The following discussion should be read in conjunction with our historical consolidated financial statements and the related notes thereto and the other financial data included in this Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2003.

Overview

We are a global medical device company specializing in rehabilitation and regeneration products for the non-operative orthopedic and spine markets. Our broad range of over 600 rehabilitation products, including rigid knee braces, soft goods, and pain management products, are used to prevent injury, to treat chronic conditions and to aid in recovery after surgery or injury. Our regeneration products consist of bone growth stimulation devices that are used to treat nonunion fractures and as an adjunct therapy after spinal fusion surgery. Our rigid knee braces, soft goods, pain management and regeneration products represented 31.4%, 40.5%, 8.2% and 19.9%, respectively, of our consolidated net revenues for the first six months of 2004.

According to Frost & Sullivan, the segment of the non-operative orthopedic and spine markets we target is estimated to generate sales of approximately $1.6 billion in 2004 and is expected to grow at approximately 5.4% per annum until 2008. We believe that the growth of the markets we target is being driven by the following factors:

• Growing elderly populations with broad medical coverage, increased disposable income and longer life expectancy. People over 65 years old currently represent about 13% of the U.S. population, yet are estimated to account for nearly 40% of healthcare expenditures. This population segment is expected to increase as a result of aging "baby boomers" (people born between 1946 and 1965) and longer life expectancies;

• Growing emphasis on physical fitness, leisure sports and conditioning, which has led to increased injuries, especially among women. A U.S. Consumer Product Safety Commission survey determined that from 1990 to 1996 there was an 18% increase in the number of sports-related injuries among the 25 to 64 population segment. From 1991-1998, "baby boomers" likewise experienced significant increases in sports-related injuries: 64% for those who lift weights, 240% for golfers and more than four times for those that engage in general exercise and running. In addition, according to industry studies, female athletes are six to eight times more likely than their male counterparts to suffer anterior cruciate ligament (ACL) injuries; and

• Increasing awareness and use of non-invasive devices for prevention, treatment and rehabilitation purposes. The growing awareness and clinical acceptance by patients and healthcare professionals of the benefits of non-invasive solutions continues to drive demand for non-operative rehabilitation and regeneration products.

We conduct our business through five segments, which, except for Regentek, reflect our primary distribution channels:

• DonJoy, our largest sales channel, comprised of the sale of rigid knee braces, pain management products and certain soft goods. Approximately 40 independent sales agents who employ approximately 300 independent commissioned sales representatives sell our DonJoy products to orthopedic surgeons, podiatrists, orthopedic and prosthetic centers, hospitals, athletic trainers and other healthcare professionals. The representatives are technical specialists responsible for educating patients on device usage. After a product order is received by a sales representative, we generally ship the product directly to the orthopedic professional and pay a sales commission to the agent based on sales of such products. These commissions are reflected in sales and marketing expense in our consolidated financial statements. DonJoy revenues comprised 39% and 49% of total consolidated net revenues in the first six months of fiscal 2004 and 2003, respectively, and 40% of pro forma consolidated net revenues for the first six months of 2003;

• ProCare, in which products are sold by approximately 30 direct and independent representatives that manage over 320 dealers focused on primary and acute facilities. Products are sold primarily to national third-party distributors, other regional medical supply dealers and medical product buying groups, generally at a discount from list prices. The majority of these products are soft goods and pain management products requiring little or no patient education. The distributors resell these products to large

hospital chains, hospital buying groups, primary care networks and orthopedic physicians for use by their patients. ProCare revenues comprised 19% and 24% of total consolidated net revenues in the first six months of fiscal 2004 and 2003, respectively, and 20% of pro forma consolidated net revenues for the first six months of 2003;

• Regentek, in which our Regentek products are sold through a combination of direct sales representatives and certain independent regional sales agents, with respect to OL1000, and by DePuy Spine under a exclusive sales agreement, with respect to SpinaLogic. These products are sold either directly to the patient or to independent distributors. We arrange billing to third-party payors or patients, for products sold directly to the patient. Regentek revenues comprised 20% of total consolidated net revenues in the first six months of fiscal 2004 and 19% of pro forma consolidated net revenue for the first six months of 2003;

• OfficeCare, in which we maintain an inventory of product (primarily soft goods) on hand at orthopedic practices for immediate disbursement to the patient. For these products, we arrange billing to the patient or third-party payor after the product is provided to the patient. We outsource certain OfficeCare billing and collection activities to an independent third-party contractor. As of June 26, 2004, the OfficeCare program was located at approximately 600 physician offices throughout the United States. We have contracts with over 350 third-party payors for our OfficeCare products. OfficeCare revenues comprised 11% and 13% of total consolidated net revenues in the first six months of fiscal 2004 and 2003, respectively, and 10% of pro forma consolidated net revenues for the first six months of 2003; and

• International, in which our products (primarily rigid knee braces and soft goods) sold in foreign countries through wholly-owned subsidiaries or independent distributors. We sell our products in over 35 foreign countries, primarily in Europe, Canada, Australia, and Japan. International revenues comprised 12% and 15% of total consolidated net revenues in the first six months of fiscal 2004 and 2003, respectively, and 12% of pro forma consolidated net revenues for the first six months of 2003.

Our Strategy

Our strategy is to increase revenue and profitability and enhance cash flow by strengthening our market leadership position. Our key initiatives to implement this strategy include:

• Regentek Integration. On July 27, 2004, we announced plans to integrate our Regentek sales organization into our DonJoy sales organization and most of the remaining Regentek operations in Tempe, Arizona into our corporate facility in Vista, California. The objectives of the Regentek integration are to strengthen the distribution activities of the business and to reduce both costs of goods sold and operating expenses as a percentage of net revenues in future periods, after the related costs of the integration have been incurred. We estimate the costs of the integration, primarily including severance, recruiting and training, will be $4 million to $5 million, and will result in annualized savings of approximately $3 million beginning in 2005. We anticipate that the integration costs will be substantially recognized in the third and fourth quarters of 2004;

• Further Penetrate Our Existing Customer Base. We are focused on increasing the number and variety of products sold to our existing customers. We believe that our OfficeCare program provides us with a strong platform for selling additional products to our existing customers because of the amount of contact our sales representatives have with the orthopedic practices who participate in the program. We also believe that the addition of the bone growth stimulation products to our existing product line will further this goal by providing significant cross-selling opportunities. We believe the Regentek acquisition will provide us the opportunity to further penetrate our customer base by providing additional products to satisfy our customers' orthopedic needs;

• Continue to Introduce New Products and Product Enhancements. We have a history of developing and introducing innovative products into the marketplace, and are committed to continuing that tradition by introducing new products across our product platform. In the six months ended June 26, 2004, we launched 15 new products. We believe that product innovation through effective and focused research and development will provide a sustainable competitive advantage. We are currently a technology leader in several product categories and we intend to continue to develop next generation technologies;

• Expand Our OfficeCare Channel. Our OfficeCare channel currently includes approximately 600 physician offices encompassing approximately 2,000 physicians. We estimate that there are approximately 10,000 orthopedic physicians in the

United States practicing in offices with three or more physicians. We believe that our OfficeCare channel serves a growing need among orthopedic practices to have a number of products readily available for immediate distribution to patients and represents an opportunity for significant sales growth. We intend to expand our OfficeCare channel into more "high-volume" orthopedic offices, thereby increasing the number of potential customers to whom we sell our products. In the three and six months ended June 26, 2004, we added 11 and 50, respectively, net new offices to our OfficeCare channel;

• Maximize Existing and Secure Additional National Accounts. We plan to capitalize on the growing practice in healthcare in which hospitals and other large healthcare providers seek to consolidate their purchasing activities to national buying groups. We were awarded three additional national contracts in the six months ended June 26, 2004. Contracts with these national accounts represent a significant opportunity for sales growth. We believe that our broad range of products are well suited to the goals of these buying groups and intend to aggressively pursue these contracts;

• Expand Product Offerings for the Spine. SpinaLogic is our first product that targets the spine. According to Frost & Sullivan, back pain is the number one cause of healthcare expenditure in the United States. The spine segment of the orthopedics market is estimated to grow in excess of 18% from 2001 to 2005. As a result, we believe that expanding our product offerings in this market represents a significant growth opportunity;

• Pursue Selective Strategic Acquisitions. We believe that strategic acquisitions represent an attractive and efficient means to broaden our product lines. The products acquired in the Regentek acquisition, for example, which generated revenues of $12.7 million and $24.9 million during the three and six months ended June 26, 2004, respectively, and pro forma revenues of $46.4 million during the year ended December 31, 2003, enabled us to enter the regeneration market, which is predicted to grow faster than the rehabilitation market. We intend to pursue acquisition opportunities that enhance sales growth, are accretive to earnings, increase customer penetration and/or provide geographic diversity;

• Expand International Sales. International sales have historically represented less than 15% of our net revenues. Although our presence outside the United States has been limited, we have successfully established direct distribution capabilities in major international markets. We believe that sales to foreign markets continue to represent a significant growth opportunity and we intend to continue to develop direct distribution capabilities in selected foreign markets; and

• Expand Low Cost Manufacturing Capabilities.We plan to continue to expand our low cost manufacturing capabilities in Mexico to reduce our costs of goods sold and improve our gross margins. At the end of 2002 we moved the manufacturing of our off-the-shelf rigid knee braces and the remaining manufacturing of our soft goods products from Vista, California to Tijuana, Mexico, resulting in a significant reduction in our costs of goods sold. This improved our gross margins beginning in 2003. In September 2004, we intend to move our Mexico operations into a new 200,000 square foot leased facility, providing further opportunities to expand our Mexico manufacturing operations. We intend to move our machine shop and the manufacturing of our cold therapy product line to Mexico by the end of the fourth quarter, which should reduce the related costs of good sold beginning in 2005. We also intend to use our expanded Mexico capabilities to vertically integrate the manufacturing of components we purchase, further reducing our costs of goods sold.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us 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, we evaluate our estimates, including those related to contractual allowances, doubtful accounts, inventories, rebates, product returns, warranty obligations, income taxes, intangibles and investments. We base our 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.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements and this discussion and analysis of our financial condition and results of operations:

Provision for Contractual Allowances and Doubtful Accounts. We maintain provisions for contractual allowances for reimbursement amounts from our third-party payor customers based on negotiated contracts and historical experience for non-contracted payors. We also maintain provisions for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We have contracts with certain third-party payors for our third-party reimbursement billings, which call for specified reductions in reimbursement of billed amounts based upon contractual reimbursement rates. In 2003, we recorded contractual allowances related to our third-party payor revenues of 22% to 33% of gross billed charges to third-party payors. Our contractual allowances percentages increased in mid-2003 following increases in our current gross price levels. In the first six months of 2004, we have recorded contractual allowances of approximately 27% - 39% of gross billed charges, which has increased from the prior year partly due to increases in our gross billed charge levels and partly due to the impact of a new Medicare reimbursement code for certain of our fracture boot products. For those sales of our Regentek products that are subject to third party reimbursement, we record revenue net of actual contractual allowances and discounts from our gross prices, which are determined on a specific identification basis and amount to approximately 23% to 24% of our gross prices.

Our reserve for doubtful accounts is based upon estimated losses from customers who are billed directly and the portion of third-party reimbursement billings that ultimately become the financial responsibility of the end user patients. Direct-billed customers represented approximately 56% of our net accounts receivable at June 26, 2004 and December 31, 2003 and we have historically experienced write-offs of less than 2% of these accounts receivable. Our third-party reimbursement customers include all of the customers of our OfficeCare business segment, the majority of customers of our Regentek business segment and certain third-party payor customers of our DonJoy business segment, including insurance companies, managed care companies and certain governmental payors such as Medicare. Our third-party payor customers represented approximately 31% and 17% of our net revenue for the three months ended June 26, 2004 and June 28, 2003, respectively, and approximately 30% and 33% of our net revenues for the six months ended June 26, 2004 and June 28, 2003, respectively, and 44% of our net accounts receivable at both June 26, 2004 and December 31, 2003. We estimate bad debt expense to be approximately 5 - 8% of gross revenues from these third-party reimbursement customers in 2004, based on our experience in 2003. If the financial condition of our customers were to deteriorate resulting in an impairment of their ability to make payments or if third-party payors were to deny claims for late filings, incomplete information or other reasons, additional provisions may be required.

Historically, we have relied heavily on third-party billing service providers to provide information about the accounts receivable of our third-party payor customers, including the data utilized to determine reserves for contractual allowances and doubtful accounts. We also continue to enhance our ability to analyze historical information, resolve issues related to our accounts receivable, and reduce our aging. Based on information currently available to us, we believe we have provided adequate reserves for our third-party payor accounts receivable. If claims are denied, or amounts are otherwise not paid in excess of our estimates, the recoverability of our net accounts receivable could be reduced by a material amount. In addition, if our third-party insurance billing service provider is not successful in collecting amounts greater than or equal to our estimates, we may be required to increase our reserve estimate by a material amount.

Reserve for Excess and Obsolete Inventories. We provide reserves for estimated excess or obsolete inventories equal to the amounts by which the cost of inventories on hand plus future purchase commitments exceed estimated market value based upon assumptions about future demand. If future demand is less favorable than currently projected by management, additional inventory write-downs may be required. In addition, reserves for inventories on hand in our OfficeCare locations are provided based on historical shrinkage rates of approximately 17% - 18%. If actual shrinkage rates differ from our estimated shrinkage rates, revisions to the reserves may be required. We also provide reserves for newer product inventories, as appropriate, based on any minimum purchase commitments and the current status of any FDA approval process, if required, and our level of sales of the new products.

Rebates. We record estimated reductions to revenues for customer rebate programs and national account administration fees based upon historical experience and estimated revenue levels. We offer certain of our distributors rebates based on sales volume, sales growth and to reimburse the distributor for certain discounts.

Returns and Warranties. We provide reserves for the estimated cost of returns and product warranties at the time revenue is recognized based on historical trends. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our suppliers, our actual returns and warranty costs could differ from our estimates. If actual product returns, failure rates, material usage or service costs differ from our estimates, revisions to the estimated return and/or warranty liabilities may be required.

Valuation Allowance for Deferred Tax Asset.As of June 26, 2004, we have approximately $56.7 million of net deferred tax assets on our balance sheet related primarily to tax deductible goodwill arising in connection with the Regentek acquisition and in

connection with our reorganization in 2001 and not amortized for book purposes. Realization of our deferred tax assets is dependent on our ability to generate approximately $153.7 million of future taxable income over the next 15 years. Our management believes that it is more likely than not that the deferred tax assets will be realized based on forecasted future taxable income. However, there can be no assurance that we will meet our expectations of future taxable income. Management will evaluate the realizability of the deferred tax assets on a quarterly basis to assess any need for valuation allowances.

Goodwill and Other Intangibles.In 2002, Statement of Financial Accounting Standards No. 142, or SFAS No. 142, Goodwill and Other Intangible Assetsbecame effective and as a result, we ceased amortization of goodwill. In lieu of amortization, we are required to perform an annual review for impairment. Goodwill is considered to be impaired if we determine that the carrying value of the segment or reporting unit exceeds its fair value. At October 1, 2003, our goodwill was evaluated for impairment and we determined that no impairment existed at that date and subsequent to that date there have been no indicators of impairment.

At December 31, 2003, our other intangible assets were evaluated for impairment as required by SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. The determination of the fair value of certain acquired assets and liabilities is subjective in nature and often involves the use of significant estimates and assumptions. Determining the fair values and useful lives of intangible assets requires the exercise of judgment. Upon initially recording certain of our other intangible assets, including the intangible assets that were acquired in connection with the Regentek acquisition, we used independent valuation firms to assist us in determining the appropriate values for these assets. Subsequently, we have used the same methodology and updated our assumptions. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets acquired, we primarily used the undiscounted cash flows expected to result from the use of the assets. This method requires significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required such as residual growth rates and discount factors. The estimates we have used are consistent with the plans and estimates that we use to manage our business and are based on available historical information and industry averages.

The value of our goodwill and other intangible assets is exposed to impairments if we experience declines in operating results, if additional negative industry or economic trends occur, or if our future performance is below our projections or estimates.

Results of Operations

We operate our business on a manufacturing calendar, with our fiscal year always ending on December 31. Each quarter is 13 weeks, consisting of one five-week and two four-week periods. Our first and fourth quarters may have more or less operating days from year to year based on the days of the week on which holidays and December 31 fall.

In November 2003, we acquired the operations of Regentek. The results of Regentek's operations are included in the consolidated results of operations for the entire three and six months ended June 26, 2004; however, for comparative purposes we have included pro forma financial information for the three and six months ended June 28, 2003 as if Regentek was acquired as of January 1, 2003. Management uses the pro forma information presented to evaluate and manage operations. We are providing this information to allow for additional financial analysis of our results of operations.

Three Months Ended June 26, 2004 Compared To Three Months Ended June 28, 2003

Net Revenues. Set forth below are net revenues, in total and on a per day basis, for our reporting segments (in thousands):

Net revenues:

                                                                                                              Pro Forma
                                                     Three months ended                                  Three months ended
                           June 26,       % of Net    June 28,     % of Net                    %        June 28,     % of Net
                             2004         Revenues      2003       Revenues    Increase     Increase      2003       Revenues
DonJoy                   $      23,864        37.8    $  23,192        48.9    $     672         2.9    $  23,192        39.3
ProCare                         12,534        19.8       11,659        24.6          875         7.5       11,659        19.8
Regentek                        12,705        20.1            -           -       12,705         N/A       11,522        19.5
OfficeCare                       6,903        10.9        6,005        12.7          898        15.0        6,005        10.2
International                    7,180        11.4        6,564        13.8          616         9.4        6,564        11.2
Consolidated net
revenues                 $      63,186       100.0    $  47,420       100.0    $  15,766        33.2    $  58,942       100.0

Average revenues per day:

                                                                                  Pro Forma
                                                                                Three months
                                Three months ended                                  ended
                               June 26,     June 28,                    %         June 28,
                                 2004         2003       Increase    Increase       2003
DonJoy                        $    372.9   $    362.4   $     10.5        2.9   $       362.4
ProCare                            195.8        182.2         13.6        7.5           182.2
Regentek                           198.5            -        198.5        N/A           180.0
OfficeCare                         107.9         93.8         14.1       15.0            93.8
International                      112.1        102.5          9.6        9.4           102.5
Consolidated average net
revenues per day              $    987.2   $    740.9   $    246.3       33.2   $       920.9
Number of operating days              64           64

Net revenues in our DonJoy segment increased in the second quarter, but our second quarter comparative growth rate in this segment was impacted by stronger than expected growth in the first quarter. Our sales increased in several product lines, primarily our rigid knee braces and soft goods, driven by strong sales of our recently introduced new products. Net revenues in our ProCare segment increased due to continued growth associated with our new national . . .