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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 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.

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EXACTECH, INC.

INDEX

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Item 1. Financial Statements

EXACTECH, INC.

CONDENSED BALANCE SHEETS

(in thousands)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

CONDENSED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(in thousands)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

See notes to condensed financial statements

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EXACTECH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements, which are for interim periods, have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission relating to interim financial statements. These unaudited condensed financial statements do not include all disclosures provided in the annual financial statements. The condensed financial statements should be read in conjunction with the financial statements and notes 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 nine month periods ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year.

2. OPTIONS AND STOCK AWARDS

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 nine month periods ended September 30, 2004 and 2003 (in thousands, except per share amounts):

3. INVENTORIES

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

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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 September 30, 2004 and December 31, 2003 (in thousands):

4. DEBT

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

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

At September 30, 2004, the Company was in compliance with all financial covenants provided for in its long-term debt agreements.

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5. COMMITMENTS AND CONTINGENCIES

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 former employees. The complaint sought damages in an undisclosed amount alleging that a former employee of Exactech, 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 by the court on April 21, 2004.

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 itself 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 Exactech has been able to obtain insurance coverage concerning product liability claims at a cost and on other terms and conditions that have been acceptable, Exactech may not be able to procure acceptable policies in the future.

Purchase Commitments

At September 30, 2004, Exactech had outstanding commitments for the purchase of inventory and raw materials of $9.5 million, along with commitments to purchase $2.8 million of capital equipment. At September 30, 2004, Exactech had outstanding purchase commitments associated with certain distribution agreements of $3.2 million throughout the remaining two year term of the agreements.

Financing Commitments

Exactech has committed to make loans available to Altiva Corporation 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 September 30, 2004, the Company has extended $500,000 to Altiva under this commitment. On November 2, 2004, the Company extended an additional $515,000 for a product line acquisition by Altiva. 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 September 30, 2004, there was $312,000 outstanding under this line. The Company recognized a contingent liability of $132,000 based on the fair value of this guarantee. 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 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. Pursuant to the requirements of Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN 46R”), Exactech has evaluated its investment in Altiva related to these financing commitments to determine if Altiva should be

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consolidated in Exactech’s financial statements. As of September 30, 2004, based on this evaluation, management believes that Altiva should not be consolidated. Moving forward, we will conduct the same evaluation each interim period to determine the necessity to consolidate Altiva into our financial statements. Should Exactech fully fund all of the commitments, dependent on the operating performance of Altiva, future funding by Exactech and draws on the line of credit guaranteed by Exactech, Exactech may be required to consolidate Altiva under the provisions of FIN 46R.

6. SEGMENT INFORMATION

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. 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:

Total assets not identified with a specific segment (in thousands of dollars) were $37,052 at September 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 nine month periods ended September 30, 2004 and 2003, Exactech invested (in thousands of dollars) $2,462 and $3,488 respectively, on non-segment specific capital expenditures.

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Geographic distribution of sales is summarized in the following table:

7. SHAREHOLDERS’ EQUITY

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

At September 30, 2004, there were 1,055,246 options to purchase shares of common stock at prices ranging from $3.34 to $21.09 per share outstanding. For the three months ended September 30, 2004, there were 12,000 options at an exercise price of $21.09 per share excluded from the computation

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of diluted EPS because the options’ exercise price was greater than the average market price of the common shares. At September 30, 2003, there were 1,024,280 options to purchase shares of common stock at prices ranging from $3.34 to $14.46 per share outstanding. For the three months ended September 30, 2003, there were no options excluded from the computation of diluted EPS.

For the nine months ended September 30, 2004, there were 12,000 options at an exercise price of $21.09 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 nine months ended September 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.

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

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

Overview of Exactech

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 and the InterSpace^™ pre-formed cement hip and knee spacers, 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 payments made to the owners of patents and 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 direct customer contact and service to orthopaedic surgeons as our primary marketing focus and traditional targeted media marketing. Since surgeons are the primary decision makers 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 Nine Months Ended September 30, 2004

Net revenue for the third quarter ended September 30, 2004 increased 15% to $19.5 million, from $17.0 million in the third quarter of 2003. Net income for the quarter increased 9% to $1.7 million, or $.14 per diluted share, compared to $1.5 million, or $.13 per diluted share, in the third quarter of 2003.

For the nine months ended September 30, 2004, revenue increased 15% to $60.9 million from $52.8 million in the first nine months of 2003. Net income for the first nine months of 2004 was up 15% to $5.4 million, or $.47 per diluted share, compared to $4.7 million, or $.41 per diluted share, in the first nine months of 2003.

Gross margins for the quarter ended September 30, 2004 of 68% remained constant as compared to the quarter ended September 30, 2003. For the nine months ended September 30, 2004, gross margins were 67%, the same as the nine months ended September 30, 2003. For the third quarter of 2004, total operating expenses increased 11% to $10.3 million from $9.3 million in the same quarter last year. For the nine months ended September 30, 2004, total operating expenses increased at the same rate of 11% to $31.7 million as compared to $28.6 million in the comparable nine month period ended September 30, 2003.

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As expected, increases in inventory caused inventory turns in the third quarter to decrease to .90 compared with .98 in the third quarter a year ago. For the nine months ended September 30, 2004, inventory turns were down to 1.00 as compared to 1.07 for the nine months ended September 30, 2003. Accounts receivable days sales outstanding, on an average annualized basis, decreased from 76 days in the quarter ended September 30, 2003 to 74 days in the quarter ended September 30, 2004 and 65 for the nine months ended September 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 nine month periods ended September 30, 2004 and September 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 nine months ended September 30, 2004 as compared to the three and nine months ended September 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