Back to GetFilings.com

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2004

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 Rule 12b-2 of the Exchange Act).

Yes x No ¨

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

EXACTECH, INC.

INDEX

1

EXACTECH, INC.

CONDENSED BALANCE SHEETS

(in thousands)

(Unaudited)

See notes to condensed financial statements

2

EXACTECH, INC.

CONDENSED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(Unaudited)

See notes to condensed financial statements

3

EXACTECH, INC.

CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(in thousands)

(Unaudited)

See notes to condensed financial statements

4

EXACTECH, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See notes to condensed financial statements

5

EXACTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2004 AND 2003

(Unaudited)

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 contained in the Annual Report on Form 10-K for the year ended December 31, 2003 of Exactech, Inc. (the “Company” or “Exactech”), as filed with the Securities and Exchange Commission.

All adjustments of a normal recurring nature which, in the opinion of management, are necessary to fairly present the results for the interim periods have been made. Results of operations for the three and six month periods ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year.

Exactech accounts for stock-based compensation utilizing the intrinsic value method per Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”. The Company’s 2003 Executive Incentive Compensation Plan provides for issuance of stock-based compensation, including the grant of stock, stock appreciation rights, stock options, and other stock-based compensation. Under the plan, the exercise price of option awards equals the market price of Exactech’s stock on the date of grant. Option 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 ten years.

The following table provides an expanded reconciliation of earnings per share as reported under APB No. 25 and the pro forma impact of stock-based compensation measured under the fair value approach in Statement of Financial Accounting Standards (“SFAS”) No. 123 for each of the three and six month periods ended June 30, 2004 and 2003 (in thousands, except per share amounts):

6

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities”. The Interpretation requires consolidation of entities with certain equity characteristics that are controlled through interests other than a majority of voting rights. In December 2003, the FASB issued a revision to FIN 46 (“FIN 46R”) to clarify and expand on accounting guidance for variable interest entities. The application of FIN 46R for companies with interests in a special purpose entity is required for fiscal years ending after December 15, 2003. The Company does not have any unconsolidated variable interests that require consolidation under FIN 46R as of June 30, 2004, and as a result, the adoption of FIN 46R on January 1, 2004 did not have an impact on the Company’s financial condition, results of operations or cash flows.

Inventories are valued at the lower of cost (first-in, first-out method) or market and include implant inventory provided to customers and agents. Exactech also provides significant amounts of consigned implant inventory to non-distributor customers. The Company’s accounting policies provide for write downs to its inventory, as necessary, based on management’s evaluation of its excess and obsolete inventory. This impairment write down establishes a new cost basis for such inventory and is not subsequently recovered through income. The following table summarizes the Company’s classifications of inventory as of June 30, 2004 and December 31, 2003 (in thousands):

Long-term debt consists of the following at June 30, 2004 and December 31, 2003 (in thousands):

7

The following is a schedule of debt maturities as of June 30, 2004 (in thousands):

Litigation

Centerpulse Orthopedics, Inc. filed a lawsuit in the Civil Court in the Eighth Judicial Circuit, Alachua County, Florida, against Exactech and one of Exactech’s employees. The complaint sought damages in an undisclosed amount alleging that Exactech’s employee who is a former employee of Centerpulse, breached a noncompete and confidentiality agreement, and that Exactech is liable for tortious interference with that agreement. This complaint was dismissed with prejudice by the court on April 28, 2004, pending finalization of a proposed settlement agreement between the Parties.

There are various other claims, lawsuits, disputes with third parties and pending actions involving various allegations against Exactech 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 that it will not face claims resulting in substantial liability for which it is not fully insured or that it will be able to maintain adequate levels of insurance on acceptable terms. A partially or completely uninsured successful claim against Exactech of sufficient magnitude could have a material adverse effect on its earnings and cash flows due to the cost of defending ourselves against such a claim. Exactech establishes accruals for losses that are deemed to be probable and subject to reasonable estimation.

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

Purchase Commitments

At June 30, 2004, Exactech had outstanding commitments for the purchase of inventory and raw materials of $2,993,000, along with commitments to purchase $644,000 of capital equipment. At June 30, 2004, Exactech had outstanding purchase commitments associated with certain distribution agreements of $3,528,000 throughout the remaining two year term of the agreements.

Financing Commitments

Exactech has committed to make loans available to Altiva Corporation (“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. As of June 30, 2004, no loans had been extended to Altiva by Exactech under this commitment, although we expect to begin providing funding to Altiva in the third quarter ending September 30, 2004. These loans can be converted into shares of the capital stock of Altiva, and in the event that Exactech loans the full $5 million commitment, upon exercise of all outstanding balances under the loans, Exactech will own a 54.5% interest in Altiva. In addition, Exactech is 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 all of Altiva’s assets, subject to the prior liens of the lender that provides the working capital line to Altiva. Pursuant to this commitment, the Company has guaranteed an initial $3 million line of credit with Merrill Lynch Business Financial Services, Inc. (“Merrill Lynch”). At June 30, 2004, there were no amounts outstanding under this line. Altiva, all other holders of Altiva’s preferred stock and certain officers of Altiva have also entered into a stockholders

8

agreement (the “Stockholders Agreement”) under the terms of which Exactech 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 Exactech’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 reports segment information by its major product lines: knee products, hip products, tissue services, and other products. The “other products” segment includes miscellaneous sales categories, such as surgical instruments held for sale, bone cement, instrument rental fees, shipping charges, and other implant product lines like the Link^® S.T.A.R.^TM ankle. The Company evaluates the performance of its operating segments based on their respective income from operations before taxes, interest income and expense, and nonrecurring items. Intersegment sales and transfers are not significant.

Summarized financial information concerning the Company’s reportable segments is shown in the following table (in thousands):

Segment assets are summarized in the following table. Capitalized surgical instruments are reported as assets of the segment associated with the appropriate implant product line supported by those assets:

9

Total assets not identified with a specific segment (in thousands of dollars) were $37,379 at June 30, 2004 and $34,286 at December 31, 2003. Assets not identified with a specific segment include cash and cash equivalents, accounts receivable, refundable income taxes, prepaid expenses, land, facilities, office furniture and computer equipment, and other assets. During the six month periods ended June 30, 2004 and 2003, Exactech invested (in thousands of dollars) $1,195 and $3,079 respectively, on non-segment specific capital expenditures.

Geographic distribution of sales is summarized in the following table:

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):

10

At June 30, 2004, there were 1,074,046 options to purchase shares of common stock at prices ranging from $3.34 to $18.60 per share outstanding. For the three months ended June 30, 2004, there were no options excluded from the computation of diluted EPS. At June 30, 2003, there were 1,043,080 options to purchase shares of common stock at prices ranging from $3.34 to $14.46 per share outstanding. For the three months ended June 30, 2003, there were 89,000 options at an exercise price of $14.46 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.

For the six months ended June 30, 2004, there were 135,200 options at an exercise price of $18.60 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. For the six months ended June 30, 2003, there were 89,000 options at an exercise price of $14.46 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.

11

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

Overview of the Company

Exactech 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. Our revenues are primarily derived from sales of our knee and hip joint replacement systems; however, revenues from worldwide distribution of bone paste products processed for use in non-spinal musculoskeletal orthopaedic procedures have steadily increased as a percentage of our total revenues. Revenue from sales of other products, including surgical instrumentation, Cemex^® bone cement, the InterSpace^™ pre-formed cement hip and knee spacers and the Link^® S.T.A.R.^TM ankle, are expected to contribute to our anticipated revenue growth. Except where the context otherwise requires, the terms “we,” “us,” or “our” refer to the business of Exactech, Inc.

Exactech’s operating expenses consist of sales and marketing expenses, general and administrative expenses, research and development expenses, depreciation and amortization 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 our 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, hip, shoulder and biological products. 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 us for our product development and manufacturing uses. Knee implant products generally carry a higher royalty charge than other implant products.

In marketing our products, Exactech uses a combination of traditional targeted media marketing and our 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, Exactech’s marketing strategy is focused on developing relationships and meeting the needs of the surgeon community in the orthopaedic industry. In cooperation with our independent domestic sales agencies and network of independent distributors internationally, we conduct this effort through continuing education forums, training programs and product development advisory panels.

Overview of the Three and Six Months Ended June 30, 2004

During the quarter ended June 30, 2004, revenue increased 15% to $20.4 million from $17.8 million in the second quarter of 2003. Net income for the quarter increased 15% to $1.9 million, or $.16 per diluted share, from $1.6 million, or $.14 per diluted share, in the second quarter of 2003.

For the first six months of 2004, revenue was $41.4 million, an increase of 16% over revenue of $35.8 million in the first six months of 2003. Net income for the first six months was $3.8 million or $.32 per diluted share, an increase of 17% over $3.2 million or $.28 per diluted share in the first half of 2003.

Gross margin for the second quarter was 66.3% compared to 66.2% in the prior comparable quarter. For the first six months of the year, gross margin was 66.6% as compared to 66.9% in the first six months of last year. Total operating expenses in the quarter increased 11% to $10.4 million. For the first six months, operating expenses increased at the same rate, 11%, to $21.4 million from $19.3 million in the first six months of 2003.

Inventory turns in the second quarter decreased to 1.05 compared with 1.14 in the second quarter a year ago. For the six months ended June 30, 2004, inventory turns were down to 1.08 as compared to 1.14 for the six months ended June 30, 2003. Accounts receivable days sales outstanding on an average annualized basis decreased from 73 days in the quarter

12

ended June 30, 2003 to 71 days in the quarter ended June 30, 2004 and 65 for the six months ended June 30, 2004, down from 69 days for the same period last year.

The following table includes the net revenue and percentage of net sales for each of Exactech’s product lines for the three and six month periods ended June 30, 2004 and June 30, 2003:

Sales Revenue by Product Line

(dollars in thousands)

The following table includes items from the Condensed Statements of Income for the three and six months ended June 30, 2004 as compared to the three and six months ended June 30, 2003, the dollar and percentage change from period to period and the percentage relationship to net sales (dollars in thousands):

Comparative Statement of Income Data