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, 1998
____ 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 February 19, 1999, the number of shares of the registrant's Common Stock
outstanding was 4,920,979. The aggregate market value of the Common Stock held
by non-affiliates of the registrant as of February 19, 1999 was approximately
$26,761,042, based on a closing sale price of $11.00 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 1999
Annual Meeting of Shareholders (to be filed pursuant to Regulation 14A).
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TABLE OF CONTENTS
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CROSS REFERENCE SHEET
PAGE NUMBER
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PART I Item 1. Business
Business Overview 3
Products 3
Marketing and Sales 6
Manufacturing and Supply 7
Patents and Proprietary Technology 7
Research and Development 9
Scientific Advisory Board 10
Competition 10
Product Liability and Insurance 10
Government Regulation 11
Employees 13
Executive Officers of the Registrant 14
Glossary 16
Item 2. Properties 18
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 19
PART II Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 20
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 22
Item 7.A Quantitative and Qualitative Disclosures About Market Risk 28
Item 8. Financial Statements and Supplementary Data 29
Item 9. Changes in and Disagreements with Accountants on 46
Accounting and Financial Disclosure
PART III Item 10. Directors and Executive Officers of the Registrant 46
Item 11. Executive Compensation 46
Item 12. Security Ownership of Certain Beneficial Owners
and Management 46
Item 13. Certain Relationships and Related Transactions 46
PART IV Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 47
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PART I
ITEM 1. BUSINESS
Certain terms used herein are defined in the Glossary on pages 16 to 18
hereof. Exactech, Inc. (the "Company", or "Exactech") develops, manufactures,
markets and sells orthopaedic implant devices and related surgical
instrumentation 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/registered
trademark/, a total primary knee replacement system, which had been in
development for three years. The Optetrak/registered trademark/ 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. The Optetrak/registered
trademark/ system represents a highly differentiated product based on precision
manufacturing techniques and a design which reduces articular contact stress.
The Optetrak/registered trademark/ system is the most modern rendition of a
series of knee implants which were first introduced in 1974 and which are still
being marketed by certain of the Company's competitors. The Company has entered
into an agreement with the Hospital for Special Surgery which gives the Company
a non-exclusive option with respect to future knee systems developed at the
Hospital for Special Surgery.
In order to raise capital, in June 1996, the Company consummated an
underwritten initial public offering (the "IPO") of 1,840,000 shares of its
common stock, $.01 par value (the "Common Stock"), resulting in net proceeds to
the Company of $12,657,910 after deduction of underwriting, legal, accounting
and other offering related expenses. The proceeds of the IPO have been and will
be used primarily to repay indebtedness, to purchase inventory and equipment,
for research and development and for working capital and general corporate
purposes.
ORTHOPAEDIC IMPLANT INDUSTRY
According to the Orthopedic Network News Volume 9 Number 3, United
States sales of orthopaedic implant products were approximately $1.9 billion in
1997, an increase of 5.3% from 1996. During 1997, sales of knee implants were
approximately $1.05 billion, an increase of 6.6% from 1996, while sales of hip
implants were approximately $833.9 million, an increase of 3.8% from 1996. The
publication reports that there were 556,060 hip and knee joint replacements in
the United States in 1997 compared to 532,532 in 1996. The Company expects sales
of hip and knee joint replacements in foreign markets to grow more rapidly than
in the United States.
Management believes that the growth in the industry is due to the
increase in the number of people over age 65, an increasingly active population,
improvements in technology and increased use of implants in younger patients.
According to an industry report, the United States population over 65 years of
age continues to grow as a percentage of the population. Longer life spans and
the continuing aging of the population increases the number of individuals whose
joints will be subject to failure. Furthermore, the "baby-boomers" are
approaching the age where arthritis and osteoporosis begin to affect joints,
necessitating joint replacement. 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
which 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 a
portion of the bones that comprise the joint, prepares the remaining bones and
surrounding tissue and then installs the implant.
Knee implants are either total or unicompartmental. Total knee
replacement systems are used to replace the entire knee joint (i.e., the
patella, upper portion of the tibia and lower portion of the femur), while
unicompartmental systems are used to replace one of the two compartments between
the femur and the tibia.
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Primary knee implant systems are used to replace the natural knee joint, while
knee revision systems are used to replace the components of a previously
installed primary implant system that has failed. The components of revision
systems are specially designed to fill bony voids created by the previous
implant.
Hip implants are either total or partial. In a total hip implant, the
acetabulum is replaced with an acetabular cup. The damaged head of the patient's
femur is removed and a stem is inserted into the femur on which a replacement
head is mounted. This femoral head is placed into the cup of the acetabulum to
recreate the ball and socket joint. In a partial hip implant, the damaged head
of a patient's femur is removed and replaced with a head mounted on a stem
inserted into the femur. However, the acetabulum is not replaced and the size of
the head is larger and more similar to the natural femoral head. Hip implants
are designed for either cemented or non-cemented applications. Cemented hip
implants are installed by using bone cement to attach the components to a
patient's bones, while porous coated hip implants are press-fit without cement.
Porous coated implants are designed to promote growth of the patient's remaining
bone tissue onto the implant. Primary hip implant systems are used to replace
the natural hip joint, while hip revision systems are used to replace a
previously installed primary implant system that has failed.
KNEE PRODUCTS. The Company believes that its Optetrak/registered
trademark/ knee system represents a major advance in knee implant design. The
Optetrak/registered trademark/ knee system was developed in collaboration with
the Hospital for Special Surgery in New York and a design team consisting of
physicians and biomechanists affiliated with major medical facilities and
academic institutions. The Company's Optetrak/registered trademark/ system is a
modular system designed to maximize stability, to provide increased range of
motion and improved patellar tracking and to reduce articular contact stress
that leads to implant failure. 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 than other comparable knee implant systems.
The Optetrak/registered trademark/ 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). These
femoral components are made of a cobalt chromium alloy. The system is also
available with several alternative tibial components, titanium backed
polyethylene tibial components with both finned keel and trapezoid keel with
stem augmentation, blocks and full or half wedges, and all polyethylene tibial
components, which are cruciate sparing and posterior stabilized. The stem, block
and wedge augmentation allow the surgeon to rebuild the ends of the patient's
bones to allow fixation of the implant system. The metal components of the
Optetrak/registered trademark/ system are fully precision machined resulting in
better congruence among components and material performance. The Company's
patellar products are made of ultra-high molecular weight polyethylene. Because
of variations in human anatomy and differing design preferences among surgeons,
knee components are manufactured by the Company in a variety of sizes and
configurations. Bone cement is used to affix the implants to the bone.
The Optetrak/registered trademark/ system also includes a total knee
revision system with respect to which the Company commenced full scale marketing
in 1997. The revision system includes a constrained condylar femoral component
and a non-modular femoral component with enhanced stem and block augmentation
and can be used with many components of the primary system. The constrained
condylar femoral component was designed to provide greater constraint between
the system components to compensate for ligaments weakened or lost due to
disease or as a result of the original implant. The Company is also designing a
unicompartmental knee with respect to which the Company will be required to
obtain Food and Drug Administration ("FDA") clearance to market.
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, its AuRA/registered trademark/Cemented Total Hip System, its
MCS/registered trademark/ Porous Coated Total Hip System, and the
Opteon/registered trademark/ Cemented Stem System. The AuRA/registered
trademark/ system also includes revision long stems and calcar replacement
stems. Additionally, the Company markets two primary partial hip implant
systems, its unipolar and its bipolar implant components.
All total hip implants produced by the Company consist of a cup, head
and stem. Because of variations in human anatomy and differing design
preferences among surgeons, hip implants are manufactured by the Company in a
variety of head sizes, neck lengths, stem lengths, stem cross-sections and
configurations. The Company's total hip replacement systems utilize either
titanium alloy or cobalt chromium alloy femoral stem components, which can
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be final machined from forgings, castings or wrought metal plate depending on
the design and material used. The Company's total hip replacement systems also
include ultra-high molecular weight polyethylene cups with and without metal
backing. The femoral heads are made of either cobalt chromium or zirconia
ceramic.
The Company's AuRA/registered trademark/ Cemented Hip System is
intended to provide optimal treatment for patients requiring cemented hip
arthroplasty (joint reconstructive surgery) by minimizing failure of the bone
cement. The femoral stem utilizes a cross-sectional design to reduce stress on
the bone cement used to affix the implant to the patient's remaining bone
tissue. The system is also designed to allow for increased range of motion in
the patient. It is available in long stem and calcar replacement versions. The
AuRA/registered trademark/ is a high demand forged cobalt chromium femoral stem.
The Company also provides a moderate demand femoral stem, the Opteon/registered
trademark/ forged cobalt chromium femoral stem. The Cemented Total Hip System is
a mature product line which the Company phased out during 1998.
The Company scaled up marketing and sales of the AuRA/registered
trademark/ Hip System in 1997. AuRA/registered trademark/ is a comprehensive
system that provides solutions for a broad range of patient problems. It is
specifically designed to support the needs of a maturing generation of more
active patients. The AuRA/registered trademark/ Hip System is comprised of a new
primary total hip replacement system as well as revision components which
include calcar replacement and long stems. It can also be used for fracture and
tumor applications. All AuRA/registered trademark/ components have a common
proximal geometry which affords the surgeon reproducability of results
regardless of which stem is selected. AuRA/registered trademark/ components can
be implanted using a single set of surgical instruments which makes the system
more cost effective.
The Company's MCS/registered trademark/ Porous Coated Total Hip System
was designed to minimize thigh pain and abnormal bone remodeling resulting from
bone-implant stiffness mismatch. The Company's MCS/registered trademark/ Porous
Coated Total Hip System was also designed to avoid unnecessary damage to the
bone and its blood supply during femoral preparation. The Company also provides
instrumentation that facilitates reproducible implantation of the implant. The
system consists of a modular acetabular cup and cup liner, screws for
supplemental fixation of the acetabular cup, a modular head and a femoral stem.
All of the Company's femoral heads are designed to be used with its femoral
stems, including the Ziramic/registered trademark/ (zirconia ceramic) femoral
head which was designed to further reduce friction and polyethylene wear, and is
also compatible with the AuRA/registered trademark/ Hip System. The system has
been cleared by FDA for use without cement.
The Company's partial hip products include a bipolar prosthesis and a
unipolar prosthesis. The Company's bipolar prosthesis also utilizes one of the
stems used in total hip replacements. The bipolar prosthesis is designed for use
in more active patients and the unipolar prosthesis is designed for use in less
active patients.
During 1996, the Company licensed patent technology for a modular
revision hip system. The Company commenced product development of the modular
revision hip system during 1997. The Company plans to continue product
development and to seek FDA clearance to market the system in 1999. Upon receipt
of FDA clearance, the Company plans to commence full scale marketing of the
product in 2000.
OTHER COMPANY PRODUCTS AND SERVICES. The Company has designed and
received FDA clearance to market a nonmodular shoulder implant system. In 1997,
the Company temporarily halted development plans for a modular version of a
shoulder implant system. The Company believes that 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 may develop this
product through a separate wholly-owned subsidiary.
The Company has signed a worldwide distribution agreement with
Regeneration Technology Inc., an affiliate of the University of Florida Tissue
Bank, for new bone grafting material technology. This material,
OpteFORM/trademark/, includes traditional allograft material components, and has
the unique property of being fully formable at a temperature of 43/degrees/ to
45/degrees/C which is just above body temperature. The material becomes a
resilient solid when its temperature falls to body temperature (37/degrees/C).
Exactech distributes OpteFORM/trademark/ as a service through the
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Company's current domestic distribution. The Company commenced this service in
the fourth quarter of 1998, with full phase-in planned over the course of 1999.
During June 1998, the Company purchased substantially all of the assets
related to Synvasive Technology, Inc.'s ("Synvasive") Acudriver/trademark/
product line. The Acudriver/trademark/ Automated Osteotome System is an
air-driven impact handpiece that aids surgeons during joint implant revision
procedures by providing effective cleavage of prosthesis/bone or cement/bone
interfaces. The Acudriver/trademark/ accomplishes this by providing the surgeon
with precise positioning without the inconvenience and inconsistency of striking
the osteotome with a mallet.
MARKETING AND SALES
The Company markets its orthopaedic implant products in the United
States through 40 independent agencies and two domestic distributors, that act
as the Company's sales representatives, and internationally through eight
foreign distributors. The customers for the Company's products consist of
hospitals, surgeons and other physicians and clinics. Traditionally, the surgeon
made the ultimate decision which orthopaedic implant to use. 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 pursuant to which the agency is granted the exclusive right to
market the Company's products in the specified territory and 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 two Regional Managers (West and East). The Company has contractual
arrangements with its domestic distributors which are similar to its
arrangements with its sales agencies, except the Company does not pay the
distributors commissions and the distributors purchase inventory from the
Company for use in fulfilling customer orders. The Company currently offers its
products in 38 states, including Florida, New York, California, Texas, Ohio,
Pennsylvania and Illinois.
The Company provides inventories of its products to its United States
sales agencies until sold or returned for their use in marketing its products
and filling customer orders. As the size of the component to be used is
frequently not known until surgery has commenced and because surgeons give
little or no advance notice of surgery, 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 material adverse effect on the Company.
During the years ended December 31, 1996, 1997 and 1998, approximately
7%, 6% and 7%, respectively, of the Company's sales were derived from a major
customer. During the years ended December 31, 1996, 1997 and 1998 one
distributor, MBA Del Principado, S.p.A., accounted for approximately 13%, 13%
and 14%, 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 twelve countries in
addition to the United States: Argentina,
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Australia, Belgium, Columbia, Greece, Japan, Italy, Luxembourg, Netherlands,
Portugal, Spain and Turkey. For the years ended December 31, 1996, 1997 and
1998, foreign sales accounted for $2,124,856, $3,051,151, and $5,007,105
representing approximately 15.4%, 17.3%, and 20.8% respectively, of the
Company's sales. For the years ended December 31, 1996, 1997, and 1998, gross
profit from foreign sales accounted for $597,944, $1,127,455 and $1,871,577,
respectively. The Company intends to continue to expand its sales in foreign
markets in which there is increasing demand for orthopaedic implant products. In
order to expand its global sales and marketing capabilities, the Company intends
to assess the attractiveness of establishing local manufacturing to serve the
Italian, Spanish and other EEC markets. The Company intends to continue to
expand its international distribution network in 1999.
MANUFACTURING AND SUPPLY
The Company has 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. The Company consults with its vendors in
the early stages of the design process of its products. This strategy of using
third-party vendors for some manufacturing and consulting enables the Company to
efficiently source product requirements while affording it considerable
flexibility. Because the Company is able to obtain competitive prices from a
number of suitable suppliers with FDA-approved facilities, the Company believes
it is able to offer high quality products at cost-effective prices, even more so
with the increase of internal manufacturing in the coming years. In order to
control its production costs, the Company continually assesses the manufacturing
capabilities and cost-effectiveness of its existing and potential vendors. The
Company may in the future establish manufacturing strategic alliances to assure
itself of continued low-cost production. For the years ended December 31, 1996,
1997 and 1998, the Company purchased approximately 62%, 72% and 74%,
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. The Company began limited manufacturing of the components of its
products, consisting primarily of final machining of components during 1998. The
Company completed a new facility which is used for principal executive offices,
research and development laboratories and manufacturing. The Company occupied
the new facility in the second quarter of 1998.
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/registered trademark/ tibial components, 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/registered trademark/ 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. See "Legal Proceedings" for information concerning
a patent infringement claim against the Company.
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
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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, 1996, 1997 and 1998, the Company paid royalties aggregating
$187,773, $288,759 and $432,242 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 of the
members of its design team in connection with the development of its
AuRA/registered trademark/ hip system.
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 1997 and 1998, the Company paid Dr. Burstein $123,750 and
$135,000, respectively, 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/registered trademark/ 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/registered trademark/ knee implant
system will not infringe the intellectual property rights of third parties.
During the years ended December 31, 1996, 1997 and 1998, the Company recognized
royalties to the Hospital for Special Surgery of $307,801, $474,357 and
$650,548, 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 10 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
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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. Under the terms of the Sublicense Agreement,
the Company received an advance on anticipated royalties in the amount of
$l00,000. 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. As a result, the $100,000 was recognized
by the Company as sublicense income in 1996 due to the non-refundable nature of
the advance.
Pursuant to a license agreement between the Company and Accumed, Inc.
("Acumed"), the Company secured a worldwide license to manufacture, use and sell
products utilizing Acumed's bipolar hip prosthesis and a license to any rights
under any patent that is issued covering Acumed'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 anniversary of the Company's first sale of a product utilizing the
Accumed design, the Company is 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 Acumed's design, the royalty payable is 2% of
the Company's net sales of applicable products in such country. During the years
ended December 31, 1996, 1997 and 1998, the Company paid royalties to Accumed of
approximately $11,577, $11,906 and $12,764, respectively.
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 is payable at the time of FDA clearance to
market the products.
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 is payable at such time as the licensor produces a
developed product.
RESEARCH AND DEVELOPMENT
During the years ended December 31, 1996, 1997 and 1998, the Company
expended $750,256, $937,988 and $1,271,825 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 revision components of the Company's Optetrak/registered
trademark/ knee implant system and the AuRA/registered trademark/ Hip System in
1997. The Company's principal research and development efforts currently relate
to the production of enhanced revision components included in the
Optetrak/registered trademark/ knee implant system, a new primary acetabular
component, integration of the AuRA/registered trademark/ and MCS/registered
trademark/ hip stem systems to allow easier interchange of surgical
instrumentation, and development of the
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modular hip implant system.
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 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: Albert H. Burstein, Ph.D., Edmund
Chao, Ph.D., Ivan Gradisar, M.D., William Murray, M.D., Raymond Robinson, M.D.,
and Robert Trousdale, M.D.
COMPETITION
The orthopaedic implant industry is 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 hip implant
market are Bristol-Myers Squibb Company (Zimmer Inc.), Johnson & Johnson,
Osteonics, Inc., Pfizer Inc. (Howmedica, Inc.), and Biomet, Inc. who, according
to an industry publication, had an estimated aggregate market share of
approximately 77.1% in 1997. The largest competitors in the orthopaedic knee
implant market are Bristol-Myers Squibb Company (Zimmer Inc.), Johnson &
Johnson, Pfizer Inc. (Howmedica, Inc.), DePuy, Inc. and Biomet, Inc. who,
according to an industry publication, had an estimated aggregate market share of
approximately 67.3% in 1997.
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, as opposed to surgeon preference,
is becoming increasingly important in the hip market, the primary basis of
competition in the knee market remains physician preference, which includes
ease-of-use, clinical results, price and relationships with sales
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, among other things, 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.
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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 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: its cemented hip implant system, including femoral
stem, acetabular cup and femoral heads; bone screws; porous coated cemented
femoral stem and acetabular component; bipolar partial hip implant;
Zirconia/registered trademark/ (ceramic) femoral heads; Opteon/registered
trademark/ femoral stem for cemented and noncemented use; MCS femoral stem and
acetabular component for cemented and noncemented use; AuRA/registered
trademark/ femoral stem; and the Optetrak/registered trademark/ knee replacement
system.
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
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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.
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.
Prior to 1996, the Company voluntarily initiated and satisfactorily
completed two Class III recalls. 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. One recall involved a partially mislabeled product. The second
involved the manufacturing process of a bone screw. FDA reviewed and authorized
these two recalls, and concluded that each of the two recalls was conducted and
completed properly. During September 1997, the Company voluntarily initiated a
Class II recall as the result of the failure of an Opteon/registered trademark/
femoral hip stem. 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.
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
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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. Certain 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 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, 1998, the Company employed 57 full time employees.
The Company has no union contracts and believes that its relationship with its
employees is good.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
William Petty, M.D. . . . . . . . . . 56 Chairman of the Board and Chief Executive Officer
Timothy J. Seese. . . . . . . . . . . . 52 President, Chief Operating Officer and Director
Gary J. Miller, Ph.D. . . . . . . . 51 Vice President, Research and Development and Director
David W. Petty. . . . . . . . . . . . . 32 Vice President, Marketing
Marc Olarsch. . . . . . . . . . . . . . . 36 Vice President, Sales
Joel C. Phillips . . . . . . . . . . . . . 31 Chief Financial Officer and Treasurer
Betty Petty . . . . . . . . . . . . . . . . 56 Secretary
</TABLE>
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 1975 to 1998 and
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. from the University of
Arkansas. He completed his residency in Orthopaedic Surgery at the Mayo Clinic
in Rochester, Minnesota. Dr. Petty continues a limited practice in the surgical
field of total joint arthroplasty. He devotes most (approximately 90%) of his
time to the business affairs of Exactech.
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, 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.
GARY J. MILLER, PH.D. was a founder and has been the Vice President,
Research and Development of the Company since October 1986 and 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 through July 1997. 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 Division since 1982 and
was appointed as an Adjunct Associate Professor in the Department of Aerospace
Engineering, Mechanics and Engineering Sciences in 1995. He was a consultant to
FDA 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 Vice President, Marketing of the Company since
April 1993. He has been employed by the Company in successive capacities in the
area of Operations and Sales and Marketing for the past ten years, including as
Vice President, Operations from April 1991 until April 1993. Mr. Petty received
his B.A. from The University of Virginia in 1988. Mr. Petty is the son of Dr.
and Ms. Petty.
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MARC 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.
JOEL C. PHILLIPS has been Chief Financial Officer of the Company since
July of 1998. Mr. Phillips has been the Treasurer of the Company since March
1996, prior to which he was Manager, Accounting and Management Information
Systems since April 1993. From January 1991 to April 1993, Mr. Phillips was
employed by Arthur Andersen. He is responsible for the Company's accounting and
control functions. Mr. Phillips received a B.S. and a Masters in Accounting from
the University of Florida and is a certified public accountant.
BETTY PETTY has been Secretary of the Company since its inception and
served as Treasurer and a Director from its inception until March 1996. Ms.
Petty is responsible for the development of all of the Company's literature,
advertising and corporate events and also serves as Human Resources Coordinator
for the Company. Ms. Petty 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.
The Company's officers are elected annually by the Board of Directors and
serve at the discretion of the Board.
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GLOSSARY
ACETABULAR COMPONENT-An orthopaedic implant that attaches to the pelvis
replacing the diseased or damaged acetabulum in total hip arthroplasty.
ACETABULAR CUP-An orthopaedic implant which replaces the acetabulum in total hip
arthroplasty.
ACETABULUM-The hip socket or cup-shaped depression on the external surface of
the pelvis, in which the femoral head fits.
ALLOGRAFT-A homograft between allogenic individuals.
ARTHROPLASTY-An operation to restore as far as possible the integrity and
functionality of a joint.
ARTICULAR CONTACT STRESS-A measure of force where two moving surfaces make
contact; in the case of a normal human joint or an artificial joint, a measure
of force between the two surfaces in contact.
BIPOLAR COMPONENT/BIPOLAR PROSTHESIS-An orthopaedic hip implant used with a
femoral stem and a femoral head to repair fractures of the neck of the femoral
stem when the acetabulum and acetabular cartilage are in good condition.
BONE REMODELING-Reshaping of the bone as a result of stresses applied, sometimes
from stresses transferred to the bone by an orthopaedic implant.
BONE SCREWS-Screws used to affix an orthopaedic implant to a bone.
CALCAR REPLACEMENT STEM-A femoral hip implant component used when there is bone
loss or destruction in the proximal medial area of the femur.
CEMENT-A nonmetallic material used for filling a cavity and attaching implants
to bone in joint arthroplasty.
CERAMIC-A glass like material made from metallic oxides used as an alternative
to metal in the ball of a ball and socket joint in hip and other large joint
orthopaedic implants.
COBALT CHROMIUM ALLAY-A substance primarily composed of a mixture of cobalt and
chromium used for orthopaedic implants.
CONSTRAINED CONDYLAR FEMORAL COMPONENT-A type of knee replacement component
typically used in revision surgery which compensates for lack of ligamentous
stability in the knee joint.
CRUCIATE LIGAMENT SPARING FEMORAL COMPONENT-A total knee replacement component
designed specifically for use in situations where the surgeon chooses to
maintain a functional or partially functional posterior cruciate ligament (one
of the major ligaments in the knee joint). Also called a cruciate retaining
femoral component.
EXTRAMEDULLARY ALIGNMENT-A method used in setting the alignment for bone
preparation in knee arthroplasty.
FEMORAL-Pertaining to the femur (large bone in the thigh).
FEMORAL HEAD-The ball of the ball and socket hip joint. The artificial ball used
to replace the natural ball of a diseased or damaged hip joint.
FEMORAL STEM-An orthopaedic implant placed into the femur or thigh bone in total
hip arthroplasty.
FEMUR-The bone located between the hip and the knee (large bone in the thigh).
FINNED KEEL-A shape or geometry of part of a specific design of a tibial
component which is implanted into the bone in knee arthroplasty.
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FIXATION METHODS-Various methods of fixating implant components of artificial
joints to human bone.
FORGING-A fabrication process whereby a metal is heated and hammered into a
final shape resulting in a strong, dense part.
HIP ARTHROPLASTY-An operation to restore as far as possible the integrity and
functionality of the hip joint.
HOMOGRAFT- A graft of tissue from the donor of the same species as the recipient
IMPLANT-A device employed in arthroplasty.
JOINT REPLACEMENT-An arthroplasty procedure where joint functionality is
restored as far as possible by totally substituting an artificial joint
orthopaedic implant system for a diseased or damaged joint.
KNEE ARTHROPLASTY-An operation to restore as far as possible the integrity and
functionality of the knee joint.
LONG STEM-A femoral hip implant component used when the length of the primary
component does not meet the fixation needs of the surgical situation.
MODULAR-Made up of interchangeable parts which, when joined together, comprise
an entire orthopaedic implant.
NON-CEMENT-Description of a total orthopaedic implant component or procedure in
which bone cement is not used and the metal of the component is placed directly
against the bone.
ORTHOPAEDICS-The medical specialty concerned with the preservation, restoration
and development of form and function of the musculoskeletal system, extremities,
spine and associated structures by medical, surgical and physical methods.
OSTEOARTHRITIS-Degenerative joint disease occurring chiefly in older persons,
characterized by degeneration of the cartilage and bone and changes in the
synovial membrane. It is accompanied by pain and stiffness, particularly after
prolonged activity.
PATELLA-A triangular sesamoid bone situated at the front of the knee (knee cap).
PATELLA TRACKING-The action of the knee cap or patella gliding over the surface
of the end of the femur or thighbone when the knee bends and straightens. Also
the action of a patellar component gliding over the surface of a femoral
component in a knee with a total knee arthroplasty.
POLYETHYLENE-A plastic polymer in the thermoplastic group compatible with tissue
in the body.
POLYETHYLENE CUP LINER-An ultra-high molecular weight polyethylene insert which
provides the articular surface inside an acetabular cup.
POROUS COATING-A coating made of metal beads applied by heat and pressure to the
metal surface of an orthopaedic implant that promotes bony ingrowth in order to
hold the orthopaedic implant in place.
POSTERIOR STABILIZED FEMORAL COMPONENT-A knee component which fits on the end of
the femur and is used in situations where the surgeon chooses to eliminate the
posterior cruciate ligament, one of the major ligaments in the knee joint. The
component replaces to some degree the function of the posterior cruciate
ligament.
PRESS FIT-A method of fixation using a wedge-fit, rather than cement.
PRIMARY SYSTEMS-Orthopaedic implants which are designed to replace the natural
joint.
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RECONSTRUCTIVE IMPLANT DEVICES-Orthopaedic implants which are implanted to
reconstruct major joints which have been damaged by degenerative bone disease or
accident.
REVISION SYSTEMS-Orthopaedic implants which are designed to replace a failed
orthopaedic implant.
TIBIA-The inner and larger bone of the leg below the knee (shin bone).
TITANIUM-A metal used primarily in non-cemented applications in joint
arthroplasty.
TOTAL JOINT ARTHROPLASTY-An operation to replace a diseased or damaged joint of
the body with artificial implants usually to reduce pain and restore function in
the joint.
TOTAL JOINT IMPLANTS-Implants used in total joint arthroplasty.
TRAPEZOID KEEL WITH STEM AUGMENTATION-A geometry of a specific design of tibial
component that allows for attaching space-filling metal blocks and stems to fill
bone defects in the tibia in knee arthroplasty.
UNICOMPARTMENTAL IMPLANTS-Implants designed to resurface only one compartment of
a human knee.
UNIPOLAR PROSTHESIS-A large hemispherical implant component which is attached to
a femoral stem in a partial hip arthroplasty.
ITEM 2. PROPERTIES
In June 1998, the Company completed construction of a new 38,000 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".
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 April 3, 1995, Joint Medical Products, Inc. ("Joint Medical")
commenced an action (the "Action") against the Company, and many of its
competitors, alleging the infringement of a United States patent held by Joint
Medical entitled "Ball and Socket Bearing for Artificial Joint" (the "Ball and
Socket Patent"). As part of the Action, Joint Medical alleged that the Company's
manufacture and sale of certain orthopaedic implants was an infringement of the
Ball and Socket Patent. The Company and Joint Medical entered into a Tolling
Agreement, effective as of April 3, 1995, pursuant to which the parties agreed
that the Action would be dismissed without prejudice as to the Company. The
Tolling Agreement further provided that neither the Company nor Joint Medical
would commence any further action regarding the Company's alleged infringement
of the Ball and Socket Patent until the rendering of a decision by the Board of
Patent Appeals and Interferences regarding such alleged patent infringement. In
accordance with the Tolling Agreement, the Action was dismissed as against the
Company, among others, as of July 28, 1995. During 1996, the Board of Patent
Appeals and Interferences ruled in Joint Medical's favor and allowed the filing
of claims to continue. On January 28, 1997, Joint Medical filed a complaint in
the U.S. District Court for the District of Connecticut against the Company
seeking injunctive relief and unspecified monetary damages. The Company
believes, based upon a reasoned opinion of patent counsel, Fish and Richardson
P.C., that Joint Medical's claims are without merit and that its orthopaedic
implants do not infringe upon the Ball and Socket Patent. In December 1997, the
complaint was dismissed without prejudice. The product line claimed to be in
violation of the patent is the MCS/registered trademark/ Porous Acetabular Shell
which represented approximately 7%, 6% and 7% of the Company's revenues for the
years ended December 31, 1996, 1997 and 1998, respectively. A finding that such
product line infringes upon the Ball and Socket Patent could materially and
adversely affect the Company's business operations,
18
<PAGE>
as well as expose the Company to significant monetary damages.
On August 21, 1997, a competitor of the Company filed a complaint in
the United States District Court in New Jersey alleging that the Company induced
several of the competitor's sales agents to breach their employment agreements
when the Company contracted with these agents to sell the Company's products.
The plaintiff was seeking an unspecified monetary award and punitive damages in
the amount to be determined at trial. The plaintiff also sought to enjoin the
Company from soliciting plaintiff's employees, interfering with their customer
relationships and selling products to their former customers. At a hearing in
the Superior Court of New Jersey on October 8, 1997, the judge denied the
plaintiff's request for injuctive relief. On December 23, 1998, the Company
settled the lawsuit by agreeing to pay the competitor an unspecified sum for the
release of all claims raised in the lawsuit.
In December 1997, a competitor of the Company filed a complaint against
one of the competitor's former sales agents in the United States District Court
in Oregon. The competitor petitioned the court to include the Company in the
complaint alleging liability for actions of the sales agent and interference by
the Company with a contract between the competitor and the sales agent. The
court refused to allow the Company to be included in the complaint, but affirmed
that the competitor could name the Company in a separate complaint. Without
admitting any wrongdoing, the Company and the agent settled the dispute through
mediation in February 1998, and obtained a release of all claims. As part of the
settlement, the Company agreed to pay $20,000 to the agent for legal expenses
and an additional $55,000 in enhanced sales commissions to the agent over an
indeterminate period of time if the commissions are earned. The Company also
agreed not to hire as a new sales agent any of the competitor's exclusive
distributors or sales representatives whose territory is west of the Mississippi
River in the continental United States for a period of four months.
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, 1998.
19
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
The Company's Common Stock has traded on the Nasdaq National Market
under the symbol "EXAC" since May 30, 1996, the date of the initial public
offering (IPO). 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
------------ -------------
1996
- -----------------------------------------
Second Quarter (beginning May 30, 1996) $ 11.00 $ 8.00
Third Quarter 8.13 5.00
Fourth Quarter 12.25 7.00
1997
- -----------------------------------------
First Quarter $ 10.00 $ 6.50
Second Quarter 7.75 6.00
Third Quarter 7.00 5.56
Fourth Quarter 6.88 3.88
1998
- -----------------------------------------
First Quarter $ 7.13 $ 5.13
Second Quarter 8.25 6.75
Third Quarter 8.19 5.88
Fourth Quarter 13.00 5.88
1999
- -----------------------------------------
First Quarter (through February 19, 1999) $ 13.50 $ 10.00
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 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 February 19, 1999, the Company had approximately 226 stockholders
of record. There are in excess of 2,500 beneficial owners of the Company's
Common Stock.
After deducting expenses of $2,062,090 of the IPO, the Company received
$12,657,910 in net proceeds from the IPO. Set forth below is information
concerning the actual use of such proceeds.
<TABLE>
<CAPTION>
Direct or Indirect payments Direct or indirect payments
to related parties (1) to others
-------------------------- ---------------------------
<S> <C> <C>
Purchase and installation of machinery
and equipment $ - $4,251,366
Repayment of indebtedness $ - $4,942,268
Other Purposes (2) $ - $3,464,276
</TABLE>
1 - Includes direct or indirect payments to directors, officers, general
partners of the Company, or their associates; to persons owning ten
percent or more of any class of equity securities of the Company; and
to affiliates of the Company.
2 - Includes increase of inventory held for sale of $3,464,276.
20
<PAGE>
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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales $5,355,804 $9,118,075 $13,839,976 $17,648,060 $24,024,356
Cost of goods sold 1,586,633 2,995,955 4,683,875 5,895,302 8,590,391
Gross profit 3,769,171 6,122,120 9,156,101 11,752,758 15,433,965
Operating expenses:
Sales and marketing 1,500,514 2,326,286 3,525,834 4,911,906 5,968,611
General and administrative 750,669 1,033,319 1,346,304 1,677,878 2,184,564
Research and development 597,812 722,118 750,256 937,988 1,271,825
Royalties 14,767 210,127 571,807 855,415 1,215,956
Depreciation and amortization 224,624 350,612 509,236 813,200 1,202,000
Total operating expenses 3,088,386 4,642,462 6,703,437 9,196,387 11,842,956
Income from operations 680,785 1,479,658 2,452,664 2,556,371 3,591,009
Other income (expense):
Interest income
(expense), net (158,288) (273,110) 12,336 200,720 (70,686)
Income from sub-license
agreement, net - 170,534 100,000 - -
Equity in net gain (loss) of
subsidiary - (22,361) (59,486) (183,909) 13,778
Income before provision for
income taxes 522,497 1,354,721 2,505,514 2,573,182 3,534,101
Provision for income taxes 176,369 527,793 950,906 997,188 1,406,671
Net income 346,128 826,928 1,554,608 1,575,994 2,127,430
Preferred stock dividends 19,298 22,798 10,154 - -
Net income available to
common shareholders 326,830 804,130 1,544,454 1,575,994 2,127,430
Basic earnings per common share * $0.11 $0.27 $0.38 $0.32 $0.43
Diluted earnings per common share * $0.11 $0.27 $0.37 $0.32 $0.43
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------------------------
BALANCE SHEET DATA: 1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total current assets $4,781,430 $8,411,133 $17,358,859 $16,867,260 $18,055,329
Total assets 6,296,745 10,620,750 21,107,072 27,154,836 29,238,120
Total current liabilities 1,896,488 4,476,374 2,182,278 2,464,461 2,187,582
Total long-term debt, net of current portion 684,903 1,002,309 18,144 3,912,835 3,906,802
Total liabilities 3,210,993 6,452,479 2,527,297 6,811,244 6,754,643
Total preferred stock 241,220 291,220 - - -
Total common shareholders' equity 2,844,532 3,877,051 18,579,775 20,343,592 22,483,477
</TABLE>
* Earnings per share for years prior to 1997 have been restated in
accordance with Statement of Financial Accounting Standards No.128
"Earnings Per Share".
21
<PAGE>
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
financial statements and related notes appearing elsewhere herein.
Exactech, Inc. was founded by an orthopaedic surgeon 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 high quality devices respond to the cost-conscious demands
of the hospital and surgical community in replacing joints which have
deteriorated as a result of injury or diseases, such as arthritis.
Early in our history, the Company's revenues were principally derived
from sales of its primary hip replacement systems. Currently, the principal
products in Exactech's line of hip implant devices consist of three primary
total hip implant systems, the Opteon/registered trademark/ Cemented Hip System,
the MCS/registered trademark/ Porous Coated Total Hip System, and the
AuRA/registered trademark/ System, and several partial hip implant systems, the
AuRA/registered trademark/ Revision hip implant, the unipolar implant, and the
bipolar implant.
Exactech scaled up marketing and sales of the AuRA/registered
trademark/ Hip System in 1997. AuRA/registered trademark/ is a comprehensive
system that provides solutions for a broad range of patient problems. It is
specifically designed to support the needs of a maturing generation of more
active patients. The AuRA/registered trademark/ Hip System is comprised of a new
primary total hip replacement system as well as revision components which
include calcar replacement and long stems. It can also be used for fracture and
tumor applications. All AuRA/registered trademark/ components have a common
proximal geometry which affords the surgeon reproducibility of results
regardless of which stem is selected. AuRA/registered trademark/ components can
be implanted using a single set of surgical instruments which makes the system
more cost effective.
During 1995, the Company introduced Optetrak/registered trademark/, a
total primary knee replacement system, which had been in development for three
years. The Optetrak/registered trademark/ knee system was conceived by Exactech
in collaboration with members of its Scientific Advisory Board in cooperation
with the Hospital for Special Surgery, an internationally known hospital for
orthopaedic surgery. The Optetrak/registered trademark/ system represents a
highly differentiated product based on precision manufacturing techniques and a
design which reduces articular contact stress. The Optetrak/registered
trademark/ system is the most modern rendition of a series of knee implants
which were first introduced in 1974 and which are still being marketed by
certain of the Company's competitors.
OpteFORM/trademark/, a newly developed biologic material for grafting
and repairing bone defects, supplied by Regeneration Technologies, Inc., was
introduced in 1998. OpteFORM/trademark/ is expected to become increasingly
important in Exactech's product line as production increases.
During June 1998, the Company began offering the Acudriver/trademark/
Automated Osteotome System, which is an air-driven impact handpiece that aids
surgeons during joint implant revision procedures by providing effective
cleavage of prosthesis/bone or cement/bone interfaces. The Acudriver/trademark/
accomplishes this by providing the surgeon with precise positioning without the
inconvenience and inconsistency of striking the osteotome with a mallet.
To market our 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.
Exactech, its directors, officers, employees, and Scientific Advisory
Board are committed to the continuing process of product design and development
to meet the exacting demands of orthopaedic surgeons and their patients.
22
<PAGE>
The following table sets forth for the periods indicated information
with respect to the number of units of the Company's products sold and the
dollar amount and percentages of revenues derived from such sales (dollars in
thousands):
<TABLE>
<CAPTION>
SALES SUMMARY BY PRODUCT LINE ($'000'S)
YEAR ENDED
----------------------------------------------------------------------------
DECEMBER 31, 1996 DECEMBER 31, 1997
UNITS $ % UNITS $ %
----- - - ----- - -
<S> <C> <C> <C> <C> <C> <C>
Hip Products
Cemented 5,370 2,339 16.9% 5,117 2,288 13.0%
Porous Coated 5,354 1,932 14.0% 4,589 1,735 9.8%
Bipolar Prosthesis 835 459 3.3% 890 417 2.4%
Revision 4 9 0.1% 54 126 0.7%
------------------------------------- -------------------------------------
Total Hip Products 11,563 4,739 34.3% 10,650 4,566 25.9%
KNEE PRODUCTS
Cemented Cruciate Sparing 9,174 4,515 32.6% 12,550 5,652 32.0%
Cemented Posterior Stabilized 3,536 1,969 14.2% 7,045 4,411 25.0%
Porous Coated 1,315 1,775 12.8% 1,428 1,502 8.5%
Revision 2,313 847 4.8%
------------------------------------- -------------------------------------
Total Knee Products 14,025 8,259 59.6% 23,336 12,412 70.3%
Instrument Sales and Rental 773 5.6% 602 3.4%
Tissue Services
Acudriver
Miscellaneous 69 0.5% 68 0.4%
========================= =========================
TOTAL 13,840 100.0% 17,648 100.0%
========================= =========================
<CAPTION>
------------------------------------
DECEMBER 31, 1998
UNITS $ %
----- - -
<S> <C> <C> <C>
Hip Products
Cemented 5,154 2,385 9.9%
Porous Coated 5,239 1,747 7.3%
Bipolar Prosthesis 1,037 475 2.0%
Revision 133 297 1.2%
------------------------------------
Total Hip Products 11,563 4,904 20.4%
KNEE PRODUCTS
Cemented Cruciate Sparing 15,802 6,711 27.9%
Cemented Posterior Stabilized 10,023 6,428 26.8%
Porous Coated 1,642 1,694 7.0%
Revision 4,689 2,451 10.2%
------------------------------------
Total Knee Products 32,156 17,284 71.9%
Instrument Sales and Rental 953 4.0%
Tissue Services 608 2.5%
Acudriver 160 0.7%
Miscellaneous 115 0.5%
=========================
TOTAL 24,024 100.0%
=========================
</TABLE>
SALES AND EARNINGS
Net sales increased by $6,376,296, or 36%, to $24,024,356 in the year
ended December 31, 1998, from $17,648,060 in the year ended December 31, 1997.
Net sales for the year ended December 31, 1997 increased $3,808,084, or 28%,
from $13,839,976 in the year ended December 31, 1996. Domestic sales increased
30%, to $19,017,251 in the year ended December 31, 1998, from $14,596,909 in the
year ended December 31, 1997. During the year ended December 31, 1997, domestic
sales increased 25%, from $11,715,120 in the year ended December 31, 1996.
International sales increased 64%, to $5,007,105 in the year ended December 31,
1998, from $3,051,151 in the year ended December 31, 1997. For the year ended
December 31, 1997, international sales increased 44%, from $2,124,856 in the
year ended December 31, 1996. As a percentage of sales, international sales
increased to 21% for the year ended December 31, 1998 from 17% for the year
ended December 31, 1997 and 15% for the year ended December 31, 1996. The
increase in net sales, in both 1998 and 1997, resulted primarily from increased
unit volume of the Company's knee implant products. Sales of knee implant
products for the year ended December 31, 1998, increased by 38%, on a unit basis
and by 39% on a dollar basis when compared to the year ended December 31, 1997,
which had increased by 66% on a unit basis and by 50% on a dollar basis from the
year ended December 31, 1996. These increases represented a continued expansion
of the Company's sales and marketing distribution network. Sales of hip implant
products for the year ended December 31, 1998 increased by 9% on a unit basis
and by 7% on a dollar basis when compared to the year ended December 31, 1997.
The increase in hip sales is primarily due to increased market acceptance of the
AuRA/registered trademark/ primary and revision cemented hip system. During
1997, hip implant sales had decreased by 8% on a unit basis and by 4% on a
dollar basis from the year ended December 31, 1996. Hip and knee instrument
sales and rentals increased 58% to $952,909 in the year ended December 31, 1998
from $602,082 in the year ended December 31, 1997, compared to a 22% decrease
from $772,554 in the year ended December 31, 1996 as international knee
instrument sales decreased.
Gross profit increased by $3,681,208, or 31%, to $15,433,965 in the
year ended December 31, 1998, from $11,752,758 in the year ended December 31,
1997, as compared to a 28% increase in 1997 of $2,596,657, from $9,156,101 in
the year ended December 31, 1996. As a percentage of sales, gross profit
decreased to 64% in the year ended December 31, 1998 compared to 67% in the year
ended December 31, 1997 and 66% in the year ended
23
<PAGE>
December 31, 1996. The decrease in the year ended December 31, 1998 was
primarily due to the increase in international sales, as a percentage of total
sales, which are at lower margins. The increase in the year ended December 31,
1997, was primarily the result of a reduction in the unit costs of the Company's
knee products as production volumes increased.
Total operating expenses increased by $2,646,570, or 29%, to
$11,842,956 in the year ended December 31, 1998, after an increase of
$2,492,950, or 37%, to $9,196,387 in the year ended December 31, 1997, from
$6,703,437 in the year ended December 31, 1996. Operating expenses decreased as
a percentage of sales for the year ended December 31, 1998, to 49%, from 52% for
the year ended December 31, 1997. Operating expenses increased as a percentage
of sales in the year ended December 31, 1997, to 52% from 48% in the year ended
December 31, 1996. Sales and marketing expenses increased by $1,056,705, or 22%,
to $5,968,611 in the year ended December 31, 1998, from $4,911,906 in the year
ended December 31, 1997, as compared to an increase of 39% from 1996 to 1997. As
a percentage of sales, sales and marketing expenses in 1998 decreased to 25% as
compared to 28% in 1997, which represented an increase from 25% in 1996. The
Company's sales and marketing expenses are largely variable costs based on sales
levels, with the largest component being commissions. During 1998, sales and
marketing expenses decreased, as a percentage of sales, in large part due to the
increased percentage of international sales, with their lower commission
structure.
General and administrative expenses increased by $506,686, or 30%, to
$2,184,564, in the year ended December 31, 1998, from $1,677,878 in the year
ended December 31, 1997, as compared to a 25% increase during 1997 from
$1,346,304 in 1996. For the year ended December 31, 1998, as a percentage of
sales, general and administrative expenses decreased slightly to 9% after
remaining relatively constant at 10% during 1996 and 1997. Total general and
administrative expenses increased on a dollar basis during 1998 as compared to
1997 primarily as a result of additional costs associated with litigation that
was settled during December 1998.
Research and development expenses increased by $333,837, or 36%, to
$1,271,825 in the year ended December 31, 1998, from $937,988 in the year ended
December 31, 1997, as compared to an increase of 25% during 1997 from 1996, as
product development expenses for an integrated primary hip and modular hip
systems increased. As a percentage of sales, research and development expenses
remained relatively constant at 5% in the years ended December 31, 1996, 1997
and 1998.
Depreciation and amortization expenses increased 48% to $1,202,000 in
the year ended December 31, 1998, from $813,200 in the year ended December 31,
1997, and $509,236 in the year ended December 31, 1996. Depreciation and
amortization expenses increased in 1998 primarily due to the completion of the
Company's new facility and the installation of furniture, fixtures, and
equipment associated with the facility. During 1998, $4,199,634 of facility,
furniture, fixtures, equipment, and instruments were placed in service.
Royalty expenses increased by $360,541, or 42%, to $1,215,956 in the
year ended December 31, 1998, from $855,415 in the year ended December 31, 1997
as compared to a 50% increase in 1997 from $571,807 in 1996. The increase in
royalty expenses was primarily the result of growth in sales of knee implant
products which incur a higher royalty rate. During 1998, the Company recognized
royalty expenses of $650,548 as compared to $474,357 in 1997 and $307,801 in
1996 in connection with the license agreement with the Hospital for Special
Surgery and $565,408 compared to $381,058 in 1997 and $187,773 in 1996 in
connection with other consulting and license agreements. As a percentage of
sales, royalty expenses were flat at 5% for the years ended December 31, 1998
and 1997, and 4% in the year ended December 31, 1996.
The Company's income from operations increased by $1,034,638, or 41%,
to $3,591,009 in the year ended December 31, 1998, from $2,556,371 in the year
ended December 31, 1997, which represented an increase of $103,707, or 4%, from
$2,452,664 in the year ended December 31, 1996. For the year ended December 31,
1998, the increase was principally due to an increase in sales combined with a
reduction in operating expenses, as a percentage of sales, partially offset by
an increase in cost of sales.
The Company recognized net interest expense of $70,686 in the year
ended December 31, 1998 as compared to net interest income of $200,720 in the
year ended December 31, 1997. The recognition of expense as compared to income
was the result of a reduction of short-term investments while there was
increased borrowing associated with construction of the new facility. Interest
expense of $233,099 for the year ended December 31,
24
<PAGE>
1998 was partially offset by $162,413 of interest income. Previously, the
COMPANY recognized net interest income of $200,720 in the year ended
December 31, 1997, as compared to $12,336 in the year ended December 31, 1996.
Interest income of $275,112 for the year ended December 31, 1997, was offset by
$74,392 of interest expense as the proceeds of the Company's IPO consummated in
June 1996 were invested in short-term commercial paper and government backed
securities. The outstanding principal balance of the Company's debt averaged
approximately $3,914,156, $510,325 and $1,427,000 during 1998, 1997 and 1996,
respectively. The average outstanding balance increased in 1998 because
approximately $3,900,000 was outstanding on the industrial revenue bond (IRB)
loan for the full year, whereas $3,900,000 was outstanding for only a month and
a half in 1997. The weighted average interest rate on such debt was 4.37%, 4.32%
and 8.56% for 1998, 1997 and 1996, respectively.
In July 1995, the Company purchased a 50% interest in Techmed S.p.A.,
its Italian distributor. Prior to September 1997, the investment in the
subsidiary was accounted for using the equity method with the Company's share of
the subsidiary's net earnings (loss) included as a separate item in the
statement of income. During September 1997, the Company wrote off its investment
in the subsidiary and reserved for trade receivables deemed uncollectible. In
April 1998, the Company sold its interest in Techmed S.p.A.
As a result, the Company recognized $13,778 in gain associated with the sale.
Income before provision for income taxes increased by $960,919, or 37%,
to $3,534,101 in the year ended December 31, 1998, from $2,573,182 in the year
ended December 31, 1997, as compared to an increase in 1997 of $67,668, or 3%,
from $2,505,514 in the year ended December 31, 1996. The provision for income
taxes increased 41% to $1,406,671 in the year ended December 31, 1998, from
$997,188 in the year ended December 31, 1997, and $950,906 in the year ended
December 31, 1996. The Company realized net income of $2,127,430 in the year
ended December 31, 1998, a 35% increase, as compared to $1,575,994 in the year
ended December 31, 1997. Net income for the year ended December 31, 1997
increased 2% from $1,544,454 in the year ended December 31, 1996.
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, 1998, the Company had working capital of $15,867,747 as compared to
$14,402,799 at December 31, 1997, and $15,176,581 at December 31, 1996. As a
result of operating, investing and financing activities, cash and cash
equivalents at December 31, 1998 decreased $46,569 to $662,652. For the year
ended December 31, 1997, cash and cash equivalents decreased to $709,221 from
$3,992,442 at December 31, 1996. The decrease in working capital was primarily
the result of costs associated with completing, furnishing, and equipping the
new facility. During 1998, the Company expended $2,044,045 in costs on the
completion of the new facility. The Company is committed to approximately
$27,000 in remaining construction costs associated with the completion of the
new facility as of December 31, 1998. During July 1998, the Company's line of
credit facility with Merrill Lynch Business Financial Services, Inc. was renewed
and increased to $6,000,000. The credit facility, which is collateralized by
accounts receivable and inventory, expires in June 2000. At December 31, 1998,
there was no amount outstanding under the line of credit. The Company believes
that funds from operations and borrowings under its existing credit facilities
will be sufficient to satisfy its contemplated cash requirements for the
following twelve months.
OPERATING ACTIVITIES
Operating activities provided net cash of $854,614 in the year ended
December 31, 1998 and used net cash of $1,625,239 in the year ended December 31,
1997 as compared to providing net cash of $8,951 in the year ended December 31,
1996. Operating activities provided cash due to the increase in net income,
which increased to $2,127,430 in the year ended December 31, 1998, from
$1,575,994 in the year ended December 31, 1997 and from $1,544,454 in 1996, as
well as a smaller increase in total inventories of $834,682 during 1998 as
compared to $3,072,123 during 1997 and $1,303,401 in 1996. Cash required as a
result of the increase in trade receivables was $1,877,814 during 1998, as
compared to $1,298,132 during 1997 and $660,735 in 1996.
FINANCING ACTIVITIES
For the year ended December 31, 1998, financing activities provided net
cash to the Company of $7,561,
25
<PAGE>
as compared to $3,892,522 in the year ended December 31, 1997 and $9,017,468 in
the year ended December 31, 1996.
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 $3,900,000 credit facility requires the payment by
the Company of principal installments as follows: $300,000 per year from 2000
through 2006; $200,000 per year from 2007 through 2013; and $100,000 per year
from 2014 through 2017. Monthly interest payments are based on an adjustable
rate as determined by the bonds remarketing agent based on market rate
fluctuations (4.1% as of December 31, 1998). The proceeds of the credit facility
were used to finance construction of the new facility. The Company's obligations
to the bank issuing the letter of credit are secured by the land and
improvements comprising the facility.
Net cash provided by financing activities for the year ended December
31, 1997 reflects the proceeds from the $3,900,000 industrial revenue bond
financing with the City. In 1997, the Company also paid $118,935 of debt
issuance costs associated with the industrial revenue bond financing which will
be recognized as expense over the term of the loan. Cash provided by financing
activities for the year ended December 31, 1996 reflects the net proceeds of
$12,657,910 from the Company's IPO consummated in June 1996.
INVESTING ACTIVITIES
The Company invested the remaining proceeds of the industrial revenue
bond financing and the IPO in daily maturing investments as of December 31,
1998. At December 31, 1997, $3,467,072 was invested in commercial paper and
discount notes yielding approximately 5%. During 1998, these investments were
liquidated to provide funds for the construction of the Company's new facility.
As of December 31, 1998, $284,794 was invested in Merrill Lynch's Treasury Fund
and Institutional Fund comprised of commercial paper and government backed
securities yielding a return of approximately 4.5%, as compared to $1,763,996 at
December 31, 1997. During the year ended December 31, 1998, net cash used in
investing activities decreased to $908,744 as compared to $5,550,504 during the
year ended December 31, 1997, which was an increase from $5,235,956 in the year
ended December 31, 1996. The decrease in 1998 was primarily due to the change in
unexpended IRB proceeds that were utilized to purchase property and equipment,
including the Company's new facility, manufacturing equipment, product licenses
and instrumentation.
YEAR 2000
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a 2
digit year is commonly referred to as the Year 2000 Compliance issue. As the
year 2000 approaches, such systems may be unable to accurately process certain
date-based information.
The Company has identified all significant applications that will
require modification to ensure Year 2000 Compliance. Internal and external
resources are being used to make the required modifications and test Year 2000
Compliance. The modification process of all significant applications is
substantially complete. The Company plans on completing the testing process of
all significant applications by June 30, 1999.
In addition, the Company has communicated with suppliers with whom it
does significant business to determine their Year 2000 Compliance readiness and
the extent to which the Company is vulnerable to any third party Year 2000
issues. The Company received acceptable responses from these suppliers as to
their readiness; however, there can be no guarantee that the systems of other
companies on which the Company's systems rely will be timely converted, or that
a failure to convert by another company, or a conversion that is incompatible
with the Company's systems, would not have a material adverse effect on the
Company.
The total cost to the Company of these Year 2000 Compliance activities
has not been and is not anticipated to be material to its financial position or
results of operations in any given year. These costs and the date on which the
Company plans to complete the Year 2000 modification and testing processes are
based on management's best estimates, which were derived utilizing numerous
assumptions of future events including the continued availability
26
<PAGE>
of certain resources, third party modification plans and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ from those plans.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 of Notes to Financial Statements for information concerning
recent accounting pronouncements.
CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis contains various
"forward looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934 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, the adequacy of the Company's year 2000
compliance program, 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 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.
27
<PAGE>
ITEM 7.A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates. For
its cash and cash equivalents, a change in interest rates effects the amount of
interest income that can be earned. For its debt instruments, changes in
interest rates effect the amount of interest expense incurred.
The following table provides information about the Company's financial
instruments that are sensitive to changes in interests rates.
<TABLE>
<CAPTION>
1999 2000 2001 2002 Thereafter Total
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CASH AND CASH EQUIVALENTS
Overnight repurchase account
at variable interest rate $ 1,141,000 1,141,000
Weighted average interest rate 4.6%
Unexpended IRB proceeds
at variable interest rate $ 856,992 856,992
Weighted average interest rate 5.6%
Short-term money funds
at variable interest rate $ 284,794 284,794
Weighted average interest rate 5.3%
LIABILITIES
Line of credit at variable - - - - - -
interest rate
Weighted average interest rate 7.9%
Industrial Revenue Bond at
variable interest rate $ 3,900,000 3,900,000
Weighted average interest rate 4.1%
Long-term capital lease at $ 6,033 6,802 12,835
fixed interest rate
Weighted average interest rate 12.8% 12.8%
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
PAGE
-----
<S> <C>
Independent Auditors' Report 30
Balance Sheets as of December 31, 1997 and 1998 31
Statements of Income for the Years Ended December 31, 1996, 1997 and 1998 32
Statement of Changes in Shareholders' Equity for the Years Ended
December 31, 1996, 1997 and 1998 33
Statements of Cash Flows for the Years Ended 34
December 31, 1996, 1997 and 1998
Notes to Financial Statements for the Years Ended 35
December 31, 1996, 1997 and 1998
</TABLE>
29
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
of Exactech, Inc.
Gainesville, Florida
We have audited the accompanying balance sheets of Exactech, Inc. (the
"Company") as of December 31, 1997 and 1998, and the related statements of
income, changes in shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 1998. These 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 generally accepted auditing
standards. 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 financial statements present fairly, in all material
respects, the financial position of Exactech, Inc. as of December 31, 1997 and
1998, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
February 12, 1999
30
<PAGE>
<TABLE>
<CAPTION>
EXACTECH, INC.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
- ---------------------------------------------------------------------------------------------------------------------
ASSETS 1997 1998
---------------- -----------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 709,221 $ 662,652
Short-term investments 1,335,740 -
Trade receivables (net of allowance of $161,046 and $153,958) 3,760,996 5,638,810
Refundable income taxes 259,778 47,681
Prepaid expenses and other assets, net 103,646 173,625
Inventories 10,697,879 11,532,561
---------------- -----------------
Total current assets 16,867,260 18,055,329
PROPERTY AND EQUIPMENT:
Land 263,301 263,301
Machinery and equipment 1,636,587 2,604,021
Surgical instruments 4,568,489 5,546,524
Furniture and fixtures 123,014 333,134
Facilities 1,371,545 3,415,590
---------------- -----------------
Total property and equipment 7,962,936 12,162,570
Accumulated depreciation (1,984,249) (2,801,971)
---------------- -----------------
Net property and equipment 5,978,687 9,360,599
OTHER ASSETS:
Product licenses and designs, net 106,494 269,394
Deferred financing costs, net 136,436 133,614
Unexpended industrial revenue
bond proceeds 3,467,072 856,992
Advances and deposits 175,752 151,758
Patents and trademarks, net 423,135 410,434
---------------- -----------------
Total other assets 4,308,889 1,822,192
================ =================
TOTAL ASSETS $ 27,154,836 $ 29,238,120
================ =================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,611,775 $ 1,336,146
Current portion of long-term debt and capital lease obligations 4,894 6,033
Commissions payable 473,028 340,248
Royalties payable 258,959 342,941
Other liabilities 115,805 162,214
---------------- -----------------
Total current liabilities 2,464,461 2,187,582
DEFERRED INCOME TAXES 433,948 660,259
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS,
NET OF CURRENT PORTION 3,912,835 3,906,802
---------------- -----------------
Total liabilities 6,811,244 6,754,643
COMMITMENTS AND CONTINGENCIES (Notes 5 and 6)
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value; 15,000,000 shares authorized, 49,047 49,072
4,904,663 and 4,907,163 shares issued and outstanding
Additional paid-in capital 15,002,968 15,015,398
Retained earnings 5,291,577 7,419,007
---------------- -----------------
Total shareholders' equity 20,343,592 22,483,477
---------------- -----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 27,154,836 $ 29,238,120
================ =================
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
31
<PAGE>
<TABLE>
<CAPTION>
EXACTECH, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
- -----------------------------------------------------------------------------------------------------------------------
1996 1997 1998
----------------- ----------------- -----------------
<S> <C> <C> <C>
NET SALES $ 13,839,976 $ 17,648,060 $ 24,024,356
COST OF GOODS SOLD 4,683,875 5,895,302 8,590,391
----------------- ----------------- -----------------
Gross profit 9,156,101 11,752,758 15,433,965
OPERATING EXPENSES:
Sales and marketing 3,525,834 4,911,906 5,968,611
General and administrative 1,346,304 1,677,878 2,184,564
Research and development 750,256 937,988 1,271,825
Depreciation and amortization 509,236 813,200 1,202,000
Royalties 571,807 855,415 1,215,956
----------------- ----------------- -----------------
Total operating expenses 6,703,437 9,196,387 11,842,956
----------------- ----------------- -----------------
INCOME FROM OPERATIONS 2,452,664 2,556,371 3,591,009
OTHER INCOME (EXPENSE):
Interest income (expense) 12,336 200,720 (70,686)
Income from sub-license agreement, net 100,000 - -
Equity in net gain (loss) of subsidiary (59,486) (183,909) 13,778
----------------- ----------------- -----------------
INCOME BEFORE PROVISION FOR
INCOME TAXES 2,505,514 2,573,182 3,534,101
PROVISION FOR INCOME TAXES
Current 837,831 890,115 1,180,360
Deferred 113,075 107,073 226,311
----------------- ----------------- -----------------
950,906 997,188 1,406,671
----------------- ----------------- -----------------
NET INCOME 1,554,608 1,575,994 2,127,430
PREFERRED STOCK DIVIDENDS 10,154 - -
----------------- ----------------- -----------------
NET INCOME AVAILABLE TO
COMMON SHAREHOLDERS $ 1,544,454 $ 1,575,994 $ 2,127,430
================= ================= =================
BASIC EARNINGS
PER COMMON SHARE $ 0.38 $ 0.32 $ 0.43
================= ================= =================
DILUTED EARNINGS
PER COMMON SHARE $ 0.37 $ 0.32 $ 0.43
================= ================= =================
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
32
<PAGE>
<TABLE>
<CAPTION>
EXACTECH, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
- ------------------------------------------------------------------------------------------------------------------------------------
ADDITIONAL TOTAL
COMMON STOCK PAID-IN RETAINED SHAREHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS EQUITY
----- ----- ------- -------- ------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1995 2,953,903 $ 29,539 $ 1,676,383 $ 2,171,129 $ 3,877,051
Issuance of common stock 1,840,000 18,400 12,639,510 12,657,910
Issuance of common stock on
conversion of subordinated debt 38,874 388 279,612 280,000
Issuance of common stock on
conversion of preferred stock 26,907 269 214,991 215,260
Dividends on preferred stock (10,154) (10,154)
Exercise of stock options 750 8 4,992 5,000
Exercise of warrants 100 100
Net income 1,554,608 1,554,608
------------- ------------ --------------- --------------- --------------
Balance, December 31, 1996 4,860,434 48,604 14,815,588 3,715,583 18,579,775
Exercise of stock options 44,229 443 146,340 146,783
Tax benefit from exercise
of stock options 41,040 41,040
Net income 1,575,994 1,575,994
------------- ------------ --------------- --------------- --------------
Balance, December 31, 1997 4,904,663 49,047 15,002,968 5,291,577 20,343,592
Exercise of stock options 2,500 25 8,187 8,212
Tax benefit from exercise
of stock options 4,243 4,243
Net income 2,127,430 2,127,430
------------- ------------ --------------- --------------- --------------
Balance, December 31, 1998 4,907,163 $ 49,072 $ 15,015,398 $ 7,419,007 $ 22,483,477
============= ============ =============== =============== ==============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
33
<PAGE>
<TABLE>
<CAPTION>
EXACTECH, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
- ----------------------------------------------------------------------------------------------------------------------------------
1996 1997 1998
---------------- ---------------- ---------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 1,554,608 $ 1,575,994 $ 2,127,430
Adjustments to reconcile net income to net
cash provided by (used in) operating activities :
Depreciation and amortization 509,236 813,200 1,202,000
Loss on disposal of equipment 50,530 120,453
Equity in net loss of subsidiary 59,486 183,909
Deferred income taxes 113,075 107,073 226,311
Increase in trade receivables (660,735) (1,298,132) (1,877,814)
Increase in inventories (1,303,401) (3,072,123) (834,682)
Increase in prepaids and other assets (74,483) (79,152) (43,163)
(Decrease) increase in income taxes payable (235,005) (300,764) 212,097
(Decrease) increase in accounts payable (9,277) 181,454 (275,629)
Increase (decrease) in other liabilities 55,447 212,772 (2,389)
---------------- ---------------- ---------------
Net cash provided by (used in) operating activities 8,951 (1,625,239) 854,614
---------------- ---------------- ---------------
INVESTING ACTIVITIES:
Purchase of product licenses and designs (106,494) (200,000)
Purchases of property and equipment (1,742,768) (3,572,840) (4,624,252)
Change in unexpended industrial revenue bond proceeds (3,467,072) 2,610,080
Maturities of short-term investments 3,083,788 1,335,740
Purchases of short-term investments (3,083,788) (1,335,740)
Investment in subsidiary (92,137) (83,271)
Cost of patents and trademarks (317,263) (68,875) (30,312)
---------------- ---------------- ---------------
Net cash used in investing activities (5,235,956) (5,550,504) (908,744)
---------------- ---------------- ---------------
FINANCING ACTIVITIES:
Net repayments under line of credit (1,844,266)
Proceeds from issuance of debt 284,763 3,900,000
Principal payments on debt (1,521,980) (27,466)
Repayments of subordinated debentures (480,000)
Principal payments on capital lease obligations (7,945) (5,810) (4,894)
Proceeds from issuance of common stock 14,725,100 144,733 12,455
Payment of offering costs (2,052,090)
Payment of debt issuance costs (118,935)
Preferred dividends paid (10,154)
Repayments of preferred stock (75,960)
---------------- ---------------- ---------------
Net cash provided by financing activities 9,017,468 3,892,522 7,561
---------------- ---------------- ---------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,790,463 (3,283,221) (46,569)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 201,979 3,992,442 709,221
---------------- ---------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,992,442 $ 709,221 $ 662,252
================ ================ ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 238,901 $ 75,114 $ 249,294
Income taxes 779,310 1,190,879 968,264
Noncash investing and financing activities:
Relief of compensation accrual on issuance of stock 43,090 2,461
Conversion of subordinated debt to common stock 280,000
Conversion of preferred stock to common stock 215,260
Financing of insurance premiums 296,106
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
34
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
- --------------------------------------------------------------------------------
1. ORGANIZATION
Exactech, Inc. (the "Company") was organized in 1985 to develop and
market orthopaedic implant devices. In 1988, the Company began
marketing its first product, a total hip replacement system. In 1994,
the Company began marketing a knee system. The Company's principal
market is the United States; however, international markets represent
approximately twenty-one percent of the Company's business.
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. The Company performs
credit evaluations on its customers and generally does not require
collateral.
SHORT TERM INVESTMENTS - The Company invests its excess funds in
various high-quality and low-risk investment securities. Debt
securities for which the Company has the positive intent and ability to
hold to maturity are classified as held to maturity and reported at
amortized cost. Securities are classified as trading securities if
bought and held principally for the purpose of selling them in the near
future. Securities not classified as held to maturity or trading are
classified as available for sale, and reported at fair value with
unrealized gains and losses excluded from earnings and reported net of
tax as a separate component of shareholders' equity until realized. The
fair values of the investments are estimated based on quoted market
prices. Short-term investments held at December 31, 1997, were
classified as held to maturity, and consisted of short-term, government
backed securities. The amortized cost of such short-term investments
approximates fair value. No such short-term investments were held at
December 31, 1998.
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 recognizes an inventory
reserve based on obsolescence and slow-moving inventory.
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. 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.
35
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (CONTINUED)
- --------------------------------------------------------------------------------
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. Distributors typically
purchase product inventory and instruments from the Company for their
use in marketing and filling customer orders. Sales to such
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.
INVESTMENT IN SUBSIDIARY - In July 1995, the Company purchased a 50%
interest in Techmed, its Italian distributor. Prior to September of
1997, the investment in the subsidiary was accounted for using the
equity method with the Company's share of the subsidiary's net earnings
(loss) included as a separate item in the statement of income. During
September 1997, the Company wrote off its investment in the subsidiary.
During 1998, a gain of $13,778 was recognized on the final disposition
of this investment.
DEFERRED FINANCING COSTS - Deferred financing costs are stated net of
accumulated amortization of $29,217. 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.
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 basis of assets and liabilities using
presently enacted tax rates.
ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles 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 11). 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.
RECLASSIFICATIONS - Certain items in the prior year financial
statements have been reclassified to conform to the 1998
presentation.
36
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (CONTINUED)
- --------------------------------------------------------------------------------
NEW ACCOUNTING STANDARDS - In June 1997, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income" ("SFAS No.
130"), effective for fiscal years beginning after December 15, 1997.
SFAS No. 130 requires that all items that are required to be recognized
under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same
prominence as other financial statements. The Company adopted this
accounting standard on January 1, 1998, as required.
Adoption of SFAS No. 130 did not have a material effect on the
Company's disclosures.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131") effective
for fiscal years beginning after December 15, 1997. SFAS No. 131
establishes standards for reporting information about operating
segments in annual financial statements and requires selected
information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers. Statement of comparative information for earlier periods
presented is required in the initial year of application. Interim
information is not required until the second year of application, at
which time comparative information is required. The Company adopted
this accounting standard on January 1, 1998, as required (Note 7).
37
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (CONTINUED)
- --------------------------------------------------------------------------------
3. INCOME TAXES
<TABLE>
<CAPTION>
The provision for income taxes consists of the following:
Current: 1996 1997 1998
------------------ ----------------- --------------------
<S> <C> <C> <C>
Federal $694,796 $685,146 $949,334
State 143,035 204,969 231,026
------------------ ----------------- --------------------
Total Current 837,831 890,115 1,180,360
Deferred:
Federal 98,579 87,723 178,248
State 14,496 19,350 48,063
------------------ ----------------- --------------------
Total Deferred 113,075 107,073 226,311
------------------ ----------------- --------------------
Total Provision $950,906 $997,188 $1,406,671
================== ================= ====================
</TABLE>
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, 1996, 1997 and 1998 follows:
<TABLE>
<CAPTION>
1996 1997 1998
------------------ ----------------- --------------------
<S> <C> <C> <C>
Statutory Federal rate 34.0% 34.0% 34.0%
State income taxes (net of Federal
income tax benefit) 4.0% 5.0% 5.0%
Other 0.8%
================== ================= ====================
38.0% 39.0% 39.8%
================== ================= ====================
</TABLE>
The types of temporary differences and their related tax effects that
give rise to deferred tax assets and liabilities at December 31, 1997
and 1998 are as follows:
<TABLE>
<CAPTION>
1997 1998
------------------ -----------------
<S> <C> <C>
Deferred tax liabilities:
Basis difference in property and equipment $565,679 $847,287
Basis difference in patents 68,203 39,171
Other 7,523
------------------------------------------------------------------------------------------------------------------
Gross deferred tax liabilities 641,405 886,458
------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Capital loss carryover 114,668 114,668
Accrued liabilities not currently deductible 92,789 111,531
------------------ -----------------
Gross deferred tax assets 207,457 226,199
------------------ -----------------
Net deferred tax liabilities $433,948 $660,259
================= =================
</TABLE>
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. The capital loss carryover will expire in 2003.
38
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998(CONTINUED)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
4. DEBT
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS:
1997 1998
-------------------- ---------------------
<S> <C> <C>
Capitalized lease obligation payable in monthly installments $ 17,729 $ 12,835
of $611 through July, 2000, collateralized by equipment with
a carrying value of approximately $14,550 as of
December 31, 1998
Industrial Revenue Bond note payable in annual 3,900,000 3,900,000
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 (4.1% as of
December 31, 1998); proceeds used to finance construction
of new facility
-------------------- ---------------------
Total long-term debt and capital lease obligations $3,917,729 $3,912,835
Less current portion (4,894) (6,033)
-------------------- ---------------------
$3,912,835 $3,906,802
==================== =====================
</TABLE>
The following is a schedule of debt maturities and future minimum lease payments
under the capital leases, together with the present value of minimum lease
payments as of December 31, 1998:
<TABLE>
<CAPTION>
Long-Term Capital Lease
Debt Obligations
-------------------- ---------------------
<S> <C> <C>
1999 ......................................................................... $ 7,333
2000 ......................................................................... $300,000 7,188
2001 ......................................................................... 300,000
2002 ......................................................................... 300,000
Thereafter...................................................................... 3,000,000
-------------------- ---------------------
Total.................................................................. $3,900,000 14,521
====================
Less interest on capital lease obligations...................................... (1,686)
---------------------
$ 12,835
=====================
</TABLE>
39
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (CONTINUED)
- --------------------------------------------------------------------------------
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. Due to the variable
nature of the note, the balance of the note payable approximates fair
value.
At December 31, 1998, the unexpended portion of the IRB proceeds,
$856,992 remained invested in short-term investments and cash
equivalents.
LINE OF CREDIT
During July 1998, the Company renewed and increased a $6,000,000 line
of credit with Merrill Lynch Business Financial Services, Inc. There
are no amounts outstanding under this line of credit at December 31,
1998.
5. RELATED PARTY TRANSACTIONS
The Company has entered into a purchase agreement with Brighton
Partners, Inc. to purchase raw materials used in the ongoing production
of its products. The agreement requires the purchase of tooling dies in
the amount of $159,000 and provides for special purchasing terms for
the Company. Some of the Company's officers and directors maintain
ownership in Brighton Partners Inc. During 1998, purchases associated
with this agreement totaled $116,058.
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
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, 1996, 1997 and 1998,
the Company paid royalties aggregating $187,773, $288,759 and $436,242,
respectively, pursuant to these consulting agreements.
6. COMMITMENTS AND CONTINGENCIES
The Company is committed to approximately $27,000 in remaining
construction costs associated with the completion of the new facility
as of December 31, 1998.
The Company, in the normal course of business, is subject to claims and
litigation in the areas of product and general liability. Management
does not believe any of such claims will have a material impact on the
Company's financial position.
40
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (CONTINUED)
- --------------------------------------------------------------------------------
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) are $10,444, $11,932, and $12,557 for the years ended December
31, 1996, 1997, and 1998, 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.
Summarized financial information concerning the Company's reportable
segments is shown in the following table.
<TABLE>
<CAPTION>
(in thousands)
----------------------------------------------------------------
Tissue
Year ended December 31 Knee Hip Services Other Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1996
Net Sales $ 8,259 $ 4,739 $ 842 $ 13,840
Segment profit (loss) from operations 870 1,093 489 2,452
Total assets, net 6,196 4,427 40 10,663
Capital expenditures 2,625 151 11 2,787
Depreciation and amortization 270 230 8 509
1997
Net Sales $ 12,412 $ 4,566 $ $ 670 $ 17,648
Segment profit (loss) from operations 1,274 924 (5) 364 2,556
Total assets, net 9,104 5,893 174 52 15,223
Capital expenditures 3,341 2,177 74 24 5,616
Depreciation and amortization 481 318 5 9 813
1998
Net Sales $ 17,284 $ 4,904 $ 608 $ 1,228 $ 24,024
Segment profit (loss) from operations 2,089 766 125 611 3,591
Total assets, net 10,755 5,427 149 350 16,681
Capital expenditures 2,251 347 106 306 3,010
Depreciation and amortization 746 376 32 48 1,202
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
41
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (CONTINUED)
- --------------------------------------------------------------------------------
MAJOR CUSTOMER AND FOREIGN OPERATIONS
During the years ended December 31, 1996, 1997, and 1998, approximately
7%, 6% and 7% respectively, of the Company's sales were derived from a
major customer. During the years ended December 31, 1996, 1997, and
1998, approximately 13%, 13% and 14%, respectively, of the Company's
sales were derived from an international distributor of its products.
Revenue and gross profits for the Company's foreign operations for the
three years ended December 31, 1998 were as follows:
1996 1997 1998
---- ---- ----
Revenues $2,124,856 $3,051,151 $5,007,105
Gross profit $597,944 $1,127,455 $1,871,577
8. PENSION PLAN
The Company currently sponsors a defined contribution 401(k) plan for
its employees. The Company provides matching contributions of 25% on
the first 3% of salary deferral by employees. The Company's total
contribution to this plan during 1998 was $12,896.
9. LICENSE AND SUBLICENSE AGREEMENTS
During October 1996, the Company licensed patent technology for
development of a modular hip system. The patent license fees total
$360,000 with $275,000 being paid at time of agreement and an
additional $85,000 being payable at time of FDA clearance to market the
products.
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 is payable at such time as the
licensor produces a developed product. The cost of the license
agreement will be amortized over the period of its estimated economic
benefit.
10. ASSET PURCHASES
During June 1998, the Company purchased substantially all of the assets
related to Synvasive Technology, Inc.'s ("Synvasive")
AcuDriver/trademark/ product line for $375,000. The assets included
inventory, tooling, fixtures, designs, trademark and future patent
rights.
11. COMMON STOCKHOLDERS' EQUITY
COMMON STOCK:
In June 1996, the Company completed an underwritten initial public
offering ("IPO") of 1,840,000 shares of its common stock at an initial
offering price of $8.00 per share, yielding gross proceeds of
$14,720,000. Net proceeds to the Company as a result of the IPO were
$12,657,910 after deduction of underwriting, legal, accounting and
other offering related expenses in the aggregate of $2,062,090. Upon
consummation of the IPO, $50,000 of 10% debentures were converted to
6,250 shares of common stock.
42
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (CONTINUED)
- --------------------------------------------------------------------------------
EARNINGS PER SHARE:
The following is a reconciliation of the numerators and denominators of the
basic and diluted EPS computations for net income and net income available to
common shareholders:
<TABLE>
<CAPTION>
1996 1997
INCOME SHARES INCOME SHARES
(NUMER- (DENOM- PER (NUMER- (DENOM- PER
ATOR) INATOR) SHARE ATOR) INATOR) SHARE
--------------------------------------------- -----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net income $1,554,608 $1,575,994
Less: Preferred Stock (10,154) -
dividends ------------------ -----------------
BASIC EPS:
Net income available to
common shareholders $1,544,454 4,050,887 $0.38 $1,575,994 4,878,795 $0.32
=========== ===========
Effect of dilutive
securities:
Stock options 81,054 40,637
Warrants 6,305 4,319
DILUTED EPS:
Net income available to
common shareholders
plus assumed conversions $1,544,454 4,138,246 $0.37 $1,575,994 4,923,751 $0.32
=========== ===========
<CAPTION>
1998
INCOME SHARES
(NUMER- (DENOM- PER
ATOR) INATOR) SHARE
-----------------------------------------------
<S> <C> <C> <C>
Net income $2,127,430
Less: Preferred Stock -
dividends -------------
BASIC EPS:
Net income available to
common shareholders $2,127,430 4,905,656 $0.43
============
Effect of dilutive
securities:
Stock options 42,634
Warrants 5,206
DILUTED EPS:
Net income available to
common shareholders
plus assumed conversions $2,127,430 4,953,496 $0.43
===========
</TABLE>
For the year ended December 31, 1996, options to purchase 336,200 shares of
common stock at prices ranging from $8.00 to $8.80 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.
For the year ended December 31, 1997, options to purchase 348,900 shares of
common stock at prices ranging from $7.50 to $9.00 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.
For the year ended December 31, 1998, options to purchase 376,700 shares of
common stock at prices ranging from $7.50 to $9.00 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.
43
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998(CONTINUED)
- --------------------------------------------------------------------------------
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 Director's 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 600,000 shares.
If compensation cost for stock option grants had been determined based
on the fair value at the grant dates for 1996, 1997 and 1998 consistent
with the method prescribed by SFAS No. 123, the Company's net earnings
and earnings per share on a diluted basis would have been adjusted to
the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1996 1997 1998
------------------ ------------------ ------------------
<S> <C> <C> <C>
Net earnings As reported $ 1,544,454 $ 1,575,994 $ 2,127,430
Pro forma 1,260,323 1,164,702 1,700,406
Earnings per share As reported $ 0.37 $ 0.32 $ 0.43
Pro forma 0.30 0.24 0.34
</TABLE>
Outstanding options, consisting of ten-year non-qualified stock
options, vest and become exercisable over a five year period from 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 1996, 1997
and 1998, respectively: dividend yield of 0, 0 and 0 percent, expected
volatility of 43, 70 and 41 percent, risk-free interest rates of 6.8,
6.0 and 5.1 percent, and expected lives of 5, 5 and 5 years.
44
<PAGE>
EXACTECH, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998(CONTINUED)
- --------------------------------------------------------------------------------
A summary of the status of fixed stock option grants under the
Company's stock-based compensation plans as of December 31, 1996, 1997
and 1998, and changes during the years ending on those dates is
presented below:
<TABLE>
<CAPTION>
1996 1997
---------------------------------- ----------------------------------
Weighted Avg Weighted Avg
Options Exercise Price Options Exercise Price
---------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Outstanding - January 1 225,386 $ 4.77 560,199 $ 6.81
Granted 341,200 8.14 28,000 7.96
Exercised (750) 6.66 (44,229) 2.34
Expired (5,637) 6.21 (20,250) 7.67
============= =============
Outstanding - December 31 560,199 6.81 523,720 7.21
============= =============
Options exercisable 172,907 $ 4.65 231,849 $ 6.30
at year end
Weighted average fair value of $ 1,709,468 $ 101,518
options granted during the year
<CAPTION>
1998
-------------------------------
Weighted Avg
Options Exercise Price
-------------------------------
<S> <C> <C>
Outstanding - January 1 523,720 $ 7.21
Granted 48,075 7.60
Exercised (2,500) 2.30
Expired (11,350) 7.08
==========
Outstanding - December 31 557,945 7.27
==========
Options exercisable 318,601 $ 6.75
at year end
Weighted average fair value of $ 156,900
options granted during the year
</TABLE>
The following table summarizes information about fixed stock options
outstanding at December 31, 1998:
Exercise Options Options Weighted Average
Price Range Outstanding Exercisable Remaining Life
----------------- -------------- ------------- ----------------
$ 2.30 - 6.67 167,245 139,481 5.38
7.13 - 8.00 289,700 136,120 7.82
8.06 - 9.00 101,000 43,000 7.53
=============== ============= ===========
Total 557,945 318,601 7.04
=============== ============= ===========
Remaining non-exercisable options as of December 31, 1998 become
exercisable as follows:
1999 87,322
2000 87,022
2001 49,290
2002 8,930
2003 6,780
==================
239,344
==================
45
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable
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 1999 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.
46
<PAGE>
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:
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<S> <C>
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)
</TABLE>
47
<PAGE>
<TABLE>
<S> <C>
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. 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)
</TABLE>
48
<PAGE>
<TABLE>
<S> <C>
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)
11.1 Computation of Earnings Per Share
21.1 Subsidiary of the Registrant(1)
27.1 Financial Data Schedule
</TABLE>
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 10-K 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.
(d) Financial Statement Schedules:
Schedule II-Valuation and Qualifying Accounts
49
<PAGE>
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 5, 1999 EXACTECH, INC.
By: /S/ WILLIAM PETTY
--------------------------
William Petty
Chairman of the Board 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.
<TABLE>
<S> <C>
March 5, 1999 By: /S/ WILLIAM PETTY
-----------------------------------------
William Petty
Chairman of the Board and
Chief Executive Officer
(principal executive officer)
March 5, 1999 By: /S/ TIMOTHY J. SEESE
-----------------------------------------
Timothy J. Seese
President and Chief
Operating Officer
March 5, 1999 By: /S/ GARY J. MILLER
-----------------------------------------
Gary J. Miller
Vice President and Director
March 5, 1999 By: /S/ JOEL C. PHILLIPS
-----------------------------------------
Joel C. Phillips
Chief Financial Officer
March 5, 1999 By: /S/ ALBERT H. BURSTEIN
-----------------------------------------
Albert H. Burstein
Director
March 5, 1999 By: /S/ R. WYNN KEARNEY, JR.
-----------------------------------------
R. Wynn Kearney, Jr.
Director
March 5, 1999 By: /S/ E. RONALD PICKARD
-----------------------------------------
E. Ronald Pickard
Director
March 5, 1999 By: /S/ PAUL E. METTS
-----------------------------------------
Paul E. Metts
Director
</TABLE>
50
<PAGE>
EXACTECH, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
Balance at Charged to
Beginning Costs and Deductions Balance at
of Year Expenses (Chargeoffs) End of Year
--------------- ---------------- ------------------ ------------------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts
1996 13,500 23,664 37,164
1997 37,164 123,882 161,046
1998 161,046 (7,088) 153,958
</TABLE>
51
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
11.1 Computation of Earnings Per Share
27.1 Financial Data Schedule
EXHIBIT 11.1
EARNINGS PER SHARE COMPUTATIONS
The table below details the number of common shares and common stock equivalents
used in the computation of primary and fully diluted earnings per share
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Basic:
Weighted average common shares outstanding
used in computing basic earnings per share 4,050,887 4,878,795 4,905,656
===========================================
Basic Earnings Per Share $0.32 $0.43
=============================
Diluted:
Weighted average common and common equivalent 4,050,887 4,878,795 4,905,656
shares outstanding
Effect of shares issuable under stock under stock plans 81,054 40,637 42,634
using the treasury method
Effect of shares contingently issuable under warrants 6,305 4,319 5,206
issued with the 8% subordinated debentures using
the treasury stock method
===========================================
Shares used in computing diluted earnings per share 4,138,246 4,923,751 4,953,496
===========================================
Diluted Earnings Per Share $0.32 $0.43
=============================
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 662,652
<SECURITIES> 0
<RECEIVABLES> 5,792,768
<ALLOWANCES> (153,958)
<INVENTORY> 11,532,561
<CURRENT-ASSETS> 18,055,329
<PP&E> 12,162,569
<DEPRECIATION> (2,801,971)
<TOTAL-ASSETS> 29,238,120
<CURRENT-LIABILITIES> 2,187,582
<BONDS> 0
0
0
<COMMON> 49,072
<OTHER-SE> 22,434,405
<TOTAL-LIABILITY-AND-EQUITY> 29,238,120
<SALES> 24,024,356
<TOTAL-REVENUES> 24,024,356
<CGS> 8,590,391
<TOTAL-COSTS> 8,590,391
<OTHER-EXPENSES> 11,842,956
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 70,686
<INCOME-PRETAX> 3,534,101
<INCOME-TAX> 1,406,671
<INCOME-CONTINUING> 2,127,430
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,127,430
<EPS-PRIMARY> 0.43
<EPS-DILUTED> 0.43
</TABLE>
