<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 JULY 1, 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 July 1, 2000 (unaudited) and December 31, 1999 3
Consolidated Statements of Income for the three and six months ended
July 1, 2000 (unaudited) and June 29, 1999 (unaudited) 4
Statements of Changes in Consolidated Members' Equity (Deficit) for the year
ended December 31, 1999 and the six months ended July 1, 2000 (unaudited) 5
Consolidated Statements of Cash Flows for the six months ended
July 1, 2000 (unaudited) and June 29, 1999 (unaudited) 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES 24
</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, a Delaware limited liability company
("dj Ortho"), a wholly-owned subsidiary of DonJoy and DJ Orthopedics Capital
Corporation ("DJ Capital"), a Delaware corporation, 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 data)
<TABLE>
<CAPTION>
July 1, December 31,
2000 1999
--------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 5,603 $ 5,927
Accounts receivable, net of allowance for doubtful
accounts of $1,468 and $989 at July 1, 2000 and
December 31, 1999, respectively ....................................... 22,562 20,056
Accounts receivable, related parties ..................................... -- 1,350
Inventories, net ......................................................... 14,998 13,664
Other current assets ..................................................... 961 917
--------- ---------
Total current assets ........................................................ 44,124 41,914
Property, plant and equipment, net .......................................... 8,863 7,297
Intangible assets, net ...................................................... 31,795 33,195
Debt issuance costs, net .................................................... 6,623 6,875
Other assets ................................................................ 558 135
--------- ---------
Total assets ................................................................ $ 91,963 $ 89,416
========= =========
LIABILITIES AND MEMBERS' DEFICIT Current liabilities:
Accounts payable ......................................................... $ 5,263 $ 6,242
Accounts payable, related parties ........................................ -- 169
Accrued compensation ..................................................... 2,377 2,443
Accrued commissions ...................................................... 1,007 954
Long-term debt, current portion .......................................... 500 500
Accrued interest ......................................................... 643 526
Other accrued liabilities ................................................ 4,040 3,667
--------- ---------
Total current liabilities ................................................... 13,830 14,501
125/8% Senior Subordinated Notes ............................................ 98,157 98,055
Long-term debt, less current portion ........................................ 14,500 14,750
Redeemable Preferred Units; 100,000 units authorized, 40,184 units issued and
outstanding at July 1, 2000 and December 31, 1999;
liquidation preference $37,533 and $35,368 at July 1, 2000 and
December 31, 1999, respectively ........................................ 35,223 32,539
Members' deficit:
Common units; 2,900,000 units authorized, 718,000 units issued
and outstanding at July 1, 2000 and December 31, 1999 ................. 66,482 66,521
Notes receivable from officers ........................................... (1,598) (1,400)
Accumulated deficit ...................................................... (134,631) (135,550)
--------- ---------
Total members' deficit ...................................................... (69,747) (70,429)
--------- ---------
Total liabilities and members' deficit ...................................... $ 91,963 $ 89,416
========= =========
</TABLE>
See accompanying notes.
3
<PAGE> 4
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 1, June 29, July 1, June 29,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues:
Third parties .......................... $ 29,029 $ 23,502 $ 58,991 $ 49,011
Related parties ........................ 1,028 2,356 2,651 5,247
-------- -------- -------- --------
Total net revenues .......................... 30,057 25,858 61,642 54,258
Cost of goods sold .......................... 12,082 11,898 24,755 25,247
-------- -------- -------- --------
Gross profit ................................ 17,975 13,960 36,887 29,011
Operating expenses:
Sales and marketing .................... 7,781 6,433 15,494 13,371
General and administrative ............. 4,251 4,298 9,034 8,773
Research and development ............... 557 490 1,164 1,048
-------- -------- -------- --------
Total operating expenses .................... 12,589 11,221 25,692 23,192
-------- -------- -------- --------
Income from operations ...................... 5,386 2,739 11,195 5,819
Interest expense ............................ (3,798) -- (7,609) --
Interest income ............................. 128 -- 253 --
-------- -------- -------- --------
Income before income taxes .................. 1,716 2,739 3,839 5,819
Provision for income taxes .................. -- 1,124 -- 2,387
-------- -------- -------- --------
Net income and comprehensive net income ..... $ 1,716 $ 1,615 $ 3,839 $ 3,432
Less: Preferred stock dividends and accretion
of preferred unit fees ................. (1,254) -- (2,480) --
-------- -------- -------- --------
Net income available to members ............. $ 462 $ 1,615 $ 1,359 $ 3,432
======== ======== ======== ========
</TABLE>
See accompanying notes.
4
<PAGE> 5
DONJOY, L.L.C.
STATEMENTS OF CHANGES IN CONSOLIDATED MEMBERS' EQUITY (DEFICIT)
(in thousands, except unit information)
<TABLE>
<CAPTION>
NOTES RETAINED TOTAL MEMBERS'
COMMON UNITS RECEIVABLE EARNINGS EQUITY
UNITS AMOUNT FROM OFFICERS (DEFICIT) (DEFICIT)
---------- ---------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998 ........... -- $ -- $ -- $ 12,832 $ 12,832
Capital contribution by Smith & Nephew,
Inc. in connection with the ............ 2,054,000 64,117 -- (16,264) 47,853
Recapitalization
Issuance of common units at $100 per
unit, net of transaction fees of $1,563 645,500 62,987 -- -- 62,987
Purchase of common units from Smith &
Nephew, Inc. ........................ (2,000,000) -- (136,707) (199,140)
Issuance of common units at $100 per
unit, in exchange for cash and notes
receivable ............................. 18,500 1,850 (1,400) -- 450
Preferred unit dividends and accretion
of preferred unit fees .............. -- -- -- (2,343) (2,343)
Net income (excluding $196 allocated to
preferred unit holders) ............. -- -- -- 6,932 6,932
---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1999 ........... 718,000 66,521 (1,400) (135,550) (70,429)
Note receivable issued for transfer of
common units (unaudited) ............ -- -- (124) -- (124)
Capitalization of interest receivable
into note receivable (unaudited) ....... -- -- (74) -- (74)
Transaction fees in connection with the
Recapitalization (unaudited) ........ -- (39) -- -- (39)
Tax distributions in connection with the
Recapitalization (unaudited) ........ -- -- -- (236) (236)
Preferred unit dividends and accretion
of preferred unit fees (unaudited) .. -- -- -- (2,480) (2,480)
Net income (excluding $204 allocated to
preferred unit holders) (unaudited) . -- -- -- 3,635 3,635
---------- ---------- ---------- ---------- ----------
BALANCE AT JULY 1, 2000 (UNAUDITED) .... 718,000 $ 66,482 $ (1,598) $ (134,631) $ (69,747)
========== ========== ========== ========== ==========
</TABLE>
See accompanying notes.
5
<PAGE> 6
DONJOY, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
<TABLE>
<CAPTION>
Six Months Ended
July 1, June 29,
2000 1999
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net income ...................................................................... $ 3,839 $ 3,432
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................................ 2,554 2,451
Amortization of debt issuance costs and discount on Senior
Subordinated Notes ....................................................... 516 --
Changes in operating assets and liabilities:
Accounts receivable ........................................................ (1,156) 1,128
Inventories ................................................................ (1,334) (74)
Other current assets ....................................................... (118) 229
Accounts payable ........................................................... (1,148) (2,179)
Accrued compensation ....................................................... (66) 419
Accrued commissions ........................................................ 53 (397)
Accrued interest ........................................................... 117 --
Intercompany activity ...................................................... -- 2,854
Restructuring reserve ...................................................... -- (340)
Other accrued liabilities .................................................. 373 (233)
-------- --------
Net cash provided by operating activities ....................................... 3,630 7,290
INVESTING ACTIVITIES
Purchases of property, plant and equipment ...................................... (2,720) (515)
Increase in intangible assets ................................................... -- (2,205)
Other assets .................................................................... (423) (68)
-------- --------
Net cash used in investing activities ........................................... (3,143) (2,788)
FINANCING ACTIVITIES
Repayment of long-term debt ..................................................... (250) --
Distributions ................................................................... (236) --
Debt issuance costs ............................................................. (162) --
Note receivable issued for transfer of common units ............................. (124) --
Transaction fees in connection with the Recapitalization ........................ (39) --
Intercompany obligations ........................................................ -- (4,225)
-------- --------
Net cash used in financing activities ........................................... (811) (4,225)
-------- --------
Net increase (decrease) in cash ................................................. (324) 277
Cash at beginning of period ..................................................... 5,927 809
-------- --------
Cash at end of period ........................................................... $ 5,603 $ 1,086
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid ................................................................ $ 6,976 $ --
======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Capital contribution.......................................................... $ -- $ 48,322
======== ========
Dividends and accretion of preferred unit fee related to
redeemable preferred units ............................................... $ 2,480 $ --
======== ========
Capitalization of interest receivable into note receivable ................... $ 74 $ --
======== ========
</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 condensed consolidated financial statements for the
three and six months ended July 1, 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. (the "Company") 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 July 1,
2000 and for the three and six months ended July 1, 2000 and June 29, 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 period ended July 1, 2000 are not necessarily
indicative of the results to be achieved for the entire year or future periods.
The three month period ended July 1, 2000 contained two more business days than
the same period in 1999, resulting in the Company recognizing approximately $1.0
million more in revenues in the three month period ended July 1, 2000 as
compared to the same period in 1999. The six month period ended July 1, 2000
contained three more business days than the same period in 1999, resulting in
the Company recognizing approximately $1.4 million more in revenues in the six
month period ended July 1, 2000 as compared to the same 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 represent approximately 7.1% of total units
outstanding in the Company. 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 4).
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.
TRANSFER OF COMMON UNITS
In accordance with a unit purchase agreement dated as of June 28, 2000, Smith &
Nephew 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 from DonJoy (See Note 5).
7
<PAGE> 8
2. FINANCIAL STATEMENT INFORMATION
INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
July 1, December 31,
2000 1999
-------- ----------
<S> <C> <C>
Raw materials ...................... $ 7,149 $ 6,392
Work-in-progress ................... 1,339 1,446
Finished goods ..................... 7,556 6,817
-------- --------
16,044 14,655
Less reserve for excess and obsolete (1,046) (991)
-------- --------
$ 14,998 $ 13,664
======== ========
</TABLE>
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
July 1, December 31,
2000 1999
--------- -----------
<S> <C> <C>
Buildings and leasehold improvements .......... $ 3,631 $ 3,577
Office furniture, fixtures, equipment and other 16,387 15,817
Construction in progress ...................... 3,393 1,297
--------- --------
23,411 20,691
Less accumulated depreciation and amortization (14,548) (13,394)
--------- --------
$ 8,863 $ 7,297
======== ========
</TABLE>
INTANGIBLE ASSETS
Intangible assets arose primarily from the initial acquisition of the Company in
1987 and the Company's acquisition of Professional Care Products, Inc. in 1995.
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 July 1, December 31,
(in years) 2000 1999
-------------------------------------------
<S> <C> <C> <C>
Goodwill........................................................................ 20 $ 24,742 $ 24,742
Patented technology............................................................. 5-20 14,437 14,437
Customer base................................................................... 20 11,600 11,600
Licensing agreements............................................................ 5 2,000 2,000
Assembled workforce............................................................. 5 250 250
Other........................................................................... 5-20 399 399
-------- --------
53,428 53,428
Less accumulated amortization .................................................. (21,633) (20,233)
-------- --------
$ 31,795 $ 33,195
======== ========
</TABLE>
3. 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):
8
<PAGE> 9
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 1, June 29, July 1, June 29,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues:
Rigid knee bracing .................... $ 12,746 $ 10,911 $ 26,125 $ 23,858
Soft goods ............................ 9,954 9,143 20,595 18,638
-------- -------- -------- --------
Net revenues for reportable segments .. 22,700 20,054 46,720 42,496
Specialty and other orthopedic products 7,357 5,804 14,922 11,762
-------- -------- -------- --------
Total consolidated net revenues ............ $ 30,057 $ 25,858 $ 61,642 $ 54,258
======== ======== ======== ========
Gross profit:
Rigid knee bracing .................... $ 9,161 $ 7,822 $ 18,727 $ 17,240
Soft goods ............................ 4,749 4,495 10,049 9,127
-------- -------- -------- --------
Gross profit for reportable segments .. 13,910 12,317 28,776 26,367
Specialty and other orthopedic products 4,356 2,961 8,850 5,896
Brand royalties ....................... -- (830) -- (1,817)
Other cost of goods sold .............. (291) (488) (739) (1,435)
-------- -------- -------- --------
Total consolidated gross profit ............ $ 17,975 $ 13,960 $ 36,887 $ 29,011
======== ======== ======== ========
</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 six months ended July 1, 2000 and June 29, 1999, dj Ortho had no
individual customer or distributor within a segment which accounted for 10% or
more of total revenues.
Assets allocated in foreign countries were not significant. Net revenues to
customers, attributed to countries based on the location of the customer, were
as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 1, June 29, July 1, June 29,
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
United States:
Third parties ............ $25,703 $22,016 $51,211 $45,073
Related parties .......... 244 338 603 585
------- ------- ------- -------
25,947 22,354 51,814 45,658
Europe:
Third parties ............ 2,748 1,337 6,679 3,632
Related parties .......... 141 867 407 2,335
------- ------- ------- -------
2,889 2,204 7,086 5,967
Other foreign countries:
Third parties ............ 578 149 1,101 306
Related parties .......... 643 1,151 1,641 2,327
------- ------- ------- -------
1,221 1,300 2,742 2,633
------- ------- ------- -------
Total consolidated net revenues $30,057 $25,858 $61,642 $54,258
======= ======= ======= =======
</TABLE>
dj Ortho does not allocate assets to reportable segments because all property
and equipment are shared by all segments of dj Ortho.
9
<PAGE> 10
4. 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 is an intercompany payable to DonJoy, L.L.C. of $45.0
million. The following condensed summarized financial information of dj Ortho
(the only issuer of the Notes with operations and assets) is presented at July
1, 2000 and for the three and six months then ended, respectively:
<TABLE>
<CAPTION>
July 1, 2000
------------
<S> <C>
Current assets ............................................................................. $ 44,124
Non-current assets ......................................................................... $ 93,286
Current liabilities ........................................................................ $ 13,830
Non-current liabilities:
Long-term debt .......................................................................... $112,657
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 1, 2000 July 1, 2000
------------ ----------------
<S> <C> <C>
Net revenues........................................................... $ 30,057 $61,642
Gross profit........................................................... $ 17,975 $36,889
Net income............................................................. $ 1,730 $ 3,835
</TABLE>
dj Ortho, DJ Capital and any future subsidiary guarantors comprise all the
direct and indirect subsidiaries of DonJoy (other than inconsequential
subsidiaries) and separate financial statements of dj Ortho, DJ Capital and any
future wholly-owned subsidiary guarantors are not included, and dj Ortho, DJ
Capital and such subsidiary guarantors 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 and other investments. These provisions
limit the ability of dj Ortho and DJ Capital to make dividends or distributions
(other then 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 July 1, 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.
5. TRANSFER 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 July 1, 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.
10
<PAGE> 11
6. SUBSEQUENT EVENTS
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 Orthopaedic"), a
subsidiary of Johnson & Johnson, related to DePuy Orthopaedic'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 of the
acquisition, 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 of which the net proceeds totaled $8.1 million (excluding
management notes receivable of $0.2 million),
- $3.6 million of Redeemable Preferred Units of which the net proceeds
totaled $3.4 million (excluding preferred unit fees of $0.2 million) to
existing holders of the Redeemable Preferred Units,
- borrowing under our amended credit agreement of approximately $36.6
million, and
- $2.0 million in existing cash.
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 Orthopaedic $47.1
Management promissory note 0.2
Transaction fees and costs 2.6
Debt issuance costs 0.4
-----
$50.3
</TABLE>
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<PAGE> 12
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 (1) $ 5,475
Equipment and furniture (2) 1,250
Other assets held for sale 451
Intangibles (2):
Goodwill $37,010
Customer list 5,000
Covenant not to compete 500 42,510
-------- --------
Net assets acquired $49,686
========
</TABLE>
12
<PAGE> 13
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 our equity
interests. As a result, the discussion below of the historical consolidated
financial position and results of operations of DonJoy is substantially the same
as ours. No financial information of DJ Capital, the co-issuer of the notes, is
included in this prospectus because management believes such information would
not be material given DJ Capital's lack of assets and activities.
On June 30 1999, the Company 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.
On July 7, 2000, DonJoy and the Company completed the purchase of certain assets
and assumed certain liabilities of DePuy Orthopaedic related to DePuy
Orthopaedic'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 Orthopaedic, comprising the Orthotech
business, for a purchase price of $47.1 million in cash. 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 adjustment to the purchase price
will be determined before September 4, 2000.
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.
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
13
<PAGE> 14
knee ligament instabilities, post-operative braces, which provide both knee
immobilization and a protected range of motion, and OA braces, which provide
relief of knee pain due to osteoarthritis. 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 3
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 73.4% and 74.8% of total net revenues in the three and
six months ended July 1, 2000. The Company markets substantially all of its
rigid knee braces, approximately 84.7% of its specialty and other orthopedic
products and approximately 40.5% of its soft goods products under the DonJoy
brand name. ProCare brand product sales represented approximately 26.6% and
25.2% of total net revenues in the three and six months ended July 1, 2000. The
Company markets approximately 59.5% of its soft goods products, approximately
15.3% of its specialty and other orthopedic products and a small percentage of
its rigid knee braces under the ProCare brand name. Following the Orthotech
Acquisition, the Company is proceeding 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 61.4% and 60.9% of total net revenues in the
three months and six months ended July 1, 2000, respectively. As a result of the
Orthotech Acquisition, the Company intends to add an additional 30 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 intends to add an additional 8 sales representatives
and 5 telemarketers. Domestic sales of ProCare brand products represented
approximately 24.9% and 23.1% of total net revenues in the three and six months
ended July 1, 2000, respectively.
INTERNATIONAL SALES. International sales, primarily in Europe, Canada and Japan,
accounted for approximately 13.7% and 13.6% of the Company's net revenues in the
second quarter of 2000 and 1999, respectively. International sales, primarily in
Europe, Canada and Japan, accounted for approximately 15.9% of the Company's net
revenues in both the first six months of 2000 and 1999. Sales in Germany, the
Company's largest foreign market, accounted for approximately 30.4% and 27.2% of
the Company's international net revenues in the three and six months ended July
1, 2000, respectively, and sales in Japan accounted for approximately 10.5% and
8.3% of the Company's international net revenues in the three and six months
ended July 1, 2000, respectively, with no other country accounting for more than
approximately 10% of the Company's international revenues in the three and six
months ended July 1, 2000, respectively. Total sales in Europe accounted for
approximately 70.3% and 72.1% of the Company's international net revenues in the
three and six months ended July 1, 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.
14
<PAGE> 15
The Company intends to sell Orthotech products internationally through our
existing or new independent distributors.In accordance with a transition
services agreement, DePuy Orthopaedic 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 10.4% and 9.9% of the Company's
net revenues for the three and six months ended July 1, 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 52.9% in the second quarter of 2000 over the same period in
1999 and an increase of 50.7% in the first six months of 2000 over the same
period in 1999. 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 the
Company 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 the Company 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 the Company.
RESULTS OF OPERATIONS. The Company 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 six
months ended July 1, 2000 were $0.5 million, respectively, which was an increase
of $0.1 million from revenues per day for the three and six months ended June
29, 1999 of $0.4 million, respectively. The three month period ended July 1,
2000 contained two more business days than the three month period ended June 29,
1999, which resulted in approximately $1.0 million more revenue in the three
month period ended July 1, 2000 as compared to the three month period ended June
29, 1999. The first six months of 2000 contained three more business days than
the first six months of 1999, which resulted in approximately $1.4 million more
revenue in the first six months of 2000 as compared to the first six months of
1999. The components of the statement of operations as a percentage of revenues
are as follows:
15
<PAGE> 16
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 1, June 29, July 1, June 29,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues:
Rigid knee bracing ..................... 42.4 % 42.2 % 42.4 % 44.0 %
Soft goods ............................. 33.1 35.4 33.4 34.3
Specialty and other orthopedic products 24.5 22.4 24.2 21.7
--------- --------- --------- ---------
Total consolidated net revenues ............. 100.0 100.0 100.0 100.0
Cost of goods sold allocable to product lines 39.2 40.9 39.0 40.5
--------- --------- --------- ---------
Gross profit exclusive of brand royalties and
other cost of sales ............ 60.8 59.1 61.0 59.5
Brand royalties ........................ -- 3.2 -- 3.3
Other cost of goods sold ............... (1.0) 1.9 (1.2) 2.7
--------- --------- --------- ---------
Gross profit ................................ 59.8 54.0 59.8 53.5
Sales and marketing .................... 25.9 24.9 25.1 24.7
General and administrative ............. 14.1 16.6 14.7 16.2
Research and development ............... 1.9 1.9 1.9 1.9
--------- --------- --------- ---------
Income from operations ................. 17.9 10.6 18.1 10.7
Interest expense ....................... 12.6) -- (12.3) --
Interest income ........................ 0.4 -- 0.4 --
--------- --------- --------- ---------
Income before income taxes .................. 5.7 10.6 6.2 10.7
Provision for income taxes ............. -- 4.4 -- 4.4
--------- --------- --------- ---------
Net income .................................. 5.7 % 6.2 % 6.2 % 6.3 %
========= ========= ========= =========
EBITDA (a) data:
Income from operations ...................... $ 5,386 $ 2,739 $ 11,195 $ 5,819
Depreciation and amortization ............... 1,289 1,263 2,556 2,451
--------- --------- --------- ---------
6,675 4,002 13,751 8,270
Brand royalties ............................. -- 830 -- 1,817
Eliminated Allocations ...................... -- 477 -- 979
Other Corporate Allocations ................. -- 406 -- 832
Estimated costs to replace Smith & Nephew
services ............................... -- (200) -- (400)
--------- --------- --------- ---------
Adjusted EBITDA (b) ......................... $ 6,675 $ 5,515 $ 13,751 $ 11,498
========= ========= ========= =========
</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");
16
<PAGE> 17
(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;
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.
THREE MONTHS ENDED JULY 1, 2000 COMPARED TO THREE MONTHS ENDED JUNE 29, 1999
NET REVENUES. Net revenues increased $4.2 million, or 16.2%, to $30.1 million
for the three month period ended July 1, 2000 from $25.9 million for the three
month period ended June 29, 1999. Revenues per day for the three months ended
July 1, 2000 were $0.5 million, which was an increase of $0.1 million from
revenues per day for the three months ended June 29, 1999 of $0.4 million. The
three month period ended July 1, 2000 contained two more business days than the
three month period ended June 29, 1999, which resulted in approximately $1.0
million more revenue in the three month period ended July 1, 2000 as compared to
the three month period ended June 29, 1999. Net revenues for the rigid knee
bracing segment increased $1.8 million over the prior year period due to
increased sales of ligament braces and osteoarthritic braces, including the
introduction of the 4TITUDE brace in June 1999 and the OAdjuster(TM) brace in
March 2000. Soft goods sales increased by $0.8 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 $1.6 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 $4.0 million, or 28.8%, to $18.0 million
for the three month period ended July 1, 2000 from $14.0 million for the three
month period ended June 29, 1999. Gross profit margin, exclusive of brand
royalties and other cost of goods sold not allocable to specific product lines,
increased from 59.1% for the three month period ended June 29, 1999 to 60.8% for
the three month period ended July 1, 2000 primarily as a result of increased
specialty and other orthopedic product sales, sales of the OAdjuster(TM) brace
and the implementation of lean manufacturing techniques in the United States and
Mexico. Gross profit for the rigid knee bracing segment increased $1.3 million,
with gross profit margin increasing to 71.9% for the three month period ended
July 1, 2000 from 71.7% for the comparable period in 1999. This increase in
gross profit margin reflects the change in product mix. Gross profit for the
soft goods segment increased $0.3 million, with gross profit margin decreasing
to 47.7% for the three month period ended July 1, 2000 from 49.2% for the
comparable period in 1999. This decrease in gross profit margin is primarily a
result of the change in product mix and the success of the group purchase
organization contracts. Gross profit for the specialty and other orthopedic
products segment increased $1.4 million, with gross profit margin increasing to
59.2% for the three month period ended July 1, 2000 from 51.0% 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 July 1, 2000, other cost of goods
sold not allocable to specific product lines increased from the comparable
period in 1999 primarily due to the OfficeCare program and the amortization of
the PainBuster(TM) Pain Management System distribution rights.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased $1.4
million, or 21.0%, to $7.8 million for the three month period ended July 1, 2000
from $6.4 million for the three month period ended June 29, 1999. The increase
primarily reflected an increase in commissions associated with higher domestic
sales of DonJoy products and increased costs associated with the OfficeCare
program.
17
<PAGE> 18
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
approximately equal over the two periods. Overall, general and administrative
expenses declined as a percentage of revenues to 14.1% for the three month
period ended July 1, 2000 from 16.6% for the comparable period of 1999, due to
the elimination of the Smith & Nephew overhead charges in 2000.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
approximately equal over the two periods. During the three month period ended
July 1, 2000, the majority of resources were focused on 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.
SIX MONTHS ENDED JULY 1, 2000 COMPARED TO SIX MONTHS ENDED JUNE 29, 1999
NET REVENUES. Net revenues increased $7.4 million, or 13.6%, to $61.6 million
for the first six months of 2000 from $54.3 million for the first six months of
1999. Revenues per day for the six months ended July 1, 2000 were $0.5 million,
which was an increase of $0.1 million from revenues per day for the six months
ended June 29, 1999 of $0.4 million. The first six months of 2000 contained
three more business days than the first six months of 1999, which resulted in
approximately $1.4 million more revenue in the first six months of 2000 as
compared to the first six months of 1999. Net revenues for the rigid knee
bracing segment increased $2.3 million over the prior period due to increased
sales of ligament braces and osteoarthritic braces, including the introduction
of the 4TITUDE brace in June 1999 and the OAdjuster(TM) brace in March 2000.
Soft goods sales increased by $2.0 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
$3.2 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 $7.9 million, or 27.1%, to $36.9 million
for the first six months of 2000 from $29.0 million for the first six months of
1999. Gross profit margin, exclusive of brand royalties and other cost of goods
sold not allocable to specific product lines, increased to 61.0% from 59.5% as a
result of increased soft goods and specialty and other orthopedic product sales
combined with the implementation of lean manufacturing techniques in the United
States and Mexico. Gross profit for the rigid knee bracing segment increased
$1.5 million, with gross profit margin decreasing to 71.7% from 72.3%. This
decrease in gross profit margin reflected the change in product mix. Gross
profit for the soft goods segment increased $0.9 million as a result of
increased sales volume, with gross profit margin decreasing to 48.8% from 49.0%.
This decrease is primarily a result of the change in product mix and the success
of the group purchase organization contracts. Gross profit for the specialty and
other orthopedic products segment increased $3.0 million, with gross profit
margin increasing to 59.3% from 50.1%. 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 six months of 2000, other cost of goods sold not
allocable to specific product lines increased primarily due to the OfficeCare
program and the amortization of the PainBuster(TM) Pain Management System
distribution rights.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased $2.1
million, or 15.9%, to $15.5 million for the first six months of 2000 from $13.4
million for the first six months of 1999. The increase primarily reflected an
increase in commissions expense associated with higher domestic sales of DonJoy
products and increased costs associated with the OfficeCare program.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $0.3 million, or 3.0%, to $9.0 million for the first six months of
2000 from $8.8 million for the first six months of 1999. The increase was
primarily due to an increase in salaries and benefits and an increase in
18
<PAGE> 19
costs related to the implementation of a new Enterprise Resource Planning
("ERP") system, offset by the elimination of the Smith & Nephew overhead charges
in 2000. Overall, general and administrative expenses declined as a percentage
of revenues to 14.7% from 16.2%.
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.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal liquidity requirements are to service its debt and meet
its working capital and capital expenditure needs. The Company's current and
long-term indebtedness at July 1, 2000 was $113.2 million. Following the
Orthotech Acquisition, the Company's current and long-term indebtedness at July
1, 2000 was $149.8 million.
Net cash provided by operating activities was $3.6 million and $7.3 million in
the first six months of 2000 and 1999, respectively. The decrease of $3.7
million in the first six months of 2000 reflects an increase in accounts
receivable and inventories during the first six months of 2000 as compared to
the first six months of 1999.
Cash flows used in investing activities were $3.1 million and $2.8 million in
the first six months of 2000 and 1999, respectively. Capital expenditures in the
first six months of 2000 reflect an increase in expenditures related to the
Company's enterprise resource planning (ERP) implementation.
Cash flows used in financing activities were $0.8 million and $4.2 million in
the first six months of 2000 and 1999, respectively. 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. Upon consummation of the
Recapitalization on June 30, 1999, the Company no longer participated 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 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 July 1, 2000, the Company had no borrowings outstanding under
the revolving credit facility and subsequently borrowed $12.6 million under that
facility 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
nine months ended December 31, 2000 through its maturity in 2005:
<TABLE>
<CAPTION>
Principal
Year Payment
---- ---------
<S> <C>
2000................................................................ $ 762
2001................................................................ 1,274
2002................................................................ 1,274
2003................................................................ 1,274
2004................................................................ 17,202
2005................................................................ 17,339
</TABLE>
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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 in 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 in 1999. The new 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
new credit facility requires the Company to maintain certain financial ratios.
Indebtedness under the new 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.
There are also restrictions on the ability of the Company and DJ Capital to pay
dividends or to make other distributions to DonJoy.
The Company incurred fees and costs of $8.8 million in connection with the
Recapitalization. Approximately $7.4 million, principally relating to financing
fees and expenses, has been capitalized and will be amortized over the terms of
the related debt instruments.
As part of 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.
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.
YEAR 2000
During fiscal 1999, the Company continued its company-wide program to prepare
the Company's computer systems for year 2000 compliance. The year 2000 issue
relates to computer systems that use the last two digits rather than all four to
define a year and whether such systems would properly and accurately process
information when the year changed to 2000. At the date of this report, the
Company had not experienced any material problems related to the year 2000. The
Company has not become aware of any significant year 2000 issues affecting the
Company's major customers or suppliers. The Company also has not received any
material complaints regarding any year 2000 issues
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related to its products. Year 2000 related costs through July 1, 2000 were
approximately $360,000 and have been expensed as incurred. These costs included
labor expended in contacting customers and suppliers, testing systems and
software, and software upgrades for year 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
In 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 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. 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 for customers but previously offset against sales and marketing
expenses. The Company has not quantified the impact on its gross profit of
implementation of Issue 00-10 at this time.
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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 following consummation of the Recapitalization
includes changes in interest rates. The Company is exposed to interest rate risk
in connection with the term loan which bears 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 July 1, 2000, the Company had $100
million principal amount of fixed rate debt represented by the Notes and $15.0
million of variable rate debt represented by borrowings under the credit
facility (at an interest rate of 9.38% as of July 1, 2000). Following the
Orthotech Acquisition, the Company had $100 million principal amount of fixed
rate debt represented by the Notes and $51.6 million of variable debt
represented by borrowings under the credit facility (at an interest rate of
9.38% as of July 1, 2000) and the revolver. 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 $0.5 million on an annual basis. Up to $12.4
million of variable rate borrowings is 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 any foreign currency
exchange risks.
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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
None.
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
27.1 Financial Data Schedule
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on August 14, 2000 on its
behalf by the undersigned thereunto duly authorized.
DJ ORTHOPEDICS, LLC
DJ ORTHOPEDICS CAPITAL CORPORATION
DONJOY, L.L.C.
(Registrant)
Date: August 11, 2000 BY: /s/ LESLIE H. CROSS
----------------- ---------------------------
Leslie H. Cross
President and Chief Executive Officer
(Principal Executive Officer)
Date: August 11, 2000 BY: /s/ CYRIL TALBOT III
----------------- ---------------------------
Cyril Talbot III
Senior Vice President - Finance and Chief
Financial Officer/Secretary
(Principal Financial Officer)
24
