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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 7, 2001
REGISTRATION NO. 333-86835
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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POST-EFFECTIVE AMENDMENT NO. 2
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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DJ ORTHOPEDICS, LLC
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 3842 52-2165554
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
DJ ORTHOPEDICS CAPITAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 3842 52-2157537
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
DONJOY, L.L.C.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 3842 33-0848317
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
2985 SCOTT STREET
VISTA, CALIFORNIA 92083
(800) 336-5690
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANTS' PRINCIPAL EXECUTIVE OFFICES)
LESLIE H. CROSS
PRESIDENT AND CHIEF EXECUTIVE OFFICER
dj ORTHOPEDICS, LLC
2985 SCOTT STREET
VISTA, CALIFORNIA 92083
(800) 336-5690
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE OF PROCESS)
------------------------
WITH A COPY TO:
JAMES M. LURIE, ESQ.
O'SULLIVAN GRAEV & KARABELL, LLP
30 ROCKEFELLER PLAZA
NEW YORK, NEW YORK 10112
(212) 408-2400
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box: [ ]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] --------------------
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] --------------------
THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(c) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(c),
MAY DETERMINE.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT
SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER
OR SALE IS NOT PERMITTED.
Subject to Completion, May 7, 2001
Prospectus
DJ ORTHOPEDICS, LLC
DJ ORTHOPEDICS CAPITAL CORPORATION
12 5/8% SENIOR SUBORDINATED NOTES DUE 2009
We issued 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.
- - The redemption prices are described on page 117.
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 15 OF THIS
PROSPECTUS IN EVALUATING AN INVESTMENT IN THE NOTES.
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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.
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The date of this Prospectus is , 2001
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TABLE OF CONTENTS
PAGE
----
Where You Can Find More
Information................... i
Forward-Looking Statements...... ii
Industry Data................... ii
Prospectus Summary.............. 1
Risk Factors.................... 15
The Recapitalization
Transactions.................. 36
Recent Developments............. 38
Use of Proceeds................. 41
Capitalization.................. 42
Selected Historical Consolidated
Financial Data................ 43
Management's Discussion and
Analysis of Financial
Condition and Results of
Operations.................... 47
PAGE
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Business........................ 65
Management...................... 90
Security Ownership of Certain
Beneficial Owners and
Management.................... 98
Certain Relationships and
Related Transactions.......... 104
Description of Credit
Facility...................... 111
Description of the Notes........ 115
Book-Entry; Delivery and Form... 169
Plan of Distribution............ 173
Legal Matters................... 173
Experts......................... 174
Index To Consolidated Financial
Statements.................... F-1
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WHERE YOU CAN FIND MORE INFORMATION
With the initial effectiveness of the Registration Statement of which this
prospectus is a part, we began filing annual and quarterly reports and other
information with the Securities and Exchange Commission (the "SEC" or the
"Commission"). You may read and copy any reports, documents and other
information we have filed at the Commission's public reference rooms in
Washington, D.C., New York, New York, and Chicago, Illinois. Please call
1-800-SEC-0330 for further information on the public reference rooms. Our
filings are available to the public from commercial document retrieval services
and at the web site maintained by the Commission at http://www.sec.gov.
We, together with our parent holding company, have filed a Registration
Statement on Form S-4 to register with the Commission the notes issued in
exchange for the old notes. This prospectus is part of that Registration
Statement. As allowed by the Commission's rules, this prospectus does not
contain all of the information you can find in the Registration Statement and
the exhibits to the Registration Statement.
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
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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.
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, the statements about our plans,
strategies, and prospects under the headings "Prospectus Summary", "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business." Forward-looking statements include all statements that are not
historical facts and can be identified by forward-looking words such as
"anticipate," "believe," "estimate," "expect," "will," "plan," "intend," and
similar expressions. Although we believe that our plans, intentions and
expectations reflected in or suggested by such forward-looking statements are
reasonable, we can give no assurance that such plans, intentions or expectations
will be achieved. Important factors that could cause actual results to differ
materially from those expressed or implied by the forward-looking statements we
make in this prospectus include, but are not limited to, (i) our high level of
indebtedness; (ii) the restrictions imposed by the terms of our indebtedness;
(iii) the ability to generate cash to service our debts; (iv) healthcare reform
and the emergence of managed care and buying groups; (v) patents and proprietary
know-how; (vi) uncertainty of domestic and foreign regulatory clearance and
approvals; (vii) dependence on orthopedic professionals, agents and
distributors; (viii) our dependence on certain key personnel; (ix) risks related
to competition in our markets; (x) risks related to changing technology and new
product developments; (xi) the sensitivity of our business to general economic
conditions; (xii) uncertainty relating to third party reimbursement; and (xiii)
the other risks referred to under the caption "Risk Factors" 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 and its segments, including the orthopedic recovery products industry,
our general expectations concerning that industry and its segments and our
market position and market share within that industry or its segments, both
domestically and internationally, are based on estimates prepared by us using
1998 data from various sources (primarily Frost & Sullivan, an international
marketing consulting firm, as well as data from our internal research) and on
assumptions made by us, based on that data and our knowledge of the orthopedic
products industry and its segments, which we believe to be reasonable. Industry
data is compiled based on the area of usage of the brace or support (i.e. for
the knee, ankle, back, wrist or upper extremities) and includes both the
non-retail market in which we compete and the retail market. Accordingly,
industry data does not correspond to the organization of our operating segments.
Thus, for example, knee braces and supports market data generally cover both
rigid and soft knee braces and supports. We believe data regarding the
orthopedic products industry and its
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segments and our market position and market share within that industry or its
segments are inherently imprecise, but are generally indicative of their size
and our market position and market share within that industry or its segments.
Data on our market position and market share within the orthopedic recovery
products industry or its segments is based on 1998 U.S. sales. Estimated
revenues for the orthopedic recovery products industry and its segments and the
historical growth rates of that industry and its segments are based on
information obtained from Frost & Sullivan based on data for 1998, the last year
for which such data is available. While we are not aware of any misstatements
regarding any industry data presented in this prospectus, 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.
DonJoy(R), ProCare(R), Defiance(R), GoldPoint(R), Monarch(R), RocketSoc(R),
IceMan(R), Air DonJoy(R), Quadrant(R), Legend(TM), TROM(TM), Playmaker(TM),
PainBuster(R), OPAL(TM), 4TITUDE(TM), OAdjuster(TM), OfficeCare(SM),
Orthotech(R), On Track(R), Playmaker(R), Knee Guarantee(TM), DonJoy Vista(TM),
Drytex(R), Never Stop Getting Better(TM), IROM(R), ELS(R), dj Ortho(TM), MC
Walker(R), Montana(TM), Nextstep(TM), ProStep(R), Rehab 3(R), Ultra-4(TM),
Ultrasling(R), and Walkabout(R) are certain of our registered trademarks and
trademarks for which we have applications pending.
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PROSPECTUS SUMMARY
The following summary highlights selected information from this prospectus
and may not contain all of the information that is important to you. This
prospectus includes information about the notes, our business, certain recent
transactions entered into by us and detailed financial data. We urge you to read
this prospectus in its entirety. Unless otherwise indicated,
- the terms "Company", "dj Ortho", "we", "our", "ours" and "us" refer to dj
Orthopedics, LLC and its subsidiaries or, where the context requires, the
operations of our predecessor, the Bracing and Support Systems division
of Smith & Nephew, Inc. ("Smith & Nephew"),
- the term "DJ Capital" refers to DJ Orthopedics Capital Corporation, our
wholly owned subsidiary and a co-obligor on the notes,
- the term "Issuers" refers to dj Orthopedics, LLC and DJ Orthopedics
Capital Corporation,
- the term "DonJoy" refers to DonJoy, L.L.C., our parent company, and
- the term "notes" refers to both the old notes and the notes.
The financial data included in this prospectus come from the financial
statements of DonJoy. DonJoy is a guarantor of the notes and of our bank
borrowings and has no material assets or operations other than its ownership of
100% of our equity interests. As a result, the consolidated financial position
and results of operations of DonJoy are substantially the same as ours. 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 activities. The pro forma
financial information set forth in this prospectus reflects the consummation of
the Orthotech Acquisition (as defined below) as if it had occurred as of January
1, 2000 for purposes of the pro forma statement of income.
THE COMPANY
OVERVIEW
We are a world leading designer, manufacturer and marketer of orthopedic
recovery products. Based on U.S. sales, we believe we are the leading provider
of orthopedic recovery products and certain complementary products in the United
States. Our broad product lines of rigid knee braces, soft goods and specialty
and other orthopedic products provide a range of solutions for patients and
orthopedic professionals during the various stages of the orthopedic treatment
and recovery process. Our products are used before, after, and as an alternative
to surgery, during and after rehabilitation and for the treatment of
osteoarthritis. We are a market leader in the orthopedic recovery products
industry, selling more than 600 individual products in over 44 countries
throughout the world. We sell our products primarily under the DonJoy and
ProCare brand names, each of which we believe enjoys one of the highest levels
of brand name recognition within the orthopedic recovery products industry. In
addition to the typical orthopedic patient, our
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products are used by professional athletes, NCAA athletic programs and the U.S.
Ski Team. We believe that our leading market positions, strong brand names,
reputation for quality products, broad product lines, established distribution
networks in the United States and commitment to research and development provide
us with significant opportunities to further grow revenues and earnings. For
2000 and 1999, our net revenues were $147.5 million and $117.8 million,
respectively, and our EBITDA (as defined) was $29.2 million and $25.1 million,
respectively. On a pro forma basis to give effect to the Orthotech Acquisition,
our net revenues and EBITDA would have been $171.4 million and $32.4 million,
respectively, for 2000.
Our product lines include rigid knee braces, soft goods and a portfolio of
specialty and other orthopedic products.
- Rigid Knee Braces. 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 ("OA") braces, which provide relief of knee
pain due to osteoarthritis. These technologically advanced products are
generally prescribed to a patient by an orthopedic professional. 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. Substantially all of our rigid knee
braces are marketed under the DonJoy brand name. These products
represented approximately 38% of our net revenues, excluding freight
revenue, for the year ended December 31, 2000.
- 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. As of December 31, 2000, approximately
58% of our revenues from soft goods products, excluding freight revenue,
were derived from products marketed under the ProCare brand name, with
the remainder marketed under the DonJoy brand name. These products
represented approximately 36% of our net revenues, excluding freight
revenue, for the year ended December 31, 2000.
- Specialty and Other Orthopedic Products. Our portfolio of specialty and
other orthopedic products, which are designed to facilitate orthopedic
rehabilitation, include lower extremity walkers (boots which are an
alternative to lower extremity casting), upper extremity braces (shoulder
and arm braces and slings), cold therapy systems (a form of pain
management which provides continuous cold therapy to assist in the
reduction of pain and swelling) and pain management delivery systems (a
range of ambulatory infusion pumps for the delivery of local anesthetic
directly into a joint following surgery). As of December 31, 2000,
approximately 84% of our revenues from specialty and other orthopedic
products, excluding freight revenue, were derived from products marketed
under the DonJoy brand name, with the remainder marketed under the
ProCare brand name. These products represented approximately 26% of our
net revenues, excluding freight revenue, for the year ended December 31,
2000.
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We sell our DonJoy products primarily to orthopedic surgeons, orthotic and
prosthetic centers, hospitals, surgery centers, physical therapists and trainers
to meet the specific needs of their patients. We sell our ProCare products under
private label brand names primarily to third party distributors who generally
resell our products to large hospital chains, hospital buying groups, primary
care networks and orthopedic physicians. Our products are used by people who
have sustained an injury, have recently completed an orthopedic surgical
procedure and/or suffer from an affliction of the joint. 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.
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OUR 1999 RECAPITALIZATION
On June 30, 1999, DonJoy consummated a recapitalization pursuant to an
agreement among Chase DJ Partners, LLC ("CDP"), Smith & Nephew, the former owner
of 100% of the equity interests of DonJoy, and DonJoy.
Approximately $207.9 million of cash was required to finance the
recapitalization, including approximately $199.1 million of cash paid to Smith &
Nephew as consideration for the repurchase of Smith & Nephew's equity interests
in DonJoy (other than a retained interest of approximately 7.3%) and $8.8
million in transaction fees and expenses. See "The Recapitalization
Transactions." The sources of funds for the recapitalization consisted of:
- a $64.6 million cash investment in the common membership units (the
"Common Units") of DonJoy by CDP;
- a $1.8 million investment in the Common Units of DonJoy by three members
of senior management (the "Management Members"), $1.4 million of which
was financed by loans from DonJoy evidenced by management promissory
notes;
- $30.0 million of net proceeds from the purchase by J.P. Morgan Partners
(23A SBIC), LLC (formerly CB Capital Investors, L.L.C.) ("JPMP (23A
SBIC)") and First Union Investors, Inc. ("First Union Investors") of
redeemable preferred membership interests (the "Redeemable Preferred
Units" and, together with the Common Units, the "Units") of DonJoy having
an aggregate liquidation preference of $31.4 million. JPMP (23A SBIC) and
First Union Investors purchased approximately $21.2 million and $10.2
million, respectively, of Redeemable Preferred Units before payment of
$1.4 million of fees to them on a pro rata basis; and
- our payment to DonJoy for DonJoy's assets and operations, financed by:
-- approximately $98.0 million from the offering of the old notes, and
-- $15.5 million of borrowings under our senior secured credit facility.
The recapitalization, the purchase of the Common Units by CDP and the
Management Members, the purchase of the Redeemable Preferred Units, the sale of
assets by DonJoy to us, the offering of the old notes and the borrowings under
our credit facility are collectively referred to in this prospectus as the
"recapitalization transactions." As a result of the recapitalization
transactions, we are a wholly owned direct subsidiary of DonJoy, holding all of
its operating assets.
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The sources and uses of funds for the recapitalization are presented in the
following table:
AMOUNT
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(DOLLARS
IN MILLIONS)
SOURCES:
Credit facility(a)...................................... $ 15.5
Old Notes............................................... 98.0
Redeemable Preferred Units(b)........................... 30.0
Common Unit investment in DonJoy by CDP................. 64.6
Retained Common Unit investment in DonJoy by Smith &
Nephew............................................... 5.4
Common Unit investment in DonJoy by Management
Members.............................................. 1.8
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Total sources........................................ $215.3
======
USES:
Consideration paid to Smith & Nephew.................... $199.1
Retained Common Unit investment in DonJoy by Smith &
Nephew............................................... 5.4
Loans to Management Members............................. 1.4
Fees and expenses....................................... 8.8
Working capital......................................... 0.6
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Total uses........................................... $215.3
======
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(a) Represents the $15.5 million term loan borrowed under our 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 on a pro rata basis.
On July 30, 1999, JPMP (23A SBIC) and First Union Investors each
transferred to affiliates (the "TCW Affiliates") of TCW/Crescent Mezzanine, LLC
approximately $5.2 million of Redeemable Preferred Units of DonJoy and $1.8
million and $0.2 million, respectively, of membership interests in CDP. In
December 1999, First Union Investors transferred its remaining interest in
DonJoy to DJ Investment, LLC ("DJ Investment"). First Union Investors is the
manager of DJ Investment.
RECENT DEVELOPMENTS
On July 7, 2000, we 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,
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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 currently offered by us. Following the Orthotech
Acquisition, we sold products under the Orthotech brand; however, we have now
integrated Orthotech products into the DonJoy and ProCare brands. Orthotech also
had an inventory management and billing program that has complemented our
current OfficeCare program.
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 related to debt issuance costs. The sources of
funds for the Orthotech Acquisition consisted of:
- the sale of $8.3 million of Common Units to CDP and the Management
Members of which the net proceeds totaled $8.1 million (excluding
management promissory notes of $0.2 million),
- $3.6 million of Redeemable Preferred Units of which the net proceeds
totaled $3.4 million (excluding preferred unit fees of $0.2 million) to
existing holders of the Redeemable Preferred Units,
- borrowings under our amended credit agreement of approximately $36.6
million, and
- $1.3 million in existing cash.
The sources and uses of funds for the Orthotech Acquisition are presented
in the following table:
AMOUNT
------------
(DOLLARS
IN MILLIONS)
SOURCES
Cash............................................. $ 1.3
Revolving credit facility........................ 12.6
Term loan........................................ 24.0
Redeemable Preferred Units(a).................... 3.4
Common unit investment by CDP.................... 8.1
Common unit investment by Management............. 0.2
-----
$49.6
=====
USES
Cash to DePuy Orthotech.......................... $46.4
Debt issuance costs.............................. 0.4
Transaction fees and costs....................... 2.6
Management promissory notes...................... 0.2
-----
$49.6
=====
- -------------------------
(a) Represents $3.6 million of proceeds received from the sale of Redeemable
Preferred Units, net of $0.2 million of fees paid to JPMP (23A SBIC), TCW
and DJ Investment on a pro rata basis.
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In accordance with a unit purchase agreement dated as of June 28, 2000,
Smith & Nephew sold its entire remaining interest of 54,000 Common Units in
DonJoy to CDP and the Management Members for $5.9 million. CDP purchased 52,495
Common Units for a total consideration of $5.7 million and the Management
Members purchased the remaining 1,505 units for a total consideration of $0.2
million, which they financed with loans from DonJoy, evidenced by promissory
notes.
On April 5, 2001, we invested in an Australian joint venture, dj
Orthopaedics Pty Ltd ("dj Australia"). dj Australia will replace our Smith &
Nephew distributor in Australia and will also sell two new product lines.
OWNERSHIP
As of the date of this prospectus, CDP, the Management Members and the
holders of the Redeemable Preferred Units own approximately 92.1%, 2.6% and
5.3%, respectively, of the voting units of DonJoy. In addition, certain members
of our management, outside directors and consultants have been granted options
to acquire up to approximately 14% of DonJoy's equity interests on a fully
diluted basis. See "Management -- 1999 Option Plan".
CDP is a limited liability company formed by JPMP (23A SBIC), First Union
Investors and Fairfield Chase Medical Partners, LLC ("Fairfield Chase"). JPMP
(23A SBIC) has invested approximately $68.0 million, First Union Investors has
invested approximately $7.6 million, Fairfield Chase invested approximately $0.3
million and the TCW Affiliates have invested approximately $2.4 million in CDP.
CDP and JPMP (23A SBIC) are affiliates of J.P. Morgan Partners, LLC ("JPMP").
JPMP 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, JPMP invests in leveraged buyouts,
recapitalizations and venture capital opportunities by providing equity and
mezzanine debt capital. Since its inception in 1984, JPMP has made over 1,150
direct investments in a variety of industries. JPMP has over $1.0 billion in
more than 100 companies in the life sciences and healthcare industries. First
Union Investors is the direct equity and mezzanine investment group of First
Union Corporation. Fairfield Chase is a private venture capital firm targeting
middle market medical device companies created by JPMP and Charles T. Orsatti
and controlled by Mr. Orsatti. For a description of the ownership, voting and
management arrangements regarding DonJoy and CDP see "Security Ownership of
Certain Beneficial Owners and Management."
SUMMARY OF THE TERMS OF THE NOTES
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
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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. First
payment: December 15, 1999.
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.
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."
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Guarantees............................... The notes are fully and
unconditionally guaranteed on an
unsecured senior subordinated
basis by DonJoy and certain of our
future subsidiaries. None of our
current subsidiaries guarantee the
notes. If we fail to make payments
on the notes, DonJoy 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 December 31, 2000, the
aggregate amount of the liabilities
of our foreign subsidiaries as
reflected on the balance sheets was
$0.2 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 DonJoy
and certain of our future
subsidiaries.
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 DonJoy and our future
guarantor subsidiaries, if any,
will be unsecured and:
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- 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.
As of December 31, 2000:
- we had $59.0 million of senior
debt to which the notes were
subordinated (which amount does
not include $4.4 million
remaining available under the
revolving credit portion of our
credit facility);
- DonJoy 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 DonJoy
did not have any senior
subordinated debt other than its
guarantee on the notes;
- we and DonJoy did not have had
any subordinated debt; and
- our foreign subsidiaries, which
are not a guarantor of the notes,
had $0.2 million of liabilities
as reflected on their balance
sheets.
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.
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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."
RISK FACTORS
You should carefully consider the information under the caption "Risk
Factors" and all other information in this prospectus before investing in the
notes.
-------------------------
dj Orthopedics, LLC is a Delaware limited liability company formed in March
1999 and is a wholly-owned subsidiary of 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. DJ
Orthopedics Capital Corporation, our wholly-owned subsidiary, is a Delaware
corporation formed in March 1999 to serve as a co-issuer of the notes. Our
principal executive offices are located at 2985 Scott Street, Vista, California
92083 and our telephone number is (800) 336-5690.
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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. DonJoy is a guarantor of the notes and of our credit
facility and has no material assets or operations other than its ownership of
100% of our equity interests. As a result, the consolidated financial position
and results of operations of DonJoy are substantially the same as ours. The
summary historical consolidated financial data for the years ended December 31,
1998, 1999 and 2000 come from DonJoy's audited consolidated financial statements
included in this prospectus. The summary pro forma consolidated financial data
set forth below come from the unaudited pro forma financial information included
in this prospectus. The pro forma consolidated statement of income data gives
effect to the Orthotech Acquisition as if it had occurred on January 1, 2000.
The summary pro forma financial data does not purport to represent what DonJoy's
results of operations would have been if the Orthotech Acquisition had been
completed as of that date, nor do such data purport to represent DonJoy's
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
DonJoy's historical consolidated financial statements and the information
included under "The Recapitalization Transactions," "Recent Developments,"
"Selected Historical Consolidated Financial Data," and "Management's Discussion
and Analysis of Financial Condition and Results of Operations," all of which is
included elsewhere in this prospectus.
PRO FORMA
YEARS ENDED DECEMBER 31, YEAR ENDED
-------------------------------- DECEMBER 31,
1998 1999 2000 2000
-------- -------- -------- ------------
(DOLLARS IN THOUSANDS)
STATEMENT OF INCOME DATA:
Net revenues................................. $104,292 $117,767 $147,469 $171,397
Cost of goods sold(a)........................ 46,466 51,744 60,178 71,668
-------- -------- -------- --------
Gross profit................................. 57,826 66,023 87,291 99,729
Operating expenses(a):
Sales and marketing........................ 28,282 30,251 42,536 49,848
General and administrative................. 16,484 16,755 19,761 22,896
Research and development................... 2,248 2,115 2,465 2,711
Merger and integration costs(b)............ -- -- 400 400
Restructuring costs(c)..................... 2,467 -- -- --
-------- -------- -------- --------
Total operating expenses................. 49,481 49,121 65,162 75,855
-------- -------- -------- --------
Income from operations....................... 8,345 16,902 22,129 23,874
Interest expense............................. -- (7,568) (16,958) (18,744)
Interest income.............................. -- 181 437 437
Discounted acquisition costs................. -- -- (449) (449)
-------- -------- -------- --------
Income before income taxes................... 8,345 9,515 5,159 5,118
Provision for income taxes................... 3,394 2,387 -- --
-------- -------- -------- --------
Net income................................... $ 4,951 $ 7,128 $ 5,159 $ 5,118
======== ======== ======== ========
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PRO FORMA
YEARS ENDED DECEMBER 31, YEAR ENDED
------------------------------ DECEMBER 31,
1998 1999 2000 2000
------- ------- -------- ------------
(DOLLARS IN THOUSANDS)
OTHER DATA:
EBITDA(d)...................................... $15,665 $21,854 $ 28,894 $32,101
Adjusted EBITDA(e)............................. 21,957 25,082 29,162 32,369
Depreciation and amortization.................. 4,853 4,952 6,365 7,827
Capital expenditures and acquired
intangibles.................................. 4,149 4,706 7,722 N/A
Cash interest expense.......................... -- 6,530 15,716 17,466
Ratio of earnings to fixed charges(f).......... 8.84x 2.12x(g) 1.29x(h) 1.26x
Ratio of EBITDA to cash interest expense....... -- 3.84x(g) 1.86x(h) 1.86x
Ratio of total debt to EBITDA.................. -- 4.52x 5.40x 4.86x
CASH FLOWS PROVIDED BY (USED IN):
Operating activities........................... $ 3,748 $16,065 $ 1,229 N/A
Investing activities........................... (4,049) (4,776) (57,015) N/A
Financing activities........................... 200 (6,171) 53,965 N/A
AS OF DECEMBER 31,
2000
------------------
(IN THOUSANDS)
BALANCE SHEET DATA
Cash........................................................ $ 4,106
Working capital............................................. 38,695
Total assets................................................ 155,672
Long-term obligations....................................... 157,222
Redeemable Preferred Units.................................. 41,660
Total deficit............................................... (63,625)
- -------------------------
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 (e) 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 Notes to
DonJoy's Audited Consolidated Financial Statements, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Overview -- Manufacturing Cost Reduction Initiatives".
(d) "EBITDA" is defined as income from operations plus restructuring costs,
merger and integration costs and depreciation and amortization. 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. Under both the credit agreement definition of EBITDA and
our definition of EBITDA, we are in compliance with all debt covenants under
the credit agreement. Our definition of EBITDA may not be comparable to that
of other companies.
(e) "Adjusted EBITDA" represents EBITDA (as defined above) adjusted to
eliminate:
(1) charges for brand royalties paid by DonJoy to Smith & Nephew for use of
the Smith & Nephew trademarks and trade names which amounts are no
longer paid following the recapitalization;
(2) foreign sales corporation commissions paid by DonJoy on sales to foreign
sales corporations established by Smith & Nephew for tax planning
purposes which amounts are no longer paid following the
recapitalization;
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(3) Smith & Nephew overhead allocations for corporate managed accounts and
new business expense and corporate management expense which were not
incurred following consummation of the recapitalization (the "Eliminated
Allocations");
(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 (collectively, the "Other Corporate
Allocations");
(5) the incremental cost of the fair market value of acquired inventories
associated with the Orthotech Acquisition;
and adjusted to include the estimated costs we expected to incur to replace
the services previously provided by Smith & Nephew as part of the Other
Corporate Allocations.
PRO FORMA
YEARS ENDED DECEMBER 31, YEAR ENDED
----------------------------- DECEMBER 31,
1998 1999 2000 2000
------- ------- ------- ------------
(DOLLARS IN THOUSANDS)
EBITDA..................................... $15,665 $21,854 $28,894 $32,101
Brand royalties............................ 3,249 1,817 -- --
Foreign sales corporation commissions...... 439 -- -- --
Eliminated Allocations..................... 1,726 979 -- --
Other Corporate Allocations................ 1,678 832 -- --
Estimated costs to replace Smith & Nephew
services................................. (800) (400) -- --
Step-up in inventory....................... -- -- 268 268
------- ------- ------- -------
Ratio of EBITDA to cash interest expense... $21,957 $25,082 $29,162 $32,369
======= ======= ======= =======
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, the services performed by Smith & Nephew after the
recapitalization and our ability to replace such services, see Note 9 of
Notes to DonJoy's Audited Consolidated Financial Statements,
"Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Overview -- Smith & Nephew Allocations and Sales" and
"Certain Relationships and Related Transactions -- Other Agreements
between DonJoy and Smith & Nephew -- Transition Services Agreement."
The adjustments described above are reflected in the consolidated pro forma
financial data presented in this prospectus.
(f) 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.
(g) Reflects interest expense beginning June 30, 1999 as a result of the
recapitalization transactions.
(h) Reflects interest expense on additional borrowing under our amended credit
agreement to finance the Orthotech Acquisition from July 7, 2000.
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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.
SUBSTANTIAL LEVERAGE -- OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR
ABILITY TO OPERATE OUR BUSINESS AND TO FULFILL OUR OBLIGATIONS UNDER THE NOTES.
As a result of the recapitalization transactions and the Orthotech
Acquisition, we are highly leveraged, which means we have a large amount of
indebtedness in relation to our members' deficit. The following chart shows
certain important credit statistics as of December 31, 2000 and 1999. The pro
forma data assumes the Orthotech Acquisition had been consummated as of January
1, 2000.
DECEMBER 31,
2000
--------------
(IN THOUSANDS)
Long-term debt.......................... $157,222
Redeemable preferred units.............. $ 41,660
Members' deficit........................ $(63,625)
PRO FORMA
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2000 2000 1999
------------ ------------ ------------
Ratio of earnings to fixed
charges................. 1.29x(a) 1.26x 2.12x(b)
- -------------------------
(a) Reflects indebtedness incurred to finance the Orthotech Acquisition from the
date of acquisition.
(b) Reflects interest expense beginning June 30, 1999 as a result of the
recapitalization transactions.
We may also 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 the credit facility and the indenture.
See "Capitalization," "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources,"
"Description of Credit Facility" and "Description of the Notes."
Our high degree of leverage could have important consequences to 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.
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- Payments on our indebtedness will reduce the funds that would otherwise
be available for our operations and future business opportunities.
- Debt under the credit facility is secured and matures prior to the notes.
- 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.
- 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.
- 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.
ABILITY TO SERVICE DEBT -- TO SERVICE OUR INDEBTEDNESS, WE WILL REQUIRE A
SIGNIFICANT AMOUNT OF CASH. OUR ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS
BEYOND OUR CONTROL.
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 performance will be
affected by prevailing economic conditions and financial, business,
regulatory and other factors, certain of which are beyond our control;
- The future availability of borrowings under the revolving credit facility
or any successor facility, the availability of which is or may depend on,
among other things, our complying with certain covenants. See
"Description of 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. However,
our operating results and borrowings under the revolving credit facility may not
be sufficient to service our 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 equity capital or bankruptcy protection. There is no assurance that
any of these remedies can be effected on satisfactory terms, if at all. In
addition, the terms of existing or future
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debt agreements, including the credit facility and the indenture, may restrict
us from adopting any of these alternatives.
SUBORDINATION OF THE NOTES AND THE GUARANTEE; STRUCTURAL SUBORDINATION OF THE
NOTES -- THE NOTES AND THE GUARANTEE BY DONJOY 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 DonJoy 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 December 31, 2000, we had approximately $59.0 million of
senior indebtedness outstanding (excluding unused commitments under the
revolving credit facility), all of which is secured, and DonJoy 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 DonJoy 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 DonJoy 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 Mexican subsidiary is not a guarantor of the
notes, the notes are effectively subordinated to all liabilities (including
trade payables and contingent liabilities) of our Mexican subsidiary 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 December 31, 2000, the aggregate amount of the
liabilities of our Mexican subsidiary as reflected on its balance sheet was $0.2
million.
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LIMITED VALUE OF DONJOY GUARANTEE -- YOU SHOULD NOT RELY ON THE GUARANTEE BY
DONJOY IN THE EVENT WE CANNOT MAKE PAYMENTS UPON THE NOTES.
All of the operations of DonJoy are conducted through us and DonJoy has no
material assets other than its ownership of 100% of our equity interests.
Accordingly, DonJoy's cash flow and, consequently, its ability to service debt,
including its guarantee of the notes and our credit facility, depends on our
operations. As a result, you should not rely on the guarantee by DonJoy for
repayment of the notes.
ASSET ENCUMBRANCES TO SECURE THE CREDIT FACILITY -- 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 DonJoy's obligations
under its guarantee) are unsecured while our obligations under the credit
facility (and DonJoy'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 DonJoy (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 DonJoy, 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.
See "Description of Credit Facility."
RESTRICTIVE DEBT COVENANTS -- OUR DEBT AGREEMENTS RESTRICT OUR BUSINESS IN MANY
WAYS.
The credit facility and the indenture impose, and the terms of any future
indebtedness may impose, operating and other restrictions on us. Such
restrictions affect, and in many respects limit or prohibit, among other things,
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,
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- redeem indebtedness that is subordinated in right of payment to the
notes,
- create liens,
- enter into certain transactions with affiliates,
- make certain investments,
- sell assets, or
- enter into mergers or consolidations.
The credit facility also requires us to achieve certain financial and
operating results and satisfy certain 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.
These restrictions contained in the indenture and the credit facility
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 facility and/or the
indenture. Upon the occurrence of an event of default under the credit facility,
the lenders could elect to declare all amounts outstanding under the credit
facility, 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 facility 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. See "-- Subordination of the
Notes and the Guarantee; Structural Subordination of the Notes," and "-- Asset
Encumbrances to Secure the Credit Facility," "Description of the Credit
Facility" and "Description of the Notes -- Certain Covenants."
UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT -- CHANGES IN REIMBURSEMENT
POLICIES FOR OUR PRODUCTS BY THIRD PARTY PAYORS OR REDUCTIONS IN REIMBURSEMENT
RATES FOR OUR PRODUCTS COULD ADVERSELY AFFECT US.
The ability of our customers (or persons to whom our customers 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. Except with respect to our
OfficeCare program and our insurance billing service, we are not directly
involved in the third party reimbursement process, and while we are unable to
give precise data, we believe that a substantial portion of our other sales to
customers (or by them to their customers) are reimbursed by third party payors.
In the United States, third party reimbursement is generally based on the
medical necessity of the product to
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the user, and generally products which are prescribed by doctors are eligible
for reimbursement. As such, we believe that substantially all of our U.S. sales
of rigid knee braces and a substantial portion of our U.S. sales of soft goods
and specialty and other orthopedic products are reimbursed by third party
payors. In response to the historic and forecasted reductions of U.S.
reimbursement rates, we and many of our competitors are introducing new product
offerings at lower prices. 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. There can be no assurance that third party reimbursement
for our products will continue to be available or at what rate such products
will be reimbursed.
Congress and certain state legislatures are considering reforms in the
health care industry that may lower 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 a number of 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.
Private health insurance plans generally set reimbursement rates at a
discount to Medicare. If enacted, Congressional or regulatory measures that
reduce Medicare reimbursement rates could reduce reimbursement rates for our
products, which could have an adverse effect on our ability to sell our products
or cause our customers to use less expensive products, which could have a
material adverse effect on our results of operations.
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
jurisdictions, most notably France, requiring products to undergo 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 jurisdictions in which our products are sold
and these efforts are expected to continue. For example, in Germany, our largest
foreign market representing approximately 32% of international sales in 2000,
exclusive of freight revenue, reimbursement for our products was decreased in
1997 to 80% from 100% by government sponsored health care payment systems and
third party payors. In Italy, our rigid knee bracing products and cold therapy
systems, among others, are no longer eligible for reimbursement at all. In the
United Kingdom, while reimbursement for our products through the National Health
Service, or 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. In France, while we believe our rigid
knee braces would be eligible for reimbursement, our knee brace
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products have not gone through the lengthy regulatory process necessary for
reimbursement eligibility and, accordingly, the cost of these products is not
currently reimbursed in France. 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 customers to use less
expensive products, which could have a material adverse effect on our results of
operations.
RESPONSES BY HEALTH CARE PROVIDERS TO PRICE PRESSURES; FORMATION OF BUYING
GROUPS -- HEALTHCARE REFORM AND MANAGED CARE AND BUYING GROUPS HAS 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 as it seeks ways 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 given rise
to, and is expected to continue to cause, pressures on 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 recovery 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 our rigid knee
bracing segment, we and many of our competitors are offering lower priced,
off-the-shelf products in response to managed care. These lower priced products
have in part contributed to our minimal sales growth in our rigid knee bracing
product lines over the past few years and could have a material adverse effect
on our business, financial condition and results of operations in the future.
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 can
offset the financial impact of discounting. We believe that our ability to enter
into more of such arrangements will be important to our future success and the
growth of our revenues. However, 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 such 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
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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 similar downward pressure on product pricing and
other effects of health care reform as 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.
POTENTIAL REGULATION LIMITING CUSTOMER BASE -- PROPOSED LAWS COULD LIMIT THE
TYPES OF ORTHOPEDIC PROFESSIONALS WHO CAN FIT, SELL OR SEEK REIMBURSEMENT FOR
OUR PRODUCTS.
Congress and state legislatures have from time to time, in response to
pressure from certain orthopedic professionals, considered proposals which would
have the effect of limiting 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. The effect of such laws could be to 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. In such event, we would seek to ensure that orthopedic
professionals continue to prescribe our products and enhance our relationships
with authorized providers. However, 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.
PATENTS AND PROPRIETARY KNOW-HOW -- 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 certain of our components and
products and have patent applications pending with respect to certain components
and products. We also anticipate that we will apply for additional patents as we
deem appropriate. We believe that certain of our existing patents, particularly
the patents for 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 OA
braces,
- series of hinges for our post-operative braces,
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- 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 and the Patient
Ready Monarch,
- osteoarthritis bracing concepts, including pending patents on the
recently released OPAL and OAdjuster braces (Monarch, PR Monarch, OPAL,
OAdjuster),
- ankle bracing, both rigid and soft (ALP, RocketSoc, ProCare stirrup), and
- rigid shoulder bracing (Quadrant),
and will continue to be extremely important to our success. 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 expires in January
2005. The expiration of this patent could have a material adverse effect on our
business, financial condition and results of operations.
In addition, we hold licenses from third parties to utilize certain
patents, patents pending and technology utilized in the design of some of our
existing products and products under development, including the IceMan and the
DonJoy Vista(TM) system. If we lost these licenses, we would not be able to
manufacture and sell the related products, which 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. See "Business -- Intellectual Property."
PATENT LITIGATION -- WE COULD BE ADVERSELY AFFECTED IF WE BECOME INVOLVED IN
LITIGATION REGARDING OUR PATENTS OR OTHER INTELLECTUAL PROPERTY RIGHTS.
The medical device 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 USPTO, to
determine the priority of inventions. The defense and prosecution of
intellectual property suits, USPTO interference proceedings and related legal
and administrative proceedings are both costly and time-consuming. We have from
time to time needed to, and may in the future need to, litigate to enforce our
patents, to protect
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our trade secrets or know-how or to determine the enforceability, scope and
validity of the proprietary rights of others. Any future litigation or
interference proceedings will result in substantial expense to us and
significant diversion of effort by our technical and management personnel. 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 failure to obtain necessary licenses could prevent
us from manufacturing and selling certain of our products, which would have a
material adverse effect on our business, financial condition and results of
operations.
UNCERTAINTY OF DOMESTIC AND FOREIGN REGULATORY CLEARANCE AND APPROVAL -- WE MAY
NOT RECEIVE REGULATORY CLEARANCE OR APPROVAL FOR OUR PRODUCTS OR OPERATIONS IN
THE UNITED STATES OR ABROAD.
Our products and operations are subject to extensive regulation in the
United States by the Federal Food and Drug Administration ("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 particular, in order for us to market
certain 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, or PMA. All of our currently manufactured products hold the
relevant exemption or premarket clearance under the FFDCA. See
"Business -- Government Regulation."
The FDA may not act favorably or quickly in its review of our 510(k) or PMA
submissions, or we may encounter significant difficulties and costs in our
efforts to obtain FDA clearance or approval, all of which could delay or
preclude sale of new products in the United States. Furthermore, the FDA may
request additional data, require us to conduct further testing, or compile more
data, including clinical data, in support of a 510(k) submission. The FDA may
also, instead of accepting a 510(k) submission, require us to submit a PMA,
which is typically a much more complex application than a 510(k). To support a
PMA, the FDA would likely require that we conduct one or more clinical studies
to demonstrate that the device is safe and effective, rather than substantially
equivalent to another legally marketed device. We may not be able to meet the
requirements to obtain 510(k) clearance or PMA approval, or the FDA may not
grant any necessary clearances
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or approvals. In addition, the FDA may place significant limitations upon the
intended use of our products as a condition to a 510(k) clearance or PMA
approval. Product applications can also be denied or withdrawn due to failure to
comply with regulatory requirements or the occurrence of unforeseen problems
following approval. Failure to obtain FDA clearance or approvals of new products
we develop, any limitations imposed by the FDA on new product 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 order to conduct a clinical investigation involving human subjects for
the purpose of demonstrating the safety and effectiveness of a device, a company
must, among other things, apply for and obtain Institutional Review Board, or
IRB, approval of the proposed investigation. In addition, if the clinical study
involves a "significant risk" (as defined by the FDA) to human health, the
sponsor of the investigation must also submit and obtain FDA approval of an
investigational device exemption application. We may not be able to obtain FDA
and/or IRB approval to undertake clinical trials in the U.S. for any new devices
we intend to market in the United States in the future. If we obtain such
approvals, we may not be able to comply with the IDE and other regulations
governing clinical investigations or the data from any such trials may not
support clearance or approval of the investigational device. Failure to obtain
such approvals or to comply with such regulations could have a material adverse
effect on our business, financial condition and results of operations.
Once the medical device sponsor obtains clearance or approval for a
product, rigorous regulatory requirements apply to medical devices. These
requirements include, among other things, the Quality System Regulation, or QSR,
recordkeeping regulations, labeling requirements and adverse event reporting
regulations. See "Business -- Government Regulation -- Medical Device
Regulation." 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. See
"Business -- Government Regulation." 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-
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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.
DEPENDENCE ON ORTHOPEDIC PROFESSIONALS, AGENTS AND DISTRIBUTORS -- WE RELY
HEAVILY ON OUR RELATIONSHIPS WITH ORTHOPEDIC PROFESSIONALS, AGENTS AND
DISTRIBUTORS FOR MARKETING OUR PRODUCTS.
The sales of our rigid knee braces depend to a significant extent on the
prescription and/or recommendation of such products by widely recognized
orthopedic surgeons and sports medicine specialists. We have developed and
maintain close relationships with a number of widely recognized orthopedic
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 rigid knee braces to retain the support of such surgeons or specialists, or
the failure of our new rigid knee braces to secure and retain similar support
from leading surgeons or 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
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. See "Business --
Sales, Marketing and Distribution."
TRANSITION TO NEW INDEPENDENT DISTRIBUTORS IN INTERNATIONAL MARKETS -- OUR
OPERATING RESULTS COULD BE ADVERSELY AFFECTED IF WE ARE NOT SUCCESSFUL IN
FINDING AND RETAINING NEW INDEPENDENT DISTRIBUTORS IN INTERNATIONAL MARKETS.
In international markets our products have historically been sold through
30 Smith & Nephew sales organizations and 12 independent distributors. Since the
recapitalization, we have replaced 18 Smith & Nephew sales organizations with
independent distributors and a subsidiary distributor. International sales made
through Smith & Nephew sales organizations were 55%, 40% and 20% of our
international sales, exclusive of freight revenue, in 1998, 1999 and 2000,
respectively. We believe that we will be able to continue to increase sales by
switching to independent distributors who will be responsible for achieving
sales targets and focused on building strong relationships with our targeted
customers. However, we may not be able to find and retain independent
distributors on favorable terms or successfully effect the transition to such
new distributors without a significant disruption or loss of sales in the
applicable foreign jurisdiction. In addition, the new distributors may not
become technically proficient in the use and benefits of our products in a
timely manner, if at all. Accordingly, our transition to new independent
distributors could have a material adverse effect on our business, financial
condition and results of operations.
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In connection with the recapitalization, we entered into a distribution
agreement pursuant to which the 30 Smith & Nephew sales organizations which sold
our products prior to the recapitalization would continue to do so, and 13 Smith
& Nephew sales organizations continue to sell our products under this agreement.
However, Smith & Nephew has the right to cease distributing our products in a
specific territory on 60 days notice. See "Certain Relationships and Related
Transactions -- Other Agreements between DonJoy and Smith & Nephew --
Distribution Agreement." If Smith & Nephew terminates the distribution of our
products in a territory, we may not be able to find a new independent
distributor to replace the Smith & Nephew sales organization, which could have a
material adverse effect on our sales in such jurisdiction. The termination of
distribution by Smith & Nephew in a sufficient number of jurisdictions prior to
the time we are able to replace the Smith & Nephew sales organizations being
terminated with new independent distributors could have a material adverse
effect on our business, financial condition and results of operations. Smith &
Nephew has not given notice to terminate any of the remaining distributors.
INTERNATIONAL OPERATIONS -- 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 12% of our net revenues for the year
ended December 31, 2000, with Germany representing approximately 32% of
international net revenues. See Note 7 of Notes to DonJoy's Audited Consolidated
Financial Statements and "Business -- Business Strategy." Since our
international sales are denominated in U.S. dollars, our operating results are
not directly impacted by foreign currency exchange fluctuations. However, the
volume and product mix of our international sales may 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 foreign customers and thus may impact the overall level
of customer purchases or result in the customer purchasing less expensive, lower
margin products. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview." In addition, future sales of
our products may be denominated in 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 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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INTERNATIONAL OPERATIONS -- 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 jurisdiction
other than Mexico. The cost of transporting our products to foreign
jurisdictions 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 customers who use or distribute them outside the United States is
often greater than products manufactured in the local foreign jurisdiction. 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 increase our exposure to
the risks of doing business in international jurisdictions. 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.
RISKS GENERALLY ASSOCIATED WITH STRATEGIC GROWTH OPPORTUNITIES -- 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 the
Orthotech Acquisition, investments and strategic alliances that either expand or
complement our business. We may not be able to identify acceptable opportunities
or complete any additional acquisitions, investments or strategic alliances on
favorable terms or in a timely manner. Acquisitions and, to a lesser extent,
investments and strategic alliances involve a number of risks, including:
- the diversion of management's attention to the assimilation of the
operations and personnel of the new business,
- adverse short-term effects on our operating results,
- the inability to successfully integrate the new businesses with our
existing business, including financial reporting, management and
information technology systems,
- unforeseen operating difficulties and expenditures,
- the need to manage a significantly larger business,
- amortization of large amounts of goodwill and other intangible assets,
such as the approximately $45.1 million of goodwill and other intangible
assets relating to our acquisition of Orthotech which we will amortize
over the next three to fifteen years,
- the risks of 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 substantial amount of our available cash to consummate the
acquisition.
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In addition, as was required in connection with the Orthotech Acquisition,
we may require additional debt or equity financings for future acquisitions,
investments or strategic alliances which 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.
IMPLEMENTATION OF BUSINESS STRATEGY -- IF WE CANNOT SUCCESSFULLY IMPLEMENT OUR
BUSINESS STRATEGY, WE MAY NOT BE ABLE TO SERVICE OUR INDEBTEDNESS.
Our business strategy is to:
- increase international sales,
- improve operating efficiencies,
- introduce new products and product enhancements, and
- pursue strategic growth opportunities.
Our ability to achieve our objectives is subject to a variety of factors,
many of which are beyond our control, and 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 certain
aspects of our business strategy and may adopt alternative or additional
strategies due to competitive factors or factors not currently foreseen, such as
unforeseen costs and expenses or events beyond our control, such as an economic
downturn. See "-- Substantial Leverage and Ability to Service and Refinance
Debt."
Any failure to successfully implement our business strategy may adversely
affect our ability to service our indebtedness, including our ability to make
principal and interest payments on the notes.
DEPENDENCE UPON KEY PERSONNEL -- 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,
and Michael R. McBrayer, our Senior Vice President -- Domestic Sales. The loss
of these key personnel could have a material adverse effect on us. See
"Management -- Employment Agreements."
COMPETITION -- WE OPERATE IN A VERY COMPETITIVE BUSINESS ENVIRONMENT.
The orthopedic recovery products industry is highly competitive and
fragmented. Our competitors include numerous smaller niche companies and a few
large, diversified orthopedic companies. Some of our competitors are part of
corporate groups that have significantly greater financial, marketing and other
resources than us. As such, we may be at a competitive disadvantage with respect
to these competitors. Our primary competitors in the rigid knee brace market
include Innovation Sports Incorporated, Townsend Industries Inc., Bledsoe Brace
Systems (a division of Medical Technology, Inc.), Generation II USA, Inc. and
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Breg, Inc. We compete in the non-retail sector of the soft goods products market
and our competitors include DeRoyal Industries, Zimmer, Inc. (a division of
Bristol-Meyers Squibb Company) and Tecnol Orthopedics (a division of Kimberly
Clark Corp.). We compete with a variety of manufacturers of specialty and other
orthopedic products, depending on the type of product. In addition, in certain
foreign countries, we compete with one or more local competitors.
TECHNOLOGICAL CHANGE -- WE MAY NOT BE ABLE TO DEVELOP AND MARKET NEW PRODUCTS OR
PRODUCT ENHANCEMENTS TO REMAIN COMPETITIVE.
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 OA braces.
Further, our ongoing success requires the continued development 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,
- obtain required regulatory approvals for such products,
- market such products in a commercially viable manner, or
- gain market acceptance for such products.
Our failure to develop and market new products and product enhancements
could have a material adverse effect on our business, financial condition and
results of operations. See "Business -- Competition."
PRODUCT LIABILITY EXPOSURE -- WE 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. Although we maintain product liability insurance in amounts which we
believe to be reasonable and standard in the industry, the amount and scope of
any coverage may be inadequate to protect us in the event of a substantial
adverse product liability judgment.
CONCENTRATION OF OWNERSHIP AND CONTROL OF THE COMPANY -- WE ARE CONTROLLED BY
CDP, FAIRFIELD CHASE AND THEIR MEMBERS AND THEIR INTERESTS MAY NOT BE ALIGNED
WITH YOURS.
CDP owns approximately 92.1% of the outstanding voting units of DonJoy,
which owns all of dj Ortho's equity interests. The members of CDP are JPMP (23A
SBIC), an affiliate of J.P. Morgan Partners, LLC, First Union Capital Partners,
LLC and DJ Investment, ("the First Union Affiliates"), affiliates of First Union
Investors, Fairfield Chase, and the TCW Affiliates. JPMP (23A SBIC), who owns a
majority of the interests of CDP and Fairfield Chase, which is controlled by
Charles T. Orsatti, is the initial managing member of CDP. In addition, through
their
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ownership of redeemable preferred units, JPMP (23A SBIC), DJ Investment, and the
TCW Affiliates also directly own approximately 2.7%, 0.8% and 1.8%,
respectively, of the outstanding voting units of DonJoy. Accordingly, CDP and
Fairfield Chase, which as managing member initially controls CDP, and their
members have the power, subject to certain exceptions, to control dj Ortho and
DonJoy. Under certain circumstances, JPMP (23A SBIC) can become the managing
member of CDP. For a description of the ownership, voting and management
arrangements regarding DonJoy and CDP, see "Security Ownership of Certain
Beneficial Owners and Management." The interests of CDP, Fairfield Chase and
their members may not in all cases be aligned with yours.
PURCHASE OF THE NOTES UPON CHANGE OF CONTROL -- 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 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. See "Description
of the Notes -- Change of Control" and "Description of Credit Facility."
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 provisions. 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.
IMPACT OF ENVIRONMENTAL AND OTHER REGULATION -- WE ARE SUBJECT TO A VARIETY OF
ENVIRONMENTAL LAWS AND OTHER REGULATIONS, WHICH COULD ADVERSELY AFFECT US.
We are subject to the requirements of federal, state and local
environmental and occupational health and safety laws and regulations of the
U.S. and foreign countries. We cannot assure you that we have been or will be at
all times in
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37
complete compliance with all such requirements or that we will not incur
material costs or liabilities in connection with such requirements in the
future. These requirements are complex, constantly changing and have tended to
become more stringent over time. It is possible that these requirements may
change or liabilities may arise in the future in a manner that could have a
material effect on our business. For more information about our environmental
compliance and potential environmental liabilities see
"Business -- Environmental and Other Matters."
REGULATION OF FRAUD AND ABUSE IN HEALTH CARE -- 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
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, we may be required to alter one or more of our practices to be in
compliance with these laws. In addition, we cannot assure you that the
occurrence of one or more violations of these laws would not 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. See "Business -- Government Regulation."
We may also become subject to litigation for submission of claims for
payment that are "not provided as claimed" under federal statutes. Federal false
claims litigation can 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 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 and for Medicaid programs as a result of an investigation arising
out of such action.
UNCERTAINTY RELATING TO GOVERNMENTAL AUDITS -- DENIED CLAIMS COULD REDUCE OUR
REVENUE OR PROFITS.
Medicare contractors and Medicaid agencies periodically conduct pre-and
post-payment reviews 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.
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FRAUDULENT CONVEYANCE STATUTES -- 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. We used the net
proceeds from the offering of the old notes, together with borrowings under the
term loan portion of the credit facility, to purchase the assets and operations
of DonJoy. DonJoy used such amounts, together with the proceeds from the
issuance of the Common Units to CDP and the Management Members and the
Redeemable Preferred Units to repurchase a portion of the equity interests of
DonJoy owned by Smith & Nephew. The obligations we incurred under the indenture
and the old notes and the obligations incurred by DonJoy under the indenture and
its guarantee 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 DonJoy's
unpaid creditors. Under these laws, if a court were to find that, at the time we
issued the old notes or DonJoy issued its guarantee of the old notes we or
DonJoy, 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 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 would
incur, debts beyond our or DonJoy's ability to pay as they matured or
became due,
then, such court might:
- subordinate the notes or DonJoy's guarantee of the notes to our or
DonJoy's presently existing or future indebtedness,
- void the issuance of the notes (in our case) or DonJoy'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 DonJoy generally
would be considered insolvent at the time we incurred indebtedness under the old
notes or DonJoy issued its guarantee, as the case may be, if either:
- the fair salable value of our or DonJoy's assets, as applicable, were
less than the amount required to pay our or DonJoy's probable liability
on our or its total existing debts and liabilities (including contingent
liabilities) as they become absolute or matured, or
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39
- the sum of our or DonJoy's debts (including contingent liabilities) were
greater than our or DonJoy's 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 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 DonJoy'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 DonJoy 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 (i) were not insolvent
or rendered insolvent thereby, (ii) had sufficient capital to run our business
and (iii) 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 DonJoy within 90 days after any payment by us with respect to the notes or by
DonJoy under its guarantee of the notes, or if we or DonJoy 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.
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
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40
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.
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THE RECAPITALIZATION TRANSACTIONS
THE RECAPITALIZATION
On June 30, 1999, DonJoy consummated a recapitalization pursuant to a
recapitalization agreement dated as of April 29, 1999 among CDP, Smith & Nephew
and DonJoy. As of the date of this prospectus, CDP, the Management Members and
the holders of the Redeemable Preferred Units own approximately 92.1%, 2.6% and
5.3%, respectively, of the outstanding voting Units of DonJoy.
Pursuant to the recapitalization, CDP made a $64.6 million cash investment
in the Common Units of DonJoy. The Management Members also made a $1.8 million
investment in the Common Units of DonJoy, $1.4 million of which was financed by
loans from DonJoy. In addition, DonJoy issued the 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 purchasing approximately
$10.2 million of such Redeemable Preferred Units before payment of $1.4 million
of fees to them on a pro rata basis. DonJoy sold all of its assets (other than
the cash proceeds from the equity contribution by CDP and the Management Members
and the issuance of the Redeemable Preferred Units) to the Company. The Company
funded the asset sale using the proceeds from the offering of the old notes and
$15.5 million of borrowings under the credit facility. DonJoy used the $207.9
million of proceeds from the asset sale, the issuance of the Redeemable
Preferred Units and the issuance of the Common Units to CDP and the Management
Members (excluding $1.4 million which was financed through loans to the
Management Members) to repurchase from Smith & Nephew its Common Units in DonJoy
(other than a retained interest of approximately 7.3%) for approximately $199.1
million and to pay transaction fees and expenses of $8.8 million.
The sources and uses of funds for the recapitalization are presented in the
following table:
AMOUNT
------
(DOLLARS IN
MILLIONS)
SOURCES:
Credit facility(a)........................................ $ 15.5
Old Notes................................................. 98.0
Redeemable Preferred Units(b)............................. 30.0
Common Unit investment in DonJoy by CDP................... 64.6
Retained Common Unit investment in DonJoy by Smith &
Nephew................................................. 5.4
Common Unit investment in DonJoy by Management Members.... 1.8
------
Total sources..................................... $215.3
======
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AMOUNT
------
(DOLLARS IN
MILLIONS)
USES:
Consideration paid to Smith & Nephew...................... $199.1
Retained Common Unit investment in DonJoy by Smith &
Nephew................................................. 5.4
Loans to Management Members............................... 1.4
Fees and expenses......................................... 8.8
Working capital........................................... 0.6
------
Total uses........................................ $215.3
======
- -------------------------
(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 on a pro rata basis.
The loans to the Management Members initially bore interest at the rate of
5.3% and had a seven-year maturity. Annual interest payments were initially
required until the maturity date, at which time the entire principal amount of
the loan must be repaid. The loans to the Management Members are full recourse
and secured by a pledge of the Common Units issued to the applicable Management
Members. These loans were amended in connection with the loans DonJoy made to
the Management Members in connection with the Orthotech Acquisition and the
purchase of the Smith & Nephew interests. See "Recent Developments."
In connection with the recapitalization, DonJoy and Smith & Nephew entered
into agreements providing for the continuation or transfer and transition of
certain aspects of the Company's business operations. See "Certain Relationships
and Related Transactions -- Additional Agreements between DonJoy and Smith &
Nephew."
Upon consummation of the recapitalization, DonJoy adopted an option plan,
which currently entitles certain members of management, outside directors and
consultants to acquire, subject to certain conditions, up to approximately 15%
of DonJoy's equity interests on a fully diluted basis. See "Management -- 1999
Option Plan."
On July 30, 1999, JPMP (23A SBIC) and First Union Investors each
transferred to the TCW Affiliates approximately $5.2 million of Redeemable
Preferred Units of DonJoy and $1.8 million and $0.2 million, respectively, of
membership interests in CDP.
In December 1999, First Union Investors transferred its remaining interest
in DonJoy to DJ Investment. First Union Investors is the manager of DJ
Investment.
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RECENT DEVELOPMENTS
THE ORTHOTECH ACQUISITION
On July 7, 2000, we completed the purchase of certain assets and assumed
certain liabilities of DePuy Orthotech related to DePuy Orthotech's bracing and
soft goods business. The Orthotech Acquisition was effected pursuant to the
terms of an Asset Purchase Agreement dated July 7, 2000 among DonJoy, us and
DePuy Orthopaedic, a copy which is filed as an exhibit to the registration
statement of which this prospectus is a part.
The Orthotech business 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 currently offered by
us. Following the Orthotech Acquisition, we sold products under the Orthotech
brand; however, we have now integrated Orthotech products into the DonJoy and
ProCare brands. The Orthotech business also had an inventory management and
billing program that has complemented our current OfficeCare program.
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. 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.
We did not acquire any of Orthotech's facilities nor did we hire a majority
of Orthotech's employees and instead have integrated the Orthotech operations
into our existing business. Upon closing of the Orthotech Acquisition, Orthotech
retained responsibility with regard to lease obligations on the Orthotech
facility and severance obligations for terminated Orthotech employees. In
accordance with the transition services agreement dated as of July 7, 2000,
DePuy Orthotech provided certain transitional services to us during the third
quarter of 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, computer services and other
administrative services.
We required approximately $49.4 million in cash to close the Orthotech
Acquisition including approximately $3.0 million for related fees and costs. A
total of $0.4 million of the fees and costs have been allocated to debt issuance
costs and will be amortized over the life of the related debt instruments. The
funds necessary to consummate the Orthotech Acquisition were raised through the
sale by DonJoy of $8.3 million of common units of which the net proceeds totaled
$8.1 million (excluding management notes receivables of $0.2 million) and $3.6
million of Redeemable Preferred Units to existing holders of the preferred units
of which the net proceeds totaled $3.4 million (excluding preferred unit fees of
$0.2 million). We raised the remaining funds by borrowing approximately $36.6
million under our credit agreement along with use of approximately $1.3 million
of existing cash. The credit agreement was amended in connection
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with the acquisition to increase the amount of term loans available by $24.0
million to $39.5 million but did not increase the revolving line of credit of
$25.0 million.
The sources and uses of funds for the Orthotech Acquisition are presented
in the following table:
AMOUNT
------
(DOLLARS IN
MILLIONS)
SOURCES:
Cash.............................................. $ 1.3
Revolving Credit Facility......................... 12.6
Term Loan......................................... 24.0
Redeemable Preferred Units(a)..................... 3.4
Common Unit Investment by CDP..................... 8.1
Common Unit Investment by Management.............. 0.2
-----
$49.6
=====
USES:
Cash to DePuy Orthotech........................... $46.4
Management Promissory Notes....................... 0.2
Transaction fees and costs........................ 2.6
Debt issuance costs............................... 0.4
-----
$49.6
=====
- -------------------------
(a) Represents $3.6 million of proceeds received from the sale of Redeemable
Preferred Units, net of $0.2 million of fees paid to JPMP (23A SBIC), TCW
and DJ Investment on a pro rata basis.
SALE OF SMITH & NEPHEW INTERESTS
In accordance with the Unit Purchase Agreement dated as of June 28, 2000,
Smith & Nephew sold its entire remaining interest of 54,000 Common Units in
DonJoy to CDP and the Management Members for $5.9 million. CDP purchased 52,495
Common Units for a total consideration of $5.7 million and the Management
Members 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 promissory notes.
In connection with the purchase, DonJoy agreed to amend and restate the
promissory notes originally issued by the Management Members 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 5.3% to 6.62% per annum, the amended and restated
notes permit the Management Member to increase the principal amount
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due under the note by the amount of a scheduled interest payment (the "PIK
Option"). If a Management Member elect 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
amended and restated notes mature in 2007.
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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 DonJoy's consolidated capitalization as of
December 31, 2000. This table should be read in conjunction with the
consolidated financial statements, including the notes thereto, "Selected
Historical Consolidated Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere in
this prospectus.
AS OF DECEMBER 31,
2000
----------------------
(DOLLARS IN THOUSANDS)
Cash.............................................. $ 4,106
========
Debt:
Credit facility, including current portion........ $ 58,962
Notes(a)........................................ 98,260
--------
Total debt.............................. 157,222
Redeemable preferred units(b)..................... 41,660
Members' equity (deficit)......................... (63,625)
--------
Total capitalization.................... $135,257
========
- -------------------------
(a) Net of unamortized debt discount of approximately $1.7 million.
(b) The liquidation preference at December 31, 2000 was $43,688.
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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following table presents selected historical consolidated financial and
other data of DonJoy as of and for the dates and periods indicated. DonJoy is a
guarantor of the notes and of the credit facility and has no material assets or
operations other than its ownership of 100% of our equity interests. As a
result, the consolidated financial position and results of operations of DonJoy
are 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 and the related notes thereto included elsewhere in this prospectus. The
historical financial data at December 31, 1998, 1997 and 1996 and for the two
years ended December 31, 1997 are derived from consolidated financial statements
of DonJoy that are not included in this prospectus. The consolidated financial
data set forth below should be read in conjunction with the historical
consolidated financial statements and the related notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," all included elsewhere in this prospectus.
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1996 1997 1998 1999 2000
------- ------- -------- -------- --------
(DOLLARS IN THOUSANDS)
STATEMENT OF INCOME DATA:
Net revenues........................................ $85,334 $95,288 $104,292 $117,767 $147,469
Cost of goods sold(a)............................... 36,916 39,393 46,466 51,744 60,178
------- ------- -------- -------- --------
Gross profit........................................ 48,418 55,895 57,826 66,023 87,291
Operating expenses(a):
Sales and marketing............................... 21,769 25,062 28,282 30,251 42,536
General and administrative........................ 12,941 15,802 16,484 16,755 19,761
Research and development.......................... 1,766 2,055 2,248 2,115 2,465
Merger and integration costs(b)................... -- -- -- -- 400
Restructuring costs(c)............................ -- -- 2,467 -- --
------- ------- -------- -------- --------
Total operating expenses............................ 36,476 42,919 49,481 49,121 65,162
------- ------- -------- -------- --------
Income from operations.............................. 11,942 12,976 8,345 16,902 22,129
Interest expense.................................... (2,459) (2,072) -- (7,568) (16,958)
Interest income..................................... -- -- -- 181 437
Discontinued acquisition costs...................... -- -- -- -- (449)
------- ------- -------- -------- --------
Income before income taxes.......................... 9,483 10,904 8,345 9,515 5,159
Provision for income taxes.......................... 3,828 4,367 3,394 2,387 --
------- ------- -------- -------- --------
Net income.......................................... $ 5,655 $ 6,537 $ 4,951 $ 7,128 $ 5,159
------- ------- -------- -------- --------
Less: Preferred stock dividends and accretion of
Preferred unit fees............................... -- -- -- (2,343) (5,415)
------- ------- -------- -------- --------
Net income (loss) available to members.............. $ 5,655 $ 6,537 $ 4,951 $ 4,785 $ (256)
======= ======= ======== ======== ========
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YEARS ENDED DECEMBER 31,
--------------------------------------------------
1996 1997 1998 1999 2000
------- ------- -------- -------- --------
(DOLLARS IN THOUSANDS)
OTHER DATA:
EBITDA(d)........................................... $16,584 $17,779 $ 15,665 $ 21,854 $ 28,894
Adjusted EBITDA(e).................................. 19,187 22,090 21,957 25,082 29,162
Depreciation and amortization....................... 4,642 4,803 4,853 4,952 6,365
Capital expenditures and acquired intangibles....... 1,848 2,273 4,149 4,706 7,722
Ratio of earnings to fixed charges(f)............... 3.94x 4.83x 8.84x 2.12x 1.29x
BALANCE SHEET DATA (AT END OF PERIOD):
Cash................................................ $ 557 $ 910 $ 809 $ 5,927 $ 4,106
Working capital..................................... 9,675 9,749 15,625 27,413 38,695
Total assets........................................ 70,787 71,288 77,056 89,416 155,672
Long-term obligations............................... -- -- -- 112,805 157,222
Redeemable preferred units.......................... -- -- -- 32,539 41,660
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)
- -------------------------
(a) Except for 2000, historical amounts include various charges and overhead
allocations from Smith & Nephew. See note (e) 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 Notes to
DonJoy's Audited Consolidated Financial Statements, and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Overview -- Manufacturing Cost Reduction Initiatives".
(d) "EBITDA" is defined as income from operations plus restructuring costs,
merger and integration costs and depreciation and amortization. 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. Under both the credit agreement definition of EBITDA and
our definition of EBITDA, we are in compliance with all debt covenants under
the credit agreement. Our definition of EBITDA may not be comparable to that
of other companies.
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(e) "Adjusted EBITDA" represents EBITDA (as defined above) adjusted to
eliminate:
(1) charges for brand royalties paid by DonJoy to Smith & Nephew for use of
the Smith & Nephew trademarks and trade names which amounts are no
longer paid following the recapitalization;
(2) foreign sales corporation commissions paid by DonJoy 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 following consummation of the recapitalization (the
"Eliminated Allocations");
(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 (collectively, the "Other Corporate
Allocations");
(5) the incremental cost of the fair market value of acquired inventories
associated with the Orthotech Acquisition;
and adjusted to include the estimated costs we expected to incur to
replace the services previously provided by Smith & Nephew as part of
the Other Corporate Allocations.
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1996 1997 1998 1999 2000
------- ------- ------- ------- -------
(IN THOUSANDS)
EBITDA(a) data:
Income from operations.... $11,942 $12,976 $ 8,345 $16,902 $22,129
Restructuring costs....... -- -- 2,467 -- --
Merger & integration
costs................... -- -- -- -- 400
Depreciation and
amortization............ 4,642 4,803 4,853 4,952 6,365
------- ------- ------- ------- -------
EBITDA (as defined)....... 16,584 17,779 15,665 21,854 28,894
Brand royalties........... 1,274 1,605 3,249 1,817 --
Foreign sales corporation
commissions............. 492 661 439 -- --
Eliminated Allocations.... 836 1,652 1,726 979 --
Other Corporate
Allocations............. 801 1,193 1,678 832 --
Step-up in inventory...... -- -- -- -- 268
Estimated costs to replace
Smith & Nephew
services................ (800) (800) (800) (400) --
------- ------- ------- ------- -------
Adjusted EBITDA........... $19,187 $22,090 $21,957 $25,082 $29,162
======= ======= ======= ======= =======
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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, the services performed by Smith & Nephew after the
recapitalization and our ability to replace such services, see Note 9
of Notes to DonJoy's Audited Consolidated Financial Statements,
"Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview -- Smith & Nephew Allocations and
Sales" and "Certain Relationships and Related Transactions -- Other
Agreements between DonJoy and Smith & Nephew -- Transition Services
Agreement."
(f) 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.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DonJoy is a guarantor of the notes and of the credit facility and has no
material assets or operations other than its ownership of all dj Ortho's equity
interests. As a result, the discussion below of the historical consolidated
financial position and results of operations of DonJoy is substantially the same
as ours. No financial information of DJ Capital, the co-issuer of the notes, is
included herein because management believes such information would not be
material given DJ Capital's lack of assets and liabilities.
On June 30, 1999, DonJoy consummated a $215.3 million recapitalization. In
connection with the recapitalization transactions, DonJoy established dj Ortho
and DJ Capital. DonJoy sold all of its net assets to dj Ortho for cash which was
funded with the net proceeds of $100.0 million principal amount of 12 5/8% Notes
issued by dj Ortho and DJ Capital, as co-issuers, and the remainder by funds
borrowed by dj Ortho under a senior credit facility. In addition, new investors,
including certain members of management, invested new capital of $96.4 million
in equity in DonJoy. 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 and canceled our liabilities to
it (which included current and deferred income taxes due to former parent) and a
then existing restructuring reserve which resulted in an additional capital
contribution in those amounts. All such amounts were treated as a capital
contribution by the former parent to DonJoy's members' equity.
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
CDP and certain members of management for $5.9 million. CDP 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 DonJoy.
On July 7, 2000, we completed the purchase of certain assets and assumed
certain liabilities of DePuy Orthotech related to DePuy Orthotech's bracing and
soft goods business. The Orthotech business 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 currently offered by us. The Orthotech business also had an inventory
management and billing program that complemented our current OfficeCare program.
The asset purchase agreement provided for the purchase of certain assets
and the assumption of certain liabilities of DePuy Orthotech, comprising the
Orthotech business, for a purchase price of $46.4 million in cash, exclusive of
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transaction fees and expenses. 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.
The following discussion should be read in conjunction with DonJoy's
audited consolidated financial statements and the related notes thereto, as well
as the unaudited pro forma consolidated financial information and the other
financial data included elsewhere in this prospectus.
OVERVIEW
SEGMENTS. We design, manufacture and market orthopedic recovery products
and complementary products. Our product lines include rigid knee braces, soft
goods and a portfolio of specialty and other orthopedic 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 OA 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
afflictions of the knee, ankle, back and upper extremities, including the
shoulder, elbow, neck and wrist. Our portfolio of specialty and other orthopedic
products, which are designed to facilitate orthopedic rehabilitation, include
lower extremity walkers, upper extremity braces, cold therapy systems and pain
management delivery systems. The rigid knee brace product lines and the soft
goods product lines constitute reportable segments under generally accepted
accounting principles. See Note 7 of Notes to DonJoy's Audited Consolidated
Financial Statements. Set forth below is revenue and gross profit information
for our three product lines for the years ended December 31, 1998, 1999 and
2000. 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 Notes
to DonJoy's Audited Consolidated Financial Statements.
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YEARS ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- ------- -------
(DOLLARS IN THOUSANDS)
RIGID KNEE BRACES:
Net revenues................................ $48,594 $49,406 $54,456
Gross profit................................ 34,460 35,721 38,493
Gross profit margin......................... 70.9% 72.3% 70.7%
SOFT GOODS:
Net revenues................................ $34,233 $39,652 $52,031
Gross profit................................ 16,637 19,276 25,761
Gross profit margin......................... 48.6% 48.6% 49.5%
SPECIALTY AND OTHER ORTHOPEDIC PRODUCTS:
Net revenues................................ $17,958 $25,194 $36,570
Gross profit................................ 8,978 12,516 22,115
Gross profit margin......................... 50.0% 49.7% 60.5%
Our total gross profit margin before brand royalties, other cost of goods
sold not allocable to specific product lines and freight revenue was 59.6%,
59.1%, 60.4%, for the years ended December 31, 1998, 1999 and 2000,
respectively.
Our products are marketed globally under the DonJoy and ProCare brand names
through several distribution channels. DonJoy brand product sales represented
approximately 74% of total net revenues, excluding freight revenue, in 2000.
Excluding freight revenue, we market substantially all of our rigid knee braces,
approximately 84% of our specialty and other orthopedic products and
approximately 42% of our soft goods products under the DonJoy brand name.
ProCare brand product sales represented approximately 26% of total net revenues,
excluding freight revenue, in 2000. Excluding freight revenue, we market
approximately 58% of our soft goods products, approximately 16% of our specialty
and other orthopedic products and a small percentage of our rigid knee braces
under the ProCare brand name. Following the Orthotech Acquisition, we sold
products under the Orthotech brand; however, we have now integrated Orthotech
products into the DonJoy and ProCare brands.
DOMESTIC SALES. In the United States, DonJoy brand products are marketed
to orthopedic surgeons, orthotic and prosthetic centers, hospitals, surgery
centers, physical therapists and athletic trainers by 30 commissioned sales
agents who employ approximately 198 sales representatives to sell DonJoy
products (including additional sales representatives added as a result of the
Orthotech Acquisition). 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. The gross profit and
gross profit margins on DonJoy products sold in the United States do not include
the commissions paid to the agents on sales of such products, which commissions
are reflected in sales and marketing expense in the DonJoy's Audited
Consolidated Financial Statements. Excluding freight revenue, domestic sales of
DonJoy brand products represented approximately 61% and 58% of total net
revenues in 1999 and 2000, respectively.
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ProCare 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 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
products represented approximately 24% and 30% of total net revenues in 1999 and
2000, respectively. Domestically, Orthotech products were historically sold
through DePuy Orthotech sales personnel.
INTERNATIONAL SALES. Excluding freight revenue, international sales,
primarily in Europe, Canada, and Japan, accounted for approximately 18%, 16%,
and 12% of our net revenues, in 1998, 1999 and 2000, respectively. Excluding
freight revenue, total sales in Europe, Germany and Canada accounted for 72%,
32% and 10%, respectively, of our 2000 international net revenues, with no other
country accounting for 10% or more of our 2000 international net revenues.
Excluding freight revenue, sales in Japan accounted for approximately 9% of our
international net revenues in 2000. The decrease in international net revenues
as a percentage of total revenues in 2000 as compared to prior years is a direct
result of the Orthotech business, which historically consisted primarily of
domestic sales. Historical Orthotech revenues were generated primarily from
domestic sales. In addition, international sales were adversely impacted by
foreign currency exchange fluctuations as the changes in the rate of exchange
between the U.S. dollar and the Euro affected the cost of our products to our
European customers.
International sales are currently made 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 product in Australia through dj Australia. Distributors in both
of these channels buy and resell our products and have the ability to sell
DonJoy and ProCare brand products within their designated countries. Excluding
freight revenue, DonJoy brand products constituted approximately 81% of 1998
international net revenues as compared to 84% in 1999 and 82% in 2000. 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 55%, 40% and 20% of our international
sales, exclusive of freight revenue, in 1998, 1999 and 2000, respectively. We
believe future opportunities for sales growth within international markets are
significant. We expect to increase international sales by reorganizing and
expanding our international distribution network and implementing the marketing
and distribution strategies which we have successfully utilized in the United
States and certain international territories, most notably Germany. In
particular, we have replaced 17 Smith & Nephew sales organizations with
independent distributors who will focus on building strong relationships with
our targeted customers and will be responsible for achieving specified sales
targets.
Our international sales are made in United States dollars. Accordingly, the
Company's results of operations are not directly impacted by foreign currency
exchange fluctuations. However, as was the case in 2000, the volume and product
mix of international sales may be impacted by foreign currency exchange
fluctuations as changes in the rate of exchange between the U.S. dollar and the
foreign currency will affect the cost of our products to our customers and thus
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may impact the overall level of customer purchases or result in the customer
purchasing less expensive products.
THIRD PARTY REIMBURSEMENT; HEALTH CARE REFORM; MANAGED CARE. While
national health care reform and the advent of managed care has impacted the
orthopedic recovery products industry, 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 U.S. orthopedic recovery
products industry have been directed towards scrutiny of medical device
reimbursement codes, whereby devices are classified to determine the dollar
amount eligible for reimbursement, and their applicability toward certain
orthopedic procedures. Reimbursement codes covering certain of our products have
been lowered or narrowed, thereby reducing the breadth of products for which
reimbursement can be sought. We expect that a 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 similar downward pressure on product pricing and
other effects of health care reform as 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.
In response to the historic and forecasted reductions of reimbursement
rates and the impact of demand matching (where patients are evaluated as to age,
need for mobility and other parameters and are then matched with an orthopedic
recovery product that is cost effective in light of such evaluation), we and
many of our competitors are introducing new product offerings at lower prices.
This is particularly evident within the U.S. rigid knee bracing segment of the
orthopedic recovery products industry where we and many of our competitors are
offering lower priced, off-the-shelf products. The minimal sales growth in our
rigid knee bracing product lines over the past few years has in part resulted
from these price pressures. The increase in 2000 in revenues from our rigid knee
bracing product line is due to the Orthotech Acquisition. Excluding sales of
Orthotech products, revenue growth within the rigid knee-bracing segment was
minimal.
We believe that we will not be materially adversely affected by U.S. or
international health care reform. We currently do not have any capitated health
care service arrangements. We believe that to the extent we respond to price
pressures through lower prices for our products, we will be able to
substantially offset the effect of this price erosion through reductions in our
manufacturing and other costs. In addition, because of the quality,
functionality and reputation of our products, our marketing and sales programs
which emphasize strong relationships with customers and the service we provide
to our customers, we believe we will be able to compete even if reimbursement
rates are materially altered. For example, revenues from the IceMan from 1997 to
2000 increased despite elimination of its eligibility for reimbursement.
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
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supplier arrangements with one or more manufacturers of orthopedic or other
medical products in return for price discounts. 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. Accordingly, although there can be no
assurance, we believe that such price discounting will not have a material
adverse effect on our operating results in the future. See "Risk
Factors -- Responses by Health Care Providers to Price Pressures; Formation of
Buying Groups" and "Business -- Sales, Distribution and Marketing -- United
States."
OFFICECARE PROGRAM. In 1996, in response to the needs of our customers, we
launched OfficeCare, an inventory management and insurance billing program for
our U.S. orthopedic physician customers. Under the OfficeCare program, we
provide the orthopedic physician with an inventory of orthopedic products for
immediate disbursement to the physician's patients. We then directly seek
reimbursement from the patient's insurance company, other third party payor or
from the patient where self-pay is applicable.
Since its inception, the OfficeCare program has been promoted specifically
to provide our orthopedic physician customers with a full complement of soft
goods and certain specialty products (including products of competitors) for
immediate patient use. The OfficeCare program is intended to introduce new
orthopedic physicians to our product lines without financial risk to the
potential customer.
The OfficeCare program represented approximately 7% and 13% of our net
revenues, excluding freight revenue, for 1999 and 2000, respectively, with sales
of soft goods and specialty and other orthopedic products representing the
majority of such sales. The OfficeCare program involves our lower priced soft
goods products, but is designed to also strengthen our relationship with the
customer, thereby also increasing sales of the higher end products. The
OfficeCare program has historically experienced a strong growth rate, with an
increase of sales, of 63% in 1999 over 1998 and 113% in 2000 over 1999. 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 has
expanded our involvement in the third party reimbursement process, or in certain
cases directly with the patient. The collection period for these receivables as
compared to other segments of our business is significantly longer and has also
resulted in a need to increase our bad debt allowance requirements. The increase
in OfficeCare bad debt allowance is the primary reason for the increase in the
allowance for doubtful accounts at December 31, 2000.
The Orthotech business also had an inventory management and billing program
that was integrated with and complements our existing OfficeCare Program. We
believe that, as the result of the acquisition of Orthotech, the percentage of
our net revenues represented by the OfficeCare program will increase in future
periods.
SMITH & NEPHEW ALLOCATIONS AND SALES. Prior to December 29, 1998, our
business was operated as the Bracing & Support Systems Division (the
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"Division") of Smith & Nephew. Effective December 29, 1998, Smith & Nephew
contributed the Division's net assets and shares of a Mexican subsidiary to
DonJoy, 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 Notes to DonJoy's Audited Consolidated Financial
Statements.
The following is a summary of such charges and allocations and their
applicability to DonJoy 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, 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 included in general and administrative expense. These
allocations ("Eliminated 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
which were included in general and administrative expense. These
allocations (referred to in this prospectus collectively as the "Other
Corporate 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 Securities and Exchange Commission. We estimate
that the aggregate annual cost of replacing these services and such
additional expenses was approximately $0.8 million following the
recapitalization.
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(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
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 service 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. As noted above, we estimate that the
services described in paragraph (4) above (which are reflected as general and
administrative expense following the recapitalization) have cost us
approximately $0.8 million following the recapitalization.
For the years ended December 31, 1998, 1999 and 2000, sales to Smith &
Nephew and its affiliates (including Smith & Nephew's sales organizations) were
$10.7 million, $8.3 million, and $4.6 million, respectively, or 11%, 7%, and 2%,
respectively, of total sales, excluding freight revenue, for these periods.
International sales made through Smith & Nephew sales organizations were 55%,
40%, and 20% of international sales, excluding freight revenue, in 1998, 1999
and 2000, 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 "Certain Relationships and
Related Transactions -- Other Agreements between DonJoy and Smith &
Nephew -- Supply Agreement" and "-- Distribution Agreement".
MANUFACTURING COST REDUCTION INITIATIVES. Over the past several years, we
have undertaken initiatives designed to lower our overall manufacturing cost
structure. In order to take advantage of the lower labor costs in Mexico, in
1993 we began manufacturing certain of our labor intensive products, principally
soft goods products, subassemblies and pads used in rigid knee braces and
covers, in two facilities 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 due to disruption
caused as we totally integrated manufacturing operations of the DonJoy and
ProCare brands which were previously separate and distinct, but returned to
prior
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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 due to disruption caused as we
integrated manufacturing operations of the DePuy Orthotech brands which were
previously separate and distinct.
We have identified additional opportunities to reduce manufacturing costs
and improve operating efficiencies. We will move as appropriate greater portions
of our labor intensive operations to our facilities in Mexico to generate
further labor cost savings for our more labor intensive products and utilize the
resulting additional capacity in our U.S. facilities to manufacture our more
technologically advanced products. 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 manufacturing operation. In
addition, we intend to further automate our manufacturing operations 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. DonJoy's former parent files a consolidated
federal income tax return which included all of its eligible subsidiaries and
divisions, which included us prior to the recapitalization. The provision for
income taxes has been presented assuming DonJoy filed a separate federal income
tax return. The recapitalization had no impact on the historical basis of our
assets and liabilities as reflected in DonJoy's consolidated financial
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, DonJoy has recorded an increase in the tax basis of
its 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. 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):
Inventory........................................... $ 3,670
Property, plant & equipment......................... 4,145
Goodwill............................................ 130,543
--------
$138,358
========
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 us under purchase
accounting (see Note 2 to Notes to DonJoy's Audited Consolidated Financial
Statements).
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Prior to the recapitalization, our results of operations were included in
the consolidated federal income tax returns which Smith & Nephew filed in the
United States and the historical financial statements reflect a provision for
income taxes assuming that DonJoy had filed a separate federal income tax
return. As limited liability companies, DonJoy and dj Ortho are not subject to
income taxes following the recapitalization. Instead, DonJoy's earnings
following the recapitalization will be allocated to its members and included in
the taxable income of its members. The indenture and the credit facility permit
us 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 us.
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.
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 and $4.4 million for
December 31, 1998, 1999 and 2000, respectively, of freight revenue from sales
and marketing expenses into net revenues. We continue to include freight
expenses in sales and marketing expense.
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The following table sets forth our operating results as a percentage of net
revenues:
YEARS ENDED DECEMBER 31,
--------------------------
1998 1999 2000
------ ------ ------
Net revenues:
Rigid knee bracing......................... 46.6% 41.9% 36.9%
Soft goods................................. 32.8 33.7 35.3
Specialty and other orthopedic products.... 17.2 21.4 24.8
----- ----- -----
Revenues from product lines.................. 96.6 97.0 97.0
Freight revenue............................ 3.4 3.0 3.0
----- ----- -----
Total consolidated net revenues......... 100.0 100.0 100.0
Cost of goods sold........................... 44.5 43.9 40.8
----- ----- -----
Gross profit................................. 55.5 56.1 59.2
Sales and marketing........................ 27.1 25.7 28.8
General and administrative................. 15.8 14.2 13.4
Research and development................... 2.2 1.8 1.7
Merger and integration costs............... -- -- 0.3
Restructuring costs........................ 2.4 -- --
----- ----- -----
Income from operations....................... 8.0 14.4 15.0
Interest expense............................. -- (6.4) (11.5)
Interest income.............................. -- 0.1 0.3
Discontinued acquisition costs............... -- -- (0.3)
----- ----- -----
Income before income taxes................... 8.0 8.1 3.5
Provision for income taxes................... (3.3) (2.0) --
----- ----- -----
Net income................................... 4.7% 6.1% 3.5%
===== ===== =====
The following table summarizes certain of our operating results by quarter
for 1999 and 2000:
YEAR ENDED DECEMBER 31, 1999
----------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- --------
(IN THOUSANDS)
Net revenues........... $29,312 $26,683 $31,120 $30,652 $117,767
Gross profit........... 15,799 14,647 18,114 17,463 66,023
Income from
operations........... 3,080 2,739 5,637 5,446 16,902
Number of operating
days................. 64 61 66 60 251
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YEAR ENDED DECEMBER 31, 2000
----------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- --------
(IN THOUSANDS)
Net revenues........... $32,569 $30,934 $40,965 $43,001 $147,469
Gross profit........... 19,685 18,613 23,120 25,873 87,291
Income from
operations........... 5,809 5,386 4,583 6,351 22,129
Number of operating
days................. 65 63 63 61 252
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
NET REVENUES. Net revenues increased $29.7 million, or 25.2%, to $147.5
million in 2000 from $117.8 million in 1999. Net revenues, excluding freight
revenue, for the rigid knee-bracing segment increased $5.1 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 $12.4 million
over the prior year due primarily to the Orthotech Acquisition and increased
sales volumes of wrist splints, ankle braces, knee braces and other general soft
good supports. The increases also reflected the growth in the OfficeCare
program. Specialty and other orthopedic product sales, excluding freight
revenue, increased by $11.4 million over the prior year due primarily to the
PainBuster(TM) Pain Management system, cold therapy units, shoulder bracing and
to increased sales of lower extremity walkers, as well as the growth in the
OfficeCare program.
GROSS PROFIT. Gross profit increased $21.3 million, or 32.2%, to $87.3
million in 2000 from $66.0 million in 1999 primarily as a result of the
Orthotech Acquisition. Gross profit margin, exclusive of brand royalties and
other cost of goods sold not allocable to specific product lines and freight
revenue increased to 60.4% in 2000 from 59.1% in 1999 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 $2.8 million, with gross
profit margin decreasing to 70.7% from 72.3%. The margin decrease reflects the
change in product mix. Gross profit, excluding freight revenue, for the soft
goods segment increased $6.5 million as a result of increased sales volume, with
gross profit increasing to 49.5% from 48.6% in 1999. The increase in gross
profit margin is a result of the change in product mix, primarily related to
sales of the Orthotech products and the success of the group purchase
organization contracts. Gross profit, excluding freight revenue, for the
specialty and other orthopedic products segment increased $9.6 million, with
gross profit margin increasing to 60.5% from 49.7%. 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. 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
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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 $12.3
million, or 40.6%, to $42.5 million in 2000 from $30.2 million in 1999. The
increase primarily reflected an increase in commissions associated with higher
sales of DonJoy products in the United States and increased costs associated
with the OfficeCare 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 increases in salaries
and benefits, an increase in consulting expenses related to the implementation
of a new Enterprise Resource Planning ("ERP") System and human resources support
combined with an 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, non-
recurring 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 $13.5 million, or 12.9%, to $117.8
million in 1999 from $104.3 million in 1998. Net revenues, excluding freight
revenue, for the rigid knee bracing segment increased $0.8 million over the
prior year due to increased sales of ligament braces, including the introduction
of the 4TITUDE brace and post-operative braces. Soft goods sales, excluding
freight revenue, increased by $5.4 million over the prior year due primarily to
increased
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sales volumes of neoprene bracing products, wrist splints, ankle braces and
other soft good supports, including the introduction of the On-Track system.
These increases primarily reflect the effect of national contracts entered into
in the second half of 1998 as well as the growth of the OfficeCare program.
Specialty and other orthopedic products sales, excluding freight revenue,
increased by $7.2 million over the prior year due primarily to the recently
introduced PainBuster(TM) Pain Management Systems, cold therapy units and to
increased sales of lower extremity walkers as well as growth of the OfficeCare
program.
GROSS PROFIT. Gross profit increased $8.2 million, or 14.2%, to $66.0
million in 1999 from $57.8 million in 1998. Gross profit margin, exclusive of
brand royalties and other cost of goods sold not allocable to specific product
lines and freight revenue, decreased to 59.1% in 1999 from 59.6% in 1998. Gross
profit, excluding freight revenue, for the rigid knee bracing segment increased
$1.3 million, with gross profit margin increasing to 72.3% from 70.9%. These
increases reflected the improved product mix. Gross profit, excluding freight
revenue, for the soft goods segment increased $2.6 million as a result of
increased sales volume, with gross profit margin remaining constant at 48.6%
from 1998 to 1999. Gross profit, excluding freight revenue, for the specialty
and other orthopedic products segment increased $3.5 million, with gross profit
margin decreasing to 49.7% from 50.0%, 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 program and the amortization of the PainBuster(TM) Pain Management
System distribution rights.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased $2.0
million, or 7.0%, to $30.3 million in 1999 from $28.3 million in 1998. The
increase primarily reflected an increase in commissions associated with higher
sales of DonJoy products in the United States and increased costs associated
with the OfficeCare 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 an 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 14.2% from 15.8% 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) System as well as the development and release of the new 4TITUDE brace
in 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
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projected sublease income, and severance costs associated with the termination
of twelve employees.
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
December 31, 2000 was $157.2 million.
Net cash provided by operating activities was $3.7 million, $16.1 million,
and $1.2 million in 1998, 1999, and 2000, respectively. 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,
and $57.0 million for 1998, 1999, and 2000, respectively. Included in investing
activities is the $49.0 million investment in Orthotech. 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.
Cash flows provided by (used in) financing activities were $0.2 million,
$(6.2) million, and $54.0 million in 1998, 1999, and 2000, respectively. The
changes 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 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 the year 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 & Nephew. Following the
recapitalization, we no longer participate in Smith & Nephew's cash management
program.
Interest payments on the notes and on borrowings under the credit facility
have significantly increased our liquidity requirements. The credit facility
provides for two term loans totaling $39.5 million. 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 of
revolving credit borrowings under the revolving credit facility, which are
available for working capital and general corporate purposes, including
financing of acquisitions, investments and strategic alliances. As of December
31, 2000, we had borrowed $20.6 million under that facility, primarily due to
the Orthotech Acquisition.
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Borrowings under the term loans and the revolving credit facility bear interest
at variable rates plus an applicable margin.
The following table sets forth the principal payments on the term loans for
2001 through their maturity in 2005:
PRINCIPAL
YEAR PAYMENT
---- ---------
2001................................................. $ 1,274
2002................................................. 1,274
2003................................................. 1,274
2004................................................. 17,202
2005................................................. 17,338
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 DonJoy, us or any of our subsidiaries and (b) 100% of the net cash
proceeds of certain asset sales or other dispositions of property by DonJoy, us
or any of our subsidiaries, in each case subject to certain exceptions. No
mandatory prepayments were required at December 31, 2000 or December 31, 1999.
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 December 31, 2000, 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.
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 will be amortized over the terms of
the related debt instruments.
As part of our strategy, we intend to pursue acquisitions, such as the
Orthotech Acquisition, investments and strategic alliances. We may require new
sources of financing to consummate any such transactions, including additional
debt or equity financing. There can be no assurance 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, including the notes, 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
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revolving credit facility, will be adequate for at least the next twelve months
to make required payments of principal and interest on our indebtedness,
including the notes, 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, including the notes, or to fund our other
liquidity needs.
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 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 December 31, 2000, we had $98.3
million principal amount of fixed rate debt represented by the notes and $59.0
million of variable rate debt represented by borrowings under the credit
facility (at interest rates ranging from 8.875% to 9.813% at December 31, 2000).
Based on our current balance outstanding under the credit facility, an immediate
increase of one percentage point in the applicable interest rate would cause an
increase in interest expense of approximately $0.6 million on an annual basis.
At December 31, 2000, up to $4.4 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. All of our sales are denominated in U.S.
dollars; thus we are not subject to foreign currency exchange risk.
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.
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YEAR 2000
The year 2000 issue relates to computer systems that use the last two
digits rather than all four to define a year and whether such systems would
properly and accurately process information when the year changed to 2000. As of
the date of this prospectus, we had not experienced any material problems
related to the year 2000. We are not aware of any significant year 2000 issues
affecting our major customers or suppliers. We also have not received any
material complaints regarding any year 2000 issues related to our products. Year
2000 related costs through December 31, 2000 were approximately $360,000 and
have been expensed as incurred. These costs included labor expended in
contacting customers and suppliers, testing systems and software, and software
upgrades for year 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments and hedging activities. The Statement will
require the recognition of all derivatives on dj Ortho's balance sheet at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of FASB Statement No. 133" which defers the adoption requirement
to the first quarter of 2001. The impact on our financial statements is not
expected to be material.
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BUSINESS
OVERVIEW
The Company is a world leading designer, manufacturer and marketer of
orthopedic recovery products. Based on U.S. sales, the Company believes it is
the leading provider of orthopedic recovery products and certain complementary
products in the United States. The Company's broad product lines of rigid knee
braces, soft goods and specialty and other orthopedic products provide a range
of solutions for patients and orthopedic professionals during the various stages
of the orthopedic treatment and recovery process. The Company's products are
used before, after, and as an alternative to surgery, during and after
rehabilitation and for the treatment of osteoarthritis. The Company is a market
leader in the orthopedic recovery products industry, selling more than 600
individual products in over 44 countries throughout the world. The Company sells
its products primarily under the DonJoy and ProCare brand names, each of which
the Company believes enjoys one of the highest levels of brand name recognition
within the orthopedic recovery products industry. In addition to the typical
orthopedic patient, the Company's products are used by professional athletes,
NCAA athletic programs and the U.S. Ski Team. The Company believes that its
leading market positions, strong brand names, reputation for quality products,
broad product lines, established distribution networks in the United States and
commitment to research and development provide it with significant opportunities
to further grow revenues and earnings. For 1999 and 2000, the Company's net
revenues were $117.8 million and $147.5 million, respectively, and the Company's
EBITDA (as defined) was $25.1 million and $29.2 million, respectively.
On July 7, 2000, the Company completed the purchase of certain assets and
assumed certain liabilities of DePuy Orthotech, a subsidiary of Johnson &
Johnson, related to DePuy Orthotech's bracing and soft goods business. 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 currently offered by the Company. Following the
Orthotech Acquisition, the Company sold products under the Orthotech brand;
however, the Company has now integrated Orthotech products into its DonJoy and
ProCare brands. Orthotech also had an inventory management and billing program
that has complemented the Company's current OfficeCare program.
The Company's product lines include rigid knee braces, soft goods and a
portfolio of specialty and other orthopedic products.
- RIGID KNEE BRACES. The Company's 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. These technologically advanced
products are generally prescribed to a patient by an orthopedic
professional. The Company's 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.
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Substantially all of the Company's rigid knee braces are marketed under
the DonJoy brand name. These products represented approximately 38% of
the Company's net revenues, excluding freight revenue, for the year ended
December 31, 2000.
- SOFT GOODS. The Company's 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. As of December 31, 2000,
approximately 58% of the Company's revenues from soft goods products,
excluding freight revenue, were derived from products marketed under the
ProCare brand name, with the remainder marketed under the DonJoy brand
name. These products represented approximately 36% of the Company's net
revenues, excluding freight revenue, for the year ended December 31,
2000.
- SPECIALTY AND OTHER ORTHOPEDIC PRODUCTS. The Company's portfolio of
specialty and other orthopedic products, which are designed to facilitate
orthopedic rehabilitation, include lower extremity walkers (boots which
are an alternative to lower extremity casting), upper extremity braces
(shoulder and arm braces and slings), cold therapy systems (a form of
pain management which provides continuous cold therapy to assist in the
reduction of pain and swelling) and pain management delivery systems (a
range of ambulatory infusion pumps for the delivery of local anesthetic
directly into a joint following surgery). As of December 31, 2000,
approximately 84% of the Company's revenues from specialty and other
orthopedic products, excluding freight revenue, were derived from
products marketed under the DonJoy brand name, with the remainder
marketed under the ProCare brand name. These products represented
approximately 26% of the Company's net revenues, excluding freight
revenue, for the year ended December 31, 2000.
The Company sells its DonJoy products primarily to orthopedic surgeons,
orthotic and prosthetic centers, hospitals, surgery centers, physical therapists
and trainers to meet the specific needs of their patients. The Company sells its
ProCare products under private label brand names primarily to third party
distributors who generally resell the Company's products to large hospital
chains, hospital buying groups, primary care networks and orthopedic physicians.
The Company's products are used by people who have sustained an injury, have
recently completed an orthopedic surgical procedure and/or suffer from an
affliction of the joint. In addition, a number of high profile professional and
amateur athletes who participate in sports such as football, basketball and
skiing, choose to use the Company's products.
COMPETITIVE STRENGTHS
The Company believes that the following competitive strengths provide it
with a strong and stable base to enable the Company to further enhance growth
and profitability.
LEADING MARKET POSITIONS. The Company is a world leading designer,
manufacturer and marketer of orthopedic recovery products and, based on U.S.
sales, the Company believes it is the leading provider of orthopedic recovery
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products and certain complementary products in the United States. As a result of
the Orthotech Acquisition, the Company believes it has increased its market
position within the U.S. to an estimated market share of 24%. Based on U.S.
sales, the Company believes it now holds the leading U.S. market position for
ligament braces, post-operative braces, back braces and soft ankle braces, with
estimated market shares of 34%, 32%, 27% and 26%, respectively, the number two
market position for OA braces, with an estimated market share of 18%, and
leading positions in the markets for certain of the Company's other products.
The Company has established its leadership positions:
- by delivering innovative products that provide patients with superior
quality and value;
- through successful marketing and sales programs which focus on gaining
the support of widely recognized orthopedic professionals and maintaining
strong relationships with the Company's customers; and
- by delivering quality products with a high standard of customer service,
including shipping the majority of the Company's products within 24 hours
of receipt of the customer order, or 72 hours in the case of customized
knee braces.
STRONG BRAND NAME RECOGNITION AND REPUTATION FOR QUALITY. The Company's
products have achieved a high degree of brand name recognition and loyalty from
its customers. The Company believes DonJoy is the most recognized brand name of
knee braces in the orthopedic recovery products industry. In addition, the
Company's ProCare brand name is well recognized by third party distributors of
soft goods in the orthopedic recovery products industry. The Company's other
trademarks include product names that are well known among orthopedic
professionals which the Company believes provide it with a significant
competitive advantage. The Company's products are known for their design,
quality construction and durability. The Company's braces are used by a number
of professional athletes and NCAA athletic programs. The Company is also the
official and exclusive supplier of braces and supports to the U.S. Ski Team and
the Company believes it is the leading supplier of knee braces to players in the
National Football League.
BROAD PRODUCT LINES. The Company believes that it has one of the broadest
product lines in the orthopedic recovery products industry. The Company markets
over 600 individual products that provide solutions to patients and orthopedic
professionals in addressing the various stages of the orthopedic treatment and
recovery process.
- The Company's quality soft goods products are used by patients to address
a wide range of orthopedic injuries and afflictions.
- The Company's customized and off-the-shelf rigid knee braces are used as
an alternative to surgery, to help bring patients back to pre-injury
levels post-surgery or to support the normal functioning of the knee for
patients who have returned to pre-injury activity levels.
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- The Company's other specialized devices such as cold therapy systems and
pain management delivery systems are used by patients who have just
undergone orthopedic surgery.
ESTABLISHED U.S. DISTRIBUTION NETWORKS. The Company has established broad
distribution networks within the United States. The Company's DonJoy product
lines are marketed by 30 commissioned sales organizations (referred to in this
prospectus as agents) which employ approximately 198 sales representatives
(including additional sales representatives added as a result of the Orthotech
Acquisition). These sales representatives undergo extensive training by both the
Company and the agent and use their technical expertise to market our products
to orthopedic surgeons, orthotic and prosthetic centers, hospitals, surgery
centers, physical therapists and trainers. The Company sells its ProCare
products primarily to large, national third party distributors, including Owens
& Minor Inc., McKesson/ HBOC and Allegiance Healthcare, as well as to regional
medical surgical dealers and medical products buying groups. The Company
believes that its strong distribution networks in the United States provide the
Company with an established base from which to introduce new or enhanced
products and expand sales of existing product lines.
SUCCESSFUL RECORD OF NEW PRODUCT DEVELOPMENT. The Company has developed a
reputation as a research and development leader by introducing a steady flow of
product enhancements and new products into the market. Since 1998, the Company
has introduced more than ten significant new products, sales of which
represented approximately 15% of the Company's net revenues for the year ended
December 31, 2000. The Company owns or has licensing rights to more than 50
patents, including the "Four Points of Leverage" system, which is a critical
element in the design of the Company's ligament braces. In addition, the Company
maintains close relationships with a number of widely recognized orthopedic
surgeons and sports medicine specialists who assist in product research,
development and marketing. These professionals often become product "champions,"
speaking about the Company's 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.
EXPERIENCED AND INCENTIVIZED MANAGEMENT TEAM. The Company's management
team has extensive experience in the orthopedic recovery products industry. The
Company's five senior executives have an average of 9 years of experience with
the Company and an average of over 20 years of experience within the orthopedic
recovery products industry. Management owns or has the right to acquire pursuant
to unit options, subject to certain conditions, up to approximately 18% of
DonJoy's equity interests on a fully diluted basis.
BUSINESS STRATEGY
The Company's strategic objectives are to strengthen its leadership
position in the orthopedic recovery products industry and to increase its
revenues and profitability. The Company intends to pursue the following
strategic initiatives:
- broaden its market reach,
- enhance and grow its core business, and
- expand its business platform.
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The key elements of its business strategy are to:
INCREASE INTERNATIONAL SALES. The Company markets products in over 44
countries, primarily in Europe, Canada and Japan, under the DonJoy and ProCare
brand names. International sales accounted for approximately 16% and 12% of the
Company's net revenues, excluding freight revenue, for the years ended December
31, 1999 and 2000, respectively. The decrease in international net revenues as a
percentage of total revenues in 2000 as compared to prior years is a direct
result of the Orthotech business which historically consisted primarily of
domestic sales. Excluding freight revenue, sales in Germany, the Company's
largest foreign market, accounted for approximately 32% of the Company's 2000
international net revenues, and sales in Canada accounted for approximately 10%
of the Company's 2000 international net revenues, with no other country
accounting for 10% or more of the Company's 2000 international net revenues.
Excluding freight revenue, total sales in Europe accounted for approximately 72%
of the Company's 2000 international net revenues, while sales in Germany, the
United Kingdom, France, Spain and Italy accounted for approximately 50% of the
Company's 2000 international net revenues. Excluding freight revenue, sales in
Japan accounted for approximately 9% of the Company's 2000 international net
revenues. In 2000, the Company sold and distributed its products in foreign
markets through 30 independent distributors and 13 remaining Smith & Nephew
sales organizations in Canada and in some smaller markets. The Company plans to
increase its international sales by continuing the reorganization and expansion
of its independent international distribution network started in 1999 and
implementing the marketing and distribution strategies which the Company
successfully utilizes in the United States and in most major international
territories. During 2001, the Company expects to replace some of the remaining
Smith & Nephew sales organizations with independent distributors who will focus
on building strong relationships with its targeted customers and will be
responsible for achieving specified sales targets. The Company continues to
develop relationships with orthopedic professionals who are well recognized in
major countries to become product "champions", similar to orthopedic
professionals in the United States who speak about our products at medical
seminars, assist in training other professionals how to use and/or fit our
products and provide us with feedback on industry's acceptance of our new
products.
IMPROVE OPERATING EFFICIENCIES. The Company is actively pursuing
opportunities to improve the efficiencies of its total operations. By upgrading
its computer systems to achieve more efficient business processes, the Company
expects to achieve more efficient customer order fulfillment and reduced
overhead and working capital requirements. The Company also is in the process of
further automating its manufacturing operations through the use of more
technologically advanced fabrication and equipment systems. In addition, the
Company will continue to move portions of its labor intensive operations to its
facilities in Mexico to generate labor cost savings and utilize the resulting
additional capacity in its U.S. facility to manufacture its more technologically
advanced products. The Company will continue to rationalize the raw materials
used in the production of its existing products, thereby enabling the Company to
leverage its purchasing power. The Company also plans to achieve cost savings by
further reducing the number of stock keeping units (SKUs) without impacting
service or breadth of the Company's product range.
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INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS. The Company intends to
maintain its position as a leading innovator of orthopedic recovery products
through its commitment to research and development and its close working
relationships with orthopedic professionals. Using its materials, process and
design expertise in bracing and supports, the Company will continue to enhance
its current range of products to address changing customer needs. In addition,
the Company intends to add complementary products through its own research and
development efforts and arrangements with third parties. For example, the
Company has introduced two pain management systems, the IceMan, a cold therapy
system, which it developed, and, more recently, the PainBuster(TM) Pain
Management System, a range of ambulatory infusion pumps, which it distributes
under a licensing arrangement. The Company believes the PainBuster(TM) provides
a platform for further opportunities in the surgical market. The Company plans
to release the DonJoy Vista(TM) System, a computerized post-operative brace
designed to optimize a patient's rehabilitation in the treatment of knee
injuries, in 2001.
PURSUE STRATEGIC GROWTH OPPORTUNITIES. The orthopedic recovery products
industry is highly fragmented and provides the Company with a number of
potential acquisition, investment and strategic alliance opportunities. The
Company intends to continue to pursue strategic growth opportunities, like the
Orthotech Acquisition, that will allow it to leverage its existing distribution
networks, brand name recognition and expertise in research and development to
increase revenues and cash flow. For example, the Company will seek growth
opportunities through acquisitions, investments or strategic alliances that
will:
- expand the Company's core business,
- enable the Company to offer complementary products, and
- diversify into the broader orthopedic products industry.
INDUSTRY
The orthopedic recovery products industry, the primary industry in which
the Company currently competes, is a segment of the worldwide orthopedic
products industry, which had estimated sales in 1998, the last year for which
data is available, of $8.5 billion, including estimated U.S. sales of $5.1
billion. The worldwide orthopedic products market includes reconstructive
implants, tissue fixation and healing products, orthopedic recovery products,
spinal implants, arthroscopy products, and other related products. The
orthopedic recovery products industry includes retail and non-retail sales of
braces and supports for the knee, ankle, back and upper extremities, including
the shoulder, elbow, neck and wrist and other related products. The U.S.
orthopedic recovery products industry generated estimated revenues of $630
million in 1998. The Company currently competes in the non-retail segment of the
U.S. orthopedic recovery products industry, which generated estimated revenues
of $535 million in 1998. The European orthopedic recovery products industry
generated estimated revenues of $330 million in 1998. Comparable data for the
rest of the world is not readily available. Complementary market segments to the
orthopedic recovery products industry within the overall orthopedic products
industry include orthopedic pain management systems and devices, a market in
which the Company currently competes, and which generated estimated 1998 U.S.
revenues of $150 million, and
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soft tissue fixation products and tissue healing products, which represent
attractive markets for the Company and which generated estimated 1998 U.S.
revenues of $350 million. Comparable data for 2000 and 1999, and for Europe and
the rest of the world is not readily available.
The orthopedic recovery products industry is highly fragmented and
characterized by competition among a few large, diversified orthopedic companies
and numerous smaller niche competitors. Revenues in the U.S. orthopedic recovery
products industry grew at an estimated compound annual growth rate of 3.5% from
1994 through 1998. This growth has been driven by increased participation in
exercise, sports and other physical activity, the aging "baby boomer" population
including adults suffering from osteoarthritis, and a growing awareness of the
importance of preventative bracing. Comparable data for 2000 and 1999 and for
Europe and the rest of the world is not readily available.
The Company believes data set forth in this prospectus regarding the
orthopedic products industry and its segments and the Company's market position
and market share within that industry or its segments are inherently imprecise,
but are generally indicative of their relative size and the Company's market
position and market share within that industry or its segments. Estimated
revenues for the orthopedic recovery products industry and its segments and the
historical growth rates for such industry and its segments are based on
information obtained from Frost & Sullivan, an international marketing
consulting firm. The Company's estimates are subject to change based on various
factors, including those described under the caption "Risk Factors". The
following are descriptions of segments of the U.S. orthopedic recovery products
industry. Comparable data for 2000 and 1999, and for Europe and the rest of the
world is not readily available.
KNEE BRACES AND SUPPORTS. The retail and non-retail knee brace and support
market generated estimated revenues of $272 million in 1998, of which
approximately $242 million was generated in the non-retail segment in which the
Company competes. The knee brace and support market consists of ligament braces,
post-operative braces, osteoarthritic braces, and soft knee supports. Revenues
in this segment of the industry grew at an estimated compound annual growth rate
of 3.0% from 1994 through 1998. This stable market growth is characterized by
increased volume and modestly declining prices. Knee injuries are the most
common affliction treated by orthopedic professionals, with approximately
644,000 knee procedures performed in 1998, including ligament repair, tissue
repair and total knee replacement procedures.
The Company believes it is the U.S. market leader in ligament braces and
post-operative braces, with an estimated 34% and 32% market share, respectively,
and the number two U.S. provider of OA braces, with an estimated 18% market
share. The knee brace and support market is highly fragmented. Many of the
participants in this market are primarily suppliers of soft knee supports.
ANKLE BRACES AND SUPPORTS. The retail and non-retail ankle brace and
support market generated estimated revenues of $157 million in 1998, of which
approximately $131 million was generated in the non-retail segment in which the
Company competes. The ankle brace and support market consists of lower extremity
walkers, rigid ankle stirrups and soft ankle supports sold through an orthopedic
prescribing professional and other soft ankle supports sold primarily in
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the retail segment. Revenues in this segment of the industry grew at an
estimated compound annual growth rate of 6.6% from 1994 through 1998. In 1998,
over 2,000,000 people sought medical attention for ankle and foot injuries. In
the non-retail segment, the Company believes it is the market leader in soft
ankle supports with an estimated 26% market share and one of the market leaders
of lower extremity walkers with an estimated 14% market share.
BACK, WRIST, AND UPPER EXTREMITY BRACES AND SUPPORTS. The retail and
non-retail back, wrist and upper extremity markets collectively generated
estimated revenues of $175 million in 1998, of which approximately $147 million
was generated in the non-retail segment in which the Company competes. The back,
wrist and upper extremity markets consist of orthopedic braces and supports to
address afflictions of the back, wrist, shoulder, elbow and neck which are sold
in the prescriptive non-retail segment as well as in the retail segment.
Aggregate revenues in these segments of the industry grew at an estimated
compound annual growth rate of 3.1% from 1994 through 1998. In the non-retail
segment, the Company believes it is the market leader in the back brace industry
with an estimated 27% market share and enjoys leading market positions in the
wrist and upper extremity markets.
COMPLEMENTARY ORTHOPEDIC PRODUCTS. Complementary orthopedic products
include orthopedic pain management systems and devices, markets in which the
Company currently competes, and soft tissue fixation and tissue healing
products, which represent attractive markets for the Company. These markets
represented revenues of approximately $150 million and approximately $350
million, respectively, in 1998. Pain management systems and devices include
infusion pumps that administer local anesthetic into the joint after a patient
has undergone surgery. Soft tissue fixation products include devices to reattach
soft tissue to the bone and tissue healing products include bone growth
stimulation products.
PRODUCTS
The Company offers a broad range of products that provide a range of
solutions for patients and orthopedic professionals during various stages of the
orthopedic treatment and recovery process. The Company's core products and
reportable segments are rigid knee braces and soft goods. In addition, the
Company offers a growing number of complementary specialty and other orthopedic
products. The Company's product lines provide a range of treatment during the
orthopedic recovery process, from soft goods which are generally used after
injury, whether or not surgery is contemplated, to rigid knee braces and other
specialty products which are generally prescribed for use after surgery and
during and after rehabilitation.
The Company markets its products under the DonJoy and ProCare brand names.
Based on net revenues, excluding freight revenue, the Company marketed
approximately 98% of its rigid knee braces, 84% of its specialty and other
orthopedic products and 42% of its soft goods products under the DonJoy brand
name during the year ended December 31, 2000. The Company believes DonJoy is the
most recognized brand name of knee braces in the orthopedic recovery products
industry. Based on net revenues, excluding freight revenue, the Company marketed
approximately 58% of its soft goods products, 16% of its specialty and
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other orthopedic products and 2% of its rigid knee braces under the ProCare
brand name during the year ended December 31, 2000. The ProCare brand name is
well recognized by third party distributors of soft goods in the orthopedic
recovery products industry.
On July 7, 2000, the Company completed the Orthotech Acquisition. Orthotech
developed, manufactured and marketed an array of orthopedic products for the
sports medicine market including braces, soft goods and specialty products which
are similar to the products currently offered by the Company. Following the
Orthotech Acquisition, the Company sold products under the Orthotech brand;
however, the Company has now integrated Orthotech products into its DonJoy and
ProCare brands.
RIGID KNEE BRACING
The Company designs, manufactures and markets a broad range of rigid knee
bracing products, including ligament braces, post-operative braces and OA
braces. These technologically-advanced products are generally prescribed to a
patient by an orthopedic professional. The Company's 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 38% of the Company's net revenues,
excluding freight revenue, for the year ended December 31, 2000.
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. The Company's ligament braces can also be used
to support the normal functioning of the knee for patients who have returned to
pre-injury activity levels. The Company's 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 the Company's ligament braces are designed using the Company's patented "Four
Points of Leverage" system. Sales of ligament braces represented approximately
64% of the net revenues, excluding freight revenue, of rigid knee bracing
products in 2000.
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 otherwise 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
surgeon. The Company's post-operative bracing product line includes a range of
premium to lower-priced off-the-shelf braces and accessory products.
OA BRACES. OA braces are used to treat patients suffering from
osteoarthritis, a form of damage to the articular surface of the knee joint. The
Company's line of customized and off-the-shelf OA braces is designed to shift
the resultant
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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.
The following table sets forth information on the Company's 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:
- ------------------------------------------------------------------------------------------------------
YEAR
PRODUCT TYPE OF BRACE INTRODUCED FUNCTION/DESCRIPTION
- ------------------------------------------------------------------------------------------------------
DEFIANCE CUSTOM KNEE BRACE Ligament/ 1992 The Company's hallmark premium
Osteoarthritic brace. Custom-built,
lightweight, strong and
ENHANCED DEFIANCE CUSTOM KNEE Ligament 1998 durable. Designed for
BRACE strenuous athletic activity.
4TITUDE BRACE Ligament 1999 The Company's newest off-the-
shelf brace. Introduced in
June 1999.
LEGEND BRACE Ligament 1995 Sturdy, low-profile,
off-the-shelf brace. Designed
for athletic use.
SE4-POINT Ligament 2001 Low cost off-the-shelf brace
- ------------------------------------------------------------------------------------------------------
TROM POST-OPERATIVE BRACE Post-operative 1998 Allows for both immobilization
and protected range of motion
after surgery. Utilizes the
Company's easy-to-use patented
hinge assembly.
TROM REHABILITATION BRACE Post-operative 1998 Designed to provide protection
for the recovering knee up to
8 weeks within a program of
aggressive long-term
rehabilitation. Utilizes the
Company's easy to use patented
hinge assembly.
IROM BRACE Post-operative 1992 Used for ligament
instabilities. Allows for both
immobilization and protected
range of motion.
- ------------------------------------------------------------------------------------------------------
TELESCOPING BAR POST-OP LINE Post-operative 2001 Adjustable bar length post-op
braces for reduced inventory
requirements and improved fit
and performance.
- ------------------------------------------------------------------------------------------------------
MONARCH CUSTOM OA BRACE Osteoarthritic 1994 Custom-built or off-the-shelf,
flexible premium braces
PATIENT READY MONARCH OA BRACE Osteoarthritic 1996 recommended for relief of
osteoarthritic pain and ease
of use. Can be easily adjusted
by the patient.
OADJUSTER BRACE Osteoarthritic 2000 The OAdjuster off-the-shelf
brace was introduced at the
AAOS conference in March 2000.
Double uprights allow improved
support. Patented hinge and
diagnostic tool.
OPAL OA KNEE BRACE Osteoarthritic 1998 Off-the-shelf, comfortable,
light-weight, low-profile,
slip-on sleeve-style Drytex
brace. Specifically designed
for women.
- ------------------------------------------------------------------------------------------------------
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- ------------------------------------------------------------------------------------------------------
YEAR
PRODUCT TYPE OF BRACE INTRODUCED FUNCTION/DESCRIPTION
- ------------------------------------------------------------------------------------------------------
DONJOY VISTA(TM) TECHNOLOGY Rehabilitation 2001 The DonJoy Vista(TM) System
System includes a post-op brace,
hand-held patient device and
Clinician computer software to
reduce the overall cost to
rehab an anterior cruciate
ligament ("ACL")
reconstruction. The rehab
system has individualized
protocols and records the
patients' progress and
compliance.
- ------------------------------------------------------------------------------------------------------
SOFT GOODS
The Company's 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. The Company currently offers 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. The Company's soft goods products include the RocketSoc, an ankle
support designed for chronic sprains, the Playmaker, a neoprene knee brace for
mild to moderate ligament instabilities, and the Air DonJoy, a line of knee
sleeves with air inflatable cushions designed to treat and ease pain from knee
malalignment. Soft goods products represented approximately 36% of the Company's
net revenues, excluding freight revenue, for the year ended December 31, 2000.
SPECIALTY AND OTHER ORTHOPEDIC PRODUCTS
The Company has a portfolio of specialty and other orthopedic recovery
products designed to facilitate orthopedic rehabilitation, including lower
extremity walkers, upper extremity braces, cold therapy systems, pain management
delivery systems and other related products and accessories. These products
represented approximately 26% of the Company's net revenues, excluding freight
revenue, for the year ended December 31, 2000.
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 showering or therapy, the Company's walkers are used as an
alternative to traditional casts. Sales of walkers represented approximately 43%
of the net revenues, excluding freight revenue, of specialty and other
orthopedic products in 2000.
UPPER EXTREMITY BRACES. The Company offers 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.
COLD THERAPY SYSTEMS. The Company manufactures markets and sells the
IceMan, a cold therapy product, which was introduced in 1996, as well as other
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cold therapy products such as ice packs and wraps. The IceMan 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
afflicted area, such as the ankle, knee or shoulder. The IceMan uses 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 DELIVERY SYSTEMS. The Company entered into an arrangement
in 1998, which was subsequently amended, with I-Flow Corporation ("I-Flow") for
the exclusive North American distribution rights for the PainBuster(TM) Pain
Management System manufactured by I-Flow for use after surgical procedures.
These pain management and relief systems provide a continuous infusion of local
anesthetic dispensed by the physician directly into the wound site following
surgical procedures. The portable PainBuster(TM) Pain Management System consists
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(TM) Pain Management System is intended to provide direct pain relief,
reduce hospital stays and allows earlier and greater ambulation. The Company
believes that the PainBuster(TM) Pain Management System provides it with a
platform for further opportunities in the surgical market.
RESEARCH AND DEVELOPMENT
The Company's research and development program is aimed at developing and
enhancing products, processes and technologies to maintain the Company's
position as a leading innovator in the orthopedic recovery products industry.
The Company's research and development expenditures were $2.2 million, $2.1
million and $2.5 million during the years ended December 31, 1998, 1999 and 2000
respectively.
The Company's research and development activities are conducted in its
Vista facility by a group of 12 product engineers and designers who have an
average of 11 years experience in developing and designing products using
advanced technologies, processes and materials. The research and development
team uses a variety of 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.
The Company's 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 the Company's existing
products. The Company is also pursuing strategic initiatives to identify areas
for technological innovation and to develop products that improve rehabilitation
by utilizing advanced technologies. For example, the Company is currently
developing the DonJoy Vista(TM) system, a rehabilitation management system that
incorporates an instrumented post-op brace, patient hand-held device and PC
software. The DonJoy Vista(TM) system is designed to lower the cost and enhance
the delivery of rehabilitation for knee injuries.
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The Company has developed and maintains close relationships with a number
of widely recognized orthopedic surgeons and sports medicine specialists who
assist in product research, development and marketing. These professionals often
become product "champions", speaking about the Company's products at medical
seminars, assisting in the training of other professionals in the use and/or
fitting of the products and providing the Company 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 the Company under which they
receive royalty payments or consultant fees in connection with the development
of particular products with which they have been involved.
The Company maintains the Clinical Education Research Facility (CERF)
Laboratory in its Vista facility, which is used by orthopedic surgeons to
practice surgical techniques. These surgeons often provide the Company with
feedback which assists the Company in the development and enhancement of
products. In addition, the Company utilizes its biomechanical laboratory in its
Vista facility to test the effectiveness of the Company's products. U.S. based
and international surgeons/researchers collaborate with the research staff to
perform biomechanical testing. The tests are designed to demonstrate
functionality of new products and 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. The Company believes it is the only
orthopedic recovery products manufacturer which has both surgical techniques and
biomechanical laboratories, the combination of which allows professionals to
practice procedures and then to measure the effectiveness of those procedures.
In addition, the Company provides 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,
after knee surgery or subjects with knee 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.
SALES, MARKETING AND DISTRIBUTION
The Company distributes its products in the U.S. and international markets
primarily through networks of agents and distributors who market and sell to
orthopedic surgeons, orthotic and prosthetic centers, third party distributors,
hospitals, surgery centers, physical therapists and trainers within the
orthopedic community. The Company's products are used by people who have
sustained an injury, have recently completed an orthopedic surgical procedure
and/or suffer from an affliction of the joint. In addition, a number of high
profile professional and amateur athletes who participate in sports such as
football, basketball and skiing, choose to use the Company's products. The
Company is the official and exclusive supplier of braces and supports to the
U.S. Ski Team. In addition, the Company believes it is the leading supplier of
knee braces to players in the National Football League, among whom use of knee
braces has more than tripled over the last two years according to a recent
survey of NFL team physicians. No individual agent or distributor accounted for
10% or more of the Company's net revenues for the year ended December 31, 2000.
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The Company is committed to providing its customers with a superior
standard of customer service. The Company's 53 customer care representatives
strive for prompt product processing and delivery by coordinating between the
customer and the Company's sales, operations and shipping departments. The
Company ships the majority of its products within 24 hours of receipt of the
customer order, or 72 hours in the case of customized braces. In addition,
customer care representatives also provide support regarding order status,
product information, returns and general information.
UNITED STATES
The Company markets products in the United States under the DonJoy and
ProCare brands through two distinct sales and distribution channels as well as
under national contracts and through the OfficeCare program. Sales in the United
States accounted for approximately 88% of the Company's net revenues, excluding
freight revenue, for the year ended December 31, 2000.
DONJOY. DonJoy products are marketed by 30 commissioned sales
organizations (referred to in this prospectus as agents) which employ
approximately 198 sales representatives (including additional sales
representatives added as a result of the Orthotech Acquisition). These sales
representatives market to orthopedic surgeons, orthotic and prosthetic centers,
hospitals, surgery centers, physical therapists and athletic trainers. Because
the DonJoy product line generally requires customer education on the application
and use of the product, the sales representatives are technical specialists who
receive extensive training from both the Company and the agent and use their
technical expertise to help fit the patient with the Company's 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, the Company ships and bills the product directly to the
orthopedic professional and the Company pays a sales commission to the agent.
The Company enjoys long-standing relationships with most of its 30 agents
and 198 sales representatives, many of which have marketed DonJoy products for
over 10 years. Under the arrangements with the agents, each agent is granted an
exclusive geographic territory for sales of the Company's products and is not
permitted to market products, or represent competitors who sell or distribute
products, that compete with the Company. 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, the Company may terminate the agent,
which the Company has done in the past.
PROCARE. ProCare 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, General Medical Corp., Allegiance Healthcare, PSS World Medical
Inc. and Bergen Brunswig Corp.; 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
products to large hospital chains, hospital buying groups, primary care networks
and orthopedic physicians for use by the patient. Unlike DonJoy products,
ProCare products generally do not require significant customer education for
their use.
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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, the Company has entered into
national contracts for DonJoy and ProCare products with large health care
providers and buying groups, such as HealthSouth Corp., NovaCare Inc., Premier
Purchasing Partners, L.P., AmeriNet Inc., US Government/Military hospitals,
Shared Services HealthCare, National Purchasing Alliance, Magnet, and Hospital
Purchasing Services. Under these contracts, the Company provides discounted
pricing to the buying group and is 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 the Company's
products. The Company is also sole supplier for Kaiser Permanente, Columbia HCA,
and Novation. The Company expects that in the future it will enter into
additional national contracts with other health care providers and buying
groups. See "Risk Factors -- Responses by Health Care Providers to Price
Pressures; Formation of Buying Groups" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Overview -- Third Party
Reimbursement; Health Care Reform; Managed Care."
OFFICECARE. The Company provides an inventory management and insurance
billing system to orthopedic physicians in the U.S. through its OfficeCare
program, which was initiated in 1996. The Company supplies the physician with a
working inventory of orthopedic products for immediate disbursement to the
physician's patients. The Company then directly seeks reimbursement from the
patient's insurance company or other third party payor or from the patient where
self-pay is applicable.
INTERNATIONAL
The Company markets products in over 44 countries, primarily in Europe,
Canada and Japan, under the DonJoy and ProCare brand names. Excluding freight
revenue, international sales accounted for approximately 16% and 12% of the
Company's net revenues for the years ended December 31, 1999 and 2000,
respectively. The decrease in international net revenues as a percentage of
total revenues in 2000 as compared to prior years is a direct result of the
Orthotech business, which historically consisted primarily of domestic sales.
Excluding freight revenue, sales in Germany, the Company's largest foreign
market, accounted for approximately 32% of the Company's 2000 international net
revenues, and sales in Canada accounted for approximately 10% of the Company's
2000 international net revenues, with no other country accounting for 10% or
more of the Company's 2000 international net revenues. Excluding freight
revenue, total sales in Europe accounted for approximately 72% of the Company's
2000 international net revenues, while sales in Germany, the United Kingdom,
France, Spain and Italy accounted for approximately 50% of the Company's 2000
international net revenues. Excluding freight revenue, sales in Japan accounted
for approximately 9% of the Company's 2000 international net revenues.
In 2000, the Company sold and distributed its products in foreign markets
through 30 independent distributors and 12 remaining Smith & Nephew sales
organizations in Canada and in some smaller markets. In April 2001, the Company
began distributing its products in Australia through dj Australia. The Company
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plans to increase its international sales by continuing the reorganization and
expansion of its independent international distribution network started in 1999
and implementing the marketing and distribution strategies which the Company
successfully utilizes in the United States and in most major international
territories. International sales made through Smith & Nephew sales organizations
were 55%, 40% and 20% of the Company's international sales, exclusive of freight
revenue, in 1998, 1999 and 2000, respectively. During 2001, the Company expects
to replace some of the remaining Smith & Nephew sales organizations with
independent distributors who will focus on building strong relationships with
its targeted customers and will be responsible for achieving specified sales
targets. The Company continues to develop relationships with orthopedic
professionals who are well recognized in major countries to become product
"champions", similar to orthopedic professionals in the United States. See "Risk
Factors -- Transition to New Independent Distributors in International Markets,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- International Sales," and "-- Business Strategy."
MANUFACTURING
The Company manufactures substantially all of its products at its three
facilities in the United States and Mexico. See "-- Facilities." The Company
operates a vertically integrated manufacturing operation at its Vista,
California facility and is capable of producing a majority of its subassemblies
and components in-house. These include metal stamped parts, injection molding
components and fabric-strapping materials. The Company also has 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, the Company can produce a design directly on computer-based
fabrication equipment, reducing both production time and costs.
The Company has achieved International Standards Organization ("ISO") 9001
certification, EN46001 certification and Certification to the European Medical
Device Directive at its Vista facility. These certifications are internationally
recognized quality standards for manufacturing and assist the Company in
marketing its products in certain foreign markets.
Utilizing the latest production technologies at its Vista and Mexico
facilities, the Company is able to reduce the labor content of many of its
products. For labor intensive operations, primarily sewing, the Company utilizes
its two facilities in Mexico for subassembly and finished product manufacturing.
The Company will continue to move its more labor intensive operations to its
facilities in Mexico to generate labor cost savings and utilize the resulting
additional capacity at its Vista facility to manufacture its more
technologically advanced products.
The Company's 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. The Company also
uses Velcro(TM) and neoprene, as well as Drytex, a wrap-knit nylon and polyester
composite, in the manufacture of its products. Most of the raw materials used by
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the Company in the manufacture of its products are available from more than one
source and are generally readily available on the open market.
The Company outsources some of its finished products from manufacturers in
China. In addition, the Company distributes the PainBuster(TM) Pain Management
Systems which are manufactured by I-Flow as well as certain other products which
are manufactured by third parties.
FACILITIES
The Company is headquartered in Vista, California and operates 3
manufacturing facilities. Manufacturing operations in the United States were
consolidated in 1998 into the Vista facility which consists of three buildings.
The Vista facility is subleased from Smith & Nephew. See "Certain Relationships
and Related Transactions -- Other Agreements between DonJoy and Smith &
Nephew -- Sublease." The two other facilities are located in Tijuana, Mexico,
within 100 miles of Vista, and are managed from the Vista facility.
OWNED/ LEASE TERMINATION SIZE
LOCATION USE LEASED DATE (SQUARE FEET)
-------- --- ------ ----------------- -------------
Vista, California Corporate Leased February 2008 266,041
Headquarters
Research &
Development
Manufacturing &
Distribution
Tijuana, Mexico Warehousing Leased December 2001(1) 48,600
Manufacturing
Tijuana, Mexico Manufacturing Owned 13,000
- -------------------------
(1) The lease for the Tijuana facility automatically renews for additional
one-year periods unless terminated by either party on 30 days prior written
notice.
COMPETITION
The orthopedic recovery products industry is highly competitive and
fragmented. The Company's competitors include a few large, diversified
orthopedic companies and numerous smaller niche companies. Some of the Company's
competitors are part of corporate groups that have significantly greater
financial, marketing and other resources than the Company. The Company's primary
competitors in the rigid knee brace market include smaller niche companies such
as Innovation Sports Incorporated, Townsend Industries Inc., Bledsoe Brace
Systems (a division of Medical Technology, Inc.), Generation II USA, Inc. and
Breg, Inc. The Company competes in the non-retail sector of the soft goods
products market and its competitors include DeRoyal Industries, Zimmer, Inc. (a
division of Bristol-Meyers Squibb Company), and Tecnol Orthopedic Products (a
division of Kimberly Clark Corp.). The Company competes with a variety of
manufacturers of specialty and other orthopedic products, depending on the type
of product. In addition, in certain foreign countries, the Company competes with
one or more local competitors.
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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
program to provide value to their customers. Electro-Biology, Inc. ("EBI")
Medical Systems, a division of Biomet, is the market leader with this type of
program. Competition in specialty and other orthopedic products is based on a
variety of factors, depending on the type of product.
The Company believes that its extensive product lines, advanced product
design, strong U.S. distribution networks, reputation with leading orthopedic
surgeons and sports medicine specialists and customer service performance
provide it with a competitive advantage over its competitors. In particular, the
Company believes that its broad product lines provide it with a competitive
advantage over the smaller niche companies which generally have innovative
technology in a focused product category, while its established distribution
networks and relationship-based selling efforts provide it with a competitive
advantage over larger manufacturers.
INTELLECTUAL PROPERTY
The Company's most significant intellectual property rights are its
patents, trademarks, including the Company's DonJoy and ProCare brand names, and
proprietary know-how.
The Company owns or has licensing rights to over 50 patents and has several
pending patent applications. The Company anticipates that it will apply for
additional patents in the future as it develops new products and product
enhancements. The Company's most significant patent involves the bracing
technology and design which it has patented as the "Four Points of Leverage"
system. Many of the Company's ligament bracing products have been designed using
the "Four Points of Leverage" system which effectively produces pressure to the
upper portion of the tibia, which, in turn, reduces strain on the damaged,
reconstructed or torn ligament. Because this system is patented, the Company's
competitors are prohibited from designing products which apply pressure to the
tibia using the Company's technique. The Company's patent covering the "Four
Points of Leverage" system expires in January 2005. The Company's other
significant patents include the Custom Contour Measuring Instrument, which
serves as an integral part of the measurement process for patients ordering the
Company's customized ligament and OA braces. In addition, the Company owns
patents covering a series of hinges for its 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 and the Patient Ready Monarch. The Company also
has patents relating to its OA braces and specific mechanisms in a number of the
Company's products. In addition to these patents, the Company relies on
non-patented know-how, trade secrets, process and other proprietary information,
which the Company protects through a variety of methods, including
confidentiality agreements and proprietary information agreements with vendors,
employees,
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consultants and others who have access to the Company's proprietary information.
See "Risk Factors" -- Patents and Proprietary Know-How."
The Company owns or has the licensing rights to a number of trademarks. In
addition to the DonJoy(R), ProCare(R), and Orthotech(R) brand names, the
Company's most significant trademarks include Defiance(R), GoldPoint(R),
Monarch(R), RocketSoc(R), IceMan(R), Air DonJoy(R), Quadrant(R), Legend(TM),
TROM(TM), Playmaker(TM), PainBuster(TM) OPAL(TM), 4TITUDE(TM), OAdjuster(TM) and
OfficeCare(SM), registered worldwide.
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) System, a
computerized post-operative brace designed to optimize a patient's
rehabilitation in the treatment of knee injuries. In connection with the
recapitalization, Smith & Nephew assigned this license to the Company.
The Company believes that its patents, trademarks and other proprietary
rights are important to the development and conduct of its business and the
marketing of its products. As a result, the Company aggressively protects its
intellectual property rights.
EMPLOYEES
As of December 31, 2000, the Company had 1,022 employees. The Company's
workforce is not unionized. The Company has not experienced any strikes or work
stoppages, and management generally considers its relationships with its
employees to be satisfactory.
GOVERNMENT REGULATION
MEDICAL DEVICE REGULATION
UNITED STATES. The Company's 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 (the "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. The Company's
current products are all Class I or Class II medical devices. All of the
Company's currently marketed products hold the relevant exemption or premarket
clearance required under the FFDCA.
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
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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" to
either:
(1) a device that was legally marketed prior to May 28, 1976, the date
upon which the Medical Device Amendments of 1976 were enacted, or
(2) 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, the Company's products
have 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 effectiveness 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 effectiveness.
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
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the clinical status of those patients when necessary to protect the public
health or to provide additional safety and effectiveness data for the device.
When FDA approval 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 the Company's current products have required human clinical trials for
approval.
In addition, the Company's 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 the Company's products. The QSR
also, among other things, requires maintenance of a device master record, device
history record, and complaint files. The Company's domestic facility, records,
and manufacturing processes are subject to periodic unscheduled inspections by
the FDA. The Company's Mexican facilities, which export products to the United
States, may also be inspected by the FDA. The Company's U.S. facility was
recently inspected by the FDA and was found to be in compliance with the
applicable QSR regulations. Based on the Company's own internal audits of its
Mexican facilities, the Company believes that its Mexican facilities are in
substantial compliance with the applicable QSR regulations.
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 the Company's facilities or relating to the Company's products and
none of the recent FDA audits of its 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
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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 the Company's 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. However, they are often required
by the foreign country importing the product.
INTERNATIONAL. In many of the foreign countries in which the Company
markets its products, it is 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 the Company's devices and products in such countries
are similar to those of the FDA, including those in Germany, the Company's
largest foreign market. In many countries, the national health or social
security organizations require the Company's products to be qualified before
they can be marketed with the benefit of reimbursement eligibility. To date, the
Company has not experienced difficulty in complying with these regulations. Due
to the movement towards harmonization of standards in the European Union, the
Company expects 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 the
Company cannot currently be predicted.
The Company is implementing policies and procedures intended to position
itself 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. The Company's 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
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 Europeanne ("CE") mark.
All of the Company's 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
The Company is 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
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programs and TRICARE. The Company has never been challenged by a governmental
authority under any of these laws and believes that its operations are in
material compliance with such laws. However, because of the far-reaching nature
of these laws, there can be no assurance that the Company would not be required
to alter one or more of its 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 the
Company's financial condition and results of operations.
ANTIKICKBACK LAWS. The Company's operations are subject to federal and
state anti-kickback laws. Certain provisions of the Social Security Act, that
commonly known collectively as the "Medicare Fraud and Abuse Statute," prohibit
entities, such as the Company, 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.
The Company operates a stock and bill program, known as the OfficeCare
program, through which it makes its products and services available in the
offices of physicians or other providers. In conjunction with the OfficeCare
program, the Company may pay participating physicians a fee for rental space and
support services provided by such physicians to the Company. 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. The Company believes it has structured the OfficeCare Program to
comply with these laws.
PHYSICIAN SELF-REFERRAL LAWS. The Company is 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
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.
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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 and for Medicaid programs as a result of an investigation arising
out of such action.
ENVIRONMENTAL AND OTHER MATTERS
The Company's facilities and operations are subject to federal, state and
local environmental and occupational health and safety requirements of the U.S.
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. The Company believes it is
currently in compliance with such requirements and does not currently anticipate
any material adverse effect on its business or financial condition as a result
of its efforts to comply with such 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 the
Company's operations. Also, in the future, contamination may be found to exist
at the Company's current or former facilities or off-site locations where the
Company has sent wastes. The Company could be held liable for such newly
discovered contamination which could have a material adverse effect on the
Company's 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 the Company's business or
financial condition.
GOVERNMENTAL AUDITS
The Company's 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, the Company, like other health care companies, receives survey audits
or reviews from governmental entities, which may cite certain deficiencies based
on the Company's alleged failure to comply with applicable supplier standards
and other requirements. The Company reviews such audits or reports and attempts
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 the Company's business,
results of operations or financial condition and could prevent the programs
involved from offering products and services to patients.
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OTHER FEDERAL AND STATE REGULATIONS
There may be other federal, state and local laws, rules and regulations
that affect the Company's business. In addition, new laws, rules and regulations
may be adopted to regulate new and existing products, services and industries.
There can be no assurances that either the states or the federal government will
not impose additional regulations upon the activities of the Company that might
adversely affect its business, results of operations and financial condition.
LEGAL PROCEEDINGS
The Company is 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 the Company. The
Company maintains product liability insurance in amounts which it believes to be
reasonable and standard in the industry.
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MANAGEMENT
BOARD OF MANAGERS AND EXECUTIVE OFFICERS
The following table sets forth certain information with respect to persons
who are members of the Board of Managers (each a "Manager") of both DonJoy and
dj Ortho, which share a common Board of Managers, and executive officers of dj
Ortho. Two additional Managers may be designated by CDP, however, such
individuals have not yet been identified.
NAME AGE POSITION
---- --- --------
Leslie H. Cross...................... 50 President, Chief Executive Officer and
Manager
Cyril Talbot III..................... 45 Senior Vice President -- Finance, Chief
Financial Officer and Secretary
Michael R. McBrayer.................. 41 Senior Vice President -- Domestic Sales
Kenneth D. Rolfes.................... 52 Senior Vice President -- Global Operations
and Customer Care
Charles T. Orsatti................... 56 Manager
Mitchell J. Blutt, M.D. ............. 43 Manager
Damion E. Wicker, M.D. .............. 39 Manager
W. Brett Ingersoll................... 37 Manager
Ivan R. Sabel, CPO................... 55 Manager
Kirby L. Cramer...................... 63 Manager
Leslie H. Cross has served as President of dj Ortho since July 1995 and
became the Chief Executive Officer and a Manager of DonJoy and dj Ortho 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.
Cyril Talbot III has served as Senior Vice President -- Finance of dj Ortho
since 1994 and became the Chief Financial Officer of DonJoy and dj Ortho upon
consummation of the recapitalization. He joined dj Ortho 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 at Miller, Cooper & Co. Ltd. Mr. Talbot earned his B.S. (Accounting/
Finance) at Miami University in Oxford, Ohio and is a Certified Public
Accountant.
Michael R. McBrayer has served as Senior Vice President -- Domestic Sales
of dj Ortho since 1993. He held several managerial positions after joining dj
Ortho in 1987 as a national sales manager for the retail product line. Mr.
McBrayer received his B.S. (Marketing and Management) at Northern Arizona
University in Flagstaff, Arizona.
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Kenneth D. Rolfes joined dj Ortho as Senior Vice President -- Global
Operations and Customer Care in 2000. Prior to joining the Company, 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.
Charles T. Orsatti became a Manager of DonJoy upon consummation of the
recapitalization. He has been a partner of Fairfield Chase since 1998. From 1995
to 1998, Mr. Orsatti was a senior consultant to Chase Capital Partners ("CCP"),
a predecessor of JPMP LLC. Prior to that, he 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. Mr. Orsatti earned a B.S. (Management and Marketing) from
Pennsylvania State University. He serves as a Vice-Chairman of Vitagen, Inc.
Mitchell J. Blutt, M.D. became a Manager of DonJoy upon consummation of the
recapitalization. He has been an Executive Partner of J.P. Morgan Partners, LLC,
or its predecessor, Chase Capital Partners ("CCP"), since 1992. J.P. Morgan
Partners, LLC serves as the management company for the private equity
organization within J.P. Morgan Chase & Co. known as JPMorgan Partners. He is
also an executive officer of J.P. Morgan Partners (23A SBIC Manager), Inc.
("JPMP (23A SBIC Mgr.)"), the managing member of JPMP (23A SBIC), and was a
General Partner of CCP from 1988 to 1992. Dr. Blutt has a B.A. and a M.D. from
the University of Pennsylvania and an M.B.A. from The Wharton School of the
University of Pennsylvania. He serves as a director of FHC, Fisher Scientific
International, Inc., Hanger Orthopedic Group, Inc., La Petite Academy, Inc.,
Medical Arts Press, Inc., Senior Psychology Services Management, Inc., UtiliMED,
Inc., Vista Healthcare Asia Pte. Ltd. and IBC Asia Health Care Ltd.
Damion E. Wicker, M.D. became a Manager of DonJoy upon consummation of the
recapitalization. He has been a partner of J.P. Morgan Partners, LLC, or its
predecessor, CCP, since 1997. He is also an executive officer of JPMP (23A SBIC
Mgr.). Prior to joining CCP in 1997, Dr. Wicker was President of Adams
Scientific and held positions with MBW Venture Partners and Alexon, Inc. Dr.
Wicker received a B.S. with honors from The Massachusetts Institute of
Technology, an M.D. from Johns Hopkins University School of Medicine and an
M.B.A. from the Wharton School of the University of Pennsylvania. He serves as a
director of Genomic Solutions, Inc., Landec Corporation, Optiscan Biomedical
Corp., Praecis Pharmaceuticals, Inc., Transurgical, Inc., Vitagen, Inc. and V.I.
Technologies, Inc.
W. Brett Ingersoll became a Manager of DonJoy in February 2001. He has been
a partner of J.P. Morgan Partners, LLC since January 1, 2001. He has worked at
J.P. Morgan Partners, LLC, or its predecessor, CCP, since 1993. He is also an
executive officer of JPMP (23A SBIC Mgr.). He received his B.A. from Brigham
Young University in Economics and an M.B.A. from the Harvard Business School.
Mr. Ingersoll currently serves as a director of MediChem Life Sciences, Inc.
HealthMarket, Inc., CB Technologies, SMG, Inc., Tricordia Health, and HealthNet.
Ivan R. Sabel, CPO, became a Manager of DonJoy in August 1999. Mr. Sabel
has been the Chairman of the Board of Directors and Chief Executive Officer of
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Hanger Orthopedic Group since August 1995 and was President of Hanger Orthopedic
Group from November 1987 to July 1, 1999. Mr. Sabel also served as the Chief
Operating Officer of Hanger Orthopedic Group from November 1987 until August
1995. Prior to that time, Mr. Sabel had been Vice President -- Corporate
Development from September 1986 to November 1987. Mr. Sabel was the founder,
owner and President of Capital Orthopedics, Inc. from 1968 until that company
was acquired by Hanger Orthopedic Group in 1986. Hanger Orthopedic Group is a
portfolio investment of JPMP. Mr. Sabel is a Certified Prosthetist and Orthotist
("CPO"), a member of the Board of Directors of the American Orthotic and
Prosthetic Association ("AOPA"), a former Chairman of the National Commission
for Health Certifying Agencies, a former member of the Strategic Planning
Committee and a current member of the Veterans Administration Affairs Committee
of AOPA and a former President of the American Board for Certification in
Orthotics and Prosthetics. Mr. Sabel serves on the Board of Nurse Finders Inc.
and is a member of their compensation and audit committee. Mr. Sabel is also a
current member of the Board of Directors of Mid-Atlantic Medical Services, Inc.,
a company engaged in the health care management services business.
Kirby L. Cramer became a Manager of DonJoy in 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 (KMDC) during its inception as a publicly traded company, and then
as Chairman of the Executive Committee. Biomet acquired KMDC in a stock and cash
exchange in 1994 for approximately $100 million. 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, where he was class president, 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 (CFA) and, in 1988, he received
an honorary Doctor of Laws degree from James Madison University.
COMMITTEES OF THE BOARD OF MANAGERS
The Board of Managers has an Executive Committee, currently consisting of
Messrs. Blutt, Cross, Ingersoll and Orsatti. The Board of Managers has a
Compensation Committee/Stock Option Committee (the "Compensation Committee")
that determines compensation for executive officers of dj Ortho and administers
DonJoy's Option Plan. Currently, Messrs. Cramer, Orsatti, Ingersoll and Wicker
serve on the Compensation Committee. The Board has an Audit Committee (the
"Audit Committee") that reviews the scope and results of audits and internal
accounting controls and all other tasks performed by the independent
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public accountants of dj Ortho. Currently, Messrs. Wicker, Sabel, and Ingersoll
serve on the Audit Committee.
COMPENSATION OF BOARD OF MANAGERS
The members of the Board of Managers affiliated with CDP do not receive
compensation for their service on the Board of Managers but are reimbursed for
their out-of-pocket expenses. Managers who are neither officers of dj Ortho nor
affiliated with CDP receive customary compensation for services on the Board of
Managers of $12,000 per year plus out-of-pocket expenses, an option grant of
2,000 common units in DonJoy, L.L.C. and the right to purchase an additional
2,000 common units in DonJoy, L.L.C. dj Ortho, DonJoy and Charles T. Orsatti
intend to enter into an agreement pursuant to which dj Ortho will agree to pay
Mr. Orsatti up to $250,000 per year if dj Ortho achieves certain performance
objectives to be established by negotiation among such parties, CDP and CCP. Mr.
Orsatti was paid $250,000 in 2000 in connection with the Orthotech Acquisition.
EXECUTIVE COMPENSATION
The following table sets forth information concerning the compensation of
the Chief Executive Officer and each of the other four most highly compensated
executive officers of dj Ortho for the year ended December 31, 2000.
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 1999 234,487 62,944 238,464
Chief Executive Officer 1998 226,825 183,258 2,669
Cyril Talbot III.................... 2000 177,132 65,582 3,500
Senior Vice President -- Finance 1999 151,088 20,352 153,825
and Chief 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 -- 1999 154,800 29,119 158,112
Domestic Sales 1998 148,300 47,923 2,363
Peter Bray(3)....................... 2000 180,478 68,848 3,067
Vice President -- 1999 161,976 30,558 84,616
International Business 1998 156,750 50,649 3,350
- -------------------------
NA = Not applicable
(1) Includes contributions to dj Ortho'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
Ortho who remained in his position through the consummation of the Change of
Control or Division Divestiture received a special retention bonus. Pursuant
to the recapitalization agreement, such special bonus was paid by
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Smith & Nephew. 1999 retention bonuses were paid out as follows: (a) Leslie H.
Cross received $235,900, (b) Cyril Talbot III received $151,945, (c) Michael R.
McBrayer received $155,715 and (d) Peter Bray received $81,510.
(2) Mr. Rolfes joined dj Ortho in January 2000.
(3) On February 28, 2001, our Board of Managers determined that Mr. Bray would
no longer be considered an executive officer of the Company though he
remains employed by us as the Vice President -- International Business.
The following table lists stock option grants to the officers named is the
summary compensation table in 2000.
OPTION GRANTS IN LAST FISCAL YEAR
---------------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
NUMBER OF PERCENT OF EXERCISE UNIT PRICE
SECURITIES TOTAL PRICE PER APPRECIATION
UNDERLYING OPTIONS UNIT AT FOR OPTION TERM(1)
OPTIONS GRANTED IN THE TIME EXPIRATION --------------------
NAME GRANTED(#) 2000 OF GRANT DATE 5% 10%
---- ---------- ---------- --------- ---------- ------ --------
(IN THOUSANDS)
Kenneth D. Rolfes......... 6,660 23.5% $100 2/1/15 $718 $2,116
- -------------------------
(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 assuming that the fair market value of the units on the date of
grant appreciates at 5% or 10% over the option term, and that the option is
exercised and sold on the last day of its option term for the appreciated
unit value. The assumed 5% and 10% rates of unit value appreciation are
provided in accordance with rules of the Securities and Exchange Commission
and do not represent our estimate or projection of our future unit value.
Actual gains, if any, on option exercises will depend on the future
performance of our unit value.
The following table sets forth information concerning option exercises
during 2000 and options held by each of the officers named in the summary
compensation table at December 31, 2000.
AGGREGATED OPTIONS EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
---------------------------------------------------------------------------------------
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
UNITS OPTIONS AT FISCAL IN-THE-MONEY OPTIONS AT
ACQUIRED ON VALUE YEAR-END FISCAL YEAR-END
NAME EXCISE(1) REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE(2)
---- ----------- -------- ---------------------------- -------------------------------
(IN THOUSANDS)
Les Cross................... -- -- 2,676/24,084 $291/$2,625
Michael McBrayer............ -- -- 892/ 8,028 97/ 875
Cy Talbot................... -- -- 892/ 8,028 97/ 875
Kenneth D. Rolfes........... -- -- 666/ 5,994 73/ 653
Peter Bray.................. -- -- 446/ 4,014 49/ 438
- -------------------------
(1) No options were exercised in 2000.
(2) Based on an assumed fair market value of the common units at December 31,
2000 of $109 per unit.
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SECOND AMENDED AND RESTATED 1999 OPTION PLAN
Under DonJoy, L.L.C.'s Second Amended and Restated 1999 Option Plan,
166,799 common units have been reserved for issuance upon exercise of options
granted under the plan. The plan is administered by the Compensation Committee
appointed from time to time by the Board of Managers. The plan expires on August
19, 2015 unless earlier terminated by the Board of Managers. The plan provides
for the grant of nonqualified options to officers, directors, and employees of,
and consultants and advisors to, dj Ortho.
Options will be granted in amounts to be agreed upon by the Compensation
Committee. Options will vest either
- ratably at specified annual intervals from the date of grant (the "Time-
Vesting Options") (provided that the maximum number of such Time-Vesting
Options granted shall not exceed 6% of the number of common units of
DonJoy outstanding on a fully diluted basis on the closing date of the
recapitalization); some Time-Vesting Options are also subject to the
achievement of certain sale targets or
- upon the occurrence of a Liquidity Event or Material Transaction (each as
defined below) and then only to the extent the common units of DonJoy
owned by CDP have provided CDP with specified internal rates of return
(as set forth in the Option Plan) since the closing date of the
recapitalization (the "Event-Vesting Options") (provided that the maximum
number of such Event-Vesting Options vesting based on achievement of
specified internal rates of return shall not exceed 9% of the number of
common units outstanding on a fully diluted basis on the closing date of
the recapitalization), provided that if no Liquidity Event has occurred
by December 31, 2007, such options shall become vested and exercisable.
A Liquidity Event means a sale or other disposition of all or substantially
all of the assets of DonJoy or all or substantially all of the outstanding
equity interests in DonJoy or a registered public offering of the common equity
interests in DonJoy resulting in a market capitalization of more than $150
million for a period of at least 20 consecutive trading days. A Material
Transaction means a dissolution or liquidation of DonJoy, a reorganization,
merger or consolidation in which DonJoy is not the surviving corporation, or
sale of all or substantially all of the assets of DonJoy. The exercise price for
the options will be the fair market value of the common units of DonJoy on the
date each such option is granted. The options will expire upon the earliest of
(i) the fifteenth anniversary of the date of grant, (ii) 12 months after the
date an Optionee's employment is terminated due to the Optionee's death or
permanent disability, (iii) immediately upon an Optionee's termination of
employment by the dj Ortho "for cause" (as defined in the Plan), (iv) 90 days
after the date an Optionee ceases to be an employee (other than as listed in
(ii) and (iii) above), (v) 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 (vi) 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. Common units in DonJoy purchased by an
Optionee upon exercise of
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an option may be repurchased by DonJoy (or its designee) upon terms and at a
price determined in accordance with the provisions of the applicable option
agreement.
As of December 31, 2000, DonJoy has granted options to purchase up to
148,840 common units under the Plan, of which 40% are Time-Vesting Options and
60% are Event-Vesting Options.
401(k) AND INCENTIVE PLANS
DonJoy has established its 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 the DonJoy 401(k) Plan.
EMPLOYMENT AGREEMENTS
In connection with the recapitalization, dj Ortho entered into employment
agreements with Leslie H. Cross, Cyril Talbot III and Michael R. McBrayer. The
employment agreements terminate on June 30, 2002. Pursuant to their respective
employment agreement, Mr. Cross serves as President of dj Ortho at an annual
base salary of $279,413, Mr. Talbot serves as Vice President of Finance of dj
Ortho at an annual base salary of $177,132 and Mr. McBrayer serves as Vice
President of Domestic Sales of dj Ortho at an annual base salary of $171,757.
These base salaries are subject to annual review and adjustment by the Board of
Managers of dj Ortho. In addition, each executive is entitled to such annual
bonuses as may be determined by the Board of Managers, four weeks paid vacation
per year, 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.
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 Ortho, he will not:
(1) induce or attempt to induce any employee of dj Ortho or any
affiliate of the dj Ortho to leave the employ of dj Ortho or any such
affiliate, or in any way interfere with the relationship between dj Ortho
or any such affiliate and any employee thereof,
(2) hire any person who was an employee of dj Ortho until six months
after such person's employment with dj Ortho or any affiliate thereof was
terminated, or
(3) induce or attempt to induce any customer, supplier, licensee or
other business relation of dj Ortho or any affiliate to cease doing
business with dj Ortho or such affiliate, or in any way interfere with the
relationship between any such customer, supplier, licensee or business
relation and dj Ortho or any such affiliate.
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Each employment agreement also contains customary non-disclosure
provisions. In addition, each executive has agreed that any inventions or other
developments relating to dj Ortho or its products or services conceived,
developed or made by the executive while employed by dj Ortho belong to dj
Ortho.
RETENTION AGREEMENTS
In December 1998, Smith & Nephew entered into retention agreements with
certain then existing members of management of dj Ortho (each, a "Management
Employee"), including Messrs. Cross, Talbot, McBrayer and Bray, to induce each
Management Employee to remain an employee of dj Ortho 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
such Management Employee who remained in his position through the consummation
of the Change of Control or Division Divestiture received a special retention
bonus. Pursuant to the recapitalization agreement, such special bonus was paid
by Smith & Nephew.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
All of dj Ortho's membership units are owned by DonJoy and all of DJ
Capital's equity securities are owned by dj Ortho. The following table sets
forth information with respect to the ownership of the Redeemable Preferred
Units and the Common Units of DonJoy as of December 31, 2000 by
- each person known to own beneficially more than 5% of the Units,
- each Manager of DonJoy,
- each executive officer of dj Ortho and DonJoy named in the summary
compensation table, and
- all executive officers and Managers of dj Ortho and DonJoy as a group.
The Redeemable Preferred Units which vote together with the common units as
a single class (see "-- Description of Operating Agreement") are owned
approximately 51% by JPMP (23A SBIC), an affiliate of CDP, approximately 33% by
the TCW Affiliates and approximately 16% by an affiliate of First Union
Investors.
The amounts and percentages of Units 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 such 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 such 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 beneficial owner of the same securities and a
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person may be deemed to be a beneficial owner of securities as to which such
person has no economic interest.
UNITS
UNDERLYING
OPTIONS
NUMBER OF EXERCISABLE PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER UNITS WITHIN 60 DAYS TOTAL CLASS
------------------------------------ --------- -------------- ------- ----------
Chase DJ Partners, LLC(1)..................... 771,770 0 771,770 92.1%
J.P. Morgan Partners (23A SBIC) LLC (formerly
CB Capital Investors L.L.C.)(1)(2).......... 794,343 0 794,343 94.8%
Charles T. Orsatti(3)......................... 771,770 0 771,770 92.1%
Leslie H. Cross(4)(9)......................... 14,946 2,676 17,622 2.1%
Cyril Talbot III(4)........................... 3,587 892 4,479 0.5%
Michael R. McBrayer(4)........................ 3,587 892 4,479 0.5%
Peter Bray(4)................................. 0 446 446 0.1%
Ken Rolfes(4)................................. 0 666 666 0.1%
Mitchell J. Blutt, M.D.(5)(6)................. 0 0 0 0%
Damion E. Wicker, M.D.(5)(6).................. 0 0 0 0%
W. Brett Ingersoll(5)(6)...................... 0 0 0 0%
Ivan R. Sabel(7)(10).......................... 0 2,500 2,500 0.3%
Kirby L. Cramer(8)(10)........................ 0 2,500 2,500 0.3%
All directors and executive officers as a
group (11 persons).......................... 816,463 10,572 827,035 97.4%
- -------------------------
(1) The address of CDP and JPMP (23A SBIC) is c/o J.P. Morgan Partners, LLC,
1221 Avenue of the Americas, New York, New York 10020. CDP was formed by
JPMP (23A C), an affiliate of J.P. Morgan Partners, LLC, and Fairfield
Chase. JPMP (23A SBIC) owns approximately 87.0%, the First Union Affiliates
own approximately 9.6%, the TCW Affiliates own approximately 3.0% and
Fairfield Chase owns approximately 0.4% of the membership interests in CDP.
The TCW Affiliates and the First Union Affiliates also own 14,802 and 7,030
Redeemable Preferred Units, respectively. Fairfield Chase is the managing
member of CDP except that under the circumstances described below, JPMP
(23A SBIC) will become the managing member of CDP. JPMP (23A SBIC) is a
licensed small business investment company (an "SBIC") and as such is
subject to certain restrictions imposed upon SBICs by the regulations
established and enforced by the United States 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 CDP if certain events described in the
constituent documents of CDP occur. See "Description of Members' Agreement
and By-Laws."
(2) Includes (i) 22,573 Redeemable Preferred Units owned by JPMP (23A SBIC) and
(ii) the common units owned by CDP of which JPMP (23A SBIC) may be deemed
the beneficial owner given its status as a member of CDP owning
approximately 87% of CDP's membership interests.
(3) Includes the common units owned by CDP given Mr. Orsatti's status as the
person controlling Fairfield Chase, which is the managing member of CDP. As
the managing member of CDP, Fairfield Chase may also be deemed to be
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the beneficial owner of these Units. The address of Mr. Orsatti is c/o
Fairfield Chase Medical Partners, LLC, 600 Cleveland Street, Suite 1100,
Clearwater, Florida 83755.
(4) The address of Messrs. Cross, Talbot, McBrayer, Rolfes and Bray is c/o
DonJoy, LLC, 2985 Scott Street, Vista, California 92083.
(5) The address of Messrs. Blutt, Wicker and Ingersoll is c/o J.P. Morgan
Partners, LLC, 1221 Avenue of the Americas, New York, New York 10020.
(6) Such person may be deemed the beneficial owner of Units owned by CDP 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).
(7) The address of Mr. Sabel is c/o Hangar Orthopedic Group, Inc., Two Bethesda
Metro Center, Suite 1200, Bethesda, Maryland 20814.
(8) The address of Mr. Cramer is c/o Hazelton Laboratories, 77-455 Iroqouis
Drive, Indian Wells, California, 92210.
(9) Units are held by a family trust, the Leslie H. Cross & Deborah L. Cross
Family Trust, of which Mr. Cross is a trustee.
(10) Includes options to purchase 500 common units under the option plan and the
right to purchase 2,000 common units.
DESCRIPTION OF OPERATING AGREEMENT
dj Ortho and DonJoy are each limited liability companies organized under
the Delaware Limited Liability Company Act. DonJoy is the sole member and
managing member of dj Ortho and controls dj Ortho's policies and operations.
DonJoy's operations are governed by a Third Amended and Restated Operating
Agreement among DonJoy, CDP, JPMP (23A SBIC), the First Union Affiliates, the
Management Members and the TCW Affiliates (each a "member" and collectively the
"members"). The operating agreement, together with the members' agreement
described below, governs the relative rights and duties of the members.
UNITS. DonJoy is authorized to issue up to 2,900,000 common units and up
to 100,000 Redeemable Preferred Units. As of December 31, 2000, 793,890 common
units and 44,405 Redeemable Preferred Units were issued and outstanding, and 19%
of the common units on a fully diluted basis have been duly reserved for
issuance to officers, directors and employees of, and independent consultants
and advisors of DonJoy or any subsidiary thereof pursuant to the Second Amended
and Restated 1999 Option Plan.
The Redeemable Preferred Units accrue a cumulative 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, including
- the failure to pay or distribute when required any amounts with respect
to the Redeemable Preferred Units,
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- breaches of representations and warranties, covenants (which are
substantially similar to the covenants contained in the indenture) and
other agreements contained in the documentation relating to the
Redeemable Preferred Units,
- an event of default under the new credit facility, the indenture or other
indebtedness having an outstanding principal amount of $15 million or
more and
- certain events of bankruptcy, insolvency or reorganization with respect
to DonJoy or any of its subsidiaries (an "event of non-compliance").
Distributions with respect to the preferred return (other than tax
distributions as described below) are at the option of DonJoy, but to the extent
the preferred return is not paid, the accrued amount of the preferred return
will compound quarterly. Since the ability of dj Ortho to make distributions to
DonJoy (other than distributions to enable DonJoy to make tax distributions as
described below) are limited by the terms of the credit facility and the
indenture, DonJoy expects that the preferred return will accrue and compound. In
addition to the rights with respect to the preferred return (including related
tax distributions and distributions to the holders of Redeemable Preferred Units
of their original capital investment in the Redeemable Preferred Units) the
Redeemable Preferred Units share ratably with the common units in any
distributions (including related tax distributions and upon liquidation) made by
DonJoy in respect of the 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
(which is defined in the operating agreement to be the same as a change of
control under the indenture), 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 on or after June 30, 2005,
holders whose Redeemable Preferred Units have been redeemed as described above,
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 credit facility and the
indenture.
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.
MANAGEMENT. The Board of Managers consists of at least nine members as
designated pursuant to the members' agreement. Upon the occurrence of an event
of non-compliance, the Board of Managers will be increased to 11 members and the
holders of the Redeemable Preferred Units will have the right to elect as a
separate class two members to the Board of Managers of DonJoy.
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Under the members' agreement, any Manager may be removed with or without
cause, except that a Manager shall not be removed without the consent of the
Member or Managers entitled to nominate such Manager. The Member or Managers
entitled to nominate any Manager may remove such Manager and may fill the
vacancy created by such removal.
TAX DISTRIBUTIONS. Subject to receipt of distributions from dj Ortho to
the extent permitted by restrictions contained in the credit facility and the
indenture, DonJoy will make distributions in agreed upon amounts to its members
to enable them to pay income taxes payable in respect of their allocable share
of the taxable income of DonJoy and its subsidiaries, including dj Ortho.
RESTRICTIONS ON TRANSFER. Subject to certain exceptions, no member may
transfer its Units without having obtained the prior written consent of members
holding greater than 50% of the number of Units outstanding at the time
(excluding members that are transferring Units), which consent may be withheld
in their sole discretion.
DESCRIPTION OF MEMBERS' AGREEMENT AND BY-LAWS
DonJoy, CDP, JPMP (23A SBIC), the First Union Affiliates, the Management
Members and the TCW Affiliates are parties to a members' agreement. The members'
agreement contains provisions with respect to the transferability and
registration of the Units. The members' agreement also contains provisions
regarding the designation of the members of the Board of Managers and other
voting arrangements. The members' agreement terminates on a sale of dj Ortho,
whether by merger, consolidation, sale of Units, a sale of assets or otherwise
(a "sale of the company").
The members' agreement:
- restricts transfers of Units subject to certain exceptions,
- grants the members (other than CDP and the Management Members) (the
"Non-CDP Members") the right to tag along on certain sales of common
units by CDP to unaffiliated third parties,
- grants the Non-CDP Members certain preemptive rights,
- grants certain rights of first refusal to DonJoy and CDP with respect to
transfers of common units by Non-CDP Members and the Management Members,
- grants DonJoy or its designee the right to repurchase a Management
Member's Units if such Management Member's employment is terminated, and
- requires the members to participate in and cooperate in consummating a
sale of the company approved by CDP.
Under the members' agreement, subject to certain limitations, the members
have been granted piggyback registration rights with respect to registrable
Units held by them and CDP and holders of Redeemable Preferred Units have been
granted certain demand registration rights, to which all members may piggyback.
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The members' agreement contains customary terms and provisions with respect to
the registration rights contained therein.
The members' agreement provides that the Board of Managers of DonJoy is to
consist of nine Managers:
- one Management Member (initially Leslie H. Cross) designated by
Management Members holding at least a majority of all Units then held by
all Management Members, provided that such Management Member shall be a
member of the Board for only so long as he is both an employee and a
holder of Units,
- five individuals nominated by CDP,
- an additional individual (initially Charles T. Orsatti) nominated by CDP
and having special voting power as described below, and
- two individuals with industry expertise designated by mutual agreement of
the other Managers. Mr. Sabel and Mr. Cramer were appointed to the Board
of Managers in August 1999 and December 1999, respectively, pursuant to
this provision.
The constituent documents of CDP provide that the five individuals
nominated by CDP shall be designated by JPMP (23A SBIC) and that the additional
individual nominated by CDP and having special voting power shall be designated
by the managing member of CDP. The managing member of CDP is initially Fairfield
Chase, except that upon the occurrence of certain events (including where JPMP
(23A SBIC) has determined that it is reasonably necessary for it to assume
control of CDP for the protection of its investment or that any other event has
occurred which would permit JPMP (23A SBIC) to assume control of CDP under
applicable law), JPMP (23A SBIC) will become the managing member of CDP. The
managing member of CDP controls CDP, including the exercise of its rights under
the operating agreement and the members' agreement. Upon becoming the managing
member of CDP, JPMP (23A SBIC) will have the ability, through CDP, to designate
Managers having a majority of the voting power of all Managers.
The By-laws of DonJoy also provide that each Manager is entitled to one
vote on each matter on which the Managers are entitled to vote, except that one
individual appointed by the managing member of CDP (initially Charles T.
Orsatti) has six votes on each matter on which the Managers are entitled to
vote.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
UNIT ISSUANCES
In connection with the Orthotech Acquisition, DonJoy issued 73,775 common
units to CDP for gross proceeds of $8.0 million. In addition, DonJoy issued
2,146, 668 and 1,407 preferred units to JPMP (23A SBIC), the First Union
Affiliates and the TCW Affiliates, respectively, for total gross proceeds of
$3.6 million.
RECAPITALIZATION AGREEMENT
In addition to providing for the sale of the common units of DonJoy to CDP
and the Management Members, and the repurchase of a portion of Smith & Nephew's
interests in DonJoy, the recapitalization agreement provided for certain other
matters in furtherance of the recapitalization transactions, including those set
forth below. The description below of certain 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 a Non-Compete Business (as defined below) in
competition with the business of dj Ortho as it existed on June 30, 1999.
"Non-Compete Business" means the developing, manufacturing or marketing of
lower-leg walkers, post-operative hinged knee braces, functional hinged knee
braces, osteoarthritic hinged knee braces, cold therapy and pain management
systems, certain high-tech hinged knee braces, including high-tech hinged knee
braces that incorporate technology covered by the Victoria Patents referred to
below, and computer-assisted rehabilitation systems using the aforementioned
hinged knee braces together with other electronic devices such as sensors and
transducers.
In connection with certain products and proprietary information relating to
a rounded cannulated interference ("RCI") screw system (the "Proprietary RCI
Screw Products"), a tissue fixation product developed by dj Ortho but
transferred to and retained by Smith & Nephew prior to the consummation of the
recapitalization, CDP has agreed that neither it nor DonJoy or any of its
subsidiaries, including dj Ortho, will, subject to certain exceptions, develop
or market with the cooperation of certain physicians who developed such
Proprietary RCI Screw Products, any product which competes with the Proprietary
RCI Screw Products.
SMITH & NEPHEW NAME. Subject to certain limited exceptions, dj Ortho 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").
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INDEMNIFICATION. Smith & Nephew has agreed to indemnify CDP and its
affiliates, including dj Ortho 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
- certain 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, warranties, covenants and
agreements in the recapitalization agreement terminate 15 months after the
closing date of the recapitalization except as otherwise set forth in the
recapitalization agreement.
OTHER AGREEMENTS BETWEEN DONJOY AND SMITH & NEPHEW
In connection with the recapitalization, DonJoy and Smith & Nephew entered
into several additional agreements providing for the continuation or transfer
and transition of certain aspects of the business operations. Such agreements
were assigned to dj Ortho 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 between DonJoy and Smith & Nephew entered
into in connection with the recapitalization, dj Ortho has agreed to supply to
Smith & Nephew to the extent ordered by Smith & Nephew:
(1) all ProCare line products,
(2) all DonJoy products currently listed in Smith & Nephew's 1999
Rehabilitation Division catalog for the United States and any replacements,
substitutions and improvements to such products and
(3) such other products as may be mutually agreed (collectively, the
"Supply Agreement Products").
So as not to interfere with dj Ortho's international business plans (see
Business -- Business Strategy -- Increase International Sales) Smith & Nephew
has agreed not to export any products listed in clause (2) above from the United
States after March 31, 2000. Through December 31, 1999, dj Ortho sold Supply
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Agreement Products 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 Ortho will sell the Supply Agreement
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 dj Ortho's products.
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 dj Ortho's Supply Agreement
Products which are included within the Non-Compete Business subject to certain
limited exceptions including the failure of dj Ortho to supply such products.
The supply agreement provides that Smith & Nephew may manufacture or purchase
from third party suppliers Supply Agreement Products which are not included
within the Non-Compete Business.
Pursuant to the supply agreement, DonJoy and dj Ortho have agreed to
indemnify Smith & Nephew and its officers and affiliates with respect to:
- any injury, death or property damage arising out of DonJoy's, dj Ortho's
or any of their employees or agents negligence or willful misconduct,
- DonJoy's or dj Ortho's negligent acts or omissions,
- DonJoy's or dj Ortho's misstatements or false claims with respect to the
Supply Agreement Products,
- any product liability claims relating to the Supply Agreement Products
(other than those claims ("Non-Indemnifiable Claims") resulting from
Smith & Nephew's or a third party's fault which do not give rise to an
indemnifiable claim against DonJoy by Smith & Nephew under the
recapitalization agreement),
- any governmentally-required recall of the Supply Agreement Products
(other than Non-Indemnifiable Claims),
- its failure to comply with its 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 Supply
Agreement Products.
In order to ensure performance of its indemnity obligations, DonJoy 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 shall name Smith & Nephew as an additional insured. In addition, Smith &
Nephew has agreed to indemnify DonJoy, dj Ortho 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,
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- Smith & Nephew's misstatements or false claims with respect to the Supply
Agreement Products,
- 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 DonJoy and Smith & Nephew.
DISTRIBUTION AGREEMENT
Pursuant to a distribution agreement entered into in connection with the
recapitalization among DonJoy, Smith & Nephew and the affiliates of Smith &
Nephew which distributed dj Ortho's products outside the United States as of the
closing date of the recapitalization (each an "S&N Group Company"), each S&N
Group Company will continue to distribute dj Ortho's products in the specific
international market (the "Territories") in which such S&N Group Company
distributed such products prior to the recapitalization. Through December 31,
1999, dj Ortho 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, dj Ortho and S&N will negotiate 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
dj Ortho's trademarks in connection with its distribution of the dj Ortho's
products.
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 dj Ortho the same quantity of products reflected in
DonJoy's 1999 budgets (the "1999 Purchase Level") and dj Ortho has agreed to
sell to the S&N Group Companies pursuant to applicable purchase orders
quantities of products at least equal to the 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 as such S&N Group Company distributed and sold dj Ortho
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
dj Ortho products or other similar products to anyone outside the 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 Non-Compete Business other than products purchased from dj
Ortho. Pursuant to the distribution agreement, DonJoy and dj Ortho have agreed
to indemnify Smith & Nephew and the S&N Group Companies and their officers and
affiliates, and Smith & Nephew have agreed to indemnify DonJoy and its officers,
managers, equity holders and affiliates to the same extent that DonJoy and Smith
& Nephew indemnify each other under the supply agreement.
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As of December 31, 2000, the Company has replaced 17 Smith & Nephew sales
organizations with independent distributors. As to the remaining 13 Smith &
Nephew distributors, both DonJoy and Smith & Nephew have the right to terminate
the distribution agreement on 60 days notice with respect to Canada, Dubai,
India, Ireland, Korea, Malaysia, Philippines, Puerto Rico, Singapore, South
Africa, Spain, Taiwan and Thailand.
Upon termination of the distribution agreement with respect to a Territory,
the applicable S&N Group Company has agreed to assist dj Ortho in the transition
to any new third party distributor designated by dj Ortho. Subject to certain
limited exceptions, any products remaining in the inventory of any terminated
S&N Group Company (the "Repurchased Inventory") upon termination of the
distribution agreement with respect to a Territory, will be repurchased by dj
Ortho, or any new third party distributor designated by dj Ortho with respect to
the Territory for an amount equal to
(1) the original purchase price of such Repurchased Inventory plus any
duty and tax paid by such S&N Group Company and the cost paid by such S&N
Group Company in shipping the Repurchased Inventory to such S&N Group
Company plus
(2) any sales tax, VAT, duty or fee incurred by such S&N Group Company
with respect to the delivery of such Repurchased Inventory to dj Ortho or
such new distributor.
With respect to the 17 terminated S&N Group Companies the inventory was
generally purchased by the new third party distributor and the amount of
inventory repurchased by the Company was minimal. If a dispute arises concerning
the applicable repurchase price of the Repurchased Inventory and the parties are
not able to resolve such dispute with 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 continues until the termination of the last Territory.
TRANSITION SERVICES AGREEMENT
Pursuant to a transition services agreement among DonJoy and Smith &
Nephew, Smith & Nephew assisted in the transfer and transition of certain
services provided by Smith & Nephew prior to the recapitalization as required by
dj Ortho, including human resources, payroll, sales tax reporting, insurance
coverage, legal and treasury and cash management. Smith & Nephew also acted as
an authorized European Agent/representative/distributor for DonJoy for purposes
of CE regulation. DonJoy did not pay any additional consideration to Smith &
Nephew for such 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 Smith & Nephew's affiliates in the United Kingdom and Belgium (the
"International Employees") through December 31, 1999. DonJoy reimbursed Smith &
Nephew $179,939 for all compensation, expenses and benefits paid or provided to
or on behalf of the 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
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Partners, L.P. and AmeriNet Inc. (the "Group Buying Contracts") to separate
agreements or arrangements between such companies and dj Ortho. The transition
services agreement terminated November 30, 2000.
GROUP RESEARCH CENTRE TECHNOLOGY AGREEMENT
Pursuant to a Group Research Centre Technology Agreement (the "GRC
Agreement") between DonJoy and Smith & Nephew entered into in connection with
the recapitalization, Smith & Nephew conveyed and assigned to DonJoy an
undivided 50% interest in and to the GRC Technology (as defined below). In
addition, Smith & Nephew has agreed to, among other things, grant to dj Ortho
exclusive or non-exclusive worldwide, royalty-free rights to manufacture, use,
import and sell products included within the Non-Compete Business which products
are based on certain specified technology and other proprietary information
developed as of the closing date of the recapitalization by Group Research
Centre, an affiliate of Smith & Nephew (the "GRC Technology"). The licenses
granted under the GRC Agreement continue with respect to any particular patent
incorporating any such technology until such patent expires, is cancelled or is
declared invalid or unenforceable. No assurance can be given that dj Ortho will
be able to develop and/or successfully market products based on the technology
and proprietary information licensed to dj Ortho pursuant to the GRC Agreement.
Any restriction contained in the GRC Agreement with respect to non-patented GRC
Technology expires on June 30, 2009.
SUBLEASE
Pursuant to a sublease between dj Ortho and Smith & Nephew entered into in
connection with the recapitalization, dj Ortho is subleasing the premises
occupied by the Vista facility from Smith & Nephew. dj Ortho 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 Ortho under the
sublease is $156,728 per month. DonJoy has guaranteed the payment of rent and
other amounts owing under the sublease by dj Ortho. Total lease payments to
Smith & Nephew in 1999 and 2000 were $0.9 million and $1.8 million,
respectively. The sublease expires on February 20, 2008 unless sooner terminated
as provided in the master lease or the sublease.
CERF LABORATORIES AGREEMENT
Pursuant to a CERF Laboratories Agreement (the "CERF Agreement") between
DonJoy and Smith & Nephew, dj Ortho allowed Smith & Nephew and its employees,
agents, representatives and invitees to use dj Ortho's Clinical Education
Research Facility ("CERF") laboratory, the equipment and supplies in the CERF
laboratory and services offered at the CERF laboratory. Smith & Nephew paid dj
Ortho a quarterly fee calculated in the same manner as it was calculated prior
to the recapitalization. For 2000 and 1999, Smith & Nephew paid DonJoy $56,991
and $85,649, respectively, for use of the CERF laboratory. On August 31, 2000,
the CERF Agreement was terminated by Smith & Nephew.
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OTHER ARRANGEMENTS WITH AFFILIATES OF CDP
In connection with the recapitalization, dj Ortho and dj Capital entered
into the 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 CDP. In connection with the new credit facility, Chase receives
customary fees for acting in such capacities. 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.
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DESCRIPTION OF CREDIT FACILITY
The following is a summary of the material terms of the credit facility
among the Company, DonJoy, certain financial institutions party thereto (the
"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 the
Company, swingline loans to the Company and the issuance of letters of
credit for the account of the Company 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 December 31, 2000, the
Company had approximately $4.4 million remaining available under the revolving
credit facility.
INTEREST
Borrowings under the credit facility bear interest at a variable rate per
annum equal (at the Company's option) to:
- an adjusted London inter-bank offered rate ("LIBOR") plus a percentage
based on the Company's 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 the Company's 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 December 31, 2000, the interest rate on the term
loans ranged from 9.18% to 9.813%. The borrowing margins applicable to the
revolving credit facility are initially 2.75% for LIBOR loans and 1.75% for ABR
loans. As of December 31, 2000, the interest rate on the revolving credit
facility ranged from 8.875% to 9.00%. Borrowing margins for the term loans and
the
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revolving credit facility are subject to downward adjustment based upon the
Company's 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.
FEES
The Company has 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 the Company's 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
The obligations of the Company under the credit facility are irrevocably
guaranteed, jointly and severally, by DonJoy and DJ Capital and will be
irrevocably guaranteed, jointly and severally, by each subsequently acquired or
organized domestic (and, to the extent no adverse tax consequences would result
therefrom, foreign) subsidiary of the Company. The Company's Mexican subsidiary
(its only existing subsidiary besides DJ Capital) is not a guarantor of the
Company's obligations under the credit facility. In addition, the credit
facility and the guarantees thereunder are secured by substantially all the
assets of DonJoy, the Company 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 the Company would result
therefrom, foreign) subsidiary, including but not limited to, in each case
subject to certain exceptions:
- a first priority pledge of all the membership interests in the Company,
- a first-priority pledge of all the capital stock, membership interests
and other equity interests held by DonJoy, the Company or any domestic
(or, subject to the foregoing limitation, foreign) subsidiary of the
Company of each existing and subsequently acquired or organized
subsidiary of the Company (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 the Company), and
- a perfected first priority security interest in, and mortgage on,
substantially all tangible and intangible assets of the Company (not
including the Company's Mexican subsidiary) and the guarantors
(including, but not
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limited to, accounts receivable, documents, inventory, trademarks, other
intellectual property, licensing agreements, equipment, the Company's
sub-lease of the Vista, California facility, cash and cash accounts and
proceeds of the foregoing).
COMMITMENT REDUCTIONS AND REPAYMENTS
The term loans mature on June 30, 2005 and the outstanding principal amount
of the term loans was $38.4 million at December 31, 2000. The term loans
amortize in quarterly amounts and are based upon the annual amounts shown below:
Fiscal Year 2001..................................... $ 1,274
Fiscal Year 2002..................................... 1,274
Fiscal Year 2003..................................... 1,274
Fiscal Year 2004..................................... 17,202
Fiscal Year 2005..................................... 17,339
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$38,363
=======
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 DonJoy, the
Company or any of its subsidiaries,
- 100% of the net cash proceeds of certain debt issuances of DonJoy, the
Company or any of its subsidiaries,
- 50% of the Company's excess cash flow (subject to an increase to 75% in
the event the Company's consolidated leverage ratio exceeds a certain
level), and
- 100% of the net cash proceeds of certain asset sales or other
dispositions of property by DonJoy, the Company or any of its
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, among other
things, restrict the ability of DonJoy, the Company and its subsidiaries 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 as
described in the definitive documentation for the credit facility), 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 the Company and its
subsidiaries, make capital expenditures, or engage in certain transactions with
affiliates and otherwise engage in certain
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activities. In addition, the credit facility requires DonJoy 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 credit facility also contains provisions that prohibit
any modifications of the Indenture in any manner adverse to the Lenders under
the credit facility and that limit the Company's 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
certain 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, DonJoy, L.L.C., is 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 only existing subsidiary (other
than DJ Capital), Smith & Nephew DonJoy de Mexico, S.A. de C.V., a corporation
formed under the laws of Mexico ("DonJoy Mexico"), is not a guarantor 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, DonJoy 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;
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- 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
- are effectively subordinated to all liabilities of DonJoy Mexico, which
is 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 DonJoy but are not and will not be guaranteed
by DonJoy Mexico or any of the Company's other foreign subsidiaries.
DonJoy'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
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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 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:
REDEMPTION
YEAR PRICE
---- ----------
2004............................................... 106.313%
2005............................................... 104.208%
2006............................................... 102.104%
2007 and thereafter................................ 100.000%
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 DonJoy 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.
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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 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 DonJoy
Mexico, its only Subsidiary (other than DJ Capital). DonJoy Mexico is 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 DonJoy Mexico 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 DonJoy Mexico 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 DonJoy Mexico and any other Subsidiaries of the Company formed or acquired in
the future that do not guarantee the notes. As of December 31, 2000, DonJoy
Mexico's total liabilities, including trade payables, as reflected on its
balance sheet, were approximately $0.2 million. Although the indenture limits
the Incurrence of Indebtedness by and the issuance of Preferred Equity Interests
of DonJoy Mexico and certain of the Company's future Subsidiaries, such
limitation is subject to a number of significant qualifications.
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As of December 31, 2000, there was outstanding:
(1) $59.0 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 DonJoy, the only Note Guarantor (other
than its guarantee of Indebtedness under the Credit Agreement); and
(5) no Senior Subordinated Indebtedness of DonJoy, currently the only
Note Guarantor (other than its Note Guarantee), and no Indebtedness of
DonJoy 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
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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
(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
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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.
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.
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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
DonJoy 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.
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
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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 DonJoy
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 DonJoy, whether as a result of issuance of
securities of DonJoy or the Company, any merger, consolidation, liquidation
or dissolution of DonJoy 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
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Permitted Holder) shall be deemed to have "beneficial ownership" of all
Equity Interests that any such person has the right to acquire, 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 DonJoy, 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 DonJoy
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 DonJoy, 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
DonJoy, 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
DonJoy, as the case may be, or whose nomination for election by the equity
holders of the Company or DonJoy, 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 DonJoy, 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 DonJoy,
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 DonJoy;
(5) the merger or consolidation of the Company or DonJoy with or into
another Person or the merger of another Person with or into the Company or
DonJoy, or the sale of all or substantially all the assets of the Company
or DonJoy 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 DonJoy 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 DonJoy 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
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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.
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
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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 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
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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,
(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
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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 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
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(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.
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
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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
(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
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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 DonJoy (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)
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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 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 DonJoy 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 redemp-
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tions 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
- 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;
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(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 DonJoy 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 included in the calculation of
the amount of Restricted Payments for the purposes of paragraph (a) above:
(A) to DonJoy in amounts equal to the amounts required for DonJoy
to pay franchise taxes and other fees required to maintain its existence
and provide for all other operating costs of DonJoy, 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 DonJoy in amounts equal to amounts expended by DonJoy to
repurchase Equity Interests of DonJoy owned by officers, directors,
consultants and employees or former officers, directors, consultants or
employees of DonJoy, the Company or its Subsidiaries or their assigns,
states and heirs; provided, however, that the aggregate amount of
dividends, distributions or other amounts to DonJoy 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;
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(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) in the event DonJoy is not treated as a pass-through entity for
United States Federal income tax purposes, dividends or distributions to
DonJoy in amounts equal to amounts required for DonJoy 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 DonJoy to fund the
payment by DonJoy of dividends on DonJoy's common Equity Interests
following the first public offering of common Equity Interests of DonJoy
after the Closing Date, of up to 6% per annum of the net proceeds
contributed to the Company by DonJoy 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 in an amount equal to the
purchase price adjustment, if any, which DonJoy is 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
(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
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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.
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
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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
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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 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
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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,
(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 DonJoy 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 DonJoy or the Company or similar rights to employees and
directors of DonJoy 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,
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(5) the payment of reasonable fees to directors of DonJoy or the
Company and its Subsidiaries who are not employees of DonJoy 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 Chase Capital Partners and Persons
controlled by Chase Capital 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,
(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, DonJoy and Charles T. Orsatti described in
this prospectus under the heading "Management -- Compensation of Board of
Managers"; 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 DonJoy or any
purchase of Equity Interests of the Company by DonJoy.
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 DonJoy's annual report and the information,
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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 DonJoy 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.
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
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(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
DonJoy) 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.
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,
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(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 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.
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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,
(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
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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,
(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
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(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.
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
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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
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Opinion of Counsel must be based on a ruling of the Internal Revenue Service or
other change in applicable Federal income tax law).
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
DonJoy (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
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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),
(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
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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.
"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
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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),
(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
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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.
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,
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(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 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;
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(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.
"Credit Agreement" means the credit agreement dated as of the Closing Date
among the Company, DonJoy, the lenders named therein, First Union National Bank,
as administrative agent and collateral agent, and The Chase Manhattan
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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"
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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 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
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(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 DonJoy, as applicable, other than public offerings
with respect to the Company's or DonJoy'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.
"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
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(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
(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;
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(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
(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
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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).
"Members' Agreement" means the Members' Agreement among DonJoy, 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 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
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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.
"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) Chase DJ Partners, LLC and its Affiliates,
(3) First Union Capital Corporation and its Affiliates,
(4) Fairfield Chase Medical Partners, LLC and its Affiliates,
(5) Charles T. Orsatti and his Related Parties,
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(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 DonJoy'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;
(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
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consists of Equity Interests (other than Disqualified Equity Interests) of
the Company or DonJoy;
(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.
"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,
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(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 DonJoy 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.
"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.
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"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
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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.
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.
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"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 this prospectus.
"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
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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 DonJoy 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 DonJoy 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
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securities held by or on behalf of DTC only through participants or indirect
participants.
The Issuers and DonJoy 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, 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, DonJoy 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
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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, DonJoy 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, DonJoy 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.
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, DonJoy 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, DonJoy 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).
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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
94.8% of the voting units of DonJoy. See "Security Ownership of Certain
Beneficial Owners and Management." 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 -- Trading Market for the Notes."
LEGAL MATTERS
The validity of the notes offered hereby and the guarantee of DonJoy was
passed upon for the Issuers and DonJoy by O'Sullivan Graev & Karabell, LLP, New
York, New York.
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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.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
DONJOY, L.L.C.:
Report of Ernst & Young LLP, Independent Auditors......... F-2
Consolidated Balance Sheets as of December 31, 2000 and
1999................................................... F-3
Consolidated Statements of Income for the years ended
December 31, 2000, 1999 and 1998....................... F-4
Consolidated Statements of Changes in Members' Equity
(Deficit) for the years ended December 31, 2000, 1999
and 1998............................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998....................... F-6
Notes to DonJoy's Audited Consolidated Financial
Statements............................................. F-7
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.:
Combined Balance Sheets as of March 31, 2000 (unaudited)
and December 31, 1999.................................. F-32
Combined Statements of Operations and Changes in Invested
Equity for the Three Months Ended March 31, 2000 and
1999 (unaudited)....................................... F-33
Combined Statements of Cash Flows for the Three Months
Ended March 31, 2000 and 1999 (unaudited).............. F-34
Notes to Combined Financial Statements (unaudited)........ F-35
Report of PricewaterhouseCoopers LLP, Independent
Accountants............................................ F-41
Combined Balance Sheets as of December 31, 1999 and
1998................................................... F-42
Combined Statements of Operations and Changes in Invested
Equity for the Year Ended December 31, 1999 and the
Period October 29, 1998 through December 31, 1998...... F-43
Combined Statements of Cash Flows for the Year Ended
December 31, 1999 and for the Period October 29, 1998
through December 31, 1998.............................. F-44
Notes to Combined Financial Statements.................... F-45
Report of PricewaterhouseCoopers LLP, Independent
Accountants............................................ F-58
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............... F-59
Statements of Cash Flows for the Period from January 1,
1998 through October 28, 1998 and for the Year Ended
December 31, 1997...................................... F-60
Notes to Financial Statements............................. F-61
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON:
Report of PricewaterhouseCoopers LLP, Independent
Accountants............................................ F-73
Statements of Revenues and Expenses for the Period of
January 1, 1998 through October 28, 1998 and for the
Year Ended December 31, 1997........................... F-74
Notes to Statements of Revenues and Expenses.............. F-75
DONJOY, L.L.C. PRO FORMA FINANCIAL INFORMATION:
Unaudited Pro Forma Consolidated Financial Information.... F-80
Unaudited Pro Forma Consolidated Statement of Income for
the Year Ended December 31, 2000....................... F-82
Notes to Unaudited Pro Forma Consolidated Statement of
Income................................................. F-83
F-1
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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, 2000 and 1999, 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. Our audits also included the financial statement
schedule listed in the Index at Item 14(a). DonJoy's Audited Consolidated
Financial Statements and schedule 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, 2000 and 1999, 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. Also, in our opinion, the related financial schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.
ERNST & YOUNG, LLP
San Diego, California
February 16, 2001
F-2
182
DONJOY, L.L.C.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT UNIT INFORMATION)
DECEMBER 31,
----------------------
2000 1999
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 4,106 $ 5,927
Accounts receivable, net of allowance for doubtful
accounts of $4,278 and $989 at December 31, 2000
and 1999, respectively.......................... 34,498 21,406
Inventories, net................................... 18,510 13,664
Other current assets............................... 3,270 917
--------- ---------
Total current assets............................... 60,384 41,914
Property, plant and equipment, net................. 12,785 7,297
Intangible assets, net............................. 75,419 33,195
Debt issuance costs, net............................. 6,549 6,875
Other assets......................................... 535 135
--------- ---------
Total assets......................................... $ 155,672 $ 89,416
========= =========
LIABILITIES AND MEMBERS' DEFICIT
Current liabilities:
Accounts payable................................... $ 8,982 $ 6,411
Accrued compensation............................... 2,937 2,443
Accrued commissions................................ 1,444 954
Long-term debt, current portion.................... 1,274 500
Accrued interest................................... 686 526
Other accrued liabilities.......................... 6,366 3,667
--------- ---------
Total current liabilities............................ 21,689 14,501
12 5/8% Senior Subordinated Notes.................... 98,260 98,055
Long-term debt, less current portion................. 57,688 14,750
Redeemable Preferred Units; 100,000 units authorized,
44,405 and 40,184 units issued and outstanding at
December 31, 2000 and 1999, respectively;
liquidation preference $43,688 and $35,368 at
December 31, 2000 and 1999, respectively........... 41,660 32,539
Commitments and contingencies (Note 11)
Members' deficit:
Common units; 2,900,000 units authorized, 793,890
and 718,000 units issued and outstanding at
December 31, 2000 and 1999, respectively........ 74,754 66,521
Notes receivable from officers....................... (1,772) (1,400)
Retained deficit..................................... (136,607) (135,550)
--------- ---------
Total members' deficit............................... (63,625) (70,429)
--------- ---------
Total liabilities and members' deficit............... $ 155,672 $ 89,416
========= =========
See accompanying notes.
F-3
183
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
-------- -------- --------
Net revenues............................... $147,469 $117,767 $104,292
Cost of goods sold......................... 60,178 51,744 46,466
Gross profit............................... 87,291 66,023 57,826
Operating expenses:
Sales and marketing...................... 42,536 30,251 28,282
General and administrative............... 19,761 16,755 16,484
Research and development................. 2,465 2,115 2,248
Merger and integration costs............. 400 -- --
Restructuring costs...................... -- -- 2,467
-------- -------- --------
Total operating expenses................... 65,162 49,121 49,481
Income from operations..................... 22,129 16,902 8,345
Interest expense........................... (16,958) (7,568) --
Interest income............................ 437 181 --
Discontinued acquisition costs............. (449) -- --
-------- -------- --------
Income before income taxes................. 5,159 9,515 8,345
Provision for income taxes................. -- 2,387 3,394
-------- -------- --------
Net income and comprehensive net income.... 5,159 7,128 4,951
Less: Preferred unit dividends and
accretion................................ (5,415) (2,343) N/A
-------- -------- --------
Net income (loss) available to members of
preferred unit fees...................... $ (256) $ 4,785 N/A
======== ======== ========
See accompanying notes.
F-4
184
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF CHANGES
IN MEMBERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT UNIT INFORMATION)
COMMON UNITS NOTES
--------------------- RECEIVABLE RETAINED TOTAL MEMBERS'
UNITS AMOUNT FROM OFFICERS EARNINGS (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)..................... -- -- 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)..................... -- -- -- 4,885 4,885
---------- -------- ------- --------- ---------
BALANCE AT DECEMBER 31, 2000... 793,890 $ 74,754 $(1,772) $(136,607) $ (63,625)
========== ======== ======= ========= =========
See accompanying notes.
F-5
185
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- --------- -------
OPERATING ACTIVITIES
Net income............................................. $ 5,159 $ 7,128 $ 4,951
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization........................ 6,365 4,952 4,853
Amortization of debt issuance costs and discount on
Senior Subordinated Notes.......................... 1,082 510 --
Step-up to fair value of acquired inventory.......... 268 -- --
Stock options granted for services................... 36 -- --
Restructuring costs.................................. -- -- 2,467
Merger and integration costs......................... 400 -- --
Changes in operating assets and liabilities:
Accounts receivable................................ (13,092) (1,564) (3,816)
Inventories........................................ (2,576) 704 (2,760)
Other current assets............................... (2,427) (106) (97)
Accounts payable................................... 2,571 (893) 495
Accrued interest................................... 160 526 --
Accrued compensation............................... 494 1,057 (174)
Accrued commissions................................ 490 (237) (377)
Income taxes....................................... -- 2,516 (744)
Restructuring reserve.............................. -- (339) (1,197)
Other accrued liabilities.......................... 2,299 1,811 147
-------- --------- -------
Net cash provided by operating activities.............. 1,229 16,065 3,748
INVESTING ACTIVITIES
Purchases of property, plant and equipment............. (6,522) (2,502) (3,189)
Proceeds from assets held for sale..................... 126 -- --
Purchase of intangible assets.......................... (1,200) (2,204) (960)
Investment in Orthotech................................ (49,019) -- --
Other assets........................................... (400) (70) 100
-------- --------- -------
Net cash used in investing activities.................. (57,015) (4,776) (4,049)
FINANCING ACTIVITIES
Net proceeds from Senior Subordinated Notes............ -- 97,953 --
Proceeds from long-term debt........................... 44,600 15,500 --
Repayment of long-term debt............................ (888) (250) --
Distributions.......................................... (563) -- --
Debt issuance costs.................................... (551) (7,283) --
Purchase of common units from Smith & Nephew
(the "Former Parent")................................ -- (199,140) --
Net proceeds from issuance of common units............. 8,059 63,437 --
Net proceeds from issuance of preferred units.......... 3,432 30,000 --
Note receivable issued for purchase of common units.... (124) -- --
Intercompany obligations............................... -- (6,388) 200
-------- --------- -------
Net cash (used in) provided by financing activities.... 53,965 (6,171) 200
-------- --------- -------
Net increase (decrease) in cash........................ (1,821) 5,118 (101)
Cash at beginning of period............................ 5,927 809 910
-------- --------- -------
Cash at end of period.................................. $ 4,106 $ 5,927 $ 809
======== ========= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid........................................ $ 15,716 $ 6,530 $ --
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Capital contribution in connection with the
Recapitalization................................... $ -- $ 47,853 $ --
Dividends and accretion of preferred unit fee related
to redeemable preferred units...................... $ 5,415 $ 2,343 $ --
Common units issued in exchange for notes receivable
and transfer of interest receivable to notes
receivable......................................... $ 248 $ 1,400 $ --
See accompanying notes.
F-6
186
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
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.
Recapitalization
On June 30, 1999, DonJoy consummated a $215.3 million recapitalization (the
"Recapitalization"). In the Recapitalization, new investors, including Chase DJ
Partners, L.L.C. ("CDP") and affiliates of CDP, invested new capital of $94.6
million in DonJoy. In addition, certain members of management invested net
equity of $0.5 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
7.3% of total units in DonJoy then outstanding. In connection with the
recapitalization transactions, DonJoy established the 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 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. DJ Capital is a wholly-owned
subsidiary of dj Ortho, has no significant assets or operations and was formed
solely for the purpose of being a co-issuer of the Notes (see Note 8).
F-7
187
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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 92.7% of members' equity from the Former Parent,
and approximately $8.8 million of costs and fees paid in association with the
Recapitalization.
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
CDP and certain members of management for $5.9 million. CDP 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. 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 currently offered by the Company.
Basis of Presentation
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 and the accounts of its wholly-owned Mexican
subsidiary that manufactures a portion of dj Ortho's products under Mexico's
maquiladora program. 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.
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.
F-8
188
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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, is 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.
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.
The Company periodically reviews its long-lived assets, including
intangibles, for indicators of impairment. If indicators exist, an analysis of
future undiscounted cash flows would be performed. If such future undiscounted
cash flows are less than the net book value of the assets, the carrying value
would be reduced to estimated fair value.
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 2000 and 1999, the Company capitalized $3.9
million and $1.1 million, respectively, related to the acquisition and
implementation of its
F-9
189
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
new enterprise resource planning system. Once the system is fully implemented,
the company will amortize the costs over three years.
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 preferable. 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 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. Estimated returns are accrued 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 warranty costs are accrued in the period sales are recognized.
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 2000, 1999 and 1998 have
been increased by the amounts billed to customers for freight of $4.4 million,
$3.5 million and $3.5 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 $7.6 million, $5.6 million and $5.6 million for December 31, 2000, 1999 and
1998, respectively.
Advertising Expense
The cost of advertising is expensed as incurred. The Company incurred
$252,000, $152,000 and $122,000 in advertising costs for the years ended
December 31, 2000, 1999 and 1998.
F-10
190
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
Foreign Currency Translation
The Company has determined that the functional currency of its Mexican
operations is the U.S. dollar. Transaction gains and losses are reported as
income or expense in the periods presented.
Concentration of Credit Risk
dj Ortho sells the majority of its products in the United States through 30
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 12%, 16% and
18% of the Company's net revenues in 2000, 1999 and 1998, 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, The Company had no
individual customer, supplier or distributor which accounted for 10% or more of
total annual revenues.
Stock-Based Compensation
As permitted under Financial Accounting Standards Board Statement No. 123,
"Accounting for Stock-Based Compensation" ("FAS 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
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. Adoption of FAS 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 FAS 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.
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
Recapitaliza-
F-11
191
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
tion 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):
Inventory........................................... $ 3,670
Property, plant and equipment....................... 4,145
Goodwill............................................ 130,543
--------
$138,358
========
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 include
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 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, 2000, 1999 and 1998 did
not differ from reported net income.
F-12
192
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities", ("FAS
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 FASB Statement No. 133" which
defers the adoption requirement to the first quarter of 2001. The impact on the
Company's financial statements is not expected to be material.
Reclassifications
Certain amounts in prior periods have been reclassified to conform with
current period presentation.
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 CDP 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.
F-13
193
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
The sources and uses of funds for the Orthotech Acquisition are presented
in the following table (dollars in millions):
AMOUNT
------
Sources
Cash.................................................. $ 1.3
Revolving credit facility............................. 12.6
Term loan............................................. 24.0
Redeemable Preferred Units............................ 3.4
Common unit investment by CDP......................... 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
=====
The Orthotech Acquisition has been accounted for using the purchase method
of accounting whereby the purchase price has been allocated to the acquired
tangible and intangible assets based on their estimated fair market values as
follows (in thousands):
Inventories....................................... $ 2,538
Equipment and furniture........................... 1,295
Other assets held for sale........................ 126
Intangibles:
Goodwill.......................................... $36,623
Customer list................................... 8,400
Assembled workforce............................. 37 45,060
------- -------
Net assets acquired............................... $49,019
=======
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
F-14
194
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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):
YEARS ENDED
DECEMBER 31,
--------------------
2000 1999
-------- --------
Net revenues.................................... $171,397 $164,487
Net income...................................... $ 5,118 $ 6,770
3. FINANCIAL STATEMENT INFORMATION
Inventories
Inventories consist of the following (in thousands):
YEARS ENDED
DECEMBER 31,
------------------
2000 1999
------- -------
Raw materials..................................... $ 9,074 $ 6,392
Work-in-progress.................................. 1,572 1,446
Finished goods.................................... 11,638 6,817
------- -------
22,284 14,655
Less reserve for excess and obsolete.............. (3,774) (991)
------- -------
$18,510 $13,664
======= =======
The reserve for excess and obsolete inventory as of December 31, 2000
includes $2.2 million relating to the inventory acquired in the Orthotech
Acquisition. The reserve recorded upon the acquisition totaled $5.1 million of
which $2.9 million was utilized in the year ended December 31, 2000.
F-15
195
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
Property, Plant and Equipment
Property, plant and equipment consists of the following (in thousands):
YEARS ENDED
DECEMBER 31,
--------------------
2000 1999
-------- --------
Buildings and leasehold improvements............ $ 3,676 $ 3,577
Office furniture, fixtures, equipment and
other......................................... 19,025 15,817
Construction in progress........................ 5,804 1,297
-------- --------
28,505 20,691
Less accumulated depreciation and amortization.. (15,720) (13,394)
-------- --------
$ 12,785 $ 7,297
======== ========
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, and the Company's acquisition of Orthotech in 2000. The
Company acquired a license in 1999 related to the distribution of the
PainBuster(TM) products. In addition, the Company re-acquired distribution
rights in 2000. Intangible assets consist of the following (in thousands):
DECEMBER 31,
USEFUL LIFE --------------------
(IN YEARS) 2000 1999
----------- -------- --------
Goodwill................................... 20 $ 61,365 $ 24,742
Patented technology........................ 5-20 14,437 14,437
Customer base.............................. 15-20 20,000 11,600
Licensing agreements....................... 5 2,000 2,000
Assembled workforce........................ 3-5 287 250
Other...................................... 5-20 1,599 399
-------- --------
99,688 53,428
Less: accumulated amortization............. (24,269) (20,233)
-------- --------
$ 75,419 $ 33,195
======== ========
F-16
196
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
Other Accrued Liabilities
Other accrued liabilities consist of (in thousands):
DECEMBER 31,
----------------
2000 1999
------ ------
Accrued cost of distribution rights................. $1,050 $ --
Accrued returns..................................... 618 397
Accrued rebate expense.............................. 541 356
Accrued warranty expense............................ 305 259
Other accruals...................................... 3,852 2,655
------ ------
$6,366 $3,667
====== ======
4. FINANCING ARRANGEMENTS
Principal balances under dj Ortho's long-term financing arrangements
consist of the following (in thousands):
DECEMBER 31,
--------------------
2000 1999
-------- --------
12 5/8% Senior Subordinated Notes due 2009, net
of $1,740 of unamortized discount at December
31, 2000...................................... $ 98,260 $ 98,055
Senior Credit Facility:
Term loans due 2005, interest rates ranging from
9.18% to 9.813% at December 31, 2000.......... 38,362 15,250
Revolving credit facility, interest rates
ranging from 8.875% to 9.00% at December 31,
2000.......................................... 20,600 --
-------- --------
157,222 113,305
Current portion of long-term debt............... (1,274) (500)
-------- --------
155,948 112,805
Less: Senior Subordinated Notes (see above)..... (98,260) (98,055)
-------- --------
Long-term debt net of current portion........... $ 57,688 $ 14,750
======== ========
12 5/8% SENIOR SUBORDINATED NOTES DUE 2009
On June 30, 1999, dj Ortho issued $100.0 million of 125/8% 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
F-17
197
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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 21, 2000, 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 Ortho's only existing subsidiary (other than DJ Capital).
Optional Redemption. 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:
REDEMPTION
YEAR PRICE
---- ----------
2004............................................... 106.313%
2005............................................... 104.208%
2006............................................... 102.104%
2007 and thereafter................................ 100.000%
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").
F-18
198
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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. As of December 31,
2000, dj Ortho has borrowed $20.6 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).
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):
2001................................................. $ 1,274
2002................................................. 1,274
2003................................................. 1,274
2004................................................. 17,202
2005................................................. 17,338
-------
Total................................................ $38,362
=======
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 (as defined in the Amended Credit Agreement) (75% if dj Ortho's
leverage ratio exceeds a certain level). dj Ortho had no excess cash flow at
December 31, 2000 or 1999. 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
F-19
199
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
certain exceptions. No mandatory prepayments were required by dj Ortho at
December 31, 2000, or 1999.
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 the
Company.
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.
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, 793,890 common units and
44,405 preferred units were issued and outstanding, and 17% of the common units
on a fully diluted basis have been reserved for issuance to officers, directors,
employees, independent consultants and advisors of the Company or any subsidiary
thereof pursuant to the Second Amended and Restated 1999 Option Plan.
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
CDP and certain members of management for $5.9 million. CDP 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 $4.6
million in 2000, $8.3 million in 1999 and $10.7 million in 1998.
F-20
200
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
In connection with the unit purchase agreement, DonJoy agreed to amend and
restate the promissory notes originally issued by the certain 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 certain 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.
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 CDP 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), and DJ Investment, LLC (formerly First Union Capital
Partners, 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 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
F-21
201
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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 holders of Redeemable Preferred Units are entitled to receive payment,
before any payments shall be made to the holders of common units, equal to the
original costs of such Redeemable Preferred Unit plus any unpaid cumulative
dividends. 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:
Prior to June 30, 2000...................................... 105%
From June 30, 2000 and prior to June 30, 2001............... 104%
From June 30, 2001 and prior to June 30, 2002............... 103%
From June 30, 2002 and prior to June 30, 2003............... 102%
From June 30, 2003 and prior to June 30, 2004............... 101%
On or after June 30, 2004................................... 100%
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. The plan is administered by the Compensation
Committee appointed from time to time by the Board of Managers. The plan expires
on August 19, 2015 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.
F-22
202
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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.
As of December 31, 2000, 14,140 units issued under this plan were
exercisable and 17,959 units were available for future grant under the option
plan. The following table summarizes option activity through December 31, 2000:
WEIGHTED AVERAGE
NUMBER PRICE EXERCISE PRICE
OF UNITS PER UNIT PER UNIT
-------- ------------ ----------------
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
=======
The following table summarizes information concerning currently outstanding
and exercisable options:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------- -----------------------------
NUMBER NUMBER
OUTSTANDING WEIGHTED EXERCISABLE
RANGE OF AS OF AVERAGE WEIGHTED AS OF WEIGHTED
EXERCISE DECEMBER 31, REMAINING LIFE AVERAGE DECEMBER 31, AVERAGE
PRICES 2000 IN YEARS EXERCISE PRICE 2000 EXERCISE PRICE
- -------- ------------ -------------- -------------- ------------ --------------
$100 136,540 13.60 $100 14,040 $100
$109 12,300 14.60 $109 -- $109
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
F-23
203
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
at the date of grant using the minimum value model for option pricing with the
following assumptions for 2000 and 1999: 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 assumption.
Because the Company's employee options have characteristics significantly
different for 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.
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):
2000 1999
------ ------
Pro forma net income................................ $3,979 $6,569
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.
7. SEGMENT 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 orthopedic products. None of the other segments
met any of
F-24
204
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
the quantitative thresholds for determining reportable segments. Information
regarding industry segments is as follows (in thousands):
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
-------- -------- --------
Net revenues:
Rigid knee bracing....................... $ 54,456 $ 49,406 $ 48,594
Soft goods............................... 52,031 39,652 34,233
-------- -------- --------
Net revenues for reportable segments..... 106,487 89,058 82,827
Specialty and other orthopedic
products.............................. 36,570 25,194 17,958
Freight revenue.......................... 4,412 3,515 3,507
-------- -------- --------
Total consolidated net revenues....... $147,469 $117,767 $104,292
Gross profit:
Rigid knee bracing....................... $ 38,493 $ 35,721 $ 34,460
Soft goods............................... 25,761 19,276 16,637
-------- -------- --------
Gross profit for reportable segments..... 64,254 54,997 51,097
Specialty and other orthopedic
products.............................. 22,115 12,516 8,978
Freight revenue.......................... 4,412 3,515 3,507
Brand royalties.......................... -- (1,817) (3,249)
Other cost of goods sold................. (3,490) (3,188) (2,507)
-------- -------- --------
Total consolidated gross profit....... $ 87,291 $ 66,023 $ 57,826
======== ======== ========
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 profit. Intersegment sales
were not significant for any period.
For the years ended December 31, 2000 and 1999, dj Ortho had no individual
customer, supplier or distributor within a segment which accounted for more than
10% or more of total annual revenues.
F-25
205
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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):
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
-------- -------- --------
United States.............................. $125,200 $ 96,370 $ 82,955
Europe..................................... 12,718 12,891 12,376
Other foreign countries.................... 5,139 4,991 5,454
Freight revenue............................ 4,412 3,515 3,507
-------- -------- --------
Total consolidated net revenues............ $147,469 $117,767 $104,292
======== ======== ========
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. This guarantee and any guarantee by
a future wholly-owned subsidiary guarantor, is full and unconditional. dj Ortho
and DJ Capital comprise all the direct and indirect subsidiaries of DonJoy
(other than inconsequential subsidiaries). We have concluded 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 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.
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 sold its remaining
interest in DonJoy to CDP and certain members of management (see Note 1). As a
result of this transaction, the Company no longer reflects any intercompany
transactions as
F-26
206
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
of December 31, 2000 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 recorded
through the intercompany obligations account follows (in thousands):
YEARS ENDED
DECEMBER 31,
--------------------
1999 1998
-------- --------
Balance at beginning of period........................ $ 45,227 $ 45,027
Net cash remitted to Former Parent.................. (17,743) (18,256)
Net intercompany sales.............................. (112) (5,078)
Net fixation device sales........................... -- 256
Share of Former Parent's current income tax
liability........................................ (134) 4,287
Corporate management expense allocations............ 3,159 5,664
Cash owed to Former Parent.......................... 1,002 --
I-Flow licensing agreement.......................... 800 --
Dividend in connection with the merger of Smith &
Nephew Don Joy, Inc. into Smith & Nephew, Inc.... -- --
Capital contribution................................ (38,865) --
Dividends to Smith & Nephew, Inc. .................. -- --
Interest on note payable............................ -- --
Direct charges:
Brand royalties.................................. 1,817 3,249
Payroll taxes and benefits....................... 4,651 8,635
Direct legal expenses............................ 67 324
Foreign Sales Corporation (FSC) commission....... -- 439
Miscellaneous other administrative expenses......... 131 680
-------- --------
Balance at end of period.............................. -- 45,227
Less current portion.................................. -- (1,210)
-------- --------
Long-term intercompany obligations.................... $ -- $ 44,017
======== ========
Average balance during the period..................... $ 22,614 $ 45,127
======== ========
F-27
207
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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.
Former Parent allocations consist of the following (in thousands):
YEARS ENDED
DECEMBER 31,
----------------
1999 1998
------ ------
Corporate managed accounts and new business......... $ 195 $ 394
Finance (risk management, treasury, audit, and
taxes)............................................ 177 310
Human resources and payroll......................... 147 291
Legal............................................... 128 223
Research and development............................ 380 854
Corporate management expense........................ 784 1,332
Bonus............................................... 467 503
Pension............................................. 267 514
Insurance........................................... 614 1,243
------ ------
$3,159 $5,664
====== ======
Amounts included in:
Cost of goods sold.................................. $ 495 $ 991
Sales and marketing................................. 94 179
General and administrative.......................... 2,553 4,439
Research and development............................ 17 55
------ ------
$3,159 $5,664
====== ======
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.
F-28
208
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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.
Minimum annual lease commitments for noncancellable operating leases as of
December 31, 2000 are as follows (in thousands):
2001........................................................ $ 2,458
2002........................................................ 2,263
2003........................................................ 2,202
2004........................................................ 1,880
2005........................................................ 1,852
2006 and thereafter......................................... 4,013
-------
$14,668
=======
Aggregate rent expense was approximately $3.2 million, $2.7 million and
$3.2 million for the years ended December 31, 2000, 1999 and 1998.
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
F-29
209
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
distribution rights for the PainBuster(TM) Pain Management System 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):
YEARS ENDED
DECEMBER 31,
------------
1999 1998
---- ----
Service costs.......................................... $242 $466
Interest costs......................................... 25 48
---- ----
Total pension expense allocated........................ $267 $514
==== ====
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 $0.4 million, $0.3 million and $0.3 million for the
years ended December 31, 2000, 1999 and 1998, 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.
F-30
210
DONJOY, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS)
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.
F-31
211
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED BALANCE SHEETS
AS OF MARCH 31, 2000 AND DECEMBER 31, 1999
AS OF AS OF
MARCH 31, DECEMBER 31,
2000 1999
----------- -------------
(UNAUDITED)
(IN THOUSANDS)
ASSETS
Current assets
Cash......................................... $ 196 $ --
Accounts receivable, less allowances ($2,490
and $2,202 at March 31, 2000 and December
31, 1999, respectively).................... 10,109 10,332
Inventories.................................. 7,397 7,203
Deferred income taxes........................ 1,760 1,761
Other current assets......................... 44 52
------- -------
Total current assets......................... 19,506 19,348
Property, plant and equipment, net.............. 3,543 3,577
Goodwill and other identifiable intangibles
assets, net.................................. 47,624 48,135
Deferred income taxes........................... 272 272
Other assets.................................... 45 45
------- -------
Total assets................................. $70,990 $71,377
------- -------
LIABILITIES AND INVESTED EQUITY
Current liabilities
Accounts payable............................. $ 1,131 $ 1,354
Book overdraft............................... 684 539
Accrued liabilities.......................... 1,790 2,291
------- -------
Total current liabilities.................... 3,605 4,184
Invested equity................................. 67,385 67,193
------- -------
Total liabilities and invested equity... $70,990 $71,377
======= =======
The accompanying notes are an integral part of these combined financial
statements.
F-32
212
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED STATEMENTS OF OPERATIONS AND
CHANGES IN INVESTED EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
FOR THE THREE FOR THE THREE
MONTHS ENDED MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999
------------- -------------
(UNAUDITED)
(IN THOUSANDS)
Net sales........................................ $12,406 $12,182
Cost of goods sold............................... 6,614 6,884
------- -------
Gross profit................................ 5,792 5,298
Selling, general and administrative expenses..... 3,614 4,010
Research and development expense................. 139 101
Amortization expense............................. 511 511
Allocated expenses (Note 3)...................... 1,189 417
------- -------
5,453 5,039
Income before provision for income taxes......... 339 259
Provision for income taxes....................... 344 209
------- -------
Net income (loss)................................ $ (5) $ 50
------- -------
Invested equity -- beginning of period........... $67,193 $66,266
Advances from (repayments to) DePuy.............. 194 (1,006)
Currency translation adjustment.................. 3 6
------- -------
Invested equity -- end of period................. $67,385 $65,316
======= =======
The accompanying notes are an integral part of these combined financial
statements.
F-33
213
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
FOR THE THREE FOR THE THREE
MONTHS ENDED MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999
------------- -------------
(UNAUDITED)
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss).............................. $ (5) $ 50
Adjustments to reconcile net income (loss) to
net cash (used in) provided by operating
activities..................................
Depreciation................................ 178 148
Amortization................................ 511 511
Deferred income taxes....................... 1 556
Provision for accounts receivable........... 288 182
Loss on disposal of property and
equipment................................. -- 6
Changes in operating assets and liabilities
(Increase) in accounts receivable........... (65) (1,334)
Decrease in other assets.................... 8 34
(Increase) decrease in inventory............ (194) 658
(Decrease) increase in accounts payable..... (223) 219
(Decrease) increase in accrued expenses..... (501) 140
----- -------
Net cash (used in) provided by operating
activities................................ (2) 1,170
----- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment............ (141) (191)
----- -------
Net cash used in investing activities....... (141) (191)
----- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Advances from (repayments to) DePuy............ 194 (1,006)
Book overdraft................................. 145 82
----- -------
Net cash provided by (used in) financing
activities................................ 339 (924)
----- -------
Net change in cash............................... 196 55
Cash, beginning of period........................ -- 2
----- -------
Cash, end of period......................... $ 196 $ 57
===== =======
The accompanying notes are an integral part of these combined financial
statements.
F-34
214
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED)
(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.
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 management, the accompanying unaudited combined financial
statements contain all adjustments necessary for a fair statement of the
combined financial position of OrthoTech as of March 31, 2000 and the combined
results of their operations and their cash flows for the three months ended
March 31, 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.
F-35
215
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL
STATEMENTS (UNAUDITED) -- (CONTINUED)
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, 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 three month periods ended March 31,
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.
F-36
216
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL
STATEMENTS (UNAUDITED) -- (CONTINUED)
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:
FOR THE THREE
MONTHS ENDED
----------------------
MARCH 31, MARCH 31,
2000 1999
--------- ---------
Net income (loss)............................... $(5) $50
Other comprehensive income
Currency translation adjustments.............. 3 6
--- ---
Total comprehensive income (loss).......... $(2) $56
=== ===
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 $798 and
$1,084 for the three months ended March 31, 2000 and 1999, respectively.
ALLOCATION OF SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Effective January 1, 2000, J&J 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 $870 for the three months ended March 31,
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
F-37
217
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL
STATEMENTS (UNAUDITED) -- (CONTINUED)
been allocated to OrthoTech based upon OrthoTech's sales to third parties,
relative to total DePuy sales to third parties. Such amounts were $56 and $61
for the three months ended March 31, 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 $263 and
$356 for the three months ended March 31, 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 three month periods
ended March 31, 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 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 101.3% and 80.7% for the
three month periods ended March 31, 2000 and 1999, respectively. Current income
taxes are considered to have been paid or charged to Johnson & Johnson.
F-38
218
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL
STATEMENTS (UNAUDITED) -- (CONTINUED)
4. INVENTORIES
Inventories consist of the following:
AS OF AS OF
MARCH 31, DECEMBER 31,
2000 1999
----------- ------------
(UNAUDITED)
Raw materials.............................. $4,028 $3,566
Work-in-process............................ 42 75
Finished goods............................. 3,327 3,562
------ ------
$7,397 $7,203
====== ======
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 three
months ended March 31, 2000 and 1999 are shown below:
OPERATING
SALES TO INCOME
THREE MONTHS ENDED MARCH 31, 2000 CUSTOMERS (LOSS)
- --------------------------------- --------- ---------
North America......................................... $11,858 $254
Europe................................................ 441 85
Asia Pacific.......................................... 87 2
Rest of the World..................................... 20 (2)
------- ----
Total.............................................. $12,406 $339
======= ====
F-39
219
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL
STATEMENTS (UNAUDITED) -- (CONTINUED)
OPERATING
SALES TO INCOME
THREE MONTHS ENDED MARCH 31, 1999 CUSTOMERS (LOSS)
- --------------------------------- --------- ---------
North America......................................... $11,334 $146
Europe................................................ 769 112
Asia Pacific.......................................... 55 3
Rest of the World..................................... 24 (2)
------- ----
Total.............................................. $12,182 $259
======= ====
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.
8. SUBSEQUENT EVENTS
On May 17, 2000, DePuy entered into a letter of exclusivity and term sheet
with a Buyer in which the Buyer agreed to purchase the inventory, property,
plant and equipment, plus certain rights and intellectual property of the
bracings and soft supports business of OrthoTech. The sale is expected to be
completed in the second quarter of 2000.
F-40
220
REPORT OF PRICEWATERHOUSECOOPERS LLP,
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
221
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
AS OF
DECEMBER 31,
------------------
1999 1998
------- -------
(IN THOUSANDS)
ASSETS
Current assets
Cash................................................. $ -- $ 2
Accounts receivable, less allowances ($2,202 and
$1,084 in 1999 and 1998, respectively)............. 10,332 6,983
Inventories.......................................... 7,203 7,460
Deferred income taxes................................ 1,761 2,140
Other current assets................................. 52 90
------- -------
Total current assets............................... 19,348 16,675
Property, plant and equipment, net...................... 3,577 3,356
Goodwill and other identifiable intangibles assets,
net.................................................. 48,135 50,179
Deferred income taxes................................... 272 254
Other assets............................................ 45 44
------- -------
Total assets......................................... $71,377 $70,508
======= =======
LIABILITIES AND INVESTED EQUITY
Current liabilities
Accounts payable..................................... $ 1,354 $ 1,828
Book overdraft....................................... 539 --
Accrued liabilities.................................. 2,291 2,414
------- -------
Total current liabilities.......................... 4,184 4,242
Invested equity...................................... 67,193 66,266
------- -------
Total liabilities and invested equity.............. $71,377 $70,508
======= =======
The accompanying notes are an integral part of these combined financial
statements.
F-42
222
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
FOR THE FOR THE PERIOD
YEAR ENDED OCTOBER 29, 1998
DECEMBER 31, THROUGH
1999 DECEMBER 31, 1998
------------ -----------------
(IN THOUSANDS)
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
======= =======
The accompanying notes are an integral part of these combined financial
statements.
F-43
223
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
FOR THE FOR THE PERIOD
YEAR ENDED OCTOBER 29, 1998
DECEMBER 31, THROUGH
1999 DECEMBER 31, 1998
------------ -----------------
(IN THOUSANDS)
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
======= =======
The accompanying notes are an integral part of these combined financial
statements.
F-44
224
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 state-
F-45
225
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
ments 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).
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.
F-46
226
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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:
Leasehold improvements.............. Shorter of life of lease or 15 years
Machinery and equipment............. 3-10 years
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.
F-47
227
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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:
FOR THE
PERIOD
OCTOBER 29,
FOR THE 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
Net income/(loss)......................... $101 $(2,715)
Other comprehensive income
Currency translation adjustments........ 23 (3)
---- -------
Total comprehensive income/(loss).... $124 $(2,718)
==== =======
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.
F-48
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DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-49
229
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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
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.
F-50
230
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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:
WEIGHTED
AVERAGE
OPTIONS EXERCISE
OUTSTANDING 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
====== =======
The following table summarized stock options outstanding and exercisable at
December 31, 1999:
OUTSTANDING EXERCISABLE
- ---------------------------------------------- ------------------
AVERAGE AVERAGE
EXERCISE AVERAGE 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 -- $--
====== === ======= == ===
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
F-51
231
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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:
FOR THE PERIOD
FOR THE OCTOBER 29, 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ----------------
Net income (loss) -- as reported....... $101 $(2,715)
Net income (loss) -- as adjusted....... $ 63 $(2,718)
Compensation cost for the determination of "net income (loss) -- as
adjusted" were estimated using the Black-Scholes option pricing model and the
following assumptions:
FOR THE PERIOD
FOR THE OCTOBER 29, 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 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
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
F-52
232
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
consolidated financial statements of Johnson & Johnson. Included in the purchase
price allocations from the acquisition of DePuy were the following intangible
assets relating to OrthoTech:
Intangible assets
Goodwill.................................................. $11,467
Existing OrthoTech products............................... 31,256
Trademarks................................................ 7,797
-------
Total.................................................. $50,520
=======
5. INVENTORIES
Inventories consist of the following:
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
====== ======
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
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
====== ======
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.
F-53
233
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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 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:
FOR THE PERIOD
FOR THE OCTOBER 29, 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 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)%
====== =======
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
F-54
234
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
significant temporary differences giving rise to deferred tax assets and
liabilities are as follows:
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)
====== ===== ====== =====
8. INTANGIBLE ASSETS
Components of net intangible assets were:
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
======= =======
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.
F-55
235
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Restructuring charges which were included in the overall $613 million
charge taken by Johnson and Johnson that related to OrthoTech included:
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
======
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.
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:
2000.................................................. $ 505
2001.................................................. 505
2002.................................................. 505
2003.................................................. 505
2004.................................................. 505
Thereafter............................................ 6,521
------
$9,046
======
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
F-56
236
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
collateral is required. OrthoTech maintains reserves for potential credit losses
and such losses, in the aggregate, have not exceeded management's expectations.
23. 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:
SALES TO OPERATING TOTAL
CUSTOMERS INCOME ASSETS
--------- --------- -------
YEAR ENDED DECEMBER 31, 1999
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
======= ====== =======
SALES TO OPERATING TOTAL
CUSTOMERS INCOME (LOSS) ASSETS
--------- ------------- -------
PERIOD OCTOBER 29, 1998 THROUGH
DECEMBER 31, 1998
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
====== ======= =======
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-57
237
REPORT OF PRICEWATERHOUSECOOPERS LLP,
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-58
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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
FOR THE PERIOD
JANUARY 1, 1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, 1998 DECEMBER 31, 1997
---------------- -----------------
(IN THOUSANDS)
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
======= =======
The accompanying notes are an integral part of these financial statements.
F-59
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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
FOR THE PERIOD
JANUARY 1, 1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, 1998 DECEMBER 31, 1997
---------------- -----------------
(IN THOUSANDS)
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
======= =======
The accompanying notes are an integral part of these financial statements.
F-60
240
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
F-61
241
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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
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.
F-62
242
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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 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:
Leasehold improvements.................. Shorter of life of lease or 15 years
Machinery and equipment................. 3-10 years
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.
F-63
243
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
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:
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
----------- ------------
Net income.................................. $595 $832
Other comprehensive income
Currency translation adjustments.......... (2) (39)
---- ----
Total comprehensive income............. $593 $793
==== ====
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.
F-64
244
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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,
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.
F-65
245
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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 allocated postretirement
benefit costs based upon participant employee headcount. Net postretirement
benefit expense
F-66
246
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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:
WEIGHTED
AVERAGE
OPTIONS EXERCISE
OUTSTANDING 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
======= ======
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,
F-67
247
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
OrthoTech's net income would have been adjusted to the amounts indicated below:
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
----------- ------------
Net income -- as reported................... $595 $832
Net income -- as adjusted................... 438 662
Compensation cost for the determination of Net Income -- as adjusted were
estimated using the Black-Scholes option pricing model and the following
assumptions:
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
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
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
F-68
248
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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:
Risk free interest rate..................................... 5.46%
Expected volatility......................................... 36.60%
Dividend yield.............................................. 0.75%
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.
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.
F-69
249
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The effective income tax rate differs from the statutory Federal income tax
rate for the following reasons:
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
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%
------ ------
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-70
250
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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:
1998 (October through December)............................. $ 84
1999........................................................ 505
2000........................................................ 505
2001........................................................ 505
2002........................................................ 505
2003........................................................ 505
Thereafter.................................................. 7,025
------
Total..................................................... $9,634
======
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:
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
======= ======
F-71
251
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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
======= ======
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-72
252
REPORT OF PRICEWATERHOUSECOOPERS LLP,
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-73
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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
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
----------- ------------
(DOLLARS IN THOUSANDS)
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)
====== ======
The accompanying notes are an integral part of these financial statements.
F-74
254
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,
F-75
255
BRACING AND SOFT SUPPORTS BUSINESS OF
JOHNSON & JOHNSON
NOTES TO STATEMENTS OF REVENUES AND
EXPENSES -- (CONTINUED)
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 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.
F-76
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BRACING AND SOFT SUPPORTS BUSINESS OF
JOHNSON & JOHNSON
NOTES TO STATEMENTS OF REVENUES AND
EXPENSES -- (CONTINUED)
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.
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.
F-77
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BRACING AND SOFT SUPPORTS BUSINESS OF
JOHNSON & JOHNSON
NOTES TO STATEMENTS OF REVENUES AND
EXPENSES -- (CONTINUED)
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.
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.
F-78
258
BRACING AND SOFT SUPPORTS BUSINESS OF
JOHNSON & JOHNSON
NOTES TO STATEMENTS OF REVENUES AND
EXPENSES -- (CONTINUED)
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-79
259
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated financial information of the
Company is based on DonJoy's historical financial statements for the year ended
December 31, 2000, and Orthotech's historical financial statements appearing
elsewhere in this prospectus, as adjusted to illustrate the estimated effects of
the Orthotech Acquisition and reclassifications to Orthotech's financial
statements to conform with the Company's presentation and financial statement
classifications.
The Orthotech Acquisition was completed on July 7, 2000. The unaudited pro
forma consolidated statement of income for the year ended December 31, 2000
gives effect to the Orthotech Acquisition as if it had occurred on January 1,
2000.
The pro forma adjustments are based upon available information and certain
assumptions that the Company believes are reasonable under the circumstances.
The unaudited pro forma consolidated statement of income does not purport to
represent what the Company's consolidated results of operations would have
actually been had the Orthotech Acquisition in fact occurred on January 1, 2000
and is not necessarily representative of the Company's consolidated financial
position or consolidated 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 the Company and Orthotech.
ORTHOTECH ACQUISITION OVERVIEW AND INTEGRATION PLAN
The Company did not acquire any of Orthotech's facilities or the majority
of its employees and instead integrated the Orthotech operations into its
existing business. Upon closing of the Orthotech Acquisition, DePuy Orthopaedic
retained all responsibility with regards to lease obligations on the Orthotech
facility and severance obligations for terminated Orthotech employees.
In accordance with a transition services agreement, DePuy Orthopaedic
provided certain transitional services to the Company for varying periods while
the operations of Orthotech were integrated into those of the Company. Such
services included continued operation of Orthotech's manufacturing facilities,
employee payroll service and benefits, and computer services and other
administrative services. Such services were terminated in the fourth quarter of
2000.
The Company integrated Orthotech into its business over a period of 90
days. Approximately 85% - 90% of Orthotech's manufactured products were
rationalized against the Company's product lines, with the remaining
manufactured products either offered as new products or discontinued. In
addition, Orthotech product offerings have been rationalized into the Company's
DonJoy, ProCare, international and OfficeCare distribution channels.
F-80
260
Historically, Orthotech sold its products internationally to related party
distributors who then re-sold the Orthotech products to the end user consumer.
In Orthotech's historical financial statements, Orthotech recorded these
revenues based on the sales value to the end user consumer. The Company has not
utilized Orthotech's related party distributors. The Company sells
internationally at a pre-determined transfer price to third party distributors
at sales values that are less than those realized on sales to the end user
consumer.
F-81
261
DONJOY, L.L.C.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
FISCAL YEAR ENDED DECEMBER 31, 2000
DONJOY ORTHOTECH PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS PRO FORMA
---------- ---------- ----------- ---------
Total net revenues............... $147,469 $23,978 $ (50)(a) $171,397
Cost of goods sold............... 60,178 13,326 (1,836)(b) 71,668
-------- ------- ------- --------
Gross profit..................... 87,291 10,652 1,786 99,729
Operating expenses:
Sales and marketing............ 42,536 6,130 1,182(c) 49,848
General and administrative..... 19,761 3,775 (640)(d) 22,896
Research and development....... 2,465 246 -- 2,711
Merger and integration
reserve..................... 400 -- -- 400
-------- ------- ------- --------
Total operating expenses......... 65,162 10,151 542 75,855
-------- ------- ------- --------
Income from operations........... 22,129 501 1,244 23,874
Interest expense................. (16,958) -- (1,786)(e) (18,744)
Interest income.................. 437 -- -- 437
Discontinued acquisition costs... (449) -- -- (449)
-------- ------- ------- --------
Income before income taxes....... 5,159 501 (542) 5,118
Provision (benefit) for income
taxes.......................... -- 461 (461)(f) --
-------- ------- ------- --------
Net income and comprehensive net
income......................... $ 5,159 $ 40 $ (81) $ 5,118
======== ======= ======= ========
Adjusted EBITDA(g)(h)............ $ 29,162 $ 1,521 $ 1,686 $ 32,369
======== ======= ======= ========
See accompanying Notes to Unaudited Pro Forma Consolidated Statement of Income.
F-82
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DONJOY, L.L.C.
NOTES TO UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF INCOME
(DOLLARS IN THOUSANDS IN ALL TABLES)
(a) Reclassification entry to make treatment of Orthotech's accounts receivable
adjustments consistent with the Company's presentation and eliminate the
sales value in excess of the transfer price associated with Orthotech
international related party distributors, as follows:
YEAR ENDED
DECEMBER 31,
2000
------------
Reclassification of accounts receivable adjustments...... $ 1,666
Elimination of sales value in excess of transfer price... (1,716)
-------
$ (50)
=======
(b) Entry records the (i) elimination of cost of goods sold associated with
Orthotech international related party distributors, (ii) elimination of
salaries, wages and benefits as a result of the consolidation of the
Orthotech operations into the Company's existing facilities in Vista,
California, (iii) elimination of discontinued building costs for the
Orthotech facility, (iv) estimated incremental cost of the fair market value
of acquired inventories, and (v) 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 3 to 7 years, as follows:
YEAR ENDED
DECEMBER 31,
2000
------------
Cost of sales associated with Orthotech international
related party distributors............................. $(1,002)
Elimination of salaries, wages and benefits.............. (1,052)
Elimination of building costs............................ (102)
Incremental cost of fair market value on inventories..... 268
Incremental depreciation on fair market value on
property, plant and equipment.......................... 52
-------
$(1,836)
=======
F-83
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DONJOY, L.L.C.
NOTES TO UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF INCOME -- (CONTINUED)
(DOLLARS IN THOUSANDS IN ALL TABLES)
(c) Reclassification entry to make treatment of Orthotech's accounts receivable
adjustments consistent with the Company's presentation and eliminate selling
costs associated with Orthotech international related party distributors, as
follows:
YEAR ENDED
DECEMBER 31,
2000
-----------------
Reclassification of accounts receivable
adjustments........................................ $1,656
Elimination of selling costs associated with
Orthotech international related party
distributors....................................... (474)
------
$1,182
======
(d) Entry records (i) reclassification to make treatment of Orthotech's accounts
receivable adjustments consistent with the Company's presentation, (ii)
elimination of administrative expenses associated with Orthotech
international related party distributors, (iii) transition expenses
including relocation costs, facility move costs, training and other related
costs that are not allowed to be classified as merger and integration costs,
(iv) depreciation on expenditures associated with the consolidation of
Orthotech into the Company's existing facilities, (v) elimination of
salaries, wages and benefits as a result of the consolidation of Orthotech
operations into the Company's existing facilities, (vi) elimination of
discontinued building costs for the Orthotech facility, (vii) elimination of
amortization recorded by Orthotech, and (viii) amortization of the estimated
fair value of goodwill and other intangible assets acquired over economic
lives ranging from 3 to 15 years, as follows:
YEAR ENDED
DECEMBER 31,
2000
------------
Reclassification of accounts receivable adjustments...... $ 10
Elimination of administrative expenses related to
Orthotech international related party distributors..... (90)
Elimination of salaries, wages and benefits.............. (960)
Elimination of building costs............................ (42)
Elimination of amortization recorded by Orthotech........ (1,020)
Amortization of intangibles recorded at fair market
value.................................................. 1,462
-------
$ (640)
=======
F-84
264
DONJOY, L.L.C.
NOTES TO UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF INCOME -- (CONTINUED)
(DOLLARS IN THOUSANDS IN ALL TABLES)
(e) Adjustment to interest expense to reflect additional borrowings under our
amended credit agreement to consummate the Orthotech Acquisition, as
follows:
YEAR ENDED
DECEMBER 31,
2000
------------
New term loan ($24,000 at assumed weighted average rate
of 9.57%).............................................. $1,148
Existing 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
======
(f) Eliminates the provision for income taxes recorded by Orthotech. On June 30,
1999, DonJoy became a stand-alone limited liability company, as such the
earnings of DonJoy and its subsidiaries are included in the taxable income
of its members.
(g) EBITDA is defined as income from operations plus restructuring costs, merger
and integration costs, and depreciation and amortization. EBITDA is not a
measure of performance under general 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. Under both the credit agreement definition of EBITDA and our
definition of EBITDA, we are in compliance with all debt covenants under the
credit agreement. The Company's definition of EBITDA may not be comparable
to that of other companies.
(h) "Adjusted EBITDA" represents EBITDA (as defined above) adjusted as follows:
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265
DONJOY, L.L.C.
NOTES TO UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF INCOME -- (CONTINUED)
(DOLLARS IN THOUSANDS IN ALL TABLES)
YEAR ENDED DECEMBER 31, 2000
-------------------------------------------------
DONJOY ORTHOTECH PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS PRO FORMA
---------- ---------- ----------- ---------
EBITDA.......................... $28,894 $1,521 $1,686(1) $32,101
Eliminated step-up in
inventory..................... 268 -- -- 268
------- ------ ------ -------
Adjusted EBITDA................. $29,162 $1,521 $1,686 $32,369
======= ====== ====== =======
- -------------------------
(1) Pro Forma Adjustments related to EBITDA include the amounts discussed
above in Notes to Unaudited Pro Forma Consolidated Statements of Income
excluding the amounts for merger and integration costs, depreciation
and amortization, interest and income taxes.
F-86
266
$100,000,000
DJ ORTHOPEDICS, LLC
DJ ORTHOPEDICS CAPITAL CORPORATION
12 5/8% SENIOR SUBORDINATED NOTES DUE 2009
267
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the General Corporation Law of the State of Delaware (the
"DGCL") provides for the indemnification of officers and directors under certain
circumstances against expenses incurred in successfully defending against a
claim and authorizes Delaware corporations to indemnify their officers and
directors under certain circumstances against expenses and liabilities incurred
in legal proceedings involving such persons because of their being or having
been an officer or director. Pursuant to Section 102(b)(7) of the DGCL, the
Certificate of Incorporation of DJ Capital provides that the directors of DJ
Capital, individually or collectively, shall not be held personally liable to DJ
Capital Corp or its stockholders for monetary damages for breaches of fiduciary
duty as directors, except that any director shall remain liable (1) for any
breach of the director's fiduciary duty of loyalty to DJ Capital Corp or its
stockholders, (2) for acts or omissions not in good faith or involving
intentional misconduct or a knowing violation of law, (3) for liability under
Section 174 of the DGCL or (4) for any transaction from which the director
derived an improper personal benefit. The by-laws of DJ Capital provide for
indemnification of its officers and directors to the full extent authorized by
law.
Section 18-108 of the Delaware Limited Liability Company Act (the "Act")
provides that, subject to such standards and restrictions, if any, as are set
forth in a limited liability company's operating agreement, a limited liability
company may, and shall have the power to, indemnify and hold harmless any member
or manager or other person from and against any and all claims and demands
whatsoever. The Bylaws of the Company and DonJoy provide that the Company and
DonJoy shall, to the fullest extent authorized under the Act, indemnify and hold
harmless against all expense, liability and loss (including attorneys' fees,
judgments, fines, excise taxes or penalties and amounts paid in settlement)
reasonably incurred or suffered, any manager or officer of the Company or
DonJoy, as the case may be, including indemnification for negligence or gross
negligence but excluding indemnification (i) for acts or omissions involving
actual fraud or willful misconduct or (ii) with respect to any transaction from
which the indemnitee derived an improper personal benefit.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS:
3.1 Amended and Restated Operating Agreement of dj Orthopedics,
LLC
3.2 Third Amended and Restated Operating Agreement dated as of
July 7, 2000 of DonJoy, L.L.C. (Incorporated by reference to
Exhibit 3.1 to DonJoy's report on Form 8-K dated July 21,
2000)
3.3 Certificate of Amendment to Certificate of Incorporation of
DJ Orthopedics Capital Corporation
3.4 By-laws of dj Orthopedics, LLC
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268
3.5 By-laws of DonJoy, LLC
3.6 By-laws of DJ Orthopedics Capital Corporation
4.1 Indenture dated as of June 30, 1999 among the Issuers, DonJoy and The Bank of New York, as
Trustee
4.2 Form of New Note (included as Exhibit B to Exhibit 4.1)
4.3 Exchange and Registration Rights Agreement dated as of June 30, 1999 among the Issuers,
DonJoy and Smith & Nephew
5.1 Opinion of O'Sullivan Graev & Karabell, LLP
10.1 Recapitalization Agreement dated as of April 29, 1999 among CDP, DonJoy and Smith & Nephew
10.2 Group Research Centre Technology Agreement dated as of June 30, 1999 between DonJoy and
Smith & Nephew
10.3 Supply Agreement dated as of June 30, 1999 between DonJoy and Smith & Nephew
10.4 Transition Services Agreement dated as of June 30, 1999 between DonJoy and Smith & Nephew
10.4A First Amendment to Transition Services Agreement dated as of December 21, 1999 between
DonJoy and Smith & Nephew. (Incorporated by reference to Exhibit 10.29 to the Annual Report
from Form 10-K for the fiscal year ended December 31, 1999)
10.5 Distribution Agreement dated as of June 30, 1999 between DonJoy, Smith & Nephew and the
affiliates of Smith & Nephew listed on Schedule I thereto
10.6 CERF Laboratories Agreement dated as of June 30, 1999 between DonJoy and Smith & Nephew
10.7 Subleases dated as of June 30, 1999 between the dj Ortho and Smith & Nephew
10.8 Guaranties dated as of June 30, 1999 executed by DonJoy
10.9 Preferred Unit Purchase Agreement dated as of June 30, 1999 among DonJoy, J.P. Morgan
Partners (23A SBIC), L.L.C. (formerly CB Capital Investors, L.L.C.) and First Union
Investors
10.10 Members' Agreement dated as of June 30, 1999 among DonJoy, CDP, J.P. Morgan Partners (23A
SBIC), L.L.C. (formerly CB Capital Investors, L.L.C.), First Union Investors, Smith &
Nephew and the Management Members
10.11 Credit Agreement dated as of June 30, 1999 among the Issuers, DonJoy, the Lenders party
thereto and First Union National Bank, as Administrative Agent
10.11A Agreement dated as of July 13, 2000 among DonJoy, L.L.C., DJ Orthopedics, L.L.C., the
Lenders under that certain Credit Agreement dated as of June 30, 1999, as amended, First
Union National Bank, as administrative agent, and The Chase Manhattan Bank, as syndication
agent. (Incorporated by reference to Exhibit 10.3 to DonJoy's report on Form 8-K dated July
21, 2000)
II-2
269
10.12 Indemnity, Subrogation and Contribution Agreement dated as
of June 30, 1999 among dj Ortho, J.P. Morgan Partners (23A
SBIC), L.L.C. (formerly CB Capital Investors, L.L.C.), DJ
Capital Investors L.L.C. and First Union National Bank, as
Collateral Agent
10.13 Parent Guarantee Agreement dated as of June 30, 1999 between
DonJoy and First Union National Bank, as Collateral Agent
10.14 Subsidiary Guarantee Agreement dated as of June 30, 1999
between DJ Capital and First Union National Bank, as
Collateral Agent
10.15 Pledge Agreement dated as of June 30, 1999 among dj Ortho,
DonJoy and First Union National Bank, as Collateral Agent
10.16 Security Agreement dated as of June 30, 1999 among dj Ortho,
DonJoy, J.P. Morgan Partners (23A SBIC), L.L.C. (formerly CB
Capital Investors, L.L.C), DJ Capital Investors, L.L.C. and
First Union National Bank, as Collateral Agent
10.17 Leasehold Deed of Trust, Security Agreement and Assignment
of Leases and Rents dated as of June 30, 1999 by dj Ortho,
as grantor, to First American Title Insurance Company, as
trustee
10.18 Employment Agreement dated as of June 30, 1999 between dj
Ortho and Leslie H. Cross
10.19 Employment Agreement dated as of June 30, 1999 between dj
Ortho and Cyril Talbot III
10.20 Employment Agreement dated as of June 30, 1999 between dj
Ortho and Michael R. McBrayer
10.21 Second Amended and Restated 1999 Option Plan of DonJoy dated
August 18, 2000
10.22 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Les Cross
10.23 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Cy Talbot
10.24 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Michael McBrayer
10.25 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Chuck Bastyr
10.26 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Peter Bray
10.27 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Kent Bachman (Incorporated by reference to
Exhibit 10.27 to the Annual Report on Form 10-K for the
fiscal year ended December 31, 1999
10.28 Employment and Separation Agreement dated as of October 25,
1999 between Chuck Bastyr and dj Orthopedics, LLC
(Incorporated by reference to Exhibit 10.28 to the Annual
Report on Form 10-K for the fiscal year ended December 31,
1999)
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10.29 Asset Purchase Agreement dated as of July 7, 2000 among
DePuy Orthopaedic Technology, Inc., dj Orthopedics, L.L.C.,
and DonJoy L.L.C. (Incorporated by reference to Exhibit 2.1
to DonJoy's report on Form 8-K dated July 21, 2000)
10.30 Preferred Unit Purchase Agreement dated as of July 7, 2000,
among DonJoy, L.L.C., and J.P. Morgan Partners (23A SBIC),
LLC (formerly CB Capital Investors, L.L.C.), First Union
Capital Partners, L.L.C., DJC, Inc., TCW/Crescent Mezzanine
Trust II, and TCW Leveraged Income Trust II, L.P.
(Incorporated by reference to Exhibit 4.1 to DonJoy's report
on Form 8-K dated July 21, 2000)
10.31 Common Unit Purchase Agreement dated as of July 7, 2000,
among DonJoy, L.L.C., and Chase DJ Partners, L.L.C., Leslie
H. Cross & Deborah L. Cross Family Trust, Michael R.
McBrayer, and Cyril Talbot III, (Incorporated by reference
to Exhibit 4.2 to DonJoy's report on Form 8-K dated July 21,
2000)
10.32 Secured Promissory Note dated as of July 7, 2000 between the
Leslie H. Cross & Deborah L. Cross Family Trust and Leslie
H. Cross and DonJoy, L.L.C. (Incorporated by reference to
Exhibit 4.3 to DonJoy's report on Form 8-K dated July 21,
2000)
10.33 Secured Promissory Note dated as of July 7, 2000 between
Cyril Talbot III and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.4 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.34 Secured Promissory Note dated as of July 7, 2000 between
Michael R. McBrayer and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.5 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.35 Second Amended and Restated Pledge Agreement dated as of
July 7, 2000, among Leslie H. Cross, Leslie H. Cross &
Deborah L. Cross Family Trust , and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.6 to DonJoy's report
on Form 8-K dated July 21, 2000)
10.36 Second Amended and Restated Pledge Agreement dated as of
July 7, 2000, Cyril Talbot III, and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.7 to DonJoy's report
on Form 8-K dated July 21, 2000)
10.37 Second Amended and Restated Pledge Agreement dated as of
July 7, 2000, between Michael R. McBrayer and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.8 to DonJoy's report
on Form 8-K dated July 21, 2000)
10.38 Unit Purchase Agreement dated as of June 28, 2000, among
Smith & Nephew Disposal, Inc. and Chase DJ Partners, L.L.C.,
Leslie H. Cross & Deborah L. Cross Family trust, Michael R.
McBrayer, and Cyril Talbot III. (Incorporated by reference
to Exhibit 4.9 to DonJoy's report on Form 8-K dated July 21,
2000)
10.39 Amended and Restated Secured Promissory Note dated as of
June 28, 2000 between Michael R. McBrayer and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.10 to DonJoy's
report on Form 8-K dated July 21, 2000)
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10.40 Amended and Restated Secured Promissory Note dated as of
June 28, 2000 among Leslie H. Cross & Deborah L. Cross
Family Trust, Leslie H. Cross and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.11 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.41 Amended and Restated Secured Promissory Note dated as of
June 28, 2000 between Cyril Talbot III and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.12 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.42 Secured Promissory Note dated as of June 28, 2000 among
Leslie H. Cross & Deborah L. Cross Family Trust, Leslie H.
Cross and DonJoy, L.L.C. (Incorporated by reference to
Exhibit 4.13 to DonJoy's report on Form 8-K dated July 21,
2000)
10.43 Secured Promissory Note dated as of June 28, 2000 between
Cyril Talbot III and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.14 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.44 Secured Promissory Note dated as of June 28, 2000 between
Michael R. McBrayer and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.15 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.45 Amended and Restated Pledge Agreement dated as of June 28,
2000 among Leslie H. Cross, Leslie H. Cross & Deborah L.
Cross Family Trust, and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.16 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.46 Amended and Restated Pledge Agreement dated as of June 28,
2000 between Cyril Talbot III and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.17 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.47 Amended and Restated Pledge Agreement dated as of June 28,
2000 between Michael R. McBrayer and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.18 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.48 Amendment No. 1 dated as of May 25, 2000 to the Credit
Agreement dated as of June 30, 1999 (Incorporated by
reference to Exhibit 10.1 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.49 Transition Services Agreement dated as of July 7, 2000 among
DePuy Orthopaedic Technology, Inc., DonJoy, L.L.C., and dj
Orthopedics, L.L.C. (Incorporated by reference to Exhibit
10.2 to DonJoy's report on Form 8-K dated July 21, 2000)
12.1* Statement re: computation of ratios of earning to fixed
charges
21.1* Subsidiaries of the Registrants
23.1 Consent of O'Sullivan Graev & Karabell, LLP (included on
Exhibit 5.1)
23.2* Consent of Ernst & Young LLP
23.3* Consent of PricewaterhouseCoopers LLP
24.1 Powers of Attorney other than Kirby L. Cramer and W. Brett
Ingersoll (included on the signature page)
24.2 Power of Attorney of Kirby L. Cramer
24.3* Power of Attorney of W. Brett Ingersoll
II-5
272
25.1 Statement of Eligibility and Qualification under the Trust Indenture Act of 1939 of The
Bank of New York as Trustee
- -------------------------
(*) Filed Herewith
(b) FINANCIAL STATEMENT SCHEDULES
DJ ORTHOPEDICS, LLC
SCHEDULE II -- VALUATION AND QUALIFYING
ACCOUNTS AND RESERVES
FOR THE THREE YEARS ENDED DECEMBER 31, 2000
ALLOWANCE FOR
DOUBTFUL RESERVE FOR
ACCOUNTS EXCESS AND
AND SALES OBSOLETE
RETURNS INVENTORY
------------- -----------
Balance at December 31, 1997....................... $ 412,000 $ 750,000
Provision........................................ 1,407,000 172,000
Write-offs and recoveries, net................... (1,463,000) (366,000)
----------- ----------
Balance at December 31, 1998....................... 356,000 556,000
Provision........................................ 2,678,000 1,052,000
Write-offs and recoveries, net................... (2,045,000) (617,000)
----------- ----------
Balance at December 31, 1999....................... 989,000 991,000
Provision........................................ 6,285,000 583,000
Write-offs and recoveries, net................... (2,996,000) 2,200,000
----------- ----------
Balance at December 31, 2000....................... $ 4,278,000 $3,774,000
=========== ==========
All other schedules are omitted because they are not applicable or not
required or because the required information is shown in the Consolidated
Financial Statements of DonJoy, LLC or the notes thereto.
ITEM 22. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrants pursuant to the Corporation Law, the Certificate of Incorporation
and By-laws, or otherwise, the Registrants have been advised that in the opinion
of the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrants of expenses incurred or paid by a director,
officer or controlling person of the Registrants in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Registrants will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against
II-6
273
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
The undersigned Registrants hereby undertake:
1. To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement;
(a) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(b) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in the volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement; and
(c) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement;
2. That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to be a
new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof;
3. To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering; and
4. That, for the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at the
time shall be deemed to be the initial bona fide offering thereof.
The undersigned Registrants hereby undertake to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11 or 13 of this form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through the
date of responding to the request.
II-7
274
The undersigned Registrants hereby undertake to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
II-8
275
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1933, the
Registrant has duly caused this Post-Effective Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, on the 7th day of May, 2001.
DJ ORTHOPEDICS, LLC
By: /s/ LESLIE H. CROSS
-----------------------------------
Leslie H. Cross
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1933, this
Post-Effective Amendment No. 2 to the Registration Statement has been signed on
the 7th day of May, 2001, by the following persons on behalf of the registrant
and in the capacities indicated.
SIGNATURE TITLE
- --------- -----
/s/ LESLIE H. CROSS President, Chief Executive Officer and
- ------------------------------------------ Manager (Principal Executive Officer)
Leslie H. Cross
* Senior Vice President, Chief Financial
- ------------------------------------------ Officer and Secretary (Principal Financial
Cyril Talbot III and Accounting Officer)
* Manager
- ------------------------------------------
Charles T. Orsatti
* Manager
- ------------------------------------------
Mitchell J. Blutt, M.D.
* Manager
- ------------------------------------------
Damion E. Wicker, M.D.
* Manager
- ------------------------------------------
W. Brett Ingersoll
* Manager
- ------------------------------------------
Ivan R. Sabel
* Manager
- ------------------------------------------
Kirby L. Cramer
*By: /s/ LESLIE H. CROSS
- -----------------------------------------
Attorney-in-Fact
II-9
276
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1933, the
Registrant has duly caused this Post-Effective Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, on the 7th day of May, 2001.
DJ ORTHOPEDICS CAPITAL CORPORATION
By: /s/ LESLIE H. CROSS
-----------------------------------
Leslie H. Cross
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1933, this
Post-Effective Amendment No. 2 to the Registration Statement has been signed on
the 7th day of May, 2001, by the following persons on behalf of the registrant
and in the capacities indicated.
SIGNATURE TITLE
- --------- -----
/s/ LESLIE H. CROSS President, Chief Executive Officer and
- ------------------------------------------ Manager (Principal Executive Officer)
Leslie H. Cross
* Senior Vice President, Chief Financial
- ------------------------------------------ Officer and Secretary (Principal Financial
Cyril Talbot III and Accounting Officer)
* Manager
- ------------------------------------------
Charles T. Orsatti
* Manager
- ------------------------------------------
Mitchell J. Blutt, M.D.
* Manager
- ------------------------------------------
Damion E. Wicker, M.D.
* Manager
- ------------------------------------------
W. Brett Ingersoll
* Manager
- ------------------------------------------
Ivan R. Sabel
* Manager
- ------------------------------------------
Kirby L. Cramer
*By: /s/ LESLIE H. CROSS
- -----------------------------------------
Attorney-in-Fact
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277
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1933, the
Registrant has duly caused this Post-Effective Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, on the 7th day of May, 2001.
DONJOY, L.L.C.
By: /s/ LESLIE H. CROSS
-----------------------------------
Leslie H. Cross
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1933, this
Post-Effective Amendment No. 2 to the Registration Statement has been signed on
the 7th day of May, 2001, by the following persons on behalf of the registrant
and in the capacities indicated.
SIGNATURE TITLE
- --------- -----
/s/ LESLIE H. CROSS President, Chief Executive Officer and
- ------------------------------------------ Manager (Principal Executive Officer)
Leslie H. Cross
* Senior Vice President, Chief Financial
- ------------------------------------------ Officer and Secretary (Principal Financial
Cyril Talbot III and Accounting Officer)
* Manager
- ------------------------------------------
Charles T. Orsatti
* Manager
- ------------------------------------------
Mitchell J. Blutt, M.D.
* Manager
- ------------------------------------------
Damion E. Wicker, M.D.
* Manager
- ------------------------------------------
W. Brett Ingersoll
* Manager
- ------------------------------------------
Ivan R. Sabel
* Manager
- ------------------------------------------
Kirby L. Cramer
*By: /s/ LESLIE H. CROSS
- -----------------------------------------
Attorney-in-Fact
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INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
- ------- -------
3.1 Amended and Restated Operating Agreement of dj Orthopedics,
LLC
3.2 Third Amended and Restated Operating Agreement dated as of
July 7, 2000 of DonJoy, L.L.C. (Incorporated by reference to
Exhibit 3.1 to DonJoy's report on Form 8-K dated July 21,
2000)
3.3 Certificate of Amendment to Certificate of Incorporation of
DJ Orthopedics Capital Corporation
3.4 By-laws of dj Orthopedics, LLC
3.5 By-laws of DonJoy, LLC
3.6 By-laws of DJ Orthopedics Capital Corporation
4.1 Indenture dated as of June 30, 1999 among the Issuers,
DonJoy and The Bank of New York, as Trustee
4.2 Form of New Note (included as Exhibit B to Exhibit 4.1)
4.3 Exchange and Registration Rights Agreement dated as of June
30, 1999 among the Issuers, DonJoy and Smith & Nephew
5.1 Opinion of O'Sullivan Graev & Karabell, LLP
10.1 Recapitalization Agreement dated as of April 29, 1999 among
CDP, DonJoy and Smith & Nephew
10.2 Group Research Centre Technology Agreement dated as of June
30, 1999 between DonJoy and Smith & Nephew
10.3 Supply Agreement dated as of June 30, 1999 between DonJoy
and Smith & Nephew
10.4 Transition Services Agreement dated as of June 30, 1999
between DonJoy and Smith & Nephew
10.4A First Amendment to Transition Services Agreement dated as of
December 21, 1999 between DonJoy and Smith & Nephew.
(Incorporated by reference to Exhibit 10.29 to the Annual
Report from Form 10-K for the fiscal year ended December 31,
1999)
10.5 Distribution Agreement dated as of June 30, 1999 between
DonJoy, Smith & Nephew and the affiliates of Smith & Nephew
listed on Schedule I thereto
10.6 CERF Laboratories Agreement dated as of June 30, 1999
between DonJoy and Smith & Nephew
10.7 Subleases dated as of June 30, 1999 between the dj Ortho and
Smith & Nephew
10.8 Guaranties dated as of June 30, 1999 executed by DonJoy
10.9 Preferred Unit Purchase Agreement dated as of June 30, 1999
among DonJoy, J.P. Morgan Partners (23A SBIC), L.L.C.
(formerly CB Capital Investors, L.L.C.) and First Union
Investors
279
EXHIBIT
NUMBER EXHIBIT
- ------- -------
10.10 Members' Agreement dated as of June 30, 1999 among DonJoy,
CDP, J.P. Morgan Partners (23A SBIC), L.L.C. (formerly CB
Capital Investors, L.L.C.), First Union Investors, Smith &
Nephew and the Management Members
10.11 Credit Agreement dated as of June 30, 1999 among the
Issuers, DonJoy, the Lenders party thereto and First Union
National Bank, as Administrative Agent
10.11 A Agreement dated as of July 13, 2000 among DonJoy, L.L.C., DJ
Orthopedics, L.L.C., the Lenders under that certain Credit
Agreement dated as of June 30, 1999, as amended, First Union
National Bank, as administrative agent, and The Chase
Manhattan Bank, as syndication agent. (Incorporated by
reference to Exhibit 10.3 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.12 Indemnity, Subrogation and Contribution Agreement dated as
of June 30, 1999 among dj Ortho, J.P. Morgan Partners (23A
SBIC), L.L.C. (formerly CB Capital Investors, L.L.C.), DJ
Capital Investors L.L.C. and First Union National Bank, as
Collateral Agent
10.13 Parent Guarantee Agreement dated as of June 30, 1999 between
DonJoy and First Union National Bank, as Collateral Agent
10.14 Subsidiary Guarantee Agreement dated as of June 30, 1999
between DJ Capital and First Union National Bank, as
Collateral Agent
10.15 Pledge Agreement dated as of June 30, 1999 among dj Ortho,
DonJoy and First Union National Bank, as Collateral Agent
10.16 Security Agreement dated as of June 30, 1999 among dj Ortho,
DonJoy, J.P. Morgan Partners (23A SBIC), L.L.C. (formerly CB
Capital Investors, L.L.C), DJ Capital Investors, L.L.C. and
First Union National Bank, as Collateral Agent
10.17 Leasehold Deed of Trust, Security Agreement and Assignment
of Leases and Rents dated as of June 30, 1999 by dj Ortho,
as grantor, to First American Title Insurance Company, as
trustee
10.18 Employment Agreement dated as of June 30, 1999 between dj
Ortho and Leslie H. Cross
10.19 Employment Agreement dated as of June 30, 1999 between dj
Ortho and Cyril Talbot III
10.20 Employment Agreement dated as of June 30, 1999 between dj
Ortho and Michael R. McBrayer
10.21 Second Amended and Restated 1999 Option Plan of DonJoy dated
August 18, 2000
10.22 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Les Cross
10.23 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Cy Talbot
280
EXHIBIT
NUMBER EXHIBIT
- ------- -------
10.24 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Michael McBrayer
10.25 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Chuck Bastyr
10.26 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Peter Bray
10.27 Retention Agreement dated December 14, 1998 between Smith &
Nephew and Kent Bachman (Incorporated by reference to
Exhibit 10.27 to the Annual Report on Form 10-K for the
fiscal year ended December 31, 1999)
10.28 Employment and Separation Agreement dated as of October 25,
1999 between Chuck Bastyr and dj Orthopedics, LLC
(Incorporated by reference to Exhibit 10.28 to the Annual
Report on Form 10-K for the fiscal year ended December 31,
1999)
10.29 Asset Purchase Agreement dated as of July 7, 2000 among
DePuy Orthopaedic Technology, Inc., dj Orthopedics, L.L.C.,
and DonJoy L.L.C. (Incorporated by reference to Exhibit 2.1
to DonJoy's report on Form 8-K dated July 21, 2000)
10.30 Preferred Unit Purchase Agreement dated as of July 7, 2000,
among DonJoy, L.L.C., and J.P. Morgan Partners (23A SBIC),
LLC (formerly CB Capital Investors, L.L.C.), First Union
Capital Partners, L.L.C., DJC, Inc., TCW/Crescent Mezzanine
Trust II, and TCW Leveraged Income Trust II, L.P.
(Incorporated by reference to Exhibit 4.1 to DonJoy's report
on Form 8-K dated July 21, 2000)
10.31 Common Unit Purchase Agreement dated as of July 7, 2000,
among DonJoy, L.L.C., and Chase DJ Partners, L.L.C., Leslie
H. Cross & Deborah L. Cross Family Trust, Michael R.
McBrayer, and Cyril Talbot III, (Incorporated by reference
to Exhibit 4.2 to DonJoy's report on Form 8-K dated July 21,
2000)
10.32 Secured Promissory Note dated as of July 7, 2000 between the
Leslie H. Cross & Deborah L. Cross Family Trust and Leslie
H. Cross and DonJoy, L.L.C. (Incorporated by reference to
Exhibit 4.3 to DonJoy's report on Form 8-K dated July 21,
2000)
10.33 Secured Promissory Note dated as of July 7, 2000 between
Cyril Talbot III and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.4 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.34 Secured Promissory Note dated as of July 7, 2000 between
Michael R. McBrayer and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.5 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.35 Second Amended and Restated Pledge Agreement dated as of
July 7, 2000, among Leslie H. Cross, Leslie H. Cross &
Deborah L. Cross Family Trust, and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.6 to DonJoy's report
on Form 8-K dated July 21, 2000)
281
EXHIBIT
NUMBER EXHIBIT
- ------- -------
10.36 Second Amended and Restated Pledge Agreement dated as of
July 7, 2000, Cyril Talbot III, and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.7 to DonJoy's report
on Form 8-K dated July 21, 2000)
10.37 Second Amended and Restated Pledge Agreement dated as of
July 7, 2000, between Michael R. McBrayer and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.8 to DonJoy's report
on Form 8-K dated July 21, 2000)
10.38 Unit Purchase Agreement dated as of June 28, 2000, among
Smith & Nephew Disposal, Inc. and Chase DJ Partners, L.L.C.,
Leslie H. Cross & Deborah L. Cross Family trust, Michael R.
McBrayer, and Cyril Talbot III. (Incorporated by reference
to Exhibit 4.9 to DonJoy's report on Form 8-K dated July 21,
2000)
10.39 Amended and Restated Secured Promissory Note dated as of
June 28, 2000 between Michael R. McBrayer and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.10 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.40 Amended and Restated Secured Promissory Note dated as of
June 28, 2000 among Leslie H. Cross & Deborah L. Cross
Family Trust, Leslie H. Cross and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.11 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.41 Amended and Restated Secured Promissory Note dated as of
June 28, 2000 between Cyril Talbot III and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.12 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.42 Secured Promissory Note dated as of June 28, 2000 among
Leslie H. Cross & Deborah L. Cross Family Trust, Leslie H.
Cross and DonJoy, L.L.C. (Incorporated by reference to
Exhibit 4.13 to DonJoy's report on Form 8-K dated July 21,
2000)
10.43 Secured Promissory Note dated as of June 28, 2000 between
Cyril Talbot III and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.14 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.44 Secured Promissory Note dated as of June 28, 2000 between
Michael R. McBrayer and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.15 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.45 Amended and Restated Pledge Agreement dated as of June 28,
2000 among Leslie H. Cross, Leslie H. Cross & Deborah L.
Cross Family Trust, and DonJoy, L.L.C. (Incorporated by
reference to Exhibit 4.16 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.46 Amended and Restated Pledge Agreement dated as of June 28,
2000 between Cyril Talbot III and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.17 to DonJoy's
report on Form 8-K dated July 21, 2000)
10.47 Amended and Restated Pledge Agreement dated as of June 28,
2000 between Michael R. McBrayer and DonJoy, L.L.C.
(Incorporated by reference to Exhibit 4.18 to DonJoy's
report on Form 8-K dated July 21, 2000)
282
EXHIBIT
NUMBER EXHIBIT
- ------- -------
10.48 Amendment No. 1 dated as of May 25, 2000 to the Credit
Agreement dated as of June 30, 1999 (Incorporated by
reference to Exhibit 10.1 to DonJoy's report on Form 8-K
dated July 21, 2000)
10.49 Transition Services Agreement dated as of July 7, 2000 among
DePuy Orthopaedic Technology, Inc., DonJoy, L.L.C., and dj
Orthopedics, L.L.C. (Incorporated by reference to Exhibit
10.2 to DonJoy's report on Form 8-K dated July 21, 2000)
12.1* Statement re: computation of ratios of earning to fixed
charges
21.1* Subsidiaries of the Registrants
23.1 Consent of O'Sullivan Graev & Karabell, LLP (included on
Exhibit 5.1)
23.2* Consent of Ernst & Young LLP
23.3* Consent of PricewaterhouseCoopers LLP
24.1 Powers of Attorney (other than Kirby L. Cramer and W. Brett
Ingersoll) (included on the signature page)
24.2 Power of Attorney of Kirby L. Cramer
24.3* Power of Attorney of W. Brett Ingersoll
25.1 Statement of Eligibility and Qualification under the Trust
Indenture Act of 1939 of The Bank of New York as Trustee
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(*) Filed herewith