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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

for the quarterly period ended September 30, 2004

or

Commission file number 000-30406

HealthTronics Surgical Services, Inc.

(Exact name of registrant as specified in its charter)

(770) 419-0691

(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.

12,282,000 Shares of No Par Value Common Stock as of October 31, 2004

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HEALTHTRONICS SURGICAL SERVICES, INC.

INDEX TO FORM 10-Q

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Part 1. Financial Information

Item 1. Financial Statements

HealthTronics Surgical Services, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(000’s omitted)

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See accompanying notes.

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HealthTronics Surgical Services, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

(000’s omitted except per share information)

See accompanying notes.

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HealthTronics Surgical Services, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(000’s omitted)

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HealthTronics Surgical Services, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (continued)

(Unaudited)

(000’s omitted)

See accompanying notes.

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The accompanying condensed consolidated financial statements include the accounts of HealthTronics Surgical Services, Inc. (“HealthTronics” or the “Company”) and its subsidiaries. All significant intercompany transactions have been eliminated.

In the opinion of HealthTronics management, the accompanying consolidated financial statements include all the necessary adjustments (consisting of normal recurring adjustments) for a fair presentation of its consolidated financial position and results of operations for the interim periods presented. The information presented in these financial statements was prepared in conformity with accounting principles generally accepted in the United States for interim financial information and instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Although management believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission.

Preparation of these interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The interim results may not be indicative of the results that may be expected for the year.

Certain prior year balances have been reclassified to conform to the 2004 presentation.

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Revenue Recognition, Gain Recognition and Allowance for Doubtful Accounts

Net revenue includes treatment fees for medical procedures in the clinical setting. Treatment revenue is primarily “wholesale” or “retail”. Wholesale revenue is generated primarily from fixed fee contracts with various medical facilities and is recorded in the month the related treatments are performed. Retail revenue, which results from directly billing third party payors for medical facility and technical fees, is recorded at the time services are rendered. These third party billings may or may not be contractual. We record a contractual allowance representing the difference between our established billing rates and the estimated amounts to be received from various payors in accordance with the provisions of the AICPA Audit and Accounting Guide – Health Care Organizations.

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For new procedures such as the orthopaedic shock wave therapy, we record revenue and the estimated contractual allowance at the time this elective procedure is performed based upon: (1) our verification of payment and coverage of this elective procedure, prior to the performance of the procedure, for the patient with the appropriate payor; and (2) our established payment history for each payor. Differences in estimates recorded and final settlements are reported during the period final settlements are made. The Company has certain negotiated agreements with third party payors that provide for payments to the Company or its subsidiaries. These payment arrangements may be based upon negotiated rates or per diem payments. Revenues are reported at the estimated net realizable amounts from medical facilities, contracted and non-contracted third party payors and individual patients for services rendered.

For sales of medical devices to unaffiliated entities, revenue is recognized upon delivery at the customer’s destination and customer acceptance.

We may sell medical devices to certain entities in which we have an interest and may have guaranteed a portion of the long-term obligations related to such purchases. We eliminate profits on such transactions where the purchaser is a consolidated subsidiary of ours. A pro rata portion of the profit representing our percentage ownership will be deferred on sales to unconsolidated subsidiaries where we have accounted for our investment interest using the equity or cost basis methods of accounting (depending on our ability to exercise significant influence over the operating and financial policies of the joint venture).

Revenue generated from service contracts is recognized ratably over the life of the related contract.

The gain on the sale of subsidiary and investment interest is the difference between the sale proceeds and HealthTronics’ carrying value of the subsidiary or investment interest. In accordance with Statement of Financial Accounting Standards 142, Goodwill and Other Intangible Assets, HealthTronics allocates goodwill from the reporting unit level to the carrying value of the subsidiary or investment interest for purposes of calculating the gain.

Accounts receivable consist primarily of amounts due from the medical facilities or partnerships, managed care health plans, commercial insurance companies and individual patients. The Company does not charge interest on its accounts receivable. Estimated provisions for doubtful accounts are recorded to the extent it is probable that a portion or all of a particular account will not be collected. In evaluating the collectibility of accounts receivable, the Company considers a number of factors, including the age of the accounts, changes in collection patterns, the composition of accounts by payor type, the status of ongoing negotiations with third party payors and general industry conditions. Changes in these estimates are charged or credited to the results of operations in the period of the change. The Company writes off accounts receivable when all collection efforts have been exhausted.

Inventory

Inventory is carried at the lower of historical cost (first-in, first-out) or market and consists of medical devices, spare parts, assemblies and consumables.

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Consolidation and Partnership Investments

The consolidated financial statements include the accounts of the Company, our wholly-owned subsidiaries, and entities more than 50% owned and limited partnerships where we, as the general partner, exercise effective control, even though our ownership is less than 50%. The related partnership agreements provide for broad powers by the general partner. The limited partners do not participate in the management of the partnership and do not have the substantial ability to remove the general partner. In accordance with FASB Interpretation 46 R, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, the Company determined that it does not have any significant VIE’s. Investments in entities in which our investment is less than 50% ownership and we do not have significant control are accounted for by the equity method if ownership is between 20%-50%, or by the cost method if ownership is less than 20%, except for certain entities, which in accordance with EITF D-46, we use the equity method if we have a greater than 3% interest. All significant intercompany accounts and transactions have been eliminated.

Variable Interest Entities

In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46”). In December 2003, the FASB modified FIN 46 to make certain technical corrections and address certain implementation issues that had arisen. FIN 46 provides a new framework for identifying variable interest entities (“VIEs”) and determining when a company should include the assets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements.

In general, a VIE is a corporation, partnership, limited-liability corporation, trust, or any other legal structure used to conduct activities or hold assets that either (1) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (2) has a group of equity owners that are unable to make significant decisions about its activities, or (3) has a group of equity owners that do not have the obligation to absorb losses or the right to receive returns generated by its operations.

FIN 46 requires a VIE to be consolidated if a party with an ownership, contractual or other financial interest in the VIE (a variable interest holder) is obligated to absorb a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the VIE’s residual returns (if no party absorbs a majority of the VIE’s losses), or both. A variable interest holder that consolidates the VIE is called the primary beneficiary. Upon consolidation, the primary beneficiary generally must initially record all of the VIE’s assets, liabilities and noncontrolling interests at fair value and subsequently account for the VIE as if it were consolidated based on majority voting interest. FIN 46 also requires disclosures about VIEs that the variable interest holder is not required to consolidate but in which it has a significant variable interest. The Company does not have any significant variable interests in a VIE and the Company does not consolidate any VIEs.

Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, management reviews long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates the carrying amount of the asset may not be recoverable and the future undiscounted cash flows expected to be generated by the asset are less than its carrying amount. If such assets are considered to be impaired, the Company records

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impairment losses and reduces the carrying amount of impaired assets to an amount that reflects the fair value of the assets at the time impairment is evident. The Company’s impairment review process relies on management’s judgment regarding the indicators of impairment, the remaining lives of assets used to generate assets’ undiscounted cash flows, and the fair value of assets at a particular point in time. Management uses historical experience, current market appraisals and various other assumptions to form the basis for making judgments about the impairment of real estate assets. Under different assumptions or conditions, the asset impairment analysis may yield a different outcome, which would alter the gain or loss on the eventual disposition of the asset.

Property and Equipment

Property and equipment is stated at cost. Depreciation (which includes amortization of assets under capital leases) is computed based on the straight-line method over three to seven years based on the estimated useful lives of the related equipment or over the term of the related lease or over 39 years for buildings.

Income Taxes

The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered or settled.

The Company recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The Company regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance based upon projected future taxable income and the expected timing of the reversals of existing temporary differences.

The Company is unable to realize the benefit of net losses of foreign subsidiaries resulting in a tax rate in excess of the statutory rate.

Stock Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for employee stock options and adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation

(“SFAS 123”) as amended by Statements of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transitional Disclosure, an Amendment to SFAS No. 123, (“SFAS 148”) for option grants to employees. The Company generally grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant and, accordingly, recognizes no compensation expense for the employee stock option grants.

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The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS 123 as amended by SFAS 148.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates and such differences may be material.

Related Party Transactions

Transactions between related parties and between different subsidiaries of the Company occur in the normal course of business. The Company eliminates transactions with its consolidated subsidiaries and appropriately discloses significant related party transactions.

Concentrations of Credit Risk

The Company sells its products primarily in the United States. Credit is extended based on an evaluation of the customer’s financial condition and collateral is generally not required. Accounts receivable are generally receivable from medical facilities, insurance companies or patients.

Fair Value of Financial Instruments

The Company’s financial instruments are comprised principally of cash and cash equivalents, trade accounts receivable, amounts due from affiliated partnerships, trade accounts payable, customer deposits, short-term borrowings and long-term debt. The carrying amounts of these financial instruments approximate their fair values.

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Long-Lived Assets

The Company has recorded property, plant and equipment and intangible assets at cost less accumulated depreciation and amortization. The determination of useful lives and whether or not these assets are impaired involves significant judgment. The Company reviews long-lived assets, including identifiable intangible assets whenever events or changes in circumstances indicate the carrying amounts of such assets may not be recoverable. Intangible assets determined to have definite lives are amortized over their remaining useful lives.

Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases. Goodwill is subject to annual testing, during the fourth quarter, for impairment at the reporting unit level unless events or circumstances indicate the carrying amount is impaired as compared to its estimated fair value as determined using estimated discounted cash flows. Reporting units are: Lithotripsy, Orthopaedics, TUMT, Cryotherapy and Manufacturing, Sales and Service.

Other Comprehensive Income

Effective February 12, 2002, the Company entered into two two-year interest rate swap agreements which qualified as cash flow hedges and matured on February 12, 2004. These hedges were highly effective and, thus, the change in fair values for the three and nine months ended September 30, 2004 are reported as other comprehensive income of $0 and $32,000, respectively, and for the three and nine months ended September 30, 2003 are reported as other comprehensive income of $85,000 and $206,000, respectively.

HealthTronics Surgical Services, Inc. (the “Company”) was incorporated in the state of Georgia in 1995. On July 21, 1997, the Company received FDA approval to market the LithoTron^®, a kidney lithotripsy device manufactured by HMT High Medical Technologies AG (“HMT”). On October 12, 2000, the Company received FDA approval to market the OssaTron^®, an HMT manufactured orthopaedic shock wave medical device, for treatment of chronic plantar fasciitis, commonly known as chronic heel pain. On March 13, 2003, HealthTronics also received FDA approval to market the OssaTron for treatment of chronic lateral epicondylitis, commonly known as tennis elbow. The Company is currently establishing additional test sites for OssaTron FDA clinical trials for additional applications.

In October 2000, with the FDA approval of the OssaTron the Company began establishing orthopaedic partnerships for the purpose of purchasing, owning and operating OssaTron devices. HealthTronics contributed certain capital to partnerships and offered equity interests to third parties. As sole general partner, through its subsidiary, HT Orthotripsy Management Company, LLC, the Company maintains control and, therefore, consolidates the second tier orthopaedic partnerships. The Company has equity interests in these partnerships ranging from 5% to 100%.

The Company operates under the terms of distribution agreements with HMT that

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grant the Company the exclusive right to use, sell and lease the OssaTron and related devices and parts in the United States, Canada and Mexico. On March 5, 2004, the Company purchased the outstanding capital stock of HMT Holding AG (“HMT Holding”), a Swiss company, which holds a 72.4% voting interest and a 39.7% financial interest in HMT.

It is the Company’s intent to generate revenues from four sources: 1) fees for clinical services provided by consolidated subsidiaries; 2) recurring revenues from sales of consumable products and maintenance of equipment; 3) sales of medical devices including related accessories; and 4) management, leasing and licensing fees. The Company also generates gains from sales of partnership investment interests.

In December 2001, the Company purchased 100% of the outstanding stock of Litho Group, Inc. (“LGI”) for $42,500,000 in cash. Through its various 100% subsidiaries, LGI is the sole general partner of several separate second and third tier lithotripsy partnerships with equity interests ranging from 15% to 100%, operating in the northern, eastern and southern United States. As sole general partner, LGI consolidates the second and third tier partnerships. The Company is also general partner or managing partner in various separate lithotripsy partnerships, which it controls and, therefore, consolidates.

The accompanying consolidated financial statements include the accounts of each of the Company’s subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

On April 1, 2004, the Company increased its ownership interest in Tenn-Ga Stone Group Three (“Tenn-Ga III”), a Tennessee general partnership, from 30% to 97% for $967,800. Prior to this acquisition, Tenn-Ga III was included in the Company’s consolidated operations based on the Company’s ability to exercise control. In conjunction with this acquisition, Tenn-Ga III purchased all of the outstanding capital stock in NGST, Inc. (“NGST”), a Tennessee corporation, for $1,116,000. In connection with this transaction, the Company purchased approximately 9% of NGST from the Company’s chief executive officer. Tenn-Ga III and NGST collectively own a 75% interest in Tenn-Ga Stone Group Two (“Tenn-Ga II”), a Tennessee general partnership. The Company’s purchase of an additional 67% of Tenn-Ga III and indirect purchase of 100% of NGST increased the Company’s indirect ownership of Tenn-Ga II from 11% to 73%. As a result of the above transactions, the Company has consolidated the operations of NGST and Tenn-Ga II since April 1, 2004 as part of the Company’s Lithotripsy reporting and business segment.

The purchase price was determined and negotiated by the parties based on the expected annual cash flow to be generated by the company purchased. The Board of Directors of HealthTronics, independent of the Company’s CEO, approved the final purchase price of NGST. The Company financed the acquisitions under its current bank financing arrangement.

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On March 5, 2004, the Company, through a wholly owned subsidiary, purchased all of the issued and outstanding capital shares of HMT Holding, from its five individual shareholders for $1,000 and 800,000 of the Company’s shares valued at $5,091,000. In September 2004 the Company negotiated the return of 160,000 of the Company’s shares held in escrow. The return of these shares, valued at $1,018,000, was recorded as a reduction of the purchase price of HMT. The purchase price was determined and negotiated by the parties based on the expected annual cash flow to be generated by HMT Holding and upon the value of certain licenses, patents and manufacturing rights to medical devices. The fair value of the Company’s common stock issued to acquire all of HMT Holding’s outstanding common stock was determined based on the average market price of the Company’s common stock just prior to and following the date of the acquisition agreement, in accordance with Emerging Issues Task Force (“EITF”) Issue No. 99-12. HMT Holding owns 72.4% of the voting shares and 39.7% of the financial interest shares of HMT, the primary supplier of the medical devices sold by the Company. HMT consolidates its Swiss manufacturing operations and its wholly owned distributorships in Japan, Germany and the United States of America. The Company, through its voting share interest, has the ability to exercise control over the operating and financial policies of HMT and its subsidiaries and therefore, the Company has consolidated the financial position and results of operations of HMT. The Company has consolidated the operations of HMT Holding and its subsidiaries since the date of acquisition as part of the Company’s manufacturing sales and service reporting unit and business segment. The Company also contributed approximately $1,550,000 to HMT Holding which HMT Holding used to repay its bank debt.

The estimated purchase prices of the above acquisitions have been allocated on a preliminary basis to assets and liabilities based on management’s estimate of their fair values. These allocations are subject to change pending the completion of the final analyses of the fair value of certain of its assets including, but not limited to evaluating licenses, patents, contracts and manufacturing rights to medical devices in order to finalize its purchase price allocations. Based on the results of these evaluations, the preliminary purchase price allocations may be subject to change.

The table below represents pro forma financial information for the nine months ended September 30, 2004 and 2003 as if the above acquisitions had occurred on January 1, 2004 and 2003, respectively.

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HealthTronics Surgical Services, Inc. and Subsidiaries

Pro Forma Combined Condensed Statements of Income

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004

(UNAUDITED)

HealthTronics Surgical Services, Inc. and Subsidiaries

Pro Forma Combined Condensed Statements of Income

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003

(UNAUDITED)

As a result of the March 5, 2004 business combination with HMT Holding, the Company has established a restructuring plan whereby it will consolidate certain of its administrative, sales and distribution activities. The plan requires the closing or relocation of certain facilities and the relocation or termination of certain employees employed in such activities acquired at March 5, 2004. The Company accrued approximately $8,192,000 as a liability assumed in the purchase of HMT Holding, as of June 30, 2004. The Company paid approximately $1,077,000 of these costs and reduced the remaining accrual by $1,481,000 primarily related to the renegotiation of certain severance agreements. As a result, the Company’s revised accrual of $5,634,000 as of September 30, 2004 represents its best estimate to date of these remaining costs. The Company will continue the process of finalizing its estimates of these related costs which are expected to impact the final aggregate purchase price.

On June 11, 2004, the Company executed a definitive Agreement and Plan of Merger with Prime Medical Services, Inc. (“Prime”). Under the terms of that agreement, Prime stockholders will receive one share of the Company common stock for each share of Prime common stock. If the merger is approved, Prime’s stockholders will own approximately 62% of the shares of HealthTronics common stock, and Prime’s directors and senior management will represent a majority of the combined company’s directors and senior management; therefore Prime will be deemed to be the acquiring company for

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accounting purposes and the merger will be accounted for as a reverse acquisition under the purchase method of accounting for business combinations in accordance with accounting principles generally accepted in the United States.

Inventory is carried at the lower of cost (first-in, first-out) or market and consists of the following:

The Company sold a portion of the partnership interests of certain limited partnerships and recognized gains of $3,000 and $258,000 for the three and nine months ended September 30, 2004, respectively and $2,129,000 and $4,344,000 for the three and nine months ended September 30, 2003, respectively. The gains represent the excess of the sales price over the Company’s investment basis in the partnership interest. The Company allocates goodwill from the reporting unit level to the carrying value of the subsidiary or investment interest for purposes of calculating the gain.

In order to protect the Company from interest rate volatility, effective February 12, 2002, the Company entered into two two-year interest rate swap agreements (“the swaps”) that matured on February 12, 2004. The total notional amount of swap agreements was $0 and $12,600,000 at September 30, 2004 and December 31, 2003, respectively. The swaps effectively converted a portion of the Company’s floating-rate debt to a fixed-rate basis through February 12, 2004, thus reducing the impact of interest-rate changes on interest expense. This fixed rate was 3.2525% plus the applicable percentage (2.5% during the third quarter of 2003). The swaps qualified as cash flow hedges under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, and expired on February 12, 2004. The Company believes that its hedges were effective with changes in fair value to be reported in other comprehensive income. As of September 30, 2004 and December 31, 2003, the market value of the derivatives was a liability of approximately $0 and $32,000, respectively, which is included on the accompanying balance sheet. The change in fair values for the three and nine months ended September 30, 2004 are reported as other comprehensive income of $0 and $32,000, respectively, and for the three and nine months ended September 30, 2003 are reported as other comprehensive income of $85,000 and $206,000, respectively.

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The counterparty to the interest rate swap agreements was a major commercial bank. The Company was exposed to counterparty credit risk for nonperformance and, in the event of nonperformance, to market risk for changes in interest rates.

The components of comprehensive income are as follows for the three and nine months ended September 30, 2004 and 2003:

The following table sets forth the computation of earnings per share:

The Company applies the disclosure provisions of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. Effective April 1, 2003, the Company internally reorganized its operating structure and as a result the Company’s business units have been aggregated into three reportable operating segments: Lithotripsy; Orthopaedics; and Manufacturing, Sales and Service. The factors for determining the reportable segments were based on the distinct nature of their operations. They are disclosed as separate operating segments because these business units each have different marketing strategies due to differences in types of consumers, different market conditions and different capital requirements. Asset information by segment, including capital expenditures, and net income beyond operating margins are not provided to the Company’s chief operating decision maker. In fiscal 2003, the Company changed from one reportable segment to three reportable segments. For all periods presented, the corresponding items of segment information have been reclassified to conform to the current presentation.

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The Lithotripsy segment provides lithotripsy services to physicians and medical facilities. The Orthopaedics segment provides non-invasive surgical solutions for a variety of orthopaedic conditions. The Manufacturing, Sales and Service segment represents manufacturing, sales and service of medical devices and related products. The “Other” category includes the Company’s non-reportable segments.

The Company primarily evaluates segment performance based on the income or loss before income taxes from its operating segments, which do not include unallocated corporate overhead and intersegment eliminations.

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