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ANIKA THERAPEUTICS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 5, 2014

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding:



· Our future sales and product revenue, including geographic expansions, possible

retroactive price adjustments, and expectations of unit volumes or other offsets to price reductions;



· Our manufacturing capacity, efficiency gains and work-in-process manufacturing

operations;



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

· The development of possible line extensions and new products;

· Our ability to achieve and/or maintain compliance with laws and regulations;

· The timing of and/or receipt of Food and Drug Administration ("FDA"), foreign

or other regulatory approvals, clearances, and/or reimbursement approvals of

current, new or potential products, and any limitations on such approvals;

· Our intention to seek patent protection for our products and processes, and to

protect our intellectual property;

· Our ability to effectively compete against current and future competitors;

· Negotiations with potential and existing partners, including our performance

under any of our existing and future distribution, license or supply agreements, or our expectations with respect to sales and sales threshold milestones pursuant to such agreements;



· The level of our revenue or sales in particular geographic areas and/or for

particular products, and the market share for any of our products;

· Our expectations of product revenue results in future quarters and for the full

year 2014;



· Our current strategy, including our corporate objectives, research and

development activities and collaboration activities;

· Our expectations regarding our joint health products, including existing

products and expectations regarding new products, expanded uses of existing

products, new distribution partnerships and revenue growth;

· Our intention to increase our market share for joint health products in

domestic and international markets or otherwise penetrate growing markets for

osteoarthritis of the knee and other joints;

· Our expectations regarding next generation osteoarthritis/joint health product

development, clinical trials, regulatory approvals and commercial launches;

· Our and Bausch & Lomb's performance under the non-exclusive, three-year

contract for the supply of AMVISC® and AMVISC® Plus ophthalmic viscoelastic

products, and our expectations regarding revenue from ophthalmic products;

· Our ability to commercialize AnikaViscTM and AnikaViscTM Plus and our

expectations regarding such commercialization and the potential profits generated thereby;



· Our ability to license our aesthetics product to new distribution partners

domestically and outside the United States;

· Our ability, and the ability of our distribution partners, to market our

aesthetics dermatology product; and our expectations regarding the distribution

and sales of our ELEVESSTM product and the timing thereof;

· Our expectations regarding development of aesthetics product line extensions;

· Our expectations regarding HYVISC® sales;

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· Our expectations regarding product gross margin;

· Our expectations regarding CINGALTM, including the expense associated

therewith, and our ability to obtain regulatory approvals for this product;

· Our expectation for changes in operating expenses, including research and

development, and selling, general and administrative expenses;

· The rate at which we use cash, the amounts used and generated by operations,

and our expectations regarding the adequacy and usage of such cash;

· Our expectation for capital expenditures spending and future amounts of

interest income and expense;

· Possible negotiations or re-negotiations with existing or new distribution or

collaboration partners;



· Our ability to continue streamlining operations and improving our manufacturing

capabilities;



· Our ability to obtain additional funds through equity or debt financings,

strategic alliances with corporate partners and other sources, to the extent

our current sources of funds are insufficient;

· Our ability to manage and maintain the operations of Anika S.r.l. from one with

losses, into a company generating continued profits;

· The strength of the economies in which the Company operates or will operate, as

well as the political stability of any of those geographic areas;

· Our ability to effectively prioritize the many research and development

projects underway;

· Our ability to expand the therapeutic applications of our existing products and

create new applications for our HA technology;

· Our ability to obtain U.S. approval for orthopedic and other product franchises

of Anika S.r.l., including the timing and potential success of such efforts,

and to expand sales of these products in the U.S., including the impact such

efforts may have on our revenue; and

· Our ability to successfully defend the Company against lawsuits and claims, and

the uncertain financial impact such lawsuits and claims and related defense

costs may have on the Company.

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 future events and trends and which do not relate to historical matters, also identify forward-looking statements. You should not rely on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control, including those factors described in the section titled "Item 1A. Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. These risks, uncertainties and other factors may cause our actual results, performance or achievement to be materially different from anticipated future results, performance or achievement, expressed or implied by the forward-looking statements. These forward-looking statements are based upon the current assumptions of our management and are only expectations of future results. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences, including those factors discussed herein and in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of this Quarterly Report on Form 10-Q, as well as the risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2013 and in our press releases and other filings with the Securities and Exchange Commission. We undertake no obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors of new information, future events or other changes. 12 --------------------------------------------------------------------------------



Management Overview

Anika Therapeutics, Inc. (together with its subsidiaries, "Anika," the "Company," "we," "us," or "our") develops, manufactures and commercializes therapeutic products for tissue protection, healing, and repair. These products are based on hyaluronic acid ("HA"), a naturally occurring, biocompatible polymer found throughout the body. Due to its unique biophysical and biochemical properties, HA plays an important role in a number of physiological functions such as the protection and lubrication of soft tissues and joints, the maintenance of the structural integrity of tissues, and the transport of molecules to and within cells. Anika's proprietary technologies for modifying the HA molecule allow product properties to be tailored specifically to therapeutic use. Our patented technologies chemically modify the HA molecule to allow for longer residence time in the body. Anika Therapeutics, Inc.'s wholly-owned subsidiary, Anika Therapeutics S.r.l., has over 20 products currently commercialized, primarily in Europe. These products are also all made from hyaluronic acid, based on two technologies: "HYAFF", which is a solid form of HA, and ACP gel, an autocross-linked polymer of HA. Both technologies are protected by an extensive portfolio of owned and licensed patents. We offer therapeutic products from these aforementioned technologies in the following areas: Anika Anika S.r.l. Orthobiologics X X Dermal Advanced wound care X Aesthetic dermatology X Surgical Anti-adhesion X X Ear, nose and throat care ("ENT") X Ophthalmic X Veterinary X



Please see Management's Discussion and Analysis of Financial Condition and Results of Operations-Management Overview (Item 7) to the Company's Annual Report on Form 10-K for the year ended December 31, 2013, for a description of each of the above therapeutic areas, including the individual products.

Research and Development

Anika's research and development efforts primarily consist of the development of new medical applications for our HA-based technologies, the management of clinical trials and studies for certain product candidates, the preparation and processing of applications for regulatory approvals or clearances at all relevant stages of product development, and process development and scale-up manufacturing activities related to our existing and new products. Our development focus includes products for tissue protection, healing and repair. Our investment in R&D varies considerably depending on the number and size of clinical trials and studies underway. We anticipate that we will commit significant resources to research and development, including clinical trials, in the future. During the first quarter of 2014, the Company received FDA approval of MONOVISC and resolved the patent lawsuit with Genzyme Corporation. As a result of the full delivery of our development obligations under this agreement, the Company recognized the remaining balance of deferred revenue relating to the initial $2,500,000 non-refundable up front payment. The Company also received a milestone payment of $17,500,000 under the Mitek MONOVISC Agreement, for FDA approval and patent litigation resolution. This payment was fully recognized as revenue during the three months ended March 31, 2014. A key product currently under development and regulatory review is CINGAL, which is based on our hyaluronic acid material with an added active therapeutic molecule designed to provide broad pain relief for a longer period of time. We have completed the formulation and biocompatibility studies of the product. During the second quarter of 2013, we commenced a multinational phase III clinical trial to obtain the needed clinical data for a CE Mark submission and approval, and to support other product registrations including in the United States. Enrollment in the clinical trial was completed in February 2014 and we expect to be in a position to submit our CE Mark application by December 31, 2014, or shortly thereafter. The technologies obtained through our acquisition of Anika S.r.l. have enhanced our research and development capabilities, and our pipeline of product candidates. Anika S.r.l. has research and development programs for new products including Hyalofast, an innovative, biodegradable support for human bone marrow mesenchymal stem cells used in connection with soft tissue regeneration and Hyalospine, an adhesion prevention gel for use after spinal surgery. Our research and development efforts may not be successful in (1) developing our existing product candidates, (2) expanding the therapeutic applications of our existing products, or (3) resulting in new applications for our HA technology. There is also a risk that we may choose not to pursue development of potential product candidates. We also may not be able to obtain regulatory approval for any new applications we develop. 13 --------------------------------------------------------------------------------



Litigation and Other Legal Matters

On July 7, 2010, Genzyme Corporation filed a complaint against the Company in the United States District Court for the District of Massachusetts seeking unspecified damages and equitable relief. The complaint alleges that the Company has infringed U.S. Patent No. 5,143,724 by manufacturing MONOVISC in the United States for sale outside the United States and will infringe U.S. Patent Nos. 5,143,724 and 5,399,351 if the Company begins manufacture and sale of MONOVISC in the United States. On March 7, 2014 Genzyme and the Company filed a joint motion to lift the stay in Genzyme's lawsuit against the Company and to dismiss with prejudice all of Genzyme's claims. On March 10, 2014, the District Court granted the motion to dismiss with prejudice all of Genzyme's claims against the Company and the case was terminated. We are also involved in various other legal proceedings arising in the normal course of business. Although the outcomes of these other legal proceedings are inherently difficult to predict, we do not expect the resolution of these other legal proceedings to have a material adverse effect on our financial position, results of operations or cash flow.



Results of Operations

Three Months Ended March 31, 2014 Compared to the



Three Months Ended March 31, 2013

2014 2013 Inc/(Dec) Product revenue $ 14,351,405 $ 14,494,489 (1 %) Licensing, milestone and contract revenue 19,658,882 752,522 2512 % Total revenue 34,010,287 15,247,011 123 % Operating expenses: Cost of product revenue 4,361,019 4,841,170 (10 %) Research & development 2,287,715 1,582,910 45 % Selling, general & administrative 3,490,985 3,947,114 (12 %) Restructuring credits - (135,607 ) N/M Total operating expenses 10,139,719 10,235,587 (1 %) Income from operations 23,870,568 5,011,424 376 % Interest income (expense), net 467 (39,558 ) (101 %) Income before income taxes 23,871,035 4,971,866 380 % Provision for income taxes 8,840,782 1,903,864 364 % Net income $ 15,030,253 $ 3,068,002 390 % Product gross profit $ 9,990,386 $ 9,653,319 3 % Product gross margin 70 % 67 % Product Revenue Product revenue for the quarter ended March 31, 2014 was $14,351,405, a decrease of 1%, as compared to $14,494,489 for the quarter ended March 31, 2013. Increases in product revenue from our Orthobiologics and Surgical franchises were offset by decreases in revenue from our Dermal, Ophthalmic and Veterinary products. The overall 1% decline from the first quarter of 2013 reflects certain nonrecurring events and the timing of orders, and is not indicative of product revenue results in future quarters. 14 --------------------------------------------------------------------------------



The following table presents product revenue by group for the three-month period ended March 31, 2014 and 2013:

Three Months Ended March 31, Increase (Decrease) 2014 2013 $ % Orthobiologics $ 11,572,150$ 11,283,547$ 288,603 3 % Dermal 188,651 241,584 (52,933 ) (22 %) Surgical 1,752,020 988,864 763,156 77 % Ophthalmic 208,584 928,458 (719,874 ) (78 %) Veterinary 630,000 1,052,036 (422,036 ) (40 %) $ 14,351,405$ 14,494,489$ (143,084 ) (1 %) Orthobiologics Our orthobiologics franchise consists of our joint health and orthopedic products. Overall, sales increased 3% for the three months ended March 31, 2014, as compared to the same period in 2013. The modest growth in the first quarter of 2014 was in line with our expectation and reflected several nonrecurring events. Included in the first quarter 2014 orthobiologics revenue was an initial U.S. stocking order for MONOVISC. This was partially offset by decreases in other orthobiologics product revenues. The initial order placed by Mitek was in preparation for the U.S. commercial launch of MONOVISC, which took place on April 15, 2014, following product approval on February 25, 2014. We expect joint health product revenue to increase in 2014 as compared to 2013, both domestically and internationally.



Dermal

Our dermal franchise consists of advanced wound care products and aesthetic dermal fillers. Overall, dermal product sales decreased 22% for the three-month period ended March 31, 2014 to $188,651, as compared to the same period in 2013. This decrease primarily reflects order timing by our distribution partners. Anika's advanced wound care products treat complex skin wounds ranging from burns to diabetic ulcers, with Hyalomatrix and Hyalofill as lead products. For the full year 2014, we expect revenue from our dermal products to increase from 2013. Surgical Our surgical franchise consists of products used to prevent post-surgical adhesions in abdominal-pelvic, spinal, and ear, nose and throat ("ENT") disorders. Sales of our surgical products increased 77% for the three-month period ended March 31, 2014 to $1,752,020, as compared to the same period ended in 2013, due to strong demand for our Hyalobarrier product by our European and Asian partners. For the full year 2014, we expect revenue from our surgical products to increase from 2013.



Ophthalmic

Our ophthalmic franchise consists of HA viscoelastic products used in ophthalmic surgery. Ophthalmic product sales decreased 78% to $208,584 for the three month-period ended March 31, 2014, as compared to the same period in 2013. The decrease was primarily attributable to Bausch & Lomb delaying its contractual minimum purchases until the fourth quarter of 2014. We expect the overall ophthalmic revenue to be lower in 2014, as compared to 2013, under the terms of the current Bausch & Lomb supply agreement.



Veterinary

Veterinary revenue from HYVISC decreased by 40% to $630,000 for the three-month period ended March 31, 2014, as compared to the same period in 2013. The variation was primarily due to order timing by our distribution partner, Boehringer Ingelheim Vetmedica. We continue to look at other veterinary applications and opportunities to expand geographic territories.

Licensing, milestone and contract revenue

Licensing, milestone and contract revenue for the three-month period ended March 31, 2014 was $19,658,882, as compared to $752,522 for the same period in 2013. Revenue for the quarter included a total of $19,652,778 in milestone and contract revenue associated with our U.S. license agreement for MONOVISC. The year-over-year increase primarily consisted of a $17,500,000 milestone payment resulting from the resolution of patent litigation with Genzyme and FDA approval of MONOVISC. It also included the recognition of the remaining unamortized upfront payment previously received in December 2011. These payments are related to development obligations under the license agreement. The FDA's approval of our MONOVISC product during the quarter-ended March 31, 2014 completed the delivery of development obligations under the license agreement, and resulted in the immediate recognition of the $17.5 million milestone payment, as well as the full recognition of prior deferred revenue in the first quarter of 2014. 15 --------------------------------------------------------------------------------



Product gross profit and margin

Product gross profit for the three months ended March 31, 2014 increased $337,067 to $9,990,386 or 70% of product revenue for the period then ended. The increase in product gross margin for the three-month period ended March 31, 2014, as compared to the same period in 2013, is attributable to more favorable product mix and continued efficiency gains at our Bedford, Massachusetts facility. This quarter's product gross margin may not be indicative of the rest of the year due to dynamics such as the future mix of our product sales.



Research and development

Research and development expenses for the three-month period ended March 31, 2014 increased $704,805 to $2,287,715, or 7% of total revenue. This primarily reflects the early completion of patient enrollment in our phase III Cingal clinical trial during the first quarter of 2014, as compared to the same period ended in 2013. We experienced small phase III CINGAL clinical trial initiation expenses during the first quarter in 2013. Research and development spending is expected to increase in future quarters as we further develop new products based on our existing technology assets.



Selling, general and administrative

Selling, general and administrative ("SG&A") expenses for the three-month period ended March 31, 2014 decreased $456,129 to $3,490,985, or 10% of total revenue, as compared to the same period ended in 2103. The decrease is primarily driven by non-recurring external professional fees and personnel costs in the first quarter of 2013. We expect general and administrative expenses to increase in 2014, as compared to 2013, reflective of the support required to grow our business both domestically and internationally.



Income taxes

Provision for income taxes increased $6,936,918 to $8,840,782 during the three-month period ended March 31, 2014, as compared to the same period ended in 2013. The increase in income taxes was due to increased net income, which reflected $19,652,778 in milestone and contract revenue associated with our U.S. license agreement for MONOVISC. See the previous discussion under Licensing, milestone and contract revenue. The provisions for the periods ended March 31, 2014 and 2013 were based on effective tax rates of 37% and 38%, respectively. The decrease in the effective tax rate for the period ended 2014, as compared to the same period ended in 2013, was driven primarily by the tax benefits associated with the increase in production activities combined with the benefits associated with increased stock option exercise activity. The Company files income tax returns in the U.S. on a federal basis, in certain U.S. states, and in Italy. The associated tax filings remain subject to examination by applicable tax authorities for a certain length of time following the tax year to which those filings relate. Our 2010 through the present tax years remain subject to examination by the IRS and other taxing authorities for U.S. federal and state tax purposes. The 2009 through the present tax years remain subject to examination by the appropriate governmental authorities in Italy. In connection with the preparation of the financial statements, the Company performed an analysis to ascertain if it was more likely than not that it would be able to utilize, in future periods, the net deferred tax assets associated with its net operating loss carryforward. We have concluded that the positive evidence outweighs the negative evidence and, thus, those deferred tax assets are realizable on a "more likely than not" basis. As such, we have not recorded a valuation allowance at March 31, 2014 or December 31, 2013, respectively. 16 --------------------------------------------------------------------------------



Liquidity and Capital Resources

We require cash to fund our operating expenses and capital expenditures. We expect that our requirements for cash to fund operations will increase as the scope of our operations expands. Historically, we have generated positive cash flow from operations, which together with our available cash and investments, meet our cash requirements. Cash and cash equivalents totaled approximately $82.2 million and $63.3 million at March 31, 2014 and December 31, 2013, respectively. Working capital totaled approximately $105.8 million at March 31, 2014 and $85.3 million at December 31, 2013. The Company believes it has adequate financial resources to support its business for the next twelve months. Cash provided by operating activities was $13,596,657 for the three months ended March 31, 2014 as compared to cash provided by operating activities of $6,068,854 for the same period in the prior year. This increase in cash provided by operations was due primarily to a $17.5 million milestone payment received under the fifteen-year license agreement with DePuy Synthes Mitek Sports Medicine to market MONOVISC in the U.S. This cash inflow is partially offset by an increase in inventory due to anticipated future sales demand. Cash used in investing activities was $276,513 for the three months ended March 31, 2014 as compared to cash provided by investing activities of $99,805 for the same period in 2013. The increase in cash used in investing activities is the result of higher capital expenditures in the first quarter 2014 compared to 2103, as well as the proceeds received from the sale of property and equipment in the prior year period relating to our reorganization at Anika S.r.l. in the beginning of 2013. Cash provided by financing activities was $5,504,016 for the three months ended March 31, 2014, as compared to cash provided by financing activities of $761,658 for the same period in 2013. The increase in cash provided by financing activities in the current year period is attributable to the increased tax benefits received in regards to employees' exercise of stock options during the first three months of 2014, as compared to the same period in the prior year.



Critical Accounting Estimates

During the three months ended March 31, 2014, the Company received FDA approval of MONOVISC and the related patent litigation was also resolved. As a result, the Company shortened the estimate of the performance period associated with its development obligations related to the Mitek MONOVISC Agreement. There were no other significant changes in our critical accounting estimates during the three months ended March 31, 2014, as compared to the critical accounting estimates disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.



Recent Accounting Pronouncements

There have been no significant applicable Recent Accounting Pronouncements since our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Contractual Obligations and Other Commercial Commitments

We have had no material changes outside the ordinary course to our contractual obligations disclosed in our Annual Report of Form 10-K for the period ended December 31, 2013. To the extent that funds generated from our operations, together with our existing capital resources, are insufficient to meet future requirements, we will be required to obtain additional funds through equity or debt financings, strategic alliances with corporate partners and others, or through other sources. No assurance can be given that any additional financing will be made available to us or will be available on acceptable terms should such a need arise.



Off-balance Sheet Arrangements

The Company does not use special purpose entities or other off-balance sheet financing techniques, except for operating leases, that we believe have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital resources. 17



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