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DJO FINANCE LLC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

April 29, 2014

Introduction

This management's discussion and analysis of financial condition and results of operations is intended to provide an understanding of our results of operations, financial condition and where appropriate, factors that may affect future performance. The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and related notes thereto as well as the other financial data included elsewhere in this Form 10-Q.



Forward Looking Statements

This report, and the following management's discussion and analysis, contain "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. To the extent that any statements are not recitations of historical fact, such statements constitute forward-looking statements that, by definition, involve risks and uncertainties. These statements can be identified because they use words like "anticipates", "believes", "estimates", "expects", "forecasts", "future", "intends", "plans" and similar terms. Specifically, statements referencing, without limitation, growth in sales of our products, profit margins and the sufficiency of our cash flow for future liquidity and capital resource needs may be forward-looking statements. These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. The section entitled "Risk Factors" in our 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 25, 2014 describes these important risk factors that may affect our business, financial condition, results of operations, and/or liquidity. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors. Overview of Business We are a global developer, manufacturer and distributor of high-quality medical devices that provide solutions for musculoskeletal health, vascular health and pain management. Our products address the continuum of patient care from injury prevention to rehabilitation after surgery, injury or from degenerative disease, enabling people to regain or maintain their natural motion. Our products are used by orthopedic specialists, spine surgeons, primary care physicians, pain management specialists, physical therapists, podiatrists, chiropractors, athletic trainers and other healthcare professionals. In addition, many of our medical devices and related accessories are used by athletes and patients for injury prevention and at-home physical therapy treatment. Our product lines include rigid and soft orthopedic bracing, hot and cold therapy, bone growth stimulators, vascular therapy systems and compression garments, therapeutic shoes and inserts, electrical stimulators used for pain management and physical therapy products. Our surgical implant business offers a comprehensive suite of reconstructive joint products for the hip, knee and shoulder.



Our products are marketed under a portfolio of brands including Aircast®, DonJoy®, ProCare®, CMF™, Empi®, Chattanooga, DJO Surgical, Dr. Comfort™, Compex®, Bell-Horn™ and Exos™.

Operating Segments

We currently develop, manufacture and distribute our products through the following four operating segments:

Bracing and Vascular Segment

Our Bracing and Vascular segment, which generates its revenues in the United States, offers our rigid knee bracing products, orthopedic soft goods, cold therapy products, vascular systems, therapeutic shoes and inserts and compression therapy products, primarily under the DonJoy, ProCare, Aircast, Dr. Comfort, Bell-Horn and Exos brands. This segment also includes our OfficeCare business, through which we maintain an inventory of soft goods and other products at healthcare facilities, primarily orthopedic practices, for immediate distribution to patients. The Bracing and Vascular segment primarily sells its products to orthopedic and sports medicine professionals, hospitals, podiatry practices, orthotic and prosthetic centers, home medical equipment providers and independent pharmacies.



Recovery Sciences Segment

Our Recovery Sciences segment, which generates its revenues in the United States, is divided into four main businesses:

Empi. Our Empi business unit offers our home electrotherapy, iontophoresis, and home traction products. We primarily sell these



products directly to patients or to physical therapy clinics. For products

sold to patients, we arrange billing to the patients and their third party

payors. 32



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• CMF. Our CMF business unit sells our bone growth stimulation products. We

sell these products either directly to patients or to independent distributors. For products sold to patients, we arrange billing to the patients and their third party payors.



Chattanooga. Our Chattanooga business unit offers products in the clinical

rehabilitation market in the category of clinical electrotherapy devices,

clinical traction devices, and other clinical products and supplies such

as treatment tables, continuous passive motion (CPM) devices and dry heat

therapy.



• Athlete Direct. Our Athlete Direct business unit offers consumers ranging

from fitness enthusiasts to competitive athletes our Compex

electrostimulation device, which is used in athletic training programs to

aid muscle development and to accelerate muscle recovery after training

sessions. Surgical Implant Segment



Our Surgical Implant segment, which generates its revenues in the United States, develops, manufactures and markets a wide variety of knee, hip and shoulder implant products that serve the orthopedic reconstructive joint implant market.

International Segment

Our International segment, which generates most of its revenues in Europe, sells all of our products and certain third party products through a combination of direct sales representatives and independent distributors. Our four operating segments enable us to reach a diverse customer base through multiple distribution channels and give us the opportunity to provide a wide range of medical devices and related products to orthopedic specialists and other healthcare professionals operating in a variety of patient treatment settings. These four segments constitute our reportable segments. See Note 15 to our Unaudited Condensed Consolidated Financial Statements for financial and other additional information regarding our segments. The tables below present financial information for our reportable segments for the periods presented. Segment results exclude the impact of amortization of intangible assets, certain general corporate expenses, and non-recurring and integration charges. Three Months Ended March 29, March 30, ($ in thousands) 2014 2013 Bracing and Vascular: Net sales $ 109,506$ 108,140 Gross profit $ 57,329$ 55,677 Gross profit margin 52.4 % 51.5 % Operating income $ 19,485$ 17,519



Operating income as a percent of net segment sales 17.8 %

16.2 % Recovery Sciences: Net sales $ 68,870$ 75,521 Gross profit $ 51,900$ 56,918 Gross profit margin 75.4 % 75.4 % Operating income $ 17,398$ 18,197



Operating income as a percent of net segment sales 25.3 %

24.1 % Surgical Implant: Net sales $ 23,932$ 21,483 Gross profit $ 17,693$ 15,702 Gross profit margin 73.9 % 73.1 % Operating income $ 2,820$ 1,884



Operating income as a percent of net segment sales 11.8 %

8.8 % International: Net sales $ 80,436$ 73,933 Gross profit $ 44,231$ 41,935 Gross profit margin 55.0 % 56.7 % Operating income $ 14,706$ 15,941

Operating income as a percent of net segment sales 18.3 % 21.6 % 33



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Results of Operations

Changes in our financial results include the impact of changes in foreign currency exchange rates in the current year. We provide "constant currency" calculations to remove the impact of this item from our results of operations.

When we use the term "constant currency," it means that we have translated financial data for a period into U.S. Dollars using the same foreign currency exchange rates that we used to translate financial data for the previous period. We believe that this calculation is a useful measure, indicating the actual growth of our operations. The constant currency financial measure is used to supplement measures that are in accordance with U.S. Generally Accepted Accounting Principles ("GAAP"). This financial measure is not a measure of financial performance under GAAP, and should not be considered as an alternative to measures presented in accordance with GAAP. The following table sets forth our statements of operations as a percentage of net sales ($ in thousands): Three Months Ended March 29, March 30, 2014 2013 Net sales $ 282,744 100.0 % $ 279,077 100.0 % Cost of sales (exclusive of amortization of intangible assets (1)) 115,748 40.9 109,639 39.3 Gross profit 166,996 59.1 169,438 60.7 Operating expenses: Selling, general and administrative 123,482 43.7 117,835 42.2 Research and development 9,753 3.4 7,979 2.9 Amortization of intangible assets 23,559 8.3 23,831 8.5 156,794 55.4 149,645 53.6 Operating income 10,202 3.7 19,793 7.1 Other (expense) income: Interest expense (43,728 ) (15.5 ) (45,445 ) (16.3 ) Interest income 57 0.0 36 0.0 Loss on modification and extinguishment of debt - - (1,059 ) (0.4 ) Other expense, net (80 ) (0.0 ) (617 ) (0.2 ) (43,751 ) (15.5 ) (47,085 ) (16.9 ) Loss before income taxes (33,549 ) (11.8 ) (27,292 ) (9.8 ) Income tax provision (2,624 ) (1.0 ) (4,834 ) (1.7 ) Net loss (36,173 ) (12.8 ) (32,126 ) (11.5 ) Net income attributable to noncontrolling interest (349 ) (0.1 ) (238 ) (0.1 )



Net loss attributable to DJO Finance LLC$ (36,522 ) (12.9 )%

$ (32,364 ) (11.6 )%



(1) Cost of sales is exclusive of amortization of intangible assets of $8,683 and

$8,788 for the three months ended March 29, 2014 and March 30, 2013,

respectively.

Three Months Ended March 29, 2014 (first quarter 2014) compared to Three Months Ended March 30, 2013 (first quarter 2013)

Net Sales. Our net sales for first quarter 2014 were $282.7 million, compared to net sales of $279.1 million for first quarter 2013, representing a 1.3% increase year over year. Net sales for first quarter 2014 were not materially affected by changes in foreign currency exchange rates compared to the rates in effect in first quarter 2013, but were impacted by fewer shipping days compared to first quarter 2013. First quarter 2014 included 62 shipping days while first quarter 2013 included 63 days. In constant currency, average daily sales for first quarter 2014 increased 2.5% compared to average daily sales for first quarter 2013. 34



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The following table sets forth the mix of our net sales by business segment ($ in thousands): First Quarter % of Net First Quarter % of Net Increase % Increase 2014 Sales 2013 Sales (Decrease) (Decrease)

Bracing and Vascular $ 109,506 38.7 % $ 108,140 38.7 % $ 1,366 1.3 % Recovery Sciences 68,870 24.4 75,521 27.1 (6,651 ) (8.8 ) Surgical Implant 23,932 8.5 21,483 7.7 2,449 11.4 International 80,436 28.4 73,933 26.5 6,503 8.8 $ 282,744 100.0 % $ 279,077 100.0 % $ 3,667 1.3 % Net sales in our Bracing and Vascular segment were $109.5 million for first quarter 2014, increasing 1.3% from net sales of $108.1 million for first quarter 2013. Average daily sales for first quarter 2014 for the Bracing and Vascular segment increased 3.0% compared to average daily sales for first quarter 2013. Growth in net sales in this segment is being driven by sales of new products as well as increased sales of existing products. Net sales in our Recovery Sciences segment were $68.9 million for first quarter 2014, decreasing 8.8% from net sales of $75.5 million for first quarter 2013. Average daily sales for first quarter 2014 for the Recovery Sciences segment decreased 7.5% compared to average daily sales for first quarter 2013. The decrease was primarily driven by changes in reimbursement for certain products in our Empi business unit and by slow market conditions for the capital equipment sold by our Chattanooga business unit. Net sales in our Surgical Implant segment were $23.9 million for first quarter 2014, increasing 11.4% from net sales of $21.5 million for first quarter 2013. Average daily sales for first quarter 2014 for the Surgical Implant segment increased 13.2% compared to average daily sales for first quarter 2013. The increase was driven by strong sales of our shoulder products as well as sales of new products and strong sales execution. Net sales in our International segment were $80.4 million for first quarter 2014, increasing 8.8% from net sales of $73.9 million for first quarter 2013. In constant currency, excluding a favorable impact of $0.9 million related to changes in foreign exchange rates in effect in first quarter 2014 compared to the rates in effect in first quarter 2013, average daily sales for first quarter 2014 for the International segment increased 8.9% compared to average daily sales for first quarter 2013. Growth in net sales in this segment is being driven by sales from new products, improved sales execution and increased sales penetration in certain geographies. Gross Profit. Consolidated gross profit as a percentage of net sales was 59.1% for first quarter 2014, compared to 60.7% for first quarter 2013. The decrease was primarily due to a lower margin mix of products sold. Gross profit in our Bracing and Vascular segment as a percentage of net sales was 52.4% for first quarter 2014, compared to 51.5% for first quarter 2013. The increase was primarily due to a higher margin mix of products sold and lower costs related to procurement and manufacturing efficiencies.



Gross profit in our Recovery Sciences segment as a percentage of net sales remained consistent at 75.4% for first quarter 2014, compared to 75.4% for first quarter 2013.

Gross profit in our Surgical Implant segment as a percentage of net sales increased to 73.9% for first quarter 2014, compared to 73.1% for first quarter 2013. The increase was primarily due to a higher margin mix of products sold.

Gross profit in our International segment as a percentage of net sales decreased to 55.0% for first quarter 2014, compared to 56.7% for first quarter 2013. The decrease was primarily due to a lower margin mix of products sold. Selling, General and Administrative (SG&A). SG&A expenses increased to $123.5 million for first quarter 2014, from $117.9 million in first quarter 2013. As a percentage of sales, SG&A expenses increased to 43.7% for first quarter 2014, compared to 42.2% for first quarter 2013, reflecting investments in sales and marketing activities. 35



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Our SG&A expenses are impacted by significant non-recurring integration charges and other adjustments related to our ongoing restructuring activities and acquisitions. We incurred the following SG&A expenses in connection with such activities during the periods presented (in thousands): First Quarter First Quarter 2014 2013 Integration charges: Commercial and global business unit reorganization and integration $ 3,404 $ 785 Acquisition related expenses and integration 417 351 CFO transition 107 - Litigation and regulatory costs and settlements, net 1,053 1,738 Other non-recurring items 3,242 1,124 Automation projects 1,709 881 $ 9,932 $ 4,879 Research and Development (R&D). R&D expenses increased to $9.8 million for first quarter 2014, from $8.0 million in first quarter 2013. As a percentage of sales, R&D expense increased to 3.4% in first quarter 2014 from 2.9% in first quarter 2013, reflecting an increase in our new product development activities. Amortization of Intangible Assets. Amortization of intangible assets decreased to $23.6 million for first quarter 2014, from $23.8 million for first quarter 2013. The decrease is due to certain intangible assets reaching full amortization, partially offset by an increase in intangible assets resulting from our acquisition of Speetec.



Interest Expense. Our interest expense decreased to $43.7 million for first quarter 2014, from $45.4 million for first quarter 2013. The decrease is due to lower weighted average interest rates on outstanding borrowings.

Loss on Modification and Extinguishment of Debt. There was no loss on modification and extinguishment of debt for first quarter 2014. Loss on modification and extinguishment of debt for first quarter 2013 consists of $0.9 million in arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.2 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with term loans which were extinguished.



Other Expense, Net. Other expense, net decreased to $0.1 million for first quarter 2014, from $0.6 million for first quarter 2013. Results for both periods presented primarily represent net realized and unrealized foreign currency translation gains and losses.

Income Tax (Provision) Benefit. We recorded an income tax expense of $2.6 million on a pre-tax loss of $33.5 million, resulting in a negative effective tax rate of 7.8% in first quarter 2014. For first quarter 2013, we recorded income tax expense of $4.8 million on pre-tax losses of $27.3 million, resulting in a negative effective tax rate of 17.7%. The change in our effective tax rates from 2013 to 2014 primarily relates to a decrease in the need for additional valuation allowance resulting from the deferred tax liability related to amortization of indefinite lived intangible assets.



Liquidity and Capital Resources

As of March 29, 2014, our primary sources of liquidity consisted of cash and cash equivalents totaling $47.0 million and our $100.0 million revolving credit facility, of which $61.5 million was available. Our revolving credit balance was $38.0 million as of March 29, 2014. We had a $0.5 million letter of credit related to collateral requirements under our product liability insurance policy. Working capital at March 29, 2014 was $215.7 million.



On April 8, 2014, we entered into the Amendment which, among other things, provided for the issuance of $40.0 million of Incremental Term Loans, the proceeds of which were used, among other things, to prepay the loan then-outstanding under the revolving credit facility. See Note 17 to our Unaudited Condensed Consolidated Financial Statements additional information regarding the Amendment.

We believe that our existing cash, plus the amounts we expect to generate from operations and amounts available through our revolving credit facility, will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures, and debt and interest repayment obligations. While we currently believe that we will be able to meet all of the financial covenants imposed by our senior secured credit facilities, there is no assurance that we will in fact be able to do so or that, if we do not, we will be able to obtain from our lenders waivers of default or amendments to the senior secured credit facilities in the future. We and our subsidiaries, affiliates, or significant shareholders (including Blackstone and its affiliates) may from time to time, in our or their sole discretion, purchase, repay, redeem or retire any of our outstanding debt or equity securities (including any publicly issued debt securities), in privately negotiated or open market transactions, by tender offer or otherwise. 36



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Cash Flows

A summary of our cash flow activity is presented below (in thousands):

First Quarter First Quarter 2014 2013 Cash provided by operating activities $ 24,678 $ 4,902 Cash used in investing activities (19,174 ) (9,966 ) Cash (used in) provided by financing activities (2,024 )



10,458

Effect of exchange rate changes on cash and cash equivalents (27 ) (447 ) Net increase in cash and cash equivalents $ 3,453



$ 4,947

Operating activities provided $24.7 million and $4.9 million of cash in first quarter 2014 and first quarter 2013, respectively, reflecting our net loss adjusted for non-cash expenses and changes in working capital. Cash paid for interest was $21.5 million and $26.5 million, respectively. Investing activities used $19.2 million and $10.0 million of cash in first quarter 2014 and first quarter 2013, respectively. Cash used in investing activities for first quarter 2014 primarily consisted of $14.0 million for purchases of property and equipment and $4.6 million related to the acquisition of Speetec. Cash used in investing activities for first quarter 2013 primarily consisted of $8.4 million for purchases of property and equipment and $1.3 million related to the acquisition of assets from our vascular distributor in Australia. Financing activities used $2.0 million of cash for first quarter 2014 and provided $10.5 million of cash for first quarter 2013. Cash used in financing activities in first quarter 2014 consisted of payments related to the repurchase of Rollover Options from our former chief financial officer, upon her departure. Cash provided in financing activities in first quarter 2013 consisted of proceeds from the borrowings under our revolving credit facility and our senior secured credit facility, offset by payments of the senior secured credit facility.



For the remainder of 2014, including the impacts of the April 8, 2014 debt refinancing, we expect to spend cash of approximately $167.6 million for the following:

$29.9 million for scheduled principal and estimated interest payments on

our senior secured credit facilities;



$110.4 million for scheduled interest payments on our 8.75% Notes, 9.875%

Notes, 7.75% Notes and 9.75% Notes; and • $27.3 million for capital expenditures 37



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Indebtedness

As of March 29, 2014, we had $2,261.6 million in aggregate indebtedness outstanding, exclusive of a net unamortized original issue discount of $1.4 million. The principal amount and carrying value of our debt was as follows for March 29, 2014 and December 31, 2013:

March 29, December 31, 2014 2013 Principal Carrying Principal Carrying Amount Value Amount Value Senior secured credit facilities: Revolving credit facility $ 38,000$ 38,000$ 38,000$ 38,000 Term loans 853,400 846,737 853,400 846,297 891,400 884,737 891,400 884,297 Note financing: 8.75% second priority senior secured notes 330,000 335,221 330,000 335,490 9.875% senior unsecured notes 440,000 440,000 440,000 440,000 7.75% senior unsecured notes 300,000 300,000 300,000 300,000 9.75% senior subordinated notes 300,000 300,000 300,000 300,000 1,370,000 1,375,221 1,370,000 1,375,490 Other debt: 188 188 - - Total indebtedness $ 2,261,588$ 2,260,146$ 2,261,400$ 2,259,787 Senior Secured Credit Facilities. Term loans outstanding under our senior secured credit facilities at March 29, 2014 consist of $853.4 million of term loans which mature on September 15, 2017. Of the $100 million total revolving credit facility which matures on March 15, 2017, $61.5 million was available. Our revolving credit balance was $38.0 million at March 29, 2014. We had a $0.5 million letter of credit related to collateral requirements under our product liability insurance policy. The interest rate margins applicable to borrowings under the senior secured revolving credit facilities are, at our option, either (a) the Eurodollar rate, plus 375 basis points or (b) a base rate determined by reference to the highest of (1) the prime rate, (2) the federal funds rate, plus 0.50% and (3) the Eurodollar rate for a one-month interest period, plus, in each case, 375 basis points. The interest rate margins applicable to the tranche B term loans are, at our option, either (a) the Eurodollar rate plus 375 basis points or (b) a base rate plus 375 basis points. There is a minimum LIBOR rate applicable to the Eurodollar component of interest rates on tranche B term loan borrowings of 1.00%. The applicable margin for borrowings under the senior secured revolving credit facilities may be reduced, subject to our attaining certain leverage ratios. As of March 29, 2014, our weighted average interest rate for all borrowings under the senior secured credit facilities was 4.71%.



We are required to pay annual payments in equal quarterly installments on the term loans in an amount equal to 1.00% of the funded total principal amount through June 2017, with any remaining amount payable in full at maturity in September 2017.

Note Financing. Our note financings mature at various dates in 2017 and 2018. Assuming we are in compliance with the terms of the indentures governing the notes, we are not required to repay principal related to any of the notes prior to the final maturity dates of the notes. We pay interest semi-annually on the notes.



See Note 9 to our Unaudited Condensed Consolidated Financial Statements for additional information regarding our indebtedness.

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Certain Covenants and Related Compliance. Pursuant to the terms of the senior secured credit facilities, we are required to maintain a maximum senior secured first lien leverage ratio of consolidated first lien net debt to Adjusted EBITDA of 4.25:1 for the trailing twelve months ended March 29, 2014. Adjusted EBITDA is defined as net income (loss) attributable to DJOFL, plus interest expense, net, income tax (provision) benefit and depreciation and amortization, further adjusted for certain non-cash items, non-recurring items and other adjustment items, as permitted in calculating covenant compliance under our senior secured credit facilities and the Indentures governing our 8.75% Notes, 9.875% Notes, 7.75% Notes and 9.75% Notes (collectively, the Notes). Adjusted EBITDA is a material component of these covenants. As of December 31, 2013, our actual senior secured first lien leverage ratio was within the required ratio at 3.17:1. Adjusted EBITDA should not be considered as an alternative to net income or other performance measures presented in accordance with GAAP, or as an alternative to cash flow from operations as a measure of our liquidity. Adjusted EBITDA does not represent net income (loss) or cash flow from operations as those terms are defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. In particular, the definition of Adjusted EBITDA in the Indentures and our senior secured credit facilities allows us to add back certain non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net loss. However, these are expenses that may recur, vary greatly and are difficult to predict. While Adjusted EBITDA and similar measures are frequently used as measures of operations and the ability to meet debt service requirements, Adjusted EBITDA is not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation. Under the Indentures governing the Notes, our ability to incur additional debt, subject to specified exceptions, is tied to either improving the ratio of our Adjusted EBITDA to fixed charges or having this ratio be at least 2.00:1 on a pro forma basis after giving effect to such incurrence. Additionally, our ability to make certain restricted payments is also tied to having an Adjusted EBITDA to fixed charges ratio of at least 2.00:1 on a pro forma basis, as defined, subject to specified exceptions. Our ratio of Adjusted EBITDA to fixed charges for the twelve months ended March 29, 2014, measured on that date, was 1.57:1. Notwithstanding these limitations, the aggregate amount of term loan increases and revolving commitment increases shall not exceed the greater of (i) $150.0 million and (ii) the additional aggregate amount of secured indebtedness which would be permitted to be incurred as of any date of determination (assuming for this purpose that the full amount of any revolving credit increase had been utilized as of such date) such that, after giving pro forma effect to such incurrence (and any other transactions consummated on such date), the senior secured leverage ratio for the immediately preceding test period would not be greater than 4.25:1. Fixed charges is defined in the Indentures as consolidated interest expense plus all cash dividends or other distributions paid on any series of preferred stock of any restricted subsidiary and all dividends or other distributions accrued on any series of disqualified stock. The following is a summary of our covenant requirements and pro forma ratios as of March 29, 2014: Covenant Requirement (Maximum) Actual Ratio Senior Secured Credit Facilities Ratio of consolidated senior secured first lien debt to Adjusted EBITDA 4.25:1 3.17:1 Covenant Requirement (Minimum) Actual Ratio Notes Ratio of Adjusted EBITDA to fixed charges required to incur additional debt pursuant to ratio provision, pro forma 2.00:1



1.57:1

As described above, our senior secured credit facilities and the Notes governed by the Indentures represent significant components of our capital structure. Under the senior secured credit facilities, we are required to maintain compliance with a specified senior secured first lien leverage ratio and which ratio is determined based on our Adjusted EBITDA. If we fail to comply with the senior secured first lien leverage ratio under our senior secured credit facilities, we would be in default. Upon the occurrence of an event of default under the senior secured credit facilities, the lenders could elect to declare all amounts outstanding under the senior secured credit facilities to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under the senior secured credit facilities could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all of our assets as collateral under the senior secured credit facilities. Any acceleration under the senior secured credit facilities would also result in a default under the Indentures governing the Notes, which could lead to the note holders electing to declare the principal, premium, if any, and interest on the then outstanding Notes immediately due and payable. In addition, under the Indentures governing the Notes, our and our subsidiaries' ability to engage in activities such as incurring additional indebtedness, making investments, refinancing subordinated indebtedness, paying dividends and entering into certain merger transactions is governed, in part, by our ability to satisfy tests based on Adjusted EBITDA. 39



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Our ability to meet the covenants specified above will depend on future events, many of which are beyond our control, and we cannot assure you that we will meet those covenants. A breach of any of these covenants in the future could result in a default under our senior secured credit facilities and the Indentures, at which time the lenders could elect to declare all amounts outstanding under our senior secured credit facilities to be immediately due and payable. Any such acceleration would also result in a default under the Indentures.



The following table provides a reconciliation from our net loss to Adjusted EBITDA for the three and twelve months ended March 29, 2014. The terms and related calculations are defined in the credit agreement relating to our senior secured credit facilities and the Indentures.

Twelve Months Three Months Ended Ended March 29, 2014 March 30, 2013 March 29, 2014 Net loss attributable to DJO Finance LLC $ (36,522 )$ (32,364 )$ (207,610 ) Interest expense, net 43,671 45,409 175,804 Income tax provision 2,624 4,834 10,906 Depreciation and amortization 32,018 31,571 129,113 Non-cash charges (a) 148 970 106,364 Non-recurring and integration charges (b) 15,418 5,678 40,340 Other adjustment items (c) 2,249 3,730 9,020 Adjusted EBITDA $ 59,606 $ 59,828 $ 263,937



(a) Non-cash items are comprised of the following:

Twelve Months Three Months Ended Ended March 29, 2014 March 30, 2013 March 29, 2014 Stock-based compensation expense $ 444 $ 563 $ 2,036 Impairment of goodwill and intangible assets - - 106,600 Purchase accounting adjustments (1) 207 396 (1,756 ) (Gain) loss on disposal of assets, net (503 ) 11 (516 ) Total non-cash charges $ 148 $

970 $ 106,364



(1) Purchase accounting adjustments for the twelve months ended March 29, 2014

consist of $0.7 million of amortization of fair market value inventory

adjustments, net of $2.5 million in adjustments to the contingent consideration for Exos.



(b) Non-recurring and integration charges are comprised of the following:

Twelve Months Three Months Ended Ended March 29, 2014 March 30, 2013 March 29, 2014 Integration charges: Commercial sales and global business unit reorganization and integration $ 4,275 $ 1,249 $ 10,103 Acquisition related expenses and integration (1) 420 556 1,727 CFO transition 107 - 1,780 Litigation and regulatory costs and settlements, net (2) 1,065 1,738 3,233 Other non-recurring items (3) 7,842 1,254 17,119 ERP implementation and other automation projects 1,709 881 6,378 Total non-recurring and integration charges $ 15,418 $ 5,678 $ 40,340



(1) Consists of direct acquisition costs and integration expenses related to

acquired businesses and costs related to potential acquisitions.

(2) For the twelve months ended March 29, 2014, litigation and regulatory

costs consisted of $2.4 million in litigation costs related to ongoing

product liability issues related to our discontinued pain pump products,

$3.7 million related to other litigation and regulatory costs and settlements, net of $2.0 million received related to an indemnity claim from a third party pain pump manufacturer and a settlement with its



insurance carrier, and a $0.9 million favorable cost estimate adjustment

for the post-market surveillance study required by the FDA related to our discontinued metal-on-metal hip implant products. 40



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(3) For the twelve months ended March 29, 2014, other non-recurring items

consist of $8.4 million in incremental Empi bad debt expense related to

the Medicare CLBP decision, $6.4 million in specifically identified non-recurring operational and regulatory projects, $1.0 million in expenses related to our Tunisia factory fire and $1.3 million in other non-recurring travel & professional fees. (c) Other adjustment items before permitted pro forma adjustments are comprised of the following: Three Months Ended Twelve Months Ended March 29, 2014 March 30, 2013 March 29, 2014 Blackstone monitoring fees $ 1,750 $ 1,750 $ 7,000 Noncontrolling interests 349 238 1,001 Loss on modification and extinguishment of debt (1) - 1,059 - Other (2) 150 683 1,019



Total other adjustment items $ 2,249 $ 3,730 $ 9,020

(1) Loss on modification and extinguishment of debt for the three months

ending March 30, 2013 consists of $0.9 million in arrangement and

amendment fees and other fees and expenses incurred in connection with the

March 2013 amendment of our senior secured credit facilities and $0.2

million related to the non-cash write off of unamortized debt issuance

costs and original issue discount associated with term loans which were extinguished.



(2) Other adjustments consist primarily of net realized and unrealized foreign

currency transaction gains and losses.

Critical Accounting Policies and Estimates

We have disclosed in our Unaudited Condensed Consolidated Financial Statements and in "Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our 2013 Annual Report on Form 10-K, those accounting policies that we consider to be significant in determining our results of operations and financial condition. There have been no material changes to those policies that we consider to be significant since the filing of our 2013 Annual Report on Form 10-K. We believe that the accounting principles utilized in preparing our Unaudited Condensed Consolidated Financial Statements conform in all material respects to GAAP.


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