Djo Finance 10-Q 2012 Q2 Quarterly report

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 June 30, 2012

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, 2012, registrant was no longer subject to the filing requirements of Section 13 or 15(d) of the Exchange Act; however, 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 August 3, 2012, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

DJO Finance LLC

INDEX

		Page Number
PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011		1
	Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June  30, 2012 and July 2, 2011		2
	Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2012 and July 2, 2011		3
	Unaudited Condensed Consolidated Statement of Equity for the six months ended June 30, 2012		4
	Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and July 2, 2011		5
	Notes to Unaudited Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		32
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		45
Item 4.	Controls and Procedures		46
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings		46
Item 1A.	Risk Factors		47
Item 6.	Exhibits		48

DJO Finance LLC

Unaudited Condensed Consolidated Balance Sheets

(in thousands)

	June 30, 2012			December 31, 2011
Assets
Current assets:
Cash and cash equivalents	$	28,982		$	38,169
Accounts receivable, net		163,534			158,982
Inventories, net		136,305			128,699
Deferred tax assets, net		43,517			43,458
Prepaid expenses and other current assets		21,682			18,791
Total current assets		394,020			388,099
Property and equipment, net		105,806			107,108
Goodwill		1,226,896			1,228,778
Intangible assets, net		1,083,208			1,132,694
Other assets		49,561			38,181
Total assets	$	2,859,491		$	2,894,860
Liabilities and Equity
Current liabilities:
Accounts payable	$	57,888		$	57,926
Accrued interest		23,815			20,928
Current portion of debt and capital lease obligations		8,625			8,820
Other current liabilities		80,815			81,771
Total current liabilities		171,143			169,445
Long-term debt and capital lease obligations		2,171,880			2,159,091
Deferred tax liabilities, net		250,499			252,194
Other long-term liabilities		15,762			16,174
Total liabilities		2,609,284			2,596,904
Commitments and contingencies
Equity:
DJO Finance LLC membership equity:
Member capital		838,124			834,871
Accumulated deficit		(588,828	)		(539,276	)
Accumulated other comprehensive (loss) income		(1,734	)		218
Total membership equity		247,562			295,813
Noncontrolling interests		2,645			2,143
Total equity		250,207			297,956
Total liabilities and equity	$	2,859,491		$	2,894,860

See accompanying notes to unaudited condensed consolidated financial statements.

1

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Operations

(in thousands)

	Three Months Ended						Six months Ended
	June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Net sales	$	285,977		$	277,786		$	564,924		$	527,497
Cost of sales (exclusive of amortization of intangible assets of $9,839 and $19,676 for the three and six months ended June 30, 2012 and $9,785 and $19,143 for the three and six months ended July 2, 2011, respectively)		111,802			111,090			220,037			204,246
Gross profit		174,175			166,696			344,887			323,251
Operating expenses:
Selling, general and administrative		114,225			128,843			231,882			245,907
Research and development		7,084			6,101			13,757			13,244
Amortization of intangible assets		24,505			24,509			49,018			44,938
		145,814			159,453			294,657			304,089
Operating income		28,361			7,243			50,230			19,162
Other income (expense):
Interest expense		(46,417	)		(42,429	)		(88,488	)		(83,556	)
Interest income		72			53			105			163
Loss on modification and extinguishment of debt		(90	)		—			(9,398	)		(2,065	)
Other income (expense), net		(1,761	)		1,681			1,061			4,453
		(48,196	)		(40,695	)		(96,720	)		(81,005	)
Loss before income taxes		(19,835	)		(33,452	)		(46,490	)		(61,843	)
Income tax (provision) benefit		(87	)		14,492			(2,475	)		21,959
Net loss		(19,922	)		(18,960	)		(48,965	)		(39,884	)
Net income attributable to noncontrolling interests		(276	)		(295	)		(587	)		(610	)
Net loss attributable to DJO Finance LLC	$	(20,198	)	$	(19,255	)	$	(49,552	)	$	(40,494	)

See accompanying notes to unaudited condensed consolidated financial statements.

2

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

	Three Months Ended						Six months Ended
	June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Net loss	$	(19,922	)	$	(18,960	)	$	(48,965	)	$	(39,884	)
Other comprehensive (loss) income, net of taxes:
Foreign currency translation adjustments, net of tax benefit (provision) of $2,707 and $942 for the three and six months ended June 30, 2012 and $(745) and $(4,260) for the three and six months ended July 2, 2011, respectively		(3,828	)		1,134			(2,037	)		6,607
Unrealized loss on cash flow hedges, net of tax benefit $75 and $167 for the three and six months ended July 2, 2011, respectively		—			(114	)		—			(259	)
Reclassification adjustment for losses on cash flow hedges included in net loss, net of tax (provision) of $(712) and $(1,402) for the three and six months ended July 2, 2011, respectively		—			1,084			—			2,175
Other comprehensive (loss) income		(3,828	)		2,104			(2,037	)		8,523
Comprehensive loss		(23,750	)		(16,856	)		(51,002	)		(31,361	)
Comprehensive loss (income) attributable to noncontrolling interests		(122	)		(356	)		(502	)		(839	)
Comprehensive loss attributable to DJO Finance LLC	$	(23,872	)	$	(17,212	)	$	(51,504	)	$	(32,200	)

See accompanying notes to unaudited condensed consolidated financial statements.

3

DJO Finance LLC

Unaudited Condensed Consolidated Statement of Equity

(in thousands)

	DJO Finance LLC
	Member capital		Accumulated deficit			Accumulated other comprehensive (loss) income			Total membership equity			Noncontrolling interests			Total equity
Balance at December 31, 2011	$	834,871	$	(539,276	)	$	218		$	295,813		$	2,143		$	297,956
Net (loss) income		—		(49,552	)		—			(49,552	)		587			(48,965	)
Other comprehensive loss, net of taxes		—		—			(1,952	)		(1,952	)		(85	)		(2,037	)
Stock-based compensation		2,253		—			—			2,253			—			2,253
Investment by parent		1,000		—			—			1,000			—			1,000
Balance at June 30, 2012	$	838,124	$	(588,828	)	$	(1,734	)	$	247,562		$	2,645		$	250,207

See accompanying notes to unaudited condensed consolidated financial statements.

4

DJO Finance LLC

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

	Six Months Ended
	June 30, 2012			July 2, 2011
Cash Flows From Operating Activities:
Net loss	$	(48,965	)	$	(39,884	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation		14,989			13,732
Amortization of intangible assets		49,018			44,938
Amortization of debt issuance costs and non-cash interest expense		5,142			4,086
Stock-based compensation expense		2,253			1,331
Loss on modification and extinguishment of debt		9,398			—
Loss on disposal of assets, net		809			378
Deferred income tax benefit		(598	)		(26,906	)
Provision for doubtful accounts and sales returns		9,928			13,232
Inventory reserves		3,144			3,688
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable		(15,352	)		(20,852	)
Inventories		(9,449	)		(10,375	)
Prepaid expenses and other assets		(2,662	)		1,746
Accrued interest		2,888			5,936
Accounts payable and other current liabilities		(604	)		16,569
Net cash provided by operating activities		19,939			7,619
Cash Flows From Investing Activities:
Cash paid in connection with acquisitions, net of cash acquired		—			(317,669	)
Purchases of property and equipment		(16,218	)		(20,692	)
Other investing activities, net		(491	)		215
Net cash used in investing activities		(16,709	)		(338,146	)
Cash Flows from Financing Activities:
Proceeds from issuance of debt		751,700			400,000
Repayments of debt and capital lease obligations		(739,662	)		(58,413	)
Payment of debt issuance costs		(25,234	)		(7,468	)
Investment by parent		1,000			—
Cancellation of vested options		—			(2,000	)
Dividend paid by subsidiary to owners of noncontrolling interests		—			(682	)
Net cash (used in) provided by financing activities		(12,196	)		331,437
Effect of exchange rate changes on cash and cash equivalents		(221	)		1,929
Net (decrease) increase in cash and cash equivalents		(9,187	)		2,839
Cash and cash equivalents at beginning of period		38,169			38,132
Cash and cash equivalents at end of period	$	28,982		$	40,971
Supplemental disclosures of cash flow information:
Cash paid for interest	$	80,596		$	69,365
Cash paid (refunded) for taxes, net	$	2,223		$	(5,519	)
Non-cash investing and financing activities:
Increases in property and equipment and in other current liabilities in connection with capitalized software costs	$	—		$	155
Increase in other current liabilities in connection with acquisition of Dr. Comfort	$	—			982

See accompanying notes to unaudited condensed consolidated financial statements.

5

DJO Finance LLC

Notes to Unaudited Condensed Consolidated Financial Statements

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and 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 ™ and Compex^®. Substantially all business activities of DJO Global, Inc. (DJO) are conducted by DJO Finance LLC (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.

Fiscal Year

We operate our business on a manufacturing calendar, with our fiscal year always ending on December 31. Each quarter is 13 weeks, consisting of two four-week periods and one five-week period. Our first and fourth quarters may have more or fewer shipping days from year to year based on the days of the week on which holidays and December 31 fall. For our domestic business segments, the three months ended June 30, 2012 and July 2, 2011 each included 64 shipping days and the six months ended June 30, 2012 and July 2, 2011 each included 128 shipping days. In the aggregate, the markets that comprise our International segment had approximately one few shipping day than the domestic business segments in each of the three and six months ended June 30, 2012.

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 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 14 for additional information about our reportable segments.

Use of Estimates

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

Basis of Presentation

We consolidate the results of operations of our 50% owned subsidiary, Medireha GmbH (Medireha), and reflect the 50% share of results not owned by us as noncontrolling interests in our 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.

6

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 financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the results of operations for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10–K for the year ended December 31, 2011.

Certain prior period amounts have been reclassified to conform to the current year presentation.

Recent Accounting Standards

In May 2011, the FASB issued guidance to amend the requirements related to fair value measurement which changes the wording used to describe many requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. Additionally, the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements. The amended guidance was effective for interim and annual periods beginning after December 15, 2011 and was applied prospectively. The Company adopted this guidance during the first quarter of fiscal year 2012. Adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

In June 2011, the FASB issued guidance to amend the presentation of comprehensive income to allow an entity the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income and a total amount for comprehensive income. The guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amended guidance was effective for interim and annual periods beginning after December 15, 2011, and was applied retrospectively. The Company adopted this guidance during the first quarter of fiscal year 2012. Adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

We do not believe that any recently issued accounting standards will have a material impact on our condensed consolidated financial statements.

2. ACCOUNTS RECEIVABLE RESERVES

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

	Six Months Ended
	June 30, 2012			July 2, 2011
Balance, beginning of period	$	38,315		$	53,076
Provision for doubtful accounts and sales returns		9,928			13,232
Write-offs, net of recoveries		(15,842	)		(14,036	)
Balance, end of period	$	32,401		$	52,272

3. INVENTORIES

Inventories consist of the following (in thousands):

	June 30, 2012			December 31, 2011
Components and raw materials	$	59,263		$	50,322
Work in process		5,836			4,681
Finished goods		61,247			60,839
Inventory held on consignment		25,595			27,003
		151,941			142,845
Less inventory reserves		(15,636	)		(14,146	)
	$	136,305		$	128,699

7

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

	Six Months Ended
	June 30, 2012			July 2, 2011
Balance, beginning of period	$	14,146		$	12,853
Provision charged to cost of sales		3,144			3,688
Write-offs, net of recoveries		(1,654	)		(2,111	)
Balance, end of period	$	15,636		$	14,430

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

4. LONG-LIVED ASSETS

Goodwill

Changes in the carrying amount of our goodwill for the six months ended June 30, 2012 are presented below (in thousands):

Balance, beginning of period	$	1,228,778
Foreign currencytranslation adjustments		(1,882	)
Balance, end of period	$	1,226,896

Intangible assets, net

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

June 30, 2012	Gross Carrying Amount		Accumulated Amortization			Intangible Assets, Net
Definite-lived intangible assets:
Customer relationships	$	568,986	$	(208,264	)	$	360,722
Patents and technology		460,715		(176,090	)		284,625
Trademarks and trade names		23,650		(2,975	)		20,675
Distributor contracts and relationships		5,162		(1,614	)		3,548
Non-compete agreements		3,634		(1,298	)		2,336
	$	1,062,147	$	(390,241	)		671,906
Indefinite-lived intangible assets:
Trademarks and trade names							411,302
Net identifiable intangible assets						$	1,083,208

December 31, 2011	Gross Carrying Amount		Accumulated Amortization			Intangible Assets, Net
Definite-lived intangible assets:
Customer relationships	$	569,528	$	(181,396	)	$	388,132
Patents and technology		460,624		(156,290	)		304,334
Trademarks and trade names		23,650		(1,807	)		21,843
Distributor contracts and relationships		5,089		(1,206	)		3,883
Non-compete agreements		3,636		(883	)		2,753
	$	1,062,527	$	(341,582	)		720,945
Indefinite-lived intangible assets:
Trademarks and trade names							411,749
Net identifiable intangible assets						$	1,132,694

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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 7.2 years for customer relationships, 10.1 years for patents and technology, 4.5 years for distributor rights, 8.7 years for trademarks and trade names, and 3.0 years for non-compete agreements. Based on our amortizable intangible asset balance as of June 30, 2012, we estimate that amortization expense will be as follows for the next five years and thereafter (in thousands):

Remaining 2012	$	47,932
2013		91,077
2014		89,054
2015		84,728
2016		80,768
Thereafter		278,347
	$	671,906

5. OTHER CURRENT LIABILITIES

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

	June 30, 2012		December 31, 2011
Accrued wages and related expenses	$	30,256	$	29,856
Accrued commissions		13,182		12,831
Income taxes payable		3,941		2,878
Accrued rebates		5,329		6,027
Accrued other taxes		3,902		4,195
Accrued professional expenses		4,044		3,927
Derivative liabilities		—		545
Other accrued liabilities		20,161		21,512
	$	80,815	$	81,771

6. DERIVATIVE INSTRUMENTS

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 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 are 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 valuation 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.

Interest Rate Swap Agreements. Historically, we have used interest rate swaps from time to time to manage the risk of unfavorable movements in interest rates on a portion of the then outstanding loan balance under our senior secured credit facility. In August 2009, we entered into four interest rate swap agreements with notional amounts aggregating $300.0 million, and a weighted average fixed LIBOR rate of 2.5825%.

Our interest rate swap agreements were designated as cash flow hedges for accounting purposes, and the hedges were considered effective. As such, the effective portion of the gain or loss on the derivative instrument was reported as a component of accumulated other comprehensive income (loss) and reclassified into interest expense in our consolidated statement of operations in the period in which it affected income (loss).

These interest rate swap agreements expired on December 31, 2011. We currently have no interest rate swap agreements in place.

Foreign Currency Exchange Rate Contracts. We utilize Mexican Peso (MXP) foreign exchange forward contracts to hedge a portion of our exposure to fluctuations in foreign currency exchange rates, as our Mexico-based manufacturing operations incur costs that are largely denominated in MXN. Foreign currency exchange forward contracts held as of June 30, 2012 expire weekly through September 2012. While our foreign currency 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 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 (MXP)				Notional Amount (USD)
	June 30, 2012		December 31, 2011		June 30, 2012		December 31, 2011
Foreign currency exchange contracts not designated as hedges		315,228		197,900	$	22,099	$	14,576

The following table summarizes the location and fair value of derivative instruments in our unaudited condensed consolidated balance sheets (in thousands):

	Balance Sheet Location	June 30, 2012		December 31, 2011
Derivative Assets:
Foreign currency exchange forward contracts not designated as hedges	Other current assets	$	1,178	$	—
Derivative Liabilities:
Foreign currency exchange forward contracts not designated as hedges	Other current liabilities	$	—	$	545

The following table summarizes the effect of derivative instruments on our unaudited condensed consolidated statements of operations (in thousands):

		Three Months Ended					Six months Ended
	Location of gain (loss)	June 30, 2012		July 2, 2011			June 30, 2012		July 2, 2011
Interest rate swap agreements designated as cash flow hedges	Interest expense (1)	$	—	$	(1,797	)	$	—	$	(3,577	)
Foreign currency exchange forward contracts not designated as hedges	Other income, net		652		204			1,723		33
		$	652	$	(1,593	)	$	1,723	$	(3,544	)

(1) Represents the loss on derivative instruments designated as cash flow hedges, which has been reclassified from accumulated other comprehensive income (loss) into interest expense during the periods presented.

The pre-tax loss on derivative instruments designated as cash flow hedges recognized in other comprehensive income (loss) is presented below (in thousands):

	Three Months Ended				Six Months Ended
	June 30, 2012		July 2, 2011		June 30, 2012		July 2, 2011
Interest rate swaps designated as cash flow hedges	$	—	$	190	$	—	$	426

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

As of June 30, 2012	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Recorded Balance
Assets:
Foreign currency exchange forward contracts not designated as hedges	$	—	$	1,178	$	—	$	1,178
As of December 31, 2011	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 currency exchange forward contracts not designated as hedges	$	—	$	545	$	—	$	545

8. DEBT AND CAPITAL LEASE OBLIGATIONS

Debt and capital lease obligations consists of the following (in thousands):

	June 30, 2012			December 31, 2011
Amended Senior Secured Credit Facility:
Revolving Credit Facility	$	51,000		$	—
$453.9 million New Term Loans, net of unamortized original issue discount of $8.0 million		445,880			—
$387.5 million Extended Term Loans, net of unamortized original issue discount of $1.7 million		385,813			—
Original Senior Secured Credit Facility:
Original Revolving Credit Facility		—			51,000
Original Term Loans, net of unamortized original issue discount of $4.4 million		—			838,591
8.75% second priority senior secured notes		230,000			—
10.875% senior unsecured notes, including unamortized original issue premium of $2.8 million and $3.3 million, respectively		467,794			678,282
7.75% senior unsecured notes		300,000			300,000
9.75% senior subordinated notes		300,000			300,000
Capital lease obligations and other		18			38
Total debt and capital lease obligations		2,180,505			2,167,911
Current maturities		(8,625	)		(8,820	)
Long-term debt and capital lease obligations	$	2,171,880		$	2,159,091

Senior Secured Credit Facility

On November 20, 2007, we entered into a Senior Secured Credit Facility (Original Senior Secured Credit Facility) consisting of a $1,065.0 million term loan facility maturing in May 2014 (Original Term Loans) and a $100.0 million revolving credit facility maturing in November 2013 (Original Revolving Credit Facility). We issued the Original Term Loans at a 1.2% discount.

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On March 20, 2012, we entered into an Amendment and Restatement Agreement to amend and restate our Original Senior Secured Credit Facility, as amended (Amended Senior Secured Credit Facility), which (1) permitted the issuance of $230.0 million aggregate principal of 8.75% second priority senior secured notes (as defined and further described below) (2) extended the maturity of $564.7 million of term loans outstanding under the Original Senior Secured Credit Facility to the earlier of November 1, 2016 or August 15, 2014, if on such date the aggregate principal amount of our 10.875% senior unsecured notes (as defined and further described below) is not less than $150.0 million (Extended Term Loans); (3) provided for the issuance of a new tranche of $350.0 million of term loans that will mature on the earlier of September 15, 2017 or August 15, 2014, if on such date the aggregate outstanding principal amount of our 10.875% senior unsecured notes is not less than $150.0 million; (4) deemed certain previous acquisitions and investments to be permitted under the terms of the Amended Senior Secured Credit Facility; (5) increased the total net leverage ratio limitation in the permitted acquisitions covenant from 7.0x to 7.5x; (6) changed the financial maintenance covenant from a senior secured leverage ratio covenant to a new Senior Secured first lien leverage ratio covenant; and (7) replaced our Original Revolving Credit Facility with a new $100.0 million revolving credit facility (Revolving Credit Facility) which matures on the earlier of March 14, 2017 or August 15, 2014, if on such date the aggregate principal amount of 10.875% senior unsecured notes is not less than $150.0 million.

On March 30, 2012, we entered into Amendment No. 1 to our Amended Senior Secured Credit Facility which among other things, provided for the issuance of an additional $105.0 million of new term loans that will mature on the earlier of September 15, 2017 or August 15, 2014, if on such date the outstanding aggregate principal amount of our 10.875% senior unsecured notes is not less than $150.0 million. The net proceeds from the issuance were used to repay $103.5 million aggregate principal of Original Term Loans under the Original Senior Secured Credit Facility and pay related fees, premiums and expenses.

Collectively, the $350.0 million of new term loans issued on March 20, 2012 and the $105.0 million of new term loans issued on March 30, 2012 are referred to as the New Term Loans.

The New Term Loans were issued at a discount as follows: $350.0 million of the New Term Loans were issued at a 1.5% discount and $105.0 million of the New Term Loans were issued at a 1.0% discount. The original issue discounts are being amortized over the term of the loans using the effective interest method.

The net proceeds from the New Term Loans were used to repay the remaining portion of the Original Term Loans maturing in May 2014 and to repay a portion of the Extended Term Loans.

As of June 30, 2012, the market values of our Amended Senior Secured Credit Facility and Revolving Credit Facility were $837.2 million and $46.9 million, respectively. We determined market value using trading prices for our credit facilities on or near that date.

Interest Rates. The interest rate margins applicable to borrowings under the Revolving Credit Facility are, at our option, either (a) the Eurodollar rate plus 475 basis points or (b) a base rate plus 375 basis points. The interest rate margins applicable to the Extended Term Loans and the New Term Loans are, at our option, either (a) the Eurodollar rate plus 500 basis points or (b) a base rate plus 400 basis points. There is a minimum LIBOR rate applicable to the Eurodollar component of interest rates on New Term Loan borrowings of 1.25%. The applicable margin for borrowings under the Revolving Credit Facility, the Extended Term Loans and the New Term Loans may be reduced, subject to our attaining certain leverage ratios. As of June 30, 2012, our weighted average interest rate for all borrowings under the Amended Senior Secured Credit Facility was 5.74%.

Fees. In addition to paying interest on outstanding principal under the Amended Senior Secured Credit Facility, we are required to pay a commitment fee to the lenders under the Revolving Credit Facility with respect to the unutilized commitments thereunder. The current commitment fee rate is 0.50% per annum, 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 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. We are required to pay annual payments in equal quarterly installments on the Extended Term Loans in an amount equal to 1.00% of the funded total principal amount through September 2016, with any remaining amount payable in full at maturity in November 2016.

Prepayments. The Amended Senior Secured Credit Facility requires us to prepay outstanding term loans, subject to certain exceptions, with (1) 50% (which percentage can be reduced to 25% or 0% upon our attaining certain leverage ratios) of our annual excess cash flow, as defined; (2) 100% of the net cash proceeds above an annual amount of $25.0 million from non-ordinary course asset sales (including insurance and condemnation proceeds) by DJOFL and its restricted subsidiaries, subject to certain exceptions to be agreed upon, including a 100% reinvestment right if reinvested or committed to reinvest within 15 months of such sale or disposition so long as reinvestment is completed within 180 days thereafter; and (3) 100% of the net cash proceeds from issuance or incurrence of debt by DJOFL and its restricted subsidiaries, other than proceeds from debt permitted to be incurred under the Amended Senior Secured Credit Facility 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 prepayments in 2012 related to our 2011 excess cash flow calculation.

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Subject to certain exceptions, voluntary prepayments of the Extended Term Loans and the New Term Loans within one year of the effective date of Amendment No. 1 are subject to a 1.0% “soft call” premium, while other voluntary prepayments of outstanding loans under the Amended Senior Secured Credit Facility 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 Amended Senior Secured Credit Facility are unconditionally guaranteed by DJO Holdings LLC (DJO Holdings) and each existing and future direct and indirect wholly-owned domestic subsidiary of DJOFL other than immaterial subsidiaries, unrestricted subsidiaries and subsidiaries that are precluded by law or regulation from guaranteeing the obligations (collectively, the Guarantors).

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

Certain Covenants and Events of Default. The Amended Senior Secured Credit Facility contains 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 Amended Senior Secured Credit Facility requires us to maintain a maximum Senior Secured first lien leverage ratio of consolidated Senior Secured first lien debt to Adjusted EBITDA (as defined) of 4.25:1 for the trailing twelve months ended June 30, 2012, stepping down periodically to 3.25 at the end of 2016. The Amended Senior Secured Credit Facility also contains certain customary affirmative covenants and events of default. As of June 30, 2012, our actual Senior Secured first lien net leverage ratio was 3.12:1, and we were in compliance with all other applicable covenants.

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8.75% Second Priority Senior Secured Notes

On March 20, 2012, DJOFL and DJO Finance Corporation (DJO Finco) (collectively, the Issuers) issued $230.0 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 Amended Senior Secured Credit Facility.

Pursuant to a second lien security agreement among the Issuers, the guarantor party thereto and The Bank of New York Mellon, as second lien collateral agent, the 8.75% Notes are secured by second priority liens, subject to permitted liens, on certain of the Issuers’ subsidiary guarantor assets that secure borrowings under the Amended Senior Secured Credit Facility.

As of June 30, 2012, the market value of the 8.75% Notes was $238.1 million. We determined market value using trading prices for the 8.75% Notes on or near that date.

Optional Redemption. Under the agreement governing the 8.75% Notes (8.75% Indenture), prior to March 15, 2015, the Issuers 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, the Issuers 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, the Issuers 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 notes issued remains outstanding.

Change of Control. Upon the occurrence of a change of control, unless DJOFL has previously sent or concurrently sends a notice exercising its optional redemption rights with respect to all of the 8.75% Notes, DJOFL will be required to make an offer to repurchase all of the 8.75% Notes at 101% of the then outstanding principal balance, plus accrued and unpaid interest.

Covenants. The 8.75% Indenture contains 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 June 30, 2012, we were in compliance with all applicable covenants.

10.875% Senior Unsecured Notes

On November 20, 2007 and January 20, 2010, the Issuers issued 10.875% senior unsecured notes maturing on November 15, 2014, with aggregate principal amounts of $575.0 million and $100.0 million, respectively (10.875% Notes). The 10.875% 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 Amended Senior Secured Credit Facility.

The $100.0 million of 10.875% Notes were issued at a 5.0% premium and we are amortizing the premium over the term of the notes using the effective interest method.

On March 20, 2012, we repurchased $210.0 million aggregate principal amount of 10.875% Notes from existing holders, using proceeds from our issuance of the $230.0 million aggregate principal amount of the 8.75% Notes. The notes were repurchased at a redemption price of 102% of the then outstanding principal balance, resulting in a total purchase price of $214.2 million. In addition, accrued and unpaid interest through the redemption date of $7.9 million was paid to the existing holders in connection with the redemption.

As of June 30, 2012, the market value of the remaining $465.0 million of aggregate principal amount of the 10.875% Notes was $473.1 million. We determined market value using trading prices for the 10.875% Notes on or near that date.

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Optional Redemption. Under the agreement governing the 10.875% Notes (10.875% Indenture), prior to November 15, 2011, the Issuers had the option to redeem some or all of the 10.875% Notes for cash at a redemption price equal to 100% of the then outstanding principal balance plus an applicable make-whole premium, plus accrued and unpaid interest. Beginning on November 15, 2011, the Issuers gained the option to redeem some or all of the 10.875% Notes at a redemption price of 105.438% of the then outstanding principal balance, plus accrued and unpaid interest. The redemption price decreases to 102.719% and 100% of the then outstanding principal balance on November 15, 2012 and 2013, respectively, plus accrued and unpaid interest.

Change of Control. Upon the occurrence of a change of control, unless DJOFL has previously sent or concurrently sends a notice exercising its optional redemption rights with respect to all of the 10.875% Notes, DJOFL will be required to make an offer to repurchase all of the 10.875% Notes at 101% of the then outstanding principal balance, plus accrued and unpaid interest.

Covenants. The 10.875% Indenture contains 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 June 30, 2012, we were in compliance with all applicable covenants.

7.75% Senior Unsecured Notes

On April 7, 2011, the Issuers 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 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 Amended Senior Secured Credit Facility.

As of June 30, 2012, the market value of the 7.75% Notes was $238.5 million. We determined market value using trading prices for the 7.75% Notes on or near that date.

Optional Redemption. Under the agreement governing the 7.75% Notes (7.75% Indenture), prior to April 15, 2014, the Issuers 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. Beginning on April 15, 2014, the Issuers may 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, plus accrued and unpaid interest. Additionally, from time to time, before April 15, 2014, the Issuers may redeem up to 35% of the 7.75% Notes at a redemption price equal to 107.75% 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 notes issued remains outstanding.

Change of Control. Upon the occurrence of a change of control, unless DJOFL has previously sent or concurrently sends a notice exercising its optional redemption rights with respect to all of the then outstanding 7.75% Notes, DJOFL will be required to make an offer to repurchase all of the then outstanding 7.75% Notes at 101% of the then outstanding principal balance, plus accrued and unpaid interest.

Covenants. The 7.75% Indenture contains 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 June 30, 2012, we were in compliance with all applicable covenants.

9.75% Senior Subordinated Notes

On October 18, 2010, the Issuers 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 subordinated 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 by any of DJOFL’s subsidiaries that are an obligor under the Amended Senior Secured Credit Facility.

As of June 30, 2012, the market value of the 9.75% Notes was $223.5 million. We determined market value using trading prices for the 9.75% Notes on or near that date.

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Optional Redemption. Under the agreement governing the 9.75% Notes (9.75% Indenture), prior to October 15, 2013, the Issuers 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. Beginning on October 15, 2013, the Issuers may redeem some or all of the 9.75% Notes at a redemption price of 107.313% of the then outstanding principal balance, plus accrued and unpaid interest. The redemption price decreases to 104.875%, 102.438% and 100% of the then outstanding principal balance at October 15, 2014, 2015 and 2016, respectively, plus accrued and unpaid interest. Additionally, from time to time, before October 15, 2013, the Issuers may redeem up to 35% of the 9.75% Notes at a redemption price equal to 109.75% 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 notes issued remains outstanding.

Change of Control. Upon the occurrence of a change of control, unless DJOFL has previously sent or concurrently sends a notice exercising its optional redemption rights with respect to all of the 9.75% Notes, DJOFL will be required to make an offer to repurchase all of the 9.75% Notes at 101% of the then outstanding principal balance, plus accrued and unpaid interest.

Covenants. The 9.75% Indenture contains 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 June 30, 2012, 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 the ratios required by certain of those covenants. A breach of any of these covenants in the future could result in a default under the Amended Senior Secured Credit Facility or the 8.75% Indenture, the 10.875% Indenture, the 9.75% Indenture or the 7.75% Indenture (collectively, the Indentures), at which time the lenders thereunder could elect to declare all amounts outstanding under the Amended Senior Secured Credit Facility to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.

Debt Issuance Costs

As of June 30, 2012 and December 31, 2011, we had incurred $45.3 million and $34.0 million, respectively, of unamortized debt issuance costs which were included in other assets in our unaudited condensed consolidated balance sheets. During the three months and six months ended June 30, 2012, we capitalized $0.3 million and $15.9 million, respectively, of debt issuance costs incurred in connection with the issuance of the 8.75% Notes and the New Term Loans and the amendment and extension of our Amended Senior Secured Credit Facility.

For the three and six months ended June 30, 2012, amortization of debt issuance costs was $2.6 million and $4.6 million, respectively. For the three and six months ended July 2, 2011, amortization of debt issuance costs was $2.0 million and $3.8 million, respectively. Amortization of debt issuance costs is included in interest expense in our unaudited condensed consolidated statements of operations.

Loss on Modification and Extinguishment of Debt

During the three months and six months ended June 30, 2012, we recognized a loss on modification and extinguishment of debt of $0.1 million and $9.4 million, consisting of $8.6 million of arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.8 million related to the write off of unamortized debt issuance costs and original issue discount associated with the portion of the Original Term Loans which were extinguished.

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 amount which would have been recorded using the U.S. statutory tax rate due primarily to certain foreign and U.S. federal and state valuation allowances provided against deferred tax assets, the impact of nondeductible expenses, foreign taxes, and deferred taxes on the assumed repatriation of foreign earnings.

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For the three and six months ended June 30, 2012, we recorded income tax expense of approximately $0.1 million and $2.5 million, respectively, on pre-tax losses of $19.8 million and $46.5 million, respectively, resulting in negative effective tax rates of 0.4% and 5.3%, respectively. For the three and six months ended July 2, 2011, we recorded income tax benefits of approximately $14.5 million and $22.0 million, respectively, on pre-tax losses of approximately $33.5 million and $61.8 million, respectively, resulting in effective tax rates of 43.3% and 35.6%, respectively. The change in our effective tax rates from 2011 to 2012 primarily relates to U.S federal and state valuation allowances beginning to be provided against deferred tax assets in the first quarter of 2012 and differences in our projected annualized effective tax rates for each year. Given the relationship between fixed dollar tax items and pre-tax financial results, the projected annual effective tax rate can change materially based on small variations of income.

We have recorded valuation allowances against a portion of the deferred tax assets related to our 2012 U.S. federal and state net operating losses. We record net deferred tax assets to the extent we conclude that it is more likely than not that the related deferred tax assets will be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. At this time, we cannot conclude that it is more likely than not that the benefit from certain U.S. federal and state net operating loss carryforwards will be realized. In recognition of this risk, we have provided valuation allowances of $16.9 million and $26.8 million, respectively, on the deferred tax assets related to the net operating loss carryforwards generated in the three and six months ended June 30, 2012. If our assumptions change and we determine that is 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 2007. The Internal Revenue Service (IRS) completed its field examination of our 2005 and 2006 tax years during the first half of 2010. The IRS had originally proposed material adjustments related to deductions for transaction costs, stock options expense and bad debt expense included in our 2006 tax return. During the second quarter of 2012, we engaged in discussions and negotiations with IRS appeals officers with respect to the adjustments proposed by the IRS. While the formal completion of the appeals process remains pending, based upon the current status of our recent discussions and negotiations with IRS appeals officers, we do not expect a material reduction to our currently unreserved net operating losses to result from the finalization of this process and we estimate that we will reduce our unrecognized tax benefits by approximately $8.8 million when the appeals process is finalized.

At June 30, 2012, our gross unrecognized tax benefits were $18.8 million, reflecting a reduction of $0.6 million, due to the expiration of certain statutes of limitation related to transfers of intellectual property, from the unrecognized amount of $19.4 million at December 31, 2011. As of June 30, 2012, 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. In addition to the reduction of unrecognized tax benefits related to the completion of the IRS appeals process, we anticipate that approximately $0.6 million of unrecognized tax benefits related to transfers of intellectual property and $0.5 million of aggregate of other individually immaterial unrecognized tax benefits will decrease in the next twelve months due to the expiration of the statutes of limitation. As of June 30, 2012, we have unrecognized various foreign and U.S. state tax benefits of approximately $4.1 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 stock, options, and other stock-based awards of shares of common stock of our indirect parent, DJO, subject to adjustment in certain events. In February 2012, we amended the 2007 Plan to increase the number of shares available to grant from 7,925,529 to 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.

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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 Tranche). 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 Tranche). 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 Tranche).

Stock-Based Compensation

During the six months ended June 30, 2012, the compensation committee granted 2,135,000 options which 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 of Blackstone achieving a minimum return of MOIC, as defined, with respect to Blackstone’s aggregate investment in DJO’s capital stock, following a liquidation of all or a portion of its investment in DJO’s capital stock, any unvested installments from prior years and all installments for future years shall thereupon vest.

In addition to the 2,135,000 Performance Options granted during the six months ended June 30, 2012, we granted 326,767 stock options to members of DJO’s Board of Directors. Of these options, 303,767 were granted to DJO’s Chairman of the Board, and vest as follows: one-third of the stock option grant will vest 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 the Chairman of the Board; one-third of the stock option grant will vest in the same manner as the Market Return Tranche; and one-third of the stock option grant will vest in the same manner as the Enhanced Market Return Tranche. The remaining 23,000 options were granted to the other five outside directors on our Board of Directors and vest 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. The time-based vesting options granted to the Chairman and to the outside directors are referred to herein as Director Service Options.

The weighted average grant date fair value of the Performance Options and the Director Service Options granted during the six months ended June 30, 2012 was $6.08.

During the six months ended July 2, 2011, we granted 970,500 stock options to employees, including 800,000 options granted to Michael P. Mogul, our new President and Chief Executive Officer. The weighted average grant date fair value of the options in the Time-Based Tranche was $6.24 per share.

For the Performance Options granted during the six months ended June 30, 2012, we only recognized expense for the options which have the potential to vest based on achievement of the 2012 Adjusted EBITDA target, as we believe that it is probable that this target will be met. We have not recognized expense for any of the options which have the potential to vest based on Adjusted EBITDA targets for years 2013-2015, as these targets have not yet been established and therefore we are unable to assess the probability of achieving these targets.

In each of the periods presented below, for the options granted prior to 2012 we only recognized expense for options granted to employees in the Time-Based Tranche, as achievement of the vesting targets for the performance and market components of the Market Return Tranche and Enhanced Market Return Tranche are not deemed probable at this time.

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

	Three Months Ended						Six Months Ended
	June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Expected volatility		35.3	%		34.0	%		35.3	%		34.0	%
Risk-free interest rate		1.5	%		2.1	%		1.5	%		2.1	%
Expected years until exercise		6.2			6.5			6.2			6.5
Expected dividend yield		0.0	%		0.0	%		0.0	%		0.0	%

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

	Three Months Ended				Six Months Ended
	June 30, 2012		July 2, 2011		June 30, 2012		July 2, 2011
Cost of goods sold	$	57	$	62	$	96	$	111
Operating Expenses:
Selling, general and administrative		1,303		351		2,094		1,192
Research and development		35		13		63		28
	$	1,395	$	426	$	2,253	$	1,331

Stock-based compensation expense for options granted to non-employees was not significant to the Company for any period presented and is included in selling, general and administrative expense in our unaudited consolidated statements of operations.

11. EQUITY

During the six months ended June 30, 2012, DJO sold 60,753 shares of its common stock at $16.46 per share to the new Chairman of its Board of Directors, subject to execution of a stockholder agreement including certain rights and restrictions. Net proceeds of $1.0 million from the share purchases were contributed by DJO to us, and are included in member capital in our unaudited condensed consolidated balance sheet as of June 30, 2012. The proceeds were used for working capital purposes.

12. RELATED PARTY TRANSACTIONS

Blackstone Management Partners V L.L.C. (BMP), an affiliate of our major shareholder, provides certain monitoring, advisory and consulting services to us for an annual monitoring fee equal to the greater of $7.0 million or 2% of consolidated EBITDA as defined in the Transaction and Monitoring Fee Agreement, payable in the first quarter of each year. The monitoring fee agreement will continue until the earlier of November 2019, or such date as DJO and BMP may mutually determine. DJO has agreed to indemnify BMP and its affiliates, directors, officers, employees, agents and representatives from and against all liabilities relating to the services contemplated by the Transaction and Monitoring Fee Agreement and the engagement of BMP pursuant to, and the performance of BMP and its affiliates of the services contemplated by, the Transaction and Monitoring Fee Agreement. At any time in connection with or in anticipation of a change of control of DJO, a sale of all or substantially all of DJO’s assets or an initial public offering of common stock of DJO, BMP may elect to receive, in lieu of remaining annual monitoring fee payments, a single lump sum cash payment equal to the then-present value of all then-current and future annual monitoring fees payable under the Transaction and Monitoring Fee Agreement, assuming a hypothetical termination date of the agreement to be November 2019. For each of the three and six month periods presented, we recognized $1.75 million and $3.50 million, respectively, related to the annual monitoring fee, which was recorded as a component of selling, general and administrative expense in our unaudited condensed consolidated statements of operations.

13. COMMITMENTS AND CONTINGENCIES

The manufacture and sale of orthopedic devices and related products exposes us to a significant risk of product liability claims. From time to time, we have been, and we are currently, subject to a number of product liability claims alleging that the use of our products resulted in adverse effects. Even if we are successful in defending against any liability claims, such claims could nevertheless distract our management, result in substantial costs, harm our reputation, adversely affect the sales of all our products and otherwise harm our business. If there is a significant increase in the number of product liability claims, our business could be adversely affected.

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Pain Pump Litigation

We are currently named as one of several defendants in a number of product liability lawsuits involving approximately 65 plaintiffs in U.S. cases and a lawsuit in Canada which has been granted class action status, related to a disposable drug infusion pump product (pain pump) manufactured by two third party manufacturers that we distributed through our Bracing and Vascular segment. We sold pumps manufactured by one manufacturer from 1999 to 2003 and then sold pumps manufactured by a second manufacturer from 2003 to 2009. 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 has resulted in cartilage damage to the plaintiffs. The lawsuits allege damages ranging from unspecified amounts to claims of up to $10 million. Many of the lawsuits which have been filed in the past three years have named multiple pain pump manufacturers and distributors without having established which manufacturer manufactured or sold the pump in issue. In the past three years, we have been dismissed from more than 380 cases when product identification was later established showing that we did not sell the pump in issue. At present, we are named in approximately 25 lawsuits in which product identification has yet to be determined and, as a result, we believe that we will be dismissed from a meaningful number of such cases in the future. In the past two years, we have entered into settlements with plaintiffs in approximately 63 pain pump lawsuits. Of these, we have settled approximately 36 cases in joint settlements involving our first manufacturer and we have settled approximately 27 cases involving our second manufacturer. As of June 30, 2012, the range of potential loss is not estimable.

Indemnity and Insurance Coverage Related to Pain Pump Claims

We have sought indemnity and tendered the defense of the pain pump cases to the two manufacturers who supplied these pumps to us, to their products liability carriers and to our products liability carriers. These lawsuits are about equally divided between the two manufacturers. Both manufacturers have rejected our tenders of indemnity. The base policy for one of the manufacturers contributed to our defense, but that policy has been exhausted by defense costs and settlements, as has a second policy of that manufacturer. This manufacturer has ceased operations, has little assets and no additional insurance coverage. The Company has asserted indemnification rights against the successor to this manufacturer and is pursuing claims against the manufacturer, its owners and its successor. This manufacturer has asserted a counterclaim for indemnity against DJO, alleging that DJO is responsible for any liability incurred by the manufacturer in connection with DJO’s sale of pain pumps supplied by this manufacturer. The base policy for the other manufacturer has been exhausted and the excess liability carriers for that manufacturer have not accepted coverage for the Company and are not expected to provide for its defense. The Company and this manufacturer have been cooperating in jointly negotiating settlements of those lawsuits in which both parties are named. Our products liability carriers have accepted coverage of these cases, subject to a reservation of the right to deny coverage for customary matters, including punitive damages and off-label promotion. In August 2010, one of our excess carriers for the period ending July 1, 2010 and for the supplemental extended reporting period (SERP) discussed below, which is insuring $10 million in excess of $25 million, informed us that it has reserved its right to rescind the policy based on an alleged failure by us and our insurance broker to disclose material information regarding the pain pump claims prior to the binding of coverage by this carrier. We disagree with this allegation and are seeking to resolve the issue with this carrier.

Pain Pump-Related Health Insurance Portability and Accountability Act (HIPAA) Subpoena

In August 2010, we were served with a subpoena under HIPAA seeking numerous documents related to our activities involving the pain pumps discussed above. The subpoena, which was issued by the United States Attorney’s Office for the Central District of California, refers to an official investigation by the DOJ and the FDA of Federal health care offenses. We have produced documents that are responsive to the subpoena. We believe that our actions related to our prior distribution of these pain pumps have been in compliance with applicable legal standards.

Pain Pump Investigation — U.S. Attorney’s Office for the Western District of Missouri

In January 2012, the Company became aware of a civil investigation by the United States Attorney’s Office for the Western District of Missouri regarding the Company’s previous sale and marketing of pain pump devices. The investigation relates to whether the Company caused false claims to be filed with government payors as a result of alleged off-label promotion of the pain pumps. The Company believes that this investigation is related to the investigation by the United States Attorney’s Office for the Central District of California that is described above. The Company denies that it improperly promoted the pain pump devices and believes that its marketing and sales activities were in compliance with applicable legal standards.

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Cold Therapy Litigation

Since mid-2010, we have been named in nine multi-plaintiff lawsuits involving a total of 210 plaintiffs, alleging that the plaintiffs had been injured following use of certain cold therapy products manufactured by the Company. The complaints are not specific as to the nature of the injuries, but allege various product liability theories, including inadequate warnings regarding the risks associated with the use of cold therapy and failure to incorporate certain safety features into the design. No specific dollar amounts of damages are alleged and as of June 30, 2012, we cannot estimate a range of potential loss. These cases have been included in a coordinated proceeding in San Diego Superior Court with a similar number of cases filed against one of our competitors. A total of ten of the plaintiffs included in the cases filed against us have been selected as the first cases to be tried, of which four of these “bellwether” cases will go to trial in April 2013. Discovery is proceeding on these bellwether cases.

Our Product Liability Insurance Coverage

We maintain product liability insurance that is subject to annual renewal. Our current policy covers claims reported between July 1, 2012 and June 30, 2013. This policy excludes coverage for claims related to both pain pump products and cold therapy products. As described below, we have other insurance which provides coverage for these excluded products. For the current policy year, we maintain coverage limits (together with excess policies) of up to $50 million, with deductibles of $500,000 per claim for claims relating to invasive products (principally our surgical implant products) and $50,000 per claim for claims relating to all other covered products, with an aggregate self-insured retention of $2 million. Starting with the 2010-2011 policy period, our products liability policy excluded claims related to pain pump products. We purchased supplemental extended reporting period (SERP) coverage for the $80 million limit product liability policy that expired on June 30, 2010, and this supplemental coverage allows us to report pain pump claims for an additional five years beyond the end of that policy period. Except for the additional excess coverage mentioned below, this SERP coverage does not provide additional limits to the aggregate $80 million limits on the 2009-2010 policy but it does provide that these limits will remain available for pain pump claims reported for an extended period of time. We also purchased additional coverage of $25 million in excess of the $80 million limits with a five year reporting period. Thus, the SERP coverage for current and future pain pump claims has a total limit of $105 million (less amounts paid for claims reported to date). Starting with the 2011-2012 policy period, our primary products liability coverage excluded claims related to cold therapy products. Concurrently with the exclusion of our cold therapy products from the 2011-2012 primary policy, we purchased SERP coverage for cold therapy product claims for injuries alleged to have occurred prior to July 1, 2011. This SERP allows us to report such cold therapy claims under our expired 2010-2011 policy which had total limits of $50 million. At that time, we also purchased separate primary and excess policies providing for a total of $5 million of coverage for claims related to cold therapy products arising from injuries alleged to have occurred after June 30, 2011, with a deductible of $250,000 per claim and an aggregate deductible of $3 million. We continued this $5 million in coverage on similar terms for the policy period commencing July 1, 2012. We believe we have adequate insurance coverage for our product liability claims.

BGS Qui Tam Action and HIPAA Subpoena

On April 15, 2009, we became aware of aqui tamaction filed in Federal Court in Boston, Massachusetts in March 2005 and amended in December 2007 that names us as a defendant along with each of the other companies that manufactures and sells external bone growth stimulators, as well as The Blackstone Group L.P., an affiliate of DJO’s principal stockholder, and the principal stockholder of one of the other companies in the bone growth stimulation business. This case is captioned United Statesex rel.Beirman v. Orthofix International, N.V.,et al., Civil Action No. 05-10557 (D. Mass.). The case was sealed when originally filed and unsealed in March 2009. The plaintiff, or 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 devices by each defendant to the present by seeking reimbursement for bone growth stimulators as a purchased item rather than a rental item. The relator also alleges that the defendants are engaged in other marketing practices constituting violations of the Federal and various state anti-kickback statutes. On December 4, 2009, we filed a motion to dismiss the relator’s complaint. The relator filed a second amended complaint in May 2010 that, among other things, dropped The Blackstone Group as a defendant. We filed another motion to dismiss directed at the second amended complaint, and that motion was denied. The case is proceeding to the discovery phase. Shortly before becoming aware of thequi tamaction, we were advised that our bone growth stimulator business was the subject of an investigation by the DOJ, and on April 10, 2009, we were served with a subpoena under HIPAA seeking numerous documents relating to the marketing and sale by us of bone growth stimulators. On September 21, 2009, we were served with a second HIPAA subpoena related to this DOJ investigation seeking additional documents relating to the marketing and sale by us of bone growth stimulators. We believe that these subpoenas are related to the DOJ’s investigation of the allegations in thequi tamaction, although the DOJ has decided not to intervene in thequi tamaction at this time. We believe that our marketing practices in the bone growth stimulation business are in compliance with applicable legal standards and we intend to defend this case and investigation vigorously. We can make no assurance as to the resources that will be needed to respond to these matters or the final outcome of such action and as of June 30, 2012, we cannot estimate a range of potential loss, fines or damages.

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14. SEGMENT AND GEOGRAPHIC INFORMATION

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

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

Bracing and Vascular Segment

Our Bracing and Vascular segment, which generates its revenues in the United States, offers our rigid knee bracing products, orthopedic soft goods, cold therapy products, vascular systems, therapeutic shoes and inserts and compression therapy products, primarily under our DonJoy, ProCare, Aircast and Dr. Comfort brands. This segment also includes our OfficeCare business, through which we maintain an inventory of soft goods and other products at healthcare facilities, primarily orthopedic practices, for immediate distribution to patients. 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.

Recovery Sciences Segment

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

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

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

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

• Athlete Direct. Our Athlete Direct business unit offers consumers ranging from fitness enthusiasts to competitive athletes our Compex electrostimulation devices, which are used in athletic training programs to aid muscle development and to accelerate muscle recovery after training sessions.

International Segment

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

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.

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Information regarding our reportable business segments is presented below (in thousands). Segment results exclude the impact of amortization of intangible assets, certain general corporate expenses and various non-recurring and integration charges, 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. We do not allocate assets to reportable segments because a significant portion of our assets are shared by segments.

	Three Months Ended						Six months Ended
	June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Net sales:
Bracing and Vascular	$	112,597		$	102,056		$	217,882		$	180,235
Recovery Sciences		84,822			86,221			169,091			171,379
International		70,465			73,083			141,978			142,948
Surgical Implant		18,093			16,426			35,973			32,935
	$	285,977		$	277,786		$	564,924		$	527,497
Gross profit:
Bracing and Vascular	$	57,328		$	53,909		$	111,842		$	96,596
Recovery Sciences		64,046			65,509			127,511			130,263
International		39,985			42,355			79,881			81,904
Surgical Implant		13,530			11,653			27,188			23,541
Expenses not allocated to segments and eliminations		(714	)		(6,730	)		(1,535	)		(9,053	)
	$	174,175		$	166,696		$	344,887		$	323,251
Operating income:
Bracing and Vascular	$	22,358		$	21,099		$	42,405		$	35,495
Recovery Sciences		23,350			23,821			43,866			47,500
International		13,960			15,864			28,898			29,067
Surgical Implant		1,946			1,060			3,934			1,403
Expenses not allocated to segments and eliminations		(33,253	)		(54,601	)		(68,873	)		(94,303	)
	$	28,361		$	7,243		$	50,230		$	19,162

Geographic Area

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

	Three Months Ended				Six months Ended
	June 30, 2012		July 2, 2011		June 30, 2012		July 2, 2011
Net sales:
United States	$	215,514	$	204,703	$	422,947	$	384,495
Germany		20,948		24,291		42,929		47,491
Other Europe, Middle East and Africa		26,982		34,648		54,243		62,337
Asia Pacific		2,552		3,603		4,910		9,288
Other		19,981		10,541		39,895		23,886
	$	285,977	$	277,786	$	564,924	$	527,497

15. SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

DJOFL and its direct wholly owned subsidiary, DJO Finco, issued $575.0 million and $100.0 million of 10.875% Notes in November 2007 and January 2010, respectively, $300.0 million of 9.75% Notes in October 2010, $300.0 million of 7.75% Notes in April 2011 and $230.0 million of 8.75% Notes in March 2012. 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.

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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 10.875% Notes and 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 Guarantors also unconditionally guarantee the Amended Senior Secured Credit Facility.

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

DJO Finance LLC

Unaudited Condensed Consolidating Balance Sheets

As of June 30, 2012

	DJOFL		Guarantors		Non - Guarantors		Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	12,151	$	281	$	16,561	$	(11	)	$	28,982
Accounts receivable, net		—		125,817		37,717		—			163,534
Inventories, net		—		115,194		28,780		(7,669	)		136,305
Deferred tax assets, net		—		43,257		260		—			43,517
Prepaid expenses and other current assets		73		17,113		4,212		284			21,682
Total current assets		12,224		301,662		87,530		(7,396	)		394,020
Property and equipment, net		—		93,877		12,588		(659	)		105,806
Goodwill		—		1,150,269		104,633		(28,006	)		1,226,896
Intangible assets, net		—		1,054,506		28,702		—			1,083,208
Investment in subsidiaries		1,297,698		1,686,366		95,885		(3,079,949	)		—
Intercompany receivables		1,096,548		—		—		(1,096,548	)		—
Other non-current assets		45,311		2,642		1,611		(3	)		49,561
Total assets	$	2,451,781	$	4,289,322	$	330,949	$	(4,212,561	)	$	2,859,491
Liabilities and Equity
Current liabilities:
Accounts payable	$	—	$	48,147	$	9,729	$	12		$	57,888
Current portion of debt and capital lease obligations		8,608		17		—		—			8,625
Other current liabilities		23,731		54,153		26,367		379			104,630
Total current liabilities		32,339		102,317		36,096		391			171,143
Long-term debt and capital lease obligations		2,171,880		—		—		—			2,171,880
Deferred tax liabilities, net		—		240,774		9,725		—			250,499
Intercompany payables, net		—		909,263		163,277		(1,072,540	)		—
Other long-term liabilities		—		14,328		1,434		—			15,762
Total liabilities		2,204,219		1,266,682		210,532		(1,072,149	)		2,609,284
Noncontrolling interests		—		—		2,645		—			2,645
Total membership equity		247,562		3,022,640		117,772		(3,140,412	)		247,562
Total liabilities and equity	$	2,451,781	$	4,289,322	$	330,949	$	(4,212,561	)	$	2,859,491

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended June 30, 2012

(in thousands)

	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	253,569		$	67,363		$	(34,955	)	$	285,977
Cost of sales (exclusive of amortization of intangible assets of $9,839)		—			102,472			44,220			(34,890	)		111,802
Gross profit		—			151,097			23,143			(65	)		174,175
Operating expenses:
Selling, general and administrative		—			92,666			21,550			9			114,225
Research and development		—			5,855			1,229			—			7,084
Amortization of intangible assets		—			23,510			995			—			24,505
		—			122,031			23,774			9			145,814
Operating income (loss)		—			29,066			(631	)		(74	)		28,361
Other income (expense):
Interest expense		(46,397	)		—			(20	)		—			(46,417	)
Interest income		6			21			45			—			72
Loss on modification and extinguishment of debt		(90	)		—			—			—			(90	)
Other income (expense), net		—			658			(2,419	)		—			(1,761	)
Intercompany income (expense)		—			(101	)		266			(165	)		—
Equity in income (loss) of subsidiaries, net		26,283			—			—			(26,283	)		—
		(20,198	)		578			(2,128	)		(26,448	)		(48,196	)
(Loss) income before income taxes		(20,198	)		29,644			(2,759	)		(26,552	)		(19,835	)
Income tax (provision) benefit		—			(2,268	)		(1,334	)		3,515			(87	)
Net (loss) income		(20,198	)		27,376			(4,093	)		(23,007	)		(19,922	)
Net income attributable to noncontrolling interests		—			—			(276	)		—			(276	)
Net (loss) income attributable to DJOFL	$	(20,198	)	$	27,376		$	(4,369	)	$	(23,007	)	$	(20,198	)

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Six months Ended June 30, 2012

(in thousands)

	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	485,351	$	134,998		$	(55,425	)	$	564,924
Cost of sales (exclusive of amortization of intangible assets of $19,676)		—			193,612		90,366			(63,941	)		220,037
Gross profit		—			291,739		44,632			8,516			344,887
Operating expenses:
Selling, general and administrative		—			189,366		42,507			9			231,882
Research and development		—			11,611		2,146			—			13,757
Amortization of intangible assets		—			47,015		2,003			—			49,018
		—			247,992		46,656			9			294,657
Operating income (loss)		—			43,747		(2,024	)		8,507			50,230
Other income (expense):
Interest expense		(88,442	)		—		(46	)		—			(88,488	)
Interest income		10			36		59			—			105
Loss on modification and extinguishment of debt		(9,398	)		—		—						(9,398	)
Other income (expense), net		—			1,868		(807	)		—			1,061
Intercompany income (expense)		—			362		(254	)		(108	)		—
Equity in income (loss) of subsidiaries, net		48,278			—		—			(48,278	)		—
		(49,552	)		2,266		(1,048	)		(48,386	)		(96,720	)
(Loss) income before income taxes		(49,552	)		46,013		(3,072	)		(39,879	)		(46,490	)
Income tax benefit (provision)		—			776		(3,251	)		—			(2,475	)
Net (loss) income		(49,552	)		46,789		(6,323	)		(39,879	)		(48,965	)
Net income attributable to noncontrolling interests		—			—		(587	)		—			(587	)
Net (loss) income attributable to DJOFL	$	(49,552	)	$	46,789	$	(6,910	)	$	(39,879	)	$	(49,552	)

26

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Six months Ended June 30, 2012

(in thousands)

	DJOFL			Guarantors			Non- Guarantors			Eliminations			Consolidated
Cash Flows from Operating Activities:
Net (loss) income	$	(49,552	)	$	46,789		$	(6,323	)	$	(39,879	)	$	(48,965	)
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Depreciation		—			12,490			2,686			(187	)		14,989
Amortization of intangible assets		—			47,014			2,004			—			49,018
Amortization of debt issuance costs and non-cash interest expense		5,142			—			—			—			5,142
Stock-based compensation expense		—			2,253			—			—			2,253
Loss on modification and extinguishment of debt		9,308			90			—			—			9,398
Loss on disposal of assets, net		—			485			324			—			809
Deferred income tax benefit		—			(684	)		86			—			(598	)
Provision for doubtful accounts and sales returns		—			9,915			13			—			9,928
Inventory reserves		—			3,023			121			—			3,144
Equity in (income) loss of subsidiaries, net		(48,278	)		—			—			48,278			—
Changes in operating assets and liabilities:
Accounts receivable		—			(10,635	)		(4,717	)		—			(15,352	)
Inventories		—			(7,477	)		5,992			(7,964	)		(9,449	)
Prepaid expenses and other assets		88			(1,671	)		(1,247	)		168			(2,662	)
Accounts payable and other current liabilities		2,867			(2,482	)		(456	)		2,355			2,284
Net cash (used in) provided by operating activities		(80,425	)		99,110			(1,517	)		2,771			19,939
Cash Flows from Investing Activities:
Purchases of property and equipment		—			(13,463	)		(2,754	)		(1	)		(16,218	)
Other investing activities, net		—			(491	)		—			—			(491	)
Net cash used in investing activities		—			(13,954	)		(2,754	)		(1	)		(16,709	)
Cash Flows from Financing Activities:
Intercompany		81,670			(86,632	)		(1,564	)		6,526			—
Proceeds from issuance of debt		751,700			—			—			—			751,700
Repayments of debt and capital lease obligations		(739,641	)		(21	)		—			—			(739,662	)
Payment of debt issuance costs		(15,926	)		—			—			(9,308	)		(25,234	)
Investment by parent		1,000			—			—			—			1,000
Net cash provided by (used in) financing activities		78,803			(86,653	)		(1,564	)		(2,782	)		(12,196	)
Effect of exchange rate changes on cash and cash equivalents		—			—			(221	)		—			(221	)
Net (decrease) increase in cash and cash equivalents		(1,622	)		(1,497	)		(6,056	)		(12	)		(9,187	)
Cash and cash equivalents at beginning of period		13,773			1,778			22,617			1			38,169
Cash and cash equivalents at end of period	$	12,151		$	281		$	16,561		$	(11	)	$	28,982

27

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended July 2, 2011

(in thousands)

	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	229,790		$	68,355		$	(20,359	)	$	277,786
Cost of sales (exclusive of amortization of intangible assets of $9,785)		—			97,948			44,824			(31,682	)		111,090
Gross profit		—			131,842			23,531			11,323			166,696
Operating expenses:
Selling, general and administrative		—			104,042			24,801			—			128,843
Research and development		—			5,050			1,051			—			6,101
Amortization of intangible assets		—			23,384			1,125			—			24,509
		—			132,476			26,977			—			159,453
Operating (loss) income		—			(634	)		(3,446	)		11,323			7,243
Other income (expense):
Interest expense		(42,386	)		(3	)		(40	)		—			(42,429	)
Interest income		3			17			33			—			53
Other income, net		—			874			807			—			1,681
Intercompany income (expense)		4,086			(3,033	)		(342	)		(711	)		—
Equity in income (loss) of subsidiaries, net		19,042			—			—			(19,042	)		—
		(19,255	)		(2,145	)		458			(19,753	)		(40,695	)
Loss before income taxes		(19,255	)		(2,779	)		(2,988	)		(8,430	)		(33,452	)
Income tax benefit (provision)		—			16,963			(2,952	)		481			14,492
Net (loss) income		(19,255	)		14,184			(5,940	)		(7,949	)		(18,960	)
Net income attributable to noncontrolling interests		—			—			(295	)		—			(295	)
Net (loss) income attributable to DJOFL	$	(19,255	)	$	14,184		$	(6,235	)	$	(7,949	)	$	(19,255	)

28

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Six months Ended July 2, 2011

(in thousands)

	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	432,879		$	134,183		$	(39,565	)	$	527,497
Cost of sales (exclusive of amortization of intangible assets of $19,143)		—			174,123			86,401			(56,278	)		204,246
Gross profit		—			258,756			47,782			16,713			323,251
Operating expenses:
Selling, general and administrative		—			198,262			47,645			—			245,907
Research and development		—			10,950			2,294			—			13,244
Amortization of intangible assets		—			42,801			2,137			—			44,938
		—			252,013			52,076			—			304,089
Operating income (loss)		—			6,743			(4,294	)		16,713			19,162
Other income (expense):
Interest expense		(83,417	)		(10	)		(129	)		—			(83,556	)
Interest income		7			94			62			—			163
Loss on modification of debt		(2,065	)		—			—			—			(2,065	)
Other income, net		—			2,216			2,237			—			4,453
Intercompany income (expense)		10,625			(8,798	)		(1,679	)		(148	)		—
Equity in income of subsidiaries, net		34,356			—			—			(34,356	)		—
		(40,494	)		(6,498	)		491			(34,504	)		(81,005	)
(Loss) income before income taxes		(40,494	)		245			(3,803	)		(17,791	)		(61,843	)
Income tax benefit (provision)		—			25,253			(3,775	)		481			21,959
Net (loss) income		(40,494	)		25,498			(7,578	)		(17,310	)		(39,884	)
Net income attributable to noncontrolling interests		—			—			(610	)		—			(610	)
Net (loss) income attributable to DJOFL	$	(40,494	)	$	25,498		$	(8,188	)	$	(17,310	)	$	(40,494	)

29

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Six months Ended July 2, 2011

(in thousands)

	DJOFL			Guarantors			Non- Guarantors			Eliminations			Consolidated
Cash Flows from Operating Activities:
Net (loss) income	$	(40,494	)	$	25,498		$	(7,578	)	$	(17,310	)	$	(39,884	)
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Depreciation		—			11,204			2,682			(154	)		13,732
Amortization of intangible assets		—			42,801			2,137			—			44,938
Amortization of debt issuance costs and non-cash interest expense		4,086			—			—			—			4,086
Stock-based compensation expense		—			1,331			—			—			1,331
Loss on disposal of assets, net		—			153			225			—			378
Deferred income tax benefit		(1,235	)		(24,796	)		(394	)		(481	)		(26,906	)
Provision for doubtful accounts and sales returns		—			12,961			271			—			13,232
Inventory reserves		—			2,959			729			—			3,688
Equity in income of subsidiaries, net		(34,356	)		—			—			34,356			—
Changes in operating assets and liabilities:
Accounts receivable		—			(16,210	)		(4,642	)		—			(20,852	)
Inventories		—			(9,418	)		5,359			(6,316	)		(10,375	)
Prepaid expenses and other assets		88			2,616			(978	)		20			1,746
Accounts payable and other current liabilities		5,929			10,798			5,352			426			22,505
Net cash (used in) provided by operating activities		(65,982	)		59,897			3,163			10,541			7,619
Cash Flows from Investing Activities:
Cash paid in connection with acquisitions, net of cash acquired		—			(317,669	)		—			—			(317,669	)
Purchases of property and equipment		—			(17,546	)		(3,085	)		(61	)		(20,692	)
Other investing activities, net		—			211			4			—			215
Net cash used in investing activities		—			(335,004	)		(3,081	)		(61	)		(338,146	)
Cash Flows from Financing Activities:
Intercompany		(271,375	)		279,439			2,416			(10,480	)		—
Proceeds from issuance of debt		400,000			—			—			—			400,000
Repayments of debt and capital lease obligations		(58,391	)		(21	)		(1	)		—			(58,413	)
Payment of debt issuance costs		(7,468	)		—			—			—			(7,468	)
Cancellation of vested options		—			(2,000	)		—			—			(2,000	)
Dividend paid by subsidiary to owners of noncontrolling interests		—			—			(682	)		—			(682	)
Net cash provided by (used in) financing activities		62,766			277,418			1,733			(10,480	)		331,437
Effect of exchange rate changes on cash and cash equivalents		—			—			1,929			—			1,929
Net (decrease) increase in cash and cash equivalents		(3,216	)		2,311			3,744			—			2,839
Cash and cash equivalents at beginning of period		16,601			621			20,910			—			38,132
Cash and cash equivalents at end of period	$	13,385		$	2,932		$	24,654		$	—		$	40,971

30

DJO Finance LLC

Condensed Consolidating Balance Sheets

As of December 31, 2011

	DJOFL		Guarantors		Non- Guarantors		Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	13,773	$	1,778	$	22,617	$	1		$	38,169
Accounts receivable, net		—		125,097		33,885		—			158,982
Inventories, net		—		97,516		20,719		10,464			128,699
Deferred tax assets, net		—		43,190		268		—			43,458
Prepaid expenses and other current assets		160		15,001		3,186		444			18,791
Total current assets		13,933		282,582		80,675		10,909			388,099
Property and equipment, net		—		94,904		13,070		(866	)		107,108
Goodwill		—		1,150,269		107,344		(28,835	)		1,228,778
Intangible assets, net		—		1,101,314		31,380		—			1,132,694
Investment in subsidiaries		1,297,699		1,686,366		72,514		(3,056,579	)		—
Intercompany receivables		1,138,947		—		—		(1,138,947	)		—
Other assets		33,971		2,655		1,557		(2	)		38,181
Total assets	$	2,484,550	$	4,318,090	$	306,540	$	(4,214,320	)	$	2,894,860
Liabilities and Equity
Current liabilities:
Accounts payable	$	—	$	47,049	$	10,872	$	5		$	57,926
Current portion of debt and capital lease obligations		8,782		38		—		—			8,820
Other current liabilities		20,864		56,509		24,805		521			102,699
Total current liabilities		29,646		103,596		35,677		526			169,445
Long-term debt and capital leases obligations		2,159,091		—		—		—			2,159,091
Deferred tax liabilities, net		—		242,237		9,957		—			252,194
Intercompany payables, net		—		996,889		142,058		(1,138,947	)		—
Other long-term liabilities		—		14,689		1,485		—			16,174
Total liabilities		2,188,737		1,357,411		189,177		(1,138,421	)		2,596,904
Noncontrolling interests		—		—		2,143		—			2,143
Total membership equity		295,813		2,960,679		115,220		(3,075,899	)		295,813
Total liabilities and equity	$	2,484,550	$	4,318,090	$	306,540	$	(4,214,320	)	$	2,894,860

31

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

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

Forward Looking Statements

This report, and the following management’s discussion and analysis, contain “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. To the extent that any statements are not recitations of historical fact, such statements constitute forward-looking statements that, by definition, involve risks and uncertainties. These statements can be identified because they use words like “anticipates”, “believes”, “estimates”, “expects”, “forecasts”, “future”, “intends”, “plans” and similar terms. Specifically, statements referencing, without limitation, growth in sales of our products, profit margins and the sufficiency of our cash flow for future liquidity and capital resource needs may be forward-looking statements. These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. The section entitled “Risk Factors” in Part II, Item 1A of this report and in our 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 21, 2012, describes these important risk factors that may affect our business, financial condition, results of operations, and/or liquidity. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors.

Overview of Business

We are a global developer, manufacturer and distributor of high-quality medical devices that provide solutions for musculoskeletal health, vascular health and pain management. Our products address the continuum of patient care from injury prevention to rehabilitation after surgery, injury or from degenerative disease, enabling people to regain or maintain their natural motion. Our products are used by orthopedic specialists, spine surgeons, primary care physicians, pain management specialists, physical therapists, podiatrists, chiropractors, athletic trainers and other healthcare professionals. In addition, many of our medical devices and related accessories are used by athletes and patients for injury prevention and at-home physical therapy treatment. Our product lines include rigid and soft orthopedic bracing, hot and cold therapy, bone growth stimulators, vascular therapy systems and compression garments, therapeutic shoes and inserts, electrical stimulators used for pain management and physical therapy products. Our surgical implant business offers a comprehensive suite of reconstructive joint products for the hip, knee and shoulder.

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

Operating Segments

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

Bracing and Vascular Segment

Our Bracing and Vascular segment, which generates its revenues in the United States, offers our rigid knee bracing products, orthopedic soft goods, cold therapy products, vascular systems, therapeutic shoes and inserts and compression therapy products, primarily under our DonJoy, ProCare, Aircast and Dr. Comfort brands. This segment also includes our OfficeCare business, through which we maintain an inventory of soft goods and other products at healthcare facilities, primarily orthopedic practices, for immediate distribution to patients. 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.

32

Recovery Sciences Segment

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

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

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

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

• Athlete Direct.Our Athlete Direct business unit offers consumers ranging from fitness enthusiasts to competitive athletes our Compex electrostimulation devices, which are used in athletic training programs to aid muscle development and to accelerate muscle recovery after training sessions.

International Segment

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

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.

Our four operating segments enable us to reach a diverse customer base through multiple distribution channels and give us the opportunity to provide a wide range of medical devices and related products to orthopedic specialists and other healthcare professionals operating in a variety of patient treatment settings. These four segments constitute our reportable segments. See Note14 to our unaudited condensed consolidated financial statements for additional information regarding our segments.

33

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 charges related to various integration activities, as defined by management.

	Three Months Ended						Six months Ended
($ in thousands)	June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Bracing and Vascular:
Net sales	$	112,597		$	102,056		$	217,882		$	180,235
Gross profit	$	57,328		$	53,909		$	111,842		$	96,596
Gross profit margin		50.9	%		52.8	%		51.3	%		53.6	%
Operating income	$	22,358		$	21,099		$	42,405		$	35,495
Operating income as a percent of net segment sales		19.9	%		20.7	%		19.5	%		19.7	%
Recovery Sciences:
Net sales	$	84,822		$	86,221		$	169,091		$	171,379
Gross profit	$	64,046		$	65,509		$	127,511		$	130,263
Gross profit margin		75.5	%		76.0	%		75.4	%		76.0	%
Operating income	$	23,350		$	23,821		$	43,866		$	47,500
Operating income as a percent of net segment sales		27.5	%		27.6	%		25.9	%		27.7	%
International:
Net sales	$	70,465		$	73,083		$	141,978		$	142,948
Gross profit	$	39,985		$	42,355		$	79,881		$	81,904
Gross profit margin		56.7	%		58.0	%		56.3	%		57.3	%
Operating income	$	13,960		$	15,864		$	28,898		$	29,067
Operating income as a percent of net segment sales		19.8	%		21.7	%		20.4	%		20.3	%
Surgical Implant:
Net sales	$	18,093		$	16,426		$	35,973		$	32,935
Gross profit	$	13,530		$	11,653		$	27,188		$	23,541
Gross profit margin		74.8	%		70.9	%		75.6	%		71.5	%
Operating income	$	1,946		$	1,060		$	3,934		$	1,403
Operating income as a percent of net segment sales		10.8	%		6.5	%		10.9	%		4.3	%

34

Results of Operations

We operate our business on a manufacturing calendar, with our fiscal year always ending on December 31. Each quarter is 13 weeks, consisting of two four-week periods and one five-week period. Our first and fourth quarters may have more or fewer shipping days from year to year based on the days of the week on which holidays and December 31 fall. For our domestic business segments, the three months ended June 30, 2012 and July 2, 2011 each included 64 shipping days and the six months ended June 30, 2012 and July 2, 2011 each included 128 shipping days. In the aggregate, the markets that comprise our International segment had approximately one few shipping day than the domestic business segments in each of the three and six months ended June 30, 2012.

Changes in our financial results include the impact of changes in foreign currency exchange rates and acquisitions made in the current year. We provide “constant currency” and “pro forma” calculations to remove the impact of these items from net sales.

When we use the term “constant currency,” it means that we have translated financial data for a period into U.S. Dollars using the same foreign currency exchange rates that we used to translate financial data for the previous period. We believe that this calculation is a useful measure, indicating the actual growth of our operations.

When we use the term “pro forma,” it means that we have included the impact of the pre-acquisition results of Dr. Comfort and Circle City Medical (Circle City), as if they had closed at the beginning of the prior year period. We believe that this calculation is a useful measure, providing a more meaningful comparison of the company’s year-over-year performance.

The constant currency and pro forma financial measures are used to supplement measures that are in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). These financial measures are not measures of financial performance under GAAP, and should not be considered as alternatives to measures presented in accordance with GAAP.

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

	Three Months Ended										Six months Ended
	June 30, 2012					July 2, 2011					June 30, 2012					July 2, 2011
Net sales	$	285,977		100.0	%	$	277,786		100.0	%	$	564,924		100.0	%	$	527,497		100.0	%
Cost of sales (exclusive of amortization of intangible assets (1))		111,802		39.1			111,090		40.0			220,037		38.9			204,246		38.7
Gross profit		174,175		60.9			166,696		60.0			344,887		61.1			323,251		61.3
Operating expenses:
Selling, general and administrative		114,225		39.9			128,843		46.4			231,882		41.0			245,907		46.6
Research and development		7,084		2.5			6,101		2.2			13,757		2.4			13,244		2.5
Amortization of intangible assets		24,505		8.6			24,509		8.8			49,018		8.7			44,938		8.5
		145,814		51.0			159,453		57.4			294,657		52.2			304,089		57.6
Operating income		28,361		9.9			7,243		2.6			50,230		8.9			19,162		3.7
Other income (expense):
Interest expense		(46,417	)	(16.2	)		(42,429	)	(15.3	)		(88,488	)	(15.7	)		(83,556	)	(15.8	)
Interest income		72		0.0			53		0.0			105		0.0			163		0.0
Loss on modification of debt		(90	)	(0.0	)		—		—			(9,398	)	(1.7	)		(2,065	)	(0.4	)
Other (expense) income, net		(1,761	)	(0.6	)		1,681		0.6			1,061		0.2			4,453		0.8
		(48,196	)	(16.9	)		(40,695	)	(14.7	)		(96,720	)	(17.1	)		(81,005	)	(15.4	)
Loss before income taxes		(19,835	)	(6.9	)		(33,452	)	(12.1	)		(46,490	)	(8.2	)		(61,843	)	(11.7	)
Income tax (provision) benefit		(87	)	(0.0	)		14,492		5.2			(2,475	)	(0.4	)		21,959		4.1
Net loss		(19,922	)	(7.0	)		(18,960	)	(6.9	)		(48,965	)	(8.7	)		(39,884	)	(7.6	)
Net income attributable to noncontrolling interests		(276	)	(0.1	)		(295	)	(0.1	)		(587	)	(0.1	)		(610	)	(0.1	)
Net loss attributable to DJO Finance LLC	$	(20,198	)	(7.1	)%	$	(19,255	)	(7.0	)%	$	(49,552	)	(8.8	)%	$	(40,494	)	(7.7	)%

(1) Cost of sales is exclusive of amortization of intangible assets of $9,839 and $19,676 for the three and six months ended June 30, 2012, respectively, and $9,785 and $19,143 for the three and six months ended July 2, 2011, respectively.

Three Months Ended June 30, 2012 (second quarter 2012) compared to Three Months Ended July 2, 2011 (second quarter 2011)

Net Sales. Net sales for second quarter 2012 were $286.0 million, increasing 2.9% from net sales of $277.8 million for second quarter 2011. This increase was driven primarily by sales of our new products, improved sales execution and sales from Dr. Comfort, which we acquired on April 7, 2011, partially offset by unfavorable changes in foreign currency exchange rates. Excluding the impact of constant currency in the second quarter 2012 of $6.2 million and including the pre-acquisition sales in the second quarter 2011 of $1.2 million, pro forma net sales (in constant currency) increased by $13.3 million, or 4.8%, to $292.2 million for the second quarter 2012 from $278.9 million for the second quarter 2011. The following table sets forth the mix of our net sales by business segment ($ in thousands):

	Second Quarter 2012		% of Net Sales			Second Quarter 2011		% of Net Sales			Increase (Decrease)			% Increase (Decrease)
Bracing and Vascular	$	112,597		39.4	%	$	102,056		36.7	%	$	10,541			10.3	%
Recovery Sciences		84,822		29.7			86,221		31.0			(1,399	)		(1.6	)
International		70,465		24.6			73,083		26.3			(2,618	)		(3.6	)
Surgical Implant		18,093		6.3			16,426		6.0			1,667			10.1
	$	285,977		100.0	%	$	277,786		100.0	%		8,191			2.9	%

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Net sales in our Bracing and Vascular segment were $112.6 million for second quarter 2012, increasing 10.3% from net sales of $102.1 million for second quarter 2011. Our Bracing and Vascular segment benefited from sales from Dr. Comfort, which we acquired on April 7, 2011. Including the impact of pre-acquisition sales in the second quarter 2011 of $1.1 million, pro forma net sales in this segment increased by $9.4 million, or 9.1%, from $103.2 million for the second quarter 2011. Growth in net sales in this segment is being driven by sales from new products and improving sales execution.

Net sales in our Recovery Sciences segment were $84.8 million for second quarter 2012, decreasing 1.6% from net sales of $86.2 million for second quarter 2011, primarily due to decreased sales in our Regeneration business unit, due partly to an unusually high level of net sales being realized in first quarter 2011 and the impact of transitions taking place with certain of our Regeneration distributors.

Net sales in our International segment were $70.5 million for second quarter 2012, decreasing 3.6% from net sales of $73.1 million for second quarter 2011. The decrease was primarily driven by the unfavorable impact of changes in foreign currency exchange rates in effect in during second quarter 2012 as compared to foreign currency exchange rates in effect during second quarter 2011. Excluding the impact of constant currency in the second quarter 2012 of $6.2 million and including the pre-acquisition sales in the second quarter 2011 of $0.1 million, pro forma net sales (in constant currency) in this segment increased by $3.6 million, or 4.9%, to $76.7 million for the second quarter 2012 from $73.1 million for the second quarter 2011. The International segment also had approximately one less shipping day in second quarter 2012 than in second quarter 2011. On the basis of average daily sales and in constant currency, second quarter 2012 net sales for the International segment reflected growth of 6.2% compared to pro forma average daily sales in second quarter 2011. Growth in net sales in this segment is being driven by sales from new products and increasing sales penetration in certain geographies.

Net sales in our Surgical Implant segment were $18.1 million for second quarter 2012, increasing 10.2% from net sales of $16.4 million for second quarter 2011. The increase was driven primarily by strong sales of new products and improving sales execution.

Gross Profit. Consolidated gross profit as a percentage of net sales was 60.9% for second quarter 2012, compared to 60.0% for second quarter 2011.

Gross profit in our Bracing and Vascular segment as a percentage of net sales was 50.9% for second quarter 2012, compared to 52.8% for second quarter 2011. The decrease was primarily due to a lower margin mix of products sold. Also impacting gross profit in second quarter 2011 were $4.4 million of purchase accounting adjustments related to the fair market value step-up of acquired inventory.

Gross profit in our Recovery Sciences segment as a percentage of net sales decreased to 75.5% for second quarter 2012, from 76.0% for second quarter 2011. The decrease was primarily due to reduced average selling prices of certain products, primarily in our Empi business unit.

Gross profit in our International segment as a percentage of net sales decreased to 56.7% for second quarter 2012, from 58.0% for second quarter 2011. The decrease was primarily driven by a lower margin mix of products sold.

Gross profit in our Surgical Implant segment as a percentage of net sales increased to 74.8% for second quarter 2012, compared to 70.9% for second quarter 2011. The increase was driven by a higher margin mix of products sold.

Selling, General and Administrative (SG&A). SG&A decreased to $114.2 million for second quarter 2012, from $128.8 million for second quarter 2011. As a percentage of sales, SG&A expense decreased to 39.9% in second quarter 2012 from 46.4% in second quarter 2011.

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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):

	Second Quarter 2012		Second Quarter 2011
Integration charges:
Employee severance and relocation	$	361	$	1,599
U.S commercial sales and marketing reorganization		57		411
Chattanooga Integration		—		54
Acquisition related expenses and integration		261		6,143
CEO transition		—		893
Other non-recurring and integration charges		1,385		1,515
Litigation costs and settlements, net		912		1,605
Additional product liability insurance		—		3,107
ERP implementation and other automation projects		1,038		6,176
	$	4,014	$	21,503

Research and Development (R&D). R&D expense was $7.1 million and $6.1 million for second quarter 2012 and second quarter 2011, respectively. As a percentage of sales, R&D expense increased to 2.5% in second quarter 2012 from 2.2% in second quarter 2011, reflecting an increase in our new product development activities.

Amortization of Intangible Assets. In both periods presented, amortization of intangible assets was $24.5 million.

Interest Expense. Interest expense was $46.4 million and $42.4 million for second quarter 2012 and second quarter 2011, respectively. The impact of an increase in the total amount of outstanding borrowings was partially offset by lower weighted average interest rates on outstanding borrowings during second quarter 2012, as compared to second quarter 2011.

Other Income (Expense), Net. Other income (expense) was $(1.8) million and $1.7 million for second quarter 2012 and second quarter 2011, respectively. Results for both periods were primarily associated with net realized and unrealized foreign currency transaction gains (losses).

Income Tax (Provision) Benefit. For second quarter 2012, we recorded income tax expense of $0.1 million on pre-tax losses of $19.8 million, resulting in a negative effective tax rate of 0.4%. For second quarter 2011, we recorded an income tax benefit of $14.5 million, on pre-tax losses of $33.5 million, resulting in an effective tax rate of 43.3%. The change in our effective tax rates from 2011 to 2012 primarily relates to U.S federal and state valuation allowances beginning to be provided against deferred tax assets in the first quarter of 2012 and differences in our projected annualized effective tax rates for each year. Given the relationship between fixed dollar tax items and pre-tax financial results, the projected annual effective tax rate can change materially based on small variations of income.

Six months Ended June 30, 2012 (first half 2012) compared to Six months Ended July 2, 2011 (first half 2011)

Net Sales. Net sales for first half 2012 were $564.9 million, increasing 7.1% from net sales of $527.5 million for first half 2011. This increase was driven primarily by sales of new products, improved sales execution and sales from our 2011 acquisitions of Dr. Comfort and Circle City, partially offset by the unfavorable impact of changes in foreign currency exchange rates in effect in during first half 2012 as compared to foreign currency exchange rates in effect during first half 2011. Excluding the impact of constant currency in the first half 2012 of $8.4 million and including pre-acquisition sales in the first half 2011 of $20.7 million, pro forma net sales (in constant currency) increased by $25.2 million, or 4.6%, to $573.4 million for the first half 2012 from $548.2 million for the first half 2011. The following table sets forth the mix of our net sales by business segment ($ in thousands):

	First Half 2012		% of Net Sales			First Half 2011		% of Net Sales			Increase (Decrease)			% Increase (Decrease)
Bracing and Vascular	$	217,882		38.6	%	$	180,235		34.2	%	$	37,647			20.9	%
Recovery Sciences		169,091		29.9			171,379		32.5			(2,288	)		(1.3	)
International		141,978		25.1			142,948		27.1			(970	)		(0.7	)
Surgical Implant		35,973		6.4			32,935		6.2			3,038			9.2
	$	564,924		100.0	%	$	527,497		100.0	%	$	37,427			7.1	%

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Net sales in our Bracing and Vascular segment were $217.9 million for first half 2012, increasing 20.9% from net sales of $180.2 million for first half 2011. Our Bracing and Vascular segment benefited from sales from Dr. Comfort and Circle City, which we acquired on April 7, 2011 and March 4, 2011, respectively. Including the impact of pre-acquisition sales in the first half 2011 of $19.9 million, pro forma net sales in this segment increased by $17.7 million, or 8.8%, from $200.2 million for the first half 2011. Growth in net sales in this segment is being driven by sales from new products and improving sales execution.

Net sales in our Recovery Sciences segment were $169.1 million for first half 2012, decreasing 1.3% from net sales of $171.4 million for first half 2011. The decrease was primarily driven by reduced reimbursement levels for certain products in our Empi business unit.

Net sales in our International segment were $142.0 million for first half 2012, decreasing 0.7% from net sales of $142.9 million for first half 2011. The decrease was primarily driven by the unfavorable impact of changes in foreign currency exchange rates in effect in during first half 2012 as compared to foreign currency exchange rates in effect during first half 2011. Excluding the impact of constant currency in the first half 2012 of $8.4 million and including pre-acquisition sales in the first half 2011 of $0.7 million, pro forma net sales (in constant currency) in this segment increased by $6.8 million, or 4.7%, to $150.4 million for first half 2012 from $143.6 million for the first half 2011. Growth in net sales in this segment is being driven by sales from new products and increasing sales penetration in certain geographies.

Net sales in our Surgical Implant segment were $36.0 million for first half 2012, increasing 9.2% from net sales of $32.9 million for first half 2011. The increase was primarily driven by strong sales of new products and improving sales execution.

Gross Profit. Consolidated gross profit as a percentage of net sales was 61.1%, for first half 2012, compared to 61.3% for first half 2011.

Gross profit in our Bracing and Vascular segment as a percentage of net sales was 51.3% for first half 2012, compared to 53.6% for first half 2011. The decrease was primarily due to a lower margin mix of products sold, including sales from our recently acquired businesses. Also impacting gross profit in first half 2011 were $5.0 million of purchase accounting adjustments related to the fair market value step-up of acquired inventory.

Gross profit in our Recovery Sciences segment as a percentage of net sales decreased to 75.4% for first half 2012, from 76.0% for first half 2011, primarily due to reduced reimbursement levels for certain products in our Empi business unit.

Gross profit in our International segment as a percentage of net sales decreased to 56.3% for first half 2012, from 57.3% for first half 2011. The decrease was primarily driven by a lower margin mix of products sold, including sales from our recently acquired businesses.

Gross profit in our Surgical Implant segment as a percentage of net sales increased to 75.6% for first half 2012, compared to 71.5% for first half 2011. The increase was driven by a higher margin mix of products sold.

Selling, General and Administrative (SG&A). SG&A decreased to $231.9 million for first half 2012, from $245.9 million for first half 2011. As a percentage of sales, SG&A expense decreased to 41.0% for first half 2012 from 46.6% for first half 2011.

Our SG&A expenses were 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 Half 2012		First Half 2011
Integration charges:
Employee severance and relocation	$	1,431	$	3,029
U.S commercial sales and marketing reorganization		95		1,203
Chattanooga integration		—		119
Acquisition related expenses and integration		555		7,345
CEO transition		173		1,627
Other non-recurring and integration charges		2,910		2,203
Litigation costs and settlements, net		2,825		3,219
Additional product liability insurance		—		3,302
ERP implementation and other automation projects		3,897		14,170
	$	11,886	$	36,217

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Research and Development (R&D). R&D expense was $13.8 million, or 2.4% of net sales, and $13.2 million, or 2.5% of sales, for first half 2012 and first half 2011, respectively. R&D expense in first half 2011 included $0.9 million related to the write-off of an abandoned product under development in our Surgical Implant segment.

Amortization of Intangible Assets. Amortization of intangible assets was $49.0 million and $44.9 million for first half 2012 and first half 2011, respectively. The increase is due to amortization of intangible assets acquired with our 2011 acquisitions of Dr. Comfort, Circle City and BetterBraces.com.

Interest Expense. Interest expense was $88.5 million for first half 2012, and $83.6 million for first half 2011. An increase in the total amount of outstanding borrowings was partially offset by lower weighted average interest rates on outstanding borrowings during first half 2012 as compared to first half 2011.

Loss on Modification of Debt. During first half 2012 and first half 2011, we recognized $9.4 million and $2.1 million respectively, of arrangement and lender consent fees related to amendments to our Senior Secured Credit Facility.

Other Income (Expense), Net. Other income was $1.1 million and $4.5 million for first half 2012 and first half 2011, respectively. Results for both periods were primarily associated with net realized and unrealized foreign currency transaction gains.

Income Tax (Provision) Benefit. For first half 2012, we recorded an income tax expense of $2.5 million on a pre-tax loss of $46.5 million, resulting in a negative effective tax rate of 5.3%. For first half 2011, we recorded income tax benefit of $22.0 million on a pre-tax loss of $61.8 million, resulting in an effective tax rate of 35.6%. The change in our effective tax rates from 2011 to 2012 primarily relates to U.S federal and state valuation allowances beginning to be provided against deferred tax assets in the first quarter of 2012 and differences in our projected annualized effective tax rates for each year. Given the relationship between fixed dollar tax items and pre-tax financial results, the projected annual effective tax rate can change materially based on small variations of income.

Liquidity and Capital Resources

As of June 30, 2012, our primary sources of liquidity consisted of cash and cash equivalents totaling $29.0 million and our $100.0 million revolving credit facility, of which $49.0 million was available. Working capital at June 30, 2012 was $222.9 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 repayment and interest obligations. While we currently believe that we will be able to meet all of our financial covenants imposed by our Senior Secured Credit Facility, we may not in fact be able to do so or be able to obtain waivers of default or amendments to the Senior Secured Credit Facility in the future. We and our subsidiaries, affiliates or significant shareholders (including Blackstone and its affiliates) may from time to time, in our or their sole discretion, purchase, repay, redeem or retire any of our outstanding debt or equity securities (including any publicly issued debt securities), in privately negotiated or open market transactions, by tender offer or otherwise.

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

	First half 2012			First half 2011
Cash provided by operating activities	$	19,939		$	7,619
Cash used in investing activities		(16,709	)		(338,146	)
Cash (used in) provided by financing activities		(12,196	)		331,437
Effect of exchange rate changes on cash and cash equivalents		(221	)		1,929
Net (decrease) increase in cash and cash equivalents	$	(9,187	)	$	2,839

Cash Flows

Operating activities provided cash of $19.9 million and $7.6 million in first half 2012 and first half 2011, respectively, reflecting our net loss adjusted for non-cash expenses. Cash paid for interest was $80.6 million and $69.4 million in first half 2012 and first half 2011, respectively.

Investing activities used $16.7 million and $338.1 million of cash in first half 2012 and first half 2011, respectively. Cash used in investing activities for first half 2012 primarily consisted of purchases of property and equipment. Cash used in investing activities for first half 2011 included $317.7 million of net cash paid for the acquisitions of Dr. Comfort, Elastic Therapy, Inc. (ETI) and Circle City and $20.7 million for purchases of property and equipment.

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Financing activities used $12.2 million of cash for first half 2012 and provided $331.4 million of cash for first half 2011. Cash used in financing activities in first half 2012 consisted of proceeds from the borrowings under our Amended Senior Secured Credit Facility and our new 8.75% Notes, offset by repayments of the Original Senior Secured Credit Facility and a portion of our 10.875% Notes and the payment of $25.2 million of debt issuance costs. Cash provided by financing activities in first half 2011 was primarily related to net proceeds from our issuance of $300.0 million aggregate principal of 7.75% Notes and net borrowings of $46.0 million from our revolving credit facility which, together with cash on hand, were primarily used to fund the acquisitions of Dr. Comfort, ETI and Circle City. For the remainder of 2012, we expect to spend cash of approximately $110.9 million for the following:

• $30.9 million for scheduled principal and estimated interest payments on our Amended Senior Secured Credit Facility;

• $61.3 million for scheduled interest payments on our 8.75% Notes, 10.875% Notes, 7.75% Notes and 9.75% Notes; and

• $18.7 million for capital expenditures.

Indebtedness

As of June 30, 2012, our total indebtedness was $2,180.5 million, net of unamortized original issue discounts and premiums of $6.9 million, net.

Senior Secured Credit Facility

Overview. On November 20, 2007, we entered into a Senior Secured Credit Facility (Original Senior Secured Credit Facility) consisting of a $1,065.0 million term loan facility maturing in May 2014 (Original Term Loans) and a $100.0 million revolving credit facility maturing in November 2013 (Original Revolving Credit Facility). We issued the Original Term Loans at a 1.2% discount.

On March 20, 2012, we entered into an Amendment and Restatement Agreement to amend and restate our Original Senior Secured Credit Facility (Amended Senior Secured Credit Facility), which (1) permitted the issuance of $230.0 million aggregate principal of 8.75% Notes; (2) extended the maturity of $564.7 million of term loans outstanding under the Original Senior Secured Credit Facility to the earlier of November 1, 2016 or August 15, 2014, if on such date the aggregate principal amount of our 10.875% Notes is not less than $150.0 million (Extended Term Loans); (3) provided for the issuance of a new tranche of $350.0 million of term loans that will mature on the earlier of September 15, 2017 or August 15, 2014 if on such date the aggregate outstanding principal amount of our 10.875% Notes is not less than $150.0 million; (4) deemed certain previous acquisitions and investments to be permitted under the terms of the Amended Senior Secured Credit Facility; (5) increased the total net leverage ratio limitation in the permitted acquisitions covenant from 7.0x to 7.5x; (6) changed the financial maintenance covenant from a senior secured leverage ratio covenant to a new Senior Secured first lien leverage ratio covenant; and (7) replaced our Original Revolving Credit Facility with a new $100.0 million revolving credit facility (Revolving Credit Facility) which matures on the earlier of March 14, 2017 or August 15, 2014, if on such date the aggregate principal amount of 10.875% Notes is not less than $150.0 million.

On March 30, 2012, we entered into Amendment No. 1 to our Amended Senior Secured Credit Facility which, among other things, provided for the issuance of an additional $105.0 million of new term loans that will mature on the earlier of September 15, 2017 or August 15, 2014, if on such date the outstanding aggregate principal amount of our 10.875% Notes is not less than $150.0 million. The net proceeds from the issuance were used to repay $103.5 million aggregate principal of existing term loans under the Original Senior Secured Credit Facility and to pay related fees, premiums and expenses.

Collectively, the $350.0 million of new term loans issued on March 20, 2012 and the $105.0 million of new term loans issued on March 30, 2012 are referred to as the New Term Loans.

The New Term Loans were issued at a discount as follows: $350.0 million of the New Term Loans were issued at a 1.5% discount and $105.0 million of the New Term Loans were issued at a 1.0% discount. We are amortizing the $6.3 million aggregate original issue discount using the effective interest method.

The net proceeds from the New Term Loans were used to repay the remaining portion of the Original Term Loans which would have matured in May 2014, and to repay a portion of the Extended Term Loans.

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As of June 30, 2012, the balance of term loans outstanding under the Amended Senior Secured Credit Facility was $841.4 million (exclusive of $9.7 million of unamortized original issue discount) and there were $51.0 million of borrowings outstanding under the Revolving Credit Facility.

Interest Rates.The interest rate margins applicable to borrowings under the Revolving Credit Facility are, at our option, either (a) the Eurodollar rate plus 475 basis points or (b) a base rate plus 375 basis points. The interest rate margins applicable to the Extended Term Loans and the New Term Loans are, at our option, either (a) the Eurodollar rate plus 500 basis points or (b) a base rate plus 400 basis points. There is a minimum LIBOR rate applicable with respect to the Eurodollar component of interest rates on New Term Loan borrowings of 1.25%. The applicable margin for borrowings under the Revolving Credit Facility, the Extended Term Loans and the New Term Loans may be reduced, subject to our attaining certain leverage ratios. As of June 30, 2012, our weighted average interest rate for all borrowings under the Amended Senior Secured Credit Facility was 5.74%.

Fees. In addition to paying interest on outstanding principal under the Amended Senior Secured Credit Facility, we are required to pay a commitment fee to the lenders under the Revolving Credit Facility with respect to the unutilized commitments thereunder. The current commitment fee rate is 0.50% per annum, 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 Term Loans in an amount equal to 1.00% of the funded total principal amount through June 2017, with the remaining amount payable in full at maturity in September 2017. We are required to pay annual payments in equal quarterly installments on the Extended Term Loans in an amount equal to 1.00% of the funded total principal amount through September 2016, with any remaining amount payable in full at maturity in November 2016.

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

• incur additional indebtedness;

• create liens on assets;

• change fiscal years;

• enter into sale and leaseback transactions;

• engage in mergers or consolidations;

• sell assets;

• pay dividends and make 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.

Pursuant to the terms of the credit agreement relating to the Amended Senior Secured Credit Facility, we are required to maintain a maximum Senior Secured first lien leverage ratio of consolidated first lien net debt to Adjusted EBITDA of 4.25:1 for the trailing twelve months ended June 30, 2012. 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 Amended Senior Secured Credit Facility and the Indentures governing our 8.75% Notes, 10.875% Notes, 7.75% Notes and 9.75% Notes. Adjusted EBITDA is a material component of these covenants. As of June 30, 2012, our actual Senior Secured first lien leverage ratio was within the required ratio at 3.12:1.

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Adjusted EBITDA should not be considered as an alternative to net (loss) 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 (loss) income or cash flow from operations as those terms are defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. In particular, the definition of Adjusted EBITDA in the Indentures and our Amended Senior Secured Credit Facility allows us to add back certain non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net income (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.

Note indentures

The Indentures governing the $230.0 million principal amount of 8.75% Notes, $465.0 million principal amount of 10.875% Notes, $300.0 million principal amount of 7.75% Notes, and $300.0 million principal amount of 9.75% Notes (collectively, the Notes) limit our (and most or all of our subsidiaries’) ability to:

• incur additional debt or issue certain preferred shares;

• pay dividends on or make other distributions in respect of our capital stock or make other restricted payments;

• make certain investments;

• sell certain assets;

• create liens on certain assets to secure debt;

• consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;

• enter into certain transactions with our affiliates; and

• designate our subsidiaries as unrestricted subsidiaries.

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 pro forma ratio of Adjusted EBITDA to fixed charges for the twelve months ended June 30, 2012, measured on that date, was below the required ratio for such additional incurrence or payments at 1.66:1. 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 first lien leverage ratio for the immediately preceding test period would not be greater than 3.50:1. 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.

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Covenant Compliance

The following is a summary of our covenant requirement ratios as of June 30, 2012:

	Covenant Requirements		Actual Ratios
Amended Senior Secured Credit Facility:
Maximum ratio of Senior Secured first lien leverage to Adjusted EBITDA		4.25:1		3.12:1
Notes:
Minimum ratio of Adjusted EBITDA to fixed charges required to incur additional debt pursuant to ratio provision, pro forma		2.00:1		1.66:1

As described above, our Amended Senior Secured Credit Facility and the Indentures governing the Notes represent significant components of our capital structure. Under our Amended Senior Secured Credit Facility, we are required to maintain specified Senior Secured first lien leverage ratios, which become more restrictive over time, and which are determined based on our Adjusted EBITDA. If we fail to comply with the Senior Secured first lien leverage ratio under our Amended Senior Secured Credit Facility, we would be in default under the credit facility. Upon the occurrence of an event of default under the Amended Senior Secured Credit Facility, the lenders could elect to declare all amounts outstanding under the Amended Senior Secured Credit Facility 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 Amended Senior Secured Credit Facility could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all of our assets as collateral under the Amended Senior Secured Credit Facility. Any acceleration under the Amended Senior Secured Credit Facility 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 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, many 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 Amended Senior Secured Credit Facility and the Indentures, at which time the lenders could elect to declare all amounts outstanding under our Amended Senior Secured Credit Facility to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.

The following table provides a reconciliation from our net loss to Adjusted EBITDA for the three and twelve months ended June 30, 2012 (in thousands). The terms and related calculations are defined in the credit agreement relating to our Amended Senior Secured Credit Facility and the Indentures.

	Three Months Ended June 30, 2012			Twelve Months Ended June 30, 2012
Net loss attributable to DJO Finance LLC	$	(20,198	)	$	(223,527	)
Interest expense, net		46,345			173,976
Income tax provision (benefit)		87			(28,110	)
Depreciation and amortization		32,169			126,588
Non-cash charges (a)		1,794			159,730
Non-recurring and integration charges (b)		5,257			37,521
Other adjustment items, before adjustments applicable for the twelve month period only (c)		3,946			23,807
Adjusted EBITDA before other adjustment items applicable to the twelve month period only		69,400			269,985
Other adjustment items applicable to the twelve month period only (d)
Future cost savings related to recent acquisitions		—			3,940
Adjusted EBITDA	$	69,400		$	273,925

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

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	Three Months Ended June 30, 2012		Twelve Months Ended June 30, 2012
Stock based compensation expense	$	1,395	$	3,623
Impairment of Chattanooga assets held for sale		380		380
Loss on disposal of assets, net		19		227
Impairment of goodwill and intangible assets		—		141,006
Purchase accounting adjustments		—		7,378
Impairment of fixed assets		—		7,116
Total non-cash charges	$	1,794	$	159,730

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

	Three Months Ended June 30, 2012		Twelve Months Ended June 30, 2012
Integration charges:
U.S. commercial sales and marketing reorganization	$	57	$	1,242
Acquisition related expenses and integration (1)		442		2,106
Chattanooga integration		—		56
CEO transition		—		966
Other non-recurring and integration expenses		2,479		11,433
Litigation costs and settlements, net		912		6,618
ERP implementation and other automation projects		1,367		15,100
Total non-recurring and integration charges	$	5,257	$	37,521

(1) Consists of direct acquisition costs and integration expenses related to the Dr. Comfort, ETI and Circle City acquisitions.

(c) Other adjustment items are comprised of the following (in thousands):

	Three Months Ended June 30, 2012		Twelve Months Ended June 30, 2012
Blackstone monitoring fees	$	1,750	$	7,000
Noncontrolling interests		275		858
Loss on modification and extinguishment of debt (1)		90		9,398
Other (2)		1,831		6,551
Total other adjustment items	$	3,946	$	23,807

(1) Loss on modification and extinguishment of debt for the twelve months ending June 30, 2012 consists of $8.6 million of arrangement and amendment fees and other fees and expenses incurred in connection with the March 2012 amendment of our Senior Secured Credit Facility and $0.8 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of the term loans which were extinguished.

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

(d) Other adjustment items applicable for the twelve month period only include future cost savings related to the acquisitions of Dr. Comfort, ETI and Circle City.

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Critical Accounting Policies and Estimates

We have disclosed in our unaudited condensed consolidated financial statements and in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2011 Annual Report on Form 10-K, those accounting policies that we consider to be significant in determining our results of operations and financial condition. There have been no material changes to those policies that we consider to be significant since the filing of our 2011 Annual Report on Form 10-K. We believe that the accounting principles utilized in preparing our unaudited condensed consolidated financial statements conform in all material respects to GAAP.

Deferred Tax Asset Valuation Allowance

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amount and the tax bases of assets, liabilities and net operating loss carryforwards (NOLs). We establish valuation allowances when the recovery of a deferred tax asset is not likely based on historical income, projected future income, the expected timing of the reversals of temporary differences and the implementation of tax-planning strategies. Beginning in the first quarter of June 30, 2012, we were unable to determine that it was more likely than not that certain U.S federal and state deferred tax assets would be realized. We therefore established a valuation allowance against those deferred tax assets.

Our gross deferred tax asset balance was approximately $226.3 million at June 30, 2012 and primarily related to reserves for accounts receivable and inventory, accrued expenses, and NOLs (see Note 9 to our unaudited condensed consolidated financial statements). As of June 30, 2012, we maintained a valuation allowance of $22.9 million due to uncertainties related to our ability to realize certain NOLs.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest Rate Risk

Our primary exposure is to fluctuating interest rates. We have historically managed our interest rate risk by balancing the amounts of our fixed and variable rate debt. 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. We have $995.0 million aggregate principal amount of fixed rate senior notes and $300 million senior subordinated notes. Our borrowings under the Amended Senior Secured Credit Facility bear interest at floating rates based on LIBOR or the prime rate, as defined. As of June 30, 2012, we had $841.4 million of borrowings outstanding under the Amended Senior Secured Credit Facility, exclusive of $9.7 million of unamortized original issue discount. A hypothetical 1% increase in variable interest rates for the Amended Senior Secured Credit Facility would have impacted our earnings and cash flow for the six months ended June 30, 2012 by approximately $4.5 million. We may use financial instruments where appropriate to manage our interest rate risk, although we had no such instruments in effect at June 30, 2012. 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 (MXP). 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.

As we continue to expand our business, the sales of our products that are denominated in foreign currencies has increased, as have the costs associated with our foreign subsidiaries which operate in currencies other than the U.S. dollar. Accordingly, our future results could be materially impacted by changes in these or other factors. For the three and six months ended June 30, 2012, sales denominated in foreign currencies accounted for approximately 20.9% and 21.4% of our consolidated net sales, respectively, of which 15.0% and 15.4%, respectively, were denominated in the Euro. In addition, our exposure to fluctuations in foreign currencies may arise 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.

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Occasionally, we seek to reduce the potential impact of currency fluctuations on our business through hedging transactions. During the six months ended June 30, 2012, we utilized MXP 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 MXP (see Note 7 to our unaudited condensed consolidated financial statements). Foreign exchange forward contracts held as of June 30, 2012 expire weekly through September 2012.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

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

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

Changes in Internal Control over Financial Reporting

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

Part II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The manufacture and sale of orthopedic devices and related products exposes us to a significant risk of product liability claims. From time to time, we have been, and we are currently, subject to a number of product liability claims alleging that the use of our products resulted in adverse effects. Even if we are successful in defending against any liability claims, such claims could nevertheless distract our management, result in substantial costs, harm our reputation, adversely affect the sales of all our products and otherwise harm our business. If there is a significant increase in the number of product liability claims, our business could be adversely affected. See Note 13 to our unaudited condensed consolidated financial statements above for additional discussion of our legal proceedings and insurance coverage.

Pain Pump Litigation

As previously described, we are named as one of several defendants in a number of product liability lawsuits in courts in several states related to a disposable drug infusion pump product (pain pump) manufactured by two third party manufacturers that we distributed through our Bracing and Vascular segment. There were approximately 65 plaintiffs in U.S. cases pending as of June 30, 2012 and a lawsuit in Canada which was recently certified as a class action. We discontinued our sale of these products in the second quarter of 2009.

Cold Therapy Litigation

Since mid-2010, we have been named in nine multi-plaintiff lawsuits filed in Superior Court, San Diego County, California, involving a total of 210 plaintiffs, alleging that the plaintiffs had been injured following use of certain cold therapy products manufactured by the Company. The complaints are not specific as to the nature of the injuries, but allege various product liability theories, including inadequate warnings regarding the risks associated with the use of cold therapy and failure to incorporate certain safety features into the design. No specific dollar amounts of damages are alleged and as of June 30, 2012, we cannot estimate a range of potential loss. These cases have been included in a coordinated proceeding in San Diego Superior Court with a similar number of cases filed against one of our competitors. A total of ten of the plaintiffs included in the cases filed against us have been selected as the first cases to be tried, of which four of these “bellwether” cases will go to trial in April 2013. Discovery is proceeding on these bellwether cases. We intend to defend these matters aggressively.

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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, 2011 filed with the SEC on February 21, 2012 and Part II, Item 1A, of the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2012 filed with the SEC on May 1, 2012. There have been no material changes to the risk factors disclosed in such Form 10-K or Form 10-Q.

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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)).
10.1+	Form of Nonstatutory Stock Option Agreement under 2007 Incentive Stock Plan (2012 Version).
10.2+	Amendment to 2007 Incentive Stock Plan, dated February 16, 2012.
10.3+	Amendment to Employment Agreement, dated April 9, 2012, between Michael P. Mogul and DJO Global, Inc.
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.
101+	The following financial information from DJO Finance LLC’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012, formatted in XBRL: (i) the Unaudited Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011, (ii) the Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2012 and July 2, 2011, (iii) the Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2012 and July 2, 2011, (iv) the Unaudited Consolidated Statement of Equity as of June 30, 2012 and December 31, 2011, (v) the Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and July 2, 2011 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: August 3, 2012	By:	/s/    MICHAEL P. MOGUL
		Michael P. Mogul
		President and Chief Executive Officer
Date: August 3, 2012	By:	/s/    VICKIE L. CAPPS
		Vickie L. Capps
		Executive Vice President, Chief Financial Officer and Treasurer

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