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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

                For the fiscal year ended December 31, 2002

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

Commission File Number 0-28240

EXACTECH, INC.

(Exact name of registrant as specified in its charter)

2320 NW 66TH COURT
GAINESVILLE, FL
32653
(Address of principal executive offices)

(352) 377-1140
(Registrant’s telephone number, including area code)

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

None.

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
(Title of Class)

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 x No o

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2 of the Act).
Yes o No o

As of March 21, 2003, the number of shares of the registrant’s Common Stock outstanding was 10,942,280. The aggregate market value of the Common Stock held by non-affiliates of the registrant as of June 30, 2002 was approximately $44,079,746 based on a closing sale price of $7.66 for the Common Stock as reported on the NASDAQ National Market System on such date. For purposes of the foregoing computation, all executive officers, directors and 5 percent beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such executive officers, directors or 5 percent beneficial owners are, in fact, affiliates of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III (Items 10, 11, 12 and 13) is incorporated by reference from the registrant’s definitive proxy statement for its 2003 Annual Meeting of Shareholders (to be filed pursuant to Regulation 14A).

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TABLE OF CONTENTS
and
CROSS REFERENCE SHEET

CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS

This report contain various “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company’s expectations or beliefs concerning future events, including, but not limited to, statements regarding growth in sales of the Company’s products, profit margins and the sufficiency of the Company’s cash flow for its future liquidity and capital resource needs. These forward looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward looking statements. These factors include, without limitation, the effect of competitive pricing, the Company’s dependence on the ability of its third-party manufacturers to produce components on a basis which is cost-effective to the Company, market acceptance of the Company’s products, the outcome of arbitration and litigation, and the effects of governmental regulation. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors.

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PART I

ITEM 1.          BUSINESS

Exactech, Inc. (the “Company”, or “Exactech”) develops, manufactures, markets and sells orthopaedic implant devices, related surgical instrumentation, and distributes biologic materials to hospitals and physicians in the United States and overseas. The Company was founded by an orthopaedic surgeon in November 1985, and is incorporated under the laws of the State of Florida. The Company’s revenues are principally derived from sales of its knee and hip replacement systems. The Company’s Optetrak^® knee replacement system was conceived and designed in collaboration with the Hospital for Special Surgery, an internationally known hospital for orthopaedic surgery. During 1999 and 2000, the Company introduced its comprehensive AcuMatch^® integrated hip system and began full United States distribution of Opteform^®, a bone allograft material, under a distribution agreement with Regeneration Technologies, Inc. (“RTI”). During 2001, the Company began distribution of a bone cement system, Cemex^®, under an exclusive distribution agreement with Italian manufacturer Tecres, S.p.A. In the first quarter of 2002, the Company entered into a distribution agreement with Link America, Inc. and its parent company, Waldemar Link GmbH & Co. (“Link”), a German manufacturer of joint replacement systems, to distribute Link’s orthopaedic products in the United States. Link implants compliment the Company’s total joint systems by expanding clinical indications beyond the design scope of the Company’s products. Late in 2002, the Company acquired the inventory and intellectual property related to a patented total shoulder system from Teknimed, a French manufacturer.

Available Information

The Company’s Internet website address is www.exac.com. The Company makes available free of charge on or through its website its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after the Company electronically files such material with, or furnishes such material to, the Securities and Exchange Commission. These reports may be found at http://www.exac.com/company3.htm by selecting the option entitled “SEC FILINGS” in “News-Investor Information”. The Company does not intend for information contained in its web site to be part of this Form 10-K.

Orthopaedic Products Industry

According to The Medical and Healthcare Marketplace Guide 2002-2003, published by Dorland Healthcare Information, the worldwide market for orthopaedic products was nearly $15 billion in 2001, which represented an increase of 13% from 2000. The three market segments in which the Company offers its products and services, reconstructive devices, biologics and other orthopaedic products, experienced 12%, 13% and 9% growth, respectively, during 2001 when compared to 2000. In 2001, the United States market for reconstructive products was $2.8 billion, and the international market was $2.6 billion. The market for biologics (which includes bone graft substitutes, allograft distribution and processing and other tissue based products and services) was $900 million in the United States and $300 million internationally in 2001. Other orthopaedic products, including power equipment, cement and cement delivery systems, experienced United States sales of $2.3 billion and international sales of $1.0 billion in 2001.

Management believes that the industry will continue to grow due to the changing demographics of an aging population in much of the world. Increasing life spans impact the number of individuals with joints subject to failure, thereby increasing demand for joint replacement procedures. In 2001, more than 1.5 million joint replacement procedures were performed. Sixty percent of these were in persons over the age of 65. This age group is expected to grow at three times the rate of the overall population. Additionally, earlier generations of implanted joint replacement prostheses have begun to reach their maximum life and are beginning to fail, resulting in increasing demand for revision procedures.

Products

The Company’s orthopaedic implant products are used to replace joints that have deteriorated as a result of injury or diseases such as arthritis. Reconstructive joint surgery involves the modification of the area surrounding the affected joint and the insertion of a set of manufactured implant components to replace or augment the joint. During the surgery, the surgeon removes damaged cartilage and a portion of the bones that comprise the joint, prepares the remaining bone surfaces and surrounding tissue and then installs the implant. When indicated, the surgeon uses biologic allograft materials to repair bone defects and provide an interface to

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stimulate new bone growth. In many joint replacement procedures, bone cement is used to affix implant components to the prepared bone surfaces. For a table setting forth the net revenue and percentage of net sales for each of the Company’s product lines, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Knee Implants. The Company believes that its Optetrak^® knee system represents a major advance in knee implant design. The Optetrak^® knee system is a modular system designed to improve patellar tracking (the movement of the knee cap), reduce articular contact stress (the force between surfaces in a joint) that leads to implant failure, and provide a functional range of motion. Laboratory testing performed by the Company and clinical testing performed by the Company’s design team members has demonstrated that the system produces substantially lower articular contact stress and improved patellar tracking compared to other knee implant systems.

The Optetrak^® system includes a total primary knee replacement system which is available with either a cruciate ligament sparing femoral components (in both cemented and porous coated designs and used in situations where the surgeon chooses to maintain certain ligaments) or a posterior stabilized femoral component (in both cemented and porous coated designs and used in situations where the surgeon chooses to eliminate certain ligaments). The Optetrak^® system also includes a constrained total knee system for revision surgery and primary surgery with severe deformities. The constrained version includes two types of femoral components: the constrained condylar modular femoral component and a constrained non-modular femoral component. The modular component includes stem and block augmentation to aid in repairing damaged or weakened bone. The constrained condylar femoral component was designed to provide greater constraint between the tibial and femoral components of the system to compensate for ligaments weakened or lost due to disease or as a result of failure of previous treatments.

In March, 2002, the Company commenced distributing Link’s line of implant products which includes the Link^®Endo-Model^TM Rotational Knee, designed to provide stability with controlled rotation for severe joint deterioration with insufficient ligament support and the Link^® Endo-Model^TM Sled Uni-Knee, designed for cases where only a portion of a joint warrants replacement.

Hip Implants. The Company’s line of hip implant products includes three total hip implant systems. The flagship hip product line is the AcuMatch^® comprehensive hip system which is designed to address the vast majority of indications for total hip replacement, including primary and revision needs. The system includes the C-Series cemented femoral stem, the A-Series acetabular components (for the hip socket), the P-Series press-fit femoral stem system, the M-Series modular femoral stem system, the L-Series femoral stem system, bipolar and unipolar partial hip replacement components, a variety of femoral heads and a cemented acetabular component. The AcuMatch^® cemented revision components include revision long stems and calcar replacement stems that were originally part of the AuRA^® Revision Hip System. The Company continues to market its Opteon^® Cemented Stem System, a moderate demand femoral stem system.

The Company’s AcuMatch^® C-Series Cemented Femoral Stem is a forged cobalt chromium stem designed to improve stability and reduce dislocation complications by improving the head/neck ratio and restoring anatomic offset for patients requiring cemented total hip arthroplasty (joint reconstructive surgery). The AcuMatch^® A-Series was designed to provide a comprehensive acetabular offering with maximum polyethylene thickness to help in reducing polyethylene wear debris. The M-Series modular stem system offers completely interchangeable components to optimize fit and enable surgeons to address limb length and offset challenges without adjusting femoral head or diaphyseal stem size. The AcuMatch^® P-Series Press Fit Femoral Stem System has multiple coating options for fixation to bone and features a scientifically sound solution to stiffness mismatch and rotational instability in the bone, potential underlying causes of post-operative residual thigh pain. The AcuMatch^® L-Series hip system features a comprehensive offering of both cemented and press fit femoral components, as well as unipolar and bipolar endoprotheses, prostheses often used for the treatment of hip fractures.

The Link hip implant product lines distributed by the Company include, the Link^® Saddle Prosthesis, designed to meet the surgeon’s needs when a patient’s acetabulum cannot be reconstructed, the Link SPII^® hip stem, the Classic Plus^® hip stem, the Ribbed hip stem, and the MP^TM Reconstruction hip stem, offering surgeons a broad range of options and design philosophy to meet the unique clinical needs of their patients.

Tissue Services. The Company is the exclusive, worldwide distributor of bone paste products processed by RTI for use in non-spinal musculoskeletal orthopaedic procedures. These unique allograft materials are distributed

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as Opteform^® and Optefil^®and are clinically proven for effectively repairing bone and filling bone defects. During 2002, the Company obtained the distribution rights to Optefil^® as part of the settlement of its arbitration with RTI (See Legal Proceedings).

Other Products. The AcuDriver^® Automated Osteotome System is an air-driven impact hand piece that aids surgeons during joint implant revision procedures by providing effective removal of failed prostheses and bone cement. The AcuDriver^® accomplishes this by providing the surgeon with precise positioning without the inconvenience and inconsistency of striking the osteotome with a mallet.

The Link^® S.T.A.R.^TM ankle is distributed under terms of a Food and Drug Administration (“FDA”) approved Investigational Device Exemption (“IDE”). If this product is found to be safe and effective, it should provide an alternative to fusion which maintains motion and pain relief in arthritic patients with the appropriate indications. The Company also distributes Link surgical instrumentation which can be used in various orthopaedic procedures including shoulder, knee, spine, foot, ankle and hip arthroplasty.

The Cemex^® bone cement system features a unique self-contained delivery system that has been clinically proven in Europe for more than a decade. By integrating bone cement powder and liquid into a sealed mixing system, Cemex^® is designed to offer surgeons and operating room personnel simplicity, safety and reliability in bone cement. The Company distributes Cemex^® in the United States under an exclusive distribution agreement with the Italian manufacturer, Tecres S.p.A.

Late in 2002, the Company acquired a patented total shoulder system from Teknimed, a French manufacturer of orthopaedic implants and processor of biological products. Teknimed will continue to manufacture and distribute the shoulder system in Europe for the Company while Exactech establishes appropriate manufacturing and engineering support infrastructure and receives marketing clearance from the FDA for United States distribution.

Marketing and Sales

The Company markets its orthopaedic implant products in the United States through fifty-five independent sales agencies and one domestic distributor that serve as the Company’s sales representatives. Internationally, the Company markets its products through eighteen foreign distributors that distribute products in twenty-three countries. The customers for the Company’s products are hospitals, surgeons and other physicians and clinics. These constituencies most commonly make the decisions collaboratively regarding which company’s products will be used.

The Company generally has contractual arrangements with its independent sales agencies whereby the agency is granted the exclusive right to market the Company’s products in the specified territory. In turn, the agency is required to meet sales quotas to maintain its relationship with the Company. The Company’s arrangements with its sales agencies typically do not preclude them from selling competitive products, although the Company believes that most of its agencies do not do so. The Company typically pays its sales agencies a commission based on net sales. The Company is highly dependent on the expertise and relationships of its sales agencies with customers. The Company’s sales organization is supervised by five Regional Directors of Sales (East, Central, Midwest, Southeast and West). The Company has a contractual arrangement with its domestic distributor that is similar to its arrangements with its sales agencies, except the Company does not pay the distributor commissions and the distributor purchases inventory from the Company for use in fulfilling customer orders. The Company currently offers its products in all fifty states, and the District of Columbia.

The Company provides inventories of its products to its United States sales agencies until sold or returned. These inventories are necessary for sales agents to market the Company’s products and fill customer orders. The size of the component to be used for a specific patient is typically not known with certainty until the time of surgery. Due to this uncertainty, a minimum of one size of each component in the system to be used must be available to each sales agency at the time of surgery. Accordingly, the Company is required to maintain substantial levels of inventory. The maintenance of relatively high levels of inventory requires the Company to incur significant expenditures of its resources. The failure by the Company to maintain required levels of inventory could have a material adverse effect on the Company’s expansion. As a result of the need to maintain substantial levels of inventory, the Company is subject to the risk of inventory obsolescence. In the event that a substantial portion of the Company’s inventory becomes obsolete, it would have a material adverse effect on the Company. The Company maintains a reserve for inventory due to obsolescence and slow moving items.

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During the years ended December 31, 2002, 2001 and 2000, approximately 4%, 4% and 5%, respectively, of the Company’s sales were derived from a major hospital customer. During each of the years ended December 31, 2002, 2001, and 2000, one international distributor accounted for approximately 8%, 9% and 11%, respectively, of the Company’s sales.

The Company generally has contractual arrangements with its foreign distributors pursuant to which the distributor is granted the exclusive right to market the Company’s products in the specified territory and the distributor is required to meet sales quotas to maintain its relationship with the Company. Foreign distributors typically purchase product inventory and instruments from the Company for their use in marketing and filling customer orders.

For the years ended December 31, 2002, 2001 and 2000, foreign sales accounted for $9,441,000, $8,391,000, and $7,582,000, respectively, representing approximately 16%, 18% and 18%, respectively, of the Company’s sales. Although, international sales continued to rise in 2002, the total percentage of sales represented by international activity decreased primarily due to the impact of U.S. only distribution agreements for Link and Cemex products. The Company intends to continue to expand its sales in foreign markets in which there is increasing demand for orthopaedic implant products.

Manufacturing and Supply

Early in its history, the Company utilized third-party vendors for the manufacture of all of its component parts, while internally performing product design, quality assurance and packaging. At present, the Company manufactures approximately 30% of its components in its manufacturing and headquarters facility in Gainesville, Florida. The Company has continued to increase the number of internally manufactured components. With the increase of internal manufacturing, the Company has experienced a greater degree of control of production costs, and it expects this trend to continue. The Company continually assesses the manufacturing capabilities and cost-effectiveness of its existing and potential vendors in its attempts to secure its supply chain and decrease dependency on a few suppliers. For the years ended December 31, 2002, 2001 and 2001, the Company purchased approximately 69%, 59% and 69%, respectively, of its externally sourced component requirements from its top three manufacturers. The Company does not maintain supply contracts with any of its manufacturers and purchases components pursuant to purchase orders placed from time to time in the ordinary course of business. The Company has several alternative sources for components and does not anticipate that it will encounter problems in obtaining adequate supplies of components. Certain tooling and equipment which are unique to the Company’s products are supplied by the Company to its vendors.

The Company’s internal manufacturing, assembly, packaging and quality control operations are conducted at its principal offices in Gainesville, Florida. Components received from its vendors are examined by Company personnel prior to assembly or packaging to ensure that the Company’s specifications and standards are maintained.

Patents and Proprietary Technology; License and Consulting Agreements

The Company holds United States patents covering several of its implant components and some of its surgical instrumentation. The Company believes that patents and intellectual property will continue to be important in the orthopaedic industry. In this regard, the Company defends its intellectual property rights and believes that its patents and products do not and will not infringe patents or violate proprietary rights of others, although it is possible that its existing patent rights may not be valid or that infringement of existing or future patents or proprietary rights may occur. In the event certain of the Company’s intellectual property and agreements relating to its knee and hip implant products are deemed invalid, such action could have a material adverse effect on the Company’s financial position and results of operations.

In connection with the development of its knee implant systems, the Company had entered into consulting agreements with Dr. William Petty and Dr. Gary J. Miller, who are executive officers, directors and principal shareholders of the Company. Pursuant to these consulting agreements, such individuals agreed to provide consulting services to the Company in connection with evaluating the design of knee implantation systems and associated instrumentation and are entitled to receive royalties during the term of the agreements. The consulting agreements were terminated pursuant to employment agreements entered into in May 1996 between the Company and each of Drs. Petty and Miller. New employment agreements entered into between the Company and each of Drs. Petty and Miller on January 1, 2003 provide for the continuation by the Company of the royalty payments required

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under these consulting agreements.

The Company has entered into a consulting agreement with Albert Burstein, Ph.D., a director of the Company, to provide services regarding many facets of the orthopaedic industry including product design rationale, manufacturing and development techniques and product sales and marketing. During the year ended December 31, 2002, the Company paid Dr. Burstein $135,000 as compensation under this consulting agreement.

Research and Development

During the years ended December 31, 2002, 2001 and 2000, the Company expended $2,803,000, $2,210,000 and $2,138,000, respectively, on research and development and anticipates that research and development expenses will continue to increase. The Company’s research and development efforts contributed to the successful integration of the AcuMatch^® hip systems, line extensions of the Optetrak^® knee system and design improvements targeted to improving internal manufacturing efficiency. The Company’s research and development efforts continue to focus on implant product line extensions, advanced biologic materials, extremity joint reconstruction and alternative bearing surfaces.

As an important part of its research and development efforts, the Company has developed strategic partnerships through agreements with Genzyme Biosurgery and Diamicron Corporation to bring expertise in advanced materials to the Company’s products. The agreement with Genzyme is for the development of polymer-based synthetic biomaterials that when delivered with other biologic products support the growth of new bone. Through its agreement with Diamicron, the Company will apply Diamicron’s polycrystalline diamond compact (PDC) technology to its hip implants. This diamond technology holds the promise of improved mechanical and wear characteristics over currently available technology. This technology will likely require a number of years of development and regulatory clearance prior to the release of products for sale.

The Company believes that the purchase of intellectual property and product line assets augmented by additional development provides a cost-effective and efficient way to bring products to market and expects to continue to do so in the future to complement its internal product development.

Competition

The orthopaedic industry is highly competitive and dominated by a number of large companies with substantially greater financial and other resources than the Company. The largest competitors in the orthopaedic market are DePuy, Inc., a division of Johnson and Johnson, Zimmer, Inc., a subsidiary of Zimmer Holdings, Inc., Stryker Howmedica Osteonics, a subsidiary of Stryker Corp., Smith and Nephew plc, Sulzer Orthopaedics, Inc., a subsidiary of Centerpulse AG (formerly Sulzer Medica AG), and Biomet Orthopaedics, a subsidiary of Biomet, Inc. These six companies, according to The Medical and Healthcare Marketplace Guide 2002-2003, had an estimated aggregate market share of approximately 85% in 2001.

Companies in the industry compete on the basis of product features and design, innovation, service, the ability to maintain new product flow, relationships with key orthopaedic surgeons and hospitals, the strength of their distribution network and price. While price is a key factor in the orthopaedic market, there are other significant factors, including: surgeon preference, ease of use, clinical results, and service provided by the company and its representatives. Due to health care reform, the rapid expansion of managed care at the expense of traditional private insurance and the advent of hospital buying groups, management believes that the price of the Company’s orthopaedic implant products will continue to become a more important competitive factor. Manufacturers of medical devices, including orthopaedic implants, are increasingly attempting to enter into contracts with hospital chains or hospitals pursuant to which the hospital chains or hospitals agree to purchase their products exclusively from such manufacturers, usually in exchange for discounted prices. If the Company’s competitors are successful in securing such contracts, the Company’s ability to compete may be materially adversely affected. Although to date generic products have not been a significant factor in the orthopaedic implant market, price may become even more important if suppliers of generic products enter the market on a larger scale.

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Product Liability and Insurance

The Company is subject to potential product liability risks which are inherent in the design, marketing and sale of orthopaedic implants and surgical instrumentation. The Company has implemented strict quality control measures and currently maintains product liability insurance in amounts which it believes are typical in the industry for similar companies. During 2002, the Company experienced substantial increases in insurance premiums primarily due to the conditions of the insurance market in general and specifically the medical device insurance market. The Company is currently evaluating its levels of product liability insurance, as well as the amount of retention carried compared to other companies in the industry. Due to the volatility of the insurance marketplace, the value of the product liability insurance products delivered and the decreasing number of providers of these products, there can be no guarantees as to whether the Company will elect or be able to secure such coverage in the future.

Government Regulation

The Company’s operations and relationships are subject to government regulation in the United States and other countries in which it distributes its products and services. The primary regulatory authority in the United States is the FDA. The development, testing, labeling, distribution, marketing and manufacture of medical devices, including reconstructive devices, are regulated under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act (the “Amendments”) and additional regulations promulgated by FDA. In general, these statutes and regulations require that manufacturers adhere to certain standards designed to ensure the safety and effectiveness of medical devices.

Under the Amendments, each medical device manufacturer must be a “registered device manufacturer” and must comply with regulations applicable generally to labeling, quality assurance, manufacturing practices and clinical investigations involving humans. FDA is authorized to obtain and inspect devices, their labeling and advertising, and the facilities in which they are manufactured in order to assure that a device is not improperly manufactured or labeled. The Company is registered with FDA and believes that it is in substantial compliance with all applicable material governmental regulations.

The Company is required to obtain various licenses and permits from foreign governments and to comply with significant regulations that vary by country in order to market its products in foreign markets. In order to continue marketing its products in Europe after mid-1998, the Company was required to obtain ISO 9001 certification and receive “CE” mark certification, an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. The ISO 9001 certification is one of the prerequisites for CE mark certification. The Company received both ISO 9001 and CE mark certification in May 1998, and is required to undergo an annual quality system audit to maintain its certification.

Employees

As of December 31, 2002, the Company employed 133 full time employees. The Company has no union contracts and believes that its relationship with its employees is good.

Executive Officers of the Registrant

The executive officers of the Company, and their ages as of March 6, 2003, are as follows:

William Petty, M.D. was a founder and has been Chairman of the Board and Chief Executive Officer of the Company since its inception. Dr. Petty also became President of the Company upon the departure of former president Timothy Seese on January 31, 2002. Dr. Petty was a Professor at the University of Florida College of Medicine from July 1975 to September 1998. Dr. Petty also served as Chairman of the Department of Orthopaedic

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Surgery at the University of Florida College of Medicine from July 1981 to January 1996. Dr. Petty has served as a member of the Hospital Board of Shands Hospital, Gainesville, Florida, as an examiner for the American Board of Orthopaedic Surgery, as a member of the Orthopaedic Residency Review Committee of the American Medical Association, on the Editorial Board of the Journal of Bone and Joint Surgery, and on the Executive Board of the American Academy of Orthopaedic Surgeons. He holds the Kappa Delta Award for Outstanding Research from the American Academy of Orthopaedic Surgeons. His book, Total Joint Replacement, was published in 1991. Dr. Petty received his B.S., M.S., and M.D. degrees from the University of Arkansas. He completed his residency in Orthopaedic Surgery at the Mayo Clinic in Rochester, Minnesota.

Gary J. Miller, Ph.D. was a founder and has been Executive Vice President, Research and Development of the Company since February 2000. He was Vice President, Research and Development from 1986 until 2000 and has been a Director since March 1989. Dr. Miller was Associate Professor of Orthopaedic Surgery and Director of Research and Biomechanics at the University of Florida College of Medicine from July 1986 until August 1996. Dr. Miller received his B.S. from the University of Florida, his M.S. (Biomechanics) from the Massachusetts Institute of Technology, and his Ph.D. in Mechanical Engineering (Biomechanics) from the University of Florida. He has held an Adjunct Associate Professorship in the College of Veterinary Medicine’s Small Animal Surgical Sciences Division since 1982 and was appointed as an Adjunct Associate Professor in the Department of Aerospace, Mechanics and Engineering Sciences in 1995. He was a consultant to the FDA from 1989 to 1992 and has served as a consultant to such companies as Johnson & Johnson Orthopaedics, Dow-Corning Wright and Orthogenesis.

David W. Petty has been Executive Vice President, Sales and Marketing since February 2000. He has been employed by the Company in successive capacities in the areas of Operations and Sales and Marketing for the past thirteen years, serving as Vice President, Operations from April 1991 until April 1993 and Vice President, Marketing from 1993 until 2000. He also served as a Director from March of 1989 until March 1996. He was appointed to the Board of Directors on January 31, 2002 to fill the vacancy created by the resignation of Timothy Seese and was elected to the Board in May 2002. Mr. Petty received his B.A. from the University of Virginia in 1988 and completed The Executive Program of the Darden School of Business in 1999. He is the son of Dr. and Ms. Petty.

Joel C. Phillips, CPA has been Chief Financial Officer of the Company since July 1998 and Treasurer since March 1996. Mr. Phillips was Manager, Accounting and Management Information Systems from April 1993 to June 1998. From January 1991 to April 1993, Mr. Phillips was employed by Arthur Andersen. Mr. Phillips received a B.S. and a Masters in Accounting from the University of Florida and is a certified public accountant.

Betty Petty was a founder and has been Vice President, Human Resources and Administration since February 2000. She has also been Secretary of the Corporation since its inception and served as Treasurer and a Director until March 1996. Ms. Petty served in the dual capacities of Human Resources Coordinator and Director of Marketing Communications from the founding of the Company until 2000. She received her B.A. from the University of Arkansas at Little Rock and her M.A. in English from Vanderbilt University. Ms. Petty is the wife of Dr. Petty.

The Company’s officers are elected annually by the Board of Directors and serve at the discretion of the Board.

ITEM 2.          PROPERTIES

The Company’s principal executive offices, research and development laboratories and manufacturing facility is a 39,000 square foot building on approximately eight acres of land owned by it in Gainesville, Florida. In 2002, the Company began a project to expand its principal facility by constructing a 37,000 square foot addition. The expansion is expected to be complete by June 30, 2003. The Company leases a 9,500 square foot distribution facility in Gainesville, Florida. The lease is for an initial term of three years at an annual rate of $42,000, expiring July 31, 2003. The Company owns approximately four and one half acres of land nearby to its existing facility in Gainesville, Florida for future expansion requirements.

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ITEM 3.          LEGAL PROCEEDINGS

The Company had been a party to an arbitration proceeding with Regeneration Technologies, Inc. (“RTI”) with respect to its agreement with RTI for the distribution of a bone grafting material technology. On September 23, 2002, the Company settled the dispute with RTI and entered into a new distribution agreement as exclusive distributor for bone paste products processed by RTI for non-spinal musculoskeletal orthopaedic procedures. The settlement agreement calls for RTI to pay the Company $1.5 million in damages in quarterly installments over a period of one and one-half years from the date of the agreement. As of December 31, 2002, the Company has received $438,000 of the settlement from RTI, net of costs of $62,000.

On December 16, 2002, Centerpulse Orthopedics, Inc. filed a lawsuit in the Civil Court in the Eighth Judicial Circuit, Alachua County, Florida, against the Company and one of the Company’s employees. The complaint filed in this action seeks damages in an undisclosed amount alleging that the Company’s employee who is a former employee of Centerpulse, breached a noncompete and confidentiality agreement, and that the Company is liable for tortious interference with that agreement. The Company has filed a response and intends to vigorously defend against all allegations made in the complaint. The Company believes the suit is without merit; however, the Company is unable to predict the outcome of the litigation.

There are various other claims, lawsuits, disputes with third parties and pending actions involving various allegations against the Company incident to the operation of its business, principally product liability cases. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be resolved unfavorably to the Company. The Company, based on the advice of counsel, does not anticipate that the adverse outcome of these matters will have a material adverse effect on the Company, its results of operations, financial position or its future business operations. The Company establishes accruals for losses that are deemed to be probable and subject to reasonable estimate.

The Company’s insurance policies covering product liability claims must be renewed annually. Although the Company has been able to obtain insurance coverage concerning product liability claims at a cost and on other terms and conditions that are acceptable to the Company, the Company may not be able to procure acceptable policies in the future.

ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the Company’s security holders during the fourth quarter of the fiscal year ended December 31, 2002.

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PART II

ITEM 5.          MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company’s Common Stock trades on the Nasdaq National Market under the symbol “EXAC”. The following table sets forth, for the periods indicated, the high and low sales price of the Common Stock, as reported on the Nasdaq National Market.

On January 29, 2003, the Company announced a two-for-one split of its Common Stock (the “stock split”). The stock split was effective February 28, 2003 for all common shareholders of record as of February 14, 2003. The share prices in the following table have been adjusted to reflect the stock split:

No cash dividends have been paid to date by the Company on its Common Stock. The Company intends to retain all future earnings for the operation and expansion of its business and does not anticipate the payment of cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will depend upon a number of factors, including future earnings, results of operations, capital requirements, the Company’s financial condition and any restrictions under credit agreements existing from time to time, as well as such other factors as the Board of Directors may deem relevant.

As of March 14, 2003, the Company had approximately 211 shareholders of record. There are in excess of 2,533 beneficial owners of the Company’s Common Stock.

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ITEM 6.          SELECTED FINANCIAL DATA

The selected financial data set forth below has been derived from the audited financial statements of the Company. This data should be read in conjunction with the financial statements, the notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.

   (1)    Earnings per share have been adjusted to reflect the two-for-one stock split effective February 28, 2003.

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ITEM 7.          MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The following discussion should be read in conjunction with the financial statements and related notes appearing elsewhere herein.

The Company develops, manufactures, markets and sells orthopaedic implant devices, related surgical instrumentation, and distributes biologic materials to hospitals and physicians in the United States and overseas.

Early in its history, the Company’s revenues were principally derived from sales of its primary hip replacement systems. Currently, however, the Company’s revenues are principally derived from sales of its knee and hip replacement systems. During 2002, 57% of the Company’s revenues were derived from sales of knee replacement systems while 24% of the Company’s revenues were derived from sales of hip replacement systems. In addition, the Company derives revenues from worldwide distribution of bone paste products processed for use in non-spinal musculoskeletal orthopaedic procedures. During 2002, 12% of the Company’s revenues were derived from distribution of bone paste products.

In 2001, the Company began distributing a unique bone cement system, Cemex^®, under an exclusive agreement with Italian manufacturer, Tecres S.p.A. The Cemex bone cement system features a self-contained delivery system that has been clinically proven in Europe for more than a decade. By integrating bone cement powder and liquid into a sealed mixing system, Cemex is designed to offer surgeons and operating room personnel simplicity, safety and reliability in bone cement.

In March 2002, the Company entered into a distribution agreement with Link, a German manufacturer of joint replacement systems, to distribute Link’s orthopaedics products in the United States. Link implants are complimentary to the Company’s total joint systems by addressing clinical indications outside the scope of the Company’s product design.

Late in 2002, the Company acquired all of the inventory and intellectual property of Teknimed, a French manufacturer that related to Teknimed’s patented total shoulder system.

To market orthopaedic implant products in the United States, Exactech utilizes a network of independent agencies and domestic distributors that act as the Company’s sales representatives. Internationally, the Company’s products are marketed through distributors.

The following two tables include (i) the net revenue and percentage of net sales for each of the Company’s product lines for the years ended December 31, 2002, 2001 and 2000 and (ii) items from the Statements of Income for the years ended December 31, 2002, 2001, and 2000, the percentage relationship to net sales and the percentage change from year to year:

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Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Net sales increased by 27% to $59,302,000 in 2002 from $46,599,000 in 2001. Worldwide sales of knee implant systems increased by 19% to $33,576,000 in 2002 from $28,214,000 in 2001. The systems contributing to this growth include the Optetrak^® comprehensive knee system and the Link^® Endo-Model™ Rotational Knee. Worldwide sales of hip implant systems increased 37% to $14,287,000 in 2002 from $10,433,000 in 2001. The hip systems contributing to this increase include the AcuMatch^® integrated hip system as well as the Link hip products. Worldwide service revenue from distribution of Opteform^® tissue increased 38% to $7,243,000 in 2002 from $5,252,000 in 2001. Sales and rental of surgical instrumentation, including the AcuDriver^® Automated Osteotome System, increased 18% to $1,912,000 in 2002 from $1,624,000 in 2001. Sales of other products increased 112% to $2,284,000 in 2002 from $1,076,000 in 2001. Sales of other products include distribution of bone cement, various instruments and supplies under the Link distribution agreement, a limited distribution of bone plates and screws for trauma procedures and limited distribution of the Link S.T.A.R. ankle system.

Domestic sales revenue increased 31% to $49,861,000 in 2002 from $38,208,000 in 2001. This increase was driven by the expansion of the Company’s distribution network, in part related to the distribution agreements with Link and RTI. International sales revenue increased 13% to $9,441,000 in 2002, representing 16% of net sales revenue, from $8,391,000 in 2001, representing 18% of net sales revenue, primarily as a result of strong growth in southern Europe and expanded distribution overseas through the addition of three international distributors.

Gross profit increased 31% to $39,724,000 in 2002 from $30,333,000 in 2001. The gross profit margin increased to 67.0% in 2002 from 65.1% in 2001. The growth in gross profit margin is attributable to improved manufacturing efficiencies achieved through internal manufacturing processes and realization of one-time net revenue of approximately $1,127,000 on licensed tissue services distributed by RTI as part of the arbitration settlement agreement. Included in gross profit is a loss on disposal of assets, which increased to $289,000 in 2002 from $79,000 in 2001 as a result of the retirement of older surgical instrumentation. The Company expects that gross profit margins in 2003 will be between the 2001 and 2002 levels.

Sales and marketing expenses increased 36% to $17,616,000 in 2002 from $12,977,000 in 2001. This increase is primarily attributable to increases in variable selling costs associated with sales growth, such as commissions paid to the Company’s independent agents for servicing surgeon and hospital accounts. As a percentage of sales, sales and marketing expenses were 29.7% in 2002 as compared to 27.9% in 2001. Factors contributing to this increase were marketing initiatives in the area of targeted market development campaigns, distribution network expansion efforts and the assumption of distribution of the Link Orthopaedics products in March 2002. The Company expects that sales and marketing expenses will remain constant as a percentage of sales in 2003 as the Company continues to invest in expansion of the sales and marketing network as well as target marketing programs.

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General and administrative expenses increased 28% to $6,119,000 in 2002 from $4,765,000 in 2001. The increase was primarily a result of increases in product liability insurance premiums and costs associated with distribution of Link’s Orthopaedics products. As a percentage of sales, general and administrative expenses were 10.3% in 2002 as compared to 10.2% in 2001. General and administrative expenses remained relatively constant, as a percentage of sales, because the reduction in legal expenses in 2002 as a result of the arbitration settlement with RTI was offset by the increases in product liability insurance. The Company expects a small reduction in general and administrative expenses as a percentage of sales in 2003, although the achievement of that reduction will be largely dependent on the cost of product liability insurance premium renewals and legal expenses which traditionally have been difficult to estimate.

Research and development expenses increased 27% to $2,803,000 in 2002 from $2,210,000 in 2001. As a percentage of sales, research and development expenses remained constant at 4.7% in 2002 and 2001. The dollar increase in research and development expenses was a result of the Company’s continuing efforts in developing new product technologies, product line extensions and clinical outcomes research, while maintaining development funding at a level supported by top line sales growth. The Company expects an increase in research and development expenses of up to a 1% of sales in 2003 to support the hip and knee new product pipeline and the continued development of the shoulder and diamond bearing technology.

Depreciation and amortization expenses increased 11% to $2,954,000 in 2002 as compared to $2,650,000 in 2001. The increase was primarily the result of continued capital investment in surgical instrumentation in support of product line extensions and expansion of the Company’s distribution network. In 2002, the Company invested $3,173,000 in surgical instrumentation. As a percentage of sales, depreciation and amortization expenses were 5.0% in 2002 and 5.7% in 2001. The Company expects depreciation and amortization expenses to continue around the 5% level as a percentage of sales as a result of continued investment in surgical instrumentation and the expansion of the Company’s principal facility.

Royalty expenses increased 11% to $1,963,000 in 2002 from $1,762,000 in 2001. The increase was driven by strong growth in sales of knee and hip implant products. As a percentage of sales, royalty expenses were 3.3% in 2002 as compared to 3.8% in 2001. This decrease, as a percentage of sales, was the result of the expiration of certain royalty agreements on the knee implant products.

Income from operations increased 39% to $8,269,000 in 2002 from $5,969,000 in 2001. The increase was primarily the result of the strong sales growth, as well as production cost improvements. As a percentage of sales, income from operations was 14.0% in 2002 as compared to 12.8% in 2001.

Other income net of other expenses resulted in other income of $220,000 in 2002 as compared to other expense of $522,000 in 2001. Included in other income and expenses is interest expense, which decreased to $172,000 in 2002 from $427,000 in 2001 due to the repayment of borrowings under the Company’s line of credit; loss of foreign currency of $59,000 in 2002 as a result of Euro denominated inventory purchases; and equity in the loss of the Company’s Asian Joint Venture of $10,000 in 2002 as compared to $131,000 in 2001. Other expenses were offset by interest income of $23,000 in 2002 as compared to $36,000 in 2001 and litigation settlement payments received in 2002 of $438,000, net of legal costs of $62,000, in connection with the arbitration settlement agreement with RTI. The Company expects other income and expenses to result in net other income of $300,000 to $500,000 in 2003 as the remaining RTI settlement payments of $1,000,000 will be offset by increases in interest expense and equity in joint venture.

Income before provision for income taxes increased 56% to $8,489,000 in 2002 from $5,447,000 in 2001. The provision for income taxes increased to $3,168,000, or 37.3% of income before taxes, in 2002, from $1,987,000, or 36.5% of income before taxes, in 2001 as a result of strong domestic sales growth, as a percentage of total sales, and reduction in the tax benefit of international sales. The Company expects for income taxes to be in a range of 37.0% to 37.5% in 2003.

As a result of the foregoing, the Company realized net income of $5,321,000 in 2002, an increase of 54%, from $3,460,000 in 2001. 2002 net income represented 9.0% of sales as compared to 7.4% in 2001. Diluted earnings per share increased 50% to $.48 in 2002 from $.32 in 2001.

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Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

During 2001, the Company’s results of operations were significantly impacted by costs associated with an arbitration dispute with RTI. Overall trends in sales growth of mechanical joint replacement systems were positive in 2001 when compared to 2000.

Net sales increased 11% to $46,599,000 in 2001 from $41,925,000 in 2000. Worldwide sales of the Optetrak^® comprehensive knee system increased 8% to $28,214,000 in 2001 from $26,109,000 in 2000. Sales of hip implant systems increased 22% worldwide to $10,433,000 in 2001 from $8,571,000 in 2000. The introduction of the first components in the Company’s comprehensive AcuMatch^® integrated hip system, including the A-Series acetabular components and the M-Series modular hip stem system contributed to this growth. Revenue from worldwide distribution of tissue services decreased 2% to $5,252,000 in 2001 from $5,348,000 in 2000. The uncertainty of the outcome of the arbitration dispute with RTI was a contributing factor in this reduction. Net sales of surgical instrumentation and other products increased 42% to $2,700,000 in 2001 from $1,897,000 in 2000. Products contributing to this growth were the Company’s surgical instrumentation sold to international distributors and the Cemex^® bone cement system.

Domestic sales increased 11% to $38,208,000 in 2001 from $34,343,000 in 2000. The increase was primarily due to the introduction of improved hip implant products and continued market penetration and acceptance of the Company’s knee systems. International sales increased 11% to $8,391,000 in 2001, representing 18% of net sales, from $7,582,000 in 2000, which was also 18% of net sales. The entry into new markets in Europe, South America and Australia fueled this growth in foreign sales.

Gross profit increased 11% to $30,333,000 in 2001 from $27,296,000 in 2000. The increase in gross profit was consistent with total increases in net sales. Gross profit margin remained constant at 65.1% in 2001 and 2000. Included in gross profit was a loss on disposal of assets, which increased to $79,000 in 2001 from $68,000 in 2000. Loss on disposal of assets for 2001 and 2000 was reclassified from other income and expenses to cost of sales to be consistent with the 2002 presentation.

Sales and marketing expenses increased 16% to $12,977,000 in 2001 from $11,230,000 in 2000. The increase was the result of marketing initiatives in the areas of training and meetings. In 2001, the Company hosted its first worldwide surgeons conference that was attended by hundreds of surgeons from the United States and overseas. As a percentage of sales, sales and marketing expenses increased to 27.9% in 2001 from 26.8% in 2000 as a result of the increased expenditures associated with supporting the training and meeting initiatives.

General and administrative expenses increased 50% to $4,765,000 in 2001 from $3,168,000 in 2000. The increase was primarily the result of $1,423,000 of legal costs associated with arbitration and litigation issues. As a percentage of sales, general and administrative expenses were 10.2% in 2001 as compared to 7.6% in 2000.

Research and development expenses increased 3% to $2,210,000 in 2001 from $2,138,000 in 2000. As a percentage of total sales, research and development expenses were 4.7% in 2001 as compared to 5.1% in 2000. This decrease in development costs, as a percentage of sales, was primarily due to the completion in 2000 of significant development efforts associated with the Company’s comprehensive improvement and line extension projects on its integrated hip system.

Depreciation and amortization expenses increased 23% to $2,650,000 in 2001 from $2,154,000 in 2000. The increase was principally due to the investment in surgical instrumentation and manufacturing equipment. In 2001, the Company invested $3,206,000 in instruments and manufacturing equipment. As a percentage of sales, depreciation and amortization expenses were 5.7% in 2001 as compared to 5.1% in 2000.

Royalty expenses increased 7% to $1,762,000 in 2001 from $1,643,000 in 2000. This increase was consistent with the overall increase in sales of hip and knee implants, the product lines incurring royalties. As a percentage of sales, royalty expenses decreased slightly to 3.8% in 2001 from 3.9% in 2000 as a result of a change in the sales mix between knee and hip implant products.

Income from operations decreased 14% to $5,969,000 in 2001 from $6,963,000 in 2000. The decrease resulted from the increases in the operating expenses outpacing the top line sales growth. As a percentage of sales, income from operations was 12.8% in 2001 as compared to 16.6% in 2000, reflecting the increase in operating

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expenses while gross profit margin remained constant.

Other expenses, net increased 81% to $522,000 in 2001 from $288,000 in 2000. Included in other income and expenses is interest expense, which increased to $427,000 in 2001 from $338,000 in 2000 as a result of borrowing under the Company’s line of credit; interest income which decreased to $36,000 from $50,000 in 2001 and the Company’s equity in the net loss of its Asian Joint Venture of $131,000 in 2001, its first year of operations.

Income before provision for income taxes decreased 18% to $5,447,000 in 2001 from $6,675,000 in 2000. The provision for income taxes decreased to $1,987,000, or 36.5% of income before taxes, in 2001 from $2,495,000, or 37.4% of income before taxes, in 2000. The decrease in the effective tax rate was primarily the result of the impact of the research and development credit and the tax benefits from foreign sales.

As a result of the foregoing, the Company realized a decrease in net income of 17% to $3,460,000 in 2001 from $4,180,000 in 2000. Earnings per share, on a diluted basis, decreased 18% to $.32 in 2001 compared to $.39 in 2000.

Liquidity and Capital Resources

The Company’s cash and cash equivalents increased to $3,651,000 at December 31, 2002 from $1,001,000 at December 31, 2001 and $448,000 at December 31, 2000. At December 31, 2002, the Company had working capital of $30,944,000, as compared to $26,336,000 at December 31, 2001 and $21,280,000 at December 31, 2000. During 2002, the increase in working capital was primarily the result of the $2,650,000 increase in cash balances and the $2,183,000 increase in trade receivables. During 2001, the increase in working capital was the result of the $553,000 increase in cash balances and the $1,447,000 increase in trade receivables. Trade receivables are expected to increase commensurate with sales growth in the short and long-term as the Company is not anticipating any significant changes in its credit terms. The Company had significant cash flows from operations for each of the last two years due to the increases in sales and profitability while improving receivables and inventory management. The Company expects to be cash flow neutral for the short-term as it is expecting that positive cash flows due to profitability will be used for additional investment in inventory, surgical instrumentation, and continued technology and product line asset purchases.

The Company maintains a credit facility with Merrill Lynch Business Financial Services, Inc., which is secured by accounts receivable and inventory (“credit line”). The credit line is limited to the lesser of 80% of the value of accounts receivable less than 90 days old, plus the lesser of 50% of the value of inventory (excluding raw materials and work-in-process inventory) and 25% of inventory on consignment or $12,000,000. The credit line was renewed in June 2002 maintaining the available limit at $12,000,000, expiring June 30, 2004. As of December 31, 2002, there were no amounts outstanding under the line of credit as compared to $1,386,000 at December 31, 2001. The Company continues to maintain an industrial revenue bond financing secured by a letter of credit with a local lending institution that was funded in 1998 for construction of the Company’s current facility. The balance due under the bond as of December 31, 2002 was $3,000,000. As of December 31, 2002 the Company was in the process of a significant expansion to the corporate facility and entered into a long-term commercial construction loan of up to $4,200,000 with a local lending institution to fund the expansion. At December 31, 2002, there was $1,666,000 outstanding under this loan. During February 2003, the Company entered into but has not drawn upon an additional long-term loan of up to $1,500,000 with a local lending institution for purposes of acquiring office and manufacturing equipment. At December 31, 2002, the Company had outstanding commitments for the purchase of inventory and raw materials of $3,483,000, along with commitments to purchase $1,002,000 of capital equipment. The Company believes that funds from operations and borrowings under its existing credit facilities will be sufficient to satisfy its contemplated cash requirements for the following twelve months.

Operating Activities- Operating activities provided net cash of $8,615,000 in 2002, as compared to $4,871,000 in 2001, while using net cash of $1,073,000 in 2000. During 2002 and 2001, operating activities provided net cash primarily as a result of the increase in sales and net income without proportionate increases in receivables and inventory. During 2000, operating activities used net cash primarily as a result of an increase in inventory of $7,758,000 made in support of new product development. During 2002, cash used as a result of the increase in trade receivables was $2,183,000 as compared to $1,447,000 during 2001 and $1,076,000 during 2000. Cash used as a result of an increase in inventory during 2002 was $440,000 as compared to $200,000 in 2001. The Company’s focus on inventory management efforts during 2001 and 2002 resulted in inventory increases far lower than the increase in sales. Inventory levels are expected to increase in the short-term due to the expected increase in

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sales although 2002 average inventory turns of .97 are expected to remain constant. During 2002 cash provided as a result of an increase in accounts payable was $1,557,000, compared to cash used as a result of a decrease in accounts payable of $1,081,000 in 2001.

Investing Activities- During 2002, net cash used in investing activities increased to $7,060,000, as compared to $3,803,000 used during 2001, and $4,361,000 used during 2000. The increase during 2002 was the result of continued rollout of new product lines and related surgical instrumentation as well as the construction in progress related to the facilities expansion. In 2003, total capital expenditures are expected to be between $8,000,000 to $9,000,000 due to significant increases in surgical instrumentation and the completion and buildout of the facility expansion that is expected to be approximately $4,000,000 of the total.

Financing Activities- During 2002, financing activities provided net cash of $1,095,000, as compared to using net cash of $515,000 in 2001 and providing net cash of $4,241,000 in 2000. During 2002, the Company used cash of $1,686,000 to pay outstanding long and short-term debt as compared to $3,800,000 used for similar purposes in 2001. Proceeds from issuance of stock related to option and warrant exercises decreased to $1,115,000 in 2002 from $2,014,000 in 2001. Borrowings under credit lines and other loans provided cash of $1,666,000 in 2002, $1,271,000 in 2001 and $3,614,000 in 2000. During 2003, the Company anticipates to fully draw down both the $4,200,000 associated with the facility expansion loan and the $1,500,000 associated with the expansion equipment loan. The Company does not foresee having to execute any borrowings under the credit line unless there are significant asset and/or technology purchase opportunities.

Contractual Obligations and Commercial Commitments

The following table indicates the Company’s contractual obligations at December 31, 2002 (in thousands):

At December 31, 2002, the Company did not have any off-balance-sheet financing arrangements (other than operating leases as discussed in Note 10 of the Notes to Financial Statements) or any unconsolidated, special purpose entities.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of its financial position and results of operations are based on the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The Company’s significant accounting policies are discussed in Note 2 of Notes to Financial Statements. In management’s opinion, the Company’s critical accounting policies include allowance for doubtful accounts, excess and obsolete inventories, intangible assets, and accrued liabilities.

Allowance for Doubtful Accounts- The Company maintains an allowance for doubtful accounts to estimate the losses due to the inability to collect required payment from our customers for products and services rendered. Should the financial condition of our customers deteriorate, resulting in an impairment of their ability to pay, additional allowances may be required which would affect the Company’s future operating results.

Excess and Obsolete Inventories- In the orthopeadic device industry, significant amounts of consigned inventory are typically utilized to meet the product needs of medical care providers. Since human anatomy differs, a wide variety of size options is necessary to meet the varying needs of patients undergoing musculoskeletal procedures. Although larger and smaller sizes may be infrequently used, inventories of all sizes must be available to meet the widest array of patient needs. In addition to large inventory requirements, the orthopaedic device industry

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is highly competitive with new products, raw materials and technologies being introduced continually, which may obsolete existing product inventories. The Company makes estimates concerning the future use of these products and calculates a provision for excess and obsolete inventories. If the actual product life-cycles, demand or general market conditions are less favorable than those projected by management, additional inventory write-downs may be required which would affect future operating results.

Intangible Assets- In assessing the value of the Company’s intangible assets, the Company must make assumptions regarding the estimated future cash flows, economic life and other factors to determine fair value of the respective assets. If these estimates or assumptions change in the future, the Company may be required to record an impairment charge for these assets. The Company adopted Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” on January 1, 2002, has analyzed its intangible assets for impairment issues, and will continue to do so on an annual basis.

Accrued Liabilities- As a result of product liability and other claims, the Company establishes accruals for losses that are deemed to be probable and subject to reasonable estimate. There are various claims, lawsuits, and disputes with third parties, as well as pending actions involving various allegations against the Company incident to the operation of its business, principally product liability cases. Should the outcome of any pending, threatened, or future litigation have an outcome unfavorable to the Company, it may affect future operating results.

Certain Risk Factors

Although it is not possible to predict or identify all such factors, they may include those listed below, which should not be considered an exhaustive statement of all potential risks and uncertainties:

•          The Company is subject to extensive government regulation. Failure to obtain government approvals and clearances for new products and/or modifications to existing products on a timely basis would likely have a material adverse effect on the business and financial results of the Company. A significant recall of one or more of the Company’s products could have a material adverse effect on the Company’s business and financial results. There can be no assurance that such clearances will be granted or that review by government authority will not involve delays materially adversely affecting the marketing and sale of the Company’s products.

•          The Company faces uncertainty relating to the availability of third-party reimbursement for its products. The failure by physicians, hospitals and other users of the Company’s products to obtain sufficient reimbursement from health care payors for procedures in which the Company’s products are used or adverse changes in governmental and private payors’ policies toward reimbursement for such procedures would have a material adverse effect on the Company’s business and financial results.

•          The Company is required to incur significant expenditures of resources in order to maintain relatively high levels of inventory. As a result of the need to maintain substantial levels of inventory, the Company is subject to the risk of inventory obsolescence. In the event that a substantial portion of the Company’s inventory becomes obsolete, it would have a material adverse effect on the Company’s business and financial results.

•          The Company conducts business in a highly competitive industry. The orthopaedic implant industry is subject to competition in the following areas: product features and design, innovation, service, the ability to maintain new product flow, relationships with key orthopaedic surgeons and hospitals, strength of distribution network, and price. In addition, the Company faces competition for regional sales representatives within the medical community. There can be no assurance that the Company will be able to compete successfully.

•          The Company’s success is partially dependent upon its ability to successfully market new and improved products and the market acceptance of those products. The failure of its products to gain market acceptance would be likely to have a material adverse effect on the Company’s business and financial results. There can be no assurance that new or improved products will gain market acceptance.

•          The Company is subject to federal anti-kickback laws and regulations. These laws and regulations prohibit any knowing and willful offer, payment, solicitation or receipt of any form of remuneration, either directly or indirectly, in return for, or to induce: referral of an individual for a service or product for which payment may be made by Medicare, Medicaid or another government sponsored health care program, or purchasing, leasing, ordering or arranging for, or recommending the purchase, lease or order of, any service or product for which payment may be made by a government-sponsored health care program. There can be no assurance that federal or state regulatory authorities will not challenge the Company’s current or future activities under these laws. Any challenge by those regulatory authorities could have a

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material adverse effect on the Company’s business or financial results. Any state or federal regulatory review of the Company, regardless of the outcome, would be costly and time consuming.

•          The Company holds patents on specific designs and processes and relies on trade secrets and proprietary know-how which can provide it with a competitive advantage. The Company also employs various methods to protect its proprietary information, including confidentiality agreements and proprietary information agreements. There can be no assurance as to the breadth or degree of protection which existing or future patents, if any, may afford the Company, that those confidential or proprietary information agreements will not be breached, that the parties from whom the Company has licensed or otherwise acquired patent rights, proprietary rights and technology have full rights to those patent rights and technology, or that the Company’s trade secrets and proprietary know-how will not otherwise become known to or independently developed by competitors.

•          The Company must devote substantial resources to research and development. There can be no assurance that the Company will be successful in developing competitive new products and/or improving existing products so that its products remain competitive and avoid obsolescence.

•          The Company is subject to potential product liability risks which are inherent in the design, marketing and sale of orthopaedic implants and surgical instrumentation. No assurance can be given that the Company will not face claims resulting in substantial liability for which the Company is not fully insured or that the Company will be able to maintain adequate levels of insurance on acceptable terms. A partially or completely uninsured successful claim against the Company of sufficient magnitude could have a material adverse effect on the Company’s business and financial results.

Recent Accounting Pronouncements

See Note 2 of Notes to the Financial Statements for information concerning recent accounting pronouncements.

ITEM 7A.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risk from interest rates. For its cash and cash equivalents, a change in interest rates effects the amount of interest income that can be earned. For its debt instruments, changes in interest rates effect the amount of interest expense incurred.

The following table provides information about the Company’s financial instruments that are sensitive to changes in interest rates. The amounts presented approximate the financial instruments’ fair market value as of December 31, 2002 (in thousands, except percentages):

The Company invoices and receives payment from international distributors in U. S. dollars and is not subject to risk associated with foreign currency exchange rates on accounts receivable. In connection with certain distribution agreements, the Company is subject to risk associated with foreign currency exchange rates on purchases of inventory payable in Euros. The Company does not invest in foreign currency derivatives. The U.S. dollar is considered the primary currency for the Company and transactions that are completed in a foreign currency are translated into U.S. dollars and recorded in the financial statements. Translation gains or losses were not material in any of the periods presented and the Company does not believe it is currently exposed to any material risk of loss on this basis.

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ITEM 8.          FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Deloitte & Touche LLP
Certified Public Accountants
Suite 2801
One Independent Drive
Jacksonville, Florida 32202-5034

Tel: (904) 665 1400
Fax: (904) 355 9104
www.deloitte.com

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Shareholders
of Exactech, Inc.
Gainesville, Florida

We have audited the accompanying balance sheets of Exactech, Inc. (the “Company”) as of December 31, 2002 and 2001, and the related statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

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EXACTECH, INC.

BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

See notes to financial statements

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EXACTECH, INC.

STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2002 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)