Attached files

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EX-32.1 - EX-32.1 - DJO Finance LLCck0001395317-ex321_8.htm
EX-10.1 - EX-10.1 - DJO Finance LLCck0001395317-ex101_385.htm
EX-10.2 - EX-10.2 - DJO Finance LLCck0001395317-ex102_386.htm
EX-99.1 - EX-99.1 - DJO Finance LLCck0001395317-ex991_321.htm
EX-31.2 - EX-31.2 - DJO Finance LLCck0001395317-ex312_7.htm
EX-31.1 - EX-31.1 - DJO Finance LLCck0001395317-ex311_6.htm
EX-32.2 - EX-32.2 - DJO Finance LLCck0001395317-ex322_9.htm
EX-10.3 - EX-10.3 - DJO Finance LLCck0001395317-ex103_387.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

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

For the quarterly period ended September 26, 2015

or

¨

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

For the transition period from                      to                      

Commission File Number: 333-142188

 

DJO Finance LLC

(Exact name of Registrant as specified in its charter)

 

 

State of Delaware

20-5653965

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

 

 

1430 Decision Street

Vista, California

92081

(Address of principal executive offices)

(Zip Code)

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

 

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  ¨    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   ¨

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

¨

Accelerated filer

¨

 

 

 

 

Non-accelerated filer

x  (Do not check if a smaller reporting company)

Smaller reporting company

¨

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

As of November 10, 2015, 100% of the issuer’s membership interests were owned by DJO Holdings LLC.

 

 

 


DJO Finance LLC

INDEX

 

 

 

 

Page
Number

 

PART I—FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

1

 

Unaudited Condensed Consolidated Balance Sheets as of September 26, 2015 and December 31, 2014

 

1

 

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 26, 2015 and September 27, 2014

 

2

 

Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 26, 2015 and September 27, 2014

 

3

 

Unaudited Condensed Consolidated Statement of Deficit for the nine months ended September 26, 2015

 

4

 

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 26, 2015 and September 27, 2014

 

5

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

6

Item 2.

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

 

38

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

48

Item 4.

Controls and Procedures

 

49

 

PART II—OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

50

Item 1A.

Risk Factors

 

50

Item 5.

Other Information

 

50

Item 6.

Exhibits

 

51

 

 

 


PART 1 – FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

DJO Finance LLC

Unaudited Condensed Consolidated Balance Sheets

(in thousands)

 

 

 

September 26,

2015

 

 

December 31,

2014

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

56,686

 

 

$

31,144

 

Accounts receivable, net

 

 

178,742

 

 

 

188,060

 

Inventories, net

 

 

185,119

 

 

 

175,340

 

Deferred tax assets, net

 

 

24,585

 

 

 

24,598

 

Prepaid expenses and other current assets

 

 

22,415

 

 

 

17,172

 

Total current assets

 

 

467,547

 

 

 

436,314

 

Property and equipment, net

 

 

120,305

 

 

 

120,107

 

Goodwill

 

 

1,019,385

 

 

 

1,141,188

 

Intangible assets, net

 

 

769,319

 

 

 

868,031

 

Other assets

 

 

3,902

 

 

 

4,221

 

Total assets

 

$

2,380,458

 

 

$

2,569,861

 

Liabilities and Deficit

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

61,768

 

 

$

62,960

 

Accrued interest

 

 

57,305

 

 

 

29,600

 

Current portion of debt obligations

 

 

10,550

 

 

 

8,975

 

Other current liabilities

 

 

93,518

 

 

 

99,145

 

Total current liabilities

 

 

223,141

 

 

 

200,680

 

Long-term debt obligations

 

 

2,320,337

 

 

 

2,233,309

 

Deferred tax liabilities, net

 

 

238,038

 

 

 

243,123

 

Other long-term liabilities

 

 

15,316

 

 

 

14,365

 

Total liabilities

 

$

2,796,832

 

 

$

2,691,477

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Deficit:

 

 

 

 

 

 

 

 

DJO Finance LLC membership deficit:

 

 

 

 

 

 

 

 

Member capital

 

 

841,144

 

 

 

839,781

 

Accumulated deficit

 

 

(1,243,753

)

 

 

(952,412

)

Accumulated other comprehensive loss

 

 

(16,780

)

 

 

(11,603

)

Total membership deficit

 

 

(419,389

)

 

 

(124,234

)

Noncontrolling interests

 

 

3,015

 

 

 

2,618

 

Total deficit

 

 

(416,374

)

 

 

(121,616

)

Total liabilities and deficit

 

$

2,380,458

 

 

$

2,569,861

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

1


DJO Finance LLC

Unaudited Condensed Consolidated Statements of Operations

(in thousands)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 26,

2015

 

 

September 27,

2014

 

 

September 26,

2015

 

 

September 27,

2014

 

Net sales

 

$

299,998

 

 

$

305,501

 

 

$

890,942

 

 

$

902,112

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales (exclusive of amortization of intangible assets of

   $8,215 and $23,988 for the three and nine months ended

   September 26, 2015 and $8,645 and $25,980 for the three and

   nine months ended September 27, 2014, respectively)

 

 

120,357

 

 

 

122,616

 

 

 

355,135

 

 

 

365,771

 

Selling, general and administrative

 

 

123,819

 

 

 

123,632

 

 

 

362,615

 

 

 

374,965

 

Research and development

 

 

7,712

 

 

 

9,159

 

 

 

25,351

 

 

 

28,500

 

Amortization of intangible assets

 

 

22,524

 

 

 

23,233

 

 

 

66,733

 

 

 

70,292

 

Impairment of goodwill

 

 

117,298

 

 

 

 

 

 

 

117,298

 

 

 

 

 

Impairment of intangible and other long lived assets

 

 

47,650

 

 

 

 

 

 

52,150

 

 

 

 

 

 

 

439,360

 

 

 

278,640

 

 

 

979,282

 

 

 

839,528

 

Operating (loss) income

 

 

(139,362

)

 

 

26,861

 

 

 

(88,340

)

 

 

62,584

 

Other (expense) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

(42,120

)

 

 

(43,280

)

 

 

(129,493

)

 

 

(130,518

)

Loss on modification and extinguishment of debt

 

 

(335

)

 

 

 

 

 

(68,302

)

 

 

(1,019

)

Other expense, net

 

 

(3,053

)

 

 

(3,464

)

 

 

(6,449

)

 

 

(2,932

)

 

 

 

(45,508

)

 

 

(46,744

)

 

 

(204,244

)

 

 

(134,469

)

Loss before income taxes

 

 

(184,870

)

 

 

(19,883

)

 

 

(292,584

)

 

 

(71,885

)

Income tax benefit (provision)

 

 

7,172

 

 

 

(1,250

)

 

 

1,849

 

 

 

(10,628

)

Net loss

 

 

(177,698

)

 

 

(21,133

)

 

 

(290,735

)

 

 

(82,513

)

Net income attributable to noncontrolling interests

 

 

(140

)

 

 

(73

)

 

 

(606

)

 

 

(649

)

Net loss attributable to DJO Finance LLC

 

$

(177,838

)

 

$

(21,206

)

 

$

(291,341

)

 

$

(83,162

)

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

2


DJO Finance LLC

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 26,

2015

 

 

September 27,

2014

 

 

September 26,

2015

 

 

September 27,

2014

 

Net loss

 

$

(177,698

)

 

$

(21,133

)

 

$

(290,735

)

 

$

(82,513

)

Other comprehensive loss, net of taxes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments, net of tax benefit of

   $37 and $377 for the three and nine months ended

   September 26, 2015 and $2,449 and $2,784 for the three and

   nine months ended September 27, 2014, respectively

 

 

(81

)

 

 

(6,105

)

 

 

(5,386

)

 

 

(8,010

)

Other comprehensive loss

 

 

(81

)

 

 

(6,105

)

 

 

(5,386

)

 

 

(8,010

)

Comprehensive loss

 

 

(177,779

)

 

 

(27,238

)

 

 

(296,121

)

 

 

(90,523

)

Comprehensive (income) loss attributable to noncontrolling

   interests

 

 

(137

)

 

 

139

 

 

 

(397

)

 

 

(405

)

Comprehensive loss attributable to DJO Finance LLC

 

$

(177,916

)

 

$

(27,099

)

 

$

(296,518

)

 

$

(90,928

)

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

3


DJO Finance LLC

Unaudited Condensed Consolidated Statements of Deficit

(in thousands)

 

 

 

DJO Finance LLC

 

 

 

 

 

 

 

 

 

 

 

Member

capital

 

 

Accumulated

deficit

 

 

Accumulated

other

comprehensive

loss

 

 

Total

membership

deficit

 

 

Non-controlling

interests

 

 

Total

deficit

 

Balance at December 31, 2014

 

$

839,781

 

 

$

(952,412

)

 

$

(11,603

)

 

$

(124,234

)

 

$

2,618

 

 

$

(121,616

)

Net (loss) income

 

 

 

 

 

(291,341

)

 

 

 

 

 

(291,341

)

 

 

606

 

 

 

(290,735

)

Other comprehensive loss, net of taxes

 

 

 

 

 

 

 

 

(5,177

)

 

 

(5,177

)

 

 

(209

)

 

 

(5,386

)

Stock-based compensation, net of taxes

 

 

1,450

 

 

 

 

 

 

 

 

 

1,450

 

 

 

 

 

 

1,450

 

Exercise of stock options

 

 

(87

)

 

 

 

 

 

 

 

 

(87

)

 

 

 

 

 

(87

)

Balance at September 26, 2015

 

$

841,144

 

 

$

(1,243,753

)

 

$

(16,780

)

 

$

(419,389

)

 

$

3,015

 

 

$

(416,374

)

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

4


DJO Finance LLC

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

 

Nine Months Ended

 

 

 

September 26,

2015

 

 

September 27,

2014

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net loss

 

$

(290,735

)

 

$

(82,513

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation

 

 

25,894

 

 

 

26,335

 

Amortization of intangible assets

 

 

66,733

 

 

 

70,292

 

Amortization of debt issuance costs and non-cash interest expense

 

 

5,987

 

 

 

6,438

 

Stock-based compensation expense

 

 

1,450

 

 

 

1,274

 

Loss on modification and extinguishment of debt

 

 

68,302

 

 

 

1,019

 

Loss (gain) on disposal of assets, net

 

 

630

 

 

 

(1,211

)

Deferred income tax (benefit) expense

 

 

(4,125

)

 

 

6,628

 

Impairment of goodwill

 

 

117,298

 

 

 

 

Impairment of intangible and other long lived assets

 

 

52,150

 

 

 

 

Changes in operating assets and liabilities, net of acquired assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

5,298

 

 

 

(2,832

)

Inventories

 

 

(12,182

)

 

 

(13,873

)

Prepaid expenses and other assets

 

 

(3,075

)

 

 

(8,758

)

Accrued interest

 

 

27,706

 

 

 

19,820

 

Accounts payable and other current liabilities

 

 

2,389

 

 

 

24,466

 

Net cash provided by operating activities

 

 

63,720

 

 

 

47,085

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Cash paid in connection with acquisition, net of cash acquired

 

 

(24,000

)

 

 

(4,587

)

Purchases of property and equipment

 

 

(30,610

)

 

 

(41,495

)

Other investing activities, net

 

 

24

 

 

 

(987

)

Net cash used in investing activities

 

 

(54,586

)

 

 

(47,069

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from issuance of debt

 

 

2,468,032

 

 

 

952,294

 

Repayments of debt obligations

 

 

(2,389,133

)

 

 

(944,720

)

Payment of debt issuance costs, modification and extinguishment costs

 

 

(62,375

)

 

 

(1,812

)

Payment of contingent consideration

 

 

 

 

 

(5,690

)

Investment by parent

 

 

 

 

 

22

 

Cash paid in connection with the cancellation of vested options

 

 

 

 

 

(2,001

)

Net cash provided by financing activities

 

 

16,524

 

 

 

(1,907

)

Effect of exchange rate changes on cash and cash equivalents

 

 

(116

)

 

 

(830

)

Net increase (decrease) in cash and cash equivalents

 

 

25,542

 

 

 

(2,721

)

Cash and cash equivalents at the beginning of the period

 

 

31,144

 

 

 

43,578

 

Cash and cash equivalents at the end of the period

 

$

56,686

 

 

$

40,857

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

95,645

 

 

$

104,011

 

Cash paid for taxes, net

 

$

6,553

 

 

$

5,418

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

5


Notes to Unaudited Condensed Consolidated Financial Statements

 

 

1. ORGANIZATION AND BASIS OF PRESENTATION

Organization and Business

We are a global developer, manufacturer and distributor of 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. 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.

DJO Finance LLC (DJOFL) is a wholly-owned indirect subsidiary of DJO Global, Inc. (DJO). Substantially all business activities of DJO are conducted by DJOFL and its wholly-owned subsidiaries. Except as otherwise indicated, references to “us,” “we,” “DJOFL,” “our,” or “the Company,” refers to DJOFL and its consolidated subsidiaries.

Segment Reporting

We market and distribute our products through four operating segments, Bracing and Vascular, Recovery Sciences, Surgical Implant, and International. Our Bracing and Vascular, Recovery Sciences, and Surgical Implant segments generate their revenues within the United States. Our Bracing and Vascular segment offers rigid knee braces, orthopedic soft goods, cold therapy products, vascular systems, compression therapy products and therapeutic footwear for the diabetes care market. Our Recovery Sciences segment offers home electrotherapy, iontophoresis, home traction products, bone growth stimulation products and clinical physical therapy equipment. Our Surgical Implant segment offers a comprehensive suite of reconstructive joint products for the knee, hip and shoulder. Our International segment offers all of our products to customers outside the United States. See Note 15 for additional information about our reportable segments.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates and assumptions are used in accounting for, among other things, contractual allowances, rebates, product returns, warranty obligations, allowances for doubtful accounts, valuation of inventories, self-insurance reserves, income taxes, loss contingencies, fair values of derivative instruments, fair values of long-lived assets and any related impairments, capitalization of costs associated with internally developed software and stock-based compensation. Actual results could differ from those estimates.

Basis of Presentation

We consolidate the results of operations of our 50% owned subsidiary, Medireha GmbH (Medireha), and reflect the 50% share of results not owned by us as non-controlling interests in our Consolidated Statements of Operations. We maintain control of Medireha through certain rights that enable us to prohibit certain business activities that are not consistent with our plans for the business and provide us with exclusive distribution rights for products manufactured by Medireha.

Interim Reporting

The accompanying Unaudited Condensed Consolidated Financial Statements include our accounts and all voting interest entities where we exercise a controlling financial interest through the ownership of a direct or indirect majority voting interest. All significant intercompany accounts and transactions have been eliminated in consolidation. Our Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP and with the instructions to Form 10–Q and Article 10 of Regulation S–X for interim financial information. Accordingly, these financial statements do not include all of the information required by GAAP or Securities and Exchange Commission (SEC) rules and regulations for complete annual financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the results of operations for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10–K for the year ended December 31, 2014.

6


Recent Accounting Standards

In April 2014, the FASB issued an accounting standards update, which includes amendments that change the requirements for reporting discontinued operations and require additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations—that is, a major effect on the organization’s operations and financial results should be presented as discontinued operations. Examples include a disposal of a major geographic area, a major line of business, or a major equity method investment. Additionally, the update requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The guidance is effective prospectively for fiscal years beginning after December 15, 2014 and interim periods within annual periods beginning on or after December 15, 2015. The adoption of this standard has the potential to impact the Company’s accounting for and disclosure of any future discontinued operations.

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 June 2014, the FASB issued an accounting standards update related to accounting for share-based payments. The standard requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The guidance is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2015. Early application is permitted. Adoption of this new guidance is not expected to have a material effect on the Company’s financial statements.

In August 2014, the FASB issued an accounting standards update related to going concern disclosures. The standard requires an entity’s management to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. The guidance is effective for annual reporting periods ending after December 15, 2016 and interim periods thereafter. Early application is permitted. Adoption of this new guidance is not expected to have a material effect on the Company’s 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.

 

 

2. ACQUISITION

 

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. The purchase price consisted of a cash payment of $24.0 million and was funded through the $20.0 million delayed draw term loan from our New Senior Secured Credit Facilities (as defined below). Additional acquisition related costs were $3.4 million and are included in the Selling, general and administrative expense line item in the Consolidated Statement of Operations.  

 

The primary reason for the acquisition was to further invest in our growing Surgical Implant segment and improve our position in the orthopedic implant market. The Discovery Elbow will be our first elbow technology and builds upon our successful upper extremity portfolio and shoulder arthroplasty experience. The Cobalt products have a substantial base of customers for hip, knee, shoulder, elbow and other orthopedic implant technologies.

 

7


The purchase price for this acquisition was allocated to the fair values of the net tangible and intangible assets acquired as follows (in thousands):

 

Inventories

 

$

2,400

 

Intangible assets

 

 

19,700

 

Goodwill

 

 

1,900

 

Total purchase price

 

$

24,000

 

 

The purchase price allocation included $15.0 million assigned to intangible assets related to existing technology. The value of the technology was determined primarily by estimating the present value of future royalty costs that will be avoided due to our ownership of the patents and technology acquired. The purchase price allocation also included $2.9 million assigned to intangible assets related to trademarks and trade names. The value of the trademarks and trade names was determined primarily by estimating the present value of future royalty costs that will be avoided due to our ownership of the trademarks and trade names acquired. Additionally, the purchase price allocation included $1.8 million assigned to intangible assets related to certain customer relationships existing on the acquisition date. The value of the customer relationships was based upon an estimate of the future discounted cash flows that would be derived from those customers, after deducting contributory asset charges.

 

Goodwill represents the excess of the purchase price over fair value of tangible and identifiable intangible assets acquired. All goodwill associated with the acquisition is allocated to our Surgical Implant segment. Among the factors which resulted in goodwill for the acquisition was the opportunity to increase our revenue and expand our presence in the surgical implant market through the use of the acquired technology and customer relationships.

 

Goodwill related to this acquisition is expected to be deductible for tax purposes.

 

 

3. ACCOUNTS RECEIVABLE RESERVES

A summary of activity in our accounts receivable reserves for doubtful accounts is presented below (in thousands):

 

 

 

Nine Months Ended

 

 

 

September 26,

2015

 

 

September 27,

2014

 

Balance, beginning of period

 

$

41,402

 

 

$

32,957

 

Provision for doubtful accounts

 

 

23,520

 

 

 

30,299

 

Write-offs, net of recoveries

 

 

(18,855

)

 

 

(20,814

)

Balance, end of period

 

$

46,067

 

 

$

42,442

 

 

Our allowance for sales returns balance was $3.8 million and $3.7 million as of September 26, 2015 and September 27, 2014, respectively.

 

 

4. INVENTORIES

Inventories consist of the following (in thousands):

 

 

 

September 26,

2015

 

 

December 31,

2014

 

Components and raw materials

 

$

61,292

 

 

$

59,578

 

Work in process

 

 

7,433

 

 

 

5,718

 

Finished goods

 

 

109,837

 

 

 

103,042

 

Inventory held on consignment

 

 

32,262

 

 

 

30,978

 

 

 

 

210,824

 

 

 

199,316

 

Inventory reserves

 

 

(25,705

)

 

 

(23,976

)

 

 

$

185,119

 

 

$

175,340

 

 

8


A summary of the activity in our reserves for estimated slow moving, excess, obsolete and otherwise impaired inventory is presented below (in thousands):

 

 

 

Nine Months Ended

 

 

 

September 26,

2015

 

 

September 27,

2014

 

Balance, beginning of period

 

$

23,976

 

 

$

23,686

 

Provision charged to costs of sales

 

 

5,643

 

 

 

6,230

 

Write-offs, net of recoveries

 

 

(3,914

)

 

 

(5,201

)

Balance, end of period

 

$

25,705

 

 

$

24,715

 

 

The write-offs to the reserve were principally related to the disposition of fully reserved inventory.

 

 

5. LONG-LIVED ASSETS

Goodwill

Changes in the carrying amount of goodwill for the nine months ended September 26, 2015 are presented in the table below (in thousands):

 

 

 

Bracing &

Vascular

 

 

Recovery

Sciences

 

 

Surgical

Implant

 

 

International

 

 

Total

 

Balance, beginning of period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

483,258

 

 

$

495,999

 

 

$

47,406

 

 

$

340,631

 

 

$

1,367,294

 

Accumulated impairment losses

 

 

 

 

 

(178,700

)

 

 

(47,406

)

 

 

 

 

 

(226,106

)

Goodwill, net of accumulated impairment losses at

   December 31, 2014

 

 

483,258

 

 

 

317,299

 

 

 

 

 

 

340,631

 

 

 

1,141,188

 

Current Year Activity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impairment

 

 

 

 

 

(117,298

)

 

 

 

 

 

 

 

 

(117,298

)

Acquisitions

 

 

 

 

 

 

 

 

1,900

 

 

 

 

 

 

1,900

 

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

(6,405

)

 

 

(6,405

)

Balance, end of period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

 

483,258

 

 

 

495,999

 

 

 

49,306

 

 

 

334,226

 

 

 

1,362,789

 

Accumulated impairment losses

 

 

 

 

 

(295,998

)

 

 

(47,406

)

 

 

 

 

 

(343,404

)

Goodwill, net of accumulated impairment losses at

   September 26, 2015

 

$

483,258

 

 

$

200,001

 

 

$

1,900

 

 

$

334,226

 

 

$

1,019,385

 

 

Intangible Assets

Identifiable intangible assets consisted of the following (in thousands):

 

September 26, 2015

 

Gross Carrying

Amount

 

 

Accumulated

Amortization

 

 

Intangible

Assets, Net

 

Definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

476,308

 

 

$

(310,236

)

 

$

166,072

 

Patents and technology

 

 

446,851

 

 

 

(238,720

)

 

 

208,131

 

Trademarks and trade names

 

 

29,763

 

 

 

(12,009

)

 

 

17,754

 

Distributor contracts and relationships

 

 

4,668

 

 

 

(3,712

)

 

 

956

 

Non-compete agreements

 

 

6,614

 

 

 

(5,432

)

 

 

1,182

 

 

 

$

964,204

 

 

$

(570,109

)

 

 

394,095

 

Indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and trade names

 

 

 

 

 

 

 

 

 

 

375,224

 

Net identifiable intangible assets

 

 

 

 

 

 

 

 

 

$

769,319

 

 

9


December 31, 2014

 

Gross Carrying

Amount

 

 

Accumulated

Amortization

 

 

Intangible

Assets, Net

 

Definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

569,360

 

 

$

(341,353

)

 

$

228,007

 

Patents and technology

 

 

486,466

 

 

 

(264,132

)

 

 

222,334

 

Trademarks and trade names

 

 

25,970

 

 

 

(9,902

)

 

 

16,068

 

Distributor contracts and relationships

 

 

4,771

 

 

 

(3,401

)

 

 

1,370

 

Non-compete agreements

 

 

6,824

 

 

 

(4,723

)

 

 

2,101

 

 

 

$

1,093,391

 

 

$

(623,511

)

 

$

469,880

 

Indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and trade names

 

 

 

 

 

 

 

 

 

 

398,151

 

Net identifiable intangible assets

 

 

 

 

 

 

 

 

 

$

868,031

 

 

Based on indication of impairment through declining sales in the second quarter of 2015, we performed an interim impairment test on goodwill, an interim impairment test on our indefinite lived trade name intangible asset of our Empi reporting unit, and an interim recoverability test on our long lived assets. We then determined that the long lived assets and the goodwill were not impaired; however, we recorded impairment charges of $4.5 million for the Empi trade name as we determined that the percentage by which the carrying value of this trade name exceeded its fair value was 18.1%. The impairment charge was included in Impairment of goodwill line item in the Consolidated Statement of Operations. This fair value measurement is categorized within Level 3 of the fair value hierarchy.

However, during the third quarter of 2015, circumstances in our Empi reporting unit continued to worsen beyond our second quarter estimates due to continuing challenges of the reimbursement environment for Empi products. As a result we performed an interim impairment test on goodwill. In performing the goodwill impairment test, we estimated the fair values of the Empi reporting unit using the income approach which includes the discounted cash flow method and the market approach which includes the use of market multiples. These fair value measurements are categorized within Level 3 of the fair value hierarchy. The discounted cash flows for the reporting unit were based on a discrete financial forecast developed by management for planning purposes, and required significant judgment with respect to forecasted sales, gross margin, selling, general and administrative expenses, depreciation, income taxes, capital expenditures, working capital requirements and the selection and use of an appropriate discount rate. Future cash flows were then discounted to present value. Publicly available information regarding comparable market capitalization was also considered in assessing the reasonableness of the cumulative fair value of the reporting unit estimated using the discounted cash flow methodology. We determined that the carrying value of our Empi reporting unit was in excess of its estimated fair value. As a result, we recorded impairment charges of $117.3 million for the Empi reporting unit. This impairment charge represents an estimated loss that has not yet been finalized at this time. We will continue to evaluate these estimates in our 2015 annual impairment test in the fourth quarter of 2015. The percentage by which the carrying value of the Empi reporting unit exceeded the fair value was 92.6%. The impairment charge was included in Impairment of goodwill line item in the Consolidated Statement of Operations. This fair value measurement is categorized within Level 3 of the fair value hierarchy.

 

Additionally, we performed an interim impairment test on our indefinite lived trade name intangible asset of our Empi reporting unit. The method of testing the indefinite lived intangible asset for impairment was consistent with our annual impairment test which is described in our 2014 Annual Report on Form 10-K filed with the SEC on February 20, 2015. We determined that the carrying value of our Empi trade name was in excess of its estimated fair value. As a result, we recorded impairment charges of $17.9 million for the Empi trade name. The percentage by which the carrying value of this trade name exceeded its fair value was 100.0%. The impairment charge was included in Impairment of intangible and other assets line item in the Consolidated Statement of Operations. This fair value measurement is categorized within Level 3 of the fair value hierarchy.

We also performed an interim recoverability test on our long lived assets related to the Empi reporting unit. We tested the recoverability of the long lived asset group to be held and used by using an undiscounted cash flow approach dependent primarily upon estimates of forecasted sales, gross margin, selling, general and administrative expenses, depreciation, income taxes, capital expenditures, working capital requirements and remaining useful lives of the primary asset. We then determined that the carrying value of the asset group was in excess of the estimated undiscounted cash flows. Accordingly, we completed the Step 2 analysis to determine the fair value of the asset group. As a result, we recorded impairment charges for the finite lived intangible assets of $29.1 million and the property, plant and equipment of $0.7 million. The impairment charges were included in Impairment of intangible and other long lived assets line item in the Consolidated Statement of Operations. This fair value measurement is categorized within Level 3 of the fair value hierarchy.

10


Our definite lived intangible assets are being amortized using the straight line method over their remaining weighted average useful lives of 4.6 years for customer relationships, 8.0 years for patents and technology, 2.0 years for distributor contracts and relationships, 6.9 years for trademarks and trade names, and 1.8 years for non-compete agreements. Based on our amortizable intangible asset balance as of September 26, 2015, we estimate that amortization expense will be as follows for the next five years and thereafter (in thousands):

 

Remaining 2015

 

$

20,081

 

2016

 

 

76,481

 

2017

 

 

66,130

 

2018

 

 

57,910

 

2019

 

 

53,042

 

Thereafter

 

 

120,451

 

 

 

$

394,095

 

 

 

6. OTHER CURRENT LIABILITIES

Other current liabilities consist of the following (in thousands):

 

 

 

September 26,

2015

 

 

December 31,

2014

 

Accrued wages and related expenses

 

$

32,336

 

 

$

32,220

 

Accrued commissions

 

 

17,083

 

 

 

16,611

 

Accrued rebates

 

 

10,533

 

 

 

12,981

 

Accrued other taxes

 

 

4,633

 

 

 

4,987

 

Accrued professional expenses

 

 

3,485

 

 

 

2,682

 

Deferred tax liability

 

 

328

 

 

 

343

 

Other accrued liabilities

 

 

25,120

 

 

 

29,321

 

 

 

$

93,518

 

 

$

99,145

 

 

 

7. DERIVATIVE INSTRUMENTS

From time to time, we use derivative financial instruments to manage interest rate risk related to our variable rate credit facilities and risk related to foreign currency exchange rates. Our objective is to reduce the risk to earnings and cash flows associated with changes in interest rates and changes in foreign currency exchange rates. Before acquiring a derivative instrument to hedge a specific risk, we evaluate potential natural hedges. Factors considered in the decision to hedge an underlying market exposure include the materiality of the risk, the volatility of the market, the duration of the hedge, and the availability, effectiveness and cost of derivative instruments. We do not use derivative instruments for speculative or trading purposes.

All derivatives, whether designated as hedging relationships or not, are recorded on the balance sheet at fair value. The fair value of our derivatives is determined through the use of models that consider various assumptions, including time value, yield curves and other relevant economic measures which are inputs that are classified as Level 2 in the fair value hierarchy. The classification of gains and losses resulting from changes in the fair values of derivatives is dependent on the intended use of the derivative and its resulting designation. Our foreign exchange contracts have not been designated as hedges, and accordingly, changes in the fair value of the derivatives are recorded in income (loss).

Foreign Exchange Rate Contracts. In prior periods, we have utilized Mexican Peso (MXN) foreign exchange forward contracts to hedge a portion of our exposure to fluctuations in foreign exchange rates, as our Mexico-based manufacturing operations incur costs that are largely denominated in MXN. As of September 26, 2015, we did not have any outstanding foreign currency exchange forward contracts. While our foreign exchange forward contracts act as economic hedges, we have not designated such instruments as hedges for accounting purposes. Therefore, gains and losses resulting from changes in the fair values of these derivative instruments are recorded in Other income (expense), net, in our accompanying Unaudited Condensed Consolidated Statements of Operations.

11


Information regarding the notional amounts of our foreign exchange forward contracts is presented in the table below (in thousands):

 

 

 

Notional Amount (MXN)

 

 

Notional Amount (USD)

 

 

 

September 26,

2015

 

 

December 31,

2014

 

 

September 26,

2015

 

 

December 31,

2014

 

Foreign exchange contracts not designated as hedges

 

 

 

 

 

7,682

 

 

$

 

 

$

526

 

 

The following table summarizes the fair value of derivative instruments in our Unaudited Condensed Consolidated Balance Sheets (in thousands):

 

 

 

Balance Sheet Location

 

September 26,

2015

 

 

December 31,

2014

 

Derivative Liabilities:

 

 

 

 

 

 

 

 

 

 

Foreign exchange forward contracts not designated

   as hedges

 

Other current liabilities

 

$

 

 

$

4

 

 

The following table summarizes the effect our derivative instruments have on our Unaudited Condensed Consolidated Statements of Operations (in thousands):