DJO Finance LLC - FORM 10-Q - November 12, 2014

DJO Finance LLC - FORM 10-Q - November 12, 2014

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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 27, 2014

¨	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)


State of Delaware		20-5653965
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer 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

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 ¨ No x (Note: As of January 1, 2014, the registrant was no longer subject to the filing requirements of Section 13 or 15(d) of the Exchange Act; however, the registrant filed all reports required to be filed during the period it was subject to Section 13 or 15(d) of the Exchange Act.)

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 x No ¨

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 ¨ No x

As of November 12, 2014, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

DJO Finance LLC

INDEX


		Page Number
PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of September 27, 2014 and December 31, 2013		1
	Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 27, 2014 and September 28, 2013		2
	Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 27, 2014 and September 28, 2013		3
	Unaudited Condensed Consolidated Statement of Deficit for the nine months ended September 27, 2014		4
	Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 27, 2014 and September 28, 2013		5
	Notes to Unaudited Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		48
Item 4.	Controls and Procedures		48
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings		49
Item 1A.	Risk Factors		49
Item 5.	Other Information		49
Item 6.	Exhibits		50

PART 1 – FINANCIAL INFORMATION

Item 1. Financial Statements

DJO Finance LLC

Unaudited Condensed Consolidated Balance Sheets

(in thousands)


	September 27, 2014			December 31, 2013
Assets
Current assets:
Cash and cash equivalents	$	40,857		$	43,578
Accounts receivable, net		185,820			185,088
Inventories, net		171,000			154,983
Deferred tax assets, net		27,470			27,527
Prepaid expenses and other current assets		37,283			27,951

Total current assets		462,430			439,127
Property and equipment, net		119,275			107,829
Goodwill		1,145,213			1,149,331
Intangible assets, net		891,661			958,993
Other assets		34,841			39,499

Total assets	$	2,653,420		$	2,694,779

Liabilities and Deficit
Current liabilities:
Accounts payable	$	61,814		$	56,374
Accrued interest		49,501			29,682
Current portion of debt obligations		8,912			8,620
Other current liabilities		120,762			109,472

Total current liabilities		240,989			204,148
Long-term debt obligations		2,259,357			2,251,167
Deferred tax liabilities, net		246,513			242,028
Other long-term liabilities		15,627			16,718

Total liabilities		2,762,486			2,714,061

Commitments and contingencies

Deficit:
DJO Finance LLC membership deficit:
Member capital		839,508			838,769
Accumulated deficit		(945,040	)		(861,878	)
Accumulated other comprehensive (loss) income		(6,583	)		1,183

Total membership deficit		(112,115	)		(21,926	)
Noncontrolling interests		3,049			2,644

Total deficit		(109,066	)		(19,282	)

Total liabilities and deficit	$	2,653,420		$	2,694,779

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Operations

(in thousands)


	Three Months Ended						Nine Months Ended
	September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Net sales	$	305,501		$	288,049		$	902,112		$	861,871
Cost of sales (exclusive of amortization of intangible assets of $8,645 and $25,980 for the three and nine months ended September 27, 2014 and $8,809 and $26,368 for the three and nine months ended September 28, 2013, respectively)		122,696			118,160			365,911			346,761

Gross profit		182,805			169,889			536,201			515,110

Operating expenses:
Selling, general and administrative		123,552			112,566			374,810			348,175
Research and development		9,159			8,028			28,515			23,749
Amortization of intangible assets		23,233			23,920			70,292			71,595

		155,944			144,514			473,617			443,519

Operating income		26,861			25,375			62,584			71,591

Other (expense) income:
Interest expense		(43,301	)		(43,842	)		(130,670	)		(133,412	)
Interest income		21			29			152			117
Loss on modification and extinguishment of debt		—			—			(1,019	)		(1,059	)
Other income (expense), net		(3,464	)		870			(2,932	)		(535	)

		(46,744	)		(42,943	)		(134,469	)		(134,889	)

Loss before income taxes		(19,883	)		(17,568	)		(71,885	)		(63,298	)
Income tax provision		(1,250	)		(807	)		(10,628	)		(7,845	)

Net loss		(21,133	)		(18,375	)		(82,513	)		(71,143	)
Net income attributable to noncontrolling interests		(73	)		(113	)		(649	)		(523	)

Net loss attributable to DJO Finance LLC	$	(21,206	)	$	(18,488	)	$	(83,162	)	$	(71,666	)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(in thousands)


	Three Months Ended						Nine Months Ended
	September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Net loss	$	(21,133	)	$	(18,375	)	$	(82,513	)	$	(71,143	)

Other comprehensive loss, net of taxes:
Foreign currency translation adjustments, net of tax benefit (provision) of $2,449 and $2,784 for the three and nine months ended September 27, 2014 and $(1,407) and $(538) for the three and nine months ended September 28, 2013, respectively		(6,105	)		2,739			(8,010	)		(71	)

Other comprehensive (loss) income		(6,105	)		2,739			(8,010	)		(71	)

Comprehensive loss		(27,238	)		(15,636	)		(90,523	)		(71,214	)
Comprehensive income (loss) attributable to noncontrolling interests		139			(212	)		(405	)		(588	)

Comprehensive loss attributable to DJO Finance LLC	$	(27,099	)	$	(15,848	)	$	(90,928	)	$	(71,802	)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

DJO Finance LLC

Unaudited Condensed Consolidated Statement of Deficit

(in thousands)


	DJO Finance LLC
	Member capital			Accumulated deficit			Accumulated other comprehensive income (loss)			Total membership deficit			Noncontrolling interests			Total deficit
Balance at December 31, 2013	$	838,769		$	(861,878	)	$	1,183		$	(21,926	)	$	2,644		$	(19,282	)
Net (loss) income		—			(83,162	)		—			(83,162	)		649			(82,513	)
Other comprehensive loss, net of taxes		—			—			(7,766	)		(7,766	)		(244	)		(8,010	)
Stock-based compensation		1,274			—			—			1,274			—			1,274
Exercise of stock options		(535	)		—			—			(535	)		—			(535	)

Balance at September 27, 2014	$	839,508		$	(945,040	)	$	(6,583	)	$	(112,115	)	$	3,049		$	(109,066	)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)


	Nine Months Ended
	September 27, 2014			September 28, 2013
Cash flows from operating activities:
Net loss	$	(82,513	)	$	(71,143	)

Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		26,335			24,128
Amortization of intangible assets		70,292			71,595
Amortization of debt issuance costs and non-cash interest expense		6,438			5,955
Stock-based compensation expense		1,274			1,544
Loss on modification and extinguishment of debt		1,019			1,059
(Gain) loss on disposal of assets, net		(1,211	)		876
Deferred income tax expense		6,628			2,766
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable		(2,832	)		(14,316	)
Inventories		(13,873	)		4,895
Prepaid expenses and other assets		(8,758	)		(7,296	)
Accrued interest		19,820			18,263
Accounts payable and other current liabilities		24,466			877

Net cash provided by operating activities		47,085			39,203

Cash flows from investing activities:
Cash paid in connection with acquisition, net of cash acquired		(4,587	)		(1,953	)
Purchases of property and equipment		(41,495	)		(24,043	)
Other investing activities, net		(987	)		(1,433	)

Net cash used in investing activities		(47,069	)		(27,429	)

Cash flows from financing activities:
Proceeds from issuance of debt		952,294			496,417
Repayments of debt		(944,720	)		(503,727	)
Payment of debt issuance costs		(1,812	)		(2,387	)
Payment of contingent consideration		(5,690	)		—
Investment by parent		22			—
Cash paid in connection with the cancellation of vested options		(2,001	)		—

Net cash used in financing activities		(1,907	)		(9,697	)
Effect of exchange rate changes on cash and cash equivalents		(830	)		226

Net (decrease) increase in cash and cash equivalents		(2,721	)		2,303
Cash and cash equivalents at the beginning of the period		43,578			31,223

Cash and cash equivalents at the end of the period	$	40,857			33,526


Supplemental disclosures of cash flow information:
Cash paid for interest	$	104,011		$	108,984
Cash paid for taxes, net	$	5,418		$	6,277

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

Notes to Unaudited Condensed Consolidated Financial Statements

1. ORGANIZATION AND BASIS OF PRESENTATION

Organization and Business

We are a global developer, manufacturer and distributor of medical devices that provide solutions for musculoskeletal health, vascular health and pain management. Our products address the continuum of patient care from injury prevention to rehabilitation after surgery, injury or from degenerative disease, enabling people to regain or maintain their natural motion. 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. Our product lines include rigid and soft orthopedic bracing, hot and cold therapy, bone growth stimulators, vascular therapy systems and compression garments, therapeutic shoes and inserts, electrical stimulators used for pain management and physical therapy products. Our surgical implant business offers a comprehensive suite of reconstructive joint products for the hip, knee and shoulder.

DJO Finance LLC (DJOFL) is a wholly owned indirect subsidiary of DJO Global, Inc. (DJO). Substantially all business activities of DJO are conducted by DJOFL and its wholly owned subsidiaries. Except as otherwise indicated, references to “us,” “we,” “DJOFL,” “our,” or “the Company,” refers to DJOFL and its consolidated subsidiaries.

Infrequent Events

In September 2013, a fire occurred at our factory in Tunisia. As a result of the fire, certain inventory and fixed assets were destroyed and the leased facility became inoperable. Estimated losses of $5.0 million related to destroyed inventory and fixed assets, excess expenses incurred and building reconstruction costs were recorded for the year ended December 31, 2013. Additionally, we have recorded $1.3 million in revenue from business interruption insurance proceeds for the year ended December 31, 2013. Final claims were settled against the insurance policies in September 2014. As a result, estimated losses were adjusted to $3.3 million, and an additional $2.3 million in revenue from business interruption insurance proceeds was recorded for the nine months ended September 27, 2014. The activity in the corresponding insurance receivable was follows (in thousands):


	Nine Months Ended September 27, 2014
Balance, beginning of period	$	6,261
Change in estimated losses		(1,617	)
Business interruption		2,274
Claim payments		(6,918	)

Balance, end of period	$	—

Segment Reporting

We market and distribute our products through four operating segments, Bracing and Vascular, Recovery Sciences, Surgical Implant, and International. Our Bracing and Vascular, Recovery Sciences, and Surgical Implant segments generate their revenues within the United States. Our Bracing and Vascular segment offers rigid knee braces, orthopedic soft goods, cold therapy products, vascular systems, compression therapy products and therapeutic footwear for the diabetes care market. Our Recovery Sciences segment offers home electrotherapy, iontophoresis, home traction products, bone growth stimulation products and clinical physical therapy equipment. Our Surgical Implant segment offers a comprehensive suite of reconstructive joint products for the knee, hip and shoulder. Our International segment offers all of our products to customers outside the United States. See Note 15 for additional information about our reportable segments.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates and assumptions are used in accounting for, among other things, contractual allowances, rebates, product returns, warranty obligations, allowances for doubtful accounts, valuation of inventories, self-insurance reserves, income taxes, loss contingencies, fair values of derivative instruments, fair values of long-lived assets and any related impairments, capitalization of costs associated with internally developed software and stock-based compensation. Actual results could differ from those estimates.

Basis of Presentation

We consolidate the results of operations of our 50% owned subsidiary, Medireha GmbH (Medireha), and reflect the 50% share of results not owned by us as noncontrolling interests in our Unaudited Condensed Consolidated Statements of Operations. We maintain control of Medireha through certain rights that enable us to prohibit certain business activities that are not consistent with our plans for the business and provide us with exclusive distribution rights for products manufactured by Medireha.

Interim Reporting

The accompanying Unaudited Condensed Consolidated Financial Statements include our accounts and all voting interest entities where we exercise a controlling financial interest through the ownership of a direct or indirect majority voting interest. All significant intercompany accounts and transactions have been eliminated in consolidation. Our Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP and with the instructions to Form 10–Q and Article 10 of Regulation S–X for interim financial information. Accordingly, these financial statements do not include all of the information required by GAAP or Securities and Exchange Commission (SEC) rules and regulations for complete annual financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the results of operations for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10–K for the year ended December 31, 2013.

Recent Accounting Standards

In July 2013, the Financial Accounting Standards Board (the “FASB”) issued an accounting standard update regarding the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance is effective prospectively for fiscal years and interim periods within those years, beginning after December 15, 2013, with an option for early adoption. This update is consistent with our current financial statement presentation and therefore we do not believe the adoption of this standard will have an impact on the Company’s consolidated financial statements.

In April 2014, the FASB issued accounting standards update, which includes amendments that change the requirements for reporting discontinued operations and require additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations—that is, a major effect on the organization’s operations and financial results should be presented as discontinued operations. Examples include a disposal of a major geographic area, a major line of business, or a major equity method investment. Additionally, the update requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The guidance is effective prospectively for fiscal years beginning after December 15, 2014 and interim periods within annual periods beginning on or after December 15, 2015. The Company is currently evaluating the new guidance to determine the impact it may have to its consolidated financial statements.

In May 2014, the FASB issued an accounting standards update related to revenue from contracts with customers. The new standard provides a five-step approach to be applied to all contracts with customers. The accounting standards update also requires expanded disclosures about revenue recognition. The guidance is effective for fiscal years beginning after December 15, 2016 and interim periods within that reporting period. Early adoption is not permitted. The Company is currently evaluating the new guidance to determine the impact it may have to its consolidated financial statements.

In June 2014, the FASB issued an accounting standards update related accounting for share-based payments. The standard requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The guidance is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2015. Early application is permitted. The Company is currently evaluating the new guidance to determine the impact it may have to its consolidated financial statements.

In August 2014, the FASB issued an accounting standards update related to going concern disclosures. The standard requires an entity’s management to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. The guidance is effective for annual reporting periods ending after December 15, 2016, and interim periods thereafter. Early application is permitted. The Company is evaluating the impact of this standard on its consolidated financial statements.

2. ACQUISITION

On January 23, 2014, we acquired all of the outstanding shares of capital stock of Speetec Implantate GmbH (“Speetec”). Speetec is a distributor and manufacturer of knee, hip and shoulder arthroplasty products in Germany. The purchase price consisted of a cash payment at closing of $5.0 million, a holdback of $1.3 million for potential indemnity claims and $1.6 million for the fair value of contingent consideration. The fair value of contingent consideration equals approximately 25% of the total potential contingent consideration of $7.3 million. The valuation is based on the probability weighted average estimate of achievement of revenue targets for 2014 and 2015. As of September 27, 2014, we reevaluated both the probability of achieving the Speetec revenue targets and the discounted present value of the current estimate of the future contingent payments, resulting in no significant change to the net fair value of the contingent consideration.

The indemnity holdback accrues interest at the Euribor rate plus 100 basis points and is 50% payable in March 2015 and March 2016, respectively, if not used for indemnification claims. The contingent consideration is 50% payable in March 2015 and March 2016, respectively, if earned.

The purchase price for this acquisition was allocated to the fair values of the net tangible and intangible assets acquired as follows (in thousands):


Cash	$	489
Accounts receivable		608
Inventories		2,766
Other current assets		154
Property, plant & equipment		379
Liabilities assumed		(1,642	)
Deferred tax liabilities		(1,003	)
Intangible assets		3,750
Goodwill		2,383

Total purchase price	$	7,884

The purchase price allocation included $2.9 million assigned to intangible assets related to certain customer relationships existing on the acquisition date. The value of the customer relationships was based upon an estimate of the future discounted cash flows that would be derived from those customers, after deducting contributory asset charges. The purchase price allocation also included $0.6 million assigned to intangible assets related to a non-compete agreement with the sellers. The value of the non-compete agreement was based on the estimated present value of the cash flows associated with having the agreement in place, less the present value of the cash flows assuming the non-compete agreement was not in place. Additionally, the purchase price allocation included $0.3 million assigned to intangible assets related to trademarks and trade names. The value of the trademarks and trade names was determined primarily by estimating the present value of future royalty costs that will be avoided due to our ownership of the trademarks and trade names acquired.

Goodwill represents the excess of the purchase price over fair value of tangible and identifiable intangible assets acquired. All goodwill associated with the Speetec acquisition is allocated to our International reporting segment. Among the factors which resulted in goodwill for the Speetec acquisition was the opportunity to expand our direct presence in the German market with our surgical products.

3. ACCOUNTS RECEIVABLE RESERVES

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


	Nine Months Ended
	September 27, 2014			September 28, 2013
Balance, beginning of period	$	32,957		$	25,211
Provision for doubtful accounts		30,299			20,207
Write-offs, net of recoveries		(20,814	)		(17,863	)

Balance, end of period	$	42,442		$	27,555

Our allowance for sales returns balance was $3.7 million and $4.0 million as of September 27, 2014 and September 28, 2013, respectively.

4. INVENTORIES

Inventories consist of the following (in thousands):


	September 27, 2014			December 31, 2013
Components and raw materials	$	59,367		$	59,825
Work in process		6,863			7,373
Finished goods		94,569			83,502
Inventory held on consignment		34,916			27,969

		195,715			178,669
Inventory reserves		(24,715	)		(23,686	)

	$	171,000		$	154,983

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


	Nine Months Ended
	September 27, 2014			September 28, 2013
Balance, beginning of period	$	23,686		$	17,313
Provision charged to cost of sales		6,230			7,532
Write-offs, net of recoveries		(5,201	)		(2,778	)

Balance, end of period	$	24,715		$	22,067

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

5. LONG-LIVED ASSETS

Goodwill

Changes in the carrying amount of goodwill for the nine months ended September 27, 2014 are presented in the table below (in thousands):


	Bracing & Vascular		Recovery Sciences			Surgical Implant			International			Total
Balance, beginning of period
Goodwill	$	483,258	$	495,999		$	47,406		$	348,774		$	1,375,437
Accumulated impairment losses		—		(178,700	)		(47,406	)		—			(226,106	)

		483,258		317,299			—			348,774			1,149,331
Acquisitions (see Note 2)		—		—			—			2,383			2,383
Foreign currency translation		—		—			—			(6,501	)		(6,501	)
Balance, end of period
Goodwill		483,258		495,999			47,406			344,656			1,371,319
Accumulated impairment losses		—		(178,700	)		(47,406	)		—			(226,106	)

	$	483,258	$	317,299		$	—		$	344,656		$	1,145,213

Intangible Assets

Identifiable intangible assets consisted of the following (in thousands):


September 27, 2014	Gross Carrying Amount		Accumulated Amortization			Intangible Assets, Net
Definite-lived intangible assets:
Customer relationships	$	570,867	$	(329,366	)	$	241,501
Patents and technology		486,600		(255,877	)		230,723
Trademarks and trade names		26,032		(9,221	)		16,811
Distributor contracts and relationships		4,827		(3,319	)		1,508
Non-compete agreements		6,926		(4,382	)		2,544

	$	1,095,252	$	(602,165	)		493,087

Indefinite-lived intangible assets:
Trademarks and trade names							398,574

Net identifiable intangible assets						$	891,661


December 31, 2013	Gross Carrying Amount		Accumulated Amortization			Intangible Assets, Net
Definite-lived intangible assets:
Customer relationships	$	570,070	$	(290,359	)	$	279,711
Patents and technology		486,246		(230,111	)		256,135
Trademarks and trade names		25,820		(7,102	)		18,718
Distributor contracts and relationships		5,054		(3,183	)		1,871
Non-compete agreements		6,423		(3,149	)		3,274

	$	1,093,613	$	(533,904	)		559,709

Indefinite-lived intangible assets:
Trademarks and trade names							399,284

Net identifiable intangible assets						$	958,993

Our definite lived intangible assets are being amortized using the straight line method over their remaining weighted average useful lives of 5.3 years for customer relationships, 8.5 years for patents and technology, 2.9 years for distributor contracts and relationships, 6.4 years for trademarks and trade names, and 2.3 years for non-compete agreements. Based on our amortizable intangible asset balance as of September 27, 2014, we estimate that amortization expense will be as follows for the next five years and thereafter (in thousands):


Remaining 2014	$	22,789
2015		88,542
2016		83,965
2017		72,778
2018		62,611
Thereafter		162,402

	$	493,087

6. OTHER CURRENT LIABILITIES

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


	September 27 2014		December 31, 2013
Accrued wages and related expenses	$	36,318	$	33,128
Accrued commissions		15,039		16,489
Accrued rebates		10,493		10,731
Accrued other taxes		4,999		4,734
Accrued professional expenses		4,224		3,372
Income taxes payable		2,172		2,877
Deferred tax liability		445		445
Other accrued liabilities		47,072		37,696

	$	120,762	$	109,472

7. DERIVATIVE INSTRUMENTS

From time to time, we use derivative financial instruments to manage interest rate risk related to our variable rate credit facilities and risk related to foreign currency exchange rates. Our objective is to reduce the risk to earnings and cash flows associated with changes in interest rates and changes in foreign currency exchange rates. Before acquiring a derivative instrument to hedge a specific risk, we evaluate potential natural hedges. Factors considered in the decision to hedge an underlying market exposure include the materiality of the risk, the volatility of the market, the duration of the hedge, and the availability, effectiveness and cost of derivative instruments. We do not use derivative instruments for speculative or trading purposes.

All derivatives, whether designated as hedging relationships or not, are recorded on the balance sheet at fair value. The fair value of our derivatives is determined through the use of models that consider various assumptions, including time value, yield curves and other relevant economic measures which are inputs that are classified as Level 2 in the fair value hierarchy. 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. Our interest rate swap agreements were designated as cash flow hedges, and accordingly, effective portions of changes in the fair value of the cash flow hedges were recorded in accumulated other comprehensive income (loss) and subsequently reclassified into our Unaudited Condensed Consolidated Statement of Operations when the hedged forecasted transaction affects income (loss). Ineffective portions of changes in the fair value of cash flow hedges are recognized in income (loss). Our foreign exchange contracts have not been designated as hedges, and accordingly, changes in the fair value of the derivatives are recorded in income (loss).

Foreign Exchange Rate Contracts. We utilize Mexican Peso (MXN) foreign exchange forward contracts to hedge a portion of our exposure to fluctuations in foreign exchange rates, as our Mexico-based manufacturing operations incur costs that are largely denominated in MXN. Foreign exchange forward contracts held as of September 27, 2014 expire weekly through November 2014. While our foreign exchange forward contracts act as economic hedges, we have not designated such instruments as hedges for accounting purposes. Therefore, gains and losses resulting from changes in the fair values of these derivative instruments are recorded in Other income (expense), net, in our accompanying Unaudited Condensed Consolidated Statements of Operations.

Information regarding the notional amounts of our foreign exchange forward contracts is presented in the table below (in thousands):


	Notional Amount (MXN)				Notional Amount (USD)
	September 27, 2014		December 31, 2013		September 27, 2014		December 31, 2013
Foreign exchange contracts not designated as hedges		19,600		302,730	$	1,481	$	22,959

The following table summarizes the fair value of derivative instruments in our Unaudited Condensed Consolidated Balance Sheets (in thousands):


	Balance Sheet Location	September 27, 2014		December 31, 2013
Derivative Liabilities:
Foreign exchange forward contracts not designated as hedges	Other current liabilities	$	25	$	44

The following table summarizes the effect our derivative instruments have on our Unaudited Condensed Consolidated Statements of Operations (in thousands):


		Three Months Ended						Nine Months Ended
	Location of gain (loss)	September 27, 2014			September 28, 2013			September 27, 2014		September 28, 2013
Foreign exchange forward contracts not designated as hedges	Other income (expense), net	$	(128	)	$	(233	)	$	19	$	(1,010	)

8. FAIR VALUE MEASUREMENTS

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. Our assessment of the significance of a particular input to the fair value measurements requires judgment and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.

The fair value of contingent consideration for the Speetec acquisition equals approximately 25% of the total potential contingent consideration of $7.3 million. The valuation is based on the probability weighted average estimate of achievement of revenue targets for 2014 and 2015. The fair value of the expected payment was then calculated using a 9.9% discount rate as the contingent consideration is 50% payable in March 2015 and March 2016, respectively, if earned. As of September 27, 2014, we reevaluted both the probability of achieving the revenue targets and the discounted present value of the current estimate of the future contingent payments, resulting in no significant change to the net fair value of the contingent consideration. This fair value measurement is categorized within Level 3 of the fair value hierarchy.

During the year ended December 31, 2013, we remeasured the fair value of the contingent consideration related to our December 2012 acquisition of Exos Corporation. We initially valued the contingent consideration at $8.2 million based on the probability weighted estimate of approximately 95% for the achievement of certain specified milestones and the budgeted 2013 Exos product line revenues. Our remeasurement of the fair value based on the probability of achieving the budgeted Exos revenue and certain specified milestones and the discounted present value of the current estimate of the future contingent payment resulted in a reduction of $2.5 million to the net fair value of the contingent consideration. This fair value measurement is categorized within Level 3 of the fair value hierarchy. The $5.7 million of contingent consideration was paid to Exos Corporation in April 2014.

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis (in thousands):


As of September 27, 2014	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Recorded Balance
Liabilities:
Foreign exchange forward contracts not designated as hedges	$	—	$	25	$	—	$	25

Contingent consideration	$	—	$	—	$	1,527	$	1,527


As of December 31, 2013	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Recorded Balance
Liabilities:
Foreign exchange forward contracts not designated as hedges	$	—	$	44	$	—	$	44

Contingent consideration	$	—	$	—	$	5,690	$	5,690

The table below presents reconciliation of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 27, 2014 (in thousands):


	Nine Months Ended
	September 27, 2014
Balance, beginning of period	$	5,690
Acquisitions		1,627
Payment of contingent consideration		(5,690	)
Foreign currency translation		(100	)

Balance, end of period	$	1,527

9. DEBT

Debt obligations consists of the following (in thousands):


	September 27, 2014			December 31, 2013
Senior secured credit facilities:
Revolving credit facility	$	10,000		$	38,000
Term Loan:
$889.0 million New Tranche B term loans, net of unamortized original issuance discount of $5.5 million as of September 27, 2014		883,496			—
$853.4 million Tranche B term loans, net of unamortized original issuance discount of $7.1 million as of December 31, 2013		—			846,297
8.75% Second priority senior secured notes, including unamortized original issue premium of $4.7 million and $5.5 million as of September 27, 2014 and December 31, 2013, respectively		334,664			335,490
9.875% Senior unsecured notes		440,000			440,000
7.75% Senior unsecured notes		300,000			300,000
9.75% Senior subordinated notes		300,000			300,000
Other		109			—

Total debt		2,268,269			2,259,787
Current maturities		(8,912	)		(8,620	)

Long-term debt	$	2,259,357		$	2,251,167

Senior Secured Credit Facilities

On November 20, 2007, we entered into senior secured credit facilities consisting of a $1,065.0 million term loan facility maturing in May 2014 and a $100.0 million revolving credit facility maturing in November 2013. On March 20, 2012, we amended and restated our senior secured credit facilities, which (1) permitted the issuance of $230.0 million aggregate principal of 8.75% second priority senior secured notes (as defined and further described below); (2) extended the maturity of $564.7 million of the original term loans outstanding under the original senior secured credit facilities to November 1, 2016 (“extended term loans”); (3) provided for the issuance of a new $350.0 million tranche of term loans that will mature on September 15, 2017 (such term loans, the “March 20 new term loans”); (4) deemed certain previous acquisitions and investments to be permitted under the terms of the senior secured credit facilities; (5) increased the total net leverage ratio limitation in the permitted acquisitions covenant from 7.0x to 7.5x; (6) changed the financial maintenance covenant from a senior secured leverage ratio covenant to a senior secured first lien leverage ratio covenant; and (7) replaced our original senior secured revolving credit facilities with a new $100.0 million revolving credit facility (the “revolving credit facility”) which matures on March 15, 2017.

On March 30, 2012, we entered into an amendment to the senior secured credit facilities which, among other things, provided for the issuance of an additional $105.0 million of new term loans that will mature on September 15, 2017 (such term loans, the “March 30 new term loans”). The net proceeds from this issuance were used to repay $103.5 million in aggregate principal amount of term loans under the original senior secured credit facilities and to pay related fees, premiums and expenses.

On December 19, 2012, we entered into an incremental amendment to our senior secured credit facilities which provided for the issuance of an additional $25.0 million of new term loans on December 28, 2012 that will mature on September 15, 2017 (such term loans, the “December 28 new term loans”; and, together with the March 20 new term loans and the March 30 new term loans, the “new term loans”). The net proceeds from the issuance were used to partially fund the acquisition of Exos Corporation.

The March 20 new term loans were issued at a 1.5% discount. The March 30 new term loans were issued at a 1.0% discount and the December 28 new term loans were issued at par.

On March 21, 2013, we entered into an amendment to the senior secured credit facilities which, among other things, (1) provided for the issuance of $421.4 million of additional term loans issued at par, the proceeds of which were used to prepay existing term loans; (2) extended the maturity of the extended term loans to September 15, 2017; (3) combined the additional term loans and the extended term loans into one new tranche (“tranche B term loans”); (4) reduced the interest rate margin applicable to all borrowings under the senior secured credit facilities; and (5) set the senior secured first lien leverage ratio covenant at a level of 4.25x for the duration of the agreement.

On April 8, 2014, we entered into an amendment (the “Amendment”) to the senior secured credit facilities that, among other things, (1) provided for the issuance of $851.2 million of refinancing term loans (the “Refinancing Term Loans”) at par, the proceeds of which were used to prepay existing tranche B term loans; (2) provided for the issuance of $40.0 million of incremental term loans (the “Incremental Term Loans”) at par, the proceeds of which were used, among other things, to prepay the loans then-outstanding under the revolving credit facility and fees and expenses associated with the Amendment; (3) combined the Refinancing Term Loans and the Incremental Term Loans into one new tranche ( the “New Tranche B Term Loans”); (4) reduced the interest rate margin applicable to all borrowings (including the revolving borrowing) under the senior secured credit facilities; and (5) set the senior secured first lien leverage ratio covenant at a level of 4.75x for the duration of the agreement. The remaining unamortized original issue discounts from the previous term loan issuances are being amortized over the term of the New Tranche B Term Loans using the effective interest method.

As of September 27, 2014, the market values of our New Tranche B Term Loans and drawings under our revolving credit facility were $886.8 million and $9.2 million, respectively. We determine market value using trading prices for the senior secured credit facilities on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Interest Rates. Effective April 8, 2014, the interest rate margins applicable to borrowings under the senior secured revolving credit facilities are, at our option, either (a) the Eurodollar rate, plus 325 basis points or (b) a base rate determined by reference to the highest of (1) the prime rate, (2) the federal funds rate, plus 0.50% and (3) the Eurodollar rate for a one-month interest period, plus in each case 325 basis points. The interest rate margins applicable to the New Tranche B Term Loans are, at our option, either (a) the Eurodollar rate plus 325 basis points or (b) a base rate plus 325 basis points. There is a minimum LIBOR rate applicable to the Eurodollar component of interest rates on New Tranche B Term Loans of 1.00%. The applicable margin for borrowings under the senior secured revolving credit facilities may be reduced, subject to our attaining certain leverage ratios. As of September 27, 2014, our weighted average interest rate for all borrowings under the senior secured credit facilities was 4.24%.

Fees. In addition to paying interest on outstanding principal under the senior secured credit facilities, we are required to pay a commitment fee to the lenders under the senior secured revolving credit facilities with respect to the unutilized commitments thereunder. The current commitment fee rate is 0.50% per annum, subject to step-downs based upon the achievement of 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 New Tranche B Term Loans in an amount equal to 1.00% of the funded total principal amount through June 2017, with any remaining amount payable in full at maturity in September 2017.

Prepayments. The senior secured credit facilities require 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 in the credit agreement relating to the senior secured credit facilities (such agreement, the “Credit Agreement”); (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 us and our restricted subsidiaries, subject to certain exceptions, including a 100% reinvestment right if reinvested or committed to be reinvested within 15 months of such asset sale or disposition so long as such reinvestment is completed within 180 days thereafter; and (3) 100% of the net cash proceeds from the issuance or incurrence of debt by us and our restricted subsidiaries, other than proceeds from debt permitted to be incurred under the senior secured credit facilities and related amendments. Any mandatory prepayments are applied to the term loan facility in direct order of maturity. We were not required to make any such prepayments in the nine months ended September 27, 2014.

Subject to certain exceptions, voluntary prepayments of the New Tranche B Term Loans within one year of the effective date of the Amendment are subject to a 1.0% “soft call” premium, while other voluntary prepayments of outstanding loans under the senior secured credit facilities may be made 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 facilities are unconditionally guaranteed by DJO Holdings LLC (“DJO Holdings”) and each of our existing and future direct and indirect wholly-owned domestic subsidiaries 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 facilities, and the guarantees of those obligations, are secured by pledges of 100% of our capital stock, 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 us or one of the Guarantors, and a security interest in, and mortgages on, substantially all tangible and intangible assets of DJO Holdings, DJOFL and each Guarantor.

Certain Covenants and Events of Default. The senior secured credit facilities contain 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 facilities require us to maintain a maximum senior secured first lien leverage ratio of consolidated senior secured first lien debt to Adjusted EBITDA (as defined in the Credit Agreement) of 4.75:1 for the trailing twelve months ended September 27, 2014. The senior secured credit facilities also contain certain customary affirmative covenants and events of default. As of September 27, 2014, our actual senior secured first lien net leverage ratio was 3.11:1, and we were in compliance with all other applicable covenants.

8.75% Second Priority Senior Secured Notes

On March 20, 2012 and October 1, 2012, we issued $330.0 million aggregate principal amount of 8.75% second priority senior secured notes (8.75% Notes) maturing on March 15, 2018. The 8.75% Notes are guaranteed jointly and severally and on a senior secured basis by each of DJOFL’s existing and future direct and indirect wholly-owned domestic subsidiaries that guarantee any of DJOFL’s indebtedness, or any indebtedness of DJOFL’s domestic subsidiaries, or is an obligor under the senior secured credit facilities.

Pursuant to a second lien security agreement, the 8.75% Notes are secured by second priority liens, subject to permitted liens, on certain of our assets that secure borrowings under the senior secured credit facilities.

As of September 27, 2014, the market value of the 8.75% Notes was $345.7 million. We determined market value using trading prices for the 8.75% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption. Under the agreement governing the 8.75% Notes (8.75% Indenture), prior to March 15, 2015, we have the option to redeem some or all of the 8.75% 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 March 15, 2015, we may redeem some or all of the 8.75% Notes at a redemption price of 104.375% of the then outstanding principal balance, plus accrued and unpaid interest. The redemption price decreases to 102.188% and 100% of the then outstanding principal balance at March 15, 2016 and 2017, respectively, plus accrued and unpaid interest. Additionally, from time to time, before March 15, 2015, we may redeem up to 35% of the 8.75% Notes at a redemption price equal to 108.75% of the then outstanding principal balance, plus accrued and unpaid interest, 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 8.75% Notes issued remains outstanding.

9.875% Senior Unsecured Notes

On October 1, 2012, we issued $440.0 million aggregate principal amount of new 9.875% senior unsecured notes (9.875% Notes) maturing on April 15, 2018. The 9.875% Notes are guaranteed jointly and severally and on an unsecured senior basis by each of DJOFL’s existing and future direct and indirect wholly owned domestic subsidiaries that guarantee any of DJOFL’s indebtedness or any indebtedness of DJOFL’s domestic subsidiaries or is an obligor under DJOFL’s senior secured credit facilities.

As of September 27, 2014, the market value of the 9.875% Notes was $462.0 million. We determined market value using trading prices for the 9.875% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption. Under the agreement governing the 9.875% Notes (the 9.875% Indenture), prior to April 15, 2015, we have the option to redeem some or all of the 9.875% 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 April 15, 2015, we may redeem some or all of the 9.875% Notes at a redemption price of 104.938% of the then outstanding principal balance plus accrued and unpaid interest. The redemption price decreases to 102.469% and 100% of the then outstanding principal balance at April 2016 and 2017, respectively. Additionally, from time to time, before April 15, 2015, we may redeem up to 35% of the 9.875% Notes at a redemption price equal to 109.875% of the principal amount then outstanding, plus accrued and unpaid interest, 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 9.875% Notes issued remains outstanding.

7.75% Senior Unsecured Notes

On April 7, 2011, we issued $300.0 million aggregate principal amount of 7.75% senior unsecured notes (7.75% Notes) maturing on April 15, 2018. The 7.75% Notes are guaranteed jointly and severally and on a senior unsecured basis by each of DJOFL’s existing and future direct and indirect wholly-owned domestic subsidiaries that guarantee any of DJOFL’s indebtedness, or any indebtedness of DJOFL’s domestic subsidiaries, or is an obligor under the senior secured credit facilities.

As of September 27, 2014, the market value of the 7.75% Notes was $304.5 million. We determined market value using trading prices for the 7.75% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption. Under the agreement governing the 7.75% Notes (the 7.75% Indenture), prior to April 15, 2014, we have the option to redeem some or all of the 7.75% 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. As of April 15, 2014, we are able to redeem some or all of the 7.75% Notes at a redemption price of 105.813% of the then outstanding principal balance plus accrued and unpaid interest. The redemption price decreases to 103.875%, 101.938% and 100% of the then outstanding principal balance at April 15, 2015, 2016 and 2017, respectively.

9.75% Senior Subordinated Notes

On October 18, 2010, we issued $300.0 million aggregate principal amount of 9.75% senior subordinated notes (9.75% Notes) maturing on October 15, 2017. The 9.75% Notes are guaranteed jointly and severally and on an unsecured senior basis by each of DJOFL’s existing and future direct and indirect wholly-owned domestic subsidiaries that guarantee any of DJOFL’s indebtedness, or any indebtedness of DJOFL’s domestic subsidiaries, or is an obligor under the senior secured credit facilities.

As of September 27, 2014, the market value of the 9.75% Notes was $303.8 million. We determined market value using trading prices for the 9.75% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption. Under the agreement governing the 9.75% Notes (the 9.75% Indenture), prior to October 15, 2013, we have the option to redeem some or all of the 9.75% 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. As of October 15, 2014, we are able to redeem some or all of the 9.75% Notes at a redemption price 104.875% of the then outstanding principal balance, plus accrued and unpaid interest. The redemption price decreases to 102.438% and 100% of the then outstanding principal balance at October 15, 2015 and 2016, respectively.

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 its 8.75% Notes, 9.875% Notes, 7.75% Notes, and 9.75% Notes (collectively, the Notes), DJOFL will be required to make an offer to repurchase all of the Notes at 101% of the then outstanding principal balance, plus accrued and unpaid interest.

Covenants

The 8.75% Indenture, the 9.75% Indenture, the 9.875% Indenture and the 7.75% Indenture (collectively, the Indentures) each contain covenants limiting, among other things, our and our restricted subsidiaries’ ability to (i) 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, (ii) make certain investments, (iii) sell certain assets, (iv) create liens on certain assets to secure debt, (v) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets, (vi) enter into certain transactions with affiliates, or (vii) designate our subsidiaries as unrestricted subsidiaries. As of September 27, 2014, we were in compliance with all applicable covenants.

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 covenants. A breach of any of these covenants in the future could result in a default under the Credit Agreement or the Indentures, at which time the lenders could elect to declare all amounts outstanding under the senior secured credit facilities to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.

Loss on Modification and Extinguishment of Debt

During the nine months ended September 27, 2014, we recognized a loss on modification and extinguishment of debt of $1.0 million. The loss consists of $0.4 million of arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.6 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of our original term loans which were extinguished.

During the nine months ended September 28, 2013, we recognized a loss on modification and extinguishment of debt of $1.1 million. The loss consists of $0.9 million of arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.2 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of our original term loans which were extinguished.

Debt Issuance Costs

As of September 27, 2014 and December 31, 2013, we had $30.7 million and $35.7 million, respectively, of unamortized debt issuance costs, which are included in Other assets in our Unaudited Condensed Consolidated Balance Sheets. For each of the nine month periods ended September 27, 2014 and September 28, 2013, we capitalized $1.5 million of debt issuance costs incurred in connection with the amendment of our senior secured credit facilities.

For the three and nine months ended September 27, 2014, amortization of debt issuance costs was $2.1 million and $6.0 million, respectively. For the three and nine months ended September 28, 2013, amortization of debt issuance costs was $1.8 million and $5.4 million, respectively. Amortization of debt issuance costs was included in Interest expense in our Unaudited Condensed Consolidated Statements of Operations for each of the periods presented.

10. INCOME TAXES

Income taxes for the interim periods presented have been included in our Unaudited Condensed Consolidated Financial Statements on the basis of an estimated annual effective tax rate, adjusted for discrete items. The income tax expense for these periods differed from the amounts which would have been recorded using the U.S. statutory tax rate due primarily to certain valuation allowances provided against deferred tax assets, the impact of nondeductible expenses, foreign taxes, and deferred taxes on the assumed repatriation of foreign earnings.

For the three and nine months ended September 27, 2014, we recorded income tax expense of approximately $1.3 million and $10.6 million on pre-tax losses of $19.9 million and $71.9 million, resulting in negative effective tax rates of 6.3% and 14.8%, respectively. For the three and nine months ended September 28, 2013, we recorded income tax expense of $0.8 million and $7.8 million on pre-tax losses of $17.6 million and $63.3 million, resulting in negative effective tax rates of 4.6% and 12.4%, respectively. Our effective tax rates are negative primarily due to valuation allowances provided against our 2014 and 2013 U.S. federal and state net operating losses.

We record net deferred tax assets to the extent we conclude that it is more likely than not that the related deferred tax assets will be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. At this time, we cannot conclude that it is more likely than not that the benefit from certain U.S. federal and state net operating loss carryforwards will be realized. Accordingly, we have provided a valuation allowance of $9.4 million and $36.3 million, respectively, on the deferred tax assets related to the net operating loss carryforwards generated in the three and nine months ended September 27, 2014. If our assumptions change and we determine that it is more likely than not that we will be able to realize the deferred tax assets related to these net operating losses, reversal of the valuation allowances we have recorded against those deferred tax assets will be recognized as a reduction of income tax expense. The establishment of valuation allowances does not preclude us from utilizing our loss carryforwards or other deferred tax assets in the future and does not impact our cash resources.

We and our subsidiaries file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or foreign income tax examinations by tax authorities for years before 2010.

At September 27, 2014, our gross unrecognized tax benefits were $13.2 million reflecting a decrease of $1.3 million from the unrecognized amount of $14.5 million at December 31, 2013. As of September 27, 2014, we have $2.6 million accrued for interest and penalties related to these unrecognized tax benefits. To the extent all or a portion of our gross unrecognized tax benefits are recognized in the future, no U.S. federal tax benefit for related state income tax deductions would result due to the existence of the U.S. federal valuation allowance. We anticipate that approximately $0.4 million aggregate of unrecognized tax benefits each of which are individually immaterial will decrease in the next twelve months due to the expiration of statutes of limitation. As of September 27, 2014, we have unrecognized various foreign and U.S. state tax benefits of approximately $5.7 million, which, if recognized, would impact our effective tax rate in future periods.

11. STOCK OPTION PLANS AND STOCK-BASED COMPENSATION

Stock Option Plan

We have one active equity compensation plan, the DJO 2007 Incentive Stock Plan (2007 Plan) under which we are authorized to grant awards of stock, options, and other stock-based awards of shares of common stock of our indirect parent, DJO, subject to adjustment in certain events. The total number of shares available to grant under the 2007 plan is 10,575,529.

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.

Options granted prior to 2012 vest as follows: one-third of each stock option grant vests over a specified period of time contingent solely upon the awardees’ continued employment with us (Time-Based Options). Another one-third of each stock option grant will vest upon achieving a minimum return of money on invested capital (MOIC), as defined, with respect to Blackstone’s aggregate investment in DJO’s capital stock, to be achieved by Blackstone following a liquidation of all or a portion of its investment in DJO’s capital stock (Market Return Options). The final one-third of each stock option grant will vest based upon achieving an increased minimum return of MOIC, as defined, with respect to Blackstone’s aggregate investment in DJO’s capital stock, to be achieved by Blackstone following a liquidation of all or a portion of its investment in DJO’s capital stock (Enhanced Market Return Options).

Options granted to employees in 2012 vest in four equal installments beginning in 2012 and for each of the three calendar years following 2012, with each such installment vesting only if the final reported financial results for such year show that the Adjusted EBITDA for such year equaled or exceeded the Adjusted EBITDA amount in the financial plan approved by DJO’s Board of Directors for such year (Performance Options). In the event that the Adjusted EBITDA in any of such four years falls short of the amount of Adjusted EBITDA in the financial plan for that year, the installment that did not therefore vest at the end of such year shall be eligible for subsequent vesting at the end of the four year vesting period if the cumulative Adjusted EBITDA for such four years equals or exceeds the cumulative Adjusted EBITDA in the financial plans for such four years and the Adjusted EBITDA in the fourth vesting year equals or exceeds the Adjusted EBITDA in the financial plan for such year. In addition, in the event Blackstone achieves a minimum return of MOIC with respect to Blackstone’s aggregate investment in DJO’s capital stock following a liquidation of all or a portion of its investment in DJO’s capital stock, any unvested installments from prior years and all installments for future years shall thereupon vest.

In February 2013, 310,000 options previously granted to new employees in 2012 were amended to convert one-third of such options into Time-Based Options, with the remaining two-thirds continuing to be Performance Options. Additionally, all 2012 Performance Options were amended to allow for vesting of the 2012 Adjusted EBITDA tranche if the 2013 Adjusted EBITDA results equal or exceed an enhanced amount of Adjusted EBITDA over the amount reflected in the 2013 financial plan. Options granted in 2013 and 2014 to existing employees had the same terms as the Performance Options described above and options granted to new employees in 2013 and 2014 had the same terms as the options amended in February 2013.

In December 2013, options were granted to employees following the net exercise of their Rollover Options (as defined below) which were scheduled to expire in December 2013. These new options were fully vested on the date of grant and have a term of ten years (“2013 Vested Options”).

In February 2014, all 2012 and 2013 Performance Options were amended to allow for vesting of the 2012 and 2013 Adjusted EBITDA tranche if the 2014 Adjusted EBITDA results equal or exceed an enhanced amount of Adjusted EBITDA reflected in the 2014 financial plan.

Except for options granted to the Chairman of the Board and two other board members as described below, options are typically granted annually to members of our Board of Directors who are not affiliates of Blackstone (referred to as Director Service Options). The Director Service Options vest in increments of 33 1/3% per year on each of the first through third anniversary dates of the grant date, contingent upon the optionee’s continued service as a director. The options granted to the Chairman of the Board and the two other board members vest as follows: one-third of the stock option grant vests in increments of 33 1/3% per year on each of the first through third anniversary dates from the grant date contingent upon the optionee’s continued service as a director; one-third of the stock option grant will vest in the same manner as the Market Return Options; and one-third of the stock option grant will vest in the same manner as the Enhanced Market Return Options.

Stock-Based Compensation

During the nine months ended September 27, 2014, the compensation committee granted 1,279,500 options to employees, of which 922,830 were Performance Options and 356,670 were Time-Based Options. The weighted average grant date fair value of the Time-Based Options granted during the nine months ended September 27, 2014 was $6.05.

During the nine months ended September 28, 2013, we granted 772,000 options to employees, of which 595,344 were Performance Options and 176,656 were Time-Based Options. Additionally, the compensation committee granted 13,800 Director Service Options to members of the Board of Directors. The weighted average grant date fair values of Time-Based Options and the Director Service Options granted during the nine months ended September 28, 2013 were $5.96 and $5.80, respectively.

The following table summarizes certain assumptions we used to estimate the fair value of the Time-Based Options and the Director Service Options of stock options granted:


	Three Months Ended						Nine Months Ended
	September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Expected volatility		31.7	%		34.6	%		31.7-33.2	%		34.6-35.1	%
Risk-free interest rate		2.0	%		1.8	%		2.0-2.2	%		0.7-1.8	%
Expected years until exercise		6.4			6.3			6.4			6.2-6.3
Expected dividend yield		0.0	%		0.0	%		0.0	%		0.0	%

We recorded non-cash stock-based compensation expense during the periods presented as follows (in thousands):


	Three Months Ended				Nine Months Ended
	September 27, 2014		September 28, 2013		September 27, 2014		September 28, 2013
Cost of goods sold	$	15	$	4	$	62	$	40
Operating expenses:
Selling, general and administrative		328		285		1,211		1,483
Research and development		—		2		1		21

	$	343	$	291	$	1,274	$	1,544

We have determined that it is not probable that we will meet the Adjusted EBITDA targets related to the Performance Options granted. As such, we did not recognize expense for any of the options which had the potential to vest in 2014. Additionally, we have not recognized expense for any of the options which have the potential to vest based on Adjusted EBITDA for 2015, 2016 and 2017, as some of these targets have not yet been established and we are unable to assess the probability of achieving such targets. Accordingly, we recognized stock-based compensation expense only for the Time-Based Options, the 2013 Vested Options and the Director Service Options granted in 2013 or 2014.

In each of the periods presented above, for the options granted prior to 2012, we recognized stock-based compensation expense only for Time-Based Options granted to employees, as the performance components of the Market Return and Enhanced Market Return Options are not deemed probable at this time.

Stock based compensation expense for options granted to non-employees was not significant to the Company for all periods presented, and was included in Selling, general and administrative expense in our Unaudited Condensed Consolidated Statements of Operations.

12. MEMBERSHIP DEFICIT

During the nine months ended September 27, 2014, DJO issued 80,110 shares of its common stock upon the net exercise of vested stock options that had been granted to two former members of DJO’s Board of Directors in 2006 in exchange for options that had previously been granted in the predecessor company to DJO (“Rollover Options”). Our stock incentive plan permits participants to exercise stock options using a net exercise method. In a net exercise, we withhold from the total number of shares that otherwise would be issued to a participant upon exercise of the stock option such number of shares having a fair market value at the time of exercise equal to the aggregate option exercise price and applicable income tax withholdings, and remit the remaining shares to the participant. The two former directors exercised these Rollover Options for a total of 411,200 shares of DJO’s common stock, from which we withheld 331,090 shares to cover $5.5 million of aggregate option exercise price and income tax withholdings and issued the remaining 80,110 shares.

Additionally, during the nine months ended September 27, 2014, DJO issued 6,447 shares of its common stock upon the exercise of stock options. Net proceeds from the share sales were contributed by DJO to us, and are included in Member capital in our Unaudited Condensed Consolidated Balance Sheet as of September 27, 2014.

13. RELATED PARTY TRANSACTIONS

Blackstone Management Partners LLC (BMP) has agreed to provide certain monitoring, advisory and consulting services to us for an annual monitoring fee equal to the greater of $7.0 million or 2% of consolidated EBITDA as defined in the Transaction and Monitoring Fee Agreement, payable in the first quarter of each year. The monitoring fee agreement will continue until the earlier of November 2019, or such date as DJO and BMP may mutually determine. DJO has agreed to indemnify BMP and its affiliates, directors, officers, employees, agents and representatives from and against all liabilities relating to the services contemplated by the Transaction and Monitoring Fee Agreement and the engagement of BMP pursuant to, and the performance of BMP and its affiliates of the services contemplated by, the Transaction and Monitoring Fee Agreement. At any time in connection with or in anticipation of a change of control of DJO, a sale of all or substantially all of DJO’s assets or an initial public offering of common stock of DJO, 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 all then-current and future annual monitoring fees payable under the Transaction and Monitoring Fee Agreement, assuming a hypothetical termination date of the agreement to be November 2019. For each of the three and nine month periods presented, we expensed $1.75 and $5.25 million related to the annual monitoring fee, which is recorded as a component of Selling, general and administrative expense in the Unaudited Condensed Consolidated Statements of Operations.

14. COMMITMENTS AND CONTINGENCIES

Litigation

Pain Pump Litigation

Over the past 6 years, we have been named in numerous product liability lawsuits involving our prior distribution of a disposable drug infusion pump product (pain pump) manufactured by two third-party manufacturers that was distributed through our Bracing and Vascular segment. We currently are a defendant in four U.S. cases and a lawsuit in Canada which has been granted class action status for a class of approximately 45 claimants. We discontinued our sale of these products in the second quarter of 2009. These cases have been brought against the manufacturers and certain distributors of these pumps. All of these lawsuits allege that the use of these pumps with certain anesthetics for prolonged periods after certain shoulder surgeries or, less commonly, knee surgeries, has resulted in cartilage damage to the plaintiffs. In the past three years, we have entered into settlements with plaintiffs in approximately 130 pain pump lawsuits. Except for the payment by the Company of policy deductibles or self-insured retentions, our products liability carriers in three policy periods have paid the defense costs and settlements related to these claims, subject to reservation of rights to deny coverage for customary matters, including punitive damages and off-label promotion. The range of potential loss for these claims is not estimable, although we believe we have adequate insurance coverage for such claims. As of September 27, 2014, we have accrued $1.1 million for unpaid settlements in 16 cases, and a corresponding receivable as all of the settlements will be paid by our product liability carriers.

Lawsuit by Insurance Carrier

In December 2013, one of our product liability insurance carriers, Ironshore Specialty Ins. Co. filed a complaint in the U.S. District Court for the Southern District of California, which seeks (a) either (i) rescission of an insurance policy (the “Policy”) purchased by the Company from the plaintiff and repayment by the Company of all amounts allegedly paid under the Policy, approximately $10 million, less premiums paid by the Company for the Policy, or, in the alternative, (ii) reformation of the Policy to exclude coverage for pain pump claims and repayment by the Company of all amounts allegedly paid under the Policy for such claims, in an unspecified amount; and/or (b) damages and other relief in an unspecified amount for alleged fraud and negligent misrepresentation based on an alleged failure by the Company and/or the involved Policy producers to disclose alleged material information while applying for the Policy. While we believe this case is without merit, we have brought third-party indemnification claims against our insurance broker and a wholesale broker who were involved in securing the Policy. The carrier under our directors and officers liability policy has agreed to reimburse defense costs incurred in this matter, subject to reservation of rights to deny coverage for customary matters.

Cold Therapy Litigation

DJO was named in nine multi-plaintiff lawsuits involving a total of 172 plaintiffs which alleged that the plaintiffs had been injured following use of certain cold therapy products manufactured by DJO. The complaints alleged various product liability theories, including inadequate warnings regarding the risks associated with the use of cold therapy and failure to incorporate certain safety features into the design. No specific dollar amounts of damages were alleged in the complaints. These cases were included in a coordinated proceeding in San Diego Superior Court with a similar number of cases filed against one of our competitors. The first of these cases was tried and ended with a deadlocked jury, resulting in no verdict and a declaration of a mistrial; therefore, the range of potential loss for these claims was not estimable at that time. In October 2014, the company reached a settlement agreement with plaintiffs’ counsel that effectively resolves all of the claims. The settlement amount will be paid by our product liability carriers. We have accrued the full settlement amount associated with these claims and the corresponding insurance receivable in our financial statements. There is no impact to the financial results.

State Licensing Subpoenas

In July 2013 and October 2014, we were served with subpoenas under the Health Insurance Portability and Accountability Act (HIPAA) seeking documents relating to the fitting of custom-fabricated or custom-fitted orthoses in the States of New Jersey, Washington and Texas. The subpoenas were issued by the United States Attorney’s Office for the District of New Jersey in connection with an investigation of compliance with professional licensing statutes in those states relating to the practice of orthotics. We responded to the first subpoena, and are in the process of responding to the second subpoena.

California Qui Tam Actions

On October 11, 2013, we were served with a summons and complaint related to a qui tam action initially filed in U.S. District Court in Los Angeles, California in August 2012. Amended in December 2012 and November 2013, the complaint names us as a defendant along with another company that manufactures and sells external bone growth stimulators for spinal applications. The case is captioned United States of America, et al.ex re. Doris Modglin and Russ Milko, v. DJO Global, Inc., DJO, LLC, DJO Finance LLC, Biomet, Inc., and EBI, LP., Case No. CV12-7152-MMM (JCGx) (C.D. Cal.). The plaintiffs, or relators, allege that the defendants have violated federal and state false claim acts by seeking reimbursement for bone growth stimulators for uses outside of the Food and Drug Administration (FDA) approved indications for use for such products. The plaintiffs are seeking treble damages alleged to have been sustained by the U.S. and the states, penalties and attorney’s fees and costs. The federal government and all of the named states have declined to intervene in this case. We filed a motion to dismiss the lawsuit and that motion was granted by the Court without leave to amend on the majority of claims. The plaintiffs have filed an amended complaint. We continue to believe that this lawsuit is without merit.

15. SEGMENT AND GEOGRAPHIC INFORMATION

We provide a broad array of orthopedic rehabilitation and CMF products, as well as surgical implants to customers in the United States and abroad.

We currently develop, manufacture and distribute our products through the following four operating segments:

Bracing and Vascular Segment

Our Bracing and Vascular segment, which generates its revenues in the United States, offers our rigid knee bracing products, orthopedic soft goods, cold therapy products, vascular systems, therapeutic shoes and inserts and compression therapy products, primarily under the DonJoy, ProCare, Aircast, Dr. Comfort, Bell-Horn and Exos brands. This segment 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.

Recovery Sciences Segment

Our Recovery Sciences segment, which generates its revenues in the United States, is divided into four main businesses:

•

Empi. Our Empi business unit offers our home electrotherapy, iontophoresis, and home traction products. We primarily sell these products directly to patients or to physical therapy clinics. For products sold to patients, we arrange billing to the patients and their third party payors.

•

CMF. Our CMF business unit sells our bone growth stimulation products. We sell these products either directly to patients or to independent distributors. For products sold to patients, we arrange billing to the patients and their third party payors.

•

Chattanooga. Our Chattanooga business unit offers products in the clinical rehabilitation market in the category 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 consumers ranging from fitness enthusiasts to competitive athletes our Compex electrostimulation device, which is used in athletic training programs to aid muscle development and to accelerate muscle recovery after training sessions.

Surgical Implant Segment

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

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.

Information regarding our reportable business segments is presented below (in thousands). Segment results exclude the impact of amortization and impairment of goodwill and intangible assets, certain general corporate expenses, and charges related to various integration activities, as defined by management. 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 in the senior secured credit facilities. We do not allocate assets to reportable segments because a significant portion of our assets are shared by the segments.


	Three Months Ended						Nine Months Ended
	September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Net sales:
Bracing and Vascular	$	129,218		$	120,947		$	366,977		$	348,455
Recovery Sciences		74,009			76,654			218,790			229,413
Surgical Implant		23,830			20,025			72,842			62,890
International		78,444			70,423			243,503			221,113

	$	305,501		$	288,049		$	902,112		$	861,871

Gross profit:
Bracing and Vascular	$	68,936		$	61,689		$	193,544		$	178,345
Recovery Sciences		55,697			57,298			164,911			172,168
Surgical Implant		18,026			13,915			54,242			45,001
International		43,871			37,844			134,780			122,828
Expenses not allocated to segments and eliminations		(3,725	)		(857	)		(11,276	)		(3,232	)

	$	182,805		$	169,889		$	536,201		$	515,110

Operating income:
Bracing and Vascular	$	26,275		$	22,537		$	71,846		$	62,942
Recovery Sciences		20,149			21,088			59,292			59,501
Surgical Implant		2,801			1,020			8,430			5,410
International		15,834			11,471			46,110			42,086
Expenses not allocated to segments and eliminations		(38,198	)		(30,741	)		(123,094	)		(98,348	)

	$	26,861		$	25,375		$	62,584		$	71,591

Geographic Area

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


	Three Months Ended				Nine Months Ended
	September 27, 2014		September 28, 2013		September 27, 2014		September 28, 2013
Net sales:
United States	$	227,057	$	217,625	$	658,609	$	640,757
Other Europe, Middle East and Africa		37,797		33,048		116,308		105,309
Germany		21,656		20,860		69,926		66,212
Australia and Asia Pacific		10,099		7,913		30,156		23,358
Canada		6,655		6,400		19,619		19,426
Latin America		2,237		2,203		7,494		6,809

	$	305,501	$	288,049	$	902,112	$	861,871

16. SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

DJOFL and its direct wholly owned subsidiary, DJO Finco, jointly issued the 9.75% Notes, 7.75% Notes, 8.75% Notes and the 9.875% Notes. DJO Finco was formed solely to act as a co-issuer of the notes, has only nominal assets and does not conduct any operations. The Indentures generally prohibit DJO Finco from holding any assets, becoming liable for any obligations or engaging in any business activity.

The 8.75% Notes are jointly and severally, fully and unconditionally guaranteed, on a senior secured basis by all of DJOFL’s domestic subsidiaries (other than the co-issuer) that are 100% owned, directly or indirectly, by DJOFL (the Guarantors). The 9.875% Notes and the 7.75% Notes are guaranteed jointly and severally and on an unsecured senior basis by the Guarantors. The 9.75% Notes are jointly and severally, fully and unconditionally guaranteed, on an unsecured senior subordinated basis by the Guarantors. Our foreign subsidiaries (the Non-Guarantors) do not guarantee the notes.

The following tables present the financial position, results of operations and cash flows of DJOFL, the Guarantors, the Non-Guarantors and certain eliminations for the periods presented.

DJO Finance LLC

Unaudited Condensed Consolidating Balance Sheets

As of September 27, 2014

(in thousands)


	DJOFL			Guarantors		Non - Guarantors		Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	16,602		$	1,050	$	23,205	$	—		$	40,857
Accounts receivable, net		—			139,868		45,952					185,820
Inventories, net		—			139,515		39,561		(8,076	)		171,000
Deferred tax assets, net		—			27,122		348		—			27,470
Prepaid expenses and other current assets		29			30,665		6,589		—			37,283

Total current assets		16,631			338,220		115,655		(8,076	)		462,430
Property and equipment, net		—			106,475		12,994		(194	)		119,275
Goodwill		—			1,066,479		114,859		(36,125	)		1,145,213
Intangible assets, net		—			875,103		16,558		—			891,661
Investment in subsidiaries		1,297,699			1,686,557		59,243		(3,043,499	)		—
Intercompany receivables		860,468			—		—		(860,468	)		—
Other non-current assets		30,736			1,917		2,188		—			34,841

Total assets	$	2,205,534		$	4,074,751	$	321,497	$	(3,948,362	)	$	2,653,420


Liabilities and (Deficit) Equity
Current liabilities:
Accounts payable	$	—		$	50,933	$	10,881	$	—		$	61,814
Current portion of debt obligations		8,912			—		—		—			8,912
Other current liabilities		49,489			90,107		30,667		—			170,263

Total current liabilities		58,401			141,040		41,548		—			240,989
Long-term debt obligations		2,259,248			—		109		—			2,259,357
Deferred tax liabilities, net		—			240,342		6,171		—			246,513
Intercompany payables, net		—			579,702		164,486		(744,188	)		—
Other long-term liabilities		—			13,082		2,545		—			15,627

Total liabilities		2,317,649			974,166		214,859		(744,188	)		2,762,486
Noncontrolling interests		—			—		3,049		—			3,049
Total membership (deficit) equity		(112,115	)		3,100,585		103,589		(3,204,174	)		(112,115	)

Total liabilities and (deficit) equity	$	2,205,534		$	4,074,751	$	321,497	$	(3,948,362	)	$	2,653,420

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended September 27, 2014

(in thousands)


	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	266,323		$	77,165		$	(37,987	)	$	305,501
Cost of sales (exclusive of amortization of intangible assets of $8,645)		—			107,755			57,229			(42,288	)		122,696

Gross profit		—			158,568			19,936			4,301			182,805

Operating expenses:
Selling, general and administrative		—			100,205			23,347			—			123,552
Research and development		—			8,158			1,001			—			9,159
Amortization of intangible assets		—			22,337			896			—			23,233

		—			130,700			25,244			—			155,944

Operating income (loss)		—			27,868			(5,308	)		4,301			26,861

Other (expense) income:
Interest expense		(43,286	)		—			(15	)		—			(43,301	)
Interest income		4			21			(4	)		—			21
Loss on modification and extinguishment of debt		—			—			—			—			—
Other income, net		—			(177	)		(3,287	)		—			(3,464	)
Intercompany income (expense), net		—			356			(408	)		52			—
Equity in income of subsidiaries, net		22,075			—			—			(22,075	)		—

		(21,207	)		200			(3,714	)		(22,023	)		(46,744	)

(Loss) income before income taxes		(21,207	)		28,068			(9,022	)		(17,722	)		(19,883	)
Income tax provision		—			(843	)		(407	)		—			(1,250	)

Net (loss) income		(21,207	)		27,225			(9,429	)		(17,722	)		(21,133	)
Net income attributable to noncontrolling interests		—			—			(73	)		—			(73	)

Net (loss) income attributable to DJOFL	$	(21,207	)	$	27,225		$	(9,502	)	$	(17,722	)	$	(21,206	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Nine Months Ended September 27, 2014

(in thousands)


	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	776,095		$	236,754		$	(110,737	)	$	902,112
Cost of sales (exclusive of amortization of intangible assets of $25,980)		—			319,433			170,795			(124,317	)		365,911

Gross profit		—			456,662			65,959			13,580			536,201

Operating expenses:
Selling, general and administrative		—			296,955			77,855			—			374,810
Research and development		—			25,241			3,274			—			28,515
Amortization of intangible assets		—			67,092			3,200			—			70,292

		—			389,288			84,329			—			473,617

Operating income (loss)		—			67,374			(18,370	)		13,580			62,584

Other (expense) income:
Interest expense		(130,455	)		—			(215	)		—			(130,670	)
Interest income		14			112			26			—			152
Loss on modification and extinguishment of debt		(1,019	)		—			—			—			(1,019	)
Other income, net		—			(30	)		(2,902	)		—			(2,932	)
Intercompany income (expense), net		—			1,065			(1,161	)		96			—
Equity in income of subsidiaries, net		48,297			—			—			(48,297	)		—

		(83,163	)		1,147			(4,252	)		(48,201	)		(134,469	)

(Loss) income before income taxes		(83,163	)		68,521			(22,622	)		(34,621	)		(71,885	)
Income tax provision		—			(8,176	)		(2,452	)		—			(10,628	)

Net (loss) income		(83,163	)		60,345			(25,074	)		(34,621	)		(82,513	)
Net income attributable to noncontrolling interests		—			—			(649	)		—			(649	)

Net (loss) income attributable to DJOFL	$	(83,163	)	$	60,345		$	(25,723	)	$	(34,621	)	$	(83,162	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Three Months Ended September 27, 2014

(in thousands)


	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(21,207	)	$	27,225	$	(9,429	)	$	(17,722	)	$	(21,133	)

Other comprehensive loss, net of taxes:
Foreign currency translation adjustments, net of tax benefit of $2,449		—			—		(6,105	)		—			(6,105	)

Other comprehensive loss		—			—		(6,105	)		—			(6,105	)

Comprehensive (loss) income		(21,207	)		27,225		(15,534	)		(17,722	)		(27,238	)

Comprehensive loss attributable to noncontrolling interests		—			—		139			—			139

Comprehensive (loss) income attributable to DJO Finance LLC	$	(21,207	)	$	27,225	$	(15,395	)	$	(17,722	)	$	(27,099	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Nine Months Ended September 27, 2014

(in thousands)


	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(83,163	)	$	60,345	$	(25,074	)	$	(34,621	)	$	(82,513	)

Other comprehensive loss, net of taxes:
Foreign currency translation adjustments, net of tax benefit of $2,784		—			—		(8,010	)		—			(8,010	)

Other comprehensive loss		—			—		(8,010	)		—			(8,010	)

Comprehensive (loss) income		(83,163	)		60,345		(33,084	)		(34,621	)		(90,523	)

Comprehensive loss attributable to noncontrolling interests		—			—		(405	)		—			(405	)

Comprehensive (loss) income attributable to DJO Finance LLC	$	(83,163	)	$	60,345	$	(33,489	)	$	(34,621	)	$	(90,928	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 27, 2014

(in thousands)


	DJOFL			Guarantors			Non- Guarantors			Eliminations			Consolidated
Cash Flows from Operating Activities:
Net (loss) income	$	(83,163	)	$	60,345		$	(25,074	)	$	(34,621	)	$	(82,513	)

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation		—			21,889			4,589			(143	)		26,335
Amortization of intangible assets		—			67,092			3,200			—			70,292
Amortization of debt issuance costs and non-cash interest expense		6,438			—			—			—			6,438
Loss on modification and extinguishment of debt		1,019			—			—			—			1,019
Stock-based compensation expense		—			1,274			—			—			1,274
(Loss) gain on disposal of assets, net		—			(1,312	)		101			—			(1,211	)
Deferred income tax expense (benefit)		—			7,399			(591	)		(180	)		6,628
Equity in income of subsidiaries, net		(48,297	)		—			—			48,297			—

Changes in operating assets and liabilities:
Accounts receivable		—			1,253			(4,085	)		—			(2,832	)
Inventories		—			(8,218	)		7,317			(12,972	)		(13,873	)
Prepaid expenses and other assets		131			(12,719	)		3,915			(85	)		(8,758	)
Accounts payable and other current liabilities		19,817			24,277			(199	)		391			44,286

Net cash (used in) provided by operating activities		(104,055	)		161,280			(10,827	)		687			47,085

Cash Flows from Investing Activities:
Cash paid in connection with acquisitions, net of cash acquired		—			—			(4,587	)		—			(4,587	)
Purchases of property and equipment		—			(37,760	)		(3,854	)		119			(41,495	)
Other investing activities, net		—			(711	)		(276	)		—			(987	)

Net cash (provided by) used in investing activities		—			(38,471	)		(8,717	)		119			(47,069	)

Cash Flows from Financing Activities:
Intercompany		94,413			(116,427	)		22,822			(808	)		—
Proceeds from issuance of debt		952,294			—			—			—			952,294
Repayments of debt		(944,629	)		—			(91	)		—			(944,720	)
Payment of debt issuance costs		(1,812	)		—			—			—			(1,812	)
Payment of contingent consideration		—			(5,690	)		—			—			(5,690	)
Investment by parent		22			—			—			—			22
Cash paid in connection with the cancellation of vested options		(2,001	)		—			—			—			(2,001	)

Net cash provided by (used in) financing activities		98,287			(122,117	)		22,731			(808	)		(1,907	)
Effect of exchange rate changes on cash and cash equivalents		—			—			(830	)		—			(830	)

Net (decrease) increase in cash and cash equivalents		(5,768	)		692			2,357			(2	)		(2,721	)
Cash and cash equivalents at beginning of period		22,370			358			20,848			2			43,578

Cash and cash equivalents at end of period	$	16,602		$	1,050		$	23,205		$	—		$	40,857

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended September 28, 2013

(in thousands)


	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	255,209		$	66,384		$	(33,544	)	$	288,049
Cost of sales (exclusive of amortization of intangible assets of $8,809)		—			106,696			46,659			(35,195	)		118,160

Gross profit		—			148,513			19,725			1,651			169,889

Operating expenses:
Selling, general and administrative		—			89,966			22,597			3			112,566
Research and development		—			7,179			849			—			8,028
Amortization of intangible assets		—			22,589			1,331			—			23,920

		—			119,734			24,777			3			144,514

Operating income (loss)		—			28,779			(5,052	)		1,648			25,375

Other (expense) income:
Interest expense		(43,834	)		—			(8	)		—			(43,842	)
Interest income		4			17			8			—			29
Loss on modification and extinguishment of debt		—			—			—			—			—
Other income (expense), net		—			(175	)		1,045			—			870
Intercompany income (expense), net		—			11,408			(211	)		(11,197	)		—
Equity in income (loss) of subsidiaries, net		25,342			—			—			(25,342	)		—

		(18,488	)		11,250			834			(36,539	)		(42,943	)

(Loss) income before income taxes		(18,488	)		40,029			(4,218	)		(34,891	)		(17,568	)
Income tax provision		—			238			(1,045	)		—			(807	)

Net (loss) income		(18,488	)		40,267			(5,263	)		(34,891	)		(18,375	)
Net income attributable to noncontrolling interests					—			(113	)		—			(113	)

Net (loss) income attributable to DJOFL	$	(18,488	)	$	40,267		$	(5,376	)	$	34,891		$	(18,488	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Nine Months Ended September 28, 2013

(in thousands)


	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	749,036		$	208,780		$	(95,945	)	$	861,871
Cost of sales (exclusive of amortization of intangible assets of $26,368)		—			309,597			142,277			(105,113	)		346,761

Gross profit		—			439,439			66,503			9,168			515,110

Operating expenses:
Selling, general and administrative		—			279,339			68,827			9			348,175
Research and development		—			20,983			2,766			—			23,749
Amortization of intangible assets		—			67,571			4,024			—			71,595

		—			367,893			75,617			9			443,519

Operating income (loss)		—			71,546			(9,114	)		9,159			71,591

Other (expense) income:
Interest expense		(133,323	)		—			(89	)		—			(133,412	)
Interest income		12			63			42			—			117
Loss on modification and extinguishment of debt		(1,059	)		—			—			—			(1,059	)
Other income (expense), net		—			(252	)		(283	)		—			(535	)
Intercompany income (expense), net		—			12,115			(1,078	)		(11,037	)		—
Equity in income (loss) of subsidiaries, net		62,704			—			—			(62,704	)		—

		(71,666	)		11,926			(1,408	)		(73,741	)		(134,889	)

(Loss) income before income taxes		(71,666	)		83,472			(10,522	)		(64,582	)		(63,298	)
Income tax provision		—			(3,898	)		(3,947	)		—			(7,845	)

Net (loss) income		(71,666	)		79,574			(14,469	)		(64,582	)		(71,143	)
Net income attributable to noncontrolling interests		—			—			(523	)		—			(523	)

Net (loss) income attributable to DJOFL	$	(71,666	)	$	79,574		$	(14,992	)	$	(64,582	)	$	(71,666	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Three Months Ended September 28, 2013

(in thousands)


	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(18,488	)	$	40,267	$	(5,263	)	$	(34,891	)	$	(18,375	)

Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustments, net of tax provision of $1,407		—			—		2,739			—			2,739

Other comprehensive income		—			—		2,739			—			2,739

Comprehensive (loss) income		(18,488	)		40,267		(2,524	)		(34,891	)		(15,636	)

Comprehensive income attributable to noncontrolling interests		—			—		(212	)		—			(212	)

Comprehensive (loss) income attributable to DJO Finance LLC	$	(18,488	)	$	40,267	$	(2,736	)	$	(34,891	)	$	(15,848	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Nine Months Ended September 28, 2013

(in thousands)


	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(71,666	)	$	79,574	$	(14,469	)	$	(64,582	)	$	(71,143	)

Other comprehensive loss, net of taxes:
Foreign currency translation adjustments, net of tax provision of $538		—			—		(71	)		—			(71	)

Other comprehensive loss		—			—		(71	)		—			(71	)

Comprehensive (loss) income		(71,666	)		79,574		(14,540	)		(64,582	)		(71,214	)

Comprehensive income attributable to noncontrolling interests		—			—		(588	)		—			(588	)

Comprehensive (loss) income attributable to DJO Finance LLC	$	(71,666	)	$	79,574	$	(15,128	)	$	(64,582	)	$	(71,802	)

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 28, 2013

(in thousands)


	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Cash Flows from Operating Activities:
Net (loss) income	$	(71,666	)	$	79,574		$	(14,469	)	$	(64,582	)	$	(71,143	)

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation		—			20,524			3,804			(200	)		24,128
Amortization of intangible assets		—			67,571			4,024			—			71,595
Amortization of debt issuance costs and non-cash interest expense		5,955			—			—			—			5,955
Loss on modification and extinguishment of debt		1,059			—			—			—			1,059
Stock-based compensation expense		—			1,544			—			—			1,544
Loss on disposal of assets, net		—			222			654			—			876
Deferred income tax expense		—			2,525			241			—			2,766
Equity in income of subsidiaries, net		(62,704	)		—			—			62,704			—

Changes in operating assets and liabilities:
Accounts receivable		—			(9,985	)		(4,331	)		—			(14,316	)
Inventories		—			4,577			6,788			(6,470	)		4,895
Prepaid expenses and other assets		131			(1,471	)		(5,952	)		(4	)		(7,296	)
Accounts payable and other current liabilities		18,393			(1,194	)		1,748			193			19,140

Net cash (used in) provided by operating activities		(108,832	)		163,887			(7,493	)		(8,359	)		39,203

Cash Flows from Investing Activities:
Cash paid in connection with acquisitions, net of cash acquired		—			(191	)		(1,762	)		—			(1,953	)
Purchases of property and equipment		—			(19,699	)		(4,322	)		(22	)		(24,043	)
Other investing activities, net		—			(1,139	)		(294	)		—			(1,433	)

Net cash used in investing activities		—			(21,029	)		(6,378	)		(22	)		(27,429	)

Cash Flows from Financing Activities:
Intercompany		116,652			(144,671	)		19,643			8,376			—
Proceeds from issuance of debt		496,417			—			—			—			496,417
Repayments of debt and capital lease obligations		(503,727	)		—			—			—			(503,727	)
Payment of debt issuance costs		(2,387	)		—			—			—			(2,387	)

Net cash provided by (used in) financing activities		106,955			(144,671	)		19,643			8,376			(9,697	)
Effect of exchange rate changes on cash and cash equivalents		—			—			226			—			226

Net (decrease) increase in cash and cash equivalents		(1,877	)		(1,813	)		5,998			(5	)		2,303
Cash and cash equivalents at beginning of period		13,176			3,122			14,919			6			31,223

Cash and cash equivalents at end of period	$	11,299		$	1,309		$	20,917		$	1		$	33,526

DJO Finance LLC

Condensed Consolidating Balance Sheets

As of December 31, 2013

(in thousands)


	DJOFL			Guarantors		Non-Guarantors		Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	22,370		$	358	$	20,848	$	2		$	43,578
Accounts receivable, net		—			141,121		43,967		—			185,088
Inventories, net		—			126,529		33,439		(4,985	)		154,983
Deferred tax assets, net		—			27,286		241		—			27,527
Prepaid expenses and other current assets		160			16,469		10,596		726			27,951

Total current assets		22,530			311,763		109,091		(4,257	)		439,127
Property and equipment, net		—			93,229		14,834		(234	)		107,829
Goodwill		—			1,066,479		121,998		(39,146	)		1,149,331
Intangible assets, net		—			941,550		17,443		—			958,993
Investment in subsidiaries		1,297,699			1,686,557		62,344		(3,046,600	)		—
Intercompany receivables		911,630			—		—		(911,630	)		—
Other non-current assets		35,675			1,828		1,996		—			39,499

Total assets	$	2,267,534		$	4,101,406	$	327,706	$	(4,001,867	)	$	2,694,779


Liabilities and (Deficit) Equity
Current liabilities:
Accounts payable	$	—		$	45,639	$	10,736	$	(1	)	$	56,374
Current portion of debt obligations		8,620			—		—		—			8,620
Other current liabilities		29,673			77,220		31,564		697			139,154

Total current liabilities		38,293			122,859		42,300		696			204,148
Long-term debt obligations		2,251,167			—		—		—			2,251,167
Deferred tax liabilities, net		—			236,230		5,798		—			242,028
Intercompany payables, net		—			693,513		143,637		(837,150	)		—
Other long-term liabilities		—			13,820		2,898		—			16,718

Total liabilities		2,289,460			1,066,422		194,633		(836,454	)		2,714,061
Noncontrolling interests		—			—		2,644		—			2,644
Total membership (deficit) equity		(21,926	)		3,034,984		130,429		(3,165,413	)		(21,926	)

Total liabilities and (deficit) equity	$	2,267,534		$	4,101,406	$	327,706	$	(4,001,867	)	$	2,694,779

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

This management’s discussion and analysis of financial condition and results of operations is intended to provide an understanding of our results of operations, financial condition and where appropriate, factors that may affect future performance. The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and related notes thereto as well as the other financial data included elsewhere in this Form 10-Q.

Forward Looking Statements

This report, and the following management’s discussion and analysis, contain “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. To the extent that any statements are not recitations of historical fact, such statements constitute forward-looking statements that, by definition, involve risks and uncertainties. These statements can be identified because they use words like “anticipates”, “believes”, “estimates”, “expects”, “forecasts”, “future”, “intends”, “plans” and similar terms. Specifically, statements referencing, without limitation, growth in sales of our products, profit margins and the sufficiency of our cash flow for future liquidity and capital resource needs may be forward-looking statements. These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. The section entitled “Risk Factors” in our 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 25, 2014 describes these important risk factors that may affect our business, financial condition, results of operations, and/or liquidity. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors.

Overview of Business

We are a global developer, manufacturer and distributor of high-quality medical devices that provide solutions for musculoskeletal health, vascular health and pain management. Our products address the continuum of patient care from injury prevention to rehabilitation after surgery, injury or from degenerative disease, enabling people to regain or maintain their natural motion.

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. In addition, many of our medical devices and related accessories are used by athletes and patients for injury prevention and at-home physical therapy treatment. Our product lines include rigid and soft orthopedic bracing, hot and cold therapy, bone growth stimulators, vascular therapy systems and compression garments, therapeutic shoes and inserts, electrical stimulators used for pain management and physical therapy products. Our surgical implant business offers a comprehensive suite of reconstructive joint products for the hip, knee and shoulder.

Our products are marketed under a portfolio of brands including Aircast^®, DonJoy^®, ProCare^®, CMF™, Empi^®, Chattanooga, DJO Surgical, Dr. Comfort™, Compex^®, Bell-Horn™ and Exos™.

Operating Segments

We currently develop, manufacture and distribute our products through the following four operating segments:

Bracing and Vascular Segment

Recovery Sciences Segment

Our Recovery Sciences segment, which generates its revenues in the United States, is divided into four main businesses:

•

Surgical Implant Segment

International Segment

Our four operating segments enable us to reach a diverse customer base through multiple distribution channels and give us the opportunity to provide a wide range of medical devices and related products to orthopedic specialists and other healthcare professionals operating in a variety of patient treatment settings. These four segments constitute our reportable segments. See Note 15 to our Unaudited Condensed Consolidated Financial Statements for financial and other additional information regarding our segments.

The tables below present financial information for our reportable segments for the periods presented. Segment results exclude the impact of amortization of intangible assets, certain general corporate expenses, and non-recurring and integration charges.


	Three Months Ended						Nine Months Ended
($ in thousands)	September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Bracing and Vascular:
Net sales	$	129,218		$	120,947		$	366,977		$	348,455
Gross profit		68,936			61,689			193,544			178,345
Gross profit margin		53.3	%		51.0	%		52.7	%		51.2	%
Operating income		26,275			22,537			71,846			62,942
Operating income as a percent of net segment sales		20.3	%		18.6	%		19.6	%		18.1	%

Recovery Sciences:
Net sales	$	74,009		$	76,654		$	218,790		$	229,413
Gross profit		55,697			57,298			164,911			172,168
Gross profit margin		75.3	%		74.7	%		75.4	%		75.0	%
Operating income		20,149			21,088			59,292			59,501
Operating income as a percent of net segment sales		27.2	%		27.5	%		27.1	%		25.9	%

Surgical Implant:
Net sales	$	23,830		$	20,025		$	72,842		$	62,890
Gross profit		18,026			13,915			54,242			45,001
Gross profit margin		75.6	%		69.5	%		74.5	%		71.6	%
Operating income		2,801			1,020			8,430			5,410
Operating income as a percent of net segment sales		11.8	%		5.1	%		11.6	%		8.6	%

International:
Net sales	$	78,444		$	70,423		$	243,503		$	221,113
Gross profit		43,871			37,844			134,780			122,828
Gross profit margin		55.9	%		53.7	%		55.4	%		55.5	%
Operating income		15,834			11,471			46,110			42,086
Operating income as a percent of net segment sales		20.2	%		16.3	%		18.9	%		19.0	%

Results of Operations

The following table sets forth our statements of operations as a percentage of net sales ($ in thousands):


	Three Months Ended										Nine Months Ended
	September 27, 2014					September 28, 2013					September 27, 2014					September 28, 2013
Net sales	$	305,501		100.0	%	$	288,049		100.0	%	$	902,112		100.0	%	$	861,871		100.0	%
Cost of sales(1)		122,696		40.2			118,160		41.0			365,911		40.6			346,761		40.2

Gross profit		182,805		59.8			169,889		59.0			536,201		59.4			515,110		59.8

Operating expenses:
Selling, general and administrative		123,552		40.4			112,566		39.1			374,810		41.5			348,175		40.4
Research and development		9,159		3.0			8,028		2.8			28,515		3.2			23,749		2.8
Amortization of intangible assets		23,233		7.6			23,920		8.3			70,292		7.8			71,595		8.3

		155,944		51.0			144,514		50.2			473,617		52.5			443,519		51.5

Operating income		26,861		8.8			25,375		8.8			62,584		6.9			71,591		8.3

Other income (expense):
Interest expense		(43,301	)	(14.2	)		(43,842	)	(15.2	)		(130,670	)	(14.5	)		(133,412	)	(15.5	)
Interest income		21		0.0			29		0.0			152		0.0			117		0.0
Loss on modification of debt		—		—			—		—			(1,019	)	(0.1	)		(1,059	)	(0.1	)
Other (expense) income, net		(3,464	)	(1.1	)		870		0.3			(2,932	)	(0.3	)		(535	)	(0.0	)

		(46,744	)	(15.3	)		(42,943	)	(14.9	)		(134,469	)	(14.9	)		(134,889	)	(15.6	)

Loss before income taxes		(19,883	)	(6.5	)		(17,568	)	(6.1	)		(71,885	)	(8.0	)		(63,298	)	(7.3	)
Income tax provision		(1,250	)	(0.4	)		(807	)	(0.3	)		(10,627	)	(1.1	)		(7,845	)	(0.9	)

Net loss		(21,133	)	(6.9	)		(18,375	)	(6.4	)		(82,512	)	(9.1	)		(71,143	)	(8.2	)
Net income attributable to noncontrolling interests		(73	)	(0.0	)		(113	)	(0.0	)		(649	)	(0.1	)		(523	)	(0.1	)

Net loss attributable to DJO Finance LLC	$	(21,206	)	(6.9	)%	$	(18,488	)	(6.4	)%	$	(83,161	)	(9.2	)	$	(71,666	)	(8.3	)%

(1)	Cost of sales is exclusive of amortization of intangible assets of $8,645 and $25,980 for the three and nine months ended September 27, 2014, respectively, and $8,809 and $26,368 for three and nine months ended September 28, 2013, which is included in operating expenses.

Three Months Ended September 27, 2014 (third quarter 2014) compared to Three Months Ended September 28, 2013 (third quarter 2013)

Net Sales. Our net sales for third quarter 2014 were $305.5 million, compared to net sales of $288.0 million for third quarter 2013, representing a 6.1% increase year over year. The impact of foreign currency was minimal for the third quarter 2014 when compared to the third quarter 2013.

The following table sets forth the mix of our net sales by business segment ($ in thousands):


	Third Quarter 2014		% of Net Sales			Third Quarter 2013		% of Net Sales			Increase (Decrease)			% Increase (Decrease)
Bracing and Vascular	$	129,218		42.3	%	$	120,947		42.0	%	$	8,271			6.8	%
Recovery Sciences		74,009		24.2			76,654		26.6			(2,645	)		(3.5	)
Surgical Implant		23,830		7.8			20,025		7.0			3,805			19.0
International		78,444		25.7			70,423		24.4			8,021			11.4

	$	305,501		100.0	%	$	288,049		100.0	%	$	17,452			6.1	%

Net sales in our Bracing and Vascular segment were $129.2 million for third quarter 2014, increasing 6.8% from net sales of $120.9 million for third quarter 2013. Growth in net sales in this segment is being driven by sales of new bracing and compression system products, as well as new account acquisition in our OfficeCare business.

Net sales in our Recovery Sciences segment were $74.0 million for third quarter 2014, decreasing 3.5% from net sales of $76.7 million for third quarter 2013. The decrease was primarily driven by changes in reimbursement for certain products in our Empi business unit and slower than anticipated sales in our CMF business unit.

Net sales in our Surgical Implant segment were $23.8 million for third quarter 2014, increasing 19.0% from net sales of $20.0 million for third quarter 2013. The increase was driven by strong sales of our shoulder products as well as sales of new hip products and overall strong sales execution.

Net sales in our International segment were $78.4 million for third quarter 2014, increasing 11.4% from net sales of $70.4 million for third quarter 2013. Growth in net sales in this segment is being driven by sales from new products, improved sales execution and increased sales penetration in certain geographies.

Gross Profit. Consolidated gross profit as a percentage of net sales was 59.8% for third quarter 2014, compared to 59.0% for third quarter 2013. The increase was primarily due to lower costs related to procurement and manufacturing efficiencies. Third quarter 2013 was impacted by higher inventory write-offs.

Gross profit in our Bracing and Vascular segment as a percentage of net sales was 53.3% for third quarter 2014, compared to 51.0% for third quarter 2013. The increase was primarily due to mix of higher margin products sold and lower costs related to procurement and manufacturing efficiencies.

Gross profit in our Recovery Sciences segment as a percentage of net sales increased to 75.3% for third quarter 2014, compared to 74.7% for third quarter 2013. The increase was primarily due to mix of products sold.

Gross profit in our Surgical Implant segment as a percentage of net sales increased to 75.6% for third quarter 2014, compared to 69.5% for third quarter 2013. The increase was primarily due to lower costs related to procurement and manufacturing efficiencies.

Gross profit in our International segment as a percentage of net sales increased to 55.9% for third quarter 2014, compared to 53.7% for third quarter 2013. The increase was primarily due to mix of products sold.

Selling, General and Administrative (SG&A). SG&A expenses increased to $123.6 million for third quarter 2014, from $112.6 million in third quarter 2013. As a percentage of sales, SG&A expenses increased to 40.4% for third quarter 2014, compared to 39.1% for third quarter 2013. The increase was driven by higher variable selling costs due to a relative increase in sales for the Bracing and Vascular and Surgical Implant segments, an increase in accounts receivable allowance for doubtful accounts in our reimbursement channels due to a trend over the past two quarters in slower collections and uncertainty as to the continuation and duration of such trend. This increase was offset by strong expense control measures.

Our SG&A expenses are impacted by significant non-recurring integration charges and other adjustments related to our ongoing restructuring activities and acquisitions. We incurred the following SG&A expenses in connection with such activities during the periods presented (in thousands):


	Third Quarter 2014			Third Quarter 2013
Integration charges:
Commercial and global business unit reorganization and integration	$	269		$	864
Acquisition related expenses and integration		23			433
CFO transition		(1	)		1,386
Litigation and regulatory costs and settlements, net		1,813			223
Other non-recurring items		811			160
Automation projects		924			1,754

	$	3,839		$	4,820

Research and Development (R&D). R&D expenses increased to $9.2 million for third quarter 2014, from $8.0 million in third quarter 2013. As a percentage of sales, R&D expense increased to 3.0% in third quarter 2014 from 2.8% in third quarter 2013, reflecting an increase in our new product development activities.

Amortization of Intangible Assets. Amortization of intangible assets decreased to $23.2 million for third quarter 2014, from $23.9 million for third quarter 2013. The decrease is due to certain intangible assets reaching full amortization, partially offset by an increase in intangible assets resulting from our acquisition of Speetec. See Note 2 to our Unaudited Condensed Consolidated Financial Statements for additional information regarding our acquisition of Speetec.

Interest Expense. Our interest expense decreased to $43.3 million for third quarter 2014, from $43.8 million for third quarter 2013. The decrease is due to lower weighted average interest rates on outstanding borrowings.

Other Income (Expense), Net. Other (expense) income, net increased to expense of $3.5 million for third quarter 2014, from income of $0.9 million for third quarter 2013. Results for both periods presented primarily represent net realized and unrealized foreign currency transaction gains and losses.

Income Tax Provision. We recorded an income tax expense of $1.3 million on a pre-tax loss of $19.9 million, resulting in a negative effective tax rate of 6.3% in third quarter 2014. For third quarter 2013, we recorded income tax expense of $0.8 million on pre-tax losses of $17.6 million, resulting in a negative effective tax rate of 4.6%. Our effective tax rates are negative primarily because of valuation allowances recorded against our U.S. federal and state net operating losses.

Nine Months Ended September 27, 2014 (nine months 2014) compared to Nine Months Ended September 28, 2013 (nine months 2013)

Net Sales. Our net sales for nine months 2014 were $902.1 million, compared to net sales of $861.9 million for nine months 2013, representing a 4.7% increase year over year. Excluding a favorable impact related to changes in foreign exchange rates in effect in nine months 2014 compared to the rates in effect in nine months 2013, net sales increased by $37.2 million, or 4.3%, to $899.1 million for nine months 2014 from $861.9 for nine months 2013.

The following table sets forth the mix of our net sales by business segment ($ in thousands):


	Nine Months 2014		% of Net Sales			Nine Months 2013		% of Net Sales			Increase (Decrease)			% Increase (Decrease)
Bracing and Vascular	$	366,977		40.7	%	$	348,455		40.4	%		18,522			5.3	%
Recovery Sciences		218,790		24.2			229,413		26.6			(10,623	)		(4.6	)
Surgical Implant		72,842		8.1			62,890		7.3			9,952			15.8
International		243,503		27.0			221,113		25.7			22,390			10.1

	$	902,112		100.0	%	$	861,871		100.0	%	$	40,241			4.7	%

Net sales in our Bracing and Vascular segment were $367.0 million for nine months 2014, increasing 5.3% from net sales of $348.5 million for nine months 2013. Growth in net sales in this segment is being driven by sales of new bracing and compression system products, as well as new account acquisition in our OfficeCare business.

Net sales in our Recovery Sciences segment were $218.8 million for nine months 2014, decreasing 4.6% from net sales of $229.4 million for nine months 2013. The decrease was primarily driven by changes in reimbursement for certain products in our Empi business unit and slower than anticipated sales in our CMF business unit.

Net sales in our Surgical Implant segment were $72.8 million for nine months 2014, increasing 15.8% from net sales of $62.9 million for nine months 2013. The increase was driven by strong sales of our shoulder products as well as sales of new hip products. and overall strong sales execution.

Net sales in our International segment were $243.5 million for nine months 2014, increasing 10.1% from net sales of $221.1 million for nine months 2013. Excluding a favorable impact of $3.1 million related to changes in foreign exchange rates in effect in nine months 2014 compared to the rates in effect in nine months 2013, net sales for nine months 2014 for the International segment increased 8.7% compared to net sales for nine months 2013. Growth in net sales in this segment is being driven by sales from new products, improved sales execution and increased sales penetration in certain geographies.

Gross Profit. Consolidated gross profit as a percentage of net sales was relatively consistent at 59.4% for nine months 2014, compared to 59.8% for nine months 2013.

Gross profit in our Bracing and Vascular segment as a percentage of net sales was 52.7% for nine months 2014, compared to 51.2% for nine months 2013. The increase was primarily due to mix of higher margin products sold and lower costs related to procurement and manufacturing efficiencies.

Gross profit in our Recovery Sciences segment as a percentage of net sales was 75.4% for nine months 2014, compared to 75.0% for nine months 2013. The increase was primarily due to a mix of products sold.

Gross profit in our Surgical Implant segment as a percentage of net sales increased to 74.5% for nine months 2014, compared to 71.6% for nine months 2013. The increase was primarily due to lower costs related to procurement and manufacturing efficiencies.

Gross profit in our International segment as a percentage of net sales remained consistent at 55.4% for nine months 2014, compared to 55.5% for nine months 2013. The decrease was primarily due to a lower margin mix of products sold.

Selling, General and Administrative (SG&A). SG&A expenses increased to $374.8 million for nine months 2014, from $348.2 million in nine months 2013. As a percentage of sales, SG&A expenses increased to 41.5% for nine months 2014, compared to 40.4% for nine months 2013. The increase was driven by higher variable selling costs due to a relative increase in sales for the Bracing and Vascular and Surgical Implant segments, an increase in accounts receivable allowance for doubtful accounts in our reimbursement channels due to a trend over the past two quarters in slower collections and uncertainty as to the continuation and duration of such trend, and an increase in reorganization and integration costs.


	Nine Months 2014		Nine Months 2013
Integration charges:
Commercial and global business unit reorganization and integration	$	6,218	$	2,897
Acquisition related expenses and integration		319		1,002
CFO transition		227		1,386
Litigation and regulatory costs and settlements, net		4,473		4,164
Other non-recurring items		4,319		1,356
Automation projects		4,656		3,375

	$	20,212	$	14,180

Research and Development (R&D). R&D expenses increased to $28.5 million for nine months 2014, from $23.8 million in nine months 2013. As a percentage of sales, R&D expense increased to 3.2% in nine months 2014 from 2.8% in nine months 2013, reflecting an increase in our new product development activities.

Amortization of Intangible Assets. Amortization of intangible assets decreased to $70.3 million for nine months 2014, from $71.6 million for nine months 2013. The decrease is due to certain intangible assets reaching full amortization, partially offset by an increase in intangible assets resulting from our acquisition of Speetec.

Interest Expense. Our interest expense decreased to $130.7 million for nine months 2014, from $133.4 million for nine months 2013. The decrease is due to lower weighted average interest rates on outstanding borrowings.

Loss on Modification and Extinguishment of Debt. Loss on modification and extinguishment of debt for nine months 2014 consists of $0.4 million of arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.6 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of our original term loans which were extinguished. Loss on modification and extinguishment of debt for nine months 2013 consists of $0.9 million in arrangement and amendment fees and other fees and expenses incurred in connection with the March 2013 amendment of our senior secured credit facilities and $0.2 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with term loans which were extinguished.

Other (Expense)Income, Net. Other (expense) income, net increased to expense of $2.9 million for nine months 2014, from expense of $0.5 million for nine months 2013. Results for both periods presented primarily represent net realized and unrealized foreign currency transaction gains and losses.

Income Tax Provision. We recorded an income tax expense of $10.6 million on a pre-tax loss of $71.9 million, resulting in a negative effective tax rate of 14.8% in nine months 2014. For nine months 2013, we recorded income tax expense of $7.8 million on pre-tax losses of $63.3 million, resulting in a negative effective tax rate of 12.4%. Our effective tax rates are negative primarily because of valuation allowances recorded against our U.S. federal and state net operating losses.

Liquidity and Capital Resources

As of September 27, 2014, our primary sources of liquidity consisted of cash and cash equivalents totaling $40.9 million and our $100.0 million revolving credit facility, of which $89.5 million was available. Our revolving credit balance was $10.0 million as of September 27, 2014 and we have provided a $0.5 million letter of credit related to collateral requirements under our product liability insurance policy. Working capital at September 27, 2014 was $221.4 million.

We believe that our existing cash, plus the amounts we expect to generate from operations and amounts available through our revolving credit facility, will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures, and debt and interest repayment obligations. While we currently believe that we will be able to meet all of the financial covenants imposed by our senior secured credit facilities, there is no assurance that we will in fact be able to do so or that, if we do not, we will be able to obtain from our lenders waivers of default or amendments to the senior secured credit facilities in the future. We and our subsidiaries, affiliates, or significant shareholders (including Blackstone and its affiliates) 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 or open market transactions, by tender offer or otherwise.

Cash Flows

A summary of our cash flow activity is presented below (in thousands):


	Nine Months 2014			Nine Months 2013
Cash provided by operating activities	$	47,085		$	39,203
Cash used in investing activities		(47,069	)		(27,429	)
Cash used in financing activities		(1,907	)		(9,697	)
Effect of exchange rate changes on cash and cash equivalents		(830	)		226

Net (decrease) increase in cash and cash equivalents	$	(2,721	)	$	2,303

Operating activities provided $47.1 million and $39.2 million of cash in nine months 2014 and nine months 2013, respectively, reflecting our net loss adjusted for non-cash expenses and changes in working capital. Cash paid for interest was $104.0 million and $109.0 million, respectively.

Investing activities used $47.1 million and $27.4 million of cash in nine months 2014 and nine months 2013, respectively. Cash used in investing activities for nine months 2014 primarily consisted of $41.5 million for purchases of property and equipment for Surgical Implant instruments to support growth, new product introductions, innovations and cost savings and $4.6 million related to the acquisition of Speetec. Cash used in investing activities for nine months 2013 primarily consisted of $24.0 million for purchases of property and equipment and $2.0 million related to the acquisition of assets from our vascular distributors in Australia and South Africa.

Financing activities used $1.9 million and $9.7 million of cash in nine months 2014 and nine months 2013, respectively. Cash used in financing activities in nine months 2014 consisted of proceeds from the borrowings under our revolving credit facility and our senior secured credit facility, offset by payments of the senior secured credit facility, payments related to the repurchase of Rollover Options from our former chief financial officer upon her departure, and payment of contingent consideration related to the acquisition of Exos. Cash provided in financing activities in nine months 2013 consisted of proceeds from the borrowings under our revolving credit facility and our senior secured credit facility, offset by payments of the senior secured credit facility.

For the remainder of 2014, we expect to spend cash of approximately $70.7 million for the following investing and financing activities:

•

$9.5 million for capital expenditures;

•

$13.2 million for scheduled principal and estimated interest payments on our senior secured credit facilities; and

•

$48.0 million for scheduled interest payments on our 8.75% Notes, 9.875% Notes, 7.75% Notes and 9.75% Notes

Indebtedness

As of September 27, 2014, we had $2,269.1 million in aggregate indebtedness outstanding, exclusive of a net unamortized original issue discount of $0.9 million. The principal amount and carrying value of our debt was as follows for September 27, 2014 and December 31, 2013 (in thousands):


	September 27, 2014				December 31, 2013
	Principal Amount		Carrying Value		Principal Amount		Carrying Value
Senior secured credit facilities:
Revolving credit facility	$	10,000	$	10,000	$	38,000	$	38,000
Term loans		889,017		883,496		853,400		846,297

		899,017		893,496		891,400		884,297

Note financing:
8.75% second priority senior secured notes		330,000		334,664		330,000		335,490
9.875% senior unsecured notes		440,000		440,000		440,000		440,000
7.75% senior unsecured notes		300,000		300,000		300,000		300,000
9.75% senior subordinated notes		300,000		300,000		300,000		300,000

		1,370,000		1,374,664		1,370,000		1,375,490

Other debt:		109		109		—		—

Total indebtedness	$	2,269,126	$	2,268,269	$	2,261,400	$	2,259,787

Senior Secured Credit Facilities. Term loans outstanding under our senior secured credit facilities at September 27, 2014 consist of $889.0 million of term loans which mature on September 15, 2017. Of the $100.0 million total revolving credit facility which matures on March 15, 2017, $89.5 million was available. Our revolving credit balance was $10.0 million at September 27, 2014 and we have provided a $0.5 million letter of credit related to collateral requirements under our product liability insurance policy.

The interest rate margins applicable to borrowings under the senior secured revolving credit facilities are, at our option, either (a) the Eurodollar rate, plus 325 basis points or (b) a base rate determined by reference to the highest of (1) the prime rate, (2) the federal funds rate, plus 0.50% and (3) the Eurodollar rate for a one-month interest period, plus, in each case, 325 basis points. The interest rate margins applicable to the New Tranche B Term Loans are, at our option, either (a) the Eurodollar rate plus 325 basis points or (b) a base rate plus 325 basis points. There is a minimum LIBOR rate applicable to the Eurodollar component of interest rates on New Tranche B Term Loans of 1.00%. The applicable margin for borrowings under the senior secured revolving credit facilities may be reduced, subject to our attaining certain leverage ratios. As of September 27, 2014, our weighted average interest rate for all borrowings under the senior secured credit facilities was 4.24%.

We are required to pay annual payments in equal quarterly installments on the term loans in an amount equal to 1.00% of the funded total principal amount through June 2017, with any remaining amount payable in full at maturity in September 2017.

Note Financing. Our outstanding notes mature at various dates in 2017 and 2018. Assuming we are in compliance with the terms of the indentures governing the notes, we are not required to repay principal related to any of the notes prior to the final maturity dates of the notes. We pay interest semi-annually on the notes.

See Note 9 to our Unaudited Condensed Consolidated Financial Statements for additional information regarding our indebtedness.

Certain Covenants and Related Compliance. Pursuant to the terms of the senior secured credit facilities, we are required to maintain a maximum senior secured first lien leverage ratio of consolidated first lien net debt to Adjusted EBITDA of 4.75:1 for the trailing twelve months ended September 27, 2014. Adjusted EBITDA is defined as net income (loss) attributable to DJOFL, plus interest expense, net, income tax (provision) benefit and depreciation and amortization, further adjusted for certain non-cash items, non-recurring items and other adjustment items, as permitted in calculating covenant compliance under our senior secured credit facilities and the Indentures governing our 8.75% Notes, 9.875% Notes, 7.75% Notes and 9.75% Notes (collectively, the Notes). Adjusted EBITDA is a material component of these covenants. As of September 27, 2014, our actual senior secured first lien leverage ratio was within the required ratio at 3.11:1. Adjusted EBITDA should not be considered as an alternative to net income or other performance measures presented in accordance with GAAP, or as an alternative to cash flow from operations as a measure of our liquidity. Adjusted EBITDA does not represent net income (loss) or cash flow from operations as those terms are defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. In particular, the definition of Adjusted EBITDA in the Indentures and our senior secured credit facilities allows us to add back certain non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net loss. However, these are expenses that may recur, vary greatly and are difficult to predict. While Adjusted EBITDA and similar measures are frequently used as measures of operations and the ability to meet debt service requirements, Adjusted EBITDA is not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation.

Under the Indentures governing the Notes, our ability to incur additional debt, subject to specified exceptions, is tied to either improving the ratio of our Adjusted EBITDA to fixed charges or having this ratio be at least 2.00:1 on a pro forma basis after giving effect to such incurrence. Additionally, our ability to make certain restricted payments is also tied to having an Adjusted EBITDA to fixed charges ratio of at least 2.00:1 on a pro forma basis, as defined, subject to specified exceptions. Our ratio of Adjusted EBITDA to fixed charges for the twelve months ended September 27, 2014, measured on that date, was 1.64:1. Notwithstanding these limitations, the aggregate amount of term loan increases and revolving commitment increases shall not exceed the greater of (i) $150.0 million and (ii) the additional aggregate amount of secured indebtedness which would be permitted to be incurred as of any date of determination (assuming for this purpose that the full amount of any revolving credit increase had been utilized as of such date) such that, after giving pro forma effect to such incurrence (and any other transactions consummated on such date), the senior secured leverage ratio for the immediately preceding test period would not be greater than 4.75:1. Fixed charges is defined in the Indentures as consolidated interest expense plus all cash dividends or other distributions paid on any series of preferred stock of any restricted subsidiary and all dividends or other distributions accrued on any series of disqualified stock.

As described above, our senior secured credit facilities and the Notes governed by the Indentures represent significant components of our capital structure. Under the senior secured credit facilities, we are required to maintain compliance with a specified senior secured first lien leverage ratio and which ratio is determined based on our Adjusted EBITDA. If we fail to comply with the senior secured first lien leverage ratio under our senior secured credit facilities, we would be in default. Upon the occurrence of an event of default under the senior secured credit facilities, the lenders could elect to declare all amounts outstanding under the senior secured credit facilities to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under the senior secured credit facilities could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all of our assets as collateral under the senior secured credit facilities. Any acceleration under the senior secured credit facilities would also result in a default under the Indentures governing the Notes, which could lead to the note holders electing to declare the principal, premium, if any, and interest on the then outstanding Notes immediately due and payable. In addition, under the Indentures governing the Notes, our and our subsidiaries’ ability to engage in activities such as incurring additional indebtedness, making investments, refinancing subordinated indebtedness, paying dividends and entering into certain merger transactions is governed, in part, by our ability to satisfy tests based on Adjusted EBITDA.

Our ability to meet the covenants specified above will depend on future events, some of which are beyond our control, and we cannot assure you that we will meet those covenants. A breach of any of these covenants in the future could result in a default under our senior secured credit facilities and the Indentures, at which time the lenders could elect to declare all amounts outstanding under our senior secured credit facilities to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.

The following table provides a reconciliation from our net loss to Adjusted EBITDA for the three and nine months ended September 27, 2014 and September 28, 2013 and the twelve months ended September 27, 2014 (in thousands). The terms and related calculations are defined in the Credit Agreement and the Indentures.


	Three Months Ended						Nine Months Ended						Twelve Months Ended September 27, 2014
	September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013			Twelve Months Ended September 27, 2014
Net loss attributable to DJO Finance LLC	$	(21,206	)	$	(18,488	)	$	(83,162	)	$	(71,666	)	$	(214,948	)
Interest expense, net		43,280			43,813			130,519			133,295			174,766
Income tax provision		1,249			807			10,627			7,845			15,898
Depreciation and amortization		32,367			32,698			96,626			95,723			129,569
Non-cash charges (a)		402			(2,090	)		162			(15	)		107,363
Non-recurring and integration charges (b)		8,797			5,857			35,203			17,426			48,377
Other adjustment items (c)		5,350			1,057			10,061			7,564			12,998

Adjusted EBITDA	$	70,239		$	63,654		$	200,036		$	190,172		$	274,023

(a)	Non-cash items are comprised of the following (in thousands):


	Three Months Ended					Nine Months Ended						Twelve Months Ended September 27, 2014
	September 27, 2014		September 28, 2013			September 27, 2014			September 28, 2013			Twelve Months Ended September 27, 2014
Stock compensation expense	$	343	$	291		$	1,274		$	1,544		$	1,885
Impairment of goodwill and intangible assets		—		—			—			—			106,600
Loss (gain) on disposal of fixed assets and assets held for sale, net		59		—			(1,344	)		(1	)		(1,344	)
Purchase accounting adjustments (1)		—		(2,381	)		232			(1,558	)		222

Total non-cash charges	$	402	$	(2,090	)	$	162		$	(15	)	$	107,363

(1)	Purchase accounting adjustments for the twelve months ended September 28, 2013 consist of $0.1 million of amortization of fair market value inventory adjustments, net of $2.5 million in adjustments to the contingent consideration for Exos.

(b)	Non-recurring and integration charges are comprised of the following (in thousands):


	Three Months Ended					Nine Months Ended				Twelve Months Ended September 27, 2014
	September 27, 2014			September 28, 2013		September 27, 2014		September 28, 2013		Twelve Months Ended September 27, 2014
Integration charges:
Commercial and global business unit reorganization and integration	$	655		$	1,517	$	8,481	$	4,256	$	11,302
Acquisition related (credits) expenses and integration (1)		23			470		322		1,708		477
CFO transition		(1	)		1,386		227		1,386		514
Litigation and regulatory costs and settlements, net (2)		1,824			340		4,495		4,800		3,601
Other non-recurring items (3)		5,372			390		17,022		1,901		25,652
Automation projects		924			1,754		4,656		3,375		6,831

Total non-recurring and integration charges	$	8,797		$	5,857	$	35,203	$	17,426	$	48,377

(1)	Consists of direct acquisition costs and integration expenses related to acquired businesses and costs related to potential acquisitions.

(2)

For the twelve months ended September 27, 2014, litigation and regulatory costs consisted of $0.7 million in litigation costs related to ongoing product liability issues related to our discontinued pain pump products, $4.8 million related to other litigation and regulatory costs and settlements, net of $1.0 million received related to an indemnity claim from a third party pain pump manufacturer and a settlement with its insurance carrier, and a $0.9 million favorable cost estimate adjustment for the post-market surveillance study required by the FDA related to our discontinued metal-on-metal hip implant products.

(3)

For the twelve months ended September 27, 2014, other non-recurring items consist of $8.0 million in incremental Empi bad debt expense related to the Medicare CLBP decision, $12.6 million in specifically identified non-recurring operational and regulatory projects, $2.6 million in expenses related to our Tunisia factory fire and $2.4 million in professional fees and other non-recurring charges.

(c)	Other adjustment items before permitted pro forma adjustments are comprised of the following (in thousands):


	Three Months Ended					Nine Months Ended				Twelve Months Ended September 27, 2014
	September 27, 2014		September 28, 2013			September 27, 2014		September 28, 2013		Twelve Months Ended September 27, 2014
Blackstone monitoring fees	$	1,750		1,750		$	5,250	$	5,250	$	7,000
Non-controlling interests		74		114			649		524		1,015
Loss on modification and extinguishment of debt (1)		—		—			1,019		1,059		1,019
Other (2)		3,526		(807	)		3,143		731		3,964

Total other adjustment items	$	5,350	$	1,057		$	10,061	$	7,564	$	12,998

(1)

Loss on modification and extinguishment of debt for the twelve months ending September 27, 2014 consists of $0.4 million of arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.6 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of our original term loans which were extinguished. Loss on modification and extinguishment of debt for the nine months ending September 28, 2013 consists of $0.9 million in arrangement and amendment fees and other fees and expenses incurred in connection with the March 2013 amendment of our senior secured credit facilities and $0.2 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with term loans which were extinguished.

(2)	Other adjustments consist primarily of net realized and unrealized foreign currency transaction gains and losses.

Critical Accounting Policies and Estimates

We have disclosed in our Unaudited Condensed Consolidated Financial Statements and in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2013 Annual Report on Form 10-K, those accounting policies that we consider to be significant in determining our results of operations and financial condition. There have been no material changes to those policies that we consider to be significant since the filing of our 2013 Annual Report on Form 10-K. We believe that the accounting principles utilized in preparing our Unaudited Condensed Consolidated Financial Statements conform in all material respects to GAAP.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certain market risks as part of our ongoing business operations, primarily from fluctuating interest rates and foreign currency exchange 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 have historically managed our interest rate risk by including components of both fixed and variable debt in our capital structure. For our fixed rate debt, interest rate changes may affect the 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 not affect the fair market value of the debt, but do impact future earnings and cash flow, assuming other factors are constant. As of September 27, 2014, we have $1,370.0 million of aggregate principal amount of fixed rate notes and $899.0 million of borrowings under the senior secured credit facilities which bear interest at floating rates based on the Eurodollar rate, as defined therein. A hypothetical 100 basis point increase in variable interest rates for the floating rate borrowings under our senior secured credit facilities would have impacted our earnings and cash flow for the nine months ended September 27, 2014 by $1.1 million. Our term loans are subject to a 1.00% minimum LIBOR rate which is higher than the actual LIBOR rate of 0.15% as of September 27, 2014. Accordingly, a hypothetical 100 basis point increase in the LIBOR rate during the nine months ended September 27, 2014 would have increased the rate applicable to our variable debt by only 0.15%. We may use derivative financial instruments where appropriate to manage our interest rate risk. However, as a matter of policy, we do not enter into derivative or other financial investments for trading or speculative purposes.

Foreign Currency Risk

Due to the global reach of our business, we are exposed to market risk from changes in foreign currency exchange rates, particularly with respect to the U.S. dollar compared to the Euro and the Mexican Peso (MXN). Our wholly owned foreign subsidiaries are consolidated into our financial results and are subject to risks typical of an international business including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange volatility. To date, we have not used international currency derivatives to hedge against our investment in our European subsidiaries or their operating results, which are converted into U.S. Dollars at period-end and average foreign exchange rates, respectively. However, as we continue to expand our business through acquisitions and organic growth, the sales of our products that are denominated in foreign currencies has increased, as well as the costs associated with our foreign subsidiaries which operate in currencies other than the U.S. dollar. Accordingly, our future results could be materially impacted by changes in these or other factors.

For the three and nine months ended September 27, 2014, sales denominated in foreign currencies accounted for 22.4% and 24.4% of our consolidated net sales, respectively, of which 15.6% and 17.4%, respectively, were denominated in the Euro. In addition, our exposure to fluctuations in foreign currencies arises because certain of our subsidiaries enter into purchase or sale transactions using a currency other than its functional currency. Accordingly, our future results could be materially impacted by changes in foreign exchange rates or other factors. Occasionally, we seek to reduce the potential impact of currency fluctuations on our business through hedging transactions. During the nine months ended September 27, 2014, we utilized MXN foreign exchange forward contracts to hedge a portion of our exposure to fluctuations in foreign exchange rates, as our Mexico-based manufacturing operations incur costs that are largely denominated in MXN (see Note 7 to our Unaudited Condensed Consolidated Financial Statements). These foreign exchange forward contracts expire weekly throughout fiscal year 2014.

ITEM 4.

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as the term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on this evaluation and subject to the foregoing, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the end of the quarter covered by this report, the design and operation of our disclosure controls and procedures were effective to accomplish their objectives at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

From time to time, we are plaintiffs or defendants in various litigation matters in the ordinary course of our business, some of which involve claims for damages that are substantial in amount. We believe that the disposition of claims currently pending will not have a material adverse impact on our financial position or results of operations. Except as disclosed below, there have been no material developments in the Legal Proceedings discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Cold Therapy Litigation

DJO was named in nine multi-plaintiff lawsuits involving a total of 172 plaintiffs which alleged that the plaintiffs had been injured following use of certain cold therapy products manufactured by DJO. The complaints alleged various product liability theories, including inadequate warnings regarding the risks associated with the use of cold therapy and failure to incorporate certain safety features into the design. No specific dollar amounts of damages were alleged in the complaints. These cases were included in a coordinated proceeding in San Diego Superior Court with a similar number of cases filed against one of our competitors. The first of these cases was tried and ended with a deadlocked jury, resulting in no verdict and a declaration of a mistrial. In October 2014, the company reached a settlement agreement with plaintiffs’ counsel that effectively resolves all of the claims. The settlement amount will be paid by our product liability carriers.

ITEM 1A.

RISK FACTORS

For a discussion of the Company’s potential risks or uncertainties, please see Part I, Item IA, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the SEC on February 25, 2014. There have been no material changes to the risk factors disclosed in such Form 10-K.

ITEM 5.

OTHER INFORMATION

Iran Sanctions Related Disclosure

Under the Iran Threat Reduction and Syrian Human Rights Act of 2012 (“ITRSHRA”), which added Section 13(r) of the Exchange Act, we are required to include certain disclosures in our periodic reports if we or any of our “affiliates” knowingly engaged in certain specified activities, transactions or dealings related to Iran or certain designated parties during the period covered by the report. An issuer must also concurrently file a separate notice with the SEC that such activities have been disclosed. We are not presently aware that we or our consolidated subsidiaries have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange Act during the quarter ended September 27, 2014.

Because the SEC defines the term “affiliate” broadly, it includes any entity controlled by us as well as any person or entity that controls us or is under common control with us (“control” is also construed broadly by the SEC). As a result, The Blackstone Group L.P. (“Blackstone”), an affiliate of our major shareholder, and certain of the companies in which Blackstone’s affiliated funds are invested (the “portfolio companies”), may be deemed to be our affiliates. During the quarter ended September 27, 2014, one such portfolio company included information in its periodic report filed with the SEC regarding activities that require disclosure under the ITRSHR. This disclosure is reproduced in Exhibit 99.1 of this report and is incorporated by reference herein. We have no involvement in or control over such activities and we have not independently verified or participated in the preparation of the disclosures described in the filing.

ITEM 6.

EXHIBITS

(a) Exhibits



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 to DJOFL’s Registration Statement on Form S-4, filed April 18, 2007 (File No. 333-142188)).

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.

99.1+		Section 13(r) Disclosure—Iran Sanctions.

101+		The following financial information from DJO Finance LLC’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2014, formatted in XBRL: (i) the Unaudited Condensed Consolidated Balance Sheets as of September 27, 2014 and December 31, 2013, (ii) the Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 27, 2014 and September 28, 2013, (iii) the Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 27, 2014 and September 28, 2013, (iv) the Unaudited Consolidated Statement of Deficit as of September 27, 2014 and December 31, 2013, (v) the Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 27, 2014 and September 28, 2013 and (vi) the Notes to the Unaudited Condensed Consolidated Financial Statements.

+	Filed herewith

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	DJO FINANCE LLC

Date: November 12, 2014	By:	/s/ MICHAEL P. MOGUL
		*Michael P. Mogul*
		*President and Chief Executive Officer*

Date: November 12, 2014	By:	/s/ SUSAN M. CRAWFORD
		*Susan M. Crawford*
		*Executive Vice President, Chief Financial Officer and Treasurer*

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