**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**Form 10-K**

| x                                                                                                                                                                               | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| **For the fiscal year ended December 31, 2005**                                                                                                                            |
| 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 000-21326**

**Anika Therapeutics, Inc.**

*(Exact Name of Registrant asSpecified in Its Charter)*

| **Massachusetts**                                                 | ** ** | **04-3145961**                          |
|-------------------------------------------------------------------|------------|-----------------------------------------|
| *(State  or Other Jurisdiction of Incorporation or Organization)* | * *   | *(I.R.S.  Employer Identification No.)* |
| **160 New Boston Street, Woburn, Massachusetts  01801**           |
| *(Address  of Principal Executive Offices) (Zip Code)*            |
| **(781) 932-6616**                                           |
| *(Registrant’s  Telephone Number, Including Area Code)*      |

 

**Securitiesregistered pursuant to Section 12 (b) of the Act:  None**

**Securitiesregistered pursuant to Section 12 (g) of the Act:**Common Stock, par value$.01 per share

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o  No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o  No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15 (d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yesx  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definitions of “accelerated filer and largeaccelerated filer” in Rule 12b-2of the Securities Exchange Act

o  Large accelerated filer                     x  Accelerated filer                     o  Non-accelerated filer

Indicate by checkmarkwhether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o  No x

The aggregate market valueof voting and non-voting stock held by non-affiliates of the Registrant as of June 30,2005, the last day of the Registrant’s most recently completed second fiscalquarter, was $120,445,000 based on the close price per share of Common Stock of$11.49 as of such date as reported on the NASDAQ National Market. Shares of ourCommon Stock held by each executive officer, director and each person or entityknown to the registrant to be an affiliate have been excluded in that suchpersons may be deemed to be affiliates; such exclusion shall not be deemed toconstitute an admission that any such person is an “affiliate” of theregistrant. At March 1, 2006, there were issued and outstanding 10,529,330shares of Common Stock, par value $.01 per share.

**Documents Incorporated ByReference**

Certain informationrequired in response to Items 10, 11, 12, 13 and 14 of Part III are herebyincorporated by reference from the registrant’s Proxy Statement for the AnnualMeeting of Stockholders to be held on June 1, 2006. Such Proxy Statementshall not be deemed to be “filed” as part of this Annual Report on Form 10-Kexcept for the parts therein which have been specifically incorporated byreference herein.

 

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**ANIKATHERAPEUTICS, INC.**TABLE OF CONTENTS

|               | ** ** |                                                                                                                         | ** ** | **Page** | ** ** |
|---------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Part I   |       |                                                                                                                    |       |     |       |   |   |
| Item 1.  |       | Business                                                                                                                |       |     | 2          |   |   |
| Item 1A. |       | Risk Factors                                                                                                            |       |     | 11         |   |   |
| Item 1B. |       | Unresolved Staff  Comments                                                                                              |       |     | 22         |   |   |
| Item 2.  |       | Properties                                                                                                              |       |     | 22         |   |   |
| Item 3.  |       | Legal Proceedings                                                                                                       |       |     | 22         |   |   |
| Item 4.  |       | Submission of  Matters to a Vote of Security Holders                                                                    |       |     | 22         |   |   |
| Part II  |       |                                                                                                                    |       |     |       |   |   |
| Item 5.  |       | Market for the  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       |     | 23         |   |   |
| Item 6.  |       | Selected Financial  Data                                                                                                |       |     | 24         |   |   |
| Item 7.  |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |       |     | 26         |   |   |
| Item 7A. |       | Quantitative  and Qualitative Disclosures About Market Risk                                                             |       |     | 39         |   |   |
| Item 8.  |       | Financial  Statements and Supplementary Data                                                                            |       |     | 40         |   |   |
| Item 9.  |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                                   |       |     | 63         |   |   |
| Item 9A. |       | Controls and  Procedures                                                                                                |       |     | 63         |   |   |
| Item 9B. |       | Other Information                                                                                                       |       |     | 63         |   |   |
| Part III |       |                                                                                                                    |       |     |       |   |   |
| Item 10. |       | Directors and  Executive Officers of the Registrant                                                                     |       |     | 63         |   |   |
| Item 11. |       | Executive  Compensation                                                                                                 |       |     | 63         |   |   |
| Item 12. |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        |       |     | 64         |   |   |
| Item 13. |       | Certain  Relationships and Related Transactions                                                                         |       |     | 64         |   |   |
| Item 14. |       | Principal  Accountant Fees and Services                                                                                 |       |     | 64         |   |   |
| Part IV  |       |                                                                                                                    |       |     |       |   |   |
| Item 15. |       | Exhibits and  Financial Statement Schedules                                                                             |       |     | 64         |   |   |
| Signatures    |       |                                                                                                                    | 69         |     |       |

 

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**FORM 10-KANIKA THERAPEUTICS, INC.For Fiscal Year Ended December 31, 2005**

*This Annual Report on Form 10-K, includingthe documents incorporated by reference into this Annual Report on Form 10-K,contains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Actof 1934, including, without limitation, statements regarding:*

·       ourfuture sales and product revenues, including geographic expansions, possibleretroactive price adjustments, and expectations of unit volumes or otheroffsets to price reductions;

·       ourefforts to increase sales of ophthalmic viscoelastic products and support ofthe distribution of ORTHOVISCÒ in the U.S. and internationally;

·       ourmanufacturing capacity and efficiency gains and work-in-process manufacturingoperations;

·       thetiming of, scope of and rate of patient enrollment for clinical trials;

·       developmentof possible new products, including plans to advance cosmetic tissueaugmentation and post-surgical adhesion therapies into initial or additionalhuman clinical trials;

·       ourability to achieve or maintain compliance with laws and regulations;

·       thetiming of and/or receipt of FDA or other regulatory approvals and/orreimbursement approvals of new or potential products;

·       ourexpectation with respect to reimbursements of ORTHOVISC products under J code;

·       our intention to seekpatent protection for our products and processes;

·       negotiationswith potential and existing partners, including our performance under any ofour distribution or supply agreements or our expectations with respect to salesand milestones pursuant to such agreements;

·       thelevel of our revenue or sales in particular geographic areas and/or forparticular products;

·       themarket share for any of our products;

·       ourprofitability and margin improvements resulting from a higher margin productmix;

·       ourexpectations of the size of the U.S. and European markets for osteoarthritis ofthe knee;

·       ourintention to increase market share for ORTHOVISC in international and domesticmarkets or otherwise penetrate growing markets for osteoarthritis of the knee;

·       ourcurrent strategy, including our corporate objectives and research anddevelopment and collaboration opportunities, including, without limitation, commencement, completion and evaluation of cosmetictissue augmentation and INCERTÒ products;

·       oursearch for a partner for our cosmetic tissue augmentation product and ourefforts to continue development of the product;

·       ourand Bausch & Lomb’s performance under the existing supply agreementfor certain of our ophthalmic viscoelastic products;

·       ourability to achieve performance and sales threshold milestones in our existingand future distribution and supply agreements;

·       ourexpectations for ophthalmic products revenue;

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·       ourexpectation for increases in operating expenses;

·       ourexpectation for increases in capital expenditures;

·       our ability to maintain asufficient supply of HA to meet anticipated demands;

·       ourexpected tax rate and taxable revenues;

·       ourability and timing with respect to filling vacancies in management positions;

·       therate at which we use cash, the amounts used and generated by operations, andour expectation regarding the adequacy of such cash; and

·       possiblenegotiations or re-negotiations with existing or new distribution orcollaboration partners, including a partner for REDEFYNEÔ.

*Furthermore,additional statements identified by words such as “will,” “likely,” “may,” “believe,”“expect,” “anticipate,” “intend,” “seek,” “designed,” “develop,” “would,” “future,”“can,” “could” and other expressions that are predictions of or indicate futureevents and trends and which do not relate to historical matters, also identifyforward-looking statements.*

*You should not rely on forward-looking statementsbecause they involve known and unknown risks, uncertainties and other factors,some of which are beyond our control, including those factors described in thesection titled “Risk Factors” in this Annual Report on Form 10-K. Theserisks, uncertainties and other factors may cause our actual results,performance or achievement to be materially different from the anticipatedfuture results, performance or achievement, expressed or implied by theforward-looking statements. These forward-looking statements are based upon thecurrent assumptions of our management and are only expectations of futureresults. You should carefully review all of these factors, and you should beaware that there may be other factors that could cause these differences,including those factors discussed in the sections titled “Business” and “Management’sDiscussions and Analysis of Financial Condition and Results of Operations”elsewhere in this Annual Report on Form 10-K. We undertake noobligation to publicly update or revise any forward-looking statement toreflect changes in underlying assumptions or factors, of new information,future events or other changes.*

**PART I**

**ITEM 1.**                BUSINESS

**Overview**

Anika Therapeutics, Inc. (“Anika,” the “Company,”“we,” “us,” or “our”) develops, manufactures and commercializes therapeuticproducts  for tissue protection andhealing. These products are based on hyaluronic acid (HA), a naturallyoccurring, biocompatible polymer found throughout the body. Due to its uniquebiophysical and biochemical properties, HA plays an important role in a numberof physiological functions such as the protection and lubrication of softtissues and joints, the maintenance of the structural integrity of tissues, andthe transport of molecules to and within cells. Our currently manufactured andmarketed products consist of ORTHOVISC®, which is an HA product used in thetreatment of some forms of osteoarthritis in humans; AMVISC®, AMVISC® Plus, STAARVISCTM-II,and ShellGelÔ, each an injectable ophthalmic viscoelastic HAproduct; and HYVISC®,which is an HA product used in the treatment of equine osteoarthritis. In theU.S. ORTHOVISC is marketed by DePuy Mitek, a subsidiary of Johnson &Johnson (collectively, “JNJ”), under the terms of a licensing, distribution,supply and marketing agreement. Outside the US, ORTHOVISC has been approved forsale since 1996 and is marketed by distributors in over 15 countries. HYVISC ismarketed in the U.S. through Boehringer Ingelheim Vetmedica, Inc. Wedeveloped and manufacture AMVISC® and AMVISC® Plus for Bausch &Lomb Incorporated under a multiyear supply agreement.

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Potential products in development include REDEFYNEÔ,an HA based dermal filler used for cosmetic tissue augmentation (CTA)applications, and INCERT®, anHA based anti-adhesive for surgical applications. In September 2005, wefiled a Pre-Market Approval (PMA) application with the FDA seeking approval tomarket and sell REDEFYNE in the United States. We received *Conformité Européenne* marking (CEmarking), a foreign regulatory approval for commercial marketing and sale, forINCERT in the third quarter of 2004. We received CE marking approval for CTA inthe first quarter of 2006. In addition, we filed a pre-market approvalapplication in September 2005 for our CTA product.

Our currentstrategy is to:

·       supportU.S. ORTHOVISC sales growth and to expand ORTHOVISC sales internationally;

·       obtainPMA approval for REDEFYNE and sign a marketing agreement with a new partner;

·       developand implement a commercialization plan for INCERT®;

·       initiateadditional human clinical trials for new ORTHOVISC formulations;

·       focusresearch and development resources on evaluating potential productapplications, including possible collaborations with other parties; and

·       increasegross margins by upgrading manufacturing processes and efficiencies.

In 2005, revenue from the sale of our productscontributed 69% of our total revenue. Licensing, milestone and contract revenuecontributed 31% of our total revenue in 2005. Revenue from the sale ofophthalmic viscoelastic products was 51% of product revenue. ORTHOVISCcontributed 39% of our product revenue, and HYVISC contributed 10% of ourproduct revenue in 2005.

The following sectionsprovide more specific information on our products and related activities:

*ORTHOVISC*â

In the U.S., ORTHOVISC is indicated for the treatmentof pain in osteoarthritis of the knee in patients who have failed to respondadequately to conservative non-pharmacologic therapy and to simple analgesics,such as acetaminophen. Outside the U.S., ORTHOVISC has been approved for use inall joints in Europe and certain other international markets. It is a sterile,non-pyrogenic, clear, viscoelastic solution of natural hyaluronan dissolved inphysiological saline, and dispensed in a single-use syringe. A natural complexsugar of the glycosaminoglycan family, hyaluronan is a high molecular weightpolysaccharide composed of repeating disaccharide units of sodium glucuronateand N-acetylglucosamine. ORTHOVISC is injected into the knee joint in a seriesof three intra-articular injections one week apart.

Osteoarthritis is a debilitating disease causing pain,inflammation and restricted movement in joints. It occurs when the cartilage ina joint gradually deteriorates due to the effects of mechanical stress, whichcan be caused by a variety of factors including the normal aging process. In anosteoarthritic joint, particular regions of articulating surfaces are exposedto irregular forces, which result in the remodeling of tissue surfaces thatdisrupt the normal equilibrium or mechanical function. As osteoarthritisadvances, the joint gradually loses its ability to regenerate cartilage tissueand the cartilage layer attached to the bone deteriorates to the point whereeventually the bone becomes exposed. Advanced osteoarthritis often requiressurgery and the possible implantation of artificial joints. The currenttreatment options for osteoarthritis before joint replacement surgery includeviscosupplementation, analgesics, non-steroidal anti-inflammatory drugs andsteroid injections.

ORTHOVISC became available for sale in the U.S. on March 1,2004, and is marketed by DePuy Mitek, Inc., a subsidiary of Johnson &Johnson, under the terms of a ten-year licensing, distribution, supply andmarketing agreement (the “JNJ Agreement”). The JNJ Agreement was originallyentered into with Ortho Biotech Products, L.P., also a Johnson &Johnson company, and was assigned to DePuy Mitek in 

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mid-2005. Under theJNJ Agreement, DePuy Mitek performs sales, marketing and distribution functions.Additionally, DePuy Mitek has the right, under certain circumstances, tofurther develop and commercialize ORTHOVISC as well as other new products forthe treatment of pain associated with osteoarthritis based on our viscosupplementationtechnology. In support of the license, the JNJ Agreement provides that DePuyMitek will fund post-marketing clinical trials for new indications of ORTHOVISC.We received an initial payment of $2.0 million upon entering into the JNJAgreement, a milestone payment of $20.0 million in February 2004, as aresult of obtaining FDA approval of ORTHOVISC and a $5.0 million milestonepayment in December 2004 for planned upgrades to our manufacturingoperations for a total of $27.0 million. This amount was initially recorded asdeferred revenue, and is being recognized as revenue ratably over the agreement’sten year life. Under the JNJ Agreement, we are the exclusive supplier ofORTHOVISC to Depuy Mitek. The JNJ Agreement provides for additional sales-basedmilestone payments to us contingent upon achieving specified sales targets, inaddition to royalty and transfer fees. The JNJ Agreement is subject to earlytermination in certain circumstances and is otherwise renewable by DePuy Mitekfor consecutive five-year terms.

We have a number ofdistribution relationships servicing international markets including Canada,European countries, Turkey, and parts of the Middle East. We will continue toseek to establish long-term distribution relationships in other regions. Seethe section captioned *“Management’sDiscussion and Analysis of Financial Condition and Results of OperationsOverview”* and *“Risk Factors.”*

*HYVISC*â

HYVISC is a high molecularweight injectable HA product for the treatment of joint dysfunction in horsesdue to non-infectious synovitis associated with equine osteoarthritis. HYVISChas viscoelastic properties that lubricate and protect the tissues in horsejoints. HYVISC is distributed by Boehringer Ingelheim Vetmedica, Inc. inthe United States.

*OPHTHALMIC PRODUCTS*

The ophthalmic products wemanufacture include the AMVISC and AMVISC Plus product line,STAARVISC-II, and ShellGel. They are injectable, high molecular weight HAproducts used as viscoelastic agents in ophthalmic surgical procedures such ascataract extraction and intraocular lens implantation. These products coat,lubricate and protect sensitive tissue such as the endothelium, and maintainthe shape of the eye, thereby facilitating ophthalmic surgical procedures.

Anika manufactures the AMVISCproduct line for Bausch & Lomb under the terms of a supply agreementthrough December 31, 2010 (the 2004 B&L Agreement) for viscoelasticproducts used in ophthalmic surgery.  Under the 2004 B&L Agreement, we willcontinue to be the exclusive global supplier (other than with respect to Japan)for AMVISC and AMVISC Plus to Bausch & Lomb. The 2004 B&LAgreement also provides us with a right to negotiate to manufacture futuresurgical ophthalmic viscoelastic products developed by Bausch & Lomb,while Bausch & Lomb has been granted rights to commercialize certainfuture surgical ophthalmic viscoelastic products developed by us. The 2004B&L Agreement applies to all products sold by us to Bausch & Lombfrom the beginning of 2004, with a price increase that started in 2005. Underthe 2004 B&L Agreement, we are entitled to continue providing surgicalviscoelastic products to our existing customers (STAAR Surgical Company andCytosol Ophthalmics, Inc.) who currently receive such products from us. Ourformer distributor for CoEase, Advanced Medical Optics (“AMO”), completed theacquisition of the surgical ophthalmology business of Pfizer, Inc., in September 2004,which included a competing line of viscoelastic products for use in ocularsurgery. As a result, our agreement with AMO expired according to its terms in June 2005.See also the section captioned *“RiskFactors.”*

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**Researchand Development of Potential Products**

As discussed below in thesection titled *“Risk Factors,”* wehave not obtained FDA approval for the sales and marketing in the U.S. of thepotential products described below.

*Cosmetic TissueAugmentation*

REDEFYNETM, our product for cosmetic tissueaugmentation (CTA), is based on a family of chemically modified, cross-linkedforms of HA designed for longer duration in the body. Cosmetic tissueaugmentation is a therapy designed as a soft tissue filler for facial wrinkles,scar remediation and lip augmentation. This new class of tissue fillertechnology based on HA is intended to supplant collagen-based products and tocompete with other HA-based products currently on the market. In October 2005,we completed a pivotal U.S. clinical trial to evaluate CTA’s effectiveness forcorrecting nasolabial folds. The trial was conducted by dermatologists andplastic surgeons at 10 centers throughout the U.S. The six month primaryendpoint results of this trial were submitted to the U.S. Food and DrugAdministration (“FDA”) in a Pre-Market Approval (“PMA”) application in September 2005. In the firstquarter of 2006, we received CE markapproval to market REDEFYNE in the European Union.

In July 2004 weentered into an exclusive worldwide development and commercializationpartnership (the OrthoNeutrogena Agreement) for our CTA products with theOrthoNeutrogena division of Ortho-McNeil Pharmaceuticals, Inc., anaffiliate of Johnson & Johnson. Under the terms of the OrthoNeutrogenaAgreement, we received an initial payment of $1.0 million. In addition,OrthoNeutrogena, subject to certain limitations, funded our pivotal clinicaltrial of our CTA product completed in October 2005. On September 1, 2005, the Companyannounced that it had mutually agreed with OrthoNeutrogena to terminate itsdevelopment and commercialization agreement, and as noted above, we filed ourPMA with the FDA seeking approval to market and sell our CTA product in theUnited States. The Company will continue the development effort on a go forwardbasis which will be self-funded. We are currently seeking a worldwidedistribution partner for this product.

*INCERT*â

INCERT is a family of chemically modified,cross-linked forms of HA designed to prevent surgical adhesions. Surgicaladhesions occur when fibrous bands of tissues form between adjacent tissuelayers during the wound healing process. Although surgeons attempt to minimizethe formation of adhesions, they nevertheless occur quite frequently aftersurgery. Adhesions in the abdominal and pelvic cavity can cause particularlyserious problems such as intestinal blockage following abdominal surgery, andinfertility following pelvic surgery. Fibrosis following spinal surgery cancomplicate re-operation and may cause pain. We received CE marking for INCERTin the third quarter of 2004.

INCERT-S is our product designed to reducepost-surgical fibrosis following spinal surgery. We completed a pilot humanclinical trial in Europe in December 2005 involving patients undergoingspinal surgery, and demonstrated safety.

Anika co-owns issued U.S. patents covering the use ofINCERT for adhesion prevention. See the section captioned *“Patent and Propriety Rights.”*

We have received CEmarking for REDEFYNE and INCERT. We cannot assure you that: (1) we willsuccessfully obtain regulatory approval for sales in the U.S. orinternationally of our CTA or INCERT-S products; or (2) if regulatoryapprovals are obtained, meaningful sales of our CTA products or INCERT-S willbe achieved.

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**Manufacturing of Hyaluronic Acid**

We have been manufacturingHA since 1983 in our facility located in Woburn, Massachusetts. This facilityis approved by the FDA for the manufacture of medical devices and drugs. Wehave developed a proprietary manufacturing process for the extraction andpurification of HA from avian combs, a source of high molecular weight HA. Wehave taken steps to minimize risks associated with the availability of rawmaterials by obtaining regulatory approval to outsource certain key intermediatesfor our products. We believe that sufficient supplies of these materials aregenerally available, or maintained in inventory, to meet anticipated demand.

**Patent and Proprietary Rights**

We have a policy of seeking patent protection forpatentable aspects of our proprietary technology. Our issued patents expirebetween 2009 and 2022. We co-own certain U.S. patents and a patent applicationwith claims relating to the chemical modification of HA and certain adhesionprevention uses and certain drug delivery uses of HA. We also solely ownpatents covering composition of matter and certain manufacturing processes. Weintend to seek patent protection for products and processes developed in thecourse of our activities when we believe such protection is in our bestinterest and when the cost of seeking such protection is not inordinaterelative to the potential benefits. See also the section captioned *“Risk Factors—We may be unable to adequately protectour intellectual property rights.”*

Other entities have filed patent applications for orhave been issued patents concerning various aspects of HA-related products orprocesses. In addition, the products or processes we develop may infringe thepatent rights of others in the future. Any such infringement may have amaterial adverse effect on our business, financial condition, and results ofoperations. See also the section captioned *“RiskFactors—We may be unable to adequately protect our intellectual propertyrights.”*

We also rely upon trade secrets and proprietaryknow-how for certain non-patented aspects of our technology. To protect suchinformation, we require all employees, consultants and licensees to enter intoconfidentiality agreements limiting the disclosure and use of such information.These agreements, however, may not provide adequate protection. See also thesection captioned *“Risk Factors—We may beunable to adequately protect our intellectual property rights.”*

We have granted Bausch & Lomb a royalty-free,worldwide, non-exclusive license to our manufacturing inventions which relateto the AMVISC products, effective upon the earlier of (1) the terminationdate of the 2004 B&L Agreement or (2) the loss of our rights ofexclusivity thereunder.

We have granted DepuyMitek an exclusive, non-transferable royalty bearing license to use and sellORTHOVISC (and other products developed pursuant to the JNJ Agreement) in theU.S., as well as a license to manufacture and have manufactured such productsin the event that we are unable to supply them with products in accordance withthe terms of the JNJ Agreement.

**Government Regulation**

*United StatesRegulation*

Our research (including clinical research),development, manufacture, and marketing of products are subject to regulationby numerous governmental authorities in the U.S. and other countries. Medicaldevices are subject to extensive and rigorous regulation by the FDA and byother federal, state and local authorities. The Federal Food, Drug and CosmeticAct (FDC Act) governs the testing, safety, effectiveness, clearance, approval,manufacture, labeling, packaging, distribution, storage, record keeping,reporting, marketing, advertising, and promotion of our products. Noncompliancewith applicable requirements can result in, among other things, fines,injunctions, civil penalties, recall or seizure of 

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products, total or partialsuspension of production, failure of the government to grant premarketclearance or approval of products, withdrawal of clearances and approvals, andcriminal prosecution.

Medical products regulated by the FDA are generallyclassified as drugs, biologics, and/or medical devices. Medical devicesintended for human use are classified into three categories (Class I, IIor III), on the basis of the controls deemed reasonably necessary by the FDA toassure their safety and effectiveness. Class I devices are subject togeneral controls, for example, labeling and adherence to the FDA’s GoodManufacturing Practices/Quality System Regulation (GMP/QSR). Most Class Idevices are exempt from premarket notification. Class II devices aresubject to general and special controls (for example, performance standards,postmarket surveillance, and patient registries). Most Class II devicesare subject to premarket notification and may be subject to clinical testingfor purposes of premarket notification and clearance for marketing. Class IIIis the most stringent regulatory category for medical devices. Most Class IIIdevices require premarket approval (PMA) from the FDA.

AMVISC, ShellGel and STAARVISC are approved as Class IIImedical devices in the U.S. for ophthalmic surgical procedures in intraocularuse in humans. ORTHOVISC is approved as a Class III medical device in theU.S. for treatment of pain resulting from osteoarthritis of the knee in humans.HYVISC is approved as an animal drug for intra-articular injection in horsejoints to treat degenerative joint disease associated with synovitis. In thepast, most HA products for human use have been regulated as medical devices. Webelieve that our products for CTA and INCERT will have to meet the regulatoryrequirements of Class III devices, including PMA.

Unless a new device is exempted from premarketnotification, its manufacturer must obtain marketing clearance from the FDAthrough premarket notification (510(k)) or PMA before the device can beintroduced into the market. Product development and approval within the FDAregulatory framework takes a number of years and involves the expenditure ofsubstantial resources. This regulatory framework may change or additionalregulations may arise at any stage of our product development process and mayaffect approval of, or delay an application related to, a product, or requireadditional expenditures by us. There can be no assurance that the FDA review ofmarketing applications will result in product approval on a timely basis, if atall. The PMA approval process is lengthy, expensive, and typically requires,among other things, valid scientific evidence which generally includesextensive data such as pre-clinical and clinical trial data to demonstrate areasonable assurance of safety and effectiveness.

Human clinical trials for significant risk devicesmust be conducted under an Investigational Device Exemption (IDE), which mustbe submitted to the FDA and either be approved or be allowed to becomeeffective before the trials may commence. There can be no assurance thatsubmission of an IDE will result in the ability to commence clinical trials. Inaddition, the IDE approval process could result in significant delay. Even ifthe FDA approves an IDE or allows an IDE for a clinical investigation to becomeeffective, clinical trials may be suspended at any time for a number of reasons.Among others, thesereasons may include: a) failure to comply with applicable requirements; b)informed consent is inadequate; and c) the data generated suggests that:the risks to clinical subjects are not outweighed by the anticipated benefitsto clinical subjects and the importance of the knowledge to be gained, theinvestigation is scientifically unsound, or there is reason to believe that thedevice, as used, is ineffective. A trial may be terminated if anunanticipated adverse device effect presents an unreasonable risk to subjects. Ifclinical studies are suspended or terminated, we may be unable to continue thedevelopment of the investigational products affected.

Upon completion of required clinical trials, for Class IIImedical devices, results are presented to the FDA in a PMA application. Inaddition to the results of clinical investigations, the PMA applicant mustsubmit other information relevant to the safety and effectiveness of thedevice, including, among other things, the results of non-clinical tests; afull description of the device and its components; a full description of themethods, facilities and controls used for manufacturing; and proposed labeling.The FDA usually 

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also conducts an on-siteinspection to determine whether an applicant conforms with the FDA’s currentQuality System Regulation (QSR), formerly known as Good Manufacturing Practices(GMP/QSR). FDA review of the PMA may not result in timely or any PMA approval,and there may be significant conditions on approval, including limitations onlabeling and advertising claims and the imposition of post-market testing,tracking, or surveillance requirements.

Product changes after approval where such changeaffects safety and effectiveness as well as the use of a different facility formanufacturing, could necessitate additional review and approval by the FDA. Postapproval changes in labeling, packaging or promotional materials may alsonecessitate further review and approval by the FDA.

Legally marketed products are subject to continuingrequirements by the FDA relating to manufacturing, quality control and qualityassurance, maintenance of records and documentation, reporting of adverseevents, and labeling and promotion. The FDC Act requires device manufacturersto comply with GMP/QSR. The FDA enforces these requirements through periodicinspections of device manufacturing facilities. In complying with standards setforth in the GMP/QSR regulations, manufacturers must continue to expend time,money and effort in the area of production and quality control to ensure fulltechnical compliance. Other federal, state, and local agencies may inspectmanufacturing establishments as well.

A set of regulations known as the Medical DeviceReporting regulations obligates manufacturers to inform FDA wheneverinformation reasonably suggests that one of their devices may have caused orcontributed to a death or serious injury, or when one of their devicesmalfunctions and if the malfunction were to recur, the device or a similardevice would be likely to cause or contribute to a death or serious injury.

The process of obtaining approvals from the FDA andforeign regulatory authorities can be costly, time consuming, and subject tounanticipated delays. Approvals of our products, processes or facilities maynot be granted on a timely basis or at all, and we may not have availableresources or be able to obtain the financing needed to develop certain of suchproducts. Any failure or delay in obtaining such approvals could adverselyaffect our ability to market our products in the U.S. and in other countries.

In addition to regulationsenforced by the FDA, we are subject to regulation under the Occupational Safetyand Health Act, the Environmental Protection Act, the Toxic Substances ControlAct, the Resource Conservation and Recovery Act and other existing and futurefederal, state and local laws and regulations as well as those of foreigngovernments. Federal, state and foreign regulations regarding the manufactureand sale of medical products are subject to change. We cannot predict whatimpact, if any, such changes might have on our business.

*Foreign Regulation*

In addition to regulationsenforced by the FDA, we and our products are subject to certain foreignregulations. International regulatory bodies often establish regulationsgoverning product standards, packing requirements, labeling requirements,import restrictions, tariff regulations, duties and tax requirements. ORTHOVISCis approved for sale and is marketed in Canada, Europe, Turkey, and parts ofthe Middle East. In Europe, ORTHOVISC is sold under *Conformité Européene* (CE mark) authorization, acertification required under European Union (EU) medical device regulations. TheCE mark, achieved in 1996, allows ORTHOVISC to be marketed without furtherapprovals in most of the EU nations as well as other countries that recognizeEU device regulations. In August 2004, we received an EC DesignExamination Certificate which entitled us to affix a CE mark to INCERT-S as abarrier to adhesion formation following surgery. AMVISC® and AMVISC® Plus are CEmarked, and in May 2005, we received an EC Design Examination Certificatewhich entitled us to affix a CE mark to ShellGelÔas an ophthalmic viscoelastic surgical device. We may not be able to achieveand/or maintain compliance 

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requiredfor CE marking or other foreign regulatory approvals for any or all of ourproducts. The requirements relating to the conduct of clinical trials, productlicensing, marketing, pricing, advertising, promotion and reimbursement alsovary widely from country to country.

**Competition**

We compete with many companies, including, amongothers, large pharmaceutical firms and specialized medical products companies. Manyof these companies have substantially greater financial and other resources,larger research and development staffs, more extensive marketing andmanufacturing organizations and more experience in the regulatory process thanus. We also compete with academic institutions, governmental agencies and otherresearch organizations, which may be involved in research, development andcommercialization of products. Many of our competitors also compete against usin securing relationships with collaborators for their research and developmentand commercialization programs.

Competition in ourindustry is based primarily on product efficacy, safety, timing and scope ofregulatory approvals, availability of supply, marketing and sales capability,reimbursement coverage, product pricing and patent protection. Some of theprincipal factors that may affect our ability to compete in our HA developmentand commercialization market include:

·       thequality and breadth of our technology and technological advances;

·       ourability to complete successful clinical studies and obtain FDA marketing andforeign regulatory approvals prior to our competitors;

·       ourability to recruit and retain skilled employees; and

·       theavailability of substantial capital resources to fund discovery, developmentand commercialization activities or the ability to defray such costs throughsecuring relationships with collaborators for our research and development andcommercialization programs.

We are aware of severalcompanies that are developing and/or marketing products utilizing HA for avariety of human applications. In some cases, competitors have already obtainedproduct approvals, submitted applications for approval or have commenced humanclinical studies, either in the U.S. or in certain foreign countries. Thereexists major worldwide competing HA based products for the use in ophthalmicsurgery and orthopedics. In early 2004, the FDA approved two HA products forthe treatment of facial wrinkles which has been marketed internationally since1996. There is a risk that we will be unable to compete effectively against ourcurrent or future competitors.

**Research and Development**

Our research and development efforts primarily consistof the development of new medical applications for our HA-based technology, themanagement of clinical trials for certain product candidates, and thepreparation and processing of applications for regulatory approvals at allrelevant stages of development. Our development focus includes chemicallymodified formulations of HA designed for longer residence time in the body. Theseefforts are presently accomplished primarily through in-house research anddevelopment personnel and resources, as well as through collaboration withother companies and scientific researchers. As of December 31, 2005, wehad ten employees engaged primarily in research and development andengineering, and three employees engaged in clinical and regulatory matters. Forthe years ended December 31, 2005, 2004, and 2003, these expenses were$4.7 million, $4.1 million, and $2.6 million, respectively. We anticipatethat we will continue to commit significant resources to research anddevelopment, including clinical trials, in the future.

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There is a risk that ourefforts will not be successful in (1) developing our existing productcandidates, (2) expanding the therapeutic applications of our existingproducts, or (3) resulting in new applications for our HA technology. Thereis also a risk that we may choose not to pursue development of potentialproduct candidates. We may not be able to obtain regulatory approval for anynew applications we develop. Furthermore, even if all regulatory approvals areobtained, there can be no assurances that we will achieve meaningful sales ofsuch products or applications.

**Employees**

As of December 31,2005, we had approximately 65 full-time employees. We consider our relationswith our employees to be good. None of our employees are represented by laborunions.

**Environmental Laws**

We believe that we are incompliance with all federal, state and local environmental regulations withrespect to our manufacturing facilities and that the cost of ongoing compliancewith such regulations does not have a material effect on our operations. Ourleased manufacturing facility is located within the Wells G&H Superfundsite in Woburn, MA. We have not been named and are not a party to any suchlegal proceedings regarding the Wells G&H Superfund site.

**Product Liability**

The testing, marketing andsale of human health care products entail an inherent risk of allegations ofproduct liability, and we cannot assure you that substantial product liabilityclaims will not be asserted against us. Although we have not received anymaterial product liability claims to date and have coverage under our insurancepolicy of $5,000,000 per occurrence and $5,000,000 in the aggregate, we cannotassure you that if material claims arise in the future, our insurance will beadequate to cover all situations. Moreover, we cannot assure you that suchinsurance, or additional insurance, if required, will be available in thefuture or, if available, will be available on commercially reasonable terms. Anyproduct liability claim, if successful, could have a material adverse effect onour business, financial condition, and results of operation.

**Recent Developments**

In November 2005, the Centers for Medicare andMedicaid Services (CMS) announced they would not implement their previous decisionto merge into a single J code all HA products designed for treatment ofosteoarthritis, and that the same J codes used in 2005 would continue to beused in 2006. As a result, the Company expects physician reimbursement forOrthoVisc in 2006 to continue to be covered under a miscellaneous J code.

In January 2006, theCompany announced Mr. Raymond J. Land’s appointment to the board ofdirectors as an independent director, and Mr. Samuel F. McKay’s retirementfrom the board of directors. Mr. Land was also appointed chairman of theaudit committee.

**Available Information**

Our Annual Reports on Form 10-K, includingour consolidated financial statements, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and other information, includingamendments and exhibits to such reports, filed or furnished pursuant to theSecurities Exchange Act of 1934, are available free of charge in the “SECFilings” section of our website located at http://www.anikatherapeutics.com, assoon as reasonably practicable after the reports are filed with or furnished tothe Securities and Exchange Commission. The information on our website is notpart of this Form 10-K.

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**ITEM 1A.**        RISKFACTORS

Our operating results andfinancial condition have varied in the past and could in the future varysignificantly depending on a number of factors. From time to time, informationprovided by us or statements made by our employees contain “forward-looking”information that involves risks and uncertainties. In particular, statementscontained in this Form 10-K, and in the documents incorporated byreference into this Form 10-K, that are not historical facts,including, but not limited to statements concerning new products, productdevelopment and offerings, product and price competition, competition andstrategy, customer diversification, product price and inventory, contingentconsideration payments, deferred revenues, economic and market conditions,potential government regulation, seasonal factors, international expansion,revenue recognition, profits, growth of revenues, composition of revenues, costof revenues, operating expenses, sales, marketing and support expenses, generaland administrative expenses, product gross profit, interest income, anticipatedoperating and capital expenditure requirements, cash inflows, contractualobligations, tax rates, SFAS 123R, leasing and subleasing activities,acquisitions, liquidity, litigation matters, intellectual property matters,distribution channels, stock price, third party licenses and potential debt orequity financings constitute forward-looking statements and are made under thesafe harbor provisions of Section 27 of the Securities Act of 1933 asamended, and Section 21E of the Securities Exchange Act of 1934, asamended. These statements are neither promises nor guarantees. Our actualresults of operations and financial condition have varied and could in thefuture vary significantly from those stated in any forward-looking statements.The following factors, among others, could cause actual results to differmaterially from those contained in forward-looking statements made in this Form 10-K,in the documents incorporated by reference into this Form 10-K orpresented elsewhere by our management from time to time. Such factors, amongothers, could have a material adverse effect upon our business, results ofoperations and financial condition.

***Our business issubject to comprehensive and varied government regulation and, as a result,failure to obtain FDA or other governmental approvals for our products maymaterially adversely affect our business, results of operations and financialcondition.***

Product development and approval within the FDA frameworktakes a number of years and involves the expenditure of substantial resources. Therecan be no assurance that the FDA will grant approval for our new products on atimely basis if at all, or that FDA review will not involve delays that willadversely affect our ability to commercialize additional products or expandpermitted uses of existing products, or that the regulatory framework will notchange, or that additional regulation will not arise at any stage of ourproduct development process which may adversely affect approval of or delay anapplication or require additional expenditures by us. In the event our futureproducts are regulated as human drugs or biologics, the FDA’s review process ofsuch products typically would be substantially longer and more expensive thanthe review process to which they are currently subject as devices.

Our HA productsunder development, including a product for the cosmetic tissue augmentationmarket (CTA), and INCERT®,a product designed to prevent surgical adhesions, have not obtained U.S.regulatory approval for commercial marketing and sale. We received *Conformité Européenne* marking (CEmarking), a foreign regulatory approval for commercial marketing and sale, forINCERT in the third quarter of 2004. We received CE marking approval for CTA inthe first quarter of 2006. In addition, we filed a pre-market approvalapplication in September 2005 for our CTA product. We cannot assure youthat:

·       wewill begin or successfully complete U.S. clinical trials for these products;

·       theclinical data will support the efficacy of these products;

·       wewill be able to successfully complete the FDA or foreign regulatory approvalprocess, where required; or

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·       additionalclinical trials will support a PMA application and/or FDA approval or otherforeign regulatory approvals, where required, in a timely manner or at all.

We also cannotassure you that any delay in receiving FDA approvals will not adversely affectour competitive position. Furthermore, even if we do receive FDA approval:

·       theapproval may include significant limitations on the indications and otherclaims sought for use for which the products may be marketed;

·       theapproval may include other significant conditions of approval such aspost-market testing, tracking, or surveillance requirements; and

·       meaningfulsales may never be achieved.

Once obtained, marketing approval can be withdrawn bythe FDA for a number of reasons, including, among others, the failure to complywith regulatory standards, or the occurrence of unforeseen problems followinginitial approval. We may be required to make further filings with the FDA undercertain circumstances. The FDA’s regulations require a PMA supplement forcertain changes if they affect the safety and effectiveness of an approveddevice, including, but not limited to, new indications for use, labelingchanges, the use of a different facility to manufacture, process or package thedevice, and changes in performance or design specifications. Changes inmanufacturing procedures or methods of manufacturing that may affect safety andeffectiveness may be deemed approved after a 30-day notice unless the FDArequests a 135-day supplement. Our failure to receive approval of a PMAsupplement regarding the use of a different manufacturing facility or any otherchange affecting the safety or effectiveness of an approved device on a timelybasis, or at all, may have a material adverse effect on our business, financialcondition, and results of operations. The FDA could also limit or prevent themanufacture or distribution of our products and has the power to require therecall of such products. Significant delay or cost in obtaining, or failure toobtain FDA approval to market products, any FDA limitations on the use of ourproducts, or any withdrawal or suspension of approval or rescission of approvalby the FDA could have a material adverse effect on our business, financialcondition, and results of operations.

In addition, all FDA approved or cleared productsmanufactured by us must be manufactured in compliance with the FDA’s GoodManufacturing Practices (GMP) regulations and, for medical devices, the FDA’sQuality System Regulations (QSR). Ongoing compliance with QSR and otherapplicable regulatory requirements is enforced through periodic inspection bystate and federal agencies, including the FDA. The FDA may inspect us and ourfacilities from time to time to determine whether we are in compliance withregulations relating to medical device and manufacturing companies, includingregulations concerning manufacturing, testing, quality control and productlabeling practices. We cannot assure you that we will be able to comply withcurrent or future FDA requirements applicable to the manufacture of products.

FDA regulations depend heavily on administrativeinterpretation and we cannot assure you that the future interpretations made bythe FDA or other regulatory bodies, with possible retroactive effect, will notadversely affect us. In addition, changes in the existing regulations oradoption of new governmental regulations or policies could prevent or delayregulatory approval of our products.

Failure to comply with applicable regulatoryrequirements could result in, among other things, warning letters, fines,injunctions, civil penalties, recall or seizure of products, total or partialsuspension of production, refusal of the FDA to grant pre-market clearance orpre-market approval for devices, withdrawal of approvals and criminalprosecution.

In addition to regulations enforced by the FDA, we aresubject to other existing and future federal, state, local and foreignregulations. International regulatory bodies often establish regulationsgoverning 

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product standards, packingrequirements, labeling requirements, import restrictions, tariff regulations,duties and tax requirements. We cannot assure you that we will be able toachieve and/or maintain compliance required for CE marking or other foreignregulatory approvals for any or all of our products or that we will be able toproduce our products in a timely and profitable manner while complying withapplicable requirements. Federal, state, local and foreign regulationsregarding the manufacture and sale of medical products are subject to change. Wecannot predict what impact, if any, such changes might have on our business.

The process of obtainingapprovals from the FDA and other regulatory authorities can be costly, timeconsuming, and subject to unanticipated delays. We cannot assure you thatapprovals or clearances of our products will be granted or that we will havethe necessary funds to develop certain of our products. Any failure to obtain,or delay in obtaining such approvals or clearances, could adversely affect ourability to market our products.

***Substantial competition could materially affect ourfinancial performance.***

We compete with manycompanies, including, among others, large pharmaceutical companies andspecialized medical products companies. Many of these companies havesubstantially greater financial and other resources, larger research anddevelopment staffs, more extensive marketing and manufacturing organizationsand more experience in the regulatory process than us. We also compete withacademic institutions, governmental agencies and other research organizationsthat may be involved in research, development and commercialization of products.Because a number of companies are developing or have developed HA products forsimilar applications and have received FDA approval, the successfulcommercialization of a particular product will depend in part upon our abilityto complete clinical studies and obtain FDA marketing and foreign regulatoryapprovals prior to our competitors, or, if regulatory approval is not obtainedprior to competitors, to identify markets for our products that may besufficient to permit meaningful sales of our products. For example, we areaware of several companies that are developing and/or marketing productsutilizing HA for a variety of human applications. In some cases, competitorshave already obtained product approvals, submitted applications for approval orhave commenced human clinical studies, either in the U.S. or in certain foreigncountries. There exist major competing products for the use of HA in ophthalmicsurgery. In addition, certain HA products for the treatment of osteoarthritisin the knee have received FDA approval before us and have been marketed in theU.S. since 1997, as well as select markets in Canada, Europe and othercountries. In early 2004 the FDA approved two HA products for the treatment offacial wrinkles which has been marketed internationally since 1996. There canbe no assurance that we will be able to compete against current or futurecompetitors or that competition will not have a material adverse effect on ourbusiness, financial condition and results of operations.

***We are uncertain regarding the success of our clinicaltrials.***

Several of our productswill require clinical trials to determine their safety and efficacy for U.S.and international marketing approval by regulatory bodies, including the FDA. Wecompleted a pilot human clinical trial in Europe for INCERT-S in December 2005and completed a pivotal clinical trial for our product for CTA in October 2005.There can be no assurance that we will be able to successfully complete theU.S. regulatory approval process for either INCERT-S or our CTA product. Inaddition, there can be no assurance that we will not encounter additionalproblems that will cause us to delay, suspend or terminate the clinical trials.In addition, we cannot make any assurance that such clinical trials, ifcompleted, will ultimately demonstrate these products to be safe andefficacious.

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***We are dependentupon marketing and distribution partners and the failure to maintain strategicalliances on acceptable terms will have a material adverse effect on ourbusiness, financial condition and results of operations.***

Our success will be dependent, in part, upon theefforts of our marketing partners and the terms and conditions of ourrelationships with such marketing partners.

We cannot assure you that such marketing partners willnot seek to renegotiate their current agreements on terms less favorable to us.Under the terms of the 2004 B&L Agreement, effective December 15,2004, we will continue to be Bausch & Lomb’s exclusive global supplier(other than with respect to Japan) of AMVISC and AMVISC Plus ophthalmicviscoelastic products. The B&L Agreement expires December 31, 2010,and superseded an existing supply contract with Bausch & Lomb that wasset to expire December 31, 2007. The new contract also provides us with aright to negotiate to manufacture future surgical ophthalmic viscoelasticproducts developed by Bausch & Lomb, while Bausch & Lomb hasbeen granted rights to commercialize certain future surgical ophthalmicviscoelastic products developed by us. In addition, under certaincircumstances, Bausch & Lomb has the right to terminate the agreement,and/or the agreement may revert to a non-exclusive basis; in each case, wecannot make any assurances that such circumstances will not occur. For theyears ended December 31, 2005 and 2004, sales of AMVISC products to Bausch &Lomb accounted for 31% and 32% of total revenues, respectively.

Our distributor for CoEase, Advanced Medical Optics,completed its previously announced acquisition of the surgical ophthalmologybusiness of Pfizer, Inc. in June 2004, which includes a competingline of viscoelastic products for use in ocular surgery. As a result, ouragreement with Advanced Medical Optics was not renewed and terminated in June 2005upon its expiration. Sales to Advanced Medical Optics were less than 1% oftotal revenue for 2005 compared to 8% of total revenue for 2004 orapproximately $2.2 million.  As a result,in the future we may not be able to sustain current product revenue levels inour ophthalmic business.

We have entered into various agreements for thedistribution of ORTHOVISC internationally which are subject to terminationunder certain circumstances. We are continuing to seek to establish long-termdistribution relationships in regions not covered by existing agreements, butcan make no assurances that we will be successful in doing so. There can be no assurance that we will be able toidentify or engage appropriate distribution or collaboration partners oreffectively transition to any such partners. There can be no assurance that wewill obtain European or other reimbursement approvals or, if such approvals areobtained, they will be obtained on a timely basis or at a satisfactory level ofreimbursement.

In December 2003 we entered into a ten-yearlicensing and supply agreement with Ortho Biotech Products, L.P., a member ofthe Johnson & Johnson family of companies, to market ORTHOVISC in theU.S. and Mexico. This agreement was assigned to DePuy Mitek, Inc. in mid-2005.Under this Agreement, DePuy Mitek performs sales, marketing and distributionfunctions. Additionally, DePuy Mitek has the right under certain circumstances,to further develop and commercialize ORTHOVISC as well as other new products forthe treatment of pain associated with osteoarthritis based on ourviscosupplementation technology. We cannot assure you that Depuy Mitek will beable to market ORTHOVISC effectively or to establish sales levels to the extentthat Anika and Depuy Mitek believe are possible in the timeframes expected, orat all, nor can we assure you that we will be able to achieve the performance-and sales- based milestones provided in the JNJ Agreement. For the year ended December 31,2004, sales of ORTHOVISC to Depuy Mitek and royalties tied to end-user salesaccounted for 18% of total revenue. Furthermore, we cannot predict whether thelicense granted to Depuy Mitek in the JNJ Agreement to further develop andcommercialize ORTHOVISC products for the treatment of pain associated withosteoarthritis based on our viscosupplementation technology will result in anynew products or indications for use.

On July 26, 2004, we announced the signing of anexclusive worldwide development and commercialization partnership with OrthoNeutrogenaa division of Ortho-McNeil Pharmaceuticals, Inc., an affiliate of Johnson &Johnson, for our CTA therapy products. On September 1, 2005, the Company 

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announcedthat it had mutually agreed with OrthoNeutrogena to terminate its developmentand commercialization agreement, and that we were seeking a new worldwidedistribution partner. Also on September 1, 2005, we announced we had filedour PMA with the FDA seeking approval to market and sell our CTA product in theUnited States. There can be no assurance that we will successfullycomplete the FDA approval process. If we are able to successfully complete theFDA approval process for our CTA product, we cannot assure you that we will beable to successfully find a distribution partner and commercialize our CTAproduct effectively, or at all.

We may need to obtain theassistance of additional marketing partners to bring new and existing productsto market and to replace certain marketing partners. The failure to establishstrategic partnerships for the marketing and distribution of our products onacceptable terms will have a material adverse effect on our business, financialcondition, and results of operations.

***Our future success depends upon market acceptance ofour existing and future products.***

Our success will depend inpart upon the acceptance of our existing and future products by the medicalcommunity, hospitals and physicians and other health care providers, andthird-party payers. Such acceptance may depend upon the extent to which themedical community perceives our products as safer, more effective orcost-competitive than other similar products. Ultimately, for our new productsto gain general market acceptance, it may also be necessary for us to developmarketing partners for the distribution of our products. There can be noassurance that our new products will achieve significant market acceptance on atimely basis, or at all. Failure of some or all of our future products toachieve significant market acceptance could have a material adverse effect onour business, financial condition, and results of operations.

***We may be unable to adequately protect ourintellectual property rights.***

Our success will depend, in part, on our ability toobtain and enforce patents, protect trade secrets, obtain licenses totechnology owned by third parties when necessary, and conduct our businesswithout infringing on the proprietary rights of others. The patent positions ofpharmaceutical, medical products and biotechnology firms, including ours, canbe uncertain and involve complex legal and factual questions. There can be noassurance that any patent applications will result in the issuance of patentsor, if any patents are issued, whether they will provide significantproprietary protection or commercial advantage, or will not be circumvented byothers. In the event a third party has also filed one or more patentapplications for any of its inventions, we may have to participate ininterference proceedings declared by the United States Patent and TrademarkOffice (PTO) to determine priority of invention, which could result in failureto obtain, or the loss of, patent protection for the inventions and the loss ofany right to use the inventions. Even if the eventual outcome is favorable tous, such interference proceedings could result in substantial cost to us, anddiversion of management’s attention away from our operations. Filing andprosecution of patent applications, litigation to establish the validity andscope of patents, assertion of patent infringement claims against others andthe defense of patent infringement claims by others can be expensive and timeconsuming. There can be no assurance that in the event that any claims withrespect to any of our patents, if issued, are challenged by one or more thirdparties, that any court or patent authority ruling on such challenge willdetermine that such patent claims are valid and enforceable. An adverse outcomein such litigation could cause us to lose exclusivity covered by the disputedrights. If a third party is found to have rights covering products or processesused by us, we could be forced to cease using the technologies or marketing theproducts covered by such rights, could be subject to significant liabilities tosuch third party, and could be required to license technologies from such thirdparty. Furthermore, even if our patents are determined to be valid,enforceable, and broad in scope, there can be no assurance that competitorswill not be able to design around such patents and compete with us using theresulting alternative technology.

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We have a policy of seeking patent protection forpatentable aspects of our proprietary technology. We intend to seek patentprotection with respect to products and processes developed in the course ofour activities when we believe such protection is in our best interest and whenthe cost of seeking such protection is not inordinate. However, no assurancecan be given that any patent application will be filed, that any filedapplications will result in issued patents or that any issued patents willprovide us with a competitive advantage or will not be successfully challengedby third parties. The protections afforded by patents will depend upon theirscope and validity, and others may be able to design around our patents.

Other entities have filed patent applications for orhave been issued patents concerning various aspects of HA-related products orprocesses. There can be no assurance that the products or processes developedby us will not infringe on the patent rights of others in the future. Any such infringementmay have a material adverse effect on our business, financial condition, andresults of operations. In particular, we received notice from the PTO in 1995that a third party was attempting to provoke a patent interference with respectto one of our co-owned patents covering the use of INCERT for post-surgicaladhesion prevention. It is unclear whether an interference will be declared. Ifan interference is declared it is not possible at this time to determine themerits of the interference or the effect, if any, the interference will have onour marketing of INCERT for this use. No assurance can be given that we wouldbe successful in any such interference proceeding. If the third-partyinterference were to be decided adversely to us, involved claims of our patentwould be cancelled, our marketing of the INCERT product may be materially andadversely affected and the third party may enforce patent rights against uswhich could prohibit the sale and use of INCERT products, which could have amaterial adverse effect on our future operating results.

We also rely upon trade secrets and proprietaryknow-how for certain non-patented aspects of our technology. To protect suchinformation, we require all employees, consultants and licensees to enter intoconfidentiality agreements limiting the disclosure and use of such information.There can be no assurance that these agreements provide meaningful protectionor that they will not be breached, that we would have adequate remedies for anysuch breach, or that our trade secrets, proprietary know-how, and ourtechnological advances will not otherwise become known to others. In addition,there can be no assurance that, despite precautions taken by us, others havenot and will not obtain access to our proprietary technology. Further, therecan be no assurance that third parties will not independently developsubstantially equivalent or better technology.

Pursuant to the 2004B&L Agreement, we have agreed to transfer to Bausch & Lomb, uponexpiration of the term of the 2004 B&L agreement on December 31, 2010,or in connection with earlier termination in certain circumstances, ourmanufacturing process, know-how and technical information, which relate to onlyAMVISC products. Upon expiration of the 2004 B&L Agreement, there can be noassurance that Bausch & Lomb will continue to use us to manufactureAMVISC and AMVISC Plus. If Bausch & Lomb discontinues the use of us asa manufacturer after such time, our business, financial condition, and resultsof operations would likely be materially and adversely affected.

***Our manufacturingprocesses involve inherent risks and disruption could materially adverselyaffect our business, financial condition and results of operations.***

Our results of operations are dependent upon the continuedoperation of our manufacturing facility in Woburn, Massachusetts. The operationof biomedical manufacturing plants involves many risks, including the risks ofbreakdown, failure or substandard performance of equipment, the occurrence ofnatural and other disasters, and the need to comply with the requirements ofdirectives of government agencies, including the FDA. In addition, we rely on asingle supplier for syringes and a small number of suppliers for a number ofother materials required for the manufacturing and delivery of our HA products.Although we believe that alternative sources for many of these and othercomponents and raw materials that we use in our manufacturing processes areavailable, any supply interruption could harm our ability to 

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manufacture our productsuntil a new source of supply is identified and qualified. We may not be able tofind a sufficient alternative supplier in a reasonable time period, or oncommercially reasonable terms, if at all, and our ability to produce and supplyour products could be impaired.

Furthermore, our manufacturing processes and researchand development efforts involve animals and products derived from animals. Weprocure our animal-derived raw materials from qualified vendors, control forcontamination and have processes that effectively inactivate infectious agents;however, we cannot assure you that we can completely eliminate the risk oftransmission of infectious agents and in the future regulatory authoritiescould impose restrictions on the use of animal-derived raw materials that couldimpact our business.

The utilization of animalsin research and development and product commercialization is subject toincreasing focus by animal rights activists. The activities of animal rightsgroups and other organizations that have protested animal based research anddevelopment programs or boycotted the products resulting from such programscould cause an interruption in our manufacturing processes and research anddevelopment efforts. The occurrence of material operational problems, includingbut not limited to the events described above, could have a material adverseeffect on our business, financial condition, and results of operations duringthe period of such operational difficulties.

***Our financial performancedepends on the continued growth and demand for our products and we may not beable to successfully manage the expansion of our operations***

Our future successdepends on substantial growth in product sales. There can be no assurance thatsuch growth can be achieved or, if achieved, can be sustained. There can be noassurance that even if substantial growth in product sales and the demand forour products is achieved, we will be able to:

·       developthe necessary manufacturing capabilities;

·       obtainthe assistance of additional marketing partners;

·       attract,retain and integrate the required key personnel;

·       implementthe financial, accounting and management systems needed to manage growingdemand for our products.

Our failure tosuccessfully manage future growth could have a material adverse effect on ourbusiness, financial condition, and results of operations.

***If we engage in anyacquisition as a part our growth strategy, we will incur a variety of costs,and may never realize the anticipated benefits of the acquisition.***

Our business strategy mayinclude the future acquisition of businesses, technologies, services orproducts that we believe are a strategic fit with our business. If we undertakeany acquisition, the process of integrating an acquired business, technology,service or product may result in unforeseen operating difficulties andexpenditures and may absorb significant management attention that wouldotherwise be available for ongoing development of our business. Moreover, wemay fail to realize the anticipated benefits of any acquisition as rapidly asexpected or at all. Future acquisitions could reduce stockholders’ ownership,cause us to incur debt, expose us to future liabilities and result inamortization expenses related to intangible assets with definite lives. Inaddition, acquisitions involve other risks, including diversion of managementresources otherwise available for ongoing development of our business and risksassociated with entering new markets with which we have limited experience orwhere experienced distribution alliances are not available. Our futureprofitability may depend in part upon our ability to develop further ourresources to adapt to these new products or business areas and to identify andenter into satisfactory 

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distributionnetworks. We may not be able to identify suitable acquisition candidates in thefuture or consummate future acquisitions.

***Sales of ourproducts are largely dependent upon third party reimbursement and ourperformance may be harmed by health care cost containment initiatives.***

In the U.S. and othermarkets, health care providers, such as hospitals and physicians, that purchasehealth care products, such as our products, generally rely on third partypayers, including Medicare, Medicaid and other health insurance and managedcare plans, to reimburse all or part of the cost of the health care product. Wedepend upon the distributors for our products to secure reimbursement andreimbursement approvals. Reimbursement by third party payers may depend on anumber of factors, including the payer’s determination that the use of ourproducts is clinically useful and cost-effective, medically necessary and notexperimental or investigational. Since reimbursement approval is required fromeach payer individually, seeking such approvals can be a time consuming andcostly process which, in the future, could require us or our marketing partnersto provide supporting scientific, clinical and cost-effectiveness data for theuse of our products to each payer separately. Significant uncertainty exists asto the reimbursement status of newly approved health care products, and anyfailure or delay in obtaining reimbursement approvals can negatively impactsales or our new products. In addition, third party payers are increasinglyattempting to contain the costs of health care products and services bylimiting both coverage and the level of reimbursement for new therapeuticproducts and by refusing in some cases to provide coverage for uses of approvedproducts for disease indications for which the FDA has not granted marketingapproval. Also, Congress and certain state legislatures have considered reformsthat may affect current reimbursement practices, including controls on healthcare spending through limitations on the growth of Medicare and Medicaidspending. There can be no assurance that third party reimbursement coveragewill be available or adequate for any products or services developed by us. Outsidethe U.S., the success of our products is also dependent in part upon theavailability of reimbursement and health care payment systems. Lack of adequatecoverage and reimbursement provided by governments and other third party payersfor our products and services, including continued classification by CMS ofORTHOVISC under a miscellaneous J-code for Medicare/Medicaid reimbursement,could have a material adverse effect on our business, financial condition, andresults of operations.

***We may seekfinancing in the future, which could be difficult to obtain and which could diluteyour ownership interest or the value of your shares.***

We had cash andcash equivalents of approximately $44.7 million at December 31, 2005. Ourfuture capital requirements and the adequacy of available funds will depend,however, on numerous factors, including:

·       marketacceptance of our existing and future products;

·       thesuccess and sales of ORTHOVISC under the JNJ Agreement;

·       thesuccessful commercialization of products in development;

·       progressin our product development efforts;

·       themagnitude and scope of such product development efforts;

·       progresswith preclinical studies, clinical trials and product clearances by the FDA andother agencies;

·       thecost and timing of our efforts to manage our manufacturing capabilities andrelated costs;

·       thecost of filing, prosecuting, defending and enforcing patent claims and otherintellectual property rights;

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·       competingtechnological and market developments;

·       thedevelopment of strategic alliances for the marketing of certain of ourproducts;

·       theterms of such strategic alliances, including provisions (and our ability tosatisfy such provisions) that provide upfront and/or milestone payments to us;and

·       thecost of maintaining adequate inventory levels to meet current and futureproduct demands.

To the extent that fundsgenerated from our operations, together with our existing capital resources areinsufficient to meet future requirements, we will be required to obtainadditional funds through equity or debt financings, strategic alliances withcorporate partners and others, or through other sources. The terms of anyfuture equity financings may be dilutive to you and the terms of any debtfinancings may contain restrictive covenants, which limit our ability to pursuecertain courses of action. Our ability to obtain financing is dependent on thestatus of our future business prospects as well as conditions prevailing in therelevant capital markets. No assurance can be given that any additionalfinancing will be made available to us or will be available on acceptable termsshould such a need arise.

***We could becomesubject to product liability claims, which, if successful, could materiallyadversely affect our business, financial condition and results of operations.***

The testing, marketing andsale of human health care products entail an inherent risk of allegations ofproduct liability, and there can be no assurance that substantial productliability claims will not be asserted against us. Although we have not receivedany material product liability claims to date and have an insurance policy of$5,000,000 per occurrence and $5,000,000 in the aggregate to cover such claimsshould they arise, there can be no assurance that material claims will notarise in the future or that our insurance will be adequate to cover allsituations. Moreover, there can be no assurance that such insurance, oradditional insurance, if required, will be available in the future or, ifavailable, will be available on commercially reasonable terms. Any productliability claim, if successful, could have a material adverse effect on ourbusiness, financial condition and results of operations.

***Our business is dependent upon hiring and retainingqualified management and scientific personnel.***

We are highly dependent onthe members of our management and scientific staff, the loss of one or more ofwhom could have a material adverse effect on us. We experienced a number ofmanagement changes in 2004 and 2005. There can be no assurances that suchmanagement changes will not adversely affect our business. We believe that ourfuture success will depend in large part upon our ability to attract and retainhighly skilled, scientific, managerial and manufacturing personnel. We facesignificant competition for such personnel from other companies, research andacademic institutions, government entities and other organizations. There canbe no assurance that we will be successful in hiring or retaining the personnelwe require. The failure to hire and retain such personnel could have a materialadverse effect on our business, financial condition and results of operations.

***We are subject toenvironmental regulation and any failure to comply with applicable laws couldsubject us to significant liabilities and harm our business.***

We are subject to avariety of local, state and federal government regulations relating to thestorage, discharge, handling, emission, generation, manufacture and disposal oftoxic, or other hazardous substances used in the manufacture of our products. Anyfailure by us to control the use, disposal, removal or storage of hazardouschemicals or toxic substances could subject us to significant liabilities,which could have a material adverse effect on our business, financialcondition, and results of operations.

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***Our future operating results may be harmed byeconomic, political and other risks relating to international sales.***

During the years ended December 31,2005 and 2004, approximately, 43% and 30%, respectively, of our product saleswere to international distributors. Our representatives, agents anddistributors who sell products in international markets are subject to the lawsand regulations of the foreign jurisdictions in which they operate and in whichour products are sold. A number of risks are inherent in international salesand operations. For example, the volume of international sales may be limitedby the imposition of government controls, export license requirements,political and/or economic instability, trade restrictions, changes in tariffs,difficulties in managing international operations, import restrictions andfluctuations in foreign currency exchange rates. Such changes in the volume ofsales may have a material adverse effect on our business, financial condition,and results of operations.

***Our stock price hasbeen and may remain highly volatile, and we cannot assure you that marketmaking in our common stock will continue.***

The market price of shares of our common stock may behighly volatile. Factors such as announcements of new commercial products ortechnological innovations by us or our competitors, disclosure of results ofclinical testing or regulatory proceedings, governmental regulation andapprovals, developments in patent or other proprietary rights, public concernas to the safety of products developed by us and general market conditions mayhave a significant effect on the market price of our common stock. The tradingprice of our common stock could be subject to wide fluctuations in response toquarter-to-quarter variations in our operating results, material announcementsby us or our competitors, governmental regulatory action, conditions in thehealth care industry generally or in the medical products industryspecifically, or other events or factors, many of which are beyond our control.In addition, the stock market has experienced extreme price and volumefluctuations which have particularly affected the market prices of many medicalproducts companies and which often have been unrelated to the operatingperformance of such companies. Our operating results in future quarters may bebelow the expectations of equity research analysts and investors. In suchevent, the price of our common stock would likely decline, perhapssubstantially.

No person is under anyobligation to make a market in the common stock or to publish research reportson us, and any person making a market in the common stock or publishingresearch reports on us may discontinue market making or publishing such reportsat any time without notice. There can be no assurance that an active public marketin our common stock will be sustained.

***Our charter documents contain anti-takeover provisionsthat may prevent or delay an acquisition of us.***

Certain provisions of ourRestated Articles of Organization and Amended and Restated By-laws could havethe effect of discouraging a third party from pursuing a non-negotiatedtakeover of us and preventing certain changes in control. These provisionsinclude a classified Board of Directors, advance notice to the Board ofDirectors of stockholder proposals, limitations on the ability of stockholdersto remove directors and to call stockholder meetings, the provision thatvacancies on the Board of Directors be filled by vote of a majority of theremaining directors. In addition, the Board of Directors adopted a ShareholdersRights Plan in April 1998. We are also subject to Chapter 110F of theMassachusetts General Laws which, subject to certain exceptions, prohibits aMassachusetts corporation from engaging in any of a broad range of businesscombinations with any “interested stockholder” for a period of three yearsfollowing the date that such stockholder became an interested stockholder. Theseprovisions could discourage a third party from pursuing a takeover of us at aprice considered attractive by many stockholders, since such provisions couldhave the effect of preventing or delaying a potential acquirer from acquiringcontrol of us and our Board of Directors.

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***Our revenues arederived from a small number of customers, the loss of which could materiallyadversely affect our business, financial condition and results of operations.***

We have historicallyderived the majority of our revenues from a small number of customers, most ofwhom resell our products to end users and most of whom are significantly largercompanies than us. For the year ended December 31, 2005, three customersaccounted for 78% of product revenue. While it is expected that our ability tomarket ORTHOVISC in the U.S. will reduce our dependence on revenues from Bausch &Lomb, historically our largest customer, we will still be dependent on a smallnumber of large customers for the majority of our revenues. Our failure togenerate as much revenue as expected from these customers or the failure ofthese customers to purchase our products would seriously harm our business. Inaddition, if present and future customers terminate their purchasingarrangements with us, significantly reduce or delay their orders, or seek torenegotiate their agreements on terms less favorable to us, our business,financial condition, and results of operations will be adversely affected. Ifwe accept terms less favorable than the terms of the current agreement, suchrenegotiations may have a material adverse effect on our business, financialcondition, and/or results of operations. Furthermore, we may be subject to theperceived or actual leverage the customers may have given their relative sizeand importance to us in any future negotiations. Any termination, change,reduction or delay in orders could seriously harm our business, financialcondition, and results of operations. Accordingly, unless and until wediversify and expand our customer base, our future success will significantlydepend upon the timing and size of future purchases by our largest customersand the financial and operational success of these customers. The loss of anyone of our major customers or the delay of significant orders from suchcustomers, even if only temporary, could reduce or delay our recognition ofrevenues, harm our reputation in the industry, and reduce our ability toaccurately predict cash flow, and, as a consequence, could seriously harm ourbusiness, financial condition, and results of operations.

***Additional costsfor complying with recent and proposed future changes in Securities and ExchangeCommission, Nasdaq Stock Market and accounting rules could adverselyaffect our profits.***

Recent and future changesin the Securities and Exchange Commission and Nasdaq rules, as well as changesin accounting rules, will cause us to incur additional costs includingprofessional fees, as well as additional personnel costs, in order to keepinformed of the changes and operate in a compliant manner. In addition, we haveand continue to expect to incur general and administrative expense as wemaintain compliance with Section 404 of the Sarbanes-Oxley Act of 2002,which requires management to report on, and our independent registered publicaccounting firm to attest to, our internal controls. These costs may besignificant enough to cause our financial position and results of operations tobe negatively impacted. In addition, compliance with these new rules couldalso result in continued diversion of management’s time and attention, whichcould prove to be disruptive to our normal business operations. Failure tocomply with any of the new laws and regulations could adversely impact marketperception of our company, which could make it difficult to access the capitalmarkets or otherwise finance our operations in the future.

***With new rules,including the Sarbanes-Oxley Act of 2002, we may have difficulty in retainingor attracting directors for the board and various sub-committees thereof orofficers.***

The recent changes in SECand Nasdaq rules, including those resulting from the Sarbanes-Oxley Act of2002, may result in our being unable to attract and retain the necessary boarddirectors and members of sub-committees thereof or officers, to effectivelyprovide for our management. The perceived increased personal risk associatedwith these recent changes may deter qualified individuals from wanting toparticipate in these roles.

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***We may havedifficulty obtaining adequate directors and officers insurance and the cost forcoverage may significantly increase.***

We may have difficulty inobtaining adequate directors’ and officers’ insurance to protect us and ourdirectors and officers from claims made against them. Additionally, even ifadequate coverage is available, the costs for such coverage may besignificantly greater than current costs. This additional cost may have asignificant effect on our profits and as a consequence our results ofoperations may be adversely affected.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

We have received nowritten comments regarding our periodic or current reports from the staff ofthe Securities and Exchange Commission that were issued 180 days or morepreceding the end of our 2005 fiscal year and that remain unresolved.

**ITEM 2.**                PROPERTIES

Our corporate headquartersis located in Woburn, Massachusetts, where we lease approximately 10,000 squarefeet of administrative and research and development space. We extended ourlease for this facility in 2004 for a term ending in December 2006. Wealso lease approximately 37,000 square feet of space at a separate location inWoburn, Massachusetts, for our manufacturing facility and warehouse. Thisfacility has received all FDA and state regulatory approvals to operate as asterile device and drug manufacturer. We extended our lease for this facilityin 2003 for an additional five-year term ending in February 2009. For theyear ended December 31, 2005, we had aggregate lease costs ofapproximately $724,000.

**ITEM 3.**                LEGALPROCEEDINGS

None.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of the securityholders during the fourth quarter of the fiscal year covered by this report.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**COMMON STOCK INFORMATION**

Ourcommon stock has traded on the Nasdaq National Market since November 25,1997, under the symbol “ANIK.” The following table sets forth, for the periodsindicated, the high and low sales prices of our common stock on the NasdaqNational Market. These prices represent prices between dealers and do notinclude retail mark-ups, markdowns, or commissions and may not necessarilyrepresent actual transactions. 

| **Year Ended December 31, 2005** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                        |       | $13.49     |       | $8.05    |       |
| Second Quarter                                       |       | 17.21      |       | 11.06    |       |
| Third Quarter                                        |       | 14.49      |       | 10.13    |       |
| Fourth Quarter                                       |       | 13.45      |       | 10.15    |       |

 

| **Year Ended December 31, 2004** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                        |       | $          | 11.87      |     | $          | 6.48    |       |
| Second Quarter                                       |       | 17.87      |       | 8.18     |       |
| Third Quarter                                        |       | 17.45      |       | 10.01    |       |
| Fourth Quarter                                       |       | 15.75      |       | 7.89     |       |
|                                                      |            |            |            |          |            |         |            |  |  |

 

At December 31, 2005, the closing price per shareof our common stock was $11.69 as reported on the Nasdaq National Market andthere were approximately 253 holders of record.

We have never declared orpaid any cash dividends on our common stock. We currently intend to retainearnings, if any, for use in our business and do not anticipate paying cashdividends on our common stock in the foreseeable future. Payment of futuredividends, if any, on our common stock will be at the discretion of our Boardof Directors after taking into account various factors, including our financialcondition, operating results, anticipated cash needs, and plans for expansion.

**EQUITYCOMPENSATION PLAN INFORMATION**

Thefollowing table sets forth information concerning the Company’s equitycompensation plan as of December 31, 2005.

| ** **                                                  | ** ** | **Equity Compensation Plan Information** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Plan category**                                      | ** ** | ** **                                              | ** ** | **Number of securities  to be issued upon  exercise of outstanding  options,warrants and rights** | ** ** | **Weighted Average  exercise price  of outstanding  options, warrants and rights** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in  column (a))** | ** ** |
| ** **                                                  | ** ** | ** **                                              | ** ** | **(a)** | ** ** | **(b)** | ** ** | **(c)** | ** ** |
| Equity  compensation plans approved by security holders     |       |                                                    | 1,797,344  | ** ** |   |   | $ | 5.80 | ** ** |   |   | 625,576 | ** ** |   |
| Equity  compensation plans not approved by security holders |       |                                                    | —     | ** ** |   |   | — | ** ** |   |   | — | ** ** |   |
| Total                                                       |       |                                                    | 1,797,344  | ** ** |   |   | $ | 5.80 | ** ** |   |   | 625,576 | ** ** |   |

 

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**ITEM 6.**                SELECTEDFINANCIAL DATA

The following selected consolidated financial datashould be read in conjunction with the Consolidated Financial Statements andthe Notes thereto and Management’s Discussion and Analysis of Financial Conditionand Results of Operations included elsewhere in this Annual Report. The BalanceSheet Data at December 31, 2005 and 2004 and the Statement of OperationsData for each of the three years ended December 31, 2005 have been derivedfrom the audited Consolidated Financial Statements for such years, includedelsewhere in this Annual Report. The Balance Sheet Data at December 31,2003, 2002 and 2001, and the Statement of Operations Data for each of the twoyears in the period ended December 31, 2002 have been derived from theaudited Consolidated Financial Statements for such years, not included in thisAnnual Report.

TheConsolidated Financial Statements for fiscal year 2001 were audited by ArthurAndersen LLP (Andersen) who has ceased operations.

**Statementof Operations Data(In thousands, except per share data)**

| ** **                                  | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Product revenue                             |       | $                                           | 20,534     |   | $ | 22,286 |   | $ | 15,330 |   | $ | 13,129 |   | $ | 11,299 |   |
| Licensing,  milestone and contract revenue  |       | 9,301                                       |       | 4,180 |   | 74 |   | 58 |   | 13 |   |
| Total revenue                               |       | 29,835                                      |       | 26,466 |   | 15,404 |   | 13,187 |   | 11,312 |   |
| Cost of product  revenue                    |       | 11,144                                      |       | 9,949 |   | 8,005 |   | 8,109 |   | 8,229 |   |
| Product gross  profit                       |       | 9,390                                       |       | 12,337 |   | 7,325 |   | 5,020 |   | 3,070 |   |
| Product gross  margin                       |       | 46                                          | %          | 55 | % | 48 | % | 38 | % | 27 | % |
| Total operating  expenses                   |       | 21,284                                      |       | 20,078 |   | 14,809 |   | 16,462 |   | 18,723 |   |
| Net income (loss)                           |       | $                                           | 5,893      |   | $ | 11,190 |   | $ | 827 |   | $ | (3,040 | ) | $ | (6,758 | ) |
| Diluted net  income (loss) per common share |       | $                                           | 0.52       |   | $ | 0.98 |   | $ | 0.08 |   | $ | (0.31 | ) | $ | (0.68 | ) |
| Diluted common shares  outstanding          |       | 11,428                                      |       | 11,384 |   | 10,850 |   | 9,934 |   | 9,934 |   |

 

**BalanceSheet Data(In thousands)**

| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Cash and cash  equivalents               |       | $                     | 44,747     |   | $ | 39,339 |   | $ | 14,592 |   | $ | 11,002 |   | $ | 9,065 |   |
| Marketable  securities                   |       | —                |       | — |   | — |   | 2,500 |   | 3,994 |   |
| Working capital                          |       | 46,584                |       | 42,135 |   | 18,450 |   | 14,921 |   | 16,756 |   |
| Total assets                             |       | 62,618                |       | 59,538 |   | 21,873 |   | 20,087 |   | 22,916 |   |
| Retained earnings  (accumulated deficit) |       | 3,514                 |       | (2,379 | ) | (13,569 | ) | (14,396 | ) | (11,357 | ) |
| Treasury stock                           |       | —                |       | — |   | (27 | ) | (280 | ) | (280 | ) |
| Stockholders’ equity                |       | 37,892                |       | 30,363 |   | 17,984 |   | 17,064 |   | 20,104 |   |
|                                          |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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On September 1, 2005, the Company announced thatit had mutually agreed with OrthoNeutrogena to terminate its development andcommercialization agreement. Under the terms of the termination agreement, wereceived a termination payment of $3.1 million from ONI including $0.8 millionfor all outstanding clinical study costs incurred and committed to by theCompany at the termination date. Given that there was no continuing performanceobligations with respect to the development and commercialization agreement orthe related termination agreement, all amounts were recognized as contractrevenue during the third quarter of 2005, including $0.3 million of previouslydeferred revenue under the performance-based model.

In the first quarter of 2004, based on ourexpectations regarding future profitability, we released the previouslyestablished valuation allowance against our deferred tax assets and recorded aone-time income tax benefit of $7.0 million.

We received an initial payment of $2.0 million in December 2003upon entering into the JNJ Agreement. In February 2004 we received amilestone payment of $20.0 million as a result of obtaining FDA approval forORTHOVISC, and in December 2004 we received a milestone payment of $5.0million upon completion of certain manufacturing upgrades. We are recognizingthese non-refundable payments as license revenue ratably over the expected termof the JNJ Agreement, which is currently 10 years, and as of December 31,2005, we had recorded deferred revenue of $21.6 million related to the JNJAgreement.

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**ITEM7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*The following section of this Annual Report on Form 10-Ktitled “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” contains statements that are not statements of historical factand are forward-looking statements within the meaning of the federal securitieslaws. These statements involve known and unknown risks, uncertainties, andother factors that may cause our actual results, performance, or achievement todiffer materially from anticipated results, performance, or achievement,expressed or implied in such forward-looking statements. These statementsreflect our current views with respect to future events and are based on assumptionsand subject to risks and uncertainties. We discuss many of these risks anduncertainties at the beginning of this Annual Report on Form 10-Kand under the heading “Business” and “Risk Factors”  The following discussion should also be readin conjunction with the Consolidated Financial Statements of Anika Therapeutics, Inc.and the Notes thereto appearing elsewhere in this report.*

**Management Overview**

Anika Therapeutics, Inc.(“Anika,” the “Company,” “we,” “us” or “our”) develops, manufactures and commercializestherapeutic products fortissue protection and healing. These products are based on hyaluronicacid (HA), a naturally occurring, biocompatible polymer found throughout thebody. Due to its unique biophysical and biochemical properties, HA plays animportant role in a number of physiological functions such as the protectionand lubrication of soft tissues and joints, the maintenance of the structuralintegrity of tissues, and the transport of molecules to and within cells. Ourcurrently manufactured and marketed products consist of ORTHOVISC® ,which is an HA product used in the treatment of some forms of osteoarthritis inhumans; AMVISC®, AMVISC® Plus, STAARVISCsTM-II, and ShellGelTM, each an injectable ophthalmic viscoelastic HA product; andHYVISC®, which is anHA product used in the treatment of equine osteoarthritis. In the U.S.ORTHOVISC is marketed by DePuy Mitek, Inc., a subsidiary of Johnson &Johnson, under the terms of a licensing, distribution, supply and marketingagreement. Outside the US, ORTHOVISC has been approved for sale since 1996 andis marketed by distributors in over 15 countries. HYVISC is marketed in theU.S. through Boehringer Ingelheim Vetmedica, Inc. We developed andmanufacture AMVISC® and AMVISC® Plus for Bausch &Lomb Incorporated under a multiyear supply agreement.

Products in developmentinclude REDEFYNETM, an HA based dermal filler used for cosmetic tissueaugmentation (CTA) applications, and INCERT®, an HA based anti-adhesive for surgicalapplications. In September 2005, we filed a Pre-Market Approval (PMA)application with the FDA seeking approval to market and sell REDEFYNE in theUnited States. We received *ConformitéEuropéenne* marking (CE marking), a foreign regulatory approval forcommercial marketing and sale, for INCERT in the third quarter of 2004. Wereceived CE marking approval for CTA in the first quarter of 2006.

*Osteoarthritis Business*

We have marketedORTHOVISC, our product for the treatment of osteoarthritis of the knee,internationally since 1996 through various distribution agreements. Internationalsales of ORTHOVISC contributed 31% of product revenue for the year ended December 31,2005 and increased 56% compared to 2004. The increase was primarily due toincreased market penetration in Turkey, Canada, Europe and the Middle East. Weexpect international sales to grow in 2006 compared to 2005 reflecting furtherincreased market penetration in certain of our existing markets as well asanticipated expansion into new international markets. For these newopportunities we have assessed the world market and we are actively pursuingcommercial partners.

As discussed in Part 1 above, ORTHOVISC  became available for sale in the U.S. on March 1,2004, and is marketed by DePuy Mitek, Inc., a subsidiary of Johnson &Johnson, under the terms of a ten-year licensing, distribution, supply andmarketing agreement (the “JNJ Agreement”). The JNJ Agreement was 

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originally entered intowith Ortho Biotech Products, L.P. (OBP), also a Johnson & Johnsoncompany, and was assigned to DePuy Mitek in mid-2005.  Sales of ORTHOVISC in the U.S. contributed 8%of our product revenue for the year ended December 31, 2005, considerablylower than 2004 due to initial overstocking of product by OBP in 2004. Consequentlyno units were sold to OBP/DePuy Mitek after March of 2005, howeverinventory levels have now been reduced to the point where a more regular orderflow is expected for 2006.

Sales of ORTHOVISC to end-users grew slower thananticipated in 2004 and 2005 as a result of a number of factors. We believethat a primary contributing factor to this slower growth has been reimbursementand the lack of receiving assignment of a specific reimbursement code. TheHealthcare Common Procedure Coding System (HCPCS) is a comprehensive and standardizedcoding system that describes classifications of like products that are medicalin nature by category for the purpose of efficient claims processing. HCPCScodes are assigned by the Centers for Medicare and Medicaid Services (CMS). Asis typical for a newly-introduced medical device, initial sales of ORTHOVISCwere made without a unique reimbursement code and reimbursement submissionswere made using a miscellaneous code with no specified reimbursement dollarvalue. We believe that using the miscellaneous reimbursement code without aspecified reimbursement dollar value negatively impacted end-user sales ofORTHOVISC in 2004 and 2005.  OrthoBiotech, with our help, submitted an application to secure a uniquereimbursement code for ORTHOVISC in March 2004. In November 2004,Ortho Biotech received a decision on the application which assigned a uniquereimbursement code to be used by hospitals in an outpatient setting (the Ccode) which specifies a reimbursement dollar value. Use of the C code was effectivein January 2005. The CMS decision, however, did not assign a uniquereimbursement code to be used in the physician office setting (the J code) asat the time we did not yet have six months of sales history required by CMS tomake a decision. An updated application for a unique J code was submitted in January 2005.In late October 2005, CMS issued a new J code - J7318, which was toinclude all FDA approved HA based products for the treatment of osteoarthritisof the knee, for use starting on January 1, 2006. In early November 2005,CMS announced they wanted to further study the situation and therefore wouldnot implement the October decision, and that the codes used in 2005 wereto continue to be used in 2006. As a result, we expect reimbursement for ORTHOVISCin the physician office setting to continue to use a miscellaneous J code. Thecontinued required use of a miscellaneous J code may result in physicianreluctance to utilize ORTHOVISC as compared to if a unique J code had beenassigned. There can be no assurance regarding the future course CMS will setfor ORTHOVISC reimbursement. While the J code has no effect on productpricing, the Mitek team is taking significant steps to assist in thereimbursement process in physicians’ offices. At the end of the year, Mitek hada specialty sales force of about 13 professionals to support the salesrepresentatives and provide hands-on assistance to the physicians’ offices.Mitek plans to significantly increase the number of specialists in 2006. Mitekalso has developed a Web site for physicians’ office personnel as a resourcefor reimbursement issues.

Sales of HYVISC, ourproduct for the treatment of equine osteoarthritis, contributed 10% to productrevenue for the year ended December 31, 2005 and was essentially flatcompared to 2004. We continue to look at other veterinary applications andopportunities to expand geographic territories.

*Ophthalmic Business*

Our ophthalmic business includes HA viscoelasticproducts used in ophthalmic surgery. For the year ended December 31, 2005,sales of ophthalmic products contributed 51% of our product revenue reflectinga decrease in sales of ophthalmic products of 9% compared to 2004. Sales toBausch & Lomb accounted for 89% of ophthalmic sales for 2005 andcontributed 46% of product revenue for the period.

Our former distributor forCoEase, Advanced Medical Optics (“AMO”), completed the acquisition of thesurgical ophthalmology business of Pfizer, Inc., in September 2004,which included a competing line of viscoelastic products for use in ocularsurgery. As a result, our agreement with AMO expired according to 

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itsterms in June 2005. There were no sales to AMO in the second half of 2005.Sales to AMO decreased 89% for 2005 compared to last year. Sales to AMOcontributed 19% of ophthalmic product revenue and 10% of total product revenuefor the year ended December 31, 2004.

In December 2004, weentered into a multi-year supply agreement (the 2004 B&L Agreement) withBausch & Lomb for viscoelastic products used in ophthalmic surgery.  Under the new agreement, which extends throughDecember 31, 2010, and superseded the existing supply contract that wasset to expire December 31, 2007, we will continue to be the exclusiveglobal supplier (other than with respect to Japan) for AMVISC and AMVISC Plusto Bausch & Lomb. The 2004 B&L Agreement also provides us with aright to negotiate to manufacture future surgical ophthalmic viscoelasticproducts developed by Bausch & Lomb, while Bausch & Lomb hasbeen granted rights to commercialize certain future surgical ophthalmicviscoelastic products developed by us. The 2004 B&L Agreement applies toall products sold by us to Bausch & Lomb from the beginning of 2004,with a price increase starting in 2005. Under the 2004 B&L Agreement, weare entitled to continue providing surgical viscoelastic products to ourexisting customers (STAAR Surgical Company and Cytosol Ophthalmics, Inc.)who currently receive such products from us.

*Research and Development*

REDEFYNETM, our productfor cosmetic tissue augmentation (CTA), is based on a family of chemicallymodified, cross-linked forms of HA designed for longer duration in the body. Cosmetictissue augmentation is a therapy designed as a soft tissue filler for facialwrinkles, scar remediation and lip augmentation. This new class of tissuefiller technology based on HA is intended to supplant collagen-based productsand to compete with other HA-based products currently on the market. In October 2005,we completed a pivotal U.S. clinical trial to evaluate CTA’s effectiveness forcorrecting nasolabial folds. The trial was conducted by dermatologists andplastic surgeons at 10 centers throughout the U.S. The six month primaryendpoint results of this trial were submitted to the U.S. Food and DrugAdministration (“FDA”) in a Pre-Market Approval (“PMA”) application in September 2005.In the first quarter of 2006, we received CE mark approval to market REDEFYNEin the European Union.

In July 2004 weentered into an exclusive worldwide development and commercializationpartnership (the OrthoNeutrogena Agreement) for our CTA products with theOrthoNeutrogena division of Ortho-McNeil Pharmaceuticals, Inc., anaffiliate of Johnson & Johnson. Under the terms of the OrthoNeutrogenaAgreement, we received an initial payment of $1,000,000. In addition,OrthoNeutrogena, subject to certain limitations, funded our pivotal clinicaltrial of our CTA product completed in October 2005. On September 1, 2005, the Companyannounced that it had mutually agreed with OrthoNeutrogena to terminate itsdevelopment and commercialization agreement, and as noted above, we filed ourPMA with the FDA seeking approval to market and sell our CTA product in theUnited States. The Company will continue the development effort on a go-forwardbasis which will be self-funded. We are currently seeking a worldwidedistribution partner for this product.

INCERT-S is our productdesigned to reduce post-surgical fibrosis following spinal surgery. Wecompleted a pilot human clinical trial in Europe in December 2005involving patients undergoing spinal surgery, and demonstrated safety.

**Summaryof Critical Accounting Policies; Significant Judgments and Estimates**

Our discussion and analysis of our financial conditionand results of operations are based upon our financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States of America. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. We monitor our estimates on an on-goingbasis for changes in facts and circumstances, and material changes in theseestimates could occur in the future. Changes in estimates are recorded in theperiod in which they become known. We base our 

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estimates on historicalexperience and other assumptions that we believe to be reasonable under thecircumstances. Actual results may differ from our estimates if past experienceor other assumptions do not turn out to be substantially accurate.

We have identified thepolicies below as critical to our business operations and the understanding ofour results of operations. The impact and any associated risks related to thesepolicies on our business operations is discussed throughout Management’sDiscussion and Analysis of Financial Condition and Results of Operations wheresuch policies affect our reported and expected financial results. For adetailed discussion on the application of these and other accounting policies,see Note 2 in the Notes to the Consolidated Financial Statements of this AnnualReport on Form 10-K for the year ended December 31, 2005.

*Revenue Recognition.*

Our revenue recognition policies are in accordancewith the Securities and Exchange Commission’s (SEC) Staff Accounting Bulletin No. 101,*Revenue Recognition in Financial Statements*,as amended by SEC Staff Accounting Bulletin No. 104,*Revenue Recognition,* and Emerging IssuesTask Force Issue No. 00-21,*Revenue Arrangements with Multiple Deliverables*.

We recognize revenue from the sales of products wemanufacture upon confirmation of regulatory compliance and shipment to thecustomer as long as there is (1) persuasive evidence of an arrangement, (2) deliveryhas occurred and risk of loss has passed, (3) the sales price is fixed ordeterminable and (4) collection of the related receivable is reasonablyassured. Amounts billed or collected prior to recognition of revenue areclassified as deferred revenue. When determining whether risk of loss hastransferred to customers on product sales or if the sales price is fixed ordeterminable we evaluate both the contractual terms and conditions of ourdistribution and supply agreements as well as our business practices. ORTHOVISChas been sold through several distribution arrangements as well as outsourceorder-processing arrangements (logistic agents). Sales of product through thirdparty logistics agents in certain markets are recognized as revenue uponshipment by the logistics agent to the customer.

Under the 2000 B&L Agreement, the price for unitssold in a calendar year was dependent on total unit volume of sales to Bausch &Lomb and other customers of certain ophthalmic products during the year. Pricesfluctuated based on sales levels, and interim quarters were subject to possibleretroactive price adjustments when the actual annual unit volume for the yearbecame known. Given the pricing in this arrangement was not fixed and wasdetermined based on qualifying sales to multiple customers, we determined thatwe could not reliably estimate the rebate, and accordingly, we deferred themaximum rebate that could be due until the annual sales volume was known in thefourth quarter. Under the 2004 B&L Agreement, the pricing is based solelyon ophthalmic products sold to Bausch & Lomb. While the unit priceswill be discounted for those units in excess of cumulative quarterly minimumsales levels, no additional amounts will be rebated. Starting in the 2005 firstquarter, the applicable discount has been measured quarterly, subject toadjustment based on cumulative annual thresholds.

In July 2004 the Company entered into anexclusive worldwide development and commercialization agreement (theOrthoNeutrogena Agreement) for our CTA products with the OrthoNeutrogena, adivision of Ortho-McNeil Pharmaceuticals, Inc., an affiliate of Johnson &Johnson. This arrangement included up front payments, specified funding ofongoing development activities, milestones upon achievement of predefinedgoals, and payments for supply of CTA products and royalties on sales. Underthe EITF 00-21 framework, in order to account for an element as aseparate unit of accounting, the element must have stand-alone value and theremust be objective and reliable evidence of fair value of the undeliveredelements. While this arrangement included several elements, we believed thattwo separate units of accounting existed (a combined license and developmentunit and a manufacturing unit) under the EITF 00-21 model. We accountedfor the combined license and development unit using the performance 

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based revenue recognitionmodel. Pursuant to this model, we estimated both the total revenues we expectedto earn and the expenses we expected to incur related to the license anddevelopment unit. We recognized revenue based on the proportion of effortexpended to total estimated effort, limited to the amount of non-refundablecash received or receivable. Quarterly, we reviewed our estimates of totalrevenue and expenses related to the license and development unit. Actualrevenue earned and/or expenses incurred may differ from our estimates and mayhave a material effect upon our results of operations.

Under the OrthoNeutrogena Agreement, we receivednon-refundable upfront fees of $1,000,000 and reimbursement for approximately$1,305,000 of costs which we incurred prior to the inception date of thisagreement. We have treated both these amounts as upfront fees that werecognized over the expected term of the license and development unit. Inaddition to the upfront fees, we received reimbursement of pre-approveddevelopment costs. For 2004, we recognized $1,392,000 as contract revenue underthis arrangement pursuant to the performance-based model. For the six monthsended June 30, 2005 we recognized an additional $3,167,000 as contractrevenue under this arrangement pursuant to the performance-based model. On September 1, 2005, the Companyannounced that it had mutually agreed with OrthoNeutrogena to terminate itsdevelopment and commercialization agreement. The Company received a payment of$3,115,000 from ONI including a $2,300,000 contract termination fee. Given thatthere were no continuing performance obligations with respect to thedevelopment and commercialization agreement or the related terminationagreement, all amounts were recognized during the third quarter of 2005,including $251,000 of previously deferred revenue under the performance-basedmodel. Total contract revenue recognized during 2005 related to the agreementswith OrthoNeutrogena was $6,537,000.

In December 2003 the Company entered into aten-year licensing and supply agreement (the JNJ Agreement) with Ortho BiotechProducts, L.P., a member of the Johnson & Johnson family of companies,to market ORTHOVISC in the U.S.. In mid-2005, the agreement was assignedto DePuy Mitek, Inc., a subsidiary of Johnson & Johnson. Underthe JNJ Agreement, DePuy Mitek performs sales, marketing and distributionfunctions and licensed the right to further develop and commercialize ORTHOVISCas well as other new products for the treatment of pain associated withosteoarthritis based on the Company’s viscosupplementation technology. Insupport of the license, the JNJ Agreement provides that DePuy Mitek will fundpost-marketing clinical trials for new indications of ORTHOVISC. The Companyreceived an initial payment of $2,000,000 upon entering into the JNJ Agreement,a milestone payment of $20,000,000 in February 2004, as a result ofobtaining FDA approval of ORTHOVISC and a milestone payment of $5,000,000 in December 2004for planned upgrades to our manufacturing operations. We evaluated the terms ofthe JNJ Agreement and determined that the upfront fee and milestone paymentsdid not meet the conditions to be recognized separately from the supplyagreement, therefore, we have deferred non refundable payments received of$27,000,000 which we are recognizing ratably over the expected 10 year term ofthe JNJ Agreement. Under the JNJ Agreement, we are the exclusive supplier ofORTHOVISC to Depuy Mitek, Inc. a subsidiary of Johnson& Johnson. TheJNJ Agreement provides for additional sales-based milestone payments to uscontingent upon achieving specified sales targets, in addition to royalty andtransfer fees. The JNJ Agreement is subject to early termination in certaincircumstances and is otherwise renewable by DePuy Mitek for consecutivefive-year terms.

*Reservefor Obsolete/Excess Inventory.*   Inventories arestated at the lower of cost or market. We regularly review our inventories andrecord a provision for excess and obsolete inventory based on certain factorsthat may impact the realizable value of our inventory including, but notlimited to, technological changes, market demand, inventory cycle time,regulatory requirements and significant changes in our cost structure. Ifultimate usage varies significantly from expected usage or other factors arisethat are significantly different than those anticipated by management,additional inventory write-down or increases in obsolescence reserves may berequired.

We generally produce finished goods based uponspecific orders or in anticipation of specific orders. As a result, wegenerally do not establish reserves against finished goods. We evaluate thevalue of 

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inventory on a quarterlybasis and may, based on future changes in facts and circumstances, determinethat a write-down of inventory is required in future periods.

*Deferredtax assets.*   We record a deferred tax asset orliability based on the difference between the financial statement and tax basisof assets and liabilities, as measured by the enacted tax rates assumed to bein effect when these differences reverse.

In 2004, we achievedmilestones under the JNJ Agreement and received payments totaling $25,000,000which we recognized as taxable income in 2004. As a result, we utilized all ofour net operating loss and credit carry-forwards in our 2004 tax return tooffset part of our taxable income. In accordance with our revenue recognitionpolicy, for financial statement purposes, the milestone payments totaling$25,000,000 were deferred and are being recognized ratably over the expectedten-year term of the JNJ Agreement. In 2004, based on management’s expectationsregarding future profitability, we released the valuation allowance previouslyestablished against our deferred tax assets and recorded a one-time income taxbenefit of $7,039,000.

**Results ofOperations**

***Year ended December 31, 2005 compared to yearended December 31, 2004***

*Statement of Operations Detail*

| ** **                                   | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Product revenue                              |       | $                                          | 20,534,000 |   | $ | 22,286,000 |   |
| Licensing, milestone and  contract revenue   |       | 9,301,000                                  |       | 4,180,000 |   |
| Total revenue                                |       | 29,835,000                                 |       | 26,466,000 |   |
| Operating Expenses:                          |       |                                       |       |   |   |
| Cost of product revenue                      |       | 11,144,000                                 |       | 9,949,000 |   |
| Research and development                     |       | 4,731,000                                  |       | 4,087,000 |   |
| Selling, general and  administrative         |       | 5,409,000                                  |       | 6,042,000 |   |
| Total operating expenses                     |       | 21,284,000                                 |       | 20,078,000 |   |
| Income from operations                       |       | 8,551,000                                  |       | 6,388,000 |   |
| Interest income                              |       | 1,241,000                                  |       | 389,000 |   |
| Income before income  taxes                  |       | 9,792,000                                  |       | 6,777,000 |   |
| Provision for income  taxes                  |       | 3,899,000                                  |       | 2,626,000 |   |
| Benefit from release of  valuation allowance |       | —                                     |       | (7,039,000 | ) |
| Net income                                   |       | $                                          | 5,893,000  |   | $ | 11,190,000 |   |
| Product gross profit                         |       | $                                          | 9,390,000  |   | $ | 12,337,000 |   |
| Product gross margin                         |       | 46%                                        |       | 55% |   |

 

*Net and operating income.**  *For the year ended December 31, 2005 income fromoperations was $8,551,000 compared to $6,388,000 for 2004. The primary driverfor the improved operating performance was $6,537,000 of contract andtermination revenue recorded in the third quarter of 2005, which is discussedin more detail hereunder. Net income for 2005 was $5,893,000 or $.52 perdiluted share compared to $11,190,000 or $.98 per diluted share for the sameperiod last year. The 2004 net income benefited from the release of valuationallowance in the amount of $7,039,000 or $.62 per diluted share.

*Revenue**  *Total revenue for the year ended December 31,2005 increased $3,369,000 to $29,835,000 compared to $26,466,000 for 2004primarily due to the receipt of $2,300,000 in connection with the terminationof the OrthoNeutrogena agreement. However, product revenue for 2005 decreased$1,752,000 to $20,534,000 for two primary reasons. Sales of ORTHOVISC to DePuyMitek in 2005 were significantly lower than in 2004 due to overstocking ofinventory by JNJ in 2004, and Advanced Medical Optics did not renew theircontract with us as they acquired a competing line of viscoelastic products foruse in ocular surgery.  See below forfurther details.

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*Product revenue by productline.**  *Productrevenue for the year ended December 31, 2005 was $20,534,000, a decreaseof $1,752,000, or 8%, compared with $22,286,000 for the year ended December 31,2004.

| ** **          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------|------------|--------------------------------------------|------------|
| ** **          | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Ophthalmic Products |       | $                                          | 10,522,000 |   | $ | 11,533,000 |   |
| ORTHOVISC           |       | 7,938,000                                  |       | 8,699,000 |   |
| HYVISC              |       | 2,074,000                                  |       | 2,054,000 |   |
|                |       | $                                          | 20,534,000 |   | $ | 22,286,000 |   |

 

Ophthalmic products sales decreased $1,011,000, or 9%,to $10,522,000. The decrease was primarily attributable to the loss of businessfrom Advanced Medical Optics. Sales to Advanced Medical Optics decreased to$249,000 from $2,195,000, or 89%, in 2005 compared to last year, andcontributed only 2% of ophthalmic product revenue for 2005 versus 19% in 2004. Thedecrease in sales to Advanced Medical Optics was attributable to AdvancedMedical Optics’ acquisition of a competing line of viscoelastic products foruse in ocular surgery. Our agreement with Advanced Medical Optics expiredaccording to its terms in June 2005. This decrease was partially offset byincreased sales to Bausch & Lomb and, to a lesser extent, to increasedsales to each of our other ophthalmic customers.

Our sales of ORTHOVISC decreased $761,000, or 9%, to$7,938,000 in 2005 as compared with $8,699,000 in 2004. The decrease inORTHOVISC sales for 2005 was primarily due to overstocking of inventory by JNJin 2004. This resulted in substantially lower purchases of ORTHOVISC by JNJfrom the Company in 2005. This domestic decrease was partially offset bycontinued robust international sales. U.S. sales of ORTHOVISC were $1,643,000,or 8% of product sales, in 2005 compared to $4,669,000, or 21% of productsales, in 2004. The impact of the decrease in unit sales was partially offsetby a 32% increase in royalty fees tied to end-user sales, and increasedinternational sales. International sales of ORTHOVISC increased to $6,296,000from $4,030,000, or 56% in 2005 compared to the same periods last year. Theincrease in international sales was primarily attributable to increased marketpenetration by our distributors in Turkey, Canada, Western Europe and MiddleEast countries. We expect both U.S. and international sales to increase in 2006compared to 2005 reflecting increased market penetration in certain of ourexisting markets as well as expansion into new international markets.

Sales of HYVISC were essentially flat in 2005 ascompared to 2004 and represented 10% and 9%, respectively, of product sales. Salesof HYVISC are made to a single customer under an exclusive agreement whichexpires in May 2006. We expect this agreement to be renewed.

*Licensing,milestone and contract revenue.**  *Licensing,milestone and contract revenue for the year ended December 31, 2005 was$9,301,000, compared to $4,180,000 for 2004. Licensing and milestone revenueincludes the ratable recognition of the $27,000,000 in up-front and milestonepayments from Ortho Biotech. These amounts are being recognized in incomeratably over the ten-year expected life of the agreement, or $675,000 perquarter. Contract revenue was $6,537,000 for 2005, compared to $1,296,000 in2004. Revenue in 2005 consisted of $4,237,000 for reimbursement of clinical anddevelopment costs due under the OrthoNeutrogena contract, and a $2,300,000termination fee to exit the contract. As previously discussed, on September 1,2005, the Company announced that it had mutually agreed with OrthoNeutrogena toterminate its development and commercialization agreement. All amounts due andcontractual obligations by both parties have been satisfied.

*Productgross profit.**  *Productgross profit for the year ended December 31, 2005 was $9,390,000, or 46%of product revenue, compared with $12,337,000, or 55% of product revenue, forthe year ended December 31, 2004. The decrease in product gross margin wasmainly due to three  factors:  the cost impact of a midyear product recalltotaling $370,000, a lower margin product mix, and volume based 

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inefficiencies in ourmanufacturing process. We expect product gross margin to improve in 2006compared to 2005 reflecting improved product mix and higher manufacturingvolume, partially offset by the impact of the implementation of stock optionexpensing in 2006 under SFAS 123R.

*Researchand development.**  *Researchand development expenses for the year ended December 31, 2005 increased by$644,000, or 16%, to $4,731,000 from $4,087,000 for the prior year. Researchand development expenses include those costs associated with our in-houseresearch and development efforts for the development of new medicalapplications for our HA-based technology, the management and cost of clinicaltrials, and the preparation and processing of applications for regulatoryapprovals at all relevant stages of development. The increase in research anddevelopment expenses during 2005 was primarily attributable to expendituresassociated with the pivotal clinical trial for our CTA product initiated in2004 and completed in late 2005, as well as engineering and scale-up activitiesin preparation for the manufacture of our CTA product. The Company filed a PMAapplication with the FDA based on the results of this clinical trial. We expectresearch and development expenses will increase in the future related to followon CTA clinical trials, next generation ORTHOVISC products, and other researchand development programs in the pipeline, as well as from the impact of theimplementation of stock option expensing in 2006 under SFAS 123R.

*Selling,general and administrative.**  *Selling,general and administrative expenses for the year ended December 31, 2005decreased by $633,000 or 10%, to $5,409,000 from $6,042,000 in the prior year. Thedecrease was primarily due to lower business development expenses andprofessional fees related to Sarbanes Oxley, which were partially offset byhigher fees related to recruiting. The Company expects that selling, generaland administrative expenses will increase in the future related to headcountincreases, recruiting costs, strategic planning efforts, and infrastructureexpansion, as well as from the impact of implementation of stock optionexpensing in 2006 under SFAS 123R.

*Interestincome.**  *Interest income increased $852,000,or 219%, to $1,241,000 for the year ended December 31, 2005, from $389,000in 2004. The increase was primarily attributable to higher average availablecash and invested balances during 2005 as well as increasing interest rates. Interestincome in 2006 is expected to increase as a result of higher average cash andinvestment balances.

*Income taxes.**  *Income taxprovision for 2005 is $3,899,000 versus a net tax benefit of $4,413,000recorded for 2004. The 2004 net benefit was comprised of a provision for incometaxes of $2,626,000 offset by a $7,039,000 benefit resulting from the releaseof the valuation allowance. As a result of the receipt of the $25,000,000 inmilestone payments in 2004 from Ortho Biotech, our recent operating results,and forecasted future income, together supported an assertion that ultimaterealization of our deferred tax assets was more likely than not at December 31,2004. Accordingly, the Company fully released the valuation allowance during2004 and correspondingly recorded a one-time tax benefit of $7,039,000 or $.62 per fully diluted share.

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***Year ended December 31,2004 compared to year ended December 31, 2003***

***Statement of Operations Detail***

| ** **                                   | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Product revenue                              |       | $                                          | 22,286,000 |   | $ | 15,330,000 |   |
| Licensing,  milestone and contract revenue   |       | 4,180,000                                  |       | 74,000 |   |
| Total revenue                                |       | 26,466,000                                 |       | 15,404,000 |   |
| Operating Expenses:                          |       |                                       |       |   |   |
| Cost of product revenue                      |       | 9,949,000                                  |       | 8,005,000 |   |
| Research and development                     |       | 4,087,000                                  |       | 2,595,000 |   |
| Selling, general and administrative          |       | 6,042,000                                  |       | 4,209,000 |   |
| Total operating expenses                     |       | 20,078,000                                 |       | 14,809,000 |   |
| Income from  operations                      |       | 6,388,000                                  |       | 595,000 |   |
| Interest income                              |       | 389,000                                    |       | 144,000 |   |
| Income before  income taxes                  |       | 6,777,000                                  |       | 739,000 |   |
| Provision for  income taxes                  |       | 2,626,000                                  |       | (88,000 | ) |
| Benefit from  release of valuation allowance |       | (7,039,000                                 | )          | — |   |
| Net income                                   |       | $                                          | 11,190,000 |   | $ | 827,000 |   |
| Product gross profit                         |       | $                                          | 12,337,000 |   | $ | 7,325,000 |   |
| Product gross margin                         |       | 55%                                        |       | 48% |   |

 

*Product revenue.**  *Product revenue for the year ended December 31,2004 was $22,286,000, an increase of $6,956,000, or 45%, compared with$15,330,000 for the year ended December 31, 2003.

| ** **           | ** ** | **Year Ended December 31,** | ** ** |
|----------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Ophthalmic  Products |       | $                                          | 11,533,000 |   | $ | 10,512,000 |   |
| ORTHOVISC            |       | 8,699,000                                  |       | 3,073,000 |   |
| HYVISC               |       | 2,054,000                                  |       | 1,745,000 |   |
|                 |       | $                                          | 22,286,000 |   | $ | 15,330,000 |   |

 

Ophthalmic products sales increased $1,021,000, or10%, to $11,533,000 compared with sales of $10,512,000 in 2003. The increasewas primarily attributable to increased sales to Bausch & Lomb and, toa lesser extent, to increased sales to each of our other ophthalmic customers. InDecember 2004, the company entered into the 2004 B&L Agreement which,among other things, established reduced unit pricing to Bausch & Lombfor units purchased in 2004 in excess of a specified volume. Under the terms ofthe 2000 B&L Agreement, which was replaced by the 2004 B&L Agreement inDecember 2004, the price for all units sold for a calendar year wasdependent on the total unit volume of sales of certain ophthalmic productsduring the year. Accordingly, unit prices for sales occurring in the ninemonths ended September 30, 2004 and 2003 were subject to possibleretroactive price adjustments when the actual annual unit volume became known. Inaccordance with our revenue recognition policy, the amount of revenuereasonably subject to the price adjustment was recorded as deferred revenueuntil the annual unit volume became known and the sales price becomes fixed. Inthe fourth quarter 2004, as a result of entering into the 2004 B&LAgreement, we applied the terms of the 2004 B&L Agreement retroactively tothe beginning of 2004 and included in product revenue $761,000 of revenuerelated to sales of AMVISC to Bausch & Lomb which had been previouslydeferred during the first three quarters of 2004 and rebated $252,000 to Bausch &Lomb. Under the 2000 B&L Agreement, during the fourth quarter of 2003 theactual annual unit volume, and therefore the final sales price, became known anddeterminable and 

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product revenue includedthe recognition of $846,000 of revenue related to sales of AMVISC to Bausch &Lomb previously deferred during the first three quarters of 2003. Our agreementwith Advanced Medical Optics was not renewed as a result of their acquisitionof a competing line of viscoelastic products for ophthalmic surgery and expiredaccording to its terms in June 2005. Sales to Advanced Medical Opticscontributed 19% of ophthalmic product revenue and 10% of total product revenuefor the year ended December 31, 2004.

Our sales of ORTHOVISC increased $5,626,000, or 183%,to $8,699,000 in 2004 as compared with $3,073,000 in 2003. The increase wasprimarily due to sales to our U.S.distributor, Ortho Biotech, and royalty fees tied to end-user sales. U. S.sales of ORTHOVISC were 21% of product sales for 2004. International sales ofORTHOVISC increased 31% for 2004 to $4,030,000 from $3,073,000 for 2003. Theincrease was primarily due to increased sales to our Turkey distributorcombined with increased sales in Canada and Greece.

Sales of HYVISC increased $309,000, or 18%, to$2,054,000 for 2004 as compared with $1,745,000 for 2003. Sales of HYVISC weremade to a single customer under an exclusive agreement which expires in May 2006.We expect this agreement to be renewed. Sales of HYVISC in 2003 includeddistributor inventory replenishment for certain units shipped withoutregulatory approval in the third quarter of 2002.

*Licensing,milestone and contract revenue.**  *Licensing,milestone and contract revenue for the year ended December 31, 2004 was$4,180,000, compared to $74,000 for 2003. Licensing and milestone revenueincluded the ratable recognition of the $2,000,000 up-front payment and$25,000,000 in milestone payments from Ortho Biotech. These amounts were beingrecognized in income ratably over the ten-year expected life of the agreement,or $675,000 per quarter. Contract revenue was $1,392,000 for the year ended December 31,2004. Contract revenue consisted of reimbursement of clinical and developmentcosts from OrthoNeutrogena as well as development-related fees and milestonesunder the OrthoNeutrogena agreement recorded utilizing a performance-basedmethod for revenue recognition.

*ProductGross profit.**  *Product**gross profit for the year ended December 31, 2004 was$12,337,000, or 55% of revenue, compared with $7,325,000, or 48% of revenue,for the year ended December 31, 2003.  The increase in product gross profit onproduct revenue was mainly due to a higher margin product mix combined withefficiency gains in our manufacturing process. We introduced outsourcedintermediates in our manufacturing process for most of our products in 2004 andcompleted the remaining in early 2005.

*Researchand development.**  *Researchand development expenses for the year ended December 31, 2004 increased by$1,492,000, or 57%, to $4,087,000 from $2,595,000 for the prior year. Researchand development expenses included those costs associated with our in-houseresearch and development efforts for the development of new medicalapplications for our HA-based technology, the management and cost of clinicaltrials, and the preparation and processing of applications for regulatoryapprovals at all relevant stages of development. The increase in research anddevelopment expenses during 2004 was primarily attributable to expendituresassociated with the pilot study for INCERT-S initiated in April 2004 andthe pivotal clinical trial for our product for cosmetic tissue augmentationinitiated in May 2004, including costs associated with the start-up of theclinical trials incurred in the first quarter of 2004. The comparative increasein 2004 was partially offset by the elimination of costs primarily incurred inthe first half of 2003 associated with the completion of our pivotal clinicaltrial for ORTHOVISC.

In 2004, our efforts were primarily related to INCERT,a product designed to prevent surgical adhesions and our products for the CTAmarket. Our research and development efforts included seeking new applicationsfor the HA molecule as well as our proprietary chemically modified HA and othertherapeutics applications of our ORTHOVISC formulation that targetosteoarthritis-related ailments.

*Selling,general and administrative.**  *Selling,general and administrative expenses for the year ended December 31, 2004increased by $1,833,000 or 44%, to $6,042,000 from $4,209,000 in the prior year.The 

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increase in selling,general and administrative expenses during 2004 was primarily due to anincrease in professional and outside services fees of $1,393,000 combined withan increase in personnel related costs of $403,000 compared with 2003. Theincrease in professional and outside services fees included an increase inaudit and tax fees and consulting fees of $773,000 primarily relating to costsfor the implementation and compliance with Section 404 of theSarbanes-Oxley Act of 2002.

*Interestincome.**  *Interest income increased $245,000,or 170%, to $389,000 for the year ended December 31, 2004, from $144,000in 2003. The increase was primarily attributable to a higher average cash andinvestment balances during 2004.

*Incometaxes.**  *A nettax benefit of $4,413,000 was recorded for the year ended December 31,2004, comprising a provision for income taxes of $2,626,000 offset by a$7,039,000 benefit resulting from the release of the valuation allowance. As aresult of the receipt of the $20,000,000 milestone payment in February 2004and the $5,000,000 milestone payment received in December 2004 from OrthoBiotech, our recent operating results and forecasted future income support anassertion that ultimate realization of our deferred tax assets was more likelythan not at December 31, 2004. Accordingly, the Company fully released thevaluation allowance during 2004 and correspondingly recorded a one-time taxbenefit of $7,039,000.

We recorded a provisionfor income taxes of $66,000 and an income tax benefit of $154,000 for yearended December 31, 2003. In 2002 federal tax law changed to allow for afive year carryback period and a suspension of certain limitations on the useof alternative minimum tax losses. We filed an income tax carryback claim tocarry our 2001 tax loss back to prior tax years.  As a result of the carryback claim, in thefirst quarter of 2003, we received a refund of approximately $154,000 of taxespaid in prior years.

**Liquidity and Capital Resources**

We require cash to fund our operating expenses and tomake capital expenditures. We expect that our requirements for cash to fundthese uses will increase as the scope of our operations expands. Historicallywe have funded our cash requirements from a combination of cash provided byoperations, and available cash and investments on hand. We expect that ourexisting capital resources, together with cash from operations and interestincome, will be sufficient to fund our operations for the foreseeable future.At December 31, 2005, cash and cash equivalents totaled $44.7 millioncompared to $39.3 million at December 31, 2004, and $14.6 million at December 31,2003.

We received an initial payment of $2.0 million in December 2003upon entering into the JNJ Agreement. In February 2004, we received amilestone payment of $20.0 million as a result of obtaining FDA approval forORTHOVISC and in December 2004 we received a milestone payment of $5.0million to use for manufacturing upgrades. In July 2004 we received aninitial payment of $1.0 million upon entering into the OrthoNeutrogenaAgreement. And in September 2005, we received a fee of $2.3 million inconnection with the termination of the OrthoNeutrogena Agreement.

Cash provided by operating activities was $6,452,000,$23,824,000 and $2,012,000 for 2005, 2004, and 2003 respectively. Cash providedby operating activities decreased by $17,372,000 from 2004 primarily due toreceipts of milestone payments under the JNJ agreement in 2004. Cash providedby operating activities in 2005 resulted primarily from net income of$5,893,000, a decrease in deferred tax assets of $1,911,000, a decrease ininventory of $826,000, tax benefit of $1,080,000 related to exercise of stockoptions, and net cash of $896,000 from other working capital assets andliabilities. This increase was partially offset by a decrease in deferredrevenue of $4,613,000 as a result of milestone payment revenue recognized forthe year. Cash provided by operating activities in 2004 resulted primarily fromnet income of $11,190,000 which includes a one-time non-cash income tax benefitof $7,039,000 from the release of the previously established valuationallowance against our deferred tax assets and an increase in deferred revenueof $24,165,000. The increase in cash provided by operating activities waspartially offset by a net increase in 

36

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other current assets andliabilities of $1,663,000. The increase in deferred revenue was primarily dueto the $25.0 million in milestone payments received in 2004 from Ortho Biotech.

Cash used in investing activities was $1,600,000 in2005. Cash provided by investing activities was $344,000 and $1,485,000 for2004 and 2003, respectively. Cash used for investing activities in 2005 wasprimarily the result of deposits for manufacturing equipment and constructioncosts to build a new manufacturing suite in connection with our new CTA productcurrently in development. Net cash flows from investing activities for 2004includes the release of restricted cash of $818,000 which was partially offsetby capital expenditures of $474,000, primarily for manufacturing and computerequipment. In connection with the issuance of an irrevocable letter of creditto one of our vendors we had deposited $818,000 with our bank to collateralizethe letter of credit which amount is recorded in restricted cash at December 31,2003. These funds were restricted from our use during the term of the letter ofcredit which expired in April 2004. We expect to increase our capitalexpenditures in 2006 primarily to complete upgrading and expanding ourmanufacturing and packaging equipment. Total costs related to manufacturing facility upgrades andmanufacturing equipment for the CTA product is expected to be approximately$3,500,000, $1,300,000 of which was included in the cash used in investingactivities in 2005. The remaining balance is expected to be spent in the firsthalf of 2006.

Cash provided by financingactivities of $556,000, $579,000 and $93,000 for 2005, 2004 and 2003,respectively, reflects the proceeds from the exercise of stock options.

*Off Balance SheetArrangements*

We do not use specialpurpose entities or other off-balance sheet financing techniques except foroperating leases as disclosed in the contractual obligations table below thatwe believe have or are reasonably likely to have a current or future materialeffect on our financial condition, changes in financial condition, revenues orexpenses, results of operations, liquidity or capital resources.

*Recent AccountingPronouncements*

In November 2004, the FASB issued SFAS 151, “InventoryCosts” which amends the guidance in Accounting Research Bulletin No. 43,Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amountsof idle facility expense, freight, handling costs, and wasted material(spoilage). In addition, SFAS 151 requires that allocation of fixed productionoverheads to the costs of conversion be based on the normal capacity of theproduction facilities. The provisions of SFAS 151 are effective for the firstannual reporting period beginning after June 15, 2005. The adoption ofSFAS 151 is not expected to have a material impact on the Company’sConsolidated Financial Statements.

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandard No. 123R, “Share-Based Payment” (“SFAS 123R”). This statement isa revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” andsupersedes APB opinion No. 25, “Accounting for Stock Issued to Employees.”SFAS 123R requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based attheir fair values. The provisions of this statement were effective for theCompany on January 1, 2006. The Company has evaluated the provisions ofthis statement and determined it will have a material negative effect onconsolidated net income. We currently estimate that adoption of the statementwill increase 2006 operating expenses by approximately $1,500,000 on a pre-taxbasis, for options granted through February 28, 2006, without forfeitureassumptions. We expect additional grants for the remainder of 2006 will resultin an additional $200,000 in operating expenses. The amount will change basedupon the number and value of actual stock option grants and forfeiture rates.

37

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*Contractual Obligationsand Other Commercial Commitments*

We have no material commitments for purchases ofinventories. We expect to incur additional investments in our operationsrelated to capital expenditures in 2006 for CTA manufacturing scale-up and tomeet anticipated higher volume requirements and for computers and software andfurniture and fixtures associated with normal operations. To the extent thatfunds generated from our operations, together with our existing capitalresources are insufficient to meet future requirements, we will be required toobtain additional funds through equity or debt financings, strategic allianceswith corporate partners and others, or through other sources. No assurance canbe given that any additional financing will be made available to us or will beavailable on acceptable terms should such a need arise.

Our future capitalrequirements and the adequacy of available funds will depend, on numerousfactors, including:

·       marketacceptance of our existing and future products;

·       thesuccess and sales of ORTHOVISC under the JNJ Agreement;

·       thesuccessful commercialization of products in development;

·       progressin our product development efforts;

·       themagnitude and scope of such efforts;

·       progresswith pre-clinical studies, clinical trials and product clearances by the FDAand other agencies;

·       thecost of maintaining adequate manufacturing capabilities;

·       thecost of filing, prosecuting, defending and enforcing patent claims and otherintellectual property rights;

·       competingtechnological and market developments;

·       thedevelopment of strategic alliances for the marketing of certain of ourproducts;

·       theterms of such strategic alliances, including provisions (and our ability tosatisfy such provisions) that provide upfront and/or milestone payments to us;and

·       thecost of maintaining adequate inventory levels to meet current and futureproduct demands.

We cannot assure you that we will record profits infuture periods. However, we believe that based on our current strategy, ourcash and investments on hand will be sufficient to meet our cash flowsrequirements beyond 2006. See the section captioned *“Risk Factors.”*

The terms of any future equity financings may bedilutive to our stockholders and the terms of any debt financings may containrestrictive covenants, which could limit our ability to pursue certain coursesof action. Our ability to obtain financing is dependent on the status of ourfuture business prospects as well as conditions prevailing in the relevantcapital markets. No assurance can be given that any additional financing may bemade available to us or may be available on acceptable terms should such a needarise.

Thetable below summarizes our contractual obligations of non-cancelable operatingleases at December 31, 2005:

| ** **       | ** ** | **Payments due by period** | ** ** |
|------------------|------------|-------------------------------------------|------------|
| ** **       | ** ** | **Total**                                 | ** ** | **Less than   1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Operating leases |       | $                                         | 2,185,000  |   | $ | 762,000 |   | $ | 1,314,000 |   | $ | 109,000 |   |   | $ | — |   |   |
|                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of December 31,2005, we did not utilize any derivative financial instruments, market risksensitive instruments or other financial and commodity instruments for whichfair value disclosure would be required under SFAS No. 107. All of ourinvestments consist of money market funds, commercial paper and municipal bondsthat are carried on our books at amortized cost, which approximates fair marketvalue.

*Primary Market Risk Exposures*

Our primary market risk exposures are in the areas ofinterest rate risk. Our investment portfolio of cash equivalent is subject tointerest rate fluctuations, but we believe this risk is immaterial due to theshort-term nature of these investments. We currently do not hedge interest rateexposure.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**ANIKA THERAPEUTICS, INC. AND SUBSIDIARIES**

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**

| Management’s Report on  Internal Control over Financial Reporting                                               |   | 41 |   |
|----------------------------------------------------------------------------------------------------------------------|--------|----|--------|
| Report of Independent Registered Public Accounting  Firm                                                             |   | 42 |   |
| Consolidated  Balance Sheets as of December 31, 2005 and 2004                                                   |   | 44 |   |
| Consolidated Statements of Operations for the Years  Ended December 31, 2005, 2004 and 2003                     |   | 45 |   |
| Consolidated Statements of Stockholders’ Equity for  the Years Ended December 31, 2005, 2004 and 2003 |   | 46 |   |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2005, 2004 and 2003                     |   | 47 |   |
| Notes to Consolidated Financial Statements                                                                           |   | 48 |   |

 

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**Management’s Report on Internal Control Over FinancialReporting**

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934. Our internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generally acceptedaccounting principles.

Because of its inherent limitations, internal controlover financial reporting can provide only reasonable assurance and may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of ourinternal control over financial reporting as of December 31, 2005. Inmaking this assessment, management used the criteria set forth by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO) in InternalControl-Integrated Framework.

Based on our assessment and those criteria, ourmanagement believes that the company maintained effective internal control overfinancial reporting as of December 31, 2005.

Our management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2005 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which is included herein.

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**Report of Independent Registered Public AccountingFirm**

To****the Board ofDirectors and Stockholders of Anika Therapeutics, Inc.:

We have completedintegrated audits of Anika Therapeutics, Inc.’s 2005 and 2004 consolidatedfinancial statements and of its internal control over financial reporting as ofDecember 31, 2005 and an audit of its 2003 consolidated financialstatements in accordance with the standards of the Public Company AccountingOversight Board (United States). Ouropinions, based on our audits, are presented below.

*Consolidated financial statements*

In our opinion, the consolidated financial statements in theaccompanying index present fairly, in all material respects, thefinancial position of Anika Therapeutics, Inc. and its subsidiaries****at December 31, 2005 and 2004, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2005 in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits. We conducted ouraudits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit of financial statements includes examining, ona test basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in Management’s Report on Internal Control Over Financial Reportingappearing under this Item 8, that the Company maintained effective internalcontrol over financial reporting as of December 31, 2005 based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2005, based on criteria established in *Internal Control -Integrated Framework* issued by the COSO. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financialreporting based on our audit. We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we consider necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance 

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of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.
|                        | /s/ PricewaterhouseCoopers LLP |
|------------------------|--------------------------------|
| Boston,  Massachusetts |                           |
| March 9,  2006    |                           |

 

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**Anika Therapeutics, Inc. and Subsidiary**

**ConsolidatedBalance Sheets**

| ** **                                                                                                                                                                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                                           | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                                      |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                                            |       | $                     | 44,747,000 |   | $ | 39,339,000 |   |
| Accounts receivable, net of reserves of $23,000 at  December 31, 2005 and 2004                                                                                                                  |       | 2,066,000             |       | 2,354,000 |   |
| Inventories                                                                                                                                                                                          |       | 3,271,000             |       | 4,227,000 |   |
| Current portion deferred income taxes                                                                                                                                                                |       | 1,301,000             |       | 1,824,000 |   |
| Prepaid expenses                                                                                                                                                                                     |       | 1,025,000             |       | 1,339,000 |   |
| Total current assets                                                                                                                                                                                 |       | 52,410,000            |       | 49,083,000 |   |
| Property and  equipment, at cost                                                                                                                                                                     |       | 11,949,000            |       | 10,349,000 |   |
| Less: accumulated  depreciation                                                                                                                                                                      |       | (9,853,000            | )          | (9,394,000 | ) |
|                                                                                                                                                                                                 |       | 2,096,000             |       | 955,000 |   |
| Long-term  deposits                                                                                                                                                                                  |       | 143,000               |       | 143,000 |   |
| Deferred income  taxes                                                                                                                                                                               |       | 7,969,000             |       | 9,357,000 |   |
| Total Assets                                                                                                                                                                                         |       | $                     | 62,618,000 |   | $ | 59,538,000 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                        | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                                                 |       |                  |       |   |   |
| Accounts payable                                                                                                                                                                                     |       | $                     | 1,277,000  |   | $ | 791,000 |   |
| Accrued expenses                                                                                                                                                                                     |       | 1,719,000             |       | 2,041,000 |   |
| Deferred revenue                                                                                                                                                                                     |       | 2,830,000             |       | 4,116,000 |   |
| Total current liabilities                                                                                                                                                                            |       | 5,826,000             |       | 6,948,000 |   |
| Long-term deferred  revenue                                                                                                                                                                          |       | 18,900,000            |       | 22,227,000 |   |
| Commitments and  contingencies (Note 8)                                                                                                                                                              |       |                  |       |   |   |
| Stockholders’ equity                                                                                                                                                                            |       |                  |       |   |   |
| Preferred stock, $.01 par value; 1,250,000 shares  authorized, no shares issued and outstanding at December 31, 2005 and  2004                                                                  |       | —                |       | — |   |
| Common stock, $.01 par value; 30,000,000 shares  authorized, 10,500,393 shares issued and outstanding at December 31,  2005, 10,257,472 shares issued and outstanding at December 31, 2004 |       | 105,000               |       | 103,000 |   |
| Additional paid-in-capital                                                                                                                                                                           |       | 34,273,000            |       | 32,639,000 |   |
| Retained earnings (accumulated deficit)                                                                                                                                                              |       | 3,514,000             |       | (2,379,000 | ) |
| Total stockholders’ equity                                                                                                                                                                      |       | 37,892,000            |       | 30,363,000 |   |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                                     |       | $                     | 62,618,000 |   | $ | 59,538,000 |   |

cps

The accompanying notes are an integral part of these consolidated financial statements.

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**Anika Therapeutics, Inc. and Subsidiary**

**ConsolidatedStatements of Operations**

| ** **                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Product revenue                                     |       | $                                                             | 20,534,000 |   | $ | 22,286,000 |   | $ | 15,330,000 |   |
| Licensing,  milestone and contract revenue          |       | 9,301,000                                                     |       | 4,180,000 |   | 74,000 |   |
| Total revenue                                       |       | 29,835,000                                                    |       | 26,466,000 |   | 15,404,000 |   |
| Operating expenses:                                 |       |                                                          |       |   |   |   |   |
| Cost of product revenue                             |       | 11,144,000                                                    |       | 9,949,000 |   | 8,005,000 |   |
| Research & development                     |       | 4,731,000                                                     |       | 4,087,000 |   | 2,595,000 |   |
| Selling, general & administrative          |       | 5,409,000                                                     |       | 6,042,000 |   | 4,209,000 |   |
| Total operating  expenses                           |       | 21,284,000                                                    |       | 20,078,000 |   | 14,809,000 |   |
| Income from  operations                             |       | 8,551,000                                                     |       | 6,388,000 |   | 595,000 |   |
| Interest income                                     |       | 1,241,000                                                     |       | 389,000 |   | 144,000 |   |
| Income before  income taxes                         |       | 9,792,000                                                     |       | 6,777,000 |   | 739,000 |   |
| Income tax expense  (benefit)                       |       |                                                          |       |   |   |   |   |
| Provision (benefit) for income taxes                |       | 3,899,000                                                     |       | 2,626,000 |   | (88,000 | ) |
| Benefit from release of valuation allowance         |       | —                                                        |       | (7,039,000 | ) | — |   |
| Net income                                          |       | $                                                             | 5,893,000  |   | $ | 11,190,000 |   | $ | 827,000 |   |
| Basic net income per share:                         |       |                                                          |       |   |   |   |   |
| Net income                                          |       | $                                                             | 0.57       |   | $ | 1.11 |   | $ | 0.08 |   |
| Basic weighted average common shares outstanding    |       | 10,410,920                                                    |       | 10,103,835 |   | 9,953,733 |   |
| Diluted net  income per share:                      |       |                                                          |       |   |   |   |   |
| Net income                                          |       | $                                                             | 0.52       |   | $ | 0.98 |   | $ | 0.08 |   |
| Diluted weighted  average common shares outstanding |       | 11,428,201                                                    |       | 11,384,155 |   | 10,849,610 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**Anika Therapeutics, Inc. and Subsidiary**

**ConsolidatedStatements of Stockholders’ Equity**

| ** **                           | ** ** | **Common Stock**      | ** ** | **Treasury Stock**  | ** ** | **Retained**                     | ** ** | ** **                 | ** ** |
|--------------------------------------|------------|----------------------------|------------|--------------------------|------------|----------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **Number of  Shares** | ** ** | **$.01 Par  Value** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Number of  Shares** | ** ** | **Cost** | ** ** | **Earnings  (Accumulated  Deficit)** | ** ** | **Total  Stockholders’  Equity** | ** ** |
| Balance, December 31, 2002      |       | 9,991,943                  |       | $                        | 100,000    |                             | $          | 31,640,000                 |       |   | 57,663 |   |   | $ | (280,000 | ) | $ | (14,396,000 | ) |   | $ | 17,064,000 |   |   |
| Exercise of common stock options     |       | —                     |       | —                   |       | (160,000                         | )          |                       | (52,125    | ) |   | 253,000 |   | — |   |   | 93,000 |   |   |
| Net income                           |       | —                     |       | —                   |       | —                           |       |                       | —     |   |   | — |   | 827,000 |   |   | 827,000 |   |   |
| Balance, December 31, 2003      |       | 9,991,943                  |       | 100,000                  |       | 31,480,000                       |       |                       | 5,538      |   |   | (27,000 | ) | (13,569,000 | ) |   | 17,984,000 |   |   |
| Exercise of common stock options     |       | 265,529                    |       | 3,000                    |       | 549,000                          |       |                       | (5,538     | ) |   | 27,000 |   | — |   |   | 579,000 |   |   |
| Tax benefit related to stock options |       | —                     |       | —                   |       | 610,000                          |       |                       | —     |   |   | — |   | — |   |   | 610,000 |   |   |
| Net income                           |       | —                     |       | —                   |       | —                           |       |                       | —     |   |   | — |   | 11,190,000 |   |   | 11,190,000 |   |   |
| Balance, December 31, 2004      |       | 10,257,472                 |       | 103,000                  |       | 32,639,000                       |       |                       | —     |   |   | — |   | (2,379,000 | ) |   | 30,363,000 |   |   |
| Exercise of common stock options     |       | 242,921                    |       | 2,000                    |       | 554,000                          |       |                       | —     |   |   | — |   | — |   |   | 556,000 |   |   |
| Tax benefit related to stock options |       | —                     |       | —                   |       | 1,080,000                        |       |                       | —     |   |   | — |   | — |   |   | 1,080,000 |   |   |
| Net income                           |       | —                     |       | —                   |       | —                           |       |                       | —     |   |   | — |   | 5,893,000 |   |   | 5,893,000 |   |   |
| Balance,  December 31, 2005     |       | 10,500,393                 |       | $                        | 105,000    |                             | $          | 34,273,000                 |       |   | — |   |   | $ | — |   | $ | 3,514,000 |   |   | $ | 37,892,000 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**AnikaTherapeutics, Inc. and SubsidiaryConsolidated Statements of Cash Flows**

| ** **                                                                         | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from  operating activities:                                             |       |                                                          |       |   |   |   |   |
| Net income                                                                         |       | $                                                             | 5,893,000  |   | $ | 11,190,000 |   | $ | 827,000 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                                          |       |   |   |   |   |
| Depreciation                                                                       |       | 459,000                                                       |       | 710,000 |   | 1,006,000 |   |
| Deferred income taxes                                                              |       | 1,911,000                                                     |       | (11,181,000 | ) | — |   |
| Provision for and writedown of inventory                                           |       | 130,000                                                       |       | 42,000 |   | — |   |
| Tax benefit related to stock options                                               |       | 1,080,000                                                     |       | 610,000 |   | — |   |
| Changes in  operating assets and liabilities:                                      |       |                                                          |       |   |   |   |   |
| Accounts receivable                                                                |       | 288,000                                                       |       | (933,000 | ) | (223,000 | ) |
| Inventories                                                                        |       | 826,000                                                       |       | (642,000 | ) | (703,000 | ) |
| Prepaid expenses                                                                   |       | 314,000                                                       |       | (1,258,000 | ) | 239,000 |   |
| Accounts payable                                                                   |       | 486,000                                                       |       | 442,000 |   | (497,000 | ) |
| Customer deposit                                                                   |       | —                                                        |       | — |   | (327,000 | ) |
| Accrued expenses                                                                   |       | (322,000                                                      | )          | 744,000 |   | (406,000 | ) |
| Deferred revenue                                                                   |       | (4,613,000                                                    | )          | 24,165,000 |   | 2,031,000 |   |
| Income taxes payable                                                               |       | —                                                        |       | (65,000 | ) | 65,000 |   |
| Net cash provided  by operating activities                                         |       | 6,452,000                                                     |       | 23,824,000 |   | 2,012,000 |   |
| Cash flows from  investing activities:                                             |       |                                                          |       |   |   |   |   |
| Proceeds from the redemption of marketable  securities                             |       | —                                                        |       | — |   | 2,500,000 |   |
| Restricted cash                                                                    |       | —                                                        |       | 818,000 |   | (818,000 | ) |
| Purchase of property and equipment                                                 |       | (1,600,000                                                    | )          | (474,000 | ) | (256,000 | ) |
| Proceeds from repayment of notes receivable from  officers                    |       | —                                                        |       | — |   | 59,000 |   |
| Net cash (used  in) provided by investing activities                               |       | (1,600,000                                                    | )          | 344,000 |   | 1,485,000 |   |
| Cash flows from  financing activities:                                             |       |                                                          |       |   |   |   |   |
| Proceeds from exercise of stock options                                            |       | 556,000                                                       |       | 579,000 |   | 93,000 |   |
| Net cash provided  by financing activities                                         |       | 556,000                                                       |       | 579,000 |   | 93,000 |   |
| Increase in cash and cash equivalents                                              |       | 5,408,000                                                     |       | 24,747,000 |   | 3,590,000 |   |
| Cash and cash  equivalents at beginning of year                                    |       | 39,339,000                                                    |       | 14,592,000 |   | 11,002,000 |   |
| Cash and cash  equivalents at end of year                                          |       | $                                                             | 44,747,000 |   | $ | 39,339,000 |   | $ | 14,592,000 |   |
| Supplemental  disclosure of cash flow information:                                 |       |                                                          |       |   |   |   |   |
| Cash paid for  income taxes                                                        |       | $                                                             | 637,000    |   | $ | 7,156,000 |   | $ | 3,000 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**Anika Therapeutics, Inc. and SubsidiaryNotes to Consolidated Financial Statements**

**1. Nature of Business**

Anika Therapeutics, Inc. (“Anika” or the “Company”)develops, manufactures and commercializes therapeutic products for tissue protection and healing. Theseproducts are based on hyaluronic acid (HA), a naturally occurring,biocompatible polymer found throughout the body. Due to its unique biophysicaland biochemical properties, HA plays an important role in a number ofphysiological functions such as the protection and lubrication of soft tissuesand joints, the maintenance of the structural integrity of tissues, and thetransport of molecules to and within cells. The Company’s currentlymanufactured and marketed products consist of ORTHOVISC®, which is an HA product used in thetreatment of some forms of osteoarthritis in humans; AMVISC®, AMVISC® Plus, STAARVISCTM-II, and ShellGelÔ,each an injectable ophthalmic viscoelastic HA product; and HYVISC®, which is an HA product used in thetreatment of equine osteoarthritis. In the U.S. ORTHOVISC is marketed by DePuyMitek, Inc., a subsidiary of Johnson & Johnson, under the termsof a licensing, distribution, supply and marketing agreement. Outside the US,ORTHOVISC has been approved for sale since 1996 and is marketed by distributorsin over 15 countries. HYVISC is marketed in the U.S. through Boehringer IngelheimVetmedica, Inc. We developed and manufacture AMVISC® andAMVISC® Plus for Bausch & Lomb Incorporatedunder a multiyear supply agreement. Potential products in development includeREDEFYNEÔ, an HA based dermal filler used for cosmetictissue augmentation (CTA) applications, and INCERT®, an HA based anti-adhesive for surgicalapplications.

The Company is subject torisks common to companies in the biotechnology and medical device industriesincluding, but not limited to, development by the Company or its competitors ofnew technological innovations, dependence on key personnel, protection ofproprietary technology, commercialization of existing and new products, andcompliance with FDA government regulations and approval requirements as well asthe ability to grow the Company’s business.

**2. Summaryof Significant Accounting Policies**

**Use of Estimates**

The preparation offinancial statements in conformity with generally accepted accountingprinciples in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

**Principles ofConsolidation**

The accompanyingconsolidated financial statements include the accounts of Anika Therapeutics, Inc.and its wholly owned subsidiary, Anika Securities, Inc. (a MassachusettsSecurities Corporation). All intercompany balances and transactions have beeneliminated in consolidation.

**Cash and CashEquivalents**

Cash and cash equivalentsconsists of cash and highly liquid investments with original maturities of 90days or less.

**FinancialInstruments**

SFAS No. 107, “DisclosuresAbout Fair Value of Financial Instruments”, requires disclosure about fairvalue of financial instruments. Financial instruments consist of cashequivalents, accounts receivable, 

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andaccounts payable. The estimated fair values of the Company’s financialinstruments approximate their carrying values.

**Revenue Recognition**

The Company’s revenuerecognition policies are in accordance with the Securities and ExchangeCommission’s (SEC) Staff Accounting Bulletin No. 101,*Revenue Recognition in Financial Statements*,as amended by SEC Staff Accounting Bulletin No. 104,*Revenue Recognition,* and Emerging IssuesTask Force Issue No. 00-21,*Revenue Arrangements with Multiple Deliverables*.

***Product Revenue***

The Company recognizes revenue from the sales ofproducts it manufactures upon confirmation of regulatory compliance andshipment to the customer as long as there is (1) persuasive evidence of anarrangement, (2) delivery has occurred and risk of loss has passed, (3) thesales price is fixed or determinable and (4) collection of the relatedreceivable is reasonably assured. Amounts billed or collected prior torecognition of revenue are classified as deferred revenue. When determiningwhether risk of loss has transferred to customers on product sales or if thesales price is fixed or determinable the Company evaluates both the contractualterms and conditions of its distribution and supply agreements as well as itsbusiness practices.

In December 2004, theCompany entered into the 2004 B&L Agreement, a supply agreement with Bausch &Lomb through December 31, 2010 for viscoelastic products used inophthalmic surgery.  This agreementsuperseded the 2000 B&L Agreement that was set to expire on December 31,2007. The Company continues to be the exclusive global supplier (other thanwith respect to Japan) for AMVISC and AMVISC Plus to Bausch & Lomb. The2004 B&L Agreement also provides the Company with a right to negotiate tomanufacture future surgical ophthalmic viscoelastic products developed byBausch & Lomb, while Bausch & Lomb has been granted rights tocommercialize certain future surgical ophthalmic viscoelastic productsdeveloped by the Company. Under the 2000 B&L Agreement, the price for unitssold in a calendar year was dependent on total unit volume of sales to Bausch &Lomb and other customers of certain ophthalmic products during the year. Pricesfluctuated based on sales levels, and interim quarters were subject to possibleretroactive price adjustments when the actual annual unit volume for the yearbecame known. Given the pricing in this arrangement was not fixed and wasdetermined based on qualifying sales to multiple customers, the Companydetermined that it could not reliably estimate the rebate, and accordingly,deferred the maximum rebate that could be due until the annual sales volume wasknown in the fourth quarter. Under the 2004 B&L Agreement, the pricing isbased solely on ophthalmic products sold to Bausch & Lomb. While theunit prices will be discounted for those units in excess of cumulative minimumsales levels, no additional amounts will be rebated. Starting in the 2005 firstquarter, the applicable discount has been measured quarterly, subject toadjustment based on cumulative annual thresholds.

***License, Milestone and Contract Revenue***

In July 2004, the Company entered into anexclusive worldwide development and commercialization agreement (theOrthoNeutrogena Agreement) for the Company’s CTA products with theOrthoNeutrogena, a division of Ortho-McNeil Pharmaceuticals, Inc., anaffiliate of Johnson & Johnson. This arrangement included up frontpayments, specified funding of ongoing development activities, milestones uponachievement of predefined goals, and payments for supply of CTA products androyalties on sales. Under the EITF 00-21 framework, in order to accountfor an element as a separate unit of accounting, the element must havestand-alone value and there must be objective and reliable evidence of fairvalue of the undelivered elements. While this arrangement included severalelements, the Company believed that two separate units of accounting exist (acombined license and development unit and a 

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manufacturing unit) underthe EITF 00-21 model. The Company accounted for the combined license anddevelopment unit using the performance based revenue recognition model.Pursuant to this model, the Company estimated both the total revenues itexpected to earn and the expenses it expected to incur related to the licenseand development unit. The Company recognized revenue based on the proportion ofeffort expended to total estimated effort, limited to the amount of non-refundablecash received or receivable. Quarterly, the Company reviewed its estimates oftotal revenue and expenses related to the license and development unit.

Under the OrthoNeutrogena Agreement, the Companyreceived non-refundable upfront fees of $1,000,000 and reimbursement forapproximately $1,305,000 of costs which it incurred prior to the inception dateof this agreement. The Company treated both these amounts as upfront fees thatwould be recognized over the expected term of the license and development unit.In addition to the upfront fees, the Company received reimbursement ofpre-approved development costs. For 2004, the Company recognized $1,392,000 ascontract revenue under this arrangement pursuant to the performance-based model.For the six months ended June 30, 2005, the Company recognized anadditional $3,167,000 as contract revenue under this arrangement pursuant tothe performance-based model. On September 1, 2005, the Company announced that it had mutuallyagreed with OrthoNeutrogena to terminate its development and commercializationagreement. The Company received a termination payment of $3,115,000 from ONIincluding $815,000 for all outstanding clinical study costs incurred andcommitted to by the Company at the termination date. Given there is nocontinuing performance obligations with respect to the development andcommercialization agreement or the related termination agreement, all amountswere recognized during the third quarter of 2005, including $251,000 ofpreviously deferred revenue under the performance-based model. Total contractrevenue recognized during 2005 related to the agreements with OrthoNeutrogenawas $6,537,000.

In December 2003 theCompany entered into a ten-year licensing and supply agreement (the JNJAgreement) with Ortho Biotech Products, L.P., a member of the Johnson &Johnson family of companies, to market ORTHOVISC in the U.S. In mid-2005,the agreement was assigned to DePuy Mitek, Inc., a subsidiary of Johnson &Johnson. Under the JNJ Agreement, DePuy Mitek performs sales, marketing anddistribution functions and licensed the right to further develop andcommercialize ORTHOVISC as well as other new products for the treatment of painassociated with osteoarthritis based on the Company’s viscosupplementationtechnology. In support of the license, the JNJ Agreement provides that DePuyMitek will fund post-marketing clinical trials for new indications of ORTHOVISC.The Company received an initial payment of $2,000,000 upon entering into theJNJ Agreement, a milestone payment of $20,000,000 in February 2004, as aresult of obtaining FDA approval of ORTHOVISC and a milestone payment of$5,000,000 in December 2004 for planned upgrades to our manufacturingoperations. The Company evaluated the terms of the JNJ Agreement and determinedthat the upfront fee and milestone payments did not meet the conditions to berecognized separately from the supply agreement, therefore, the Company havedeferred non refundable payments received of $27,000,000 which we arerecognizing ratably over the expected 10 year term of the JNJ Agreement. Underthe JNJ Agreement, we are the exclusive supplier of ORTHOVISC to Johnson&Johnson. The JNJ Agreement provides for additional sales-based milestonepayments to us contingent upon achieving specified sales targets, in additionto royalty and transfer fees. The JNJ Agreement is subject to early terminationin certain circumstances and is otherwise renewable by DePuy Mitek forconsecutive five-year terms.

**Accounts Receivableand Allowance for Doubtful Accounts**

Trade accounts receivableare recorded at the invoiced amount and do not bear interest. The allowance fordoubtful accounts is the Company’s best estimate of the amount of probablecredit losses in its existing accounts receivable. The Company determines theallowance based on historical write-off experience by industry and regionaleconomic data. The Company reviews its allowance for doubtful 

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accountsmonthly. Past due balances over 90 days are reviewed individually forcollectibility. Account balances are charged off against the allowance when theCompany feels it is probable the receivable will not be recovered. The Companydoes not have any off-balance-sheet credit exposure related to its customers.

**Inventories**

Inventories are stated atthe lower of cost or market, with cost being determined using the first-in,first-out (FIFO) method. Work-in-process and finished goods inventories includematerials, labor, and manufacturing overhead.

**Property andEquipment**

Propertyand equipment are carried at cost less accumulated depreciation. Costs of majoradditions and betterments are capitalized; maintenance and repairs that do notimprove or extend the life of the respective assets are charged to operations. Ondisposal, the related accumulated depreciation or amortization is removed fromthe accounts and any resulting gain or loss is included in results ofoperations. Depreciation is computed using the straight-line method over theestimated useful lives of the assets as follows:

| Machinery and equipment |   | 3-7 years                                        |
|-------------------------|--------|--------------------------------------------------|
| Furniture and  fixtures |   | 3-5 years                                        |
| Leasehold  improvements |   | Shorter of lease  term or  estimated useful life |

 

The Company accounts for impairment of long-livedassets in accordance with SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets.”  SFAS No. 144establishes a uniform accounting model for long-lived assets to be disposed of.This Statement also requires that long-lived assets be reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held andused is measured by comparing the carrying amount of an asset to estimatedundiscounted future net cash flows expected to be generated by the asset. Ifthe carrying amount of the asset exceeds its estimated future cash flows, animpairment charge is recognized by the amount by which the carrying amount ofthe asset exceeds the fair value of the asset. As of December 31, 2005 and2004, long-lived assets consisted of machinery, equipment and leaseholdimprovements.

During the years ended December 31,2005, 2004, and 2003 the Company did not record losses on impairment.

**Research andDevelopment**

Research and developmentcosts consists primarily of salaries and related expenses for personnel andfees paid to outside consultants and outside service providers, including costsassociated with licensing, milestone and contract revenue.  Research and development costs are expensed asincurred.

**Income Taxes**

The Company provides forincome taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”.SFAS No. 109 requires the recognition of deferred tax assets andliabilities for the expected future tax consequences of temporary differencesbetween the financial reporting and tax basis of assets and liabilities.

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**Stock-BasedCompensation**

Statementof Financial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation,” as amended by SFAS No. 148, requires that companies eitherrecognize compensation expense for grants of stock options and other equityinstruments based on fair value, or provide pro forma disclosure of net income(loss) and net income (loss) per share in the notes to the financial statements.At December 31, 2005, the Company has stock options outstanding underthree stock-based compensation plans, which are described more fully inNote 9. The Company accounts for those plans under the recognition andmeasurement principles of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations. Accordingly, nocompensation cost has been recognized under SFAS 123 for the Company’semployee stock option plans. Had compensation cost for the awards under thoseplans been determined based on the grant date fair values, consistent with themethod required under SFAS 123, the Company’s net income and net incomeper share would have been reduced to the pro forma amounts indicated below:

| ** **                                                                                                     | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                     | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                                                                                     |       |                  |       |   |   |   |   |
| As reported                                                                                                    |       | $                     | 5,893,000  |   | $ | 11,190,000 |   | $ | 827,000 |   |
| Add: Stock-based  employee compensation expense included in reported net income                                |       | —                |       | — |   | — |   |
| Deduct: Total  stock-based employee compensation under the fair-value-based method for all  awards, net of tax |       | (697,000              | )          | (481,000 | ) | (439,000 | ) |
| Pro forma net  income                                                                                          |       | $                     | 5,196,000  |   | $ | 10,709,000 |   | $ | 388,000 |   |
| Basic net income  per share                                                                                    |       |                  |       |   |   |   |   |
| As reported                                                                                                    |       | $                     | 0.57       |   | $ | 1.11 |   | $ | 0.08 |   |
| Proforma                                                                                                       |       | $                     | 0.50       |   | $ | 1.06 |   | $ | 0.04 |   |
| Diluted net  income per share                                                                                  |       |                  |       |   |   |   |   |
| As reported                                                                                                    |       | $                     | 0.52       |   | $ | 0.98 |   | $ | 0.08 |   |
| Proforma                                                                                                       |       | $                     | 0.45       |   | $ | 0.94 |   | $ | 0.04 |   |

 

Thefair value of each stock option granted is estimated on the grant date usingthe fair value method with the following weighted average assumptions: 

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-free  interest rate |       | 3.84                  | %          | 3.27 | % | 2.69 | % |
| Expected dividend  yield |       | 0.00                  | %          | 0.00 | % | 0.00 | % |
| Expected lives           |       | 4                     |       | 4 |   | 4 |   |
| Expected volatility      |       | 69.51                 | %          | 77.68 | % | 101.66 | % |

 

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**Concentrationof Credit Risk and Significant Customers**

SFAS No. 105,“Disclosure of Information About Financial Instruments with Off-Balance-Sheet-Riskand Financial Instruments with Concentrations of Credit Risk” requiresdisclosure of any significant off-balance-sheet-risk, or concentrations ofcredit risk. The Company has no significant off-balance sheet or concentrationsof credit risk such as foreign exchange contracts, option contracts or otherforeign hedging arrangements. The Company, by policy, limits the amount ofcredit exposure to any one financial institution, and routinely assesses thefinancial strength of its customers. As a result, the Company believes that itsaccounts receivable credit risk exposure is limited and has not experienced significantwrite-downs in its accounts receivable balances. As of December 31, 2005,Bausch & Lomb, Boehringer Ingelheim Vetmedica, Pharmaren, JNJ, StaarSurgical and Ferrer Grupo combined, represented 91% of the Company’s accountsreceivable balance. As of December 31, 2004, Bausch & Lomb, JNJ,OrthoNeutrogena, and  BoehringerIngelheim Vetmedica, combined, represented 90% of the Company’s accountsreceivable balance.

**Reporting Comprehensive Income**

SFAS No. 130, “ReportingComprehensive Income” establishes standards for reporting and display ofcomprehensive income and its components in the financial statements. Comprehensiveincome is the total of net income and all other non-owner changes in equityincluding such items as unrealized holding gains/losses on securities, foreigncurrency translation adjustments and minimum pension liability adjustments. TheCompany had no such items for the years ended December 31, 2005, 2004, and2003 and as a result, comprehensive income is the same as reported net incomefor all periods presented.

**DisclosuresAbout Segments of an Enterprise and Related Information**

Operating segments areidentified as components of an enterprise about which separate discretefinancial information is available for evaluation by the chief operatingdecision maker, or decision-making group, in making decisions regarding how toallocate resources and assess performance. The Company’s chief operatingdecision maker is its Chief Executive Officer. Based on the criteriaestablished by SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information,” the Company has one reportable operating segment, theresults of which are disclosed in the accompanying consolidated financialstatements. Substantially all of the operations and assets of the Company havebeen derived from and are located in the United States.

**Recent Accounting Pronouncements**

In November 2004, the FASB issued SFAS 151, “InventoryCosts” which amends the guidance in Accounting Research Bulletin No. 43,Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amountsof idle facility expense, freight, handling costs, and wasted material(spoilage). In addition, SFAS 151 requires that allocation of fixed productionoverheads to the costs of conversion be based on the normal capacity of theproduction facilities. The provisions of SFAS 151 are effective for the firstannual reporting period beginning after June 15, 2005. The adoption ofSFAS 151 is not expected to have a material impact on the Company’s ConsolidatedFinancial Statements.

In December, 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandard No. 123R, “Share-Based Payment” (“SFAS 123R”). This statement isa revision of SFAS No. 123, “Accounting for Stock-Based Compensation”, andsupersedes APB opinion No. 25, “Accounting for Stock Issued to Employees.”SFAS 123R requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based attheir fair values. The provisions of this statement were effective for theCompany on January 1, 2006. The Company has evaluated the provisions ofthis statement and determined it will have a material negative effect on 

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consolidatednet income. The Company currently estimates that adoption of the statement willincrease 2006 operating expenses by approximately $1,500,000 on a pre-taxbasis, for options granted through February 28, 2006, without forfeitureassumptions. The amount will change based upon the number and value of actualstock option grants and forfeiture rates.

**3. Net Income per Common Share**

The Company reports earnings per share in accordancewith SFAS No. 128, “Earnings per Share,” which establishes standards forcomputing and presenting earnings per share. Basic earnings per share iscomputed by dividing net income by the weighted average number of common sharesoutstanding during the period. Diluted earnings per share is computed bydividing net income by the weighted average number of common shares outstandingand the number of dilutive potential common share equivalents during the period.Under the treasury stock method, unexercised “in-the-money” stock options areassumed to be exercised at the beginning of the period or at issuance, if later.The assumed proceeds are then used to purchase common shares at the averagemarket price during the period.

Sharesused in calculating basic and diluted earnings per share for each of the yearsended December 31, 2005, 2004 and 2003, are as follows: 

| ** **                                                               | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Net income                                                               |       | $          | 5,893,000  |       | $          | 11,190,000 |       | $ | 827,000 |   |
| Basic weighted  average common shares outstanding                        |       | 10,410,920 |       | 10,103,835 |       | 9,953,733  |       |
| Dilutive effect  of assumed exercise of stock options and warrants       |       | 1,017,281  |       | 1,280,320  |       | 895,877    |       |
| Diluted weighted average  common and potential common shares outstanding |       | 11,428,201 |       | 11,384,155 |       | 10,849,610 |       |
|                                                                          |            |            |            |            |            |            |            |  |  |  |

 

Options to purchase approximately85,000, 14,000, and 728,000 shares were outstanding at December 31, 2005,2004, and 2003, respectively, but not included in the computation of dilutedearnings per share because the options’ exercise prices were greater than theaverage market price during the period.

**4. Allowance for Doubtful Accounts**

Asummary of the allowance for doubtful account activity is as follows:

| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Balance,  beginning of the year |       | $                     | 23,000     |   | $ | 29,000 |   | $ | 35,000 |   |
| Amounts written  off            |       | —                |       | (6,000 | ) | (6,000 | ) |
| Balance, end of the year        |       | $                     | 23,000     |   | $ | 23,000 |   | $ | 29,000 |   |

 

**5. Inventories**

Inventoriesconsist of the following:

| ** **      | ** ** | **December 31,** | ** ** |
|-----------------|------------|-----------------------|------------|
| ** **      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Raw Materials   |       | $                     | 1,594,000  |   | $ | 1,842,000 |   |
| Work-in-Process |       | 1,507,000             |       | 1,589,000 |   |
| Finished Goods  |       | 170,000               |       | 796,000 |   |
| Total           |       | $                     | 3,271,000  |   | $ | 4,227,000 |   |

 

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**6. Property & Equipment**

Propertyand equipment is stated at cost and consists of the following: 

| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Machinery and  equipment       |       | $                     | 7,270,000  |   | $ | 6,237,000 |   |
| Furniture and  fixtures        |       | 737,000               |       | 725,000 |   |
| Leasehold  improvements        |       | 3,942,000             |       | 3,387,000 |   |
|                           |       | 11,949,000            |       | 10,349,000 |   |
| Less accumulated  depreciation |       | (9,853,000            | )          | (9,394,000 | ) |
| Total                          |       | $                     | 2,096,000  |   | $ | 955,000 |   |

 

Depreciation expense was$459,000, $710,000, and $1,006,000 for the years ended December 31, 2005,2004 and 2003, respectively.

**7. Accrued Expenses**

Accruedexpenses consist of the following:

| ** **            | ** ** | **December 31,** | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Payroll and  benefits |       | $                     | 1,007,000  |   | $ | 933,000 |   |
| Professional fees     |       | 347,000               |       | 637,000 |   |
| Clinical trial        |       | 151,000               |       | 265,000 |   |
| Other                 |       | 214,000               |       | 206,000 |   |
| Total                 |       | $                     | 1,719,000  |   | $ | 2,041,000 |   |

 

**8. Commitments and Contingencies**

*OperatingLeases.**  *TheCompany’s corporate headquarters is located in Woburn, Massachusetts, where itleases approximately 10,000 square feet of administrative and research anddevelopment space. The lease on this facility terminates in December 2006.The Company also leases approximately 37,000 square feet of space at a separatelocation in Woburn, Massachusetts, for its manufacturing facility and warehouse.The lease for this facility terminates in February 2009. Rental expense inconnection with the leases, totaled $724,000, $700,000, and $685,000, for theyears ended December 31, 2005, 2004, and 2003, respectively.

Futureminimum lease payments under noncancelable operating leases at December 31,2005 are as follows:

| ** ** | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
| 2006       |       | $          | 762,000    |   |
| 2007       |       | 658,000    |       |
| 2008       |       | 656,000    |       |
| 2009       |       | 109,000    |       |
| 2010       |       | —     |       |
| Thereafter |       | —     |       |
| Total      |       | $          | 2,185,000  |   |

 

*Guarantor Arrangements.*   Incertain of its contracts, the Company warrants to its customers that theproducts it manufactures conform to the product specifications as in effect at thetime of delivery of the 

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product. TheCompany may also warrant that the products it manufactures do not infringe,violate or breach any U.S. patent or intellectual property rights, trade secretor other proprietary information of any third party. On occasion, the Companycontractually indemnifies its customers against any and all losses arising outof or in any way connected with any claim or claims of breach of its warrantiesor any actual or alleged defect in any product caused by the negligence or actsor omissions of the Company.  The Companymaintains a products liability insurance policy that limits its exposure. Basedon the Company’s historical activity in combination with its insurance policycoverage, the Company believes the estimated fair value of theseindemnification agreements is minimal. The Company has no accrued warrantiesand has no history of claims.

**9. Stock Option Plan**

The Company had reserved 3,485,000 shares of commonstock for the grant of stock options to employees, directors, consultants andadvisors under the Anika Therapeutics, Inc. 1993 Stock Option Plan, asamended (the “1993 Plan”). In addition, the Company also established theDirectors’ Stock Option Plan (the “Directors’ Plan”) and reserved 40,000 sharesof the Company’s common stock for issuance to the Board of Directors. On March 3,2003, the 1993 Plan expired in accordance with its terms and approximately662,000 shares reserved under the plan were released. On April 4, 2003 theBoard of Directors approved the 2003 Anika Therapeutics, Inc. Stock Optionand Incentive Plan (the “2003 Plan”). The Company has reserved 1,500,000 sharesof common stock for grant of stock options to employees, directors, consultantsand advisors under the 2003 Plan, which was approved by stockholders on June 4,2003.

Combined stock optionactivity under the three plans is summarized as follows:

| ** **                                                    | ** ** | **2005**                   | ** ** | **2004**                                               | ** ** | **2003**                   | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                    | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price per  Share** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price per  Share** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price per  Share** | ** ** |
| Outstanding at beginning  of year                             |       | 1,707,305                  |       |                                                   | $          | 4.16                       |       |   | 2,072,297 |   |   | $ | 3.51 |   |   | 1,352,647 |   |   | $ | 2.49 |   |   |
| Granted                                                       |       | 409,525                    |       |                                                   | $          | 10.46                      |       |   | 207,000 |   |   | $ | 12.60 |   |   | 811,400 |   |   | $ | 4.99 |   |   |
| Canceled                                                      |       | (76,565                    | )          |                                                   | $          | 5.31                       |       |   | (275,925 | ) |   | $ | 7.73 |   |   | (39,625 | ) |   | $ | 1.34 |   |   |
| Expired                                                       |       | —                     |       |                                                   | —     |                       |       | (25,000 | ) |   | $ | 2.63 |   |   | — |   |   | — |   |   |
| Exercised                                                     |       | (242,921                   | )          |                                                   | $          | 2.29                       |       |   | (271,067 | ) |   | $ | 2.13 |   |   | (52,125 | ) |   | $ | 1.78 |   |   |
| Outstanding at end of  year                                   |       | 1,797,344                  |       |                                                   | $          | 5.80                       |       |   | 1,707,305 |   |   | $ | 4.16 |   |   | 2,072,297 |   |   | $ | 3.51 |   |   |
| Options exercisable at  end of year                           |       | 1,030,507                  |       |                                                   | $          | 3.90                       |       |   | 1,015,055 |   |   | $ | 3.32 |   |   | 974,472 |   |   | $ | 2.92 |   |   |
| Weighted average fair  value of options granted at fair value |       |                       |       |                                                   | $          | 5.76                       |       |   |   |   |   | $ | 7.45 |   |   |   |   |   | $ | 3.53 |   |   |

 

Generally, options vest in equal, annual installmentsup to four years after the date of grant and have an expiration date no laterthan ten years after the date of grant. There are 625,576 options available forfuture grant at December 31, 2005.

56

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Thefollowing table summarizes significant ranges of outstanding options under thethree plans at December 31, 2005:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding**      | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.90 - $1.05                               |       |                         | 352,826    |                         |       |   | 6.52 |   |   |   | $ | 1.02 |   |   | 253,826 |   |   | $ | 1.00 |   |   |
|   1.06  - 1.17                    |       |                         | 278,125    |                         |       |   | 5.22 |   |   |   | $ | 1.17 |   |   | 257,938 |   |   | $ | 1.17 |   |   |
|   1.18  - 4.75                    |       |                         | 125,924    |                         |       |   | 5.04 |   |   |   | $ | 2.48 |   |   | 93,549 |   |   | $ | 2.60 |   |   |
|   4.76  - 9.21                    |       |                         | 420,400    |                         |       |   | 5.63 |   |   |   | $ | 7.21 |   |   | 239,500 |   |   | $ | 6.07 |   |   |
|   9.22  - 10.69                   |       |                         | 384,194    |                         |       |   | 8.12 |   |   |   | $ | 9.33 |   |   | 175,819 |   |   | $ | 9.29 |   |   |
| $9.22 - $15.45                              |       |                         | 235,875    |                         |       |   | 9.57 |   |   |   | $ | 11.94 |   |   | 9,875 |   |   | $ | 13.73 |   |   |
|                                        |       |                         | 1,797,344  |                         |       |   |   |   |   |   |   |   |   | 1,030,507 |   |   |   |   |   |
|                                             |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**10. Shareholder Rights Plan**

On April 6, 1998, the Board of Directors adopteda shareholder rights agreement (the “Rights Plan”) which was subsequentlyamended as of November 5, 2002. In connection with the adoption of theRights Plan, the Board of Directors declared a dividend distribution of onepreferred stock purchase right (a “Right”) for each outstanding share of commonstock to stockholders of record as of the close of business on April 23,1998. Currently, these Rights are not exercisable and trade with the shares ofthe Company’s Common Stock.

Under the Rights Plan, the Rights generally becomeexercisable if: (1) a person becomes an “Acquiring Person” by acquiring15% or more of the Company’s Common Stock, (2) a person commences a tenderoffer that would result in that person owning 15% or more of the Company’s CommonStock, or (3) the Board of Directors deems a person to be an “AdversePerson,” as defined under the Rights Plan. In the event that a person becomesan “Acquiring Person,” or an “Adverse Person,” each holder of a Right (otherthan the Acquiring Person or Adverse Person) would be entitled to acquire suchnumber of units of preferred stock (which are equivalent to shares of theCompany’s Common Stock) having a value of twice the exercise price of theRight. If, after any such event, the Company enters into a merger or otherbusiness combination transaction with another entity, each holder of a Rightwould then be entitled to purchase, at the then-current exercise price, sharesof the acquiring company’s common stock having a value of twice the exercise priceof the Right. The current exercise price per Right is $45.00.

The Rights will expire at the close of business onApril 6, 2008 (the “Expiration Date”), unless previously redeemed orexchanged by the Company as described below. The Rights may be redeemed inwhole, but not in part, at a price of $0.01 per Right (payable in cash, sharesof the Company’s Common Stock or other consideration deemed appropriate by theBoard of Directors) by the Board of Directors only until the earlier of(1) the time at which any person becomes an “Acquiring Person” or an“Adverse Person”, or (2) the Expiration Date. At any time after any personbecomes an “Acquiring Person” or an “Adverse Person”, the Board of Directorsmay, at its option, exchange all or any part of the then outstanding andexercisable Rights for shares of the Company’s Common Stock at an exchangeratio specified in the Rights Plan. Notwithstanding the foregoing, the Board ofDirectors generally will not be empowered to affect such exchange at any timeafter any person becomes the beneficial owner of 50% or more of the Company’sCommon Stock.

Until a Right is exercised, the holder will have norights as a stockholder of the Company (beyond those as an existingstockholder), including the right to vote or to receive dividends.

57

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In connection with theestablishment of the Rights Plan, the Board of Directors approved the creationof Preferred Stock of the Company designated as Series B JuniorParticipating Cumulative Preferred Stock with a par value of $0.01 per share.The Board also reserved 150,000 shares of preferred stock for issuance uponexercise of the Rights.

**11. Stock Repurchase Plan**

In October 1998, theBoard of Directors approved a stock repurchase plan under which the Company isauthorized to purchase up to $4,000,000 of the Company’s Common Stock, with thetotal number of shares repurchased not to exceed 9.9% of the total number ofshares issued and outstanding. Under the plan, shares may be repurchased fromtime to time and in such amounts as market conditions warrant, subject toregulatory considerations. As of December 31, 2005 and 2004, the Companyhad repurchased a total of 762,100 shares at a net cost of approximately$3,873,000 and has reissued all shares upon exercise of employee stock options.No shares were purchased in 2005 or 2004.

**12. Employee Benefit Plan**

Employees are eligible to participate in the Company’s401(k) savings plan. Employees may elect to contribute a percentage oftheir compensation to the plan, and the Company will make matchingcontributions up to a limit of 5% of an employee’s compensation. In addition,the Company may make annual discretionary contributions. For the years endedDecember 31, 2005, 2004, and 2003, the Company made matching contributionsof $202,000 $177,000, and $157,000 respectively.

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**13.  Revenue by Product Group, by SignificantCustomer and by Geographic Region**

Product revenue by product group is as follows:

 

| ** **           | ** ** | **Years Ended December 31,** | ** ** |
|----------------------|------------|---------------------------------------------|------------|
| ** **           | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Ophthalmic  Products |       | $                                           | 10,522,000 |   | $ | 11,533,000 |   | $ | 10,512,000 |   |
| ORTHOVISC            |       | 7,938,000                                   |       | 8,699,000 |   | 3,073,000 |   |
| HYVISC               |       | 2,074,000                                   |       | 2,054,000 |   | 1,745,000 |   |
|                 |       | $                                           | 20,534,000 |   | $ | 22,286,000 |   | $ | 15,330,000 |   |

 

Productrevenue by significant customers as a percent of product revenues is asfollows:

| ** **                           | ** ** | **Percent of Product Revenue** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **Years Ended December 31,**   | ** ** |
| ** **                           | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Bausch &  Lomb Incorporated |       | 45.6                                          | %          | 38.3 | % | 50.6 | % |
| Pharmaren  AG/Biomeks                |       | 23.2                                          | %          | 13.6 | % | 14.3 | % |
| Boehringer  Ingelheim Vetmedica      |       | 10.1                                          | %          | 9.2 | % | 11.3 | % |
| Depuy Mitek /  Ortho Biotech         |       | 8.0                                           | %          | 21.0 | % | — |   |
| Advanced Medical  Optics             |       | 1.2                                           | %          | 9.9 | % | 13.4 | % |
|                                 |       | 88.1                                          | %          | 92.0 | % | 89.6 | % |

 

Revenuesby geographic location in total and as a percentage of total revenues are asfollows:

| ** **               | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------|------------|---------------------------------------------|------------|
| ** **               | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **               | ** ** | **Revenue**                                 | ** ** | **Percent of  Revenue** | ** ** | **Revenue** | ** ** | **Percent of  Revenue** | ** ** | **Revenue** | ** ** | **Percent of  Revenue** | ** ** |
| **Geographic location:** |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States            |       | $                                           | 21,090,000 |   |   | 70.7 | % |   | $ | 19,768,000 |   |   | 74.7 | % |   | $ | 9,918,000 |   |   | 64.4 | % |   |
| Europe                   |       | 3,167,000                                   |       |   | 10.6 | % |   | 3,115,000 |   |   | 11.8 | % |   | 2,848,000 |   |   | 18.5 | % |   |
| Turkey                   |       | 4,764,000                                   |       |   | 16.0 | % |   | 3,024,000 |   |   | 11.4 | % |   | 2,208,000 |   |   | 14.3 | % |   |
| Other                    |       | 814,000                                     |       |   | 2.7 | % |   | 559,000 |   |   | 2.1 | % |   | 430,000 |   |   | 2.8 | % |   |
| Total                    |       | $                                           | 29,835,000 |   |   | 100.00 | % |   | $ | 26,466,000 |   |   | 100.00 | % |   | $ | 15,404,000 |   |   | 100.00 | % |   |

 

All licensing, milestoneand contract revenue was derived in the United States for 2005, 2004 and 2003.

**14. Income Taxes**

Income tax expense(benefit) was $3,899,000, ($4,413,000), and ($88,000) for the years ended December 31,2005, 2004, and 2003, respectively. Prepaid taxes of $663,000 and $933,000 wereincluded in the prepaid expenses and other receivables at December 31,2005 and 2004, respectively.

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The components of theprovision for income taxes and benefit from release of valuation allowance areas follows:

| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |       |
|-----------------------------------------------|------------|---------------------------------------------|------------|------------|
| ** **                                    | ** ** | **2005**                                    | ** ** | **2004**   | ** ** | **2003** | ** ** |   |
| Current:                                      |       |                                        |       |       |   |   |   |   |
| Federal                                       |       | $                                           | 1,787,000  |       | $ | 5,846,000 |   | $ | (90,000 | ) |   |
| State                                         |       | 201,000                                     |       | 922,000    |   | 2,000 |   |   |
|                                          |       | 1,988,000                                   |       | 6,768,000  |   | (88,000 | ) |   |
| Deferred:                                     |       |                                        |       |       |   |   |   |   |
| Federal                                       |       | 1,298,000                                   |       | (3,680,000 | ) | — |   |   |
| State                                         |       | 613,000                                     |       | (462,000   | ) | — |   |   |
|                                          |       | 1,911,000                                   |       | (4,142,000 | ) | — |   |   |
| Provision for  income taxes                   |       | 3,899,000                                   |       | 2,626,000  |   | (88,000 | ) |   |
| Benefit from release of  valuation allowance: |       |                                        |       |       |   |   |   |   |
| Federal                                       |       | —                                      |       | (5,760,000 | ) | — |   |   |
| State                                         |       | —                                      |       | (1,279,000 | ) | — |   |   |
|                                          |       | —                                      |       | (7,039,000 | ) | — |   |
| Tax expense (benefit)                         |       | $                                           | 3,899,000  |       | $ | (4,413,000 | ) | $ | (88,000 | ) |   |
|                                               |            |                                             |            |            |  |  |  |  |  |  |  |  |  |

 

The Company receives a tax deduction upon the exerciseof nonqualified stock options and disqualifying dispositions by employees forthe difference between the exercise price and the market price of theunderlying common stock on the date of exercise. The benefit of the related taxdeduction in the amounts of $1,080,000 and $610,000 were not recorded throughthe tax provision, rather they were credited directly to additional paid incapital in 2005 and 2004, respectively.

In 2004, the Company achieved milestones under the JNJAgreement and received payments totaling $27,000,000 which the Companyrecognized as taxable income in 2004. As a result, the Company has determinedthat it will be able to utilize all of its net operating loss and creditcarry-forwards in 2004 to offset part of its taxable income. In accordance withthe Company’s revenue recognition policy, for financial statement purposes, themilestone payments totaling $27,000,000 were deferred and are being recognizedratably over the expected ten-year term of the JNJ Agreement. The Companyrecorded a deferred tax asset of approximately $9,800,000 representing theapproximate income tax effect of the timing difference of revenue recognitionfor financial statement purposes and for tax purposes related to these milestonepayments as of December 31, 2004. As of December 31, 2004, based onmanagement’s expectations regarding future profitability, the Company releasedthe valuation allowance previously established against its deferred tax assetsand recorded a one-time income tax benefit of $7,039,000.

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Theincome tax expense (benefit) differs from the amounts computed by applying theU.S. Federal income tax rate to pretax income as a result of the following: 

| ** **                                                     | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Computed expected  tax expense                                 |       | $                                           | 3,329,000  |   | $ | 2,304,000 |   | $ | 251,000 |   |
| State tax expense  (net of federal benefit)                    |       | 418,000                                     |       | 190,000 |   | 48,000 |   |
| State deferred  tax assets rate change                         |       | 436,000                                     |       | — |   | — |   |
| Permanent items,  including nondeductible expenses             |       | (83,000                                     | )          | 58,000 |   | 4,000 |   |
| Federal and state  research and development, and other credits |       | (137,000                                    | )          | (121,000 | ) | (64,000 | ) |
| Alternative  minimum tax benefit from carryback                |       | —                                      |       | — |   | (154,000 | ) |
| Alternative  minimum tax liability                             |       | —                                      |       | — |   | 64,000 |   |
| Other                                                          |       | (64,000                                     | )          | — |   | (34,000 | ) |
| Federal rate  difference                                       |       | —                                      |       | 195,000 |   | — |   |
| Change in  valuation allowance related to income tax benefit   |       | —                                      |       | (7,039,000 | ) | (203,000 | ) |
| Tax (benefit) expense                                          |       | $                                           | 3,899,000  |   | $ | (4,413,000 | ) | $ | (88,000 | ) |

 

TheCompany records a deferred tax asset or liability based on the differencebetween the financial statement and tax bases of assets and liabilities, asmeasured by the enacted tax rates assumed to be in effect when thesedifferences reverse. The approximate income tax effect of each type oftemporary difference and carryforward is as follows:

| ** **                 | ** ** | **Years ended December 31,** | ** ** |
|----------------------------|------------|---------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Deferred tax assets:       |       |                                        |       |   |   |
| Depreciation               |       | $                                           | 654,000    |   | $ | 525,000 |   |
| Accrued expenses and other |       | 144,000                                     |       | 366,000 |   |
| Inventory reserves         |       | 84,000                                      |       | 68,000 |   |
| Deferred revenue           |       | 8,388,000                                   |       | 10,222,000 |   |
| Deferred tax asset         |       | $                                           | 9,270,000  |   | $ | 11,181,000 |   |

 

As of December 31,2005, management determined that it is more likely than not that the deferredtax assets will be realized and, therefore, a valuation allowance has not beenrecorded.

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**15. QuarterlyFinancial Data (Unaudited)**

| ** **                         | ** ** | **Quarter ended** | ** ** | **Quarter ended** | ** ** | **Quarter ended** | ** ** | **Quarter ended** | ** ** |
|------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| **Year 2005**                 | ** ** | ** **             | ** ** | **December 31,**  | ** ** | **September 30,** | ** ** | **June 30,**      | ** ** | **March 31,** | ** ** |
| Product revenue                    |       |                   | $          | 4,774,000              |       |                   |       | $                      | 5,999,000  |   |   |   | $ | 4,084,000 |   |   |   | $ | 5,677,000 |   |   |
| Total revenue                      |       |                   | 5,466,000  |                   |       |                   | 10,058,000 |                   |       |   | 7,020,000 |   |   |   | 7,291,000 |   |   |
| Cost of product revenue            |       |                   | 2,266,000  |                   |       |                   | 3,767,000  |                   |       |   | 2,117,000 |   |   |   | 2,994,000 |   |   |
| Gross profit on product  revenue   |       |                   | 2,508,000  |                   |       |                   | 2,232,000  |                   |       |   | 1,967,000 |   |   |   | 2,683,000 |   |   |
| Net income                         |       |                   | $          | 823,000                |       |                   |       | $                      | 2,531,000  |   |   |   | $ | 1,337,000 |   |   |   | $ | 1,202,000 |   |   |
| Per common share information       |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Basic net income per  share        |       |                   | $          | 0.08                   |       |                   |       | $                      | 0.24       |   |   |   | $ | 0.13 |   |   |   | $ | 0.12 |   |   |
| Basic common shares  outstanding   |       |                   | 10,496,453 |                   |       |                   | 10,482,850 |                   |       |   | 10,391,538 |   |   |   | 10,269,389 |   |   |
| Diluted net income per  share      |       |                   | $          | 0.07                   |       |                   |       | $                      | 0.22       |   |   |   | $ | 0.12 |   |   |   | $ | 0.11 |   |   |
| Diluted common shares  outstanding |       |                   | 11,412,632 |                   |       |                   | 11,480,570 |                   |       |   | 11,537,538 |   |   |   | 11,264,595 |   |   |
|                                    |            |                        |            |                        |            |                        |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                         | ** ** | **Quarter ended** | ** ** | **Quarter ended** | ** ** | **Quarter ended** | ** ** | **Quarter ended** | ** ** |
|------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| **Year 2004**                 | ** ** | ** **             | ** ** | **December 31,**  | ** ** | **September 30,** | ** ** | **June 30,**      | ** ** | **March 31,** | ** ** |
| Product revenue                    |       |                   | $          | 5,473,000              |       |                   |       | $                      | 5,554,000  |   |   |   | $ | 5,690,000 |   |   |   | $ | 5,569,000 |   |   |
| Total revenue                      |       |                   | 7,656,000  |                   |       |                   | 6,407,000  |                   |       |   | 6,262,000 |   |   |   | 6,141,000 |   |   |
| Cost of product revenue            |       |                   | 2,335,000  |                   |       |                   | 2,451,000  |                   |       |   | 2,442,000 |   |   |   | 2,721,000 |   |   |
| Gross profit on product  revenue   |       |                   | 3,138,000  |                   |       |                   | 3,103,000  |                   |       |   | 3,248,000 |   |   |   | 2,848,000 |   |   |
| Net income                         |       |                   | $          | 1,755,000              |       |                   |       | $                      | 884,000    |   |   |   | $ | 765,000 |   |   |   | $ | 7,786,000 |   |   |
| Per common share information       |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Basic net income per  share        |       |                   | $          | 0.17                   |       |                   |       | $                      | 0.09       |   |   |   | $ | 0.08 |   |   |   | $ | 0.78 |   |   |
| Basic common shares  outstanding   |       |                   | 10,224,407 |                   |       |                   | 10,140,925 |                   |       |   | 10,060,866 |   |   |   | 9,987,410 |   |   |
| Diluted net income per  share      |       |                   | $          | 0.15                   |       |                   |       | $                      | 0.08       |   |   |   | $ | 0.07 |   |   |   | $ | 0.69 |   |   |
| Diluted common shares  outstanding |       |                   | 11,329,592 |                   |       |                   | 11,506,999 |                   |       |   | 11,396,116 |   |   |   | 11,257,264 |   |   |
|                                    |            |                        |            |                        |            |                        |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the second quarter of 2005, the Company’sophthalmic sales were significantly impacted as a result of a voluntary productrecall instigated by our discovery of defective vendor-supplied finished goodspackaged with our HA viscoelastic product. This voluntary recall resulted in adecrease of $1,359,000 in sales of ophthalmic product for the three monthsended June 30, 2005 and a corresponding similar increase in third quartersales as we completed restocking of our customers, with very little impact onrevenue from the recall for the nine and twelve months ended September 30and December 31, 2005, respectively.

On September 1, 2005, the Company announced thatit had mutually agreed with OrthoNeutrogena to terminate its development and commercializationagreement. Under the terms of the termination agreement, we received atermination payment of $3,115,000 from ONI including $815,000 for alloutstanding clinical study costs incurred and committed to by the Company atthe termination date. Given there is no continuing performance obligations withrespect to the development and commercialization agreement or the relatedtermination agreement, all amounts were recognized as contract revenue duringthe third quarter of 2005 under the performance-based model. See Notes 2.

In the first quarter of 2004, based on itsexpectations regarding future profitability, the Company released thepreviously established valuation allowance against its deferred tax assets andrecorded a one-time income tax benefit of $7,039,000. See Note 14.

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

(a)   Evaluationof disclosure controls and procedures.

As required by Rule 13a-15under the Securities Exchange Act of 1934 (Exchange Act), we carried out anevaluation under the supervision and with the participation of the ourmanagement, including our chief executive officer and chief financial officer,of the effectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report. Based upon thatevaluation, the chief executive officer and principal financial officer haveconcluded that our disclosure controls and procedures are reasonably effectiveto ensure that material information relating to us required to be disclosed byus in reports we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in Securities andExchange Commission rules and forms. Disclosure controls and proceduresinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by the Company in the reports it files orsubmits under the Exchange Act is accumulated and communicated to the Company’smanagement, including our chief executive officer and chief financial officer,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, our management recognized that any controlsand procedures, no matter how well designed and operated, can provide onlyreasonable assurances of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in designing andevaluating the controls and procedures. On an on-going basis, we review anddocument our disclosure controls and procedures, and our internal control overfinancial reporting, and may from time to time make changes aimed at enhancingtheir effectiveness and to ensure that our systems evolve with our business.

(b)   Changes ininternal controls over financial reporting.

There were no changes inour internal control over financial reporting during the fourth quarter offiscal year 2005 that have materially affected, or that are reasonably likelyto materially affect, our internal controls over financial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

The information requiredby Item 10 is hereby incorporated by reference to the Registrant’s ProxyStatement (the Proxy Statement) for the Annual Meeting of Stockholders to beheld on June 1, 2006 under the heading “Election of Directors.”

**ITEM 11.**         EXECUTIVECOMPENSATION

The information requiredby Item 11 is hereby incorporated by reference to the Proxy Statement under theheading “Executive Co-mpensation.”

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**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information requiredby Item 12 is hereby incorporated by reference to the Proxy Statement under theheading “Beneficial Ownership of Common Stock” and from Item 5 of this AnnualReport on Form 10-K under the heading “Equity Compensation PlanInformation.”

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information requiredby Item 13 is hereby incorporated by reference to the Proxy Statement under theheadings “Agreements with Named Executive Officers” and “Certain Relationshipsand Related Transactions.”

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information requiredby Item 14 is hereby incorporated by reference to the Proxy Statement under theheadings “PrincipalAccounting Fees and Services.”

**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

(a)           Documents filed as partof Form 10-K.

(1)         FinancialStatements

| Managements Report on  Internal Control Over Financial Reporting |   | 41    |   |
|------------------------------------------------------------------|--------|-------|--------|
| Report of  Independent Registered Public Accounting Firm         |   | 42    |   |
| Consolidated  Balance Sheets                                     |   | 44    |   |
| Consolidated  Statements of Operations                           |   | 45    |   |
| Consolidated  Statements of Stockholder’s Equity            |   | 46    |   |
| Consolidated  Statements of Cash Flows                           |   | 47    |   |
| Notes to Consolidated  Financial Statements                      |   | 49-62 |   |

 

(2)         Schedules

Schedules have been omitted as all requiredinformation has been disclosed in the financial statements and relatedfootnotes.

(3)         Exhibits

The list of Exhibits filedas a part of this Annual Report on Form 10-K are set forth on the Exhibit Index(b) below.

| (b) Exhibit No.                      | ** ** | **Description**                                                                                                                                                                                                                                                                                          |
|------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3) Articles of Incorporation and Bylaws: |
| 3.1                                            |       | The Amended and Restated Articles of Organization of  the Company, incorporated herein by reference to Exhibit 3.1 to the  Company’s Registration Statement on Form 10 (File no. 000-21326),  filed with the Securities and Exchange Commission on March 5, 1993.                    |
| 3.2                                            |       | Certificate of Vote of Directors Establishing a  Series of Convertible Preferred Stock, incorporated herein by reference  to Exhibits to the Company’s Registration Statement on Form 10 (File no.  000-21326), filed with the Securities and Exchange Commission on  March 5, 1993. |

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| 3.3                                                           |   | Amendment to the Amended and Restated Articles of  Organization of the Company, incorporated herein by reference to  Exhibit 3.1 to the Company’s quarterly report on Form 10-QSB  for the period ended November 30, 1996, (File no. 000-21326),  filed with the Securities and Exchange Commission on January 14, 1997.                                                                                                                        |
|---------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.4                                                           |   | Certificate of Vote of Directors Establishing a  Series of a Class of Stock, incorporated herein by reference to  Exhibit 3.1 of the Company’s Registration Statement on Form 8-AB12  (File no. 001-14027), filed with the Securities and Exchange Commission  on April 7, 1998.                                                                                                                                                           |
| 3.5                                                           |   | Amendment to the Amended and Restated Articles of  Organization of the Company, incorporated herein by reference to  Exhibit 3.3 of the Company’s quarterly report on Form 10-Q  for the quarterly period ending June 30, 2002 (File no. 000-21326),  filed with the Securities and Exchange Commission on August 14, 2002.                                                                                                                     |
| 3.6                                                           |   | The Amended and Restated Bylaws of the Company,  incorporated herein by reference to Exhibit 3.6 to the Company’s  quarterly report on Form 10-Q for the quarterly period ended  June 30, 2002 (File no. 000-21326), filed with the Securities and  Exchange Commission on August 14, 2002.                                                                                                                                                     |
| (4) Instruments Defining the Rights of Security  Holders |
| 4.1                                                           |   | Shareholder Rights Agreement dated as of  April 6, 1998 between the Company and Firstar Trust Company,  incorporated herein by reference to Exhibit 4.1 to the Company’s  Registration Statement on Form 8-A12B (File no. 001-14027),  filed with the Securities and Exchange Commission on April 7, 1998.                                                                                                                                      |
| 4.2                                                           |   | Amendment to Shareholder Rights Agreement dated as  of November 5, 2002 between the Company and American Stock Transfer and  Trust Company, as successor to Firstar Trust Company incorporated herein by  reference to Exhibit 4.2 to the Company’s quarterly report on  Form 10-Q for the quarterly period ended September 30, 2002  (File no. 000-21326), filed with the Securities and Exchange Commission  on November 13, 2002.       |
| (10) Material Contracts                                  |
| 10.1                                                          |   | Supply Agreement dated as of July 25, 2000 by  and between the Company and Bausch & Lomb, Inc., incorporated  herein by reference to Exhibit 10.1 to the Company’s quarterly report on  Form 10-Q for the quarterly period ended September 30, 2000  (File no. 001-14027), filed with the Securities and Exchange Commission  on November 14, 2000. Confidential treatment was granted to certain  portions of this Exhibit. |
| 10.2                                                          |   | 1993 Stock Option Plan, as amended, incorporated  herein by reference to Annex A of the Company’s Proxy Statement (File no. 001-14027),  filed with the Securities and Exchange Commission on April 28, 2000.                                                                                                                                                                                                                                                  |
| 10.3                                                          |   | Lease dated March 10, 1995 between the Company  and Cummings Properties, incorporated herein by reference to  Exhibit 10.8 to the Company’s Annual Report on Form 10-K for  the fiscal year ended December 31, 2000 (File no. 001-14027),  filed with the Securities Exchange Commission on April 2, 2001.                                                                                                                                 |
| 10.4                                                          |   | First Amendment to Lease dated December 11, 1997  between the Company and Cummings Properties, incorporated herein by reference  to Exhibit 10.9 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2000 (File no. 001-14027),  filed with the Securities Exchange Commission on April 2, 2001.                                                                                                           |

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| 10.5  |   | Extension of Lease dated November 23, 1999  between the Company and Cummings Properties, incorporated herein by reference  to Exhibit 10.10 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2000 (File no. 001-14027),  filed with the Securities Exchange Commission on April 2, 2001.                                                                                     |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.6  |   | Second Amendment to Lease dated November 23,  1998 between the Company and Cummings Properties, incorporated herein by  reference to Exhibit 10.11 to the Company’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2000 (File  no. 001-14027), filed with the Securities Exchange Commission on  April 2, 2001.                                                                             |
| 10.7  |   | Lease dated September 23, 1999 between the  Company and Cummings Properties, incorporated herein by reference to  Exhibit 10.12 to the Company’s Annual Report on Form 10-K for  the fiscal year ended December 31, 2000 (File no. 001-14027),  filed with the Securities Exchange Commission on April 2, 2001.                                                                                                 |
| 10.8  |   | Letter Agreement dated April 15, 1998 between  the Company and Charles H. Sherwood, incorporated herein by reference to  Exhibit 10.3 to the Company’s quarterly report on Form 10-Q  for the quarterly period ended June 30, 2000 (File no. 001-14027),  filed with the Securities and Exchange Commission on August 14, 2000.                                                                                 |
| 10.9  |   | Non-Disclosure and Non-Competition Agreement dated  May 5, 1998 between the Company and Charles H. Sherwood, incorporated  herein by reference to Exhibit 10.26 to the Company’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2000 (File  no. 001-14027), filed with the Securities Exchange Commission on  April 2, 2001.                                                                |
| 10.10 |   | Stipulation and Agreement of Compromise, Settlement  and Release dated May 25, 2001 in connection with In Re Anika  Therapeutics, Inc. Securities Litigation, incorporated herein by  reference to Exhibit 10.2 to the Company’s quarterly report on  Form 10-Q for the quarterly period ended June 30, 2001 (File  no. 001-14027), filed with the Securities and Exchange Commission on  August 14, 2001. |
| 10.11 |   | Amendment to Lease #3 dated November 1, 2001 by  and between the Company and Cummings Properties, incorporated herein by  reference to Exhibit 10.1 to the Company’s quarterly report on  Form 10-Q for the quarterly period ended September 30, 2001  (File no. 001-14027), filed with the Securities and Exchange Commission  on November 14, 2001.                                                           |
| 10.12 |   | Sublease effective as of November 2001, between  MedChem Products, Inc. and the Company, incorporated herein by reference  to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q  for the quarterly period ended March 31, 2002 (File no. 000-21326),  filed with the Securities and Exchange Commission on May 14, 2002.                                                                         |
| 10.13 |   | Amended and Restated Change in Control, Bonus and  Severance Agreement dated July 8, 2002 by and between the Company and  Charles H. Sherwood incorporated herein by reference to Exhibit 10.4 to  the Company’s quarterly report on Form 10-Q for the quarterly  period ended June 30, 2002 (File no. 000-21326), filed with the  Securities and Exchange Commission on August 14, 2002.                       |
| 10.14 |   | Change in Control, Bonus and Severance Agreement  dated June 9, 2003 by and between the Company and Francesco J. Luppino,  incorporated herein by reference to Exhibit 10.35 to the Company’s  quarterly report on Form 10-Q for the quarterly period ended  June 30, 2003 (File no. 000-21326), filed with the Securities and  Exchange Commission on August 14, 2003.                                         |

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| 10.15   |   | Lease Extension dated October 8, 2003 by and  between the Company and Cummings Properties, LLC, incorporated herein by  reference to Exhibit 10.36 to the Company’s quarterly report on  Form 10-Q for the quarterly period ended September 30, 2003  (File no. 000-21326), filed with the Securities and Exchange Commission  on November 14, 2003.                                                                                                                                     |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.16   |   | Lease Amendment dated October 8, 2003 by and  between the Company and MedChem Products, Inc., incorporated herein by  reference to Exhibit 10.36 to the Company’s quarterly report on  Form 10-Q for the quarterly period ended September 30, 2003  (File no. 000-21326), filed with the Securities and Exchange Commission  on November 14, 2003.                                                                                                                                  |
| 10.17   |   | License Agreement dated as of December 20, 2003  by and between the Company and Ortho Biotech Products, L.P., incorporated  herein by reference to Exhibit 10.38 to the Company’s annual report on  Form 10-K for the year ended December 31, 2003 (File no. 000-21326),  filed with the Securities and Exchange Commission on March 29, 2004.                                                                                                                                           |
| 10.18   |   | License Agreement dated as of July 23, 2004 by  and between the Company and Ortho-McNeil Pharmaceutical, Inc., acting  through its OrthoNeutrogena Division., incorporated herein by reference to  Exhibit 10.39 to the Company’s quarterly report on Form 10-Q  for the quarterly period ended June 30, 2004 (File no. 000-21326),  filed with the Securities and Exchange Commission on August 16, 2004.  Confidential treatment was granted to certain portions of this Exhibit. |
| 10.19   |   | Letter Agreement dated October 6, 2004 by and  between the Company and Carol A. Toth, Ph.D., incorporated herein by  reference to the Company’s current report on Form 8-K (File no.  000-21326), filed with the Securities and Exchange Commission on  November 19, 2004.                                                                                                                                                                                                                         |
| 10.20   |   | Change of Control, Bonus and Severance Agreement  dated October 6, 2004 by and between the Company and Carol A. Toth,  Ph.D., incorporated herein by reference to the Company’s current report on  Form 8-K (File no. 000-21326), filed with the Securities and  Exchange Commission on November 19, 2004.                                                                                                                                                                                         |
| **10.21 |   | Supply Agreement dated as of December 15, 2004  by and between the Company and Bausch & Lomb, Incorporated.                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.22   |   | Lease Amendment dated October 13, 2004 by and  between the Company and MedChem Products, Inc., incorporated herein by  reference to the Company’s annual report on Form 10-K for the  period ended December 31, 2004 (File no. 001-14027), filed with  the Securities and Exchange Commission on March 16, 2005.                                                                                                                                                                         |
| 10.23   |   | Letter Agreement dated June 30, 2005, as  amended, by and between the Company and Kevin W. Quinlan, incorporated herein  by reference to the Company’s current report on Form 8-K (File no.  001-14027), filed with the Securities and Exchange Commission on  July 12, 2005.                                                                                                                                                                                                                      |
| 10.24   |   | Change in Control, Bonus and Severance Agreement,  dated as of July 11, 2005, by and between the Company and Kevin W.  Quinlan, incorporated herein by reference to the Company’s current report on  Form 8-K (File no. 001-14027), filed with the Securities and  Exchange Commission on July 12, 2005.                                                                                                                                                                                           |

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| 10.25   |   | Letter Agreement, dated as of August 31, 2005,  regarding the termination of the License Agreement, dated as of July 23,  2004, between the Company and OrthoNeutrogena Division, OrthoMcNeil  Pharmaceutical, Inc., incorporated herein by reference to  Exhibit 10.1 to the Company’s quarterly report on Form 10-Q  for the quarterly period ended September 30, 2005 (File no. 001-14027),  filed with the Securities and Exchange Commission on November 7, 2005. |
|---------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.26   |   | 2003 Stock Option and Incentive Plan, as amended,  incorporated herein by reference to Exhibit A of the Company’s Proxy  Statement (File no. 001-14027), filed with the Securities and Exchange  Commission on April 30, 2003.                                                                                                                                                                                                                                                                  |
| 10.27   |   | First Amendment to the Company’s 2003 Stock Option  and Incentive Plan incorporated herein by reference to Exhibit 4.9 of  the Company’s Form S-8 (File no. 333-110326), filed with the  Securities and Exchange Commission on November 7, 2003.                                                                                                                                                                                                                                 |
| 10.28   |   | Form of Incentive Stock Option Agreement under  the Company’s 2003 Stock Option and Incentive Plan, incorporated herein by  reference to Exhibit 10.3 to the Company’s current report on Form 8-K  (File no. 001-14027), filed with the Securities and Exchange Commission  on October 5, 2004.                                                                                                                                                                                  |
| 10.29   |   | Form of Non-Qualified Stock Option Agreement  under the Company’s 2003 Stock Option and Incentive Plan, incorporated herein  by reference to Exhibit 10.4 to the Company’s current report on Form 8-K  (File no. 001-14027), filed with the Securities and Exchange Commission  on October 5, 2004.                                                                                                                                                                              |
| (11)    |   | Statement Regarding the Computation of Per Share  Earnings                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 11.1    |   | See Note 3 to the Financial Statements included  herewith.                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (21)    |   | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *21.1   |   | List of Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (23)    |   | Consent of Experts                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *23.1   |   | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| *31.1   |   | Certification of Charles H. Sherwood, Ph.D. pursuant  to Rules 13a-15(e) and 15d-15(e), as adopted pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                  |
| *31.2   |   | Certification of Kevin W. Quinlan pursuant to  Rules 13a-15(e) and 15d-15(e), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                            |
| ***32.1 |   | Certification of Charles H. Sherwood, Ph.D. and Kevin  W. Quinlan, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                        |
| (99)    |   | Additional Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|    |   | None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

----

*                    Filedherewith

**             Certainportions of this document have been omitted pursuant to a confidentialtreatment request filed with the Commission. The omitted portions have beenfiled separately with the Commission.

***      Furnishedherewith.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, as amended, the registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized in Woburn,Massachusetts on March 9, 2006.

|                          |   |   | ANIKA  THERAPEUTICS, INC. |
|--------------------------|--------|--------|--------------------------------|
| Date: March 9, 2006 | By:    |   | /s/ CHARLES H. SHERWOOD, PH.D. |
|                     |   |   | Charles H. Sherwood, Ph.D.     |
|                     |   |   | *Chief  Executive Officer*     |

 

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act, this report has been signedbelow by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

|                                 | **Signature** | ** **                            | ** ** |                     | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|---------------------------------|---------------|---------------------------------------|------------|---------------------|-----------|------------|------------|--|----------|------------|
| /s/ CHARLES H.  SHERWOOD, PH.D. |          | Chief Executive  Officer and Director |       | March 9,  2006 |
| Charles  H. Sherwood, Ph.D.     |          | *(Principal Executive Officer)*       |       |                |
| /s/ KEVIN W.  QUINLAN           |          | Chief Financial Officer               |       |                |
| Kevin  W. Quinlan               |          | *(Principal Accounting Officer)*      |       | March 9, 2006  |
| /s/ JOSEPH L.  BOWER            |          |                                  |       |                |
| Joseph  L. Bower                |          | Director                              |       | March 9, 2006  |
| /s/ EUGENE A.  DAVIDSON, PH.D.  |          |                                  |       |                |
| Eugene  A. Davidson, Ph.D.      |          | Director                              |       | March 9, 2006  |
| /s/ RAYMOND J.  LAND            |          |                                  |       |                |
| Raymond  J. Land                |          | Director                              |       | March 9, 2006  |
|                            |          |                                  |       |                |
| /s/ HARVEY S. SADOW, PH.D.      |          |                                  |       |                |
| Harvey  S. Sadow, Ph.D.         |          | Director                              |       | March 9, 2006  |
| /s/ STEVEN E.  WHEELER          |          |                                  |       |                |
| Steven E. Wheeler               |          | Director                              |       | March 9, 2006  |

 

 

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