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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 26, 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)

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

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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

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

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

As of October 29, 2009, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

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DJO FINANCE LLC

FORM 10-Q

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DJO Finance LLC

Unaudited Condensed Consolidated Balance Sheets

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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DJO Finance LLC

Unaudited Condensed Consolidated Statements of Operations

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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DJO Finance LLC

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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DJO Finance LLC

Notes to Unaudited Condensed Consolidated Financial Statements

1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES

Basis of Presentation and Principles of Consolidation.  We are a global provider of high-quality, orthopedic devices, with a broad range of products used for rehabilitation, pain management and physical therapy. We also develop, manufacture and distribute a broad range of surgical reconstructive implant products. We offer healthcare professionals and patients a diverse range of orthopedic rehabilitation products addressing the complete spectrum of preventative, pre-operative, post-operative, clinical and home rehabilitation care. Our products are used by orthopedic specialists, spine surgeons, primary care physicians, pain management specialists, physical therapists, podiatrists, chiropractors, athletic trainers and other healthcare professionals to treat patients with musculoskeletal conditions resulting from degenerative diseases, deformities, traumatic events and sports-related injuries. In addition, many of our non-surgical medical devices and related accessories are used by athletes and patients for injury prevention and at-home physical therapy treatment.

In the first quarter of 2009, we changed how we report our segmented financial information in accordance with the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 280-10-50 (formerly Financial Accounting Standards Statement (“SFAS”) No.131, “Disclosures about Segments of an Enterprise and Related Information”).  Prior to 2009, we included the international components of the Surgical, Chattanooga, and Empi businesses in either the Surgical or Domestic Rehabilitation segments, as their operations were managed domestically.  During the fourth quarter of 2008, we effected an operational reorganization which resulted in the non-U.S. components of all of our businesses being managed abroad.  Our restated segment information now reflects the international components of all of our businesses within our International segment.

We market and distribute our products through three operating segments, Domestic Rehabilitation, International, and Domestic Surgical Implant. Our Domestic Rehabilitation Segment offers to customers in the United States, non-invasive medical products that are used before and after surgery to assist in the repair and rehabilitation of soft tissue and bone, and to protect against further injury; electrotherapy devices and accessories used to treat pain and restore muscle function; iontophoretic devices and accessories used to deliver medication; clinical therapy tables, traction equipment and other clinical therapy equipment; orthotic devices used to treat joint and spine conditions; orthopedic soft goods; rigid knee braces; and vascular systems which include products intended to prevent deep vein thrombosis following surgery. Our Domestic Surgical Implant Segment offers a comprehensive suite of reconstructive joint products to customers in the United States.  Our International segment offers all of our products to customers outside the United States.

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

Noncontrolling interests reflect the 50% separate ownership of Medireha GmbH (“Medireha”) not owned by us, which we have consolidated due to our controlling interest. Our controlling interest consists of our 50% ownership and our control of one of the two director seats, our rights to prohibit certain business activities that are not consistent with our plans for the business and our exclusive distribution rights for products manufactured by Medireha. All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements as of September 26, 2009 and for the three and nine months ended September 26, 2009 and September 27, 2008 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. The accompanying unaudited condensed consolidated financial statements as of September 26, 2009 and for the three and nine months ended September 26, 2009 and September 27, 2008 have been prepared on the same basis as the audited consolidated financial statements and include all adjustments consisting of normal recurring accruals which, in the opinion of management, are necessary for a fair presentation of the financial position, operating results and cash flows for the interim date and interim periods presented. Results for the interim periods are not necessarily indicative of the results to be achieved for the entire year or future periods.  At October 29, 2009, there are no material subsequent events requiring additional disclosure in, or amendment to, our financial statements.

Use of Estimates.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of

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revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates, 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. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

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

Computer Software Costs.  Software is stated at cost less accumulated amortization and is amortized using the straight-line method over its estimated useful life ranging from three to seven years.  In accordance with ASC 350-40-25 (formerly American Institute of Certified Public Accountants Statement of Position (“SOP”) 98-1, “Accounting for  the Costs of Computer software Developed or Obtained for Internal Use”), we capitalize costs of internally developed software during the development stage.  Additionally, we capitalize related costs including external consulting costs, cost of software licenses, and internal payroll and payroll-related costs for employees who are directly associated with a software project.  Software assets are reviewed for impairment when events or circumstances indicate that the carrying value may not be recoverable over the remaining lives of the assets. Upgrades and enhancements are capitalized if they result in added functionality.  Recently we began implementing a new ERP system resulting in approximately $7.8 million of capitalized software costs as of September 26, 2009.

Derivative Financial Instruments.  We account for derivatives pursuant to ASC 815-20 (formerly SFAS No. 133, “Accounting for Derivative Instruments and Hedging”), which requires that all derivative instruments be recognized in the financial statements and measured at fair value regardless of the purpose or intent for holding them.

Foreign Exchange Forward Contracts

We use foreign exchange forward contracts to hedge expense commitments that are denominated in currencies other than the U.S. dollar. The purpose of our foreign currency hedging activities is to fix the dollar value of specific commitments and payments to foreign vendors. Before acquiring a derivative instrument to hedge a specific risk, potential natural hedges are evaluated.  While our foreign exchange contracts act as economic hedges, we have not designated such instruments as hedges under ASC 815-30 (formerly SFAS No. 133, “Accounting for Derivative Instruments and Hedging”).  We account for our foreign forward contracts in accordance with ASC 815-20-25 (formerly SFAS No. 157, “Fair Value Measurement”).  The classification of gains and losses resulting from changes in the fair values of derivatives is dependent on the intended use of the derivative and its resulting designation. The change in fair value of the ineffective portion of a hedge, and changes in the fair values of the derivative are recorded in other comprehensive income and are subsequently recognized in earnings when the hedged item affects earnings.   At September 26, 2009, the fair value of our foreign exchange forward contracts was a gain of $11.4 million and was determined 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 valuation hierarchy.

Interest Rate Swap Agreements

We make use of debt financing as a source of funds and are therefore exposed to interest rate fluctuations in the normal course of business. Our credit facilities are subject to floating interest rates. We manage the risk of unfavorable movements in interest rates by hedging a portion of the outstanding loan balance, thereby locking in a fixed rate on a portion of the principal, reducing the effect of possible rising interest rates and making interest expense more predictable.  We have designated these interest rate swap agreements as cash flow hedges and account for our interest rate swap agreements in accordance with ASC 815-20.  At September 26, 2009, the fair value of our interest rate swap agreements was a loss of $18.6 million and was determined 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 valuation hierarchy.

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

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Comprehensive loss consists of the following for the three and nine months ended September 26, 2009 (in thousands):

Comprehensive loss consists of the following for the three and nine months ended September 27, 2008 (in thousands):

Reclassifications.  The condensed consolidated financial statements and accompanying footnotes reflect certain reclassifications to prior year consolidated financial statements to conform to the current year presentation.

Discontinued Operations.  In determining whether a group of assets disposed of (or to be disposed of) should be presented as a discontinued operation, we make a determination of whether the group of assets being disposed of comprises a component of the entity; that is, whether it has historic operations and cash flows that can be clearly distinguished (both operationally and for financial reporting purposes). We also determine whether the cash flows associated with the group of assets have been significantly (or will be significantly) eliminated from our ongoing operations as a result of the disposal transaction and whether we have no significant continuing involvement in the operations of the group of assets after the disposal transaction. If these determinations can be made affirmatively, the results of operations of the group of assets being disposed of (as well as any gain or loss on the disposal transaction) are aggregated for separate presentation apart from our continuing operating results in our condensed consolidated financial statements. See Note 3 for a summary of discontinued operations.

Recent Accounting Pronouncements.  As of September 2009, we have adopted ASC 105-10 (formerly SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles”), which makes the Codification the source of authoritative US Generally Accepted Accounting Principles recognized by the FASB and applied to non-governmental entities. ASC 105-10 does not change previously issued Accounting Standards, but reorganizes the Accounting Standards into Topics. In circumstances where previous Accounting Standards require a revision, FASB will issue an Accounting Standards Update (“ASU”) on the Topic.

In September 2009, the FASB issued ASU 2009-13, which amends ASC 605-25 (formerly EITF Issue No. 08-1, “Revenue Arrangements with Multiple Deliverables.”). ASU 2009-13 provides guidance concerning (1) the determination of whether an arrangement involving multiple deliverables contains more than one unit of accounting, and (2) the manner in which consideration should be measured and allocated to the separate units of accounting in the multiple-element arrangement and is effective for fiscal years beginning on or after June 15, 2010. We are currently evaluating the impact, if any, this issue will have on its consolidated financial statements. However, we do not expect that this issue will result in a change in current practice.

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46 (R)” (“SFAS 167”) which amends certain requirements of FASB Interpretation No. 46, “Consolidation of Variable Interest entities” (“FIN 46”), including the addition of entities previously considered qualifying special-purpose entities.  As of September 26, 2009, this statement has not been transitioned into the ASC Codification, but is effective for fiscal years beginning after November 15, 2009.  We will adopt this statement as of the beginning of 2010 and are currently assessing the potential impact of adoption.

In June 2009, the FASB issued SFAS No. 166, “Accounting for the Transfers of Financial Assets as amendment of FASB Statement No. 140” (“SFAS 166”) which amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets” (“SFAS 140”).  SFAS 166 makes the following amendments to SFAS 140: 1) removes concept of qualifying special-purpose entities from SFAS 140; 2) modifies the financial components approach used and limits the circumstances in which a transferor has not transferred the original financial asset to an entity that is not consolidated with the transferor in the financial statements; 3) establishes conditions for reporting a transfer of a portion of a financial asset as a sale; 4) redefines a participating interest; 5) clarifies that an entity must consider all arrangements or agreements made contemporaneously with, or in contemplation of, a transfer, even if not entered into at the time of the transfer; 6) clarifies that the transferor must evaluate whether it, its consolidated affiliates included in the financial statements being presented, or its agency effectively control the transferred financial asset directly or indirectly; 7) requires that the transferor recognize and initially measure at fair value all assets obtained and liabilities incurred as a result of the a transfer of an entire asset or group of financial assets accounted for as a sale; 8) removes special provisions for guaranteed mortgage securitizations to require them to be treated that same as any other transfer of financial assets; 9) Removes fair value practicability

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exception from measuring the proceeds received by a transferor in a transfer that meet the conditions for sale accounting at fair value; and 10) requires enhanced disclosures.  As of September 26, 2009, this statement has not been transitioned into the ASC Codification, but is effective for fiscal years beginning after November 15, 2009.  We will adopt this statement as of the beginning of 2010 and are currently assessing the potential impact of adoption.

In May 2009, the FASB issued, and we adopted, ASC 855-10 (formerly SFAS No. 165, “Subsequent Events”), which requires entities to disclose certain events that occur after the balance sheet date but before the financial statements are issued.  In addition, ASC 855-10 requires entities to disclose the date through which the entity evaluated subsequent events and the basis for such date.

As of January 1, 2009, we adopted ASC 815-10-65 (formerly SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities”), which requires entities to disclose the fair values of derivative instruments and their gains and losses in a tabular format and to provide enhanced disclosures about (a) how and why they use derivative instruments, (b) how derivative instruments and related hedged items are accounted for under ASC 815-20 and its related interpretations, and (c) how derivative instruments and related hedged items affect their financial performance, and cash flows.  Except for adding the required disclosures (see Note 15) the adoption of ASC 815-10-65 had no impact on our consolidated financial statements.

We have adopted ASC 810-10 (formerly SFAS No. 160, “Non-controlling Interests 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 reporting standards for the noncontrolling interest in a subsidiary.  This standard defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent.  ASC 810-10 requires, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value.  We have applied the presentation and disclosure requirements of ASC 810-10 retrospectively.

We have adopted ASC 805-10 (formerly SFAS No. 141R, “Business Combinations”) as of January 1, 2009, which requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination (see Note 2).

2. ACQUISITIONS

We account for acquisitions in accordance with ASC 805-10, with the results of operations attributable to each acquisition included in the condensed consolidated financial statements from the date of acquisition.

Acquisition of Chattanooga Group Inc.

On August 4, 2009 we acquired Chattanooga Group Inc., a Canadian distributor of certain of our products (“Chattanooga Canada”), for $7.2 million.  Our primary reason for the acquisition of Chattanooga Canada was to move from an indirect sales model (i.e., sales to distributors at a discount) to a direct sales model, resulting in increased gross profit and operating income.  Pursuant to the terms 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 provides security for potential indemnification claims and, if not used for such, indemnification claims will be paid to the sellers.  The holdback also provides for the accrual of interest at an annual rate of 2.5% for the first 18 months and a variable rate thereafter.  Fifty percent of the holdback with interest is due in January 2011 and the remainder of the balance with interest is due in three years, upon expiration of the tax statute of limitations period.  The note provides for the accrual of interest at an annual rate of 6% with the principal and interest due in August 2010.

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The fair values of the assets acquired and the liabilities assumed were estimated in accordance with ASC 805-10.  The purchase price was allocated as follows to the fair values of the net tangible and intangible asset acquired:

The purchase price allocation of the Chattanooga Canada acquisition included approximately $5.0 million assigned to intangible assets related to certain customer relationships existing on the acquisition date and $0.3 million assigned to intangible assets related to a 5-year noncompetition agreement with the seller. The value of the customer relationships was based upon an estimate of the future discounted cash flows that would be derived from sales to those customers.  The value of the noncompetition agreement was based on an estimate of the future discounted cash flows that compares scenarios with and without the noncompetition agreement in place.

Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired and liabilities assumed. For the Chattanooga Canada acquisition, a value of approximately $3.4 million, representing the difference between the total purchase price and the aggregate fair value assigned to the net tangible assets acquired and the liabilities assumed and the identifiable intangible assets acquired, was assigned to goodwill. The remainder of the goodwill balance is related to estimated synergies in the purchase price. As a result of the acquisition, we anticipate cost savings driven by operating efficiencies.

Acquisition of Empi Canada Inc.

On August 4, 2009 we acquired Empi Canada Inc., a Canadian distributor of certain of our products (“Empi Canada”), for $7.4 million.  Our primary reason for the acquisition of Empi Canada was to move from an indirect sales model (i.e., sales to distributors at a discount) to a direct sales model, resulting in increased gross profit and operating income.  Pursuant to the terms 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 provides security for potential indemnification claims and, if not used for such, indemnification claims will be paid to the sellers.  The holdback also provides for the accrual of interest at an annual rate of 2.5% for the first 18 months and a variable rate thereafter.  Fifty percent of the holdback with interest is due in January 2011 and the remainder of the balance with interest is due in three years, upon expiration of the tax statute of limitations period.  The note provides for the accrual of interest at an annual rate of 6% with the principal and interest due in August 2010.

The fair values of the assets acquired and the liabilities assumed were estimated in accordance with ASC 805-10.  The purchase price was allocated as follows to the fair values of the net tangible and intangible asset acquired:

The purchase price allocation of the Empi Canada acquisition included approximately $2.5 million assigned to intangible assets related to certain customer relationships existing on the acquisition date and $0.2 million assigned to intangible assets related to a 5-year noncompetition agreement with the seller.  This value of the customer relationships was based upon an estimate of the future discounted cash flows that would be derived from sales to those customers.  The value of the noncompetition agreement was based on an estimate of the future discounted cash flows that compares scenarios with and without the noncompetition agreement in place.

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Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired and liabilities assumed. For the Empi Canada acquisition, a value of approximately $4.9 million, representing the difference between the total purchase price and the aggregate fair value assigned to the net tangible assets acquired and the liabilities assumed and the identifiable intangible assets acquired, was assigned to goodwill. The remainder of the goodwill balance is related to estimated synergies in the purchase price. As a result of the acquisition, we anticipate cost savings driven by operating efficiencies.

Acquisition of DonJoy Orthopaedics Pty., Ltd.

On February 3, 2009 we acquired DonJoy Orthopaedics Pty., Ltd. an Australian distributor of certain of our products (“DJO Australia”), for $3.7 million.  Our primary reason for the acquisition of DJO Australia was to move from an indirect sales model (i.e., sales to distributors at a discount) to a direct sales model, resulting in increased gross profit and operating income.  Pursuant to the terms of the acquisition agreement and included within the purchase price at fair value, is an additional amount of up to $0.5 million payable to the selling shareholder of DJO Australia if certain revenue targets are met by December 31, 2009.

The fair values of the assets acquired and the liabilities assumed were estimated in accordance with ASC 805-10.  The purchase price was allocated as follows to the fair values of the net tangible and intangible asset acquired:

The purchase price allocation of the DJO Australia acquisition included approximately $1.6 million assigned to intangible assets related to certain customer relationships existing on the acquisition date. This value was based upon an estimate of the future discounted cash flows that would be derived from those customers.

Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired and liabilities assumed. For the DJO Australia acquisition, a value of approximately $0.9 million, representing the difference between the total purchase price and the aggregate fair value assigned to the net tangible assets acquired and the liabilities assumed and the identifiable intangible assets acquired, was assigned to goodwill.

3. DISCONTINUED OPERATIONS

On June 12, 2009 we sold our Empi Therapy Solutions (“ETS”) catalog business, formerly known as Rehab Medical Equipment, or RME, to Patterson Medical Supply, Inc. for approximately $21.0 million plus an additional payment related to the retention by DJO of certain outstanding liabilities.  Our ETS business, which was included within our Domestic Rehabilitation Segment, sold a wide range of proprietary and third party rehabilitation products to physical therapists and chiropractors through printed catalog and an on-line e-commerce site.  Financial data for the three and nine months ended September 26, 2009 and September 27, 2008 related to discontinued operations includes the following (in thousands):

Included within discontinued operations for the three and nine months ended September 26, 2009 is a pre-tax gain on disposal of discontinued operations of $6.5 million. The effective tax rate of the discontinued operations for the nine months ended September 26, 2009 is 107%, and differs from the amount which would have been recorded using the US statutory tax rate due primarily to a large difference in the book and tax basis of goodwill.

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4. ACCOUNTS RECEIVABLE RESERVES

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

5. INVENTORIES

Inventories consist of the following (in thousands):

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

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

6. GOODWILL AND INTANGIBLE ASSETS

A summary of adjustments to our goodwill balance for the nine months ended September 26, 2009 is as follows (in thousands):

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Identifiable intangible assets consisted of the following as of September 26, 2009 (in thousands):

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

Our amortizable intangible assets are being amortized over the estimated useful lives of 10 and nine years on a weighted average basis for technology-based and customer-based intangible assets, respectively.

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

7. OTHER CURRENT LIABILITIES

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

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8. LONG-TERM DEBT AND CAPITAL LEASES

Long-term debt (including capital lease obligations) consists of the following (in thousands):

Senior Secured Credit Facility

On November 20, 2007, we entered into the Senior Secured Credit Facility which consists of a $1,065.0 million term loan facility maturing May 2014 and a $100.0 million revolving credit facility maturing November 2013. We issued the term loan facility at a 1.2% discount, resulting in net proceeds of $1,052.4 million. The original $12.6 million discount is being amortized as additional interest expense over the term of the term loan facility and increases the reported outstanding balance accordingly. The market value of our term loan facility was approximately $1,001.8 million as of September 26, 2009 and was determined using trading prices for our term loan on or near that date. As of September 26, 2009, no amounts were drawn related to our revolving credit facility.

Interest Rate and Fees.  Borrowings under the Senior Secured Credit Facility bear interest at a rate equal to an applicable margin plus, at our option, either (a) a base rate determined by reference to the higher of (1) the prime rate of Credit Suisse and (2) the federal funds rate plus 0.50% or (b) the Eurodollar rate determined by reference to the costs of funds for deposits in U.S. dollars for the interest period relevant to each borrowing adjusted for required reserves. The initial applicable margin for borrowings under the term loan facility and the revolving credit facility is 2.00% with respect to base rate borrowings and 3.00% with respect to Eurodollar borrowings. The applicable margin for borrowings under the term loan facility and the revolving credit facility may be reduced subject to us attaining certain leverage ratios.

We use interest rate swap agreements in an effort to hedge our exposure to fluctuating interest rates related to a portion of our Senior Secured Credit Facility (See note 15).  On November 20, 2007, we entered into an interest rate swap agreement for a notional amount of $515.0 million at a fixed LIBOR rate of 4.205%. This swap agreement amortizes through December 2009. As of September 26, 2009, the remaining notional amount of the swap was $435.0 million. In February 2009, we entered into two additional non-amortizing interest rate swap agreements. The first is for a notional amount of $550.0 million at a fixed LIBOR rate of 1.04% beginning February 2009 through December 2009 (with a notional amount of $550.0 million as of September 26, 2009). The second is for a notional amount of $750.0 million at a fixed LIBOR rate of 1.88% beginning January 2010 through December 2010.  In August 2009, we entered into four new non-amortizing interest swap agreements with notional amounts aggregating $300.0 million.  Each of 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%.   As of September 26, 2009, our weighted average interest rate for all borrowings under the Senior Secured Credit Facility was 5.3%.

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

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

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Prepayments.  The Senior Secured Credit Facility requires us to prepay outstanding term loans, subject to certain exceptions, with (1) 50% (which percentage can be reduced to 25% or 0% upon our attaining certain leverage ratios) of our annual excess cash flow, as defined; (2) 100% of the net cash proceeds above an annual amount of $25.0 million from non-ordinary course asset sales (including insurance and condemnation proceeds) by DJO Finance LLC (“DJOFL”) and its restricted subsidiaries, subject to certain exceptions to be agreed upon, including a 100% reinvestment right if reinvested or committed to reinvest within 15 months of such sale or disposition so long as reinvestment is completed within 180 days thereafter; and (3) 100% of the net cash proceeds from issuances or incurrences of debt by DJOFL and its restricted subsidiaries, other than proceeds from debt permitted to be incurred under the Senior Secured Credit Agreement. The foregoing mandatory prepayments will be applied to the term loan facilities in direct order of maturity.  We have not been required to make any mandatory pre-payments through September 26, 2009.  We may voluntarily prepay outstanding loans under the Senior Secured Credit Facility at any time without premium or penalty, provided that voluntary prepayments of Eurodollar loans made on a date other than the last day of an interest period applicable thereto shall be subject to customary breakage costs.

Guarantee and Security.  All obligations under the Senior Secured Credit Facility are unconditionally guaranteed by DJO Holdings LLC (“Holdings”) and each existing and future direct and indirect wholly-owned domestic subsidiary of DJOFL other than immaterial subsidiaries, unrestricted subsidiaries and subsidiaries that are precluded by law or regulation from guaranteeing the obligations (collectively, the “Guarantors”).

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

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

·                  incur additional indebtedness;

·                  create liens on assets;

·                  change fiscal years;

·                  enter into sale and leaseback transactions;

·                  engage in mergers or consolidations;

·                  sell assets;

·                  pay dividends and other restricted payments;

·                  make investments, loans or advances;

·                  repay subordinated indebtedness;

·                  make certain acquisitions;

·                  engage in certain transactions with affiliates;

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

·                  amend material agreements governing our subordinated indebtedness; and

·                  change our lines of business.

In addition, the Senior Secured Credit Facility requires us to maintain a maximum senior secured leverage ratio of 4.50:1 as of the twelve months ended September 26, 2009, stepping down over time to 3.25:1 by the end of 2011. The Senior Secured Credit Facility also contains certain customary affirmative covenants and events of default. Our maximum senior secured leverage ratio was within the covenant level as of September 26, 2009.

10.875% Senior Notes Payable

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

The 10.875% Notes require semi-annual interest payments of approximately $31.3 million each May 15 and November 15 and are due November 15, 2014. The market value of the 10.875% Notes was approximately $582.2 million as of September 26, 2009 and was determined using trading prices for the 10.875% Notes on or near that date. We believe the trading prices reflect certain differences between prevailing market terms and conditions and the actual terms of our 10.875% Notes.

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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% Notes for cash at a redemption price equal to 100% of the then outstanding principal balance plus an applicable make-whole premium plus accrued and unpaid interest. Beginning on November 15, 2011, the Issuers may redeem some or all of the 10.875% Notes at a redemption price of 105.438% of the then outstanding principal balance plus accrued and unpaid interest. The redemption price decreases to 102.719% and 100% of the then outstanding principal balance at November 2012 and 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 redemption price 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, in certain offerings of equity of DJOFL or its direct or indirect parent companies, as long as at least 65% of the aggregate principal amount of the notes issued remains outstanding.

Change of Control.  Upon the occurrence of a change of control, unless DJOFL has previously sent or concurrently sends a notice exercising its optional 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 the then-outstanding 10.875% Notes at 101% of their principal amount, plus accrued and unpaid interest.

Covenants.  The 10.875% Indenture contains covenants limiting, among other things, our and our restricted subsidiaries’ ability to incur additional indebtedness or issue certain preferred and convertible shares, pay dividends on, redeem, repurchase or make distributions in respect of the capital stock of DJO or make other restricted payments, make certain investments, sell certain assets, create liens on certain assets to secure debt, consolidate, merge, sell or otherwise dispose of all or substantially all of our assets, enter into certain transactions with affiliates, and designate our subsidiaries as unrestricted subsidiaries. As of September 26, 2009, we were in compliance with all applicable covenants.

11.75% Senior Subordinated Notes Payable

The Issuers issued $200.0 million aggregate principal amount of 11.75% senior subordinated notes in November 2006 (the “11.75% Notes”). The 11.75% Notes require semi-annual interest payments of approximately $11.0 million each May 15 and November 15 and are due November 15, 2014.

The market value of the 11.75% Notes was approximately $185.0 million as of September 26, 2009 and was determined using trading prices for the 11.75% Notes on or near that date. We believe the trading prices reflect certain differences between prevailing market terms and conditions and the actual terms of our 11.75% Notes.

The 11.75% Notes contain similar provisions as the 10.875% Notes with respect to change of control and covenant requirements. Under the Indenture governing 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 for cash at a redemption price equal to 100% of the then outstanding principal balance plus an applicable make-whole premium plus accrued and unpaid interest. Beginning on November 15, 2010, the Issuers may redeem some or all of the 11.75% Notes at a redemption price of 105.875% of the then outstanding principal balance plus accrued and unpaid interest on the 11.75% Notes. The redemption price decreases to 102.938% and 100% of the then outstanding principal balance at November 2011 and November 2012, respectively. Additionally, from time to time, before November 15, 2009, the Issuers may redeem up to 35% of the 11.75% Notes at a redemption price equal to 111.75% of the principal amount then outstanding, in each case, with proceeds we raise, or a direct or indirect parent company raises, in certain offerings of equity of DJOFL or its direct or indirect parent companies, as long as at least 65% of the aggregate principal amount of the notes issued remains outstanding.

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

Debt Issue Costs

We incurred $30.7 million, $24.5 million, and $10.2 million of debt issue costs in connection with the Senior Secured Credit Facility, the 10.875% Notes, and the 11.75% Notes, respectively. These costs have been capitalized and are included in other non-current assets in the condensed consolidated balance sheets at September 26, 2009 and December 31, 2008. Debt issue costs are being amortized over the terms of the respective debt instruments through November 2014.

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9. STOCK OPTION PLANS AND STOCK-BASED COMPENSATION

2007 Stock Incentive Plan

We have one active equity plan, the DJO Incorporated 2007 Incentive Stock Plan (the “2007 Plan”), which is authorized to grant options up to 7,500,000 shares, subject to adjustment in certain events. Options issued under the 2007 Plan can be either incentive stock options or non-qualified stock options. The exercise price of stock options granted will not be less than 100% of the fair market value of the underlying shares on the date of grant, and will expire no more than ten years from the date of grant. In addition, we adopted a form of non-statutory stock option agreement (the “DJO Form Option Agreement”) for employee stock option awards under the 2007 Plan. Under the DJO Form Option Agreement, one-third of stock options will vest over a specified period of time (typically five years) contingent solely upon the awardees’ continued employment with us (“Time-Based Tranche”). Another one-third of stock options will vest over a specified performance period (typically four to five years) from the date of grant upon the achievement of certain pre-determined performance targets based on Adjusted EBITDA and free cash flow on an annual basis (“Performance-Based Tranche”), as defined in the DJO Form Option Agreement.  The final one-third of stock options was originally determined to vest based upon achieving enhanced pre-determined performance targets based on Adjusted EBITDA and free cash flow (“Enhanced Performance-Based Tranche”), but has been modified as described herein. The DJO Form Option Agreement includes certain forfeiture provisions upon an awardees’ separation from service with us.

During March 2009, we made modifications to the terms of the outstanding options and the 2007 Plan. The Time-Based Tranche terms remain the same as discussed above. The performance conditions for the portion of the options within the Performance-Based Tranche that vest based on 2009 financial performance were modified to require achievement of the levels of Adjusted EBITDA and free cash flow that were established in connection with our 2009 budget process. As with the original terms of such options, the optionees may earn 80% or more of such portion of options upon achievement of at least a minimum threshold amount of the budgeted Adjusted EBITDA and of the free cash flow targets for 2009. The financial targets for the Performance-Based Tranches for the years 2010-2012 remain unchanged and we added financial targets for 2013-2015. The vesting provisions of the Performance-Based Tranche were modified to provide that upon achievement of the annual target for a given year, the annual portion of the tranche associated with all prior years will also vest to the extent not previously vested. The financial performance targets for the entire Enhanced Performance-Based Tranche were replaced by targets with different financial metrics. These new targets require achievement of a minimum internal rate of return (“IRR”) and multiple of invested capital (“MOIC”), each measured with respect to Blackstone’s aggregate investment in our capital stock, to be achieved by Blackstone following a liquidation of all or a portion of its investment in our capital stock. As a result of this modification, the Enhanced Performance-Based Tranche has both a performance component and a market condition component.

Options granted under the 2007 Plan contain change-in-control provisions that cause the vesting of a portion of the tranches upon the occurrence of a change-in-control, as follows: 1) the option shares in the Time-Based Tranche will become immediately exercisable upon the occurrence of a change-in-control if the optionee remains in continuous employment of the Company until the consummation of the change-in-control and 2) the option shares of the Performance-Based Tranche for the year in which such change-in-control is consummated and for any subsequent performance periods will become immediately exercisable if the optionee remains in continuous employment of the Company until the consummation of the change-in-control. This provision does not operate to vest the Enhanced Performance-Based Tranche which requires the achievement of the IRR and MOIC targets by Blackstone on its equity investment in us.

Employee Stock Options

During the nine months ended September 26, 2009 we granted 708,932 stock options under the 2007 Plan to our executive officers, senior management, and certain other employees.

For the three and nine months ended September 26, 2009, we recorded non-cash compensation expense of approximately $0.9 million and $2.2 million, respectively, associated with stock options issued under the 2007 Plan.  During the first half of 2008, the achievement of 2008 targets was deemed probable and we recorded non-cash compensation expense of approximately $0.4 million. At September 27, 2008, the Company reassessed the probability of achieving 2008 targets and determined that achievement of such targets was no longer probable.  As such, for the three months ended September 27, 2008, we recorded a net reversal of non-cash compensation expense of approximately $22,000.  For the nine months ended September 27, 2008, we recorded non-cash compensation expense of approximately $1.2 million associated with stock options under the 2007 Plan.

The fair value of each option award is estimated on the date of grant, or modification, using the Black-Scholes-Merton option pricing model for service and performance based awards, and a binomial model for market based awards. In estimating fair value for new options issued under the 2007 Plan, expected volatility was based completely on historical volatility of comparable publicly-traded companies. As our historical share option exercise experience does not provide a reasonable basis upon which to estimate the

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expected term, we used the simplified approach to calculate the expected term. Expected life is calculated in two tranches based on the employment level defined as executive or employee. The risk-free rate used in calculating fair value of service and performance-based stock options for periods within the expected term of the option is based on the U.S. Treasury yield bond curve in effect at the time of grant.

We record expense for awards with a performance condition only to the extent deemed probable of achievement, with the exception of market-based options previously modified during the first quarter of 2008 and reallocated to the Time-Based and Performance-Based Tranches.  The expense related to the previously modified options is recognized ratably over the expected term of the stock options using the original grant-date fair value regardless of the probability of achieving the performance conditions.  We are required to reassess at each reporting period whether the achievement of any performance condition is probable, at which time we would recognize the related compensation expense over the remaining performance or service period, if any. During 2008 we did not recognize compensation expense associated with our Performance-Based Tranche as the performance targets under the original grant were not achieved.  As a result of the modification of the 2009 targets and our actual results for the nine months ended September 26, 2009, we now believe that it is probable that we will achieve the 2009 performance targets.  As such, for the nine months ended September 26, 2009, we recognized compensation expense for the modified options and the annual portion of the tranche associated with the 2008 options that were not previously vested.  To date, no amount has been recorded for the Enhanced Performance-Based Tranche, as achievement of the performance component is not deemed probable at this time.

As a result of the 2009 modification, we will no longer use the original grant date fair value to measure compensation cost and have re-assessed the assumptions used to determine the fair value of options at the date of modification and at subsequent grant dates. The following table presents the assumptions we used in calculating the fair value of employee stock options for the nine months ended September 26, 2009 and September 27, 2008:

Non-Employee Stock Options

During the nine months ended September 26, 2009 we granted 24,800 stock options under the 2007 Plan to non-employees (“non-employee options”). The non-statutory stock option agreement for the non-employees states that the options have an exercise price of $16.46 per share, which was equal to 100% of the estimated fair market value of the stock and will become effective upon the defined effective date and expire ten years from that date. A number of shares equal to 25% of the options granted become vested and exercisable at the end of each of the first four years subsequent to the effective date, provided the optionee is still affiliated with and providing services to the Company. The non-employee option agreement does not include any performance requirements on the optionee’s part in order to vest in the options granted.  Non-employee options are accounted for in accordance with ASC 505-50 (formerly Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Counjunction with Selling Goods or Services”) which states that the fair value of each option will be re-measured at the end of each reporting period until vested, when the final fair value of the vesting of the option is determined.

10. SEGMENT AND GEOGRAPHIC INFORMATION

We provide 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 how we report financial information to the Chief Operating Decision Maker.  Prior to 2009, we included the international components of the Surgical, Chattanooga, and Empi businesses in either the Surgical or Domestic Rehabilitation segments, as their operations were managed domestically.  During the fourth quarter of 2008, we effected an operational reorganization which resulted in the non-U.S. components of all of our businesses being managed abroad.  As a result, the segment financial data for the three and nine months ended September 26, 2009 reflects this new segmentation and the data for the three and nine months ended September 27, 2008, as noted below, has been restated to reflect this change.  We currently develop, manufacture and distribute our products through the following three operating segments.

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Domestic Rehabilitation Segment

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

·                  Bracing and Supports.  Our Bracing and Supports business unit offers our DonJoy, ProCare and Aircast products, including rigid knee bracing, orthopedic soft goods, cold therapy products, and vascular systems.  This business unit also includes our OfficeCare business, through which we maintain an inventory of soft goods and other products at healthcare facilities, primarily orthopedic practices, for immediate distribution to patients.

·                  Empi.  Our Empi business unit offers products in the categories of home electrotherapy, iontophoresis, and home traction.

·                  Regeneration.  Our Regeneration business unit primarily sells our bone growth stimulation products.  These products are sold through a combination of certain DonJoy sales representatives and additional independent and employed sales representatives dedicated to selling these products either directly to patients or independent distributors.  We arrange billing to these third party payors or patients for products directly sold to the patients.

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

·                  Athlete Direct.  Our Athlete Direct business unit offers our Compex electrostimulation device to consumers, ranging from people interested in improving their fitness to competitive athletes, to assist in athletic training programs through muscle development and to accelerate muscle recovery after training sessions.

International Segment

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

Domestic Surgical Implant Segment

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

Information regarding our reportable business segments is presented below (in thousands). This information excludes the impact of certain expenses not allocated to segments, primarily general corporate expenses and non-recurring charges related to our integration activities. All prior periods presented have been restated to reflect our current reportable segments.

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

Geographic Area

Following are our net sales by geographic area, based on location of customer (in thousands):

11. INCOME TAXES

Income taxes for the interim periods presented have been included in the accompanying unaudited condensed consolidated financial statements on the basis of an estimated annual effective tax rate, adjusted for discrete items. The tax benefit for these periods differed from the amount which would have been recorded using the U.S. statutory tax rate due primarily to the impact of foreign taxes, including favorable adjustments related to prior year foreign taxes, unfavorable adjustments related to deferred foreign exchange gains, deferred taxes on the assumed repatriation of foreign earnings and the favorable impact of new California legislation discussed below.

For the three and nine months ended September 26, 2009, we recorded an income tax benefit of approximately $3.0 million and $19.9 million, respectively, on pre-tax losses of approximately $13.9 million and $57.8 million, respectively.  For the three and nine months ended September 27, 2008, we recorded an income tax benefit of approximately $11.0 million and $29.0 million, respectively, on pre-tax losses of approximately $25.5 million and $88.7 million, respectively.

During the first quarter of 2009, the state of California enacted legislation which will allow corporate taxpayers to elect to use a single sales factor apportionment formula to apportion business income to California for tax years beginning on or after January 1, 2011. We anticipate making this election in fiscal year 2011 and thereafter. In the first quarter of 2009, we recorded a tax benefit of $3.8 million related to the enactment of this legislation which represents a reduction in our net deferred tax liabilities due to a lower effective state tax rate.

We and our subsidiaries file income tax returns in the U.S. federal jurisdiction, various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2005. At December 31, 2008, our gross unrecognized tax benefits were $15.4 million.  For the three and nine months ended September 26, 2009, we increased our gross unrecognized tax benefits by $0.4 million and $0.7 million, respectively, due to additions and settlements of unrecognized tax benefits related to tax positions of prior years.  For the three and nine months ended September 26, 2009, we recognized an additional $0.1 million and $0.4 million, respectively, in interest and penalties.  Our total gross unrecognized tax benefits were $16.1 million at September 26, 2009, including $1.6 million related to interest and penalties.  We do not anticipate a decrease in any gross uncertain tax positions within the next twelve months.  Due to the adoption of ASC 805-740 (formerly SFAS No. 141R, “Business Combinations”) on  January 1, 2009, all of our unrecognized tax benefits will impact our effective tax rate upon recognition. We believe that it is reasonably possible that an increase of $0.4 million in unrecognized tax benefits related to various immaterial state exposures may be necessary within the next twelve months.

12. RESTRUCTURING AND RELATED CHARGES

In June 2009, we announced our plans to close our Chattanooga manufacturing and distribution facility, located in Hixson, Tennessee, and to integrate the operations of the Chattanooga site into our other existing sites. The transition of our Chattanooga activities is expected to take approximately nine to 12 months to complete. As a result of this transition, we expect to incur approximately $6.0 million to $8.0 million of cash expenses, mainly related to one-time termination benefits and employee retention.

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A summary of the activity relating to the restructuring for the period from June 1, 2009 through September 26, 2009 is as follows (in thousands):