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Anika Therapeutics Inc. (NASDAQ:ANIK)

Q2 2011 Earnings Call

August 5, 2011 9:00 am ET

Executives

Kevin W. Quinlan – Chief Financial Officer

Charles H. Sherwood, Ph.D. – President and Chief Executive Officer

Analysts

Jim Gentrup – Discovery Investment Research

James Liberman – Wells Fargo Advisors

Lawrence Anderson – Raymond James

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Anika Therapeutics Investor Conference Call. My name is Modeska, and I’ll be your coordinator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference call.

I will now turn the call over to Mr. Kevin Quinlan, Anika’s Chief Financial Officer. Please proceed Mr. Quinlan.

Kevin W. Quinlan

Thank you, Modeska, and good morning, everyone. If you have not received a copy of the Anika news release, which was issued after the market closed yesterday or would like to be added to our contact list, please contact Sharon Merrill Associates at 617-542-5300. The news release is also posted in the Investor Relations section of Anika Therapeutics’ website at anikatherapeutics.com.

Also, I want to mention that we have slides posted on the Anika website that illustrates some of the points we’ll be covering during today’s call. These slides can be found on the Investor Relations section of the website, under the Events, Webcasts & Presentations tab. We invite you to take a moment to open the file and follow the presentation along with us.

Please turn to slide number two. Before we begin, please remember that the statements made in this call, which are not statements of historical fact, are forward-looking statements as defined in the Securities Exchange Act of 1934. Words such as will, believe, appear, plan, expect, anticipate, forward, seek, continue, target, goals, objectives, on track, intend, pursue, outlook, as well as other expressions, which are predictions or indications of future events or trends and which do not constitute historical matters, identify forward-looking statements.

These statements are based on the current beliefs and expectations of management and are subject to significant risks and uncertainties. The company’s actual results could differ materially from any anticipated future results, performance or achievements described in the forward-looking statements, as a result of a number of factors, which include those set forth in last evening’s press release and the company’s SEC filings.

Please turn to slide number three, as I turn the call over to Anika’s President and Chief Executive Officer, Dr. Charles Sherwood.

Charles H. Sherwood

Thank you, Kevin. Good morning, everyone, and thanks for joining us today. Anika made good progress in this second quarter and the first half of 2011 both operationally and financially. It was another strong quarter for our Orthobiologics franchise highlighted by continued growth in domestic demand for Orthovisc. In addition, we had productive discussions with the FDA in April regarding our PMA application for Monovisc although we are disappointed that we are still waiting for their response.

Q2 was a successful quarter for Anika S.r.l., which cut its net loss in half compared to last year’s second quarter.

Our new U.S. distribution partner Misonix, placed its first order for our Hyalomatrix. We also received Korean FDA approval for both of our Hyalobarrier products, Gel and Gel Endo, and made our first shipments of these products to our partner Korean Green Cross.

And lastly, we acquired and installed an additional syringe product filler suitable for aseptic products in Bedford. We are in the process of validating this equipment, but the significance here is that we have now uncoupled the Bedford manufacturing approval from first moving out of Woburn.

We will be prepared for a final FDA inspection for Bedford aseptic manufacturing in early Q4 and expect to have final approval in the first quarter of 2012. We have recently received approval for Bedford to manufacture aseptic products for sale in the EU, and we will begin full-scale EU market supply from Bedford in Q4. To recap, our Bedford facility is now fully approved under EU regulations to manufacture all of Anika’s products.

The equipment problem we reported in the first quarter that delayed shipment of approximately $1.4 million of orthobiologic and abdominal products from Q1 into Q2 is now successfully behind us. Although, we continue to carry some Orthovisc back orders, related to our customer safety stock buildup into the third quarter. We don’t believe that our distributor’s end user sales have been significantly impacted by this situation. Our financial results for the second quarter reflect the impact of these shifts in timing.

Combining these pluses and minuses, our product revenue for the second quarter grew 12% year-over-year and total revenue was up 11%. Our operating and net income improved significantly from Q2 last year and earnings more than doubled to $0.17 per share.

I'll review our product franchises included in the presentation after Kevin's financial review, and with that I'll turn the call back over to you Kevin.

Kevin W. Quinlan

Thanks, Chuck. Please turn to slide number four in the presentation.

Anika’s total revenue for the second quarter of 2011 increased 11% from the second quarter of last year to $16.1 million. As Chuck said, product revenue for the second quarter was up 12% year-over-year. This growth mainly reflected another strong quarter for our Joint Health, Orthobiologics franchise. In our Ophthalmic franchise, revenue declined year-over-year, but to a lesser extent than we initially expected due to the extension of our contract with Bausch & Lomb.

Product revenue in our Dermal franchise was down year-over-year due primarily to weakness and the tie in sales of the advanced wound care products, notwithstanding our first shipment of Hyalomatrix to our U.S. distributor Misonix.

It was another good quarter for our Surgical franchise were growth in product revenue continues to be driven by products from Anika S.r.l. including the initial approval and shipments of Hyalobarrier Gel and Gel Endo to our Korean distributor as Chuck mentioned.

Turning to slide 5, total Orthobiologics franchise revenue grew 27% from the second quarter of 2010 to $9.8 million. We are continuing to see strong growth in deomestic sales of Orthovisc which are up 36% year-over-year for the quarter and 28% year-to-date. International Monovisc product revenue also contributed to the growth this quarter increasing 29% over last year’s second quarter.

Breaking it down by geography, Orthobiologics sales in the U.S. domestic market grew 36% while international Orthobiologics sales, including Anika S.r.l., grew 6%. Again primarily due to the Orthovisc back order situation.

Slide number 6, summarizes our income statement for the second quarter. Product gross margin at 57% was flat with the second quarter last year. This is a significant improvement from the 49% gross margin we reported for the sequential first quarter which reflected the last batch of in process Orthovisc product. We made some progress catching up on back orders in the second quarter and we will be fully caught up by the end of the year.

Operating income for the second quarter of 2011 was $3.7 million compared with $1.8 million in the second quarter of 2010. Net income grew to $2.3 million or $0.17 per diluted share from $1.1 million or $0.08 per diluted share in the second quarter last year.

As Chuck mentioned, Anika S.r.l. losses were significant lower in the second quarter and we are making good progress on our goal to achieve breakeven in that business during the second half of the year and most likely in the fourth quarter.

Our tax rate for the second quarter of 2011 declined to 37.2% from 38.9% in the second quarter last year, primarily as a result of the impact of S.r.l’s lower losses on our global tax rate.

Turning to slide number seven, research and development expense was down 14% to $1.6 million in Q2, primarily due to lower clinical spending compared to last year's second quarter in our ongoing operational streamlining initiatives. In line with some upcoming clinical and pipeline development activities that Chuck will discuss in a moment, we expect R&D spending to increase modestly in future quarters.

As shown on slide number eight, selling, general and administrative expenses for the second quarter of 2011 were $4.2 million, down 15% from the second quarter last year. The lower SG&A reflected the impact of companywide operational efficiency improvements and integration activities we completed last year subsequent to the acquisition of Anika S.r.l., and our insourcing of accounting and purchasing services that were previously provided by Fidia, S.r.l’s former parent company.

Looking forward, we expect SG&A cost to increase as we prepare to launch Monovisc in the U.S., and incur defense costs related to the Genzyme patent infringement plans.

Turning to slide number nine in our balance sheet highlights, Anika closed the second quarter of 2011 with $26.8 million in cash and equivalents, compared with $28.2 million on December 31, 2010. The decrease in cash was mainly as a result of an increase in net working capital requirements driven primarily by a combination of higher June sales and required vendor payments.

All in all, Anika performed well from a financial perspective in the second quarter of 2011 and we’re looking forward to a successful second half. And with that, I will turn the call back to Chuck.

Charles H. Sherwood

Thanks, Kevin. The topics I'll be covering in this business review are summarized on slide number 10. In our largest franchise, Orthobiologics, Anika’s flagship Orthovisc product is continuing to sell very well. Second quarter product revenue from sales of Orthovisc in the United States was up 36% year-over-year. This growth demonstrates the commitment of our distribution partner Mitek to the product and the success they are seeing in reaching out to physicians across the country who prefer our multiple-injection regime for treating osteoarthritis of the knee. This growth rate demonstrates to all of us that Orthovisc is continuing to gain share in the U.S. market.

We are also working with Mitek to address Latin and South American markets for Orthovisc. To date, we had received approvals in five countries with five additional approvals pending. Sales ramp up is taking some time, but we expect to see accelerated revenue growth once the additional approvals are granted.

International sales of Orthovisc were down 22% from the second quarter of 2010. This was mainly due to the back order situation and as I mentioned earlier, we put that issue behind us and expect to eliminate our back orders well before the end of this year.

Meanwhile, underlying demand for Orthovisc is continuing to grow overseas and we’re strengthening our international distribution network. Nycomed our new distributor in Turkey completed their transition from Biomeks for both our joint health products. And we had initial Orthovisc sales to our distributions in Singapore and Malaysia where we recently received regulatory approvals.

Q2 was another strong quarter for international sale of Monovisc, which were up 29% year-over-year again driven primarily by growing product demand in Germany, the Czech Republic and Turkey. We continue to make good progress expanding our Monovisc distribution channel in Europe and other international markets, adding distributorships in the Ukraine, Bulgaria, and United Arab Emirates during the quarter. We have several attractive opportunities that we are working on for Monovisc in the Asian markets and hope to report some positive developments next quarter.

Turning now to the third bullet on slide number 10, I’ll give you a brief update on the domestic approval for Monovisc. As we reported last quarter, we had what we believe to be a productive meeting with the FDA in late April with the next step being the FDA reaching a decision on our PMA application. Because the safety profile of Monovisc is well established, our discussions with the FDA has centered on efficacy, which we believe has thoroughly been demonstrated at this point.

Although there has been no decision as yet on the approval of product or the need for an advisory panel meeting, based on the clinical data and all of our discussions with consultants in the FDA, we continue to believe that Monovisc should eventually be approved, but the timing is not yet clear.

Now I’ll mention three other points regarding our Orthobiologics franchise. The first is that Mitek has successfully completed the clinical trial of a single injection product for treating osteoarthritis of the shoulder. We are in active discussions about the trial with Mitek and making progress with them in developing our regulatory strategy with the intent of making a PMA amendment submission for this new indication in the fourth quarter.

The second point is the opportunity we see developing for CINGAL, a single-injection viscosupplementation product that combines Monovisc with a therapeutic agent. We believe there is significant sales potential for CINGAL in Europe as an additional single-injection therapy for osteoarthritis, and we’re in the late stages of preparing regulatory submission documents to support approval there.

We believe there is even greater potential in the U.S. market for CINGAL as a therapy for osteoarthritis. We are continuing our dialogue with the FDA and anticipate fully developing our domestic clinical strategy for CINGAL in the current quarter. We’ll keep you updated on our progress in quarters ahead.

The final issue we discuss here is the Genzyme patent infringement lawsuit. As we have previously reported, Genzyme amended this suit in April to add a third patent. Also as previously reported, the first two patents set very near-term expiration dates and represent primarily a nuisance factor which nevertheless must be dealt with.

The recently issued patent has an expiration date past 2020. We are currently completing the development of our strategy to address this served patent. For obvious reasons, I will not discuss the strategy on the call, but will conclude by saying that we intend to fight vigorously and defend the Monovisc franchise.

Let’s now turn to Anika S.r.l., in the fourth bullet on slide number 10. As Kevin discussed, we are seeing the expected benefits of cost synergies, tight control over operating expenses and the rationalization of our combined product lines as we continue to integrate the S.r.l. business into Ankia.

For the first six months of 2011, S.r.l’s operating loss was down 26% from the same period last year and we continue to expect this business to achieve breakeven results most likely in the fourth quarter of 2011.

Revenue growth is an important part of this equation. S.r.l’s top line was essentially flat year-over-year in the second quarter, following 15% growth in Q1. This was largely due to some temporary issues that I'll discuss in a moment.

Looking ahead, we're optimistic about S.r.l’s revenue growth for the second half of the year and I'll discuss the factors we see driving this growth as well. The key challenges faced by S.r.l. this quarter were the advanced wound care and surgical product lines. Sales of advanced wound care products were down significantly due primarily to lower demand and very weak economic performance in Italy.

As we announced in May however, we’ve entered into a new five-year exclusive U.S. distribution agreement with Misonix to distribute and sell Hyalomatrix, one of the three S.r.l. advanced wound care products that have already been approved for sale in the U.S.

Hyalomatrix is an advanced wound dressing indicated for a treatment of wide variety of acute and chronic wounds. Misonix has dedicated U.S. sales and marketing organizations in both the clinical and surgical settings where acute and chronic wounds are treated. Consequently, this is an important new step for us in penetrating to large and growing U.S. markets for advanced wound treatments.

We began manufacturing and supplying finished product to Misonix in the second quarter for their planned third quarter commercial launch and recorded approximately $180,000 in revenue from their initial order. We're looking forward to a significant ramp in orders and revenue in the quarters ahead.

The centerpiece in S.r.l’s surgical franchise is our Hyalobarrier anti-adhesion product line which consists of Hyalobarrier Gel and Hyalobarrier Gel Endo. Driven primarily by sales of the Gel Endo product in Europe, our second quarter surgical product revenue was up 98 from Q2 of 2010. Also contributing to this growth were shipments of both the Gel and Gel Endo products to our new distribution partners in Korea, Korean Green Cross.

Reflecting solid underlying product demand in Europe as well as initial shipments subsequent to the Korean product approvals in Q2 this year, Hyalobarrier sales for the first six months in 2011 have doubled from the same period in 2010.

This was also a strong quarter for sales of S.r.l's orthopedic products which grew more than 60% year-over-year. This growth was largely driven by Hyalofast our newest product for cartilage regeneration as well as sales of Hyaloglide in Europe and Hyalos in the Far East. While we’ve made good progress on our goal to expand international distribution of Hyalograft C, haven’t yet translated to significant increases in product revenue.

Revenue in Italy, historically our largest market, is significantly lower reflecting their difficult economic conditions. Although dealing with the reimbursement issue in multiple jurisdiction has been challenging, for Hyalograft C, we’ve added additional distributorships in European countries outside Italy during the past six months and we are in the process of adding several more.

The next to last bullet on slide number 10, the first, the work we have been doing to transfer all of Anika’s product manufacture from Woburn, Massachusetts to Bedford. As we said last quarter, because of the extension of our contract with Bausch & Lomb, we need to remain in Woburn to manufacture our AMVISC and AMVISC Plus ophthalmic products through the second half of 2011.

The Bausch & Lomb contract extension represents an additional $6 million of product revenue beyond what they had initially requested. This business effectively sustains our ophthalmic sales at a high level providing us with an important incremental revenue stream prior to our Monovisc launch.

In the second quarter, we acquired and installed in Bedford a syringe filler for aseptic products and we are in the process of validating this equipment which should uncouple the Bedford manufacturing approval from the timing of moving out of our Woburn facility.

Meanwhile, we are very pleased with the progress being made by our new distribution partner Visco Technologies in launching and generating awareness in the U.S. for ANIKAVISC, our own ophthalmic product. We are also making progress ourselves in making international commercial plans for ANIKAVISC. After receiving the CE Mark approval in the first quarter, in mid July we received approval to market ANIKAVISC in Canada.

In summary, 2011 is shaping up to be a very successful year for Anika. Domestic sales of Orthovisc remain very strong, International demand for joint health products continues to growth, and we are continuing to strengthen our international distributor network not only for Orthovisc but for Monovisc as well. Despite some temporary headwinds in the first half of 2011, we feel good about the prospect for top line growth at Anika S.r.l. and we continue to expect that business to become breakeven by year’s end.

And finally, we are on track to complete the consolidation of our manufacturing operations in Bedford in the first quarter of 2012.

With that I'll turn the call back over to you Modeska, so that we can take questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) The first question today comes from the line of Jim Gentrup with Discovery Investment Research. Please proceed.

Jim Gentrup – Discovery Investment Research

Good morning.

Kevin W. Quinlan

Good morning, Jim.

Jim Gentrup – Discovery Investment Research

I have several questions for you. Just first of all, it sounds like the equipment failure has actually impacted overall because you had a little bit of catching up to do you and you still have, it sounds like, some backlogs. I wondered if you could – I know you did $26.5 million in the first six months in product revenue. I wondered if you could kind of see what’s been the real number there, if you would have not had that failure would have been $2 million or $3 million more or can you give us a little more color there?

Kevin W. Quinlan

Yes, I can. This is Kevin. It would not have been significantly different, and that the revenue that we lost out of Q1 that came into Q2 was significantly offset by the back order situation. So the quarters would have come out a little bit differently, Q1 would have been a better, Q2 little bit lower. But overall, for the six months, it would have been in that same ballpark.

Jim Gentrup – Discovery Investment Research

So you were able to catch up then maybe in other words.

Kevin W. Quinlan

No, we do have some back orders still on the Orthovisc product because of the lost batch at the end of March.

Charles H. Sherwood

It would have been a little greater then.

Jim Gentrup – Discovery Investment Research

Yeah, so that will give you some lift going into Q3.

Kevin W. Quinlan

Yes.

Jim Gentrup – Discovery Investment Research

All right. So can you give us a little more information on you mentioned Mitek’s efforts, can you just give us a little more color there? I mean, are they competing better because of price, because they put more people on the field, can you give us little more color on that end?

Charles H. Sherwood

I can give you a little more color. First of all, I think many people are coming to the full understanding that Orthovisc is an outstanding product. Second, I think Mitek is not working the price angle at all. And third, I think they are making a fairly substantial investments, but they’re very prudent about the way that they invest in the campaigns that they’ve run. So I think that they’ve gotten a very strong network of opinion leaders behind Orthovisc. So they’ve been, if I could just summarize in maybe two sentences, I think they’ve been very prudent in the way that they have invested their money and they have invested a fair amount in this franchise, and they’re just getting results. They’ve done a few things in distribution and some other things, but I think the main impact is the way that they’ve been successful in adding KOLs and promoting the product in a way that it resonates with the physician community.

Jim Gentrup – Discovery Investment Research

So compared to last year at this time, they’re not doing a whole lot differently?

Charles H. Sherwood

I think they continue to invest and when they find something that works with them they expand it. So in one way it's a little bit of more of the same, but they keep adding new programs in their – I believe they’re standing beyond into other physician specialties and they’re just doing a lot of promotion. So more compared to last year, as the sales ramp they invest more.

Jim Gentrup – Discovery Investment Research

Okay. Now you’ve done, I guess $3.5 million in the ophthalmic revenue during the first half of the year. I know you’re on the $6 million order now, is part of that shift into Q2 or can you just add a little more, what do you expect in the second half?

Kevin W. Quinlan

We expect the second half of the year to be relatively strong on the ophthalmic side, because we have a good portion of that $6 million additional order that we had announced during the last, the previous conference call. A good portion of that will be impacting the second half of the year. So overall, we expect the second half revenue to be good for the ophthalmic area.

Jim Gentrup – Discovery Investment Research

Good, but still down year-over-year in the second half, just looking at the second half of last year to this year?

Kevin W. Quinlan

Yes, and for the year, for the full year, we will be down from 2010 in the ophthalmic, but not significantly down.

Charles H. Sherwood

We’re still developing our own products, the ANIKAVISC Plus and maybe even an additional one. But right now the only partner we have working that angle is Visco Technologies, so that’s an upside, but we’re not factoring that strongly into our numbers right now.

Jim Gentrup – Discovery Investment Research

So, and that leads into our next question, thank you. Should we – I mean, I’m not expecting you to replace the revenue that you get to $7 million, $8 million or a little bit more this year from Bausch & Lomb. But are you, I guess its going out on a little bit but I mean ANIKAVISC Plus for 2012 what should be our expectations there?

Charles H. Sherwood

I think the – this is – now we’re in August here, it’s the second quarter that they are selling the ANIKAVISC product here in the U.S. We’ve got some growth potential outside the U.S. with that. I think it’d be difficult for us to try to give you a number at this point as to what that could translate to, but we think it will be a significant number, and it will be a more profitable number at whatever level it turns out to be, But at this point I can’t give you a forecast for next year for ANIKAVISC.

Kevin W. Quinlan

Yeah, I think, it’s however safe to say though that the ANIKAVISC product released probably next year is not going to be producing the same level of revenue that B&L product revenue stream produced. So in 2012, I’d expect that we would derive less revenue from our ophthalmic franchise than we did this year.

Jim Gentrup – Discovery Investment Research

Yeah, that’s our expectation as well, but we are just trying to get better ideas.

Kevin W. Quinlan

Yeah, while there is still a few moving parts here. And I guess it is our assumption also that we will – from Bausch & Lomb, we will drive minimal or potentially zero revenue, but that’s still in a state of flex as well.

Jim Gentrup – Discovery Investment Research

But it will be whenever you do, if you do, my numbers is, for example, throwing out $3 million or $4 million on your own will be higher margin revenue?

Kevin W. Quinlan

Absolutely.

Jim Gentrup – Discovery Investment Research

And the difference would be, I mean can you fill in the blank there? I mean how much difference are we talking about as far as (inaudible) margins?

Kevin W. Quinlan

Jim, I don’t think that we can merely give you an answer on that at this point. I think it’d be prudent to see how the launch goes on the ANIKAVISC product at this point. We’re just so early on into the launch that we don’t really have a whole lot of data to make some projections from so.

Jim Gentrup – Discovery Investment Research

Yeah. Fair enough. Yeah, it’s a tough question, I realize, but I do appreciate. When you guys get more clarity you can give us a little more help there, just because there is pretty big party revenue going the way although ortho obviously is focus and mono. On the surgical side, surgical is up 48% now in the first half of the year. Can you help us kind on the second half of this year; do you expect that kind of revenue growth? I know it’s coming off a low base, but is there lumpiness there or are you getting pretty strong increase demand in that area for your product?

Charles H. Sherwood

Well, I think part of the driver here has been some additional distributors outside of Italy, in Europe as well as of course the Far East and bringing on the Korean Green Cross. The forecast on the Korean side look encouraging and I think we are looking to see some good continued growth in the surgical area. But as you know, we don’t really, we don’t give guidance and we’re not going to give you revenue growth expectations. But it’s along with the Orthobiologics area, it’s an area that we expect to see some good growth.

Kevin W. Quinlan

Yeah, I think the Hyalobarrier products Gel and Gel Endo have in the markets where we participated so far received some good reviews. There is opportunities now where we’re starting to expand with new territories and new distributors, and a couple of these new distributors are just starting. So I would think the growth of those products and we’re not in the United States, we’re not in South America and we’re in Asia in a very limited way. So I would think that those – that the potential for growth in that product area is very good. However, I really can’t quantitate that. Some of it depends on additional approvals and some of it depends on how fast our partners work to build that market share.

Jim Gentrup – Discovery Investment Research

Now I’ll let somebody jump in.

Operator

(Operator Instructions) Your next question comes from the line of James Liberman with Wells Fargo. Please proceed.

James Liberman – Wells Fargo Advisors

It was a very good quarter and well done, and it’s exciting to see significant progresses taking place in Asia and the continued progress in Europe. You mentioned that there are three S.r.l. products approved in the U.S. and the one that’s currently under market agreement, the Hyalomatrix, can you comment on the two others?

Charles H. Sherwood

They are called Hyalofill and Hyalogran. Hyalomatrix is probably the most sophisticated of the three. There is likely to be interest by Misonix in at least one of the other two products, but at the current juncture they are trying to launch Hyalomatrix, so they’re trying to focus their efforts. But we feel that there is some reasonable potential for those products in the U.S. market. We’re also looking to expand with those same three products into other markets as well, outside the U.S.

Wound cares in area, it’s really growing. And we see that the products that we have are fairly attractive and is performing really well. We also see some opportunities for some additional new products in this area. So I think this will be an area that we focus on in the future in the United States, as I said, probably our efforts at least in the short-term will be focused on working with Misonix and trying to expand our business with them.

James Liberman – Wells Fargo Advisors

Very good. And can you comment further on the progress and expected sort of take off of various products in the South America, say how Monovisc is shaping up there?

Charles H. Sherwood

Actually Monovisc is not there.

James Liberman – Wells Fargo Advisors

It was not there, okay.

Charles H. Sherwood

Only Orthovisc is there.

James Liberman – Wells Fargo Advisors

Okay.

Charles H. Sherwood

So that remains – some untapped potential there vis-à-vis Monovisc. We have had some distribution down there with the would care products, but sales this year have been anemic at best. It is a good and growing market and we’re seriously looking about what we can do to increase sales of our products in that area.

James Liberman – Wells Fargo Advisors

Would Monovisc in South America tie in with approval in the U.S. or is there a separate approval process down there?

Charles H. Sherwood

Separate. I mean it certainly helps if you have a U.S. approval because you can piggyback on that, but you still need to make the applications. And in some places, some countries in South America, it helps, but it’s still a lengthy process in others, it helps and it’s a slam-dunk. The biggest markets typically take as you might imagine, the longest time.

James Liberman – Wells Fargo Advisors

Sure. It sounds like you’re making great progress. There is nothing further that you can comment on the FDA discussions, that’s just something you have to keep under wraps for now, regarding Monovisc?

Charles H. Sherwood

Pretty much, I pretty much did a full disclosure of what’s going on in my prepared remarks. As a CEO I think I’ve been pretty positive in my remarks about the FDA compared to some of the guys that run some of these other medical companies. It’s just difficult, they are going to reorganization there, the timelines are just simply not being met and it’s a situation that unfortunately we have to live it.

James Liberman – Wells Fargo Advisors

I’m very impressed with how you’re managing everything and how you’re positioning the company, great quarter. Thanks, again.

Charles H. Sherwood

Thank you.

Kevin W. Quinlan

Thank you.

Operator

Your next question comes from the line of Neal Gore, a private investor. Please proceed.

Unidentified Analyst

Good morning, and I also agree, very good quarter. On the front page of your website, the home page, in the lower corner, there is something about your acquisition of Fidia. And in there it talks about the three products that you are expecting 510(k) clearance on. We haven’t heard much about them and were well behind schedule, can you tell us what’s going wrong with 510(k)s on these three products?

Charles H. Sherwood

Yeah. There is three as you pointed out. The names are Hyalofast, Hyaloglide, and Hyalonect. The Hyalonect is pretty much used in fracture repair and some other applications in the orthopedic field. We expect a positive reaction from the FDA on our application within the next couple of months.

Hyalofast, is used generally with regard to cartilage generation. So our application was taken from one branch and put over to sever the biologics people. And they are now reviewing that. We believe we submitted a pretty decent file, so we are hoping to get some positive view from them by the end of the year.

The Hyaloglide, we are in a bit of dispute because we believe the applications and the claims that we’ve made support a 510(k) application. The FDA is leaning more towards having us make a PMA submission and as you may or may not know, this whole 510(k) approval process is under significant review now at the FDA. So that one might take a bit longer as we work through the disagreements we have with the FDA.

Unidentified Analyst

So, again referring to the same front page of your website, it said what’s your goal was in -- once you get an updating clearance of these three products and we’re past the date you expected that to happen that you’re going to be building your direct sales force to market Monovisc in the U.S. with these people. With the delay in Monovisc and the delay of these, what steps are you taking if any to build your own sales force?

Charles H. Sherwood

What we talked about before Neal is in the last call we said that we are still evaluating or currently evaluating all of the options for direct commercialization, which will include our own sales force. I misspoke, let me go back. We are currently evaluating all of the options for commercialization of our products. So one of those options would be a direct sales force and another option might be a contract sales force. The third option might be partnering in products. So we still have not pulled the trigger on our final selection of exactly what we are going to do. So we have opportunities in all three of those areas?

Unidentified Analyst

Okay. Thank you very much. And again, a great quarter, keep it up.

Charles H. Sherwood

Thanks.

Kevin W. Quinlan

Thank you, Neal.

Operator

Your next question is a follow-up from the line of Jim Gentrup with Discovery Investment Research. Please proceed.

Jim Gentrup – Discovery Investment Research

Yeah, just some quick follow-ups guys. The account receivable was up quite a bit sequentially, it kind of hurt your cash flow this quarter. Can you give us a little update on the collections there?

Kevin W. Quinlan

Sure. There is no collection issues per say. What took place, if you go back and look at the transcript from the first quarter, you will note that we made a comment that we were going to voluntarily hold up shipments after the equipment issue has been resolved as we went through some additional systems testing. And therefore we had a very significant amount of our revenue with the second quarter generated in the month of June. Therefore the product that we shipped is still within payment terms as of the end of June and the cash collections were down significantly. So it’s just a timing difference in terms of getting paid the cash, but as you pointed out, it does affect the cash flow statement.

Jim Gentrup – Discovery Investment Research

Then what is the normal collection time, is that 45 days or?

Kevin W. Quinlan

Yeah, we’re in that 45 to 50 day sale outstanding kind of metric normally.

Jim Gentrup – Discovery Investment Research

Okay, so nothing doubtful. Nothing, no increase in that area.

Charles H. Sherwood

Nothing going on there that should cause any concern just as I said timing issue on the collections. But we should see some strong collections in the third quarter.

Jim Gentrup – Discovery Investment Research

Your payment on the Monovisc as it relates to the FDA, I just had a quick question, I may have missed it. Are you guys -- the FDA kind of like -- is there a clock tier that they need to get back to you by? I mean are they already over that time limit? I was under the impression that they were supposed to get back to you at the end of deadline, they haven’t get back to you, but…

Charles H. Sherwood

When we met with them and they were going to get back to us within 60 days, it’s been 90.

Jim Gentrup – Discovery Investment Research

Okay, so.

Charles H. Sherwood

That’s just, Jim, that’s just the way things are going these days.

Kevin W. Quinlan

The 60 days was not a legally mandated timeframe, it was their statement as to what they thought would take place.

Charles H. Sherwood

I think there is no real mechanism to make the FDA move more rapidly and still maintain a good courtroom professional business relationship.

Jim Gentrup – Discovery Investment Research

You are certainly not alone, so…

Charles H. Sherwood

I know that.

Jim Gentrup – Discovery Investment Research

You’re not alone there guys. And on the expense side I think, Kevin, you gave us some update there. I just want to confirm real quick, R&D, you expect to pick up a little bit in the second half. Is that where you kind of was?

Kevin W. Quinlan

As we said in future quarters, we’re looking at them and making some decisions about some potential clinical studies. And when new kick-in that’s when we’ll see an uptick. That’s usually the big variable in terms of our R&D spending is whether we’re heavily into a trial or between trials so to speak.

Jim Gentrup – Discovery Investment Research

But as far as, for modeling purposes, you’re not saying like next quarter, you don’t know exactly when it’s going to hit the increases I guess, is my question is?

Kevin W. Quinlan

It’s not going to get in Q3. We will start to see some impact later in the second half.

Jim Gentrup – Discovery Investment Research

Okay. All right. And then, of course on the G&A side, SG&A side, we shouldn’t expect much until you actually get up approval for Monovisc and then we should expect to see some real ramp there?

Kevin W. Quinlan

Yeah, that end also we are managing litigation expenses around the patent infringement suite now. But those will ramp up to some degree as we move forward here third quarter, fourth quarter as we get little more deeper into the whole discovery process.

Jim Gentrup – Discovery Investment Research

And will you break that out for us, if it gets material, so we can kind of see what the pro forma would be without it?

Kevin W. Quinlan

That would be hard to do in the sense of we don’t really want to disclose what we’re spending in terms of legal defense to the opposition.

Charles H. Sherwood

I would say there is some other things going on that, one, we are just finally coming to the end of – or actually we’re maybe a month away from really getting our strategy down there. And the strategy that we plan to take has a fairly significant impact on the expenses that we will incur. So it’s hard to predict right now. Also there is some other factors that I really don’t want to talk about that are going on that might have an impact on the amount of money we spend generally to reduce the amount, but again, I can’t really say anything more about that at this juncture.

Jim Gentrup – Discovery Investment Research

As you guys talk about the Bedford facility and moving in there and getting it all under one roof, and it’s a very impressive facility by the way. I just – looking into next year what should be the biggest impact on your expenses? I mean is the gross margin going to see a noticeable increase? I would imagine you get some improvement there. But can you walk us through a little bit as you go into 2012; shouldn’t we see more profitability for this company?

Charles H. Sherwood

Yes, we would expect, I’d say two factors that will impact the gross margin next year. One, as you said would be the consolidation of the manufacturing and when we leave Woburn and we’ll see a small positive impact on margin as a result of that. And then the second with as Chuck discussed in his remarks the movement manufacturing for the Gel ACP products from S.r.l. into the facility here in Bedford, we expect that there will be a nice margin impact from that as well. So overall we think that we’ll see some margin improvement next year.

Jim Gentrup – Discovery Investment Research

So, that’s in the gross line, gross margin.

Kevin W. Quinlan

Yes, gross margin, correct.

Jim Gentrup – Discovery Investment Research

And so Italy will become more of a just a distribution center.

Kevin W. Quinlan

No, keep in mind that the S.r.l. products are currently manufactured by their former parent company, so transitioning the manufacturing to the U.S. will have no impact on S.r.l’s operations per say.

Jim Gentrup – Discovery Investment Research

Okay.

Charles H. Sherwood

S.r.l. operations, let me be clear so you understand. The operations, it’s really a wholly-owned subsidiary. And they do also – they do manufacturing under the S.r.l. roof for the cell ceded products so that all of those tissue-engineered products are actually made by S.r.l. They contract out to the former parent company for the Gel products, and for some other raw materials for some of the matrices that they use to make the cell ceded products but all of the quality organization or regulatory and all that stuff is still there over in Italy. So instead of contracting out some of the manufacturing to their former parent, they will contract that manufacturing out to us here in Bedford.

Jim Gentrup – Discovery Investment Research

Okay. Thanks very much.

Charles H. Sherwood

But there’s still manufacturing that goes on over in Italy under the S.r.l. roof.

Jim Gentrup – Discovery Investment Research

Okay. Thanks. And then my last question is that would you consider buying back shares at these levels?

Kevin W. Quinlan

At this point in time, we don’t think that that’s a good use of cash for investors.

Jim Gentrup – Discovery Investment Research

All right, fair enough, guys. Thanks for all the color. I appreciate it.

Charles H. Sherwood

You’re welcome.

Kevin W. Quinlan

You’re welcome.

Operator

Your next comes from the line of Lawrence Anderson with Raymond James. Please proceed.

Lawrence Anderson – Raymond James

Good morning, gentlemen.

Charles H. Sherwood

Hi, Larry.

Lawrence Anderson – Raymond James

Good quarter. I appreciate that you’re mentioning the progress of the partnership with DePuy Mitek for Orthovisc (inaudible) shoulder. Any additional color there regarding, is this a single or a multiple injection product, possible timing, size of the market, things of that nature?

Charles H. Sherwood

I can answer only one of those questions Larry. It’s a single-injection product. The trails completed. I don’t believe that the data has been fully, I’m sure of those. Actually the data hasn’t been fully analyzed yet. So I can’t tell you anything about that. And I’m really not in a good position to really cite you the size of the market, but I believe a lot of that will depend on how successfully we’re in trail. But the knee market is of course the biggest market, but the shoulder, I think its really difficult some times to think about what the usage might be in the shoulder because of course there is not much usage in that joint at the current time. So its probably going to be something that Mitek is going to have to develop that application. But they’re ideally suited to do that.

I would also tell you that others have tried to get products approved in that area, but the clinical data hasn’t been very strong and supportive of an approval. So we are certainly hoping that when we actually see the final data that is strong and supports a robust application. But I think it will be the only mark – should we be successful, it will be the only product approved for that particular application and that’s a specialty at Mitek. So I believe they can get some – make some good headway there.

Lawrence Anderson – Raymond James

Great, thank you.

Charles H. Sherwood

You’re welcome.

Operator

Ladies and gentlemen, this does conclude the Q&A portion of the call. I’d now like to turn it back over to Dr. Charles Sherwood for closing remarks.

Charles H. Sherwood

Thank you, Modeska, and thanks to all of you for participating on the call today. I think it’s very nice to get some questions to answer and also some good questions. I think as we go forward, we certainly have a lot of activity that’s going on here and we answered a lot of those questions that you asked today with a commentary that we will have to see how things develop. So it’s a pretty exciting time for us here. We’re very pleased with the quarter. We hope to be able to duplicate the few more quarters this year like that, and we look forward to the next conference call to tell you about our progress. Thanks.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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