10-K405 1 d10k405.txt ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 ____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-28240 EXACTECH, INC. (Exact name of registrant as specified in its charter) FLORIDA 59-2603930 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2320 NW 66TH COURT GAINESVILLE, FL 32653 (Address of principal executive offices) (352) 377-1140 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 13, 2002, the number of shares of the registrant's Common Stock outstanding was 5,327,709. The aggregate market value of the Common Stock held by non-affiliates of the registrant as of March 13, 2002 was approximately $43,469,744 based on a closing sale price of $16.00 for the Common Stock as reported on the Nasdaq National Market System on such date. For purposes of the foregoing computation, all executive officers, directors and 5 percent beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such executive officers, directors or 5 percent beneficial owners are, in fact, affiliates of the registrant. DOCUMENTS INCORPORATED BY REFERENCE The information required by Part III (Items 10, 11, 12 and 13) is incorporated by reference from the registrant's definitive proxy statement for its 2001 Annual Meeting of Shareholders (to be filed pursuant to Regulation 14A). TABLE OF CONTENTS and CROSS REFERENCE SHEET
Page Number ----------- PART I Item 1. Business Business Overview 3 Products 3 Marketing and Sales 5 Manufacturing and Supply 6 Patents and Proprietary Technology 6 Research and Development 8 Scientific Advisory Board 8 Competition 9 Product Liability and Insurance 9 Government Regulation 9 Employees 12 Executive Officers of the Registrant 12 Item 2. Properties 13 Item 3. Legal Proceedings 14 Item 4. Submission of Matters to a Vote of Security Holders 14 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 15 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 23 Item 8. Financial Statements and Supplementary Data 24 Item 9. Changes in and Disagreements with Accountants on 41 Accounting and Financial Disclosure PART III Item 10. Directors and Executive Officers of the Registrant 41 Item 11. Executive Compensation 41 Item 12. Security Ownership of Certain Beneficial Owners and Management 41 Item 13. Certain Relationships and Related Transactions 41 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 42
2 PART I ------- ITEM 1. BUSINESS Exactech, Inc. (the "Company", or "Exactech") develops, manufactures, markets and sells orthopaedic implant devices, related surgical instrumentation and materials, and distributes biologic materials to hospitals and physicians in the United States and overseas. The Company was founded by an orthopaedic surgeon in November 1985, and is incorporated under the laws of the State of Florida. Early in the Company's history, revenues were principally derived from sales of its primary hip replacement systems. During 1995, the Company introduced Optetrak(R), a total primary knee replacement system. The Optetrak(R) knee system was conceived by the Company in collaboration with members of its Scientific Advisory Board in cooperation with the Hospital for Special Surgery, an internationally known hospital for orthopaedic surgery. During 1999, the Company began full domestic distribution of Opteform(R), a bone allograft material, under a distribution agreement with the University of Florida Tissue Bank. The Company introduced its comprehensive AcuMatch(R) integrated hip system during 1999 and 2000, with the M-Series modular femoral stem system, C-Series cemented femoral stem, the A-Series acetabular components, the L-Series system, and the P-Series press fit femoral stem. During 2001, the Company began distribution of a bone cement system, Cemex(R), under an exclusive distribution agreement with Italian manufacturer Tecres, S.p.A. Orthopaedic Implant and Biologics Industry According to the Orthopedic Network News Volume 12 Number 3, United States sales of orthopaedic implant products were approximately $2.24 billion in 2000, an increase of 10.1% from 1999. During 2000, sales of knee implants were approximately $1.22 billion, an increase of 10.5% from 1999, while sales of hip implants were approximately $1.02 billion, an increase of 9.9% from 1999. Volume 11 Number 4 of this same publication reported that sales of bone graft and bone substitutes were approximately $552 million in 2000, an increase of 21% from 1999. Sales of bone cement and related supplies was reported as $136.3 million in 2000, representing an increase of 3.6% from 1999. Management believes that the industry will continue to grow due to the increase in the number of people over age 65. Longer life spans and the continuing aging of the population increases the number of individuals whose joints will be subject to failure. As this segment of the population continues to age, an increasing demand for joint replacement procedures is anticipated. Finally, the earlier generations of implanted joint replacement prostheses have begun to reach their maximum life and are beginning to fail, resulting in an increased demand for hip and knee revisions. Products The Company's orthopaedic implant products are used to replace joints that have deteriorated as a result of injury or diseases such as arthritis. Reconstructive joint surgery involves the modification of the area surrounding the affected joint and the insertion of a set of manufactured implant components to replace or augment the joint. During the surgery, the surgeon removes damaged cartilage and a portion of the bones that comprise the joint, prepares the remaining bone surfaces and surrounding tissue and then installs the implant. When indicated, biologic allograft materials are used by the surgeon to repair bone defects and provide an interface to stimulate new bone growth. Bone cement is used to affix implant components to the prepared bone surfaces. Knee Products. The Company believes that its Optetrak(R) knee system represents a major advance in knee implant design. The Optetrak(R) knee system was developed in collaboration with the Hospital for Special Surgery in New York and a design team consisting of physicians and bioengineers affiliated with major medical facilities and academic institutions. The Company's Optetrak(R) knee system is a modular system designed to improve patellar tracking, reduce articular contact stress that leads to implant failure, and provide good range of motion. Laboratory testing performed by the Company and clinical testing performed by the Company's design team members has demonstrated that the system produces substantially lower articular contact stress and improved patellar tracking compared to other knee implant systems. The Optetrak(R) system includes a total primary knee replacement system which is available with either a cruciate ligament sparing femoral component (in both cemented and porous coated designs) or a posterior stabilized femoral component (in both cemented and porous coated designs). The Optetrak(R) system also includes a constrained total knee system for revision surgery and primary surgery with severe deformities. The system includes two types 3 of components: the constrained condylar modular femoral component and a constrained non-modular femoral component. The modular component includes enhanced stem and block augmentation and can be used with components of the primary system. The constrained condylar femoral component was designed to provide greater constraint between the tibial and femoral components of the system to compensate for ligaments weakened or lost due to disease or as a result of deterioration with the original implant. Hip Products. The Company began marketing a hip implant system in 1987. Currently, the Company's line of hip implant products includes three total hip implant systems. The flagship hip product line is the AcuMatch(R) comprehensive hip system which is designed to address the vast majority of indications for total hip replacement, including primary and revision needs. The system includes the C-Series cemented femoral stem, the A-Series acetabular components, the P-Series press-fit femoral stem system, the M-Series modular femoral stem system, L-Series femoral stem system, bipolar and unipolar partial hip replacement components, a variety of femoral heads and a cemented acetabular component. The AcuMatch(R) cemented revision components include revision long stems and calcar replacement stems that were originally part of the AuRA(R) Revision Hip System. The Company continues to market its MCS(R) Porous Coated Total Hip System, and the Opteon(R) Cemented Stem System, a moderate demand femoral stem system. During October 1999, the Company began full-scale marketing of the AcuMatch(R) C-Series Cemented Femoral Stem that was the initial product release of a comprehensive update to its hip product systems. This forged cobalt chromium stem is designed to improve stability and reduce dislocation complications by improving head/neck ratio and restoring anatomic offset for patients requiring cemented hip arthroplasty (joint reconstructive surgery). During 2000, the Company introduced the AcuMatch(R) A-Series Acetabular System, the AcuMatch(R) M-Series modular stem system, and the AcuMatch(R) P-Series press-fit stem system. The AcuMatch(R) A-Series was designed to provide a more comprehensive acetabular offering to replace the existing MCS(R) Acetabular System, while offering maximum polyethylene thickness and reducing polyethylene wear debris. The M-Series modular stem system offers completely interchangeable components to optimize fit and enable surgeons to address leg length and offset challenges without adjusting femoral head or diaphyseal stem size. The AcuMatch(R) P-Series Press Fit Femoral Stem System has multiple coating options and features the same prosthesis neck geometry. The P-Series stem will ultimately replace the original MCS(R) Porous Coated Total Hip System stem. During 2001, the AcuMatch(R) L-Series hip system was introduced with both cemented and press fit femoral components but without the premium features of the C-Series and P-Series stems. The Company's partial hip products include a bipolar prosthesis and a unipolar prosthesis. The Company's bipolar and unipolar prostheses mate with one of the stems used in total hip replacements to create a partial hip replacement. The bipolar prosthesis is designed for use in more active patients and the unipolar prosthesis is designed for use in less active patients. Other Company Products and Services. The Company has signed a worldwide distribution agreement with Regeneration Technology Inc., an affiliate of the Southeast Tissue Alliance, formerly the University of Florida Tissue Bank, for a bone grafting material technology. The material supplied under this agreement, Opteform(R), includes traditional allograft material components, and has the unique property of being fully formable at a temperature of 43(Degree) to 45(Degree)C which is just above body temperature. The material becomes a resilient solid when its temperature cools to body temperature (37(Degree)C). Exactech distributes Opteform(R) as a service through the Company's current distribution channel. The Company began full-scale distribution of Opteform(R) in the United States in 1999. The AcuDriver(R) Automated Osteotome System is an air-driven impact hand piece that aids surgeons during joint implant revision procedures by providing effective cleavage of prosthesis/bone or cement/bone interfaces. The AcuDriver(R) accomplishes this by providing the surgeon with precise positioning without the inconvenience and inconsistency of striking the osteotome with a mallet. The Cemex(R) bone cement system features a unique self-contained delivery system that has been clinically proven in Europe for more than a decade. By integrating bone cement powder and liquid into a sealed mixing system, Cemex(R) is designed to offer surgeons and operating room personnel simplicity, safety and reliability in bone cement. The Company distributes Cemex(R) under an exclusive distribution agreement with the Italian manufacturer, Tecres S.p.A. The Company has designed and received FDA clearance to market a non-modular shoulder implant system. The Company has suspended development plans for a modular version of a shoulder implant system. Management 4 believes that its other opportunities currently provide a more optimal use of the Company's resources. The Company has acquired an exclusive license for an improved, and patented, surgical oscillating saw system that significantly reduces vibration, noise, and problems with control in surgery. The Company believes that options exist for this product; however, management has determined that focusing on supporting distribution of existing product lines currently utilizes the Company's resources more efficiently. Marketing and Sales The Company markets its orthopaedic implant products in the United States through 50 independent sales agencies and one domestic distributor that act as the Company's sales representatives, and internationally through seventeen foreign distributors that distribute products in twenty countries. The customers for the Company's products are hospitals, surgeons and other physicians and clinics. Traditionally, the surgeon made the ultimate decision regarding which orthopaedic implant to use for a specific patient. As a result of health care reform, the rapid expansion of managed care at the expense of traditional private insurance, the advent of hospital buying groups, and various bidding procedures that have been imposed at many hospitals, sales representatives may also make presentations to hospital administrators, material management personnel, purchasing agents or review committees that may influence the final decision. The Company generally has contractual arrangements with its independent sales agencies whereby the agency is granted the exclusive right to market the Company's products in the specified territory. In turn, the agency is required to meet sales quotas to maintain its relationship with the Company. The Company's arrangements with its sales agencies typically do not preclude them from selling competitive products, although the Company believes that most of its agencies do not do so. The Company typically pays its sales agencies a commission based on net sales. The Company is highly dependent on the expertise and relationships of its sales agencies with customers. The Company's sales organization, comprised of the Company's independent sales agencies, is supervised by four Regional Directors of Sales (East, Central, Southeast and West). The Company has a contractual arrangement with its domestic distributor that is similar to its arrangements with its sales agencies, except the Company does not pay the distributor commissions and the distributor purchases inventory from the Company for use in fulfilling customer orders. The Company currently offers its products in 46 states, including Florida, New York, California, Texas, Ohio, Pennsylvania, Michigan and Illinois. The Company provides inventories of its products to its United States sales agencies until sold or returned. These inventories are necessary for sales agents to market the Company's products and fill customer orders. The size of the component to be used for a specific patient is typically not known with certainty until the time of surgery. Due to this uncertainty, a minimum of one size of each component in the system to be used must be available to each sales agency at the time of surgery. Accordingly, the Company is required to maintain substantial levels of inventory. The maintenance of relatively high levels of inventory requires the Company to incur significant expenditures of its resources. The failure by the Company to maintain required levels of inventory could have a material adverse effect on the Company's expansion. As a result of the need to maintain substantial levels of inventory, the Company is subject to the risk of inventory obsolescence. In the event that a substantial portion of the Company's inventory becomes obsolete, it would have a material adverse effect on the Company. The Company maintains a reserve for inventory due to obsolescence and slow moving items. During the years ended December 31, 1999, 2000 and 2001, approximately 6%, 5% and 4%, respectively, of the Company's sales were derived from a major hospital customer. During each of the years ended December 31, 1999, 2000, and 2001, one distributor, MBA Del Principado, S.p.A., accounted for approximately 13%, 11% and 9%, respectively, of the Company's sales. The Company generally has contractual arrangements with its foreign distributors pursuant to which the distributor is granted the exclusive right to market the Company's products in the specified territory and the distributor is required to meet sales quotas to maintain its relationship with the Company. Foreign distributors typically purchase product inventory and instruments from the Company for their use in marketing and filling customer orders. The Company currently offers its products in twenty countries in addition to the United States: Argentina, Australia, Austria, Belgium, Brazil, China, Colombia, Cyprus, Germany, Greece, Japan, Italy, Lebanon, Luxembourg, Mexico, Netherlands, Portugal, Spain, Turkey, and the United Kingdom. For the years ended December 31, 1999, 2000 and 2001, foreign sales accounted for $6,169,250, $7,582,076 and $8,391,101, 5 respectively, representing approximately 19%, 18% and 18%, respectively, of the Company's sales. For the years ended December 31, 1999, 2000, and 2001, gross profit from foreign sales accounted for $2,627,166, $3,102,552 and $3,289,170, respectively. The Company intends to continue to expand its sales in foreign markets in which there is increasing demand for orthopaedic implant products. In 2001, the Company entered into a joint venture to enter the Asian market in the People's Republic of China and the Republic of China (Taiwan). In addition, the Company added a distributor in Germany, the largest orthopaedic market in Northern Europe. Manufacturing and Supply The Company historically utilized third-party vendors for the manufacture of all of its component parts, while performing product design, quality assurance and packaging internally. During 1998, the Company began manufacturing some of its components upon completion of the current manufacturing and headquarters facility. Since that time, the Company has continued to increase the number of internally manufactured components. With the increase of internal manufacturing, the Company has experienced a greater degree of control of production costs, and it expects this trend to continue. The Company continually assesses the manufacturing capabilities and cost-effectiveness of its existing and potential vendors in its attempts to secure its supply chain and decrease dependency on a few suppliers. For the years ended December 31, 1999, 2000 and 2001, the Company purchased approximately 71%, 69% and 59% respectively, of its component requirements from three manufacturers. The Company does not maintain supply contracts with any of its manufacturers and purchases components pursuant to purchase orders placed from time to time in the ordinary course of business. The Company has several alternative sources for components and does not anticipate that it will encounter problems in obtaining adequate supplies of components. Certain tooling and equipment which are unique to the Company's products are supplied by the Company to its vendors. The Company's internal manufacturing, assembly, packaging and quality control operation are conducted at its principal offices in Gainesville, Florida. Each component received from its vendors is examined by Company personnel prior to assembly or packaging to ensure that it meets the Company's specifications. Patents and Proprietary Technology; License and Consulting Agreements The Company holds United States patents covering one of its femoral stem components, its bipolar partial hip implant system, features of its Optetrak(R) tibial components, its modular hip prothesis, and certain surgical instrumentation, has patent applications pending with respect to certain surgical instrumentation and certain implant components and anticipates that it will apply for additional patents it deems appropriate. In addition, the Company holds licenses from third parties to utilize certain patents, including an exclusive license to an oscillating saw technology and a non-exclusive license (described below) to certain patents, patents pending and technology utilized in the design of the Optetrak(R) knee system. As a result of the rapid rate of development of reconstructive products, the Company believes that patents have not been a major factor in the orthopaedic industry to date. However, patents on specific designs and processes can provide a competitive advantage and management believes that patent protection of orthopaedic products will become more important as the industry matures. Although the Company believes that its patents and products do not and will not infringe patents or violate proprietary rights of others, it is possible that its existing patent rights may not be valid or that infringement of existing or future patents or proprietary rights may occur. In addition to patents, the Company relies on trade secrets and proprietary know-how and employs various methods to protect its proprietary information, including confidentiality agreements and proprietary information agreements. In connection with the development of its knee implant systems, the Company entered into consulting agreements with certain of its executive officers and design team members, including Dr. William Petty and Dr. Gary J. Miller, who are executive officers, directors and principal shareholders of the Company, and Ivan A. Gradisar, Jr., M.D., and William Murray, M.D. Pursuant to these consulting agreements, such individuals agreed to provide consulting services to the Company in connection with evaluating the design of knee implantation systems and associated instrumentation and are entitled to receive royalties during the term of the agreements aggregating 3% of the Company's net sales of such products in the United States and less than 3% of the Company's net sales of such products outside the United States. During the years ended December 31, 1999, 2000 and 2001, the Company paid royalties aggregating $540,773, $489,561 and $450,210 respectively, pursuant to these consulting agreements. The consulting agreements with Drs. Petty and Miller were superseded by their employment agreements which provide for the continuation of the royalty payments. The Company has entered into consulting agreements with two 6 members of its design team in connection with the development of its AuRA(R) and AcuMatch(R) hip systems. In January 1997, the Company entered into an oral consulting agreement with Albert Burstein, Ph.D., a director of the Company, to provide services regarding many facets of the orthopaedic industry including product design rationale, manufacturing and development techniques and product sales and marketing. During 1999, 2000 and 2001, the Company paid Dr. Burstein $135,000 in each year as compensation under the consulting agreement. From time to time, the Company enters into license agreements with certain unaffiliated third parties under which the Company is granted the right to utilize certain patented products, designs and processes. Pursuant to a license agreement with the Hospital for Special Surgery (the "HSS License Agreement"), the Company obtained a non-exclusive right and license to certain patents, patents pending and technology utilized in the design of the Optetrak(R) knee implant system and to manufacture, use and sell total knee prostheses incorporating such patents and technology. The term of the HSS License Agreement continues until the earlier to occur of (i) the expiration of a period of ten years and (ii) the expiration of the licensed patents. In consideration for the grant of the license, the Company agreed to pay to the Hospital for Special Surgery royalties in an amount equal to 5% of net sales of the licensed products. Pursuant to the HSS License Agreement, the Company has the option to acquire a non-exclusive license to use any improvement or invention made or acquired by the Hospital for Special Surgery relating to the licensed products and the option to obtain an exclusive license to any such improvement or invention made jointly by the Hospital for Special Surgery and the Company. As is the case in many license agreements of this nature, the Hospital for Special Surgery did not represent to the Company that the manufacture, use or sale of the Optetrak(R) knee implant system will not infringe the intellectual property rights of third parties. During the years ended December 31, 1999, 2000 and 2001, the Company recognized royalties to the Hospital for Special Surgery of $812,832, $1,019,598 and $1,077,281, respectively. Pursuant to a License Agreement (the "University License Agreement") between the University of Florida (the "University") and the Company, the Company has been granted the exclusive right and license in perpetuity to make, use and sell a spinal implant device under patents owned by the University. In consideration for the right to utilize the University patents, the Company paid the University an initial license issue fee of $6,000 and, if and when the patented products or processes are utilized in devices or products sold by the Company, the Company will be required to pay the University a royalty in an amount equal to 5% of the Company's net sales of any such products in the United States, up to a maximum royalty of $500,000, and thereafter a royalty of 2% of such net sales. This royalty will be payable by the Company during the period ending ten years from the Company's first sale of a device utilizing the University patent. In addition, the University License Agreement provides that the Company will remit to the University 75% of all royalties received by the Company for sales outside of the United States under sublicense agreements relating to the patented products or processes. In connection with the University License Agreement, the Company also has agreed to assist the University in developing certain other devices currently being researched and tested which are intended to be patented by the University. To date, the Company has only utilized the University patents in connection with product research and development and accordingly, the Company has paid no royalties to the University under the University License Agreement. The Company has also entered into a sublicense agreement (the "Sublicense Agreement") with Sofamor Danek Properties, Inc. ("SDP") pursuant to which the Company granted SDP the exclusive worldwide right and sublicense to utilize the patents licensed to the Company pursuant to the University License Agreement. The term of the Sublicense Agreement continues until the last of the patents owned by the University and sublicensed to SDP terminates, unless sooner terminated in accordance with the terms of the Sublicense Agreement. Pursuant to the Sublicense Agreement, the Company received an initial sublicense fee of $250,000 and, if and when FDA approves an SDP product utilizing the University patents, the Company will receive an additional $250,000 sublicense fee. Additionally, at such time as a product utilizing the University patent is manufactured and sold by SDP, the Company will be entitled to receive a royalty from SDP in the amount of 5% of SDP's net sales of such products in the United States, up to a maximum of $500,000, and thereafter a royalty of 2% of such net sales. To date, SDP has not marketed a product utilizing the University patents and, during 1996, SDP was initially denied FDA clearance to market products using the University patents. Pursuant to a license agreement between the Company and Accumed, Inc. ("Accumed"), the Company secured a worldwide license to manufacture, use and sell products utilizing Accumed's bipolar hip prosthesis and a license to any rights under any patent that is issued covering Accumed's bipolar hip prosthesis design. The term of this license agreement continues until the expiration of the last patent comprising any part of the Accumed design, unless sooner terminated in accordance with the terms of such agreement. During the period ending on the seventh 7 anniversary of the Company's first sale of a product utilizing the Accumed design, the Company was obligated to pay Accumed an annual royalty of 3.5% of all net receipts from the Company's worldwide sale of products incorporating an Accumed product or design patent licensed to the Company. However, if a patent is not issued within a particular country in which the Company sells products utilizing Accumed's design, the royalty payable is 2% of the Company's net sales of applicable products in such country. Pursuant to the terms of the agreement, royalty payments ceased on, April 6, 1999, the seventh anniversary of the Company's first sale. During the year ended December 31, 1999, the Company paid royalties to Accumed of approximately $6,988. The Company has also entered into a patent agreement (the "Patent Agreement") with Phillip Cripe, a shareholder of the Company, under which the Company was assigned the patent rights associated with a surgical saw designed by Mr. Cripe and the concepts, techniques and processes embodied in such product. The term of this patent agreement continues until the later of ten years or the expiration of the last patent comprising any part of the surgical saw design unless sooner terminated in accordance with the terms of the Patent Agreement. In connection with the execution of the Patent Agreement, the Company granted Mr. Cripe an option to purchase 7,500 shares of the Company's Common Stock at an exercise price of $6.67 per share. The Company has also agreed to pay Mr. Cripe an annual royalty of 5% of all net receipts from the sale of products incorporating the concepts, techniques and processes embodied in the patented product (but 2% of all net receipts from the sale of associated surgical saw blades) by or on behalf of the Company. To date, the Company has not developed a product utilizing the assigned patent or know how. During October 1996, the Company licensed certain patent technology for development of a modular hip system from Medicine Lodge, Inc. The patent license fees total $360,000, of which $275,000 was paid upon the execution of the agreement and an additional $85,000 was payable at the time of FDA clearance to market the products. Additionally, the original agreement required the Company to issue a stock option for 20,000 shares of the Company's stock. During May 1999, the Company entered into an amendment to this patent agreement. Pursuant to this amendment, the Company paid the additional $85,000 from the original agreement and paid $92,188 in lieu of issuing a stock option for 20,000 shares of the Company's common stock. During 2000 and 2001, the Company paid $9,648 and $36,436, respectively, in royalties pursuant to this agreement. During 1997, the Company licensed certain technology. The license fees total $250,000, of which $100,000 was paid upon the execution of the agreement and the balance of $150,000 was paid in January 1999. During 2000, the Company entered into a patent purchase agreement with George Callaway for the purchase of a certain surgical device. The patent purchase price totaled $50,000, of which $25,000 was paid upon the execution of the agreement and an additional $25,000 was paid in January 2001. During 2001, the Company entered into a license agreement with Brighton Partners, Inc. for the purchase of certain product production technology. The licensing fee of $350,000 is payable upon acceptance conditions and issuance of patent. The Company paid $25,000 upon the signing of the agreement. Research and Development During the years ended December 31, 1999, 2000 and 2001, the Company expended $1,621,175, $2,137,978 and $2,210,216, respectively, on research and development and anticipates that research and development expenses will continue to increase. The Company's research and development efforts contributed to the introduction of the AcuMatch(R) Cemented Hip System in 1999, the AcuMatch(R) A-Series primary acetabular system, AcuMatch(R) M-Series modular hip system, AcuMatch(R) P-Series press-fit hip system in 2000, as well as the AcuMatch(R) L-Series femoral stem system in 2001. The Company's principal research and development efforts currently relate to product line enhancements to the Optetrak(R) knee system, expansion of the hip product lines, advanced biologic materials and alternative bearing surfaces. Scientific Advisory Board The Company's strategy is to utilize members of its Scientific Advisory Board, consisting of internationally known physicians and biomechanists, in the design process to facilitate the development of high quality products at cost-effective prices. The Scientific Advisory Board assists the Company in identifying new product opportunities, provides evaluation and comments on existing product development and clinical programs, and provides a direct link between the Company and the academic, medical and scientific communities which permits the Company to quickly 8 identify and respond to the demands of orthopaedic surgeons. Members of the Scientific Advisory Board generally meet at least quarterly. In addition, from time to time, the members of the Scientific Advisory Board consult with the Company individually at the request of the Company. The Company has entered into consulting agreements with certain members of the Scientific Advisory Board pursuant to which the Company pays royalties to such members. See "Patents and Proprietary Technology; License and Consulting Agreements." The members of the Scientific Advisory Board in addition to Dr. William Petty and Dr. Gary J. Miller include: Gordon Allen, M.D., Albert H. Burstein, Ph.D., Edmund Chao, Ph.D., Charles Cornell, M.D., James Crutcher, M.D., Ivan Gradisar, M.D., Norm Johansen, M.D., Wayne Moody, M.D., Charles Nelson, M.D., Raymond Robinson, M.D., and William Wilson, M.D. Competition The orthopaedic implant industry remains highly competitive and dominated by a number of large companies with substantially greater financial and other resources than the Company and competition is expected to intensify. From time to time, the Company and certain of its competitors have offered significant discounts as a competitive tactic, and may be expected to continue to do so. The Company believes its future operations will depend upon its ability to be responsive to the needs of its customers and to provide high quality products at cost-effective prices. The largest competitors in the orthopaedic implant market are DePuy (a division of Johnson and Johnson), Zimmer Medical Holdings, Howmedica/Osteonics/Stryker, and Biomet, who, according to the Orthopedic Network News, had an estimated aggregate market share of approximately 78% in 2000. Companies in the industry compete on the basis of product features and design, innovation, service, the ability to maintain new product flow, relationships with key orthopaedic surgeons and hospitals, the strength of their distribution network and price. While price is a key factor in the orthopaedic market, there are other significant factors, including: surgeon preference, ease-of-use, clinical results, and service provided by the Company and its representatives. Due to health care reform, the rapid expansion of managed care at the expense of traditional private insurance and the advent of hospital buying groups, management believes that the price of the Company's orthopaedic implant products will continue to become a more important competitive factor. Manufacturers of medical devices, including orthopaedic implants, are increasingly attempting to enter into contracts with hospital chains or hospitals pursuant to which the hospital chains agree to purchase their products exclusively from such manufacturers, usually in exchange for discounted prices. If the Company's competitors are successful in securing such contracts, the Company's ability to compete may be materially adversely affected. Although to date generic products have not been a significant factor in the orthopaedic implant market, price may become even more important if suppliers of generic products enter the market on a larger scale. Product Liability and Insurance The Company is subject to potential product liability risks which are inherent in the design, marketing and sale of orthopaedic implants and surgical instrumentation. The Company has implemented strict quality control measures and currently maintains product liability insurance in amounts which it believes are typical in the industry for similar companies. Government Regulation The Company's operations and relationships are subject to extensive, rigorous, expensive, time-consuming and uncertain regulation in the United States and certain other countries. The primary regulatory authority in the United States is the FDA. The development, testing, labeling, distribution, marketing and manufacture of medical devices, including reconstructive devices, are regulated under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act (the "Amendments") and additional regulations promulgated by FDA. In general, these statutes and regulations require that manufacturers adhere to certain standards designed to ensure the safety and effectiveness of medical devices. Under the Amendments, each medical device manufacturer must be a "registered device manufacturer" and must comply with regulations applicable generally to labeling, quality assurance, manufacturing practices and clinical investigations involving humans. FDA is authorized to obtain and inspect devices, their labeling and advertising, and the facilities in which they are manufactured in order to assure that a device is not improperly manufactured or labeled. The Company is registered with FDA and believes that it is in substantial compliance with all applicable material governmental regulations. Under the Amendments, medical devices are classified into one of three classes depending on the degree of 9 risk imparted to patients by the medical device. The Amendments define Class I devices as those for which safety and effectiveness can be guaranteed by adherence to general controls, which include compliance with Good Manufacturing Practices ("GMP"), registration and listing, reporting of adverse medical events, and appropriate truthful and non-misleading labeling. The Amendments define Class II devices as those which require pre-market demonstration of adherence to certain standards or other special controls. Such demonstration is provided through the filing of a 510(k) pre-market notification. The Amendments define a Class III product as a product which has a wholly new intended use or a product for which advances in technology cannot be assessed without clinical study. The Amendments provide that submission and approval of a pre-market application ("PMA") is required before marketing of a Class III product can proceed. The PMA process is more extensive than 510(k) process. In practice, however, FDA has developed a three-tier regulatory approach that does not exactly parallel the classification system. PMAs are currently required of medical devices which have new intended uses and some other products classified as Class III. PMAs have only been required of "old" Class III products (i.e., which were marketed on or prior to the date of enactment of the Amendments on July 28, 1976, or which are substantially equivalent to such previously marketed devices) when FDA has published a "call" for the relevant Class III pre-Amendments device. Generally, therefore, pre-Amendments Class III and almost all Class II products are cleared for marketing by FDA based on a demonstration that the safety and effectiveness of the product is substantially equivalent to a pre-Amendments device or a similar, already-marketed, predicate device that received 510(k) clearance. Finally, Class I products are, and a few Class II products have been exempted, from the requirement to file for 510(k) clearance. The Company's products have been classified by FDA as Class II devices and, currently, all marketed devices hold valid cleared 510(k) pre-market notifications, including: AuRA(R) Cemented Femoral Stem, Opteon(R) Femoral Stem, MCS(R) Femoral Stem, MCS(R) Acetabular Component, All-Polyethylene Acetabular Component, AcuMatch(R) C-Series Cemented Femoral Stem, AcuMatch(R) L-Series Cemented Femoral Stem, AcuMatch(R) A-Series Acetabular Component, AcuMatch(R) M-Series Modular Femoral Stem, AcuMatch(R) P-Series Press-Fit Femoral Stem, AcuMatch(R) L-Series Press-Fit Femoral Stem, AcuMatch(R) L-Series Unipolar Endoprosthesis, AcuMatch(R) L-Series Bipolar Endoprosthesis, AcuDriver(TM) Automated Osteotome System, Cobalt Chrome Femoral Head, Ziramic(R) Zirconia Ceramic Femoral Head, Optetrak(R) Total Knee System, Optetrak(R) B-Series Total Knee System, PMMA femoral stem centralizers and bone screws. New medical device products of the Company will likely be subject to this clearance process, although FDA has gradually enhanced the clinical data requirements applicable to many 510(k) applications over the last few years. The process of obtaining regulatory clearances is lengthy, expensive and uncertain. FDA could choose to reclassify the Company's prosthetic systems as Class III products subject to a PMA under various conditions, such as a determination that the device could not demonstrate substantial equivalence to a predicate device based on a new intended use or because a technological change or modification in the device could not be adequately evaluated for safety and effectiveness without a requirement for a PMA. Further, FDA could choose to impose strict labeling requirements, onerous operator training requirements, post-marketing surveillance, individual patient recipient lifetime tracking, or other requirements as a condition of marketing clearance, any of which could limit the Company's ability to market its products and would have a material adverse effect on the Company's business, financial condition and results of operations. Further, if the Company wishes to modify a product after clearance, including changes in indications, manufacturing, or other changes, additional clearance may be required. Failure to receive, or delays in receipt of, FDA clearance, including the need for additional clinical trials or data as a prerequisite, could limit the ability of the Company to market its products and could have a material adverse effect on the Company's business, financial condition and results of operations. The design, manufacturing, labeling, distribution and marketing of the Company's products are subject to extensive and rigorous government regulation in the United States well beyond that encompassed by the requirement to file a 510(k) premarket notification or a PMA application, including additional conditions or requirements that may become a part of FDA clearance or approval. Regulatory clearance may also include significant limitations on the indicated uses for which the Company's products may be marketed. To that end, all marketing materials are subject to exhaustive control. FDA enforcement policy strictly prohibits the marketing of approved or cleared products for unapproved uses. Furthermore, FDA does not provide an opportunity to review and approve such materials but may take action after the production and use of such materials. 10 In addition, the Company's manufacturing processes are required to comply with GMP regulations. These regulations cover the methods of design, testing, production, control, quality assurance, labeling, packaging, shipping, documentation and other requirements. Enforcement of GMP regulations has increased significantly in the last several years, and FDA has publicly stated that compliance will be more strictly scrutinized. New regulations which became effective in 1997 offer additional controls which parallel international standards. The Company's facilities and manufacturing processes, as well as that of certain of the Company's third-party suppliers, are subject to periodic inspections by FDA or other agencies. To date, the Company has successfully undergone three such inspections with only minor deficiencies cited at the exit interview and for which appropriate corrective responses were found acceptable to FDA. Failure to comply with applicable regulatory requirements could result in, among other things, warning letters, fines, injunctions, civil penalties, repairs, replacements, refunds, recalls or seizures of products, total or partial suspensions of production, refusals of FDA to grant future premarket clearances or approvals, withdrawals or suspensions of current clearances or approvals, and criminal prosecution, which could have a material adverse effect on the Company's business, financial condition and results of operations. Product recalls are classified by the FDA into three categories based on potential risk to public safety. A Class I recall is defined as a situation in which the use of a violative product causes reasonable probability of serious adverse health consequences or death. A Class II recall is defined as a situation in which the use of a violative product may cause temporary or medically reversible adverse health consequences or where the probability of serious adverse health consequences is remote. A Class III recall is defined as a situation in which the use of a violative product is not likely to cause adverse health consequences. Prior to 1996, the Company voluntarily initiated three Class III recalls. In 1997, the Company voluntarily initiated one Class II recall. In 2000, the Company voluntarily initiated one Class I recall and two Class II recalls. In 2001, the Company voluntarily initiated two Class II recalls and four recalls as yet unclassified. These voluntary recalls were reported to the FDA and are considered complete and closed. Generally, the Company must obtain export certificates from FDA before it can export any product. While the process for issuance of export certificates has been expedited by FDA, and the Company has obtained export certificates under this expedited (and its predecessor) process, there can be no assurance that the issuance of export certificates in the future will not be subject to new restrictions, or that the Company will continue to receive or not be delayed in its receipt of such export certificates. Such future actions could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is required to obtain various licenses and permits from foreign governments and to comply with significant regulations that vary by country in order to market its products in foreign markets. In order to continue marketing its products in Europe after mid-1998, the Company was required to obtain ISO 9001 certification and receive "CE" mark certification, an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. The ISO 9001 certification is one of the prerequisites for CE mark certification. The Company received both ISO 9001 and CE mark certification in May 1998. Certain provisions of the Social Security Act, commonly referred to as the "Anti-kickback Statute," prohibit entities, such as the Company, from offering, paying, soliciting or receiving any form of remuneration in return for the referral of Medicare or state health program patients or patient care opportunities, or in return for the recommendation, arrangement, purchase, lease or order of items or services that are covered by Medicare or state health programs. The Anti-kickback Statute is broad in scope and has been broadly interpreted by courts in many jurisdictions. Read literally, the statute places at risk many business arrangements, potentially subjecting such arrangements to lengthy, expensive investigations and prosecutions initiated by federal and state governmental officials. Many states have adopted similar prohibitions against payments intended to induce referrals of Medicaid and other third party payer patients. Violation of the Anti-kickback Statute is a felony, punishable by fines up to $25,000 per violation and imprisonment for up to five years. In addition, the Department of Health and Human Services may impose civil penalties excluding violators from participation in Medicare or state health programs. In July 1991, in part to address concerns regarding the Anti-kickback Statute, the federal government published regulations that provide exceptions, or "safe harbors," for transactions that will be deemed not to violate the Anti-kickback Statute. Some of the Company's relationships do not qualify for safe harbor protection. The fact that a relationship does not qualify for safe harbor protection, however, does not mean that it is illegal, and the Company believes that it is not in violation of the Anti-kickback Statute. If the Company's current or future practices 11 are found to be in violation of the statute, such finding could have a material adverse effect on the Company. Any state or federal regulatory review of the Company, regardless of the outcome, would be both costly and time consuming. Significant prohibitions against physician referrals were enacted by Congress in the Omnibus Budget Reconciliation Act of 1993. These prohibitions, commonly known as "Stark II," amended prior physician self-referral legislation known as "Stark I" by dramatically enlarging the field of physician-owned or physician-interested entities to which the referral prohibitions apply. Effective January 1, 1995, Stark II prohibits, subject to certain exemptions, a physician or a member of his immediate family from referring Medicare or Medicaid patients to an entity providing "designated health services" in which the physician has an ownership or investment interest, or with which the physician has entered into a compensation arrangement. The penalties for violating Stark II include a prohibition on payment by these government programs and civil penalties of as much as $15,000 for each violative referral and $100,000 for participation in a "circumvention scheme." The Stark legislation is broad and ambiguous and interpretative regulations clarifying the provisions of Stark II as it would relate to the Company have not been issued. While the Company believes it is in compliance with the Stark legislation, there can be no assurance this is the case or that the government would not take a contrary view. The violation of Stark I or II by the Company could result in significant fines or penalties and exclusion from participation in the Medicare and Medicaid programs. The Company is also subject to regulation by the Occupational Safety and Health Administration and the Environmental Protection Agency and similar state and foreign agencies and authorities. Employees As of December 31, 2001, the Company employed 119 full time employees. The Company has no union contracts and believes that its relationship with its employees is good. Executive Officers of the Registrant The executive officers of the Company, and their ages as of March 13, 2002, are as follows: Name Age Position ---- --- -------- William Petty, M.D......... 59 Chairman of the Board, Chief Executive Officer, and President Gary J. Miller, Ph.D....... 54 Executive Vice President, Research and Director David W. Petty............. 35 Executive Vice President, Sales and Marketing and Director Marc J. Olarsch............ 40 Vice President, Sales Joel C. Phillips........... 34 Chief Financial Officer Betty Petty................ 59 Vice President, Administration and Human Resources William Petty, M.D. was a founder and has been Chairman of the Board and Chief Executive Officer of the Company since its inception. Dr. Petty was a Professor at the University of Florida College of Medicine from July 1975 to September 1998. Dr. Petty also served as Chairman of the Department of Orthopaedic Surgery at the University of Florida College of Medicine from July 1981 to January 1996. Dr. Petty has also served as a member of the Hospital Board of Shands Hospital, Gainesville, Florida, as an examiner for the American Board of Orthopaedic Surgery, as a member of the Orthopaedic Residency Review Committee of the American Medical Association, on the Editorial Board of the Journal of Bone and Joint Surgery, and on the Executive Board of the American Academy of Orthopaedic Surgeons. He holds the Kappa Delta Award for Outstanding Research from the American Academy of Orthopaedic Surgeons. His book, Total Joint Replacement, was published in 1991. Dr. Petty received his B.S., M.S., and M.D. degrees from the University of Arkansas. He completed his residency in Orthopaedic Surgery at the Mayo Clinic in Rochester, Minnesota. Dr. Petty assumed the additional title of President upon Mr. Seese's resignation. Timothy J. Seese has been President and Chief Operating Officer of the Company since March 1991 and a director since April 1991. From October 1987 to December 1990, Mr. Seese served as President and Chief Executive Officer of Meritech, Inc., a development stage company involved with infection control products. From December 1986 to October 1987, he served as President of the Critical Care Monitoring Division of Becton Dickinson and Company, a manufacturer and marketer of medical devices, upon the acquisition of Deseret Medical, 12 Inc. by Becton Dickinson and Company. From January 1983 to December 1986, he served as Business Unit Director and Director, Marketing and Sales for the Critical Care Business of Deseret Medical, Inc. Division of Warner Lambert, a medical device, pharmaceutical and consumer products company. He received his B.S. in Metallurgical Engineering from the University of Cincinnati and his M.B.A. from Harvard University. Mr. Seese resigned his position as President, Chief Operating Officer and Director effective January 31, 2002 to take a position as President and Chief Executive Officer of Ascension Orthopaedics. Dr. William Petty, the Company's Chief Executive Officer and Chairman of the Board assumed the additional title of President upon Mr. Seese's resignation. Mr. David Petty, the Company's Executive Vice President, Sales and Marketing, has been appointed to fill the vacancy on the Board of Directors created by Mr. Seese's resignation until a new member is elected and qualified. Gary J. Miller, Ph.D. was a founder and has been Executive Vice President, Research since February 2000. He was Vice President, Research and Development from 1986 until 2000 and has been a Director since March 1989. Dr. Miller was Associate Professor of Orthopaedic Surgery and Director of Research and Biomechanics at the University of Florida College of Medicine from July 1986 until August 1996. Dr. Miller received his B.S. from the University of Florida, his M.S. (Biomechanics) from Massachusetts Institute of Technology, and his Ph.D. in Mechanical Engineering (Biomechanics) from the University of Florida. He has held an Adjunct Associate Professorship in the College of Veterinary Medicine's Small Animal Surgical Sciences Division since 1982 and was appointed as an Adjunct Associate Professor in the Department of Aerospace, Mechanics and Engineering Sciences in 1995. He was a consultant to the United States Food and Drug Administration from 1989 to 1992 and has served as a consultant to such companies as Johnson & Johnson Orthopaedics, Dow-Corning Wright and Orthogenesis. David W. Petty has been Executive Vice President, Sales and Marketing since February 2000. He has been employed by the Company in successive capacities in the areas of Operations and Sales and Marketing for the past twelve years, serving as Vice President, Operations from April 1991 until April 1993 and Vice President, Marketing from 1993 until 2000. He also served as a Director from March of 1989 until March of 1996. Mr. Petty received his B.A. from the University of Virginia. He is the son of Dr. and Ms. Petty. Mr. Petty has been appointed to fill the vacancy on the Board of Directors created by Mr. Seese's resignation. Joel C. Phillips, CPA has been Chief Financial Officer of the Company since July 1998 and Treasurer since March 1996. Mr. Phillips was Manager, Accounting and Management Information Systems from April 1993 to June 1998. From January 1991 to April 1993, Mr. Phillips was employed by Arthur Andersen. Mr. Phillips received a B.S. and a Masters in Accounting from the University of Florida and is a certified public accountant. Betty Petty was a founder and has been Vice President, Human Resources and Administration since February 2000. She has also been Secretary of the Corporation since its inception and served as Treasurer and a Director until March 1996. Ms. Petty served in the duel capacities of Human Resources Coordinator and Director of Marketing Communications from the founding of the Company until 2000. She received her B.A. from the University of Arkansas at Little Rock and her M.A. in English from Vanderbilt University. Ms. Petty is the wife of Dr. Petty. Marc J. Olarsch has been Vice President, Sales since July 1993. From 1984 to July 1993, he was employed by Carapace, the United States subsidiary of Lohmann GmbH & Co., KB, Neuwied, Germany, a manufacturer of orthopaedic casting material, surgical wound dressings and bandages. During his tenure with Carapace, he held the positions of Regional Sales Manager and National Sales Manager. He has extensive experience with group purchasing organizations, independent manufacturers' representatives, as well as company-employed territory managers and sales representatives. The Company's officers are elected annually by the Board of Directors and serve at the discretion of the Board. ITEM 2. PROPERTIES In June 1998, the Company completed construction of a new 39,000 square foot facility on approximately eight acres of land owned by it in Gainesville, Florida to be used by the Company for principal executive offices, research and development laboratories and manufacturing. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". 13 In August 1999, the Company acquired approximately three acres of land nearby to its existing facility for future expansion requirements. ITEM 3. LEGAL PROCEEDINGS In the ordinary course of business, the Company is, from time to time, a party to pending and threatened legal proceedings, primarily involving claims for product liability. The Company believes that the outcome of such legal actions and proceedings will not have a material adverse effect on the Company. On December 27, 2000, a complaint was filed against the Company in the District Court of Buffalo County, Nebraska alleging the improper design of a prosthetic device manufactured by the Company. The complaint was subsequently settled on August 23, 2001 without admission of liability on the part of the Company. On May 8, 2001, a complaint was filed against the Company in the Superior Court of the state of California, San Francisco County, alleging negligence and the improper design of a prosthetic device manufactured by the Company. The case has subsequently been removed to the United States District Court, Northern District of California and remains in the early stages. The plaintiff is seeking an unspecified monetary award and damages in an amount to be determined at trial. This case remains in the early stages. The Company is pursuing the defense of this claim vigorously. On June 14, 2001, the Company's insurance carrier denied coverage under the Company's product liability insurance policy. The Company maintains that these cases should be covered by the products liability policy with that carrier and is involved in ongoing negotiations with the insurer to resolve the coverage issue. However, there can be no assurances that the Company will be able to reach agreement with the insurance company on the disputed coverage. In the event that the Company is unable to reach agreement with the insurance company, the Company will consider its remedies against the insurer, and intends to pursue such remedies vigorously. Based on the facts known at this time, the Company has provided for reserves for the independent resolution of this matter. There can be no assurances as to the adequacy of these reserves. During March 2001, the Company secured retroactive annual product liability insurance coverage that it expects will cover any future litigation related to these devices, which were subject to recall during 1997 and 1998. The Company is a party to an arbitration proceeding with Regeneration Technologies, Inc. ("RTI") with respect to its agreement with RTI for the distribution of a bone grafting material technology. In the proceeding, the Company has asserted that RTI is violating the exclusivity provisions of the agreement by engaging in the distribution of certain products utilizing that technology. A hearing as to liability was held before the arbitration panel in July 2001. The panel delivered its ruling on December 21, 2001 affirming Exactech's exclusive distribution rights to the technology. The Company is in the process of gathering data to assess the extent of the Company's damages. The Company expects another hearing to be held by the panel regarding such damages. The Company's insurance policies covering product liability claims must be renewed annually. Although the Company has been able to obtain insurance coverage concerning product liability claims at a cost and on other terms and conditions that are acceptable to the Company, the Company makes no assurances that it will able to procure such policies in the future. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the fourth quarter of the fiscal year ended December 31, 2001. 14 PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock trades on the Nasdaq National Market under the symbol "EXAC". The following table sets forth, for the periods indicated, the high and low sales price of the Common Stock, as reported on the Nasdaq National Market: High Low ------------ ------------ 2000 -------------------------------------- First Quarter $ 20.00 $ 11.06 Second Quarter 17.00 12.38 Third Quarter 19.00 16.00 Fourth Quarter 21.50 17.00 2001 -------------------------------------- First Quarter $ 20.00 $ 15.88 Second Quarter 17.25 11.00 Third Quarter 13.50 11.35 Fourth Quarter 16.60 11.00 2002 -------------------------------------- First Quarter (through March 13th) $ 18.50 $ 15.05 No cash dividends have been paid to date by the Company on its Common Stock. The Company intends to retain all future earnings for the operation and expansion of its business and does not anticipate the payment of cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will depend upon a number of factors, including future earnings, results of operations, capital requirements, the Company's financial condition and any restrictions under credit agreements existing from time to time, as well as such other factors as the Board of Directors may deem relevant. As of March 13, 2002, the Company had approximately 217 shareholders of record. There are in excess of 2,626 beneficial owners of the Company's Common Stock. 15 ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below has been derived from the audited financial statements of the Company. This data should be read in conjunction with the financial statements, the notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.
Year Ended December 31, ------------------------------------------------------------------------------- 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- Statement of Operations Data: Net sales $17,648,060 $24,024,356 $32,954,283 $41,925,375 $46,599,351 Cost of goods sold 5,844,772 8,469,938 11,558,593 14,561,656 16,186,624 Gross profit 11,803,288 15,554,418 21,395,690 27,363,719 30,412,727 Operating expenses: Sales and marketing 4,911,906 5,968,611 8,445,544 11,229,966 12,976,732 General and administrative 1,677,878 2,184,564 2,665,035 3,168,029 4,765,246 Research and development 937,988 1,271,825 1,621,175 2,137,978 2,210,216 Depreciation and amortization 813,200 1,202,000 1,679,676 2,153,807 2,649,957 Royalties 855,415 1,215,956 1,508,098 1,643,378 1,762,326 Total operating expenses 9,196,387 11,842,956 15,919,528 20,333,158 24,364,477 Income from operations 2,606,901 3,711,462 5,476,162 7,030,561 6,048,250 Other income (expense): Interest income (expense), net 200,720 (70,686) (136,893) (287,988) (390,734) Loss on disposal of assets (50,530) (120,453) (155,683) (68,281) (79,217) Equity in net (loss) income of subsidiary (183,909) 13,778 - - (131,574) Income before provision for income taxes 2,573,182 3,534,101 5,183,586 6,674,292 5,446,725 Provision for income taxes 997,188 1,406,671 2,016,019 2,494,774 1,987,193 Net income 1,575,994 2,127,430 3,167,567 4,179,518 3,459,532 Basic earnings per common share $ 0.32 $ 0.43 $ 0.64 $ 0.83 $ 0.66 Diluted earnings per common share $ 0.32 $ 0.43 $ 0.61 $ 0.78 $ 0.64 ------------------------------------------------------------------------------- Balance Sheet Data: 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- Total current assets $16,867,260 $18,055,329 $21,447,309 $29,473,191 $31,665,906 Total assets 27,154,836 29,238,120 34,609,406 44,548,568 47,477,575 Total current liabilities 2,464,461 2,187,582 3,594,627 8,192,866 5,329,849 Total long-term debt, net of current portion 3,912,835 3,906,802 3,600,000 3,300,000 3,000,000 Total liabilities 6,811,244 6,754,643 8,169,607 12,912,890 10,097,807 Total common shareholders' equity 20,343,592 22,483,477 26,439,799 31,635,678 37,379,768
16 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW -------- The following discussion should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere herein. Exactech, Inc. was founded by an orthopaedic surgeon and bioengineer in November 1985 to develop, manufacture, market and sell orthopaedic implant devices and related surgical instrumentation to hospitals and physicians in the United States and overseas. Exactech's products and services respond to the demands of hospitals and the surgical community in replacing joints which have deteriorated as a result of injury or diseases, such as arthritis. Early in its history, the Company's revenues were principally derived from sales of its primary hip replacement systems. In 1999, the Company began a comprehensive design project to integrate concepts of cemented and press-fit hips into one system. That design project produced the AcuMatch(R) Integrated Hip System. Part of the design rationale was to enable all AcuMatch primary femoral components to be implanted using a single set of surgical instruments therefore making the system more efficient and user friendly. Presently, the AcuMatch system features the M-Series Modular Femoral Stem System, the C-Series Cemented Femoral Stem, the P-Series Press Fit Femoral Stem, the L-Series Hip System, and the A-Series Acetabular Components. The Opteon(R) Cemented Stem, the MCS(R) Porous Coated Total Hip System and the AcuMatch Integrated Hip System comprise Exactech's extensive line of hip implant devices. In 1995, the Company introduced the primary components of the comprehensive Optetrak(R) knee system. The Optetrak knee system was conceived by Exactech in collaboration with members of its Scientific Advisory Board in cooperation with the Hospital for Special Surgery in New York, an internationally recognized hospital for orthopaedic surgery. The Optetrak system represents a differentiated product based on precision manufacturing techniques and a design which reduces articular contact stress. The Optetrak system is the most modern design of a series of proven knee implants which were first introduced in 1974. In 1997, the Optetrak system was enhanced to include constrained condylar components for revision procedures to replace failed implants and complex primary total knee replacement surgeries. In 1998, Exactech introduced Opteform(R), a biologic material for grafting and repairing bone defects, supplied by Regeneration Technologies, Inc.. Full-scale domestic distribution of the Opteform tissue service began during 1999. Opteform is used by surgeons to repair bone by creating osteoinductive and osteoconductive components to aid bone growth. In 2001, the Company began distributing a unique bone cement system, Cemex(R), under an exclusive agreement with Italian manufacturer, Tecres S.p.A. The Cemex bone cement system features a self-contained delivery system that has been clinically proven in Europe for more than a decade. By integrating bone cement powder and liquid into a sealed mixing system, Cemex is designed to offer surgeons and operating room personnel simplicity, safety and reliability in bone cement. To market orthopaedic implant products in the United States, Exactech utilizes a network of independent agencies and domestic distributors that act as the Company's sales representatives. Internationally, the Company's products are marketed through distributors. 17 The following table sets forth for the periods indicated information with respect to the dollar amount of sales of the Company's products and the percentages of revenues derived from such sales (dollars in thousands): SALES SUMMARY BY PRODUCT LINE
Year Ended ------------------------------------------------------------------------------------- December 31, 1999 December 31, 2000 December 31, 2001 $ % $ % $ % - - - - - - Knee Products 21,259 64.5% 26,109 62.3% 28,214 60.5% Hip Products 5,928 18.0% 8,571 20.5% 10,433 22.4% Tissue Services 4,053 12.3% 5,348 12.8% 5,252 11.3% Instrument Sales and Rental 1,171 3.6% 1,230 2.9% 1,392 3.0% Acudriver 284 0.8% 230 0.5% 232 0.5% Bone Cement - 0.0% - 0.0% 382 0.8% Miscellaneous 259 0.8% 437 1.0% 694 1.5% --------------------------- --------------------------- --------------------------- Total 32,954 100.0% 41,925 100.0% 46,599 100.0% =========================== =========================== ===========================
SALES AND EARNINGS ------------------ Overall, indicators and trends remain positive except for operating income and the resulting calculations of Earnings Per Share, which decreased primarily as a result of the impact of the arbitration and litigation issues (see Note 6 to the consolidated financial statements). Net sales increased by $4,673,976, or 11%, to $46,599,351 in the year ended December 31, 2001 from $41,925,375 in the year ended December 31, 2000. Net sales for the year ended December 31, 2000 increased $8,971,092, or 27%, from $32,954,283 in the year ended December 31, 1999. Domestic sales increased 11% to $38,208,250 in the year ended December 31, 2001 from $34,343,299 in the year ended December 31, 2000, which represented an increase of 28% from $26,785,033 in the year ended December 31, 1999. International sales increased 11% to $8,391,101 in the year ended December 31, 2001 from $7,582,076 in the year ended December 31, 2000, an increase of 23% from $6,169,250 in the year ended December 31, 1999. As a percentage of sales, international sales remained constant at 18% for the years ended December 31, 2000 and December 31, 2001, after decreasing from 19% for the year ended December 31, 1999. The overall increase in net sales in each of the years ended December 31, 2000 and 2001 resulted from growth in the Company's major product lines, both in terms of units and dollars. This continued growth can be attributed to increased market penetration of the Company's products, paced by the Company's line of hip implant products. Sales of hip implant products for the year ended December 31, 2001 increased by 6% on a unit basis and by 22% on a dollar basis from the year ended December 31, 2000, which had increased by 41% on a unit basis and by 45% on a dollar basis from the year ended December 31, 1999. The increase in hip sales for both of the years ended December 31, 2000 and 2001, resulted from increased marketing efforts in support of the product introduction of the Company's comprehensive AcuMatch(R) Integrated Hip System. Sales of knee implant products for the year ended December 31, 2001 increased by 13% on a unit basis and by 8% on a dollar basis, as compared to an increase of 23% on a unit and dollar basis for the year ended December 31, 2000 from the year ended December 31, 1999. The increases in sales of knee implant products reflect a continued market acceptance for the Company's Opetrak(R) knee systems. For the year ended December 31, 2001, the Company experienced a slightly lower average selling price worldwide for knee implants from the year ended December 31, 2000, resulting in lower dollar sales growth as compared to unit sales growth, primarily due to higher international unit sales growth. Hip and knee surgical instrument sales and rentals increased 13% to $1,391,680 in the year ended December 31, 2001, as compared to $1,229,842 in the year ended December 31, 2000, which represented an increase of 5% from $1,170,436 in the year ended December 31, 1999. Gross profit increased by $3,049,008, or 11%, to $30,412,727 in the year ended December 31, 2001, from $27,363,719 in the year ended December 31, 2000, which represented an increase of $5,968,029, or 28%, from $21,395,690 in the year ended December 31, 1999. As a percentage of sales, gross profit remained constant at 65.3% in the years ended December 31, 2001 and December 31, 2000, compared to 64.9% in the year ended December 31, 1999. The increase in the gross margin, as a percentage of sales, in the year ended December 31, 2000 was primarily due to reduced unit costs of the Company's products realized because of increased internal 18 manufacturing of components. Total operating expenses increased by $4,031,319, or 20%, to $24,364,477 in the year ended December 31, 2001 from $20,333,158 in the year ended December 31, 2000, which represented an increase of $4,413,630, or 28%, from $15,919,528 in the year ended December 31, 1999. As a percentage of sales, operating expenses increased to 52% for the year ended December 31, 2001, as compared to 49% for the year ended December 31, 2000 and 48% for the year ended December 31, 1999. Sales and marketing expenses increased by $1,746,766, or 16%, to $12,976,732 in the year ended December 31, 2001, from $11,229,966 in the year ended December 31, 2000, which represented an increase of $2,784,422, or 33%, from $8,445,544 in the year ended December 31, 1999. As a percentage of sales, sales and marketing expenses for the year ended December 31, 2001 increased slightly to 28%, as compared to 27% in the year ended December 31, 2000 and 26% in the year ended December 31, 1999. The Company's sales and marketing expenses are largely variable costs based on sales levels, with the largest component being commissions. Sales and marketing expenses increased in both 2000 and 2001, primarily as a result of marketing initiatives in the area of meetings, training, and targeted advertising campaigns. In the year ended December 31, 2001, the Company hosted its first worldwide surgeons conference that was attended by over 200 surgeons from the United States and overseas. For the year ended December 31, 2000, sales and marketing expenses increased primarily as a result of marketing efforts to support new product introductions and expanded training programs for the Company's sales representatives. General and administrative expenses increased by $1,597,217, or 50%, to $4,765,246 in the year ended December 31, 2001 from $3,168,029 in the year ended December 31, 2000, which represented an increase of $502,994, or 19%, from $2,665,035 in the year ended December 31, 1999. General and administrative expenses for the year ended December 31, 2001 increased primarily as a result of $1,423,168 of legal expenditures for ongoing arbitration and litigation issues (see Note 6 - Commitments and Contingencies in the accompanying notes to consolidated financial statements). As a percentage of sales, general and administrative expenses increased to 10% for the year ended December 31, 2001, as compared to 8% in each of the years ended December 31, 2000 and December 31, 1999. General and administrative expenses increased in the year ended December 31, 2000 as compared to the year ended December 31, 1999 primarily as a result of increased expenditures for infrastructure to support the Company's growth. Research and development expenses increased by $72,238, or 3%, to $2,210,216 in the year ended December 31, 2001 from $2,137,978 in the year ended December 31, 2000, which represented an increase of $516,803, or 32%, from $1,621,175 in the year ended December 31, 1999. Product development costs increased slightly in the year ended December 31, 2001 due primarily to the completion in 2000 of efforts associated with comprehensive improvements to the Company's integrated primary hip and modular hip systems. As a percentage of sales, research and development expenses have remained constant at 5% in the years ended December 31, 2001, 2000 and 1999. Depreciation and amortization expenses increased by $496,150, or 23%, to $2,649,957 in the year ended December 31, 2001 from $2,153,807 in the year ended December 31, 2000, which represented an increase of $474,131, or 28%, from $1,679,676 in the year ended December 31, 1999. Depreciation and amortization expenses increased in the year ended December 31, 2001 primarily due to the addition of surgical instrumentation and manufacturing equipment. During the year ended December 31, 2001, $3,205,541 of equipment and instrumentation was placed in service, as compared to $4,401,462 of equipment and instrumentation placed in service during the year ended December 31, 2000. The increase in depreciation and amortization expense has resulted from Exactech's continuing commitment to invest in capital for the growth of its customers. Royalty expenses increased by $118,948, or 7%, to $1,762,326 in the year ended December 31, 2001 from $1,643,378 in the year ended December 31, 2000, as compared to an increase of $135,280, or 9%, from $1,508,098 in the year ended December 31, 1999. As a percentage of sales, royalty expenses remained constant at 4% for the years ended December 31, 2001 and December 31, 2000, after decreasing from 5% for the year ended December 31, 1999. The smaller increases in royalty expenses for the years ended December 31, 2000 and 2001 were primarily the result of the growth in sales of hip implants and tissue services which incur a lower, or no, royalty rate. During each of the years ended December 31, 1999, 2000 and 2001, the Company recognized royalties to the Hospital for Special Surgery of $812,832, $1,019,598 and $1,077,281, respectively. The Company's income from operations decreased by $982,311, or 14%, to $6,048,250 in the year ended 19 December 31, 2001 from $7,030,561 in the year ended December 31, 2000, which represented an increase of $1,554,399, or 28%, from $5,476,162 in the year ended December 31, 1999. For the year ended December 31, 2001, the decrease was primarily the result of the increase in operating expenses, the largest component being legal charges associated with the Company's arbitration and litigation. For the year ended December 31, 2000, the increase was primarily due to the increase in sales, coupled with an increase in gross margin, along with a relatively flat growth in operating expenses, as a percentage of sales. Interest income decreased $13,315, or 27%, to $36,388 in the year ended December 31, 2001 from $49,703 in the year ended December 31, 2000, which represented a decrease of $33,725, or 40%, from $83,428 for the year ended December 31, 1999. For the year ended December 31, 2001, interest expense increased $89,431, or 27%, to $427,122 from $337,691 for the year ended December 31, 2000, which represented an increase of $117,370, or 53%, from $220,321 in the year ended December 31, 1999. For the year ended December 31, 2001, interest income decreased as available cash was used to service current liabilities while interest charges were incurred on borrowing under the Company's credit facility during the year ended December 31, 2000. Similarly, for the year ended December 31, 2000, the decrease in interest income and increase in interest expense was the result of a reduction of cash levels while there was increased borrowing associated with the Company's infrastructure and inventory expansion. The weighted average outstanding principal balance of the Company's long-term debt was approximately $3,550,000, $3,850,000 and $3,906,418 during 2001, 2000 and 1999, respectively. The average outstanding balance has decreased in each of the two years ended December 31, 2001 and December 31, 2000 due to the payment of principal on the outstanding Industrial Revenue Bond (IRB) financing. The weighted average interest rate on such debt was 2.78%, 4.32%, and 3.44% for 2001, 2000 and 1999, respectively. During the year ended December 31, 2001, the Company incurred interest expense on borrowings under an existing short-term line of credit. The average outstanding principal balance on the line of credit was $1,411,340, as compared to $1,207,784 during the year ended December 31, 2000. The weighted average interest rate on the line of credit was 5.93% for the year ended December 31, 2001 as compared to 8.81% for the year ended December 31, 2000. Income before provision for income taxes decreased by $1,227,567, or 18%, to $5,446,725 in the year ended December 31, 2001 from $6,674,292 in the year ended December 31, 2000, which represented an increase of $1,490,706, or 29%, from $5,183,586 in the year ended December 31, 1999. The provision for income taxes decreased $507,581, or 20%, to $1,987,193 in the year ended December 31, 2001 from $2,494,774 in the year ended December 31, 2000, which increased $478,755, or 24%, from $2,016,019 in the year ended December 31, 1999. The effective tax rate for the year ended December 31, 2001 was 36.5% as compared to 37.4% for the year ended December 31, 2000 and 38.9% in the year ended December 31, 1999. The decrease in the effective tax rates for each of the years ended December 31, 2001 and 2000 was primarily a result of an increased impact of the research and development credit and foreign sales corporation tax benefits. As a result of the foregoing, the Company realized net income of $3,459,532 in the year ended December 31, 2001, a decrease of 17% from $4,179,518 in the year ended December 31, 2000. Net income for the year ended December 31, 2000 represented an increase of 32% as compared to $3,167,567 in the year ended December 31, 1999. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- Since inception, the Company has financed its operations through borrowings, the sale of equity securities and cash flow from operations. At December 31, 2001, the Company had working capital of $26,336,057, as compared to $21,280,325 at December 31, 2000 and $17,852,682 at December 31, 1999. As a result of operating, investing and financing activities, cash and cash equivalents at December 31, 2001 increased $552,677 to $1,001,000 from $448,323 at December 31, 2000, which was a decrease of $1,192,748 from $1,641,071 at December 31, 1999. For the year ended December 31, 2001, the increase in working capital was primarily the result of an increase in trade receivables of $1,447,046 and a reduction in current liabilities, including a reduction in the short-term line of credit facility of $2,228,883. For the year ended December 31, 2000, the increase in working capital was the result of the increase in inventory in support of new product launches. For the year ended December 31, 1999, the increase in working capital was primarily the result of increases in net sales and income while maintaining a minimal increase in inventory. The Company maintains a credit facility with Merrill Lynch Business Financial Services, Inc., which is secured by accounts receivable and inventory. The credit line is limited to the lesser of 80% of the value of accounts receivable less than 90 days old, plus the lesser of 50% of the value of inventory (excluding raw materials and work-in-process inventory) and 25% of inventory on consignment or $6,000,000. The credit line was extended in January 20 2001 to increase the available limit to $12,000,000, expiring June 30, 2002. As of December 31, 2001, there was $1,385,566 outstanding under the line of credit as compared to $3,614,449 at December 31, 2000. At December 31, 2001, the Company had outstanding commitments for the purchase of inventory and raw materials of $4,312,430, along with commitments to purchase $276,771 of capital equipment. The Company believes that funds from operations and borrowings under its existing credit facility will be sufficient to satisfy its contemplated cash requirements for the following twelve months. Operating Activities -------------------- Operating activities provided net cash of $4,600,007 in the year ended December 31, 2001, as compared to using net cash of $1,162,408 in the year ended December 31, 2000. For the year ended December 31, 1999, operating activities provided net cash of $4,022,610. In the year ended December 31, 2001, operating activities provided net cash primarily as a result of sales and increases in other liabilities, which increased by $428,537. In the year ended December 31, 2000, operating activities used net cash primarily as a result of the increase in inventory, which increased to $19,397,100 at December 31, 2000, from $11,638,895 at December 31, 1999. In the year ended December 31, 2001, cash used as a result of the increase in trade receivables was $1,447,046 as compared to $1,076,130 during 2000 and $2,340,671 during 1999. Cash used as a result of an increase in inventory for the year ended December 31, 2001 was $200,441 as compared to $7,758,205 in the year ended December 31, 2000 and $106,334 in the year ended December 31, 1999. The large increase in inventory in the year ended December 31, 2000 was primarily the result of purchases associated with the Company's comprehensive revision to its hip implant product lines. For the year ended December 31, 2001 cash required as a result of a decrease in accounts payable was $1,081,161, compared to cash provided as a result of an increase in accounts payable of $804,793 in 2000 and $1,082,356 in 1999. Investing Activities -------------------- During the year ended December 31, 2001, net cash used in investing activities decreased to $3,803,005, as compared to $4,361,150 used during the year ended December 31, 2000, and $3,820,111 used during the year ended December 31, 1999. The decrease in the year ended December 31, 2001 was primarily the result of comparatively fewer purchases of manufacturing equipment and surgical instrumentation. Financing Activities -------------------- For the year ended December 31, 2001, financing activities used net cash of $244,325, as compared to financing activities providing net cash of $4,330,810 for the year ended December 31, 2000 and $775,920 in the year ended December 31, 1999. For the year ended December 31, 2001, the Company used cash of $3,800,000 to pay outstanding long and short-term debt, which was partially offset by proceeds from the issuance of stock providing cash of $2,284,558. Borrowings under the Company's line of credit provided cash of $1,271,117 in the year ended December 31, 2001, as compared to $3,614,449 in the year ended December 31, 2000. At December 31, 2001, the Company did not have any off-balance sheet financing arrangements (other than operating leases disclosed in Note 11 of the Notes to the Consolidated Financial Statements) or any unconsolidated, special purpose entities. CERTAIN RISK FACTORS -------------------- Although it is not possible to predict or identify all such factors, they may include those listed below, which should not be considered an exhaustive statement of all potential risks and uncertainties: . The Company is subject to extensive government regulation. Failure to obtain government approvals and clearances for new products and/or modifications to existing products on a timely basis would likely have a material adverse effect on the business and financial results of the Company. A significant recall of one or more of the Company's products could have a material adverse effect on the Company's business and financial results. There can be no assurance that such clearances will be granted or that review by government authority will not involve delays materially adversely affecting the marketing and sale of the Company's products. 21 . The Company faces uncertainty relating to the availability of third-party reimbursement for its products. The failure by physicians, hospitals and other users of the Company's products to obtain sufficient reimbursement from health care payors for procedures in which the Company's products are used or adverse changes in governmental and private payors' policies toward reimbursement for such procedures would have a material adverse effect on the Company's business and financial results. . The Company is required to incur significant expenditures of resources in order to maintain relatively high levels of inventory. As a result of the need to maintain substantial levels of inventory, the Company is subject to the risk of inventory obsolescence. In the event that a substantial portion of the Company's inventory becomes obsolete, it would have a material adverse effect on the Company's business and financial results. . The Company conducts business in a highly competitive industry. The orthopaedic implant industry is subject to competition in the following areas: product features and design, innovation, service, the ability to maintain new product flow, relationships with key orthopaedic surgeons and hospitals, strength of distribution network, and price. In addition, the Company faces competition for regional sales representatives within the medical community. There can be no assurance that the Company will be able to compete successfully. . The Company's success is partially dependent upon its ability to successfully market new and improved products and the market acceptance of those products. The failure of its products to gain market acceptance would be likely to have a material adverse effect on the Company's business and financial results. There can be no assurance that new or improved products will gain market acceptance. . The Company is subject to federal anti-kickback laws and regulations. These laws and regulations prohibit any knowing and willful offer, payment, solicitation or receipt of any form of remuneration, either directly or indirectly, in return for, or to induce: referral of an individual for a service or product for which payment may be made by Medicare, Medicaid or another government sponsored health care program, or purchasing, leasing, ordering or arranging for, or recommending the purchase, lease or order of, any service or product for which payment may be made by a government-sponsored health care program. There can be no assurance that federal or state regulatory authorities will not challenge the Company's current or future activities under these laws. Any challenge by those regulatory authorities could have a material adverse effect on the Company's business or financial results. Any state or federal regulatory review of the Company, regardless of the outcome, would be costly and time consuming. . The Company holds patents on specific designs and processes which can provide it with a competitive advantage. There can be no assurance as to the breadth or degree of protection which existing or future patents, if any, may afford the Company, that any patent applications will result in issued patents, that patents will not be circumvented or invalidated, or that the parties from whom the Company has licensed or otherwise acquired patent rights, proprietary rights and technology have full rights to those patent rights and technology. . The Company relies on trade secrets and proprietary know-how. The Company employs various methods to protect its proprietary information, including confidentiality agreements and proprietary information agreements. There can be no assurance that those confidential or proprietary information agreements will not be breached, that the Company would have adequate remedies for any breach, or that its trade secrets and proprietary know-how will not otherwise become known to or independently developed by competitors. . The Company is required to make significant royalty payments under license agreements. There can be no assurance that the Company will have the funds to make those royalty payments or that the payment of those royalties will not have a material adverse effect on the Company's results of operation. . The Company must devote substantial resources to research and development. There can be no assurance that the Company will be successful in developing competitive new products and/or improving existing products so that its products remain competitive and avoid obsolescence. 22 . The Company is subject to potential product liability risks which are inherent in the design, marketing and sale of orthopaedic implants and surgical instrumentation. No assurance can be given that the Company will not face claims resulting in substantial liability for which the Company is not fully insured or that the Company will be able to maintain adequate levels of insurance on acceptable terms. A partially or completely uninsured successful claim against the Company of sufficient magnitude could have a material adverse effect on the Company's business and financial results. RECENT ACCOUNTING PRONOUNCEMENTS -------------------------------- See Note 2 of Notes to Consolidated Financial Statements for information concerning recent accounting pronouncements. CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS ----------------------------------------------------------- Certain matters discussed with this report contain various "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events, including, but not limited to, statements regarding growth in sales of the Company's products, profit margins and the sufficiency of the Company's cash flow for its future liquidity and capital resource needs. These forward looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward looking statements. These factors include, without limitation, the effect of competitive pricing, the Company's dependence on the ability of its third-party manufacturers to produce components on a basis which is cost-effective to the Company, market acceptance of the Company's products, the outcome of arbitration and litigation, and the effects of governmental regulation. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risk from interest rates. For its cash and cash equivalents, a change in interest rates affects the amount of interest income that can be earned. For its debt instruments, changes in interest rates affect the amount of interest expense incurred. The Company invoices and receives payment from international distributors in United States Dollars and is not subject to risk associated with foreign currency exchange rates. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. The amounts presented approximate the financial instruments' fair market value as of December 31, 2001.
2002 2003 2004 2005 Thereafter Total ------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents Overnight repurchase account at variable interest rate $ 1,000,000 $ 1,000,000 Weighted average interest rate 2.7% Liabilities Line of credit at variable interest rate $ 1,385,566 $ 1,385,566 Weighted average interest rate 5.9% Industrial Revenue Bond at variable interest rate $ 300,000 $ 300,000 $ 300,000 $ 300,000 $ 2,100,000 $ 3,300,000 Weighted average interest rate 2.8% 2.8% 2.8% 2.8% 2.8% -------------------------------------------------------------------------------------------------------------------------------
23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TABLE OF CONTENTS
Page ---- Independent Auditors' Report 25 Consolidated Balance Sheets as of December 31, 2000 and 2001 26 Consolidated Statements of Income for the Years Ended December 31, 1999, 2000 and 2001 27 Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 1999, 2000 and 2001 28 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 2000 and 2001 29 Notes to Consolidated Financial Statements for the Years Ended December 31, 1999, 2000 and 2001 30
24 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Exactech, Inc. Gainesville, Florida We have audited the accompanying consolidated balance sheets of Exactech, Inc. and subsidiary (the "Company") as of December 31, 2000 and 2001, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2000 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP Deloitte & Touche LLP Certified Public Accountants Jacksonville, Florida February 14, 2002 25 EXACTECH, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2000 AND 2001 --------------------------------------------------------------------------------
2000 2001 ---------------- --------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 448,323 $ 1,001,000 Trade receivables (net of allowance of $381,041 and $373,262) 9,055,611 10,502,657 Refundable income taxes 156,314 - Prepaid expenses and other assets, net 234,439 275,452 Inventories 19,397,100 19,597,541 Deferred tax assets 181,404 289,256 ---------------- --------------- Total current assets 29,473,191 31,665,906 PROPERTY AND EQUIPMENT: Land 462,629 462,629 Machinery and equipment 5,873,964 6,523,595 Surgical instruments 9,420,782 11,513,487 Furniture and fixtures 530,406 551,837 Facilities 3,595,476 3,595,476 ---------------- --------------- Total property and equipment 19,883,257 22,647,024 Accumulated depreciation (5,900,006) (7,860,860) ---------------- --------------- Net property and equipment 13,983,251 14,786,164 OTHER ASSETS: Product licenses and designs, net 305,195 273,096 Deferred financing costs, net 121,221 108,216 Investment in joint venture - 13,999 Advances and deposits 143,646 143,526 Patents and trademarks, net 522,064 486,668 ---------------- --------------- Total other assets 1,092,126 1,025,505 ---------------- --------------- TOTAL ASSETS $ 44,548,568 $ 47,477,575 ================ =============== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 3,223,295 $ 2,142,134 Income taxes payable - 18,490 Line of credit 3,614,449 1,385,566 Current portion of long-term debt 300,000 300,000 Commissions payable 565,377 672,018 Royalties payable 399,973 453,020 Other liabilities 89,772 358,621 ---------------- --------------- Total current liabilities 8,192,866 5,329,849 LONG-TERM LIABILITIES: Deferred tax liabilities 1,420,024 1,767,958 Long-term debt, net of current portion 3,300,000 3,000,000 ---------------- --------------- Total long-term liabilities 4,720,024 4,767,958 ---------------- --------------- Total liabilities 12,912,890 10,097,807 COMMITMENTS AND CONTINGENCIES (Notes 6 and 11) SHAREHOLDERS' EQUITY: Common stock, $.01 par value; 15,000,000 shares authorized, 5,101,848 and 5,323,809 shares issued and outstanding 51,018 53,238 Additional paid-in capital 16,818,568 19,100,906 Retained earnings 14,766,092 18,225,624 ---------------- --------------- Total shareholders' equity 31,635,678 37,379,768 ---------------- --------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 44,548,568 $ 47,477,575 ================ ===============
See notes to consolidated financial statements 26 EXACTECH, INC. CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 --------------------------------------------------------------------------------
1999 2000 2001 ---------------- ---------------- ---------------- NET SALES $ 32,954,283 $ 41,925,375 $ 46,599,351 COST OF GOODS SOLD 11,558,593 14,561,656 16,186,624 ---------------- ---------------- ---------------- Gross profit 21,395,690 27,363,719 30,412,727 OPERATING EXPENSES: Sales and marketing 8,445,544 11,229,966 12,976,732 General and administrative 2,665,035 3,168,029 4,765,246 Research and development 1,621,175 2,137,978 2,210,216 Depreciation and amortization 1,679,676 2,153,807 2,649,957 Royalties 1,508,098 1,643,378 1,762,326 ---------------- ---------------- ---------------- Total operating expenses 15,919,528 20,333,158 24,364,477 ---------------- ---------------- ---------------- INCOME FROM OPERATIONS 5,476,162 7,030,561 6,048,250 OTHER INCOME (EXPENSE): Interest income 83,428 49,703 36,388 Interest expense (220,321) (337,691) (427,122) Loss on disposal of assets (155,683) (68,281) (79,217) Equity in net loss of joint venture - - (131,574) ---------------- ---------------- ---------------- Total other (expense) income (292,576) (356,269) (601,525) ---------------- ---------------- ---------------- INCOME BEFORE PROVISION FOR INCOME TAXES 5,183,586 6,674,292 5,446,725 PROVISION FOR INCOME TAXES Current 1,701,298 2,231,134 1,747,111 Deferred 314,721 263,640 240,082 ---------------- ---------------- ---------------- 2,016,019 2,494,774 1,987,193 ---------------- ---------------- ---------------- NET INCOME $ 3,167,567 $ 4,179,518 $ 3,459,532 ================ ================ ================ BASIC EARNINGS PER COMMON SHARE $ 0.64 $ 0.83 $ 0.66 ================ ================ ================ DILUTED EARNINGS PER COMMON SHARE $ 0.61 $ 0.78 $ 0.64 ================ ================ ================
See notes to consolidated financial statements 27 EXACTECH, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 --------------------------------------------------------------------------------
Additional Total Common Stock Paid-In Retained Shareholders' Shares Amount Capital Earnings Equity ------ ------ ------- -------- ------ Balance, December 31, 1998 4,907,163 $ 49,072 $ 15,015,398 $ 7,419,007 $ 22,483,477 Issuance of common stock 700 7 6,993 7,000 Exercise of stock options 29,107 291 155,600 155,891 Exercise of warrants 66,542 665 559,363 560,028 Issuance of common stock under the Company's Employee Stock Purchase Plan 4,567 46 47,709 47,755 Tax benefit from exercise of stock options 18,081 18,081 Net income 3,167,567 3,167,567 ---------- --------- -------------- -------------- ------------- Balance, December 31, 1999 5,008,079 50,081 15,803,144 10,586,574 26,439,799 Issuance of common stock 922 9 12,306 12,315 Exercise of stock options 21,856 218 128,259 128,477 Exercise of warrants 58,488 585 654,481 655,066 Issuance of common stock under the Company's Employee Stock Purchase Plan 12,503 125 131,802 131,927 Compensation benefit of non-qualified stock options 5,089 5,089 Tax benefit from exercise of stock options 83,487 83,487 Net income 4,179,518 4,179,518 ---------- --------- -------------- -------------- ------------- Balance, December 31, 2000 5,101,848 51,018 16,818,568 14,766,092 31,635,678 Issuance of common stock 883 9 15,991 16,000 Exercise of stock options 136,541 1,366 1,047,306 1,048,672 Exercise of warrants 72,737 727 813,927 814,654 Issuance of common stock under the Company's Employee Stock Purchase Plan 11,800 118 134,928 135,046 Compensation benefit of non-qualified stock options 8,724 8,724 Tax benefit from exercise of stock options 261,462 261,462 Net income 3,459,532 3,459,532 ---------- --------- -------------- -------------- ------------- Balance, December 31, 2001 5,323,809 $ 53,238 $ 19,100,906 $ 18,225,624 $ 37,379,768 ========== ========= ============== ============== =============
See notes to consolidated financial statements 28 EXACTECH, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 --------------------------------------------------------------------------------
1999 2000 2001 -------------- -------------- --------------- OPERATING ACTIVITIES: Net income $ 3,167,567 $ 4,179,518 $ 3,459,532 Adjustments to reconcile net income to net cash provided by (used in) operating activities : Depreciation and amortization 1,754,370 2,289,835 2,842,797 Loss on disposal of equipment 155,683 68,281 79,217 Equity in net loss of joint venture - - 131,574 Deferred income taxes 314,721 263,640 240,082 Increase in trade receivables (2,340,671) (1,076,130) (1,447,046) Increase in inventories (106,334) (7,758,205) (200,441) (Increase) decrease in prepaids and other assets (60,533) 20,225 (27,888) Decrease (increase) in refundable income taxes 24,729 (133,362) 174,804 Increase (decrease) in accounts payable 1,082,356 804,793 (1,081,161) Increase in other liabilities 30,722 178,997 428,537 -------------- -------------- --------------- Net cash provided by (used in) operating activities 4,022,610 (1,162,408) 4,600,007 -------------- -------------- --------------- INVESTING ACTIVITIES: Purchase of product licenses and designs (150,000) - (25,000) Purchases of property and equipment (4,349,916) (4,307,299) (3,602,782) Investment in joint venture - - (145,573) Change in unexpended industrial revenue bond proceeds 856,992 - - Cost of patents and trademarks (177,187) (53,851) (29,650) -------------- -------------- --------------- Net cash used in investing activities (3,820,111) (4,361,150) (3,803,005) -------------- -------------- --------------- FINANCING ACTIVITIES: Net proceeds from borrowing (payments) on line of credit - 3,614,449 (2,228,883) Principal payments on debt - (300,000) (300,000) Principal payments on capital lease obligations (12,835) - - Proceeds from issuance of common stock 788,755 1,016,361 2,284,558 -------------- -------------- --------------- Net cash provided by (used in) financing activities 775,920 4,330,810 (244,325) -------------- -------------- --------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 978,419 (1,192,748) 552,677 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 662,652 1,641,071 448,323 -------------- -------------- --------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,641,071 $ 448,323 $ 1,001,000 ============== ============== =============== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 217,683 $ 338,371 $ 331,428 Income taxes 1,658,488 2,307,546 1,466,115 Noncash investing and financing activities: Relief of compensation accrual on issuance of stock 5,971 - -
See notes to consolidated financial statements 29 EXACTECH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 -------------------------------------------------------------------------------- 1. ORGANIZATION The consolidated financial statements include the amounts of Exactech, Inc. and its wholly-owned subsidiary, Exactech International, Inc. (collectively referred to as the "Company"). All significant intercompany items have been eliminated. The Company was organized in 1985 to develop and market orthopaedic implant devices. In 1987, the Company began marketing its first product, a total hip replacement system. In 1995, the Company began marketing a knee system. In 1999, the Company began full domestic distribution of a licensed tissue service. In 2001, the Company began distribution of a bone cement system under an agreement. The Company's principal market is the United States; however, international markets represent approximately eighteen percent of the Company's business. During 1999, Exactech International, Inc., a Foreign Sales Corporation, was founded to act as agent on behalf of Exactech for international sales transactions. All sales to international distributors are billed payable in U.S. Dollars and are not subject to foreign currency risks. In 2001, the Company entered into an agreement for a joint-venture in the Peoples Republic of China (Taiwan). The Company accounts for its investment in the joint-venture under the equity method. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash and Cash Equivalents -- Cash and cash equivalents consist of cash on deposit in financial institutions, including a money market account, institutional money funds, overnight repurchase agreements, and other short-term investments with a maturity of 90 days or less at the time of purchase. Concentration of Credit Risk - The Company's accounts receivable consist primarily of amounts due from hospitals. Amounts due from international distributors carry longer payment terms than domestic customers, typically due in 120 days. The Company performs credit evaluations on its customers and generally does not require collateral. Financial Instruments - The Company's financial instruments include cash and cash equivalents, trade receivables and debt. 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. Inventories - Inventories are valued at the lower of cost (first-in, first-out method) or market and include implants provided to customers and agents. The Company provides significant loaned implant inventory to non-distributor customers. The Company provides an adjustment to inventory based on obsolescence and slow-moving inventory. This impairment adjustment establishes a new cost basis for such inventory and is not subsequently recovered through income. The following table summarizes inventory classification as of December 31, ------------------------------------------------ 2000 2001 Raw materials $ 3,377,106 $ 2,086,586 Work in process 311,232 199,952 Finished goods 15,708,762 17,311,003 ------------ ------------ $ 19,397,100 $ 19,597,541 ============ ============ ------------------------------------------------ Property and Equipment - Property and equipment is stated at cost less accumulated depreciation. Depreciation expense is computed using the straight-line method over estimated useful lives of the related assets ranging from five to thirty-nine years. Depreciation expense for the years ended December 31, 1999, 30 2000 and 2001 was $1,562,456, $2,037,420 and $2,527,812, respectively. Maintenance and repairs are charged to expense. Certain instruments utilized in the surgical implant procedures are loaned to customers and are amortized over an estimated useful life of seven years. Periodically, management reviews property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is measured by comparing the carrying amount of the asset to the sum of expected future cash flows (undiscounted and without interest charges) resulting from use of the asset and its eventual disposition. Revenue Recognition - The Company provides inventories of its products to its United States sales agencies until sold or returned for use in marketing its products and filling customer orders. In the case of sales through such sales agencies, sales revenues are generally recognized when the product is implanted. Foreign distributors typically purchase product inventory and instruments from the Company for their use in marketing and filling customer orders. Sales to such foreign distributors are recognized upon shipment of the product. Estimated costs of returns and allowances on sales to foreign distributors are accrued at the time products are shipped. Deferred Financing Costs - Deferred financing costs are stated net of accumulated amortization of $40,560 at December 31, 2000 and $78,510 at December 31, 2001. These costs are amortized to interest expense over the expected life of the underlying debt. Patents and Trademarks - Patents and trademarks are amortized on a straight-line basis over their estimated useful lives ranging from five to seventeen years and stated net of accumulated amortization of $387,930 at December 31, 2000 and $510,075 at December 31, 2001. Income Taxes - Deferred income taxes are provided on temporary differences which arise from certain transactions being reported for financial statement purposes in different periods than for income tax purposes. Deferred tax assets and liabilities are recognized using an asset and liability approach and are based on differences between financial statement and tax bases of assets and liabilities using presently enacted tax rates. Research and Development - Research and development costs are expensed in the period incurred. Earnings Per Share - Basic earnings per common share is calculated by dividing net income by the average number of common shares outstanding during the year. Diluted earnings per common share is calculated by adjusting outstanding shares, assuming conversion of all potentially dilutive stock options. Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during each reporting period. Actual results could differ from those estimates. Options and Stock Awards - The Company has elected to account for its employee stock compensation plans under the intrinsic value based method with pro forma disclosures of net earnings and earnings per share, as if the fair value based method of accounting defined in SFAS No. 123 "Accounting for Stock Based Compensation" had been applied (Note 10). Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at the grant date or other measurement date over the amount an employee must pay to acquire the stock. Under the fair value based method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. For grants of options to non-employees, the Company accounts for these transactions utilizing the fair value based method of accounting defined in SFAS No. 123, incurring a charge for the value of the option, as calculated by the Black-Scholes asset pricing model, amortized over the service period of the option. Reclassifications - Certain amounts in the 1999 and 2000 financial statements have been reclassified to conform to the 2001 presentation. New Accounting Standards - In June 1998, the Financial Accounting Standards Board ("FASB") issued 31 Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities". In June 2000, the FASB issued SFAS No. 138, which amends certain provisions of SFAS 133 to clarify four areas causing difficulties in implementation. The amendment included expanding the normal purchase and sale exemption for supply contracts, permitting the offsetting of certain intercompany foreign currency derivatives and thus reducing the number of third party derivatives, permitting hedge accounting for foreign-currency denominated assets and liabilities, and redefining interest rate risk to reduce sources of ineffectiveness. The Company adopted SFAS 133 and the corresponding amendments under SFAS 138 on January 1, 2001. SFAS 133, as amended by SFAS 138, did not have a material impact on the Company's consolidated results of operations, financial position or cash flows. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS No. 143, "Accounting for Asset Retirement Obligations." In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 141 requires companies to apply the purchase method of accounting for all business combinations initiated after June 30, 2001 and prohibits the use of the pooling-of-interest method. SFAS 142 changes the method by which companies may recognize intangible assets in purchase business combinations and generally requires identifiable intangible assets to be recognized separately from goodwill. In addition, it eliminates the amortization of all existing and newly acquired goodwill on a prospective basis and requires companies to assess goodwill for impairment, at least annually, based on the fair value of the reporting unit associated with the goodwill. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company adopted SFAS 141 on July 1, 2001. The adoption of SFAS 141 did not have a material effect on the Company's financial position, results of operations or cash flows. The Company will adopt SFAS 142 and SFAS 144 effective January 1, 2002, and SFAS 143 effective January 1, 2003. It does not appear the adoption of SFAS 142, SFAS 143 or SFAS 144 will have a material impact on the Company's financial position, results of operations or cash flows. 3. INCOME TAXES The provision for income taxes consists of the following: Current: 1999 2000 2001 ----------- ----------- ----------- Federal $ 1,318,286 $ 1,752,842 $ 1,381,248 State 383,012 478,292 365,863 ----------- ----------- ----------- Total current 1,701,298 2,231,134 1,747,111 Deferred: Federal 243,219 209,946 191,186 State 71,502 53,694 48,896 ----------- ----------- ----------- Total deferred 314,721 263,640 240,082 ----------- ----------- ----------- Total provision $ 2,016,019 $ 2,494,774 $ 1,987,193 =========== =========== =========== A reconciliation between the amount of reported income tax provision and the amount computed at the statutory Federal income tax rate for the years ended December 31, 1999, 2000 and 2001 follows:
1999 2000 2001 ------ ------ ------ Statutory Federal rate 34.0% 34.0% 34.0% State income taxes (net of Federal income tax benefit) 5.3% 5.3% 5.3% Other -0.4% -1.9% -2.8% ------ ------ ------ 38.9% 37.4% 36.5% ====== ====== ======
32 The types of temporary differences and their related tax effects that give rise to deferred tax assets and liabilities at December 31, 1999, 2000, and 2001 are as follows:
1999 2000 2001 ----------- ------------ ----------- Deferred tax liabilities: Basis difference in property and equipment $ 1,111,392 $ 1,392,592 $ 1,747,888 Basis difference in patents 25,059 27,432 20,070 ----------- ------------ ----------- Gross deferred tax liabilities 1,136,451 1,420,024 1,767,958 ----------- ------------ ----------- Deferred tax assets: Capital loss carryover 82,313 82,313 82,313 Valuation allowance of capital loss carryover (58,745) (82,313) (82,313) Accrued liabilities not currently deductible 137,903 181,404 289,256 ----------- ------------ ----------- Gross deferred tax assets 161,471 181,404 289,256 ----------- ------------ ----------- Net deferred tax liabilities $ 974,980 $ 1,238,620 $ 1,478,702 =========== ============ ===========
During the year ended December 31, 1998, the Company generated a capital loss carryover of $294,399 which is available to offset future taxable capital gains. During 1999, a valuation allowance was charged against this deferred tax asset assuming that $60,000 of the loss would be able to be realized by offsetting future taxable capital gains prior to the capital loss carryover expiration in 2003. For the year ended December 31, 2000, this valuation allowance was increased to 100% assuming that none of the loss would be realized, as the Company has yet to achieve any benefit from the carryover. 4. DEBT Long-term debt consists of the following as of December 31, 2000 and 2001:
2000 2001 ----------- ----------- Industrial Revenue Bond payable in annual $ 3,600,000 $ 3,300,000 principal installments as follows: $300,000 per year from 2000-2006; $200,000 per year from 2007-2013; $100,000 per year from 2014-2017; monthly interest payments based on adjustable rate as determined by the bonds remarketing agent based on market rate fluctuations (1.75% as of December 31, 2001); proceeds used to finance construction of current facility ----------- ----------- Total long-term debt $ 3,600,000 $ 3,300,000 Less current portion (300,000) (300,000) ----------- ----------- $ 3,300,000 $ 3,000,000 =========== ===========
The following is a schedule of debt maturities as of December 31, 2001: Long-Term Debt ----------- 2002 $ 300,000 2003 300,000 2004 300,000 2005 300,000 2006 300,000 Thereafter 1,800,000 ----------- $ 3,300,000 =========== 33 Industrial Revenue Bond Note Payable In November 1997, the Company entered into a $3,900,000 industrial revenue bond financing with the City of Gainesville, Florida (the "City"), pursuant to which the City issued its industrial revenue bonds and loaned the proceeds to the Company. The bonds are secured by an irrevocable letter of credit issued by a bank. The financing agreement contains financial covenants that must be met on a continuing basis, including debt to equity ratio, current ratio, net worth amount and working capital amount. The Company was in compliance with all such covenants at December 31, 2001. Due to the variable nature of the note, the balance of the note payable approximates fair value. Line of Credit The Company maintains a credit facility with Merrill Lynch Business Financial Services, Inc., which is secured by accounts receivable and inventory. The credit line is limited to the lesser of 80% of the value of accounts receivable less than 90 days old, plus the lesser of 50% of the value of inventory (excluding raw materials and WIP inventory) and 25% of inventory on consignment or $6,000,000. The credit line was extended in January 2001 to increase the available limit to $12,000,000, expiring June 30, 2002. As of December 31, 2001, there was $1,385,566 outstanding under the line of credit at a varying interest rate of 3.88%. 5. RELATED PARTY TRANSACTIONS The Company has entered into a purchase agreement with Brighton Partners, Inc. to purchase raw materials and equipment used in the ongoing production of its products. In 1999, the agreement required the purchase of tooling dies in the amount of $91,250 and provided for special purchasing terms for the Company. In 2001, the Company entered into a purchase agreement to acquire the license of a certain proprietary production technology for the sum of $350,000. The Company paid $25,000 upon signing of the agreement. Some of the Company's officers and directors have ownership interest in Brighton Partners, Inc. Purchases of raw materials and equipment associated with these agreements totaled $418,625, $849,035 and $668,059 in 1999, 2000 and 2001, respectively. In January 1997, the Company entered into an oral consulting agreement with Albert Burstein, Ph.D., a director of the Company, to provide services regarding many facets of the orthopaedic industry including product design rationale, manufacturing and development techniques and product sales and marketing. During 1999, 2000 and 2001, the Company paid Dr. Burstein $135,000 in each year as compensation under the consulting agreement. The Company has entered into consulting agreements with certain of its executive officers, directors and principal shareholders in connection with product design which entitles them to royalty payments aggregating 1% of the Company's net sales of such products in the United States and less than 1% of the Company's net sales of such products outside the United States. During the years ended December 31, 1999, 2000 and 2001, the Company paid royalties aggregating $182,349, $223,654 and $241,904, respectively, pursuant to these consulting agreements. 6. COMMITMENTS AND CONTINGENCIES Legal - In the ordinary course of business, the Company is, from time to time, a party to pending and threatened legal proceedings, primarily involving claims for product liability. The Company believes that the outcome of such legal actions and proceedings will not have a material adverse effect on the Company. On December 27, 2000, a complaint was filed against the Company in the District Court of Buffalo County, Nebraska alleging the improper design of a prosthetic device manufactured by the Company. The complaint was subsequently settled on August 23, 2001 without admission of liability on the part of the Company. On May 8, 2001, a complaint was filed against the Company in the Superior Court of the state of California, San Francisco County, alleging negligence and the improper design of a prosthetic device manufactured by the Company. The case has subsequently been removed to the United States District Court, Northern District of California and remains in the early stages. The plaintiff is seeking an unspecified monetary award and damages in an amount to be determined at trial. This case remains in the 34 early stages. The Company is pursuing the defense of this claim vigorously. On June 14, 2001, the Company's insurance carrier denied coverage under the Company's product liability insurance policy. The Company maintains that these cases should be covered by the products liability policy with that carrier and is involved in ongoing negotiations with the insurer to resolve the coverage issue. However, there can be no assurances that the Company will be able to reach agreement with the insurance company on the disputed coverage. In the event that the Company is unable to reach agreement with the insurance company, the Company will consider its remedies against the insurer, and intends to pursue such remedies vigorously. Based on the facts known at this time, the Company has provided for reserves for the independent resolution of this matter. There can be no assurances as to the adequacy of these reserves. During March 2001, the Company secured retroactive annual product liability insurance coverage that it expects will cover any future litigation related to these devices, which were subject to recall during 1997 and 1998. The Company is a party to an arbitration proceeding with Regeneration Technologies, Inc. ("RTI") with respect to its agreement with RTI for the distribution of a bone grafting material technology. In the proceeding, the Company has asserted that RTI is violating the exclusivity provisions of the agreement by engaging in the distribution of certain products utilizing that technology. A hearing as to liability was held before the arbitration panel in July 2001. The panel delivered its ruling on December 21, 2001 affirming Exactech's exclusive distribution rights to the technology. The Company is in the process of gathering data to assess the extent of the Company's damages. The Company expects another hearing to be held by the panel regarding such damages. The Company's insurance policies covering product liability claims must be renewed annually. Although the Company has been able to obtain insurance coverage concerning product liability claims at a cost and on other terms and conditions that are acceptable to the Company, the Company makes no assurances that it will able to procure such policies in the future. Purchase Commitments - At December 31, 2001, the Company had outstanding commitments for the purchase of inventory and raw materials of $4,312,430, along with commitments to purchase $276,771 of capital equipment. 7. SEGMENT INFORMATION Segment information is reported by the major product lines of the Company: knee implants, hip implants, and tissue services. The "other" category is for minor sales categories, such as instrument rental fees and shipping charges. The accounting policies of the reportable segments are the same as those described in Note 2. The Company evaluates the performance of its operating segments based on income from operations before taxes, interest income and expense, and nonrecurring items. Intersegment sales and transfers are not significant. Total assets not identified with a specific segment (in thousands of dollars) were $16,670, $17,065 and $19,431 at December 31, 1999, 2000 and 2001, respectively. Assets not identified with a specific segment include cash and cash equivalents, accounts receivable, refundable income taxes, prepaid expenses, land, facilities, office furniture and computer equipment, and other assets. 35 Summarized financial information concerning the Company's reportable segments is shown in the following table.
(in thousands) --------------------------------------------------------------------------------------- Tissue Year ended December 31, Knee Hip Services Other Total --------------------------------------------------------------------------------------------------------------------------- 1999 Net Sales $ 21,259 $ 5,928 $ 4,053 $ 1,714 $ 32,954 Segment profit from operations 2,970 1,018 994 494 5,476 Total assets, net 11,706 5,213 630 390 17,939 Capital expenditures 1,783 798 509 107 3,197 Depreciation and amortization 1,028 476 84 92 1,680 2000 Net Sales $ 26,109 $ 8,571 $ 5,348 $ 1,897 $ 41,925 Segment profit from operations 4,426 1,438 1,146 21 7,031 Total assets, net 17,114 8,468 1,228 675 27,484 Capital expenditures 6,389 3,833 633 360 11,214 Depreciation and amortization 1,266 668 117 103 2,154 2001 Net Sales $ 29,289 $10,677 $ 5,252 $ 1,381 $ 46,599 Segment profit (loss) from operations 3,854 1,570 919 (295) 6,048 Total assets, net 15,570 10,848 927 702 28,047 Capital expenditures (432) 3,105 (261) 106 2,517 Depreciation and amortization 1,524 875 127 123 2,650 --------------------------------------------------------------------------------------------------------------------------
Major Customer and Foreign Operations During the years ended December 31, 1999, 2000 and 2001, approximately 6%, 5% and 4%, respectively, of the Company's sales were derived from a major hospital customer. During each of the years ended December 31, 1999, 2000, and 2001, the Company's Spanish distributor accounted for approximately 13%, 11% and 9%, respectively, of the Company's sales. Geographic distribution of the Company's sales are summarized in the following table: --------------------------------------------------------------------------- Year ended December 31, 1999 2000 2001 Domestic sales revenue $26,785,033 $34,343,299 $38,208,250 Sales revenue from Spain 4,223,750 4,736,812 4,260,069 Other international sales revenue 1,945,500 2,845,264 4,131,032 ----------- ----------- ----------- Total Sales Revenue $32,954,283 $41,925,375 $46,599,351 =========== =========== =========== --------------------------------------------------------------------------- 8. PENSION PLAN The Company currently sponsors a defined contribution 401(k) plan for its employees. The Company provides matching contributions of 100% on the first 3% of salary deferral by employees. The Company's total contributions to this plan during 1999, 2000 and 2001 were $56,329, $99,951 and $116,718, respectively. 9. LICENSE AND SUBLICENSE AGREEMENTS During 1997, the Company licensed certain technology. The license fees total $250,000, of which $100,000 was paid upon the execution of the agreement and an additional $150,000 was paid during 1999 at the time the licensor produced a developed product. The cost of the license agreement is being amortized 36 over fifteen years, the period of its estimated economic benefit. Accumulated amortization related to this license agreement was $51,300 at December 31, 2000 and $68,400 at December 31, 2001. During 2001, the Company licensed certain technology. The license fees total $350,000, of which $25,000 was paid upon execution of the agreement and an additional sum of $175,000 is due upon completion of the first production article, with a final payment of $150,000 due upon issuance of US Letters of Patent. The cost of the license agreement is due to be amortized over ten years, the period of its estimated economic benefit. 10. COMMON SHAREHOLDERS' EQUITY Earnings Per Share: The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations for net income:
1999 2000 2001 Income Shares Income Shares Income Shares (Numer- (Denom- Per (Numer- (Denom- Per (Numer- (Denom- Per ator) inator) Share ator) inator) Share ator) inator) Share ------------------------------------ ------------------------------------- -------------------------------- Net income $3,167,567 $4,179,518 $3,459,532 Basic EPS: Net income $3,167,567 4,960,220 $0.64 $4,179,518 5,060,101 $0.83 $3,459,532 5,238,426 $0.66 ===== ===== ===== Effect of dilutive securities: Stock options 199,103 278,605 174,321 Warrants 18,874 29,161 5,633 Diluted EPS: Net income plus assumed conversions $3,167,567 5,178,197 $0.61 $4,179,518 5,367,867 $0.78 $3,459,532 5,418,380 $0.64 ===== ===== =====
For the year ended December 31, 1999, options to purchase 5,000 shares of common stock at a price of $13.06 per share were outstanding but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares. For the year ended December 31, 2000, options to purchase 79,213 shares of common stock at a price of $18.81 per share were outstanding but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares. For the year ended December 31, 2001, options to purchase 116,038 shares of common stock at a prices ranging from $14.62 to $18.81 per share were outstanding but were not included in the computation of diluted EPS because the options' exercise prices were greater than the average market price of the common shares. 37 A summary of the status of fixed stock option grants under the Company's stock-based compensation plans as of December 31, 1999, 2000 and 2001, and changes during the years ending on those dates is presented below:
1999 2000 2001 ------------------------------- ------------------------------ -------------------------- Weighted Avg Weighted Avg Weighted Avg Options Exercise Price Options Exercise Price Options Exercise Price ------------------------------- ------------------------------ -------------------------- Outstanding - January 1 557,945 $ 7.27 567,174 $ 7.89 636,511 $ 9.56 Granted 80,086 11.14 109,213 17.25 43,625 15.85 Exercised (29,107) 5.07 (21,856) 5.88 (136,541) 7.68 Expired (41,750) 7.76 (18,020) 8.13 (12,440) 9.11 ---------- -------- -------- Outstanding - December 31 567,174 7.89 636,511 9.56 531,155 10.57 ========== ======== ======== Options exercisable 372,695 $ 7.30 473,468 $ 7.99 469,065 $ 10.19 at year end Weighted average fair value per share of options granted during the year $ 6.33 $ 13.53 $ 12.54
The following table summarizes information about fixed stock options outstanding at December 31, 2001: Exercise Options Options Weighted Average Price Range Outstanding Exercisable Remaining Life ------------ ----------- ----------- ---------------- $ 3.28 - 6.67 88,831 88,831 2.70 7.13 - 7.75 29,280 21,840 4.65 8.00 - 8.00 179,420 179,420 4.41 9.00 - 11.69 82,086 61,791 5.08 12.25 - 16.40 45,000 27,600 7.93 17.00 - 17.25 28,625 18,000 9.29 18.81 - 18.81 77,913 71,583 8.95 -------- -------- ----- Total 531,155 469,065 5.47 ======== ======== ===== Remaining non-exercisable options as of December 31, 2001 become exercisable as follows: 2002 31,188 2003 12,718 2004 7,852 2005 6,507 2006 3,825 -------- 62,090 ======== Employee Stock Purchase Plan: The Company sponsors an Employee Stock Purchase Plan which allows participants to purchase shares of the Company's common stock at a fifteen percent (15%) discount via payroll deduction. This plan became effective July 1, 1999, 125,000 shares are reserved for issuance under the plan. Employees participating in this plan purchased 4,567, 12,503 and 11,800 shares in the years ended December 31, 1999, 2000 and 2001, respectively. Options and Stock Awards: The Company sponsors an Employee Stock Option and Incentive Plan which provides for the issuance of stock options and restricted stock awards to key employees and a Directors Stock Option Plan which provides for the issuance of stock options to non-employee directors (collectively the "Plans"). The Company also issues stock options to sales agents and other individuals. The maximum number of common shares issuable under the Plans is 830,000 shares. 38 For each of the years ended December 31, 1999 and 2001, the Company did not grant options for shares of the Company's common stock to non-employees For the year ended December 31, 2000, the Company granted options for 4,500 shares of the Company's common stock to non-employees with a fair value of $14.63 per share. If compensation cost for stock option grants had been determined based on the fair value at the grant dates for 1999, 2000 and 2001 consistent with the method prescribed by SFAS No. 123, the Company's net earnings and earnings per share on a basic and diluted basis would have been adjusted to the pro forma amounts indicated below:
1999 2000 2001 ----------- ------------ ----------- Net earnings As reported $ 3,167,567 $ 4,179.518 $ 3,459,532 Pro forma 2,645,565 3,563,679 2,544,457 Earnings per share As reported Basic $ 0.64 $ 0.83 $ 0.66 Diluted 0.61 0.78 0.64 Pro forma Basic $ 0.53 $ 0.70 $ 0.49 Diluted 0.51 0.66 0.47
Outstanding options, consisting of ten-year non-qualified stock options, vest and become exercisable over a five year period from the date of grant. The outstanding options expire ten years from the date of grant or upon retirement from the Company, and are contingent upon continued employment during the applicable ten-year period. Under SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1999, 2000 and 2001, respectively: dividend yield of 0, 0 and 0 percent, expected volatility of 64, 74 and 70 percent, risk-free interest rates of 6.2, 5.1 and 5.1 percent, and expected lives of 5, 5 and 5 years. 11. OPERATING LEASES In June 2000, the Company entered into an operating lease for an approximately 9,500 square foot facility in the Northwood Commercial Park, Gainesville, Florida, to serve as the Company's Distribution Center and warehouse. The initial term of the lease is for a period of three years, commencing August 1, 2000. The Company maintains an operating lease with Pitney Bowes for a postage meter, with automatically renewable two-year terms. The following is a schedule by years of minimum future rentals on non-cancelable operating leases as of December 31, 2001: Year Ending December 31, 2002 $ 41,698 2003 24,234 --------- $ 65,932 ========= 39 12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Following is a summary of the quarterly results of operations for the years ended December 31, 2000 and December 31, 2001. All dollar amounts are in thousands, except per share amounts:
Quarter First Second Third Fourth Total ---------------------------------------------------------------------------------------- 2000 Net sales $ 10,305 $ 10,916 $ 9,820 $ 10,884 $ 41,925 Gross profit 6,647 7,120 6,565 7,032 27,364 Net income 925 1,115 961 1,179 4,180 Basic EPS 0.18 0.22 0.19 0.23 0.83 Diluted EPS 0.17 0.21 0.18 0.22 0.78 2001 Net sales $ 11,546 $ 11,802 $ 11,269 $ 11,982 $ 46,599 Gross profit 7,494 7,553 7,381 7,985 30,413 Net income 1,048 370 775 1,267 3,460 Basic EPS 0.20 0.07 0.15 0.24 0.66 Diluted EPS 0.19 0.07 0.14 0.23 0.64 ----------------------------------------------------------------------------------------
40 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the caption "Management" in the Company's definitive Proxy Statement for its 2002 Annual Meeting of Shareholders (the "Proxy Statement") is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information set forth under the caption "Executive Compensation" in the Company's Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the caption "Security Ownership" in the Company's Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the caption "Certain Transactions" in the Company's Proxy Statement is incorporated herein by reference. 41 PART IV. OTHER INFORMATION ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Financial Statements The financial statements filed as part of this report are listed under Item 8. (b) Reports on Form 8-K None (c) Exhibits: Exhibit Description ------- ----------- 3.1 Registrant's Articles of Incorporation, as amended(1) 3.2 Registrant's Bylaws(1) 3.3 Forms of Articles of Amendment to Articles of Incorporation(1) 4.1 Specimen Common Stock Certificate(1) 4.2 Shareholders' Agreement, dated as of November 30, 1992, as amended, by and among the Registrant, William Petty, M.D., Betty Petty, David Petty, Mark Petty and Julie Petty(1) 4.3 Form of Underwriter's Warrant(1) 4.4 Specimen Series A Preferred Stock Certificate(1) 4.5 Specimen Series B Preferred Stock Certificate(l) 4.6 Specimen Series C Preferred Stock Certificate(1) 4.7 Form of Amendment to Shareholder's Agreement, dated as of May 1996, by and among the Registrant, William Petty, M.D., Betty Petty, David Petty, Mark Petty and Julie Petty(1) 10.1 Registrant's Employee Stock Option and Incentive Plan, as amended(1) (2) 10.2 Registrant's Directors' Stock Option Plan(1) (2) 10.3 Form of Indemnification Agreement between the Registrant and each of the Registrant's Directors and Executive Officers(1) 10.4 Form of Employment Agreement between the Registrant and William Petty, M.D.(1) (2) 10.5 Form of Employment Agreement between the Registrant and Timothy J. Seese(1) (2) 10.6 Form of Employment Agreement between the Registrant and Gary J. Miller, Ph.D.(1) (2) 10.7 Working Capital Management Account Term Loan and Security Agreement, dated as of June 23, 1995, as amended, between the Registrant and Merrill Lynch Business Financial Services(1) 10.8 Collateral Installment Note, dated as of June 23, 1995, executed by the Registrant in favor of Merrill Lynch Business Financial Services(1) 10.9 Unconditional Guaranty executed by William Petty, M.D. in favor of Merrill Lynch Business Financial Services(1) 10.10 Subordinated Convertible Debenture Agreement, dated April 18, 1995, between the Registrant and Alan Chervitz and related Registration Rights Agreement dated April 18, 1995(1) 10.11 Subordinated Convertible Debenture Agreement, dated April 18, 1995, between the Registrant and E. Marlowe Goble and related Registration Rights Agreement dated April 18, 1995(1) 10.12 Subordinated Convertible Debenture Agreement, dated April 18, 1995, between the Registrant and Marc Richman and related Registration Rights Agreement dated April 18, 1995(1) 10.13 Subordinated Convertible Debenture Agreement, dated April 18, 1995, between the Registrant and David P. Luman and related Registration Rights Agreement dated April 18, 1995(1) 10.14 Subordinated Convertible Debenture Agreement, dated May 2, 1995, between the Registrant and Donna C. Phillips and related Registration Rights Agreement dated May 2, 1995(1) 10.15 Subordinated Convertible Debenture Agreement, dated April 22, 1995, between the Registrant and Peggy S. Wolfe and related Registration Rights Agreement dated April 22, 1995(1) 10.16 Subordinated Convertible Debenture Agreement, dated April 22, 1995, between the Registrant and Joaquin J. Diaz and related Registration Rights Agreement dated April 22, 1995(1) 10.17 Letter Agreement, dated December 28, 1992, between the Registrant and Michael Kearney, M.D. regarding purchase of 8% debentures and warrants(1) 10.18 Letter Agreement, dated December 28, 1992, between the Registrant and R. Wynn Kearney, M.D. 42 regarding purchase of 8% debentures and warrants(1) 10.19 First Mortgage Deed and Promissory Note, each dated September 27, 1994, executed by the Registrant in favor of American National Bank of Florida(1) 10.20 Shareholders' Agreement, dated July 19, 1995, between the Registrant and Edoardo Caminita in connection with the formation of Techmed S.p.A.(1) 10.21 Small Business Cooperative Research and Development Agreement, dated December 31, 1995, between the Registrant and The Regents for the University of California, Lawrence Livermore National Laboratory(1) 10.22 Business Lease, dated July 1, 1995, between the Registrant and BCB Partnership(1) 10.23 Consulting Agreement, dated January 1, 1993, between the Registrant and Ivan Gradisar, Jr., M.D.(1) 10.24 Consulting Agreement, dated January 1, 1993, between the Registrant and William Murray, M.D.(1) 10.25 Consulting Agreement, dated March 1, 1993, between the Registrant and Edmund Chao, Ph.D.(1) 10.26 Consulting Agreement, dated January 1, 1993, between the Registrant and William Petty, M.D.(1) 10.27 Consulting Agreement, dated January 1, 1993, between the Registrant and Gary J. Miller, Ph.D.(1) 10.28 Consulting Agreement, dated as of November 1, 1993, between the Registrant and Virginia Mason Clinic (regarding Raymond P. Robinson, M.D.)(1) 10.29 Manufacturers Representative Agreement, dated January 1, 1996, between the Registrant and Prince Medical, Inc.(1) 10.30 Distribution Agreement, dated as of January 1, 1996, between the Registrant and Precision Instruments, Inc.(1) 10.31 Manufacturers Representative Agreement, dated January 31, 1996, between the Registrant and Futur-Tek, Inc.(1) 10.32 Distribution Agreement, dated October 5, 1995, between the Registrant and Techmed S.p.A.(1) 10.33 Distribution Agreement, dated January 1, 1994, between the Registrant and Akaway Medical Co., Ltd.(1) 10.34 Distribution Agreement between the Registrant and MBA Del Principado, S.p.A.(1) 10.35 Distribution Agreement, dated February 1, 1993, between the Registrant and Yu Han Meditech(1) 10.36 Distribution Agreement, dated October 31, 1995, between the Registrant and Buro Ortopedik-Thbbi Malzemeler Ithalat Ihracat Tic. Ltd. (1) 10.37 Technology License Agreement, dated as of August 5, 1991, between the Registrant and Accumed, Inc.(1) 10.38 License Agreement, dated August 20, 1993, between the Registrant and The University of Florida, as amended(1) 10.39 Exclusive Sublicense Agreement dated June 30, 1995, between the Registrant and Sofamor Danek Properties, Inc.(1) 10.40 License Agreement, dated as of January 1, 1996, between the Registrant and The Hospital for Special Surgery(1) 10.41 Assignment of Patent, dated November 20, 1995, executed by Phillip H. Cripe in favor of the Registrant(1) 10.42 United States Patent No. 5,190,549 for Locking Surgical Tool Handle System dated March 2, 1993(1) 10.43 United States Patent No. 5,190,550 for Locking Surgical Tool Handle System dated March 2, 1993(1) 10.44 Assignment, dated July 28, 1990, of Locking Surgical Tool Handle System patent(1) 10.45 United States Patent No. 5,263,988 for Bipolar Endoprosthesis dated November 23, 1993(1) 10.46 United States Patent No. 5,152,799 for Prosthetic Femoral Stem dated October 6, 1992(1) 10.47 Assignment, dated October 31, 1991, of Femoral Stem patent(1) 10.48 Application for United States Patent for an Improved Intramedullary Alignment Guide(1) 10.49 Application for United States Patent for Hole Caps for Prosthetic Implants(1) 10.50 Tolling Agreement, dated April 3, 1995, between the Registrant and Joint Medical Products Corporation(1) 10.51 Patent Agreement, dated October 9, 1995, between the Registrant and Phillip H. Cripe(1) 10.52 Letter Agreements dated March 8, 1993 and April 13, 1993 between the Registrant and Ridgeway Construction(1) 10.53 Letter Agreements dated April 12, 1993 between the Registrant and Bosshardt Realty Services, Inc.(1) 10.54 Copyright Assignment and Consulting Agreement, effective as of April 12, 1993, by and between Walter Reid and the Registrant(1) 43 10.55 Letter agreement, dated November 30, 1993, between the Registrant and Associated Business Consultants, Inc.(1) 10.56 Letter agreements, dated February 23, 1996, between Merrill Lynch Business Financial Services Inc. and the Registrant(1) 10.57 Consulting Agreement dated as of June 1, 1993 between the Registrant and Kim Jun -Man(1) 10.58 Consulting Agreement. dated as of January 1, 1993 between the Registrant and Professors Luis Lopez Duran and Fernando Marco(1) 10.59 Merrill Lynch WCMA line of credit extension dated July 29, 1996(3) 10.60 Loan Agreement, dated as of November 1, 1997, between the City of Gainesville, Florida and the Registrant(4) 10.61 Letter of Credit Agreement, dated as of November 1, 1997, between SunTrust Bank, North Central Florida ("SunTrust") and the Registrant(4) 10.62 Pledge and Security Agreement, dated as of November 1, 1997 between SunTrust and the Registrant(4) 10.63 Mortgage and Security Agreement, dated as of November 1, 1997, from the Registrant to SunTrust(4) 10.64 Settlement agreement between Biomet, Inc., Ella K. Jirka & Associates, Richard A. Bland, N.W. Medical Products, Inc. and the Registrant dated February 9, 1998(4) 10.65 Letter Agreement dated June 18, 1998, between Merrill Lynch Business Financial Services Inc. and the Registrant(5) 10.66 Letter Agreement dated June 22, 2000, between Merrill Lynch Business Financial Services Inc. and the Registrant(6) 10.67 Distribution Agreement, dated September 11, 2000, between aap Implantate, AG, aap Implants, Inc. and the Registrant(6) 10.68 Office/Warehouse Lease, dated June 9, 2000, between Creel and Wilcox Development, LLC and the Registrant(7) 10.69 Letter Agreement dated March 2, 2001, between Merrill Lynch Business Financial Services Inc. and the Registrant(8) 21.1 Subsidiary of the Registrant(1) 23.1 Independent Auditors' Consent Copies of the exhibits filed with this Annual Report on Form 10-K or incorporated herein by reference do not accompany copies hereof for distribution to shareholders of the Company. The Company will furnish a copy of any of such exhibits to any shareholder requesting the same. (1) Incorporated by reference to the exhibit of the same number filed with the Registrant's Registration Statement on Form S-1 (File No. 333-02980). (2) Management contract or compensation plan. (3) Incorporated by reference to exhibit 10 filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996. (4) Incorporated by reference to the exhibit of the same number filed with the Registrant's Annual Report on Form 10K for the year ended December 31, 1997. (5) Incorporated by reference to exhibit 10 filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. (6) Incorporated by reference to exhibit 10 filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000. (7) Incorporated by reference to the exhibit of the same number filed with the Registrant's Annual Report on Form 10K for the year ended December 31, 2000. (8) Incorporated by reference to exhibit 10 filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001. (d) Financial Statement Schedules: Schedule II-Valuation and Qualifying Accounts 44 EXACTECH, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 2001
Balance at Charged to Beginning Costs and Deductions Balance at of Year Expenses (Chargeoffs) End of Year ----------- ----------- ------------- ----------- Allowance for doubtful accounts 1999 $ 153,958 $ 178,735 $ 332,693 2000 332,693 48,348 381,041 2001 381,041 61,158 (68,937) 373,262
45 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) 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. March 13, 2002 EXACTECH, INC. By: /s/ William Petty ------------------------------------- William Petty Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. March 13, 2002 By: /s/ William Petty ----------------------------------- William Petty Chairman of the Board, President and Chief Executive Officer (principal executive officer) March 13, 2002 By: /s/ Gary J. Miller ----------------------------------- Gary J. Miller Executive Vice President and Director March 13, 2002 By: /s/ Joel C. Phillips ----------------------------------- Joel C. Phillips Chief Financial Officer March 13, 2002 By: /s/ Albert H. Burstein ----------------------------------- Albert H. Burstein Director March 13, 2002 By: /s/ R. Wynn Kearney, Jr. ----------------------------------- R. Wynn Kearney, Jr. Director March 13, 2002 By: /s/ Paul E. Metts ----------------------------------- Paul E. Metts Director March 13, 2002 By: /s/ David W. Petty ----------------------------------- David W. Petty Executive Vice President and Director 46 Exhibit Index Exhibit Number Description ------ ----------- 23.1 Independent Auditors Consent