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**UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**Form 10-Q**

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

**For the Quarterly Period Ended September 30, 2006**

**Commission File No. 000-19495**

| **Embrex,   Inc.**                                                                       |
|------------------------------------------------------------------------------------------|
|                                                                                          |
| *(Exact name   of registrant as specified in its charter)*                               |
|                                                                                     |   |   |
| **North Carolina**                                                                       |   | **56-1469825** |
|                                                                                          |   |  |
| *(State or   other jurisdiction of   incorporation or organization)*                     |   | *(I.R.S.   Employer   Identification No.)* |
|                                                                                     |   |   |
| **1040 Swabia Court, Durham, NC**                                                        |   | **27703** |
|                                                                                          |   |  |
| *(Address of   principal executive offices)*                                             |   | *(Zip Code)* |
|                                                                                     |   |   |
| **Registrant’s telephone number, including area code:  (919)   941-5185** |

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

| Yes  x | No  o |
|------------------|-----------------|

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one): 

| Large accelerated filer  o | Accelerated Filer  x | Non-accelerated Filer  o |
|--------------------------------------|--------------------------------|------------------------------------|

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

| Yes  o | No  x |
|------------------|-----------------|

The number of shares of Common Stock, $0.01 par value, outstanding as of October 30, 2006 was 8,346,348.

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EMBREX, INC.

INDEX

|                                                               |   |          |                                                                                    | **Page** |
|--------------------------------------------------------------------|--------|---------------|-----------------------------------------------------------------------------------------|----------|
|                                                               |   |          |                                                                                    |          |
| Part I      Financial   Information: |   |
|                                                               |   |          |                                                                                    |
|                                                               |   | Item   1:     | Consolidated Financial Statements (unaudited)                                           |     |
|                                                               |   |          |                                                                                    |
|                                                               |   |          | Consolidated Balance Sheets                                                             | 3 of 46  |
|                                                               |   |          |                                                                                    |     |
|                                                               |   |          | Consolidated Statements of Operations                                                   | 4 of 46  |
|                                                               |   |          |                                                                                    |     |
|                                                               |   |          | Consolidated Statements of Cash Flows                                                   | 5 of 46  |
|                                                               |   |          |                                                                                    |     |
|                                                               |   |          | Notes to Interim Consolidated Financial Statements                                      | 6 of 46  |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   2:     | Management's Discussion and Analysis of Financial Condition   and Results of Operations | 19 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   3:     | Quantitative and Qualitative Disclosures About Market Risk                              | 30 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   4:     | Controls and Procedures                                                                 | 31 of 46 |
|                                                               |   |          |                                                                                    |     |
| Part II    Other Information:                  |   |
|                                                               |   |          |
|                                                               |   | Item   1:     | Legal Proceedings                                                                       | 32 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   1A:    | Risk Factors                                                                            | 33 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   2:     | Unregistered Sales of Equity Securities and Use of Proceeds                             | 44 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   3:     | Defaults Upon Senior Securities                                                         | 44 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   4:     | Submission of Matters to a Vote of Security Holders                                     | 44 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   5:     | Other Information                                                                       | 44 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Item   6:     | Exhibits                                                                                | 44 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Signatures    |                                                                                    | 45 of 46 |
|                                                               |   |          |                                                                                    |     |
|                                                               |   | Exhibit Index | 46 of 46                                                                                |

2

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PART I - FINANCIAL INFORMATION

Item 1.     Consolidated Financial Statements

Embrex, Inc.

**Consolidated Balance Sheets (In thousands, except share and per share amounts) (*Unaudited)**

|                                                                                                                                                                                                                     |   | **September   30,   2006*** |    | **December   31,   2005** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|---------------------------|--------|
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **ASSETS**                                                                                                                                                                                                               |   |                        |    |                      |   |   |   |
| **Current Assets**                                                                                                                                                                                                       |   |                        |    |                      |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                |   | $                           | 3,048   |                      | $      | 1,975 |   |
| Restricted cash                                                                                                                                                                                                          |   |                        | 123     |                      |   | 116 |   |
| Accounts receivable – trade (net of allowance of   $459 and $332 in 2006 and 2005, respectively)                                                                                                                    |   |                        | 8,827   |                      |   | 7,815 |   |
| Inventories:                                                                                                                                                                                                             |   |                        |    |                      |   |   |   |
| Materials and supplies                                                                                                                                                                                                   |   |                        | 3,063   |                      |   | 2,927 |   |
| Product                                                                                                                                                                                                                  |   |                        | 1,316   |                      |   | 1,377 |   |
| Current deferred tax asset                                                                                                                                                                                               |   |                        | 1,050   |                      |   | 1,149 |   |
| Other current assets                                                                                                                                                                                                     |   |                        | 2,210   |                      |   | 1,970 |   |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **Total Current Assets**                                                                                                                                                                                                 |   |                        | 19,637  |                      |   | 17,329 |   |
| **Land**                                                                                                                                                                                                                 |   |                        | 745     |                      |   | 336 |   |
| **Devices under construction**                                                                                                                                                                                           |   |                        | 4,168   |                      |   | 3,368 |   |
| **Devices**                                                                                                                                                                                                              |   |                        | 58,488  |                      |   | 52,998 |   |
| Less accumulated depreciation                                                                                                                                                                                            |   |                        | (35,352 | )                         |   | (32,653 | ) |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
|                                                                                                                                                                                                                     |   |                        | 23,136  |                      |   | 20,345 |   |
| **Plant and Equipment**                                                                                                                                                                                                  |   |                        | 32,759  |                      |   | 31,869 |   |
| Less accumulated depreciation and amortization                                                                                                                                                                           |   |                        | (12,898 | )                         |   | (11,371 | ) |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
|                                                                                                                                                                                                                     |   |                        | 19,861  |                      |   | 20,498 |   |
| **Other Assets**                                                                                                                                                                                                         |   |                        |    |                      |   |   |   |
| Intangible assets (net of accumulated   amortization of $863 in 2006 and $682 in 2005)                                                                                                                                   |   |                        | 6,782   |                      |   | 5,371 |   |
| Long-term deferred tax asset                                                                                                                                                                                             |   |                        | 168     |                      |   | 45 |   |
| Other long-term assets                                                                                                                                                                                                   |   |                        | 917     |                      |   | 182 |   |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **Total Other Assets**                                                                                                                                                                                                   |   |                        | 7,867   |                      |   | 5,598 |   |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **Total Assets**                                                                                                                                                                                                         |   | $                           | 75,414  |                      | $      | 67,474 |   |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **LIABILITIES AND SHAREHOLDERS' EQUITY**                                                                                                                                                                                 |   |                        |    |                      |   |   |   |
| **Current Liabilities**                                                                                                                                                                                                  |   |                        |    |                      |   |   |   |
| Accounts payable                                                                                                                                                                                                         |   | $                           | 2,064   |                      | $      | 949 |   |
| Accrued expenses                                                                                                                                                                                                         |   |                        | 5,358   |                      |   | 4,647 |   |
| Deferred revenue                                                                                                                                                                                                         |   |                        | 566     |                      |   | 668 |   |
| Product warranty accrual                                                                                                                                                                                                 |   |                        | 176     |                      |   | 149 |   |
| Short-term debt                                                                                                                                                                                                          |   |                        | 1,601   |                      |   | -0- |   |
| Notes payable – current portion                                                                                                                                                                                     |   |                        | 433     |                      |   | 463 |   |
| Current portion of capital lease obligations                                                                                                                                                                             |   |                        | 5       |                      |   | 7 |   |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **Total Current Liabilities**                                                                                                                                                                                            |   |                        | 10,203  |                      |   | 6,883 |   |
| **Long-term debt, less current portion**                                                                                                                                                                                 |   |                        | 7,816   |                      |   | 8,102 |   |
| **Capital Lease Obligations, less current portion**                                                                                                                                                                      |   |                        | 7       |                      |   | 11 |   |
| **Other long-term liabilities**                                                                                                                                                                                          |   |                        | 20      |                      |   | 31 |   |
| **Shareholders’ Equity**                                                                                                                                                                                            |   |                        |    |                      |   |   |   |
| Common Stock, $0.01 par value per share:                                                                                                                                                                                 |   |                        |    |                      |   |   |   |
| Authorized - 30,000,000 shares; Issued and   outstanding – 8,342,263 net of 1,674,666 treasury shares and 8,134,447 net of   1,674,666 treasury shares at September 30, 2006 and December 31, 2005,   respectively. |   |                        | 99      |                      |   | 97 |   |
| Additional paid-in capital                                                                                                                                                                                               |   |                        | 68,579  |                      |   | 67,854 |   |
| Accumulated other comprehensive income                                                                                                                                                                                   |   |                        | 1,050   |                      |   | 349 |   |
| Deferred compensation                                                                                                                                                                                                    |   |                        | -0-     |                      |   | (1,318 | ) |
| Retained earnings                                                                                                                                                                                                        |   |                        | 7,487   |                      |   | 5,312 |   |
| Treasury stock                                                                                                                                                                                                           |   |                        | (19,847 | )                         |   | (19,847 | ) |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **Total Shareholders’ Equity**                                                                                                                                                                                      |   |                        | 57,368  |                      |   | 52,447 |   |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |
| **Total Liabilities and Shareholders’ Equity**                                                                                                                                                                      |   | $                           | 75,414  |                      | $      | 67,474 |   |
|                                                                                                                                                                                                                     |   |                             |         |                      |        |  |   |

See accompanying notes.

3

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Embrex, Inc.

**Consolidated Statements of Operations (Unaudited) (In thousands, except per share amounts)**

|                                                |   | **Three Months Ended   September 30** |   | **Nine Months Ended   September 30** |   |
|-----------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                |   |                                       |   |                                      |   |
|                                                |   | **2006**                              |   | **2005**                             |   | **2006** |   | **2005** |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Revenues**                                        |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Device revenues                                     |   | $                                     | 13,425 |                                 | $      | 12,415 |   | $ | 37,887 |   | $ | 36,509 |   |
| Product sales                                       |   |                                  | 771    |                                 |   | 721 |   |   | 2,303 |   |   | 2,144 |   |
| Other revenues                                      |   |                                  | 203    |                                 |   | 192 |   |   | 701 |   |   | 456 |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Total Revenues**                                  |   |                                  | 14,399 |                                 |   | 13,328 |   |   | 40,891 |   |   | 39,109 |   |
| **Cost of Device Revenues and Product Sales**       |   |                                  | 6,220  |                                 |   | 5,631 |   |   | 17,054 |   |   | 16,611 |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Gross Profit**                                    |   |                                  | 8,179  |                                 |   | 7,697 |   |   | 23,837 |   |   | 22,498 |   |
| **Operating Expenses**                              |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| General and administrative                          |   |                                  | 2,967  |                                 |   | 2,941 |   |   | 8,765 |   |   | 8,209 |   |
| Sales and marketing                                 |   |                                  | 1,949  |                                 |   | 1,020 |   |   | 5,210 |   |   | 3,215 |   |
| Research and development                            |   |                                  | 1,986  |                                 |   | 2,677 |   |   | 6,637 |   |   | 7,677 |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Total Operating Expenses**                        |   |                                  | 6,902  |                                 |   | 6,638 |   |   | 20,612 |   |   | 19,101 |   |
| **Operating Income**                                |   |                                  | 1,277  |                                 |   | 1,059 |   |   | 3,225 |   |   | 3,397 |   |
| **Other Income (Expense)**                          |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Interest income                                     |   |                                  | 49     |                                 |   | 44 |   |   | 161 |   |   | 108 |   |
| Interest expense                                    |   |                                  | (93    | )                                    |   | (3 | ) |   | (218 | ) |   | (28 | ) |
| Miscellaneous other income (expense)                |   |                                  | (23    | )                                    |   | 50 |   |   | 74 |   |   | 227 |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Total Other Income (Expense)**                    |   |                                  | (67    | )                                    |   | 91 |   |   | 17 |   |   | 307 |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Income Before Income Tax Expense**                |   |                                  | 1,210  |                                 |   | 1,150 |   |   | 3,242 |   |   | 3,704 |   |
| **Income Tax Expense**                              |   |                                  | 476    |                                 |   | 490 |   |   | 1,066 |   |   | 1,188 |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Net Income**                                      |   | $                                     | 734    |                                 | $      | 660 |   | $ | 2,176 |   | $ | 2,516 |   |
|                                                |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| **Net Income per share of Common Stock:**           |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Basic                                               |   | $                                     | 0.09   |                                 | $      | 0.08 |   | $ | 0.26 |   | $ | 0.32 |   |
| Diluted                                             |   | $                                     | 0.09   |                                 | $      | 0.08 |   | $ | 0.26 |   | $ | 0.30 |   |
| **Number of Shares Used in Per Share Calculation:** |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Basic                                               |   |                                  | 8,316  |                                 |   | 8,010 |   |   | 8,250 |   |   | 7,970 |   |
| Diluted                                             |   |                                  | 8,482  |                                 |   | 8,340 |   |   | 8,482 |   |   | 8,294 |   |

See accompanying notes.

4

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Embrex, Inc.

**Consolidated Statements of Cash Flows (Unaudited) (In thousands)**

|                                                                                       |   | **Nine   Months Ended   September 30** |    |
|--------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|
|                                                                                       |   |                                        |    |
|                                                                                       |   | **2006**                               |    | **2005** |   |
|                                                                                       |   |                                        |         |   |  |  |   |
| Operating   Activities                                                                     |   |                                   |    |   |   |   |   |
| Net income                                                                                 |   | $                                      | 2,176   |   | $ | 2,516 |   |
| Adjustments to reconcile net income to net cash   provided by operating activities:        |   |                                   |    |   |   |   |   |
| Depreciation and amortization                                                              |   |                                   | 5,849   |   |   | 4,725 |   |
| Loss on sale of fixed assets                                                               |   |                                   | 109     |   |   | 103 |   |
| Change in restricted cash                                                                  |   |                                   | -0-     |   |   | 1 |   |
| Change in deferred tax asset                                                               |   |                                   | (24     | ) |   | 593 |   |
| Restricted stock amortization                                                              |   |                                   | -0-     |   |   | 458 |   |
| Equity compensation                                                                        |   |                                   | 744     |   |   | -0- |   |
| Tax benefit of equity-based compensation                                                   |   |                                   | 175     |   |   | -0- |   |
| Changes in operating assets and liabilities:                                               |   |                                   |    |   |   |   |   |
| Accounts receivable, inventories and other   current assets                                |   |                                   | (2,062  | ) |   | 1,304 |   |
| Accounts payable, accrued expenses, deferred   revenue and warranty accrual                |   |                                   | 1,739   |   |   | (1,091 | ) |
|                                                                                       |   |                                        |         |   |  |  |   |
| **Net Cash Provided By Operating Activities**                                              |   |                                   | 8,706   |   |   | 8,609 |   |
| Investing   Activities                                                                     |   |                                   |    |   |   |   |   |
| Purchases of devices, equipment, furniture and   fixtures                                  |   |                                   | (9,149  | ) |   | (10,487 | ) |
| Cash proceeds from sale of devices, equipment,   furniture and fixtures                    |   |                                   | 11      |   |   | 20 |   |
| Investment in patents and other non-current   assets                                       |   |                                   | (1,592  | ) |   | (1,338 | ) |
|                                                                                       |   |                                        |         |   |  |  |   |
| **Net Cash Used In Investing Activities**                                                  |   |                                   | (10,730 | ) |   | (11,805 | ) |
| Financing   Activities                                                                     |   |                                   |    |   |   |   |   |
| Issuance of common stock                                                                   |   |                                   | 1,126   |   |   | 863 |   |
| Net change in line of credit                                                               |   |                                   | 1,601   |   |   | -0- |   |
| Repayment of long-term debt, capital lease   obligations and other long-term   liabilities |   |                                   | (324    | ) |   | (298 | ) |
|                                                                                       |   |                                        |         |   |  |  |   |
| **Net Cash Provided By Financing Activities**                                              |   |                                   | 2,403   |   |   | 565 |   |
| Increase   (decrease) in cash and cash equivalents                                         |   |                                   | 379     |   |   | (2,631 | ) |
| Currency   translation adjustments                                                         |   |                                   | 694     |   |   | 483 |   |
| Cash   and cash equivalents at beginning of period                                         |   |                                   | 1,975   |   |   | 4,469 |   |
|                                                                                       |   |                                        |         |   |  |  |   |
| **Cash And Cash Equivalents At End Of Period**                                             |   | $                                      | 3,048   |   | $ | 2,321 |   |
|                                                                                       |   |                                        |         |   |  |  |   |

See accompanying notes.

5

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FORM 10-Q September 30, 2006

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1 - Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Embrex, Inc. and its wholly owned subsidiaries, Embrex Europe Limited, Embrex France s.a.s., Embrex Iberica, Embrex BioTech Trade (Shanghai) Co., Ltd., Inovoject do Brasil Ltda., Embrex Poultry Health, LLC, Embrex de Mexico S. de R.L. de C.V. and Vaccination Services S. de R.L. de C.V. (“Embrex” or the “Company”) and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, these consolidated financial statements do not include all of the information and notes required by accounting principles generally accepted in the United States.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial condition andresults of operations have been included.  Operating results for the three-month and nine-month periods ended September 30, 2006 are not necessarily indicative of the results that may be attained for the entire year.  For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2005.

Note 2 – Critical Accounting Policies

The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including but not limited to those related to:

|   | • | Allowance   for uncollectible accounts               |
|--------|--------|------------------------------------------------------|
|   | • | Warranty   accruals                                  |
|   | • | Inventory   obsolescence                             |
|   | • | Deferred   tax assets                                |
|   | • | Employee   fringe benefit plan accrual               |
|   | • | Employee   short-term incentive compensation accrual |

The Company bases its estimates on historical experience and on various other assumptions, including planned results, that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about carrying values of assets and liabilities that are not readily discernible from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies are material to the preparation of its consolidated financial statements.  

6

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Revenue Recognition

Revenues for devices subject to lease agreements are recognized based on eggs processed during the period in accordance with lease terms.  Product sales are recognized upon delivery, as that is when title passes to the customer.  Contract research revenue is recognized as services are performed or as milestones are met over the term of the contract.  Grant revenue is recognized as expenses related to the specific grants are incurred.  Revenue received, but not yet earned, is classified as deferred revenue.  Revenue received from sales of devices to vaccine manufacturers is recognized when the device has been installed and has passed on-site testing.  These sales frequently include a maintenance agreement for which the revenue is recognized over the period covered by the agreement.  All revenues are recognized net of any applicable sales, use or rental taxes.

The revenues section of the consolidated statements of operations divides revenues into three sections: device revenues, which include device lease fees and device sales; product sales, all or most of which are derived from sales of the Company’s vaccine, Bursaplex®; and other revenues, which include income derived from contract research and development and grant sources. 

Allowance for Uncollectible Accounts

To date, the Company has not experienced any material trade accounts receivable collection issues.  However, based on a review of cumulative balances, industry experience and the current economic environment, the Company ordinarily reserves from 2% to 4% of trade accounts receivable, depending on the credit terms in various markets, as an allowance for uncollectible accounts. In addition, adjustments due to the financial stability of individual customers will affect the overall percentage reserved. Once the Company determines an account is uncollectible, it writes off the receivable balance against the reserve. Accounts are written off based on individual circumstances and only after all reasonable efforts of collection have been exhausted.  The consolidated balance reserved for uncollectible accounts as of September 30, 2006 was $0.5 million, which represents 5% of the trade accounts receivable balance as of September 30, 2006.  The current reservepercentage of 5% exceeds the range described above primarily due to the Company’s concerns regarding avian influenza outbreaks overseas and the potential impact on the operations and financial condition of the Company’s customers in the U.S. and abroad.  

Warranty Accruals

To date, the Company has not experienced any material device or product warranty issues in excess of amounts reserved.  Based on the sale and lease of devices and sale of products, the Company has established a reserve for future claims.  The reserve is based on the estimated damages that a customer would experience if an Inovoject® system or batch of Bursaplex® should fail to perform to product specifications. The consolidated balance reserved for warranties as of September 30, 2006 was $0.2 million.

Inventory Obsolescence

To date, the Company has not experienced any material inventory obsolescence.  However, based on a percentage of the current product and device parts inventory levels, the Company has established a reserve against future device parts obsolescence due to technological improvements and limited shelf life of product inventories.  The percentage used to calculate the reserve is based on a historical percentage rate adjusted for anticipated technological advances on devices and shelf life of existing vaccine product inventories.  The consolidated balance reserved for product and parts obsolescence as of September 30, 2006 was $0.3 million.

7

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Deferred Tax Assets

The Company records deferred tax assets based upon amounts that are likely to be realized. Based on the Company’s recent profitability and belief that 2006 will result in an overall profit, the Company has recorded net current deferred tax assets of $1.1 million.  The Company has also recorded a long-term tax asset of $0.2 million due to research and development (“R&D”) tax credits and depreciation timing differences.  The Company’s net deferred tax assets include a valuation allowance for two items that the Company may not be able to realize in future periods. The two items are R&D tax credits and deferred tax assets in foreign subsidiaries. This determination is based, in part, on historical operating performance as well as the likelihood of future income. The valuation allowance will be reduced when the Company believes that the likelihood of realizing the related assets is more likely than not. In the event the Companydetermines that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the valuation allowance would increase income in the period such determination was made. However, in the event the Company determines that it would not be able to realize its net recorded deferred tax asset in the future, an adjustment to the valuation allowance would decrease income in the period such determination was made.

Employee Fringe Benefit Plan Accrual 

The Company has established a reserve related to its employee fringe benefit plan.  The most significant component of the accrual is the amount reserved for the self-insured employee health plan. The amount of the reserve is based on management’s estimate of future employee health claims.  The reserve covers expected short-term claims and is based on historical data adjusted for major events and anticipated changes in headcount or participation. The net balance reserved for the employee self-insured health plan as of September 30, 2006 was $0.2 million.

Employee Short-Term Incentive Compensation Accrual 

The Company accrues for payments to employees under a short-term incentive plan.  The accrual is based upon the Company’s net income performance against a target established by the Board of Directors.  The accrual is recorded monthly and re-evaluated quarterly based upon the Company’s projections for the year.  Payments to employees are based upon the Company’s performance against targets as well as the employees’ contribution as measured against their individual contribution plan.  The net balance accrued for the employee short-term incentive compensation plan as of September 30, 2006 was $1.0 million.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”).  SFAS 123(R), a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees (“APB 25”), and amends SFAS No. 95, “Statement of Cash Flows.”  SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values.  SFAS 123(R) is effective for the beginning of the first interim or annual period beginning after December 31, 2005.  Therefore, the Company adopted SFAS 123(R) on January 1, 2006.  The impact of the adoption of SFAS 123(R)is described below under the heading “SHARE-BASED COMPENSATION PLANS.”

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces APB Opinion No. 20, “Accounting Changes” (“APB 20”), and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.”  SFAS 154 applies to all voluntary changes in accounting principle and modifies the requirements for accounting for and reporting a change in accounting principle.  SFAS 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable.   SFAS 154 requires that a change in method of depreciation, amortization or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. APB 20 previously required that such a change be reported as a change in accounting principle.  The adoption of SFAS 154 is not expected to have a material impact on the financial statements of the Company.  

8

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In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which provided clarification of the accounting under SFAS No. 109, “Accounting for Income Taxes.”  The interpretation provides a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  The interpretation is effective for fiscal years beginning after December 15, 2006.  Therefore, the Company plans to adopt FIN 48 on January 1, 2007.  The Company is currently evaluating the details of the interpretation, but it has not yet determined the impact it will have on the Company’s consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, where the FASB has previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. However, for some entities, the application of SFAS 157 will change current practice.  SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of SFAS 157 is not expected to have a material impact on the financial statements of the Company.  

SHARE-BASED COMPENSATION PLANS

Employee Stock Purchase Plan   

The Company maintains an Employee Stock Purchase Plan (“ESPP”) for its U.S.-based employees (the “U.S. Purchase Plan”) and a similar plan for some of its employees outside the U.S. (the “Non-U.S. Purchase Plan,” and together with the U.S. Purchase Plan, the “Purchase Plans”).  Under the terms of each of the Purchase Plans, all regular full-time employees of the Company (or the Company’s subsidiaries) may make voluntary payroll contributions, thereby enabling them to purchase Common Stock. Contributions are limited to 20% of an employee’s compensation. As of September 30, 2006, the number of shares that may be issued under the Purchase Plans together shall not exceed 500,000. Of this amount, 219,253 shares are available for future purchases. The purchase price of the Common Stock is the lesser of 85% of the fair market value on the first business day of the plan year, which runs from July 1 in one year toJune 30 in the succeeding year, or 85% of the fair market value on the date of exercise, which can occur at any time during the plan year, as determined by each participating employee.  During the three months ended September 30, 2006 and 2005, 1,786  and 1,126 shares, respectively, of Common Stock were purchased. The weighted-average purchase price of these shares was $8.58 and $9.58, respectively. During the nine months ended September 30, 2006 and 2005, 36,331 shares and 28,535 shares, respectively, of Common Stock were purchased. The weighted-average purchase price of these shares was $8.84 and $9.64, respectively.

9

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*Other Share-Based Compensation Plans*

In addition to the Purchase Plans, the Company maintains other share-based compensation plans (the “Share Plans”) under which it may provide to eligible employees and directors share-based compensation in the form of restricted stock-type awards (i.e., restricted stock and restricted stock units) and option-type awards (i.e., stock appreciation rights, incentive stock options and non-qualified stock options).  Option-type awards are generally granted with an exercise price equal to the market price of the Company’s Common Stock on the date of grant, generally vest based on four years of continuous service and have ten-year contractual terms.  Restricted stock-type awards do not have an exercise price and generally vest over four years as well.  Certain awards under the Share Plans provide for accelerated vesting if there is a change in control of the Company.  As of September 30, 2006, a total of 2,058,210 shares of Common Stockare reserved for future issuance under the Share Plans. Of this amount, 388,458 shares are available for future awards. 

The following table summarizes the activity of restricted stock awards: 

|                              |   | **Shares** |    | **Weighted-   Average   Grant-Date   Fair Value** |   |
|-----------------------------------|--------|------------|---------|---------------------------------------------------|--------|
|                              |   |            |         |                                              |        |  |   |
| Nonvested at December 31, 2004    |   |       | 87,025  |                                              | $      | 10.91 |   |
| Granted                           |   |       | -0-     |                                              |   | —   |   |
| Vested                            |   |       | (24,975 | )                                                 | $      | 10.67 |   |
| Forfeited                         |   |       | -0-     |                                              |   | —   |   |
|                              |   |            |         |                                              |        |  |   |
| Nonvested at December 31, 2005    |   |       | 62,050  |                                              | $      | 11.01 |   |
| Granted                           |   |       | -0-     |                                              |   | —   |   |
| Vested                            |   |       | (23,725 | )                                                 | $      | 10.75 |   |
| Forfeited                         |   |       | (4,550  | )                                                 | $      | 10.55 |   |
|                              |   |            |         |                                              |        |  |   |
| Nonvested at September 30,   2006 |   |       | 33,775  |                                              | $      | 11.24 |   |
|                              |   |            |         |                                              |        |  |   |

No restricted stock awards vested during the three months ended September 30, 2006 and 2005. The aggregate pre-tax, vest-date intrinsic value of restricted stock-type awards that vested during the nine months ended September 30, 2006 and 2005 was $12.03 and $11.73, respectively.

The following table summarizes the activity of restricted stock unit awards: 

|                              |   | **Shares** |    | **Weighted-   Average Grant-Date Fair Value** |   |
|-----------------------------------|--------|------------|---------|-----------------------------------------------|--------|
|                              |   |            |         |                                          |        |  |   |
| Nonvested at December 31, 2004    |   |       | -0-     |                                          |   | —   |   |
| Granted                           |   |       | 114,940 |                                          | $      | 11.25 |   |
| Vested                            |   |       | -0-     |                                          |   | —   |   |
| Forfeited                         |   |       | (480    | )                                             | $      | 11.25 |   |
|                              |   |            |         |                                          |        |  |   |
| Nonvested at December 31, 2005    |   |       | 114,460 |                                          | $      | 11.25 |   |
| Granted                           |   |       | 225,600 |                                          | $      | 9.21 |   |
| Vested                            |   |       | (37,990 | )                                             | $      | 11.25 |   |
| Forfeited                         |   |       | (6,900  | )                                             | $      | 11.25 |   |
|                              |   |            |         |                                          |        |  |   |
| Nonvested at September 30,   2006 |   |       | 295,170 |                                          | $      | 9.69 |   |
|                              |   |            |         |                                          |        |  |   |

No restricted stock unit awards vested during the three months ended September 30, 2006 and 2005. The aggregate pre-tax, vest-date intrinsic value of restricted stock unit awards that vested during the nine months ended September 30, 2006 was $13.86. No restricted stock unit awards vested during the nine months ended September 30, 2005.

10

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The following table summarizes the activity of stock option awards: 

|                                                  |   | **Shares** |      | **Weighted-   Average   Exercise   Price Per   Share** |   | **Weighted-   Average   Remaining   Contractual   Life (Years)** |   | **Aggregate   Pre-Tax   Intrinsic   Value** |   |
|-------------------------------------------------------|--------|------------|-----------|--------------------------------------------------------|--------|------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                  |   |            |           |                                                   |        |                                                                  |   |                                             |        |   |  |  |   |
| Outstanding at December 31,   2004                    |   |       | 1,772,932 |                                                   | $      | 11.50                                                            |   |                                        |   |   |   |   |   |
| Granted                                               |   |       | 2,000     |                                                   | $      | 11.57                                                            |   |                                        |   |   |   |   |   |
| Exercised                                             |   |       | (151,594  | )                                                      | $      | 6.86                                                             |   |                                        |   |   |   |   |   |
| Forfeited   or expired                                |   |       | (32,510   | )                                                      | $      | 14.80                                                            |   |                                        |   |   |   |   |   |
|                                                  |   |            |           |                                                   |   |                                                             |   |                                        |   |   |   |   |   |
| Outstanding at December 31,   2005                    |   |       | 1,590,828 |                                                   | $      | 11.88                                                            |   |                                        |   |   |   |   |   |
| Granted                                               |   |       | -0-       |                                                   |   | —                                                 |   |                                        |   |   |   |   |   |
| Exercised                                             |   |       | (124,420  | )                                                      | $      | 6.59                                                             |   |                                        |   |   |   |   |   |
| Forfeited   or expired                                |   |       | (106,476  | )                                                      | $      | 15.36                                                            |   |                                        |   |   |   |   |   |
|                                                  |   |            |           |                                                   |   |                                                             |   |                                        |   |   |   |   |   |
| Outstanding at September 30,   2006                   |   |       | 1,359,932 |                                                   | $      | 12.09                                                            |   |                                        | 4.4    |   | $ | 2,443,397 |   |
| Vested & expected to vest   at September 30, 2006 |   |       | 1,356,259 |                                                   | $      | 12.09                                                            |   |                                        | 4.4    |   | $ | 2,441,626 |   |
| Exercisable at September 30,   2006                   |   |       | 1,248,704 |                                                   | $      | 12.11                                                            |   |                                        | 4.1    |   | $ | 2,360,384 |   |

The following table summarizes significant ranges of exercise prices of outstanding and exercisable options as of September 30, 2006: 

|                         |   | **Options Outstanding** |      | **Options Exercisable**                                          |   |
|------------------------------|--------|-------------------------|-----------|------------------------------------------------------------------|--------|
|                         |   |                         |      |                                                                  |   |
| **Range of Exercise Prices** |   | **Shares**              |      | **Weighted-   Average   Remaining   Contractual   Life (Years)** |   | **Weighted-   Average   Exercise   Price Per   Share** |   | **Shares** |   | **Weighted-   Average   Exercise   Price Per   Share** |   |
|                              |   |                         |           |                                                             |        |  |   |  |  |   |  |  |   |  |  |   |
| $5.13 - $9.66                |   |                    | 462,403   |                                                             |   | 3.1 |   | $ | 7.09 |   |   | 424,436 |   | $ | 6.86 |   |
| $10.50 - $13.09              |   |                    | 366,906   |                                                             |   | 5.2 |   | $ | 11.69 |   |   | 296,145 |   | $ | 11.37 |   |
| $13.25 - $17.25              |   |                    | 276,191   |                                                             |   | 4.4 |   | $ | 15.56 |   |   | 273,691 |   | $ | 15.58 |   |
| $17.99                       |   |                    | 254,432   |                                                             |   | 5.4 |   | $ | 17.99 |   |   | 254,432 |   | $ | 17.99 |   |
|                         |   |                         |           |                                                             |   |   |   |   |   |   |  |  |   |   |   |   |
| Total                        |   |                    | 1,359,932 |                                                             |   | 4.4 |   | $ | 12.09 |   |   | 1,248,704 |   | $ | 12.11 |   |
|                         |   |                         |           |                                                             |   |   |   |   |   |   |  |  |   |   |   |   |

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*Share-Based Compensation Expense*

On January 1, 2006, the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based compensation awards made to employees and directors based on estimated fair values.  SFAS 123(R) supersedes the Company’s previous accounting under APB 25 for periods beginning on or after January 1, 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R). 

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006. The Company’s Consolidated Financial Statements as of and for the three and nine months ended September 30, 2006 reflect the impact of SFAS 123(R).  In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized under SFAS 123(R) for the three and nine months ended September 30, 2006 was $262 thousand and $744 thousand, respectively.  Share-based compensation expense of $187 thousand and $458 thousand was recognized under previous accounting standards for the three and nine months ended September 30, 2005, respectively.  As of September 30, 2006, there was $2.0 million of totalunrecognized compensation cost related to outstanding awards that are expected to vest in the future; the weighted-average period over which that cost is expected to be recognized is 1.7  years.  The actual tax benefit realized from tax deductions relating to stock option exercises for the three months ended September 30, 2006 and 2005, amounted to $0 and $100 thousand, respectively. The actual tax benefit realized from tax deductions relating to stock option exercises for the nine months ended September 30, 2006 and 2005, was $175 thousand and $113 thousand, respectively.  

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations. Prior to the adoption of SFAS 123(R), the Company accounted for share-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under SFAS 123.

Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Share-based compensation expense recognized in the Company’s Consolidated Statement of Operations for the three months ended September 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123.  Compensation expense for all stock option-type awards granted on or prior to December 31, 2005 has been and will continue to be recognized using the accelerated multiple-option approach, while compensation expense for all restricted stock-type awards granted on or prior to December 31, 2005 has been and will continue to be recognized using the straight-line single-option method.  Both restricted stock-typeand stock option-type awards granted subsequent to December 31, 2005 will be recognized using the straight-line single-option method.  

12

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Prior to the Company’s adoption of SFAS 123(R) on January 1, 2006, the Company accounted for forfeitures as they occurred.  SFAS 123(R), however, requires forfeitures to be estimated at the time of grant and revised in subsequent periods if actual forfeitures differ, or are expected to differ, from those estimates.  Estimated forfeitures differ among award types and among grantee groups that have significantly different historical forfeiture behavior.  As share-based compensation expense recognized in the Consolidated Statement of Operations for the first nine months of 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.

On November 10, 2005, the FASB issued Staff Position No. FAS 123(R)-3 “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123(R).   

The Company computed the fair value of option-type awards granted under the Share Plans and ESPP option elements under the Purchase Plans using the Black-Scholes-Merton closed-form option pricing model. The weighted-average assumptions used in this model to estimate fair value and resulting values are as follows: 

|                                                   |   | **Three Months Ended   Sept 30** |   | **Nine Months Ended   Sept 30** |   |
|--------------------------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                                   |   |                                  |   |                                 |   |
|                                                   |   | **2006**                         |   | **2005**                        |   | **2006** |   | **2005** |   |
|                                                   |   |                                  |        |                            |        |  |   |  |  |   |  |  |   |
| **Option-Type   Awards under the Share Plans:**        |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Expected dividend yield (1)                            |   |                             | (5     | )                               |   | (5 | ) |   | (5 | ) |   | 0.0 | % |
| Risk-free interest rate (2)                            |   |                             | (5     | )                               |   | (5 | ) |   | (5 | ) |   | 3.5 | % |
| Expected volatility (3)                                |   |                             | (5     | )                               |   | (5 | ) |   | (5 | ) |   | 57.0 | % |
| Expected life (in years) (4)                           |   |                             | (5     | )                               |   | (5 | ) |   | (5 | ) |   | 4.5 |   |
| Weighted-average  grant-date fair value per share |   |                             | (5     | )                               |   | (5 | ) |   | (5 | ) | $ | 5.70 |   |
| **Employee   Stock Purchase Plans:**                   |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Expected dividend yield (1)                            |   |                             | 0.0    | %                               |   | 0.0 | % |   | 0.0 | % |   | 0.0 | % |
| Risk-free interest rate (2)                            |   |                             | 5.2    | %                               |   | 3.5 | % |   | 5.2 | % |   | 3.5 | % |
| Expected volatility (3)                                |   |                             | 42.0   | %                               |   | 57.0 | % |   | 42.0 | % |   | 57.0 | % |
| Expected life (in years) (4)                           |   |                             | 1      |                            |   | 1 |   |   | 1 |   |   | 1 |   |
| Weighted-average  grant-date fair value per share |   | $                                | 3.34   |                            | $      | 4.32 |   | $ | 3.34 |   | $ | 4.31 |   |

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|    |
|----|
| 1. | The Company has no plans to   pay a dividend during the expected life of the option-type awards or ESPP   option elements. |
| 2. | Represents the risk-free interest   rate based on the U.S. Treasury yield curve in effect at the time of grant. |
| 3. | Based on the historical daily   percentage change in the price of the Company’s common stock. Beginning as of   January 1, 2006, the historical period referenced for this purpose is the   most recent period of time equal to the length of the expected life of the   applicable option-type award or ESPP option element. |
| 4. | Represents the   weighted-average period of time that the option-type awards or ESPP option   elements are expected to be outstanding.    Where relevant, the expected term for option-type awards differs among   grantee groups with similar, historical exercise behavior. |
| 5. | Not applicable, since there   were no related awards granted in this period. |

*Pro Forma Information Under SFAS 123 for Periods Ending on or before December 31, 2005*

Pro forma information regarding share-based compensation is as follows (in thousands, except per share amounts): 

|                                                                                                                                              |   | **Three Months Ended   September 30, 2005(unaudited)** |   | **Nine Months Ended   September 30, 2005(unaudited)** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|
|                                                                                                                                              |   |                                                                  |        |                                                            |        |  |   |
| Net income, as reported                                                                                                                           |   | $                                                                | 660    |                                                            | $      | 2,516 |   |
| Add:  Non-cash   share-based compensation included in net income, net of related tax effects                                                 |   |                                                             | 86     |                                                            |   | 283 |   |
| Deduct:  Total   share-based compensation expense determined under fair value-based method for   all awards, net of related tax effects |   |                                                             | (204   | )                                                               |   | (705 | ) |
|                                                                                                                                              |   |                                                                  |        |                                                            |        |  |   |
| Pro forma net income                                                                                                                              |   | $                                                                | 542    |                                                            | $      | 2,094 |   |
|                                                                                                                                              |   |                                                                  |        |                                                            |        |  |   |
| Earnings per share:                                                                                                                               |   |                                                             |   |                                                            |   |   |   |
| Basic—as   reported                                                                                                                          |   | $                                                                | 0.08   |                                                            | $      | 0.32 |   |
| Basic—pro   forma                                                                                                                            |   | $                                                                | 0.07   |                                                            | $      | 0.26 |   |
| Diluted—as   reported                                                                                                                        |   | $                                                                | 0.08   |                                                            | $      | 0.30 |   |
| Diluted—pro   forma                                                                                                                          |   | $                                                                | 0.07   |                                                            | $      | 0.25 |   |

Note 3 - Revenues

Device revenues include device-related income, which consists of Inovoject® system lease fees, Inovoject® system sales, Egg Remover® fees, Egg Remover® sales, Vaccine Saver® fees, Vaccine Saver® sales and Inovoject® system distributor royalties. Product sales include sales of Bursaplex®, the Company’s *in ovo* infectious bursal disease vaccine.  The item “other revenues” includes revenues derived from contract research and development and grant sources**.**

Note 4 – Plant and Equipment

Plant and equipment are recorded at cost.  Depreciation is computed principally by using straight-line methods over the estimated useful lives of the assets placed in service, generally three to seven years. Manufacturing buildings and equipment are depreciated using the same methodology, but could be depreciated over a period spanning from 5 to 40 years.  The Company’s total depreciation expense for plant and equipment for the nine months ended September 30, 2006 was $1.9 million. Plant and equipment, at cost, consist of (in thousands): 

14

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| **(*unaudited)**                             |   | **September 30, 2006*** |    | **December 31, 2005** |   |
|----------------------------------------------|--------|-------------------------|---------|-----------------------|--------|
|                                              |   |                         |         |                  |        |  |   |
| Plant and equipment                          |   |                    |    |                  |   |   |   |
| Office   buildings                           |   | $                       | 281     |                  | $      | 122 |   |
| Building   and land improvements             |   |                    | 8,236   |                  |   | 299 |   |
| Manufacturing   equipment                    |   |                    | 6,505   |                  |   | 1,011 |   |
| Construction   in progress                   |   |                    | 78      |                  |   | 13,225 |   |
| Leasehold   improvements                     |   |                    | 5,643   |                  |   | 5,613 |   |
| Furniture,   office and lab equipment, other |   |                    | 9,546   |                  |   | 9,164 |   |
| Vehicles                                     |   |                    | 2,470   |                  |   | 2,435 |   |
|                                         |   |                         |         |                  |        |  |   |
| Total   plant and equipment                  |   |                    | 32,759  |                  | $      | 31,869 |   |
| Less:  accumulated depreciation         |   |                    | (12,898 | )                     |   | (11,371 | ) |
|                                         |   |                         |         |                  |        |  |   |
| Net plant and equipment                      |   | $                       | 19,861  |                  | $      | 20,498 |   |
|                                         |   |                         |         |                  |        |  |   |

Note 5 – Intangible Assets

The Company capitalizes legal costs incurred in conjunction with the application for and filing of U.S. patents on internally developed technology, as well as the costs incurred to acquire exclusive licenses of U.S. patents. Exclusive license agreements are amortized over the period of the license, and patents are amortized over the shorter of the useful or legal life of the patent.  In some cases, patent infringement lawsuit expenses are capitalized and then amortized using the straight-line method upon successful defense and over the remaining life of the related patent.  In the third quarter of 2006, approximately $0.5 million of expenses related to patent infringement lawsuits were capitalized. As of September 30, 2006, an aggregate of $3.0 million of legal expenses related to patent infringement lawsuits currently pending were capitalized.  If the lawsuits covered by these expenses are not resolved in the Company’s favor, either viasettlement or judgment by the applicable court, the capitalized cost will be expensed at the earlier of the time of resolution or when the Company determines that the lawsuits will not be resolved in the Company’s favor.   In addition, capitalized costs incurred to obtain patents on internally developed technology would be expensed at the time the Company decides to abandon a patent application or a patent is denied. The Company’s total amortization expense of intangible assets for the nine-month periods ended September 30, 2006 and 2005 was approximately $0.2 million.  The Company estimates amortization of intangible assets will be approximately $0.2 million per year over the next five years based on current asset values and remaining lives.  Trademarks and goodwill are not amortized, but analyzed for impairment annually, in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets".  Net intangible assets consist of (in thousands): 

| **(*unaudited)**                        |   | **September 30,   2006*** |   | **December 31,   2005** |   |
|-----------------------------------------|--------|---------------------------|--------|-------------------------|--------|
|                                         |   |                           |        |                    |        |  |   |
| Intangible assets                       |   |                      |   |                    |   |   |   |
| Patents   and exclusive patent licenses |   | $                         | 5,927  |                    | $      | 4,583 |   |
| Goodwill                                |   |                      | 639    |                    |   | 587 |   |
| Trademarks                              |   |                      | 183    |                    |   | 163 |   |
| Other   intangibles                     |   |                      | 33     |                    |   | 38 |   |
|                                    |   |                           |        |                    |        |  |   |
| Net   intangible assets                 |   | $                         | 6,782  |                    | $      | 5,371 |   |
|                                    |   |                           |        |                    |        |  |   |

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Note 6 – 401(k) Retirement Savings Plan

The Company has a 401(k) Plan that is available to all U.S.-based employees who are at least 18 years of age.  Employer contributions are voluntary at the discretion of the Company.  Historically, under its 401(k) Plan, the Company has based participant and employer contributions on participants’ salary. In the third quarter of 2005, the Company discovered that the 401(k) Plan documents prepared by its third party administrator provide (and the Company believes incorrectly) that other elements of compensation be included when determining the appropriate contributions. The Company’s intent always has been that contributions be based only on base salary. The Company intends to seek approval to conform the 401(k) Plan document retroactively to its intent and practice. Should this relief not be granted, the Company believes it would be required to make additional contributions to the 401(k) Plan for participants who had not already reached themaximum contribution.  The Company is unable to estimate at this time the amount of additional contributions that potentially could be required and for what time periods.

Note 7 - Income Tax Expense  

The reported tax rate for third quarter 2006 was 39% in comparison to the 43% reported tax rate for third quarter 2005.  The reported tax rate for the third quarter of 2006 decreased in comparison to the same period of 2005 due to an adjustment in the accrual for foreign income taxes.

The reported tax rate for the nine month period ended September 30, 2006 was 33% in comparison to the 32% reported tax rate for the same nine month period in 2005.  The reported tax rate for the third quarter of 2006 decreased in comparison to the same period of 2005 due to an adjustment in the accrual for foreign income taxes as a result of the establishment of a branch office in one of the Company’s foreign markets, thereby changing the tax status and method of tax accrual for those operations. 

In addition, the Company filed an election during the first quarter of 2006 to change the U.S. tax classification of one of its subsidiaries.  As a result of this election, an adjustment was recorded that increased the deferred tax asset and reduced the provision for income taxes.  The tax benefit related to this adjustment was approximately $0.4 million and was recorded as a discrete benefit in the first quarter of 2006, resulting in a lower tax rate in the first nine months of 2006.  The reported tax rate for the nine months ended September 30, 2006 would have been 49% if the election had not been filed.

In the third quarter of 2006, withholding taxes accounted for 10 percentage points of the 39% tax rate, and U.S. and non-U.S. income taxes represented the remaining 29 percentage points.  In the same period of 2005, the 43% reported tax rate included 10 percentage points of withholding tax and 33 percentage points due to income taxes.  Withholding taxes are assessed on revenues in non-U.S. markets, regardless of taxable income position. 

In the first nine months of 2006, withholding taxes accounted for 11 percentage points of the 33% tax rate, and U.S. and non-U.S. income taxes represented the remaining 22 percentage points.  In the same period of 2005, the 32% reported tax rate included 12 percentage points of withholding tax and 20 percentage points due to income taxes.  

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Note 8 - Net Income Per Share

The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts): 

|                                                                                                                |   | **Three Months Ended   September 30(unaudited)** |   | **Nine Months Ended   September 30(unaudited)** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                                                                |   |                                                  |   |                                                 |   |
|                                                                                                                |   | **2006**                                         |   | **2005**                                        |   | **2006** |   | **2005** |   |
|                                                                                                                |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |
| Numerator:                                                                                                          |   |                                             |   |                                            |   |   |   |   |   |   |   |   |   |
| Net Income                                                                                                          |   | $                                                | 734    |                                            | $      | 660 |   | $ | 2,176 |   | $ | 2,516 |   |
|                                                                                                                |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |
| Denominator:                                                                                                        |   |                                             |   |                                            |   |   |   |   |   |   |   |   |   |
| Denominator for basic net   income per share—weighted-average shares                                           |   |                                             | 8,316  |                                            |   | 8,010 |   |   | 8,250 |   |   | 7,970 |   |
| Effect of Dilutive Securities:   Stock Options, Restricted Stock and Restricted Stock Units                         |   |                                             | 166    |                                            |   | 330 |   |   | 232 |   |   | 324 |   |
| Denominator for diluted net   income per share—adjusted weighted-average shares and assumed option   exercises |   |                                             | 8,482  |                                            |   | 8,340 |   |   | 8,482 |   |   | 8,294 |   |
|                                                                                                                |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |
| Basic net income per share                                                                                          |   | $                                                | 0.09   |                                            | $      | 0.08 |   | $ | 0.26 |   | $ | 0.32 |   |
|                                                                                                                |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |
| Diluted net income per share                                                                                        |   | $                                                | 0.09   |                                            | $      | 0.08 |   | $ | 0.26 |   | $ | 0.30 |   |
|                                                                                                                |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |

Basic net income per share was determined by dividing net income by the weighted-average number of common shares outstanding during each period presented. Diluted net income per share is based on the average number of shares used for the basic net income per share calculation, adjusted for the dilutive effect of stock options, restricted stock and restricted stock units.  The dilutive effect of these securities was calculated using the Treasury Stock Method.  For the diluted net income per share denominator for the three months ended September 30, 2006 and September 30, 2005, 899,303 and 800,632 shares, respectively, underlying outstanding stock options were excluded from the calculation because the exercise price of such options exceeded the average closing price of the Company’s Common Stock during the applicable period and, thus, are non-dilutive.

For the diluted net income per share denominator for the nine months ended September 30, 2006 and September 30, 2005, 744,688 and 805,557 shares, respectively, underlying outstanding stock options were excluded from the calculation for the same reason as listed above.

Note 9 – Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income” (“SFAS 130”), establishes standards for reporting and display of comprehensive income and its components in the financial statements.  In accordance with SFAS 130, the Company has determined total comprehensive income net of tax to be $1.0 million and $0.9 million for the quarters ended September 30, 2006 and 2005, respectively.  For the nine-month period ended September 30, 2006 and 2005, the Company has determined total comprehensive income net of tax to be $2.9 million and $3.0 million, respectively.  

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The Company’s total comprehensive income represents net income plus the effect of foreign currency translation adjustments for the periods presented as summarized below (in thousands):  

|                               |   | **Three Months Ended   September 30(unaudited)** |   | **Nine Months Ended   September 30(unaudited)** |   |
|------------------------------------|--------|--------------------------------------------------|--------|-------------------------------------------------|--------|
|                               |   |                                                  |   |                                                 |   |
|                               |   | **2006**                                         |   | **2005**                                        |   | **2006** |   | **2005** |   |
|                               |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |
| Net Income                         |   | $                                                | 734    |                                            | $      | 660 |   | $ | 2,176 |   | $ | 2,516 |   |
| Currency Translation   Adjustments |   |                                             | 249    |                                            |   | 259 |   |   | 701 |   |   | 483 |   |
|                               |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |
| Comprehensive Income               |   | $                                                | 983    |                                            | $      | 919 |   | $ | 2,877 |   | $ | 2,999 |   |
|                               |   |                                                  |        |                                            |        |  |   |  |  |   |  |  |   |

Note 10 – Segments

The Company operates in a single segment.  The table below presents the Company’s operations by geographic area (in thousands):

| **(* unaudited)**              |   | **Three Months Ended   September 30** |   | **Nine Months Ended   September 30** |   |
|--------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                |   |                                       |   |                                      |   |
|                           |   | **2006 ***                            |   | **2005 ***                           |   | **2006 *** |   | **2005 *** |   |
|                           |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| U.S. Revenues:                 |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Device   Revenues              |   | $                                     | 8,132  |                                 | $      | 8,084 |   | $ | 24,297 |   | $ | 24,435 |   |
| Product   Sales                |   |                                  | -0-    |                                 |   | -0- |   |   | -0- |   |   | -0- |   |
| Other   Revenues               |   |                                  | 163    |                                 |   | 154 |   |   | 576 |   |   | 364 |   |
|                           |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| Total   U.S. Revenues          |   | $                                     | 8,295  |                                 | $      | 8,238 |   | $ | 24,873 |   | $ | 24,799 |   |
| International Revenues:        |   |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Device   Revenues              |   | $                                     | 5,293  |                                 | $      | 4,331 |   | $ | 13,590 |   | $ | 12,074 |   |
| Product   Sales                |   |                                  | 771    |                                 |   | 721 |   |   | 2,303 |   |   | 2,144 |   |
| Other   Revenues               |   |                                  | 40     |                                 |   | 38 |   |   | 125 |   |   | 92 |   |
|                           |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |
| Total   International Revenues |   | $                                     | 6,104  |                                 | $      | 5,090 |   | $ | 16,018 |   | $ | 14,310 |   |
| Total Revenues                 |   | $                                     | 14,399 |                                 | $      | 13,328 |   | $ | 40,891 |   | $ | 39,109 |   |
|                           |   |                                       |        |                                 |        |  |   |  |  |   |  |  |   |

|            |   | **September 30,   2006 *** |   | **December 31,   2005** |   |   |   |   |   |   |   |
|-----------------|--------|----------------------------|--------|-------------------------|--------|--------|--------|--------|--------|--------|--------|
|                 |   |                            |        |                    |        |        |   |   |   |   |   |   |   |
| Total Assets:   |   |                       |   |                    |   |   |   |   |   |   |   |   |   |
| United   States |   | $                          | 57,168 |                    | $      | 51,885 |   |   |   |   |   |   |   |
| International   |   |                       | 18,246 |                    |   | 15,589 |   |   |   |   |   |   |   |
|            |   |                            |        |                    |        |        |   |   |   |   |   |   |   |
| Total           |   | $                          | 75,414 |                    | $      | 67,474 |   |   |   |   |   |   |   |
|            |   |                            |        |                    |        |        |   |   |   |   |   |   |   |

|                                          |   | **September 30, 2006 *** |   | **December 31, 2005** |   |   |   |   |   |   |   |
|-----------------------------------------------|--------|--------------------------|--------|-----------------------|--------|--------|--------|--------|--------|--------|--------|
|                                               |   |                          |        |                  |        |        |   |   |   |   |   |   |   |
| Depreciation and   Amortization Expense:      |   |                     |   |                  |   |   |   |   |   |   |   |
| United   States                               |   |                     | 3,924  |                  | $      | 3,914  |   |   |   |   |   |   |   |
| International                                 |   |                     | 1,925  |                  |   | 2,549  |   |   |   |   |   |   |   |
|                                          |   |                          |        |                  |        |        |   |   |   |   |   |   |   |
| Total Depreciation and   Amortization Expense |   | $                        | 5,849  |                  | $      | 6,463  |   |   |   |   |   |   |   |
|                                          |   |                          |        |                  |        |        |   |   |   |   |   |   |   |

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Note 11 – Debt

The Company obtained a $9.0 million construction/term loan from its bank, Branch Banking and Trust Company (“BB&T”), in August 2003 to be used for construction and equipping of Embrex Poultry Health, LLC, the Company’s InovocoxTM vaccine manufacturing facility located in Scotland County, North Carolina.  The interest rate of the loan is based on the one-month LIBOR plus 1.25%, which is a 25 basis point reduction since the second quarter of 2006.  The loan has a term of 139 months, or 11.5 years, with payments of interest only for the first 18 months.  Principal repayment on the loan began in March 2005 at the end of the interest only period and equal monthly installments of principal plus interest are payable over the remainder of the loan term.  At September 30, 2006, $8.2 million of the construction/term loan was outstanding.  

The Company has a $6.0 million secured revolving line of credit with Branch Banking & Trust Co. (BB&T), which may be used for working capital purposes.  The term of this line of credit has been extended to May 2007.  The line of credit carries an interest rate of the current LIBOR plus 1.25%, which has been reduced 20 basis points since the second quarter of 2006.  At September 30, 2006, the Company’s outstanding borrowings under this credit facility were $1.6 million.   These funds were used primarily for pre-launch demonstration and marketing activities of InovocoxTM and start-up expenses of Embrex Poultry Health.

Note 12 – Commitments and Contingencies

The Company has certain contractual obligations due to mortgage financing of theInovocoxTM manufacturing facility, capital leases, operating leases relatedto office and storage space rentals and purchase obligations related to themanufacturing of devices, serum and vaccines and the purchase of othermiscellaneous supplies. The terms of these obligations vary from less than ayear to 10 years. 

The Company is engaged in certain legal and administrative proceedings incidental to its normal business activities.  While it is not possible to determine the ultimate outcome of those actions, in the opinion of management, after discussion with legal counsel, it is unlikely that the outcome of such litigation and other proceedings will have a material adverse effect on the results of the Company’s operations or its financial position, except that capitalized costs related to lawsuits could be expensed in future periods.  See Note 5, “Intangible Assets,” above. 

The Company operates in multiple tax jurisdictions and significant judgment is required in determining its worldwide provision for income taxes.  In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain.  Although the Company believes its approach to determining its various tax provisions is reasonable, no assurance can be given that the final outcome will not be materially different than that which is reflected in the Company’s historical income tax provision and accruals upon review by taxing authorities.  Management believes that adequate amounts of tax and related interest and penalties, if any, have been reserved for any adjustments that may result from years open to examination from taxing authorities. As of September 30, 2006, $0.9 million has been reserved.  

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

Information set forth in this Quarterly Report on Form 10-Q of Embrex, Inc. contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934. These statements represent the Company’s judgment concerning the future and are subject to risks and uncertainties that could cause the Company’s actual operating results and financial position to differ materially. Such forward-looking statements can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “plan,” “intend,” “target,” “anticipate,” “estimate,” “believe” or “continue,” or the negative thereof or other variations thereof or comparable terminology. 

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The Company cautions that any such forward-looking statements include statementswith respect to future products, services, markets and financial results. These statements involve risks and uncertainties that could cause actual resultsto differ materially.  Risks include, without limitation, the degree ofgrowth in the poultry industry in the U.S. and globally, competition arisingwithin the United States and elsewhere, possible decreases in production by theCompany’s customers, avian disease outbreaks in the Company’s markets,and market acceptance and cost of expansion in new geographic markets. Additional risks include the Company’s ability to penetrate new markets andthe degree of market acceptance of new products, the complete development andcommercialization of potential future products and approved products on a costeffective basis, including Newplex® and InovocoxTM, the availability ofadequate product supplies, the ability of the Company’s contractmanufacturers to support its products, and the ability to obtain regulatoryapproval of products.  Such approval is dependent upon a number of factors,such as results of trials, the discretion of regulatory officials and potentialchanges in regulations.  Additional information on these risks and otherfactors that could affect the Company’s consolidated financial results aredescribed in Part II, Item 1A, “Risk Factors,” below and in theCompany’s other filings with the Securities and Exchange Commission,including the Company’s Forms 10-Q, 10-K and 8-K. 

The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and related notes appearing elsewhere in this report.  The notes to the consolidated financial statements include Note 1, which describes the basis for presentation, and Note 2, which describes the Company’s critical accounting policies, including the Company’s SFAS 123(R) disclosure.

INTRODUCTION

Embrex, the In Ovo Company®, is an international biotechnology company engaged in the development of innovative in ovo solutions that meet the needs of the global poultry industry.  The Company derives most of its global revenues from lease fees for the number of eggs processed by its Inovoject® systems. Other revenue sources for the Company come from lease fees related to its Egg Remover® systems and Vaccine Saver® option installations. In addition to these sources, the Company may sell each of these devices to distributors under special circumstances in selected countries and to human flu vaccine manufacturers. Revenues from these sources are categorized as device revenues in the Company’s financial statements. Another source of revenue for the Company is product sales, which currently consist of sales of Bursaplex®, an in ovo vaccine for infectious bursal disease.  The Company also derives some revenues from contractresearch and development, and grant sources.  The Company’s cost of revenues is primarily attributable to the costs of supporting the Company’s devices at customer locations around the world.  These costs include the labor, travel and parts necessary to ensure proper biological and mechanical operation, as well as maintenance of Embrex’s devices located at hatcheries of the Company’s customers.  These costs also include associated depreciation, as well as sales and property tax expenses. The Company has also built the Embrex Poultry Health, LLC (Embrex Poultry Health or “EPH”) vaccine manufacturing facility.  In April 2006, the United States Department of Agriculture (“USDA”) granted product and manufacturing facility approvals for the Company to produce InovocoxTM, an in ovo vaccine for the control of coccidiosis, at EPH. 

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RESULTS OF OPERATIONS

Three Months Ended September 30, 2006 and 2005

CONSOLIDATED NET INCOME

(dollars in thousands except per share amounts)

|                              |   | **Three Months   Ended   September 30(unaudited)** |   |
|-----------------------------------|--------|----------------------------------------------------|--------|
|                              |   |                                                    |   |
|                              |   | **2006**                                           |   | **2005** |   | **Change** |   | **Change** |   |
|                              |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Total Revenue                     |   | $                                                  | 14,399 |   | $ | 13,328 |   | $ | 1,071 |   |   | 8 | % |
| Gross Profit                      |   | $                                                  | 8,179  |   | $ | 7,697 |   | $ | 482 |   |   | 6 | % |
| Operating Income                  |   | $                                                  | 1,277  |   | $ | 1,059 |   | $ | 218 |   |   | 21 | % |
| Net Income                        |   | $                                                  | 734    |   | $ | 660 |   | $ | 74 |   |   | 11 | % |
| Earnings per share – basic   |   | $                                                  | 0.09   |   | $ | 0.08 |   | $ | 0.01 |   |   | 13 | % |
| Earnings per share – diluted |   | $                                                  | 0.09   |   | $ | 0.08 |   | $ | 0.01 |   |   | 13 | % |

Consolidated net income was $0.7 million for the third quarter of 2006, a $0.1 million, or 11% increase in comparison to the same period in 2005. Diluted earnings per share were $0.09 for third quarter 2006 and $0.08 for the same period in 2005.           

OUTSTANDING SHARES

(in thousands except percentages)

|                                          |   | **Three Months Ended   September 30   (unaudited)** |   |
|-----------------------------------------------|--------|-----------------------------------------------------|--------|
|                                          |   |                                                     |   |
|                                          |   | **2006**                                            |   | **2005** |   | **Change** |   | **Change** |   |
|                                          |   |                                                     |        |   |  |  |   |  |  |   |  |  |   |
| Basic Weighted Average Shares   Outstanding   |   |                                                | 8,316  |   |   | 8,010 |   |   | 306 |   |   | 4 | % |
| Diluted Weighted Average Shares   Outstanding |   |                                                | 8,482  |   |   | 8,340 |   |   | 142 |   |   | 2 | % |

The basic weighted average shares outstanding increased by 306 thousand shares, or 4%, from third quarter 2005 to the same period in 2006. The diluted weighted-average shares outstanding increased by 142 thousand shares, or 2% in the third quarter of 2006 over the same period in 2005.  These increases are primarily attributable to stock option exercises and restricted stock grants. 

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CONSOLIDATED REVENUES

(dollars in thousands)

|            |   | **Three Months Ended   September 30   (unaudited)** |   |
|-----------------|--------|-----------------------------------------------------|--------|
|            |   |                                                     |   |
|            |   | **2006**                                            |   | **2005** |   | **Change** |   | **Change** |   |
|            |   |                                                     |        |   |  |  |   |  |  |   |  |  |   |
| Device revenues |   | $                                                   | 13,425 |   | $ | 12,415 |   | $ | 1,010 |   |   | 8 | % |
| Product sales   |   |                                                | 771    |   |   | 721 |   |   | 50 |   |   | 7 | % |
| Other revenues  |   |                                                | 203    |   |   | 192 |   |   | 11 |   |   | 6 | % |
|            |   |                                                     |        |   |  |  |   |  |  |   |  |  |   |
| Total revenues  |   | $                                                   | 14,399 |   | $ | 13,328 |   | $ | 1,071 |   |   | 8 | % |
|            |   |                                                     |        |   |  |  |   |  |  |   |  |  |   |

Consolidated revenues for the third quarter of 2006 totaled $14.4 million, representing an increase of 8% over consolidated revenues of $13.3 million for the same period in 2005.

In the third quarter of 2006, device revenues increased $1.0 million, or 8%, to $13.4 million, which was primarily due to an increase in device sales over the same period in 2005.  The increase was also partially due to an increase in installed Inovoject® systems, particularly in Latin America, and new Egg Remover® installations, which were somewhat offset by reduced egg sets as customers adjusted to supply and demand factors in both domestic and export markets.  The 2006 third quarter device revenues include an increase of $0.2 million in device lease fees derived from single- and multi-year contracts and paid trials over the third quarter of 2005. These recurring fees generally contribute more than 90% of the device revenues in most quarters.  Device revenues also include sales of Inovoject® and Egg Remover® systems to distributors and human flu vaccine manufacturers. The sporadic nature of Inovoject® and Egg Remover®system sales to distributors and human flu vaccine companies may cause variability in revenue and gross profit on an annual and quarterly basis.  For the third quarter of 2006, device sales were $1.1 million, an increase of $0.8 million over the same period in 2005.   

Product sales consisted of revenues from sales of Bursaplex®, theCompany’s proprietary vaccine for avian infectious bursal disease(“IBD”).  Bursaplex® is a product that uses theCompany’s antigen-antibody complex (“AAC”) technology.  Todate, approval to sell Bursaplex® has been received in 33 countries. Currently, Bursaplex® vaccine is being marketed in most of the countrieswhere regulatory approval has been obtained.  Regulatory approvals arebeing sought in various Latin American, Middle Eastern and Asian markets for*in ovo* and post-hatch use of Bursaplex® vaccine.  Product salesfor the third quarter of 2006 totaled $0.8 million, representing an increase of7% over product sales of $0.7 million for the same period in 2005.  Thiswas primarily due to increased Bursaplex® sales in Japan.

Other revenues remained substantially unchanged at approximately $0.2 million for both the third quarter of 2006 and 2005.  Other revenues in the third quarter of 2006 consisted primarily of funding from grant sources. 

COST OF REVENUE

Gross margin decreased slightly from 58% for the third quarter of 2005 to 57% for the third quarter of 2006.  This decrease in gross margin is partially offset by certain sales and marketing expenses thatwere previously allocated to cost of revenue in 2005 and that have been retained in sales and marketing expenses in 2006 because such expenses are now primarily related to the support of the Company’s installed product base rather than the sale of the Company’s products.  Additional sales and marketing expenses may continue to be recorded under this classification rather than allocated to cost of revenue as infrastructure expands and matures. 

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Downward pressure on device lease fees, upward changes in other input costs, and regional and product mix could also cause gross margins to decrease in the future.  Depreciation expense included in cost of revenue amounted to $1.4 million and $1.1 million in the third quarters of 2006 and 2005, respectively.  Equity compensation expense included in cost of revenue amounted to $12 thousand in the third quarter of 2005.  There was no equity compensation included in cost of revenue in the third quarter of 2006.

OPERATING EXPENSES

(dollars in thousands)

|                       |   | **Three Months Ended   September 30   (unaudited)** |   |
|----------------------------|--------|-----------------------------------------------------|--------|
|                       |   |                                                     |   |
|                       |   | **2006**                                            |   | **2005** |   | **Change** |   | **Change** |   |
|                       |   |                                                     |        |   |  |  |   |  |  |   |  |  |   |
| General and administrative |   | $                                                   | 2,967  |   | $ | 2,941 |   | $ | 26 |   |   | 1 | % |
| Sales and marketing        |   |                                                | 1,949  |   |   | 1,020 |   |   | 929 |   |   | 91 | % |
| Research and development   |   |                                                | 1,986  |   |   | 2,677 |   |   | (691 | ) |   | (26 | )% |
|                       |   |                                                     |        |   |  |  |   |  |  |   |  |  |   |
| Total Operating Expenses   |   | $                                                   | 6,902  |   | $ | 6,638 |   | $ | 264 |   |   | 4 | % |
|                       |   |                                                     |        |   |  |  |   |  |  |   |  |  |   |

Operating expenses totaled $6.9 million for the third quarter of 2006 compared to $6.6 million for the same period of 2005.  The expense categories below include additional equity compensation expenses of nearly $0.1 million in accordance with SFAS 123(R) that were incurred in the third quarter of 2006.  

General and administrative (“G&A”) expenses were $3.0 million for the third quarter of 2006, a 1% increase over G&A expenses of $2.9 million for the same period of 2005.  Contributing to the increase were increases in staff-related and third-party expenses to support business growth in Latin America, increased expenses related to the start-up of Embrex Poultry Health and equity compensation expense.  Depreciation and amortization expense included in G&A amounted to $0.2 million in the third quarter of 2006 and $0.1 million in the third quarter of 2005.  Equity compensation expense included in G&A amounted to $118 thousand in the third quarter of 2006 and $71 thousand during the same quarter in 2005.  

Sales and marketing expenses were $1.9 million during the third quarter of 2006, an increase of 91% or $0.9 million over the same period in 2005.  The primary reason for the overall increase was pre-launch demonstration and marketing activities of InovocoxTM.  To a lesser extent, the increase was also due to expansion in Latin American operations and the continued support of existing products. Additionally, certain sales and marketing expenses that were previously allocated to cost of revenue in 2005 have been retained in sales and marketing expenses in 2006 because such expenses are now primarily related to the support of the Company’s installed product base rather than the sale of the Company’s products.  Additional sales and marketing expenses may continue to be recorded under this classification rather than allocated to cost of revenue as infrastructure expands and matures.  Depreciation and amortization expense included insales and marketing expenses amounted to $0.1 million in both the third quarter of 2006 and 2005. Equity compensation expense included in sales and marketing expenses amounted to $86 thousand in the third quarter of 2006 and $46 thousand in the third quarter of 2005. 

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Research and development (“R&D”) expenses decreased $0.7 million from the third quarter of 2005 to the third quarter of 2006.  Depreciation and amortization expense included in R&D expense amounted to $0.5 million in the third quarter of 2006 and $0.3 million for the same period in 2005.  Equity compensation expense included in R&D amounted to $58 thousand in the third quarter of 2006 and $26 thousand in the third quarter of 2005.  The Company’s overall R&D expenses reflect expenditures incurred in three distinct departments:

The first of these departments, R&D, is responsible for expenditures associated with the work on the Company’s product portfolio, particularly Newplex® vaccine and InovocoxTM, the *in ovo* coccidiosis vaccine.  R&D expenses increased $0.1 million from $1.2 million for the third quarter of 2005 to $1.3 million for the third quarter of 2006.  

The second of these R&D departments, Global Product Development & Supply (“GPDS”), is responsible for development and testing of commercial machine devices and supply of biological products.  During 2005 this group also was responsible for development and commercial testing related to the Gender Sort project and overseeing start-up of the Embrex Poultry Health manufacturing facility for the production of InovocoxTM. GPDS expenses were $0.7 million in the third quarter of 2005 and decreased to $0.2 million in the third quarter of 2006.  This $0.5 million reduction is primarily due to the suspension of the Gender Sort project in the third quarter of 2005.  

The third R&D department is Engineering and Manufacturing, which makesdesign modifications and improvements to the Inovoject® and EggRemover® systems, as well as the Vaccine Saver® option. Manufacturingcosts associated with Embrex Poultry Health are captured in Engineering andManufacturing expenses as well.  Operating expenses for this departmentdecreased from $0.8 million in the third quarter of 2005 to $0.5 million for thethird quarter of 2006 as some Embrex Poultry Health expenses have transitionedfrom manufacturing functions to the sales and marketing group in support ofpre-launch demonstration and marketing activities of InovocoxTMvaccine.  Depreciation expense of the Embrex Poultry Health facility andrelated manufacturing equipment was $0.2 million in the third quarter of2006.   R&D expense classifications may change as the purpose ofthe specific activity or activities change to meet the Company’s strategicand operational objectives.  In particular, a number of activities such asproduct portfolio work for Newplex® and InovocoxTM may take the form ofcommercial support.

OTHER INCOME AND EXPENSE

Net other income decreased from income of $0.1 million in the third quarter of 2005 to an expense of $0.1 million in the third quarter of 2006

Interest expense commenced in the second quarter of 2006 as the Embrex Poultry Health facility obtained USDA approval to manufacture InovocoxTM in April 2006.  The Company expects the interest expense related to the term loan to be approximately $0.2 million for the remainder of 2006.

Interest income was essentially unchanged from the third quarter of 2005 to the same period of 2006 at less than $0.1 million. 

Miscellaneous other income (expense) decreased from the third quarter of 2005 to the third quarter of 2006 primarily due to foreign currency transaction gains and losses, and had a net change of $0.1 million. 

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INCOME TAX EXPENSE

Income taxes were $476 thousand in the third quarter of 2006 compared to $490 thousand in the third quarter of 2005.  The third-quarter 2006 reported tax rate was 39%, compared to 43% for the same period in 2005.  In the third quarter of 2006, withholding taxes were $123 thousand and accounted for 10 percentage points of the 39% effective tax rate.  U.S. and non-U.S. income taxes were $353 thousand, or 29 percentage points of the 39% effective tax rate.   In the third quarter of 2005, withholding taxes amounted to $112 thousand, or 10 percentage points of the 43% tax rate, while U.S. and non-U.S. income taxes were $378 thousand and accounted for 33 percentage points of the 43% tax rate.  

Income tax expense was lower in the third quarter of 2006 due to an adjustment in the accrual for foreign income taxes as a result of the establishment of a branch office in one of the Company’s foreign markets, thereby changing the tax status and method of tax accrual for those operations. 

Nine Months Ended September 30, 2006 and 2005

CONSOLIDATED NET INCOME

(dollars in thousands except per share amounts)

|                              |   | **Nine Months Ended   September 30   (unaudited)** |   |
|-----------------------------------|--------|----------------------------------------------------|--------|
|                              |   |                                                    |   |
|                              |   | **2006**                                           |   | **2005** |   | **Change** |   | **Change** |   |
|                              |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Total Revenue                     |   | $                                                  | 40,891 |   | $ | 39,109 |   | $ | 1,782 |   |   | 5 | % |
| Gross Profit                      |   | $                                                  | 23,837 |   | $ | 22,498 |   | $ | 1,339 |   |   | 6 | % |
| Operating Income                  |   | $                                                  | 3,225  |   | $ | 3,397 |   | $ | (172 | ) |   | (5 | )% |
| Net Income                        |   | $                                                  | 2,176  |   | $ | 2,516 |   | $ | (340 | ) |   | (14 | )% |
| Earnings per share – basic   |   | $                                                  | 0.26   |   | $ | 0.32 |   | $ | (0.06 | ) |   | (19 | )% |
| Earnings per share – diluted |   | $                                                  | 0.26   |   | $ | 0.30 |   | $ | (0.04 | ) |   | (13 | )% |

Consolidated net income for the first nine months of 2006 was $2.2 million, a 14% decrease from $2.5 million for the same period in 2005.  Diluted earnings per share were $0.26 for the first nine months of 2006 and $0.30 for the same period in 2005.  Diluted earnings per share of $0.26 for the first nine months of 2006 reflects the earnings per share impact of $0.06 in severance expense, as well as depreciation and term loan interest that the Company began to expense for Embrex Poultry Health after the InovocoxTM vaccine and the facility were approved by the USDA in April, as well as a one-time election for including the Company’s Brazilian subsidiary in its consolidated federal income tax returns. Diluted earnings per share of $0.30 for the first nine months of 2005 reflects the earnings per share impact of $0.09 in capitalized InovocoxTM pre-licensure serials amounting to $0.5 million and extraterritorial income exclusions from thefiling of 2001 and 2002 amended tax returns that amounted to another $0.5 million.

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OUTSTANDING SHARES

(in thousands except percentages)

|                                          |   | **Nine Months Ended   September 30   (unaudited)** |   |
|-----------------------------------------------|--------|----------------------------------------------------|--------|
|                                          |   |                                                    |   |
|                                          |   | **2006**                                           |   | **2005** |   | **Change** |   | **Change** |   |
|                                          |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Basic Weighted Average Shares   Outstanding   |   |                                               | 8,250  |   |   | 7,970 |   |   | 280 |   |   | 4 | % |
| Diluted Weighted Average   Shares Outstanding |   |                                               | 8,482  |   |   | 8,294 |   |   | 188 |   |   | 2 | % |

The basic weighted-average shares outstanding increased 280 thousand shares, or 4%, from the first nine months of 2005 to the first nine months of 2006.  The diluted weighted-average shares outstanding increased by 188 thousand shares, or 2%, in the first nine months of 2006 compared to the first nine months of 2005.  These increases are primarily attributable to stock option exercises and restricted stock grants.   

CONSOLIDATED REVENUES

(dollars in thousands)

|            |   | **Nine Months Ended   September 30   (unaudited)** |   |
|-----------------|--------|----------------------------------------------------|--------|
|            |   |                                                    |   |
|            |   | **2006**                                           |   | **2005** |   | **Change** |   | **Change** |   |
|            |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Device revenues |   | $                                                  | 37,887 |   | $ | 36,509 |   | $ | 1,378 |   |   | 4 | % |
| Product sales   |   |                                               | 2,303  |   |   | 2,144 |   |   | 159 |   |   | 7 | % |
| Other revenues  |   |                                               | 701    |   |   | 456 |   |   | 245 |   |   | 54 | % |
|            |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Total revenues  |   | $                                                  | 40,891 |   | $ | 39,109 |   | $ | 1,782 |   |   | 5 | % |
|            |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |

Consolidated revenues for the first nine months of 2006 totaled $40.9 million, representing an increase of 5% over consolidated revenues of $39.1 million for the same period in 2005.

In the first nine months of 2006, device lease fees increased 2% or $0.7 million as compared to the first nine months of the prior year. The increase in device fees is primarily due to an increase in the Inovoject® system customer base, particularly in Latin America, as well as additional Egg Remover® installations.  Device revenues also include sales of Inovoject® and Egg Remover® systems to distributors and human flu vaccine manufacturers. The sporadic nature of Inovoject® and Egg Remover® system sales to distributors and human flu vaccine companies may cause variability in revenue and gross profit on an annual and quarterly basis. For the first nine months of 2006, this resulted in a $0.7 million increase in device sales when compared to the first nine months of 2005. Overall, device revenues totaled $37.9 million for the first nine months of 2006 compared to $36.5 million for the same period in 2005, representing a 4%increase year over year.   Although device revenues are up thus far in 2006 compared to 2005, the Company continues to have concerns based on possible avian influenza outbreaks that may disrupt global poultry production and consumption levels, adversely impacting Inovoject® injection and/or product revenues.

Product sales increased 7% to $2.3 million in the first nine months of 2006 as compared to $2.1 million for the same period in 2005, primarily due to increased Bursaplex® sales in Japan.

Other revenues of $0.7 million increased 54% from the first nine months of 2005 to the same period of 2006.  Other revenues in the first nine months of 2006 consisted primarily of funding from grant sources.  

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COST OF REVENUE

Gross margin remained unchanged at 58% for the first nine months of both 2005 and 2006. Certain sales and marketing expenses that were previously allocated to cost of revenue in 2005 have been retained in sales and marketing expenses in 2006 because such expenses are now primarily related to the support of the Company’s installed product base rather than the sale of the Company’s products.  Additional sales and marketing expenses may continue to be recorded under this classification rather than allocated to cost of revenue as infrastructure expands and matures. 

Downward pressure on device lease fees, upward changes in other input costs, and regional and product mix could cause gross margins to decrease in the future.  Depreciation expense included in cost of revenue amounted to $3.7 million and $3.2 million in the first nine months of 2006 and 2005, respectively.  Equity compensation expense included in cost of revenue amounted to $12 thousand in the first nine months of 2005.  There was no equity compensation included in cost of revenue in the first nine months of 2006.

OPERATING EXPENSES

(Dollars in thousands)

|                       |   | **Nine Months Ended   September 30   (unaudited)** |   |
|----------------------------|--------|----------------------------------------------------|--------|
|                       |   |                                                    |   |
|                       |   | **2006**                                           |   | **2005** |   | **Change** |   | **Change** |   |
|                       |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| General and administrative |   | $                                                  | 8,765  |   | $ | 8,209 |   | $ | 556 |   |   | 7 | % |
| Sales and Marketing        |   |                                               | 5,210  |   |   | 3,215 |   |   | 1,995 |   |   | 62 | % |
| Research and development   |   |                                               | 6,637  |   |   | 7,677 |   |   | (1,040 | ) |   | (14 | )% |
|                       |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Total Operating Expenses   |   | $                                                  | 20,612 |   | $ | 19,101 |   | $ | 1,511 |   |   | 8 | % |
|                       |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |

Operating expenses totaled $20.6 million for the first nine months of 2006 compared to $19.1 million for the same period of 2005. The primary reason for the overall increase was to support growth in Latin American operations and prepare for the InovocoxTM pre-launch activities.  The expense categories below include additional equity compensation expenses of nearly $0.3 million in accordance with SFAS 123(R) that were incurred in the first nine months of 2006.  Other factors are described below.

G&A expenses were $8.8 million for the first nine months of 2006, up $0.6 million or 7% compared to $8.2 million for the same period of 2005.  Contributing to the increase was severance expense of $0.1 million incurred in the first quarter of 2006, increases in staff-related and third-party expenses to support business growth in Latin America, increased expenses related to the start-up of Embrex Poultry Health and equity compensation.  Depreciation and amortization expense included in G&A amounted to $0.5 million in the first nine months of 2006 and $0.4 million in the first nine months of 2005.  Equity compensation expense included in G&A amounted to $323 thousand in the first nine months of 2006 and $183 thousand for the same period of 2005.  

Sales and marketing expenses for the first nine months of 2006 were $5.2 million, up $2.0 million compared to $3.2 million for the same period in 2005.  The primary reason for the overall increase was growth in marketing expenses related to pre-launch demonstration and marketing activities of InovocoxTM.  To a lesser extent, the increase was also due to expansion in Latin American operations and the continued support of existing products.

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Additionally, certain sales and marketing expenses that were previously allocated to cost of revenue in 2005 have been retained in sales and marketing expenses in 2006 because such expenses are now primarily related to the support of the Company’s installed product base rather than the sale of the Company’s products.  Additional sales and marketing expenses may continue to be recorded under this classification rather than allocated to cost of revenue as infrastructure expands and matures.  Depreciation and amortization expense included in sales and marketing expenses amounted to $0.3 million in both the first nine months of 2006 and 2005.  Equity compensation expense included in sales and marketing expenses amounted to $249 thousand in the first nine months of 2006 and $114 thousand in the first nine months of 2005. 

R&D expenses decreased approximately $1.0 million from $7.7 million for the first nine months of 2005 to $6.6 million for the same period of 2006.  The decrease is principally due to reduced expenses related to the Gender Sort project, which was suspended in the third quarter of 2005, although partially offsetting this was severance expense of $0.3 million incurred in the first nine months of 2006.  Depreciation and amortization expense included in R&D expenses amounted to $1.3 million in the first nine months of 2006 and $0.8 million for the first nine months of 2005.  Equity compensation expense included in R&D expenses amounted to $172 thousand in the first nine months of 2006 and $67 thousand in the first nine months of 2005.  Depreciation expense of the Embrex Poultry Health facility and related manufacturing equipment was $0.4 million in the first nine months of 2006.  Approximately $0.5 million of thisdepartment’s expenses were capitalized in 2005 related to validation costs for USDA pre-licensing serials of InovocoxTM vaccine for the Embrex Poultry Health facility.  Without this capitalization, R&D expenses for the first nine months of 2006 would have shown a decrease of an additional $0.5 million, for a reduction of 19% from the first nine months of 2005.

OTHER INCOME AND EXPENSE

Net other income decreased from $307 thousand in the first nine months of 2005 to $17 thousand in the first nine months of 2006.  The reduction results primarily from interest expense related to the term loan for construction of the Embrex Poultry Health facility, which was not reflected in 2005 interest expense totals, as that interest cost was capitalized as part of the construction cost of the facility.   Also contributing to the decrease was lower currency translation gains in 2006 as compared to the same period in 2005.

Interest income totaled $161 thousand for the first nine months of 2006, a $53 thousand increase in comparison to the same period of 2005.  The increase in interest income is mainly due to higher cash balances held in non-U.S. regions, where higher interest rates prevailed in 2006 as compared to 2005. 

Interest expense in the first nine months of 2006 increased seven-fold over the same period of 2005 to $218 thousand.  This increase is primarily due to interest for the Embrex Poultry Health construction term loan that was previously capitalized prior to licensure of the Embrex Poultry Health facility and InovocoxTM vaccine.

Other income totaled $74 thousand in the first nine months of 2006, a $153 thousand decrease in comparison to the same period of 2005.  The other income in both periods is primarily related to foreign currency transaction gains and losses. 

INCOME TAX EXPENSE

Income taxes totaled $1.1 million for the first nine months of 2006, a $0.1 million decrease in comparison to the same period in 2005. The reported tax rate for the first nine months of 2006 was 33% in comparison to the 32% reported tax rate for the first nine months of 2005.  In the first nine months of 2006, withholding taxes were $0.4 million and accounted for 11 percentage points of the 33% effective tax rate.  U.S. and non-U.S. income taxes were $0.7 million and accounted for 22 percentage points of the 33% effective tax rate.   In the first nine months of 2005, withholding taxes amounted to $0.4 million, or 12 percentage points of the 32% effective tax rate.  U.S. and non-U.S. income taxes were $0.8 million, or 20 percentage points of the 32% effective tax rate.  

28

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The decrease in income tax expense for the first nine months of 2006 in comparison to the same period of 2005 was primarily due to lower pre-tax net income and slightly reduced foreign withholding taxes from the first nine months of 2005 to the same period of 2006.  Partially offsetting these reductions was an income tax increase caused by a difference between individual discrete events that occurred in the first nine months of 2006 and 2005.  During the first nine months of 2006, the Company filed an election to change the U.S. tax classification of one of its subsidiaries.  As a result of this election, an adjustment was recorded that increased the deferred tax asset and reduced the provision for income taxes.  The tax benefit related to this adjustment was approximately $0.4 million and was recorded as a discrete benefit in the first nine months of 2006.  In the first nine months of 2005, a tax benefit of $0.5 million was recorded fromthe filing of amended tax returns.  The returns were amended to reflect the Company’s claim for the extraterritorial income exclusion in 2001 and 2002.  

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2006, the Company’s cash and cash equivalents balances totaled $3.0 million compared to $2.0 million at December 31, 2005. 

During the first nine months of 2006, more than $8.7 million of cash flow was generated by operating activities.  Of this, $2.2 million was generated by net income and $5.8 million in cash flows from operations was related to depreciation and amortization.  Non-cash equity-based compensation charges and a related tax benefit provided $0.9 million, and the balance was primarily a result of changes in working capital.

Cash from operations was invested in $9.1 million of capital expenditures, of which $7.3 million or approximately 80% was used to acquire revenue generating devices, such as Inovoject® and Egg Remover® systems.  Approximately $0.5 million was invested in Embrex Poultry Health while the remainder was invested in other capital items.  Another $1.6 million was invested in patents and intellectual property protection.

Approximately $1.1 million was provided from the issuance of Common Stock related to the exercise of stock options and purchases under the Company’s Employee Stock Purchase Plans.  

Drawdown on the Company’s short-term revolving line of credit provided $1.6 million, while repayments of long-term debt used to fund most of the Embrex Poultry Health manufacturing facility consumed $0.3 million.  

Consequently, the Company generated $0.4 million of cash during the first nine months of 2006.  

The Company obtained a $9.0 million construction/term loan from Branch Banking & Trust Co. (BB&T) in August 2003 that was used for building and equipping the Embrex Poultry Health facility located in Scotland County, North Carolina.  At September 30, 2006, $8.2 million of the construction/term loan was outstanding.  

The Company has a $6.0 million secured revolving line of credit with BB&T, which may be used for working capital purposes.  The term of this line of credit has been extended to May 2007.  The line of credit carries an interest rate of the current LIBOR plus 1.25%, which has been reduced 20 basis points since the second quarter of 2006.  At September 30, 2006, the Company’s outstanding borrowings under this credit facility were $1.6 million.   

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The terms of the construction/term loan and the line of credit require the Company to maintain a ratio of total current assets to total current liabilities, or current ratio, of 2.0 to 1.0.  As of the end of the third quarter of 2006, the Company’s current ratio was approximately 1.925 to 1.0.  This current ratio was the result of the timing of certain payments made by or due to the Company near the end of the third quarter 2006, and the Company does not believe that this timing has had any material effect on the Company’s liquidity and capital resources.  Embrex has since obtained a waiver from BB&T of the current ratio requirement through December 31, 2006, and the line of credit remains available for use.

Based on its current operations, management believes that the Company’s available cash and cash equivalents, together with cash flow from operations and its bank line of credit, will be sufficient to meet its cash requirements as these currently exist.  However, Embrex may continue to explore additional alternative funding opportunities with respect to collaborative ventures and product expansion and would evaluate its cash requirements as appropriate.

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of potential loss arising from adverse changes in market rates and prices.  The Company’s primary market risk exposure is in changes in foreign currency exchange rates.  Approximately 37%, 34% and 32% of Embrex’s revenues for the years ended December 31, 2005, 2004 and 2003, respectively, were derived from the Company’s operations outside the United States. The Company’s consolidated financial statements are denominated in U.S. Dollars and, accordingly, changes in the exchange rates between foreign currencies and the U.S. Dollar will affect the translation of the Company’s subsidiaries’ financial results into U.S. Dollars for purposes of reporting the Company’s consolidated financial results.  From December 31, 2005 to September 30, 2006, the Pound Sterling and Euro appreciated 9% and 7% against the U.S. Dollar, respectively.  Certain Asian and Latin American currencies appreciatedagainst the U.S. Dollar as well, particularly the Brazilian Real, which appreciated 5% against the U.S. Dollar during the same period.  If average exchange rates during the first nine months of 2006 had remained the same as the average exchange rates for these currencies during the same period of 2005, the Company’s revenues for the first nine months of 2006 would have been approximately $40.5 million instead of $40.9 million, representing a year-to-year growth rate of 4% as compared to the actual exchange-adjusted growth rate of 5%.  

Accumulated currency translation adjustments recorded as a separate component of shareholders’ equity were $1.0 million at September 30, 2006 as compared with $0.3 million at December 31, 2005. This increase was mainly attributable to the overall weakening of the U.S. Dollar with respect to the currencies in which the Company has an exchange rate risk. The primary contributor to the change in currency translation adjustments was the Latin America region, specifically Brazil.  

In addition to currency translation risk described above, the Company is subject to transaction risk. Transaction risk is the risk of potential loss arising from adverse changes in exchange rates from the date invoices are issued until the receipts are collected.  Most of Embrex’s transaction risk resides in the Company’s largest subsidiary, Embrex Europe, where accrued revenues are recorded in the functional currency, British Pounds.  However, most of Embrex Europe’s revenues are invoiced in U.S. Dollars or Euros.  When revenues are collected, there is a risk that changes in the respective exchange rates could cause the amount collected (when converted to British Pounds) to be less than originally accrued.  As the Company’s business grows in other markets, such as Brazil, it expects that transaction and translation risk may increase in these markets.  To date, the Company has not utilized any derivative financialinstruments or other hedging instruments to affect this exposure.  

30

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As of September 30, 2006, the Company’s exposure to market risk for a change in interest rates is related to debt outstanding under the term loan used for construction and equipping of the Embrex Poultry Health facility and the short-term revolving line of credit.  At September 30, 2006, the variable rate debt outstanding that was exposed to fluctuations in the market rate of interest under the term loan totaled $8.2 million.  The variable rate debt outstanding that was exposed to fluctuations in the market rate of interest under the line of credit totaled $1.6 million. The definitive extent of the Company’s interest rate risk under this term loan is not quantifiable or predictable because of the variability of future interest rates and business financing requirements.  Based on the current balance outstanding, an increase in the LIBOR of 100 basis points would increase the Company’s annualized interest expense by approximately $0.1million.  

Item 4.     Controls and Procedures   

*Disclosure Controls and Procedures*

The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to provide reasonable assurances that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer and Vice President, Finance and Administration (the Company’s Chief Financial Officer), as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well designed and operated,can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  

An evaluation was carried out under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer believe, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in that they provide reasonable assurances that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.  

*Changes to Internal Control Over Financial Reporting*

The Company routinely reviews its internal control over financial reporting and from time to time makes changes intended to enhance the effectiveness of its internal control over financial reporting.  The Company made no changes in its internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ending September 30, 2006 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.  The Company has comprehensively assessed financial controls related to a subsidiary operation that has become material to its financial reporting for the fiscal year ended December 31, 2005.  Activities to strengthen the control environment at the subsidiary are ongoing.

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PART II – OTHER INFORMATION

Item 1.     Legal Proceedings  

In December 2003, Embrex filed suit in the U.S. District Court for the EasternDistrict of North Carolina against Breuil S.A. (“Breuil”) ofLandivisiau, France, and New Tech Solutions, Inc. of Gainesville, Georgia,asserting patent infringement.  Embrex alleges that each of thedefendants’ development of candling and in ovo selective injection devices,designed to compete with Embrex’s patented Inovoject® system injectionwith Vaccine Saver® option and Egg Remover® system, infringes twoEmbrex patents related to Embrex’s proprietary apparatus and methods fordistinguishing live eggs from infertile or “dead” eggs and forselectively injecting specific eggs identified as suitable for inoculation aswell as the apparatus performing this function.  Embrex seeks injunctiverelief and monetary damages and has asked for a jury trial.  The defendantshave denied infringement and alleged that Embrex’s two patents areinvalid.  Fact discovery is nearly completed. The court conducted a Markmanhearing to determine the meaning and scope of the patent claims. The courtissued a Markman opinion adopting Embrex’s claim construction.  Breuilfiled a motion for summary judgment on patent marking.  Embrex opposed themotion.  The court granted Breuil’s motion as to both patents for theVaccine Saver® option, and denied Breuil’s motion as to one patent forthe Egg Remover® system.  Breuil also filed a motion for leave to filea supplemental answer and counterclaims to include an alleged affirmativedefense of patent misuse, a counterclaim for alleged federal antitrust liabilityand a counterclaim for alleged trade secret misappropriation.  The courtgranted the motion.  Embrex answered the supplemental counterclaims denyingany liability and asserting affirmative defenses.  Embrex filed a motionfor summary judgment of infringement and a motion for summary judgment of patentvalidity.  Briefing on the motions is completed.  The court’sdecision is pending. On August 30, 2006, Breuil and New Tech Solutions’attorneys filed a motion to withdraw as counsel for the defendants.  OnSeptember 7, 2006, the Court granted the motion.  The Court also orderedBreuil and New Tech Solutions to retain new counsel and file a notice ofappearance on or before October 2, 2006.  The Court’s Order furtherstates that failure to do so will result in this matter being referred to thepresiding District Judge for appropriate sanctions, including the possibility ofentry of judgment in favor of Embrex.

Breuil and New Tech Solutions failed to retain new counsel as directed.  On October 5, 2006, the Court entered an Order ordering Breuil and New Tech Solutions to appear at a Show Cause Hearing on October 19, 2006 to show cause why they have failed to retain new counsel.  The Order further stated that the failure of Breuil and New Tech Solutions to attend the hearing and to establish good cause will result in a recommendation that judgment be entered against Breuil and New Tech Solutions for failure to defend and to comply with the court’s orders.

On October 19, 2006, Breuil and New Tech Solutions failed to appear at the Show Cause Hearing.  At the hearing, the court advised Embrex that the court intends to issue a Memorandum and Recommendation recommending that judgment be entered against Breuil and New Tech Solutions, and permitting Embrex to submit to the Court proposed terms for a permanent injunction and an accounting of damages.  Because of this lawsuit, the Company’s results of operations have been impacted and will continue to be impacted by the costs of pursuing this litigation. Moreover, there can be no assurance the Company will prevail in its claims against Breuil  or New Tech Solutions, Inc.  Even if the court finds in Embrex’s favor, the Company has no assurances that any damage award will exceed the Company’s costs of pursuing this litigation or that the Company would be able to collect any damages from either defendant.  

In August 2004, Embrex filed suit in the U.S. District Court for the Middle District of North Carolina against AviTech, LLC (“AviTech”) of Hebron, Maryland asserting patent infringement.  Embrex alleges that AviTech’s injection system, designed to compete with the Company’s patented Inovoject® system, infringes one of the Company’s patents related to the Company’s proprietary apparatus and methods for accurately and precisely injecting eggs to the same depth and location when the eggs are of varying sizes and may be presented to the injection apparatus in somewhat different orientations.  The Company seeks injunctive relief and monetary damages and has asked for a jury trial.  The defendant denied that the North Carolina court has jurisdiction and moved to dismiss or, in the alternative, for transfer to the United States District Court in Maryland.  The Company opposed the defendant’s motion. The court heard oral argument on the motion, granted the defendant’s motion in part and transferred the case to the U.S. District Court for the District of Maryland, Northern Division, where AviTech filed a complaint against Embrex for a declaratory judgment of alleged patent invalidity, patent noninfringement, patent unenforceability and monetary damages based on an alleged antitrust claim.  Embrex filed a motion to dismiss AviTech’s declaratory judgment claims.  The court granted the motion with respect to the antitrust claim, and allowed Avitech to file a motion to replead with the necessary particularity.  Discovery on the patent issues is nearly completed and discovery on the antitrust issues recently commenced.  The parties have filed cross-motions for summary judgment on the patent infringement and validity issues.  Briefing on the cross-motions is ongoing and is expected to be completed in November 2006.  Because of this lawsuit, the Company’s results of operations have been impacted and will continue to be affected by the costs of pursuing this litigation. Moreover, there can be no assurance the Company will prevail in its claims against AviTech or that the Company will be able to successfully defend against AviTech’s claims.  Even if the court finds in the Company’s favor, the Company has no assurances that any damage award will exceed the Company’s costs of pursuing this litigation or that the Company would be able to collect any damages from the defendant. 

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For a description of patent infringement proceedings initiated by the Company and related legal proceedings, see the Company’s Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission on March 8, 2006.

Item 1A.     Risk Factors

If any of the following risks occur, our business, financial condition or results of operations could be materially adversely affected.

***OUR FUTURE GROWTH DEPENDS ON EXPANSION OF INTERNATIONAL REVENUES AND WE WILL BE SUBJECT TO INCREASED RISKS IN THE INTERNATIONAL MARKETPLACE***

We estimate that our Inovoject® system inoculates approximately 85% of all eggs produced for the U.S. and Canadian broiler poultry markets.  Given this market penetration, we expect only limited growth in the number of system installations and only minor system revenue growth in this market.  Additionally, due to our market penetration and the significance of the U.S. and Canadian poultry markets to our revenue, any adverse conditions in these markets could have a material and adverse effect on our revenues.  For this reason, we must expand our device installations and product sales in markets outside the United States and Canada in order to realize revenue growth.  In 2005, international sales accounted for 37% of our consolidated revenues.  In 2004 and 2003, international sales accounted for 34% and 32% of our consolidated revenues, respectively.  Revenue growth outside the United States and Canada depends on gaining andpreserving market acceptance of our devices and*in ovo* administration of vaccine products in markets outside the United States and Canada to treat prevailing poultry diseases in those markets.  Lack of market acceptance of our devices and*in ovo* products in these markets would materially adversely affect our revenue growth.  Our operating expenses associated with operations outside the United States and Canada historically have been relatively higher as a percentage of revenues than similar costs for operations inside the United States and Canada.  Accordingly, we believe that international sales may result in decreased gross margin percentages for Embrex.

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International sales are also subject to a variety of risks, including risks arising from the following:

|   | • | exchange rate risks (including   risk associated with the translation of our subsidiaries’ financial results   into U.S. Dollars and transaction risk), tariffs, trade barriers and taxes;                                                                                                             |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                        |
|   | • | adverse changes in local   investment or exchange control regulations, potential restrictions on the   flow of international capital and the possibility of confiscatory taxation,   price controls or the taking or modification of our property rights by a   country in the exercise of its sovereignty; |
|   |   |                                                                                                                                                                                                                                                                                                        |
|   | • | economic and political   conditions beyond our control, including country-specific conditions such as   political instability, government corruption and civil unrest;                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                        |
|   | • | the risk that we may not be   granted a renewal license due to regulatory changes or other reasons with   respect to current product registrations in certain foreign countries that   are subject to periodic re-registration; and                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                        |
|   | • | trade restrictions and economic   embargoes imposed by the United States and other countries.                                                                                                                                                                                                               |

***OUR FUTURE GROWTH ALSO DEPENDS ON THE DEVELOPMENT AND MARKET ACCEPTANCE OF NEW PRODUCTS***

In addition to international expansion, we need to develop and market new products to continue to generate increased revenues and growth of our business.  We currently are developing, both independently and in collaboration with others, various products that address poultry health and performance needs.  These products are being designed to be delivered*in ovo* through the Inovoject® system or in conjunction with the Inovoject® system and are in various stages of development.  We may increase, decrease or eliminate funding for any product under development at any time depending on our assessment of our priorities, available funding, the probability that the product can be successfully commercialized, potential return on investment and other factors. There is no guarantee that any new products will be successfully developed and marketed.  In addition, we have not initiated the regulatory approval process for some of thesepotential products, and we cannot assure you that regulatory approval will be obtained.  Our inability to develop new products or any delay in our development of these products may materially adversely affect our revenue growth.  Because of a number of factors, a new product may not reach the market without lengthy delays, if at all.  Some of the factors that may affect our development and marketing of new products include the following:

|   | • | our research and evaluations   of compounds and new technologies may not yield product opportunities;                                                                                                                                       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                        |
|   | • | potential products may involve   extensive and time-consuming clinical trials to demonstrate safety and   effectiveness, and the results of such trials are uncertain;                                                                      |
|   |   |                                                                                                                                                                                                                                        |
|   | • | potential products may require   collaborative partners and we may be unable to identify partners or enter   into arrangements on terms acceptable to us;                                                                                   |
|   |   |                                                                                                                                                                                                                                        |
|   | • | we may not be able to produce   or contract for the manufacture of new products at a cost or in quality or   quantities necessary to make them commercially viable;                                                                         |
|   |   |                                                                                                                                                                                                                                        |
|   | • | domestic and international   regulatory approval of these products may not be obtained or may be obtained   only with lengthy delays;                                                                                                       |
|   |   |                                                                                                                                                                                                                                        |
|   | • | we may not be able to secure   additional financing that may be needed to bring a potential product to   market;                                                                                                                            |
|   |   |                                                                                                                                                                                                                                        |
|   | • | we may experience unexpected   safety, regulatory or efficacy concerns with respect to marketed products,   whether or not scientifically justified, leading to adverse public reaction,   product recalls, withdrawals or declining sales; |
|   |   |                                                                                                                                                                                                                                        |
|   | • | marketing products developed   jointly with other parties may require royalty payments or other payments by   us to our co-developers, which may materially adversely affect our profitability;                                             |
|   |   |                                                                                                                                                                                                                                        |
|   | • | we may be unable to accurately   predict market requirements and evolving standards; and                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                        |
|   | • | we may not be able to attract   and retain sufficient numbers of qualified development personnel.                                                                                                                                           |

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We have developed and commercialized two devices that work with the Inovoject® system: the Egg Remover® and Vaccine Saver®.  The Egg Remover® can also be used without an Inovoject® system in specific situations where customers do not need injection services.  These two devices have had initial success; however, there is no guarantee that acceptance of these devices will continue to grow.

In April 2006, the USDA granted our InovocoxTM coccidiosis vaccine forpoultry a Veterinary Biological Product License which allows us to market andsell the product in the United States. Simultaneously, the USDA granted aVeterinary Biologics Establishment License to Embrex Poultry Health LLC, ourmanufacturing subsidiary based in Scotland County, North Carolina, where the newvaccine will be manufactured, packaged and shipped to customers.  Marketingthis product in non-U.S. countries will require us to pursue separate approvalsfrom foreign regulatory agencies.  There is no assurance that approvals inother markets will be granted, supplies will be available or that InovocoxTMwill be sold in commercial quantities in the United States or in any of theother countries where approval may be obtained, or that product sales will besufficient to offset our investment in development of the product andconstruction of the InovocoxTM vaccine manufacturing facility.

We have developed and commercialized AAC, which is technology that we use in our Bursaplex® vaccine.  Bursaplex® has been sold in commercial quantities during the past six years, and we currently have approval to sell it in 33 countries.  However, there is no assurance that supplies will continue to be available or that the product will continue to be sold in commercial quantities.

In May 2003, the USDA provided regulatory approval of Newplex®, our*inovo* Newcastle Disease vaccine, within the United States.  Newplex®vaccine is also based on AAC technology.  Although we have receivedapproval to sell Newplex® in nine countries, we have recently discovereddifficulties in the formulation and production of Newplex®, which hasaffected manufacturing on a consistent basis. While we resolve these issues wemay not have product supplies available.  There is no assurance that wewill resolve these manufacturing issues, that supplies will be available, thatNewplex® will be sold in commercial quantities in the United States or inany of the other countries where approval has been obtained or that approvals inother markets will be granted.  

There can be no assurance that we will successfully complete the development and commercialization of any new products, or that any of these new products will meet revenue and profit expectations if developed and commercialized.

***ECONOMIC FACTORS AFFECTING OUR CUSTOMERS MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS***

Our revenues principally come from leases and sales to the poultry industry.  If there is a general economic decline in that industry, our operations and financial condition could be materially and adversely affected.  Also, domestic and global economic factors beyond our control may adversely impact our customers and, as a result, our revenues and earnings.  Examples of these factors include the following:

|   | • | fluctuations in the prices of   energy and poultry feed;                                 |
|--------|--------|------------------------------------------------------------------------------------------|
|   |   |                                                                                     |
|   | • | disease outbreaks that   adversely affect poultry production, including avian influenza; |

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|   | • | market demand for poultry   products, including the supply and pricing of alternative proteins;                                                                                                     |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                |
|   | • | costs to comply with   applicable laws and regulations, including those relating to environmental   protection, food safety, market regulation and genetically modified organisms   or ingredients; |
|   |   |                                                                                                                                                                                                |
|   | • | product recalls and related   adverse publicity and consumer reaction;                                                                                                                              |
|   |   |                                                                                                                                                                                                |
|   | • | access to domestic or export   markets together with global economic conditions, including currency   fluctuations and trade restrictions; and                                                      |
|   |   |                                                                                                                                                                                                |
|   | • | the extent to which our cost   of products and operating expenses increase faster than contractual price   adjustments with our customers.                                                          |

For example, if rising poultry feed prices increase the production costs of commercial poultry producers or any government bans the importation of U.S. chicken or chicken sourced from other key poultry producing countries, these producers may reduce poultry production.  This decreased production could adversely impact our revenues since a principal component of our revenues are fees charged to customers for the number of eggs injected or processed by our devices, and to a lesser extent products sold to customers, such as vaccines.

***POULTRY HEALTH AND DISEASE FACTORS AFFECTING OUR CUSTOMERS MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS***

Any poultry health problem or disease outbreak, such as avian influenza in poultry, could have a negative impact on our key markets and global poultry production.  Our revenues and earnings derived from the U.S. and certain key international markets, as well as the international poultry industry in general could be materially and adversely affected.  In addition, the emergence of new disease variants, serotypes and strains in the domestic and/or global markets may reduce the efficacy of our vaccine products and result in reduced revenues and earnings.  

***WE FACE RISKS OF COMPETITION AND CHANGING TECHNOLOGY***

The Inovoject® system uses a process that was patented in the United States by the USDA in 1984.  We held the exclusive license to the Sharma Patent until June 2002, when the Sharma Patent expired.  With the expiration of the Sharma Patent, competitive*in ovo* delivery systems are being developed and marketed.  Embrex is aware of four companies that are marketing *in ovo* injection systems to poultry companies.  Although there has not been widespread commercial acceptance of any of these competing systems, we are aware of direct competition for customers and limited commercial placements by some of these companies, including with some of our customers.  Increased competition could result in lower prices for our products, reduced demand for our products and a corresponding reduction in our ability to recover development, engineering, manufacturing and service costs.  Also, a significant portion of our revenues comesfrom a relatively small number of customers.  If we lose one or more large customers due to competition, our revenues could be significantly lower.  Any of these developments could have a material adverse effect on our business, results of operations and financial condition.

The poultry vaccine business is especially competitive and dominated by a few large companies with an established global presence.  In order for us to expand our sales of*in ovo* vaccines, these products must be commercially accepted worldwide and compete effectively against the vaccines of these other companies.  Our inability to compete successfully in the poultry vaccine sector could materially adversely affect our revenue growth.

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Our competitors and potential competitors include independent companies that specialize in biotechnology, as well as major agricultural or animal health companies, pharmaceutical companies, chemical companies, universities and public and private research organizations.  Many of these competitors are well established and have substantially greater marketing, financial, technological and other resources than we have.  Competitors may succeed in developing technologies and products that are more effective than any that have been or are being developed by us or that could render our technology and products obsolete or non-competitive.

***THE LOSS OF KEY CUSTOMERS COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS***

Historically, a significant portion of our revenues has come from a relatively small number of customers. Tyson Foods, Inc. (Tyson) accounted for approximately 17% and 18% of our consolidated 2005 and 2004 revenues, respectively.  The only other customer representing greater than 10% of total consolidated revenues is Pilgrim’s Pride Inc. (Pilgrim’s), representing 11% and 12% of consolidated 2005 and 2004 revenues, respectively.  As with many of our customers, we have short-term contracts with Tyson and Pilgrim’s.  Our top three customers, including Tyson and Pilgrim’s, accounted for approximately 33% and 36% of our consolidated 2005 and 2004 revenues, respectively.  We expect a similar level of customer concentration to continue in future years.  The poultry market is highly concentrated, with the largest poultry producers dominating the market.  For example, in 2005, Tyson and Pilgrim’s supplied approximately23% and 15% of all broilers grown in the United States, respectively.  The concentration of our revenues with these large customers means factors affecting those customers also will impact our revenues and earnings.  If we lose a large customer and fail to add new customers to replace lost revenues, our operating results will be materially and adversely affected.  Also, if these customers reduce the number of eggs they incubate at hatcheries, we will receive lower device revenues since our fees are based on the number of eggs injected.

***IF WE LOSE THE PROTECTION OF OUR PATENTS AND PROPRIETARY RIGHTS, OUR FINANCIAL RESULTS COULD SUFFER***

Some of our products and processes used to produce our products involve proprietary rights, including patents.  We own some of the technologies employed in these processes, and some are owned by others and licensed to us.  The Inovoject® system utilizes a process that was patented by the USDA in the United States.  We held an exclusive license to the Sharma Patent until it expired in June 2002.  We have supplemented the Sharma Patent with additional U.S. and foreign patents and have submitted additional patent applications covering specific design features of the Inovoject® system, as well as Embrex’s Egg Remover® system and Vaccine Saver® option.  Our competitors or potential competitors may have filed for or received United States and foreign patents and may obtain additional patents and proprietary rights relating to *in ovo* technology, vaccines, uses and/or processes which may compete with our existingproducts and our products under development.  Accordingly, we cannot assure you that our patent applications will result in patents being issued or that, if issued, the claims under our patents will afford protection against competitors with similar technology.  We cannot be sure that others will not obtain patents of different technology that we would need to license or circumvent in order to practice our inventions.  Even though we strive to take appropriate action to protect our intellectual property, there is a risk that competitive systems currently being developed and marketed could gain acceptance in the United States or elsewhere.

We believe that patent protection of materials or processes we develop and any products that may result from the research and development efforts of our licensors and us are important to the commercial success of our products.  The loss of the protection of these patents and proprietary rights could materially adversely affect our business and our competitive position in the market.  The patent position of companies such as ours generally is highly uncertain and involves complex legal and factual questions.  Some of the reasons for this uncertainty include the following:

|   | • | To date, no consistent   regulatory policy has emerged regarding the breadth of claims allowed in   biotechnology patents.  Consequently,   there can be no assurance that patent applications relating to our products   or technology will result in patents being issued or that, if issued, the   patents will afford protection against competitors with similar technology; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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|   | • | Some patent licenses held by   us may be terminated upon the occurrence of specified events or become   non-exclusive after a specified period;                                                                                                                                                     |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                |
|   | • | Companies that obtain patents   claiming products or processes that are necessary for or useful to the development   of our products could bring legal actions against us claiming infringement   (though we currently are not the subject of any patent infringement claim);                       |
|   |   |                                                                                                                                                                                                                                                                                                |
|   | • | Issuance of a valid patent   does not prevent other companies from using alternative, non-infringing   technology, so we cannot be sure that any of our patents (or patents issued   to others and licensed to us) will provide significant commercial protection;                                  |
|   |   |                                                                                                                                                                                                                                                                                                |
|   | • | We may not have the financial   resources necessary to obtain patent protection in some countries or to   enforce any patent rights we may hold;                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                |
|   | • | The laws of some foreign   countries may not protect proprietary rights to the same extent as the laws   of the United States, and many companies have encountered significant   problems in protecting their proprietary rights in these foreign countries;                                        |
|   |   |                                                                                                                                                                                                                                                                                                |
|   | • | We may be required to obtain   licenses from others to develop, manufacture or market our products.  We may not be able to obtain these   licenses on commercially reasonable terms, and we cannot be sure that the   patents underlying the licenses will be valid and enforceable; and       |
|   |   |                                                                                                                                                                                                                                                                                                |
|   | • | We also rely upon unpatented,   proprietary technology, which we may not be able to protect fully if others   independently develop substantially equivalent proprietary information or   techniques, improperly gain access to our proprietary technology or disclose   this technology to others. |

We attempt to protect our proprietary materials and processes by relying on trade secret laws and non-disclosure and confidentiality agreements with our employees and other persons with access to our proprietary materials or processes or who have licensing or research arrangements with us.  We plan to continue to use these protections in the future, but we cannot be sure that these agreements will not be breached or that we would have adequate remedies for any breach.  Even with these protections, others may independently develop or obtain access to these materials or processes, which may materially adversely affect our competitive position.

If we are sued for infringing the patent or other proprietary rights of a third party, we could incur substantial costs and diversion of management and technical personnel, whether or not the litigation is ultimately determined in our favor.

For a description of the patent litigations in which we have been involved, see Part II, Item 1, “Legal Proceedings,” above.

***WE DO NOT MANUFACTURE MOST OF OUR DEVICES OR VACCINE PRODUCTS. WE ARE DEPENDENT ON ONE CONTRACT MANUFACTURER FOR INOVOJECT® AND EGG REMOVER® DEVICES AND ANOTHER CONTRACT MANUFACTURER FOR A KEY COMPONENT OF AAC PRODUCTION.  WE ARE ALSO DEPENDENT ON SINGLE CONTRACT MANUFACTURERS FOR PRODUCTION OF BOTH BURSAPLEX® AND NEWPLEX® ***

General Risks Associated with Reliance on Contract Manufacturers

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We currently do not have facilities for the production of most of our devices and vaccine products.  Therefore, we rely principally upon relationships with contract manufacturers.  There can be no assurance that we can maintain manufacture and supply agreements on terms and at costs acceptable to us.  We have various relationships with manufacturers and suppliers, including those described below.  The loss of any of these relationships could materially adversely affect our operating results.  There are a number of risks associated with our dependence on contract manufacturers, including:

|   | • | reduced control over delivery   schedules;                                                                                                                                                        |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                              |
|   | • | potential inability to monitor   and maintain inventory levels;                                                                                                                                   |
|   |   |                                                                                                                                                                                              |
|   | • | reduced control over quality   assurance;                                                                                                                                                         |
|   |   |                                                                                                                                                                                              |
|   | • | reduced control over   manufacturing yields and costs;                                                                                                                                            |
|   |   |                                                                                                                                                                                              |
|   | • | potential lack of adequate   capacity during periods of unanticipated demand;                                                                                                                     |
|   |   |                                                                                                                                                                                              |
|   | • | limited warranties on products   supplied to us;                                                                                                                                                  |
|   |   |                                                                                                                                                                                              |
|   | • | increases in prices at a   higher rate than our ability to recover our increased costs through   contractual price adjustments with our customers;                                                |
|   |   |                                                                                                                                                                                              |
|   | • | reduced control over   regulatory efforts;                                                                                                                                                        |
|   |   |                                                                                                                                                                                              |
|   | • | potential misappropriation of   our intellectual property;                                                                                                                                        |
|   |   |                                                                                                                                                                                              |
|   | • | catastrophic loss of   production capacity due to property damage, either man-made or by nature;                                                                                                  |
|   |   |                                                                                                                                                                                              |
|   | • | the loss of these contract   manufacturers due to financial circumstances in their respective businesses   or their exit from the business lines that manufacture our devices and   products; and |
|   |   |                                                                                                                                                                                              |
|   | • | minimum purchase requirements,   which could result in excessive inventories if the demand for products falls   short of such minimum purchase requirements.                                      |

If our contract manufacturers failed to provide us with an adequate supply of finished devices or vaccine products, our business would be harmed.  We do not have long-term contracts or arrangements with several of our vendors that guarantee product availability or the continuation of particular payment terms.  In addition, we are currently dependent on a single contract manufacturer for several of our key products as described below.  Although we believe our relationships with our contract manufacturers generally are sound, we cannot assure you that we will continue to maintain relationships with them or that they will continue to exist.

Inovoject® and Egg Remover® Systems

We rely on Precision Automation Company, Inc. (Precision) to fabricate all of our Inovoject® and Egg Remover® systems.  While other machine fabricators exist and have constructed limited numbers of Inovoject® systems, we do not currently have alternative sources for production of either the Inovoject® or Egg Remover® systems.  If Precision is unable to carry out its manufacturing obligations to our satisfaction, we may be unable to obtain alternative manufacturing, or to obtain such manufacturing on commercially reasonable terms or on a timely basis.  Any delays in the manufacturing process may adversely impact our ability to meet commercial demands for Inovoject® and Egg Remover® system installations and delay receipt of revenues from those installations.

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Vaccines and AAC Technology

We obtain all of our requirements for one of the active ingredients in AAC technology from Charles River Laboratories, Inc. through its SPAFAS Avian Products Services Divisions (SPAFAS).  Currently our sole manufacturer for Bursaplex® is Merial Select, Inc. (Select), and our sole manufacturer for Newplex® is a subsidiary of Lohmann Animal Health International (LAHI).  The manufacture of AAC antibody and all vaccines must be performed in licensed facilities and is subject to USDA regulation.  The regulatory approvals granted by the USDA for Bursaplex® in January 1997 and for Newplex® in May 2003 specifically cover vaccines produced with SPAFAS-manufactured AAC antibody.  

As the USDA licensed manufacturers of record, Select holds the USDA license for Bursaplex® and LAHI holds the USDA license for Newplex®.  Although there are other manufacturers that may be capable of manufacturing AAC antibody, Bursaplex®, and Newplex®, we do not currently have alternative sources for production.

If SPAFAS, Select or LAHI is unable to carry out its respective manufacturing obligations (described above) to our satisfaction, we may be unable to obtain alternative manufacturing, or to obtain such manufacturing on commercially reasonable terms or on a timely basis.  We have received notice from Select that it does not intend to renew its contract to manufacture Bursaplex®.  Select remains obligated to us to provide a cross-license, sub-license or sell the USDA product license to an alternative producer of our choice, which we are evaluating.  However, there is no assurance that we will be able to arrange continued supply of Bursaplex® on a timely basis or on commercially reasonable terms.  A change of any of our suppliers could materially adversely affect our future operating results due to the time it would take a new supplier to obtain regulatory approval by the USDA of its production process or manufacturing facilities. Current regulatory approvals in foreign countries are or will be based on AAC-antibody as manufactured by SPAFAS, Bursaplex® as manufactured by Select, or Newplex® as manufactured by LAHI.  A change of manufacturer would result in the need to reapply for regulatory approval in those countries and may lead to suspended sales of that product until new approvals could be secured.  Any delays in securing new approvals would have a material adverse effect on our revenues and growth prospects.  We cannot guarantee that we would be able to secure new approvals in every country or that such approvals would be granted in a timely fashion.  

***WE FACE RISKS RELATED TO COMPLIANCE WITH LAWS IMPACTING CORPORATE GOVERNANCE AND FINANCIAL REPORTING STANDARDS***

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), new Public Company Accounting Oversight Board standards and rules, new U.S. Securities and Exchange Commission (SEC) regulations and new Nasdaq rules, are creating uncertainty and expense for companies such as ours.  These new or changed laws, regulations and standards are complex and extensive, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in evolving disclosure and corporate governance practices.  As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased G&A expenses and management time related to compliance activities.  In particular, our efforts to comply with Section 404 of Sarbanes-Oxleyand the related regulations regarding our assessment of our internal controls over financial reporting and our external auditors’ audit of that assessment has required the commitment of significant financial and managerial resources.  We expect these efforts to require the continued commitment of significant resources including additional outside legal, accounting and advisory services.  In addition, as our international operations continue to grow and foreign operations become financially significant, it will be necessary for those foreign subsidiaries to meet requirements for internal control over financial reporting pursuant to Section 404 of Sarbanes-Oxley.  Due to the limited staffing at some of our foreign subsidiaries, there is no assurance that we would be able to meet requirements for internal control over financial reporting, particularly requirements for segregation of duties.  If we fail to comply with new or changed laws, regulations and standards, ourreputation may be harmed and we might be subject to sanctions or investigation by regulatory authorities, such as the SEC.  Any such action could adversely affect our financial results and the market price of our Common Stock. 

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***WE FACE THE RISK THAT WE MAY NEED TO MAKE ADDITIONAL CONTRIBUTIONS TO OUR 401(K) PLAN***

Historically, under our 401(k) Plan, we have based participant and employer contributions on participants’ salaries. In the third quarter of 2005, we discovered that the 401(k) Plan documents prepared by our third party administrator provide (and we believe incorrectly) that other elements of compensation be included when determining the appropriate contributions. Our intent has always been that contributions be based only on base salary. We intend to seek approval to conform the 401(k) Plan document retroactively to our intent and practice. Should this relief not be granted, we believe we would be required to make additional contributions to the 401(k) Plan for participants who had not already reached the maximum contribution. We are unable to estimate at this time the amount of additional contributions that potentially could be required and for what time periods. We are not able to predict whether any additional contributions would have a material adverseeffect on our historical or future financial statements.  

***WE ARE DEPENDENT ON DISTRIBUTORS IN CERTAIN MARKETS***

We market and distribute our devices principally by leasing and licensing the systems directly to hatcheries.  In some markets, such as Japan, we instead rely upon distributors for our devices.  We may enter into other such distribution arrangements in the future.  We also rely on third parties to market certain of our vaccine products, such as products containing AAC technology, and we may enter into other arrangements in the future.  There can be no assurance that we can maintain these relationships on terms acceptable to us.  The loss of any of these relationships could materially adversely affect our operating results.  There are a number of risks associated with our dependence on distributors and other third parties including:

|   | • | reduced control over   regulatory efforts, which may delay local regulatory approvals and thus   market introduction;                                                                                                                            |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                             |
|   | • | reduced control over marketing   and sales efforts and in turn the extent of resulting market penetration or   acceptance;                                                                                                                       |
|   |   |                                                                                                                                                                                                                                             |
|   | • | reduced control over   distribution and related customer satisfaction; and                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                             |
|   | • | potential delays in   distribution associated with securing new distributors, including the   possible need to seek re-registration in markets where a distributor may hold   product registration, if current relationships are not maintained. |

***THE LOSS OF KEY COLLABORATORS, SUPPLIERS AND OTHER KEY PARTIES COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS***

We currently conduct our operations with various third-party collaborators, suppliers, licensors or licensees.  We plan to continue developing these relationships and believe our present and future collaborators, suppliers, licensors and licensees will perform their obligations under their agreements with us, based on an economic motivation to succeed.  However, financial or other difficulties facing these parties may affect the amount and timing of funds and other resources devoted by the parties under these agreements.  In addition, disagreements may arise with these third parties which could delay or lead to the termination of the development or commercialization of new products, or result in litigation or arbitration, which would be time-consuming and expensive.  Thus, there is no assurance that we will develop any new products or generate any revenues from these collaborative agreements.

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***WE ARE SUBJECT TO AN INHERENT RISK OF PRODUCT LIABILITY***

The development, manufacture, distribution and marketing of our products involve an inherent risk of product liability claims and associated adverse publicity.  These claims may be made even with respect to those products that are manufactured in licensed and approved facilities or that otherwise possess regulatory approval for commercial sale.  These claims could expose us to significant liabilities that could prevent or interfere with the development and marketing of our products.  Product liability claims could require us to spend significant time and money in litigation or pay significant damages.  Although we currently maintain liability insurance that we believe is adequate to cover our potential exposure in this area, there can be no assurance that the coverage limits of our policies will be adequate.  Such insurance is expensive, difficult to obtain and may not continue to be available on acceptable terms or at all.

***GOVERNMENT REGULATION AND THE NEED FOR REGULATORY APPROVAL MAY ADVERSELY AFFECT OUR BUSINESS***

Regulatory approval required in various areas of our business may materially adversely affect our operations.  The primary emphasis of these requirements is to assure the safety and effectiveness of our products.  While the use of the Inovoject® system is not subject to regulatory approval in the United States, it may require regulatory approval by foreign agencies.  Also, R&D activities and the investigation, manufacture and sale of poultry health products are subject to regulatory approval in the United States by either the USDA or the Food and Drug Administration (FDA) and state agencies, as well as by foreign agencies.  Obtaining regulatory approval is a lengthy, costly and uncertain process. Approval by the USDA generally takes one to three years, while approval by the FDA may take five or more years.  Approval by foreign governments can take one to five years for an application submitted after U.S. approval. We currently have no products under development that would require approval by the FDA.  Various problems may arise during the regulatory approval process and may have an adverse impact on our operations.  Changes in the policies of U.S. and foreign regulatory bodies could increase the time required to obtain regulatory approval for each new product.  Delays in obtaining approval may materially adversely affect the marketing of, and the ability to receive revenues and royalties from, products developed by us.  There is no assurance that any future products developed by us or by our collaborative partners will receive regulatory approval without lengthy delays, if at all.  Even when approved, regulators may impose limitations on the uses for which the product may be marketed and may continue to review a product after approving it for marketing.  Regulators may impose restrictions and sanctions, including banning the continued sale of the product, if they discover problemswith the product or its manufacturer.

Pursuant to some of our licensing or joint development agreements, the licensees or joint developers bear the costs associated with the regulatory approval process for some products.  We plan to continue to enter into these types of agreements in the future.  If we cannot generate sufficient funds from operations or enter into licensing or joint development agreements to develop products, we may not have the financial resources to complete the regulatory approval process with respect to all or any of the products currently under development.  

Other regulations apply or may apply to research and manufacturing activities, including federal, state and local laws, regulations and recommendations relating to the following:

|   | • | safe working conditions;                                                                 |
|--------|--------|------------------------------------------------------------------------------------------|
|   |   |                                                                                     |
|   | • | laboratory and manufacturing   practices; and                                            |
|   |   |                                                                                     |
|   | • | use and disposal of hazardous   substances used in conjunction with research activities. |

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It is difficult to predict the extent to which these or other government regulations may adversely impact the production and marketing of our products.

***OUR INABILITY TO ATTRACT AND RETAIN KEY PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS***

We must continue to attract and retain experienced and highly educated scientific, technical and management personnel and advisors to be able to develop marketable products and maintain a competitive research and technological position.  Competition for qualified employees among biotechnology companies is intense.  There can be no assurance that we will be able to continue to attract and retain qualified staff.  The departure of any key executive or our inability to recruit and retain key scientific or management personnel could have an adverse effect on our business, results of operations or financial condition.  Our ability to replace key individuals may be difficult and may take an extended period of time because of the limited number of individuals in the biotechnology industry with the breadth of skills and experience required to develop and commercialize products successfully.  Competition to hire from this limited pool is intense,and we may be unable to hire, train, retain or motivate such individuals.  

***IF WE CANNOT CONTINUE TO PROVIDE TIMELY SUPPORT AND MAINTENANCE TO OUR CUSTOMERS, OUR BUSINESS MAY SUFFER***

We are required to supply, support and maintain large numbers of Inovoject® systems at our customers’ hatcheries on a timely basis at a reasonable cost to us.  There can be no assurance that we will be able to continue to provide these services on a timely or cost-effective basis.  If we are unable to do so, our customers may reduce their use of our products, which could materially adversely affect our operating results.

***WE HAVE ANTI-TAKEOVER DEFENSES THAT COULD DISCOURAGE OR DELAY A TAKEOVER***

Provisions of our certificate of incorporation and bylaws could have the effect of discouraging or delaying an acquisition of our company.  For example, the Board of Directors has the authority to issue up to 15,000,000 shares of Preferred Stock in one or more series and to determine the designations, preferences and relative rights and qualifications, limitations or restrictions of the shares constituting any series of Preferred Stock.  The issuance of Preferred Stock by the Board of Directors could affect the rights of the holders of Common Stock.  For example, an issuance could result in a class of securities outstanding that would have preferences with respect to voting rights and dividends and in liquidation over the Common Stock and could (upon conversion or otherwise) enjoy all of the rights applicable to Common Stock.  The authority of the Board of Directors to issue Preferred Stock potentially could be used to discourage attempts byothers to obtain control of us through merger, tender offer, proxy contest or otherwise by making these attempts more difficult to achieve or more costly.  The Board of Directors may issue the Preferred Stock without shareholder approval and such Preferred Stock could have voting and conversion rights that could materially adversely affect the voting power of the holders of Common Stock.  No agreements or understandings currently exist for the issuance of Preferred Stock, and the Board of Directors has no present intention to issue any Preferred Stock.  The Board has adopted a shareholder rights plan that could have the effect of discouraging a takeover of us.  The rights plan, if triggered, would make it more difficult to acquire us by, among other things, allowing existing shareholders to acquire additional shares of Common Stock at a substantial discount, thus substantially inhibiting the ability of an interested party to obtain control of our company.

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Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3.     Defaults Upon Senior Securities

Not applicable.

Item 4.     Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5.     Other Information

Not applicable.

Item 6.     Exhibits

|   | **Exhibit Number** |   | **Description of   Document**                                                                                                                                                                                                                                                                         |
|--------|-------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                         |   |                                                                                                                                                                                                                                                                                                       |
|   | 10.1                    |   | Embrex, Inc. Short-Term   Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)                                                                                    |
|   | 10.2                    |   | Form A – Restricted Stock Unit   Agreement (incorporated herein by reference to Exhibit 10.2 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)                                                                             |
|   | 10.3                    |   | Form B – Restricted Stock Unit   Agreement (incorporated herein by reference to Exhibit 10.3 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)                                                                             |
|   | 10.4                    |   | Change in Control Severance   Agreement dated July 24, 2006 between Embrex and Ronald Bryant (incorporated   herein by reference to Exhibit 10.4 to Embrex’s Current Report on Form 8-K,   as filed with the Securities and Exchange Commission on July 26, 2006)                                |
|   | 10.5                    |   | Amended and Restated Change in   Control Severance Agreement dated July 24, 2006 between Embrex and Randall L.   Marcuson (incorporated herein by reference to Exhibit 10.5 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)   |
|   | 10.6                    |   | Amended and Restated Change in   Control Severance Agreement dated July 24, 2006 between Embrex and Joseph P.   O’Dowd (incorporated herein by reference to Exhibit 10.6 to Embrex’s Current   Report on Form 8-K, as filed with the Securities and Exchange Commission on   July 26, 2006) |
|   | 10.7                    |   | Amended and Restated Change in   Control Severance Agreement dated July 24, 2006 between Embrex and Don T.   Seaquist (incorporated herein by reference to Exhibit 10.7 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)       |
|   | 10.8                    |   | Branch Banking & Trust Co.   letter dated November 2, 2006                                                                                                                                                                                                                                        |
|   | 31.1                    |   | Certification of Principal   Executive Officer of Periodic Report Pursuant to Rule 13a-14(a) or Rule   15d-14(a)                                                                                                                                                                                      |
|   | 31.2                    |   | Certification of Principal   Financial Officer of Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a)                                                                                                                                                                                        |
|   | 32.1                    |   | Certification of Principal   Executive Officer of Periodic Report Pursuant to Rule 13a-14(b) or Rule   15d-14(b) and 18 U.S.C. Section 1350                                                                                                                                                           |
|   | 32.2                    |   | Certification of Principal   Financial Officer of Periodic Report Pursuant to Rule 13a-14(b) or Rule   15d-14(b) and 18 U.S.C. Section 1350                                                                                                                                                           |

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date:  November 6, 2006

|   | EMBREX, INC. |
|--------|--------------|
|   |         |   |
|   |         |   |
|   | By:          | /s/ Randall L. Marcuson |
|   |         |  |
|   |         | Randall L. Marcuson |
|   |         | President and Chief Executive   Officer |
|   |         |   |
|   |         |   |
|   |         |   |
|   | By:          | /s/ Don T. Seaquist |
|   |         |  |
|   |         | Don T. Seaquist |
|   |         | Vice President, Finance and   Administration |

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**EXHIBIT INDEX**

|   | **Exhibit Number** |   | **Description of   Document**                                                                                                                                                                                                                                                                         |
|--------|-------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                         |   |                                                                                                                                                                                                                                                                                                       |
|   | 10.1                    |   | Embrex, Inc. Short-Term   Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)                                                                                    |
|   | 10.2                    |   | Form A – Restricted Stock Unit   Agreement (incorporated herein by reference to Exhibit 10.2 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)                                                                             |
|   | 10.3                    |   | Form B – Restricted Stock Unit   Agreement (incorporated herein by reference to Exhibit 10.3 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)                                                                             |
|   | 10.4                    |   | Change in Control Severance   Agreement dated July 24, 2006 between Embrex and Ronald Bryant (incorporated   herein by reference to Exhibit 10.4 to Embrex’s Current Report on Form 8-K,   as filed with the Securities and Exchange Commission on July 26, 2006)                                |
|   | 10.5                    |   | Amended and Restated Change in   Control Severance Agreement dated July 24, 2006 between Embrex and Randall L.   Marcuson (incorporated herein by reference to Exhibit 10.5 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)   |
|   | 10.6                    |   | Amended and Restated Change in   Control Severance Agreement dated July 24, 2006 between Embrex and Joseph P.   O’Dowd (incorporated herein by reference to Exhibit 10.6 to Embrex’s Current   Report on Form 8-K, as filed with the Securities and Exchange Commission on   July 26, 2006) |
|   | 10.7                    |   | Amended and Restated Change in   Control Severance Agreement dated July 24, 2006 between Embrex and Don T.   Seaquist (incorporated herein by reference to Exhibit 10.7 to Embrex’s   Current Report on Form 8-K, as filed with the Securities and Exchange   Commission on July 26, 2006)       |
|   | 10.8                    |   | Branch Banking & Trust Co.   letter dated November 2, 2006                                                                                                                                                                                                                                        |
|   | 31.1                    |   | Certification of Principal   Executive Officer of Periodic Report Pursuant to Rule 13a-14(a) or Rule   15d-14(a)                                                                                                                                                                                      |
|   | 31.2                    |   | Certification of Principal   Financial Officer of Periodic Report Pursuant to Rule 13a-14(a) or Rule   15d-14(a)                                                                                                                                                                                      |
|   | 32.1                    |   | Certification of Principal   Executive Officer of Periodic Report Pursuant to Rule 13a-14(b) or Rule   15d-14(b) and 18 U.S.C. Section 1350                                                                                                                                                           |
|   | 32.2                    |   | Certification of Principal Financial   Officer of Periodic Report Pursuant to Rule 13a-14(b) or Rule 15d-14(b) and   18 U.S.C. Section 1350                                                                                                                                                           |

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