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Table of Contents

 

 

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 March 28, 2015

or

 

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

For the transition period from                      to                     

Commission File Number: 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.

 

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

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 April 20, 2015, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

 

 

 


Table of Contents

DJO Finance LLC

INDEX

 

         Page
Number
 
PART I—FINANCIAL INFORMATION   

Item 1.

 

Financial Statements

  
 

Unaudited Condensed Consolidated Balance Sheets as of March 28, 2015 and December 31, 2014

     3   
 

Unaudited Condensed Consolidated Statements of Operations for the three months ended March 28, 2015 and March 29, 2014

     4   
 

Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 28, 2015 and March 29, 2014

     5   
 

Unaudited Condensed Consolidated Statement of Deficit for the three months ended March 28, 2015

     6   
 

Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 28, 2015 and March 29, 2014

     7   
 

Notes to Unaudited Condensed Consolidated Financial Statements

     8   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     36   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     44   

Item 4.

 

Controls and Procedures

     44   
PART II—OTHER INFORMATION   

Item 1.

 

Legal Proceedings

     45   

Item 1A.

 

Risk Factors

     46   

Item 5.

 

Other Information

     46   

Item 6.

 

Exhibits

     47   

 

2


Table of Contents

PART 1 – FINANCIAL INFORMATION

Item 1. Financial Statements

DJO Finance LLC

Unaudited Condensed Consolidated Balance Sheets

(in thousands)

 

     March 28,
2015
    December 31,
2014
 
Assets     

Current assets:

    

Cash and cash equivalents

   $ 35,688      $ 31,144   

Accounts receivable, net

     180,821        188,060   

Inventories, net

     179,700        175,340   

Deferred tax assets, net

     24,598        24,598   

Prepaid expenses and other current assets

     13,913        17,172   
  

 

 

   

 

 

 

Total current assets

  434,720      436,314   

Property and equipment, net

  119,036      120,107   

Goodwill

  1,133,893      1,141,188   

Intangible assets, net

  844,456      868,031   

Other assets

  30,783      32,853   
  

 

 

   

 

 

 

Total assets

$ 2,562,888    $ 2,598,493   
  

 

 

   

 

 

 
Liabilities and Deficit

Current liabilities:

Accounts payable

$ 56,186    $ 62,960   

Accrued interest

  55,549      29,600   

Current portion of debt obligations

  8,950      8,975   

Other current liabilities

  85,085      99,145   
  

 

 

   

 

 

 

Total current liabilities

  205,770      200,680   

Long-term debt obligations

  2,259,088      2,261,941   

Deferred tax liabilities, net

  249,523      243,123   

Other long-term liabilities

  14,177      14,365   
  

 

 

   

 

 

 

Total liabilities

$ 2,728,558    $ 2,720,109   
  

 

 

   

 

 

 

Commitments and contingencies

Deficit:

DJO Finance LLC membership deficit:

Member capital

  840,394      839,781   

Accumulated deficit

  (987,938   (952,412

Accumulated other comprehensive loss

  (20,761   (11,603
  

 

 

   

 

 

 

Total membership deficit

  (168,305   (124,234

Noncontrolling interests

  2,635      2,618   
  

 

 

   

 

 

 

Total deficit

  (165,670   (121,616
  

 

 

   

 

 

 

Total liabilities and deficit

$ 2,562,888    $ 2,598,493   
  

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

3


Table of Contents

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Operations

(in thousands)

 

     Three Months Ended  
     March 28,
2015
    March 29,
2014
 

Net sales

   $ 280,101      $ 282,744   

Costs and operating expenses:

    

Cost of sales (exclusive of amortization of intangible assets of $7,887 and $8,683 for the three months ended March 28, 2015 and March 29, 2014, respectively)

     109,242        115,715   

Selling, general and administrative

     119,773        123,530   

Research and development

     8,900        9,738   

Amortization of intangible assets

     22,109        23,559   
  

 

 

   

 

 

 
  260,024      272,542   
  

 

 

   

 

 

 

Operating income

  20,077      10,202   

Other expense:

Interest expense, net

  (42,821   (43,671

Other expense, net

  (4,151   (80
  

 

 

   

 

 

 
  (46,972   (43,751
  

 

 

   

 

 

 

Loss before income taxes

  (26,895   (33,549

Income tax provision

  (8,330   (2,624
  

 

 

   

 

 

 

Net loss

  (35,225   (36,173

Net income attributable to noncontrolling interests

  (301   (349
  

 

 

   

 

 

 

Net loss attributable to DJO Finance LLC

$ (35,526 $ (36,522
  

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

4


Table of Contents

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

 

     Three Months Ended  
     March 28,
2015
    March 29,
2014
 

Net loss

   $ (35,225   $ (36,173

Other comprehensive loss, net of taxes:

    

Foreign currency translation adjustments, net of tax benefit (provision) of $492 and $(11) for the three months ended March 28, 2015 and March 29, 2014, respectively

     (9,442     (303
  

 

 

   

 

 

 

Other comprehensive loss

  (9,442   (303
  

 

 

   

 

 

 

Comprehensive loss

  (44,667   (36,476

Comprehensive income attributable to non-controlling interests

  (17   (345
  

 

 

   

 

 

 

Comprehensive loss attributable to DJO Finance LLC

$ (44,684 $ (36,821
  

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

5


Table of Contents

DJO Finance LLC

Unaudited Condensed Consolidated Statements of (Deficit) Equity

(in thousands)

 

     DJO Finance LLC              
   Member
capital
     Accumulated
Deficit
    Accumulated
other
comprehensive
income (loss)
    Total
membership
(deficit)
equity
    Non-controlling
interests
    Total
(deficit)
equity
 

Balance at December 31, 2014

   $ 839,781       $ (952,412   $ (11,603   $ (124,234   $ 2,618      $ (121,616

Net (loss) income

     —           (35,526     —          (35,526     301        (35,225

Other comprehensive loss, net of taxes

     —           —          (9,158     (9,158     (284     (9,442

Stock-based compensation

     613         —          —          613        —          613   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 28, 2015

$ 840,394    $ (987,938 $ (20,761 $ (168,305 $ 2,635    $ (165,670
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

6


Table of Contents

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

     Three Months Ended  
     March 28,
2015
    March 29,
2014
 

Cash Flows From Operating Activities:

    

Net loss

   $ (35,225   $ (36,173

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation

     8,357        8,459   

Amortization of intangible assets

     22,109        23,559   

Amortization of debt issuance costs and non-cash interest expense

     2,288        2,090   

Stock-based compensation expense

     613        444   

Loss (gain) on disposal of assets, net

     74        (476

Deferred income tax provision

     7,291        739   

Changes in operating assets and liabilities, net of acquired assets and liabilities:

    

Accounts receivable

     3,208        1,607   

Inventories

     (8,101     161   

Prepaid expenses and other assets

     2,782        4,417   

Accrued interest

     25,950        20,103   

Accounts payable and other current liabilities

     (11,690     (252
  

 

 

   

 

 

 

Net cash provided by operating activities

  17,656      24,678   
  

 

 

   

 

 

 

Cash Flows From Investing Activities:

Purchases of property and equipment

  (8,731   (14,086

Cash paid in connection with acquisitions, net of cash acquired

  —        (4,587

Other investing activities, net

  —        (501
  

 

 

   

 

 

 

Net cash used in investing activities

  (8,731   (19,174
  

 

 

   

 

 

 

Cash Flows From Financing Activities:

Proceeds on long term obligations

  17,000      8,000   

Repayments on long term obligations

  (20,019   (8,023

Cash paid in connection with the cancellation of vested options

  —        (2,001
  

 

 

   

 

 

 

Net cash used in financing activities

  (3,019   (2,024
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

  (1,362   (27
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

  4,544      3,453   

Cash and cash equivalents, beginning of period

  31,144      43,578   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

$ 35,688    $ 47,031   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

Cash paid for interest

$ 14,574    $ 21,465   

Cash paid for taxes, net

$ 2,302    $ 1,072   

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

7


Table of Contents

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.

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 13 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 non-controlling interests in our 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

 

8


Table of Contents

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, 2014.

Recent Accounting Standards

In April 2014, the FASB issued an 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 adoption of this standard has the potential to impact the Company’s accounting for and disclosure of any future discontinued operations.

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 to 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. Adoption of this new guidance is not expected to have a material effect on the Company’s 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. Adoption of this new guidance is not expected to have a material effect on the Company’s financial statements.

2. ACCOUNTS RECEIVABLE RESERVES

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

 

     Three Months Ended  
     March 28,
2015
     March 29,
2014
 

Balance, beginning of period

   $ 41,402       $ 32,957   

Provision for doubtful accounts

     7,895         9,258   

Write-offs, net of recoveries

     (4,621      (8,507
  

 

 

    

 

 

 

Balance, end of period

$ 44,676    $ 33,708   
  

 

 

    

 

 

 

Our allowance for sales returns balance was $3.6 million and $3.6 million as of March 28, 2015 and March 29, 2014, respectively.

 

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Table of Contents

3. INVENTORIES

Inventories consist of the following (in thousands):

 

     March 28,
2015
     December 31,
2014
 

Components and raw materials

   $ 57,471       $ 59,578   

Work in process

     6,581         5,718   

Finished goods

     108,645         103,042   

Inventory held on consignment

     31,416         30,978   
  

 

 

    

 

 

 
  204,113      199,316   

Inventory reserves

  (24,413   (23,976
  

 

 

    

 

 

 
$ 179,700    $ 175,340   
  

 

 

    

 

 

 

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

 

     Three Months Ended  
     March 28,
2015
     March 29,
2014
 

Balance, beginning of period

   $ 23,976       $ 23,686   

Provision charged to costs of sales

     1,996         1,758   

Write-offs, net of recoveries

     (1,559      (163
  

 

 

    

 

 

 

Balance, end of period

$ 24,413    $ 25,281   
  

 

 

    

 

 

 

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

 

10


Table of Contents

4. LONG-LIVED ASSETS

Goodwill

Changes in the carrying amount of goodwill for the three months ended March 28, 2015 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      $ 340,631      $ 1,367,294   

Accumulated impairment losses

     —           (178,700     (47,406     —          (226,106
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
  483,258      317,299      —        340,631      1,141,188   

Acquisition

  —        —        —        —        —     

Foreign currency translation

  —        —        —        (7,295   (7,295

Balance, end of period

Goodwill

  483,258      495,999      47,406      333,336      1,359,999   

Accumulated impairment losses

  —        (178,700   (47,406   —        (226,106
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
$ 483,258    $ 317,299    $ —      $ 333,336    $ 1,133,893   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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Intangible Assets

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

 

March 28, 2015

   Gross Carrying
Amount
     Accumulated
Amortization
     Intangible
Assets, Net
 

Definite-lived intangible assets:

        

Customer relationships

   $ 566,784       $ (352,566    $ 214,218   

Patents and technology

     486,306         (271,859      214,447   

Trademarks and trade names

     25,831         (10,520      15,311   

Distributor contracts and relationships

     4,738         (3,506      1,232   

Non-compete agreements

     6,707         (4,937      1,770   
  

 

 

    

 

 

    

 

 

 
$ 1,090,366    $ (643,388   446,978   
  

 

 

    

 

 

    

Indefinite-lived intangible assets:

Trademarks and trade names

  397,478   
        

 

 

 

Net identifiable intangible assets

$ 844,456   
        

 

 

 

 

December 31, 2014

   Gross Carrying
Amount
     Accumulated
Amortization
     Intangible
Assets, Net
 

Definite-lived intangible assets:

        

Customer relationships

   $ 569,360       $ (341,353    $ 228,007   

Patents and technology

     486,466         (264,132      222,334   

Trademarks and trade names

     25,970         (9,902      16,068   

Distributor contracts and relationships

     4,771         (3,401      1,370   

Non-compete agreements

     6,824         (4,723      2,101   
  

 

 

    

 

 

    

 

 

 
$ 1,093,391    $ (623,511 $ 469,880   
  

 

 

    

 

 

    

Indefinite-lived intangible assets:

Trademarks and trade names

  398,151   
        

 

 

 

Net identifiable intangible assets

$ 868,031   
        

 

 

 

 

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Our definite lived intangible assets are being amortized using the straight line method over their remaining weighted average useful lives of 4.9 years for customer relationships, 8.1 years for patents and technology, 2.5 years for distributor contracts and relationships, 6.0 years for trademarks and trade names, and 2.0 years for non-compete agreements. Based on our amortizable intangible asset balance as of March 28, 2015, we estimate that amortization expense will be as follows for the next five years and thereafter (in thousands):

 

Remaining 2015

$ 66,077   

2016

  83,704   

2017

  72,569   

2018

  62,426   

2019

  51,718   

Thereafter

  110,484   
  

 

 

 
$ 446,978   
  

 

 

 

5. OTHER CURRENT LIABILITIES

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

 

     March 28,
2015
     December 31,
2014
 

Accrued wages and related expenses

   $ 31,473       $ 32,220   

Accrued commissions

     13,195         16,611   

Accrued rebates

     8,681         12,981   

Accrued other taxes

     3,870         4,987   

Accrued professional expenses

     3,663         2,682   

Income taxes payable

     599         2,477   

Deferred tax liability

     343         343   

Other accrued liabilities

     23,261         26,844   
  

 

 

    

 

 

 
$ 85,085    $ 99,145   
  

 

 

    

 

 

 

6. 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 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. In prior periods, we have utilized 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. As of March 28, 2015, we did not have any outstanding foreign currency exchange forward contracts. 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.

 

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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)  
     March 28,
2015
     December 31,
2014
     March 28,
2015
     December 31,
2014
 

Foreign exchange contracts not designated as hedges

   $ —         $ 7,682       $ —         $ 526   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

     Balance Sheet Location    March 28,
2015
     December 31,
2014
 

Derivative Liabilities:

        

Foreign exchange forward contracts not designated as hedges

   Other current liabilities    $ —         $ 4   
     

 

 

    

 

 

 

 

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

 

          Three Months Ended,  
     Location of gain (loss)    March 28,
2015
     March 29,
2014
 

Foreign exchange forward contracts not designated as hedges

   Other income, net    $ 4       $ 70   
     

 

 

    

 

 

 

7. 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.

During the year ended December 31, 2014, we remeasured the fair value of contingent consideration related to our January 2014 acquisition of Speetec. We initially valued the contingent consideration at $1.6 million which equaled approximately 25% of the total potential contingent consideration of $7.3 million. The valuation was based on the probability weighted average estimate of achievement of revenue targets for 2014 and 2015. Our remeasurement of the fair value based on the probability of achieving the Speetec revenue targets and the discounted present value of the current estimate of the future contingent payments reduced the net fair value of the contingent consideration to zero. This fair value measurement is categorized within Level 3 of the fair value hierarchy.

As of March 28, 2015, the balance of financial assets and liabilities measured at fair value on a recurring basis was zero.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 (in thousands):

 

As of December 31, 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

   $ —        $ 4       $ —        $ 4   
  

 

 

    

 

 

    

 

 

    

 

 

 

Contingent consideration

$ —     $ —     $ —      $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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8. DEBT

Debt obligations consist of the following (in thousands):

 

     March 28,
2015
     December 31,
2014
 

Senior secured credit facilities:

     

Revolving credit facility

   $ 14,000       $ 17,000   

Term Loan:

     

$884.6 million New Tranche B term loans, net of unamortized original issuance discount of $4.6 million and $5.1 million as of March 28, 2015 and December 31, 2014, respectively

     879,917         879,476  

8.75% Second priority senior secured notes, including unamortized original issue premium of $4.0 million and $4.4 million as of March 28, 2015 and December 31, 2014, respectively

     334,083         334,377   

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

     38         63   
  

 

 

    

 

 

 

Total debt

  2,268,038      2,270,916   

Current maturities

  (8,950   (8,975
  

 

 

    

 

 

 

Long-term debt

$ 2,259,088    $ 2,261,941   
  

 

 

    

 

 

 

Senior Secured Credit Facilities

Our senior secured credit facilities consist of term loans and a $100.0 million revolving credit facility, originally entered into on November 20, 2007 and subsequently amended and restated on March 20, 2012.

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 term loans issued under the original senior secured credit facilities to September 15, 2017 (“extended term loans”); (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.

 

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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 March 28, 2015, the market values of our New Tranche B Term Loans and drawings under our revolving credit facility were $886.8 million and $12.9 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 March 28, 2015, 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 three months ended March 28, 2015.

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.

 

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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 March 28, 2015. The senior secured credit facilities also contain certain customary affirmative covenants and events of default. As of March 28, 2015, our actual senior secured first lien net leverage ratio was 3.06:1, 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 March 28, 2015, 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.

 

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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 March 28, 2015, the market value of the 9.875% Notes was $460.9 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 March 28, 2015, the market value of the 7.75% Notes was $306.8 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 were 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 March 28, 2015, the market value of the 9.75% Notes was $308.3 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 were 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.

 

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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 March 28, 2015, 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 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.

Debt Issuance Costs

As of March 28, 2015 and December 31, 2014, we had $26.5 million and $28.6 million, respectively, of unamortized debt issuance costs, which are included in Other Assets in our Unaudited Condensed Consolidated Balance Sheets.

For the three months ended March 28, 2015 and March 29, 2014, amortization of debt issuance costs was $2.1 million and $1.9 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.

9. 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 months ended March 28, 2015, we recorded income tax expense of approximately $8.3 million on pre-tax losses of $26.9 million, resulting in a negative effective tax rate of 31.0%. For the three months ended March 29, 2014, we recorded income tax expense of $2.6 million on pre-tax losses of $33.5 million, resulting in a negative effective tax rate of 7.8%.

Our tax rates are negative because our U.S. federal tax losses, and certain state tax losses, are unavailable to offset income taxes arising in other states and in the foreign jurisdictions where we are subject to tax. In addition, we do not currently recognize a tax benefit for our US and state tax loss carryovers because we cannot conclude that it is more likely than not they will offset future taxable income.

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 $15.0 million on the deferred tax assets related to the net operating loss carryforwards generated in the three months ended March 28, 2015. If our assumptions change and we

 

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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 March 28, 2015, our gross unrecognized tax benefits were $14.1 million reflecting an increase of $0.2 million from the unrecognized amount of $13.9 million at December 31, 2014. As of March 28, 2015, we have $2.3 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 March 28, 2015, we have unrecognized various foreign and U.S. state tax benefits of approximately $5.6 million, which, if recognized, would impact our effective tax rate in future periods.

10. 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 restricted and unrestricted stock, options, and other stock-based awards based on the 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).

 

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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 on its 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 and December 2014, options were granted to employees following the net exercise of their Rollover Options which were scheduled to expire in December 2013 and December 2014, respectively. These new options were fully vested on the date of grant and have a term of ten years (“Vested Options”).

In February 2014, all 2012 and 2013 Performance Options were amended to allow for vesting of the 2012 and 2013 Adjusted EBITDA tranches 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 three months ended March 28, 2015, the compensation committee granted 261,121 options to employees, of which 215,834 were Performance Options, 24,166 were Time-Based Options and 21,121 were Vested Options. Additionally, the compensation committee granted 23,000 Director Performance Options to members of the Board of Directors. The weighted average grant date fair values of the Time-Based Options, the Vested Options, and the Director Options, granted during the three months ended March 28, 2015 were $6.07, $5.27, and $6.92, respectively.

During the three months ended March 29, 2014, the compensation committee granted 362,500 options to employees, of which 287,497 were Performance Options and 75,003 were Time-Based Options. The weighted average grant date fair values of the Time-Based Options granted during the three months ended March 29, 2014 were $6.08.

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

 

     Three Months Ended  
     March 28,
2015
    March 29,
2014
 

Expected volatility

     33.3     33.2

Risk-free interest rate

     1.5%-2.0     2.0

Expected term until exercise

     5.1-8.3        6.4   

Expected dividend yield

     0.0     0.0

 

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

 

     Three Months Ended  
     March 28,
2015
     March 29,
2014
 

Cost of sales

   $ 30       $ 23   

Operating expenses:

     

Selling, general and administrative

     579         418   

Research and development

     4         3   
  

 

 

    

 

 

 
$ 613    $ 444   
  

 

 

    

 

 

 

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 2015. Additionally, we have not recognized expense for any of the options which have the potential to vest based on Adjusted EBITDA for 2016, 2017, and 2018. 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 Vested Options and the Director Service Options granted in 2014 or 2015.

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.

11. 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 months presented, we expensed $1.75 million related to the annual monitoring fee, which is recorded as a component of Selling, general and administrative expense in the Consolidated Statements of Operations.

12. COMMITMENTS AND CONTINGENCIES

Pain Pump Litigation

Over the past 7 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

 

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Bracing and Vascular segment. We currently are a defendant in two 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 four years, we have entered into settlements with plaintiffs in approximately 140 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 March 28, 2015, we have accrued $0.2 million for unpaid settlements in this case, 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. The parties entered into a settlement agreement in February 2015 which settles all claims and dismisses the lawsuit in all respects, resulting in no material financial impact.

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 have supplied the documents requested under the subpoenas.

BGS Qui Tam Action

We are a defendant in a qui tam action filed in Federal Court in Boston, Massachusetts, captioned United States, ex rel. Bierman v. Orthofix International, N.V. et al., in which the relator, or whistleblower, names us and each other company engaged in the external bone growth stimulator industry as defendants. The case was filed under seal in March 2005 and unsealed in March 2009, during which time the government investigated the claims made by relator and decided not to intervene in the case. The government continued its investigation of DJO for several years following the unsealing of the case but did not ultimately bring any criminal or civil charges against us relating to the investigation. The relator alleges that the defendants have engaged in Medicare fraud and violated federal and state false claims acts from the time of the original introduction of the bone growth stimulation devices by each defendant to the present by seeking reimbursement for such devices as purchased items rather than rental items. The relator also alleges that the defendants are engaged in other marketing practices constituting violations of the federal and various state false claim and anti-kickback statutes. Orthofix International, N.V. has settled with the relator and we understand that two other defendants have reached settlements. The case continues against the remaining defendants, with the relator pressing for discovery after years of inactivity on the case. While we believe the case against us has no merit, we can make no assurances as to the resources that will be needed to respond to this matter or the final outcome of the case.

California Qui Tam Action

On October 11, 2013, we were served with a summons and complaint related to a qui tam action filed in U.S. District Court in Los Angeles, California in August 2012 and amended in December 2012 that names us as a defendant along with each of the other companies 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, Orthofix, Inc., 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 FDA approved

 

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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 second amended complaint, which motion was granted with leave to amend. Relators then filed a third amended complaint and we filed a motion to dismiss the third amended complaint and that motion is pending. We believe that this lawsuit is without merit and intend to vigorously defend this case.

Minnesota Investigation

On April 1, 2015, we became aware of an investigation headed by an Assistant U.S. Attorney (“AUSA”) in Minneapolis, Minnesota into the sales from (July 1, 2010 to the present) of TENS products by our subsidiary, Empi, Inc., for which government payors reimbursed us. The AUSA has not provided any further description of the investigation, nor have we received a subpoena or other official document relating to the investigation.

13. SEGMENT AND GEOGRAPHIC INFORMATION

For the periods ended March 28, 2015 and March 29, 2014, we reported our business in four operating segments: Bracing and Vascular; Recovery Sciences; Surgical Implant and International.

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 channel, through which we maintain an inventory of soft goods and other products at healthcare facilities, primarily orthopedic practices, for immediate distribution to patients. The Bracing and Vascular segment primarily sells its products to orthopedic and sports medicine professionals, hospitals, podiatry practices, orthotic and prosthetic centers, home medical equipment providers and independent pharmacies. In 2014 we expanded our consumer channel to focus on marketing, selling and distributing our products, including bracing and vascular products, to professional and consumer retail customers and on-line. The bracing and vascular products sold through the channel will principally be sold under the DonJoy Performance, Bell-Horn and Doctor Comfort brands.

Recovery Sciences Segment

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

 

    Empi. Our Empi channel 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 channel 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 channel 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.

 

    Consumer. Our consumer channel offers professional and consumer retail customers our Compex electrostimulation device, which is used in 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

 

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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  
     March 28,
2015
     March 29,
2014
 

Net sales:

     

Bracing and Vascular

   $ 113,904       $ 109,506   

Recovery Sciences

     67,115         68,870   

Surgical Implant

     26,926         23,932   

International

     72,156         80,436   
  

 

 

    

 

 

 
$ 280,101    $ 282,744   
  

 

 

    

 

 

 

Operating income (loss):

Bracing and Vascular

$ 20,896    $ 19,485   

Recovery Sciences

  16,424      17,398   

Surgical Implant

  4,320      2,820   

International

  12,385      14,706   

Expenses not allocated to segments and eliminations

  (33,948   (44,207
  

 

 

    

 

 

 
$ 20,077    $ 10,202   
  

 

 

    

 

 

 

Geographic Area

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

 

     Three Months Ended  
     March 28,
2015
     March 29,
2014
 

United States

   $ 207,945       $ 202,308   

Other Europe, Middle East, and Africa

     33,694         38,377   

Germany

     21,034         24,471   

Australia and Asia Pacific

     9,891         9,114   

Canada

     5,352         6,213   

Latin America

     2,185         2,261   
  

 

 

    

 

 

 
$ 280,101    $ 282,744   
  

 

 

    

 

 

 

 

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14. 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 jointly and severally, fully and unconditionally guaranteed, 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.

 

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DJO Finance LLC

Unaudited Condensed Consolidating Balance Sheets

As of March 28, 2015

(in thousands)

 

     DJOFL     Guarantors     Non-
Guarantors
     Eliminations     Consolidated  

Assets

           

Current assets:

           

Cash and cash equivalents

   $ 28,732      $ (6,171   $ 13,127       $ —        $ 35,688   

Accounts receivable, net

     —          135,606        45,215         —          180,821   

Inventories, net

     —          145,860        49,967         (16,127     179,700   

Deferred tax assets, net

     —          24,368        230         —          24,598   

Prepaid expenses and other current assets

     117        9,021        4,775         —          13,913   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total current assets

  28,849      308,684      113,314      (16,127   434,720   

Property and equipment, net

  —        105,726      13,427      (117   119,036   

Goodwill

  —        1,066,479      98,790      (31,376   1,133,893   

Intangible assets, net

  —        831,543      12,913      —        844,456   

Investment in subsidiaries

  1,297,699      1,686,558      50,463      (3,034,720   —     

Intercompany receivables

  802,196      —        —        (802,196   —     

Other non-current assets

  26,490      1,981      2,312      —        30,783   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

$ 2,155,234    $ 4,000,971    $ 291,219    $ (3,884,536 $ 2,562,888   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Liabilities and (Deficit) Equity

Current liabilities:

Accounts payable

$ —     $ 44,711    $ 11,475    $ —      $ 56,186   

Current portion of debt obligations

  8,912      —        38      —        8,950   

Other current liabilities

  55,539      62,814      22,281      —        140,634   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total current liabilities

  64,451      107,525      33,794      —        205,770   

Long-term debt obligations

  2,259,088      —        —        —        2,259,088   

Deferred tax liabilities, net

  —        244,971      4,552      —        249,523   

Intercompany payables, net

  —        505,389      149,709      (655,098   —     

Other long-term liabilities

  —        12,573      1,604      —        14,177   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

  2,323,539      870,458      189,659      (655,098   2,728,558   

Noncontrolling interests

  —        —        2,635      —        2,635   

Total membership (deficit) equity

  (168,305   3,130,513      98,925      (3,229,438   (168,305
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and (deficit) equity

$ 2,155,234    $ 4,000,971    $ 291,219    $ (3,884,536 $ 2,562,888   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended March 28, 2015

(in thousands)

 

     DJOFL     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Net sales

   $ —        $ 250,982      $ 70,536      $ (41,417   $ 280,101   

Costs and operating expenses:

     —             

Cost of sales (exclusive of amortization of intangible assets of $7,887)

     —          98,279        53,334        (42,371     109,242   

Selling, general and administrative

     —          96,926        22,847        —         119,773   

Research and development

     —          7,918        982        —          8,900   

Amortization of intangible assets

     —          21,479        630        —          22,109   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  —        224,602      77,793      (42,371   260,024   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

  —        26,380      (7,257   954      20,077   

Other (expense) income:

Interest (expense) income, net

  (42,871   57      (7   —        (42,821

Other expense, net

  —        (520   (3,631   —        (4,151

Intercompany income (expense), net

  —        319      25      (344   —     

Equity in loss of subsidiaries, net

  7,344      —        —        (7,344   —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  (35,527   (144   (3,613   (7,688   (46,972
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income taxes

  (35,527   26,236      (10,870   (6,734   (26,895

Income tax provision

  —        (7,988   (342   —        (8,330
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

  (35,527   18,248      (11,212   (6,734   (35,225

Net income attributable to noncontrolling interests

  —        —        (301   —        (301
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income attributable to DJOFL

$ (35,527 $ 18,248    $ (11,513 $ (6,734 $ (35,526
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Three Months Ended March 28, 2015

(in thousands)

 

     DJOFL     Guarantors      Non-
Guarantors
    Eliminations     Consolidated  

Net (loss) income

   $ (35,527   $ 18,248       $ (11,212   $ (6,734   $ (35,225

Other comprehensive income, net of taxes:

           

Foreign currency translation adjustments, net of tax benefit of $492

     —          —           (9,442     —          (9,442
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Other comprehensive loss

  —        —        (9,442   —        (9,442
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income

  (35,527   18,248      (20,654   (6,734   (44,667
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to noncontrolling interests

  —        —        (17   —        (17
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income attributable to DJO Finance LLC

$ (35,527 $ 18,248    $ (20,671 $ (6,734 $ (44,684
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Three Months Ended March 28, 2015

(in thousands)

 

     DJOFL     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Cash Flows From Operating Activities:

        

Net (loss) income

   $ (35,527   $ 18,248      $ (11,212   $ (6,734   $ (35,225

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

          

Depreciation

     —          7,181        1,202        (26     8,357   

Amortization of intangible assets

     —          21,479        630        —          22,109   

Amortization of debt issuance costs and non-cash interest expense

     2,288        —          —          —          2,288   

Stock-based compensation expense

     —          613        —          —          613   

Loss on disposal of assets, net

     —          40        34        —          74   

Deferred income tax expense (benefit)

     —          7,631        (340     —          7,291   

Equity in loss of subsidiaries, net

     (7,344     —          —          7,344        —     

Changes in operating assets and liabilities, net of acquired assets and liabilities:

          

Accounts receivable

     —          5,176        (1,968       3,208   

Inventories

     —          (22     (5,291     (2,788     (8,101

Prepaid expenses and other assets

     44       2,280        265        193        2,782   

Accounts payable and other current liabilities

     25,950        (12,205     (4,100     4,615        14,260   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by operating activities

  (14,589   50,421      (20,780   2,604      17,656   

Cash Flows From Investing Activities:

Purchases of property and equipment

  —        (7,229   (1,505   3      (8,731
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

  —        (7,229   (1,505   3      (8,731

Cash Flows From Financing Activities:

Intercompany

  33,363      (49,366   18,610      (2,607   —     

Proceeds from issuance of debt

  17,000      —        —        —        17,000   

Repayments of debt obligations

  (20,000   —        (19   —        (20,019

Payment of debt issuance, modification and extinguishment costs

  —        —        —        —        —     

Investment by parent

  —        —        —        —        —     

Payment of contingent consideration

  —        —        —        —        —     

Cancellation of vested options

  —        —        —        —        —     

Dividend paid by subsidiary to owners of noncontrolling interests

  —        —        —        —        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

  30,363      (49,366   (18,591   (2,607   (3,019

Effect of exchange rate changes on cash and cash equivalents

  —        —        (1,362   —        (1,362
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

  15,774      (6,174   (5,056   —        4,544   

Cash and cash equivalents, beginning of year

  12,958      3      18,183      —        31,144   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of year

$ 28,732    $ (6,171 $ 13,127    $ —      $ 35,688   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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DJO Finance LLC

Condensed Consolidating Balance Sheets

As of December 31, 2014

(in thousands)

 

     DJOFL     Guarantors      Non-
Guarantors
     Eliminations     Consolidated  

Assets

            

Current assets:

            

Cash and cash equivalents

   $ 12,958      $ 3       $ 18,183       $ —        $ 31,144   

Accounts receivable, net

     —          140,782         47,278         —          188,060   

Inventories, net

     —          145,046         31,134         (840     175,340   

Deferred tax assets, net

     —          24,351         247         —          24,598   

Prepaid expenses and other current assets

     160        11,464         5,548         —          17,172   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

  13,118      321,646      102,390      (840   436,314   

Property and equipment, net

  —        106,191      14,071      (155   120,107   

Goodwill

  —        1,066,479      109,260      (34,551   1,141,188   

Intangible assets, net

  —        853,023      15,008      —        868,031   

Investment in subsidiaries

  1,297,699      1,686,557      56,572      (3,040,828   —     

Intercompany receivables

  836,759      —        —        (836,759   —     

Other non-current assets

  28,632      1,822      2,399      —        32,853   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

$ 2,176,208    $ 4,035,718    $ 299,700    $ (3,913,133 $ 2,598,493   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities and (Deficit) Equity

Current liabilities:

Accounts payable

$ —      $ 50,590    $ 12,370    $ —      $ 62,960   

Current portion of debt obligations

  8,912      —        63      —        8,975   

Other current liabilities

  29,589      70,073      29,083      —        128,745   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total current liabilities

  38,501      120,663      41,516      —        200,680   

Long-term debt obligations

  2,261,941      —        —        —        2,261,941   

Deferred tax liabilities, net

  —        237,813      5,310      —        243,123   

Intercompany payables, net

  —        552,612      135,833      (688,445   —     

Other long-term liabilities

  —        12,243      2,122      —        14,365   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities

  2,300,442      923,331      184,781      (688,445   2,720,109   

Noncontrolling interests

  —        —        2,618      —        2,618   

Total membership (deficit) equity

  (124,234   3,112,387      112,301      (3,224,688   (124,234
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and (deficit) equity

$ 2,176,208    $ 4,035,718    $ 299,700    $ (3,913,133 $ 2,598,493   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended March 29, 2014

(in thousands)

 

     DJOFL     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Net sales

   $ —       $ 238,179      $ 78,076      $ (33,511   $ 282,744   

Costs and operating expenses:

          

Cost of sales (exclusive of amortization of intangible assets of $8,683)

     —         100,258        53,960        (38,503     115,715   

Selling, general and administrative

     —         96,412        27,118        —         123,530   

Research and development

     —         8,523        1,215        —         9,738   

Amortization of intangible assets

     —         22,415        1,144        —         23,559   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  —       227,608      83,437      (38,503 )   272,542   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

  —       10,571      (5,361   4,992      10,202   

Other (expense) income:

Interest expense, net

  (43,698   49     (22   —       (43,671

Other (expense) income, net

  —       (207   127      —       (80

Intercompany income (expense), net

  —       348      (264   (84   —    

Equity in income of subsidiaries, net

  7,176      —       —       (7,176   —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  (36,522   190      (159   (7,260   (43,751
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income taxes

  (36,522   10,761      (5,520   (2,268   (33,549

Income tax (provision) benefit

  —       (1,381   (1,243   —       (2,624
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

  (36,522   9,380      (6,763   (2,268   (36,173

Net income attributable to noncontrolling interests

  —       —       (349   —       (349
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income attributable to DJOFL

$ (36,522 $ 9,380      (7,112 $ (2,268 $ (36,522
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Three Months Ended March 29, 2014

(in thousands)

 

     DJOFL     Guarantors      Non-
Guarantors
    Eliminations     Consolidated  

Net (loss) income

   $ (36,522   $ 9,380       $ (6,763   $ (2,268   $ (36,173

Other comprehensive loss, net of taxes:

           

Foreign currency translation adjustments, net of tax provision of $11

     —          —           (303     —          (303
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Other comprehensive loss

  —        —        (303   —        (303
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income

  (36,522   9,380      (7,066   (2,268   (36,476
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive loss attributable to noncontrolling interests

  —        —        (345   —        (345
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income attributable to DJO Finance LLC

$ (36,522 $ 9,380    $ (7,411 $ (2,268 $ (36,821
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

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Table of Contents

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Year Three Months Ended March 29, 2014

(in thousands)

 

     DJOFL     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Cash Flows from Operating Activities:

          

Net (loss) income

   $ (36,522   $ 9,380      $ (6,763   $ (2,268   $ (36,173

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

          

Depreciation

     —          6,883        1,630        (54     8,459   

Amortization of intangible assets

     —          22,415        1,144        —          23,559   

Amortization of debt issuance costs and non-cash interest expense

     2,090        —          —          —          2,090   

Stock-based compensation expense

     —          444        —          —          444   

Gain (loss) on disposal of assets, net

     —          (502     26        —          (476

Deferred income tax expense

     —          779        (1     (39     739   

Equity in income of subsidiaries, net

     (7,176     —          —          7,176        —     

Changes in operating assets and liabilities:

          

Accounts receivable

     —          6,246        (4,639     —          1,607   

Inventories

     —          (132     4,931        (4,638     161   

Prepaid expenses and other assets

     44        5,896        (1,594     71        4,417   

Accounts payable and other current liabilities

     20,104        652        (567     (338     19,851   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by operating activities

  (21,460   52,061      (5,833   (90   24,678   

Cash Flows from Investing Activities:

Cash paid in connection with acquisitions, net of cash acquired

  —        —        (4,587   —        (4,587

Purchases of property and equipment

  —        (12,676   (1,453   43      (14,086

Other investing activities, net

  —        (412   (89   —        (501
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in (provided by) investing activities

  —        (13,088   (6,129   43      (19,174

Cash Flows from Financing Activities:

Intercompany

  25,645      (38,128   12,438      45      —     

Proceeds from issuance of debt

  8,000      —        —        8,000   

Repayments of debt and capital lease obligations

  (8,000   —        (23   —        (8,023

Cash paid in connection with the cancellation of vested options

  (2,001   —        —        —        (2,001
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

  23,644      (38,128   12,415      45      (2,024

Effect of exchange rate changes on cash and cash equivalents

  —        —        (27   —        (27
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

  2,184      845      426      (2   3,453   

Cash and cash equivalents at beginning of period

  22,370      358      20,848      2      43,578   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

$ 24,554    $ 1,203    $ 21,274    $ —      $ 47,031   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

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 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 2014 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 20, 2015 describes these important risk factors that may affect our business, financial condition, results of operation, 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™.

 

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Table of Contents

Operating Segments

The company’s continuing operations consist of four operating segments; Bracing and Vascular; Recovery Sciences; Surgical Implant; and International. See Note 14 to our Unaudited Condensed Consolidated Financial Statements for financial and other additional information regarding our segments.

Some of 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  

($ in thousands)

   March 28,
2015
    March 29,
2014
 

Bracing and Vascular:

    

Net sales

   $ 113,904      $ 109,506   

Operating income

     20,896      $ 19,485   

Operating income as a percent of net segment sales

     18.3     17.8

Recovery Sciences:

    

Net sales

   $ 67,115      $ 68,870   

Operating income

     16,424      $ 17,398   

Operating income as a percent of net segment sales

     24.5     25.3

Surgical Implant:

    

Net sales

   $ 26,926      $ 23,932   

Operating income

     4,320      $ 2,820   

Operating income as a percent of net segment sales

     16.0     11.8

International:

    

Net sales

   $ 72,156      $ 80,436   

Operating income

     12,385      $ 14,706   

Operating income as a percent of net segment sales

     17.2     18.3

 

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Table of Contents

Results of Operations

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

 

     Three Months Ended  
     March 28,
2015
    March 29,
2014
 

Net sales

   $ 280,101         100.0   $ 282,744         100.0

Costs and operating expenses:

          

Cost of sales (exclusive of amortization of intangible assets (1))

     109,242         38.9        115,715         40.9   

Selling, general and administrative

     119,773         42.8        123,530         43.7   

Research and development

     8,900         3.2        9,738         3.4   

Amortization of intangible assets

     22,109         7.9        23,559         8.3   
  

 

 

    

 

 

   

 

 

    

 

 

 
  260,024      92.8      272,542      96.3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating income

  20,077      7.2      10,202      3.7   

Other expense:

Interest expense, net

  (42,821   (15.3   (43,671   (15.5

Other expense, net

  (4,151   (1.5   (80   (0.0
  

 

 

    

 

 

   

 

 

    

 

 

 
  (46,972   (16.8   (43,751   (15.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Loss from continuing operations before income taxes

  (26,895   (9.6   (33,549   (11.8

Income tax provision

  (8,330   (3.0   (2,624   (1.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Net loss

  (35,225   (12.6   (36,173   (12.8

Net income attributable to noncontrolling interests

  (301   (0.1   (349   (0.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Net loss attributable to DJOFL

$ (35,526   (12.7 )%  $ (36,522   (12.9 )% 
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Cost of sales is exclusive of amortization of intangible assets of $7,887 and $8,683 for the three months ended March 28, 2015 and March 29, 2014, respectively.

 

Three Months Ended March 28, 2015 (first quarter 2015) compared to Three Months Ended March 29, 2014 (first quarter 2014)

Net Sales. Our net sales for first quarter 2015 were $280.1 million, compared to net sales of $282.7 million for first quarter 2014, representing a 0.9% decrease year over year. In constant currency, excluding an unfavorable impact of $12.0 million related to changes in foreign exchange rates in effect in first quarter 2015 compared to the rates in effect in first quarter 2014, net sales increased by $9.4 million, or 3.3%, to $292.1 million for first quarter 2015 from $282.7 million for first quarter 2014.

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

 

     First Quarter
2015
     % of Net
Sales
    First Quarter
2014
     % of Net
Sales
    Increase
(Decrease)
    % Increase
(Decrease)
 

Bracing and Vascular

   $ 113,904         40.7   $ 109,506         38.7   $ 4,398        4.0

Recovery Sciences

     67,115         24.0        68,870         24.4        (1,755     (2.5 %) 

Surgical Implant

     26,926         9.6        23,932         8.5        2,994        12.5

International

     72,156         25.7        80,436         28.4        (8,280     (10.3 %) 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total net sales

$ 280,101      100.0 $ 282,744      100.0 $ (2,643   (0.9 %) 

 

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Table of Contents

Net sales in our Bracing and Vascular segment were $113.9 million for first quarter 2015, an increase of 4.0% compared to net sales of $109.5 million for first quarter 2014. The increase is primarily due to new account acquisition in our OfficeCare channel, an increase in third party payor billing and increased sales in compression hosiery products and therapeutic footwear sold to government agencies and through online purchases.

Net sales in our Recovery Sciences segment were $67.1 million for first quarter 2015, decreasing 2.5% from net sales of $68.9 million for first quarter 2014. The decrease continues to be driven by changes in reimbursement for certain Empi products limiting the amount of reimbursement for certain diagnosis codes and requiring additional documentation which caused a lag in the billing process.

Net sales in our Surgical Implant segment were $26.9 million for first quarter 2015, increasing 12.5% from net sales of $23.9 million for first quarter 2014. The increase was driven by strong sales of our shoulder and new hip products.

Net sales in our International segment were $72.2 million for first quarter 2015, decreasing 10.3% from net sales of $80.4 million for first quarter 2014. In constant currency, excluding an unfavorable impact of $12.0 million related to changes in foreign exchange rates in effect in first quarter 2015 compared to the rates in effect in first quarter 2014, net sales for first quarter 2015 for the International segment increased 4.7% compared to net sales for first quarter 2014. 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.

Cost of Sales. Costs of sales decreased to $109.2 million for first quarter 2015, from $115.7 million for first quarter 2014. As a percentage of net sales, costs of sales decreased to 38.9% for first quarter 2015, compared to 40.9% for first quarter 2014 due to benefits from certain cost savings and productivity initiatives.

Selling, General and Administrative (SG&A). SG&A expenses decreased to $119.8 million for first quarter 2015, from $123.5 million in first quarter 2014. As a percentage of net sales, SG&A expenses were 42.8% for first quarter 2015, compared to 43.7% for first quarter 2014. The decrease resulted from controlled selling and marketing costs and a decrease in reorganization and integration costs primarily related to information technology projects. These decreases were partially offset by higher variable selling expenses due to the relative increase in sales in the Bracing and Vascular, Surgical Implant and International segments, excluding currency impact.

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):

 

     First Quarter
2015
     First Quarter
2014
 

Integration charges:

     

Global business unit reorganization and integration

   $ 2,996       $ 3,404   

Acquisition related expenses and integration

     500         417   

CFO transition

     —           107   

Litigation and regulatory costs and settlements, net

     936         1,053   

Automation projects

     747         3,242   

Other non-recurring items

     (108      1,709   
  

 

 

    

 

 

 
$ 5,071    $ 9,932   
  

 

 

    

 

 

 

Research and Development (R&D). R&D expenses decreased to $8.9 million for first quarter 2015, from $9.7 million in first quarter 2014. As a percentage of net sales, R&D expense was 3.2% which was consistent with 3.4% in the first quarter 2014. The company continues to focus on the development of new products, as well as the enhancement of existing products with the latest technology and updated designs, primarily our Bracing and Vascular and Surgical Implant segments.

Amortization of Intangible Assets. Amortization of intangible assets decreased to $22.1 million for first quarter 2015, from $23.6 million for first quarter 2014. The decrease is due to certain intangible assets reaching full amortization primarily in our patents and technology category.

Interest Expense, net. Our interest expense, net decreased to $42.8 million for first quarter 2015, from $43.7 million for first quarter 2014. The decrease is due to lower weighted average interest rates on our senior secured credit facilities.

 

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Table of Contents

Other Expense, Net. Other expense, net increased to $4.2 million for first quarter 2015, from $0.1 million for first quarter 2014. Results for both periods presented primarily represent net realized and unrealized foreign currency translation gains and losses.

Income Tax Provision. We record income tax expense using an estimated annual effective tax rate, adjusted for discrete items. We recorded income tax expense of $8.3 million on pre-tax losses of $26.9 million, resulting in a negative effective tax rate of 31.0% in first quarter 2015. For first quarter 2014, we recorded income tax expense of $2.6 million on pre-tax losses of $33.5 million, resulting in a negative effective tax rate of 7.8%.

Our tax rates are negative because our U.S. federal tax losses, and certain state tax losses, are unavailable to offset income taxes arising in other states and in the foreign jurisdictions where we are subject to tax. In addition, we do not currently recognize a tax benefit for our US and state tax loss carryovers because we cannot conclude that it is more likely than not they will offset future taxable income.

Liquidity and Capital Resources

As of March 28, 2015, our primary sources of liquidity consisted of cash and cash equivalents totaling $35.7 million and our $100 million revolving credit facility, of which $85.5 million was available. Our revolving credit balance was $14.0 million as of March 28, 2015 and we have provided a $0.5 million letter of credit related to collateral requirements under our product liability insurance policy. Working capital at March 28, 2015 was $229.0 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. 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

Operating activities provided $17.7 million and $24.7 million of cash in first quarter 2015 and first quarter 2014, respectively. Cash provided by operating activities for all periods presented primarily represented our net loss, adjusted for non-cash expenses and changes in working capital. In the first quarter 2015, changes in working capital largely consisted of increases in inventories, timing of accounts payable, and payment of higher variable accrued expenses due to revenue growth. For first quarter 2015 and first quarter 2014, cash paid for interest was $14.6 million and $21.5 million, respectively.

Investing activities used $8.7 million and $19.2 million of cash for first quarter 2015 and first quarter 2014, respectively. Cash used in investing activities for first quarter 2015 primarily consisted of $8.8 million for purchases of property and equipment primarily for surgical instruments to support growth, IT automation technology, manufacturing equipment for new products and more efficient production. Cash used in investing activities for first quarter 2014 primarily consisted of $14.1 million for purchases of property and equipment and $4.6 million related to the acquisition of Speetec.

Financing activities used cash of $3.0 million and $2.0 million in first quarter 2015 and 2014, respectively. Cash used in financing activities in first quarter 2015 consisted of proceeds from the borrowings under our senior secured credit facilities, offset by payments of the senior secured credit facilities. Cash used in financing activities in first quarter 2014 consisted of payments related to the repurchase of Rollover Options from our former chief financial officer, upon her departure.

 

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Table of Contents

Indebtedness

The principal amount and carrying value of our debt, exclusive of a net unamortized original issue discount of $0.6 million, was as follows for March 28, 2015 (in thousands):

 

     March 28,
2015
     December 31,
2014
 
     Principal
Amount
     Carrying
Value
     Principal
Amount
     Carrying
Value
 

Senior secured credit facilities:

           

Revolving credit facility

   $ 14,000       $ 14,000       $ 17,000       $ 17,000   

Term loans

     884,561         879,917         884,560         879,476   
  

 

 

    

 

 

    

 

 

    

 

 

 
  898,561      893,917      901,560      896,476   

Note financing:

8.75% second priority senior secured notes

  330,000      334,083      330,000      334,377   

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      1,374,083      1,370,000      1,374,377   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other debt:

  38      38      63      63   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total indebtedness

$ 2,268,599    $ 2,268,038    $ 2,271,623    $ 2,270,916   
  

 

 

    

 

 

    

 

 

    

 

 

 

Senior Secured Credit Facilities. Our senior secured credit facilities at March 28, 2015 consist of $884.6 million of term loans which mature on September 15, 2017 and a $100.0 million revolving credit facility which matures on March 15, 2017. Our revolving credit balance was $14.0 million at March 28, 2015 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 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 term loan borrowings 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 March 28, 2015, 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 8 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 three months ended March 28, 2015. 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 March 28, 2015, our actual senior secured first lien leverage ratio was within the required ratio at 3.06:1. 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

 

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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 three months ended March 28, 2015, measured on that date, was 1.71:1. 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 months ended March 2015, 2014, and 2013. The terms and related calculations are defined in the credit agreement relating to our senior secured credit facilities and the Indentures.

 

     Three Months
Ended,
     Twelve Months
Ended
 

(in thousands)

   March 28,
2015
     March 29,
2014
     March 28,
2015
 

Net loss attributable to DJO Finance LLC

   $ (35,526    $ (36,522    $ (89,538

Interest expense, net

     42,821         43,671         173,441   

Income tax expense (benefit)

     8,330         2,624         18,596   

Depreciation and amortization

     30,466         32,018         127,258   

Non-cash charges (a)

     675         199         334   

Non-recurring and integration charges (b)

     5,929         15,418         33,069   

Other adjustment items, before permitted pro forma adjustments (c)

     6,279         2,248         18,414   
  

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

$ 58,974    $ 59,656    $ 281,574   
  

 

 

    

 

 

    

 

 

 

 

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

 

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     Three Months
Ended
     Twelve Months
Ended
 

(in thousands)

   March 28,
2015
     March 29,
2014
     March 28,
2015
 

Stock compensation expense

   $ 613       $ 444       $ 2,038   

Purchase accounting adjustments (1)

     287         207         (1,170

Gain on disposal of assets, net

     (225      (452      (534
  

 

 

    

 

 

    

 

 

 

Total non-cash items

$ 675    $ 199    $ 334   
  

 

 

    

 

 

    

 

 

 

 

(1) Purchase accounting adjustments for the twelve months ended March 28, 2015 consist of $0.3 million of amortization of fair market value inventory adjustments, net of $1.5 million in adjustments to the contingent consideration for Speetec.

 

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

 

     Three Months
Ended
     Twelve Months
Ended
 

(in thousands)

   March 28,
2015
     March 29,
2014
     March 28,
2015
 

Integration charges:

        

Global business unit reorganization and integration

   $ 3,494       $ 4,275       $ 9,249   

Acquisition related expenses and integration (1)

     499         420         410   

CFO transition

     —           107         120   

Litigation and regulatory costs and settlements, net (2)

     944         1,065         5,631   

Other non-recurring items (3)

     245         7,842         12,754   

ERP implementation and other automation projects

     747         1,709         4,905   
  

 

 

    

 

 

    

 

 

 

Total non-recurring and integration charges

$ 5,929    $ 15,418    $ 33,069   
  

 

 

    

 

 

    

 

 

 

 

(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 March 28, 2015, litigation and regulatory costs consisted of $0.6 million in litigation costs related to ongoing product liability issues related to our discontinued pain pump products and $5.0 million related to other litigation and regulatory costs and settlements.
(3) For the twelve months ended March 28, 2015, $9.7 million in specifically identified non-recurring operational and regulatory projects, $2.1 million in expenses related to our Tunisia factory fire and $2.3 million in professional fees and other non-recurring charges, offset by $1.3 million in adjustments to incremental Empi bad debt expense related to the Medicare CLBP decision.

 

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

 

     Three Months
Ended,
     Twelve Months
Ended
 

(in thousands)

   March 28,
2015
     March 29,
2014
     March 28,
2015
 

Blackstone monitoring fee

   $ 1,750       $ 1,750       $ 7,000   

Noncontrolling interests

     301         349         924   

Loss on modification and extinguishment of debt (1)

     —          —          938   

Other (2)

     4,228         149         9,552   
  

 

 

    

 

 

    

 

 

 

Total other adjustment items before permitted pro form adjustments

$ 6,279    $ 2,248    $ 18,414   
  

 

 

    

 

 

    

 

 

 

 

(1) Loss on modification and extinguishment of debt for the twelve months ending March 28, 2015 consists of $0.3 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.
(2) Other adjustments consist primarily of net realized and unrealized foreign currency transaction gains and losses.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certain market risks as part of our ongoing business operations, primarily risks from changing 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 March 28, 2015, we have $1,370.0 million of aggregate fixed rate notes and $898.6 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 three months ended March 28, 2015 by $0.4 million. As of March 28, 2015, our term loans are subject to a 1.00% minimum LIBOR rate which is higher than the actual LIBOR rate of 0.18% as of March 28, 2015. Accordingly, a hypothetical 100 basis point increase in the LIBOR rate during the three months ended March 28, 2015 would have increased the rate applicable to our variable debt by only 0.18%. 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 months ended March 28, 2015, sales denominated in foreign currencies accounted for 23.3% of our consolidated net sales, of which 16.6% 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.

 

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.

 

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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, 2014.

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. The parties entered into a settlement agreement in February 2015 which settles all claims and dismisses the lawsuit in all respects, resulting in no material financial impact.

BGS Qui Tam Action

We are a defendant in a qui tam action filed in Federal Court in Boston, Massachusetts, captioned United States, ex rel. Bierman v. Orthofix International, N.V. et al., in which the relator, or whistleblower, names us and each other company engaged in the external bone growth stimulator industry as defendants. The case was filed under seal in March 2005 and unsealed in March 2009, during which time the government investigated the claims made by relator and decided not to intervene in the case. The government continued its investigation of DJO for several years following the unsealing of the case but did not ultimately bring any criminal or civil charges against us relating to the investigation. The relator alleges that the defendants have engaged in Medicare fraud and violated federal and state false claims acts from the time of the original introduction of the bone growth stimulation devices by each defendant to the present by seeking reimbursement for such devices as purchased items rather than rental items. The relator also alleges that the defendants are engaged in other marketing practices constituting violations of the federal and various state false claim and anti-kickback statutes. Orthofix International, N.V. has settled with the relator, and we understand that two other defendants have reached settlements. The case continues against the remaining defendants, with the relator pressing for discovery after years of inactivity on the case. While we believe the case against us has no merit, we can make no assurances as to the resources that will be needed to respond to this matter or the final outcome of the case.

Minnesota Investigation

On April 1, 2015, we became aware of an investigation headed by an Assistant U.S. Attorney (“AUSA”) in Minneapolis, Minnesota into the sale from (July 1, 2010 to the present) of TENS products by our subsidiary, Empi, Inc., for which government payors reimbursed us. The AUSA has not provided any further description of the investigation, nor have we received a subpoena or other official document relating to the investigation.

 

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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, 2014 filed with the SEC on February 20, 2015. 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 March 28, 2015.

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 March 28, 2015, 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.

 

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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 March 28, 2015, formatted in XBRL: (i) the Unaudited Condensed Consolidated Balance Sheets as of March 28, 2015 and December 31, 2014, (ii) the Unaudited Condensed Consolidated Statements of Operations for the three months ended March 28, 2015 and March 29, 2014, (iii) the Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 28, 2015 and March 29, 2014, (iv) the Unaudited Consolidated Statement of Deficit as of March 28, 2015 and December 31, 2014, (v) the Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 28, 2015 and March 29, 2014 and (vi) the Notes to the Unaudited Condensed Consolidated Financial Statements.

 

+ Filed herewith

 

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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: April 20, 2015

By:

/s/    MICHAEL P. MOGUL

Michael P. Mogul
President and Chief Executive Officer

Date: April 20, 2015

By:

/s/    SUSAN M. CRAWFORD

Susan M. Crawford
Executive Vice President, Chief Financial Officer and Treasurer

 

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