ANIKA THERAPEUTICS INC - 10-K Annual Report

Massachusetts (State or Other Jurisdiction of Incorporation or Organization)		04-3145961 (I.R.S. Employer Identification No.)
160 New Boston Street, Woburn, Massachusetts (Address of Principal Executive Offices)		01801 (Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ý No o

The aggregate market value of voting and non-voting stock held by non-affiliates of the Registrant as of June 30, 2004, the last day of the Registrant's most recently completed second fiscal quarter, was $172,235,000 based on the average bid and ask price per share of Common Stock of $17.34 as of such date as reported on the NASDAQ National Market. Shares of our Common Stock held by each executive officer, director and each person or entity known to the registrant to be an affiliate have been excluded in that such persons may be deemed to be affiliates; such exclusion shall not be deemed to constitute an admission that any such person is an "affiliate" of the registrant. At March 4, 2005, there were issued and outstanding 10,296,222 shares of Common Stock, par value $.01 per share.

Certain information required in response to Items 10, 11, 12, 13 and 14 of Part III are hereby incorporated by reference from the registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on June 1, 2005. Such Proxy Statement shall not be deemed to be "filed" as part of this Annual Report on Form 10-K except for the parts therein which have been specifically incorporated by reference herein.

This Annual Report on Form 10-K, including the documents incorporated by reference into this Annual Report on Form 10-K, 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, without limitation, statements regarding:

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 "Risk Factors and Certain Factors Affecting Future Operating Results," in this Annual Report on Form 10-K. These risks, uncertainties and other factors may cause our actual results, performance or achievement to be materially different from the 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 in the sections titled "Business" and "Management's Discussions and Analysis of Financial Condition and Results of Operations" elsewhere in this Annual Report on Form 10-K. 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.

Anika Therapeutics develops, manufactures and commercializes therapeutic products and devices intended to promote the protection and healing of bone, cartilage and soft tissue. 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. Our currently marketed products consist of ORTHOVISC®, which is an HA product used in the treatment of some forms of osteoarthritis in humans, CoEase™, STAARVISC™-II, and ShellGel™, each an injectable ophthalmic viscoelastic HA product, and HYVISC®, which is an HA product used in the treatment of equine osteoarthritis. In December 2003 we entered into a licensing, distribution, supply and marketing agreement with Ortho Biotech Products, L.P., a member of the Johnson & Johnson family of companies, for ORTHOVISC covering the U.S. and Mexico, and in February 2004 we received marketing approval from the U.S. Food and Drug Administration (FDA) for ORTHOVISC. ORTHOVISC became available for sale in the U.S. on March 1, 2004 and has been approved for sale and marketed internationally since 1996. HYVISC is marketed in the U.S. through Boehringer Ingelheim Vetmedica, Inc. We manufacture AMVISC® and AMVISC® Plus, HA viscoelastic supplement products used in ophthalmic surgery, for Bausch & Lomb Incorporated. In December 2004, we entered into a multi-year supply agreement with Bausch & Lomb covering viscoelastic products used in ophthalmic surgery, including the AMVISC and AMVISC Plus family of products.

In 2004, revenue from the sale of our products contributed 84% of our total revenue. Licensing, milestone and contract revenue contributed 16% of our total revenue in 2004. Revenue from the sale of ophthalmic viscoelastic products was 43% of total revenue in 2004 or 52% of product revenue. ORTHOVISC contributed 33% of our total revenue in 2004 or 39% of product revenue and HYVISC contributed 8% of our total revenue or 9% of product revenue in 2004.

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

ORTHOVISC is indicated for the treatment of pain in osteoarthritis of the knee in patients who have failed to respond adequately to conservative non-pharmacologic therapy and to simple analgesics, such as acetaminophen. It is a sterile, non-pyrogenic, clear, viscoelastic solution of hyaluronan contained in a single-use syringe. ORTHOVISC consists of high molecular weight, ultra-pure natural hyaluronan dissolved in physiological saline. A natural complex sugar of the glycosaminoglycan family, hyaluronan is a high molecular weight polysaccharide composed of repeating disaccharide units of sodium glucuronate and N-acetylglucosamine. ORTHOVISC is injected into the knee joint in a series of 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 in a joint gradually deteriorates due to the effects of mechanical stress, which can be caused by a variety of factors including the normal aging process. In an osteoarthritic joint, particular regions of articulating surfaces are exposed to irregular forces, which result in the remodeling of tissue surfaces that disrupt the normal equilibrium or mechanical function. As osteoarthritis advances, the joint gradually loses its ability to regenerate cartilage tissue and the cartilage layer attached to the bone deteriorates to the point where eventually the bone becomes exposed. Advanced osteoarthritis often requires surgery and the possible implantation of artificial joints. The current treatment options for osteoarthritis before joint replacement surgery include viscosupplementation, analgesics, non-steroidal anti-inflammatory drugs and steroid injections.

In February 2004, we received marketing approval from the FDA for ORTHOVISC based on integrated effectiveness data from two randomized, controlled, double-blind, multi-center, pivotal U.S. clinical studies encompassing a total of 458 patients suffering from osteoarthritis of the knee. Safety data from a third U.S. trial were also included in the FDA review. The objective of the studies was to assess the effectiveness of ORTHOVISC for the treatment of joint pain. There were no serious adverse events associated with ORTHOVISC.

In December 2003 we entered into a ten-year licensing and supply agreement (the OBI Agreement) with Ortho Biotech Products, L.P., a member of the Johnson & Johnson family of companies, to market ORTHOVISC in the U.S. and Mexico. Under the OBI Agreement, Ortho Biotech will perform sales, marketing and distribution functions. Additionally, Ortho Biotech licensed the right to further develop and commercialize ORTHOVISC as well as other new products for the treatment of pain associated with osteoarthritis based on our viscosupplementation technology. In support of the license, the OBI Agreement provides that Ortho Biotech will fund post-marketing clinical trials for new indications of ORTHOVISC. We received an initial payment of $2.0 million upon entering into the OBI Agreement, a milestone payment of $20.0 million in February 2004, as a result of obtaining FDA approval of ORTHOVISC and a $5.0 million milestone payment in December 2004 for planned upgrades to our manufacturing operations. Under the OBI Agreement, we are the exclusive supplier of ORTHOVISC to Ortho Biotech. The OBI Agreement provides for additional sales-based milestone payments to us

contingent upon achieving specified sales targets, in addition to royalty and transfer fees. The OBI Agreement is subject to early termination in certain circumstances and is otherwise renewable by Ortho Biotech for consecutive five-year terms.

We have a number of distribution relationships servicing international markets including Canada, the U.K., Italy, and other European countries, Turkey, and parts of the Middle East. We are continuing to seek to establish long-term distribution relationships in other regions, but can make no assurances that we will be successful in doing so. See the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations Overview" and "Risk Factors and Certain Factors Affecting Future Operating Results."

HYVISC is a high molecular weight injectable HA product for the treatment of joint dysfunction in horses due to non-infectious synovitis associated with equine osteoarthritis. HYVISC has viscoelastic properties that lubricate and protect the tissues in horse joints. HYVISC is distributed by Boehringer Ingelheim Vetmedica, Inc. in the United States.

The ophthalmic products we manufacture include the AMVISC and AMVISC Plus product line, CoEase, STAARVISC-II, and ShellGel. Our injectable ophthalmic viscoelastic products are high molecular weight HA products used as viscoelastic agents in ophthalmic surgical procedures such as cataract extraction and intraocular lens implantation. These products coat, lubricate and protect sensitive tissues such as the endothelium and maintain the space between them, thereby facilitating ophthalmic surgical procedures.

Anika manufactures the AMVISC product line for Bausch & Lomb. In December 2004, we entered into a multi-year supply agreement (the 2004 B&L Agreement) with Bausch & Lomb for viscoelastic products used in ophthalmic surgery. Under the 2004 B&L Agreement, which extends through December 31, 2010, and superseded the existing supply contract that was set to expire December 31, 2007, we will continue to be the exclusive global supplier (other than with respect to Japan) for AMVISC and AMVISC Plus to Bausch & Lomb. The 2004 B&L Agreement also provides us with a right to negotiate to manufacture future surgical ophthalmic viscoelastic products developed by Bausch & Lomb, while Bausch & Lomb has been granted rights to commercialize certain future surgical ophthalmic viscoelastic products developed by us. The 2004 B&L Agreement applies to all 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, we are entitled to continue providing surgical viscoelastic products to our existing customers (e.g. Advanced Medical Optics, STAAR Surgical Company, Cytosol Ophthalmics, Inc.) who currently receive such products from us. See also the section captioned "Risk Factors and Certain Factors Affecting Future Operating Results—Dependence on Marketing Partners" and "—Reliance on a Small Number of Customers."

As discussed below in the section titled "Risk Factors and Certain Factors Affecting Future Operating Results," we have not obtained FDA approval for the sales and marketing in the U.S. of the potential products described below.

Our products for cosmetic tissue augmentation (CTA) are based on a family of chemically modified, cross-linked forms of HA designed for longer duration in the body. Cosmetic tissue augmentation is a therapy designed as a soft tissue filler for facial wrinkles, scar remediation and lip augmentation. This new class of tissue filler technology based on HA is intended to supplant collagen-based products currently on

the market. In May 2004, we commenced a pivotal U.S. clinical trial to evaluate CTA's effectiveness for correcting nasolabial folds. The trial is being conducted by dermatologists and plastic surgeons at 10 centers throughout the U.S. Patient enrollment was completed during the third quarter of 2004 and patients will be monitored for 6 to 12 months following initial treatment.

In July 2004 we entered into an exclusive worldwide development and commercialization partnership (the OrthoNeutrogena Agreement) for our CTA products with the OrthoNeutrogena division of Ortho-McNeil Pharmaceuticals, Inc., an affiliate of Johnson & Johnson. Under the terms of the OrthoNeutrogena Agreement, we received an initial payment of $1.0 million. In addition, OrthoNeutrogena is required, subject to certain limitations, to fund our ongoing pivotal clinical trial of our CTA product initiated in May 2004 and to support the development of the CTA product, as well as future line extensions. The OrthoNeutrogena Agreement also provides for sales- and development-based milestone payments to be made upon receipt of final marketing approval from the U.S. Food and Drug Administration (FDA), receipt of a European CE Mark, and upon achievement of other sales and development targets in addition to royalty payments and transfer payments for the supply of CTA products.

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

INCERT-S is our product designed to reduce post-surgical fibrosis following spinal surgery. We initiated a pilot human clinical trial in Europe in April 2004 involving patients undergoing spinal surgery. The clinical trial is being conducted at two centers in the U.K. and will involve approximately 45 patients. As of December 31, 2004, patient enrollment was approximately two-thirds complete.

Anika co-owns issued U.S. patents covering the use of INCERT for adhesion prevention. See the section captioned "Patent and Propriety Rights".

We cannot assure you that: (1) we will successfully complete clinical trials of our CTA products or INCERT-S; (2) if completed, regulatory approval for sales in the U.S. or internationally, in the case of our CTA products, will be obtained; or (3) if regulatory approvals are obtained, meaningful sales of our CTA products or INCERT-S will be achieved.

We have been manufacturing HA since 1983 in our facility located in Woburn, Massachusetts. This facility is approved by the FDA for the manufacture of medical devices and drugs. We have developed a proprietary manufacturing process for the extraction and purification of HA from avian combs, a source of high molecular weight HA. We have taken steps to minimize risks associated with the availability of raw materials by obtaining regulatory approval in 2003 to outsource certain key intermediates for some of our products, which we have expanded to include all of our current products. We believe that sufficient supplies of these materials are generally available, or maintained in inventory, to meet anticipated demand.

We have a policy of seeking patent protection for patentable aspects of our proprietary technology. Our issued patents expire between 2009 and 2022. We co-own certain U.S. patents and a patent application

with claims relating to the chemical modification of HA and certain adhesion prevention uses and certain drug delivery uses of HA. We also solely own patents covering composition of matter and certain manufacturing processes. We also hold a license from Tufts University to use technologies claimed in a U.S. patent for the anti-metastasis applications of HA oligosaccharides. The license expires upon expiration of the underlying patent. We intend to seek patent protection for products and processes developed in the course of our activities when we believe such protection is in our best interest and when the cost of seeking such protection is not inordinate relative to the potential benefits. See also the section captioned "Risk Factors and Certain Factors Affecting Future Operating Results—We may be unable to adequately protect our intellectual property."

Other entities have filed patent applications for or have been issued patents concerning various aspects of HA-related products or processes. In addition, the products or processes we develop may infringe the patent rights of others in the future. Any such infringement may have a material adverse effect on our business, financial condition, and results of operations. See also the section captioned "Risk Factors and Certain Factors Affecting Future Operating Results—We may be unable to adequately protect our intellectual property."

We also rely upon trade secrets and proprietary know-how for certain non-patented aspects of our technology. To protect such information, we require all employees, consultants and licensees to enter into confidentiality agreements limiting the disclosure and use of such information. These agreements, however, may not provide adequate protection. See also the section captioned "Risk Factors and Certain Factors Affecting Future Operating Results—We may be unable to adequately protect our intellectual property."

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

We have granted Ortho Biotech an exclusive, non-transferable royalty bearing license to use and sell ORTHOVISC (and other products developed pursuant to the OBI Agreement) in the U.S. and Mexico, as well as a license to manufacture and have manufactured such products in the event that we are unable to supply Ortho Biotech with products in accordance with the terms of the OBI Agreement.

We have granted Ortho Neutrogena a worldwide, exclusive, non-transferable license to use, sell and offer our CTA product currently in development (and other products developed pursuant to the OrthoNeutrogena Agreement), as well as a non-transferable license to manufacture and have manufactured such products in the event (and during such times) that we are unable to supply OrthoNeutrogena with CTA products in accordance with the terms of the OrthoNeutrogena Agreement.

Our research (including clinical research), development, manufacture, and marketing of products are subject to regulation by numerous governmental authorities in the U.S. and other countries. In the U.S., medical devices are subject to extensive and rigorous regulation by the FDA and by other federal, state and local authorities. The Federal Food, Drug and Cosmetic Act (FDC Act) governs the testing, safety, effectiveness, clearance, approval, manufacture, labeling, packaging, distribution, storage, record keeping, reporting, marketing, advertising, and promotion of our products. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance or approval of products, withdrawal of clearances and approvals, and criminal prosecution.

Medical products regulated by the FDA are generally classified as drugs, biologics, and/or medical devices. AMVISC, ShellGel, CoEase and STAARVISC are approved as Class III medical devices in the U.S. for ophthalmic surgical procedures in intraocular use in humans. ORTHOVISC is approved as a

Class III medical device in the U.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 horse joints to treat degenerative joint disease associated with synovitis. In the past, most HA products for human use have been regulated as medical devices. We believe that the our products for CTA and INCERT will have to meet the regulatory requirements of Class III devices, including premarket approval (PMA).

Unless a new device is exempted from premarket notification, its manufacturer must obtain marketing clearance from the FDA through a premarket notification (510(k)) or approval through a PMA before the device can be introduced into the market. Product development and approval within the FDA regulatory framework takes a number of years and involves the expenditure of substantial resources. This regulatory framework may change or additional regulation may arise at any stage of our product development process and may affect approval of, or delay an application related to, a product, or require additional expenditures by us. There is no assurance that the FDA review of marketing applications will result in product approval on a timely basis, or at all.

In the U.S., medical devices intended for human use are classified into three categories (Class I, II or III), on the basis of the controls deemed reasonably necessary by the FDA to assure their safety and effectiveness. Class I devices are subject to general controls, for example, labeling and adherence to the FDA's Good Manufacturing Practices/Quality System Regulation (GMP/QSR). Most Class I devices are exempt from premarket notification. Class II devices are subject to general and special controls (for example, performance standards, postmarket surveillance, and patient registries). Most Class II devices are subject to premarket notification and may be subject to clinical testing for purposes of premarket notification and clearance for marketing. Class III is the most stringent regulatory category for medical devices. Most Class III devices require PMA approval from the FDA.

The PMA approval process is lengthy, expensive, and typically requires, among other things, valid scientific evidence which typically includes extensive data such as pre-clinical and clinical trial data to demonstrate a reasonable assurance of safety and effectiveness.

Human clinical trials for significant risk devices must be conducted under an Investigational Device Exemption (IDE), which must be submitted to the FDA and either be approved or be allowed to become effective before the trials may commence. There can be no assurance that submission of an IDE will result in the ability to commence clinical trials. In addition, the IDE approval process could result in significant delay. Even if the FDA approves an IDE or allows an IDE for a clinical investigation to become effective, clinical trials may be suspended at any time for a number of reasons, including, among others, failure to comply with applicable requirements, if there is reason to believe that the risks to clinical subjects are not outweighed by the anticipated benefits to clinical subjects and the importance of the knowledge to be gained, informed consent is inadequate, the investigation is scientifically unsound, there is reason to believe that the device, as used, is ineffective. A trial may be terminated if an unanticipated adverse device effect presents an unreasonable risk to subjects. If clinical studies are suspended or terminated, we may be unable to continue the development of the investigational products affected.

Upon completion of required clinical trials, for Class III medical devices, results are presented to the FDA in a PMA application. In addition to the results of clinical investigations, the PMA applicant must submit other information relevant to the safety and effectiveness of the device, including, among other things, the results of non-clinical tests; a full description of the device and its components; a full description of the methods, facilities and controls used for manufacturing; and proposed labeling. The FDA usually also conducts an on-site inspection to determine whether an applicant conforms with the FDA's current 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 on labeling and advertising claims and the imposition of post-market testing, tracking, or surveillance requirements.

Product changes after approval where such change affects safety and effectiveness as well as the use of a different facility for manufacturing, could necessitate additional FDA review and approval by the FDA.

Post approval changes in labeling, packaging or promotional materials may also necessitate further FDA review and approval by the FDA.

Legally marketed products are subject to continuing requirements by the FDA relating to manufacturing, quality control and quality assurance, maintenance of records and documentation, reporting of adverse events, and labeling and promotion. The FDC Act requires device manufacturers to comply with GMP/QSR. The FDA enforces these requirements through periodic inspections of device manufacturing facilities. In complying with standards set forth in the GMP/QSR regulations, manufacturers must continue to expend time, money and effort in the area of production and quality control to ensure full technical compliance. Other federal, state, and local agencies may inspect manufacturing establishments as well.

A set of regulations known as the Medical Device Reporting regulations obligates manufacturers to inform FDA whenever information reasonably suggests that one of their devices may have caused or contributed to a death or serious injury, or when one of their devices malfunctions and if the malfunction were to recur, the device or a similar device would be likely to cause or contribute to a death or serious injury.

In addition to regulations enforced by the FDA, we are subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other existing and future federal, state and local laws and regulations as well as those of foreign governments. Federal, state and foreign regulations regarding the manufacture and sale of medical products are subject to change. We cannot predict what impact, if any, such changes might have on our business.

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

In addition to regulations enforced by the FDA, we and our products are subject to certain foreign regulations. International regulatory bodies often establish regulations governing product standards, packing requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. ORTHOVISC is approved for sale and is marketed in Canada, Europe, Turkey, and parts of the Middle East. In Europe, ORTHOVISC is sold under Conformité Européene (CE mark) authorization, a certification required under European Union (EU) medical device regulations. The CE mark allows ORTHOVISC to be marketed without further approvals in most of the EU nations as well as other countries that recognize EU device regulations. In October 1996, we received an EC Design Examination and an EC Quality System Certificate from a European Notified Body, which entitled us to affix the CE mark to ORTHOVISC as a viscoelastic supplement or a replacement for synovial fluid in human joints. In August 2004, we received an EC Design Examination Certificate which entitled us to affix a CE mark to INCERT-S as a barrier to adhesion formation following surgery. We may not be able to achieve and/or maintain compliance required for CE marking or other foreign regulatory approvals for any or all of our products. The requirements relating to the conduct of clinical trials, product licensing, marketing, pricing, advertising, promotion and reimbursement also vary widely from country to country.

We compete with many companies, including, among others, large pharmaceutical firms and specialized medical products companies. Many of these companies have substantially greater financial and other resources, larger research and development staffs, more extensive marketing and manufacturing

organizations and more experience in the regulatory process than us. We also compete with academic institutions, governmental agencies and other research organizations, which may be involved in research, development and commercialization of products. Many of our competitors also compete against us in securing relationships with collaborators for their research and development and commercialization programs.

General competition in our industry is based primarily on product efficacy, safety, timing and scope of regulatory approvals, availability of supply, marketing and sales capability, reimbursement coverage, product pricing and patent protection. Some of the principal factors that may affect our ability to compete in our HA development and commercialization market include:

We are aware of several companies that are developing and/or marketing products utilizing HA for a variety of human applications. In some cases, competitors have already obtained product approvals, submitted applications for approval or have commenced human clinical studies, either in the U.S. or in certain foreign countries. There exists major competing products for the use of HA in ophthalmic surgery. In addition, certain HA products for the treatment of osteoarthritis in the knee have received FDA approval and have been marketed in the U.S. since 1997, as well as select markets in Canada, Europe and other countries. In December 2003, the FDA approved an HA product for the treatment of facial wrinkles which has been marketed internationally since 1996. There is a risk that we will be unable to compete effectively against our current or future competitors.

Our research and development efforts primarily consist of the development of new medical applications for our HA-based technology and the management of clinical trials for certain product candidates and the preparation and processing of applications for regulatory approvals at all relevant stages of development. Our development of new products is presently accomplished primarily through in-house research and development personnel and resources as well as through collaboration with other companies and scientific researchers. As of December 31, 2004, we had nine employees engaged primarily in research and development and engineering and two employees engaged in regulatory matters. For the years ended December 31, 2004, 2003, and 2002, research and development expenses were $4.1 million, $2.6 million, and $3.9 million, respectively. We anticipate that we will continue to commit significant resources to research and development, including clinical trials, in the future.

Under the OBI Agreement, Ortho Biotech has the right (1) to file for regulatory approval to market ORTHOVISC in Mexico at its sole cost and expense and (2) to further develop ORTHOVISC by carrying out clinical trials. Under the OBI Agreement, Ortho Biotech has agreed to begin a clinical trial for a new indication for ORTHOVISC or a Phase IV clinical trial within twelve months of the FDA approval of ORTHOVISC.

In April of 2004 we initiated a pilot human clinical trial in Europe for INCERT-S, our product designed to reduce post-surgical fibrosis following spinal surgery. In May we commenced a pivotal clinical trial in the U.S. for our product for CTA. We cannot assure you that: (1) we will successfully complete clinical trials of our INCERT-S or CTA products; (2) if completed, regulatory approval for sales in the U.S.

or internationally, in the case of our CTA product, will be obtained; or (3) if regulatory approvals are obtained, meaningful sales of our products will be achieved

Under the OrthoNeutrogena Agreement, OrthoNeutrogena is required, subject to certain limitations, to fund the May 2004 pivotal Phase III CTA clinical trial and to support us in our development of this CTA product, as well as possible future line extensions.

There is a risk that our efforts will 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 may not be able to obtain regulatory approval for any new applications we develop. Furthermore, even if all regulatory approvals are obtained, there can be no assurances that we will achieve meaningful sales of such products or applications.

As of December 31, 2004, we had approximately 61 full-time employees. We consider our relations with our employees to be good. None of our employees are represented by labor unions.

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

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

On December 20, 2004, we announced the signing of a multi-year supply agreement, effective December 15, 2004, with Bausch & Lomb for viscoelastic products used in ophthalmic surgery.

Our Annual Reports on Form 10-K, including our consolidated financial statements, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other information, including amendments and exhibits to such reports, filed or furnished pursuant to the Securities Exchange Act of 1934, are available free of charge in the "SEC Filings" section of our website located at http://www.anikatherapeutics.com, as soon as reasonably practicable after the reports are filed with or furnished to the Securities and Exchange Commission.

Our corporate headquarters is located in Woburn, Massachusetts, where we lease approximately 10,000 square feet of administrative and research and development space. We extended our lease for this facility in 2004 for a term ending in December 2006. We also lease approximately 37,000 square feet of space at a separate location in Woburn, Massachusetts, for our manufacturing facility and warehouse. This facility has received all FDA and state regulatory approvals to operate as a sterile device and drug manufacturer. We extended our lease for this facility in 2003 for an additional five-year term ending in February 2009. For the year ended December 31, 2004, we had aggregate lease costs of approximately $700,000.

Securities and Exchange Commission Investigation. In May 2000, the Securities and Exchange Commission (SEC) issued a formal order of investigation in connection with certain revenue recognition matters. On January 13, 2003 we announced that we had entered into a settlement with the SEC concluding and resolving this investigation, which pertained to the company's historical accounting for and disclosures concerning sales of ORTHOVISC under a long-term supply and distribution agreement with Zimmer, Inc. To conclude this matter, we consented to the entry of an order to comply with sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and rules 12b-20, 13a-1 and 13a-13 promulgated thereunder. The settlement did not impose any monetary sanctions against us, and it is not expected to affect our results of operations or financial condition. We neither admitted nor denied the findings in the SEC's administrative cease and desist order resolving the matter.

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

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock has traded on the Nasdaq National Market since November 25, 1997, under the symbol "ANIK." The following table sets forth, for the periods indicated, the high and low sales prices of our common stock on the Nasdaq National Market. These prices represent prices between dealers and do not include retail mark-ups, markdowns, or commissions and may not necessarily represent actual transactions.

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

Year Ended December 31, 2003	High		Low
First Quarter	$	1.82	$	0.97
Second Quarter		4.17		1.45
Third Quarter		6.75		2.64
Fourth Quarter		11.65		5.67

At December 31, 2004, the closing price per share of our common stock was $9.15 as reported on the Nasdaq National Market and there were approximately 275 holders of record.

We have never declared or paid any cash dividends on our common stock. We currently intend to retain earnings, if any, for use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future. Payment of future dividends, if any, on our common stock will be at the discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, anticipated cash needs, and plans for expansion.

The following table sets forth information concerning the Company's equity compensation plan as of December 31, 2004.

The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Annual Report. The Balance Sheet Data at December 31, 2004 and 2003 and the Statement of Operations Data for each of the three years ended December 31, 2004 have been derived from the audited Consolidated Financial Statements for such years, included elsewhere in this Annual Report. The Balance Sheet Data at December 31, 2002, 2001 and 2000, and the Statement of Operations Data for each of the two years in the period ended December 31, 2001 have been derived from the audited Consolidated Financial Statements for such years, not included in this Annual Report.

The Consolidated Financial Statements for fiscal years 2000 and 2001 were audited by Arthur Andersen LLP (Andersen) who has ceased operations.

In the first quarter of 2004, based on our expectations regarding future profitability, we released the previously established valuation allowance against our deferred tax assets and recorded a one-time income tax benefit of $7.0 million.

We received an initial payment of $2.0 million in December 2003 upon entering into the OBI Agreement. In February 2004 we received a milestone payment of $20.0 million as a result of obtaining FDA approval for ORTHOVISC and in December 2004 we received a milestone payment of $5.0 million upon completion of certain manufacturing upgrades. We are recognizing these non-refundable payments ratably over the expected term of the OBI Agreement, which is currently 10 years, and as of December 31, 2004, we had recorded deferred revenue of $24.3 million.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following section of this Annual Report on Form 10-K titled "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains statements that are not statements of historical fact and are forward-looking statements within the meaning of the federal securities laws. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievement to differ materially from anticipated results, performance, or achievement, expressed or implied in such forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. We discuss many of these risks and uncertainties at the beginning of this Annual Report on Form 10-K and under the heading "Business" and "Risk Factors and Certain Factors Affecting Future Operating Results." The following discussion should also be read in conjunction with the Consolidated Financial Statements of Anika Therapeutics, Inc. and the Notes thereto appearing elsewhere in this report.

Our currently marketed products include ORTHOVISC®, an HA product used in the treatment of some forms of osteoarthritis in humans, and HYVISC®, an HA product used in the treatment of equine osteoarthritis. In the U.S., ORTHOVISC became available for sale on March 1, 2004 and is marketed by Ortho Biotech Products, L.P., under an exclusive license and supply agreement. Internationally, ORTHOVISC has been approved for sale and marketed since 1996 under various distribution and marketing agreements. HYVISC is marketed in the U.S. through an exclusive agreement with Boehringer Ingelheim Vetmedica, Inc. Our ophthalmic products include CoEase™, STAARVISC™-II, and ShellGel™, each an injectable ophthalmic viscoelastic HA product, distributed by Advanced Medical Optics, Inc., STAAR Surgical Company, and Cytosol Ophthalmics, Inc., respectively. We also manufacture AMVISC® and AMVISC® Plus, HA viscoelastic supplement products used in ophthalmic surgery, for Bausch & Lomb Incorporated.

In December 2004, we entered into a multi-year supply agreement (the 2004 B&L Agreement) with Bausch & Lomb for viscoelastic products used in ophthalmic surgery, including the AMVISC and AMVISC Plus family of products. Under the new agreement, which extends through December 31, 2010, and superseded the existing supply contract that was set to expire December 31, 2007, we will continue to be the exclusive global supplier (other than with respect to Japan) for AMVISC and AMVISC Plus to Bausch & Lomb. The 2004 B&L Agreement also provides us with a right to negotiate to manufacture future surgical ophthalmic viscoelastic products developed by Bausch & Lomb, while Bausch & Lomb has been granted rights to commercialize certain future surgical ophthalmic viscoelastic products developed by us. The 2004 B&L Agreement applies to all 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, we are entitled to continue providing surgical viscoelastic products to our existing customers (e.g. Advanced Medical Optics, STAAR Surgical Company, Cytosol Ophthalmics, Inc.) who currently receive such products from us.

On July 26, 2004, we announced the signing of an exclusive worldwide development and commercialization partnership for our CTA products with the OrthoNeutrogena division of Ortho- McNeil Pharmaceuticals, Inc., an affiliate of Johnson & Johnson. Under the terms of the OrthoNeutrogena Agreement, we received an initial payment of $1.0 million. In addition, OrthoNeutrogena is required, subject to certain limitations, to fund our ongoing pivotal clinical trial of our CTA product initiated in May 2004 and to support the development of the CTA product, as well as future line extensions. The OrthoNeutrogena Agreement also provides for sales- and development-based milestone payments in addition to royalty payments and transfer payments for the supply of CTA products.

We have marketed ORTHOVISC, our product for the treatment of osteoarthritis of the knee, internationally since 1996 through various distribution agreements. International sales of ORTHOVISC contributed 18% of product revenue for the year ended December 31, 2004 and increased 31% compared to 2003. The increase was primarily due to increased market penetration in Canada and Greece, as well as significant sales increase in Turkey. We expect international sales to grow in 2005 compared to 2004 reflecting further increased market penetration in certain of our existing markets as well as anticipated expansion into new international markets. For these new opportunities we have assessed the world market and we are actively pursuing commercial partners.

In December 2003 we entered into the OBI Agreement with Ortho Biotech for the sales, marketing and distribution of ORTHOVISC in the U.S. and we received marketing approval from the U.S. FDA in February 2004 for ORTHOVISC. Sales of ORTHOVISC were initiated in March 2004 by Ortho Biotech with the U.S. launch of ORTHOVISC at the annual meeting of the American Academy of Orthopedic Surgeons. Sales of ORTHOVISC in the U.S. contributed 21% of our product revenue for the year ended December 31, 2004.

Our sales of ORTHOVISC in the U.S. during 2004 represented primarily product for the initial product launch and inventory building. Sales of ORTHOVISC to end-users grew slower than anticipated in 2004 as a result of a number of factors. We believe that a primary contributing factor to this slower growth has been reimbursement and lack of receiving assignment of a specific reimbursement code. The Healthcare Common Procedure Coding System (HCPCS) is a comprehensive and standardized coding system that describes classifications of like products that are medical in nature by category for the purpose of efficient claims processing. HCPCS codes are assigned by the Centers for Medicare and Medicaid Services (CMS). As is typical for a newly-introduced medical device, initial sales of ORTHOVISC were made without a unique reimbursement code and reimbursement submissions were made using a miscellaneous code with no specified reimbursement dollar value. We believe that using the miscellaneous reimbursement code without a specified reimbursement dollar value negatively impacted end-user sales of ORTHOVISC in 2004. Ortho Biotech, with our help, submitted an application to secure a unique reimbursement code for ORTHOVISC in March 2004. In November 2004, Ortho Biotech received a decision on the application which assigned a unique reimbursement code to be used by hospitals in an outpatient setting (the C code) which specifies a reimbursement dollar value. Use of the C code was effective January 2005. The CMS decision, however, did not assign a unique reimbursement code to be used in the physician office setting (the J code) because the application filed in March 2004 did not reflect the required six months of sales history. Instead of a unique J code, submission for reimbursement of ORTHOVISC is to continue using a miscellaneous J code. However, under the decision, the dollar value to be reimbursed under the miscellaneous J code is defined. An application for a unique J code was re-submitted in January 2005 which, if assigned, will be effective in January 2006. There can be no assurance that ORTHOVISC will receive a unique J code.

As a result of the CMS decision which did not assign a unique J code for ORTHOSVISC to be effective January 2005 we are not entitled to a contractual milestone under the OBI Agreement that would have been triggered had a unique J code been assigned by a specific date. The decision by the CMS to not

assign a unique J code for ORTHOVISC may further adversely impact our ORTHOVISC revenues. The required use of a miscellaneous J code may result in physician reluctance to utilize ORTHOVISC as compared to if a unique J code had been assigned. These negative trends are further effected by changes in the categories of revenues we are entitled to under the OBI agreement. In addition to milestone payments, the OBI Agreement provides for Ortho Biotech to pay us transfer fees, which are related to sales to Ortho Biotech, and royalty fees, which are tied to end-user sales. As a result of Ortho Biotech's inventory buildup during 2004, we presently expect to experience a reduction in transfer fees, which may be offset by royalties as, and if, ORTHOVISC achieves desired market penetration. As a result of these factors, we did not ship any ORTHOVISC to Ortho Biotech in the fourth quarter of 2004. We expect unit sales of ORTHOVISC to Ortho Biotech in 2005 will be below 2004 levels. We expect the negative impact on our revenues will be partially offset by expected increased royalties we receive on end-user sales.

Sales of HYVISC, our product for the treatment of equine osteoarthritis, contributed 9% to product revenue for the year ended December 31, 2004 and increased 18% compared to 2003. We expect sales of HYVISC to decrease modestly in 2005 compared to 2004 primarily due to distributor inventory replenishment patterns. We continue to look at other veterinary applications and opportunities to expand geographic territories.

Our ophthalmic business includes HA viscoelastic products used in ophthalmic surgery. For the year ended December 31, 2004, sales of ophthalmic products contributed 52% of our product revenue reflecting an increase in sales of ophthalmic products of 10% compared to 2003. Sales to Bausch & Lomb accounted for 74% of ophthalmic sales for 2004 and contributed 38% of product revenue for the period.

In December 2004, we entered into a multi-year supply agreement (the 2004 B&L Agreement) with Bausch & Lomb for viscoelastic products used in ophthalmic surgery. Under the new agreement, which extends through December 31, 2010, and superseded the existing supply contract that was set to expire December 31, 2007, we will continue to be the exclusive global supplier (other than with respect to Japan) for AMVISC and AMVISC Plus to Bausch & Lomb. The 2004 B&L Agreement also provides us with a right to negotiate to manufacture future surgical ophthalmic viscoelastic products developed by Bausch & Lomb, while Bausch & Lomb has been granted rights to commercialize certain future surgical ophthalmic viscoelastic products developed by us. The 2004 B&L Agreement applies to all 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, we are entitled to continue providing surgical viscoelastic products to our existing customers (e.g. Advanced Medical Optics, STAAR Surgical Company, Cytosol Ophthalmics, Inc.) who currently receive such products from us.

Prior to entering into the 2004 B&L Agreement sales to Bausch & Lomb were made under the 2000 B&L Agreement. Under the terms of the 2000 B&L Agreement the price applicable for all units sold to Bausch & Lomb in a calendar year was dependent on the total unit volume of sales of certain ophthalmic products during the year. In accordance with our revenue recognition policy, revenue is not recognized if the sale price is not fixed or determinable, and any amounts received in excess of revenue recognized are recorded as deferred revenue. During the fourth quarter the actual annual unit volume became known and we recorded revenue equal to the amounts earned or we provided a rebate to our customer. In each of the previous three fiscal years (i.e. 2003, 2002, 2001), the annual unit volume was below levels fixed under our agreement with Bausch & Lomb and, accordingly, in the fourth quarter of each of these years we recognized as revenue the amounts deferred during the first three quarters. For the nine months ended September 30, 2004, we deferred $1.0 million related to sales to Bausch & Lomb which was subject to possible retroactive price adjustments. As a result of entering into the 2004 B&L Agreement, which retroactively applies to sales from the beginning of 2004, we applied the unit pricing terms under the 2004 B&L Agreement to our 2004 Bausch & Lomb sales activity. These terms essentially provide for fixed unit pricing with reduced unit pricing applicable for units purchased in excess of a specified amount during the

fiscal year. As a result of applying this new pricing to 2004 transactions, we earned $761,000 of revenue which was previously deferred during the first nine months of 2004 and rebated $252,000 to Bausch & Lomb.

Our distributor for CoEase, Advanced Medical Optics, completed the acquisition of the surgical ophthalmology business of Pfizer, Inc., in June 2004, which includes a competing line of viscoelastic products for use in ocular surgery. As a result, our agreement with Advanced Medical Optics has not been renewed and we expect will terminate in July 2005 upon its expiration. We expect sales to Advanced Medical Optics will decline to minimum required levels in accordance with the agreement and to discontinue during the first quarter of 2005. As a result, in the future we may not be able to sustain current product revenue levels in our ophthalmic business. Sales to Advanced Medical Optics contributed 19% of ophthalmic product revenue and 10% of total product revenue for the year ended December 31, 2004.

Our current research and development efforts are focused on our chemically modified formulations of HA designed for longer residence time in the body. We initiated a U.S. pivotal clinical trial for our product for cosmetic tissue augmentation (CTA), a therapy for correcting dermal defects, including facial wrinkles, scar remediation and lip augmentation, in May 2004. The trial is designed to evaluate the effectiveness of CTA for correcting nasolabial folds and is being conducted by dermatologists and plastic surgeons at 10 centers throughout the U.S. Patient enrollment was completed during the third quarter of 2004 and patients will be monitored for 6 to 12 months following initial treatment. As discussed above, we are being reimbursed for the clinical trial expenses, subject to certain limitations, in connection with the OrthoNeutrogena Agreement which is included in contract revenue.

In April 2004 we initiated a pilot human clinical trial for INCERT®-S, a chemically modified form of HA designed to act as a barrier to prevent internal tissue adhesion and scarring following spinal surgery. The clinical trial is being conducted at two centers in the U.K. and will involve approximately 45 patients. As of December 31, 2004, patient enrollment was approximately two-thirds complete.

For the year ended December 31, 2004 net income increased to $11,190,000 or $.98 per diluted share from $827,000, or $.08 per diluted share for the same period last year. Net income from operations for 2004 was $6,388,000 compared to $595,000 for 2003.

Revenue We increased sales in each of our product groups for the year ended December 31, 2004 compared to the same period last year. Sales of our ophthalmic products increased 10%, HYVISC sales increased 18% and ORTHOVISC sales increased 183% in 2004 compared to 2003. The increases in product sales were primarily due to increased sales volume with existing customers and also included the launch of ORTHOVISC in the U.S. License, milestone and contract revenue comprised 16% of total revenue in 2004 and consists of the ratable recognition of the upfront and milestone payments received under the OBI Agreement and contract revenue received under the Ortho Neutrogena Agreement.

Cost of product revenue Our cost of product revenue includes material, labor and manufacturing overhead costs, obsolescence charges, packaging and shipping costs. Our costs of product revenue may vary over time based on the mix of products sold. Over the past three years we have experienced a decrease in the cost of product revenue as a percentage of product revenue primarily due to increased manufacturing efficiencies and product volume combined with cost cutting efforts. Gross margin on product revenue for the year ended December 31, 2004 increased to 55% compared to 48% for the year ended December 31, 2003. We expect gross margin on product sales to be relatively consistent in 2005 compared to 2004 reflecting product mix and comparable manufacturing volume.

Research and development Our research and development costs consists primarily of salaries and related expenses for personnel and fees paid to outside consultants and outside service providers. Our research and development costs increased 57% for the year ended December 31, 2004 compared to the same period last year primarily due to costs associated with the clinical trials for CTA and INCERT. We expect to incur additional costs associated with the human clinical trials for our product candidates and to increase personnel-related expenses as we expand our research and development efforts. As a result, we expect research and development costs will increase in 2005 compared to 2004.

Selling, general and administrative Selling, general and administrative costs consists primarily of salaries and related expenses for personnel in executive, finance and accounting, human resources, information technology, and sales and marketing functions. Other costs include professional fees for legal and accounting, fees for consulting and outside services, and insurance costs. Selling, general and administrative expenses for the year ended December 31, 2004 increased 44% compared to the prior year. The increase in selling, general and administrative expenses during 2004 is primarily due to an increase in professional and outside services fees, including costs for implementation and compliance of Section 404 of the Sarbanes-Oxley Act of 2002, combined with an increase in personnel related costs. We expect selling, general and administrative expenses to increase in 2005 compared to 2004 as a result of increased personnel related costs as well as expanded marketing efforts for ORTHOVISC and partially offset by lower audit and tax fees and consulting fees for ongoing Sarbanes-Oxley compliance.

Income taxes. We recorded a provision for income taxes for the year ended December 31, 2004 reflecting an effective tax rate of approximately 39%. As a result of the receipt of the upfront and milestone payments from Ortho Biotech, we have determined that we will utilize all of our net operating loss and credit carry-forwards. In addition, based on our current expectations regarding future profitability, we released the previously established valuation allowance against our deferred tax assets and recorded a one-time income tax benefit of $7.0 million in the first quarter of 2004.

Summary of Critical Accounting Policies; Significant Judgments and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We monitor our estimates on an on-going basis for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.

We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 2 in the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K for the year ended December 31, 2004.

Our revenue recognition policies are in accordance with 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 Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.

We recognize revenue from the sales of products we manufacture upon confirmation of regulatory compliance and shipment to the customer as long as there is (1) persuasive evidence of an arrangement, (2) delivery has occurred and risk of loss has passed, (3) the sales price is fixed or determinable and (4) collection of the related receivable is probable. Amounts billed or collected prior to recognition of revenue are classified as deferred revenue. When determining whether risk of loss has transferred to customers on product sales or if the sales price is fixed or determinable we evaluate both the contractual terms and conditions of our distribution and supply agreements as well as our business practices. ORTHOVISC has been sold through several distribution arrangements as well as outsource order-processing arrangements (logistic agents). Sales of product through third party logistics agents in certain markets are recognized as revenue upon shipment by the logistics agent to the customer.

Under the 2000 B&L Agreement, the price for units sold 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. Prices fluctuated based on sales levels, and interim quarters were subject to possible retroactive price adjustments when the actual annual unit volume for the year became known. Given the pricing in this arrangement was not fixed and was determined based on qualifying sales to multiple customers, we determined that we could not reliably estimate the rebate, and accordingly, we deferred the maximum rebate that could be due until the annual sales volume was known in the fourth quarter. Under the 2004 B&L Agreement, the pricing is based solely on ophthalmic products sold to Bausch & Lomb. While the unit prices will be discounted for those units in excess of cumulative minimum sales levels, no amounts will be rebated. The applicable discount will be measured quarterly, subject to adjustment based on cumulative annual thresholds. Since quarterly revenue may be adjusted higher or lower depending on the relationship of our quarterly activity relative to our annual goals, we will need to estimate annual unit volume to determine the amount of revenue recognition in each quarter, thereby spreading the discount, if any, across all units purchased in a given annual period. Factors we will consider in developing our estimate include: (1) the discount will be based solely on sales activity with Bausch &Lomb who has been a long standing customer of our ophthalmic products; (2) the homogeneous nature of the products purchased under this arrangement; (3) our expected future activity with Bausch & Lomb based on historical experience and product forecasts provided by them; and (4) overall market demand for our ophthalmic products. In 2004, retroactive application of the 2004 Bausch & Lomb agreement resulted in recognition of $761,000 of revenue which was previously deferred during the first nine months of 2004 and we rebated $252,000 to Bausch & Lomb.

In July 2004 the Company entered into an exclusive worldwide development and commercialization agreement (the OrthoNeutrogena Agreement) for our CTA products with the OrthoNeutrogena, a division of Ortho-McNeil Pharmaceuticals, Inc., an affiliate of Johnson & Johnson. This arrangement included up front payments, funding of ongoing development activities, milestones upon achievement of predefined goals, in addition, we will receive payments for supply of CTA products and royalties on sales. We believe this is a multiple element arrangement that falls under the scope of EITF 00-21. Under the EITF 00-21 framework, in order to account for an element as a separate unit of accounting, the element must have stand-alone value and there must be objective and reliable evidence of fair value of the undelivered elements. While this arrangement includes several elements, we believe that two separate units of accounting exist (a combined license and development unit and a manufacturing unit) under the EITF 00-21 model.

We are accounting for the combined license and development unit using the performance based model, which recognizes revenue as the efforts are expended limited to the amount of non-refundable cash received. Under this arrangement, we received non-refundable upfront fees of $1 million and reimbursement for approximately $1.3 million of costs which were incurred prior to our entering into this arrangement. We have treated both these amounts as upfront fees that will be recognized over the

expected term of the license and development unit. In addition to the upfront fees, we are receiving reimbursement of pre-approved development costs incurred. For the year ended December 31, 2004 we recognized $1,392,000 as contract revenue for this arrangement under the performance-based method.

In December 2003 the Company entered into a ten-year licensing and supply agreement (the OBI Agreement) with Ortho Biotech Products, L.P., a member of the Johnson & Johnson family of companies, to market ORTHOVISC in the U.S. and Mexico. Under the OBI Agreement, Ortho Biotech will perform sales, marketing and distribution functions and licensed the right to further develop and commercialize ORTHOVISC as well as other new products for the treatment of pain associated with osteoarthritis based on the Company's viscosupplementation technology. In support of the license, the OBI Agreement provides that Ortho Biotech will fund post-marketing clinical trials for new indications of ORTHOVISC. The Company received an initial payment of $2.0 million upon entering into the OBI Agreement, a milestone payment of $20.0 million in February 2004, as a result of obtaining FDA approval of ORTHOVISC and a milestone payment of $5.0 million in December 2004 for planned upgrades to our manufacturing operations. We evaluated the terms of the OBI Agreement and determined that the upfront fee and milestone payments did not meet the conditions to be recognized separately from the supply agreement, therefore, we have deferred non refundable payments received of $27.0 million which we are recognizing ratably over the expected term of the OBI Agreement, which is currently 10 years.

Reserve for Obsolete/Excess Inventory. Inventories are stated at the lower of cost or market. We regularly review our inventories and record a provision for excess and obsolete inventory based on certain factors that may impact the realizable value of our inventory including, but not limited to, technological changes, market demand, inventory cycle time, regulatory requirements and significant changes in our cost structure. If ultim

		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		1,702,305	$	4.16	999,850
Equity compensation plans not approved by security holders		—		—	—

	Total	1,702,305	$	4.16	999,850

		Years ended December 31,
		2004		2003		2002			2001			2000
Product revenue		$	22,286	$	15,330	$	13,129		$	11,299		$	12,935
Licensing, milestone and contract revenue			4,180		74		58			13			3,400

	Total revenue		26,466		15,404		13,187			11,312			16,335
Cost of product revenue			9,949		8,005		8,109			8,229			9,871

Gross profit			16,517		7,399		5,078			3,083			6,464
Total operating expenses			10,129		6,804		8,353			10,494			7,448
Net income (loss)		$	11,190	$	827	$	(3,040	)	$	(6,758	)	$	174
Diluted net income (loss) per common share		$	0.98	$	0.08	$	(0.31	)	$	(0.68	)	$	0.02
Diluted common shares outstanding			11,384		10,850		9,934			9,934			10,042

	December 31,
	2004			2003			2002			2001			2000
Cash and cash equivalents	$	39,339		$	14,592		$	11,002		$	9,065		$	8,266
Marketable securities		—			—			2,500			3,994			10,040
Working capital		42,135			18,450			14,921			16,756			23,083
Total assets		59,538			21,873			20,087			22,916			28,979
Accumulated deficit		(2,379	)		(13,569	)		(14,396	)		(11,357	)		(4,599	)
Treasury stock		—			(27	)		(280	)		(280	)		(280	)
Stockholders' equity		30,363			17,984			17,064			20,104			26,712