FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 2, 2004

OR

[   ] 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: 0-26538

ENCORE MEDICAL CORPORATION

512-832-9500
(Registrant’s telephone number including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [   ] No [X]

     Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of November 1, 2004

ENCORE MEDICAL CORPORATION
Quarterly Report on Form 10-Q
For the period ended October 2, 2004

TABLE OF CONTENTS

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Part I. Financial Information

Item 1. Financial Statements

Encore Medical Corporation and Subsidiaries
Consolidated Balance Sheets
As of October 2, 2004 and December 31, 2003
(in thousands, except share and per share data)
(unaudited)

See accompanying notes to unaudited consolidated financial statements.

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Encore Medical Corporation and Subsidiaries
Consolidated Statements of Operations
For the three and nine months ended October 2, 2004 and September 27, 2003
(in thousands, except per share data)
(unaudited)

See accompanying notes to unaudited consolidated financial statements.

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Encore Medical Corporation and Subsidiaries
Consolidated Statements of Cash Flows
For the nine months ended October 2, 2004 and September 27, 2003
(in thousands)
(unaudited)

See accompanying notes to unaudited consolidated financial statements.

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Encore Medical Corporation and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Encore Medical Corporation, a Delaware corporation, and its wholly owned subsidiaries (individually and collectively referred to as “us,” “we,” “our company” or “Encore”). All significant intercompany balances and transactions have been eliminated in consolidation. The unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended October 2, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in our Form 10-K dated December 31, 2003. Certain prior year amounts have been reclassified to conform to the current year presentation.

Description of Business

We are a diversified orthopedic device company with leading positions in many of the markets in which we compete. We develop, manufacture and distribute a comprehensive range of high quality orthopedic devices, including surgical implants, sports medicine equipment and products for orthopedic rehabilitation, pain management and physical therapy. Our products are used by orthopedic surgeons, physicians, orthopedic therapists, chiropractors, athletic trainers, and other healthcare professionals to treat patients with musculoskeletal conditions resulting from degenerative diseases, deformities, traumatic events and sports-related injuries. We categorize our products into the following product lines:

•

Surgical Implant Products. Our surgical implant products, including reconstructive joint products, such as knee, hip, shoulder and spinal implants, and trauma products, are used across the major segments of the orthopedic surgical market; and

•

Orthopedic Rehabilitative Products. Our orthopedic rehabilitative products include soft goods products used before and after surgery to assist in the repair and rehabilitation of soft tissue and bone and to protect against injury; electrotherapy devices and accessories used to treat pain and restore and maintain muscle function; clinical therapy tables and traction equipment; and orthotics devices used to treat joint and spine conditions.

Our two divisions enable us to reach a diverse customer base through multiple distribution channels and give us the opportunity to provide a comprehensive range of orthopedic devices and related products to orthopedic specialists operating in a variety of treatment settings.

Our products are subject to regulation by the Food and Drug Administration (“FDA”) with respect to their sale in the United States, and we must, in many cases, obtain FDA authorization to market our products before they can be sold in the United States. Additionally, we are subject to similar regulations in many of the international countries in which we sell products.

2. STOCK-BASED COMPENSATION

We have adopted the disclosure-only provisions of SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosures” (“SFAS 148”) as well as those outlined in SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). As permitted by SFAS 148 and SFAS 123, we continue to apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock issued to Employees” and related interpretations in accounting for our plans. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of our stock at the date of the grant over the amount an employee must pay to acquire the stock. Stock based awards for non-employees are accounted for under the provisions of SFAS 123 and Emerging Issues Task Force Consensus 96-18.

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Had compensation cost for all stock option grants been determined based on their fair value at the grant dates consistent with the method prescribed by SFAS 148 and SFAS 123, our net income (loss) and earnings (loss) per share would have been adjusted to the pro forma amounts indicated below (in thousands):

We estimate the fair value of each option grant on the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used for grants during the first nine months of 2004 and 2003:

3. INVESTMENTS

We invest our excess cash in U.S. treasury securities. These are items with readily determinable fair market values and original maturities in excess of three months but less than twelve months. All investments have been classified as held-to-maturity and are carried at amortized cost, which approximates fair value due to the short period of time to maturity. As of October 2, 2004 and December 31, 2003 we had investments with fair values and amortized costs of approximately $25.1 million and $35.0 million, respectively.

4. INVENTORIES

Our inventories consist of the following (in thousands):

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Our inventory value is stated at the lower of cost or market, with cost being average actual cost. We establish reserves for such issues as slow moving or excess inventory, product obsolescence and valuation impairment. Our inventory reserve policy is primarily based on the products and market practices. Each division determines the amount and timing of write-downs. For all divisions, we utilize a specific identification methodology (product rationalization), which can occur whenever there is a change in strategy. In addition, we review our sales performance on at least a quarterly basis to determine the amounts that should be adjusted to the existing reserve. We dispose of the reserved inventory items primarily by scrapping or donating them to charitable organizations.

5. INTANGIBLE ASSETS

Our intangible assets consisted of the following (in thousands) as of October 2, 2004:

Our intangible assets consisted of the following (in thousands) as of December 31, 2003:

During the nine months ended October 2, 2004, we acquired $709,000 of technology based intangible assets. Amortization expense for the nine months ended October 2, 2004 and September 27, 2003 was $555,000 and $747,000, respectively.

Our estimated amortization expense for the three months ended December 31, 2004 and the next five years is as follows (in thousands):

Our amortizable assets will continue to be amortized over their remaining useful lives ranging from 1 to 38 years, absent future impairment or change in estimates of future utility.

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6. LONG-TERM DEBT

Our long-term debt (including capital lease obligations) consisted of the following (in thousands):

On October 4, 2004, all amounts outstanding under our $25,000,000 credit facility and the $24,000,000 senior subordinated notes payable were paid in full and these debt agreements were terminated. These agreements contained warranties and covenants and required maintenance of certain financial ratios. As of October 4, 2004, we were in compliance with all debt covenants and warranties. See Note 10 for additional information concerning new long-term debt into which we entered on October 4, 2004, in connection with our acquisition of Empi, Inc.

On March 1, 2004, we acquired an exclusive license to manufacture and sell products incorporating a patented implant design and mechanism for a total purchase price of $709,000. In connection with this acquisition, we issued a $250,000 note to the holders of the patents. Payments under this note are due in quarterly installments equal to 6% of our net sales of products utilizing this technology. The interest rate under this note will be adjusted annually to equal the New York prime rate. All unpaid principal and interest under this note shall be due March 1, 2009.

7. EARNINGS PER SHARE

The reconciliation of the denominators we used to calculate the basic and diluted earnings per share for the periods ended October 2, 2004 and September 27, 2003, respectively, are as follows (in thousands):

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We have excluded certain stock options and warrants from the calculation of diluted earnings per share because their exercise price was greater than the average market price of the common shares. The total number of common stock equivalents excluded (because to include them would be anti-dilutive) from the calculations of diluted earnings per common share was 1,171,317 for the quarter ended October 2, 2004 and 10,142,833 for the quarter ended September 27, 2003. The total number of common stock equivalents excluded from the calculations of diluted earnings per common share was 915,500 for the first nine months of 2004 and 14,422,002 for the first nine months of 2003.

8. SEGMENT INFORMATION

We have two reportable segments as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). Our reportable segments are business units that offer different products that are managed separately because each business requires different manufacturing and marketing strategies. Our Surgical Implant Division sells reconstructive joint products including knee, hip, shoulder and spinal implants and trauma products. The Orthopedic Rehabilitation Division sells electrotherapy devices and accessories, clinical therapy tables and traction equipment, soft goods products, and orthotics devices.

Information regarding business segments is as follows (in thousands):