<Page>
Prospectus
dj Orthopedics, LLC
DJ Orthopedics Capital Corporation
12 5/8% Senior Subordinated Notes due 2009
We issued our 12 5/8% Senior Subordinated Notes due 2009 which have been
registered under the Securities Act of 1933 in exchange for our 12 5/8% Senior
Subordinated Notes due 2009 in an exchange offer consummated in December 1999.
Maturity
- The notes will mature on June 15, 2009.
Interest
- Interest on the notes will be payable on June 15 and December 15 of
each year, beginning December 15, 1999.
Redemption
- We may redeem some or all of the notes at any time after June 15, 2004.
- We may also redeem up to $35,000,000 of the notes before June 15, 2002
using the proceeds of certain equity offerings. On November 30, 2001, we
gave notice to the trustee that we would redeem $25,000,000 principal
amount of notes pursuant to this provision on December 31, 2001.
- The redemption prices are described on page 124.
Change of control
- If we experience a change of control, we must offer to purchase the
notes.
Security and ranking
- The notes are unsecured. The notes will be subordinated to all of our
existing and future senior debt, will rank equally with all of our other
senior subordinated debt and will rank senior to all of our future
subordinated debt.
Guarantees
- If we fail to make payments on the notes, our parent company must make
them instead. This guarantee will be a senior subordinated obligation of
our parent company. Our existing subsidiary will not guarantee the notes.
We prepared this prospectus for use by J.P. Morgan Securities, Inc. (JPMSI) in
connection with offers and sales related to market-making transactions of the
notes. JPMSI may act as principal or agent in these transactions. These sales
will be made at prices related to prevailing market prices at the time of sale.
We will not receive any of the proceeds of these sales.
YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS BEGINNING ON PAGE 11 OF THIS
PROSPECTUS IN EVALUATING AN INVESTMENT IN THE NOTES.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is December 21, 2001
<Page>
Table of contents
<Table>
<Caption>
Page
Prospectus summary................... 1
Risk factors......................... 12
Forward-looking statements........... 31
Industry data........................ 32
The reorganization and initial public
offering........................... 32
Use of proceeds...................... 34
Capitalization....................... 35
Selected historical consolidated
financial data..................... 36
Unaudited pro forma consolidated
financial information.............. 39
Management's discussion and analysis
of financial condition and results
of operations...................... 49
</Table>
<Table>
<Caption>
Page
Business............................. 69
Management........................... 94
Principal stockholders............... 107
Related party transactions........... 110
Description of credit facility....... 119
Description of the notes............. 122
Book-entry; delivery and form........ 169
Plan of distribution................. 172
Legal matters........................ 173
Experts.............................. 173
Additional information............... 173
Index to consolidated financial
statements......................... F-1
</Table>
----------------------------------
WE HAVE NOT AUTHORIZED ANYONE TO GIVE YOU ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS ABOUT US OR THE TRANSACTIONS WE DISCUSS IN THIS PROSPECTUS OTHER
THAN THOSE CONTAINED IN THIS PROSPECTUS. IF YOU ARE GIVEN ANY INFORMATION OR
REPRESENTATIONS ABOUT THESE MATTERS THAT IS NOT DISCUSSED IN THIS PROSPECTUS,
YOU MUST NOT RELY ON THAT INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL
OR A SOLICITATION OF AN OFFER TO BUY SECURITIES ANYWHERE OR TO ANYONE WHERE OR
TO WHOM WE ARE NOT PERMITTED TO OFFER OR SELL SECURITIES UNDER APPLICABLE LAW.
THE DELIVERY OF THIS PROSPECTUS DOES NOT, UNDER ANY CIRCUMSTANCES, MEAN THAT
THERE HAS NOT BEEN A CHANGE IN OUR AFFAIRS SINCE THE DATE OF THIS PROSPECTUS. IT
ALSO DOES NOT MEAN THAT THE INFORMATION IN THIS PROSPECTUS IS CORRECT AFTER THIS
DATE.
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Prospectus summary
This summary highlights selected information contained elsewhere in this
prospectus. You should read the entire prospectus, including "Risk factors" and
the financial statements contained herein, carefully before making an investment
decision. Unless otherwise indicated, the information contained in this
prospectus gives effect to the initial public offering by our parent company, dj
Orthopedics, Inc., the successor to DonJoy, L.L.C., and the transactions
described herein under the heading "The reorganization and initial public
offering."
The financial data included in this prospectus comes from the financial
statements of DonJoy, L.L.C. which, effective November 20, 2001, merged with and
into dj Orthopedics, Inc. DonJoy, L.L.C. was, and dj Orthopedics, Inc. is, a
guarantor of the notes and of our bank borrowings. DonJoy, L.L.C. did not have,
and dj Orthopedics, Inc. does not have, any material assets or operations other
than its ownership of 100% of the equity interests of dj Orthopedics, LLC. As a
result, the consolidated financial position and results of operations of DonJoy,
L.L.C. are, and the consolidated financial position and results of operations of
dj Orthopedics, Inc. will be, substantially the same as dj Orthopedics, LLC. No
financial information of DJ Orthopedics Capital Corporation, the co-issuer of
the notes, is included in this prospectus because management believes such
information would not be material given DJ Capitals' lack of assets and
activities.
OUR BUSINESS
We are a global orthopedic sports medicine company specializing in the design,
manufacture and marketing of surgical and non-surgical products and services
that repair, regenerate and rehabilitate soft tissue and bone, help protect
against injury, and treat osteoarthritis of the knee. Our broad range of over
600 existing products, many of which are based on proprietary technologies,
includes rigid knee braces, soft goods, specialty and other complementary
orthopedic products and our recently introduced line of surgical products. These
products provide solutions for patients and orthopedic sports medicine
professionals throughout the patient's continuum of care.
We sell our products in over 44 countries, primarily under the
DonJoy-Registered Trademark- and ProCare-Registered Trademark- brand names, each
of which has achieved a high level of brand name recognition within the
orthopedic sports medicine market. Our surgical products are marketed under the
Alaron Surgical-TM- brand name. Numerous professional and amateur athletes,
including participants in the NFL, NBA and NCAA, and members of the U.S. Ski and
Snowboard Teams of which we are a sponsor, choose to use our products. We
believe that our strong relationships with orthopedic sports medicine
professionals, leading market positions, strong brand names, reputation for
quality, broad product lines, established distribution networks and commitment
to research and development provide significant opportunities to grow revenues
and earnings. For 2000 and the first nine months of 2001, our net revenues were
$143.6 million and $127.4 million, respectively, our EBITDA was $28.9 million
and $24.8 million, respectively, and our net income, adjusted to give effect to
the tax effects of the reorganization of our parent into corporate form, would
have been $3.3 million and $2.7 million, respectively.
THE ORTHOPEDIC SPORTS MEDICINE MARKET
The orthopedic products industry generated estimated worldwide sales of
$13.1 billion in 2000. We estimate that the segments of the orthopedic sports
medicine market that we are targeting accounted for over $3 billion of these
sales. The orthopedic sports medicine market encompasses a broad range of
product segments addressing the repair, regeneration and rehabilitation of soft
tissue and bone and the
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treatment of osteoarthritis. This market is served by over 5,000 orthopedic
surgeons in the United States who cite sports medicine as an area of
concentration and practice focus. In addition, we believe that outside the
United States another approximately 5,000 orthopedic surgeons are actively
engaged in orthopedic sports medicine.
The repair segment of the orthopedic sports medicine market includes
reconstructive implants, joint replacements, fracture fixation and arthroscopy
and soft tissue repair products. The regeneration segment includes bone growth
stimulation and orthobiologic materials, which are used to replace damaged or
diseased bone and soft tissue and to stimulate natural growth. The
rehabilitation segment includes braces and supports for the knee, ankle, back
and upper extremities and specialty and other complementary orthopedic products.
We estimate that the portions of the repair, regeneration and rehabilitation
segments that we target represent approximately 60%, 10%, and 30% of the
orthopedic sports medicine market, based on worldwide sales in 2000. We believe
revenues in the U.S. orthopedic sports medicine market grew at a rate of 7% to
9% in 1999 and 2000 and that they will continue to grow at a similar rate for
the next several years.
PRODUCTS
Our product lines support a range of treatments throughout the orthopedic
patient's continuum of care. Our products include rigid knee braces and other
specialty products, which are generally prescribed for use after surgery and
during and after rehabilitation, and soft goods, which are generally used after
injury, whether or not surgery is contemplated. These products are also used to
reduce the risk of new and repeat injuries. In addition, Alaron Surgical-TM-
products address the repair stage of the patient's continuum of care. In the
future, we plan to pursue the development of an additional line of products for
the regeneration of bone and soft tissue, including a bone growth stimulator and
a cartilage regeneration product.
REHABILITATION
- RIGID KNEE BRACES. Our rigid knee braces include ligament braces, which
provide support for knee ligament instabilities, post-operative braces,
which provide both knee immobilization and a protected range of motion,
and osteoarthritic braces, which provide relief of knee pain due to
osteoarthritis. These technologically advanced products are generally
prescribed by orthopedic sports medicine surgeons.
- SOFT GOODS. Our soft goods products, most of which are constructed from
fabric or neoprene materials, provide support and/or heat retention and
compression of the knee, ankle, back and upper extremities, including the
shoulder, elbow, neck and wrist.
- SPECIALTY AND OTHER COMPLEMENTARY ORTHOPEDIC PRODUCTS. Our portfolio of
specialty and other complementary orthopedic products includes two
post-surgery systems: a continuous cold therapy system to assist in the
reduction of pain and swelling and a pain management delivery system that
employs ambulatory infusion pumps for the delivery of local anesthetic to
the surgical site. Also included within this product category are lower
extremity walkers, which are an alternative to lower extremity casting,
and upper extremity shoulder and arm braces and slings.
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REPAIR
- SURGICAL PRODUCTS. Our recently introduced Alaron Surgical-TM- products
are used to repair soft tissue and cartilage. Products used during ACL
reconstruction include surgical screws made from a next-generation
composite bioabsorbable material, titanium surgical screws, hamstring
graft anchors designed to reduce surgical procedure time and a suture
fixation device that allows the surgeon to adjust the tension of the
graft. We have also introduced a cartilage repair system used for
transplanting the patient's own healthy knee cartilage into damaged areas
of the knee joint. We recently received FDA clearance to market an
adjustable high tibial osteotomy plate used to surgically realign, and
reduce pain in, the osteoarthritic knee.
REGENERATION
- BONE AND CARTILAGE GROWTH STIMULATION. Our bone growth stimulator is
undergoing the regulatory approval process. The bone growth stimulator
utilizes electromagnetic field technology to aid in healing fractures and,
unlike competitors' products, is intended to be worn by patients
continuously as part of a bracing or cast system. Our cartilage
regeneration product is in an early stage of development.
STRATEGIC OBJECTIVES
Our strategic objectives are to strengthen our leadership position in the
orthopedic sports medicine market and to increase our revenues and
profitability. We plan to do this by:
- expanding existing and developing new relationships with orthopedic
sports medicine surgeons and their allied health care professionals;
- applying our research and development expertise to introduce new
products and product enhancements;
- capitalizing on the breadth and market focus of the sales
representatives in our U.S. distribution networks and their experience
with the higher margin products we have and will introduce;
- growing international revenues and profits through the selective
replacement of our third-party distributors with direct representation in
key countries;
- increasing margins by capitalizing on the recent investments in our
infrastructure and operating efficiencies; and
- pursuing strategic growth opportunities by acquiring or licensing
complementary products and technologies.
CORPORATE INFORMATION AND BACKGROUND
dj Orthopedics, LLC is a Delaware limited liability company formed in March 1999
and is a wholly-owned subisidiary of dj Orthopedics, Inc., the successor to
DonJoy, L.L.C., a Delaware limited liability company formed in December 1998
which acquired the assets and certain liabilities of the Bracing and Support
Systems division of Smith & Nephew, Inc. DJ Orthopedics Capital Corporation
(DJ Capital), a wholly owned subsidiary of dj Orthopedics, LLC, is a Delaware
corporation formed in March 1999 to serve as a co-issuer of the notes.
dj Orthopedics, Inc., was incorporated in Delaware on August 16, 2001 and became
our parent company on November 20, 2001. See "The reorganization and initial
public offering."
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Our principal executive offices are located at 2985 Scott Street, Vista,
California 92083 and our telephone number is 800-336-5690. Our website is
located at www.djortho.com. Information contained on our website does not
constitute a part of this prospectus.
We are the successor to a corporation established in December 1982 as
DonJoy, Inc. which was acquired in 1987 by Smith & Nephew, Inc. (Smith &
Nephew), a wholly-owned subsidiary of Smith & Nephew plc., a United Kingdom
company. Effective December 29, 1998, Smith & Nephew contributed our net assets
and shares of our Mexican subsidiary to DonJoy, L.L.C. and became its sole
member. On June 30, 1999, DonJoy, L.L.C. consummated a recapitalization pursuant
to which J.P. Morgan DJ Partners, LLC, formerly Chase DJ Partners LLC (JPMDJ
Partners), obtained a controlling interest in DonJoy, L.L.C.
DONJOY-REGISTERED TRADEMARK-, PROCARE-REGISTERED TRADEMARK-, ALARON
SURGICAL-TM-, TIMAX-TM-, DEFIANCE-REGISTERED TRADEMARK-,
GOLDPOINT-REGISTERED TRADEMARK-, MONARCH-REGISTERED TRADEMARK-,
ROCKETSOC-REGISTERED TRADEMARK-, ICEMAN-REGISTERED TRADEMARK-, AIR
DONJOY-REGISTERED TRADEMARK-, QUADRANT-REGISTERED TRADEMARK-, LEGEND-TM-,
TROM-TM-, OPAL-TM-, 4TITUDE-REGISTERED TRADEMARK-, OADJUSTER-TM-,
OFFICECARE-REGISTERED TRADEMARK-, ORTHOTECH-TM-,
PLAYMAKER-REGISTERED TRADEMARK-, KNEE GUARANTEE-TM-, DONJOY VISTA-TM-,
DRYTEX-REGISTERED TRADEMARK-, NEVER STOP GETTING BETTER-TM-, IROM-TM-, ELS-TM-,
DJ ORTHO-REGISTERED TRADEMARK-, MC WALKER-REGISTERED TRADEMARK-,
MONTANA-REGISTERED TRADEMARK-, NEXTEP-TM-, PROSTEP-TM-, REHAB
3-REGISTERED TRADEMARK-, ULTRA-4-TM-, ULTRASLING-REGISTERED TRADEMARK-,
COMFORTFORM-TM-, SURROUND-REGISTERED TRADEMARK-, ENDOLOK-TM-, DURAFIX-TM-,
ENDOLOK TPS-TM-, TWISTER-TM- AND WALKABOUT-TM- ARE CERTAIN OF OUR REGISTERED
TRADEMARKS AND TRADEMARKS FOR WHICH WE HAVE APPLICATIONS PENDING OR COMMON LAW
RIGHTS. PAINBUSTER-REGISTERED TRADEMARK- IS A REGISTERED TRADEMARK OF I-FLOW
CORPORATION. ONTRACK-REGISTERED TRADEMARK- IS A REGISTERED TRADEMARK OF ORTHO
RX, INC. ORTHOPULSE-TM- IS A TRADEMARK OF I.M.D., B.V. AIR-GEL-TM- ANKLE IS A
TRADEMARK OF NORTHEAST EMS. BILOK-TM- IS A TRADEMARK OF BIOCOMPOSITES, LTD.
4
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Summary of the terms of the notes
<Table>
Issuers..................... dj Orthopedics, LLC and DJ Orthopedics Capital Corporation.
Notes outstanding........... $100,000,000 aggregate principal amount of 12 5/8% Senior
Subordinated Notes due 2009. The notes were issued in
exchange for $100,000,000 aggregate principal amount of
12 5/8% Senior Subordinated Notes (the old notes) pursuant
to an exchange offer effected December 1999.
Maturity.................... June 15, 2009.
Interest.................... Annual rate: 12 5/8%.
Payment frequency: every six months on June 15 and
December 15.
Optional redemption......... On and after June 15, 2004, we may redeem some or all of the
notes at the redemption prices listed in the section
entitled "Description of the notes--optional redemption."
Prior to such date, we may not redeem the notes, except as
described in the following paragraph.
At any time prior to June 15, 2002, we may redeem up to 35%
of the original aggregate principal amount of the notes with
the net cash proceeds of certain equity offerings at a
redemption price equal to 112.625% of the principal amount
thereof, plus accrued interest, so long as (a) at least 65%
of the original aggregate amount of the notes remains
outstanding after each such redemption and (b) any such
redemption by us is made within 90 days of such equity
offering. On November 30, 2001, we gave notice to the
trustee that we would redeem $25 million aggregate principal
amount of the notes on December 31, 2001 pursuant to this
provision with a portion of the net cash proceeds received
by our parent and contributed by it to us from the initial
public offering of common stock of our parent company.
Change of control........... Upon the occurrence of a change of control, unless we have
exercised our right to redeem all of the notes as described
above, you will have the right to require us to repurchase
all or a portion of your notes at a purchase price in cash
equal to 101% of the principal amount thereof, plus accrued
interest to the date of repurchase. See "Description of the
notes--change of control."
Guarantees.................. The notes are fully and unconditionally guaranteed on an
unsecured senior subordinated basis by dj Orthopedics, Inc.
and certain of our future subsidiaries. None of our current
subsidiaries guarantee the notes. If we fail to make
payments on the notes, dj Orthopedics, Inc. and our future
subsidiaries that are guarantors, if any, must make them
instead.
Our foreign subsidiaries, currently our only subsidiaries
besides DJ Capital, do not guarantee the notes. As of
September 29, 2001, the aggregate amount of the liabilities
of our foreign subsidiaries as reflected on our balance
sheet was $1.1 million and such subsidiaries accounted for
less than 1% of our assets.
Guarantees of the notes are subordinated to the guarantees
of our senior indebtedness under our credit facility issued
by dj Orthopedics, Inc. and certain of our future
subsidiaries.
</Table>
5
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<Table>
Ranking..................... The notes are unsecured and:
- subordinate to all of our existing and future senior debt;
- rank equally with all of our other future senior
subordinated debt;
- rank senior to all of our future subordinated debt;
- effectively subordinated to our secured indebtedness to
the extent of the value of the assets securing such
indebtedness; and
- effectively subordinated to all liabilities of our foreign
subsidiaries and any other future subsidiary which does not
guarantee the notes.
Similarly, the guarantees of the notes by dj Orthopedics,
Inc. and our future guarantor subsidiaries, if any, will be
unsecured and:
- subordinate to all of the applicable guarantor's existing
and future senior debt;
- rank equally with all of the applicable guarantor's other
future senior subordinated debt;
- rank senior to all of the applicable guarantor's future
subordinated debt; and,
- effectively subordinated to any secured indebtedness of
such guarantor to the extent of the value of the assets
securing such indebtedness.
After giving effect to the reorganization of our parent and
the consummation by our parent of its initial public
offering and the application of the proceeds thereof, as of
September 29, 2001 on a pro forma basis:
- we had $37.4 million of senior debt to which the notes
were subordinated (which amount does not include
$25.0 million available under the revolving credit portion
of our credit facility);
- dj Orthopedics, Inc. and DJ Capital had no senior debt
(other than their respective guarantees of our indebtedness
under our credit facility);
- we and DJ Capital did not have any senior subordinated
debt other than the notes, and dj Orthopedics, Inc. did not
have any senior subordinated debt other than its guarantee
on the notes;
- we and dj Orthopedics, Inc. did not have had any
subordinated debt; and
- our foreign subsidiaries, which are not a guarantor of the
notes, had $1.1 million of liabilities as reflected on our
balance sheet.
</Table>
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<Table>
As of the date of this prospectus, the indenture relating to
the notes would permit us to incur additional senior
indebtedness if we satisfy certain ratio tests.
Certain covenants........... The indenture, among other things, restricts our ability and
the ability of our subsidiaries to:
- borrow money;
- make distributions, redeem equity interests or redeem
subordinated debt;
- make investments;
- use assets as security in other transactions;
- sell assets;
- guarantee other indebtedness;
- enter into agreements that restrict dividends from
subsidiaries;
- merge or consolidate; and
- enter into transactions with affiliates.
These covenants are subject to a number of important
exceptions. For more details, see "Description of the
notes--certain covenants."
</Table>
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Summary historical and pro forma financial data
The following table presents summary historical and pro forma consolidated
financial data of DonJoy, L.L.C. Prior to the reorganization described under
"The reorganization and initial public offering," DonJoy, L.L.C. was, and as a
result of the reorganization, dj Orthopedics, Inc. is, a guarantor of the notes
and of our credit facility. DonJoy, L.L.C. did not have, and dj Orthopedic, Inc.
does not have, any material assets or operations other than its ownership of
100% of the equity interests of dj Orthopedics, LLC. As a result, the
consolidated financial position and results of operations of DonJoy, L.L.C. are,
and the consolidated financial position and results of operations of dj
Orthopedics, Inc. will be, substantially the same as ours. The summary
historical consolidated financial data at December 31, 1999 and 2000 and for the
three years ended December 31, 2000 come from DonJoy, L.L.C.'s audited
consolidated financial statements included elsewhere in this prospectus. The
summary historical financial data at December 31, 1998 comes from DonJoy,
L.L.C.'s audited consolidated financial statements which are not included in
this prospectus. The summary historical financial data at September 29, 2001 and
for the nine months ended September 29, 2001 and September 30, 2000 have been
derived from DonJoy, L.L.C.'s unaudited consolidated financial statements
included elsewhere in this prospectus. These unaudited financial statements
include, in the opinion of our management, all adjustments, consisting of only
normal recurring adjustments, necessary to present fairly the data for such
periods. The results of operations for interim periods are not necessarily
indicative of operating results for the full year.
The pro forma consolidated statement of income data for the year ended
December 31, 2000 gives effect to our July 2000 acquisition of a portion of the
assets of DePuy Orthopaedic Technology, Inc., a subsidiary of Johnson & Johnson,
the reorganization and the initial public offering of common stock of dj
Orthopedics, Inc. as if they had occurred on January 1, 2000. In this
prospectus, we refer to that acquisition as the Orthotech acquisition. The pro
forma consolidated statement of income data for the nine months ended
September 29, 2001 gives effect to the reorganization and the initial public
offering of common stock of dj Orthopedics, Inc. as if they had occurred on
January 1, 2000. The pro forma consolidated balance sheet data at September 29,
2001 gives effect to the reorganization and the initial public offering of the
common stock of dj Orthopedics, Inc. as if they had occurred on September 29,
2001. The summary pro forma financial data does not purport to represent what
our financial position or results of operations would have been if the Orthotech
acquisition, the reorganization and the initial public offering of the common
stock of dj Orthopedics, Inc. and the application of the proceeds thereof had
been completed as of the dates indicated, nor do such data purport to represent
our financial position or results of operations for any future date or period.
We urge you to read the financial data set forth below together with our
historical consolidated financial statements and the information included under
"Selected historical consolidated financial data," "Unaudited pro forma
consolidated financial information" and "Management's discussion and analysis of
financial condition and results of operations," all of which are included
elsewhere in this prospectus.
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<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------
Historical Pro forma
----------------------------------------------------------- ---------------------------
Nine months ended Nine
Years ended December 31, ----------------------------- Year ended months ended
(In thousands except ---------------------------- September 30, September 29, December 31, September 29,
per share data) 1998 1999 2000 2000 2001 2000 2001
- --------------------------------------------------------------------------------------------------------------
Statement of income
data:
Net revenues... $103,643 $116,418 $143,586 $ 102,186 $ 127,361 $ 165,858 $ 127,361
Cost of goods
sold(a)... 46,466 51,744 60,178 43,050 53,856 71,400 53,856
----------------------------------------------------------------------------------------
Gross profit... 57,177 64,674 83,408 59,136 73,505 94,458 73,505
Operating
expenses(a):
Sales and
marketing... 27,633 28,902 38,653 26,751 35,661 44,309 35,661
General and
administrative... 16,484 16,755 19,761 14,529 18,270 22,896 18,270
Research and
development... 2,248 2,115 2,465 1,678 1,813 2,711 1,813
Merger and
integration
costs(b).. -- -- 400 400 -- 400 --
Restructuring
costs(c)... 2,467 -- -- -- -- -- --
----------------------------------------------------------------------------------------
Total
operating
expenses... 48,832 47,772 61,279 43,358 55,744 70,316 55,744
----------------------------------------------------------------------------------------
Income from
operations... 8,345 16,902 22,129 15,778 17,761 24,142 17,761
Interest
expense... -- (7,568) (16,958) (12,245) (13,701) (14,733) (10,136)
Interest income... -- 181 437 348 230 437 230
Discontinued
acquisition
costs... -- -- (449) -- -- (449) --
----------------------------------------------------------------------------------------
Income before
income taxes... 8,345 9,515 5,159 3,881 4,290 9,397 7,855
Provision for
income
taxes(d)... 3,394 2,387 -- -- -- 3,477 2,906
----------------------------------------------------------------------------------------
Net income... 4,951 7,128 5,159 3,881 4,290 5,920 4,949
Less: Preferred
unit dividends
and accretion of
preferred unit
fees... N/A (2,343) (5,415) (3,908) (4,738) -- --
----------------------------------------------------------------------------------------
Net income (loss)
available to
members/stockholders............. N/A $ 4,785 $ (256) $ (27) $ (448) $ 5,920(e)(g) $ 4,949(e)(g)
----------------------------------------------------------------------------------------
Pro forma net
income (loss)... $ (2,165)(f) $ (2,035)(f)
----------------------------------------------------------------------------------------
Pro forma net
income (loss)
per share:
Basic... $ (0.25)(f) $ (0.22)(f) $ 0.36(g) $ 0.29(g)
----------------------------------------------------------------------------------------
Diluted... $ (0.25)(f) $ (0.22)(f) $ 0.35(g) $ 0.28(g)
----------------------------------------------------------------------------------------
Pro forma weighted
average shares
outstanding:
Basic... 8,631(f) 9,465(f) 16,431(g) 17,265(g)
----------------------------------------------------------------------------------------
Diluted... 8,631(f) 9,465(f) 17,044(g) 17,955(g)
- --------------------------------------------------------------------------------------------------------------
</Table>
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<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------------------
Historical
----------------------------------------------------
Nine months
ended
Years ended December 31, September 29,
------------------------------ -------------------
(in thousands except per share data) 1998 1999 2000 2000 2001
- ------------------------------------------------------------------------------------------------------------------
Other data:
EBITDA(h)................................................. $15,665 $21,854 $ 28,894 $ 20,805 $ 24,762
Adjusted EBITDA(i)........................................ 21,957 25,082 29,162 21,073 24,762
Depreciation and amortization............................. 4,853 4,952 6,365 4,627 7,001
Capital expenditures and acquired intangibles............. 4,149 4,706 7,722 4,635 5,641
Cash interest expense..................................... N/A 6,530 15,716 8,167 9,853
Ratio of earnings to fixed charges(j)..................... 8.84x 2.12x 1.29x 1.30x 1.29x
Ratio of Adjusted EBITDA to cash interest expense......... N/A 3.84x 1.86x 2.58x 2.51x
Ratio of total debt to Adjusted EBITDA.................... N/A 4.52x 5.40x 7.09x 6.03x
Cash flows provided by (used in):
Operating activities...................................... $ 3,748 $16,065 $ 1,229 $ 5,758 $ 3,537
Investing activities...................................... (4,049) (4,776) (57,015) (54,551) (6,984)
Financing activities...................................... 200 (6,171) 53,965 46,410 1,395
==================================================================================================================
</Table>
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------------
Historical Pro forma
---------------------------------------------------- -----------------
At December 31,
-------------------------------- At September 29, At September 29,
(dollars in thousands) 1998 1999 2000 2001 2001
- ---------------------------------------------------------------------------------------------------------------------------
Balance sheet data:
Cash and cash equivalents...................... $ 809 $ 5,927 $ 4,106 $ 1,886 $ 32,418
Working capital................................ 15,625 27,413 38,695 45,406 78,613
Total assets................................... 77,056 89,416 155,672 164,924 249,084
Long-term obligations.......................... -- 113,305 157,222 149,418 111,215(k)
Redeemable preferred units of DonJoy, L.L.C.... -- 32,539 41,660 46,610 --
Total equity (deficit)......................... $12,832 $(70,429) $(63,625) $ (55,098) $ 116,550
===========================================================================================================================
</Table>
N/A Not applicable.
Notes to summary historical and pro forma financial data
(a) 1998 and 1999 historical amounts include various charges and overhead
allocations from Smith & Nephew. See note (i) below.
(b) We recorded merger and integration costs in 2000 associated with the
consolidation of the Orthotech operations into our existing facilities including
merger integration and information systems consulting.
(c) We recorded restructuring costs in 1998 relating to the consolidation of our
operations at our Vista, California facility. See note 10 of the notes to
DonJoy, L.L.C.'s consolidated financial statements, and "Management's discussion
and analysis of financial condition and results of
operations--Overview--Manufacturing cost reduction initiatives".
(d) Because DonJoy, L.L.C. operated as a limited liability company from the date
of its recapitalization in June 1999 through November 20, 2001, the date the
reorganization was consummated, in accordance with federal, state and local
income tax regulations which provide that no income taxes are levied on U.S.
limited liability companies and each member of DonJoy, L.L.C. was individually
responsible for reporting the member's share of our net income or loss, we have
not provided for income taxes in our historical consolidated financial
statements.
(e) The pro forma statements of income do not reflect: (a) the deferred tax
asset benefit of $54,794 for the difference between the book and the tax basis
of DonJoy, L.L.C.'s assets, and (b) an extraordinary charge (net of tax) of
$3.3 million for the write-off of unamortized deferred debt issuance costs, debt
discount and prepayment premiums on the redemption of $25.0 million principal
amount of the notes. These amounts will be reflected in dj Orthopedics, Inc.'s
financial statements in the quarter or quarters in which the reorganization, the
repayment of the revolving credit facility and the redemption of the redeemable
preferred units and a portion of the notes occur.
(f) Pro forma net income (loss) gives effect to the conversion of our parent
into a corporation in the reorganization and is provided for comparability
assuming we were a taxable entity for the pro forma periods presented. Pro forma
net income (loss) per share is based on the weighted average shares outstanding
after giving effect to the issuance of 9,063,641 and 10,055,566 shares of common
stock of dj Orthopedics, Inc. in the reorganization as of December 31, 2000 and
September 29, 2001, respectively.
(g) Pro forma net income (loss) gives effect to the conversion of our parent
into a corporation in the reorganization and to the initial public offering of
common stock of dj Orthopedics, Inc. and in 2000 to the Orthotech acquisition
and is provided for comparability assuming we were a taxable entity for the pro
forma periods presented. Pro forma net income (loss) per share is based on the
weighted average shares outstanding after giving effect to the issuance of
9,063,641 and 10,055,566 shares of common stock of dj Orthopedics, Inc. in the
reorganization as of December 31, 2000 and September 29, 2001, respectively, and
7,800,000 shares in the initial public
10
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<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------------
Historical Pro forma
---------------------------------------------------- -----------------
At December 31,
-------------------------------- At September 29, At September 29,
(dollars in thousands) 1998 1999 2000 2001 2001
- ---------------------------------------------------------------------------------------------------------------------------
</Table>
offering. For a description of the method used to compute the weighted average
shares outstanding, see the notes to the unaudited pro forma statements of
income included elsewhere in this prospectus.
(h) EBITDA is defined as income from operations plus restructuring costs, merger
and integration costs and depreciation and amortization. Discontinued
acquisition costs are excluded from income from operations because the charge is
not considered a direct cost of operating the business. EBITDA is not a measure
of performance under generally accepted accounting principles. EBITDA should not
be considered in isolation or as a substitute for net income, cash flows from
operating activities and other income or cash flow statement data prepared in
accordance with generally accepted accounting principles, or as a measure of
profitability or liquidity. However, management has included EBITDA because it
may be used by certain investors to analyze and compare companies on the basis
of operating performance, leverage and liquidity and to determine a company's
ability to service debt. Our definition of EBITDA differs from the definition of
EBITDA under our credit agreement in that our definition of EBITDA excludes
discontinued acquisition costs. Under both the credit agreement definition of
EBITDA and our definition of EBITDA, we were in compliance with all debt
covenants under the credit agreement at September 29, 2001. Our definition of
EBITDA may not be comparable to that of other companies.
(i) Adjusted EBITDA represents EBITDA, as defined above, adjusted to eliminate
those direct charges from Smith & Nephew as well as those allocations of
Smith & Nephew's overhead and other expenses that we have not incurred on a
stand-alone basis. These amounts were charged or allocated to us on the basis of
direct usage where identifiable, with the remainder allocated to us on the basis
of its annual sales or the capital employed by Smith & Nephew in our business.
See note 9 of the notes to our consolidated financial statements. These charges
and allocations include:
(1) charges for brand royalties we paid to Smith & Nephew for use of the
Smith & Nephew trademarks and trade names, which amounts are no longer
paid following the recapitalization since we no longer have the right to
use Smith & Nephew trademarks and trade names;
(2) foreign sales corporation commissions that we paid on sales to
foreign sales corporations established by Smith & Nephew for tax
planning purposes, which amounts are no longer paid following the
recapitalization;
(3) Smith & Nephew overhead allocations for corporate managed accounts
and new business expense and corporate management expense, which were
not incurred or replaced following consummation of the recapitalization;
(4) Smith & Nephew overhead allocations for research and development and
for amounts charged by Smith & Nephew for services provided to us for
finance (risk management, treasury, audit and taxes), human resources
and payroll and legal services;
(5) the incremental adjustment to the carrying value of acquired
inventories associated with the Orthotech acquisition to state them at
fair market value;
and adjusted to include the estimated costs we expected to incur to replace the
services described in note (4) above previously provided by Smith & Nephew. On a
stand-alone basis, we have replaced these services provided by Smith & Nephew
following the recapitalization and we have incurred additional expenses
associated with external auditing and periodic filings with the SEC.
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
Years ended December 31,
------------------------------
(dollars in thousands) 1998 1999 2000
- --------------------------------------------------------------------------------------------
EBITDA.................................................. $15,665 $21,854 $28,894
Brand royalties......................................... 3,249 1,817 --
Foreign sales corporation commissions................... 439 -- --
Amounts eliminated as set forth in note (3) above....... 1,726 979 --
Amounts eliminated as set forth in note (4) above....... 1,678 832 --
Estimated costs to replace Smith & Nephew services...... (800) (400) --
Step-up in inventory.................................... -- -- 268
------------------------------
Adjusted EBITDA......................................... $21,957 $25,082 $29,162
============================================================================================
</Table>
Adjusted EBITDA does not reflect adjustments for Smith & Nephew allocations
for bonus, pension and insurance or payroll taxes and benefits or charges
for direct legal expenses incurred by Smith & Nephew on our behalf, which
costs and expenses we believe we would have incurred in approximately the
same amounts on a stand-alone basis, and are of a nature we have continued
to incur following the recapitalization. Accordingly, no adjustments for
these items have been made. For a more complete description of the
corporate charges and allocations and the services performed by Smith &
Nephew after the recapitalization, see note 9 of the notes to DonJoy,
L.L.C.'s consolidated financial statements, "Management's discussion and
analysis of financial condition and results of
operations--Overview--Smith & Nephew allocations and sales" and "Related
party transactions--Other agreements with Smith & Nephew--Transition
services agreement."
(j) Earnings consist of income before income taxes plus fixed charges. Fixed
charges consist of (i) interest, whether expensed or capitalized,
(ii) amortization of debt issuance costs, whether expensed or capitalized, and
(iii) an allocation of one-third of the rental expense from operating leases
which management considers to be a reasonable approximation of the interest
factor of rental expense.
(k) Reflects the repayment of borrowing under our revolving credit facility. In
addition, reflects the redemption of $25.0 million principal amount of notes for
which we gave irrevocable notice of redemption on November 30, 2001.
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<Page>
Risk factors
In addition to the matters described in this prospectus, you should carefully
consider the specific factors set forth below before making an investment in the
notes.
Risks related to our debt level
Our substantial indebtedness could limit our ability to operate our business,
obtain additional financing, pursue other business opportunities and fulfill our
obligations under the notes.
We are highly leveraged, which means we have a large amount of indebtedness in
relation to our stockholders' equity. The following chart shows certain
important credit statistics and is presented on an historical and pro forma
basis. The pro forma data at September 29, 2001 assumes the reorganization, the
initial public offering by our parent and the application of the proceeds
therefrom had been consummated as of September 29, 2001. The pro forma data with
respect to the ratio of earnings to fixed charges assumes that the Orthotech
acquisition, the reorganization, the initial public offering by our parent and
the application of the proceeds thereof had occurred as of January 1, 2000.
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------
Historical Pro forma
September 29, September 29,
(in thousands) 2001 2001
- ---------------------------------------------------------------------------------------------
Long-term debt.............................................. $ 149,418 $ 111,215
Redeemable preferred units.................................. $ 46,610 $ --
Members' deficit/Stockholders' equity (pro forma)........... $ (55,098) $ 116,550
- ---------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
Year ended Nine months ended
December 31, 2000 September 29, 2001
----------------------- -----------------------
Historical Pro forma Historical Pro Forma
- ---------------------------------------------------------------------------------------------------------------
Ratio of earnings to fixed charges.......................... 1.29x(a) 1.59x 1.29x 1.72x
- ---------------------------------------------------------------------------------------------------------------
</Table>
- ------------------------
(a) Reflects indebtedness incurred to finance the Orthotech acquisition from the
date of acquisition.
We may incur additional indebtedness from time to time to finance acquisitions,
as we did in connection with the Orthotech acquisition, investments or strategic
alliances or capital expenditures or for other purposes subject to the
restrictions contained in our credit facility and the indenture relating to the
notes.
Our high degree of leverage could have negative consequences for us, including
the following:
- our ability to obtain additional financing, if necessary, for working
capital, capital expenditures, acquisitions or other purposes may be
impaired or such financing may not be available on favorable terms;
- we will need a substantial portion of our cash flow to pay the principal
and interest on our indebtedness, including indebtedness that we may incur
in the future;
- payments on our indebtedness will reduce the funds that would otherwise
be available for our operations and future business opportunities;
- a substantial decrease in our net operating cash flows could make it
difficult for us to meet our debt service requirements and force us to
modify our operations;
12
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- we may be more highly leveraged than our competitors, which may place us
at a competitive disadvantage;
- our debt level may make us more vulnerable than our competitors to a
downturn in our business or the economy generally;
- our debt level reduces our flexibility in responding to changing
business and economic conditions;
- some of our debt has a variable rate of interest, which exposes us to
the risk of increased interest rates; and
- there would be a material adverse effect on our business and financial
condition if we are unable to service our indebtedness or obtain
additional financing, as needed.
Our debt agreements certain operating and financial restrictions which may
restrict our business and financing activities.
The operating and financial restrictions and covenants in our credit agreement,
the indenture and any future financing agreements may adversely affect our
ability to finance future operations, meet our capital needs or engage in our
business activities. Currently, our existing debt agreements restrict our
ability to:
- incur additional indebtedness;
- issue redeemable equity interests and preferred equity interests;
- pay dividends or make distributions, repurchase equity interests or make
other restricted payments;
- redeem indebtedness that is subordinated in right of payment to the
notes;
- make capital expenditures;
- create liens;
- enter into certain transactions with affiliates;
- make investments;
- sell assets; or
- enter into mergers or consolidations.
With respect to mergers or acquisitions, our credit agreement and the indenture
governing our senior subordinated notes limit our ability to finance
acquisitions through additional borrowings. In addition, our credit agreement
prohibits us from acquiring assets or the equity of another company without the
consent of the lenders if:
- we acquire less than 100% of the equity of the acquired company, in the
case of an acquisition of equity;
- the assets or entity acquired are in a different line of business from
ours;
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- after giving effect to the acquisition, a pro forma consolidated
leverage ratio and pro forma interest coverage ratio are not satisfied;
and
- the purchase price exceeds $30 million in the case of any one
acquisition or $50 million in the aggregate of which no more than
$10 million may involve acquisitions outside the United States.
The credit agreement also limits investments in joint ventures to an aggregate
limit of $3,000,000, and limits other investments to $1,000,000.
Our credit facility also requires us to satisfy specified financial ratios and
prohibits us from prepaying our other indebtedness (including the notes) while
indebtedness under the credit facility is outstanding. Our ability to comply
with such provisions may be affected by events beyond our control.
Restrictions contained in the indenture and the credit agreement could:
- limit our ability to plan for or react to market conditions or meet
capital needs or otherwise restrict our activities or business plans; and
- adversely affect our ability to finance our operations, acquisitions,
investments or strategic alliances or other capital needs or to engage in
other business activities that would be in our interest.
A breach of any of these covenants, ratios, tests or other restrictions could
result in an event of default under the credit agreement and/or the indenture.
Upon the occurrence of an event of default under the credit agreement, the
lenders could elect to declare all amounts outstanding under the credit
agreement, together with accrued interest, to be immediately due and payable. If
we were unable to repay those amounts, the lenders could proceed against the
collateral granted to them to secure such indebtedness. If the lenders under the
credit agreement accelerate the payment of the indebtedness, there can be no
assurance that our assets would be sufficient to repay in full such indebtedness
and our other indebtedness, including the notes.
We may not have sufficient cash to service our indebtedness.
Our ability to pay principal and interest on the notes and to satisfy our other
obligations will depend upon, among other things:
- our future financial and operating performance, which will be affected
by prevailing economic conditions and financial, business, regulatory and
other factors, many of which are beyond our control; and
- the future availability of borrowings under our revolving credit
facility or any successor facility, the availability of which depends or
may depend on, among other things, our complying with covenants in our
credit facility.
Based on our current and expected levels of operations, we expect that our
operating cash flow and borrowings under the revolving credit facility should be
sufficient for us to meet our operating expenses, to make necessary capital
expenditures and to service our debt requirements as they become due for at
least the next twelve months. However, our operating results and borrowings
under the revolving credit facility may not be sufficient to service our current
and future indebtedness, including the notes. In addition, we may incur
additional indebtedness in order to make acquisitions, investments or strategic
alliances. If we cannot service our indebtedness, we will be forced to take
actions such as reducing or delaying acquisitions, investments, strategic
alliances and/or capital expenditures, selling assets, restructuring or
refinancing our indebtedness (which could include the notes), or seeking
additional
14
<Page>
equity capital or bankruptcy protection. We can not assure you that any of these
remedies can be effected on satisfactory terms, if at all. In addition, the
terms of existing or future debt agreements, including the credit facility and
the indenture, may restrict us from adopting any of these alternatives.
The notes and the guarantee by dj Orthopedics, Inc. are, and guarantees by any
of our future subsidiaries will be, effectively subordinated to all senior debt
of our subsidiaries.
The notes are subordinated in right of payment to the prior payment in full of
all our existing and future senior indebtedness and the guarantee of the notes
by dj Orthopedics, Inc. and any future subsidiaries providing a guarantee of the
notes will be subordinated in right of payment to all senior indebtedness of the
applicable guarantor. The indenture requires each of our domestic subsidiaries
that is formed or acquired in the future to guarantee the notes, unless we
designate the subsidiary as an Unrestricted Subsidiary (as defined in the
indenture). As of September 29, 2001, we had approximately $37.4 million of
senior indebtedness outstanding (excluding $25.0 million available on a pro
forma basis under the revolving credit facility), all of which is secured, and
our parent company had no senior indebtedness outstanding (other than its
guarantee of our borrowings under the credit facility). In addition, the
indenture permits us and our Restricted Subsidiaries (as defined in the
indenture) to incur additional senior indebtedness, including indebtedness under
the credit facility. We or the applicable guarantor may not pay principal,
premium (if any), interest or other amounts on account of the notes or the
guarantee by dj Orthopedics, Inc. or any subsidiary in the event of a payment
default on, or another default that has resulted in the acceleration of, certain
senior indebtedness (including debt under the credit facility) unless such
indebtedness has been paid in full or the default has been cured or waived. In
the event of certain other defaults with respect to certain senior indebtedness,
we or the applicable guarantor may not be permitted to pay any amount on account
of the notes or the guarantee by our parent company or any subsidiary for a
designated period of time. In the event of a bankruptcy, liquidation,
dissolution, reorganization or similar proceeding with respect to us or a
guarantor, our assets or a guarantor's assets, as the case may be, will be
available to pay obligations on the notes or the guarantor's guarantee, as
applicable, only after our senior indebtedness or the senior indebtedness of
that guarantor has been paid in full, and there can be no assurance that there
will be sufficient assets remaining to pay amounts due on all or any of the
notes or any guarantee of the notes.
Our right to receive assets of any subsidiary which is not a guarantor upon the
liquidation or reorganization of that subsidiary (and thus the rights of the
holders of notes to realize any value with respect to those assets) will be
subject to the prior claims of creditors of that subsidiary (including trade
creditors). Accordingly, since our foreign subsidiaries are not a guarantor of
the notes, the notes are effectively subordinated to all liabilities (including
trade payables and contingent liabilities) of our foreign subsidiaries and any
of our future subsidiaries that do not provide a guarantee of the notes except
to the extent that we are recognized as a creditor of such subsidiary. However,
even if we were recognized as a creditor of a subsidiary that does not guarantee
the notes, our claims would still be subordinate to any security interest in the
assets of that subsidiary, and any indebtedness of that subsidiary senior to
that held by us. As of September 29, 2001, the aggregate amount of the
liabilities of our foreign subsidiaries as reflected on our balance sheet was
$1.1 million.
You should not rely on the guarantee by dj Orthopedics, Inc. in the event we
cannot make payments upon the notes.
All of the operations of dj Orthopedics, Inc. are conducted through us and dj
Orthopedics, Inc. has no material assets other than its ownership of 100% of our
equity interests. Accordingly, dj Orthopedics, Inc.'s cash flow and,
consequently, its ability to service debt, including its guarantee of the notes
and
15
<Page>
our credit facility, depends on our operations. As a result, you should not rely
on the guarantee by dj Orthopedics, Inc. for repayment of the notes.
Indebtedness under our credit facility is secured while our obligations under
the notes are not secured and if we default under our senior debt, our senior
lenders can foreclose on the assets we have pledged to secure payment of the
senior debt to your exclusion.
In addition to being contractually subordinated to all existing and future
senior indebtedness, our obligations under the notes (and dj Orthopedics, Inc.'s
obligations under its guarantee) are unsecured while our obligations under the
credit facility (and dj Orthopedics, Inc.'s obligations under its guarantee of
our indebtedness under the credit facility) are secured by a security interest
in substantially all of our assets and the assets of dj Orthopedics, Inc. (which
consist principally of 100% of our equity interests) and each of our existing
and subsequently acquired or organized U.S. and, subject to certain limitations,
non-U.S. subsidiaries, including a pledge of all of the issued and outstanding
equity interests in our existing or subsequently acquired or organized U.S.
subsidiaries and 65% of the equity interests in each of our subsequently
acquired or organized non-U.S. subsidiaries. If we are declared bankrupt or
insolvent or if we default under the credit facility, the lenders could declare
all of the funds borrowed under the credit facility, together with accrued
interest, immediately due and payable. If we were unable to repay that
indebtedness, the lenders could foreclose on our equity interests pledged by
dj Orthopedics, Inc., on the pledged equity interests of our subsidiaries and on
the assets in which they have been granted a security interest, in each case to
your exclusion, even if an event of default exists under the indenture at such
time. Furthermore, if all equity interests of any future subsidiary guarantor
are sold to persons pursuant to an enforcement of the pledge of equity interests
in that subsidiary guarantor for the benefit of the senior lenders, then the
applicable subsidiary guarantor will be released from its guarantee of the notes
automatically and immediately upon such sale.
Our credit agreement requires us to make mandatory payments which could limit
our ability to grow our business.
We are required to make annual mandatory payments of the term loans under the
credit agreement in an amount equal to 50% of our excess cash flow (75% if our
ratio of total debt to EBITDA exceeds 4 to 1). Excess cash flow represents our
net income adjusted for extraordinary gains or losses, depreciation,
amortization and other non-cash charges, changes in working capital, changes in
deferred revenues, payments for capital expenditures, and repayment of
indebtedness. In addition, the term loans are subject to mandatory prepayments
in an amount equal to:
- 100% of the net cash proceeds of equity and debt issuances by us,
dj Orthopedics, Inc. or any of our other subsidiaries; and
- 100% of the net cash proceeds of asset sales or other dispositions of
property by us, dj Orthopedics, Inc. or any of our other subsidiaries,
in each case subject to certain exceptions. If we have to use cash to make our
annual prepayments, we may not have sufficient funds to grow our business to
make acquisitions, enter into joint ventures or make capital expenditures.
We may not have the ability to raise the funds necessary to finance the change
of control offer required by the indenture.
Upon a change of control, we are required to offer to purchase all of the notes
then outstanding at 101% of the principal amount thereof plus accrued interest.
If a change of control were to occur, we
16
<Page>
may not have sufficient funds to pay the purchase price for the outstanding
notes tendered, and we expect that we would require third-party financing.
However, we may not be able to obtain such financing on favorable terms, if at
all. In addition, the credit facility restricts our ability to repurchase the
notes, including pursuant to an offer in connection with a change of control. A
change of control under the indenture may also result in an event of default
under the credit facility and may cause the acceleration of other senior
indebtedness, if any, in which case the subordination provisions of the notes
would require payment in full of the credit facility and any other senior
indebtedness before repurchase of the notes. Our future indebtedness may also
contain restrictions on our ability to repay the notes upon certain events or
transactions that could constitute a change of control under the indenture. The
inability to repay senior indebtedness upon a change of control or to purchase
all of the tendered notes, would each constitute an event of default under the
indenture.
The change of control provision in the indenture will not necessarily afford you
protection in the event of a highly leveraged transaction, including a
reorganization, restructuring, merger or other similar transaction involving us,
that may adversely affect you. Such transaction may not involve a change in
voting power or beneficial ownership, or, even if it does, may not involve a
change of the magnitude required under the definition of change of control in
the indenture to trigger these provision. Except as described under "Description
of the notes--Change of control," the indenture does not contain provisions that
permit the holders of the notes to require us to repurchase or redeem the notes
in the event of a takeover, recapitalization or similar transaction.
Federal and state laws permit a court to void the notes and guarantees under
certain circumstances.
The notes were issued in exchange for the old notes which were issued in June
1999 in connection with the recapitalization of DonJoy, L.L.C. The obligations
we incurred under the indenture and the old notes and the obligations incurred
by DonJoy, L.L.C. under the indenture and its guarantee of the notes and assumed
by dj Orthopedics, Inc. in the reorganization may be subject to review under
federal bankruptcy law or relevant state fraudulent conveyance and similar
statutes in a bankruptcy or reorganization case or lawsuit commenced by or on
behalf of our or our parent's unpaid creditors. Under these laws, if a court
were to find that, at the time we issued the old notes or DonJoy, L.L.C. issued
its guarantee of the old notes we or DonJoy, L.L.C., as the case may be:
- incurred such indebtedness with the intent of hindering, delaying or
defrauding present or future creditors; or
- received less than the reasonably equivalent value or fair consideration
for incurring such indebtedness; and
- were insolvent or rendered insolvent by reason of any of the
recapitalization transactions;
- were engaged or about to engage in a business or transaction for
which our or DonJoy's, L.L.C. assets constituted unreasonably small
capital to carry on our or its business; or
- intended to incur, or did incur, or believed that we or DonJoy,
L.L.C. would incur, debts beyond our or DonJoy's, L.L.C. ability to
pay as they matured or became due;
then, such court might:
- subordinate the notes or our parent's guarantee of the notes to our or
our parent's presently existing or future indebtedness;
17
<Page>
- void the issuance of the notes (in our case) or our parent's guarantee;
or
- take other actions detrimental to holders of the notes.
The measure of insolvency for purposes of the foregoing will vary depending upon
the law of the jurisdiction being applied. However, we or our parent generally
would be considered insolvent at the time we incurred indebtedness under the old
notes or DonJoy, L.L.C. issued its guarantee, as the case may be, if either:
- the fair salable value of our or DonJoy's, L.L.C. assets, as applicable,
were less than the amount required to pay our or DonJoy's, L.L.C. probable
liability on our or its total existing debts and liabilities (including
contingent liabilities) as they become absolute or mature; or
- the sum of our or DonJoy's, L.L.C. debts (including contingent
liabilities) were greater than our or DonJoy's, L.L.C. assets, at fair
valuation.
We cannot predict:
- what standard a court would apply in order to determine whether we or
DonJoy were insolvent as of the date we or DonJoy issued the old notes or
the guarantee, or that regardless of the method of valuation a court would
determine that we or DonJoy were insolvent on that date; or
- whether a court would not determine that the payments constituted
fraudulent transfers on another ground.
In rendering their opinions in connection with the June 1999 recapitalization
transactions, our counsel and counsel to the initial purchaser of the old notes
did not express any opinion as to the applicability of federal bankruptcy or
state fraudulent transfer and conveyance laws.
To the extent a court voids our parent's guarantee as a fraudulent conveyance or
holds it unenforceable for any other reason, holders of the notes would cease to
have any claim in respect of dj Orthopedics, Inc. and would be creditors solely
of us.
Based upon financial and other information available to us, we believe that we
and DonJoy issued the old notes and the guarantee of the old notes for proper
purposes and in good faith and that at the time we and DonJoy issued the old
notes and the guarantee of the old notes, we and DonJoy were not insolvent or
rendered insolvent thereby, had sufficient capital to run our business, and were
able to pay our debts as they mature or become due. In reaching these
conclusions, we relied on various valuations and estimates of future cash flow
that necessarily involve a number of assumptions and choices of methodology.
However, a court may not adopt the assumptions and methodologies we have chosen
or concur with our conclusion as to our solvency.
Additionally, under federal bankruptcy or applicable state insolvency law, if
certain bankruptcy or insolvency proceedings were initiated by or against us or
dj Orthopedics, Inc. within 90 days after any payment by us with respect to the
notes or by dj Orthopedics, Inc. under its guarantee of the notes, or if we or
dj Orthopedics, Inc. anticipated becoming insolvent at the time of such payment,
all or a portion of such payment could be avoided as a preferential transfer and
the recipient of such payment could be required to return such payment.
In the event there are any subsidiary guarantors in the future, the foregoing
would apply to their guarantees.
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Risks related to our business
If we cannot successfully implement our business strategy, our business, results
of operations and potential for growth will be adversely effected.
Our ability to achieve our business objectives is subject to a variety of
factors, many of which are beyond our control. For example, our business
strategy contemplates that existing customers for some of our current products
will buy new products from us in the future and that we can sell our products to
more orthopedic sports medicine professionals than we do now. Similarly, we
believe our revenues will increase with the aging of the general population and
as individuals engage in increasingly active lifestyles. Our business strategy
further contemplates a growth in international sales through the development of
direct distribution capabilities in a number of foreign jurisdictions. If our
assumptions regarding these trends prove to be incorrect, we may not be
successful in implementing our strategy. In addition, the implementation of our
strategy may not improve our operating results. We may decide to alter or
discontinue aspects of our business strategy and may adopt alternative or
additional strategies due to business or competitive factors or factors not
currently foreseen, such as the introduction of new products by our competitors
and new medical technologies that would make our products obsolete. Any failure
to successfully implement our business strategy may adversely affect our
business, results of operations and potential for growth.
We have limited experience in designing, manufacturing and marketing products
for the repair and regeneration segments of the orthopedic sports medicine
market and the failure of our products for these segments to achieve acceptance
by orthopedic sports medicine surgeons would adversely affect our ability to
enter these new markets and grow our business.
Historically, our principal focus has been the market for orthopedic
rehabilitation products. Prior to commencing sales of the first six of our
Alaron Surgical-TM- products on August 1, 2001, we had limited experience in the
market for orthopedic repair products. We have never sold any products for the
regeneration segment of the orthopedic sports medicine market, although we are
currently undergoing FDA review of the OrthoPulse-TM- bone growth stimulator for
which we will have exclusive North American distribution rights. We cannot
assure you that our existing Alaron Surgical-TM- products or, if FDA approval is
obtained, the OrthoPulse-TM- bone growth stimulator or any additional repair or
regeneration products that we may introduce in the future will achieve wide
acceptance by orthopedic sports medicine surgeons. In addition, the repair and
regeneration segments of the orthopedic sports medicine market may have
different competitive characteristics from those we have experienced in the
market for our rehabilitation products. If our repair and regeneration products
do not receive market acceptance by orthopedic sports medicine surgeons, our
ability to successfully grow our business will be materially and adversely
affected. In addition, our quarterly operating results could be adversely
affected if we are not able to introduce new products for these markets in a
timely manner due to delays in receiving FDA approval or otherwise.
If we are not able to develop or license and market new products or product
enhancements we will not remain competitive.
Our future success and the ability to grow our revenues and earnings require the
continued development or licensing of new products and the enhancement of our
existing products. We may not be able to:
- continue to develop successful new products and enhance existing
products;
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- obtain required regulatory clearances and approvals for such products;
- market such products in a commercially viable manner; or
- gain market acceptance for such products.
Our failure to develop or license and market new products and product
enhancements could have a material adverse effect on our business, financial
condition and results of operations.
In addition, our competitors may develop new medical procedures, technologies or
products that are more effective than ours or that would render our technology
or products obsolete or uncompetitive, which could have a material adverse
effect on us. For example, the development and use of joint lubricants to treat
osteoarthritis in the knee may prove to be an effective alternative to the use
of our osteoarthritic braces. Additionally, we expect the development of
surgical products to be more costly and entail greater development time than we
have experienced with rehabilitation products, such as knee braces, and soft
goods.
Our transition to direct distribution of our products in selected foreign
countries could adversely affect our revenues and income in these countries.
Our strategy to selectively replace our third party international distributors
with wholly or partially owned distributorships may adversely affect our revenue
and net income in those countries. We are currently selling products in Germany,
our largest foreign market, the United Kingdom and Austria, which together
aggregated $6.5 million in 2000 and represented 36% of our 2000 international
sales and 5% of total sales, through an independent third party distributor. On
May 18, 2001, we notified that distributor that we will not renew the
distributor arrangement at the end of its current term on December 31, 2001.
Accordingly, commencing January 1, 2002, we will need to have fully implemented
a direct distribution capability in these countries. We cannot assure you that
our direct distribution capabilities will be fully implemented by that date.
Additionally, this distributor has the right to return to us the remainder of
our products then in its inventory. In the case of products that are in their
original packaging, correctly numbered and labeled and less than one year old,
we must pay the distributor the full invoiced price, plus duty and freight. In
the case of all other products, we will pay a price to be agreed upon at the
time. This distributor typically carries approximately one month of purchases
from us in its ending inventory balance, which as of the date of termination of
December 31, 2001 at our cost is estimated to be approximately $0.3 million. As
a result, we will not record revenues on sales to this distributor in the fourth
quarter 2001, unless the products are sold by the distributor to third party end
users. Therefore, the financial impact to us for any returns is expected to be
nominal. This distributor will remain in those markets as an experienced
competitor and may take actions designed to limit or undercut our ability to
sell our products or otherwise restrict our ability to successfully operate in
those countries. Such actions could include discounting sales of our products in
those countries prior to December 31, 2001 and replacement products beginning
January 1, 2002, the effect of which could make it harder for us to sell our
products in those countries beginning January 1, 2002 for a period of time.
Accordingly, our transition to direct distribution in Germany, the United
Kingdom and Austria could have a material adverse effect on our revenues and
earnings in those countries during the fourth quarter of this year and at least
through the first six months of next year. To the extent that we decide to
replace our independent distributors in other countries, we may experience
similar disruptions to our business in those countries. Moreover, we have no
experience in managing a large international operation and the creation of
direct distribution capabilities in Germany, the United Kingdom and
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Austria and other selected foreign countries will require changes in our
organization and the implementation of additional financial and operational
controls.
We rely heavily on our relationships with orthopedic professionals, agents and
distributors for marketing our products and our failure to maintain these
relationships would adversely effect our business and operating results.
The sales of our rigid knee braces and our recently introduced line of surgical
products depend to a significant extent on the prescription and/or
recommendation of such products by orthopedic sports medicine surgeons and other
sports medicine professionals. Sales of our rigid knee braces represented
approximately 41.8% of our net revenues and approximately 49.9% of our gross
profit in 2000 excluding freight revenue and other cost of goods sold not
allocable to segments. We have developed and maintain close relationships with a
number of widely recognized orthopedic sports medicine surgeons and sports
medicine specialists who assist in product research, development and marketing.
These professionals often become product champions, speaking about our products
at medical seminars, assisting in the training of other professionals in the use
and/or fitting of our products and providing us with feedback on the industry's
acceptance of our new products. The failure of our existing rigid knee braces
and surgical products to retain the support of those surgeons and specialists,
or the failure of our new rigid knee braces, new bone growth stimulator product,
OrthoPulse-TM-, and new surgical products to secure and retain similar support
from leading surgeons and specialists, could have a material adverse effect on
our business, financial condition and results of operations.
Our marketing success in the United States also depends largely upon marketing
arrangements with independent agents and distributors. Our success depends upon
our agents' and distributors' sales and service expertise and their
relationships with the customers in the marketplace. Our failure to maintain
relationships with agents and distributors could have a material adverse effect
on our business, financial condition and results of operations.
If the technology license and distribution agreements relating to some of our
key products, including our new surgical products, were terminated, we would not
be able to sell those products, which would adversely affect our business,
results of operations and prospects for future growth.
We have distribution rights to certain of our products that are manufactured by
others and hold licenses from third parties to utilize selected patents, patents
pending and technology utilized in the design of some of our existing products
and products under development, including the IceMan-Registered Trademark-
device, the DonJoy Vista-TM- Rehabilitation System, the
PainBuster-Registered Trademark- Pain Management Systems and our new ACL
surgical screws. We also license OrthoPulse-TM-, which will be subject to
premarket approval review by the FDA. The revenues from these distribution
agreements and licenses represented less than 7% of our net revenues for each of
the year ended December 31, 2000 and 6% of our net revenues for the nine months
ended September 29, 2001. However, if any of the distribution agreements were
terminated or if we lost any of these licenses, we would not be able to
manufacture and/or sell the related products, which could have an adverse effect
on our future business, financial condition and results of operations. In
particular, the loss of the licenses relating to our new ACL surgical screws
would significantly limit our ability to grow our Alaron Surgical-TM- division.
Similarly, the loss of our license for OrthoPulse-TM- would significantly impair
our ability to enter the regeneration market and to grow our revenues in this
area in the future.
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We intend to pursue, but may not be able to identify, finance or successfully
complete strategic growth opportunities.
One element of our growth strategy is to pursue acquisitions, such as our
Orthotech and Alaron acquisitions, as well as investments and strategic
alliances that either expand or complement our business. We may not be able to
identify acceptable opportunities, complete any additional acquisitions,
investments or strategic alliances, or license products or technologies on
favorable terms or in a timely manner. Acquisitions and, to a lesser extent,
investments and strategic alliances involve a number of risks, several of which
impacted our business in connection with our Orthotech acquisition, including:
- the diversion of our management's attention from our existing business
while evaluating acquisitions, and thereafter while assimilating the
operations and personnel of the new business;
- adverse short-term effects on our operating results;
- the inability to successfully and rapidly integrate the new businesses,
personnel and products with our existing business, including financial
reporting, management and information technology systems;
- higher than anticipated costs of integration;
- unforeseen operating difficulties and expenditures;
- the need to manage a significantly larger business;
- the lack of prior experience in new markets or countries we may enter;
- loss of employees of an acquired business, including employees who may
have been instrumental to the success or growth of that business; and
- the use of a substantial amount of our available cash to consummate the
acquisition.
In addition, as was required in connection with the Orthotech acquisition, we
may require additional debt or equity financing for future acquisitions,
investments or strategic alliances. Such financing may not be available on
favorable terms, if at all. We may not be able to successfully integrate or
operate profitably any new business we acquire and we cannot assure you that any
other investments we make, or strategic alliances we enter into, will be
successful.
Our international sales may be adversely affected by foreign currency exchange
fluctuations and other risks.
Excluding freight revenue, sales in foreign markets, primarily Europe, Canada
and Japan, represented approximately 13% of our net revenues for the year ended
December 31, 2000 and 12% for the nine months ended September 29, 2001, with
Germany and Austria together representing approximately 31% and 42% of
international net revenues in 2000 and the first nine months of 2001,
respectively. Since our international sales have historically been denominated
in U.S. dollars, our operating results have not been directly impacted by
foreign currency exchange fluctuations. However, the volume and product mix of
our international sales has been and may continue to be adversely impacted by
foreign currency exchange fluctuations as changes in the rate of exchange
between the U.S. dollar and the applicable foreign currency affect the cost of
our products to our foreign customers and thus may impact the overall level of
customer purchases or result in the customer purchasing less expensive, lower
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margin products. In addition, as we begin to directly distribute our products in
selected foreign markets, we expect that future sales of our products in these
markets will be denominated in the applicable foreign currencies which would
cause currency fluctuations to more directly impact our operating results.
We are also subject to other risks inherent in international operations
including, foreign regulatory requirements relating to healthcare reimbursement,
exposure to different legal requirements and standards governing the
introduction or distribution of medical devices, potential difficulties in
protecting our intellectual property in foreign jurisdictions where intellectual
property protection laws may not be as developed as in the United States, import
and export restrictions, increased costs of transportation or shipping,
difficulties in staffing and managing international operations, labor disputes,
difficulties in collecting accounts receivable, longer collection periods and
potentially adverse tax consequences. As we continue to expand our international
business, our success will be dependent, in part, on our ability to anticipate
and effectively manage these risks. These factors may have a material adverse
effect on our international operations or on our business, financial condition
and results of operations.
We operate in a very competitive business environment.
The orthopedic sports medicine market is highly competitive and fragmented. Our
competitors include a few large, diversified general orthopedic products
companies and numerous smaller niche companies. Some of our competitors are part
of corporate groups that have significantly greater financial, marketing and
other resources than we do. Accordingly, we may be at a competitive disadvantage
with respect to these competitors. Our primary competitors in the rigid knee
brace product line include Bledsoe Brace Systems (a division of Medical
Technology, Inc.), Breg, Inc., Generation II USA, Inc., Innovation Sports
Incorporated and Townsend Industries Inc. Our competitors in the soft goods
products segment include DeRoyal Industries, Tecnol Orthopedics (a division of
Encore Medical Corporation) and Zimmer Holdings, Inc. Our competitors in the
surgical products market include Arthrex, Inc., Biomet, Inc., Johnson & Johnson,
Linvatec (a division of Conmed), Smith & Nephew and Stryker, Inc. We compete
with a variety of manufacturers of specialty and other complementary orthopedic
products, depending on the type of product. In addition, in certain foreign
countries, we compete with one or more local competitors such as Bauerfeind in
Germany and FGP in Italy. As competition in any of these markets becomes
stronger, we may not realize profit margins at the same rate as today.
Our quarterly operating results are subject to substantial fluctuations and you
should not rely on them as an indication of our future results.
Our quarterly operating results may vary significantly due to a combination of
factors, many of which are beyond our control. These factors include:
- demand for our products, which historically has been higher in the first
and fourth quarters when scholastic sports and ski injuries are more
frequent;
- our ability to meet the demand for our products;
- our transition to direct distribution of our products in foreign
countries such as Germany and the United Kingdom;
- the number, timing and significance of new products and product
introductions and enhancements by us and our competitors, including delays
in obtaining government review and clearance of medical devices;
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- our ability to develop, introduce and market new and enhanced versions
of our products on a timely basis;
- changes in pricing policies by us and our competitors and reimbursement
rates by third party payors, including government health care agencies;
- changes in the treatment practices of orthopedic sports medicine
surgeons and their allied health care professionals; and
- the timing of significant orders and shipments.
Accordingly, we believe that our quarterly sales and operating results may vary
significantly in the future and that period-to-period comparisons of our results
of operations may not be meaningful and should not be relied upon as indications
of future performance. We cannot assure you that our sales will increase or be
sustained in future periods or that we will be profitable in any future period.
We rely on a supplier in China for a portion of our finished soft goods
products, which makes us susceptible to supply shortages of these products.
Some of our important suppliers are in China and other parts of Asia. We obtain
approximately 10% of our total purchased materials from a supplier in China
providing us predominately finished soft goods products. Political and economic
instability and changes in government regulations in these areas could affect
our ability to continue to receive materials from our suppliers there. The loss
of our supplier in China or any other interruption or delay in the supply of our
required materials or our inability to obtain these materials at acceptable
prices and within a reasonable amount of time could impair our ability to meet
scheduled product deliveries to our customers and could hurt our reputation and
cause customers to cancel orders.
Our results of operations and financial condition could be adversely affected if
a product liability claim is brought against us and we do not have adequate
insurance.
The manufacturing and marketing of our products entails risks of product
liability and from time to time we have been subject to product liability
claims. In the future, we may be subject to additional product liability claims,
which may have a negative impact on our business. Our existing product liability
insurance coverage may be inadequate to protect us from any liabilities we might
incur. If a product liability claim or series of claims is brought against us
for uninsured liabilities or in excess of our insurance coverage, our business
could suffer. In addition, as a result of a product liability claim, we may have
to recall some of our products, which could result in significant costs to us.
In addition, our entry into the surgical products market may increase our
exposure to product liability claims in the future. This year we introduced the
Knee Guarantee-TM- program, in relation to our Defiance-Registered Trademark-
knee brace. The Knee Guarantee-TM- will, in specified instances, cover a
patient's insurance deductible up to $1,000, or give uninsured patients $1,000,
towards surgery should an ACL re-injury occur while wearing the brace. We have
not yet had any claims under this program, but we cannot be certain that we will
not have claims under it in the future.
Our lack of manufacturing operations outside the United States may cause our
products to be less competitive in international markets.
We currently have no manufacturing operations in any foreign country other than
Mexico. The cost of transporting our products to foreign countries is currently
borne by our customers, who are also often required to pay foreign import duties
on our products. As a result, the cost of our products to
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customers who use or distribute them outside the United States is often greater
than products manufactured in that country. In addition, foreign manufacturers
of competitive products often receive various local tax concessions which lower
their overall manufacturing costs. In order to compete successfully in
international markets, we may be required to open or acquire manufacturing
operations abroad, which would be costly to implement and would increase our
exposure to the risks of doing business in international countries. We may not
be able to successfully operate off-shore manufacturing operations, which could
have a material adverse effect on our international operations or on our
business, financial condition and results of operations.
We may be adversely affected if we lose any member of our senior management.
We are dependent on the continued services of our senior management team,
including Leslie H. Cross, our President and Chief Executive Officer, Cyril
Talbot III, our Senior Vice President, Finance and Chief Financial Officer,
Michael R. McBrayer, our Senior Vice President, Professional Relations and
Business Development and Paul K. Nichols, our Senior Vice President, Global
Sales and Marketing. These executives have substantial experience and expertise
in our business and have made significant contributions to our growth and
success. Mr. Cross, Mr. Talbot and Mr. McBrayer are the key management personnel
who led our 1999 recapitalization and transition from ownership by Smith &
Nephew to a stand-alone company. Mr. Nichols, who became the principal executive
of our new surgical products division when we acquired Alaron Technologies, has
significant experience in the orthopedic surgical industry. The loss of one or
more of these key personnel could have a material adverse effect on us.
If a natural or man-made disaster strikes our manufacturing facilities, we will
be unable to manufacture our products for a substantial amount of time and our
sales will decline.
We have relied to date solely on our manufacturing facilities in Vista,
California and Tijuana, Mexico. These facilities and the manufacturing equipment
we use to produce our products would be difficult to replace and could require
substantial lead-time to repair or replace. Our facilities may be affected by
natural or man-made disasters. If one of our facilities were affected by a
disaster, we would be forced to rely on third-party manufacturers or shift
production to another manufacturing facility. Although we believe we possess
adequate insurance for damage to our property and the disruption of our business
from casualties, such insurance may not be sufficient to cover all of our
potential losses and may not continue to be available to us on acceptable terms,
or at all.
Risks related to government regulation
Our failure to receive regulatory clearance or approval for our products or
operations in the United States or abroad would adversely affect our revenues
and potential for future growth.
Our products and operations are subject to extensive regulation in the United
States by the Food and Drug Administration. The FDA regulates the research,
testing, manufacturing, safety, labeling, storage, recordkeeping, promotion,
distribution, and production of medical devices in the United States to ensure
that medical products distributed domestically are safe and effective for their
intended uses. In particular, in order for us to market selected products for
clinical use in the United States, we generally must first obtain clearance from
the FDA, pursuant to Section 510(k) of the Federal Food, Drug and Cosmetic Act
(FFDCA). Clearance under Section 510(k) requires demonstration that a new device
is substantially equivalent to another legally marketed device. In addition, if
we develop products in the future that are not considered to be substantially
equivalent to a legally marketed device, we will be required to obtain FDA
approval by submitting a premarket approval application (PMA). All of our
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currently manufactured products hold the relevant exemption or premarket
clearance under the FFDCA. However, OrthoPulse-TM-, a bone growth stimulation
product under development will undergo PMA review. We anticipate that the
OrthoPulse-TM- PMA submission will be submitted to the FDA by the end of 2001.
Failure to obtain FDA clearance or approvals of new products we develop in the
future, any limitations imposed by the FDA on new product development or use, or
the costs of obtaining FDA clearance or approvals could have a material adverse
effect on our business, financial condition and results of operations.
In addition to clearance or approval requirements, our medical device products
are subject to other rigorous FDA regulatory requirements, including the Quality
System Regulation (QSR) recordkeeping regulations, labeling requirements and
adverse event reporting regulations. Failure to comply with applicable FDA
medical device regulatory requirements could result in, among other things,
warning letters, fines, injunctions, civil penalties, repairs, replacements,
refunds, recalls or seizures of products, total or partial suspension of
production, the FDA's refusal to grant future premarket clearances or approvals,
withdrawals or suspensions of current product applications, and criminal
prosecution. Any of these actions, in combination or alone, could have a
material adverse effect on our business, financial condition, and results of
operations.
In many of the foreign countries in which we market our products, we are subject
to regulations affecting, among other things, product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. Many of the regulations applicable to our devices
and products in such countries are similar to those of the FDA, including those
in Germany, our largest foreign market. In addition, in many countries the
national health or social security organizations require our products to be
qualified before they can be marketed with the benefit of reimbursement
eligibility. Failure to receive, or delays in the receipt of, relevant foreign
qualifications could also have a material adverse effect on our business,
financial condition, and results of operations. Due to the movement towards
harmonization of standards in the European Union, we expect a changing
regulatory environment in Europe characterized by a shift from a
country-by-country regulatory system to a European Union wide single regulatory
system. The timing of this harmonization and its effect on us cannot currently
be predicted. Any such developments could have a material adverse effect on our
business, financial condition and results of operations.
Changes in reimbursement policies for our products by third party payors or
reductions in reimbursement rates for our products could adversely affect our
business and results of operations.
The ability of orthopedic sports medicine surgeons and their allied health care
professionals (or persons to whom they sell our products) to receive
reimbursement for the cost of our products from private third party payors and,
to a lesser extent, Medicare, Medicaid and other governmental programs, is
important to our business.
Congress and certain state legislatures are considering reforms in the health
care industry that may modify reimbursement practices, including controls on
health care spending through limitations on the growth of Medicare and Medicaid
spending. In addition to extensive existing government healthcare regulation,
there are numerous initiatives at the federal and state levels for comprehensive
reforms affecting the payment for and availability of healthcare products and
services, including some proposals that would significantly limit reimbursement
under Medicare and Medicaid. It is not clear at this time what proposals, if
any, will be adopted or, if adopted, what effect these proposals would have on
our business.
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Private health insurance plans generally establish their coverage and
reimbursement policies after Medicare policies are enacted. If enacted,
Congressional or regulatory measures that reduce Medicare reimbursement rates
could cause private health insurance plans to reduce their reimbursement rates
for our products, which could have an adverse effect on our ability to sell our
products or cause our orthopedic professional customers to use less expensive
products introduced by us and our competitors.
Failure by users of our products to obtain sufficient reimbursement from third
party payors for our products or adverse changes in governmental and private
payors' policies toward reimbursement for our products could have a material
adverse effect on our business, financial condition and results of operations.
We cannot assure you that third party reimbursement for our products will
continue to be available or at what rate such products will be reimbursed.
Similar to our domestic business, our success in international markets also
depends upon the eligibility of our products for reimbursement through
government sponsored health care payment systems and third party payors,
particularly in Europe and Japan, our principal international markets.
Reimbursement practices vary significantly by country, with certain countries,
most notably France, requiring products to undergo a lengthy regulatory review
in order to be eligible for reimbursement. In addition, health care cost
containment efforts similar to those we face in the United States are prevalent
in many of the foreign countries in which our products are sold and these
efforts are expected to continue. For example, in Germany, our largest foreign
market, which in 2000 represented approximately 31% of international sales,
exclusive of freight revenue, reimbursement by government sponsored health care
payment systems for some categories of our products was decreased in 1997. Under
the current formula, the German government reimburses 80% of the cost of the
affected products and patients bear the remaining 20% of the cost. In Italy, our
rigid knee bracing products and cold therapy systems, among others, are no
longer eligible for reimbursement. In the United Kingdom, while reimbursement
for our products through the National Health Service (NHS), is currently
available, the cost of our products is not reimbursed by private health
insurance plans and orthopedic professionals are being pressured by the NHS to
reduce or eliminate the number of rigid knee braces prescribed for orthopedic
patients. Any developments in our foreign markets that eliminate or reduce
reimbursement rates for our products could have an adverse effect on our ability
to sell our products or cause our orthopedic professional customers to use less
expensive products, which could have a material adverse effect on our results of
operations.
Healthcare reform, managed care and buying groups have put downward pressure on
the prices of our products.
Within the United States, health care reform and managed care are changing the
dynamics of the health care industry in response to the need to control rising
health care costs. As a result of health care reform, the U.S. health care
industry has seen a rapid expansion of managed care at the expense of
traditional private insurance. The development of managed care programs in which
the providers contract to provide comprehensive health care to a patient
population at a fixed cost per person (referred to as capitation) has put
pressure on, and is expected to continue to lead, health care providers to lower
costs. The advent of managed care has also resulted in greater attention to the
tradeoff between patient need and product cost, so-called demand matching, where
patients are evaluated as to age, need for mobility and other parameters and are
then matched with an orthopedic product that is cost effective in light of such
evaluation. One result of demand matching has been, and is expected to continue
to be, a shift toward lower priced products, and any such shift in our product
mix to lower margin, off-the-shelf products could have an adverse impact on our
operating results. For example, in
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our rigid knee bracing segment, we and many of our competitors are offering
lower priced, off-the-shelf products in response to managed care.
A further result of managed care and the related pressure on costs has been the
advent of buying groups in the United States. Such buying groups enter into
preferred supplier arrangements with one or more manufacturers of orthopedic or
other medical products in return for price discounts. The extent to which such
buying groups are able to obtain compliance by their members with such preferred
supplier agreements varies considerably depending on the particular buying
groups. In response to the organization of new buying groups, we have entered
into national contracts with selected groups and believe that the high levels of
product sales to such groups and the opportunity for increased market share have
the potential to offset the financial impact of discounting. We believe that our
ability to maintain our existing arrangements will be important to our future
success and the growth of our revenues. In addition, we may not be able to
obtain new preferred supplier commitments for major buying groups, in which case
we could lose significant potential sales, to the extent these groups are able
to command a high level of compliance by their members. On the other hand, if we
receive preferred supplier commitments from particular groups which do not
deliver high levels of compliance, we may not be able to offset the negative
impact of lower per unit prices or lower margins with any increases in unit
sales or in market share, which could have a material adverse effect on our
business, financial condition and results of operations.
In international markets, where the movement toward health care reform and the
development of managed care are generally not as advanced as in the United
States, we have experienced downward pressure on product pricing and other
effects of health care reform similar to that which we have experienced in the
United States. We expect health care reform and managed care to continue to
develop in our primary international markets, including Europe and Japan, which
we expect will result in further downward pressure in product pricing. The
timing and the effects on us of health care reform and the development of
managed care in international markets cannot currently be predicted.
Proposed laws that would limit the types of orthopedic professionals who can
fit, sell or seek reimbursement for our products could, if adopted, adversely
affect our business and results of operations.
Congress and state legislatures have from time to time, in response to pressure
from certain orthopedic professionals, considered proposals which limit the
types of orthopedic professionals who can fit and/or sell our products or who
can seek reimbursement for our products. In particular, Texas, Florida, New
Jersey, Illinois and Washington have adopted legislation which prohibits the
practice of orthotics and prosthetics, including the measuring, fitting and
adjusting of certain medical devices, without a license. Such laws could
substantially limit our potential customers in those jurisdictions in which such
legislation or regulations are enacted and could provide the authorized
providers of our products with greater purchasing power. We may not be
successful in responding to such laws and therefore the adoption of such laws
could have a material adverse effect on our business, financial condition and
results of operations.
We may need to change our business practices to comply with health care fraud
and abuse regulations.
We are subject to various federal and state laws pertaining to health care fraud
and abuse, including antikickback laws and physician self-referral laws.
Violations of these laws are punishable by criminal and/or civil sanctions,
including, in some instances, imprisonment and exclusion from participation in
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federal and state health care programs, including Medicare, Medicaid,
Veterans Administration health programs and TRICARE. We have not been challenged
by a governmental authority under any of these laws and believe that our
operations are in compliance with such laws. However, because of the
far-reaching nature of these laws, we may be required to alter one or more of
our practices to be in compliance with these laws. Health care fraud and abuse
regulations are complex and even minor, inadvertent irregularities in
submissions can potentially give rise to claims that the statute has been
violated. Any violations of these laws could result in a material adverse effect
on our business, financial condition and results of operations. If there is a
change in law, regulation or administrative or judicial interpretations, we may
have to change our business practices or our existing business practices could
be challenged as unlawful, which could have a material adverse effect on our
business, financial condition and results of operations.
We could become subject to false claims litigation under federal statutes, which
can lead to civil money penalties, criminal fines and imprisonment, and/or
exclusion from participation in Medicare, Medicaid and other federal and state
health care programs. These false claims statutes include the False Claims Act,
which allows any person to bring suit alleging false or fraudulent Medicare or
Medicaid claims or other violations of the statute and to share in any amounts
paid by the entity to the government in fines or settlement. Such suits, known
as qui tam actions, have increased significantly in recent years and have
increased the risk that a health care company will have to defend a false claim
action, pay fines or be excluded from the Medicare program, Medicaid programs or
other federal and state health care programs as a result of an investigation
arising out of such action. We cannot assure you that we will not become subject
to such litigation or, if we are not successful in defending against such
actions, that such actions will not have a material adverse effect on our
business, financial condition and results of operations.
Denied claims from government agencies could reduce our revenue or profits.
Medicare contractors and Medicaid agencies periodically conduct pre- and
post-payment review and other audits of claims, and are under increasing
pressure to scrutinize more closely health care claims. We cannot assure you
that such reviews and/or similar audits of our claims will not result in
material recoupments or denials, which could have a material adverse effect on
our business, results of operations or financial condition.
Risks related to our intellectual property
We rely on intellectual property to develop and manufacture our products and our
business could be adversely affected if we lose our intellectual property
rights.
We hold U.S. and foreign patents relating to a number of our components and
products and have patent applications pending with respect to other components
and products. We also expect to apply for additional patents as we deem
appropriate. We believe that several of our existing patents are, and will
continue to be, extremely important to our success. These include the patents
relating to our:
- "Four Points of Leverage" system, the critical element in the design of
all of our ligament braces;
- Custom Contour Measuring System, which serves as an integral part of the
measurement process for patients ordering our customized ligament and
osteoarthritic braces;
- series of hinges for our post-operative braces;
- pneumatic pad design and production technologies which utilize air
inflatable cushions that allow the patient to vary the location and degree
of support provided by braces such as the Defiance-Registered Trademark-;
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- osteoarthritis bracing concepts;
- ankle bracing, both rigid and soft; and
- rigid shoulder bracing.
However, we cannot assure you that:
- our existing or future patents, if any, will afford us adequate
protection;
- our patent applications will result in issued patents; or
- our patents will not be circumvented or invalidated.
The patent for our "Four Points of Leverage" system is registered only in the
United States and expires in January 2005. Products using the "Four Points of
Leverage" system represented approximately 27% our net revenues, excluding
freight revenue, in 2000. The expiration of this patent could have a material
adverse effect on our business, financial condition and results of operations.
Our success also depends on non-patented proprietary know-how, trade secrets,
processes and other proprietary information. We employ various methods to
protect our proprietary information, including confidentiality agreements and
proprietary information agreements with vendors, employees, consultants and
others who have access to our proprietary information. However, these methods
may not provide us with adequate protection. Our proprietary information may
become known to, or be independently developed by, competitors, or our
proprietary rights in intellectual property may be challenged, any of which
could have a material adverse effect on our business, financial condition and
results of operations.
Our operating results and financial condition could be adversely affected if we
become involved in litigation regarding our patents or other intellectual
property rights.
The orthopedic products industry has experienced extensive litigation regarding
patents and other intellectual property rights. We or our products may become
subject to patent infringement claims or litigation or interference proceedings
declared by the United States Patent and Trademark Office or the foreign
equivalents thereto to determine the priority of inventions. The defense and
prosecution of intellectual property suits, USPTO interference proceedings or
the foreign equivalents thereto and related legal and administrative proceedings
are both costly and time-consuming. An adverse determination in litigation or
interference proceedings to which we may become a party could:
- subject us to significant liabilities to third parties;
- require disputed rights to be licensed from a third party for royalties
that may be substantial; or
- require us to cease using such technology.
Any one of these outcomes could have a material adverse effect on us.
Furthermore, we may not be able to obtain necessary licenses on satisfactory
terms, if at all. Accordingly, adverse determinations in a judicial or
administrative proceeding or our failure to obtain necessary licenses could
prevent us from manufacturing and selling our products, which would have a
material adverse effect on our business, financial condition and results of
operations. Moreover, even if we are successful in such litigation, the expense
of defending such claims could have a material adverse effect on our financial
condition and results of operations.
In addition, we have from time to time needed to, and may in the future need to,
litigate to enforce our patents, to protect our trade secrets or know-how or to
determine the enforceability, scope and validity of the proprietary rights of
others. Such prosecution of our intellectual property rights could involve
counterclaims against us. Any future litigation or interference proceedings will
result in
30
<Page>
substantial expense to us and significant diversion of effort by our technical
and management personnel.
Risks related to the ownership of our parent, dj Orthopedics, Inc.
Our parent has a single stockholder who can substantially influence the outcome
of all matters voted upon by its stockholders and the interests of that
stockholder may not be aligned with yours.
JPMDJ Partners beneficially owns approximately 45.7% of the outstanding common
stock of our parent. As a result, JPMDJ Partners will be able to substantially
influence all matters requiring the approval of its stockholders, including the
election of directors and the approval of significant corporate transactions,
such as acquisitions. The managing member of JPMDJ Partners is J.P. Morgan
Fairfield Partners, LLC (formerly Fairfield Chase Medical Partners, LLC), which
is controlled by Charles T. Orsatti, our chairman of the board of directors.
Accordingly, JPMDJ Partners and JPM Fairfield Partners, which as the managing
member initially controls JPMDJ Partners, and their members have the power,
subject to certain exceptions, to control dj Orthopedics, Inc. and us. The
interests of JPMDJ Partners, JPM Fairfield Partners and their members may not in
all cases be aligned with yours.
Risks related to the trading market for the notes
You cannot be sure that an active trading market will develop for the notes.
We do not intend to apply for a listing of the notes on a securities exchange or
any automated dealer quotation system. We have been advised by J.P. Morgan
Securities, Inc. (JPMSI) that as of the date of this prospectus JPMSI intends to
make a market in the notes. JPMSI is not obligated to do so, however, and any
market-making activities with respect to the notes may be discontinued at any
time without notice. In addition, this market-making activity will be subject to
limits imposed by the Securities Act and the Exchange Act. Because JPMSI is our
affiliate, JPMSI is required to deliver a current market-making prospectus and
otherwise comply with the registration requirements of the Securities Act in any
secondary market sale of the notes. Accordingly, the ability of JPMSI to make a
market in the notes may, in part, depend on our ability to maintain a current
market-making prospectus.
The liquidity of the trading market in the notes, and the market price quoted
for the notes may be adversely affected by changes in the overall market for
high yield securities and by changes in our financial performance or prospects
or in the prospects for companies in our industry generally. As a result, you
cannot be sure that an active trading market will develop for the notes.
Forward-looking statements
This prospectus includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934 including, in particular, statements that reflect our
current estimates, expectations and projections about our future results,
performance, prospects and opportunities. Forward-looking statements include,
among other things, the information concerning our possible future results of
operations, business and growth strategies, financing plans, our competitive
position and the effects of competition, the projected growth of the markets in
which we operate, and the benefits and synergies to be obtained from our
completed and any future acquisitions. Forward-looking statements include all
statements that are not historical facts. In some cases, you can identify these
statements by forward-looking words such as anticipate, believe, could,
estimate, expect, intend, may, should, will, plan, intend, would and similar
expressions. These forward-looking statements are based on information currently
available to us and are subject to a number of risks, uncertainties and other
factors that could cause our actual results, performance,
31
<Page>
prospects or opportunities to differ materially from those expressed in, or
implied by, the forward-looking statements we make in this prospectus. Important
factors that could cause our actual results to differ materially from the
results referred to in the forward-looking statements we make in this prospectus
are discussed under "Risk factors" and elsewhere in this prospectus.
All forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by the cautionary statements
included in this prospectus.
Industry data
Information contained in this prospectus concerning the orthopedic products
industry, including the orthopedic sports medicine market, our general
expectations concerning that industry and market, the historic growth rate of
the orthopedic sports medicine market, and our market position and market share
within the orthopedic sports medicine market and with respect to certain product
lines in that market, both domestically and internationally, are based on
estimates that we prepared using data from various sources (primarily Frost &
Sullivan, an international market consulting firm, and Knowledge
Enterprises, Inc., a market research consulting firm focusing on the orthopedic
industry, as well as data from our internal research) and on assumptions made by
us, based on that data and other similar reliable sources and our knowledge of
the orthopedic products industry and its segments, which we believe to be
reasonable. We believe data regarding the orthopedic products industry and the
orthopedic sports medicine market and our market position and market share
within that market and with respect to certain of the product lines in that
market is inherently imprecise, but is generally indicative of their size and
our market position and market share within that industry or its segments. Our
estimates, in particular as they relate to our general expectations concerning
the orthopedic products industry, involve risks and uncertainties and are
subject to change based on various factors, including those discussed under the
caption "Risk factors" in this prospectus.
The information in this prospectus relating to our estimated U.S. market share
and market position for certain of our core rehabilitation products comes from a
Frost & Sullivan study commissioned by us and Frost & Sullivan has consented to
our use of that information in this prospectus. This study is not otherwise
available to the investing public. The data that we have relied upon regarding
2000 global sales in the orthopedic products market was contained in a general
industry report prepared by Knowledge Enterprises, Inc. We did not commission
Knowledge Enterprises to prepare the report, and it was not required to, and did
not, consent to our use of this data in this prospectus.
The reorganization and initial public offering
The reorganization
dj Orthopedics, Inc. was formed on August 16, 2001 and has had no operations
or revenues since that date. Pursuant to an Agreement and Plan of Merger dated
as of October 26, 2001, on November 20, 2001 a newly formed, wholly-owned
subsidiary of dj Orthopedics, Inc. was merged with and into DonJoy, L.L.C. with
DonJoy, L.L.C. remaining as the surviving entity of the merger and becoming a
wholly-owned subsidiary of dj Orthopedics, Inc. Pursuant to the merger
agreement:
- each outstanding common unit of DonJoy, L.L.C. was converted into the
right to receive 10.812 shares of common stock;
- each outstanding preferred unit of DonJoy, L.L.C. was converted into the
right to receive:
- an amount in cash equal to approximately $1,044, representing the
liquidation preference of the preferred unit, plus accrued and unpaid
distributions thereon to but excluding the date that the
reorganization was effective; and
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<Page>
- 10.812 shares of common stock; and
- each outstanding option and right to purchase common units of DonJoy,
L.L.C. was assumed by dj Orthopedics, Inc. and became an option or right,
as applicable, to purchase that number of shares of common stock of dj
Orthopedics, Inc. equal to the number of common units of DonJoy, L.L.C.
subject to the option or right multiplied by 10.812 at an exercise or
purchase price proportionately adjusted.
Immediately following the consummation of the foregoing merger, and pursuant to
a separate merger agreement, DonJoy, L.L.C. merged with and into dj
Orthopedics, Inc., which was the surviving entity of this second merger. Both
mergers were consummated immediately prior to the consummation of the initial
public offering of common stock of dj Orthopedics, Inc.
The structure and ownership of our parent both before and after the initial
public offering, are described in the diagrams set forth below, which do not
give effect to the exercise of any options.
[GRAPH]
Two side-by-side box graphs appear under the labels "Pre-Offering" (left)
and "Post Offering" (right).
Pre-Offering graph depicts a box around the word "DonJoy, L.L.C." Under the box
is an arrow with the notation 100% over a box around the word "dj Orthopedics,
LLC". Under the box is an arrow with the notation 100%, which breaks into two
arrows over two boxes. The first box to the left contains the word "dj
Orthopedics Capital Corporation". The second box contains the word "Foreign
Subsidiaries*"
To the left of the DonJoy, L.L.C. box appear: "JPMDJ Partners (92.6%), Other
Institutional Investors (4.8%), Management (2.6%)"
Post-Offering graph depicts a box around the word "dj Orthopedics, Inc." Under
the box is an arrow with the notation 100% over a box around the word "dj
Orthopedics, LLC". Under the box is an arrow with the notation 100%, which
breaks into two arrows over two boxes. The first box to the left contains the
word "dj Orthopedics Capital Corporation". The second box contains the word
"Foreign Subsidiaries*"
To the right of the dj Orthopedics, Inc. box appears: "JPMDJ Partners (45.7%),
Other Institutional Investors (2-4%), Management (1.5%), Public Shareholders
(50.4%)."
Under the box graphs appears the notation "*All foreign subsidiaries are 100%
owned except dj Australia, which is 50% owned."
Upon consummation of the reorganization, dj Orthopedics, Inc. became a guarantor
under the credit agreement and the indenture for the notes.
The initial public offering
On November 20, 2001, our parent consummated an initial public offering of
9,000,000 shares of common stock at $17.00 per share, of which 7,800,000 shares
were sold by our parent and 1,200,000 shares were sold by certain stockholders
of our parent. In addition, the selling stockholders granted the underwriters of
the offering an option, exercisable through December 14, 2001, to purchase an
additional 1,350,000 shares of common stock to cover over-allotments. The net
proceeds from the offering to our parent are estimated to be approximately
$119.6 million, based on the initial public offering price of $17.00 per share,
after deducting underwriting discounts and commissions and estimated expenses of
the offering. Our parent did not receive any proceeds from the sale of shares in
the offering by the selling stockholders.
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<Page>
Of such net proceeds:
- approximately $10.6 million was used and $3.0 million will be used to
repay outstanding borrowings under our revolving credit facility and
interest accrued on those borrowings through December 14, 2001, the date
of repayment, a portion of which was received by affiliates of certain of
the selling stockholders;
- approximately $47.3 million was used to pay the cash portion of the
consideration received by the holders of preferred units of DonJoy, L.L.C.
in the reorganization, representing the liquidation preference of the
preferred units and accrued and unpaid distributions thereon through
November 20, 2001 the date of repayment, all of which was received by the
selling stockholders or their affiliates; and
- approximately $29.1 million will be used to redeem $25 million principal
amount of the notes at a redemption price of 112.625% of their principal
amount as permitted by the terms of the indenture for the notes plus
accrued interest on the notes so redeemed through the expected date of
repayment, a portion of which will be received by a selling stockholder.
At September 29, 2001, outstanding borrowings under our revolving credit
agreement totaled approximately $13.6 million. Borrowings under the revolving
credit facility bore interest at the rate of 5.3% per annum and mature on
June 30, 2004.
The remaining net proceeds from the offering of approximately $29.6 million will
be used to fund working capital and for other general corporate purposes,
including, if consummated, the possible acquisitions of European manufacturers
and distributors as discussed under "Management's discussion and analysis of
financial condition and results of operations--Overview--Possible acquisitions".
The reduction in indebtedness under our revolving credit facility as a result of
the application of a portion of the net proceeds of the offering as described
above will enhance our ability to make acquisitions and investments to expand
our current product offerings through research and development and acquisitions
of our investments in, companies, products, technologies and processes. We
currently have no commitments or agreements with respect to any future
acquisitions or investments and no portion of these remaining net proceeds has
been allocated for acquisitions or investments. However, we evaluate acquisition
opportunities on an on-going basis. Pending their use for these purposes, the
net proceeds of the offering will be invested in short-term interest bearing
investment-grade securities, certificates of deposit or direct or guaranteed
obligations of the United States government.
In the aggregate, the selling stockholders and their affiliates will receive
approximately $74.4 million of the net proceeds of the offering, including
$19.0 million of net proceeds received by them from the sale of their common
stock in the offering, assuming no exercise of the underwriters' overallotment
option. See "Related party transactions--Proceeds of offering to be received by
the selling stockholders and their affiliates." Two of the selling stockholders,
JPMDJ Partners and JPMP (23A SBIC), are our affiliates, and the other selling
stockholders may be considered our affiliates under applicable SEC rules.
Use of proceeds
This prospectus is delivered in connection with the sale of the notes by JPMSI
in market-making transactions. We will not receive any of the proceeds from
these transactions.
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Capitalization
The following table sets forth the capitalization of our parent as of
September 29, 2001:
- on an actual basis; and
- on a pro forma basis to give effect to the reorganization and the sale
of 7,800,000 shares of the common stock of dj Orthopedics, Inc. in its
initial public offering at an initial public offering price of $17.00 per
share, after deducting underwriting discounts and commissions and
estimated expenses of the offering.
You should read this table in conjunction with the consolidated and pro forma
financial statements and notes to those financial statements appearing elsewhere
in this prospectus.
<Table>
<Caption>
- --------------------------------------------------------------------------------------
------------------------
At September 29, 2001
(dollars in thousands) Actual Pro forma(1)
- --------------------------------------------------------------------------------------
Cash and cash equivalents................................... $ 1,886 $ 32,418
------------------------
Long-term debt, including current portion:
Credit facility:(2)
Term loans.............................................. $ 37,405 $ 37,405
Revolving credit facility............................... 13,600 --
Senior subordinated notes(3).............................. 98,413 73,810
------------------------
Total long-term debt.................................... 149,418 111,215
Redeemable preferred units.................................. 46,610 --
Minority interest........................................... 144 144
Members'/stockholders' equity:
Common units.............................................. 84,517 --
Preferred Stock, $0.01 par value, 25,000,000 shares
authorized and pro forma; none issued and outstanding
(pro forma)............................................. -- --
Common Stock, $0.01 par value, 100,000,000 shares
authorized; 17,855,566 issued and outstanding (pro
forma).................................................. -- 179
Additional paid-in capital................................ -- 118,453
Less: Notes receivable from officers...................... (2,082) (2,082)
Accumulated deficit....................................... (137,533) --
------------------------
Total members'/stockholders' equity (deficit)............. (55,098) 116,550
------------------------
Total capitalization........................................ $ 141,074 $ 227,909
- --------------------------------------------------------------------------------------
</Table>
(1) For a discussion of the pro forma adjustments, see "Unaudited pro forma
consolidated financial information."
(2) For a description of the senior credit facility, see "Description of credit
agreement."
(3) Net of unamortized debt discount of approximately $0.4 million at
September 29, 2001.
The foregoing table excludes:
- 1,911,550 shares of common stock issuable upon exercise of options
outstanding under our parent's stock incentive plans as of September 29,
2001 after giving effect to the reorganization and options issued through
the date of the initial public offering, at exercise prices ranging from
$9.25 to $16.00 per share, with a weighted average exercise price of
$10.58 per share;
- 6,321,624 shares of common stock reserved for future grant under our
parent's employee stock incentive plans; and
- rights to purchase 43,248 shares of common stock of our parent at an
exercise price equal to their fair market value at the time of exercise.
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<Page>
Selected historical consolidated financial data
The following table presents selected historical consolidated financial and
other data of DonJoy, L.L.C. Prior to the reorganization, DonJoy, L.L.C. was,
and as a result the reorganization, dj Orthopedics, Inc. is, a guarantor of the
notes and of our credit facility. DonJoy, L.L.C. did not have, and dj
Orthopedics, Inc. does not have, any material assets or operations other than
its ownership of 100% of the equity interests of dj Orthopedics, LLC. As a
result, the consolidated financial position and results of operations of DonJoy,
L.L.C. are, and the consolidated financial position and results of operations of
dj Orthopedics, Inc. will be, substantially the same as ours. The historical
consolidated financial data at December 31, 1999 and 2000 and for the years
ended December 31, 1998, 1999 and 2000 are derived from the audited consolidated
financial statements of DonJoy, L.L.C. and the related notes thereto included
elsewhere in this prospectus. The historical financial data at December 31,
1996, 1997 and 1998 and for the two years ended December 31, 1997 are derived
from the audited consolidated financial statements of DonJoy, L.L.C. that are
not included in this prospectus. The selected consolidated financial data at
September 29, 2001 and for the nine-month periods ended September 30, 2000 and
September 29, 2001 come from the unaudited consolidated financial statements of
DonJoy, L.L.C. included elsewhere in this prospectus. The balance sheet data at
September 30, 2000 comes from the unaudited consolidated financial statements of
DonJoy, L.L.C. which are not included in this prospectus. The unaudited
financial statements include, in the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
data for such periods. The results of operations for the interim periods are not
necessarily indicative of operating results for the full year. The consolidated
financial data set forth below should be read in conjunction with the historical
consolidated financial statements and the related notes thereto, "Unaudited pro
forma consolidated financial information" and "Management's discussion and
analysis of financial condition and results of operations," all included
elsewhere in this prospectus.
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------------------
-------------------------------
Nine months ended
-------------------------------------------------------
Years ended December 31,
September 30, September 29,
(in thousands except per share data) 1996 1997 1998 1999 2000 2000 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Statement of Income Data:
Net revenues........................ $85,264 $94,855 $103,643 $116,418 $143,586 $ 102,186 $ 127,361
Cost of goods sold(a)............... 36,916 39,393 46,466 51,744 60,178 43,050 53,856
-----------------------------------------------------------------------------------------
Gross profit........................ 48,348 55,462 57,177 64,674 83,408 59,136 73,505
Operating expenses(a):
Sales and marketing............... 21,699 24,629 27,633 28,902 38,653 26,751 35,661
General and administrative........ 12,941 15,802 16,484 16,755 19,761 14,529 18,270
Research and development.......... 1,766 2,055 2,248 2,115 2,465 1,678 1,813
Merger and integration costs(b)... -- -- -- -- 400 400 --
Restructuring costs(c)............ -- -- 2,467 -- -- -- --
-----------------------------------------------------------------------------------------
Total operating expenses.......... 36,406 42,486 48,832 47,772 61,279 43,358 55,744
-----------------------------------------------------------------------------------------
Income from operations.............. 11,942 12,976 8,345 16,902 22,129 15,778 17,761
Interest expense.................... (2,459) (2,072) -- (7,568) (16,958) (12,245) (13,701)
Interest income..................... -- -- -- 181 437 348 230
Discontinued acquisition costs...... -- -- -- -- (449) -- --
-----------------------------------------------------------------------------------------
Income before income taxes.......... 9,483 10,904 8,345 9,515 5,159 3,881 4,290
Provision for income taxes(d)....... 3,828 4,367 3,394 2,387 -- -- --
-----------------------------------------------------------------------------------------
Net income.......................... $ 5,655 $ 6,537 $ 4,951 $ 7,128 $ 5,159 $ 3,881 $ 4,290
Less: Preferred unit dividends and
accretion of preferred unit
fees.............................. N/A N/A N/A (2,343) (5,415) (3,908) (4,738)
-----------------------------------------------------------------------------------------
Net income (loss) available to
members............................. N/A N/A N/A $ 4,785 $ (256) $ (27) $ (448)
-----------------------------------------------------------------------------------------
Pro forma net income (loss)(e)...... $ (2,165) $ (2,035)
-----------------------------------------------------------------------------------------
Pro forma net income (loss)
per share(e):
Basic............................. $ (0.25) $ (0.22)
-------- -------------
Diluted........................... $ (0.25) $ (0.22)
-------- -------------
Pro forma weighted average shares
outstanding(e):
Basic............................. 8,631 9,465
-------- -------------
Diluted........................... 8,631 9,465
- ---------------------------------------------------------------------------------------------------------------------------------
</Table>
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<Page>
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------------------
-------------------------------
Nine months ended
-------------------------------------------------------
Years ended December 31,
September 30, September 29,
(dollars in thousands) 1996 1997 1998 1999 2000 2000 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Other data:
EBITDA(f)........................... $16,584 $17,779 $ 15,665 $ 21,854 $ 28,894 $ 20,805 $ 24,762
Adjusted EBITDA(g).................. 19,187 22,090 21,957 25,082 29,162 21,073 24,762
Depreciation and amortization....... 4,642 4,803 4,853 4,952 6,365 4,627 7,001
Capital expenditures and acquired
intangibles....................... 1,848 2,273 4,149 4,706 7,722 4,635 5,641
Ratio of earnings to fixed charges
(h)............................... 3.94x 4.83x 8.84x 2.12x 1.29x 1.30x 1.29x
Cash flow provided by (used in):
Operating activities................ $ 9,631 $11,076 $ 3,748 $ 16,065 $ 1,229 $ 5,758 $ 3,537
Investing activities................ (1,860) (2,322) (4,049) (4,776) (57,015) (54,551) (6,984)
Financing activities................ (7,932) (8,401) 200 (6,171) 53,965 46,410 1,395
Balance sheet data (at end of period):
Cash and cash equivalents........... $ 557 $ 910 $ 809 $ 5,927 $ 4,106 $ 3,544 $ 1,886
Working capital..................... 9,675 9,749 15,625 27,413 38,695 30,268 45,406
Total assets........................ 70,787 71,288 77,056 89,416 155,672 148,610 164,924
Long-term obligations............... -- -- -- 113,305 157,222 149,490 149,418
Redeemable preferred units of
DonJoy, L.L.C....................... -- -- -- 32,539 41,660 40,086 46,610
Obligations to Smith & Nephew
(including current portion)....... 53,428 45,027 45,227 -- -- -- --
Total equity (deficit).............. 1,344 7,881 12,832 (70,429) (63,625) (63,203) (55,098)
- ---------------------------------------------------------------------------------------------------------------------------------
</Table>
N/A not applicable.
(a) Amounts in 1999 and prior years include various charges and overhead
allocations from Smith & Nephew. See note (g) below.
(b) We recorded merger and integration costs in 2000 associated with the
consolidation of the Orthotech operations into our existing facilities including
merger and integration and information systems consulting.
(c) We recorded restructuring costs in 1998 relating to the consolidation of our
operations at our Vista, California facility. See note 10 of the notes to
DonJoy, L.L.C.'s consolidated financial statements, and "Management's discussion
and analysis of financial condition and results of
operations--Overview--Manufacturing cost reduction initiatives."
(d) Because DonJoy, L.L.C. operated as a limited liability company from the date
of its recapitalization in June 1999 through November 20, 2001, the date the
reorganization was consummated its initial public offering, in accordance with
federal, state and local income tax regulations which provide that no income
taxes are levied on U.S. limited liability companies and each member of DonJoy,
L.L.C. was individually responsible for reporting the member's share of our net
income or loss, we have not provided for income taxes in our consolidated
financial statements.
(e) Pro forma net income (loss) gives effect to the conversion of our parent
into a corporation in the reorganization and is provided for comparability
assuming we were a taxable entity for the pro forma periods presented. Pro forma
income (loss) per share is based on the weighted average shares outstanding
after giving effect to the issuance of 9,063,641 and 10,055,566 shares of common
stock of dj Orthopedics, Inc. in the reorganization as of December 31, 2000 and
September 29, 2001, respectively.
(f) EBITDA is defined as income from operations plus restructuring costs, merger
and integration costs and depreciation and amortization. Discontinued
acquisition costs are excluded from income from operations since the charge is
not considered a direct cost of operating the business. EBITDA is not a measure
of performance under generally accepted accounting principles. EBITDA should not
be considered in isolation or as a substitute for net income, cash flows from
operating activities and other income or cash flow statement data prepared in
accordance with generally accepted accounting principles, or as a measure of
profitability or liquidity. However, management has included EBITDA because it
may be used by certain investors to analyze and compare companies on the basis
of operating performance, leverage and liquidity and to determine a company's
ability to service debt. Our definition of EBITDA differs from the definition of
EBITDA under our credit agreement in that our definition of EBITDA excludes
discontinued acquisition costs. Under both the credit agreement definition of
EBITDA and our definition of EBITDA, we were in compliance with all debt
covenants under the credit agreement at September 29, 2001. Our definition of
EBITDA may not be comparable to that of other companies.
(g) Adjusted EBITDA represents EBITDA, as defined above, adjusted to eliminate
those direct charges from Smith & Nephew as well as those allocations of
Smith & Nephew's overhead and other expenses that we have not incurred on a
stand-alone basis. These amounts were charged or allocated to us on the basis of
direct usage where identifiable, with the remainder allocated to us on the basis
of its
37
<Page>
annual sales or the capital employed by Smith & Nephew in our business. See
note 9 of the notes to our consolidated financial statements. These charges and
allocations include:
(1) charges for brand royalties that we paid to Smith & Nephew for use
of the Smith & Nephew trademarks and trade names which amounts are no
longer paid following the recapitalization since we no longer have the
right to use Smith & Nephew trademarks and trade names;
(2) foreign sales corporation commissions that we paid on sales to
foreign sales corporations established by Smith & Nephew for tax
planning purposes which amounts are no longer paid following the
recapitalization;
(3) Smith & Nephew overhead allocations for corporate managed accounts
and new business expense and corporate management expense which were not
incurred or replaced following consummation of the recapitalization;
(4) Smith & Nephew overhead allocations for research and development and
for amounts charged by Smith & Nephew for services provided to us for
finance (risk management, treasury, audit and taxes), human resources
and payroll and legal services;
(5) the incremental adjustment to the carrying value of acquired
inventories associated with the Orthotech acquisition to state them at
fair market value;
and adjusted to include the estimated costs we expected to incur to
replace the services described in note (4) above previously provided by
Smith & Nephew. On a stand-alone basis, we have replaced these services
provided by Smith & Nephew following the recapitalization and we have
incurred additional expenses associated with external auditing and
periodic filings with the SEC.
<Table>
<Caption>
------------------------------------------------------------------------------------------------------------------------
-------------------------------
Nine months ended
----------------------------------------------------
Years ended December 31,
September 30, September 29,
(dollars in thousands) 1996 1997 1998 1999 2000 2000 2001
------------------------------------------------------------------------------------------------------------------------
EBITDA data:
Income from operations.......... $11,942 $12,976 $ 8,345 $16,902 $22,129 $ 15,778 $ 17,761
Restructuring costs............. -- -- 2,467 -- -- -- --
Merger and integration costs.... -- -- -- -- 400 400 --
Depreciation and amortization... 4,642 4,803 4,853 4,952 6,365 4,627 7,001
--------------------------------------------------------------------------------------
EBITDA (as defined)............. 16,584 17,779 15,665 21,854 28,894 20,805 24,762
Brand royalties................. 1,274 1,605 3,249 1,817 -- -- --
Foreign sales corporation
commissions................... 492 661 439 -- -- -- --
Amounts eliminated as set forth
in note (3) above............. 836 1,652 1,726 979 -- -- --
Amounts eliminated as set forth
in note (4) above............. 801 1,193 1,678 832 -- -- --
Step-up in inventory............ -- -- -- -- 268 268 --
Estimated costs to replace Smith
& Nephew services............. (800) (800) (800) (400) -- -- --
--------------------------------------------------------------------------------------
Adjusted EBITDA................. $19,187 $22,090 $21,957 $25,082 $29,162 $ 21,073 $ 24,762
------------------------------------------------------------------------------------------------------------------------
</Table>
Adjusted EBITDA does not reflect adjustments for Smith & Nephew
allocations for bonus, pension and insurance or payroll taxes and
benefits or charges for direct legal expenses incurred by Smith & Nephew
on our behalf, which costs and expenses we believe we would have
incurred in approximately the same amounts on a stand-alone basis, and
are of a nature we have continued to incur following the
recapitalization. Accordingly, no adjustments for these items have been
made. For a more complete description of the corporate charges and
allocations and the services performed by Smith & Nephew after the
recapitalization, see note 9 of the notes to DonJoy, L.L.C.'s
consolidated financial statements, "Management's discussion and analysis
of financial condition and results of operations--Overview--Smith &
Nephew allocations and sales" and "Related party transactions--Other
agreements with Smith & Nephew--Transition services agreement."
(h) Earnings consist of income before income taxes plus fixed charges. Fixed
charges consist of (i) interest, whether expensed or capitalized, (ii)
amortization of debt issuance costs, whether expensed or capitalized, and (iii)
an allocation of one-third of the rental expense from operating leases which
management considers to be a reasonable approximation of the interest factor of
rental expense.
38
<Page>
Unaudited pro forma consolidated financial information
dj Orthopedics, Inc. was incorporated in Delaware on August 16, 2001 with
nominal capital. dj Orthopedics, Inc. has nominal assets, no liabilities and has
had no operations or revenues since that date. Concurrently with and contingent
upon the completion of the initial public offering of common stock of dj
Orthopedics, Inc., a wholly-owned subsidiary of dj Orthopedics, Inc. merged with
and into DonJoy, L.L.C., with DonJoy, L.L.C. being the surviving entity of the
merger, and the holders of the common and preferred units of DonJoy, L.L.C.
received shares of common stock of dj Orthopedics, Inc. See "The reorganization
and initial public offering."
The following unaudited pro forma consolidated financial information of dj
Orthopedics, Inc. is based on DonJoy, L.L.C.'s historical financial statements
for the year ended December 31, 2000 and the six months ended June 29, 2001 and
Orthotech's historical financial statements for the nine months ended
September 30, 2000, each appearing elsewhere in this prospectus, as adjusted to
illustrate the estimated effects of the Orthotech acquisition completed on
July 7, 2000, reclassifications to Orthotech's financial statements to conform
with DonJoy, L.L.C.'s presentation and financial statement classifications, the
reorganization and the initial public offering. The Orthotech historical
financial statements relate to our acquisition of a portion of the assets of
DePuy Orthopaedic Technology, Inc., a subsidiary of Johnson & Johnson.
The unaudited pro forma consolidated balance sheet gives effect to the
reorganization and the initial public offering as if they occurred on
September 29, 2001. The unaudited pro forma consolidated statement of income for
the year ended December 31, 2000 gives effect to the Orthotech acquisition, the
reorganization and the initial public offering as if they had occurred on
January 1, 2000. The unaudited pro forma consolidated statement of income for
the nine months ended September 29, 2001 gives effect to the reorganization and
the initial public offering as if they had occurred as of January 1, 2000. The
reorganization and the initial public offering were consummated on November 20,
2001. On that date our parent paid the cash portion of the consideration
receivable by the holders of perferred units of DonJoy, L.L.C. in the
reorganization. On November 30, 2001 we repaid $10.6 million of borrowings under
our revolving credit facility and $0.5 million of accrued interest thereon. On
November 30, 2001, we gave irrevocable notice of our intent to redeem
$25 million principal amount of the notes at 112.625% of the principal amount
thereof on December 31, 2001. On December 14, 2001, we will repay $3.0 million
of borrowings under our revolving credit facility and $0.01 million of accrued
interest thereon.
The pro forma adjustments are based upon available information and certain
assumptions that management believes are reasonable under the circumstances. The
unaudited pro forma consolidated financial data does not purport to represent
what our financial position or results of operations would have actually been if
the Orthotech acquisition, the reorganization and the initial public offering
had in fact occurred on the dates indicated and are not necessarily
representative of our consolidated financial position or results of operations
for any future date or period. The unaudited pro forma consolidated financial
data should be read in conjunction with the above-referenced historical
financial statements and the notes thereto of DonJoy, L.L.C. and Orthotech
included elsewhere in this prospectus.
Possible Acquisitions
The unaudited pro forma financial statements do not reflect adjustments for, or
the use of a portion of the net proceeds of the initial public offering to
consummate, our possible acquisitions for which letters
39
<Page>
of intent have been executed of two European manufacturers and distributors for
an estimated aggregate initial purchase price of $9.5 million in cash.
Consummation of these acquisitions is subject to completion of our due
diligence, execution of definitive agreements, the receipt of financing and the
receipt of necessary regulatory approvals. See "Management's discussion and
analysis of financial condition and results of operations--Overview--Possible
acquisitions."
Orthotech acquisition overview and integration plan
We did not acquire any of Orthotech's facilities or many of its employees and
instead integrated the Orthotech operations into our existing business. Upon
closing of the Orthotech acquisition, DePuy Orthopaedic Technology, Inc.
retained all responsibility with regards to lease obligations on the Orthotech
facilities and severance obligations for terminated Orthotech employees. The
synergies from the Orthotech acquisition were due primarily to reduction of
headcount, the transfer of the majority of Orthotech's sales force to
independent distributors and the consolidation of Orthotech's operations into
our manufacturing facilities.
In accordance with a transition services agreement, DePuy Orthopaedic
Technology, Inc. provided various transitional services to us through October
2000 while the operations of Orthotech were integrated into ours. Such services
included continued operation of Orthotech's manufacturing facilities, employee
payroll service and benefits, and computer services and other administrative
services.
We integrated Orthotech into our business over a period of 90 days. The majority
of Orthotech's manufactured products were rationalized against our product
lines, with the remaining manufactured products either offered as new products
or discontinued. In addition, Orthotech product offerings were rationalized into
the DonJoy-Registered Trademark-, ProCare-Registered Trademark-, international
and OfficeCare-Registered Trademark- distribution channels.
Historically, Orthotech sold its products internationally to affiliated
companies who then re-sold the Orthotech products to the end user consumer.
Orthotech's historical combined financial statements include the operating
results of its affiliated companies which reflect revenues based on the sales
value to the end user consumer. We did not purchase Orthotech's international
affiliated companies in the acquisition. We sell products internationally at a
transfer price to third-party distributors that is less than the amount realized
on sales to the end customer. We recognize revenue when products are shipped to
the international distributor.
40
<Page>
dj Orthopedics, Inc. unaudited pro forma consolidated balance sheet
September 29, 2001
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------
Pro forma
(in thousands except unit/share information) Historical adjustments Pro forma
- -------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Assets
Current assets:
Cash and cash equivalents................................ $ 1,886 $ 30,532 (1) $ 32,418
Accounts receivable, net discounts and allowances........ 44,235 44,235
Inventories, net......................................... 21,771 21,771
Other current assets..................................... 2,638 2,638
------------------------------------------
Total current assets..................................... 70,530 30,532 101,062
Property, plant and equipment, net......................... 14,880 14,880
Intangible assets, net..................................... 72,029 72,029
Debt issuance costs, net................................... 5,857 (1,166)(2) 4,691
Deferred income taxes...................................... -- 54,794 (3) 54,794
Other assets............................................... 1,628 1,628
------------------------------------------
Total assets............................................... $ 164,924 $ 84,160 $ 249,084
- -------------------------------------------------------------------------------------------------------
Liabilities and members'/stockholders' equity (deficit)
Current liabilities:
Accounts payable......................................... $ 9,430 $ 9,430
Accrued compensation..................................... 2,398 2,398
Accrued commissions...................................... 1,360 1,360
Long-term debt, current portion.......................... 1,274 1,274
Accrued interest......................................... 3,690 (929)(4) 2,761
Other accrued liabilities................................ 6,972 (1,746)(5) 5,226
------------------------------------------
Total current liabilities................................ 25,124 (2,675) 22,449
12 5/8% senior subordinated notes.......................... 98,413 (24,603)(6) 73,810
Long-term debt, less current portion....................... 49,731 (13,600)(7) 36,131
Redeemable preferred units; 100,000 units authorized,
44,405 units issued and outstanding at September 29,
2001; liquidation preference of $46,383 at September 29,
2001..................................................... 46,610 (46,610)(8) --
Minority interest.......................................... 144 144
Members'/stockholders' equity (deficit):
Common units; 2,900,000 units authorized, 885,633 units
issued and outstanding at September 29, 2001........... 84,517 (84,517)(9) --
Common stock, $0.01 par value; 100,000,000 shares
authorized and 17,855,566 shares issued and
outstanding, pro forma................................. -- 179 (9) 179
Additional paid in capital............................... -- 118,453 (10) 118,453
Notes receivable from officers........................... (2,082) (2,082)
Retained earnings (deficit).............................. (137,533) 137,533 (11) --
------------------------------------------
Total members'/stockholders' equity (deficit).............. (55,098) 171,648 116,550
------------------------------------------
Total liabilities and members'/stockholders' equity
(deficit)................................................ $ 164,924 $ 84,160 $ 249,084
- -------------------------------------------------------------------------------------------------------
</Table>
41
<Page>
dj Orthopedics, Inc. notes to unaudited pro forma consolidated balance sheet
(dollars in thousands)
(1) Reflects the increase in cash resulting from the initial public offering and
the application of the net proceeds as follows:
<Table>
- ----------------------------------------------------------------------
Proceeds from the sale of 7,800,000 shares of common stock
of dj Orthopedics, Inc. at an initial offering price of
$17.00 per share, after deducting underwriting discounts
and commissions and estimated costs of the initial public
offering of $13,000....................................... $119,600
Less:
Repayment of principal on the revolving credit facility of
$13,600 and accrued interest of $8........................ (13,608)
Redemption of the notes, comprised of principal of $25,000,
a prepayment premium of $3,156 (see note 4 of notes to
DonJoy's consolidated financial statements) and accrued
interest of $921.......................................... (29,077)
Redemption of redeemable preferred units (see note 5 of
notes to DonJoy's consolidated financial statements)...... (46,383)
--------
Net increase in cash........................................ $ 30,532
- ----------------------------------------------------------------------
</Table>
The net increase in cash does not reflect the $9,500 of funds which would be
required to consummate our two possible acquisitions for which letters of intent
have been executed.
(2) Reflects the write-off of unamortized debt issuance costs of $1,166
following the redemption of a portion of the notes.
(3) In connection with the reorganization, we will record a deferred tax asset
benefit of $54,794 related to the difference between the book and the tax basis
of certain assets and liabilities of DonJoy, L.L.C. at September 29, 2001 as the
related amortization will be deductible for tax purposes. The tax basis
differences arose at the time of the recapitalization when for income tax
purposes we elected to increase the basis of certain assets in an amount equal
to the gain recognized by our former parent. See "income taxes" in note 1 of
notes to DonJoy, L.L.C.'s consolidated financial statements.
(4) Reflects payment of accrued interest:
<Table>
- ------------------------------------------------------------------
Revolving credit facility................................... $ 8
12 5/8% senior subordinated notes........................... 921
----
$929
- ------------------------------------------------------------------
</Table>
(5) Records tax benefit of $1,746 for the prepayment premium on the portion of
senior subordinated notes redeemed of $3,156, the write-off of unamortized debt
issuance costs of $1,166 and debt discount of $397 based on dj Orthopedics,
Inc.'s estimated effective tax rate of 37%.
(6) Reflects the redemption of a portion of the senior subordinated notes:
<Table>
- ---------------------------------------------------------------------
Principal................................................... $25,000
Unamortized discount........................................ (397)
-------
$24,603
- ---------------------------------------------------------------------
</Table>
42
<Page>
(7) Records the payment of the principal balance on the revolving credit
facility of $13,600.
(8) Reflects the redemption of the redeemable preferred units as follows:
<Table>
- ----------------------------------------------------------------------
Redemption amount........................................... $ 46,383
Add: 2000 and 2001 tax distributions........................ 763
Add: allocation of earnings for book purposes............... 682
Less: unamortized accretion of preferred unit fees.......... (1,218)
--------
$ 46,610
- ----------------------------------------------------------------------
</Table>
(9) Reflects the exchange of membership units of DonJoy, L.L.C. at the exchange
ratio of 10.812 shares of common stock of dj Orthopedics, Inc. and the issuance
of common stock in the initial public offering as follows:
<Table>
- --------------------------------------------------------------------------
Common units................................................ 885,633
Preferred units............................................. 44,405
------------
930,038
Exchange ratio.............................................. 10.812
------------
Shares*..................................................... 10,055,566
Shares issued in offering................................... 7,800,000
------------
17,855,566
Par value per share......................................... $ 0.01
------------
Par value................................................... $ 179
- --------------------------------------------------------------------------
</Table>
* Fractional shares resulting from the merger exchange ratio were paid in cash.
(10) Reflects the change in additional paid-in-capital as a result of the
following:
<Table>
- -----------------------------------------------------------------------
Net proceeds from the sale of shares in the initial public
offering.................................................. $ 119,600
Conversion of membership units of DonJoy, L.L.C. in the
reorganization and the shares issued in the initial public
offering, less par value of $179.......................... 84,338
Reclassification of accumulated deficit of DonJoy, L.L.C. to
additional paid-in-capital at the reorganization date..... (85,485)
---------
$ 118,453
- -----------------------------------------------------------------------
</Table>
(11) Reflects the adjustment to retained earnings (deficit) as follows:
<Table>
- ----------------------------------------------------------------------
Write-off of unamortized debt issuance costs for the portion
of the senior subordinated notes redeemed................. $ (1,166)
Deferred tax asset benefit.................................. 54,794
Write-off of debt discount for the portion of the notes
redeemed.................................................. (397)
Prepayment premium on the redemption of the portion of the
notes..................................................... (3,156)
Tax benefit of the write-off of unamortized debt issuance
costs and debt discount and prepayment premium on the
redemption of the portion of the notes.................... 1,746
Acceleration of recognition of unamortized accretion of
preferred unit fees....................................... (1,218)
Add back of the 2000 and 2001 tax distributions............. 763
Add back of the earnings allocation to holders of preferred
units of DonJoy, L.L.C.................................... 682
Reclassification of retained earnings to additional paid in
capital................................................... 85,485
--------
$137,533
- ----------------------------------------------------------------------
</Table>
43
<Page>
dj Orthopedics, Inc. unaudited pro forma consolidated statement of income year
ended December 31, 2000
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------------------
Pro forma adjustments
DonJoy, -------------------------------
(in thousands, L.L.C. Orthotech Orthotech Reorganization
except per share data) historical historical acquisition and offering Pro forma
- -----------------------------------------------------------------------------------------------------------
(unaudited) (unaudited) (unaudited)
Total net revenues......... $ 143,586 $ 23,978 $ (1,706)(1) $ 165,858
Cost of goods sold......... 60,178 13,326 (2,104)(2) 71,400
-----------------------------------------------------------------------------
Gross profit............... 83,408 10,652 398 94,458
Operating expenses
Sales and marketing...... 38,653 6,130 (474)(3) 44,309
General and
administrative......... 19,761 3,775 (640)(4) 22,896
Research and
development............ 2,465 246 2,711
Merger and integration
costs.................. 400 400
-----------------------------------------------------------------------------
Total operating expenses... 61,279 10,151 (1,114) 70,316
Income from operations..... 22,129 501 1,512 24,142
Interest expense........... (16,958) (1,786)(5) 4,011(7) (14,733)
Interest income............ 437 437
Discontinued acquisition
costs.................... (449) (449)
-----------------------------------------------------------------------------
Income before income
taxes.................... 5,159 501 (274) 4,011 9,397
Provision (benefit) for
income taxes............. -- 461 (461)(6) 3,477(8) 3,477
-----------------------------------------------------------------------------
Net income................. 5,159 40 187 534 5,920
-----------------------------------------------------------------------------
Less: Preferred unit
dividends and accretion
of preferred unit fees... (5,415) -- -- 5,415(9) --
-----------------------------------------------------------------------------
Net income (loss) available
to members/stockholders.. $ (256) $ 40 $ 187 $ 5,949 $ 5,920(10)
-----------------------------------------------------------------------------
Pro forma net income
(loss)................... $ (2,165) $ 5,920
-----------------------------------------------------------------------------
Pro forma net income (loss)
per share:
Basic.................... $ (0.25) $ 0.36
-----------------------------------------------------------------------------
Diluted.................. $ (0.25) $ 0.35
-----------------------------------------------------------------------------
Pro forma weighted average
shares outstanding:
Basic.................... 8,631 16,431(11)
-----------------------------------------------------------------------------
Diluted.................. 8,631 17,044(11)
- -----------------------------------------------------------------------------------------------------------
</Table>
44
<Page>
dj Orthopedics, Inc. unaudited pro forma consolidated statement of income nine
months ended September 29, 2001
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------
DonJoy,
L.L.C. Pro forma
(in thousands, except per share data) historical adjustments Pro forma
- ------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Total net revenues.......................................... $ 127,361 $ 127,361
Cost of goods sold.......................................... 53,856 53,856
----------------------------------------
Gross profit................................................ 73,505 73,505
Operating expenses
Sales and marketing....................................... 35,661 35,661
General and administrative................................ 18,270 18,270
Research and development.................................. 1,813 1,813
----------------------------------------
Total operating expenses.................................... 55,744 55,744
Income from operations...................................... 17,761 17,761
Interest expense............................................ (13,701) 3,565(7) (10,136)
Interest income............................................. 230 230
----------------------------------------
Income before income taxes.................................. 4,290 3,565 7,855
Provision (benefit) for income taxes........................ -- 2,906(8) 2,906
----------------------------------------
Net income.................................................. 4,290 659 4,949
Less: Preferred unit dividends and accretion of preferred
unit fees................................................. (4,738) 4,738(9) --
----------------------------------------
Net income (loss) available to members/stockholders......... $ (448) $ 5,397 $ 4,949(10)
----------------------------------------
Pro forma net income (loss)................................. $ (2,035) $ 4,949
----------------------------------------
Pro forma net income (loss) per share:
Basic..................................................... $ (0.22) $ 0.29
----------------------------------------
Diluted................................................... $ (0.22) $ 0.28
----------------------------------------
Pro forma weighted average shares outstanding:
Basic..................................................... 9,465 17,265(11)
----------------------------------------
Diluted................................................... 9,465 17,955(11)
- ------------------------------------------------------------------------------------------------------
</Table>
45
<Page>
dj Orthopedics, Inc. notes to unaudited pro forma consolidated statements of
income
(dollars in thousands)
(1) Entry records (i) reclassification to make treatment of Orthotech's accounts
receivable adjustments consistent with our presentation and (ii) the elimination
of incremental revenues Orthotech realized by selling to end customers through
their international sales affiliates directly as compared to revenues we would
realize by selling through third party distributors, as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
Year ended
December 31, 2000
- -------------------------------------------------------------------------------
Reclassification of accounts receivable adjustments......... $ 10
Elimination of incremental sales revenue.................... (1,716)
-----------------
$ (1,706)
- -------------------------------------------------------------------------------
</Table>
(2) Entry records the (i) elimination of cost of goods sold associated with
Orthotech international affiliated companies which we did not purchase in the
acquisition, (ii) elimination of salaries, wages and benefits for specifically
identified employees whose positions were eliminated as a result of the
consolidation of the Orthotech operations into our existing facilities in Vista,
California, net of additional specifically identified positions required to be
added in our existing facility to handle the increased operations,
(iii) elimination of discontinued building costs for the Orthotech facility, and
(iv) estimated incremental depreciation of the fair market value of acquired
property, plant and equipment on a straight-line basis over the estimated
economic lives of the underlying fixed assets ranging from three to
seven years, as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
Year ended
December 31, 2000
- -------------------------------------------------------------------------------
Cost of sales associated with Orthotech international
affiliated companies...................................... $ (1,002)
Elimination of salaries, wages and benefits................. (1,052)
Elimination of discontinued building costs.................. (102)
Incremental depreciation on fair market value of property,
plant and equipment....................................... 52
-----------------
$ (2,104)
- -------------------------------------------------------------------------------
</Table>
(3) Reclassification entry to eliminate selling costs associated with Orthotech
international affiliated companies which we did not purchase in the acquisition,
as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
Year ended
December 31, 2000
- -------------------------------------------------------------------------------
Elimination of selling costs associated with Orthotech
international affiliated companies........................ $ (474)
- -------------------------------------------------------------------------------
</Table>
(4) Entry records (i) reclassification to make treatment of Orthotech's accounts
receivable adjustments consistent with our presentation, (ii) elimination of
administrative expenses associated with Orthotech international affiliated
companies which we did not purchase in the acquisition, (iii) elimination of
salaries, wages and benefits for specifically identified employees whose
positions were eliminated as a result of the consolidation of Orthotech into our
existing facilities, net of additional specifically identified positions
required to be added in our existing facility to handle the increased
operations, (iv) elimination of discontinued building costs for the Orthotech
facility, (v) elimination of amortization historically
46
<Page>
recorded by Orthotech on its goodwill, and (vi) amortization of the estimated
fair value of goodwill and other intangible assets acquired over economic lives
ranging from 3 to 15 years, as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
Year ended
December 31, 2000
- -------------------------------------------------------------------------------
Reclassification of accounts receivable adjustments......... $ 10
Elimination of administrative expenses related to Orthotech
international affiliated companies........................ (90)
Elimination of salaries, wages and benefits................. (960)
Elimination of discontinued building costs.................. (42)
Elimination of amortization recorded by Orthotech........... (1,020)
Amortization of intangibles recorded at fair market value... 1,462
-----------------
$ (640)
- -------------------------------------------------------------------------------
</Table>
(5) Adjustment to interest expense to reflect additional borrowings under our
amended credit agreement to consummate the Orthotech acquisition, as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
Year ended
December 31, 2000
- -------------------------------------------------------------------------------
Term loan ($24,000 at assumed weighted average rate of
9.57%).................................................... $ 1,148
Revolving credit facility ($12,600 at assumed
weighted average rate of 9.07%)........................... 571
Commitment fee on unused portion of revolving credit
facility ($12,400 at 0.5%)................................ 31
Amortization of debt issuance costs......................... 36
-----------------
$ 1,786
- -------------------------------------------------------------------------------
</Table>
(6) Eliminates the provision for income taxes recorded by Orthotech. On
June 30, 1999, DonJoy, L.L.C. became a stand-alone limited liability company. As
such, the earnings of DonJoy, L.L.C. and its subsidiaries were included in the
taxable income of its members.
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
Year ended Nine months ended
December 31, September 29,
2000 2001
- -------------------------------------------------------------------------------------------------
(7) Eliminates historical interest expense and amortization
of debt issuance costs and debt discount that would not
have been incurred had the initial public offering and
repayment of debt occurred at the beginning of the
periods presented:
Revolving credit facility............................. $ 585 $ 1,047
12 5/8% senior subordinated notes..................... 3,426 2,518
-----------------------------------
$ 4,011 $ 3,565
- -------------------------------------------------------------------------------------------------
(8) Records tax provision at our estimated effective
tax rate of 37%, which is composed of the federal
statutory rate of 34%, the average state rate of 4.2%, less
the tax benefit from tax planning initiatives............... $ 3,477 $ 2,906
- -------------------------------------------------------------------------------------------------
(9) Eliminates preferred unit dividends and accretion of
preferred unit fees.................................... $ 5,415 $ 4,738
- -------------------------------------------------------------------------------------------------
</Table>
47
<Page>
(10) Does not reflect: (a) the deferred tax asset benefit of $54,794 for the
difference between the book and the tax basis of DonJoy, L.L.C.'s assets, and
(b) an extraordinary charge (net of tax) of $3.3 million for the write-off of
unamortized deferred debt issuance costs, debt discount and prepayment premiums
on the redemption of the portion of the notes. These amounts will be reflected
in dj Orthopedics, Inc.'s financial statements in the quarter or quarters in
which the reorganization, the repayment of the revolving credit facility and the
redemption of the redeemable preferred units and a portion of the notes occur.
(11) The pro forma net income (loss) per common share is computed based on the
weighted average number of shares of common stock outstanding for each period
presented assuming the reorganization and the offering occurred as of the
beginning of the respective period. The dilutive effect of common stock
equivalents (options to purchase common stock) for the periods ended
December 31, 2000 and September 29, 2001, respectively, which is computed using
the treasury stock method, were not considered in calculating diluted net income
(loss) per share, because the effect is antidilutive. The following table
reconciles the denominators used in computing basic and diluted earnings (loss)
per share:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------
Year ended Nine months ended
(in thousands) December 31, 2000 September 29, 2001
- -------------------------------------------------------------------------------------------------------
Pro forma weighted average common shares outstanding after
the reorganization........................................ 8,631 9,465
Effect of the issuance of shares in the offering............ 7,800 7,800
-----------------------------------------
Pro forma basic weighted average shares outstanding......... 16,431 17,265
Effect of dilutive stock options............................ 613 690
-----------------------------------------
Pro forma diluted weighted average shares outstanding....... 17,044 17,955
- -------------------------------------------------------------------------------------------------------
</Table>
48
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Management's discussion and analysis of financial
condition and results of operations
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH DONJOY, L.L.C.'S
CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES TO THOSE FINANCIAL
STATEMENTS AS WELL AS THE UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
AND THE OTHER FINANCIAL DATA INCLUDED ELSEWHERE IN THIS PROSPECTUS.
dj Orthopedics, Inc. is, and prior to the reorganization, DonJoy, L.L.C. was, a
guarantor of the notes and of the credit facility. Neither DonJoy, L.L.C. had,
nor dj Orthopedics, Inc. has, any material assets or operations other than its
ownership of all of the equity interests of dj Orthopedics, LLC. As a result,
the discussion of the historical consolidated financial position and results of
operations of DonJoy, L.L.C. is substantially the same as dj Orthopedics, LLC's.
No financial information of DJ Capital, the co-issuer of the notes, is included
in this prospectus because management believes such information would not be
material given DJ Capital's lack of assets and liabilities.
Overview
Recapitalization
On June 30 1999, DonJoy, L.L.C. consummated a $215.3 million recapitalization.
In connection with the recapitalization transactions, DonJoy, L.L.C. established
dj Orthopedics, LLC and DJ Orthopedics Capital Corporation (DJ Capital), a
co-issuer of the senior subordinated notes with no material assets or
operations. DonJoy, L.L.C. sold all of its net assets to dj Orthopedics, LLC for
cash which was funded with the net proceeds of $100.0 million principal amount
of senior subordinated notes issued by dj Orthopedics, LLC and DJ Capital, as
co-issuers, and the remainder by funds borrowed by dj Orthopedics, LLC under a
senior credit facility. In addition, new investors, including three members of
our senior management, invested new capital of $94.6 million in equity in
DonJoy, L.L.C. The proceeds of the equity investment together with debt
financings were used as follows:
- approximately $199.1 million as consideration paid to redeem a portion
of members' equity from DonJoy's former parent, and
- approximately $8.8 million to pay costs and fees in connection with the
recapitalization.
As part of the recapitalization agreement, immediately prior to the
recapitalization, DonJoy's former parent made a capital contribution in an
amount equal to our then existing cash balance. In addition, it canceled current
and deferred liabilities due to our former parent and assumed a then existing
restructuring reserve which resulted in an additional capital contribution in
those amounts. These amounts aggregated $47.9 million and were treated as a
capital contribution by our former parent to DonJoy's members' equity.
Acquisitions and other recent transactions
In accordance with a unit purchase agreement dated as of June 28, 2000, DonJoy's
former parent sold its remaining interest in 54,000 common units in DonJoy,
L.L.C. to JPMDJ Partners and certain members of management for $5.9 million.
JPMDJ Partners purchased 52,495 common units for a total consideration of
$5.7 million and the members of management purchased the remaining 1,505 units
for a total consideration of $0.2 million, which they financed by cash and
promissory notes issued to us. Upon consummation of the reorganization, these
units purchased by JPMDJ Partners and the members of management were exchanged
for 567,575 and 16,272 shares of common stock of dj Orthopedics, Inc.,
respectively, reflecting an effective purchase price of $10.08 per share.
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On July 7, 2000, we completed the purchase of specified assets and assumed
specified liabilities related to the rehabilitation business, referred to in
this prospectus as Orthotech or the Orthotech business, of DePuy Orthopaedic
Technology, Inc., a subsidiary of Johnson & Johnson. We acquired Orthotech for a
purchase price of $46.4 million in cash, exclusive of transaction fees and
expenses. Orthotech developed, manufactured, and marketed an array of orthopedic
products for the orthopedic sports medicine market including braces, soft goods
and specialty products which were similar to the products offered by us.
Orthotech also had an inventory management and billing program that complemented
our OfficeCare-Registered Trademark- program. We purchased primarily inventory,
equipment and certain intellectual property. We were not required to assume any
liabilities existing prior to the closing date. The Orthotech acquisition has
been accounted for using the purchase method of accounting whereby the total
purchase price has been allocated to tangible and intangible assets acquired and
liabilities assumed based on their estimated fair market values.
Effective March 5, 2001, we invested in an Australian joint venture, dj
Orthopaedics Pty Ltd (dj Australia) which is 60% owned by dj Orthopedics, LLC.
dj Australia has replaced our Smith & Nephew distributor in Australia and also
sells two new product lines.
On June 1, 2001, we completed the acquisition of substantially all of the assets
and liabilities of Alaron Technologies, L.L.C. for an aggregate purchase price
of $500,000 in cash, payable in four equal installments of $125,000 each, all of
which has been paid. Alaron provided product development, manufacturing and
supply chain management services related to medical and surgical devices. We
purchased primarily equipment and acquired technology. The Alaron acquisition
has been accounted for using the purchase method of accounting whereby the total
purchase price has been allocated to tangible and intangible assets acquired and
liabilities assumed based on their estimated fair market values. The acquisition
also provided order fulfillment and supply chain management systems and software
for our new Alaron Surgical-TM- division. These systems will allow us to better
serve the overall sports medicine market by offering our surgical products in
procedure-specific kits. In connection with the Alaron acquisition, we entered
into an employment agreement with Paul K. Nichols, a principal owner of Alaron
Technologies, L.L.C., who serves as a Senior Vice President and head of the
Alaron Surgical-TM- division.
Possible acquisitions
We have executed letters of intent to acquire two European orthopedic products
manufacturers and distributors, Ro+Ten SRL, a manufacturer of soft goods and our
current distributor in Italy, and its Swiss affiliate, Orthoservice AG, which
manufactures orthopedic products for Ro+Ten. The expected aggregate purchase
price is approximately $9.5 million in cash and an expected additional
$0.5 million, if specified performance targets are met. Consummation of the
acquisitions is subject to completion of our due diligence, execution of
definitive agreements, receipt of necessary financing and the receipt of
necessary regulatory approvals and, accordingly, we cannot assure you that
either of these acquisitions will be consummated. If consummated, we anticipate
that these transactions would close during the first quarter of 2002. We are
also negotiating to acquire a European manufacturer of rigid knee braces that is
one of our current European distributors. We do not expect that the purchase
price of this company would exceed $2.5 million. Our acquisition of these
companies, if consummated, is part of our strategy to expand our direct
distribution capability in selected international markets where we believe that
there is significant potential to increase sales due to high per capita health
care expenditures.
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Segments
We are a global designer, manufacturer and marketer of products for the
orthopedic sports medicine market. Our product lines include rigid knee braces,
soft goods, a portfolio of specialty and other complementary orthopedic products
and our recently introduced line of surgical products. Our rigid knee braces
include ligament braces, which provide durable support for knee ligament
instabilities, post-operative braces, which provide both knee immobilization and
a protected range of motion, and osteoarthritic braces, which provide relief of
knee pain due to osteoarthritis. Our soft goods products, most of which are
fabric or neoprene-based, provide support and/or heat retention and compression
for injuries to the knee, ankle, back and upper extremities, including the
shoulder, elbow, neck and wrist. Our portfolio of specialty and other
complementary orthopedic products, which are designed to facilitate orthopedic
rehabilitation, include lower extremity walkers, upper extremity braces, cold
therapy systems and pain management delivery systems. Our recently introduced
surgical products include fixation devices for soft tissue repair in the knee as
well as to address cartilage damage due to trauma or osteoarthritis. These
products are reported in the specialty and other complementary products segment.
The rigid knee brace product lines and the soft goods product lines constitute
reportable segments under generally accepted accounting principles. See note 7
of the notes to DonJoy, L.L.C.'s consolidated financial statements. We began
selling our Alaron Surgical-TM- products in the third quarter of 2001.
Set forth below is revenue and gross profit information for our product lines
for the years ended December 31, 1998, 1999 and 2000 and the first nine months
of 2000 and 2001. Gross profit information is presented before brand royalties
charged by Smith & Nephew for use of Smith & Nephew trademarks and trade names
for periods prior to the June 1999 recapitalization (which charges are no longer
incurred by us following the recapitalization), certain other cost of goods
sold, primarily manufacturing variances and royalty expenses, which have not
been directly allocated to any of the product lines, and freight revenue. See
note 9 of the notes to DonJoy, L.L.C.'s consolidated financial statements.
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------
Nine months ended
Years ended December 31, -------------------------------
--------------------------- September 30, September 29,
(Dollars in thousands) 1998 1999 2000 2000 2001
- --------------------------------------------------------------------------------------------------
Rigid knee bracing:
Net revenues..................... $52,473 $52,953 $58,115 $ 42,640 $ 50,190
Gross profit..................... 36,669 37,994 41,189 30,372 35,551
Gross profit margin.............. 69.9% 71.8% 70.9% 71.2% 70.8%
Soft goods:
Net revenues..................... $32,010 $38,606 $51,412 $ 35,592 $ 46,194
Gross profit..................... 15,707 18,723 24,662 16,903 19,997
Gross profit margin.............. 49.1% 48.5% 48.0% 47.5% 43.3%
Specialty and other complementary
orthopedic products:
Net revenues..................... $15,653 $21,344 $29,647 $ 20,733 $ 27,371
Gross profit..................... 7,050 9,447 16,635 11,648 15,060
Gross profit margin.............. 45.0% 44.3% 56.1% 56.2% 55.0%
- --------------------------------------------------------------------------------------------------
</Table>
Our total gross profit margin was 55.2%, 55.6%, 58.1%, 57.9% and 57.7% for the
years ended December 31, 1998, 1999 and 2000 and the first nine months of 2000
and 2001, respectively. Total
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gross profit margins for 1998 and 1999 are lower due to charges for brand
royalties charged by Smith & Nephew which charges are no longer incurred by us
following the recapitalization. Excluding these charges, gross profit margins
for 1998 and 1999 were 58.3% and 57.1%, respectively.
Our products are marketed under the DonJoy-Registered Trademark-,
ProCare-Registered Trademark- and Alaron Surgical-TM- brand names through
several distribution channels. DonJoy-Registered Trademark- brand product sales
represented approximately 75% and 71% of total net revenues, excluding freight
revenue, in 2000 and the first nine months of 2001, respectively. Excluding
freight revenue, we marketed substantially all of our rigid knee braces,
approximately 84% of our specialty and other complementary orthopedic products
and approximately 41% of our soft goods products under the
DonJoy-Registered Trademark- brand name in 2000. ProCare-Registered Trademark-
brand product sales represented approximately 25% and 27% of total net revenues,
excluding freight revenue, in 2000 and the first nine months of 2001,
respectively. Excluding freight revenue, we sold approximately 59% of our soft
goods products, approximately 16% of our specialty and other complementary
orthopedic products and a nominal percentage of our rigid knee braces under the
ProCare-Registered Trademark- brand name in 2000. Following the Orthotech
acquisition, we sold products under the Orthotech brand; however, in 2000 we
integrated Orthotech products into the DonJoy-Registered Trademark- and
ProCare-Registered Trademark- brands. Our recently introduced surgical products
are marketed under the Alaron Surgical-TM- brand name.
Domestic sales
In the United States, DonJoy-Registered Trademark- brand products are marketed
to orthopedic sports medicine surgeons, orthotic and prosthetic centers,
hospitals, surgery centers, physical therapists and athletic trainers. Our
surgical products, which are sold under the Alaron Surgical-TM- brand name, are
marketed to orthopedic sports medicine surgeons, hospitals and surgery centers.
Both DonJoy-Registered Trademark- and Alaron Surgical-TM- products are sold by
38 commissioned sales agents who employ approximately 210 sales representatives.
After a product order is received by a sales representative, we generally ship
the product directly to the orthopedic professional and we pay a sales
commission to the agent on sales of such products, which commissions are
reflected in sales and marketing expense in our consolidated financial
statements. Excluding freight revenue, domestic sales of
DonJoy-Registered Trademark- brand products represented approximately 63% and
64% of total net revenues in 1999 and 2000, respectively, and 63% and 61% of
total net revenues in the first nine months of 2000 and 2001, respectively.
Our ProCare-Registered Trademark- products are sold in the United States to
third party distributors, including large, national distributors, regional
specialty dealers and medical products buying groups who generally purchase such
products at a discount from list prices. These distributors then resell
ProCare-Registered Trademark- products to large hospital chains, hospital buying
groups, primary care networks and orthopedic physicians for use by the patients.
Excluding freight revenue, domestic sales of ProCare-Registered Trademark-
products represented approximately 22% and 24% of total net revenues in 1999 and
2000, respectively, and 25% and 26% of total net revenues in the first nine
months of 2000 and 2001, respectively.
The change in the mix of domestic sales between the DonJoy-Registered Trademark-
and ProCare-Registered Trademark- brands has been a direct result of the
Orthotech acquisition. A majority of the Orthotech products were soft goods and
have been integrated into the ProCare-Registered Trademark- brands, thus
increasing the percent of domestic sales sold under the
ProCare-Registered Trademark- brand while decreasing the percent of domestic
sales sold under the DonJoy-Registered Trademark- brand.
International sales
Excluding freight revenue, international sales accounted for approximately 17%,
16%, 13%, 13% and 13% of our net revenues, in 1998, 1999 and 2000 and the first
nine months of 2000 and 2001, respectively. Excluding freight revenue, total
sales in Europe, Germany/Austria and Canada accounted for
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62%, 31% and 11%, respectively, of our 2000 international net revenues and 68%,
42% and 11%, respectively, of our international revenues in the first nine
months of 2001, with no other country accounting for 10% or more of our
international net revenues in 2000 or the first nine months of 2001. The
decrease in international net revenues as a percentage of total revenues in 2000
and the first nine months of 2001 as compared to prior years is a direct result
of the Orthotech business, which historically consisted primarily of domestic
sales.
International sales are currently made primarily through two distinct channels:
independent third party distributors (such as in Germany) and Smith & Nephew
sales organizations within certain major countries (such as Canada). We
distribute our products in Australia through dj Australia. Distributors in these
channels buy and resell the DonJoy-Registered Trademark- and
ProCare-Registered Trademark- brand products within their designated countries.
Excluding freight revenue, DonJoy-Registered Trademark- brand products
constituted approximately 90%, 86%, 85%, 89% and 89% of international net
revenues in 1998, 1999, 2000 and the first nine months of 2000 and 2001,
respectively. A significant amount of 2000 sales were transferred from Smith &
Nephew sales organizations to independent distributors. International sales made
through Smith & Nephew sales organizations were 52%, 40%, 20% and 13% of our
international sales, exclusive of freight revenue, in 1998, 1999 and 2000 and
the first nine months of 2001, respectively. We believe future opportunities for
sales growth within international markets are significant. We intend to
selectively replace our third-party independent distributors with wholly or
partially owned distributors in key countries where we believe the opportunity
for growth is significant due to higher per capita health care spending. We
believe that more direct control of the distribution network in these countries
will allow us to accelerate the launch of new products and product enhancements,
to benefit from the sale of our higher margin products and to capture the
distributor's margin. Our possible acquisitions, if completed, the establishment
of our Australian subsidiary and our recent decision not to renew the
distribution agreement with our existing distributor in Germany, the United
Kingdom and Austria effective December 31, 2001 represent our initial steps in
pursuing this strategy.
Since our international sales have historically been made in U.S. dollars, our
results of operations have not been directly impacted by foreign currency
exchange fluctuations. However, as was the case in 2000, the volume and product
mix of international sales has been and may continue to be adversely impacted by
foreign currency exchange fluctuations as changes in the rate of exchange
between the U.S. dollar and the applicable foreign currency will affect the cost
of our products to our customers and thus may impact the overall level of
customer purchases. International sales in 2000 were adversely impacted by
foreign currency exchange fluctuations as the strengthening of the U.S. dollar
against the Euro effectively increased the cost of our products to our European
customers. In addition, as we begin to directly distribute our products in
selected foreign countries, we expect that future sales of our products in these
markets will be denominated in the applicable foreign currencies which would
cause currency fluctuations to more directly impact our operating results. We
may seek to reduce the potential impact of currency fluctuations on our business
through hedging transactions.
We are also subject to other risks inherent in international operations
including political and economic conditions, foreign regulatory requirements,
exposure to different legal requirements and standards, potential difficulties
in protecting intellectual property, import and export restrictions, increased
costs of transportation or shipping, difficulties in staffing and managing
international operations, labor disputes, difficulties in collecting accounts
receivable and longer collection periods and potentially adverse tax
consequences. As we continue to expand our international business, our success
will be dependent, in part, on our ability to anticipate and effectively manage
these and other risks. These and other factors may have a material adverse
effect on our international operations or on our business, financial condition
and results of operations.
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Third party reimbursement; health care reform; managed care
While national health care reform and the advent of managed care has impacted
the orthopedic sports medicine market, its impact has not been as dramatic as
experienced by other sectors of the health care market, such as long term care,
physician practice management and managed care (capitation) programs. In recent
years, efforts to control medical costs within the United States have been
directed towards scrutiny of medical device reimbursement codes, whereby devices
are classified to determine the reimbursement levels including reimbursement for
products packaged with related orthopedic procedures. Reimbursement codes
covering certain of our products have been redefined, thereby reducing the
breadth of products for which reimbursement can be sought under recognized
codes. We expect that reduction in the total dollar value eligible for
reimbursement will occur in the future as the reform process continues.
In international markets, while the movement toward health care reform and the
development of managed care are generally not as advanced as in the United
States, we have experienced some downward pressure on the pricing of certain of
our products and other effects of health care reform similar to those we have
experienced in the United States. We expect health care reform and managed care
to continue to develop in primary international markets, including Europe and
Japan, which will result in further downward pressure on product pricing.
A further result of managed care and the related pressure on costs has been the
advent of buying groups in the United States which enter into preferred supplier
arrangements with one or more manufacturers of orthopedic or other medical
products in return for price discounts. Price discounting with buying groups is
an integral aspect of the competitive bid process in the marketplace. The impact
on our operating results is expected to be offset by increased volume
commitments offered by such buying groups and the opportunity to market products
not included in the request for bids. We have entered into national contracts
with selected buying groups and expect to enter into additional national
contracts in the future. We believe that the high level of product sales to such
groups, to the extent such groups are able to command a high level of compliance
by their members with the preferred supplier arrangements, and the opportunity
for increased market share can offset the financial impact of the price
discounting under such contracts. Revenues from group buying organizations
accounted for approximately 21% and 20% of our net revenues for the year ended
December 31, 2000 and the nine months ended September 29, 2001, respectively,
with the largest organization accounting for less than 5% of our net revenues.
Accordingly, although we cannot assure you, we believe that such price
discounting will not have a material adverse effect on our operating results in
the future. See "Risk factors--Healthcare reform, managed care and buying groups
have put downward pressure on the prices of our products" and "Business--Sales,
distribution and marketing--United States."
OfficeCare-Registered Trademark- program
In 1996, in response to the needs of our customers, we launched
OfficeCare-Registered Trademark-, an inventory management and insurance billing
program for our U.S. orthopedic sports medicine surgeons. Under the
OfficeCare-Registered Trademark- program, we provide the orthopedic sports
medicine surgeon with an inventory of orthopedic products for immediate
disbursement to the patient. We then seek reimbursement directly from the
patient's insurance company or other third party payor or from the patient where
self-pay is applicable. The majority of these billings are performed by an
independent third-party contractor.
Since its inception, the OfficeCare-Registered Trademark- program has been
promoted specifically to provide our orthopedic sports medicine surgeons with a
broad array of soft goods and certain other specialty products for
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immediate patient use. The OfficeCare-Registered Trademark- program is also
intended to facilitate the introduction of our products to the orthopedic sports
medicine surgeons who had not previously been our customers.
The OfficeCare-Registered Trademark- program represented approximately 6%, 10%,
9% and 13% of our net revenues, excluding freight revenue, for 1999 and 2000 and
the first nine months of 2000 and 2001, respectively, with sales of soft goods
and specialty and other complementary orthopedic products representing the
majority of such sales. The OfficeCare-Registered Trademark- program involves
our lower margin soft goods products, but is designed to also strengthen our
relationship with the customer, and serves to provide a pull-through effect for
both existing and planned sales of our higher margin products. The
OfficeCare-Registered Trademark- program has historically experienced a strong
growth rate, with an increase of sales, of 42% in 1999 over 1998, 99% in 2000
over 1999 and 69% for the first nine months of 2001 over the first nine months
of 2000. The increases in 2000 and the first nine months of 2001 are primarily
due to the Orthotech acquisition.
As a result of the growth of the program, our working capital needs have
significantly increased due to higher levels of accounts receivable and
inventories necessary to operate the program. In addition,
OfficeCare-Registered Trademark- has increased our involvement in the
third-party reimbursement process, or in certain cases, our direct billings to
the patient. The collection period for these receivables as compared to other
portions of our business is significantly longer and has also resulted in a need
to increase our accounts receivable discounts and allowance requirements. The
increase in the accounts receivable discounts and allowances for
OfficeCare-Registered Trademark- is the primary reason for the increase in our
accounts receivable discounts and allowances at December 31, 2000 and
September 29, 2001. Through December 31, 2000, we reflected allowances and
discounts applicable to the OfficeCare-Registered Trademark- program as selling
and marketing expense. With the growth in the program, management believes that
these charges are more appropriately presented as adjustments to revenues,
rather than as operating expense. As a result, we reclassified $0.6 million,
$1.3 million, $3.9 million and $2.3 million of charges for the years ended
December 31, 1998, 1999 and 2000 and the first nine months of 2000,
respectively, which were previously included in selling and marketing expenses,
against revenues related to our OfficeCare-Registered Trademark- program.
Smith & Nephew allocations and sales
Prior to December 29, 1998, our business was operated as the Bracing and Support
Systems Division of Smith & Nephew. Effective December 29, 1998, Smith & Nephew
contributed the Division's net assets and shares of a Mexican subsidiary to
DonJoy, L.L.C., then a newly formed Delaware limited liability company, the sole
member of which was Smith & Nephew. Accordingly, the contribution has been
accounted for on a predecessor basis for financial reporting purposes.
As a result of formerly being a division of Smith & Nephew, our historical
results of operations prior to the June 1999 recapitalization reflect certain
direct charges from Smith & Nephew as well as certain allocations of Smith &
Nephew's overhead and other expenses. These amounts were charged or allocated to
us on the basis of direct usage where identifiable, with the remainder allocated
to us on the basis of its annual sales or the capital employed by Smith & Nephew
in our business. See note 9 of the notes to DonJoy, L.L.C.'s consolidated
financial statements.
The following is a summary of such charges and allocations and their
applicability to us on a stand-alone basis following the recapitalization:
(1) Charges for brand royalties historically included in cost of goods
sold resulting from our use of the Smith & Nephew trademarks and trade
name. These charges were $3.2 million and $1.8 million in 1998 and 1999,
respectively. As a result of the recapitalization on June 30,
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1999, we no longer have the right to use the Smith & Nephew trademarks and
trade names and, accordingly, these charges are no longer incurred by us.
(2) Foreign sales corporation commissions historically included in general
and administrative expense paid by us on sales to foreign sales
corporations established by Smith & Nephew. The use of sales corporations
was a tax planning strategy for Smith & Nephew. These charges were
$0.4 million in 1998. As of January 1999, we no longer incurred these
charges.
(3) Smith & Nephew allocations for a portion of its corporate managed
accounts and new business expense and corporate management expense
historically were included in general and administrative expense. These
allocations were $1.7 million and $1.0 million in 1998 and 1999,
respectively. These allocations were for a portion of Smith & Nephew's
overhead expenses that we have not incurred or replaced following the
recapitalization.
(4) Smith & Nephew allocations for research and development and for
finance (risk management, treasury, audit and taxes), human resources and
payroll, and legal services historically provided by Smith & Nephew to us
were included in general and administrative expense. These allocations
were $1.7 million and $0.8 million in 1998 and 1999, respectively. These
allocations were for a portion of Smith & Nephew's overhead expenses. On a
stand-alone basis, we have replaced these services provided by Smith &
Nephew following the recapitalization and we have incurred additional
expenses associated with external auditing and periodic filings with the
SEC. We estimate that the aggregate annual cost of replacing these
services and such additional expenses that we replaced after the
recapitalization was approximately $0.8 million.
(5) Other allocations relating to bonuses, pension and insurance
historically included in cost of goods sold, sales and marketing expense
and general and administrative expense, and charges for payroll taxes and
benefits and direct legal expenses incurred by Smith & Nephew on our
behalf were included in general and administrative expense. These costs
and expenses are of a nature we continue to incur on a stand-alone basis
following the recapitalization.
Under a transition services agreement entered into in connection with the
recapitalization, Smith & Nephew continued to provide certain of the
administrative services referred to in paragraph (4) above as required by us
through November 30, 2000. We have replaced the services provided by Smith &
Nephew with internal staff, including the addition of new employees and through
arrangements with third party providers.
For the years ended December 31, 1998, 1999 and 2000 and the first nine months
of 2000 and 2001, sales to Smith & Nephew and its affiliates (including Smith &
Nephew's sales organizations) were $8.9 million, $7.2 million, $4.6 million,
$2.8 million and $2.1 million, respectively, or 9%, 6%, 3%, 3% and 2%
respectively, of total sales, excluding freight revenue, for these periods.
International sales made through Smith & Nephew sales organizations were 52%,
40%, 20% 22% and 13% of international sales, excluding freight revenue, in 1998,
1999 and 2000 and the first nine months of 2000 and 2001, respectively. In
connection with the recapitalization, Smith & Nephew and its sales
organizations, which distribute our products internationally, entered into
agreements with us regarding the purchase of our products following consummation
of the recapitalization. However, neither Smith & Nephew nor such sales
organizations have any obligation to purchase any specific or minimum quantity
of products pursuant to such agreements. See "Related party transactions--Other
agreements with Smith & Nephew--Supply agreement" and "--Distribution
agreement".
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Manufacturing cost reduction initiatives
Over the past several years, we have undertaken initiatives designed to further
strengthen our overall manufacturing cost structure and improve operating
efficiency. In order to take advantage of the lower labor costs in Mexico, in
1993 we began manufacturing certain of our labor intensive operations,
principally sewing, final assembly and packaging, in Tijuana, Mexico. In 1998,
we completed the consolidation of our domestic operations into one location in
Vista, California. As a result, we incurred $2.5 million of restructuring costs
in 1998, substantially all of which related to lease termination costs on the
vacated facility. Pursuant to the recapitalization agreement, the remainder of
the restructuring reserve, which amounted to $0.9 million at June 29, 1999 and
consisted of the remaining lease obligations on the vacated facility, was
assumed by Smith & Nephew. In addition, in 1998 general and administrative
expense included $0.2 million of costs related to moving costs resulting from
the consolidation of the facilities. Operating results for the first three
quarters of 1998 were adversely affected by the consolidation and integration of
the manufacturing operations of the DonJoy-Registered Trademark- and
ProCare-Registered Trademark- brands which were previously separate and
distinct, but returned to prior levels in the fourth quarter of 1998 and
sustained these levels through the remainder of 1999 and 2000.
In 2000, we completed the consolidation of the Orthotech operations into our
Vista, California location. Operating results for the last two quarters of 2000
were adversely affected by the consolidation and integration of the
manufacturing operations of the Orthotech brands which were previously separate
and distinct.
We have identified additional opportunities to reduce manufacturing costs and
improve operating efficiency. In 2001 we consolidated our two separate Mexican
operations into one campus location and have listed the vacated facility for
sale. We have recently leased additional space in Mexico, directly within the
current campus. Consolidation of these facilities will enable us to continue to
take advantage of the lower labor costs in Mexico and utilize the resulting
additional capacity in our U.S. facilities to manufacture our more
technologically advanced, high value products. We have begun to take advantage
of our operating efficiencies by moving our post operative and walker lines to
Mexico. By upgrading our computer systems to achieve more efficient production,
we expect to achieve material and labor cost reductions as well as economies of
scale across our entire manufacturing operation. We have converted our
manufacturing scheduling to produce finished goods upon customer demand. We will
further convert our procurement process to enable us to replenish our supply of
raw materials upon usage. Both processes will allow us to decrease the level of
inventory necessary to operate the business and reduce the risk of excess and
obsolete inventory. We have also reorganized our manufacturing facility into
product focused groups. The reorganization and streamlining of the manufacturing
facility is expected to reduce the total manufacturing costs, principally
overhead costs. In addition, we intend to further automate our manufacturing
operations in the rigid knee brace product line through the use of more
technologically advanced fabrication and equipment systems. We will continue to
rationalize raw materials used in the production of our existing products,
thereby enabling us to leverage our purchasing power. Finally, in order to
achieve further cost savings, we intend to further reduce the number of stock
keeping units (SKUs) without impacting service or breadth of our product range.
Basis of presentation; taxes
Our former parent files a consolidated federal income tax return which includes
all of its eligible subsidiaries and divisions, which included us prior to the
recapitalization. The provision for income taxes has been presented assuming we
filed a separate federal income tax return. The recapitalization had no impact
on the historical basis of our assets and liabilities as reflected in our
consolidated financial
57
<Page>
statements except for the elimination of the remaining restructuring reserve and
the intercompany accounts. However, as a result of the recapitalization, for
federal income tax purposes, we have recorded an increase in the tax basis of
our fixed and intangible assets in an amount approximately equal to the taxable
gain recognized by Smith & Nephew on the sale of its interest in us. As a
result, after the recapitalization, for tax purposes we are able to depreciate
assets with a higher tax basis than for financial reporting purposes. The
increase in tax basis as of December 31, 1999 was as follows (in thousands):
<Table>
- ----------------------------------------------------------------------
Inventory................................................... $ 3,670
Property, plant & equipment................................. 4,145
Goodwill.................................................... 130,543
--------
$138,358
- ----------------------------------------------------------------------
</Table>
The Orthotech acquisition also resulted in an increase in the tax basis due to
the fixed and intangible assets acquired. The increase in tax basis due to the
Orthotech acquisition is equal to the amounts we recorded under purchase
accounting. See note 2 of the notes to DonJoy, L.L.C.'s consolidated financial
statements.
Prior to the recapitalization, our results of operations were included in the
consolidated federal income tax returns that Smith & Nephew filed in the United
States and the historical financial statements reflect a provision for income
taxes assuming that we had filed a separate federal income tax return. As
limited liability companies, DonJoy, L.L.C. and dj Orthopedics, LLC were not
subject to income taxes following the recapitalization. Instead, DonJoy,
L.L.C.'s earnings following the recapitalization were allocated to its members
and included in the taxable income of the members. The indenture governing the
notes and the credit facility currently permit dj Orthopedics, LLC to make
distributions to dj Orthopedics, Inc. in amounts required for dj Orthopedics,
Inc. to pay federal, state and local income taxes to the extent such income
taxes are attributable to the income of dj Orthopedics, LLC and its
subsidiaries.
Effects of the reorganization
Upon the consummation of the initial public offering and the reorganization, our
parent, dj Orthopedics, Inc., became subject to the payment of federal income
taxes and is required to file a separate federal tax return. In addition, we
will record a deferred tax asset of approximately $54.8 million, representing
the difference at September 29, 2001 between the book basis and tax basis of the
assets of DonJoy, L.L.C. We will also incur an extraordinary charge, net of tax,
of approximately $3.3 million for the write-off of unamortized deferred debt
issuance costs, debt discount and prepayment premiums as a result of the
redemption of a portion of the notes. These amounts will be reflected in dj
Orthopedics, Inc.'s financial statements in the quarter or quarters in which the
reorganization, the repayment of the revolving credit facility and the
redemption of the redeemable preferred units and a portion of the notes occur.
See "Unaudited pro forma consolidated financial information."
Results of operations
We operate our business on a manufacturing calendar, with our fiscal year always
ending on December 31. Each quarter is 13 weeks, consisting of one five-week
and two four-week periods. The first and fourth quarters may have more or less
working days from year to year based on what day of the week holidays fall on.
The first nine months of 2001 contained one less business day than the first
nine months of 2000, which resulted in approximately $0.7 million less revenue
in the first nine months of 2001 as compared to the first nine months of 2000.
58
<Page>
In the fourth quarter of 2000, we adopted Emerging Issues Task Force (EITF)
Issue 00-10 "Accounting for Shipping and Handling Fees and Costs." As a result,
we have reclassified $3.5 million, $3.5 million, $4.4 million, and $3.2 million
for December 31, 1998, 1999 and 2000 and the first nine months of 2000,
respectively, of freight revenue from sales and marketing expenses into net
revenues. We continue to include freight expenses in sales and marketing
expense.
The following table sets forth our operating results as a percentage of net
revenues:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------
Years ended Nine months ended
December 31, -------------------------------
------------------------ September 30, September 29,
1998 1999 2000 2000 2001
- -------------------------------------------------------------------------------------------------------
Net revenues:
Rigid knee bracing....................... 50.6% 45.5% 40.5% 41.7% 39.4%
Soft goods............................... 30.9 33.2 35.8 34.8 36.3
Specialty and other complementary
orthopedic products.................... 15.1 18.3 20.6 20.3 21.5
----------------------------------------------------------
Revenues from product lines................ 96.6 97.0 96.9 96.8 97.2
Freight revenue.......................... 3.4 3.0 3.1 3.2 2.8
----------------------------------------------------------
Total consolidated net revenues............ 100.0 100.0 100.0 100.0 100.0
Cost of goods sold......................... 44.8 44.4 41.9 42.1 42.3
----------------------------------------------------------
Gross profit............................... 55.2 55.6 58.1 57.9 57.7
Sales and marketing...................... 26.7 24.9 26.9 26.2 28.0
General and administrative............... 15.9 14.4 13.8 14.2 14.3
Research and development................. 2.2 1.8 1.7 1.6 1.4
Merger and integration costs............. -- -- 0.3 0.4 --
Restructuring costs...................... 2.3 -- -- -- --
----------------------------------------------------------
Income from operations..................... 8.1 14.5 15.4 15.5 14.0
Interest expense........................... -- (6.5) (11.8) (12.0) (10.8)
Interest income............................ -- 0.2 0.3 0.3 0.2
Discontinued acquisition costs............. -- -- (0.3) -- --
----------------------------------------------------------
Income before income taxes................. 8.1 8.2 3.6 3.8 3.4
Provision for income taxes................. (3.3) (2.1) -- -- --
----------------------------------------------------------
Net income................................. 4.8% 6.1% 3.6% 3.8% 3.4%
- -------------------------------------------------------------------------------------------------------
</Table>
59
<Page>
The following table summarizes certain of our operating results by quarter for
1999 and 2000 and the first nine months of 2001:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
Year ended December 31, 1999
------------------------------------------------
First Second Third Fourth Total
(in thousands) quarter quarter quarter quarter year
- --------------------------------------------------------------------------------------------
Net revenues.............................. $29,030 $26,400 $30,717 $30,271 $116,418
Gross profit.............................. 15,517 14,364 17,711 17,082 64,674
Income from operations.................... 3,080 2,739 5,637 5,446 16,902
Number of operating days.................. 64 61 66 60 251
- --------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
Year ended December 31, 2000
------------------------------------------------
First Second Third Fourth Total
(in thousands) quarter quarter quarter quarter year
- --------------------------------------------------------------------------------------------
Net revenues.............................. $31,881 $30,432 $39,873 $41,400 $143,586
Gross profit.............................. 18,997 18,111 22,028 24,272 83,408
Income from operations.................... 5,809 5,386 4,583 6,351 22,129
Number of operating days.................. 65 63 63 61 252
- --------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------------------------------
Nine months ended
September 29, 2001
---------------------------
First Second Third
(in thousands) quarter quarter quarter
- -----------------------------------------------------------------------------------------
Net revenues................................................ $40,295 $42,988 $44,078
Gross profit................................................ 23,528 25,075 24,902
Income from operations...................................... 5,994 5,731 6,036
Number of operating days.................................... 64 63 63
- -----------------------------------------------------------------------------------------
</Table>
Several factors impacted our business during the four quarters following the
Orthotech acquisition. The closing of the Orthotech facility shortly after the
acquisition required that significant resources be allocated to the integration
of Orthotech manufacturing operations into our Vista facility. We also decided
to pursue another strategic acquisition. These matters diverted resources from a
planned significant implementation of a new company-wide enterprise resource
planning (ERP) system and led to a decision to delay completion of the ERP
system implementation. The proposed acquisition was terminated in the fourth
quarter of 2000 and the ERP system implementation was completed in March 2001,
approximately seven months later than originally planned. These factors,
together with the increased debt leverage resulting from Orthotech acquisition,
affected our operating results during the second half of 2000 and the first six
months of 2001. With both the full integration of Orthotech into our business
and the ERP system implementation now having been completed, the synergies and
operating efficiencies originally expected from the Orthotech acquisition and
the ERP system are beginning to be realized.
Nine months ended September 29, 2001 compared to nine months ended
September 30, 2000
Net revenues. Net revenues increased $25.2 million, or 24.6%, to
$127.4 million for the first nine months of 2001 from $102.2 million for the
first nine months of 2000. Net revenues, excluding freight
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<Page>
revenue, for the rigid knee bracing segment increased $7.6 million over the
prior period due to growth in the domestic sales of the OA and ligament product
lines. We introduced the DonJoy Vista-TM- Rehabilitation System in April 2001,
the SE Four Point Brace in March 2001, and a low cost ACL off-the-shelf brace
and a new post-operative brace line with telescoping bars in February 2001. Soft
goods sales, excluding freight revenue, increased by $10.6 million over the
prior period due primarily to the Orthotech acquisition, a $2.4 million growth
in the OfficeCare-Registered Trademark- program, a substantial portion of which
was due to the Orthotech acquisition, and $7.5 million from increased sales
volumes of wrist splints, ankle braces and knee braces, including those sold
through the OfficeCare-Registered Trademark- program. Specialty and other
complementary orthopedic products sales, excluding freight revenue, increased by
$6.6 million over the prior period due primarily to a $6.4 million increase in
sales of lower extremity walkers, cold therapy units, and shoulder braces, as
well as the growth of the OfficeCare-Registered Trademark- program. Specialty
and other complementary products sales in the first nine months of 2001 included
less than $50,000 from sales of our Alaron Surgical-TM- products, which were
introduced in August 2001.
Gross profit. Gross profit increased $14.4 million, or 24.3%, to $73.5 million
for the first nine months of 2001 from $59.1 million for the first nine months
of 2000. Gross profit margin decreased from 57.9% for the first nine months of
2000 to 57.7% for the first nine months of 2001 primarily as a result of
increased soft goods sales which carry a lower gross profit margin. The decrease
in gross profit margin primarily reflects the effects of the Orthotech
acquisition, which occurred in July 2000, and the related increase in soft goods
in the mix of products sold. Our gross profit margin subsequent to the Orthotech
acquisition has remained relatively constant. Gross profit for the rigid knee
bracing segment increased $5.2 million, with gross profit margins at 70.8% for
the first nine months of 2001 versus 71.2% for the comparable period in 2000.
Gross profit for the soft goods segment increased $3.1 million, with gross
profit margin decreasing to 43.3% for the first nine months of 2001 from 47.5%
for the comparable period in 2000. This decrease in gross profit margin is a
result of the change in product mix, primarily related to sales of Orthotech
products. Gross profit for the specialty and other complementary orthopedic
products segment increased $3.4 million, with gross profit margin decreasing to
55.0% for the first nine months of 2001 from 56.2% for the comparable period in
2000. The decrease in the gross profit margin is a result of the change in
product mix, primarily related to sales of Orthotech products.
Sales and marketing expenses. Sales and marketing expenses increased
$8.9 million, or 33.3%, to $35.7 million for the first nine months of 2001 from
$26.8 million for the first nine months of 2000. The increase primarily reflects
increased commissions ($1.9 million) due to higher sales of domestic products,
increased freight expenses ($1.8 million), increased costs ($2.9 million)
related to OfficeCare-Registered Trademark- volumes and an increase in salaries
and benefits ($2.6 million) due to increased headcount. Headcount increased due
to the Orthotech acquisition and growth in the OfficeCare-Registered Trademark-
program. In addition, amortization expense related to the intangibles acquired
in the Orthotech acquisition was $0.3 million in the first nine months of 2001
and minimal during the 2000 period. Overall, sales and marketing expense
increased as a percentage of revenues to 28.0% for the first nine months of 2001
from 26.2% for the comparable period in 2000.
General and administrative expenses. General and administrative expenses
increased $3.7 million, or 25.7%, to $18.2 million for the first nine months of
2001 from $14.5 million for the first nine months of 2000. The increase was
primarily due to amortization associated with the intangible assets acquired as
part of the July 2000 acquisition of Orthotech. These amortization expenses were
$1.0 million in the 2001 period and $0.7 million in the 2000 period. To a lesser
extent, the increase in general and administrative expenses reflected expenses
related to these acquisitions and the creation of
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<Page>
dj Australia and depreciation associated with our new enterprise software
system. Overall, general and administrative expenses increased slightly as a
percentage of revenues to 14.3% for the first nine months of 2001 compared to
14.2% for the first nine months of 2000.
Research and development expenses. Research and development expenses increased
$0.1 million, or 8.0%, to $1.8 million for the first nine months of 2001 from
$1.7 million for the first nine months of 2000. During the second quarter of
2001, we introduced the DonJoy VISTA-TM- Rehabilitation System. In addition, we
developed a low cost ACL off-the-shelf brace, a new post operative brace line
with telescoping bars along with other competitive products, and the
SE Brace II. We have also continued to focus on the development of our new bone
growth stimulation product, Orthopulse-Registered Trademark-.
Merger and integration costs. In the 2000 period, we incurred $0.4 million in
one-time merger and integration costs associated with the consolidation of the
Orthotech operations into our existing facilities including merger and
integration and information systems consulting costs. Other integration costs
are included in the operating expenses above.
Interest expense. Interest expense increased approximately $1.5 million, or
11.9% to $13.7 million in the first nine months of 2001 from $12.2 million in
the first nine months of 2000. The 2001 interest expense reflects the additional
interest expense on the $24.0 million term loan and the $12.6 million borrowing
under the revolving credit facility, both of which were incurred in July 2000 to
partially finance the Orthotech acquisition. There were additional borrowings of
$8.0 million under the revolving credit facility in December 2000 which also
contributed to the increase in interest expense, offset in part by our
$5.0 million and $2.0 million repayments under the revolving credit facility in
June 2001 and July 2001, respectively.
Year ended December 31, 2000 compared to year ended December 31, 1999
Net revenues. Net revenues increased $27.2 million, or 23.3%, to
$143.6 million in 2000 from $116.4 million in 1999. Net revenues, excluding
freight revenue, for the rigid knee-bracing segment increased $5.2 million over
the prior year due to growth in the domestic sales for the OA and post-operative
product lines including the introduction of the OAdjuster-TM- brace in
March 2000. Soft goods sales, excluding freight revenue, increased by
$12.8 million over the prior year due primarily to the Orthotech acquisition,
including $10.5 million from increased sales volumes of wrist splints, ankle
braces and knee braces. The increases also reflected a $3.2 million growth in
the OfficeCare-TM- program. Specialty and other complementary orthopedic product
sales, excluding freight revenue, increased by $8.3 million over the prior year
due primarily to the PainBuster-Registered Trademark- Pain Management system,
cold therapy units, shoulder bracing and to increased sales of lower extremity
walkers, as well as the growth in the OfficeCare-Registered Trademark- program.
Gross profit. Gross profit increased $18.7 million, or 29.0%, to $83.4 million
in 2000 from $64.7 million in 1999 primarily as a result of the Orthotech
acquisition. Gross profit margin increased to 58.1% in 2000 from 55.6% in 1999,
primarily as a result of the elimination of Smith & Nephew charges for brand
royalties which totalled $1.8 million in 1999 and were not incurred in 2000. As
a result of the consummation of the recapitalization on June 30, 1999, we no
longer have the right to use the Smith & Nephew trademarks and trade names and,
accordingly, charges for brand royalties are no longer incurred by us. In
addition, gross profit margin increased as a result of increased walker sales
combined with the implementation of efficient manufacturing techniques in the
United States and Mexico. Gross profit, excluding freight revenue, for the rigid
knee bracing segment increased $3.2 million, with gross profit margin decreasing
to 70.9% from 71.7%. The margin decrease reflects
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<Page>
the change in product mix. Gross profit, excluding freight revenue, for the soft
goods segment increased $5.9 million as a result of increased sales volume, with
gross profit decreasing to 48.0% from 48.5% in 1999. Gross profit, excluding
freight revenue, for the specialty and other complementary orthopedic products
segment increased $7.2 million, with gross profit margin increasing to 56.1%
from 44.3%. The increase in gross profit margin reflects lower costs associated
with the production of walkers, which resulted from the production of these
walkers moving to our facilities in Mexico in the first quarter of 2000 to take
advantage of labor cost savings. Other cost of goods sold not allocable to
specific product lines increased $0.3 million from 1999 primarily due to the
step-up in inventory acquired in the Orthotech acquisition to fair market value,
and various facility costs incurred as part of the Orthotech acquisition.
Sales and marketing expenses. Sales and marketing expenses increased
$9.8 million, or 33.7%, to $38.7 million in 2000 from $28.9 million in 1999. The
increase primarily reflected a $2.7 million increase in commissions associated
with higher sales of DonJoy products in the United States and increased costs of
$1.6 million associated with the OfficeCare-TM- program. In addition, as a
result of the Orthotech acquisition, we incurred higher than anticipated freight
expenses along with amortization expense related to the acquired intangibles.
General and administrative expenses. General and administrative expenses
increased $3.0 million, or 17.9%, to $19.8 million in 2000 from $16.8 million in
1999. In 2000, we completed the consolidation of the Orthotech operations into
our Vista, California location. As a result, we incurred $0.5 million in
consolidation costs consisting primarily of consulting, information systems,
travel and moving expenses. The increase was also due to a $1.6 million increase
in salaries and benefits, $0.5 million in consulting expenses related to the
implementation of a new Enterprise Resource Planning (ERP) System in the 2000
period with minimal expense in the 1999 period and human resources support
combined with a $0.9 million increase in amortization associated with the
intangible assets acquired as part of the Orthotech acquisition.
Research and development expenses. Research and development expenses increased
$0.4 million, or 16.5%, to $2.5 million in 2000 from $2.1 million in 1999. The
increase was primarily due to investment in clinical trials associated with new
product development, licensed products, as well as continued studies in core
product efficacy.
Merger and integration costs. We incurred $0.4 million in one-time merger and
integration costs associated with the consolidation of the Orthotech operations
into our existing facilities including merger and integration and information
systems consulting. Other integration costs are included in the operating
expenses above.
Interest expense. Interest expense increased $9.4 million, or 124.1% to
$17.0 million in 2000 from $7.6 million in 1999. The recapitalization occurred
in June 1999 and thus 1999 includes only six months of interest expense on the
$100.0 million principal amount of senior subordinated notes and the
$15.5 million term loan borrowed under the credit agreement to partially finance
the recapitalization. Additionally, 2000 includes additional interest expense on
the $24.0 million term loan and the $12.6 million borrowing under the revolving
credit facility, both of which were incurred to partially finance the Orthotech
acquisition.
Year ended December 31, 1999 compared to year ended December 31, 1998
Net revenues. Net revenues increased $12.8 million, or 12.3%, to
$116.4 million in 1999 from $103.6 million in 1998. Net revenues, excluding
freight revenue, for the rigid knee bracing segment
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increased $0.5 million over the prior year due to increased sales of ligament
braces, including the introduction of the 4TITUDE-Registered Trademark- brace
and post-operative braces in June 1999. Soft goods sales, excluding freight
revenue, increased $6.6 million over the prior year due primarily to increased
sales volumes of neoprene bracing products, wrist splints, ankle braces and
other soft good supports, including the introduction of the
On-Track-Registered Trademark- system. These increases primarily reflect the
effect of national contracts entered into in the second half of 1998 as well as
the $0.8 million growth of the OfficeCare-Registered Trademark- program.
Specialty and other complementary orthopedic products sales, excluding freight
revenue, increased by $5.7 million over the prior year due primarily to the
recently introduced PainBuster-Registered Trademark- Pain Management Systems,
cold therapy units and to increased sales of lower extremity walkers as well as
growth of the OfficeCare-Registered Trademark- program.
Gross profit. Gross profit increased $7.5 million, or 13.1%, to $64.7 million
in 1999 from $57.2 million in 1998. Gross profit margin increased to 55.6% in
1999 from 55.2% in 1998. The 1999 period included only six months of charges for
brand royalties paid to Smith & Nephew, which were $1.8 million, as compared to
a full twelve months of such charges in 1998, which were $3.2 million. Gross
profit, excluding freight revenue, for the rigid knee bracing segment increased
$1.3 million, with gross profit margin increasing to 71.7% from 69.9%. These
increases reflected the improved product mix. Gross profit, excluding freight
revenue, for the soft goods segment increased $3.0 million as a result of
increased sales volume, with gross profit margin decreasing to 48.5% from 49.1%.
Gross profit, excluding freight revenue, for the specialty and other
complementary orthopedic products segment increased $2.4 million, with gross
profit margin decreasing to 44.3% from 45.0%, reflecting increased sales of
lower margin products. As a result of the consummation of the recapitalization
on June 30, 1999, we no longer have the right to use the Smith & Nephew
trademarks and trade names and, accordingly, charges for brand royalties are no
longer incurred by us. Other cost of goods sold not allocable to specific
product lines increased to $3.2 million in 1999 from $2.5 million in 1998. This
increase is primarily due to costs associated with support of the SKU reduction
plan, the OfficeCare-Registered Trademark- program and the amortization of the
PainBuster-Registered Trademark- Pain Management System distribution rights.
Sales and marketing expenses. Sales and marketing expenses increased
$1.3 million, or 4.6%, to $28.9 million in 1999 from $27.6 million in 1998. The
increase primarily reflected a $0.6 million increase in commissions associated
with higher sales of DonJoy-Registered Trademark- products in the United States
and a $0.7 million increase in costs associated with the
OfficeCare-Registered Trademark- program.
General and administrative expenses. General and administrative expenses
increased $0.3 million, or 1.6%, to $16.8 million in 1999 from $16.5 million in
1998. The increase was primarily due to a $1.3 million increase in salaries and
benefits offset by a reduction in corporate allocations from Smith & Nephew of
$1.9 million. General and administrative expenses declined as a percentage of
net revenues to 14.4% from 15.9% primarily due to the reduction in Smith &
Nephew allocations.
Research and development expenses. Research and development expenses were
approximately equal over the two periods. Significant resources within the
department were re-deployed to focus primarily on the development of the DonJoy
Vista-TM- Rehabilitation System as well as the development and release of the
new 4TITUDE-Registered Trademark- brace in June 1999.
Restructuring costs. In March 1998, we combined our two operating facilities
into one location in Vista, California and accrued $2.5 million in costs
resulting from the restructuring which had no future economic benefit. These
costs related primarily to remaining lease obligations on the vacated facility,
net of projected sublease income, and severance costs associated with the
termination of twelve employees.
64
<Page>
Interest expense. Interest expense in 1999 was $7.6 million. The
recapitalization occurred in June 1999 and thus 1999 includes only six months of
interest expense on the $100.0 million principal amount of senior subordinated
notes and the $15.5 million term loan borrowed under the credit agreement to
partially finance the recapitalization.
Liquidity and capital resources
Our principal liquidity requirements are to service our debt and meet our
working capital and capital expenditure needs. Long-term indebtedness at
September 29, 2001 was $149.4 million. After giving effect to the initial public
offering of common stock of dj Orthopedics, Inc. and the application of the
proceeds thereof to repay borrowings under our revolving credit facility and to
redeem $25.0 million principal amount of the senior subordinated notes, our pro
forma long-term indebtedness would have been $111.2 million.
Net cash provided by operating activities was $3.7 million, $16.1 million,
$1.2 million, $5.8 million and $3.5 million in 1998, 1999, 2000, and the first
nine months of 2000 and 2001, respectively. The decrease of $2.3 million in the
first nine months of 2001 primarily reflects increased inventory levels in
conjunction with the working capital needs associated with the Orthotech
acquisition combined with decreased levels of accrued liabilities. The decrease
of $14.9 million in 2000 primarily reflects the increased levels in accounts
receivable and inventories during 2000 as compared to 1999, primarily as a
result of the working capital needs associated with the Orthotech acquisition
(which did not include the purchase of the Orthotech historical accounts
receivables).
Cash flows used in investing activities were $4.0 million, $4.8 million,
$57.0 million, $54.6 million and $7.0 million for 1998, 1999, 2000 and the first
nine months of 2000 and 2001, respectively. Capital expenditures in the first
nine months of 2001 primarily reflected an increase in the capitalization of
costs directly associated with our acquisition and implementation of an
enterprise resource planning system which was completed in March 2001,
investments in manufacturing equipment, and the Alaron acquisition in
June 2001. Included in investing activities in 2000 is the $46.4 million
investment in Orthotech, exclusive of transaction fees and expenses of
$3.0 million. Capital expenditures in 2000 primarily reflect an increase in
construction in progress related to the capitalization of costs directly
associated with our acquisition and implementation of an enterprise resource
planning system and investments in manufacturing equipment.
Capital expenditures for the remainder of 2001 are estimated at $2.6 million,
substantially all of which are maintenance capital expenditures. We also
purchased in October 2001 5% of the equity in a licensor of one of our products
for an aggregate purchase price of $0.5 million.
Cash flows provided by (used in) financing activities were $0.2 million, $(6.2)
million, $54.0 million, $46.4 million and $1.4 million in 1998, 1999, and 2000
and the first nine months of 2000 and 2001, respectively. The increase in the
first nine months of 2001 is the primarily the result of the $9.6 million in net
proceeds from an equity investment in June 2001 net of $8.0 million repaid under
our credit facility. The sources of funds in 2000 primarily reflect the
$24.0 million term loan and $12.6 million of borrowings under the revolving
credit facility during the third quarter of 2000 and the net proceeds from the
issuance by DonJoy, L.L.C. of common and preferred units in the third quarter of
2000, all related to the Orthotech acquisition. We borrowed an additional
$8.0 million at the end of 2000 as a result of the increase in working capital
associated with the Orthotech acquisition. Prior to the recapitalization, we
participated in Smith & Nephew's central cash management program, wherein all of
our cash receipts were remitted to Smith & Nephew and all cash disbursements
were funded by Smith &
65
<Page>
Nephew. Following the recapitalization, we no longer participate in Smith &
Nephew's cash management program.
Interest payments on the senior subordinated notes and on borrowings under the
credit facility have significantly increased our liquidity requirements. The
$100.0 million of senior subordinated notes, due 2009, bear interest at 12 5/8%,
payable semi-annually on June 15 and December 15. The credit facility provides
for two term loans totaling $39.5 million, of which $37.4 million was
outstanding at September 29, 2001. The first term loan, in the amount of
$15.5 million, was borrowed in connection with the recapitalization and the
second term loan, in the amount of $24.0 million, was borrowed to finance the
Orthotech acquisition. We also have available up to $25.0 million under the
revolving credit facility, which is available for working capital and general
corporate purposes, including financing of acquisitions, investments and
strategic alliances. As of September 29, 2001, we had $13.6 million outstanding
under that facility, primarily due to the Orthotech acquisition. Borrowings
under the term loans and on the revolving credit facility bear interest at
variable rates plus an applicable margin. At September 29, 2001, the effective
interest rate on the term loans and the revolving credit facility was 5.7% and
5.3%, respectively.
The following table sets forth the principal payments on the term loans for the
last three months of 2001 through their maturity in 2005:
<Table>
<Caption>
- -----------------------------------------------------------------------
Principal
Year payment
- -----------------------------------------------------------------------
2001........................................................ $ 317
2002........................................................ 1,274
2003........................................................ 1,274
2004........................................................ 17,202
2005........................................................ 17,338
- -----------------------------------------------------------------------
</Table>
We repaid $13.6 million of borrowings under the revolving credit facility with a
portion of the net proceeds of the initial public offering. Such repayment can
be reborrowed.
In addition, we are required to make annual mandatory prepayments of the term
loans under the credit facility in an amount equal to 50% of excess cash flow
(as defined in the credit facility) (75% if our leverage ratio exceeds a certain
level). We had no excess cash flow at December 31, 2000 or December 31, 1999. In
addition, the term loans are subject to mandatory prepayments in an amount equal
to (a) 100% of the net cash proceeds of certain equity and debt issuances by us,
our parent company or any of our other subsidiaries and (b) 100% of the net cash
proceeds of certain asset sales or other dispositions of property by us, our
parent company or any of our other subsidiaries, in each case subject to certain
exceptions. No mandatory prepayments were required at December 31, 2000 or
December 31, 1999. In August 2001, we obtained a waiver from our bank lenders
with respect to our obligation to prepay the term loans with the proceeds of the
$10.0 million equity investment.
The credit facility and the indenture impose certain restrictions on us,
including restrictions on our ability to incur indebtedness, pay dividends, make
investments, grant liens, sell our assets and engage in certain other
activities. In addition, the credit facility requires us to maintain certain
financial ratios. At September 29, 2001, we were in compliance with all of these
covenants. Indebtedness under the credit facility is secured by substantially
all of our assets, including our real and personal property, inventory, accounts
receivable, intellectual property and other intangibles.
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We incurred fees and costs of $8.8 million in connection with the
recapitalization. Approximately $7.4 million, principally relating to financing
fees and expenses, has been capitalized and are being amortized over the terms
of the related debt instruments.
As part of our strategy, we intend to pursue acquisitions, such as the Orthotech
and Alaron acquisitions, investments and strategic alliances. We may require new
sources of financing to consummate any such transactions, including additional
debt or equity financing. We cannot assure you that such additional sources of
financing will be available on acceptable terms, if at all.
Our ability to satisfy our debt obligations and to pay principal and interest on
our indebtedness, fund working capital requirements and make anticipated capital
expenditures will depend on our future performance, which is subject to general
economic, financial and other factors, some of which are beyond our control.
Management believes that based on current levels of operations and anticipated
growth, cash flow from operations, together with other available sources of
funds including the availability of borrowings under the revolving credit
facility, will be adequate for at least the next twelve months to make required
payments of principal and interest on our indebtedness, to fund anticipated
capital expenditures and for working capital requirements. There can be no
assurance, however, that our business will generate sufficient cash flow from
operations or that future borrowings will be available under the revolving
credit facility in an amount sufficient to enable us to service our indebtedness
or to fund our other liquidity needs. In such event, we may need to raise
additional funds through public or private equity or debt financings. We cannot
assure you that any such funds will be available to us on favorable terms or at
all.
Market risk
We are exposed to certain market risks as part of our ongoing business
operations. Primary exposure includes changes in interest rates. We are exposed
to interest rate risk in connection with the term loans and borrowings under the
revolving credit facility which bear interest at floating rates based on London
Inter-Bank Offered Rate (LIBOR) or the prime rate plus an applicable borrowing
margin. We manage our interest rate risk by balancing the amount of fixed and
variable debt. For fixed rate debt, interest rate changes affect the fair market
value but do not impact earnings or cash flows. Conversely, for variable rate
debt, interest rate changes generally do not affect the fair market value but do
impact future earnings and cash flows, assuming other factors are held constant.
As of September 29, 2001, we had $100.0 million principal amount of fixed rate
debt represented by the senior subordinated notes and $51.0 million of variable
rate debt represented by borrowings under the credit facility (at interest rates
ranging from 5.19% to 5.81% at September 29, 2001). Based on our current balance
outstanding under the credit facility, an immediate change of one percentage
point in the applicable interest rate would cause an increase or decrease in
interest expense of approximately $0.5 million on an annual basis. At
September 29, 2001, up to $11.4 million of variable rate borrowings was
available under the revolving credit facility. We may use derivative financial
instruments, where appropriate, to manage our interest rate risks. However, as a
matter of policy, we do not enter into derivative or other financial investments
for trading or speculative purposes. As all of our sales have historically been
denominated in U.S. dollars; we have not been subject to foreign currency
exchange risk. However, as we begin to directly distribute our products in
selected foreign markets, we expect that future sales of our products in these
markets will be denominated in the applicable foreign currencies which would
cause currency fluctuations to more directly impact our operating results. We
may seek to reduce the potential impact of currency fluctuations on our business
through hedging transactions.
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Seasonality
We generally record our highest net revenues in the first and fourth quarters
due to the greater number of orthopedic surgeries and injuries resulting from
increased sports activity, particularly football and skiing. In addition, during
the fourth quarter, a patient has a greater likelihood of having satisfied his
annual insurance deductible than in the first three-quarters of the year, and
thus there is an increase in the number of elective orthopedic surgeries.
Conversely, we generally have lower net revenues during the second and third
quarters as a result of decreased sports activity and fewer orthopedic
surgeries. Our results of operations would be adversely and disproportionately
affected if our sales were substantially lower than those normally expected
during the first and fourth quarters. Increases in our net revenues beginning in
the third quarter of 2000 reflect the Orthotech acquisition.
Recent accounting pronouncements
We adopted Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities," of the Financial
Accounting Standards Board (FASB) in the first quarter of 2001. SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
hedging activities and requires the recognition of all derivatives on our
balance sheet at fair market value. The adoption of SFAS No. 133 on our
financial statements for the first nine months of 2001 was not material.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Use of the pooling-of-interests method is no longer
permitted. SFAS No. 141 also includes guidance on the initial recognition and
measurement of goodwill and other intangible assets acquired in a business
combination that is completed after June 30, 2001. SFAS No.142 no longer permits
the amortization of goodwill and indefinite-lived intangible assets. Instead,
these assets must be reviewed annually, or more frequently in some
circumstances, for impairment in accordance with this statement. This impairment
test uses a fair value approach rather than the undiscounted cash flows approach
previously required by SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Intangible
assets that do not have indefinite lives will continue to be amortized over
their useful lives and reviewed for impairment in accordance with SFAS No. 121.
We are required to adopt SFAS No. 142 effective January 1, 2002 at which time we
will be required to reassess the intangible assets, including goodwill,
previously recorded in connection with previous purchase acquisitions, as well
as the useful lives of such intangible assets. Upon adoption of SFAS 142, we
will stop amortizing goodwill and certain other intangibles resulting from
acquisitions prior to July 1, 2001, which has been estimated to reduce annual
amortization expense by approximately $3.4 million. Goodwill and intangibles
with indefinite lives will be assigned to reporting units as determined by us
for purposes of impairment testing and tested using a two-step approach for
impairment annually or whenever there is an impairment indicator. The impact of
stopping goodwill amortization has been estimated to increase our annual net
income by approximately $2.0 million.
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Business
Overview
We are a global orthopedic sports medicine company specializing in the design,
manufacture and marketing of surgical and non-surgical products and services
that repair, regenerate and rehabilitate soft tissue and bone, help protect
against injury, and treat osteoarthritis of the knee. Osteoarthritis is a form
of damage to or degeneration of the articular surface of a joint. Our broad
range of over 600 existing products, many of which are based on proprietary
technologies, includes rigid knee braces, soft goods, specialty and other
complementary orthopedic products and our recently introduced line of surgical
products. These products provide solutions for patients and orthopedic sports
medicine professionals throughout the patient's continuum of care.
We sell our products in over 44 countries, primarily under the
DonJoy-Registered Trademark- and ProCare-Registered Trademark- brand names, each
of which has achieved a high level of brand name recognition within the
orthopedic sports medicine market. Our surgical products are marketed under the
Alaron Surgical-TM- brand name. Numerous professional and amateur athletes,
including participants in the NFL, NBA and NCAA, and members of the U.S. Ski and
Snowboard Teams of which we are a sponsor, choose to use our products. We
believe that our strong relationships with orthopedic sports medicine
professionals, leading market positions, strong brand names, reputation for
quality, broad product lines, established distribution networks and commitment
to research and development provide significant opportunities to grow revenues
and earnings. For 2000 and the first nine months of 2001, our net revenues were
$143.6 million and $127.4 million, respectively, our EBITDA was $28.9 million
and $24.8 million, respectively, and our net income, adjusted to give effect to
the tax effect of the reorganization into corporate form, would have been
$3.3 million and $2.7 million, respectively.
Our product lines provide a range of treatment during the orthopedic recovery
process, from rigid knee braces and other specialty products which are generally
prescribed for use after surgery and during and after rehabilitation to soft
goods which are generally used after injury, whether or not surgery is
contemplated. These products are also used to reduce the risk of new and repeat
injuries. In addition, we now offer products for the repair stage of the
patient's continuum of care with our Alaron Surgical-TM- products. In the
future, we plan to pursue the development of an additional line of products for
the regeneration of bone and soft tissue, including a bone growth stimulator and
a cartilage regeneration product.
Rehabilitation
- RIGID KNEE BRACES. Our rigid knee braces include ligament braces, which
provide support for knee ligament instabilities, post-operative braces,
which provide both knee immobilization and a protected range of motion,
and osteoarthritic braces, which provide relief of knee pain due to
osteoarthritis. These technologically advanced products are generally
prescribed by orthopedic sports medicine surgeons. Our rigid knee braces
are either customized braces, utilizing basic frames which are then
custom-manufactured to fit a patient's particular measurements, or are
standard braces which are available "off-the-shelf" in various sizes and
can be easily adjusted to fit the patient in the orthopedic professional's
office. We also offer a complete rehabilitation system that facilitates
the progression of patient rehabilitation in a home or clinical setting by
motivating and improving patient compliance through continuous feedback
and recorded home exercise sessions. Substantially all of our rigid knee
braces are marketed under the DonJoy-Registered Trademark- brand name.
These products represented approximately 42% and 41% of our net revenues,
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excluding freight revenue, for the year ended December 31, 2000 and the
first nine months of 2001.
- SOFT GOODS. Our soft goods products, most of which are constructed from
fabric or neoprene materials, provide support and/or heat retention and
compression of the knee, ankle, back and upper extremities, including the
shoulder, elbow, neck and wrist. For the year ended December 31, 2000 and
the first nine months of 2001, approximately 59% and 62%, respectively, of
our revenues from soft goods products, excluding freight revenue, were
derived from products marketed under the ProCare-Registered Trademark-
brand name, with the remainder marketed under the
DonJoy-Registered Trademark- brand name. Soft goods represented
approximately 37% of our net revenues, excluding freight revenue, for each
of the year ended December 31, 2000 and the first nine months of 2001.
- SPECIALTY AND OTHER COMPLEMENTARY ORTHOPEDIC PRODUCTS. Our portfolio of
specialty and other complementary orthopedic products includes two
post-surgery systems: a continuous cold therapy system to assist in the
reduction of pain and swelling and a pain management delivery system that
employs ambulatory infusion pumps for the delivery of local anesthetic to
the surgical site. Also included within this product category are lower
extremity walkers, which are an alternative to lower extremity casting,
and upper extremity shoulder and arm braces and slings. For the year ended
December 31, 2000 and the first nine months of 2001, approximately 84% of
our revenues from specialty and other complementary orthopedic products,
excluding freight revenue, were derived from products marketed under the
DonJoy-Registered Trademark- brand name, with the remainder marketed under
the ProCare-Registered Trademark- brand name. Specialty and other
complementary products represented approximately 21% and 22% of our net
revenues, excluding freight revenue, for the year ended December 31, 2000
and the first nine months of 2001, respectively.
Repair
- SURGICAL PRODUCTS. Our recently introduced Alaron Surgical-TM- products
are used to repair soft tissue and cartilage. Products used during ACL
reconstruction include surgical screws made from a next-generation
composite bioabsorbable material, titanium surgical screws, hamstring
graft anchors designed to reduce surgical procedure time and a suture
fixation device that allows the surgeon to adjust the tension of the
graft. We have also introduced a cartilage repair system used for
transplanting the patient's own healthy knee cartilage into damaged areas
of the knee joint. We recently received FDA clearance to market an
adjustable high tibial osteotomy plate used to surgically realign, and
reduce pain in, the osteoarthritic knee.
Regeneration
- BONE AND CARTILAGE GROWTH STIMULATION. Our bone growth stimulator is
undergoing the regulatory approval process. The bone growth stimulator
utilizes electromagnetic field technology to aid in healing fractures and,
unlike competitors' products, is intended to be worn by patients
continuously as part of a bracing or cast system. Our cartilage
regeneration product is in an early stage of development.
We sell our DonJoy-Registered Trademark- products primarily to orthopedic sports
medicine surgeons, orthotic and prosthetic centers, hospitals, surgery centers,
physical therapists and trainers to meet the specific needs of their patients.
We sell our ProCare-Registered Trademark- products under private label brand
names primarily to third party distributors who generally resell our products to
large hospital chains, hospital buying groups, primary
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care networks and orthopedic physicians. Our recently introduced Alaron
Surgical-TM- brand of products is being marketed to orthopedic sports medicine
surgeons, hospitals and surgery centers.
The orthopedic sports medicine market
The orthopedic products industry generated estimated worldwide sales of
$13.1 billion in 2000. We estimate that the segments of the orthopedic sports
medicine market that we are targeting accounted for over $3 billion of these
sales. This market is served by over 5,000 orthopedic surgeons in the United
States who cite sports medicine as an area of concentration and practice focus.
In addition, we believe that outside the United States another approximately
5,000 orthopedic surgeons are actively engaged in orthopedic sports medicine.
The orthopedic sports medicine market encompasses a broad range of product
segments addressing the repair, regeneration and rehabilitation of soft tissue
and bone and the treatment of osteoarthritis, as described below:
REPAIR. The repair segment is comprised of products and services used during a
surgical procedure to repair bone or soft tissue or to reconstruct joints in the
treatment of osteoarthritis. Major product categories in the repair segment
include:
- suture anchors, tissue anchors, interference screws, and other soft
tissue repair devices;
- arthroscopy equipment and surgical instruments;
- bone pins, screws, bone graft materials and other fracture fixation
devices; and
- total joint implants.
REGENERATION. Products in this segment are used to stimulate the body to
regenerate bone or cartilage. For example, bone growth stimulators apply an
electromagnetic field to facilitate the healing of fractures. Similar technology
may assist the body in forming new cartilage for the treatment of
osteoarthritis.
REHABILITATION. These products are used to assist the patient in the recovery
from an injury or a surgical procedure and/or to protect against re-injury or
damage to the surgical repair site. Rehabilitation products include:
- knee, shoulder, ankle and wrist braces;
- neoprene supports; and
- physical therapy equipment.
We estimate that the portions of the repair, regeneration and rehabilitation
segments that we are targeting represent approximately 60%, 10% and 30% of the
orthopedic sports medicine market, based on worldwide sales in 2000. We believe
revenues in the U.S. orthopedic sports medicine market grew at a rate of 7% to
9% in 1999 and 2000 and that they will continue to grow at a similar rate for
the next several years.
The growth of the orthopedic sports medicine market is being driven by:
- increased participation in exercise, sports and other physical activity
by all age groups;
- the aging "baby boomer" population, including adults suffering from
osteoarthritis;
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- heightened expectations for less intrusive therapies and more rapid and
complete recoveries to highly active lifestyles and high quality of life
expectations;
- a growing awareness of the importance of prevention and rehabilitation
of orthopedic injuries; and
- growth in the number of orthopedic surgery fellowship programs
specializing in sports medicine from 10% in 1991 to 21% in 2001.
According to the American Association of Orthopedic Surgeons approximately 11%
of all injuries in the United States, or 6.6 million annually, are sports
injuries and nearly three out of four orthopedic patients are under the age of
65.
Competitive strengths
We believe that our competitive strengths will enable us to grow our revenues
and profitability. Our competitive strengths are:
Broad product offering in the orthopedic sports medicine market with leading
U.S. market positions for a number of our core rehabilitation products. We
offer a broad range of over 600 products to orthopedic sports medicine surgeons
and their allied health care professionals. Our existing and planned future
products provide solutions to patients and orthopedic professionals in
addressing the various stages of the orthopedic repair, regeneration and
rehabilitation process. Over 90% of our 2000 revenues are derived from our
concentrated focus on the orthopedic sports medicine market.
Our dedication to quality has contributed to achievement of a leading market
position within the United States in a number of our core rehabilitation
products. The following table sets forth our leading U.S. market positions for
certain of our core rehabilitation products based on 2000 U.S. non-retail sales.
<Table>
<Caption>
- ------------------------------------------------------------------------------------
Estimated
U.S. market Market
Product share position
- ------------------------------------------------------------------------------------
Ligament braces............................................. 38% 1
Post-operative braces....................................... 24% 1
Fracture boots.............................................. 27% 2
Pain management systems..................................... 26% 2
Osteoarthritic braces....................................... 21% 2
Soft goods.................................................. 18% 2
Rigid ankle supports........................................ 9% 2
====================================================================================
</Table>
LONG STANDING, LOYAL RELATIONSHIPS WITH ORTHOPEDIC SPORTS MEDICINE SURGEONS AND
THEIR ALLIED HEALTH CARE PROFESSIONALS. Our company is focused exclusively on
serving orthopedic sports medicine surgeons and their allied health care
professionals. We have established long-standing and loyal relationships with
our orthopedic sports medicine customers by expanding and enhancing our product
lines, as well as through our focused sales, customer service and research and
development efforts. These relationships have contributed to the revenue growth
we have achieved in each of the last five years and our current leading U.S.
market position in a number of our core rehabilitation products. We host
numerous orthopedic sports medicine surgeons at our biomechanical laboratory and
our surgical techniques laboratory, which allows us to further enhance our
relationships with our primary customers.
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Our OfficeCare-Registered Trademark- program further allows us to continue to
build our relationships with orthopedic sports medicine surgeons.
The strength of our relationships with orthopedic sports medicine surgeons is
also evident in the use of our products by 39 accredited sports medicine
fellowship programs in North America. We maintain close relationships with 34 of
these programs and supply all or a significant portion of the bracing and soft
goods products to these programs, including four through the
OfficeCare-Registered Trademark- program. These centers are important in setting
standards of care in the field of sports medicine, because the fellowships they
sponsor enable new orthopedic surgeons to learn the latest techniques,
treatments, products and tools. On average, these centers have been our
customers for at least five years.
ESTABLISHED GLOBAL MARKETING AND DISTRIBUTION NETWORKS. In the United States,
our DonJoy-Registered Trademark- and Alaron Surgical-TM- product lines and
services are marketed by 38 commissioned sales organizations (referred to in
this prospectus as agents) which employ approximately 210 sales representatives
who are primarily dedicated to the sale of our products to the orthopedic sports
medicine market. We believe these sales representatives undergo the most focused
sales training program specializing in the orthopedic sports medicine market.
Our sales representatives use their technical expertise to market our products
to orthopedic sport medicine surgeons, orthotic and prosthetic centers,
hospitals, surgery centers, physical therapists and trainers. We sell our
ProCare-Registered Trademark- products to some of the largest national third
party distributors, including Owens & Minor Inc., McKesson/HBOC, Allegiance
Healthcare, a subsidiary of Cardinal Health Inc., and PSS World Medical Inc., as
well as to regional medical surgical dealers and medical products buying groups.
We believe that our strong distribution networks in the United States provide us
with an established base from which to introduce new or enhanced products and
expand sales of existing product lines. Our products are currently sold through
a global network of independent distributors which employs 105 sales
representatives who focus on building strong relationships with our target
customers. Internationally, we expect to distribute our products through a
network of partially or wholly-owned distributors in key countries.
STRONG BRAND NAME RECOGNITION AND REPUTATION FOR QUALITY. We believe
DonJoy-Registered Trademark- is the most recognized brand name of knee braces in
the orthopedic sports medicine market. In addition, our
ProCare-Registered Trademark- brand name is well recognized by third party
distributors of soft goods in the orthopedic sports medicine market. Our other
trademarks include product names that are well known among sports medicine
professionals which we believe provide us with a significant competitive
advantage. Our products are known for their design, quality construction and
durability. Our braces are used by a number of high profile professional and
amateur athletes and NCAA athletic programs. We are also the official and
exclusive supplier of braces and supports to the U.S. Ski and Snowboard Teams
and we believe we are the leading supplier of knee braces to players in the NFL.
SUCCESSFUL RECORD OF NEW PRODUCT INNOVATION AND DEVELOPMENT. We have developed
a reputation as an innovator of orthopedic sports medicine products. During
2000, 24.6%, 6.3% and 17.6% of our net revenues, excluding freight revenues in
the rigid knee, soft goods and specialty and other complementary product
segments, respectively, were comprised of products introduced since 1998. Our
recently introduced line of Alaron Surgical-TM- products reflects our continuing
commitment to the orthopedic sports medicine surgeon. We own or have licensing
rights to more than 50 U.S. and foreign patents, including a U.S. patent
covering the "Four Points of Leverage" system, which is a unique element in the
design of our ligament braces. In addition, we maintain close relationships with
a number of widely recognized orthopedic sports medicine surgeons and sports
medicine specialists who assist in product research and development. These
professionals often become product champions, speaking about our products at
medical seminars, assisting in the training of other professionals in the
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use and/or fitting of the products and providing us with feedback on the
industry's acceptance of the new products.
SCALABLE, EFFICIENT INFRASTRUCTURE TO SUPPORT OUR GROWTH. Through
implementation of an advanced enterprise resource planning system, continuing
implementation of lean manufacturing techniques designed to reduce lead times
and work-in-process inventory, and expansions of our facilities in Vista,
California and Tijuana, Mexico, we have developed a manufacturing and
operational infrastructure that is scalable to meet our expected growth. Our
investments in our infrastructure have allowed us to become a high-volume, low
cost producer for a number of our core rehabilitation products in which we have
achieved substantial market share. This infrastructure will also allow us to
continue to move portions of our manufacturing operations to our facilities in
Mexico to generate additional labor cost savings and utilize the resulting
additional capacity in our U.S. facility to manufacture our more technologically
advanced products.
SENIOR MANAGEMENT TEAM EXPERIENCED IN THE CORE ELEMENTS OF OUR STRATEGY. Our
three management investors, Messrs. Cross, Talbot and McBrayer, have an average
of 14 years of experience with our company and, together with the two other
members of our senior management team, have an average of over 21 years of
experience within the medical device industry. In particular, Mr. Cross, our
Chief Executive Officer, has 20 years of experience in the design, manufacture
and marketing of surgical and non-surgical orthopedic products. While at Smith &
Nephew, he developed and successfully commercialized products, including a
market-leading soft tissue fixation device currently sold by Smith & Nephew.
Upon completion of the initial public offering, management owned or had the
right to acquire pursuant to options, subject to certain conditions, up to
approximately 748,588 shares of common stock on a fully diluted basis.
Strategic objectives
Our strategic objectives are to strengthen our leadership position in the
orthopedic sports medicine market and to increase our revenues and
profitability. We intend to pursue the following strategic initiatives:
- broaden our market penetration and reach;
- enhance and grow our core business; and
- expand our business platform.
The key elements of our business strategy include:
EXPANDING EXISTING AND DEVELOPING NEW RELATIONSHIPS WITH ORTHOPEDIC SPORTS
MEDICINE SURGEONS AND THEIR ALLIED HEALTH CARE PROFESSIONALS. Our continuum of
care strategy provides a broad product offering to meet the complete product
needs of orthopedic sports medicine surgeons and their allied health care
professionals. We expect to increase our revenues and profitability by
leveraging our relationships with our existing orthopedic sports medicine
surgeon customers and by developing relationships with additional orthopedic
sports medicine surgeons. We believe that our new Alaron Surgical-TM- products
will allow us to expand our relationships with our existing orthopedic sports
medicine surgeon customers and will give us a new point of entry with orthopedic
sports medicine surgeons who are not currently our customers.
APPLYING OUR RESEARCH AND DEVELOPMENT EXPERTISE TO INTRODUCE NEW PRODUCTS AND
PRODUCT ENHANCEMENTS. We intend to remain an innovator of orthopedic sports
medicine products through
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our commitment to research and development and our close working relationships
with orthopedic professionals by designing, developing and introducing products
in each of the repair, regeneration and rehabilitation segments of the
orthopedic sports medicine market. Using our materials, process and design
expertise in bracing and supports, we will continue to enhance our current range
of products to address changing customer needs, emphasizing high quality product
designs that will reduce labor and material costs. In addition, we intend to add
complementary products through our own research and development efforts and
arrangements with third parties. For example, we have introduced two pain
management systems, the IceMan-Registered Trademark- device, a cold therapy
system, which we developed, and, more recently, the
PainBuster-Registered Trademark- Pain Management System, a range of ambulatory
infusion pumps, which we distribute under a licensing arrangement and which
represented our initial entry into the surgical market. We have recently
expanded our efforts in this market by introducing new surgical products all of
which we distribute under licensing arrangements and have plans to introduce
additional surgical products, subject to receipt of necessary FDA approval, over
the next several years. In 2001, we released the DonJoy Vista-TM- Rehabilitation
System, a computerized, post-surgical brace designed to optimize a patient's
rehabilitation in the treatment of knee injuries.
CAPITALIZING ON OUR EXTENSIVE U.S. DISTRIBUTION NETWORKS. We intend to
capitalize on the breadth and market focus of our U.S. distribution networks and
their experience in selling our DonJoy-Registered Trademark- and
ProCare-Registered Trademark- products to sell our higher margin products and
product enhancements, including our new Alaron Surgical-TM- line of products.
Substantially all of our agents employ sales representatives who have experience
in selling surgical products.
GROWING INTERNATIONAL REVENUES AND PROFITS THROUGH THE SELECTIVE REPLACEMENT OF
OUR THIRD-PARTY DISTRIBUTORS WITH DIRECT REPRESENTATION IN KEY COUNTRIES. We
intend to increase our international revenues and profits by selectively
replacing our third-party independent distributors with wholly or
partially-owned distributorships or joint ventures in key countries where we
believe the opportunity for growth is significant due to high per capita health
care spending. We believe that more direct control of the distribution networks
in these countries will allow us to accelerate the launch of new products and
product enhancements, to benefit from the sale of our higher margin, value added
products and to capture the distributor's margin. Our possible acquisitions, if
completed, the establishment of our Australian subsidiary and our planned
transition to direct distribution in Germany, the United Kingdom and Austria
effective January 1, 2002, represent our initial steps in pursuing this
strategy. We market products in over 44 countries, primarily in Europe, Canada
and Japan, under the DonJoy-Registered Trademark- and
ProCare-Registered Trademark- brand names. International sales accounted for
approximately 13% of our net revenues, excluding freight revenue, in each of
2000 and the first nine months of 2001. We sell and distribute our products in
foreign markets through 30 independent distributors, including in Australia,
through our 60% owned subsidiary and nine remaining Smith & Nephew sales
organizations in Canada and in some smaller markets.
INCREASING MARGINS BY CAPITALIZING ON THE RECENT INVESTMENTS IN OUR
INFRASTRUCTURE AND OPERATING EFFICIENCIES. We intend to capitalize on the
recent investments in our infrastructure and build upon improved operating
efficiencies to enhance gross margins. By upgrading our computer systems to
achieve more efficient business processes, we expect to achieve more efficient
customer order fulfillment and reduced overhead and working capital
requirements. We have recently completed the process of converting our
manufacturing into product focused work teams, which we describe as lean
manufacturing, which will reduce direct labor and overhead costs. We are also in
the process of further vertical integration and are automating our manufacturing
operations through the use of more technologically advanced fabrication and
assembly equipment. In addition, we will continue to move
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portions of our labor intensive operations to our facilities in Mexico to
generate labor cost savings, thereby allowing us to use the resulting additional
capacity in our U.S. facility to manufacture our more technologically advanced
products. We have converted our manufacturing scheduling to produce finished
goods on customer demand and are in the process of converting our procurement
process to enable us to replenish our supply of raw materials upon usage. Both
processes will allow us to decrease the level of inventory necessary to operate
the business as well as reduce the risk of excess and obsolete inventory. We
will continue to rationalize the raw materials used in the production of our
existing products, thereby enabling us to leverage our purchasing power. We also
plan to achieve cost savings by further reducing the number of stock keeping
units (SKUs) without impacting service or breadth of our product range.
PURSUING STRATEGIC GROWTH OPPORTUNITIES BY ACQUIRING OR LICENSING COMPLEMENTARY
PRODUCTS AND TECHNOLOGIES. We intend to continue to acquire or license
complementary products and technologies applicable to the orthopedic sports
medicine market that will allow us to broaden our product lines and leverage our
existing infrastructure, distribution networks, brand name recognition and
expertise in research and development. We believe our Orthotech and Alaron
acquisitions demonstrate our ability to identify, evaluate and rapidly integrate
acquisitions. We will seek growth opportunities through acquisitions,
investments or strategic alliances that will:
- expand our core rehabilitation business,
- enable us to offer complementary products, and
- further diversify into the repair and expand research and development
efforts in the regeneration segments of the orthopedic sports medicine
market.
Products
We currently offer products in the repair and rehabilitation segments of the
orthopedic sports medicine market and intend to offer, subject to necessary FDA
approvals, products in the regeneration segment of the orthopedic sports
medicine market. Our broad offering of over 600 products provides a range of
solutions for patients and orthopedic professionals during various stages of the
orthopedic treatment and rehabilitation. Our reportable segments are rigid knee
braces and soft goods rehabilitation products. In addition, we offer a growing
number of specialty and other complementary orthopedic products. Our product
lines provide a range of treatment during the orthopedic recovery process, from
rigid knee braces and other specialty products which are generally prescribed
for use after surgery and during and after rehabilitation to soft goods which
are generally used after injury, whether or not surgery is contemplated. In
addition, our recently introduced Alaron Surgical-TM- line of products now
allows us to offer products for the repair stage of the patient's continuum of
care.
We market our products under the DonJoy-Registered Trademark-,
ProCare-Registered Trademark- and, since August 1, 2001, Alaron Surgical-TM-
brand names. Based on net revenues, excluding freight revenue, we marketed
substantially all of our rigid knee braces, 84% of our specialty and other
complementary orthopedic products and 41% of our soft goods products under the
DonJoy-Registered Trademark- brand name during the year ended December 31, 2000.
We believe DonJoy-Registered Trademark- is the most recognized brand name of
knee braces in the orthopedic sports medicine market. Based on net revenues,
excluding freight revenue, we marketed approximately 59% of our soft goods
products, 16% of our specialty and other complementary orthopedic products and a
nominal percentage of our rigid knee braces under the
ProCare-Registered Trademark- brand name during the year ended December 31,
2000. The ProCare-Registered Trademark- brand name is well recognized by third
party distributors of soft goods in the orthopedic sports medicine market.
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Rehabilitation
Rigid knee bracing
We design, manufacture and market a broad range of rigid knee bracing products,
including ligament braces, post-operative braces and osteoarthritic braces.
These technologically advanced products are generally prescribed to a patient by
an orthopedic sport medicine surgeon. Our rigid knee braces are either
customized braces, utilizing basic frames which are then custom-manufactured to
fit a patient's particular measurements, or are standard braces which are
available "off-the-shelf" in various sizes and can be easily adjusted to fit the
patient in the orthopedic professional's office. Rigid knee bracing products
represented approximately 42% of our net revenues, excluding freight revenue,
for the year ended December 31, 2000 and 41% for the nine months ended
September 29, 2001.
LIGAMENT BRACES. Ligament braces provide durable support for moderate to severe
knee ligament instabilities to help patients regain range of motion capability
so they can successfully complete rehabilitation and resume the activities of
daily living after knee surgery or injury. They are generally prescribed six to
eight weeks after knee surgery, often after use of a more restrictive
post-operative brace. Our ligament braces can also be used to support the normal
functioning of the knee. Our ligament bracing product line includes premium
customized braces generally designed for strenuous athletic activity and
off-the-shelf braces generally designed for use in less rigorous activity. All
of our ligament braces are designed using our patented "Four Points of Leverage"
system. This system exerts a force on the upper portion of the tibia, which, in
turn, reduces strain on the damaged, reconstructed or torn ligament. Our U.S.
patent covering the "Four Points of Leverage" system expires in January 2005.
POST-OPERATIVE BRACES. Post-operative braces limit a patient's range of motion
after knee surgery and protect the repaired ligaments/joints from stress and
strain which would slow or prevent a healthy healing process. The products
within this line provide both immobilization and a protected range of motion,
depending on the rehabilitation protocol prescribed by the orthopedic sports
medicine surgeon. Our post-operative bracing product line includes a range of
premium to lower-priced off-the-shelf braces and accessory products.
OSTEOARTHRITIC BRACES. Osteoarthritic braces are used to treat patients
suffering from osteoarthritis. Our line of customized and off-the-shelf
osteoarthritic braces is designed to shift the resultant load going through the
knee, providing additional stability and reducing pain, and in some cases may
serve as a cost-efficient alternative to total knee replacement.
DONJOY VISTA-TM- REHABILITATION SYSTEM. The patented DonJoy Vista-TM-
Rehabilitation System facilitates patient rehabilitation in a home or clinical
setting by motivating and improving compliance of patients through continuous
feedback and recorded home exercise sessions. It is the first and only system
using a unique hand-held patient device to monitor home rehabilitation exercise
programs and assist clinicians and patients in assessing individual
rehabilitation. The DonJoy Vista-TM- Rehabilitation System is comprised of three
main components: customized clinician software, a hand-held patient device and
an instrumental telescoping post-operative brace. The customized clinician
software allows surgeons or physical therapists to create individual exercise
programs that are transferred to the patient device. The hand-held device guides
patients through a prescribed exercise with visual cues and feedback. The
instrumental telescoping device is equipped to measure the range of motion and
load while reporting data to the hand-held patient device during exercises.
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The following table sets forth information on our primary products within the
three rigid knee bracing product lines, all of which are sold under the DonJoy
brand name and a new product category for the DonJoy Vista-TM- technology:
<Table>
<Caption>
Year
Product Category Introduced Function/Description
<Caption>
Defiance-Registered Trademark- Ligament Instability 1992 Our flagship knee brace, custom fitted to
Osteoarthritis patient measurements. Available in a broad
range of colors and patterns. Designed for
strenuous athletic and work activity.
Legend-TM- Ligament Instability 1995 Sturdy, patient ready brace available in
seven sizes with a rugged rubberized coating.
Designed for both athletic and work activity.
4TITUDE-Registered Trademark- Ligament Instability 1999 Our premium patient ready knee brace
available in seven sizes and two length
options to suit a wider variety of patient
requirements. Features include an low
profile, light weight, and high durability.
Enhanced Ligament Instability 2000 Multi-purpose non-rigid brace widely used to
Playmaker-Registered Trademark- address mild to moderate instabilities.
SE 4-point-TM- Ligament Instability 2001 Lower cost, patient ready brace addressing
targeted market needs while still delivering
DonJoy performance and support.
DonJoy CE-TM- Ligament Instability 2001 Low cost custom knee product targeted for
specialty markets and managed care.
IROM-TM- Brace Post-operative Motion 1992 Used for post-operative management of various
(Improved Range Of Control and Stability knee procedures. Allows for immobilization
Motion) and/or protected range of motion.
DonJoy ELS-TM- Post-operative knee 1996 Designed to accommodate aggressive
(Extension Lock Splint) support with selective rehabilitation, the ELS features a simple
immobilization slide lock mechanism that can be easily
manipulated by the patient.
TROM-TM- Brace Post-operative Motion 1998 Allows for both immobilization and for
(Total Range Of Motion) Control and Stability protected range of motion after surgery.
Features a patented hinge adjustment system
for ease of use and patient convenience.
IROM,-TM- ELS-TM-, and Post-operative Motion 2001 Adjustable length post-op braces in all hinge
TROM-TM- Control and Stability designs introduced to reduce customer
Braces with Telescoping inventory requirements and offer improved fit
Bars and performance features.
OPAL-TM- Osteoarthritis 1998 Comfortable, lightweight, low profile slip-on
brace using DonJoy Drytex material, yet
delivering substantial support. Designed for
patients with mild to moderate
osteoarthritis, or those who are not sure
they need a brace.
OAdjuster-TM- Osteoarthritis 2000 The unique OAdjuster brace is designed to be
patient ready, easy to fit and comfortable to
wear. OAdjuster features a bi-axial hinge
that provides ability to shift pressures and
load in the knee.
Montana-Registered Trademark- Osteoarthritis 2000 Custom cast molded brace acquired from
Orthotech provides pain relief for
osteoarthritis patients with large cuffs for
hard-to-fit patients, a multi-vector hinge
and diagonal loading straps for patient
adjustment to address pain.
DonJoy Vista-TM- Rehabilitation System for 2001 Features a TROM post-op brace, a hand-held
Rehabilitation System patient education, brace, patient data device similar in look and feel
coaching, and real time to a personal digital device, and custom
biofeedback clinician computer software used to design
rehabilitation protocols. Using the system
for ligament reconstruction procedures, total
joint replacements, and other knee procedures
can help the patient, therapist and physician
better monitor and measure rehabilitation
progress. This system allows for daily
rehabilitation sessions for patients with
limited medical insurance.
</Table>
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Soft goods
Our soft goods products, most of which are fabric or neoprene-based, provide
support and/or heat retention and compression for afflictions of the knee,
ankle, back and upper extremities, including the shoulder, elbow, neck and
wrist. We currently offer products ranging from simple neoprene knee sleeves to
complex products that incorporate advanced materials and features such as
air-inflated cushions and metal alloy hinge components. Our soft goods products
include the RocketSoc-Registered Trademark-, an ankle support designed for
chronic sprains, the Playmaker-Registered Trademark-, a neoprene knee brace for
mild to moderate ligament instabilities, and the Air
DonJoy-Registered Trademark-, a line of knee sleeves with air inflatable
cushions designed to treat and ease pain from knee malalignment. Soft goods
products represented approximately 37% of our net revenues, excluding freight
revenue, for each of the year ended December 31, 2000 and the nine months ended
September 29, 2001.
<Table>
Year
Product Category Introduced Function/Description
Walker Post-trauma and 1993 Low profile orthotic device designed to provide
post-casting comfortable stability for acute ankle sprains, soft
applications for tissue and stress fractures to the lower leg and ankle,
lower leg and stable fractures of the ankle. Low profile design
allows for proper, natural stride.
ProSTEP-TM- Post-trauma and 1996 Low cost orthotic device is a one-piece design with open
post-casting heel to meet specific market needs. Provides stability
applications for for acute ankle sprains, soft tissue and stress fractures
lower leg to the lower leg and ankle, and stable fractures of the
ankle.
Stabilizing Ankle Chronic ankle 1997 Low profile, lace-up design with figure eight strapping
Support instabilities locks in heel and provides compressive support to help
prevent injury during athletic or daily activities.
COMFORTFORM-TM- Wrist Ligament and 1997 Provides comfortable support for the wrist to help reduce
cumulative trauma pain and inflammation from conditions such as sprains,
applications strains, arthritis and cumulative trauma injuries such as
carpal tunnel.
Air-Gel-TM- Ankle Post-trauma and 1999 Functional ankle stirrup design provides rigid ankle
chronic ankle support with cold therapy. Removable pre-inflated air and
instabilities gel liner provides support and cold therapy as needed.
Surround-Registered Trademark- Post-trauma and 2001 Rigid ankle stirrup design with pre-inflated air bladder
w/Air Ankle chronic ankle lined with compressive foam to provide support and
instabilities compression to swollen tissue. While walking, air bladder
compresses the joint to reduce swelling.
</Table>
Specialty and other complementary orthopedic products
We have a portfolio of specialty and other complementary orthopedic products
designed to facilitate orthopedic rehabilitation, including cold therapy
systems, pain management systems, lower extremity walkers, upper extremity
braces, and other related products and accessories. These products represented
approximately 21% and 22% of our net revenues, excluding freight revenue, for
the year ended December 31, 2000 and the nine months ended September 29, 2001,
respectively.
COLD THERAPY SYSTEMS. We manufacture, market and sell the
IceMan-Registered Trademark- device, a cold therapy product, which was
introduced in 1996, as well as other cold therapy products such as ice packs and
wraps. The IceMan-Registered Trademark- product is a portable device used after
surgery or injury to reduce swelling, minimize the need for post-operative pain
medications and accelerate the rehabilitation process. The product consists of a
durable quiet pump and control system, which is used to circulate cold water
from a reservoir to a pad which is designed to fit the injured area, such as the
ankle, knee or shoulder. The IceMan-Registered Trademark- product uses
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a patented circulation system to provide constant fluid flow rates, thereby
minimizing temperature fluctuations which can reduce device effectiveness and
create the potential for tissue or nerve damage.
PAIN MANAGEMENT SYSTEMS. We are a North American orthopedic distributor of the
PainBuster-Registered Trademark- Pain Management Systems, which are used after
surgical procedures. These pain management and relief systems provide a
continuous infusion of local anesthetic dispensed by the physician directly into
the surgical site following surgical procedures. The portable
PainBuster-Registered Trademark- Pain Management Systems consist of a range of
introducer needles, catheters for easy insertion and connection during surgery
and pumps for continuous infusion for up to 72 hours. The
PainBuster-Registered Trademark- Pain Management Systems are intended to provide
direct pain relief, reduce hospital stays and allow earlier and greater
ambulation. Our distribution rights for these products terminate at the end of
2005, unless extended.
LOWER EXTREMITY WALKERS. These products are boots which fit on a patient's foot
and provide comfort and stability for ankle and foot injuries. Because they can
be removed for bathing or therapy, our walkers are used as an alternative to
traditional casts. Sales of walkers represented approximately 56% and 61% of the
net revenues, excluding freight revenue, of specialty and other complementary
orthopedic products for the year ended December 31, 2000 and the nine months
ended September 29, 2001, respectively.
UPPER EXTREMITY BRACES. We offer a line of shoulder and arm braces and slings,
including the Quadrant Shoulder Brace and the UltraSling. The Quadrant Shoulder
Brace is technologically advanced and designed for immobilization after shoulder
surgery and allows for controlled motion. The UltraSling is a durable oversized
sling, which offers lower-priced immobilization and support for mild shoulder
sprains and strains.
Repair
Surgical products
On August 1, 2001 we introduced a line of surgical products for ligament and
cartilage repair. These products are sold primarily through our
DonJoy-Registered Trademark- salesforce, supported by the procedure specific kit
program system obtained in the Alaron acquisition.
SOFT TISSUE REPAIR. We have exclusive U.S. distribution rights until
April 2006, unless extended, for knee ligament fixation screws manufactured from
a next-generation bioabsorbable material offering improved graft healing over
existing bioabsorbable technology. On August 1, 2001 we introduced two graft
fixation screws under the BiLok-TM- name for ACL repair. We also introduced a
line of titanium graft fixation screws for surgeons who prefer a metallic
device, as well as a suture anchor that allows for post-fixation tensioning of
the graft. These fixation devices are supported with a high quality set of
surgical instruments for performing ACL repair that we purchase from a German
manufacturer. Other graft fixation devices are planned for introduction in the
near future.
CARTILAGE REPAIR. On August 1, 2001, we also introduced the ProCart-TM- system
for transplanting healthy knee cartilage to repair a cartilage defect in the
knee. The ProCart-TM- system consists of the surgical instruments needed to
perform the procedure and single use devices used in the transplantation
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process. We market the ProCart-TM- system in the United States for a German
surgical products manufacturer.
<Table>
<Caption>
Year
Product Category Introduced Function/Description
<Caption>
BiLok-TM- Interference Screw- 2001 Composite absorbable
Bioabsorbable interference screw for
ACL/PCL repair. Offered in
femoral (tapered/headed) and
tibial
(non-tapered/parallel-sided)
configurations.
EndoLok-TM- Interference Screw-Titanium 2001 Titanium interference screw
for ACL/PCL repair. Tubular,
tapered, with rounded head
and thread design.
DuraFix-TM- Graft Anchor for ACL 2001 Anchoring system for fixation
Reconstruction of hamstring grafts in ACL
repair.
EndoLok TPS-TM- Graft Anchor for ACL 2001 Post screw for graft fixation
Reconstruction in ACL repair.
Twister-TM- Suture Disk Suture/Graft Anchor for ACL 2001 Suture disk for fixation of
Reconstruction ACL repair. Tensioning device
allows for adjustment of
graft tension.
Cruciate Ligament Repair ACL Repair Support System 2001 Flexible instrument and
System accessory system for ACL
repair.
ProCart-TM- System Cartilage Transplantation 2001 Instruments and single use
System devices for cartilage repair.
</Table>
Research and development
Our internal research and development program is aimed at developing and
enhancing products, processes and technologies in order to remain an innovator
in the orthopedic sports medicine market. Our research and development
expenditures were $2.2 million, $2.1 million, $2.5 million and $1.8 million in
1998, 1999 and 2000 and the first nine months of 2001, respectively.
Our research and development activities are conducted in our Vista facility by a
group of 11 product engineers and designers who have an average of 12 years
experience in developing and designing products using advanced technologies,
processes and materials. The research and development team uses computational
tools and computer aided design (CAD) systems during the development process
which allow a design to be directly produced on computer-based fabrication
equipment, reducing both production time and costs.
Our current research and development activities are focused on using new
materials, innovative designs and state of the art manufacturing processes to
develop new products and to enhance our existing products. We are also pursuing
strategic initiatives to identify areas for technological innovation and to
develop products that improve rehabilitation by utilizing advanced technologies.
We have engineers focused on the development of products for the repair and
regeneration segments.
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We have developed and maintain close relationships with a number of widely
recognized orthopedic sports medicine surgeons and sports medicine specialists
who assist in product research, development and marketing. These professionals
often become product champions, speaking about our products at medical seminars,
assisting in the training of other professionals in the use and/or fitting of
the products and providing us with feedback on the industry's acceptance of the
new products. Some of these surgeons and specialists who participate in the
design of products and/or provide consulting services have contractual
relationships with us under which they receive royalty payments or consultant
fees in connection with the development of particular products with which they
have been involved.
We maintain the Clinical Education Research Facility (CERF) Laboratory in the
Vista facility, which is used by orthopedic sports medicine surgeons to evaluate
our soft tissue repair products in a simulated surgical setting and practice
surgical techniques. These surgeons often provide us with feedback which assists
us in the development and enhancement of products. In addition, we utilize our
biomechanical laboratory in the Vista facility to test the effectiveness of our
products. U.S. based and international surgeons/researchers collaborate with the
research staff to perform biomechanical testing. The tests are designed to
demonstrate the functionality of new products and the effectiveness of new
surgical procedures. State of the art mechanical models are used to simulate
behavior of normal, injured and osteoarthritic knees and look at the performance
of new product designs as well as competitive products. We host numerous
orthopedic sports medicine surgeons at our biomechanical laboratory and our
surgical techniques laboratory, which allows professionals to practice
procedures and then to measure the effectiveness of those procedures. In
addition, we provide external clinical and academic research grants to leading
health care professionals and institutions. The focus of these projects is to
evaluate treatments on specific patient populations, for example, patients who
have completed knee surgery or who have osteoarthritis. Recent projects include
measurement of ACL strain with and without brace use, patient outcome after ACL
surgery with and without brace use, strength of ACL fixation devices, and cold
therapy effectiveness.
In addition to our internal research and development efforts, we have entered
into a number of technology licensing arrangements with third parties that
provide us innovative technologies and processes for the manufacture and
development of our products. Finally, we also act as the exclusive U.S.
distributor of a number of products that are manufactured by others.
Sales, marketing and distribution
We distribute our products in the United States and international markets
primarily through networks of agents and distributors who market and sell to
orthopedic sports medicine surgeons, orthotic and prosthetic centers, third
party distributors, hospitals, surgery centers, physical therapists and trainers
within the orthopedic sports medicine community. Our products are used by people
who have sustained an orthopedic injury. In addition, our products are used by
people who have recently completed an orthopedic surgical procedure and/or
suffer from osteoarthritis and to help protect against injury. In addition, a
number of high profile professional and amateur athletes who participate in
sports such as football, basketball and skiing, choose to use our products. We
are the official and exclusive supplier of braces and supports to the U.S. Ski
and Snowboard Teams. In addition, we believe we are the leading supplier of knee
braces to players in the NFL. No individual agent or distributor accounted for
10% or more of our net revenues for the year ended December 31, 2000.
We are committed to providing our customers with a superior standard of customer
service. Our 34 customer care representatives strive for prompt product
processing and delivery by coordinating between
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the customer and our sales, operations and shipping departments. In addition,
customer care representatives also provide support regarding order status,
product information, returns and general information.
United States
We market products in the United States under the DonJoy-Registered Trademark-,
ProCare-Registered Trademark- and, since August 1, 2001, Alaron Surgical-TM-
brands through two distinct sales and distribution channels as well as under
national contracts and through the OfficeCare-Registered Trademark- program.
Sales in the United States accounted for approximately 87% and 88% of our net
revenues, excluding freight revenue, for the year ended December 31, 2000 and
the nine month period ended September 29, 2001, respectively.
DONJOY-REGISTERED TRADEMARK- AND ALARON SURGICAL-TM-. These products are
marketed by 38 commissioned sales agents which employ approximately 210 sales
representatives who are primarily dedicated to the sale of our products to the
orthopedic sports medicine market. These sales representatives market to
orthopedic sports medicine surgeons, orthotic and prosthetic centers, hospitals,
surgery centers, physical therapists and athletic trainers. Because the
DonJoy-Registered Trademark- and Alaron Surgical-TM- product lines generally
require customer education on the application and use of the product, the sales
representatives are technical specialists who receive extensive training both
from us and the agent and use their technical expertise to help fit the patient
with our product and assist the orthopedic professional in choosing the
appropriate product to meet the patient's needs. After a product order is
received by a sales representative, we ship and bill the product directly to the
orthopedic professional and we pay a sales commission to the agent.
We enjoy long-standing relationships with most of our 38 agents and 210 sales
representatives, many of whom have marketed DonJoy-Registered Trademark-
products for over 10 years. Under the arrangements with the agents, each agent
is granted an exclusive geographic territory for sales of our products and is
not permitted to market products, or represent competitors who sell or
distribute products, that compete with our existing products. The agents receive
a commission which varies based on the type of product being sold. If an agent
fails to achieve specified sales quotas during any quarter, we may terminate the
agent, as we have done in the past.
We also provide supply chain management services to orthopedic sports medicine
surgeons, hospitals and surgery centers by providing procedure-specific
orthopedic surgery kits to the surgeon, hospital or surgery with as little as
24 hours notice before a scheduled surgery. This service allows the surgeon,
hospital or surgery center to eliminate inventory requirements and
administrative costs.
PROCARE-REGISTERED TRADEMARK-. These products are sold in non-exclusive
territories under private label brand names to third party distributors. These
distributors include large, national third party distributors such as Owens &
Minor Inc., McKesson/HBOC, Allegiance Healthcare and PSS World Medical Inc.;
regional medical surgical dealers; and medical products buying groups which
consist of a number of dealers who make purchases through the buying group.
These distributors generally resell the ProCare-Registered Trademark- products
to large hospital chains, hospital buying groups, primary care networks and
orthopedic physicians for use by the patient. Unlike
DonJoy-Registered Trademark- products, ProCare-Registered Trademark- products
generally do not require significant customer education for their use.
NATIONAL CONTRACTS. In response to the emergence of managed care and the
formation of buying groups, national purchasing contracts and various bidding
procedures imposed by hospitals and buying groups, we have entered into national
contracts for DonJoy-Registered Trademark- and ProCare-Registered Trademark-
products to large health care
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providers and buying groups, such as AmeriNet Inc., US Government/Military
hospitals, National Purchasing Alliance, Magnet, and Hospital Purchasing
Services and, we are also currently selling our products to HealthSouth Corp.,
Hanger Orthopedic Group, Premier Purchasing Partners, L.P., and Shared Services
HealthCare pending renegotiation of contracts with them. Under these contracts,
we provide discounted pricing to the buying group and are generally designated
as one of several preferred purchasing sources for the members of the buying
group for specified products, although the members are not obligated to purchase
our products. We are also sole supplier for HCA and Novation. We expect that in
the future we will enter into additional national contracts with other health
care providers and buying groups. See "Risk factors--Healthcare reform, managed
healthcare and buying groups have exerted downward pressure on the prices of our
products" and "Management's discussion and analysis of financial condition and
results of operations--Overview--Third party reimbursement; Health care reform;
Managed care."
OFFICECARE-REGISTERED TRADEMARK-. We provide an inventory management and
insurance billing system to orthopedic sports medicine surgeons in the United
States through the OfficeCare-Registered Trademark- program, which was initiated
in 1996. We supply the surgeon with a working inventory of orthopedic products
for immediate disbursement to the surgeon's patients. We then directly seek
reimbursement from the patient's insurance company or other third party payors
or from the patient where self-pay is applicable. The majority of these billings
are performed by an independent third-party contractor.
International
We market products in over 44 countries, primarily in Europe, Canada and Japan,
under the DonJoy-Registered Trademark-, Alaron Surgical-TM- and
ProCare-Registered Trademark- brand names. Excluding freight revenue,
international sales accounted for approximately 16%, 13% and 13% of our net
revenues for the years ended December 31, 1999 and 2000 and for the nine month
period ended September 29, 2001, respectively. Excluding freight revenue, sales
in Germany, our largest foreign market, and Austria accounted for approximately
31% and 42% of our international net revenues in 2000 and the first nine months
of 2001, respectively, and sales in Canada accounted for approximately 11% and
11% of our international net revenues in 2000 and the first nine months of 2001,
respectively, with no other country accounting for 10% or more of our
international net revenues during such periods. Excluding freight revenue, total
sales in Europe accounted for approximately 62% and 68% of our international net
revenues in 2000 and the first nine months of 2001, respectively, while sales in
Germany/Austria, the United Kingdom, France, Spain and Italy accounted for
approximately 49% and 57% of our international net revenues in 2000 and the
first nine months of 2001, respectively. Excluding freight revenue, sales in
Japan accounted for approximately 9% and 8% of our international net revenues in
2000 and the first nine months of 2001, respectively.
We sell and distribute our products in foreign markets through 30 independent
distributors including, in the case of Australia, through our 60% Australian
subsidiary, and nine remaining Smith & Nephew sales organizations in Canada and
in some smaller markets. These distributors employ 105 sales representatives who
focus on building strong relationships with our target customers. Since our
June 1999 recapitalization, we have reorganized our international distribution
efforts by successfully replacing 21 Smith & Nephew sales organizations with
independent distributors who focus on building strong relationships with our
target customers and who are responsible for achieving specified sales targets
and implementing the marketing and distribution strategies which we successfully
utilize in the United States and in most major international territories.
International sales made through Smith & Nephew sales organizations were 52%,
40%, 20% and 13% of our international sales, exclusive of freight revenue, in
1998, 1999 and 2000 and the first nine months of 2001, respectively. We plan to
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implement a direct distribution capability in selected foreign countries where
we believe the opportunity for growth is significant due to higher per capita
health care spending. We believe that directly owned and operated distributors
in these countries will allow us to accelerate the launch of new products and
product enhancements, and to benefit from the sale of higher margin products and
to capture the distributor's margin. We began to implement this strategy in
April 2001 through the establishment in Australia of our 60% owned subsidiary
which has replaced a Smith & Nephew distributor in Australia. In addition, we
have given notice to our sole distributor in Germany, the United Kingdom and
Austria that we will not renew its distributorship at the end of its current
term on December 31, 2001. Finally, if our possible acquisitions are
consummated, we would begin to distribute our products directly in Italy. During
the remainder of 2001 and 2002, we expect to replace other independent
distributors or some of the remaining Smith & Nephew distributors with our own
directly owned distributors. See "Risk factors--Our transition to direct
distribution of our products in selected foreign markets could adversely affect
our revenues and income in these countries," "Management's discussion and
analysis of financial condition and results of operations--International sales,"
and "--Business strategy."
Manufacturing
We manufacture substantially all of our products at two locations in the United
States and Mexico. See "--Facilities." We operate a vertically integrated
manufacturing and cleanroom packaging operation at the Vista, California
facility and are capable of producing a majority of our subassemblies and
components in-house. These include metal stamped parts, injection molding
components and fabric-strapping materials. We also have extensive in-house tool
and die fabrication capabilities which provide savings in the development of
typically expensive tools and molds as well as flexibility to respond to and
capitalize on market opportunities as they are identified. Utilizing a variety
of computational tools and CAD systems during the development process, we can
produce a design directly on computer-based fabrication equipment, reducing both
tool production time and costs.
We have achieved ISO 9001 certification, EN46001 certification and Certification
to the European Medical Device Directive at the Vista facility and are preparing
to have our Mexico facilities certified in 2002. These certifications are
internationally recognized quality standards for manufacturing and assist us in
marketing our products in certain foreign markets.
Utilizing the latest production technologies at our Vista and Mexico facilities,
we are able to reduce the labor content of many of our products. For labor
intensive operations, primarily sewing, final assembly and packaging, we utilize
our operation in Mexico. We will continue to move our more labor intensive
operations to our facility in Mexico to generate labor cost savings and utilize
the resulting additional capacity at the Vista facility to manufacture our more
technologically advanced products.
Our manufacturing operations use new and innovative technologies and materials
including thermoplastics, various composites and polypropylene glass, as well as
a variety of light weight metals and alloys. We also use Velcro-TM- and
neoprene, as well as Drytex-Registered Trademark-, a wrap-knit nylon and
polyester composite, in the manufacture of our products. Most of the raw
materials that we use in the manufacture of our products are available from more
than one source and are generally readily available on the open market.
We outsource some of our finished products from manufacturers in China. In
addition, we distribute the PainBuster-Registered Trademark- Pain Management
Systems, which are manufactured by I-Flow Corporation, as well as other products
which are manufactured by third parties.
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Facilities
We are headquartered in Vista, California and operate two manufacturing
locations. Manufacturing operations in the United States were consolidated in
1998 into the Vista campus which consists of three campus buildings. The Vista
facilities are subleased from Smith & Nephew, with the exception of a nearby
parcel of vacant land upon which we plan future expansion. See "Related party
transactions--Other agreements with Smith & Nephew--Sublease." The two other
facilities are located in Tijuana, Mexico, within 100 miles of Vista, and are
managed from the Vista facility. We also lease warehouse and office space in
Germany, Australia and the United Kingdom.
<Table>
<Caption>
Lease Termination Size (Square
Location Use Owned/Leased Date Feet)
<Caption>
Vista, California Corporate Headquarters Subleased February 2008 266,041
Research & Development
Manufacturing &
Distribution
Vista, California Parking Lot/Future Leased July 2006 285,000
Expansion
Tijuana, Mexico 2 Manufacturing Leased December 2001 (1) 48,600
Facilities June 2003 (2) 30,000
Tijuana, Mexico Manufacturing Owned Held for sale 8,980
</Table>
(1) The lease for this Tijuana facility may be renewed, upon 90 days notice
prior to the expiration of the current term, for two additional one-year
periods.
(2) The lease for the Tijuana facility may be renewed at the option of the
lessee for 5 additional one-year periods.
Competition
The orthopedic sports medicine market is highly competitive and fragmented. Our
competitors include a few large, diversified orthopedic companies and numerous
smaller niche companies. Some of our competitors are part of corporate groups
that have significantly greater financial, marketing and other resources than we
do. Our primary competitors in the rigid knee brace market include smaller niche
companies such as Bledsoe Brace Systems (a division of Medical
Technology, Inc.), Breg, Inc., Generation II USA, Inc., Innovation Sports
Incorporated and Townsend Industries Inc. In the soft goods products market, our
competitors include DeRoyal Industries, Tecnol Orthopedic Products (a division
of Encore Medical Corporation) and Zimmer Holdings, Inc. Our competitors in the
surgical products market include Arthrex, Inc., Biomet, Inc., Johnson & Johnson,
Linvatec (a division of Conmed), Smith & Nephew and Stryker, Inc. We compete
with a variety of manufacturers of specialty and other complementary orthopedic
products, depending on the type of product. In addition, in certain foreign
countries, we compete with one or more local or regional competitors.
Competition in the rigid knee brace market is primarily based on product
technology, quality and reputation, relationships with customers, service and
price. Competition in the soft goods market is less dependent on innovation and
technology and is primarily based on product range, service and price.
Competitors have initiated stock and bill programs similar to our
OfficeCare-Registered Trademark- program to provide value to their customers.
Electro-Biology, Inc. (EBI) Medical Systems, a division of Biomet, is our
primary competitor for this type of program. Competition in specialty and other
complementary orthopedic products is based on a variety of factors, depending on
the type of product. Competition in the surgical products segment is primarily
based on product technology, quality and reputation, sales representative access
to orthopedic sports medicine surgeons and relationships with research
institutions.
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We believe that our extensive product lines, advanced product design, strong
distribution networks, reputation with leading orthopedic sports medicine
surgeons and their allied health care professionals and customer service
performance provide us with a competitive advantage over our competitors. In
particular, we believe that our broad product lines provide us with a
competitive advantage over the smaller niche companies which generally have
innovative technology in a focused product category, while our established
distribution networks and relationship-based selling efforts provide us with a
competitive advantage over larger manufacturers.
Intellectual property
Our most significant intellectual property rights are our patents and
trademarks, including our DonJoy-Registered Trademark- and
ProCare-Registered Trademark- brand names, and proprietary know-how.
We own or have licensing rights to over 50 U.S. and foreign patents and have
several pending patent applications. We anticipate that we will apply for
additional patents in the future as we develop new products and product
enhancements. Our most significant patent, which is registered only in the
United States, involves the bracing technology and design called the "Four
Points of Leverage" system. A majority of our ligament bracing products have
been designed using the "Four Points of Leverage" system which exerts a force on
the upper portion of the tibia, which, in turn, reduces strain on the damaged,
reconstructed or torn ligament. Our patent covering the "Four Points of
Leverage" system expires in January 2005. Excluding freight revenue, revenues
generated from products using our "Four Points of Leverage" system accounted for
approximately 27% and 26% of our net revenues for the year ended December 31,
2000 and for the nine months ended September 29, 2001, respectively. Our other
significant patents include the Custom Contour Measuring Instrument, which
serves as an integral part of the measurement process for patients ordering our
customized ligament and osteoarthritic braces. In addition, we own patents
covering a series of hinges for our post-operative braces, as well as pneumatic
pad design and production technologies (which utilize air inflatable cushions
that allow the patient to vary the location and degree of support) used in
braces such as the Defiance-Registered Trademark-. We also have patents relating
to our osteoarthritic braces and specific mechanisms in a number of our
products. In addition to these patents, we rely on non-patented know-how, trade
secrets, process and other proprietary information, which we protect through a
variety of methods, including confidentiality agreements and proprietary
information agreements with vendors, employees, consultants and others who have
access to our proprietary information.
DonJoy-Registered Trademark-, ProCare-Registered Trademark-, Alaron
Surgical-TM-, TiMax-TM-, Orthotech-TM-, Defiance-Registered Trademark-,
GoldPoint-Registered Trademark-, Monarch-Registered Trademark-,
RocketSoc-Registered Trademark-, IceMan-Registered Trademark-, Air
DonJoy-Registered Trademark-, Quadrant-Registered Trademark-, Legend-TM-,
TROM-TM-, OPAL-TM-, 4TITUDE-Registered Trademark-, OAdjuster-TM-,
OfficeCare-Registered Trademark-, Playmaker-Registered Trademark-, Knee
Guarantee-TM-, DonJoy Vista-TM-, Drytex-Registered Trademark-, Never Stop
Getting Better-TM-, IROM-TM-, ELS-TM-, dj Ortho-Registered Trademark-, MC
Walker-Registered Trademark-, Montana-Registered Trademark-, Nextep-TM-,
ProSTEP-TM-, Rehab 3-Registered Trademark-, Ultra-4-TM-,
Ultrasling-Registered Trademark-, COMFORTFORM-TM-,
Surround-Registered Trademark-, EndoLok-TM-, DuraFix-TM-, EndoLok TPS-TM-,
Twister-TM- and Walkabout-TM- are certain of our registered trademarks and
trademarks for which we have applications pending or common law rights.
PainBuster-Registered Trademark- is a registered trademark of I-Flow
Corporation. OnTrack-Registered Trademark- is a registered trademark of Ortho
Rx, Inc. OrthoPulse-TM- is a trademark of I.M.D., b.v. Air-Gel-TM- Ankle is a
trademark of Northeast EMS. BiLok-TM- is a trademark of Biocomposites, Ltd.
In August 1998, Smith & Nephew entered into a five-year exclusive arrangement
with IZEX Technologies to license know-how and technology for the design,
manufacture and distribution of the DonJoy Vista-TM- Rehabilitation System, a
computerized post-operative brace designed to optimize a patient's
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rehabilitation in the treatment of knee injuries. In connection with the
recapitalization, Smith & Nephew assigned this license to us.
We believe that our patents, trademarks and other proprietary rights are
important to the development and conduct of our business and the marketing of
our products. As a result, we aggressively protect our intellectual property
rights.
Employees
As of September 29, 2001, we had approximately 1,130 employees. Our workforce is
not unionized. We have not experienced any strikes or work stoppages, and
management considers its relationships with our employees to be good.
Government regulation
MEDICAL DEVICE REGULATION
UNITED STATES. Our products and operations are subject to extensive and
rigorous regulation by the FDA. The FDA regulates the research, testing,
manufacturing, safety, labeling, storage, recordkeeping, promotion,
distribution, and production of medical devices in the United States to ensure
that medical products distributed domestically are safe and effective for their
intended uses. In addition, the FDA regulates the export of medical devices
manufactured in the United States to international markets.
Under the Federal Food, Drug, and Cosmetic Act (FFDCA), medical devices are
classified into one of three classes--Class I, Class II or Class III--depending
on the degree of risk associated with each medical device and the extent of
control needed to ensure safety and effectiveness. Our currently marketed
products are all Class I or Class II medical devices.
Class I devices are those for which safety and effectiveness can be assured by
adherence to a set of guidelines, which include compliance with the applicable
portions of the FDA's Quality System Regulation (QSR), facility registration and
product listing, reporting of adverse medical events, and appropriate, truthful
and non-misleading labeling, advertising, and promotional materials (the General
Controls). Some Class I devices also require premarket clearance by the FDA
through the 510(k) premarket notification process described below.
Class II devices are those which are subject to the General Controls and most
require premarket demonstration of adherence to certain performance standards or
other special controls, as specified by the FDA, and clearance by the FDA.
Premarket review and clearance by the FDA for these devices is accomplished
through the 510(k) premarket notification procedure. For most Class II devices,
the manufacturer must submit to the FDA a premarket notification submission,
demonstrating that the device is "substantially equivalent", as defined in the
statute, to either:
- a device that was legally marketed prior to May 28, 1976, the date upon
which the Medical Device Amendments of 1976 were enacted, or
- to another commercially available, similar device which was subsequently
cleared through the 510(k) process.
If the FDA agrees that the device is "substantially equivalent", it will grant
clearance to commercially market the device. By regulation, the FDA is required
to clear a 510(k) within 90 days of submission of the application. As a
practical matter, clearance often takes longer; however, our products have
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generally been cleared within the 90-day time period. The FDA may require
further information, including clinical data, to make a determination regarding
substantial equivalence. If the FDA determines that the device, or its intended
use, is not "substantially equivalent", the FDA will place the device, or the
particular use of the device, into Class III, and the device sponsor must then
fulfill much more rigorous premarketing requirements.
A Class III product is a product which has a new intended use or uses advanced
technology that is not substantially equivalent to a use or technology with
respect to a legally marketed device. The safety and efficacy of Class III
devices cannot be assured solely by the General Controls and the other
requirements described above. These devices almost always require formal
clinical studies to demonstrate safety and efficacy. One of our proposed new
products, OrthoPulse-TM-, is a Class III device and will undergo the premarket
approval process described below.
Approval of a premarket approval application (PMA) from the FDA is required
before marketing of a Class III product can proceed. The PMA process is much
more demanding than the 510(k) premarket notification process. A PMA
application, which is intended to demonstrate that the device is safe and
effective, must be supported by extensive data, including data from pre-clinical
studies and human clinical trials and existing research material, and must
contain a full description of the device and its components, a full description
of the methods, facilities, and controls used for manufacturing, and proposed
labeling. Following receipt of a PMA application, once the FDA determines that
the application is sufficiently complete to permit a substantive review, the FDA
will accept the application for review. The FDA, by statute and by regulation,
has 180 days to review a filed PMA application, although the review of an
application more often occurs over a significantly longer period of time, up to
several years. In approving a PMA application or clearing a 510(k) application,
the FDA may also require some form of post-market surveillance, whereby the
manufacturer follows certain patient groups for a number of years and makes
periodic reports to the FDA on the clinical status of those patients when
necessary to protect the public health or to provide additional safety and
effectiveness data for the device. We anticipate that the OrthoPulse-TM- PMA
will be submitted to the FDA by the end of 2001.
When FDA clearance of a Class I, Class II or Class III device requires human
clinical trials, if the device presents a "significant risk" (as defined by the
FDA) to human health, the device sponsor is required to file an investigational
device exemption (IDE) application with the FDA and obtain IDE approval prior to
commencing the human clinical trial. If the device is considered a
"non-significant" risk, IDE submission is not required. Instead, only approval
from the Institutional Review Board conducting the clinical trial is required.
Human clinical studies are generally required in connection with approval of
Class III devices and to a much lesser extent for Class I and II devices. None
of our Class I or Class II products have required human clinical trials for
approval.
In addition, our manufacturing processes are required to comply with the
applicable portions of the QSR, which covers the methods and documentation of
the design, testing, production, processes, controls, quality assurance,
labeling, packaging, and shipping of our products. The QSR also, among other
things, requires maintenance of a device master record, device history record,
and complaint files. Our domestic facility, records, and manufacturing processes
are subject to periodic unscheduled inspections by the FDA. Our Mexican
facilities, which export products to the United States, may also be inspected by
the FDA. Our U.S. facility has recently been inspected by the FDA and found to
be in compliance with the applicable QSR regulations. Based on internal audits
of our Mexican facilities, we believe that our Mexican facilities are in
substantial compliance with the applicable QSR regulations.
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Failure to comply with the applicable U.S. medical device regulatory
requirements could result in, among other things, warning letters, fines,
injunctions, civil penalties, repairs, replacements, refunds, recalls or
seizures of products, total or partial suspension of production, the FDA's
refusal to grant future premarket clearances or approvals, withdrawals or
suspensions of current product applications, and criminal prosecution. There are
currently no adverse regulatory compliance issues or actions pending with the
FDA at any of our facilities or relating to our products and none of the recent
FDA audits of the Vista, California facility has resulted in any enforcement
actions by the FDA.
There are no restrictions under U.S. law on the export from the United States of
any medical device that can be legally distributed in the United States. In
addition, there are only limited restrictions under U.S. law on the export from
the United States of medical devices that cannot be legally distributed in the
United States. If a Class I or Class II device does not have 510(k) clearance,
but is eligible for approval under the 510(k) process, then the device can be
exported to a foreign country for commercial marketing without the submission of
any type of export request or prior FDA approval, if it satisfies certain
limited criteria relating primarily to specifications of the foreign purchaser
and compliance with the laws of the country to which it is being exported.
Class III devices which do not have PMA approval may be exported to any foreign
country, if the product complies with the laws of that country and, with respect
to the following countries, has valid marketing authorization under the laws of
such country: Australia, Canada, Israel, Japan, New Zealand, Switzerland, South
Africa, the European Union, a country in the European Economic Area or such
other countries as may be approved by the FDA. The unapproved device must also
satisfy the criteria required to be satisfied by Class I and Class II devices as
well as additional criteria applicable to the devices. All of our products which
are exported to foreign countries currently comply with the restrictions
described in this paragraph.
Certificates for export (certifying the status of a product under the FFDCA) are
not required by the FDA for export of Class I and Class II devices. However,
they are often required by the foreign country importing the product. For
Class III devices, the manufacturer must notify the FDA via the export
certification process.
INTERNATIONAL. In many of the foreign countries in which we market our
products, we are subject to regulations affecting, among other things, product
standards, packaging requirements, labeling requirements, import restrictions,
tariff regulations, duties and tax requirements. Many of the regulations
applicable to our devices and products in such countries are similar to those of
the FDA, including those in Germany, our largest foreign market. In many
countries, the national health or social security organizations require our
products to be qualified before they can be marketed with the benefit of
reimbursement eligibility. To date, we have not experienced difficulty in
complying with these regulations. Due to the movement towards harmonization of
standards in the European Union, we expect a changing regulatory environment in
Europe characterized by a shift from a country-by-country regulatory system to a
European Union wide single regulatory system. The timing of this harmonization
and its effect on us cannot currently be predicted.
We are implementing policies and procedures intended to position us for the
expected international harmonization of regulatory requirements. The ISO 9000
series of standards have been developed as an internationally recognized set of
guidelines that are aimed at ensuring the design and manufacture of quality
products. ISO 9001 is the highest level of ISO certification, covering both the
quality system for manufacturing as well as that for product design control; ISO
9002 covers the quality system for manufacturing operations that do not include
product design. Our Vista facility has received ISO 9001 certification. See
"--Manufacturing." A company that passes an ISO audit and obtains ISO
registration becomes internationally recognized as functioning under a competent
quality system. In certain foreign
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markets, it may be necessary or advantageous to obtain ISO 9000 series
certification, which, in certain respects, is analogous to compliance with the
FDA's QSR requirements. The European Economic Community has promulgated rules
which require that medical products receive a Conformite Europeenne (CE) mark.
All of our products currently distributed in Europe have received the CE mark. A
CE mark is an international symbol indicating that the device meets common
European standards of performance and safety.
FRAUD AND ABUSE
We are subject to various federal and state laws pertaining to health care fraud
and abuse, including anti-kickback laws and physician self-referral laws.
Violations of these laws are punishable by criminal and/or civil sanctions,
including, in some instances, imprisonment and exclusion from participation in
federal and state health care programs, including Medicare, Medicaid, VA health
programs and TRICARE. We have never been challenged by a governmental authority
under any of these laws and believe that our operations are in material
compliance with such laws. However, because of the far-reaching nature of these
laws, there can be no assurance that we would not be required to alter one or
more of our practices to be in compliance with these laws. In addition, there
can be no assurance that the occurrence of one or more violations of these laws
would not result in a material adverse effect on our financial condition and
results of operations.
ANTI-KICKBACK LAWS. Our operations are subject to federal and state
anti-kickback laws. Certain provisions of the Social Security Act, that are
commonly known collectively as the Medicare Fraud and Abuse Statute, prohibit
entities, such as us, from offering, paying, soliciting or receiving any form of
remuneration in return for the referral of Medicare or state health program
patients or patient care opportunities, or in return for the recommendation,
arrangement, purchase, lease or order of items or services that are covered by
Medicare or state health programs. Violation of the Medicare Fraud and Abuse
Statute is a felony, punishable by fines up to $25,000 per violation and
imprisonment for up to five years. In addition, the Department of Health and
Human Services may impose civil penalties of up to $50,000 per act plus three
times the remuneration offered and exclude violators from participation in
Medicare or state health programs. Many states have adopted similar prohibitions
against payments intended to induce referrals to Medicaid and other third party
payor patients.
We operate a stock and bill program, known as the
OfficeCare-Registered Trademark- program, through which we make our products and
services available in the offices of physicians or other providers. In
conjunction with the OfficeCare-Registered Trademark- program, we may pay
participating physicians a fee for rental space and support services provided by
such physicians to us. In a Special Fraud Alert issued by the Office of
Inspector General of the Department of Health and Human Services (OIG) in
February 2000, the OIG indicated that it may scrutinize stock and bill programs
involving excessive rental payments for possible violation of the Medicare Fraud
and Abuse Statute, but notes that legitimate arrangements, including fair market
value rental arrangements that meet the requirements of applicable safe harbors,
will be immune from prosecution under the statute. We believe we have structured
the OfficeCare-Registered Trademark- Program to comply with these laws.
PHYSICIAN SELF-REFERRAL LAWS. We are also subject to federal and state
physician self-referral laws. Federal physician self-referral legislation (known
as the Stark law) prohibits, subject to certain exceptions, a physician or a
member of his immediate family from referring Medicare or Medicaid patients to
an entity providing "designated health services" in which the physician has an
ownership or investment interest, or with which the physician has entered into a
compensation arrangement. The Stark law also prohibits the entity receiving the
referral from billing any good or service furnished pursuant to an
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unlawful referral. The penalties for violations include a prohibition on payment
by these government programs and civil penalties of as much as $15,000 for each
violative referral and $100,000 for participation in a "circumvention scheme".
Various state laws also contain similar provisions and penalties.
FALSE CLAIMS LAWS. Under separate statutes, submission of claims for payment
that are "not provided as claimed" may lead to civil money penalties, criminal
fines and imprisonment, and/or exclusion from participation in Medicare,
Medicaid and other federally funded state health programs. These false claims
statutes include the Federal False Claims Act, which allows any person to bring
suit alleging false or fraudulent Medicare or Medicaid claims or other
violations of the statute and to share in any amounts paid by the entity to the
government in fines or settlement. Such suits, known as qui tam actions, have
increased significantly in recent years causing greater numbers of health care
companies to have to defend a false claim action, pay fines or be excluded from
the Medicare, Medicaid or other federal or state health care programs as a
result of an investigation arising out of such action.
Environmental and other matters
Our facilities and operations are subject to federal, state and local
environmental and occupational health and safety requirements of the United
States and foreign countries, including those relating to discharges of
substances to the air, water and land, the handling, storage and disposal of
wastes and the cleanup of properties affected by pollutants. We believe we are
currently in compliance with such requirements and do not currently anticipate
any material adverse effect on our business or financial condition as a result
of our efforts to comply with these requirements.
In the future, federal, state, local or foreign governments could enact new or
more stringent laws or issue new or more stringent regulations concerning
environmental and worker health and safety matters that could effect our
operations. Also, in the future, contamination may be found to exist at our
current or former facilities or off-site locations where we have sent wastes. We
could be held liable for such newly discovered contamination which could have a
material adverse effect on our business or financial condition. In addition,
changes in environmental and worker health and safety requirements or
liabilities from newly discovered contamination could have a material effect on
our business or financial condition.
Governmental audits
Our operations are subject to periodic survey by governmental entities or
contractors to assure compliance with Medicare and Medicaid standards and
requirements. From time to time in the ordinary course of business, we, like
other health care companies, are audited by or receive claims documentation
requests from governmental entities, which may cite certain deficiencies based
on our alleged failure to comply with applicable supplier standards or other
requirements. We review and assess such audits or reports and attempt to take
appropriate corrective action. The failure to effect such action or to obtain,
renew or maintain any of the required regulatory approvals, certifications or
licenses could adversely affect our business, results of operations or financial
condition and could prevent the programs involved from offering products and
services to patients.
Other federal and state regulations
There may be other federal, state and local laws, rules and regulations that
affect our business. In addition, new laws, rules and regulations may be adopted
to regulate new and existing products,
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services and industries. There can be no assurance that either the states or the
federal government will not impose additional regulations upon our activities
that might adversely affect our business, results of operations and financial
condition.
Legal proceedings
We are involved from time to time in litigation arising in the ordinary course
of business, including product liability claims, none of which is currently
expected to have a material adverse effect on us. We maintain product liability
insurance in amounts which we believe to be reasonable and standard in the
industry.
On November 27, 2001, Marc Kaysen filed a purported class action in the United
States District Court for the Southern District of New York, captioned KAYSEN V.
CROSS, ET AL., 01 Civ. 10707 (HB), allegedly on behalf of himself and all
purchasers of our stock pursuant to or traceable to the our initial public
offering. The complaint names as defendants dj Orthopedics, Inc., our chief
executive officer, chief financial officer, and chairman of our board of
directors, and the lead underwriters of our initial public offering. The
complaint alleges causes of action for violations of Sections 11, 12(a)(2), and
15 of the Securities Act of 1933, based on, among other things, supposed
materially false and misleading statements and omissions in the registration
statement and prospectus for the initial public offering. The complaint seeks
rescission of plaintiffs' purchases and other unspecified damages. Six
additional purported class actions, allegedly on behalf of the same class of
plaintiffs, naming the same defendants, incorporating substantially similar
allegations, and seeking substantially similar relief as the KAYSEN action, have
since been filed in the United States District Courts for the Southern District
of California and the Southern District of New York: STEINBERG V. CROSS, ET AL.,
01 CV 10478, was filed in New York on December 6, 2001; EAST SIDE HOLDINGS
ELEVEN LTD. V. CROSS, ET AL., 01 CV 10991, was filed in New York on December 6,
2001; BEVERLY V. CROSS, ET AL., 01 CV 11384, was filed in New York on
December 11, 2001; WESSEL V. CROSS, ET AL., 01 CV 11471, was filed in New York
on December 14, 2001; LARKY V. DJ ORTHOPEDICS, INC. ET AL.,
01 CV 2238 K (LSP), was filed in California on December 5, 2001; and GREEN V.
DJ ORTHOPEDICS, INC. ET AL., 01 CV 2260 IEG (LAB) was filed in California on
December 7, 2001. Additionally, as of December 20, 2001, we are aware of reports
in the news media of the filing of two other actions purportedly containing
similar allegations, but we have not yet seen either of those two complaints. We
believe that all of the actions' allegations lack merit and intend to defend the
actions vigorously.
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Management
Board of directors and executive officers
The following table sets forth certain information with respect to persons who
are members of the Board of Directors of dj Orthopedics, Inc., and executive
officers of dj Orthopedics, LLC. Each director was a member of the Board of
Managers of DonJoy, L.L.C. before the reorganization.
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------------
Name Age Position
- -------------------------------------------------------------------------------------------------------------------
Leslie H. Cross........................... 50 President, Chief Executive Officer and Director
Cyril Talbot III.......................... 46 Senior Vice President--Finance, Chief Financial Officer and
Secretary
Michael R. McBrayer....................... 42 Senior Vice President--Professional Relations and Business
Development
Kenneth D. Rolfes......................... 53 Senior Vice President--Global Operations and Customer Care
Paul K. Nichols........................... 46 Senior Vice President--Global Sales and Marketing
Charles T. Orsatti........................ 57 Chairman of the Board
Mitchell J. Blutt, M.D.................... 44 Director
Kirby L. Cramer........................... 65 Director
Damion E. Wicker, M.D..................... 40 Director
===================================================================================================================
</Table>
LESLIE H. CROSS has been the Chief Executive Officer and a director of dj
Orthopedics, Inc. since its incorporation. He has served as President of dj
Orthopedics, LLC since July 1995 and became the Chief Executive Officer and a
Manager of DonJoy, L.L.C. and dj Orthopedics, LLC upon consummation of the
recapitalization. From 1990 to 1994, Mr. Cross held the position of Senior Vice
President of Marketing and Business Development. He was a Managing Director of
two different divisions of Smith & Nephew from 1982 to 1990. Prior to that time,
he worked at American Hospital Supply Corporation. Mr. Cross earned a diploma in
Medical Technology from Sydney Technical College in Sydney, Australia and
studied Business at the University of Cape Town in Cape Town, South Africa. He
also serves as a director of Sonus Corporation.
CYRIL TALBOT III has been Senior Vice President--Finance and Chief Financial
Officer of dj Orthopedics, Inc. since its incorporation. He has served as Senior
Vice President--Finance of dj Orthopedics, LLC since 1994 and became the Chief
Financial Officer of DonJoy, L.L.C. and dj Orthopedics, LLC upon consummation of
the recapitalization. He joined dj Orthopedics, LLC in 1991 as Director of
Finance. From 1981 to 1991, he held several management positions at American
Hospital Supply Corporation and McGaw, Inc. Prior to that time, he was an Audit
Manager and a Certified Public Accountant at Miller, Cooper & Co. Ltd.
Mr. Talbot earned his B.S. (Accounting/Finance) at Miami University in Oxford,
Ohio.
MICHAEL R. MCBRAYER became Senior Vice President--Professional Relations and
Business Development of dj Orthopedics, LLC in 2001. He has held several other
managerial positions with us, including Senior Vice President--Sales, since
joining dj Orthopedics, LLC in 1987 as a national sales manager for the
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retail product line. Mr. McBrayer received his B.S. (Marketing and Management)
at Northern Arizona University in Flagstaff, Arizona.
KENNETH D. ROLFES joined dj Orthopedics, LLC as Senior Vice President--Global
Operations and Customer Care in 2000. Prior to joining us, he was corporate
officer and vice president of operations of Graphic Controls, a leading company
providing hospitals with cardiovascular, obstetric, and operating room supplies.
Mr. Rolfes holds a Bachelor of Science in Industrial Engineering and a Master of
Business Administration in Finance.
PAUL K. NICHOLS joined dj Orthopedics, LLC as Senior Vice President--Global
Sales and Marketing in 2001 upon our acquisition of Alaron Technologies LLC.
Prior to joining dj Orthopedics, LLC, Mr. Nichols served as President and
Co-Founder of Alaron Technologies since 2000. Prior to founding Avanta
Orthopedics, L.L.C., a leading upper extremity surgical products company, in
1995, Mr. Nichols held several senior management positions at IVAC Corporation,
then a subsidiary of Eli Lilly, and Sutter Corporation, then a subsidiary of HCA
Healthcare. Mr. Nichols holds a Bachelor of Arts in Mathematics from the
University of California at San Diego.
CHARLES T. ORSATTI has been Chairman of the Board of Directors of dj
Orthopedics, Inc. since its incorporation. He became a Manager of DonJoy, L.L.C.
upon consummation of the recapitalization. Since 1998, he has been the Managing
Member of J.P. Morgan Fairfield Partners, LLC, a private equity firm with
holdings exclusively in dj Orthopedics, Inc. He is also the Managing Partner of
Fairfield Capital Partners, Inc., a private equity fund with investments in
securities, commercial real estate and business equity investments. From 1995 to
1998, Mr. Orsatti was a senior consultant to Chase Capital Partners (CCP), a
predecessor of J.P. Morgan Partners, LLC. He had previously served as an advisor
and business consultant to CCP since 1987. Until 1995, Mr. Orsatti was the
Chairman and Chief Executive Officer of Fairfield Medical Products Corporation,
a worldwide manufacturer of critical care products sold to hospitals and
alternative care facilities. He previously held executive positions with British
Oxygen Corporation, Johnson & Johnson, Coloplast, A/S Denmark and Air Products
and Chemicals, Inc. Mr. Orsatti earned a B.S. (Management and Marketing) from
Pennsylvania State University. He also serves as a Vice-Chairman of
Vitagen, Inc.
MITCHELL J. BLUTT, M.D. has been a director of dj Orthopedics, Inc. since its
incorporation. He became a Manager of DonJoy, L.L.C. upon consummation of the
recapitalization. He has been an Executive Partner of J.P. Morgan Partners, LLC,
or its predecessor, CCP, since 1992. J.P. Morgan Partners, LLC is the private
equity organization within J.P. Morgan Chase & Co. Dr. Blutt was a General
Partner of CCP from 1988 to 1992. Dr. Blutt earned his B.A. and M.D. from the
University of Pennsylvania and received his M.B.A. at the Wharton School of the
University of Pennsylvania during the Clinical Scholars Fellowship sponsored by
the Robert Wood Johnson Foundation. He completed his medical residency at the
New York Hospital/Cornell Medical School. He serves as a director of Hanger
Orthopedic Group, Fisher Scientific Corp., La Petite Academy Corp., and other
companies. Dr. Blutt is also on the Board of the National Venture Capital
Association. He is also an Adjunct Professor of Medicine at Weill Medical
College and Graduate School of Medical Sciences of Cornell University. He also
serves on the Board of the Michael J. Fox Foundation for Parkinson's Research.
Dr. Blutt is a member of the Board of Trustees of the University of Pennsylvania
and is also a member of the Board of Overseers of the University of
Pennsylvania's School of Arts and Sciences and is the Vice Chair of the
University Committee for Undergraduate Financial Aid.
KIRBY L. CRAMER became a director of dj Orthopedics, Inc. upon consummation of
the initial public offering of common stock of dj Orthopedics, Inc. He became a
Manager of DonJoy, L.L.C. in
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December 1999. Mr. Cramer is a professional corporate director, having served as
Chairman of five companies. He is Chairman Emeritus of Hazelton Laboratories
Corporation (HLC), the world's largest contract biological and chemical research
laboratory. He is also Chairman of the Board of Northwestern Trust and Investors
Advisory Company located in Seattle, Washington and president of Keystone
Capital Company, a firm specializing in leveraged buyouts and venture capital in
the Pacific Northwest. Prior to that time, Mr. Cramer served as Chairman of
Kirschner Medical Corporation during its inception as a publicly traded company,
and then as Chairman of the Executive Committee. Additionally, he is a Trustee
Emeritus and Past President of Virginia's Colgate Darden Graduate School of
Business Administration, Chairman of the Major Gifts Committee of the University
of Washington Foundation, and has served as Chairman of the Advisory Board of
the School of Business Administration of the University of Washington. In 1997,
Mr. Cramer received the University of Washington's Business School's Alumni
Service Award. Mr. Cramer is a graduate of Harvard Business School's Advanced
Management Program, received his M.B.A. degree from the University of Washington
and obtained his B.A. degree from Northwestern University. He is a Chartered
Financial Analyst and, in 1988, he received an honorary Doctor of Laws degree
from James Madison University.
DAMION E. WICKER, M.D. became a director of dj Orthopedics, Inc. upon
consummation of the initial public offering of common stock of dj Orthopedics,
Inc. He was a Manager of DonJoy, L.L.C. from June 30, 1999 until August 2001,
and was reappointed a Manager of DonJoy, L.L.C. in October 2001. He is currently
a General Partner with J.P. Morgan Partners (formerly CCP). Dr. Wicker received
a B.S. with honors from M.I.T. in 1983, an M.D. from Johns Hopkins in 1987 and
holds an M.B.A. from the Wharton School of the University of Pennsylvania. Prior
to joining CCP in 1993, Dr. Wicker was President of Adams Scientific and held
positions with MBW Venture Partners and Alexon, Inc. Dr. Wicker was also a
Commonwealth Fund Medical Fellow for the National Institute of Health. He is
currently a member of the NVCA Life Science Group Board and the Board of
Trustees of the New York Academy of Medicine. Dr. Wicker currently is also a
director of Genomic Solutions, MediChem Life Sciences, Neuron Therapeutics,
Optiscan, Transurgical, Vitagen and V.I. Technologies.
JPMDJ Partners and JPMP (23A SBIC) are affiliates of J.P. Morgan Partners, LLC
(JPMP). J.P. Morgan Partners is the private equity division of J.P. Morgan
Chase & Co., one of the largest bank holding companies in the United States, and
is one of the largest private equity organizations in the United States, with
over $22 billion under management. Through its affiliates, J.P. Morgan Partners
invests in leveraged buyouts, recapitalizations and venture capital
opportunities by providing equity and mezzanine debt capital. Since its
inception in 1984, J.P. Morgan Partners has made over 1,150 direct investments
in a variety of industries. J.P. Morgan Partners has invested over $1.0 billion
in more than 100 companies in the life sciences and healthcare industries. JPM
Fairfield Partners is a private venture capital firm targeting middle market
medical device companies created by J.P. Morgan Partners and Charles T. Orsatti
and is controlled by Mr. Orsatti.
First Union Capital Partners, LLC has the right to designate one observer to
attend meetings of our board of directors.
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Directors' terms
The Board of Directors of dj Orthopedics, Inc. is divided into three classes
that serve staggered three-year terms:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------
Class Expiration Board Member
- --------------------------------------------------------------------------------------------------------
Class I..................................................... 2002 Messrs. Cross and Cramer
Class II.................................................... 2003 Messrs. Orsatti and Wicker
Class III................................................... 2004 Dr. Blutt
========================================================================================================
</Table>
Committees of the board of directors
The Board of Directors of dj Orthopedics, Inc. has an Executive Committee, a
Compensation Committee and an Audit Committee. The Executive Committee may
exercise all the powers of the Board of Directors in the management of our
business and affairs except for those powers expressly reserved to the Board
under Delaware law. The members of the Executive Committee are Messrs. Blutt,
Cross, Wicker and Orsatti. The Compensation Committee determines compensation
for our executive officers and administers our incentive compensation plans.
Currently, Messrs. Cramer, Orsatti and Wicker serve on the Compensation
Committee. The Audit Committee provides assistance to the board in fulfilling
its legal and fiduciary obligations in matters involving our accounting,
auditing, financial reporting, internal control and legal compliance functions.
The Audit Committee also oversees the audit efforts of our independent
accountants and takes those actions as it deems necessary to satisfy itself that
the auditors are independent of management. Prior to the initial public
offering, the Audit Committee consisted of two former members of the DonJoy,
L.L.C. Board of Managers. Effective upon consummation of the initial public
offering, the Audit Committee of dj Orthopedics, Inc. has consisted of
Mr. Cramer and Dr. Wicker. The Board of Directors of dj Orthopedics, Inc. will
appoint an additional person to the Board within 12 months of the offering who
will also serve on the Audit Committee.
Compensation of board of directors
The members of the Board of Directors affiliated with JPMDJ Partners do not
receive compensation for their service on the Board of Directors but are
reimbursed for their out-of-pocket expenses. Directors who are neither officers
nor affiliated with JPMDJ Partners receive customary compensation for services
on our Board of Directors of $12,000 per year plus out-of-pocket expenses. Upon
his election to the Board of Managers of DonJoy, L.L.C. in 1999, Mr. Cramer
received a one-time grant of an option to purchase 2,000 common units of DonJoy,
L.L.C., which upon consummation of the reorganization were converted into the
right to purchase 21,624 shares of the common stock of dj Orthopedics, Inc. at
an exercise price of $9.25 per share, and the right to purchase an additional
2,000 common units of DonJoy, L.L.C., which upon consummation of the
reorganization were converted into a right to purchase 21,624 shares of common
stock at an exercise price equal to the fair market value at the time of
exercise.
Our parent has adopted the dj Orthopedics, Inc. 2001 Non-Employee Directors'
Stock Option Plan. Each of the directors of dj Orthopedics, Inc. who is not an
employee of dj Orthopedics, Inc. or the employee of any of its subsidiaries and
who was not initially elected to the board of directors, and was not an employee
of dj Orthopedics, Inc. or the employee of any of its subsidiaries, within the
previous 12 months will, immediately following each annual meeting of the
stockholders of dj Orthopedics, Inc., commencing with the annual meeting in
2003, automatically receive an annual grant of options to
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purchase 15,000 shares of common stock of dj Orthopedics, Inc. at an exercise
price equal to 100% of the fair market value of our common stock at the date of
grant of the option. Except as discussed below, each non-employee director of dj
Orthopedics, Inc., upon initially joining its board of directors, will also
receive under the plan an initial grant of options to purchase 15,000 shares of
its common stock at an exercise price equal to 100% of the fair market value of
the common stock as of such date. Neither Dr. Wicker nor Mr. Cramer received an
initial grant upon their joining the board of directors of dj Orthopedics, Inc.
upon consummation of the initial public offering. In addition, any new
non-employee director appointed to the board of directors of dj
Orthopedics, Inc. within 12 months of the effective date of the registration
statement relating to the initial public offering of common stock of dj
Orthopedics, Inc. will receive an initial grant of options to purchase 30,000
shares of its common stock. A total of 1,500,000 shares of common stock of dj
Orthopedics, Inc. has been reserved for issuance under the plan. Options granted
under the plan will vest ratably over a three-year period, commencing on the
first anniversary of the date of grant.
The plan also provides that non-employee directors may elect at their discretion
to receive up to 100% of the annual cash retainer fee in the form of options
granted under the Plan. The number of options received in lieu of the annual
retainer fee, or the method of computing the number, and the terms and
conditions of these options shall be determined by the Compensation Committee.
The plan is administered by the board of directors of dj Orthopedics, Inc. or
the Compensation Committee of the board of directors of dj Orthopedics, Inc. and
became effective on November 15, 2001, the first day on which price quotations
were reported for the common stock of dj Orthopedics, Inc. on the New York Stock
Exchange.
The unexercised portion of any option granted under the plan will terminate on
the first to occur of the ten-year anniversary of the date of grant; the
three-month anniversary of the optionholder's termination by reason other than
death, disability or for cause; the twelve-month anniversary of the
optionholder's termination by reason of death or disability; or the date of
termination for cause.
The plan may be amended by the stockholders of dj Orthopedics, Inc. The plan may
also be amended by the board of directors of dj Orthopedics, Inc., except that
no action may adversely affect any outstanding options without the consent of
the optionholders affected.
Compensation committee interlocks and insider participation
No member of the Compensation Committee of dj Orthopedics, Inc. serves as a
member of the board of directors or compensation committee of any entity that
has one or more executive officers serving as members of the board of directors
or Compensation Committee of dj Orthopedics, Inc.
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Executive compensation
The following table sets forth information concerning the compensation of our
Chief Executive Officer and each of our other four most highly compensated
executive officers for the year ended December 31, 2000 and such persons'
compensation during the two preceding years.
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------
Annual compensation
-------------------------------- All other
Name and principal position Year Salary Bonus compensation(1)
- ---------------------------------------------------------------------------------------------------
Leslie H. Cross................................ 2000 $279,413 $143,526 $ 2,917
President and Chief Executive Officer 1999 234,487 62,944 238,464
1998 226,825 183,258 2,669
Cyril Talbot III............................... 2000 177,132 65,582 3,500
Senior Vice President--Finance and Chief 1999 151,088 20,352 153,825
Financial Officer 1998 146,100 48,397 1,888
Kenneth D. Rolfes(2)........................... 2000 197,588 9,750 64,730
Senior Vice President--Global Operations/
Customer Care
Michael R. McBrayer............................ 2000 171,757 66,857 2,461
Senior Vice President--Professional Relations 1999 154,800 29,119 158,112
and
Business Development 1998 148,300 47,923 2,363
Peter Bray(3).................................. 2000 180,478 68,848 3,067
Vice President--International Business 1999 161,976 30,558 84,616
1998 156,750 50,649 3,350
===================================================================================================
</Table>
(1) Includes contributions to dj Orthopedics, LLC's 401(k) Plan, relocation
expenses in the amount of $61,230 in the case of Mr. Rolfes in 2000 and
retention bonuses paid to Messrs. Cross, Talbot, McBrayer and Bray in 1999 upon
consummation of the recapitalization. The recapitalization constituted a change
of control or division divestiture, as defined in the retention agreements of
these employees. Consequently, each of these members of management of dj
Orthopedics, LLC who remained in his position through the consummation of the
recapitalization received a special retention bonus. Pursuant to the
recapitalization agreement, the special bonus was paid by Smith & Nephew. 1999
retention bonuses were paid out as follows: Leslie H. Cross received $235,900,
Cyril Talbot III received $151,945, Michael R. McBrayer received $155,715 and
Peter Bray received $81,510.
(2) Mr. Rolfes joined dj Orthopedics, LLC in January 2000.
(3) Mr. Bray ceased to be considered an executive officer effective
February 28, 2001. Mr. Bray remains employed by us as the Vice
President--International Business.
The following table lists stock option grants to the officers named in the
summary compensation table in 2000 after giving effect to the reorganization.
<Table>
- -------------------------------------------------------------------------------------------------------------------------------
Option Grants in last fiscal year
---------------------------------------------------------------------------------------------
Number of Percent of Potential realizable value at assumed
securities total Exercise annual rates of share price
underlying options price at appreciation for option term(1)
options granted in the time Expiration ------------------------------------------
Name granted (#) 2000 of grant date 0% 5% 10%
- -------------------------------------------------------------------------------------------------------------------------------
(in thousands)
Leslie H. Cross (CEO)........... -- -- -- -- $ -- $ -- $ --
Cyril Talbot III................ -- -- -- -- $ -- $ -- $ --
Kenneth D. Rolfes............... 72,008 23.5% $ 9.25 2/1/15 $ 558 $ 1,879 $ 4,447
Michael R. McBrayer............. -- -- -- -- $ -- $ -- $ --
Peter Bray...................... -- -- -- -- $ -- $ -- $ --
===============================================================================================================================
</Table>
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(1) The potential realizable value listed in the table represents hypothetical
gains that could be achieved for the options if exercised at the end of the
option term. These gains are based on assumed rates of stock price appreciation
of 0%, 5% or 10% compounded annually from the date the respective options were
granted to their expiration date, based upon the initial public offering price
of $17.00 per share of the common stock of dj Orthopedics, Inc. The assumed 0%,
5% and 10% rates of appreciation are provided in accordance with rules of the
SEC and do not represent our estimate or projection of our future stock value.
Actual gains, if any, on option exercises will depend on the future performance
of the common stock and overall market conditions. The potential realizable
value computation does not take into account federal or state income tax
consequences of option exercises or sales of appreciated stock.
The following table sets forth information concerning options held by each of
the officers named in the summary compensation table at December 31, 2000 after
giving effect to the reorganization. No options were exercised by these persons
in 2000.
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------------
Aggregated fiscal year-end option values
------------------------------------------------------------------------
Number of common shares Value of unexercised
underlying in-the-money options at
unexercised options at fiscal year-end fiscal year-end
Name exercisable/unexercisable(1) exercisable/unexercisable(1)(2)
- ----------------------------------------------------------------------------------------------------------------------
(in thousands)
Leslie H. Cross (CEO)....................... 28,933/260,396 $ 224/$2,018
Michael McBrayer............................ 9,644/86,799 $ 75/$673
Cyril Talbot III............................ 9,644/86,799 $ 75/$673
Kenneth D. Rolfes........................... 7,201/64,807 $ 56/$502
Peter Bray.................................. 4,822/43,399 $ 37/$336
======================================================================================================================
</Table>
(1) Based on the initial public offering price of $17.00 per share of the common
stock of dj Orthopedics, Inc., less the exercise price, multiplied by the number
of shares underlying the option.
(2) Included within the amount of unexercisable options at December 31, 2000 are
Tier 2 and Tier 3 options granted under the dj Orthopedics, Inc. 1999 Option
Plan to each of the persons set forth in the table. Tier 2 options granted to
those individuals provide for the purchase of an aggregate of 77,154 shares,
25,722 shares, 25,722 shares, 19,203 shares and 12,855 shares by each of
Messrs. Cross, McBrayer, Talbot, Rolfes and Bray, respectively, and Tier 3
options granted to those individuals provide for the purchase of an aggregate of
96,443 shares, 32,144 shares, 32,144 shares, 24,003 shares and 16,077 shares by
each of Messrs. Cross, McBrayer, Talbot, Rolfes and Bray, respectively. As
discussed in note 1 under "Principal stockholders," it is assumed that the
Tier 2 options, but not the Tier 3 options, vested and became exercisable
following consummation of the initial public offering.
Amended and restated 1999 option plan
The following discussion of the dj Orthopedics Inc. employee stock option plan
gives effect to the reorganization.
Under our Amended and Restated 1999 Option Plan, 1,933,174 common shares have
been reserved for issuance upon exercise of options granted under the plan. The
plan is administered by the Compensation Committee. The plan will expire on
June 30, 2014 unless we terminate it before that date. The plan provides for the
grant of nonqualified options to our officers, directors, employees, consultants
and advisors.
Options will be granted in amounts to be agreed upon by the Compensation
Committee. Options will vest in either of the two following methods:
- as time-vesting options (ratably at specified annual intervals from the
date of grant). Up to 951,607 shares may be issued upon exercise of
time-vesting options. Some time-vesting options are also subject to the
achievement of sale targets.
- as event-vesting options, upon the occurrence of a liquidity event or a
material transaction (each as described below) and then only to the extent
JPMDJ Partners has realized specified internal rates of return on our
parent's common equity securities since the closing date of the
recapitalization. Up to 981,567 shares may be issued upon exercise of
event-vesting options. If
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no liquidity event has occurred by December 31, 2007, these event-based
options will become vested and exercisable.
A liquidity event means a sale or other disposition of all or substantially all
of the assets of dj Orthopedics, Inc. or all or substantially all of the
outstanding equity interests of dj Orthopedics, Inc. or a registered public
offering of the common equity of dj Orthopedics, Inc. resulting in a market
capitalization of more than $150 million for a period of at least 20 consecutive
trading days. A material transaction means the dissolution or liquidation, a
reorganization, merger or consolidation in which dj Orthopedics, Inc. is not the
surviving corporation, or sale of all or substantially all of the assets dj
Orthopedics, Inc. The exercise price for the options will be the fair market
value of the common equity dj Orthopedics, Inc., as determined by the Board, on
the date the option is granted. The options will expire upon the earliest of:
- the fifteenth anniversary of the date of grant;
- 12 months after the date an optionee's employment is terminated due to
the optionee's death or permanent disability;
- immediately upon an optionee's termination of employment for cause (as
defined in the Plan);
- 3 months after the date an optionee ceases to be an employee (other than
as described in the second and third points just listed above);
- the effective date of a material transaction if provision is made in
connection with such transaction for the assumption of outstanding options
by, or the substitution for such option of new options covering equity
securities of, the surviving, successor or purchasing corporation; or
- the expiration of such other period of time or the occurrence of such
other event as the Compensation Committee, in its discretion, may provide
in any option agreement.
The number of options granted to an employee, and/or the exercise price thereof,
may be adjusted in the event the shares of common stock are split, converted or
exchanged into other securities, to ensure that the options are nearly
equivalent to their options immediately before such a split, conversion, or
exchange.
Options to purchase an aggregate of 1,911,550 shares of common stock under the
plan have been granted, of which approximately 51% are time-vesting options and
approximately 49% are event-vesting options.
2001 omnibus plan
Our parent has adopted the dj Orthopedics, Inc. 2001 Omnibus Plan to aid it and
its subsidiaries in attracting and retaining key personnel, including
consultants and advisors, and to enhance the interest of these persons in our
continued success. The following summary of the Omnibus Plan is qualified in its
entirety by reference to the full text of the plan, a copy of which has been
filed as an exhibit to the registration statement of which this prospectus is a
part.
The Omnibus Plan provides for awards of stock options, stock appreciation
rights, performance awards, restricted stock, restricted stock units, stock
bonuses, stock unit awards and cash bonuses. Subject to equitable adjustments to
reflect certain corporate events, the maximum number of shares of common stock
of dj Orthopedics, Inc. with respect to which awards may be granted under the
Omnibus Plan is
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3,800,000. On each January 1, commencing January 1, 2003, the number of shares
of common stock available for issuance under the Omnibus Plan will be
automatically increased by a number of shares equal to 3% of the number of
shares of common stock outstanding on the previous December 31. In addition,
shares of common stock subject to awards that are forfeited, terminated,
canceled or settled without the delivery of common stock under the Omnibus Plan
and the Amended and Restated 1999 Stock Option Plan will increase the number of
shares available for awards under the Omnibus Plan. Also, shares tendered to dj
Orthopedics, Inc. in satisfaction or partial satisfaction of the exercise price
of any award under the Omnibus Plan or the Amended and Restated 1999 Option Plan
will increase the number of shares available for awards under the Omnibus Plan
to the extent permitted by Rule 16b-3 under the Securities Exchange Act of 1934,
as amended. Awards with respect to no more than 300,000 shares of common stock
may be granted in any year to any eligible participant under the Omnibus Plan
and no more than 1,000,000 of the shares may be granted as incentive stock
options. The shares of common stock to be delivered under the Omnibus Plan will
be made available from the authorized but unissued shares of common stock or
from treasury shares.
The Omnibus Plan is administered by the Compensation Committee of dj
Orthopedics, Inc. which will have the sole and complete authority to grant
awards under the Omnibus Plan to eligible employees and officers of, and
consultants and advisors to, dj Orthopedics, Inc. and its subsidiaries, to
establish the terms of awards and to interpret the provisions of the Omnibus
Plan and adopt, amend and repeal administrative rules, guidelines and practices
governing the operation of the Omnibus Plan as it deems advisable. The
Compensation Committee's determinations of which eligible individuals will be
granted awards and the terms of awards will be in the sole discretion of the
Compensation Committee.
Options granted under the Omnibus Plan may be either nonqualified options or
incentive stock options. Stock appreciation rights may be granted in conjunction
with or unrelated to options and, if in conjunction with an outstanding option,
may be granted at the time of the option grant or thereafter, at the exercise
price of the option. The Compensation Committee has discretion to fix the
exercise price of the options and stock appreciation rights, but the exercise
price may not be less than the fair market value of the common stock at the date
of grant. The Compensation Committee also has broad discretion as to the terms
and conditions on which options and stock appreciation rights will be
exercisable.
The exercise price of options may be satisfied in cash or, in the discretion of
the Compensation Committee, by exchanging shares of common stock owned by the
optionee, or by a combination of cash and shares of common stock. The ability to
pay the option exercise price in shares of common stock would, if permitted by
the Compensation Committee, enable an optionee to engage in a series of
successive stock-for-stock exercises of an option, a practice sometimes referred
to as "pyramiding", and as a result fully exercise an option with little or no
cash investment. In the event that a participant is permitted to and does
exercise an option granted under the Omnibus Plan by delivering shares of common
stock, the Compensation Committee is authorized to grant or provide for the
automatic grant of a restoration option to the optionee, subject to the
satisfaction of conditions or criteria established by the Compensation
Committee. A restoration option will entitle the participant to purchase a
number of shares of common stock equal to the number of shares surrendered in
payment of the exercise price of the original option, at a per share exercise
price equal to not less than 100% of the per share fair market value of the
common stock on the date of grant of the restoration option. The terms and
conditions of the restoration option will be determined by the Committee.
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On the exercise of a stock appreciation right, a participant will be entitled to
receive a cash payment equal to the excess of the fair market value of the
shares to which the right relates at the date of exercise over the exercise
price of the right.
Performance awards will be earned to the extent performance goals established by
the Compensation Committee are achieved over a period of time specified by the
Compensation Committee. The Compensation Committee will have discretion to
determine the value of each performance award, to adjust the performance goals
as it deems equitable to reflect events affecting us or changes in law or
accounting principles or other factors, and to determine the extent to which
performance awards that are earned may be paid in the form of cash, shares of
common stock or a combination of both.
Awards of restricted stock or restricted stock units under the Omnibus Plan will
consist of shares of common stock or units, the value of which is equal to a
share of common stock. Restricted stock and restricted stock units will be
granted to a participant subject to restrictions on transfer and forfeiture
specified by the Compensation Committee. In general, a participant who has been
granted restricted stock will from the date of grant have the benefits of
ownership in respect of the shares, including the right to vote the shares and
to receive dividends and other distributions thereon, subject to the
restrictions set forth in the Omnibus Plan and in the instrument evidencing the
award. The shares of restricted stock will be held by us, or by an escrow agent
designated by us, during the restricted period. The Compensation Committee has
authority to determine the duration of the restricted period as well as the
other terms and conditions of the restricted stock and restricted stock units.
Restricted stock units may be paid, in the discretion of the Compensation
Committee, in cash, shares of common stock, other securities or other property
upon the lapse of the applicable restrictions.
The Omnibus Plan also authorizes the Compensation Committee to grant to
participants a stock unit award, which shall consist of a right which is an
award of shares of common stock or an award denominated or payable in, or that
is valued in whole or in part by reference to, or is otherwise based on, the
value of shares of common stock. The Compensation Committee has discretion to
determine the participants to whom stock unit awards are to be made, the times
at which the awards are to be made, the size of the awards, and all other
conditions of the awards, including any restrictions, deferral periods, or
performance requirements.
The Omnibus Plan also authorizes the Compensation Committee to grant to
participants stock bonuses. The Compensation Committee has discretion to
determine the participants to whom stock bonuses are to be made, the times at
which the awards are to be made, the size of the awards, and all other
conditions of the awards, including any restrictions, deferral periods, or
performance requirements.
Any award under the Omnibus Plan may provide that the participant has the right
to receive currently, or on deferred basis, dividends or dividend equivalents
and/or other cash payments in addition to or in lieu of the award, all as the
Compensation Committee determines.
The Compensation Committee may in its discretion, in connection the grant of an
award under the Omnibus Plan, grant a cash bonus payable after the date on which
the participant is required to recognize income for federal income tax purposes
in connection with the award or at any other time as the Committee determines.
The amount of any cash bonus will be determined by the Committee, provided that
in no event will the amount of the cash bonus exceed the fair market value of
the shares of common stock to which the award relates. A cash bonus will be
subject to conditions determined by the Compensation Committee at the time the
cash bonus is granted.
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In connection with the grant of any stock award under the Omnibus Plan, the
Compensation Committee will have the right to grant to the participant a stock
loan in an amount and on such terms as may be approved by the Compensation
Committee for the purpose of financing in whole or in part the exercise price or
other payment to be made by the participant in connection with the award or any
tax payable in connection with the award. Any loan will be made with full
recourse to the participant, will be secured by the common stock and will bear
interest at a rate sufficient to avoid imputed income under applicable
provisions of the Internal Revenue Code.
If the Compensation Committee determines that any stock split, reverse stock
split, stock dividend or other distribution (whether in the form of cash,
securities, or other property), recapitalization reorganization, merger,
consolidation, split-up, spin-off, combination, repurchase or exchange of
shares, issuance of warrants or other rights to purchase shares at a price below
fair market value, or other similar corporate event affects the common stock
such that an adjustment is required in order to preserve the benefits intended
under the Omnibus Plan, the Committee has discretion to make equitable
adjustments in the number and kind of shares that may be the subject of future
awards under the Omnibus Plan and the number and kind of shares (or other
securities or property) subject to outstanding awards and the respective grant
or exercise prices of any future or outstanding awards.
The Compensation Committee has broad discretion as to the specific terms and
conditions of each award and any rules applicable to an award, including but not
limited to, subject to the terms of the Plan, the effect on an award of the
death, retirement or other termination of employment of the participant or
termination of the provision of services pursuant to an advisory or consultant
engagement. The terms of each award are to be evidenced by a written instrument
delivered to the participant. The awards authorized under the Omnibus Plan are
subject to applicable tax withholding by us, which may be satisfied by the
withholding of shares payable under the Omnibus. Awards may not be assigned or
transferred, except by will or the law of descent and distribution or pursuant
to a qualified domestic relations order or as otherwise provided in the Plan.
The Omnibus Plan may be amended or terminated at any time by the board of
directors of dj Orthopedics, Inc., except that no amendment may be made without
stockholder approval if the Compensation Committee determines that stockholder
approval is necessary to comply with any tax or regulatory requirement,
including any approval requirement which is a prerequisite for the exemptive
relief from Section 16 of the Securities Exchange Act of 1934, as amended, for
which or with which the Committee determines that it is desirable to qualify or
comply.
Employee stock purchase plan
The dj Orthopedic, Inc. 2001 Employee Stock Purchase Plan became effective on
November 15, 2001, the first day on which price quotations were reported for the
common stock of dj Orthopedics, Inc. on the NYSE. Initially, 1,000,000 shares of
common stock of dj Orthopedics, Inc. has been reserved under this plan. On each
January 1 of each year, commencing January 1, 2003, the aggregate number of
shares reserved for issuance under this plan will increase automatically by a
number of shares equal to 1.0% of our outstanding shares on December 31 of the
preceding year. The board of directors of dj Orthopedics, Inc. or the
Compensation Committee may reduce the amount of the increase in any particular
year. The aggregate number of shares reserved for issuance under the Stock
Purchase Plan may not exceed 5,000,000 shares.
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The Stock Purchase Plan is administered by the Compensation Committee of dj
Orthopedics, Inc. The Compensation Committee has the authority to construe and
interpret the plan, and its decisions will be final and binding.
Employees generally will be eligible to participate in the Stock Purchase Plan
if they are employed before the beginning of the applicable offering period, are
customarily employed by dj Orthopedics, Inc., or any of its subsidiaries that
are designated, for 20 hours or more per week and more than five months in a
calendar year and are not, and would not become as a result of being granted an
option under the plan, 5% stockholders of dj Orthopedics, Inc. or its designated
subsidiaries. Participation in the Stock Purchase Plan will end automatically
upon termination of employment for any reason.
Under the Stock Purchase Plan, eligible employees will be permitted to acquire
shares of common stock of dj Orthopedics, Inc. through payroll deductions.
Eligible employees may select a rate of payroll deduction between 1% and 15% of
their compensation and are subject to maximum purchase limitations.
Except for the first offering period and the first purchase period, each
offering period under the Stock Purchase Plan will be for two years and consist
of four six-month purchase periods. Offering periods and purchase periods will
begin on January 1 and July 1 of each year. The first offering period is
expected to begin on the first business day on which price quotations for the
common stock of dj Orthopedics, Inc. are reported on the NYSE and will end on
December 31, 2003, and the first purchase period of the first offering period
will begin on the first business day on which price quotations for the common
stock of dj Orthopedics, Inc. are reported on the New York Stock Exchange and
will end on June 30, 2002.
The Stock Purchase Plan will provide that the purchase price for common stock
purchased under the plan will be 85% of the lesser of the fair market value of
the common stock on the first day of the applicable offering period or the last
day of the applicable purchase period. The Compensation Committee will have the
power to change the offering dates, purchase dates and durations of offering
periods without stockholder approval, if the change is announced prior to the
beginning of the affected date or offering period.
The Stock Purchase Plan is intended to qualify as an "employee stock purchase
plan" under Section 423 of the Internal Revenue Code. The plan will terminate
10 years from the date of the adoption of the plan by our board of directors,
unless it is terminated earlier under the terms of the plan. The board will have
the authority to amend, terminate or extend the term of the plan, except that no
action taken by the board may adversely affect any outstanding options
previously granted under the plan.
Except for the automatic annual increase of shares described above, stockholder
approval will be required to increase the number of shares that may be issued or
to change the terms of eligibility under the Stock Purchase Plan. The board will
be able to make amendments to the plan as it determines to be advisable if the
financial accounting treatment for the plan is different from the financial
accounting treatment in effect on the date the plan was adopted by the board.
401(k) plan
We have established our own 401(k) Plan, which is substantially the same as the
plan previously provided by Smith & Nephew. The assets funding the Smith &
Nephew plan were transferred to our 401(k) Plan.
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Employment agreements
In connection with the recapitalization, dj Orthopedics, LLC entered into
employment agreements with Leslie H. Cross, Cyril Talbot III and Michael R.
McBrayer. The employment agreements terminate on June 30, 2002, but are
renewable annually by mutual agreement thereafter. Pursuant to their respective
employment agreements, Mr. Cross serves as President and CEO of dj Orthopedics,
LLC at an annual base salary of $279,413, Mr. Talbot serves as Senior Vice
President of Finance, CFO and Secretary of dj Orthopedics, LLC at an annual base
salary of $177,132 and Mr. McBrayer serves as Senior Vice President of Domestic
Sales and Assistant Secretary of dj Orthopedics, LLC at an annual base salary of
$171,757. These base salaries are subject to annual review and adjustment by the
board of directors of dj Orthopedics, Inc. In connection with the Alaron
acquisition, dj Orthopedics, LLC entered into an employment agreement with
Paul K. Nichols, our Senior Vice President--Global Sales and Marketing at an
annual base salary of $200,000. In addition, each executive is entitled to such
annual bonuses as may be determined by the board of directors of
dj Orthopedics, Inc., four weeks paid vacation per year (three weeks in the case
of Mr. Talbot), a car allowance and, for 1999 only, club membership dues and tax
preparation fees. Each executive may be terminated at any time during the term
of the applicable employment agreement with or without cause, as defined in the
applicable employment agreement. In the event of an executive's termination
without cause, the executive will be entitled to receive his base salary from
the date of termination until the first anniversary of the date of termination
(the second anniversary in the case of Mr. Cross). Pursuant to the applicable
employment agreement, each executive has agreed that until the fourth
anniversary of the date of termination or expiration of his employment with
dj Orthopedics, LLC, he will not:
- induce or attempt to induce any employee of dj Orthopedics, LLC or any
of its affiliates to leave the employ of dj Orthopedics, LLC or any such
affiliate, or in any way interfere with the relationship between dj
Orthopedics, LLC or any such affiliate and any employee thereof;
- hire any person who was an employee of dj Orthopedics, LLC until six
months after such person's employment with dj Orthopedics, LLC or any
affiliate thereof was terminated; or
- induce or attempt to induce any customer, supplier, licensee or other
business relation of dj Orthopedics, LLC or any affiliate to cease doing
business with dj Orthopedics, LLC or such affiliate, or in any way
interfere with the relationship between any such customer, supplier,
licensee or business relation and dj Orthopedics, LLC or any such
affiliate.
Each employment agreement also contains customary non-disclosure provisions. In
addition, each executive has agreed that any inventions or other developments
relating to dj Orthopedics, LLC or its products or services conceived, developed
or made by the executive while employed by dj Orthopedics, LLC belong to dj
Orthopedics, LLC.
Retention agreements
In December 1998, Smith & Nephew entered into retention agreements with some of
the then existing members of management of dj Orthopedics, LLC, including
Messrs. Cross, Talbot, McBrayer and Bray, to induce them to remain employees of
dj Orthopedics, LLC in the event of a change of control or division divestiture,
as defined in the retention agreement. The recapitalization constituted a change
of control or division divestiture. Each of these management employees who
remained in his position through the consummation of the recapitalization
received a special retention bonus. Pursuant to the recapitalization agreement,
the special bonus was paid by Smith & Nephew.
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Principal stockholders
The following table sets forth information with respect to the ownership of the
common stock of dj Orthopedics, Inc. as of October 19, 2001 after giving effect
to the reorganization and the sale of 7,800,000 shares of common stock in the
initial public offering, for:
- each person known to own beneficially more than 5% of the equity
securities of dj Orthopedics, Inc.;
- each of the directors of dj Orthopedics, Inc.;
- each executive officer named in the summary compensation table; and
- all executive officers and directors as a group.
DonJoy's redeemable preferred units were owned approximately 51% by JPMP
(23A SBIC), an affiliate of JPMDJ Partners, approximately 33% by affiliates of
TCW/Crescent Mezzanine, LLC and approximately 16% by First Union Capital
Partners, LLC and DJ Investment, LLC (together with First Union Capital Partners
2001, LLC, Wachovia Capital Partners). In the reorganization, each preferred
unit was converted into the right to receive an amount in cash equal to the
liquidation preference of the preferred unit and the applicable premium plus
accrued and unpaid distributions thereon to but excluding the date that the
reorganization is effective, and 10.812 shares of common stock.
JPMDJ Partners purchased the common units of DonJoy and each of JPMP (23A SBIC),
Wachovia Capital Partners and the TCW affiliates purchased their redeemable
preferred units of DonJoy in the ordinary course of business. At the respective
times of purchase, none of the foregoing entities had any agreement or
understanding, directly or indirectly, with any person to distribute such common
units or redeemable preferred units, as applicable, or the common stock into
which all such units were converted upon consummation of the reorganization.
The amounts and percentages of shares beneficially owned are reported on the
basis of regulations of the SEC governing the determination of beneficial
ownership of securities. Under the rules of the SEC, a person is deemed to be a
beneficial owner of a security if that person has or shares voting power or
investment power, which includes the power to dispose of or to direct the
disposition of the security. A person is also deemed to be a beneficial owner of
any securities of which that person has a right to acquire beneficial ownership
within 60 days. Securities that can be so acquired are deemed to be outstanding
for purposes of computing that person's ownership percentage, but not for
purposes of computing any other person's percentage. Under these rules, more
than one person may be deemed a beneficial owner of the same securities and a
person may be deemed to be a beneficial owner of securities as to which that
person has no economic interest.
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<Table>
<Caption>
- --------------------------------------------------------------------------------------
Shares beneficially
owned after the
reorganization and the
initial public offering
------------------------
<Caption>
Name Number(1) Percentage
- --------------------------------------------------------------------------------------
J.P. Morgan DJ Partners, LLC (formerly Chase DJ Partners,
LLC)(2)................................................... 8,167,512(13) 45.7%
J.P. Morgan Partners (23A SBIC), LLC (formerly CB Capital
Investors LLC)(2)(3)...................................... 8,381,652(13) 46.9%
Charles T. Orsatti(4)....................................... 8,167,512 45.7%
Leslie H. Cross(5)(6)....................................... 315,288 1.8%
Cyril Talbot III(5)(7)...................................... 88,280 0.5%
Michael R. McBrayer(5)(7)................................... 88,280 0.5%
Peter Bray(5)(8)............................................ 22,500 0.1%
Ken Rolfes(5)(9)............................................ 33,605 0.2%
Mitchell J. Blutt, M.D.(10)................................. 8,381,652 46.9%
Damion E. Wicker, M.D.(10).................................. 8,381,652 46.9%
Kirby L. Cramer(11)......................................... 43,248 0.2%
All directors and executive officers as a group
(9 persons) (12).......................................... 8,973,544 49.4%
======================================================================================
</Table>
(1) For purposes of calculating the number of shares beneficially owned after
the initial public offering, all Tier 2 options, but no Tier 3 options, granted
under the 1999 Stock Option Plan are assumed to have vested as described below.
Under the Plan, Tier 2 and Tier 3 options vest upon the consummation of an
initial public offering resulting in a market capitalization of more than
$150 million for a period of 20 consecutive trading days and if JPMDJ Partners
has realized specified initial rates of return on the common stock as set forth
in the plan since June 30, 1999, the closing date of our 1999 recapitalization.
See "Amended and restated 1999 option plan." For purposes of the table, it is
assumed that each of these conditions has been met following the offering with
respect to the Tier 2 options; however, no Tier 3 options vested as the
specified rate of return on the common stock since June 30, 1999 was not
achieved. Tier 1 options granted under the plan are time vesting options which
vested ratably at specified intervals from the date of grant. Tier 1 options are
included for purposes of the table to the extent they have vested or will vest
within 60 days after October 19, 2001.
(2) The address of JPMDJ Partners and JPMP (23A SBIC) is c/o J.P. Morgan
Partners, LLC, 1221 Avenue of the Americas, New York, New York 10020. JPMDJ
Partners was formed by JPMP (23A SBIC) and JPM Fairfield Partners. JPMP (23A
SBIC) owns approximately 86.9%, Wachovia Capital Partners owns approximately
9.6%, the TCW affiliates own approximately 3.1% and JPM Fairfield Partners owns
approximately 0.4% of the membership interests in JPMDJ Partners, representing
investments in JPMDJ Partners of approximately $76.5 million, $8.5 million,
$2.7 million and $0.3 million, respectively. JPM Fairfield Partners is the
managing member of JPMDJ Partners except that under the circumstances described
below, JPMP (23A SBIC) will become the managing member of JPMDJ Partners. JPMP
(23A SBIC) is a licensed small business investment company (SBIC) and as such is
subject to restrictions imposed upon SBICs by the regulations established and
enforced by the Small Business Administration. Among these restrictions are
certain limitations on the extent to which an SBIC may exercise control over
companies in which it invests. As a result of these restrictions, JPMP (23A
SBIC) will only become the managing member of JPMDJ Partners if specified events
described in the constituent documents of JPMDJ Partners occur. These events are
the breach of any representations made by JPM Fairfield Partners in the JPMDJ
Partners limited liability company agreement; the default by JPM Fairfield
Partners in the performance of any of its obligations under the JPMDJ Partners
limited liability company agreement; JPMP (23A SBIC) believes circumstances
exist that require it to take control of JPMDJ Partners; and JPMP (23A SBIC)
determines both that it is permitted under appropriate law to take control of
JPMDJ Partners and that it is in its interest and the interest of the other
members of JPMDJ Partners to do so.
(3) Includes (i) 214,140 shares owned by JPMP (23A SBIC) and (ii) 8,167,512
shares owned by JPMDJ Partners of which JPMP (23A SBIC) may be deemed the
beneficial owner given its status as a member of JPMDJ Partners owning
approximately 87% of JPMDJ Partners' membership interests.
(4) Reflects the shares owned by JPMDJ Partners given his status as the person
controlling JPM Fairfield Partners, which is the managing member of JPMDJ
Partners. As the managing member of JPMDJ Partners, JPM Fairfield Partners may
also be deemed to be the beneficial owner of these shares. Mr. Orsatti disclaims
beneficial ownership of these shares except to the extent of his pecuniary
interest. The address of Mr. Orsatti is c/o J.P. Morgan Fairfield Medical
Partners, LLC, 600 Cleveland Street, Suite 1100, Clearwater, Florida 83755.
(5) The address of Messrs. Cross, Talbot, McBrayer, Rolfes and Bray is c/o dj
Orthopedics, Inc., 2985 Scott Street, Vista, California 92083.
(6) Includes 180,268 shares held by the Leslie H. Cross & Deborah L. Cross
Family Trust, of which Mr. Cross is a trustee. Also includes 57,866 shares
issuable upon exercise of Tier I options and 77,154 shares issuable upon
exercise of Tier 2 options.
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(7) Includes 43,269 shares. Also includes 19,289 shares issuable upon exercise
of Tier I options and 25,722 shares issuable upon exercise of Tier 2 options.
(8) Includes 9,644 shares issuable upon exercise of Tier I options and 12,856
common shares issuable upon exercise of Tier 2 options.
(9) Includes 14,402 shares issuable upon exercise of Tier I options and 19,203
shares issuable upon exercise of Tier 2 options.
(10) Reflects the shares owned by JPMDJ Partners and JPMP (23A SBIC) due to his
status as an executive officer of J.P. Morgan Partners (23A SBIC Manager), Inc.,
the managing member of JPMP (23A SBIC). JPMP (23A SBIC Manager) may also be
considered the beneficial owner of these shares. Such person and JPMP (23A SBIC
Manager) disclaims beneficial ownership of these shares except to the extent of
his or its pecuniary interest. The address of Messrs. Blutt and Wicker and JPMP
(23A SBIC Manager) is c/o J.P. Morgan Partners, LLC, 1221 Avenue of the
Americas, New York, New York 10020.
(11) Includes 21,624 shares issuable upon exercise of Tier I options and the
right to purchase 21,624 shares. The address of Mr. Cramer is c/o Hazelton
Laboratories, 77-455 Iroqouis Drive, Indian Wells, California, 92210.
(12) Includes 185,530 shares issuable upon exercise of Tier I options and rights
to purchase and 166,586 shares issuable upon exercise of Tier 2 options.
(13) In the initial public offering, JPMDJ Partners, JPMP (23A SBIC) and the
other selling stockholders have granted the underwriters of the offering a
30-day option to purchase additional shares of common stock of dj Orthopedics,
Inc. to cover over-allotments. Such right is exercisable through December 14,
2001. The following table sets forth the maximum number of shares which may be
sold by each of JPMDJ Partners and JPMP (23A SBIC) as well as such person's
beneficial ownership if the underwriters' overallotment option is exercised in
full.
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
Number of additional Beneficial ownership
Name shares to be sold after the offering
<Caption>
- -----------------------------------------------------------------------------------------------
JPMDJ Partners.................................... 1,283,787 38.6%
J.P. Morgan Partners (23A SBIC), LLC.............. 33,659 39.6%
===============================================================================================
</Table>
Assuming the exercise in full of the underwriters' overallotment option, the
executive officers and directors as a group (9 persons) will beneficially own
7,656,097 shares, representing 42.1% of our outstanding shares.
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Related party transactions
Recent unit issuances
In connection with our acquisition in July 2000 of a portion of the assets of
DePuy Orthopaedic Technology, Inc., a subsidiary of Johnson & Johnson, DonJoy,
L.L.C. issued 73,775 common units to JPMDJ Partners for gross proceeds of
$8.0 million, 1,429 common units to Mr. Cross for gross proceeds of
$0.2 million and 343 common units to each of Mr. Talbot and Mr. McBrayer for
gross proceeds of $38,000. Substantially all of the purchase price payable by
our management investors was paid for through the issuance of full recourse
promissory notes. Upon consummation of the reorganization, these common units of
JPMDJ Partners, Mr. Cross, Mr. Talbot and Mr. McBrayer were exchanged for
797,655, 15,450, 3,708 and 3,708 shares of common stock of dj Orthopedics, Inc.,
respectively, reflecting an effective purchase price of $10.08 per share. In
addition, DonJoy, L.L.C. issued 2,146, 668 and 1,407 redeemable preferred units
to JPMP (23A SBIC), Wachovia Capital Partners and the TCW affiliates,
respectively, for gross proceeds of $1.8 million, $0.6 million and
$1.2 million, respectively. Upon consummation of the reorganization, these
preferred units of JPMP (23A SBIC), Wachovia Capital Partners and the TCW
affiliates were exchanged for 23,202, 7,222 and 15,212 shares of common stock of
dj Orthopedics, Inc., respectively. The effective purchase price for these
shares of common stock is also $10.08 per share.
On June 11, 2001, DonJoy, L.L.C. obtained additional financing through the
private placement of its common units. JPMDJ Partners made a cash investment of
$9.7 million for 89,186 common units, Mr. Cross invested $0.2 million for 1,727
common units and each of Mr. Talbot and Mr. McBrayer invested $45,000 for 415
common units. Part of the purchase price of the management investors' common
units was financed through full recourse promissory notes. Upon consummation of
the reorganization, these common units of JPMDJ Partners, Mr. Cross, Mr. Talbot
and Mr. McBrayer were exchanged for 964,279, 18,672, 4,486 and 4,486 shares of
common stock of dj Orthopedics, Inc., respectively, reflecting an effective
purchase price of $10.08 per share.
Our 1999 recapitalization
On June 30, 1999, DonJoy, L.L.C. consummated a recapitalization pursuant to a
recapitalization agreement dated as of April 29, 1999 with JPMDJ Partners and
Smith & Nephew. Prior to the recapitalization, Smith & Nephew owned 100% of the
membership interests of DonJoy, L.L.C.
Pursuant to the recapitalization, JPMDJ Partners made a $64.6 million cash
investment in the common units of DonJoy, L.L.C. Mr. Cross invested
$1.3 million and each of Mr. Talbot and Mr. McBrayer invested $0.3 million in
the common units of DonJoy, L.L.C., reflecting in each case an effective
purchase price of $9.25 per share of common stock of dj Orthopedics, Inc. after
giving effect to the reorganization. $1.4 million of the aggregate investment of
the management investors was financed by full recourse promissory notes. In
addition, DonJoy, L.L.C. issued redeemable preferred units for an aggregate
purchase price of $31.4 million, with JPMP (23A SBIC) purchasing approximately
$21.2 million and First Union Investors, Inc. purchasing approximately
$10.2 million of the redeemable preferred units before payment of $1.4 million
of fees to them on a pro rata basis. The effective purchase price of the shares
of common stock of dj Orthopedics, Inc. received by these entities in exchange
for these preferred units in the reorganization is $9.25 per share. DonJoy,
L.L.C. sold all of its assets (other than the cash proceeds from the equity
contribution by JPMDJ Partners and the management investors and the issuance of
the redeemable preferred units) to dj Orthopedics, LLC which had been created as
a
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<Page>
wholly-owned subsidiary of DonJoy, L.L.C. as part of the recapitalization for
purposes of becoming the operating company subsidiary of DonJoy, L.L.C. through
the asset sale. dj Orthopedics, LLC funded the asset sale using the proceeds
from the offering of the notes and $15.5 million of borrowings under its credit
facility. DonJoy, L.L.C. used the $207.9 million of proceeds from the asset
sale, the issuance of the redeemable preferred units and the issuance of common
units to JPMDJ Partners and the management investors (excluding $1.4 million
which was financed through loans to the management investors) to repurchase from
Smith & Nephew its interest in DonJoy, L.L.C. (other than a retained interest of
approximately 7.1%) for approximately $199.1 million and to pay transaction fees
and expenses of $8.8 million. The purchase price for the units repurchased from
Smith & Nephew was $100 per unit, representing an effective purchase price of
$9.25 per share of common stock of dj Orthopedics, Inc. after giving effect to
the reorganization.
The issuance by DonJoy, L.L.C. of the common units and the redeemable preferred
units, the issuance by dj Orthopedics, LLC and DJ Capital, as co-issuers, of the
notes, the borrowing by dj Orthopedics, LLC under the credit facility, the asset
sale and DonJoy, L.L.C.'s repurchase of the Smith & Nephew interest in DonJoy
(other than its retained interest of approximately 7.1%) were all contingent
upon each other and were consummated concurrently on June 30, 1999. Together,
each of these transactions constitute the recapitalization. As a result of the
recapitalization, JPMDJ Partners obtained a controlling interest in DonJoy,
L.L.C.
The sources and uses of funds for the recapitalization are presented in the
following table:
<Table>
<Caption>
- ----------------------------------------------------------------------
(dollars in millions) Amount
- ----------------------------------------------------------------------
Sources:
Credit facility(a)........................................ $ 15.5
Senior subordinated notes................................. 98.0
Redeemable preferred units(b)............................. 30.0
Common unit investment in DonJoy, L.L.C. by JPMDJ
Partners................................................ 64.6
Retained common unit investment in DonJoy, L.L.C. by Smith
& Nephew................................................ 5.4
Common unit investment in DonJoy, L.L.C. by management
investors............................................... 1.8
--------
Total sources............................................. $ 215.3
--------
Uses:
Consideration paid to Smith & Nephew...................... $ 199.1
Retained common unit investment in DonJoy, L.L.C. by Smith
& Nephew................................................ 5.4
Loans to management investors............................. 1.4
Fees and expenses......................................... 8.8
Working capital........................................... 0.6
--------
Total uses................................................ $ 215.3
======================================================================
</Table>
(a) Represents the $15.5 million term loan borrowed under the credit facility to
consummate the recapitalization.
(b) Represents $31.4 million of proceeds received from the sale of redeemable
preferred units, net of $1.4 million of fees paid to JPMP (23A SBIC) and First
Union Investors, Inc. on a pro rata basis.
On July 30, 1999, JPMP (23A SBIC) and First Union Investors, Inc. each sold to
the TCW affiliates approximately $5.2 million of DonJoy, L.L.C.'s redeemable
preferred units and $1.8 million and $0.2 million, respectively, of membership
interests in JPMDJ Partners. Upon consummation of the reorganization, these
redeemable preferred units purchased by the TCW affiliates were exchanged for
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<Page>
144,826 shares of common stock of dj Orthopedics, Inc. The effective purchase
price for these shares of common stock was $9.25 per share.
In December 1999, First Union Investors, Inc. transferred its remaining interest
in DonJoy, L.L.C. to DJ Investment, LLC. First Union Investors, Inc. is the
manager of DJ Investment, LLC.
RECAPITALIZATION AGREEMENT. In addition to providing for the sale of the common
units of DonJoy, L.L.C. to JPMDJ Partners and the management investors, and the
repurchase of a portion of Smith & Nephew's interests in DonJoy, L.L.C., the
recapitalization agreement provided for other matters in furtherance of the
recapitalization transactions, including those set forth below. The description
below of selected provisions of the recapitalization agreement is subject to,
and is qualified in its entirety by reference to, the definitive
recapitalization agreement, a copy of which was filed as an exhibit to the
registration statement of which this prospectus is a part.
COVENANTS NOT TO COMPETE. Smith & Nephew has agreed that until June 30, 2004,
neither it nor any of its affiliates will, subject to certain exceptions, engage
anywhere in the world in the business of developing, manufacturing or marketing
of lower-leg walkers, post-operative hinged knee braces, functional hinged knee
braces, osteoarthitic hinged knee braces, cold therapy and pain management
systems, specified high-tech hinged knee braces and computer-assisted
rehabilitation systems using the aforementioned hinged knee braces together with
other electronic devices such as sensors and transducers.
In connection with specified products and proprietary information relating to a
rounded cannulated interference (RCI) screw system, a tissue fixation product
developed by dj Orthopedics, LLC but transferred to and retained by Smith &
Nephew prior to the consummation of the recapitalization, JPMDJ Partners has
agreed that neither it nor dj Orthopedics, Inc. or any of its subsidiaries,
including dj Orthopedics, LLC, will, subject to specified exceptions, develop or
market competing RCI screw system products with the cooperation of certain
physicians who developed them with dj Orthopedics, LLC.
SMITH & NEPHEW NAME. Subject to limited exceptions, dj Orthopedics, LLC has
agreed that following the recapitalization, it shall not, and shall not permit
any of its subsidiaries to, use any of Smith & Nephew's trademarks or trade
names (including, without limitation, Smith & Nephew).
INDEMNIFICATION. Smith & Nephew has agreed to indemnify JPMDJ Partners and its
affiliates, including dj Orthopedics, LLC and its subsidiaries, for all losses
and expenses incurred by them as a result of:
- any breach by Smith & Nephew of its representations and warranties,
covenants and agreements in the recapitalization agreement;
- any tax liabilities for which Smith & Nephew is liable pursuant to the
recapitalization agreement; and
- specified excluded liabilities.
However, the recapitalization agreement provides that with respect to breaches
of its representations and warranties, Smith & Nephew shall not be required to
make indemnification payments with respect to any such breach unless the
aggregate amount of the losses and expenses with respect thereto exceeds
$3 million ($0.8 million in the case of environmental matters) and that the
aggregate amount of such payments shall not exceed $75 million ($7.5 million in
the case of environmental matters). Smith & Nephew's indemnification obligations
with respect to breaches of its representations,
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warranties, covenants and agreements in the recapitalization agreement
terminated 15 months after the closing date of the recapitalization except as
otherwise set forth in the recapitalization agreement.
Other agreements with Smith & Nephew
In connection with the recapitalization, DonJoy, L.L.C. and Smith & Nephew
entered into several additional agreements providing for the continuation or
transfer and transition of various aspects of the business operations. Such
agreements were assigned to dj Orthopedics, LLC in connection with the
consummation of the recapitalization. The description below of these agreements
is subject to, and is qualified in its entirety by reference to, the definitive
agreements, copies of which have been filed as exhibits to the registration
statement of which this prospectus is a part.
Supply agreement
Pursuant to a supply agreement entered into in connection with the
recapitalization, dj Orthopedics, LLC has agreed to supply to Smith & Nephew to
the extent ordered by Smith & Nephew:
- all ProCare-Registered Trademark- line products;
- all DonJoy-Registered Trademark- products listed in Smith & Nephew's
1999 Rehabilitation Division catalog for the United States and any
replacements, substitutions and improvements to such products; and
- such other products as may be mutually agreed upon.
So as not to interfere with our international business plans, Smith & Nephew
agreed not to export any products listed in the second bullet above from the
United States after March 31, 2000. Through December 31, 1999, we sold products
under the supply agreement to Smith & Nephew at the same prices at which such
products were sold to Smith & Nephew prior to the recapitalization, which prices
were consistent with prices at which products were sold to third party
international distributors. Commencing January 1, 2000 and for each year
thereafter until termination of the supply agreement, dj Orthopedics, LLC will
sell these products to Smith & Nephew at its best distributor prices (including
discounts and rebates offered to distributors) if and to the extent agreed to by
Smith & Nephew and pursuant to purchase orders for our products. Purchases by
Smith & Nephew under the supply agreement were $0.9 million in 1999,
$0.8 million in 2000 and $0.4 million in the first nine months of 2001.
Smith & Nephew has no obligation to purchase any specific or minimum quantity of
products pursuant to the supply agreement. However, Smith & Nephew has agreed
not to purchase from anyone other than us products covered by this agreement
which are included in the business in which it has agreed not to compete with
us, subject to limited exceptions including the failure of dj Orthopedics, LLC
to supply such products. The supply agreement provides that Smith & Nephew may
manufacture or purchase from third party suppliers products which are not
included within the non-compete business.
Pursuant to the supply agreement, dj Orthopedics, Inc. and dj Orthopedics, LLC
have agreed to indemnify Smith & Nephew and its officers and affiliates with
respect to:
- any injury, death or property damage arising out of dj Orthopedics,
Inc., dj Orthopedics, LLC's or any of their employees or agents negligence
or willful misconduct;
- dj Orthopedics, Inc.'s or dj Orthopedics, LLC's negligent acts or
omissions;
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- dj Orthopedics, Inc.'s or dj Orthopedics, LLC's misstatements or false
claims with respect to the products covered by the supply agreement;
- any product liability claims relating to the products covered by the
supply agreement, other than those claims resulting from the fault of
Smith & Nephew or a third party which do not give rise to an indemnifiable
claim against dj Orthopedics, Inc. by Smith & Nephew under the
recapitalization agreement;
- any governmentally-required recall of the products covered by the supply
agreement, other than non-indemnifiable claims described above;
- our failure to comply with our obligations under the supply agreement;
and
- any claim of infringement by any third party of any patents or any
claimed violation of any other intellectual property right of any third
party arising in connection with the sale or distribution of products
covered by the supply agreement.
In order to ensure performance of its indemnity obligations, dj Orthopedics,
Inc. has agreed to maintain at least $3 million of product liability and general
public liability insurance with a deductible or self-insurance of no more than
$100,000 and to name Smith & Nephew as an additional insured. In addition,
Smith & Nephew has agreed to indemnify dj Orthopedics, Inc., dj Orthopedics, LLC
and its officers, managers, equity holders and affiliates with respect to:
- any injury, death or property damage arising out of Smith & Nephew's or
its employees' or agents' negligence or willful misconduct;
- Smith & Nephew's negligent act or omission;
- Smith & Nephew's misstatements or false claims with respect to the
products covered by the supply agreement;
- Smith & Nephew's misuse of supply agreement product literature; or
- Smith & Nephew's failure to comply with its obligations under the supply
agreement.
The supply agreement terminates in June 2004 unless extended by mutual agreement
of dj Orthopedics, Inc. and Smith & Nephew.
Distribution agreement
Pursuant to a distribution agreement entered into in connection with the
recapitalization among DonJoy, L.L.C., Smith & Nephew and the affiliates of
Smith & Nephew which distributed our products outside the United States as of
the closing date of the recapitalization (S&N Group Companies), each S&N Group
Company will continue to distribute our products in the specific international
market, or territory, in which such S&N Group Company distributed such products
prior to the recapitalization. Through December 31, 1999, we sold products to
the S&N Group Companies at the same prices at which such products were sold to
the S&N Group Companies prior to the recapitalization. Thereafter, we and
Smith & Nephew have negotiated the sale price of any product in good faith.
During the term of the distribution agreement with respect to a territory, each
S&N Group Company has a royalty-free right to use our trademarks in connection
with its distribution of our products.
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The S&N Group Companies have no obligation to purchase any minimum quantity of
products pursuant to the distribution agreement. However, Smith & Nephew has
agreed to use its commercially reasonable efforts to have the S&N Group
Companies purchase from us the same quantity of products reflected in our 1999
budgets (the 1999 Purchase Level) and dj Orthopedics, LLC has agreed to sell to
the S&N Group Companies pursuant to applicable purchase orders quantities of
products at least equal to its 1999 Purchase Level. Smith & Nephew has also
agreed to use its commercially reasonable efforts to have each S&N Group Company
distribute and resell products in the same geographical markets within the
territories identified in the agreement where the relevant S&N Group Company
distributed and sold our products prior to the recapitalization, and Smith &
Nephew and each S&N Group Company agrees to employ efforts and methods to sell
and promote the sale of the products in its territory that are substantially the
same as the efforts and methods employed prior to the consummation of the
recapitalization. The S&N Group Companies may not, subject to certain limited
exceptions, sell or supply our products or other similar products to anyone
outside those territories. During the time any territory is subject to the
distribution agreement, no S&N Group Company may import, sell or promote the
sale of any products which are included within the businesses in which Smith &
Nephew has agreed not to compete with us, other than products purchased from dj
Orthopedics, LLC. Pursuant to the distribution agreement, dj Orthopedics, Inc.
and dj Orthopedics, LLC have agreed to indemnify Smith & Nephew and the S&N
Group Companies and their officers and affiliates, and Smith & Nephew has agreed
to indemnify dj Orthopedics, Inc. and its officers, managers, equity holders and
affiliates to the same extent that dj Orthopedics, Inc. and Smith & Nephew
indemnify each other under the supply agreement.
As of September 29, 2001, we have replaced 21 Smith & Nephew sales organizations
with independent distributors, including, in the case of Australia, our 60%
owned subsidiary, dj Australia. As to the remaining 9 Smith & Nephew
distributors, both dj Orthopedics, Inc. and Smith & Nephew have the right to
terminate the distribution agreement on 60 days notice with respect to Canada,
Dubai, Ireland, Malaysia, the Philippines, Puerto Rico, Singapore, South Africa
and Thailand.
Upon termination of the distribution agreement with respect to a territory, the
applicable S&N Group Company has agreed to assist us in the transition to any
new third party distributor that we designate. Subject to limited exceptions,
any products remaining in the inventory of any terminated S&N Group Company upon
termination of the distribution agreement with respect to a territory, will be
repurchased by dj Orthopedics, LLC, or any new third party distributor
designated by dj Orthopedics, LLC with respect to the territory for an amount
equal to:
- the original purchase price of the repurchased inventory plus any duty
and tax paid by the relevant S&N Group Company and the cost paid by that
S&N Group Company in shipping the repurchased inventory to the S&N Group
Company; plus
- any sales tax, VAT, duty or fee incurred by the S&N Group Company with
respect to the delivery of the repurchased inventory to dj Orthopedics,
LLC or the new distributor.
With respect to the 21 terminated S&N Group Companies, the inventory was
generally purchased by the new third party distributor and the amount of
inventory we have repurchased was minimal. If a dispute arises concerning the
applicable repurchase price of repurchased inventory and the parties are not
able to resolve such dispute within ten business days, the applicable S&N Group
Company has the right to sell and distribute the products that are the subject
of the dispute within or outside the territories. The distribution agreement
will remain in effect until the termination of the last territory.
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Transition services agreement
Pursuant to a transition services agreement with Smith & Nephew, Smith & Nephew
assisted in the transfer and transition of selected services provided by
Smith & Nephew prior to the recapitalization as required by dj Orthopedics, LLC,
including human resources, payroll, sales tax reporting, insurance coverage,
legal and treasury and cash management. Smith & Nephew also acted as our
authorized European Agent/representative/distributor for purposes of CE
regulation. We did not pay any additional consideration to Smith & Nephew for
these services, but reimbursed Smith & Nephew for all payments to third parties
in connection with the foregoing services. Such amounts were not material. In
addition, Smith & Nephew continued to employ two individuals as employees of its
affiliates in the United Kingdom and Belgium through December 31, 1999. We
reimbursed Smith & Nephew $179,939 for all compensation, expenses and benefits
paid or provided to or on behalf of these international employees. In accordance
with the transition services agreement Smith & Nephew also assisted in the
transition of master group buying contracts relating to ProCare products with
NovaCare, Inc., Premier Purchasing Partners, L.P. and AmeriNet Inc. to separate
agreements or arrangements between those companies and dj Orthopedics, LLC. The
transition services agreement terminated November 30, 2000.
Sublease
Pursuant to a sublease with Smith & Nephew entered into in connection with the
recapitalization, dj Orthopedics, LLC is subleasing the premises occupied by the
Vista facility from Smith & Nephew. We will pay rent during the term of the
sublease in an amount equal to the amount required to be paid by Smith & Nephew
as tenant under the master lease for the Vista facility together with all taxes
and other amounts which are the responsibility of Smith & Nephew under the
master lease. The current rent payable by dj Orthopedics, LLC under the sublease
is $156,728 per month. dj Orthopedics, Inc. has guaranteed the payment of rent
and other amounts owing under the sublease by dj Orthopedics, LLC. Total lease
payments to Smith & Nephew in 1999 and 2000 and the first nine months of 2001
were $0.9 million, $1.8 million and $1.4 million, respectively. The sublease
expires on February 19, 2008 unless sooner terminated as provided in the master
lease or the sublease.
CERF laboratories agreement
Pursuant to the CERF Laboratories Agreement with Smith & Nephew, we allowed
Smith & Nephew and its employees, agents, representatives and invitees to use
our Clinical Education Research Facility (CERF) laboratory, the equipment and
supplies in the CERF laboratory and services offered at the CERF laboratory.
Smith & Nephew paid us a quarterly fee calculated in the same manner as it was
calculated prior to the recapitalization. For 2000 and 1999, Smith & Nephew paid
us $56,991 and $85,649, respectively, for use of the CERF laboratory. On
August 31, 2000, the CERF agreement was terminated by Smith & Nephew.
Loans to executive officers
We have received full recourse promissory notes from three of our senior
executive officers, Leslie H. Cross, Cyril Talbot III and Michael R. McBrayer,
as partial consideration for their purchase of common units of DonJoy, L.L.C. on
June 30, 1999 in connection with the recapitalization, on July 7, 2000 in
connection with the financing of the Orthotech acquisition and on June 11, 2001
in connection with the $10.0 million equity financing. In addition, in
connection with their purchase of common units from Smith & Nephew on June 28,
2000, we loaned these officers a portion of the purchase price, evidenced by
full recourse promissory notes.
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The following table sets forth information with respect to these loans:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------
Original Principal amount
principal outstanding at
Date amount September 29, 2001
- --------------------------------------------------------------------------------------------------------
Leslie H. Cross............................. June 1999 $ 1,000,000 $ 1,109,274
June 2000 88,645 94,594
July 2000 124,609 132,995
June 2001 150,610 150,610
----------------------------------------------------------
Total................................... $ 1,487,473
----------------------------------------------------------
Cyril Talbot III............................ June 1999 $ 200,000 $ 221,855
June 2000 17,729 18,919
July 2000 24,925 26,602
June 2001 30,122 30,122
----------------------------------------------------------
Total................................... $ 297,498
----------------------------------------------------------
Michael McBrayer............................ June 1999 $ 200,000 $ 221,855
June 2000.. 17,729 18,919
July 2000.. 24,925 26,602
June 2001.. 30,122 30,122
----------------------------------------------------------
Total................................... $ 297,498
========================================================================================================
</Table>
Each of the notes matures on the seventh anniversary of its issue date and bears
interest at the rate of 6.62% per annum in the case of the notes issued in 1999
and 2000 and 5.25% per annum in the case of the notes issued in 2001. Each note
permits the management investor to increase the principal amount due under the
note by the amount of a scheduled interest payment (the PIK Option). If the
management investor elects the PIK Option, the principal amount of this note is
increased by the amount of the scheduled interest payment and interest accrues
on the principal amount of the note as so increased. The notes issued in
June 1999 were amended in June 2000 to include the PIK Option and to increase
the interest rate from 5.30% per annum to 6.62% per annum. As a result of this
amendment, the principal amount of each June 1999 note was increased to reflect
the amount of accrued and unpaid interest from June 30, 1999 to June 28, 2000.
The notes of each management investor are secured by the shares of common stock
owned by that management investor.
Other arrangements with JPMDJ Partners and its affiliates
In 2000, DonJoy, L.L.C paid J.P. Morgan Partners $250,000 for providing
financial advisory services in connection with financings and acquisitions,
including providing the services of Charles T. Orsatti as one of its Board of
Managers. An additional $250,000 was paid to JPM Fairfield Partners upon
consummation of dj Orthopedics, Inc.'s initial public offering. Following the
offering, annual compensation of $250,000 will be paid to JPM Fairfield Partners
but will terminate if Mr. Orsatti ceases to be a member of the Board of
Directors of dj Orthopedics, Inc. or if JPMDJ Partners owns less than 5% of the
outstanding common stock of dj Orthopedics, Inc.
In connection with the recapitalization, dj Orthopedics, LLC and DJ Capital
entered into a credit facility with Chase Securities Inc. (CSI), the predecessor
of J.P. Morgan Securities Inc., as arranger and book manager, and The Chase
Manhattan Bank (Chase), as syndication agent and a lender, both of which are
affiliates of JPMDJ Partners. Chase receives customary fees for acting in such
capacities. CSI was also the
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initial purchaser of the notes and received a discount in connection with the
purchase of those notes in the amount of $3.0 million. CSI acted as financial
advisor to Smith & Nephew in connection with the recapitalization and was paid a
fee of $2.0 million by Smith & Nephew upon consummation of the recapitalization.
CSI also acted as financial advisor in connection with the Orthotech acquisition
and was paid a fee of $0.2 million.
Proceeds of initial public offering received by the selling stockholders and
their affiliates
JPMDJ Partners and JPMP (23A SBIC), two of the selling stockholders in
dj Orthopedics, Inc.'s initial public offering, are our affiliates due to their
ownership of a majority of the outstanding common stock of dj Orthopedics, Inc.,
and Wachovia Capital Partners and the TCW affiliates which were also selling
stockholders in the initial public offering, may be considered our affiliates
under applicable rules of the SEC due to their being members of JPMDJ Partners,
our controlling stockholder. Each of these entities other than JPMDJ Partners
received their respective portion of the proceeds from the initial public
offering used to redeem the outstanding redeemable preferred units of DonJoy,
L.L.C. Affiliates of JPMP (23A SBIC) and Wachovia Capital Partners are lenders
under our credit agreement and received their pro rata share of the proceeds
from the initial public offering used to repay borrowings under our revolving
credit facility. In addition, several of the TCW affiliates are holders of the
notes and will receive a portion of the proceeds from the initial public
offering used to redeem a portion of those notes. The following table sets forth
the amount of proceeds from the initial public offering received by each of the
foregoing entities for each of the foregoing purposes and in the aggregate based
upon the initial offering price of $17.00 per share.
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------------------
Proceeds used
Proceeds used to redeem a
Proceeds from to redeem Proceeds used to portion
sale of shares redeemable repay borrowing of the senior
in the initial preferred units under revolving subordinated
(in millions) public offering of DonJoy credit facility notes Total(4)
- -------------------------------------------------------------------------------------------------------------------------
JPMDJ Partners.................. $ 18.0(1) -- -- -- $ 18.0
JPMP (23A SBIC) and affiliated
bank lender................... $ 0.5(2) $ 23.6(2) $ 0.7 -- $ 24.8
Wachovia Capital Partners and
affiliated bank lender........ $ 0.1(2) $ 7.3(2) $ 2.7 -- $ 10.2
TCW affiliates.................. $ 0.3(2) $ 15.5(2) -- $ 5.6(3) $ 21.4
=========================================================================================================================
</Table>
(1) JPMDJ Partners acquired the shares being sold in the initial public offering
for an aggregate purchase price of approximately $10.6 million.
(2) JPMP (23A SBIC), Wachovia Capital Partners and the TCW affiliates paid an
aggregate of $17.0 million, $5.3 million and $11.1 million, respectively, for
DonJoy, L.L.C.'s redeemable preferred units. In the reorganization, each
preferred unit was converted into the right to receive approximately $1,050 in
cash and 10.812 shares of common stock. See "The reorganization and initial
public offering". The common stock sold by these selling stockholders in the
initial public offering represented a portion of the shares received by them in
respect of their redeemable preferred units in the reorganization.
(3) The TCW affiliate purchased the notes being redeemed for an aggregate
purchase price of $4.9 million.
(4) In the initial public offering, the selling stockholders have granted the
underwriters of the offering a 30-day option to purchase additional shares of
common stock of dj Orthopedics, Inc. to cover over-allotments. If the
underwriters' over-allotment option is exercised in full, the total proceeds to
be received by JPMDJ Partners, JPMP (23A SBIC), Wachovia Capital Partners and
the TCW affiliates will be $38.3 million, $25.3 million, $10.4 million and
$21.7 million, respectively.
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Description of credit facility
The following is a summary of the material terms of the credit facility among
us, dj Orthopedics, Inc., the financial institutions participating as lenders,
First Union National Bank, as administrative agent and collateral agent, and
Chase, as syndication agent. The following summary is qualified in its entirety
by reference to the definitive documentation for the credit facility, copies of
which have been filed as an exhibit to the registration statement of which this
prospectus is a part.
The facilities
STRUCTURE. The credit facility provides for:
- the term loan in an aggregate principal amount of $15.5 million, which
was borrowed to finance a portion of the recapitalization,
- an additional term loan in an aggregate principal amount of
$24.0 million, which was borrowed to finance the Orthotech acquisition,
and
- the revolving credit facility providing for revolving loans to dj
Orthopedics, LLC, swingline loans to dj Orthopedics, LLC and the issuance
of letters of credit for account of dj Orthopedics, LLC in an aggregate
principal amount (including swingline loans and the aggregate stated
amount of letters of credit) of $25.0 million.
AVAILABILITY. The full amount of the $15.5 term loan was drawn on the closing
date of the recapitalization and amounts repaid or prepaid may not be
reborrowed. The full amount of the $24.0 million term loan was drawn on the
closing date of the Orthotech acquisition and amounts repaid or prepaid may not
be reborrowed. Availability under the revolving credit facility is subject to
various conditions precedent typical of bank loans. Amounts under the revolving
credit facility are available on a revolving basis. As of November 30, 2001,
$22.0 million was available under the revolving credit facility.
Interest
Borrowings under the credit facility bear interest at a variable rate per annum
equal (at our option) to:
- an adjusted London inter-bank offered rate (LIBOR) plus a percentage
based on our financial performance or
- a rate equal to the highest of the administrative agent's published
prime rate, a certificate of deposit rate plus 1% and the Federal Funds
effective rate plus 1/2 of 1% (ABR)
plus, in each case, a margin based on our financial performance. The borrowing
margin applicable to the term loans is initially 3.25% for LIBOR loans and 2.25%
for ABR loans. As of September 29, 2001, the interest rate on the term loans was
5.69%. The borrowing margins applicable to the revolving credit facility are
initially 2.75% for LIBOR loans and 1.75% for ABR loans. As of September 29,
2001, the interest rate on the revolving credit facility ranged from 5.19% to
5.81%. Borrowing margins for the term loans and the revolving credit facility
are subject to downward adjustment based upon our consolidated leverage ratio.
Amounts outstanding under the credit facility not paid when due bear interest at
a default rate equal to 2.00% above the rates otherwise applicable to the loans
under the credit facility.
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Fees
We have agreed to pay certain fees with respect to the credit facility,
including:
- fees on the unused commitments of the Lenders equal to 0.50% on the
undrawn portion of the commitments in respect of the revolving credit
facility (subject to a reduction based on our consolidated leverage
ratio);
- letter of credit fees on the aggregate face amount of outstanding
letters of credit equal to the then applicable borrowing margin for LIBOR
loans under the revolving credit facility and a 0.25% per annum issuing
bank fee for the issuing bank;
- annual administration fees; and
- agent, arrangement and other similar fees.
Security; guarantees
Our obligations under the credit facility are irrevocably guaranteed, jointly
and severally, by dj Orthopedics, Inc. and DJ Capital and will be irrevocably
guaranteed, jointly and severally, by each of our subsequently acquired or
organized domestic (and, to the extent no adverse tax consequences would result
therefrom, foreign) subsidiaries. None of our foreign subsidiaries is a
guarantor of our obligations under the credit facility. In addition, the credit
facility and the guarantees thereunder are secured by substantially all the
assets of dj Orthopedics, Inc., dj Orthopedics, LLC and DJ Capital and will be
secured by substantially all the assets of each subsequently acquired or
organized domestic (and, to the extent no adverse tax consequences to us would
result therefrom, foreign) subsidiary, including but not limited to, in each
case subject to certain exceptions:
- a first priority pledge of all our membership interests,
- a first-priority pledge of all the capital stock, membership interests
and other equity interests held by dj Orthopedics, Inc., us or any of our
domestic (or, subject to the foregoing limitation, foreign) subsidiaries
of each existing and subsequently acquired or organized subsidiary of us
(which pledge, in the case of any foreign subsidiary, shall be limited to
65% of the capital stock, membership interests or other equity interests
of such foreign subsidiary to the extent the pledge of any greater
percentage would result in adverse tax consequences to us), and
- a perfected first priority security interest in, and mortgage on,
substantially all our tangible and intangible assets (not including our
Mexican and other foreign subsidiaries) and the guarantors (including, but
not limited to, accounts receivable, documents, inventory, trademarks,
other intellectual property, licensing agreements, equipment, our
sub-lease of the Vista, California facility, cash and cash accounts and
proceeds of the foregoing).
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Commitment reductions and repayments
The term loans mature on June 30, 2005 and the outstanding principal amount of
the term loans was $37.4 million at September 29, 2001. The term loans amortize
in quarterly amounts and are based upon the annual amounts shown below:
<Table>
- ----------------------------------------------------------------------
Three Months Ending December 31, 2001....................... $ 317
Fiscal Year 2002............................................ 1,274
Fiscal Year 2003............................................ 1,274
Fiscal Year 2004............................................ 17,202
Fiscal Year 2005............................................ 17,338
--------
$37,405
======================================================================
</Table>
In addition, the term loans are subject to mandatory prepayments and reductions
in an amount equal to:
- 100% of the net cash proceeds of certain equity issuances by
dj Orthopedics, Inc., us or any of our subsidiaries;
- 100% of the net cash proceeds of certain debt issuances of
dj Orthopedics, Inc., us or any of our subsidiaries;
- 50% of our excess cash flow (subject to an increase to 75% in the event
our consolidated leverage ratio exceeds a specified level); and
- 100% of the net cash proceeds of specified asset sales or other
dispositions of property by dj Orthopedics, Inc., us or any of our
subsidiaries.
The revolving credit facility is available until June 30, 2004, and extensions
of credit outstanding thereunder on such date will mature on the fifth business
day prior to such date.
Affirmative, negative, and financial covenants
The credit facility contains a number of covenants that significantly restrict
our ability to dispose of assets, incur additional indebtedness, incur or
guarantee obligations, prepay other indebtedness or amend other debt
instruments, pay dividends or make other distributions (except for certain tax
distributions permitted by the credit agreement), redeem or repurchase
membership interests or capital stock, create liens on assets, make investments,
loans or advances, make acquisitions, engage in mergers or consolidations,
change the business conducted by us and our subsidiaries, make capital
expenditures, or engage in certain transactions with affiliates and otherwise
engage in activities outside our current line of business. In addition, the
credit facility requires us to maintain a ratio of total debt to EBITDA of no
more than 5.00 to 1 prior to December 30, 2001 and decreasing to 3.50 to 1 from
and after December 31, 2003 and a ratio of consolidated EBITDA to consolidated
interest expense of at least 1.60 to 1 prior to December 30, 2001 and increasing
to 2.50 to 1 from and after December 31, 2003. The credit facility also contains
provisions that prohibit any modifications of the indenture for the notes in any
manner adverse to the lenders under the credit facility and that limit our
ability to refinance or otherwise prepay the notes without the consent of such
lenders.
Events of default
The credit facility contains customary events of default, including non-payment
of principal, interest or fees, violation of covenants, inaccuracy of
representations or warranties in any material respect, cross default to
specified other indebtedness, bankruptcy, ERISA events, material judgments and
liabilities, actual or asserted invalidity of any material security interest and
change of control.
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Description of the notes
Definitions of certain terms used in this "Description of the notes" may be
found under the heading "Certain definitions". For the purposes of this section,
the term "Company" refers only to dj Orthopedics, LLC and not any of its
subsidiaries, "DJ Capital" refers to DJ Orthopedics Capital Corporation, a
Wholly Owned Subsidiary of the Company with nominal assets which conducts no
operations, and the "Issuers" refers to the Company and DJ Capital. The parent
of the Company, dj Orthopedics, Inc., is the successor of DonJoy, L.L.C. and a
guarantor of the notes. Although certain of the Company's subsidiaries formed or
acquired in the future, if any, are required to guarantee the notes, the
Company's existing subsidiaries (other than DJ Capital), are not guarantors of
the notes. Each company which guarantees the notes is referred to in this
section as a "Note Guarantor." Each such guarantee is termed a "Note Guarantee."
The Issuers issued the notes under the indenture, dated as of June 30, 1999,
among the Company, DJ Capital, dj Orthopedics, Inc., as successor to DonJoy,
L.L.C., and The Bank of New York, as trustee (the "Trustee"), a copy of which
has been filed as an exhibit to the registration statement of which this
prospectus is a part. The indenture contains provisions, which define your
rights under the notes. In addition, the indenture governs the obligations of
the Issuers and of each Note Guarantor under the notes. The terms of the notes
include those stated in the indenture and those made part of the Indenture by
reference to the TIA.
On June 30, 1999, the Issuers issued $100.0 million aggregate principal amount
of old notes under the indenture. All of the old notes were exchanged for an
equal aggregate principal amount of notes upon the consummation of an exchange
offer in December 1999. The terms of the notes are identical in all material
respects to the old notes, except the notes do not contain transfer restrictions
and holders of notes do not have any registration rights or entitlement to any
liquidated damages.
The following description is meant to be only a summary of certain provisions of
the indenture. It does not restate the terms of the indenture in their entirety.
We urge that you carefully read the indenture as it, and not this description,
governs your rights as Holders.
Overview of the notes and the note guarantees
The notes
These notes:
- are general unsecured obligations of the Issuers;
- are subordinated in right of payment to all existing and future Senior
Indebtedness of each of the Issuers;
- rank PARI PASSU in right of payment with all future Senior Subordinated
Indebtedness of each of the Issuers;
- are senior in right of payment to any future Subordinated Obligations of
each of the Issuers;
- are effectively subordinated to any Secured Indebtedness of the Company,
DJ Capital and the other Subsidiaries of the Company to the extent of the
value of the assets securing such Indebtedness; and
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- are effectively subordinated to all liabilities of the Company's foreign
subsidiaries, which are not guaranteeing the notes, and any other future
Subsidiaries which do not guarantee the notes.
DJ Capital has no, and the terms of the indenture prohibit it from having any,
obligations other than the notes and its guarantee in respect of the credit
facility.
The note guarantees
The notes are guaranteed by dj Orthopedics, Inc. but are not guaranteed by any
of the Company's foreign subsidiaries.
dj Orthopedics, Inc.'s Note Guarantee and all Note Guarantees, if any, made by
future subsidiaries of the Company:
- are general unsecured obligations of the applicable Note Guarantor;
- are subordinated in right of payment to all future Senior Indebtedness
of such Note Guarantor;
- rank PARI PASSU in right of payment with all future Senior Subordinated
Indebtedness of such Note Guarantor;
- are senior in right of payment to any future Subordinated Obligations of
such Note Guarantor; and
- are effectively subordinated to any Secured Indebtedness of such Note
Guarantor to the extent of the value of the assets securing such
Indebtedness.
Principal, maturity and interest
We issued the notes in an aggregate principal amount of $100.0 million. The
notes are limited to $100.0 million in aggregate principal amount and will
mature on June 15, 2009. The notes are in fully registered form, without
coupons, in denominations of $1,000 and any integral multiple of $1,000.
Each note bears interest at a rate of 12 5/8% per annum from the Closing Date,
or from the most recent date to which interest has been paid or provided for. We
will pay interest semiannually on June 15 and December 15 of each year,
commencing December 15, 1999 to Holders of record at the close of business on
the June 1 or December 1 immediately preceding the interest payment date. We
will pay interest on overdue principal and, to the extent lawful, overdue
installments of interest at the rate borne by the notes.
Paying agent and registrar
We will pay the principal of, premium, if any, and interest on the notes at any
office of ours or any agency designated by us which is located in the Borough of
Manhattan, The City of New York. We have initially designated the corporate
trust office of the Trustee to act as our agent in such matters. The location of
the corporate trust office is 101 Barclay Street, New York, New York 10286. We,
however, reserve the right to pay interest to Holders by check mailed directly
to Holders at their registered addresses.
Holders may exchange or transfer their notes at the same location given in the
preceding paragraph. No service charge will be made for any registration of
transfer or exchange of notes. We, however, may
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require Holders to pay any transfer tax or other similar governmental charge
payable in connection with any such transfer or exchange.
Optional redemption
Except as set forth in the following paragraph, the Issuers may not redeem the
notes prior to June 15, 2004. On or after that date, the Issuers may redeem the
notes, in whole or in part, on not less than 30 nor more than 60 days' prior
notice, at the following redemption prices (expressed as percentages of
principal amount), plus accrued and unpaid interest and liquidated damages
thereon, if any, to the redemption date (subject to the right of Holders of
record on the relevant record date to receive interest due on the relevant
interest payment date), if redeemed during the 12-month period commencing on
June 15 of the years set forth below:
<Table>
<Caption>
- ---------------------------------------------------------------------------
Redemption
Year price
- ---------------------------------------------------------------------------
2004........................................................ 106.313%
2005........................................................ 104.208%
2006........................................................ 102.104%
2007 and thereafter......................................... 100.000%
===========================================================================
</Table>
Prior to June 15, 2002, the Issuers may, on one or more occasions, also redeem
up to a maximum of 35% of the original aggregate principal amount of the notes
with the Net Cash Proceeds of one or more Equity Offerings (1) by the Company or
(2) by dj Orthopedics, Inc. to the extent the Net Cash Proceeds thereof are
contributed to the Company or used to purchase Equity Interests (other than
Disqualified Equity Interests) of the Company from the Company, at a redemption
price equal to 112.625% of the principal amount thereof, plus accrued and unpaid
interest and liquidated damages thereon, if any, to the redemption date (subject
to the right of Holders of record on the relevant record date to receive
interest due on the relevant interest payment date); provided, however, that
after giving effect to any such redemption:
(1) at least 65% of the original aggregate principal amount of the notes
remains outstanding; and
(2) any such redemption by the Issuers must be made within 90 days of such
Equity Offering and must be made in accordance with certain procedures set
forth in the indenture.
Pursuant to this provision, on November 30, 2001, we gave notice to the trustee
that we would redeem $25 million aggregate principal amount of the notes on
December 31, 2001 with a portion of the net cash proceeds received by dj
Orthopedics, Inc. and contributed by it to us from the initial public offering
of common stock of dj Orthopedics, Inc.
Selection
If we partially redeem notes, the Trustee will select the notes to be redeemed
on a pro rata basis, by lot or by such other method as the Trustee in its sole
discretion shall deem to be fair and appropriate, although no note of $1,000 in
original principal amount will be redeemed in part. If we redeem any note in
part only, the notice of redemption relating to such note shall state the
portion of the principal amount thereof to be redeemed. A note in principal
amount equal to the unredeemed portion thereof will be issued in the name of the
Holder thereof upon cancellation of the original note. On and after the
redemption date, interest will cease to accrue on notes or portions thereof
called for redemption so
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long as we have deposited with the Paying Agent funds sufficient to pay the
principal of, plus accrued and unpaid interest and liquidated damages, if any,
on, the notes to be redeemed.
Ranking
The notes are unsecured Senior Subordinated Indebtedness of the Issuers, are
subordinated in right of payment to all existing and future Senior Indebtedness
of each of the Issuers, rank PARI PASSU in right of payment with all existing
and future Senior Subordinated Indebtedness of each of the Issuers and are
senior in right of payment to all existing and future Subordinated Obligations
of each of the Issuers. DJ Capital has no, and the terms of the indenture
prohibit it from having any, obligations other than the notes and its guarantee
of the credit facility. The notes also are effectively subordinated to any
Secured Indebtedness of the Company, DJ Capital and the other Subsidiaries of
the Company to the extent of the value of the assets securing such Indebtedness.
However, payment from the money or the proceeds of U.S. Government Obligations
held in any defeasance trust described below under the caption "--Defeasance"
will not be subordinated to any Senior Indebtedness or subject to the
restrictions described herein.
The Company currently conducts certain of its operations through foreign
subsidiaries, its only Subsidiaries (other than DJ Capital). The Company's
foreign subsidiaries are not a guarantor of the notes. The indenture does not
restrict the ability of the Company to create, acquire or capitalize
Subsidiaries in the future. Creditors of the Company's foreign subsidiaries and
any future Subsidiary that does not Guarantee the notes, including trade
creditors and preferred equity holders (if any), generally will have priority
with respect to the assets and earnings of such foreign subsidiary or such
future Subsidiary over the claims of the Company's and DJ Capital's creditors,
including Holders. The notes, therefore, are effectively subordinated to claims
of creditors, including trade creditors and preferred equity holders (if any),
of the Company's foreign subsidiaries and any other Subsidiaries of the Company
formed or acquired in the future that do not guarantee the notes. As of
September 29, 2001, the total liabilities, including trade payables, of the
Company's foreign subsidiaries as reflected on the Company's balance sheet, were
approximately $1.1 million. Although the indenture limits the Incurrence of
Indebtedness by and the issuance of Preferred Equity Interests of the Company's
foreign subsidiaries and certain of the Company's future Subsidiaries, such
limitation is subject to a number of significant qualifications.
After giving effect to the reorganization of our parent and the consummation by
our parent of its initial public offering and the application of the proceeds
thereof as of September 29, 2001 on a pro forma basis, there was outstanding:
(1) $37.4 million of Senior Indebtedness of the Company, all of which
would have been Secured Indebtedness (exclusive of unused commitments
under the revolving credit facility);
(2) no Senior Subordinated Indebtedness of the Company (other than the
notes) and no indebtedness of the Company that is subordinate or junior in
right of payment to the notes;
(3) no Indebtedness of DJ Capital (other than the notes and its guarantee
in respect of the Credit Agreement);
(4) no Senior Indebtedness of dj Orthopedics, Inc., the only Note
Guarantor (other than its guarantee of Indebtedness under the Credit
Agreement); and
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(5) no Senior Subordinated Indebtedness of dj Orthopedics, Inc., currently
the only Note Guarantor (other than its Note Guarantee), and no
Indebtedness of dj Orthopedics, Inc. that is subordinate or junior in
right of payment to its Note Guarantee.
Subject to certain conditions, the indenture permits us to incur substantial
amounts of additional Indebtedness. Such Indebtedness may be Senior
Indebtedness. See "--Certain covenants--Limitation on indebtedness" below.
"Senior Indebtedness" of the Company, DJ Capital or any Note Guarantor, as the
case may be, means the principal of, premium (if any) and accrued and unpaid
interest on (including interest accruing on or after the filing of any petition
in bankruptcy or for reorganization of the Company, DJ Capital or any Note
Guarantor, as applicable, regardless of whether or not a claim for post-filing
interest is allowed in such proceedings), and fees and all other amounts owing
in respect of, Bank Indebtedness and all other Indebtedness of the Company, DJ
Capital or any Note Guarantor, as applicable, whether outstanding on the Closing
Date or thereafter Incurred, unless in the instrument creating or evidencing the
same or pursuant to which the same is outstanding it is provided that such
obligations are not superior in right of payment to the notes or such Note
Guarantor's Note Guarantee; provided, however, that Senior Indebtedness shall
not include:
(1) any obligation of the Company to any Subsidiary of the Company or of
any Note Guarantor or DJ Capital to the Company or any other Subsidiary of
the Company;
(2) any liability for federal, state, local or other taxes owed or owing
by the Company, DJ Capital or any Note Guarantor;
(3) any accounts payable or other liability to trade creditors arising in
the ordinary course of business (including Guarantees thereof or
instruments evidencing such liabilities);
(4) any Indebtedness or obligation of the Company, DJ Capital or any Note
Guarantor (and any accrued and unpaid interest in respect thereof) that by
its terms is subordinate or junior in right of payment to any other
Indebtedness or obligation of the Company, DJ Capital or such Note
Guarantor, as applicable, including any Senior Subordinated Indebtedness
and any Subordinated Obligations;
(5) any obligations with respect to any Equity Interest; or
(6) any Indebtedness Incurred in violation of the indenture.
Only Indebtedness of the Company or DJ Capital that is Senior Indebtedness will
rank senior to the notes. The notes will rank PARI PASSU in all respects with
all other Senior Subordinated Indebtedness of the Company or DJ Capital. The
Issuers have agreed in the indenture that each of them will not Incur, directly
or indirectly, any Indebtedness which is subordinate or junior in right of
payment to Senior Indebtedness of such Issuer unless such Indebtedness is Senior
Subordinated Indebtedness or is expressly subordinated in right of payment to
Senior Subordinated Indebtedness. Unsecured Indebtedness is not deemed to be
subordinate or junior to Secured Indebtedness merely because it is unsecured.
The Issuers may not pay principal of, premium (if any) or interest on the notes,
or make any deposit pursuant to the provisions described under Defeasance below,
and may not otherwise repurchase, redeem or otherwise retire any notes
(collectively, "pay the notes") if:
(1) any Designated Senior Indebtedness of either of the Issuers is not
paid when due, or
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(2) any other default on such Designated Senior Indebtedness occurs and
the maturity of such Designated Senior Indebtedness is accelerated in
accordance with its terms unless, in either case,
(x) the default has been cured or waived and any such acceleration
has been rescinded, or
(y) such Designated Senior Indebtedness has been paid in full;
provided, however, that the Issuers may pay the notes without regard to the
foregoing if the Issuers and the Trustee receive written notice approving such
payment from the Representative of the Designated Senior Indebtedness with
respect to which either of the events set forth in clause (1) or (2) above has
occurred and is continuing.
During the continuance of any default (other than a default described in
clause (1) or (2) above) with respect to any Designated Senior Indebtedness of
either Issuer pursuant to which the maturity thereof may be accelerated
immediately without further notice (except such notice as may be required to
effect such acceleration) or the expiration of any applicable grace periods, the
Issuers may not pay the notes for a period (a "Payment Blockage Period")
commencing upon the receipt by the Trustee (with a copy to the Issuers) of
written notice, specified as a "Notice of Default" and describing with
particularity the default under such Designated Senior Indebtedness (a "Blockage
Notice"), of such default from the Representative of such Designated Senior
Indebtedness specifying an election to effect a Payment Blockage Period and
ending 179 days thereafter (or earlier if such Payment Blockage Period is
terminated:
(1) by written notice to the Trustee and the Issuers from the Person or
Persons who gave such Blockage Notice,
(2) by repayment in full of such Designated Senior Indebtedness, or
(3) because the default giving rise to such Blockage Notice is no longer
continuing).
Notwithstanding the provisions described in the immediately preceding sentence
(but subject to the provisions contained in the second preceding sentence),
unless the holders of such Designated Senior Indebtedness or the Representative
of such holders have accelerated the maturity of such Designated Senior
Indebtedness, the Issuers may resume payments on the notes after the end of such
Payment Blockage Period.
Not more than one Blockage Notice may be given in any consecutive 360-day
period, irrespective of the number of defaults with respect to Designated Senior
Indebtedness during such period. However, if any Blockage Notice within such
360-day period is given by or on behalf of any holders of Designated Senior
Indebtedness other than the Bank Indebtedness, the Representative of the Bank
Indebtedness may give another Blockage Notice within such period. In no event,
however, may the total number of days during which any Payment Blockage Period
or Periods is in effect exceed 179 days in the aggregate during any 360
consecutive day period. For purposes of this paragraph, no default or event of
default that existed or was continuing on the date of the commencement of any
Payment Blockage Period with respect to the Designated Senior Indebtedness
initiating such Payment Blockage Period shall be, or be made, the basis of the
commencement of a subsequent Payment Blockage Period by the Representative of
such Designated Senior Indebtedness, whether or not within a period of 360
consecutive days, unless such default or event of default shall have been cured
or waived for a period of not less than 90 consecutive days.
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Upon any payment or distribution of the assets of the Company or DJ Capital to
their respective creditors upon a total or partial liquidation or a total or
partial dissolution of the Company or DJ Capital or in a bankruptcy,
reorganization, insolvency, receivership or similar proceeding relating to the
Company or its property or DJ Capital or its property:
(1) the holders of Senior Indebtedness of the Company or DJ Capital, as
the case may be, will be entitled to receive payment in full of such
Senior Indebtedness before the Holders of the notes are entitled to
receive any payment of principal of or interest on the notes; and
(2) until such Senior Indebtedness is paid in full, any payment or
distribution to which Holders would be entitled but for the subordination
provisions of the indenture will be made to holders of such Senior
Indebtedness as their interests may appear, except that Holders of the
notes may receive Equity Interests and any debt securities that are
subordinated to such Senior Indebtedness to at least the same extent as
the notes.
If a payment or distribution is made to Holders of the notes that due to the
subordination provisions of the indenture should not have been made to them,
such Holders will be required to hold it in trust for the benefit of the holders
of Senior Indebtedness of the Company or DJ Capital, as the case may be, and pay
it over to them as their interests may appear.
If payment of the notes is accelerated because of an Event of Default, the
Issuers or the Trustee shall promptly notify the holders of each Issuer's
Designated Senior Indebtedness (or their Representative) of the acceleration. If
any such Designated Senior Indebtedness is outstanding, the Issuers may not pay
the notes until five Business Days after such holders or the Representative of
such Designated Senior Indebtedness receive notice of such acceleration and,
thereafter, may pay the notes only if the subordination provisions of the
indenture otherwise permit payment at that time.
By reason of the subordination provisions of the indenture, in the event of
insolvency, creditors of the Issuers who are holders of Senior Indebtedness may
recover more, ratably, than the Holders of the notes, and creditors of the
Issuers who are not holders of Senior Indebtedness may recover less, ratably,
than holders of Senior Indebtedness and may recover more, ratably, than the
holders of the notes.
Note guarantees
dj Orthopedics, Inc. has, and certain future Subsidiaries of the Company (as
described below) will, as primary obligors and not merely as sureties, jointly
and severally unconditionally Guarantee on an unsecured senior subordinated
basis the performance and full and punctual payment when due, whether at Stated
Maturity, by acceleration or otherwise, of all obligations of the Issuers under
the indenture (including obligations to the Trustee) and the notes, whether for
payment of principal of or interest on or liquidated damages in respect of the
notes, expenses, indemnification or otherwise (all such obligations guaranteed
by such Note Guarantors being herein called the "Guaranteed Obligations"). Such
Note Guarantors have agreed to pay, in addition to the amount stated above, any
and all costs and expenses (including reasonable counsel fees and expenses)
incurred by the Trustee or the Holders in enforcing any rights under the Note
Guarantees. Each Note Guarantee is limited in amount to an amount not to exceed
the maximum amount that can be Guaranteed by the applicable Note Guarantor
without rendering the Note Guarantee, as it relates to such Note Guarantor, void
or voidable under applicable law relating to fraudulent conveyance or fraudulent
transfer or similar laws affecting the rights of creditors generally. The
Company has agreed to cause each Domestic Subsidiary to execute and deliver to
the Trustee a supplemental indenture pursuant to which such Restricted
Subsidiary will Guarantee payment of the notes. See "Certain covenants--Future
note guarantors" below.
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The obligations of a Note Guarantor under its Note Guarantee are senior
subordinated obligations. As such, the rights of Holders to receive payment by a
Note Guarantor pursuant to its Note Guarantee are subordinated in right of
payment to the rights of holders of Senior Indebtedness of such Note Guarantor.
The terms of the subordination provisions described above with respect to the
Issuers' obligations under the notes apply equally to a Note Guarantor and the
obligations of such Note Guarantor under its Note Guarantee.
Each Note Guarantee is a continuing guarantee and shall
- remain in full force and effect until payment in full of all the
Guaranteed Obligations,
- be binding upon each Note Guarantor and its successors, and
- inure to the benefit of, and be enforceable by, the Trustee, the Holders
and their successors, transferees and assigns.
Change of control
Upon the occurrence of any of the following events (each a "Change of Control"),
each Holder will have the right to require the Issuers to repurchase all or any
part of such Holder's notes at a purchase price in cash equal to 101% of the
principal amount thereof plus accrued and unpaid interest (and, in the case of
the old notes, liquidated damages, if any), to the date of repurchase (subject
to the right of Holders of record on the relevant record date to receive
interest due on the relevant interest payment date); provided, however, that
notwithstanding the occurrence of a Change of Control, the Issuers shall not be
obligated to repurchase the notes pursuant to this covenant in the event that
the Issuers have exercised their right to redeem all the notes under the terms
of the section titled "Optional redemption":
(1) prior to the earlier to occur of
(A) the first public offering of common Equity Interests of
dj Orthopedics, Inc. or
(B) the first public offering of common Equity Interests of the
Company,
the Permitted Holders cease to be the "beneficial owner" (as defined in
Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of
a majority in the aggregate of the total voting power of the Voting Equity
Interests of the Company or dj Orthopedics, Inc., whether as a result of
issuance of securities of dj Orthopedics, Inc. or the Company, any merger,
consolidation, liquidation or dissolution of dj Orthopedics, Inc. or the
Company, any direct or indirect transfer of securities by any Permitted
Holder or otherwise (for purposes of this clause (1) and clause (2) below,
the Permitted Holders shall be deemed to beneficially own any Voting
Equity Interests of an entity (the "specified entity") held by any other
entity (the "parent entity") so long as the Permitted Holders beneficially
own (as so defined), directly or indirectly, in the aggregate a majority
of the voting power of the Voting Equity Interests of the parent entity);
(2)(A) any "person" (as such term is used in Sections 13(d) and 14(d) of
the Exchange Act, including any group acting for the purpose of acquiring,
holding or disposing of securities within the meaning of Rule 13d-5(b)(1)
under the Exchange Act), other than one or more Permitted Holders, is or
becomes the beneficial owner (as defined in clause (1) above, except that
for purposes of this clause (2) a person (including a Permitted Holder)
shall be deemed to have "beneficial ownership" of all Equity Interests
that any such person has the right to acquire,
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whether such right is exercisable immediately or only after the passage of
time, upon the happening of any event or otherwise), directly or
indirectly, of more than 35% of the total voting power of the Voting
Equity Interests of the Company or dj Orthopedics, Inc., and
(B) the Permitted Holders "beneficially own" (as defined in clause (1)
above), directly or indirectly, in the aggregate a lesser percentage of
the total voting power of the Voting Equity Interests of the Company or
dj Orthopedics, Inc. than such other person and do not have the right or
ability by voting power, contract or otherwise to elect or designate for
election a majority of the Governing Board of the Company or
dj Orthopedics, Inc., as the case may be (for the purposes of this
clause (2), such other person shall be deemed to beneficially own any
Voting Equity Interests of a specified entity held by a parent entity, if
such other person is the beneficial owner (as defined in this
clause (2)), directly or indirectly, of more than 35% of the voting power
of the Voting Equity Interests of such parent entity and the Permitted
Holders "beneficially own" (as defined in clause (1) above), directly or
indirectly, in the aggregate a lesser percentage of the voting power of
the Voting Equity Interests of such parent entity and do not have the
right or ability by voting power, contract or otherwise to elect or
designate for election a majority of the Governing Board of such parent
entity);
(3) during any period of two consecutive years, individuals who at the
beginning of such period constituted the Governing Board of the Company or
dj Orthopedics, Inc., as the case may be (together with any new persons
(A) elected in accordance with the Members' Agreement so long as such
agreement is in effect or (B) whose election by such Governing Board of
the Company or dj Orthopedics, Inc., as the case may be, or whose
nomination for election by the equity holders of the Company or
dj Orthopedics, Inc., as the case may be, was approved by a vote of at
least a majority of the members of the Governing Board of the Company or
dj Orthopedics, Inc., as the case may be, then still in office who were
either members of the Governing Board at the beginning of such period or
who were selected in accordance with the Members' Agreement or whose
election or nomination for election was previously so approved), cease for
any reason to constitute a majority of the Governing Board of the Company
or dj Orthopedics, Inc., as the case may be, then in office;
(4) the adoption of a plan relating to the liquidation or dissolution of
the Company, DJ Capital or dj Orthopedics, Inc.;
(5) the merger or consolidation of the Company or dj Orthopedics, Inc.
with or into another Person or the merger of another Person with or into
the Company or dj Orthopedics, Inc., or the sale of all or substantially
all the assets of the Company or dj Orthopedics, Inc. to another Person
(other than a Person that is controlled by the Permitted Holders), and, in
the case of any such merger or consolidation, the securities of the
Company or dj Orthopedics, Inc. that are outstanding immediately prior to
such transaction and which represent 100% of the aggregate voting power of
the Voting Equity Interests of the Company or dj Orthopedics, Inc. are
changed into or exchanged for cash, securities or property, unless
pursuant to such transaction such securities are changed into or exchanged
for, in addition to any other consideration, securities of the surviving
Person or transferee that represent immediately after such transaction, at
least a majority of the aggregate voting power of the Voting Equity
Interests of the surviving Person or transferee; or
(6) the Company ceases to own, of record or beneficially, all the Equity
Interests of DJ Capital.
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In the event that at the time of a Change of Control the terms of any agreement
governing Indebtedness of the Company or its Subsidiaries restrict or prohibit
the repurchase of notes pursuant to this covenant, then prior to the mailing of
the notice to Holders provided for in the immediately following paragraph but in
any event within 30 days following any Change of Control, the Company shall:
(1) repay in full all such Indebtedness or offer to repay in full all such
Indebtedness and repay the Indebtedness of each lender who has accepted
such offer, or
(2) obtain the requisite consent of the lenders under such agreements to
permit the repurchase of the notes as provided for below.
If the Company does not obtain such consents or repay such Indebtedness, the
Company will remain prohibited from repurchasing the notes pursuant to this
covenant. In such event the Company's failure to make an offer to purchase notes
pursuant to this covenant would constitute an Event of Default under the
indenture which in turn would constitute default under the Credit Agreement. In
such circumstances, the subordination provisions of the indenture would likely
prohibit payments to Holders of the notes.
Within 30 days following any Change of Control, the Issuers shall mail a notice
to each Holder with a copy to the Trustee (the Change of Control Offer) stating:
(1) that a Change of Control has occurred and that such Holder has the
right to require the Issuers to purchase such Holder's notes at a purchase
price in cash equal to 101% of the principal amount thereof, plus accrued
and unpaid interest (and, in the case of the old notes, liquidated
damages, if any) to the date of repurchase (subject to the right of
Holders of record on the relevant record date to receive interest on the
relevant interest payment date);
(2) the circumstances and relevant facts and financial information
regarding such Change of Control;
(3) the repurchase date (which shall be no earlier than 30 days nor later
than 60 days from the date such notice is mailed); and
(4) the instructions determined by the Issuers, consistent with this
covenant, that a Holder must follow in order to have its notes purchased.
The Issuers will not be required to make a Change of Control Offer upon a Change
of Control if a third party makes the Change of Control Offer in the manner, at
the times and otherwise in compliance with the requirements set forth in the
indenture applicable to a Change of Control Offer made by the Issuers and
purchases all notes validly tendered and not withdrawn under such Change of
Control Offer.
The Issuers will comply, to the extent applicable, with the requirements of
Section 14(e) of the Exchange Act and any other securities laws or regulations
in connection with the repurchase of notes pursuant to this covenant. To the
extent that the provisions of any securities laws or regulations conflict with
provisions of this covenant, the Issuers will comply with the applicable
securities laws and regulations and will not be deemed to have breached its
obligations under this covenant by virtue thereof.
The Change of Control purchase feature is a result of negotiations among the
Issuers and the initial purchaser of the old notes in the private offering.
Management has no present intention to engage in a transaction involving a
Change of Control, although it is possible that the Issuers would decide to do
so in the future. Subject to the limitations discussed below, the Issuers could,
in the future, enter into certain transactions, including acquisitions,
refinancings or other recapitalizations, that would not
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constitute a Change of Control under the indenture, but that could increase the
amount of indebtedness outstanding at such time or otherwise affect the Issuers'
capital structures or credit ratings. Restrictions on the ability of the Issuers
to incur additional Indebtedness are contained in the covenants described under
"--Certain covenants--Limitation on indebtedness" and "--Limitation on the
conduct of business of DJ Capital." Such restrictions can only be waived with
the consent of the Holders of a majority in principal amount of the notes then
outstanding. Except for the limitations contained in such covenants, however,
the indenture will not contain any covenants or provisions that may afford
Holders protection in the event of a highly leveraged transaction.
The occurrence of certain of the events which would constitute a Change of
Control would constitute a default under the Credit Agreement. Future Senior
Indebtedness may contain prohibitions of certain events which would constitute a
Change of Control or require such Senior Indebtedness to be repurchased upon a
Change of Control. Moreover, the exercise by the Holders of their right to
require the Issuers to repurchase the notes could cause a default under such
Senior Indebtedness, even if the Change of Control itself does not, due to the
financial effect of such repurchase on the Issuers. Finally, the Issuers'
ability to pay cash to the Holders upon a repurchase may be limited by the
Issuers' then existing financial resources. There can be no assurance that
sufficient funds will be available when necessary to make any required
repurchases. The provisions under the indenture relative to the Issuers'
obligation to make an offer to repurchase the notes as a result of a Change of
Control may be waived or modified with the written consent of the Holders of a
majority in principal amount of the notes.
Certain covenants
The indenture contains covenants including, among others, the following:
LIMITATION ON INDEBTEDNESS. (a) The Company will not, and will not permit any
Restricted Subsidiary to, Incur, directly or indirectly, any Indebtedness;
provided, however, that the Company or any Restricted Subsidiary that is a Note
Guarantor may Incur Indebtedness if on the date of such Incurrence and after
giving effect thereto the Consolidated Coverage Ratio would be greater than
2.00:1.00 if such Indebtedness was Incurred on or prior to December 31, 2000 and
2.25:1.00 if such Indebtedness is Incurred thereafter. Notwithstanding the
foregoing, the Company will not permit DJ Capital to Incur any Indebtedness
other than the notes and its guarantee in respect of the credit facility.
(b) Notwithstanding the foregoing paragraph (a), the Company and its Restricted
Subsidiaries (other than DJ Capital) may Incur the following Indebtedness:
(1) Indebtedness Incurred pursuant to the Credit Agreement in an aggregate
principal amount not to exceed $40.5 million at any one time outstanding
less the aggregate amount of all repayments of principal of such
Indebtedness pursuant to the covenant described under"--Limitation on
sales of assets and subsidiary equity interests";
(2) Indebtedness of the Company owed to and held by any Restricted
Subsidiary or Indebtedness of a Restricted Subsidiary owed to and held by
the Company or any Restricted Subsidiary; provided, however, that
(A) any subsequent issuance or transfer of any Equity Interests or
any other event that results in any such Restricted Subsidiary
ceasing to be a Restricted Subsidiary or any subsequent transfer of
any such Indebtedness (except to the Company or a Restricted
Subsidiary) shall be deemed, in each case, to constitute the
Incurrence of such Indebtedness by the issuer thereof,
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(B) if the Company is the obligor on such Indebtedness, such
Indebtedness is expressly subordinated to the prior payment in full
in cash of all obligations with respect to the notes,
(C) if a Restricted Subsidiary is the obligor on such Indebtedness,
such Indebtedness is made pursuant to an intercompany note, and
(D) if a Note Guarantor is the obligor on such Indebtedness, such
Indebtedness is subordinated in right of payment to the Note
Guarantee of such Note Guarantor
(3) Indebtedness
(A) represented by the notes and the Note Guarantees,
(B) outstanding on the Closing Date (other than the Indebtedness
described in clauses (1) and (2) above),
(C) consisting of Refinancing Indebtedness Incurred in respect of
any Indebtedness described in this clause (3) (including
Indebtedness Refinancing Indebtedness) or the foregoing
paragraph (a) and
(D) consisting of Guarantees of any Indebtedness permitted under
clauses (1) and (2) of this paragraph (b);
(4) (A) Indebtedness of a Restricted Subsidiary Incurred and outstanding
on or prior to the date on which such Restricted Subsidiary was
acquired by the Company (other than Indebtedness Incurred as
consideration in, or to provide all or any portion of the funds
or credit support utilized to consummate, the transaction or
series of related transactions pursuant to which such Restricted
Subsidiary became a Subsidiary of or was otherwise acquired by
the Company) and
(B) Refinancing Indebtedness Incurred by a Restricted Subsidiary in
respect of Indebtedness Incurred by such Restricted Subsidiary
pursuant to this clause (4);
(5) Indebtedness of the Company or a Restricted Subsidiary
(A) in respect of performance bonds, bankers' acceptances, letters
of credit and surety or appeal bonds provided by the Company and
the Restricted Subsidiaries in the ordinary course of their
business, and
(B) under Interest Rate Agreements and Currency Agreements entered
into for bona fide hedging purposes of the Company or any
Restricted Subsidiary in the ordinary course of business; provided,
however, that such Interest Rate Agreements or Currency Agreements
do not increase the principal amount of Indebtedness of the Company
and its Restricted Subsidiaries outstanding at any time other than
as a result of fluctuations in interest rates or foreign currency
exchange rates or by reason of fees, indemnities and compensation
payable thereunder;
(6) Indebtedness (including Capitalized Lease Obligations) Incurred by the
Company or any of its Restricted Subsidiaries to finance the purchase,
lease or improvement of property (real or personal), equipment or other
assets (in each case whether through the direct purchase of assets or the
Equity Interests of any Person owning such assets) in an aggregate
principal amount which, when aggregated with the principal amount of all
other Indebtedness then outstanding and Incurred pursuant to this
clause (6) and all Refinancing Indebtedness Incurred
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to refund, refinance or replace any Indebtedness Incurred pursuant to this
clause (6), does not exceed $10.0 million;
(7) Indebtedness arising from the honoring by a bank or other financial
institution of a check, draft or similar instrument (except in the case of
daylight overdrafts) drawn against insufficient funds in the ordinary
course, provided that such Indebtedness is extinguished within five
Business Days of Incurrence;
(8) Indebtedness of the Company and its Restricted Subsidiaries arising
from agreements of the Company or a Restricted Subsidiary providing for
indemnification, adjustment of purchase price or similar obligations, in
each case incurred or assumed in connection with the disposition of any
business, assets or a Subsidiary of the Company in accordance with the
terms of the indenture, other than Guarantees by the Company or any
Restricted Subsidiary of Indebtedness Incurred by any Person acquiring all
or any portion of such business, assets or a Subsidiary of the Company for
the purpose of financing such acquisition; provided, however, that
(A) such Indebtedness is not reflected on the consolidated balance
sheet of the Company and
(B) the maximum aggregate liability in respect of all such
Indebtedness shall not exceed the gross proceeds, including the
fair market value as determined in good faith by a majority of the
Governing Board of noncash proceeds (the fair market value of such
noncash proceeds being measured at the time it is received and
without giving effect to any subsequent changes in value), actually
received by the Company and its Restricted Subsidiaries in
connection with such disposition; or
(9) Indebtedness of the Company and its Restricted Subsidiaries (in
addition to Indebtedness permitted to be Incurred pursuant to the
foregoing paragraph (a) or any other clause of this paragraph (b)) in an
aggregate principal amount on the date of Incurrence that, when added to
all other Indebtedness Incurred pursuant to this clause (9) and then
outstanding, shall not exceed $15.0 million.
(c) Notwithstanding the foregoing, the Company may not Incur any Indebtedness
pursuant to paragraph (b) above if the proceeds thereof are used, directly or
indirectly, to repay, prepay, redeem, defease, retire, refund or refinance any
Subordinated Obligations unless such Indebtedness will be subordinated to the
notes to at least the same extent as such Subordinated Obligations. The Company
may not Incur any Indebtedness if such Indebtedness is subordinate or junior in
right of payment to any Senior Indebtedness unless such Indebtedness is Senior
Subordinated Indebtedness or is expressly subordinated in right of payment to
Senior Subordinated Indebtedness. In addition, the Company may not Incur any
Secured Indebtedness which is not Senior Indebtedness unless contemporaneously
therewith effective provision is made to secure the notes equally and ratably
with (or on a senior basis to, in the case of Indebtedness subordinated in right
of payment to the notes) such Secured Indebtedness for so long as such Secured
Indebtedness is secured by a Lien, except for Senior Subordinated Indebtedness
and Subordinated Obligations secured by Liens on the assets of any entity
existing at the time such entity is acquired by, and becomes a Restricted
Subsidiary of, the Company, whether by merger, consolidation, purchase of assets
or otherwise, provided that such Liens
(1) are not created, incurred or assumed in connection with, or in
contemplation of such entity being acquired by the Company, and
(2) do not extend to any other assets of the Company or any of its
Subsidiaries.
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A Note Guarantor may not Incur any Indebtedness if such Indebtedness is by its
terms expressly subordinate or junior in right of payment to any Senior
Indebtedness of such Note Guarantor unless such Indebtedness is Senior
Subordinated Indebtedness of such Note Guarantor or is expressly subordinated in
right of payment to Senior Subordinated Indebtedness of such Note Guarantor. In
addition, a Note Guarantor may not Incur any Secured Indebtedness that is not
Senior Indebtedness of such Note Guarantor unless contemporaneously therewith
effective provision is made to secure the Note Guarantee of such Note Guarantor
equally and ratably with (or on a senior basis to, in the case of Indebtedness
subordinated in right of payment to such Note Guarantee) such Secured
Indebtedness for as long as such Secured Indebtedness is secured by a Lien,
except for Senior Subordinated Indebtedness and Subordinated Obligations of such
Note Guarantor secured by Liens on the assets of any entity existing at the time
such entity is acquired by such Note Guarantor, whether by merger,
consolidation, purchase of assets or otherwise, provided that such Liens
(1) are not created, incurred or assumed in connection with or in
contemplation of such assets being acquired by such Note Guarantor, and
(2) do not extend to any other assets of the Company or any of its
Subsidiaries
(d) Notwithstanding any other provision of this covenant, the maximum amount of
Indebtedness that the Company or any Restricted Subsidiary may Incur pursuant to
this covenant shall not be deemed to be exceeded solely as a result of
fluctuations in the exchange rates of currencies. For purposes of determining
the outstanding principal amount of any particular Indebtedness Incurred
pursuant to this covenant:
(1) Indebtedness Incurred pursuant to the Credit Agreement prior to or on
the Closing Date shall be treated as Incurred pursuant to clause (1) of
paragraph (b) above,
(2) Guarantees or obligations in respect of letters of credit relating to
Indebtedness which is otherwise included in the determination of a
particular amount of Indebtedness shall not be included,
(3) The principal amount of any Disqualified Equity Interests or Preferred
Equity Interests shall be equal to the greater of the maximum mandatory
redemption or repurchase price (not including, in either case, any
redemption or repurchase premium) or the maximum liquidation preference,
(4) The principal amount of Indebtedness, Disqualified Equity Interests or
Preferred Equity Interests issued at a price less than the principal
amount thereof, the maximum fixed redemption or repurchase price thereof
or liquidation preference thereof, as applicable, will be equal to the
amount of the liability or obligation in respect thereof determined in
accordance with GAAP,
(5) If such Indebtedness is denominated in a currency other than U.S.
dollars, the U.S. dollar equivalent principal amount thereof shall be
calculated based on the relevant currency exchange rates in effect on the
date such Indebtedness was Incurred,
(6) The accrual of interest, accrual of dividends, the accretion of
accreted value, the payment of interest in the form of additional
Indebtedness and the payment of dividends or distributions in the form of
additional Equity Interests shall not be deemed an incurrence of
Indebtedness for purposes of this covenant,
(7) Indebtedness permitted by this covenant need not be permitted solely
by reference to one provision permitting such Indebtedness but may be
permitted in part by one such provision and in part by one or more other
provisions of this covenant permitting such Indebtedness, and
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(8) In the event that Indebtedness meets the criteria of more than one of
the types of Indebtedness described in this covenant, the Company, in its
sole discretion, shall classify such Indebtedness and only be required to
include the amount of such Indebtedness in one of such clauses.
LIMITATION ON RESTRICTED PAYMENTS. (a) The Company will not, and will not
permit any Restricted Subsidiary, directly or indirectly, to:
(1) declare or pay any dividend or make any distribution of any kind on or
in respect of its Equity Interests (including any payment in connection
with any merger or consolidation involving the Company) or similar payment
to the direct or indirect holders (in their capacities as such) of its
Equity Interests except dividends or distributions payable solely in its
Equity Interests (other than Disqualified Equity Interests) and except
dividends or distributions payable to the Company or another Restricted
Subsidiary (and, if such Restricted Subsidiary has equity holders other
than the Company or other Restricted Subsidiaries, to its other equity
holders on a pro rata basis),
(2) purchase, redeem, retire or otherwise acquire for value any Equity
Interests of dj Orthopedics, Inc. (or any other direct or indirect parent
company of the Company), the Company or any Restricted Subsidiary held by
Persons other than the Company or another Restricted Subsidiary,
(3) purchase, repurchase, redeem, defease or otherwise acquire or retire
for value, prior to scheduled maturity, scheduled repayment or scheduled
sinking fund payment any Subordinated Obligations (other than
(A) the purchase, repurchase or other acquisition of Subordinated
Obligations purchased in anticipation of satisfying a sinking fund
obligation, principal installment or final maturity, in each case
due within one year of the date of acquisition and
(B) Indebtedness described in clause (2) of paragraph (b) of the
covenant described under "--Limitation on indebtedness"), or
(4) make any Investment (other than a Permitted Investment) in any Person
(any such dividend, distribution, purchase, redemption, repurchase,
defeasance, other acquisition, retirement or Investment being herein
referred to as a "Restricted Payment") if at the time the Company or such
Restricted Subsidiary makes such Restricted Payment:
(A) a Default will have occurred and be continuing (or would result
therefrom);
(B) the Company could not Incur at least $1.00 of additional
Indebtedness under paragraph (a) of the covenant described under
"--Limitation on indebtedness"; or
(C) the aggregate amount of such Restricted Payment and all other
Restricted Payments (the amount so expended, if other than in cash,
to be determined in good faith by the Governing Board, whose
determination will be conclusive and evidenced by a resolution of
the Governing Board) declared or made subsequent to the Closing
Date would exceed the sum, without duplication, of:
(i) 50% of the Consolidated Net Income accrued during the
period (treated as one accounting period) from the beginning
of the fiscal quarter immediately following the fiscal
quarter during which the Closing Date occurs to the end of
the most recent fiscal quarter ending prior to the date of
such Restricted Payment for which consolidated financial
statements of the Company are
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publicly available (or, in case such Consolidated Net Income
will be a deficit, minus 100% of such deficit);
(ii) the aggregate Net Cash Proceeds received by the Company
- as capital contributions to the Company after the
Closing Date or
- from the issue or sale of its Equity Interests
(other than Disqualified Equity Interests) subsequent
to the Closing Date (other than a capital
contribution from or an issuance or sale to
- a Subsidiary of the Company or
- an employee equity ownership or participation
plan or other trust established by the Company or
any of its Subsidiaries);
(iii) the amount by which Indebtedness of the Company or its
Restricted Subsidiaries is reduced on the Company's balance
sheet upon the conversion or exchange (other than by a
Subsidiary of the Company) subsequent to the Closing Date of
any Indebtedness of the Company or its Restricted
Subsidiaries issued after the Closing Date which is
convertible or exchangeable for Equity Interests (other than
Disqualified Equity Interests) of dj Orthopedics, Inc. or
the Company (less the amount of any cash or the fair market
value of other property distributed by the Company or any
Restricted Subsidiary upon such conversion or exchange);
(iv) 100% of the aggregate amount received by the Company or
any Restricted Subsidiary in cash from the sale or other
disposition (other than to
- the Company or a Subsidiary of the Company or
- an employee equity ownership or participation plan
or other trust established by the Company or any of
its Subsidiaries)
of Restricted Investments made by the Company or any
Restricted Subsidiary after the Closing Date and from
repurchases and redemptions of such Restricted Investments
from the Company or any Restricted Subsidiary by any Person
(other than
- the Company or any of its Subsidiaries or
- an employee equity ownership or participation plan
or other trust established by the Company or any of
its Restricted Subsidiaries)
and from repayments of loans or advances which constituted
Restricted Investments; provided, however, that the amount
included in this clause (iv) with respect to any particular
Restricted Investment shall not exceed the amount of cash
expended by the Company or any Restricted Subsidiary in
connection with making such Restricted Investment; and
(v) the amount equal to the net reduction in Investments in
Unrestricted Subsidiaries resulting from
- payments of dividends, repayments of the principal
of loans or advances or other transfers of assets to
the Company or any Restricted Subsidiary from
Unrestricted Subsidiaries or
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- the redesignation of Unrestricted Subsidiaries as
Restricted Subsidiaries (valued in each case as
provided in the definition of "Investment") not to
exceed, in the case of any Unrestricted Subsidiary,
the amount of Investments previously made by the
Company or any Restricted Subsidiary in such
Unrestricted Subsidiary, which amount was included in
the calculation of the amount of Restricted Payments.
(b) The provisions of the foregoing paragraph (a) will not prohibit:
(1) any purchase, repurchase, retirement or other acquisition or
retirement for value of, or other distribution in respect of, Equity
Interests of the Company made by exchange for, or out of the proceeds of
the substantially concurrent sale of, Equity Interests of the Company or
capital contributions to the Company after the Closing Date (other than
Disqualified Equity Interests and other than Equity Interests issued or
sold to, or capital contributions from, a Subsidiary of the Company or an
employee equity ownership or participation plan or other trust established
by the Company or any of its Subsidiaries); provided, however, that:
(A) such Restricted Payment will be excluded in the calculation of
the amount of Restricted payments, and
(B) the Net Cash Proceeds from such sale or capital contribution
applied in the manner set forth in this clause (1) will be excluded
from the calculation of amounts under clause (4)(C)(ii) of
paragraph (a) above;
(2) any purchase, repurchase, redemption, defeasance or other acquisition
or retirement for value of Subordinated Obligations of the Company or a
Restricted Subsidiary made by exchange for, or out of the proceeds of the
substantially concurrent sale of
(A) Equity Interests of dj Orthopedics, Inc. or the Company (other
than Disqualified Equity Interests) or
(B) Subordinated Obligations of the Company or a Restricted
Subsidiary that are permitted to be Incurred pursuant to the
covenant described under--"Limitation on Indebtedness";
provided, however, that such purchase, repurchase, redemption, defeasance
or other acquisition or retirement for value will be excluded in the
calculation of the amount of Restricted Payments;
(3) any purchase or redemption of Subordinated Obligations from Net
Available Cash to the extent permitted by the covenant described under
"--Limitation on sales of assets and subsidiary equity interests";
provided, however, that such purchase or redemption will be excluded in
the calculation of the amount of Restricted Payments;
(4) dividends or other distributions paid to holders of, or redemptions
from holders of, Equity Interests within 60 days after the date of
declaration thereof, or the giving of formal notice of redemption, if at
such date of declaration such dividends or other distributions or
redemptions would have complied with this covenant; provided, however,
that such dividend, distribution or redemption will be included in the
calculation of the amount of Restricted Payments;
(5) payment of dividends, other distributions or other amounts by the
Company for the purposes set forth in clauses (A) and (B) below; provided,
however, that such dividend, distribution or amount set forth in
clause (A) shall be excluded and in clause (B) shall be
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included in the calculation of the amount of Restricted Payments for the
purposes of paragraph (a) above:
(A) to dj Orthopedics, Inc. in amounts equal to the amounts
required for dj Orthopedics, Inc. to pay franchise taxes and other
fees required to maintain its existence and provide for all other
operating costs of dj Orthopedics, Inc., including, without
limitation, in respect of director fees and expenses,
administrative, legal and accounting services provided by third
parties and other costs and expenses of being a public company,
including, all costs and expenses with respect to filings with the
SEC, of up to $500,000 per fiscal year; and
(B) to dj Orthopedics, Inc. in amounts equal to amounts expended by
dj Orthopedics, Inc. to repurchase Equity Interests of
dj Orthopedics, Inc. owned by officers, directors, consultants and
employees or former officers, directors, consultants or employees
of dj Orthopedics, Inc., the Company or its Subsidiaries or their
assigns, estates and heirs; provided, however, that the aggregate
amount of dividends, distributions or other amounts to
dj Orthopedics, Inc. pursuant to this clause (B) shall not, in the
aggregate, exceed $3.0 million per fiscal year of the Company, up
to a maximum aggregate amount of $7.0 million during the term of
the indenture;
(6) for so long as the Company is treated as a pass-through entity for
United States Federal income tax purposes, Tax Distributions; provided,
however, that such Tax Distributions shall be excluded in the calculation
of the amount of Restricted Payments;
(7) dividends or distributions to dj Orthopedics, Inc. in amounts equal to
amounts required for dj Orthopedics, Inc. to pay Federal, state and local
income taxes to the extent such income taxes are attributable to the
income of the Company and its Restricted Subsidiaries (and, to the extent
of amounts actually received from its Unrestricted Subsidiaries, in
amounts required to pay such taxes to the extent attributable to the
income of such Unrestricted Subsidiaries); provided, however, that such
distributions shall be excluded in the calculation of the amount of
Restricted Payments;
(8) the payment of dividends or distributions to dj Orthopedics, Inc. to
fund the payment by dj Orthopedics, Inc. of dividends on common Equity
Interests of dj Orthopedics, Inc. following the first public offering of
common Equity Interests of dj Orthopedics, Inc. after the Closing Date, of
up to 6% per annum of the net proceeds contributed to the Company by
dj Orthopedics, Inc. from such public offering; provided, however, that
such dividends or distributions will be included in the calculation of the
amount of Restricted Payments; or
(9) dividends or distributions to DonJoy, L.L.C. in an amount equal to the
purchase price adjustment, if any, which DonJoy, L.L.C. was required to
pay to Smith & Nephew in connection with the recapitalization pursuant to
Article III of the recapitalization agreement as such agreement is in
effect on the Closing Date; provided, however, that such distributions
shall be excluded in the calculation of the amount of Restricted Payments.
LIMITATION ON RESTRICTIONS ON DISTRIBUTIONS FROM RESTRICTED SUBSIDIARIES. The
Company will not, and will not permit any Restricted Subsidiary to, create or
otherwise cause or permit to exist or become effective any consensual
encumbrance or restriction on the ability of any Restricted Subsidiary to:
(1) pay dividends or make any other distributions on its Equity Interests
or pay any Indebtedness or other obligations owed to the Company;
(2) make any loans or advances to the Company; or
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(3) transfer any of its property or assets to the Company, except:
(A) any encumbrance or restriction pursuant to applicable law or
any applicable rule, regulation or order, or an agreement in effect
at or entered into on the Closing Date;
(B) any encumbrance or restriction with respect to a Restricted
Subsidiary pursuant to an agreement relating to any Equity
Interests or Indebtedness of such Restricted Subsidiary, in each
case Incurred by such Restricted Subsidiary prior to the date on
which such Restricted Subsidiary was acquired by the Company (other
than Equity Interests or Indebtedness Incurred as consideration in,
in contemplation of, or to provide all or any portion of the funds
or credit support utilized to consummate the transaction or series
of related transactions pursuant to which such Restricted
Subsidiary became a Restricted Subsidiary or was otherwise acquired
by the Company) and outstanding on such date;
(C) any encumbrance or restriction pursuant to an agreement
effecting a Refinancing of Indebtedness Incurred pursuant to an
agreement referred to in clause (A) or (B) of this covenant or this
clause (C) or contained in any amendment to an agreement referred
to in clause (A) or (B) of this covenant or this clause (C);
provided, however, that the encumbrances and restrictions contained
in any such Refinancing agreement or amendment are no more
restrictive, taken as a whole, than the encumbrances and
restrictions contained in such predecessor agreements;
(D) in the case of clause (3), any encumbrance or restriction
(i) that restricts in a customary manner the assignment of
any lease, license or similar contract or the subletting,
assignment or transfer of any property or asset that is
subject to a lease, license or similar contract,
(ii) that is or was created by virtue of any transfer of,
agreement to transfer or option or right with respect to any
property or assets of the Company or any Restricted
Subsidiary not otherwise prohibited by the Indenture,
(iii) contained in security agreements securing Indebtedness
of a Restricted Subsidiary to the extent such encumbrance or
restriction restricts the transfer of the property subject
to such security agreements, or
(iv) encumbrances or restrictions relating to Indebtedness
permitted to be Incurred pursuant to clause (b)(6) of the
covenant described under "--Limitation on indebtedness" for
property acquired in the ordinary course of business that
only imposes encumbrances or restrictions on the property so
acquired;
(E) with respect to a Restricted Subsidiary, any restriction
imposed pursuant to an agreement entered into for the sale or
disposition of all or substantially all the Equity Interests or
assets of such Restricted Subsidiary pending the closing of such
sale or disposition;
(F) customary provisions in joint venture agreements and other
similar agreements entered into in the ordinary course of business;
and
(G) net worth provisions in leases and other agreements entered
into by the Company or any Restricted Subsidiary in the ordinary
course of business.
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LIMITATION ON SALES OF ASSETS AND SUBSIDIARY EQUITY INTERESTS. (a) The Company
will not, and will not permit any Restricted Subsidiary to, make any Asset
Disposition unless:
(1) the Company or such Restricted Subsidiary receives consideration
(including by way of relief from, or by any other Person assuming sole
responsibility for, any liabilities, contingent or otherwise) at the time
of such Asset Disposition at least equal to the fair market value of the
Equity Interests and assets subject to such Asset Disposition,
(2) at least 80% of the consideration thereof received by the Company or
such Restricted Subsidiary is in the form of
(A) cash or Temporary Cash Investments,
(B) properties and assets to be owned by the Company or any
Restricted Subsidiary and used in a Permitted Business, or
(C) Voting Equity Interests in one or more Persons engaged in a
Permitted Business that are or thereby become Restricted
Subsidiaries of the Company, and
(3) an amount equal to 100% of the Net Available Cash from such Asset
Disposition is applied by the Company (or such Restricted Subsidiary, as
the case may be)
(A) FIRST,
(i) to the extent the Company elects (or is required by the
terms of any Indebtedness), to prepay, repay, redeem or
purchase Senior Indebtedness of the Company or Indebtedness
(other than any Disqualified Equity Interests) of a
Restricted Subsidiary (in each case other than Indebtedness
owed to the Company or an Affiliate of the Company and other
than Preferred Equity Interests) or
(ii) to the extent the Company or such Restricted Subsidiary
elects, to reinvest in Additional Assets (including by means
of an Investment in Additional Assets by a Restricted
Subsidiary with Net Available Cash received by the Company
or another Restricted Subsidiary or the application by the
Company of the Net Available Cash received by a Restricted
Subsidiary of the Company),
in each case within 320 days from the later of such Asset Disposition or
the receipt of such Net Available Cash, provided that pending the final
application of any such Net Available Cash, the Company and its Restricted
Subsidiaries may temporarily reduce Indebtedness or otherwise invest such
Net Available Cash in any manner not prohibited by the indenture;
(B) SECOND, within 365 days from the later of such Asset
Disposition or the receipt of such Net Available Cash, to the
extent of the balance of such Net Available Cash after such
application in accordance with clause (A), to make an Offer (as
defined below) to purchase notes pursuant to and subject to the
conditions set forth in section (b) of this covenant; provided,
however, that if the Company elects (or is required by the terms of
any other Senior Subordinated Indebtedness), such Offer may be made
ratably to purchase the notes and other Senior Subordinated
Indebtedness of the Company; and
(C) THIRD, to the extent of the balance of such Net Available Cash
after application in accordance with clauses (A) (other than the
proviso thereof) and (B), for any general corporate purpose not
restricted by the terms of the indenture; provided, however, that
in connection with any prepayment, repayment or purchase of
Indebtedness pursuant
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to clause (A) or (B) above, the Company or such Restricted
Subsidiary will retire such Indebtedness and will cause the related
loan commitment (if any) to be permanently reduced in an amount
equal to the principal amount so prepaid, repaid or purchased.
Notwithstanding the foregoing provisions of this covenant, the Company and the
Restricted Subsidiaries will not be required to apply any Net Available Cash in
accordance with this covenant except to the extent that the aggregate Net
Available Cash from all Asset Dispositions that is not applied in accordance
with this covenant exceeds $5.0 million.
For the purposes of this covenant, the following are deemed to be cash:
- the assumption of any liabilities of the Company (other than
Disqualified Equity Interests of the Company) or any Restricted Subsidiary
and the release of the Company or such Restricted Subsidiary from all
liability on such liabilities in connection with such Asset Disposition,
and
- securities received by the Company or any Restricted Subsidiary from the
transferee that are promptly converted by the Company or such Restricted
Subsidiary into cash.
(b) In the event of an Asset Disposition that requires the purchase of notes
(and other Senior Subordinated Indebtedness) pursuant to clause (a)(3)(B) of
this covenant, the Issuers will be required to purchase notes (and other Senior
Subordinated Indebtedness) tendered pursuant to an offer by the Issuers for the
notes (and other Senior Subordinated Indebtedness) (the "Offer") at a purchase
price of 100% of their principal amount plus accrued and unpaid interest and
liquidated damages thereon, if any, to the date of purchase in accordance with
the procedures (including prorating in the event of oversubscription), set forth
in the indenture. If the aggregate purchase price of notes (and other Senior
Subordinated Indebtedness) tendered pursuant to the Offer is less than the Net
Available Cash allotted to the purchase of the notes (and other Senior
Subordinated Indebtedness), the Company may apply the remaining Net Available
Cash for any general corporate purpose not restricted by the terms of the
Indenture. The Issuers will not be required to make an Offer for notes (and
other Senior Subordinated Indebtedness) pursuant to this covenant if the Net
Available Cash available therefor (after application of the proceeds as provided
in clause (a)(3)(A)) is less than $5.0 million for any particular Asset
Disposition (which lesser amount will be carried forward for purposes of
determining whether an Offer is required with respect to the Net Available Cash
from any subsequent Asset Disposition). Upon completion of the Offer, the amount
of Net Available Cash shall be reduced to zero.
(c) The Issuers will comply, to the extent applicable, with the requirements of
Section 14(e) of the Exchange Act and any other securities laws or regulations
in connection with the repurchase of notes pursuant to this covenant. To the
extent that the provisions of any securities laws or regulations conflict with
provisions of this covenant, the Issuers will comply with the applicable
securities laws and regulations and will not be deemed to have breached its
obligations under this covenant by virtue thereof.
LIMITATION ON TRANSACTIONS WITH AFFILIATES. (a) The Company will not, and will
not permit any Restricted Subsidiary to, directly or indirectly, enter into or
conduct any transaction (including the purchase, sale, lease or exchange of any
property or the rendering of any service) with any Affiliate of the Company (an
"Affiliate Transaction") unless such transaction is on terms:
(1) that are no less favorable to the Company or such Restricted
Subsidiary, as the case may be, than those that could be obtained at the
time of such transaction in arm's-length dealings with a Person who is not
such an Affiliate,
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(2) that, in the event such Affiliate Transaction involves an aggregate
amount in excess of $1.0 million,
(A) are set forth in writing, and
(B) except as provided in clause (a)(3) below, have been approved
by a majority of the members of the Governing Board having no
personal stake in such Affiliate Transaction (if any such members
exist), and
(3) that, in the event
(A) such Affiliate Transaction involves an amount in excess of
$5.0 million, or
(B) if there are no members of the Governing Board having no
personal stake in such Affiliate Transaction and such Affiliate
Transaction involves an aggregate amount in excess of
$1.0 million, have been determined by a nationally recognized
appraisal, accounting or investment banking firm to be fair, from a
financial standpoint, to the Company and its Restricted
Subsidiaries.
(b) The provisions of the foregoing paragraph (a) will not prohibit:
(1) any Restricted Payment permitted to be paid pursuant to the covenant
described under
"--Limitation on restricted payments",
(2) any issuance of securities, or other payments, awards or grants in
cash, securities or otherwise pursuant to, or the funding of, employment
arrangements, options to purchase Equity Interests of dj Orthopedics, Inc.
or the Company and equity ownership or participation plans approved by the
Governing Board,
(3) the grant of options (and the exercise thereof) to purchase Equity
Interests of dj Orthopedics, Inc. or the Company or similar rights to
employees and directors of dj Orthopedics, Inc. or the Company pursuant to
plans approved by the Governing Board,
(4) loans or advances to officers, directors or employees in the ordinary
course of business, but in any event not to exceed $1.5 million in the
aggregate outstanding at any one time,
(5) the payment of reasonable fees to directors of dj Orthopedics, Inc. or
the Company and its Subsidiaries who are not employees of dj Orthopedics,
Inc. or the Company or its Subsidiaries and other reasonable fees,
compensation, benefits and indemnities paid or entered into by the Company
or its Restricted Subsidiaries in the ordinary course of business to or
with the officers, directors or employees of the Company and its
Restricted Subsidiaries,
(6) any transaction between the Company and a Restricted Subsidiary or
between Restricted Subsidiaries,
(7) the provision by Persons who may be deemed Affiliates or stockholders
of the Company (other than J.P. Morgan Partners (f/k/a Chase Capital
Partners) and Persons controlled by J.P. Morgan Partners) of investment
banking, commercial banking, trust, lending or financing, investment,
underwriting, placement agent, financial advisory or similar services to
the Company or its Subsidiaries,
(8) sales of Equity Interests to Permitted Holders approved by a majority
of the members of the Governing Board who do not have a material direct or
indirect financial interest in or with respect to the transaction being
considered,
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(9) (A) the existence or performance by the Company or any Restricted
Subsidiary under any agreement as in effect as of the Closing
Date or any amendment thereto or replacement agreement therefor
or any transaction contemplated thereby (including pursuant to
any amendment thereto or replacement agreement therefor) so long
as such amendment or replacement is not more disadvantageous to
the Holders of the notes in any material respect than the
original agreement as in effect on the Closing Date, and
(B) the execution, delivery and performance of the contemplated
agreement among the Company, dj Orthopedics, Inc. and Charles T.
Orsatti described in this prospectus under the heading "Related
party transactions--Other arrangements with JPMDJ Partners and its
affiliates"; provided that the amount payable to Mr. Orsatti
pursuant to such agreement shall not exceed $250,000 per year,
(10) any tax sharing agreement or payments pursuant thereto among the
Company and its Subsidiaries and any other Person with which the Company
or its Subsidiaries is required or permitted to file a consolidated tax
return or with which the Company or any of its Restricted Subsidiaries is
or could be part of a consolidated group for tax purposes, which payments
are not in excess of the tax liabilities attributable solely to the
Company and its Restricted Subsidiaries (as a consolidated group), or
(11) any contribution to the capital of the Company by dj Orthopedics,
Inc. or any purchase of Equity Interests of the Company by
dj Orthopedics, Inc.
SEC REPORTS. Notwithstanding that the Issuers may not be subject to the
reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company
will file with the SEC (if permitted by SEC practice and applicable law and
regulations) and provide the Trustee and Holders and prospective Holders (upon
request) within 15 days after it files them with the SEC (or if not permitted,
within 15 days after it would have otherwise been required to file them with the
SEC), copies of the Company's or dj Orthopedics, Inc.'s annual report and the
information, documents and other reports that are specified in Sections 13 and
15(d) of the Exchange Act. In addition, following an Equity Offering, the
Issuers shall furnish to the Trustee and the Holders, promptly upon their
becoming available, copies of the annual report to equity holders and any other
information provided by the Company or dj Orthopedics, Inc. to its public equity
holders generally. The Issuers also will comply with the other provisions of
Section 314(a) of the TIA.
FUTURE NOTE GUARANTORS. The Company will cause each Domestic Subsidiary to
become a Note Guarantor, and, if applicable, execute and deliver to the Trustee
a supplemental indenture in the form set forth in the indenture pursuant to
which such Domestic Subsidiary will Guarantee payment of the Notes. Each Note
Guarantee will be limited to an amount not to exceed the maximum amount that can
be Guaranteed by that Domestic Subsidiary without rendering the Note Guarantee,
as it relates to such Domestic Subsidiary, void or voidable under applicable law
relating to fraudulent conveyance or fraudulent transfer or similar laws
affecting the rights of creditors generally.
LIMITATION ON LINES OF BUSINESS. The Company will not, and will not permit any
Restricted Subsidiary to, engage in any business, other than a Permitted
Business.
LIMITATION ON THE CONDUCT OF BUSINESS OF DJ CAPITAL. DJ Capital will not
conduct any business or other activities, own any property, enter into any
agreements or Incur any Indebtedness or other liabilities, other than in
connection with serving as an Issuer and obligor with respect to the notes and
its guarantee in respect of the credit facility.
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Merger and consolidation
Neither the Company nor DJ Capital will consolidate with or merge with or into,
or convey, transfer or lease all or substantially all its assets to, any Person;
provided, however, that the Company may consolidate with or merge with or into,
or convey, transfer or lease all or substantially all its assets to, any Person
if:
(1) the resulting, surviving or transferee Person (the "Successor
Company") will be a corporation, partnership or limited liability company
organized and existing under the laws of the United States of America, any
State thereof or the District of Columbia and the Successor Company (if
not the Company) will expressly assume, by a supplemental indenture,
executed and delivered to the Trustee, in form satisfactory to the
Trustee, all the obligations of the Company under the notes and the
indenture;
(2) immediately after giving effect to such transaction (and treating any
Indebtedness which becomes an obligation of the Successor Company or any
Restricted Subsidiary as a result of such transaction as having been
Incurred by the Successor Company or such Restricted Subsidiary at the
time of such transaction), no Default shall have occurred and be
continuing;
(3) immediately after giving effect to such transaction, the Successor
Company would be able to Incur an additional $1.00 of Indebtedness under
paragraph (a) of the covenant described under "--Limitation on
indebtedness"; and
(4) the Company shall have delivered to the Trustee an Officers'
Certificate and an Opinion of Counsel, each stating that such
consolidation, merger or transfer and such supplemental indenture (if any)
comply with the Indenture.
The Successor Company will succeed to, and be substituted for, and may exercise
every right and power of, the Company under the Indenture, but the predecessor
Company in the case of a conveyance, transfer or lease of all or substantially
all its assets will not be released from the obligation to pay the principal of
and interest on the notes.
In addition, the Company will not permit any Note Guarantor (other than dj
Orthopedics, Inc.) to consolidate with or merge with or into, or convey,
transfer or lease all or substantially all of its assets to any Person unless:
(1) the resulting, surviving or transferee Person will be a corporation,
partnership or limited liability company organized and existing under the
laws of the United States of America, any State thereof or the District of
Columbia, and such Person (if not such Note Guarantor) will expressly
assume, by a supplemental indenture, executed and delivered to the
Trustee, in form satisfactory to the Trustee, all the obligations of such
Note Guarantor under its Note Guarantee;
(2) immediately after giving effect to such transaction (and treating any
Indebtedness which becomes an obligation of the resulting, surviving or
transferee Person as a result of such transaction as having been Incurred
by such Person at the time of such transaction), no Default shall have
occurred and be continuing; and
(3) the Company will have delivered to the Trustee an Officers'
Certificate and an Opinion of Counsel, each stating that such
consolidation, merger or transfer and such supplemental indenture (if any)
comply with the Indenture.
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Notwithstanding any of the foregoing:
(A) any Restricted Subsidiary (other than DJ Capital) may
consolidate with, merge into or transfer all or part of its
properties and assets to the Company or a Subsidiary that is a Note
Guarantor, and
(B) the Company may merge with an Affiliate incorporated solely for
- the purpose of incorporating the Company or
- organizing the Company in another jurisdiction to realize
tax or other benefits.
Defaults
Each of the following is an Event of Default:
(1) a default in any payment of interest or liquidated damages on any note
when due and payable, whether or not prohibited by the provisions
described under "Ranking" above, continued for 30 days,
(2) a default in the payment of principal of any note when due and payable
at its Stated Maturity, upon required redemption or repurchase, upon
declaration or otherwise, whether or not such payment is prohibited by the
provisions described under "Ranking" above,
(3) the failure by either Issuer to comply with its obligations under the
covenant described under "Merger and consolidation" above,
(4) the failure by either Issuer to comply for 30 days after written
notice (specifying the default and demanding that the same be remedied)
with any of its obligations under the covenants described under "Change of
control" or "Certain covenants" above (in each case, other than a failure
to purchase notes),
(5) the failure by either Issuer or any Note Guarantor to comply for
60 days after written notice (specifying the default and demanding that
the same be remedied) with its other agreements contained in the notes or
the indenture,
(6) the failure by either Issuer or any Restricted Subsidiary of the
Company to pay any Indebtedness within any applicable grace period after
final maturity or the acceleration of any such Indebtedness by the holders
thereof because of a default if the total amount of such Indebtedness
unpaid or accelerated exceeds $10.0 million or its foreign currency
equivalent (the "cross acceleration provision") and such failure continues
for 10 days after receipt of the notice specified in the indenture,
(7) certain events of bankruptcy, insolvency or reorganization of either
Issuer or a Significant Subsidiary (the "bankruptcy provisions"),
(8) the rendering of any judgment or decree for the payment of money in
excess of $10.0 million (net of any amounts with respect to which a
reputable and creditworthy insurance
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company has acknowledged liability in writing) or its foreign currency
equivalent against the Company, DJ Capital or a Restricted Subsidiary of
the Company if:
(A) an enforcement proceeding thereon is commenced by any creditor
or
(B) such judgment or decree remains outstanding for a period of
60 days following such judgment and is not discharged, waived or
stayed (the "judgment default provision"), or
(9) any Note Guarantee ceases to be in full force and effect (except as
contemplated by the terms thereof) or any Note Guarantor or Person acting
by or on behalf of such Note Guarantor denies or disaffirms such Note
Guarantor's obligations under the Indenture or any Note Guarantee and such
Default continues for 10 days after receipt of the notice specified in the
indenture.
The foregoing will constitute Events of Default whatever the reason for any such
Event of Default and whether it is voluntary or involuntary or is effected by
operation of law or pursuant to any judgment, decree or order of any court or
any order, rule or regulation of any administrative or governmental body.
However, a default under clauses (4), (5), (6) or (9) will not constitute an
Event of Default until the Trustee or the Holders of at least 25% in principal
amount of the outstanding notes notify the Issuers of the default and the
Issuers do not cure such default within the time specified in clauses (4), (5),
(6) or (9) after receipt of such notice.
If an Event of Default (other than an Event of Default relating to certain
events of bankruptcy, insolvency or reorganization of the Company or DJ Capital)
occurs and is continuing, the Trustee or the Holders of at least 25% in
principal amount of the outstanding notes by written notice to the Issuers and
the Trustee specifying the Event of Default and that it is a "notice of
acceleration" may declare the principal of and accrued but unpaid interest and
liquidated damages on all the notes to be due and payable. Upon such a
declaration, such principal and interest and liquidated damages will be due and
payable immediately. If an Event of Default relating to certain events of
bankruptcy, insolvency or reorganization of the Company or DJ Capital occurs,
the principal of and interest and liquidated damages on all the notes will
become immediately due and payable without any declaration or other act on the
part of the Trustee or any Holders. Under certain circumstances, the Holders of
a majority in principal amount of the outstanding notes may rescind any such
acceleration with respect to the notes and its consequences.
Subject to the provisions of the indenture relating to the duties of the
Trustee, in case an Event of Default occurs and is continuing, the Trustee will
be under no obligation to exercise any of the rights or powers under the
Indenture at the request or direction of any of the Holders unless such Holders
have offered to the Trustee reasonable indemnity or security against any loss,
liability or expense. Except to enforce the right to receive payment of
principal, premium (if any) or interest when due, no Holder may pursue any
remedy with respect to the indenture or the notes unless:
(1) such Holder has previously given the Trustee notice that an Event of
Default is continuing,
(2) Holders of at least 25% in principal amount of the outstanding notes
have requested the Trustee in writing to pursue the remedy,
(3) such Holders have offered the Trustee reasonable security or indemnity
against any loss, liability or expense,
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(4) the Trustee has not complied with such request within 60 days after
the receipt of the request and the offer of security or indemnity and
(5) the Holders of a majority in principal amount of the outstanding notes
have not given the Trustee a direction inconsistent with such request
within such 60-day period.
Subject to certain restrictions, the Holders of a majority in principal amount
of the outstanding notes will be given the right to direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee or of
exercising any trust or power conferred on the Trustee. The Trustee, however,
may refuse to follow any direction that conflicts with law or the indenture or
that the Trustee determines is unduly prejudicial to the rights of any other
Holder or that would involve the Trustee in personal liability. Prior to taking
any action under the Indenture, the Trustee will be entitled to indemnification
satisfactory to it in its sole discretion against all losses and expenses caused
by taking or not taking such action.
If a Default occurs and is continuing and is known to the Trustee, the Trustee
must mail to each Holder notice of the Default within the earlier of 90 days
after it occurs or 30 days after it is known to a Trust Officer or written
notice of it is received by the Trustee. Except in the case of a Default in the
payment of principal of, premium (if any) or interest on any note (including
payments pursuant to the redemption provisions of such note), the Trustee may
withhold notice if and so long as a committee of its Trust Officers in good
faith determines that withholding notice is in the interests of the Holders. In
addition, the Issuers will be required to deliver to the Trustee, within
120 days after the end of each fiscal year, a certificate indicating whether the
signers thereof know of any Default that occurred during the previous year. The
Issuers will also be required to deliver to the Trustee, within 30 days after
the occurrence thereof, written notice of any event which would constitute
certain Events of Default, their status and what action the Issuers are taking
or propose to take in respect thereof.
Amendments and waivers
Subject to certain exceptions, the indenture or the notes may be amended with
the written consent of the Holders of a majority in principal amount of the
notes then outstanding and any past default or compliance with any provisions
may be waived with the consent of the Holders of a majority in principal amount
of the notes then outstanding. However, without the consent of each Holder of an
outstanding note affected, no amendment may, among other things:
(1) reduce the amount of notes whose Holders must consent to an amendment,
(2) reduce the rate of or extend the time for payment of interest or any
liquidated damages on any note,
(3) reduce the principal of or extend the Stated Maturity of any note,
(4) reduce the premium payable upon the redemption of any note or change
the time at which any note may be redeemed as described under "Optional
redemption" above,
(5) make any note payable in money other than that stated in the note,
(6) make any change to the subordination provisions of the Indenture that
adversely affects the rights of any Holder,
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(7) impair the right of any Holder to receive payment of principal of, and
interest or any liquidated damages on, such Holder's notes on or after the
due dates therefor or to institute suit for the enforcement of any payment
on or with respect to such Holder's notes,
(8) make any change in the amendment provisions which require each
Holder's consent or in the waiver provisions or
(9) modify the Note Guarantees in any manner adverse to the Holders.
Without the consent of any Holder, the Issuers and Trustee may amend the
indenture to:
(1) cure any ambiguity, omission, defect or inconsistency,
(2) provide for the assumption by a successor corporation of the
obligations of the Company under the Indenture,
(3) provide for uncertificated notes in addition to or in place of
certificated notes (provided that the uncertificated notes are issued in
registered form for purposes of Section 163(f) of the Code, or in a manner
such that the uncertificated notes are described in Section 163(f)(2)(B)
of the Code),
(4) make any change in the subordination provisions of the indenture that
would limit or terminate the benefits available to any holder of Senior
Indebtedness of the Company or DJ Capital (or any representative thereof)
under such subordination provisions,
(5) add additional Guarantees with respect to the notes,
(6) secure the notes,
(7) add to the covenants of the Issuers for the benefit of the Holders or
to surrender any right or power conferred upon the Issuers,
(8) make any change that does not materially and adversely affect the
rights of any Holder, subject to the provisions of the indenture,
(9) provide for the issuance of the notes, or
(10) comply with any requirement of the SEC in connection with the
qualification of the indenture under the TIA.
However, no amendment may be made to the subordination provisions of the
indenture that adversely affects the rights of any holder of Senior Indebtedness
of the Company, DJ Capital or any Note Guarantor then outstanding unless the
holders of such Senior Indebtedness (or any group or representative thereof
authorized to give a consent) consent to such change.
The consent of the Holders will not be necessary to approve the particular form
of any proposed amendment. It will be sufficient if such consent approves the
substance of the proposed amendment.
After an amendment becomes effective, the Issuers are required to mail to
Holders a notice briefly describing such amendment. However, the failure to give
such notice to all Holders, or any defect therein, will not impair or affect the
validity of the amendment.
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Transfer and exchange
Subject to compliance with the restrictions on transfer and exchange set forth
in the Indenture, a Holder will be able to transfer or exchange notes. Upon any
transfer or exchange, the registrar and the Trustee may require a Holder, among
other things, to furnish appropriate endorsements and transfer documents and the
Issuers may require a Holder to pay any taxes required by law or permitted by
the Indenture. The Issuers will not be required to transfer or exchange any note
selected for redemption or to transfer or exchange any note for a period of
15 days prior to a selection of notes to be redeemed. The notes will be issued
in registered form and the Holder will be treated as the owner of such note for
all purposes.
Defeasance
The Issuers may at any time terminate all their obligations under the notes and
the indenture ("legal defeasance"), except for certain obligations, including
those respecting the defeasance trust and obligations to register the transfer
or exchange of the notes, to replace mutilated, destroyed, lost or stolen notes
and to maintain a registrar and paying agent in respect of the notes. In
addition, the Issuers may at any time terminate:
(1) their obligations under the covenants described under "Change of
control" and "Certain covenants",
(2) the operation of the cross acceleration provision, the bankruptcy
provisions with respect to Significant Subsidiaries, the judgment default
provision and the Note Guarantee provision described under "Defaults"
above and the limitations contained in clauses (3) under the first
paragraph of "Merger and consolidation" above ("covenant defeasance").
In the event that the Issuers exercise their legal defeasance option or their
covenant defeasance option, each Note Guarantor will be released from all of its
obligations with respect to its Note Guarantee.
The Issuers may exercise their legal defeasance option notwithstanding their
prior exercise of their covenant defeasance option. If the Issuers exercise
their legal defeasance option, payment of the notes may not be accelerated
because of an Event of Default with respect thereto. If the Issuers exercise
their covenant defeasance option, payment of the notes may not be accelerated
because of an Event of Default specified in clause (4), (6), (7) (with respect
to Significant Subsidiaries only), (8) or (9) under Defaults above or because of
the failure of the Issuers to comply with clause (3) under the first paragraph
of "Merger and consolidation" above.
In order to exercise either defeasance option, the Issuers must irrevocably
deposit in trust (the "defeasance trust") with the Trustee money or U.S.
Government Obligations for the payment of principal, premium (if any) and
interest on the notes to redemption or maturity, as the case may be, and must
comply with certain other conditions, including delivery to the Trustee of an
Opinion of Counsel to the effect that Holders will not recognize income, gain or
loss for Federal income tax purposes as a result of such deposit and defeasance
and will be subject to Federal income tax on the same amounts and in the same
manner and at the same times as would have been the case if such deposit and
defeasance had not occurred (and, in the case of legal defeasance only, such
Opinion of Counsel must be based on a ruling of the Internal Revenue Service or
other change in applicable Federal income tax law).
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Concerning the trustee
The Bank of New York is to be the Trustee under the indenture and has been
appointed by the Issuers as Registrar and Paying Agent with regard to the notes.
Governing law
The indenture and the notes will be governed by, and construed in accordance
with, the laws of the State of New York without giving effect to applicable
principles of conflicts of law to the extent that the application of the law of
another jurisdiction would be required thereby.
Certain definitions
"Additional Assets" means:
(1) any property or assets (other than Indebtedness and Equity Interests)
to be used by the Company or a Restricted Subsidiary in a Permitted
Business or any improvements to any property or assets that are used by
the Company or a Restricted Subsidiary in a Permitted Business;
(2) Equity Interests of a Person that becomes a Restricted Subsidiary as a
result of the acquisition of such Equity Interests by the Company or
another Restricted Subsidiary; or
(3) Equity Interests constituting a minority interest in any Person that
at such time is a Restricted Subsidiary;
provided, however, that any such Restricted Subsidiary described in clauses
(2) or (3) above is primarily engaged in a Permitted Business.
"Affiliate" of any specified Person means any other Person, directly or
indirectly, controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control" when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise; and the terms
"controlling" and "controlled" have meanings correlative to the foregoing. For
purposes of the provisions described under "--Certain covenants--Limitation on
transactions with affiliates" and"--Certain covenants--Limitation on sales of
assets and subsidiary equity interests" only, "Affiliate" shall also mean any
beneficial owner of Equity Interests representing 5% or more of the total voting
power of the Voting Equity Interests (on a fully diluted basis) of dj
Orthopedics, Inc. (or any other direct or indirect parent company of the
Company) or the Company or of rights or warrants to purchase such Voting Equity
Interests (whether or not currently exercisable) and any Person who would be an
Affiliate of any such beneficial owner pursuant to the first sentence hereof.
"Asset Disposition" means any sale, lease (other than an operating lease entered
into in the ordinary course of business), transfer or other disposition (or
series of related sales, leases, transfers or dispositions) by the Company or
any Restricted Subsidiary, including any disposition by means of a merger,
consolidation, or similar transaction (each referred to for the purposes of this
definition as a "disposition"), of:
(1) any Equity Interests of a Restricted Subsidiary (other than directors'
qualifying Equity Interests or Equity Interests required by applicable law
to be held by a Person other than the Company or a Restricted Subsidiary),
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(2) all or substantially all the assets of any division or line of
business of the Company or any Restricted Subsidiary or
(3) any other assets of the Company or any Restricted Subsidiary outside
of the ordinary course of business of the Company or such Restricted
Subsidiary other than, in the case of (1), (2) and (3) above,
(A) a disposition by a Restricted Subsidiary to the Company or by
the Company or a Restricted Subsidiary to a Wholly Owned
Subsidiary,
(B) for purposes of the provisions described under "--Certain
covenants--Limitation on sales of assets and subsidiary equity
interests" only, the making of a Permitted Investment or a
disposition subject to the covenant described under "--Certain
covenants--Limitation on restricted payments",
(C) a disposition of obsolete or worn out property or equipment or
property or equipment that is no longer useful in the conduct of
business of the Company and its Restricted Subsidiaries, and
(D) any other disposition of assets with a fair market value, as
conclusively determined by senior management of the Company in good
faith, of less than $500,000.
"Attributable Debt" in respect of a Sale/Leaseback Transaction means, as at the
time of determination, the present value (discounted at the interest rate borne
by the notes, compounded annually) of the total obligations of the lessee for
rental payments during the remaining term of the lease included in such
Sale/Leaseback Transaction (including any period for which such lease has been
extended).
"Average Life" means, as of the date of determination, with respect to any
Indebtedness or Preferred Equity Interests, the quotient obtained by dividing:
(1) the sum of the products of the numbers of years from the date of
determination to the dates of each successive scheduled principal payment
of such Indebtedness or redemption or similar payment with respect to such
Preferred Equity Interests multiplied by the amount of such payment by
(2) the sum of all such payments.
"Bank Indebtedness" means any and all amounts payable under or in respect of the
Credit Agreement and any Refinancing Indebtedness with respect thereto, as
amended from time to time, including principal, premium (if any), interest
(including interest accruing on or after the filing of any petition in
bankruptcy or for reorganization relating to the Company whether or not a claim
for post-filing interest is allowed in such proceedings), fees, charges,
expenses, reimbursement obligations, guarantees and all other amounts payable
thereunder or in respect thereof.
"Business Day" means each day which is not a Legal Holiday.
"Capitalized Lease Obligations" means an obligation that is required to be
classified and accounted for as a capitalized lease for financial reporting
purposes in accordance with GAAP, and the amount of Indebtedness represented by
such obligation shall be the capitalized amount of such obligation determined in
accordance with GAAP; and the Stated Maturity thereof shall be the date of the
last payment of rent or any other amount due under such lease prior to the first
date upon which such lease may be prepaid by the lessee without payment of a
penalty.
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"Closing Date" means the date of the indenture.
"Code" means the Internal Revenue Code of 1986, as amended.
"Consolidated Coverage Ratio" as of any date of determination means the ratio
of:
(1) the aggregate amount of EBITDA for the period of the most recent four
consecutive fiscal quarters for which financial statements are publicly
available ending prior to the date of such determination to
(2) Consolidated Interest Expense for such four fiscal quarters;
provided, however, that:
(A) if the Company or any Restricted Subsidiary has Incurred any
Indebtedness since the beginning of such period that remains
outstanding on such date of determination or if the transaction
giving rise to the need to calculate the Consolidated Coverage
Ratio is an Incurrence of Indebtedness, EBITDA and Consolidated
Interest Expense for such period shall be calculated after giving
effect on a pro forma basis to such Indebtedness as if such
Indebtedness had been Incurred on the first day of such period and
the discharge of any other Indebtedness repaid, repurchased,
defeased or otherwise discharged with the proceeds of such new
Indebtedness as if such discharge had occurred on the first day of
such period,
(B) if the Company or any Restricted Subsidiary has repaid,
repurchased, defeased or otherwise discharged any Indebtedness
since the beginning of such period or if any Indebtedness is to be
repaid, repurchased, defeased or otherwise discharged (in each case
other than Indebtedness Incurred under any revolving credit
facility unless such Indebtedness has been permanently repaid and
has not been replaced) on the date of the transaction giving rise
to the need to calculate the Consolidated Coverage Ratio, EBITDA
and Consolidated Interest Expense for such period shall be
calculated on a pro forma basis as if such discharge had occurred
on the first day of such period and as if the Company or such
Restricted Subsidiary has not earned the interest income actually
earned during such period in respect of cash or Temporary Cash
Investments used to repay, repurchase, defease or otherwise
discharge such Indebtedness,
(C) if since the beginning of such period the Company or any
Restricted Subsidiary shall have made any Asset Disposition, the
EBITDA for such period shall be reduced by an amount equal to the
EBITDA (if positive) directly attributable to the assets that are
the subject of such Asset Disposition for such period or increased
by an amount equal to the EBITDA (if negative) directly
attributable thereto for such period and Consolidated Interest
Expense for such period shall be reduced by an amount equal to the
Consolidated Interest Expense directly attributable to any
Indebtedness of the Company or any Restricted Subsidiary repaid,
repurchased, defeased or otherwise discharged with respect to the
Company and its continuing Restricted Subsidiaries in connection
with such Asset Disposition for such period (or, if the Equity
Interests of any Restricted Subsidiary are sold, the Consolidated
Interest Expense for such period directly attributable to the
Indebtedness of such Restricted Subsidiary to the extent the
Company and its continuing Restricted Subsidiaries are no longer
liable for such Indebtedness after such sale),
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(D) if since the beginning of such period the Company or any
Restricted Subsidiary (by merger or otherwise) shall have made an
Investment in any Restricted Subsidiary (or any Person that becomes
a Restricted Subsidiary or is merged with and into the Company) or
an acquisition of assets, including any acquisition of assets
occurring in connection with a transaction causing a calculation to
be made hereunder, which constitutes all or substantially all of an
operating unit of a business, EBITDA and Consolidated Interest
Expense for such period shall be calculated after giving pro forma
effect thereto (including the Incurrence of any Indebtedness) as if
such Investment or acquisition occurred on the first day of such
period, and
(E) if since the beginning of such period any Person (that
subsequently became a Restricted Subsidiary or was merged with or
into the Company or any Restricted Subsidiary since the beginning
of such period) shall have made any Asset Disposition or any
Investment or acquisition of assets that would have required an
adjustment pursuant to clause (C) or (D) above if made by the
Company or a Restricted Subsidiary during such period, EBITDA and
Consolidated Interest Expense for such period shall be calculated
after giving pro forma effect thereto as if such Asset Disposition,
Investment or acquisition of assets occurred on the first day of
such period.
For purposes of this definition, whenever pro forma effect is to be given to an
Investment or acquisition of assets, the amount of income or earnings relating
thereto and the amount of Consolidated Interest Expense associated with any
Indebtedness Incurred in connection therewith, the pro forma calculations shall
be determined in good faith by a responsible financial or accounting Officer of
the Company. Any such pro forma calculations may include operating expense
reductions for such period resulting from the acquisition which is being given
pro forma effect that
(a) would be permitted pursuant to Article XI of Regulation S-X under the
Securities Act or
(b) have been realized or for which the steps necessary for realization
have been taken or are reasonably expected to be taken within six months
following any such acquisition, including, but not limited to, the
execution or termination of any contracts, the termination of any
personnel or the closing (or approval by the Governing Board of any
closing) of any facility, as applicable,
provided that, such adjustments are set forth in an Officers' Certificate signed
by the Company's chief financial officer and another Officer which states
- the amount of such adjustment or adjustments,
- that such adjustment or adjustments are based on the reasonable good
faith beliefs of the officers executing such Officers' Certificate at the
time of such execution and
- that any related Incurrence of Indebtedness is permitted pursuant to the
Indenture.
In addition, to the extent not covered by the foregoing, if the Transactions
have occurred in the four quarter period used to determine the Consolidated
Coverage Ratio, then the Consolidated Coverage Ratio shall be determined giving
pro forma effect on the basis given in the offering memorandum dated June 17,
1999 used in connection with the private offering of the old notes to the
Transactions, with all calculations relating thereto to be made at the date of
determination by the Company's chief financial officer, and set forth in an
Officer's Certificate signed by the chief financial officer and another Officer
and meeting the requirements for the Officer's Certificate described in the
preceding sentence.
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If any Indebtedness bears a floating rate of interest and is being given pro
forma effect, the interest expense on such Indebtedness shall be calculated as
if the rate in effect on the date of determination had been the applicable rate
for the entire period (taking into account any Interest Rate Agreement or
Currency Agreement applicable to such Indebtedness if such Interest Rate
Agreement or Currency Agreement has a remaining term as at the date of
determination in excess of 12 months).
"Consolidated Interest Expense" means, for any period, the total interest
expense of the Company and its Consolidated Restricted Subsidiaries (excluding
amortization and write-off of debt issuance costs) plus, to the extent Incurred
by the Company and its Restricted Subsidiaries in such period but not included
in such interest expense:
(1) interest expense attributable to Capitalized Lease Obligations and the
interest expense attributable to leases constituting part of a
Sale/Leaseback Transaction,
(2) amortization of debt discount,
(3) capitalized interest,
(4) non-cash interest expense,
(5) commissions, discounts and other fees and charges attributable to
letters of credit and bankers' acceptance financing,
(6) interest accruing on any Indebtedness of any other Person to the
extent such Indebtedness is Guaranteed by the Company or any Restricted
Subsidiary,
(7) net costs associated with Hedging Obligations (including amortization
of fees),
(8) dividends and distributions in respect of all Disqualified Equity
Interests of the Company and all Preferred Equity Interests of any of the
Subsidiaries of the Company, to the extent held by Persons other than the
Company or a Wholly Owned Subsidiary,
(9) interest Incurred in connection with investments in discontinued
operations and
(10) the cash contributions to any employee equity ownership or
participation plan or similar trust to the extent such contributions are
used by such plan or trust to pay interest or fees to any Person (other
than the Company) in connection with Indebtedness Incurred by such plan or
trust
Notwithstanding anything to the contrary contained herein, commissions,
discounts, yield and other fees and charges Incurred in connection with any
transaction pursuant to which the Company or any Subsidiary of the Company may
sell, convey or otherwise transfer or grant a security interest in any accounts
receivable or related assets shall be included in Consolidated Interest Expense.
"Consolidated Net Income" means, for any period, the net income (loss) of the
Company and its Consolidated Subsidiaries for such period; provided, however,
that there shall not be included in such Consolidated Net Income:
(1) any net income (loss) of any Person (other than the Company) if such
Person is not a Restricted Subsidiary, except that:
(A) subject to the limitations contained in clause (4), (5) and
(6) below, the Company's equity in the net income of any such
Person for such period shall be included in such
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Consolidated Net Income up to the aggregate amount of cash actually
distributed by such Person during such period to the Company or a
Restricted Subsidiary as a dividend or other distribution (subject,
in the case of a dividend or other distribution made to a
Restricted Subsidiary, to the limitations contained in clause
(3) below) and
(B) the Company's equity in a net loss of any such Person for such
period shall be included in determining such Consolidated Net
Income to the extent such loss has been funded with cash from the
Company or a Restricted Subsidiary;
(2) other than for purposes of clauses (D) and (E) of the definition of
Consolidated Coverage Ratio, any net income (or loss) of any Person
acquired by the Company or a Subsidiary in a pooling of interests
transaction for any period prior to the date of such acquisition;
(3) any net income (or loss) of any Restricted Subsidiary if such
Restricted Subsidiary is subject to restrictions, directly or indirectly,
on the payment of dividends or the making of distributions or loans or
intercompany advances by such Restricted Subsidiary, directly or
indirectly, to the Company, except that:
(A) subject to the limitations contained in clause (4), (5) and
(6) below, the Company's equity in the net income of any such
Restricted Subsidiary for such period shall be included in such
Consolidated Net Income up to the aggregate amount of cash actually
distributed, loaned or advanced by such Restricted Subsidiary
during such period to the Company or another Restricted Subsidiary
as a dividend, distribution, loan or advance (subject, in the case
of a dividend, distribution, loan or advance made to another
Restricted Subsidiary, to the limitation contained in this clause)
and
(B) the Company's equity in a net loss of any such Restricted
Subsidiary for such period shall be included in determining such
Consolidated Net Income;
(4) any gain (loss) realized upon the sale or other disposition of any
asset of the Company or its Consolidated Subsidiaries (including pursuant
to any Sale/Leaseback Transaction) that is not sold or otherwise disposed
of in the ordinary course of business and any gain (loss) realized upon
the sale or other disposition of any Equity Interests of any Person;
(5) any extraordinary gain or loss; and
(6) the cumulative effect of a change in accounting principles.
Notwithstanding the foregoing, for the purpose of the covenant described under
"--Certain covenants--Limitation on restricted payments" only, there shall be
excluded from Consolidated Net Income any dividends, repayments of loans or
advances or other transfers of assets from Unrestricted Subsidiaries to the
Company or a Restricted Subsidiary to the extent such dividends, repayments or
transfers increase the amount of Restricted Payments permitted under such
covenant pursuant to clause (a)(4)(C)(v) thereof.
"Consolidation" means the consolidation of the amounts of each of the Restricted
Subsidiaries with those of the Company in accordance with GAAP consistently
applied; provided, however, that "Consolidation" will not include consolidation
of the accounts of any Unrestricted Subsidiary, but the interest of the Company
or any Restricted Subsidiary in an Unrestricted Subsidiary will be accounted for
as an investment. The term "Consolidated" has a correlative meaning.
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"Credit Agreement" means the credit agreement dated as of the Closing Date among
the Company, dj Orthopedics, Inc., as successor for DonJoy, L.L.C., the lenders
named therein, First Union National Bank, as administrative agent, and
collateral agent, and The Chase Manhattan Bank, as syndication agent, in each
case as amended, modified, supplemented, restated, renewed, refunded, replaced,
restructured, repaid or refinanced from time to time (including any agreement
extending the maturity thereof or increasing the amount of available borrowings
thereunder or adding Restricted Subsidiaries of the Company as additional
borrowers or guarantors thereunder) whether with the original agents and lenders
or otherwise and whether provided under the original credit agreement or other
credit agreements or otherwise.
"Currency Agreement" means with respect to any Person any foreign exchange
contract, currency swap agreements or other similar agreement or arrangement to
which such Person is a party or of which it is a beneficiary.
"Default" means any event, which is, or after notice or passage of time or both
would be, an Event of Default.
"Designated Senior Indebtedness" of the Company means
(1) the Bank Indebtedness and
(2) any other Senior Indebtedness of the Company that, at the date of
determination, has an aggregate principal amount outstanding of, or under
which, at the date of determination, the holders thereof are committed to
lend up to at least $15.0 million and is specifically designated by the
Company in the instrument evidencing or governing such Senior Indebtedness
as "Designated Senior Indebtedness" for purposes of the indenture.
"Designated Senior Indebtedness" of DJ Capital or a Note Guarantor has a
correlative meaning.
"Disqualified Equity Interest" means, with respect to any Person, any Equity
Interest of such Person which by its terms (or by the terms of any security into
which it is convertible or for which it is exchangeable or exercisable) or upon
the happening of any event:
(1) matures or is mandatorily redeemable pursuant to a sinking fund
obligation or otherwise,
(2) is convertible or exchangeable for Indebtedness or Disqualified Equity
Interests (excluding Equity Interests convertible or exchangeable solely
at the option of the Company or a Restricted Subsidiary, provided, that
any such conversion or exchange shall be deemed an issuance of
Indebtedness or an issuance of Disqualified Equity Interests, as
applicable) or
(3) is redeemable at the option of the holder thereof, in whole or in
part,
in each case on or prior to 91 days after the Stated Maturity of the notes;
provided, however, that only the portion of the Equity Interests which so
matures or is mandatorily redeemable, is so convertible or exchangeable or is so
redeemable at the option of the holder thereof prior to such date will be deemed
Disqualified Equity Interests; provided, further, any Equity Interests that
would not constitute Disqualified Equity Interests but for provisions thereof
giving holders thereof the right to require such Person to repurchase or redeem
such Equity Interests upon the occurrence of an "asset sale" or "change of
control" shall not constitute Disqualified Equity Interests if the "asset sale"
or change of control provisions applicable to such Equity Interests provide that
such Person may not repurchase or redeem such Equity Interests pursuant to such
provisions unless such Person has first complied with the
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provisions described under "Change of control" and the provisions of the
covenant described under "--Certain covenants--Limitation on sales of assets and
subsidiary equity interests", as applicable; and provided, further that any
class of Equity Interests of such Person that, by its terms, authorizes such
Person to satisfy in full its obligations with respect to payment of dividends
or upon maturity, redemption (pursuant to a sinking fund or otherwise) or
repurchase thereof or other payment obligations or otherwise by delivery of
Equity Interests that are not Disqualified Equity Interests, and that is not
convertible, puttable or exchangeable for Disqualified Equity Interests or
Indebtedness, shall not be deemed Disqualified Equity Interests so long as such
Person satisfies its obligations with respect thereto solely by the delivery of
Equity Interests that are not Disqualified Equity Interests.
"Domestic Subsidiary" means any Restricted Subsidiary of the Company other than
a Foreign Subsidiary.
"EBITDA" for any period means the Consolidated Net Income for such period, plus
the following to the extent deducted in calculating such Consolidated Net
Income:
(1) income tax expense of the Company and its Consolidated Restricted
Subsidiaries,
(2) Consolidated Interest Expense,
(3) depreciation expense of the Company and its Consolidated Restricted
Subsidiaries,
(4) amortization expense of the Company and its Consolidated Restricted
Subsidiaries (excluding amortization expense attributable to a prepaid
cash item that was paid in a prior period), and
(5) other non-cash charges of the Company and its Consolidated Restricted
Subsidiaries (excluding any such non-cash charge to the extent it
represents an accrual of or reserve for cash expenditures in any future
period).
Notwithstanding the foregoing, the provision for taxes based on the income or
profits of, and the depreciation and amortization and non-cash charges of, a
Restricted Subsidiary of the Company shall be added to Consolidated Net Income
to compute EBITDA only to the extent (and in the same proportion) that the net
income (loss) of such Restricted Subsidiary was included in calculating
Consolidated Net Income and only if a corresponding amount would be permitted at
the date of determination to be dividended, loaned or advanced to the Company by
such Restricted Subsidiary without prior approval (that has not been obtained),
pursuant to the terms of its charter and all agreements, instruments, judgments,
decrees, orders, statutes, rules and governmental regulations applicable to such
Restricted Subsidiary or its equity holders.
"Equity Interest" of any Person means any and all shares, interests, rights to
purchase, warrants, options, participations or other equivalents of or interests
in (however designated) equity of such Person, including any Preferred Equity
Interests, but excluding any debt securities convertible into such equity.
"Equity Offering" means any public or private sale of common Equity Interests of
the Company or dj Orthopedics, Inc., as applicable, other than public offerings
with respect to the Company's or dj Orthopedics, Inc.'s common Equity Interests
registered on Form S-8 or other issuances upon exercise of options by employees
of the Company or any of its Restricted Subsidiaries.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Existing Management Stockholders" means each of Leslie H. Cross, Cyril Talbot
III and Michael McBrayer.
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"Foreign Subsidiary" means any Restricted Subsidiary of the Company that is not
organized under the laws of the United States of America or any State thereof or
the District of Columbia.
"GAAP" means generally accepted accounting principles in the United States of
America as in effect as of the Closing Date, including those set forth in:
(1) the opinions and pronouncements of the Accounting Principles Board of
the American Institute of Certified Public Accountants,
(2) statements and pronouncements of the Financial Accounting Standards
Board,
(3) such other statements by such other entities as are approved by a
significant segment of the accounting profession, and
(4) the rules and regulations of the SEC governing the inclusion of
financial statements (including pro forma financial statements) in
periodic reports required to be filed pursuant to Section 13 of the
Exchange Act, including opinions and pronouncements in staff accounting
bulletins and similar written statements from the accounting staff of the
SEC.
All ratios and computations based on GAAP contained in the indenture shall be
computed in conformity with GAAP.
"Governing Board" of the Company or any other Person means, (i) the managing
member or members or any controlling committee of members of the Company or such
Person, for so long as the Company or such Person is a limited liability
company, (ii) the board of directors of the Company or such Person, if the
Company or such Person is a corporation or (iii) any similar governing body.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness of any other Person and any
obligation, direct or indirect, contingent or otherwise, of such Person:
(1) to purchase or pay (or advance or supply funds for the purchase or
payment of) such Indebtedness of such other Person (whether arising by
virtue of partnership arrangements, or by agreement to keep-well, to
purchase assets, goods, securities or services, to take-or-pay, or to
maintain financial statement conditions or otherwise) or
(2) entered into for purposes of assuring in any other manner the obligee
of such Indebtedness of the payment thereof or to protect such obligee
against loss in respect thereof (in whole or in part); provided, however,
that the term "Guarantee" shall not include endorsements for collection or
deposit in the ordinary course of business. The term Guarantee used as a
verb has a corresponding meaning. The term "Guarantor" shall mean any
Person Guaranteeing any obligation.
"Hedging Obligations" of any Person means the obligations of such Person
pursuant to any Interest Rate Agreement or Currency Agreement.
"Holder" means the Person in whose name a note is registered on the Registrar's
books.
"Income Tax Liabilities" means an amount determined by multiplying
(a) (1) all taxable income and gains of the Company for such calendar
year (the "Taxable Amount") minus
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(2) an amount (not to exceed the Taxable Amount for such calendar
year) equal to all losses of the Company in any of the three prior
calendar years that have not been previously subtracted pursuant to
this clause (2) from the Taxable Amount for any prior year by
(b) forty-four percent (44%).
"Incur" means issue, assume, Guarantee, incur or otherwise become liable for;
provided, however, that any Indebtedness or Equity Interests of a Person
existing at the time such Person becomes a Subsidiary (whether by merger,
consolidation, acquisition or otherwise) shall be deemed to be Incurred by such
Person at the time it becomes a Subsidiary. The term "Incurrence" when used as a
noun shall have a correlative meaning.
"Indebtedness" means, with respect to any Person on any date of determination
(without duplication):
(1) the principal of and premium (if any) in respect of indebtedness of
such Person for borrowed money;
(2) the principal of and premium (if any) in respect of obligations of
such Person evidenced by bonds, debentures, notes or other similar
instruments;
(3) all obligations of such Person in respect of letters of credit or
other similar instruments (including reimbursement obligations with
respect thereto);
(4) all obligations of such Person to pay the deferred and unpaid purchase
price of property or services (except Trade Payables and other accrued
liabilities arising in the ordinary course of business which are not
overdue), which purchase price is due more than six months after the date
of placing such property in service or taking delivery and title thereto
or the completion of such services;
(5) all Capitalized Lease Obligations and all Attributable Debt of such
Person;
(6) the amount of all obligations of such Person with respect to the
redemption, repayment or other repurchase of any Disqualified Equity
Interests or, with respect to any Subsidiary of such Person, any Preferred
Equity Interests (but excluding, in each case, any accrued dividends);
(7) all Indebtedness of other Persons secured by a Lien on any asset of
such Person, whether or not such Indebtedness is assumed by such Person;
provided, however, that the amount of Indebtedness of such Person shall be
the lesser of:
(A) the fair market value of such asset at such date of
determination and
(B) the amount of such Indebtedness of such other Persons;
(8) to the extent not otherwise included in this definition, the net
obligations under Hedging Obligations of such Person;
(9) to the extent not otherwise included, the amount then outstanding
(i.e., advanced, and received by, and available for use by, such Person)
under any receivables financing (as set forth in the books and records of
such Person and confirmed by the agent, trustee or other representative of
the institution or group providing such receivables financing); and
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(10) all obligations of the type referred to in clauses (1) through
(9) of other Persons and all dividends of other Persons for the payment of
which, in either case, such Person is responsible or liable, directly or
indirectly, as obligor, guarantor or otherwise, including by means of any
Guarantee.
The amount of Indebtedness of any Person at any date shall be the outstanding
balance at such date of all unconditional obligations as described above and the
maximum liability, upon the occurrence of the contingency giving rise to the
obligation, of any contingent obligations at such date.
"Interest Rate Agreement" means with respect to any Person any interest rate
protection agreement, interest rate future agreement, interest rate option
agreement, interest rate swap agreement, interest rate cap agreement, interest
rate collar agreement, interest rate hedge agreement or other similar agreement
or arrangement as to which such Person is party or a beneficiary.
"Investment" in any Person means any direct or indirect advance, loan (other
than advances to customers in the ordinary course of business that are recorded
as accounts receivable on the balance sheet of the lender) or other extension of
credit (including by way of Guarantee or similar arrangement) or capital
contribution to (by means of any transfer of cash or other property to others or
any payment for property or services for the account or use of others), or any
purchase or acquisition of Equity Interests, Indebtedness or other similar
instruments issued by such Person. For purposes of the definition of
Unrestricted Subsidiary and the covenant described under "--Certain
Covenants--Limitation on Restricted Payments":
(1) "Investment" shall include the portion (proportionate to the Company's
equity interest in such Subsidiary) of the fair market value of the net
assets of any Subsidiary of the Company at the time that such Subsidiary
is designated an Unrestricted Subsidiary; provided, however, that upon a
redesignation of such Subsidiary as a Restricted Subsidiary, the Company
shall be deemed to continue to have a permanent "Investment" in an
Unrestricted Subsidiary in an amount (if positive) equal to:
(A) the Company's "Investment" in such Subsidiary at the time of
such redesignation less
(B) the portion (proportionate to the Company's equity interest in
such Subsidiary) of the fair market value of the net assets of such
Subsidiary at the time of such redesignation; and
(2) any property transferred to or from an Unrestricted Subsidiary shall
be valued at its fair market value at the time of such transfer,
in each case as determined in good faith by
- the senior management of the Company if the amount thereof is less than
$1.0 million and
- the Governing Board if in excess thereof.
"Legal Holiday" means a Saturday, Sunday or other day on which banking
institutions in New York State are authorized or required by law to close.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including any conditional sale or other title retention
agreement or lease in the nature thereof).
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"Members' Agreement" means the Members' Agreement among DonJoy, L.L.C, J.P.
Morgan DJ Partners, LLC (f/k/a Chase DJ Partners, LLC), First Union
Investors, Inc., Leslie H. Cross, Cyril Talbot III and Michael R. McBrayer, as
such agreement shall be in effect on the Closing Date and any amendments,
modifications, supplements or waivers thereto (collectively, "amendments"),
other than any such amendment to the provisions thereof relating to the election
or appointment of members of the Governing Board of the Company or DonJoy,
L.L.C., that are materially adverse to the Holders of the notes.
"Net Available Cash" from an Asset Disposition means cash payments received
(including any cash payments received by way of deferred payment of principal
pursuant to a note or installment receivable or otherwise and proceeds from the
sale or other disposition of any securities received as consideration, but only
as and when received, but excluding any other consideration received in the form
of assumption by the acquiring Person of Indebtedness or other obligations
relating to the properties or assets that are the subject of such Asset
Disposition or received in any other non-cash form) therefrom, in each case net
of:
(1) all legal, accounting, investment banking, title and recording tax
expenses, commissions and other fees and expenses incurred, and all
Federal, state, provincial, foreign and local taxes required to be paid or
accrued as a liability under GAAP, as a consequence of such Asset
Disposition,
(2) all payments made on any Indebtedness which is secured by any assets
subject to such Asset Disposition, in accordance with the terms of any
Lien upon or other security agreement of any kind with respect to such
assets, or which must by its terms, or in order to obtain a necessary
consent to such Asset Disposition, or by applicable law be repaid out of
the proceeds from such Asset Disposition,
(3) all distributions and other payments required to be made to minority
interest holders in Subsidiaries or joint ventures as a result of such
Asset Disposition and
(4) appropriate amounts to be provided by the seller as a reserve, in
accordance with GAAP, against any liabilities associated with the property
or other assets disposed of in such Asset Disposition and retained by the
Company or any Restricted Subsidiary after such Asset Disposition.
"Net Cash Proceeds", with respect to any issuance or sale of Equity Interests,
means the cash proceeds of such issuance or sale net of attorneys' fees,
accountants' fees, underwriters' or placement agents' fees, discounts or
commissions and brokerage, consultant and other fees and expenses actually
incurred in connection with such issuance or sale and net of taxes paid or
payable as a result thereof.
"Note Guarantee" means each Guarantee of the obligations with respect to the
notes issued by a Person pursuant to the terms of the indenture. Each such Note
Guarantee will have subordination provisions equivalent to those contained in
the indenture and will be substantially in the form prescribed in the indenture.
"Note Guarantor" means any Person that has issued a Note Guarantee.
"Officer" of either Issuer, as the case may be, means the Chairman of the Board,
the Chief Executive Officer, the Chief Financial Officer, the President, any
Vice President, the Treasurer or the Secretary of such Issuer.
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"Officers' Certificate" of either Issuer, as the case may be, means a
certificate signed by two Officers of such Issuer.
"Opinion of Counsel" means a written opinion from legal counsel who is
acceptable to the Trustee. The counsel may be an employee of or counsel to the
Company or the Trustee.
"Permitted Business" means the design, manufacture and/or marketing of
orthopedic products, devices, accessories or services, other medical products,
devices, accessories or services or any businesses that are reasonably related,
ancillary or complementary thereto.
"Permitted Holders" means each of
(1) J.P. Morgan Partners, LLC (the successor of Chase Capital Partners)
and its Affiliates,
(2) J.P. Morgan DJ Partners (f/k/a Chase DJ Partners, LLC) and its
Affiliates,
(3) First Union Capital Corporation and its Affiliates,
(4) J.P. Morgan Fairfield Partners, LLC (f/k/a Fairfield Chase Medical
Partners, LLC) and its Affiliates,
(5) Charles T. Orsatti and his Related Parties,
(6) the Existing Management Stockholders and their Related Parties and
(7) any Person acting in the capacity of an underwriter in connection with
a public or private offering of the Company's or dj Orthopedics, Inc.'s
Equity Interests.
"Permitted Investment" means an Investment by the Company or any Restricted
Subsidiary in:
(1) the Company, a Restricted Subsidiary or a Person that will, upon the
making of such Investment, become a Restricted Subsidiary; provided,
however, that the primary business of such Restricted Subsidiary is a
Permitted Business;
(2) another Person if as a result of such Investment such other Person is
merged or consolidated with or into, or transfers or conveys all or
substantially all its assets to, the Company or a Restricted Subsidiary
(other than DJ Capital); provided, however, that such Person's primary
business is a Permitted Business;
(3) Temporary Cash Investments;
(4) receivables owing to the Company or any Restricted Subsidiary (other
than DJ Capital) if created or acquired in the ordinary course of business
and payable or dischargeable in accordance with customary trade terms;
provided, however, that such trade terms may include such concessionary
trade terms as the Company or any such Restricted Subsidiary deems
reasonable under the circumstances;
(5) payroll, travel and similar advances to cover matters that are
expected at the time of such advances ultimately to be treated as expenses
for accounting purposes and that are made in the ordinary course of
business;
(6) loans or advances to officers, directors, consultants or employees
made in the ordinary course of business and not exceeding $1.5 million in
the aggregate outstanding at any one time;
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(7) Equity Interests, obligations or securities received in settlement of
debts created in the ordinary course of business and owing to the Company
or any Restricted Subsidiary or in satisfaction of judgments or pursuant
to any plan of reorganization or similar arrangement upon the bankruptcy
or insolvency of a debtor;
(8) any Person to the extent such Investment represents the non-cash
portion of the consideration received for an Asset Disposition that was
made pursuant to and in compliance with the covenant described under
"--Certain covenants--Limitation on sale of assets and subsidiary equity
interests";
(9) Hedging Obligations entered into in the ordinary course of business;
(10) endorsements of negotiable instruments and documents in the ordinary
course of business;
(11) assets or Equity Interests of a Person acquired by the Company or a
Restricted Subsidiary to the extent the consideration for such acquisition
consists of Equity Interests (other than Disqualified Equity Interests) of
the Company or dj Orthopedics, Inc.;
(12) Investments in existence on the Closing Date;
(13) Investments of a Person or any of its Subsidiaries existing at the
time such Person becomes a Restricted Subsidiary of the Company or at the
time such Person merges or consolidates with the Company or any of its
Restricted Subsidiaries, in either case in compliance with the Indenture,
provided that such Investments were not made by such Person in connection
with, or in anticipation or contemplation of, such Person becoming a
Restricted Subsidiary of the Company or such merger or consolidation; and
(14) additional Investments having an aggregate fair market value (as
determined in good faith by (i) senior management of the Company if such
fair market value is less than $1.0 million or (ii) by the Governing Board
of the Company if in excess thereof), taken together with all other
Investments made pursuant to this clause (14) that are at the time
outstanding, not to exceed the greater of 10% of Total Assets or
$10.0 million at the time of such Investment (with the fair market value
of each Investment being measured at the time made and without giving
effect to subsequent changes in value).
"Person" means any individual, corporation, partnership, limited liability
company, joint venture, association, joint-stock company, trust, unincorporated
organization, government or any agency or political subdivision thereof or any
other entity.
"Preferred Equity Interests", as applied to the Equity Interests of any Person,
means Equity Interests of any class or classes (however designated) that are
preferred as to the payment of dividends, or as to the distribution of assets
upon any voluntary or involuntary liquidation or dissolution of such Person,
over Equity Interests of any other class of such Person.
"principal" of a note means the principal of the note plus the premium, if any,
payable on the note which is due or overdue or is to become due at the relevant
time.
"Refinance" means, in respect of any Indebtedness, to refinance, extend, renew,
refund, repay, prepay, redeem, defease or retire, or to issue other Indebtedness
exchange or replacement for, such Indebtedness. "Refinanced" and "Refinancing"
shall have correlative meanings.
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"Refinancing Indebtedness" means Indebtedness that is Incurred to refund,
refinance, replace, renew, repay or extend (including pursuant to any defeasance
or discharge mechanism) any Indebtedness of the Company or any Restricted
Subsidiary existing on the Closing Date or Incurred in compliance with the
indenture (including Indebtedness of the Company or a Restricted Subsidiary that
Refinances Refinancing Indebtedness); provided, however, that:
(1) the Refinancing Indebtedness has a Stated Maturity no earlier than the
Stated Maturity of the Indebtedness being Refinanced,
(2) the Refinancing Indebtedness has an Average Life at the time such
Refinancing Indebtedness is Incurred that is equal to or greater than the
Average Life of the Indebtedness being refinanced,
(3) such Refinancing Indebtedness is Incurred in an aggregate principal
amount (or if issued with original issue discount, an aggregate issue
price) (whether in U.S. dollars or a foreign currency) that is equal to or
less than the aggregate principal amount (or if issued with original issue
discount, the aggregate accreted value) (in U.S. dollars or such foreign
currency, as applicable) then outstanding (plus, without duplication,
accrued interest, fees and expenses, including premium and defeasance
costs) of the Indebtedness being Refinanced and
(4) if the Indebtedness being Refinanced is subordinated in right of
payment to the notes or a Note Guarantee of a Note Guarantor, such
Refinancing Indebtedness is subordinated in right of payment to the notes
or the Note Guarantee at least to the same extent as the Indebtedness
being Refinanced;
provided further, however, that Refinancing Indebtedness shall not include:
(A) Indebtedness of a Restricted Subsidiary that is not a Note
Guarantor that Refinances Indebtedness of the Company or
(B) Indebtedness of the Company or a Restricted Subsidiary that
Refinances Indebtedness of an Unrestricted Subsidiary.
"Related Parties" means with respect to a Person that is a natural person
(a) (1) any spouse, parent or lineal descendant of such Person or
(2) the estate of such Person during any period in which such
estate holds Equity Interests of dj Orthopedics, Inc. or
the Company for the benefit of any person referred to in
clause (a)(1) and
(b) any trust, corporation, partnership or other entity, the
beneficiaries, stockholders, partners, owners or Persons
beneficially owning an interest of more than 50% of which consist
of such Person and/or such other Persons referred to in the
immediately preceding clause (a).
"Representative" means the trustee, agent or representative (if any) for an
issue of Senior Indebtedness.
"Restricted Investment" means any Investment other than a Permitted Investment.
"Restricted Subsidiary" means DJ Capital and any other Subsidiary of the Company
other than an Unrestricted Subsidiary.
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"Sale/Leaseback Transaction" means an arrangement relating to property now owned
or hereafter acquired by the Company or a Restricted Subsidiary whereby the
Company or a Restricted Subsidiary transfers such property to a Person and the
Company or such Restricted Subsidiary leases it from such Person, other than
leases between the Company and a Wholly Owned Subsidiary or between Wholly Owned
Subsidiaries.
"SEC" means the Securities and Exchange Commission.
"Secured Indebtedness" means any Indebtedness of the Company or DJ Capital
secured by a Lien. "Secured Indebtedness" of a Note Guarantor has a correlative
meaning.
"Senior Subordinated Indebtedness" of the Company means the notes and any other
Indebtedness of the Company that specifically provides that such Indebtedness is
to rank PARI PASSU with the notes in right of payment and is not subordinated by
its terms in right of payment to any Indebtedness or other obligation of the
Company which is not Senior Indebtedness. "Senior Subordinated Indebtedness" of
DJ Capital or a Note Guarantor has a correlative meaning.
"Significant Subsidiary" means any Restricted Subsidiary that would be a
Significant Subsidiary of the Company within the meaning of Rule 1-02 under
Regulation S-X promulgated by the SEC.
"Stated Maturity" means, with respect to any security, the date specified in
such security as the fixed date on which the final payment of principal of such
security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency beyond the control of the issuer unless such contingency has
occurred).
"Subordinated Obligation" means any Indebtedness of the Company (whether
outstanding on the Closing Date or thereafter Incurred) that is subordinate or
junior in right of payment to the notes pursuant to a written agreement.
"Subordinated Obligation" of DJ Capital or a Note Guarantor has a correlative
meaning.
"Subsidiary" of any Person means any corporation, association, partnership,
limited liability company or other business entity of which more than 50% of the
total voting power of Equity Interests (including partnership interests)
entitled (without regard to the occurrence of any contingency) to vote in the
election of directors, representatives, managers or trustees thereof is at the
time owned or controlled, directly or indirectly, by:
(1) such Person,
(2) such Person and one or more Subsidiaries of such Person or
(3) one or more Subsidiaries of such Person.
"Tax Distribution" means any distribution by the Company to its members which
(1) with respect to quarterly estimated tax payments due in each calendar
year, shall be equal to twenty-five percent (25%) of the Income Tax
Liabilities for such calendar year as estimated in writing by the chief
financial officer of the Company and
(2) with respect to tax payments to be made with income tax returns filed
for a full calendar year or with respect to adjustments to such returns
imposed by the Internal Revenue Service or other taxing authority, shall
be equal to the Income Tax Liabilities for each calendar year minus the
aggregate amount distributed for such calendar year as provided in clause
(1) above.
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In the event the amount determined under clause (2) is a negative amount, the
amount of any Tax Distributions in the succeeding calendar year (or, if
necessary, any subsequent calendar years) shall be reduced by such negative
amount.
"Temporary Cash Investments" means any of the following:
(1) any investment in direct obligations of the United States of America
or any agency or instrumentality thereof or obligations Guaranteed or
insured by the United States of America or any agency or instrumentally
thereof,
(2) investments in checking accounts, savings accounts, time deposit
accounts, certificates of deposit, bankers' acceptances and money market
deposits maturing within 180 days of the date of acquisition thereof
issued by a bank or trust company that is organized under the laws of the
United States of America, any state thereof or any foreign country
recognized by the United States of America having capital, surplus and
undivided profits aggregating in excess of $250,000,000 (or the foreign
currency equivalent thereof) and whose long-term debt is rated "A" (or
such similar equivalent rating) or higher by at least one nationally
recognized statistical rating organization (as defined in Rule 436 under
the Securities Act),
(3) repurchase obligations with a term of not more than 30 days for
underlying securities of the types described in clause (1) above entered
into with a bank meeting the qualifications described in clause (2) above,
(4) investments in commercial paper, maturing not more than 270 days after
the date of acquisition, issued by a corporation (other than an Affiliate
of the Company) organized and in existence under the laws of the United
States of America or any foreign country recognized by the United States
of America with a rating at the time as of which any investment therein is
made of "P-1" (or higher) according to Moody's Investors Service, Inc. or
"A-1" (or higher) according to Standard and Poor's Ratings Service, a
division of The McGraw-Hill Companies, Inc. ("S&P"),
(5) investments in securities with maturities of six months or less from
the date of acquisition issued or fully guaranteed by any state,
commonwealth or territory of the United States of America, or by any
political subdivision or taxing authority thereof, and rated at least "A"
by S&P or "A" by Moody's Investors Service, Inc., and
(6) investments in money market funds that invest substantially all of
their assets in securities of the types described in clauses (1) through
(5) above.
"TIA" means the Trust Indenture Act of 1939 (15 U.S.C. sec.sec.77aaa-77bbbb) as
in effect on the Closing Date.
"Total Assets" means the total consolidated assets of the Company and its
Restricted Subsidiaries, as shown on the most recent balance sheet of the
Company.
"Trade Payables" means, with respect to any Person, any accounts payable or any
indebtedness or monetary obligation to trade creditors created, assumed or
Guaranteed by such Person arising in the ordinary course of business in
connection with the acquisition of goods or services.
"Transactions" has the meaning specified in the offering memorandum dated
June 17, 1999 used in connection with the private offering of the old notes.
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"Trustee" means the party named as such in the Indenture until a successor
replaces it and, thereafter, means the successor.
"Trust Officer" means the Chairman of the Board, the President or any other
officer or assistant officer of the Trustee assigned by the Trustee to
administer its corporate trust matters.
"Unrestricted Subsidiary" means:
(1) any Subsidiary of the Company that at the time of determination shall
be designated an Unrestricted Subsidiary by the Governing Board in the
manner provided below and
(2) any Subsidiary of an Unrestricted Subsidiary.
The Governing Board may designate any Subsidiary of the Company (including any
newly acquired or newly formed Subsidiary of the Company), other than DJ
Capital, to be an Unrestricted Subsidiary unless such Subsidiary or any of its
Subsidiaries owns any Equity Interests in or Indebtedness of, or owns or holds
any Lien on any property of, the Company or any other Subsidiary of the Company
that is not a Subsidiary of the Subsidiary to be so designated; provided,
however, that either:
- the Subsidiary to be so designated has total Consolidated assets of
$1,000 or less or
- if such Subsidiary has Consolidated assets greater than $1,000, then
such designation would be permitted under the covenant entitled
"Limitation on restricted payments".
The Governing Board may designate any Unrestricted Subsidiary to be a Restricted
Subsidiary; provided, however, that immediately after giving effect to such
designation:
- the Company could Incur $1.00 of additional Indebtedness under paragraph
(a) of the covenant described under "--Certain covenants--Limitation on
indebtedness" and
- no Default shall have occurred and be continuing.
Any such designation of a Subsidiary as a Restricted Subsidiary or Unrestricted
Subsidiary by the Governing Board shall be evidenced to the Trustee by promptly
filing with the Trustee a copy of the resolution of the Governing Board giving
effect to such designation and an Officers' Certificate certifying that such
designation complied with the foregoing provisions.
"U.S. Government Obligations" means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States of
America (including any agency or instrumentality thereof) for the payment of
which the full faith and credit of the United States of America is pledged and
which are not callable or redeemable at the issuer's option.
"Voting Equity Interests" of a Person means the Equity Interests in a
corporation or other Person with voting power under ordinary circumstances
(without regard to the occurrence of any contingency) entitling the holders
thereof to elect or appoint the board of managers, board of directors, executive
committee, management committee or other governing body of such corporation or
Person.
"Wholly Owned Subsidiary" means a Restricted Subsidiary of the Company all the
Equity Interests of which (other than directors' qualifying Equity Interests)
are owned by the Company or another Wholly Owned Subsidiary.
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Book-entry; delivery and form
The notes will initially be represented by one or more permanent global notes in
definitive, fully registered book-entry form, without interest coupons that will
be deposited with, or on behalf of, DTC and registered in the name of DTC or its
nominee, on behalf of the acquirers of notes represented thereby for credit to
the respective accounts of the acquirers, or to such other accounts as they may
direct, at DTC, or Euroclear Bank S.A./N.V., or Cedel Bank, societe anonyme.
Except as set forth below, the global notes may be transferred, in whole and not
in part, solely to another nominee of DTC or to a successor of DTC or its
nominee. Beneficial interests in the global notes may not be exchanged for notes
in physical, certificated form except in the limited circumstances described
below.
All interests in the global notes, including those held through Euroclear or
Cedel, may be subject to the procedures and requirements of DTC. Those interests
held through Euroclear or Cedel may also be subject to the procedures and
requirements of such systems.
Certain book-entry procedures for the global notes
The descriptions of the operations and procedures of DTC, Euroclear and Cedel
set forth below are provided solely as a matter of convenience. These operations
and procedures are solely within the control of the respective settlement
systems and are subject to change by them from time to time. Neither the Issuers
nor dj Orthopedics, Inc. takes any responsibility for these operations or
procedures, and investors are urged to contact the relevant system or its
participants directly to discuss these matters.
DTC has advised the Issuers and dj Orthopedics, Inc. that it is
(1) a limited purpose trust company organized under the laws of the State
of New York,
(2) a "banking organization" within the meaning of the New York Banking
Law,
(3) a member of the Federal Reserve System,
(4) a "clearing corporation" within the meaning of the Uniform Commercial
Code, as amended, and
(5) a "clearing agency" registered pursuant to Section 17A of the Exchange
Act.
DTC was created to hold securities for its participants and facilitates the
clearance and settlement of securities transactions between participants through
electronic book-entry changes to the accounts of its participants, thereby
eliminating the need for physical transfer and delivery of certificates. DTC's
participants include securities brokers and dealers, banks and trust companies,
clearing corporations and certain other organizations. Indirect access to DTC's
system is also available to other entities such as banks, brokers, dealers and
trust companies that clear through or maintain a custodial relationship with a
participant, either directly or indirectly. Investors who are not participants
may beneficially own securities held by or on behalf of DTC only through
participants or indirect participants.
The Issuers and dj Orthopedics, Inc. expect that pursuant to procedures
established by DTC ownership of the notes will be shown on, and the transfer of
ownership thereof will be effected only through,
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records maintained by DTC (with respect to the interests of participants) and
the records of participants and the indirect participants (with respect to the
interests of persons other than participants).
The laws of some jurisdictions may require that certain purchasers of securities
take physical delivery of such securities in definitive form. Accordingly, the
ability to transfer interests in the notes represented by a global note to such
persons may be limited. In addition, because DTC can act only on behalf of its
participants, who in turn act on behalf of persons who hold interests through
participants, the ability of a person having an interest in notes represented by
a global note to pledge or transfer such interest to persons or entities that do
not participate in DTC's system, or to otherwise take actions in respect of such
interest, may be affected by the lack of a physical definitive security in
respect of such interest.
So long as DTC or its nominee is the registered owner of a global note, DTC or
such nominee, as the case may be, will be considered the sole owner or holder of
the notes represented by the global note for all purposes under the indenture.
Except as provided below, owners of beneficial interests in a global note
- will not be entitled to have notes represented by such global note
registered in their names,
- will not receive or be entitled to receive physical delivery of
certificated notes, and
- will not be considered the owners or holders thereof under the indenture
for any purpose, including with respect to the giving of any direction,
instruction or approval to the trustee thereunder.
Accordingly, each holder owning a beneficial interest in a global note must rely
on the procedures of DTC and, if such holder is not a participant or an indirect
participant, on the procedures of the participant through which such holder owns
its interest, to exercise any rights of a holder of notes under the indenture or
such global note. The Company understands that under existing industry practice,
in the event that the Company requests any action of holders of notes, or a
holder that is an owner of a beneficial interest in a global note desires to
take any action that DTC, as the holder of such global note, is entitled to
take, DTC would authorize the participants to take such action and the
participants would authorize holders owning through such participants to take
such action or would otherwise act upon the instruction of such holders. Neither
the Issuers, dj Orthopedics, Inc. nor the trustee will have any responsibility
or liability for any aspect of the records relating to or payments made on
account of notes by DTC, or for maintaining, supervising or reviewing any
records of DTC relating to such notes.
Payments with respect to the principal of, and premium, if any, and interest on,
any notes represented by a global note registered in the name of DTC or its
nominee on the applicable record date will be payable by the trustee to or at
the direction of DTC or its nominee in its capacity as the registered holder of
the global note representing the notes under the indenture. Under the terms of
the indenture, the Issuers, dj Orthopedics, Inc. and the trustee may treat the
persons in whose names the notes, including the global notes, are registered as
the owners thereof for the purpose of receiving payment thereon and for any and
all other purposes whatsoever. Accordingly, neither the Issuers, dj Orthopedics,
Inc. nor the trustee has or will have any responsibility or liability for the
payment of such amounts to owners of beneficial interests in a global note
(including principal, premium, if any, liquidated damages, if any, and
interest). Payments by the participants and the indirect participants to the
owners of beneficial interests in a global note will be governed by standing
instructions and customary industry practice and will be the responsibility of
the participants or the indirect participants and DTC.
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Transfers between participants in DTC will be effected in accordance with DTC's
procedures, and will be settled in same-day funds. Transfers between
participants in Euroclear or Cedel will be effected in the ordinary way in
accordance with their respective rules and operating procedures.
Cross-market transfers between the participants in DTC, on the one hand, and
Euroclear or Cedel participants, on the other hand, will be effected through DTC
in accordance with DTC's rules on behalf of Euroclear or Cedel, as the case may
be, by its respective depositary; however, such cross-market transactions will
require delivery of instructions to Euroclear or Cedel, as the case may be, by
the counterpart in such system in accordance with the rules and procedures and
within the established deadlines (Brussels time) of such system. Euroclear or
Cedel, as the case may be, will, if the transaction meets its settlement
requirements, deliver instructions to its respective depositary to take action
to effect final settlement on its behalf by delivering or receiving interests in
the relevant global notes in DTC, and making or receiving payment in accordance
with normal procedures for same-day funds settlement applicable to DTC.
Euroclear participants and Cedel participants may not deliver instructions
directly to the depositaries for Euroclear or Cedel.
Because of time zone differences, the securities account of a Euroclear or Cedel
participant purchasing an interest in a global note from a participant in DTC
will be credited, and any such crediting will be reported to the relevant
Euroclear or Cedel participant, during the securities settlement processing day
(which must be a business day for Euroclear and Cedel) immediately following the
settlement date of DTC. Cash received in Euroclear or Cedel as a result of sales
of interest in a global note by or through a Euroclear or Cedel participant to a
participant in DTC will be received with value on the settlement date of DTC but
will be available in the relevant Euroclear or Cedel cash account only as of the
business day for Euroclear or Cedel following DTC's settlement date.
Although DTC, Euroclear and Cedel have agreed to the foregoing procedures to
facilitate transfers of interests in the global notes among participants in DTC,
Euroclear and Cedel, they are under no obligation to perform or to continue to
perform such procedures, and such procedures may be discontinued at any time.
Neither the Issuers, dj Orthopedics, Inc. nor the trustee will have any
responsibility for the performance by DTC, Euroclear or Cedel or their
respective participants or indirect participants of their respective obligations
under the rules and procedures governing their operations.
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Certificated notes
If
- the Company notifies the trustee in writing that DTC is no longer
willing or able to act as a depositary or DTC ceases to be registered as a
clearing agency under the Exchange Act and a successor depositary is not
appointed within 90 days of such notice or cessation,
- the Company, at its option, notifies the trustee in writing that it
elects to cause the issuance of notes in definitive form under the
indenture or
- upon the occurrence of certain other events as provided in the
indenture,
then, upon surrender by DTC of the global notes, certificated notes will be
issued to each person that DTC identifies as the beneficial owner of the notes
represented by the global notes. Upon any such issuance, the trustee is required
to register such certificated notes in the name of such person or persons (or
the nominee of any thereof) and cause the same to be delivered thereto.
Neither the Issuers, dj Orthopedics, Inc. nor the trustee shall be liable for
any delay by DTC or any participant or indirect participant in identifying the
beneficial owners of the related notes and each such person may conclusively
rely on, and shall be protected in relying on, instructions from DTC for all
purposes (including with respect to the registration and delivery, and the
respective principal amounts, of the notes to be issued).
Plan of distribution
This prospectus has been prepared for use by JPMSI in connection with offers and
sales of the notes in market-making transactions effected from time to time.
JPMSI may act as a principal or agent in these transactions, including as agent
for the counterparty when acting as principal or as agent for both parties, and
may receive compensation in the form of discounts and commissions, including
from both counterparties when it acts as agent for both. These sales will be
made at prevailing market prices at the time of sale, at prices related thereto
or at negotiated prices. The Issuers will not receive any of the proceeds of
these sales. The Issuers have agreed to indemnify JPMSI against certain
liabilities, including liabilities under the Securities Act, and to contribute
payments which JPMSI might be required to make in respect thereof.
As of the date of this prospectus, affiliates of JPMSI own approximately 45.7%
of the common stock of dj Orthopedics, Inc. JPMSI has informed the Issuers that
it does not intend to confirm sales of the notes to any accounts over which it
exercises discretionary authority without the prior specific written approval of
these transactions by the customer.
The Issuers have been advised by JPMSI that, subject to applicable laws and
regulations, JPMSI currently intends to make a market in the notes. However,
JPMSI is not obligated to do so and any such market making may be interrupted or
discontinued at any time without notice. In addition, such market-making
activity will be subject to the limits imposed by the Securities Act and the
Exchange Act. There can be no assurance that an active trading market will
develop or be sustained. See "Risk factors--Risks related to the trading market
for the notes--You cannot be sure that an active trading market will develop for
the notes.
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Legal matters
The validity of the notes offered hereby and the guarantee of dj Orthopedics,
Inc. has been passed upon for the Issuers and dj Orthopedics, Inc. by O'Sullivan
LLP, New York, New York.
Experts
The consolidated financial statements of DonJoy, L.L.C. at December 31, 2000 and
1999 and for each of the three years in the period ended December 31, 2000
appearing in this prospectus have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such report given on the authority of such firm as
experts in accounting and auditing.
The (i) combined balance sheets as of December 31, 1999 and 1998, and the
related combined statements of operations and changes in invested equity, and
combined statements of cash flows for the year ended December 31, 1999 and for
the period October 29, 1998 through December 31, 1998 of DePuy Orthopaedic
Technology, Inc., an integrated operation of DePuy, Inc., which is a
wholly-owned subsidiary of Johnson & Johnson; (ii) statements of operations and
changes in invested equity, and statements of cash flows for the period
January 1, 1998 through October 28, 1998 and for the year ended December 31,
1997 of DePuy Orthopaedic Technology, Inc., an integrated operation of
DePuy, Inc.; and (iii) historical statements of revenues and expenses of the
Bracing and Soft Supports Business of Johnson & Johnson, an integrated operation
of Johnson & Johnson, for the period January 1, 1998 through October 28, 1998
and for the year ended December 31, 1997, appearing herein have been so included
in reliance on the report of PricewaterhouseCoopers LLP, independent
accountants, given on the authority of said firm as experts in auditing and
accounting.
Additional information
We have filed a registration statement on Form S-1 under the Securities Act to
register with the SEC the notes offered by this prospectus. The term
registration statement means the original registration statement and any and all
amendments, including the schedules and exhibits to the original registration
statement and any amendments. This prospectus is part of that registration
statement. This prospectus does not contain all of the information set forth in
the registration statement or the exhibits to the registration statement.
dj Orthopedics, Inc. is subject to the information and reporting requirements of
the Securities Exchange Act of 1934, as amended, and, in accordance with those
requirements, will file periodic reports, proxy statements and other information
with the SEC. From the date of the recapitalization through the date of the
reorganization, DonJoy, L.L.C. filed periodic reports with the SEC but was not
subject to the SEC's proxy rules. The SEC filings of dj Orthopedics, Inc. and
DonJoy, L.L.C. are available over the Internet at the SEC's web site at
http://www.sec.gov. You may also read and copy any reports, documents and other
information we have filed at the SEC's public reference rooms located at 450
Fifth Street, N.W., Washington, D.C., 20549, as well as at the regional offices
of the SEC located at The Woolworth Building, 233 Broadway, New York, New York
10048 and Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661.
Please call 1-800-SEC-0330 for further information on the public reference rooms
and their copy charges.
173
<Page>
Index to consolidated financial statements
<Table>
<Caption>
Page
DonJoy, L.L.C.:
Report of Ernst & Young LLP, Independent Auditors........... F-2
Consolidated Balance Sheets as of December 31, 1999 and 2000
and September 29, 2001 (unaudited)........................ F-3
Consolidated Statements of Income for the years ended
December 31, 1998, 1999 and 2000 and for the nine months
ended September 30, 2000 (unaudited) and September 29,
2001(unaudited)........................................... F-4
Consolidated Statements of Changes in Members' Equity
(Deficit) and Comprehensive Income for the years ended
December 31, 1998, 1999 and 2000 and for the nine months
ended September 29, 2001 (unaudited)...................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1999 and 2000 and for the nine months
ended September 30, 2000 (unaudited) and September 29,
2001
(unaudited)............................................... F-6
Notes to Consolidated Financial Statements.................. F-7
DePuy Orthopaedic Technology, Inc.:
Combined Balance Sheets as of December 31, 1999 and
June 30, 2000 (unaudited)................................. F-33
Combined Statements of Operations and Changes in Invested
Equity for the six months ended June 30, 1999 and 2000
(unaudited)............................................... F-34
Combined Statements of Cash Flows for the six months ended
June 30, 1999 and 2000
(unaudited)............................................... F-35
Notes to Combined Financial Statements (unaudited).......... F-36
Report of Independent Accountants........................... F-41
Combined Balance Sheets as of December 31, 1998 and 1999.... F-42
Combined Statements of Operations and Changes in Invested
Equity for the period October 29, 1998 through
December 31, 1998 and year ended December 31, 1999........ F-43
Combined Statements of Cash Flows for the period October 29,
1998 through
December 31, 1998 and year ended December 31, 1999........ F-44
Notes to Combined Financial Statements...................... F-45
Report of Independent Accountants........................... F-57
Statements of Operations and Changes in Invested Equity for
the year ended
December 31, 1997 and for the period January 1, 1998
through October 28, 1998.................................. F-58
Statements of Cash Flows for the year ended December 31,
1997 and for the period January 1, 1998 through
October 28, 1998.......................................... F-59
Notes to Financial Statements............................... F-60
Bracing and soft supports business of Johnson & Johnson:
Report of Independent Accountants........................... F-69
Statements of Revenues and Expenses for the year ended
December 31, 1997 and the period January 1, 1998 through
October 28, 1998.......................................... F-70
Notes to Statements of Revenues and Expenses................ F-71
</Table>
F-1
<Page>
Report of Ernst & Young LLP, independent auditors
To the Board of Managers
DonJoy, L.L.C.
We have audited the accompanying consolidated balance sheets of DonJoy, L.L.C.
as of December 31, 1999 and 2000, and the related consolidated statements of
income, members' equity and cash flows for each of the three years in the period
ended December 31, 2000. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of DonJoy, L.L.C. at
December 31, 1999 and 2000, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States.
ERNST & YOUNG LLP
San Diego, California
February 16, 2001
F-2
<Page>
DonJoy, L.L.C. consolidated balance sheets
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------------
dj Orthopedics, Inc.
pro forma
December 31, ---------------------
--------------------- September 29, September 29,
(in thousands, except unit/share information) 1999 2000 2001 2001
- ----------------------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Assets
Current assets:
Cash and cash equivalents........................... $ 5,927 $ 4,106 $ 1,886 $ 1,886
Accounts receivable, net of discounts and allowances
of $989, $4,278 and $6,963 at December 31, 1999
and 2000 and September 29, 2001, respectively..... 21,406 34,498 44,235 44,235
Inventories, net.................................... 13,664 18,510 21,771 21,771
Other current assets................................ 917 3,270 2,638 2,638
--------------------------------------------------------------
Total current assets................................ 41,914 60,384 70,530 70,530
Property, plant and equipment, net.................... 7,297 12,785 14,880 14,880
Intangible assets, net................................ 33,195 75,419 72,029 72,029
Debt issuance costs, net.............................. 6,875 6,549 5,857 5,857
Deferred tax asset.................................... -- -- -- 54,794
Deferred offering costs and other assets.............. 135 535 1,628 1,628
--------------------------------------------------------------
Total assets.......................................... $ 89,416 $ 155,672 $ 164,924 $ 219,718
--------------------------------------------------------------
Liabilities and members' deficit/stockholders' deficit (pro forma)
Current liabilities:
Accounts payable.................................... $ 6,411 $ 8,982 $ 9,430 $ 9,430
Accrued compensation................................ 2,443 2,937 2,398 2,398
Accrued commissions................................. 954 1,444 1,360 1,360
Long-term debt, current portion..................... 500 1,274 1,274 1,274
Accrued interest.................................... 526 686 3,690 3,690
Other accrued liabilities........................... 3,667 6,366 6,972 6,972
--------------------------------------------------------------
Total current liabilities............................. 14,501 21,689 25,124 25,124
12 5/8% Senior Subordinated Notes..................... 98,055 98,260 98,413 98,413
Long-term debt, less current portion.................. 14,750 57,688 49,731 49,731
Redeemable Preferred Units; 100,000 units authorized,
40,184, 44,405 and 44,405 units issued and
outstanding at December 31, 1999 and 2000 and
September 29, 2001 (unaudited), respectively;
liquidation preference $35,368, $43,688 and $48,497
at December 31, 1999 and 2000 and September 29, 2001
(unaudited), respectively........................... 32,539 41,660 46,610 46,610
Minority interest..................................... -- -- 144 144
Commitments and contingencies (Note 11 and Note 14)
Members' deficit/stockholders' deficit (pro forma):
Common units; 2,900,000 units authorized, 718,000,
793,890 and 885,633 units issued and outstanding
at December 31, 1999 and 2000 and September 29,
2001 (unaudited), respectively.................... 66,521 74,754 84,517 --
Preferred stock, $0.01 par value;
25,000,000 shares authorized (pro forma), none
issued and outstanding (pro forma) (unaudited).... -- -- -- --
Common stock, $0.01 par value;
100,000,000 shares authorized (pro forma),
10,055,566, shares outstanding at September 29,
2001 (pro forma) (unaudited).................... -- -- -- 101
Additional paid-in capital (pro forma).............. -- -- -- (52,919)
Notes receivable from officers...................... (1,400) (1,772) (2,082) (2,082)
Retained earnings (deficit)......................... (135,550) (136,607) (137,533) 54,596
--------------------------------------------------------------
Total members' deficit/stockholders' deficit (pro
forma).............................................. (70,429) (63,625) (55,098) (304)
--------------------------------------------------------------
Total liabilities and members' deficit/stockholders'
deficit (pro forma)................................. $ 89,416 $ 155,672 $ 164,924 $ 219,718
======================================================================================================================
</Table>
SEE ACCOMPANYING NOTES.
F-3
<Page>
DonJoy, L.L.C. consolidated statements of income
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------
Years ended Nine months ended
December 31, -----------------------------
--------------------------------- September 30, September 29,
(in thousands, except per share data) 1998 1999 2000 2000 2001
- --------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Net revenues........................ $103,643 $116,418 $143,586 $102,186 $127,361
Cost of goods sold.................. 46,466 51,744 60,178 43,050 53,856
-----------------------------------------------------------------
Gross profit........................ 57,177 64,674 83,408 59,136 73,505
Operating expenses:
Sales and marketing............... 27,633 28,902 38,653 26,751 35,661
General and administrative........ 16,484 16,755 19,761 14,529 18,270
Research and development.......... 2,248 2,115 2,465 1,678 1,813
Merger and integration costs...... -- -- 400 400 --
Restructuring costs............... 2,467 -- -- -- --
-----------------------------------------------------------------
Total operating expenses............ 48,832 47,772 61,279 43,358 55,744
-----------------------------------------------------------------
Income from operations.............. 8,345 16,902 22,129 15,778 17,761
Interest expense.................... -- (7,568) (16,958) (12,245) (13,701)
Interest income..................... -- 181 437 348 230
Discontinued acquisition costs...... -- -- (449) -- --
-----------------------------------------------------------------
Income before income taxes.......... 8,345 9,515 5,159 3,881 4,290
Provision for income taxes.......... 3,394 2,387 -- -- --
-----------------------------------------------------------------
Net income and comprehensive
net income........................ 4,951 7,128 5,159 3,881 4,290
Less: Preferred unit dividends and
accretion of preferred unit fees... N/A (2,343) (5,415) (3,908) (4,738)
-----------------------------------------------------------------
Net income (loss) available to
members........................... N/A $ 4,785 $ (256) $ (27) $ (448)
-----------------------------------------------------------------
Pro forma information (See Note 1):
Income before income taxes........ N/A $ 9,515 $ 5,159 $ 3,881 $ 4,290
Provision for income taxes:
Historical...................... N/A 2,387 -- -- --
Pro forma adjustment............ N/A 1,133 1,909 1,436 1,587
-----------------------------------------------------------------
3,520 1,909 1,436 1,587
-----------------------------------------------------------------
Pro forma net income and
comprehensive income............ N/A 5,995 3,250 2,445 2,703
Less: Preferred unit dividends and
accretion of preferred unit
fees............................ N/A (2,343) (5,415) (3,908) (4,738)
-----------------------------------------------------------------
Pro forma net income (loss)
available to members............ N/A $ 3,652 $ (2,165) $ (1,463) $ (2,035)
-----------------------------------------------------------------
Pro forma net income (loss) per
share:
Basic........................... N/A $ 0.89 $ (0.25) $ (0.17) $ (0.22)
-----------------------------------------------------------------
Diluted......................... N/A $ 0.84 $ (0.25) $ (0.17) $ (0.22)
-----------------------------------------------------------------
Pro forma weighted average shares
outstanding:
Basic........................... N/A 4,099 8,631 8,467 9,465
-----------------------------------------------------------------
Diluted......................... N/A 4,354 8,631 8,467 9,465
========================================================================================================
</Table>
SEE ACCOMPANYING NOTES.
F-4
<Page>
DonJoy, L.L.C. consolidated statements of changes in members' equity (deficit)
and comprehensive income
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------------
Common Units Notes
----------------------- receivable Retained Total members'
(in thousands, except unit information) Units Amount from officers equity (deficit) equity (deficit)
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997... -- $ -- $ -- $ 7,881 $ 7,881
Net income..... -- -- -- 4,951 4,951
-----------------------------------------------------------------------------
Balance at December 31, 1998... -- -- -- 12,832 12,832
Capital contribution by Smith & Nephew,
Inc. in connection with the
Recapitalization... 2,054,000 64,117 -- (16,264) 47,853
Issuance of common units at $100 per
unit, net of transaction fees of
$1,563....... 645,500 62,987 -- -- 62,987
Purchase of common units from Smith &
Nephew, Inc.... (2,000,000) (62,433) -- (136,707) (199,140)
Issuance of common units at $100 per
unit, in exchange for cash and notes
receivable... 18,500 1,850 (1,400) -- 450
Preferred unit dividends and accretion
of preferred unit fees... -- -- -- (2,343) (2,343)
Net income (excluding $196 allocated to
preferred unit holders--see
note 5)..... -- -- -- 6,932 6,932
-----------------------------------------------------------------------------
Balance at December 31, 1999... 718,000 66,521 (1,400) (135,550) (70,429)
Issuance of common units at $109 per
unit, in exchange for cash and notes
receivable... 75,890 8,272 (174) -- 8,098
Note receivable issued to Management
for purchase of common units... -- -- (124) -- (124)
Transfer of interest receivable to note
receivable... -- -- (74) -- (74)
Transaction fees in connection with the
Recapitalization... -- (39) -- -- (39)
Stock options granted for services... -- -- -- 36 36
Tax distributions to preferred unit
holders...... -- -- -- (563) (563)
Preferred unit dividends and accretion
of preferred unit fees... -- -- -- (5,415) (5,415)
Net income (excluding $274 allocated to
preferred unit holders--see
note 5)..... -- -- -- 4,885 4,885
-----------------------------------------------------------------------------
Balance at December 31, 2000... 793,890 74,754 (1,772) (136,607) (63,625)
Issuance of common units at $109 per
unit, in exchange for cash and notes
receivable, net of transaction fees
of $234 (unaudited)... 91,743 9,763 (211) -- 9,552
Transfer of interest receivable to note
receivable (unaudited)... -- -- (99) -- (99)
Stock options granted for services
(unaudited)... -- -- -- 102 102
Tax distributions to preferred unit
holders (unaudited)... -- -- -- (200) (200)
Foreign currency translation adjustment
(unaudited)... -- -- -- (168) (168)
Preferred unit dividends and accretion
of preferred unit fees (unaudited)... -- -- -- (4,738) (4,738)
Net income (excluding $212 allocated to
preferred unit holders--see note 5)
(unaudited)... -- -- -- 4,078 4,078
-----------------------------------------------------------------------------
Balance at September 29, 2001
(unaudited)... 885,633 $ 84,517 $ (2,082) $ (137,533) $ (55,098)
======================================================================================================================
<Caption>
- --------------------------------------- ---------------
Comprehensive
(in thousands, except unit information) income
- --------------------------------------- ---------------
Balance at December 31, 1997...
Net income.....
---------------
Balance at December 31, 1998...
Capital contribution by Smith & Nephew,
Inc. in connection with the
Recapitalization...
Issuance of common units at $100 per
unit, net of transaction fees of
$1,563.......
Purchase of common units from Smith &
Nephew, Inc....
Issuance of common units at $100 per
unit, in exchange for cash and notes
receivable...
Preferred unit dividends and accretion
of preferred unit fees...
Net income (excluding $196 allocated to
preferred unit holders--see
note 5).....
---------------
Balance at December 31, 1999...
Issuance of common units at $109 per
unit, in exchange for cash and notes
receivable...
Note receivable issued to Management
for purchase of common units...
Transfer of interest receivable to note
receivable...
Transaction fees in connection with the
Recapitalization...
Stock options granted for services...
Tax distributions to preferred unit
holders......
Preferred unit dividends and accretion
of preferred unit fees...
Net income (excluding $274 allocated to
preferred unit holders--see
note 5)..... $ 4,885
---------------
Balance at December 31, 2000... $ 4,885
---------------
Issuance of common units at $109 per
unit, in exchange for cash and notes
receivable, net of transaction fees
of $234 (unaudited)...
Transfer of interest receivable to note
receivable (unaudited)...
Stock options granted for services
(unaudited)...
Tax distributions to preferred unit
holders (unaudited)...
Foreign currency translation adjustment
(unaudited)... (168)
Preferred unit dividends and accretion
of preferred unit fees (unaudited)...
Net income (excluding $212 allocated to
preferred unit holders--see note 5)
(unaudited)... 4,078
---------------
Balance at September 29, 2001
(unaudited)... $ 3,910
=======================================
</Table>
SEE ACCOMPANYING NOTES.
F-5
<Page>
DonJoy, L.L.C. consolidated statements of cash flows
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------------------
Years ended Nine months
December 31, ended
----------------------------------- -------------------------------
September 30, September 29,
(in thousands) 1998 1999 2000 2000 2001
- ---------------------------------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Operating activities
Net income.............................................. $ 4,951 $ 7,128 $ 5,159 $ 3,881 $ 4,290
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 4,853 4,952 6,365 4,627 7,001
Amortization of debt issuance costs and discount on
Senior Subordinated Notes............................. -- 510 1,082 800 845
Step-up to fair value of acquired inventory............. -- -- 268 268 --
Stock-based compensation................................ -- -- 36 -- 102
Restructuring costs..................................... 2,467 -- -- -- --
Merger and integration costs............................ -- -- 400 400 --
Minority interest....................................... -- -- -- -- 144
Changes in operating assets and liabilities:
Accounts receivable................................... (3,816) (1,564) (13,092) (9,715) (9,737)
Inventories........................................... (2,760) 704 (2,576) (1,042) (3,261)
Other current assets.................................. (97) (106) (2,427) (1,296) 533
Accounts payable...................................... 495 (893) 2,571 289 448
Accrued interest...................................... -- 526 160 3,278 3,004
Accrued compensation.................................. (174) 1,057 494 (276) (539)
Accrued commissions................................... (377) (237) 490 430 (84)
Income taxes.......................................... (744) 2,516 -- -- --
Restructuring reserve................................. (1,197) (339) -- (281) --
Other accrued liabilities............................. 147 1,811 2,299 4,395 791
---------------------------------------------------------------------
Net cash provided by operating activities............... 3,748 16,065 1,229 5,758 3,537
Investing activities
Purchases of property, plant and equipment.............. (3,189) (2,502) (6,522) (4,635) (4,581)
Proceeds from assets held for sale...................... -- -- 126 -- --
Purchase of intangible assets........................... (960) (2,204) (1,200) -- (1,060)
Orthotech acquisition................................... -- -- (49,019) (49,686) --
Alaron acquisition...................................... -- -- -- -- (250)
Other assets............................................ 100 (70) (400) (230) (1,093)
---------------------------------------------------------------------
Net cash used in investing activities................... (4,049) (4,776) (57,015) (54,551) (6,984)
Financing activities
Net proceeds from Senior Subordinated Notes............. -- 97,953 -- -- --
Proceeds from long-term debt............................ -- 15,500 44,600 36,600 --
Repayment of long-term debt............................. -- (250) (888) (569) (7,957)
Transaction fees in connection with recapitalization.... -- -- -- -- --
Distributions to preferred unit holders................. -- -- (563) (400) (200)
Debt issuance costs..................................... -- (7,283) (551) (588) --
Purchase of common units from Smith & Nephew (the
"Former Parent")...................................... -- (199,140) -- -- --
Net proceeds from issuance of common units.............. -- 63,437 8,059 8,059 9,552
Net proceeds from issuance of preferred units........... -- 30,000 3,432 3,432 --
Note receivable issued for purchase of common units..... -- -- (124) (124) --
Intercompany obligations................................ 200 (6,388) -- -- --
---------------------------------------------------------------------
Net cash (used in) provided by financing activities..... 200 (6,171) 53,965 46,410 1,395
---------------------------------------------------------------------
Effect of exchange rate changes on cash................... -- -- -- -- (168)
---------------------------------------------------------------------
Net increase (decrease) in cash........................... (101) 5,118 (1,821) (2,383) (2,220)
Cash at beginning of period............................... 910 809 5,927 5,927 4,106
---------------------------------------------------------------------
Cash at end of period..................................... $ 809 $ 5,927 $ 4,106 $ 3,544 $ 1,886
---------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Interest paid........................................... $ -- $ 6,530 $ 15,716 $ 8,167 $ 9,853
---------------------------------------------------------------------
Supplemental disclosure of non-cash transactions:
Capital contribution in connection with the
Recapitalization...................................... $ -- $ 47,853 $ -- $ -- $ --
---------------------------------------------------------------------
Dividends and accretion of preferred unit fees related
to redeemable preferred units......................... $ -- $ 2,343 $ 5,415 $ 3,908 $ 4,738
---------------------------------------------------------------------
Common units issued in exchange for notes receivable and
transfer of interest receivable to notes receivable... $ -- $ 1,400 $ 248 $ -- $ 310
=================================================================================================================================
</Table>
SEE ACCOMPANYING NOTES.
F-6
<Page>
DonJoy, L.L.C. notes to consolidated financial statements
(Information as of September 29, 2001 and for the
nine months ended September 30, 2000 and
September 29, 2001 is unaudited)
1. Organization and summary of significant accounting policies
DonJoy, L.L.C. ("DonJoy"), through its subsidiary dj Orthopedics, LLC ("dj
Ortho") and dj Ortho's subsidiaries (collectively the "Company"), designs,
manufactures and markets various lines of recovery products and accessories and
is the successor to a corporation established in December 1982 as DonJoy, Inc.
DonJoy, Inc. was acquired by Smith & Nephew, Inc. (formerly Smith & Nephew
Consolidated, Inc., the "Former Parent") effective September 18, 1987 through a
purchase of all the then outstanding shares of stock. Smith & Nephew, Inc. is a
wholly-owned subsidiary of Smith & Nephew plc., a United Kingdom company. In
November 1996, DonJoy, Inc. was merged into Smith & Nephew, Inc. and began to
operate as a division. Effective December 29, 1998, the Former Parent
contributed the division's net assets and shares of a Mexican subsidiary into
DonJoy, L.L.C., a newly formed Delaware limited liability company, and became
the sole member of the new entity.
DonJoy, L.L.C. will be dissolved on December 31, 2030, unless prior to that date
certain events occur as defined in the Third Amended and Restated Operating
Agreement dated as of July 7, 2000. The debts, obligations and liabilities of
the Company, whether arising in contract, tort or otherwise, shall be solely
debts, obligations and liabilities of the Company, and no member or manager of
DonJoy, L.L.C. shall be obligated personally for any such debt, obligation or
liability of the Company solely by reason of being a member or manager.
Reorganization and pro forma information (unaudited)
dj Orthopedics, Inc. was capitalized with a nominal amount and incorporated in
Delaware on August 16, 2001. dj Orthopedics, Inc. has nominal assets, no
liabilities and has no operations or revenues since that date. Concurrently with
and contingent upon the completion of the initial public offering contemplated
by this Prospectus, a newly-formed, wholly-owned subsidiary of dj Orthopedics,
Inc. will merge with and into DonJoy, L.L.C. with DonJoy, L.L.C. being the
surviving entity of the merger, and holders of the common and preferred units of
DonJoy, L.L.C. will receive shares of dj Orthopedics, Inc.'s common stock. In
addition, following the foregoing merger, DonJoy, L.L.C. will merge with and
into dj Orthopedics, Inc. which will be the surviving entity of the merger. Both
of these mergers are referred to herein as the "Reorganization". At September
29, 2001, deferred offering costs in connection with the initial public offering
total $0.7 million and in the event that such offering is not completed, these
costs will be written off against the Company's results of operations.
The September 29, 2001 pro forma balance sheet of dj Orthopedics, Inc. is
presented to give effect to the Reorganization as if the Reorganization occurred
on September 29, 2001. Prior to the Reorganization, the operating results of
DonJoy, L.L.C. were allocated to the members. At the time of the Reorganization,
members' equity will be reclassified into Common Stock and additional paid-in
capital. The pro forma statements of operations reflect the Company's operations
for the periods ended December 31, 1999, 2000 and September 29, 2001 as if the
Reorganization occurred as of the
F-7
<Page>
beginning of the respective period for 2000 and 2001 and as of the date of the
recapitalization for 1999.
Pro forma deferred income taxes in the balance sheet represents the deferred
income taxes related to the difference in the tax basis of the assets of DonJoy,
L.L.C. at September 29, 2001 of $54.8 million. Pro forma income tax expense in
the statements of income represents the charge based on the Company's operating
results for the periods ended December 31, 1999, 2000 and September 29, 2001, as
if the Company were a corporation from the beginning of the respective period.
(See disclosure under "Income Taxes" included elsewhere in Note 1).
As of September 29, 2001 and giving effect to the Reorganization, 10,055,566
shares of Common Stock will be issued and outstanding.
The pro forma basic and diluted net income (loss) per common share is computed
based on the weighted average number of shares of Common Stock outstanding for
each period presented assuming the Reorganization occurred as of the beginning
of the respective period. The dilutive effect of common stock equivalents
(options to purchase common stock) for the periods ended December 31, 1999 and
2000 and September 29, 2001, respectively, which is computed using the treasury
stock method, were not considered in calculating diluted net income (loss) per
share, except in 1999, because the effect is antidilutive. The following table
reconciles the denominators used in computing basic and diluted earnings (loss)
per share:
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------
Years ended Nine months ended
December 31, -------------------------------
------------------------------ September 30, September 29,
1998 1999 2000 2000 2001
- ----------------------------------------------------------------------------------------------------------------
(in thousands) (in thousands)
Weighted average common shares outstanding.... N/A 4,099 8,631 8,467 9,465
Effect of dilutive stock options.............. N/A 255 -- -- --
----------------------------------------------------------------
N/A 4,354 8,631 8,467 9,465
================================================================================================================
</Table>
On November 20, 2001, immediately prior to the consummation of its initial
public offering, the above mergers were completed.
Recapitalization
Prior to June 30, 1999, the sole member of DonJoy and 100% owner of DonJoy's
capital was Smith & Nephew Consolidated, Inc. On June 30, 1999, DonJoy
consummated a $215.3 million recapitalization (the "Recapitalization"). In the
Recapitalization, new investors, including J.P. Morgan DJ Partners, L.L.C.
(formerly Chase DJ Partners, L.L.C.) ("JPMDJ Partners") and affiliates of JPMDJ
Partners, invested new capital of $94.6 million in DonJoy, of which
$64.6 million was for common units and $30.0 million for preferred units. In
addition, certain members of management invested net equity of $0.4 million, by
purchasing $1.8 million in equity which was financed in part by $1.4 million in
interest-bearing, full recourse loans from DonJoy. The Former Parent retained
54,000 common units, which represented approximately 7.1% of total units in
DonJoy then outstanding. In connection with the recapitalization transactions,
DonJoy established dj Ortho and DJ Orthopedics Capital Corporation ("DJ
Capital"). DonJoy sold all of its net assets including its shares of its
wholly-owned Mexican subsidiary to dj Ortho for cash, which was funded with the
net proceeds of $100.0 million of 12 5/8% Senior Subordinated Notes (the
"Notes") issued by dj Ortho and DJ Capital, as co-issuers, and the remainder by
funds borrowed by dj
F-8
<Page>
Ortho under a senior credit facility. The Notes are fully and unconditionally
guaranteed by DonJoy. dj Ortho is a wholly-owned subsidiary of DonJoy and
represents substantially all of the revenues and net income of DonJoy, which has
no independent assets or operations. DJ Capital is a wholly-owned subsidiary of
dj Ortho, has no independent assets or operations and was formed solely for the
purpose of being a co-issuer of the Notes (see Note 8).
The proceeds of the equity investment together with $113.5 million of net
proceeds from debt financing were used for approximately $199.1 million of
consideration paid to redeem 92.9% of members' equity from the Former Parent,
and approximately $8.8 million of costs and fees paid in association with the
Recapitalization.
Since the Former Parent's retained ownership interest following the
recapitalization was above 5%, in accordance with Staff Accounting Bulletin
No. 54, the debt and equity transactions were accounted for using historical
values (referred to as recap accounting) and the new investors' higher basis in
the Company's net assets was not pushed-down to the Company's separate financial
statements. The recap accounting resulted in $136.7 million reduction to
retained earnings because the cost of redeeming the Former Parent's, 2,000,000
units exceeded their historical issue price of $62.4 million.
Transactions with the former parent, Smith & Nephew, Inc.
In accordance with a unit purchase agreement dated as of June 28, 2000, the
Former Parent sold its remaining interest of 54,000 common units in DonJoy to
JPMDJ Partners and certain members of management for $5.9 million. JPMDJ
Partners purchased 52,495 common units for a total consideration of
$5.7 million and the members of management purchased the remaining 1,505 units
for a total consideration of $0.2 million, substantially all of which was
financed by DonJoy and evidenced by full recourse promissory notes. As a result
of this transaction, Smith and Nephew, Inc. is no longer a related party;
accordingly, the Company no longer reflects its transactions with Smith &
Nephew, Inc. separately as transactions with an affiliate in its consolidated
financial statements.
Orthotech acquisition
On July 7, 2000, the Company completed the purchase of certain assets and
assumed certain liabilities ("the Orthotech Acquisition") of DePuy Orthopaedic
Technology, Inc. ("DePuy Orthotech"), a subsidiary of Johnson & Johnson, related
to DePuy Orthotech's bracing and soft goods business ("Orthotech"). Orthotech
developed, manufactured, and marketed an array of orthopedic products for the
sports medicine market, including braces, soft goods and specialty products
which were similar to the products offered by the Company.
The asset purchase agreement provided for the purchase of certain assets and the
assumption of certain liabilities of Orthotech, comprising the Orthotech
business, for a purchase price of $46.4 million in cash and related costs of
$3.0 million. We purchased primarily inventory, equipment, certain intellectual
property and other intangible assets. We were not required to assume any
liabilities existing prior to the closing date. The Orthotech acquisition has
been accounted for using the purchase method of accounting whereby the total
purchase price has been allocated to tangible and intangible assets acquired and
liabilities assumed based on their estimated fair market value.
Australian joint venture
Effective March 5, 2001, the Company invested in an Australian joint venture, dj
Orthopaedics Pty Ltd ("dj Australia") which is 60% owned by dj Ortho and is
included in the consolidated financial
F-9
<Page>
statements of dj Ortho from the date of the investment. dj Australia has
replaced the Smith & Nephew distributor in Australia and also sells two new
product lines.
Alaron acquisition
On June 1, 2001, the Company acquired Alaron Technologies, L.L.C. ("Alaron")
under an asset purchase agreement (the "Alaron Acquisition"). Alaron provided
product development, manufacturing and supply chain management services related
to medical and surgical devices.
The asset purchase agreement provided for the purchase of certain assets and the
assumption of certain liabilities of Alaron, comprising the Alaron business, for
a purchase price of $0.5 million in cash payable in four equal installments on
closing, July 31, 2001, October 1, 2001 and November 30, 2001. The Company
purchased primarily equipment and acquired technology. The Alaron Acquisition
has been accounted for using the purchase method of accounting whereby the total
purchase price has been allocated to tangible and intangible assets acquired and
liabilities based on their estimated fair values.
Equity investment
In connection with an equity investment in June 2001, DonJoy sold in a private
placement 89,186 common units to JPMDJ Partners for gross proceeds of
$9.7 million and 2,557 common units to certain members of management for gross
proceeds of $0.3 million (of which $0.2 million was paid for through the
issuance of full recourse promissory notes to DonJoy).
Basis of presentation and principles of consolidation
The accompanying consolidated financial statements present the historical
consolidated financial position and results of operations of the Company and
include the accounts of dj Ortho, the accounts of its wholly-owned Mexican
subsidiary that manufactures a portion of dj Ortho's products under Mexico's
maquiladora program and the accounts of its majority owned subsidiary,
dj Australia. The maquiladora program allows foreign manufacturers to take
advantage of Mexico's lower cost production sharing capabilities. All
intercompany accounts and transactions have been eliminated in consolidation.
Minority interest at September 29, 2001, represents the minority stockholders'
proportionate share of the assets of dj Australia.
Use of estimates in the preparation of financial statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
Interim financial data
The financial statements for the nine months ended September 30, 2000 and
September 29, 2001 are unaudited. The unaudited financial statements have been
prepared on the same basis as the audited financial statements and, in the
opinion of management, include all adjustments, consisting only of normal
recurring adjustments, necessary to state fairly the financial information set
forth therein, in accordance with generally accepted accounting principles. The
results of operations for the interim period ended September 29, 2001 are not
necessarily indicative of the results which may be reported for any other
interim period or for the year ending December 31, 2001.
F-10
<Page>
DonJoy's fiscal year ends on December 31. Each quarter consists of one five-week
and two four-week periods. The first and fourth quarters may have more or less
working days from year to year based on what day of the week holidays fall on.
The nine-month period ended September 29, 2001 contained one less business day
than the nine months ended September 30, 2000, resulting in the Company
recognizing approximately $0.7 million less in revenues in the nine months ended
September 29, 2001 as compared to the same period in 2000.
Cash equivalents
Cash equivalents are short-term, highly liquid investments and consist of
investments in money market funds and commercial paper purchased with average
maturities of three months or less.
Fair value of financial instruments
In accordance with requirements of Statement of Financial Accounting Standards
("SFAS") No. 107, "Disclosures about Fair Value of Financial Instruments," the
following methods and assumptions were used in estimating the fair value
disclosures:
- CASH AND CASH EQUIVALENTS AND ACCOUNTS RECEIVABLES. The carrying
amounts approximate fair values because of short maturities of these
instruments and the reserves for doubtful accounts which, in the opinion
of management, are adequate to state accounts receivable at their fair
value.
- LONG-TERM DEBT. Based on the borrowing rates currently available to dj
Ortho for loans with similar terms and average maturities, management
believes the fair value of long-term debt approximates its carrying value
at December 31, 2000.
Discounts and allowances
Accounts receivable is presented on the consolidated balance sheets net of
payment discounts, contractual allowances related to third-party payors, and
allowances for doubtful accounts.
Long-lived assets
Property, plant and equipment and intangible assets are recorded at cost. The
Company provides for depreciation on property, plant and equipment and
intangible assets using the straight-line method over the estimated useful lives
of the assets, which range from three to five years. Leasehold improvements are
amortized over the lesser of their estimated useful life or the term of the
related lease.
In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," whenever events or changes
in circumstances indicate that the carrying amount of its assets might not be
recoverable, the Company, using its best estimates based upon reasonable and
supportable assumptions and projections, reviews the carrying value of
long-lived assets to determine whether the carrying value can be recovered
through undiscounted future operating cash flow. Impairment for long-lived
assets to be held is measured by comparing the carrying amount of the asset to
its fair value. Impairment is reviewed at the lowest levels for which there are
identifiable cash flows that are independent of the cash flows of other groups
of assets. The Company performs such analysis on an individual asset basis and
estimates fair values based on sales prices for comparable assets. The Company
measures impairment for long-lived assets to be disposed of at the lower of the
carrying amount or net realizable value (fair market value less costs to
dispose).
F-11
<Page>
Computer software costs
In 1999, the Company adopted the American Institute of Certified Public
Accountants Statement of Position 98-1 "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use". This standard requires
companies to capitalize qualifying computer software costs, which are incurred
during the application development stage and amortize them over the software's
estimated useful life. During 1999 and 2000, the Company capitalized
$1.1 million and $3.9 million, respectively, related to the acquisition and
implementation of its new enterprise resource planning system. Once the system
is fully implemented, the company will amortize the costs over seven years.
Debt issuance costs
As of September 29, 2001, December 31, 2000 and 1999, debt issuance costs
associated with the issuance of the Notes and the credit facility equal
$7.8 million, $7.8 million and $7.3 million (which are reflected on the balance
sheets net of accumulated amortization of $0.7 million, $1.3 million and
$1.7 million, respectively). The Company is amortizing these costs over the life
of the debt which ranges from six to ten years and classifies the amortization
as additional interest incurred.
Inventories
Inventories are stated at the lower of cost or market, with cost determined on a
first-in, first-out (FIFO) basis. In connection with the recapitalization
transactions described in Note 1, the Company changed its method of valuing its
inventory from the last-in, first-out method (LIFO) to the FIFO method because
management believes the FIFO method is more representative of the Company's
operations. This change was implemented during 1998, retroactively for all
periods presented. The effect of the change was an increase in net income of
$346,000 in 1998.
Revenue recognition
The Company distributes its products in the United States and international
markets primarily through networks of agents and distributors who market and
sell to orthopedic sports medicine surgeons, orthotic and prosthetic centers,
third party distributors, hospitals, surgery centers, physical therapists and
trainers within the orthopedic sports medicine community.
The Company recognizes revenue pursuant to Staff Accounting Bulletin No. 101
"Revenue Recognition in Financial Statements." Accordingly, revenue is
recognized when all four of the following criteria are met: (i) persuasive
evidence that an arrangement exists; (ii) shipment of goods and passage of
title; (iii) the selling price is fixed or determinable; and
(iv) collectibility is reasonably assured. Revenues from third-party payors are
recorded net of contractual allowances. Contractual allowances are accrued as a
percent of revenues based on historical percentages. Revenues are also reduced
by return rates and rebates. For the Company's international sales and certain
of its sales in the United States that are transacted through distribution
agreements, sales are recorded upon shipment and the agreements provide the
distributors with a right of return as it relates to excess and obsolete
inventory. Estimated returns are accrued based on historical returns in the
period sales are recognized in accordance with the provisions of SFAS No. 48,
"Revenue Recognition When Right of Return Exists". Some products have a limited
warranty and estimated costs are accrued based on historical experience in the
period sales are recognized. In addition, rebates are accrued at the time of
sale based upon agreed upon terms with customers. Other than contractual
allowances, returns and warranties and rebates, there are no additional
obligations after shipment. Historically, the percentage of reductions to
revenues have been less than 10% of revenues.
F-12
<Page>
Shipping and handling costs
During 2000, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." The issue
concluded that all amounts billed to a customer in a sale transaction represent
the fees earned for the goods provided and, accordingly, should be included with
revenues in the statement of income. The Company has implemented Issue 00-10 in
the fourth quarter of 2000. As a result, revenues in the years ended 1998, 1999
and 2000 and the nine months ended September 30, 2000 and September 29, 2001
have been increased by the amounts billed to customers for freight of
$3.5 million, $3.5 million, $4.4 million and $3.2 million and $3.6 million,
respectively, which was previously offset against shipping and handling costs
which are part of sales and marketing expenses. Shipping and handling costs
included as part of sales and marketing expenses were $5.6 million,
$5.6 million and $7.6 million for December 31, 1998, 1999 and 2000 and
$5.1 million and $4.9 million for September 30, 2000 and September 29, 2001,
respectively.
Advertising expense
The cost of advertising is expensed as incurred. The Company incurred $122,000,
$152,000 and $252,000 in advertising costs for the years ended December 31,
1998, 1999 and 2000 and $206,000 and $163,000 in advertising costs for the nine
months ended September 30, 2000 and September 29, 2001.
Foreign currency translation
The financial statements of the Company's international operations where the
local currency is the functional currency are translated into U.S. dollars using
period-end exchange rates for assets and liabilities and average exchange rates
during the period for revenues and expenses. Cumulative translation gains and
losses are excluded from results of operations and recorded as a separate
component of the consolidated statements of changes in members' equity
(deficit).
Concentration of credit risk
dj Ortho sells the majority of its products in the United States through
commissioned sale organizations (referred to as agents). Products which are
generic are sold through large distributors, specialty dealers and buying
groups. Excluding freight revenue, international sales comprised 17%, 16% and
13% of the Company's net revenues for the years ended December 31, 1998, 1999
and 2000 and 15% and 13% for the nine months ended September 30, 2000 and
September 29, 2001, respectively, and are primarily sold through independent
distributors. Credit is extended based on an evaluation of the customer's
financial condition and generally collateral is not required. The Company also
provides a reserve for estimated sales returns. Both credit losses and returns
have been within management's estimates.
During the three years ended December 31, 2000 and for the nine months ended
September 30, 2000 and September 29, 2001, the Company had no individual
customer or distributor which accounted for 10% or more of total annual
revenues.
Stock-based compensation
As permitted under Financial Accounting Standards Board ("FASB") Statement
No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company
has elected to follow Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees", in accounting for outstanding stock
options and warrants issued to employees. Under APB Opinion No. 25, compensation
F-13
<Page>
expense relating to employee stock options is determined based on the excess of
the market price of the stock over the exercise price on the date of grant and
does not require the recognition of compensation expense for stock issued under
plans defined as non-compensatory. The amount of expense for these types of
arrangements is not material. Adoption of SFAS No. 123 for options issued to
employees would require recognition of employee compensation expense based on
their computed "fair value" on the date of grant. In accordance with SFAS
No. 123 and EITF 96-18, stock options and warrants issued to consultants and
other non-employees as compensation for services provided to the Company are
accounted for based upon the fair value of the services provided or the
estimated fair market value of the option or warrant, whichever can be more
clearly determined. The Company recognizes this expense over the period the
services are provided. During the year ended December 31, 2000 and the nine
months ended September 29, 2001, the Company recorded $36,000 and $99,000,
respectively, of expense related to these types of arrangements.
Income taxes
The Former Parent files a consolidated federal income tax return which includes
all of its eligible subsidiaries and divisions, which prior to the
Recapitalization in June 1999 included the Company. The provision for income
taxes has been presented assuming the Company filed a separate federal income
tax return. The Recapitalization had no impact on the historical basis of the
Company's assets and liabilities as reflected in its consolidated financial
statements except for the elimination of the restructuring reserve and
intercompany accounts. However, as a result of the Recapitalization, for federal
income tax purposes, the Company recorded an increase in the tax basis of its
inventory, fixed and intangible assets in an amount approximately equal to the
taxable gain recognized by Smith & Nephew on the sale of its interest in DonJoy
and, for tax purposes, the Company is able to depreciate assets with a higher
tax basis than for financial reporting purposes. The increase in tax basis as of
December 31, 1999 was as follows (in thousands):
<Table>
<Caption>
- -----------------------------------------------------------------------
Inventory................................................... $ 3,670
Property, plant and equipment............................... 4,145
Goodwill.................................................... 130,543
---------
$138,358
=======================================================================
</Table>
The Orthotech Acquisition also resulted in an increase in the tax basis due to
the fixed and intangible assets acquired. The increase in tax basis due to the
Orthotech Acquisition is equal to the amounts recorded by the Company under
purchase accounting (see Note 2).
Prior to the Recapitalization, the Company's results of operations included a
provision for income taxes assuming that the Company had filed a separate
federal income tax return. As a limited liability company, neither DonJoy nor dj
Ortho is subject to income taxes. Instead, DonJoy's earnings will be allocated
to its members and included in the taxable income of its members. The indenture
and the credit facility permit dj Ortho to make distributions to DonJoy in
certain amounts to allow DonJoy to make distributions to its members to pay
income taxes in respect of their allocable share of taxable income of DonJoy and
its subsidiaries, including dj Ortho.
Comprehensive income
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income," which
requires that all components of comprehensive income, including net income, be
reported in the financial statements in the period in which they are recognized.
Comprehensive income is defined as the change in equity
F-14
<Page>
during a period from transactions and other events and circumstances from
non-owner sources. Net income and other comprehensive income, including foreign
currency translation adjustments, and unrealized gains and losses on
investments, shall be reported, net of their related tax effect, to arrive at
comprehensive income. Comprehensive income for the years ended December 31,
1998, 1999 and 2000 and the nine months ended September 30, 2000 and
September 29, 2001 did not differ materially from reported net income.
Recently issued accounting standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," ("SFAS
No. 133"), which establishes accounting and reporting standards for derivative
instruments and hedging activities. The statement will require the recognition
of all derivatives on the Company's balance sheet at fair value.
In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of SFAS
No. 133" which deferred the adoption requirement to the first quarter of 2001.
The impact of adoption on the Company's financial statements was not material.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, "Business Combinations," and No. 142,
"Goodwill and Other Intangible Assets."
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. Use of the
pooling-of-interests method is no longer permitted. SFAS No. 141 also includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination that is completed after
June 30, 2001.
SFAS No.142 no longer permits the amortization of goodwill and indefinite-lived
intangible assets. Instead, these assets must be reviewed annually (or more
frequently under certain conditions) for impairment in accordance with this
statement. This impairment test uses a fair value approach rather than the
undiscounted cash flows approach previously required by SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." Intangible assets that do not have indefinite lives will
continue to be amortized over their useful lives and reviewed for impairment in
accordance with SFAS No. 121. We are required to adopt SFAS No. 142 effective
January 1, 2002, at which time we will be required to reassess the intangible
assets, including goodwill, previously recorded in connection with previous
purchase acquisitions, as well as the useful lives of such intangible assets.
Upon adoption of SFAS No. 142, the Company will stop amortizing goodwill and
certain other intangibles resulting from acquisitions prior to July 1, 2001,
which has been estimated to reduce annual amortization expense by approximately
$3.4 million. Goodwill and intangibles with indefinite lives will be assigned to
reporting units as determined by the Company for purposes of impairment testing
and tested using a two-step approach for impairment annually or whenever there
is an impairment indicator. The impact of stopping goodwill amortization has
been estimated to increase the Company's annual net income by approximately
$2.0 million.
F-15
<Page>
Reclassifications
As a result of the growth of the OfficeCare-Registered Trademark- program, our
working capital needs have significantly increased due to higher levels of
accounts receivable and inventories necessary to operate the program.
Historically, the Company reflected allowances and discounts applicable to the
OfficeCare-Registered Trademark- program as selling and marketing expense on the
premise that their charges were primarily related to credit and collection
issues. With the growth in the program, the discounting and allowances are
considered to be a normal and recurring reduction to revenue and, to be
consistent with industry practice, management believes that the charges are more
appropriately presented as adjustments to revenue than as operating expenses. To
be consistent with the current period's presentation, the Company reclassified
$0.6 million, $1.3 million, $3.9 million and $2.3 million of charges for the
years ended December 31, 1998, 1999 and 2000 and the first nine months of 2000,
respectively, which were previously included in selling and marketing expenses,
against revenues related to the Company's OfficeCare-Registered Trademark-
program. This reclassification had no effect on net income (loss) for the
foregoing periods.
2. Acquisition
On July 7, 2000, the Company completed the Orthotech Acquisition. Approximately
$49.4 million in cash was required to finance the Orthotech Acquisition,
including approximately $3.0 million for transaction fees and expenses
($0.4 million of which relates to debt issuance costs). The sources of funds for
the Orthotech Acquisition consisted of:
- The sale of common units to JPMDJ Partners and certain members of
management for $8.3 million, of which $0.2 million was for management
notes receivable.
- The sale of Redeemable Preferred Units for net proceeds of $3.4 million
(excluding preferred unit fees of $0.2 million) to existing holders of the
Redeemable Preferred Units,
- Borrowing under our amended credit agreement of approximately
$36.6 million, and
- $1.3 million from available cash.
The sources and uses of funds for the Orthotech Acquisition are presented in the
following table (dollars in millions):
<Table>
<Caption>
- ----------------------------------------------------------------------
Amount
- ----------------------------------------------------------------------
SOURCES
Cash........................................................ $ 1.3
Revolving credit facility................................... 12.6
Term loan................................................... 24.0
Redeemable Preferred Units.................................. 3.4
Common unit investment by JPMDJ Partners.................... 8.1
Common unit investment by Management........................ 0.2
--------
$ 49.6
--------
USES
Cash to DePuy Orthopaedic................................... $ 46.4
Debt issuance costs......................................... 0.4
Transaction fees and costs.................................. 2.6
Management promissory notes................................. 0.2
--------
$ 49.6
======================================================================
</Table>
F-16
<Page>
The Orthotech Acquisition has been accounted for using the purchase method of
accounting and the Company has allocated the purchase price to the tangible and
intangible assets based on their estimated fair values as determined by the
Company, in accordance with Accounting Principles Board Opinion No. 16. The
purchase price has been allocated to the acquired tangible and intangible assets
based on their fair market values as follows (in thousands):
<Table>
- ---------------------------------------------------------------------------------
Inventories................................................. $ 2,538
Equipment and furniture..................................... 1,295
Other assets held for sale.................................. 126
Intangibles:
Goodwill.................................................. $36,623
Customer base............................................. 8,400
Assembled workforce....................................... 37 45,060
-------------------
Net assets acquired......................................... $49,019
=================================================================================
</Table>
The net assets acquired have been reduced by the $0.4 million relating to debt
issuance costs incurred.
As a result of the Orthotech Acquisition, the Company incurred $0.4 million in
post-closing merger and integration costs. These costs relate primarily to
consulting and information systems expenses that did not qualify for
capitalizations under EITF 95-3, "Recognition of Liabilities in Connection with
a Purchase Business Combination."
The accompanying consolidated statements of income reflect the operating results
of Orthotech since the date of acquisition. Assuming the purchase of Orthotech
had occurred on January 1 of the respective years, the pro forma unaudited
results of operations would have been as follows (in thousands):
<Table>
<Caption>
- -----------------------------------------------------------------------------------
December 31,
---------------------
1999 2000
- -----------------------------------------------------------------------------------
Net revenues................................................ $161,159 $165,858
Net income.................................................. $ 6,770 $ 5,386
===================================================================================
</Table>
3. Financial Statement Information
Inventories
Inventories consist of the following (in thousands):
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------
December 31,
------------------- September 29,
1999 2000 2001
- ------------------------------------------------------------------------------------------------
(unaudited)
Raw materials............................................. $ 6,392 $ 9,074 $ 10,745
Work-in-progress.......................................... 1,446 1,572 1,191
Finished goods............................................ 6,817 11,638 12,893
------------------------------------
14,655 22,284 24,829
Less reserve for excess and obsolete...................... (991) (3,774) (3,058)
------------------------------------
$13,664 $18,510 $ 21,771
================================================================================================
</Table>
F-17
<Page>
The reserves are primarily for excess and obsolete inventories as of
December 31, 2000 and September 29, 2001 and include $2.2 million and
$1.0 million, respectively, relating to the inventory acquired in the Orthotech
Acquisition. The reserve recorded upon the acquisition totaled $5.1 million of
which $2.9 million and $4.1 million was utilized during the twelve months ended
December 31, 2000 and the nine months ended September 29, 2001, respectively.
Property, plant and equipment
Property, plant and equipment consists of the following (in thousands):
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
December 31,
------------------- September 29,
1999 2000 2001
- -----------------------------------------------------------------------------------------------
(unaudited)
Buildings and leasehold improvements..................... $ 3,577 $ 3,676 $ 4,176
Office furniture, fixtures, equipment and other.......... 15,817 19,025 27,322
Construction in progress................................. 1,297 5,804 1,665
------------------------------------
20,691 28,505 33,163
Less accumulated depreciation and amortization........... (13,394) (15,720) (18,283)
------------------------------------
$ 7,297 $ 12,785 $ 14,880
===============================================================================================
</Table>
Intangible assets
Intangible assets arose primarily from the initial acquisition of DonJoy in 1987
by the Former Parent, the Company's acquisition of Professional Care
Products, Inc. in 1995, the Company's acquisition of Orthotech in 2000 and the
Company's acquisition of Alaron in 2001. The licensing agreements pertain to the
acquisition of the distribution rights of the PainBuster-Registered Trademark-
products. In addition, the Company re-acquired distribution rights in 2000.
Intangible assets consist of the following (in thousands):
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
Useful December 31,
lives -------------------- September 29,
(in years) 1999 2000 2001
- -------------------------------------------------------------------------------------------------
(unaudited)
Goodwill..................................... 20 $ 24,742 $ 61,365 $ 60,930
Patented technology.......................... 5-20 14,437 14,437 15,859
Customer base................................ 15-20 11,600 20,000 20,000
Licensing agreements......................... 5 2,000 2,000 2,000
Other........................................ 3-20 649 1,886 1,936
-------------------------------------
53,428 99,688 100,725
Less: accumulated amortization............... (20,233) (24,269) (28,696)
-------------------------------------
$ 33,195 $ 75,419 $ 72,029
=================================================================================================
</Table>
F-18
<Page>
Other Accrued Liabilities
Other accrued liabilities consist of (in thousands):
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------
December 31,
------------------- September 29,
1999 2000 2001
- --------------------------------------------------------------------------------------------------
(unaudited)
Accrued cost of distribution rights......................... $ -- $1,050 $ 453
Accrued returns............................................. 397 618 587
Accrued rebate expense...................................... 356 541 406
Accrued warranty expense.................................... 259 305 341
Accrued credit memos........................................ 617 898 2,129
Other accruals.............................................. 2,038 2,954 3,056
------------------------------------
$3,667 $6,366 $ 6,972
==================================================================================================
</Table>
4. Financing arrangements
Principal balances under dj Ortho's long-term financing arrangements consist of
the following (in thousands):
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------
December 31,
--------------------- September 29,
1999 2000 2001
- ------------------------------------------------------------------------------------------------
(unaudited)
12 5/8% Senior Subordinated Notes due 2009, net of
$1,740 and $1,587 of unamortized discount at
December 31, 2000 and September 29, 2001,
respectively.......................................... $ 98,055 $ 98,260 $ 98,413
Senior Credit Facility:
Term loans due 2005, interest rates ranging from 9.18%
to 9.81% at December 31, 2000 and 5.69% at
September 29, 2001.................................... 15,250 38,362 37,405
Revolving credit facility, interest rates ranging from
8.88% to 9.00% at December 31, 2000 and 5.19% to 5.81%
at September 29, 2001................................. -- 20,600 13,600
--------------------------------------
113,305 157,222 149,418
Current portion of long-term debt....................... (500) (1,274) (1,274)
--------------------------------------
112,805 155,948 148,144
Less: Senior Subordinated Notes (see above)............. (98,055) (98,260) (98,413)
--------------------------------------
Long-term debt net of current portion................... $ 14,750 $ 57,688 $ 49,731
================================================================================================
</Table>
F-19
<Page>
12 5/8% senior subordinated notes due 2009
On June 30, 1999, dj Ortho issued $100.0 million of 12 5/8% Senior Subordinated
Notes due 2009 (the "Notes") to various investors in connection with the
financing of the Recapitalization. The Notes were issued at a discount of
$2.0 million which is being accreted to the Notes balance and amortized to
interest expense over the life of the Notes. The Notes are general unsecured
obligations of dj Ortho, subordinated in right of payment to all existing and
future senior indebtedness of dj Ortho, pari passu in right of payment to all
senior subordinated indebtedness of dj Ortho and senior in right of payment to
all subordinated indebtedness.
Interest on the Notes is payable in cash semi-annually on each June 15 and
December 15, commencing on December 15, 1999. The aggregate principal amount of
the Notes matures on June 15, 2009.
COVENANTS. The Notes contain covenants restricting the ability of dj Ortho and
its subsidiaries to (i) incur additional indebtedness; (ii) prepay, redeem or
repurchase debt; (iii) make loans and investments; (iv) incur liens and engage
in sale lease-back transactions; (v) enter into transactions with affiliates;
(vi) engage in mergers, acquisitions and asset sales; (vii) make optional
payments on or modify the terms of the subordinated debt; (viii) restrict
preferred and capital stock of subsidiaries; (ix) declare dividends or redeem or
repurchase capital stock; and (x) engage in other lines of businesses. As of
December 31, 2000 and September 29, 2001, the Company was in compliance with all
covenants.
GUARANTEES; CO-ISSUERS. The Notes are guaranteed by DonJoy and co-issued by dj
Ortho and DJ Capital, but are not guaranteed by dj Orthopedics, LLC de Mexico de
S.A. de C.V., dj Orthopaedics Pty Ltd or dj Ortho Canada, Inc., dj Ortho's only
existing subsidiaries (other than DJ Capital).
OPTIONAL REDEMPTION. Before June 15, 2002, up to 35% of the aggregate principal
amount of the Notes may be redeemed with the proceeds from sales of common
equity at a redemption price of 112.625% of their principal amount, plus any
accrued and unpaid interest.
On or after June 15, 2004, the Notes may be redeemed, in whole or in part, at
the following redemption prices (expressed as percentages of principal amount),
plus accrued and unpaid interest and liquidated damages thereon, if any, to the
redemption date if redeemed during the 12-month period commencing on June 15 of
the years set forth below:
<Table>
<Caption>
- -------------------------------------------------------------------------
Redemption
Year Price
- -------------------------------------------------------------------------
2004........................................................ 106.313%
2005........................................................ 104.208%
2006........................................................ 102.104%
2007 and thereafter......................................... 100.000%
=========================================================================
</Table>
Amended credit facility
In connection with the Recapitalization, dj Ortho entered into a Credit
Agreement with First Union National Bank ("First Union") and the Chase Manhattan
Bank ("Chase") and other lenders. In connection with the Orthotech Acquisition,
the Credit Agreement was amended ("Amended Credit Agreement"). Under the Amended
Credit Agreement, dj Ortho may borrow up to $64.5 million consisting of a
revolving credit facility of up to $25.0 million (the "revolving credit
facility") and term loans in a principal amount of $39.5 million (the "term
loans"). The first term loan, in the amount of $15.5 million, was
F-20
<Page>
borrowed in connection with the Recapitalization and the second term loan, in
the amount of $24.0 million, was borrowed to finance the Orthotech Acquisition.
As of September 29, 2001, dj Ortho has borrowed $13.6 million under the
revolving credit facility, primarily to consummate and fund working capital
needs of the Orthotech Acquisition. The revolving credit facility includes
options by dj Ortho to enter into revolving loans of up to $25.0 million, to
enter into swingline loans and to obtain letters of credit from time to time.
The revolving credit facility provides for letters of credit in an aggregate
stated amount at any time outstanding not in excess of the lesser of
$5.0 million and the difference between $25.0 million and the sum of the
outstanding principal amount of dj Ortho revolving loans, letter of credit
exposure and swingline exposure at such time. Borrowings under the Amended
Credit Agreement bear interest at the rate per annum equal to the greatest of
(a) the Prime Rate in effect on such day, (b) the Base Certificate of Deposit
Rate in effect on such day plus 1% and (c) the Federal Funds Effective Rate in
effect on such day plus 1/2 of 1%. Borrowings under the revolving credit
facility and term loans bear interest at variable rates plus an applicable
margin (ranging from 8.875% to 9.813% as of December 31, 2000 and 5.188% to
5.813% as of September 29, 2001).
In addition to paying interest on outstanding principal under the Amended Credit
Agreement, dj Ortho is required to pay a commitment fee to the lenders under the
revolving credit facility in respect of the unutilized commitments thereunder at
a rate equal to 0.5% per annum.
REPAYMENT. The term loans will mature on June 30, 2005 and are subject to
mandatory repayments and reductions as defined in the Amended Credit Agreement.
The following table sets forth the principal payments on the term loans for the
years 2001 through its maturity in 2005 (in thousands):
<Table>
<Caption>
- ---------------------------------------------------------------------
2001........................................................ $ 1,274
2002........................................................ 1,274
2003........................................................ 1,274
2004........................................................ 17,202
2005........................................................ 17,338
-------
Total....................................................... $38,362
=====================================================================
</Table>
In addition, dj Ortho is required to make annual mandatory prepayments of the
term loan under the amended credit facility in an amount equal to 50% of excess
cash flow (75% if dj Ortho's leverage ratio exceeds a certain level). Excess
cash flow represents net income adjusted for (i) extraordinary gains or losses;
(ii) depreciation, amortization and other non-cash charges; (iii) changes in
working capital; (iv) changes in deferred revenues; (v) payments for capital
expenditures; and (vi) repayment of indebtedness. dj Ortho had no excess cash
flow at December 31, 1999 or 2000. In addition, the term loan is subject to
mandatory prepayments in an amount equal to (a) 100% of the net cash proceeds of
certain equity and debt issuances by DonJoy, dj Ortho or any of its subsidiaries
and (b) 100% of the net cash proceeds of certain asset sales or other
dispositions of property by DonJoy, dj Ortho or any of its subsidiaries, in each
case subject to certain exceptions. No mandatory prepayments were required by dj
Ortho at December 31, 1999, December 31, 2000 or September 29, 2001.
SECURITY; GUARANTEES. The obligations of dj Ortho under the Amended Credit
Agreement are irrevocably guaranteed, jointly and severally, by DonJoy, DJ
Capital and future subsidiaries. In addition, the Amended Credit Agreement and
the guarantees thereunder are secured by substantially all the assets of the
Company.
F-21
<Page>
COVENANTS. The Amended Credit Agreement contains a number of covenants that,
among other things, restrict the ability of dj Ortho and its subsidiaries to
(i) dispose of assets; (ii) incur additional indebtedness; (iii) incur or
guarantee obligations; (iv) prepay other indebtedness or amend other debt
instruments; (v) pay dividends or make other distributions (except for certain
tax distributions); (vi) redeem or repurchase membership interests or capital
stock, create liens on assets, make investments, loans or advances, make
acquisitions; (vii) engage in mergers or consolidations; (viii) change the
business conducted by dj Ortho and its subsidiaries; (ix) make capital
expenditures; (x) or engage in certain transactions with affiliates and
otherwise engage in certain activities. In addition, the Amended Credit
Agreement requires dj Ortho and its subsidiaries to comply with specified
financial ratios and tests, including a maximum consolidated leverage ratio test
and a minimum consolidated interest coverage ratio test. The Amended Credit
Agreement also contains provisions that prohibit any modifications of the Notes
in any manner adverse to the lenders under the Amended Credit Agreement and that
limit the dj Ortho's ability to refinance or otherwise prepay the Notes without
the consent of such lenders. dj Ortho was in compliance with the covenants at
December 31, 2000 and September 29, 2001.
5. Common and preferred units
DonJoy is authorized to issue up to 2,900,000 common units and up to 100,000
preferred units. As of December 31, 2000 and September 29, 2001, 793,890 and
885,633 common units, respectively, and 44,405 and 44,405 preferred units,
respectively, were issued and outstanding.
Just prior to the recapitalization in June 1999, the Company's Former Parent
contributed intercompany accounts totaling $47,853 to the Company. At the same
time the Company's capitalization of 2,054,000 common units was established and
the Company's total equity value of $64,117 was recorded to common units
resulting in a charge to retained earnings of $16,264, which represents the
retained earnings balance through December 31, 1997 plus the net income through
the date of the recapitalization of $3,432.
In accordance with a unit purchase agreement dated as of June 28, 2000, the
Former Parent sold its remaining interest of 54,000 common units in DonJoy to
JPMDJ Partners and certain members of management for $5.9 million. JPMDJ
Partners purchased 52,495 common units for a total consideration of
$5.7 million and the members of management purchased the remaining 1,505 units
for a total consideration of $0.2 million, substantially all of which was
financed by loans from DonJoy, evidenced by full recourse promissory notes with
market interest rates. As a result of this transaction, dj Ortho no longer
reflects any intercompany transactions in its consolidated financial statements.
The related party revenues were $10.7 million in 1998, $8.3 million in 1999 and
$4.6 million in 2000.
In connection with the unit purchase agreement, DonJoy agreed to amend and
restate the promissory notes originally issued by the members of management in
connection with the Recapitalization. The principal amount of each amended and
restated note was equal to the sum of outstanding principal on the original
notes and any accrued and unpaid interest on the notes. In addition to
increasing the rate of interest payable on the notes from 5.30% to 6.62% per
annum, the amended and restated notes permit the members of management to
increase the principal amount due under the note by the amount of a scheduled
interest payment (the "PIK Option"). If a certain member of management elects
the PIK Option, the principal amount of his note is increased by the amount of
the scheduled interest payment and interest then accrues on the principal amount
of the note as so increased. The amended and restated notes mature in 2007.
F-22
<Page>
In connection with the Orthotech Acquisition, gross proceeds of $8.3 million
from the sale of common units were received through the issuance of 73,775
common units to JPMDJ Partners for gross proceeds of $8.0 million and the
issuance of 2,115 common units to certain members of management for gross
proceeds of $231,000 (of which $174,000 was paid for through the issuance of
full recourse promissory notes by the management members). Gross proceeds of
$3.6 million from the sale of 4,221 units of Redeemable Preferred Units were
received from existing Redeemable Preferred Unit holders of which the net
proceeds totaled $3.4 million (excluding preferred unit fees).
The Redeemable Preferred Units accrue a cumulative quarterly preferred return at
a fixed rate of 14.0% per annum, subject to increase to 16.0% per annum upon the
occurrence of certain events of non-compliance. Total dividends for the year
ended December 31, 2000 were $5.3 million. Payment of the preferred dividends is
made at the discretion of the Board of Managers. The proceeds received from the
sale of the Redeemable Preferred Units are net of $1.8 million of preferred unit
fees paid to J.P. Morgan Partners (23A SBIC), LLC (formerly CB Capital
Investors, LLC), First Union Capital Partners, LLC and DJ Investment, LLC. These
Redeemable Preferred Unit fees are being accreted over a period of 114 months,
beginning July 1, 1999 and ending on December 31, 2008. The accretion of these
Redeemable Preferred Units for the year ended December 31, 2000 was
$0.2 million and are included in dividends. In addition to the rights with
respect to the preferred return (including related tax distributions and
distributions to the holders of preferred units of their original capital
investment), the Redeemable Preferred Units will share ratably with the common
units in any distributions (including tax distributions and upon liquidation)
made by DonJoy in respect of common units (the Redeemable Preferred Units
Participating Interest).
The Redeemable Preferred Units (other than the Redeemable Preferred Units
Participating Interest) are subject to mandatory redemption on December 31, 2009
and may be redeemed at DonJoy's option at any time. Upon a change of control,
holders of Redeemable Preferred Units will have the right, subject to certain
conditions, to require DonJoy to redeem their Redeemable Preferred Units
(including the Redeemable Preferred Units Participating Interest). In addition,
at any time after June 30, 2005 holders will have the right, subject to certain
conditions, to require DonJoy to redeem their Redeemable Preferred Units
Participating Interest. Unless equity proceeds or other funds are available to
DonJoy for the purpose, the ability of DonJoy to make any of the foregoing
payments will be subject to receipt of distributions from dj Ortho in amounts
sufficient to make such payments and such distributions will be subject to the
restrictions contained in the Amended Credit Agreement and the Indenture.
Upon the occurrence of any Liquidation Event (as defined in the Third Amended
and Restated Operating Agreement of DonJoy, L.L.C. dated July 7, 2000 (the
"Operating Agreement")), the holders of Redeemable Preferred Units are entitled
to receive payment, before any payments shall be made to the holders of common
units, based on a calculation referred to in the Operating Agreement. In
addition, DonJoy has the option to redeem the Redeemable Preferred Units prior
to the redemption date based upon the following percents which would be applied
to the total of the original costs of such Redeemable Preferred Unit plus any
unpaid cumulative dividends:
<Table>
Prior to the first anniversary of original issuance date.... 105%
On or after the first anniversary and prior to the second
anniversary of original issuance date..................... 104%
On or after the second anniversary and prior to the third
anniversary of original issuance date..................... 103%
On or after the third anniversary and prior to the fourth
anniversary of original issuance date..................... 102%
On or after the fourth anniversary and prior to the fifth
anniversary of original issuance date..................... 101%
On or after the fifth anniversary of original issuance
date...................................................... 100%
</Table>
F-23
<Page>
VOTING. Except as otherwise required by applicable law or as set forth in the
operating agreement or the members' agreement, holders of common units and
Redeemable Preferred Units shall vote together as a single class on all matters
to be voted on by the members, with each unit being entitled to one vote.
TAX DISTRIBUTIONS. The indenture and the credit facility permit dj Ortho to
make distributions to DonJoy in certain amounts to allow DonJoy to make
distributions to its members to pay income taxes in respect of their allocable
share of the taxable income of DonJoy and its subsidiaries including dj Ortho.
Unit options.
Under DonJoy, L.L.C.'s Second Amended and Restated 1999 Option Plan, 166,799
common units are reserved for issuance upon exercise of options granted or to be
granted under the plan as of December 31, 2000. In February 2001, the Company
amended the 1999 Option Plan and, as of September 29, 2001, 178,799 common units
are reserved for issuance upon exercise of options granted or to be granted
under the Plan, as amended. The plan is administered by the Compensation
Committee appointed from time to time by the Board of Managers and allows for
the issuance of common unit options to officers, directors, employees,
independent consultants and advisors of the Company. The plan expires on
June 30, 2014 unless earlier terminated by the Board of Managers. The plan
provides for the grant of nonqualified options to officers, directors, and
employees of, and independent consultants and advisors to, the Company.
Options will be granted in amounts to be agreed upon by the Compensation
Committee. Options will generally vest either:
- 25% beginning on June 30, 2000 and thereafter ratably over a 3 year
period for those options granted on June 30, 2000 (Tier I), or
- 25% at the end of 1 year from the date of the grant and the balance
vesting ratably thereafter for all options granted after June 30, 2000
(Tier I), or
- Tier II and III options which cliff vest on December 31, 2007; however,
accelerated vesting can be achieved upon completion of certain events, or
- Time-vested based upon achievement of certain sales targets.
F-24
<Page>
As of December 31, 2000 and September 29, 2001, 14,140 and 29,485 units,
respectively, issued under this plan were exercisable and 17,959 and 16,729
units, respectively, were available for future grant under the option plan. The
following table summarizes option activity through September 29, 2001:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
Weighted
average
exercise
Options Option price price
- -----------------------------------------------------------------------------------------------
Outstanding as of December 31, 1998...................... -- $-- $ --
Granted................................................ 120,512 $100 $ 100
Exercised.............................................. -- -- --
Cancelled.............................................. -- -- --
-------
Outstanding as of December 31, 1999...................... 120,512 $100 $ 100
Granted................................................ 28,328 $100 to $109 $ 104
Exercised.............................................. -- -- --
Cancelled.............................................. -- -- --
-------
Outstanding at December 31, 2000......................... 148,840 $100 to $109 $ 101
Granted (unaudited).................................... 28,860 $100 to $147 $ 147
Exercised (unaudited).................................. -- -- --
Cancelled (unaudited).................................. (15,630) $100 to $109 $ 102
-------
Outstanding at September 29, 2001 (unaudited)............ 162,070 $100 to $147 $ 109
===============================================================================================
</Table>
The following table summarizes information concerning currently outstanding and
exercisable options:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------ ------------------------------
Number
outstanding Weighted Weighted Number Weighted
Range of as of average average exercisable as of average
exercise December 31, remaining exercise December 31, exercise
prices 2000 life in years price 2000 price
- ---------------------------------------------------------------------------------------------------
100.....$.... 136,540 13.60 $ 100 14,040 $ 100
109.....$.... 12,300 14.60 $ 109 -- $ 109
===================================================================================================
</Table>
Pro forma information regarding net income is required by SFAS 123 and has been
determined as if the Company had accounted for its employee options under the
fair value method of SFAS 123. The fair value of these options was estimated at
the date of grant using the minimum value model for option pricing with the
following assumptions for 1999 and 2000: a risk-free interest rate of 6.25%; a
dividend yield of zero; and a weighted average life of the option of 4 years for
Tier I options and 8.5 years for Tier II and Tier III options.
Option valuation models require the input of highly subjective assumptions.
Because the Company's employee options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee options.
F-25
<Page>
For purposes of adjusted pro forma disclosures the estimated fair value of the
options is amortized to expense over the vesting period. The Company's pro forma
information is as follows for the years ended December 31 (in thousands):
<Table>
<Caption>
- ---------------------------------------------------------------------------------
1999 2000
- ---------------------------------------------------------------------------------
Pro forma net income........................................ $6,569 $3,979
=================================================================================
</Table>
The pro forma effect on net income is not necessarily indicative of potential
pro forma effects on results for future years.
6. Recapitalization costs and fees
In connection with the Recapitalization, the Company incurred costs and fees of
$8.8 million, $5.9 million for the Notes, $1.4 million for the credit agreement
and $1.5 million for transaction fees and expenses related to equity. Of the
$8.8 million, $7.4 million ($6.5 million net of accumulated amortization) has
been capitalized in the accompanying balance sheet as of December 31, 2000. The
remaining $1.5 million has been recorded as a reduction to members' equity
(deficit) transaction fees and expenses as of December 31,1999. The capitalized
debt fees are being amortized over the term of the related debt.
F-26
<Page>
7. Segments and related information
dj Ortho has two reportable segments as defined by Financial Accounting
Standards Board SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information". dj Ortho's reportable segments are business units that
offer different products that are managed separately because each business
requires different technology and marketing strategies. The rigid knee bracing
segment designs, manufactures and sells rigid framed ligament and osteoarthritis
knee braces and post-operative splints. The soft goods segment designs,
manufactures and sells fabric, neoprene and Drytex based products for the knee,
ankle, shoulder, back and wrist. dj Ortho's other operating segments are
included in specialty and other complementary orthopedic products. None of the
other segments met any of the quantitative thresholds for determining reportable
segments. In 2001, dj Ortho determined that certain products within the soft
goods segment and specialty and other complementary orthopedic products were
more appropriately classified in the rigid knee bracing segment. In addition,
certain products within specialty and other complementary orthopedic products
were more appropriately classified in the soft goods segment. To be consistent
with the current period presentation, prior periods have been reclassified.
Information regarding industry segments is as follows (in thousands):
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------
Nine months Nine months
Years ended December 31, ended ended
------------------------------------ September 30, September 29,
1998 1999 2000 2000 2001
- ----------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Net revenues:.....................
Rigid knee bracing.............. $ 52,473 $ 52,953 $ 58,115 $ 42,640 $ 50,190
Soft goods...................... 32,010 38,606 51,412 35,592 46,194
----------------------------------------------------------------------
Net revenues for reportable
segments...................... 84,483 91,559 109,527 78,232 96,384
Specialty and other
complementary orthopedic
products...................... 15,653 21,344 29,647 20,733 27,371
Freight revenue................. 3,507 3,515 4,412 3,221 3,606
----------------------------------------------------------------------
Total consolidated net revenues... $103,643 $116,418 $143,586 $ 102,186 $ 127,361
----------------------------------------------------------------------
Gross profit:
Rigid knee bracing.............. $ 36,669 $ 37,994 $ 41,189 $ 30,372 $ 35,551
Soft goods...................... 15,707 18,723 24,662 16,903 19,997
----------------------------------------------------------------------
Gross profit for reportable
segments...................... 52,376 56,717 65,851 47,275 55,548
Specialty and other
complementary orthopedic
products...................... 7,050 9,447 16,635 11,648 15,060
Freight revenue................. 3,507 3,515 4,412 3,221 3,606
Brand royalties................. (3,249) (1,817) -- -- --
Other cost of goods sold........ (2,507) (3,188) (3,490) (3,008) (709)
----------------------------------------------------------------------
Total consolidated gross profit... $ 57,177 $ 64,674 $ 83,408 $ 59,136 $ 73,505
==========================================================================================================
</Table>
The accounting policies of the reportable segments are the same as those
described in the basis of presentation. dj Ortho allocates resources and
evaluates the performance of segments based on gross
F-27
<Page>
profit and therefore has not disclosed certain other items, such as interest,
depreciation and amortization by segment as permitted by SFAS No. 131.
Intersegment sales were not significant for any period.
For the periods ended December 31, 1999 and 2000 and September 29, 2001, dj
Ortho had no individual customer or distributor within a segment which accounted
for more than 10% or more of total revenues.
Assets allocated in foreign countries were not significant. Net revenues to
customers, attributed to countries based on the location of the customer, were
as follows (in thousands):
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------
Nine months ended
Years ended December 31, -------------------------------
------------------------------------ September 30, September 29,
1998 1999 2000 2000 2001
- ----------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
United States..................... $ 82,898 $ 95,022 $121,125 $ 86,586 $ 108,307
Europe............................ 11,050 11,473 11,124 8,200 10,544
Other countries................... 6,188 6,408 6,925 4,179 4,904
Freight revenue................... 3,507 3,515 4,412 3,221 3,606
----------------------------------------------------------------------
Total consolidated net revenues... $103,643 $116,418 $143,586 $ 102,186 $ 127,361
==========================================================================================================
</Table>
dj Ortho does not allocate assets to reportable segments because all property
and equipment are shared by all segments of dj Ortho.
8. Condensed consolidating financial information
As discussed in Notes 1 and 4 above, dj Ortho's obligations under the Notes are
guaranteed by its parent, DonJoy L.L.C., which has no independent assets or
operations. This guarantee and any guarantee by a future parent or wholly-owned
subsidiary guarantor, is full and unconditional. dj Ortho (DonJoy's operating
subsidiary) and DJ Capital (a subsidiary formed solely for the purpose of being
a co-issuer) comprise all the direct and indirect subsidiaries of DonJoy (other
than minor foreign subsidiaries). We have concluded that separate financial
statements of DonJoy, dj Ortho and DJ Capital are not required to be filed as
separate reports under the Securities Exchange Act of 1934. The Notes and the
Amended Credit Agreement contain certain covenants restricting the ability of dj
Ortho and DJ Capital to, among other things, pay dividends or make other
distributions (other than certain tax distributions) or loans or advances to
DonJoy unless certain financial tests are satisfied in the case of the indenture
or the consent of the lenders is obtained in the case of the credit facility.
The indenture and the credit facility permit dj Ortho to make distributions to
DonJoy in certain amounts to allow DonJoy to make distributions to its members
to pay income taxes in respect of their allocable share of taxable income of
DonJoy and its subsidiaries, including dj Ortho. At December 31, 2000, under
these requirements, neither dj Ortho nor DJ Capital would be permitted to make
dividends, distributions, loans or advances to DonJoy except for the permitted
tax distributions. The restricted net assets (deficit) of DonJoy L.L.C.'s
consolidated subsidiaries amount to $(22) million.
9. Transactions with Smith & Nephew
Prior to the Recapitalization, the Company was a wholly owned subsidiary of
Smith & Nephew, Inc. On June 30, 1999 the Company consummated the
Recapitalization. On June 28, 2000, the Former Parent
F-28
<Page>
sold its remaining interest in DonJoy to JPMDJ Partners and certain members of
management (see Note 1). As a result of this transaction, the Company no longer
reflects any intercompany transactions on the consolidated balance sheets,
statements of income and statements of cash flows.
Under the control of its Former Parent, the Company had numerous transactions
with its Former Parent and its affiliates. The intercompany obligations
represent a net balance as the result of various transactions. There were no
terms of settlement or interest charges associated with the account balance. The
balance results from the Company's former participation in the Former Parent's
central cash management program, wherein all the Company's cash receipts were
remitted to the Former Parent and all cash disbursements were funded by the
Former Parent. An analysis of intercompany transactions follows (in thousands):
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
Years ended December 31,
-----------------------------
1998 1999
- -------------------------------------------------------------------------------------------
Net cash remitted to Former Parent.......................... $ (18,256) $ (17,743)
Net intercompany sales...................................... (4,822) (112)
Share of Former Parent's current income taxes............... 4,287 (134)
Corporate management expense allocations.................... 5,664 3,159
Cash owed to Former Parent.................................. -- 1,002
I-Flow licensing agreement.................................. -- 800
Capital contribution........................................ -- (38,865)
Direct charges:
Brand royalties........................................... 3,249 1,817
Payroll taxes and benefits................................ 8,635 4,651
Direct legal expenses..................................... 324 67
Foreign Sales Corporation (FSC) commission................ 439 --
Miscellaneous other administrative expenses................. 680 131
===========================================================================================
</Table>
Prior to the Recapitalization, the Former Parent and Smith & Nephew, plc
provided certain management, financial, administrative and legal services to the
Company. These expenses and all other central operating costs, were charged on
the basis of direct usage when identifiable, with the remainder allocated among
the Former Parent's subsidiaries and divisions on the basis of their respective
annual sales or percentage of capital employed.
F-29
<Page>
Former Parent allocations consist of the following (in thousands):
<Table>
<Caption>
- ---------------------------------------------------------------------------------
Years ended
December 31,
-------------------
1998 1999
- ---------------------------------------------------------------------------------
Corporate managed accounts and new business................. $ 394 $ 195
Finance (risk management, treasury, audit, and taxes)....... 310 177
Human resources and payroll................................. 291 147
Legal....................................................... 223 128
Research and development.................................... 854 380
Corporate management expense................................ 1,332 784
Bonus....................................................... 503 467
Pension..................................................... 514 267
Insurance................................................... 1,243 614
-------------------
$5,664 $3,159
-------------------
Amounts included in:
Cost of goods sold........................................ $ 991 $ 495
Sales and marketing....................................... 179 94
General and administrative................................ 4,439 2,553
Research and development.................................. 55 17
-------------------
$5,664 $3,159
=================================================================================
</Table>
Also prior to the Recapitalization, the Company participated in the Former
Parent's corporate insurance programs for workers' compensation, product and
general liability. These charges were settled with the Former Parent, and thus,
accruals for related liabilities, if any, were maintained by the Former Parent
and are not reflected in the accompanying consolidated balance sheets.
10. Restructuring
In March 1998, dj Ortho combined its two operating facilities into one location
in Vista, California and accrued $2.5 million in costs resulting from the
restructuring which had no future economic benefit. These costs relate primarily
to remaining lease obligations on the vacated facility, net of projected
sublease income, and severance costs associated with the termination of twelve
employees. Included in general and administrative costs for 1998 are
$0.2 million of costs also related to the combination of the facilities.
Pursuant to the Recapitalization agreement, the restructuring reserve, which
amounted to $0.9 million at June 29, 1999 and consisted of the remaining lease
obligations on the vacated facility, was assumed by Smith & Nephew.
11. Commitments and contingencies
The Company is obligated under various noncancellable operating leases for land,
buildings, equipment, vehicles and office space through February 2008. Certain
of the leases provide that dj Ortho pay all or a portion of taxes, maintenance,
insurance and other operating expenses, and certain of the rents are subject to
adjustment for changes as determined by certain consumer price indices and
exchange rates. In connection with the Recapitalization, the Company entered
into a subleasing agreement with Smith & Nephew for its Vista facility. DonJoy
has guaranteed the payment of rent and other amounts owed under the sublease by
the Company.
F-30
<Page>
Minimum annual lease commitments for noncancellable operating leases as of
December 31, 2000 are as follows (in thousands):
<Table>
- ---------------------------------------------------------------------
2001........................................................ $ 2,458
2002........................................................ 2,263
2003........................................................ 2,202
2004........................................................ 1,880
2005........................................................ 1,852
2006 and thereafter......................................... 4,013
-------
$14,668
=====================================================================
</Table>
Aggregate rent expense was approximately $3.2 million, $2.7 million and
$3.2 million for the years ended December 31, 1998, 1999 and 2000 and
$2.3 million and $2.6 million for the nine months ended September 30, 2000 and
September 29, 2001, respectively.
License agreements
In August of 1998, the Company entered into an exclusive license agreement with
IZEX Technologies, Incorporated ("IZEX") to acquire the intellectual property
rights and to retain IZEX to consult on the design and development of an
advanced rehabilitation bracing system. Under the license, the Company also has
the worldwide exclusive rights to manufacture, use and sell developed products.
At December 31, 2000, $1.0 million is included in intangible assets (patented
technology) in the accompanying balance sheet. Under an amended agreement, the
Company is obligated to make an additional payment of $0.8 million.
In 1999, the Company entered into an agreement, which was subsequently amended,
with I-Flow Corporation ("I-Flow") for the exclusive North American distribution
rights for the PainBuster-Registered Trademark- Pain Management Systems
manufactured by I-Flow for use after orthopedic surgical procedures. The license
payment has been capitalized during 1999 and is being amortized over 5 years. In
addition, the Company purchased $2.8 million in I-Flow product during 2000 and
is required to purchase $2.5 million in I-Flow product in 2001.
Contingencies
The Company is subject to legal proceedings and claims that arise in the normal
course of business. While the outcome of the proceedings and claims cannot be
predicted with certainty, management does not believe that the outcome of any of
these matters will have a material adverse effect on the Company's consolidated
financial position or results of operations.
12. Retirement plans
Prior to the Recapitalization, substantially all of the Company's employees
participated in a defined benefit pension plan sponsored by the Former Parent.
Benefits related to this plan were computed using formulas, which were generally
based on age and years of service. Aggregate pension prepayments and liabilities
related to this plan are recorded by the Former Parent. Pension expense
allocated (based on relative participation) to the Company related to this plan
was as follows (in thousands):
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
Years ended December 31,
-----------------------------
1998 1999
- -------------------------------------------------------------------------------------------
Service costs............................................... $ 466 $ 242
Interest costs.............................................. 48 25
-----------------------------
Total pension expense allocated............................. $ 514 $ 267
===========================================================================================
</Table>
F-31
<Page>
DonJoy has a qualified 401(k) profit-sharing plan covering substantially all of
its U.S. employees, which is substantially the same as the plan previously
provided by Smith & Nephew. The assets funding the Smith & Nephew plan were
transferred to the DonJoy 401(k) Plan. The Company matches dollar for dollar the
first $500, then matches at a 30 percent rate, employee contributions up to
6 percent of total compensation. The Company's matching contributions related to
this plan were $0.3 million, $0.3 million and $0.4 million for the years ended
December 31, 1998, 1999 and 2000, respectively. The plan also provides for
discretionary Company contributions (employee profit sharing) which began on
June 30, 1999 as approved by the Board of Managers. There were no contributions
for the year ended December 31, 2000. The Company's discretionary 401(k)
contributions for the year ended December 31, 1999 were $228,000. DonJoy's
401(k) plan is administered by Fidelity Investments Institutional Services
Company, Inc.
13. Terminated acquisition
In October 2000, the Company decided to discontinue its pursuit of a potential
acquisition. Absent the resumption of negotiations which is not currently
anticipated, costs incurred related to this potential acquisition have been
expensed during the fourth quarter of 2000 in the amount of $0.4 million.
14. Subsequent event--Legal proceedings (unaudited)
On November 27, 2001, Marc Kaysen filed a purported class action in the United
States District Court for the Southern District of New York, captioned KAYSEN V.
CROSS, ET AL., 01 CV 10707 (HB), allegedly on behalf of himself and all
purchasers of dj Orthopedics, Inc.'s stock pursuant to or traceable to its
initial public offering (the "Offering"). The complaint names as defendants dj
Orthopedics, Inc., its Chief Executive Officer, Chief Financial Officer, and
Chairman of the Board of Directors, and the lead underwriters of the Offering.
The complaint alleges causes of action for violations of Sections 11, 12(a)(2),
and 15 of the Securities Act of 1933, based on, among other things, supposed
materially false and misleading statements and omissions in the Offering's
registration statement and prospectus. The complaint seeks rescission of
plaintiffs' purchases and other unspecified damages. Six additional purported
class actions, allegedly on behalf of the same plaintiffs, naming the same
defendants, incorporating substantially similar allegations, and seeking
substantially similar relief as the KAYSEN action, have since been filed in the
United States District Courts for the Southern District of California and the
Southern District of New York: STEINBERG V. CROSS, ET AL., 01 CV 10978, was
filed in New York on December 6, 2001; EAST SIDE HOLDINGS ELEVEN LTD. V. CROSS,
ET AL., 01 CV 10991, was filed in New York on December 6, 2001; BEVERLY V.
CROSS, ET AL., 01 CV 11384, was filed in New York on December 11, 2001;
WESSEL V. CROSS, ET AL., 01 CV 11471, was filed in New York on December 14,
2001; LARKY V. DJ ORTHOPEDICS, INC. ET AL., 01 CV 2238 K (LSP), was filed in
California on December 5, 2001; and GREEN V. DJ ORTHOPEDICS, ET AL., 01 CV 2260
IEG (LAB) was filed in California on December 7, 2001. Additionally, as of
December 20, 2001, dj Orthopedics, Inc. is aware of reports in the news media of
the filing of two other actions purportedly containing similar allegations;
however, the Company has not yet seen either of those complaints. dj
Orthopedics, Inc. believes that all of the actions' allegations lack merit and
intends to defend the actions vigorously.
F-32
<Page>
Depuy Orthopaedic Technology, Inc.
combined balance sheets
<Table>
<Caption>
- -----------------------------------------------------------------------------------------
As of As of
June 30, December 31,
As of June 30, 2000 and December 31, 1999 (in thousands) 2000 1999
- -----------------------------------------------------------------------------------------
(unaudited)
Assets
Current assets
Cash...................................................... $ 12 $ --
Accounts receivable, less allowances ($2,499 and $2,202 at
June 30, 2000 and December 31, 1999, respectively)...... 9,595 10,332
Inventories............................................... 6,473 7,203
Deferred income taxes..................................... 1,760 1,761
Other current assets...................................... 7 52
---------------------------
Total current assets.................................... 17,847 19,348
Property, plant and equipment, net.......................... 3,377 3,577
Goodwill and other identifiable intangibles assets, net..... 47,120 48,135
Deferred income taxes....................................... 272 272
Other assets................................................ 45 45
---------------------------
Total assets............................................ $ 68,661 $ 71,377
---------------------------
Liabilities and invested equity
Current liabilities
Accounts payable.......................................... $ 754 $ 1,354
Book overdraft............................................ 556 539
Accrued liabilities....................................... 1,503 2,291
---------------------------
Total current liabilities............................... 2,813 4,184
Invested equity............................................. 65,848 67,193
---------------------------
Total liabilities and invested equity................... $ 68,661 $ 71,377
=========================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE COMBINED FINANCIAL
STATEMENTS.
F-33
<Page>
DePuy Orthopaedic Technology, Inc. combined statements of operations and changes
in invested equity
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
For the six For the six
months ended months ended
For the six months ended June 30, 2000 and 1999 (in thousands) June 30, 2000 June 30, 1999
- -----------------------------------------------------------------------------------------------
(unaudited)
Net sales.................................................... $ 23,978 $ 22,901
Cost of goods sold........................................... 13,326 13,005
-------------------------------
Gross profit............................................... 10,652 9,896
Selling, general and administrative expenses................. 5,637 6,272
Research and development expense............................. 246 185
Amortization expense......................................... 1,015 1,022
Allocated expenses (Note 3).................................. 3,253 834
-------------------------------
10,151 8,313
Income before provision for income taxes..................... 501 1,583
Provision for income taxes................................... 461 569
-------------------------------
Net income (loss)............................................ $ 40 $ 1,014
-------------------------------
Invested equity--beginning of period......................... $ 67,193 $ 66,266
Advances from (repayments to) DePuy.......................... (1,348) 3,726
Currency translation adjustment.............................. 3 6
-------------------------------
Invested equity--end of period............................... $ 65,848 $ 69,998
===============================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE COMBINED FINANCIAL
STATEMENTS.
F-34
<Page>
DePuy Orthopaedic Technology, Inc. combined statements of cash flows
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
For the six For the six
months ended months ended
For the six months ended June 30, 2000 and 1999 (in thousands) June 30, 2000 June 30, 1999
- -----------------------------------------------------------------------------------------------
(unaudited)
Cash flows from operating activities
Net income (loss).......................................... $ 40 $ 1,014
Adjustments to reconcile net income to net cash (used in)
provided by operating activities
Depreciation............................................. 334 328
Amortization............................................. 1,015 1,022
Deferred income taxes.................................... 1 --
Provision for accounts receivable........................ 297 364
Changes in operating assets and liabilities
(Increase) in accounts receivable........................ 440 (2,003)
(Increase) decrease in other assets...................... 45 (110)
(Increase) decrease in inventory......................... 730 (8,413)
Increase (decrease) in accounts payable.................. (600) 1,235
Increase (decrease) in accrued expenses.................. (788) 3,397
-------------------------------
Net cash (used in) provided by operating activities.......... 1,514 (3,166)
-------------------------------
Cash flows from investing activities
Purchases of property and equipment........................ (134) (439)
-------------------------------
Net cash used in investing activities........................ (134) (439)
-------------------------------
Cash flows from financing activities
Advances from (repayments to) DePuy........................ (1,388) 3,726
Book overdraft............................................. 17 --
-------------------------------
Net cash provided by (used in) financing activities.......... (1,371) 3,726
-------------------------------
Effect of exchange rate changes on cash...................... 3 6
-------------------------------
Net change in cash........................................... 12 127
Cash, beginning of period.................................... -- 2
-------------------------------
Cash, end of period.......................................... $ 12 $ 129
===============================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE COMBINED FINANCIAL
STATEMENTS.
F-35
<Page>
DePuy Orthopaedic Technology, Inc. notes to combined financial statements
(unaudited)
(dollars in thousands)
1. Background and description of business
On July 7, 2000, Johnson & Johnson sold the net assets, consisting principally
of inventory, property, plant and equipment, plus certain rights and
intellectual property, of the bracing and soft supports business of DePuy
Orthopaedic Technology, Inc. to DonJoy, L.L.C. and dj Orthopedics, LLC.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate, public
entity from 1993 (year of initial public offering) through March 1996. In
March 1996, Orthopedic Technology was purchased by DePuy, Inc. ("DePuy").
Shortly after the acquisition in 1996, the existing DePuy sports medicine
business, which had products in the bracing and soft support business, was
combined with Orthopedic Technology and the resulting business was renamed DePuy
Orthopaedic Technology, Inc. ("OrthoTech"). Subsequently, on October 29, 1998,
Johnson & Johnson acquired DePuy in a purchase business combination, and the
existing Johnson & Johnson bracing and soft supports products (the "J&J
Business") were transferred to OrthoTech as of January 1, 1999. As a result of
these transactions, OrthoTech became an integrated operation of DePuy, which is
a wholly-owned subsidiary of Johnson & Johnson. The accompanying combined
financial statements exclude the operations of an arthroscopy business of
OrthoTech, which was transferred to another operation of Johnson & Johnson on
January 1, 2000, as well as a casting business which is not part of the sale
described above. Accordingly, the accompanying combined financial statements of
OrthoTech present an aggregation of the bracing and soft supports operations of
DePuy, as well as the J&J Business.
OrthoTech engages in the development, manufacturing and marketing of bracing and
soft supports products which assist in the treatment of both hard and soft
tissue injury management. OrthoTech's primary markets are North America, Europe
and the Asia Pacific Region. OrthoTech sells its products through Johnson &
Johnson and DePuy affiliated companies outside of the U.S. market.
2. Summary of significant accounting policies
Basis of presentation
In the opinion of dj Orthopedics, LLC's management, the accompanying unaudited
combined financial statements contain all adjustments necessary for a fair
statement of the combined financial position of OrthoTech as of June 30, 2000
and the combined results of their operations and their cash flows for the six
months ended June 30, 2000 and 1999. Such adjustments are generally of a normal
recurring nature and include adjustments to certain accruals and reserves to
appropriate levels.
The unaudited combined quarterly financial statements contained herein should be
read in conjunction with the combined annual financial statements and related
notes thereto for the year ended December 31, 1999.
As an integrated operation of DePuy, and an indirect wholly-owned subsidiary of
Johnson & Johnson, OrthoTech did not, in the normal course of operations,
prepare separate financial statements in accordance with accounting principles
generally accepted in the United States. Accordingly, the accompanying unaudited
combined financial statements have been derived by extracting the assets,
F-36
<Page>
liabilities and revenues and expenses of OrthoTech from the consolidated assets,
liabilities and revenues and expenses of DePuy and Johnson & Johnson. The
accompanying unaudited combined financial statements reflect assets,
liabilities, revenues and expenses directly attributable to OrthoTech as well as
allocations deemed reasonable by management to present the combined results of
their operations for the six month periods ended June 30, 2000 and 1999 on a
stand alone basis. The allocation methodologies have been described within the
respective notes and management considers the allocations to be reasonable.
However, the combined financial position, results of operations and their cash
flows of OrthoTech may differ from those that may have been achieved had
OrthoTech operated autonomously or as an entity independent of DePuy and
Johnson & Johnson. In addition, due to the reliance of the OrthoTech business on
Johnson & Johnson and DePuy, the historical operating results may not be
indicative of future results.
There was no direct interest expense incurred by OrthoTech therefore, no
interest expense has been reflected in the combined financial statements.
All significant accounts and transactions within OrthoTech have been eliminated.
Risks and uncertainties
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported. Actual results could differ
from those estimates.
Cash
OrthoTech participates in DePuy's cash pooling arrangements, under which cash
balances are cleared automatically to a central account. All transactions
between OrthoTech and DePuy have been accounted for as settled in cash at the
time such transactions were recorded by OrthoTech.
Comprehensive income
In accordance with Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income", components of other comprehensive income
(loss) consist of the following:
<Table>
<Caption>
- -------------------------------------------------------------------------------------
For the
six months ended
-----------------------
June 30, June 30,
2000 1999
- -------------------------------------------------------------------------------------
Net income (loss)........................................... $ 40 $ 1,014
Other comprehensive income
Currency translation adjustments.......................... 3 6
-----------------------
Total comprehensive income (loss)....................... $ 43 $ 1,020
=====================================================================================
</Table>
3. Transactions with Johnson & Johnson and DePuy
OrthoTech relies on Johnson & Johnson and DePuy for certain services, including
treasury, cash management, employee benefits, tax compliance, risk management,
internal audit, financial reporting and general corporate services. Although
certain expenses related to services have been allocated to
F-37
<Page>
OrthoTech, the combined financial position, results of operations and cash flows
presented in the accompanying combined financial statements may not have been
the same as those that would have occurred had OrthoTech been an independent
entity. A description of the related party transactions follows:
Sales of products
OrthoTech sells its products through Johnson & Johnson and DePuy affiliated
companies outside of the U.S. market. Net sales for such products were $1,596
and $2,128 for the six months ended June 30, 2000 and 1999, respectively.
Allocation of selling, general and administrative expenses
Effective January 1, 2000, Johnson & Johnson began allocating certain costs to
OrthoTech. These costs include insurance, fringe benefits (principally pension
and postretirement benefits), legal, payroll, accounts payable, and certain
other administrative costs. Such costs have been allocated to OrthoTech based
upon headcount and sales, and amounted to $2,615 for the six months ended
June 30, 2000. Management believes these allocations are reasonable. Prior to
January 1, 2000, these cost were incurred and paid by OrthoTech.
OrthoTech has been allocated a portion of the costs of the DePuy central support
functions. These costs include central departments, notably legal, tax,
treasury, finance, business development, and human resources. Such costs have
been allocated to OrthoTech based upon OrthoTech's sales to third parties,
relative to total DePuy sales to third parties. Such amounts were $112 and $122
for the six months ended June 30, 2000 and 1999, respectively. Management
believes these allocations are reasonable.
In addition, OrthoTech has been allocated a portion of the selling, general and
administrative expenses of the Johnson & Johnson and DePuy affiliates outside of
the U.S. that sold OrthoTech's products. Such amounts were $526 and $712 for the
six months ended June 30, 2000 and 1999, respectively. These amounts have been
allocated based upon OrthoTech's sales to third parties, relative to total DePuy
sales to third parties. Management believes these allocations are reasonable.
The total allocated selling, general and administrative expenses described above
are separately identified on the combined statements of operations.
Invested equity
Invested equity consists of capital contributions by DePuy and Johnson &
Johnson, borrowings and repayments to DePuy and Johnson & Johnson, retained
earnings/deficit and the cumulative translation adjustment.
Intercompany account with DePuy
The average intercompany balance outstanding for the six month periods ended
June 30, 2000 and 1999 was a net payable due to DePuy of $2,507 and $2,473,
respectively.
Income taxes
OrthoTech is not a separate taxable entity in any jurisdiction. Rather,
OrthoTech's taxable income is included in consolidated income tax returns of
Johnson & Johnson in most jurisdictions. However, for
F-38
<Page>
purposes of these unaudited combined financial statements, the provision for
income taxes has been computed on a separate return basis using estimated annual
effective tax rates in various tax jurisdictions. Effective tax rates were 92.0%
and 35.9% for the six month periods ended June 30, 2000 and 1999, respectively.
Current income taxes are considered to have been paid or charged to Johnson &
Johnson.
4. Inventories
Inventories consist of the following:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------
As of As of
June 30, December 31,
2000 1999
- -----------------------------------------------------------------------------------------
(unaudited)
Raw materials............................................... $ 3,117 $ 3,566
Work-in-process............................................. 30 75
Finished goods.............................................. 3,326 3,562
---------------------------
$ 6,473 $ 7,203
=========================================================================================
</Table>
5. Concentration of credit risk
OrthoTech sells its products to physicians, hospitals and clinics located
throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk with respect to trade receivables are limited due
to the large numbers of customers comprising OrthoTech's customer base. No one
customer represents more than 10% of sales or receivables. Ongoing credit
evaluations of customers' financial conditions are performed, and, generally, no
collateral is required. OrthoTech maintains reserves for potential credit losses
and such losses, in the aggregate, have not exceeded management's expectations.
6. Geographic areas
Information about OrthoTech's operations by geographic area for the six months
ended June 30, 2000 and 1999 are shown below:
<Table>
<Caption>
- ----------------------------------------------------------------------------------------
Sales to Operating
Six months ended June 30, 2000 customers income (loss)
- ----------------------------------------------------------------------------------------
North America............................................... $ 22,909 $ 323
Europe...................................................... 882 170
Asia Pacific................................................ 147 4
Rest of the World........................................... 40 (4)
--------------------------
Total..................................................... $ 23,978 $ 501
========================================================================================
</Table>
F-39
<Page>
<Table>
<Caption>
- ----------------------------------------------------------------------------------------
Sales to Operating
Six months ended June 30, 1999 customers income (loss)
- ----------------------------------------------------------------------------------------
North America............................................... $ 21,205 $ 1,357
Europe...................................................... 1,538 224
Asia Pacific................................................ 110 6
Rest of the World........................................... 48 (4)
--------------------------
Total..................................................... $ 22,901 $ 1,583
========================================================================================
</Table>
7. Contingencies
In the normal course of business, OrthoTech is party to claims and disputes.
OrthoTech has provided for these legal matters where it is probable that a
liability has been incurred and the amount of cost could be reasonably
estimated. While the ultimate outcome of these claims and lawsuits cannot be
readily determined, it is the opinion of management that none of them,
individually or in the aggregate, will have a material adverse effect on
OrthoTech's combined financial position, results of operations or cash flows.
F-40
<Page>
Report of Independent Accountants
To the Board of Directors of
Johnson & Johnson:
In our opinion, the accompanying combined balance sheets and the related
combined statements of operations and changes in invested equity, and combined
statements of cash flows present fairly, in all material respects, the combined
financial position of DePuy Orthopaedic Technology, Inc. ("OrthoTech"), an
integrated operation of DePuy, Inc. ("DePuy"), which is a wholly-owned
subsidiary of Johnson & Johnson as described in Note 1 to the combined financial
statements, as of December 31, 1999 and 1998, and the combined results of their
operations and their cash flows for the year ended December 31, 1999 and the
period October 29, 1998 through December 31, 1998, in conformity with accounting
principles generally accepted in the United States. These combined financial
statements are the responsibility of OrthoTech's management; our responsibility
is to express an opinion on these combined financial statements based on our
audits. We conducted our audits of these statements in accordance with auditing
standards generally accepted in the United States which require that we plan and
perform the audit to obtain reasonable assurance about whether the combined
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the combined financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall combined
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
OrthoTech is a fully integrated operation of DePuy, which is a wholly-owned
subsidiary of Johnson & Johnson. Consequently, as indicated in Note 2, these
combined financial statements have been derived from the consolidated financial
statements and accounting records of Johnson & Johnson and DePuy and reflect
significant assumptions and allocations. Moreover, as indicated in Note 3,
OrthoTech relies on DePuy for administrative, management and other services. The
financial position, results of operations and cash flows of OrthoTech could
differ from those that would have resulted had OrthoTech operated autonomously
or as an entity independent of Johnson & Johnson and DePuy.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
April 19, 2000
F-41
<Page>
Depuy Orthopaedic Technology, Inc. combined statements of operations and changes
in invested equity
for the year ended December 31, 1999 and for the period October 29, 1998 through
December 31, 1998
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
For the year For the period
ended October 29, 1998
December 31, through
(in thousands) 1999 December 31, 1998
- -------------------------------------------------------------------------------------------------
Net sales................................................... $ 48,423 $ 8,046
Cost of goods sold (1998 includes $1,891 of inventory
write-offs for restructuring).............................. 27,019 7,241
-----------------------------------
Gross profit.............................................. 21,404 805
Selling, general and administrative expenses................ 16,069 2,828
Research and development expense............................ 286 34
Amortization expense........................................ 2,044 341
Allocated expenses (Note 3)................................. 1,498 302
Restructuring charges (Note 9).............................. -- 1,500
-----------------------------------
19,897 5,005
Income (loss) before provision/(benefit) for income taxes... 1,507 (4,200)
Provision/(benefit) for income taxes........................ 1,406 (1,485)
-----------------------------------
Net income (loss)........................................... $ 101 $ (2,715)
-----------------------------------
Invested equity--beginning of period........................ $ 66,266 $ 68,324
Advances from (repayments to) DePuy......................... 803 660
Currency translation adjustment............................. 23 (3)
-----------------------------------
Invested equity--end of period.............................. $ 67,193 $ 66,266
=================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE COMBINED FINANCIAL
STATEMENTS.
F-43
<Page>
DePuy Orthopaedic Technology, Inc.
combined statements of cash flows
for the year ended December 31, 1999 and for the period October 29, 1998 through
December 31, 1998
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
For the year For the period
ended October 29, 1998
December 31, through
(in thousands) 1999 December 31, 1998
- -------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net income (loss)......................................... $ 101 $ (2,715)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation............................................ 629 89
Amortization............................................ 2,044 341
Deferred income taxes................................... 361 (1,832)
Provision for accounts receivable....................... 1,118 114
Provisions for restructuring............................ -- 1,500
Loss on disposal of property and equipment.............. 6 --
Changes in operating assets and liabilities
(Increase) decrease in accounts receivable.............. (4,467) 244
Decrease (increase) in other assets..................... 37 (63)
Decrease in inventory................................... 257 2,150
(Decrease) increase in accounts payable................. (474) 189
(Decrease) in accrued expenses.......................... (123) (770)
-----------------------------------
Net cash used in operating activities....................... (511) (753)
-----------------------------------
Cash flows from investing activities
Purchases of property and equipment....................... (833) (116)
-----------------------------------
Net cash used in investing activities....................... (833) (116)
-----------------------------------
Cash flows from financing activities
Advances from DePuy....................................... 803 660
Book overdraft............................................ 539 --
-----------------------------------
Net cash provided by financing activities................... 1,342 660
-----------------------------------
Net change in cash.......................................... (2) (209)
Cash, beginning of period................................... 2 211
-----------------------------------
Cash, end of period......................................... $ -- $ 2
=================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE COMBINED FINANCIAL
STATEMENTS.
F-44
<Page>
DePuy Orthopaedic Technology, Inc. notes to combined financial statements
(dollars in thousands)
1. Background and description of business
Johnson & Johnson is negotiating the sale of the net assets, consisting
principally of inventory, property, plant and equipment, plus certain rights and
intellectual property, of the bracing and soft supports business of DePuy
Orthopaedic Technology, Inc.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate, public
entity from 1993 (year of initial public offering) through March 1996. In
March 1996, Orthopedic Technology was purchased by DePuy, Inc. ("DePuy").
Shortly after the acquisition in 1996, the existing DePuy sports medicine
business, which had products in the bracing and soft support business, was
combined with Orthopaedic Technology and the resulting business was renamed
DePuy Orthopaedic Technology, Inc. ("OrthoTech"). Subsequently, on October 29,
1998, Johnson & Johnson acquired DePuy in a purchase business combination, and
the existing Johnson & Johnson bracing and soft supports products (the "J&J
Business") were transferred to OrthoTech as of January 1, 1999. As a result of
these transactions, OrthoTech became an integrated operation of DePuy, which is
a wholly-owned subsidiary of Johnson & Johnson. The accompanying combined
financial statements exclude the operations of an arthroscopy business of
OrthoTech, which was transferred to another operation of Johnson & Johnson on
January 1, 2000, as well as a casting business which is not part of the sale
described above. Accordingly, the accompanying combined financial statements of
OrthoTech present an aggregation of the bracing and soft supports operations of
DePuy, as well as the J&J Business, effective October 29, 1998 (the date upon
which the combined business being sold was under common control). Refer to Note
2 for additional details.
OrthoTech engages in the development, manufacturing and marketing of bracing and
soft supports products which assist in the treatment of both hard and soft
tissue injury management. OrthoTech's primary markets are North America, Europe
and the Asia Pacific Region. OrthoTech sells its products through Johnson &
Johnson and DePuy affiliated companies outside of the U.S. market.
2. Summary of significant accounting policies
Basis of presentation
As described in Note 1, the businesses that comprise OrthoTech were not under
common management control during the entire three year period ended
December 31, 1999. Accordingly, the combined financial statements of OrthoTech
presented herein represent the business being sold for the period they were
under common control (Johnson & Johnson's acquisition of DePuy on October 29,
1998). Separate financial statements of OrthoTech and separate financial
statements of the J&J Business have been prepared for the period prior to
Johnson & Johnson acquiring DePuy on October 29, 1998 as follows:
a. Separate financial statements have been prepared which depict the
results of operations and cash flows of OrthoTech for the period January 1,
1998 through October 28, 1998 and the year ended December 31, 1997 which
represents the period OrthoTech was controlled by DePuy (prior to Johnson &
Johnson acquiring DePuy).
F-45
<Page>
b. Separate financial statements have been prepared to depict the
revenues and direct expenses of the J&J Business for the period January 1,
1998 through October 28, 1998 and for the year ended December 31, 1997. This
represents the period in which the bracing and soft supports business, which
was later transferred to OrthoTech and is part of the net assets being sold,
was owned directly by Johnson & Johnson.
As an integrated operation of DePuy, and an indirect wholly-owned subsidiary of
Johnson & Johnson, OrthoTech did not, in the normal course of operations,
prepare separate financial statements in accordance with accounting principles
generally accepted in the United States. Accordingly, the accompanying combined
financial statements have been derived by extracting the assets, liabilities and
revenues and expenses of OrthoTech from the consolidated assets, liabilities and
revenues and expenses of DePuy and Johnson & Johnson. The accompanying combined
financial statements reflect assets, liabilities, revenues and expenses directly
attributable to OrthoTech as well as allocations deemed reasonable by management
to present the combined financial position of OrthoTech at December 31, 1999 and
1998, and the combined results of their operations and cash flows for the year
ended December 31, 1999 and the period October 29, 1998 through December 31,
1998 on a stand alone basis. The allocation methodologies have been described
within the respective notes and management considers the allocations to be
reasonable. However, the combined financial position, results of operations and
cash flows of OrthoTech may differ from those that may have been achieved had
OrthoTech operated autonomously or as an entity independent of DePuy and
Johnson & Johnson. In addition, due to the reliance of the OrthoTech business on
Johnson & Johnson and DePuy, the historical operating results may not be
indicative of future results.
There was no direct interest expense incurred by OrthoTech therefore, no
interest expense has been reflected in the combined financial statements.
All significant accounts and transactions within OrthoTech have been eliminated.
Risks and uncertainties
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported. Actual results could differ
from those estimates.
Revenue recognition
Revenues from product sales are recognized when goods are shipped and title and
risk of loss passes to customers.
Cash
OrthoTech participates in DePuy's cash pooling arrangements, under which cash
balances are cleared automatically to a central account. All transactions
between OrthoTech and DePuy have been accounted for as settled in cash at the
time such transactions were recorded by OrthoTech.
F-46
<Page>
Property, plant and equipment
Property, plant and equipment are stated at cost. OrthoTech utilizes the
straight-line method of depreciation over the estimated useful lives of the
assets:
<Table>
- --------------------------------------------------------------------------------------------------
Leasehold improvements...................................... Shorter of life of lease or 15 years
Machinery and equipment..................................... 3-10 years
==================================================================================================
</Table>
Gains and losses on disposals are included in selling, general and
administrative expense. Major additions and betterments are capitalized, whereas
maintenance and repairs are expensed as incurred.
Intangible assets
The goodwill reflected in these combined financial statements relates to the
acquisition of DePuy by Johnson & Johnson and is being amortized on a
straight-line basis over a period of 40 years. Values assigned to other
identifiable intangible assets, consisting of the trademarks and OrthoTech's
existing products, are being amortized on a straight-line basis over a period of
40 years and 20 years, respectively.
Long-lived assets
OrthoTech continually evaluates the carrying value of its long-lived assets,
including intangibles, for impairment. Any impairments would be recognized when
the expected future operating cash flows derived from such intangible assets is
less than their carrying value.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method.
Foreign currency translation
The local currencies of OrthoTech's international operations represent their
respective functional currencies. Assets and liabilities of foreign operations
are translated from their respective local currencies to U.S. dollars using
exchange rates in effect at the corresponding balance sheet dates. Income
statement and cash flow amounts are translated using the average exchange rates
in effect during the period. Adjustments resulting from the translation of
foreign currency financial statements have been included in invested equity.
Gains and losses resulting from foreign currency transactions are included in
the results of operations and are immaterial to the periods presented.
F-47
<Page>
Comprehensive income
In accordance with Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," components of other comprehensive income/
(loss) consist of the following:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
For the year For the period
ended October 29, 1998
December 31, through
1999 December 31, 1998
- -------------------------------------------------------------------------------------------------
Net income/(loss)........................................... $ 101 $ (2,715)
Other comprehensive income
Currency translation adjustments.......................... 23 (3)
-----------------------------------
Total comprehensive income/(loss)....................... $ 124 $ (2,718)
=================================================================================================
</Table>
Advertising
Costs associated with advertising are expensed in the year incurred. Advertising
expenses, which are comprised of print media, television and radio advertising,
were $74 and $45 for the year ended December 31, 1999 and the period
October 29, 1998 through December 31, 1998, respectively.
Research and development
Research and development costs are expensed as incurred.
3. Transactions with Johnson & Johnson and DePuy
OrthoTech relies on Johnson & Johnson and DePuy for certain services, including
treasury, cash management, employee benefits, tax compliance, risk management,
internal audit, financial reporting and general corporate services. Although
certain expenses related to services have been allocated to OrthoTech, the
combined financial position, results of operations and cash flows presented in
the accompanying combined financial statements may not have been the same as
those that would have occurred had OrthoTech been an independent entity. A
description of the related party transactions follows:
Sales of products
OrthoTech sells its products through Johnson & Johnson and DePuy affiliated
companies outside of the U.S. market. Net sales for such products were $3,816
and $655 for the year ended December 31, 1999 and the period from October 29,
1998 through December 31, 1998, respectively.
Allocation of selling, general and administrative expenses
OrthoTech has been allocated a portion of the costs of the DePuy central support
functions. These costs include central departments, notably legal, tax,
treasury, finance, business development, and human resources. Such costs have
been allocated to OrthoTech based upon OrthoTech's sales to third parties,
relative to total DePuy sales to third parties. Such amounts were $243 and $73
for the year ended December 31, 1999 and the period October 29, 1998 through
December 31, 1998, respectively. Management believes these allocations are
reasonable.
F-48
<Page>
In addition, OrthoTech has been allocated a portion of the selling, general and
administrative expenses of the Johnson & Johnson and DePuy affiliates outside of
the U.S. that sold OrthoTech's products. Such amounts were $1,255 and $229 for
the year ended December 31, 1999 and for the period October 29, 1998 through
December 31, 1998, respectively. These amounts have been allocated based upon
OrthoTech's sales to third parties, relative to total DePuy sales to third
parties. Management believes these allocations are reasonable.
The total allocated selling, general and administrative expenses described above
are separately identified on the combined statements of operations.
Invested equity
Invested equity consists of capital contributions by DePuy and Johnson &
Johnson, borrowings and repayments to DePuy and Johnson & Johnson, retained
earnings/deficit and the cumulative translation adjustment.
Intercompany account with dePuy
The average intercompany balance outstanding for the year ended December 31,
1999 and for the period October 29, 1998 through December 31, 1998 was a net
payable due to DePuy of $5,244 and a net receivable due from DePuy of $13,364,
respectively.
Pensions
Eligible OrthoTech employees are provided with pension benefits through a
noncontributory defined contribution plan which covers substantially all
non-union employees of DePuy in the United States. This plan provides for
targeted benefits based on the employee's average compensation in the years
preceding retirement. In general, DePuy's policy is to contribute actuarially
determined amounts that are expected to be sufficient to meet projected benefit
payment requirements.
Employees of DePuy's international subsidiaries are covered by various pension
benefit arrangements, some of which are considered to be defined benefit plans
for financial reporting purposes. Funding policies are based on legal
requirements, tax considerations and local practices.
Since the aforementioned pension arrangements are part of certain DePuy employee
benefit plans, no discrete actuarial data is available for the portion allocable
to OrthoTech. Therefore, no liability or asset is reflected in the accompanying
combined financial statements. OrthoTech has been allocated pension costs based
upon participant employee headcount. Net pension expense included in the
accompanying combined financial statements was $284 and $31 for the year ended
December 31, 1999 and the period October 29, 1998 through December 31, 1998,
respectively.
Postretirement benefits other than pensions
Certain OrthoTech employees are covered under DePuy's unfunded postretirement
health care benefit plans. In general, DePuy pays a defined portion of an
eligible retiree's health care premium. The plans are contributory based on
years of services, with contributions adjusted annually.
Since the aforementioned postretirement benefit arrangements are part of certain
DePuy benefit plans, no discrete actuarial data is available for the portion
allocable to OrthoTech. Therefore, no asset or liability is reflected in the
accompanying combined financial statements. OrthoTech has been allocated
F-49
<Page>
postretirement benefit costs based upon participant employee headcount. Net
postretirement benefit expense included in the accompanying combined financial
statements was $159 and $17 for the year ended December 31, 1999 and the period
October 29, 1998 through December 31, 1998, respectively.
Savings plan
Under an employee savings plan sponsored by DePuy, non-union employees of
OrthoTech in the United States may contribute up to 11% of their compensation,
subject to certain limitations. DePuy matches 100% of an employees' contribution
up to 4% of their compensation. Matching contributions made by DePuy and
expensed were $315 and $55 for the year ended December 31, 1999 and the period
October 29, 1998 through December 31, 1998, respectively.
Stock based compensation
For the year ended December 31, 1999 and the period October 29, 1998 through
December 31, 1998, certain employees of OrthoTech participated in certain
Johnson & Johnson sponsored share option and long-term share incentive plans.
Stock options expire 10 years from the date they are granted and vest over
service periods that range from one to six years. All options granted are valued
at current market price.
A summary of the status of OrthoTech's participation in Johnson & Johnson's
stock option plans as of December 31, 1999 and December 31, 1998 and changes
during the period ending on those dates, is presented below:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
Options Weighted average
outstanding exercise price
- -----------------------------------------------------------------------------------------------
Balance at October 29, 1998................................. -- $ --
Option granted.............................................. 15,350 80.31
Options exercised........................................... -- --
Options cancelled/forfeited................................. -- --
---------------------------------
Balance at December 31, 1998................................ 15,350 80.31
Options granted............................................. 12,550 100.16
Options exercised........................................... -- --
Options cancelled/forfeited................................. 2,000 80.31
---------------------------------
Balance at December 31, 1999................................ 25,900 $ 89.93
===============================================================================================
</Table>
The following table summarized stock options outstanding and exercisable at
December 31, 1999:
<Table>
<Caption>
- ----------------------------------------------------------------------------
Outstanding Exercisable
- ------------------------------------------------------ -------------------
Average Average
Average exercise exercise
Exercise price range Options life price Options price
- ----------------------------------------------------------------------------
$80.31 13,350 8.9 $ 80.31 -- $ --
$100.16 12,550 9.9 100.16 -- --
----------------------------------------------------
$80.31 - $100.16 25,900 9.4 $ 89.93 -- $ --
============================================================================
</Table>
F-50
<Page>
Johnson & Johnson applies the provision of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," that calls for
companies to measure employee stock compensation expense based on the fair value
method of accounting. However, as allowed by the Statement, Johnson & Johnson
elected continued use of Accounting Principle Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," with pro forma disclosure of net
income determined as if the fair value method had been applied in measuring
compensation cost. Had the fair value method been applied, net (loss) income
would have been adjusted to the amounts indicated below:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
For the For the period
year ended October 29, 1998
December 31, through
1999 December 31, 1998
- -------------------------------------------------------------------------------------------------
Net income (loss)--as reported.............................. $ 101 $ (2,715)
Net income (loss)--as adjusted.............................. $ 63 $ (2,718)
=================================================================================================
</Table>
Compensation cost for the determination of "net income (loss) -- as adjusted"
were estimated using the Black-Scholes option pricing model and the following
assumptions:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
For the For the period
year ended October 29, 1998
December 31, through
1999 December 31, 1998
- -------------------------------------------------------------------------------------------------
Risk free interest rate..................................... 6.35% 4.47%
Expected volatility......................................... 24.00% 22.00%
Expected dividend yield..................................... 1.13% 1.30%
Expected life............................................... 5.0 years 5.0 years
=================================================================================================
</Table>
The weighted average fair value of options granted in the year ended
December 31, 1999 and the period from October 29, 1998 through December 31, 1998
was $30.21 and $19.61, respectively.
Income taxes
OrthoTech is not a separate taxable entity in any jurisdiction. Rather, the
OrthoTech's taxable income is included in consolidated income tax returns of
Johnson & Johnson in most jurisdictions. However, for purposes of these combined
financial statements, the provision for income taxes has been computed on a
separate return basis. Current income taxes are considered to have been paid or
charged to Johnson & Johnson. The principal components of deferred taxes are
related to depreciation and amortization of fixed assets and intangibles, and
the impact of certain costs and accruals not currently deductible.
4. Johnson & Johnson acquisition of DePuy
On October 29, 1998, Johnson & Johnson completed its acquisition of DePuy. The
excess of purchase price over the estimated fair value of net tangible assets
acquired has been allocated to identifiable intangibles and goodwill in the
consolidated financial statements of Johnson & Johnson. Included in the
F-51
<Page>
purchase price allocations from the acquisition of DePuy were the following
intangible assets relating to OrthoTech:
<Table>
- ---------------------------------------------------------------------
Intangible assets
Goodwill.................................................. $11,467
Existing OrthoTech products............................... 31,256
Trademarks................................................ 7,797
-------
Total................................................... $50,520
=====================================================================
</Table>
The amount attributed to OrthoTech's existing products represents the value of
OrthoTech's technology (product designs), surgeon champion relationships and
clinical data for each existing product category.
5. Inventories
Inventories consist of the following:
<Table>
<Caption>
- ---------------------------------------------------------------------------------
As of
December 31,
-------------------
1999 1998
- ---------------------------------------------------------------------------------
Raw materials............................................... $3,566 $4,102
Work-in-process............................................. 75 120
Finished goods.............................................. 3,562 3,238
-------------------
$7,203 $7,460
=================================================================================
</Table>
6. Property, plant and equipment
Property, plant and equipment consist of the following:
<Table>
<Caption>
- ---------------------------------------------------------------------------------
As of
December 31,
-------------------
1999 1998
- ---------------------------------------------------------------------------------
Leasehold improvements...................................... $ 581 $ 279
Machinery and equipment..................................... 3,723 3,070
Construction in progress.................................... -- 78
-------------------
$4,304 $3,427
Less: Accumulated depreciation.............................. (727) (71)
-------------------
$3,577 $3,356
=================================================================================
</Table>
Depreciation expense amounted to $629 and $89 for the year ended December 31,
1999 and for the period from October 29, 1998 through December 31, 1998,
respectively.
7. Income taxes
The provision for income taxes was calculated by applying statutory tax rates to
the reported pretax income after considering permanent items that do not enter
into the determination of taxable income
F-52
<Page>
and tax credits reflected in the consolidated provision of Johnson & Johnson,
which are related to OrthoTech.
The effective income tax rate differs from the statutory Federal income tax rate
for the following reasons:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
For the year For the period
ended October 29, 1998
December 31, through
1999 December 31, 1998
- -------------------------------------------------------------------------------------------------
U.S......................................................... $ 1,078 $ (4,265)
Foreign..................................................... 429 65
-----------------------------------
Income/(loss) before provision/(benefit) for income
taxes................................................... 1,507 (4,200)
-----------------------------------
Statutory taxes......................................... $ 527 $ (1,470)
-----------------------------------
Tax rates:
Statutory Federal income tax rate......................... 35.0% (35.0)%
Goodwill amortization not deductible...................... 48.0% 2.8%
State and local taxes, net of Federal tax benefit......... 2.8% 3.8%
Other..................................................... 7.5% (7.0)%
-----------------------------------
Effective income tax rate............................... 93.3% (35.4)%
=================================================================================================
</Table>
Other consists principally of non-deductible business meal and entertainment
expenses and tax differences related to foreign operations.
Deferred income taxes are recognized for tax consequences of "temporary
differences" by applying enacted statutory tax rates to differences between the
financial reporting and the tax basis of existing assets and liabilities. The
more significant temporary differences giving rise to deferred tax assets and
liabilities are as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------
As of As of
December 31, 1999 December 31, 1998
---------------------- ----------------------
Assets Liabilities Assets Liabilities
- -------------------------------------------------------------------------------------------------------
Reserves.............................................. $1,130 $1,354
Accruals.............................................. 313 312
Intangibles........................................... 525 525
Depreciation.......................................... $ (297) $ (215)
Other................................................. 362 418
-----------------------------------------------
Total deferred income taxes......................... $2,330 $ (297) $2,609 $ (215)
=======================================================================================================
</Table>
F-53
<Page>
8. Intangible assets
Components of net intangible assets were:
<Table>
<Caption>
- ---------------------------------------------------------------------------------
As of
December 31,
-------------------
1999 1998
- ---------------------------------------------------------------------------------
Goodwill.................................................... $11,467 $11,467
Trademarks.................................................. 7,797 7,797
Existing OrthoTech products................................. 31,256 31,256
-------------------
50,520 50,520
Less: Accumulated amortization.............................. (2,385) (341)
-------------------
$48,135 $50,179
=================================================================================
</Table>
Amortization expense was $2,044 and $341 for the year ended December 31, 1999
and for the period October 29, 1998 through December 31, 1998, respectively.
9. Restructuring charges
In the fourth quarter of 1998, Johnson & Johnson approved a plan to reconfigure
its global network of manufacturing and operating facilities with the objective
of enhancing operating efficiencies. The estimated cost of this plan was $613
million which was reflected in the 1998 consolidated financial statements of
Johnson & Johnson (cost of sales ($60 million), and restructuring charge ($553
million)). The charge consisted of employee separation costs of $161 million,
assets impairments of $322 million, impairments of intangibles of $52 million,
and other exit costs of $78 million.
Restructuring charges which were included in the overall $613 million charge
taken by Johnson and Johnson that related to OrthoTech included:
<Table>
<Caption>
- ---------------------------------------------------------------------------------
For the period
October 29, 1998
through
December 31, 1998
- ---------------------------------------------------------------------------------
Inventory write-off's....................................... $ 1,891
Write-off of intangible assets.............................. 1,500
-------------------
Total..................................................... $ 3,391
=================================================================================
</Table>
Inventory write-off's represent costs to exit business related to certain
bracing and soft supports products. The write-off of intangible assets consists
of the net book value of a patent related to a product which was discontinued.
10. Rental expense and lease commitments
Rental expense relating to OrthoTech's administrative building and land under an
operating lease amounted to approximately $505 and $84 for the year ended
December 31, 1999 and the period October 29, 1998 through December 31, 1998.
F-54
<Page>
The approximate minimum rental payments required under the operating lease that
has initial or remaining noncancellable lease terms in excess of one year at
December 31, 1999 are:
<Table>
- --------------------------------------------------------------------
2000........................................................ $ 505
2001........................................................ 505
2002........................................................ 505
2003........................................................ 505
2004........................................................ 505
Thereafter.................................................. 6,521
------
$9,046
====================================================================
</Table>
11. Concentration of credit risk
OrthoTech sells its products to physicians, hospitals and clinics located
throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk with respect to trade receivables are limited due
to the large numbers of customers comprising OrthoTech's customer base. No one
customer represents more than 10% of sales or receivables. Ongoing credit
evaluations of customers' financial conditions are performed, and, generally, no
collateral is required. OrthoTech maintains reserves for potential credit losses
and such losses, in the aggregate, have not exceeded management's expectations.
12. Geographic areas
Information about OrthoTech's operations by geographic area for the year ended
December 31, 1999 and the period October 29, 1998 through December 31, 1998 are
shown below:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------
Sales to Operating Total
Year ended December 31, 1999 customers income assets
- -------------------------------------------------------------------------------------------------
North America............................................... $ 45,610 $ 995 $70,643
Europe...................................................... 2,452 489 669
Asia Pacific................................................ 267 17 55
Rest of the World........................................... 94 6 10
-----------------------------------
Total..................................................... $ 48,423 $ 1,507 $71,377
=================================================================================================
</Table>
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------
Sales to Operating Total
Period October 29, 1998 through December 31, 1998 customers income (loss) assets
- ----------------------------------------------------------------------------------------------------
North America............................................... $ 7,566 $ (4,259) $69,737
Europe...................................................... 411 44 712
Asia Pacific................................................ 58 14 53
Rest of the World........................................... 11 1 6
--------------------------------------
Total..................................................... $ 8,046 $ (4,200) $70,508
====================================================================================================
</Table>
F-55
<Page>
13. Contingencies
In the normal course of business, OrthoTech is party to claims and disputes.
OrthoTech has provided for these legal matters where it is probable that a
liability has been incurred and the amount of cost could be reasonably
estimated. While the ultimate outcome of these claims and lawsuits cannot be
readily determined, it is the opinion of management that none of them,
individually or in the aggregate, will have a material adverse effect on
OrthoTech's combined financial position, results of operations or cash flows.
F-56
<Page>
Report of independent accountants
To the Board of Directors
of Johnson & Johnson
In our opinion, the accompanying statements of operations and changes in
invested equity, and statements of cash flows present fairly, in all material
respects, the results of operations and cash flows of DePuy Orthopaedic
Technology, Inc. ("OrthoTech"), an integrated operation of DePuy, Inc., as
described in Note 1, for the period January 1, 1998 through October 28, 1998 and
for the year ended December 31, 1997, in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of OrthoTech's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
For the period January 1, 1998 through October 28, 1998 and the year ended
December 31, 1997, OrthoTech was a fully integrated operation of DePuy.
Consequently, as indicated in Note 2, these statements have been derived from
the consolidated financial statements and accounting records of DePuy and
reflect significant assumptions and allocations. Moreover, as indicated in Note
3, OrthoTech relied on DePuy for administrative, management and other services.
The results of operations and cash flows of OrthoTech could differ from those
that would have resulted had OrthoTech operated autonomously or as an entity
independent of DePuy.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
April 19, 2000
F-57
<Page>
DePuy Orthopaedic Technology, Inc. statements of operations and changes in
invested equity
For the period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------------
For the period
January 1, 1998 For the
through year ended
(in thousands) October 28, 1998 December 31, 1997
- -----------------------------------------------------------------------------------------------------
Net sales................................................... $ 32,863 $ 38,846
Cost of goods sold.......................................... 18,190 21,281
---------------------------------------
Gross profit.............................................. 14,673 17,565
Selling, general and administrative expenses................ 10,932 12,795
Research and development expenses........................... 173 323
Amortization expense........................................ 1,163 1,389
Allocated expenses from DePuy (Note 3)...................... 749 792
---------------------------------------
13,017 15,299
---------------------------------------
Income before provision for income taxes.................... 1,656 2,266
Provision for income taxes.................................. 1,061 1,434
---------------------------------------
Net income................................................ $ 595 $ 832
---------------------------------------
Invested equity--beginning of period........................ $ 51,418 $ 52,714
Advances from (repayments to) DePuy......................... (1,513) (2,089)
Currency translation adjustment............................. (2) (39)
---------------------------------------
Invested equity--end of period.............................. $ 50,498 $ 51,418
=====================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-58
<Page>
DePuy Orthopaedic Technology, Inc. statements of cash flows for the period
January 1, 1998 through October 28, 1998 and for the year ended December 31,
1997
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------------
For the period
January 1, 1998 For the
through year ended
(in thousands) October 28, 1998 December 31, 1997
- -----------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net income................................................ $ 595 $ 832
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation............................................ 447 388
Amortization............................................ 1,163 1,389
Deferred income taxes................................... (298) (26)
Provision for accounts receivable....................... 572 102
Changes in operating assets and liabilities:
Increase in accounts receivable....................... (708) (211)
Decrease in other assets.............................. 72 375
(Increase) decrease in inventory...................... (939) 295
Increase in accounts payable.......................... 121 327
Increase in accrued expenses.......................... 843 27
---------------------------------------
Net cash provided by operating activities................... 1,868 3,498
---------------------------------------
Cash flows from investing activities
Purchases of property and equipment....................... (756) (620)
---------------------------------------
Net cash used in investing activities................. (756) (620)
---------------------------------------
Cash flows from financing activities
Repayments to DePuy....................................... (1,513) (2,089)
Book overdraft............................................ -- (356)
---------------------------------------
Net cash used in financing activities....................... (1,513) (2,445)
---------------------------------------
Net change in cash.................................... (401) 433
Cash, beginning of period................................... 612 179
---------------------------------------
Cash, end of period................................... $ 211 $ 612
=====================================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-59
<Page>
DePuy Orthopaedic Technology, Inc. notes to financial statements
(dollars in thousands)
1. Background and description of business
Johnson & Johnson is negotiating the sale of the net assets, consisting
principally of inventory, property, plant and equipment, plus certain rights and
intellectual property, of the bracing and soft supports business of DePuy
Orthopaedic Technology, Inc.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate, public
entity from 1993 (year of initial public offering) through March 1996. In
March 1996, Orthopedic Technology was purchased by DePuy, Inc. ("DePuy") in a
purchase business combination. Shortly after the acquisition in 1996, the
existing DePuy sports medicine business, which had products in the bracing and
soft supports business, was combined with Orthopedic Technology and the
resulting business was renamed DePuy Orthopaedic Technology, Inc. ("OrthoTech").
DePuy was formed as the result of a worldwide reorganization completed by its
parent, Corange Limited ("Corange"), to realign its worldwide orthopaedic
operations into a stand-alone entity in order to sell shares of the realigned
entity to the public through an Initial Public Offering ("IPO"). The IPO
occurred in October 1996 and approximately 16% of DePuy's shares were sold to
the public.
On May 24, 1997, the shareholders of Corange entered into an agreement to sell
100% of its shares to an indirect subsidiary of Roche Holding Ltd. ("Roche"), a
multinational company. This transaction was finalized on March 5, 1998. As a
result of this transaction, Roche held approximately 84% of DePuy. DePuy
continued to operate as an independent organization until October 28, 1998.
On October 29, 1998, Johnson & Johnson acquired DePuy, in a purchase business
combination, and the existing Johnson & Johnson bracing and soft supports
products (the "J&J Business") were transferred to OrthoTech as of January 1,
1999. As a result of these transactions, OrthoTech became an integrated
operation of DePuy, which is a wholly-owned subsidiary of Johnson & Johnson.
Refer to Note 2 for additional details.
OrthoTech engages in the development, manufacturing and marketing of bracing and
soft supports products which assist in the treatment of both hard and soft
tissue injury management. OrthoTech's primary markets are North America, Europe
and the Asia Pacific Region. OrthoTech sells its products through DePuy
affiliated companies outside of the U.S. market.
2. Summary of significant accounting policies
Basis of presentation
As described in Note 1, the businesses that comprise OrthoTech were not under
common management control during the entire three year period ended
December 31, 1999. Accordingly, the financial statements of OrthoTech presented
herein represent the predecessor business being sold for the period in which it
was controlled by DePuy and not under common management control (the period
prior to Johnson & Johnson acquiring DePuy on October 29, 1998). Separate
combined financial statements of OrthoTech and the J&J Business have been
prepared for the period the business was under common control (the period
subsequent to Johnson & Johnson acquiring DePuy on October 29, 1998) and
F-60
<Page>
separate financial statements of the J&J Business have been prepared for the
period prior to Johnson & Johnson acquiring DePuy on October 29, 1998 as
follows:
a. Separate combined financial statements have been prepared which depict
the combined financial position of OrthoTech and the J&J Business as of
December 31, 1999 and 1998, and the combined results of their operations and
cash flows for the year ended December 31, 1999 and the period October 29,
1998 through December 31, 1998. This represents the period in which OrthoTech
was controlled by Johnson & Johnson (October 29, 1998 through December 31,
1999).
b. Separate financial statements have been prepared to depict the
revenues and direct expenses of the J&J Business for the period January 1,
1998 through October 28, 1998 and the year ended December 31, 1997. This
represents the period in which the bracing and soft supports business, which
was later transferred to OrthoTech and is part of the net assets being sold,
was owned directly by Johnson & Johnson.
The accompanying financial statements exclude the operations of an arthroscopy
business of OrthoTech, which was transferred to another operation of Johnson &
Johnson on January 1, 2000, and is not part of the sale described in Note 1.
As an integrated operation of DePuy, OrthoTech did not, in the normal course of
operations, prepare separate financial statements in accordance with accounting
principles generally accepted in the United States. Accordingly, the
accompanying financial statements have been derived by extracting the assets,
liabilities and revenues and expenses of OrthoTech from the consolidated assets,
liabilities and revenues and expenses of DePuy. The accompanying financial
statements reflect assets, liabilities, revenues and expenses directly
attributable to OrthoTech as well as allocations deemed reasonable by management
to present the results of OrthoTech's operations and cash flows for the period
January 1, 1998 through October 28, 1998 and the year ended December 31, 1997 on
a stand alone basis. The allocation methodologies have been described within the
respective notes and management considers the allocations to be reasonable.
However, the results of operations and cash flows of OrthoTech may differ from
those that may have been achieved had OrthoTech operated autonomously or as an
entity independent of DePuy. In addition, due to the reliance of the OrthoTech
business on DePuy, the historical operating results may not be indicative of
future results.
There was no direct interest expense incurred by OrthoTech therefore, no
interest expense has been reflected in the financial statements.
All significant accounts and transactions within OrthoTech have been eliminated.
Risks and uncertainties
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported. Actual results could differ
from those estimates.
Revenue recognition
Revenues from product sales are recognized when goods are shipped and title and
risk of loss passes to customers.
F-61
<Page>
Cash
OrthoTech participated in DePuy's cash pooling arrangements, under which cash
balances are cleared automatically to a central account held by another DePuy
business. All transactions between OrthoTech and DePuy have been accounted for
as settled in cash at the time such transactions were recorded by OrthoTech.
Property, plant and equipment and depreciation
Property, plant and equipment are stated at cost. OrthoTech utilizes the
straight-line method of depreciation over the estimated useful lives of the
assets:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------
Leasehold improvements...................................... Shorter of life of lease or 15 years
Machinery and equipment..................................... 3-10 years
==================================================================================================
</Table>
Gains and losses on disposals are included in selling, general and
administrative expenses. Major additions and betterments are capitalized,
whereas maintenance and repairs are expensed as incurred.
Intangible assets
The excess of the cost over the fair value of the net assets of purchased
businesses is recorded as goodwill and is amortized on a straight-line basis
over periods of 30 years or less. The cost of other identifiable intangibles is
amortized on a straight-line basis over their estimated useful lives.
Long-lived assets
OrthoTech continually evaluates the carrying value of its long-lived assets,
including intangibles, for impairment. Any impairments would be recognized when
the expected future operating cash flows derived from such intangible assets is
less than their carrying value.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method.
Foreign currency translation
The local currencies of OrthoTech's international operations represent their
respective functional currencies. Assets and liabilities of foreign operations
are translated from their respective local currencies to U.S. dollars using
exchange rates in effect at the corresponding balance sheet dates. Income
statement and cash flow amounts are translated using the average exchange rates
in effect during the period. Gains and losses resulting from foreign currency
transactions are included in the results of operations and are immaterial to the
periods presented.
F-62
<Page>
Comprehensive income
In accordance with Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," components of other comprehensive
income/(loss) consist of the following:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
For the period For the
January 1, 1998 year ended
through December 31,
October 28, 1998 1997
- -----------------------------------------------------------------------------------------------
Net income.................................................. $ 595 $ 832
Other comprehensive income
Currency translation adjustments.......................... (2) (39)
---------------------------------
Total comprehensive income.............................. $ 593 $ 793
===============================================================================================
</Table>
Advertising
Costs associated with advertising are expensed in the year incurred. Advertising
expenses, which are comprised of print media, television and radio were $5 and
$9 for the period January 1, 1998 through October 28, 1998 and the year ended
December 31, 1997, respectively.
Research and development
Research and development costs are expensed as incurred.
3. Transactions with DePuy
OrthoTech relies on DePuy for certain services, including treasury, cash
management, employee benefits, tax compliance, risk management, financial
reporting and general corporate services. Although certain expenses related to
these services have been allocated to OrthoTech, the results of operations and
cash flows presented in the financial statements may not have been the same as
those that would have occurred had OrthoTech been an independent entity. A
description of the related party transactions follows:
Sales of products
OrthoTech sells its products through DePuy affiliated companies outside of the
U.S. market. Net sales for such products were $1,392 and $1,677 for the period
from January 1, 1998 through October 28, 1998 and the year ended December 31,
1997, respectively.
Allocation of selling, general and administrative expenses
OrthoTech has been allocated a portion of the costs of the DePuy central support
functions. These costs include central departments, notably legal, tax,
treasury, finance, business development, investor relations and human resources.
Such amounts were $324 and $349 for the period January 1, 1998 through
October 28, 1998 and for the year ended December 31, 1997, respectively. Such
costs have been allocated to OrthoTech based upon Ortho Tech's sales to third
parties, relative to total DePuy sales to third parties. Management believes
these allocations are reasonable.
In addition, OrthoTech has been allocated a portion of the selling, general and
administrative expenses of the DePuy affiliates outside of the U.S. that sold
OrthoTech's products. Such amounts were $425 and $443 for the period January 1,
1998 through October 28, 1998 and for the year ended December 31,
F-63
<Page>
1997, respectively. These amounts have been allocated based upon OrthoTech's
sales to third Parties, relative to total DePuy sales to third parties.
Management believes these allocations are reasonable.
The total allocated selling, general and administrative expenses described above
are separately identified on the statements of operations.
Invested equity
Invested equity consists of capital contributions by DePuy, borrowings and
repayments to DePuy, retained earnings/deficit and the cumulative translation
adjustment.
Intercompany account with DePuy
The average intercompany balance outstanding for the period January 1, 1998
through October 28, 1998 and for the year ended December 31, 1997 was a net
receivable due from DePuy of $15,200 and $13,902, respectively.
Pensions
Eligible OrthoTech employees are provided with pension benefits through a
noncontributory defined contribution plan which covers substantially all
non-union employees of DePuy in the United States. This plan provides for
targeted benefits based on the employee's average compensation in the years
preceding retirement. In general, DePuy's policy is to contribute actuarially
determined amounts that are expected to be sufficient to meet projected benefit
payment requirements.
Employees of DePuy's international subsidiaries are covered by various pension
benefit arrangements, some of which are considered to be defined benefit plans
for financial reporting purposes. Funding policies are based on legal
requirements, tax considerations and local practices.
Since the aforementioned pension arrangements are part of certain DePuy employee
benefit plans, no discrete actuarial data is available for the portion allocable
to OrthoTech. OrthoTech has been allocated pension costs based upon participant
employee headcount. Net pension expense included in the accompanying financial
statements was $153 and $40 for the period January 1, 1998 through October 28,
1998 and the year ended December 31, 1997, respectively.
Savings plan
DePuy also sponsors a 401(k) plan for non-union employees of its domestic
operations. Non-union employees may contribute up to 11% of their compensation,
subject to certain limitations. DePuy matches 100% of an employee's contribution
up to 4% of their compensation. Matching contributions made by DePuy and
expensed were $235 and $278 for the period January 1, 1998 through October 28,
1998 and the year ended December 31, 1997, respectively.
Postretirement benefits other than pensions
Effective January 1, 1998, certain OrthoTech employees become eligible to be
covered under DePuy's unfunded postretirement healthcare benefit plans. In
general, DePuy pays a defined portion of an eligible retiree's healthcare
premium. The plans are contributory based on years of services, with
contributions adjusted annually.
Since the aforementioned postretirement benefit arrangements are part of certain
DePuy benefit plans, no discrete actuarial data is available for the portion
allocable to OrthoTech. OrthoTech has been
F-64
<Page>
allocated postretirement benefit costs based upon participant employee
headcount. Net postretirement benefit expense included in the accompanying
financial statements was $84 for the period January 1, 1998 through October 28,
1998.
Stock based compensation
For the period January 1, 1998 through October 28, 1998 and the year January 1,
1997 through December 31, 1997, certain employees of OrthoTech participated in
certain DePuy sponsored share option and long-term share incentive plans. Grants
pursuant to these plans were at the market price of the DePuy shares at the date
of grant except for the DePuy Stock Purchase Plan described below for which the
option price is 85% of the fair market value of DePuy stock. DePuy elected to
measure compensation expense based upon the intrinsic value approach under APB
No. 25.
A summary of the status of OrthoTech's participation in DePuy's stock option
plans as of October 28, 1998 and December 31, 1997 and changes during the
periods ending on those dates, is presented below:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
Options Weighted average
outstanding exercise price
- -----------------------------------------------------------------------------------------------
Balance at January 1, 1997.................................. 61,500 $ 17.50
Option granted.............................................. 52,500 23.46
Options exercised........................................... (1,412) 17.50
Options cancelled/forfeited................................. (20,750) 17.50
---------------------------------
Balance at December 31, 1997................................ 91,838 20.86
Options granted............................................. -- --
Options exercised........................................... -- --
Options cancelled/forfeited................................. (18,335) 20.38
---------------------------------
Balance at October 28, 1998................................. 73,503 $ 21.04
===============================================================================================
</Table>
Had compensation cost for DePuy's stock option grants been determined consistent
with the fair value approach of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" which requires recognition of
compensation cost ratably over the vesting period of the underlying instruments
and had such compensation cost been allocated to OrthoTech,
OrthoTech's net income would have been adjusted to the amounts indicated below:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
For the period For the
January 1, 1998 year ended
through December 31,
October 28, 1998 1997
- -----------------------------------------------------------------------------------------------
Net income--as reported..................................... $ 595 $ 832
Net income--as adjusted..................................... 438 662
===============================================================================================
</Table>
F-65
<Page>
Compensation cost for the determination of Net Income--as adjusted were
estimated using the Black-Scholes option pricing model and the following
assumptions:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
For the period For the
January 1, 1998 Year ended
through December 31,
October 28, 1998 1997
- -----------------------------------------------------------------------------------------------
Risk free interest rate..................................... 5.90% 5.90%
Expected volatility......................................... 39.74% 39.74%
Expected dividend yield..................................... 0.75% 0.75%
Expected life............................................... 6 years 6 years
===============================================================================================
</Table>
The weighted-average fair value of options granted during the year ended
December 31, 1997 was $11.49. The weighted-average fair value of options granted
below market price during 1997 was $11.74. The weighted-average exercise price
of options granted at market price during 1997 was $25.60. The weighted-average
exercise price of options granted below market price during 1997 was $17.50.
There were no options granted during the period January 1, 1998 through October
28, 1998.
Effective January 1, 1997, DePuy adopted the DePuy, Inc. Employee Stock
Option/Purchase Plan (the "Stock Purchase Plan") for purposes of providing its
employees with an opportunity to participate in equity ownership by purchasing
DePuy stock at a discount. The committee administering the Stock Purchase Plan
determined the maximum number of shares to be issued during each annual period.
All employees who had completed 90 days of employment were eligible to
participate in offerings under the Stock Purchase Plan. In order to participate,
an eligible employee had to authorize a payroll deduction at a rate of 1% to 10%
of base pay, which was credited to the participant's plan account. The option
price of the stock under the Stock Purchase Plan was 85% of the fair market
value of the stock on the offering commencement date. During 1997, OrthoTech
employees purchased approximately 8,850 shares at an average price of $17.96.
The weighted average fair value was $5.49 per share. There were no shares
purchased by OrthoTech employees during the period January 1, 1998 through
October 28, 1998. Compensation cost for the determination of "Net income-as
adjusted" were estimated using the Black-Scholes option pricing model with the
following weighted average assumptions:
<Table>
<Caption>
- -------------------------------------------------------------------
Risk free interest rate..................................... 5.46%
Expected volatility......................................... 36.60%
Dividend yield.............................................. 0.75%
===================================================================
</Table>
Income taxes
OrthoTech is not a separate taxable entity in any jurisdiction. Rather, the
OrthoTech's taxable income is included in consolidated income tax returns of
DePuy in most jurisdictions. However, for purposes of these financial
statements, the provision for income taxes has been computed on a separate
return basis. Current income taxes are considered to have been paid or charged
to DePuy. The principal components of deferred taxes are related to depreciation
and amortization of fixed assets and intangibles, and the impact of certain
costs and accruals not currently deductible.
F-66
<Page>
4. DePuy acquisition of Orthotech
On March 11, 1996, DePuy acquired all of the outstanding shares of common stock
of Orthopedic Technology, in consideration of $46.3 million in cash. The
purchase method of accounting was applied to this acquisition and the excess of
purchase price over the estimated fair value of net assets acquired of $41.5
million was allocated to goodwill. The goodwill relating to this acquisition is
amortized on a straight-line basis over a period of 30 years.
5. Income taxes
The provision for income taxes was calculated by applying statutory tax rates to
the reported pretax income after considering permanent items that do not enter
into the determination of taxable income and tax credits reflected in the
consolidated provision of DePuy, which are related to OrthoTech.
The effective income tax rate differs from the statutory Federal income tax rate
for the following reasons:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
Period For the
January 1, 1998 year ended
through December 31,
October 28, 1998 1997
- -----------------------------------------------------------------------------------------------
U.S......................................................... $ 1,551 $ 2,107
Foreign..................................................... 105 159
---------------------------------
Income before provision for income taxes.................... $ 1,656 $ 2,266
---------------------------------
Statutory taxes............................................. $ 580 $ 793
Tax rates:
Statutory federal income tax rate......................... 35.0% 35.0%
Goodwill amortization not deductible...................... 24.6% 21.5%
State and local taxes, net of federal tax benefit......... 3.5% 3.2%
Other..................................................... 1.0% 3.6%
---------------------------------
Effective income tax rate................................. 64.1% 63.3%
===============================================================================================
</Table>
6. Amortization of intangible assets
Amortization expense was $1,163 and $1,389 for the period January 1, 1998
through October 28, 1998 and for the year ended December 31, 1997, respectively.
7. Rental expense and lease commitments
Rental expense relating to OrthoTech's administrative building and land under an
operating lease amounted to approximately $387 and $323 for the period
January 1, 1998 through October 28, 1998 and $323 for the year ended December
31, 1997, respectively.
F-67
<Page>
The approximate minimum rental payments required under operating leases that
have initial or remaining noncancellable lease terms in excess of one year at
October 31, 1998 are:
<Table>
<Caption>
- --------------------------------------------------------------------
1998 (October through December)............................. $ 84
1999........................................................ 505
2000........................................................ 505
2001........................................................ 505
2002........................................................ 505
2003........................................................ 505
Thereafter.................................................. 7,025
------
Total..................................................... $9,634
====================================================================
</Table>
8. Concentration of credit risk
OrthoTech sells its products to physicians, hospitals and clinics located
throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk is limited due to the large numbers of customers
comprising OrthoTech's customer base and their dispersion across geographic
areas. No one customer represents more than 10% of sales. Ongoing credit
evaluations of customers' financial conditions are performed, and, generally, no
collateral is required. OrthoTech maintains reserves for potential credit losses
and such losses, in the aggregate, have not exceeded management's expectations.
9. Geographic areas
Information about OrthoTech's operations by geographic area for the period
January 1, 1998 through October 28, 1998 and for the year end December 31, 1997
are shown below:
<Table>
<Caption>
- -------------------------------------------------------------------------------------
Sales to Operating
Period January 1, 1998 through October 28, 1998 customers income
- -------------------------------------------------------------------------------------
North America............................................... $ 32,084 $ 1,480
Europe...................................................... 640 126
Asia Pacific................................................ 139 50
-----------------------
Total..................................................... $ 32,863 $ 1,656
=====================================================================================
- -------------------------------------------------------------------------------------
<Caption>
Sales to Operating
Period ended December 31, 1997 customers income
North America............................................... $ 37,941 $ 2,039
Europe...................................................... 697 155
Asia Pacific................................................ 208 72
-----------------------
Total..................................................... $ 38,846 $ 2,266
=====================================================================================
</Table>
10. Contingencies
In the normal course of business, OrthoTech is party to claims and disputes.
OrthoTech has provided for these legal matters where it is probable that a
liability has been incurred and the amount of cost could be reasonably
estimated. While the ultimate outcome of these claims and lawsuits cannot be
readily determined, it is the opinion of management that none of them,
individually or in the aggregate, will have a material adverse effect on
OrthoTech's results of operations or cash flows.
F-68
<Page>
Report of independent accountants
To the Board of Directors
of Johnson & Johnson:
We have audited the accompanying historical statements of revenues and expenses
of the Bracing and Soft Supports Business of Johnson & Johnson (the "Bracing and
Soft Supports Business"), an integrated operation of Johnson & Johnson, for the
period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997. These historical statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
historical statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the historical statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the historical statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall presentation of the historical statements. We believe
that our audits provide a reasonable basis for our opinion.
The accompanying historical statements were prepared for the purpose of
complying with the rules and regulations of the Securities and Exchange
Commission as described in Note 2 and are not intended to be a complete
presentation of the Bracing and Soft Supports Business' revenues and expenses.
In our opinion, the historical statements of revenues and expenses present
fairly, in all material respects, the revenues and expenses described in Note 2
of the Bracing and Soft Supports Business for the period January 1, 1998 through
October 28, 1998 and for the year ended December 31, 1997, in conformity with
accounting principles generally accepted in the United States.
For the period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997, the Bracing and Soft Supports Business was a fully integrated
operation of Johnson & Johnson. Consequently, as indicated in Note 2, these
historical statements have been derived from the consolidated financial
statements and accounting records of Johnson & Johnson and reflect significant
assumptions and allocations. Moreover, as indicated Note 2, the Bracing and Soft
Supports Business relied on Johnson & Johnson for administrative, management and
other services. The results of operations of the Bracing and Soft Supports
Business could differ from those that would have resulted had the Bracing and
Soft Supports Business operated autonomously or as an entity independent of
Johnson & Johnson.
/s/ PricewaterhouseCoopers
Florham Park, New Jersey
April 19, 2000
F-69
<Page>
Bracing and Soft Supports Business of Johnson & Johnson statements of revenues
and expenses
For the period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
For the period For the
January 1, 1998 year ended
through December 31,
(dollars in thousands) October 28, 1998 1997
- -----------------------------------------------------------------------------------------------
Net sales................................................... $ 7,640 $ 7,955
Expenses
Costs of goods sold....................................... 4,811 5,857
Selling, marketing and distribution expenses.............. 2,566 2,870
---------------------------------
Total expenses.......................................... 7,377 8,727
---------------------------------
Revenues in excess of expenses/(expenses in excess of
revenues)........................................... $ 263 $ (772)
===============================================================================================
</Table>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-70
<Page>
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Notes to Statements of Revenues and Expenses
(dollars in thousands)
1. BACKGROUND AND DESCRIPTION OF BUSINESS
Johnson & Johnson is negotiating the sale of the net assets, consisting
principally of inventory, property, plant and equipment, plus certain rights and
intellectual property, of the bracing and soft supports business of DePuy
Orthopaedic Technology, Inc.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate, public
entity from 1993 (year of initial public offering) through March 1996. In
March 1996, Orthopedic Technology was purchased by DePuy, Inc. ("DePuy").
Shortly after the acquisition in 1996, the existing DePuy sports medicine
business, which had products in the bracing and soft supports business, was
combined with OrthoTech, and the resulting business was renamed DePuy
Orthopaedic Technology, Inc. ("OrthoTech"). Subsequently, on October 29, 1998,
Johnson & Johnson acquired DePuy in a purchase business combination. The
existing Johnson & Johnson bracing and soft supports products (the "J&J
Business") were transferred to OrthoTech as of January 1, 1999. The net assets
of the J&J Business will be included in the potential sale of the net assets of
OrthoTech. Accordingly, these accompanying financial statements relate to the
J&J Business.
The J&J Business engages in the development, manufacturing and marketing of
bracing and soft supports products which assist in the treatment of both hard
and soft tissue injury management. The J&J Business' primarily markets are North
America, Europe and the Asia Pacific Region. The J&J Business sells its products
through Johnson & Johnson affiliated companies outside of the U.S. market.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
As described in Note 1, the businesses that comprise OrthoTech were not under
common management control during the entire three years ended December 31, 1999.
Accordingly, the financial statements of the J&J Business presented herein
represent the J&J Business being sold during the period it was owned directly by
Johnson & Johnson and not under common management control with OrthoTech (the
period prior to Johnson & Johnson acquiring DePuy on October 29, 1998). Separate
combined financial statements of OrthoTech and the J&J Business have been
prepared for the period it was under common management control (Johnson &
Johnson acquisition of DePuy on October 29, 1998) and separate financial
statements of OrthoTech have been prepared for the period it was not under
common management control (the period prior to Johnson & Johnson acquiring DePuy
on October 29, 1998) as follows:
a. Separate combined financial statements have been prepared to depict the
financial position of OrthoTech and the J&J Business at December 31, 1999 and
1998, and the results of their operations and cash flows for the year ended
December 31, 1999 and the period October 29, 1998 through December 31, 1998.
This represents the period in which OrthoTech was controlled by Johnson &
Johnson (October 29, 1998 through December 31, 1999).
b. Separate financial statements have been prepared which depict the results
of operations and cash flows of OrthoTech for the year ended December 31,
1997 and the period January 1, 1998
F-71
<Page>
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Notes to Statements of Revenues and Expenses (Continued)
(dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
through October 28, 1998. This represents the period in which OrthoTech was
controlled by DePuy (prior to Johnson & Johnson acquiring DePuy).
As an integrated operation of Johnson & Johnson, the J&J Business did not, in
the normal course of operations, prepare separate financial statements in
accordance with accounting principles generally accepted in the United States.
The Statements of Revenues and Expenses are derived by extracting the revenues
and direct expenses of the J&J Business from the consolidated revenues and
expenses of Johnson & Johnson. Accordingly, the accompanying financial
statements have been prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission and reflect revenues and
expenses directly attributable to the J&J Business and are not intended to be a
complete presentation of the J&J Business' revenues and expenses. The operations
of the J&J Business rely on Johnson & Johnson affiliated companies for selling,
marketing, sales order processing, billing, collections, warehousing,
distribution, information technology, insurance, human resources, accounting,
premises, regulatory, treasury, tax and legal support. The direct expenses of
the J&J Business presented in these statements include selling, marketing,
warehousing and distribution and have been allocated based on management's
estimates of the cost of service provided to the J&J Business by other
Johnson & Johnson affiliated companies. Management believes that these
allocations are based on assumptions that are reasonable under the
circumstances. Allocations of general and administrative expenses and Johnson &
Johnson Corporate overhead have been excluded from these statements. Due to the
reliance of the J&J Business on Johnson & Johnson and its affiliated companies,
the historical operating results may not be indicative of future results.
There was no direct interest expense incurred by or allocated to the J&J
Business, therefore, no interest expense has been reflected in these statements.
All significant intercompany accounts and transactions within the J&J Business
have been eliminated.
REVENUE RECOGNITION
Revenue is recognized from product sales when the goods are shipped and title
and risk of loss passes to the customer.
SELLING, MARKETING AND DISTRIBUTION EXPENSES
The direct selling, marketing and distribution expenses includes an allocation
of such expenses from Johnson & Johnson and its affiliates. Different allocation
methods apply to the various components of these expenses. Management believes
that these allocation methods, which include sales, employee headcount, case and
volume weight, are reasonable.
The direct expenses allocated to the J&J Business by Johnson & Johnson and its
affiliates for the period January 1, 1998 through October 28, 1998 and for the
year ended December 31, 1997 for selling, marketing, warehousing and
distribution were $2,566 and $2,870, respectively.
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BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Notes to Statements of Revenues and Expenses (Continued)
(dollars in thousands)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined on the
first-in, first-out ("FIFO") method.
FOREIGN CURRENCY TRANSLATION
The local currencies of the J&J Business' international operations represent
their respective functional currencies. Revenues and expense amounts are
translated using the average exchange rates in affect during the period.
RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported. Actual results could differ
from those estimates.
3. INCOME TAXES
The J&J Business is not a separate legal taxable entity for Federal, state or
local income tax purposes and therefore, a provision for income taxes has not
been presented in these statements. The operations of the J&J Business are
included in the consolidated Federal income tax return of Johnson & Johnson, to
the extent appropriate and are included in the Foreign, state and local returns
of the other Johnson & Johnson domestic and international affiliates.
4. INTERNATIONAL OPERATIONS
Net sales of the international operations of the J&J Business for the period
January 1, 1998 through October 28, 1998 and for the year ended December 31,
1997, were $1,817 and $2,431, respectively.
5. RETIREMENT AND PENSION PLANS
Certain of the J&J Business' employees are covered under various retirement and
pension plans which are sponsored by Johnson & Johnson and its affiliates. Net
pension expense charged to the J&J Business for its participation in the
Johnson & Johnson defined benefit plans for the period January 1, 1998 through
October 28, 1998 and for the year ended December 31, 1997, was approximately $11
and $11, respectively.
Certain of J&J Business' employees also participate in a voluntary 401(k)
savings plan sponsored by Johnson & Johnson which is designed to enhance the
existing retirement program covering eligible domestic employees. The J&J
Business was charged approximately $12 and $11 for its portion of Johnson &
Johnson contributions to the savings plan for the period January 1, 1998 through
October 28, 1998 and for the year ended December 31, 1997, respectively.
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<Page>
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Notes to Statements of Revenues and Expenses (Continued)
(dollars in thousands)
6. OTHER POSTRETIREMENT BENEFITS
The J&J Business, through Johnson & Johnson sponsored plans, provides
postretirement benefits, primarily health care, to all domestic retired
employees and their dependents. Most international employees are covered by
government-sponsored programs and the cost of the J&J Business is not
significant. The J&J Business does not fund retiree health care benefits in
advance and has the right to modify these plans in the future. The cost of
providing these postretirement benefits is determined in accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions."
Net postretirement benefit costs charged to the J&J Business for the period
January 1, 1998 through October 28, 1998 and for the year ended December 31,
1997 was $12 and $11, respectively.
The J&J Business, through Johnson & Johnson, provides certain other
postemployment benefits. The cost of providing these postemployment benefits is
determined in accordance with the provisions of SFAS No. 112, "Employers'
Accounting for Postemployment Benefits."
Net postemployment benefit costs charged to the J&J Business for the period
January 1, 1998 through October 28, 1998 and for the year ended December 31,
1997 was $19 and $18, respectively.
7. CONCENTRATION OF CREDIT RISK
The J&J Business sells its products to physicians, hospitals and clinics located
throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk is limited due to the large numbers of customers
comprising the J&J Business customer base and their dispersion across geographic
areas. No one customer represents more than 10% of sales.
8. CONTINGENCIES
In the normal course of business, the J&J Business is party to claims and
disputes. The J&J Business' has provided for these legal matters where it is
probable that a liability has been incurred and the amount of cost could be
reasonably estimated. While the ultimate outcome of these claims and lawsuits
cannot be readily determined, it is the opinion of management that none of them,
individually or in the aggregate, will have a material adverse effect on the J&J
Business' results of operations.
F-74
<Page>
$100,000,000
DJ ORTHOPEDICS, LLC
DJ ORTHOPEDICS CAPITAL CORPORATION
12 5/8% SENIOR SUBORDINATED NOTES DUE 2009