10-K 1 djo-10k_20151231.htm 10-K djo-10k_20151231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015

or

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

Commission file number 333-142188

 

DJO Finance LLC

(Exact name of Registrant as specified in its charter)

 

 

Delaware

20-5653965

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

 

1430 Decision Street

Vista, California

92081

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (800) 336-5690

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Name of each exchange on which registered

None

None

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  o    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  x    No  o

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  o    No  x (Note: As of January 1, 2014, the registrant was no longer subject to the filing requirements of Section 13 or 15(d) of the Exchange Act; however, the registrant filed all reports required to be filed during the period it was subject to Section 13 or 15(d) of the Exchange Act.)

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

o

Accelerated filer

o

 

 

 

 

Non-accelerated filer

x  (Do not check if a smaller reporting company)

Smaller reporting company

o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  o    No  x

As of March 25, 2016, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

 

 

 

 

 


 

DJO FINANCE LLC

FORM 10-K

TABLE OF CONTENTS

 

 

 

 

 

Page

No.

 

 

PART I

 

 

Item 1.

 

Business

 

4

Item 1A.

 

Risk Factors

 

19

Item 2.

 

Properties

 

33

Item 3.

 

Legal Proceedings

 

33

Item 4.

 

Mine Safety Disclosures

 

34

 

 

 

 

 

 

 

PART II

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

35

Item 6.

 

Selected Financial Data

 

36

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

37

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

50

Item 8.

 

Financial Statements and Supplementary Data

 

52

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

102

Item 9A.

 

Controls and Procedures

 

102

Item 9B.

 

Other Information

 

102

 

 

 

 

 

 

 

PART III

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

103

Item 11.

 

Executive Compensation

 

108

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

121

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

122

Item 14.

 

Principal Accounting Fees and Services

 

124

 

 

 

 

 

 

 

PART IV

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

 

125

SIGNATURES

 

130

 

 

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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (Annual Report) of DJO Finance LLC (DJOFL, or the Company) for the year ended December 31, 2015 contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which are intended to be covered by the safe harbors created thereby. 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. Specifically, the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” may contain forward-looking statements. These statements can be identified because they use words like “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “future,” “intends,” “plans,” and similar terms. These statements reflect only our current expectations. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, capital expenditures, future results, our competitive strengths, our business strategy, the trends in our industry and the benefits of our acquisitions.

Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy, and actual results may differ materially from those we anticipated due to a number of uncertainties, many of which are unforeseen, including, among others, the risks we face as described elsewhere in this filing. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report. In any forward-looking statement where we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and is believed to have a reasonable basis, but there can be no assurance that any future results or events expressed by the statement of expectation or belief will be achieved or accomplished.

We believe it is important to communicate our expectations to holders of our notes. There may be events in the future, however, that we are unable to predict accurately or over which we have no control. The risk factors listed in Item 1A below, as well as any cautionary language in this Annual Report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements.

 

 

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PART I.

ITEM 1.

BUSINESS

Overview

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.

DJO Finance LLC (DJOFL) is a wholly owned indirect subsidiary of DJO Global, Inc (DJO). DJOFL is a Delaware limited liability company organized in 2006. Substantially all business activities of DJO are conducted by DJOFL and its wholly owned subsidiaries.

Except as otherwise indicated, references to “us”, “we”, “our”, or “the Company” in this Annual Report refers to DJOFL and its consolidated subsidiaries. Each one of the following trademarks, trade names or service marks, which is used in this Annual Report, is either (i) our registered trademark, (ii) a trademark for which we have a pending application, or (iii) a trademark or service mark for which we claim common law rights: Cefar®, Exos™, Bell-Horn®, Compex®, Aircast®, DonJoy®, OfficeCare®, ProCare®, MotionCare™, SpinaLogic®, Dr. Comfort™, CMF™, OL1000™, and OL1000 SC™. All other trademarks, trade names or service marks of any other company appearing in this Annual Report belong to their respective owners.

Operating Segments and Products

We currently develop, manufacture and distribute our products through the following four operating segments: Bracing and Vascular; Recovery Sciences; Surgical Implant; and International.

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 to treat patients with musculoskeletal conditions resulting from degenerative diseases, deformities, traumatic events and sports related injuries. In addition, many of our non-surgical 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®, DonJoy Performance®, ProCare®, CMF™, MotionCare™, Chattanooga, DJO Surgical, Dr. Comfort™, Compex®, Bell-Horn™ and ExosTM.

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 and to the retail consumer. These four segments constitute our reportable segments. See Note 18 of the Notes to Consolidated Financial Statements included in Part II, Item 8, herein for financial and other additional information regarding our segments.

Exit of Empi Business

During the fourth quarter of 2015, we ceased manufacturing, selling and distributing products of our Empi business and the related insurance billing operations domestically. The Empi business primarily manufactured and sold TENS devices for pain relief, other electrotherapy and orthopedic products and the related supplies.  Empi was facing a challenging regulatory and compliance environment, decreasing reimbursement rates and remained below the level needed to reach adequate profitability within an economically justified period of time.  Empi was part of our Recovery Sciences operating segment. For financial statement purposes, the results of the Empi business are reported within discontinued operations in the Consolidated Financial Statements included in Part II, Item 8, herein.

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 footwear for the diabetes care market and compression therapy products, primarily under the DonJoy, ProCare, Aircast, Dr. Comfort, Bell-Horn and Exos brands. This segment also includes

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our OfficeCare channel, 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. In 2014 we expanded our consumer channel to focus on marketing, selling and distributing our products, including bracing and vascular products, to professional and consumer retail customers and on-line. The bracing and vascular products sold through this channel will principally be sold under the DonJoy Performance, Bell-Horn and Doctor Comfort brands.

The following table summarizes our Bracing and Vascular segment product categories:

 

Product Category 

 

Description 

Rigid bracing and soft goods

 

Soft goods

Lower extremity fracture boots

Ligament braces

Post-operative braces

Osteoarthritis braces

Ankle bracing

Shoulder, elbow and wrist braces

Back braces

Neck braces

ExosTM thermoformable braces

Cold and compression therapy

 

Cold and compression therapy products

Vascular therapy

 

Vascular system pumps

Compression hosiery

Therapeutic shoes and inserts

 

Therapeutic footwear and related medical and comfort products

 

Recovery Sciences Segment

Our Recovery Sciences segment, which generates its revenues in the United States, consisted, prior to the fourth quarter of 2015, of three key brands: Empi, CMF and Chattanooga. In the fourth quarter we ceased domestic business operations of our Empi business and ceased selling any products under the Empi brand. The CMF and Chattanooga products are sold to medical clinics, independent distributors or patient direct for consumer home use. For products sold directly to patients, we arrange billing to the patients and their third party payors, if applicable. The CMF brand of bone growth stimulation products provides medical professionals with an effective tool for healing problem fractures and spinal fusion procedures. Chattanooga rehabilitation equipment is used for treating musculoskeletal, neurological and soft tissue disorders. These products include 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. This segment also provides professional and consumer retail customers our Compex electrostimulation device, which is used in training programs to aid muscle development and to accelerate muscle recovery after training sessions. During 2015 we added two product lines to our Recovery Sciences business, Tenex ultrasound devices designed to treat soft tissue disease such as chronic tendon disease and New Clip products designed for the surgical repair of distal radius and ankle fractures.  

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The following table summarizes our Recovery Sciences segment product categories:

 

Product Category

 

Description

Iontophoresis

 

Needle-free transdermal drug delivery

Bone growth stimulation

 

Non-union fracture bone growth stimulation devices

Adjunct to spinal fusion bone growth stimulation devices

Trauma Products

 

Tenex Ultrasound devices

New Clip surgical repair products

Clinical electrotherapy

 

TENS

NMES

Ultrasound / Acoustic wave therapy

Laser / Light therapy

Shortwave Diathermy

Electrodes

Patient care

 

Patient safety devices

Continuous passive motion devices

Back braces

Compounded pain relief cream

Physical therapy tables and traction products

 

Treatment tables

Traction tables

Cervical traction for home use

Lumbar traction for home use

Hot, cold and compression therapy

 

Dry heat therapy

Hot/cold therapy

Paraffin wax therapy

Moist heat therapy

Cold therapy

Compression therapy

 

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.

The following table summarizes our Surgical Implant segment product categories:

 

Product Category

 

Description

Knee implants

 

Primary total joint replacement

Revision total joint replacement

Unicondylar joint replacement

Hip implants

 

Primary replacement stems

Acetabular cup system

Revision joint replacement

Shoulder implants

 

Primary total joint replacement

Fracture repair system

Revision total joint replacement (including reverse shoulder)

Elbow Implants

 

Primary total joint replacement

Bone Cement

 

Bone cement and cement mixing accessories

 

On June 30, 2015, our subsidiary Encore Medical, L.P., dba DJO Surgical, acquired from Zimmer Biomet Holdings, Inc., the U.S. rights to an elbow implant product marketed under the name Discovery® Elbow System, and a line of bone cement for use with implants marketed as Cobalt™ Bone Cement, Optivac® Cement Mixing Accessories and SoftPac™ Pouch.

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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. The product categories for our International segment are similar to the product categories for our domestic segments except certain products are tailored to international market requirements and preferences. In addition, our International segment sells a number of products, none of which is individually significant, that we do not sell domestically.

Research and Development

Our research and development programs focus on the development of new products, as well as the enhancement of existing products with the latest technology and updated designs. We seek to develop new technologies to improve durability, performance and usability of existing products, and to develop our manufacturing process to improve product performance and reduce manufacturing costs. In addition to our own research and development, we receive new product and invention ideas from orthopedic surgeons and other healthcare professionals. We also seek to obtain rights to ideas we consider promising from a clinical and commercial perspective through entering into either assignment or licensing agreements. We conduct research and development programs at our facilities in Vista, California; Austin, Texas; and Ecublens, Switzerland.

We maintain contractual relationships with orthopedic surgeons who assist us in developing our products and provide consulting services in connection with our products. In addition to providing design input into our new products, some of these orthopedic surgeons may give demonstrations using our products, speak about our products at medical seminars, train other orthopedic surgeons in the use of our products, and provide us with feedback on the acceptance of our products. We have also established relationships with surgeons who conduct clinical studies on various products, establish protocols for use of the products and participate at various symposia.

Marketing and Sales

Our products reach our customers, including hospitals and other healthcare facilities, physicians and other healthcare providers and end user patients and consumers, through several sales and distribution channels.

No particular customer or distributor accounted for 10% or more of product sales in any of our segments for the year ended December 31, 2015. Medicare and Medicaid together accounted for approximately 4.2% of our consolidated 2015 net sales.

Bracing and Vascular Segment

We market and sell our Bracing and Vascular segment products in several different ways. The DonJoy brand is primarily dedicated to the sale of our bracing and supports products to orthopedic surgeons, podiatrists, orthotic and prosthetic centers, hospitals, surgery centers, physical therapists, athletic trainers and other healthcare professionals. The DonJoy brand is mostly sold through independent commissioned sales representatives who are employed by independent sales agents. Because the DonJoy products generally require customer education in the application and use, DonJoy sales representatives are technical specialists who receive extensive training, and use their expertise to help fit the patient with the product and assist the orthopedic professional in choosing the appropriate product to meet the patient’s needs. After a sales representative receives a product order, we generally ship and bill the product directly to the orthopedic professional, and pay a sales commission to the agent. For certain custom rigid braces and other products, we sell directly to the patient and bill a third party payor, if applicable, on behalf of the patient. We enjoy long-standing relationships with most of our agents and sales representatives. Under the arrangements with the agents, each agent is granted an exclusive geographic territory for sales of our products and is not permitted to market products, or represent competitors who sell or distribute products, that compete with our existing products. The agents receive a commission, which varies based on the type of product being sold. If an agent fails to achieve specified sales quotas, we have the right to terminate our relationship with the agent. Certain DonJoy sales representatives also sell our Recovery Sciences and Vascular products.

The ProCare/Aircast brand is sold by direct and independent sales representatives that manage a network of distributors focused on selling our bracing and supports products to primary and acute care facilities. Vascular systems are also included in this brand. These products are generally sold in non-exclusive territories to third party distributors as well as through our direct sales force. Our distributors include large, national third party distributors such as Owens & Minor Inc., McKesson/HBOC, Allegiance Healthcare and PSS World Medical, regional medical and surgical distributors, outpatient surgery centers and medical products buying groups that consist of a number of healthcare providers who make purchases through the buying group. These distributors and our direct sales force generally sell our products to large hospital chains, primary care networks and orthopedic physicians for use by the patients. In addition, we sell our products through group purchasing organizations (GPOs) that are a preferred purchasing source for members of a buying group. These products generally do not require significant customer education for their use. Our vascular pumps are provided

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to primary and acute care facilities, supplemented by vascular system specialists. Our vascular systems pumps and related equipment are typically consigned to hospitals, and the hospitals then purchase the cuffs that are applied to each patient. We have recently introduced vascular pumps for home use.

Under the Dr. Comfort brand, we market and distribute our therapeutic footwear and related medical and comfort products primarily through the podiatry, home medical equipment (HME), pharmacy, and orthotic and prosthetic (O&P) channels through our sales force of direct and independent sales representatives. Compression hosiery is private labeled and sold to customers who resell the products.

OfficeCare provides stock and bill arrangements for physician practices. Through OfficeCare, we maintain an inventory of bracing and supports products at approximately 2,000 orthopedic practices and other healthcare facilities for immediate distribution to patients. We then bill the patient or, if applicable, a third party payor.

Our Consumer channel, which we expanded in 2014, sells or plans to sell certain of our bracing products, primarily orthopedic soft goods, and footwear based on our therapeutic footwear in the professional retail and consumer retail markets. The Consumer channel is also developing products designed for consumers in the athletic and sports retail market. A wide variety of our bracing and vascular products are offered by the Consumer channel through an on-line web site.

In a marketing program conducted under the framework of Motion is Medicine™ and coordinated by the Bracing and Vascular and Recovery Sciences segments, we are offering to physicians and clinics a protocol of products that address the full spectrum of requirements to treat common indications, such as osteoarthritis of the knee or anterior cruciate ligament (ACL) injuries. Under this program, called MotionCare™, the physician has readily available for prescription our preventative products, pain management products and rehabilitative products to provide a conservative care regimen to patients. We plan to expand this MotionCare approach to other indications where a range of conservative care products would be beneficial to patients in treating chronic conditions or injuries and in preparing for and recovering from surgery.

Recovery Sciences Segment

We market and sell our Recovery Sciences segment products in several different ways, including the MotionCare program described above under the Bracing and Vascular segment. As described above, in the fourth quarter of 2015, we ceased active domestic business operations in our Empi subsidiary.  The Empi brand product line consisted of prescription-based home therapy products primarily marketed to physicians and physical therapy clinics, and Empi generally billed third party payors, either government payors such as Medicare and Medicaid, or private payors, on behalf of the patient.

CMF non-union fracture bone growth stimulator devices (OL1000) and spine bone growth stimulator device (SpinaLogic) are sold by our direct and independent sales representatives specially trained to sell the product. Most of our bone growth stimulator products are sold directly to the patient and a third party payor is billed, if applicable, on behalf of the patient. 

In 2015 we entered into an agreement with Tenex Health, Inc, appointing DJO to sell certain Tenex products within designated territories in the US, designed to treat soft tissue disease such as chronic tendon disease.  We also entered into a supply agreement with New Clip USA, LLC, where our Recovery Sciences segment purchases and resells products within the US designed for the surgical repair of Distal Radius and Ankle fractures.  We believe that both of these arrangements will results in synergies with our Recovery Sciences sales force and existing customers.

We sell our Chattanooga rehabilitation product lines to physical therapy clinics, primarily through a national network of independent distributors, which are managed by our employed sales managers. These distributors sell our clinical rehabilitation products to a variety of healthcare professionals, including physical therapists, athletic trainers, chiropractors, and sports medicine physicians. Except for distributors outside of the United States, we do not maintain formal distribution contracts for our clinical rehabilitation products. These distributors purchase products from us at discounts off our published list price. We maintain an internal marketing and sales support program to support our distributor network. This program comprises a group of individuals who provide distributor and end-user training, develop promotional materials, and attend trade shows each year.

Our Consumer Compex electrostimulation device is marketed and sold to fitness enthusiasts and competitive athletes in a direct-to-consumer model and through our on-line web site. We are planning to market and sell this device, as well as other Recovery Sciences products appropriate for sale directly to the end user, in the professional and consumer retail markets.

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Surgical Implant Segment

We market and sell our Surgical Implant products to hospitals and orthopedic surgeons through a network of independent commissioned sales representatives who are employed by independent sales agents. Generally, our independent sales representatives sell a range of reconstructive joint products, including our products. We usually enter into agreements with sales agents for a term of one to five years. Agents are typically paid a sales commission and are eligible for bonuses if sales exceed certain preset objectives. Our independent sales representatives work for these agents. We assign each of our sales agents to an exclusive sales territory and require them to meet specific periodic sales targets. Substantially all of our sales agents agree not to sell competitive products. We provide our sales agents with product inventories, on consignment, for their use in marketing and filling customer orders.

International Segment

We sell our products internationally through a network of wholly owned subsidiaries and independent distributors. In Europe, we use sales forces of direct and independent salespersons and a network of independent distributors who call on healthcare professionals, as well as consumer retail stores, such as sporting equipment providers and pharmacies, to sell our products. We intend to continue to expand our direct and indirect distribution capabilities in attractive foreign markets.

Manufacturing

We use both in-house manufacturing capabilities and relationships with third party vendors to supply our products. Generally, we use third party vendors only when they have special manufacturing capabilities or when we believe it is appropriate based on certain factors, including our in-house capacity, lead-time control and cost. Although we have certain sole source supply agreements, we believe alternate vendors are available, and we believe that adequate capacity exists at our current vendors to meet our anticipated needs.

Our manufacturing facilities are generally certified by the International Organization for Standardization (ISO) and generally comply with the U.S. Food and Drug Administration (FDA) current Good Manufacturing Practice and Quality System Regulations (QSRs) requirements, which provide standards for safe and consistent manufacturing of medical devices and appropriate documentation of the manufacturing and distribution process. Many of our products carry the European Community Medical Device Directive (CE) certification mark.

Our manufacturing facility in Tijuana, Mexico is our largest manufacturing facility. Our Mexico facility has achieved ISO 13485 certification. This certification reflects internationally recognized quality standards for manufacturing and assists us in marketing our products. Our Vista, California facility has achieved certification to ISO 13485, the Canadian Medical Device Regulation and the European Medical Device Directive. Products manufactured at the Vista, California facility include our custom rigid knee bracing products, the pump portion of our vascular systems products, and our CMF products. Products manufactured at our Tijuana, Mexico facility include most of our bracing and supports product lines, and most of our Chattanooga products including electrotherapy devices, patient care products and CPM devices. Within both our Vista and Tijuana facilities, we operate vertically integrated manufacturing and packaging operations and many subassemblies and components are produced in-house. These include metal stamped parts, injection molded components and fabric-strapping materials. We also have extensive in-house tool and die fabrication capabilities, which typically provide savings in the development of tools and molds as well as flexibility to respond to and capitalize on market opportunities as they are identified.

In our Bracing and Vascular segment, the ETI factory in Asheboro, North Carolina, manufactures a full range of compression products, such as anti-embolism stockings; men’s and women’s daily wear and sports compression socks; sheer and surgical weight below knee, thigh length, and pantyhose compression stockings; braces and lymphedema arm sleeves. The products are sold to worldwide OEM customers as well as to our internal distribution network. The factory specializes in circular knitting and is FDA and ISO 9001:2008 certified and sells under the CE mark in Europe. The primary raw materials used for the compression hosiery are yarn (spandex, nylon, and polyester), dyes, and woven elastics.

Also in our Bracing and Vascular segment, the Dr. Comfort manufacturing facility in Mequon, Wisconsin, manufactures therapeutic footwear and related medical and comfort products. These products are the custom insoles provided primarily as additional product with our Diabetic footwear collections as well as shoe modifications. The primary raw material is a foam ethylene vinyl acetate (EVA) copolymer that is machined to closely match the plantar surface of our customer. The facility is a registered manufacturer with the FDA.

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Our Clear Lake, South Dakota facility manufactured home electrotherapy devices and a variety of clinical devices, both electrotherapy and other, sold in the United States and certain components and related accessories. With the exit of our Empi business, the Clear Lake facility no longer manufactures home electrotherapy devices, but is currently engaged in electronic and mechanical assembly, electrode fabrication and assembly and fabric sewing processes used in other DJO products. The Company is assessing its options with the Clear Lake facility, including a possible sale of the facility and entering into supply agreements with third parties to continue the supply of these products.

Many of the component parts and raw materials we use in our manufacturing and assembly operations are available from more than one supplier and are generally available on the open market. We source some of our finished products from manufacturers in China as well as other third party manufacturers. We also currently purchase certain CPM devices from a single supply source, Medireha, which is 50% owned by us. Our distribution agreement with Medireha grants us exclusive rights to the distribution of products that Medireha manufactures. The distribution agreement also requires that we purchase a certain amount of product annually and that we seek Medireha’s approval if we choose to manufacture or distribute products that are identical or similar, or otherwise compete with the products that are the subject of the distribution agreement.

In our Surgical Implant segment, we manufacture our products in our Austin, Texas facility. This manufacturing facility includes computer controlled machine tools, belting, polishing, cleaning, packaging and quality control. Our Austin facility has achieved the ISO 13485:2003 certification. The primary raw materials used in the manufacture of our surgical implant products are cobalt chromium alloy, stainless steel alloys, titanium alloy and ultra high molecular weight polyethylene. All products in our Surgical Implant segment go through in-house quality control, cleaning and packaging operations.

Many of the products for our International segment are manufactured in the same facilities as our domestic segments. We operate a manufacturing facility in Tunisia that provides Bracing and Vascular and Recovery Sciences products for the European markets. In addition, our German and French channels source certain of the products they sell from third party suppliers. Our French channel currently utilizes a single vendor for many of its home electrotherapy devices.

Intellectual Property

We own or have licensing rights to U.S. and foreign patents covering a wide range of our products and have filed applications for additional patents. We have numerous trademarks registered in the United States, a number of which are also registered in countries around the world. We also assert ownership of numerous unregistered trademarks, some of which have been submitted for registration in the United States and foreign countries. In the future, we will continue to apply for such additional patents and trademarks as we deem appropriate. Additionally, we seek to protect our non-patented know-how, trade secrets, processes and other proprietary confidential information, through a variety of methods; including having our vendors, employees and consultants sign invention assignment agreements, proprietary information agreements and confidentiality agreements and having our independent sales agents and distributors sign confidentiality agreements. Because many of our products are regulated, proprietary information created during our development of a new or improved product may have to be disclosed to the FDA or another U.S. or foreign regulatory agency in order for us to have the lawful right to market such product. We have distribution rights for certain products that are manufactured by others and hold both exclusive and nonexclusive licenses under third party patents and trade secrets that cover some of our existing products and products under development.

The validity of any of the patents or other intellectual property owned by or licensed to us may not be upheld if challenged by others in litigation. Due to these and other risks described in this Annual Report, we do not rely solely on our patents and other intellectual property to maintain our competitive position. We believe that the development and marketing of new products and improvement of existing ones is, and will continue to be, more important to our competitive position than relying solely on existing products and intellectual property.

Competition

The markets we compete in are highly competitive and fragmented. Some of our competitors, either alone or in conjunction with their respective corporate parent groups, have greater research and development, sales and marketing, and manufacturing capabilities than we do, and thus may have a competitive advantage over us. Although we believe that the design and quality of our products compare favorably with those of our competitors, if we are unable to offer products with the latest technological advances at competitive prices, our ability to compete successfully could be materially adversely affected.

Given our sales history, our history of product development and the experience of our management team, we believe we are capable of effectively competing in our markets in the future. Further, we believe the comprehensive range of products we offer enables us to reach a diverse customer base and to use multiple distribution channels in an attempt to increase our growth across our

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markets. In addition, we believe the various company and product line acquisitions we have made in recent years continue to improve the name recognition of our company and our products. Our ability to compete is affected by, among other things, our ability to:

 

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develop new products and innovative technologies,

 

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obtain regulatory clearance and compliance for our products,

 

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manufacture and sell our products cost-effectively,

 

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meet all relevant quality standards for our products and their markets,

 

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respond to competitive pressures specific to each of our geographic markets, including our ability to enforce non-compete agreements,

 

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protect the proprietary technology of our products and manufacturing processes,

 

·

market our products,

 

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attract and retain skilled employees and sales representatives, and

 

·

establish and maintain distribution relationships.

All of our segments compete with large, diversified corporations and companies that are part of corporate groups that have significantly greater financial, marketing and other resources than we do, as well as numerous smaller niche companies.

Bracing and Vascular Segment

Our primary competitors in the rigid knee bracing market include companies such as Össur hf., the recent combination by merger of Breg, Inc. (Breg) and Bledsoe Brace Systems (Bledsoe), and Townsend Design. Competition in the rigid knee brace market is primarily based on product technology, quality and reputation, relationships with customers, service and price.

In the soft goods products market, our competitors include DeRoyal Industries, Össur hf. and Zimmer Biomet Holdings, Inc. (Zimmer Biomet). In the cold therapy products market, our competitors include Breg and Bledsoe and Stryker Corporation (Stryker). Competition in the soft goods and pain management markets is less dependent on innovation and technology and is primarily based on product range, quality, service and price.

The therapeutic footwear and related medical and comfort products market is highly fragmented with multiple channels, servicing customers as diverse as podiatrists, home medical equipment users, orthotists, retail pharmacy and numerous other service categories. Our competitors include several multi-product companies and numerous smaller niche competitors. Competition in the therapeutic footwear market tends to be based on product technology, quality and reputation, relationships with customers, service and price.

Several competitors have initiated stock and bill programs similar to our OfficeCare program, and there are numerous regional stock and bill competitors.

Recovery Sciences Segment

The primary competitors of our Chattanooga products are Dynatronics Corporation, Mettler Electronics Corporation, Rich-Mar, Patterson Medical, Enraf-Nonius, Gymna-Uniphy and Acorn Engineering. The physical therapy products market is highly competitive and fragmented. Our competitors in the CPM devices market include several multi-product companies with significant market share and numerous smaller niche competitors. Competition in these markets is based primarily on the quality and technical features of products, product pricing and contractual arrangements with third party payors and national accounts.

Our competitors for CMF products are large, diversified orthopedic companies. In the non-union bone growth stimulation market, our competitors include Orthofix International, N.V. (Orthofix), Zimmer Biomet and Bioventus LLC, formerly known as Smith & Nephew plc, and in the spinal fusion market, we compete with Zimmer Biomet and Orthofix. Competition in bone growth stimulation devices is limited as higher regulatory thresholds provide a barrier to market entry.

Surgical Implant Segment

The market for orthopedic products similar to those produced by our surgical implant business is dominated by a number of large companies, including, DePuy, Inc. (a Johnson & Johnson company), Smith & Nephew plc, Stryker, and Zimmer Biomet, which

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are much larger and have significantly greater financial resources than we do. Our Surgical Implant segment also faces competition from U.S.-based companies similar in size to ours, such as Wright Medical Group, Inc. and Exactech, Inc. Competition in the market in which our Surgical Implant segment participates is based primarily on innovative design and technical capability, scale of field sales and service organization, breadth of product line, quality and price.

International Segment

Competition for the products in our International segment arises from many of the companies and types of companies that compete with our domestic segments and from foreign manufacturers whose costs may be lower due to their ability to manufacture products within their respective countries. Competition is based primarily on quality, innovative design and technical capability, breadth of product line, availability of and qualification for reimbursement, and price.

Government Regulation

FDA and Similar Foreign Government Regulations

Our products are subject to rigorous government agency regulation in the United States and in other countries. In the United States, the FDA regulates the development, testing, labeling, manufacturing, storage, recordkeeping, pre-market clearance or approval, promotion, distribution and marketing of medical devices to ensure that medical products distributed in the United States are safe and effective for their intended uses. The FDA also regulates the export of medical devices manufactured in the United States to international markets. Our medical devices are subject to such FDA regulation.

Under the Food, Drug and Cosmetic Act, as amended, medical devices are generally classified into one of three classes depending on the degree of risk to patients using the device. Class I is the lowest risk classification and most Class I devices are exempt from pre-market submission requirements. Some Class I devices and most Class II devices require a pre-market notification to and clearance from FDA as set forth under § 510(k) of the Food, Drug and Cosmetic Act, as amended, also known as a “510(k)” submission. The 510(k) process is one in which the FDA seeks to determine if a device is “substantially equivalent” to a legally marketed device. Class III devices are the highest risk devices, and a Pre-Market Approval (PMA) application must be submitted to and approved by the FDA before the manufacturer of a Class III product can proceed in marketing the product.

We sell products in all three of the FDA classifications. All our currently marketed devices are either exempt from the FDA clearance and approval process (based on our interpretation of those regulations) or we have obtained the requisite clearances or approvals, as appropriate, required under federal medical device law. The FDA may disagree with our conclusion that clearances or approvals were not required for specific products and may require clearances or approval for such products. In these circumstances, we may be required to cease distribution of the product, the devices may be subject to seizure by the FDA or to a voluntary or mandatory recall, and we could be subject to significant fines and penalties.

Our manufacturing processes are also required to comply with the FDA’s current Good Manufacturing Practice requirements for medical devices, which are specified in FDA’s Quality System Regulation (QSRs). The QSRs cover the methods and documentation of the design, testing, production processes, control, quality assurance, labeling, packaging and shipping of our products. Furthermore, our facilities, records and manufacturing processes are subject to periodic unscheduled inspections by the FDA and other agencies. We are also required to report to the FDA if our products cause or contribute to death or serious injury or malfunction in a way that would likely cause or contribute to death or serious injury were the malfunction to recur, and the FDA or other agencies may require the recall of products in the event of material defects or deficiencies in design or manufacturing. The FDA can also withdraw or limit our product approvals or clearances in the event of serious unanticipated health or safety concerns.

Even if regulatory approval or clearance of a medical device is granted, the FDA may impose limitations or restrictions on the use and indications for which the device may be labeled or promoted. Medical devices may be marketed only for the uses and indications for which they are cleared or approved. FDA regulations prohibit a manufacturer from promotion for an unapproved or off-label use.

The FDA has broad regulatory and enforcement powers. If the FDA determines we have failed to comply with applicable regulatory requirements, it can impose a variety of enforcement actions, from warning letters, fines, injunctions, consent decrees, and civil penalties, to suspension or delayed issuance of applications, seizure or recall of our products, total or partial shutdowns, withdrawals of approvals or clearances already granted, and criminal prosecution. The FDA can also require us to repair, replace, or refund the costs of devices we manufactured or distributed.

We must obtain export certificates from the FDA before we can export certain of our products. We are also subject to extensive regulations that are similar to those of the FDA in many of the foreign countries in which we sell our products, including those in

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Europe, our largest foreign market. These include product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. In addition, the national health or social security organizations of certain countries, including certain countries outside Europe, require our products to be qualified before they can be marketed in those countries.

Third Party Reimbursement

Our rigid knee braces, CMF products, diabetic shoes and inserts, and certain of our soft goods are generally prescribed by physicians and health care professionals such as podiatrists and are eligible for third party reimbursement by government payors, such as Medicare and Medicaid, and private payors. Customer selection of our products depends, in part, on coverage of our products and whether third party payment amounts will be adequate. We believe that Medicare and other third party payors will continue to focus on measures to contain or reduce their costs through managed care, selective contracting, and other methods. Medicare policies are important to our business not only because we must continue to meet the criteria for a qualified Medicare supplier, but also because private payors often model their policies after the Medicare program’s coverage and reimbursement policies.

In recent years, Congress has enacted a number of laws that affect Medicare reimbursement for and coverage of durable medical equipment (DME) and durable medical equipment, prosthetics, orthotics and supplies (DMEPOS), including many of our products. These laws have included temporary freezes or reductions in Medicare fee schedule updates. For instance, in March 2010, President Obama signed into law the Patient Protection and Affordable Care Act, which was amended by a second bill signed into law on March 30, 2010, known as the Health Care and Education Reconciliation Act (collectively referred to as the Affordable Care Act or ACA). Several provisions of the ACA specifically impact the medical equipment industry. Among other things, the ACA eliminated the full inflation update to the DMEPOS fee schedule for the years 2011 through 2014. Instead, beginning in 2011, the ACA reduces the inflation update for DMEPOS by a “productivity adjustment” factor intended to reflect productivity gains in delivering health care services. For 2015 the update factor is 1.5% (reflecting a 2.1% inflation update that is partially offset by 0.6% “productivity adjustment”). For 2016, the update factor is -0.4%, based on a 0.1% inflation update that is reduced by a 0.5% productivity adjustment.  As discussed below, Medicare fee schedule rates are further adjusted to take into account DMEPOS competitive bidding rates, beginning in 2016.  

Medicare payment for DMEPOS also can be impacted by the DMEPOS competitive bidding program, under which Medicare rates are based on bid amounts for certain products in designated geographic areas, rather than the Medicare fee schedule amount. Only those suppliers selected through the competitive bidding process within each designated competitive bidding area (CBA) are eligible to have their products reimbursed by Medicare. Our products were first included in competitive bidding in 2012 when Centers for Medicare & Medicaid Services (CMS) included TENS electrotherapy units in a recompetition of a prior round of competitive bidding in nine CBAs as part of a new “General Home Equipment and Related Supplies and Accessories” product category. Although we submitted bids to supply products in this category and were selected as a successful bidder in two CBAs, we did not enter into a contract to be a supplier in those two regions. The reimbursement rate in those two regions was established at a 46% reduction to the Medicare fee schedule rate, which is generally consistent with the results of competitive bidding for other items of DME. As a result of the closure of our Empi business, we no longer have any products currently affected by reimbursement rates established through competitive bidding. In 2013 CMS released a listing of codes that it considers to be off-the-shelf (OTS) orthotics and subject to competitive bidding in the future. When our orthotic products are subject to competitive bidding, if we are not a contract supplier (or subcontractor) in a particular region or if contract prices are significantly below Medicare fee schedule reimbursement levels, it could have a material adverse impact on our sales and profitability. CMS has not yet announced the schedule for competitive bidding for off-the-shelf orthotics. The ACA also authorizes the Secretary to use competitive bidding payment information to adjust OTS orthotics payments and other fee schedule amounts in areas outside of CBAs beginning in 2016. CMS finalized the methodology for making such fee schedule adjustments in a November 6, 2014 final rule, but the methodology does not apply to OTS orthotics until such time as these items are subject to competitive bidding.  On February 9, 2016, President Obama issued his fiscal year 2017 budget proposal, in which he called for competitive bidding to be expanded to additional categories of DMEPOS, including all orthotics (not just OTS orthotics) in order to achieve budget savings; such a change would require Congress to enact legislation to modify the Social Security Act.

CMS is seeking to tie Medicare payment to quality and value through a variety of innovative Medicare payment models. For instance, under the Medicare Comprehensive Care for Joint Replacement model, which will begin on April 1, 2016, CMS will make bundled payments to hospitals in 67 metropolitan statistical areas for an “episode of care” for lower extremity joint replacement surgery.  The bundled payment will cover all services provided during the inpatient admission through 90 days post-discharge, including DME, although suppliers will still continue to receive Medicare payment through the usual Medicare fee-for-service payment systems.  Because hospitals ultimately will be held responsible for the episode spending, such bundled payment arrangements could increase pressure on hospitals to control costs associated with medical products such as ours.  

 

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The ACA established new disclosure requirements (sometimes referred to as the Physician Payment Sunshine Act) regarding financial arrangements between medical device and supplies manufacturers, among others, and physicians, including physicians who serve as consultants. The recordkeeping requirements became effective August 1, 2013. The regulations require us to report annually to CMS all payments and other transfers of value to physicians and teaching hospitals for products payable under federal health care programs, as well as ownership or investments held by physicians or their family members. Failure to fully and accurately disclose transfers of value to physicians could subject us to civil monetary penalties. Several states also have enacted specific marketing and payment disclosure requirements and other states may do so in the future.

In response to pressure from certain groups (primarily orthotists), the United States Congress and state legislatures have periodically considered proposals that limit the types of individuals who can fit our orthotic device products or who can seek reimbursement for them. Several states have adopted legislation which imposes certification or licensing requirements on the measuring, fitting and adjusting of certain orthotic devices. Although some of these state laws exempt manufacturers’ representatives, other states’ laws subject the activities of such representatives to certification or licensing requirements. The state of Texas has adopted such a licensure law which the state regulatory board has interpreted as not including an exemption for manufacturer’s sales representatives acting under the supervision of a physician and has issued a cease and desist letter directed to the fitting activities of our sales representatives in that state. We have requested clarification of such letter. Additional states may be considering similar legislation. If these laws are enforced without an exemption for manufacturer’s sales representatives or without our sales representatives qualifying as certified or licensed persons, our ability to fit and bill these products will be adversely impacted. In addition, in July 2013 we were served with a subpoena under HIPAA (as defined and further described below) seeking documents relating to the fitting of custom-fabricated or custom-fitted orthoses in the States of New Jersey, Washington and Texas. The subpoena was issued by the United States Attorney’s Office for the District of New Jersey in connection with an investigation of compliance with professional licensing statutes in those states relating to the practice of orthotics. We have supplied the documents requested under the subpoena.

Efforts have also been made to establish similar certification requirements at the federal level for the Medicare program. For example, in 2000, Congress passed the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA). BIPA contained a provision requiring, as a condition for payment by the Medicare program, that certain certification or licensing requirements be met for individuals and suppliers furnishing certain, but not all, custom-fabricated orthotic devices. CMS has not implemented this requirement to date. In July 2014, CMS promulgated regulations to define the “specialized training” that is needed to provide custom fitting of orthotics under the Medicare program if the fitter is not a certified orthotist. Under the proposed definition, CMS would consider only the following four categories of individuals to have such specialized training: a physician, a treating practitioner, an occupational therapist, or a physical therapist. Under this proposal, trained manufacturers’ representatives, certified athletic trainers, certified orthotic fitters, and other categories of individuals would not have been considered qualified to provide custom-fitting of orthotics. However, in the final rule published on November 6, 2014, CMS specified that it was not finalizing changes to this standard at this time. In 2015 CMS advised that it is developing a proposed rule that would, among other things, specify the qualifications needed for practitioners to furnish custom-fabricated orthotics, but no such proposed rule has yet been published.

Our international sales also depend in part upon the eligibility of our products for reimbursement through third party payors, the amount of reimbursement, and the allocation of payments between the patient and third party payors. Reimbursement practices vary significantly by country, with certain countries requiring products to undergo a lengthy regulatory review in order to be eligible for third party reimbursement. In addition, healthcare cost containment efforts similar to those we face in the United States are prevalent in many of the foreign countries in which our products are sold, and these efforts are expected to continue in the future, possibly resulting in the adoption of more stringent reimbursement standards. For example, in Germany, our largest foreign market, new regulations generally require adult patients to pay a portion of the cost of each medical technical device prescribed. This may adversely affect our sales and profitability by making it more difficult for patients in Germany to pay for our products.

A 2015 court decision in Germany has resulted in reimbursement coverage for continuous passive motion devices (CPM) and continuous active motion devices (CAM) to be challenged by the Federal Joint Committee authorities.  The Federal Joint Committee is the highest decision-making body of the joint self-government of physicians, dentists, hospitals and health insurance funds in Germany.  These authorities have mandated that an independent scientific institute compile a dossier on the safety and effectiveness of CAM devices in an outpatient setting. The institute must report by August 2017 on its findings. 

Any developments in our foreign markets that eliminate, reduce or materially modify coverage of, and reimbursement rates for, our products could have an adverse impact on our ability to sell our products.

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Fraud and Abuse

We are subject to various and frequently changing federal and state laws and regulations pertaining to healthcare fraud and abuse. Many of these laws and regulations are vague or indefinite and may be interpreted or applied by a prosecutorial, regulatory, or judicial authority in a manner that could require us to make changes to our operations. Violations of these laws are punishable by criminal, civil and administrative sanctions, including, in some instances, loss of licenses and exclusion from participation in federal and state healthcare programs, including Medicare, Medicaid, Veterans Administration health programs and TRICARE (the health care program for active duty military, retirees and their families managed by the Department of Defense).

Anti-Kickback and Other Fraud Laws

Our operations are subject to federal and state anti-kickback laws. Certain provisions of the Social Security Act, commonly referred to as the Anti-Kickback Statute, prohibit persons from knowingly and willfully soliciting, receiving, offering or providing remuneration directly or indirectly to induce either the referral of an individual, or the furnishing, recommending, or arranging for a good or service, for which payment may be made under a federal healthcare program such as Medicare and Medicaid. The definition of remuneration has been broadly interpreted to include anything of value, including such items as gifts, discounts, waivers of payment, and providing anything at less than its fair market value. The U.S. Department of Health and Human Services (HHS) has issued regulations, commonly known as safe harbors, which set forth certain conditions, which if fully met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-Kickback Statute for their involvement in certain types of arrangements or activities. The penalties for violating the Anti-Kickback Statute include imprisonment for up to five years, fines of up to $25,000 per violation and possible exclusion from federal healthcare programs such as Medicare and Medicaid. Many states have adopted prohibitions similar to the Anti-Kickback Statute, some of which apply to the referral of patients for healthcare services reimbursed by any source, not only by the Medicare and Medicaid programs.

HIPAA

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) created two new federal crimes effective as of August 21, 1996, relating to healthcare fraud and false statements regarding healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing or attempting to execute a scheme or artifice to defraud any healthcare benefit program, including private payors. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation in connection with the delivery of or payment for healthcare benefits, items or services. HIPAA applies to any healthcare benefit plan, not just Medicare and Medicaid. Additionally, HIPAA granted expanded enforcement authority to HHS and the DOJ and provided enhanced resources to support the activities and responsibilities of the HHS, OIG and DOJ by authorizing large increases in funding for investigating fraud and abuse violations relating to healthcare delivery and payment. In addition, HIPAA mandates the adoption of standards for the electronic exchange of health information, as described below in greater detail under “Federal Privacy and Transaction Law and Regulations.”

Physician Self-Referral Laws

We may also be subject to federal and state physician self-referral laws. Federal physician self-referral legislation, commonly known as the Stark Law, prohibits, subject to certain exceptions, physician referrals of Medicare and Medicaid patients to an entity providing certain “designated health services” if the physician or an immediate family member of the physician or a physician organization in which the physician participates has any financial relationship with the entity. DME and orthotics are included as designated health services. The Stark Law also prohibits the entity receiving the referral from billing any good or service furnished pursuant to an unlawful referral, and any person collecting any amounts in connection with an unlawful referral is obligated to refund such amounts. A person who engages in a scheme to circumvent the Stark Law’s referral prohibition may be fined up to $100,000 for each such arrangement or scheme. The penalties for violating the Stark Law also include civil monetary penalties of up to $15,000 per referral and possible exclusion from federal healthcare programs such as Medicare and Medicaid. Various states have corollary laws to the Stark Law, including laws that require physicians to disclose any financial interest they may have with a healthcare provider to their patients when referring patients to that provider. Both the scope and exceptions for such laws vary from state to state.

False Claims Laws

Under multiple state and federal statutes, submissions of claims for payment that are “not provided as claimed” may lead to civil money penalties, criminal fines and imprisonment and/or exclusion from participation in Medicare, Medicaid and other federally funded state health programs. These false claims statutes include the federal False Claims Act, which prohibits the knowing filing of a false claim or the knowing use of false statements to obtain payment from the federal government. When an entity is determined to have violated the False Claims Act, it must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Suits filed under the False Claims Act, known as “qui tam”

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actions, can be brought by any individual on behalf of the government, and such individuals, commonly known as whistleblowers, may share in any amounts paid by the entity to the government in fines or settlement. In addition, certain states have enacted laws modeled after the federal False Claims Act. Qui tam actions have increased significantly in recent years, causing greater numbers of healthcare companies to have to defend a false claim action, which may be costly and protracted, pay fines or be excluded from Medicare, Medicaid or other federal or state healthcare programs as a result of an investigation arising out of such action. A number of states have enacted false claims acts that are similar to the federal False Claims Act.

The federal government has used the federal False Claims Act to prosecute a wide variety of alleged false claims and fraud allegedly perpetrated against Medicare and state healthcare programs. Under the ACA, claims for items and services resulting from a violation of the federal Anti-Kickback Statute constitute a false claim. The government and a number of courts also have taken the position that claims presented in violation of certain other statutes, including the Stark Law, and of regulations and conditions of participation, can be considered a violation of the federal False Claims Act, based on the theory that a provider impliedly certifies compliance with all applicable laws, regulations and other rules when submitting claims for reimbursement.

On May 20, 2009, President Obama signed into law the Fraud Enforcement and Recovery Act of 2009 (FERA). Among other things, FERA modified the federal False Claims Act by expanding liability to contractors and subcontractors who do not directly present claims to the federal government. FERA also expanded False Claims Act liability for what is referred to as a “reverse false claim” by explicitly making it unlawful to knowingly conceal or knowingly and improperly avoid or decrease an obligation owed to the federal government. FERA also sought to clarify that liability exists for attempts to avoid repayment of overpayments, including improper retention of federal funds. In February 2016, CMS issued implementing regulations on the FERA requirements to return overpayments. FERA and its implementing regulations are likely to increase both the volume and liability exposure of False Claims Act cases brought against healthcare entities. Additional fraud and abuse measures were adopted as part of the ACA, as noted above.

Just prior to the acquisition in 2011 of Dr. Comfort by DJO, Dr. Comfort entered into a settlement agreement with the U.S. Attorney’s Office for the Eastern District of Wisconsin and the Office of the Inspector General of HHS (OIG) resolving allegations by two whistleblowers that Dr. Comfort made false claims relating to products that allegedly did not meet Medicare standards. This settlement agreement required Dr. Comfort to, among other things, enter into a five-year Corporate Integrity Agreement (CIA) covering its compliance program. Dr. Comfort has complied with its obligations under the CIA for the past four years and expects that the OIG will confirm its compliance for the fifth and final year.

Customs and Import/Export Laws and Regulations

Our business is conducted world-wide, with raw material and finished goods imported from and exported to a substantial number of countries. In particular, a significant portion of our products are manufactured in our plant in Tijuana, Mexico and imported to the United States before shipment to domestic customers or export to other countries. We are subject to customs and import/export rules in the U.S. and other countries and to requirements for payment of appropriate duties and other taxes as goods move between countries. Customs authorities monitor our shipments and payments of duties, fees and other taxes and can perform audits to confirm compliance with applicable laws and regulations.

Foreign Corrupt Practices Act

We are also subject to the U.S. Foreign Corrupt Practices Act (the FCPA), antitrust and anti-competition laws, and similar laws in foreign countries, any violation of which could create a substantial liability for us and also cause a loss of reputation in the market. The FCPA prohibits U.S. companies and their representatives, officers, directors, employees, shareholders acting on their behalf and agents from corruptly offering, promising, authorizing or making payments, or giving anything of value, directly or indirectly, to foreign officials for the purpose of obtaining or retaining business abroad or otherwise obtaining favorable treatment. Companies must also maintain records that fairly and accurately reflect transactions and maintain an adequate system of internal accounting controls. In many countries, hospitals and clinics are government-owned and healthcare professionals employed by such hospitals and clinics, with whom we regularly interact, may be considered as meeting the definition of foreign officials for purposes of the FCPA. If we are found to have violated the FCPA or similar law, we may face sanctions including fines, criminal penalties, disgorgement of profits and suspension or debarment of our ability to contract with government agencies or receive export licenses.

Governmental Audits and Surveys

Because we participate in governmental programs as a supplier of medical devices, our operations are subject to periodic surveys and audits by governmental entities or contractors to assure compliance with Medicare and Medicaid standards and requirements. To maintain our billing privileges, we are required to comply with certain supplier standards, including licensure and documentation requirements for our claims submissions. From time to time in the ordinary course of business, we, like other healthcare companies, are audited by, or receive claims documentation requests from, governmental entities, which may identify

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certain deficiencies based on our alleged failure to comply with applicable supplier standards or other requirements. Medicare contractors and Medicaid agencies periodically conduct pre-payment and post-payment reviews and other audits of claims and are under increasing pressure to more closely scrutinize healthcare claims and supporting documentation, as well as on-site operations. Among other things, the ACA expanded the Recovery Audit Contractors (RAC) program, an audit tool that utilizes private companies operating on a contingent fee basis to identify and recoup Medicare overpayments. The Medicare and Medicaid programs also have broad authority to impose payment suspensions and supplier number revocations when they believe credible allegations of fraud or other supplier standard noncompliance issues exist. We have historically been subject to pre and post-payment reviews as well as audits of claims, as well as supplier number revocations we were able to resolve in a short period of time. We may experience such reviews and audits of claims in the future. We review and assess such claims’ audits or reports and attempt to take appropriate corrective action. We are also subject to surveys of our facilities for compliance with the supplier standards. Noncompliance can result in, among other things, a revocation of Medicare billing privileges or termination from the Medicare program.

Federal Privacy and Transaction Law and Regulations

The Health Insurance Portability and Accountability Act of 1996, and its implementing regulations, as amended by the regulations promulgated pursuant to the Health Information Technology for Economic and Clinical Health Act (HITECH Act), which we collectively refer to as HIPAA, contain substantial restrictions and requirements with respect to the use and disclosure of certain individually identifiable health information (referred to as protected health information, or PHI). These restrictions and requirements are set forth in the HIPAA Privacy, Security and Breach Notification Rules.

In many of our operations, we are a “covered entity” under HIPAA and therefore required to comply with the Privacy, Security and Breach Notification Rules, and are subject to significant civil and criminal penalties for failure to do so. We also provide services to customers that are covered entities themselves, and we are required to provide satisfactory written assurances to these customers through our written agreements that we will provide our services in accordance with HIPAA. Failure to comply with these contractual agreements could lead to loss of customers, contractual liability to our customers, and direct action by the federal government, including penalties.

On January 25, 2013, the Office for Civil Rights (OCR) of the Department of Health and Human Services published its final rule to modify the HIPAA Privacy, Security, Breach Notification and Enforcement Rules, including most revisions/additions made by the HITECH Act. The rule expanded the privacy and security requirements for business associates that create, receive, maintain or transmit protected health information for or on behalf of covered entities, increased penalties for noncompliance, and strengthened requirements for reporting of breaches of unsecured protected health information, among other changes. The rule also made business associates and their subcontractors directly liable for civil monetary penalties for impermissible uses and disclosures of protected health information. The rule became effective on March 23, 2013, and, with limited exception, entities and business associates covered by the rule were required to comply with most of the applicable requirements by September 23, 2013.

In addition to HIPAA, we must adhere to state patient confidentiality laws that are not preempted by HIPAA, including those that are more stringent than HIPAA requirements.

In November 2014, the Company experienced the loss of certain electronic protected health information following the theft of a laptop computer from the car of an IT consultant who was working for our Empi business in Shoreview, MN. The laptop belonged to the Company and contained reports which included patient data for approximately 160,000 patients. The data saved on the laptop computer was not encrypted. The Company has taken actions to notify all of the affected individuals and the media in most states as required by HIPAA. The Company has also provided the required notice to the Office of Civil Rights. As a result of this breach, the Company has undertaken additional remedial actions to strengthen its privacy and information security policies and infrastructure. In February 2016, the Company received notice from OCR indicating that OCR would be investigating the incident and the Company’s compliance with the Privacy, Security and Breach Notification Rules and requesting certain information related to the incident and the Company’s compliance with the Privacy, Security and Breach Notification Rules.  We are unable to predict at this time whether or to what extent OCR, or other federal or state agencies, will impose any civil monetary penalties or take other action as a result of this breach.

There are costs and administrative burdens associated with ongoing compliance with HIPAA and similar state law requirements. Any failure or perceived failure to comply carries with it the risk of significant penalties and sanctions. We cannot predict at this time the costs associated with ongoing compliance, or the ultimate impact of such laws and regulations on our results of operations, cash flows or financial condition.

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European Union Data Privacy Rules

The European Union (“EU”) has adopted a comprehensive law, called the Data Protection Directive 95/46/EC (the “Directive”), regulating the transfer of personal data from each EU state, including transfers to the US.  These rules impacted, among other things, the transfer of human resources information from our subsidiaries in the EU states to our headquarters in the US.  Failure to comply with the Directive would expose the Company to substantial fines and penalties.  The Company, like other multinational companies doing business in the EU, had agreed to a set of principles and guidelines negotiated between the US and the EU (called the “Safe Harbor”) which, if followed, assured compliance with the Directive.  In October 2015 the European Court of Justice declared the Safe Harbor to be invalid.  The Company and each of its subsidiaries are in the process of adopting a set of standard contractual clauses approved by the European Commission which are deemed to comply with the Directive. The Company has also negotiated an arrangement with a vendor to cover all transfers of human resources data from EU states to the US in accordance with a set of these standard contractual clauses and we intend to include such clauses in other arrangements we may enter into with the third parties who may process such data.  The EU and the US continue to negotiate an alternative structure to the former Safe Harbor to provide a framework under which private data can be transferred and processed in a manner consistent with the Directive.  If such a framework is finalized, the Company may be required to proceed thereunder or may be permitted to continue to act in accordance with the standard contractual clauses.

Iran Sanctions Related Disclosure

Under the Iran Threat Reduction and Syrian Human Rights Act of 2012 (“ITRSHRA”), which added Section 13(r) of the Exchange Act, we are required to include certain disclosures in our periodic reports if we or any of our “affiliates” knowingly engaged in certain specified activities, transactions or dealings related to Iran or certain designated parties during the period covered by the report. An issuer must also concurrently file a separate notice with the SEC that such activities have been disclosed. We are not presently aware that we or our consolidated subsidiaries have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange Act during the year ended December 31, 2015.

Because the SEC defines the term “affiliate” broadly, it includes any entity controlled by us as well as any person or entity that controls us or is under common control with us (“control” is also construed broadly by the SEC). As a result, The Blackstone Group L.P. (“Blackstone”), an affiliate of our major shareholder, and certain of the companies in which Blackstone’s affiliated funds are invested (“portfolio companies”), may be deemed to be our affiliates. During 2015, Blackstone included information in its periodic reports filed with the SEC regarding activities of its portfolio companies that require disclosure under the ITRSHR. These disclosures are reproduced in Exhibit 99.1 of this report and are incorporated by reference herein. We have no involvement in or control over such activities and we have not independently verified or participated in the preparation of the disclosures described in the filing.

Employees

As of December 31, 2015, we had approximately 5,260 employees. Of these, approximately 3,760 were engaged in production and production support, approximately 100 in research and development, approximately 1,000 in sales and support, and approximately 400 in various administrative capacities including third party billing. Of these employees, approximately 2,070 were located in the United States, approximately 2,150 were located in Mexico and approximately 1,040 were located in various other countries, primarily in Europe. We have not experienced any strikes or work stoppages, and our management considers our relationship with our employees to be good.

Segment and Geographic Information

Information about our segments and geographic areas can be found in Note 18 of the Notes to Consolidated Financial Statements included in Part II, Item 8, herein.

Available Information

We have made available free of charge through our website, www.DJOglobal.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, other Exchange Act reports and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (SEC). This information can be found under the “Corporate Information—Investors-SEC reports” page of our website. DJO uses its website as a channel of distribution of material Company information. Financial and other material information regarding the Company is routinely posted and accessible on our website. Our SEC reports are also available free of charge on the SEC website at, www.sec.gov. Such reports can also be inspected and copied at the Public Reference Room of the SEC located at 100 F Street, N.E., Washington, D.C. 20549. Copies of such material can be obtained from the Public Reference Room of the SEC at prescribed rates. You may obtain

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information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our Code of Business Conduct and Ethics is available free of charge under the “Corporate Information—Investors-Corporate Governance” page of our website.

 

 

ITEM 1A.

RISK FACTORS

Our ability to achieve our operating and financial goals is subject to a number of risks, including risks relating to our business operations, our debt level and government regulations. If any of the following risks actually occur, our business, operating results, prospects or financial condition could be materially and adversely affected. The risks described below are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also affect our business operations.

Risks Related To Our Indebtedness

Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under our indebtedness.

We are highly leveraged. As of December 31, 2015, our total indebtedness was $2,397.4 million, exclusive of net unamortized debt issuance costs and original issue discount of $42.3 million. We also had an additional $119.5 million available for borrowing under our revolving credit facility. Our high degree of leverage could have important consequences, including:

 

·

making it difficult for us to make payments on our 8.125% second lien notes, 10.75% third lien notes, our 9.75% senior subordinated notes (collectively, the Notes) and other debt,

 

·

increasing our vulnerability to general economic and industry conditions,

 

·

requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities,

 

·

exposing us to the risk of increased interest rates as certain of our borrowings, including certain borrowings under our senior secured credit facilities, will be subject to variable rates of interest,

 

·

limiting our ability to make strategic acquisitions or causing us to make non-strategic divestitures,

 

·

limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes, and

 

·

limiting our ability to adjust to changing market conditions and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged.

Our debt agreements contain restrictions that limit our flexibility in operating our business.

Our senior secured credit facilities and the Indentures contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our and our restricted subsidiaries’ ability to, among other things:

 

·

incur additional indebtedness or issue certain preferred shares,

 

·

pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments,

 

·

make certain investments,

 

·

sell certain assets,

 

·

create liens,

 

·

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets, and

 

·

enter into certain transactions with our affiliates.

In addition, we are required to satisfy and maintain a specified senior secured leverage ratio. This covenant could materially adversely affect our ability to finance our future operations or capital needs. Furthermore, it may restrict our ability to conduct and expand our business and pursue our business strategies. Our ability to meet this senior secured leverage ratio can be affected by events beyond our control, including changes in general economic and business conditions, and we cannot assure you that we will meet the senior secured leverage ratio in the future or at all.

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A breach of any of these covenants could result in a default under one or more of these agreements, including as a result of cross default provisions. Upon the occurrence of an event of default under our senior secured credit facilities, the lenders could elect to declare all amounts outstanding under our senior secured credit facilities to be immediately due and payable and terminate all commitments to extend further credit. Such actions by those lenders could cause cross defaults under our other indebtedness. If we were unable to repay those amounts, the lenders under our 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 our senior secured credit facilities. If the lenders under our senior secured credit facilities accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay the amounts borrowed under our senior secured credit facilities, as well as our unsecured indebtedness.

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures could affect the operation and growth of our business and may not be successful and may not permit us to meet our scheduled debt service obligations. If our operating results and available cash are insufficient to meet our debt service obligations, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. In that case, we may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them, and the proceeds from those dispositions may not be adequate to meet any debt service obligations then due. Additionally, our senior secured credit facilities and the Indentures limit the use of the proceeds from dispositions of assets; as a result, we may not be permitted to use the proceeds from such dispositions to satisfy all current debt service obligations.

Substantially all of our indebtedness matures in 2020 and 2021 and changes in the debt financing markets could negatively impact our ability to obtain attractive financing or re-financing for repayment of such indebtedness which would lead to increased financing costs and reduce our income.

Approximately $1,052.4 million principal amount of term loan borrowings under our senior secured credit facilities mature in June 2020 and approximately $1,315.0 million aggregate principal amount of our notes mature between April 2020 and June 2021. Any recurrence of the significant contraction in the market for debt financing that occurred in 2008 and 2009 or other adverse change relating to the terms of such debt financing with, for example, higher rates and/or more restrictive covenants, would have a material adverse impact on our business. To the extent that the credit markets and/or regulatory changes render such financing difficult to obtain or more expensive, this may negatively impact our operating performance. In addition, to the extent that the markets and/or regulatory changes make it difficult or impossible to refinance debt that is maturing in the near term, we may be unable to repay such debt at maturity and may be forced to sell assets, undergo a recapitalization or seek bankruptcy protection.

Risks Related To Our Business

If adequate levels of reimbursement and coverage from third party payors for our products are not obtained, healthcare providers and patients may be reluctant to use our products; our margins may suffer and our revenue and profits may decline.

Our sales depend largely on whether there is adequate reimbursement and coverage by government healthcare programs, such as Medicare and Medicaid, and by private payors. We believe that surgeons, hospitals, physical therapists and other healthcare providers may not use, purchase or prescribe our products and patients may not purchase our products if these third party payors do not provide satisfactory coverage of and reimbursement for the costs of our products or the procedures involving the use of our products.  Reduced reimbursement rates will also lower our margins on product sales and could adversely impact the profitability and viability of the affected products.

Third party payors continue to review their coverage policies carefully and can, without notice, reduce or eliminate reimbursement for our products or treatments that use our products. For instance, they may attempt to control costs by (i) authorizing fewer elective surgical procedures, including joint reconstructive surgeries, (ii) requiring the use of the least expensive product available, (iii) reducing the reimbursement for or limiting the number of authorized visits for rehabilitation procedures or (iv) otherwise restricting coverage or reimbursement of our products or procedures using our products.

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Medicare payment for durable medical equipment, prosthetics, orthotics and supplies (DMEPOS) also can be impacted by the DMEPOS competitive bidding program, under which Medicare rates are based on bid amounts for certain products in designated geographic areas, rather than the Medicare fee schedule amount. Only those suppliers selected through the competitive bidding process within each designated competitive bidding area (CBA) are eligible to have their products reimbursed by Medicare. CMS also has adopted regulations to begin adjusting national DMEPOS fee schedules to take into account competitive bidding pricing. See “Government Regulations—Third Party Reimbursement” in the “Business” section above. If we are not selected as a contract supplier (or subcontractor) in a particular region under competitive bidding, or if contract or fee schedule prices are significantly below current Medicare fee schedule reimbursement levels, it could have an adverse impact on our sales and profitability.

Because many private payors model their coverage and reimbursement policies on Medicare, other third party payors’ coverage of, and reimbursement for, our products also could be negatively impacted by legislative, regulatory or other measures that restrict Medicare coverage or reduce Medicare reimbursement.

Our international sales also depend in part upon the coverage and eligibility for reimbursement of our products through government-sponsored healthcare payment systems and third party payors, the amount of reimbursement, and the cost allocation of payments between the patient and government-sponsored healthcare payment systems and third party payors. Coverage and reimbursement practices vary significantly by country, with certain countries requiring products to undergo a lengthy regulatory review in order to be eligible for third party coverage and reimbursement. In addition, healthcare cost containment efforts similar to those we face in the United States are prevalent in many of the foreign countries in which our products are sold, and these efforts are expected to continue in the future, possibly resulting in the adoption of more stringent reimbursement standards relating to our international operations.

Federal and state health reform and cost control efforts include provisions that could adversely impact our business and results of operations.

ACA is a sweeping measure designed to expand access to affordable health insurance, control health care spending, and improve health care quality. Several provisions of the ACA specifically affect the medical equipment industry. In addition to changes in Medicare DMEPOS reimbursement and an expansion of the DMEPOS competitive bidding program, the ACA provides that for sales on or after January 1, 2013, manufacturers, producers, and importers of specified taxable medical devices must pay an annual excise tax of 2.3% of a deemed price for these products. A limited number of our products are subject to the new tax. A two-year suspension of the medical device tax was passed in late 2015, resulting in no medical device tax obligations for 2016 and 2017. ACA also establishes enhanced Medicare and Medicaid program integrity provisions, including expanded documentation requirements for Medicare DMEPOS orders, more stringent procedures for screening Medicare and Medicaid DMEPOS suppliers, and new disclosure requirements regarding manufacturer payments to physicians and teaching hospitals, along with broader expansion of federal fraud and abuse authorities. Although the eventual impact of the ACA is still uncertain, it is possible that the legislation will have a material adverse impact on our business. Likewise, most states have adopted or are considering policies to reduce Medicaid spending as a result of state budgetary shortfalls, which in some cases include reduced reimbursement for DMEPOS items and/or other Medicaid coverage restrictions. As states continue to face significant financial pressures, it is possible that state health policy changes will adversely affect our profitability.

If we fail to meet Medicare accreditation and surety bond requirements or DMEPOS supplier standards, it could negatively affect our business operations.

Medicare DMEPOS suppliers (other than certain exempted professionals) must be accredited by an approved accreditation organization as meeting DMEPOS quality standards adopted by CMS including specific requirements for suppliers of custom-fabricated and custom-fitted orthoses and certain prosthetics. Medicare suppliers also are required to meet surety bond requirements. In addition, Medicare DMEPOS suppliers must comply with Medicare supplier standards in order to obtain and retain billing privileges, including meeting all applicable federal and state licensure and regulatory requirements. CMS periodically expands or otherwise clarifies the Medicare DMEPOS supplier standards and states periodically change licensure requirements, including licensure rules imposing more stringent requirements on out-of-state DMEPOS suppliers. We believe we currently are in compliance with these requirements. If we fail to maintain our Medicare accreditation status and/or do not comply with Medicare surety bond or supplier standard requirements or state licensure requirements in the future, or if these requirements are changed or expanded, it could adversely affect our profits and results of operations.

If we, our contract manufacturers, or our component suppliers fail to comply with the Food and Drug Administration’s (the FDA) Quality System Regulation, our manufacturing could be delayed, and our product sales and profitability could suffer.

Our manufacturing processes, and the manufacturing processes of our contract manufacturers and component suppliers are required to comply with the FDA’s Quality System Regulation, which covers current Good Manufacturing Practice requirements

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including procedures concerning (and documentation of) the design, testing, production processes, controls, quality assurance, labeling, packaging, storage and shipping of our devices. We also are subject to state requirements and licenses applicable to manufacturers of medical devices. In addition, we must engage in extensive recordkeeping and reporting and must make available our manufacturing facilities and records for periodic unscheduled inspections by governmental agencies, including the FDA, state authorities and comparable agencies in other countries. Moreover, if we fail to pass a Quality System Regulation inspection or to comply with these and other applicable regulatory requirements, we may receive a notice of a violation in the form of inspectional observations on Form FDA-483 or a warning letter, or we could otherwise be required to take corrective action and, in severe cases, we could suffer a disruption of our operations and manufacturing delays. If we fail to take adequate corrective actions, we could be subject to certain enforcement actions, including, among other things, significant fines, suspension of approvals, seizures or recalls of products, operating restrictions and criminal prosecutions. We cannot assure you that the FDA or other governmental authorities would agree with our interpretation of applicable regulatory requirements or that we have in all instances fully complied with all applicable requirements. Any notice or communication from the FDA regarding a failure to comply with applicable requirements could adversely affect our product sales and profitability. We have received FDA warnings letters in the past and we cannot assure you that the FDA will not take further action in the future.

Our contract manufacturers and our component suppliers are also required to comply with the FDA’s Quality System Regulations. We cannot assure anyone that our contract manufacturers’ or component suppliers’ facilities would pass any future quality system inspection. If our or any of our contract manufacturers’ or component suppliers’ facilities fail a quality system inspection, our product sales and profitability could be adversely affected.

The loss of the services of our key management and personnel could adversely affect our ability to operate our business.

Our executive officers have substantial experience and expertise in our industry. Our future success depends, to a significant extent, on the abilities and efforts of our executive officers and other members of our management team. We compete for such personnel with other companies, academic institutions, government entities and other organizations, and our failure to hire and retain qualified individuals for senior executive positions could have a material adverse impact on our business.

We may experience substantial fluctuations in our quarterly operating results and you should not rely on them as an indication of our future results.

Our quarterly operating results may vary significantly due to a combination of factors, many of which are beyond our control. These factors include

 

·

demand for many of our products, which historically has been higher in the fourth quarter when scholastic sports and ski injuries are more frequent,

 

·

our ability to meet the demand for our products,

 

·

the direct distribution of our products in foreign countries that have seasonal variations,

 

·

the number, timing and significance of new products and product introductions and enhancements by us and our competitors, including delays in obtaining government review and clearance of medical devices,

 

·

our ability to develop, introduce and market new and enhanced versions of our products on a timely basis,

 

·

the impact of any acquisitions that occur in a quarter,

 

·

the impact of any changes in generally accepted accounting principles,

 

·

changes in pricing policies by us and our competitors and reimbursement rates by third party payors, including government healthcare agencies and private insurers,

 

·

the loss of any of our significant distributors,

 

·

changes in the treatment practices of orthopedic and spine surgeons, primary care physicians, and pain-management specialists, and their allied healthcare professionals, and

 

·

the timing of significant orders and shipments.

Accordingly, our quarterly sales and operating results may vary significantly in the future and period-to-period comparisons of our results of operations may not be meaningful and should not be relied upon as indications of future performance. We cannot assure you that our sales will increase or be sustained in future periods or that we will be profitable in any future period.

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Our reported results may be adversely affected by increases in reserves for contractual allowances, rebates, product returns, uncollectible accounts receivable and inventory.

We have established reserves to account for contractual allowances, rebates, product returns and reserves for rental credits. Significant management judgment must be used and estimates must be made in connection with establishing the reserves for contractual allowances, rebates, product returns, uncollectible accounts receivable and inventory and other allowances in any accounting period. If such judgments and estimates are inaccurate, our reserves for such items may have to be increased which could adversely affect our reported financial results by reducing our net revenues and/or profitability for the reporting period.

We operate in a highly competitive business environment, and our inability to compete effectively could adversely affect our business prospects and results of operations.

We operate in highly competitive and fragmented markets. Our Bracing and Vascular, Recovery Sciences and International segments compete with both large and small companies, including several large, diversified companies with significant market share and numerous smaller niche companies, particularly in the physical therapy products market. Our Surgical Implant segment competes with a small number of very large companies that dominate the market, as well as other companies similar to our size. We may not be able to offer products similar to, or more desirable than, those of our competitors or at a price comparable to that of our competitors. Compared to us, many of our competitors have

 

·

greater financial, marketing and other resources,

 

·

more widely accepted products,

 

·

a larger number of endorsements from healthcare professionals,

 

·

a larger product portfolio,

 

·

superior ability to maintain new product flow,

 

·

greater research and development and technical capabilities,

 

·

patent portfolios that may present an obstacle to the conduct of our business,

 

·

stronger name recognition,

 

·

larger sales and distribution networks, and/or

 

·

international manufacturing facilities that enable them to avoid the transportation costs and foreign import duties associated with shipping our products manufactured in the United States to international customers.

Accordingly, we may be at a disadvantage with respect to our competitors. These factors may materially impair our ability to develop and sell our products.

The success of all of our products depends heavily on acceptance by healthcare professionals who prescribe and recommend our products, and our failure to maintain a high level of confidence by key healthcare professionals in our products could adversely affect our business.

We have maintained customer relationships with numerous orthopedic surgeons, primary care physicians, other specialist physicians, physical therapists, athletic trainers, chiropractors and other healthcare professionals. We believe that sales of our products depend significantly on their confidence in, and recommendations of, our products. Acceptance of our products depends on educating the healthcare community as to the distinctive characteristics, perceived benefits, clinical efficacy and cost-effectiveness of our products compared to the products offered by our competitors and on training healthcare professionals in the proper use and application of our products. Failure to maintain these customer relationships and develop similar relationships with other leading healthcare professionals could result in fewer recommendations of our products, which may adversely affect our sales and profitability.

In addition, from time to time, CMS or its contractors have considered imposing restrictions on the ability of DMEPOS suppliers to maintain consigned inventory in physicians’ offices and then for bill for such inventory once a physician prescribes the item for a patient.  In December 2015, the National Supplier Clearinghouse (NSC), a CMS contractor, suggested limits on the ability of a DMEPOS supplier to perform functions at the provider’s facility and then bill for the consigned inventory.  The NSC policy was subsequently rescinded.  There can be no assurances that CMS or its contractors will not adopt more restrictive policies regarding consignment arrangements in the future.

 

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The success of our surgical implant products depends on our relationships with leading surgeons who assist with the development and testing of our products, and our ability to comply with enhanced disclosure requirements regarding payments to physicians.

A key aspect of the development and sale of our surgical implant products is the use of designing and consulting arrangements with orthopedic surgeons who are well recognized in the healthcare community. These surgeons assist in the development and clinical testing of new surgical implant products. They also participate in symposia and seminars introducing new surgical implant products and assist in the training of healthcare professionals in using our new products. We may not be successful in maintaining or renewing our current designing and consulting arrangements with these surgeons or in developing similar arrangements with new surgeons. In that event, our ability to develop, test and market new surgical implant products could be adversely affected.

In addition, the Physician Payment Sunshine Act and related state marketing and payment disclosure requirements and industry guidelines could have an adverse impact on our relationships with surgeons, and there can be no assurances that such requirements and guidelines would not impose additional costs on us and/or adversely impact our consulting and other arrangements with surgeons.

Proposed laws that would limit the types of orthopedic professionals who can fit, sell or seek reimbursement for our products could, if adopted, adversely affect our business.

Federal and state legislatures and regulators have periodically considered proposals to limit the types of orthopedic professionals who can fit or sell our orthotic products or who can seek reimbursement for them. Several states have adopted legislation imposing certification or licensing requirements on the measuring, fitting and adjusting of certain orthotic devices, and additional states may do so in the future. Although some of these state laws exempt manufacturers’ representatives, others do not. Such laws could reduce the number of potential customers by restricting our sales representatives’ activities in those jurisdictions and/or reduce demand for our products by reducing the number of professionals who fit and sell them. The adoption of such policies could have a material adverse impact on our business.

In addition, legislation has been adopted, but not implemented to date, requiring that certain certification or licensing requirements be met for individuals and suppliers furnishing certain custom-fabricated orthotic devices as a condition of Medicare payment. Medicare currently follows state policies in those states that require the use of an orthotist or prosthetist for furnishing of orthotics or prosthetics. In 2014 CMS proposed, but ultimately did not adopt, a regulatory change that would have narrowly defined the “specialized training” that is needed to provide custom fitting of orthotics under the Medicare program if the fitter is not a certified orthotists. In 2015 CMS advised that it is developing a proposed rule that would, among other things, specify the qualifications needed for practitioners to furnish custom-fabricated orthotics, but no such proposed rule has yet been published. We cannot predict whether additional restrictions will be implemented at the state or federal level or the impact of such policies on our business.

We rely on our own direct sales force for certain of our products, which may result in higher fixed costs than our competitors and may slow our ability to reduce costs in the face of a sudden decline in demand for our products.

We rely on our own direct sales force of representatives in the United States and in Europe to market and sell certain of the orthopedic rehabilitation products which are intended for use in the home and in rehabilitation clinics. Some of our competitors rely predominantly on independent sales agents and third party distributors. A direct sales force may subject us to higher fixed costs than those of companies that market competing products through independent third parties, due to the costs that we will bear associated with employee benefits, training, and managing sales personnel. As a result, we could be at a competitive disadvantage. Additionally, these fixed costs may slow our ability to reduce costs in the face of a sudden decline in demand for our products, which could have a material adverse impact on our results of operations.

If we fail to establish new sales and distribution relationships or maintain our existing relationships, or if our third party distributors and independent sales representatives fail to commit sufficient time and effort or are otherwise ineffective in selling our products, our results of operations and future growth could be adversely impacted.

The sale and distribution of certain of our orthopedic products, CMF products and our surgical implant products depend, in part, on our relationships with a network of third party distributors and independent commissioned sales representatives. These third party distributors and independent sales representatives maintain the customer relationships with the hospitals, orthopedic surgeons, physical therapists and other healthcare professionals that purchase, use and recommend the use of our products. Although our internal sales staff trains and manages these third party distributors and independent sales representatives, we do not directly monitor the efforts that they make to sell our products. In addition, some of the independent sales representatives that we use to sell our surgical implant products also sell products that directly compete with our core product offerings. These sales representatives may not dedicate the necessary effort to market and sell our products. If we fail to attract and maintain relationships with third party distributors and skilled independent sales representatives or fail to adequately train and monitor the efforts of the third party distributors and sales

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representatives that market and sell our products, or if our existing third party distributors and independent sales representatives choose not to carry our products, our results of operations and future growth could be adversely affected.

Our international operations expose us to risks related to conducting business in multiple jurisdictions outside the United States.

The international scope of our operations exposes us to economic, regulatory and other risks in the countries in which we operate. We generated 26.6% of our net revenues from customers outside the United States for the year ended December 31, 2015. Doing business in foreign countries exposes us to a number of risks, including the following:

 

·

fluctuations in currency exchange rates,

 

·

imposition of investment, currency repatriation and other restrictions by foreign governments,

 

·

potential adverse tax consequences, including the imposition or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries, which, among other things, may preclude payments or dividends from foreign subsidiaries from being used for our debt service, and exposure to adverse tax regimes,

 

·

difficulty in collecting accounts receivable and longer collection periods,

 

·

the imposition of additional foreign governmental controls or regulations on the sale of our products,

 

·

intellectual property protection difficulties,

 

·

changes in political and economic conditions, including the recent political changes in Tunisia in which we maintain a small manufacturing facility and security issues in Mexico in which we maintain a significant manufacturing facility,

 

·

difficulties in attracting high-quality management, sales and marketing personnel to staff our foreign operations,

 

·

labor disputes,

 

·

import and export restrictions and controls, tariffs and other trade barriers,

 

·

increased costs of transportation or shipping,

 

·

exposure to different approaches to treating injuries,

 

·

exposure to different legal, regulatory and political standards, and

 

·

difficulties of local governments in responding to severe weather emergencies, natural disasters or other such similar events.

In addition, as we grow our operations internationally, we will become increasingly dependent on foreign distributors and sales agents for our compliance and adherence to foreign laws and regulations that we may not be familiar with, and we cannot assure you that these distributors and sales agents will adhere to such laws and regulations or adhere to our own business practices and policies. Any violation of laws and regulations by foreign distributors or sales agents or a failure of foreign distributors or sales agents to comply with our business practices and policies could result in legal or regulatory sanctions against us or potentially damage our reputation in that respective international market. If we fail to manage these risks effectively, we may not be able to grow our international operations, and our business and results of operations may be materially adversely affected.

We may fail to comply with customs and import/export laws and regulations

Our business is conducted world-wide, with raw material and finished goods imported from and exported to a substantial number of countries. In particular, a significant portion of our products are manufactured in our plant in Tijuana, Mexico and imported to the United States before shipment to domestic customers or export to other countries. We are subject to customs and import/export rules in the U.S., including FDA regulatory requirements applicable to medical devices, detailed below, and in other countries, and to requirements for payment of appropriate duties and other taxes as goods move between countries. Customs authorities monitor our shipments and payments of duties, fees and other taxes and can perform audits to confirm compliance with applicable laws and regulations. Our failure to comply with import/export rules and restrictions or to properly classify our products under tariff regulations and pay the appropriate duty could expose us to fines and penalties and adversely affect our financial condition and business operations.

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Fluctuations in foreign exchange rates may adversely affect our financial condition and results of operations and may affect the comparability of our results between financial periods.

Our foreign operations expose us to currency fluctuations and exchange rate risks. We are exposed to the risk of currency fluctuations between the U.S. Dollar and the Euro, Pound Sterling, Canadian Dollar, Mexican Peso, Swiss Franc, Australian Dollar, Japanese Yen, Norwegian Krone, Danish Krone, Swedish Krona, South African Rand, Tunisian Dinar, Chinese Yuan Renminbi and Indian Rupee. Sales denominated in foreign currencies accounted for 24.1% of our consolidated net sales for the year ended December 31, 2015, of which 16.9% were denominated in the Euro. Our exposure to fluctuations in foreign currencies arises because certain of our subsidiaries’ results are recorded in these currencies and then translated into U.S. Dollars for inclusion in our consolidated financial statements, and certain of our subsidiaries enter into purchase or sale transactions using a currency other than our functional currency. As we continue to distribute and manufacture our products in selected foreign countries, we expect that future sales and costs associated with our activities in these markets will continue to be denominated in the applicable foreign currencies, which could cause currency fluctuations to materially impact our operating results. Changes in currency exchange rates may adversely affect our financial condition and results of operations and may affect the comparability of our results between reporting periods.

We may not be able to effectively manage our currency translation risks, and volatility in currency exchange rates may adversely affect our financial condition and results of operations.

Our success depends on receiving regulatory approval for our products, and failure to do so could adversely affect our growth and operating results.

Our products are subject to extensive regulation in the United States by the FDA and by similar governmental authorities in the foreign countries where we do business. The FDA regulates virtually all aspects of a medical device’s development, testing, manufacturing, labeling, promotion, distribution and marketing, as well as modifications to existing products and the marketing of existing products for new indications. In general, unless an exemption applies, a medical device and modifications to the device or its indications must receive either pre-market approval or pre-market clearance from the FDA before it can be marketed in the United States. While in the past we have received such approvals and clearances, we may not be successful in the future in receiving such approvals and clearances in a timely manner or at all. See “Government Regulations—FDA and Similar Foreign Government Regulations” in the “Business” section above. If we begin to have significant difficulty obtaining such FDA approvals or clearances in a timely manner or at all, it could have a material adverse impact on our revenues and growth.

We may fail to receive positive clinical results for our products in development that require clinical trials, and even if we receive positive clinical results, we may still fail to receive the necessary clearance or approvals to market our products.

In the development of new products or new indications for, or modifications to, existing products, we may conduct or sponsor clinical trials. Clinical trials are expensive and require significant investment of time and resources and may not generate the data we need to support a submission to the FDA. Clinical trials are subject to regulation by the FDA and, if federal funds are involved or if an investigator or site has signed a federal assurance, are subject to further regulation by the Office for Human Research Protections and the National Institutes of Health. Failure to comply with such regulation, including, but not limited to, failure to obtain adequate consent of subjects, failure to adequately disclose financial conflicts or failure to report data or adverse events accurately, could result in fines, penalties, suspension of trials, and the inability to use the data to support an FDA submission.

If we fail to comply with the various regulatory regimes for the foreign markets in which we operate, our operational results could be adversely affected.

In many of the foreign countries in which we market our products, we are subject to extensive regulations, including those in Europe. The regulation of our products in the European Economic Area (which consists of the twenty-seven member states of the European Union, as well as Iceland, Liechtenstein and Norway) is governed by various directives and regulations promulgated by the European Commission and national governments. Only medical devices that comply with certain conformity requirements are allowed to be marketed within the European Economic Area. In addition, the national health or social security organizations of certain foreign countries, including certain countries outside Europe, require our products to be qualified before they can be marketed in those countries. Failure to receive or delays in the receipt of, relevant foreign qualifications in the European Economic Area or other foreign countries could have a material adverse impact on our business.

The FDA regulates the export of medical devices from the United States to foreign countries and certain foreign countries may require FDA certification that our products are in compliance with U.S. law. If we fail to obtain or maintain export certificates required for the export of our products, we could suffer a material adverse impact on our revenues and growth.

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We are subject to laws concerning our marketing activities in foreign countries where we conduct business. For example, within the EU, the control of unlawful marketing activities is a matter of national law in each of the member states of the EU. The member states of the EU closely monitor perceived unlawful marketing activity by companies. We could face civil, criminal and administrative sanctions if any member state determines that we have breached our obligations under its national laws. In particular, as a result of conducting business in the U.K. through our subsidiary in that country, we are, in certain circumstances, subject to the anti-corruption provisions of the U.K. Bribery Act in our activities conducted in any country in the world. Industry associations also closely monitor the activities of member companies. If these organizations or authorities name us as having breached our obligations under their regulations, rules or standards, our reputation would suffer and our business and financial condition could be adversely affected. We are also subject to the U.S. Foreign Corrupt Practices Act (the FCPA), antitrust and anti-competition laws, and similar laws in foreign countries, any violation of which could create a substantial liability for us and also cause a loss of reputation in the market. The EU and various of its constituent states have promulgated extensive rules regulating the process and means by which personal data can be exported out of the EU or its constituent states to the US and elsewhere, including for human resources purposes by multinational companies. From time to time, we may face audits or investigations by one or more domestic or foreign government agencies, compliance with which could be costly and time-consuming, and could divert our management and key personnel from our business operations. An adverse outcome under any such investigation or audit could subject us to fines or other penalties, which could adversely affect our business and financial results.

If the Department of Health and Human Services (HHS), the Office of Inspector General (OIG), the FDA or another regulatory agency determines that we have promoted off-label use of our products, we may be subject to various penalties, including civil or criminal penalties, and the off-label use of our products may result in injuries that lead to product liability suits, which could be costly to our business.

The OIG, the FDA and other regulatory agencies actively enforce regulations prohibiting the promotion of a medical device for a use that has not been cleared or approved by the FDA. Use of a device outside its cleared or approved indications is known as “off-label” use. Physicians may prescribe our products for off-label uses, as the FDA does not restrict or regulate a physician’s choice of treatment within the practice of medicine. However, if the OIG or the FDA, or another regulatory agency determines that our promotional materials, training, or activities constitute improper promotion of an off-label use, the regulatory agency could request that we modify our promotional materials, training, or activities, or subject us to regulatory enforcement actions, including the issuance of a warning letter, injunction, seizure, civil fine and criminal penalties. Although our policy is to refrain from statements and activities that could be considered off-label promotion of our products, the FDA, another regulatory agency, or the U.S. Department of Justice could disagree and conclude that we have engaged in off-label promotion and, potentially, caused the submission of false claims. In addition, the off-label use of our products may increase the risk of injury to patients, and, in turn, the risk of product liability claims. Product liability claims are expensive to defend and could divert our management’s attention and result in substantial damage awards against us.

Our compensation, marketing and sales practices may contain certain risks with respect to the manner in which these practices were historically conducted that could have a material adverse impact on us.

Although we believe our agreements and arrangements with healthcare providers are in compliance with applicable laws, under applicable federal and state healthcare fraud and abuse, anti-kickback, false claims and self-referral laws, it could be determined that our designing and consulting arrangements with surgeons, our marketing and sales practices, and our OfficeCare program fall outside permitted arrangements, thereby subjecting us to possible civil and/or criminal sanctions (including exclusion from the Medicare and Medicaid programs), which could have a material adverse impact on our business. These arrangements will be subject to increased visibility once the provisions of the Physician Payments Sunshine Act are fully implemented. Although we believe we maintain a satisfactory compliance program, it may not be adequate in the detection or prevention of violations. The form and effectiveness of our compliance program may be taken into account by the government in assessing sanctions, if any, should it be determined that violations of laws have occurred.

Audits or denials of our claims by government agencies could reduce our revenues or profits.

As part of our business operations, we submit claims on behalf of patients directly to, and receive payments directly from, the Medicare and Medicaid programs and private payors. Therefore, we are subject to extensive government regulation, including detailed requirements for submitting reimbursement claims under appropriate codes and maintaining certain documentation to support our claims. Medicare contractors and Medicaid agencies periodically conduct pre- and post-payment reviews and other audits of claims and are under increasing pressure to more closely scrutinize healthcare claims and supporting documentation. We have historically been subject to pre-payment and post-payment reviews as well as audits of claims and may experience such reviews and audits of claims in the future. Such reviews and/or similar audits of our claims including by Recovery Audit Contractors (private companies operating on a contingent fee basis to identify and recoup Medicare overpayments) could result in material delays in payment, as well

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as material recoupment or denials, which would reduce our net sales and profitability, or in exclusion from participation in the Medicare or Medicaid programs. Private payors may from time to time conduct similar reviews and audits.

Additionally, we participate in the government’s Federal Supply Schedule program for medical equipment, whereby we contract with the government to supply certain of our products. Participation in this program requires us to follow certain pricing practices and other contract requirements. Failure to comply with such pricing practices and/or other contract requirements could result in delays in payment or fines or penalties, which could reduce our revenues or profits.

Federal and state agencies have become increasingly vigilant in recent years in their investigation of various business practices under various healthcare “fraud and abuse” laws with respect to our business arrangements with prescribing physicians and other healthcare professionals, as well as our filing of DMEPOS claims for reimbursement.

We are, directly or indirectly through our customers, subject to various federal and state laws pertaining to healthcare fraud and abuse, including the Federal Anti-Kickback Statute, several federal False Claims statutes, HIPAA’s healthcare fraud statute and false statements statute, federal physician self-referral prohibition (Stark Law) and state equivalents to these statutes.

The federal government has significantly increased investigations of and enforcement activity involving medical device manufacturers with regard to alleged kickbacks and other forms of remuneration to physicians who use and prescribe their products. Such investigations often arise based on allegations of violations of the federal Anti-Kickback Statute and sometimes allege violations of the civil False Claims Act, in connection with off-label marketing of products to physicians and others. In addition, significant state and federal investigative and enforcement activity addresses alleged improprieties in the filings of claims for payment or reimbursement by Medicare, Medicaid, and other payors.

The fraud and abuse laws and regulations are complex, and even minor, inadvertent irregularities in submissions can potentially give rise to investigations and claims that the law has been violated. Any violations of these laws or regulations could result in a material adverse impact on our business, financial condition and results of operations. If there is a change in law, regulation or administrative or judicial interpretations, we may have to change one or more of our business practices to be in compliance with these laws. Required changes could be costly and time consuming. Any failure to make required changes could result in our losing business or our existing business practices being challenged as unlawful.

Our activities are subject to Federal Privacy and Transaction Law and Regulations, which could have an impact on our operations.

HIPAA and the HIPAA Rules impact the transmission, maintenance, use and disclosure of PHI. As such, HIPAA and the HIPAA Rules apply to certain aspects of our business. To the extent applicable to our operations, we believe we are currently in compliance with HIPAA and the applicable HIPAA Rules. There are costs and administrative burdens associated with ongoing compliance with the HIPAA Rules and similar state law requirements. Any failure to comply with current and applicable future requirements could adversely affect our profitability. Related to the incident described in the “Government Regulations—Federal Privacy and Transaction Law and Regulations” subsection in the “Business” section above, our compliance with the HIPAA Rules is currently under investigation by the Office for Civil Rights.  If OCR does not agree that we are in compliance with the HIPAA Rules, we may be subject to civil money penalties or other actions.  We are unable to predict at this time whether or to what extent OCR will impose any civil monetary penalties or take other action as a result of the breach.

Managed care and buying groups have put downward pressure on the prices of our products.

The growth of managed care and the advent of buying groups in the United States have caused a shift toward coverage and payments based on more cost-effective treatment alternatives. Buying groups enter into preferred supplier arrangements with one or more manufacturers of medical products in return for price discounts to members of these buying groups. Our failure to obtain new preferred supplier commitments from major group purchasing organizations or our failure to retain our existing preferred supplier commitments could adversely affect our sales and profitability. In international markets where we sell our products, we have historically experienced downward pressure on product pricing and other effects of healthcare cost control efforts that are similar to that which we have experienced in the United States. We expect a continued emphasis on healthcare cost controls, alternate payment models such as bundled payments, and managed care in the United States and in these international markets, which could put further downward pressure on product pricing, which, in turn may adversely affect our sales and profitability.

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Our marketed, approved, or cleared products are subject to the recall authority of U.S. and foreign regulatory bodies. Product recalls could harm our reputation and business.

We are subject to ongoing medical device reporting regulations that require us to report to the FDA and similar governmental authorities in other countries if we receive a report or otherwise learn that any of our products may have caused, or contributed to death or serious injury, or that any of our products has malfunctioned in a way that would be likely to cause, or contribute to, death or serious injury if the malfunction were to recur. The FDA and similar governmental authorities in other countries have the authority to require us to recall our products in the event of actual or potential material deficiencies or defects in design manufacturing, or labeling, and we have been subject to product recalls in the past. In addition, in light of an actual or potential material deficiency or defect in design, manufacturing, or labeling, we may voluntarily elect to recall our products. A government mandated recall or a voluntary recall initiated by us could occur as a result of actual or potential component failures, manufacturing errors, or design defects, including defects in labeling. Any recall would divert managerial and financial resources and could harm our reputation with our customers and with the healthcare professionals that use, prescribe and recommend our products. We could have product recalls that result in significant costs to us in the future, and such recalls could have a material adverse impact on our business.

Product liability claims may harm our business, particularly if the number of claims increases significantly or our product liability insurance proves inadequate.

The manufacture and sale of orthopedic devices and related products exposes us to a significant risk of product liability claims. From time to time, we have been, and we are currently, subject to a number of product liability claims alleging that the use of our products resulted in adverse effects. Even if we are successful in defending against any liability claims, such claims could nevertheless distract our management, result in substantial costs, harm our reputation, adversely affect the sales of all our products and otherwise harm our business. If there is a significant increase in the number of product liability claims, our business could be adversely affected. Further, a significant increase in claims or adverse outcomes could result in our product liability insurance being inadequate.

Our concentration of manufacturing operations in Mexico increases our business and competitive risks.

Our most significant manufacturing facility is our facility in Tijuana, Mexico, and we also have a relatively small manufacturing operation in Tunisia. Our current and future foreign operations are subject to risks of political and economic instability inherent in activities conducted in foreign countries. Because there are no readily accessible alternatives to these facilities, any event that disrupts manufacturing at or distribution or transportation from these facilities would materially adversely affect our operations. In addition, as a result of this concentration of manufacturing activities, our sales in foreign markets may be at a competitive disadvantage to products manufactured locally due to freight costs, custom and import duties and favorable tax rates for local businesses.

If we lose one of our key suppliers or one of our contract manufacturers stops making the raw materials and components used in our products, we may be unable to meet customer orders for our products in a timely manner or within our budget.

We rely on a limited number of foreign and domestic suppliers for the raw materials and components used in our products. One or more of our suppliers may decide to cease supplying us with raw materials and components for reasons beyond our control. FDA regulations may require additional testing of any raw materials or components from new suppliers prior to our use of those materials or components. In addition, in the case of a device which is the subject of a pre-market approval, we may be required to obtain prior FDA permission (which may or may not be given), which could delay or prevent our access or use of such raw materials or components. If we are unable to obtain materials we need from our suppliers or our agreements with our suppliers are terminated, and we cannot obtain these materials from other sources, we may be unable to manufacture our products to meet customer orders in a timely manner or within our manufacturing budget. In that event, our business and results of operations could be adversely affected.

In addition, we rely on third parties to manufacture some of our products. For example, we use a single source for many of the home electrotherapy devices our French channel distributes. If our agreements with these manufacturing companies were terminated, we may not be able to find suitable replacements within a reasonable amount of time or at all. Any such cessation, interruption or delay may impair our ability to meet scheduled deliveries of our products to our customers and may cause our customers to cancel orders. In that event, our reputation and results of operations may be adversely affected.

Some of our important suppliers are in China and other parts of Asia and provide predominately finished soft goods products. In the year ended December 31, 2015, we obtained 14.1% of our total purchased materials from suppliers in China and other parts of Asia. Political and economic instability and changes in government regulations in these areas could affect our ability to continue to receive materials from suppliers there. The loss of suppliers in China and other parts of Asia, any other interruption or delay in the supply of required materials or our inability to obtain these materials at acceptable prices and within a reasonable amount of time could impair our ability to meet scheduled product deliveries to our customers and could hurt our reputation and cause customers to cancel orders.

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In addition, we purchase the microprocessor used in the OL1000 and SpinaLogic devices from a single manufacturer. Although there are feasible alternate microprocessors that might be used immediately, all are produced by a single supplier. In addition, there are single suppliers for other components used in the OL1000 and SpinaLogic devices and only two suppliers for the magnetic field sensor employed in them. Establishment of additional or replacement suppliers for these components cannot be accomplished quickly.

If our patents and other intellectual property rights do not adequately protect our products, we may lose market share to our competitors and may not be able to operate our business profitably. We may also become involved in litigation regarding our patents and other intellectual property rights which can have a material adverse effect on our operating results and financial condition.

We rely on a combination of patents, trade secrets, copyrights, trademarks, license agreements and contractual provisions to establish and protect our intellectual property rights in our products and the processes for the development, manufacture and marketing of our products.

We use non-patented, proprietary know-how, trade secrets, processes and other proprietary information and currently employ various methods to protect this proprietary information, including confidentiality agreements, invention assignment agreements and proprietary information agreements with vendors, employees, independent sales agents, distributors, consultants, and others. However, these agreements may be breached. The FDA or another governmental agency may require the disclosure of such information in order for us to have the right to market a product. The FDA may also disclose such information on its own initiative if it should decide that such information is not confidential business or trade secret information. Trade secrets, know-how and other unpatented proprietary technology may also otherwise become known to or independently developed by our competitors.

In addition, we also hold U.S. and foreign patents relating to a number of our components and products and have patent applications pending with respect to other components and products. We also apply for additional patents in the ordinary course of our business, as we deem appropriate. However, these precautions offer only limited protection, and our proprietary information may become known to, or be independently developed by, competitors, or our proprietary rights in intellectual property may be challenged, any of which could have a material adverse impact on our business, financial condition and results of operations. Additionally, we cannot assure you that our existing or future patents, if any, will afford us adequate protection or any competitive advantage, that any future patent applications will result in issued patents or that our patents will not be circumvented, invalidated or declared unenforceable.

We may become a party to lawsuits involving patents or other intellectual property. Such litigation is costly and time consuming. If we lose any of these proceedings, a court or a similar foreign governing body could invalidate or render unenforceable our owned or licensed patents or other intellectual property, require us to pay significant damages, seek licenses and/or pay ongoing royalties to third parties (which may not be available under terms acceptable to us, or at all), require us to redesign our products, or prevent us from manufacturing, using or selling our products, any of which would have an adverse impact on our results of operations and financial condition.

Any proceedings before the U.S. Patent and Trademark Office could result in adverse decisions as to the priority of our inventions and the narrowing or invalidation of claims in issued or pending patents. We could also incur substantial costs in any such proceedings. In addition, the laws of some of the countries in which our products are or may be sold may not protect our products and intellectual property to the same extent as U.S. laws, if at all. We may also be unable to protect our rights in trade secrets, trademarks and unpatented proprietary technology in these countries.

In addition, we hold patent, trademark and other intellectual property licenses from third parties for some of our products and on technologies that are necessary in the design and manufacture of some of our products. The loss of such licenses could prevent us from manufacturing, marketing and selling these products, which in turn could harm our business.

Our business strategy relies on certain assumptions concerning demographic and other trends that impact the market for our products. If these assumptions prove to be incorrect, demand for our products may be lower than we currently expect.

Our ability to achieve our business objectives is subject to a variety of factors, including the relative increase in the aging of the general population and an increase in participation in exercise and sports and more active lifestyles. In addition, our business strategy relies on an increasing awareness and clinical acceptance of non-invasive, non-systemic treatment and rehabilitation products, such as electrotherapy. We believe that these trends will increase the need for our orthopedic, physical therapy, regenerative and surgical implant products. The projected demand for our products could materially differ from actual demand if our assumptions regarding these trends and acceptance of our products by healthcare professionals and patients prove to be incorrect or do not materialize. If our assumptions regarding these factors prove to be incorrect, we may not be able to successfully implement our business strategy, which

30


 

could adversely affect our results of operations. In addition, the perceived benefits of these trends may be offset by competitive or business factors, such as the introduction of new products by our competitors or the emergence of other countervailing trends.

We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could harm our business, financial condition, results of operations and prospects.

We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information, and manage or support a variety of business processes, including medical records, financial transactions and records, personal identifying information, and payroll data. We rely on commercially available systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential patient and other customer information, such as individually identifiable information, including information relating to health protected by HIPAA. Although we have taken steps to protect the security of our information systems and the data maintained in those systems, it is possible that our safety and security measures will not prevent the systems’ improper functioning or damage or the improper access or disclosure of personally identifiable information such as in the event of cyber-attacks. Security breaches, including physical or electronic break-ins, theft of mobile equipment, computer viruses, attacks by hackers and similar breaches can create system disruptions or shutdowns or the unauthorized disclosure of confidential information. If personal or otherwise protected information of our patients is improperly accessed, tampered with or distributed, we may incur significant costs to remediate possible injury to the affected patients and we may be subject to sanctions and civil or criminal penalties if we are found to be in violation of the privacy or security rules under HIPAA or other similar federal or state laws protecting confidential patient health information. Any failure to maintain proper functionality and security of our information systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties and could have a material adverse effect on our business, financial condition, results of operations and prospects.

We could incur significant costs complying with environmental and health and safety requirements, or as a result of liability for contamination or other harm caused by hazardous materials that we use.

Our research and development and manufacturing processes involve the use of hazardous materials. We are subject to federal, state, local and foreign environmental requirements, including regulations governing the use, manufacture, handling, storage and disposal of hazardous materials, discharge to air and water, the cleanup of contamination and occupational health and safety matters. We cannot eliminate the risk of contamination or injury resulting from hazardous materials, and we may incur liability as a result of any contamination or injury. Under some environmental laws and regulations, we could also be held responsible for costs relating to any contamination at our past or present facilities and at third party waste disposal sites where we have sent wastes. These could include costs relating to contamination that did not result from any violation of law, and in some circumstances, contamination that we did not cause. We may incur significant expenses in the future relating to any failure to comply with environmental laws. Any such future expenses or liability could have a significant negative impact on our financial condition. The enactment of stricter laws or regulations, the stricter interpretation of existing laws and regulations or the requirement to undertake the investigation or remediation of currently unknown environmental contamination at our own or third party sites may require us to make additional expenditures, which could be material.

If a natural or man-made disaster strikes our manufacturing facilities, we will be unable to manufacture our products for a substantial amount of time and our sales will decline.

A significant portion of our rehabilitation products are manufactured in a facility in Tijuana, Mexico, with a number of products for the European market manufactured in a Tunisian facility. In Vista, California we manufacture our custom rigid bracing products, which remain in the United States to facilitate quick turnaround on custom orders, vascular products, and our CMF product line. Our clinical electrotherapy devices, patient care products, physical therapy and certain CPM devices are now manufactured in our facilities located in Tijuana, Mexico. In our Surgical Implant business, we manufacture our products in our manufacturing facility at Austin, Texas. These facilities and the manufacturing equipment we use to produce our products would be difficult to repair or replace. Our facilities may be affected by natural or man-made disasters. If one of our facilities were affected by a disaster, we would be forced to rely on third party manufacturers or shift production to another manufacturing facility. In such an event, we would face significant delays in manufacturing which would prevent us from being able to sell our products. In addition, our insurance may not be sufficient to cover all of the potential losses and may not continue to be available to us on acceptable terms, or at all.

Affiliates of Blackstone own substantially all of the equity interest in us and may have conflicts of interest with us or investors in the future.

As of March 25, 2016, affiliates of Blackstone collectively beneficially own 97.4% of DJO’s issued and outstanding capital stock and Blackstone designees hold a majority of the seats on DJO’s board of directors. As a result, affiliates of Blackstone have control over our decisions to enter into any corporate transaction and have the ability to prevent any transaction that requires the approval of security holders regardless of whether holders of the Notes believe that any such transactions are in their own best

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interests. For example, affiliates of Blackstone could collectively cause us to make acquisitions that increase the amount of indebtedness or to sell assets, or could cause us to issue additional capital stock or declare dividends. So long as affiliates of Blackstone continue to directly or indirectly own a significant amount of the outstanding shares of our common stock, they will continue to be able to strongly influence or effectively control our decisions. In addition, Blackstone has no obligation to provide us with any additional debt or equity financing.

Additionally, Blackstone and its affiliates are in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Blackstone and its affiliates may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us.

If we do not achieve and maintain effective internal controls over financial reporting, we could fail to accurately report our financial results.

During the course of the preparation of our financial statements, we evaluate our internal controls to identify and correct deficiencies in our internal controls over financial reporting. In the event we are unable to identify and correct deficiencies in our internal controls in a timely manner, we may not record, process, summarize and report financial information accurately and within the time periods required for our financial reporting under the terms of the agreements governing our indebtedness.

It is possible that control deficiencies could be identified by our management or independent registered public accounting firm in the future or may occur without being identified. Such a failure could negatively impact the market price and liquidity of the Notes, cause holders of our Notes to lose confidence in our reported financial condition, lead to a default under our senior secured credit facilities and the Indentures and otherwise materially adversely affect our business and financial condition.

 

 

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ITEM 2.

PROPERTIES 

Information about our facilities is set forth in the following table:

 

Location

 

Use

 

Status

 

Lease

Termination Date

 

Square Feet

(in thousands)

 

Vista, California

 

Corporate headquarters, operations, research

   and development

 

Leased

 

August 2021

 

 

112

 

Tijuana, Mexico

 

Manufacturing and distribution facility

 

Leased

 

April 2027

 

 

286

 

Asheboro, North Carolina

 

Manufacturing and distribution facility

 

Owned

 

N/A

 

 

115

 

Indianapolis, Indiana

 

Distribution facility

 

Leased

 

October 2019

 

 

110

 

Mequon, Wisconsin

 

Office, manufacturing and distribution

   facility

 

Leased

 

June 2024

 

 

95

 

Shoreview, Minnesota

 

Office, operations, medical billing

 

Leased

 

October 2016

 

 

94

 

Clear Lake, South Dakota

 

Manufacturing, distribution and

   refurbishment, and repair facility

 

Owned

 

N/A

 

 

91

 

Sfax, Tunisia

 

Manufacturing facility

 

Leased

 

December 2019

 

 

70

 

Austin, Texas

 

Operations and manufacturing facility,

   warehouse, research and development

 

Leased

 

March 2019

 

 

53

 

Austin, Texas

 

Office and distribution facility

 

Leased

 

February 2020

 

 

35

 

Vista, California

 

Manufacturing facility

 

Leased

 

December 2018

 

 

53

 

Vista, California

 

Office and distribution facility

 

Leased

 

February 2017

 

 

21

 

Freiburg, Germany

 

Research and development, distribution

   facility

 

Leased

 

December 2016

 

 

22

 

Freiburg, Germany

 

Research and development, distribution

   facility

 

Leased

 

June 2017

 

 

27

 

Mouguerre, France

 

Office and distribution facility

 

Leased

 

December 2021

 

 

58

 

Sydney, Australia

 

Office and distribution facility

 

Leased

 

April 2017

 

 

28

 

Mississauga, Canada

 

Office and distribution facility

 

Leased

 

April 2020

 

 

30

 

Freiburg, Germany

 

Office and distribution facility

 

Leased

 

December 2020

 

 

20

 

Herentals, Belgium

 

Office and distribution facility

 

Leased

 

March 2018

 

 

17

 

Malmo, Sweden

 

Office and distribution facility

 

Leased

 

March 2017

 

 

14

 

Guildford, United Kingdom

 

International headquarters, office, operations

 

Leased

 

January 2025

 

 

12

 

Guildford, United Kingdom

 

Warehouse and distribution facility

 

Leased

 

January 2020

 

 

12

 

Other various locations

 

Various

 

Leased

 

Various

 

 

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ITEM 3.

LEGAL PROCEEDINGS

From time to time, we are plaintiffs or defendants in various litigation matters in the ordinary course of our business, some of which involve claims for damages that are substantial in amount. We believe that the disposition of claims currently pending will not have a material adverse impact on our financial position or results of operations.

Pain Pump Litigation

Over the past 9 years, we were named in numerous product liability lawsuits in the U.S. involving our prior distribution of a disposable drug infusion pump product (pain pump) manufactured by two third-party manufacturers that was distributed through our Bracing and Vascular segment. We currently are a defendant in one U.S. case and a lawsuit in Canada which has been granted class action status for a class of approximately 45 claimants. We discontinued our sale of these products in the second quarter of 2009. These cases have been brought against the manufacturers and certain distributors of these pumps. All of these lawsuits allege that the use of these pumps with certain anesthetics for prolonged periods after certain shoulder surgeries or, less commonly, knee surgeries, has resulted in cartilage damage to the plaintiffs. Except for the payment by the Company of policy deductibles or self-insured retentions, our products liability carriers in three policy periods have paid the defense costs and settlements related to these claims, subject to reservation of rights to deny coverage for customary matters, including punitive damages and off-label promotion.  We have engaged in settlement discussions with the Canadian plaintiffs and have reached an agreement in principal to settle these claims with a payment in the first quarter of 2017 in an amount that is covered in part by the remaining limits under the insurance policy for the applicable reporting period, with the balance to be paid by the Company, which amount is not material to the Company’s financial position or the results of its operations.  

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BGS Qui Tam Action

We are a defendant in a qui tam action filed in Federal Court in Boston, Massachusetts, captioned United States, ex rel. Bierman v. Orthofix International, N.V. et al., in which the relator, or whistleblower, names us and each other company engaged in the external bone growth stimulator industry as defendants. The case was filed under seal in March 2005 and unsealed in March 2009, during which time the government investigated the claims made by relator and decided not to intervene in the case. The government continued its investigation of DJO for several years following the unsealing of the case but did not ultimately bring any criminal or civil charges against us relating to the investigation. The relator alleges that from 1993 to the present, the defendants have engaged in Medicare fraud and violated federal and state false claims acts by seeking reimbursement for bone growth stimulation devices as purchased items rather than rental items. The relator also alleges that the defendants are engaged in other marketing practices constituting violations of the federal and various state false claim and anti-kickback statutes. Orthofix International, N.V. has settled with the relator and we understand that the other three defendants have reached settlements. The case continues against us. While we believe the case against us has no merit, we can make no assurances as to the final outcome of the case.

California Qui Tam Action

On October 11, 2013, we were served with a summons and complaint related to a qui tam action filed in U.S. District Court in Los Angeles, California in August 2012 and amended in December 2012 that names us as a defendant along with each of the other companies that manufactures and sells external bone growth stimulators for spinal applications. The case is captioned United States of America, et al.ex re. Doris Modglin and Russ Milko, v. DJO Global, Inc., DJO, LLC, DJO Finance LLC, Orthofix, Inc., Biomet, Inc., and EBI, LP., Case No. CV12-7152-MMM (JCGx) (C.D. Cal.). The plaintiffs, or relators, allege that the defendants have violated federal and state false claim acts by seeking reimbursement for bone growth stimulators for uses outside of the FDA approved indications for use for such products. The plaintiffs are seeking treble damages alleged to have been sustained by the U.S. and the states, penalties and attorney’s fees and costs. The federal government and all of the named states have declined to intervene in this case. We filed a motion to dismiss the second amended complaint, which motion was granted with leave to amend. Relators then filed a third amended complaint and we filed a motion to dismiss the third amended complaint and that motion has been granted without leave to amend as to the federal false claim act allegations. The Court declined jurisdiction over the remaining state claims. Relators have appealed the decision to the US Court of Appeals for the 9th Circuit.

Empi Investigation

Our subsidiary, Empi, Inc., was served with a subpoena dated May 11, 2015, issued by the Office of Inspector General (OIG) for the U.S. Department of Defense seeking a variety of documents primarily relating to the supply of home electrotherapy units and supplies by Empi to beneficiaries covered under medical insurance programs sponsored or administered by TRICARE, the Defense Health Agency and the Department of Defense. The relevant time period for these documents is from January 1, 2010 to the date of the subpoena. We are in the process of collecting and producing responsive documents to the OIG. We have also commenced discussions with the OIG regarding possible settlement of this investigation, but the potential range of loss is yet to be determined. We cannot provide any assurance as to the outcome of the investigation by the OIG or that any consequences will not have a material adverse effect on our reputation, business, prospects, financial condition and results of operations.

New Jersey Orthotics Investigation

In July 2013 we were served with a subpoena under HIPAA seeking documents relating to the fitting of custom-fabricated or custom-fitted orthoses in the States of New Jersey, Washington and Texas. The subpoena was issued by the United States Attorney’s Office for the District of New Jersey in connection with an investigation of compliance with professional licensing statutes in those states relating to the practice of orthotics. We have supplied the documents requested under the subpoena. We cannot provide any assurance as to the outcome of the investigation or that any consequences will not have a material adverse effect on our reputation, business, prospects, financial condition and results of operations.

 

 

 

 

ITEM 4.

MINE SAFETY DISCLOSURES

None.

 

 

34


 

PART II.

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

As a result of the acquisition of DJO by Blackstone in November 2006, the common stock of DJO is privately held and there is no established trading market for DJO’s common stock.

During the year ended December 31, 2015, DJO issued 8,848 shares of its common stock upon the net exercise of vested stock options that had been granted to an employee in 2007 in exchange for options that had previously been granted in the predecessor company to DJO (Rollover Options). Our stock incentive plan permits participants to exercise stock options using a net exercise method. In a net exercise, we withhold from the total number of shares that otherwise would be issued to a participant upon exercise of the stock option such number of shares having a fair market value at the time of exercise equal to the aggregate option exercise price and applicable income tax withholdings, and remit the remaining shares to the participant. The employee exercised these Rollover Options for a total of 30,529 shares of DJO’s common stock, from which we withheld 21,681 shares to cover $0.4 million of aggregate option exercise price and income tax withholdings and issued the remaining 8,848 shares.

During the year ended December 31, 2014, DJO issued 115,693 shares of its common stock upon the net exercise of vested stock options that had been granted to two former members of DJO’s Board of Directors in 2006 and to employees in 2007 in exchange for options that had previously been granted in the predecessor company to DJO (“Rollover Options”). Our stock incentive plan permits participants to exercise stock options using a net exercise method. In a net exercise, we withhold from the total number of shares that otherwise would be issued to a participant upon exercise of the stock option such number of shares having a fair market value at the time of exercise equal to the aggregate option exercise price and applicable income tax withholdings, and remit the remaining shares to the participant. The two former directors and employees exercised these Rollover Options for a total of 507,088 shares of DJO’s common stock, from which we withheld 391,395 shares to cover $6.5 million of aggregate option exercise price and income tax withholdings and issued the remaining 115,693 shares.

Additionally, during the year ended December 31, 2014, DJO issued 6,447 shares of its common stock upon the exercise of stock options. Net proceeds are included in Member capital in our Consolidated Balance Sheet as of December 31, 2014.

During the year ended December 31, 2013, DJO issued 72,151 shares of common stock upon the net exercise of Rollover Options. During the year ended December 31, 2013, the net exercise method was employed by the participants to exercise Rollover Options to acquire 221,057 shares of our common stock; we withheld 148,906 of the shares subject to the Rollover Options to cover $2.5 million of aggregate option exercise price and income tax withholdings and issued the remaining 72,151 shares to the participants.

The proceeds from these stock sales were contributed by DJO to us, and were used for working capital purposes. All such sales were subject to execution of a stockholder agreement including certain rights and restrictions (See Note 17 of the Notes to Consolidated Financial Statements).

As of March 25, 2016, there were 38 holders of DJO’s common stock.

As of March 25, 2016, 100% of DJOFL’s membership interests were owned by DJO Holdings LLC.

 

 

35


 

ITEM 6.

SELECTED FINANCIAL DATA 

The following table presents data as of and for the periods indicated and has been derived from the audited historical consolidated financial statements. The data reported for all periods includes the results of operations attributable to businesses acquired from the date of acquisition. This selected financial data should be read in conjunction with the audited consolidated financial statements and related notes thereto, and Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report.

 

($ in thousands)

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

1,113,627

 

 

$

1,087,529

 

 

$

1,020,784

 

 

$

962,785

 

 

$

902,910

 

Loss from continuing operations

 

 

(182,507

)

 

 

(111,304

)

 

 

(189,461

)

 

 

(170,549

)

 

 

(165,981

)

Net loss attributable to DJOFL (1)

 

 

(340,927

)

 

 

(90,534

)

 

 

(203,452

)

 

 

(119,150

)

 

 

(214,469

)

Depreciation and amortization

 

 

117,455

 

 

 

119,157

 

 

 

118,919

 

 

 

113,016

 

 

 

105,768

 

Balance Sheet Data (at period end):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

48,943

 

 

$

31,144

 

 

$

43,578

 

 

$

31,223

 

 

$

38,169

 

Total assets

 

 

2,309,558

 

 

 

2,569,861

 

 

 

2,660,520

 

 

 

2,822,656

 

 

 

2,860,889

 

Long-term debt, net of current portion

 

 

2,344,562

 

 

 

2,233,309

 

 

 

2,216,908

 

 

 

2,184,056

 

 

 

2,125,120

 

DJOFL membership (deficit) equity

 

 

(468,170

)

 

 

(124,234

)

 

 

(21,926

)

 

 

182,092

 

 

 

295,813

 

 

 

 

 

(1)

Results for the years ended December 31, 2015, 2013 and 2011 include aggregate goodwill and intangible asset impairment charges of $169.4 million, $106.6 million and $7.4 million, respectively.

 

 

36


 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

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. These factors are described in Item 1A, Risk Factors, noted above. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors.

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 audited consolidated financial statements and notes thereto as well as the other financial data included elsewhere in this Annual Report.

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®, Donjoy Performance®, ProCare®, CMF, Chattanooga, DJO Surgical, Dr. Comfort, Compex®, Bell-Horn and Exos.

Operating Segments

The company’s continuing operations fall into four operating segments: Bracing and Vascular; Recovery Sciences; Surgical Implant; and International. See Note 18 to our Consolidated Financial Statements for financial and other additional information regarding our segments.

Recent Acquisitions

On June 30, 2015, our subsidiary Encore Medical, L.P., dba DJO Surgical, acquired certain assets from Zimmer Biomet Holdings, Inc., including the Biomet Cobalt Bone Cement, Optivac® Cement Mixing Accessories, SoftPac Pouch and Discovery® Elbow System product lines.

On January 23, 2014, we acquired all of the outstanding shares of capital stock of Speetec Implantate GmbH (“Speetec”). Speetec is a distributor and manufacturer of knee, hip and shoulder arthroplasty products in Germany.

On July 1, 2013 we acquired certain assets of Blue Leaf Medical CC (“Blue Leaf”). The assets acquired relate to certain vascular product lines in South Africa, Namibia, Botswana, Mozambique and Zambia.

37


 

On March 7, 2013 we acquired certain assets of Vasyli Medical Asia/Pacific Pty Ltd. (“Vasyli”). The assets acquired relate to the distribution of certain vascular product lines in Australia and New Zealand.

Exit of Empi Business

During the fourth quarter of 2015, we ceased manufacturing, selling and distributing products of our Empi business and the related insurance billing operations domestically. The Empi business primarily manufactured and sold TENS devices for pain relief, other electrotherapy and orthopedic products and the related supplies.  Empi was facing a challenging regulatory and compliance environment, decreasing reimbursement rates and remained below the level needed to reach adequate profitability within an economically justified period of time.  Empi was part of our Recovery Sciences operating segment. For financial statement purposes, the results of the Empi business are reported within discontinued operations in the Consolidated Financial Statements included in Part II, Item 8, herein.

The following table sets forth our statements of operations as a percentage of net sales ($ in thousands):

 

 

 

Year Ended December 31,

 

 

 

2015

 

 

2014

 

 

2013

 

Net sales

 

$

1,113,627

 

 

 

100

%

 

$

1,087,529

 

 

 

100.0

%

 

$

1,020,784

 

 

 

100.0

%

Costs and operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales (exclusive of amortization of

   intangible assets (1))

 

 

466,019

 

 

 

41.9

 

 

 

462,000

 

 

 

42.5

 

 

 

434,708

 

 

 

42.6

 

Selling, general and administrative

 

 

454,724

 

 

 

40.9

 

 

 

439,872

 

 

 

40.5

 

 

 

409,192

 

 

 

40.1

 

Research and development

 

 

35,105

 

 

 

3.2

 

 

 

37,277

 

 

 

3.4

 

 

 

32,976

 

 

 

3.2

 

Amortization of intangible assets

 

 

79,964

 

 

 

7.2

 

 

 

83,944

 

 

 

7.7

 

 

 

86,412

 

 

 

8.5

 

Impairment of goodwill

 

 

 

 

 

 

 

 

 

 

 

 

 

 

49,600

 

 

 

4.9

 

 

 

 

1,035,812

 

 

 

93.0

 

 

 

1,023,093

 

 

 

94.1

 

 

 

1,012,888

 

 

 

99.3

 

Operating (loss) income

 

 

77,815

 

 

 

7.0

 

 

 

64,436

 

 

 

5.9

 

 

 

7,896

 

 

 

0.8

 

Other (expense) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

(172,290

)

 

 

(15.5

)

 

 

(174,325

)

 

 

(16.0

)

 

 

(177,570

)

 

 

(17.4

)

Loss on modification and extinguishment of

   debt

 

 

(68,473

)

 

 

(6.2

)

 

 

(938

)

 

 

(0.1

)

 

 

(1,059

)

 

 

(0.1

)

Other expense, net

 

 

(7,303

)

 

 

(0.7

)

 

 

(5,197

)

 

 

(0.4

)

 

 

(1,277

)

 

 

(0.1

)

 

 

 

(248,066

)

 

 

(22.3

)

 

 

(180,460

)

 

 

(16.5

)

 

 

(179,906

)

 

 

(17.6

)

Loss from continuing operations before

   income taxes

 

 

(170,251

)

 

 

(15.3

)

 

 

(116,024

)

 

 

(10.6

)

 

 

(172,010

)

 

 

(16.8

)

Income tax provision (benefit)

 

 

12,256

 

 

 

1.1

 

 

 

(4,720

)

 

 

(0.4

)

 

 

17,451

 

 

 

1.7

 

Net loss from continuing operations

 

 

(182,507

)

 

 

(16.4

)

 

 

(111,304

)

 

 

(10.2

)

 

 

(189,461

)

 

 

(18.5

)

Net (loss) income from discontinued operations

 

 

(157,580

)

 

 

(14.2

)

 

 

21,742

 

 

 

2.0

 

 

 

(13,101

)

 

 

(1.3

)

Net loss

 

 

(340,087

)

 

 

(30.6

)

 

 

(89,562

)

 

 

(8.2

)

 

 

(202,562

)

 

 

(19.8

)

Net income attributable to noncontrolling interests

 

 

(840

)

 

 

(0.1

)

 

 

(972

)

 

 

(0.1

)

 

 

(890

)

 

 

(0.1

)

Net loss attributable to DJOFL

 

$

(340,927

)

 

 

(30.6

)%

 

$

(90,534

)

 

 

(8.3

)%

 

$

(203,452

)

 

 

(19.9

)%

 

(1)

Cost of sales is exclusive of amortization of intangible assets of $30,719, $32,962, and $33,719 for the years ended December 31, 2015, 2014 and 2013, respectively.

Year Ended December 31, 2015 (2015) Compared to Year Ended December 31, 2014 (2014)

Net Sales. Net sales for 2015 were $1,113.7 million, compared to net sales of $1,087.6 million for 2014. Excluding the unfavorable impact of foreign currency exchange rates, which resulted in a decrease in net sales of $46.8 million, net sales increased 6.6% for the year ended 2015.  Net sales from acquisitions completed in 2015 were $18.4 million. The results of the Company’s non-U.S. operations are translated into U.S. dollars to report consolidated results.

38


 

The following table sets forth the mix of our net sales by business segment ($ in thousands):

 

 

 

2015

 

 

% of Net

Sales

 

 

2014

 

 

% of Net

Sales

 

 

Increase

(Decrease)

 

 

% Increase

(Decrease)

 

Bracing and Vascular

 

$

526,295

 

 

 

47.3

%

 

$

504,590

 

 

 

46.4

%

 

$

21,705

 

 

 

4.3

%

Recovery Sciences

 

 

156,194

 

 

 

14.0

 

 

 

157,485

 

 

 

14.5

 

 

 

(1,291

)

 

 

(0.8

)%

Surgical Implant

 

 

134,843

 

 

 

12.1

 

 

 

100,139

 

 

 

9.2

 

 

 

34,704

 

 

 

34.7

%

International

 

 

296,295

 

 

 

26.6

 

 

 

325,315

 

 

 

29.9

 

 

 

(29,020

)

 

 

(8.9

)%

Total net sales

 

$

1,113,627

 

 

 

100.0

%

 

$

1,087,529

 

 

 

100.0

%

 

$

26,098

 

 

 

2.4

%

 

Net sales in our Bracing and Vascular segment were $526.3 million for 2015, an increase of 4.3% from net sales of $504.6 million for 2014. The increase is primarily due to new account acquisition in our OfficeCare channel, an increase in third party payor billing and growth in sales of direct consumer products.

Net sales in our Recovery Sciences segment were $156.2 million for 2015, a decrease of 0.8% from net sales of $157.5 million for 2014. The decrease was driven primarily by continued slow market conditions affecting the sale of Chattanooga rehabilitation equipment, together with a mix shift in bone growth stimulation products from reimbursement to direct customers. The decrease was compensated by growth in retail sales of Compex electrostimulation devices.

Net sales in our Surgical Implant segment were $134.8 million for 2015, an increase of 34.7% from net sales of $100.1 million for 2014. The increase was driven by sales of bone cement, which was acquired with the assets purchased from Zimmer Biomet in third quarter 2015. The segment also had strong organic growth in shoulder, hip and knee products due to new product introductions and new accounts.

Net sales in our International segment were $296.3 million for 2015, a decrease of 8.9% from net sales of $325.3 million for 2014. In constant currency, excluding an unfavorable impact of $46.8 million related to changes in foreign exchange rates in effect during 2015 compared to the rates in effect in 2014, net sales increased 5.5% for 2015 compared to 2014. Growth in net sales in this segment is being driven by stronger sales in direct markets, primarily Germany and Spain, and increased sales penetration in emerging markets.

Cost of Sales. As a percentage of net sales, cost of sales decreased to 41.9% for 2015, compared to 42.5% for 2014 mainly due to a mix between and within the reporting segments.

Selling, General and Administrative (SG&A). SG&A expenses increased to $454.7 million for 2015, from $439.9 million in 2014. The increase was mainly driven by acquisition and related integrations costs in our Surgical Implant segment, variable selling expenses due to growth and legal settlements, offset by a decrease in accounts receivable allowance for doubtful accounts due to process improvements in our reimbursement channels and a reduction in expenses related to information technology projects.

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):

 

 

 

2015

 

 

2014

 

Integration charges:

 

 

 

 

 

 

 

 

Commercial and global business unit reorganization

   and integration

 

$

7,124

 

 

$

7,304

 

Acquisition related expenses and integration

 

 

8,460

 

 

 

325

 

CFO transition

 

-

 

 

 

227

 

Litigation and regulatory costs and settlements, net

 

 

8,841

 

 

 

5,730

 

Other non-recurring items

 

 

2,418

 

 

 

3,240

 

Automation projects

 

 

3,634

 

 

 

5,867

 

 

 

$

30,477

 

 

$

22,693

 

 

Research and Development (R&D). R&D expenses were $35.1 million for 2015, compared to $37.3 million in 2014, or 3.2% and 3.4% of net sales, respectively. In 2014 the company incurred consulting fees for testing, documentation and software implementation to enhance new product introductions and ensure FDA compliance. The company continues to focus on the development of new products, as well as the enhancement of existing products with the latest technology and updated designs, primarily our Bracing and Vascular and Surgical Implant segments.

39


 

Amortization of Intangible Assets. Amortization of intangible assets decreased to $80.0 million for 2015, from $83.9 million for 2014. The decrease is due to certain intangible assets reaching full amortization primarily in our patents and technology category.

Interest Expense, net. Our interest expense, net was $172.3 million for 2015 compared to $174.3 million for 2014. The decrease is due to lower weighted average interest rates on our senior secured credit facilities.

Loss on Modification and Extinguishment of Debt.  Loss on modification and extinguishment of debt for 2015 consists of $47.8 million in premiums related to the redemption of our 8.75% Notes, 9.875% Notes and 7.75% Notes (each as defined herein), $11.9 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of our debt that was extinguished and $8.8 million of arrangement and amendment fees and other fees and expenses incurred in connection with the refinancing. Loss on modification and extinguishment of debt for 2014 consists of $0.3 million of arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our prior senior secured credit facilities and $0.6 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of our original term loans which were extinguished.

Other Expense, Net. Other expense, net, increased to $7.3 million for 2015 from $5.2 million for 2014. Results for both periods presented primarily represent net realized and unrealized foreign currency transaction gains and losses.

 

Income Tax Provision. For 2015, we recorded an income tax provision of $12.3 million on a pre-tax loss of $170.3 million, resulting in a negative effective tax rate of 7.2%. For 2014, we recorded an income tax benefit of $4.7 million on pre-tax losses of $116.0 million, resulting in an effective tax rate of 4.1%.

We recorded income tax expense, although there were pretax losses, for the year ended December 31, 2015 primarily because of the existence of a full deferred tax asset valuation allowance at the beginning of the period.  The income tax expense recorded for the year ended December 31, 2015 primarily relates to foreign tax expense and the accrual of non-cash tax expense related to an additional valuation allowance in connection with the tax amortization of indefinite-lived intangible assets.

 

ASC 740-20 requires total income tax expense or benefit to be allocated among continuing operations, discontinued operations, extraordinary items, other comprehensive income and items charged directly to shareholders’ equity. This allocation is referred to as intra-period tax allocation. The exit from the Empi business is reported under discontinued operations in the Consolidated Financial Statements.  Accordingly we are required to allocate the provision for income taxes between continuing operations and discontinued operations.  For the year ended December 31, 2014 we recognized a gain from discontinued operations, and, as a result, we recorded a tax expense of $17.6 million in discontinued operations and a corresponding tax benefit to continuing operations.  The difference between the tax expense from discontinued operations, $17.6 million, and the tax benefit reflected in the Consolidated Financial Statements primarily relates to foreign tax expense and accrual of non-cash tax expense related to an additional valuation allowance in connection with the tax amortization of indefinite-lived intangible assets.

Discontinued Operations. During the fourth quarter of 2015, we ceased production, selling and billing operations of our Empi product line. Loss of $157.6 million was recognized for 2015, primarily consisting of asset impairment charges, net income from Empi operations, severance and other termination costs.

Year Ended December 31, 2014 (2014) Compared to Year Ended December 31, 2013 (2013)

Net Sales. Our net sales for 2014 were $1,087.5 million, compared to net sales of $1,020.8 million for 2013, representing a 4.6% increase year over year. In constant currency, excluding an unfavorable impact of $3.0 million related to changes in foreign exchange rates in effect in 2014 compared to the rates in effect in 2013, net sales increased 4.8%.

The following table sets forth the mix of our net sales by business segment ($ in thousands):

 

 

 

2014

 

 

% of Net

Sales

 

 

2013

 

 

% of Net

Sales

 

 

Increase

(Decrease)

 

 

% Increase

(Decrease)

 

Bracing and Vascular

 

$

504,590

 

 

 

46.4

%

 

$

476,492

 

 

 

46.7

%

 

$

28,098

 

 

 

5.9

%

Recovery Sciences

 

 

157,485

 

 

 

14.5

 

 

 

158,110

 

 

 

15.5

 

 

 

(625

)

 

 

(0.4

)

Surgical Implant

 

 

100,139

 

 

 

9.2

 

 

 

87,088

 

 

 

8.5

 

 

 

13,051

 

 

 

15.0

 

International

 

 

325,315

 

 

 

29.9

 

 

 

299,094

 

 

 

29.3

 

 

 

26,221

 

 

 

8.8

 

Total net sales

 

$

1,087,529

 

 

 

100.0

%

 

$

1,020,784

 

 

 

100.0

%

 

$

66,745

 

 

 

6.5

%

 

40


 

Net sales in our Bracing and Vascular segment were $504.6 million for 2014, increasing 5.9% from net sales of $476.5 million for 2013. Growth in net sales in this segment is being driven by sales of new bracing and compression system products, as well as new account acquisition in our OfficeCare channel.

Net sales in our Recovery Sciences segment were $157.5 million for 2014, decreasing 0.4% from net sales of $158.1 million for 2013. The decrease was primarily driven by slower than anticipated CMF product sales.

Net sales in our Surgical Implant segment were $100.1 million for 2014, increasing 15.0% from net sales of $87.1 million for 2013. The increase was driven by strong sales of our shoulder and hip products due to new product introductions and new accounts.

Net sales in our International segment were $325.3 million for 2014, increasing 8.8% from net sales of 299.1 million for 2013. In constant currency, excluding an unfavorable impact of $3.0 million related to changes in foreign exchange rates in effect in 2014 compared to the rates in effect in 2013, net sales for 2014 for the International segment increased 9.8% compared to net sales for 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.

Cost of Sales. Costs of sales increased to $462.0 million for 2014, from $434.7 million for 2013. As a percentage of net sales, costs of sales remained fairly consistent at 42.5% for 2014, compared to 42.6% for 2013.

Selling, General and Administrative (SG&A). SG&A expenses increased to $439.9 million for 2014, from $409.2 million in 2013. As a percentage of net sales, SG&A expenses remained fairly consistent at 40.5% for 2014, compared to 40.1% for 2013. The increase was driven by higher variable selling costs due to a relative increase in sales for the Bracing and Vascular and Surgical Implant segments, an increase in accounts receivable allowance for doubtful accounts in our reimbursement channels due to a trend in slower collections and an increase in reorganization and integration costs, offset by savings in wages and related costs of benefits.

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):

 

 

 

2014

 

 

2013

 

Integration charges:

 

 

 

 

 

 

 

 

Global business unit reorganization and integration

 

$

7,304

 

 

$

5,438

 

Acquisition related expenses and integration

 

 

325

 

 

 

1,152

 

CFO transition

 

 

227

 

 

 

1,673

 

Litigation and regulatory costs and settlements, net

 

 

5,730

 

 

 

3,563

 

Automation projects

 

 

5,867

 

 

 

5,550

 

Other non-recurring items

 

 

3,240

 

 

 

2,733

 

 

 

$

22,693

 

 

$

20,109

 

 

Research and Development (R&D). R&D expenses increased to $37.3 million for 2014, from $33.0 million in 2013. As a percentage of net sales, R&D expense increased to 3.4% in 2014 from 3.2% in 2013, primarily due to consulting fees for testing, documentation and software implementation to enhance new product introductions and ensure FDA compliance.

Amortization of Intangible Assets. Amortization of intangible assets decreased to $83.9 million for 2014, from $86.4 million for 2013. The decrease is due to certain intangible assets reaching full amortization primarily in our patents and technology category, partially offset by an increase in intangible assets resulting from our acquisition of Speetec.

Interest Expense, net. Our interest expense, net was $174.3 million for 2014 and $177.6 million for 2013. The decrease is due to lower weighted average interest rates on our senior secured credit facilities.

Loss on Modification and Extinguishment of Debt. Loss on modification and extinguishment of debt for 2014 consists of $0.3 million of arrangement and amendment fees and other fees and expenses incurred in connection with the amendment of our senior secured credit facilities and $0.6 million related to the non-cash write off of unamortized debt issuance costs and original issue discount associated with the portion of our original term loans which were extinguished. Loss on modification and extinguishment of debt for 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.

41


 

Other Expense, Net. Other expense, net increased to $5.2 million for 2014, from $1.3 million for 2013. Results for both periods presented primarily represent net realized and unrealized foreign currency transaction gains and losses.

Income Tax Provision. We recorded income tax benefit of $4.7 million on pre-tax losses of $116.0 million, resulting in an effective tax rate of 4.1% in 2014. For 2013, we recorded income tax expense of $17.5 million on pre-tax losses of $172.0 million, resulting in a negative effective tax rate of 10.1%.

We recorded income tax expense, although there were pretax losses, for the year ended December 31, 2013 primarily because of the existence of a full deferred tax asset valuation allowance at the beginning of the period.  The income tax expense recorded for the year ended December 31, 2013 primarily relates to foreign tax expense and the accrual of non-cash tax expense related to an additional valuation allowance in connection with the tax amortization of indefinite-lived intangible assets.

ASC 740-20 requires total income tax expense or benefit to be allocated among continuing operations, discontinued operations, extraordinary items, other comprehensive income and items charged directly to shareholders’ equity. This allocation is referred to as intra-period tax allocation. The exit from the Empi business is reported under discontinued operations in the Consolidated Financial Statements.  Accordingly we are required to allocate the provision for income taxes between continuing operations and discontinued operations.  For the year ended December 31, 2014 we recognized a gain from discontinued operations, and, as a result, we recorded a tax expense of $17.6 million in discontinued operations and a corresponding tax benefit to continuing operations.  The difference between the tax expense from discontinued operations, $17.6 million, and the tax benefit reflected in the Consolidated Financial Statements primarily relates to foreign tax expense and accrual of non-cash tax expense related to an additional valuation allowance in connection with the tax amortization of indefinite-lived intangible assets.

Discontinued Operations.  During the fourth quarter of 2015, we ceased production, selling and billing operations of our Empi product line. Discontinued operations for 2014 consisted primarily of net income from Empi operations.  

Recent Accounting Pronouncements

In May 2014, the FASB issued an accounting standards update related to revenue from contracts with customers. The new standard provides a five-step approach to be applied to all contracts with customers. The accounting standards update also requires expanded disclosures about revenue recognition. On July 9, 2015, the FASB decided to defer the effective date of the standard. The guidance is now effective for fiscal years beginning after December 15, 2017 and interim periods within that reporting period. Early adoption is permitted as early as the original effective date of December 15, 2016. The Company is currently evaluating the new guidance to determine the impact it may have to its consolidated financial statements.

In April 2015, the FASB issued an accounting standards update related to the presentation of debt issuance costs. The standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The guidance is effective for annual and interim periods beginning after December 15, 2015. Early application is permitted. The Company has early adopted this update and the impact is reflected in the current and prior periods presented.

In April 2015, the FASB issued an accounting standards update related to internal-use software. The standard provides guidance to clarify the customer’s accounting for fees paid in a cloud computing arrangement. The guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Adoption of this new guidance is not expected to have a material effect on the Company’s financial statements.

In July 2015, the FASB issued an accounting standards update which requires an entity to measure inventory at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This guidance does not apply to inventory that is measured using last-in, first-out (LIFO). The guidance is effective for annual and interim periods beginning after December 15, 2016. Early adoption is permitted. Adoption of this new guidance is not expected to have a material effect on the Company’s financial statements.

In September 2015, the FASB issued an accounting standards update which eliminates the requirement for an acquirer in a business combination to restate prior period financial statements for measurement period adjustments. The new guidance requires that the cumulative impact of a measurement period adjustment (including the impact on prior periods) be recognized in the reporting period in which the adjustment is identified. The new guidance also sets forth new disclosure requirements related to the adjustments. The guidance is effective for annual and interim periods beginning after December 15, 2015. Early adoption is permitted. Adoption of this new guidance is not expected to have a material effect on the Company’s financial statements.

42


 

In November 2015, the FASB issued an accounting standards update which requires all deferred income taxes be presented on the balance sheet as noncurrent. The new guidance is intended to simplify financial reporting by eliminating the requirement to classify deferred taxes between current and noncurrent. The guidance is effective for annual and interim periods beginning after December 15, 2016. Early adoption is permitted. The Company has early adopted this update and the impact is reflected prospectively in the Company’s financial statements.

In January 2016, the FASB issued an accounting standards update which affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. This guidance retains the current accounting for classifying and measuring investments in debt securities and loans, but requires equity investments to be measured at fair value with subsequent changes recognized in net income, except for those accounted for under the equity method or requiring consolidation. The guidance also changes the accounting for investments without a readily determinable fair value and that do not qualify for the practical expedient permitted by the guidance to estimate fair value. A policy election can be made for these investments whereby estimated fair value may be measured at cost and adjusted in subsequent periods for any impairment or changes in observable prices of identical or similar investments. The guidance is effective for annual periods beginning after December 15, 2017. Early application is permitted. Adoption of this new guidance is not expected to have a material effect on the Company’s financial statements.

In February 2016, the FASB issued an accounting standards update which affects the accounting for leases. The guidance requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. The amendment also will require qualitative and quantitative disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. The guidance is effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. We are still assessing the impact of adoption on our consolidated financial statements.

Liquidity and Capital Resources

As of December 31, 2015, our primary sources of liquidity consisted of cash and cash equivalents totaling $48.9 million and our $150.0 million revolving credit facility, of which $119.5 million was available. Our revolving credit balance was $30.0 million as of December 31, 2015 and we have provided a $0.5 million letter of credit related to collateral requirements under our product liability insurance policy. Working capital at December 31, 2015 was $218.3 million.

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.

As market conditions warrant, we and our equity holders, including Blackstone, its affiliates and members of our management, may from time to time, seek to purchase our outstanding debt securities or loans, including the notes and borrowings under our credit facilities, in privately negotiated or open market transactions, by tender offer or otherwise. Subject to any applicable limitations contained in the agreements governing our indebtedness, any purchases made by us may be funded by the use of cash on our balance sheet or the incurrence of new secured or unsecured debt, including borrowings under our credit facilities. The amounts involved in any such purchase transactions, individually or in the aggregate, may be material. Any such purchases may be with respect to a substantial amount of a particular class or series of debt, with the attendant reduction in the trading liquidity of such class or series. In addition, any such purchases made at prices below the “adjusted issue price” (as defined for U.S. federal income tax purposes) may result in taxable cancellation of indebtedness income to us, which amounts may be material, and in related adverse tax consequences to us.

Cash Flows

Operating activities from continuing operations provided $9.7 million and used $7.4 million and $24.0 million of cash for 2015, 2014 and 2013, respectively. Cash from operating activities for all years presented primarily represented our net loss, adjusted for non-cash expenses and changes in working capital. In 2015 and 2014, changes in working capital largely consisted of increases in inventories which used cash of $8.1 million and $19.5 million, respectively and provided cash of $3.2 million in 2013. For 2015, 2014 and 2013, cash paid for interest was $176.7 million, $165.5 million and $171.4 million, respectively.

Investing activities from continuing operations used $68.1 million, $58.4 million, and $41.1 million of cash for 2015, 2014 and 2013 respectively. Cash used in investing activities for 2015 was for purchases of property and equipment primarily for the acquisition

43


 

of certain surgical assets from Zimmer Biomet, consigned surgical instruments and vascular system pumps used as rental units, IT automation technology and manufacturing equipment for new products and more efficient production.  Cash used in investing activities for 2014 primarily consisted of $52.7 million for purchases of property and equipment primarily for surgical instruments to support growth, IT automation technology, manufacturing equipment for new products and more efficient production, and $4.6 million related to the acquisition of Speetec. Cash used in investing activities for 2013 primarily consisted of purchases of property and equipment of $37.5 million primarily for surgical instruments and IT automation technology, and $2.0 million related to the acquisition of assets from our vascular distributors in Australia and South Africa.

Financing activities provided cash of $36.1 million in 2015, used cash of $23 thousand in 2014 and provided $23.3 million of cash in 2013, respectively.  Cash provided by financing activities in 2015 consisted of proceeds from the borrowings related to the refinancing of our debt, offset by the repayments of our prior senior secured credit facilities and our 8.75% Notes, 9.875% Notes and 7.75% Notes. Cash used in financing activities in 2014 consisted of proceeds from the borrowings under our senior secured credit facilities, offset by payments of the senior secured credit facilities, payments related to the repurchase of Rollover Options from our former chief financial officer upon her departure, and payment of contingent consideration related to the acquisition of Exos. Cash provided in financing activities in 2013 consisted of proceeds from the borrowings under our senior secured credit facilities, offset by payments of the senior secured credit facilities.

Indebtedness

As of December 31, 2015, we had $2,397.4 million in aggregate indebtedness outstanding, exclusive of a net unamortized debt issuance costs and original issue discount of $42.3 million. The principal amount and carrying value of our debt was as follows for December 31, 2015 and 2014 (in thousands):

 

 

 

2015

 

 

2014

 

 

 

Principal

Amount

 

 

Carrying

Value

 

 

Principal

Amount

 

 

Carrying

Value

 

Credit facilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revolving credit facility

 

$

30,000

 

 

$

27,886