Anika Therapeutics--An Injection for Growth?

On January 26, 2006, the Compensation Committee of the Board of Directors of Anika Therapeutics, Inc. (ANIK-$10.07) increased the annual salary of the Company's executive officers and exercised its discretion to approve cash bonus payments, despite slower than anticipated growth to end-users of several key products; product recalls of key opthalmic products [due to incomplete heat seals in the cannula pouches that are included with the viscoelastic syringe, which might have compromised product(s) sterility]; and a delay in the Company's clinical program for cosmetic tissue augmentation (CTA) during 2005.

On January 26, 2006, the Nominating Committee recommended, and the Board of Directors approved, too, that for fiscal 2006, non-employee directors receive an aggregate cash fee of $20,000, and be awarded a number of stock appreciation rights having a value of approximately $10,000. In addition, each non-employee director is entitled to be paid $1,000 for each regular Board of Directors meeting or committee meeting attended in person or by telephone and $500 for each special Board of Directors meeting or committee meeting attended in person or by telephone. All non-employee directors are also reimbursed for out-of-pocket expenses incurred in attending meetings of the Board of Directors and any committees thereof. [ed. note: not a bad gig--if you can get it!] One hand washes the other....

Anika Therapeutics, Inc. engages in the development, manufacture, and commercialization of therapeutic products and devices that are designed to repair, protect and heal bone, cartilage, and soft tissue. Its products are based on hyaluronic acid (HA), a naturally occurring, biocompatible polymer found throughout the body. HA enhances joint function and coats, protects, cushions, and lubricates soft tissues. All of the Company's products use hyaluronan that is extracted from the forehead of chickens'--"chicken combs."

The Company's HA products marketed in the treatment of osteoarthritis, for humans and horses, are ORTHOVISC and HYVISC, respectively. ORTHOVISC is currently being sold under marketing agreements with Ortho Biotech and Depuy Mitek, Inc., both Johnson & Johnson companies, under an exclusive license and supply agreement. HYVISC is distributed in the U.S. through an exclusive agreement with Boehringer Ingelheim Vetmedica, Inc.

The annual market for injectable viscosupplementation in the U.S. is estimated to be $400 million. While we expect unit volume to expand by 20% (+) per annum, the aggregate dollar volume will face continued pressure because of predicted competitive pricing and lower reimbursements rates. The other major viscosupplement competitors in the U.S. for osteoarthritis of the knee approved by the FDA, include Genzyme Biosurgery's Synvisc, Hyalgan from Sanofi-Aventis, Ontario-based Stellar Pharmaceuticals' Neovisc, and Smith & Nephew's Supartz.

Synvisc is the dominant product with an estimated 70% market share.

During ophthalmic procedure's such as cataract removal, intraocular lens implantation, and corneal transplantation it is vital to maintain normal eye shape and protect eye tissues. Sodium hyaluronate, a thick, transparent liquid similar to the natural fluid found in the eye, is ideal for this task. It acts as a tissue lubricant and maintains eye fluid volume during surgery. STAARVISC-II and ShellGel, each an injectable ophthalmic viscoelastic HA product, are distributed by STAAR Surgical Company, and Cytosol Ophthalmics, Inc., respectively. The Company also develops and manufactures AMVISC and AMVISC Plus, HA viscoelastic supplement products used in ophthalmic surgery, for Bausch & Lomb Incorporated.

There exists major competing products for the use of HA in ophthalmic surgery. LA VISC, LA GEL and LA LON, manufactured by LA Labs, contain Sodium Hyaluronate, derived from bacterial fermentation, designed for routine cataract or retinal surgery; the Healon and Vitrax family of viscoelastics, manufactured by Advanced Medical Optics; and Duovisc--Viscoat & Provisc--dispersive and cohesive viscoelastic products marketed together by Alcon--three among a plethora of competitors (not including collagen-based products)

For the nine-month period ended September 30,2005, product revenue was $15,760,000 versus $16,813,000 in the comparable period in 2004. Domestic OrthoVisc sales for 2005 have been negatively impacted by high inventory levels held by the company's distribution partner. Ophthalmic product sales were flat compared to the prior year period, primarily due to the aforementioned product(s) recall. ORTHOVISC, HYVISC, and the opthalmic products contributed 38%, 9%, and 53%, respectively, to net sales.

As of September 30, 2005, three customers, Bausch & Lomb, Inc. (46.4%), Pharmaren AG/Biomeks (22.8%), Boehringer Ingelheim Vetmedica (9%), represented 78.2% of the Company's aggregate product revenues.

Regarding investor concerns of concentration of sales risk--In December 2004, the Company entered into a new multi-year supply agreement with Bausch & Lomb for viscoelastic products used in ophthalmic surgery. Under the new agreement, which extends through December 31, 2010, and supersedes a supply contract that was set to expire December 2007, the Company continues to be the exclusive global supplier (other than with respect to Japan) for AMVISC and AMVISC Plus to Bausch & Lomb. A justification for senior management's aforementioned 2006 compensation schedule? Score one for corporate.

Anika Therapeutics will endure pricing pressures from current--and emerging--market competitors and reimbursement resistance from Medicare and other healthcare providers. For example, Medicare has been cutting reimbursements of procedures using HA-based material for cataracts and knee osteoarthritis.

The Company must shoulder [or enter into partnerships] R&D expenses to provide next-generation advances in HA-based biomaterial markets to compete for market share and to recapture pricing power. This should not be a problem for corporate. The Company has a strong balance sheet, with no long-term debt, approximately $45.9 million in cash, and $22.3 million in deferred revenue sitting on the balance sheet as liabilities--waiting to be recognized as income [when 'earned'].

Begrudgingly, we will give management the chance to earn their 2006 paychecks before we pass judgement on the dollars being doled out. Historically, corporate has demonstrated suffiencies needed to negotiate win-win licensing, royalty, and supply and distribution contracts--albeit this does not necessarily ensure future wins.

Anika Therapeutics' current research and development efforts are focused on its chemically modified formulations of HA designed for longer residence time in the body. A pivotal clinical trial for its product for cosmetic tissue augmentation (CTA), a therapy for correcting dermal defects, including facial wrinkles, scar remediation and lip augmentation, wrapped up last year. The trial was designed to evaluate the effectiveness of CTA for correcting nasolabial folds and was conducted by dermatologists and plastic surgeons at 10 centers throughout the U.S.

On September 1, 2005, the Company announced that it had mutually agreed with OrthoNeutrogena to terminate its development and commercialization agreement. Instead, flying solo, corporate filed its PMA application with the FDA seeking approval to market and sell its CTA product in the United States. The Company will continue the development effort on a go forward basis which will be self-funded.

For those seeking to disguise the effects of aging, the FDA has approved two injectable HA products, Restylane and Hylaform, for the treatment of facial wrinkles. Other HA injectible fillers available in Europe--and hoping to reach our shores, include Dermalive and Dermadeep (Dermatech), and Hyalite (Mentor).

According to Medtech Insight, LLC, the market is projected to grow from $65 million to approximately $175 million within three years. We predict that with the rollout of other dermal filler options, this dollar growth analysis has underestimated the actual demand for CTA products. For example, Facial Cosmetic Surgery and Rejuvenation Markets, predicts that over 21 million procedures from simple botulinum toxin injections to full surgical rhinoplasty will be preformed in 2006. Furthermore, the majority of the procedures will be simple injections or laser treatments for wrinkles.

For treating wrinkles and facial contours, patients and their dermatologists or plastic surgeons, have other biological implant/filler options: collagen (marketed as Zyderm, Alloderm, Cymetra, or Cosmoderm), Fibrel (freeze dried gelatin derived from pig connective tissue mixed with the patient's blood plasma and a chemical to encourage the formation of new collagen), subcutaneous injections of calcium hydroxyapatite (FDA-approved for over 20 years in powder and block form, CaHa is an inorganic substance that mimics the structure of bone. It is now marketed in the U.S. as Radiesse); "off-label" use of a medical grade injectable silicone, Silikon 1000; and, F-A-T injections.

In spite of the number of competitive options, we are attracted to the science of HA-fillers. Chemically modified HA has the capacity to hold more water than other natural or synthetic polymers, thereby increasing the resistance of tissues to compression. The unique biophysical characteristics and the inherent safety of HA make it an ideal material for treatment of dermal defects.

As previously noted, a number of companies are developing or have developed HA products for similar applications and have received FDA approval. Ergo, the successful commercialization of Anika Therapeutics' CTA will depend on the timing of the FDA's review, a distribution channel to go-to-market quickly (proprietary salesforce and/or joint-marketing agreement), and reimbursement endorsements.

The second product in the Company's product pipeline is a family of bioabsorbable, chemically modified hyaluronic acid (HA) therapies, called INCERT, intended to act as a barrier to prevent internal tissue adhesion and scarring following spinal, cardiac, pelvic or abdominal surgery.

The initial research for INCERT is for spinal surgeries such as discectomy, laminectomy or laminotomy. INCERT-S is designed to reduce post-surgical fibrosis following spinal surgery. The Company initiated a pilot trial in the U.K. in April 2004, involving about 45 patients undergoing spinal surgery. As of December 31, 2004, patient enrollment was approximately two-thirds complete. There are a large number of spinal surgeries worldwide susceptible to the complications of post-surgical adhesions, including approximately 700,000 each year in the United States alone.

According to a recent Frost & Sullivan study, there are a number of drivers that make HA-based companies like Anika Therapeutics an attractive biotech holding:

• Key application markets for HA-based biomaterials, include viscoelastics for cataract surgery, viscosupplementation treatment for osteoarthritis, facial aesthetic implants, and vesicoureteral reflux implants.
• Demand is expected to be buoyed by aging baby boomers. The number of people above 65 years is expected to more than double from 35 million in 2000 to 71 million in 2020 in the United States. People in this age group will be entering a stage where the incidence of osteoarthritis, cataract, and facial wrinkles increases. HA-based biomaterials have a significant role to play in the treatment of all these afflictions. Thus, the demand for HA-based biomaterials is expected to be spurred by the aging demographics.
• Since the knee osteoarthritis patient population is expected to increase by 26 percent from 15 million in 2000 to 19 million in 2010, viscosupplements can expect an escalation in demand. Apart from a huge market for osteoarthritis medication, the post-surgical anti-adhesion barrier market also carries a huge potential. Internal adhesions after abdominal surgeries can cause problems, such as bowel obstruction and pain. Due to the critical nature of these complications, surgeons are demanding anti-adhesion barriers that perform consistently. Adhesion lysis surgeries are performed more frequently on those above 65 years than on younger age groups.
• Hyaluronic acid (HA)-based biomaterials have wide-ranging applications in the healthcare industry. The materials derived from HA are being used to relieve the pain of knee osteoarthritis, in cataract surgeries, in abdominal and pelvic surgeries, and as a dermal filler to erase facial wrinkles. Moreover, an aging population, several product innovations, and underserved end-user segments are creating a huge market for HA-based biomaterials. Some existing end users include rheumatologists, ophthalmologists, plastic and reconstructive surgeons, anti-adhesive wound care specialists, and gynecologists.
• Risks. Many market segments where HA-based biomaterials have become firmly entrenched are facing increasing competition. An example is the lower reimbursements for physicians for cataract surgeries and ostearthritic knee treatments, who, in turn, want reduced prices for HA-based viscoelastics. These market segments have not seen significant recent innovations with HA-based biomaterials. The market needs to fight price erosion by adding value to its products.

Anika Therapeutics stock is selling near its 12-month lows. Management is being paid handsomely to enable the development of growth strategies to increase its existing product market shares and to grow the top-line by entering new HA market segments. To date, it has done a good job in laying the foundation for future growth. Catalysts for an upward move in the share price are dependent on (1) approval of a CTA program and (2) positive news from the INCERT-S trial. However, given that these material events are probably months away, we are slapping a HOLD on the stock. BUY on any pullback below $8.00 per share.