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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

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

Common Stock Purchase Rights

(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  ¨

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.  ¨

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

As of March 8, 2004, the number of shares of the registrant’s Common Stock outstanding was 11,032,879. The aggregate market value of the Common Stock held by non-affiliates of the registrant as of June 30, 2003 was approximately $90,661,000 based on a closing sale price of $14.65 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 2004 Annual Meeting of Shareholders (to be filed pursuant to Regulation 14A).

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and

CROSS REFERENCE SHEET

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 Item 7 of this report.

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PART I

ITEM 1. BUSINESS

Exactech, Inc. (the “Company”, or “Exactech”) develops, manufactures, markets, distributes and sells orthopaedic implant devices and related surgical instrumentation, and distributes biologic materials to hospitals and physicians in the United States and internationally. 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 and distribution of its joint replacement systems, including knee and hip implant systems, and distribution of biologic allograft materials.

The Company manufactures some components of its knee and hip joint replacement systems at its facility in Gainesville, Florida utilizing state of the art computer aided manufacturing equipment. Internal manufacturing is complimented by externally manufactured components through the formation of strategic alliances with suppliers and business partners. Other products and services are acquired and distributed through exclusive agreements, such as the Company’s agreements with Regeneration Technologies, Inc. (“RTI”), Link America, Inc. and its parent company, Waldemar Link GmbH & Co. (“Link”), and Tecres, S.p.A (“Tecres”).

On October 30, 2003, for an investment of $1 million, the Company acquired a 16.7% minority interest in Altiva Corporation (“Altiva”), an early stage company which is building an asset portfolio through the acquisition of existing spinal products and systems as well as acquiring broad distribution rights to other existing spinal market technologies. As part of the agreement under which the Company purchased this minority interest, the Company has committed to make loans available to Altiva in an amount of up to $5 million for a period of five years as well as provide Altiva with, or guarantee on behalf of Altiva, a working capital credit line in an amount up to $6 million. The Company also entered into a Stockholders Agreement with Altiva and some stockholders of Altiva under the terms of which the Company was granted an option to purchase all of Altiva’s outstanding securities for a specified purchase price. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”.

Orthopaedic Products Industry

According to a research report published by Gabelli & Company, Inc. in December 2003, the worldwide market for orthopaedic products in 2003 was estimated to be $16 billion, and expected to grow at a rate of 10% to 13% annually over the next ten years. According to this study, four market segments in which the Company offers its products and services, knee reconstructive devices, hip reconstructive devices, allograft materials and other products (which includes instrumentation and other orthopaedic products), were $3.2 billion, $2.9 billion, $0.8 billion and $4.3 billion, respectively during 2003.

Management shares the belief that the industry will continue to grow due to an aging population in much of the world. The same report by Gabelli & Company highlighted US Census Bureau statistics that reveal the number of people over age 65 in the United States is projected to increase steadily to 70 million by the year 2030, as compared to 35 million in 2000. Increasing life spans impact the number of individuals with joints subject to failure, thereby increasing demand for joint replacement procedures.

Products

The Company’s joint replacement implant products are used by orthopaedic surgeons to repair or replace joints that have deteriorated as a result of injury or disease. 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, like those distributed by Exactech, to repair bone defects and provide an interface to stimulate new bone growth. In many joint replacement procedures, bone cement is used to affix implant components to the prepared bone surfaces.

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The following table includes the net revenue and percentage of net sales for each of the Company’s product lines for the years ended December 31, 2003, 2002 and 2001:

Sales Revenue by Product Line

(dollars in thousands)

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. During 2004, the Company intends to commence full-scale marketing of an asymmetrical femoral component product line extension to the Optetrak system. This line extension includes a cruciate sparing, posterior stabilized and a new high flexion line. These asymmetrical line extensions will provide for differentiated right and left femoral components that the Company hopes will be successful in meeting surgeon preferences.

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

Hip Implants. The Company’s line of hip implant and instrument products includes the AcuMatch^® Integrated 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, the M-Series modular femoral stem, 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

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maximum polyethylene thickness to help in reducing polyethylene wear debris. The M-Series modular femoral stem offers components that are 100% interchangeable, allowing the surgeon to customize the prosthesis at the time of surgery and according to the patient’s bony structures. This versatility and the manner in which the components mate can have a positive effect on patient outcomes. 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 both cemented and press fit femoral components, as well as unipolar and bipolar endoprostheses, often used for the treatment of hip fractures.

The Link hip implant product lines distributed by the Company include the MP^™ Modular Femoral Revision stem, offering surgeons a product specifically designed and indicated for situations where there is deficient proximal bone. This unique design offers enhanced stability and fatigue strength over and above competitive stems indicated for similar clinical situations. Also distributed by the Company is the Link^® Saddle Prosthesis, a salvage type prosthesis designed to support the pelvic region when the acetabulum cannot be reconstructed, the Link SPII^® hip stem, and the Link^® Partial Pelvis.

The Company’s product pipeline includes several new hip systems which the Company feels will make its hip offerings more competitive, including the Novus^™ System, featuring press-fit and cemented primary femoral stems, press-fit revision stems, and a comprehensive acetabular system which will incorporate the use of alternative bearing couples such as ceramic and diamond. Instrumentation to address reduced incision lengths are also planned for launch during 2004.

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 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 “Item 3 - Legal Proceedings”. During 2003, the Company continued to expand the breadth of its allograft materials line in cooperation with RTI by releasing the Optefil^® RT line and intends to release an Opteform^® RT line during early 2004. These RT (Room Temperature) lines are allograft products that are distributed in a non-frozen form. As an addendum to the RTI distribution agreement, the Company also initiated distribution of Regenaform^® and Regenafil^® product lines during July 2003 for usage in oral and dental applications.

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.^™ 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 that will maintain motion and pain relief in arthritic patients with the appropriate indications. The Company also distributes Link surgical instrumentation that 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.. In January 2004 the Company announced that Tecres had received clearance from the FDA to market a pre-formed cement hip spacer product containing an antibiotic that is included in the Company’s distribution agreement. The spacer is used in two stage revision total hip procedures involving an infection with a previously implanted total hip and provides orthopaedic surgeons with a new, convenient way to treat this difficult problem. The Company expects to begin marketing the spacer in the second quarter of 2004.

Late in 2002, the Company acquired rights to a patented total shoulder system from Teknimed, a French manufacturer of orthopaedic implants and processor of biological products. Teknimed will

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continue to manufacture and distribute the shoulder system in Europe for the Company while Exactech establishes appropriate manufacturing support, upgrades the design and pursues marketing clearance from the FDA for United States usage.

Marketing and Sales

The Company markets its orthopaedic implant products in the United States through fifty-five independent sales agencies and one domestic distributor. These agencies, along with their independently contracted personnel, serve as the Company’s sales representatives. Internationally, the Company markets its products through twenty-two distributors that currently distribute products in twenty-five countries. The customers for the Company’s products are hospitals, surgeons and other physicians and clinics.

The Company generally has contractual arrangements with its independent sales agencies whereby the agency is granted the exclusive right to sell 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 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 managed 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 of each 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 reviews its inventory for obsolescence on a regular basis and adjusts its inventory for impairment.

During 2003, 2002 and 2001, approximately 3%, 4% and 4%, respectively, of the Company’s sales were derived from a major hospital customer. During 2003, 2002, and 2001, one international distributor accounted for approximately 8%, 8% and 9%, respectively, of the Company’s sales.

The Company generally has contractual arrangements with its international 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. International 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, 2003, 2002 and 2001, international sales accounted for $12,895,000, $9,441,000, and $8,391,000, respectively, representing approximately 18%, 16% and 18%, respectively, of the Company’s sales. Of those international sales, sales to the Company’s Spanish distributor accounted for $5,628,000, $4,838,000, and $4,260,000 in 2003, 2002 and 2001, respectively. The Company intends to continue to expand its sales in international 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 facility

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and headquarters 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 key suppliers. For the years ended December 31, 2003, 2002 and 2001, the Company purchased approximately 66%, 69% and 59%, respectively, of its externally sourced component requirements from its top three suppliers. The Company does not maintain supply contracts with most 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 suppliers. Order backlog is not a material aspect of the Company’s business.

The Company’s internal manufacturing, assembly, packaging and quality control operations are conducted at its principal offices in Gainesville, Florida. Components received from its suppliers 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 and international patents covering several of its implant components, biologic materials technologies 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 products are deemed invalid, such action could have a material adverse effect on the Company’s financial condition and results of operations.

In connection with the development of its knee implant systems, the Company pays royalties to Dr. William Petty and Dr. Gary Miller, who are executive officers and principal shareholders of the Company. Dr. Petty also serves as Chairman of the Company’s Board of Directors. New employment agreements entered into between the Company and each of Drs. Petty and Miller on January 1, 2003 provide for the continuation of the royalty payments in addition to their regular compensation as executive officers. Compensation associated with these agreements is the only compensation paid by the Company to Drs. Petty and Miller.

The Company has entered into a verbal 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 2003, the Company paid Dr. Burstein $165,000 as compensation under this consulting agreement.

Research and Development

During 2003, 2002 and 2001, the Company expended $3,748,000, $2,803,000 and $2,210,000, 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 intends to apply Diamicron’s polycrystalline diamond compact (PDC) technology to its hip implants. This diamond

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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, and Biomet Orthopaedics, a subsidiary of Biomet, Inc. These five companies, according to The Medical and Healthcare Marketplace Guide 2002-2003, published by Dorland Healthcare Information, 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.

Product Liability and Insurance

The Company is subject to potential product liability risks that 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 that 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. During 2003, the Company experienced stabilization of these insurance premiums. The Company annually evaluates 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 small 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 at a cost deemed to be appropriate.

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 the 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.

New medical device products of the Company will likely be subject to a clearance process conducted by the FDA. The process of obtaining regulatory clearances is lengthy, expensive and uncertain. Further, the FDA could choose to impose various requirements which could limit the Company’s ability to market its products. Further, if the Company wishes to modify a product after

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clearance, including changes in indications, manufacturing, or other changes, additional clearance may be required. Failure to receive, or delays in receipt of, FDA clearance, including the need for additional clinical trials or data as a prerequisite, could limit the ability of the Company to market its products and could result in decreased sales of the Company’s products.

Failure to comply with applicable regulatory requirements could result in, among other things, warning letters, fines, injunctions, civil penalties, repairs, replacements, refunds, recalls or seizures of products, total or partial suspensions of production, refusals of FDA to grant future premarket clearances or approvals, withdrawals or suspensions of current clearances or approvals, and criminal prosecution, which could result in reduced revenues and earnings.

Prior to 1996, the Company voluntarily initiated and satisfactorily completed two Class III recalls. A Class III recall is defined as a situation in which the use of a violative product is not likely to cause adverse health consequences. One recall involved a partially mislabeled product. The second involved the manufacturing process of a bone screw. FDA reviewed and authorized these two recalls, and concluded that each of the two recalls was conducted and completed properly. During September 1997, the Company voluntarily initiated a Class II recall as the result of the failure of an Opteon^® femoral hip stem. A Class II recall is defined as a situation in which the use of a violative product may cause temporary or medically reversible adverse health consequences or where the probability of serious adverse health consequences is remote. To the extent a product has already been implanted, it cannot be recalled. The Company is subject to potential products liability claims for these products.

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. Violation of these laws is a felony, punishable by fines up to $25,000 per violation and imprisonment for up to five years. Civil penalties may also be imposed which exclude violators from participation in Medicare or state health programs. Regulators may challenge or review the Company’s current or future activities under these laws which would be costly and time consuming and could reduce cash flows and revenues.

Significant prohibitions against physician referrals were enacted by Congress in the Omnibus Budget Reconciliation Act of 1993. These laws prohibit, subject to specified exemptions, a physician or a member of his immediate family from referring Medicare or Medicaid patients to an entity providing “designated health services” in which the physician has an ownership or investment interest, or with which the physician has entered into a compensation arrangement. The penalties for violating these laws include a prohibition on payment by these government programs and civil penalties of as much as $15,000 for each violative referral and $100,000 for participation in a “circumvention scheme.” The violation of these laws by the Company could result in significant fines or penalties and exclusion from participation in the Medicare and Medicaid programs.

The Company is required to obtain various licenses and permits from international governments and to comply with significant regulations that vary by country in order to market its products in international 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.

The Company is also subject to regulation by the Occupational Safety and Health Administration and the Environmental Protection Agency and similar state and foreign agencies and authorities.

Environmental Law Compliance

The Company’s operations are subject to numerous and increasingly stringent federal, state and local environmental laws and regulations concerning, among other things, the generation, handling, storage, transportation, treatment and disposal of toxic and hazardous substances and the discharge of pollutants into the air and water. Environmental permits and controls are required for some of the

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Company’s manufacturing operations and these permits are subject to modification, renewal and revocation by the issuing authorities. The Company believes that its facilities are in substantial compliance with its permits and environmental laws and regulations and does not believe that future environmental compliance will have a material adverse effect on its business, financial condition or results of operations. The Company’s environmental capital expenditures and costs for environmental compliance may increase in the future as a result of changes in environmental laws and regulations or as a result of increased manufacturing activities at its facilities. The Company could be materially adversely affected by any failure to comply with environmental laws, including the costs of undertaking a clean up at a site to which its wastes were transported.

Employees

As of December 31, 2003, the Company employed 154 full time employees. The Company has no union contracts and believes that its relationship with employees is good.

Executive Officers of the Registrant

The executive officers of the Company, and their ages as of March 8, 2004, are as follows:

William Petty, M.D. was a founder of the Company. He has been Chairman of the Board and Chief Executive Officer of the Company since its inception and President since January 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 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 was a Director from March 1989 through May 2003. 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 fifteen 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 1989

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until March 1996 and again from January 2002 until May 2003. 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 at the Company 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 Company 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.

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”. The Company does not intend for information contained in its web site to be part of this Annual Report on Form 10-K.

ITEM 2. PROPERTIES

The Company’s principal executive offices, research and development laboratories and manufacturing facility is a 76,000 square foot building on approximately eight acres of land owned by it in Gainesville, Florida. In 2003, the Company completed an expansion project to its principal facility by constructing a 37,000 square foot addition which is part of the 76,000 square foot complex. The Company leases a 9,500 square foot distribution facility in Gainesville, Florida. The lease has been renewed for a term of three years at an annual rate of $44,000, expiring July 31, 2006. The Company leases a 1,000 square foot office in Great Neck, New York. The lease is for a term of two and one half years at an annual rate of $25,000, expiring March 31, 2006. The Company owns approximately four and one half acres of land nearby to its existing facility in Gainesville, Florida for future expansion requirements.

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 required RTI to pay the Company $1.5 million in damages in quarterly installments of $250,000 over a period of one and one-half years from the date of the agreement. Such payments were received by the Company from the third quarter of 2002 through the fourth quarter of 2003.

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.

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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 cannot provide assurance it 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 earnings and cash flows due the cost of defending itself against such a claim. 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, 2003.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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. The share prices have been adjusted to reflect the two-for-one split of the Company’s Common Stock that was effective February 28, 2003:

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 8, 2004 the Company had approximately 225 shareholders of record. There are in excess of 2,550 beneficial owners of the Company’s Common Stock.

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Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2003 with respect to compensation plans (including individual compensation arrangements) under which the Company’s equity securities are authorized for issuance.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

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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.

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

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

Overview of the Company

The Company develops, manufactures, markets and sells orthopaedic implant devices, related surgical instrumentation and supplies, as well as distributes services for biologic materials to hospitals and physicians in the United States and internationally. The Company’s revenues are primarily derived from sales of its knee and hip joint replacement systems; however, revenues from worldwide distribution of bone paste products processed for use in non-spinal musculoskeletal orthopaedic procedures has steadily

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increased as a percentage of the Company’s total revenues. This increase is likely to continue as the Company expands its current distribution from the introduction of new, advanced biologic materials and services. Revenue from sales of other products, including surgical instrumentation, Cemex^® bone cement, the recently FDA approved InterSpace^™ pre-formed cement hip spacer and the Link^® S.T.A.R.^™ ankle are expected to contribute to the Company’s anticipated revenue growth.

The Company’s operating expenses consist of sales and marketing expenses, general and administrative expenses, research and development expenses, depreciation expenses and royalty expenses. The largest component of operating expenses, sales and marketing expenses, primarily consists of payments made to independent sales representatives for their services to hospitals and surgeons on the Company’s behalf. As a result of the nature of these sales and marketing expenses, these expenses tend to be variable in nature and related to sales growth. Research and development expenses primarily consist of expenditures on projects concerning active knee and hip implant product lines and biologic services. Royalty expenses consist primarily of expenditures made to the owners of patents and contributing surgeons who have licensed the use of their inventions or contributed their professional expertise to the Company for its product development and manufacturing uses. Knee implant products generally carry a higher royalty charge than other implant products.

In marketing its products, the Company uses a combination of traditional targeted media marketing and its primary marketing focus, direct customer contact and service to orthopaedic surgeons. Since surgeons are the primary decision maker when it comes to the choice of products and services that best meet the needs of their patients, the Company’s marketing strategy is focused on developing relationships and meeting the needs of the surgeon community in the orthopaedic industry. In cooperation with its organization of independent sales agencies in the United States and network of independent distributors internationally, the Company conducts this effort through continuing education forums, training programs and product development advisory panels.

Recent Events

In 2003, the Company augmented its growth strategy to supplement organic growth with an acquisition program. The Company continuously evaluates opportunities to improve its product lines and capabilities through a combination of product technology and asset acquisitions. As an initial implementation of this strategy, on October 30, 2003, for an investment of $1 million, the Company acquired a 16.7% minority interest in Altiva Corporation (“Altiva”), an early stage company which is building an asset portfolio through the acquisition of existing spinal products and systems as well as acquiring broad distribution rights to other existing spinal market technologies. As part of the agreement under which the Company purchased this minority interest, the Company has committed to make loans available to Altiva in an amount of up to $5 million for a period of five years as well as provide Altiva with, or guarantee on behalf of Altiva, a working capital credit line in an amount up to $6 million. The Company also entered into a Stockholders Agreement with Altiva and some stockholders of Altiva under the terms of which the Company was granted an option to purchase all of Altiva’s outstanding securities for a specified purchase price. See “Liquidity and Capital Resources”.

In 2002, the Company entered into a distribution agreement with Link, a German manufacturer of joint replacement systems, to distribute Link’s orthopaedic 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 existing product designs.

Overview of 2003

The year 2003 was a year of progress and growth for the Company. Total revenue increased 20% from 2002. Gross profit margin, aided by expanded internal manufacturing capabilities which could be conducted at lower costs, increased to 67.6% in 2003 from 67.0% during 2002. Increases in operating expenses were driven by research and development expenditures, which increased 34% from 2002, as the Company continued to move new product development projects forward. Overall, operating expenses increased 23% from 2002, relatively on pace with sales growth. Income from operations posted solid growth, up 15% from 2002. In 2003, the Company recognized the final payments due under a settlement agreement with Regeneration Technologies, Inc. (“RTI”), contributing to other income equaling 1% of total net sales. Net income increased 22% from the prior year, equaling the same 9% of net sales achieved in 2002.

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The balance sheet at the end of 2003 remained strong, enabling the Company to make several strategic investments in product line technologies, including a total shoulder system and entry into the spinal products market through its minority investment in Altiva Corporation. Working capital increased 9% to $33.6 million, and return on average shareholders’ equity increased to 13.6% in 2003, up from 13.1% in 2002. The Company’s operations continued to produce positive cash flow in 2003 of $8.4 million, down slightly from $8.6 million in the prior year, enabling the Company to invest in inventory for product line and distribution expansion.

The following table includes the net revenue and percentage of net sales for each of the Company’s product lines for the years ended December 31, 2003, 2002 and 2001:

Sales Revenue by Product Line

(dollars in thousands)

The following table includes: (i) items from the Statements of Income for the year ended December 31, 2003 as compared to 2002, the dollar and percentage change from year to year and the percentage relationship to net sales (ii) items from the Statements of Income for the year ended December 31, 2002 as compared to 2001, the dollar and percentage change from year to year and the percentage relationship to net sales (dollars in thousands):

Comparative Statement of Income Data

Net Sales Revenue

The increase in net sales revenue of 20% in 2003 from 2002 was primarily driven by strong growth in the Company’s knee implant product lines, both in the United States and internationally. During 2003, sales of knee implant products increased 23% in both the domestic and international markets. In the United States, the Company benefited from increased market share with its Optetrak^® comprehensive knee system, coupled with increases in average selling prices in the range of 4% to 6%. Internationally, the Company expanded its distribution in existing markets as well as entered new markets with the addition of several new distributors in Europe, the Middle East and Asia. While the overall increase in 2003 sales of hip implant products of 4% was disappointing, international sales of this product line grew 67% from 2002, as existing and new distributors expanded their product offering with the Company’s AcuMatch^® integrated hip systems. In the United States, sales of hip implants decreased 2% in 2003 from 2002, primarily due to the Company’s lack of an alternative acetabular bearing surface, like the ceramic to

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ceramic and metal to metal components that are gaining prominence in the industry. Looking forward, sales of hip implant products are anticipated to return to positive growth rates upon the release of a new press fit hip system currently scheduled for release in the second half of 2004. The increase in tissue services revenue of 34% in 2003 from 2002 resulted from expansion of the distribution channels along with expansion of the tissue service line to include Optefil^® bone paste. Sales revenue from other product lines increased 29% during 2003 as compared to 2002, primarily from increased sales of surgical instruments to new international distributors, along with a 41% increase in sales of Cemex^® bone cement as the Company achieved better market penetration in new and existing accounts.

During 2002, net sales revenue increased 27% from 2001, as the Company experienced sales growth in all of its major product lines. Worldwide sales of knee implant products increased 19% in 2002, as compared to 2001, while worldwide sales of hip implant products increased 37% during the same period. The growth in hip implant sales was fueled by the Company’s AcuMatch^® M-Series modular hip system and the addition of the Link Orthopaedics hip products line in the United States, which contributed a growth rate of 42% from 2001. Revenue from tissue services increased 38% in 2002 from 2001 as the Company began to benefit from the settlement of its dispute with RTI and implementation of a newly expanded distribution agreement. Sales of other product lines increased 55% during 2002 when compared to 2001, as the Company realized incremental sales of the Link Orthopaedic products, including the Link^® S.T.A.R.^™ ankle.

Gross Profit

The improvement in the gross profit margin to 67.6% in 2003 from 67.0% in 2002 was due to the benefits of lower cost internally manufactured components along with the increase in average sales prices. The Company continued to expand the quantity of its joint replacement implant products it manufactures in its facility with the addition of a limited second shift and the recently completed expansion of its production facility. Looking forward, the Company expects to continue to increase the percentage of components manufactured internally by ramping up capacity with capital acquisitions and additional personnel. This increased production strategy is expected to increase the gross profit margin during 2004 in the range of 50 to 75 basis points.

The gross profit margin increase to 67.0% in 2002 from 65.1% in 2001 was also 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.

Operating Expenses

Sales and marketing expenses increased 23% in 2003 from 2002, primarily as a result of 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. In addition to increases in variable expenses, the Company incurred expenses in connection with its collaboration with the Hospital for Special Surgery in New York City to host a continuing education conference for surgeons to address the challenges for improving the outcome for their patients with total joint arthroplasty (joint replacement). The 36% increase in sales and marketing expenses experienced in 2002 from 2001 were primarily attributable to increases in variable selling costs, marketing initiatives in the area of targeted market development campaigns, distribution network expansion efforts and the commencement of distribution of the Link Orthopaedics’ products in March 2002. The Company expects that sales and marketing expenses will remain in the range of 29% to 30% as a percentage of sales in 2004 as the Company continues many of its marketing programs.

The 23% increase in general and administrative expenses in 2003 from 2002 was primarily attributable to increases in the Company’s allowance for uncollectible accounts receivable, which increased 65%, as the Company implemented a more stringent collection policy and increases in product liability costs, which increased 124%. In 2004, the Company expects general and administrative expenses in the range of 9% to 10% of net sales, slightly lower than the prior three years, as comparative growth rates in product liability insurance and costs are anticipated to be lower. General and administrative expenses increased 28% in 2002 from 2001 primarily as a result of significant comparative increases in product liability insurance premiums over 2001 and costs associated with the initiation of distribution of the Link Orthopaedics products.

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Research and development expenses increased 34% in 2003 from the prior year due to the Company’s continuing development efforts to bring new and advanced products to market. The Company’s primary development efforts have focused on product line expansion of its OpteTrak^® knee system to include asymmetric (left and right) components, a new press fit hip stem system, a total shoulder system, and several advanced biologic based materials. Looking ahead, the Company expects similar increases in research and development expenses in 2004 to support the active projects in the pipeline for its knee, hip, shoulder, biologics and enhanced bearing surfaces technology. During 2002, research and development expenditures increased 27% from 2001 as a result of the efforts on new product technologies, product line extensions on the Company’s AcuMatch^® integrated hip systems and clinical outcomes research.

Depreciation and amortization expenses increased 19% in 2003 when compared to 2002, as the Company invested $10.8 million in capital, including $2.6 million to expand its facility, $1.0 million to purchase manufacturing equipment and $3.0 million in surgical instrumentation. Capital expenditures in 2004 are anticipated to range from $7 million to $8 million to support new product launches and increased manufacturing capacity. In 2002, depreciation and amortization increased 12% from 2001, primarily from the acquisition of $3.2 million in surgical instrumentation.

During 2003, royalty expenses increased 16% from 2002, primarily due to the strong sales growth in the Company’s knee implant products. For 2004, royalty expenses are anticipated to be consistent with the prior year of 2003, as a percentage of sales. The increase of 11% in 2002 from 2001 was also driven by strong growth in sales of knee implant products. As a percentage of sales, royalty expenses were relatively unchanged from 2003 and 2002, but were lower than 2001 levels as a result of the expiration of certain royalty agreements on the Company’s knee implant products.

Income from Operations

Income from operations increased 15% in 2003 from 2002, as growth in operating expenses outpaced sales growth. Looking forward, the Company anticipates growth in sales and gross profit margin, coupled with lower growth in operating expenses, to result in income from operations in the range of 13% to 15% of total net sales. The increase in income from operations in 2002 of 39% from 2001 resulted from strong sales growth, as well as production cost improvements.

Other Income and Expenses

Other income, net of other expenses, increased 212% primarily as a result of the final litigation settlement payments from RTI of $1.0 million. Due to its minority investment in Altiva Corporation, the Company expects other income, net of other expenses, for 2004 to be a net expense approximately equal to 1% of total net sales. In 2002, other income, due to the receipt of the initial litigation settlement payments received from RTI of $438,000, net of legal costs of $62,000, represented a decrease of 142% from a net expense in 2001.

Net Income

Income before provision for income taxes increased 20% in 2003 from 2002. The effective income tax rate for 2003 was 36.3%, as compared to 37.3% in 2002, as the Company realized the tax benefit of strong international sales growth, coupled with domestic sales growth in lower taxed states. In 2004, the Company expects an effective tax rate of approximately 37%. In contrast, the 37.3% effective tax rate in 2002 as compared to 36.5% in 2001, was the result of strong domestic sales growth, as a percentage of total sales, and reduction in the tax benefit of international sales.

As a result of the foregoing, the Company realized an increase in net income of 22% in 2003, representing 9.1% of sales and diluted earnings per share of $.57, as compared to 9.0% of sales and diluted earnings per share of $.48 in 2002. The 2002 net income increased 54% from 2001, which was 7.4% of net sales and diluted earnings per share of $.32.

Liquidity and Capital Resources

Historically, the Company has financed its operations through a combination of traditional,

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commercial debt financing, sales of equity securities and cash flows from its operating activities. At December 31, 2003, the Company had working capital of $33.6 million, an increase of 9% from $30.9 million at the end of 2002. Working capital increased primarily as a result of the Company’s investment in inventory to support implant product line expansion and increased distribution of tissue services. The Company anticipates similar increases in inventory during 2004 as occurred in 2003 as it continues its efforts to expand its business through broader product offerings. The Company projects that cash flows from its operating activities and borrowing under its existing line of credit will be sufficient to meet is commitments and cash requirements in the following twelve months.

Operating Activities

Operating activities continued to provide net cash during 2003; however, the $8.4 million total for the year was a decrease of 3% from the $8.6 million of cash provided by operating activities during 2002, primarily as a result of the Company’s increased inventory balances. Looking forward, the Company anticipates the investment in inventory to continue, with expected inventory balances at the end of 2004 to be in the range of $28 million to $30 million, dependent upon the completion of active product development projects. Even though inventory balances increased, the Company’s inventory management efforts during the year resulted in average inventory turns of 1.03, up from .97 during 2002. Inventory turns are anticipated to decrease slightly in the following twelve months as a result of the anticipated inventory build.

As a result of the Company’s focus on account management efforts during 2003, total accounts receivable balances increased 7% from 2002, well below the net sales growth rate of 20%, contributing to the realization of positive cash flow from operating activities. During 2003, the total days sales outstanding (DSO) ratio, based on average accounts receivable balances, decreased to 66 from 70 during 2002. The Company expects increases in accounts receivable during 2004 to be consistent with sales growth, and is not anticipating any significant changes in its credit terms.

During 2003, the Company increased its reserve for product liability claims and its commitment to acquire patented product technology, as reflected in the increase in other liabilities. While the timing and certainty of such claims is difficult to predict, the Company believes that its reserves are adequate and appropriately valued based on the best information available. The Company does not anticipate that future claims will have a material effect on the Company’s cash flows.

Investing Activities

Investing activities used $11.5 million in net cash during 2003 as the Company made significant investments in the expansion of its facility, surgical instrumentation, Altiva Corporation and the acquisition of patented product technologies. In 2003, investment in surgical instrumentation used cash of $3.0 million, while the expansion of the facility used cash of $2.6 million, along with $1.0 million in manufacturing equipment associated with the project. This use of cash represented an increase of 63% over 2002. The investment was consistent with management’s growth strategy and necessary to build the infrastructure to support the Company’s business moving forward. In 2004, investment in capital acquisitions is estimated to be in the range of $7 million to $8 million to support planned product introductions and manufacturing capacity increases.

Financing Activities

During 2003, financing activities provided net cash of $3.0 million to the Company from borrowing under its commercial loans for the expansion and equipping of its current facility. The facility expansion was completed in the second quarter of 2003; however, the equipping of the expanded manufacturing facility will continue into 2004 as the Company expects to invest between $1 million to $2 million in machinery to increase its internal manufacturing capacity. Based on outstanding options that will vest and become exercisable in 2004, cash provided by the issuance of common stock upon the exercise of options is anticipated to be in the range of $500,000 to $1.0 million.

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

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(excluding raw materials and work-in-process inventory) and 25% of inventory on consignment. The credit line expires June 30, 2004. The Company is currently reviewing a renewal of this line and expects to either renew or secure a similar line of credit facility. At December 31, 2003, the interest rate on the line of credit was 3.12%; however, there were no amounts outstanding under the line of credit. In 1998, the Company entered into an industrial revenue bond financing secured by a letter of credit with a local lending institution for construction of the Company’s current facility. The balance due under the bond as of December 31, 2003 was $2.7 million and bears, as of that date, a variable rate of interest equal to 1.3%.

In November 2002, the Company entered into a long-term commercial construction loan of up to $4.2 million, bearing interest at a rate equal to one month LIBOR plus 1.5%, with a local lending institution, secured by an existing letter of credit, to fund the recently completed expansion of its corporate facility. At December 31, 2003, there was $4.0 million outstanding under this loan, representing the fully funded amount, including the final draw. During February 2003, the Company entered into an additional long-term loan of up to $1.5 million, bearing interest at a rate of one month LIBOR plus 1.75% with a minimum rate equal to 3.5%, with a local lending institution for purposes of acquiring office and manufacturing equipment for its facility expansion. At December 31, 2003, $404,000 was outstanding under this loan and bears a variable rate of interest equal to 3.5%.

On October 30, 2003, the Company acquired for $1 million a 16.7% minority interest in Altiva Corporation. As part of the agreement under which the Company purchased this minority interest, the Company has committed to make loans available to Altiva in an amount of up to $5 million for a period of five years, the proceeds of which are to be used for the acquisition of various spine and spine-related product lines. These loans will be convertible into shares of the capital stock of Altiva, and in the event that the Company loans the full $5 million commitment, upon exercise of all outstanding balances under the loans, the Company will own a 54.5% interest in Altiva. In 2004, the Company expects to fund between $2 million to $4 million of loans in connection with this agreement, dependent upon the product line and technology acquisition opportunities available to Altiva. In addition, the Company has committed to provide Altiva with, or guarantee on behalf of Altiva, a working capital credit line in an amount up to $6 million, which would be collateralized by Altiva’s receivables and inventory. The Company, Altiva, all other holders of Altiva’s preferred stock and certain officers of Altiva have also entered into a stockholders agreement (the “Stockholders Agreement”) under the terms of which the Company was granted an option (the “Buyout Option”), exercisable any time between October 29, 2005 and October 28, 2008, to purchase all of the outstanding shares of Altiva’s common stock, preferred stock and securities that are convertible into common stock or preferred stock, or all or substantially all of the assets of Altiva. The purchase price payable under the Buyout Option will be based on a valuation of Altiva that is obtained by reference to a multiple which is indexed to the price of the Company’s common stock and multiplied by Altiva’s trailing twelve months revenue at the time the Buyout Option is exercised. The valuation of Altiva used to compute the purchase price of the Buyout Option may not be less than $25 million.

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 was in compliance with such covenants at December 31, 2003, and anticipates that it will remain in compliance with these covenants during the following twelve months.

Contractual Obligations and Commercial Commitments

The following table indicates the Company’s contractual obligations at December 31, 2003 (in thousands):

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At December 31, 2003, the Company did not have any off-balance-sheet financing arrangements or any unconsolidated, special purpose entities.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of its financial condition 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 included in this report. 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 due to increased expenses for the resulting uncollectible bad debt.

Excess and Obsolete Inventories- In the orthopaedic 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 is highly competitive with new products, raw materials and technologies being introduced continually, which may make 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 due to increased costs from the resulting adjustment.

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 in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets”. The Company analyzes its intangible assets for impairment issues 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 due to the resulting increases in operating expenses associated with such litigation.

Risk Factors

Although it is not possible to predict or identify all risk factors inherent in the Company’s business, they may include those listed below, which should not be considered an exhaustive statement of all potential risks and uncertainties:

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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. The Company cannot provide assurance that such clearances will be granted or that review by government authority will not involve delays that could materially adversely effect the Company’s revenues and earnings.

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Recent Accounting Pronouncements

See Note 2 of Notes to 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, 2003, and the weighted average interest rates are those experienced during the fiscal year ended December 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 international currency exchange rates on accounts receivable. In connection with some distribution agreements, the Company is subject to risk associated with international currency exchange rates on purchases of inventory payable in Euros. The Company does not invest in international currency derivatives. The U.S. dollar is considered the primary currency for the Company, and transactions that are completed in an international 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

TABLE OF CONTENTS

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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, 2003 and 2002, 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, 2003. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules 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, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

/s/ Deloitte & Touche LLP

Deloitte & Touche LLP

Certified Public Accountants

Jacksonville, Florida

March 1, 2004

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EXACTECH, INC.

BALANCE SHEETS

DECEMBER 31, 2003 AND 2002

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)