<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------------------------------------------------
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _______________.
Commission File Number 333-86835
--------------------------------------------------------------------------------
DJ ORTHOPEDICS, LLC
(Exact name of registrant as specified in charter)
<TABLE>
<S> <C> <C>
DELAWARE 3842 52-2165554
------------------------------- ---------------------------- -------------------------------
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification
incorporation or organization) Classification Code Number) Number)
</TABLE>
DJ ORTHOPEDICS CAPITAL CORPORATION
(Exact name of registrant as specified in charter)
<TABLE>
<S> <C> <C>
DELAWARE 3842 52-2157537
------------------------------- ---------------------------- -------------------------------
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification
incorporation or organization) Classification Code Number) Number)
</TABLE>
DONJOY, L.L.C.
(Exact name of registrant as specified in charter)
<TABLE>
<S> <C> <C>
DELAWARE 3842 33-0848317
------------------------------- ---------------------------- -------------------------------
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification
incorporation or organization) Classification Code Number) Number)
</TABLE>
2985 Scott Street
Vista, California 92083
(800) 336-5690
(Address, including zip code, and telephone number, including area code, of
registrants' principal executive offices)
Indicate by check mark whether each registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
DJ ORTHOPEDICS, LLC Yes [X] No [ ]
DJ ORTHOPEDICS CAPITAL CORPORATION Yes [X] No [ ]
DONJOY, L.L.C. Yes [X] No [ ]
================================================================================
<PAGE> 2
DJ ORTHOPEDICS, LLC
DJ ORTHOPEDICS CAPITAL CORPORATION
DONJOY, L.L.C.
FORM 10-Q INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
EXPLANATORY NOTE 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2000 (unaudited) and December 31, 1999 3
Consolidated Statements of Income for the three and nine months ended
September 30, 2000 (unaudited) and October 2, 1999 (unaudited) 4
Consolidated Statements of Changes in Members' Equity (Deficit) for the year
ended December 31, 1999 and the nine months ended September 30, 2000 (unaudited) 5
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2000 (unaudited) and October 2, 1999 (unaudited) 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
</TABLE>
EXPLANATORY NOTE
This integrated Form 10-Q is filed pursuant to the Securities Exchange Act of
1934, as amended, for each of DonJoy, L.L.C. ("DonJoy"), a Delaware limited
liability company, dj Orthopedics, LLC ("dj Ortho"), a Delaware limited
liability company and a wholly-owned subsidiary of DonJoy, and DJ Orthopedics
Capital Corporation ("DJ Capital"), a Delaware corporation and a wholly-owned
subsidiary of dj Ortho, (collectively, "the Company"). DJ Capital was formed
solely to act as a co-issuer (and as a joint and several obligor) with dj Ortho
of $100,000,000 aggregate principal amount at maturity of 12 5/8% Senior
Subordinated Notes (the "Notes") due 2009. DJ Capital does not hold any assets
or other properties or conduct any business. No separate financial information
for DJ Capital has been provided herein because management believes such
information would not be meaningful because DJ Capital has no financial or other
data to report in response to the requirements of Form 10-Q and thus, there is
no separate information regarding DJ Capital to report herein. DonJoy is a
guarantor of the Notes and of dj Ortho's bank borrowings and has no material
assets or operations other than its ownership of 100% of dj Ortho's equity
interests. As a result, the consolidated financial position and results of
operations of DonJoy are substantially the same as dj Ortho's.
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
DONJOY, L.L.C.
CONSOLIDATED BALANCE SHEETS
(in thousands, except unit information)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ...................................................... $ 3,544 $ 5,927
Accounts receivable, net of allowance for doubtful
accounts of $2,567 and $989 at September 30, 2000 and
December 31, 1999, respectively ............................................. 31,121 20,056
Accounts receivable, related parties ........................................... -- 1,350
Inventories, net ............................................................... 16,976 13,664
Other current assets ........................................................... 2,139 917
--------- ---------
Total current assets ............................................................... 53,780 41,914
Property, plant and equipment, net ................................................. 11,431 7,297
Intangible assets, net ............................................................. 75,763 33,195
Debt issuance costs, net ........................................................... 6,820 6,875
Other assets ....................................................................... 817 135
--------- ---------
Total assets ....................................................................... $ 148,611 $ 89,416
========= =========
LIABILITIES AND MEMBERS' DEFICIT
Current liabilities:
Accounts payable ............................................................... $ 6,700 $ 6,242
Accounts payable, related parties .............................................. -- 169
Accrued compensation ........................................................... 2,167 2,443
Accrued commissions ............................................................ 1,384 954
Long-term debt, current portion ................................................ 1,274 500
Accrued interest ............................................................... 3,804 526
Other accrued liabilities ...................................................... 8,181 3,667
--------- ---------
Total current liabilities .......................................................... 23,510 14,501
12 5/8% Senior Subordinated Notes .................................................. 98,209 98,055
Long-term debt, less current portion ............................................... 50,007 14,750
Redeemable Preferred Units; 100,000 units authorized, 44,405 units and 40,184
issued and outstanding at September 30, 2000 and December 31, 1999,
respectively; liquidation preference $42,333 and $35,368 at September 30,
2000 and December 31, 1999, respectively ..................................... 40,086 32,539
Members' deficit:
Common units; 3,000,000 units authorized, 793,890 and 718,000 units issued
and outstanding at September 30, 2000 and December 31, 1999,
respectively .................................................................. 74,754 66,521
Notes receivable from Management members ....................................... (1,772) (1,400)
Accumulated deficit ............................................................ (136,183) (135,550)
--------- ---------
Total members' deficit ............................................................. (63,201) (70,429)
--------- ---------
Total liabilities and members' deficit ............................................. $ 148,611 $ 89,416
========= =========
</TABLE>
See accompanying notes.
3
<PAGE> 4
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, in thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues:
Third parties .............................. $ 39,605 $ 28,527 $ 98,596 $ 77,538
Related parties ............................ -- 1,694 2,651 6,941
--------- --------- --------- ---------
Total net revenues ............................... 39,605 30,221 101,247 84,479
Cost of goods sold ............................... 17,544 12,851 42,299 38,098
--------- --------- --------- ---------
Gross profit ..................................... 22,061 17,370 58,948 46,381
Operating expenses:
Sales and marketing ........................ 11,069 7,186 26,563 20,557
General and administrative ................. 5,495 4,088 14,529 12,861
Research and development ................... 514 461 1,678 1,509
Merger and integration costs ............... 400 -- 400 --
--------- --------- --------- ---------
Total operating expenses ......................... 17,478 11,735 43,170 34,927
--------- --------- --------- ---------
Income from operations ........................... 4,583 5,635 15,778 11,454
Interest expense ................................. (4,636) (3,779) (12,245) (3,779)
Interest income .................................. 95 45 348 45
--------- --------- --------- ---------
Income before income taxes ....................... 42 1,901 3,881 7,720
Provision for income taxes ....................... -- -- -- 2,387
--------- --------- --------- ---------
Net income and comprehensive net
income ..................................... $ 42 $ 1,901 $ 3,881 $ 5,333
Less: Preferred unit dividends and accretion
of preferred unit fees ..................... (1,428) (1,196) (3,908) (1,196)
--------- --------- --------- ---------
Net income (loss) available to members ........... $ (1,386) $ 705 $ (27) $ 4,137
========= ========= ========= =========
</TABLE>
See accompanying notes.
4
<PAGE> 5
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' EQUITY (DEFICIT)
(in thousands, except unit information)
<TABLE>
<CAPTION>
NOTES
RECEIVABLE FROM
COMMON UNITS MANAGEMENT
UNITS AMOUNT MEMBERS
---------- ---------- ---------------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998 ....................... -- $ -- $ --
Capital contribution by Smith & Nephew, Inc.
in connection with the recapitalization ......... 2,054,000 64,117 --
Issuance of common units at $100 per unit,
net of transaction fees of $1,563 ............... 645,500 62,987 --
Purchase of common units from Smith &
Nephew, Inc. .................................... (2,000,000) (62,433) --
Issuance of common units at $100 per unit,
in exchange for cash and notes receivable ....... 18,500 1,850 (1,400)
Preferred unit dividends and accretion
of preferred unit fees .......................... -- -- --
Net income (excluding $196 allocated to
preferred unit holders) ......................... -- -- --
---------- ---------- ----------
BALANCE AT DECEMBER 31, 1999 ....................... 718,000 66,521 (1,400)
Issuance of common units, in exchange for
cash and notes receivable (unaudited) ........... 75,890 8,272 (174)
Note receivable issued by Management for purchase of
common units (unaudited) ........................... -- -- (124)
Transfer of interest receivable to
note receivable (unaudited) ..................... -- -- (74)
Transaction fees in connection with the
recapitalization (unaudited) .................... -- (39) --
Tax distributions to preferred unit holders
(unaudited) ..................................... -- -- --
Preferred unit dividends and accretion
of preferred unit fees (unaudited) .............. -- -- --
Net income (excluding $206 allocated to
preferred unit holders) (unaudited) ............. -- -- --
---------- ---------- ----------
BALANCE AT SEPTEMBER 30, 2000 (UNAUDITED) .......... 793,890 $ 74,754 $ (1,772)
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
RETAINED TOTAL MEMBERS'
EARNINGS(DEFICIT) EQUITY(DEFICIT)
----------------- ---------------
<S> <C> <C>
BALANCE AT DECEMBER 31, 1998 ....................... $ 12,832 $ 12,832
Capital contribution by Smith & Nephew, Inc.
in connection with the recapitalization ......... (16,264) 47,853
Issuance of common units at $100 per unit,
net of transaction fees of $1,563 ............... -- 62,987
Purchase of common units from Smith &
Nephew, Inc. .................................... (136,707) (199,140)
Issuance of common units at $100 per unit,
in exchange for cash and notes receivable ....... -- 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 ....................... (135,550) (70,429)
Issuance of common units, in exchange for
cash and notes receivable (unaudited) ........... -- 8,098
Note receivable issued by Management for purchase of
common units (unaudited) ........................... -- (124)
Transfer of interest receivable to
note receivable (unaudited) ..................... -- (74)
Transaction fees in connection with the
recapitalization (unaudited) .................... -- (39)
Tax distributions to preferred unit holders
(unaudited) ..................................... (400) (400)
Preferred unit dividends and accretion
of preferred unit fees (unaudited) .............. (3,908) (3,908)
Net income (excluding $206 allocated to
preferred unit holders) (unaudited) ............. 3,675 3,675
---------- ----------
BALANCE AT SEPTEMBER 30, 2000 (UNAUDITED) .......... $ (136,183) $ (63,201)
========== ==========
</TABLE>
See accompanying notes.
5
<PAGE> 6
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, October 2,
2000 1999
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income ...................................................................... $ 3,881 $ 5,333
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ............................................... 4,627 3,691
Amortization of debt issuance costs and discount on Senior
Subordinated Notes ...................................................... 800 252
Step-up in inventory ........................................................ 268 --
Changes in operating assets and liabilities:
Accounts receivable ....................................................... (9,715) (1,519)
Inventories ............................................................... (1,042) 93
Other current assets ...................................................... (1,296) 90
Accounts payable .......................................................... 289 (1,991)
Accrued compensation ...................................................... (276) 689
Accrued commissions ....................................................... 430 (120)
Accrued interest .......................................................... 3,278 3,156
Intercompany activity ..................................................... -- 3,239
Restructuring reserve ..................................................... (281) (339)
Merger and integration costs .............................................. 400 --
Other accrued liabilities ................................................. 4,395 2,338
--------- ---------
Net cash provided by operating activities ....................................... 5,758 14,912
INVESTING ACTIVITIES
Purchases of property, plant and equipment ...................................... (4,635) (950)
Increase in intangible assets ................................................... -- (2,204)
Investment in Orthotech ......................................................... (49,686) --
Other assets .................................................................... (230) (66)
--------- ---------
Net cash used in investing activities ........................................... (54,551) (3,220)
FINANCING ACTIVITIES
Net proceeds from Senior Subordinated Notes ..................................... -- 97,953
Proceeds from long term debt .................................................... 36,600 15,500
Repayment of long term debt ..................................................... (569) (125)
Distributions ................................................................... (400) --
Debt issuance costs ............................................................. (589) (7,169)
Purchase of common units from Smith & Nephew (the "Former Parent") .............. -- (199,756)
Net proceeds from issuance of common units ...................................... 8,098 65,000
Net proceeds from issuance of preferred units ................................... 3,433 30,000
Note receivable issued for purchase of common units ............................. (124) --
Transaction fees in connection with the recapitalization ........................ (39) (1,517)
Intercompany obligations ........................................................ -- (5,347)
--------- ---------
Net cash provided by (used in) financing activities ............................. 46,410 (5,461)
Net increase (decrease) in cash ................................................. (2,383) 6,231
Cash at beginning of period ..................................................... 5,927 809
--------- ---------
Cash at end of period ........................................................... $ 3,544 $ 7,040
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid ............................................................... $ 8,167 $ 368
========= =========
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Capital contribution ........................................................ $ -- $ 48,323
========= =========
Dividends and accretion of preferred unit fee related to
redeemable preferred units ............................................... $ 3,908 $ 1,196
========= =========
</TABLE>
See accompanying notes.
6
<PAGE> 7
DONJOY, L.L.C.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements for the three and
nine months ended September 30, 2000 have been prepared in accordance with
generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
These consolidated financial statements should be read in conjunction with the
audited consolidated financial statements of DonJoy, L.L.C. and footnotes
thereto included in the Annual Report on Form 10-K for the year ended December
31, 1999. The accompanying consolidated financial statements at September 30,
2000 and for the three and nine months ended September 30, 2000 and October 2,
1999 are unaudited and include all adjustments (consisting of normal recurring
accruals) which, in the opinion of management, are necessary for a fair
statement of the financial position, operating results and cash flows for the
interim date and periods presented.
INTERIM ACCOUNTING PERIODS
The Company's fiscal year ends on December 31. Each quarter consists of one
five-week and two four-week periods. The first and fourth quarters may have more
or less working days from year to year based on what day of the week holidays
fall on. Results for the interim periods ended September 30, 2000 are not
necessarily indicative of the results to be achieved for the entire year or
future periods. The three month period ended September 30, 2000 contained three
less business days than the same period in 1999, resulting in the Company
recognizing approximately $1.4 million less in revenues in the three month
period ended September 30, 2000 as compared to the same period in 1999. The nine
month period ended September 30, 2000 contained the same number of business days
as the comparable period in 1999.
RECAPITALIZATION
On June 30, 1999, the Company consummated a $215.3 million recapitalization (the
"recapitalization"). Under the recapitalization, new investors, including Chase
DJ Partners, L.L.C. ("CDP") and affiliates of CDP, invested new capital of $94.6
million in the Company. 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 the
Company. The Company's former sole equity holder (the "Former Parent") retained
54,000 common units, which represented approximately 7.5% of total units in the
Company then outstanding. In connection with the recapitalization transactions,
the Company established dj Orthopedics, LLC ("dj Ortho") and DJ Orthopedics
Capital Corporation ("DJ Capital"). The Company sold all of its net assets 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
the Company. dj Ortho is a wholly-owned subsidiary of the Company and represents
substantially all of the revenues and net income of the Company. 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
5).
The proceeds of the equity investment together with $113.5 million of proceeds
from debt financing were used for approximately $199.1 million of consideration
paid to redeem a portion of members' equity from the Company's Former Parent,
and approximately $8.8 million of fees and costs paid in association with the
recapitalization.
7
<PAGE> 8
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2000, the Emerging Issues Task Force ("EITF") reached a tentative
consensus on Issue 00-10, "Accounting for Shipping and Handling Fees and Costs."
The Issue addresses, in the context of a sale transaction for goods, how the
seller should classify amounts billed and incurred for shipping and handling in
the income statement. It has no impact on net income. In July 2000, the EITF
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; however, the EITF did not reach a consensus
on how shipping and handling costs should be classified. The EITF indicated that
the consensus must be followed even by those entities that believe that they
are, in substance, acting as an agent in providing the shipping and handling
services and desire to record revenue net. In September 2000, the EITF reached a
consensus that the classification of shipping and handling costs is an
accounting policy decision that should be disclosed pursuant to APB 22. A
company may adopt a policy of including shipping and handling costs in costs of
goods sold. If shipping and handling costs are significant and are not included
in cost of goods sold, a company should disclose both the amount of such costs
and which line item on the income statement includes that amount. Additionally,
the EITF indicated that a company cannot net the shipping and handling costs
against the shipping and handling revenues in the financial statements. The
Company plans to implement Issue 00-10 in the fourth quarter of 2000 at which
time revenues will be increased by the amounts billed to customers but
previously offset against shipping and handling costs which are part of sales
and marketing expenses. While the impact of this is expected to increase
revenues and increase selling and marketing expenses, the ultimate effect has
not been determined for the actual amounts that will be reclassified upon
implementation of Issue 00-10.
RECLASSIFICATIONS
Certain amounts in prior periods have been reclassified to conform with current
period presentation.
2. ACQUISITION OF DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
On July 7, 2000, DonJoy and its wholly-owned subsidiary, dj Ortho, 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 develops, manufactures, and markets 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.
Orthotech also has an inventory management and billing program that will
complement the Company's current OfficeCare program.
Approximately $50.1 million in cash, subject to a purchase price adjustment
based on the actual value of Orthotech's inventory on the closing date, 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 $8.3 million of common units to CDP and the Management Members
for $8.1 million (excluding management notes receivable of $0.2 million),
- The sale of $3.6 million of Redeemable Preferred Units for $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
- $2.0 million from available cash.
8
<PAGE> 9
The sources and uses of funds for the Orthotech Acquisition are presented in the
following table:
<TABLE>
<CAPTION>
Amount
-----------
(Dollars in
millions)
<S> <C>
SOURCES
Cash $ 2.0
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
-----
$50.3
=====
USES
Cash to DePuy Orthopedic $47.1
Debt issuance costs 0.4
Transaction fees and costs 2.6
Management promissory notes 0.2
-----
$50.3
=====
</TABLE>
The Orthotech Acquisition has been accounted for using the purchase method of
accounting whereby the purchase price has been preliminary allocated to the
acquired tangible and intangible assets based on their estimated fair market
values as follows:
<TABLE>
<S> <C> <C>
Inventories $ 2,538
Equipment and furniture 1,250
Other assets held for sale 451
Intangibles:
Goodwill $39,947
Customer list 5,000
Covenant not to compete 500 45,447
------- -------
Net assets acquired $49,686
=======
</TABLE>
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 for the nine months ended September 30, 2000 and October
2, 1999 would have been as follows (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended
September 30, October 2,
2000 1999
------------- ----------
<S> <C> <C>
Net revenues $125,175 $119,643
Net income $ 2,441 $ 4,488
</TABLE>
9
<PAGE> 10
3. FINANCIAL STATEMENT INFORMATION
INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Raw materials .................................... $ 8,322 $ 6,392
Work-in-progress ................................. 1,370 1,446
Finished goods ................................... 12,408 6,817
-------- --------
22,100 14,655
Less reserve for excess and obsolete ............. (5,124) (991)
-------- --------
$ 16,976 $ 13,664
======== ========
</TABLE>
The reserve for excess and obsolete inventory as of September 30, 2000 includes
$3.9 million relating to the inventory acquired in the Orthotech Acquisition.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Buildings and leasehold improvements ............. $ 3,687 $ 3,577
Office furniture, fixtures, equipment and other .. 18,527 15,817
Construction in progress ......................... 4,403 1,297
-------- --------
26,617 20,691
Less accumulated depreciation and amortization ... (15,186) (13,394)
-------- --------
$ 11,431 $ 7,297
======== ========
</TABLE>
INTANGIBLE ASSETS
Intangible assets arose primarily from the initial acquisition of the Company in
1987, 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. Intangible
assets consist of the following (in thousands):
<TABLE>
<CAPTION>
Useful Life September 30, December 31,
(in years) 2000 1999
----------- ------------ ------------
<S> <C> <C> <C>
Goodwill .......................... 20 $ 64,641 $ 24,742
Patented technology ............... 5-20 14,437 14,437
Customer base ..................... 15-20 16,600 11,600
Licensing agreements .............. 5 2,000 2,000
Assembled workforce ............... 3-5 250 250
Other ............................. 5-20 899 399
-------- --------
98,827 53,428
Less accumulated amortization ..... (23,064) (20,233)
-------- --------
$ 75,763 $ 33,195
======== ========
</TABLE>
10
<PAGE> 11
4. 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 braces. 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 the quantitative thresholds for determining reportable segments.
Information regarding industry segments is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- --------- ------------ ---------
<S> <C> <C> <C> <C>
Net revenues:
Rigid knee bracing .......................... $ 14,010 $ 12,507 $ 40,135 $ 36,365
Soft goods .................................. 15,274 10,959 35,869 29,597
--------- --------- --------- ---------
Net revenues for reportable segments ........ 29,284 23,466 76,004 65,962
Specialty and other orthopedic products ..... 10,321 6,755 25,243 18,517
--------- --------- --------- ---------
Total consolidated net revenues .................. $ 39,605 $ 30,221 $ 101,247 $ 84,479
========= ========= ========= =========
Gross profit:
Rigid knee bracing .......................... $ 9,747 $ 9,109 $ 28,474 $ 26,349
Soft goods .................................. 7,520 5,303 17,569 14,430
--------- --------- --------- ---------
Gross profit for reportable segments ........ 17,267 14,412 46,043 40,779
Specialty and other orthopedic products ..... 6,312 3,417 15,162 9,313
Brand royalties ............................. -- -- -- (1,817)
Other cost of goods sold .................... (1,518) (459) (2,257) (1,894)
--------- --------- --------- ---------
Total consolidated gross profit .................. $ 22,061 $ 17,370 $ 58,948 $ 46,381
========= ========= ========= =========
</TABLE>
The accounting policies of the reportable segments are the same as those
described in the basis of presentation. dj Ortho allocates resources and
evaluates the performance of segments based on gross profit. Intersegment sales
were not significant for any period.
For the nine months ended September 30, 2000 and October 2, 1999, dj Ortho had
no individual customer or distributor within a segment which accounted for 10%
or more of total revenues.
11
<PAGE> 12
Assets allocated in foreign countries were not significant. Net revenues to
customers, attributed to countries based on the location of the customer, were
as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
United States:
Third parties ..................... $ 35,968 $ 25,987 $ 87,179 $ 71,060
Related parties ................... -- 300 603 885
-------- -------- -------- --------
35,968 26,287 87,782 71,945
Europe:
Third parties ..................... 2,379 1,835 9,058 5,467
Related parties ................... -- 748 407 3,083
-------- -------- -------- --------
2,379 2,583 9,465 8,550
Other foreign countries:
Third parties ..................... 1,258 705 2,359 1,011
Related parties ................... -- 646 1,641 2,973
-------- -------- -------- --------
1,258 1,351 4,000 3,984
-------- -------- -------- --------
Total consolidated net revenues ........ $ 39,605 $ 30,221 $101,247 $ 84,479
======== ======== ======== ========
</TABLE>
dj Ortho does not allocate assets to reportable segments because all property
and equipment are shared by all segments of dj Ortho.
5. CONDENSED FINANCIAL DATA
As discussed in Note 1 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. Included in
non-current assets at September 30, 2000 is an intercompany payable to DonJoy,
L.L.C. of $34.1 million. The following condensed summarized financial
information of dj Ortho (the only issuer of the Notes with operations and
assets) is presented at September 30, 2000 and for the three and nine months
then ended, respectively:
<TABLE>
<CAPTION>
September 30, 2000
------------------
<S> <C>
Current assets ......................... $ 53,780
Non-current assets ..................... $128,911
Current liabilities .................... $ 23,510
Non-current liabilities:
Long-term debt ...................... $148,216
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 2000 September 30, 2000
------------------ ------------------
<S> <C> <C>
Net revenues .............. $ 39,605 $101,247
Gross profit .............. $ 22,061 $ 58,948
Net income (loss) ......... $ 13 $ 3,848
</TABLE>
dj Ortho and DJ Capital comprise all the direct and indirect subsidiaries of
DonJoy (other than inconsequential subsidiaries). Separate financial statements
of dj Ortho and DJ Capital are not included, and dj Ortho and DJ Capital are not
filing separate reports under the Exchange Act because management has determined
that they would not be material to investors. Although summarized information
would normally be provided for DJ Capital, as a co-issuer of the Notes, such
disclosure would not be meaningful given DJ Capital's lack of assets and
activities. The notes and the credit facility 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. At September 30, 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.
12
<PAGE> 13
6. PURCHASE OF COMMON UNITS
In accordance with a unit purchase agreement dated as of June 28, 2000, the
Former Parent sold its entire 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 certain 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 promissory notes. As a result of this transaction, dj Ortho no longer
reflects any intercompany transactions as of September 30, 2000 on the
consolidated balance sheets and statements of cash flows. The related party
revenue shown on the consolidated statements of income will continue to be
presented on a historical basis.
In connection with the unit purchase agreement, the Company 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 5.3% 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.
7. AMENDED CREDIT FACILITY
In connection with the Orthotech Acquisition, the Company amended its Credit
Agreement ("Amended Credit Agreement") with First Union National Bank ("First
Union") and the Chase Manhattan Bank ("Chase") and other lenders, pursuant to
which the Company may borrow up to $64.5 million consisting of a revolving
credit facility of up to $25.0 million (the "revolving credit facility") and
term loans in a principal amount of $39.5 million (the "term loans"). The first
term loan, in the amount of $15.5 million, was borrowed in connection with the
recapitalization and the second term loan, in the amount of $24 million, was
borrowed to finance the Orthotech Acquisition. As of September 30, 2000, the
Company has borrowed $12.6 million under the revolving credit facility,
primarily to consummate the Orthotech Acquisition. Borrowings under the terms
loans and the revolving credit facility bear interest at variable rates plus an
applicable margin.
In addition to paying interest on outstanding principal under the Amended Credit
Agreement, DonJoy 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.
The following table sets forth the principal payments on the term loans for the
three months ending December 31, 2000 through its maturity in 2005:
<TABLE>
<CAPTION>
Principal
Payment
---------
<S> <C>
2000 .......... $ 318
2001 .......... 1,274
2002 .......... 1,274
2003 .......... 1,274
2004 .......... 17,202
2005 .......... 17,339
-------
Total ......... $38,681
=======
</TABLE>
The Amended Credit Agreement and the indenture relating to the Company's 12 5/8%
Senior Subordinated Notes ("Indenture") contain certain restrictions on the
Company, including restrictions on its ability to incur indebtedness, pay
dividends, make investments, grant liens, sell its assets and engage in certain
other activities. Furthermore, the Amended Credit Agreement requires the Company
to maintain certain financial ratios. Indebtedness under the Amended Credit
Agreement is secured by substantially all of the assets of the Company,
including the Company's real and personal property, inventory, accounts
receivable, intellectual property and other intangibles.
Commencing with the year ended December 31, 1999, the Company is required to
make annual mandatory prepayments of the term loans under the Amended Credit
Agreement in an amount equal to 50% of excess cash flow (as defined in the
Amended Credit Agreement) (75% if the Company's leverage ratio exceeds a certain
level). 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, the Company or any of its subsidiaries and (b) 100% of the
net cash proceeds of certain asset sales or other dispositions of property by
DonJoy, the Company or any of its subsidiaries, in each case subject to certain
exceptions.
13
<PAGE> 14
8. COMMON AND PREFERRED UNITS
The Company is authorized to issue up to 3,000,000 common units and up to
100,000 preferred units. As of September 30, 2000, 793,890 common units and
44,405 preferred units were issued and outstanding, and 15% of the common units
on a fully diluted basis have been reserved for issuance to employees, directors
and independent consultants and contractors of the Company or any subsidiary
thereof pursuant to the 1999 Option Plan.
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 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).
To the extent permitted by restrictions contained in the Amended Credit
Agreement and the Indenture, the Company 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 the Company and its subsidiaries.
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. 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), the Redeemable Preferred Units will share ratably with the
common units in any distributions (including tax distributions and upon
liquidation) made by the Company in respect of common units (the Redeemable
Preferred Units Participating Interest).
The Redeemable Preferred Units are subject to mandatory redemption ten and
one-half years following the closing of the Company's June 30, 1999
recapitalization and may be redeemed at the Company'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 the Company to redeem their Redeemable
Preferred Units (including the Redeemable Preferred Units Participating
Interest). In addition, at any time following the sixth anniversary of the
closing of the recapitalization, holders will have the right, subject to certain
conditions, to require the Company to redeem their Redeemable Preferred Units
Participating Interest. Unless equity proceeds or other funds are available to
the Company for the purpose, the ability of the Company to make any of the
foregoing payments will be subject to receipt of distributions from the Company
in amounts sufficient to make such payments and such distributions will be
subject to the restrictions contained in the new credit facility and the
Indenture.
9. 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 will be
expensed during the fourth quarter. Such costs are estimated to be in a range of
approximately $0.4 million to $0.5 million.
14
<PAGE> 15
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
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 of 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 dj Ortho's. 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
activities.
On June 30 1999, DonJoy consummated a $215.3 million recapitalization. In
connection with the recapitalization transactions, the Company established dj
Ortho and DJ Capital. The Company sold all of its net assets to dj Ortho for
cash which was funded with the net proceeds of $100 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 (i) for approximately $199.1
million of consideration paid to redeem a portion of members' equity from the
Company's Former Parent, and (ii) approximately $8.8 million of costs and fees
paid in association with the recapitalization. As part of the recapitalization
agreement, immediately prior to the recapitalization, the Company's Former
Parent made a capital contribution in an amount equal to the Company's then
existing cash balance and canceled the 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 members' equity.
In accordance with a unit purchase agreement dated as of June 28, 2000, Smith &
Nephew, the Company's former parent, sold its entire 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
certain members of management purchased the remaining 1,505 units for a total
consideration of $0.2 million, which they financed by promissory notes and cash
issued to DonJoy.
On July 7, 2000, DonJoy and the Company 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 develops, manufactures,
and markets 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. The Orthotech business also has an
inventory management and billing program that will complement the Company's
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 $50.3 million. The Company purchased primarily
inventory, equipment and certain intellectual property. The Company was not
required to assume any liabilities existing prior to the closing date. The
purchase price in the Orthotech Acquisition is subject to an adjustment based
upon the actual value of the physical inventory of Orthotech as of closing. If
Orthotech's inventory as of closing is greater than the target inventory
established in the asset purchase agreement, the purchase price is increased. If
Orthotech's inventory as of closing is less than the target inventory, the
purchase price is decreased. The Company estimates that upon finalization of the
purchase price in the fourth quarter of 2000, there will be a reduction in the
purchase price of approximately $0.7 million.
The Orthotech Acquisition has been accounted for using the purchase method of
accounting whereby the total purchase price has been primarily allocated to
tangible and intangible assets acquired and liabilities assumed based on their
estimated fair market values. The Company is in the process of conducting an
independent valuation to determine the fair value of the assets acquired. Upon
completion of the independent valuation, adjustments to the preliminary
allocation may be required.
The following discussion should be read in conjunction with the Company's
historical consolidated financial statements and the related notes thereto and
the other financial data included in the Annual Report on Form 10-K for the year
ended December 31, 1999.
15
<PAGE> 16
SEGMENTS. The Company designs, manufactures and markets orthopedic recovery
products and complementary products. The Company's product lines include rigid
knee braces, soft goods and a portfolio of specialty and other orthopedic
products. 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 ("OA") braces, which provide relief of knee pain due to
osteoarthritis. 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's 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 4 of Notes to Unaudited Consolidated Financial
Statements.
The Company's products are marketed globally under the DonJoy and ProCare brand
names through several distribution channels. DonJoy brand product sales
represented approximately 61.1% and 69.1% of total net revenues in the three and
nine months ended September 30, 2000. The Company markets substantially all of
its rigid knee braces, approximately 79.6% of its specialty and other orthopedic
products and approximately 31.0% of its soft goods products under the DonJoy
brand name. ProCare brand product sales represented approximately 38.9% and
30.9% of total net revenues in the three and nine months ended September 30,
2000. The Company markets approximately 69.0% of its soft goods products,
approximately 20.4% of its specialty and other orthopedic products and a small
percentage of its rigid knee braces under the ProCare brand name. Since the
Orthotech Acquisition, the Company has begun to integrate the current Orthotech
brand name into the DonJoy and ProCare brand names.
DOMESTIC SALES. In the United States, the Company's DonJoy brand products are
marketed to orthopedic surgeons, orthotic and prosthetic centers, hospitals,
surgery centers, physical therapists and athletic trainers by 25 commissioned
agents who employ approximately 185 sales representatives. 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 gross profit and gross profit margins on DonJoy brand 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 consolidated financial statements. Domestic sales of DonJoy brand
products represented approximately 53.7% and 58.1% of total net revenues in the
three months and nine months ended September 30, 2000, respectively. As a result
of the Orthotech Acquisition, the Company has added an additional 40 sales
representatives and 3 regional general managers.
The Company's ProCare brand 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 brand
products to large hospital chains, hospital buying groups, primary care networks
and orthopedic physicians for use by the patients. As a result of the Orthotech
Acquisition, the Company has added an additional 7 sales representatives and 5
telemarketers and intends to add one more sales representative. Domestic sales
of ProCare brand products represented approximately 37.0% and 28.5% of total net
revenues in the three and nine months ended September 30, 2000, respectively.
INTERNATIONAL SALES. International sales, primarily in Europe, Canada and Japan,
accounted for approximately 9.2% and 13.0% of the Company's net revenues in the
third quarter of 2000 and 1999, respectively. This reflects the increased mix of
domestic sales from the Orthotech Acquisition. International sales, primarily in
Europe, Canada and Japan, accounted for approximately 13.3% and 14.8% of the
Company's net revenues in the first nine months of 2000 and 1999. Sales in
Germany, the Company's largest foreign market, accounted for approximately 27.9%
and 27.4% of the Company's international net revenues in the three and nine
months ended September 30, 2000, respectively, sales in Japan accounted for
approximately 12.0% and 9.3% of the Company's international net revenues in the
three and nine months ended September 30, 2000, respectively, and sales in
Canada accounted for approximately 10.2% and 9.4% of the Company's international
net revenues in the three and nine months ended September 30, 2000,
respectively, with no other country accounting for more than approximately 10%
of the Company's international revenues in the three and nine months ended
September 30, 2000, respectively. Total sales in Europe accounted for
approximately 67.1% and 70.7% of the Company's international net revenues in the
three and nine months ended September 30, 2000.
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).
Distributors in both of these channels buy and resell the Company's products and
have the ability to sell DonJoy and ProCare brand products within their
designated countries.
16
<PAGE> 17
The Company intends to sell Orthotech products internationally through our
existing or new independent distributors. In accordance with a transition
services agreement, DePuy OrthoTech has agreed to provide certain foreign and
domestic transitional services to DonJoy for varying periods while the
operations of Orthotech are integrated into those of DonJoy.
OFFICECARE PROGRAM. In 1996, in response to the needs of its customers, the
Company launched OfficeCare, an inventory management and insurance billing
program for its U.S. orthopedic physician customers. Under the OfficeCare
program, the Company provides the orthopedic physician with an inventory of
orthopedic products for immediate disbursement to the physician's patients. The
Company then directly seeks reimbursement from the patient's insurance company,
other third party payor or from the patient when self-pay is applicable.
Since its inception, the OfficeCare program has been promoted specifically to
provide the Company's 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 the Company's product lines.
The OfficeCare program represented approximately 13.7% and 11.3% of the
Company's net revenues for the three and nine months ended September 30, 2000
with sales of soft goods and specialty and other orthopedic products
representing the majority of such sales. The OfficeCare program involves the
Company's lower priced soft goods products, but is designed to also strengthen
the Company's 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 101.6% in the third quarter of
2000 over the same period in 1999 and an increase of 71.1% in the first nine
months of 2000 over the same period in 1999. These increases primarily reflect
the Orthotech Acquisition, since approximately one quarter of Orthotech's
historical sales consist of sales related to the OfficeCare partnership program.
As a result of the growth of the program, the Company's working capital needs
have increased due to higher levels of accounts receivable and inventories
necessary to operate the program. In addition, OfficeCare has expanded the
Company's 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 the Company's business is significantly longer and
has also resulted in a corresponding need to increase the Company's accounts
receivable reserve requirements.
BASIS OF PRESENTATION; TAXES. 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
new 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.
RESULTS OF OPERATIONS. dj Ortho operates its business on a manufacturing
calendar, with its 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. Revenues per day for the three and nine
months ended September 30, 2000 were $0.6 million and $0.5 million,
respectively, compared to revenues per day for the three and nine months ended
October 2, 1999 of $0.5 million and $0.4 million, respectively. The three month
period ended September 30, 2000 contained three less business days than the
three month period ended October 2, 1999, which resulted in approximately $1.4
million less revenue in the three month period ended September 30, 2000 as
compared to the three month period ended October 2, 1999. The first nine months
of 2000 contained the same number of business days as the first nine months of
1999. The components of the statement of operations as a percentage of revenues
are as follows:
17
<PAGE> 18
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- --------- ------------- ---------
<S> <C> <C> <C> <C>
Net revenues:
Rigid knee bracing ............................... 35.4% 41.4% 39.7% 43.1%
Soft goods ....................................... 38.6 36.3 35.4 35.0
Specialty and other orthopedic products .......... 26.0 22.3 24.9 21.9
--------- --------- --------- ---------
Total consolidated net revenues ....................... 100.0 100.0 100.0 100.0
Cost of goods sold allocable to product lines ......... 40.5 41.0 39.5 40.7
--------- --------- --------- ---------
Gross profit exclusive of brand royalties and
other cost of sales ...................... 59.5 59.0 60.5 59.3
Brand royalties .................................. -- -- -- 2.2
Other cost of goods sold ......................... 3.8 1.5 2.3 2.2
--------- --------- --------- ---------
Gross profit .......................................... 55.7 57.5 58.2 54.9
Sales and marketing .............................. 27.9 23.8 26.2 24.3
General and administrative ....................... 13.9 13.5 14.4 15.2
Research and development ......................... 1.3 1.5 1.7 1.8
Merger and integration costs ..................... 1.0 -- 0.1 --
--------- --------- --------- ---------
Income from operations ........................... 11.6 18.7 15.8 13.6
Interest expense ................................. (11.7) (12.5) (12.1) (4.6)
Interest income .................................. 0.2 0.1 0.1 0.1
--------- --------- --------- ---------
Income before income taxes ............................ 0.1 6.3 3.8 9.1
Provision for income taxes ....................... -- -- -- 2.8
--------- --------- --------- ---------
Net income ............................................ 0.1% 6.3% 3.8% 6.3%
========= ========= ========= =========
</TABLE>
The components of the Company's calculation of EBITDA are as follows:
<TABLE>
<S> <C> <C> <C> <C>
EBITDA (a) data:
Income from operations ................................ $ 4,583 $ 5,635 $ 15,778 $ 11,454
Depreciation and amortization ......................... 2,073 1,240 4,627 3,691
--------- --------- --------- ---------
EBITDA ................................................ 6,656 6,875 20,405 15,145
Brand royalties ....................................... -- -- -- 1,817
Eliminated Allocations ................................ -- -- -- 979
Other Corporate Allocations ........................... -- -- -- 832
Step-up in inventory .................................. 268 -- 268 --
Merger and integration costs .......................... 400 -- 400 --
Estimated costs to replace Smith & Nephew
services ......................................... -- -- -- (400)
--------- --------- --------- ---------
Adjusted EBITDA (b) ................................... $ 7,324 $ 6,875 $ 21,073 $ 18,373
========= ========= ========= =========
</TABLE>
(a) "EBITDA" is defined as income from operations plus 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 may not be comparable to that of other companies.
(b) "Adjusted EBITDA" represents EBITDA (as defined above) adjusted to
eliminate:
(1) charges for brand royalties paid by the Company to Smith &
Nephew for use of the Smith & Nephew trademarks and trade names
which amounts are no longer paid following the recapitalization;
(2) Smith & Nephew overhead allocations for corporate managed
accounts and new business expense and corporate management
expense which amounts were not incurred following the
recapitalization (the "Eliminated Allocations");
18
<PAGE> 19
(3) Smith & Nephew overhead allocations for research and development
and for amounts charged by Smith & Nephew for services provided
to the Company for finance (risk management, treasury, audit and
taxes), human resources and payroll and legal services
(collectively, the "Other Corporate Allocations") which amounts
are not incurred following the recapitalization;
(4) The incremental cost of the fair market value of acquired
inventories associated with the Orthotech Acquisition;
(5) Merger and integration costs associated with the Orthotech
Acquisition;
and adjusted to include the estimated costs we expect to incur to replace the
services previously provided by Smith & Nephew as part of the Other Corporate
Allocations. These adjustments are consistent with the terms of the Company's
debt covenants.
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED OCTOBER 2,
1999
NET REVENUES. Net revenues increased $9.4 million, or 31.1%, to $39.6 million
for the three month period ended September 30, 2000 from $30.2 million for the
three month period ended October 2, 1999. Revenues per day for the three months
ended September 30, 2000 and October 2, 1999 were $0.6 million which was an
increase of $0.1 or 37.3% million from revenues per day for the three months
ended October 2, 1999 of $0.5 million. The three month period ended September
30, 2000 contained three less business days than the three month period ended
October 2, 1999, which resulted in approximately $1.4 million less revenue in
the three month period ended September 30, 2000 as compared to the three month
period ended October 2, 1999. Net revenues for the rigid knee bracing segment
increased $1.5 million over the prior year period due to increased sales of
ligament braces and osteoarthritic braces, including the introduction of the
4TITUDE(TM) brace in June 1999 and the OAdjuster(TM) brace in March 2000. Soft
goods sales increased by $4.3 million over the prior period due primarily to
increased sales volumes of wrist splints, ankle braces, knee braces and other
general soft good supports. These increases also reflect the growth of the
OfficeCare program. Specialty and other orthopedic products sales increased by
$3.6 million over the prior period 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 of the OfficeCare program.
GROSS PROFIT. Gross profit increased $4.7 million, or 27.0%, to $22.1 million
for the three month period ended September 30, 2000 from $17.4 million for the
three month period ended October 2, 1999. Gross profit margin, exclusive of
brand royalties and other cost of goods sold not allocable to specific product
lines, increased from 59.0% for the three month period ended October 2, 1999 to
59.5% for the three month period ended September 30, 2000 primarily as a result
of increased walker sales, sales of the OAdjuster(TM) brace and the
implementation of efficient manufacturing techniques in the United States and
Mexico. Gross profit for the rigid knee bracing segment increased $0.6 million,
with gross profit margin decreasing to 69.6% for the three month period ended
September 30, 2000 from 72.8% for the comparable period in 1999. This decrease
in gross profit margin reflects the change in product mix. Gross profit for the
soft goods segment increased $2.2 million, with gross profit margin increasing
to 49.2% for the three month period ended September 30, 2000 from 48.4% for the
comparable period in 1999. This increase in gross profit margin is primarily a
result of the change in product mix, primarily related to sales of Orthotech
products, and the success of the group purchase organization contracts. Gross
profit for the specialty and other orthopedic products segment increased $2.9
million, with gross profit margin increasing to 61.2% for the three month period
ended September 30, 2000 from 50.6% for the comparable period in 1999. 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 the Company's facilities in Mexico in the first quarter of 2000 to
take advantage of labor cost savings. Additionally, the increase is a result of
more favorable pricing terms on the PainBuster(TM) Pain Management System.
As a result of the consummation of the recapitalization on June 30, 1999, the
Company no longer has the right to use the Smith & Nephew trademarks and trade
names and, accordingly, charges for brand royalties are no longer incurred by
the Company. In the three month period ended September 30, 2000, other cost of
goods sold not allocable to specific product lines increased from the comparable
period in 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 $3.9
million, or 54.0%, to $11.1 million for the three month period ended September
30, 2000 from $7.2 million for the three month period ended October 2, 1999. The
increase over 1999 is primarily associated with $1.1 million in commissions on
increased domestic sales, $1.2 million in transition services from Orthotech
related to customer service, partnership program and distribution costs, and
increases in headcount associated with absorption of the Orthotech Acquisition.
Overall, sales and marketing expenses increased as a percentage of revenues to
27.9% for the three month period ended September 30, 2000 from 23.8% for the
three month period ended October 2, 1999.
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<PAGE> 20
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $1.4 million, or 34.4%, to $5.5 million for the three month period
ended September 30, 2000 from $4.1 million for the three month period ended
October 2, 1999. The increase over 1999 is associated with $0.7 million in
amortization expense related to the intangible assets acquired as part of the
Orthotech Acquisition and $0.3 million in transition services from Orthotech.
Overall, general and administrative expenses increased as a percentage of
revenues to 13.9% for the three month period ended September 30, 2000 from 13.5%
for the comparable period of 1999.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
approximately equal over the two periods. During the three month period ended
September 30, 2000, the majority of resources were focused on the development of
the VISTA System, which is expected to be introduced in the fourth quarter of
2000, and a new post-operation splint which is scheduled for release at the end
of the year.
MERGER AND INTEGRATION COSTS. The Company incurred $0.4 million in one-time,
non-recurring merger and integration costs associated with the consolidation of
the Orthotech operations into the Company's 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 $0.9 million, or 22.7%, to $4.7
million for the three month period ended September 30, 2000 from $3.8 million
for the three month period ended October 2, 1999. The increase primarily
reflects the additional interest expense on the $24 million term loan and the
$12.6 million of borrowings under the revolving credit facility, both of which
were incurred to partially finance the Orthotech Acquisition.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED OCTOBER 2,
1999
NET REVENUES. Net revenues increased $16.8 million, or 19.8%, to $101.3 million
for the first nine months of 2000 from $84.5 million for the first nine months
of 1999. Revenues per day for the nine months ended September 30, 2000 were $0.5
million, which was an increase of $0.1 million or 19.8% from revenues per day
for the nine months ended October 2, 1999 of $0.4 million. The first nine months
of 2000 contained the same number of business days as the first nine months of
1999. Net revenues for the rigid knee bracing segment increased $3.8 million
over the prior period due to increased sales of ligament braces and
osteoarthritic braces, including the introduction of the 4TITUDE(TM) brace in
June 1999 and the OAdjuster(TM) brace in March 2000. Soft goods sales increased
by $6.2 million over the prior period due primarily to increased sales volumes
of wrist splints, ankle braces, knee braces and other general soft good
supports. These increases also reflect the growth of the OfficeCare program.
Specialty and other orthopedic products sales increased by $6.7 million over the
prior period 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 of the OfficeCare program.
GROSS PROFIT. Gross profit increased $12.5 million, or 27.1%, to $58.9 million
for the first nine months of 2000 from $46.4 million for the first nine months
of 1999. Gross profit margin, exclusive of brand royalties and other cost of
goods sold not allocable to specific product lines, increased to 60.5% from
59.3% as a result of increased walker sales combined with the implementation of
efficient manufacturing techniques in the United States and Mexico. Gross profit
for the rigid knee bracing segment increased $2.1 million, with gross profit
margin decreasing to 70.9% from 72.5%. This decrease in gross profit margin
reflected the change in product mix. Gross profit for the soft goods segment
increased $3.1 million as a result of increased sales volume, with gross profit
margin increasing from 49.0% to 48.8%. The increase in gross profit margin is
primarily a result of the change in product mix, primarily related to sales of
Orthotech products in the third quarter of 2000, and the success of the group
purchase organization contracts. Gross profit for the specialty and other
orthopedic products segment increased $5.8 million, with gross profit margin
increasing to 60.1% from 50.3%. The increase in gross profit margin reflects
lower costs associated with the production of walkers, which resulted from the
production of these walkers moving to the Company's facilities in Mexico in the
first quarter of 2000 to take advantage of labor cost savings. Additionally, the
increase is a result of more favorable pricing terms on the PainBuster(TM) Pain
Management System.
As a result of the consummation of the recapitalization on June 30, 1999, the
Company no longer has the right to use the Smith & Nephew trademarks and trade
names and, accordingly, charges for brand royalties are no longer incurred by
the Company. In the first nine months of 2000, other cost of goods sold not
allocable to specific product lines increased primarily due to the growth of the
OfficeCare program, amortization of the PainBuster(TM) Pain Management System
distribution rights and step-up in inventory and various facility costs incurred
as part of the Orthotech Acquisition in the third quarter of 2000.
20
<PAGE> 21
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased $6.0
million, or 29.2%, to $26.6 million for the first nine months of 2000 from $20.6
million for the first nine months of 1999. Overall, sales and marketing expenses
increased as a percentage of revenues to 26.2% for the nine month period ended
September 30, 2000 from 24.3% for the nine month period ended October 2, 1999.
The increase was primarily related to higher commissions expense associated with
the growth in domestic product sales and expenses associated with the
integration of the Orthotech Acquisition.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $1.7 million, or 13.0%, to $14.5 million for the first nine months of
2000 from $12.9 million for the first nine months of 1999. The increase was
primarily due to an increase in salaries and benefits, an increase in consulting
expenses related to the implementation of a new Enterprise Resource Planning
("ERP") system and amortization during the third quarter of 2000 related to the
intangible assets acquired as part of the Orthotech Acquisition, offset by the
elimination of the Smith & Nephew overhead charges in 2000. Overall, general and
administrative expenses declined as a percentage of revenues to 14.4% from
15.2%.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
approximately equal over the two periods. Significant resources were re-deployed
to focus primarily on the development of the OAdjuster(TM) osteoarthritic brace,
which was released in April 2000, the development of the VISTA System, which is
expected to be introduced in the second half of 2000, and a new post-operation
splint which is scheduled for release at the end of the year.
MERGER AND INTEGRATION COSTS. The Company incurred $0.4 million in one-time,
non-recurring merger and integration costs associated with the consolidation of
the Orthotech operations into the Company's 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 $8.4 million, or 224.0%, to $12.2
million for the nine month period ended September 30, 2000 from $3.8 million for
the nine month period ended October 2, 1999. The recapitalization occurred in
June 1999 and thus the nine months ended October 2, 1999 includes only three
months of interest expense on the $100 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, the third
quarter of 2000 includes additional interest expense on the $24 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.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity requirements are to service its debt and meet
its working capital and capital expenditure needs. On June 29, 1999, all
long-term intercompany obligations and certain other current liabilities owed to
Smith & Nephew were contributed to members' equity in accordance with the
recapitalization agreement. The Company's long-term indebtedness at September
30, 2000 was $148.2 million.
Net cash provided by operating activities was $5.8 million and $14.9 million in
the first nine months of 2000 and 1999, respectively. The decrease of $8.2
million in the first nine months of 2000 primarily reflects the decrease in net
income as a result of increased interest expense, combined with increased levels
in accounts receivable and inventories during the first nine months of 2000 as
compared to the first nine months of 1999, primarily as a result of the
Orthotech Acquisition.
Cash flows used in investing activities were $54.6 million and $3.2 million for
the first nine months of 2000 and 1999, respectively. Capital expenditures in
the first nine months of 2000 primarily reflect an increase in construction in
progress related to the capitalization of costs directly associated with the
Company's ERP implementation and investments in lean manufacturing equipment.
The Company's $49.7 million investment in Orthotech had a significant impact on
cash flows used in investing activities during the first nine months of 2000.
Cash flows provided by (used in) financing activities were $46.4 million and
$(5.5) million in the first nine months of 2000 and 1999, respectively. The
changes primarily reflect the $24 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 of common and preferred units in the
third quarter of 2000, all related to the Orthotech Acquisition.
21
<PAGE> 22
Additionally, the changes are a result of the change in intercompany
obligations. Prior to the recapitalization, the Company participated in Smith &
Nephew's central cash management program, wherein all of the Company's cash
receipts were remitted to Smith & Nephew and all cash disbursements were funded
by Smith & Nephew. Following the recapitalization, the Company no longer
participates in Smith & Nephew's cash management program.
Interest payments on the Notes and on borrowings under the new credit facility
have significantly increased the Company's 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 million, was
borrowed to finance the Orthotech Acquisition. The Company also has 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 September 30, 2000, the Company has borrowed $12.6 million
under that facility, primarily to consummate the Orthotech Acquisition.
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 the
three months ending December 31, 2000 through its maturity in 2005:
<TABLE>
<CAPTION>
Principal
Year Payment
---- -------
<S> <C>
2000 ................ $ 318
2001 ................ 1,274
2002 ................ 1,274
2003 ................ 1,274
2004 ................ 17,202
2005 ................ 17,339
</TABLE>
In addition, commencing with the year ending December 31, 1999, the Company is
required to make annual mandatory prepayments of the term loan under the new
credit facility in an amount equal to 50% of excess cash flow (as defined in the
new credit facility) (75% if the Company's leverage ratio exceeds a certain
level). The Company had no excess cash flow at December 31, 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, the
Company or any of its subsidiaries and (b) 100% of the net cash proceeds of
certain asset sales or other dispositions of property by DonJoy, the Company or
any of its subsidiaries, in each case subject to certain exceptions. No
mandatory prepayments were required by the Company at December 31, 1999.
The credit facility and the indenture impose certain restrictions on the
Company, including restrictions on its ability to incur indebtedness, pay
dividends, make investments, grant liens, sell its assets and engage in certain
other activities. In addition, the credit facility requires the Company to
maintain certain financial ratios. Indebtedness under the credit facility is
secured by substantially all of the assets of the Company, including the
Company's real and personal property, inventory, accounts receivable,
intellectual property and other intangibles. At September 30, 2000, the Company
was in compliance with all of these covenants.
The Company incurred fees and costs of $8.8 million in connection with the
recapitalization. Approximately $7.3 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 its strategy, the Company intends to pursue acquisitions, such as the
Orthotech Acquisition, investments and strategic alliances. The Company 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.
The Company's ability to satisfy its debt obligations and to pay principal and
interest on its indebtedness, including the notes, fund working capital
requirements and make anticipated capital expenditures will depend on its future
performance, which is subject to general economic, financial and other factors,
some of which are beyond its 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 new revolving credit facility, will be adequate for the foreseeable
future to make required payments of principal and interest on the Company's
indebtedness, including the notes, to fund anticipated capital expenditures and
for working capital requirements. There can be no assurance, however, that the
Company's business will generate sufficient cash flow from operations or that
future borrowings will be available under the new revolving credit facility in
an amount sufficient to enable the Company to service its indebtedness,
including the notes, or to fund its other liquidity needs.
22
<PAGE> 23
SEASONALITY
The Company generally records its 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, the Company generally has lower net revenues
during its second and third quarters as a result of decreased sports activity
and fewer orthopedic surgeries. The Company's results of operations would be
adversely and disproportionately affected if the Company's sales were
substantially lower than those normally expected during its first and fourth
quarters.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2000, the Emerging Issues Task Force ("EITF") reached a tentative
consensus on Issue 00-10, "Accounting for Shipping and Handling Fees and Costs."
The Issue addresses, in the context of a sale transaction for goods, how the
seller should classify amounts billed and incurred for shipping and handling in
the income statement. It has no impact on net income. In July 2000, the EITF
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; however, the EITF did not reach a consensus
on how shipping and handling costs should be classified. The EITF indicated that
the consensus must be followed even by those entities that believe that they
are, in substance, acting as an agent in providing the shipping and handling
services and desire to record revenue net. In September 2000, the EITF reached a
consensus that the classification of shipping and handling costs is an
accounting policy decision that should be disclosed pursuant to APB 22. A
company may adopt a policy of including shipping and handling costs in costs of
goods sold. If shipping and handling costs are significant and are not included
in cost of goods sold, a company should disclose both the amount of such costs
and which line item on the income statement includes that amount. Additionally,
the EITF indicated that a company cannot net the shipping and handling costs
against the shipping and handling revenues in the financial statements. The
Company plans to implement Issue 00-10 in the fourth quarter of 2000 at which
time revenues will be increased by the amounts billed to customers but
previously offset against shipping and handling costs which are part of sales
and marketing expenses. While the impact of this is expected to increase
revenues and increase selling and marketing expenses, the ultimate effect has
not been determined for the actual amounts that will be reclassified upon
implementation of Issue 00-10.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Accounting Standards 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 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 the Company's financial
statements is not expected to be material.
23
<PAGE> 24
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements which are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements are based on the beliefs of
our management as well as on assumptions made by and information currently
available to us at the time such statements were made. When used in this
Quarterly Report on Form 10-Q, the words "anticipate," "believe," "estimate,"
"expect," "intends" and similar expressions, as they relate to our Company are
intended to identify forward-looking statements. Actual results could differ
materially from those projected in the forward-looking statements. Important
factors that could affect our results 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 debt; (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; (xiii) risks related to the success of our Year 2000
remediation efforts; and (xiv) the other risks referred to under the caption
"Factors Affecting Future Performance" in the Annual Report on Form 10-K for the
year ended December 31, 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain market risks as part of its ongoing business
operations. Primary exposure includes changes in interest rates. The Company is
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. The Company will manage its
interest rate risk by balancing the amount of fixed and variable debt. For fixed
rate debt, interest rate changes affect the fair market value but do not impact
earnings or cash flows. Conversely for variable rate debt, interest rate changes
generally do not affect the fair market value but do impact future earnings and
cash flows, assuming other factors are held constant. As of September 30, 2000,
the Company had $100 million principal amount of fixed rate debt represented by
the Notes and $52.1 million of variable rate debt represented by borrowings
under the credit facility (at interest rates ranging from 9.50% to 9.813% at
September 30, 2000). Based on the Company's 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 $0.7 million on an annual basis. At September 30, 2000, up to
$12.4 million of variable rate borrowings was available under the revolving
credit facility. The Company may use derivative financial instruments, where
appropriate, to manage its interest rate risks. However, the Company, as a
matter of policy, does not enter into derivative or other financial investments
for trading or speculative purposes. All of the Company's sales are denominated
in U.S. dollars, thus the Company is not subject to foreign currency exchange
risk.
24
<PAGE> 25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with the Orthotech Acquisition on July 7, 2000, DonJoy sold in a
private placement 73,775 common units to CDP for gross proceeds of $8.0 million
and 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 promissory
notes to DonJoy, L.L.C.). In addition, DonJoy sold in a private placement 4,221
Redeemable Preferred Units to existing holders of Redeemable Preferred Units for
net proceeds of $3.4 million (excluding $0.2 million of preferred unit fees).
The issuance of the common units and the Redeemable Preferred Units was made in
reliance on Section 4(2) of the Securities Act of 1933, as amended, and
Regulation D promulgated thereunder. Each of the purchasers of these units is an
accredited investor, no general solicitation was made and the certificates
underlying these units contain an approximate legend restricting transfer.
During the third quarter of 2000, the Company granted options under its employee
option plan to purchase 10,070 common units. These options were issued pursuant
to Rule 701 under the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
Report on Form 8-K dated July 21, 2000 reporting the acquisition of certain
assets and the assumption of certain liabilities of DePuy Orthopaedic
Technology, Inc.
25
<PAGE> 26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on November 13, 2000 on its
behalf by the undersigned thereunto duly authorized.
DJ ORTHOPEDICS, LLC
DJ ORTHOPEDICS CAPITAL CORPORATION
DONJOY, L.L.C.
(Registrant)
Date: November 13, 2000
BY: /s/ LESLIE H. CROSS
-----------------------------------
Leslie H. Cross
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 13, 2000
BY: /s/ CYRIL TALBOT III
-----------------------------------
Cyril Talbot III
Senior Vice President - Finance and
Chief Financial Officer/Secretary
(Principal Financial Officer)
26
