The following table includes: (i) items from the Statements of Income for the year ended December 31, 2012 as compared to 2011, and the dollar and percentage change from year to year and the percentage relationship to net sales, and (ii) items from the Statements of Income for the year ended December 31, 2011 as compared to 2010, and the dollar and percentage change from year to year and the percentage relationship to net sales:

  (dollars in                                                     2012 - 2011          2011 - 2010
thousands)                  Years Ended December 31,               Inc (decr)           Inc (decr)                 % of Sales
                        2012          2011          2010          $          %         $          %        2012       2011       2010
Net sales            $ 224,337     $ 205,397     $ 190,483     18,940       9.2     14,914       7.8     100.0  %   100.0  %   100.0  %
Cost of goods sold      68,731        64,847        63,961      3,884       6.0        886       1.4      30.6       31.6       33.6
Gross profit           155,606       140,550       126,522     15,056      10.7     14,028      11.1      69.4       68.4       66.4
Operating expenses:
Sales and marketing     81,979        77,243        66,123      4,736       6.1     11,120      16.8      36.5       37.6       34.7
General and
administrative          20,139        21,969        17,622     (1,830 )    (8.3 )    4,347      24.7       9.0       10.7        9.2
Research and
development             16,803        13,059        13,631      3,744      28.7       (572 )    (4.2 )     7.5        6.4        7.2
Depreciation and
amortization            15,343        14,455        10,744        888       6.1      3,711      34.5       6.8        7.0        5.6
Total operating
expenses               134,264       126,726       108,120      7,538       5.9     18,606      17.2      59.8       61.7       56.7
Income from
operations              21,342        13,824        18,402      7,518      54.4     (4,578 )   (24.9 )     9.5        6.7        9.7
Other income
(expense), net          (1,448 )        (514 )        (181 )     (934 )   181.7       (333 )   184.0      (0.6 )     (0.2 )     (0.1 )
Income before taxes     19,894        13,310        18,221      6,584      49.5     (4,911 )   (27.0 )     8.9        6.5        9.6
Provision for income
taxes                    7,153         4,484         7,756      2,669      59.5     (3,272 )   (42.2 )     3.2        2.2        4.1
Net income           $  12,741     $   8,826     $  10,465      3,915      44.4     (1,639 )   (15.7 )     5.7        4.3        5.5

Sales
Comparison of the years ended December 31, 2012 and 2011
For the year ended December 31, 2012, sales increased 9% to $224.3 million from
$205.4 million in the comparable twelve months ended December 31, 2011. The
following table includes the net sales for each of our product lines along with
the percentage of net sales, as well as a comparison of net sales change to net
sales change calculated on a constant currency basis for the years ended
December 31, 2012 and 2011:
                                                                                Constant Currency
                                  Years Ended                      % Change         % Change
 (in thousands)   December 31, 2012        December 31, 2011      2012-2011         2012-2011
Knee            $    81,387     36.3 %   $    80,088     39.0 %        1.6                3.1
Hip                  40,826     18.2          33,688     16.4         21.2               22.1
Biologics/Spine      24,463     10.9          24,341     11.9          0.5                1.6
Extremity            52,061     23.2          39,923     19.4         30.4               31.3
Other                25,600     11.4          27,357     13.3         (6.4 )             (4.5 )
Total           $   224,337    100.0 %   $   205,397    100.0 %        9.2               10.5

The increase in sales of knee implant products was related to the market acceptance of our Optetrak Logic system. Sales of our extremity products increased significantly as we continued to penetrate market share with our Equinoxe reverse shoulder system. Hip implant sales increased as we continued to experience market penetration with our Novation Element hip system. Our biologics and spine sales increase was a result of increased spinal revenues worldwide. The decrease in the sales of all other products was related to a reduction in sales of our surgical instrumentation sold outside the United States. Domestically, sales increased 9% to $145.6 million, or 65% of total sales, during the year ended December 31, 2012, up from $133.0 million, which also represented 65% of total sales during 2011. Internationally, sales increased 9% to $78.7 million, representing 35% of total sales, for the year ended

December 31, 2012, as compared to $72.4 million, which was also 35% of total sales during 2011. The international sales increase was primarily attributable to market growth in our direct sales operations. Comparison of the years ended December 31, 2011 and 2010 During 2011 sales increased 8% to $205.4 million for the year ended 2011 from $190.5 million in 2010. The following table includes the net sales for each of our product lines along with the percentage of net sales, as well as a comparison of net sales change to net sales change calculated on a constant currency basis for the years ended December 31, 2011 and 2010:

                                                                                Constant Currency
                                  Years Ended                      % Change         % Change
 (in thousands)   December 31, 2011        December 31, 2010      2011-2010         2011-2010
Knee            $    80,088     39.0 %   $    76,509     40.1 %        4.7                 3.1
Hip                  33,688     16.4          28,710     15.1         17.3                15.0
Biologics/Spine      24,341     11.9          27,987     14.7        (13.0 )             (13.7 )
Extremity            39,923     19.4          30,033     15.8         32.9                32.4
Other                27,357     13.3          27,244     14.3          0.4                (0.9 )
Total           $   205,397    100.0 %   $   190,483    100.0 %        7.8                 6.5

Sales of knee implant products increased as we continued the introduction of our Logic PS knee system. Sales of hip implant products increased due to the continued interest in our expanded Novation hip system. Our increase in extremities sales was due to the market acceptance of our Equinoxe shoulder replacement systems. Our reduction in our biologic and spine services sales was a result of a decrease in biologic revenues in the United States due to sales force transitions. Sales of other products remained relatively flat as a result of sales growth of our cement products offset by sales contraction from other products from our distributors. Internationally, net sales increased 24% to $72.4 million, representing 35% of total sales, from $58.5 million, or 31% of total sales, during 2010. The international sales growth was a result of our continued expansion efforts. Domestically, sales increased 1% during 2011 to $133.0 million from $132.0 million in 2010. Gross Profit
Gross profit increased 11% to $155.6 million for the year ended December 31, 2012 from $140.6 million for the year ended December 31, 2011. As a percentage of sales, gross profit increased to 69% during the year ended December 31, 2012 as compared to 68% in the same twelve month period in 2011, as a result of continued cost reductions in our internally manufactured products . Gross profit increased 11% to $140.6 million in 2011, or 68% gross profit margin, from $126.5 million, or 66% gross profit margin in 2010, which was primarily due to growth in our expanding higher margin direct international operations. During 2013, we anticipate that gross profit will decrease to a range from 67-68% due to the projected impact of the medical device excise tax implemented by the PPACA , which is 2.3% of medical device sales, or first use of product, in the United States.
Operating Expenses
Total operating expenses increased 6% to $134.3 million in the year ended December 31, 2012 from $126.7 million in the year ended December 31, 2011. As a percentage of sales, total operating expenses decreased to 60% for the twelve months ended December 31, 2012, as compared to 62% for the same period in 2011. The decrease as a percentage of sales is a result of lower compliance costs as well as our focus on reducing operating expenses. Included in operating expenses for the twelve months of 2012 is $2.3 million in compliance costs, compared to $4.5 million in the twelve months of 2011.
Sales and marketing expenses, the largest component of total operating expenses, increased 6% for the year ended December 31, 2012 to $82.0 million from $77.2 million in the comparable period of December 31, 2011. Sales and marketing expenses, as a percentage of sales, decreased slightly to 37% for the year ended December 31, 2012, from 38% for the year ended December 31, 2011. Sales and marketing expenses increased 17% in 2011 to $77.2 million from $66.1 million in 2010, as we continued our international growth efforts in direct distribution operations in Germany,

Spain, and Japan. Looking forward, sales and marketing expenditures, as a percentage of sales, are expected to be in the range of 36% to 37% for 2013. General and administrative expenses decreased 8% to $20.1 million in the twelve months ended December 31, 2012 from $22.0 million in the twelve months ended December 31, 2011, which included the $2.3 million and $4.5 million in compliance expenses for each of the periods, respectively. As a percentage of sales, general and administrative expenses decreased to 9% for the twelve months ended December 31, 2012, as compared to 11% in the year ended December 31, 2011. General and administrative expenses increased 25% to $22.0 million in 2011 from $17.6 million in 2010. The increase during 2011 was primarily due to increased compliance costs. During 2011, compliance spending increased to $4.5 million as compared to $1.3 million in 2010. As a percentage of sales, general and administrative expenses increased to 11% for the year ended December 31, 2011, as compared to 9% in the year ended December 31, 2010. General and administrative expenses for 2013 are expected to be in the range of 8% to 9% of sales for 2013.
Research and development expenses increased 29% for the year ended December 31, 2012 to $16.8 million from $13.1 million for 2011. As a percentage of sales, research and development expenses increased to 7% for the twelve months ended December 31, 2012 from 6% for the comparable period last year. The increase was due primarily to increased design and development activities, including our cartilage repair development project. Research and development expenses decreased 4% to $13.1 million in 2011 from $13.6 million in 2010, primarily as a result of lower prototype costs. As a percentage of sales, research and development expenses decreased to 6% for 2011 from 7% for 2010. We anticipate research and development expenditures, as a percent of sales, to range from 7% to 8% of sales during 2013.
Depreciation and amortization increased 6% to $15.3 million during the year ended December 31, 2012 from $14.5 million in the twelve months ended December 31, 2011, as a result of continuing investment in our operations and expanding surgical instrumentation deployment. As a percentage of sales, depreciation and amortization remained flat at 7% for the years ended December 31, 2012 and 2011. Total capital expenditure investment for 2012 was $22.4 million, which included $17.9 million of surgical instrumentation placed in service and approximately $1.4 million for patents and trademarks spent during the twelve months of 2012. Depreciation and amortization expenses increased 35% in 2011 to $14.5 million from $10.7 million in 2010, as we invested $24.9 million in capital expenditures, including $3.4 million to purchase manufacturing equipment, and $20.1 million in surgical instrumentation. Income from Operations
Our income from operations increased 54% to $21.3 million, or 10% of sales in the year ended December 31, 2012 from $13.8 million, or 7% of sales in the twelve month period ended December 31, 2011. The increase in our income from operations was a result of the increase in sales combined with our efforts to reduce our growth in expenses. Income from operations decreased 25% to $13.8 million in 2011 from $18.4 million in 2010, which was due to an increase in expenses related to compliance and legal costs, as well as increased expenses from our expanded international operations. As a percentage of sales, income from operations decreased to 7% in 2011 from 10% in 2010. Looking forward, we expect operating expenses to increase slower than sales growth however due to the reduction in gross profit margins as a result of the medical device excise tax, we anticipate income from operations to be in the range of 8% to 10% for 2013.
Other Income and Expenses
We had other expenses, net of other income, of $1.4 million during the year ended December 31, 2012, as compared to other expenses, net of other income of $0.5 million in the twelve months ended December 31, 2011. The decrease to net other expenses was primarily due to the reduction to net foreign currency loss of $0.1 million for 2012 from a foreign currency gain of $0.5 million for 2011. Net foreign currency activities during the twelve months ended December 31, 2012 consisted of $0.2 million in foreign currency transaction gains, offset by the realized loss of $0.3 million from our forward currency option hedge. Also contributing to the decrease was net interest expense, which increased for the twelve months ended December 31, 2012 to $1.4 million from $1.1 million during the twelve months ended December 31, 2011 due to increased full year average borrowing under our line of credit facility. Other expenses, net of other income, increased 184% to $0.5 million in 2011 from $0.2 million in 2010, primarily related to increased interest expense due to our increased line of credit balance, which was partially offset by gains on foreign currency transactions.

Taxes and Net Income
Income before provision for income taxes increased 49% to $19.9 million in the year ended December 31, 2012 from $13.3 million in the same period in 2011. The effective tax rate, as a percentage of income before taxes, was 36% for the twelve months ended December 31, 2012 and 34% for the same twelve month periods in 2011. The increase in the effective tax rate for the year ended was primarily due to the tax impact of the research and development tax credit that was effective for 2011 as opposed to having expired during 2012, and the change in estimate of the non-deductible portion of the 2010 DOJ settlement. Formerly, we anticipated that $0.6 million of this settlement was non-deductible and, as a result of IRS discussions with the DOJ in the second quarter of 2012, pursuant to an IRS audit being conducted for tax years 2009 and 2010, it was clarified that $1.3 million of this settlement was non-deductible resulting in $0.3 million of additional tax liability. We expect our effective tax rate to range from 28% to 31% for the first quarter of 2013, as a result of the retroactive renewal of the 2012 research and development tax credit, that was enacted on January 2, 2013, and will be a tax benefit during the first quarter of 2013. During the full year 2013, we anticipate an effective tax rate of 31 to 33%. As a result of the foregoing, we realized net income of $12.7 million in the year ended December 31, 2012, an increase of 44% from $8.8 million in the twelve months ended December 31, 2011. As a percentage of sales, net income increased to 6% from 4% during the year ended December 31, 2011. Earnings per share, on a diluted basis, increased to $0.96 for the twelve months ended December 31, 2012, from $0.67 for the twelve months ended December 31, 2011. Income before provision for income taxes decreased 27% in 2011 from 2010. The effective income tax rate, as a percentage of income before taxes, for 2011 was 34%, as compared to 43% in 2010. The decrease in the effective rate during 2011 was primarily due to a larger percentage of our sales and profits being in tax jurisdictions outside the U.S. with lower effective tax rates. As a result of the foregoing, we realized a decrease in net income of 16% in 2011 to $8.8 million, representing 4% of sales, and diluted earnings per share of $0.67, as compared to net income of $10.5 million, or 5% of sales and diluted earnings per share of $0.80, in 2010
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 December 31, 2012, we had working capital of $98.7 million, an increase of 7% from $92.2 million at the end of 2011. Working capital in 2012 increased primarily as a result of an increase in our current inventory balance, and was partially offset by increases in our accounts payable and accrued expenses associated with our expansion. We experienced overall increases in our current assets and liabilities due to our continued growth. We project that cash flows from operating activities, borrowing under our new line of credit, and the issuance of equity securities, in connection with both stock purchases under the 2009 ESPP and stock option exercises will be sufficient to meet our commitments and cash requirements in the next twelve months. If not, we will seek additional funding options with any number of possible combinations of additional debt, additional equity or convertible debt.
Operating Activities - Operating activities provided net cash of $27.5 million in the twelve months ended December 31, 2012, as compared to net cash from operations of $20.4 million during the twelve months ended December 31, 2011. A primary contributor to this change related to the increase in inventory of $8.0 million during the year ended December 31, 2012, compared to an increase of $1.2 million during the same period ended December 31, 2011, as a result of our product line and market expansions and the inventory return agreement discussed below. Expansion of accounts receivable used net cash of $0.5 million for the year ended December 31, 2012 and $7.3 million for the year ended December 31, 2011. A major contributor to the collection effort was our sales distribution office in Spain, which during the second quarter of 2012, received approximately 8.2 million EUR for substantially all of its accounts receivable aged six months or older. Our allowance for doubtful accounts and sales returns decreased to $1.0 million at December 31, 2012 from $3.2 million at December 31, 2011, principally as a result of the inventory return agreement with our former Spanish distributor, which resulted in the elimination of approximately $2.2 million in allowances for doubtful account and sales returns. See Note 7 of Notes to Consolidated Financial Statements for further discussion on the inventory return. The total days sales outstanding (DSO) ratio, based on average accounts receivable balances, was 75 for the twelve months ended December 31, 2012, which is flat when compared to the same ratio of 75 for the year ended December 31, 2011. As we continue to expand our operations internationally, our DSO ratio could increase, due to the fact that credit terms outside the U.S. tend to be relatively longer than those in the U.S.
In September 2012, we terminated the forward currency hedging option instrument, for a notional amount of 9.0 million EUR, which we had entered into during May 2012 as an offset to projected EUR accounts receivable payments through the second and third quarters of 2012. The hedge instrument was a combination call and put option that was due to expire on September 28, 2012, with a strike price of 1.25 USD/EUR and a maximum strike price of 1.3165 USD/EUR. For the twelve months ended December 31, 2012, we realized a loss of $0.3 million on the Consolidated Statements of Income related to the termination of this instrument.

Investing Activities - Investing activities used net cash of $22.2 million for the year ended December 31, 2012, as compared to $24.6 million for the year ended December 31, 2011. The decrease was due to a reduction of purchases of property and equipment. Our cash outlays for surgical instrumentation and manufacturing equipment was $20.6 million, and $1.4 million for purchases of patents, trademarks and product licenses during the year ended December 31, 2012, as compared to $22.2 million for purchases of surgical instrumentation and manufacturing equipment, and $0.9 million for purchases of product licenses during the same period of 2011.
During 2012, we invested $1.3 million in ongoing license and milestone payments to Blue Ortho related to the Guided Personalized Surgery knee technology. Distribution Subsidiary - Exactech Ibérica During the first quarter of 2010, we established a distribution subsidiary in Spain, Exactech Ibérica, S.A.. ("Exactech Ibérica"), and obtained our import registration allowing Exactech Ibérica to import our products for sale in Spain. Exactech Ibérica actively commenced distribution activities during the third quarter of 2010. The sales distribution subsidiary, based in Gijon, enables us to directly control our Spanish marketing and distribution operations. During the first quarter of 2010, we notified our previous independent distributor in Spain of the non-renewal of our distribution agreement. As a result of that non-renewal, our relationship with this independent distributor terminated during the third quarter of 2010. During the third quarter of 2012, we reached an inventory return agreement with our former Spanish distributor for a sales return of approximately $4.0 million, of which $3.0 million was previously recognized. The return was settled through a $1.5 million cash payment and settlement of the outstanding accounts receivable of $2.5 million. License technology
Our Taiwanese subsidiary, Exactech Taiwan, has entered into a license agreement with the Industrial Technology Research Institute (ITRI) and the National Taiwan University Hospital (NTUH) for the rights to technology and patents related to the repair of cartilage lesions. As of December 31, 2012, we had paid approximately $2.1 million for the licenses, patents, equipment related to this license agreement, and prepaid expenses, and we will make royalty payments when the technology becomes marketable. Using the technology, we plan to launch a cartilage repair program that will include a device and method for the treatment and repair of cartilage in the knee joint. 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. We are currently evaluating regulatory approval pathways for this technology. Financing Activities - Financing activities used net cash of $4.3 million for the year ended December 31, 2012, as compared to providing $5.0 million in net cash for the year ended December 31, 2011, primarily due to reduction in total outstanding debt. In 2012, we had net debt repayments of $5.5 million as compared to net borrowings of $3.8 million in 2011. Proceeds from the exercise of stock options provided cash of $1.9 million for the year ended December 31, 2012, as compared to $1.2 million for the year ended December 31, 2011, 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 million, referred to as the New . . .