Djo Finance 10-Q 2013 Q3 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 September 28, 2013

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  x    No  ¨

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 October 29, 2013, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

DJO Finance LLC

INDEX

		Page Number
	PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of September 28, 2013 and December 31, 2012		1
	Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 28, 2013 and September 29, 2012		2
	Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 28, 2013 and September 29, 2012		3
	Unaudited Condensed Consolidated Statement of Equity for the nine months ended September 28, 2013		4
	Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 28, 2013 and September 29, 2012		5
	Notes to Unaudited Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		36
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		48
Item 4.	Controls and Procedures		49
	PART II—OTHER INFORMATION
Item 1.	Legal Proceedings		49
Item 1A.	Risk Factors		50
Item 5.	Other Information		50
Item 6.	Exhibits		52

DJO Finance LLC

Unaudited Condensed Consolidated Balance Sheets

(in thousands)

	September 28, 2013			December 31, 2012
Assets
Current assets:
Cash and cash equivalents	$	33,526		$	31,223
Accounts receivable, net		181,128			166,742
Inventories, net		153,865			156,315
Deferred tax assets, net		32,418			33,283
Prepaid expenses and other current assets		26,037			18,073
Total current assets		426,974			405,636
Property and equipment, net		103,965			107,035
Goodwill		1,250,877			1,249,305
Intangible assets, net		987,393			1,055,531
Other assets		40,574			45,216
Total assets	$	2,809,783		$	2,862,723
Liabilities and Equity
Current liabilities:
Accounts payable	$	60,954		$	54,294
Accrued interest		49,914			31,653
Current portion of debt and capital lease obligations		8,620			8,858
Other current liabilities		100,088			93,640
Total current liabilities		219,576			188,445
Long-term debt and capital lease obligations		2,217,305			2,223,816
Deferred tax liabilities, net		243,714			241,202
Other long-term liabilities		16,449			24,850
Total liabilities		2,697,044			2,678,313
Commitments and contingencies
Equity:
DJO Finance LLC membership equity:
Member capital		838,777			839,234
Accumulated deficit		(730,092	)		(658,426	)
Accumulated other comprehensive income		1,148			1,284
Total membership equity		109,833			182,092
Noncontrolling interests		2,906			2,318
Total equity		112,739			184,410
Total liabilities and equity	$	2,809,783		$	2,862,723

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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DJO Finance LLC

Unaudited Condensed Consolidated Statements of Operations

(in thousands)

	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Net sales	$	288,049		$	273,986		$	861,871		$	838,910
Cost of sales (exclusive of amortization of intangible assets of $8,809 and $26,368 for the three and nine months ended September 28, 2013 and $9,837 and $29,513 for the three and nine months ended September 29, 2012, respectively)		118,160			108,297			346,761			328,334
Gross profit		169,889			165,689			515,110			510,576
Operating expenses:
Selling, general and administrative		112,566			110,735			348,175			342,617
Research and development		8,028			7,938			23,749			21,695
Amortization of intangible assets		23,920			24,487			71,595			73,505
		144,514			143,160			443,519			437,817
Operating income		25,375			22,529			71,591			72,759
Other income (expense):
Interest expense		(43,842	)		(46,411	)		(133,412	)		(134,899	)
Interest income		29			46			117			151
Loss on modification and extinguishment of debt		—			—			(1,059	)		(9,398	)
Other income (expense), net		870			1,870			(535	)		2,931
		(42,943	)		(44,495	)		(134,889	)		(141,215	)
Loss before income taxes		(17,568	)		(21,966	)		(63,298	)		(68,456	)
Income tax provision		(807	)		(569	)		(7,845	)		(3,044	)
Net loss		(18,375	)		(22,535	)		(71,143	)		(71,500	)
Net income attributable to noncontrolling interests		(113	)		(27	)		(523	)		(614	)
Net loss attributable to DJO Finance LLC	$	(18,488	)	$	(22,562	)	$	(71,666	)	$	(72,114	)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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DJO Finance LLC

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Net loss	$	(18,375	)	$	(22,535	)	$	(71,143	)	$	(71,500	)
Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustments, net of tax provision of $1,407 and $538 for the three and nine months ended September 28, 2013 and $1,488 and $546 for the three and nine months ended September 29, 2012, respectively		2,739			2,119			(71	)		82
Other comprehensive income (loss)		2,739			2,119			(71	)		82
Comprehensive loss		(15,636	)		(20,416	)		(71,214	)		(71,418	)
Comprehensive income attributable to noncontrolling interests		(212	)		(97	)		(588	)		(599	)
Comprehensive loss attributable to DJO Finance LLC	$	(15,848	)	$	(20,513	)	$	(71,802	)	$	(72,017	)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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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, 2012	$	839,234		$	(658,426	)	$	1,284		$	182,092		$	2,318	$	184,410
Net (loss) income		—			(71,666	)		—			(71,666	)		523		(71,143	)
Other comprehensive loss, net of taxes		—			—			(136	)		(136	)		65		(71	)
Stock-based compensation		1,544			—			—			1,544			—		1,544
Cancellation of vested options		(2,001	)		—			—			(2,001	)		—		(2,001	)
Balance at September 28, 2013	$	838,777		$	(730,092	)	$	1,148		$	109,833		$	2,906	$	112,739

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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DJO Finance LLC

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

	Nine Months Ended
	September 28, 2013			September 29, 2012
Cash flows from operating activities:
Net loss	$	(71,143	)	$	(71,500	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		24,128			22,673
Amortization of intangible assets		71,595			73,505
Amortization of debt issuance costs and non-cash interest expense		5,955			7,729
Stock-based compensation expense		1,544			3,563
Loss on modification and extinguishment of debt		1,059			9,398
Loss on disposal of assets, net		876			936
Deferred income tax expense (benefit)		2,766			(1,836	)
Provision for doubtful accounts and sales returns		20,270			16,442
Inventory reserves		7,532			4,440
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable		(34,586	)		(17,677	)
Inventories		(2,637	)		(16,568	)
Prepaid expenses and other assets		(7,296	)		(3,670	)
Accrued interest		18,263			23,897
Accounts payable and other current liabilities		877			(29	)
Net cash provided by operating activities		39,203			51,303
Cash flows from investing activities:
Cash paid in connection with acquisition		(1,953	)		—
Purchases of property and equipment		(24,043	)		(23,448	)
Other investing activities, net		(1,433	)		(656	)
Net cash used in investing activities		(27,429	)		(24,104	)
Cash flows from financing activities:
Proceeds from issuance of debt		496,417			751,700
Repayments of debt and capital lease obligations		(503,727	)		(754,824	)
Payment of debt issuance costs		(2,387	)		(25,234	)
Investment by parent		—			1,000
Net used in financing activities		(9,697	)		(27,358	)
Effect of exchange rate changes on cash and cash equivalents		226			215
Net increase in cash and cash equivalents		2,303			56
Cash and cash equivalents at beginning of period		31,223			38,169
Cash and cash equivalents at end of period	$	33,526		$	38,225
Supplemental disclosures of cash flow information:
Cash paid for interest	$	108,984		$	103,351
Cash paid for taxes, net	$	6,277		$	3,198

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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

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

Infrequent Events

In September 2013, a fire occurred at our factory in Tunisia. As a result of the fire, certain inventory and fixed assets were destroyed and the leased facility became inoperable. Estimated losses of $4.4 million related to destroyed inventory and fixed assets, excess expenses incurred and building reconstruction costs have been recorded for the three months ended September 28, 2013. As the recorded losses are recoverable against our property and business interruption insurance policies and recovery is considered probable, we have recorded a corresponding insurance receivable of $4.4 million as of September 28, 2013 to offset the recognized losses.

Segment Reporting

In the first quarter of 2013, we reassigned certain product lines between our Bracing and Vascular and Recovery Sciences segments and revised the way we allocate costs among all of our segments. Segment information for all periods presented has been restated to reflect these changes.

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, therapeutic footwear for the diabetes care market and compression therapy products. Our Recovery Sciences segment offers home electrotherapy, iontophoresis, home traction products, bone growth stimulation products and clinical physical therapy equipment. Our Surgical Implant segment offers a comprehensive suite of reconstructive joint products for the knee, hip and shoulder. Our International segment offers all of our products to customers outside the United States. See Note 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.

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Interim Reporting

The accompanying Unaudited Condensed Consolidated Financial Statements include our accounts and all voting interest entities where we exercise a controlling financial interest through the ownership of a direct or indirect majority voting interest. All significant intercompany accounts and transactions have been eliminated in consolidation.

Our Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP and with the instructions to Form 10–Q and Article 10 of Regulation S–X for interim financial information. Accordingly, these financial statements do not include all of the information required by GAAP or Securities and Exchange Commission (SEC) rules and regulations for complete 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, 2012.

Reclassifications

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

Recent Accounting Standards

In July 2012, the FASB issued an accounting standard update regarding testing of intangible assets for impairment. This standard update allows companies the option to perform a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. An entity is not required to calculate the fair value of an indefinite-lived intangible asset and perform the quantitative impairment test unless the entity determines that it is more likely than not the asset is impaired. We adopted this standard update during the first quarter of 2013. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued an accounting standard update regarding reporting amounts reclassified out of accumulated other comprehensive income. This update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional details about those amounts. The amended guidance was effective for interim and annual periods beginning after December 15, 2012. The Company adopted this standard update during the first quarter of 2013. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.

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

2. ACQUISITIONS

On July 1, 2013 we acquired certain assets of Blue Leaf Medical CC, (“Blue Leaf”) for a total purchase price of $0.6 million. The assets acquired relate to certain vascular product lines in South Africa, Nambia, Botswana, Mozambique and Zambia. The purchase price consisted of a cash payment at closing of $0.4 million, $0.1 million for the purchase of inventory on hand at closing and $0.1 million which was held back to provide security for potential indemnification claims and, if not used for such indemnification claims, will be paid to the sellers in July 2014.

On March 7, 2013 we acquired certain assets of Vasyli Medical Asia/Pacific Pty Ltd, (“Vasyli”) for a total purchase price of $2.2 million. The assets acquired relate to the distribution of certain vascular product lines in Australia and New Zealand. The purchase price consisted of a cash payment at closing of $1.3 million, $0.5 million for the purchase of inventory on hand at closing and $0.4 million which was held back to provide security for potential indemnification claims and, if not used for such indemnification claims, will be paid to the sellers in March 2014. Additionally, there is $0.3 million of contingent consideration payable one year from the acquisition date if certain revenue targets are met by December 31, 2013. Based on the probability of achievement of the revenue targets, we have assigned a fair value of zero to the contingent consideration.

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Our primary reason for the acquisitions was to move from an indirect sales model (i.e., sales to distributors at a discount) to a direct sales model, resulting in increased gross profit and operating income.

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

	Blue Leaf		Vasyli
Inventories	$	59	$	542
Other current assets		—		31
Property, plant & equipment		—		12
Intangible assets		201		1,238
Goodwill		322		363
Total purchase price	$	582	$	2,186

The purchase price allocation for Blue Leaf and Vasyli included $0.1 million and $0.9 million, respectively, assigned to intangible assets related to a non-compete agreement with the sellers. The value of the non-compete agreements were based on the estimated present value of the cash flows associated with having the agreements in place, less the present value of the cash flows assuming the non-compete agreements were not in place. The purchase price allocation for Blue Leaf and Vasyli also included $0.1 million and $0.3 million, respectively, assigned to intangible assets related to certain customer relationships existing on the respective acquisition dates. The value of the customer relationships was based upon an estimate of the future discounted cash flows that would be derived from those customers, after deducting contributory asset charges.

Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired. All goodwill associated with these acquisitions is allocated to our International reporting segment. Among the factors which resulted in goodwill for the Blue Leaf and Vasyli assets was the opportunity to expand our direct presence in the local markets with our vascular products.

3. ACCOUNTS RECEIVABLE RESERVES

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

	Nine Months Ended
	September 28, 2013			September 29, 2012
Balance, beginning of period	$	29,194		$	38,315
Provision for doubtful accounts and sales returns		20,270			16,442
Write-offs, net of recoveries		(17,864	)		(23,666	)
Balance, end of period	$	31,600		$	31,091

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4. INVENTORIES

Inventories consist of the following (in thousands):

	September 28, 2013			December 31, 2012
Components and raw materials	$	54,248		$	50,619
Work in process		6,986			4,563
Finished goods		88,331			94,683
Inventory held on consignment		26,367			23,763
		175,932			173,628
Less inventory reserves		(22,067	)		(17,313	)
	$	153,865		$	156,315

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

	Nine Months Ended
	September 28, 2013			September 29, 2012
Balance, beginning of period	$	17,313		$	14,146
Provision charged to cost of sales		7,532			4,440
Write-offs, net of recoveries		(2,778	)		(1,854	)
Balance, end of period	$	22,067		$	16,732

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

5. LONG-LIVED ASSETS

Goodwill

Changes in the carrying amount of our goodwill for the nine months ended September 28, 2013 are presented below (in thousands):

Balance, beginning of period	$	1,249,305
Acquisitions (see Note 2)		685
Foreign currency translation		887
Balance, end of period	$	1,250,877

Intangible assets, net

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

September 28, 2013	Gross Carrying Amount		Accumulated Amortization			Intangible Assets, Net
Definite-lived intangible assets:
Customer relationships	$	570,270	$	(276,969	)	$	293,301
Patents and technology		486,262		(221,369	)		264,893
Trademarks and trade names		25,798		(6,382	)		19,416
Distributor contracts and relationships		5,096		(2,750	)		2,346
Non-compete agreements		6,486		(2,793	)		3,693
	$	1,093,912	$	(510,263	)		583,649
Indefinite-lived intangible assets:
Trademarks and trade names							403,744
Net identifiable intangible assets						$	987,393

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December 31, 2012	Gross Carrying Amount		Accumulated Amortization			Intangible Assets, Net
Definite lived intangible assets:
Customer relationships	$	570,221	$	(236,228	)	$	333,993
Patents and technology		485,675		(195,099	)		290,576
Trademarks and trade names		25,773		(4,248	)		21,525
Distributor contracts and relationships		3,662		(1,659	)		2,003
Non-compete agreements		5,547		(1,722	)		3,825
	$	1,090,878	$	(438,956	)		651,922
Indefinite lived intangible assets:
Trademarks and trade names							403,609
Net identifiable intangible assets						$	1,055,531

Our definite-lived intangible assets are being amortized using the straight-line method over their remaining weighted average useful lives of 6.1 years for customer relationships, 9.3 years for patents and technology, 2.6 years for distributor rights, 7.4 years for trademarks and trade names, and 3.0 years for non-compete agreements. Based on our amortizable intangible asset balance as of September 28, 2013, we estimate that amortization expense will be as follows for the next five years and thereafter (in thousands):

Remaining 2013	$	23,939
2014		92,830
2015		87,994
2016		83,612
2017		72,432
Thereafter		222,842
	$	583,649

6. OTHER CURRENT LIABILITIES

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

	September 28, 2013		December 31, 2012
Accrued wages and related expenses	$	32,246	$	29,888
Accrued commissions		13,633		14,182
Accrued rebates		6,805		4,380
Accrued taxes		5,146		6,860
Accrued professional expenses		3,207		4,477
Income taxes payable		1,885		3,525
Derivative liabilities		233		—
Other accrued liabilities		36,933		30,328
	$	100,088	$	93,640

7. DERIVATIVE INSTRUMENTS

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

All derivatives, whether designated as hedging relationships or not, are recorded on the balance sheet at fair value. The fair value of our derivatives is determined through the use of models that consider various assumptions, including time value, yield curves and other relevant economic measures which are inputs that are classified as Level 2 in the fair value hierarchy. The classification of gains and losses resulting from changes in the fair values of derivatives is dependent on the intended use of the derivative and its resulting designation. Our foreign exchange contracts have not been designated as hedges, and accordingly, changes in the fair value of the derivatives are recorded in income (loss).

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Foreign Currency Exchange Rate Contracts. In prior periods we have utilized Mexican Peso (MXN) foreign exchange forward contracts to hedge a portion of our exposure to fluctuations in foreign currency exchange rates, as our Mexico-based manufacturing operations incur costs that are largely denominated in MXN. Foreign exchange contracts held as of September 28, 2013 expire weekly through August 2014. 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.

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

	Notional Amount (MXN)				Notional Amount (USD)
	September 28, 2013		December 31, 2012		September 28, 2013		December 31, 2012
Foreign exchange contracts not designated as hedges		294,626		92,617	$	22,437	$	6,376

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

	Balance Sheet Location	September 28, 2013		December 31, 2012
Derivative Assets:
Foreign exchange forward contracts not designated as hedges	Other current assets	$	—	$	777
Derivative Liabilities:
Foreign exchange forward contracts not designated as hedges	Other current liabilities		233		—

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

	Location of (loss) gain	Three Months Ended					Nine Months Ended
		September 28, 2013			September 29, 2012		September 28, 2013			September 29, 2012
Foreign exchange forward contracts not designated as hedges	Other (expense) income, net	$	(233	)	$	281	$	(1,010	)	$	2,004

8. FAIR VALUE MEASUREMENTS

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

During the quarter ended September 28, 2013, we remeasured the fair value of the contingent consideration related to our December 2012 acquisition of Exos Corporation. We initially valued the contingent consideration at $8.2 million based on the probability weighted estimate of approximately 95% for the achievement of certain specified milestones and the budgeted 2013 Exos product line revenues. Our remeasurement of the fair value based on the probability of achieving the budgeted Exos revenue and certain specified milestones and the discounted present value of the current estimate of the future contingent payment resulted in a reduction of $2.5 million to the net fair value of the contingent consideration. This fair value measurement is categorized within Level 3 of the fair value hierarchy.

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

As of September 28, 2013	Quoted Prices in Active Markets for Identical Assets (Level  1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Recorded Balance
Liabilities:
Foreign exchange forward contracts not designated as hedges	$	—	$	233	$	—	$	233
Contingent consideration	$	—	$	—	$	5,700	$	5,700

As of December 31, 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 exchange forward contracts not designated as hedges	$	—	$	777	$	—	$	777
Liabilities:
Contingent consideration	$	—	$	—	$	8,200	$	8,200

The table below presents reconciliation of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 28, 2013 (in thousands):

	Nine Months Ended
	September 28, 2013
Balance, beginning of period	$	8,200
Total (gains) or losses (realized/unrealized):
Included in selling, general and administrative expense		(2,500	)
Included in other comprehensive income		—
Balance, end of period	$	5,700

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9. DEBT AND CAPITAL LEASE OBLIGATIONS

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

	September 28, 2013			December 31, 2012
Senior secured credit facilities:
Revolving credit facility	$	—		$	3,000
Term Loans:
$857.7 million tranche B term loans, net of unamortized original issuance discount of $7.5 million		850,172			—
$476.5 million new term loans, net of unamortized original issue discount of $7.3 million		—			469,200
$385.5 million extended term loans, net of unamortized original issue discount of $1.5 million		—			383,965
8.75% Second priority senior secured notes, including unamortized original issue premium of $5.7 million and $6.5 million, respectively		335,753			336,509
9.875% Senior unsecured notes		440,000			440,000
7.75% Senior unsecured notes		300,000			300,000
9.75% Senior subordinated notes		300,000			300,000
Total debt		2,225,925			2,232,674
Current maturities		(8,620	)		(8,858	)
Long-term debt	$	2,217,305		$	2,223,816

Senior Secured Credit Facilities

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

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

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

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

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

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As of September 28, 2013, the market values of our tranche B term loans and revolving credit facility were $862.0 million and zero, respectively. We determine market value using trading prices for the senior secured credit facilities on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Interest Rates. Effective March 21, 2013, the interest rate margins applicable to borrowings under the senior secured revolving credit facilities are, at our option, either (a) the Eurodollar rate, plus 375 basis points or (b) a base rate determined by reference to the highest of (1) the prime rate, (2) the federal funds rate, plus 0.50% and (3) the Eurodollar rate for a one-month interest period, plus in each case 375 basis points. The interest rate margins applicable to the tranche B term loans are, at our option, either (a) the Eurodollar rate plus 375 basis points or (b) a base rate plus 375 basis points. There is a minimum LIBOR rate applicable to the Eurodollar component of interest rates on tranche B term loan borrowings of 1.00%. The applicable margin for borrowings under the senior secured revolving credit facilities may be reduced, subject to our attaining certain leverage ratios. As of September 28, 2013, our weighted average interest rate for all borrowings under the senior secured credit facilities was 4.75%.

Fees.In addition to paying interest on outstanding principal under the senior secured credit facilities, we are required to pay a commitment fee to the lenders under the senior secured revolving credit facilities with respect to the unutilized commitments thereunder. The current commitment fee rate is 0.50% per annum, subject to step-downs based upon the achievement of certain leverage ratios. We must also pay customary letter of credit fees.

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

Prepayments. The senior secured credit facilities require us to prepay outstanding term loans, subject to certain exceptions, with (1) 50% (which percentage is reduced to 25% or 0% upon our attaining certain leverage ratios) of our annual excess cash flow, as defined in the credit agreement relating to the senior secured credit facilities (such agreement, the “credit agreement”); (2) 100% of the net cash proceeds above an annual amount of $25.0 million from non-ordinary course asset sales (including insurance and condemnation proceeds) by us and our restricted subsidiaries, subject to certain exceptions, including a 100% reinvestment right if reinvested or committed to be reinvested within 15 months of such asset sales so long as such reinvestment is completed within 180 days thereafter; and (3) 100% of the net cash proceeds from the issuance or incurrence of debt by us and our restricted subsidiaries, other than proceeds from debt permitted to be incurred under the senior secured credit facilities and related amendments. Any mandatory prepayments are applied to the term loan facility in direct order of maturity. We were not required to make any such prepayments in the nine months ended September 28, 2013.

Subject to certain exceptions, voluntary prepayments of the tranche B term loans within one year of the effective date of the March 2013 amendment are subject to a 1.0% “soft call” premium, while other voluntary prepayments of outstanding loans under the senior secured credit facilities may be made at any time without premium or penalty, provided that voluntary prepayments of Eurodollar loans made on a date other than the last day of an interest period applicable thereto shall be subject to customary breakage costs.

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

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

Certain Covenants and Events of Default. The senior secured credit facilities contain a number of covenants that, among other things, restrict, subject to certain exceptions, our and our subsidiaries’ ability to:

• incur additional indebtedness;

• create liens on assets;

• change fiscal years;

• enter into sale and leaseback transactions;

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• engage in mergers or consolidations;

• sell assets;

• pay dividends and other restricted payments;

• make investments, loans or advances;

• repay subordinated indebtedness;

• make certain acquisitions;

• engage in certain transactions with affiliates;

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

• amend material agreements governing our subordinated indebtedness; and

• change our lines of business.

In addition, the senior secured credit facilities require us to maintain a maximum senior secured first lien leverage ratio of consolidated senior secured first lien debt to Adjusted EBITDA (as defined in the credit agreement) of 4.25:1 for the trailing twelve months ended September 28, 2013. The senior secured credit facilities also contain certain customary affirmative covenants and events of default. As of September 28, 2013, our actual senior secured first lien net leverage ratio was 3.12:1, and we were in compliance with all other applicable covenants.

8.75% Second Priority Senior Secured Notes

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

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

As of September 28, 2013, the market value of the 8.75% Notes was $358.9 million. We determined market value using trading prices for the 8.75% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption. Under the agreement governing the 8.75% Notes (8.75% Indenture), prior to March 15, 2015, we have the option to redeem some or all of the 8.75% Notes for cash at a redemption price equal to 100% of the then outstanding principal balance plus an applicable make-whole premium, plus accrued and unpaid interest. Beginning on March 15, 2015, we may redeem some or all of the 8.75% Notes at a redemption price of 104.375% of the then outstanding principal balance, plus accrued and unpaid interest. The redemption price decreases to 102.188% and 100% of the then outstanding principal balance at March 15, 2016 and 2017, respectively, plus accrued and unpaid interest. Additionally, from time to time, before March 15, 2015, we may redeem up to 35% of the 8.75% Notes at a redemption price equal to 108.75% of the then outstanding principal balance, plus accrued and unpaid interest, in each case, with proceeds we raise, or a direct or indirect parent company raises, in certain offerings of equity of DJOFL or its direct or indirect parent companies, as long as at least 65% of the aggregate principal amount of the 8.75% Notes issued remains outstanding.

9.875% Senior Unsecured Notes

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

As of September 28, 2013, the market value of the 9.875% Notes was $465.3 million. We determined market value using trading prices for the 9.875% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption.Under the agreement governing the 9.875% Notes (the 9.875% Indenture), prior to April 15, 2015, we have the option to redeem some or all of the 9.875% Notes for cash at a redemption price equal to 100% of the then outstanding principal balance plus an applicable make-whole premium plus accrued and unpaid interest. Beginning on April 15, 2015, we may redeem some or all of the 9.875% Notes at a redemption price of 104.938% of the then outstanding principal balance plus accrued and unpaid interest. The redemption price decreases to 102.469% and 100% of the then outstanding principal balance at April 2016 and 2017, respectively. Additionally, from time to time, before April 15, 2015, we may redeem up to 35% of the 9.875% Notes at a redemption price equal to 109.875% of the principal amount then outstanding, plus accrued and unpaid interest, in each case, with proceeds we raise, or a direct or indirect parent company raises, in certain offerings of equity of DJOFL or its direct or indirect parent companies, as long as at least 65% of the aggregate principal amount of the 9.875% Notes issued remains outstanding.

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7.75% Senior Unsecured Notes

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

As of September 28, 2013, the market value of the 7.75% Notes was $297.0 million. We determined market value using trading prices for the 7.75% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption. Under the agreement governing the 7.75% Notes (the 7.75% Indenture), prior to April 15, 2014, we have the option to redeem some or all of the 7.75% Notes for cash at a redemption price equal to 100% of the then outstanding principal balance plus an applicable make-whole premium plus accrued and unpaid interest. Beginning on April 15, 2014, we 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. Additionally, from time to time, before April 15, 2014, we may redeem up to 35% of the 7.75% Notes at a redemption price equal to 107.75% 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 us or our direct or indirect parent companies, as long as at least 65% of the aggregate principal amount of the 7.75% Notes issued remains outstanding.

9.75% Senior Subordinated Notes

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

As of September 28, 2013, the market value of the 9.75% Notes was $303.8 million. We determined market value using trading prices for the 9.75% Notes on or near that date. This fair value measurement is categorized within Level 2 of the fair value hierarchy.

Optional Redemption. Under the agreement governing the 9.75% Notes (the 9.75% Indenture), prior to October 15, 2013, we have the option to redeem some or all of the 9.75% Notes for cash at a redemption price equal to 100% of the then outstanding principal balance plus an applicable make-whole premium, plus accrued and unpaid interest. Beginning on October 15, 2013, we 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. Additionally, from time to time, before October 15, 2013, we 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 9.75% 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 its 8.75% Notes, 9.875% Notes, 7.75% Notes, and 9.75% Notes (collectively, the Notes), DJOFL will be required to make an offer to repurchase all of the Notes at 101% of the then outstanding principal balance, plus accrued and unpaid interest.

Covenants

The indentures for each of the Notes issuances contain covenants limiting, among other things, our and our restricted subsidiaries’ ability to (i) incur additional indebtedness or issue certain preferred and convertible shares, pay dividends on, redeem, repurchase or make distributions in respect of the capital stock of DJO or make other restricted payments, (ii) make certain investments, (iii) sell certain assets, (iv) create liens on certain assets to secure debt, (v) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets, (vi) enter into certain transactions with affiliates, or (vii) designate our subsidiaries as unrestricted subsidiaries. As of September 28, 2013, we were in compliance with all applicable covenants.

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Our ability to continue to meet the covenants related to our indebtedness specified above in future periods will depend, in part, on events beyond our control, and we may not continue to meet those covenants. A breach of any of these covenants in the future could result in a default under the senior secured credit facilities, the 8.75% Indenture, the 9.75% Indenture, the 9.875% Indenture and the 7.75% Indenture (collectively, the Indentures), at which time the lenders could elect to declare all amounts outstanding under the senior secured credit facilities to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.

Loss on Modification and Extinguishment of Debt

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

During the nine months ended September 29, 2012, we recognized a loss on modification and extinguishment of debt of $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 non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of the term loans which were extinguished.

Debt Issuance Costs

As of September 28, 2013 and December 31, 2012, we had $37.6 million and $41.6 million, respectively, of unamortized debt issuance costs, which are included in other assets in our Consolidated Balance Sheets. During the nine months ended September 28, 2013, we capitalized $1.5 million of debt issuance costs incurred in connection with the amendment of our senior secured credit facilities. During the nine months ended September 29, 2012, we capitalized $15.9 million, respectively, of debt issuance costs incurred in connection with the issuance of $230.0 million aggregate principal of 8.75% Notes and the March 2012 amendment and extension of our senior secured credit facilities.

For the three and nine months ended September 28, 2013, amortization of debt issuance costs was $1.8 million and $5.4 million, respectively. For the three and nine months ended September 29, 2012, amortization of debt issuance costs was $2.5 million and $7.1 million, respectively. Amortization of debt issuance costs was included in interest expense in our Consolidated Statements of Operations for each of the periods presented.

10. INCOME TAXES

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

For the three and nine months ended September 28, 2013, we recorded income tax expense of approximately $0.8 million and $7.8 million on pre-tax losses of $17.6 million and $63.3 million, resulting in negative effective tax rates of 4.6% and 12.4%, respectively. For the three and nine months ended September 29, 2012, we recorded income tax expense of $0.6 million and $3.0 million, respectively, on a pre-tax loss of $22.0 million and $68.5 million, respectively, resulting in negative effective tax rates of 2.6% and 4.5%, respectively. Our effective tax rates are negative primarily due to valuation allowances provided against U.S federal and state deferred tax assets. 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 and 2013 U.S. federal and state net operating losses. We record net deferred tax assets to the extent we conclude that it is more likely than not that the related deferred tax assets will be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. At this time, we cannot conclude that it is more likely than not that the benefit from certain U.S. federal and state net operating loss carryforwards will be realized. Accordingly, we have provided a valuation allowance of $10.8 million and $32.0 million, respectively, on the deferred tax assets related to the net operating loss carryforwards generated in the three and nine months ended September 28, 2013. If our assumptions change and we determine that it is more likely than not that we will be able to realize the deferred tax assets related to these net operating losses, reversal of the valuation allowances we have recorded against those deferred tax assets will be recognized as a reduction of income tax expense. The establishment of valuation allowances does not preclude us from utilizing our loss carryforwards or other deferred tax assets in the future and does not impact our cash resources.

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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 2009.

At September 28, 2013, our gross unrecognized tax benefits were $13.9 million reflecting an increase of $1.5 million from the unrecognized amount of $12.3 million at December 31, 2012. As of September 28, 2013, we have $2.4 million accrued for interest and penalties related to these unrecognized tax benefits. To the extent all or a portion of our gross unrecognized tax benefits are recognized in the future, no U.S. federal tax benefit for related state income tax deductions would result due to the existence of the U.S. federal valuation allowance. We anticipate that approximately $1.1 million aggregate of unrecognized tax benefits each of which are individually immaterial will decrease in the next twelve months due to the expiration of statutes of limitation. As of September 28, 2013, we have unrecognized various foreign and U.S. state tax benefits of approximately $5.0 million, which, if recognized, would impact our effective tax rate in future periods.

11. STOCK OPTION PLANS AND STOCK-BASED COMPENSATION

Stock Option Plan

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

Options issued under the 2007 Plan can be either incentive stock options or non-qualified stock options. The exercise price of stock options granted will not be less than 100% of the fair market value of the underlying shares on the date of grant and will expire no more than ten years from the date of grant.

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

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

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

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As of September 28, 2013, options granted to members of our Board of Directors, other than the Chairman of the Board and one other board member, vest in increments of 33 1/3% per year on each of the first through third anniversary dates of the grant date, contingent upon the optionee’s continued service as a director. These time-based vesting options granted to the directors specified above are referred to herein as Director Service Options. The options granted to the Chairman of the Board and the other board member vest as follows: one-third of the stock option grant vests in increments of 33 1/3% per year on each of the first through third anniversary dates from the grant date contingent upon the optionee’s continued service as a director; one-third of the stock option grant will vest in the same manner as the Market Return Options; and one-third of the stock option grant will vest in the same manner as the Enhanced Market Return Options.

Stock-Based Compensation

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

During the nine months ended September 29, 2012, we granted 2,482,100 Performance Options to employees, 303,767 options to DJO’s Chairman of the Board, 100,000 to one other board member, and 18,400 Director Service Options to certain members of our Board of Directors. The weighted average grant date fair value of the Performance Options and the Director Service Options granted during the nine months ended September 29, 2012 was $6.09.

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

	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013	September 29, 2012
Expected volatility		34.6	%		37.7	%	34.6-35.1%	35.3 -37.7%
Risk-free interest rate		1.8	%		0.8	%	0.7-1.8%	0.8-1.5%
Expected years until exercise		6.3			6.1		6.2-6.3	6.1-6.2
Expected dividend yield		0.0	%		0.0	%	0.0%	0.0%

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

	Three Months Ended				Nine Months Ended
	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Cost of goods sold	$	4	$	66	$	40	$	162
Operating Expenses:
Selling, general and administrative		285		1,215		1,483		3,309
Research and development		2		29		21		92
	$	291	$	1,310	$	1,544	$	3,563

We have determined that it is not probable that we will meet the Adjusted EBITDA targets related to the Performance Options granted. As such, we have not recognized expense for any of the options which have the potential to vest in 2013. Additionally, we have not recognized expense for any of the options which have the potential to vest based on Adjusted EBITDA for 2014 and 2015, as some of these targets have not yet been established and we are unable to assess the probability of achieving such targets. Accordingly, we recognized stock-based compensation expense only for the Time-Based Options granted in 2012 or 2013.

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

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

12. RELATED PARTY TRANSACTIONS

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

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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.

Pain Pump Litigation

We are currently named as one of several defendants in a number of product liability lawsuits involving approximately 15 plaintiffs in U.S. cases and a lawsuit in Canada which has been granted class action status for a class of approximately 45 claimants, 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 or, less commonly, knee surgeries, has resulted in cartilage damage to the plaintiffs. In the past three years, we have been dismissed from approximately 410 cases when product identification was later established showing that we did not sell the pump in issue. In the past three years, we have entered into settlements with plaintiffs in approximately 110 pain pump lawsuits. As of September 28, 2013, the range of potential loss for these claims is not estimable, although we believe we have adequate insurance coverage for such claims.

Cold Therapy Litigation

DJO is named in nine multi-plaintiff lawsuits involving a total of 172 plaintiffs alleging that the plaintiffs had been injured following use of certain cold therapy products manufactured by DJO. The complaints 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. 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. Nine of the plaintiffs included in the cases filed against us have been selected as the first cases to be tried. The first of these “bellwether” cases commenced trial in July 2013, with three other bellwether cases selected for consecutive trials in late 2013 and early 2014. The first bellwether trial ended with a deadlocked jury, resulting in no verdict and declaration of a mistrial. We are engaged in settlement discussions with plaintiffs with the goal of resolving these cases. As of September 28, 2013, the range of potential loss for these claims is not estimable, although we believe we have adequate insurance coverage for such claims.

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California Qui Tam Actions

On April 15, 2009, we became aware of aqui tamaction filed in U.S.District Court in Boston, Massachusetts in March 2005 and amended in December 2007 and May 2010 that names us as a defendant along with each of the other companies that manufactures and sells external bone growth stimulators. 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. We believe that our marketing activities are in compliance with applicable Federal and state law. The case is proceeding to the discovery phase. The government has decided not to intervene in the case at this time. We believe that this lawsuit is without merit.

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

State Licensing Subpoena

In July 2013 we were served with a subpoena under HIPAA seeking documents relating to the fitting of custom-fabricated or custom-fitted orthoses in the States of New Jersey, Washington and Texas. The subpoena was issued by the United States Attorney’s Office for the District of New Jersey in connection with an investigation of compliance with professional licensing statutes in those states relating to the practice of orthotics. We are in the process of supplying the documents requested under the subpoena.

14. SEGMENT AND GEOGRAPHIC INFORMATION

We are a global developer, manufacturer and distributor of medical devices that provide solutions for musculoskeletal health, vascular health and pain management.

In the first quarter of 2013, we reassigned certain product lines between our Bracing and Vascular and Recovery Sciences segments and revised the way we allocate costs among all of our segments. Segment information for all periods presented has been restated to reflect these changes.

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 footwear for the diabetes care market and compression therapy products, primarily under our DonJoy, ProCare, Aircast, Dr. Comfort, Bell-Horn, and Exos brands. This segment also includes our OfficeCare business, through which we maintain an inventory of soft goods and other products at healthcare facilities, primarily orthopedic practices, for immediate distribution to patients. 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.

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

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

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

Surgical Implant Segment

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

International Segment

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

Information regarding our reportable business segments is presented below (in thousands). Segment results exclude the impact of amortization 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 in the senior secured credit facilities. We do not allocate assets to reportable segments because a significant portion of our assets are shared by segments.

	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Net sales:
Bracing and Vascular	$	120,947		$	111,951		$	348,455		$	331,189
Recovery Sciences		76,654			80,167			229,413			247,902
Surgical Implant		20,025			17,197			62,890			53,170
International		70,423			64,671			221,113			206,649
	$	288,049		$	273,986		$	861,871		$	838,910
Gross profit:
Bracing and Vascular	$	61,689		$	58,151		$	178,345		$	171,555
Recovery Sciences		57,298			60,811			172,168			186,760
Surgical Implant		13,915			12,670			45,001			39,858
International		37,844			34,815			122,828			114,696
Expenses not allocated to segments and eliminations		(857	)		(758	)		(3,232	)		(2,293	)
	$	169,889		$	165,689		$	515,110		$	510,576
Operating income:
Bracing and Vascular	$	22,537		$	22,667		$	62,942		$	65,812
Recovery Sciences		21,088			22,551			59,501			65,658
Surgical Implant		1,020			492			5,410			3,805
International		11,471			10,656			42,086			39,650
Expenses not allocated to segments and eliminations		(30,741	)		(33,837	)		(98,348	)		(102,166	)
	$	25,375		$	22,529		$	71,591		$	72,759

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Geographic Area

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

	Three Months Ended				Nine Months Ended
	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Net sales:
United States	$	217,625	$	209,314	$	640,757	$	632,261
Other Europe, Middle East and Africa		33,048		29,729		105,309		98,146
Germany		20,860		19,790		66,212		64,209
Australia and Asia Pacific		7,913		6,506		23,358		19,418
Canada		6,400		6,301		19,426		18,264
Latin America		2,203		2,346		6,809		6,612
	$	288,049	$	273,986	$	861,871	$	838,910

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15. SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

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

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

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

DJO Finance LLC

Unaudited Condensed Consolidating Balance Sheets

As of September 28, 2013

(in thousands)

	DJOFL		Guarantors		Non - Guarantors		Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	11,299	$	1,309	$	20,917	$	1		$	33,526
Accounts receivable, net		—		139,573		41,555		—			181,128
Inventories, net		—		128,059		34,116		(8,310	)		153,865
Deferred tax assets, net		—		32,235		183		—			32,418
Prepaid expenses and other current assets		29		16,566		9,024		418			26,037
Total current assets		11,328		317,742		105,795		(7,891	)		426,974
Property and equipment, net		—		91,872		12,374		(281	)		103,965
Goodwill		—		1,168,479		120,931		(38,533	)		1,250,877
Intangible assets, net		—		968,648		18,745		—			987,393
Investment in subsidiaries		1,297,699		1,686,557		82,150		(3,066,406	)		—
Intercompany receivables		1,039,077		—		—		(1,039,077	)		—
Other non-current assets		37,559		1,409		1,605		1			40,574
Total assets	$	2,385,663	$	4,234,707	$	341,600	$	(4,152,187	)	$	2,809,783
Liabilities and Equity
Current liabilities:
Accounts payable	$	—	$	51,593	$	9,363	$	(2	)	$	60,954
Current portion of debt and capital lease obligations		8,620		—		—		—			8,620	��
Other current liabilities		49,905		71,760		27,979		358			150,002
Total current liabilities		58,525		123,353		37,342		356			219,576
Long-term debt and capital lease obligations		2,217,305		—		—		—			2,217,305
Deferred tax liabilities, net		—		236,530		7,184		—			243,714
Intercompany payables, net		—		721,043		156,042		(877,085	)		—
Other long-term liabilities		—		14,616		1,833		—			16,449
Total liabilities		2,275,830		1,095,542		202,401		(876,729	)		2,697,044
Noncontrolling interests		—		—		2,906		—			2,906
Total membership equity		109,833		3,139,165		136,293		(3,275,458	)		109,833
Total liabilities and equity	$	2,385,663	$	4,234,707	$	341,600	$	(4,152,187	)	$	2,809,783

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended September 28, 2013

(in thousands)

	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	255,209		$	66,384		$	(33,544	)	$	288,049
Cost of sales (exclusive of amortization of intangible assets of $8,809)		—			106,696			46,659			(35,195	)		118,160
Gross profit		—			148,513			19,725			1,651			169,889
Operating expenses:
Selling, general and administrative		—			89,966			22,597			3			112,566
Research and development		—			7,179			849			—			8,028
Amortization of intangible assets		—			22,589			1,331			—			23,920
		—			119,734			24,777			3			144,514
Operating income (loss)		—			28,779			(5,052	)		1,648			25,375
Other (expense) income:
Interest expense		(43,834	)		—			(8	)		—			(43,842	)
Interest income		4			17			8			—			29
Loss on modification and extinguishment of debt		—			—			—			—			—
Other income (expense), net		—			(175	)		1,045			—			870
Intercompany income (expense), net		—			11,408			(211	)		(11,197	)		—
Equity in income (loss) of subsidiaries, net		25,342			—			—			(25,342	)		—
		(18,488	)		11,250			834			(36,539	)		(42,943	)
(Loss) income before income taxes		(18,488	)		40,029			(4,218	)		(34,891	)		(17,568	)
Income tax provision		—			238			(1,045	)		—			(807	)
Net (loss) income		(18,488	)		40,267			(5,263	)		(34,891	)		(18,375	)
Net income attributable to noncontrolling interests					—			(113	)		—			(113	)
Net (loss) income attributable to DJOFL	$	(18,488	)	$	40,267		$	(5,376	)	$	34,891		$	(18,488	)

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Nine Months Ended September 28, 2013

(in thousands)

	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	749,036		$	208,780		$	(95,945	)	$	861,871
Cost of sales (exclusive of amortization of intangible assets of $26,368)		—			309,597			142,277			(105,113	)		346,761
Gross profit		—			439,439			66,503			9,168			515,110
Operating expenses:
Selling, general and administrative		—			279,339			68,827			9			348,175
Research and development		—			20,983			2,766			—			23,749
Amortization of intangible assets		—			67,571			4,024			—			71,595
		—			367,893			75,617			9			443,519
Operating income (loss)		—			71,546			(9,114	)		9,159			71,591
Other (expense) income:
Interest expense		(133,323	)		—			(89	)		—			(133,412	)
Interest income		12			63			42			—			117
Loss on modification and extinguishment of debt		(1,059	)		—			—			—			(1,059	)
Other income (expense), net		—			(252	)		(283	)		—			(535	)
Intercompany income (expense), net		—			12,115			(1,078	)		(11,037	)		—
Equity in income (loss) of subsidiaries, net		62,704			—			—			(62,704	)		—
		(71,666	)		11,926			(1,408	)		(73,741	)		(134,889	)
(Loss) income before income taxes		(71,666	)		83,472			(10,522	)		(64,582	)		(63,298	)
Income tax provision		—			(3,898	)		(3,947	)		—			(7,845	)
Net (loss) income		(71,666	)		79,574			(14,469	)		(64,582	)		(71,143	)
Net income attributable to noncontrolling interests		—			—			(523	)		—			(523	)
Net (loss) income attributable to DJOFL	$	(71,666	)	$	79,574		$	(14,992	)	$	(64,582	)	$	(71,666	)

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Three Months Ended September 28, 2013

(in thousands)

	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(18,488	)	$	40,267	$	(5,263	)	$	(34,891	)	$	(18,375	)
Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustments, net of tax provision of $1,407		—			—		2,739			—			2,739
Other comprehensive income		—			—		2,739			—			2,739
Comprehensive (loss) income		(18,488	)		40,267		(2,524	)		(34,891	)		(15,636	)
Comprehensive income attributable to noncontrolling interests		—			—		(212	)		—			(212	)
Comprehensive (loss) income attributable to DJO Finance LLC	$	(18,488	)	$	40,267	$	(2,736	)	$	(34,891	)	$	(15,848	)

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Nine Months Ended September 28, 2013

(in thousands)

	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(71,666	)	$	79,574	$	(14,469	)	$	(64,582	)	$	(71,143	)
Other comprehensive loss, net of taxes:
Foreign currency translation adjustments, net of tax provision of $538		—			—		(71	)		—			(71	)
Other comprehensive loss		—			—		(71	)		—			(71	)
Comprehensive (loss) income		(71,666	)		79,574		(14,540	)		(64,582	)		(71,214	)
Comprehensive income attributable to noncontrolling interests		—			—		(588	)		—			(588	)
Comprehensive (loss) income attributable to DJO Finance LLC	$	(71,666	)	$	79,574	$	(15,128	)	$	(64,582	)	$	(71,802	)

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DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 28, 2013

(in thousands)

	DJOFL			Guarantors			Non- Guarantors			Eliminations			Consolidated
Cash Flows from Operating Activities:
Net (loss) income	$	(71,666	)	$	79,574		$	(14,469	)	$	(64,582	)	$	(71,143	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation		—			20,524			3,804			(200	)		24,128
Amortization of intangible assets		—			67,571			4,024			—			71,595
Amortization of debt issuance costs and non-cash interest expense		5,955			—			—			—			5,955
Loss on modification and extinguishment of debt		1,059			—			—			—			1,059
Stock-based compensation expense		—			1,544			—			—			1,544
Loss on disposal of assets, net		—			222			654			—			876
Deferred income tax expense		—			2,525			241			—			2,766
Provision for doubtful accounts and sales returns		—			20,080			190			—			20,270
Inventory reserves		—			5,745			1,787			—			7,532
Equity in income of subsidiaries, net		(62,704	)		—			—			62,704			—
Changes in operating assets and liabilities:
Accounts receivable		—			(30,065	)		(4,521	)		—			(34,586	)
Inventories		—			(1,168	)		5,001			(6,470	)		(2,637	)
Prepaid expenses and other assets		131			(1,471	)		(5,952	)		(4	)		(7,296	)
Accounts payable and other current liabilities		18,393			(1,194	)		1,748			193			19,140
Net cash (used in) provided by operating activities		(108,832	)		163,887			(7,493	)		(8,359	)		39,203
Cash Flows from Investing Activities:
Cash paid in connection with acquisitions, net of cash acquired		—			(191	)		(1,762	)		—			(1,953	)
Purchases of property and equipment		—			(19,699	)		(4,322	)		(22	)		(24,043	)
Other investing activities, net		—			(1,139	)		(294	)		—			(1,433	)
Net cash used in investing activities		—			(21,029	)		(6,378	)		(22	)		(27,429	)
Cash Flows from Financing Activities:
Intercompany		116,652			(144,671	)		19,643			8,376			—
Proceeds from issuance of debt		496,417			—			—			—			496,417
Repayments of debt and capital lease obligations		(503,727	)		—			—			—			(503,727	)
Payment of debt issuance costs		(2,387	)		—			—			—			(2,387	)
Net cash provided by (used in) financing activities		106,955			(144,671	)		19,643			8,376			(9,697	)
Effect of exchange rate changes on cash and cash equivalents		—			—			226			—			226
Net (decrease) increase in cash and cash equivalents		(1,877	)		(1,813	)		5,998			(5	)		2,303
Cash and cash equivalents at beginning of period		13,176			3,122			14,919			6			31,223
Cash and cash equivalents at end of period	$	11,299		$	1,309		$	20,917		$	1		$	33,526

29

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Three Months Ended September 29, 2012

(in thousands)

	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	241,368	$	60,905		$	(28,287	)	$	273,986
Cost of sales (exclusive of amortization of intangible assets of $9,837)		—			97,277		41,764			(30,744	)		108,297
Gross profit		—			144,091		19,141			2,457			165,689
Operating expenses:
Selling, general and administrative		—			91,661		19,080			(6	)		110,735
Research and development		—			6,735		1,203			—			7,938
Amortization of intangible assets		—			23,507		980			—			24,487
		—			121,903		21,263			(6	)		143,160
Operating income (loss)		—			22,188		(2,122	)		2,463			22,529
Other income (expense):
Interest expense		(46,386	)		—		(25	)		—			(46,411	)
Interest income		4			36		6			—			46
Loss on modification and extinguishment of debt		—			—		—			—			—
Other income (expense), net		—			625		1,245			—			1,870
Intercompany income (expense)		—			366		(407	)		41			—
Equity in income (loss) of subsidiaries, net		23,821			—		—			(23,821	)		—
		(22,561	)		1,027		819			(23,780	)		(44,495	)
(Loss) income before income taxes		(22,561	)		23,215		(1,303	)		(21,317	)		(21,966	)
Income tax (provision) benefit		—			605		(1,174	)		—			(569	)
Net (loss) income		(22,561	)		23,820		(2,477	)		(21,317	)		(22,535	)
Net income attributable to noncontrolling interests		—			—		(27	)		—			(27	)
Net (loss) income attributable to DJOFL	$	(22,561	)	$	23,820	$	(2,504	)	$	(21,317	)	$	(22,562	)

30

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Operations

For the Nine Months Ended September 29, 2012

(in thousands)

	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net sales	$	—		$	726,719	$	195,903		$	(83,712	)	$	838,910
Cost of sales (exclusive of amortization of intangible assets of $29,513)		—			290,889		132,130			(94,685	)		328,334
Gross profit		—			435,830		63,773			10,973			510,576
Operating expenses:
Selling, general and administrative		—			281,024		61,589			4			342,617
Research and development		—			18,346		3,349			—			21,695
Amortization of intangible assets		—			70,523		2,982			—			73,505
		—			369,893		67,920			4			437,817
Operating income (loss)		—			65,937		(4,147	)		10,969			72,759
Other income (expense):
Interest expense		(134,829	)		—		(70	)		—			(134,899	)
Interest income		14			72		65			—			151
Loss on modification and extinguishment of debt		(9,398	)		—		—						(9,398	)
Other income (expense), net		—			2,493		438			—			2,931
Intercompany income (expense)		—			728		(661	)		(67	)		—
Equity in income (loss) of subsidiaries, net		72,099			—		—			(72,099	)		—
		(72,114	)		3,293		(228	)		(72,116	)		(141,215	)
(Loss) income before income taxes		(72,114	)		69,230		(4,375	)		(61,197	)		(68,456	)
Income tax benefit (provision)		—			1,381		(4,425	)		—			(3,044	)
Net (loss) income		(72,114	)		70,611		(8,800	)		(61,197	)		(71,500	)
Net income attributable to noncontrolling interests		—			—		(614	)		—			(614	)
Net (loss) income attributable to DJOFL	$	(72,114	)	$	70,611	$	(9,414	)	$	(61,197	)	$	(72,114	)

31

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Three Months Ended September 29, 2012

(in thousands)

	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(22,561	)	$	23,820	$	(2,477	)	$	(21,317	)	$	(22,535	)
Other comprehensive loss, net of taxes:
Foreign currency translation adjustments, net of tax provision of $1,488		—			—		2,119			—			2,119
Other comprehensive loss		—			—		2,119			—			2,119
Comprehensive (loss) income		(22,561	)		23,820		(358	)		(21,317	)		(20,416	)
Comprehensive income attributable to noncontrolling interests		—			—		(97	)		—			(97	)
Comprehensive (loss) income attributable to DJO Finance LLC	$	(22,561	)	$	23,820	–	(455	)	$	(21,317	)	$	(20,513	)

32

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Comprehensive Loss

For the Nine Months Ended September 29, 2012

(in thousands)

	DJOFL			Guarantors		Non - Guarantors			Eliminations			Consolidated
Net (loss) income	$	(72,114	)	$	70,611	$	(8,800	)	$	(61,197	)	$	(71,500	)
Other comprehensive loss, net of taxes:
Foreign currency translation adjustments, net of tax benefit of $546		—			—		82			—			82
Other comprehensive loss		—			—		82			—			82
Comprehensive (loss) income		(72,114	)		70,611		(8,718	)		(61,197	)		(71,418	)
Comprehensive income attributable to noncontrolling interests		—			—		(599	)		—			(599	)
Comprehensive (loss) income attributable to DJO Finance LLC	$	(72,114	)	$	70,611	$	(9,317	)	$	(61,197	)	$	(72,017	)

33

DJO Finance LLC

Unaudited Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 29, 2012

(in thousands)

	DJOFL			Guarantors			Non - Guarantors			Eliminations			Consolidated
Cash Flows from Operating Activities:
Net (loss) income	$	(72,114	)	$	70,611		$	(8,800	)	$	(61,197	)	$	(71,500	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation		—			19,063			3,883			(273	)		22,673
Amortization of intangible assets		—			70,523			2,982			—			73,505
Amortization of debt issuance costs and non-cash interest expense		7,729			—			—			—			7,729
Stock-based compensation expense		—			3,563			—			—			3,563
Loss on modification and extinguishment of debt		9,398			—			—			—			9,398
Loss on disposal of assets, net		—			485			451			—			936
Deferred income tax benefit		—			(1,247	)		(62	)		(527	)		(1,836	)
Provision for doubtful accounts and sales returns		—			16,281			161			—			16,442
Inventory reserves		—			4,198			242			—			4,440
Equity in (income) loss of subsidiaries, net		(72,099	)		—			—			72,099			—
Changes in operating assets and liabilities:
Accounts receivable		—			(16,296	)		(1,381	)		—			(17,677	)
Inventories		—			(12,871	)		6,175			(9,872	)		(16,568	)
Prepaid expenses and other assets		131			(2,856	)		(886	)		(59	)		(3,670	)
Accounts payable and other current liabilities		23,867			345			(3,533	)		3,189			23,868
Net cash (used in) provided by operating activities		(103,088	)		151,799			(768	)		3,360			51,303
Cash Flows from Investing Activities:
Purchases of property and equipment		—			(19,921	)		(3,519	)		(8	)		(23,448	)
Other investing activities, net		—			(656	)		—			—			(656	)
Net cash used in investing activities		—			(20,577	)		(3,519	)		(8	)		(24,104	)
Cash Flows from Financing Activities:
Intercompany		137,154			(131,288	)		(2,489	)		(3,377	)		—
Proceeds from issuance of debt		751,700			—			—			—			751,700
Repayments of debt and capital lease obligations		(754,792	)		(32	)		—			—			(754,824	)
Payment of debt issuance costs		(25,234	)		—			—			—			(25,234	)
Investment by parent		1,000			—			—			—			1,000
Net cash provided by (used in) financing activities		109,828			(131,320	)		(2,489	)		(3,377	)		(27,358	)
Effect of exchange rate changes on cash and cash equivalents		—			—			215			—			215
Net increase (decrease) in cash and cash equivalents		6,740			(98	)		(6,561	)		(25	)		56
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	$	20,513		$	1,680		$	16,056		$	(24	)	$	38,225

34

DJO Finance LLC

Condensed Consolidating Balance Sheets

As of December 31, 2012

(in thousands)

	DJOFL		Guarantors		Non - Guarantors		Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	13,176	$	3,122	$	14,919	$	6		$	31,223
Accounts receivable, net		—		129,588		37,154		—			166,742
Inventories, net		—		132,130		26,824		(2,639	)		156,315
Deferred tax assets, net		—		33,102		181		—			33,283
Prepaid expenses and other current assets		160		14,513		2,985		415			18,073
Total current assets		13,336		312,455		82,063		(2,218	)		405,636
Property and equipment, net		—		94,899		12,634		(498	)		107,035
Goodwill		—		1,168,479		110,257		(29,431	)		1,249,305
Intangible assets, net		—		1,035,066		20,465		—			1,055,531
Investment in subsidiaries		1,297,699		1,680,446		80,386		(3,058,531	)		—
Intercompany receivables		1,093,618		—		—		(1,093,618	)		—
Other assets		41,624		1,988		1,604		—			45,216
Total assets	$	2,446,277	$	4,293,333	$	307,409	$	(4,184,296	)	$	2,862,723
Liabilities and Equity
Current liabilities:
Accounts payable	$	—	$	46,283	$	9,147	$	(1,136	)	$	54,294
Current portion of debt and capital lease obligations		8,858		—		—		—			8,858
Other current liabilities		31,511		68,413		25,017		352			125,293
Total current liabilities		40,369		114,696		34,164		(784	)		188,445
Long-term debt and capital leases obligations		2,223,816		—		—		—			2,223,816
Deferred tax liabilities, net		—		234,332		6,870		—			241,202
Intercompany payables, net		—		861,014		131,558		(992,572	)		—
Other long-term liabilities		—		22,917		1,933		—			24,850
Total liabilities		2,264,185		1,232,959		174,525		(993,356	)		2,678,313
Noncontrolling interests		—		—		2,318		—			2,318
Total membership equity		182,092		3,060,374		130,566		(3,190,940	)		182,092
Total liabilities and equity	$	2,446,277	$	4,293,333	$	307,409	$	(4,184,296	)	$	2,862,723

35

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

Introduction

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

Forward Looking Statements

This report, and the following management’s discussion and analysis, contain “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. To the extent that any statements are not recitations of historical fact, such statements constitute forward-looking statements that, by definition, involve risks and uncertainties. These statements can be identified because they use words like “anticipates”, “believes”, “estimates”, “expects”, “forecasts”, “future”, “intends”, “plans” and similar terms. Specifically, statements referencing, without limitation, growth in sales of our products, profit margins and the sufficiency of our cash flow for future liquidity and capital resource needs may be forward-looking statements. These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. The section entitled “Risk Factors” in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 28, 2013 describes these important risk factors that may affect our business, financial condition, results of operations, and/or liquidity. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors.

Overview of Business

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

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

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

Operating Segments

In the first quarter of 2013, we reassigned certain product lines between our Bracing and Vascular and Recovery Sciences segments and revised the way we allocate costs among all of our segments. Segment information for all periods presented has been restated to reflect these changes.

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 footwear for the diabetes care market and compression therapy products, primarily under our DonJoy, ProCare, Aircast, Dr. Comfort, Bell-Horn, and Exos brands. This segment also includes our OfficeCare business, through which we maintain an inventory of soft goods and other products at healthcare facilities, primarily orthopedic practices, for immediate distribution to patients. 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.

36

Recovery Sciences Segment

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

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

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

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

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

Surgical Implant Segment

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

International Segment

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

Our four operating segments enable us to reach a diverse customer base through multiple distribution channels and give us the opportunity to provide a wide range of medical devices and related products to orthopedic specialists and other healthcare professionals operating in a variety of patient treatment settings. These four segments constitute our reportable segments. See Note 14 to our Unaudited Condensed Consolidated Financial Statements for additional information regarding our segments.

37

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

	Three Months Ended						Nine Months Ended
($ in thousands)	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Bracing and Vascular:
Net sales	$	120,947		$	111,951		$	348,455		$	331,189
Gross profit		61,689			58,151			178,345			171,555
Gross profit margin		51.0	%		51.9	%		51.2	%		51.8	%
Operating income		22,537			22,667			62,942			65,812
Operating income as a percent of net segment sales		18.6	%		20.2	%		18.1	%		19.9	%
Recovery Sciences:
Net sales	$	76,654		$	80,167		$	229,413		$	247,902
Gross profit		57,298			60,811			172,168			186,760
Gross profit margin		74.7	%		75.9	%		75.0	%		75.3	%
Operating income		21,088			22,551			59,501			65,658
Operating income as a percent of net segment sales		27.5	%		28.1	%		25.9	%		26.5	%
Surgical Implant:
Net sales	$	20,025		$	17,197		$	62,890		$	53,170
Gross profit		13,915			12,670			45,001			39,858
Gross profit margin		69.5	%		73.7	%		71.6	%		75.0	%
Operating income		1,020			492			5,410			3,805
Operating income as a percent of net segment sales		5.1	%		2.9	%		8.6	%		7.2	%
International:
Net sales	$	70,423		$	64,671		$	221,113		$	206,649
Gross profit		37,844			34,815			122,828			114,696
Gross profit margin		53.7	%		53.8	%		55.5	%		55.5	%
Operating income		11,471			10,656			42,086			39,650
Operating income as a percent of net segment sales		16.3	%		16.5	%		19.0	%		19.2	%

Results of Operations

Changes in our financial results include the impact of changes in foreign currency exchange rates in the current year. We provide “constant currency” calculations to remove the impact of this item from our results of operations.

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.

The constant currency financial measure is used to supplement measures that are in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). This financial measure is not a measure of financial performance under GAAP, and should not be considered as an alternative to measures presented in accordance with GAAP.

38

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

	Three Months Ended										Nine Months Ended
	September 28, 2013					September 29, 2012					September 28, 2013					September 29, 2012
Net sales	$	288,049		100.0	%	$	273,986		100.0	%	$	861,871		100.0	%	$	838,910		100.0	%
Cost of sales (exclusive of amortization of intangible assets (1))		118,160		41.0			108,297		39.5			346,761		40.2			328,334		39.1
Gross profit		169,889		59.0			165,689		60.5			515,110		59.8			510,576		60.9
Operating expenses:
Selling, general and administrative		112,566		39.1			110,735		40.4			348,175		40.4			342,617		40.8
Research and development		8,028		2.8			7,938		2.9			23,749		2.8			21,695		2.6
Amortization of intangible assets		23,920		8.3			24,487		8.9			71,595		8.3			73,505		8.8
		144,514		50.2			143,160		52.2			443,519		51.5			437,817		52.2
Operating income		25,375		8.8			22,529		8.3			71,591		8.3			72,759		8.7
Other income (expense):
Interest expense		(43,842	)	(15.2	)		(46,411	)	(16.9	)		(133,412	)	(15.5	)		(134,899	)	(16.1	)
Interest income		29		0.0			46		0.0			117		0.0			151		0.0
Loss on modification of debt		—		—			—		—			(1,059	)	(0.1	)		(9,398	)	(1.1	)
Other income (expense), net		870		0.3			1,870		0.7			(535	)	(0.0	)		2,931		0.3
		(42,943	)	(14.9	)		(44,495	)	(16.2	)		(134,889	)	(15.6	)		(141,215	)	(16.9	)
Loss before income taxes		(17,568	)	(6.1	)		(21,966	)	(7.9	)		(63,298	)	(7.3	)%		(68,456	)	(8.2	)
Income tax provision		(807	)	(0.3	)		(569	)	(0.2	)		(7,845	)	(0.9	)		(3,044	)	(0.4	)
Net loss		(18,375	)	(6.4	)		(22,535	)	(8.1	)		(71,143	)	(8.2	)		(71,500	)	(8.6	)
Net income attributable to noncontrolling interests		(113	)	(0.0	)		(27	)	(0.0	)		(523	)	(0.1	)		(614	)	(0.1	)
Net loss attributable to DJO Finance LLC	$	(18,488	)	(6.4	)%	$	(22,562	)	(8.1	)%	$	(71,666	)	(8.3	)%	$	(72,114	)	(8.7	)%

(1) Cost of sales is exclusive of amortization of intangible assets of $8,809 and $26,368 for the three and nine months ended September 28, 2013, respectively, and $9,837 and $29,513 for the three and nine months ended September 29, 2012, respectively.

39

Three Months Ended September 28, 2013 (third quarter 2013) compared to Three Months Ended September 29, 2012 (third quarter 2012)

Net Sales. Net sales for third quarter 2013 were $288.0 million, representing a 5.1% increase from net sales of $274.0 million for third quarter 2012. In constant currency, excluding a favorable impact of $1.2 million related to changes in foreign exchange rates in effect in third quarter 2013 compared to the rates in effect in third quarter 2012, net sales increased by $12.9 million, or 4.7%, to $286.9 million for third quarter 2013 from $274.0 million for third quarter 2012.

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

	Third Quarter 2013		% of Net Sales			Third Quarter 2012		% of Net Sales			Increase (Decrease)			% Increase (Decrease)
Bracing and Vascular	$	120,947		42.0	%	$	111,951		40.9	%	$	8,996			8.0	%
Recovery Sciences		76,654		26.6			80,167		29.2			(3,513	)		(4.4	)
Surgical Implant		20,025		7.0			17,197		6.3			2,828			16.4
International		70,423		24.4			64,671		23.6			5,752			8.9
	$	288,049		100.0	%	$	273,986		100.0	%	$	14,063			5.1	%

Net sales in our Bracing and Vascular segment were $120.9 million for third quarter 2013, increasing 8.0% from net sales of $112.0 million for third quarter 2012. Growth in net sales in this segment is being driven by sales of new products as well as increased sales of existing products.

Net sales in our Recovery Sciences segment were $76.7 million for third quarter 2013, decreasing 4.4% from net sales of $80.2 million for third quarter 2012. The decrease was primarily driven by changes in reimbursement for certain products in our Empi business unit and slow market conditions for capital equipment sold by our Chattanooga business unit.

Net sales in our Surgical Implant segment were $20.0 million for third quarter 2013, increasing 16.4% from net sales of $17.2 million for third quarter 2012. The increase was driven primarily by strong sales of new products and improved sales execution.

Net sales in our International segment were $70.4 million for third quarter 2013, increasing 8.9% from net sales of $64.7 million for third quarter 2012. In constant currency, excluding a favorable impact of $1.2 million related to changes in foreign exchange rates in effect in third quarter 2013 compared to the rates in effect in third quarter 2012, net sales for third quarter 2013 for the International segment increased 7.0% compared to net sales for third quarter 2012. Growth in net sales in this segment is being driven by sales from new products, improved sales execution and increased sales penetration in certain geographies.

Gross Profit. Consolidated gross profit as a percentage of net sales was 59.0% for third quarter 2013, compared to 60.5% for third quarter 2012. The decrease in gross profit as a percentage of net sales is primarily due to a lower margin mix of products sold, higher inventory reserve provisions and the impact of the medical device excise tax, which became effective on January 1, 2013.

Gross profit in our Bracing and Vascular segment as a percentage of net sales was 51.0% for third quarter 2013, compared to 51.9% for third quarter 2012. The decrease was primarily due to a lower margin mix of products sold.

Gross profit in our Recovery Sciences segment as a percentage of net sales was 74.7% for third quarter 2013, compared to 75.9% for third quarter 2012. The decrease was primarily due to a lower margin mix of products sold and higher inventory write offs.

Gross profit in our Surgical Implant segment as a percentage of net sales decreased to 69.5% for third quarter 2013, compared to 73.7% for third quarter 2012. The decrease was primarily driven by the impact of the medical device excise tax, which became effective on January 1, 2013.

Gross profit in our International segment as a percentage of net sales decreased to 53.7% for third quarter 2013, from 53.8% for third quarter 2012. The decrease was primarily driven by a lower margin mix of products sold.

Selling, General and Administrative (SG&A). SG&A increased to $112.6 million for third quarter 2013, from $110.7 million for third quarter 2012. As a percentage of sales, SG&A expense decreased to 39.1% for third quarter 2013, compared to 40.4% for third quarter 2012.

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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):

	Third Quarter 2013		Third Quarter 2012
Integration charges:
Commercial and global business unit reorganization and integration	$	864	$	1,429
Acquisition related expenses and integration		433		192
CFO transition		1,386		—
Litigation and regulatory costs and settlements, net		223		1,920
Other non-recurring items		160		1,511
Automation projects		1,754		723
	$	4,820	$	5,775

Research and Development (R&D). R&D expense was $8.0 million and $7.9 million for third quarter 2013 and third quarter 2012, respectively. As a percentage of sales, R&D expense decreased slightly to 2.8% in third quarter 2013 from 2.9% in third quarter 2012.

Amortization of Intangible Assets. Amortization of intangible assets was $23.9 million and $24.5 million for third quarter 2013 and third quarter 2012, respectively. The decrease is due to certain intangible assets reaching full amortization, partially offset by an increase in intangible assets resulting from our 2012 acquisition of Exos.

Interest Expense. Interest expense was $43.8 million and $46.4 million for third quarter 2013 and third quarter 2012, respectively. The decrease is due to lower weighted average interest rates on outstanding borrowings.

Other Income. Other income was $0.9 million and $1.9 million for third quarter 2013 and third quarter 2012, respectively. Results for both periods were primarily associated with net realized and unrealized foreign currency transaction gains.

Income Tax Provision. For third quarter 2013, we recorded income tax expense of $0.8 million on pre-tax losses of $17.6 million, resulting in a negative effective tax rate of 4.6%. For third quarter 2012, we recorded income tax expense of $0.6 million, on pre-tax losses of $22.0 million, resulting in a negative effective tax rate of 2.6%. Our effective tax rates are negative primarily due to valuation allowances provided against U.S federal and state deferred tax assets beginning in the first quarter of 2012. 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.

Nine Months Ended September 28, 2013 (nine months 2013) compared to Nine Months Ended September 29, 2012 (nine months 2012)

Net Sales. Net sales for nine months 2013 were $861.9 million, representing a 2.7% increase from net sales of $838.9 million for nine months 2012. In constant currency, excluding a favorable impact of $1.9 million related to changes in foreign exchange rates in effect in nine months 2013 compared to the rates in effect in nine months 2012, net sales increased by $21.1 million, or 2.5%, to $860.0 million for nine months 2013 from $838.9 million for nine months 2012.

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

	Nine Months 2013		% of Net Sales			Nine Months 2012		% of Net Sales			Increase (Decrease)			% Increase (Decrease)
Bracing and Vascular	$	348,455		40.4	%	$	331,189		39.5	%	$	17,266			5.2	%
Recovery Sciences		229,413		26.6			247,902		29.6			(18,489	)		(7.5	)
Surgical Implant		62,890		7.3			53,170		6.3			9,720			18.3
International		221,113		25.7			206,649		24.6			14,464			7.0
	$	861,871		100.0	%	$	838,910		100.0	%	$	22,961			2.7	%

Net sales in our Bracing and Vascular segment were $348.5 million for nine months 2013, increasing 5.2% from net sales of $331.2 million for nine months 2012. Growth in net sales in this segment is being driven by sales of new products as well as increased sales of existing products.

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Net sales in our Recovery Sciences segment were $229.4 million for nine months 2013, decreasing 7.5% from net sales of $247.9 million for nine months 2012. The decrease was primarily driven by changes in reimbursement for certain products in our Empi business unit and slow market conditions for capital equipment sold by our Chattanooga business.

Net sales in our Surgical Implant segment were $62.9 million for nine months 2013, increasing 18.3% from net sales of $53.2 million for nine months 2012. The increase was driven primarily by strong sales of new products and improved sales execution.

Net sales in our International segment were $221.1 million for nine months 2013, increasing 7.0% from net sales of $206.7 million for nine months 2012. In constant currency, excluding a favorable impact of $1.9 million related to changes in foreign exchange rates in effect in nine months 2013 compared to the rates in effect in nine months 2012, net sales for nine months 2013 for the International segment increased 6.1% compared to net sales for nine months 2012. Growth in net sales in this segment is being driven by sales from new products, improved sales execution and increased sales penetration in certain geographies.

Gross Profit. Consolidated gross profit as a percentage of net sales was 59.8% for nine months 2013, compared to 60.9% for nine months 2012. The decrease in gross profit as a percentage of net sales is primarily due to a lower margin mix of products sold, higher inventory reserve provisions and the impact of the medical device excise tax, which became effective on January 1, 2013

Gross profit in our Bracing and Vascular segment as a percentage of net sales was 51.2% for nine months 2013, compared to 51.8% for nine months 2012. The decrease was primarily due to a lower margin mix of products sold.

Gross profit in our Recovery Sciences segment as a percentage of net sales was 75.0% for nine months 2013, compared to 75.3% for nine months 2012. The decrease was primarily due to a lower margin mix of products sold and higher inventory write offs.

Gross profit in our Surgical Implant segment as a percentage of net sales decreased to 71.6% for nine months 2013, compared to 75.0% for nine months 2012. The decrease was primarily driven by the impact of the medical device excise tax, which became effective on January 1, 2013.

Gross profit in our International segment as a percentage of net sales remained consistent at 55.5% for nine months 2013 and 2012.

Selling, General and Administrative (SG&A). SG&A increased to $348.2 million for nine months 2013, from $342.6 million for nine months 2012. As a percentage of sales, SG&A expense remained fairly consistent at 40.4% for nine months 2013, compared to 40.8% for nine months 2012.

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):

	Nine Months 2013		Nine Months 2012
Integration charges:
Commercial and global business unit reorganization and integration	$	2,897	$	4,690
Acquisition related expenses and integration		1,002		771
CEO transition		—		183
CFO transition		1,386		—
Litigation and regulatory costs and settlements, net		4,164		4,745
Other non-recurring items		1,356		3,018
Automation projects		3,375		4,620
	$	14,180	$	18,027

Research and Development (R&D). R&D expense was $23.8 million and $21.7 million for nine months 2013 and nine months 2012, respectively. As a percentage of sales, R&D expense increased to 2.8% in nine months 2013 from 2.6% in nine months 2012, reflecting an increase in our new product development activities, including expenses incurred in 2013 by Exos, which we acquired in December 2012.

Amortization of Intangible Assets. Amortization of intangible assets was $71.6 million and $73.5 million for nine months 2013 and nine months 2012, respectively. The decrease is due to certain intangible assets reaching full amortization partially offset by an increase in intangible assets resulting from our 2012 acquisition of Exos.

Interest Expense. Interest expense was $133.4 million and $134.9 million for nine months 2013 and nine months 2012, respectively. The decrease is due to lower weighted average interest rates on outstanding borrowings.

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Other (Expense) Income, Net. Other (expense) income was $(0.5) million and $2.9 million for nine months 2013 and nine months 2012, respectively. Results for both periods were primarily associated with net realized and unrealized foreign currency transaction gains (losses).

Income Tax Provision. For nine months 2013, we recorded income tax expense of $7.8 million on pre-tax losses of $63.3 million, resulting in a negative effective tax rate of 12.4%. For nine months 2012, we recorded an income tax expense of $3.0 million, on pre-tax losses of $68.5 million, resulting in a negative effective tax rate of 4.4%. Our effective tax rates are negative primarily due to valuation allowances provided against U.S federal and state deferred tax assets beginning in the first quarter of 2012. 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 September 28, 2013, our primary sources of liquidity consisted of cash and cash equivalents totaling $33.5 million and our $100.0 million revolving credit facility, of which $99.5 million was available. Our revolving credit balance was zero at September 28, 2013. We had a $0.5 million letter of credit related to collateral requirements under our product liability insurance policy. Working capital at September 28, 2013 was $207.4 million. We believe that our existing cash, plus the amounts we expect to generate from operations and amounts available through our revolving credit facility, will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures and debt 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 facilities, 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 facilities in the future. We and our subsidiaries, affiliates or significant shareholders (including Blackstone and its affiliates) may from time to time, in our or their sole discretion, purchase, repay, redeem or retire any of our outstanding debt or equity securities (including any publicly issued debt securities), in privately negotiated or open market transactions, by tender offer or otherwise.

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

	Nine Months 2013			Nine Months 2012
Cash provided by operating activities	$	39,203		$	51,303
Cash used in investing activities		(27,429	)		(24,104	)
Cash used in financing activities		(9,697	)		(27,358	)
Effect of exchange rate changes on cash and cash equivalents		226			215
Net increase in cash and cash equivalents	$	2,303		$	56

Cash Flows

Operating activities provided cash of $39.2 million and $51.3 million in nine months 2013 and nine months 2012, respectively, reflecting our net loss adjusted for non-cash expenses and changes in working capital. Cash paid for interest was $109.0 million and $103.4 million in nine months 2013 and nine months 2012, respectively.

Investing activities used $27.4 million and $24.1 million of cash in nine months 2013 and nine months 2012, respectively. Cash used in investing activities for nine months 2013 primarily consisted of $24.0 million for purchases of property and equipment and $2.0 million related to the acquisition of assets from our vascular distributors in Australia and South Africa. Cash used in investing activities for nine months 2012 primarily consisted of $23.4 million of cash for purchases of property and equipment.

Financing activities used $9.7 million of cash for nine months 2013 and $27.4 million of cash for nine months 2012. Cash provided in financing activities in nine months 2013 consisted of proceeds from the borrowings under our revolving credit facility and our senior secured credit facility, offset by payments of the senior secured credit facility. Cash used in financing activities in nine months 2012 consisted of proceeds from the borrowings under our senior secured credit facilities and the 8.75% Notes, offset by payments of the senior secured credit facilities and the 10.875% senior unsecured notes (10.875% Notes) due 2014 and the payment of $25.2 million of debt issuance costs.

For the remainder of 2013, we expect to spend cash of approximately $72.1 million for the following:

• $10.8 million for scheduled principal and estimated interest payments on our senior secured credit facilities;

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

• $13.3 million for capital expenditures.

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Indebtedness

As of September 28, 2013, our total indebtedness was $2,227.7 million, exclusive of net aggregate unamortized original issue discounts of $1.8 million. The principal amount and carrying value of our debt was as follows for September 28, 2013 and December 31, 2012:

	September, 2013				December 31, 2012
	Principal Amount		Carrying Value		Principal Amount		Carrying Value
Senior secured credit facilities:
Revolving credit facility	$	—	$	—	$	3,000	$	3,000
Term loans		857,710		850,172		862,021		853,165
		857,710		850,172		865,021		856,165
Note financing:
8.75% second priority senior secured notes		330,000		335,753		330,000		336,509
9.875% senior unsecured notes		440,000		440,000		440,000		440,000
7.75% senior unsecured notes		300,000		300,000		300,000		300,000
9.75% senior subordinated notes		300,000		300,000		300,000		300,000
		1,370,000		1,375,753		1,370,000		1,376,509
Total indebtedness	$	2,227,710	$	2,225,925	$	2,235,021	$	2,232,674

Senior Secured Credit Facilities.Term loans outstanding under our senior secured credit facilities at September 28, 2013 consist of $857.7 million of term loans which mature on September 15, 2017. Of the $100.0 million total revolving credit facility which matures on March 15, 2017, $99.5 million was available. Our revolving credit balance was zero at September 28, 2013. A $0.5 million letter of credit was outstanding at September 28, 2013 under our credit facility related to collateral requirements under our product liability insurance policy.

The interest rate margins applicable to borrowings under the senior secured revolving credit facilities are, at our option, either (a) the Eurodollar rate, plus 375 basis points or (b) a base rate determined by reference to the highest of (1) the prime rate, (2) the federal funds rate, plus 0.50% and (3) the Eurodollar rate for a one-month interest period, plus, in each case, 375 basis points. The interest rate margins applicable to the tranche B term loans are, at our option, either (a) the Eurodollar rate plus 375 basis points or (b) a base rate plus 375 basis points. There is a minimum LIBOR rate applicable to the Eurodollar component of interest rates on tranche B term loan borrowings of 1.00%. The applicable margin for borrowings under the senior secured revolving credit facilities may be reduced, subject to our attaining certain leverage ratios. As of September 28, 2013, our weighted average interest rate for all borrowings under the senior secured credit facilities was 4.75%.

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

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

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

Certain Covenants and Related Compliance. Pursuant to the terms of the senior secured credit facilities, we are required to maintain a maximum senior secured first lien leverage ratio of consolidated first lien net debt to Adjusted EBITDA of 4.25:1 for the trailing twelve months ended September 28, 2013. Adjusted EBITDA is defined as net income (loss) attributable to DJOFL, plus interest expense, net, income tax (provision) benefit and depreciation and amortization, further adjusted for certain non-cash items, non-recurring items and other adjustment items, as permitted in calculating covenant compliance under our senior secured credit facilities and the Indentures governing our 8.75% Notes, 9.875% Notes, 7.75% Notes and 9.75% Notes (collectively, the Notes). Adjusted EBITDA is a material component of these covenants. As of September 28, 2013, 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 income or other performance measures presented in accordance with GAAP, or as an alternative to cash flow from operations as a measure of our liquidity. Adjusted EBITDA does not represent net income (loss) or cash flow from operations as those terms are defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. In particular, the definition of Adjusted EBITDA in the Indentures and our senior secured credit facilities allows us to add back certain non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net loss. However, these are expenses that may recur, vary greatly and are difficult to predict. While Adjusted EBITDA and similar measures are frequently used as measures of operations and the ability to meet debt service requirements, Adjusted EBITDA is not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation.

Under the Indentures governing the Notes, our ability to incur additional debt, subject to specified exceptions, is tied to either improving the ratio of our Adjusted EBITDA to fixed charges or having this ratio be at least 2.00:1 on a pro forma basis after giving effect to such incurrence. Additionally, our ability to make certain restricted payments is also tied to having an Adjusted EBITDA to fixed charges ratio of at least 2.00:1 on a pro forma basis, as defined, subject to specified exceptions. Our ratio of Adjusted EBITDA to fixed charges for the twelve months ended September 28, 2013, measured on that date, was 1.50:1. Notwithstanding these limitations, the aggregate amount of term loan increases and revolving commitment increases shall not exceed the greater of (i) $150.0 million and (ii) the additional aggregate amount of secured indebtedness which would be permitted to be incurred as of any date of determination (assuming for this purpose that the full amount of any revolving credit increase had been utilized as of such date) such that, after giving pro forma effect to such incurrence (and any other transactions consummated on such date), the senior secured leverage ratio for the immediately preceding test period would not be greater than 4.25:1. 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.

Covenant Compliance

The following is a summary of our covenant requirement ratios as of September 28, 2013:

	Covenant Requirements	Actual Ratios
Senior Secured Credit Facilities:
Maximum ratio of consolidated senior secured first lien debt 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	1.50:1

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

Our ability to meet the covenants specified above will depend on future events, 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 senior secured credit facilities and the Indentures, at which time the lenders could elect to declare all amounts outstanding under our senior secured credit facilities to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.

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The following table provides a reconciliation from our net loss to Adjusted EBITDA for the three and nine months ended September 28, 2013 and September 29, 2012 and the twelve months ended September 28, 2013 (in thousands). The terms and related calculations are defined in the credit agreement relating to our senior secured credit facilities and the Indentures.

	Three Months Ended						Nine Months Ended						Twelve Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012			September 28, 2013
Net loss attributable to DJO Finance LLC	$	(18,488	)	$	(22,562	)	$	(71,666	)	$	(72,114	)	$	(118,702	)
Interest expense, net		43,813			46,365			133,295			134,748			181,401
Income tax provision		807			569			7,845			3,044			(103	)
Depreciation and amortization		32,698			32,170			95,723			96,177			127,005
Non-cash charges (a)		(2,090	)		1,317			(15	)		3,955			6,772
Non-recurring and integration charges (b)		5,857			7,011			17,426			20,987			29,023
Other adjustment items, before adjustments applicable for the twelve month periods only (c)		1,057			33			7,564			12,570			36,395
Adjusted EBITDA before other adjustment items applicable for the twelve month period only														261,791
Other adjustment items applicable for the twelve month period only (d):
Pre-acquisition Adjusted EBITDA														262
Future cost savings related to recent acquisitions														63
Adjusted EBITDA	$	63,654		$	64,903		$	190,172		$	199,367		$	262,116

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

	Three Months Ended					Nine Months Ended					Twelve Months Ended
	September 28, 2013			September 29, 2012		September 28, 2013			September 29, 2012		September 28, 2013
Stock compensation expense	$	291		$	1,310	$	1,544		$	3,563	$	320
Impairment of goodwill and intangible assets		—			—		—			—		7,397
Impairment of fixed assets and assets held for sale		—			—		—			380		595
(Gain) loss on disposal of assets, net		—			7		(1	)		12		18
Purchase accounting adjustments (1)		(2,381	)		—		(1,558	)		—		(1,558	)
Total non-cash charges	$	(2,090	)	$	1,317	$	(15	)	$	3,955	$	6,772

(1) Purchase accounting adjustments for the three months ended September 28, 2013 consist of $0.1 million of amortization of fair market value inventory adjustments, net of $2.5 million in adjustments to the contingent consideration for Exos. Purchase accounting adjustments for the nine and twelve months ended September 28, 2013 consist of $0.9 million of amortization of fair market value inventory adjustments, net of $2.5 million in adjustments to the contingent consideration for Exos.

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

	Three Months Ended				Nine Months Ended				Twelve Months Ended
	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012		September 28, 2013
Integration charges:
Commercial and global business unit reorganization and integration	$	1,517	$	2,070	$	4,256	$	5,423	$	5,858
Acquisition related expenses and integration (1)		470		580		1,708		1,512		3,240
CEO transition		—		—		—		183		—
CFO transition		1,386		—		1,386		—		1,386
Litigation and regulatory costs and settlements, net (2)		340		1,920		4,800		4,745		12,637
Other non-recurring items		390		1,718		1,901		3,763		2,244
Automation projects		1,754		723		3,375		5,361		3,658
Total non-recurring and integration charges	$	5,857	$	7,011	$	17,426	$	20,987	$	29,023

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

(2) For the twelve months ended September 28, 2013, litigation and regulatory costs consisted of $2.8 million of estimated costs to complete a post-market surveillance study required by the FDA related to our discontinued metal-on-metal hip implant products, $4.6 million in litigation costs related to ongoing product liability issues related to our discontinued pain pump products, net of $1.0 million received in an indemnity claim from a third party manufacturer, a $1.3 million judgment related to a French litigation matter on appeal and $4.9 million related to other litigation and regulatory costs and settlements.

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

	Three Months Ended						Nine Months Ended					Twelve Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013		September 29, 2012			September 28, 2013
Blackstone monitoring fees	$	1,750			1,750		$	5,250	$	5,250		$	7,000
Non-controlling interests		114			27			524		613			692
Loss on modification and extinguishment of debt (1)		—			—			1,059		9,398			28,550
Other (2)		(807	)		(1,744	)		731		(2,691	)		153
Total other adjustment items	$	1,057		$	33		$	7,564	$	12,570		$	36,395

(1) Loss on modification and extinguishment of debt for the nine months ending September 28, 2013 consists of $0.9 million in arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.2 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with term loans which were extinguished. Loss on modification and extinguishment of debt for the twelve months ending September 28, 2013 consists of the preceding amounts and $17.2 million in premiums related to the repurchase or redemption of our 10.875% Notes, $12.7 million related to the non-cash write off of unamortized debt issuance costs related to the 10.875% Notes and $0.1 million in legal and other fees, net of $2.5 million related to the non-cash write off of unamortized original issue premium associated with the 10.875% Notes. Loss on modification and extinguishment of debt for the nine months ending September 29, 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 a portion of our 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 include pre-acquisition EBITDA and future cost savings related to the acquisition of Exos Corporation.

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Infrequent Events

In September 2013, a fire occurred at our factory in Tunisia. As a result of the fire, certain inventory and fixed assets were destroyed and the leased facility became inoperable. Estimated losses of $4.4 million related to destroyed inventory and fixed assets, excess expenses incurred and building reconstruction costs have been recorded for the three months ended September 28, 2013. As the recorded losses are recoverable against our property and business interruption insurance policies, we have recorded a corresponding insurance receivable of $4.4 million as of September 28, 2013 to offset the recognized losses.

The facility in Tunisia was used to manufacture products representing approximately $33.0 million in annual revenues of our International segment. We had inventory on hand at our other international locations to fulfill customer orders for the three months ending September 28, 2013. In the fourth quarter of 2013, we expect to open alternative manufacturing sites and use subcontractors to manufacture products to meet customer demand. If we are unable to fulfill certain customer orders due to the fire, we have business interruption insurance coverage, which we currently believe will be sufficient to materially offset future lost profits. Given our operational contingency plans, the finished goods inventory on hand at our other distribution locations and the insurance coverage, we do not currently believe that the fire will have a material impact on our results of operations or ability to service our customers.

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 2012 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 2012 Annual Report on Form 10-K. We believe that the accounting principles utilized in preparing our Unaudited Condensed Consolidated Financial Statements conform in all material respects to GAAP.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest Rate Risk

Our primary exposure is to changing interest rates. We have historically managed our interest rate risk by including components of both fixed and variable debt in our capital structure. For our fixed rate debt, interest rate changes may affect the market value of the debt, but do not impact our earnings or cash flow. Conversely, for our variable rate debt, interest rate changes generally do not affect the fair market value of the debt, but do impact future earnings and cash flow, assuming other factors are constant. As of September 28, 2013, we have $1,370.0 million of aggregate fixed rate notes and $857.7 million of borrowings under the senior secured credit facilities which bear interest at floating rates based on the Eurodollar rate, as defined therein. A hypothetical 100 basis point increase in variable interest rates for the floating rate borrowings under our senior secured credit facilities would have impacted our earnings and cash flow for the nine months ended September 28, 2013 by $1.2 million. As of September 28, 2013, our term loans are subject to a 1.00% minimum LIBOR rate which is higher than the actual LIBOR rate of 0.18% as of September 28, 2013. Accordingly, a hypothetical 100 basis point increase in the LIBOR rate during the nine months ended September 28, 2013 would have increased the rate applicable to our variable debt by only 0.18%. We may use derivative financial instruments where appropriate to manage our interest rate risk. However, as a matter of policy, we do not enter into derivative or other financial investments for trading or speculative purposes.

Foreign Currency Risk

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

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For the three and nine months ended September 28, 2013, sales denominated in foreign currencies accounted for 21.7% and 22.7% of our consolidated net sales, respectively, of which 15.1% and 16.2%, respectively, were denominated in the Euro. In addition, our exposure to fluctuations in foreign currencies arises because certain of our subsidiaries enter into purchase or sale transactions using a currency other than its functional currency. Accordingly, our future results could be materially impacted by changes in foreign exchange rates or other factors. Occasionally, we seek to reduce the potential impact of currency fluctuations on our business through hedging transactions. During the nine months ended September 28, 2013, we utilized MXN foreign exchange forward contracts to hedge a portion of our exposure to fluctuations in foreign exchange rates, as our Mexico-based manufacturing operations incur costs that are largely denominated in MXN (see Note 7 to our Unaudited Condensed Consolidated Financial Statements). These foreign exchange forward contracts expire weekly throughout August 2014.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

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

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

Changes in Internal Control over Financial Reporting

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

Part II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we are plaintiffs or defendants in various litigation matters in the ordinary course of our business, some of which involve claims for damages that are substantial in amount. We believe that the disposition of claims currently pending will not have a material adverse impact on our financial position or results of operations.

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.

Pain Pump Litigation

We are currently named as one of several defendants in a number of product liability lawsuits involving approximately 15 plaintiffs in U.S. cases and a lawsuit in Canada which has been granted class action status for a class of approximately 45 claimants, 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, or less commonly, knee surgeries, has resulted in cartilage damage to the plaintiffs. In the past three years, we have been dismissed from approximately 410 cases when product identification was later established showing that we did not sell the pump in issue. In the past three years, we have entered into settlements with plaintiffs in approximately 110 pain pump lawsuits.

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Cold Therapy Litigation

DJO is named in nine multi-plaintiff lawsuits involving a total of 172 plaintiffs alleging that the plaintiffs had been injured following use of certain cold therapy products manufactured by DJO. The complaints 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. 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. Nine of the plaintiffs included in the cases filed against us have been selected as the first cases to be tried. The first of these “bellwether” cases commenced trial in July 2013, with three other bellwether cases selected for consecutive trials in late 2013 and early 2014. The first bellwether trial ended with a deadlocked jury, resulting in no verdict and declaration of a mistrial. We are engaged in settlement discussions with plaintiffs with the goal of resolving these cases.

State Licensing Subpoena

In July 2013 we were served with a subpoena under HIPAA seeking documents relating to the fitting of custom-fabricated or custom-fitted orthoses in the States of New Jersey, Washington and Texas. The subpoena was issued by the United States Attorney’s Office for the District of New Jersey in connection with an investigation of compliance with professional licensing statutes in those states relating to the practice of orthotics. We are in the process of supplying the documents requested under the subpoena.

California Qui Tam Action

On October 11, 2013, we were served with a summons and complaint related to a qui tam action filed in U.S. District Court in Los Angeles, California in August 2012 and amended in December 2012 that names us as a defendant along with each of the other companies that manufactures and sells external bone growth stimulators for spinal applications. The case is captioned United States of America, et al.ex re. Doris Modglin and Russ Milko, v. DJO Global, Inc., DJO, LLC, DJO Finance LLC, Orthofix, Inc., Biomet, Inc., and EBI, LP., Case No. CV12-7152-MMM (JCGx) (C.D. Cal.). The plaintiffs, or relators, allege that the defendants have violated Federal and state false claim acts by seeking reimbursement for bone growth stimulators for uses outside of the FDA approved indications for use for such product. The plaintiffs are seeking treble the damages alleged to have been sustained by the U.S. and the States, penalties, attorney’s fees and costs. The Federal government and all of the named States have declined to intervene in this case. Although we believe that this lawsuit is without merit, we can make no assurance as to the resources that will be needed to respond to this case or the final outcome of this action.

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, 2012 filed with the SEC on February 28, 2013. There have been no material changes to the risk factors disclosed in such Form 10-K.

ITEM 5. OTHER INFORMATION

Transition of Chief Financial Officer

On September 30, 2013, we announced that Vickie L. Capps, Executive Vice President, Chief Financial Officer and Treasurer, will be leaving the Company at the end of the year to pursue other business opportunities. Pursuant to the Severance Protection Agreement between Ms. Capps and the Company dated March 14, 2011, a copy of which is filed as Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012, Ms. Capps is entitled to receive certain compensation and benefits, including the repurchase of Rollover Options (as defined in the Severance Protection Agreement). On October 28, 2013, Ms. Capps and the Company entered into an Amendment to the Severance Protection Agreement which provides that a total of 131,172 vested options shall not terminate 90 days after termination of her employment and instead shall remain exercisable and continue in effect until the expiration of their original term. As previously reported, the Company is commencing a search for a successor chief financial officer.

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Iran Sanctions Related Disclosure

Under the Iran Threat Reduction and Syria Human Rights Act of 2012 (“ITRSHRA”), which added Section 13(r) of the Exchange Act, we are required to include certain disclosures in our periodic reports if we or any of our “affiliates” knowingly engaged in certain specified activities, transactions or dealings related to Iran or certain designated parties during the period covered by the report. Issuers must also file a notice with the SEC that such activities have been disclosed. We are not presently aware that we or our consolidated subsidiaries have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange Act during the quarter ended September 28, 2013.

Because the SEC defines the term “affiliate” broadly, it includes any entity controlled by us as well as any person or entity that controls us or is under common control with us (“control” is also construed broadly by the SEC). As a result, The Blackstone Group, L.P. (“Blackstone”), an affiliate of our major shareholder, and certain of the companies in which Blackstone’s affiliated funds are invested (“portfolio companies”), may be deemed to be affiliates of ours. Since we filed our quarterly report on Form 10-Q on July 26, 2013, Blackstone and its affiliates have included information in their Quarterly Reports on Form 10-Q regarding activities that require disclosure under the ITRSHR. These disclosures are reproduced in Exhibit 99.1 of this report and are incorporated by reference herein. We have no involvement in or control over such activities, and we have not independently verified or participated in the preparation of the disclosures described in the filing.

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ITEM 6. EXHIBITS

(a)Exhibits

3.1	Certificate of Formation of DJOFL and amendments thereto (incorporated by reference to Exhibit 3.1 to DJOFL’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007).
3.2	Limited Liability Company Agreement of DJOFL (incorporated by reference to Exhibit 3.2 to DJOFL’s Registration Statement on Form S-4, filed April 18, 2007 (File No. 333-142188)).
31.1+	Certification (pursuant to Securities Exchange Act Rule 13a-14a) by Chief Executive Officer.
31.2+	Certification (pursuant to Securities Exchange Act Rule 13a-14a) by Chief Financial Officer.
32.1+	Section 1350—Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) by Chief Executive Officer.
32.2+	Section 1350—Certification (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002) by Chief Financial Officer.
99.1+	Section 13(r) Disclosure—Iran Sanctions.
101+	The following financial information from DJO Finance LLC’s Quarterly Report on Form 10-Q for the quarterly period ended September 28, 2013, formatted in XBRL: (i) the Unaudited Condensed Consolidated Balance Sheets as of September 28, 2013 and December 31, 2012, (ii) the Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 28, 2013 and September 29, 2012, (iii) the Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 28, 2013 and September 29, 2012, (iv) the Unaudited Consolidated Statement of Equity as of September 28, 2013 and December 31, 2012, (v) the Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 28, 2013 and September 29, 2012 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: October 29, 2013	By:	/S/    MICHAEL P. MOGUL
		Michael P. Mogul
		President and Chief Executive Officer
Date: October 29, 2013	By:	/S/    VICKIE L. CAPPS
		Vickie L. Capps
		Executive Vice President, Chief Financial Officer and Treasurer

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