EXACTECH INC - FORM 10-Q - November 5, 2014

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EX-31.2 - EXHIBIT - EXACTECH INCexac20140930exhibit312.htm
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EX-32.2 - EXHIBIT - EXACTECH INCexac20140930exhibit322.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________ 
FORM 10-Q
 _________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 
For the quarterly period ended September 30, 2014
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
Commission File Number 0-28240
 _________________________________
EXACTECH, INC.
(Exact name of registrant as specified in its charter)
_________________________________
FLORIDA
59-2603930
(State or other jurisdiction of
(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)
_________________________________
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x   No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
o
Accelerated Filer
x
Non-Accelerated Filer
o
Smaller Reporting Company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o   No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at October 31, 2014
Common Stock, $.01 par value
 
13,808,170


EXACTECH, INC.
INDEX
 
 
Page
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Item 1. Financial Statements
EXACTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
 
(unaudited)
 
(audited)
 
September 30,
 
December 31,
 
2014
 
2013
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
9,086

 
$
6,011

Accounts receivable, net of allowances of $821 and $993
46,882

 
59,109

Prepaid expenses and other assets, net
3,711

 
2,865

Income taxes receivable
550

 
1,331

Inventories – current
74,171

 
71,590

Deferred tax assets – current
1,521

 
1,653

Total current assets
135,921

 
142,559

PROPERTY AND EQUIPMENT:
 
 
 
Land
2,208

 
2,215

Machinery and equipment
34,321

 
35,439

Surgical instruments
100,946

 
95,902

Furniture and fixtures
4,547

 
4,200

Facilities
19,251

 
19,187

Projects in process
1,133

 
852

Total property and equipment
162,406

 
157,795

Accumulated depreciation
(82,350
)
 
(76,127
)
Net property and equipment
80,056

 
81,668

OTHER ASSETS:
 
 
 
Deferred financing and deposits, net
835

 
870

Non-current inventories
17,089

 
11,100

Product licenses and designs, net
8,664

 
9,457

Patents and trademarks, net
1,777

 
2,005

Customer relationships, net
317

 
669

Goodwill
13,224

 
13,514

Total other assets
41,906

 
37,615

TOTAL ASSETS
$
257,883

 
$
261,842

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
15,631

 
$
16,254

Income taxes payable
—

 
39

Accrued expenses and other liabilities
8,693

 
10,974

Other current liabilities
250

 
250

Current portion of long-term debt
3,000

 
3,000

Total current liabilities
27,574

 
30,517

LONG-TERM LIABILITIES:
 
 
 
Deferred tax liabilities
2,890

 
4,200

Line of credit
—

 
10,732

Long-term debt, net of current portion
21,000

 
23,250

Other long-term liabilities
432

 
719

Total long-term liabilities
24,322

 
38,901

Total liabilities
51,896

 
69,418

SHAREHOLDERS’ EQUITY:
 
 
 
Common stock
138

 
136

Additional paid-in capital
74,315

 
69,175

Accumulated other comprehensive loss
(6,850
)
 
(3,902
)
Retained earnings
138,384

 
127,015

Total shareholders’ equity
205,987

 
192,424

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
257,883

 
$
261,842

See notes to condensed consolidated financial statements

2

EXACTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(Unaudited)
 
Three Month Periods Ended September 30,
 
Nine Month Periods Ended September 30,
 
2014
 
2013
 
2014
 
2013
NET SALES
$
57,884

 
$
55,650

 
$
185,061

 
$
175,510

COST OF GOODS SOLD
16,929

 
16,126

 
55,128

 
53,791

Gross profit
40,955

 
39,524

 
129,933

 
121,719

OPERATING EXPENSES:
 
 
 
 
 
 
 
Sales and marketing
21,304

 
20,274

 
67,902

 
63,281

General and administrative
5,380

 
5,384

 
16,832

 
15,801

Research and development
4,464

 
5,068

 
13,521

 
13,523

Depreciation and amortization
4,289

 
3,963

 
12,735

 
11,992

Total operating expenses
35,437

 
34,689

 
110,990

 
104,597

INCOME FROM OPERATIONS
5,518

 
4,835

 
18,943

 
17,122

OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Interest income
5

 
2

 
13

 
5

Other income
3

 
18

 
53

 
69

Interest expense
(253
)
 
(281
)
 
(860
)
 
(852
)
Foreign currency (loss) gain, net
(652
)
 
271

 
(452
)
 
(312
)
Total other income (expense)
(897
)
 
10

 
(1,246
)
 
(1,090
)
INCOME BEFORE INCOME TAXES
4,621

 
4,845

 
17,697

 
16,032

PROVISION FOR INCOME TAXES
1,610

 
1,653

 
6,328

 
5,255

NET INCOME
$
3,011

 
$
3,192

 
$
11,369

 
$
10,777

BASIC EARNINGS PER SHARE
$
0.22

 
$
0.24

 
$
0.83

 
$
0.80

DILUTED EARNINGS PER SHARE
$
0.21

 
$
0.23

 
$
0.81

 
$
0.79

See notes to condensed consolidated financial statements




3

EXACTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)
 
Three Month Periods Ended September 30,
 
Nine Month Periods Ended September 30,
 
2014
 
2013
 
2014
 
2013
Net Income
$
3,011

 
$
3,192

 
$
11,369

 
$
10,777

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in fair value of cash flow hedge
81

 
(79
)
 
131

 
93

Change in currency translation
(2,546
)
 
1,486

 
(3,079
)
 
156

Other comprehensive income (loss), net of tax
(2,465
)
 
1,407

 
(2,948
)
 
249

Comprehensive income
$
546

 
$
4,599

 
$
8,421

 
$
11,026

See notes to condensed consolidated financial statements

4

EXACTECH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
Nine Month Periods Ended September 30,
 
2014
 
2013
OPERATING ACTIVITIES:
 
 
 
Net income
$
11,369

 
$
10,777

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Provision for allowance for doubtful accounts and sales returns
172

 
219

Inventory allowance
348

 
2,272

Depreciation and amortization
13,898

 
13,060

Restricted common stock issued for services
205

 
259

Compensation cost of stock awards
1,184

 
1,236

Loss on disposal of equipment
1,611

 
487

Loss on disposal of intangible assets
13

 
23

Foreign currency option gain
(107
)
 
—

Foreign currency exchange loss
559

 
312

Deferred income taxes
(1,289
)
 
(559
)
Changes in assets and liabilities which provided (used) cash:
 
 
 
Accounts receivable
10,905

 
(8,310
)
Prepaids and other assets
(923
)
 
—

Inventories
(9,794
)
 
(9,250
)
Accounts payable
(259
)
 
(211
)
Income taxes receivable/payable
733

 
(2,818
)
Accrued expense & other liabilities
(2,347
)
 
(414
)
Net cash provided by operating activities
26,278

 
7,083

INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment
(13,507
)
 
(12,307
)
Proceeds from sale of property and equipment
3

 
1

Purchase of intangible assets
(138
)
 
(413
)
Net cash used in investing activities
(13,642
)
 
(12,719
)
FINANCING ACTIVITIES:
 
 
 
Net (repayments) borrowings on line of credit
(10,732
)
 
6,189

Principal payments on debt
(2,250
)
 
(1,875
)
Payments on capital leases
(60
)
 
(61
)
Debt issuance costs
(15
)
 
(15
)
Proceeds from issuance of common stock
3,766

 
2,452

Net cash (used in) provided by financing activities
(9,291
)
 
6,690

Effect of foreign currency translation on cash and cash equivalents
(270
)
 
(113
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
3,075

 
941

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
6,011

 
5,838

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
9,086

 
$
6,779

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
846

 
$
756

Income taxes
6,872

 
8,270

Non-cash investing and financing activities:
 
 
 
Cash flow hedge gain, net of tax
131

 
93

Capitalized lease additions
—

 
6

Purchase of equipment payable
—

 
217

See notes to condensed consolidated financial statements

5

EXACTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2014 AND 2013
(Unaudited)
1.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Exactech, Inc. and its subsidiaries (the “Company” or “Exactech”), which are for interim periods, have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission relating to interim financial statements. These unaudited condensed consolidated financial statements do not include all disclosures provided in the annual financial statements. The condensed financial statements should be read in conjunction with the financial statements and notes contained in Exactech's Annual Report on Form 10-K for the year ended December 31, 2013 as filed with the Securities and Exchange Commission.
In the opinion of management, all adjustments considered necessary for a fair presentation have been included, consisting of normal recurring adjustments. Our subsidiaries, Exactech Asia, Exactech UK, Exactech Japan, Exactech France, Exactech Taiwan, Exactech Deutschland, Exactech Ibérica, Exactech International Operations, and Exactech U.S., are consolidated for financial reporting purposes, and all intercompany balances and transactions have been eliminated. Results of operations for the three and nine month periods ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year.
Certain amounts reported for prior periods have been reclassified to be consistent with the current period presentation.
2.
NEW ACCOUNTING PRONOUNCEMENTS AND STANDARDS
In May 2014, the Financial Accounting Standards Board, or FASB, issued new revenue recognition guidance that supersedes the existing revenue recognition guidance and most industry-specific guidance applicable to revenue recognition. The new guidance is based on the principle that revenue is recognized upon the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance will also result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively, and clarify guidance for multiple-element arrangements. The guidance is effective for annual and interim periods beginning after December 15, 2016, including interim periods within that reporting period and early application is not permitted. We are currently assessing the impact of adopting this guidance on our financial statements.
In April 2014, the FASB issued new guidance related to the definition and criteria of a discontinued operation and modifying the related disclosure requirements for both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. The guidance applies prospectively to new disposals and new classifications of assets as held for sale after the effective date and is effective for annual and interim periods beginning after December 15, 2014, with early adoption permitted. We do not expect adoption of this standard will have a material impact on our financial statements.
3.
FAIR VALUE MEASURES
Our financial instruments include cash and cash equivalents, trade receivables, debt, and cash flow hedges. The carrying amounts of cash and cash equivalents, and trade receivables approximate fair value due to their short maturities. The carrying amount of debt approximates fair value due to the variable rate associated with the debt. The fair value of cash flow hedges are based on dealer quotes.
Certain financial assets and liabilities are accounted for at fair value, which is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy prioritizes the inputs used to measure fair value:
Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies.

6

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value from the perspective of a market participant.
The table below provides information on our liabilities that are measured at fair value on a recurring basis:
 
 
 
 
 
 
 
 
(In Thousands)
Total Fair Value at September 30, 2014
 
Quoted Prices in Active Markets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Interest rate swap
$
259

 
$
—

 
$
259

 
$
—

 
 
 
 
 
 
 
 
The fair value of our interest rate swap agreement is based on dealer quotes, and is recorded as accumulated other comprehensive loss and other long-term liabilities in the condensed consolidated balance sheets. We analyze the effectiveness of our interest rate swap on a quarterly basis, and, for the period ended September 30, 2014, we have determined that the interest rate swap was effective.
4.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill – The following table provides the changes to the carrying value of goodwill for the nine month period ended September 30, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Knee
 
Hip
 
Biologics
and Spine
 
Extremities
 
Other
 
Total
Balance as of December 31, 2013
$
3,830

 
$
670

 
$
7,553

 
$
459

 
$
1,002

 
$
13,514

Foreign currency translation effects
(131
)
 
(49
)
 
—

 
(33
)
 
(77
)
 
(290
)
Balance as of September 30, 2014
$
3,699

 
$
621

 
$
7,553

 
$
426

 
$
925

 
$
13,224

 
 
 
 
 
 
 
 
 
 
 
 
We test goodwill for impairment annually as of the 1st of October. Our impairment analysis as of October 1, 2014 has not yet been completed, however we do not expect an impairment to goodwill.
Other Intangible Assets – The following table summarizes the carrying values of our other intangible assets at September 30, 2014 and December 31, 2013:
 
 
 
 
 
 
 
 
(in thousands)
Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
 
Weighted Avg Amortization Period
Balance at September 30, 2014
 
 
 
 
 
 
 
Product licenses and designs
$
15,363

 
$
6,699

 
$
8,664

 
9.9
Patents and trademarks
4,705

 
2,928

 
1,777

 
14.0
Customer relationships
3,075

 
2,758

 
317

 
6.9
 
 
 
 
 
 
 
 
Balance at December 31, 2013
 
 
 
 
 
 
 
Product licenses and designs
$
15,522

 
$
6,065

 
$
9,457

 
10.1
Patents and trademarks
4,777

 
2,772

 
2,005

 
14.0
Customer relationships
3,168

 
2,499

 
669

 
6.9
 
 
 
 
 
 
 
 

7

5.
HEDGING ACTIVITIES AND FOREIGN CURRENCY TRANSLATION
Foreign Currency Transactions
The following table provides information on the components of our foreign currency activities recognized in the unaudited condensed consolidated statements of income:
 
 
 
 
 
 
 
 
(in thousands)
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Foreign currency transactions (loss) gain
$
(759
)
 
$
271

 
$
(559
)
 
$
(312
)
Foreign currency option gain
107

 
—

 
107

 
—

Foreign currency (loss) gain, net
$
(652
)
 
$
271

 
$
(452
)
 
$
(312
)
 
 
 
 
 
 
 
 
Foreign Currency Transactions – Gains and losses resulting from our transactions and our subsidiaries’ transactions that are made in currencies different from our and their own, are included in income as they occur and as other income (expense) in the condensed consolidated statements of income.
Foreign Currency Option – During September 2014, we entered into a foreign currency put option instrument to sell €5.0 million prior to December 31, 2014 as an economic hedge against strengthening of the U.S. Dollar (USD) against the Euro (EUR). We paid a premium of $108,500 for a strike price of 1.28 or, a $6.4 million call amount. The foreign currency option expires on December 31, 2014. During the quarter ended September 30, 2014, we recognized a gain of $107,000 on the condensed consolidated statements of income related to the fair value of this currency option based upon a dealer's quote.
Foreign Currency Translation
We are exposed to market risk related to changes in foreign currency exchange rates. The functional currency of substantially all of our international subsidiaries is their local currency. Transactions are translated into USD, and exchange gains and losses arising from translation are recognized in “Other comprehensive income (loss)”. Fluctuations in exchange rates affect our financial position and results of operations. The majority of our foreign currency exposure is to the EUR, British Pound (GBP), and Japanese Yen (JPY). During the nine months ended September 30, 2014, translation losses were $3.1 million, which were primarily due to the weakening of the JPY, EUR and GBP against the USD. During the nine months ended September 30, 2013, translation gains were $0.2 million, which were primarily due to the strengthening of the EUR, offset partially by the weakening of the JPY against the USD. We may continue to experience translation gains and losses during the year ending December 31, 2014; however, these gains and losses are not expected to have a material effect on our financial position, results of operations, or cash flows.
Other Comprehensive Income (Loss)
Other comprehensive income (loss) is composed of unrealized gains or losses from the change in fair value of certain derivative instruments that qualify for hedge accounting, and for foreign currency translation effects. The following table provides information on the components of our other comprehensive loss:
 
 
 
 
 
 
(in thousands)
Cash Flow Hedge
 
Foreign Currency Translation
 
Total
Balance December 31, 2013
$
(284
)
 
$
(3,618
)
 
$
(3,902
)
2014 adjustments, net of tax
131

 
(3,079
)
 
(2,948
)
Balance September 30, 2014
$
(153
)
 
$
(6,697
)
 
$
(6,850
)
 
 
 
 
 
 
We do not enter into or hold derivative instruments for trading or speculative purposes. We entered into our interest rate swap to eliminate variability in future cash flows by converting LIBOR-based variable-rate interest payments into fixed-rate interest payments. The fair value of our interest rate swap agreement is based on dealer quotes, and the change in fair value is recorded as accumulated other comprehensive loss in the consolidated balance sheets. We do not expect the change in fair value of our interest rate swap to have a material impact on our results of operations, financial position or cash flows.

8

6.
INVENTORIES
Inventories are valued at the lower of cost or market and include implants consigned to customers and agents. We also loan a significant amount of implant inventory to non-distributor customers. The consigned or loaned inventory remains our inventory until we are notified of the implantation. We are also required to maintain substantial levels of inventory as it is necessary to maintain all sizes of each component to fill customer orders. The size of the component to be used for a specific patient is typically not known with certainty until the time of surgery. Due to this uncertainty, a minimum of one of each size of each component in the system to be used must be available to each sales representative at the time of surgery. As a result of the need to maintain substantial levels of inventory, we are subject to the risk of inventory obsolescence. In the event that a substantial portion of our inventory becomes obsolete, it would have a material adverse effect on the Company. Allowance charges for obsolete and slow moving inventories are recorded based upon an analysis of specific identification of obsolete inventory items and quantification of slow moving inventory items. For slow moving inventory, this analysis compares the quantity of inventory on hand to the historical sales of such inventory items. As a result of this analysis, we record an estimated allowance for slow moving inventory. Due to the nature of the slow moving inventory, this allowance may fluctuate up or down, as a charge or recovery. Allowance charges for the three and nine months ended September 30, 2014 were $0.4 million and $0.3 million, respectively. Allowance charges for the three and nine months ended September 30, 2013 were $0.6 million and $2.3 million respectively. We also test our inventory levels for the amount of inventory that we expect to sell within one year. At certain times, such as when we stock new subsidiaries, add consignment locations, and launch new products, the level of inventory can exceed the forecasted level of cost of goods expected to be sold for the next twelve months. We classify such inventory as non-current.
The following table summarizes our classifications of inventory as of September 30, 2014 and December 31, 2013:
 
 
 
 
(in thousands)
September 30,
2014
 
December 31,
2013
Raw materials
$
20,934

 
$
19,668

Work in process
1,444

 
1,178

Finished goods on hand
31,561

 
26,474

Finished goods on loan/consignment
37,321

 
35,370

Inventory total
91,260

 
82,690

Non-current inventories
17,089

 
11,100

Inventories, current
$
74,171

 
$
71,590

 
 
 
 
7.
INCOME TAX
At September 30, 2014, net operating loss carry forwards of our foreign and domestic subsidiaries totaled $25.5 million, some of which begin to expire in 2020. For accounting purposes, the estimated tax effect of this net operating loss carry forward results in a deferred tax asset. The deferred tax asset associated with these losses was $8.2 million with a valuation allowance of $5.0 million charged against this deferred tax asset assuming these losses will not be fully realized. At December 31, 2013, these net operating loss carry forwards totaled $25.9 million, and the deferred tax asset was $8.4 million with a valuation allowance of $5.2 million charged against this deferred tax asset assuming these losses will not be fully realized.
Our income tax returns are subject to examination in numerous state, federal and foreign jurisdictions due to the multiple income tax jurisdictions in which we operate. On March 25, 2013, the United States Internal Revenue Service, or IRS, completed an income tax audit for the 2009 through 2011 tax years. Audit adjustments were recorded prior to 2013. As of September 30, 2014, we have no liability recorded as an uncertain tax benefit.
The American Taxpayer Relief Act of 2012 was enacted on January 2, 2013. This law retroactively reinstated the Internal Revenue Code Section 41, Credit for Increasing Research Activities, for the year ended December 31, 2012. As a result of this reinstatement, we were allowed a research credit of $0.6 million for 2012, which we recorded during the quarter ended March 31, 2013. The Credit for Increasing Research Activities expired for the year ending December 31, 2014, and for the nine months ended September 30, 2014, we have not recorded a research credit.

9

8.
DEBT
Debt consisted of the following at September 30, 2014 and December 31, 2013:
 
 
 
 
(in thousands)
September 30,
2014
 
December 31,
2013
Term loan payable in quarterly principal installments of $750, from June 2013 to December 2016. Interest based on adjustable rate as determined by three month LIBOR (1.74% as of 9/30/2014)
$
24,000

 
$
26,250

Business line of credit payable on a revolving basis, plus interest based on adjustable rate as determined by one month LIBOR based on our ratio of funded debt to EBITDA
—

 
10,732

Total debt
24,000

 
36,982

Less current portion
(3,000
)
 
(3,000
)
 
$
21,000

 
$
33,982

 
 
 
 
The following is a schedule of future debt maturities as of September 30, 2014, for the years ending December 31 (in thousands):
 
 
2014
$
750

2015
3,000

2016
3,000

2017
17,250

2018
—

Thereafter
—

 
$
24,000

 
 
During the quarter ended March 31, 2014, we terminated an interest rate swap agreement we had entered into during 2005 to fix the interest rate on our debt, and as a result, we recorded a loss of $38,000.
9.
COMMITMENTS AND CONTINGENCIES
Litigation
There are various claims, lawsuits, and disputes with third parties and pending actions involving various allegations against us incident to the operation of our business, principally product liability cases. While we believe that the various claims are without merit, we are unable to predict the ultimate outcome of such litigation. We therefore maintain insurance, subject to self-insured retention limits, for all such claims, and establish accruals for product liability and other claims based upon our experience with similar past claims, advice of counsel and the best information reasonably available. At September 30, 2014 and December 31, 2013, we had $110,000 and $135,000 accrued, respectively, for product liability claims. These product liability claims are subject to various uncertainties, and it is possible that they may be resolved unfavorably to us. While it is not possible to predict with certainty the outcome of the various cases, it is the opinion of management that, upon ultimate resolution, the cases will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Our insurance policies covering product liability claims must be renewed annually. Although we have been able to obtain insurance coverage for product liability claims at a cost and on other terms and conditions that have been acceptable to us, we may not be able to procure acceptable policies in the future.
Purchase Commitments
At September 30, 2014, we had outstanding commitments for the purchase of inventory, raw materials and supplies of $11.0 million and outstanding commitments for the purchase of capital equipment of $4.9 million. Purchases under our distribution agreements were $4.8 million during the nine months ended September 30, 2014.

10

Our Taiwanese subsidiary, Exactech Taiwan, has entered into a license agreement with the Industrial Technology Research Institute (ITRI) and the National Taiwan University Hospital (NTUH) for the rights to technology and patents related to the repair of cartilage lesions. As of September 30, 2014, we have paid approximately $2.1 million for the licenses, patents, and equipment related to this license agreement, and we will make royalty payments when the technology becomes marketable. Using the technology, we plan to launch a cartilage repair program that will include a device and method for the treatment and repair of cartilage in the knee joint. It is expected that the project will require us to complete human clinical trials under the guidance of the Food & Drug Administration in order to obtain pre-market approval for the device in the United States. The agreement terms include a license fee based on the achievement of specific, regulatory milestones and a royalty arrangement based on sales once regulatory clearances are established.
10.
SEGMENT INFORMATION
We evaluate our operating segments by our major product lines: knee implants, hip implants, biologics and spine, extremity implants and other products. The “other products” segment includes miscellaneous sales categories, such as surgical instruments held for sale, bone cement, instrument rental fees, shipping charges, and other implant product lines. Evaluation of the performance of operating segments is based on their respective incomes from operations before taxes, interest income and expense, and nonrecurring items. Intersegment sales and transfers are not significant. The accounting policies of the reportable segments are the same as those described in Note 2 of the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013.
Total assets not identified with a specific segment are listed as “corporate” and include cash and cash equivalents, accounts receivable, income taxes receivable, deposits and prepaid expenses, deferred tax assets, land, facilities, office furniture and computer equipment, notes receivable, and other investments. Depreciation and amortization on corporate assets is allocated to the product segments for purposes of evaluating the income (loss) from operations, and capitalized surgical instruments are allocated to the appropriate product line supported by those assets.
Summarized information concerning our reportable segments is shown in the following table (in thousands):
 
 
 
 
 
 
 
 
Three Months Ended September 30,
Knee
Hip
Biologics & Spine
Extremity
Other
Corporate
Total
2014
 
 
 
 
 
 
 
Net sales
$
18,148

$
10,160

$
5,415

$
18,601

$
5,560

$
—

$
57,884

Segment profit (loss)
981

372

93

4,253

(181
)
(897
)
4,621

Total assets, net
67,528

33,233

24,848

27,920

15,002

89,352

257,883

Capital expenditures
1,101

1,794

356

1,250

574

324

5,399

Depreciation and Amortization
2,049

702

317

609

155

852

4,684

2013
 
 
 
 
 
 
 
Net sales
$
18,607

$
9,802

$
6,005

$
15,122

$
6,114

$
—

$
55,650

Segment profit (loss)
1,749

260

273

3,333

(780
)
10

4,845

Total assets, net
66,696

35,256

27,220

25,781

5,331

101,659

261,943

Capital expenditures
308

215

465

1,044

90

1,091

3,213

Depreciation and Amortization
1,824

668

291

458

87

969

4,297

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
Knee
Hip
Biologics & Spine
Extremity
Other
Corporate
Total
2014
 
 
 
 
 
 
 
Net sales
$
59,762

$
32,160

$
17,707

$
57,278

$
18,154

$
—

$
185,061

Segment profit (loss)
4,820

2,483

497

13,399

(2,256
)
(1,246
)
17,697

Total assets, net
67,528

33,233

24,848

27,920

15,002

89,352

257,883

Capital expenditures
3,215

3,306

871

3,228

1,119

1,906

13,645

Depreciation and Amortization
5,943

2,107

920

1,660

487

2,781

13,898

2013
 
 
 
 
 
 
 
Net sales
$
60,154

$
30,824

$
18,855

$
47,087

$
18,590

$
—

$
175,510

Segment profit (loss)
5,870

1,727

267

10,679

(1,421
)
(1,090
)
16,032

Total assets, net
66,696

35,256

27,220

25,781

5,331

101,659

261,943

Capital expenditures
5,199

1,279

1,118

2,393

271

2,683

12,943

Depreciation and Amortization
5,466

1,994

943

1,313

284

3,060

13,060

 
 
 
 
 
 
 
 

11

Geographic distribution of our long-lived assets and inventory is shown in the following table (in thousands):
 
 
 
 
 
 
 
 
As of:
September 30, 2014
 
December 31, 2013
 
Domestic
 
International
 
Domestic
 
International
Long lived assets, gross
$
142,393

 
$
43,157

 
$
139,406

 
$
41,857

Accumulated depreciation and amortization
(79,140
)
 
(15,596
)
 
(73,876
)
 
(13,588
)
Long lived assets, net
63,253

 
27,561

 
65,530

 
28,269

 
 
 
 
 
 
 
 
Inventory
$
61,652

 
$
29,608

 
$
56,960

 
$
25,730

 
 
 
 
 
 
 
 
Geographic distribution of our sales is summarized in the following table (in thousands):
 
 
 
 
 
 
Three Months Ended September 30,
2014
 
2013
 
% Inc/Decr
Domestic sales
$
40,019

 
$
39,093

 
2.4
International sales
17,865

 
16,557

 
7.9
Total sales
$
57,884

 
$
55,650

 
4.0
 
 
 
 
 
 
Nine Months Ended September 30,
2014
 
2013
 
% Inc/Decr
Domestic sales
$
123,826

 
$
117,911

 
5.0
International sales
61,235

 
57,599

 
6.3
Total sales
$
185,061

 
$
175,510

 
5.4
 
 
 
 
 
 
11.
SHAREHOLDERS’ EQUITY
The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations for net income and net income available to common shareholders:
 
 
 
 
 
 
 
 
 
Income (Numerator)
Shares (Denominator)
Per Share
 
Income (Numerator)
Shares (Denominator)
Per Share
 
Three Months Ended
 
Three Months Ended
(in thousands, except per share amounts)
September 30, 2014
 
September 30, 2013
Net income
$
3,011

 
 
 
$
3,192

 
 
Basic EPS:
 
 
 
 
 
 
 
Net income available to common shareholders
$
3,011

13,766

$
0.22

 
$
3,192

13,494

$
0.24

Effect of dilutive securities:
 
 
 
 
 
 
 
Stock options
 
298

 
 
 
218

 
Diluted EPS:
 
 
 
 
 
 
 
Net income available to common shareholders plus assumed conversions
$
3,011

14,064

$
0.21

 
$
3,192

13,712

$
0.23

 
 
 
 
 
 
 
 
 
Nine Months Ended
 
Nine Months Ended
(in thousands, except per share amounts)
September 30, 2014
 
September 30, 2013
Net income
$
11,369

 
 
 
$
10,777

 
 
Basic EPS:
 
 
 
 
 
 
 
Net income available to common shareholders
$
11,369

13,690

$
0.83

 
$
10,777

13,433

$
0.80

Effect of dilutive securities:
 
 
 
 
 
 
 
Stock options
 
299

 
 
 
199

 
Diluted EPS:
 
 
 
 
 
 
 
Net income available to common shareholders plus assumed conversions
$
11,369

13,989

$
0.81

 
$
10,777

13,632

$
0.79

 
 
 
 
 
 
 
 

12

For the three months ended September 30, 2014, weighted average options to purchase 206,150 shares of common stock were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method. For the three months ended September 30, 2013, weighted average options to purchase 293,859 shares of common stock were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method.
For the nine months ended September 30, 2014, weighted average options to purchase 119,710 shares of common stock were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method. For the nine months ended September 30, 2013, weighted average options to purchase 420,366 shares of common stock were outstanding but were not included in the computation of diluted EPS because the options were antidilutive under the treasury stock method.
Changes in Shareholders’ Equity:
The following is a summary of the changes in shareholders’ equity for the nine months ended September 30, 2014: 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Total
(in thousands)
Shares
 
Amount
 
Balance December 31, 2013
13,577

 
$
136

 
$
69,175

 
$
127,015

 
$
(3,902
)
 
$
192,424

Net income
—

 
—

 
—

 
11,369

 
—

 
11,369

Other comprehensive income (loss), net of tax
—

 
—

 
—

 
—

 
(2,948
)
 
(2,948
)
Exercise of stock options
183

 
2

 
3,252

 
—

 
—

 
3,254

Issuance of restricted common stock for services
13

 
—

 
205

 
—

 
—

 
205

Issuance of common stock under Employee Stock Purchase Plan
26

 
—

 
512

 
—

 
—

 
512

Compensation cost of stock options
—

 
—

 
1,184

 
—

 
—

 
1,184

Tax impact on stock awards
—

 
—

 
(13
)
 
—

 
—

 
(13
)
Balance September 30, 2014
$
13,799

 
$
138

 
$
74,315

 
$
138,384

 
$
(6,850
)
 
$
205,987

 
 
 
 
 
 
 
 
 
 
 
 
Stock-based Compensation Awards:
We sponsor an Executive Incentive Compensation Plan, which provides for the award of stock-based compensation, including options, stock appreciation rights, restricted stock and other stock-based incentive compensation awards to key employees, directors and independent agents and consultants. We implemented a comprehensive, consolidated incentive compensation plan upon shareholder approval at our Annual Meeting of Shareholders on May 7, 2009, referred to as the 2009 Plan, which was amended and restated at our 2014 Annual Meeting of Shareholders, held on May 8, 2014, to increase the maximum number of shares issuable under the 2009 Plan by 500,000. The maximum number of common shares issuable under the amended and restated 2009 Plan is 1,500,000 plus (a) the number of shares with respect to awards previously granted under our preexisting plans that terminate without being exercised, expire, are forfeited or canceled, plus (b) the number of shares that remain available for future issuance under our preexisting plans plus (c) the number of shares that are surrendered in payment of any awards or any tax withholding with respect thereto. Common stock issued upon exercise of stock options is settled with authorized but unissued shares available. Under the 2009 Plan, the exercise price of option awards equals the market price of our common stock on the date of grant, and each award has a maximum term of ten years. As of September 30, 2014, there were 501,812 total shares remaining issuable under the 2009 Plan.
The aggregate compensation cost charged against income for the 2009 Plan and the 2009 Employee Stock Purchase Plan, referred to as the 2009 ESPP, was $1.2 million and $1.2 million for the nine months ended September 30, 2014 and 2013, respectively. Income tax benefit on exercises of non-qualified stock options was $0.3 million and $0.3 million for the nine months ended September 30, 2014 and 2013, respectively. As of September 30, 2014, total unrecognized compensation cost related to unvested awards was $1.9 million and is expected to be recognized over a weighted-average period of 2.01 years.

13

Stock Options:
A summary of the status of stock option activity under our stock-based compensation plans as of September 30, 2014 and changes during the year to date is presented below:
 
 
 
 
 
 
 
 
 
2014
 
Options    
 
Weighted Avg Exercise Price
 
Weighted Avg Remaining Contractual Term
 
Aggregate Intrinsic Value (In thousands)
Outstanding - January 1
1,317,678

 
$
16.78

 
 
 
 
Granted
201,217

 
20.90

 
 
 
 
Exercised
(182,770
)
 
17.21

 
 
 
$
1,025

Forfeited or Expired
(9,960
)
 
18.01

 
 
 
 
Outstanding - September 30
1,326,165

 
$
17.34

 
3.48
 
$
7,360

Exercisable - September 30
770,528

 
$
16.34

 
1.99
 
$
5,044

 
 
 
 
 
 
 
 
Outstanding options, consisting of five-year to ten-year incentive and non-qualified stock options, vest and become exercisable ratably over a three to five year period from the date of grant. The outstanding options expire from five to ten years from the date of grant or upon termination of employment with Exactech, and are contingent upon continued employment during the applicable option term. Certain non-qualified stock options are granted to non-employee sales agents and consultants, and they typically vest ratably over a period of three to four years from the date of grant and expire in five years or less from the date of grant, or upon termination of the agent's or consultant’s contract with Exactech. Stock options for 201,217 shares of common stock were granted during the nine months ended September 30, 2014, compared to stock options for 241,000 shares of common stock granted during the nine months ended September 30, 2013.
Restricted Stock Awards:
Under the 2009 Plan, we may grant restricted stock awards to eligible employees, directors, and independent agents and consultants. Restrictions on transferability, risk of forfeiture and other restrictions are determined by the Compensation Committee of the Board of Directors, or the Committee, at the time of the award. During February 2014, the Committee approved equity compensation to the outside members of the Board of Directors for their service on the Board of Directors. The annual compensation for each director consists of the grant of stock awards with an aggregate market value of $75,000, payable in four equal quarterly grants of common stock based on the market price of our common stock on the respective dates of grant. The summary information of the restricted stock grants for the first nine months of 2014 is presented below: 
 
 
 
 
Grant date
February 28, 2014

May 31, 2014

August 29, 2014

Aggregate shares of restricted stock granted
4,020

4,502

4,710

Grant date fair value
$
94,000

$
105,000

$
112,000

Weighted average fair value per share
$
23.30

$
23.29

$
23.88

 
 
 
 
During February 2013, the Committee approved equity compensation to the outside members of the Board of Directors for their service on the Board of Directors. The annual compensation for each director consisted of the grant of stock awards with an aggregate market value of $69,000, payable in four equal quarterly grants of common stock based on the market price of our common stock on the respective dates of grant. The summary information of the restricted stock grants for the first nine months of 2013 is presented below:
 
 
 
 
Grant date
February 28, 2013

May 31, 2013

August 30, 2013

Aggregate shares of restricted stock granted
4,685

4,735

4,530

Grant date fair value
$
86,000

$
86,000

$
86,000

Weighted average fair value per share
$
18.41

$
18.20

$
19.04

 
 
 
 
 
All of the restricted stock awards in 2014 and 2013 were fully vested at each of the grant dates. The restricted stock awards require no service period and thus contain no risk of, or provision for, forfeiture.

14

Employee Stock Purchase Plan:
On February 18, 2009, our board of directors adopted the 2009 ESPP, and our shareholders approved the 2009 ESPP at our Annual Meeting of Shareholders on May 7, 2009. Under the 2009 ESPP, employees are able to purchase shares of our common stock at a fifteen percent (15%) discount via payroll deduction, up to a maximum number of shares issuable under the 2009 ESPP of 300,000. There are four offering periods during an annual period. As of September 30, 2014, 92,033 shares remained available for purchase under this 2009 ESPP. The fair value of the employees' purchase rights is estimated using the Black-Scholes model. Purchase information and fair value assumptions are presented in the following table:
 
 
 
 
Nine Months Ended September 30,
2014
 
2013
Shares purchased
26,258
 
32,807
Dividend yield
—
 
—
Expected life
1 year
 
1 year
Expected volatility
27%
 
32%
Risk free interest rates
0.1%
 
0.2%
Weighted average per share fair value
$4.92
 
$3.98
 
 
 
 

15

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes appearing elsewhere in this report.
Overview of the Company
We develop, manufacture, market and sell orthopaedic implant devices, related surgical instrumentation, supplies and biologic materials to hospitals and physicians in the United States and internationally. Our revenues are principally derived from sales of knee, hip, and extremity joint replacement systems and spinal fusion products. Our continuing research and development projects will enable us to continue the introduction of new, advanced biologic materials, joint replacement product line extensions and other products and services.
Our operating expenses consist of sales and marketing expenses, general and administrative expenses, research and development expenses, and depreciation expenses. The largest component of operating expenses, sales and marketing expenses, primarily consists of payments made to independent sales representatives for their services to hospitals and surgical facilities on our behalf. These expenses tend to vary and generally relate to our sales growth. Research and development expenses primarily consist of expenditures on projects concerning knee, extremities, spine and hip implant product lines and biologic materials and services.
In marketing our products, we use a combination of traditional targeted media marketing together with our primary marketing focus, direct customer contact and service to orthopaedic surgeons. Because surgeons are important decision makers when it comes to the choice of products and services that best meet the needs of their patients, we focus our marketing strategy on meeting the needs of the orthopaedic surgeon community. In addition to surgeon’s preference, hospitals and buying groups, as the economic customers, actively participate with physicians in the choice of implants and services.
Overview of the Three and Nine Months Ended September 30, 2014
During the quarter ended September 30, 2014, sales increased 4% to $57.9 million from $55.7 million in the quarter ended September 30, 2013, as a result of 8% growth in our international sales and 2% growth in our domestic sales. Gross margins decreased to 70.7% in the third quarter of 2014 from 71.0% for the same quarter in 2013, primarily due to growth in the international market, in which our margins are lower. Operating expenses increased 2% when compared to the quarter ended September 30, 2013, however as a percentage of sales, operating expenses decreased to 61% during the third quarter of 2014 as compared to 62% for the same quarter in 2013. This decrease, as a percentage of sales, was primarily due to our continued efforts to manage the increase in operating expenses. Net income for the quarter ended September 30, 2014, decreased 6%, and diluted earnings per share was $0.21 as compared to $0.23 in the same quarter last year, which was primarily a result of foreign currency losses due to the strengthening of the U.S. Dollar (USD) against the Euro (EUR) and Japanese Yen (JPY).
During the nine months ended September 30, 2014, sales increased 5% to $185.1 million from $175.5 million in the nine months ended September 30, 2013, as a result of 5% growth in our domestic sales and 6% growth in our international sales. Gross margins increased to 70% in the first nine months of 2014 from 69% for the same period in 2013, primarily due to continued growth in the higher margin U.S. extremity segment. Operating expenses increased 6% when compared to the nine months ended September 30, 2013, and, as a percentage of sales, operating expenses remained constant at 60% during both of the nine months ended September 30, 2014 and 2013. Net income for the nine months ended September 30, 2014 increased 5%, and diluted earnings per share was $0.81 as compared to $0.79 in the same period last year.
During the nine months ended September 30, 2014, we acquired $13.5 million in property and equipment, including new production equipment and surgical instrumentation. Net cash flow from operations was $26.3 million for the nine months ended September 30, 2014, as compared to net cash flow from operations of $7.1 million during the nine months ended September 30, 2013. The increase was primarily due to the reduction in accounts receivable.

16

The following table includes the net sales and percentage of net sales, as well as a comparison of net sales change to net sales change calculated on a constant currency basis, for each of our product lines, which are also our reportable segments, for the three and nine month periods ended September 30, 2014 and September 30, 2013:
Sales by Product Line
($ in 000’s)
 
Three Months Ended
 
Inc (decr)
 
September 30, 2014
 
September 30, 2013
 
2014 - 2013
 
Constant Currency
Knee
$
18,148

 
31.4
%
 
$
18,607

 
33.4
%
 
(2.5
)%
 
(2.4
)%
Extremity
18,601

 
32.1

 
15,122

 
27.2

 
23.0

 
22.5

Hip
10,160

 
17.5

 
9,802

 
17.6

 
3.7

 
4.0

Biologics and Spine
5,415

 
9.4

 
6,005

 
10.8

 
(9.8
)
 
(10.2
)
Other
5,560

 
9.6

 
6,114

 
11.0

 
(9.1
)
 
(9.3
)
Total
$
57,884

 
100.0
%
 
$
55,650

 
100.0
%
 
4.0
 %
 
3.9
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
Inc (decr)
 
September 30, 2014
 
September 30, 2013
 
2014- 2013
 
Constant Currency
Knee
$
59,762

 
32.3
%
 
$
60,154

 
34.3
%
 
(0.7
)%
 
(0.7
)%
Extremity
57,278

 
30.9

 
47,087

 
26.8

 
21.6

 
21.1

Hip
32,160

 
17.4

 
30,824

 
17.6

 
4.3

 
4.7

Biologics and Spine
17,707

 
9.6

 
18,855

 
10.7

 
(6.1
)
 
(6.9
)
Other
18,154

 
9.8

 
18,590

 
10.6

 
(2.3
)
 
(2.9
)
Total
$
185,061

 
100.0
%
 
$
175,510

 
100.0
%
 
5.4
 %
 
5.2
 %
 
 
 
 
 
 
 
 
 
 
 
 
The following table includes items from the unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2014 as compared to the three and nine months ended September 30, 2013, the dollar and percentage change from period to period and the percentage relationship to net sales (dollars in thousands):
Comparative Statement of Income Data
 
Three Months Ended September 30,
 
2014 – 2013 Inc (decr)
 
% of Sales
 
2014
 
2013
 
$
 
%
 
2014
 
2013
Net sales
$
57,884

 
$
55,650

 
2,234

 
4.0

 
100.0
 %
 
100.0
 %
Cost of goods sold
16,929

 
16,126

 
803

 
5.0

 
29.3

 
29.0

Gross profit
40,955

 
39,524

 
1,431

 
3.6

 
70.7

 
71.0

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
21,304

 
20,274

 
1,030

 
5.1

 
36.8

 
36.4

General and administrative
5,380

 
5,384

 
(4
)
 
(0.1
)
 
9.3

 
9.7

Research and development
4,464

 
5,068

 
(604
)
 
(11.9
)
 
7.7

 
9.1

Depreciation and amortization
4,289

 
3,963

 
326

 
8.2

 
7.4

 
7.1

Total operating expenses
35,437

 
34,689

 
748

 
2.2

 
61.2

 
62.3

Income from operations
5,518

 
4,835

 
683

 
14.1

 
9.5

 
8.7

Other income (expense), net
(897
)
 
10

 
(907
)
 
9,070.0

 
(1.5
)
 
—

Income before taxes
4,621

 
4,845

 
(224
)
 
(4.6
)
 
8.0

 
8.7

Provision for income taxes
1,610

 
1,653

 
(43
)
 
(2.6
)
 
2.8

 
3.0

Net income
$
3,011

 
$
3,192

 
(181
)
 
(5.7
)
 
5.2

 
5.7

 
 
 
 
 
 
 
 
 
 
 
 

17

Comparative Statement of Income Data
 
Nine Months Ended September 30,
 
2014 – 2013 Inc (decr)
 
% of Sales
 
2014
 
2013
 
$
 
%
 
2014
 
2013
Net sales
$
185,061

 
$
175,510

 
9,551

 
5.4

 
100.0
 %
 
100.0
 %
Cost of goods sold
55,128

 
53,791

 
1,337

 
2.5

 
29.8

 
30.6

Gross profit
129,933

 
121,719

 
8,214

 
6.7

 
70.2

 
69.4

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
67,902

 
63,281

 
4,621

 
7.3

 
36.7

 
36.1

General and administrative
16,832

 
15,801

 
1,031

 
6.5

 
9.1

 
9.0

Research and development
13,521

 
13,523

 
(2
)
 
—

 
7.3

 
7.7

Depreciation and amortization
12,735

 
11,992

 
743

 
6.2

 
6.9

 
6.8

Total operating expenses
110,990

 
104,597

 
6,393

 
6.1

 
60.0

 
59.6

Income from operations
18,943

 
17,122

 
1,821

 
10.6

 
10.2

 
9.8

Other income (expense), net
(1,246
)
 
(1,090
)
 
(156
)
 
14.3

 
(0.7
)
 
(0.7
)
Income before taxes
17,697

 
16,032

 
1,665

 
10.4

 
9.5

 
9.1

Provision for income taxes
6,328

 
5,255

 
1,073

 
20.4

 
3.4

 
3.0

Net income
$
11,369

 
$
10,777

 
592

 
5.5

 
6.1

 
6.1

Three and Nine Months Ended September 30, 2014 Compared to Three and Nine Months Ended September 30, 2013
Sales
For the quarter ended September 30, 2014, sales increased 4% to $57.9 million from $55.7 million in the quarter ended September 30, 2013, principally as a result of 8% international sales growth and 2% increase in domestic sales. Sales of knee implant products decreased 2% to $18.1 million for the quarter ended September 30, 2014, compared to $18.6 million for the same quarter in 2013. The decrease is a result of continued pricing pressures in the worldwide knee market. Sales of our extremity products were up 23% to $18.6 million as compared to $15.1 million for the same period in 2013, as we continued to gain global market share with our Equinoxe® reverse shoulder system. Hip implant sales of $10.2 million during the quarter ended September 30, 2014 increased 4% from the $9.8 million during the quarter ended September 30, 2013, as a result of hip sales increases both domestically and internationally. Sales from biologics and spine decreased 10% during the quarter ended September 30, 2014 to $5.4 million from $6.0 million in the comparable quarter in 2013, primarily as a result of continued competitive pricing pressures in the domestic biologics market. Sales of all other products decreased to $5.6 million as compared to $6.1 million in the same quarter last year. Domestically, sales increased 2% to $40.0 million, or 69% of total sales, during the quarter ended September 30, 2014, up from $39.1 million, which represented 70% of total sales in the comparable quarter last year. Internationally, sales increased 8% to $17.9 million, representing 31% of total sales, for the quarter ended September 30, 2014, as compared to $16.6 million, which was 30% of total sales for the same quarter in 2013. On a constant currency basis, international sales increased approximately 8% during the quarter ended September 30, 2014, compared to the same quarter in 2013.
For the nine months ended September 30, 2014, sales increased 5% to $185.1 million from $175.5 million during the nine months ended September 30, 2013, as a result of domestic sales growth of 5% and international sales growth of 6%. Sales of knee implant products decreased 1% to $59.8 million for the nine months ended September 30, 2014 as compared to $60.2 million for the same nine months in 2013, as a result of worldwide pricing pressures. Sales of our extremity products were up 22% to $57.3 million as compared to $47.1 million for the same period in 2013, primarily due to the continued growth with our Equinoxe® reverse shoulder system. Hip implant sales of $32.2 million during the nine months ended September 30, 2014 increased 4% from the $30.8 million in sales during the nine months ended September 30, 2013. Sales from biologics and spine decreased 6% during the nine months ended September 30, 2014 to $17.7 million, from $18.9 million in the comparable period in 2013. The decrease in the biologics and spine segment is a result of domestic competitive pricing pressures in the biologics market, which was partially offset by improvements in our spine sales units. Sales of all other products decreased to $18.2 million as compared to $18.6 million in the same nine months last year. Domestically, sales increased 5% to $123.8 million, or 67% of total sales, during the nine months ended September 30, 2014, up from $117.9 million, which also represented 67% of total sales,

18

in the comparable period last year. Internationally, sales increased 6% to $61.2 million, representing 33% of total sales, for the nine months ended September 30, 2014, as compared to $57.6 million, which was also 33% of total sales, for the same nine months in 2013. On a constant currency basis, international sales increased approximately 6% during the nine months ended September 30, 2014, compared to the same period in 2013.
Gross Profit
Gross profit increased to $41.0 million in the quarter ended September 30, 2014 from $39.5 million in the quarter ended September 30, 2013. As a percentage of sales, gross profit decreased to 70.7% during the quarter ended September 30, 2014 from 71.0% for the quarter ended September 30, 2013, primarily as a result of growth in the lower margined international market.
Gross profit increased to $129.9 million in the nine months ended September 30, 2014 from $121.7 million in the nine months ended September 30, 2013. As a percentage of sales, gross profit increased to 70.2% during the nine months ended September 30, 2014 from 69.4% for the nine months ended September 30, 2013, primarily as a result of growth in the higher margin U.S. extremities segment. Looking forward to the fourth quarter, we expect gross profit, as a percentage of sales, to be roughly flat as compared to prior year quarter due to expected consistent sales mix.
Operating Expenses
Total operating expenses increased 2% to $35.4 million in the quarter ended September 30, 2014 from $34.7 million in the quarter ended September 30, 2013. As a percentage of sales, total operating expenses decreased to 61% for the quarter ended September 30, 2014, as compared to 62% for the quarter ended September 30, 2013. The lower increase was related to a reduction in variable compensation expenses. Total operating expenses increased 6% to $111.0 million in the nine months ended September 30, 2014 from $104.6 million in the nine months ended September 30, 2013, primarily due to increased compliance expenses and variable selling expenses. As a percentage of sales, total operating expenses remained constant at 60% for the each of the nine month periods ended September 30, 2014, and 2013.
Sales and marketing expenses, the largest component of total operating expenses, increased 5% for the quarter ended September 30, 2014 to $21.3 million from $20.3 million in the same quarter last year. The increase was primarily related to additional variable selling costs as a result of our sales growth. Sales and marketing expenses, as a percentage of sales, were 37% for the quarter ended September 30, 2014, compared to 36% for the quarter ended September 30, 2013. Sales and marketing expenses increased 7% for the nine months ended September 30, 2014 to $67.9 million from $63.3 million in the same period last year, which was primarily related to global compliance expenditures, as well as additional variable selling costs as a result of our sales growth. Sales and marketing expenses, as a percentage of sales, were 37% for the nine months ended September 30, 2014 and 36% for the nine months ended September 30, 2013. Looking forward, sales and marketing expenditures, as a percentage of sales, are expected to be in the range of 35% to 36% for the fourth quarter of 2014.
General and administrative expenses remained unchanged at $5.4 million in each of the quarters ended September 30, 2014 and 2013. As a percentage of sales, general and administrative expenses decreased to 9% for the quarter ended September 30, 2014 from 10% for the quarter ended September 30, 2013. General and administrative expenses increased to $16.8 million in the nine months ended September 30, 2014 from $15.8 million during the same nine months in 2013, primarily due to additional regulatory and compliance expenditures. As a percentage of sales, general and administrative expenses remained at 9% for each of the nine month periods ended September 30, 2014 and 2013. General and administrative expenses for the fourth quarter of 2014 are expected to be in the range of 8% to 9% of sales.
Research and development expenses decreased 12% for the quarter ended September 30, 2014 to $4.5 million from $5.1 million in the same quarter last year, primarily due to lower product testing and clinical study expenses. As a percentage of sales, research and development expenses decreased to 8% for the quarter ended September 30, 2014, compared to 9% for the quarter ended September 30, 2013. Research and development expenses were unchanged at $13.5 million for both of the nine month periods ended September 30, 2014 and 2013. As a percentage of sales, research and development expenses decreased to 7% for the nine month period ended September 30, 2014, compared to 8% for the same period in 2013. We expect research and development expenses ranging from 7% to 8% of sales for the fourth quarter of 2014.
Depreciation and amortization increased 8% to $4.3 million for the quarter ended September 30, 2014 from $4.0 million during the same quarter in 2013. As a percentage of sales, depreciation and amortization remained flat at 7% during each of the quarters ended September 30, 2014 and 2013. Depreciation and amortization increased 6% to $12.7

19

million for the nine months ended September 30, 2014 from $12.0 million during the same period in 2013. As a percentage of sales, depreciation and amortization remained flat at 7% during each of the nine month periods ended September 30, 2014 and 2013. We placed $11.7 million of surgical instrumentation and $1.1 million of equipment in service during the first nine months of 2014.
Income from Operations
Our income from operations increased 14% to $5.5 million, or 10% of sales, in the quarter ended September 30, 2014 from $4.8 million, or 9% of sales, in the quarter ended September 30, 2013. The increase in our income from operations for the quarter was a result of our sales growth, coupled with minimal growth in operating expenses. Our income from operations increased 11% to $18.9 million, or 10% of sales, during the nine months ended September 30, 2014 from $17.1 million, or 10% of sales, in the nine months ended September 30, 2013 as a result of the sales growth and expanded gross margins from the strength of the worldwide performance in the extremities segment. Looking forward, we expect operating expenses for the fourth quarter of the year to increase approximately the same as sales growth, therefore we anticipate income from operations, as a percentage of sales, to remain relatively flat with the fourth quarter of 2013.
Other Income and Expenses
We had other expenses, net of other income, of $0.9 million during the quarter ended September 30, 2014, compared to other income, net of other expenses of $10,000 in the quarter ended September 30, 2013. The change for the quarter was primarily a result of net foreign currency losses of $0.7 million for the quarter ended September 30, 2014, compared to currency transaction gains of $0.3 million for the same quarter of 2013. The currency loss in the quarter ended September 30, 2014 was primarily due to intercompany debt, which was higher than expected due to the significant strengthening of the USD against the EUR and JPY. Net interest expense was $0.2 million for the quarter ended September 30, 2014 and $0.3 million for the same quarter in 2013. We had other expenses, net of other income, of $1.2 million during the nine months ended September 30, 2014, compared to other expenses, net of other income of $1.1 million in the nine months ended September 30, 2013. Included in other expenses were net foreign currency losses of $0.5 million, compared to foreign currency transaction losses of $0.3 million for the same nine month period of 2013. Included in the foreign currency losses during both the three and nine months ended September 30, 2014, was a gain of $0.1 million related to a foreign currency forward option we entered into during September 2014. Net interest expense remained unchanged at $0.8 million for each of the nine month periods ended September 30, 2014 and 2013.
Taxes and Net Income
Income before provision for income taxes decreased 5% to $4.6 million in the quarter ended September 30, 2014 from $4.8 million in the quarter ended September 30, 2013, primarily due to the foreign currency transaction losses experienced as a result of the weakened EUR and JPY against the USD during the quarter. The effective tax rate, as a percentage of income before taxes, was 35% for the quarter ended September 30, 2014, compared to 34% for the same quarter in 2013. As a result of the foregoing, we realized net income of $3.0 million in the quarter ended September 30, 2014, a decrease of 6% from $3.2 million in the quarter ended September 30, 2013. As a percentage of sales, net income decreased to 5.2% for the quarter ended September 30, 2014 from 5.7% for the same quarter in 2013. Earnings per share, on a diluted basis, decreased to $0.21 for the quarter ended September 30, 2014, from $0.23 for the quarter ended September 30, 2013.
Income before provision for income taxes increased 10% to $17.7 million in the nine months ended September 30, 2014 from $16.0 million in the nine months ended September 30, 2013. The effective tax rate, as a percentage of income before taxes, was 36% for the nine months ended September 30, 2014 as compared to 33% for the nine months ended September 30, 2013. The increase in the effective tax rate for the first nine months of 2014 was due primarily to the expiration in 2014 of the credit for research and development activities that reduced the comparative 2013 effective tax rate. As a result of the foregoing, we realized net income of $11.4 million in the nine months ended September 30, 2014, an increase of 5% from $10.8 million in the nine months ended September 30, 2013. As a percentage of sales, net income remained at 6.1% for both of the nine month periods ended September 30, 2014 and 2013. Earnings per share, on a diluted basis, increased to $0.81 for the nine months ended September 30, 2014, from $0.79 for the nine months ended September 30, 2013.
Liquidity and Capital Resources
We have financed our operations primarily through a combination of commercial debt financing and cash flows from our operating activities. At September 30, 2014, we had working capital of $108.3 million, a decrease of 3% from

20

$112.0 million at the end of 2013. Working capital in 2014 decreased primarily as a result of the reduction in our cash and accounts receivable balances, partially offset by an increase in our inventory balance. Inventory and capitalized surgical instrumentation increases were impacted by the $1.7 million paid for the medical device excise tax in the first nine months of 2014.
We expect that cash flows from operating activities, borrowings under our line of credit, and the issuance of equity securities in connection with both stock purchases under the 2009 ESPP and the exercise of stock option awards under the 2009 Plan will be sufficient to meet our commitments and cash requirements in the next twelve months. If not, we will seek additional funding through any number of possible combinations of additional debt, additional issuance of equity or convertible debt.
Operating Activities – Operating activities provided net cash of $26.3 million in the nine months ended September 30, 2014, as compared to net cash from operations of $7.1 million during the nine months ended September 30, 2013. A primary contributor to this increase related to the decrease in accounts receivable experienced in the first nine months of 2014, which provided cash of $10.9 million for the nine months ended September 30, 2014, in contrast to an increase in accounts receivable using net cash of $8.3 million for the nine months ended September 30, 2013. A major contributor to the decrease in total accounts receivable was the payment of government receivables in February to our distribution operation in Spain, aggregating approximately €9.4 million, or approximately $12.9 million at an exchange rate of $1.37 per Euro. Our allowance for doubtful accounts and sales returns decreased to $0.8 million at September 30, 2014 from $1.0 million at December 31, 2013. The total days sales outstanding (DSO) ratio, based on average accounts receivable balances, was 77 for the nine month period ended September 30, 2014, compared to 80 for the nine month period ended September 30, 2013, as we continue to see improvement in international accounts receivable payment terms. However, as we continue to expand our operations internationally, our DSO ratio could increase again due to the fact that credit terms outside the U.S. tend to be relatively longer than those in the U.S. Inventory increased by $9.8 million during the first nine months ended September 30, 2014, compared to an increase of $9.3 million during the same period ended September 30, 2013, as we prepared for a number of new product launches.
Investing Activities - Investing activities used net cash of $13.6 million in the nine months ended September 30, 2014, as compared to $12.7 million in the nine months ended September 30, 2013. The primary contributor to the increase in investing activities cash outflow was our increased cash outlays for surgical instrumentation and manufacturing equipment, which were $12.8 million during the nine month period ended September 30, 2014, as compared to cash outlays of $12.2 million for purchases of surgical instrumentation and manufacturing equipment during the same period of 2013.
License technology
Our Taiwanese subsidiary, Exactech Taiwan, entered into a license agreement with the Industrial Technology Research Institute (ITRI) and the National Taiwan University Hospital (NTUH) for the rights to technology and patents related to the repair of cartilage lesions. As of September 30, 2014, we had paid approximately $2.1 million for the licenses, patents, and equipment related to this license agreement, as well as prepaid expenses, and we will make royalty payments when the technology becomes marketable. Using the technology, we plan to launch a cartilage repair program that will include a device and method for the treatment and repair of cartilage in the knee joint. It is expected that the project will require us to complete human clinical trials under the guidance of the Food & Drug Administration in order to obtain pre-market approval for the device in the United States. The agreement terms include a license fee based on the achievement of specific, regulatory milestones and a royalty arrangement based on sales once regulatory clearances are established.
Financing Activities - Financing activities used net cash of $9.3 million in the nine months ended September 30, 2014, as compared to $6.7 million in net cash provided for the nine months ended September 30, 2013. In the first nine months of 2014, we had net debt repayments of $13.0 million, due to the repayment of our line of credit balance, as compared to net borrowings of $4.3 million in the first nine months of 2013. Proceeds from the exercise of stock options provided cash of $3.8 million during the nine months ended September 30, 2014, as compared to $2.5 million during the nine months ended September 30, 2013, with the proceeds used to fund general working capital.
Long-term Debt
On February 24, 2012, we entered into a revolving credit and term loan agreement for a maximum aggregate principal amount of $100.0 million, referred to as the Credit Agreement, with SunTrust Bank, as Administrative Agent, issuing bank and swingline lender, and a syndicate of other lenders. The Credit Agreement is composed of a $30.0 million term loan facility and revolving credit line in an aggregate principal amount of up to $70.0 million, of which, a portion is a $5.0 million swingline facility. Interest on loans outstanding under the Credit Agreement is based, at our election, on a base rate, a Eurodollar Rate or an index rate, in each case plus an applicable margin. The Credit Agreement

21

expires on February 24, 2017. Additionally, the Credit Agreement contains financial covenants requiring that we maintain a leverage ratio of not greater than 2.50 to 1.00 and a fixed charge coverage ratio (as defined in the Credit Agreement) of not less than 2.00 to 1.00. As of September 30, 2014, we were in compliance with all financial covenants. For additional information regarding the Credit Agreement, please see note 6 - Debt to our audited consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2013.
Other Commitments and Contingencies
At September 30, 2014, we had outstanding commitments for the purchase of inventory, raw materials and supplies of $11.0 million and outstanding commitments for the purchase of capital equipment of $4.9 million. Purchases under our distribution agreements were $4.8 million during the nine months ended September 30, 2014.


22

CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS
This report contains various “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which represent the Company’s expectations or beliefs concerning future events, including, but not limited to, statements regarding growth in sales of the Company’s products, profit margins and the sufficiency of the Company’s cash flow for its future liquidity and capital resource needs. When used in this report, the terms “anticipate,” “believe,” “estimate,” “expect” and “intend” and words or phrases of similar import, as they relate to the Company or its subsidiaries or its management, are intended to identify forward-looking statements. These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the effect of competitive pricing, the Company’s dependence on the ability of its third-party suppliers to produce components on a cost-effective basis to the Company, significant expenditures of resources to maintain high levels of inventory, market acceptance of the Company’s products, the impact of the medical device excise tax, the outcome of litigation, the effects of governmental regulation, potential product liability risks and risks of securing adequate levels of product liability insurance coverage, and the availability of reimbursement to patients from health care payers for procedures in which the Company’s products are used. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors, including those factors discussed under “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2013 and each quarterly report on Form 10-Q we filed after this annual report. Exactech undertakes no obligation to update, and the Company does not have a policy of updating or revising, these forward-looking statements. Except where the context otherwise requires, the terms, “we”, “us”, “our”, “the Company,” or “Exactech” refer to the business of Exactech, Inc. and its consolidated subsidiaries.

23

Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are exposed to market risk from interest rates. For our cash and cash equivalents, a change in interest rates affects the amount of interest income that can be earned. For our debt instruments, changes in interest rates affect the amount of interest expense incurred. If our variable rates of interest increased by 1%, our debt service would increase by approximately $0.1 million for the remainder of 2014.
At September 30, 2014, we had one interest-rate swap agreement outstanding that converts variable-rate interest to fixed-rate interest based on three-month LIBOR. We entered into our interest rate swap to eliminate variability in future cash flows by converting LIBOR-based variable-rate interest payments into fixed-rate interest payments. We do not expect our interest rate swap will have a material impact on our results of operations, financial position or cash flows.
The table that follows provides information about our financial instruments that are sensitive to changes in interest rates, including debt obligations and the interest rate swap. The table presents principal cash flow by expected maturity dates and weighted average interest rates for our debt obligations and interest rate swap. We believe that the amounts presented reasonably approximate the financial instrument's respective fair market value as of September 30, 2014, and the weighted average interest rate is that experienced during the nine months ended September 30, 2014:
 
 
 
 
 
 
 
(in thousands, except percentages)
2014
2015
2016
2017
Thereafter
Total
Liabilities
 
 
 
 
 
 
Term loan at variable interest rate
$
750

$
3,000

$
3,000

$
17,250

$
—

$
24,000

Weighted average interest rate
1.8
%
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate Swap
 
 
 
 
 
 
Notional amount
 
 
 
27,000

 
 
Fixed rate interest
 
 
 
1.5
%
 
 
 
 
 
 
 
 
 
Foreign Currency Risk
We are exposed to market risk related to changes in foreign currency exchange rates. The functional currency of substantially all of our international subsidiaries is their local currency. Transactions are translated into U.S. Dollars (USD), and exchange gains and losses arising from translation are recognized in “Other comprehensive income (loss)”. Fluctuations in exchange rates affect our financial position and results of operations. The majority of our foreign currency exposure is to the Euro (EUR), British Pound (GBP), and Japanese Yen (JPY). During the nine months ended September 30, 2014, translation losses were $3.1 million, which were primarily due to the weakening of the JPY, EUR and GBP against the USD. During the nine months ended September 30, 2013, translation gains were $0.2 million.
Foreign Currency Transactions – The U.S. dollar is our primary currency, and transactions that are completed in a foreign currency are translated into U.S. dollars and recorded in the financial statements. We recognized currency transaction losses of $0.6 million for the nine months ended September 30, 2014, due to the weakening of the JPY, EUR and GBP as compared to the USD, and currency transaction losses of $0.3 million during the same period in 2013, which was due to the effect of amounts payable to us from our distribution offices in Japan and the UK and the weakening of the JPY and GBP as compared to the U.S. dollar. We currently believe that our exchange rate risk exposure is not material to our operations.
Foreign Currency Option – During September 2014, we entered into a foreign currency put option instrument to sell €5.0 million prior to December 31, 2014 as an economic hedge against strengthening of the U.S. Dollar (USD) against the Euro (EUR). We paid a premium of $108,500 for a strike price of 1.28 or, a $6.4 million call amount. The foreign currency option expires on December 31, 2014. During the quarter ended September 30, 2014, we recognized a gain of $107,000 on the condensed consolidated statements of income related to the fair value of this currency option based upon a dealer's quote.


24

Item 4. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and our Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of our disclosure controls and procedures, or “disclosure controls,” pursuant to Exchange Act Rule 13a-15(b). Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly report, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms. Disclosure controls include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Our disclosure controls include some, but not all, components of our internal control over financial reporting. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2014.
Changes in Internal Control over Financial Reporting
There have not been any changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 during the three months ended September 30, 2014, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

25

PART II.
OTHER INFORMATION
Item 1. Legal Proceedings
There are various claims, lawsuits, and disputes with third parties and pending actions involving various allegations against us incident to the operation of our business, principally product liability cases. While we believe that the various claims are without merit, we are unable to predict the ultimate outcome of such litigation. We therefore maintain insurance, subject to self-insured retention limits, for all such claims, and establish accruals for product liability and other claims based upon our experience with similar past claims, advice of counsel and the best information reasonably available. At September 30, 2014 and December 31, 2013, we had $110,000 and $135,000 accrued, respectively, for product liability claims. These product liability claims are subject to various uncertainties, and it is possible that they may be resolved unfavorably to us. While it is not possible to predict with certainty the outcome of the various cases, it is the opinion of management that, upon ultimate resolution, the cases will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Our insurance policies covering product liability claims must be renewed annually. Although we have been able to obtain insurance coverage for product liability claims at a cost and on other terms and conditions that have been acceptable to us, we may not be able to procure acceptable policies in the future.
Item 1A. Risk Factors
There have been no material changes to the risk factors set forth in Part I, Item 1A, of our Annual Report on Form 10-K for the year ended December 31, 2013.

26

Item 6. Exhibits
(a) Exhibit
 
Description
31.1
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
 
Certification of Chief Executive Officer pursuant to 18 USC Section 1350.
32.2
 
Certification of Chief Financial Officer pursuant to 18 USC Section 1350.
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase
101.LAB
 
XBRL Taxonomy Extension Label Linkbase
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase


27

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
  
 
Exactech, Inc.
 
 
 
 
Date:
November 5, 2014
By:
/s/ David Petty                                               
 
 
 
David Petty
 
 
 
Chief Executive Officer (principal executive officer) and President
 
 
 
 
Date:
November 5, 2014
By:
/s/ Joel C. Phillips                                             
 
 
 
Joel C. Phillips
 
 
 
Chief Financial Officer (principal financial officer and principal accounting officer) and
 
 
 
Treasurer

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