UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004March 31, 2005

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File Number 000-21326

Anika Therapeutics, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number, Including Area Code: (781) 932-6616

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.

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 last 90 days.  Yes ý    No o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.  At November 5, 2004April 25, 2005 there were 10,196,07610,314,972 outstanding shares of Common Stock, par value $.01 per share.

PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

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

2

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the NineThree Months Ended

(Unaudited)

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

4

ANIKA THERAPEUTICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.              Nature of Business

Anika Therapeutics, Inc.  (“Anika” or the “Company”)  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.  The Company’s currently marketed products consist of ORTHOVISCÒ, which is an HA product used in the treatment of some forms of osteoarthritis in humans, CoEaseÔ,  STAARVISC™-II, and ShellGelÔ, each an injectable ophthalmic viscoelastic HA product, and HYVISCÒ, which is an HA product used in the treatment of equine osteoarthritis.  In February 2004, the Company 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.  The Company manufactures AMVISC® and AMVISC® Plus, HA viscoelastic supplement products used in ophthalmic surgery, for Bausch & Lomb Incorporated.

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

2.              Basis of Presentation

The accompanying consolidated financial statements have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and in accordance with accounting principles generally accepted in the United States.  In the opinion of management, these consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the financial position of the Company as of September 30, 2004,March 31, 2005 and the results of its operations for the quarter and nine months ended September 30, 2004 and 2003 and its cash flows for the ninethree months ended September 30, 2004March 31, 2005 and 2003.2004.

The accompanying consolidated financial statements and related notes should be read in conjunction with the Company’s annual financial statements filed with its Annual Report on Form 10-K for the year ended December 31, 2003.2004.  The results of operations for the quarter and ninethree months ended September 30, 2004March 31, 2005 are not necessarily indicative of the results to be expected for the year ending December 31, 20042005 or any future periods.

3.              Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

5

As of September 30, 2004,March 31, 2005, three customers represented 92.2%77% of the Company’s accounts receivable balance and as of March 31, 2004, two customers represented 85% of the Company’s accounts receivable balance.

Revenues by geographic location in total and as a percentage of total revenues are as follows:

earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding and the number of dilutive potential common share equivalents during the period.  Under the treasury stock method, unexercised “in-the-money” stock options are assumed to be exercised at the beginning of the period or at issuance, if later.  The assumed proceeds are then used to purchase common shares at the average market price during the period.  For periods where the Company has incurred a loss, dilutive net loss per share is equal to basic net loss per share.

Shares used in calculating basic and diluted earnings per share for the quarter and nine month periods ending September 30,quarters ended March 31, are as follows:

In July 2004 the Company entered into a ten-year exclusive worldwide licensingdevelopment and supply agreement (the OrthoNeutrogena Agreement)commercialization partnership for its CTA products with the OrthoNeutrogena division of Ortho-McNeil Pharmaceuticals, Inc., an affiliate of Johnson & Johnson.  Under the terms of the OrthoNeutrogena Agreement, the Company received an initial payment of $1.0 million.  In addition, OrthoNeutrogena will, subject to certain limitations, fund the Company’s ongoing pivotal clinical trial of the Company’sits CTA product initiated in May 2004 and support the development of the CTA product, as well as future line extensions.  The Company received an initial payment of $1.0 million upon entering into the OrthoNeutrogena Agreement in July 2004 and will receive reimbursement of $1.3 million for development and clinical expenses incurred prior to the signing of the agreement which will be recognized over the term of the OrthoNeutrogena Agreement.  The OrthoNeutrogena Agreementalso provides for additional performance-sales- and sales-baseddevelopment-based milestone payments to the Company contingentbe 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 fees.  The OrthoNeutrogena Agreement is subject to early termination in certain circumstances and will automatically extendpayments for perpetual additional periodsthe supply of five-year intervals unless OrthoNeutrogena notifiesCTA products.  For the three months ended March 31, 2005 the Company of its decision to not extendrecognized $918,000 as contract revenue under the term.performance-based revenue recognition 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 proprietary viscosupplementation technology.  In support of the license, the OBI Agreement provides that Ortho Biotech will fund Phase IV clinical trials orpost-marketing clinical trials for new indications of ORTHOVISC.  The Company received an initial payment of $2.0 million upon entering into the OBI Agreement, in December 2003 and a milestone payment of $20.0 million in February 2004, as a result of obtaining FDA approval of ORTHOVISC.ORTHOVISC and a milestone payment of $5.0 million in December 2004 for planned upgrades to our manufacturing operations.  Under the OBI Agreement, the Company will be the exclusive supplier of ORTHOVISC to Ortho Biotech.  The OBI Agreement provides for additional performance- and sales-based milestone payments to the Company contingent upon planned manufacturing upgrades, reimbursement code approval, and 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.

In July 2000, the Company entered into a seven-year supply agreement (the “B&L Agreement”) with Bausch & Lomb Surgical, a unit of Bausch & Lomb, which was subsequently merged into Bausch & Lomb Incorporated.  Under the terms of the B&L Agreement the price for units sold in a calendar year is dependent on total unit volume of sales of certain ophthalmic products to all customers during the year.  Accordingly, unit prices for sales occurring in interim quarters are subject to possible retroactive price adjustments when the actual annual unit volume for the year becomes known.  In accordance with the Company’s revenue recognition policy, the amount of revenue subject to the price adjustment is recorded as deferred revenue until the annual unit volume becomes known and the sales price becomes fixed.  At September 30, 2004 and 2003, the deferred revenue under the B&L Agreement amounted to approximately $1.0 million and $895,000, respectively.

8.7.              Guarantor Arrangements

In certain of its contracts, the Company warrants to its customers that the products it manufactures conform to the product specifications as in effect at the time of delivery of the product.  The Company may also warrant that the products it manufactures do not infringe, violate or breach any U.S. patent or intellectual property rights, trade secret or other proprietary information of any third party.  On occasion, the Company contractually indemnifies its customers against any and all losses arising out of or in any way connected with any claim or claims of breach of its warranties or any actual or alleged defect

10

products liability insurance policy that limits its exposure.  Based on the Company’s historical activity in combination with its insurance policy coverage, the Company believes the accrued value of these indemnification agreements is minimal.  The Company has no accrued warranties and has no history of claims.

9.8.              Income Taxes

The Company records a deferred tax asset or liability based on the difference between the financial statement and tax basis of assets and liabilities, as measured by the enacted tax rates assumed to be in effect when these differences reverse.

In FebruaryThe Company also recorded a current provision for taxes of $816,000 and $504,000 related to income for the three months ended March 31, 2005 and 2004, respectively.  The effective tax rate for the current provision in each of the quarters was approximately 40%.

The Company achieved a milestonemilestones under the OBI Agreement and received a payment of $20.0payments totaling $27.0 million which will bethe Company recognized as taxable income in 2004.  As a result, the Company expectsdetermined that it will be able to utilize all of its net operating loss and credit carry-forwards in 2004 to offset part of its taxable income.  Based on these expectations, the Company recorded income taxes payable of $2.6 million to estimate its income tax liability for the $20.0 million milestone payment, net of all net operating loss and credit carry-forwards.

In accordance with the Company’s revenue recognition policy, for financial statement purposes, the milestone payment of $20.0payments totaling $27.0 million waswere deferred and isare being recognized ratably over the expected ten-year term of the OBI Agreement.  The Company recorded a deferred tax asset of $7.8$9.8 million representing the approximate income tax effect of the timing difference of revenue recognition for financial statement purposes and for tax purposes.purposes related to these milestone payments as of December 31, 2004.  Based on management’s current expectations regarding future profitability, the Company released the valuation allowance previously established against its deferred tax assets and recorded a one-time income tax benefit of $7.0 million.million in the quarter ended March 31, 2004.  As of March 31, 2005, management determined that it is more likely than not that the deferred tax assets will be realized and, therefore, a valuation allowance has not been recorded.

The Company also recorded a provision for taxes of $734,000 and $1,841,000 related to income for the quarter and nine months ended September 30, 2004, respectively.  The effective tax rate for the provision for the nine months was approximately 43%; the Company anticipates a similar rate for the balance of the year.

1112

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

•                  our efforts to increase sales of ophthalmic viscoelastic products and support of the distribution of ORTHOVISC^Ò in the U.S.; and internationally;

•                  our manufacturing capacity and efficiency gains and work-in-process manufacturing operations;

•                  the timing of, scope of and rate of patient enrollment for clinical trials;

•                  development of possible new products, including plans to advance cosmetic tissue augmentation and post-surgical adhesion therapies into human clinical trials;

•                  FDA or other regulatory approvals and/or reimbursement approvals of new or potential products;

•                  negotiations with potential and existing customers, including our performance under any of our distribution or supply agreements or our expectations with respect to sales and milestones pursuant to such agreements;

•                  the level of our revenue or sales in particular geographic areas and/or for particular products;

•                  the market share for any of our products;

•                  our profitability and margin improvements resulting from a higher margin product mix;

•                  our expectations of the size of the U.S. and European markets for osteoarthritis of the knee;

•                  our intention to increase market share for ORTHOVISC in international and domestic markets or otherwise penetrate growing markets for osteoarthritis of the knee;

•                  our current strategy, including our corporate objectives and research and development and collaboration opportunities, including, without limitation, commencement and completion of cosmetic tissue augmentation product and INCERT^Ò clinical trials;

•                  our and OrthoNeutrogena’s performance under the newly entered license agreement for our cosmetic tissue augmentation product;

•                  our ability to achieve performance and sales threshold milestones in our existing and future distribution and supply agreements;

•                  our and Bausch & Lomb’s performance under the newly-entered supply agreement for certain of our ophthalmic viscoelastic products;

•our expected tax rate and taxable revenues;

•our ability and timing with respect to filling vacancies in senior management positions;

•                  the rate at which we use cash, the amounts used, and the utilization of such cash; and

•                  possible negotiations or re-negotiations with existing or new distribution or collaboration partners.

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 Quarterly Report on Form 10-Q.  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 Discussions and Analysis of Financial Condition and Results of Operations” beginning on page 1213 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, 20032004 and in our

13

press releases and other filings with the Securities and Exchange Commission.  We undertake no obligation to update or revise any forward-looking statement to reflect changes in underlying assumptions or factors of new information, future events or other changes.

12

expect the decrease for the fourth quarter ofIn December 2004, compared to the fourth quarter of 2003 to occur primarily due to the projected inability to replicate deferred revenue which was recognized in the fourth quarter of 2003.  Under the terms of ourwe entered into a multi-year supply agreement (the 2004 B&L Agreement) with Bausch & Lomb for viscoelastic products used in ophthalmic surgery.   Under the pricenew agreement, which extends through December 31, 2010, and superseded the supply contract (the 2000 B&L Agreement) that was set to expire December 31, 2007, we will continue to be the exclusive global supplier (other than with respect to Japan) for units sold inAMVISC and AMVISC Plus to Bausch & Lomb.  The 2004 B&L Agreement also provides us with a calendar year is dependent on the total unit volume of sales of certainright to negotiate to manufacture future surgical ophthalmic viscoelastic 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 becomes fixed or determinable.  In each of the last three fiscal years, the annual unit volume was below levels fixed under our agreement withdeveloped by Bausch & Lomb, and, accordingly, in the fourth quarter of each of the years we recognized as revenue the amounts deferred during the first three quarters.  For the nine months ended September 30,while Bausch & Lomb has been granted rights to commercialize certain future surgical ophthalmic viscoelastic products developed by us.  The 2004 we have deferred revenue of approximately $1.0 million relatedB&L Agreement applies to salesall products sold by us to Bausch & Lomb whichfrom the beginning of 2004, with a price increase starting in 2005.  Under the 2004 B&L Agreement, we are subjectentitled to possible retroactive price adjustments when actual unit volume for the year becomes known.  If the total unit volume of sales of certain ophthalmiccontinue providing surgical viscoelastic products for the year meets or exceeds levels fixed underto our agreement with Bausch & Lomb we will be required to rebate to Bausch & Lomb, in the form of a cash payment, the amount deferred during the year.  As of the date of this filing, we expect, but cannot be certain, that total unit volume of sales of certain ophthalmicexisting customers (e.g. Advanced Medical Optics, STAAR Surgical Company, Cytosol Ophthalmics, Inc.) who currently receive such products will be above levels fixed under our agreement with Bausch & Lomb and amounts deferred will not be recognized as revenue in the fourth quarter of 2004.from us.

Our distributor for CoEase, Advanced Medical Optics, completed its previously announcedthe 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, we expect our agreement with Advanced Medical Optics will terminateexpire according to its terms in JulyJune 2005 upon its expiration.  We also expect salesand will not be renewed.  Sales to Advanced Medical Optics will declinedecreased 90.9% for the quarter ended March 31, 2005 compared to minimum required levels in accordance with the agreementsame period last year and to discontinue during the first quartercontributed less than 1% of 2005.  As a result, in the future we may not be able to sustain current product revenue levels in our ophthalmic business.  Forfor the quarter and nine months ended September 30, 2004, salesquarter.  Sales to Advanced Medical Optics contributed 24.9% and 23.3%19% of ophthalmic product revenue and 14.1% and 11.3%10% of total product revenue respectively.for the year ended December 31, 2004.

Research and Development

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 expect to receive data to compile and, assuming positive results, submit a PMA application with the FDA by the end of the third quarter of 2005.  Under our agreement with Ortho Neutrogena, we are being reimbursed for the clinical trial expenses, subject to certain limitations, in connection with the OrthoNeutrogena Agreement which weamounts are recording asincluded in contract revenue.

In April 2004 we initiated a pilot human clinical trial for INCERT^Ò-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 we expect will involve up to approximately 45 patients.  As of September 30, 2004,We expect to complete patient enrollment was approximately 50% complete.by the end of the second quarter of 2005 and, if successful, conclude the study after the six-month follow-up has been completed.

Our researchRecent Developments; Correction to Press Release and development costs increased 105.0% and 55.8%Form 8-K

On April 27, 2005, we furnished on a Current Report on Form 8-K a press release that announced financial results for the first quarter and nineof 2005.  In the press release (and in our subsequent conference call to discuss these results) we mistakenly indicated that we were reporting net income of $.10 per diluted share, when in fact the correct net income per diluted share should have been reported as $.11.  The correct net income per diluted share is reflected in this Form 10-Q.  There is no change to earlier reported aggregate net income for the three months ended September 30, 2004 compared to the same periods in 2003 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 in 2004 and to increase personnel-related expenses as we expand our research and development efforts.  As a result, we expect research and development costs will continue to increase in the fourth quarter of 2004 compared to 2003.March 31, 2005.

15

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 3 in the Notes to the Consolidated Financial Statements of this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004.March 31, 2005.

Revenue Recognition.

Our revenue recognition policies are in accordance with the Securities and Allowance for Doubtful AccountsExchange 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.  Product

We recognize revenue is recognizedfrom 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.

Under our agreement with Bausch & Lomb,the 2000 B&L Agreement, the price for units sold in a calendar year iswas dependent on total unit volume of sales to Bausch & Lomb and other customers of certain ophthalmic products during the year.  Accordingly, unit prices forPrices fluctuated based on sales occurring inlevels, and interim quarters arewere subject to possible retroactive price adjustments when the actual annual unit volume for the year becomesbecame known.  In accordance withGiven 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 revenue recognition policy,quarterly activity relative to our annual goals, we will need to estimate annual unit volume to determine the amount of revenue subject torecognition in each quarter, thereby spreading the contracted price adjustment is recorded as deferred revenue untildiscount, if any, across all units purchased in a given annual period.  Factors we consider in developing our estimate include:  (1) the annual unit volume becomes known and thediscount will be based solely on sales price becomes fixed.  ORTHOVISCactivity with Bausch &Lomb who has been sold through several distribution arrangements as well as outsource order-processing arrangements  (logistic agents).  Salesa 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 through third party logistics agents in certain markets are recognized as revenue upon shipmentforecasts provided by the logistics agent to the customer.them; and (4) overall market demand for our ophthalmic products.

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

17

royalties on sales.  We recognize non-refundable upfront payments receivedbelieve 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 parta separate unit of supply, distribution,accounting, the element must have stand-alone value and marketing arrangements, ratably over the terms of the arrangements to which the payments apply.  Milestone payments received as part of supply, distribution, and marketing arrangements are evaluated under Emerging Issues Task Force No. 00-21, “Revenue Arrangements with Multiple Deliverables,” to determine whether the delivered item has value to the customer on a stand-alone basis and whetherthere must be objective and reliable evidence of the fair value of the undelivered item exists. We recognize milestone payments as revenue upon achievement of the milestone only if (1) it represents aelements.  While this arrangement includes several elements, we believe that two separate unitunits of accounting as defined inexist (a combined license and development unit and a manufacturing unit) under the EITF 00-21 (2)model.

We are accounting for the milestone paymentscombined license and development unit using the performance based model, which recognizes revenue as the efforts are non-refundable, (3) substantive effort is involved in achieving the milestone, and (4)expended limited to the amount of the milestone is reasonable in relationnon-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 the effort expended or the risk associated with achievement of the milestone.  If any ofour entering into this arrangement.  We have treated both these conditions are not met, weamounts as upfront fees that will defer the milestone payments and recognize them as revenuebe 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 quarter ended March 31, 2005 we recognized $918,000 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 as it completes our performance obligations.  We will apply recognition of deferred milestone payments over the term(the OBI Agreement) with Ortho Biotech Products, L.P., a member of the agreement, on a cumulative basis,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 date the milestone is achieved.  As such, the term over which deferred milestone payments are recognized as revenue will begin on the effective dateCompany’s viscosupplementation technology.  In support of the related arrangement to which the payment applies.  In February 2004, as part oflicense, the OBI agreement, weAgreement 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

16

income.  In accordance with our revenue recognition policy, for financial statement purposes, the milestone payment of $20.0payments totaling $25.0 million waswere deferred and isare being recognized ratably over the expected ten-year term of the OBI Agreement.  We recorded a deferred tax asset of $7.8$9.1 million representing the approximate income tax effect of the timing difference of revenue recognition for financial statement purposes and for tax purposes.purposes related to these milestone payments as of December 31, 2004.  Based on management’s current expectations regarding future profitability, we released the valuation allowance previously established against itsour deferred tax assets and recorded a one-time income tax benefit of $7.0 million.million in the first quarter of 2004.  As of March 31, 2005, management determined that it is more likely than not that the deferred tax assets will be realized and, therefore, a valuation allowance has not been recorded.

Results of Operations

Product revenue.  Product revenue for the quarter ended September 30, 2004March 31, 2005 was $5,554,000,$5,677,000, an increase of $1,888,000,$108,000, or 51.5%1.9%, compared to $3,666,000$5,569,000 for the quarter ended September 30, 2003.  For the nine months ended September 30, 2004, product revenue was $16,813,000, an increase of $6,474,000 or 62.6% compared to $10,339,000 for the nine months ended September 30, 2004.  Product sales included shipments to our U.S. distributor of ORTHOVISC, Ortho Biotech, beginning in the first quarter of 2004, and related royalty fees tied to ORTHOVISC end-user sales beginning in March 31, 2004.

17Quarter Ended March 31,

(in thousands)

last year is partiallybelieved to be primarily attributable to increasing competitive pressure.distributor stocking patterns.  HYVISC sales contributed 5.5%8.9% and 8.5%16.5% of product revenue for the quarterquarters ended March 31, 2005 and nine months ended September 30, 2004, respectively.

Licensing, milestone and contract revenue.revenue.  Licensing, milestone and contract revenue for the quarter and nine months ended September 30, 2004March 31, 2005 was $853,000 and $1,997,000,$1,614,000, compared to $22,000 and $51,000$572,000 for the same periods last year.  Licensing and milestone revenue includedquarter ended March 31, 2004.  For the ratable recognitionfirst quarter of the $2.0 million up-front payment and $20.0 million milestone payment from Ortho Biotech, or $550,000 each quarter for the nine months ended September 30, 2004.  In addition,2005, licensing and milestone revenue includes the ratable recognition of the $1.0$27.0 million upfront paymentin up-front and milestone payments from OrthoNeutrogena and $1.3Ortho Biotech.  These amounts are being recognized in income ratably over the ten-year expected life of the agreement, or $675,000 per quarter.  As of March 31, 2004, $22.0 million of reimbursable clinicalthe up-front and development costs incurred prior to the effective date of the OrthoNeutrogena Agreement,milestone payments had been received and maintenance payments on certain supply agreements with distributors of our ophthalmic products.$550,000 was included in income.  Contract revenue was $243,000$918,000 for the quarter and nine months ended September 30, 2004, forMarch 31, 2005.  Contract revenue consists of reimbursement under the OrthoNeutrogena agreement of clinical and development costs incurred from the effective date ofOrthoNeutrogena as well as development-related fees and milestones under the OrthoNeutrogena Agreement through the end of the quarter ended September 30, 2004.agreement recorded utilizing a performance-based method for revenue recognition.

Gross profit.  Gross profit for the quarter ended September 30, 2004March 31, 2005 was $3,956,000,$4,297,000, or 61.7%58.9% of revenue, an increase of $2,198,000,$877,000, or 125.0%25.6%, from gross profit of $1,758,000,$3,420,000, representing 47.7%55.7% of revenue, for the quarter ended September 30, 2003.March 31, 2004.  Gross margin on product revenue was 55.9% for the

18

provisions of SFAS ,  As of December 31, 2004, we had approximately 692,000 stock options outstanding which had not yet become vested.

In April 2005, the SEC issued Staff Accounting Bulletin 107, “Shares-Based Payment,” which expresses the SEC Staff’s views regarding the application of SFAS No. 123(R).  At present, we have deferred revenue of approximately $1.0 million related to sales to Bausch & Lomb which are subject to possible retroactive price adjustments when actual unit volume fornot evaluated the year becomes known.  If the total unit volume of sales of certain ophthalmic products for the year meets or exceeds levels fixed under our agreement with Bausch & Lomb we will be required to rebate to Bausch & Lomb, in the form of a cash payment, the amount deferred during the year.  As of the dateeffect of this filing, we expect, but cannot be certain, that total unit volume of sales of certain ophthalmic products will be above levels fixed under our agreement with Bausch & Lomb.standard.

RISK FACTORS AND CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS

Our business is subject to comprehensive and varied government regulation and, as a result, failure to obtain FDA or other governmental approvals for our products may materially adversely affect our business, results of operations and financial condition.

Product development and approval within the FDA framework takes a number of years and involves the expenditure of substantial resources.  There can be no assurance that the FDA will grant

20

labeling changes, the use of a different facility to manufacture, process or package the device, and changes in performance or design specifications.  Changes in manufacturing procedures or methods of manufacturing that may affect safety and effectiveness may be deemed approved after a 30-day notice unless the FDA requests a 135-day supplement.  Our failure to receive approval of a PMA supplement regarding the use of a different manufacturing facility or any other change affecting the safety or effectiveness of an approved device on a timely basis, or at all, may have a material adverse effect on our business, financial condition, and results of operations.  The FDA could also limit or prevent the manufacture or distribution of our products and has the power to require the recall of such products.  Significant delay or cost in obtaining, or failure to obtain FDA approval to market products, any FDA limitations on the use of our products, or any withdrawal or suspension of approval or rescission of approval by the FDA could have a material adverse effect on our business, financial condition, and results of operations.

In addition, all FDA approved or cleared products manufactured by us must be manufactured in compliance with the FDA’s Good Manufacturing Practices (GMP) regulations and, for medical devices, the FDA’s Quality System Regulations (QSR).  Ongoing compliance with QSR and other applicable regulatory requirements is enforced through periodic inspection by state and federal agencies, including the FDA.  The

21

We have historically incurred operating losses and we cannot make any assurances about our future profitability.

From our inception through December 31, 1996 and 1999 through 2002 we have incurred annual operating losses.  For the yearyears ended December 31, 2004 and 2003, we recorded net income of $827,000.$11.2 million and $827,000, respectively.  For the nine months ended September 30, 2004first quarter of 2005 we recorded net income of $9.4$1.2 million and as of September 30, 2004,March 31 2005, we had an accumulated deficit of approximately $4.1$1.2 million.  Our ability to maintain profitability is uncertain.  The continued development of our products will require the commitment of substantial resources to conduct research and preclinical and clinical development programs, and the establishment of sales and marketing capabilities or distribution arrangements either by us or our partners.  We cannot assure you that we will be able to develop these products or new medical applications of our existing products or technology, or that if developed, the necessary regulatory approvals will be obtained, or if obtained, that sales, marketing and distribution capabilities and arrangements will be established in order to permit us to maintain profitability.

Substantial competition could materially affect our financial performance.

We compete with many companies, including, among others, large pharmaceutical companies 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 that may be involved in research,

22

medical devices for surgery, with a focus on sports medicine and reconstruction.  We have been informed that DePuy Mitek will focus its ORTHOVISC sales efforts on arthroscopists and orthopedic surgeons who typically see patients prior to a need for total knee replacement and Ortho Biotech will retain the primary responsibility for marketing ORTHOVISC to rheumatologists and other specialties.  We do not expect that the effect of this broadened sales effort will begin to impact ORTHOVISC revenues prior to the second half of 2005, nor can we provide assurance that these efforts will have a material effect on ORTHOVISC sales.  For the ninethree months ended September 30,March 31, 2005 and 2004, sales of ORTHOVISC to Ortho Biotech and royalties tied to end-user sales accounted for 25.3%10.4% and 23.6% of total revenue.revenue, respectively.  Furthermore, we cannot predict whether the license granted to Ortho Biotech in the OBI Agreement to further develop and commercialize ORTHOVISC as well as new products for the treatment of pain associated with osteoarthritis based on our proprietary viscosupplementation technology will result in any new products or indications for use.

On July 26, 2004, we announced the signing of an exclusive worldwide development and commercialization partnership with OrthoNeutrogena a division of Ortho-McNeil Pharmaceuticals, Inc., an affiliate of Johnson & Johnson, for our CTA therapy products.  Under the terms of the agreement, OrthoNeutrogena will, subject to certain limitations, reimburse us for costs incurred for the ongoing pivotal clinical trial with our CTA product initiated in May 2004 and support the development of the CTA product, as well as future line extensions.  There can be no assurance that we will successfully complete the clinical trial for our CTA product or that we will be able to successfully complete the FDA approval process.  If we are able to successfully complete the FDA approval process for our CTA product, we cannot assure you that OrthoNeutrogena will be able to commercialize our CTA product effectively, or at all, nor can we assure you that we will be able to achieve the sales- and performance-based milestones provided in the agreement.

24

obtain, or the loss of, patent protection for the inventions and the loss of any right to use the inventions.  Even if the eventual outcome is favorable to us, such interference proceedings could result in substantial cost to us, and diversion of management’s attention away from our operations.  Filing and prosecution of patent applications, litigation to establish the validity and scope of patents, assertion of patent infringement claims against others and the defense of patent infringement claims by others can be expensive and time consuming.  There can be no assurance that in the event that any claims with respect to any of our patents, if issued, are challenged by one or more third parties, that any court or patent authority ruling on such challenge will determine that such patent claims are valid and enforceable.  An adverse outcome in such litigation could cause us to lose exclusivity covered by the disputed rights.  If a third party is found to have rights covering products or processes used by us, we could be forced to cease using the technologies or marketing the products covered by such rights, could be subject to significant liabilities to such third party, and could be required to license technologies from such third party.  Furthermore, even if our patents are determined to be valid, enforceable, and broad in scope, there can be no assurance that competitors will not be able to design around such patents and compete with us using the resulting alternative technology.

We have a policy of seeking patent protection for patentable aspects of our proprietary technology.  We intend to seek patent protection with respect to 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.  However, no assurance can be given that any patent application will be filed, that any filed applications will result in issued patents or that any issued patents will provide us with a competitive advantage or will not be successfully challenged by third parties.  The protections afforded by patents will depend upon their scope and validity, and others may be able to design around our patents.

25

assurance that Bausch & Lomb will continue to use us to manufacture AMVISC and AMVISC Plus.  If Bausch & Lomb discontinues the use of us as a manufacturer after such time, our business, financial condition, and results of operations would likely be materially and adversely affected.

Our manufacturing processes involve inherent risks and disruption could materially adversely affect our business, financial condition and results of operations.

Our results of operations are dependent upon the continued operation of our manufacturing facility in Woburn, Massachusetts.  The operation of biomedical manufacturing plants involves many risks, including the risks of breakdown, failure or substandard performance of equipment, the occurrence of natural and other disasters, and the need to comply with the requirements of directives of government agencies, including the FDA.  In addition, we rely on a single supplier for syringes and a small number of suppliers for a number of other materials required for the manufacturing and delivery of our HA products.  Although we believe that alternative sources for many of these and other components and raw materials that we use in our manufacturing processes are available, any supply interruption could harm our ability to manufacture our products until a new source of supply is identified and qualified.  We may not be able to find a sufficient alternative supplier in a reasonable time period, or on commercially reasonable terms, if at all, and our ability to produce and supply our products could be impaired.

Furthermore, our manufacturing processes and research and development efforts involve animals and products derived from animals.  We procure our animal-derived raw materials from qualified vendors, control for contamination and have processes that effectively inactivate infectious agents; however, we cannot assure you that we can completely eliminate the risk of transmission of infectious agents and in the

26

•                  market acceptance of our existing and future products;

•                  the successful commercialization of products in development;

•                  progress in our product development efforts;

•                  the magnitude and scope of such product development efforts,

•                  progress with preclinical studies, clinical trials and product clearances by the FDA and other agencies;

•                  the cost and timing of our efforts to manage our manufacturing capabilities and related costs;

•                  the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;

•                  competing technological and market developments;

•                  the development of strategic alliances for the marketing of certain of our products;

•                  the terms of such strategic alliances, including provisions (and our ability to satisfy such provisions) that provide upfront and/or milestone payments to us; and

•                  the cost of maintaining adequate inventory levels to meet current and future product demands.

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

28

notice to the Board of Directors of stockholder proposals, limitations on the ability of stockholders to remove directors and to call stockholder meetings, the provision that vacancies on the Board of Directors be filled by vote of a majority of the remaining directors.  In addition, the Board of Directors adopted a Shareholders Rights Plan in April 1998.  We are also subject to Chapter 110F of the Massachusetts General Laws which, subject to certain exceptions, prohibits a Massachusetts corporation from engaging in any of a broad range of business combinations with any “interested stockholder” for a period of three years following the date that such stockholder became an interested stockholder.  These provisions could discourage a third party from pursuing a takeover of us at a price considered attractive by many stockholders, since such provisions could have the effect of preventing or delaying a potential acquirer from acquiring control of us and our Board of Directors.

Our revenues are derived from a small number of customers, the loss of which could materially adversely affect our business, financial condition and results of operations.

We have historically derived the majority of our revenues from a small number of customers, most of whom resell our products to end users and most of whom are significantly larger companies than us.  For the ninethree months ended September 30, 2004,March 31, 2005, three customers accounted for 72.2%77.7% of product revenue.  While it is expected that our ability to market ORTHOVISC in the U.S. as a result of the receipt of FDA approval in February 2004, and our entering into the OBI Agreement, will reduce our dependence on revenues from Bausch & Lomb, for revenues, historically our largest customer, we will still be dependent on a small number of large customers for the majority of our revenues.  Our failure to generate as much revenue as expected from these customers or the failure of these customers to purchase our products would seriously

30

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of September 30, 2004,March 31, 2005, we did not utilize any derivative financial instruments, market risk sensitive instruments or other financial and commodity instruments for which fair value disclosure would be required under SFAS No. 107.  All of our investments consist of money market funds, commercial paper and municipal bonds that are carried on our books at amortized cost, which approximates fair market value.

Primary Market Risk Exposures

Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk.  Our investment portfolio of cash equivalent and short-term investments is subject to interest rate fluctuations, but we believe this risk is immaterial due to the short-term nature of these investments.  Our exposure to currency exchange rate fluctuations is specific to the extent that certain sales were effected through logistics agents in foreign currencies.  The impact of currency exchange rate movements on sales through logistics agents was immaterial for the quarter ended September 30, 2004.  Currently, we do not engage in foreign currency hedging activities.

ITEM 4.  CONTROLS AND PROCEDURES

(a)           Evaluation of disclosure controls and procedures.

As required by Rule 13a-15 under the Securities Exchange Act of 1934 (Exchange Act), the Companywe carried out an evaluation under the supervision and with the participation of the Company’sour management, including the Company’s Chief Executive Officerour chief executive officer and Principal Financial Officer,principal financial officer, of the effectiveness of the design and operation of the Company’sour disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officerchief executive officer and Principal Financial Officerprincipal financial officer have concluded that they believe that the Company’sour disclosure controls and procedures are reasonably effective to ensure that material information relating to the Companyus required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. In designing and evaluating the disclosure controls and procedures, the Company’sour management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. The CompanyWe currently isare in the process of further reviewing and documenting itsour disclosure controls and procedures, and itsour internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

(b)           Changes in internal controls.

There were no changes in our internal control over financial reporting during the thirdfirst quarter of fiscal year 20042005 that have materially affected, or that are reasonably likely to materially affect, our internal controls over financial reporting.

PART II: OTHER INFORMATION

Item 6.Exhibits

32