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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2003

For the transition period from              to             

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)

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 ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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EXACTECH, INC.

INDEX

CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS

This report contains 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 suppliers to produce components on a cost-effective basis to the Company, market acceptance of the Company’s products, the outcome of 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, including those factors discussed in “Risk Factors” in the Company’s 2002 Annual Report on Form 10-K.

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Item 1. Financial Statements

EXACTECH, INC.

CONDENSED BALANCE SHEETS

(in thousands)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

CONDENSED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(in thousands)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2003 AND 2002

(Unaudited)

1.    BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements, which are for interim periods, have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission relating to interim financial statements. These unaudited condensed financial statements do not include all disclosures provided in the annual financial statements. The condensed financial statements should be read in conjunction with the financial statements and notes thereto contained in the Annual Report on Form 10-K for the year ended December 31, 2002 of Exactech, Inc. (the “Company”), as filed with the Securities and Exchange Commission.

All adjustments of a normal recurring nature which, in the opinion of management, are necessary to present a fair statement of results for the interim periods have been made. Results of operations for the three month period ended March 31, 2003 are not necessarily indicative of the results to be expected for the full year.

2.    NEW ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations”. This statement requires entities to record the cost of any legal obligation for the retirement of tangible long-lived assets in the period in which it is incurred. The Company adopted the standard effective January 1, 2003. The adoption of SFAS 143 did not have a material effect on the financial position, results of operations or cash flows of the Company.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Disposal Activities”. Under SFAS 146, liabilities for costs associated with a plan to dispose of an asset or to exit a business activity must be recognized in the period in which the costs are incurred. SFAS 146 is effective for disposal activities initiated after December 31, 2002. The Company adopted the standard effective January 1, 2003. The adoption of SFAS 146 did not have a significant impact on the financial position, results of operations or cash flows of the Company.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”. SFAS 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation”, and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 is effective for financial statements for annual periods ending after December 15, 2002 and interim periods beginning after December 31, 2002. The Company has adopted the amendments to SFAS 123 disclosure provisions required under SFAS 148 but will continue to use intrinsic value method under APB 25 to account for stock-based compensation. As such, the adoption of this statement has not had a significant impact on the Company’s financial position, results of operations or cash flows.

In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. This interpretation addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees. It also clarifies (for guarantees issued after January 1, 2003) that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligations undertaken in issuing the guarantee. At March 31, 2003, the Company did not have any significant guarantees. The Company adopted the disclosure requirements of FIN 45 for the year ended December 31, 2002, and the recognition provisions effective January 1, 2003.

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3.    INVENTORIES

Inventories are valued at the lower of cost (first-in, first-out method) or market and include implants provided to customers and agents. The Company provides significant loaned implant inventory to non-distributor customers. The Company provides an adjustment to inventory based on obsolescence and slow-moving inventory. This impairment adjustment establishes a new cost basis for such inventory that is not subsequently recovered through income. The following table summarizes inventory classification as of December 31, 2002 and March 31, 2003 (in thousands):

4.    DEBT

Long-term debt consists of the following at March 31, 2003 and December 31, 2002 (in thousands):

The following is a schedule of debt maturities as of March 31, 2003 (in thousands):

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5.    COMMITMENTS AND CONTIGENCIES

Litigation

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, based on the advice of counsel, 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.

Purchase Commitments

At March 31, 2003, the Company had outstanding commitments for the purchase of inventory and raw materials of $5,158,000, along with commitments to purchase $1,172,000 of capital equipment. At March 31, 2003, the Company had outstanding purchase commitments associated with certain distribution agreements of $1,527,000.

Segment information is reported by the major product lines of the Company: knee products, hip products, and tissue services. The “other” category consists of minor sales categories, such as instrument sales and rental fees and shipping charges. The Company evaluates the performance of its operating segments based on income from operations before taxes, interest income and expense, and nonrecurring items. Intersegment sales and transfers are not significant.

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Summarized interim reporting information concerning the Company’s reportable segments is shown in the following table:

Total assets not identified with a specific segment (in thousands) were $29,806 at March 31, 2003 and $27,640 at December 31, 2002. Assets not identified with a specific segment include cash and cash equivalents, accounts receivable, deferred income taxes, prepaid expenses, land, facilities, office furniture and computer equipment, and other assets.

Segment assets are summarized in the following table:

Geographic distribution of sales is summarized in the following table (in thousands):

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7.    SHAREHOLDERS’ EQUITY

The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations for net income and net income available to common shareholders (in thousands, except per share amounts):

At March 31, 2003, there were 980,700 options to purchase shares of common stock at prices ranging from $3.34 to $12.13 per share outstanding. During the quarter ended March 31, 2003, there were 49,000 options at an exercise price of $12.13 per share excluded from the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.

At March 31, 2002, there were 1,098,110 options to purchase shares of common stock at prices ranging from $1.64 to $9.41 per share outstanding. During the quarter ended March 31, 2002, there were 223,076 options at exercise prices ranging from $8.20 to $9.41 per share excluded from the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares.

8.    OPTIONS AND STOCK AWARDS

The Company accounts for stock-based compensation utilizing the intrinsic value method per Accounting Principles Board No. 25 (APB 25), “Accounting for Stock Issued to Employees”. The Company’s Executive Incentive Compensation Plan provides for the grant of stock options, stock appreciation rights and other stock-based awards. The exercise price of each award equals the market price of the Company’s stock on the date of grant. Awards typically vest in equal increments over a five-year period starting on the first anniversary of the date of grant. An option’s maximum term is 10 years.

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In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”. Pursuant to the disclosure requirements of SFAS 148, the following table provides an expanded reconciliation for each of the three month periods ended March 31 (in thousands, except per share amounts):

9.    RECLASSIFICATIONS

Certain amounts in the 2002 financial statements have been reclassified to conform with the 2003 financial statements presentation.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion should be read in conjunction with the condensed financial statements and related notes appearing elsewhere herein, and the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

The Company develops, manufactures, markets, and sells orthopaedic implant devices, and related surgical instrumentation, and distributes biologic materials to hospitals and physicians in the United States and overseas. The Company was incorporated in 1985 and began selling its first hip implant products in 1987. 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 table sets forth, for the periods indicated, information with respect to the Company’s products and services sold and percentages of revenues derived from such sales:

Sales Revenue by Product Line

(dollars in thousands)

The following table includes items from the Condensed Statements of Income for the periods indicated, the percentage relationship to net sales and the percentage change from period to period:

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Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

Worldwide net sales increased 31% to $18.0 million in the quarter ended March 31, 2003 from $13.8 million in the quarter ended March 31, 2002. The increase in sales resulted from growth in all major product lines, aided by increases in average selling prices ranging from 2% to 5%. Sales of knee products increased 27% to $10.6 million in the quarter ended March 31, 2003 from $8.4 million in the quarter ended March 31, 2002. Hip implant product sales increased 19% to $3.7 million in the quarter ended March 31, 2003, as compared to $3.1 million in the quarter ended March 31, 2002. Revenue from tissue services distribution increased 53% to $2.2 million in the first quarter of 2003 from $1.5 million in the comparable quarter in 2002. Sales of other products, including surgical instrumentation, the Link^® S.T.A.R.^TM ankle, and the Cemex^® bone cement system, increased 82% to $1.5 million in the quarter ended March 31, 2003 from $814,000 in the quarter ended March 31, 2002. Sales revenue in the United States increased 25% to $14.3 million in the quarter ended March 31, 2003, which represented 79% of worldwide sales, as compared to $11.4 million in the quarter ended March 31, 2002, which represented 83% of worldwide sales. International net sales increased 59% to $3.7 million in the quarter ended March 31, 2003, which represented 21% of worldwide sales, from $2.3 million in the quarter ended March 31, 2002, which represented 17% of worldwide sales.

Gross profit increased 37% to $12.2 million in the quarter ended March 31, 2003 from $8.9 million in the quarter ended March 31, 2002. As a percentage of sales, gross profit increased to 67.6% in the first quarter of 2003 as compared to 64.5% in the first quarter of 2002. The improvement in gross profit percentage was primarily the result of improved manufacturing processes, coupled with an increasing number of internally manufactured components.

Total operating expenses increased 43% to $9.9 million in the quarter ended March 31, 2003 from $6.9 million in the quarter ended March 31, 2002. The largest component of total operating expenses, sales and marketing expenses, increased 40% to $5.4 million in the first quarter of 2003 from $3.9 million in the comparable quarter of 2002, primarily as a result of increased variable agency service costs associated with growth in sales revenue. As a percentage of sales, total sales and marketing expenses increased to 30.2% in the quarter ended March 31, 2003 as compared to 28.3% in the quarter ended March 31, 2002, primarily as a result of increased spending on customer targeted marketing initiatives, including the Company’s national sales and service training for its agents.

General and administrative expenses increased 80% to $2.1 million in the quarter ended March 31, 2003 from $1.1 million in the quarter ended March 31, 2002. The increase was primarily due to significant increases in product liability costs experienced in the first quarter of 2003 when compared to the first quarter of 2002. The Company first experienced significant increases in product liability insurance premiums beginning in the second quarter of 2002 as the Company’s annual insurance policy period begins April 1, 2003 and ends March 31, 2004. Looking forward, the comparative increases in product liability insurance expenses will not be as significant during the balance of 2003. As a percentage of sales, general and administrative expenses increased to 11.4% in the first quarter of 2003 as compared to 8.3% in the first quarter of 2002.

Research and development expenses increased 58% to $1.0 million in the quarter ended March 31, 2003 from $647,000 in the quarter ended March 31, 2002. The increase in research and development expenditures reflects the Company’s continuing commitment to new products and technologies, as well as improving the performance of its existing product lines. As a percentage of sales, research and development expenses increased to 5.7% in the first quarter of 2003 from 4.7% in the same quarter of 2002.

Depreciation and amortization increased 8% to $787,000 in the quarter ended March 31, 2003, as compared to $727,000 in the quarter ended March 31, 2002, primarily as a result of continued investment in surgical instrumentation to support sales growth. During the quarter ended March 31, 2003, $321,000 of such equipment was placed in service.

Royalty expenses increased 21% to $640,000 in the quarter ended March 31, 2003 from $529,000 in the quarter ended March 31, 2002. The total dollar increase was primarily the result of strong growth in sales of the Company’s knee implant products, which incur a higher royalty than other product lines. As a percentage of total sales, royalty expenses decreased slightly to 3.6% in the first quarter of 2003 from 3.8% in the first quarter of 2002, primarily as a result of change in the Company’s net sales mix, with revenue from knee products decreasing as a percentage of total sales.

The Company’s income from operations increased 15% to $2.2 million in the quarter ended March 31, 2003

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from $1.9 million in the quarter ended March 31, 2002. The increase in operating expenses outpaced the increase in sales revenue, resulting in a lower rate of growth in income from operations.

The Company incurred net interest expense of $29,000 in the quarter ended March 31, 2003 as compared to $40,000 in the quarter ended March 31, 2002. The decrease in net interest expense was primarily the result of a reduction in amounts outstanding on borrowings under the Company’s existing line of credit, partially offset by increases in borrowings under the Company’s commercial construction loan. Interest expense for the quarter ended March 31, 2003 of $40,000 was partially offset by $11,000 of interest income. In the quarter ended March 31, 2003, the Company realized a gain on foreign currency exchange of $6,000 and incurred a loss on its investment in its joint venture in the People’s Republic of China and the Republic of China (Taiwan) of $10,000 as compared to a $14,000 loss in the same quarter last year. The Company realized a gain of $250,000 for the quarter ended March 31, 2003 on its arbitration settlement with RTI.

Income before provision for income taxes increased 30% to $2.4 million in the quarter ended March 31, 2003 from $1.9 million in the quarter ended March 31, 2002. The provision for income taxes was $864,000 in the quarter ended March 31, 2003, compared to $677,000 in the quarter ended March 31, 2002. The effective tax rate for the quarter ended March 31, 2003 was 35.4% as compared to 36.0% in the quarter ended March 31, 2002. The decrease in the effective rate was primarily the result of a favorable adjustment of the prior year’s tax provision to the actual 2002 tax returns.

As a result of the foregoing, the Company realized net income of $1.6 million in the quarter ended March 31, 2003 as compared to $1.2 million in the quarter ended March 31, 2002, an increase of 31%. As a percentage of sales, net income remained constant at 9% for each of the quarters ended March 31, 2003 and 2002. Earnings per share, on a diluted basis, were $0.14 for the quarter ended March 31, 2003, as compared to $0.11 for the quarter ended March 31, 2002.

Liquidity and Capital Resources

The Company’s cash and cash equivalents decreased to $3,453,000 at March 31, 2003 from $3,651,000 at December 31, 2002. At March 31, 2003, the Company had working capital of $32,062,000, as compared to $30,944,000 at December 31, 2002. During the first quarter of 2003, the increase in working capital was primarily the result of the $1,442,000 increase in trade receivables.

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 a maximum amount of $12,000,000. In addition to this maximum, the credit line may not exceed 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. The credit line was renewed in June 2002 maintaining the available limit at $12,000,000, expiring June 30, 2004. As of March 31, 2003 there were no amounts outstanding under the line of credit. 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 March 31, 2003 was $3,000,000. The Company is in the process of a significant expansion to its corporate facility and in November 2002, entered into a long-term commercial construction loan of up to $4,200,000 with a local lending institution to fund the expansion. At March 31, 2003, there was $2,457,000 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 March 31, 2003, the Company had outstanding commitments for the purchase of inventory and raw materials of $5,158,000, purchases related to certain distribution agreements of $1,527,000, along with commitments to purchase $1,172,000 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. The Company’s credit facility and other loans contain customary affirmative and negative covenants including certain financial covenants with respect to the Company’s consolidated net worth, interest and debt coverage ratios and limits on capital expenditures and dividends in addition to other restrictions. The Company is in compliance with such covenants at March 31, 2003.

Operating Activities–Operating activities provided net cash of $1,490,000 in the three months ended March 31, 2003, as compared to $2,730,000 in the three months ended March 31, 2002. The primary reasons for the decrease were increases in inventory of $325,000 and prepaid expenses of $831,000 in the three months ended

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March 31, 2003, which compared to decreases in inventory of $919,000 and prepaid expenses of $45,000 in the three months ended March 31, 2002. Depreciation and amortization was $851,000 for the three months ended March 31, 2003, as compared to $788,000 for the comparable three months ended March 31, 2002.

Investing Activities–The Company used net cash in investing activities of $2,704,000 in the three months ended March 31, 2003, as compared to $1,440,000 in the three months ended March 31, 2002, primarily for the purchase of property and equipment, which includes the facility expansion in progress, and the purchase of certain patents.

Financing Activities–Financing activities provided net cash of $1,016,000 for the three months ended March 31, 2003, as compared to using net cash of $1,295,000 in the three months ended March 31, 2002. In the three months ended March 31, 2003, borrowings under the commercial construction loan for the facility expansion provided net cash of $791,000 and the issuance of stock provided net cash of $225,000. This compared to repayment of borrowings under the credit facility with Merrill Lynch using net cash of $1,386,000 and proceeds from issuance of stock providing net cash of $91,000 in the three months ended March 31, 2002.

Item 3. 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 March 31, 2003 (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 from such currency translations.

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Item 4. Controls and Procedures

(a)    Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Form 10-Q, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

(b)    Changes in internal control. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation described above.

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PART II.    OTHER INFORMATION

Item 1.    Legal Proceedings

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, based on the advice of counsel, 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 2.    Changes in Securities

None

Item 3.    Defaults Upon Senior Securities

None

Item 4.    Submission of Matters to a Vote of Security Holders

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