Anika Therapeutics, Inc. - Annual Report: 2019 (Form 10-K)

Our global operations, particularly in Italy, may be adversely affected by the coronavirus outbreak and face risks that could impact our business.

A novel strain of coronavirus, COVID-19, originated in Wuhan, China, in December 2019. The virus has spread to Italy, which as of March 2020 reportedly had the highest number of coronavirus infections outside Asia. Though it represents a relatively small percentage of our consolidated business, we conduct commercial activity, product development, sales and inventory management and other services in our Padova, Italy location, and those business operations are subject to potential business interruptions arising from protective measures that may be taken by the Italian government or other agencies or governing bodies. Business disruptions elsewhere in the world could also negatively affect the sources and availability of components and materials that are essential to the operation of our business in both Italy and the United States. Extended periods of interruption to our Italian or U.S. operations due to the coronavirus outbreak could adversely impact the growth of our business, could cause us to cease or delay operations, and could prevent our customers from receiving shipments or processing payments.

The extent to which the coronavirus impacts our global business, sales and results of operations will depend on future developments, which are highly uncertain and cannot be predicted. This includes new information that may emerge concerning the severity of the coronavirus, the spread and proliferation of the coronavirus around the world, and the actions taken to contain the coronavirus or treat its impact, among others.

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

The operation of biomedical manufacturing plants involves many risks, including the risks of breakdown, failure, or substandard performance of equipment, the need to comply with the requirements of directives of government agencies, including the FDA, and the occurrence of natural and other disasters. Such occurrences could have a material adverse effect on our business, financial condition, and results of operations during the period of such operational difficulties and beyond.

We rely on a small number of suppliers for certain key raw materials and a small number of suppliers for a number of other materials required for the manufacturing and delivery of our products, and disruption could materially adversely affect our business, financial condition, and results of operations.

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, we cannot be certain that the supply of key raw materials will continue to be available at current levels or will be sufficient to meet our future needs. For the manufacture of the surgical joint implant and instrumentation products produced by our subsidiary Arthrosurface, we engage a single third-party organization as a contract manufacturer. 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 sufficient alternative suppliers 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.

We use raw materials derived from animal sources to produce certain of our products, and there is no guarantee that we will be able to continue to utilize this source of material in the future.

Our manufacturing processes and research and development efforts for some of our ophthalmic and veterinary products involve products derived from animals. We procure our animal-derived raw materials from a qualified vendor, who controls for contamination and has processes that effectively inactivate infectious agents; however, we cannot assure you that we can completely eliminate the risk of transmission of infectious agents. Furthermore, regulatory authorities could in the future impose restrictions on the use of animal-derived raw materials that could impact our business.

The utilization of animals in research and development and product commercialization is subject to increasing focus by animal rights activists. The activities of animal rights groups and other organizations that have protested animal based research and development programs or boycotted the products resulting from such programs could cause an interruption in our manufacturing processes and research and development efforts. The occurrence of material operational problems, including but not limited to the events described above, could have a material adverse effect on our business, financial condition, and results of operations during the period of such operational difficulties and beyond.

We lease properties in the United States and Italy, and there is no guarantee that these leaseholds will be without issue or sufficient to support future growth.

We lease approximately 134,000 square feet of administrative, research and development, and manufacturing space in Bedford, Massachusetts, approximately 10,000 square feet of administrative, research and development, and warehouse facility in Franklin, Massachusetts, approximately 40,000 square feet of administrative, research and development, and manufacturing space in Sarasota, Florida, and approximately 33,000 square feet of office, research and development, training, and warehousing space in Padova, Italy. The current term of the Bedford lease extends to 2022, and the current term of the Padova lease extends to 2032, each with several options for renewal. Please see Item 2 – Properties for additional information on our current leases. The nature of these leaseholds presents certain risks. We must maintain a positive working relationship with the respective owners as a dispute with either owner over payment, maintenance, or any other matter could be disruptive to our business. Additionally, there is a possibility that changes to our business or the geographic location of the facilities could make either location less suitable to our operations. Any renegotiation or termination of either lease could result in substantial cost or business interruption to our operations. Additionally, there is no guarantee that our current space will be sufficient to support our future growth or that any future relocation or expansion of our operations would be completed smoothly or in a timely manner due to, among other things, unexpected construction delays or unexpected difficulties related to the achievement of necessary permitting. Any business disruption as a result of any of these factors could have a material impact on our business, financial condition, and results of operations.

We may face circumstances in the future that will result in impairment charges, including, but not limited to, goodwill impairment and In-Process Research and Development (“IPR&D”) charges.

As of December 31, 2019, we had long-lived assets, including goodwill and IPR&D, of $96.4 million. If the fair value of any of our long-lived assets, including those that we recently acquired in the acquisitions of Arthrosurface and Parcus Medical for which purchase accounting is not yet complete, decreases as a result of an economic slowdown, a downturn in the markets where we sell products and services, a downturn in our financial performance or future outlook or for other reasons, we may be required to record an impairment charge on such assets.

We are required to test intangible assets with indefinite life periods for potential impairment annually and on an interim basis if there are indicators of a potential impairment. We also are required to evaluate amortizable intangible assets and fixed assets for impairment if there are indicators of a possible impairment. Impairment charges could have a negative impact on our results of operations and financial position, as well as on the market price of our common stock.

We could become subject to product liability claims, which, if successful, could materially adversely affect our business, financial condition, and results of operations.

The testing, marketing, and sale of human health care products entail an inherent risk of allegations of product liability, and there can be no assurance 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 an insurance policy of $5.0 million per occurrence and $5.0 million in the aggregate to cover such product liability claims should they arise, there can be no assurance that material claims will not arise in the future or that our insurance will be adequate to cover all situations. Moreover, there can be no assurance 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 operations. 

Our business is dependent upon hiring and retaining qualified management and technical personnel, including our hiring of a permanent chief executive officer.

We are highly dependent on the members of our management and technical staff, the loss of one or more of whom could have a material adverse effect on us. We have experienced a number of management changes in recent years, and there can be no assurances that any future management changes will not adversely affect our business. We believe that our future success will depend in large part upon our ability to attract and retain technical and highly skilled executive, managerial, professional, and technical personnel. We face significant competition for such personnel from competitive companies, research and academic institutions, government entities, and other organizations. There can be no assurance that we will be successful in hiring or retaining the personnel we require. The failure to hire and retain such personnel could have a material adverse effect on our business, financial condition, and results of operations.

On January 29, 2020, Joseph Darling, our former President and Chief Executive Officer, passed away unexpectedly. Dr. Cheryl Blanchard, a member of the Board of Directors, has been named Interim Chief Executive Officer. The Board of Directors has undertaken a search process to identify and hire a permanent chief executive officer. A failure to hire a highly qualified successor chief executive officer, or an extended delay in the hiring process, could materially limit or restrict our ability to execute our long-term strategy and to operate our business.

Currency exchange rate fluctuations may have a negative impact on our reported earnings.

Approximately 4% of our business during 2019 was conducted in functional currencies other than the U.S. dollar, which is our reporting currency. Thus, currency fluctuations among the U.S. dollar and the other currencies in which we do business have caused and will continue to cause foreign currency transaction gains and losses. Currently, we attempt to manage foreign currency risk through the matching of assets and liabilities. In the future, we may undertake to manage foreign currency risk through additional hedging methods. We recognize foreign currency gains or losses arising from our operations in the period incurred. We cannot guarantee that we will be successful in managing foreign currency risk or in predicting the effects of exchange rate fluctuations upon our future operating results because of the variability of currency exposure and the potential volatility of currency exchange rates.

Information security breaches or business system disruptions may adversely affect our business.

We rely on our information technology infrastructure and management information systems to effectively run our business. While we have not previously experienced a material information security breach caused by illegal hacking, computer viruses, or acts of vandalism or terrorism, we may in the future be subject to such a breach. Our security measures or those of our third-party service providers may not detect or prevent such breaches. Any such compromise to our information security could result in an interruption in our operations, the unauthorized publication of our confidential business or proprietary information, the unauthorized release of customer, vendor, or employee data, the violation of privacy, including under the GDPR recently promulgated in the European Union, or other laws and exposure to litigation, any of which could harm our business and operating results.

Risks Related to Our Intellectual Property

We may be unable to adequately protect our intellectual property rights, which could have a material impact on our business and future financial results.

Our efforts to enforce our intellectual property rights may not be successful. We rely on a combination of copyright, trademark, patent, and trade secret laws, confidentiality procedures, and contractual provisions to protect our proprietary rights. Our success will depend, in part, on our ability to obtain and enforce patents and trademarks, to protect trade secrets, to obtain licenses to technology owned by third parties when necessary, and to conduct our business without infringing on the proprietary rights of others. The patent positions of pharmaceutical, medical product, and biotechnology firms, including ours, can be uncertain and involve complex legal and factual questions. There can be no assurance that any patent applications will result in the issuance of patents or, if any patents are issued, that they will provide significant proprietary protection or commercial advantage or will not be circumvented by others. 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, 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 or patent review process 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, we could be subject to significant liabilities to such third party, and we could be required to license technologies from such third party in order to continue production of the products. 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.

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. There can be no assurance that these agreements provide meaningful protection or that they will not be breached, that we would have adequate remedies for any such breach, or that our trade secrets, proprietary know-how, and our technological advances will not otherwise become known to others. In addition, there can be no assurance that, despite precautions taken by us, others have not and will not obtain access to our proprietary technology. Further, there can be no assurance that third parties will not independently develop substantially equivalent or better technology. 

There can be no assurance that we will not infringe upon the intellectual property rights of others, which could have a significant impact on our business and financial results.

Other entities have filed patent applications for, or have been issued patents concerning, various aspects of HA-related products or processes, including in the segments in which we do business. There can be no assurance that the products or processes developed by us will not infringe on the patent rights of others in the future. The cost of defending infringement suits is typically large, and there is no guarantee that any future defense would be successful. In addition, infringement could lead to substantial damages payouts or our inability to produce or market certain of our current or future products. As a result, any such infringement may have a material adverse effect on our business, financial condition, and results of operations.

Risks Related to Ownership of Our Common Stock

Our stock price may be highly volatile, and we cannot assure you that market making in our common stock will continue.

The market price of shares of our common stock may be highly volatile. Factors such as announcements of new commercial products or technological innovations by us or our competitors, disclosure of results of clinical testing or regulatory proceedings, government regulation and approvals, developments in patent or other proprietary rights, public concern as to the safety of products developed by us, and general market conditions may have a significant effect on the market price of our common stock. The trading price of our common stock could be subject to wide fluctuations in response to quarter-to-quarter variations in our operating results, material announcements by us or our competitors, governmental regulatory action, conditions in the health care industry generally or in the medical products industry specifically, or other events or factors, many of which are beyond our control. In addition, the stock market has experienced extreme price and volume fluctuations, which have particularly affected the market prices of many medical products companies and which often have been unrelated to the operating performance of such companies. Our operating results in future quarters may be below the expectations of equity research analysts and investors. In such an event, the price of our common stock would likely decline, perhaps substantially.

If securities or industry analysts do not publish or cease publishing research or reports about us, our business, or our market, or if they adversely change their recommendations regarding our stock, our stock price and trading volume could decline.

 The trading market for our common stock is influenced by the research and reports that securities or industry analysts may publish about us, our business, our market, or our competitors. No person is under any obligation to publish research or reports on us, and any person publishing research or reports on us may discontinue doing so at any time without notice. If adequate research coverage is not maintained on our company or if any of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business or provide relatively more favorable recommendations about our competitors, our stock price would likely decline. If any analysts who cover us were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Our charter documents contain anti-takeover provisions that may prevent or delay an acquisition of our company.

Our charter documents continue to contain anti-takeover provisions that could prevent or delay an acquisition of our company. The provisions include, among others, a classified board of directors, advance notice to the board of stockholder proposals, limitations on the ability of stockholders to remove directors and to call stockholder meetings, and a provision that allows vacancies on the Board of Directors to be filled by vote of a majority of the remaining directors. We are also subject to Section 203 of the Delaware General Corporate Law which, subject to certain exceptions, prohibits a Delaware 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 becomes an interested stockholder. Those provisions could have the effect of discouraging a third party from pursuing a non-negotiated takeover of our company at a price considered attractive by many stockholders and could have the effect of preventing or delaying a potential acquirer from acquiring control of our company.

ITEM 2. PROPERTIES

Our corporate headquarters is located in Bedford, Massachusetts, where we lease approximately 134,000 square feet of administrative, research and development, and manufacturing space. We entered into this lease in January 2007, and the lease commenced in May 2007 for an initial term of ten and a half years. In October 2016, we exercised the first option under the lease to extend its term for five years. There are three additional renewal periods, each of which is subject to the condition that we notify the landlord of our exercise of such option at least one year prior to the expiration of the then current term. Two additional renewal options each extend the term an additional five years, and the final renewal option extends the term an additional six years.

In October 2015, Anika S.r.l. entered into a build-to-suit lease agreement for a new European headquarters facility consisting of approximately 33,000 square feet of general office, research and development, training, and warehousing space located in Padova, Italy. This lease, which has an initial term of fifteen years, commenced in February 2017 in accordance with the lease agreement, as amended in February 2017. The lease will automatically renew for up to three additional six-year terms, subject to certain terms and conditions. Anika S.r.l. may elect to early withdraw from this lease subject to certain financial penalties after six years and with no penalties after the ninth year.

In the first quarter of 2020 we added approximately 10,000 square feet of administrative, research and development, and warehouse facility in Franklin, Massachusetts and approximately 40,000 square feet of administrative, research and development, and manufacturing space in Sarasota, Florida through our respective acquisitions of Arthrosurface, Incorporated and Parcus Medical, LLC.

In 2019, we had aggregate facility lease expenses of approximately $1.9 million. We believe that the capacity of our Bedford, Franklin, Sarasota, and Padova facilities will be sufficient to satisfy our needs for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

We are involved from time-to-time in various legal proceedings arising in the normal course of business. Although the outcomes of these legal proceedings are inherently difficult to predict, we do not expect the resolution of these proceedings to have a material adverse effect on our financial position, results of operations, or cash flow.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Common Stock Information

Our common stock has traded on the NASDAQ Global Select Market since November 25, 1997, under the symbol “ANIK.” At December 31, 2019, the closing price per share of our common stock was $51.85 as reported on the NASDAQ Global Select Market, and there were 116 holders of record. We believe that the number of beneficial owners of our common stock at that date was substantially greater, due to shares being held by intermediaries.

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.

Performance Graph

Set forth below is a graph comparing the total returns of our company, the NASDAQ Composite Index, and the NASDAQ Biotechnology Index. The graph assumes $100 is invested on December 31, 2014 in our common stock and each of the indices. Past performance is not indicative of future results.

Issuer Purchases and Withholding of Equity Securities

Under our equity compensation plans, and subject to the specific approval of the Compensation Committee of our Board of Directors, grantees have the option of electing to satisfy tax withholding obligations at the time of vesting or exercise by allowing us to withhold shares of stock otherwise issuable to the grantee. During the three-month period ended December 31, 2019, we withheld 672 shares to satisfy grantee tax withholding obligations on restricted stock award vesting events.

Following is a summary of stock repurchases for the three-month period ended December 31, 2019 (in thousands, except share data):

Securities Authorized for Issuance Under Equity Compensation Plans

For information regarding securities authorized for issuance under our employee stock-based compensation plans, see Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, included elsewhere in this Annual Report on Form 10-K.

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. The Balance Sheet Data at December 31, 2019 and 2018 and the Statement of Operations Data for each of the three years ended December 31, 2019, 2018, and 2017 have been derived from the audited Consolidated Financial Statements for such years, included elsewhere in this Annual Report on Form 10-K. The Balance Sheet Data at December 31, 2017, 2016, and 2015, and the Statement of Operations Data for each of the two years in the period ended December 31, 2016 and 2015 have been derived from audited consolidated financial statements for such years not included in this Annual Report on Form 10-K.

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

The following section 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, are based on assumptions, and are 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 sections captioned “Business” and “Risk Factors.” The following discussion should also be read in conjunction with the consolidated financial statements and the Notes thereto appearing elsewhere in this Annual Report on Form 10-K.

Management Overview

Founded in 1992, Anika Therapeutics, Inc. is a global, integrated joint preservation and regenerative therapies company based in Bedford, Massachusetts. Our mission is to be the global leader in orthopedic joint therapies and sports medicine with innovative technologies that exceed our customers’ expectations. We are committed to delivering solutions to improve the lives of patients across a continuum of care from joint pain management and regenerative therapies to sports medicine and orthopedic joint preservation and restoration. We have nearly thirty years of global expertise commercializing more than twenty products based on our hyaluronic acid, or HA, technology platform, and we are focused on adding innovative and differentiated offerings to our consolidated portfolio. Our proprietary technologies for modifying the HA molecule allow product properties to be tailored specifically to multiple therapeutic uses. Certain of our technology chemically modifies HA to allow for longer residence time in the body. We have two forms of cross-linked HA gel technologies, and a solid form of HA technology – HYAFF which is the platform for our regenerative medicine. These proprietary technologies are protected by an extensive portfolio of owned and licensed patents.

As we look towards the future, our business is uniquely positioned to capture value within the sports and regenerative medicine market. Our success is driven by our focus on our talent and culture, investment in innovative research and development programs to feed our product pipeline, expanding our commercial footprint domestically and internationally, and pursuing strategic inorganic growth opportunities. We intend to continue to accelerate our commercial capabilities as we transform into a customer-centric company dedicated to advancing the joint preservation and restoration continuum of care. We believe that this commitment, along with our financial resources and operating history, have positioned us well to deliver sustained value to our shareholders.

In early 2020, we expanded our overall technology platform through our strategic acquisitions of Parcus Medical, LLC, or Parcus Medical, a sports medicine implant and instrumentation solutions provider focused on surgical repair and reconstruction of ligaments and tendons, and Arthrosurface, Incorporated, or Arthrosurface, a joint preservation technology company specializing in less invasive, bone preserving partial and total joint replacement solutions. The Company expects the Parcus Medical and Arthrosurface acquisitions to drive growth by:

·       Broadening Anika's product portfolio further into the sports medicine joint preservation and restoration space;

·       Adding high-growth revenue streams;

·       Expanding our commercial capabilities;

·       Diversifying our revenue base; and

·       Expanding our product pipeline and research and development expertise.

In addition, we believe that our historical HA and regenerative medicine expertise will be highly complementary to the sports medicine implants and instrumentation expertise of Parcus Medical and the partial and total joint replacement expertise of Arthrosurface. We believe that the combination of these three businesses positions Anika to provide innovative solutions along the orthopedic continuum of care and build significant value for patients, physicians, and key healthcare system stakeholders.

Key Developments

On January 4, 2020, we signed agreements to acquire Parcus Medical and Arthrosurface. The Parcus Medical transaction closed on January 24, 2020. Under the terms of the Parcus Medical agreement, Anika acquired all outstanding membership interests of Parcus Medical in exchange for an upfront payment of approximately $35.0 million in cash from our then-existing balance sheet. In addition, Parcus Medical unitholders will be eligible to receive an additional $60.0 million contingent upon the achievement of certain commercial milestones. The Arthrosurface transaction closed on February 3, 2020. Under the terms of the Arthrosurface agreement, Anika acquired all outstanding shares of Arthrosurface in exchange for an upfront payment of approximately $60.0 million in cash from our then-existing balance sheet. In addition, Arthrosurface shareholders will be eligible to receive an additional $40.0 million contingent upon achievement of certain regulatory and commercial milestones.

On January 29, 2020, we announced that our board of directors had appointed an Office of the President, comprised of three of our executive officers, to provide ongoing leadership and oversight of day-to-day operations following the unexpected death of Joseph Darling, our former President and Chief Executive Officer, earlier on that date. On February 12, 2020, we announced that the board appointed Dr. Cheryl R. Blanchard, one of our directors, to serve as our Interim Chief Executive Officer, in lieu of the continuation of the Office of the President, effective February 10, 2020. The previously appointed Office of the President was dissolved as of that date.

Products

Historically, we have categorized our product offerings into four segments: Orthobiologics, Dermal, Surgical, and Other, which included our ophthalmic and veterinary products. Moving forward, we will divide our product portfolio into three categories: Joint Pain Management Therapy, Orthopedic Joint Preservation and Restoration Care, and Other. The table below demonstrates the categorization of key products based on the products commercialized as of December 31, 2019:

The table below demonstrates the recategorization of key products based on the current product portfolio being commercialized, including those from the recent acquisitions of Arthrosurface and Parcus Medical.

*Through the acquisition of Parcus Medical, we added a line of implant and instrumentation products used by surgeons to repair and reconstruct damaged ligaments and tendons due to sports injuries, trauma and disease. These solutions include screws, sutures, anchors, and other surgical systems that facilitate surgical procedures on the shoulder, knee, hip, distal extremities, and tissue. Through the acquisition of Arthrosurface, we added a portfolio of partial and total joint surface and preservation solutions including a catalogue of over 150 different surface implant curvatures for the knee, shoulder, hip, ankle, wrist and toe that are designed to treat upper and lower extremity orthopedic conditions caused by trauma, injury and arthritic disease. Moving forward, these products will be included in the Orthopedic Joint Preservation and Restoration Care category.

The following sections provide more information about our products:

Joint Pain Management Therapies

Our Joint Pain Management Therapies product family consists of injectable viscosupplement products that provide pain relief from osteoarthritis conditions. These products include MONOVISC, ORTHOVISC, CINGAL, and HYVISC, HA-based intraarticular injectable products indicated for the treatment of osteoarthritis pain. Our Joint Pain Management Therapy products are administered to patients in an office setting. We distribute the products in this category using a distributor model, as more fully described in the section titled “Sales Channel.”

In the United States, MONOVISC and ORTHOVISC are marketed by DePuy Synthes Mitek Sports Medicine, a division of DePuy Orthopaedics, Inc., or Mitek, under the terms of a pair of licensing, distribution, supply, and marketing agreements, or the Mitek MONOVISC Agreement and Mitek ORTHOVISC Agreement. In the United States, MONOVISC and ORTHOVISC have maintained the combined overall viscosupplement market leadership position since the first quarter of 2018 on a revenue generation basis. Internationally, we market our Joint Pain Management Therapy products using a growing network of commercial distributors in Canada, Europe, the Middle East, Latin America, and Asia.

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 is distributed by Boehringer Ingelheim Vetmedica, Inc., Boehringer, in the United States.

Orthopedic Joint Preservation and Restoration Care

Our Orthopedic Joint Preservation and Restoration Care family consists of the following key products:

Other

Our Other product family consists of legacy HA-based products that do not fit into one of our other primary product categories. These products include:

Sales Channels

Since our inception in 1992, we historically utilized a commercial partnership model for the distribution of our products to end-users. Our strong, worldwide network of distributors has historically provided, and continues to provide, a solid foundation for our revenue growth and territorial expansion. In 2019, we implemented a hybrid commercial approach that balances a small direct model with a network of distributor partners in the U.S. market, and we utilized this hybrid approach for the launch of TACTOSET. The acquisitions of Arthrosurface and Parcus Medical each added to our commercial infrastructure, especially in the United States. Arthrosurface has approximately 35 sales representatives and 100 distributors in the U.S., while Parcus Medical employs a similar, though more mature, model as Anika and has over 50 U.S. distributors in place.

For products in our Orthopedic Joint Preservation and Restoration Care family, including those currently in research and development or those not yet developed, we intend to leverage the expanded hybrid-direct sales infrastructure of the consolidated entity. This framework pairs an internal direct sales team with external sales agent partners to maximize territorial coverage and sales generation. Generally, products within this family are sold into surgical environments, such as hospitals or ambulatory surgery centers, and we believe that we have a strong infrastructure now in place to service these customers. We intend to cross-train the sales staffs to create a consolidated sales structure selling all of the products within our portfolio. We also intend to assess each selling territory to maximize our coverage and reach as many customers and patients as possible.

For longer-term future products in the U.S. market within our Joint Pain Management Therapies or Other families, we intend to evaluate our commercial model and possible alternatives or augmentations in each instance on a case-by-case basis, based on market dynamics and other factors. These models could include direct sales, distribution partnerships, or a hybrid of those forms. For current products in the U.S. market, we intend to retain our current distribution relationships, including with Mitek, as they continue to provide meaningful revenue and growth opportunities.

Internationally, we expect to maintain our current distribution model for the foreseeable future. Notwithstanding that general expectation, we will evaluate modifications or possible alternatives to that model on a case-by-case basis based upon market dynamics and resource allocation. We also intend to evaluate and synergize our international distributor base to ensure that we maximize our partnerships and grow revenue from our entire product portfolio.

Manufacturing

We manufacture the majority of our products ourselves at our facilities in Bedford, Massachusetts, where we make the totality of the products associated with the historic Anika business, and, following our acquisition of Parcus Medical, in Sarasota, Florida, where we make the vast majority of the historic Parcus Medical finished products. For the manufacture of the partial and total joint surface implants and preservation products produced Arthrosurface, we engage a single third-party organization as a contract manufacturer. The raw materials necessary to manufacture our products are generally available from multiple sources. However, we rely on a small number of suppliers for certain key raw materials and a small number of suppliers for certain other materials required for the manufacturing and delivery of these products.

Research and Development

Our research and development efforts primarily consist of the development of new medical applications for our technology platform, the development of intellectual property with respect to our technology platform, the management of clinical trials for certain product candidates, the preparation and processing of applications for regulatory approvals, and process development and scale-up manufacturing activities for new and existing products. Our development is focused on orthopedic and regenerative medicine, including products for tissue protection, repair, and regeneration. For the years ended December 31, 2019, 2018, and 2017, research and development expenses were $16.7 million, $18.2 million, and $18.8 million respectively. The decrease in 2019 was mainly due to timing and decision-making regarding our clinical activities. We anticipate that we will continue to commit significant resources to, and increase our aggregate spending on, research and development efforts including new product development, preclinical activities and clinical trials in the future.

Current research and development activities include clinical trials for CINGAL, a joint pain management therapy composed of our proprietary cross-linked HA material combined with an approved steroid, and HYALOFAST, an innovative product for cartilage tissue repair, meant to support eventual regulatory approval for these products in the United States. In pursuing a U.S. regulatory pathway for CINGAL, we have conducted two Phase III clinical trials and two follow-up studies, and the United States Food and Drug Administration, or FDA, has indicated an additional Phase III trial is necessary to support U.S. approval. We are currently working to initiate a pilot study to confirm our trial design, increase our probability of success in a Phase III trial and generate data that ultimately will be needed to support FDA approval. We remain on track to commence the CINGAL pilot study in the first half of 2020. We are also conducting a Phase III trial to support the U.S. regulatory approval of HYALOFAST. We expect to complete patient enrollment in the HYALOFAST study by the end of 2020.

In addition, we are working to expand our regenerative medicine pipeline with a new product candidate in the form of an implant for rotator cuff repair utilizing our proprietary solid HA technology, which could be employed to repair partial and full-thickness rotator cuff tears. We finalized an initial product prototype, and we are currently performing preclinical testing on the product and developing the surgical instrumentation for the potential product.

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 consolidated financial statements included elsewhere in this Annual Report on Form 10-K, which consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We monitor our estimates on an ongoing 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 are discussed throughout this section captioned “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 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Revenue Recognition – General

        We adopted the guidance in the ASC 606 using the modified retrospective method effective January 1, 2018. The adoption of ASC 606 was applied to all contracts not completed as of the date of adoption. The adoption did not have a material impact on the amount and timing of revenue recognized in the consolidated financial statements. We made no adjustments to our previously reported product and total revenue, as those periods continue to be presented in accordance with our historical accounting practices under Topic 605, Revenue Recognition.

Pursuant to ASC 606, we recognize revenue when a customer obtains control of promised goods or services. The amount of revenue that is recorded reflects the consideration that we expect to receive in exchange for those goods or services. We apply the following five-step model in order to determine this amount: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are capable of being distinct or distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) we satisfy each performance obligation.

We have agreements with Mitek that include the grant of certain licenses, performance of development services, and the supply of product at Mitek’s option. Revenues from the agreements with Mitek represent 71% of total revenues for the year-ended December 31, 2019. We completed the performance obligations related to granted licenses and development services under these agreements prior to 2016. We have no remaining material performance obligations under the Mitek agreements.

We have agreements with other customers that may include the delivery of a license and supply of product. The upfront payments under such agreements upon the delivery of the license have not been material.

Our typical distributor supply agreements represent a promise to deliver product at the customer’s discretion that are considered options. We assess if these options provide a material right to the licensee and if so, they are accounted for as separate performance obligations.  The majority of our supply agreements do not provide options that are considered material rights.

Certain of our agreements include sales-based royalties and milestones. As we consider the license to be the predominant item to which the royalties relate for these agreements, sales-based royalties and milestones are only recognized when the later of the underlying sale occurs or the performance obligation to which some or all of the sales-based royalty has been satisfied (or partially satisfied). This is generally in the same period that our licensees complete their product sales in their territory, for which we are contractually entitled to a percentage-based royalty. Revenue from sales-based royalties is included in product revenues.

Product Revenue

We sell our products principally to a number of distributors (i.e., our customers) under legally-enforceable, executed contracts. Our distributors subsequently resell the products to sub-distributors and health care providers, among others. We recognize revenue from product sales when the distributor obtains control of our product, which typically occurs upon shipment to the distributor, in return for agreed-upon, fixed-price consideration. Performance obligations are generally settled quickly after purchase order acceptance; therefore, the value of unsatisfied performance obligations at the end of any reporting period is generally insignificant.

Our payment terms are consistent with prevailing practice in the respective markets in which we do business. Most of our distributors make payments based on fixed-price contract terms, which are not affected by contingent events that could impact the transaction price. Payment terms fall within the one-year guidance for the practical expedient, which allows us to forgo adjustment of the contractual payment amount of consideration for the effects of a significant financing component. Our contracts with customers do not customarily provide a right of return, unless certain product quality standards are not met.

Some of our distributor agreements have volume based discounts with tiered pricing which are generally prospective in nature. These prospective discounts together with any free-of-charge sample units offered are evaluated as potential material rights. If the prospective discounts or free-of-charge sample units are considered material rights, these would be separate performance obligations and a portion of the sales transaction price is allocated to the material right. Revenue allocated to the material right is recognized when the additional goods are transferred to the customer or when the option expires. During 2019, the consideration allocated to material rights was not significant.

We receive payments from our customers based on billing schedules established in each contract. Up-front payments and fees are recorded as deferred revenue upon receipt or when due, and may require deferral of revenue recognition to a future period until we perform our obligations under these arrangements. Amounts are recorded as accounts receivable when our right to consideration is unconditional.

Generally, distributor contracts contain Free on Board (FOB) or Ex-Works (EXW) shipping point terms where the customer pays the shipping company directly for all shipping and handling costs. In those contracts in which we pay for the shipping and handling, the associated costs are generally recorded along with the product sale at the time of shipment in cost of product revenue when control over the products has transferred to the customer. We do not collect sales tax on product sales as it is not applicable. Value-add and other taxes collected by us concurrently with revenue-producing activities are excluded from revenue. Our general product warranty does not extend beyond an assurance that the product or services delivered will be consistent with stated contractual specifications, which does not create a separate performance obligation. We recognize the incremental costs of obtaining contracts as an expense when incurred as the amortization period of the assets that we otherwise would have recognized is one year or less in accordance with the practical expedient in paragraph ASC 340-40-25-4. These costs are included in selling, general & administrative expenses.

Included as a component of product revenue is sales-based royalty revenue, which represents the utilization of our intellectual property licensed by our commercial partners. We record royalty revenues based on estimated net sales of licensed products as reported to us by our commercial partners. Differences between actual and estimated royalty revenues have not been material and are typically adjusted in the following quarter when the actual amounts are known. Under our distribution model, we sell to a diversified base of customers and, therefore, believes there is no material concentration of credit risk.

Inventories

Inventories are primarily stated at the lower of standard cost and net realizable value, with approximate cost determined using the first-in, first-out method. Work-in-process and finished goods inventories include materials, labor, and manufacturing overhead. Inventory costs associated with product candidates that have not yet received regulatory approval are capitalized if we believe there is probable future commercial use and future economic benefit.

Our policy is to write-down inventory when conditions exist that suggest inventory may be in excess of anticipated demand or is obsolete based upon assumptions about future demand for our products and market conditions. We regularly evaluate the ability to realize the value of inventory based on a combination of factors including, but not limited to, historical usage rates, forecasted sales or usage, product end of life dates, and estimated current or future market values. Purchasing requirements and alternative usage avenues are explored within these processes to mitigate inventory exposure.

When recorded, inventory write-downs are intended to reduce the carrying value of inventory to its net realizable value. If actual demand for our products deteriorates, or if market conditions are less favorable than those projected, additional inventory write-downs may be required. Other long-term assets include inventory expected to remain on hand beyond one year.

Goodwill and Acquired In-Process Research and Development

Goodwill is the amount by which the purchase price of acquired net assets in a business combination exceeded the fair values of net identifiable assets on the date of acquisition. Acquired In-Process Research and Development (“IPR&D”) represents the fair value assigned to research and development assets that we acquire that have not been completed at the date of acquisition or are pending regulatory approval in certain jurisdictions. The value assigned to the acquired IPR&D is determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting revenue from the projects, and discounting the net cash flows to present value.

Goodwill and IPR&D are evaluated for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Factors we consider important, on an overall company basis, that could trigger an impairment review include significant underperformance relative to historical or projected future operating results, significant changes in our use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period, or a reduction of our market capitalization relative to net book value.

To conduct impairment tests of goodwill, the fair value of the reporting unit is compared to its carrying value. If the reporting unit’s carrying value exceeds its fair value, we record an impairment loss to the extent that the carrying value of goodwill exceeds its implied fair value. Our annual assessment for impairment of goodwill as of November 30, 2019 indicated that the fair value of our reporting unit exceeded the carrying value of the reporting unit.

To conduct impairment tests of IPR&D, the fair value of the IPR&D project is compared to its carrying value. If the carrying value exceeds its fair value, we record an impairment loss to the extent that the carrying value of the IPR&D project exceeds its fair value. We estimate the fair value for IPR&D projects using discounted cash flow valuation models, which require the use of significant estimates and assumptions, including, but not limited to, estimating the timing of and expected costs to complete the in-process projects, projecting regulatory approvals, estimating future cash flows from product sales resulting from completed projects and in-process projects, and developing appropriate discount rates. Our annual assessment for impairment of IPR&D indicated that the fair value of our other IPR&D assets as of November 30, 2019 exceeded their respective carrying values.

Through December 31, 2019, there have not been any events or changes in circumstances that indicate that the carrying value of goodwill or acquired intangible assets may not be recoverable. We continue to monitor and evaluate the financial performance of our business, including the impact of general economic conditions, to assess the potential for the fair value of the reporting unit to decline below its book value. There can be no assurance that, at the time future impairment tests are completed, a material impairment charge will not be recorded.

Stock-Based Compensation

We measure the compensation cost of award recipients’ services received in exchange for an award of equity instruments based on the grant-date fair value of the underlying award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award. For performance-based options with financial and business milestone achievement targets, we recognize expense using the graded vesting methodology over the service period. For performance restricted stock units with financial and business milestone achievement targets, we recognize expense based on the grant-date price of our shares with corresponding compensation cost recognized over the requisite service period. For all performance-based equity awards, compensation cost is based on the probable outcome of the performance conditions. Changes to the probability assessment and the estimated shares expected to vest will result in adjustments to the related stock-based compensation expense that will be recorded in the period of the change. If the performance targets are not achieved, no compensation cost is recognized, and any previously recognized compensation cost is reversed. See Note 13, Equity Incentive Plan, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a description of the types of stock-based awards granted, the compensation expense related to such awards, and detail of equity-based awards outstanding. See Note 16, Income Taxes, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for details related to the tax benefit recognized in the consolidated statement of operations for stock-based compensation.

Results of Operations

Year ended December 31, 2019 compared to year ended December 31, 2018

Statement of Operations Detail

Total revenue

Total revenue for the year ended December 31, 2019 increased by $9.1 million, as compared to the prior year, to $114.6 million. This increase was primarily due to increase in global viscosupplement revenue and the recovery from the 2018 voluntary recall of certain production lots of certain of our HYAFF-based products previously-described.

Product revenue

Product revenue for the year ended December 31, 2019 was $114.5 million, an increase of $9.0 million, or 9%, compared to prior year. This increase was primarily due to increase in global viscosupplement revenue and the recovery from the 2018 voluntary recall of certain production lots of certain of our HYAFF-based products previously-described. The following table presents comparative product revenue analysis by product franchise:

Joint Pain Management Therapy

Our Joint Pain Management Therapy category consists of our injectable viscosupplement products. Overall, revenue from our Joint Pain Management Therapy franchise increased by $6.7 million in 2019 as compared to 2018 is primarily driven by increased revenue from MONOVISC domestically and internationally, as well as increased revenue from CINGAL in international markets. We expect the Joint Pain Management Therapy product revenue in 2020 to increase as compared to 2019, primarily due to domestic MONOVISC and international CINGAL revenue.

Orthopedic Joint Preservation and Restoration Care

Our Orthopedic Joint Preservation and Restoration Care products consist of regenerative products based on our proprietary HYAFF technology which is a solid form of HA; TACTOSET, an HA-enhanced bone repair therapy designed to treat insufficiency fractures; and starting in 2020, a line of surgical implant and instrumentation solutions; and a catalogue of joint surface implants and preservation solutions for shoulder, wrist, hip, ankle, and toe joints. Overall, revenue from our Orthopedic Joint Preservation and Restoration Care franchise increased by $0.9 million in 2019 as compared to 2018 primarily due to recovery from the previously discussed 2018 voluntary product recall and the U.S. commercial launch of TACTOSET, formally launched in the U.S. in December 2019. We expect a significant increase in the Orthopedic Joint Preservation and Restoration Care franchise in 2020, as a result of the acquisitions of Parcus Medical and Arthrosurface along with the increased sales of TACTOSET through our hybrid commercial model.

Other

Our other products include advanced wound care products, based on the HYAFF technology, an aesthetic dermal filler, based on our proprietary chemically modified, cross-linked HA technology, products used in connection with the treatment of ENT disorders, a post-surgical anti-adhesion product, and our ophthalmic and veterinary products. Overall, revenue from our other franchise increased by $1.3 million primarily due to our previously described voluntary recall of certain production lots of our HYAFF-based dermal products. We expect our other franchise to remain flat in 2020 to be in line with 2019.

Product gross profit and margin

Product gross profit for the year ended December 31, 2019 was $85.8 million, or 75% of product revenue, as compared with $74.3 million, or 70% of product revenue, for the year ended December 31, 2018. The increase in product gross margin for the year ended December 31, 2019 was primarily driven by more favorable changes in revenue mix, including an increase in domestic royalty revenue from the viscosupplement business and the recovery from the 2018 voluntary product recall previously described.

Research and development

Research and development expenses for the year ended December 31, 2019 decreased by $1.5 million, or 8%, as compared to the prior year, primarily due to a decrease in clinical trial expenses related to the CINGAL phase III clinical trials partially offset by higher pre-clinical product development activities associated with the development of product candidates in our research and development pipeline, including our rotator cuff therapy.  Research and development expense as a percentage of total revenue was 15% in 2019 compared to 17% in 2018. Research and development expenses are expected to increase in 2020 as we further develop new products and clinical trial activities, including preparation for the CINGAL pilot study, expanded patient enrollment in the HYALOFAST Phase III study, continued product development activities including the rotator cuff repair therapy, and performance of required post-market clinical follow-ups for our MONOVISC and ORTHOVISC-T products in the European Union related to the European Union Medical Device Regulation.

Selling, general and administrative

Selling, general and administrative expenses for the year ended December 31, 2019 increased by $0.6 million, or 2%, as compared to 2018. The increase was primarily due to costs related to the acquisitions of Parcus Medical and Arthrosurface, which totaled $2.9 million in 2019, the U.S. hybrid commercial model, and the launch of TACTOSET, as well as increased personnel-related costs and external professional fees. We expect selling, general and administrative expenses for 2020 to increase from 2019 as a result of the continued TACTOSET U.S. commercialization and the expanded commercial infrastructure through the acquisitions of Arthrosurface and Parcus Medical.

Income taxes

Provisions for income taxes were $8.9 million and $4.5 million for the years ended December 31, 2019 and 2018, respectively. The increase in the effective tax rate in 2019 of 5.4%, as compared to 2018, is primarily due to a windfall tax benefit in 2018 related to exercises of employee equity awards resulting in an income tax benefit of $1.5 million compared to an insignificant amount in 2019. 

As of December 31, 2019, we had gross net operating loss (“NOL”) carry-forwards for income tax purposes in Italy of $7.5 million with no expiration date. In connection with the preparation of the financial statements, we performed an analysis to ascertain if it was more likely than not that we would be able to utilize, in future periods, the net deferred tax assets associated with our NOL carry-forward. We have concluded that the positive evidence outweighs the negative evidence and, thus, that the deferred tax assets are realizable on a “more likely than not” basis. As such, we have not recorded a valuation allowance at December 31, 2019 or 2018.

In the normal course of business, Anika and its subsidiaries may be periodically examined by various taxing authorities. We file income tax returns in the U.S. federal jurisdiction, in certain U.S. states, and in Italy. The associated tax filings remain subject to examination by applicable tax authorities for a certain length of time following the tax year to which those filings relate. The 2016 through 2018 tax years remain subject to examination by the IRS and other taxing authorities for U.S. federal and state tax purposes. The 2013 through 2018 tax years remain subject to examination by the appropriate governmental authorities for Italy.

Net income

For the year ended December 31, 2019, net income was $27.2 million, or $1.89 per diluted share, compared to $18.7 million, or $1.27 per diluted share, for the same period in the prior year. The increase in net income and diluted earnings per share was primarily a result of increased total revenue, increased product gross profit and a decrease in one-time expenses associated with the retirement of a former CEO and the 2018 voluntary product recall previously-described.

Non-GAAP Financial Measures

Adjusted EBITDA

We present information below with respect to adjusted EBITDA, which we define as our net income excluding interest and other income, net, income tax benefit (expense), depreciation and amortization, stock-based compensation and acquisition related expenses. This financial measure is not based on any standardized methodology prescribed by accounting principles generally accepted in the United States (“GAAP”) and are not necessarily comparable to similarly titled measures presented by other companies.

We have presented adjusted EBITDA because it is a key measure used by our management and Board of Directors to understand and evaluate our operating performance and to develop operational goals for managing our business. We believe this financial measure helps identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular, we believe that the exclusion of the expenses eliminated in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core operating performance. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational decision-making.

Adjusted EBITDA is not prepared in accordance with GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared in accordance with GAAP. There are a number of limitations related to the use of adjusted EBITDA rather than net income (loss), which is the nearest GAAP equivalent. Some of these limitations are:

The following is a reconciliation of net income to adjusted EBITDA for the years ended December 31, 2019 and 2018, respectively:

Adjusted EBITDA in the year ended December 31, 2019 increased $10.5 million as compared with the comparable period in 2018. The increase in adjusted EBITDA for the periods was primarily due to an increase in total revenue, product gross profit and operating income as a result of a more favorable revenue mix. In addition, the product gross margin for the year ended December 31, 2018 was also adversely impacted by the previously-described voluntary product recall.

Adjusted Net Income and Adjusted EPS

We present information below with respect to adjusted net income and adjusted diluted earnings per share (“adjusted EPS”), which we define as our net income excluding acquisition related expenses on a tax effected basis. Acquisition related expenses are those that the Company would not have incurred except as a direct result of acquisition transactions. Acquisition related expenses consist of investment banking, legal, accounting, and other professional and related expenses and the impact of purchase accounting, including inventory step-up, associated with acquisition transactions. In the context of adjusted net income, acquisition related expenses include inventory step up and the amortization of intangible assets recorded as part of purchase accounting for acquisition transactions. The amortized assets contribute to revenue generation, and the amortization of such assets will recur in future periods until such assets are fully amortized. These assets include the estimated fair value of certain identified assets acquired in acquisitions in 2020 and beyond, including in-process research and development, developed technology, customer relationships and acquired tradenames. Adjusted EPS is defined by the Company as GAAP EPS excluding acquisition related costs on a tax-adjusted per share basis. This financial measure is not based on any standardized methodology prescribed by GAAP and is not necessarily comparable to similarly titled measures presented by other companies.

We have presented adjusted net income and adjusted EPS because they are key measures used by our management and board of directors to understand and evaluate our operating performance and to develop operational goals for managing our business. We believe these financial measures help identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular, we believe that the exclusion of the expenses eliminated in calculating adjusted net income and adjusted EPS can provide useful measures for period-to-period comparisons of our core operating performance. Accordingly, we believe that adjusted net income and adjusted EPS provide useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational decision-making.

The following is a reconciliation of adjusted net income to net income for the years ended December 31, 2019 and 2018, respectively:

The following is a reconciliation of adjusted diluted EPS to diluted EPS for the years ended December 31, 2019 and 2018, respectively (in thousands, expect per share data):

Adjusted net income and adjusted diluted EPS in the year ended December 31, 2019 increased $10.7 million and $0.78 as compared with the comparable period in 2018. The increase for the period was primarily due to an increase in total revenue, product gross profit and operating income as a result of a more favorable revenue mix. In addition, the product gross margin for the year ended December 31, 2018 was also adversely impacted by the previously-described voluntary product recall.

Year ended December 31, 2018 compared to year ended December 31, 2017

Statement of Operations Detail    

Total revenue

Total revenue for the year ended December 31, 2018 decreased by $7.9 million, as compared to the prior year, to $105.6 million. This decrease was primarily due to the achievement of a one-time $5.0 million milestone in 2017 for reaching a target MONOVISC U.S. end-user sales threshold set forth in the Mitek MONOVISC Agreement and the absence of an equivalent milestone payment in 2018, as well as the impact of pricing declines in the U.S. viscosupplement market and the previously-described voluntary recall of certain production lots of certain of our HYAFF-based products.

Product revenue

Product revenue for the year ended December 31, 2018 was $105.6 million, a decrease of $2.3 million, or 2.0%, compared to prior year. A moderate decrease in our dermal and orthobiologics product revenue was partially offset by a product revenue increase in our surgical and other franchises. The following table presents comparative product revenue analysis by product franchise:

Orthobiologics

Our orthobiologics franchise consists of our joint health and orthopedic products. Overall, revenue from our orthobiologics franchises decreased by $0.3 million in 2018 as compared to 2017 primarily as a result of the voluntary recall of certain production lots of our HYAFF-based products and a decline in worldwide ORTHOVISC revenue offset in part by strong growth in domestic MONOVISC and international CINGAL revenue.

Dermal

Our dermal franchise consists of advanced wound care products, which are based on our HYAFF technology, and aesthetic dermal fillers. Our advanced wound care products treat complex skin wounds ranging from burns to diabetic ulcers, with HYALOMATRIX and HYALOFILL as the lead products. Dermal revenue had a significant decline in 2018 as compared to 2017 due to the previously-described voluntary recall of certain production lots of our HYAFF-based products. We resolved the matter and resumed shipment of these products in November 2018.

Surgical

Our surgical franchise consists primarily of our anti-adhesion products, HYALOBARRIER and our ENT offerings, of which MEROGEL is the leading product. We are partnered with Medtronic for the worldwide distribution of our ENT products. Revenue from our surgical products increased $0.3 million, or 5%, in 2018 as compared to 2017. The increase of surgical product revenue was primarily due to an increase in sales of our ENT products. 

Other

Other product revenue was derived from sales of our ophthalmic and veterinary products. Other product revenue increased modestly in 2018 as compared to 2017 primarily as a result of increased sales of ophthalmic products.

Licensing, milestone and contract revenue

Licensing, milestone and contract revenue for the year ended December 31, 2018 was insignificant, compared to $5.6 million for 2017. This decrease was primarily due to the achievement of a one-time $5.0 million milestone in 2017 for reaching a target MONOVISC U.S. end-user sales threshold set forth in the Mitek MONOVISC Agreement and the absence of an equivalent milestone payment in 2018.

Product gross profit and margin

Product gross profit for the year ended December 31, 2018 was $74.3 million, or 70% of product revenue, as compared with $80.4 million, or 75% of product revenue, for the year ended December 31, 2017. The decrease in product gross margin for the twelve-month period ended December 31, 2018 was primarily caused by an increase in inventory reserves related to certain raw materials, inventory write-offs and charges associated with the previously described voluntary-recall of certain production lots of our HYAFF-based products, higher production costs, and revenue mix and pricing dynamics.

Research and development

Research and development expenses for the year ended December 31, 2018 decreased by $0.6 million, or 3%, as compared to the prior year, mainly due to a decrease in expenses for our HYALOFAST and CINGAL phase III clinical trials, partially offset by increases in our product development activities, including those related to the development of a product for rotator cuff therapy and pre-commercial development of TACTOSET. Research and development expense as a percentage of total revenue was 17% in 2018 and 2017.

Selling, general and administrative

Selling, general and administrative expenses for the year ended December 31, 2018 increased by $12.8 million, or 59%, as compared to 2017. The increase was primarily due to non-cash stock-based compensation expense related to the retirement of our former Chief Executive Officer, Charles H. Sherwood, Ph.D., non-recurring CINGAL U.S. pre-launch market research activities, and increased personnel and external professional fees.

Income taxes

Provisions for income taxes were $4.5 million and $14.4 million for the years ended December 31, 2018 and 2017, respectively. The decrease in the effective tax rate in 2018 of 11.8%, as compared to 2017, is primarily due to the reduction of the corporate tax rate as a result of the Tax Cuts and Jobs Act of 2017 (“Tax Act”) tax reform legislation. This legislation makes significant changes to the U.S. tax law, including a reduction in the corporate tax rate from 35% to 21% starting in 2018. In addition, the Company realized a windfall tax benefit in 2018 related to exercises of employee equity awards resulting in a discrete period income tax benefit of $1.5 million compared to $0.4 million in 2017.

As of December 31, 2018, we had gross net operating losses (“NOL”) for income tax purposes in Italy of $5.8 million with no expiration date. In connection with the preparation of the financial statements, we performed an analysis to ascertain if it was more likely than not that we would be able to utilize, in future periods, the net deferred tax assets associated with our NOL carry-forward. We have concluded that the positive evidence outweighs the negative evidence and, thus, that the deferred tax assets are realizable on a “more likely than not” basis. As such, we have not recorded a valuation allowance at December 31, 2018 or 2017.

Net income

For the year ended December 31, 2018, net income was $18.7 million, or $1.27 per diluted share, compared to $31.8 million, or $2.11 per diluted share, for the same period in the prior year. The decrease in net income and diluted earnings per share was primarily a result of decreased total revenue, decreased product gross margin, the impact of the previously-described voluntary recall of certain production lots of certain of our HYAFF-based products, and one-time expenses associated with the retirement of a former CEO, Charles H. Sherwood, Ph.D., and the 2018 voluntary product recall previously-described. The decreased revenue and increased expenses are offset by a decreased effective federal income tax rate as a result of the 2017 Income Tax Reform Legislation.

Concentration of Risk

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 year ended December 31, 2019, five customers accounted for 82% of product revenue, with Mitek alone accounting for 71% of product revenue. We expect to continue to be dependent on a small number of large customers, especially Mitek, for the majority of our revenues for the foreseeable future. The failure of these customers to purchase our products in the amounts they historically have or in amounts that we expect would seriously harm our business.

In addition, if present and future customers terminate their purchasing arrangements with us, significantly reduce or delay their orders, or seek to renegotiate their agreements on terms less favorable to us, our business, financial condition, and results of operations will be adversely affected. If we accept terms less favorable than the terms of the current agreements, such renegotiations may have a material adverse effect on our business, financial condition, and/or results of operations. Furthermore, in any future negotiations we may be subject to the perceived or actual leverage that these customers may have given their relative size and importance to us. Any termination, change, reduction, or delay in orders could seriously harm our business, financial condition, and results of operations. Accordingly, unless and until we diversify and expand our customer base, our future success will significantly depend upon the timing and size of future purchases by our largest customers and the financial and operational success of these customers. The loss of any one of our major customers or the delay of significant orders from such customers, even if only temporary, could reduce or delay our recognition of revenues, harm our reputation in the industry, and reduce our ability to accurately predict cash flow, and, as a consequence, it could seriously harm our business, financial condition, and results of operations.

See Note 12, Revenue by Product Group, by Significant Customer and by Geographic Location; Geographic Information, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for information regarding significant customers.

Liquidity and Capital Resources

We require cash to fund our operating expenses and to make capital expenditures. Historically we have generated positive cash flow from operations, which, together with our available cash, investments, and debt, have met our cash requirements. Cash, cash equivalents, and investments totaled $184.9 million and $159.0 million, and working capital totaled $218.0 million and $191.7 million, at December 31, 2019 and December 31, 2018, respectively. As of December 31, 2019, we have $50.0 million of available credit under our senior revolving credit facility with Bank of America, N.A., and we were in compliance with the terms of said credit agreement. We believe that we have adequate financial resources to support our business for at least the next twelve months.

Cash provided by operating activities was $37.0 million, $34.9 million, and $40.8 million for 2019, 2018, and 2017, respectively. The increase was primarily related to an increase in accrued expenses offset by a decrease in collections of our accounts receivable due to timing of receipts and an increase in payments for income taxes.

Cash provided by (used in) investing activities was $39.7 million, ($50.3) million, and ($12.5) million for 2019, 2018, and 2017, respectively. The change was due to increased maturities in investments and lower capital expenditures as compared to the same period in 2018 and 2017.

Cash provided by (used in) financing activities was ($8.1) million, ($28.9) million, and $0.3 million for 2019, 2018, and 2017, respectively. For the years ended December 31, 2019 and 2018 we executed $30.0 million accelerated share repurchase programs each year. The decrease in cash used in financing activities for the year ended December 31, 2019, was primarily the result of an increase in proceeds from the exercise of employee equity awards as compared to the corresponding period in 2018 and 2017, respectively.

Contractual Obligations and Other Commercial Commitments

The table below summarizes our non-cancelable operating leases, purchase commitments, and contractual obligations related to future periods which are not reflected in our consolidated balance sheet at December 31, 2019. Purchase commitments relate primarily to non-cancellable inventory commitments and capital expenditures entered in the normal course of business:

Accounting for Off-Balance Sheet Arrangements

We do not use special purpose entities or other off-balance sheet financing techniques, except for operating leases as disclosed in the contractual obligations table above, that we believe have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, or capital resources.

 Recent Accounting Pronouncements

A discussion of recent accounting pronouncements is included in Note 2 to the consolidated financial statements in this Annual Report on Form 10-K.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Primary Market Risk Exposures

We manage our investment portfolio in accordance with our investment policy. The primary objectives of our investment policy are to preserve principal, maintain a high degree of liquidity to meet operating and other needs, and obtain competitive returns subject to prevailing market conditions without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and investments in a variety of high quality securities, including money market funds and U.S. treasury bills. The investments are classified as available-for-sale and consequently are recorded at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss). Our portfolio of cash equivalents and investments is subject to interest rate fluctuations, changes in credit quality of the issuer, and other factors.

Foreign Exchange Risk

Our primary market risk exposures are in the area of currency exchange rate risk. A significant portion of Anika S.r.l.’s revenue and operating expenses are denominated in Euros. We are utilizing clinical vendors which are located in various countries outside of the United States and invoice us in their local currency. We do not engage in foreign currency hedging arrangements for our accounts payable, and, consequently, foreign currency fluctuations may adversely affect our earnings. In addition, we have one major supplier contract denominated in a foreign currency. Gains and losses arising from transactions denominated in foreign currencies are primarily related to intercompany accounts that have been determined to be temporary in nature and cash, accounts payable, and accounts receivable denominated in non-functional currencies. Unfavorable fluctuations in exchange rates would have a negative impact on our financial statements. The impact of currency exchange rate fluctuations for the contract on our financial statements were insignificant in 2019. In the future, we may undertake to manage foreign currency risk through additional hedging methods. We recognize foreign currency gains or losses arising from our operations in the period incurred.  

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ANIKA THERAPEUTICS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Anika Therapeutics, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Anika Therapeutics, Inc. and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive income, cash flows, and stockholders’ equity for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with the accounting principles generally accepted in the United States of America (GAAP).

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 5, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.

Change in Accounting Principle

As discussed in Note 2 to the financial statements, the Company has changed its method of accounting for leases in fiscal year 2019 due to the adoption of Accounting Standards Update No. 2016-02, Leases (ASC 842), using the modified retrospective approach.

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Deloitte & Touche LLP

Boston, Massachusetts
March 5, 2020

We have served as the Company's auditor since 2017.

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Balance Sheets

(in thousands, except per share data)

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

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Statements of Operations and Comprehensive Income

(in thousands, except per share data)

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

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity

(in thousands)

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

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands)

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

Anika Therapeutics, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(amounts in thousands, except share and per share amounts or as otherwise noted)