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FORM 10-Q

(Mark one)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
	FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 2002
OR
[   ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _____________ TO _______________.

Commission File Number 001-16757

DJ ORTHOPEDICS, INC.
(Exact name of registrant as specified in charter)

DELAWARE		3842		33-0978270
(State or other jurisdiction of incorporation or organization)		(Primary Standard Industrial Classification Code Number)		(I.R.S. Employer Identification Number)

2985 Scott Street
Vista, California 92083
(800) 336-5690

(Address, including zip code, and telephone number, including area code, of registrants’ principal executive offices)

Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [   ]

The number of shares of the Registrant’s Common Stock outstanding at November 6, 2002 was 17,872,956 shares.

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EXPLANATORY NOTE

     dj Orthopedics, Inc. (dj Orthopedics), through its subsidiary dj Orthopedics, LLC (dj Ortho) and dj Ortho’s subsidiaries (collectively, the Company), is a global designer, manufacturer and marketer of products for the orthopedic sports medicine market. dj Orthopedics was incorporated in Delaware in August 2001. We are the successor to DonJoy, L.L.C. (DonJoy) which, prior to June 30, 1999, was wholly owned by Smith & Nephew, Inc. (Smith & Nephew), a wholly owned subsidiary of Smith & Nephew plc., a United Kingdom company. On June 30, 1999, DonJoy consummated a recapitalization pursuant to which J.P. Morgan DJ Partners, LLC, formerly Chase DJ Partners, LLC (JPMDJ Partners), obtained a controlling interest in DonJoy. Concurrently with the completion of dj Orthopedics’ initial public offering on November 20, 2001, DonJoy merged with and into dj Orthopedics through a series of transactions, referred to herein as the “Reorganization”. As a result of the foregoing transactions, dj Ortho became a wholly owned subsidiary of dj Orthopedics.

     This Form 10-Q is filed pursuant to the Securities Exchange Act of 1934, as amended, for dj Orthopedics. dj Orthopedics and dj Orthopedics Development Corporation (dj Development), a wholly owned subsidiary of dj Ortho, guarantee dj Ortho’s bank borrowings and the 12 5/8% Senior Subordinated Notes (the Notes) issued by dj Ortho and DJ Orthopedics Capital Corporation (DJ Capital), a wholly owned subsidiary of dj Ortho. DJ Capital was formed solely to act as a co-issuer (and as a joint and several obligor) with dj Ortho with respect to the Notes. DJ Capital does not hold any assets or other properties or conduct any business. No separate financial information for DJ Capital has been provided herein because management believes such information would not be meaningful as DJ Capital has no financial or other data to report in response to the requirements of Form 10-Q. Condensed consolidating financial statements showing separate information for dj Orthopedics, dj Ortho, dj Development and the Company’s non-guarantor subsidiaries in the aggregate have been provided within the notes to the financial statements included herein.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DJ ORTHOPEDICS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)

See accompanying notes.

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DJ ORTHOPEDICS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

For the required information related to the pro forma impact of income taxes on the 2001 results, see Note 1.

See accompanying notes.

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DJ ORTHOPEDICS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

See accompanying notes.

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DJ ORTHOPEDICS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)

1. General

Business and Organization

     dj Orthopedics, Inc. (dj Orthopedics), through its subsidiary dj Orthopedics, LLC (dj Ortho) and dj Ortho’s subsidiaries (collectively, the Company), is a global designer, manufacturer and marketer of products for the orthopedic sports medicine market. dj Orthopedics was incorporated in Delaware in August 2001. dj Orthopedics is the successor to DonJoy, L.L.C. (DonJoy), which, prior to June 30, 1999, was wholly owned by Smith & Nephew, Inc. (Smith & Nephew), a wholly owned subsidiary of Smith & Nephew plc., a United Kingdom company. On June 30, 1999, DonJoy consummated a recapitalization pursuant to which J.P. Morgan DJ Partners, LLC, formerly Chase DJ Partners, LLC (JPMDJ Partners), obtained a controlling interest in DonJoy. Concurrently with the completion of dj Orthopedics’ initial public offering on November 20, 2001, DonJoy merged with and into dj Orthopedics through a series of transactions, referred to herein as the “Reorganization”. As a result of the foregoing transactions, dj Ortho became a wholly owned subsidiary of dj Orthopedics.

     Effective January 1, 2002, the Company commenced direct distribution of its products in Germany and the United Kingdom through its two new wholly owned subsidiaries, dj Orthopedics Deutschland GmbH (dj Germany) and dj Orthopaedics UK Ltd (dj UK). dj Germany and dj UK replaced third-party distributors in those countries. Effective May 7, 2002, the Company commenced direct distribution of its products in Canada through its wholly owned subsidiary, dj Ortho, Canada Inc. (dj Canada), replacing the Smith & Nephew sales organization, which previously distributed the Company’s products in Canada.

Basis of Presentation

     The accompanying unaudited consolidated financial statements as of and for the three and nine months ended September 28, 2002 and September 29, 2001 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements of dj Orthopedics and the notes thereto included in dj Orthopedics’ Annual Report on Form 10-K for the year ended December 31, 2001. The accompanying unaudited consolidated financial statements as of and for the three and nine months ended September 28, 2002 and September 29, 2001 have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting of normal recurring accruals and the adjustments described in Notes 4, 5 and 6) which, in the opinion of management, are necessary for a fair presentation of the financial position, operating results and cash flows for the interim date and interim periods presented. Results for the interim period ended September 28, 2002 are not necessarily indicative of the results to be achieved for the entire year or future periods.

     The accompanying consolidated financial statements present the historical financial position and results of operations of dj Orthopedics and include the accounts of dj Ortho, the accounts of dj Ortho’s wholly owned subsidiaries, dj Orthopedics Development Corporation (dj Development) and DJ Orthopedics Capital Corporation (DJ Capital), the accounts of dj Ortho’s wholly owned Mexican subsidiary that manufactures a portion of dj Ortho’s products under Mexico’s maquiladora program, the accounts of dj Ortho’s wholly owned subsidiaries in Canada, Germany and the United Kingdom, and the accounts of dj Ortho’s majority owned subsidiary in Australia (formed March 2001). All intercompany accounts and transactions have been eliminated in consolidation. Minority interest at September 28, 2002 represents the minority stockholders’ proportionate share of the net assets of dj Australia.

     The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates including those related to contractual

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allowances, doubtful accounts, inventories, rebates, product returns, warranty obligations, income taxes, intangibles and investments. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     The Company’s fiscal year ends on December 31. Each quarter consists of one five-week and two four-week periods.

Per Share Information

     Earnings per share are computed in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. Basic earnings per share are computed using the weighted average number of common shares outstanding during each period. Diluted earnings per share include the dilutive effect of weighted average common share equivalents potentially issuable upon the exercise of stock options. For purposes of computing diluted earnings per share, weighted average common share equivalents (computed using the treasury stock method) do not include stock options with an exercise price that exceeds the average fair market value of the Company’s common stock during the periods presented. For the three and nine months ended September 28, 2002, options to purchase approximately 1,893,381 and 1,848,432 shares, respectively, of common stock were excluded from the computation because their exercise price exceeded the average fair market value of the Company’s common stock for those periods and therefore are antidilutive.

Pro Forma Income Taxes and Pro Forma Per Share Information

     The pro forma income tax expense and the related calculations of pro forma per share information reflect the Company’s operations for the three and nine month periods ended September 29, 2001 as if the Reorganization occurred as of the beginning of 2001. Pro forma income tax expense represents the estimated charge based on the Company’s operating results for the three and nine month periods ended September 29, 2001 as if the Company were a corporation from the beginning of 2001, using an estimated combined worldwide effective tax rate of 40.0%. The pro forma basic and diluted per share information is computed based on the weighted average number of shares of common stock outstanding for the three and nine month periods ended September 29, 2001. For comparative purposes, the 7,800,000 shares of common stock issued as part of the Company’s initial public offering have been included in the weighted averaged number of shares outstanding for the three and nine months ended September 29, 2001, as if the shares were outstanding for the entire periods. Basic and diluted shares used for the calculation of pro forma earnings per share were the same due to the net loss position of the Company for the three and nine months ended September 29, 2001 since all weighted average common share equivalents were antidilutive. The following table presents the information referenced above (in thousands, except per share amounts):

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Foreign Currency Translation

     The financial statements of the Company’s international subsidiaries, where the local currency is the functional currency, are translated into U.S. dollars using period-end exchange rates for assets and liabilities and average exchange rates during the period for revenues and expenses. Cumulative translation gains and losses are excluded from results of operations and recorded as a separate component of consolidated stockholders’ equity.

Recently Issued Accounting Standards

     In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) Nos. 141 and 142, Business Combinations and Goodwill and Other Intangible Assets. SFAS 141 replaces prior accounting standards and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. SFAS 141 and SFAS 142 are effective for all business combinations completed after June 30, 2001. Effective January 1, 2002, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 ceased, and intangible assets acquired prior to July 1, 2001 that do no meet the criteria for separate recognition under SFAS 141 have been reclassified to goodwill. SFAS 142 changes the accounting for goodwill from an amortization method to an impairment write-off approach. Under SFAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. In addition, SFAS 142 requires the completion of a transitional impairment test within six months of adoption, with any impairment treated as a cumulative effect of a change in accounting principle as of the date of adoption. The Company completed the transitional impairment test during the second quarter of 2002 and determined that no impairment existed as of the date of adoption. The adoption of SFAS No. 142 reduced third quarter and year to date amortization expense by approximately $0.8 million and $2.2 million, respectively, compared to the prior year. On an ongoing basis, absent any indicators of impairment, the Company expects to perform its annual impairment evaluation during the fourth quarter.

     In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 replaces SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The FASB issued SFAS 144 to establish a single accounting model, based on the framework established in SFAS 121, as SFAS 121 did not address the accounting for a segment of a business accounted for as a discontinued operation under Accounting Principles Board (APB) No. 30, Reporting The Results of Operations — Reporting The Effects of Disposal of a Segment of a Business, and Extraordinary Unusual and Infrequently Occurring Events and Transactions. SFAS 144 also resolves significant implementation issues related to SFAS 121. Companies were required to adopt SFAS 144 as of the beginning of fiscal 2002 (see Note 6).

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     In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. Besides rescinding the three FASB Statements, this Statement amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company adopted SFAS 145 in the three months ended June 29, 2002. The adoption of SFAS 145 on the Company’s financial statements was not material.

     In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The principal difference between SFAS 146 and Issue 94-3 relates to SFAS 146’s requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recorded as a liability when incurred. Under Issue 94-3, a liability for an exit cost as generally defined in Issue 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company elected not to early apply SFAS 146 in connection with its performance improvement program commenced in the third quarter of 2002 (see Note 4). The Company has recorded its performance improvement and restructuring costs in accordance with Issue 94-3. If the Company had elected early adoption of SFAS 146, $1.9 million of lease termination and other exit costs recorded in the third quarter of 2002 would have been deferred until the leased facilities were actually vacated. The Company does not expect the adoption of SFAS 146 in 2003 to have a material impact on its financial position and results of operations.

Reclassifications

     Certain amounts in prior periods have been reclassified to conform with current period presentation.

2. Financial Statement Information

     Inventories consist of the following (in thousands):

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3. Comprehensive Income (Loss)

     Comprehensive income (loss) consists of the following components (in thousands):

4. Performance Improvement and Restructuring Costs

     In August 2002, the Company commenced a performance improvement program with the objective of increasing revenues and reducing both costs of goods sold and operating expenses as a percentage of net revenues in future periods, after the related costs of such program have been incurred. There can be no assurance the performance improvement program will be successful or achieve the desired goals. With the objective of reducing costs by streamlining its organization structure, the Company began its performance improvement program with the elimination of several senior management positions. In September 2002, the Company also announced the move of the manufacturing of all its remaining soft goods and certain non-custom rigid braces manufactured in the United States to the Company’s manufacturing facilities in Mexico. The move of these manufacturing operations is expected to result in the elimination of approximately 200 U.S. positions by the end of 2002, of which 33 positions were eliminated in the third quarter of 2002. A comparable number of positions are expected to be added in Mexico. The manufacturing move is expected to result in reduced manufacturing costs. Other focuses of the performance improvement program include reducing operating expenses; improving the profitability of revenue from the Company’s OfficeCare® and Insurance channels; reducing working capital and improving the Company’s business processes and information systems. The Company has retained the services of AlixPartners, LLC, a consulting firm specializing in corporate performance enhancement, to assist with the performance improvement program and expects the program to continue through the fourth quarter of 2002 and possibly into 2003.

     The results for the third quarter of 2002 include charges totaling $9.4 million ($6.0 million net of tax, with an effect of $0.34 on diluted loss per share) related to the Company’s performance improvement program, including charges for severance pay, consultants, moving costs and accrued rent related to manufacturing facilities expected to be vacated by the Company in the United States and reserves for inventory and intangibles related to discontinued product lines.

     The severance pay relates to the elimination of the United States manufacturing positions and the senior management positions. In connection with the manufacturing move, a portion of the Company’s United States manufacturing facilities will be vacated. The Company has estimated the net rent that will be paid for the vacated facilities, in excess of estimated sublease income. In accordance with Emerging Issues Task Force Issue 94-3 and Staff Accounting Bulletin No. 100, the employee severance costs and the net lease expense related to the vacated facilities have been deemed to be performance improvement and restructuring costs, and were accrued in the third quarter of 2002.

     Other performance improvement costs in the accompanying statement of operations consist primarily of consulting expenses, moving cost and other related costs, which have been expensed as incurred. The Company’s agreement with AlixPartners, LLC provides for hourly fees for services rendered during the implementation phase of the performance improvement program, as well as certain success and bonus fees based upon the attainment of agreed upon qualitative and quantitative milestones established for the program. The implementation fees have been expensed as incurred. A

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portion of the estimated success and bonus fees have been pro-rated and recognized in the third quarter of 2002 based on accomplishments through the end of the third quarter.

     In connection with the performance improvement program, the Company intends to refocus its resources on its core business within the rehabilitation segment of the orthopedic sports medicine market. As a result, the Company will focus on a smaller product offering within its surgical products area and will not enter the total joint replacement market at this time. In the third quarter of 2002, the Company recorded provisions for inventories related to surgical product lines that will be discontinued in the amount of $2.8 million ($1.8 million net of tax, with an effect of $0.10 on diluted loss per share). The Company will continue to market a limited number of surgical products. Additionally, the Company has estimated that future cash flows from its remaining surgical products will be insufficient to recover the value of certain related intangible assets and accordingly, the Company has recognized $0.5 million primarily for the write-off of goodwill and reported it in the third quarter of 2002 as an impairment of these long-lived assets.

     Charges recorded by the Company in connection with the performance improvement program in the accompanying unaudited consolidated statement of operations for the three and nine months ended September 28, 2002, are as follows (in thousands):

     The Company expects to incur additional costs in connection with the performance improvement program of approximately $5.0 to $8.0 million, primarily for additional severance pay and consulting expenses. The Company expects the majority of these additional expenses to be incurred in the fourth quarter of 2002.

5. Changes in Accounting Estimates

Contractual Allowances and Doubtful Accounts

     As disclosed in the Company’s critical accounting policies in its Form 10-K for the year ended December 31, 2001 and its Forms 10-Q for the three months ended March 30, 2002 and the six months ended June 29, 2002, the Company experienced a problem with a third-party insurance billing company, which required that a substantial portion of the accounts receivable from its OfficeCare® and Insurance programs be transferred to another third-party billing company in the latter half of 2001. During the second quarter of 2002, the Company enhanced the ability of its systems to obtain and analyze the information processed by its third-party billing companies. Historically, the Company relied heavily on these billing companies to provide information about the OfficeCare® and Insurance programs, including the data utilized to determine reserves for contractual allowances and doubtful accounts. The Company’s increased ability to obtain and better analyze information in the second quarter of 2002 revealed that, as a result of the third-party billing problems, the Company has experienced an increase in write-offs and bad debts for accounts receivable from its OfficeCare® and Insurance programs. Accordingly, the Company increased its related reserves by $4.4 million ($2.8 million net of tax, with an effect of $0.16 on diluted loss per

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share) in the second quarter of 2002, which is included in sales and marketing expenses in the accompanying unaudited consolidated statements of operations for the nine months ended September 28, 2002.

Excess and Obsolete Inventories

     In the second quarter of 2002, the Company provided incremental provisions for estimated excess inventories in the amount of $1.3 million ($0.8 million net of tax, with an effect of $0.05 on diluted loss per share). The increase in the Company’s estimate for these reserves was primarily related to inventories on hand for certain new product areas which had not achieved anticipated market share, including the Company’s OrthoPulse® bone growth stimulator product. The Company has experienced continuing delays in obtaining FDA approval for the OrthoPulse® bone growth stimulator product. On July 1, 2002, notification was received from the FDA that the premarket approval application (PMA) for OrthoPulse® was placed on an integrity hold due to concerns that the clinical data submitted in support of the PMA were not reliable. As required by the FDA, an independent review of the clinical data was completed and an amended PMA is expected to be filed by the manufacturer of OrthoPulse® in the fourth quarter of 2002.

6. Impairment of Long-Lived Assets

     In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, whenever events or changes in circumstances indicate that the carrying amount of its assets might not be recoverable, the Company, using its best estimates based upon reasonable and supportable assumptions and projections, reviews the carrying value of its long-lived assets to determine whether the carrying value can be recovered through undiscounted future operating cash flows. Impairment for long-lived assets to be held is measured by comparing the carrying amount of the asset to its fair value. Impairment is reviewed at the lowest levels for which there are identifiable cash flows that are independent of the cash flows of other groups of assets. The Company performed such analysis on an individual asset basis and estimated fair values based on expected future discounted cash flows. The Company measures impairment for long-lived assets to be disposed of at the lower of the carrying amount or net realizable value (fair market value less costs to dispose).

     As a result of certain new products not achieving anticipated revenues or estimated recovery values of assets being disposed of being less than anticipated, the Company’s estimated future cash flows from such new products and assets are lower than originally estimated. During the second and third quarters of 2002, the Company recognized $1.9 million and $0.5 million, respectively, in charges related to impairment of certain long-lived assets. These long-lived assets primarily include intangible assets associated with the Company’s DonJoy Vista™ Rehabilitation System product line, estimated impairment related to an investment in an internet marketing company, and goodwill related to the acquisition of Alaron.

7. Segment and Related Information

     dj Ortho has two reportable segments as defined by FASB Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information. dj Ortho’s reportable segments are its business units that offer different products, which are managed separately because each business requires different technology and marketing strategies. The rigid knee bracing segment designs, manufactures and sells rigid framed ligament and osteoarthritis knee braces and post-operative splints. The soft goods segment designs, manufactures and sells fabric, neoprene and Drytex® based products for the knee, ankle, shoulder, back and wrist. dj Ortho’s other business units are included in specialty and other complementary orthopedic products. None of the other business units met any of the quantitative thresholds for determining reportable segments, including the Company’s line of surgical products. Information regarding industry segments is as follows (in thousands):

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     The accounting policies of the reportable segments are the same as those described in Note 1 of the notes to dj Orthopedics’ consolidated financial statements included in dj Orthopedics’ 2001 Form 10-K filed with the Securities and Exchange Commission. dj Ortho allocates resources and evaluates the performance of segments based on gross profit and therefore has not disclosed certain other items, such as interest, depreciation and amortization by segment as permitted by SFAS No. 131. dj Ortho does not allocate assets to reportable segments because a significant portion of assets are shared by all segments of dj Ortho.

     For the three and nine months ended September 28, 2002 and September 29, 2001, dj Ortho had no individual customer or distributor within a segment which accounted for more than 10% or more of total net revenues.

     In connection with the performance improvement program, the Company is reviewing its reportable segments to determine whether the segments should be changed to be more representative of how the Company will manage its operations upon completion of the program. If a decision is made to change the reportable segments, all previously reported segment results will be restated to conform to the new presentation.

     Net revenues to customers, attributed to regions based on the location of the customer, were as follows (in thousands):

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     Total assets by region were as follows (in thousands):

8. Income Taxes

     In connection with the Reorganization on November 20, 2001, the Company became a corporation and became subject to U.S. federal, state, and foreign income taxes on its earnings after that date. The Company’s estimated worldwide effective tax rate was 40% for the period from November 20 to December 31, 2001. Based on its expected net loss, the Company currently estimates its annual worldwide tax benefit effective rate to be approximately 36% for 2002. The comparable tax benefit is reduced primarily due to the disallowance by certain states of net operating loss carryforwards. As of September 28, 2002, the Company had recorded approximately $61.9 million of net deferred tax assets, for which no valuation allowance has been recorded, related primarily to tax deductible goodwill not recognized for book purposes. Realization of the Company’s deferred tax assets is dependent on the Company’s ability to generate approximately $165.0 million of future taxable income over the next 13 years. Management believes that it is more likely than not that the assets will be realized based on forecasted future taxable income. However, there can be no assurance that the Company will meet its expectations of future taxable income.

9. Contingencies

     Several class action complaints were filed in the United States District Courts for the Southern District of New York and for the Southern District of California on behalf of purchasers of the Company’s common stock alleging violations of the federal securities laws in connection with the Company’s November 15, 2001 initial public offering. The Company is named as a defendant along with Leslie H. Cross, President and Chief Executive Officer, Cyril Talbot III, former Senior Vice President, Finance, Chief Financial Officer, and Secretary, Charles T. Orsatti, former Chairman of the Company’s Board of Directors, and the underwriters of the Company’s initial public offering. The complaints sought unspecified damages and alleged that defendants violated Sections 11, 12, and 15 of the Securities Act of 1933 by, among other things, misrepresenting and/or failing to disclose material facts in connection with the Company’s registration statement and prospectus for the initial public offering. On February 25, 2002, plaintiffs agreed to dismiss the New York actions without prejudice. On February 28, 2002, a federal district court judge consolidated the Southern District of California actions into a single action, In re DJ Orthopedics, Inc. Securities Litigation, Case No. 01-CV-2238-K (LSP) (S.D. Cal.), and appointed Oracle Partners, L.P. as lead plaintiff. On May 3, 2002, the lead plaintiff filed its consolidated amended complaint, which alleges the same causes of action and adds our outside directors Mitchell J. Blutt, M.D., Kirby L. Cramer, and Damion E. Wicker, M.D. as defendants. On June 17, 2002, the Company and the other defendants filed a motion to dismiss the Consolidated Complaint. On August 6, 2002, the Court granted in part and denied in part the motion to dismiss. The Court dismissed several categories of the misstatements and omissions alleged by plaintiffs. The remaining allegation pertains to a purported failure to disclose material intra-quarterly sales data in the registration statement and prospectus. The Company believes the claims are without merit and intends to defend the action vigorously. However, there can be no assurance that the Company will succeed in defending or settling this action. Additionally, there can be no assurance that the action will not have a material adverse effect on the Company’s business.

     On February 13, 2002, the Company filed a complaint in the United States District Court, Southern District of California, against medi Bayreuth and medi UK, Ltd., the Company’s former distributors in Germany and the United Kingdom, respectively, alleging breach of contract, unfair competition and patent infringement resulting from the termination of the Company’s distributorship arrangements with them. On April 19, 2002, the defendants filed their answer and counterclaims seeking a net recovery from the Company of approximately $1.4 million for the

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repurchase of inventory. The Company has recently settled the portion of the litigation relating to medi UK, Ltd. The remaining portion of the litigation relating to medi Bayreuth is currently proceeding, and the Company intends to vigorously prosecute its remaining claims and to vigorously defend against the counterclaims brought by this entity. There can be no assurance that the Company will be successful in this litigation. The Company expects settlement of this litigation relating to medi Bayreuth before December 31, 2002 and does not anticipate a material impact on the financial statements.

     On June 7, 2002, a patent infringement action was filed against the Company and its former parent, Smith & Nephew, in the United States District Court, Eastern District of Texas, by Generation II Orthotics Inc. and Generation II USA Inc. (the Plaintiffs). The suit alleges that the Company and Smith & Nephew willfully infringed, and are infringing, certain United States patents owned by the Plaintiffs by manufacturing, using and selling certain orthopedic knee braces for the treatment of unicompartmental osteoarthritis. The lawsuit seeks unspecified monetary damages and an injunction to prevent the Company from infringing the patents and from selling the relevant knee braces. The Company believes the claims are without merit and intends to defend the action vigorously. The Company has filed an answer and counterclaims seeking to invalidate the patents. Pursuant to a prior contractual obligation, the Company has agreed to indemnify and defend Smith & Nephew in this matter. There can be no assurance that the Company will be successful in this litigation.

     On September 11, 2002, John R. Kline filed a lawsuit against the Company and its former parent, Smith & Nephew DonJoy, Inc., in Superior Court of the State of California, County of San Diego. The plaintiff also sued Shannon Cool, Electro Science Technologies, Inc., Electro Science Technologies Equine, Inc. and other individual principals of Shannon Cool, with whom he had previously entered into an agreement regarding the assignment of royalties from certain patent assets. The plaintiff’s alleged causes of action include breach of contract, intentional interference with contract, fraud, conversion and civil conspiracy, arising out of a Patent Transfer Agreement between the Company and Shannon Cool, and punitive damages. The Company has not yet been served in the action, but believes the claims are without merit and intends to defend the action vigorously if served. In addition, if the Company is served, there may be rights of indemnification against others. There can be no assurance that the Company will be successful in this litigation.

     The Company from time to time is involved in lawsuits arising in the ordinary course of business. With respect to these matters, management believes that it has adequate legal defense, insurance and/or has provided adequate accruals for related costs. The Company is not aware of any pending lawsuits not mentioned above that could have a material adverse effect on the Company’s business, financial condition and results of operations.

10. Subsequent Events

     In October 2002, the Company completed an amendment to its bank credit facility (the Amendment). The Amendment changed certain financial covenants contained in the bank credit facility for the fourth quarter of 2002 and through February 15, 2003 and amended the definition of consolidated EBITDA for purposes of computing those financial covenants. The amended definition of consolidated EBITDA permits the Company to add back to net income, for purposes of computing consolidated EBITDA, up to $17.0 million of charges incurred in connection with its performance improvement program. The Company was in compliance with all financial covenants, as amended, as of September 28, 2002. The Company intends to request an additional amendment to the bank credit facility during the first quarter of 2003 to modify the financial covenants for the remaining term of the bank credit facility. There can be no assurance that the lenders under the bank credit facility will grant any such amendment.

11. Condensed Consolidating Financial Information

     dj Ortho is a wholly owned operating subsidiary of dj Orthopedics and represents substantially all of the revenues and operating results of dj Orthopedics and has no independent assets or operations. DJ Capital is a wholly owned subsidiary of dj Ortho, has no independent assets or operations and was formed solely for the purpose of being a co-issuer of the Senior Subordinated Notes (the Notes). dj Ortho’s obligations under the Notes are guaranteed by dj Orthopedics and dj Development. The guarantees of the Notes by dj Orthopedics and dj Development and any guarantee of the Notes by a future parent or wholly owned subsidiary guarantor are full and unconditional. dj Ortho, DJ Capital and dj Development comprise all the direct and indirect subsidiaries of dj

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Orthopedics other than foreign subsidiaries, which are non-guarantors of the Notes. The indenture governing the Notes (Indenture) and the Amended Credit Agreement (Bank Credit Facility) contain certain covenants restricting the ability of dj Ortho and DJ Capital to, among other things, pay dividends or make other distributions (other than certain tax distributions) or loans or advances to dj Orthopedics unless certain financial tests are satisfied in the case of the Indenture or the consent of the lenders is obtained in the case of the Bank Credit Facility. Such financial covenants were amended for 2002 in conjunction with the performance improvement program discussed above. The Indenture and the Bank Credit Facility permit dj Ortho to make distributions to dj Orthopedics in amounts required by dj Orthopedics to pay federal, state and local income taxes to the extent such income taxes are attributable to the income of dj Ortho and its subsidiaries.

     The following supplemental condensed consolidating financial information presents the balance sheet as of September 28, 2002, the statements of operations for the three and nine months ended September 28, 2002 and the statement of cash flows for the nine months ended September 28, 2002. Since the Company did not establish dj Development until the second quarter of 2002 and the non-guarantor foreign subsidiaries were previously minor, a supplemental condensed consolidating balance sheet as of December 31, 2001 and condensed consolidating statements of operations for the three and nine months ended September 29, 2001 and the statement of cash flows for the nine months ended September 29, 2001 are not required under the Securities Exchange Act of 1934. As discussed in Note 1 above, during 2002, the Company established new operating subsidiaries in Germany, the United Kingdom and Canada. Therefore, in the aggregate, the non-guarantor subsidiaries are no longer minor. For purposes of the financial information below, “DJO, Inc.” represents dj Orthopedics, “DJO, LLC” represents dj Ortho, “DJODC” represents dj Development (subsidiary guarantor), “Non-Guarantors” represents the Company’s subsidiaries in Mexico, Germany, Australia, the United Kingdom and Canada (non-guarantor subsidiaries) and “Elims” represents the consolidating elimination entries recorded by the Company. No separate financial information has been provided herein for DJ Capital because management believes such information would not be meaningful as DJ Capital has no financial or other data to report in response to the requirements of Form 10-Q. The accompanying unaudited condensed consolidating financial statements for the three and nine months ended September 28, 2002, respectively, have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. They have been prepared using the same basis as the Company’s audited consolidated financial statements and include all adjustments (consisting of normal recurring accruals, and the adjustments discussed in Notes 4, 5 and 6) which, in the opinion of management, are necessary for a fair presentation of the financial position, operating results and cash flows for the interim date and interim periods presented.

Unaudited Condensed Consolidating Balance Sheet
September 28, 2002
(in thousands)