |       | 101,576          |       |
| Total current liabilities                                      |       | 34,733    |       | 95,882         |       | 29,030               |       | 1                |       | 159,646          |       |
| Long-term debt and capital leases, net of current portion |       | 1,796,859 |       | 83             |       | 2                    |       | —           |       | 1,796,944        |       |
| Deferred tax liabilities, net                                  |       | —    |       | 302,870        |       | 15,272               |       | 2,989            |       | 321,131          |       |
| Intercompany payable, net                                      |       | —    |       | 960,790        |       | 104,903              |       | (1,065,693       | )          | —           |       |
| Other non-current liabilities                                  |       | —    |       | 11,162         |       | 2,927                |       | —           |       | 14,089           |       |
| Total liabilities                                              |       | 1,831,592 |       | 1,370,787      |       | 152,134              |       | (1,062,703       | )          | 2,291,810        |       |
| Noncontrolling interests                                       |       | —    |       | —         |       | 2,509                |       | —           |       | 2,509            |       |
| Membership equity                                              |       | 555,860   |       | 3,585,535      |       | 139,153              |       | (3,724,688       | )          | 555,860          |       |
| Total liabilities and membership equity                        |       | $         | 2,387,452  |           | $          | 4,956,322            |       | $                | 293,796    |             | $          | (4,787,391 | ) | $ | 2,850,179 |   |

 

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**DJO Finance LLC**

 

**Condensed Consolidating Balance Sheets**

**As of December 31,2008**

**(inthousands)**

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

 

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**DJO Finance LLC**

 

**Condensed Consolidating Statements of Operations**

**For theYear Ended December 31, 2009**

**(inthousands)**

 
| ** **                                                         | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non- Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|-----------|------------|----------------|------------|--------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                          |       | $         | —     |           | $          | 804,912                  |       | $                | 268,644    |             | $          | (127,430 | ) | $ | 946,126 |   |
| Cost of sales                                                      |       | —    |       | 290,097        |       | 175,464                  |       | (126,842         | )          | 338,719          |       |
| Gross profit                                                       |       | —    |       | 514,815        |       | 93,180                   |       | (588             | )          | 607,407          |       |
| Operating expenses:                                                |       |      |       |           |       |                     |       |             |       |             |       |
| Selling, general and administrative                                |       | —    |       | 343,574        |       | 76,201                   |       | 983              |       | 420,758          |       |
| Research and development                                           |       | —    |       | 20,712         |       | 2,828                    |       | —           |       | 23,540           |       |
| Amortization and impairment of  acquired intangibles          |       | —    |       | 81,431         |       | 2,821                    |       | —           |       | 84,252           |       |
| Operating income                                                   |       | —    |       | 69,098         |       | 11,330                   |       | (1,571           | )          | 78,857           |       |
| Other income (expense):                                            |       |      |       |           |       |                     |       |             |       |             |       |
| Interest income                                                    |       | 50,355    |       | 3,002          |       | 886                      |       | (53,210          | )          | 1,033            |       |
| Interest expense                                                   |       | (156,228  | )          | (50,522        | )          | (3,492                   | )          | 53,210           |       | (157,032         | )          |
| Other income (expense), net                                        |       | 55,440    |       | 90,714         |       | 1,264                    |       | (141,345         | )          | 6,073            |       |
| Income (loss) from continuing operations  before income taxes |       | (50,433   | )          | 112,292        |       | 9,988                    |       | (142,916         | )          | (71,069          | )          |
| Benefit for income taxes                                           |       | —    |       | (23,555        | )          | (1,876                   | )          | 3,753            |       | (21,678          | )          |
| Income (loss) from continuing operations                           |       | (50,433   | )          | 135,847        |       | 11,864                   |       | (146,669         | )          | (49,391          | )          |
| Loss from discontinued operations, net of tax                      |       | —    |       | (319           | )          | —                   |       | —           |       | (319             | )          |
| Net income (loss)                                                  |       | (50,433   | )          | 135,528        |       | 11,864                   |       | (146,669         | )          | (49,710          | )          |
| Less: Net income attributable to noncontrolling  interests         |       | —    |       | —         |       | 723                      |       | —           |       | 723              |       |
| Net income (loss) attributable to DJO                              |       | $         | (50,433    | )              | $          | 135,528                  |       | $                | 11,141     |             | $          | (146,669 | ) | $ | (50,433 | ) |

 

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**DJO Finance LLC**

 

**Condensed Consolidating Statements of Operations**

**For theYear Ended December 31, 2008**

**(inthousands)**

 
| ** **                                                         | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non- Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|-----------|------------|----------------|------------|--------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                          |       | $         | —     |           | $          | 789,960                  |       | $                | 255,414    |             | $          | (96,905 | ) | $ | 948,469 |   |
| Cost of sales                                                      |       | —    |       | 298,766        |       | 151,650                  |       | (100,239         | )          | 350,177          |       |
| Gross profit                                                       |       | —    |       | 491,194        |       | 103,764                  |       | 3,334            |       | 598,292          |       |
| Operating expenses:                                                |       |      |       |           |       |                     |       |             |       |             |       |
| Selling, general and administrative                                |       | —    |       | 353,464        |       | 85,601                   |       | (6               | )          | 439,059          |       |
| Research and development                                           |       | —    |       | 23,965         |       | 2,973                    |       | —           |       | 26,938           |       |
| Amortization and impairment of  acquired intangibles          |       | —    |       | 96,894         |       | 2,060                    |       | —           |       | 98,954           |       |
| Operating income                                                   |       | —    |       | 16,871         |       | 13,130                   |       | 3,340            |       | 33,341           |       |
| Other income (expense):                                            |       |      |       |           |       |                     |       |             |       |             |       |
| Interest income                                                    |       | 45,032    |       | 4,230          |       | 808                      |       | (48,408          | )          | 1,662            |       |
| Interest expense                                                   |       | (172,286  | )          | (45,193        | )          | (4,091                   | )          | 48,408           |       | (173,162         | )          |
| Other income (expense), net                                        |       | 29,468    |       | (6,395         | )          | (2,810                   | )          | (29,468          | )          | (9,205           | )          |
| Income (loss) from continuing operations  before income taxes |       | (97,786   | )          | (30,487        | )          | 7,037                    |       | (26,128          | )          | (147,364         | )          |
| Provision (benefit) for income taxes                               |       | —    |       | (52,143        | )          | 2,462                    |       | —           |       | (49,681          | )          |
| Income (loss) from continuing operations                           |       | (97,786   | )          | 21,656         |       | 4,575                    |       | (26,128          | )          | (97,683          | )          |
| Income from discontinued operations, net of tax                    |       | —    |       | 946            |       | —                   |       | —           |       | 946              |       |
| Net income (loss)                                                  |       | (97,786   | )          | 22,602         |       | 4,575                    |       | (26,128          | )          | (96,737          | )          |
| Less: Net income attributable to noncontrolling  interests         |       | —    |       | —         |       | 1,049                    |       | —           |       | 1,049            |       |
| Net income (loss) attributable to DJO                              |       | $         | (97,786    | )              | $          | 22,602                   |       | $                | 3,526      |             | $          | (26,128 | ) | $ | (97,786 | ) |

 

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**DJOFinance LLC**

 

**Condensed Consolidating Statement of Operations**

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

**(in thousands)**

** **
| ** **                                                           | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                            |       | $         | —     |           | $          | 368,979              |       | $                | 113,057    |             | $          | (17,225 | ) | $ | 464,811 |   |
| Cost of sales                                                        |       | —    |       | 145,123        |       | 57,073               |       | (16,998          | )          | 185,198          |       |
| Gross profit                                                         |       | —    |       | 223,856        |       | 55,984               |       | (227             | )          | 279,613          |       |
| Operating expenses:                                                  |       |      |       |           |       |                 |       |             |       |             |       |
| Selling, general and administrative                                  |       | 2,942     |       | 216,713        |       | 47,304               |       | (52              | )          | 266,907          |       |
| Research and development                                             |       | —    |       | 16,998         |       | 4,049                |       | —           |       | 21,047           |       |
| Amortization of acquired intangibles                                 |       | —    |       | 30,803         |       | 2,693                |       | —           |       | 33,496           |       |
| Operating income (loss)                                              |       | (2,942    | )          | (40,658        | )          | 1,938                |       | (175             | )          | (41,837          | )          |
| Other income (expense):                                              |       |      |       |           |       |                 |       |             |       |             |       |
| Interest income                                                      |       | 21,590    |       | 5,101          |       | 344                  |       | (25,903          | )          | 1,132            |       |
| Interest expense                                                     |       | (72,085   | )          | (22,216        | )          | (4,011               | )          | 25,903           |       | (72,409          | )          |
| Other income (expense), net                                          |       | (14,446   | )          | (22,876        | )          | 496                  |       | 37,568           |       | 742              |       |
| Loss on early extinguishment of debt                                 |       | (14,539   | )          | —         |       | —               |       | —           |       | (14,539          | )          |
| Income (loss) before income taxes and  noncontrolling interests |       | (82,422   | )          | (80,649        | )          | (1,233               | )          | 37,393           |       | (126,911         | )          |
| Benefit for income taxes                                             |       | —    |       | (43,215        | )          | (241                 | )          | —           |       | (43,456          | )          |
| Net loss from continuing operations                                  |       | (82,422   | )          | (37,434        | )          | (992                 | )          | 37,393           |       | (83,455          | )          |
| Income from discontinued operations, net of tax                      |       | —    |       | 1,448          |       | —               |       | —           |       | 1,448            |       |
| Net loss                                                             |       | (82,422   | )          | (35,986        | )          | (992                 | )          | 37,393           |       | (82,007          | )          |
| Less: Net income attributable to noncontrolling  interests           |       | —    |       | —         |       | 415                  |       | —           |       | 415              |       |
| Net income (loss) attributable to DJO                                |       | $         | (82,422    | )              | $          | (35,986              | )          | $                | (1,407     | )                | $          | 37,393 |   | $ | (82,422 | ) |

 

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**DJO Finance LLC**

 

**Condensed Consolidating Statements of Cash Flows**

**For theYear Ended December 31, 2009**

**(inthousands)**

 
| ** **                                                                                               | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING ACTIVITIES:**                                                                                |       |      |       |           |       |                 |       |             |       |             |       |
| Net income (loss)                                                                                        |       | $         | (50,433    | )              | $          | 135,528              |       | $                | 11,864     |             | $          | (146,669 | ) | $ | (49,710 | ) |
|                                                                                                     |       |      |       |           |       |                 |       |             |       |             |       |
| Adjustments to reconcile net income (loss) to  net cash provided by (used in) operating activities: |       |      |       |           |       |                 |       |             |       |             |       |
| Depreciation                                                                                             |       | —    |       | 23,400         |       | 4,992                |       | (496             | )          | 27,896           |       |
| Amortization and impairment of intangibles                                                               |       | —    |       | 81,431         |       | 2,821                |       | —           |       | 84,252           |       |
| Amortization of debt issuance costs                                                                      |       | 12,679    |       | —         |       | —               |       | —           |       | 12,679           |       |
| Stock-based compensation                                                                                 |       | —    |       | 3,382          |       | —               |       | —           |       | 3,382            |       |
| Loss on disposal of assets                                                                               |       | —    |       | 455            |       | 651                  |       | (142             | )          | 964              |       |
| Deferred income taxes                                                                                    |       | —    |       | (26,474        | )          | (3,228               | )          | 6,012            |       | (23,690          | )          |
| Non-cash income from subsidiaries                                                                        |       | (65,501   | )          | (18,643        | )          | (32,671              | )          | 116,815          |       | —           |       |
| Provision for doubtful accounts and sales returns                                                        |       | —    |       | 34,175         |       | 729                  |       | —           |       | 34,904           |       |
| Inventory reserves                                                                                       |       | —    |       | 6,894          |       | 568                  |       | —           |       | 7,462            |       |
| Gain on sales of product lines                                                                           |       | —    |       | (3,058         | )          | —               |       | —           |       | (3,058           | )          |
| Net effect of discontinued operations                                                                    |       | —    |       | (496           | )          | —               |       | 103              |       | (393             | )          |
| Changes in operating assets and liabilities, net  of acquired assets and liabilities:               |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts receivable                                                                                      |       | —    |       | (17,962        | )          | 2,806                |       | —           |       | (15,156          | )          |
| Inventories                                                                                              |       | —    |       | (3,958         | )          | (705                 | )          | 2,795            |       | (1,868           | )          |
| Prepaid expenses, other assets and liabilities                                                           |       | 141       |       | 17,353         |       | (13,718              | )          | (338             | )          | 3,438            |       |
| Accounts payable and accrued expenses                                                                    |       | (2,962    | )          | (6,143         | )          | (4,456               | )          | 253              |       | (13,308          | )          |
| Net cash provided by (used in) operating  activities                                                     |       | (106,076  | )          | 225,884        |       | (30,347              | )          | (21,667          | )          | 67,794           |       |
| **INVESTING ACTIVITIES:**                                                                                |       |      |       |           |       |                 |       |             |       |             |       |
| Acquisition of businesses and intangibles, net  of cash acquired                                    |       | —    |       | (2,580         | )          | (10,506              | )          | —           |       | (13,086          | )          |
| Proceeds from sale of assets                                                                             |       | —    |       | 25,617         |       | —               |       | —           |       | 25,617           |       |
| Purchases of property and equipment                                                                      |       | —    |       | (24,601        | )          | (5,961               | )          | 1,690            |       | (28,872          | )          |
| Other                                                                                                    |       | —    |       | 341            |       | —               |       | —           |       | 341              |       |
| Net cash used in investing activities                                                                    |       | —    |       | (1,223         | )          | (16,467              | )          | 1,690            |       | (16,000          | )          |
| **FINANCING ACTIVITIES:**                                                                                |       |      |       |           |       |                 |       |             |       |             |       |
| Intercompany                                                                                             |       | 147,725   |       | (221,581       | )          | 53,879               |       | 19,977           |       | —           |       |
| Payments on long-term debt and revolving  line of credit                                            |       | (102,650  | )          | (76            | )          | (795                 | )          | —           |       | (103,521         | )          |
| Proceeds from long- debt and revolving line  of credit                                              |       | 68,000    |       | 12             |       | 248                  |       | —           |       | 68,260           |       |
| Dividend paid to minority interests of subsidiary                                                        |       | —    |       | —         |       | —               |       | —           |       | —           |       |
| Net cash provided by financing activities                                                                |       | 113,075   |       | (221,645       | )          | 53,332               |       | 19,977           |       | (35,261          | )          |
| Effect of exchange rate changes on cash and cash  equivalents                                            |       | —    |       | —         |       | (2,405               | )          | —           |       | (2,405           | )          |
| **Net increase (decrease) in cash  and cash equivalents**                                                |       | 6,999     |       | 3,016          |       | 4,113                |       | —           |       | 14,128           |       |
| Cash and cash equivalents at beginning of period                                                         |       | —    |       | 14,373         |       | 16,110               |       | —           |       | 30,483           |       |
| Cash and cash equivalents at end of period                                                               |       | $         | 6,999      |           | $          | 17,389               |       | $                | 20,223     |             | $          | — |   | $ | 44,611 |   |

 

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**DJO Finance LLC**

 

**Condensed Consolidating Statements of Cash Flows**

**For theYear Ended December 31, 2008**

**(inthousands)**

 
| ** **                                                                                               | ** ** | **DJOFL** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING ACTIVITIES:**                                                                                |       |      |       |           |       |                 |       |             |       |             |       |
| Net income (loss)                                                                                        |       | $         | (97,786    | )              | $          | 22,602               |       | $                | 4,575      |             | $          | (26,128 | ) | $ | (96,737 | ) |
|                                                                                                     |       |      |       |           |       |                 |       |             |       |             |       |
| Adjustments to reconcile net income (loss) to  net cash provided by (used in) operating activities: |       |      |       |           |       |                 |       |             |       |             |       |
| Depreciation                                                                                             |       | —    |       | 20,113         |       | 4,189                |       | (705             | )          | 23,597           |       |
| Amortization and impairment of intangibles                                                               |       | —    |       | 96,894         |       | 2,060                |       | —           |       | 98,954           |       |
| Amortization of debt issuance costs                                                                      |       | 13,177    |       | —         |       | —               |       | —           |       | 13,177           |       |
| Stock-based compensation                                                                                 |       | —    |       | 1,381          |       | —               |       | —           |       | 1,381            |       |
| Loss on disposal of assets                                                                               |       | —    |       | 2,610          |       | 602                  |       | (143             | )          | 3,069            |       |
| Deferred income taxes                                                                                    |       | —    |       | (41,927        | )          | (230                 | )          | —           |       | (42,157          | )          |
| Non-cash income from subsidiaries                                                                        |       | (29,468   | )          | 11,980         |       | —               |       | 17,488           |       | —           |       |
| Provision for doubtful accounts and sales returns                                                        |       | —    |       | 25,421         |       | 856                  |       | —           |       | 26,277           |       |
| Inventory reserves                                                                                       |       | —    |       | 7,922          |       | 715                  |       | —           |       | 8,637            |       |
| Changes in operating assets and liabilities, net  of acquired assets and liabilities:               |       |      |       |           |       |                 |       |             |       |             |       |
| Accounts receivable                                                                                      |       | —    |       | (34,543        | )          | (2,521               | )          | —           |       | (37,064          | )          |
| Inventories                                                                                              |       | —    |       | 1,788          |       | 136                  |       | (3,533           | )          | (1,609           | )          |
| Prepaid expenses, other assets and liabilities                                                           |       | (293      | )          | (2,760         | )          | 3,125                |       | (4               | )          | 68               |       |
| Accounts payable and accrued expenses                                                                    |       | 770       |       | (9,188         | )          | (1,325               | )          | 89               |       | (9,654           | )          |
| Net cash provided by (used in) operating  activities                                                     |       | (113,600  | )          | 102,293        |       | 12,182               |       | (12,936          | )          | (12,061          | )          |
| **INVESTING ACTIVITIES:**                                                                                |       |      |       |           |       |                 |       |             |       |             |       |
| Acquisition of businesses and intangibles, net  of cash acquired                                    |       | —    |       | (3,234         | )          | (1,861               | )          | —           |       | (5,095           | )          |
| Proceeds from sale of assets held for sale                                                               |       | —    |       | 2              |       | 12                   |       | —           |       | 14               |       |
| Purchases of property and equipment                                                                      |       | —    |       | (22,412        | )          | (4,502               | )          | 1,009            |       | (25,905          | )          |
| Other                                                                                                    |       | —    |       | 1,696          |       | (306                 | )          | —           |       | 1,390            |       |
| Net cash used in investing activities                                                                    |       | —    |       | (23,948        | )          | (6,657               | )          | 1,009            |       | (29,596          | )          |
| **FINANCING ACTIVITIES:**                                                                                |       |      |       |           |       |                 |       |             |       |             |       |
| Intercompany                                                                                             |       | 99,731    |       | (107,914       | )          | (3,744               | )          | 11,927           |       | —           |       |
| Payments on long-term debt and revolving  line of credit                                            |       | (29,650   | )          | (752           | )          | (6,892               | )          | —           |       | (37,294          | )          |
| Proceeds from long- debt and revolving line  of credit                                              |       | 43,000    |       | —         |       | 3,540                |       | —           |       | 46,540           |       |
| Dividend paid to minority interests of subsidiary                                                        |       | —    |       | —         |       | (381                 | )          | —           |       | (381             | )          |
| Net cash provided by financing activities                                                                |       | 113,081   |       | (108,666       | )          | (7,477               | )          | 11,927           |       | 8,865            |       |
| Effect of exchange rate changes on cash and cash  equivalents                                            |       | —    |       | —         |       | (196                 | )          | —           |       | (196             | )          |
| **Net increase (decrease) in cash  and cash equivalents**                                                |       | (519      | )          | (30,321        | )          | (2,148               | )          | —           |       | (32,988          | )          |
| Cash and cash equivalents at beginning of period                                                         |       | 519       |       | 44,694         |       | 18,258               |       | —           |       | 63,471           |       |
| Cash and cash equivalents at end of period                                                               |       | $         | —     |           | $          | 14,373               |       | $                | 16,110     |             | $          | — |   | $ | 30,483 |   |

 

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**DJOFinance LLC**

 

**Condensed ConsolidatingStatements of Cash Flows**

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

**(in thousands)**

** **
| ** **                                                                                          | ** ** | **DJOFL**  | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| **OPERATING ACTIVITIES:**                                                                           |       |       |       |           |       |                 |       |             |       |             |       |
| Net loss                                                                                            |       | $          | (82,422    | )              | $          | (35,986              | )          | $                | (992       | )                | $          | 37,393 |   | $ | (82,007 | ) |
|                                                                                                |       |       |       |           |       |                 |       |             |       |             |       |
| 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            |       |
| 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 |   |

 

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**ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL    DISCLOSURE**

 

## **None.**

## ** **

## **ITEM 9A. CONTROLS AND PROCEDURES**

## ** **

**MANAGEMENT’S EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES**

 

Wemaintain disclosure controls and procedures (as the term is defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicatedto management, including our Chief Executive Officer and our Chief FinancialOfficer, as appropriate, to allow timely decisions regarding requireddisclosure.

 

Any controls and procedures,no matter how well designed and operated, can provide only reasonable assuranceof achieving the desired control objectives. Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of the effectiveness of our disclosure controls andprocedures.  Based on this evaluation andsubject to the foregoing, our Chief Executive Officer and our Chief FinancialOfficer concluded that, our disclosure controls and procedures were effective atDecember 31, 2009, to accomplish their objectives at the reasonableassurance level.

 

Inaddition, there has been no change in our internal control over financialreporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) that occurred during the fourth quarter ended December 31,2009 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIALREPORTING**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting.  TheCompany’s internal control over financial reporting is designed to providereasonable assurances regarding the reliability of financial reporting and thepreparation of the consolidated financial statements of the Company inaccordance with U.S. generally accepted accounting principles.  Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree or compliance with the policies or procedures maydeteriorate.

 

Withthe participation of our Chief Executive Officer and our Chief FinancialOfficer, our management conducted an evaluation of the effectiveness of ourinternal control over financial reporting as of December 31, 2009 based onthe framework in *Internal Control—IntegratedFramework*issued by the Committee of Sponsoring Organizations of theTreadway Commission.   Based on ourevaluation under the framework in *InternalControl—Integrated Framework,*our management has concluded that theCompany’s internal control over financial reporting is effective as of December 31,2009.

 

Thisannual report does not include an attestation report of our registered publicaccounting firm regarding internal control over financial reporting. Management’sreport was not subject to attestation by our registered public accounting firmpursuant to temporary rules of the Securities and Exchange Commission thatpermit us to provide only management’s report in this Annual Report.

 

**ITEM 9B.  OTHER INFORMATION**

 

None.

 

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**PART III.**

 

## **ITEM 10.  DIRECTORS, EXECUTIVEOFFICERS AND CORPORATE GOVERNANCE**

## ** **

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

 
| **Name**               | ** ** | **Age** | ** ** | **Position**                                                                        |
|------------------------|------------|---------|------------|-------------------------------------------------------------------------------------|
| Leslie  H. Cross       |       | 59      |       | President,  Chief Executive Officer and Director                                    |
| Vickie  L. Capps       |       | 48      |       | Executive  Vice President, Chief Financial Officer and Treasurer                    |
| Luke  T. Faulstick     |       | 46      |       | Executive  Vice President and Chief Operating Officer                               |
| Donald  M. Roberts     |       | 61      |       | Executive  Vice President, General Counsel and Secretary                            |
| Thomas  A. Capizzi     |       | 51      |       | Executive  Vice President, Global Human Resources                                   |
| Stephen  Murphy        |       | 45      |       | Executive  Vice President, Sales and Marketing, International Commercial Businesses |
| Andrew  Holman         |       | 42      |       | Executive  Vice President, Sales and Marketing, U.S. Commercial Businesses          |
| Chinh  E. Chu          |       | 43      |       | Chairman  of the Board                                                              |
| Julia  Kahr            |       | 31      |       | Director                                                                            |
| Sidney  Braginsky      |       | 72      |       | Director                                                                            |
| Bruce  McEvoy          |       | 32      |       | Director                                                                            |
| Phillip  J. Hildebrand |       | 57      |       | Director                                                                            |
| Lesley  Howe           |       | 65      |       | Director                                                                            |
| Paul  LaViolette       |       | 52      |       | Director                                                                            |

 

*Leslie H. Cross—President, Chief Executive Officer and Director.*  Mr. Cross was appointed Chief ExecutiveOfficer of DJO and DJOFL and one of DJO’s directors as of the effective date ofthe DJO Merger, and was appointed President in May 2008. Mr. Crossbecame one of DJOFL’s managers in January 2009. Prior to the DJO Merger, Mr. Crosswas the Chief Executive Officer and President and a member of the board ofdirectors of DJO Opco since August 2001. He served as the Chief ExecutiveOfficer and a Manager of DonJoy, L.L.C., from June 1999 until November 2001,and has served as President of DJO, LLC, or its predecessor, the Bracing &Support Systems division of Smith & Nephew, Inc., since June 1995.From 1990 to 1994, Mr. Cross held the position of Senior Vice President ofMarketing and Business Development of the Bracing & Support Systemsdivision of Smith & Nephew. He was a Managing Director of twodifferent divisions of Smith & Nephew from 1982 to 1990. Prior to thattime, he worked at American Hospital Supply Corporation. Mr. Cross earneda diploma in medical technology from Sydney Technical College in Sydney,Australia and studied business at the University of Cape Town in Cape Town,South Africa.

 

*Vickie L. Capps—Executive Vice President, Chief FinancialOfficer and Treasurer.*  Ms. Cappswas appointed Executive Vice President, Chief Financial Officer and Treasurerof DJO 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 Treasurer ofDJO Opco since July 2002. From September 2001 until July 2002, Ms. Cappswas employed by AirFiber, a privately held provider of broadband wirelesssolutions, 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 currently serves on the board of directors and is amember of the audit committee and chairperson of the nominating and governancecommittee of SenoRx, Inc., a publicly traded medical device company.

 

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

 

*Donald M. 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. 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.

 

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*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.

 

*Stephen Murphy—Executive Vice President, Sales andMarketing, International Commercial Business.* Mr. Murphy wasappointed Executive Vice President, Sales and Marketing, InternationalCommercial Business of DJO in September 2009. Prior to September 2009,Mr. Murphy served as Senior Vice President, International Sales andMarketing of DJO since the DJO Merger and before that in various internationalpositions with DJO Opco since August 2001. Prior to this, Mr. Murphy servedin similar positions with DonJoy, L.L.C., since June 1999 and served invarious international sales and marketing positions since 1992 with affiliatesof DonJoy, L.L.C.’s predecessor, Smith & Nephew, Inc., assumingresponsibility first for the Medical Business of Smith & Nephew inIreland and later for the international business of the S&N HomecraftRehabilitation business, based in England. Mr. Murphy began his career asan accountant with Smith & Nephew Ireland in 1991. He is a CharteredManagement Accountant and completed his studies at the Accountancy and BusinessCollege in Dublin in 1991.

 

*Andrew Holman—Executive Vice President, Sales and Marketing, U.S.Commercial Businesses.* Mr. Holman was appointed Executive VicePresident, Sales & Marketing, U.S. Commercial Businesses in September 2009.Prior to that, Mr. Holman served as President, Americas for theOrthopaedics Division of Smith & Nephew from October 2007 to June 2009.He served as General Manager, Americas of the Reconstructive Joint Division ofSmith & Nephew from October 2006 to October 2007, and wasthe U.S. Vice President of Sales of the Reconstructive Joints Division from October 2005to September 2006. Prior to that, Mr. Holman served as U.S. VicePresident of Sales for Codman & Shurtleff, Inc, a division of Johnson &Johnson from April 2003 to October 2005. He also served as U.S.Director of Sales for Codman & Shurtleff, Inc, a division of Johnson &Johnson from April 2001 to April 2003. From July 2000 to April 2001,Mr. Holman served as a Product Manager for Codman & Shurtleff.Prior to his tenure at Johnson & Johnson, Mr. Holman served invarious sales, sales management and marketing roles at Boston ScientificCorporation in the Microvasive Urology Division. His experience in sales beganwith three years as a direct sales representative for Xerox Corporation. Mr. Holmangraduated Magna Cum Laude from Rollins College with a B.S. in Psychology.

 

*Chinh E. Chu—Chairman of the Board.*  Mr. Chu became one of DJO’s directorsand one of our managers immediately after the completion of the PriorTransaction and became Chairman of the Board in January 2009. Mr. Chuis a senior managing director of The Blackstone Group. An affiliate of TheBlackstone Group owns substantially all of the capital stock of DJO. Sincejoining Blackstone in 1990, Mr. Chu has led the execution of Blackstone’sinvestments in Healthmarkets, Inc., SunGuard Data Systems Inc.,Nalco, Celanese, Nycomed and LIFFE. He has also been involved in the executionof Blackstone’s investments in Graham Packaging, Sirius Satellite Radio,StorageApps, Haynes International, Prime Succession/Rose Hills, InterstateHotels, HFS and Alco Holdings. Before joining Blackstone, Mr. Chu workedat Salomon Brothers in the Mergers & Acquisitions Department. Mr. Chucurrently serves on the boards of directors of Catalent, Graham Packaging,SunGard Data Systems Inc., Healthmarkets, Inc, Bayview FinancialHoldings, Bank United Financial Corporation and Alliant Insurance Services.  Mr. Chu was formerly a director ofCelanese Corporation and Financial Guaranty Insurance Company.

 

*Julia Kahr—Director.*  Ms. Kahr became one of DJO’s directorsand one of our managers immediately after the completion of the PriorTransaction. Ms. Kahr is currently a principal of The Blackstone Group.Before joining Blackstone in 2004, Ms. Kahr was a Project Leader at theBoston Consulting Group, where she worked with companies in a variety ofindustries, including financial services, pharmaceuticals, media andentertainment, and consumer goods. Ms. Kahr is a director of SummitMaterials.  Ms. Kahr is also thesole author of Working Knowledge, a book published by Simon & Schusterin 1998.

 

*Sidney Braginsky—Director.*  Mr. Braginsky became one of DJO’sdirectors on December 14, 2006. Mr. Braginsky has been President,Chief Executive Officer and Chairman of the Board of Atropos Technology, LLCsince July 2000. Mr. Braginsky also serves a director of Double D(Devices and Diagnostics), a Venture Capital Fund and is Chairman and CEO ofDigilab LLC, a molecular spectroscopy division acquired by Atropos in 2001.Double D and Digilab LLC are both affiliated with Atropos Technology, LLC.Before joining Atropos, Mr. Braginsky served as President of OlympusAmerica, Inc. where he built a large business focused on optical products.Prior to Olympus America, Mr. Braginsky served as President and ChiefOperating Officer of Mediscience Technology Corp., a designer and developer ofdiagnostic medical devices for cancer detection.  Mr. Braginsky currently serves on theboard of directors and audit committees of Diomed Holdings, Inc.,Electro—Optical Sciences, Inc., Geneva Acquisition Corp and InvendoMedical GmbH.  Mr. Braginskyformerly served on the board of directors of Noven Pharmaceuticals, Inc.

 

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*Bruce McEvoy—Director.*  Mr. McEvoy became one of DJO’s directorsin August 2007. Mr. McEvoy is a principal of The Blackstone Group.Before joining Blackstone in 2006, Mr. McEvoy worked as an Associate atGeneral Atlantic from 2002 to 2004 and was a consultant at McKinsey &Company from 1999 to 2002. Mr. McEvoy currently serves on the boards ofdirectors of Catalent, RGIS Inventory Services, Performance Food Group andSeaWorld Parks and Entertainment.  Mr. McEvoyformerly served on the board of Vistar.

 

*Phillip J. Hildebrand — Director*.  Mr. Hildebrand became one of DJO’sdirectors in December 2008.  Mr. Hildebrandserves as President, Chief Executive Officer and a director of HealthMarkets, Inc.,a company in which affiliates of The Blackstone Group own a 55.6% equityinterest. Mr. Hildebrand is also Chairman, President and Chief ExecutiveOfficer of The MEGA Life and Health Insurance Company, Mid—West National LifeInsurance Company of Tennessee, The Chesapeake Life Insurance Company, FidelityFirst Insurance Company and Insphere Insurance Solutions, Inc.  Before joining HealthMarkets, Mr. Hildebrandserved in several senior management positions during his 33 years at the NewYork Life Insurance Company, retiring in 2008 as Vice Chairman.

 

*Lesley Howe — Director*.  Mr. Howe became one of DJO’s directorsin January 2009.  Mr. Howe hasover 40 years of financial accounting and management experience.  He was with KPMG for 30 yearsuntil his retirement as Area Managing Partner/Managing Partner of that firm’sLos Angeles office.  From 2001 until itssale in 2007, Mr. Howe served as CEO of Consumer Networks LLC, a privatelyowned San Diego based internet marketing firm. Mr. Howe served on the Board of Directors of DJO Opco from October 2002to the date of the DJO Merger.  Mr. Howecurrently serves on the boards of directors of NuVasive, Inc.,VolcanoCorporation, P.F. Chang’s China Bistro Inc. and Jamba Inc.

 

*Paul LaViolette — Director*.  Mr. LaViolette became one of DJO’sdirectors in January 2009.  Mr. LaVioletteis a Venture Partner with SV Life Sciences, a capital advisor and manger in thehuman life sciences sector.  Mr. LaVioletteserved as Chief Operating Officer of Boston Scientific Corporation, a worldwideleader in less invasive medical devices, from 2004 until the end of 2008.  Prior to 2004, Mr. LaViolette heldmarketing and general management positions at CR Bard, and various marketingroles at The Kendall Company, at that time a subsidiary of ColgatePalmolive.  He currently serves on the boards of directors of TranS1, Inc.,Tjoratec Corp.,  DirectFlow Medical, Inc.and Conceptus Incorporated.  Hepreviously served on the board of directors and on the Executive Committee ofthe Advanced Medical Technology Association (ADVAMED), the world’s largestmedical technology association as well as on the boards of directors ofUrologix, Inc. and Percutaneous Valve Technologies, Inc.

 

**CORPORATE GOVERNANCE MATTERS**

 

*Background and Experience of Directors*.  When considering whether directors andnominees have the experience, qualifications, attributes or skills, taken as awhole, to enable the DJO Board of Directors to satisfy its oversightresponsibilities effectively in light of DJO’s business and structure, the DJOBoard of Directors focused primarily on each person’s background and experienceas reflected in the information discussed in each of the directors’ individualbiographies set forth immediately above. We believe that our directors provide an appropriate mix of experienceand skills relevant to the size and nature of DJO’s business. In particular,the members of the DJO Board of Directors considered the following important characteristics:(i) Mr. Chu, Ms. Kahr and Mr. McEvoy are representativesappointed by The Blackstone Group, our principal stockholder and havesignificant financial and  investmentexperience from their involvement in Blackstone’s investment in numerous portfoliocompanies and have played active roles in overseeing those businesses, (ii) OurChief Executive Officer, has extensive experience in the orthopedic deviceindustry and in executive management, and (iii) our outside directors havea diverse background of management, accounting and financial experience fromthe healthcare and medical device industries, as well as other industries:Specifically Mr. Howe, is the Chairman of our Audit Committee and is an “auditcommittee financial expert” as defined in Item 407(d)(5)(ii) of RegulationS-K under the Exchange Act, by virtue of his years of experience with a majorauditing firm, as well as in various senior management and board positions; Mr. Braginsky,brings both financial and management experience in a diverse range ofbusinesses, as well as audit and board service; Mr. Hildebrand, bringsextensive management and Board level experience in the healthcare and insuranceindustries; and Mr. LaViolette, brings extensive experience frommanagement positions in life sciences, medical device and related businesses,as well as service on the board of public and private companies and on theboard of ADVAMED, the world’s largest medical technology association.

 

Inrecommending directors, our Board of Directors considers the specificbackground and experience of the Board members and other personal attributes inan effort to provide a diverse mix of capabilities, contributions andviewpoints which the Board believes enables it to function effectively as theBoard of Directors of a company with our size and nature of business.

 

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*Board Leadership Structure*. Our Board of Directors isled by the Chairman of the Board, who is a representative of our principalstockholder. The Chief Executive Officer position is separate from the Chairmanposition. We believe that the separation of the Chairman and CEO positions isappropriate for a company of the size and nature of DJO.

 

*Role of Board in Risk Oversight*. The Board of Directors hasextensive involvement in the oversight of risk related to the company and itsbusiness. The Audit Committee of the Board plays a key role in representing andassisting the Board in discharging its oversight responsibility relating to theaccounting, reporting and financial practices of the company, including theintegrity of our financial statements, the surveillance of administrative andfinancial controls and the company’s compliance with legal and regulatoryrequirements. Through its regular meetings with management, including legal,regulatory, compliance and internal audit functions, the Audit Committeereviews and discusses all of the principal functions of our business andupdates the Board of Directors on all material matters.

 

*Audit Committee*. Until January 2009, our Audit Committee consisted of threeappointed Directors, Mr. Braginsky (Chairman), Ms. Kahr and Mr. McEvoy.  In January 2009, Mr. Howe wasappointed to the Audit Committee and selected to serve as Chairman of thatCommittee.  As a privately held company,our Audit Committee is not required to be composed of only independentdirectors. We believe that Messrs. Howe and Braginsky each meet thedefinition of an independent director under the Rules of the New YorkStock Exchange.  Our Board of Directorshas determined that Mr. Howe is an “audit committee financial expert” asdefined in SEC Regulation S-K Item 407 (d)(5)(ii). Our Board ofDirectors also believes that the other members of the Audit Committee haverequisite levels of financial literacy and financial sophistication to enablethe Audit Committee to be effective in relation to the purposes outlined in itscharter and in light of the scope and nature of our business and financialstatements.

 

*Compensation Committee*.  The Compensation Committee of the DJO Boardconsists of three appointed Directors, Mr. Chu, Ms. Kahr, and Mr. McEvoy.  Because DJO is a privately held company, theCompensation Committee is not required to be composed of independent directors.

 

*Code of Ethics.* OurBusiness Ethics Policy and Code of Conduct, Code of Conduct for the Board ofDirectors, and Code of Ethics for the Chief Executive Officer and SeniorExecutives and Financial Officers are available, free of charge, on the Company’swebsite at *www.DJOglobal.com*.Please note, however, that the information contained on the website is notincorporated by reference in, or considered part of, this Annual Report. Wewill post any amendments to the Code of Ethics, and any waivers that arerequired to be disclosed by the SEC rules on our website within therequired time period. We will also provide copies of these documents, free ofcharge, to any securityholder upon written request to:  Director, Investor Relations, DJOIncorporated, 1430 Decision Street, Vista, California 92081-8553.

 

**ITEM 11.  EXECUTIVE COMPENSATION**

 

**Compensation Discussion and Analysis**

 

Thefollowing Compensation Discussion and Analysis describes the objectives of ourexecutive Compensation Program and the material elements of compensation forour executive officers identified under Item 11. “Executive Compensation —Summary Compensation Table” (the “Named Executive Officers” or “NEOs”), alongwith the role of the Compensation Committee of the DJO Board of Directors (the “CompensationCommittee”) in reviewing and making decisions regarding our executivecompensation program.

 

Role of the Compensation Committee inEstablishing Compensation

 

TheCompensation Committee establishes salaries and reviews benefit programs forthe Chief Executive Officer (“CEO”) and each of our other executive officers;reviews and approves our annual incentive compensation for managementemployees; reviews, administers and grants stock options under our employeestock option plan; advises the DJO Board and makes recommendations with respectto plans that require Board approval; and approves employment agreements withour executive officers. The Compensation Committee establishes and maintainsour executive compensation program through internal evaluations of performance,and analysis of compensation practices in industries where we compete forexperienced senior management. The Compensation Committee reviews ourcompensation programs and philosophy regularly, particularly in connection withits evaluation and approval of changes in the compensation structure for agiven year. The Compensation Committee met seven times during 2009. Five of theseven meetings were in conjunction with the DJO Board and the other twomeetings included only Compensation Committee members.  The CEO makes recommendations for thesalaries for executive officers other than himself and reviews suchrecommendations with the Compensation Committee.

 

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Objectives of Our Compensation Program

 

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

 

·                  Attract 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 the interests of ourstockholders, with long-term incentive compensation that links a significantportion of executive compensation to our sustained performance through stockoption and restricted stock awards; and

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

 

The Elements of Our Executive Compensation Program

 

Theelements of our executive compensation program are as follows:

 

·                  Base salary;

·                  Annual and quarterly cashincentive compensation (performance-based bonuses, with bonus of up to 60% ofbase salary for achieving target goals and with a supplemental bonus of up toan additional 60% of base salary for achieving enhanced goals.);

·                  Equity-based awards (stockoptions); and

·                  Other benefits;

 

*Base Salary.*Basesalaries provide a fixed form of compensation designed to reward an executiveofficer’s core competence in his or her role. The Compensation Committee determines base salaries by taking intoconsideration such factors as competitive industry salaries; the nature of theposition; the contribution and experience of the officers; and the length ofservice.

 

*Annual and Quarterly Cash Incentive Compensation. *Performance-based cashincentive 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.

 

Followingthe DJO Merger in 2007, the Compensation Committee adopted a bonus plan whichreflected the significant increase in size and changes in structure of theCompany. This new bonus plan was effective on January 1, 2008 (the “BonusPlan”). The basic structure of the Bonus Plan was intended to remain in effectfrom year to year, although the financial targets would be separatelyestablished for each year.

 

InFebruary 2009, the Compensation Committee approved the bonus plan for 2009(“2009 Bonus Plan”) for the executive officers of the Company based upon thestructure of the Bonus Plan that was previously approved in 2008, with certainmodifications to the financial metrics used for determining whether theperformance bonus portion has been met. Under the 2009 Bonus Plan, each executive officer had an opportunity toearn up to 60% of such executive’s annual base salary as a target bonus (“TargetBonus”), with 50% of the annual bonus earned based on certain quarterlyfinancial results and the remaining 50% earned based on the overall 2009financial results. The portion of the bonus that could be earned in each of thefiscal quarters was divided among the four quarters in proportion to thebudgeted quarterly contribution of the particular quarter to the annual 2009budgeted amount of each of the financial performance goals described below. The2009 Bonus Plan contained quarterly and annual Adjusted EBITDA goals thatdetermined whether 60% of the Target Bonus was earned; quarterly and annualoperating free cash flow goals that determined whether 20% of the Target Bonuswas earned; and quarterly and annual revenue goals that determined whether theremaining 20% of the Target Bonus was earned. At the end of each quarter and the full year, the bonus opportunity wasdetermined based on whether the applicable financial targets were met, and ifone or more such targets were met, the available portion of the target bonuswould be paid.  The CompensationCommittee retains the discretion to reduce an executive’s bonus if theexecutive failed to achieve individual performance goals.  The 2009 Bonus Plan provided for the paymentof as little as 40% of the Target Bonus if the Company’s financial performancefell short of the applicable goal by less than 2.5% for revenue, 5% foroperating free cash flow and 6.5% for Adjusted EBITDA (“Threshold Bonus”).Likewise, the 2009 Plan provided for the payment of an additional supplementalbonus (“Supplemental Bonus”) of up to 100% of the Target Bonus if the Company’sfinancial performance exceeded the applicable goal by up to 2.5% of revenue, 5%of operating free cash flow and 6.5% of Adjusted EBITDA. The effects of foreigncurrency translation were excluded from the financial calculations under the2009 Bonus Plan, and if one or more quarterly bonuses had been paid but theCompany’s annual adjusted EBITDA for 2009 fell below a minimum amount, theexecutive officers would be required to repay all such quarterly bonuses thathad previously been paid during 2009.

 

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TheCompensation Committee selected revenue, Adjusted EBITDA and free cash flow asthe relevant company-wide performance criteria for the 2009 Bonus Plan becausethe Compensation Committee believes that these criteria are consistent with themetrics by which the DJO Brand measures the overall goals and long-termstrategic for DJO. Further, these criteria are closely related to or reflectiveof DJO’s financial and operational improvements, growth and return toshareholders. Revenue growth is a critical metric for enhancing the value ofthe Company.  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.Adjusted EBITDA, for the purposes of the Bonus Plan, was calculated as earningsbefore interest, income taxes, depreciation and amortization, further adjustedfor non-cash items, non-recurring items and other adjustment items pursuant tothe definition of consolidated EBITDA contained in the credit agreement for ourSenior Secured Credit Facility, excluding forward cost savings as determined bythe Board of Directors. Free cash flow is another non-GAAP measurement toolthat our management uses to assess how well we are achieving our goal ofreducing our outstanding debt over time, which also contributes to creation ofvalue for our shareholders and creditors. Free cash flow, for the purposes ofthe Bonus Plan, was calculated as Adjusted EBITDA, as defined above, lesscapital expenditures, and adjusted for changes in operating working capital.  In establishing the performance criteria forthe 2009 Bonus Plan, the Compensation Committee set the revenue, AdjustedEBITDA and free cash flow targets to reflect growth over 2008 of 6.6%, 25.3%and 18.9%, respectively.  As a result ofactual performance in 2009, revenue, Adjusted EBITDA and free cash flow were 0%,18.4%, and 28.3% of the application performance target, respectively, resultingin no bonuses for revenue, 93.6% of the Target Bonus for Adjusted EBITDA and 100%of the Target Bonus for free cash flow.

 

InFebruary 2010, the Compensation Committee approved the bonus plan for 2010(the “2010 Bonus Plan”) for the executive officers of the Company based on astructure similar to the 2009 Bonus Plan, with the following terms.  Thefinancial metrics were simplified in the 2010 Bonus Plan to 50% of the TargetBonus based on meeting Adjusted EBITDA targets and 50% based on meeting revenuetargets. Given the over achievement related to the free cash flow metric in2009, the 2010 performance metrics reflect the Compensation Committee’s desireto focus management exclusively on growth in revenue and Adjusted EBITDA. One-half of the Target Bonus will be based on full-year performance andone-half on quarterly performance, with each quarter representing 25% of thequarterly bonus opportunity. The revenue and Adjusted EBITDA targets wouldresult in growth in revenue and Adjusted EBITDA of approximately 8% and 10%,respectively.  A minimum bonus of 40% of Target Bonus can earned if theCompany’s growth for either or both of revenue or Adjusted EBITDA is at leastapproximately 4% and 6%, respectively.  For the full year only, anadditional Supplemental Bonus of up to 100% of the Target Bonus could be earnedif the Company’s growth for either or both of revenue or Adjusted EBITDA is atleast approximately 10% and 15%, respectively.

 

*Retention Bonus*.  Inconnection with the DJO Merger, each of our executive officers (other than Mr. Holmanwho was not an executive officer at the time) entered into an agreement toreceive a retention bonus, of which 50% was paid in January 2008 and 50%was paid in January 2009. The terms of the retention bonus agreementrequired each executive officer to repay the retention bonus received if his orher employment with us was terminated prior to January 1, 2009, the datethrough which the bonus was earned, other than by reason of death, disability,or a termination by us without cause. All of the NEOs served through December 31, 2008 and received theirfull retention bonus.

 

*Equity Compensation. *In connectionwith the DJO Merger, the Compensation Committee adopted the 2007 IncentiveStock Plan (the “2007 Incentive Stock Plan”). The purpose of the 2007 IncentiveStock Plan was to promote the interests of us and our shareholders by enablingselected key employees to participate in our long-term growth by receiving theopportunity to acquire shares of DJO common stock and to provide for additionalcompensation based on appreciation in DJO common stock.  The 2007 Incentive Stock Plan provides forthe grant of stock options and other stock-based awards to key employees,directors and consultants, including the executive officers.  In addition, DJO adopted a form of stockoption agreement (the “DJO Form Option Agreement”) for awards under the2007 Incentive Stock Plan. Under the DJO Form Option Agreement, one-thirdof the stock options will vest over a specified period of time (typically fiveyears) contingent solely upon the awardee’s continued employment with us.  Another one-third of the stock options willvest over a specified performance period (typically five years) from the grantdate upon the achievement of pre-determined performance targets over time,consisting of Adjusted EBITDA and free cash flow as defined above.  Prior to the amendments in March 2009 tothe DJO Form Option Agreement and outstanding options described below, thefinal one-third of the options were scheduled to vest based upon achieving ahigher level of such Adjusted EBITDA and free cash flow performance targets.The DJO Form Option Agreement includes certain forfeiture provisions uponan awardee’s separation from service with us. 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 IncentiveStock Plan, provided that no options may be granted after November 20,2017 and no option may be exercisable after ten years from the date of grant.All 

 

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optionawards granted under the 2007 Incentive Stock Plan have an exercise price equalto the fair market value of DJO’s common stock on the date of grant. Fairmarket value is defined under the 2007 Incentive Stock Plan to be the closingmarket price of a share of DJO’s common stock on the date of grant or if nomarket price is available, the fair market value as determined by the Board ofDirectors. The Compensation Committee retains the discretion to make equityawards at any time in connection with the initial hiring of a new employee, forretention purposes, or otherwise. We do not have any program, plan or practiceto time annual or ad hoc grants of stock options or other equity-based awardsin coordination with the release of material non-public information orotherwise. The 2007 Incentive Stock Plan may be amended or terminated at anytime by the DJO Board. However, any amendment that would require shareholderapproval in order for the 2007 Incentive Stock Plan to continue to meet anyapplicable legal or regulatory requirements will be effective only if it isapproved by DJO’s shareholders. A total of 7,500,000 shares of DJO common stockare authorized for issuance under the 2007 Incentive Stock Plan.  Equity awards under the 2007 Incentive StockPlan may be in the form of options or other stock-based awards.  Options can be either incentive stock optionsor non-qualified stock options.

 

Inconnection with the DJO Merger, certain members of DJO Opco management werepermitted to exchange a portion of their DJO Opco stock options for options topurchase an aggregate of 1,912,577 shares of DJO common stock granted under the2007 Incentive Stock Plan on a tax-deferred basis (the “DJO Management RolloverOptions”). The exercise price and number of shares underlying such optionswere each adjusted in proportion to the relative market values of DJO Opco’sand DJO’s common stock upon the closing of the DJO Merger. All of the DJOManagement Rollover Options were fully vested and remained subject to the sameterms as were applicable to the original options.

 

In February 2008, we granted options for atotal of 1,860,055 shares (“Options”) under the 2007 Stock Incentive Plan toour executive officers who are NEOs, Mr. Cross, Ms. Capps, Mr. Roberts,Mr. Faulstick, and Mr. Capizzi. The Options have a term of tenyears from the date of grant and an exercise price of $16.46 per share. Whengranted, the Options initially provided for vesting in accordance with thefollowing schedule: (a) one-third of each stock option grant constituted, and may be purchased pursuant to theprovisions of the Time-Based Tranche (defined below), (b) one-third ofeach stock option grant constituted and may be purchased pursuant to theprovisions of the Performance-Based Tranche (defined below), and (c) one-thirdof each stock option grant constituted and may be purchased pursuant to theprovisions of the Enhanced Performance-Based Tranche (defined below).  Asdescribed below, in March 2009, the Compensation Committee amended theperformance-based vesting provisions of the Options. The Options becameexercisable with respect to 25% of the Time-Based Tranche on December 31,2008 and became exercisable with respect to 20% of the Time-Based Tranche on December 31,2009. The Options will become exercisable with respect to 18.33% of theTime-Based Tranche on each of December 31, 2010 and 2011, and 18.34% on December 31,2012 if such optionee remains employed with us or any of our subsidiaries oraffiliates as of each such date.  As initially granted, each of thePerformance-Based Tranche and Enhanced Performance-Based Tranche containedAdjusted EBITDA and free cash flow targets, with the Enhanced Performance-BasedTranche requiring greater performance than the Performance-Based Tranche. Prior to being amended in 2009, the optionee was entitled to earn the right toexercise the Option to purchase 25% of the Performance-Based Tranche or boththe Performance-Based Tranche and Enhanced Performance-Based Tranche on December 31,2008 and 20% of each of those two tranches on December 31, 2009 if theapplicable performance targets were achieved, and would earn the right toexercise the option to purchase 18.33% of the Performance-Based Tranche or boththe Performance-Based Tranche and Enhanced Performance-Based Tranche on each ofDecember 31, 2010 and 2011, and 18.34% of the Performance-Based Tranche orboth the Performance-Based Tranche and Enhanced Performance-Based Tranche on December 31,2012, if the applicable performance targets are achieved as of such dates, andprovided that the optionee remains employed with us or any of our subsidiariesor affiliates as of each such date.  The optionee may earn 80% of theannual portion of a given performance tranche upon achievement of anestablished threshold “base case” for Adjusted EBITDA and free cash flow. The Adjusted EBITDA and free cashflow targets established by the Compensation Committee for vesting purposes asdescribed above represent, for the Performance-Based Tranche, reasonablychallenging performance criteria in the judgment of the Compensation Committee,particularly in light of the significant integration challenges and synergygoals relating to the DJO Merger. As initially granted, meeting the criteriafor the enhanced Performance-Based Tranche was determined to be difficult andwould require superior performance by the Company’s management. As initiallygranted, the financial targets for the Performance-Based Tranche and EnhancedPerformance-Based Tranche were not met for 2008.

 

*Changes to 2008 Option Awards*.  In March 2009, the CompensationCommittee determined that it would be in the best interests of the Company andits shareholders to make certain modifications to the Options that were grantedin 2008 to the NEOs and other members of management to reflect the significantchallenges faced by management and the Company in connection with theintegration activities associated with the DJO Merger and as a result of thesevere economic environment. The Compensation Committee also desired to broadenmanagement’s focus to include certain measures of longer-term shareholdervalue. As a result, the Compensation Committee made the following modificationsto the outstanding Options and to the DJO Form Option Agreement:

 

1.              No changes weremade to the Time-Based Tranche.

 

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2.              The performanceconditions for the portion of the Options within the Performance-Based Tranchethat would vest based on 2009 financial performance were modified to requireachievement of Adjusted EBITDA and free cash flow that were established in February 2009in connection with the Company’s 2009 budget process and are the same as theBonus Target for 2009 for Adjusted EBITDA and free cash flow. As with theoriginal terms of such options, the optionees may earn 80% or more of suchportion of options upon achievement of at least 93.5% of the budgeted AdjustedEBITDA and 95% of the free cash flow targets for 2009. The financial targetsfor the Performance-Based Tranches for years 2010-2012 remain unchanged.

 

3.              The vestingprovisions of the Performance-Based Tranche were modified to provide that uponachievement of the partial or total annual target for a given year, resultingin partial or full vesting for that year, any portion of the tranche associatedwith prior years will also vest up to the percentage vested in the given year,to the extent not previously vested.  Forexample, the financial targets for 2008 were not met, but the financialperformance targets for 2009 were met at the 90% level, so in addition tovesting 90% of the 2009 Performance-Based Tranche, the 2008 Performance BasedTranche also vested at the 90% level as of December 31, 2009.

 

4.              The financialperformance targets for the entire Enhanced Performance-Based Tranche werereplaced by targets with different financial metrics.  These new targets require achievement of aminimum internal rate of return (IRR) and money on invested capital (MOIC) tobe achieved by Blackstone following the sales of all or a portion of its sharesof the Company’s capital stock. Both the IRR and MOIC requirements must beachieved or none of the options in the Enhanced Performance-Based Tranche willvest.  Achievement of the IRR and MOICtargets will also result in vesting of the portion of the EnhancedPerformance-Based Tranche related to the 2008 annual targets which did not vestat the end of 2008.  As a result of thisamendment to the Enhanced Performance-Based Tranche, this tranche will now bereferred to as the “Market Return Tranche.”

 

5.              The termsdescribed above will also apply to any new options awarded under the 2007Incentive Stock Plan; provided, however, the Compensation Committee willestablish additional financial targets for succeeding years to allow forvesting of such options over a five year period.

 

In March 2009, we granted options for 44,228,33,202, and 33,202 shares under the 2007 Incentive Stock Plan to Messrs. Capizzi,Faulstick, and Roberts, respectively. These options have a term of 10 yearsfrom the date of grant and an exercise price of $16.46 per share with one-thirdof each  option grant consisting of aTime-Based Tranche, a Performance-Based Tranche and a Market ReturnTranche.  In the case of these options,the Time-Based Tranche vests with respect to 25% of the Time-Based Tranche oneyear the date of grant, or March 7, 2010, 20% of the Time-Based Tranche onMarch 7, 2011, 10.33% of the Time-Based tranche on each of March 7,2012 and 2013, and 18.34% of the Time-Based tranche on March 7, 2014.  The Performance-Based Tranche vests based onthe same performance conditions established for 2009-2012 for the amended 2008option grants, with the addition of the financial targets for 2013 for thefifth performance year after the date of grant. The Market Return Tranche has the same terms as the Market ReturnTranche described above for the amended 2008 option grant.

 

The Options granted in 2008 and 2009 to ourexecutive officers and other members of management contain change-in-controlprovisions that cause the vesting of a portion of the tranches upon theoccurrence of a change-in-control, as follows: 1) the Option shares in theTime-Based Tranche will become immediately exercisable upon the occurrence of achange-in-control if the optionee remains in continuous employment of theCompany until the consummation of the change-in-control and 2) the Optionshares of the 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.  This provision does not operate to vest the MarketReturn Tranche which requires the achievement of the IRR and MOIC targetsfollowing a liquidation by Blackstone of all or a portion of its equityinvestment in the Company.

 

*Other Benefits.***Other benefits to theexecutive officers include a 401(k) plan which covers the NEOs. Wemaintain the 401(k) plan for our employees, including our NEOs, because wewish to encourage our employees to save some percentage of their cashcompensation, through voluntary deferrals, for their eventual retirement. Wematch employee deferrals.  For the 2009plan year, we made matching contributions equal to 100% of the first 1% and 50%of the next 5% of compensation deferred by employees (subject to InternalRevenue Service limits and non-discrimination testing). For the 2010 plan year,the employer contribution percentage will remain unchanged. DJO maintains anon-qualified deferred compensation plan for its most senior management.  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. DJOhas the discretion to contribute matching contributions, but no such matchingcontributions have yet been made.

 

*Benefits Upon Termination of Employment.*  None of the NEOs currently are parties toemployment or severance agreements with the Company.  The Compensation Committee does notcontemplate entering into employment or severance agreements with the NEOs atthis time.

 

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The Tax and Accounting Considerations

 

Section 162(m) ofthe Internal Revenue Code of 1986, as amended, provides that compensation inexcess of $1,000,000 paid to the CEO or to other executive officers of a publiccompany will not be deductible for federal income tax purposes unless suchcompensation is paid pursuant to one of the enumerated exceptions set forth in Section 162(m).As a privately held company, we are no longer required to comply with Section 162(m) to ensure tax deductibility of executive compensation.

 

**Summary Compensation Table**

 

Thefollowing table sets forth summary information about the compensation during2009, 2008 and 2007 for services rendered in all capacities by our ChiefExecutive Officer, Chief Financial Officer and each of our three other mosthighly compensated executive officers. All of the individuals listed in thefollowing table are referred herein collectively as the “Named ExecutiveOfficers” or “NEOs.”

 
| **Name and  Principal Position**           | ** ** | **Year**   | ** ** | **Salary (1)** | ** ** | **Bonus (2)** | ** ** | ** Option  Awards  (3)** | ** ** | **Non-Equity  Incentive  Plan  Compensation  (6)** | ** ** | **All Other  Compensation  (7)** | ** ** | **Total $** | ** ** |
|------------------------------------------------------|------------|------------|------------|---------------------|------------|--------------------|------------|-------------------------------|------------|----------------------------------------------------|------------|---------------------------------------|------------|------------------|------------|
| ** **                                           | ** ** | ** ** | ** ** | ** **          | ** ** | ** **         | ** ** | ** **                    | ** ** | ** **                                         | ** ** | ** **                            | ** ** | ** **       | ** ** |
| Leslie H. Cross                                      |       | 2009       |       | $                   | 629,808    |               | $          | —                        |       | $                                                  | —     |                                  | $          |  247,981    |       | $ | 8,575 |   | $ | 886,364 |   |
| *Chief  Executive Officer and Director*              |       | 2008       |       | 625,000             |       | 800,000            |       | 1,577,585                     | (4)        | 336,511                                            |       | 8,050                                 |       | 3,347,146        |       |
|                                                 |       | 2007       |       | 60,135              |       | 248,438            |       | 1,327,352                     |       | —                                             |       | —                                |       | 1,635,925        |       |
|                                                 |       |       |       |                |       |               |       |                          |       |                                               |       |                                  |       |             |       |
| Vickie L. Capps                                      |       | 2009       |       | 453,461             |       | —             |       | —                        |       | 178,546                                            |       | 8,575                                 |       | 640,582          |       |
| *Executive  Vice President, Chief Financial Officer* |       | 2008       |       | 450,000             |       | 800,000            |       | 1,296,549                     | (4)        | 181,538                                            |       | 8,050                                 |       | 2,736,137        |       |
| *and  Treasurer*                                     |       | 2007       |       | 35,740              |       | 118,125            |       | 703,687                       |       | —                                             |       | —                                |       | 857,552          |       |
|                                                 |       |       |       |                |       |               |       |                          |       |                                               |       |                                  |       |             |       |
| Luke T. Faulstick                                    |       | 2009       |       | 403,077             | ** ** | —             | ** ** | 185,650                       | (5)        | 158,708                                            | ** ** | 8,575                                 | ** ** | 756,010          |       |
| *Executive  Vice President and Chief Operating*      |       | 2008       |       | 400,000             |       | 700,000            |       | 1,152,491                     | (4)        | 174,492                                            |       | 8,050                                 |       | 2,435,033        |       |
| *Officer*                                            |       | 2007       |       | 35,740              | ** ** | 118,125            | ** ** | 544,766                       |       | —                                             | ** ** | —                                | ** ** | 698,631          |       |
|                                                 |       |       |       |                |       |               |       |                          |       |                                               |       |                                  |       |             |       |
| Donald M. Roberts                                    |       | 2009       |       | 302,308             |       | —             |       | 139,366                       | (5)        | 119,031                                            |       | 8,575                                 |       | 569,280          |       |
| *Executive  Vice President, General Counsel and*     |       | 2008       |       | 300,000             |       | 500,000            |       | 702,295                       | (4)        | 145,400                                            |       | 8,050                                 |       | 1,655,745        |       |
| *Secretary*                                          |       | 2007       |       | 31,202              |       | 103,125            |       | 568,066                       |       | —                                             |       | —                                |       | 702,393          |       |
|                                                 |       |       |       |                |       |               |       |                          |       |                                               |       |                                  |       |             |       |
| Thomas A. Capizzi                                    |       | 2009       |       | 272,077             |       | —             |       | 139,366                       | (5)        | 107,128                                            |       | 8,575                                 |       | 527,146          |       |
| *Executive Vice President, Global Human*             |       | 2008       |       | 270,000             |       | 500,000            |       | 702,295                       | (4)        | 94,504                                             |       | 8,050                                 |       | 1,574,849        |       |
| *Resources*                                          |       | 2007       |       | 31,250              |       | 56,456             |       | —                        |       | —                                             |       | —                                |       | 87,706           |       |
|                                                      |            |            |            |                     |            |                    |            |                               |            |                                                    |            |                                       |            |                  |            |  |  |  |  |  |  |

 

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| (1)    |   | Prior  to the DJO Merger, all of the NEOs were employees of DJO Opco. Since none of  the NEOs were employed by the Company prior to the DJO Merger, the amounts  for 2007 represent salary earned from the date of the DJO Merger  (November 20, 2007) through December 31, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (2)    |   | Amounts  shown in this column for 2008 consist of retention bonuses which were entered  into in November 2007 with each of our executive officers in connection  with the DJO Merger, of which 50% of the retention bonus was paid in  January 2008 and 50% was paid in January 2009 and were contingent  upon the executive’s continued service through December 31, 2008. The  amounts shown in this column for 2007 consist of bonuses that were paid  during 2008 related to performance by DJO Opco under the 2007 DJO Opco bonus  plan for the fourth quarter and full fiscal year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (3)    |   | The  amounts shown in this column reflect the aggregate grant date fair value of  the awards granted in the respective years, as determined in accordance with  ASC Topic 718.  Pursuant to SEC rules,  the amounts shown exclude the impact of estimated forfeitures related to  service-based vesting conditions. Pursuant to SEC rule changes effective  February 28, 2010, we are required to reflect the total grant date fair  values of the option grants in the year of grant, rather than the portion of  this amount that was recognized for financial statement reporting purposes in  a given fiscal year which was required under the prior SEC rules, resulting  in a change to the amounts reported in prior Annual Reports in respect of  2007 and 2008. These amounts may not correspond to the actual value that is  ultimately realized by the NEOs. See Note 11 to the audited consolidated  financial statements included in the Annual Report for a discussion of the  relevant assumptions used in calculating the aggregate grant date fair value.  The amounts in 2007 for Messrs. Cross, Roberts, and Faulstick and  Ms. Capps represent the aggregate grant date fair value of the DJO  Management Rollover Options, less the intrinsic value of vested DJO Opco  options that each exchanged for the DJO Management Rollover Options in the  following approximate amounts: Mr. Cross: $3.0 million, Ms. Capps:  $2.0 million, Mr. Roberts: $1.0 million and Mr. Faulstick: $1.0  million. Additional information regarding grants awarded in 2009 is presented  in the “Grants of Plan-Based Awards in 2009” table below. |

 

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| (4)    |   | The  amounts shown for 2008 option awards include an amount related to the  Performance-Based Tranche (prior to giving effect to the 2009 modification)  because achievement of the performance conditions related to this tranche at  the grant date was determined to be probable. However, the portion of the  2008 options included in the Enhanced Performance-Based Tranche was excluded  because achievement of the performance conditions related to this tranche at  the grant date was not deemed probable. If the achievement of the conditions  to the Enhanced Performance-Based Tranche (without giving affect to 2009  modification) was probable, the aggregate grant date fair value of the 2008  options would have been: $2,366,377 for Mr. Cross, $1,944,821 for  Ms. Capps, $1,728,732 for Mr. Faulstick, and $1,053,443 for each of  Messrs. Roberts and Capizzi. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (5)    |   | The  amounts shown for 2009 option awards include an amount related to the  Performance-Based Tranche because achievement of the performance conditions  related to this tranche at the grant date was determined to be probable.  However, the value attributable to the portion of the 2009 options included  in the Market Return Tranche, which has both a performance component and a  market component, was excluded because achievement of the performance  component related to this tranche at the grant date was not deemed probable.  If the satisfaction of the performance component to Market Return Tranche was  determined to be probable, the aggregate grant date fair value of the 2009  options would have been: $206,878 for Mr. Faulstick and $155,303 for each  of Messrs. Roberts and Capizzi.                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (6)    |   | The  amounts shown in this column represent amounts earned in the respective year  based on the results of the Bonus Plan; some of which was paid in the  subsequent year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (7)    |   | These  amounts represent matching contributions of $8,575 each by the Company to the  accounts of each NEO in the Company’s 401(k) plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

**Grants of Plan-BasedAwards in 2009**

 

The following table setsforth certain information with respect to grants of plan-based awards made tothe NEOs during 2009.

 
| ** **              | ** ** | ** **          | ** ** | **Estimated Future Payouts Under Non-Equity  Incentive Plan Awards** | ** ** | **Estimated Future Payouts Under Equity  Incentive Plan Awards** | ** ** | **All Other  Option  Awards:  Number of  Securities  Underlying** | ** ** | **Exercise  or Base  Price of  Option** | ** ** | **Grant Date  Fair Value  of Option** | ** ** |
|-------------------------|------------|---------------------|------------|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------------------------------------------------|------------|
| **Name**                | ** ** | **Grant Date** | ** ** | **Threshold  ($)**                                                                                 | ** ** | **Target  ($)**                                                                                | ** ** | **Maximum  ($)**                                                            | ** ** | **Threshold  (#)**                                | ** ** | **Target  (#)**                                      | ** ** | **Maximum  (#)** | ** ** | **Options  (#)** | ** ** | **Awards  ($/Sh)** | ** ** | **Awards  ($/Sh) (3)** | ** ** |
| Leslie H. Cross         |       | 1/1/2009            | (1)        | $                                                                                                  | 151,154    |                                                                                           | $          | 377,885                                                                     |       | $                                                 | 755,770    |                                                 | —     |   | — |   | — |   | — |   | $ | — |   | $ | — |   |
|                    |       |                |       |                                                                                               |       |                                                                                           |       |                                                                        |       |                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Vickie  L. Capps   |       | 1/1/2009            | (1)        | 108,831                                                                                            |       | 272,077                                                                                        |       | 544,154                                                                     |       | —                                            |       | —                                               |       | — |   | — |   | — |   | — |   |
|                    |       |                |       |                                                                                               |       |                                                                                           |       |                                                                        |       |                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Luke  T. Faulstick |       | 1/1/2009            | (1)        | 96,738                                                                                             |       | 241,846                                                                                        |       | 483,692                                                                     |       | —                                            |       | —                                               |       | — |   | — |   | — |   | — |   |
|                    |       | 3/7/2009            | (2)        | —                                                                                             |       | —                                                                                         |       | —                                                                      |       | 11,794                                            |       | 14,743                                               |       | 29,485 |   | 14,743 |   | 16.46 |   | 206,878 |   |
|                    |       |                |       |                                                                                               |       |                                                                                           |       |                                                                        |       |                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Donald  M. Roberts |       | 1/1/2009            | (1)        | 72,554                                                                                             |       | 181,385                                                                                        |       | 362,770                                                                     |       | —                                            |       | —                                               |       | — |   | — |   | — |   | — |   |
|                    |       | 3/7/2009            | (2)        | —                                                                                             |       | —                                                                                         |       | —                                                                      |       | 8,854                                             |       | 11,067                                               |       | 22,134 |   | 11,068 |   | 16.46 |   | 155,303 |   |
|                    |       |                |       |                                                                                               |       |                                                                                           |       |                                                                        |       |                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Thomas A.Capizzi        |       | 1/1/2009            | (1)        | 65,298                                                                                             |       | 163,246                                                                                        |       | 326,492                                                                     |       | —                                            |       | —                                               |       | — |   | — |   | — |   | — |   |
|                    |       | 3/7/2009            | (2)        | —                                                                                             |       | —                                                                                         |       | —                                                                      |       | 8,854                                             |       | 11,067                                               |       | 22,134 |   | 11,068 |   | 16.46 |   | 155,303 |   |
|                         |            |                     |            |                                                                                                    |            |                                                                                                |            |                                                                             |            |                                                   |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| (1)    |   | The  amounts set forth in these rows under the column “Estimated Future Payouts  Under Non-Equity Incentive Plan Awards” represent the threshold, target and  maximum bonus potential under the 2009 Bonus Plan. See discussion of  “Threshold Bonus”, “Target Bonus” and “Supplemental Bonus” in “Annual and  Quarterly Cash Incentive Compensation” in “Compensation Discussion and  Analysis” above for a description of the conditions for the 2009 Bonus Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (2)    |   | The  share amounts set forth in these rows under the column “Estimated Future  Payouts under Equity Incentive Plan Awards” represent the Performance-Based  and Market Tranches of the options granted to the applicable NEO in  March 2009, with the “Threshold” amounts representing 80% of the  Performance-Based Tranche, the “Target” amount representing 100% of the  Performance-Based Tranche and the “Maximum” amount representing the sum of  the Performance-Based Tranche and the Market Tranches. The share amounts set  forth in these rows under the column “All Other Option Awards; Number of  Securities Underlying Options” represent the “Time-Based Tranche” of the  options granted to the NEOs in March 2009. See “Compensation Discussion  and Analysis — The Elements of Our Executive Compensation Program — Equity  Compensation” for a description of the vesting conditions for these options. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (3)    |   | The grant date fair value is the value of awards granted in 2009 as  determined in accordance with ASC Topic 718.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |

 

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**Outstanding Equity Awards at 2009Fiscal Year-End**

 

The following table sets forth certain informationregarding options held by each of the NEOs as of December 31, 2009.  There were no restricted stock awardsoutstanding as of December 31, 2009.

 
| ** **        | ** ** | **Option Awards**                                                                      | ** ** |
|-------------------|------------|----------------------------------------------------------------------------------------|------------|
| **Name**          | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#) Exercisable** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#) Unexercisable** | ** ** | **Equity Incentive  Plan Awards:  Number of  Securities  Underlying  Unexercised  Unearned Options  (#) (5)** | ** ** | **Option  Exercise  Price ($)** | ** ** | **Option  Expiration Date** | ** ** |
|              |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Leslie H. Cross   |       | 138,723                                                                                | (1)        | 89,282 | (3) | 258,994 |   | 16.46 |   | 2/21/2018 |   |
|              |       | 213,700                                                                                | (2)        | — |   | — |   | 13.10 |   | 5/12/2017 |   |
|              |       | 82,427                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|              |       | 4,530                                                                                  | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 188,724                                                                                | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 43,351                                                                                 | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|              | ** ** | **671,455**                                                                            | ** ** | **89,282** | ** ** | **258,994** |   |   |   |   |   |
|              |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Vickie L. Capps   |       | 114,011                                                                                | (1)        | 73,377 | (3) | 212,855 |   | 16.46 |   | 2/21/2018 |   |
|              |       | 91,586                                                                                 | (2)        | — |   | — |   | 13.10 |   | 5/11/2017 |   |
|              |       | 48,846                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|              |       | 69,785                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 6,075                                                                                  | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 15,725                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 6                                                                                      | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|              |       | 76,315                                                                                 | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|              |       | 5,342                                                                                  | (2)        | — |   | — |   | 7.18 |   | 2/26/2014 |   |
|              | ** ** | **427,691**                                                                            | ** ** | **73,377** | ** ** | **212,855** |   |   |   |   |   |
|              |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Luke T. Faulstick |       | 3,314                                                                                  | (1)        | 14,743 | (4) | 26,171 |   | 16.46 |   | 3/7/2019 |   |
|              |       | 101,344                                                                                | (1)        | 65,224 | (3) | 189,204 |   | 16.46 |   | 2/21/2018 |   |
|              |       | 91,586                                                                                 | (2)        | — |   | — |   | 13.10 |   | 5/11/2017 |   |
|              |       | 48,846                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|              |       | 6,075                                                                                  | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 4,753                                                                                  | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 34,964                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 2,552                                                                                  | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|              |       | 7,479                                                                                  | (2)        | — |   | — |   | 7.00 |   | 12/8/2014 |   |
|              | ** ** | **300,913**                                                                            | ** ** | **79,967** | ** ** | **215,375** |   |   |   |   |   |
|              |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Donald M. Roberts |       | 2,490                                                                                  | (1)        | 11,068 | (4) | 19,644 |   | 16.46 |   | 3/7/2019 |   |
|              |       | 61,756                                                                                 | (1)        | 39,745 | (3) | 115,297 |   | 16.46 |   | 2/21/2018 |   |
|              |       | 91,586                                                                                 | (2)        | — |   | — |   | 13.10 |   | 5/12/2017 |   |
|              |       | 48,846                                                                                 | (2)        | — |   | — |   | 12.91 |   | 4/3/2016 |   |
|              |       | 1,557                                                                                  | (2)        | — |   | — |   | 8.84 |   | 5/25/2015 |   |
|              |       | 6,075                                                                                  | (2)        | — |   | — |   | 8.84 |   | 5/25/2015 |   |
|              |       | 22,896                                                                                 | (2)        | — |   | — |   | 8.84 |   | 5/25/2015 |   |
|              |       | 10,810                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              |       | 24,270                                                                                 | (2)        | — |   | — |   | 8.29 |   | 12/9/2013 |   |
|              | ** ** | **270,286**                                                                            | ** ** | **50,813** | ** ** | **134,941** |   |   |   |   |   |
|              |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Thomas A. Capizzi |       | 2,490                                                                                  | (1)        | 11,068 | (4) | 19,644 |   | 16.46 |   | 3/7/2019 |   |
|              |       | 61,756                                                                                 | (1)        | 39,745 | (3) | 115,297 |   | 16.46 |   | 2/21/2018 |   |
|              | ** ** | **64,246**                                                                             | ** ** | **50,813** | ** ** | **134,941** |   |   |   |   |   |

 

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| (1)    |   | These  amounts reflect (a) the number of shares underlying the “Time-Based  Tranche” of options that are vested and exercisable which were granted in  2008 under the 2007 Incentive Stock Plan, and (b) the number of shares  underlying the “Performance-Based Tranche” of options that have been earned  (i.e., their performance conditions have been satisfied) for 2008 and 2009 that  were granted in 2009 and 2008 under the 2007 Incentive Stock Plan. No portion  of the “Time-Based Tranche” of the options granted in 2009 were vested as of  December 31, 2009. See footnote (4) below. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (2)    |   | These  amounts reflect the number of shares underlying the DJO Management Rollover  Options which were fully vested upon issuance in connection with the DJO  Merger.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (3)    |   | These  amounts reflect the number of shares underlying the “Time-Based Tranche” of  options that are not vested and not exercisable which were granted in 2008  under the 2007 Incentive Stock Plan. These options reflect the remaining  portion of the grant made in 2008 and vest as follows: 18.33% of the original  grant vests on each of December 31, 2010 and December 21, 2011 and  18.34% of the original grant vests on December 31, 2012.                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (4)    |   | All  of the shares underlying the “Time-Based Tranche” of options that were  granted in 2009 under the 2007 Incentive Stock Plan are not vested and not  exercisable as of December 31, 2009. These options vest as follows: 25%  of the original grant date vests on March 7, 2010, 20% of the original  grant vests on March 7, 2011, 18.33% of the original grant vests on each  of March 7, 2012, and March 7, 2013 and 18.34% of the original grant  vests on March 7, 2014.                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (5)    |   | The  amounts set forth in this column reflect the number of shares underlying the  “Performance-Based Tranche” and the “Market Tranche” of options that have not  been earned (i.e., their performance conditions have not been satisfied).                                                                                                                                                                                                                                                                                                                                                                                        |

 

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**Option Exercises and Stock Vested During 2009**

 

Nooptions were exercised and no restricted stock awards vested during the yearended December 31, 2009  by or forour NEOs.

 

**Non-Qualified Deferred Compensation for 2009**

 

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 DJOFL. The Deferred Plan allowsexecutives to save for retirement in a tax-effective way at minimal cost toDJO, LLC. Under this program, amounts deferred by the executive are depositedinto a trust for investment and eventual benefit payment. The obligations ofDJO, LLC under the Deferred Plan are unsecured obligations to pay deferredcompensation in the future from the assets of the trust. Participants will havethe status of unsecured general creditors with respect to the benefitobligations of the Deferred Plan, and the assets set aside in the trust forthose benefits will be available to creditors of DJO, LLC in the event ofbankruptcy or insolvency. Each participant may elect to defer under the DeferredPlan all or a portion of his or her cash compensation that may otherwise bepayable in a calendar year. A participant’s compensation deferrals are creditedto the participant’s account under the Deferred Plan and the trust. Eachparticipant may elect to have the amounts in such participant’s accountinvested in one or more investment options available under the Deferred Plan,which investment options are substantially the same investment optionsavailable to participants in DJO, LLC’s 401(k) Savings Plan. TheDeferred Plan also permits DJO, LLC to make contributions to the Deferred Plan,including matching contributions, at its discretion, but no such contributionshave been made to date. To the extent that Company contributions are made tothe Deferred Plan, the Committee may impose vesting criteria to aid in theemployment retention of participants. A participant’s eventual benefit willdepend on his or her level of contributions, DJO, LLC’s contributions, if any,and the investment performance of the particular investment options selected.The following table sets forth information for each of the Named ExecutiveOfficers who participated in DJO, LLC’s Nonqualified Deferred Compensation Planduring 2009.

 
| **Name**          | ** ** | **Executive  Contributions  in Last  Fiscal Year(1)** | ** ** | **Registrant  Contributions  in Last  Fiscal Year** | ** ** | **Aggregate  Earnings/  (Losses)  in Last  Fiscal Year** | ** ** | **Aggregate  Withdrawals/  Distributions** | ** ** | **Aggregate  Balance at Last  Fiscal Year** | ** ** |
|-------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------------------------|------------|
| Leslie H. Cross   |       | $                                                               | —     |                                                          | $          | —                                                             |       | $                                          | —     |                                                       | $          | — |   | $ | — |   |
| Vickie L. Capps   |       | —                                                          |       | —                                                        |       | —                                                             |       | —                                     |       | —                                                     |       |
| Luke T. Faulstick |       | —                                                          |       | —                                                        |       | —                                                             |       | —                                     |       | —                                                     |       |
| Donald M. Roberts |       | 42,783                                                          |       | —                                                        |       | 32,806                                                             |       | —                                     |       | 145,529                                                    |       |
| Thomas A. Capizzi |       | —                                                          |       | —                                                        |       | —                                                             |       | —                                     |       | —                                                     |       |
|                   |            |                                                                 |            |                                                               |            |                                                                    |            |                                            |            |                                                            |            |  |  |  |  |  |

 

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| (1) |   | Amounts deferred by the executive under the Deferred  Plan have been reported as 2009 compensation to such executive in the “Salary”  column in the Summary Compensation Table above. Amounts in the aggregate  balance include amounts earned as compensation prior to the DJO Merger when  Mr. Roberts was an executive officer of DJO Opco. Amounts included in  aggregate earnings are not required to be included in Summary Compensation  table above. |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**Potential Payments UponTermination or Change-in-Control**

 

TheNEOs are not party to any employment contracts or contracts or arrangementsthat provide for payment at, following, or in connection with any termination,including without limitation; resignation, severance, retirement, death orconstructive termination of the NEO, or a change in control of the Company.

 

TheOptions granted in February 2008 and March 2009 to our executiveofficers and other members of management contain change-in-control provisionsthat cause the vesting of a portion of the tranches upon the occurrence of achange-in-control, as follows: 1) the Option shares in the Time-Based Tranchewill become immediately exercisable upon the occurrence of a change-in-controlif the optionee remains in continuous employment of the Company until theconsummation of the change-in-control and 2) the Option shares of thePerformance-Based Tranche for the year in which such change-in-control isconsummated and for any subsequent performance periods will become immediatelyexercisable if the optionee remains in continuous employment of the Companyuntil the consummation of the change-in-control. This provision does notoperate to vest the Market Tranche which requires achievement of the IRR andMOIC targets following a complete liquidation by Blackstone of its equityinvestment in the Company.

 

**Compensation of Directors**

 

TheCompensation Committee of the DJO Board reviews the compensation of ourDirectors on an annual basis.  Our Boardof Directors consists of eight persons: Chinh E. Chu, Julia Kahr, Bruce McEvoy,Leslie H. Cross, Sidney Braginsky, Phillip Hildebrand, Lesley Howe, and PaulLaViolette. Mr. Chu, Ms. Kahr and Mr. McEvoy are affiliated withBlackstone and are not compensated for serving as members of our Board ofDirectors. Mr. Cross is our Chief Executive Officer and is not separatelycompensated for serving as a member of the Board of Directors.

 

Thestandard compensation package for directors who are not employed by the Companyor by any Blackstone-controlled entity (“Eligible Directors”), namely Messrs. Braginsky,Hildebrand, Howe, and LaViolette, consists of an annual fee for each suchdirector, a per meeting fee and stock option grants. Each of the EligibleDirectors is paid an annual fee of $75,000. In addition, the Chairman of the AuditCommittee receives an annual fee of $25,000 and the other members of the AuditCommittee (who are Eligible Directors) receive an annual fee of $15,000. TheEligible Directors were also eligible for annual option awards under the 2007Incentive Stock Plan. In February 2009, the Compensation Committeeawarded Messrs. Braginsky, Hildebrand, Howe and LaViolette options topurchase 4,600 shares of Common Stock with an exercise price of $16.46 pershare, which was determined to be the fair market value of such shares on thedate of grant. These options are scheduled to vest in one-third annualincrements beginning the first anniversary of the date of grant and any sharesissued on exercise of such options will be subject to a Management StockholdersAgreement.

 

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Thefollowing table sets forth the compensation earned by our non-employeedirectors for their services in 2009:

 
| ** **           | ** ** | **Directors Compensation for 2009**          | ** ** |
|----------------------|------------|----------------------------------------------|------------|
| **Name**             | ** ** | **Fees  Earned or  Paid in  Cash** | ** ** | **Option  Awards(1)** | ** ** | **Total** | ** ** |
| Chinh E. Chu         |       | $                                            | —     |   | $ | — |   | $ | — |   |
| Julia Kahr           |       | —                                       |       | — |   | — |   |
| Bruce McEvoy         |       | —                                       |       | — |   | — |   |
| Sidney Braginsky     |       | 90,000                                       |       | 28,963 |   | 118,963 |   |
| Phillip Hildebrand   |       | 75,000                                       |       | 28,963 |   | 103,963 |   |
| Lesley Howe          |       | 100,000                                      |       | 28,963 |   | 128,963 |   |
| Paul LaViolette      |       | 75,000                                       |       | 28,963 |   | 103,963 |   |
| Kenneth Davidson (2) |       | —                                       |       | — |   | — |   |
| Paul Chapmen (2)     |       | —                                       |       | — |   | — |   |
|                      |            |                                              |            |  |  |  |  |  |  |  |

 

----

| (1)    | Amounts shown for the option  awards to Messrs. Braginsky, Hildebrand, Howe, and LaViolette reflect  grant date fair value of options granted in 2009 as determined in accordance  with ASC Topic 718. A discussion of the relevant assumptions used in the  valuation is contained in Note 11 to our audited consolidated financial  statements contained in this Annual Report. As of December 31, 2009,  Messrs. Braginsky, Hildebrand, Howe, and LaViolette held a total of  11,450, 4,600, 4,600, and 4,600 stock options outstanding, respectively. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (2)    | Messrs. Davidson  and Chapman resigned as directors effective January 22, 2009.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

 

**Compensation Committee Interlocks and Insider Participation**

 

During2009, our Compensation Committee consisted of three designees of Blackstone, Mr. Chu,Ms. Kahr and Mr. McEvoy. None of the members of the CompensationCommittee is or has been an officer or employee of DJO. See “Item 13. CertainRelationships and Related Transactions, and Director Independence” below for adescription of certain agreements with Blackstone. None of our executiveofficers has served as a director or a member of the compensation committee (orother committee serving an equivalent function) of any other entity, which hasone or more executive officers serving as a director of DJO or member of ourCompensation Committee.

 

**Compensation Committee Report**

 

TheCompensation Committee of the DJO Board of Directors oversees our company’scompensation program on behalf of the Board. In fulfilling its oversightresponsibilities, the Compensation Committee reviewed and discussed withmanagement the Compensation Discussion and Analysis set forth in this AnnualReport.  Based upon the review anddiscussions referred to above, the Compensation Committee recommended to theDJO Board that the Compensation Discussion and Analysis be included in thisAnnual Report.

 

Submitted by the Compensation Committee:

ChinhE. Chu (Chair)

JuliaKahr

BruceMcEvoy

 

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**ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

DJOFL is a wholly ownedsubsidiary of DJO, which owns all of our issued and outstanding capitalstock.  The following table sets forth asof March 5, 2010, certain information regarding the beneficial ownershipof the voting securities of DJO by each person who beneficially owns more thanfive percent of DJO’s common stock, and by each of the directors and NEOs ofDJO, individually, and by our directors and executive officers as a group.

 
| ** **                                                                       | ** ** | **Aggregate Number of Shares Beneficially Owned (1)** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **Name and Address of Beneficial Owner**                | ** ** | **Number of Issued  Shares**                                              | ** ** | **Acquirable within  60 days (2)** | ** ** | **Percent of Class** | ** ** |
| Grand Slam Holdings, LLC (3)                                                     |       | 48,098,209                                                                          |       | — |   | 98.82 | % |
| **Directors and Executive Officers**                                             |       |                                                                                |       |   |   |   |   |
| Leslie H. Cross  President, Chief Executive Officer and Director                 |       | —                                                                              |       | 671,455 |   | 1.38 | % |
| Vickie L. Capps  Executive Vice President, Chief Financial Officer and Treasurer |       | —                                                                              |       | 427,692 |   | * |   |
| Donald M. Roberts,  Executive Vice President, General Counsel and Secretary      |       | —                                                                              |       | 273,051 |   | * |   |
| Luke T. Faulstick  Executive Vice President and Chief Operating Officer          |       | —                                                                              |       | 304,598 |   | * |   |
| Tom Capizzi  Executive Vice President, Global Human Resources                    |       | —                                                                              |       | 67,012 |   | * |   |
| Chinh E. Chu  Chairman of the Board (4)                                          |       | 48,098,209                                                                          |       | — |   | 98.82 | % |
| Julia Kahr  Director (5)                                                         |       | —                                                                              |       | — |   | — |   |
| Sidney Braginsky  Director                                                       |       | —                                                                              |       | 5,281 |   | * |   |
| Bruce McEvoy  Director (5)                                                       |       | —                                                                              |       | — |   | — |   |
| Phillip J. Hildebrand  Director                                                  |       | —                                                                              |       | 1,518 |   | — |   |
| Lesley Howe  Director                                                            |       | —                                                                              |       | 1,518 |   | — |   |
| Paul LaViolette  Director                                                        |       | —                                                                              |       | 1,518 |   | — |   |
| All Directors and executive officers as a group                                  |       | 48,098,209                                                                          |       | 1,753,643 |   | 98.86 | % |

 

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* Less than 1%

 
| (1)    | Includes shares held in the beneficial owner’s name or  jointly with others, or in the name of a bank, nominee or trustee for the  beneficial owner’s account. Unless otherwise indicated in the footnotes to  this table and subject to community property laws where applicable, we  believe that each stockholder named in this table has sole voting and  investment power with respect to the shares indicated as beneficially owned.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (2)    | Includes the number of shares that could be purchased by  exercise of options on or within 60 days after March 5, 2010 under DJO’s  stock option plans. For the NEOs, this number includes the “DJO Management  Rollover Options” which are fully vested and the portion of the “Time-Based  Tranche” and “Performance-Based Tranche” of options that have vested or will  vest in 60 days, but no portion of the “Market Tranche.”                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (3)    | Shares of common stock of DJO held by Grand Slam  Holdings, LLC (“BCP Holdings”) may also be deemed to be beneficially owned by  the following entities and persons: (i) Blackstone Capital Partners V  L.P., a Delaware limited partnership (“BCP V”), Blackstone Family Investment  Partnership V L.P., a Delaware limited partnership (“BFIP”), Blackstone  Family Investment Partnership V-A L.P., a Delaware limited partnership  (“BFIP-A”), and Blackstone Participation Partnership V L.P., a Delaware  limited partnership (together with BCP V, BFIP and BFIP-A, the “Blackstone  Partnerships”), which collectively own all of the equity in BCP Holdings;  (ii) Blackstone Management Associates V L.L.C., a Delaware limited  liability company (“BMA”), the general partner of the Blackstone  Partnerships; (iii) BMA V L.L.C., a Delaware limited liability company  (“BMA V”), the sole member of BMA; and (iv) Peter G. Peterson and Stephen  A. Schwarzman, the founding members and controlling persons of BMA V. Each of  Messrs. Peterson and Schwarzman disclaims beneficial ownership of such  shares, except to the extent of his pecuniary interest therein. The address  of BCP Holdings and each of the entities and individuals listed in this  footnote is c/o The Blackstone Group, L.P., 345 Park Avenue, New York, New  York 10154. |

 

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| (4)    | Mr. Chu,  a director of DJO, is a member of BMAV and a senior managing director of The  Blackstone Group, L.P. The number of shares disclosed for Mr. Chu are  also included in the above table in the number of shares disclosed for “Grand  Slam Holdings, LLC.” Mr. Chu disclaims beneficial ownership of any  shares owned or controlled by BCP Holdings, except to the extent of his  pecuniary interest therein. |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (5)    | Ms. Kahr  and Mr. McEvoy are employees of The Blackstone Group, L.P. but do not  have any investment or voting control over the shares beneficially owned by  BCP Holdings.                                                                                                                                                                                                                                                           |

 

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

 

Thefollowing table provides information as of December 31, 2009 with respectto the number of shares to be issued upon the exercise of outstanding stockoptions under our 2007 Incentive Stock Plan, which is our only equitycompensation plan and has been approved by the stockholders:

 
| **Plan Category**                             | ** ** | **(a) Number of  securities to be  issued upon  exercise of  outstanding  options, warrants  and rights** | ** ** | **Weighted-average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by stockholders |       | 6,880,342                                                                                                                                         |       | 14.69                                                                                                   |       | 619,658                                                                                                                                                                                                          |       |

 

**ITEM 13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

**Management Stockholder’s Agreement**

 

Allmembers of DJO’s management who hold shares of DJO common stock or options topurchase DJO common stock are parties to a Management Stockholders Agreement,dated November 3, 2006, among DJO, Grand Slam Holdings, LLC (“BCP Holdings”),Blackstone Capital Partners V L.P. (“Blackstone”), certain of its affiliates,and such members of DJO’s management, as amended by the First Amendment toManagement Stockholders Agreement (the “Management Stockholders Agreement”).   The Management Stockholders Agreementprovides that upon termination of a management stockholder’s employment for anyreason, DJO and a Blackstone Parent Stockholder may collectively exercise theright to purchase all of the shares of DJO common stock held by such managementstockholder within one year after such termination (or, with respect to sharespurchased upon exercise of options after termination of employment, one yearfollowing such exercise).  If amanagement stockholder is terminated for “cause” (as defined in the Agreement),or voluntarily terminates their employment and such termination would haveconstituted a termination for “cause” if it would have been initiated by DJO,and DJO or a Blackstone Parent Stockholder exercises its call rights after suchtermination, the management stockholder would receive the lower of fair marketvalue or “cost” for the management stockholder’s callable shares.  In thecase of all other terminations of employment, the management stockholder wouldreceive fair market value for such shares.

 

TheManagement Stockholders Agreement imposes significant restrictions on transfersof shares of DJO’s common stock held by management stockholders and provides aright of first refusal to DJO (or Blackstone), if DJO fails to exercise suchright) on any proposed sale of DJO’s common stock held by a managementstockholder following the lapse of the transfer restrictions and prior to theoccurrence of a ‘‘qualified public offering’’ (as such term is defined in thatagreement) of DJO. In addition, prior to a qualified public offering,Blackstone will have drag-along rights, and management stockholders will havetag-along rights, in the event of a sale of DJO’s common stock by Blackstone toa third party (or in the event of a sale of BCP Holdings’ equity interests to athird party) in the same proportion as the shares or equity interests sold byBlackstone. The Management Stockholders Agreement also provides that, after theoccurrence of a qualified public offering, the management stockholders willreceive customary piggyback registration rights with respect to shares of DJOcommon stock held by them.

 

On December 13, 2006,DJO, BCP Holdings, Blackstone and certain of its affiliates entered into astockholders agreement with Sidney Braginsky, one of DJO’s directors. The termsand conditions of the stockholders agreement with Mr. Braginsky are thesame, in all material respects, as the management stockholders agreementdescribed above.  In addition, allparties receiving an award of stock options, including all DJO directors whohave been granted options, automatically become parties to the ManagementStockholders Agreement.

 

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**Transaction and Monitoring Fee Agreement**

 

Inconnection with the DJO Merger, on November 20, 2007, DJO and BlackstoneManagement Partners V L.L.C. (“BMP”) amended and restated the transaction andmonitoring fee agreement in existence at that time (the “Old Transaction andMonitoring Fee Agreement”) between them, with effect from and after the closingof the DJO Merger (such agreement, as amended and restated, the “NewTransaction and Monitoring Fee Agreement”).

 

Underthe New Transaction and Monitoring Fee Agreement, DJO paid BMP, at the closingof the DJO Merger, a $15.0 million transaction fee and $0.6 million for relatedexpenses. Also pursuant to this agreement, at the closing of the DJO Merger,DJO paid Blackstone Advisory Services, L.P., an affiliate of BMP (“BAS”), a$3.0 million advisory fee in consideration of the provision of certainstrategic and other advice and assistance by BAS on behalf of BMP.

 

Underthe New Transaction and Monitoring Fee Agreement, BMP (including through itsaffiliates and representatives) will continue to provide certain monitoring,advisory and consulting services to DJO, on substantially the same terms andconditions as the Old Transaction and Monitoring Fee Agreement, for an annualmonitoring fee which has been increased from $3.0 million to the greater of$7.0 million or 2.0% of consolidated EBITDA (as defined in the New Transactionand Monitoring Fee Agreement).

 

TheNew Transaction and Monitoring Fee Agreement also provides, on substantiallythe same terms and conditions as the Old Transaction and Monitoring FeeAgreement, 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 Monitoring FeeAgreement 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

 

·                  DJO will indemnify BMP and its affiliates,and their respective partners, members, shareholders, directors, officers,employees, agents and representatives from and against all liabilities relatingto the services performed under the Old Transaction and Monitoring FeeAgreement or by the New Transaction and Monitoring Fee Agreement and theengagement of BMP pursuant to, and the performance of BMP and its affiliatesand their respective representatives of the services contemplated by, each suchagreement.

 

**Policy and Procedures with Respect to Related Person Transactions**

 

The Board of Directors has not adopted a formal written policy for thereview and approval of transactions with related persons.  However, all such transactions will bereviewed by the Board on an as-needed basis.

 

**Director Independence**

 

As a privately held company,the DJO Board is not required to have a majority of its directors beindependent.  We believe that Messrs. Braginsky,Howe and LaViolette would be deemed independent directors according to theindependence definition promulgated under the New York Stock Exchange listingstandards.

 

**ITEM 14.  PRINCIPAL ACCOUNTINGFEES AND SERVICES**

 

**FeesPaid to the Independent Auditor**

 

Thefollowing table sets forth the aggregate fees billed by Ernst & YoungLLP for audit services rendered in connection with the consolidated financialstatements and reports for fiscal years 2009 and 2008 and for other servicesrendered during fiscal years 2009 and 2008 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 relatedservices were pre-approved by the audit committee.

** **
| ** **         | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------|------------|----------|------------|----------|------------|
|               |       |     |       |     |       |
| Audit fees         |       | $        | 1,120,528  |     | $          | 1,276,123 |   |
| Audit-related fees |       | 25,156   |       | 31,425   |       |
| Tax fees           |       | 25,000   |       | —   |       |
| All other fees     |       | 193,759  |       | —   |       |
|                    |            |          |            |          |            |  |  |

 

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AuditFees:  Consists of fees billed forprofessional services rendered for the audit of DJO’s consolidated financialstatements, review of interim condensed consolidated financial statementsincluded in quarterly reports and services that are normally provided byauditors in connection with statutory and regulatory filings.

 

Audit-RelatedFees:  Consists of fees billed forassurance and related services that are reasonably related to the performanceof the audit or review of DJO’s consolidated financial statements and are notreported under “Audit Fees”. During 2009 and 2008 all audit-related fees werespecifically pre-approved pursuant to the Audit Committee Pre-Approval Policydiscussed below.

 

TaxFees:  Consists of tax compliance andconsultation services.  There were no taxfees in 2008.

 

AllOther Fees:  Consists of fees for allother services other than those reported above.   There were no other fees in 2008.

 

**Audit Committee Pre-Approval Policy**

 

Allservices to be performed for us by our independent auditors must bepre-approved by the audit committee, or a designated member of the audit committee,to assure that the provision of such services does not impair the auditor’sindependence.

 

Theannual audit services engagement terms and fees are subject to the specificpre-approval of the audit committee.  Theaudit committee will approve, if necessary, any changes in terms, conditions,and fees resulting from changes in audit scope or other matters.  All other audit services not otherwiseincluded in the annual audit services engagement must be specifically pre-approvedby the audit committee.

 

Audit-relatedservices are services that are reasonably related to the performance of theaudit or review of our financial statements or traditionally performed by theindependent auditors.  Examples ofaudit-related services include employee benefit and compensation plan audits,due diligence related to mergers and acquisitions, attestations by the auditorsthat are not required by statute or regulation, consulting on financialaccounting/reporting standards and internal controls, and consultations relatedto compliance with Section 404 of the Sarbanes-Oxley Act of 2002.  All audit-related services must bespecifically pre-approved by the audit committee.

 

Theaudit committee may grant pre-approval of other services that are permissibleunder applicable laws and regulations and that would not impair theindependence of the auditors.  All ofsuch permissible services must be specifically pre-approved by the auditcommittee.

 

Requestsor applications for the independent auditors to provide services that require specificapproval by the audit committee are considered after consultation withmanagement and the auditors.  Questionsabout whether the scope of a proposed service requires specific pre-approval,or is permitted by applicable laws and regulations, are to be referred to ourlegal department.

 

**PART IV**

 

**ITEM 15.  EXHIBITS, FINANCIALSTATEMENT SCHEDULES**

 

(a)       The following documents are filed as part of thisAnnual Report:

 

1.  The following consolidated financialstatements of DJO Finance LLC, including the reports thereon of Ernst &Young LLP, are filed as part of this report under Part II, Item 8.Financial Statements and Supplementary Data:

 

·                  Reports of Independent Registered PublicAccounting Firm.

 

·                  Consolidated Balance Sheets as of December 31,2009 and 2008.

 

·                  Consolidated Statements ofOperations for the years ended December 31, 2009, 2008, and 2007.

 

·                  Consolidated Statements of Changes inMembership Equity and Comprehensive Loss for the years ended December 31,2009, 2008, and 2007.

 

·                  Consolidated Statements of Cash Flows for theyears ended December 31, 2009, 2008, and 2007.

 

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·                  Notes to Audited Consolidated FinancialStatements.

 

2.         Financial StatementSchedules:

 

Schedule II — Valuation andQualifying Accounts

 

Allother financial statement schedules are not required under the relatedinstructions 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 (incorporated by reference to  Exhibit 3.1 to DJOFL’s Annual Report on Form 10-K for the fiscal  year ended December 31, 2007).                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2    |   | Limited Liability Company  Agreement of DJOFL (incorporated by reference to Exhibit 3.2 of DJOFL’s  Registration Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188)).                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.1    |   | Indenture,  dated as of November 3, 2006, among DJOFL, DJO Finance Corporation  (f/k/a Encore Medical Finance Corp. and ReAble Therapeutics Finance  Corporation) (“DJO Finco”), the Guarantors named therein and The Bank of New  York as Trustee, governing the 113/4 Senior Subordinated Notes  (incorporated by reference to Exhibit 4.1 of DJOFL’s Registration  Statement on Form S-4, filed on April 18, 2007 (File  No. 333-142188)). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.2    |   | Registration  Rights Agreement, dated as of November 3, 2006, by and among DJOFL, DJO  Finco, the Guarantors named therein, Banc of America Securities LLC and  Credit Suisse Securities (USA) LLC (incorporated by reference to  Exhibit 4.2 of DJOFL’s Registration Statement on Form S-4, filed on  April 18, 2007 (File No. 333-142188)).                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.3    |   | Indenture, dated  November 20, 2007, among DJOFL, DJO Finco, the Guarantors party therein  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                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.4    |   | Registration Rights  Agreement, dated November 20, 2007, among DJOFL, DJO Finco, the  Guarantors party thereto and Credit Suisse Securities (USA) LLC and Banc of  America Securities LLC (incorporated by reference to Exhibit 4.2 to  DJOFL’s Current Report on Form 8-K, filed on November 27, 2007).                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.5    |   | Credit Agreement, dated  November 20, 2007, among DJOFL, as borrower, DJO Holdings, Credit  Suisse, as administrative agent, the lenders from time to time party thereto  and the other agents named therein (incorporated by reference to Exhibit 4.3  to DJOFL’s Current Report on Form 8-K, filed on November 27, 2007).                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.6    |   | Security Agreement,  dated November 20, 2007, among DJOFL, as borrower, DJO Holdings and  certain subsidiaries named therein, and Credit Suisse, as collateral agent  (incorporated by reference to Exhibit 4.5 to DJOFL’s Current Report on  Form 8-K, filed on November 27, 2007).                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.7    |   | Guaranty Agreement,  dated November 20, 2007, among DJOFL, as borrower, DJO Holdings and  certain subsidiaries named therein, and Credit Suisse, as collateral agent  (incorporated by reference to Exhibit 4.4 to DJOFL’s Current Report on  Form 8-K, filed on November 27, 2007).                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.8    |   | First Supplemental  Indenture, dated as of January 20, 2010, by and among the Issuers, the  guarantors named therein and The Bank of New York Mellon, as Trustee  (incorporated by reference to Exhibit 4.1 to DJOFL’s Current Report on  Form 8-K, filed on January 21, 2010).                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.9    |   | Form of 10.875%  Senior Notes due 2014 (incorporated by reference to Exhibit 4.2 to  DJOFL’s Current Report on Form 8-K, filed on January 21, 2010).                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.10   |   | Registration  Rights Agreement, dated as of January 20, 2010, by and among the  Issuers, the guarantors named therein and Credit Suisse Securities (USA) LLC  (incorporated by reference to Exhibit 4.3 to DJOFL’s Current Report on  Form 8-K, filed on January 21, 2010).                                                                                                                                                                                       |

 

126

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| 10.1*  |   | 2007 Incentive Stock  Plan, dated November 20, 2007 (incorporated by reference to  Exhibit 10.7 to DJOFL’s Current Report on Form 8-K, filed on  November 27, 2007).                                                                                                                                           |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.2*  |   | Amendment  to 2007 Incentive Stock Plan, dated April 25, 2008 (incorporated by  reference to Exhibit 10.1 to DJOFL’s Current Report on Form 8-K,  filed on May 1, 2008).                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.3*  |   | Form of  Nonstatutory Stock Option Agreement under 2007 Incentive Stock Plan  (incorporated by reference to Exhibit 10.1 to DJOFL’s Quarterly Report  on Form 10-Q for the quarter ended March 28, 2009).                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.4*  |   | Form of  Amendment No. 1 to Nonstatutory Stock Option Agreement (incorporated by  reference to Exhibit 10.2 to DJOFL’s Quarterly Report on Form 10-Q  for the quarter ended March 28, 2009).                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.5*  |   | Form of  DJO Incorporated Directors’ Nonstatutory Stock Option Agreement under 2007  Incentive Stock Plan (incorporated by reference to Exhibit 10.7 to  DJOFL’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2007).                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.6*  |   | Form of  Nonstatutory Stock Option Agreement under 2007 Incentive Stock Plan  (Replacement Version) (incorporated by reference to Exhibit 10.8 to  DJOFL’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2007).                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.7*  |   | Form of  Nonstatutory Stock Option Rollover Agreement under 2007 Incentive Stock Plan  (incorporated by reference to Exhibit 10.9 to DJOFL’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2007).                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.8*  |   | Form of  Incentive Stock Option Rollover Agreement under 2007 Incentive Stock Plan  (incorporated by reference to Exhibit 10.10 to DJOFL’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2007).                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.9   |   | 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)).                            |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.10  |   | 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).                      |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.11  |   | 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)).                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.12  |   | 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).                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.13  |   | 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). |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.14  |   | Equity Commitment  Letter from Blackstone Capital Partners V L.P., dated as of July 15, 2007  (incorporated by reference to Exhibit 10.2 to DJOFL’s Current Report on  Form 8-K, filed on July 20, 2007).                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.15* |   | Transition  Agreement, dated August 14, 2008, and Separation of Employment Agreement  and General Release, dated as of August 31, 2008, between DJO and Peter  Baird (incorporated by reference to Exhibit 10.1 to DJOFL’s Quarterly  Report on Form 10-Q for the quarter ended September 27, 2008).      |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.16  |   | Lease  Agreement between Professional Real Estate Services, Inc. and dj  Orthopedics, LLC (now known as DJO, LLC), dated October 20, 2004 (Vista  facility) (Incorporated by reference to Exhibit 10.1 to DJO Opco’s  Current Report on Form 8-K, filed on October 26, 2004).                             |
|   |   |                                                                                                                                                                                                                                                                                                                                    |
| 10.17  |   | Lease  Agreement, dated February 17, 2006, between MetroAir Partners, LLC, and  dj Orthopedics, LLC (Indianapolis facility) (Incorporated by reference to  Exhibit 10.2 to DJO Opco’s Quarterly Report on Form 10-Q for the  quarter ended April 1, 2006)                                                      |

 

127

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| 10.18  |   | Lease  Agreement, dated June 11, 1996, between Met 94, Ltd. and Encore  Orthopedics, Inc. covering 52,800 sq. ft. facility in Austin, Texas,  together with amendments thereto (Incorporated by reference to  Exhibit 10.27 to DJOFL’s Annual Report on Form 10-K for the fiscal  year ended December 31, 2008).                                                                                                                                                                                                              |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.19  |   | Office/Light  Manufacturing Lease, dated June 14, 2996, between Cardigan Investments  Limited Partnership and EMPI, Inc., covering 93,666 sq. ft. facility in  St. Paul, Minnesota, together with amendments thereto (Incorporated by  reference to Exhibit 10.28 to DJOFL’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2008).                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.20  |   | Lease  Agreement, dated December 10, 2003, between BBVA Bancomer Servicios,  S.A. and DJ Orthopedics de Mexico, S.A. de C.V., covering 200,000 sq. ft.  facility in Tijuana, Mexico (Incorporated by reference to Exhibit 10.29  to DJOFL’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2008).                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.21  |   | Agreement,  dated April 4, 2006, between BBVA Bancomer Servicios, S.A. and DJ  Orthopedics de Mexico, S.A. de C.V., amending Leases covering 200,000 sq.  ft., 58,400 sq. ft. and 27,733 sq. ft. facilities in Tijuana Mexico  (Incorporated by reference to Exhibit 10.30 to DJOFL’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2008).                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.22  |   | Asset Purchase  Agreement, dated June 12, 2009, by and between Patterson Medical  Supply, Inc. and Empi, Inc. (incorporated by reference to  Exhibit 10.1 to DJOFL’s Quarterly Report on Form 10-Q, for the  quarter ended June 27, 2009).                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.23  |   | Amendment  No. 1, dated as of January 13, 2010, to the Credit Agreement dated  as of November 20, 2007, among DJO Finance LLC (f/k/a ReAble  Therapeutics Finance LLC), DJO Holdings LLC (f/k/a/ ReAble Therapeutics  Holdings LLC), Credit Suisse AG (f/k/a/ Credit Suisse), as Administrative  Agent, Collateral Agent, Swing Line Lender and an L/C Issuer and the lenders  from time to party thereto (incorporated by reference to Exhibit 10.1 to  DJOFL’s Current Report on Form 8-K, filed on January 21, 2010). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 12.1+  |   | Computation  of Ratio of Earnings to Fixed Charges                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 21.1+  |   | Subsidiaries  of DJO Finance LLC                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 31.1+  |   | Certification (pursuant to  Securities Exchange Act Rule 13a-14a) by Chief Executive Officer.                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 31.2+  |   | Certification (pursuant to  Securities Exchange Act Rule 13a-14a) by Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 32.1+  |   | Section 1350 —  Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of  2002) by Chief Executive Officer.                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 32.2+  |   | Section 1350 —  Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of  2002) by Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                                                                                                       |

 

----

| * | constitutes management  contract or compensatory arrangement |
|---|--------------------------------------------------------------|
| + | filed herewith                                               |

 

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Table of Contents

 

**DJOFINANCE LLC**

 

**SCHEDULEII—VALUATION AND QUALIFYING ACCOUNTS**

**(inthousands)**

 
| ** **                                | ** ** | **Allowance for  Doubtful  Accounts** | ** ** | **Allowance  for Sales  Returns** | ** ** | **Allowance for  Sales  Discounts and  Other Allowances (1)** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------------------|------------|
| **Balance as of December 31,  2006** |       | 6,686                                      |       | 285                                    |       | 36,636                                                                       |       |
| Provision                                 |       | 22,409                                     |       | 19                                     |       | 99,803                                                                       |       |
| Acquired through business acquisitions    |       | 14,591                                     |       | —                                 |       | 38,706                                                                       |       |
| Write-offs, net of recoveries             |       | (11,472                                    | )          | (101                                   | )          | (123,802                                                                     | )          |
| **Balance as of December 31,  2007** |       | 32,214                                     |       | 203                                    |       | 51,343                                                                       |       |
| Provision                                 |       | 26,022                                     |       | 255                                    |       | 161,492                                                                      |       |
| Write-offs, net of recoveries             |       | (22,082                                    | )          | (91                                    | )          | (147,334                                                                     | )          |
| **Balance as of December 31,  2008** |       | $                                          | 36,154     |                                   | $          | 367                                                                          |       | $ | 65,501 |   |
| Provision                                 |       | 34,793                                     |       | 111                                    |       | 163,616                                                                      |       |
| Write-offs, net of recoveries             |       | (22,951                                    | )          | (168                                   | )          | (155,267                                                                     | )          |
| **Balance as of December 31,  2009** |       | $                                          | 47,996     |                                   | $          | 310                                                                          |       | $ | 73,850 |   |

 

----

(1) Amounts are excluded from theprovisions included in the consolidated statements of cash flows as theinclusion would not provide meaningful information.

 

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Table of Contents

 

**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
| Date:  March 5, 2010 | **DJO  FINANCE LLC** |
|---------------------------|----------------------|
|                      |                 |   |
|                      | By:                  | /s/  Leslie H. Cross |
|                      |                 | Leslie  H. Cross |
| * *                  | * *             | *President,  Chief Executive Officer and Director* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 
| **Signature**             | ** ** | **Title**                                               | ** ** | **Date**            |
|---------------------------|------------|---------------------------------------------------------|------------|---------------------|
| ** **                | ** ** | ** **                                              | ** ** | ** **          |
| /s/ Leslie H. Cross       |       | President,  Chief Executive Officer and Director        |       | March 5,  2010 |
| Leslie H. Cross           |       | (Principal  Executive Officer)                          |       |                |
|                      |       |                                                    |       |                |
| /s/ Vickie L. Capps       |       | Executive  Vice President, Chief Financial Officer and  |       | March 5,  2010 |
| Vickie L. Capps           |       | Treasurer  (Principal Financial and Accounting Officer) |       |                |
|                      |       |                                                    |       |                |
| /s/ Chinh E. Chu          |       | Chairman  of the Board of Directors                     |       | March 5,  2010 |
| Chinh E. Chu              |       |                                                    |       |                |
|                      |       |                                                    |       |                |
| /s/ Julia Kahr            |       | Director                                                |       | March 5,  2010 |
| Julia Kahr                |       |                                                    |       |                |
|                      |       |                                                    |       |                |
| /s/ Sidney Braginsky      |       | Director                                                |       | March 5,  2010 |
| Sidney Braginsky          |       |                                                    |       |                |
|                      |       |                                                    |       |                |
| /s/ Bruce McEvoy          |       | Director                                                |       | March 5,  2010 |
| Bruce McEvoy              |       |                                                    |       |                |
|                      |       |                                                    |       |                |
| /s/ Phillip J. Hildebrand |       | Director                                                |       | March 5,  2010 |
| Phillip J. Hildebrand     |       |                                                    |       |                |
|                      |       |                                                    |       |                |
| /s/ Lesley Howe           |       | Director                                                |       | March 5,  2010 |
| Lesley Howe               |       |                                                    |       |                |
|                      |       |                                                    |       |                |
| /s/ Paul LaViolette       |       | Director                                                |       | March 5,  2010 |
| Paul LaViolette           |       |                                                    |       |                |

 

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