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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   For the quarterly period ended September 30, 2011
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   For the transition period from              to             

Commission File Number 0-28240

 

EXACTECH, INC.

(Exact name of registrant as specified in its charter)

 

FLORIDA   59-2603930

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x   No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  ¨   Accelerated Filer  x   Non-Accelerated Filer  ¨   Smaller Reporting Company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨   No x

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

 

                Class                 

 

                Outstanding at November 4, 2011                

Common Stock, $.01 par value   13,140,792

 

 


Table of Contents

EXACTECH, INC.

INDEX

 

        

Page

Number

 

PART 1.

          FINANCIAL INFORMATION   

    Item 1.

  Condensed Consolidated Financial Statements   
  Condensed Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010      2       
  Condensed Consolidated Statements of Income (unaudited) for the Three and Nine Month Periods Ended September 30, 2011 and September 30, 2010      3       
  Condensed Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income (unaudited) for the Nine Month Period Ended September  30, 2011      4       
  Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Month Periods Ended September 30, 2011 and September 30, 2010      5       
  Notes to Condensed Consolidated Financial Statements (unaudited) for the Three and Nine Month Periods Ended September 30, 2011 and September 30, 2010      6       

    Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      19       

    Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      32       

    Item 4.

  Controls and Procedures      33       

PART II.

          OTHER INFORMATION      34       

    Item 1.

  Legal Proceedings      34       

    Item 1A.

  Risk Factors      34       

    Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      34       

    Item 3.

  Defaults Upon Senior Securities      34       

    Item 5.

  Other Information      34       

    Item 6.

  Exhibits      35       

    Signatures

     36       


Table of Contents

Item 1. Financial Statements

EXACTECH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

    (unaudited)
        September 30,    
    (audited)
      December 31,    
 
    2011     2010  

ASSETS

   

      CURRENT ASSETS:

   

           Cash and cash equivalents

  $ 3,897      $ 3,935   

           Accounts receivable, net of allowances of $3,010 and $2,751

    43,094        39,796   

           Prepaid expenses and other assets, net

    4,899        3,384   

           Income taxes receivable

    727        1,544   

           Inventories – current

    62,788        61,602   

           Deferred tax assets – current

    2,563        2,278   
 

 

 

   

 

 

 

               Total current assets

    117,968        112,539   

      PROPERTY AND EQUIPMENT:

   

           Land

    2,214        2,210   

           Machinery and equipment

    30,023        27,155   

           Surgical instruments

    72,666        60,077   

           Furniture and fixtures

    3,754        3,583   

           Facilities

    17,984        16,365   

           Projects in process

    1,702        3,669   
 

 

 

   

 

 

 

               Total property and equipment

    128,343        113,059   

           Accumulated depreciation

    (52,955     (44,377
 

 

 

   

 

 

 

               Net property and equipment

    75,388        68,682   

      OTHER ASSETS:

   

           Deferred financing and deposits, net

    472        881   

           Non-current inventories

    11,866        9,191   

           Product licenses and designs, net

    11,529        11,812   

           Patents and trademarks, net

    1,668        1,938   

           Customer relationships, net

    1,689        2,003   

           Goodwill

    13,461        12,947   
 

 

 

   

 

 

 

               Total other assets

    40,685        38,772   
 

 

 

   

 

 

 

TOTAL ASSETS

  $ 234,041      $ 219,993   
 

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

   

      CURRENT LIABILITIES:

   

           Accounts payable

  $ 15,025      $ 15,855   

           Income taxes payable

    614          

           Accrued expenses and other liabilities

    7,642        8,847   

           Other current liabilities

    330        296   

           Current portion of long-term debt

    644        1,066   
 

 

 

   

 

 

 

               Total current liabilities

    24,255        26,064   

      LONG-TERM LIABILITIES:

   

           Deferred tax liabilities

    6,196        6,175   

           Line of credit

    44,591        37,556   

           Long-term debt, net of current portion

    3,669        4,153   

           Other long-term liabilities

    565        629   
 

 

 

   

 

 

 

               Total long-term liabilities

    55,021        48,513   
 

 

 

   

 

 

 

               Total liabilities

    79,276        74,577   

      SHAREHOLDERS’ EQUITY:

   

           Common stock

    131        130   

           Additional paid-in capital

    60,075        57,735   

           Accumulated other comprehensive loss

    (2,521     (2,525

           Retained earnings

    97,080        90,076   
 

 

 

   

 

 

 

               Total shareholders’ equity

    154,765        145,416   
 

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

  $ 234,041      $ 219,993   
 

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

2


Table of Contents

EXACTECH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(Unaudited)

 

       Three Month Periods  
   Ended September 30,  
    Nine Month Periods
  Ended September  30,  
 
     2011     2010     2011     2010  

NET SALES

   $ 47,278      $ 42,023      $ 152,329      $ 138,693   

COST OF GOODS SOLD

     14,898        13,704        48,156        47,810   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     32,380        28,319        104,173        90,883   

OPERATING EXPENSES:

        

  Sales and marketing

     18,041        15,711        57,292        46,914   

  General and administrative

     5,070        3,850        16,555        12,427   

  Research and development

     3,502        2,981        9,717        10,064   

  Depreciation and amortization

     3,663        2,682        10,642        7,619   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     30,276        25,224        94,206        77,024   
  

 

 

   

 

 

   

 

 

   

 

 

 

INCOME FROM OPERATIONS

     2,104        3,095        9,967        13,859   

OTHER INCOME (EXPENSE):

        

  Interest income

     —          1        3        3   

  Other income

     30        23        73        60   

  Interest expense

     (281     (198     (821     (458

  Foreign currency exchange (loss) gain

     (48     852        845        669   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expenses)

     (299     678        100        274   
  

 

 

   

 

 

   

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     1,805        3,773        10,067        14,133   

PROVISION FOR INCOME TAXES

     494        2,290        3,063        6,377   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 1,311      $ 1,483      $ 7,004      $ 7,756   
  

 

 

   

 

 

   

 

 

   

 

 

 

BASIC EARNINGS PER SHARE

   $ 0.10      $ 0.11      $ 0.54      $ 0.60   
  

 

 

   

 

 

   

 

 

   

 

 

 

DILUTED EARNINGS PER SHARE

   $ 0.10      $ 0.11      $ 0.53      $ 0.59   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

3


Table of Contents

EXACTECH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

 

    Common Stock     Additional
Paid-In
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 
  Shares     Amount           

Balance, December 31, 2010

    13,028      $ 130      $ 57,735       $ 90,076      $ (2,525   $ 145,416   

Exercise of stock options

    67        1        600                       601   

Issuance of restricted common stock for services

    12               212                       212   

Issuance of common stock under the Employee Stock Purchase Plan

    33               461                       461   

Compensation cost of stock options

                  1,037                       1,037   

Tax benefit from exercise of stock awards

                  30                       30   

Comprehensive Income:

            

Net income

                          7,004               7,004   

Change in fair value of cash flow hedge, net of tax

                                 17        17   

Change in currency translation

                                 (13     (13
            

 

 

 

Other comprehensive income

               4   
            

 

 

 

Comprehensive income

               7,008   
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Balance, September 30, 2011

    13,140      $ 131      $ 60,075       $ 97,080      $ (2,521   $ 154,765   
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

4


Table of Contents

EXACTECH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

     Nine Month Periods
Ended September 30,
 
           2011                 2010        

OPERATING ACTIVITIES:

    

Net income

   $ 7,004      $ 7,756   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

    

Provision for allowance for doubtful accounts and sales returns

     259        1,361   

Inventory allowance

     218        665   

Depreciation and amortization

     11,876        8,727   

Restricted common stock issued for services

     212        122   

Compensation cost of stock awards

     1,037        1,349   

Tax benefit from exercise of stock options

     30        98   

Excess tax benefit from exercise of stock options

     (30     (98

Loss on disposal of equipment

     475        94   

Foreign currency exchange gain

     (845     (669

Deferred income taxes

     (276     893   

Changes in assets and liabilities which provided (used) cash:

    

Accounts receivable

     (3,361     (2,801

Prepaids and other assets

     (1,469     (1,976

Inventories

     (3,606     (12,463

Accounts payable

     (164     5,974   

Income taxes payable/receivable

     1,437        (701

Accrued expense & other liabilities

     (1,794     (1,511
  

 

 

   

 

 

 

Net cash provided by operating activities

     11,003        6,820   
  

 

 

   

 

 

 

INVESTING ACTIVITIES:

    

Purchases of property and equipment

     (17,672     (17,724

Purchase of spine assets

     —          (2,578

Purchase of product licenses and designs

     (635     (1,077

Proceeds from sale of equipment

     1        3   

Purchase of patents and trademarks

     —          (167

Acquisition of subsidiary, net of cash acquired

     —          (6,221
  

 

 

   

 

 

 

Net cash used in investing activities

     (18,306     (27,764
  

 

 

   

 

 

 

FINANCING ACTIVITIES:

    

Net borrowings on line of credit

     7,035        20,443   

Principal payments on debt

     (906     (892

Debt issuance costs

     (5     (41

Excess tax benefit from exercise of stock options

     30        98   

Proceeds from issuance of common stock

     1,062        964   
  

 

 

   

 

 

 

Net cash provided by financing activities

     7,216        20,572   
  

 

 

   

 

 

 

Effect of foreign currency translation on cash and cash equivalents

     49        (35

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (38     (407

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     3,935        2,889   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 3,897      $ 2,482   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

    

Cash paid during the period for:

    

Interest

   $ 751      $ 333   

Income taxes

     2,222        7,006   

Non-cash investing and financing activities:

    

Purchase guarantee payable

     420        —     

Spine assets purchase contingency payable

     —          950   

Estimated sales and use tax liability

     60        976   

Cash flow hedge gain (loss), net of tax

     17        (26

See notes to condensed consolidated financial statements

 

5


Table of Contents

EXACTECH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2011 AND 2010

(Unaudited)

1.   BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Exactech, Inc. and its subsidiaries, 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 consolidated 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, 2010 of Exactech, Inc. (the “Company” or “Exactech”), as filed with the Securities and Exchange Commission.

In the opinion of management, all adjustments considered necessary for a fair presentation have been included, consisting of normal recurring adjustments. All adjustments of a normal recurring nature which, in the opinion of management, are necessary to fairly present the results for the interim period have been made. Our subsidiaries, Exactech Asia, Exactech UK, Exactech Japan, France Medica, Exactech Taiwan, Exactech Deutschland, Exactech Iberica, and Exactech International Operations are consolidated for financial reporting purposes, and all intercompany balances and transactions have been eliminated. Results of operations for the three and nine month period ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year.

Certain amounts reported for prior periods have been reclassified to be consistent with the current period presentation.

2.   NEW ACCOUNTING PRONOUNCEMENTS AND STANDARDS

In September 2011, the Financial Accounting Standards Board (“FASB”) amended its goodwill guidance that provides companies the option to first perform a qualitative assessment whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If the company determines that this is the case, it is required to perform the currently prescribed two step goodwill impairment test. The amendment is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The adoption of this updated authoritative guidance is not expected to have a significant impact on the company’s Condensed Consolidated Financial Statements.

In June 2011, the FASB amended its guidance on the presentation of comprehensive income in financial statements. This new guidance will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements, eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The new guidance is required retroactively, effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We are currently evaluating the impact of adopting this guidance on our financial statements.

In May 2011, the FASB amended its guidance on fair value measurements and related disclosures. This new guidance is issued as part of the convergence project between U.S. GAAP and International Financial Reporting Standards (IFRS) on the requirements for measurement of and disclosures about fair value, and results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between IFRS and U.S. GAAP. The new guidance also changes certain fair value measurement principles and enhances the disclosure requirements related to activities in Level 3 of the fair value hierarchy. The amendment is effective for interim and annual periods beginning after December 15, 2011. The adoption of this updated authoritative guidance is not expected to have a significant impact on the company’s Condensed Consolidated Financial Statements.

 

6


Table of Contents

3.   FAIR VALUE MEASURES

Our financial instruments include cash and cash equivalents, trade receivables, debt and cash flow hedges. The carrying amounts of cash and cash equivalents, and trade receivables approximate fair value due to their short maturities. The carrying amount of debt approximates fair value due to the variable rate associated with the debt. The fair values of cash flow hedges are based on dealer quotes.

Certain financial assets and liabilities are accounted for at fair value, which is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy prioritizes the inputs used to measure fair value:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies.

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value from the perspective of a market participant.

The table below provides information on our liabilities that are measured at fair value on a recurring basis:

 

 

 

    (In Thousands)       Total Fair Value at
    September 30, 2011
   

Quoted Prices in

Active Markets

          (Level 1)          

   

    Significant Other
    Observable

    Inputs

            (Level 2)        

   

Significant
Unobservable

Inputs

            (Level 3)             

 

Interest Rate Swap

  $ 191      $      $ 191      $   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 191      $      $ 191      $   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

The fair value of our interest rate swap agreement is based on dealer quotes, and is recorded as accumulated other comprehensive loss in the consolidated balance sheets. We analyze the effectiveness of our interest rate swap on a quarterly basis, and, for the period ended September 30, 2011, we have determined the interest rate swap to be effective.

4.   GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill – The following table provides the changes to the carrying value of goodwill for the period ended September 30, 2011 (in thousands):

 

 

 

     Knee      Hip      Biologics
and Spine
     Extremities      Other      Total  

Balance as of December 31, 2010

   $     3,572       $     601       $     7,553       $         393       $     828       $   12,947   

Acquired goodwill

     192         42                 49         137         420   

Foreign currency translation effects

     42         18                 11         23         94   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance as of September 30, 2011

   $ 3,806         661       $ 7,553       $ 453         988         13,461   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

We test goodwill for impairment annually as of the 1st of October. Our impairment analysis during the fourth quarter of 2010 indicated no impairment to goodwill.

 

7


Table of Contents

Other Intangible Assets – The following tables summarize our carrying values of our other intangible assets at September 30, 2011 and December 31, 2010 (in thousands):

 

 

 

        Carrying    
Value
    Accumulated
    Amortization    
        Net Carrying    
Value
    Weighted Avg
    Amortization    
Period
 

Balance at September 30, 2011

       

Product licenses and designs

  $ 14,600      $ 3,071      $ 11,529        10.7   

Customer relationships

    3,152        1,463        1,689        7.0   

Patents and trademarks

    4,063        2,395        1,668        13.0   

Balance at December 31, 2010

       

Product licenses and designs

  $ 13,967      $ 2,155      $ 11,812        10.7   

Customer relationships

    3,109        1,106        2,003        7.0   

Patents and trademarks

    4,092        2,154        1,938        12.9   

 

 

5.     FOREIGN CURRENCY TRANSLATION AND HEDGING ACTIVITIES

Foreign Currency Translation – We are exposed to market risk related to changes in foreign currency exchange rates. The functional currency of substantially all of our international subsidiaries is the local currency. Transactions are translated into U.S. dollars and exchange gains and losses arising from translation are recognized in “Other comprehensive income (loss)”. Fluctuations in exchange rates affect our financial position and results of operations. The majority of our foreign currency exposure is to the Euro (EUR), British Pound (GBP), and Japanese Yen (JPY). During the nine months ended September 30, 2011, translation losses were $13,000. During the nine months ended September 30, 2010, translation losses were $366,000, which were due to the weakening of the EUR. We may experience translation gains and losses during the year ending December 31, 2011; however, these gains and losses are not expected to have a material effect on our financial position, results of operations, or cash flows. Gains and losses resulting from our transactions and our subsidiaries’ transactions, which are made in currencies different from their own, are included in income as they occur and as other income (expense) in the Condensed Consolidated Statements of Income. We recognized currency transaction gains of $845,000 for the nine months ended September 30, 2011 and currency transaction gains of $669,000 for the nine months ended September 30, 2010.

Other Comprehensive Income (Loss) – Other comprehensive income (loss) is comprised of unrealized gains or losses from the change in fair value of certain derivative instruments, and for foreign currency translation effects. The following table provides information on the components of our other comprehensive loss (in thousands):

 

 

 

     Cash Flow
      Hedge      
    Foreign
Currency
       Translation      
            Total          

Balance December 31, 2010

   $ (134   $ (2,391   $ (2,525

2011 Adjustments

     17        (13     4   
  

 

 

   

 

 

   

 

 

 

Balance September 30, 2011

   $ (117   $ (2,404   $ (2,521
  

 

 

   

 

 

   

 

 

 

 

 

We do not enter into or hold derivative instruments for trading or speculative purposes. We entered into our interest rate swap to eliminate variability in future cash flows by converting LIBOR-based variable-rate interest payments into fixed-rate interest payments. The fair value of our interest rate swap agreement is based on dealer quotes, and the change in fair value is recorded as accumulated other comprehensive loss in the consolidated balance sheets. We do not expect the change in our interest rate swap to have a material impact on our results of operations, financial position or cash flows.

 

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6.     INVENTORIES

Inventories are valued at the lower of cost or market and include implants consigned to customers and agents. We also provide significant loaned implant inventory to non-distributor customers. The consigned or loaned inventory remains our inventory until we are notified of the implantation. We are also required to maintain substantial levels of inventory as it is necessary to maintain all sizes of each component to 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 representative at the time of surgery. As a result of the need to maintain substantial levels of inventory, we are subject to the risk of inventory obsolescence. In the event that a substantial portion of our inventory becomes obsolete, it would have a material adverse effect on the Company. Allowance charges for obsolete and slow moving inventories are recorded based upon an analysis of specific identification of obsolete inventory items and quantification of slow moving inventory items. For slow moving inventory, this analysis compares the quantity of inventory on hand to the projected sales of such inventory items. As a result of this analysis, we record an estimated allowance for slow moving inventory. Due to the nature of the slow moving inventory, this allowance may fluctuate up or down, as a charge or recovery. Allowance changes for the three and nine months ended September 30, 2011 were $(172,000) and $218,000, respectively. Allowance changes for the three and nine months ended September 30, 2010 were $686,000 and $665,000, respectively. We also test our inventory levels for the amount of inventory that would be sold within one year. At certain times, as we stock new subsidiaries, add consignment locations, and launch new products, the level of inventory can exceed the forecasted level of cost of goods sold for the next twelve months. As of September 30, 2011, we determined that $11.9 million of inventory should be classified as non-current. As of December 31, 2010, we determined that $9.2 million of inventory should be classified as non-current.

The following table summarizes our classifications of inventory as of September 30, 2011 and December 31, 2010 (in thousands):

 

 

 

                     2011                                   2010               

Raw materials

   $ 17,690       $ 17,180   

Work in process

     1,015         1,192   

Finished goods on hand

     24,232         24,268   

Finished goods on loan/consignment

     31,717         28,153   
  

 

 

    

 

 

 

Inventory total

     74,654         70,793   

Non-current inventories

     11,866         9,191   
  

 

 

    

 

 

 

Inventories, current

   $ 62,788       $ 61,602   
  

 

 

    

 

 

 

 

 

7.     ACQUISITION AND DISTRIBUTION SUBSIDIARY START-UPS

Acquisition of Spine Assets

Effective August 27, 2010, we acquired the inventory, instruments and design licenses for several innovative spine product lines from VertiFlex, Inc., a leading developer of minimally invasive and motion preserving spinal surgery technologies. The VertiFlex products were acquired to enhance our current product offering for minimally invasive spinal surgery procedures. We also acquired the customer list related to the acquired products. We initially paid $2.5 million in cash for these assets, with two contingent consideration payments for a potential maximum of an additional $1.0 million payable in cash. As part of the acquisition terms of the spine assets acquired from VertiFlex, Inc., two contingent consideration payables were recorded. The first contingent consideration for $500,000 was paid upon VertiFlex completing certain regulatory matters prior to the end of 2010. The second contingent consideration was for an additional payable based on our achieving certain sales targets during the six month period following the date of close. The range of contingent earn-out payment was $150,000 for the minimum U.S. sales and $500,000 for the maximum sales goal. During March 2011, we paid $250,000 in settlement of that contingency, of which, in December 2010 we had $300,000 in contingencies payable

 

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recorded based on our estimated probability of completing the earn-out contingency measures. We paid closing fees of approximately $78,000.

Acquisition of Brighton Partners

Effective May 24, 2010, we completed the 100% acquisition of our supplier, Brighton Partners, Inc., the sole source supplier for our net compression molded (NCM) polyethylene bearings for our Optetrak® knee system. Our purchase price at closing was $5.5 million dollars in cash, paid to the shareholders of Brighton in exchange for their shares of common stock in Brighton. We financed the acquisition through our existing line of credit. Accounts payable of $99,000 to Brighton Partners related to our supplier relationship was eliminated at acquisition. We identified and recognized an intangible asset for the technology process valued at $4.8 million, which management has determined to be the principal asset acquired. We recognized $2.0 million in goodwill.

Prior to acquisition, Brighton Partners was deemed to be 24% beneficially owned by Albert H. Burstein, Ph.D., a director of the Company. Additionally, William Petty, Chairman of the Board and Chief Executive Officer of the Company, and Betty Petty, Secretary of the Company, jointly owned 4.6% of Brighton Partners. Gary J. Miller, Executive Vice President of the Company, beneficially owned 2.8% of Brighton Partners. Other executive officers of the Company owned less than 3% of Brighton Partners, Inc. No member of Exactech’s management had control over, or influenced the operations of, Brighton Partners.

We have an oral consulting agreement with Albert Burstein, Ph.D., to provide services regarding many facets of the orthopaedic industry including product design rationale, manufacturing and development techniques and product sales and marketing. This agreement is terminable at will by either party. Pursuant to this agreement, we paid Dr. Burstein $180,000 each year in 2010, 2009 and 2008, as compensation under the consulting agreement. The consulting agreement continues post acquisition.

Acquisition of Germany Assets

Effective April 1, 2010, we completed the acquisition of certain assets of Tantum AG, our prior independent distributor in Germany, which was accomplished to obtain a certain hip product line and to maintain access to a large European market with an established workforce and existing customers. Our purchase price at closing was approximately 1 million EUR, or $1.35 million translated at the March 31, 2010 exchange rate of $1.35 per 1.00 EUR. Consideration paid was in the form of 410,000 EUR in cash and 563,000 EUR in forgiven accounts receivable that were owed to us as of March 31, 2010. We recognized an intangible customer relationship of $193,000, and goodwill of $695,000. We financed the acquisition through our existing line of credit.

Acquisition of France Medica

Effective April 1, 2008, we completed the acquisition of our French distributor, France Medica. The total purchase price of approximately $10.3 million was paid, in a combination of cash and Exactech common stock, to certain shareholders of France Medica over a three year period. The final contingent installment for a translated amount of $420,000, based on the exchange rate as of the end of June of $1.44 per 1.00 EUR, was released in the third quarter of 2011, and was recorded in goodwill, as additional cost of the acquisition, on our consolidated balance sheets, as of June 30, 2011. As of September 30, 2011, we recognized goodwill of $3.1 million for the acquisition and currency translation effect of $(221,000), for a final adjustment to goodwill of $2.9 million.

New International Operations Center – Exactech International Operations

During 2010, we established an international sales office in Switzerland, to manage the international sales and marketing efforts for our foreign subsidiaries. In January 2011, we renamed our international sales office to Exactech International Operations, AG (“EIO”), and relocated the office to Bern, Switzerland, as part of our realignment of our foreign subsidiaries and operations. The equity ownership of our foreign subsidiaries, with the exception of our Chinese operations, was transferred to EIO. EIO also acquired certain licenses to our intangibles to allow the use of our intellectual property outside the U.S. These actions have been undertaken to streamline and consolidate our international operations with the expectation of achieving improved customer service, cost savings, and international tax efficiency.

 

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Distribution Subsidiary – Exactech Iberica

During the first quarter of 2010, we established a distribution subsidiary in Spain, Exactech Iberica, S.A.U. (“Exactech Iberica”). The sales distribution subsidiary, based in Gijon, enables us to directly control our Spanish marketing and distribution operations. We obtained our import registration to allow Exactech Iberica to import our products for sale in Spain and actively commenced distribution activities during the third quarter of 2010. During the first quarter of 2010, we notified our existing independent distributor in Spain of the non-renewal of our distribution agreement. As a result of that non-renewal, our relationship terminated during the third quarter of 2010. We expect a return of product from the former distributor, and as a result we have a sales return allowance of approximately $1.3 million recorded against accounts receivable for this distributor on the consolidated balance sheet as of September 30, 2011.

8.     INCOME TAX

At December 31, 2010, net operating loss carry forwards of our foreign and domestic subsidiaries totaled $34.8 million, some of which begin to expire in 2013. For accounting purposes, the estimated tax effect of these net operating loss carry forwards results in a deferred tax asset. This deferred tax asset was $9.2 million at December 31, 2010; however, a valuation allowance of $4.6 million was charged against this deferred tax asset assuming these losses will not be fully realized. At September 30, 2011, these loss carry forwards totaled $37.8 million, and the deferred tax asset associated with these losses was $10.2 million with a valuation allowance of $6.2 million charged against this deferred tax asset assuming these losses will not be fully realized.

9.     DEBT

Debt consists of the following at September 30, 2011 and December 31, 2010 (in thousands):

 

 

 

             2011                   2010        

Commercial construction loan payable in monthly principal installments of $17.5, plus interest based on adjustable rate as determined by one month LIBOR (1.73% as of September 30, 2011); proceeds used to finance expansion of current facility

   $ 2,358      $ 2,515   

Commercial equipment loan payable in monthly principal installments of $49.5, beginning November 2006, plus interest based on adjustable rate as determined by one month LIBOR with a minimum floor of 5.58%; proceeds used to finance equipment for production facility expansion

     —          443   

Commercial real estate loan payable in monthly installments of $46.4, including principal and interest based on an adjustable rate as determined by one month LIBOR, fixed by a swap agreement with the lender at 6.61% as a cash flow hedge. Proceeds used to remodel facilities and restructure portion of debt.

     1,955        2,261   

Business line of credit payable on a revolving basis, plus interest based on adjustable rate as determined by one month LIBOR based on our ratio of funded debt to EBITDA (2.57% for the accordion portion and 1.97% for the remainder, as of September 30, 2011). Proceeds used to fund working capital.

     44,591        37,556   
  

 

 

   

 

 

 

          Total debt

     48,904        42,775   

          Less current portion

     (644     (1,066
  

 

 

   

 

 

 
   $ 48,260      $ 41,709   
  

 

 

   

 

 

 

 

 

 

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The following is a schedule of debt maturities as of September 30, 2011, for the years ended December 31:

 

 

 

2011

   $ 158   

2012

     651   

2013

     45,272   

2014

     713   

2015

     643   

Thereafter

     1,467   
  

 

 

 
   $           48,904   
  

 

 

 

 

 

10.  COMMITMENTS AND CONTINGENCIES

Litigation

There are various claims, lawsuits, and disputes with third parties and pending actions involving various allegations against us incident to the operation of our business, principally product liability cases. We are currently a party to several product liability suits related to the products distributed by us on behalf of RTI Biologics, Inc., or RTI. Pursuant to our license and distribution agreement with RTI, we will tender all cases to RTI. While we believe that the various claims are without merit, we are unable to predict the ultimate outcome of such litigation. We therefore maintain insurance, subject to self-insured retention limits, for all such claims, and establish accruals for product liability and other claims based upon our experience with similar past claims, advice of counsel and the best information available. At September 30, 2011, we had $50,000 accrued for product liability claims and as of December 31, 2010, we did not have any accruals for product liability claims. These matters are subject to various uncertainties, and it is possible that they may be resolved unfavorably to us. However, while it is not possible to predict with certainty the outcome of the various cases, it is the opinion of management that, upon ultimate resolution, the cases will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Our 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 to us, we may not be able to procure acceptable policies in the future.

On December 7, 2010, we entered into a twelve-month Deferred Prosecution Agreement, or DPA, with the United States Attorney’s Office for the District of New Jersey, or the USAO, and a five year Corporate Integrity Agreement, or CIA, with the Office of the Inspector General of the United States Department of Health and Human Services. The foregoing agreements, together with a related settlement agreement, resolve the investigation commenced by the USAO in December 2007 into our consulting arrangements with orthopaedic surgeons relating to our hip and knee products in the United States, which we refer to as the Subject Matter. As set forth in the DPA, the USAO specifically acknowledges that it does not allege that our conduct adversely affected patient health or patient care. Pursuant to the DPA, the USAO has agreed not to prosecute us in connection with the Subject Matter provided that we comply with our obligations under the DPA during its term. Additionally, pursuant to the DPA, an independent monitor will review and evaluate our compliance with our obligations under the DPA monitorship. CIA acknowledges the existence of our corporate compliance program and provides us with certain other compliance-related obligations during the CIA’s term. See “Item 1A — Risk Factors” for more information about our obligations under these agreements. We continue to enhance and apply our corporate compliance program, and we monitor our practices on an ongoing basis to ensure that we have in place proper controls necessary to comply with applicable laws in the jurisdictions in which we do business. Our failure to maintain compliance with U.S. healthcare regulatory laws could expose us to significant liability including, but not limited to, extension of the term of the DPA, exclusion from federal healthcare program participation, including Medicaid and Medicare, civil and criminal fines or penalties, and additional litigation cost and expense. Pursuant to the CSA, we settled civil and administrative claims relating to the matter for a payment of $3.0 million, without any admission by the Company. We previously accrued

 

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approximately $3.5 million for an anticipated settlement and legal expenses related to this investigation, and therefore, these agreements did not materially impact our results of operations.

On October 18, 2010, MBA Incorporado, S.L., or MBA, our former distributor in Spain filed an action against Exactech, Inc. and Exactech Ibérica, S.A.U. in the Court of First Instance No. 10 of Gijon, Spain in connection with our termination of the distribution agreement with MBA in July 2010. In the lawsuit, MBA alleges, (i) wrongful solicitation of certain employees of MBA subsequent to the termination of the distribution agreement, (ii) breach of contract with respect to the termination date established by Exactech and Exactech’s alleged failure to follow the termination transitioning protocols set forth in the distribution agreement, and (iii) commercial damages and lost sales and customers due to Exactech’s alleged failure to supply products requested by MBA during the transition period of the distribution agreement termination. In the Complaint 1 filing MBA seeks damages of forty-four million (44,000,000) Euros compensation for all benefits alleged to be owed by Exactech under the distribution agreement, including alleged loss of clientele, alleged loss of prestige and credibility, alleged loss of client confidence and alleged illegitimate business practices. On December 1, 2010, MBA filed a second action (“Complaint 2”) against Exactech Iberica and two of the former principals of MBA, in the Mercantile Court No. 3 of Gijon, Spain, also in connection with our termination of the distribution agreement with MBA in July 2010, seeking among other things injunctive relief. In March 2011, the court dismissed injunctive relief as requested by MBA in Complaint 2. Both complaints are currently working through the legal proceedings process, but the second one has been suspended until such time as the first lawsuit receives final and definitive resolution. While it is not possible to predict with certainty the outcome of the lawsuit, we believe that our termination of the distribution agreement with MBA was proper, all actions taken by us in connection with the termination (including during the transition period) were proper and, accordingly, the claims are without merit and subject to a number of defenses we possess. We intend to vigorously defend ourselves against these claims.

Purchase Commitments

At September 30, 2011, we had outstanding commitments for the purchase of inventory, raw materials and supplies of $11.3 million and outstanding commitments for the purchase of capital equipment of $0.7 million. Purchases under our distribution agreements were $5.5 million during the nine months ended September 30, 2011.

Our Taiwanese subsidiary, Exactech Taiwan, has entered into a license agreement with the Industrial Technology Research Institute (ITRI) and the National Taiwan University Hospital (NTUH) for the rights to technology and patents related to the repair of cartilage lesions. As of September 30, 2011, we have paid approximately $1.5 million for the licenses, patents, and equipment related to this license agreement, and we will make royalty payments when the technology becomes marketable. Using the technology, we plan to launch a cartilage repair program that will include a device and method for the treatment and repair of cartilage in the knee joint. It is expected that the project will require us to complete human clinical trials under the guidance of the Food & Drug Administration in order to obtain pre-market approval for the device in the United States. The agreement terms include a license fee based on the achievement of specific, regulatory milestones and a royalty arrangement based on sales once regulatory clearances are established.

Contingencies

As of September 30, 2011, we recorded a contingent liability of $1.0 million based on the estimated weighted probability of the outcome of a claim by the State of Florida for sales and use tax, based on the State’s audit of such tax dating back to May 2005, which was assessed by the State of Florida for the value of surgical instruments removed from inventory and capitalized as property and equipment worldwide. In consultation with counsel, management is challenging the assessment; however, there can be no assurances that we will ultimately prevail in our challenge against the assessment. In evaluating the contingent liability, management followed the FASB guidance on contingencies, and concluded that the contingent liability is probable, based on verbal assertions by Florida Department of Revenue personnel, and can be reasonably estimated, however if we are unsuccessful in our challenge against the

 

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State of Florida, we could have a maximum potential liability of $2.9 million for the tax period audited through September 30, 2011. Any use tax determined to be due and payable to the Florida Department of Revenue will increase the basis of the surgical instruments, and this amount will be amortized over the remaining useful life of the instruments.

11.  SEGMENT INFORMATION

We evaluate our operating segments by our major product lines: knee implants, hip implants, biologics and spine, extremity implants 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. Evaluation of the performance of operating segments is based on their respective income from operations before taxes, interest income and expense, and nonrecurring items. Intersegment sales and transfers are not significant. The accounting policies of the reportable segments are the same as those described in Note 2 of the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2010.

Total assets not identified with a specific segment are listed as “corporate” and include cash and cash equivalents, accounts receivable, income taxes receivable, deposits and prepaid expenses, deferred tax assets, land, facilities, office furniture and computer equipment, notes receivable, and other investments. Depreciation and amortization on corporate assets is allocated to the product segments for purposes of evaluating the income (loss) from operations, and capitalized surgical instruments are allocated to the appropriate product line supported by those assets.

Total gross assets held outside the United States as of September 30, 2011, was $34.9 million. Included in these assets is $21.8 million in surgical instrumentation, stated gross as it is impracticable to account for depreciation on these assets by region.

 

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Summarized information concerning our reportable segments is shown in the following table (in thousands):

 

 

 

(in thousands)    Knee      Hip    

Biologics

& Spine

    Extremity      Other     Corporate     Total  

Three months ended

September 30,

2011

                

Net sales

   $     17,908       $         7,990      $         5,415      $     9,780       $     6,185      $      $     47,278   

Segment profit (loss)

     2,650         (136     (143     345         (612     (299     1,805   

Total assets, net

     62,380         31,445        22,020        16,336         8,872        92,988        234,041   

Capital expenditures

     1,420         597        284        913         21        691        3,926   

Depreciation and Amortization

     1,351         592        354        287         116        1,362        4,062   

2010

                

Net sales

   $ 15,619       $ 6,561      $ 6,343      $ 7,317       $ 6,183      $      $ 42,023   

Segment profit (loss)

     2,151         117        287        1,590         (1,050     678        3,773   

Total assets, net

     62,551         26,036        25,160        12,319         5,910        76,650        208,625   

Capital expenditures

     4,051         871               810         185        2,772        8,689   

Depreciation and Amortization

     1,178         439        240        180         69        976        3,082   
                                                            

Nine months ended

September 30,

2011

                

Net sales

   $ 59,946       $ 24,393      $ 18,423      $ 28,874       $ 20,693      $      $ 152,329   

Segment profit (loss)

     7,195         579        516        3,624         (1,947     100        10,067   

Total assets, net

     62,380         31,445        22,020        16,336         8,872        92,988        234,041   

Capital expenditures

     5,591         3,692        1,452        2,400         1,519        3,653        18,307   

Depreciation and Amortization

     4,143         1,659        968        773         364        3,969        11,876   

2010

                

Net sales

   $ 55,893       $ 20,509      $ 20,539      $ 21,478       $ 20,274      $      $ 138,693   

Segment profit (loss)

     7,792         1,048        1,739        5,596         (2,316     274        14,133   

Total assets, net

     62,551         26,036        25,160        12,319         5,910        76,650        208,625   

Capital expenditures

     8,891         2,366        9        1,443         402        6,657        19,768   

Depreciation and Amortization

     3,289         1,378        629        568         242        2,621        8,727   

 

 

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

 

 

 

Three months ended September 30,                         2011                      2010          % Inc (Decr)     

Domestic sales

   $ 31,451       $ 31,868         (1.3

International sales

     15,827         10,155         55.9   
  

 

 

    

 

 

    

 

 

 

Total sales

   $ 47,278       $ 42,023         12.5   
  

 

 

    

 

 

    

 

 

 
   
Nine months ended September 30,    2011      2010      % Inc (Decr)  

Domestic sales

   $ 99,049       $ 97,481         1.6   

International sales

     53,280         41,212         29.3   
  

 

 

    

 

 

    

 

 

 

Total sales

   $ 152,329       $ 138,693         9.8   
  

 

 

    

 

 

    

 

 

 

 

 

 

 

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12.  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):

 

 

 

     Income
(Numer-
ator)
     Shares
(Denom-
inator)
     Per
Share
         Income
(Numer-
ator)
     Shares
(Denom-
inator)
     Per
Share
 
  

 

 

      

 

 

 
     Three Months Ended
September 30, 2011
         Three Months Ended
September 30, 2010
 

Net income

   $         1,311               $         1,483         

Basic EPS:

                   
Net income available to common shareholders    $ 1,311         13,125       $     0.10         $ 1,483         12,908       $     0.11   
        

 

 

            

 

 

 

Effect of dilutive securities:

                   

Stock options

        82                 141      
     

 

 

            

 

 

    

Diluted EPS:

                   
Net income available to common shareholders plus assumed conversions    $ 1,311         13,207       $ 0.10         $ 1,483         13,049       $ 0.11   
        

 

 

            

 

 

 

 

 

 

     Income
(Numer-
ator)
     Shares
(Denom-
inator)
     Per
Share
         Income
(Numer-
ator)
     Shares
(Denom-
inator)
     Per
Share
 
  

 

 

      

 

 

 
     Nine Months Ended
September 30, 2011
         Nine Months Ended
September 30, 2010
 

Net income

   $         7,004               $         7,756         

Basic EPS:

                   
Net income available to common shareholders    $ 7,004         13,083       $     0.54         $ 7,756         12,879       $     0.60   
        

 

 

            

 

 

 

Effect of dilutive securities:

                   

Stock options

        132                 202      
     

 

 

            

 

 

    

Diluted EPS:

                   
Net income available to common shareholders plus assumed conversions    $ 7,004         13,215       $ 0.53         $ 7,756         13,081       $ 0.59   
        

 

 

            

 

 

 

 

 

For the three months ended September 30, 2011, weighted average options to purchase 789,448 shares of common stock at exercise prices ranging from $15.89 to $26.43 per share were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method. For the three months ended September 30, 2010, weighted average options to purchase 726,635 shares of common stock at exercise prices ranging from $15.89 to $26.43 per share were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method.

For the nine months ended September 30, 2011, weighted average options to purchase 519,424 shares of common stock at exercise prices ranging from $17.15 to $26.43 per share were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method. For the nine months ended September 30, 2010, weighted average options to purchase 448,236 shares of common stock at exercise prices ranging from $18.10 to $26.43 per share were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method.

 

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Stock-based Compensation Awards:

We sponsor an Executive Incentive Compensation Plan, which provides for the award of stock-based compensation, including options, stock appreciation rights, restricted stock and other stock-based incentive compensation awards to key employees, directors and independent agents and consultants. We implemented a comprehensive, consolidated incentive compensation plan upon shareholder approval at our Annual Meeting of Shareholders on May 7, 2009, referred to as the 2009 Plan, which replaced the 2003 incentive compensation plan. An amendment to the 2009 Plan was approved at the 2011 Annual Meeting of Shareholders on June 9, 2011 to increase the maximum number of shares issuable from 500,000 to 1,000,000. The maximum number of common shares issuable under the 2009 Plan is 1,000,000 shares plus any remaining shares issuable under the 2003 plan. The terms of the 2009 Plan are substantially similar to the terms of the 2003 Plan. Common stock issued upon exercise of stock options is settled with authorized but unissued shares available. Under the plans, the exercise price of option awards equals the market price of our stock on the date of grant, and has a maximum term of ten years. As of September 30, 2011, there were 823,707 total remaining shares issuable under the 2009 Plan.

The compensation cost that has been charged against income for the Plan and 2009 Employee Stock Purchase Plan, or 2009 ESPP, was $1,037,000 and $1,349,000 and income tax benefit of $234,000 and $282,000 for the nine months ended September 30, 2011 and 2010, respectively. Included in the above compensation cost is non-employee stock compensation expense of approximately $1,000 and $7,000, net of taxes, during the nine months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, total unrecognized compensation cost related to unvested awards was $665,000 and is expected to be recognized over a weighted-average period of 0.86 years.

Stock Options:

A summary of the status of stock option activity under our stock-based compensation plans as of September 30, 2011 and changes during the nine months ended September 30, 2011 is presented below:

 

Intrinsic Value Intrinsic Value Intrinsic Value Intrinsic Value

 

 
     2011  
  

 

 

 
Options        Shares         Weighted
  Avg Exercise  
Price
       Weighted Avg  
Remaining
Contractual
Term
     Aggregate
  Intrinsic Value  
(In thousands)
 

Outstanding – January 1

     1,379,256      $ 15.79         

Granted

     74,700        18.93              

Exercised

     (67,254     8.94            602   

Forfeited or Expired

     (42,664     12.72         
  

 

 

   

 

 

    

 

 

    

 

 

 

Outstanding – September 30

     1,344,038        16.40         3.28         546   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable – September 30

     996,335        16.20         2.88         497   
  

 

 

   

 

 

    

 

 

    

 

 

 
Weighted average fair value per share of options vested during the nine months      $ 7.07         
    

 

 

       
Weighted average fair value per share of options granted during the nine months      $ 8.23         
    

 

 

       

 

 

Outstanding options, consisting of five-year to ten-year incentive stock options, vest and become exercisable ratably over a three to five year period from the date of grant. The outstanding options expire from five to ten years from the date of grant or upon retirement from Exactech, and are contingent upon continued employment during the applicable option term. Certain non-qualified stock options are granted to non-employee sales agents and consultants, and they typically vest ratably over a period of three to four years from the date of grant and expire in five years or less from the date of grant, or upon termination of the agent or consultant’s contract with Exactech. There were 74,700 shares of stock options granted during the nine months ended September 30, 2011. There were 327,060 shares of stock options granted during the nine months ended September 30, 2010, which included options to purchase 133,421 shares of common stock granted pursuant to the employment agreement with our chief executive officer.

 

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Restricted Stock Awards:

Under the plans, we may grant restricted stock awards to eligible employees, directors, and independent agents and consultants. Restrictions on transferability, risk of forfeiture and other restrictions are determined by the Compensation Committee of the Board of Directors (“Committee”) at the time of the award. During March 2011, the Committee approved equity compensation to the six outside members of the Board of Directors for their service on the Board of Directors. The compensation for each director was for the grant of stock awards to each director with an annual market value of $50,000, payable in the form of four equal quarterly grants of common stock based on the market price at the dates of grant. The summary information of the restricted stock grants for the first nine months of 2011 is presented below:

 

 

 

 

 

 

   

 

 

   

 

 

 
Grant date     March 4, 2011           May 31, 2011           August 31, 2011  

Aggregate shares of restricted stock granted

    4,044        3,990        4,215   

Grant date fair value

    $ 75,000        $ 75,000        $ 62,000   

Weighted average fair value per share

    $ 18.53        $ 18.78        $ 14.82   

 

 

During December 2009, the Committee approved equity compensation to the five outside members of the Board of Directors for their service on the Board of Directors. The compensation for each director was for either the grant of stock awards to each director with an annual market value of $50,000, payable in the form of four equal quarterly grants of common stock based on the market price at the dates of grant, or an option to purchase common stock, the choice being at the discretion of each individual director. Pursuant to the approved grant, four of our outside directors chose to receive the restricted stock awards. The first one-third of the compensation was granted on December 1, 2009 and the remaining two-thirds of the compensation was payable during 2010 in four equal quarterly grants. The summary information of the restricted stock grants, as of September 30, 2010, is presented below:

 

 

 

Grant date    December 1, 2009       February 26, 2010      May 28, 2010     August 31, 2010  
Aggregate shares of restricted stock granted     4,192        1,716        2,564        3,065   

Grant date fair value

    $ 67,000        $ 33,000        $ 44,000        $ 44,000   

Weighted average fair value per share

    $ 15.89        $ 19.39        $ 17.33        $ 14.51   

 

 

All of the restricted stock awards in 2011 and 2010 were considered fully vested at each of the grant dates. The restricted stock awards require no service period and thus, no risk or provision for forfeiture.

Employee Stock Purchase Plan:

On February 18, 2009, our board of directors adopted the Exactech, Inc. 2009 Employee Stock Purchase Plan, which we refer to as the 2009 ESPP. Our shareholders approved this new 2009 ESPP at our Annual Meeting of Shareholders on May 7, 2009. Under the 2009 ESPP, employees are allowed to purchase shares of our common stock at a fifteen percent (15%) discount via payroll deduction. There are four offering periods during an annual period. There are 150,000 shares reserved for issuance under the plan. As of September 30, 2011, 58,640 shares remain available to purchase under this 2009 ESPP. The fair value of the employee’s purchase rights is estimated using the Black-Scholes model. Purchase information and fair value assumptions are presented in the following table:

 

 

 

Nine months ended September 30,    2011     2010  

Shares purchased

                 33,265                    29,420   

Dividend yield

              

Expected life

     1 year        1 year   

Expected volatility

     40%        52%   

Risk free interest rates

     2.9%        3.7%   

Weighted average per share fair value

     $ 4.21        $ 4.65   

 

 

 

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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 consolidated financial statements and related notes appearing elsewhere in this report.

Overview of the Company

We develop, manufacture, market and sell orthopaedic implant devices, related surgical instrumentation, supplies and biologic materials to hospitals and physicians in the United States and internationally. Our revenues are principally derived from sales of knee, hip, and extremity joint replacement systems and spinal fusion products. Revenue from the worldwide distribution of biologic materials contributes to our total reported sales and has been a key component of growth over the last few years. Our continuing research and development projects will enable us to continue the introduction of new, advanced biologic materials and other products and services. Revenue from sales of other products, including surgical instrumentation, Cemex® bone cement, the InterSpace™ pre-formed, antibiotic cement hip, knee and shoulder spacers have contributed to revenue growth and are expected to continue to be an important part of our anticipated future revenue growth.

Our operating expenses consist of sales and marketing expenses, general and administrative expenses, research and development expenses, and depreciation 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 surgical facilities on our behalf. These expenses tend to be variable in nature and related to sales growth. Research and development expenses primarily consist of expenditures on projects concerning knee, extremities, spine and hip implant product lines and biologic materials and services.

In marketing our products, we use a combination of traditional targeted media marketing together with our primary marketing focus, direct customer contact and service to orthopaedic surgeons. Because surgeons are the primary decision maker when it comes to the choice of products and services that best meet the needs of their patients, our marketing strategy is focused on meeting the needs of the orthopaedic surgeon community. In addition to surgeon’s preference, hospitals and buying groups, as the economic customer, are actively participating with physicians in the choice of implants and services.

Overview of the Three and Nine Months Ended September 30, 2011

During the quarter ended September 30, 2011, sales increased 13% to $47.3 million from $42.0 million in the comparable quarter ended September 30, 2010, as we continued to gain market share in our large joint product segments and experienced a positive currency impact of approximately $1.0 million. Gross margins increased to 68.5% from 67.4% as a result of our expanded direct distribution operations internationally. Operating expenses increased 20% from the quarter ended September 30, 2010, and as a percentage of sales, operating expenses increased to 64% during the third quarter of 2011 as compared to 60% for the same quarter in 2010. This increase, as a percentage of sales, was primarily due to additional expenses related to our new distribution offices in Spain and Germany, as well as compliance and legal costs associated with the monitorship of the DPA agreement entered into with the Department of Justice, or DOJ, of $951,000 in the third quarter of 2011, which increased from $216,000 of related DOJ inquiry expenses in the third quarter of 2010. Net income for the quarter ended September 30, 2011 decreased 12% to $1.3 million, and diluted earnings per share were $0.10 as compared to $0.11 last year.

During the nine months ended September 30, 2011, sales increased 10% to $152.3 million from $138.7 million in the comparable nine months ended September 30, 2010, as we continued to gain market share in our large joint product segments. Gross margins increased to 68.4% from 65.5% as a result of our growth in our international direct distribution subsidiaries. Operating expenses increased 22% from the nine months ended September 30, 2010, and, as a percentage of sales, operating expenses increased to 62% during the first nine months of 2011 as compared to 56% for the same period in 2010. This increase, as a percentage of sales, was primarily due to the additional expenses related to our new distribution

 

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offices, and to an increase in compliance and legal costs to $3.7 million in the first nine months of 2011 from $795,000 in the first nine months of 2010 as a result of higher compliance costs associated with the DPA agreement with the DOJ. Net income for the nine months ended September 30, 2011 decreased 10% to $7.0 million, and diluted earnings per share were $0.53 as compared to $0.59 last year.

During the nine months ended September 30, 2011, we acquired $17.7 million in property and equipment, including new production equipment and surgical instrumentation. Cash flow from operations was $11.0 million for the nine months ended September 30, 2011 as compared to a net cash flow from operations of $6.8 million during the nine months ended September 30, 2010.

The following table includes the net sales and percentage of net sales for each of our product lines for the three month periods ended September 30, 2011 and September 30, 2010:

 

 

Sales by Product Line

(dollars in thousands)

 
     Three Months Ended         
     September 30, 2011      September 30, 2010      Change  

Knee Products

   $         17,908         37.9%       $         15,619         37.2%         14.7%   

Hip Products

     7,990         16.9            6,561         15.6            21.8      

Biologics & Spine

     5,415         11.4            6,343         15.1            (14.6)     

Extremity

     9,780         20.7            7,317         17.4                        33.7      

Other Products

     6,185                   13.1            6,183                 14.7            —      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 47,278         100.0%       $ 42,023         100.0%         12.5%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Nine Months Ended         
     September 30, 2011      September 30, 2010      Change  

Knee Products

   $ 59,946         39.3%       $ 55,893         40.3%         7.3%   

Hip Products

     24,393         16.0            20,509         14.8            18.9      

Biologics & Spine

     18,423         12.1            20,539         14.8            (10.3)     

Extremity

     28,874         19.0            21,478         15.5            34.4      

Other Products

     20,693         13.6            20,274         14.6            2.1      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 152,329         100.0%       $ 138,693         100.0%         9.8%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

The following table includes items from the unaudited Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2011 as compared to the three and nine months ended September 30, 2010, the dollar and percentage change from period to period and the percentage relationship to net sales (dollars in thousands):

 

Comparative Statement of Income Data

 

     Three Months Ended
September 30,
         

2011 – 2010

Inc (decr)

         % of Sales  
     2011     2010           $     %          2011     2010  

Net sales

   $     47,278      $     42,023            5,255        12.5           100.0     100.0

Cost of goods sold

     14,898        13,704            1,194        8.7           31.5        32.6   

Gross profit

     32,380        28,319            4,061        14.3           68.5        67.4   

Operating expenses:

                         

Sales and marketing

     18,041        15,711            2,330        14.8           38.2        37.4   

General and administrative

     5,070        3,850            1,220        31.7           10.7        9.1   

Research and development

     3,502        2,981            521        17.5           7.4        7.1   

Depreciation and amortization

     3,663        2,682            981        36.6           7.7        6.4   

Total operating expenses

     30,276        25,224            5,052        20.0           64.0        60.0   

Income from operations

     2,104        3,095            (991     (32.0        4.5        7.4   

Other (expenses) income, net

     (299     678            (977     (144.1        (0.7     1.6   

Income before taxes

     1,805        3,773            (1,968     (52.2        3.8        9.0   

Provision for income taxes

     494        2,290            (1,796     (78.4        1.0        5.5   

Net income

   $ 1,311      $ 1,483            (172     (11.6        2.8        3.5   

 

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     Nine Months Ended
September 30,
        

2011 – 2010

Inc (decr)

         % of Sales  
     2011      2010          $     %          2011     2010  

Net sales

   $   152,329       $ 138,693           13,636        9.8           100.0     100.0

Cost of goods sold

     48,156         47,810           346        0.7           31.6        34.5   

Gross profit

     104,173         90,883           13,290        14.6           68.4        65.5   
           

Operating expenses:

                         

Sales and marketing

     57,292         46,914           10,378        22.1           37.6        33.8   

General and administrative

     16,555         12,427           4,128        33.2           10.9        9.0   

Research and development

     9,717         10,064           (347     (3.4        6.4        7.3   

Depreciation and amortization

     10,642         7,619           3,023        39.7           7.0        5.4   

Total operating expenses

     94,206         77,024           17,182        22.3           61.9        55.5   

Income from operations

     9,967         13,859           (3,892     (28.1        6.5        10.0   

Other (expenses) income, net

     100         274           (174     (63.5        0.1        0.2   

Income before taxes

     10,067         14,133           (4,066     (28.8        6.6        10.2   

Provision for income taxes

     3,063         6,377           (3,314     (52.0        2.0        4.6   

Net income

   $ 7,004       $ 7,756           (752     (9.7        4.6        5.6   

Three and Nine Months Ended September 30, 2011 Compared to Three and Nine Months Ended September 30, 2010

Sales

For the quarter ended September 30, 2011, total sales increased 13% to $47.3 million from $42.0 million in the comparable quarter ended September 30, 2010. Sales of knee implant products increased 15% to $17.9 million for the quarter ended September 30, 2011 compared to $15.6 million for the quarter ended September 30, 2010, as we continued the introduction of our Logic PS™ knee system. Hip implant sales of $8.0 million during the quarter ended September 30, 2011 increased 22% over the $6.6 million in sales during the quarter ended September 30, 2010, as we continued to experience market penetration with our Novation Element™ hip system. Sales from biologics and spine decreased 15% during the quarter ended September 30, 2011 to $5.4 million, down from $6.3 million in the comparable quarter in 2010, primarily as a result of increased competition and general economic pressure. Sales of our extremity products were up 34% to $9.8 million as compared to $7.3 million for the same period in 2010, as our Equinoxe® shoulder systems, including the reverse and platform fracture stem line extensions, continue their increasing market acceptance. Sales of all other products remained flat at $6.2 million for each of the quarters ended September 30, 2011 and 2010. Domestically, total sales decreased 1% to $31.5 million, or 67% of total sales, during the quarter ended September 30, 2011, down from $31.9 million, which represented 76% of total sales, in the comparable quarter last year. Internationally, total sales increased 56% to $15.8 million, representing 33% of total sales, for the quarter ended September 30, 2011, as compared to $10.2 million, or 24% of total sales, for the same quarter in 2010.

For the nine months ended September 30, 2011, total sales increased 10% to $152.3 million from $138.7 million in the comparable nine months ended September 30, 2010. Sales of knee implant products increased 7% to $59.9 million for the nine months ended September 30, 2011 compared to $55.9 million for the nine months ended September 30, 2010. Hip implant sales of $24.4 million during the nine months ended September 30, 2011 increased 19% over the $20.5 million in sales during the nine months ended September 30, 2010, as our Element hip systems continue to receive market acceptance. Sales from biologics and spine decreased 10% during the nine months ended September 30, 2011 to $18.4 million, from $20.5 million in the comparable nine months in 2010. Sales of our extremity products were up 34% to $28.9 million as compared to $21.5 million for the same period in 2010, as we continue to see increasing market acceptance of our Equinoxe® reverse shoulder system. Sales of all other products increased to $20.7 million as compared to $20.3 million in the same nine month period last year. Domestically, total sales increased 2% to $99.0 million, or 65% of total sales, during the nine months ended September 30, 2011, up from $97.5 million, which represented 70% of total sales, in the comparable nine months last year. Internationally, total sales increased 29% to $53.3 million, representing 35% of total sales, for the nine months ended September 30, 2011, as compared to $41.2 million, which was 30% of total sales, for the same period in 2010.

 

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Gross Profit

Gross profit increased 14% to $32.4 million in the quarter ended September 30, 2011 from $28.3 million in the quarter ended September 30, 2010. As a percentage of sales, gross profit increased to 68.5% during the quarter ended September 30, 2011 as compared to 67.4% in the quarter ended September 30, 2010, primarily as a result of higher growth in our international direct selling operations which result in higher margins than our international independent distributor business.

Gross profit increased 15% to $104.2 million in the nine months ended September 30, 2011 from $90.9 million in the nine months ended September 30, 2010. As a percentage of sales, gross profit increased to 68.4% during the nine months ended September 30, 2011 as compared to 65.5% in the nine month period ended September 30, 2010, as a result of growth in both our domestic market and international direct markets, which generally results in higher margin sales. Looking forward, for the fourth quarter of 2011, we expect gross profit, as a percentage of sales, to be 0.5-1.0% higher than prior year quarter on a comparative quarter basis.

Operating Expenses

Total operating expenses increased 20% to $30.3 million in the quarter ended September 30, 2011 from $25.2 million in the quarter ended September 30, 2010. As a percentage of sales, total operating expenses increased to 64% for the quarter ended September 30, 2011, as compared to 60% for the same period in 2010. The increase in operating expenses was principally due to increased expenses from our new distribution operations in Spain, increased research and development activities and increased Health Care Professional, or HCP, compliance expenditures related to the DPA monitorship. Total operating expenses increased 22% to $94.2 million in the nine months ended September 30, 2011 from $77.0 million in the nine months ended September 30, 2010. As a percentage of sales, total operating expenses increased to 62% for the nine months ended September 30, 2011, as compared to 56% for the same period in 2010. Included in operating expenses for the first nine months in 2011 is $3.7 million in compliance costs related to the DPA monitorship, as compared to $795,000 in DOJ inquiry expenses incurred in the first nine months of 2010. The increase as a percentage of sales was primarily due to the increased operating expenses from our new subsidiaries as well as the increase in compliance costs.

Sales and marketing expenses, the largest component of total operating expenses, increased 15% for the quarter ended September 30, 2011 to $18.0 million from $15.7 million in the same quarter last year, as we continue to expand our global marketing efforts through our new subsidiaries, of which expenses in Spain, Germany and Japan contributed $1.8 million of the increase. Sales and marketing expenses, as a percentage of sales increased to 38% for the quarter ended September 30, 2011, from 37% for the quarter ended September 30, 2010. Sales and marketing expenses increased 22% for the nine months ended September 30, 2011 to $57.3 million from $46.9 million in the same period last year. Sales and marketing expenses, as a percentage of sales increased to 38% for the nine months ended September 30, 2011, from 34% for the nine months ended September 30, 2010, primarily due to our increases in expenditures from expanding our international distribution network. Looking forward, sales and marketing expenditures, as a percentage of sales, are expected to be in the range of 36% to 38% for the fourth quarter of 2011.

General and administrative expenses increased 32% to $5.1 million in the quarter ended September 30, 2011 from $3.9 million in the quarter ended September 30, 2010, which included the $0.9 million and $0.2 million in expenses related to the DPA monitorship and DOJ inquiry for each of the periods, respectively. As a percentage of sales, general and administrative expenses increased to 11% for the quarter ended September 30, 2011, as compared to 9% in the quarter ended September 30, 2010. Excluding the compliance related expenses, general and administrative expenses remained at 9% of sales for both years. General and administrative expenses increased 33% to $16.6 million in the nine months ended September 30, 2011 from $12.4 million in the nine months ended September 30, 2010, which included the $3.7 million and $0.8 million in expenses related to the DPA monitorship and DOJ inquiry for each of the periods, respectively. As a percentage of sales, general and administrative expenses increased to 11% for the nine months ended September 30, 2011, as compared to 9% in the nine months ended September 30,

 

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2010. Excluding the DOJ expenses, general and administrative expenses were flat at 8% of sales for the nine month period for both years. General and administrative expenses for the fourth quarter ending December 31, 2011 are expected to be in the range of 8% to 9%, as a percentage of sales, excluding the impact of compliance expenses.

Research and development expenses increased 17% for the quarter ended September 30, 2011 to $3.5 million from $3.0 million in the same quarter last year, as we incurred increased design input costs from our surgeon consultants as compared to the first half of the year. As a percentage of sales, research and development expenses remained at 7% for each of the quarters ended September 30, 2011 and 2010. Research and development expenses decreased 3% for the nine months ended September 30, 2011 to $9.7 million from $10.1 million in the same period last year. As a percentage of sales, research and development expenses decreased to 6% for the nine months ended September 30, 2011 from 7% for the comparable nine months last year. We anticipate growth in research and development expenditures to continue to keep pace with sales growth as increases in product development and consulting expenses for the fourth quarter are expected, with total research and development expenses ranging from 7% to 8% of sales.

Depreciation and amortization increased 37% to $3.7 million during the quarter ended September 30, 2011 from $2.7 million in the quarter ended September 30, 2010, primarily as a result of continuing investment in our manufacturing capabilities and surgical instrumentation. As a percentage of sales, depreciation and amortization increased to 8% for the third quarter of 2011, compared to 6% during the quarter ended September 30, 2010. Depreciation and amortization increased 40% to $10.6 million during the nine months ended September 30, 2011 from $7.6 million in the nine months ended September 30, 2010. As a percentage of sales, depreciation and amortization increased to 7% for the nine month period ended September 30, 2011, compared to 5% during the nine month period ended September 30, 2010 as we continued to invest in surgical instrumentation to support global distribution expansion and product launches. We placed $14.7 million of surgical instrumentation in service, $4.3 million in manufacturing equipment and facilities, and spent $635,000 for product licenses and designs during the first nine months of 2011.

Income from Operations

Our income from operations decreased 32% to $2.1 million, or 4% of sales in the quarter ended September 30, 2011 from $3.1 million, or 7% of sales in the quarter ended September 30, 2010. The reduction is partially due to increased sales and marketing expenses related to the expansion of our international direct distribution operations, as well as the $951,000 in expenses for the HCP compliance program. Excluding the impact of these HCP compliance program expenses during the third quarter of 2011, and $216,000 during the third quarter of 2010, income from operations for the quarter ended September 30, 2011, decreased 8% to $3.1 million from $3.3 million adjusted income from operations during the third quarter of 2010. Our income from operations decreased 28% to $10.0 million, or 7% of sales in the nine months ended September 30, 2011 from $13.9 million, or 10% of sales in the nine month period ended September 30, 2010. Excluding the impact of the HCP compliance expenses of $3.7 million recognized during the first nine months of 2011, and $795,000 during the first nine months of 2010, income from operations for the nine months ended September 30, 2011, decreased 7% to $13.7 million from $14.7 million adjusted income from operations during the same nine months of 2010. Looking forward, we expect to continue to experience increases in compliance costs greater than sales growth and therefore we anticipate income from operations to be in the range of 7 - 9% for the fourth quarter of 2011.

Other Income and Expenses

We had other expenses, net of other income, of $299,000 during the quarter ended September 30, 2011, as compared to other income, net of other expenses of $678,000 in the quarter ended September 30, 2010, primarily due to currency transaction losses during the quarter, and by increased net interest expense for the quarter ended September 30, 2011 of $281,000 as compared to $198,000 during the quarter ended September 30, 2010. We had other income, net of other expenses, of $100,000 during the

 

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nine months ended September 30, 2011, as compared to other, income net of other expenses of $274,000 in the nine months ended September 30, 2010, primarily due to gains related to foreign currency transactions during the first nine months of 2011, partially offset by an increase in net interest expense for the nine months ended September 30, 2011 to $821,000 as compared to $458,000 during the nine months ended September 30, 2010, due to increased borrowing under our line of credit facility.

Taxes and Net Income

Income before provision for income taxes decreased 52% to $1.8 million in the quarter ended September 30, 2011 from $3.8 million in the quarter ended September 30, 2010. The effective tax rate, as a percentage of income before taxes, was 27% for the quarter ended September 30, 2011 and 61% for the quarter ended September 30, 2010. As a result of the foregoing, we realized net income of $1.3 million in the quarter ended September 30, 2011, a decrease of 12% from $1.5 million in the quarter ended September 30, 2010. As a percentage of sales, net income decreased to 3% for the quarter ended September 30, 2011 from 4% for the quarter ended September 30, 2010. Earnings per share, on a diluted basis, decreased to $0.10 for quarter ended September 30, 2011 from $0.11 for the quarter ended September 30, 2010. Income before provision for income taxes decreased 29% to $10.1 million in the nine months ended September 30, 2011 from $14.1 million in the nine months ended September 30, 2010. The effective tax rate, as a percentage of income before taxes, was 30% for the nine months ended September 30, 2011 and 45% for the nine months ended September 30 2010. The decrease in the effective tax rate for the first nine months of the year was primarily due to the tax impact of our international restructuring of our sales and marketing operations as well as the research and development tax credit that was effective in the first nine months of 2011 as opposed to it having expired during the first nine months of 2010. We expect our effective tax rates to range from 31% to 33% for the balance of 2011. As a result of the foregoing, we realized net income of $7.0 million in the nine months ended September 30, 2011, a decrease of 10% from $7.8 million in the nine months ended September 30, 2010. As a percentage of sales, net income decreased to 5% for the nine months ended September 30, 2011 as compared to 6% for the first nine months of 2010. Earnings per share, on a diluted basis, decreased to $0.53 for nine months ended September 30, 2011, from $0.59 for the nine months ended September 30, 2010.

Non-GAAP Financial Measures

In addition to providing results that are determined in accordance with accounting principles generally accepted in the United States, referred to as GAAP, we have provided certain financial measures that are not in accordance with GAAP. Our non-GAAP financial results and metrics of sales and operating expenses on a constant currency basis are provided to assist investors in the comparison of our operating performance without the impact of currency exchange fluctuations related to our operations where the functional currency is not in USD. Financial results and metrics that are adjusted for constant currency are calculated by restating current period activity into USD using the comparable prior period’s foreign currency exchange rates. Our non-GAAP financial measures of adjusted net income and adjusted diluted earnings per share exclude the charges we incurred in relation to the DOJ inquiry in 2010 and the DPA related monitorship and enhanced HCP compliance program costs in 2011, less the tax effect of the charges. Because the DOJ inquiry and DPA related monitorship costs are unique events, not directly related to our normal operations, we believe these non-GAAP financial measures may help investors better understand and compare our quarterly operating results and trends by eliminating the unusual components included in GAAP financial measures.

 

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The following table compares the total percent increase in sales by product line for the three and nine months ended September 30, 2011 from the three and nine month periods ended September 30, 2010, per U.S. GAAP sales compared to sales calculated on a constant currency basis.

 

 

 

    Three Month Change     Nine Month Change  
     U.S. GAAP       Constant
    Currency    
      U.S. GAAP       Constant
    Currency    
 

Knee Products

    14.7     11.8     7.3     5.6

Hip Products

    21.8        19.0        18.9        17.2   

Biologics & Spine

    (14.6     (15.7     (10.3     (11.0

Extremity

    33.7        32.6        34.4        33.8   

Other Products

           (3.1     2.1        0.2   

Total

    12.5        10.2        9.8        8.4   

 

 

Adjustments to operating expenses for constant currency impact and HCP related expenses for the three and nine month periods ended September 30, 2011 and 2010, are reconciled below (in thousands):

 

 

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
        2011     2010     Incr/(Decr)         2011     2010     Incr/(Decr)  

Total operating expense

  $ 30,276      $ 25,224        20.0   $ 94,206      $ 77,024        22.3

Constant currency impact

    (839         (2,061    
 

 

 

   

 

 

     

 

 

   

 

 

   
    29,437        25,224        16.7        92,145        77,024        19.6   

HCP related expenses

    (951     (216       (3,692     (795  
 

 

 

   

 

 

     

 

 

   

 

 

   

Adjusted operating expenses

  $ 28,486      $ 25,008        13.9      $ 88,453      $ 76,229        16.0   
 

 

 

   

 

 

     

 

 

   

 

 

   

 

 

Excluding the impact of the pre-tax expenses of $951,000 for the management of our HCP compliance program and other DPA monitorship related expenses recognized during the third quarter of 2011, and $216,000 during the third quarter of 2010, income from operations for the quarter ended September 30, 2011, decreased 8% to $3.1 million from $3.3 million adjusted income from operations during the third quarter of 2010. Adjusted net income for the quarter ended September 30, 2011, increased 19% to $1.9 million, as compared to an adjusted 2010 net income of $1.6 million, also adjusted for DOJ inquiry expenses incurred during the same quarter of 2010. Adjusted diluted earnings per share for the third quarter of 2011 increased to $0.15 compared to adjusted diluted earnings per share of $0.12 for the third quarter of 2010. Excluding the impact of the pre-tax expenses of $3.7 million for management of our HCP compliance and other DPA monitorship related expenses recognized during the first nine months of 2011, and $795,000 during the first nine months of 2010, income from operations for the nine months ended September 30, 2011, decreased 7% to $13.7 million from $14.7 million adjusted income from operations during the same nine months of 2010. Adjusted net income for the nine months ended September 30, 2011, increased 13% to $9.4 million, as compared to an adjusted 2010 net income of $8.3 million, adjusted also for DOJ inquiry expenses incurred during the same period of 2010. Adjusted diluted earnings per share for first nine months of 2011 increased to $0.71 as compared to adjusted diluted earnings per share of $0.63 for the first nine months of 2010.

 

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The reconciliations of these non-GAAP financial measures are as follows (in thousands, except per share amounts):

 

 

 

$14,654 $14,654 $14,654 $14,654
     Three Month Period Ended
September 30,
     Nine Month Period Ended
September 30,
 
     2011      2010      2011      2010  

Income from operations

   $ 2,104       $ 3,095       $ 9,967       $ 13,859   

HCP compliance expenses, pre-tax

     951         216         3,692         795   
  

 

 

    

 

 

    

 

 

    

 

 

 
Adjusted income from operations - excluding HCP compliance expenses    $ 3,055       $ 3,311       $ 13,659       $ 14,654   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

 

 

 

$14,654 $14,654 $14,654 $14,654
     Three Month Period Ended
September 30,
    Nine Month Period Ended
September 30,
 
     2011     2010     2011     2010  

Net Income

   $ 1,311      $ 1,483      $ 7,004      $ 7,756   

Adjustments for HCP compliance expenses:

        

HCP compliance expenses, pre-tax

     951        216        3,692        795   

Income tax benefit

     (329     (80     (1,343     (294
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjustments, net of tax

     622        136        2,349        501   
  

 

 

   

 

 

   

 

 

   

 

 

 
Adjusted net income - excluding HCP compliance expenses    $ 1,933      $ 1,619      $ 9,353      $ 8,257   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per share

   $ 0.10      $ 0.11      $ 0.53      $ 0.59   

Adjustment of HCP compliance expenses, net

     0.05        0.01        0.18        0.04   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted diluted earnings per share

   $ 0.15      $ 0.12      $ 0.71      $ 0.63   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

The weighted-average diluted shares outstanding used in the calculation of these non-GAAP financial measures are the same as the weighted-average shares outstanding used in the calculation of the reported per share amounts.

Liquidity and Capital Resources

We have financed our operations through a combination of commercial debt financing, equity issuances and cash flows from our operating activities. At September 30, 2011, we had working capital of $93.7 million, an increase of 8% from $86.5 million at the end of 2010. Working capital in 2011 increased primarily as a result of an increase in accounts receivable as well as our inventory build associated with product line and market expansions. We experienced overall increases in our current assets due to our growth. We project that cash flows from operating activities, borrowing under our existing line of credit, and issuance of equity securities, from stock purchases under the employee stock purchase plan and stock option exercises, will be sufficient to meet our commitments and cash requirements in the following twelve months. If not, we will seek additional funding options with any number of possible combinations of additional debt, additional equity or convertible debt.

Operating Activities - Operating activities provided net cash of $11.0 million in the nine months ended September 30, 2011, as compared to net cash from operations of $6.8 million during the nine months ended September 30, 2010. A primary contributor to this change related to lower increases in our inventory, and offset partially by our increase in accounts receivable and decrease in accounts payable during the first nine months of 2011. Our allowance for doubtful accounts and sales returns increased to $3.0 million at September 30, 2011 from $2.8 million at December 31, 2010. Included in the accounts receivable allowances in the comparable periods is an estimated sales return, net of cost of goods sold, of $1.3 million related to the nonrenewal of our agreement with our Spanish independent distributor. We cannot give assurances that the transitioning to direct sales outside the U.S. will not result in a larger amount of returned products with a corresponding increase in this allowance. The total days sales outstanding (DSO) ratio, based on average accounts receivable balances, was 73 for the nine months

 

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ended September 30, 2011, up from a ratio of 66 for the nine months ended September 30, 2010. As we continue to expand our operations internationally, our DSO ratio could continue to increase, due to the fact that credit terms outside the U.S. tend to be relatively longer than those in the U.S. Inventory was increased by $3.6 million during the first nine months ended September 30, 2011, compared to an increase of $12.5 million during the same period ended September 30, 2010, due to a completion in the initial stocking of our direct distribution market expansions during 2010. The decrease in accounts payable for the nine months ended September 30, 2011 used aggregate net cash of $0.2 million, in contrast to net cash provided of $6.0 million for the nine months ended September 30, 2010.

Investing Activities - Investing activities used net cash of $18.3 million in the nine months ended September 30, 2011, as compared to $27.8 million in the nine months ended September 30, 2010. The decrease was due to our cash outlay of $17.7 million for purchases of surgical instrumentation, manufacturing equipment, and facility expansion, and $635,000 for purchases of product licenses during the nine months ended September 30, 2011 as compared to activity during the same period of 2010 resulting in cash outlay of $17.7 million for purchases of surgical instrumentation and manufacturing equipment, $1.2 million for purchases of product licenses, patents and trademarks, and $8.8 million for a business combination and asset acquisition.

Acquisition of Spine Assets

Effective August 27, 2010, we acquired the inventory, instruments and design licenses for several innovative spine product lines from VertiFlex, Inc., a leading developer of minimally invasive and motion preserving spinal surgery technologies. The VertiFlex products were acquired to enhance our current product offering for minimally invasive spinal surgery procedures. We also acquired the customer list related to the acquired products. We initially paid $2.5 million in cash for these assets, with two contingent consideration payments for a potential maximum of an additional $1.0 million payable in cash. As part of the acquisition terms of the spine assets acquired from VertiFlex, Inc., two contingent consideration payables were recorded. The first contingent consideration for $500,000 was paid upon VertiFlex completing certain regulatory matters prior to the end of 2010. The second contingent consideration was for an additional payable based on our achieving certain sales targets during the six month period following the date of close. The range of contingent earn-out payment was $150,000 for the minimum U.S. sales and $500,000 for the maximum sales goal. During March 2011, we paid $250,000 in settlement of that contingency, of which, in December 2010 we had $300,000 in contingencies payable recorded based on our estimated probability of completing the earn-out contingency measures. We paid closing fees of approximately $78,000.

Acquisition of Brighton Partners

Effective May 24, 2010, we completed the 100% acquisition of our supplier, Brighton Partners, Inc., the sole source supplier for our net compression molded (NCM) polyethylene bearings for our Optetrak® knee system. Our purchase price at closing was $5.5 million dollars in cash, paid to the shareholders of Brighton in exchange for their shares of common stock in Brighton. We financed the acquisition through our existing line of credit. Accounts payable of $99,000 to Brighton Partners related to our supplier relationship was eliminated at acquisition. We identified and recognized an intangible asset for the technology process valued at $4.8 million, which management has determined to be the principal asset acquired. We recognized $2.0 million in goodwill.

Prior to acquisition, Brighton Partners was deemed to be 24% beneficially owned by Albert H. Burstein, Ph.D., a director of the Company. Additionally, William Petty, Chairman of the Board and Chief Executive Officer of the Company, and Betty Petty, Secretary of the Company, jointly owned 4.6% of Brighton Partners. Gary J. Miller, Executive Vice President of the Company, beneficially owned 2.8% of Brighton Partners. Other executive officers of the Company owned less than 3% of Brighton Partners, Inc. No member of Exactech’s management had control over, or influenced the operations of, Brighton Partners.

We have an oral consulting agreement with Albert Burstein, Ph.D., to provide services regarding many facets of the orthopaedic industry including product design rationale, manufacturing and development techniques and product sales and marketing. This agreement is terminable at will by either party.

 

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Pursuant to this agreement, we paid Dr. Burstein $180,000 each year in 2010, 2009 and 2008, as compensation under the consulting agreement. The consulting agreement continues post acquisition.

Acquisition of Germany Assets

Effective April 1, 2010, we completed the acquisition of certain assets of Tantum AG, our prior independent distributor in Germany, which was accomplished to obtain a certain hip product line and to maintain access to a large European market with an established workforce and existing customers. Our purchase price at closing was approximately 1 million EUR, or $1.35 million translated at the March 31, 2010 exchange rate of $1.35 per 1.00 EUR. Consideration paid was in the form of 410,000 EUR in cash and 563,000 EUR in forgiven accounts receivable that were owed to us as of March 31, 2010. We recognized an intangible customer relationship of $193,000, and goodwill of $695,000. We financed the acquisition through our existing line of credit.

Acquisition of France Medica

Effective April 1, 2008, we completed the acquisition of our French distributor, France Medica. The total purchase price of approximately $10.3 million was paid, in a combination of cash and Exactech common stock, to certain shareholders of France Medica over a three year period. The final contingent installment for a translated amount of $420,000, based on the exchange rate as of the end of June of $1.44 per 1.00 EUR, was released in the third quarter of 2011, and was recorded in goodwill, as additional cost of the acquisition, on our consolidated balance sheets, as of June 30, 2011. As of September 30, 2011, we recognized goodwill of $3.1 for the acquisition and currency translation effect of $(221,000), for a final adjustment to goodwill of $2.9 million.

New International Operations Center – Exactech International Operations

During 2010, we established an international sales office in Switzerland, to manage the international sales and marketing efforts for our foreign subsidiaries. In January 2011, we renamed our international sales office to Exactech International Operations, AG (“EIO”), and relocated the office to Bern, Switzerland, as part of our realignment of our foreign subsidiaries and operations. The equity ownership of our foreign subsidiaries, with the exception of our Chinese operations, was transferred to EIO. EIO also acquired certain licenses to our intangibles to allow the use of our intellectual property outside the U.S. These actions have been undertaken to streamline and consolidate our international operations with the expectation of achieving improved customer service, cost savings, and international tax efficiency.

Distribution Subsidiary – Exactech Iberica

During the first quarter of 2010, we established a distribution subsidiary in Spain, Exactech Iberica, S.A.U. (“Exactech Iberica”). The sales distribution subsidiary, based in Gijon, enables us to directly control our Spanish marketing and distribution operations. We obtained our import registration to allow Exactech Iberica to import our products for sale in Spain and actively commenced distribution activities during the third quarter of 2010. During the first quarter of 2010, we notified our existing independent distributor in Spain of the non-renewal of our distribution agreement. As a result of that non-renewal, our relationship terminated during the third quarter of 2010. We expect a return of product from the former distributor, and as a result we have a sales return allowance of approximately $1.3 million recorded against accounts receivable for this distributor on the consolidated balance sheet as of September 30, 2011.

License technology

Our Taiwanese subsidiary, Exactech Taiwan, has entered into a license agreement with the Industrial Technology Research Institute (ITRI) and the National Taiwan University Hospital (NTUH) for the rights to technology and patents related to the repair of cartilage lesions. As of September 30, 2011, we have paid approximately $1.5 million for the licenses, patents, equipment related to this license agreement, and prepaid expenses, and we will make royalty payments when the technology becomes marketable. Using the technology, we plan to launch a cartilage repair program that will include a device and method for the treatment and repair of cartilage in the knee joint. It is expected that the project will require us to complete human clinical trials under the guidance of the Food & Drug Administration in order to obtain pre-market approval for the device in the United States. The agreement terms include a license fee based on the achievement of specific, regulatory milestones and a royalty arrangement based on sales once regulatory clearances are established.

 

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Financing Activities - Financing activities provided net cash of $7.2 million in the nine months ended September 30, 2011, as compared to $20.6 million in net cash for the nine months ended September 30, 2010. In the first nine months of 2011, we had net borrowings under our credit line of $7.0 million as compared to net borrowings of $20.4 million in the first nine months of 2010. Our commercial debt facilities decreased by $906,000 as a result of repayments during the nine months ended September 30, 2011, as compared to $892,000 in the first nine months of 2010. Proceeds from the exercise of stock options provided cash of $1.1 million in the nine months ended September 30, 2011, as compared to $964,000 in the nine months ended September 30, 2010, with the proceeds used to fund general working capital needs.

Long-term Debt

On June 13, 2008, we entered into a revolving credit agreement for an aggregate principal amount of $40 million, referred to as the Credit Agreement with SunTrust Bank, a Georgia banking corporation, or SunTrust, as administrative agent and swingline lender and potential other lenders. The credit agreement was originally composed of a revolving credit line in an amount equal to $25 million between us and SunTrust, and a revolving credit line in an amount equal to $15 million between us and Compass Bank, an Alabama banking corporation, or Compass. Included in the credit agreement is a swingline note for $3 million, whereby excess bank account cash balance is swept into the swingline to reduce the outstanding balance. Interest on the notes consists of annual LIBOR, adjusted monthly, and an applicable margin, ranging from 1.25 % to 2.00%, based on a ratio of funded debt to EBITDA. The Credit Agreement has a five year term and the lending commitments under it terminate on June 13, 2013, with the swingline commitment terminating and all outstanding amounts thereunder due in full one week prior to the revolver note. The obligations under the Credit Agreement have been guaranteed by the domestic subsidiaries of the Company under the terms of a subsidiary guarantee and are secured by a security interest granted in substantially all of the assets of the Company and its domestic subsidiaries to the lenders party to the Credit Agreement. The outstanding balance under the Credit Agreement may be prepaid at any time without premiums or penalties. Upon an event of default the commitment will be terminated, all principal and interest will be payable immediately and begin to accrue interest at a default rate equal to the applicable rate in effect plus five percentage points. The Credit Agreement includes certain covenants and terms that place certain restrictions on our ability to incur additional debt, incur additional liens, engage in certain investments, effect certain mergers, declare or pay dividends, effect certain sales of assets, or engage in certain transactions with affiliates, sale and leaseback transactions, hedging agreements, or capital expenditures. Additionally, there are restrictions against us using the proceeds borrowed under this facility for funding our foreign subsidiaries unless such foreign subsidiaries are included in the facility by virtue of execution of a subsidiary guarantee or pledge of the capital stock of such foreign subsidiary. We are also subject to several financial covenants regarding the ratio of debt to EBITDA and fixed charge coverage ratio.

On November 10, 2010, we entered into an amendment to the Credit Agreement. The amendment provides us with an accordion facility that permits us to increase the revolver commitment available by an amount up to $15 million, provided that aggregate commitments available under the Credit Agreement may not exceed $55 million. Interest on the accordion facility accrues at an applicable margin between 2.35% and 2.50% above the LIBOR rate at the time of exercising the accordion. Additionally, the amendment amends certain terms of the Credit Agreement in respect to the calculation of the fixed charge coverage ratio as well as covenants relating to our ability to effect transactions involving our subsidiaries. We paid aggregate closing costs of $172,000 for the Credit Agreement and amendment, which we are expensing over the life of the Credit Agreement. Additional administrative fees will be due and expensed each fiscal quarter based on a percentage of the unused revolver balance. As of September 30, 2011, there was $44.6 million outstanding under the revolving line of credit, of which $6.0 million bore an interest rate of 2.6%, and the remaining balance bore an interest rate of 2.0%.

In September 2002, we 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 expansion of our corporate facility. At September 30, 2011, there was $2.4 million outstanding under this loan bearing a variable rate of interest equal to 1.7%. In October 2005, we entered into a long-term commercial real estate loan of $4.0 million, bearing interest at a rate of

 

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one month LIBOR plus 1.53%, with a local lending institution to recapture costs of improvements to our existing real estate facilities and restructure portions of existing working capital debt. This variable rate debt was fixed at 6.6% interest by entering into an interest swap agreement as a cash flow hedge. At September 30, 2011, there was $2.0 million outstanding under this loan.

Our credit facility and other loans contain customary affirmative and negative covenants including certain financial covenants with respect to our consolidated net worth, interest and debt coverage ratios and limits on capital expenditures, dividends, debt incurrence and liens in addition to other restrictions. We were in compliance with such covenants at September 30, 2011.

Other Commitments and Contingencies

At September 30, 2011, we had outstanding commitments for the purchase of inventory, raw materials and supplies of $11.3 million and outstanding commitments for the purchase of capital equipment of $0.7 million. Purchases under our distribution agreements were $5.5 million during the nine months ended September 30, 2011.

As of September 30, 2011, we recorded a contingent liability of $1.0 million based on the estimated weighted probability of the outcome of a claim by the State of Florida for sales and use tax, based on the State’s audit of such tax dating back to May 2005, which was assessed by the State of Florida for the value of surgical instruments removed from inventory and capitalized as property and equipment worldwide. In consultation with counsel, management is challenging the assessment; however, there can be no assurances that we will ultimately prevail in our challenge against the assessment. In evaluating the liability, management followed the FASB guidance on contingencies, and concluded that the contingent liability is probable, based on verbal assertions by Florida Department of Revenue personnel, and can be reasonably estimated, however if we are unsuccessful in our challenge against the State of Florida, we could have a maximum potential liability of $2.9 million for the tax period audited through September 30, 2011. Any use tax determined to be due and payable to the Florida Department of Revenue will increase the basis of the surgical instruments, and this amount will be amortized over the remaining useful life of the instruments.

 

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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. When used in this report, the terms “anticipate,” “believe,” “estimate,” “expect” and “intend” and words or phrases of similar import, as they relate to the Company or its subsidiaries or its management, are intended to identify forward-looking statements. 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 impact of our DPA monitorship, including the associated compliance costs, the outcome of the State of Florida unasserted claim, 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, significant expenditures of resources to maintain high levels of inventory, market acceptance of the Company’s products, the outcome of litigation, the effects of governmental regulation, potential product liability risks and risks of securing adequate levels of product liability insurance coverage, and the availability of reimbursement to patients from health care payers for procedures in which the Company’s products are used. 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 under “Risk Factors” in our 2010 annual report on Form 10-K and each quarterly report on Form 10-Q we have filed after this annual report. Exactech undertakes no obligation to update, and the Company does not have a policy of updating or revising, these forward-looking statements. Except where the context otherwise requires, the terms, “we”, “us”, “our”, “the Company,” or “Exactech” refer to the business of Exactech, Inc. and its consolidated subsidiaries.

 

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk from interest rates. For our cash and cash equivalents, a change in interest rates affects the amount of interest income that can be earned. For our debt instruments, changes in interest rates affect the amount of interest expense incurred.

The table that follows provides information about our financial instruments that are sensitive to changes in interest rates. If our variable rates of interest experienced an upward increase of 1%, our debt service would increase approximately $3,000 for the remainder of 2011. We believe that the amounts presented approximate the financial instruments’ fair market value as of September 30, 2011, and the weighted average interest rates are those experienced during the year to date ended September 30, 2011 (in thousands, except percentages):

 

             
       2011        2012         2013         2014         Thereafter         Total   

Liabilities

                

Commercial construction loan at variable interest rate

   $         53      $         210       $         210       $         210       $ 1,675       $ 2,358   

Weighted average interest rate

     1.7              

Commercial real estate loan at fixed rate swap

     105        441         471         503         435         1,955   

Weighted average interest rate

     6.6              

Line of credit at variable interest rate

                    44,591                         44,591   

Weighted average interest rate

     1.9              

 

 

We are exposed to market risk related to changes in foreign currency exchange rates. The functional currency of substantially all of our international subsidiaries is the local currency. Transactions are translated into U.S. dollars and exchange gains and losses arising from translation are recognized in “Other comprehensive income (loss)”. Fluctuations in exchange rates affect our financial position and results of operations. The majority of our foreign currency exposure is to the Euro (EUR), Pound Sterling (GBP), and Japanese Yen (JPY). During the nine months ended September 30, 2011, translation losses were $13,000, which were primarily due to the fluctuation in exchange rates and the strengthening of the EUR and GBP in the first nine months of 2011. During the nine months ended September 30, 2010, translation losses were $366,000 which were due to the weakening of the EUR.

In connection with some agreements, we are subject to risk associated with international currency exchange rates on purchases of inventory payable in Euros. At present, we do not hedge our exposure or invest in international currency derivatives. The U.S. dollar is considered our primary currency, and transactions that are completed in an international currency are translated into U.S. dollars and recorded in the financial statements. We recognized currency transaction gains of $845,000 for the nine months ended September 30, 2011 and currency transaction gains of $669,000 for the nine months ended September 30, 2010, primarily due to the effect of our European expansion and the strengthening of the Euro as compared to the U.S. dollar during the first half of 2011. We do not believe we are currently exposed to any material risk of loss due to exchange rate risk exposure.

 

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Item 4.   Controls and Procedures

Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures, or “disclosure controls,” pursuant to Exchange Act Rule 13a-15(b). Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly report, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms. Disclosure controls include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Our disclosure controls include some, but not all, components of our internal control over financial reporting. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2011.

Change in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting during the quarter ended September 30, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II.   OTHER INFORMATION

 

Item 1.

   Legal Proceedings

There have been no material developments related to our legal proceedings since the filing of our most recent Annual Report on Form 10-K, as updated by our subsequently filed Quarterly Reports on Form 10-Q.

 

Item 1A.

   Risk Factors

Information about risk factors for the nine months ended September 30, 2011, does not differ materially from those in set forth in Part I, Item 1A, of our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3.

  

Defaults Upon Senior Securities

None

 

Item 5.

  

Other Information

None

 

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Item 6.       Exhibits

  (a) Exhibits

 

10.1  

Third amendment to employment agreement between Exactech, Inc. and R. William Petty, M.D.(1)

10.2  

Amendment to Exactech, Inc. 2009 Executive Incentive Compensation Plan (2)

31.1  

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2  

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1  

Certification of Chief Executive Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2  

Certification of Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS**  

XBRL Instance Document

101.SCH**  

XBRL Taxonomy Extension Schema

101.CAL**  

XBRL Taxonomy Extension Calculation Linkbase

101.DEF**  

XBRL Taxonomy Extension Definition Linkbase

101.LAB**  

XBRL Taxonomy Extension Label Linkbase

101.PRE**  

XBRL Taxonomy Extension Presentation Linkbase

 

  (1)    

Incorporated by reference to exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the SEC on October 6, 2011.

 

  (2)    

Incorporated by reference to exhibit A to the Company’s Definitive Proxy Statement on Schedule 14A, filed with the SEC on April 29, 2011.

 

  **    

Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

      Exactech, Inc.
Date: November 8, 2011   By:   /s/ William Petty                                               
    William Petty, M.D.
   

Chief Executive Officer (principal executive

officer), President and

    Chairman of the Board
Date: November 8, 2011   By:   /s/ Joel C. Phillips                                             
    Joel C. Phillips
   

Chief Financial Officer (principal financial

officer and principal accounting officer) and

Treasurer

 

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