<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------------------------------------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
JULY 21, 2000
Date of Report (Date of earliest event reported)
DJ ORTHOPEDICS, LLC
(Exact name of Registrant as specified in charter)
<TABLE>
<CAPTION>
<S> <C> <C>
DELAWARE 333-86835 52-2165554
------------------------------- ------------------------ ----------------------
(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation or organization) Identification Number)
</TABLE>
DJ ORTHOPEDICS CAPITAL CORPORATION
(Exact name of registrant as specified in charter)
<TABLE>
<CAPTION>
<S> <C> <C>
DELAWARE 333-86835 52-2157537
------------------------------- ------------------------ ----------------------
(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation or organization) Identification Number)
</TABLE>
DONJOY, L.L.C.
(Exact name of registrant as specified in charter)
<TABLE>
<CAPTION>
<S> <C> <C>
DELAWARE 333-86835 33-0848317
------------------------------- ------------------------ ----------------------
(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation or organization) Identification 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)
<PAGE> 2
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
On July 7, 2000, DonJoy, L.L.C. ("DonJoy") and its wholly-owned subsidiary, dj
Orthopedics, LLC ("DJ" or the "Company") completed the purchase of certain
assets and assumed certain liabilities of DePuy Orthopaedic Technology, Inc.
("DePuy Orthopaedic") related to DePuy Orthopaedic's bracing and soft goods
business ("Orthotech"). The acquisition transaction ("Transaction") was effected
pursuant to the terms of an Asset Purchase Agreement, dated as of July 7, 2000
(the "Asset Purchase Agreement"), by and among DonJoy, DJ and DePuy Orthopaedic.
The Asset Purchase Agreement is filed as an exhibit hereto and the following
description thereof is qualified in its entirety by reference thereto.
The Orthotech business within DePuy Orthopaedic 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 DJ. The Orthotech business also has an inventory management
and billing program that will complement the Company's current OfficeCare
program.
TERMS OF THE TRANSACTION
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 ("Purchase Price") of $47.1 million in
cash. The Company is purchasing primarily inventory, equipment and certain
intellectual property. The Company is not required to assume any liabilities
existing prior to the closing date. The Purchase Price will be subject to an
adjustment based upon the value of the physical inventory of Orthotech as of
closing. If Orthotech's inventory as of closing is greater than the Target
Inventory (as defined in the Asset Purchase Agreement), the Purchase Price will
be increased. If Orthotech's inventory as of closing is less than the Target
Inventory, the Purchase Price will be decreased. The adjustment to the Purchase
Price will be determined prior to September 4, 2000 (i.e., within 60 days of the
closing).
The Transaction has been accounted for using the purchase method of accounting
whereby the total Purchase Price will be allocated to tangible and intangible
assets acquired and liabilities assumed based on their fair market values.
The Company is not acquiring any of Orthotech's facilities or the majority of
its employees and instead will integrate the Orthotech operations into its
existing business. Upon closing of the Transaction, DePuy Orthopaedic has
responsibility with regard to lease obligations on the Orthotech facility and
severance obligations for terminated Orthotech employees. The synergies the
Company anticipates from the Transaction are due primarily to reduction of
headcount, the transfer of the majority of Orthotech's sales force to
independent distributors and consolidation of the operations into DJ's
manufacturing facilities. In accordance with the Transition Services Agreement
dated as of July 7, 2000 and filed as an exhibit hereto, DePuy Orthopaedic has
agreed to provide certain transitional services to DJ for varying periods while
the operations of Orthotech are integrated into those of DJ. Such services
include continued operation of Orthotech's manufacturing facilities, employee
payroll service and benefits, computer services and other administrative
services.
DonJoy and DJ required approximately $50.1 million in cash to close the
Transaction including approximately $3.0 million for related fees and costs. A
total of $0.4 million of the fees and costs have been allocated to debt issuance
costs and will be amortized over the life of the related debt instruments and
the remaining portion will be included in the total Purchase Price. The funds
were raised by DonJoy through the sale of $8.3 million of common units of which
the net proceeds totaled $8.1 million (excluding Management notes receivables of
$0.2 million) and $3.6 million of Redeemable Preferred Units of which the net
proceeds totaled $3.4 million (excluding preferred unit fees of $0.2 million) to
existing holders of the preferred units. DJ raised the remaining funds by
borrowing approximately $36.6 million under its Amended Credit Agreement along
with use of approximately $2.0 million of existing cash. The Amended Credit
Agreement increased the amount of term loans available to $39.5 million but
2
<PAGE> 3
did not increase the revolving line of credit of $25.0 million. Upon
consummation of the Transaction, the Company had approximately $12.4 million
remaining available under the revolving line of credit which is available for
working capital, general corporate purposes, financing of investments and
strategic alliances.
DESCRIPTION OF THE AMENDED CREDIT AGREEMENT
The Credit Agreement ("Credit Agreement") dated June 30, 1999 among the
borrower, DonJoy, L.L.C., the lenders party thereto, First Union National Bank,
as administrative agent and collateral agent, and The Chase Manhattan Bank, as
syndication agent, issuing bank and swingline lender has been amended ("Amended
Credit Agreement") (a) to increase the aggregate principal amount of the term
loans available under the Credit Agreement by $24.0 million so that the total
availability of (i) the term loans under the Amended Credit Agreement will be
$39.5 million and (ii) the aggregate loans under the Amended Credit Agreement
will be $64.5 million, and (b) to effect other changes to the Credit Agreement
generally on the terms specified in Amendment No. 1 filed as an exhibit hereto,
including permitting the Orthotech acquisition. The Amended Credit Agreement was
provided by Chase Securities, Inc. as sole advisor and arranger.
The following description of the Amended Credit Agreement does not purport to be
complete and is qualified in its entirety by reference to certain agreements
setting forth principal terms and conditions of the facility, including
Amendment No. 1 to the Credit Agreement, dated as of May 25, 2000, filed as an
exhibit hereto.
The Amended Credit Agreement provides for a term loan of $15.5 million, which
was borrowed in connection with our June 30, 1999 recapitalization, an
additional term loan of $24.0 million which was borrowed to finance the
Transaction, and up to $25.0 million of revolving credit borrowings under the
revolving credit facility, which are available for working capital, general
corporate purposes, financing of investments and strategic alliances. Borrowings
under the term loans and the revolving credit facility bear interest at variable
rates plus an applicable margin. As of April 1, 2000, the actual interest rate
on the existing term loan was 9.19% and if we had borrowed on the revolving line
of credit, the applicable interest rate would have been 9.07%.
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 term loans under the Amended Credit Agreement amortize in quarterly amounts
and are based upon the annual amounts shown below (dollars in thousands):
<TABLE>
<CAPTION>
<S> <C>
Fiscal Year 2000 ............. $ 887
Fiscal Year 2001 ............. 1,274
Fiscal Year 2002 ............. 1,274
Fiscal Year 2003 ............. 1,274
Fiscal Year 2004 ............. 17,202
Fiscal Year 2005 ............. 17,339
-------
$39,250
</TABLE> =======
The revolving credit facility matures in 2004.
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
3
<PAGE> 4
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).
DESCRIPTION OF THE COMMON AND PREFERRED EQUITY
The following description does not purport to be complete and is qualified in
its entirety by reference to the Preferred Unit Purchase Agreement ("Preferred
Unit Purchase Agreement") dated as of July 7, 2000, among DonJoy, L.L.C., and CB
Capital Investors, L.L.C., First Union Capital Partners, L.L.C., DJC, Inc.,
TCW/Crescent Mezzanine Trust II, and TCW Leveraged Income Trust II, L.P., and
the Common Unit Purchase Agreement ("Common Unit Purchase Agreement") dated as
of July 7, 2000, among DonJoy, L.L.C., and Chase DJ Partners, L.L.C., the Leslie
H. Cross & Deborah L. Cross Family Trust, Michael R. McBrayer, and Cyril Talbot
III which documents are filed as exhibits hereto.
To obtain a portion of the funds required to pay the Purchase Price pursuant to
the Asset Purchase Agreement, the Company raised gross proceeds of $8.3 million
in common equity and $3.6 million in preferred equity financing. The common
equity financing included the purchase of 73,775 and 2,115 common units by Chase
DJ Partners, L.L.C. and Management for a total consideration of $8.1 million and
$0.2 million (the majority of which was paid in the form of promissory notes),
respectively. The preferred equity financing included the purchase of 4,221
Redeemable Preferred Units for a total consideration of $3.6 million by existing
unit holders.
In accordance with the Unit Purchase Agreement dated as of June 28, 2000 filed
as an exhibit hereto, Smith & Nephew Disposal, Inc. sold its entire interest of
54,000 common units in DonJoy, L.L.C. to Chase DJ Partners, L.L.C. and
Management for $5.9 million. Chase DJ Partners, L.L.C. purchased 52,495 common
units for a total consideration of $5.7 million and Management purchased the
remaining 1,505 units for a total consideration of $0.2 million.
The Company is authorized to issue up to 2,900,000 common units and up to
100,000 preferred units ("Redeemable Preferred Units"). As of December 31, 1999,
The Company had 718,000 common units and 40,184 Redeemable Preferred Units
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 Amended and Restated DonJoy, L.L.C. 1999 Option Plan. Upon consummation of
the Transaction the Company had 793,890 common units and 44,405 Redeemable
Preferred Units issued and outstanding.
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
4
<PAGE> 5
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.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
DePuy, Inc. purchased DePuy Orthopaedic in 1996. In 1997, the arthroscopy
business of DePuy, Inc. was transferred to DePuy Orthopaedic. DePuy, Inc. was
subsequently purchased by Johnson & Johnson on October 28, 1998. In January
1999, Johnson & Johnson transferred its bracing and soft goods business to
DePuy, Inc., creating the existing DePuy Orthopaedic. While Orthotech is not a
separate legal entity, DePuy Orthopaedic has separately stated the financial
results of Orthotech. As a result, all relevant financial statements are
presented to meet the requirements of Rule 3-05(b) of Regulation S-X.
Attached hereto are (i) Combined Balance Sheets as of March 31, 2000 (unaudited)
and December 31, 1999, (ii) unaudited Combined Statements of Operations and
Changes in Invested Equity for the three months ended March 31, 2000 and 1999,
(iii) unaudited Combined Statements of Cash Flows for the three months ended
March 31, 2000 and 1999, and (iv) related notes to unaudited combined financial
statements for DePuy Orthopaedic Technology, Inc.
Attached hereto are audited (i) Combined Balance Sheets as of December 31, 1999
and 1998, (ii) Combined Statements of Operations and Changes in Invested Equity
for the year ended December 31, 1999 and the period October 29, 1998 through
December 31, 1998, (iii) Combined Statements of Cash Flows for the year ended
December 31, 1999 and for the period October 29, 1998 through December 31, 1998,
(iv) report of independent accountants, and (v) related notes to combined
financial statements for DePuy Orthopaedic Technology, Inc.
Attached hereto are audited (i) Statements of Operations and Changes in Invested
Equity for the period January 1, 1998 through October 28, 1998 and for the year
ended December 31, 1997, (ii) Statements of Cash Flows for the period from
January 1, 1998 through October 28, 1998 and for the year ended December 31,
1997, (iii) report of independent accountants, and (iv) related notes to
financial statements for DePuy Orthopaedic Technology, Inc.
Attached hereto are audited (i) Statements of Revenues and Expenses for the
period January 1, 1998 through October 28, 1998 and for the year ended December
31, 1997, (ii) report of independent accountants, and (iii) related notes to
Statements of Revenues and Expenses for Bracing and Soft Supports Business of
Johnson & Johnson.
(b) PRO FORMA FINANCIAL INFORMATION.
Attached hereto is the pro forma consolidated balance sheet of DonJoy, L.L.C. as
of April 1, 2000 ("Unaudited Consolidated Pro Forma Balance Sheet") and the
unaudited consolidated statements of income ("Unaudited Consolidated Statements
of Income") for the year ended December 31, 1999, and for the three months ended
April 1, 2000 based on DonJoy's historical financial statements and adjusted to
give effect to the Transaction.
5
<PAGE> 6
(c) EXHIBITS
The following exhibits are filed herewith:
<TABLE>
<CAPTION>
Exhibit No. Document
----------- --------
<S> <C>
2.1 Asset Purchase Agreement dated as of July 7, 2000 among
DePuy Orthopaedic Technology, Inc., dj Orthopedics,
L.L.C., and DonJoy, L.L.C.
3.1 Third Amended and Restated Operating Agreement dated as
of July 7, 2000 of DonJoy, L.L.C.
4.1 Preferred Unit Purchase Agreement dated as of July 7,
2000, among DonJoy, L.L.C., and CB Capital Investors,
L.L.C., First Union Capital Partners, L.L.C., DJC,
Inc., TCW/Crescent Mezzanine Trust II, and TCW
Leveraged Income Trust II, L.P.
4.2 Common Unit Purchase Agreement dated as of July 7,
2000, among DonJoy, L.L.C., and Chase DJ Partners,
L.L.C., Leslie H. Cross & Deborah L. Cross Family
Trust, Michael R. McBrayer, and Cyril Talbot III.
4.3 Secured Promissory Note dated as of July 7, 2000
between the Leslie H. Cross & Deborah L. Cross Family
Trust and Leslie H. Cross, and DonJoy, L.L.C.
4.4 Secured Promissory Note dated as of July 7, 2000
between Cyril Talbot III and DonJoy, L.L.C.
4.5 Secured Promissory Note dated as of July 7, 2000
between Michael R. McBrayer and DonJoy, L.L.C.
4.6 Second Amended and Restated Pledge Agreement dated as
of July 7, 2000, among Leslie H. Cross, Leslie H. Cross
& Deborah L. Cross Family Trust, and DonJoy, L.L.C.
4.7 Second Amended and Restated Pledge Agreement dated as
of July 7, 2000 between Cyril Talbot III and DonJoy,
L.L.C.
4.8 Second Amended and Restated Pledge Agreement dated as
of July 7, 2000, between Michael R. McBrayer and
DonJoy, L.L.C.
4.9 Unit Purchase Agreement dated as of June 28, 2000,
among Smith & Nephew Disposal, Inc. and Chase DJ
Partners, L.L.C., Leslie H. Cross & Deborah L. Cross
Family Trust, Michael R. McBrayer, and Cyril Talbot
III.
4.10 Amended and Restated Secured Promissory Note dated as
of June 28, 2000 between Michael R. McBrayer and
DonJoy, L.L.C.
4.11 Amended and Restated Secured Promissory Note dated as
of June 28, 2000 among Leslie H. Cross & Deborah L.
Cross Family Trust, Leslie H. Cross and DonJoy, L.L.C.
</TABLE>
6
<PAGE> 7
<TABLE>
<CAPTION>
<S> <C>
4.12 Amended and Restated Secured Promissory Note dated as
of June 28, 2000 between Cyril Talbot III and DonJoy,
L.L.C.
4.13 Secured Promissory Note dated as of June 28, 2000 among
Leslie H. Cross & Deborah L. Cross Family Trust, Leslie
H. Cross and DonJoy, L.L.C.
4.14 Secured Promissory Note dated as of June 28, 2000
between Cyril Talbot III and DonJoy, L.L.C.
4.15 Secured Promissory Note dated as of June 28, 2000
between Michael R. McBrayer and DonJoy, L.L.C.
4.16 Amended and Restated Pledge Agreement dated as of June
28, 2000 among Leslie H. Cross, Leslie H. Cross &
Deborah L. Cross Family Trust, and DonJoy, L.L.C.
4.17 Amended and Restated Pledge Agreement dated as of June
28, 2000 between Cyril Talbot III and DonJoy, L.L.C.
4.18 Amended and Restated Pledge Agreement dated as of June
28, 2000 between Michael R. McBrayer and DonJoy, L.L.C.
10.1 Amendment No. 1 dated as of May 25, 2000 to the Credit
Agreement dated as of June 30, 1999
10.2 Transition Services Agreement dated as of July 7, 2000
among DePuy Orthopaedic Technology, Inc., DonJoy,
L.L.C., and dj Orthopedics, L.L.C.
10.3 Agreement dated as of July 13, 2000 among DonJoy,
L.L.C., DJ Orthopedics, L.L.C., the financial
institutions included in exhibit 10.3 hereto, and The
Chase Manhattan Bank on behalf of the revised Schedule
2.01 and pursuant to the (a) Credit Agreement dated as
of June 30, 1999, and (b) Amendment No. 1 dated as of
May 25, 2000 to the Credit Agreement dated as of June
30, 1999.
99.1 Press Release
</TABLE>
7
<PAGE> 8
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DJ ORTHOPEDICS, LLC
DJ ORTHOPEDICS CAPITAL CORPORATION
DONJOY, L.L.C.
(Registrant)
Date: July 21, 2000 BY: /s/ LESLIE H. CROSS
------------------------------------
Leslie H. Cross
President and Chief Executive Officer
(Principal Executive Officer)
Date: July 21, 2000 BY: /s/ CYRIL TALBOT III
------------------------------------
Cyril Talbot III
Senior Vice President, Chief Financial
Officer and Secretary
(Principal Financial Officer)
8
<PAGE> 9
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.:
Combined Balance Sheets as of March 31, 2000 (unaudited)
and December 31, 1999 F-1
Combined Statements of Operations and Changes in Invested
Equity for the Three Months ended March 31, 2000 and 1999 F-2
Combined Statements of Cash Flows for the Three Months
ended March 31, 2000 and 1999 F-3
Notes to Combined Financial Statements F-4
Report of Independent Accountants F-9
Combined Balance Sheets as of December 31, 1999 and 1998 F-10
Combined Statements of Operations and Changes in Invested
Equity for the Year Ended December 31, 1999 and the Period
October 29, 1998 through December 31, 1998 F-11
Combined Statements of Cash Flows for the Year Ended
December 31, 1999 and for the Period October 29, 1998
through December 31, 1998 F-12
Notes to Combined Financial Statements F-13
Report of Independent Accountants F-26
Statements of Operations and Changes in Invested Equity
for the Period January 1, 1998 through October 28, 1998
and for the Year Ended December 31, 1997 F-27
Statements of Cash Flows for the Period from January 1, 1998
through October 28, 1998 and for the Year Ended
December 31, 1997 F-28
Notes to Financial Statements F-29
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON:
Report of Independent Accountants F-40
Statements of Revenues and Expenses for the Period
January 1, 1998 through October 28, 1998 and for the
Year Ended December 31, 1997 F-41
Notes to Statements of Revenues and Expenses F-42
DONJOY, L.L.C.:
Unaudited Pro Forma Consolidated Financial Data F-46
Unaudited Pro Forma Consolidated Balance Sheet as of April 1, 2000 F-47
Notes to Unaudited Pro Forma Consolidated Balance Sheet F-48
Unaudited Pro Forma Consolidated Statements of Income for the
Year Ended December 31, 1999 F-49
Unaudited Pro Forma Consolidated Statements of Income for the
Three Months Ended April 1, 2000 F-50
Notes to Unaudited Pro Forma Consolidated Statements of Income F-51
</TABLE>
9
<PAGE> 10
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED BALANCE SHEETS
AS OF MARCH 31, 2000 AND DECEMBER 31, 1999
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(UNAUDITED)
AS OF AS OF
MARCH 31, DECEMBER 31,
2000 1999
<S> <C> <C>
ASSETS
Current assets
Cash $ 196 $ --
Accounts receivable, less allowances ($2,490 and $2,202 at
March 31, 2000 and December 31, 1999, respectively) 10,109 10,332
Inventories 7,397 7,203
Deferred income taxes 1,760 1,761
Other current assets 44 52
------- -------
Total current assets 19,506 19,348
Property, plant and equipment, net 3,543 3,577
Goodwill and other identifiable intangibles assets, net 47,624 48,135
Deferred income taxes 272 272
Other assets 45 45
------- -------
Total assets $70,990 $71,377
------- -------
LIABILITIES AND INVESTED EQUITY
Current liabilities
Accounts payable $ 1,131 $ 1,354
Book overdraft 684 539
Accrued liabilities 1,790 2,291
------- -------
Total current liabilities 3,605 4,184
Invested equity 67,385 67,193
------- -------
Total liabilities and invested equity $70,990 $71,377
======= =======
</TABLE>
The accompanying notes are an integral part of
these combined financial statements.
F-1
<PAGE> 11
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED STATEMENTS OF OPERATIONS AND CHANGES IN INVESTED EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(UNAUDITED)
FOR THE THREE FOR THE THREE
MONTHS ENDED MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999
<S> <C> <C>
Net sales $ 12,406 $ 12,182
Cost of goods sold 6,614 6,884
-------- --------
Gross profit 5,792 5,298
Selling, general and administrative expenses 3,614 4,010
Research and development expense 139 101
Amortization expense 511 511
Allocated expenses (Note 3) 1,189 417
-------- --------
5,453 5,039
Income before provision for income taxes 339 259
Provision for income taxes 344 209
-------- --------
Net income (loss) $ (5) $ 50
-------- --------
Invested equity - beginning of period $ 67,193 $ 66,266
Advances from (repayments to) DePuy 194 (1,006)
Currency translation adjustment 3 6
-------- --------
Invested equity - end of period $ 67,385 $ 65,316
======== ========
</TABLE>
The accompanying notes are an integral part
of these combined financial statements.
F-2
<PAGE> 12
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(UNAUDITED)
FOR THE THREE FOR THE THREE
MONTHS ENDED MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (5) $ 50
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities
Depreciation 178 148
Amortization 511 511
Deferred income taxes 1 556
Provision for accounts receivable 288 182
Loss on disposal of property and equipment -- 6
Changes in operating assets and liabilities
(Increase) in accounts receivable (65) (1,334)
Decrease in other assets 8 34
(Increase) decrease in inventory (194) 658
(Decrease) increase in accounts payable (223) 219
(Decrease) increase in accrued expenses (501) 140
------- -------
Net cash (used in) provided by operating activities (2) 1,170
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (141) (191)
------- -------
Net cash used in investing activities (141) (191)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Advances from (repayments to) DePuy 194 (1,006)
Book overdraft 145 82
------- -------
Net cash provided by (used in) financing activities 339 (924)
------- -------
Net change in cash 196 55
Cash, beginning of period -- 2
------- -------
Cash, end of period $ 196 $ 57
======= =======
</TABLE>
The accompanying notes are an integral part
of these combined financial statements.
F-3
<PAGE> 13
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED)
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
1. BACKGROUND AND DESCRIPTION OF BUSINESS
Johnson & Johnson is negotiating the sale of the net assets, consisting
principally of inventory, property, plant and equipment, plus certain
rights and intellectual property, of the bracing and soft supports
business of DePuy Orthopaedic Technology, Inc.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate,
public entity from 1993 (year of initial public offering) through March
1996. In March 1996, Orthopedic Technology was purchased by DePuy, Inc.
("DePuy"). Shortly after the acquisition in 1996, the existing DePuy
sports medicine business, which had products in the bracing and soft
support business, was combined with Orthopaedic Technology and the
resulting business was renamed DePuy Orthopaedic Technology, Inc.
("OrthoTech"). Subsequently, on October 29, 1998, Johnson & Johnson
acquired DePuy in a purchase business combination, and the existing
Johnson & Johnson bracing and soft supports products (the "J&J Business")
were transferred to OrthoTech as of January 1, 1999. As a result of these
transactions, OrthoTech became an integrated operation of DePuy, which is
a wholly-owned subsidiary of Johnson & Johnson. The accompanying combined
financial statements exclude the operations of an arthroscopy business of
OrthoTech, which was transferred to another operation of Johnson &
Johnson on January 1, 2000, as well as a casting business which is not
part of the sale described above. Accordingly, the accompanying combined
financial statements of OrthoTech present an aggregation of the bracing
and soft supports operations of DePuy, as well as the J&J Business.
OrthoTech engages in the development, manufacturing and marketing of
bracing and soft supports products which assist in the treatment of both
hard and soft tissue injury management. OrthoTech's primary markets are
North America, Europe and the Asia Pacific Region. OrthoTech sells its
products through Johnson & Johnson and DePuy affiliated companies outside
of the U.S. market.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited combined
financial statements contain all adjustments necessary for a fair
statement of the combined financial position of OrthoTech as of March 31,
2000 and the combined results of their operations and their cash flows
for the three months ended March 31, 2000 and 1999. Such adjustments are
generally of a normal recurring nature and include adjustments to certain
accruals and reserves to appropriate levels.
The unaudited combined quarterly financial statements contained herein
should be read in conjunction with the combined annual financial
statements and related notes thereto for the year ended December 31,
1999.
As an integrated operation of DePuy, and an indirect wholly-owned
subsidiary of Johnson & Johnson, OrthoTech did not, in the normal course
of operations, prepare separate financial statements in accordance with
accounting principles generally accepted in the United States.
Accordingly, the accompanying unaudited combined financial statements
have been derived by
F-4
<PAGE> 14
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED)
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
extracting the assets, liabilities and revenues and expenses of OrthoTech
from the consolidated assets, liabilities and revenues and expenses of
DePuy and Johnson & Johnson. The accompanying unaudited combined
financial statements reflect assets, liabilities, revenues and expenses
directly attributable to OrthoTech as well as allocations deemed
reasonable by management to present the combined results of their
operations for the three month periods ended March 31, 2000 and 1999 on a
stand alone basis. The allocation methodologies have been described
within the respective notes and management considers the allocations to
be reasonable. However, the combined financial position, results of
operations and their cash flows of OrthoTech may differ from those that
may have been achieved had OrthoTech operated autonomously or as an
entity independent of DePuy and Johnson & Johnson. In addition, due to
the reliance of the OrthoTech business on Johnson & Johnson and DePuy,
the historical operating results may not be indicative of future results.
There was no direct interest expense incurred by OrthoTech therefore, no
interest expense has been reflected in the combined financial statements.
All significant accounts and transactions within OrthoTech have been
eliminated.
RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the amounts reported. Actual
results could differ from those estimates.
CASH
OrthoTech participates in DePuy's cash pooling arrangements, under which
cash balances are cleared automatically to a central account. All
transactions between OrthoTech and DePuy have been accounted for as
settled in cash at the time such transactions were recorded by OrthoTech.
COMPREHENSIVE INCOME
In accordance with Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income", components of other comprehensive
income (loss) consist of the following:
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999
<S> <C> <C>
Net income (loss) $(5) $50
Other comprehensive income
Currency translation adjustments 3 6
--- ---
Total comprehensive income (loss) $(2) $56
--- ---
</TABLE>
F-5
<PAGE> 15
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED)
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
3. TRANSACTIONS WITH JOHNSON & JOHNSON AND DEPUY
OrthoTech relies on Johnson & Johnson and DePuy for certain services,
including treasury, cash management, employee benefits, tax compliance,
risk management, internal audit, financial reporting and general
corporate services. Although certain expenses related to services have
been allocated to OrthoTech, the combined financial position, results of
operations and cash flows presented in the accompanying combined
financial statements may not have been the same as those that would have
occurred had OrthoTech been an independent entity. A description of the
related party transactions follows:
SALES OF PRODUCTS
OrthoTech sells its products through Johnson & Johnson and DePuy
affiliated companies outside of the U.S. market. Net sales for such
products were $798 and $1,084 for the three months ended March 31, 2000
and 1999, respectively.
ALLOCATION OF SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Effective January 1, 2000, J&J began allocating certain costs to
OrthoTech. These costs include insurance, fringe benefits (principally
pension and postretirement benefits), legal, payroll, accounts payable,
and certain other administrative costs. Such costs have been allocated to
OrthoTech based upon headcount and sales, and amounted to $870 for the
three months ended March 31, 2000. Management believes these allocations
are reasonable. Prior to January 1, 2000, these cost were incurred and
paid by OrthoTech.
OrthoTech has been allocated a portion of the costs of the DePuy central
support functions. These costs include central departments, notably
legal, tax, treasury, finance, business development, and human resources.
Such costs have been allocated to OrthoTech based upon OrthoTech's sales
to third parties, relative to total DePuy sales to third parties. Such
amounts were $56 and $61 for the three months ended March 31, 2000 and
1999, respectively. Management believes these allocations are reasonable.
In addition, OrthoTech has been allocated a portion of the selling,
general and administrative expenses of the Johnson & Johnson and DePuy
affiliates outside of the U.S. that sold OrthoTech's products. Such
amounts were $263 and $356 for the three months ended March 31, 2000 and
1999, respectively. These amounts have been allocated based upon
OrthoTech's sales to third parties, relative to total DePuy sales to
third parties. Management believes these allocations are reasonable.
The total allocated selling, general and administrative expenses
described above are separately identified on the combined statements of
operations.
INVESTED EQUITY
Invested equity consists of capital contributions by DePuy and Johnson &
Johnson, borrowings and repayments to DePuy and Johnson & Johnson,
retained earnings/deficit and the cumulative translation adjustment.
F-6
<PAGE> 16
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED)
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
INTERCOMPANY ACCOUNT WITH DEPUY
The average intercompany balance outstanding for the three month periods
ended March 31, 2000 and 1999 was a net payable due to DePuy of $2,507
and $2,473, respectively.
INCOME TAXES
OrthoTech is not a separate taxable entity in any jurisdiction. Rather,
OrthoTech's taxable income is included in consolidated income tax returns
of Johnson & Johnson in most jurisdictions. However, for purposes of
these unaudited combined financial statements, the provision for income
taxes has been computed on a separate return basis using estimated annual
effective tax rates in various tax jurisdictions. Effective tax rates
were 101.3% and 80.7% for the three month periods ended March 31, 2000
and 1999, respectively. Current income taxes are considered to have been
paid or charged to Johnson & Johnson.
4. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
(UNAUDITED)
AS OF AS OF
MARCH 31, DECEMBER 31,
2000 1999
<S> <C> <C>
Raw materials $4,028 $3,566
Work-in-process 42 75
Finished goods 3,327 3,562
------ ------
$7,397 $7,203
====== ======
</TABLE>
5. CONCENTRATION OF CREDIT RISK
OrthoTech sells its products to physicians, hospitals and clinics located
throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk with respect to trade receivables are
limited due to the large numbers of customers comprising OrthoTech's
customer base. No one customer represents more than 10% of sales or
receivables. Ongoing credit evaluations of customers' financial
conditions are performed, and, generally, no collateral is required.
OrthoTech maintains reserves for potential credit losses and such losses,
in the aggregate, have not exceeded management's expectations.
F-7
<PAGE> 17
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED)
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
6. GEOGRAPHIC AREAS
Information about OrthoTech's operations by geographic area for the three
months ended March 31, 2000 and 1999 are shown below:
<TABLE>
<CAPTION>
OPERATING
SALES TO INCOME
THREE MONTHS ENDED MARCH 31, 2000 CUSTOMERS (LOSS)
<S> <C> <C>
North America $11,858 $ 254
Europe 441 85
Asia Pacific 87 2
Rest of the World 20 (2)
------- --------
Total $12,406 $ 339
======= =======
</TABLE>
<TABLE>
<CAPTION>
OPERATING
SALES TO INCOME
THREE MONTHS ENDED MARCH 31, 1999 CUSTOMERS (LOSS)
<S> <C> <C>
North America $11,334 $ 146
Europe 769 112
Asia Pacific 55 3
Rest of the World 24 (2)
------- --------
Total $12,182 $ 259
======= =======
</TABLE>
7. CONTINGENCIES
In the normal course of business, OrthoTech is party to claims and
disputes. OrthoTech has provided for these legal matters where it is
probable that a liability has been incurred and the amount of cost could
be reasonably estimated. While the ultimate outcome of these claims and
lawsuits cannot be readily determined, it is the opinion of management
that none of them, individually or in the aggregate, will have a material
adverse effect on OrthoTech's combined financial position, results of
operations or cash flows.
8. SUBSEQUENT EVENTS
On May 17, 2000, DePuy entered into a letter of exclusivity and term
sheet with a Buyer in which the Buyer agreed to purchase the inventory,
property, plant and equipment, plus certain rights and intellectual
property of the bracings and soft supports business of OrthoTech. The
sale is expected to be completed in the second quarter of 2000.
F-8
<PAGE> 18
[PRICEWATERHOUSECOOPERS LETTERHEAD]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Johnson & Johnson:
In our opinion, the accompanying combined balance sheets and the related
combined statements of operations and changes in invested equity, and combined
statements of cash flows present fairly, in all material respects, the combined
financial position of DePuy Orthopaedic Technology, Inc. ("OrthoTech"), an
integrated operation of DePuy, Inc. ("DePuy"), which is a wholly-owned
subsidiary of Johnson & Johnson as described in Note 1 to the combined financial
statements, as of December 31, 1999 and 1998, and the combined results of their
operations and their cash flows for the year ended December 31, 1999 and the
period October 29, 1998 through December 31, 1998, in conformity with accounting
principles generally accepted in the United States. These combined financial
statements are the responsibility of OrthoTech's management; our responsibility
is to express an opinion on these combined financial statements based on our
audits. We conducted our audits of these statements in accordance with auditing
standards generally accepted in the United States which require that we plan and
perform the audit to obtain reasonable assurance about whether the combined
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the combined financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall combined
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
OrthoTech is a fully integrated operation of DePuy, which is a wholly-owned
subsidiary of Johnson & Johnson. Consequently, as indicated in Note 2, these
combined financial statements have been derived from the consolidated financial
statements and accounting records of Johnson & Johnson and DePuy and reflect
significant assumptions and allocations. Moreover, as indicated in Note 3,
OrthoTech relies on DePuy for administrative, management and other services.
The financial position, results of operations and cash flows of OrthoTech could
differ from those that would have resulted had OrthoTech operated autonomously
or as an entity independent of Johnson & Johnson and DePuy.
/s/ PRICEWATERHOUSECOOPERS LLP
April 19, 2000
F-9
<PAGE> 19
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND 1998
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
-----------------
1999 1998
------- -------
<S> <C> <C>
ASSETS
Current assets
Cash $ -- $ 2
Accounts receivable, less allowances ($2,202
and $1,084 in 1999 and 1998, respectively) 10,332 6,983
Inventories 7,203 7,460
Deferred income taxes 1,761 2,140
Other current assets 52 90
------- -------
Total current assets 19,348 16,675
Property, plant and equipment, net 3,577 3,356
Goodwill and other identifiable intangibles
assets, net 48,135 50,179
Deferred income taxes 272 254
Other assets 45 44
------- -------
Total assets $71,377 $70,508
======= =======
LIABILITIES AND INVESTED EQUITY
Current liabilities
Accounts payable $ 1,354 $ 1,828
Book overdraft 539 --
Accrued liabilities 2,291 2,414
------- -------
Total current liabilities 4,184 4,242
Invested equity 67,193 66,266
------- -------
Total liabilities and invested equity $71,377 $70,508
======= =======
</TABLE>
The accompanying notes are an integral
part of these combined financial statements.
F-10
<PAGE> 20
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED STATEMENTS OF OPERATIONS AND CHANGES IN INVESTED EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1999 AND FOR THE
PERIOD OCTOBER 29, 1998 THROUGH DECEMBER 31, 1998
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE FOR THE PERIOD
YEAR ENDED OCTOBER 29, 1998
DECEMBER 31, THROUGH
1999 DECEMBER 31, 1998
------------ -----------------
<S> <C> <C>
Net sales $48,423 $ 8,046
Cost of goods sold (1998 includes $1,891 of
inventory write-offs for restructuring) 27,019 7,241
------- --------
Gross profit 21,404 805
Selling, general and administrative expenses 16,069 2,828
Research and development expense 286 34
Amortization expense 2,044 341
Allocated expenses (Note 3) 1,498 302
Restructuring charges (Note 9) - 1,500
-------- --------
19,897 5,005
Income (loss) before provision/(benefit)
for income taxes 1,507 (4,200)
Provision/(benefit) for income taxes 1,406 (1,485)
------- --------
Net income (loss) $ 101 $(2,715)
------- -------
Invested equity - beginning of period $66,266 $68,324
Advances from (repayments to) DePuy 803 660
Currency translation adjustment 23 (3)
------- -------
Invested equity - end of period $67,193 $66,266
------- -------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-11
<PAGE> 21
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
COMBINED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1999 AND FOR THE
PERIOD OCTOBER 29, 1998 THROUGH DECEMBER 31, 1998
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
FOR THE PERIOD
YEAR ENDED OCTOBER 29, 1998
DECEMBER 31, THROUGH
1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 101 $(2,715)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation 629 89
Amortization 2,044 341
Deferred income taxes 361 (1,832)
Provision for accounts receivable 1,118 114
Provisions for restructuring -- 1,500
Loss on disposal of property and equipment 6 --
Changes in operating assets and liabilities
(Increase) decrease in accounts receivable (4,467) 244
Decrease (increase) in other assets 37 (63)
Decrease in inventory 257 2,150
(Decrease) increase in accounts payable (474) 189
(Decrease) in accrued expenses (123) (770)
------- -------
Net cash used in operating activities (511) (753)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (833) (116)
------- -------
Net cash used in investing activities (833) (116)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Advances from DePuy 803 660
Book overdraft 539 --
------- -------
Net cash provided by financing activities 1,342 660
------- -------
Net change in cash (2) (209)
Cash, beginning of period 2 211
======= =======
Cash, end of period -- 2
======= =======
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-12
<PAGE> 22
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
1. BACKGROUND AND DESCRIPTION OF BUSINESS
Johnson & Johnson is negotiating the sale of the net assets, consisting
principally of inventory, property, plant and equipment, plus certain
rights and intellectual property, of the bracing and soft supports business
of DePuy Orthopaedic Technology, Inc.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate,
public entity from 1993 (year of initial public offering) through March
1996. In March 1996, Orthopedic Technology was purchased by DePuy, Inc.
("DePuy"). Shortly after the acquisition in 1996, the existing DePuy sports
medicine business, which had products in the bracing and soft support
business, was combined with Orthopaedic Technology and the resulting
business was renamed DePuy Orthopaedic Technology, Inc. ("OrthoTech").
Subsequently, on October 29, 1998, Johnson & Johnson acquired DePuy in a
purchase business combination, and the existing Johnson & Johnson bracing
and soft supports products (the "J&J Business") were transferred to
OrthoTech as of January 1, 1999. As a result of these transactions,
OrthoTech became an integrated operation of DePuy, which is a wholly-owned
subsidiary of Johnson & Johnson. The accompanying combined financial
statements exclude the operations of an arthroscopy business of OrthoTech,
which was transferred to another operation of Johnson & Johnson on January
1, 2000, as well as a casting business which is not part of the sale
described above. Accordingly, the accompanying combined financial
statements of OrthoTech present an aggregation of the bracing and soft
supports operations of DePuy, as well as the J&J Business, effective
October 29, 1998 (the date upon which the combined business being sold was
under common control). Refer to Note 2 for additional details.
OrthoTech engages in the development, manufacturing and marketing of
bracing and soft supports products which assist in the treatment of both
hard and soft tissue injury management. OrthoTech's primary markets are
North America, Europe and the Asia Pacific Region. OrthoTech sells its
products through Johnson & Johnson and DePuy affiliated companies outside
of the U.S. market.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
As described in Note 1, the businesses that comprise OrthoTech were not
under common management control during the entire three year period ended
December 31, 1999. Accordingly, the combined financial statements of
OrthoTech presented herein represent the business being sold for the period
they were under common control (Johnson & Johnson's acquisition of DePuy on
October 29, 1998). Separate financial statements of OrthoTech and separate
financial statements of the J&J Business have been prepared for the period
prior to Johnson & Johnson acquiring DePuy on October 29, 1998 as follows:
a. Separate financial statements have been prepared which depict the
results of operations and cash flows of OrthoTech for the period
January 1, 1998 through October 28, 1998 and the year ended December
31, 1997 which represents the period OrthoTech was controlled by DePuy
(prior to Johnson & Johnson acquiring DePuy).
F-13
<PAGE> 23
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
b. Separate financial statements have been prepared to depict the
revenues and direct expenses of the J&J Business for the period
January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997. This represents the period in which the
bracing and soft supports business, which was later transferred
to OrthoTech and is part of the net assets being sold, was owned
directly by Johnson & Johnson.
As an integrated operation of DePuy, and an indirect wholly-owned
subsidiary of Johnson & Johnson, OrthoTech did not, in the normal course
of operations, prepare separate financial statements in accordance with
accounting principles generally accepted in the United States.
Accordingly, the accompanying combined financial statements have been
derived by extracting the assets, liabilities and revenues and expenses
of OrthoTech from the consolidated assets, liabilities and revenues and
expenses of DePuy and Johnson & Johnson. The accompanying combined
financial statements reflect assets, liabilities, revenues and expenses
directly attributable to OrthoTech as well as allocations deemed
reasonable by management to present the combined financial position of
OrthoTech at December 31, 1999 and 1998, and the combined results of
their operations and cash flows for the year ended December 31, 1999 and
the period October 29, 1998 through December 31, 1998 on a stand alone
basis. The allocation methodologies have been described within the
respective notes and management considers the allocations to be
reasonable. However, the combined financial position, results of
operations and cash flows of OrthoTech may differ from those that may
have been achieved had OrthoTech operated autonomously or as an entity
independent of DePuy and Johnson & Johnson. In addition, due to the
reliance of the OrthoTech business on Johnson & Johnson and DePuy, the
historical operating results may not be indicative of future results.
There was no direct interest expense incurred by OrthoTech therefore, no
interest expense has been reflected in the combined financial
statements.
All significant accounts and transactions within OrthoTech have been
eliminated.
RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management
to make estimates and assumptions that affect the amounts reported.
Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenues from product sales are recognized when goods are shipped and
title and risk of loss passes to customers.
CASH
OrthoTech participates in DePuy's cash pooling arrangements, under which
cash balances are cleared automatically to a central account. All
transactions between OrthoTech and DePuy have been accounted for as
settled in cash at the time such transactions were recorded by
OrthoTech.
F-14
<PAGE> 24
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. OrthoTech utilizes the
straight-line method of depreciation over the estimated useful lives of
the assets:
Leasehold improvements Shorter of life of lease or 15 years
Machinery and equipment 3-10 years
Gains and losses on disposals are included in selling, general and
administrative expense. Major additions and betterments are
capitalized, whereas maintenance and repairs are expensed as incurred.
INTANGIBLE ASSETS
The goodwill reflected in these combined financial statements relates to
the acquisition of DePuy by Johnson & Johnson and is being amortized on
a straight-line basis over a period of 40 years. Values assigned to
other identifiable intangible assets, consisting of the trademarks and
OrthoTech's existing products, are being amortized on a straight-line
basis over a period of 40 years and 20 years, respectively.
LONG-LIVED ASSETS
OrthoTech continually evaluates the carrying value of its long-lived
assets, including intangibles, for impairment. Any impairments would be
recognized when the expected future operating cash flows derived from
such intangible assets is less than their carrying value.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method.
FOREIGN CURRENCY TRANSLATION
The local currencies of OrthoTech's international operations represent
their respective functional currencies. Assets and liabilities of
foreign operations are translated from their respective local currencies
to U.S. dollars using exchange rates in effect at the corresponding
balance sheet dates. Income statement and cash flow amounts are
translated using the average exchange rates in effect during the period.
Adjustments resulting from the translation of foreign currency financial
statements have been included in invested equity. Gains and losses
resulting from foreign currency transactions are included in the results
of operations and are immaterial to the periods presented.
F-15
<PAGE> 25
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
------------------------------------------------------------------------------
COMPREHENSIVE INCOME
In accordance with Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," components of other comprehensive
income/(loss) consist of the following:
<TABLE>
<CAPTION>
FOR THE
PERIOD
OCTOBER 29,
FOR THE 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 1998
<S> <C> <C>
Net income/(loss) $101 $(2,715)
Other comprehensive income
Currency translation adjustments 23 (3)
---- -------
Total comprehensive income/(loss) $124 $(2,718)
==== =======
</TABLE>
ADVERTISING
Costs associated with advertising are expensed in the year incurred.
Advertising expenses, which are comprised of print media, television and
radio advertising, were $74 and $45 for the year ended December 31, 1999
and the period October 29, 1998 through December 31, 1998, respectively.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
3. TRANSACTIONS WITH JOHNSON & JOHNSON AND DEPUY
OrthoTech relies on Johnson & Johnson and DePuy for certain services,
including treasury, cash management, employee benefits, tax compliance,
risk management, internal audit, financial reporting and general corporate
services. Although certain expenses related to services have been allocated
to OrthoTech, the combined financial position, results of operations and
cash flows presented in the accompanying combined financial statements may
not have been the same as those that would have occurred had OrthoTech been
an independent entity. A description of the related party transactions
follows:
SALES OF PRODUCTS
OrthoTech sells its products through Johnson & Johnson and DePuy affiliated
companies outside of the U.S. market. Net sales for such products were
$3,816 and $655 for the year ended December 31, 1999 and the period from
October 29, 1998 through December 31, 1998, respectively.
F-16
<PAGE> 26
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
------------------------------------------------------------------------------
ALLOCATION OF SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
OrthoTech has been allocated a portion of the costs of the DePuy central
support functions. These costs include central departments, notably legal,
tax, treasury, finance, business development, and human resources. Such
costs have been allocated to OrthoTech based upon OrthoTech's sales to
third parties, relative to total DePuy sales to third parties. Such amounts
were $243 and $73 for the year ended December 31, 1999 and the period
October 29, 1998 through December 31, 1998, respectively. Management
believes these allocations are reasonable.
In addition, OrthoTech has been allocated a portion of the selling, general
and administrative expenses of the Johnson & Johnson and DePuy affiliates
outside of the U.S. that sold OrthoTech's products. Such amounts were
$1,255 and $229 for the year ended December 31, 1999 and for the period
October 29, 1998 through December 31, 1998, respectively. These amounts
have been allocated based upon OrthoTech's sales to third parties, relative
to total DePuy sales to third parties. Management believes these
allocations are reasonable.
The total allocated selling, general and administrative expenses described
above are separately identified on the combined statements of operations.
INVESTED EQUITY
Invested equity consists of capital contributions by DePuy and Johnson &
Johnson, borrowings and repayments to DePuy and Johnson & Johnson, retained
earnings/deficit and the cumulative translation adjustment.
INTERCOMPANY ACCOUNT WITH DEPUY
The average intercompany balance outstanding for the year ended December
31, 1999 and for the period October 29, 1998 through December 31, 1998 was
a net payable due to DePuy of $5,244 and a net receivable due from DePuy of
$13,364, respectively.
PENSIONS
Eligible OrthoTech employees are provided with pension benefits through a
noncontributory defined contribution plan which covers substantially all
non-union employees of DePuy in the United States. This plan provides for
targeted benefits based on the employee's average compensation in the years
preceding retirement. In general, DePuy's policy is to contribute
actuarially determined amounts that are expected to be sufficient to meet
projected benefit payment requirements.
Employees of DePuy's international subsidiaries are covered by various
pension benefit arrangements, some of which are considered to be defined
benefit plans for financial reporting purposes. Funding policies are based
on legal requirements, tax considerations and local practices.
Since the aforementioned pension arrangements are part of certain DePuy
employee benefit plans, no discrete actuarial data is available for the
portion allocable to OrthoTech. Therefore, no liability or asset is
reflected in the accompanying combined financial statements. OrthoTech has
been allocated pension costs based upon participant employee headcount. Net
pension expense included in the accompanying combined financial statements
was $284 and $31 for the year ended December 31, 1999 and the period
October 29, 1998 through December 31, 1998, respectively.
F-17
<PAGE> 27
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
-------------------------------------------------------------------------------
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Certain OrthoTech employees are covered under DePuy's unfunded postretirement
health care benefit plans. In general, DePuy pays a defined portion of an
eligible retiree's health care premium. The plans are contributory based on
years of services, with contributions adjusted annually.
Since the aforementioned postretirement benefit arrangements are part of certain
DePuy benefit plans, no discrete actuarial data is available for the portion
allocable to OrthoTech. Therefore, no asset or liability is reflected in the
accompanying combined financial statements. OrthoTech has been allocated
postretirement benefit costs based upon participant employee headcount. Net
postretirement benefit expense included in the accompanying combined financial
statements was $159 and $17 for the year ended December 31, 1999 and the period
October 29, 1998 through December 31, 1998, respectively.
SAVINGS PLAN
Under an employee savings plan sponsored by DePuy, non-union employees of
OrthoTech in the United States may contribute up to 11% of their compensation,
subject to certain limitations. DePuy matches 100% of an employees' contribution
up to 4% of their compensation. Matching contributions made by DePuy and
expensed were $315 and $55 for the year ended December 31, 1999 and the period
October 29, 1998 through December 31, 1998, respectively.
STOCK BASED COMPENSATION
For the year ended December 31, 1999 and the period October 29, 1998 through
December 31, 1998, certain employees of OrthoTech participated in certain
Johnson & Johnson sponsored share option and long-term share incentive plans.
Stock options expire 10 years from the date they are granted and vest over
service periods that range from one to six years. All options granted are valued
at current market price.
A summary of the status of OrthoTech's participation in Johnson & Johnson's
stock option plans as of December 31, 1999 and December 31, 1998 and changes
during the period ending on those dates, is presented below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS EXERCISE
OUTSTANDING PRICE
----------- --------
<S> <C> <C>
Balance at October 29, 1998 - $ -
Option granted 15,350 80.31
Options exercised - -
Options cancelled/forfeited - -
----------- --------
Balance at December 31, 1998 15,350 80.31
Options granted 12,550 100.16
Options exercised - -
Options cancelled/forfeited 2,000 80.31
----------- --------
Balance at December 31, 1999 25,900 $ 89.93
=========== ========
</TABLE>
F-18
<PAGE> 28
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
The following table summarized stock options outstanding and exercisable at
December 31, 1999:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
AVERAGE AVERAGE
EXERCISE AVERAGE EXERCISE EXERCISE
PRICE RANGE OPTIONS LIFE PRICE OPTIONS PRICE
<S> <C> <C> <C> <C> <C>
$ 80.31 13,350 8.9 $ 80.31 -- $ --
$100.16 12,550 9.9 100.16 -- --
------ --- ------- ------ ------
$80.31 - $100.16 25,900 9.4 $ 89.93 -- $ --
====== === ======= ====== ======
</TABLE>
Johnson & Johnson applies the provision of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," that calls for
companies to measure employee stock compensation expense based on the fair value
method of accounting. However, as allowed by the Statement, Johnson & Johnson
elected continued use of Accounting Principle Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," with pro forma disclosure of net
income determined as if the fair value method had been applied in measuring
compensation cost. Had the fair value method been applied, net (loss) income
would have been adjusted to the amounts indicated below:
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE OCTOBER 29, 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 1998
<S> <C> <C>
Net income (loss) - as reported $ 101 $ (2,715)
Net income (loss) - as adjusted $ 63 $ (2,718)
</TABLE>
Compensation cost for the determination of "net income (loss) - as adjusted"
were estimated using the Black-Scholes option pricing model and the following
assumptions:
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE OCTOBER 29, 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 1998
<S> <C> <C>
Risk free interest rate 6.35% 4.47%
Expected volatility 24.00% 22.00%
Expected dividend yield 1.13% 1.30%
Expected life 5.0 years 5.0 years
</TABLE>
The weighted average fair value of options granted in the year ended December
31, 1999 and the period from October 29, 1998 through December 31, 1998 was
$30.21 and $19.61, respectively.
F-19
<PAGE> 29
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
INCOME TAXES
OrthoTech is not a separate taxable entity in any jurisdiction. Rather, the
OrthoTech's taxable income is included in consolidated income tax returns
of Johnson & Johnson in most jurisdictions. However, for purposes of these
combined financial statements, the provision for income taxes has been
computed on a separate return basis. Current income taxes are considered to
have been paid or charged to Johnson & Johnson. The principal components of
deferred taxes are related to depreciation and amortization of fixed assets
and intangibles, and the impact of certain costs and accruals not currently
deductible.
4. JOHNSON & JOHNSON ACQUISITION OF DEPUY
On October 29, 1998, Johnson & Johnson completed its acquisition of DePuy.
The excess of purchase price over the estimated fair value of net tangible
assets acquired has been allocated to identifiable intangibles and goodwill
in the consolidated financial statements of Johnson & Johnson. Included in
the purchase price allocations from the acquisition of DePuy were the
following intangible assets relating to OrthoTech:
<TABLE>
<S> <C>
Intangible assets
Goodwill $11,467
Existing OrthoTech products 31,256
Trademarks 7,797
-------
Total $50,520
=======
</TABLE>
5. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
1999 1998
<S> <C> <C>
Raw materials $3,566 $4,102
Work-in-process 75 120
Finished goods 3,562 3,238
------ ------
$7,203 $7,460
====== ======
</TABLE>
F-20
<PAGE> 30
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
1999 1998
<S> <C> <C>
Leasehold improvements $ 581 $ 279
Machinery and equipment 3,723 3,070
Construction in progress -- 78
------ ------
$4,304 $3,427
Less: Accumulated depreciation (727) (71)
------ ------
$3,577 $3,356
------ ------
</TABLE>
Depreciation expense amounted to $629 and $89 for the year ended December
31, 1999 and for the period from October 29, 1998 through December 31,
1998, respectively.
7. INCOME TAXES
The provision for income taxes was calculated by applying statutory tax
rates to the reported pretax income after considering permanent items that
do not enter into the determination of taxable income and tax credits
reflected in the consolidated provision of Johnson & Johnson, which are
related to OrthoTech.
F-21
<PAGE> 31
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
-----------------------------------------------------------------------------
The effective income tax rate differs from the statutory Federal income tax
rate for the following reasons:
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE OCTOBER 29, 1998
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1999 1998
<S> <C> <C>
U.S. $1,078 $(4,265)
Foreign 429 65
------ -------
Income/(loss) before provision/(benefit) for
income taxes 1,507 (4,200)
------ -------
Statutory taxes $ 527 $(1,470)
------ -------
Tax rates:
Statutory Federal income tax rate 35.0% (35.0)%
Goodwill amortization not deductible 48.0% 2.8 %
State and local taxes, net of Federal tax benefit 2.8% 3.8 %
Other 7.5% (7.0)%
------ -------
Effective income tax rate 93.3% (35.4)%
====== =======
</TABLE>
Other consists principally of non-deductible business meal and
entertainment expenses and tax differences related to foreign operations.
Deferred income taxes are recognized for tax consequences of "temporary
differences" by applying enacted statutory tax rates to differences between
the financial reporting and the tax basis of existing assets and
liabilities. The more significant temporary differences giving rise to
deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 31, 1999 DECEMBER 31, 1998
ASSETS LIABILITIES ASSETS LIABILITIES
<S> <C> <C> <C> <C>
Reserves $1,130 $1,354
Accruals 313 312
Intangibles 525 525
Depreciation $(297) $(215)
Other 362 418
------ ----- ------ -----
Total deferred income taxes $2,330 $(297) $2,609 $(215)
====== ===== ====== =====
</TABLE>
F-22
<PAGE> 32
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
------------------------------------------------------------------------------
8. INTANGIBLE ASSETS
Components of net intangible assets were:
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
1999 1998
<S> <C> <C>
Goodwill $11,467 $11,467
Trademarks 7,797 7,797
Existing OrthoTech products 31,256 31,256
------- -------
50,520 50,520
Less: Accumulated amortization (2,385) (341)
------- -------
$48,135 $50,179
======= =======
</TABLE>
Amortization expense was $2,044 and $341 for the year ended December 31,
1999 and for the period October 29, 1998 through December 31, 1998,
respectively.
9. RESTRUCTURING CHARGES
In the fourth quarter of 1998, Johnson & Johnson approved a plan to
reconfigure its global network of manufacturing and operating facilities
with the objective of enhancing operating efficiencies. The estimated cost
of this plan was $613 million which was reflected in the 1998 consolidated
financial statements of Johnson & Johnson (cost of sales ($60 million), and
restructuring charge ($553 million)). The charge consisted of employee
separation costs of $161 million, assets impairments of $322 million,
impairments of intangibles of $52 million, and other exit cost of $78
million.
Restructuring charges which were included in the overall $613 million
charge taken by Johnson and Johnson that related to OrthoTech included:
<TABLE>
<CAPTION>
FOR THE PERIOD
OCTOBER 29,
1998 THROUGH
DECEMBER 31,
1998
<S> <C>
Inventory write-off's $1,891
Write-off of intangible assets 1,500
------
Total $3,391
======
</TABLE>
F-23
<PAGE> 33
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
Inventory write-off's represent costs to exit business related to
certain bracing and soft supports products. The write-off of intangible
assets consists of the net book value of a patent related to a product
which was discontinued.
10. RENTAL EXPENSE AND LEASE COMMITMENTS
Rental expense relating to OrthoTech's administrative building and land
under an operating lease amounted to approximately $505 and $84 for the
year ended December 31, 1999 and the period October 29, 1998 through
December 31, 1998.
The approximate minimum rental payments required under the operating
lease that has initial or remaining noncancellable lease terms in excess
of one year at December 31, 1999 are:
<TABLE>
<S> <C>
2000 $ 505
2001 505
2002 505
2003 505
2004 505
Thereafter 6,521
------
$9,046
======
</TABLE>
11. CONCENTRATION OF CREDIT RISK
OrthoTech sells its products to physicians, hospitals and clinics
located throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk with respect to trade receivables are
limited due to the large numbers of customers comprising OrthoTech's
customer base. No one customer represents more than 10% of sales or
receivables. Ongoing credit evaluations of customers' financial
conditions are performed, and, generally, no collateral is required.
OrthoTech maintains reserves for potential credit losses and such
losses, in the aggregate, have not exceeded management's expectations.
F-24
<PAGE> 34
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
23. GEOGRAPHIC AREAS
Information about OrthoTech's operations by geographic area for the year
ended December 31, 1999 and the period October 29, 1998 through December
31, 1998 are shown below:
<TABLE>
<CAPTION>
SALES TO OPERATING TOTAL
YEAR ENDED DECEMBER 31, 1999 CUSTOMERS INCOME ASSETS
<S> <C> <C> <C>
North America $45,610 $ 995 $70,643
Europe 2,452 489 669
Asia Pacific 267 17 55
Rest of the World 94 6 10
------- ------- -------
Total $48,423 $ 1,507 $71,377
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
PERIOD OCTOBER 29, 1998 THROUGH SALES TO OPERATING TOTAL
DECEMBER 31, 1998 CUSTOMERS INCOME (LOSS) ASSETS
<S> <C> <C> <C>
North America $ 7,566 $(4,259) $69,737
Europe 411 44 712
Asia Pacific 58 14 53
Rest of the World 11 1 6
------- ------- -------
Total $ 8,046 $(4,200) $70,508
======= ======= =======
</TABLE>
13. CONTINGENCIES
In the normal course of business, OrthoTech is party to claims and
disputes. OrthoTech has provided for these legal matters where it is
probable that a liability has been incurred and the amount of cost could
be reasonably estimated. While the ultimate outcome of these claims and
lawsuits cannot be readily determined, it is the opinion of management
that none of them, individually or in the aggregate, will have a
material adverse effect on OrthoTech's combined financial position,
results of operations or cash flows.
F-25
<PAGE> 35
[PRICEWATERHOUSECOOPERS LETTERHEAD]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Johnson & Johnson
In our opinion, the accompanying statements of operations and changes in
invested equity, and statements of cash flows present fairly, in all material
respects, the results of operations and cash flows of DePuy Orthopaedic
Technology, Inc. ("OrthoTech"), an integrated operation of DePuy, Inc., as
described in Note 1, for the period January 1, 1998 through October 28, 1998 and
for the year ended December 31, 1997, in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of OrthoTech's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
For the period January 1, 1998 through October 28, 1998 and the year ended
December 31, 1997, OrthoTech was a fully integrated operation of DePuy.
Consequently, as indicated in Note 2, these statements have been derived from
the consolidated financial statements and accounting records of DePuy and
reflect significant assumptions and allocations. Moreover, as indicated in Note
3, OrthoTech relied on DePuy for administrative, management and other services.
The results of operations and cash flows of OrthoTech could differ from those
that would have resulted had OrthoTech operated autonomously or as an entity
independent of DePuy.
/s/ PRICEWATERHOUSECOOPERS LLP
April 19, 2000
F-26
<PAGE> 36
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
STATEMENTS OF OPERATIONS AND CHANGES IN INVESTED EQUITY
FOR THE PERIOD JANUARY 1, 1998 THROUGH OCTOBER 28, 1998 AND
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
PERIOD FOR THE
JANUARY 1, 1998 YEAR ENDED
THROUGH DECEMBER 31,
OCTOBER 28, 1998 1997
<S> <C> <C>
Net sales $32,863 $38,846
Cost of goods sold 18,190 21,281
------- -------
Gross profit 14,673 17,565
Selling, general and administrative
expenses 10,932 12,795
Research and development expenses 173 323
Amortization expense 1,163 1,389
Allocated expenses from DePuy (Note 3) 749 792
------- -------
13,017 15,299
------- -------
Income before provision for income taxes 1,656 2,266
Provision for income taxes 1,061 1,434
------- -------
Net income $ 595 $ 832
======= =======
Invested equity - beginning of period $51,418 $52,714
Advances from (repayments to) DePuy (1,513) (2,089)
Currency translation adjustment (2) (39)
------- -------
Invested equity - end of period $50,498 $51,418
------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE> 37
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
STATEMENTS OF CASH FLOWS
FOR THE PERIOD JANUARY 1, 1998 THROUGH OCTOBER 28, 1998 AND
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
PERIOD FOR THE
JANUARY 1, 1998 YEAR ENDED
THROUGH DECEMBER 31,
OCTOBER 28, 1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 595 $ 832
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation 447 388
Amortization 1,163 1,389
Deferred income taxes (298) (26)
Provision for accounts receivable 572 102
Changes in operating assets and liabilities:
Increase in accounts receivable (708) (211)
Decrease in other assets 72 375
(Increase) decrease in inventory (939) 295
Increase in accounts payable 121 327
Increase in accrued expenses 843 27
------- -------
Net cash provided by operating activities 1,868 3,498
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (756) (620)
------- -------
Net cash used in investing activities (756) (620)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments to DePuy (1,513) (2,089)
Book overdraft -- (356)
------- -------
Net cash used in financing activities (1,513) (2,445)
------- -------
Net change in cash (401) 433
Cash, beginning of period 612 179
------- -------
Cash, end of period $ 211 $ 612
------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE> 38
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
1. BACKGROUND AND DESCRIPTION OF BUSINESS
Johnson & Johnson is negotiating the sale of the net assets, consisting
principally of inventory, property, plant and equipment, plus certain
rights and intellectual property, of the bracing and soft supports business
of DePuy Orthopaedic Technology, Inc.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate,
public entity from 1993 (year of initial public offering) through March
1996. In March 1996, Orthopedic Technology was purchased by DePuy, Inc.
("DePuy") in a purchase business combination. Shortly after the
acquisition in 1996, the existing DePuy sports medicine business, which
had products in the bracing and soft supports business, was combined with
Orthopedic Technology and the resulting business was renamed DePuy
Orthopaedic Technology, Inc. ("OrthoTech"). DePuy was formed as the result
of a worldwide reorganization completed by its parent, Corange Limited
("Corange"), to realign its worldwide orthopaedic operations into a
stand-alone entity in order to sell shares of the realigned entity to the
public through an Initial Public Offering ("IPO"). The IPO occurred in
October 1996 and approximately 16% of DePuy's shares were sold to the
public.
On May 24, 1997, the shareholders of Corange entered into an agreement to
sell 100% of its shares to an indirect subsidiary of Roche Holding Ltd.
("Roche"), a multinational company. This transaction was finalized on
March 5, 1998. As a result of this transaction, Roche held approximately
84% of DePuy. DePuy continued to operate as an independent organization
until October 28, 1998.
On October 29, 1998, Johnson & Johnson acquired DePuy, in a purchase
business combination, and the existing Johnson & Johnson bracing and soft
supports products (the "J&J Business") were transferred to OrthoTech as of
January 1, 1999. As a result of these transactions, OrthoTech became an
integrated operation of DePuy, which is a wholly-owned subsidiary of
Johnson & Johnson. Refer to Note 2 for additional details.
OrthoTech engages in the development, manufacturing and marketing of
bracing and soft supports products which assist in the treatment of both
hard and soft tissue injury management. OrthoTech's primary markets are
North America, Europe and the Asia Pacific Region. OrthoTech sells its
products through DePuy affiliated companies outside of the U.S. market.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
As described in Note 1, the businesses that comprise OrthoTech were not
under common management control during the entire three year period ended
December 31, 1999. Accordingly, the financial statements of OrthoTech
presented herein represent the predecessor business being sold for the
period in which it was controlled by DePuy and not under common management
control (the period prior to Johnson & Johnson acquiring DePuy on October
29, 1998). Separate combined financial statements of OrthoTech and the J&J
Business have been prepared for the period the business was under common
control (the period subsequent to Johnson & Johnson
F-29
<PAGE> 39
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
acquiring DePuy on October 29, 1998) and separate financial statements of the
J&J Business have been prepared for the period prior to Johnson & Johnson
acquiring DePuy on October 29, 1998 as follows:
a. Separate combined financial statements have been prepared which depict the
combined financial position of OrthoTech and the J&J Business as of December
31, 1999 and 1998, and the combined results of their operations and cash
flows for the year ended December 31, 1999 and the period October 29, 1998
through December 31, 1998. This represents the period in which OrthoTech was
controlled by Johnson & Johnson (October 29, 1998 through December 31,
1999).
b. Separate financial statements have been prepared to depict the revenues and
direct expenses of the J&J Business for the period January 1, 1998 through
October 28, 1998 and the year ended December 31, 1997. This represents the
period in which the bracing and soft supports business, which was later
transferred to OrthoTech and is part of the net assets being sold, was owned
directly by Johnson & Johnson.
The accompanying financial statements exclude the operations of an arthroscopy
business of OrthoTech, which was transferred to another operation of Johnson &
Johnson on January 1, 2000, and is not part of the sale described in Note 1.
As an integrated operation of DePuy, OrthoTech did not, in the normal course of
operations, prepare separate financial statements in accordance with accounting
principles generally accepted in the United States. Accordingly, the
accompanying financial statements have been derived by extracting the assets,
liabilities and revenues and expenses of OrthoTech from the consolidated assets,
liabilities and revenues and expenses of DePuy. The accompanying financial
statements reflect assets, liabilities, revenues and expenses directly
attributable to OrthoTech as well as allocations deemed reasonable by management
to present the results of OrthoTech's operations and cash flows for the period
January 1, 1998 through October 28, 1998 and the year ended December 31, 1997 on
a stand alone basis. The allocation methodologies have been described within the
respective notes and management considers the allocations to be reasonable.
However, the results of operations and cash flows of OrthoTech may differ from
those that may have been achieved had OrthoTech operated autonomously or as an
entity independent of DePuy. In addition, due to the reliance of the OrthoTech
business on DePuy, the historical operating results may not be indicative of
future results.
There was no direct interest expense incurred by OrthoTech therefore, no
interest expense has been reflected in the financial statements.
All significant accounts and transactions within OrthoTech have been eliminated.
RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported. Actual results could differ
from those estimates.
REVENUE RECOGNITION
Revenues from product sales are recognized when goods are shipped and title and
risk of loss passes to customers.
F-30
<PAGE> 40
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
------------------------------------------------------------------------------
CASH
OrthoTech participated in DePuy's cash pooling arrangements, under which
cash balances are cleared automatically to a central account held by
another DePuy business. All transactions between OrthoTech and DePuy have
been accounted for as settled in cash at the time such transactions were
recorded by OrthoTech.
PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
Property, plant and equipment are stated at cost. OrthoTech utilizes the
straight-line method of depreciation over the estimated useful lives of the
assets:
Leasehold improvements Shorter of life of lease or 15 years
Machinery and equipment 3-10 years
Gains and losses on disposals are included in selling, general and
administrative expenses. Major additions and betterments are capitalized,
whereas maintenance and repairs are expensed as incurred.
INTANGIBLE ASSETS
The excess of the cost over the fair value of the net assets of purchased
businesses is recorded as goodwill and is amortized on a straight-line
basis over periods of 30 years or less. The cost of other identifiable
intangibles is amortized on a straight-line basis over their estimated
useful lives.
LONG-LIVED ASSETS
OrthoTech continually evaluates the carrying value of its long-lived
assets, including intangibles, for impairment. Any impairments would be
recognized when the expected future operating cash flows derived from such
intangible assets is less than their carrying value.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
FOREIGN CURRENCY TRANSLATION
The local currencies of OrthoTech's international operations represent
their respective functional currencies. Assets and liabilities of foreign
operations are translated from their respective local currencies to U.S.
dollars using exchange rates in effect at the corresponding balance sheet
dates. Income statement and cash flow amounts are translated using the
average exchange rates in effect during the period. Gains and losses
resulting from foreign currency transactions are included in the results of
operations and are immaterial to the periods presented.
F-31
<PAGE> 41
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
COMPREHENSIVE INCOME
In accordance with Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," components of other comprehensive
income/(loss) consist of the following:
<TABLE>
<CAPTION>
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
<S> <C> <C>
Net income $ 595 $ 832
Other comprehensive income
Currency translation adjustments (2) (39)
------ ------
Total comprehensive income $ 593 $ 793
------ ------
</TABLE>
ADVERTISING
Costs associated with advertising are expensed in the year incurred.
Advertising expenses, which are comprised of print media, television and
radio were $5 and $9 for the period January 1, 1998 through October 28,
1998 and the year ended December 31, 1997, respectively.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
3. TRANSACTIONS WITH DEPUY
OrthoTech relies on DePuy for certain services, including treasury, cash
management, employee benefits, tax compliance, risk management, financial
reporting and general corporate services. Although certain expenses related
to these services have been allocated to OrthoTech, the results of
operations and cash flows presented in the financial statements may not
have been the same as those that would have occurred had OrthoTech been an
independent entity. A description of the related party transactions
follows:
SALES OF PRODUCTS
OrthoTech sells its products through DePuy affiliated companies outside of
the U.S. market. Net sales for such products were $1,392 and $1,677 for the
period from January 1, 1998 through October 28, 1998 and the year ended
December 31, 1997, respectively.
ALLOCATION OF SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
OrthoTech has been allocated a portion of the costs of the DePuy central
support functions. These costs include central departments, notably legal,
tax, treasury, finance, business development, investor relations and human
resources. Such amounts were $324 and $349 for the period January 1, 1998
through October 28, 1998 and for the year ended December 31, 1997,
F-32
<PAGE> 42
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
respectively. Such costs have been allocated to OrthoTech based upon Ortho
Tech's sales to third parties, relative to total DePuy sales to third parties.
Management believes these allocations are reasonable.
In addition, OrthoTech has been allocated a portion of the selling, general and
administrative expenses of the DePuy affiliates outside of the U.S. that sold
OrthoTech's products. Such amounts were $425 and $443 for the period January 1,
1998 through October 28, 1998 and for the year ended December 31, 1997,
respectively. These amounts have been allocated based upon OrthoTech's sales to
third Parties, relative to total DePuy sales to third parties. Management
believes these allocations are reasonable.
The total allocated selling, general and administrative expenses described
above are separately identified on the statements of operations.
INVESTED EQUITY
Invested equity consists of capital contributions by DePuy, borrowings and
repayments to DePuy, retained earnings/deficit and the cumulative translation
adjustment.
INTERCOMPANY ACCOUNT WITH DEPUY
The average intercompany balance outstanding for the period January 1, 1998
through October 28, 1998 and for the year ended December 31, 1997 was a net
receivable due from DePuy of $15,200 and $13,902, respectively.
PENSIONS
Eligible OrthoTech employees are provided with pension benefits through a
noncontributory defined contribution plan which covers substantially all
non-union employees of DePuy in the United States. This plan provides for
targeted benefits based on the employee's average compensation in the years
preceding retirement. In general, DePuy's policy is to contribute actuarially
determined amounts that are expected to be sufficient to meet projected benefit
payment requirements.
Employees of DePuy's international subsidiaries are covered by various pension
benefit arrangements, some of which are considered to be defined benefit plans
for financial reporting purposes. Funding policies are based on legal
requirements, tax considerations and local practices.
Since the aforementioned pension arrangements are part of certain DePuy employee
benefit plans, no discrete actuarial data is available for the portion allocable
to OrthoTech. OrthoTech has been allocated pension costs based upon participant
employee headcount. Net pension expense included in the accompanying financial
statements was $153 and $40 for the period January 1, 1998 through October 28,
1998 and the year ended December 31, 1997, respectively.
SAVINGS PLAN
DePuy also sponsors a 401(k) plan for non-union employees of its domestic
operations. Non-union employees may contribute up to 11% of their compensation,
subject to certain limitations. DePuy matches 100% of an employee's
contribution up to 4% of their compensation. Matching contributions made by
DePuy and expensed were $235 and $278 for the period January 1, 1998 through
October 28, 1998 and the year ended December 31, 1997, respectively.
F-33
<PAGE> 43
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
-------------------------------------------------------------------------------
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Effective January 1, 1998, certain OrthoTech employees become eligible to be
covered under DePuy's unfunded postretirement healthcare benefit plans. In
general, DePuy pays a defined portion of an eligible retiree's healthcare
premium. The plans are contributory based on years of services, with
contributions adjusted annually.
Since the aforementioned postretirement benefit arrangements are part of certain
DePuy benefit plans, no discrete actuarial data is available for the portion
allocable to OrthoTech. OrthoTech has been allocated postretirement benefit
costs based upon participant employee headcount. Net postretirement benefit
expense included in the accompanying financial statements was $84 for the period
January 1, 1998 through October 28, 1998.
STOCK BASED COMPENSATION
For the period January 1, 1998 through October 28, 1998 and the year January 1,
1997 through December 31, 1997, certain employees of OrthoTech participated in
certain DePuy sponsored share option and long-term share incentive plans. Grants
pursuant to these plans were at the market price of the DePuy shares at the date
of grant except for the DePuy Stock Purchase Plan described below for which the
option price is 85% of the fair market value of DePuy stock. DePuy elected to
measure compensation expense based upon the intrinsic value approach under APB
No. 25.
A summary of the status of OrthoTech's participation in DePuy's stock option
plans as of October 28, 1998 and December 31, 1997 and changes during the
periods ending on those dates, is presented below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS EXERCISE
OUTSTANDING PRICE
----------- --------
<S> <C> <C>
Balance at January 1, 1997 61,500 $ 17.50
Option granted 52,500 23.46
Options exercised (1,412) 17.50
Options cancelled/forfeited (20,750) 17.50
----------- --------
Balance at December 31, 1997 91,838 20.86
Options granted - -
Options exercised - -
Options cancelled/forfeited (18,335) 20.38
----------- --------
Balance at October 28, 1998 73,503 $ 21.04
=========== ========
</TABLE>
Had compensation cost for DePuy's stock option grants been determined
consistent with the fair value approach of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" which requires
recognition of compensation cost ratably over the vesting
F-34
<PAGE> 44
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
-----------------------------------------------------------------------------
period of the underlying instruments and had such compensation cost been
allocated to OrthoTech, OrthoTech's net income would have been adjusted to the
amounts indicated below:
<TABLE>
<CAPTION>
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
<S> <C> <C>
Net income - as reported $595 $832
Net income - as adjusted 438 662
</TABLE>
Compensation cost for the determination of Net Income - as adjusted were
estimated using the Black-Scholes option pricing model and the following
assumptions:
<TABLE>
<CAPTION>
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
<S> <C> <C>
Risk free interest rate 5.90% 5.90%
Expected volatility 39.74% 39.74%
Expected dividend yield 0.75% 0.75%
Expected life 6 years 6 years
</TABLE>
The weighted-average fair value of options granted during the year ended
December 31, 1997 was $11.49. The weighted-average fair value of options
granted below market price during 1997 was $11.74. The weighted-average
exercise price of options granted at market price during 1997 was $25.60. The
weighted-average exercise price of options granted below market price during
1997 was $17.50. There were no options granted during the period January 1,
1998 through October 28, 1998.
Effective January 1, 1997, DePuy adopted the DePuy, Inc. Employee Stock
Option/Purchase Plan (the "Stock Purchase Plan") for purposes of providing its
employees with an opportunity to participate in equity ownership by purchasing
DePuy stock at a discount. The committee administering the Stock Purchase Plan
determined the maximum number of shares to be issued during each annual period.
All employees who had completed 90 days of employment were eligible to
participate in offerings under the Stock Purchase Plan. In order to
participate, an eligible employee had to authorize a payroll deduction at a
rate of 1% to 10% of base pay, which was credited to the participant's plan
account. The option price of the stock under the Stock Purchase Plan was 85% of
the fair market value of the stock on the offering commencement date. During
1997, OrthoTech employees purchased approximately 8,850 shares at an average
price of
F-35
<PAGE> 45
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
$17.96. The weighted average fair value was $5.49 per share. There were no
shares purchased by OrthoTech employees during the period January 1, 1998
through October 28, 1998. Compensation cost for the determination of "Net
income-as adjusted" were estimated using the Black-Scholes option pricing
model with the following weighted average assumptions:
<TABLE>
<S> <C>
Risk free interest rate 5.46%
Expected volatility 36.60%
Dividend yield 0.75%
</TABLE>
INCOME TAXES
OrthoTech is not a separate taxable entity in any jurisdiction. Rather, the
OrthoTech's taxable income is included in consolidated income tax returns
of DePuy in most jurisdictions. However, for purposes of these financial
statements, the provision for income taxes has been computed on a separate
return basis. Current income taxes are considered to have been paid or
charged to DePuy. The principal components of deferred taxes are related to
depreciation and amortization of fixed assets and intangibles, and the
impact of certain costs and accruals not currently deductible.
4. DEPUY ACQUISITION OF ORTHOTECH
On March 11, 1996, DePuy acquired all of the outstanding shares of common
stock of Orthopedic Technology, in consideration of $46.3 million in cash.
The purchase method of accounting was applied to this acquisition and the
excess of purchase price over the estimated fair value of net assets
acquired of $41.5 million was allocated to goodwill. The goodwill relating
to this acquisition is amortized on a straight-line basis over a period of
30 years.
5. INCOME TAXES
The provision for income taxes was calculated by applying statutory tax
rates to the reported pretax income after considering permanent items that
do not enter into the determination of taxable income and tax credits
reflected in the consolidated provision of DePuy, which are related to
OrthoTech.
F-36
<PAGE> 46
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
The effective income tax rate differs from the statutory Federal income tax
rate for the following reasons:
<TABLE>
<CAPTION>
PERIOD
JANUARY 1, 1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
<S> <C> <C>
U.S. $1,551 $2,107
Foreign 105 159
------ ------
Income before provision for income taxes $1,656 $2,266
------ ------
Statutory taxes $ 580 $ 793
Tax rates:
Statutory Federal income tax rate 35.0% 35.0%
Goodwill amortization not deductible 24.6% 21.5%
State and local taxes, net of federal tax benefit 3.5% 3.2%
Other 1.0% 3.6%
------ ------
Effective income tax rate 64.1% 63.3%
------ ------
</TABLE>
6. AMORTIZATION OF INTANGIBLE ASSETS
Amortization expense was $1,163 and $1,389 for the period January 1, 1998
through October 28, 1998 and for the year ended December 31, 1997,
respectively.
7. RENTAL EXPENSE AND LEASE COMMITMENTS
Rental expense relating to OrthoTech's administrative building and land
under an operating lease amounted to approximately $387 and $323 for the
period January 1, 1998 through October 28, 1998 and $323 for the year ended
December 31, 1997, respectively.
F-37
<PAGE> 47
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
The approximate minimum rental payments required under operating leases
that have initial or remaining noncancellable lease terms in excess of one
year at October 31, 1998 are:
<TABLE>
<S> <C>
1998 (October through December) $ 84
1999 505
2000 505
2001 505
2002 505
2003 505
Thereafter 7,025
------
Total $9,634
======
</TABLE>
8. CONCENTRATION OF CREDIT RISK
OrthoTech sells its products to physicians, hospitals and clinics located
throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk is limited due to the large numbers of
customers comprising OrthoTech's customer base and their dispersion across
geographic areas. No one customer represents more than 10% of sales.
Ongoing credit evaluations of customers' financial conditions are
performed, and, generally, no collateral is required. OrthoTech maintains
reserves for potential credit losses and such losses, in the aggregate,
have not exceeded management's expectations.
9. GEOGRAPHIC AREAS
Information about OrthoTech's operations by geographic area for the period
January 1, 1998 through October 28, 1998 and for the year end December 31,
1997 are shown below:
<TABLE>
SALES TO OPERATING
PERIOD JANUARY 1, 1998 THROUGH OCTOBER 28, 1998 CUSTOMERS INCOME
<S> <C> <C>
North America $32,084 $1,480
Europe 640 126
Asia Pacific 139 50
------- ------
Total $32,863 $1,656
======= ======
</TABLE>
F-38
<PAGE> 48
DEPUY ORTHOPAEDIC TECHNOLOGY, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
<TABLE>
SALES TO OPERATING
PERIOD ENDED DECEMBER 31, 1997 CUSTOMERS INCOME
<S> <C> <C>
North America $37,941 $2,039
Europe 697 155
Asia Pacific 208 72
------- ------
Total $38,846 $2,266
======= ======
</TABLE>
10. CONTINGENCIES
In the normal course of business, OrthoTech is party to claims and
disputes. OrthoTech has provided for these legal matters where it is
probable that a liability has been incurred and the amount of cost could be
reasonably estimated. While the ultimate outcome of these claims and
lawsuits cannot be readily determined, it is the opinion of management that
none of them, individually or in the aggregate, will have a material
adverse effect on OrthoTech's results of operations or cash flows.
F-39
<PAGE> 49
[PRICEWATERHOUSECOOPERS LETTERHEAD]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Johnson & Johnson:
We have audited the accompanying historical statements of revenues and expenses
of the Bracing and Soft Supports Business of Johnson & Johnson (the "Bracing and
Soft Supports Business"), an integrated operation of Johnson & Johnson, for the
period January 1, 1998 through October 28, 1998 and for the year ended December
31, 1997. These historical statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these historical
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the historical statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the historical statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall presentation of the historical statements. We believe
that our audits provide a reasonable basis for our opinion.
The accompanying historical statements were prepared for the purpose of
complying with the rules and regulations of the Securities and Exchange
Commission as described in Note 2 and are not intended to be a complete
presentation of the Bracing and Soft Supports Business' revenues and expenses.
In our opinion, the historical statements of revenues and expenses present
fairly, in all material respects, the revenues and expenses described in Note 2
of the Bracing and Soft Supports Business for the period January 1, 1998 through
October 28, 1998 and for the year ended December 31, 1997, in conformity with
accounting principles generally accepted in the United States.
For the period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997, the Bracing and Soft Supports Business was a fully integrated
operation of Johnson & Johnson. Consequently, as indicated in Note 2, these
historical statements have been derived from the consolidated financial
statements and accounting records of Johnson & Johnson and reflect significant
assumptions and allocations. Moreover, as indicated Note 2, the Bracing and Soft
Supports Business relied on Johnson & Johnson for administrative, management and
other services. The results of operations of the Bracing and Soft Supports
Business could differ from those that would have resulted had the Bracing and
Soft Supports Business operated autonomously or as an entity independent of
Johnson & Johnson.
/s/ PricewaterhouseCoopers
April 19, 2000
F-40
<PAGE> 50
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Statements of Revenues and Expenses
For the Period January 1, 1998 through October 28, 1998
and for the Year Ended December 31, 1997
(Dollars in thousands)
-----------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
PERIOD
JANUARY 1,
1998 FOR THE
THROUGH YEAR ENDED
OCTOBER 28, DECEMBER 31,
1998 1997
<S> <C> <C>
Net sales $7,640 $7,955
Expenses
Costs of goods sold 4,811 5,857
Selling, marketing and distribution expenses 2,566 2,870
------ ------
Total expenses 7,377 8,727
------ ------
Revenues in excess of expenses/(expenses
in excess of revenues) $ 263 $ (772)
====== ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-41
<PAGE> 51
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Notes to Statements of Revenues and Expenses
(Dollars in thousands)
--------------------------------------------------------------------------------
1. BACKGROUND AND DESCRIPTION OF BUSINESS
Johnson & Johnson is negotiating the sale of the net assets, consisting
principally of inventory, property, plant and equipment, plus certain
rights and intellectual property, of the bracing and soft supports
business of DePuy Orthopaedic Technology, Inc.
Orthopedic Technology, Inc. ("Orthopedic Technology") was a separate,
public entity from 1993 (year of initial public offering) through March
1996. In March 1996, Orthopedic Technology was purchased by DePuy, Inc.
("DePuy"). Shortly after the acquisition in 1996, the existing DePuy sports
medicine business, which had products in the bracing and soft supports
business, was combined with OrthoTech, and the resulting business was
renamed DePuy Orthopaedic Technology, Inc. ("OrthoTech"). Subsequently, on
October 29, 1998, Johnson & Johnson acquired DePuy in a purchase business
combination. The existing Johnson & Johnson bracing and soft supports
products (the "J&J Business") were transferred to OrthoTech as of January
1, 1999. The net assets of the J&J Business will be included in the
potential sale of the net assets of OrthoTech. Accordingly, these
accompanying financial statements relate to the J&J Business.
The J&J Business engages in the development, manufacturing and marketing
of bracing and soft supports products which assist in the treatment of
both hard and soft tissue injury management. The J&J Business' primarily
markets are North America, Europe and the Asia Pacific Region. The J&J
Business sells its products through Johnson & Johnson affiliated companies
outside of the U.S. market.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
As described in Note 1, the businesses that comprise OrthoTech were not
under common management control during the entire three years ended
December 31, 1999. Accordingly, the financial statements of the J&J
Business presented herein represent the J&J Business being sold during the
period it was owned directly by Johnson & Johnson and not under common
management control with OrthoTech (the period prior to Johnson & Johnson
acquiring DePuy on October 29, 1998). Separate combined financial
statements of OrthoTech and the J&J Business have been prepared for the
period it was under common management control (Johnson & Johnson
acquisition of DePuy on October 29, 1998) and separate financial statements
of OrthoTech have been prepared for the period it was not under common
management control (the period prior to Johnson & Johnson acquiring DePuy
on October 29, 1998) as follows:
a. Separate combined financial statements have been prepared to depict
the financial position of OrthoTech and the J&J Business at December
31, 1999 and 1998, and the results of their operations and cash flows
for the year ended December 31, 1999 and the period October 29, 1998
through December 31, 1998. This represents the period in which
OrthoTech was controlled by Johnson & Johnson (October 29, 1998
through December 31, 1999).
b. Separate financial statements have been prepared which depict the
results of operations and cash flows of OrthoTech for the year ended
December 31, 1997 and the period January 1, 1998 through October 28,
1998. This represents the period in which OrthoTech was controlled by
DePuy (prior to Johnson & Johnson acquiring DePuy).
F-42
<PAGE> 52
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Notes to Statements of Revenues and Expenses
(Dollars in thousands)
--------------------------------------------------------------------------------
As an integrated operation of Johnson & Johnson, the J&J Business did not, in
the normal course of operations, prepare separate financial statements in
accordance with accounting principles generally accepted in the United States.
The Statements of Revenues and Expenses are derived by extracting the revenues
and direct expenses of the J&J Business from the consolidated revenues and
expenses of Johnson & Johnson. Accordingly, the accompanying financial
statements have been prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission and reflect revenues and
expenses directly attributable to the J&J Business and are not intended to be a
complete presentation of the J&J Business' revenues and expenses. The operations
of the J&J Business rely on Johnson & Johnson affiliated companies for selling,
marketing, sales order processing, billing, collections, warehousing,
distribution, information technology, insurance, human resources, accounting,
premises, regulatory, treasury, tax and legal support. The direct expenses of
the J&J Business presented in these statements include selling, marketing,
warehousing and distribution and have been allocated based on management's
estimates of the cost of service provided to the J&J Business by other Johnson
& Johnson affiliated companies. Management believes that these allocations are
based on assumptions that are reasonable under the circumstances. Allocations of
general and administrative expenses and Johnson & Johnson Corporate overhead
have been excluded from these statements. Due to the reliance of the J&J
Business on Johnson & Johnson and its affiliated companies, the historical
operating results may not be indicative of future results.
There was no direct interest expense incurred by or allocated to the J&J
Business, therefore, no interest expense has been reflected in these statements.
All significant intercompany accounts and transactions within the J&J Business
have been eliminated.
REVENUE RECOGNITION
Revenue is recognized from product sales when the goods are shipped and title
and risk of loss passes to the customer.
SELLING, MARKETING AND DISTRIBUTION EXPENSES
The direct selling, marketing and distribution expenses includes an allocation
of such expenses from Johnson & Johnson and its affiliates. Different allocation
methods apply to the various components of these expenses. Management believes
that these allocation methods, which include sales, employee headcount, case and
volume weight, are reasonable.
The direct expenses allocated to the J&J Business by Johnson & Johnson and its
affiliates for the period January 1, 1998 through October 28, 1998 and for the
year ended December 31, 1997 for selling, marketing, warehousing and
distribution were $2,566 and $2,870, respectively.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined on the
first-in, first-out ("FIFO") method.
FOREIGN CURRENCY TRANSLATION
The local currencies of the J&J Business' international operations represent
their respective functional currencies. Revenues and expense amounts are
translated using the average exchange rates in affect during the period.
F-43
<PAGE> 53
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON & JOHNSON
Notes to Statements of Revenues and Expenses
(Dollars in thousands)
--------------------------------------------------------------------------------
RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management
to make estimates and assumptions that affect the amounts reported.
Actual results could differ from those estimates.
3. INCOME TAXES
The J&J Business is not a separate legal taxable entity for Federal,
state or local income tax purposes and therefore, a provision for income
taxes has not been presented in these statements. The operations of the
J&J Business are included in the consolidated Federal income tax return
of Johnson & Johnson, to the extent appropriate and are included in the
Foreign, state and local returns of the other Johnson & Johnson domestic
and international affiliates.
4. INTERNATIONAL OPERATIONS
Net sales of the international operations of the J&J Business for the
period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997, were $1,817 and $2,431, respectively.
5. RETIREMENT AND PENSION PLANS
Certain of the J&J Business' employees are covered under various
retirement and pension plans which are sponsored by Johnson & Johnson
and its affiliates. Net pension expense charged to the J&J Business for
its participation in the Johnson & Johnson defined benefit plans for the
period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997, was approximately $11 and $11, respectively.
Certain of J&J Business' employees also participate in a voluntary
401(k) savings plan sponsored by Johnson & Johnson which is designed to
enhance the existing retirement program covering eligible domestic
employees. The J&J Business was charged approximately $12 and $11 for
its portion of Johnson & Johnson contributions to the savings plan for
the period January 1, 1998 through October 28, 1998 and for the year
ended December 31, 1997, respectively.
6. OTHER POSTRETIREMENT BENEFITS
The J&J Business, through Johnson & Johnson sponsored plans, provides
postretirement benefits, primarily health care, to all domestic retired
employees and their dependents. Most international employees are covered
by government-sponsored programs and the cost of the J&J Business is not
significant. The J&J Business does not fund retiree health care benefits
in advance and has the right to modify these plans in the future. The
cost of providing these postretirement benefits is determined in
accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions."
F-44
<PAGE> 54
BRACING AND SOFT SUPPORTS BUSINESS OF JOHNSON
NOTES TO STATEMENTS OF REVENUES AND EXPENSES
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------
Net postretirement benefit costs charged to the J&J Business for the
period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997 was $12 and $11, respectively.
The J&J Business, through Johnson & Johnson, provides certain other
postemployment benefits. The cost of providing these postemployment
benefits is determined in accordance with the provisions of SFAS No.
112, "Employers' Accounting for Postemployment Benefits."
Net postemployment benefit costs charged to the J&J Business for the
period January 1, 1998 through October 28, 1998 and for the year ended
December 31, 1997 was $19 and $18, respectively.
7. CONCENTRATION OF CREDIT RISK
The J&J Business sells its products to physicians, hospitals and clinics
located throughout North America, Europe and the Asia Pacific Region.
Concentrations of credit risk is limited due to the large numbers of
customers comprising the J&J Business customer base and their dispersion
across geographic areas. No one customer represents more than 10% of
sales.
8. CONTINGENCIES
In the normal course of business, the J&J Business is party to claims
and disputes. The J&J Business' has provided for these legal matters
where it is probable that a liability has been incurred and the amount
of cost could be reasonably estimated. While the ultimate outcome of
these claims and lawsuits cannot be readily determined, it is the
opinion of management that none of them, individually or in the
aggregate, will have a material adverse effect on the J&J Business'
results of operations.
F-45
<PAGE> 55
DONJOY, L.L.C.
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA
The following unaudited pro forma consolidated financial data of DonJoy, L.L.C.
(the "Company") is based on the Company's historical financial statements for
the year ended December 31, 1999 contained in its Annual Report on Form 10-K for
the year then ended and the three month period ended April 1, 2000 contained in
its Quarterly Report on Form 10-Q, and Orthotech's historical financial
statements appearing elsewhere in this report, as adjusted to illustrate the
estimated effects of the Transaction and related financing transactions during
the periods presented, and reclassifications to Orthotech's financial statements
to conform with the Company's presentation and financial statement
classifications.
The unaudited pro forma consolidated balance sheet gives effect to the
Transaction as if it occurred on April 1, 2000. The unaudited pro forma
consolidated statements of income for the year ended December 31, 1999 and for
the three-month period ended April 1, 2000 give effect to the Transaction as if
it had occurred on January 1, 1999.
The pro forma adjustments are based upon available information and certain
assumptions that the Company believes are reasonable under the circumstances.
The unaudited pro forma consolidated financial data does not purport to
represent what financial position or consolidated results of operations would
have actually been if the Transaction had in fact occurred on the dates
indicated and are not necessarily representative of the Company's consolidated
financial position or consolidated results of operations for any future date or
period. The unaudited pro forma consolidated financial data should be read in
conjunction with the above-referenced historical financial statements and the
notes thereto of the Company and Orthotech.
TRANSACTION OVERVIEW AND INTEGRATION PLAN
The Company is not acquiring any of Orthotech's facilities or the majority of
its employees and instead will integrate the Orthotech operations into its
existing business. Upon closing of the Transaction, DePuy Orthopaedic has all
responsibility with regards to lease obligations on the Orthotech facility and
severance obligations for terminated Orthotech employees. The synergies the
Company anticipates arising from the Transaction are due primarily to reduction
of headcount, the transfer of the majority of Orthotech's sales force to
independent distributors and consolidation of the operations into the Company's
manufacturing facilities.
In accordance with the Transition Services Agreement, DePuy Orthopaedic has
agreed to provide certain transitional services to DJ for varying periods while
the operations of Orthotech are integrated into those of DJ. Such services
include continued operation of Orthotech's manufacturing facilities, employee
payroll service and benefits, and computer services and other administrative
services.
The Company plans to integrate Orthotech into its business over a period of 90
days. Approximately 85% - 90% of Orthotech's manufactured products will be
rationalized against DJ's product line, with the remaining manufactured products
either offered as new products or discontinued. In addition, Orthotech product
offerings will be rationalized into the Company's DonJoy, ProCare, international
and OfficeCare distribution channels.
Historically, Orthotech sold its products internationally to related party
distributors who then re-sold the Orthotech products to the end user consumer.
In Orthotech's historical financial statements, Orthotech recorded these
revenues based on the sales value to the end user consumer. The Company
will not utilize Orthotech's related party distributors. The Company intends to
sell internationally at a pre-determined transfer price to third party
distributors at sales values that are less than those realized on sales to the
end user consumer.
F-46
<PAGE> 56
DONJOY, L.L.C.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
April 1, 2000
(Dollars in thousands)
<TABLE>
<CAPTION>
Pro Forma
Historical Adjustments Pro Forma
---------- ------------- ---------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ........................ $ 8,676 $ (1,980)(a) $ 6,696
Accounts receivable, net of allowance for doubtful
accounts of $1,391 ............................ 21,579 - 21,579
Accounts receivable, related parties ............. 1,469 - 1,469
Inventories, net ................................. 13,707 5,475(b) 19,182
Other current assets ............................. 1,123 - 1,123
---------- ------------- ---------
Total current assets ................................ 46,554 3,495 50,049
Property, plant and equipment, net .................. 7,750 1,250(b) 9,000
Intangible assets, net .............................. 32,495 42,510(b) 75,005
Debt issuance costs, net ............................ 6,830 425(a) 7,255
Other assets ........................................ 321 451(b) 772
---------- ------------- ---------
Total assets ........................................ $ 93,950 $ 48,131 $ 142,081
========== ============= =========
LIABILITIES AND MEMBERS' (DEFICIT) EQUITY
Current liabilities:
Accounts payable ................................. $ 5,695 $ - $ 5,695
Accounts payable, related parties ................ 20 - 20
Accrued compensation ............................. 1,872 - 1,872
Accrued commissions .............................. 1,132 - 1,132
Long-term debt, current portion .................. 500 580(a) 1,080
Accrued interest ................................. 3,682 - 3,682
Other accrued liabilities ........................ 4,085 - 4,085
---------- ------------- ---------
Total current liabilities ........................... 16,986 580 17,566
12 5/8% Senior Subordinated Notes ................... 98,106 - 98,106
Long-term debt, less current portion ................ 14,625 23,420(a) 38,045
Revolving credit facility ........................... - 12,600(a) 12,600
Redeemable Preferred Units; 100,000 units authorized,
40,184 units issued and outstanding at
April 1, 2000; liquidation preference $34,872 at
April 1, 2000 ................................... 33,878 3,433(a) 37,311
Members' deficit:
Common units; 2,900,000 units authorized, 718,000
units issued and outstanding at April 1, 2000 ... 66,521 8,272(a) 74,793
Notes receivable from officers ................... (1,400) (174)(a) (1,574)
Accumulated deficit .............................. (134,766) - (134,766)
---------- ------------- ---------
Total members' (deficit) equity ..................... (69,645) 8,098 (61,547)
---------- ------------- ---------
Total liabilities and members' (deficit) equity ..... $ 93,950 $ 48,131 $ 142,081
========== ============= =========
</TABLE>
See accompanying notes to Unaudited Pro Forma Consolidated Balance Sheet.
F-47
<PAGE> 57
DONJOY, L.L.C.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
(Dollars in thousands in all tables)
(a) The Company financed the Transaction through borrowings under its Amended
Credit Agreement, common and preferred equity financing and available cash.
Under the Amended Credit Agreement, the Company borrowed $24.0 million
under a new term loan facility along with a $12.6 million borrowing on the
revolving line of credit. Gross proceeds of $8.3 million from the sale of
common units were received through the issuance of 73,775 common units to
Chase DJ Partners, LLC (CDP) for gross proceeds of $8.0 million along with
the issuance of 2,115 common units to Management for gross proceeds of
$231,000 (of which $174,000 in promissory notes were issued by DonJoy,
L.L.C.). 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. The following table lists the sources and uses of funds
related to the Transaction (in thousands):
<TABLE>
<CAPTION>
SOURCES
-------
<S> <C>
Cash $ 1,980
Revolving credit facility 12,600
Term loan 24,000
Redeemable Preferred Units 3,595
Common unit investment by CDP 8,041
Common unit investment by
Management 231
---------
$ 50,447
=========
</TABLE>
<TABLE>
<CAPTION>
USES
----
<S> <C>
Cash to DePuy Orthopaedic $ 47,111
Management promissory notes 174
Transaction fees and costs 2,575
Debt issuance costs 425
Redeemable Preferred Unit fee 162
----------
$ 50,447
==========
</TABLE>
(b) The Purchase Price of $49.7 million includes $47.1 million paid to DePuy
Orthopaedic along with $2.6 million in fees and costs (the remaining $0.4
million of fees and costs related to debt issuance costs that will be
amortized over the terms of the related debt instruments). The Company is
in the process of conducting an independent valuation to determine the fair
value of the assets acquired. The Purchase Price, including related fees
and costs, has been preliminarily allocated to the tangible and intangible
assets acquired based on their estimated fair market values. Upon
completion of the independent valuation, adjustments to the preliminary
allocation may be required. Under the Asset Purchase Agreement, the Company
did not assume any liabilities existing prior to the closing date.
The following is the allocation of the Purchase Price (in thousands):
<TABLE>
<CAPTION>
<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>
(1) Includes $0.7 million for the incremental cost of fair market value
on inventories.
(2) The depreciation and amortization periods range from 3 to 7 years
for equipment, furniture and fixtures and 3 to 15 years for the
intangibles.
F-48
<PAGE> 58
DONJOY, L.L.C.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
FISCAL YEAR ENDED DECEMBER 31, 1999
(Dollars in thousands)
<TABLE>
<CAPTION>
DonJoy Orthotech Pro Forma
Historical Historical Adjustment Pro Forma
----------- ---------- ------------ ---------
<S> <C> <C> <C> <C>
Total net revenues ...................... $ 114,252 $ 48,423 $ (1,703)(a) $ 160,972
Cost of goods sold ...................... 51,056 27,019 (3,957)(b) 74,118
----------- ---------- ------------ ---------
Gross profit ............................ 63,196 21,404 2,254 86,854
Operating expenses:
Sales and marketing ................. 27,424 12,859 927 (c) 41,210
General and administrative .......... 16,755 6,752 (780)(d) 22,727
Research and development ............ 2,115 286 - 2,401
Merger and integration costs ........ - - 400 (e) 400
----------- ---------- ------------ ---------
Total operating expenses ................ 46,294 19,897 547 66,738
----------- ---------- ------------ ---------
Income from operations .................. 16,902 1,507 1,707 20,116
Interest expense ........................ (7,568) - (3,572)(f) (11,140)
Interest income ......................... 181 - - 181
----------- ---------- ------------ ---------
Income before income taxes .............. 9,515 1,507 (1,865) 9,157
Provision (benefit) for income taxes .... 2,387 1,406 (1,406)(g) 2,387
----------- ---------- ------------ ---------
Net income and comprehensive net income . $ 7,128 $ 101 $ (459) $ 6,770
=========== ========== ============ =========
EBITDA (h)(i) ........................... $ 25,082 $ 4,404 $ 33,296
=========== ========== =========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Consolidated Statements of Income.
F-49
<PAGE> 59
DONJOY, L.L.C.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED APRIL 1, 2000
(Dollars in thousands)
<TABLE>
<CAPTION>
DonJoy Orthotech Pro Forma
Historical Historical Adjustment Pro Forma
----------- ---------- ------------ ----------
<S> <C> <C> <C> <C>
Total net revenues ...................... $ 31,585 $ 12,406 $ 35(a) $ 44,026
Cost of goods sold ...................... 12,673 6,614 (1,107)(b) 18,180
----------- ---------- ------------ ----------
Gross profit ............................ 18,912 5,792 1,142 25,846
Operating expenses:
Sales and marketing ................. 7,713 3,401 608(c) 11,722
General and administrative .......... 4,783 1,913 (352)(d) 6,344
Research and development ............ 607 139 - 746
Merger and integration costs ........ - - - -
----------- ---------- ------------ ----------
Total operating expenses ................ 13,103 5,453 256 18,812
----------- ---------- ------------ ----------
Income from operations .................. 5,809 339 886 7,034
Interest expense ........................ (3,811) - (893)(f) (4,704)
Interest income ......................... 125 - - 125
----------- ---------- ------------ ----------
Income before income taxes .............. 2,123 339 (7) 2,455
Provision (benefit) for income taxes .... - 344 (344)(g) -
----------- ---------- ------------ ----------
Net income and comprehensive net income . $ 2,123 $ (5) $ 337 $ 2,455
=========== ========== ============ ==========
EBITDA (h) .............................. $ 7,076 $ 1,007 $ 9,217
=========== ========== ==========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Consolidated Statements of Income.
F-50
<PAGE> 60
DONJOY, L.L.C.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands in all tables)
(a) Reclassification entry to make treatment of Orthotech's bad debt expense
consistent with the Company's presentation and eliminate the sales value in
excess of the transfer price associated with Orthotech international
related party distributors, as follows:
<TABLE>
<CAPTION>
Three Months
Year Ended Ended
December 31, 1999 April 1, 2000
----------------- -------------
<S> <C> <C>
Reclassification of bad debt expense ........................ $ 2,113 $ 833
Elimination of sales value in excess of transfer price ...... (3,816) (798)
------- -------
$(1,703) $ 35
======= =======
</TABLE>
(b) Entry records the (i) elimination of cost of goods sold associated with
Orthotech international related party distributors, (ii) elimination of
salaries, wages and benefits as a result of the consolidation of the
Orthotech operations into the Company's existing facilities in Vista,
California, (iii) elimination of discontinued building costs for the
Orthotech facility, (iv) estimated incremental cost of the fair market
value of acquired inventories, and (v) estimated incremental depreciation
of the fair market value of acquired property, plant and equipment on a
straight line basis over the estimated economic lives of the underlying
fixed assets ranging from 3 to 7 years, as follows:
<TABLE>
<CAPTION>
Three Months
Year Ended Ended
December 31, 1999 April 1, 2000
----------------- -------------
<S> <C> <C>
Cost of sales associated with Orthotech international related
party distributors ....................................... $(2,132) $ (471)
Elimination of salaries, wages and benefits .................... (2,103) (525)
Elimination of building costs .................................. (543) (136)
Incremental cost of fair market value on inventories ........... 717 -
Incremental depreciation on fair market value on property,
plant and equipment ....................................... 104 25
------- -------
$(3,957) $(1,107)
======= =======
</TABLE>
(c) Reclassification entry to make treatment of Orthotech's bad debt expense
consistent with the Company's presentation and eliminate selling costs
associated with Orthotech international related party distributors, as
follows:
<TABLE>
<CAPTION>
Three Months
Year Ended Ended
December 31, 1999 April 1, 2000
----------------- -------------
<S> <C> <C>
Reclassification of bad debt expense ....................... $ 1,979 $ 828
Elimination of selling costs associated with Orthotech
international related party distributors .............. (1,052) (220)
------- -------
$ 927 $ 608
======= =======
</TABLE>
(d) Entry records (i) reclassification to make treatment of Orthotech's bad
debt expense consistent with the Company's presentation, (ii) elimination
of administrative expenses associated with Orthotech international related
party distributors, (iii) transition expenses including relocation costs,
facility move costs, training and other related costs that are not allowed
to be classified as merger and integration costs, (iv) depreciation on
expenditures associated with the consolidation of Orthotech into the
Company's existing facilities, (v) elimination of salaries, wages and
benefits as a result of the consolidation of Orthotech operations into the
Company's existing facilities, (vi) elimination of discontinued building
costs for the Orthotech facility, (vii) elimination of amortization
recorded by Orthotech, and (viii)
F-51
<PAGE> 61
amortization of the estimated fair value of goodwill and other intangible
assets acquired over economic lives ranging from 3 to 15 years, as follows:
<TABLE>
<CAPTION>
Three Months
Year Ended Ended
December 31, 1999 April 1, 2000
----------------- -------------
<S> <C> <C>
Reclassification of bad debt expense ........................... $ 134 $ 5
Elimination of administrative expenses related to Orthotech
international related party distributors ................... (203) (42)
Transition expenses ............................................ 550 -
Elimination of salaries, wages and benefits .................... (1,919) (480)
Elimination of building costs .................................. (224) (56)
Elimination of amortization recorded by Orthotech .............. (2,044) (510)
Amortization of intangibles recorded at fair market value ...... 2,926 731
------- -------
$ (780) $ (352)
======= =======
</TABLE>
(e) Entry records estimated 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.
(f) Pro forma adjustments to interest expense as a result of the Transaction
are as follows:
<TABLE>
<CAPTION>
Three Months
Year Ended Ended
December 31, 1999 April 1, 2000
----------------- -------------
<S> <C> <C>
Increase in term loan ($24,000 at assumed weighted average
rate of 9.57%) ................................................ $2,297 $ 574
Existing revolving credit facility ($12,600 at assumed weighted
average rate of 9.07%) ....................................... 1,142 285
Commitment fee on unused portion of revolving credit facility
($12,400 at 0.5%) ............................................. 62 16
Amortization of debt issuance costs .............................. 71 18
------ ------
$3,572 $ 893
====== ======
</TABLE>
(g) Eliminates the provision for income taxes recorded by Orthotech. On June
30, 1999, DonJoy became a stand-alone limited liability company, as such
the earnings of DonJoy and its subsidiaries will be included in the taxable
income of its members. The provision for income taxes for 1999 is for the
period prior to DonJoy becoming a stand-alone limited liability company.
(h) EBITDA is defined as income from operations plus merger and integration
costs, and depreciation and amortization. EBITDA is not a measure of
performance under general accepted accounting principles. EBITDA should not
be considered in isolation or as a substitute for net income, cash flows
from operating activities and other income or cash flow statement data
prepared in accordance with generally accepted accounting principles, or as
a measure of profitability or liquidity. However, Management has included
EBITDA because it may be used by certain investors to analyze and compare
companies on the basis of operating performance, leverage and liquidity and
to determine a company's ability to service debt. The Company's definition
of EBITDA may not be comparable to that of other companies.
(i) "Adjusted EBITDA" represents EBITDA (as defined above) adjusted to
eliminate:
- charges for brand royalties paid by DonJoy to Smith & Nephew for use of
the Smith & Nephew trademarks and trade names which amounts are no
longer paid following the recapitalization;
F-52
<PAGE> 62
- Smith & Nephew overhead allocations for corporate managed accounts and
new business expense and corporate management expense which were not
incurred following consummation of the recapitalization (the "Eliminated
Allocations");
- Smith & Nephew overhead allocations for research and development and for
amounts charged by Smith & Nephew for services provided to DonJoy for
finance (risk management, treasury, audit and taxes), human resources
and payroll and legal services (collectively, the "Other Corporate
Allocations");
- adjustments to include the costs incurred by DonJoy to replace the
services previously provided by Smith & Nephew as part of the Other
Corporate Allocations;
The following are the EBITDA adjustments:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
DonJoy Orthotech Pro Forma
Historical Historical Adjustments Pro Forma
---------- ---------- ------------ ---------
<S> <C> <C> <C> <C>
EBITDA $ 21,854 $ 4,180 $ 3,093(1) $ 29,127
Brand royalties 1,817 - - 1,817
Eliminated Allocations 979 - - 979
Other Corporate Allocations 832 - - 832
Estimated costs to replace Smith &
Nephew services (400) - - (400)
Eliminated step-up in inventory - 224 717(2) 941
======== ======== ======== ========
Adjusted EBITDA $ 25,082 $ 4,404 $ 3,810 $ 33,296
======== ======== ======== ========
</TABLE>
(1) Pro Forma Adjustments related to EBITDA include the amounts
discussed above in Notes to Unaudited Pro Forma Consolidated
Statements of Income, excluding the amounts for depreciation and
amortization, interest and income taxes.
(2) Eliminates the incremental cost of the fair market value of acquired
inventories associated with the Transaction (See Note (b) to Notes
to Unaudited Pro Forma Consolidated Statements of Income).
F-53
