**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

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**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15( ) OF THESECURITIES EXCHANGE ACT OF 1934

**For the fiscal year ended December 31,2005**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15( ) OF THESECURITIES EXCHANGE ACT OF 1934

**For the transition periodfrom                 to                       **

**Commission file number 0-25323**

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**Albany Molecular Research, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                   |   | **14-1742717**       |
|------------------------------------------------|--------|----------------------|
| (State or Other  Jurisdiction of               |   | (IRS Employer        |
| Incorporation or  Organization)                |   | Identification  No.) |
| **21  Corporate Circle, P.O. Box 15098,** |   | ** **           |
| **Albany,  New York**                          |   | **12212-5098**       |
| (Address of  principal executive offices)      |   | (zip code)           |

 

**(518) 464-0279**

(Registrant’stelephone number, including area code)

Securities registered pursuant to Section 12(b) ofthe Act:

**None**

Securitiesregistered pursuant to Section 12(g) of the Act:

**Common Stock, parvalue $.01 per share**

**Preferred Stock Purchase Rights**

(Title of Each Class)

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o   No  x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes   o   No  x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes  x    No  o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definitions of “accelerated filer and largeaccelerated filer” in  12b-2 of theExchange Act

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

 

Indicate by checkmark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Act). Yes  o    No  x

The aggregate market value of the Registrant’s CommonStock held by non-affiliates of the Registrant on June 30, 2005 wasapproximately $304 million based upon the closing price per share of theRegistrant’s Common Stock as reported on the Nasdaq National Market on June 30,2005. Shares of Common Stock held by each officer and director and by eachperson who owns 10% or more of the outstanding Common Stock have been excludedin that such persons may be deemed to be affiliates. This determination ofaffiliate status is not necessarily a conclusive determination for otherpurposes. As of February 17, 2006, there were 32,406,859 outstandingshares of the Registrant’s Common Stock.

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**DOCUMENTSINCORPORATED BY REFERENCE**

The information requiredpursuant to Part III of this report is incorporated by reference from theCompany’s definitive proxy statement, relating to the annual meeting ofstockholders to be held in on June 1, 2006, pursuant to Regulation 14A tobe filed with the Securities and Exchange Commission.

 

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**ALBANY MOLECULAR RESEARCH, INC.INDEX TOANNUAL REPORT ON FORM 10-K**
|                                                       | ** ** | ** **                                                                                                                      | ** ** | **Page No.** |
|-------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
|                                                  |       | Cover page                                                                                                                      |       |              |
|                                                  |       | Part I.                                                                                                                    |       |              |
| Cautionary  Note Regarding Forward-Looking Statements |       | 3                                                                                                                               |
| Item 1.                                               |       | Business                                                                                                                        |       | 5                 |
| Item 1A.                                              |       | Risk  Factors                                                                                                                   |       | 16                |
| Item 1B.                                              |       | Unresolved Staff Comments                                                                                                       |       | 23                |
| Item 2.                                               |       | Properties                                                                                                                      |       | 23                |
| Item  3.                                              |       | Legal  Proceedings                                                                                                              |       | 24                |
| Item 4.                                               |       | Submission of Matters to a Vote of Security Holders                                                                             |       | 25                |
|                                                  |       | Part II.                                                                                                                   |       |              |
| Item 5.                                               |       | Market for Registrant’s Common Equity, Related  Stockholder Matters, and Issuer Purchases of Equity Securities             |       | 26                |
| Item 6.                                               |       | Selected Financial Data                                                                                                         |       | 28                |
| Item 7.                                               |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations       |       | 29                |
| Item 7A.                                              |       | Quantitative and Qualitative Disclosures about Market  Risk                                                                     |       | 49                |
| Item 8.                                               |       | Financial Statements and Supplementary Data                                                                                     |       | 50                |
| Item 9.                                               |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                  |       | 50                |
| Item 9A.                                              |       | Controls and Procedures                                                                                                         |       | 50                |
| Item  9B.                                             |       | Other  Information                                                                                                              |       | 52                |
|                                                  |       | Part III.                                                                                                                  |       |              |
| Item 10.                                              |       | Directors and Executive Officers of the Registrant                                                                              |       | 53                |
| Item 11.                                              |       | Executive Compensation                                                                                                          |       | 53                |
| Item 12.                                              |       | Security Ownership of Certain Beneficial Owners and  Management                                                                 |       | 53                |
| Item 13.                                              |       | Certain Relationships and Related Transactions                                                                                  |       | 53                |
| Item 14.                                              |       | Principal Accountant Fees and Services                                                                                          |       | 53                |
|                                                  |       | Part IV.                                                                                                                   |       |              |
| Item 15.                                              |       | Exhibits and Financial Statement Schedules                                                                                      |       | 53                |

 

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**Forward-Looking Statements**

This Form 10-K, including Management’sDiscussion and Analysis of Financial Condition and Results of Operations,contains “forward-looking statements” within the meaning of Section 27Aof the Securities Act, and Section 21E of the Securities Exchange Act of1934, as amended (the “Exchange Act”). These statements may be identified byforward-looking words such as “may,” “could,” “should,” “would,” “will,” “intend,”“expect,” “anticipate,” “believe,” and “continue” or similar words and include,but are not limited to, statements concerning the Mount Prospect ResearchCenter, pension and postretirement benefit costs, GE Healthcare, contractrevenues, costs and margins, royalty revenues, patent protection and theongoing Allegra patent infringement litigation, Allegra royalty revenue,government regulation, retention and recruitment of employees, customerspending and business trends, foreign operations (including Singapore, Indiaand Hungary), clinical supply manufacturing, management’s strategic plans, drugdiscovery, product commercialization, license arrangements, research anddevelopment projects and expenses, selling, general and administrative expensesand tax rates. The Company’s actual results may differ materially from such forward-lookingstatements as a result of numerous factors, some of which the Company may notbe able to predict and may not be within the Company’s control. Factors thatcould cause such differences include, but are not limited to, the risk that theCompany will not achieve the cost savings expected to result from the closureand relocation of its Mount Prospect operations, the Company’s ability torecruit and retain experienced scientists and other highly-skilled employees,trends in pharmaceutical and biotechnology companies outsourcing chemicalresearch and development, competition from domestic competitors and foreigncompanies operating under lower cost structures,  the loss of a significant customer, sales ofAllegra (including any deviations in sales estimates provided bySanofi-Aventis) and the Company’s receipt of significant royalties from theAllegra license agreement, the risk that Allegra may be approved forover-the-counter use and Claritin’s approval for over-the-counter use, theCompany’s and Sanofi-Aventis’s ability to successfully enforce their respectiveintellectual property, patent rights and technology, including with respect tothe generic companies’ Abbreviated New Drug Application filings, theintegration and operating risks associated with the Company’s acquisition ofOrganichem, the Company’s ability to successfully develop novel compounds andlead candidates in its research programs and collaborative arrangements, theCompany’s performance under the collaboration with BMS, BMS’s continuousutilization of the Company’s services at levels set forth in the contract withBMS, BMS’s continued pursuit of programs under which the Company providesservices, delay or denial of marketing approvals from the FDA resulting from,among other things, adverse FDA decisions or interpretations of data thatdiffer from BMS’s interpretations and that may require additional clinicaltrials or potential changes in the cost, scope and duration of clinical trials,if approved, the inability to successfully launch, increase sales of or sustainthe product or products in the market, the inability to successfully andefficiently scale-up manufacturing for commercialized compounds, the outcome ofclinical work that will be required to commercialize compounds, the Company’sability to take advantage of proprietary technology and expand the scientifictools available to it, the ability of the Company’s strategic investments andacquisitions to perform as expected and any goodwill impairment related to suchinvestments and acquisitions, the Company’s ability to successfully completeits ongoing expansion projects on schedule, the risks associated withinternational operations and managing our international operations, especiallyin India, Singapore and Hungary, the Company’s ability to execute its businessplan for compound and chemical screening libraries, the Company’s ability toeffectively manage its growth, liability for harm caused by drugs the Companydevelops and tests, liability for contamination or other harm caused byhazardous materials used by the Company, failure to meet strict regulatoryrequirements, health care reform reducing the price pharmaceutical andbiotechnology companies can  charge fordrugs, thus reducing resources available to retain our Company, and thepossibility of a natural disaster, catastrophic event or terrorist attack. Allforward-looking statements are made as of the date of this report, and wedo not undertake to update any such forward-looking statements in thefuture. References to “we,” “us,” and “our,” refers to Albany MolecularResearch, Inc. and its subsidiaries, taken as a whole. Readers are 

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cautioned that theseforward-looking statements are only predictions and are subject to risks,uncertainties and assumptions that are difficult to predict. Therefore, actualresults may differ materially and adversely from those expressed in any forward-lookingstatements. Readers should review carefully the risks and uncertaintiesidentified below under the caption “Risk Factors and Certain Factors AffectingForward-Looking Statements” and elsewhere in this 10-K. We do notundertake any obligation to update our forward-looking statements, exceptas required by applicable law.

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**PART I**

**ITEM 1.**               BUSINESS.

**Overview**

Albany Molecular Research, Inc.(“the Company”), a Delaware corporation incorporated on June 20, 1991, isa global chemistry-based drug discovery and development company focusedon identifying and developing novel biologically active small molecules withapplications in the drug market. We engage in chemistry research, from leaddiscovery, optimization and development to commercial manufacturing. We believewe are the only company providing a critical mass of contract chemistryservices to customers across the entire product development cycle from leaddiscovery to commercial manufacturing. We conduct research and developmentprojects and collaborate with many leading pharmaceutical, and biotechnologycompanies, and are developing proprietary new chemistry technology forpotential pharmaceutical products.

**Business Strategy**

****

***Chemistry Services—***Chemistryservice companies typically derive their contract revenue from research anddevelopment expenditures of the pharmaceutical and biotechnology industry. Webelieve the industry continues to be under pressure to contain costs and todevelop new drugs faster. We also believe that the industry is undergoing aglobalization transformation and we are seeking to expand the scope of ourservice alternatives in order to meet this demand. In 2005, we establishedoperations in Singapore and India, enabling us to provide our chemistryresearch and development services in lower-cost environments. In February 2006, we completed theacquisition of ComGenex, a privately held drug discovery service company inBudapest, Hungary. We expect the addition of ComGenex to provide the Companywith significantly increased access to the European market, as well as anotherlower-cost environment from which we can provide our services.  We have designed our operating structure andour services to provide our customers with opportunities to reduce overall drugdevelopment time and cost and to simultaneously pursue a greater number of drugdiscovery and development opportunities across a wide range of technologies,geographic locations, and cost structures.

***Biotech/Drug Discovery******—***We also conduct proprietaryresearch and development to discover new lead compounds with commercialpotential. We anticipate that we would then license these compounds to thirdparties in return for up-front service fees and milestone payments as well asrecurring royalty payments if these compounds are developed into new commercialdrugs. We have successfully licensed the compounds we have developed. In October 2005,we licensed the worldwide rights to develop and commercialize potentialproducts from our amine neurotransmitter reuptake inhibitors identified in oneof our proprietary research programs to Bristol-Myers Squibb Company (“BMS”). Webelieve that this technology provides the opportunity to yield multiple drugcandidates. Under our contract with BMS, the successful advancement of two suchcandidates could result in the receipt of in excess of $150 million in up-frontlicense, contract service, and milestone revenue. In 1995, our proprietaryresearch and development activities led to the development, patenting andlicensing of a substantially pure form of, and 

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a manufacturingprocess for, the active ingredient in the non-sedating antihistaminefexofenadine HCl marketed by Sanofi-Aventis as Allegra in the Americas and asTelfast elsewhere. Under our license agreement with Sanofi-Aventis we haveearned a total of $313.2 million in milestones and royalty revenue from1995 through December 31, 2005 and are entitled to receive ongoingroyalties from Sanofi-Aventis based upon a percentage of worldwide sales ofAllegra and its authorized generic alternative.  We presently have multiple other programs inpre-licensing research and development.

**Industry Overview**

Opportunities to develop therapeutics for previouslyunmet or undermet medical needs are being fueled by advances in disciplinessuch as molecular biology, high throughput synthesis and screening and humangenomics research. In addition, pharmaceutical and biotechnology companies areunder pressure to deliver new drugs to market and reduce the time required fordrug development. This pressure has come about, in part, as a result of thesignificant number of current drug products on the market for which patentprotection has or will soon expire.

In order to take advantageof these opportunities and to respond to these pressures, many pharmaceuticaland biotechnology companies have augmented their internal research anddevelopment capacity through outsourcing.

**Drug Discovery,Development and Manufacturing Process**

Although manyscientific disciplines are required for new drug discovery and development,chemistry and biology are core technologies. Chemists and biologists typicallywork together to develop laboratory models of disease, screen small moleculecompounds to identify those that demonstrate the desired activity and finallycreate a marketable drug. The drug discovery and development process includesthe following steps:

·  lead discovery—the identification of acompound that may be developed into a new drug;

·  lead optimization—an iterative process ofmodifying the structure of a lead compound to optimize its therapeuticproperties;

·  preclinical testing—the testing of thecompound in increasingly complex animal models;

·  clinical trials—the multi-phase testingof the compound for safety and efficacy in humans; and

·  productcommercialization—the manufacture, marketing and sale of commercial quantitiesof the approved drug.

**The Importance ofChemistry in the Drug Discovery and Development Process**

**LeadDiscovery.****  **Thefirst major hurdle in drug discovery is the identification of one or more leadcompounds that interact with a biological target, such as an enzyme, receptoror other protein that may be associated with a disease. A biological test, orassay, based on the target is developed and used to test or “screen” chemicalcompounds. Medicinal chemistry and combinational chemistry workinginteractively with computational science are used to synthesize these compoundsrapidly and study the interaction between the three-dimensional molecularstructures of the compounds and biological targets. The objective of leaddiscovery is to identify a lead compound for further research and development.

**LeadOptimization.****  **Oncea lead compound has been identified, medicinal chemistry is used to optimizethat lead compound by modifying and synthesizing analogs of active leadcandidates with improved potency, selectivity and/or pharmacokinetics (improvedabsorption, solubility, half-life and metabolism) in order to identify a morepromising drug candidate. This iterative process involves the synthesis ofcompounds for biological testing, the analysis of the screening results and thefurther design 

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and synthesis ofadditional compounds based upon the analysis of structure-activityrelationships. During lead optimization, specialists in chemical developmentoptimize the synthesis process and perform the scale-up synthesis of a leadcompound as that compound is advanced through the drug discovery anddevelopment process. These scientists are experts in the preparation ofchemicals on a larger scale and focus on the efficiency, economics, simplicityand safety of the preparation of such chemicals. Chemical development is alsoan iterative process which may require progressive improvements in chemicalsynthesis as subsequent repeat batches are prepared. In addition to providingrepeat synthesis, significant process research may be required to refineexisting or develop new synthesis processes. Also, during the lead optimizationstage, analytical chemistry services are incorporated to assure the identityand purity of the lead candidate.

**PreclinicalTesting.****  **Followingthe development of a lead compound during the lead optimization stage, advancedpreclinical testing is conducted in order to evaluate the efficacy and safetyof the lead compound prior to initiating human clinical trials. The leadcompound must demonstrate a scientifically proven benefit in controlled andwell-defined biological tests in animal models, and must exhibit this benefitat doses much lower than those at which side effects would occur. During thelead optimization and preclinical testing phases, scientists continue thesynthesis of additional analogs of the lead compound using medicinal chemistry.Often a second compound, referred to as a backup compound or second generationanalog, is synthesized and enters the drug development cycle. In addition,continued synthesis is desirable in order to prepare compounds of significantdiversity to broaden potential patent coverage. As a result, the advancement ofa lead compound into preclinical testing is often a catalyst which increases,rather than decreases, the need for additional medicinal chemical synthesis andother chemical services. During this phase, specialists in chemical developmentcontinue to conduct significant process research to optimize the production ofa compound.

**ClinicalTrials.****  **Duringclinical trials, several phases of studies are conducted to test the safety andefficacy of a drug candidate. As study populations increase and trial durationslengthen, larger quantities of the active ingredient are required. The activepharmaceutical ingredient (“API”), and the formulated drug product, must beprepared under current good manufacturing practices, commonly referred to ascGMP, guidelines. Analytical chemistry services are critical to cGMPmanufacturing. Additional preparations provide an opportunity to further refinethe manufacturing process, with the ultimate goal of maximizing the costeffectiveness and safety of the synthesis prior to commercialization.

**Product Commercialization.****  **Before approving a drug, the Foodand Drug Administration (FDA) requires that manufacturing procedures andoperations conform to cGMP regulations, International Conference onHarmonization (ICH) guidance and manufacturing guidelines and guidance publishedby the FDA. Manufacturing procedures and operations must be in compliance withall regulatory and quality regulations at all times during the manufacture ofcommercial products and APIs. Once a drug has received all necessary approvals,the manufacture, marketing and sale of commercial quantities of the approveddrug may commence.

**Trends inContracting for Chemistry Services**

Contract serviceshave traditionally been limited to the later stages of drug development, suchas clinical trial management and manufacturing. In recent years, manypharmaceutical and biotechnology companies have utilized contract chemistryservice providers to complement, or in some cases supplement, internalchemistry expertise. During this time, only a few companies provided chemistryservices for drug discovery, development and manufacturing, and these companiestypically focused only on certain stages of the drug development process. Thefollowing trends led to an increase in demand for contract chemistry servicesin drug discovery, development and manufacturing:

·  a larger number of drugs marketed today werenot discovered in-house;

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·  development of new technologies that continuedto increase the number of targets and accelerate the identification of activecompounds;

·  pressure to develop new lead compounds due tothe near-term loss of patent protection for many drug products;

·  increased pressure to reduce the time spent indrug discovery and development to bring drugs to market sooner and maximizepatent life;

·  increased focus on converting fixed costs tovariable costs and streamlining operations by contracting for research anddevelopment services;

·  heightened regulatory environment andincreased complexity that made the internal management of complicateddiscovery, development and manufacturing projects more difficult and costly;and

·  biotechnology and emerging pharmaceuticalcompanies, in many cases, lacking the required in-house drug discovery anddevelopment expertise.

In 2003 and 2004,the domestic market for contract chemistry services began to tighten. Thistimeframe marked a period of financial decline for the pharmaceutical andbiotechnology industry due to factors such as patent expirations and successfulpatent challenges on “blockbuster” drugs, product recalls, and failure inclinical trials of developmental compounds expected to replace expiringpatents. These factors, as well as consolidation within the industry,  led to an overall decrease in spending oncontract chemistry services, as well as a shift in spending away from thediscovery phase of the pharmaceutical research and development process in aneffort to bring previously identified compounds to market. In addition, thenumber of entrants in the market began to increase, including a number offoreign companies operating under substantially lower cost structures,resulting in increased competition for services and pricing pressures.

2005 marked a period ofcontinued transition in the market for the discovery and development componentof contracted pharmaceutical research and development services.  We experienced increased demand in the areasof developmental and small-scale cGMP manufacturing services, reflecting theindustry’s renewed efforts to bring identified compounds into clinical trials.  During the year, we continued to advance ourstrategic initiatives to successfully position ourselves in the currentmarketplace, establishing lower-cost international operations in Singapore andIndia. Our ability to provide services under a variety of business models andcost structures was well-received by our customers, resulting in an increase indemand for our discovery services both internationally and domestically duringthe latter portion of 2005.  The trend ofsourcing contracted chemistry services to lower-cost providers accelerated in2005, particularly in China and India, resulting in several of our domesticcompetitors exiting or significantly reducing their presence in the marketplaceduring the year. We believe that we are positioned to fill the void left bythese providers, enabling us to further increase our market share, and weexpect the trend of increased demand for our services to continue in 2006.

**Our Capabilities**

We have a broad range ofhigh-quality drug discovery and development, chemistry research andmanufacturing capabilities. The problem-solving abilities of ourscientists provide added value throughout the drug discovery, development andmanufacturing process. We offer proprietary discovery technologies as well aschemistry services on a contract basis that have traditionally requiredsignificant time and capital investment to create internally. Our comprehensivesuite of services allows our customers to contract with a single partner,eliminating the time and cost of transitioning projects among multiple vendors.

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**Service Offerings**

***Drug Lead Discovery and Technologies***

We provide chemistry services and proprietary drugdiscovery technologies used to identify new lead compounds. We have developedbiocatalysis technology that assists in the creation of novel chemistrylibraries. Biocatalysis technology uses enzymes and microbial cell systems tosynthesize new compounds which are unattainable by traditional means in one ortwo chemical steps. Additional discovery technologies that we provide include isolation,purification, structure elucidation and the supply of sample collectionlibraries from microbial and botanical sources, computational chemistry,virtual screening, microbiology, fermentation, asymmetric synthesis, metabolicprofiling, and high throughput biological screening. We seek to bundle our drugdiscovery technologies and screening collections in a strategic alliance tocost effectively identify new drug candidates with selected partners. Inreturn, we would expect to receive a combination of fee for service, milestoneand royalty payments based on the success of the drug candidate.

Our drug discoverytechnologies complement our medicinal chemistry services as additional methodsof developing and screening large numbers of compounds against drug targets togenerate new drug leads. These drug discovery technologies give us thecapability to:

·  identify hit and lead compounds for furtheroptimization;

·  improve the pharmacology, toxicology andefficacy or selectivity of chemical compounds for currently marketed drugs;

·  develop lead extensions from unsuccessfulPhase II or Phase III clinical trials;

·  improve solubility and/or bioavailability ofdrug compounds;

·  create analogs of potential lead compounds;

·  identify active metabolites;

·  widen patent coverage; and

·  performprocess research, consisting of the improvement or modification of existingprocesses.

***Medicinal Chemistry***

The chemistryfunctions associated with the identification and optimization of a leadcompound are handled by chemists specializing in medicinal chemistry. The roleof the medicinal chemist is to synthesize small quantities of new andpotentially patentable compounds for biological testing. Our medicinalchemistry group assists our customers in the pursuit of new drug leads as wellas in lead development and optimization using modern structure-based drugdesign, as well as many other cutting edge techniques. Our medicinal chemistrygroup uses tools such as computational and combinatorial chemistry inconjunction with the traditional techniques of medicinal drug development.Medicinal chemistry services that we provide include:

·  design and synthesis of potential leadcompounds;

·  design, modify and synthesis of compounds toimprove receptor binding and selectivity, enzyme inhibition and selectivityaffording drug candidates with improved potency and pharmacokinetics;

·  development and synthesis of analogs of leadcompounds to broaden patent protection; and

·  resynthesisand expansion of customers’ chemistry libraries by employing combinatorial andcomputational chemistry.

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***Chemical Development***

Chemicaldevelopment involves the scale-up synthesis of a lead compound. Processesdeveloped for small scale production of a compound may not be suitable forlarger scale production because they may be too expensive or environmentally unacceptableor they may present safety concerns. Our chemical development scientists designnovel or improved methods and processes suitable for medium to large scaleproduction. Our chemical development scientists possess expertise in a broadrange of structural classes of molecules and are able to address a wide varietyof chemical synthesis and production problems. Chemical development servicesthat we provide include:

·       processresearch, consisting of the improvement or modification of existing processes;

·       discoveryand development of new synthetic methodologies to prepare products;

·       processdevelopment and production of single-isomer molecules; and

·       development of practicalpurification techniques.

***Analytical Chemistry Services***

Our analyticalchemistry services develop assays for studying the purity of the varioussubstances we synthesize, examining and detecting impurities, conduct physicaltesting, validate methods against established protocols and conduct stabilitytesting. We also provide regulatory consulting services, including thepreparation of regulatory filings, chemistry manufacturing and controldocumentation and testing, and scientific and technical writing. The cGMPguidelines mandated by the FDA necessitate employing analytical support fordrugs under development, as well as for drugs already on the market. Ouranalytical services are designed to support our customers’ compliance withthese guidelines. We typically provide these services at several stagesthroughout the drug discovery, development and manufacturing process startingwith lead optimization. Analytical services that we provide include:

·       testmethod development and validation;

·       qualitycontrol and release testing;

·       highperformance liquid and/or gas chromatography for purity assessment, separationof enantiomers and identification of impurities;

·       evaluationof polymorphic forms, crystallization properties, and salt selection for newdrug candidates;

·       stabilitystudies for bulk active ingredients and formulated drug products; and

·       preparation of regulatorydocumentation, including chemistry manufacturing and control sections ofinvestigational new drug applications, new drug applications and drug masterfiles.

***cGMP Manufacturing Services***

***Small Scale Manufacturing***

We provide chemicalsynthesis and manufacturing services for our customers in accordance with cGMPguidelines. All facilities and manufacturing techniques used in the manufactureof products for clinical use or for sale in the United States must be operatedin conformity with cGMP guidelines as established by the FDA. Our Albany, N.Y.location has production facilities and quarantine and restricted access storagenecessary to manufacture quantities of drug substances under cGMP conditionssufficient for conducting clinical trials from Phase I through Phase II, andlater stages for selected products, based on volume and other parameters.

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***Large Scale Manufacturing***

Our large scalemanufacturing facility in Rensselaer, NY is equipped to provide a wide range ofcustom chemical development and manufacturing capabilities. We conductcommercial cGMP manufacturing of active pharmaceutical ingredients and advancedintermediates. Our large-scale cGMP manufacturing facilities providesynergies with our small-scale development laboratories, offering ourcustomers excellence at every scale, from bench to production. We have a numberof highly specialized production capabilities, including manufacturing ofhighly potent and cytotoxic agents, purification using critical fluid technology,production of controlled substances, and cryogenic reaction capabilities. Inthe second quarter of 2005, our focus on quality was reinforced after asuccessful FDA inspection of our Rensselaer facility resulted in no issuancesof Form FDA 483 *Observations ofObjectionable Conditions and Practices*.

***Consulting Services***

We provide to ourcustomers, in particular our biotechnology customers, consulting servicesacross all chemistry phases of drug discovery, development and manufacturing.

***Proprietary Research and Development***

Leveraging our wide arrayof chemistry disciplines and discovery technologies, we seek to discover anddevelop promising drug candidates and license these candidates in return forupfront fees, milestones and downstream royalty payments for commercializeddrug products. Utilizing our medicinal chemistry expertise, high throughputbiological screening capabilities, our combinatorial biocatalysis technology,natural products sample collections and other chemically and structurallydiverse chemical collections generated through the application of combinatorialchemistry integrated with our computer assisted drug design capabilities, wepursue drug discovery opportunities and generate novel biologically activechemical substances. Our broad array of scientific disciplines also includecapabilities in microbial fermentation, molecular biology, cell culturetechnologies, gene expression and cloning, *invitro* drug metabolism testing and scale up synthesis of humanmetabolites. We have spent $14.5 million, $23.9 million, and $22.5 million onproprietary research and development activities in 2005, 2004, and 2003,respectively. Research and development expenditures in 2004 included a $3.1million non-cash charge related to the issuance of warrants to Bristol-MyersSquibb (“BMS”) in exchange for one of BMS’ pre-clinical drug candidates. Thesewarrants were cancelled in October 2005 in conjunction with our entry intoa Licensing and Research Agreement with BMS in an effort to further develop andcommercialize products from this technology.

***Licensing Agreements***

In October 2005, we licensed the worldwide rightsto develop and commercialize potential products from our amine neurotransmitterreuptake inhibitors identified in one of our proprietary research programs toBMS. In conjunction with the licensing agreement, we received a non-refundable,non-creditable up-front payment of $8 million. In addition, the agreementprovides for the establishment of a research program, under which BMS will purchaseapproximately $10.0 million in research and development services over theinitial three year term of the program. The agreement also sets forth milestoneevents that, if achieved by these products, would entitle the Company tonon-refundable, non-creditable milestone payments of up to $66.0 million foreach of the first and second products to achieve these events, and up to $22.0million for each subsequent product to achieve these events. The agreement alsoprovides for the Company to receive royalty payments on worldwide sales of anysuch product that is commercialized.

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Our proprietary research and development efforts todate have contributed to the discovery and development of one product that hasreached the market. We discovered a new process to prepare a metabolite knownas terfenadine carboxylic acid, or TAM, in a purer form. The purer form of TAMis the active ingredient in the non-sedating antihistamine known asfexofenadine HCl, which is sold by Sanofi-Aventis under the name Allegra in theAmericas and as Telfast elsewhere. We have been issued several United Statesand foreign patents relating to TAM and the process chemistry by which TAM isproduced. Subject to payment of government annuities and maintenance fees, ourissued patents relating to TAM expire between 2013 and 2015. See “Item 3—LegalProceedings” for discussion of current legal proceedings related toAllegra/Telfast.

In March 1995, weentered into a license agreement with Sanofi-Aventis. Under the terms of thelicense agreement, we granted Sanofi-Aventis an exclusive, worldwide license toany patents issued to us related to our original TAM patent applications. Sincethe beginning of the agreement through December 31, 2005, we have earned$7.4 million in milestone payments and $305.8 million in royaltiesunder this license agreement. Sanofi-Aventis is obligated under the licenseagreement to pay ongoing royalties to us based upon its sales ofAllegra/Telfast and generic fexofenadine. We are not entitled, however, toreceive any additional milestone payments under the license agreement. Sales ofAllegra/Telfast and generic fexofenadine by Sanofi-Aventis worldwide wereapproximately $1.76 billion for the year ended December 31, 2005,$1.85 billion for the year ended December 31, 2004, and$1.97 billion for the year ended December 31, 2003. Allergicreactions to plants, pollens and other airborne allergens generally occurduring the spring and summer seasons. Therefore, we expect the demand forAllegra to be lower during other times of the year. Because Allegra saleschange seasonally based on the demand for allergy medicines, our revenues aretypically lower during the first and fourth calendar quarters.

***Business Segments***

Our large scale cGMPmanufacturing activities represent a distinct business segment as defined byStatement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosuresabout Segments of an Enterprise and Related Information”. The Company’sremaining activities, including drug lead discovery, optimization, drugdevelopment, and small scale commercial manufacturing represent a separatedistinct business segment as defined by SFAS No. 131. See the notes to theconsolidated financial statements for financial information on the Company’sbusiness segments.

***Customers***

Our customers includepharmaceutical companies and biotechnology companies and, to a limited extent,agricultural companies, fine chemical companies and contract chemicalmanufacturers. For the year ended December 31, 2005, contract revenue fromour three largest customers represented 37%, 6% and 4%, respectively, of ourcontract revenue. For the year ended December 31, 2004, contract revenuefrom our three largest customers respectively represented approximately 38%, 6%and 4% of our contract revenue. For the year ended December 31, 2003,contract revenue from our three largest customers respectively representedapproximately 34%, 10% and 6% of our contract revenue. Our largest customer, GEHealthcare (“GE”) (formerly Amersham Health PLC), represented 37% of totalcontract revenue for the year ended December 31, 2005.  See Note 17 to the consolidated financialstatements for information on geographic and other customer concentrations.

***Marketing***

Our services are marketedprimarily by our senior management and dedicated business developmentpersonnel. Because our customers are typically highly skilled scientists, ouruse of technical experts in marketing has allowed us to establish strongcustomer relationships. In addition to our internal marketing efforts, we alsorely on the marketing efforts of consultants, both in the United States andabroad. We 

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marketour services directly to customers through targeted mailings, meetings withsenior management of pharmaceutical and biotechnology companies, maintenance ofan extensive Internet web site, participation in trade conferences and shows,and advertisements in scientific and trade journals. We also receive asignificant amount of business from customer referrals and through expansion ofexisting contracts.

***Employees***

As of February 1,2006, we had 847 employees. Our large-scale manufacturing hourly work force of107 employees is covered by a collective bargaining agreement with theInternational Chemical Workers Union. A new 3-year collective bargainingagreement was signed in January 2004 with the union and expires on January 10,2007. None of our other employees are covered by collective bargainingagreements. We consider our relations with our employees and the union to begood.

***Competition***

We face competition based on a number of factors,including size, relative expertise and sophistication, speed and costs ofidentifying and optimizing potential lead compounds and of developing andoptimizing chemical processes. In certain aspects of our business we also faceforeign competition with lower cost structures. We compete with the researchdepartments of pharmaceutical companies, biotechnology companies, combinatorialchemistry companies, contract research companies, contract drug manufacturingcompanies and research and academic institutions. Many of these competitorshave greater financial and other resources and more experience in research anddevelopment than we do. Smaller companies may also prove to be significantcompetitors, particularly through arrangements with large corporatecollaborators.

Historically, pharmaceutical companies have maintainedclose control over their research and development activities, including thesynthesis, screening and optimization of chemical compounds and the developmentof chemical processes. Many of these companies, which represent a significantpotential market for our products and services, are developing or alreadypossess in-house technologies and services offered by us. Academicinstitutions, governmental agencies and other research organizations are alsoconducting research in areas in which we provide services either on their ownor through collaborative efforts.

We anticipate that we willface increased competition in the future as new companies enter the market, includinginternational competitors, and as advanced technologies become available. Wealso anticipate increased foreign competition from Asia, India and EasternEurope and other lower-cost environments. Our services and expertise may berendered obsolete or uneconomical by technological advances or entirelydifferent approaches developed by one or more of our competitors. The existingapproaches of our competitors or new approaches or technologies developed byour competitors may be more effective than those developed by us. We cannotgive assurance that our competitors will not develop more effective or moreaffordable technologies or services, thus rendering our technologies and/orservices obsolete, uncompetitive or uneconomical.

***Patents and Proprietary Rights***

Our success will depend, in part, on our ability toobtain and enforce patents, protect trade secrets, obtain licenses totechnology owned by third parties when necessary, and conduct our businesswithout infringing the proprietary rights of others. The patent positions ofpharmaceutical, medical products and biotechnology firms can be uncertain andinvolve complex legal and factual questions. We cannot assure you that anypatent applications will result in the issuance of patents or, if any patents areissued, whether they will provide significant proprietary protection orcommercial advantage, or will not be circumvented by others. In the event athird party has also filed one or more patent applications for inventions which

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conflict with one of ours,we may have to participate in interference proceedings declared by theUnited States Patent and Trademark Office to determine priority ofinvention, which could result in the loss of any opportunity to secure patentprotection for the inventions and the loss of any right to use the inventions.Even if the eventual outcome is favorable to us, these proceedings could resultin substantial cost to us. The filing and prosecution of patent applications,litigation to establish the validity and scope of patents, assertion of patentinfringement claims against others and the defense of patent infringementclaims by others can be expensive and time consuming. We cannot assure you thatin the event that any claims with respect to any of our patents, if issued, arechallenged by one or more third parties, that any court or patent authorityruling on such challenge will determine that such patent claims are valid andenforceable. An adverse outcome in such litigation could cause us to loseexclusivity afforded by the disputed rights. If a third party is found to haverights covering products or processes used by us, we could be forced to ceaseusing the technologies covered by such rights, could be subject to significantliability to the third party, and could be required to license technologiesfrom the third party. Furthermore, even if our patents are determined to bevalid, enforceable, and broad in scope, we cannot assure you that competitorswill not be able to design around such patents and compete with us and our licenseesusing the resulting alternative technology.

We have a policy of seeking patent protection forpatentable aspects of our proprietary technology. We have been issued variousUnited States and international patents covering fexofenadine HC1 and certainrelated manufacturing processes. Our United States patents begin to expire in2013, and our international patents begin to expire in 2014. Additionally, ourUnited States patents related to substituted biaryl purines as potentanticancer agents and a series of aryl and heteroaryl tetrahydroisoquinolinesrelated to central nervous system indications begin to expire in 2020.

We seek patent protection with respect to products andprocesses developed in the course of our activities when we believe such protectionis in our best interest and when the cost of seeking such protection is notinordinate. However, we cannot assure you that any patent application will befiled, that any filed applications will result in issued patents, or that anyissued patents will provide us with a competitive advantage or will not besuccessfully challenged by third parties. The protections afforded by patentswill depend upon their scope and validity, and others may be able to designaround our patents.

Many of our other currentcontracts with our customers provide that ownership of proprietary technologydeveloped by us in the course of work performed under the contract is vested inthe customer, and we retain little or no ownership interest.

We also rely upon tradesecrets and proprietary know-how for certain unpatented aspects of ourtechnology. To protect such information, we require all employees, consultantsand licensees to enter into confidentiality agreements limiting the disclosureand use of such information. We cannot assure you that these agreements providemeaningful protection or that they will not be breached, that we would haveadequate remedies for any such breach, or that our trade secrets, proprietaryknow-how, and technological advances will not otherwise become known to others.In addition, we cannot assure you that, despite precautions taken by us, othershave not and will not obtain access to our proprietary technology. Further, wecannot assure you that third parties will not independently develop substantiallyequivalent or better technology.

***GovernmentRegulation***

The manufacture,transportation and storage of our products are subject to certaininternational, Federal, state and local laws and regulations. Our futureprofitability is indirectly dependent on the sales of pharmaceuticals and otherproducts developed by our customers. Regulation by governmental entities in theUnited States and other countries will be a significant factor in theproduction and marketing of any pharmaceutical products that may be developedby our customers. The nature and the extent to which such regulation may applyto our customers will vary depending on the nature of any such pharmaceutical 

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products.Virtually all pharmaceutical products developed by our customers will requireregulatory approval by governmental agencies prior to commercialization. Humanpharmaceutical products are subject to rigorous preclinical and clinicaltesting and other approval procedures by the FDA and by foreign regulatoryauthorities. Various federal and, in some cases, state statutes and regulationsalso govern or influence the manufacturing, safety, labeling, storage, recordkeeping and marketing of such pharmaceutical products. The process of obtainingthese approvals and the subsequent compliance with appropriate federal andforeign statutes and regulations are time consuming and require the expenditureof substantial resources.

Generally, in order togain FDA approval, a company first must conduct preclinical studies in thelaboratory and in animal models to gain preliminary information on a compound’sefficacy and to identify any safety problems. The results of these studies aresubmitted as a part of an investigational new drug application, or IND, thatthe FDA must review before human clinical trials of an investigational drug canstart. In order to commercialize any products, we or our customer will berequired to sponsor and file an IND and will be responsible for initiating andoverseeing the clinical studies to demonstrate the safety and efficacy that arenecessary to obtain FDA approval of any such products. Clinical trials arenormally done in three phases and generally take two to seven years, but maytake longer, to complete. After completion of clinical trials of a new product,FDA and foreign regulatory authority marketing approval must be obtained. Ifthe product is classified as a new drug, we or our customer will be required tofile a new drug application, or NDA, and receive approval beforecommercial marketing of the drug. The testing and approval processes requiresubstantial time, effort and expense, and we cannot assure you that anyapproval will be granted on a timely basis, if at all. NDAs submitted to theFDA can take several years to obtain approval. Even if FDA regulatory clearancesare obtained, a marketed product is subject to continual review. Laterdiscovery of previously unknown problems or failure to comply with theapplicable regulatory requirements may result in restrictions on the marketingof a product or withdrawal of the product from the market as well as possiblecivil or criminal sanctions. For marketing outside the United States, we willalso be subject to foreign regulatory requirements governing human clinicaltrials and marketing approval for pharmaceutical products. The requirementsgoverning the conduct of clinical trials, product licensing, pricing andreimbursement vary widely from country to country.

All facilities andmanufacturing techniques used in the manufacture of products for clinical useor for sale in the United States must be operated in conformity with cGMPguidelines as established by the FDA. Our facilities are subject to scheduledperiodic regulatory inspections to ensure compliance with cGMP requirements.Failure on our part to comply with applicable requirements could result in thetermination of ongoing research or the disqualification of data for submissionto regulatory authorities. A finding that we had materially violated cGMPrequirements could result in additional regulatory sanctions and, in severecases, could result in a mandated closing of our facilities or significantfines, which would materially and adversely affect our business, financialcondition and results of operations. FDA inspections of our Albany andRensselaer manufacturing facilities were completed in the second quarter of2005, resulting in no issuances of Form FDA 483.

Our manufacturing andresearch and development processes involve the controlled use of hazardousmaterials. We are subject to federal, state and local laws and regulationsgoverning the use, manufacture, storage, handling and disposal of suchmaterials and certain waste products. Although we believe that our activitiescurrently comply with the standards prescribed by such laws and regulations,the risk of accidental contamination or injury from these materials cannot beeliminated. In the event of such an accident, we could be held liable for anydamages that result and any such liability could exceed our resources. Inaddition, we cannot assure you that we will not be required to incursignificant costs to comply with environmental laws and regulations in thefuture.

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***Internet Website***

We maintain a website onthe World Wide Web at www.albmolecular.com. The information contained on ourwebsite is not included as a part of, or incorporated by reference into, thisAnnual Report on Form 10-K. We make available on our website, freeof charge, our annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and amendments tothose reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934, as amended, as soon asreasonably practicable after such reports are electronically filed with, orfurnished to, the SEC. Our reports filed with, or furnished to, the SEC arealso available at the SEC’s website at *www.sec.gov*.

**ITEM1A.**        RISK FACTORS

The following factors shouldbe considered carefully in addition to the other information in thisForm 10-K. Except as mentioned under “Quantitative and QualitativeDisclosure About Market Risk” and except for the historical informationcontained herein, the discussion contained in this Form 10-Kcontains “forward-looking statements,” within the meaning ofSection 27A of the Securities Act and Section 21E of the ExchangeAct, that involve risks and uncertainties. Our actual results could differmaterially from those discussed in this Form 10-K. Important factorsthat could cause or contribute to such differences include those discussedbelow, as well as those discussed elsewhere herein.

**The royalties we earn on Allegra may continue todecrease.**

Royalties from sales ofAllegra currently constitute a significant portion of our total revenues andoperating income. During the year ended December 31, 2005, our royaltiesfrom Allegra were $46.9 million, which represented approximately 26% ofour total revenues. For the year ended December 31, 2004, our royaltiesfrom Allegra were $48.0 million, which represented approximately 28% ofour total revenues.  The decrease isprimarily attributable to the at-risk launch of generic fexofenadine announced byBarr Pharmaceuticals, Inc. and Teva Pharmaceuticals Industries Ltd. onSeptember 6, 2005, which had a material adverse impact on U.S. sales ofAllegra in the fourth quarter of 2005. Continued generic Allegra competition,including the entrance of additional generic competitors upon the expiration ofBarr’s 180-day exclusivity period for marketing generic fexofenadine oran at-risk launch of a generic version of Allegra-D by a generic competitor,may further adversely affect U.S. sales of Allegra. If the dollar amount ofAllegra sales subject to our license agreement decreases, due to these or anyother factors, our revenues from our license agreement with Sanofi-Aventis willalso decrease. Because we have very few costs associated with the Allegralicense, a decrease in revenues from our license agreement for Allegra wouldhave a material adverse effect on our revenue, operating income, and financialcondition. For example, a $5.0 million decrease in our Allegra royaltyrevenue would decrease our operating income by $4.5 million.

The recurring royalties wereceive on the sales of Allegra/Telfast have historically provided a materialportion of our revenues, earnings, and operating cash flows. The at-risk launchof generic fexofenadine announced by Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd. on September 6, 2005 had a materialadverse impact on U.S. sales of Allegra in the fourth quarter of 2005,resulting in a 49% year-over-year decrease in our royalty revenues for thefourth quarter. We currently expect that the at-risk launch of genericfexofenadine will have a similar impact on our royalty revenues in futureperiods. We expect to experience a decrease in revenues, earnings, andoperating cash flows in the short term as we continue to develop our businessin an effort to supplement the revenues, earnings and operating cash flows thathave historically been provided by Allegra/Telfast royalties.

We have been issuedseveral patents on a pure form of, and a manufacturing process for,fexofenadine HCl. The patent positions of pharmaceutical, medical andbiotechnology firms can be uncertain and can involve complex legal and factualquestions. Litigation, in particular patent litigation, can be complex andtime-consuming and the outcome is inherently uncertain. We cannot assure our stockholdersthat Sanofi-Aventis will ultimately succeed in its current or any futurelitigation against generic drug manufacturers 

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involvingpatents with respect to Allegra. In the event that one or more of the patentsowned by us or Sanofi-Aventis are ultimately determined to be invalid orunenforceable, Sanofi-Aventis and we would lose exclusivity with respect to theclaims covered by those patents. Any such loss of exclusivity or theintroduction of generic forms of fexofenadine HCl may cause a reduction inAllegra sales. In addition, under our current arrangements with Sanofi-Aventis,Sanofi-Aventis, with consultation from us, has the right to lead with respectto preparing and executing a strategy to defend and enforce certain of thepatents relating to Allegra, and is executing that role in the currentlitigation. As a result, we may not be able to control the conduct of suchlitigation and the strategic decisions that are made during the course of suchlitigation. See “Item 3—Legal Proceedings.”

**Pharmaceuticaland biotechnology companies may discontinue or decrease their usage of ourservices.**

We depend onpharmaceutical and biotechnology companies that use our services for a largeportion of our revenues. Although there has been a trend among pharmaceuticaland biotechnology companies to outsource drug research and developmentfunctions, this trend may not continue. We have experienced increasing pressureon the part of our customers to reduce expenses, including the use of ourservices as a result of negative economic trends generally and in thepharmaceutical industry. Although our contract revenues increased in 2005, wemay be adversely effected in future periods as a result of general economic orpharmaceutical industry downturns. If pharmaceutical and biotechnologycompanies discontinue or decrease their usage of our services, including as aresult of a slowdown in the overall United States economy, our revenues andearnings could be lower than we currently expect and our revenues may decreaseor not grow at historical rates.

**Wemay lose one or more of our major customers.**

During the year-ended December 31,2005, revenues from GE totaled $50.8 million and represented approximately37% of our contract revenue, or 28% of our total revenue. GE discontinuedpurchases of one of the products that we sell to them in 2005. Sales of thisproduct totaled $17.0 million, which represented 21% of Organichem’s 2005revenue and 12% of total contract revenue for the year ended December 31,2005. With respect to another product, Organichem entered into a long-termsupply agreement with GE in 1999 that was renewed in 2005, extending theexpiration date of the original agreement from 2007 to 2010. The renewedagreement also provided the terms under which Organichem would supply a rawmaterial for use in one of GE’s diagnostic imaging agents. GE’s  purchases have historically exceeded thecontractual minimum purchases, however, this may not continue. If GE materiallyreduces its historical purchase levels or we can not replace the revenue fromthe discontinued product, there may be a material decrease in our revenues andoperating income. In addition, during the year ended December 31, 2005,our DDS segment provided services to three major customers representingapproximately 13% of our contract revenues or 9% of our total revenue. Thesecustomers typically may cancel their contracts with 30 days’ to one-year’sprior notice depending on the size of the contract, for a variety of reasons,many of which are beyond our control. If any one of our major customers cancelsits contract with us, our contract revenues may decrease.

**Weface increased competition.**

We compete directly withthe in-house research departments of pharmaceutical companies and biotechnologycompanies, as well as combinatorial chemistry companies, contract researchcompanies, and research and academic institutions. We are also experiencingincreased competition from foreign companies operating under lower coststructures. Many of our competitors have greater financial and other resourcesthan we have. As new companies enter the market and as more advancedtechnologies become available, we currently expect to face increasedcompetition. In the future, any one of our competitors may developtechnological advances that render the services that we provide obsolete. Whilewe plan to develop technologies, which will give us competitive advantages, ourcompetitors plan to do the 

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same. Wemay not be able to develop the technologies we need to successfully compete inthe future, and our competitors may be able to develop such technologies beforewe do or provide those services at a lower cost. Consequently, we may not beable to successfully compete in the future.

**Wemay be unsuccessful in producing and licensing proprietary technology developedfrom our internal research and development efforts or acquired from a thirdparty.**

We have expended andcontinue to expend significant time and money on internal research anddevelopment with the intention of producing proprietary technologies in orderto patent and then license them to other companies. For example, in October 2005we licensed our proprietary amine neurotransmitter reuptake inhibitortechnology to BMS. However, we may not be successful in producing anyadditional valuable technology or successfully licensing it to a third party inthe future. To the extent we are unable to produce technology that we canlicense, we may not receive any revenues related to our internal research anddevelopment efforts.

**Wemay be unsuccessful in our collaboration with BMS.**

Our objective is to patentand license our proprietary technologies to other companies for the purpose ofadvancing compounds associated with these technologies through human clinicaltrials, and ultimately, obtaining regulatory approval for the commercial saleof products containing these compounds. We seek to enter into licensingarrangements with selected partners that provide for a combination of up-frontlicense fees, milestone payments upon the achievement of specified research anddevelopment objectives, and royalty payments based on sales of relatedcommercial products. In October 2005, we licensed the worldwide rights todevelop and commercialize potential products from our amine neurotransmitterreuptake inhibitors identified in one of our proprietary research programs toBMS. In conjunction with the licensing agreement, we received a non-refundable,non-creditable up-front fee of $8 million. In addition, BMS will purchaseapproximately $10 million in research and development services over the initialthree year term of our agreement. The license agreement also sets forthdevelopment related milestone events that, if achieved by our products, wouldentitle us to non-refundable, non-creditable milestone payments of up to $66.0million for each of the first and second products to achieve these events, andup to $22.0 million for each subsequent product to achieve these events. Thelicense agreement also provides for us to receive royalty payments on worldwidesales of any such product that is commercialized for a ten year period.

Our arrangement with BMSis a significant component of our proprietary research and development business.If there is a delay or failure in BMS’s performance, our proprietary researchand development business may not produce the long-term revenues, earnings, orstrategic benefits that we anticipate. We cannot control BMS’s performance orthe resources it devotes to our collaborative program. We cannot guarantee BMS’scontinuous utilization of our services at levels set forth in our agreementafter the initial term of the agreement, and we cannot guarantee BMS’scontinued pursuit of programs covered by our agreement. Furthermore, withrespect to any drug candidate resulting from our collaborative program, the FDAmay delay or deny marketing approvals because of adverse FDA decisions orinterpretations of data that differ from BMS’s interpretations and that mayrequire additional clinical trials or potential changes in the cost, scope andduration of clinical trials. Even if we succeed in getting market approvals,BMS may not have the ability to successfully launch, increase sales of orsustain the product or products in the market, or efficiently scale-upmanufacturing for commercialized compounds. Disputes may arise between us andBMS, which may not be resolved in our favor. Further, BMS could merge with orbe acquired by another company or experience financial or other setbacksunrelated to our collaboration that could, nevertheless, adversely affect us. Theoccurrence of any of these could result in our proprietary research anddevelopment business not producing the long-term revenues, earnings, orstrategic benefits that we anticipate.

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**Ourgoodwill may become impaired.**

As of December 31,2005, we have $25.7 million of goodwill on our consolidated balance sheet.We perform an annual assessment of the carrying value of our goodwill forpotential impairment through an independent third-party. A determinationof impairment is made based upon the estimated future cash flows of theoperations associated with goodwill. If goodwill is determined to be impairedin the future we would be required to record a charge to our results ofoperations. For example, during 2004 we recorded goodwill impairment chargestotaling $14.5 million. Factors we consider important which could result in animpairment include the following:

·       significantunderperformance relative to historical or projected future operating results;

·       significantchanges in the manner of our use of the acquired assets or the strategy for ouroverall business;

·       significantnegative industry or economic trends; and

·       ourmarket capitalization relative to net book value.

See Note 19 to theconsolidated financial statements for further information regarding the 2004impairment charge.

**Wemay lose valuable intellectual property if we are unable to protect it.**

Some of our most valuableassets include patents and trade secrets. Part of our business isdeveloping technologies that we patent and then license to other companies.However, some technologies that we develop may already be patented by othercompanies. For this and other reasons, we may not be able to obtain patents foreach new technology that we develop. Even if we are able to obtain patents, thepatents may not sufficiently protect our interest in the technology. Similarly,we may not be able to protect our trade secrets by keeping them confidential.Additionally, protecting our patents and trade secrets may be costly and timeconsuming. To the extent we are unable to protect intellectual property, ourinvestment in those technologies may not yield the benefits we expected. Inaddition, we may be subject to claims that we are infringing on theintellectual property of others. We could incur significant costs defendingsuch claims. If we are unsuccessful in defending these claims, we may besubject to liability for infringement.

**Ourfailure to manage our expansion may adversely affect us.**

Our business has expandedrapidly in the past several years. Expansion places increased stress on ourfinancial, managerial and human resources. As we expand, we will need torecruit and retain additional highly skilled scientists and technicians.Expansion of our facilities may lead to increased expenses and may divertmanagement attention away from operations.

**Futureacquisitions may disrupt our business and distract our management.**

We have engaged in anumber of acquisitions and strategic investments, and we currently expect tocontinue to do so. For example, in February 2006, we completed theacquisition of ComGenex, a privately held drug discovery service company inBudapest, Hungary. However, we may not be able to identify additional suitableacquisition candidates, and if we do identify suitable candidates, we may notbe able to make such acquisitions on commercially acceptable terms or at all.If we acquire another company, we may not be able to successfully integrate theacquired business into our existing business in a timely and non-disruptivemanner or at all. We may have to devote a significant amount of time andresources to do so. Even with this investment of time and resources, anacquisition may not produce the revenues, earnings or business synergies thatwe anticipate. If we fail to integrate the acquired business effectively or ifkey employees of that business leave, the anticipated benefits of theacquisition would be jeopardized. The time, capital, management and otherresources spent on an acquisition that fails to meet our expectations could causeour business and financial condition to be materially and adversely affected.In addition, 

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acquisitionscan involve charges of significant amounts related to goodwill that couldbecome impaired and adversely affect our results of operations.

**Wemay not be able to realize the benefits of recent acquisitions and strategicinvestments.**

We made a strategicinvestment in Organichem Corporation in December 1999 to facilitate amanagement buyout of a chemical manufacturing facility from Nycomed Amersham,plc and completed the full acquisition of Organichem in February 2003. Alsoduring 2003, we made equity investments in two private companies. Under theterms of these agreements, we also provided FTE services to each company inexchange for equity securities and fee for service cash payments. Both of thesecompanies are currently in the process of raising additional financing. In February 2006,we completed the acquisition of ComGenex, a privately held drug discoveryservice company in Budapest, Hungary. These transactions may not be asbeneficial to us as we currently expect. We record an impairment charge when webelieve an investment has experienced a decline in value that is other thantemporary. Future adverse changes in market conditions, poor operating resultsof underlying investments or the investees’ inability to obtain additionalfinancing could result in our inability to recover the carrying value of theinvestments, thereby requiring an impairment charge in the future. For example,during the fourth quarter of 2004 we recorded a $1.3 million impairment chargerelated to an investment we made in a drug discovery company.

**Wemay not be able to effectively manage our international operations.**

We established researchfacilities in Singapore and Hyderabad, India in 2005. In February 2006, wecompleted the acquisition of ComGenex, a privately held drug discovery servicecompany in Budapest, Hungary. There are significant risks associated with theestablishment of foreign operations, including, but not limited to:geopolitical risks, foreign currency exchange rates and the impact of shifts inthe U.S. and local economies on those rates, compliance with local laws andregulations, the protection of our intellectual property and that of ourcustomers, the ability to integrate our corporate culture with local customsand cultures, and the ability to effectively and efficiently supply ourinternational facilities with the required equipment and materials. If we areunable to effectively manage these risks, these locations may not produce therevenues, earnings, or strategic benefits that we anticipate.

**Wemay not be able to recruit and retain the highly skilled employees we need.**

Our future growth andprofitability depends upon the research and efforts of our highly skilledemployees, such as our scientists, and their ability to keep pace with changesin drug discovery and development technologies. We believe that there is ashortage of scientists, and we compete vigorously with pharmaceutical firms,biotechnology firms, contract research firms, and academic and researchinstitutions to recruit scientists. If we cannot recruit and retain scientistsand other highly skilled employees, we will not be able to continue ourexisting services and will not be able to expand the services we offer to ourcustomers.

**Wemay lose one or more of our key employees.**

Ourbusiness is highly dependent on our senior management and scientific staff,including:

·       Dr. ThomasE. D’Ambra, our Chairman, Chief Executive Officer and President;

·       MarkT. Frost, our Chief Financial Officer, Secretary and Treasurer;

·       BrianD. Russell, our Vice President, Human Resources;

·       EricSmart, our Vice President, Business Development;

·       Dr. MichaelP. Trova, our Senior Vice President, Chemistry;

·       Dr. BruceJ. Sargent, our Vice President, Discovery Research and Development;

·       KentonShultis, our Vice President and General Manager, Large Scale Manufacturing;

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·       Dr. HaroldMeckler, our Vice President, Science & Technology; and;

·       PatriciaEllis, our Vice President, Quality and Analytical Services.

Although we haveemployment agreements with certain individuals listed above, we do not haveemployment agreements with all of our key employees. Additionally, the loss ofany of our other key employees, including our scientists, may have an adverseeffect on our business.

**The royalties weearn on Allegra will likely be affected by the seasonal nature of allergies.**

Allergic reactions toplants, pollens and other airborne allergens generally occur during the springand summer seasons. Therefore, we currently expect the demand for Allegra to belower during other times of the year. Because Allegra sales change seasonallybased on the demand for allergy medicines, our quarter-to-quarter revenues willlikely experience fluctuations.

**Wemay be held liable for harm caused by drugs that we develop and test.**

We develop, test and, to alimited extent, manufacture drugs that are used by humans. If any of the drugsthat we develop, test or manufacture harm people, we may be required to paydamages to those persons. Although we carry liability insurance, we may berequired to pay damages in excess of the amounts of our insurance coverage.Damages awarded in a product liability action could be substantial and couldhave a negative impact on our financial condition.

**Wemay be liable for contamination or other harm caused by hazardous materialsthat we use.**

Our research and development processes involve the useof hazardous materials. We are subject to Federal, state and local regulationgoverning the use, manufacture, handling, storage and disposal of hazardousmaterials. We cannot completely eliminate the risk of contamination or injuryresulting from hazardous materials and we may incur liability as a result ofany contamination or injury. We may also incur expenses relating to compliancewith environmental laws. Such expenses or liabilities could have a significantnegative impact on our financial condition.

We have completed anenvironmental remediation assessment associated with groundwater contaminationat our Rensselaer, New York location. This contamination is associated withpast practices at the facility prior to 1990, and prior to AMRI’s investment orownership of the facility. Ongoing costs associated with the remediationinclude biannual monitoring and reporting to the State of New York’s Departmentof Environmental Conservation. Under the remediation plan, we are expected topay for monitoring and reporting until 2009. Under a 1999 agreement with thefacility’s previous owner, our maximum liability under the remediation is$5.0 million. If the State of New York Department of EnvironmentalConservation finds that we fail to comply with the appropriate regulatorystandards, it may impose fines on us which could have a negative impact on ouroperations. Additionally, if we are unable to enforce our contractual maximumremediation liability of $5.0 million, it may have an adverse affect onour results of operations.

**If wefail to meet strict regulatory requirements, we could be required to pay finesor even close our facilities.**

All facilities andmanufacturing techniques used to manufacture drugs in the United States mustconform to standards that are established by the federal Food and DrugAdministration, or FDA. The FDA conducts scheduled periodic inspections of ourfacilities to monitor our compliance with regulatory standards. If the FDAfinds that we fail to comply with the appropriate regulatory standards, it mayimpose fines on us or, if the FDA determines that our non-compliance is severe,it may close our facilities. Any adverse action by the FDA would have anegative impact on our operations.

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**Ouroperations may be interrupted by the occurrence of a natural disaster or othercatastrophic event at our primary facilities.**

We depend on ourlaboratories and equipment for the continued operation of our business. Ourresearch and development operations and all administrative functions areprimarily conducted at our facilities in Albany and Rensselaer, New York.Although we have contingency plans in effect for natural disasters or othercatastrophic events, these events could still disrupt our operations. Eventhough we carry business interruption insurance policies, we may suffer lossesas a result of business interruptions that exceed the coverage available underour insurance policies. Any natural disaster or catastrophic event in theAlbany area or at our facilities could have a significant negative impact onour operations.

**Terroristattacks or acts of war may seriously harm our business.**

Terrorist attacks or actsof war may cause damage or disruption to our company, our employees, ourfacilities and our customers, which could significantly impact our revenues,costs and expenses and financial condition. For example, the terrorist attacksthat took place in the United States on September 11, 2001 wereunprecedented events that have created many economic and political uncertainties,some of which may materially adversely affect our business, results ofoperations and financial condition. The potential for future terrorist attacks,the national and international responses to terrorist attacks, and other actsof war, including the current war in Iraq, or hostility have created manyeconomic and political uncertainties, which could materially adversely affectour business, results of operations, and financial condition in ways that wecurrently cannot predict.

**Healthcare reform could reduce the prices pharmaceutical and biotechnology companiescan charge for drugs they sell which, in turn, could reduce the amounts thatthey have available to retain our services.**

We depend on contractswith pharmaceutical and biotechnology companies for a majority of our revenues.We therefore depend upon the ability of pharmaceutical and biotechnologycompanies to earn enough profit on the drugs they market to devote substantialresources to the research and development of new drugs. Future legislation maylimit the prices pharmaceutical and biotechnology companies can charge for thedrugs they market. Such laws may have the effect of reducing the resources thatpharmaceutical and biotechnology companies can devote to the research anddevelopment of new drugs. If pharmaceutical and biotechnology companiesdecrease the resources they devote to the research and development of newdrugs, the amount of services that we perform, and therefore our revenues,could be reduced.

**Theability of our stockholders to control our policies and effect a change ofcontrol of our company is limited, which may not be in your best interests.**

There areprovisions in our certificate of incorporation and bylaws which may discouragea third party from making a proposal to acquire us, even if some of ourstockholders might consider the proposal to be in their best interests. Theseprovisions include the following:

·       Ourcertificate of incorporation provides for three classes of directors with theterm of office of one class expiring each year, commonly referred to as a“staggered board.” By preventing stockholders from voting on the election ofmore than one class of directors at any annual meeting of stockholders, thisprovision may have the effect of keeping the current members of our board ofdirectors in control for a longer period of time than stockholders may desire.

·       Ourcertificate of incorporation authorizes our board of directors to issue sharesof preferred stock without stockholder approval and to establish the preferencesand rights of any preferred stock issued, which would allow the board to issueone or more classes or series of preferred stock that could discourage or delaya tender offer or change in control.

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Additionally, we are subject to Section 203 ofthe Delaware General Corporation Law, which, in general, imposes restrictionsupon acquirers of 15% or more of our stock.

We have adopted a Shareholder Rights Plan, the purposeof which is, among other things, to enhance the Board’s ability to protectshareholder interests and to ensure that shareholders receive fair treatment inthe event any coercive takeover attempt of us is made in the future. Under theterms of the Shareholder Rights Plan, the Board can in effect prevent a personor group from acquiring more than 15% of the outstanding shares of our CommonStock. Once a shareholder acquires more than 15% of our outstanding CommonStock without Board approval (the “acquiring person”), all other shareholderswill have the right to purchase securities from us at a price less than theirthen fair market value. These subsequent purchases by other shareholderssubstantially reduce the value and influence of the shares of Common Stockowned by the acquiring person.

**Ourofficers and directors have significant control over us and their interests maydiffer from yours.**

At February 21, 2006,our directors and officers beneficially owned or controlled approximately 15.4%of our common stock. Individually and in the aggregate, these stockholderssignificantly influence our management, affairs and all matters requiringstockholder approval. In particular, this concentration of ownership may havethe effect of delaying, deferring or preventing an acquisition of us and mayadversely affect the market price of our common stock.

**Becauseour stock price may be volatile, our stock price could experience substantialdeclines.**

The market price of ourcommon stock has historically experienced and may continue to experiencevolatility. Our quarterly operating results, changes in general conditions inthe economy or the financial markets and other developments affecting us or ourcompetitors could cause the market price of our common stock to fluctuatesubstantially. In addition, in recent years, the stock market has experiencedsignificant price and volume fluctuations. In addition, the global economic andpotential uncertainty, including as a result of the war in Iraq and theinternational controversy that accompanied it, have created significantadditional volatility in the United States capital markets. This volatility andthe recent market decline has affected the market prices of securities issuedby many companies, often for reasons unrelated to their operating performanceor their business prospects, and may adversely affect the price of our commonstock.

**Becausewe do not intend to pay dividends, you will benefit from an investment in ourcommon stock only if it appreciates in value.**

We have never declared orpaid any cash dividends on our common stock. We currently intend to retain our futureearnings, if any, to finance the expansion of our business and do not expect topay any cash dividends in the foreseeable future. As a result, the success ofyour investment in our common stock will depend entirely upon any futureappreciation. There is no guarantee that our common stock will appreciate invalue or even maintain the price at which you purchased your shares.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS.

We have received nowritten comments regarding our periodic or current reports from the staff ofthe Securities and Exchange Commission that were issued 180 days or morepreceding the end of our 2005 fiscal year and that remain unresolved.

**ITEM 2.**                PROPERTIES.

Ourprincipal manufacturing and research and development facilities are located inthe United States. The aggregate square footage of our operating facilities isapproximately 753,377 square feet, of which 

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458,400 square feet are owned and 294,977 square feetare leased. Set forth below is information on our principal facilities:

| **Location**              | ** ** | ** ** | ** ** | **Square Feet** | ** ** | **Primary Purpose**                                           | ** ** |
|---------------------------|------------|------------|------------|----------------------|------------|--------------------------------------------------------------------|------------|
| Albany, New York          |       |       | 268,000    |                 |       | Manufacturing,  Research & Development and Administration |       |
| Rensselaer, New  York     |       |       | 251,400    |                 |       | Manufacturing &  Research & Development          |       |
| East Greenbush,  New York |       |       | 64,000     |                 |       | Manufacturing &  Research & Development          |       |
| Syracuse, New  York       |       |       | 28,000     |                 |       | Manufacturing &  Research & Development          |       |
| Bothell,  Washington      |       |       | 32,977     |                 |       | Research &  Development                                   |       |
| Singapore                 |       |       | 16,000     |                 |       | Research &  Development                                   |       |
| Hyderabad, India          |       |       | 5,000      |                 |       | Research &  Development                                   |       |
| Mt. Prospect, Illinois    |       |       | 88,000     |                 |       | Held for Sale                                                      |       |

 

Our Rensselaer, NYfacility is used in our Large-Scale Manufacturing (“LSM”) segment as reportedin the consolidated financial statements. All other facilities are used in ourDiscovery/Development/Small Scale Manufactring (“DDS”) segment as reported inthe consolidated financial statements. We consider these facilities to be ingood condition and suitable for their purpose. The capacity associated withthese facilities is adequate to meet our anticipated needs through 2006.

**ITEM 3.**                LEGALPROCEEDINGS.

The Company, from time to time, may be involved invarious claims and legal proceedings arising in the ordinary course ofbusiness. Except as noted below in regards to litigation relating to Allegra,the Company is not currently a party to any such claims or proceedings which,if decided adversely to the Company, would either individually or in theaggregate have a material adverse effect on the Company’s business, financialcondition, results of operations or cash flows.

AMR Technology, a subsidiary of the Company, alongwith Aventis Pharmaceuticals Inc., the U.S. pharmaceutical business ofSanofi-Aventis S.A., are involved in legal proceedings with several companiesseeking to market generic versions of Allegra. Beginning in 2001, BarrLaboratories, Inc., Impax Laboratories, Inc., Mylan Pharmaceuticals, Inc.,Teva Pharmaceuticals USA, Dr. Reddy’s Laboratories, Ltd./Dr. Reddy’sLaboratories, Inc., Ranbaxy Laboratories Ltd./Ranbaxy PharmaceuticalsInc., and Sandoz Inc. filed Abbreviated New Drug Applications (ANDAs) with theU.S. Food and Drug Administration, or FDA, to produce and market genericversions of Allegra products.

In response to the filings described above, beginningin 2001, Aventis Pharmaceuticals filed patent infringement lawsuits againstBarr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, TevaPharmaceuticals, Dr. Reddy’s Laboratories, Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., and Sandoz. Each of the lawsuits was filedin the U.S. District Court in New Jersey and alleges infringement of one ormore patents owned by Aventis Pharmaceuticals. Further, beginning in March 5,2004, AMR Technology, along with Aventis Pharmaceuticals, filed suit in theU.S. District Court in New Jersey against Barr Laboratories, ImpaxLaboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Amino Chemicals, Ltd., Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., and Sandoz, Inc., asserting infringement of two ofour U.S. patents that are exclusively licensed to Aventis Pharmaceuticalsrelating to Allegra and Allegra-D products.

In the pending litigations, Aventis Pharmaceuticalsand AMR Technology have entered into covenants not to sue the defendants underU.S. Patent No. 5,578,610, which patent has not been asserted in thelitigation but which Aventis Pharmaceuticals exclusively licenses from us.However, we and Aventis Pharmaceuticals have agreed that AventisPharmaceuticals will continue to pay royalties to us based on that patent underour original license agreement with Aventis Pharmaceuticals. Under ourarrangements with Aventis Pharmaceuticals, we will receive royalties untilexpiration of the underlying patents (2013 for 

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U.S. Patent No. 5,578,610and 2015 for U.S. Patent No. 5,750,703) unless the patents are earlierdetermined to be invalid.

Under applicable federal law, marketing of anFDA-approved generic version of Allegra may not commence until the earlier of adecision favorable to the generic challenger in the patent litigation or 30months after the date the patent infringement lawsuit was filed. In general,the first generic filer is entitled to a 180-day marketing exclusivityperiod upon FDA approval.

On September 6, 2005, Barr Pharmaceuticals, Inc.and Teva Pharmaceuticals Industries Ltd. announced that they have entered intoan agreement for the launch of Fexofenadine Hydrochloride 30 mg, 60 mg and 180mg tablets, the generic version of Allegra tablets in the United States. Thelaunch of the generic product is considered an “at-risk” launch due to theon-going litigation. This generic launch had a material adverse impact on U.S.sales of Allegra by Sanofi-Aventis in the fourth quarter of 2005 and in turn,the royalties earned by the Company on those sales. The launch has not had amaterial impact on non-U.S. sales of Allegra to date.

On September 20, 2005, AMR Technology, along withAventis Pharmaceuticals, filed a Motion for Preliminary Injunction in the U.S.District Court in New Jersey seeking to enjoin Barr Pharmaceuticals, Inc., TevaPharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd. fromthe sale of generic versions of Allegra in the United States. On January 30,2006, the U.S. District Court denied the request by AMR Technology and AventisPharmaceuticals for a preliminary injunction. A notice of appeal to the U.S.Court of Appeals for the Federal Circuit was filed on February 2, 2006.

Should the Company beunsuccessful in defending these patents we would continue to experience amaterial decrease in operating cash flows and a material adverse effect on ourresults of operations and financial condition.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.

There were no matters submitted during the fourthquarter of the fiscal year covered by this report to a vote of security holdersthrough solicitation of proxies or otherwise.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUERPURCHASES OF EQUITY SECURITIES.

(a)   Market Information.   The Common Stock ofthe Company is traded on the Nasdaq National Market (“Nasdaq”) under the symbol“AMRI.” The following table sets forth the high and low closing prices for ourCommon Stock as reported by Nasdaq for the periods indicated:

| **Period**                          | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| Year ending  December 31, 2005 |       |       |       |     |       |
| First Quarter                       |       | $          | 11.27      |     | $          | 8.06    |       |
| Second Quarter                      |       | $          | 14.20      |     | $          | 9.01    |       |
| Third Quarter                       |       | $          | 16.99      |     | $          | 11.77   |       |
| Fourth Quarter                      |       | $          | 13.71      |     | $          | 10.79   |       |
| Year ending  December 31, 2004 |       |       |       |     |       |
| First Quarter                       |       | $          | 16.22      |     | $          | 14.47   |       |
| Second Quarter                      |       | $          | 17.19      |     | $          | 12.12   |       |
| Third Quarter                       |       | $          | 12.76      |     | $          | 9.00    |       |
| Fourth Quarter                      |       | $          | 11.52      |     | $          | 8.55    |       |

 

(b)   Holders.   Thenumber of record holders of our Common Stock as of February 18, 2006 wasapproximately 202. We believe that the number of beneficial owners of ourCommon Stock at that date was substantially greater than 202.

(c)   Dividends.   Wehave not declared any cash dividends on our Common Stock since our inception in1991. We currently intend to retain our earnings for future growth and,therefore, do not anticipate paying cash dividends in the foreseeable future.Under Delaware law, we are permitted to pay dividends only out of our surplus,or, if there is no surplus, out of our net profits. Although our current bankcredit facility permits us to pay cash dividends, subject to certainlimitations, the payment of cash dividends may be prohibited under agreementsgoverning debt which we may incur in the future.

(d)   RecentSales of Unregistered Securities; Use of Proceeds from Registered Securities.

In March 2004, we issued to Bristol-MyersSquibb Company (BMS)warrants topurchase up to 516,232 shares of our common stock, with exercise prices rangingfrom $30.24 to $35.24 per share. The exercise period for these warrants was 5.5years. The issuance of these warrants resulted from a 2002 agreement wherebyBMS transferred intellectual property to us, providing us with ownership of oneof BMS’s preclinical drug candidates, along with patent applications coveringattention deficit hyperactivity disorder (ADHD) and central nervous systemindications. In connection with the agreement, in March 2004, we electedto retain ownership of the technology and all improvements made to date by us,resulting in the issuance of the warrants to BMS. The warrants were offered and sold in reliance upon Section 4(2) ofthe Securities Act of 1933, as amended.

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(e)   Equity Compensation Plan Information—Thefollowing table provides information about the securities authorized forissuance under our equity compensation plans as of December 31, 2005:

| **Plan Category**                                      | ** ** | ** ** | ** ** | **(a)  Number of securities to be  issued upon exercise of  outstanding options,  warrants  and rights** | ** ** | **(b)  Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **(c)  Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders(1)  |       |       | 2,240,975  |                                                                                                                                                  |       |                                                                                                             | $          | 19.99                                                                                                                                                                                                             |       |   |   | 2,010,663 |   |   |
| Equity  compensation plans not approved by security holders |       |       | —     |                                                                                                                                                  |       |                                                                                                             | —     |                                                                                                                                                                                                              |       |   | — |   |   |
| Total                                                       |       |       | 2,240,975  |                                                                                                                                                  |       |                                                                                                             | $          | 19.99                                                                                                                                                                                                             |       |   |   | 2,010,663 | (2) |   |

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(1)          Consists of the StockOption Plan and the Employee Stock Purchase Plan (ESPP). Does not includepurchase rights accruing under the ESPP because the purchase price (andtherefore the number of shares to be purchased) will not be determined untilthe end of the purchase period. Includes shares available for future issuanceunder the ESPP and Stock Option Plan.

(2)          Includes 1,612,536shares available for the Stock Option Plan and 398,127 shares available for theESPP.

 

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**ITEM 6.**                SELECTED FINANCIALDATA.

Theselected financial data shown below for the fiscal years ended December 31,2005, 2004, and 2003 and as of December 31, 2005 and 2004, have beenderived from our audited consolidated financial statements included in this Form 10-K.The selected financial data set forth below for the fiscal years ended December 31,2002 and 2001 and as of December 31, 2003, 2002 and 2001 have been derivedfrom our audited consolidated financial statements for those years, which arenot included in this Form 10-K. All share and per share amounts havebeen adjusted for stock splits. The information should be read in conjunctionwith the Company’s audited consolidated financial statements and related notesand other financial information included herein, including Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”.

| ** **                                           | ** ** | **As of and for the Year Ending December 31,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                                                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                           | ** ** | **(in thousands, except per share data)**                     | ** ** |
| **Consolidated  Statements of Income Data:**         |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Contract revenue                                     |       | $                                                                                      | 136,988    |   | $ | 121,554 |   | $ | 144,667 |   | $ | 71,688 |   | $ | 60,334 |   |
| Recurring royalties                                  |       | 46,918                                                                                 |       | 47,973 |   | 51,682 |   | 51,139 |   | 41,675 |   |
| Total revenue                                        |       | 183,906                                                                                |       | 169,527 |   | 196,349 |   | 122,827 |   | 102,009 |   |
| Cost of contract revenue                             |       | 112,642                                                                                |       | 96,932 |   | 101,753 |   | 41,313 |   | 34,946 |   |
| Write-down of library inventories                    |       | 2,063                                                                                  |       | 5,974 |   | — |   | — |   | — |   |
| Total cost of contract  revenue                      |       | 114,705                                                                                |       | 102,906 |   | 101,753 |   | 41,313 |   | 34,946 |   |
| Technology incentive award                           |       | 4,695                                                                                  |       | 4,789 |   | 5,183 |   | 5,107 |   | 4,165 |   |
| Research and development                             |       | 14,468                                                                                 |       | 23,887 |   | 22,466 |   | 7,096 |   | 4,290 |   |
| Selling, general and administrative                  |       | 26,494                                                                                 |       | 22,812 |   | 20,318 |   | 12,897 |   | 12,194 |   |
| Property and equipment impairment                    |       | —                                                                                 |       | 4,728 |   | — |   | — |   | — |   |
| Goodwill impairment                                  |       | —                                                                                 |       | 14,494 |   | — |   | — |   | — |   |
| Intangible asset impairment                          |       | —                                                                                 |       | 3,541 |   | — |   | — |   | — |   |
| Restructuring charge                                 |       | —                                                                                 |       | 1,184 |   | — |   | — |   | — |   |
| Total costs and expenses                             |       | 160,362                                                                                |       | 178,341 |   | 149,720 |   | 66,413 |   | 55,595 |   |
| Income (loss) from operations                        |       | 23,544                                                                                 |       | (8,814 | ) | 46,629 |   | 56,414 |   | 46,414 |   |
| Equity in (loss) income of unconsolidated affiliates |       | —                                                                                 |       | (65 | ) | (372 | ) | 2,795 |   | 1,130 |   |
| Interest income, net                                 |       | 1,787                                                                                  |       | 317 |   | 785 |   | 3,108 |   | 6,650 |   |
| Minority interest in consolidated subsidiaries       |       | —                                                                                 |       | — |   | 133 |   | — |   | — |   |
| Loss on equity investment                            |       | —                                                                                 |       | (1,274 | ) | — |   | — |   | — |   |
| Other (loss) income, net                             |       | (185                                                                                   | )          | (18 | ) | 403 |   | 93 |   | 127 |   |
| Income (loss) before income tax expense              |       | 25,146                                                                                 |       | (9,854 | ) | 47,578 |   | 62,410 |   | 54,321 |   |
| Income tax expense                                   |       | 8,825                                                                                  |       | 1,837 |   | 16,714 |   | 22,686 |   | 19,707 |   |
| Net income (loss)                                    |       | $                                                                                      | 16,321     |   | $ | (11,691 | ) | $ | 30,864 |   | $ | 39,724 |   | $ | 34,614 |   |
| Basic earnings (loss) per share                      |       | $                                                                                      | 0.51       |   | $ | (0.37 | ) | $ | 0.97 |   | $ | 1.22 |   | $ | 1.05 |   |
| Diluted earnings (loss) per share                    |       | $                                                                                      | 0.50       |   | $ | (0.37 | ) | $ | 0.95 |   | $ | 1.19 |   | $ | 1.01 |   |
| Weighted average common shares outstanding, basic    |       | 32,334                                                                                 |       | 31,627 |   | 31,880 |   | 32,632 |   | 33,065 |   |
| Weighted average common shares outstanding, diluted  |       | 32,044                                                                                 |       | 31,627 |   | 32,366 |   | 33,309 |   | 34,154 |   |
| **Consolidated Balance Sheet  Data:**                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and investment securities     |       | $                                                                                      | 127,910    |   | $ | 133,749 |   | $ | 124,628 |   | $ | 129,537 |   | $ | 135,865 |   |
| Property and equipment, net                          |       | 151,078                                                                                |       | 145,753 |   | 146,639 |   | 72,518 |   | 59,756 |   |
| Working capital                                      |       | 158,837                                                                                |       | 179,765 |   | 174,609 |   | 163,133 |   | 155,276 |   |
| Total assets                                         |       | 379,182                                                                                |       | 376,892 |   | 390,945 |   | 302,736 |   | 284,059 |   |
| Long-term debt, excluding current installments       |       | 18,521                                                                                 |       | 48,603 |   | 53,129 |   | 5,281 |   | 5,930 |   |
| Total stockholders’ equity                      |       | 313,061                                                                                |       | 295,476 |   | 301,935 |   | 282,147 |   | 263,761 |   |
| **Other Consolidated Data:**                         |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Capital  expenditures                                |       | $                                                                                      | 19,166     |   | $ | 23,716 |   | $ | 30,554 |   | $ | 17,387 |   | $ | 21,155 |   |

 

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

**Overview**

We are a global chemistry-based drug discoveryand development company, focused on identifying and developing novelbiologically active small molecules with applications in the prescription drugmarket. We engage in comprehensive chemistry research from lead discovery,optimization and development to commercial manufacturing and conduct cell andnon-cell based high throughput screening on a variety of biological targets. Weperform chemistry research for many of the leading pharmaceutical andbiotechnology companies and for our own internal research and development.

In addition to our chemistry contract services, wealso conduct proprietary research and development to discover newtherapeutically-active lead compounds with commercial potential. Weanticipate that we would then license these compounds to third parties inreturn for up-front service fees and milestone payments as well as recurringroyalty payments if these compounds are developed into new commercial drugs. In1995, our proprietary research and development activities led to thedevelopment, patenting and licensing of a substantially pure form of, and amanufacturing process for, the active ingredient in the non-sedatingantihistamine fexofenadine HCl marketed by Sanofi-Aventis S.A. as Allegra inthe Americas and as Telfast elsewhere. In October 2005, we licensed theworldwide rights to develop and commercialize potential products from our amineneurotransmitter reuptake inhibitors identified in one of our proprietaryresearch programs to BMS.

Our total revenue for 2005was $183.9 million, including $137.0 million from our chemistrycontract service business and $46.9 million revenue from our royalties onsales of Allegra. During 2005 we performed work for more than 244 customers,including 37 new customers. We generated $42.8 million in cash fromoperations and spent $19.2 million in capital on our facilities andequipment, primarily related to the construction and outfitting of researchfacilities in Singapore and India and the expansion of our manufacturing suitesat our Rensselaer facility. In addition, we paid down $30.1 million inoutstanding principal on our credit facilties. We recorded net income of $16.3million in 2005. As of December 31, 2005, we had $127.9 million incash, cash equivalents and investments and $23.1 million in bank and otherrelated debt, carrying a blended interest rate of approximately 4.34%.

*Strategy*

We continue to execute a long-term strategy to growour global platform chemistry services business while leveraging ourproprietary technologies and capabilities to provide greater value to ourcustomers and further growth for the Company. In 2005, we established operationsin Singapore and India, enabling us to provide our chemistry research anddevelopment services in lower-cost environments. In February 2006, wecompleted the acquisition of ComGenex, a privately held drug discovery servicecompany in Budapest, Hungary. We expect the addition of ComGenex to provide theCompany with significantly increased access to the European market, as well asanother lower-cost environment from which we can provide our services.  We have designed our operating structure andour services to provide our customers with opportunities to reduce overall drugdevelopment time and cost and to simultaneously pursue a greater number of drugdiscovery and development opportunities across a wide range of technologies,geographic locations, and cost structures. The ongoing trend of sourcingcontracted chemistry services to lower-cost providers resulted in several ofour domestic competitors exiting or significantly reducing their presence inthe marketplace during the year. We believe that we are positioned to fill thevoid left by these providers, enabling us to further increase our market share.

We also continued to expand our clinical supplymanufacturing capabilities at our large-scale manufacturing facility, enablingus to seamlessly transition our customers’ clinical supply manufacturingprojects through the drug discovery and development process from thedevelopment of these materials at 

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our smaller scalechemistry laboratories to large-scale production for use in advanced stagehuman trials. Clinical supply manufacturing supplements our Rensselaer facility’slegacy services, which include large scale cGMP commercial production, as wellas high potency and controlled drug substance manufacturing. In addition,clinical supply manufacturing presents additional commercial productionopportunities, as we seek to enter into comprehensive agreements with ourcustomers that also provide for commercial supply of these materials uponmeeting regulatory approval.  Clinicalsupply manufacturing represented 22% of our 2005 large-scale manufacturingrevenue, compared to 12% in 2004.  Ourlargest customer, GE Healthcare (formerly Amersham PLC) (“GE”), discontinuedpurchases of one of the products that we sold to them in 2005. Sales of thisproduct totaled $17.0 million in 2005, which represented 21% of 2005 largescale manufacturing revenue and 12% of total contract revenue for the yearended December 31, 2005. Our objective is to recoup the revenuesassociated with this sales decrease through increased sales of another productto GE, as well as continued growth in clinical supply manufacturing.  We will continue to seek opportunities to addservices and technologies that add value to our customers. We are alsoevaluating opportunities to leverage our large-scale cGMP productionfacilities, including identifying niche products to manufacture such as activepharmaceutical ingredients (“API”) for use in generic versions of compoundswhose patents have expired or will be expiring, as well as assessingcomplementary lines of business that support cGMP production.

We continue to advance our proprietary technologiesand programs with the goal to generate licensing and other revenueopportunities. In 2005, we licensed the worldwide rights to develop andcommercialize potential products from our most advanced proprietary researchprogram, involving amine neurotransmitter reuptake inhibitors, to BMS. Inconjunction with the licensing agreement, we received a non-refundable,non-creditable up-front fee of $8 million. In addition, the agreement providesfor BMS funding of Company research scientists to further advance the programover a period of three years, as well milestone and royalty payments for theachievement of certain events and commercial sales of compounds derived fromthe program. We also continue to utilize our proprietary technologies tofurther advance other early to middle stage internal research programs in thefields of oncology, immunosuppresion and inflammation, with a view to seeking alicensing partner for these programs at an appropriate research ordevelopmental stage.

Additionally, we continue to seek comprehensivechemistry research and supply agreements with our customers that incorporateseveral of our service offerings and span across the entire pharmaceuticalresearch and development process, including access to our chemical compound andnatural product libraries, performance of screening and other lead discoveryactivities, performance of lead optimization and pre-clinical testing, andlarge-scale manufacturing for clinical trials and commercial sale if theproduct meets regulatory approval. Under these comprehensive agreements,companies typically receive a combination of fees for performance and deliveryof goods and services, as well as milestone and royalty payments shouldcollaborative efforts lead to the discovery of new products that reach themarket.

We are currently in the process of implementing acompany-wide enterprise resource planning (“ERP”) system, which will ultimatelyresult in the management of all components of our business across all locationswithin one integrated operating system. We expect the ERP to provide increasedvisibility into the operation and management of our contract chemistry serviceand research and development businesses. In addition, we expect to realizeefficiencies through the consolidated processing of our administrativefunctions in a uniform manner across all locations.

The business environment for chemistry outsourcingcontinued to evolve in 2005.  The pharmaceuticaland biotech industries that comprise our customer base showed indications ofreturning to growth, and the increase in demand for our developmental andsmall-scale cGMP manufacturing services that we experienced in the second halfof 2004 continued through 2005, reflecting a reduction in budgetary constraintsand  renewed efforts to bring identifiedcompounds into clinical trials. Pricing for our services remained extremelycompetitive, and the trend of sourcing contracted chemistry services to lower-cost

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providers continued. Wecommenced lower-cost international operations in Singapore and India in April andJuly 2005, respectively. Our ability to provide services under a varietyof business models and cost structures was well-received by our customers,resulting in an increase in demand for our discovery services bothinternationally and domestically during the latter portion of 2005, ending atwo-year period of declining demand for these services. We expect the trend ofincreased demand for our services to continue in 2006.

The competitive environment facing Allegra alsoremained challenging during the past year. As discussed in Item 3 of this Form 10-K,several generic manufacturers have filed ANDA applications with the FDA seekingauthorization to produce and market a generic version of Allegra. We andAventis Pharmaceuticals have filed several patent infringement suits againstthese generic companies alleging infringement of certain U.S. patents. On September 6,2005, Barr Pharmaceuticals, Inc. and Teva Pharmaceuticals Industries Ltd.announced that they had entered into an agreement for the launch ofFexofenadine Hydrochloride 30 mg, 60 mg and 180 mg tablets, the generic versionof Allegra tablets in the United States. The launch of the generic product isconsidered an “at-risk” launch due to the on-going litigation.  The at-risk launch of generic fexofenadine hada material adverse impact on U.S. sales of Allegra by Sanofi-Aventis in thefourth quarter of 2005 and in turn, the royalties earned by us on those sales.  On September 20, 2005, we and AventisPharmaceuticals filed a Motion for Preliminary Injunction in the U.S. DistrictCourt in New Jersey seeking to enjoin Barr Pharmaceuticals,  Inc., Teva Pharmaceuticals Ltd., RanbaxyLaboratories, Ltd. and Amino Chemicals, Ltd. from the sale of generic versionsof Allegra in the United States. Our motion was denied on January 30, 2006.We continue to forcefully and vigorously defend our intellectual propertyrelated to Allegra. We have filed an appeal of the ruling in the PreliminaryInjunction matter, and we continue to pursue our intellectual property rightsas the patent infringement litigation progresses. However, should we or Aventisbe unsuccessful in defending these patents we would continue to experience amaterial decrease in royalty revenues and operating cash flows.

The recurring royalties wereceive on the sales of Allegra/Telfast have historically provided a materialportion of our revenues, earnings, and operating cash flows. The at-risk launchof generic fexofenadine announced by Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd. on September 6, 2005 had a materialadverse impact on U.S. sales of Allegra in the fourth quarter of 2005,resulting in a 49% year-over-year decrease in our royalty revenues for thefourth quarter. We currently expect that the at risk-launch of genericfexofenadine will have a similar impact on our royalty revenues in futureperiods. We expect to experience a decrease in revenues, earnings, andoperating cash flows in the short term as we continue to develop our businessin an effort to supplement the revenues, earnings and operating cash flows thathave historically been provided by Allegra/Telfast royalties.

*Library InventoryWrite-Off*

In 2004, we recorded a reserveof $6.0 million to reduce the carrying value of our library inventories toreflect less favorable market conditions than previously projected bymanagement and an excess quantity and carrying value of inventory on handcompared to projected future sales revenue. We****continuedto monitor the carrying value of our remaining natural product and chemicallead finding sample collections for impairment throughout 2005.  As previously disclosed, if we were unable tomeet forecasted revenues related to those assets or if actual market conditionswere less favorable than those projected, we might be required to write-downall or a portion of the remaining value of certain compound library assets. Inconnection with our ongoing monitoring of the valuation of our library assetsfor the quarter ended December 31, 2005, we determined that an unfavorableshift in the market for compound libraries had occurred, and we were unable toforecast any meaningful demand for our chemical lead finding sample collections.As a result, we recorded a final reserve increase of $2.1 million to eliminatethe remaining carrying value of these collections.

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**Results of Operations**

Effective January 1,2003, we began consolidating our financial results with Organichem Corporation.For the period January 1, 2003 through February 11, 2003, ourconsolidated financial results reflect a 75.0% ownership of Organichem.Effective February 12, 2003, the date of our purchase of the remaining 25%ownership of Organichem, our financial results reflect 100% ownership ofOrganichem. As a result, our revenues and operating expenses in 2003, 2004, and2005 include the results for Organichem.

*Operating SegmentData*

We have organized oursales, marketing and production activities into the Discovery/Development/SmallScale Manufacturing (“DDS”) and Large Scale Manufacturing (“LSM”) segmentsbased on the criteria set forth in SFAS No. 131, ‘‘Disclosures aboutSegments of an Enterprise and Related Information.’’ We rely on an internalmanagement accounting system to report results of these segments. Theaccounting system includes revenue and cost information by segment. We makefinancial decisions and allocate resources based on the information we receivefrom this internal system. The DDS segment includes activities such as druglead discovery, optimization, drug development and small scale manufacturing.The LSM segment includes pilot to commercial scale manufacturing of activepharmaceutical ingredients and intermediates and high potency and controlledsubstance manufacturing, all of which are in compliance with the Food and DrugAdministration’s (FDA) current Good Manufacturing Practices, or cGMP.

*Contract Revenue*

Contractrevenue consists primarily of fees earned under contracts with third-partycustomers. Our contract revenues for each of our DDS and LSM segments were asfollows:

| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** ** | ** ** | **(in 000’s)**                        | ** ** |
| DDS        |       | $                                          | 55,645     |   | $ | 53,488 |   | $ | 65,600 |   |
| LSM        |       | 81,343                                     |       | 68,066 |   | 79,067 |   |
| Total      |       | $                                          | 136,988    |   | $ | 121,554 |   | $ | 144,667 |   |

 

DDS contract revenue for 2005 was $55.6 million, anincrease of 4% compared to contract revenue of $53.5 million in 2004. Theincrease in contract revenue was due to an increase in demand for developmentand small-scale manufacturing services, as our customers increased theirefforts to further develop previously identified compounds and bring them intoclinical trials. The increase in development and small-scale manufacturingrevenue was partially offset by a decrease in discovery services revenues, asthe industry trends of reduced spending and sourcing of these services tolower-cost international providers continued in 2005. However, upon commencinglower-cost international operations in Singapore and India, our ability tooffer our services under a variety of business models and cost structures waswell-received by our customers, resulting in an increase in demand for ourdiscovery services both internationally and domestically during the latterportion of 2005. In addition, the License and Research Agreement that we signedwith BMS in October 2005 includes a significant contract researchcomponent and also results in the recognition of an $8 million up-front paymentover a three-year research term. These factors contributed to an 18%year-over-year increase in discovery services revenue in the fourth quarter of2005. We expect the growth trends in both discovery services and developmentand small-scale manufacturing services to continue in 2006.

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LSM contract revenue increased by $13.3 million, or19.5%, to $81.3 million in 2005 compared to $68.1 in 2004. The increase incontract revenue was primarily attributable to an increase in demand forclinical supply products for advanced stage human trials as we shift the focusof our large-scale manufacturing operations. Clinical supply manufacturingrevenues were $17.9 million in 2005, or 22% of total LSM revenue, compared to$8.1 million in 2004, or 12% of  total LSMrevenue. Our largest LSM customer, GE,discontinued purchases of one of the products that we sell to them in 2005.Sales of this product totaled $17.0 million, which represented 21% of  2005 LSM revenue, and 12% of total contractrevenue for the year ended December 31, 2005. We expect a modest decreasein large-scale contract revenue in 2006, as the decrease in revenue resultingfrom discontinued sales of this product to GE are expected to be largely offsetby increased sales of another product to GE, as well as continued growth in thearea of clinical supply manufacturing for advanced stage human trials.

DDS contract revenue for2004 was $53.5 million, a decrease of 18% compared to contract revenue of$65.6 million in 2003. The reduction in our contract services was attributableto reduced spending by our customers due to a weak economic environment,leading to budgetary pressures within the pharmaceutical and biotechindustries. Additionally, an increase in foreign competition operating withlower cost structures impacted certain areas of our business during 2004. LSMcontract revenue declined by $11.0 million, or 14%, to $68.1 millionin 2004 compared to 2003. The decline was primarily attributable to a decreasein revenue from its second largest customer due to the timing of deliveryrequirements from this customer, partially offset by an increase in demand forclinical supply manufacturing for advanced stage human trials.

*Recurring Royalties*

Weearned royalties under our licensing agreement with Sanofi-Aventis S.A. for theactive ingredient in Allegra/Telfast. Royalties were as follows:

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2005**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| **(in 000’s)**               | ** ** |
| $46,918                                |       | $ | 47,973 |   | $ | 51,682 |  |
|                                        |            |  |  |  |  |  |  |

 

Recurring royalties decreased 2% to $46.9 million forthe year ended December 31, 2005 from $48.0 million for 2004. The decreaseis primarily attributable to the fourth quarter 2005 impact of the at-risklaunch of generic fexofenadine by Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd. For the nine months ended September 30,2005, recurring royalties were $40.7 million, an increase of $4.9 million or14% from $35.8 million for the nine months ended September 30, 2004, dueto higher year-to-date worldwide sales of Allegra, as well as higher royaltypayments in certain countries. The at-risk launch of generic fexofenadineannounced by Barr Pharmaceuticals, Inc. and Teva PharmaceuticalsIndustries Ltd. on September 6, 2005 had a material adverse impact on U.S.sales of Allegra in the fourth quarter of 2005. Recurring royalties for thethree months ended December 31, 2005 were $6.2 million, a decrease of $5.9million or 49% from $12.2 million for the three months ended December 31,2004.

The recurring royalties wereceive on the sales of Allegra/Telfast have historically provided a materialportion of our revenues, earnings, and operating cash flows. The at-risk launchof generic fexofenadine announced by Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd. on September 6, 2005 had a materialadverse impact on U.S. sales of Allegra in the fourth quarter of 2005,resulting in a 49% year-over-year decrease in our royalty revenues for thefourth quarter. We currently expect that the at risk-launch of genericfexofenadine will have a similar impact on our royalty revenues in futureperiods. We expect to experience a decrease in revenues, earnings, andoperating cash flows in the short term as we continue to develop our businessin an effort to supplement the revenues, earnings and operating cash flows thathave historically been provided by Allegra/Telfast royalties.

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On September 20, 2005, we and AventisPharmaceuticals filed a Motion for Preliminary Injunction in the U.S. DistrictCourt in New Jersey seeking to enjoin Barr Pharmaceuticals,  Inc., Teva Pharmaceuticals Ltd., RanbaxyLaboratories, Ltd. and Amino Chemicals, Ltd. from the sale of generic versionsof Allegra in the United States. Our motion was denied on January 30,2006. We continue to forcefully and vigorously defend our intellectual propertyrelated to Allegra. We have filed an appeal of the ruling in the PreliminaryInjunction matter, and we continue to pursue our intellectual property rightsas the patent infringement litigation progresses. However, should we or Aventisbe unsuccessful in defending these patents we would continue to experience amaterial decrease in royalty revenues. Furthermore, the entrance of additionalgeneric competitors upon the expiration of Barr’s 180-day exclusivityperiod for marketing generic fexonfenadine or an at-risk launch of a genericversion of Allegra-D by a generic competitor could result in further decreasesin royalty revenues.

Recurring royalties forthe year ended December 31, 2004 decreased 7% to 48.0 million, compared to$51.7 million for 2003. The decrease was primarily attributable to decreasedsales of Allegra/Telfast by Sanofi-Aventis, due to over-the-countercompetition from Allegra’s primary competitor, Claritin.

*Cost of ContractRevenue*

Costof contract revenue, from which we derive gross profit from contract revenue,consists primarily of compensation and associated fringe benefits foremployees, chemicals, depreciation and other indirect costs. Cost of contractrevenue for our DDS and LSM segments were as follows:
|                    | ** ** | **Year Ended December 31,** | ** ** |
|--------------------|------------|--------------------------------------------|------------|
| ** **         | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **         | ** ** | **(in 000’s)**                   | ** ** |
| DDS                |       | $                                          | 45,179     |   | $ | 51,186 |   | $ | 42,962 |   |
| LSM                |       | 69,526                                     |       | 51,720 |   | 58,791 |   |
| Total              |       | $                                          | 114,705    |   | $ | 102,906 |   | $ | 101,753 |   |
| DDS Gross Margin   |       | 18.8                                       | %          | 4.3 | % | 34.5 | % |
| LSM Gross Margin   |       | 14.5                                       | %          | 24.0 | % | 25.6 | % |
| Total Gross Margin |       | 16.3                                       | %          | 15.3 | % | 29.7 | % |

 

DDS contract revenue gross margin was 18.8% for theyear ended December 31, 2005, compared to 4.3% in 2004. The increase ingross margin largely resulted from the increase in contract revenues inrelation to the fixed cost components of DDS contract business, a decrease incompensation and benefits expense of $3.0 million due to a reduction inscientific personnel, a decrease in facilities and overhead costs of $1.1million due to the reallocation of these costs to more appropriately reflectthe cost of operating our laboratory and administrative facilties, as well asdecreases in write-downs of our library and raw material inventories from $6.0million and $1.6 million, respectively in 2004, to $2.1 million and $0.2 million,respectively in 2005.  These decreaseswere partially offset by an increase in library amortization expense of $0.6million. We expect DDS contract revenue gross margin to improve in 2006 due toincreases in contract revenues both domestically and internationally, areduction in inventory charges, and the elimination of library amortizationexpense due to the write-down of the underlying assets. ** **These increases are expected to bepartially offset by the recognition of additional stock-based compensation in2006.

LSM contract revenue gross margin decreased to 14.5%for the year ended December 31, 2005 compared to 24.0% in 2004. Thedecline in gross margin is due to the transition of our large-scalemanufacturing facility from specializing in the manufacturing of commercialproducts to the manufacturing of clinical supply compounds for use in humantrials.  We expect gross margins toincrease slightly or remain flat in 2006 as we continue to implement processmanagement improvements and cost savings 

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initiatives in an effortto maximize the efficiency and profitability of our clinical supplymanufacturing operations.

DDS contract revenuemargin was 4.3% for the year ended December 31, 2004 compared to 34.5% for2003. The decrease in DDS contract revenue margin was due to write-downs of ourlibrary and raw material inventories, as well as the decline in contractrevenues in relation to the fixed cost components of DDS contract business.  LSM contract revenue margin decreased to 24.0%in 2004 from 25.6% in 2003 due to the decline in production and sales volume inrelation to the fixed cost components of LSM contract business.

*TechnologyIncentive Award*

Wemaintain a Technology Development Incentive Plan designed to stimulate andencourage novel technology development by our employees. This plan allowseligible participants to share in a percentage of the net revenue earned by usrelating to patented technology with respect to which the eligible participantis named as an inventor. Under our Technology Development Incentive Plan,Thomas E. D’Ambra, our Chairman, President and Chief Executive Officer,receives payments as the sole inventor of the patents for fexofenadine HClequal to 10% of the total payments received by us with respect to thosepatents. The incentive award was as follows:

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2005**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| **(in 000’s)**               | ** ** |
| $                                      | 4,695      |   | $ | 4,789 |   | $ | 5,183 |   |
|                                        |            |  |  |  |  |  |  |  |

 

The technology incentive award expense incurred underour Technology Development Incentive Plan decreased 2% to $4.7 million for theyear ended December 31, 2005, compared to $4.8 million for 2004. Thedecrease was directly attributable to the decrease in Allegra royalties in 2005.We expect technology incentive award expense to fluctuate directionally andproportionately with fluctuations in Allegra royalties in future periods.

The technology incentiveaward expense incurred under our Technology Development Incentive Plan decreased8% to $4.8 million for the year ended December 31, 2004, compared to $5.2million for 2003. The decrease was directly attributable to the decrease inAllegra royalties in 2004 compared to 2003.

*Research andDevelopment*

Researchand development expense consists of compensation and benefits for scientificpersonnel, costs of chemicals and other out-of-pocket costs and overhead costsfor work performed on proprietary technology research and development projects.We utilize our expertise in small molecule chemistry, biocatalysis andnatural products to perform our internal research and development projects. Thegoal of these programs is to discover new compounds with commercial potential.We would then seek to license these compounds to a third party in return for acombination of up-front license fees, milestone payments and recurring royaltypayments if these compounds are successfully developed into new drugs and reachthe market. In addition, research and development is performed at our Rensselaer,NY facility related to the improvement of production processes as well asresearch related to the potential manufacture of new products. Research anddevelopment expenses were as follows:

|            | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** ** | ** ** | **(in 000’s)**                   | ** ** |
|            |       | $                                          | 14,468     |   | $ | 23,887 |   | $ | 22,466 |   |
|            |            |                                            |            |  |  |  |  |  |  |  |

 

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Research and development expenses decreased 39% to$14.5 million for the year ended December 31, 2005 from $23.9 million for2004. The decrease in research and development expenses is due to the fact thatresearch and development expenses for the year ended December 31, 2004include a $3.1 million charge related to the issuance of warrants to BMS inconjunction with our acquisition of intellectual property related to ourcentral nervous system (CNS) programs. The decrease is also due to the factthat we licensed our CNS programs, which represented our most significantinvestment in R&D in both 2005 and 2004, to BMS in October 2005. As aresult, after signing the agreement in October 2005, we did not incursignificant R&D expenditures that would have been necessary to furtheradvance these programs. In addition, certain costs associated with theseprograms, primarily consisting of compensation and benefit costs related to theAMRI scientific personnel working on these programs, have shifted to cost ofcontract revenue related to the contract research we are performing for BMS inconjunction with the licensing and research agreement. Finally, the decrease isalso due to initiatives we undertook to reorganize our internal departments inorder to have a more formalized and structured R&D business group in 2005,resulting in a more narrow focus of the scope of our research and developmentactivities. Research and development expenses are expected to decrease in 2006due to the elimination of costs associated with our advanced-stage CNS programs.Research and development expenses in 2006 are expected to be related to theevaluation and continued advancement of our early to middle-stage internalresearch programs.

Projecting expected project completion dates and anticipated revenue fromour internal research programs is not practical at this time due to the earlystages of the projects and the inherent risks related to the development of newdrugs. Our internal central nervous system program was our most advancedproject to date, which we licensed to BMS in exchange for up-front licensefees, contracted research services, and the rights to future milestone androyalty payments.   We also continue to utilize our proprietarytechnologies to further advance other early to middle-stage internal researchprograms in the fields of oncology, immunosuppresion and inflammation, with aview to seeking a licensing partner for these programs at an appropriateresearch or developmental stage.

We budget and monitor our research and developmentcosts by type or category, rather than by project on a comprehensive or fullyallocated basis. In addition, a significant portion of our research anddevelopment expenses is not tracked by project as it benefits multiple projectsor our technology platform. Consequently, fully loaded research and developmentcost summaries by project are not available.

Research and developmentexpenses increased 6% to $23.9 million for the year ended December 31,2004 from $22.5 million for 2003. The increase is primarily attributableto $3.1 million in expenses recorded for the issuance of warrants to purchaseshares of the Company’s common stock to Bristol-Myers Squibb (BMS) in the firstquarter of 2004. The warrants were issued in conjunction with an agreementwhereby BMS transferred intellectual property related to preclinical drugcandidates and patent applications covering attention deficit hyperactivity disorder(ADHD) and central nervous system applications to the Company.  These warrants were cancelled in October 2005in conjunction with the licensing of our CNS programs to BMS. The increase waspartially offset by a decrease in costs associated with the design, research,and testing of the Company’s semi-exclusive libraries.

*Selling, Generaland Administrative*

Selling,general and administrative expenses consist of compensation and related fringebenefits for marketing, operational and administrative employees, professionalservices, marketing costs and costs related to facilities and informationservices. Selling, general and administrative expenses were as follows:

|            | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** ** | ** ** | **(in 000’s)**                   | ** ** |
|            |       | $                                          | 26,494     |   | $ | 22,812 |   | $ | 20,318 |   |
|            |            |                                            |            |  |  |  |  |  |  |  |

 

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The increase in selling, general, and administrativeexpenses is due to an increase in salary and benefit expenses of $2.7 millionresulting from the addition of administrative and business development personnel,as well as the reallocation of certain personnel expenses to more appropriatelyreflect the current use of these resources; the addition of $2.4 million instart-up and administrative costs associated with our Singapore and Indiaoperations; and a $1.1 million increase in facilities costs associated with thereallocation of these costs to more appropriately reflect the current cost ofoperating our laboratory and administrative facilities.  These increases are partially offset by $1.4million of employee and equipment relocation costs associated with the closureof our Mount Prospect facility incurred during 2004, as well as a decrease inprofessional fees of $1.3 million due to an overall decrease in Sarbanes-Oxleycompliance service costs and additional accounting and valuation service feesassociated with the impairment analyses performed at our Bothell and MountProspect facilities in 2004. Selling, general and administrative expenses areexpected to increase in 2006 due to increased administrative personnel costs,the recognition of additional stock-based compensation costs, additional travelcosts associated with our international operations, and additional recruitingcosts associated with the staffing of scientific personnel at both our domesticand international operations resulting from the anticipated increased demandfor our contract services. These increases are expected to be partially offsetby a decrease in professional fees related to Sarbanes-Oxley complianceservices.

Selling, general andadministrative expenses increased 12% to $22.8 million for the year ended December 31,2004 compared to $20.3 million for 2003. The increase in selling, general andadministrative expenses for the year ended December 31, 2004 is primarilydue to professional fees related to our Sarbanes Oxley compliance initiativesand other accounting and valuation services of $2.6 million, and $1.4 millionin employee and equipment relocation costs associated with the closure of theMount Prospect facility. These increases were partially offset by theelimination of $1.4 million in abandonment costs associated with the relocationof our Iowa operations in 2003.

*Impairment andRestructuring Charges*

As of June 30, 2004 we completed an in-depthreview of the carrying value of all of our natural product and chemicalcompound library inventories. As a result of this review, which was based onexpected future revenues, it was determined that a significant write-down inthe carrying value of library inventories was required. The reduction in thecarrying value of the library inventories reflected less favorable marketconditions than previously projected.

The write-down of library inventories triggered anassessment of the recoverability of certain other related long-lived assets andgoodwill within the Bothell reporting unit, including the goodwill andintangibles which resulted from the 2001 acquisition of New Chemical Entities(NCE), in accordance with the provisions of Statement of Financial AccountingStandards (SFAS) No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets” (SFAS No. 144), and SFAS No. 142, “Goodwill andOther Intangible Assets” (SFAS No. 142). Based on our review, wedetermined that an impairment of certain related goodwill and long-lived assetshad occurred.

In addition, we initiated a restructuring whichresulted in the closure of our Mt. Prospect Research Center and theconsolidation of Mt. Prospect’s operations in our New York facilities. Therestructuring triggered an assessment of the carrying value of the Mt. ProspectResearch Center property and equipment and related goodwill. Based on thisreview, and in accordance with the provisions of SFAS No. 144 and SFAS No. 142,we determined that an impairment of certain related goodwill and property andequipment had occurred. Further, we incurred restructuring costs related to theMt. Prospect restructuring.

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Therestructuring costs are included under the caption restructuring charge in theconsolidated statements of operations and the restructuring liabilities areincluded in accounts payable and accrued expenses on the consolidated balancesheets at December 31, 2004 and 2005. The following table displays therestructuring activity and liability balances:

| ** **            | ** ** | **Balance at  January 1,  2005** | ** ** | **Adjustments** | ** ** | **Payments** | ** ** | **Balance at  December 31,  2005** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|-----------------|------------|--------------|------------|----------------------------------------------|------------|
| ** **            | ** ** | **(in 000’s)**                   | ** ** |
| Termination  benefits |       |                                       | $          | 129             |       |         |       | (65                                          | )          |   |   | $ | (64 | ) |   |   | — |   |   |
| Asset disposal  costs |       |                                       | 513        |            |       |         | —     |                                         |       |   | — |   |   |   | 513 |   |   |
| Total                 |       |                                       | $          | 642             |       |         |       | (65                                          | )          |   |   | $ | (64 | ) |   |   | $ | 513 |   |   |
|                       |            |                                            |            |                 |            |              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |

 

Costs of termination benefits related to severancepackages, outplacement services and career counseling for employees affected bythe restructuring. Asset disposal costs relate primarily to brokeragecommissions, legal fees, and marketing expenses associated with the plannedsale of the Mount Prospect Research Center facility, which is included inproperty and equipment held for sale on the consolidated balance sheet.

The Company also incurred $1.4 million in employee andequipment relocation costs during 2004. These relocation costs are includedunder the caption “selling, general and administrative” in the consolidatedstatement of operations.

We are currently marketing the Mt. Prospect ResearchCenter facility for sale. The facility qualified for held for sale treatment inaccordance with SFAS No. 144 during the fourth quarter of 2004. Thelong-lived assets associated with Mt. Prospect have been segregated to aseparate line item on the consolidated balance sheet until they are sold anddepreciation expense has ceased respective to those assets. We anticipate thecompletion of the sale of the facility by June 2006.

The above restructuringactivity was recorded exclusively in the DDS operating segment. The net cashoutflow related to the restructuring for the year ended December 31, 2005was $0.1 million. Anticipated cash outflows related to the restructuring for2006 are $0.5 million, which primarily consists of the payment of accrued assetdisposal costs.

*Equity in income(loss) of unconsolidated affiliates*

Equityin income (loss) of unconsolidated affiliates represented the Company’sproportionate share in the income or loss of investees that the Companyaccounts for under the equity method. Equity in income (loss) of unconsolidatedaffiliates was as follows:

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **(in 000’s)**                   | ** ** |
| $—                                    |       |   | $ | (65 | ) |   |   | $ | (372 | ) |   |
|                                            |            |  |  |  |  |  |  |  |  |  |  |

 

The decrease in loss to($0.1) million for the year ended December 31, 2004 from ($0.4) millionfor 2003 is attributed to the Company’s share of net losses in an equity methodinvestee. The loss recorded in 2004 reduced the value of the Company’sinvestment to $0, and as such, no further adjustments will be recorded untilthe investee returns to a position of positive net worth.

The decrease in income of $3.1 million or 113% to($0.4) million for the year ended December 31, 2003 from $2.8 million for2002 is attributed to our acquisition of the remaining stock of Organichem in2003, which increased our ownership percentage to 100% at February 11,2003 from 39.2% at December 31, 2002, resulting in the full consolidationof Organichem’s financial results (reduced by a 

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minorityinterest share representing the previous owners’ share of net income from January 1,2003 through February 11, 2003) in 2003. The loss recorded in 2003represented the Company’s share of the net loss in a separate equity methodinvestee.

*Interest expense*

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **(in 000’s)**                   | ** ** |
| $1,772                                     |       | $ | 1,641 |   | $ | 1,446 |   |
|                                            |            |  |  |  |  |  |  |

 

Interest expense increased$0.1 million or 8% to $1.8 million for the year ended December 31, 2005from $1.6 million in 2004. The increase was due to increases in the rates paidon the Company’s variable rate debt that were not hedged by its interest rateswaps, partially offset by the paydown of the $25.5 million outstanding balanceon the Company’s line of credit in the third quarter of 2005.

Interest expense increased$0.2 million to $1.6 million for the year ended December 31,2004 compared to 2003. The increase was primarily due to the capitalization ofinterest costs incurred during the construction of the Company’s headquartersfacility in 2003.

*Interest income*

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **(in 000’s)**                   | ** ** |
| $3,559                                     |       | $ | 1,958 |   | $ | 2,231 |   |
|                                            |            |  |  |  |  |  |  |

 

Interest income increased $1.6 million or 82% to $3.6million for the year ended December 31, 2005 from $2.0 million for 2004.The increase in interest income was primarily due to increases in the ratesearned on short-term cash equivalents and investment securities, as well as aneffort by management to maximize balances held in short-term cash equivalentaccounts, which are higher yielding than interest-bearing cash accounts.

Interest income decreased12% to $2.0 million for the year ended December 31, 2004 from$2.2 million for 2003. The decrease was due primarily to a decrease in ourrate of return as higher-yielding securities matured and were replacedwith securities yielding the lower rates reflected in the market conditions atthat time. The Company also earned lower rates on its interest-bearing cashaccounts and other short-term cash equivalents in 2004 due to the downturn inthe interest rate environment.

*Loss on equityinvestment*

We have equity investments in leveraged privatecompanies that have operations in areas within our strategic focus. During2003, we made equity investments in two private companies totaling$2.1 million. Under the terms of these agreements, we provided FTE servicesto each customer in exchange for equity securities, plus additional fee forservice cash payments. We assess the fair value of these investments quarterlyor whenever events or changes in circumstance indicate that the investmentvalue may not be recoverable. During the fourth quarter of 2004, one of ourinvestees attempted to raise additional financing in order to fund itsoperations, but was unable to secure such financing on acceptable terms. Assuch, we performed an assessment of the carrying value of our investment basedon an analysis of the investee’s current financial condition, its prospects ofgenerating additional cash flow from operating activities, the marketconditions for raising capital funding for companies in this industry and thelikelihood that any funding raised would significantly dilute our ownershippercentage. As a result of this 

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analysis it was ourjudgment that an other-than-temporary impairment had occurred and that the fairvalue of our investment was zero, resulting in a non-cash loss on investment of$1.3 million.

We determined that noimpairment was required for our remaining $956,000 equity investment based onour analysis as of December 31, 2005. However, should the events andconditions that are indicative of impairment as noted above arise, the Companymay be required to record additional impairment charges in future periods.

*Income tax expense*

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **(in 000’s)**                   | ** ** |
| $8,825                                     |       | $ | 1,837 |   | $ | 16,714 |   |
|                                            |            |  |  |  |  |  |  |  |

 

Income tax expense increased to $8.8 million for theyear ended December 31, 2005, compared to $1.8 million for 2004. Theoverall increase in income tax expense is attributable to an increase in incomebefore income tax expense, even though income tax expense for 2004 reflects thegoodwill and intangible asset impairment charges as non-deductible tax items. Thefluctuation in the effective rate results primarily from the impact the revised2004 projected annual results had in relationship to the 2004 projected annualpermanent differences. Our 2005 effective tax rate is consistent with theCompany’s historical experience excluding the impact of the 2004 impairmentcharges. We expect the effective tax rate to approximate 37% of pre-tax incomefor 2006.

Income tax expensedecreased to $1.8 million for the year ended December 31, 2004,compared to $16.7 million for 2003. Income tax expense in 2004 reflectsthe goodwill and intangible asset impairment charges as non-deductible taxitems. Excluding the impact of these items on pre-tax income, the decrease inthe effective tax rate from 2003 is due to the increased impact of permanenttax-deductible items in relation to decreased pre-tax income in 2004.

**Liquidity and Capital Resources**

We have historically funded our business throughoperating cash flows, proceeds from borrowings and the issuance of equitysecurities. During 2005, we generated cash of $42.8 million from operatingactivities. The primary sources of operating cash flows were payments receivedfor the performance of contracted chemistry services, royalty payments receivedfrom Sanofi-Aventis based upon a percentage of sales of Allegra, and anup-front licensing fee from BMS in conjunction with the signing of a licenseand research agreement. The primary uses of operating cash flows are the paymentof compensation and benefits to both scientific and administrative personnel,purchases of inventory and supplies, and payment of occupancy costs. TheCompany’s 2005 net income of $16.3 million includes several significantnon-cash costs includingdepreciation and amortization of$15.5 million and  impairments of libraryinventories of $2.1 million. These non-cash costs are partially offset by therecognition of $1.9 million of deferred tax benefit, which is a non-cash incomeitem.

The recurring royalties we receive on the sales ofAllegra/Telfast have historically provided a material portion of our operatingcash flows. As discussed in Item 3 of this Form 10-K, severalgeneric manufacturers have filed ANDA applications with the FDA seekingauthorization to produce and market a generic version of Allegra. We andAventis Pharmaceuticals have filed several patent infringement suits againstthese generic companies alleging infringement of certain U.S. patents. On September 6,2005, Barr Pharmaceuticals, Inc. and Teva Pharmaceuticals Industries Ltd.announced that they had entered into an agreement for the launch ofFexofenadine Hydrochloride 30 mg, 60 mg and 180 mg tablets, the generic versionof Allegra tablets in the United States. The launch of the generic product isconsidered an “at-risk” 

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launch due to the on-goinglitigation.  The at-risk launch ofgeneric fexofenadine had a material adverse impact on U.S. sales of Allegra bySanofi-Aventis in the fourth quarter of 2005 and in turn, the royalties earnedby us on those sales.  On September 20,2005, we and Aventis Pharmaceuticals filed a Motion for Preliminary Injunctionin the U.S. District Court in New Jersey seeking to enjoin BarrPharmaceuticals,  Inc., TevaPharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd. fromthe sale of generic versions of Allegra in the United States. Our motion wasdenied on January 30, 2006. We continue to forcefully and vigorouslydefend our intellectual property related to Allegra. We have filed an appeal ofthe ruling in the Preliminary Injunction matter, and we continue to pursue ourintellectual property rights as the patent infringement litigation progresses. However,should we or Aventis be unsuccessful in defending these patents we would continueto experience a material decrease in royalty revenues and operating cash flows.

During 2005, we used $27.6 million in cash forinvesting activities, primarily resulting from $19.2 million for theacquisition of property and equipment, and purchases of investment securitiesnet of proceeds from sales and maturities of these securities of $8.1 million.During 2005, we used $28.7 million for financing activities, consisting of$30.1 million in long-term debt repayments, offset by $1.3 million provided byproceeds from stock option and stock purchase plan exercises.

Working capital was $158.8 million as of December 31,2005, compared to $179.8 million at December 31, 2004. The decrease of$21.0 million resulted from a $6.6 million increase in income taxes payable dueto the timing of income tax payments and the generation of additional taxableincome in 2005. In addition, there was a decrease in cash, cash equivalents,and investments of $5.8 million, which primarily resulted from the pay-down ofoutstanding balances on our line of credit of $30.1 million and capitalexpenditures of $19.2 million. These decreases were partially offset by cashflows from operations of $42.8 million, which includes the receipt of an $8.0million up-front license fee from BMS in conjunction with a license andresearch agreement signed in October 2005. The up-front fee was includedin deferred revenue and will be recognized over the initial three-year term ofthe agreement. Finally, there was a decrease in royalty receivables of $5.9million due to reduced royalties on sales of Allegra/Telfast resulting from theat-risk launch of generic fexonfenadine in the fourth quarter of 2005. Thesedecreases are partially offset by an increase in accounts receivable of $8.0million due to increased contract revenues and the timing of payments receivedfrom our customers.

Total capital expenditures for the year endedDecember, 31 2005 were $19.2 million as compared to $23.7 million for the yearended December 31, 2004. Capital expenditures in 2005 were primarilyrelated to the expansion and modification of our large-scale manufacturingfacilities, the construction of our research facilities in Singapore and India,and development of an enterprise resource planning (ERP) system. For 2006, we expectto incur $21.5 million in capital expenditures, primarily related to thecontinued expansion and modification of our large-scale manufacturingfacilities, the continued outfitting of our research facilities in Singaporeand India, the continued development of our ERP system, and the addition orreplacement, as appropriate, of laboratory equipment for our discovery,development, and small-scale manufacturing services. In addition, in February 2006,we completed the acquisition of ComGenex, a chemistry services company based inBudapest, Hungary, for $11.1 million in cash consideration.

We entered into a credit facility consisting of a$30.0 million term loan and a $35.0 million line of credit to fund theacquisition of Organichem during 2003. The term loan matures in February, 2008.As of December 31, 2005, the interest rate on $12.9 million of theoutstanding term loan balance was 4.36% and the interest rate on the remaining$5.3 million was 5.02%. On June 30, 2005, the Company amended the creditfacility to extend the maturity date on the line of credit from February 2006to June 2010. The line of credit bears interest at a variable rate basedon the Company’s leverage ratio.  As of December 31,2005, the outstanding balance of the line of credit was $0. The credit facilitycontains certain financial covenants, including a maximum leverage ratio, aminimum required operating cash flow coverage ratio, a minimum earnings beforeinterest and taxes to interest ratio and a minimum current ratio. Other covenantsinclude 

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limits on asset disposalsand the payment of dividends. As of December 31, 2005 and 2004 we were incompliance with all covenants under the credit facility.

Working capital was $179.8 million at December 31,2004 compared to $174.6 million at December 31, 2003. The increase of$5.2 million resulted primarily from the reclassification of $5.6 millionin property and equipment as held-for-sale due to the closure of the Mt.Prospect Research Center, an increase in cash, cash equivalents and investmentsof $9.1 million due to the collection of receivables (a corresponding decreasein working capital of $4.8 million) and reduced capital expenditures in 2004,and a decrease in the current portion of accrued pension benefits payable of$1.9 million. Partially offsetting these increases in working capital were anincrease in taxes payable of $1.0 million due to the timing of income taxpayments and an increase in unearned income of $0.9 million due to the receiptof funds at the end of 2004 for customer projects that were performed in 2005.

Total capital expenditures for the year ended December 31,2004 were $23.7 million as compared to $30.6 million for the yearended December 31, 2003. Capital expenditures in 2004 were predominantlyin connection with expansion of our manufacturing facilities. Theseexpenditures were primarily financed through operating cash flows.

During 2004, we used $10.9 million in cash forinvesting activities, resulting from $23.7 million for the acquisition ofproperty and equipment, partially offset by net proceeds from investmentsecurities of $13.1 million. During 2004, we used $2.7 million for financingactivities, consisting of $4.5 million in long-term debt repayments, offset by$1.8 million provided by stock option and stock purchase plan exercises.

We continue to pursue theexpansion of our operations through internal growth and strategic acquisitions.We expect that such activities will be funded from existing cash and cashequivalents, cash flow from operations, the issuance of debt or equitysecurities and borrowings. Future acquisitions, if any, could be funded withcash on hand, cash from operations, borrowings under our credit facility and/orthe issuance of equity or debt securities. There can be no assurance that attractiveacquisition opportunities will be available to us or will be available atprices and upon such other terms that are attractive to us. We regularlyevaluate potential acquisitions of other businesses, products and product linesand may hold discussions regarding such potential acquisitions. As a generalrule, we will publicly announce such acquisitions only after a definitiveagreement has been signed. In addition, in order to meet our long-termliquidity needs or consummate future acquisitions, we may incur additionalindebtedness or issue additional equity or debt securities, subject to marketand other conditions. There can be no assurance that such additional financingwill be available on terms acceptable to us or at all. The failure to raise thefunds necessary to finance our future cash requirements or consummate futureacquisitions could adversely affect our ability to pursue our strategy andcould negatively affect our operations in future periods. Furthermore, acontinued significant decrease in royalties from Allegra would negativelyaffect our cash flow from operations and financial condition in future periods.

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**Contractual Obligations**

The following table setsforth our long-term contractual obligations and commitments as of December 31,2005.

**PaymentsDue by Period (in thousands)**

| ** **                    | ** ** | **Total** | ** ** | **Under 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5  Years** | ** ** |
|-------------------------------|------------|-----------|------------|----------------------------|------------|--------------------|------------|--------------------|------------|-----------------------------------|------------|
| Long-Term  Debt (principal)   |       | $         | 23,056     |                       |       | $                  | 4,535      |               |       | $                                 | 14,441     |   |   | $ | 530 |   |   |   | $ | 3,550 |   |   |
| Long-Term Debt  (interest)(1) |       | 3,001     |       |                       | 974        |               |       | 1,021              |       |                              | 272        |   |   |   | 734 |   |   |
| Operating Leases              |       | 11,755    |       |                       | 2,259      |               |       | 3,594              |       |                              | 2,550      |   |   |   | 3,352 |   |   |
| Purchase  Commitments         |       | 10,911    |       |                       | 10,911     |               |       | —             |       |                              | —     |   |   |   | — |   |   |
| Pension Plan Contributions    |       | 1,285     |       |                       | 1,015      |               |       | 270                |       |                              | —     |   |   |   | — |   |   |
|                               |            |           |            |                            |            |                    |            |                    |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Representsestimated interest payments on the Company’s long-term debt based on currentinterest rates.

**Related Party Transactions**

***Technology Development Incentive Plan***

In 1993, we adopted a Technology Development IncentivePlan to provide a method to stimulate and encourage novel innovative technologydevelopment. To be eligible to participate, the individual must be an employeeand must be the inventor or co-inventor of novel technology that results in newrevenues received by us. Eligible participants will share in awards based on apercentage of the licensing, royalty or milestone revenue received by us, asdefined by the Plan.

In 2005, 2004 and 2003 weawarded Technology Incentive Compensation to the inventor of the terfenadinecarboxylic acid metabolite technology, which is covered by the Company’spatents relating to the active ingredient in Allegra. The inventor is Thomas D’Ambra,our Chairman, President and Chief Executive Officer. The amounts awarded andincluded in the consolidated statements of income for the years ended December 31,2005, 2004 and 2003 are $4.7 million, $4.8 million and$5.2 million, respectively. Included in accrued compensation in theaccompanying consolidated balance sheets at both December 31, 2005 and2004 are unpaid Technology Development Incentive Compensation awards ofapproximately $623,000 and $1.2 million, respectively.

***Notes Receivable***

From time to time we makeloans to non-officer employees in the form of notes receivable. The notesreceivable and accrued interest will not be repaid to us provided the employeeremains in our employ throughout the term of the loan. If employment isterminated prior to the end of the loan term, a pro-rata portion of theprincipal and interest shall be repaid to us. Notes receivable from employeesat December 31, 2005 and 2004 totaled $284,000 and $414,000, respectively.The amounts forgiven and charged to operations in the consolidated statementsof income for the years ended December 31, 2005, 2004 and 2003 are$185,000, $91,000 and $192,000, respectively.

***Telecommunication Services***

A member of the Company’sboard of directors is the Chief Executive Officer of one of the providers oftelephone and internet services to the Company. This telecommunications companywas paid approximately $194,000, $169,000 and $165,000 for services rendered tothe Company in 2005, 2004 and 2003, respectively.

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**CriticalAccounting Policies and Estimates**

Our discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with U.S. generally accepted accountingprinciples. The preparation of these consolidated  financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. On an on-going basis, we evaluate our estimates, includingthose related to bad debts, inventories, intangible assets, equity investments,unbilled revenue, income taxes, pension and postretirement benefit plans, andcontingencies. We base our estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources. Actual results may differ from these estimates under differentassumptions or conditions.

We believe the followingcritical accounting policies affect our more significant judgments andestimates used in the preparation of our consolidated financial statements.

*Contract RevenueRecognition*

Our contract revenue consists primarily of fees earnedunder contracts with third-party customers and reimbursed expenses undersuch contracts. We also seek to include provisions in certain contracts whichcontain a combination of up-front licensing fees, milestone and royaltypayments should our proprietary technology and expertise lead to the discoveryof new products that reach the market. Reimbursed expenses consist of chemicalsand other project specific costs. We view contract revenue as our primarymeasure of revenue growth rather than licensing fees and royalties, which aredependent upon our licensees’ sales. Generally, our contracts may be terminatedby the customer upon 30 days’ to one year’s prior notice, depending on the size of the contract.

We generate contract revenue on the following basis:

*Full-timeEquivalent (FTE).**  *AnFTE agreement establishes the number of our employees contracted for a projector a series of projects, the duration of the contract period, the price perFTE, plus an allowance for chemicals and other project specific costs, whichmay or may not be incorporated in the FTE rate. Typically, our FTE contractshave terms of six months or longer. Our FTE contracts typically provide forannual adjustments in billing rates for the scientists assigned to thecontract. These contracts involve our scientists providing services on a “bestefforts” basis in the development of novel chemistry for our customers. Thereare no fixed deliverables as part of these services. As such, we recognizerevenue under FTE contracts on a monthly basis as services are performedaccording to the terms of the contract.

*Timeand Materials.***  **Undera time and materials contract we charge our customers an hourly rate plus anallowance for chemicals and other project specific costs. We recognize revenuefor time and material contracts based on the number of hours devoted to theproject multiplied by the customer’s billing rate plus other project specificcosts incurred.

*FixedFee.**  *Undera fixed-fee contract we charge a fixed agreed upon amount for a deliverable.Fixed-fee contracts have fixed deliverables upon completion of the project. Werecognize revenue for fixed fee contracts after projects are completed,delivery is made and title transfers to the customer and collection isreasonably assured.

*Up-FrontLicense Fees Milestone and Royalty Revenue.**  *We analyze ouragreements to determine whether the elements can be separated and accounted forindividually or as a single unit of accounting in accordance with EITF No. 00-21,“Revenue Arrangements with MultipleDeliverables*,”* and SAB104, “Revenue Recognition.”Allocation of revenue to individual elements which qualify for separateaccounting is based on the estimated fair value of the respective elements.Generally, the provisions for 

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licensing, milestone androyalty payments included in our contracts are related to the occurrence ofspecific identifiable events. We will recognize revenue from up-frontnon-refundable licensing fees over the period we have continuing involvement inthe underlying project. We will recognize revenue arising from a milestonepayment upon the successful achievement of the event, and the resolution of anyuncertainties or contingencies regarding potential collection of the relatedpayment, or, if appropriate, over the remaining term of the agreement.

*DeferredRevenue.**  *Deferredrevenue represents monies received for services that have not yet beenperformed as well as customer billings related to completed production whichhas not yet shipped. As an added service, during 2003 we began to temporarilystore completed cGMP production at our facilities for certain customers. Underthese arrangements, upon completion of the customer project we typically willenter into a storage agreement with the customer. We will temporarily store andsubsequently ship the completed production, often in multiple shipments tomultiple sites. The revenue related to these arrangements is recognized at thetime the products are ultimately shipped.

*Recurring Royalty RevenueRecognition.**  *Recurringroyalties consist of royalties under a license agreement with Sanofi-Aventisbased on the worldwide sales of fexofenadine HCl, marketed as Allegra in theAmericas and Telfast elsewhere. We record royalty revenue in the period inwhich the sales of Allegra occur. Royalty payments from Sanofi-Aventis are duewithin 45 days after each calendar quarter and are determined based onsales of Allegra/Telfast in that quarter.

*RestructuringCharges*

TheCompany accounts for its restructuring costs as required by SFAS No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities” (SFAS No. 146).SFAS No. 146 requires that a liability for a cost associated with an exitor disposal activity be recognized and measured initially at its fair value inthe period in which the liability is incurred, except for one-time terminationbenefits that meet certain requirements.

*Inventory*

Inventory consistsprimarily of commercially available fine chemicals used as raw materials in theresearch and production process, work-in-process and finished goods at ourlarge-scale manufacturing location and chemical compounds in the form ofnatural product and novel compound collections. We capitalize the costsassociated with the production of our novel compound collections. Inventoriesare stated at the lower of cost (first-in, first-out basis) or market. Werecord reserves for excess and obsolete inventory equal to the differencebetween the cost of inventory and the estimated market value based uponassumptions about future demand and market conditions, which could result in acharge to operations.

*Goodwill*

In accordance withthe provisions of SFAS No. 142, the Company performs an annual****assessment of the carrying value of goodwill for potentialimpairment (or on an interim basis if certain triggering events occur). Adetermination of impairment is made based upon the estimated discounted futurecash flows of the operations associated with the related reporting unit. Ifgoodwill is determined to be impaired in the future the Company would berequired to record a charge to its results of operations. Factors the Companyconsiders important which could result in an impairment include the following:

·       significantunderperformance relative to historical or projected future operating results;

·       significantchanges in the manner of our use of the acquired assets or the strategy foroverall business;

·       significantnegative industry or economic trends; and

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·       marketcapitalization relative to net book value.

If management’sexpectations of future operating results change, or if there are changes toother assumptions, the estimate of the fair value of our reporting units couldchange significantly. Such a change could result in additional goodwillimpairment charges in future periods, which could have a significant impact onour consolidated financial statements. Total goodwill recorded on the Company’sconsolidated balance sheet at December 31, 2005 was $25.7 million,including $23.1 million of goodwill associated with the Company’s acquisitionof Organichem Corporation.

*Long-Lived Assets*

In accordance withthe provisions of SFAS No. 144**,**the Companyassesses the impairment of long-lived assets whenever events or changes incircumstances indicate that their carrying value may not be recoverable.Factors the Company considers important which could trigger an impairmentreview include, among others, the following:

·       asignificant change in the extent or manner in which a long-lived asset is beingused;

·       asignificant change in the business climate that could affect the value of along-lived asset; and

·       asignificant decrease in the market value of assets.

If the Company determinesthat the carrying value of long-lived assets may not be recoverable, based uponthe existence of one or more of the above indicators of impairment, the Companycompares the carrying value of the asset group to the undiscounted cash flowsexpected to be generated by the asset group. If the carrying value exceeds theundiscounted cash flows an impairment charge is recorded. An impairment chargeis recognized to the extent that the carrying amount of the asset group exceedstheir fair value and will reduce only the carrying amounts of the long-livedassets.

*Equity Investments*

We have equity investmentsin leveraged private companies that have operations in areas within ourstrategic focus. We account for these investments using the cost method ofaccounting for investments as our ownership interest in each customer is below20% and we do not have the ability to exercise significant influence over theentities. We assess the fair value of these investments quarterly or wheneverevents or changes in circumstance, such as changes in market conditions, pooroperating results of the underlying investments, or the inability of theentities to obtain additional financing indicate that the investment value maynot be recoverable. However, should the events and conditions that areindicative of impairment as noted above arise, the Company may be required torecord additional impairment charges in future periods. Total equityinvestments recorded on the Company’s consolidated balance sheet at December 31,2005 were $1.0 million.

*Pension andPostretirement Benefit Plans*

We maintain pension andpostretirement costs and liabilities that are developed from actuarialvaluations. Inherent in these valuations are key assumptions, includingdiscount rates, expected return on plan assets, and trends in health carecosts, which are updated on an annual basis. We are required to considercurrent market conditions, including changes in interest rates, in making theseassumptions. Changes in the related pension benefit costs may occur in thefuture due to changes in the assumptions.

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*Allowance forDoubtful Accounts*

We record an allowance fordoubtful accounts to absorb estimated receivable losses as circumstances arisethat bring into doubt our ability to fully collect on outstanding receivablebalances. The allowance and related accounts receivable are reduced when theaccount is deemed uncollectible.

*EnvironmentalLiabilities*

In the ordinary course ofbusiness the Company is subject to environmental laws and regulations, and hasmade provisions for the estimated financial impact of environmental cleanuprelated costs. The quantification of environmental exposures requires anassessment of many factors, including changing laws and regulations,advancements in environmental technologies, the quality of informationavailable related to specific sites, the assessment stage of each siteinvestigation, preliminary findings and the length of time involved in theremediation or settlement. The Company accrues environmental cleanup relatedcosts when those costs are believed to be probable and can be reasonablyestimated.

*Stock-BasedCompensation*

The Company applies the intrinsic value-basedmethod of accounting prescribed by Accounting Principles Board (“APB”) OpinionNo. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations, in accounting for its fixed plan stock options. As such,compensation expense would be recorded only if, on the date of grant, thecurrent market price of the underlying stock exceeded the exercise price. Anycompensation expense would be recognized over the vesting period.

The Company discloses the pro-forma compensation costfor stock option grants in accordance with SFAS No. 123. Pro-formacompensation cost is based on the fair value of the options on their grantdate, and is recognized over the period of requisite service. The fair value ofstock option grants is determined utilizing the Black-Scholes option pricingmodel. Inherent in these valuations are key assumptions, including expectedvolatility in the Company’s common share price, risk-free interest rates, andthe expected lives of the options granted, and are updated for each optiongrant. We are required to consider current market conditions, includinginterest rates and the market for the Company’s common stock, as well ashistorical data regarding option exercises and forfeitures in making theseassumptions. Changes in the related compensation costs associated with futuregrants may occur due to changes in the assumptions.

Effective December 30, 2005, pursuant to and inaccordance with the recommendation of the Compensation Committee (the “Committee”)of the Board of Directors, the Board of Directors of the Company approved fullacceleration of the vesting of each otherwise unvested stock option that had anexercise price of $15.00 or greater granted under the Company’s 1998 StockOption and Incentive Plan (the “Plan”) that was held by employees, officers,and non-employee directors. These options had exercise prices in excess of thecurrent market value of the Company’s common stock, based on the closing priceof $12.15 per share on December 30, 2005 (i.e., such options were“underwater”). Options to purchase approximately 1.3 million shares of theCompany’s common stock, including approximately 101,000 options held byexecutive officers, were subject to this acceleration.

The Committee also required that, as a condition tothe acceleration of vesting, each executive officer and each non-employeedirector agree to refrain from selling shares of the Company’s common stockacquired upon the exercise of accelerated options (other than shares needed tocover the exercise price and satisfy withholding taxes) until the date on whichthe exercise of such options would have been permitted under the option’spre-acceleration vesting terms or, if earlier, the officer’s or director’s lastday of employment or upon a “change in control” as defined in the Plan.

The decision to acceleratethe vesting of these underwater options was made primarily to minimize certainfuture compensation expenses that the Company would otherwise recognize in itsconsolidated 

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statementsof income (loss) with respect to these options pursuant to SFAS No. 123(Revised), “Share-Based Payment”,**which becomes effective for the Company forreporting periods beginning after December 31, 2005. The Company alsobelieves that the acceleration may have a positive effect on employee morale,retention and the perception of option value. The acceleration had no effect onreported net income for the year ended December 31, 2005, and anapproximate $3.9 million, net of tax, impact on pro forma net income inthe fourth quarter of 2005.

*Income Taxes*

Income taxes are accounted for under the asset andliability method. Deferred tax assets and liabilities are recognized for theincome tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin income in the period that includes the enactment date.

In assessing therealizability of deferred tax assets, management considers whether it is morelikely than not that some portion or all of the deferred tax assets will not berealized. The ultimate realization of deferred tax assets is dependent upon thegeneration of future taxable income and the taxable income in the two previoustax years to which tax loss carryback can be applied. Management considers thescheduled reversal of deferred tax liabilities, projected future taxableincome, taxable income in the carryback period and tax planning strategies inmaking this assessment, and records a valuation allowance on deferred taxassets when considered necessary.

**Recent Accounting Pronouncements**

In November 2004, the FASBissued Statement No. 151, “Inventory Costs—an Amendment of ARB No. 43,Chapter 4”, to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs, and wasted material (spoilage). ThisStatement requires that those items be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal” as defined inARB No. 43. In addition, this Statement requires that allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities. The provisions of this Statement are effectivefor inventory costs incurred during fiscal years beginning after June 15,2005, with earlier application permitted. This statement applies to the Companyfor the fiscal year ending December 31, 2006. The adoption of thisstatement is not expected to have a material impact on the Company’s financialposition, results of operations, or cash flows.

In December 2004, the FASB issued Statement No. 123(Revised), “Share-Based Payment (Revised)” (“SFAS No. 123(R)”), whichamends FASB Statement No. 123, “ Accounting for Stock-Based Compensation,”**and supersedes APB Opinion No. 25, “Accounting forStock Issued to Employees,”**in establishingstandards for the accounting for transactions in which an entity exchanges itsequity instruments for goods or services, as well as transactions in which anentity incurs liabilities in exchange for goods or services that are based onthe fair value of the entity’s equity instruments or that may be settled by theissuance of those equity instruments. This Statement requires that the costresulting from all share-based payment transactions be recognized in thefinancial statements. This Statement establishes fair value as the measurementobjective in accounting for share-based payment transactions with employees,except for equity instruments held by employee share ownership plans. Thisstatement applies to the Company for the fiscal year ending December 31,2006. In March 2005, the Securities and Exchange Commission (“SEC”) issuedStaff Accounting Bulletin No. 107 (“SAB 107”), “Share-Based Payment”. SAB107 provides guidance on the initial implementation of SFAS No. 123(R). Inparticular, SAB 107 includes guidance related to share-based paymentawards for non-employees, valuation methods, and selecting underlyingassumptions such as expected volatility and expected terms.

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The Company will adopt SFAS No. 123(R) on January 1,2006, using the modified prospective approach. The modified prospectiveapproach requires that compensation expense be recorded for restricted stock,all unvested stock options outstanding as of January 1, 2006, and anyshare-based payments issued after the effective date, as well as for theportion of the purchase discount on the market price of the Company’s commonstock offered to employees in conjunction with the Company’s Employee StockPurchase Plan (ESPP) that is considered compensatory based on the guidance inSFAS No. 123(R). We expect to continue using the Black-Scholes valuationmodel in determining the fair value of share-based payments. For pro formafootnote disclosure purposes, we recognized our share-based compensation costson a straight-line basis over the requisite service period as permitted by SFASNo. 123, and we expect to continue to use this method of recognition uponadoption of SFAS No. 123(R).

SFAS No. 123(R) will also require us tochange the classification of any tax benefits realized upon exercise of stockoptions in excess of that which is associated with the expense recognized forfinancial reporting purposes. These amounts will be presented as a financingcash inflow rather than as an adjustment of operating activity as currentlypresented.

The specific impact of the adoption cannot bepredicted because it will depend on the level of share-based payments grantedin the future, the differences between actual and estimated forfeitures ofstock options and restricted shares, and the level of participation in theCompany’s Employee Stock Purchase Plan (ESPP). The Company’s stock options andrestricted stock vest over a five year period. Based on options and restrictedshares outstanding at December 31, 2005, using expected forfeiture ratesof 8% and 6% for stock options and restricted shares, respectively, andassuming historical levels of participation in the ESPP, the Company expects torecognize share-based compensation expense of approximately $903,000 and$799,000 in 2006 and 2007, respectively, as a result of the adoption of SFAS No. 123(R).

In March 2005, the FASB issued FASB IntepretationNo. 47, “Accounting for Conditional Asset Retirement Obligations—anInterpretation of FASB Statement No. 143” (“FIN 47”). FIN 47 providesguidance in applying the provisions of FASB Statement No. 143, “Accountingfor Asset Retirement Obligations”, as they relate to conditional assetretirement obligations. FIN 47 requires that entities recognize a liability forthe fair value of conditional asset retirement obligations if their fair valuescan be reasonably estimated.

The Company has identifiedlegal obligations related to environmental remediation matters at itsRensselaer, NY facility. The liability associated with these obligations cannotbe reasonably estimated due to the fact that a settlement date cannot be determined. Management does not believethat these items are material to the Company’s results of operations, financialposition or cash flows as of December 31, 2005. Also, the adoption of FIN47 would not have a material impact on the Company’s results of operations,financial position or cash flows had it been applied to all periods presented. TheCompany will continue to monitor and evaluate its obligation as necessary.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have market risk with respect to foreign currencyexchange rates and interest rates. The market risk is the potential lossarising from adverse changes in these rates as discussed below.

The Company has research facilities in Singapore andIndia and therefore is subject to foreign currency risk. This risk is composedof both potential losses from the translation of foreign currency financialstatements and the remeasurement of foreign currency transactions. The totalnet assets of non-U.S. operations denominated in non-functional currenciessubject to potential loss amount to approximately $4.8 million. The potentialloss in fair value resulting from a hypothetical 10% adverse change in quotedforeign currency exchange rates amounts to approximately $481,000. Furthermore,related to foreign currency transactions, the Company has exposure tonon-functional currency balances totaling approximately $655,000. This amountincludes, on an absolute basis, exposures to foreign currency 

49

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assets and liabilities. Ona net basis, the Company had approximately $89,000 of foreign currencyliabilities as of December 31, 2005. As currency rates change, thesenon-functional currency balances are revalued, and the corresponding adjustmentis recorded in the consolidated statement of income. A hypothetical change of10% in currency rates could result in an adjustment to the consolidatedstatement of income of approximately $9,000.

With respect to interest rates, the risk is composedof changes in future cash flows due to changes in interest rates on ourvariable rate $18.2 million term loan and $4.8 million industrial developmentauthority bonds.

To mitigate this risk, we have entered into interestrate swap agreements that have fixed the interest rate on 56% of our variablerate debt. Included in other assets is approximately $263,000, which representsthe estimated market value of the swap agreements.

The potential loss in 2006cash flows from a 10% adverse change in quoted interest rates would approximate$44,000.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.

Financial statements andnotes thereto appear on pages F-1 to F-41 of this Form 10-KAnnual Report.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

On May 18, 2005, the Company dismissedPricewaterhouseCoopers LLP (“PricewaterhouseCoopers”) as the Company’sindependent registered public accounting firm. The decision to dismissPricewaterhouseCoopers was made and approved by the Audit Committee of theBoard of Directors of the Company on May 18, 2005, and ratified at ameeting of the Board of Directors held on May 19, 2005.

On May 19, 2005, the Audit Committee of the Boardof Directors of the Company engaged KPMG LLP (“KPMG”), subject to thecompletion of KPMG’s client acceptance procedures (which were completed on May 20,2005), as its new independent registered public accounting firm to audit theCompany’s consolidated financial statements for the year ending December 31,2005. The Company’s decision to engage KPMG as its independent registered publicaccounting firm was the result of a competitive selection process involvingseveral accounting firms.

The Company filed a reporton Form 8-K with the Securities and Exchange Commission with respectto this matter.

**ITEM 9A. CONTROLS AND PROCEDURES**

***Evaluation of Disclosure Controls and Procedures***

As required by rule 13a-15(b) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of theend of the period covered by this Annual Report on Form 10-K, theCompany’s management conducted an evaluation with the participation of theCompany’s Chief Executive Officer and Chief Financial Officer regarding theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act). Based upon that evaluation the Company’s Chief ExecutiveOfficer and Chief Financial Officer have concluded that the Company’sdisclosure controls and procedures were effective as of December 31, 2005.

50

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***Management’s Annual Report on Internal Control overFinancial Reporting***

The Company’smanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting, as such term is defined in Rule 13a-15(f) underthe Exchange Act. The Company’s internal control over financial reporting is aprocess designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with U.S. generally accepted accounting principles, andincludes those policies and procedures that:

·       pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company;

·       providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles and, that receipts and expenditures of the Company arebeing made only in accordance with authorization of management and directors ofthe Company; and

·       providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Company’s assets that could have amaterial effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

The Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, assessed as of December 31,2005 the effectiveness of the Company’s internal control over financialreporting. In making this assessment, management used the criteria set forth inthe framework in *Internal**Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). Basedon the results of this evaluation, management has concluded that the Companymaintained effective internal control over financial reporting as of December 31,2005.

Management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2005 has been audited by KPMG LLP, an independentregistered public accounting firm, as stated in their report which is includedon page F-3 of this Annual Report on Form 10-K.

***Remediation of Material Weakness***

During 2005, weimplemented a number of remediation measures to address the material weaknessdisclosed in the Company’s Annual Report on Form 10-K for the yearended December 31, 2004. These measures include:

·       Anenhanced process for reconciling system generated obsolete inventory reports tothe general ledger reserve account to ensure that the general ledger reserveaccount is accurate and complete.

·       Increasedinternal documentation to support the Company’s excess inventory reserves.

·       Implementationof new procedures to analyze the deferred inventory amortization period,including documentation of the method used to calculate the amortizationperiod.

·       Implementationof new procedures to ensure completed projects are removed from the accumulatedunbilled project costs account balance in a timely manner including a review byadditional Company personnel.

51

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While the planned remediation steps were designed andin place by the end of the second quarter of 2005, management continued toevaluate their operating effectiveness through the end of fiscal year 2005 whenit was concluded that the Company’s internal control over financial reporting hadbeen sufficiently tested to support an assessment that the previously disclosedmaterial weakness had been remediated.

***Changes in Internal Control Over Financial Reporting***

There were no changes inthe Company’s internal control over financial reporting identified inconnection with the evaluation of such internal control that occurred duringthe Company’s last fiscal quarter that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

 

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information appearingunder the captions “Directors and Executive Officers,” “Section 16(a) BeneficialOwnership Reporting Compliance” and “Code of Ethics” in the Company’s definitiveproxy statement relating to the Annual Meeting of Stockholders to be held on June 1,2006 is incorporated herein by reference.

**ITEM 11.**         EXECUTIVECOMPENSATION.

The information appearingunder the captions “Executive Compensation—Summary Compensation,—CompensationCommittee Interlocks and Insider Participation, and—Agreements with NamedExecutive Officers,” and “Information Regarding Directors—The Board ofDirectors and its Committees” in the Company’s definitive proxy statementrelating to the Annual Meeting of Stockholders to be held on June 1, 2006is incorporated herein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.

The information appearingunder the caption “Principal and Management Stockholders” in the Company’sdefinitive proxy statement relating to the Annual Meeting of Stockholders to beheld on June 1, 2006 is incorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.

The information appearingunder the caption “Certain Transactions” in the Company’s definitive proxystatement relating to the Annual Meeting of Stockholders to be held on June 1,2006 is incorporated herein by reference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

The information appearingunder the caption “Audit Fees” in the Company’s definitive proxy statementrelating to the Annual Meeting of Stockholders to be held on June 1, 2006is incorporated herein by reference.

**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

(a) (1)                 FinancialStatements.

Theconsolidated financial statements required by this item are submitted in aseparate section beginning on page F-1 of this report.

|                                                                                       | ** ** | **Page  Number** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------|------------|
| Reports of Independent Registered Public Accounting  Firms                            |       |             | F-2        |   |   |
| Consolidated statements of income (loss)                                              |       |             | F-5        |   |   |
| Consolidated balance sheets                                                           |       |             | F-6        |   |   |
| Consolidated statements of stockholders’ equity and  comprehensive income (loss) |       |             | F-7        |   |   |
| Consolidated statements of cash flows                                                 |       |             | F-8        |   |   |
| Notes to consolidated financial statements                                            |       |             | F-10       |   |   |

 

53

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(a) (2)                 FinancialStatement Schedules

The followingfinancial schedule of Albany Molecular Research, Inc. is included in thisannual report on Form 10-K.

| Schedule II—Valuation and  Qualifying Accounts |   | 1 |   |
|-----------------------------------------------------|--------|---|--------|

 

Schedules other than that which is listed above havebeen omitted since they are either not required, are not applicable, or therequired information is shown in the consolidated financial statements orrelated notes.

(a) (3)                 Exhibits

**EXHIBIT INDEX**

| Exhibit   No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **Description** |
|---------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1           |       | Restated Certificate of Incorporation of the Company  (incorporated herein by reference to Exhibit 3.2 to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 31,  1998, File No. 000-25323).                                                                                                                                                                                                                  |
| 3.2           |       | Amended and Restated By-Laws of the Company  (incorporated herein by reference to Exhibit 3.1 to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 31,  1998, File No. 000-25323).                                                                                                                                                                                                                           |
| 4.1           |       | Specimen certificate for shares of Common Stock,  $0.01 par value, of the Company (incorporated herein by reference to  Exhibit 4.1 to Amendment No. 3 to the Company’s Registration  Statement on Form S-1 (File No. 333-58795)).                                                                                                                                                                                                      |
| 4.2           |       | Certificate of Designations, Preferences and Rights  of a Series of Preferred Stock of Albany Molecular Research, Inc.  classifying and designating the Series A Junior Participating Cumulative  Preferred Stock. (incorporated herein by reference to Exhibit 3.1 to the  Company’s Registration Statement on Form 8-A filed with the  Securities and Exchange Commission on September 19, 2002 (File  No. 000-25323). |
| 4.3           |       | Shareholder Rights Agreement, dated as of  September 18, 2002, between the Company and Mellon Investor Services  LLC, as Rights Agent (incorporated herein by reference to Exhibit 3.2 to  the Company’s Registration Statement on Form 8-A filed with the  Securities and Exchange Commission on September 19, 2002 (File  No. 000-25323).                                                                                        |
| 10.1          |       | Lease dated as of October 9, 1992, as amended,  by and between the Company and Hoffman Enterprises (incorporated herein by  reference to Exhibit 10.1 to Amendment No. 3 to the Company’s  Registration Statement on Form S-1 (File No. 333-58795)).                                                                                                                                                                               |
| 10.2*         |       | 1998 Stock Option and Incentive Plan of the Company  (incorporated herein by reference to Exhibit 10.2 to Amendment  No. 3 to the Company’s Registration Statement on Form S-1  (File No. 333-58795)).                                                                                                                                                                                                                                  |
| 10.3*         |       | Amended and Restated 1992 Stock Option Plan of the  Company (incorporated herein by reference to Exhibit 10.3 to Amendment  No. 2 to the Company’s Registration Statement on Form S-1  (File No. 333-58795)).                                                                                                                                                                                                                           |
| 10.4*         |       | 1998 Employee Stock Purchase Plan of the Company  (incorporated herein by reference to Exhibit 10.4 to Amendment  No. 2 to the Company’s Registration Statement on Form S-1  (File No. 333-58795)).                                                                                                                                                                                                                                     |
| 10.5          |       | Form of Indemnification Agreement between the  Company and each of its directors (incorporated herein by reference to  Exhibit 10.5 to Amendment No. 2 to the Company’s Registration  Statement on Form S-1 (File No. 333-58795)).                                                                                                                                                                                                 |

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| 10.6   |   | License Agreement dated March 15, 1995 by and  between the Company and Marion Merrell Dow Inc. (now Sanofi-Aventis, S.A.)  (excluding certain portions which have been omitted as indicated based upon  an order for confidential treatment, but which have been filed separately  with the Commission) (incorporated herein by reference to Exhibit 10.7  to Amendment No. 3 to the Company’s Registration Statement on  Form S-1 (File No. 333-58795)). |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7*  |   | Amendment to 1998 Stock Option and Incentive Plan of  the Company (incorporated herein by reference to Exhibit 10.7 to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2004 File No. 000-25323)                                                                                                                                                                                                                                   |
| 10.8*  |   | Technology Development Incentive Plan (incorporated  herein by reference to Exhibit 10.10 to Amendment No. 2 to the  Company’s Registration Statement on Form S-1 (File No. 333-58795)).                                                                                                                                                                                                                                                                       |
| 10.9*  |   | Employment Agreement between the Company and Thomas  E. D’Ambra, Ph.D. (incorporated herein by reference to Exhibit 10.11 to  the Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 1998, File No. 000-25323).                                                                                                                                                                                                                 |
| 10.10* |   | Employment Agreement between the Company and Harold  Meckler, Ph.D. (incorporated herein by reference to Exhibit 10.12 to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 1998, File No. 000-25323).                                                                                                                                                                                                                         |
| 10.11* |   | Employment Agreement between the Company and Michael  P. Trova, Ph.D. (incorporated herein by reference to Exhibit 10.13 to  the Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 1998, File No. 000-25323).                                                                                                                                                                                                                       |
| 10.12* |   | Form of Employee Innovation, Proprietary  Information and Post-Employment Activity Agreement between the Company  and each of its executive officers (incorporated herein by reference to  Exhibit 10.14 to Amendment No. 3 to the Company’s Registration  Statement on Form S-1 (File No. 333-58795)).                                                                                                                                              |
| 10.13* |   | Employment Agreement between the Company and Mark  Frost (incorporated herein by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the Securities and Exchange  Commission on December 7, 2004 File No. 000-25323).                                                                                                                                                                                                            |
| 10.14  |   | Credit Agreement, dated as of February 12,  2003, by and between the Company and Fleet National Bank, Fleet  Securities, Inc., JP Morgan Chase Bank, and Citizens Bank of  Massachusetts (incorporated herin by reference to Exhibit 10.19 to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2004 File No. 000-25323).                                                                                            |
| 10.15  |   | Second Amendment, dated as of June 30, 2005, to  Credit Agreement between Albany Molecular Research, Inc. and Bank of  America, N.A., JP Morgan Chase Bank, N.A. and Citizens Bank of Massachusetts (incorporated herin  by reference to Exhibit 10.1 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended June 30, 2005 filed with the  Securities and Exchange Commission on August 9, 2005 File No. 000-25323).             |
| 10.16  |   | Restated and Revised Lease Agreement, dated as of  December 1, 1999, between the University at Albany Foundation and the  Company (incorporated herein by reference to Exhibit 10.21 to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 1999, File No. 000-25323).                                                                                                                                                      |
| 10.17* |   | Form of Restricted Stock Award Agreement under  1998 Stock Option and Incentive Plan (incorporated herein by reference to  Exhibit 10.1 to the Company’s Current Report on Form 8-K  filed with the Securities and Exchange Commission on March 17, 2005 File  No. 000-25323)                                                                                                                                                                             |
| 10.18* |   | Albany Molecular Research, Inc. Incentive Bonus  Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the Securities and Exchange  Commission on May 3, 2005 File No. 000-25323)                                                                                                                                                                                                                |

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| 10.19* |   | Form of Incentive Stock Option Agreement under  1998 Stock Option and Incentive Plan (incorporated herein by reference to  Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 2005 filed with the Securities and  Exchange Commission on May 10, 2005 File No. 000-25323)                                                                                                                                                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.20* |   | Form of Non-Qualified Stock Option Agreement  under 1998 Stock Option and Incentive Plan (incorporated herein by reference  to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 2005 filed with the Securities and  Exchange Commission on May 10, 2005 File No. 000-25323)                                                                                                                                                                                                                                            |
| 10.21  |   | Supply Agreement, dated as of August 31, 2005,  between Organichem Corporation and Amersham Health AS, a wholly-owned  subsidiary of GE Healthcare, Inc. (filed with certain information  omitted pursuant to a request for confidential treatment and filed separately  with the Securities and Exchange Commission) (incorporated herein by  reference to Exhibit 10.1 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended September 30, 2005 filed with  the Securities and Exchange Commission on November 4, 2005 File  No. 000-25323) |
| 10.22  |   | License and Research Agreement, dated as of  October 20, 2005, between Albany Molecular Research, Inc., AMR  Technology, Inc. and Bristol-Myers Squibb Company (filed herewith with  certain information omitted pursuant to a request for confidential treatment  and filed separately with the Securities and Exchange Commission)                                                                                                                                                                                                                                                   |
| 10.23* |   | Form of Notice of Acceleration of Certain Stock  Options and Acknowledgement of Lock-Up dated January 25, 2006 (filed  herewith)                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 21.1   |   | Subsidiaries of the Company (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 23.1   |   | Consent of KPMG LLP (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 23.2   |   | Consent of PricewaterhouseCoopers LLP (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 31.1   |   | Rule 13a-14(a)/15d-14(a) certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.2   |   | Rule 13a-14(a)/15d-14(a) certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 32.1   |   | Section 1350 certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.2   |   | Section 1350 certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

----

*                    Denotesmanagement contract of compensation plan or arrangement

56

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

| Dated: March 16, 2006 | ALBANY  MOLECULAR RESEARCH, Inc. |
|----------------------------|---------------------------------------|
|                       | By:                                   | /s/* *THOMAS E. D’AMBRA |
|                       |                                  | Thomas E. D’Ambra,  Ph.D. |
|                       |                                  | *Chairman  of the Board, President, Chief Executive Officer and Director* |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

|                                    | **Signature** | ** **                                         | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------------------|---------------|----------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/* *THOMAS E.  D’AMBRA |          | Chairman of the Board,  President, Chief Executive |       | March 16,  2006 |
| Thomas E.  D’Ambra, Ph.D.     |          | Officer and Director (Principal Executive Officer) |       |                 |
| /s/  MARK T. FROST                 |          | Chief Financial Officer,  Treasurer and Secretary  |       | March 16,  2006 |
| Mark T. Frost                      |          | (Principal Financial and Accounting Officer)       |       |                 |
| /s/  PAUL S. ANDERSON              |          | Director                                           |       | March 16,  2006 |
| Paul S. Anderson,  Ph.D.           |          |                                               |       |                 |
| /s/  FRANK W. HAYDU                |          | Director                                           |       | March 16,  2006 |
| Frank W.  Haydu, III          |          |                                               |       |                 |
| /s/  DONALD E. KUHLA               |          | Director                                           |       | March 16,  2006 |
| Donald E. Kuhla,  Ph.D.            |          |                                               |       |                 |
| /s/  KEVIN O’CONNOR           |          | Director                                           |       | March 16,  2006 |
| Kevin O’Connor                |          |                                               |       |                 |
| /s/  ARTHUR J. ROTH                |          | Director                                           |       | March 16,  2006 |
| Arthur J. Roth                     |          |                                               |       |                 |
| /s/  ANTHONY P. TARTAGLIA          |          | Director                                           |       | March 16,  2006 |
| Anthony P.  Tartaglia, M.D.        |          |                                               |       |                 |

 

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**INDEX TOCONSOLIDATEDFINANCIAL STATEMENTS ALBANY MOLECULAR RESEARCH, INC.**

|                                                                                                                                                       | ** ** | **Page** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Reports of Independent Registered Public Accounting  Firms                                                                                            |       | F-2      |       |
| Consolidated Statements of Income (Loss) for the Years  Ended December 31, 2005, 2004 and 2003                                              |       | F-5      |       |
| Consolidated Balance Sheets at December 31, 2005  and 2004                                                                                       |       | F-6      |       |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income (Loss) for the Years Ended December 31, 2005, 2004  and 2003 |       | F-7      |       |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2005, 2004 and 2003                                                 |       | F-8      |       |
| Notes to Consolidated Financial Statements                                                                                                            |       | F-10     |       |

 

F-1

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**Reports of Independent Registered Public AccountingFirms**

The Board of Directors and StockholdersAlbany Molecular Research, Inc.:

We have audited the accompanying consolidated balancesheet of Albany Molecular Research, Inc. and subsidiaries (the Company) asof December 31, 2005, and the related consolidated statements of income,stockholders’ equity and comprehensive income, and cash flows for the year thenended. In connection with our audit of the consolidated financial statements,we also have audited the financial statement schedule listed in the indexappearing under Item 15(a)(2). These consolidated financial statements andfinancial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Albany Molecular Research, Inc. and subsidiaries as of December 31,2005, and the results of their operations and their cash flows for the yearthen ended, in conformity with U.S. generally accepted accounting principles. Alsoin our opinion, the related financial statement schedule, when considered inrelation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Albany Molecular Research, Inc. andsubsidiaries’ internal control over financial reporting as of December 31,2005, based upon criteria establishedin Internal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 3,2006, expressed an unqualified opinionon management’s assessment of, and the effective operation of, internal controlover financial reporting.

/s/ KPMG LLPAlbany, New YorkMarch 3, 2006

F-2

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The Board of Directors and StockholdersAlbany Molecular Research, Inc.:

We have audited management’sassessment, included in the accompanying Management’s Annual Report on InternalControl over Financial Reporting,**thatAlbany Molecular Research, Inc. and subsidiaries (the Company) maintainedeffective internal control over financial reporting as of December 31,2005, based on criteria established in*Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).**The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that Albany Molecular Research, Inc. and subsidiariesmaintained effective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on criteria established in *Internal Control—Integrated Framework*issued by COSO.**Also, inour opinion, Albany Molecular Research, Inc. and subsidiaries maintained,in all material respects, effective internal control over financial reportingas of December 31, 2005, based on criteriaestablished in *Internal**Control—Integrated Framework* issued byCOSO.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheet of Albany Molecular Research, Inc.and subsidiaries as of December 31, 2005, and the related consolidatedstatements of income, stockholders’ equity and comprehensive income, and cashflows for the year then ended, and the related financial statement schedule,and our report dated March 3, 2006, expressed an unqualified opinion on those consolidated financial statements andrelated financial statement schedule.

/s/ KPMG LLPAlbany, New YorkMarch 3, 2006

F-3

----

To the Stockholders and Board of Directors of AlbanyMolecular Research, Inc:

In our opinion, theconsolidated balance sheet as of December 31, 2004****andthe related consolidated statements of (loss) income, stockholders’ equity andcomprehensive (loss) income and cash flows present fairly, in all materialrespects, the financial position of Albany Molecular Research, Inc. and****its subsidiaries at December 31, 2004, and the resultsof their operations and their****cash flows foreach of the two years in the period ended December 31, 2004, in conformitywith accounting principles generally accepted in the United States of America. In addition, in our opinion, the financialstatement schedule listed in the index appearing under Item 15(a)(2), presentfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated****financialstatements. These financial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements and financial statementschedule based on our audits. We conducted our audits of these statements inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management,and evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.

/s/PricewaterhouseCoopers LLPAlbany, New YorkMarch 14, 2005

F-4

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**ALBANYMOLECULAR RESEARCH, INC.CONSOLIDATED STATEMENTS OF INCOME (LOSS) Years Ended December 31, 2005, 2004 and 2003(Dollars in thousands, except per share amounts)**

| ** **                                     | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Contract revenue                               |       | $                                          | 136,988    |   | $ | 121,554 |   | $ | 144,667 |   |
| Recurring royalties                            |       | 46,918                                     |       | 47,973 |   | 51,682 |   |
| Total revenue                                  |       | 183,906                                    |       | 169,527 |   | 196,349 |   |
| Cost of contract revenue                       |       | 112,642                                    |       | 96,932 |   | 107,753 |   |
| Write-down of library inventories              |       | 2,063                                      |       | 5,974 |   | — |   |
| Total cost of contract  revenue                |       | 114,705                                    |       | 102,906 |   | 101,753 |   |
| Technology incentive award                     |       | 4,695                                      |       | 4,789 |   | 5,183 |   |
| Research and development                       |       | 14,468                                     |       | 23,887 |   | 22,466 |   |
| Selling, general and administrative            |       | 26,494                                     |       | 22,812 |   | 20,318 |   |
| Property and equipment impairment              |       | —                                     |       | 4,728 |   | — |   |
| Goodwill impairment                            |       | —                                     |       | 14,494 |   | — |   |
| Intangible asset impairment                    |       | —                                     |       | 3,541 |   | — |   |
| Restructuring charge                           |       | —                                     |       | 1,184 |   | — |   |
| Total costs and expenses                       |       | 160,362                                    |       | 178,341 |   | 149,720 |   |
| Income (loss) from  operations                 |       | 23,544                                     |       | (8,814 | ) | 46,629 |   |
| Equity in loss of  unconsolidated affiliates   |       | —                                     |       | (65 | ) | (372 | ) |
| Interest expense                               |       | (1,772                                     | )          | (1,641 | ) | (1,446 | ) |
| Interest income                                |       | 3,559                                      |       | 1,958 |   | 2,231 |   |
| Minority interest in consolidated subsidiaries |       | —                                     |       | — |   | 133 |   |
| Loss on equity investment                      |       | —                                     |       | (1,274 | ) | — |   |
| Other (expense) income, net                    |       | (185                                       | )          | (18 | ) | 403 |   |
| Income (loss) before income  tax expense       |       | 25,146                                     |       | (9,854 | ) | 47,578 |   |
| Income tax expense                             |       | 8,825                                      |       | 1,837 |   | 16,714 |   |
| Net income (loss)                              |       | $                                          | 16,321     |   | $ | (11,691 | ) | $ | 30,864 |   |
| Basic earnings (loss) per  share               |       | $                                          | 0.51       |   | $ | (0.37 | ) | $ | 0.97 |   |
| Diluted earnings (loss) per share              |       | $                                          | 0.50       |   | $ | (0.37 | ) | $ | 0.95 |   |

 

See Accompanying Notes to Consolidated Financial Statements.

F-5

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**ALBANYMOLECULAR RESEARCH, INC.CONSOLIDATED BALANCE SHEETSYears Ended December 31, 2005 and 2004(In thousands, except per share amounts)**

| ** **                                                                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                              | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **Assets**                                                                                                                              |       |                  |       |   |   |
| Current assets:                                                                                                                         |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                              |       | $                     | 27,606     |   | $ | 41,171 |   |
| Investment securities,  available-for-sale                                                                                              |       | 100,304               |       | 92,578 |   |
| Accounts receivable (net  of allowance for doubtful accounts of $98 at December 31, 2005 and  $205 at December 31, 2004) |       | 22,238                |       | 14,263 |   |
| Royalty income  receivable                                                                                                              |       | 6,247                 |       | 12,178 |   |
| Inventory                                                                                                                               |       | 30,603                |       | 32,415 |   |
| Unbilled services                                                                                                                       |       | 213                   |       | 21 |   |
| Prepaid expenses and  other current assets                                                                                              |       | 6,178                 |       | 3,893 |   |
| Property and equipment  held for sale                                                                                                   |       | 5,376                 |       | 5,627 |   |
| Total current assets                                                                                                                    |       | 198,765               |       | 202,146 |   |
| Property and equipment,  net                                                                                                            |       | 151,078               |       | 145,753 |   |
| Goodwill                                                                                                                                |       | 25,747                |       | 25,747 |   |
| Intangible assets and  patents, net                                                                                                     |       | 1,434                 |       | 1,201 |   |
| Equity investment in  unconsolidated affiliates                                                                                         |       | 956                   |       | 956 |   |
| Other assets                                                                                                                            |       | 1,202                 |       | 1,089 |   |
| Total assets                                                                                                                            |       | $                     | 379,182    |   | $ | 376,892 |   |
| **Liabilities and Stockholders’ Equity**                                                                                           |       |                  |       |   |   |
| Current liabilities:                                                                                                                    |       |                  |       |   |   |
| Accounts payable and  accrued expenses                                                                                                  |       | $                     | 10,473     |   | $ | 9,621 |   |
| Deferred revenue                                                                                                                        |       | 12,537                |       | 2,089 |   |
| Accrued compensation                                                                                                                    |       | 3,902                 |       | 4,668 |   |
| Accrued pension benefits                                                                                                                |       | 1,014                 |       | 631 |   |
| Income taxes payable                                                                                                                    |       | 7,466                 |       | 846 |   |
| Current installments of  long-term debt                                                                                                 |       | 4,536                 |       | 4,526 |   |
| Total current  liabilities                                                                                                              |       | 39,928                |       | 22,381 |   |
| Long-term liabilities:                                                                                                                  |       |                  |       |   |   |
| Long-term debt,  excluding current installments                                                                                         |       | 18,521                |       | 48,603 |   |
| Deferred income taxes                                                                                                                   |       | 5,080                 |       | 6,997 |   |
| Pension and  postretirement benefits                                                                                                    |       | 2,356                 |       | 3,139 |   |
| Environmental  liabilities                                                                                                              |       | 236                   |       | 296 |   |
| Total liabilities                                                                                                                       |       | 66,121                |       | 81,416 |   |
| Commitments and contingencies (notes 12, 14)                                                                                            |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                              |       |                  |       |   |   |
| Preferred stock, $0.01  par value, authorized 2,000 shares, none issued or outstanding                                             |       | —                |       | — |   |
| Common stock, $0.01 par  value, authorized 50,000 shares, 34,471 shares issued in 2005 and  33,942 shares issued in 2004      |       | 345                   |       | 340 |   |
| Additional paid-in  capital                                                                                                             |       | 193,066               |       | 189,608 |   |
| Unearned  compensation—restricted stock                                                                                            |       | (1,921                | )          | — |   |
| Retained earnings                                                                                                                       |       | 159,137               |       | 142,816 |   |
| Accumulated other  comprehensive loss, net                                                                                              |       | (395                  | )          | (117 | ) |
|                                                                                                                                    |       | 350,232               |       | 332,647 |   |
| Less, treasury shares at  cost, 2,077 shares in 2005 and 2004                                                            |       | (37,171               | )          | (37,171 | ) |
| Total stockholders’  equity                                                                                                        |       | 313,061               |       | 295,476 |   |
| Total liabilities and stockholders’ equity                                                                                         |       | $                     | 379,182    |   | $ | 376,892 |   |

See Accompanying Notes to Consolidated FinancialStatements.

F-6

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**ALBANYMOLECULAR RESEARCH, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)Years Ended December 31, 2005, 2004 and 2003**

| ** ** | ** ** | ** **    | ** ** | ** **            | ** ** | ** **     | ** ** | ** **       | ** ** | **Unamortized** | ** ** | ** **   | ** ** | **Accumulated**         | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------|------------|---------------|------------|-----------------------|------------|----------------|------------|------------------|------------|-----------------|------------|--------------|------------|-------------------------|------------|--------------------|------------|------------|------------|------------|------------|-------------------|------------|
| ** ** | ** ** | ** **    | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Compensation** | ** ** | ** **      | ** ** | **Other**    | ** ** | **Treasury Stock** | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** ** | ** ** | **Preferred** | ** ** | **Number of**    | ** ** | **Par**        | ** ** | **Paid-in**      | ** ** | **Restricted**  | ** ** | **Retained** | ** ** | **Comprehensive**       | ** ** | **Number of** | ** ** | ** ** | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** ** | ** ** | **Stock**     | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital**      | ** ** | **Stock**       | ** ** | **Earnings** | ** ** | **Loss**                | ** ** | **Shares**         | ** ** | **Amount** | ** ** | **Total**  | ** ** | **Income (Loss)** | ** ** |

| Balances at December 31, 2002                                                                                        |   |   | $      | — |   |   |   | 33,445 |   |   |   | $      | 334    |   |   |   | $      | 182,642 |   |   |   | $      | —  |   |   |   | $      | 123,643 |   |   |   | $      | (793   | )       |   |    | (1,118 | )      |   | $       | (23,679 | )      | $ | 282,147 |   |   |   |   |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|---------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|---------|--------|---------|--------|--------|--------|---------|---------|--------|---|---------|--------|--------|--------|--------|--------|
| Comprehensive Income:                                                                                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |    |   |   |   |    |    |
| Net income                                                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   | 30,864  |   |   |   |   |    |   |   |   |   |   |    |   | 30,864  |   |   | $      | 30,864  |    |   |
| Unrealized loss on investment securities,  available-for-sale, net of taxes                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | (189   | )       |   |   |   |   |   |    |   | (189    | )      |   | (189   | )       |    |
| Organichem Corporation  Other                                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |    |   |   |   |    |    |
| Comprehensive Loss                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | 1,035  |    |   |   |   |   |   |    |   | 1,035   |   |   | 1,035  |    |    |
| Unrealized loss on interest rate swap contract, net  of taxes                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | (156   | )       |   |   |   |   |   |    |   | (156    | )      |   | (156   | )       |    |
| Total comprehensive income                                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |    |   |   | $      | 31,554  |    |   |
| Tax benefit from exercise of stock options                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 591    |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 591     |   |   |   |    |    |
| Issuance of common  stock in connection with stock option

plan  and ESPP         |   |   |   |   |   |   | 249    |   |   |   | 3      |   |   |   | 1,132  |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 1,135   |   |   |   |    |    |
| Treasury shares purchased                                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   | (959   | )      |   | (13,492 | )      | (13,492 | )      |   |   |    |    |
| Balances at December 31, 2003                                                                                        |   |   | $      | — |   |   |   | 33,694 |   |   |   | $      | 337    |   |   |   | $      | 184,365 |   |   |   | $      | —  |   |   |   | $      | 154,507 |   |   |   | $      | (103   | )       |   |    | (2,077 | )      |   | $       | (37,171 | )      | $ | 301,935 |   |   |   |   |   |
| Comprehensive loss:                                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |    |   |   |   |    |    |
| Net loss                                                                                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   | (11,691 | )      |   |   |   |    |   |   |   |   |   |    |   | (11,691 | )      |   | $      | (11,691 | )       |   |
| Unrealized loss on investment securities,  available-for-sale, net of taxes                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | (218   | )       |   |   |   |   |   |    |   | (218    | )      |   | (218   | )       |    |
| Reclassification adjustment for net securities losses  included in net income, net of taxes                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | 22     |    |   |   |   |   |   |    |   | 22      |   |   | 22     |    |    |
| Unrealized gain on interest rate swap contract, net  of taxes                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | 182    |    |   |   |   |   |   |    |   | 182     |   |   | 182    |    |    |
| Total comprehensive loss                                                                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |    |   |   | $      | (11,705 | )       |   |
| Tax benefit from exercise of stock options                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 347    |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 347     |   |   |   |    |    |
| Issuance of warrants to BMS                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 3,053  |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 3,053   |   |   |   |    |    |
| Issuance of common stock in connection with stock  option plan and ESPP                                                   |   |   |   |   |   |   | 248    |   |   |   | 3      |   |   |   | 1,843  |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 1,846   |   |   |   |    |    |
| Balances at December 31, 2004                                                                                        |   |   | $      | — |   |   |   | 33,942 |   |   |   | $      | 340    |   |   |   | $      | 189,608 |   |   |   | $      | —  |   |   |   | $      | 142,816 |   |   |   | $      | (117   | )       |   |    | (2,077 | )      |   | $       | (37,171 | )      | $ | 295,476 |   |   |   |   |   |
| Comprehensive Income:                                                                                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |    |   |   |   |    |    |
| Net income                                                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   | 16,321  |   |   |   |   |    |   |   |   |   |   |    |   | 16,321  |   |   | $      | 16,321  |    |   |
| Unrealized loss on investment securities,  available-for-sale, net of taxes                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | (92    | )       |   |   |   |   |   |    |   | (92     | )      |   | (92    | )       |    |
| Unrealized gain on interest rate swap contract, net  of taxes                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | 132    |    |   |   |   |   |   |    |   | 132     |   |   | 132    |    |    |
| Increase in additional minimum pension liability, net  of taxes                                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | (254   | )       |   |   |   |   |   |    |   | (254    | )      |   | (254   | )       |    |
| Foreign currency translation loss                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   | (64    | )       |   |   |   |   |   |    |   | (64     | )      |   | (64    | )       |    |
| Total comprehensive income                                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |    |   |   | $      | 16,043  |    |   |
| Tax benefit from exercise of stock options                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 416    |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 416     |   |   |   |    |    |
| Modification of stock options                                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 37     |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 37      |   |   |   |    |    |
| Cancellation of BMS warrants                                                                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (562   | )      |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | (562    | )      |   |   |    |    |
| Issuance of restricted stock                                                                                              |   |   |   |   |   |   | 288    |   |   |   | 3      |   |   |   | 2,505  |   |   |    | (2,508 | )      |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | —  |   |   |   |    |    |
| Amortization of unearned compensation - restricted  stock                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    | 327    |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 327     |   |   |   |    |    |
| Forfeiture of unearned compensation - restricted  stock                                                                   |   |   |   |   |   |   | (31    | )      |   |   |   |   |   |   | (260   | )      |   |    | 260    |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | —  |   |   |   |    |    |
| Issuance of common stock in connection with stock  option plan and ESPP                                                   |   |   |   |   |   |   | 272    |   |   |   | 2      |   |   |   | 1,322  |   |   |    |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   | 1,324   |   |   |   |    |    |
| Balances at  December 31, 2005                                                                                       |   |   | $      | — |   |   |   | 34,471 |   |   |   | $      | 345    |   |   |   | $      | 193,066 |   |   |   | $      | (1,921  | )      |   |   | $      | 159,137 |   |   |   | $      | (395   | )       |   |    | (2,077 | )      |   | $       | (37,171 | )      | $ | 313,061 |   |   |   |   |   |

 

See Accompanying Notes to Consolidated FinancialStatements.

F-7

 

----

**ALBANYMOLECULAR RESEARCH, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2005, 2004 and 2003**

**(Inthousands)**

| ** **                                                                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Operating Activities**                                                                  |       |                                       |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                          | 16,321     |   | $ | (11,691 | ) | $ | 30,864 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 15,260                                     |       | 15,264 |   | 13,105 |   |
| Net amortization of premiums on securities                                                |       | 259                                        |       | 446 |   | 324 |   |
| Abandonment loss                                                                          |       | —                                     |       | — |   | 1,400 |   |
| Provision for obsolete inventories                                                        |       | 1,950                                      |       | 3,579 |   | 645 |   |
| Write-down of library inventories                                                         |       | 2,063                                      |       | 5,974 |   | — |   |
| Property, plant and equipment impairment                                                  |       | —                                     |       | 4,728 |   | — |   |
| Goodwill impairment                                                                       |       | —                                     |       | 14,494 |   | — |   |
| Intangible asset impairment                                                               |       | —                                     |       | 3,541 |   | — |   |
| Warrant issuance expense                                                                  |       | —                                     |       | 3,053 |   | — |   |
| Provision for doubtful accounts                                                           |       | (103                                       | )          | (77 | ) | 279 |   |
| Loss on equity investment in unconsolidated affiliates                                    |       | —                                     |       | 1,274 |   | — |   |
| Tax benefit of stock option exercises                                                     |       | 416                                        |       | 347 |   | 591 |   |
| Equity in loss of unconsolidated affiliates                                               |       | —                                     |       | 65 |   | 372 |   |
| Minority interest in consolidated subsidiary                                              |       | —                                     |       | — |   | (133 | ) |
| Forgiven principal on notes receivable- related parties                                   |       | 186                                        |       | 91 |   | 192 |   |
| Deferred income tax (benefit) expense                                                     |       | (2,787                                     | )          | (4,366 | ) | 3,280 |   |
| Net realized loss on sale of securities                                                   |       | —                                     |       | 36 |   | — |   |
| Change in fair value of non-hedge interest rate swap                                      |       | —                                     |       | — |   | (231 | ) |
| Loss on disposal of property, plant and equipment                                         |       | 236                                        |       | — |   | — |   |
| Stock-based compensation expense                                                          |       | 364                                        |       | — |   | (231 | ) |
| Foreign exchange gain                                                                     |       | (3                                         | )          | — |   | — |   |
| (Increase)  decrease in operating assets, net of business combination:                    |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                       |       | (7,871                                     | )          | 3,971 |   | (980 | ) |
| Royalty income receivable                                                                 |       | 5,931                                      |       | 792 |   | 280 |   |
| Unbilled services                                                                         |       | (192                                       | )          | 227 |   | 308 |   |
| Inventory                                                                                 |       | (3,420                                     | )          | (8,286 | ) | (2,958 | ) |
| Prepaid expenses and other assets                                                         |       | (2,485                                     | )          | 1,523 |   | 2,548 |   |
| Increase  (decrease) in operating liabilities, net of business combination:               |       |                                       |       |   |   |   |   |
| Accounts payable, accrued compensation and accrued expenses                               |       | 86                                         |       | 1,445 |   | (4,901 | ) |
| Income taxes payable                                                                      |       | 7,500                                      |       | 846 |   | 2,060 |   |
| Deferred revenue                                                                          |       | 9,886                                      |       | 910 |   | 63 |   |
| Pension and postretirement benefits                                                       |       | (690                                       | )          | (1,574 | ) | (733 | ) |
| Environmental liability                                                                   |       | (60                                        | )          | (47 | ) | (81 | ) |
| Net cash provided by operating activities                                                 |       | 42,847                                     |       | 36,565 |   | 46,294 |   |
| **Investing Activities**                                                                  |       |                                       |       |   |   |   |   |
| Net purchases of securities                                                               |       | (183,117                                   | )          | (63,213 | ) | (34,081 | ) |
| Proceeds from sale of investment securities                                               |       | 174,980                                    |       | 76,268 |   | 41,425 |   |
| Purchase of business, net of cash acquired                                                |       | —                                     |       | — |   | (28,304 | ) |
| Purchases of property, plant and equipment                                                |       | (19,166                                    | )          | (23,716 | ) | (30,554 | ) |
| Payments for patent applications and other costs                                          |       | (334                                       | )          | (245 | ) | (410 | ) |
| Proceeds from disposal of property, plant and equipment                                   |       | 38                                         |       | — |   | — |   |
| Net cash used in investing activities                                                     |       | (27,599                                    | )          | (10,906 | ) | (51,924 | ) |
| **Financing Activities**                                                                  |       |                                       |       |   |   |   |   |
| Proceeds from borrowings under long-term debt                                             |       | —                                     |       | — |   | 30,071 |   |
| Principal payments on capital leases                                                      |       | —                                     |       | — |   | (491 | ) |
| Principal payments on long-term debt                                                      |       | (30,072                                    | )          | (4,521 | ) | (8,469 | ) |
| Payment to acquire treasury shares                                                        |       | —                                     |       | — |   | (13,492 | ) |
| Proceeds from exercise of options and ESPP                                                |       | 1,323                                      |       | 1,846 |   | 1,135 |   |
| Net cash (used in) provided by financing activities                                       |       | (28,749                                    | )          | (2,675 | ) | 8,754 |   |
| Effect of exchange rate changes on cash flows                                             |       | (64                                        | )          | — |   | — |   |
| (Decrease) increase in cash and cash equivalents                                          |       | (13,565                                    | )          | 22,984 |   | 3,124 |   |
| Cash and cash equivalents at beginning of period                                          |       | 41,171                                     |       | 18,187 |   | 15,063 |   |
| Cash and cash equivalents at end of period                                                |       | $                                          | 27,606     |   | $ | 41,171 |   | $ | 18,187 |   |
| Supplemental disclosure of non-cash investing  and financing activities:                  |       |                                       |       |   |   |   |   |
| Increase in net  unrealized loss on securities available-for-sale, net of tax             |       | $                                          | (92        | ) | $ | (196 | ) | $ | (189 | ) |
| Increase  (decrease) in net unrealized gain/(loss) on swap contract, net of tax           |       | $                                          | 132        |   | $ | 182 |   | $ | (156 | ) |
| Increase in  additional minimum pension liability, net of tax                             |       | $                                          | (254       | ) | $ | — |   | $ | — |   |
| Issuance of  restricted stock                                                             |       | $                                          | 2,505      |   | $ | — |   | $ | — |   |
| Conversion of  accounts receivable to equity investments and note receivable              |       | $                                          | —     |   | $ | 104 |   | $ | 2,894 |   |
| Conversion of  debenture receivable to investment in Organichem                           |       | —                                     |       | — |   | $ | 15,000 |   |
| Supplemental disclosures of cash flow information:                                        |       |                                       |       |   |   |   |   |
| Cash paid during the period for:                                                          |       |                                       |       |   |   |   |   |
| Interest                                                                                  |       | $                                          | 1,812      |   | $ | 1,846 |   | $ | 1,265 |   |
| Income taxes                                                                              |       | $                                          | 4,900      |   | $ | 4,545 |   | $ | 10,728 |   |

 

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**ALBANYMOLECULAR RESEARCH, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Continued)**

**YearsEnded December 31, 2005, 2004 and 2003**

**(In thousands)**

In2003, the Company purchased all remaining stock of Organichem Corporation for$29,926. In conjunction with the acquisition, liabilities were assumed asfollows:

| Fair value of  assets acquired                         |   | $       | 79,493 |   |
|--------------------------------------------------------|--------|---------|--------|--------|
| Cash paid for the  capital stock, net of cash acquired |   | (28,304 | )      |
| Liabilities assumed                                    |   | $       | 51,189 |   |

 

See Accompanying Notes to Consolidated FinancialStatements.

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**ALBANYMOLECULAR RESEARCH, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2005, 2004 and 2003(In thousands, except per share amounts)**

**1.**   Summary ofSignificant Accounting Policies

**Nature of Business:**

Albany Molecular Research, Inc.(the “Company”) is a global chemistry-based drug discovery anddevelopment company focused on identifying and developing novel biologicallyactive small molecules with applications in the drug market. The Companyengages in chemistry research, from lead discovery, optimization anddevelopment to commercial manufacturing and has operations in the UnitedStates, India and Singapore. The Company conducts research and developmentprojects and collaborates with many leading pharmaceutical, and biotechnologycompanies, and is developing proprietary new chemistry technology for potentialpharmaceutical products.

**Basis of Presentation:**

The consolidated financial statements include theaccounts of Albany Molecular Research, Inc. (“AMRI”) and its wholly-ownedsubsidiaries. All intercompany balances and transactions have been eliminatedduring consolidation. When necessary, prior years’ consolidated financialstatements have been reclassified to conform to the current year presentation. Assetsand liabilities of non-U.S. operations are translated at period-end rates ofexchange, and the statements of operations are translated at the average ratesof exchange for the period. Gains or losses resulting from translating non-U.S.currency financial statements are recorded in accumulated other comprehensiveloss in the accompanying December 31, 2005 consolidated balance sheet.

Under the terms of theDebenture Purchase Agreement with Organichem Corporation (“Organichem”)described in Note 2, the Company converted debentures into additionalshares of Organichem common stock on January 1, 2003, thereby increasingthe Company’s ownership interest of Organichem Corporation to 75%. Accordingly,100% of the operating results of Organichem Corporation have been included inthe Company’s results of operations from January 1, 2003 to February 11,2003, with an offset to minority interest in consolidated subsidiaries equal to25% of Organichem Corporation’s operating results. On February 12, 2003,the Company exercised its call option under the Put/Call Agreement described inNote 2 and acquired all of the remaining outstanding common stock ofOrganichem Corporation for $29.9 million in cash. Accordingly, 100% ofOrganichem Corporation’s operating results are included in the Company’sresults of operations since February 12, 2003.

**Revenue Recognition:**

The Company’s revenue recognition policies are inaccordance with the Securities and Exchange Commission’s (“SEC”) StaffAccounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”) andEITF No. 00-21, “RevenueArrangements with Multiple Deliverables”.

The Company recognizes revenue under full-timeequivalent contracts on a monthly basis as work is performed based on the termsof the contract. Time and material contract revenues are recognized based on thenumber of hours devoted to the project multiplied by the customer’s billingrates plus the material costs incurred. Fixed fee contract revenue isrecognized by the Company as projects are completed and delivery is made to thecustomer. Revenues from manufacturing performed contracts are recognized uponshipment and the transfer of title and risk of loss to the customer. Ingeneral, contract provisions include 

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predetermined paymentschedules, or the submission of appropriate billing detail establishing prerequisitesfor billings. Deferred revenue represents monies received for services thathave not yet been performed as well as customer billings related to completedproduction which has not yet shipped. Any losses on contracts are recorded whenthey are determinable and estimable.

Generally, the provisions for licensing, milestone androyalty payments included in contracts are related to the occurrence ofspecific identifiable events. The Company recognizes revenue from up-frontnon-refundable licensing fees over the period the Company has a continuinginvolvement in the underlying project. The Company will recognize revenuearising from a milestone payment over the remaining contract term or upon thesuccessful achievement of the event, the resolution of any uncertainties orcontingencies regarding potential collection of the related payment, and whenthe payment approximates the fair value of achieving the milestone.

Recurring royaltiesconsist of royalties under a license agreement with Sanofi-Aventis based on theworldwide sales of fexofenadine HCl, marketed as Allegra in the Americas andTelfast elsewhere. The Company records royalty revenue in the period in whichthe sales of Allegra/Telfast occur, because such royalties can be reasonablyestimated. Royalty payments from Sanofi-Aventis are due within45 days after each calendar quarter and are determined based on sales ofAllegra/Telfast in that quarter.

**Cash Equivalents:**

Cash equivalents consistof money market accounts and overnight deposits. For purposes of theconsolidated statements of cash flows, the Company considers all highly liquidinvestments with a maturity of three months or less when purchased to be cashequivalents.

**Allowance for Doubtful Accounts:**

The Company records anallowance for doubtful accounts for estimated receivable losses. Managementreviews outstanding receivable balances on a regular basis in order to assessthe collectibility of these balances, and adjusts the allowance for doubtfulaccounts accordingly. The allowance and related accounts receivable are reducedwhen the account is deemed uncollectible.

**Inventory:**

Inventory consistsprimarily of commercially available fine chemicals used as raw materials,work-in-process and finished goods in our large scale manufacturing plant andchemical compounds in the form of natural product and novel compound libraries.The Company capitalizes the costs associated with the production of its novelcompound libraries. Inventories are stated at the lower of cost (first-in,first-out basis) or market. Large-scale manufacturing inventories are valuedbased on standard costs as they are produced. Variances from standard costs areaccumulated as they are incurred and are included in the carrying value ofinventory. Accumulated variances are deferred and recognized through cost ofcontract revenue in the consolidated statement of income over the estimatedperiod of inventory turns. The Company writes down inventories for obsolescenceequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions. Anysuch write-down results in a charge to operations.

**Investment Securities:**

In accordance with Statement of Financial AccountingStandards (SFAS) No. 115, “Accounting for Certain Debt and EquitySecurities,” short-term investments are classified as available-for-sale.Available-for-sale securities are carried at fair value, with the unrealizedgains and losses reported in accumulated other comprehensive income. The amortizedcost of debt securities in this category is adjusted for amortization ofpremiums and accretion of discounts to maturity. Such amortization is includedin interest 

F-11

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income or expense.Realized gains and losses and declines in value judged to be other-than-temporary,if any, on available-for-sale securities are included in other income orexpense. The cost of securities sold is based on the specific identificationmethod. Interest and dividends on securities classified as available-for-saleare included in interest income.

At December 31, 2005and 2004, our investments in marketable securities in the current assetssection of the consolidated balance sheets included $15.9 million and $39.8million, respectively, of auction rate municipal bonds, classified asavailable-for-sale securities. Our investments in these securities are recordedat cost, which approximates fair market value due to their variable interestrates, which typically reset every 7 to 35 days, and, despite the long-termnature of their stated contractual maturities, we have the ability to quicklyliquidate these securities. As a result, there are no cumulative grossunrealized holding gains (losses) or gross realized gains (losses) from thesesecurities. All income generated from these current investments is recorded asinterest income.

**Property and Equipment:**

Property and equipment are recorded at cost.Expenditures for maintenance and repairs are expensed when incurred. Whenassets are sold, retired, or otherwise disposed of, the applicable costs andaccumulated depreciation are removed from the accounts and the resulting gainor loss is recognized.

Depreciation is determined using the straight-linemethod over the estimated useful lives of the individual assets. Acceleratedmethods of depreciation have been used for income tax purposes.

TheCompany provides for depreciation of property and equipment over the followingestimated useful lives:

| Laboratory  equipment and fixtures |   | 7-18 years |   |
|------------------------------------|--------|------------|--------|
| Office equipment                   |   | 3-7 years  |   |
| Computer  equipment                |   | 3-5 years  |   |
| Buildings                          |   | 39 years   |   |

 

Leasehold improvements areamortized over the lesser of the life of the asset or the lease term.

**EquityInvestments in Unconsolidated Subsidiaries:**

The Company maintains three equity investments incompanies that have operations in areas within its strategic focus. Two ofthese investments are in leveraged start-up companies and were recorded athistorical cost. The third equity investment is accounted for under the equitymethod of accounting.

The Company records an impairmentcharge when we believe an investment has experienced a decline in value that isother than temporary. Future adverse changes in market conditions or pooroperating results of underlying investments could result in the Company’sinability to recover the carrying value of the investments thereby requiring animpairment charge in the future.

**Long-Lived Assets:**

In accordance withthe provisions of SFAS No. 144, *“*Accounting forImpairment or Disposal of Long-Lived Assets”, (“SFAS No. 144”),**the Company assesses the impairment of long-livedassets whenever events or changes in circumstances indicate that their carryingvalue may not be recoverable. Factors the Company considers important whichcould trigger an impairment review include, among others, the following:

·       asignificant change in the extent or manner in which a long-lived asset is beingused;

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·       asignificant change in the business climate that could affect the value of along-lived asset; and

·       asignificant decrease in the market value of assets.

If the Company determinesthat the carrying value of long-lived assets may not be recoverable, based uponthe existence of one or more of the above indicators of impairment, the Companycompares the carrying value of the asset group to the undiscounted cash flowsexpected to be generated by the asset group. If the carrying value exceeds theundiscounted cash flows an impairment charge is recorded. An impairment chargeis recognized to the extent that the carrying amount of the asset group exceedstheir fair value and will reduce only the carrying amounts of the long-livedassets. The Company utilizes the assistance of an independent valuation firm indetermining the fair values.

**Goodwill:**

In accordance withthe provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFASNo. 142”)*,* the Company performs an annual****assessment of the carrying value of goodwill for potentialimpairment (or on an interim basis if certain triggering events occur). Adetermination of impairment is made based upon the estimated discounted futurecash flows of the operations associated with the related reporting unit. Ifgoodwill is determined to be impaired the Company would be required to record acharge to its results of operations. Factors the Company considers importantwhich could result in an impairment include the following:

·       significantunderperformance relative to historical or projected future operating results;

·       significantchanges in the manner of our use of the acquired assets or the strategy foroverall business;

·       significantnegative industry or economic trends; and

·       marketcapitalization relative to net book value.

Included in goodwill as ofDecember 31, 2005 are $23.1 million related to the acquisition ofOrganichem  and $2.7 million related tothe acquisition of American Advanced Organics, Inc. See Note 19 forfurther information on the Company’s goodwill balances.

**Patents,Patent Application Costs, and Licensing Rights:**

The costs of patents issued and acquired are beingamortized on the straight-line method over the estimated remaining lives of theissued patents, generally 17 years. Patent application and processingcosts are capitalized and will be amortized over the estimated life once apatent is acquired or expensed in the period the patent application is deniedor the related appeal process has been exhausted.

Licensing costs areaccumulated and amortized once the license agreement is executed. The costs oflicensing rights are being amortized on the straight-line method over the termof the license agreement. Licensing costs are written off in the period thelicensing rights are canceled or are determined not to provide future benefits.

**Swap Contracts:**

The Company maintains twointerest rate swap agreements. These agreements have been designated asinterest rate hedges on future cash flows of our variable debt instruments inaccordance with SFAS No. 133, “Accounting for Derivatives and HedgingActivities”**as amended by SFAS No. 138,**“Accounting for Certain Derivative and Certain HedgingActivities.”**Accordingly, these contracts arereported at fair value in the consolidated balance sheets, and any change infair value is recorded as an adjustment to accumulated other comprehensiveincome, net of tax, because the hedges are deemed effective.

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**Pensionand Postretirement Benefits:**

The Company maintainspension and post-retirement benefit costs and liabilities that are developedfrom actuarial valuations. Inherent in these valuations are key assumptions,including discount rates and expected return on plan assets, which are updatedon an annual basis. The Company is required to consider current marketconditions, including changes in interest rates, in making these assumptions.Changes in the related pension and post-retirement benefit costs may occur in thefuture due to changes in the assumptions.

**Environmental Costs:**

In the ordinary course ofbusiness the Company is subject to environmental laws and regulations, and hasmade provisions for the estimated financial impact of environmental cleanuprelated costs. The quantification of environmental exposures requires anassessment of many factors, including changing laws and regulations,advancements in environmental technologies, the quality of informationavailable related to specific sites, the assessment stage of each siteinvestigation, preliminary findings and the length of time involved in theremediation or settlement. The Company accrues environmental cleanup relatedcosts when those costs are believed to be probable and can be reasonablyestimated.

**Research and Development:**

Research and developmentcosts are charged to operations when incurred and are included in operatingexpenses.

**Income Taxes:**

Income taxes are accountedfor under the asset and liability method. Deferred tax assets and liabilities arerecognized for the income tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date.

**Stock-Based Compensation:**

The Company applies the intrinsic value-basedmethod of accounting prescribed by APB Opinion No. 25, “Accounting forStock Issued to Employees” (“APB No. 25”), and related interpretations, aspermitted by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFASNo. 123”), in accounting for its equity compensation plans. As such,compensation expense would be recorded only if, on the date of grant, thecurrent market price of the underlying stock exceeded the exercise price. Anycompensation expense would be recognized over the vesting period.

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UnderSFAS No. 123, compensation cost for stock option grants would bebased on the fair value at the grant date and the resulting compensationexpense would be shown as an expense in the consolidated statements of incomeas the option vests. Had compensation cost for the Company been determinedconsistent with SFAS No. 123, the Company’s net income and earnings pershare would have been reduced to the following pro-forma amounts:

| ** **                                                                                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  (loss), as reported                                                                                                                    |       | $                                          | 16,321     |   | $ | (11,691 | ) | $ | 30,864 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                       |       | 218                                        |       | — |   | — |   |
| Deduct: Total  stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |       | 7,633                                      |       | 4,696 |   | 5,045 |   |
| Pro forma                                                                                                                                          |       | $                                          | 8,906      |   | $ | (16,387 | ) | $ | 25,819 |   |
| Earnings (loss) per  share:                                                                                                                        |       |                                       |       |   |   |   |   |
| Basic as reported                                                                                                                                  |       | $                                          | 0.51       |   | $ | (0.37 | ) | $ | 0.97 |   |
| Basic pro forma                                                                                                                                    |       | $                                          | 0.28       |   | $ | (0.52 | ) | $ | 0.81 |   |
| Diluted as  reported                                                                                                                               |       | $                                          | 0.50       |   | $ | (0.37 | ) | $ | 0.95 |   |
| Diluted pro forma                                                                                                                                  |       | $                                          | 0.28       |   | $ | (0.52 | ) | $ | 0.80 |   |

 

Effective December 30, 2005, pursuant to and inaccordance with the recommendation of the Compensation Committee (the “Committee”)of the Board of Directors, the Board of Directors of the Company approved fullacceleration of the vesting of each otherwise unvested stock option that had anexercise price of $15.00 or greater granted under the Company’s 1998 StockOption and Incentive Plan (the “Plan”) that was held by employees, officers,and non-employee directors. These options had exercise prices in excess of thecurrent market value of the Company’s common stock, based on the closing priceof $12.15 per share, on December 30, 2005 (i.e., such options were “underwater”).Options to purchase approximately 1.3 million shares of the Company’s commonstock, including approximately 101,000 options held by executive officers, weresubject to this acceleration.

The Committee also required that, as a condition tothe acceleration of vesting, each executive officer and each non-employeedirector agree to refrain from selling shares of the Company’s common stockacquired upon the exercise of accelerated options (other than shares needed tocover the exercise price and satisfy withholding taxes) until the date on whichthe exercise of such options would have been permitted under the option’spre-acceleration vesting terms or, if earlier, the officer’s or director’s lastday of employment or upon a “change in control” as defined in the Plan.

The decision to accelerate the vesting of theseunderwater options was made primarily to minimize certain future compensationexpenses that the Company would otherwise recognize in its consolidatedstatements of income (loss) with respect to these options pursuant to SFAS No. 123(Revised), “Share-Based Payment”,**which becomes effective for the Company forreporting periods beginning after December 31, 2005. The Company alsobelieves that the acceleration may have a positive effect on employee morale,retention and the perception of option value. The acceleration had no effect onreported net income for the year ended December 31, 2005, and anapproximate $3,881, net of tax, impact on pro forma net income in the fourthquarter of 2005. The impact of the acceleration is reflected in the pro formaamounts above.

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Theper share weighted-average fair value of stock options granted isdetermined using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions:

| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life in  years: |       | 5        |       | 5        |       | 5        |       |
| Interest rate            |       | 4.06     | %          | 3.41     | %          | 2.96     | %          |
| Volatility               |       | 48       | %          | 59       | %          | 62       | %          |
| Dividend yield           |       | —   |       | —   |       | —   |       |

 

**Earnings Per Share:**

Basic earnings per share are computed by dividingincome available to common stockholders by the weighted average number ofcommon shares outstanding for the period. Diluted earnings per share reflectsthe potential dilution that could occur if securities or other contracts toissue common stock were exercised or converted into common stock or resulted inthe issuance of common stock that then shared in the earnings of the Company(such as stock options and warrants).

Thefollowing table provides basic and diluted earnings per share calculations:

| ** **                              | ** ** | **Year Ended December 31, 2005** | ** ** | **Year Ended December 31, 2004** | ** ** | **Year Ended December 31, 2003** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                              | ** ** | **Net  Income**                                      | ** ** | **Weighted  Average  Shares**                        | ** ** | **Per Share  Amount**                           | ** ** | **Net  Loss** | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic earnings  per share               |       | $                                                    | 16,321     |                                                 |       | 32,044                                               |       |   |   | $ | 0.51 |   |   | $ | (11,691 | ) |   | 31,627 |   |   |   | $ | (0.37 | ) |   | $ | 30,864 |   |   | 31,880 |   |   |   | $ | 0.97 |   |   |
| Dilutive effect  of stock options  |       | —                                               |       |                                                 | 239        |                                                 |       |   | (0.01 | ) |   | — |   |   | — |   |   |   | — |   |   | — |   |   | 486 |   |   |   | (0.02 | ) |   |
| Dilutive effect  of restricted stock    |       | —                                               |       |                                                 | 51         |                                                 |       |   | — |   |   | — |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   |   | — |   |   |
| Diluted earnings per  share             |       | $                                                    | 16,321     |                                                 |       | 32,334                                               |       |   |   | $ | 0.50 |   |   | $ | (11,691 | ) |   | 31,627 |   |   |   | $ | (0.37 | ) |   | $ | 30,864 |   |   | 32,366 |   |   |   | $ | 0.95 |   |   |

 

The weighted averageamount of anti-dilutive options and warrants outstanding were 2,390, 3,519 and2,025 for the years ended December 31, 2005, 2004 and 2003, respectively,and were excluded from the calculation of diluted earnings per share.

**Restructuring Charges:**

TheCompany accounts for its restructuring costs as required by SFAS No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”).SFAS No. 146 requires that a liability for a cost associated with an exitor disposal activity be recognized and measured initially at its fair value inthe period in which the liability is incurred, except for one-time terminationbenefits that meet certain requirements.

**Use of Management Estimates:**

The preparation ofconsolidated financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, and disclosures ofcontingent assets and liabilities, at the date of the consolidated financialstatements, and the reported amounts of revenues and expenses during thereporting period. The most significant estimates included in the accompanyingconsolidated financial 

F-16

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statementsinclude assumptions regarding the collectibility of receivables, the valuationof inventory, and the fair value of goodwill, intangible assets, and long-livedassets. Other significant estimates include assumptions utilized in determiningthe amount and realizabilty of deferred tax assets and assumptions utilized indetermining actuarial obligations in conjunction with the Company’s pension andpostretirement health plans. Actual results can vary from these estimates.

**Recent Accounting Pronouncements:**

In November 2004, the FASBissued Statement No. 151, “Inventory Costs—an Amendment of ARB No. 43,Chapter 4*”*, to clarify the accounting forabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterial (spoilage). This Statement requires that those items be recognized ascurrent-period charges regardless of whether they meet the criterion of “soabnormal” as defined in ARB No. 43. In addition, this Statement requiresthat allocation of fixed production overhead to the costs of conversion bebased on the normal capacity of the production facilities. The provisions ofthis Statement are effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005, with earlier application permitted. Thisstatement applies to the Company for the fiscal year ending December 31,2006. The adoption of this statement is not expected to have a material impacton the Company’s financial position, results of operations, or cash flows.

In December 2004, the FASB issued SFAS No. 123(Revised), “Share-Based Payment (Revised)” (“SFAS No. 123(R)”) whichamends SFAS No. 123 and supersedes APB No. 25**inestablishing standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services, as well as transactionsin which in an entity incurs liabilities in exchange for goods or services thatare based on the fair value of the entity’s equity instruments or that may besettled by the issuance of those equity instruments. This Statement requiresthat the cost resulting from all share-based payment transactions be recognizedin the financial statements based on fair value of the share-based payment.This Statement establishes fair value as the measurement objective inaccounting for share-based payment transactions with employees, except forequity instruments held by employee share ownership plans. This statementapplies to the Company for the fiscal year ending December 31, 2006.

In March 2005, the Securities and Exchange Commission(“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”),“Share-Based Payment”. SAB 107 provides guidance on the initialimplementation of SFAS No 123(R). In particular, SAB 107includes guidance related to share-based payment awards for non-employees,valuation methods, and selecting underlying assumptions such as volatility andexpected terms.

The Company will adopt SFAS No. 123(R) on January 1,2006, using the modified prospective approach. The modified prospectiveapproach requires that compensation expense be recorded for restricted stock,all unvested stock options outstanding as of January 1, 2006, and anyshare-based payments issued after the effective date, as well as for theportion of the purchase discount on the market price of the Company’s commonstock offered to employees in conjunction with the Company’s Employee StockPurchase Plan (ESPP) that is considered compensatory based on the guidance inSFAS No. 123(R). We expect to continue using the Black-Scholes valuationmodel in determining the fair value of share-based payments. For pro formafootnote disclosure purposes, we recognized our share-based compensation costson a straight-line basis over the requisite service period as permitted by SFASNo. 123, and we expect to continue to use this method of recognition uponadoption of SFAS No. 123(R).

SFAS No. 123(R) will also require us tochange the classification of any tax benefits realized upon exercise of stockoptions in excess of that which is associated with the expense recognized forfinancial reporting purposes. These amounts will be presented as a financingcash inflow rather than as an adjustment of operating activity as currentlypresented.

F-17

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The specific impact of the adoption cannot bepredicted because it will depend on the level of share-based payments grantedin the future, the differences between actual and estimated forfeitures ofstock options and restricted shares, and the level of participation in theCompany’s Employee Stock Purchase Plan (ESPP). The Company’s stock options andrestricted stock vest over a five year period. Based on options and restrictedshares outstanding at December 31, 2005, using expected forfeiture ratesof 8% and 6% for stock options and restricted shares, respectively, andassuming historical levels of participation in the ESPP, the Company expects torecognize share-based compensation expense of approximately $903 and $799 in2006 and 2007, respectively, as a result of the adoption of SFAS No. 123(R).

In March 2005, the FASB issued FASB IntepretationNo. 47, “Accounting for Conditional Asset Retirement Obligations—anInterpretation of FASB Statement No. 143” (“FIN 47”). FIN 47 providesguidance in applying the provisions of FASB Statement No. 143, “Accountingfor Asset Retirement Obligations”, as they relate to conditional assetretirement obligations. FIN 47 requires that entities recognize a liability forthe fair value of conditional asset retirement obligations if their fair valuescan be reasonably estimated.

The Company has identifiedlegal obligations related to environmental remediation matters at itsRensselaer, NY facility. The liability associated with these obligations cannotbe reasonably estimated due to the fact that a settlement date cannot be determined. Management does not believethat these items are material to the Company’s results of operations, financialposition or cash flows as of December 31, 2005. Also, the adoption of FIN47 would not have a material impact on the Company’s results of operations,financial position or cash flows had it been applied to all periods presented. TheCompany will continue to monitor and evaluate its obligation as necessary.

**2.**   Investmentin Organichem

On December 21, 1999, the Company completed anequity method investment in Organichem pursuant to a Stock Purchase Agreement.Under the terms of the Stock Purchase Agreement, the Company acquired 37.5% ofOrganichem’s outstanding common stock. During 2000, Organichem purchased aportion of its common stock into treasury, increasing the Company’s ownershipinterest in Organichem to 39.2%. The Stock Purchase Agreement also incorporateda Put/Call Agreement among the Company, Organichem and its stockholders thatpermited the Company to purchase, at the Company’s option, all of theoutstanding shares of common stock of Organichem within 90 days subsequentto the year ending December 31, 2002.

The Company also entered into a Debenture PurchaseAgreement with Organichem at December 21, 1999. Under the terms of theDebenture Purchase Agreement, the Company purchased convertible subordinateddebentures (“Debentures”) for an aggregate purchase price of $15,000. TheCompany converted the Debentures into additional shares of common stock on January 1,2003, thereby increasing the Company’s ownership interest to 75%.

On February 12, 2003,the Company exercised its call option under the Put/Call Agreement and acquiredall of the outstanding common stock of Organichem for $29.9 million incash. The purchase price was determined based on Organichem’s earnings beforeinterest, taxes, depreciation and amortization (“EBITDA”), as defined in thePut/Call Agreement, for the year ending December 31, 2002. The finalallocation of the purchase price to the estimated fair value of the assetsacquired as of February 12, 2003 resulted in the recognition of $23,060 ingoodwill. The purchase price was funded through borrowings under the Company’s$30.0 million term loan and refinanced $25.5 million of Organichem’sexisting bank debt using the Company’s $35.0 million line of credit.

F-18

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**3.**   Restructuring

On May 4, 2004 the Company announced a plan toconsolidate operations by relocating the Mt. Prospect facility operations toits facilities in New York. The Company’s proprietary biocatalysis technologyplatform, drug metabolism screening, research fermentation and chemicaldevelopment technologies in Mt. Prospect have been relocated to New York andcontinue to be fully integrated with the Company’s drug discovery anddevelopment technologies. The restructuring resulted in the closure of the Mt.Prospect Research Center in the fourth quarter of 2004. The consolidation wasinitiated as a result of a lack of anticipated growth in the Company’s chemicaldevelopment services at the facility. As a result of the restructuring, 33employees were terminated and 25 employees were relocated to facilities in NewYork.

Therestructuring costs were included under the caption restructuring charge in the2004 consolidated statement of loss and the restructuring liabilities areincluded in accounts payable and accrued expenses in the consolidated balancesheets at December 31, 2005 and 2004. The following table displays therestructuring activity and liability balances:

| ** **            | ** ** | ** **                    | ** ** | ** **  | ** ** | ** **   | ** ** | **Balance at**   | ** ** |
|-----------------------|------------|-------------------------------|------------|-------------|------------|--------------|------------|-----------------------|------------|
| ** **            | ** ** | **Balance at**           | ** ** | ** **  | ** ** | ** **   | ** ** | **December 31,** | ** ** |
| ** **            | ** ** | **January 1, 2005** | ** ** | **Charges** | ** ** | **Payments** | ** ** | **2005**              | ** ** |
| Termination  benefits |       |                          | $          | 129         |       |         |       | $                     | (65        | ) |   |   | $ | (64 | ) |   |   | $ | — |   |   |
| Asset disposal  costs |       |                          | 513        |        |       |         | —     |                  |       |   | — |   |   |   | 513 |   |   |
| Total                 |       |                          | $          | 642         |       |         |       | $                     | (65        | ) |   |   | $ | (64 | ) |   |   | $ | 513 |   |   |

 

| ** **              | ** ** | ** **                    | ** ** | ** **  | ** ** | ** **   | ** ** | **Balance at**   | ** ** |
|-------------------------|------------|-------------------------------|------------|-------------|------------|--------------|------------|-----------------------|------------|
| ** **              | ** ** | **Balance at**           | ** ** | ** **  | ** ** | ** **   | ** ** | **December 31,** | ** ** |
| ** **              | ** ** | **January 1, 2004** | ** ** | **Charges** | ** ** | **Payments** | ** ** | **2004**              | ** ** |
| Termination  benefits   |       |                          | $          | —      |       |         |       | $                     | 645        |   |   |   | $ | (516 | ) |   |   | $ | 129 |   |   |
| Asset disposal  costs   |       |                          | —     |        |       |         | 513        |                  |       |   | — |   |   |   | 513 |   |   |
| Other associated  costs |       |                          | —     |        |       |         | 26         |                  |       |   | (26 | ) |   |   | — |   |   |
| Total                   |       |                          | $          | —      |       |         |       | $                     | 1,184      |   |   |   | $ | (542 | ) |   |   | $ | 642 |   |   |

 

Costs of termination benefits relate to severancepackages, outplacement services and career counseling for employees affected bythe restructuring. Asset disposal costs relate primarily to brokeragecommissions, legal fees, and marketing expenses associated with the plannedsale of the Mt. Prospect Research Center facility, which is included inproperty and equipment held for sale on the consolidated balance sheet.

The Company also incurred approximately $0.2 millionand $1.4 million in employee and equipment relocation costs during the yearsended December 31, 2005 and 2004, respectively. These relocation costs areincluded under the caption “selling, general and administrative” in theconsolidated statements of operations.

The Company is currently marketing the Mt. ProspectResearch Center facility for sale. The facility qualified for held for saletreatment in accordance with SFAS No. 144 during the fourth quarter of2004. The long-lived assets associated with Mt. Prospect have been segregatedto a separate line item in the consolidated balance sheet until they are soldand depreciation expense has ceased respective to those assets. The completionof the sale of the facility is anticipated by June 2006.

The above restructuringactivity was recorded exclusively in the DDS operating segment. The net cashoutflow related to the restructuring for the years ended December 31, 2005and 2004 was $64 and $542, respectively. Anticipated cash outflows related tothe restructuring for 2006 is $513, which consist of the payment of assetdisposal costs.

F-19

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**4.**   Inventory

Inventoryconsisted of the following at December 31, 2005 and 2004:

| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Raw materials                               |       | $                     | 13,039     |   | $ | 4,818 |   |
| Work in process                             |       | 2,188                 |       | 1,273 |   |
| Finished goods                              |       | 15,029                |       | 22,644 |   |
| Libraries, net of  accumulated amortization |       | 347                   |       | 3,680 |   |
| Total inventories, at  cost                 |       | $                     | 30,603     |   | $ | 32,415 |   |

 

In connection with the ongoing evaluation of libraryvaluation for the year ended December 31, 2005, the Company determinedthat an unfavorable shift in the market for compound libraries had occurred,and the Company was unable to forecast any demand for its chemical lead findingsample collections. As a result, the Company recorded a reserve of $2,063 toeliminate the remaining carrying value of these collections.

For the quarter ended June 30,2004, the Company completed an in-depth review of the carrying value of itslibrary inventories and determined that thecarrying value of its natural product and chemical lead finding librariesexceeded their forecasted revenues. The Company’s forecasted revenues fromnatural product and chemical lead finding libraries had been lowered to reflectless favorable market conditions than previously projected. As a result, theCompany recorded a $6,000 non-cash charge to reduce the carrying value of its libraryinventories. See Note 19 for a discussion of impairment charges on relatedmicrobial cultures in 2004.

**5.    Investment Securities, Available-for-Sale**

Theamortized cost, gross unrealized gains, gross unrealized losses and fair valuefor available-for-sale investment securities by major security type were asfollows:

| ** **                                       | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Obligations of states and political subdivisions |       | $                               | 54,166     |   |   | $ | 1 |   |   |   | $ | (98 | ) |   | $ | 54,069 |   |
| U.S. Government and Agency obligations           |       | 30,629                          |       |   | — |   |   |   | (294 | ) |   | 30,335 |   |
| Auction rate securities                          |       | 15,900                          |       |   | — |   |   |   | — |   |   | 15,900 |   |
|                                             |       | $                               | 100,695    |   |   | $ | 1 |   |   |   | $ | (392 | ) |   | $ | 100,304 |   |

 

|  

** **                               | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Obligations of states and political subdivisions |       |                            | $          | 24,887 |   |   |   | $ | 9 |   |   |   | $ | (11 | ) |   | $ | 24,885 |   |
| Corporate debt obligations                       |       |                            | 28,130     |   |   |   | — |   |   |   | (237 | ) |   | 27,893 |   |
| Auction rate securities                          |       |                            | 39,800     |   |   |   | — |   |   |   | — |   |   | 39,800 |   |
|                                             |       |                            | $          | 92,817 |   |   |   | $ | 9 |   |   |   | $ | (248 | ) |   | $ | 92,578 |   |

 

F-20

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Maturitiesof corporate debt obligations, obligations of states and politicalsubdivisions, and auction rate securities classified as available-for-sale at December 31,2005 and 2004 were as follows:

| ** **                             | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Amortized  Cost**             | ** ** | **Fair  Value**                 | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| Due less than one year                 |       | $                               | 42,023     |                            | $          | 41,704 |   |   | $ | 30,177 |   |   | $ | 30,133 |   |
| Due after one year through five years  |       | 8,196                           |       | 8,124                           |       |   | 25,440 |   |   | 25,245 |   |
| Due after five years through ten years |       | 1,683                           |       | 1,684                           |       |   | — |   |   | — |   |
| Due after ten years                    |       | 48,793                          |       | 48,792                          |       |   | 37,200 |   |   | 37,200 |   |
|                                   |       | $                               | 100,695    |                            | $          | 100,304 |   |   | $ | 92,817 |   |   | $ | 92,578 |   |

 

Information on temporarily impaired securities at December 31,2005, segregated according to the length of time such securities had been in acontinuous unrealized loss position, is summarized as follows:

| ** **                                                        | ** ** | **Less than 12 Months** | ** ** | **12 Months or Longer** | ** ** | **Total**             | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-----------------------|------------|
| ** **                                                        | ** ** | **Fair  Value**                        | ** ** | **Unrealized  Loss**                   | ** ** | **Fair   Value** | ** ** | **Unrealized   Loss** | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** |
| Obligations of  states  and political subdivisions |       | $                                      | 11,862     |                                   |       | $                     | (43        | ) |   | $ | 3,243 |   |   | $ | (27 | ) |   | $ | 15,105 |   |   | $ | (70 | ) |   |
| U.S.  Governmentand Agency obligations                  |       | 12,864                                 |       |                                   | (114       | )                     |       | 30,942 |   |   | (208 | ) |   | 43,806 |   |   | (322 | ) |   |
|                                                              |       | $                                      | 24,726     |                                   |       | $                     | (157       | ) |   | $ | 34,185 |   |   | $ | (235 | ) |   | $ | 58,911 |   |   | $ | (392 | ) |   |

 

The above table represents 42securities where the current fair value is less than the related amortizedcost. These unrealized losses do not reflect any deterioration of the creditworthiness of the issuing entities. No security has a rating that is below “A2.”The unrealized losses on these temporarily impaired securities are a result ofchanges in interest rates for fixed-rate securities where the interest ratereceived is less than the current rate available for new offerings of similarsecurities and changes in market spreads as a result of shifts in supply anddemand. The Company has the ability and intent to hold these securities tomaturity, at which time full recovery of the investment is expected.

The Company receivedproceeds of $174,980, $76,268, and $41,425 and recorded realized losses of $0,$36, and $0 from the sale of available-for-sale securities during the yearsended December 31, 2005, 2004, and 2003, respectively.

F-21

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**6.**   Property and Equipment

Propertyand equipment consists of the following:

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Laboratory  equipment and fixtures                   |       | $                     | 94,703     |   | $ | 93,201 |   |
| Office equipment                                     |       | 15,416                |       | 14,928 |   |
| Leasehold  improvements                              |       | 28,188                |       | 25,555 |   |
| Buildings                                            |       | 53,894                |       | 44,387 |   |
| Land                                                 |       | 2,152                 |       | 1,949 |   |
|                                                 |       | 194,353               |       | 180,020 |   |
| Less accumulated  depreciation and amortization      |       | (49,956               | )          | (41,246 | ) |
|                                                 |       | 144,397               |       | 138,774 |   |
| Construction-in-progress                             |       | 12,057                |       | 12,606 |   |
| Less: Property  and equipment held for sale (Note 3) |       | (5,376                | )          | (5,627 | ) |
|                                                 |       | $                     | 151,078    |   | $ | 145,753 |   |

 

Depreciation andamortization expense of property and equipment was $13.8 million, $14.2million, and $12.7 million for the years ended December 31, 2005, 2004,and 2003, respectively.

***Impairment Charges:***

The Company’s decision toclose the Mt. Prospect Research Center as discussed in Note 3 above and thewrite-down of library inventories at the Bothell Research Center as discussedin Note 4 above triggered an assessment of the recoverability of certain otherrelated long-lived assets at these reporting units. The Company performed SFAS No. 144analyses of its property and equipment for potential impairment at its Mt.Prospect and Bothell Research Centers. The Company’s analyses concluded thatthe carrying value of the respective asset groups exceeded their fair values.Accordingly, during 2004, the Company recorded impairment losses on itslong-lived assets at its Mt. Prospect and Bothell Research Centers of$1.6 million and $3.1 million, respectively. The Company utilized theassistance of an independent valuation firm in determining fair values. Theimpairment charges were recorded exclusively in the AMR operating segment.

**7.**   Equity Investments

The Company has entered into equity investments withtwo entities in the Company’s area of strategic focus. The Company accounts forthese investments using the cost method of accounting as the Company’sownership interest in each investee is below 20% and the Company does not havethe ability to exercise significant influence over the investees.

During the fourth quarterof 2004, the Company performed an assessment of the carrying value of itsinvestment based on an analysis of the investee’s current financial condition,its prospects of generating additional cash flow from operating activities, thecurrent market conditions for raising capital funding for companies in its industryand the likelihood that any funding raised would significantly dilute theCompany’s ownership percentage was performed. As a result of this analysis itwas the Company’s judgment that an other than temporary impairment had occurredand that the fair value of our investment was zero, resulting in a non-cashloss on investment of $1.3 million.

F-22

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**8.**   Long-Term Debt and SwapContracts

***Long-Term Debt***

The Company entered into a $30.0 million termloan and $35.0 million line of credit to fund the acquisition ofOrganichem. The term loan matures in February, 2008 and bears interest at avariable rate based on the Company’s leverage ratio. As of December 31,2005, the variable interest rate was 5.02%. On June 30, 2005, the Companyamended the credit facility to extend the maturity date on the line of creditfrom February 2006 to June 2010. The line of credit bears interest ata variable rate based on the Company’s leverage ratio.  As of December 31, 2005, the outstandingbalance of the line of credit was $0. The credit facility contains certainfinancial covenants, including a maximum leverage ratio, a minimum requiredoperating cash flow coverage ratio, a minimum earnings before interest andtaxes to interest ratio and a minimum current ratio. Other covenants includelimits on asset disposals and the payment of dividends. As of December 31,2005 and 2004, the Company was in compliance with all covenants under thecredit facility.

The Company maintains variable interest rateindustrial development authority bonds due in increasing annual installmentsthrough 2021. Interest payments are due monthly with a current interest rate of3.56%.

Thefollowing table summarizes long-term debt:

| ** **                                                                   | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan                                                                    |       |                        | $          | 18,214                      |       |   |   | $ | 22,500 |   |   |
| Line of credit                                                               |       |                        | —     |                        |       |   | 25,546 |   |   |
| Industrial  development authority bonds                                      |       |                        | 4,820      |                        |       |   | 5,050 |   |   |
| Notes payable to  financing company due in monthly installments through 2008 |       |                        | 23         |                        |       |   | 33 |   |   |
|                                                                         |       |                        | 23,057     |                        |       |   | 53,129 |   |   |
| Less current  portion                                                        |       |                        | (4,536     | )                           |       |   | (4,526 | ) |   |
| Total long-term  debt                                                        |       |                        | $          | 18,521                      |       |   |   | $ | 48,603 |   |   |

 

Theaggregate maturities of long-term debt at December 31, 2005 are asfollows:

| 2006       |   | $     | 4,536  |   |
|------------|--------|-------|--------|--------|
| 2007       |   | 4,541 |   |
| 2008       |   | 9,900 |   |
| 2009       |   | 260   |   |
| 2010       |   | 270   |   |
| Thereafter |   | 3,550 |   |

 

***Swap Contracts***

TheCompany entered into two swap agreements effective April 1, 2003. Theobjective of these swaps is to hedge interest rate risk associated with futurecash flows on a portion of the $30 million variable rate term loan. Thefollowing table summarizes these swap transactions:

| **Swap Description** | ** ** | ** ** | ** ** | **Original  Notional  Amount** | ** **  | **AMRI pays** | ** ** | **AMRI  Receives** | ** **     | **Maturity Date** | ** **            | **Reprice/Settlement  Dates** | ** ** |
|---------------------------|------------|------------|------------|--------------------------------|-------------|--------------------|------------|--------------------|----------------|------------------------|-----------------------|-------------------------------|------------|
| April 1,  2003 Swap  |       | $          | 13,333     |                           | Fixed 3.37% |               | LIBOR      |               | February, 2008 |                   | End of fiscal quarter |                          |
| April 1,  2003 Swap  |       | 6,667      |       | Fixed 3.37%                    |        | LIBOR              |       | February, 2008     |           | End of fiscal quarter  |                  |
| Total                     |       | $          | 20,000     |                           |        |               |       |               |           |                   |                  |                          |

 

F-23

----

 

The fair value of these hedges, which represents thecash the Company would pay to settle the agreements, is recorded as a swapcontract asset/liability with a corresponding offset to other comprehensiveincome.

The weighted average rate received from thecounterparties on all swaps was 3.29%, 1.46%, and 1.20% for the years ended December 31,2005, 2004, and 2003, respectively. The fair value of the interest rate swapagreements was $263 and $44 and was included in other long-term assets in theconsolidated balance sheets at December 31, 2005 and 2004, respectively.The Company recorded an unrealized gain (loss), net of tax, of $132,$182, and $(156) in accumulated other comprehensive income representingthe change in the fair value of its hedges during the years ended December 31,2005, 2004, and 2003, respectively. The Company recognized $14, $328, and $560in additional interest expense related to the net settlement of the swapsduring the years ended December 31, 2005, 2004, and 2003, respectively.

Organichem maintained aswap agreement that hedged its previous term facility interest rate exposure.The Company acquired the swap as part of the acquisition described inNote 2. Under the terms of the agreement, each party made interestpayments on a notional amount. The Company paid a fixed rate of 7.15% and thecounterparty paid a floating rate based on LIBOR. The swap agreement expired onNovember 15, 2003. Since the previous term facility was refinanced withnew loans, the swap was an ineffective hedge. Therefore, for the period ended December 31,2003, changes in the fair value of this swap contract resulted in a gain of$231 to the consolidated statement of income.

**9.**   Income Taxes

Thecomponents of income (loss) before taxes and income tax expense (benefit) areas follows:

| ** **                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|
| ** **                     | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Income (loss) before  taxes:   |       |                                       |       |   |   |   |   |
| U.S.                           |       | $                                          | 25,058     |   | $ | (9,854 | ) | $ | 47,578 |   |
| Foreign                        |       | 88                                         |       | — |   | — |   |
|                           |       | $                                          | 25,146     |   | $ | (9,854 | ) | $ | 47,578 |   |
| Income tax  expense (benefit): |       |                                       |       |   |   |   |   |
| Current:                       |       |                                       |       |   |   |   |   |
| Federal                        |       | $                                          | 11,572     |   | $ | 4,923 |   | $ | 13,432 |   |
| State                          |       | 10                                         |       | 1,280 |   | 2 |   |
| Foreign                        |       | 30                                         |       | — |   | — |   |
|                           |       | 11,612                                     |       | 6,203 |   | 13,434 |   |
| Deferred:                      |       |                                       |       |   |   |   |   |
| Federal                        |       | (3,014                                     | )          | (1,934 | ) | 2,622 |   |
| State                          |       | 227                                        |       | (2,432 | ) | 658 |   |
|                           |       | (2,787                                     | )          | (4,366 | ) | 3,280 |   |
|                           |       | $                                          | 8,825      |   | $ | 1,837 |   | $ | 16,714 |   |

 

 

F-24

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Thedifferences between income tax expense and income taxes computed using afederal statutory rate of 35% for the years ended December 31, 2005, 2004and 2003, were as follows:

| ** **                                                                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Pre-tax  income at statutory rate                                         |       | 8,801                                      |       | (3,449 | ) | $ | 16,765 |   |
| Increase (reduction) in  taxes resulting from:                            |       |                                       |       |   |   |   |   |
| Tax-free  interest income                                                 |       | (412                                       | )          | (222 | ) | (350 | ) |
| Goodwill and  intangible asset impairment                                 |       | —                                     |       | 5,972 |   | — |   |
| State taxes, net  of federal benefit                                      |       | 154                                        |       | (818 | ) | 688 |   |
| Non-deductible  Organichem purchase accounting expenses                   |       | —                                     |       | — |   | 358 |   |
| Extraterritorial  income credit                                           |       | (448                                       | )          | (558 | ) | (560 | ) |
| Increase in  valuation reserve for realized and unrealized capital losses |       | —                                     |       | 481 |   | — |   |
| Domestic  production deduction                                            |       | (86                                        | )          | — |   | — |   |
| Termination of  outstanding warrants                                      |       | 818                                        |       | — |   | — |   |
| Other, net                                                                |       | (2                                         | )          | 431 |   | (187 | ) |
|                                                                      |       | $                                          | 8,825      |   | $ | 1,837 |   | $ | 16,714 |   |
|                                                                           |            |                                            |            |  |  |  |  |  |  |  |

 

The tax effects oftemporary differences giving rise to significant portions of the deferred taxassets and liabilities are as follows:

| ** **                                                                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Deferred tax assets:                                                                          |       |                  |       |   |   |
| Nondeductible  accrued expenses                                                               |       | $                     | 422        |   | $ | 605 |   |
| Allowance for  doubtful accounts                                                              |       | 36                    |       | 95 |   |
| Library  amortization                                                                         |       | 574                   |       | 243 |   |
| Inventory  reserves                                                                           |       | 2,938                 |       | 1,553 |   |
| Warrants                                                                                      |       | 198                   |       | 1,157 |   |
| Environmental  reserves                                                                       |       | 88                    |       | 118 |   |
| Pension and  postretirement costs                                                             |       | 1,003                 |       | 1,503 |   |
| Research and  experimentation credit carryforwards                                            |       | 192                   |       | 192 |   |
| State tax credit  carryforward                                                                |       | 2,153                 |       | 3,929 |   |
| Impairment  charges                                                                           |       | 2,048                 |       | 3,381 |   |
| Investment  write-downs and losses                                                            |       | 885                   |       | 988 |   |
| Capital loss on  sale of fixed assets                                                         |       | 77                    |       | 72 |   |
| Deferred revenue                                                                              |       | 2,907                 |       | — |   |
| Net operating  loss carryforwards                                                             |       | 375                   |       | 849 |   |
|                                                                                          |       | 13,896                |       | 14,685 |   |
| Less valuation  allowance                                                                     |       | (2,997                | )          | (1,770 | ) |
| Deferred tax  assets, net                                                                     |       | 10,899                |       | 12,915 |   |
| Deferred tax  liabilities:                                                                    |       |                  |       |   |   |
| Property and  equipment depreciation differences (accelerated depreciation for tax  purposes) |       | (15,593               | )          | (19,571 | ) |
| Prepaid real  estate taxes                                                                    |       | (242                  | )          | (162 | ) |
| Goodwill  amortization                                                                        |       | (316                  | )          | (273 | ) |
| Net deferred tax  liability                                                                   |       | $                     | (5,252     | ) | $ | (7,091 | ) |

 

F-25

----

The preceding table does not include deferred taxassets of $156 and $94 at December 31, 2005 and 2004, respectively,associated with the Company’s unrealized losses/gains on investment securitiesdiscussed in Note 5, deferred tax liability of $98 at December 31,2005 associated with the Company’s swap contract asset as discussed in Note 8,and deferred tax asset of $114 at December 31, 2005 associated the Company’sadditional minimum pension liability as discussed in Note 11.

The Company’s net operating loss carryforwards beginto expire in 2012. As a result of change in control related to acquisitions,the Company’s use of net operating loss carryforwards is limited toapproximately $451 per year. The Company’s state investment tax creditcarryforwards begin to expire in 2018. The Company’s research and developmentcredit carryforwards begin to expire in 2011.

The Company has not recorded an income tax provisionon earnings from certain of its foreign operations due to the fact that it hasbeen granted certain tax holidays.

In assessing the realizability of deferred tax assets,management considers whether it is more likely than not that some portion orall of the deferred tax assets will not be realized. The ultimate realizationof deferred tax assets is dependent upon the generation of future taxableincome and the taxable income in the two previous tax years to which tax losscarryback can be applied. Management considers the scheduled reversal ofdeferred tax liabilities, projected future taxable income, taxable income inthe carryback period and tax planning strategies in making this assessment.Based upon the level of projected future taxable income over the periods inwhich the deferred tax assets are deductible and tax planning strategies, avaluation allowance of $2,997 and $1,770 at December 31, 2005 and 2004,respectively, is included in deferred tax assets above. The net deferred taxassets represent a level where management believes it is more likely than notthat the Company will realize the benefits of those deductible differences. Theincrease in valuation allowance in 2005 is related to a reduction in theCompany’s effective state tax rate due to 2005 state legislation and its effecton the realizability of state investment tax credit carryforwards. The amountof the deferred tax asset considered realizable could be reduced if estimatesof future taxable income during the carryforward period are reduced.

**10.**   Stockholders’Equity

During the years ended December 31,2005, 2004, and 2003, the Company repurchased 0, 0, and 959 shares of treasurystock at a cost of $0, $0, and $13,492, respectively.

***Employee Stock Purchase Plan***

The Company’s 1998 Employee Stock Purchase Plan (the “Plan”)was adopted during August 1998. Up to 600 shares of common stock may beissued under the Plan, which is administered by the Compensation Committee ofthe Board of Directors. It established two stock offering periods per calendaryear, the first beginning on January 1 and ending on June 30, and thesecond beginning on July 1 and ending December 31. All employees whowork more than 20 hours per week are eligible for participation in thePlan. Employees who are deemed to own greater than 5% of the combined votingpower of all classes of stock of the Company are not eligible for participationin the Plan.

During each offering, anemployee may purchase shares under the Plan by authorizing payroll deductionsup to 10% of their cash compensation during the offering period. The maximumnumber of shares to be issued to any single employee during an offering periodis limited to one thousand. At the end of the offering period, the accumulatedpayroll deductions will be used to purchase common stock on the last businessday of the offering period at a price equal to 85% of the closing price of thecommon stock on the first or last day of the offering period, whichever islower. During the years ended December 31, 2005, 2004, and 2003, employeespurchased 41, 48, and 43 shares, respectively.

F-26

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***Stock Option Plan***

The Company has a Stock Option Plan, through whichincentive stock options or non-qualified stock options may be issued. Incentivestock options granted to employees may not be granted at prices less than 100%of the fair market value of the Company’s common stock at the date of optiongrant. Non-qualified stock options may be granted to employees, directors,advisors, consultants and other key persons of the Company at pricesestablished at the date of grant, and may be less than the fair market value atthe date of grant. All incentive stock options may be exercised at any time,after vesting, over a ten-year period subsequent to the date of grant.Incentive stock options generally vest over five years, with a 60% vestingoccurring at the end of the third anniversary of the grant date, 20% at the endof the fourth anniversary of the grant date and 20% at the end of the fifthanniversary of the grant date. Non-qualified stock option vesting terms areestablished at the date of grant, but shall have a duration of not more thanten years.

Followingis a summary of the status of stock option programs during 2005, 2004 and 2003:

| ** **                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                        | ** ** | **Number of  Shares**                 | ** ** | **Weighted  Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Exercise  Price** | ** ** |
| Outstanding,  beginning of year   |       |                                       | 2,814      |   |   |   | $ | 19.76 |   |   |   | 2,854 |   |   |   | $ | 20.10 |   |   |   | 2,427 |   |   |   | $ | 20.21 |   |   |
| Granted                           |       |                                       | 47         |   |   |   | 13.36 |   |   |   | 544 |   |   |   | 14.48 |   |   |   | 714 |   |   |   | 15.18 |   |   |
| Exercised                         |       |                                       | (221       | ) |   |   | 3.91 |   |   |   | (200 | ) |   |   | 6.41 |   |   |   | (206 | ) |   |   | 2.86 |   |   |
| Forfeited                         |       |                                       | (399       | ) |   |   | 26.56 |   |   |   | (384 | ) |   |   | 21.66 |   |   |   | (81 | ) |   |   | 23.55 |   |   |
| Outstanding, end  of year         |       |                                       | 2,241      |   |   |   | $ | 19.99 |   |   |   | 2,814 |   |   |   | $ | 19.76 |   |   |   | 2,854 |   |   |   | $ | 20.10 |   |   |
| Options exercisable, end  of year |       |                                       | 2,075      |   |   |   | $ | 20.65 |   |   |   | 1,246 |   |   |   | $ | 19.72 |   |   |   | 1,014 |   |   |   | $ | 12.04 |   |   |

 

Effective December 30, 2005, pursuant to and inaccordance with the recommendation of the Compensation Committee (the “Committee”)of the Board of Directors, the Board of Directors of the Company approved fullacceleration of the vesting of each otherwise unvested stock option that had anexercise price of $15.00 or greater granted under the Company’s 1998 StockOption and Incentive Plan (the “Plan”) that was held by employees, officers,and non-employee directors. These options had exercise prices in excess of thecurrent market value of the Company’s common stock, based on the closing priceof $12.15 per share, on December 30, 2005 (i.e., such options were “underwater”).Options to purchase approximately 1.3 million shares of the Company’s commonstock, including approximately 101,000 options held by executive officers, weresubject to this acceleration.

The Committee also required that, as a condition tothe acceleration of vesting, each executive officer and each non-employeedirector agree to refrain from selling shares of the Company’s common stockacquired upon the exercise of accelerated options (other than shares needed tocover the exercise price and satisfy withholding taxes) until the date on whichthe exercise of such options would have been permitted under the option’spre-acceleration vesting terms or, if earlier, the officer’s or director’s lastday of employment or upon a “change in control” as defined in the Plan.

The decision to accelerate the vesting of theseunderwater options was made primarily to minimize certain future compensationexpenses that the Company would otherwise recognize in its consolidatedstatements of income (loss) with respect to these options pursuant to SFAS No. 123(Revised), “Share-Based Payment”,**which becomes effective for the Company forreporting periods beginning after December 31, 2005. The Company alsobelieves that the acceleration may have a positive effect on employee morale,retention and the perception of option value.

F-27

----

The following summarizes information about stockoptions outstanding as of December 31, 2005:

| ** **                                          | ** ** | **Outstanding Options** | ** ** | **Exercisable Options** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of Option  Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding**      | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| $ 0.06-$6.54                                   |       |                         | 230        |                         |       |   | 1.57 |   |   |   | $ | 1.91 |   |   |   | 230 |   |   |   | $ | 1.91 |   |   |
| $ 6.54-$13.09                                  |       |                         | 274        |                         |       |   | 7.36 |   |   |   | 11.20 |   |   |   | 120 |   |   |   | 10.81 |   |   |
| $13.09-$19.63                                       |       |                         | 744        |                         |       |   | 7.54 |   |   |   | 15.56 |   |   |   | 732 |   |   |   | 15.60 |   |   |
| $19.63-$26.18                                       |       |                         | 608        |                         |       |   | 5.22 |   |   |   | 24.63 |   |   |   | 608 |   |   |   | 24.63 |   |   |
| $26.18-$32.72                                       |       |                         | 108        |                         |       |   | 4.90 |   |   |   | 27.95 |   |   |   | 108 |   |   |   | 27.95 |   |   |
| $32.72-$39.26                                       |       |                         | 44         |                         |       |   | 4.83 |   |   |   | 34.09 |   |   |   | 44 |   |   |   | 34.09 |   |   |
| $39.26-$45.81                                       |       |                         | 211        |                         |       |   | 5.09 |   |   |   | 43.24 |   |   |   | 211 |   |   |   | 43.24 |   |   |
| $45.81-$52.35                                       |       |                         | 15         |                         |       |   | 5.11 |   |   |   | 48.60 |   |   |   | 15 |   |   |   | 48.60 |   |   |
| $52.35-$58.89                                       |       |                         | 5          |                         |       |   | 4.87 |   |   |   | 54.84 |   |   |   | 5 |   |   |   | 54.84 |   |   |
| $58.89-$65.44                                       |       |                         | 2          |                         |       |   | 4.99 |   |   |   | 65.44 |   |   |   | 2 |   |   |   | 65.44 |   |   |
|                                                |       |                         | 2,241      |                         |       |   | 5.84 |   |   |   | $ | 19.99 |   |   |   | 2,075 |   |   |   | $ | 20.65 |   |   |
|                                                     |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following are theshares of common stock reserved for issuance at December 31, 2005:

| ** **                    | ** ** | **Number of  Shares** | ** ** |
|-------------------------------|------------|----------------------------|------------|
| Employee Stock  Option Plans  |       |                       | 3,854      |   |   |
| Employee Stock  Purchase Plan |       |                       | 398        |   |   |
| Shares reserved for  issuance |       |                       | 4,252      |   |   |

 

***Restricted Stock***

In 2005, theCompensation Committee of the Board of Directors granted an award of 288restricted shares of common stock to employees of the Company under the 1998Stock Option and Incentive Plan. The shares are issued as restricted stock andare held in the custody of the Company until all vesting restrictions aresatisfied. Shares vest under this grant over a period of five years, with 60%vesting after three years of continuous employment from the grant date and anadditional 20% vesting after each of four and five years of continuousemployment from the grant date. If the vesting terms under which the award wasgranted are not satisfied, the shares are forfeited. Unearned compensation of$2,508 was recorded based on the market value of the shares on the grant date,and is included as a separate component of shareholders’ equity and amortizedover the applicable vesting period. During the year ended December 31,2005, a total of 31 shares with an unamortized unearned compensation balance of$245 had been forfeited. The amount amortized to expense during year ended December 31,2005, net of the impact of forfeitures, was approximately $327.

***Shareholder Rights Plan***

The Company has adopted a Shareholder Rights Plan, thepurpose of which is, among other things, to enhance the Board of Directors’ability to protect shareholder interests and to ensure that shareholdersreceive fair treatment in the event any coercive takeover attempt of theCompany is made in the future. The Shareholder Rights Plan could make it moredifficult for a third party to acquire, or could discourage a third party fromacquiring, the Company or a large block of the Company’s Common Stock. Thefollowing summary description of the Shareholder Rights Plan does not purportto be complete and is qualified in its entirety by reference to the Company’sShareholder Rights Plan, which has been previously filed with the Securitiesand Exchange Commission as an exhibit to a Registration Statement on Form 8-A.

F-28

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In connection with theadoption of the Shareholder Rights Plan, the Board of Directors of the Companydeclared a dividend distribution of one preferred stock purchase right (a“Right”) for each outstanding share of Common Stock to stockholders of record asof the close of business on September 19, 2002. The Rights currently arenot exercisable and are attached to and trade with the outstanding shares ofCommon Stock. Under the Shareholder Rights Plan, the Rights become exercisableif a person becomes an “acquiring person” by acquiring 15% or more of theoutstanding shares of Common Stock or if a person commences a tender offer thatwould result in that person owning 15% or more of the Common Stock. Astockholder owning 15% or more of the common stock of the Company as ofSeptember 19, 2002, is “grandfathered” under the Shareholder Rights Planand will become an “acquiring person” upon acquiring an additional 1¤2%of the Common Stock. If a person becomes an “acquiring person,” each holder ofa Right (other than the acquiring person) would be entitled to purchase, at thethen-current exercise price, such number of shares of the Company’s preferredstock which are equivalent to shares of Common Stock having twice the exerciseprice of the Right. If the Company is acquired in a merger or other businesscombination transaction after any such event, each holder of a Right would thenbe entitled to purchase, at the then-current exercise price, shares of theacquiring company’s common stock having a value of twice the exercise price ofthe Right.

***Stock Purchase Warrants***

In March 2004,the Company issued warrants to purchase up to 516 shares of the Company’scommon stock, with exercise prices ranging from $30.24 to $35.24, toBristol-Myers Squibb Company (BMS). The warrants expire in September, 2009. Theissuance of these warrants results from a 2002 agreement whereby BMStransferred intellectual property to the Company, providing the Company withownership of one of BMS’s preclinical drug candidates, along with patent applicationscovering attention deficit hyperactivity disorder (ADHD) and central nervoussystem indications. In connection with the agreement, in March 2004, theCompany elected to retain ownership of the technology and all improvements madeto date, resulting in the issuance of the warrants to BMS. The issuance ofthese warrants satisfies all equity-related obligations to BMS and results inthe Company’s full ownership of these preclinical drug candidates and relatedintellectual property. Such warrants, which had a value of $3.1 million on thedate of issuance, were charged to research and development costs, with acorresponding credit to stockholders’ equity, during the three months ended March 31,2004. The value of warrants issued was determined using the Black-Scholesoption-pricing model with the following assumptions.

| Expected Life  (years) |   | 5.5    |   |
|------------------------|--------|--------|--------|
| Interest rate          |   | 2.73   | %      |
| Volatility             |   | 62.00  | %      |
| Dividend yield         |   | — |   |

 

F-29

----

In October 2005,the Company entered into a License and Research Agreement (“the Agreement”)with BMS. In conjunction with the Agreement, all outstanding warrants werecancelled. The cancellation of the warrants was deemed to represent additionalup-front licensing consideration from BMS. As a result, the cancelled warrants,which had a value of $562 on the date of cancellation, were charged to deferredrevenue, with a corresponding debit to shareholders’ equity during the quarterended December 31, 2005. The value of the cancelled warrants will berecognized as contract revenue in the consolidated statement of income over thethree-year term of the Agreement. The value of warrants cancelled wasdetermined using the Black-Scholes option-pricing model with the followingweighted-average assumptions.

| Expected Life  (years) |   | 3.2    |   |
|------------------------|--------|--------|--------|
| Interest rate          |   | 4.30   | %      |
| Volatility             |   | 42.68  | %      |
| Dividend yield         |   | — |   |

 

**11.**   EmployeeBenefit Plans

***DefinedContribution Plans***

AMRI maintains a savingsand profit sharing plan under section 401(k) of the Internal RevenueCode covering all eligible non-union employees. Employees must complete onecalendar month of service and be over 20.5 years of age as of the plan’sentry dates. Participants may contribute up to 100% of their compensation,subject to IRS limitations. AMRI currently makes matching contributions equalto 50% of the participant’s contributions (up to a limit of 10% of theparticipant’s compensation). In addition, AMRI has reserved the right to makediscretionary profit sharing contributions to employee accounts. AMRI has madeno discretionary profit sharing contributions. Employer matching contributionsvest at a rate of 20% per year beginning after two years of participation inthe plan. Employer matching contributions were approximately $1,100, $1,100 and$800 for the years ended December 31, 2005, 2004 and 2003, respectively.

AMRI also sponsors asavings and profit sharing plan under section 401(k) of the InternalRevenue Code covering union employees. Employees may contribute from 1.75% to100% of their regular wages, subject to IRS limitations, and Organichem matches50% of each dollar contributed by the employee up to 10% of their wages.Employer matching contributions vest at a rate of 20% per year beginning aftertwo years of participation in the plan. Employer matching contributions were $400,$300, and $400 for the years ended December 31, 2005, 2004 and 2003,respectively.

***Defined Benefit andPostretirement Welfare Plan***

Organichem maintains twonon-contributory defined benefit plans (salaried and hourly) and anon-contributory, unfunded post-retirement welfare plan, covering substantiallyall employees. Benefits for the salaried defined benefit plan are based onsalary and years of service. Benefits for the hourly defined benefit plan (forunion employees) are based on negotiated benefits and years of service. Thehourly defined benefit plan is covered under a collective bargaining agreementwith the International Chemical Workers Union which represents the hourlyworkforce at Organichem.

Effective June 5,2003, the Company eliminated all benefits under the non-contributory, unfundedpost-retirement welfare plan for salaried employees. Effective August 1,2003, the Company curtailed the salaried defined benefit pension plan.Effective March 1, 2004, the Company curtailed the hourly defined benefitpension plan.

F-30

----

Thefollowing table provides a reconciliation of the changes in the plans’ benefitobligations and fair value of the plans’ assets during the years ended December 31,2005 and 2004, and a reconciliation of the funded status to the net amountrecognized in the consolidated balance sheets as of December 31 (the plans’measurement dates) of both years:

| ** **                                     | ** ** | **Pension Benefits** | ** ** | **Postretirement   Benefits** | ** ** |
|------------------------------------------------|------------|---------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2005**                  | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Change in benefit obligation:**              |       |                      |       |                               |       |   |   |   |   |
| Benefit obligation at  January 1          |       | $                         | 20,803     |                               | $          | 19,581 |   | $ | 462 |   | $ | 234 |   |
| Service cost                                   |       | —                    |       | 39                                 |       | 63 |   | 34 |   |
| Interest cost                                  |       | 1,161                     |       | 1,169                              |       | 25 |   | 16 |   |
| Actuarial loss (gain)                          |       | 532                       |       | 903                                |       | (29 | ) | 178 |   |
| Benefits paid                                  |       | (1,013                    | )          | (889                               | )          | — |   | — |   |
| Benefit obligation at  December 31        |       | 21,483                    |       | 20,803                             |       | 521 |   | 462 |   |
| **Change in plan assets:**                     |       |                      |       |                               |       |   |   |   |   |
| Fair value of plan  assets at January 1   |       | 17,900                    |       | 15,039                             |       | — |   | — |   |
| Actual return on plan  assets                  |       | 1,252                     |       | 1,908                              |       | — |   | — |   |
| Employer contributions                         |       | 737                       |       | 1,842                              |       | — |   | — |   |
| Benefits paid                                  |       | (1,013                    | )          | (889                               | )          | — |   | — |   |
| Fair value of plan assets  at December 31 |       | 18,876                    |       | 17,900                             |       | — |   | — |   |
| **Funded  status**                             |       | 2,607                     |       | 2,903                              |       | 521 |   | 462 |   |
| Unrecognized net  actuarial gain (loss)        |       | 428                       |       | 626                                |       | (184 | ) | (221 | ) |
| Net amount recognized                          |       | $                         | 3,034      |                               | $          | 3,529 |   | $ | 337 |   | $ | 241 |   |

 

The net amount recognized for pension benefits at December 31,2005, includes an additional minimum pension liability of $368. The Companyincluded $(254) in other comprehensive income for the year ended December 31,2005, which represents the increase in the additional minimum pensionliability, net of related tax benefits.

At December 31, 2005and 2004, the accumulated benefit obligation (the actuarial present value ofbenefits, vested and non-vested, earned by employees based on current and pastcompensation levels) for the Company’s pension plans totaled $21,483 and$20,803, respectively.

Thefollowing table provides the components of net periodic benefit (income) costfor the years ended December 31:

| ** **                          | ** ** | **Pension Benefits** | ** ** | **Postretirement  Benefits** | ** ** |
|-------------------------------------|------------|---------------------------|------------|------------------------------|------------|
| ** **                          | ** ** | **2005**                  | ** ** | **2004**                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                        |       | $                         | —     |                         | $          | 39 |   |   | $ | 63 |   |   |   | $ | 34 |   |   |
| Interest cost                       |       | 1,161                     |       | 1,169                        |       |   | 25 |   |   |   | 16 |   |   |
| Expected return  on plan assets     |       | (1,230                    | )          | (1,100                       | )          |   | — |   |   |   | — |   |   |
| Amortization of  net loss           |       | 21                        |       | —                       |       |   | 8 |   |   |   | — |   |   |
| Net periodic  benefit (income) cost |       | $                         | (48        | )                            | $          | 108 |   |   | $ | 96 |   |   |   | $ | 50 |   |   |

 

The following assumptionswere used to determine the periodic pension cost for the defined benefitpension plans for the year ended December 31:

| ** **                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Discount rate                   |       | 5.50     | %          | 5.75     | %          |
| Expected return  on plan assets |       | 8.00     | %          | 8.00     | %          |
| Rate of compensation  increase  |       | N/A      |       | N/A      |       |

 

F-31

----

The discount rate that wasutilized for determining the Company’s fiscal 2005 pension obligation andprojected fiscal 2006 net periodic benefit cost was selected using high-quality long-termcorporate bond indices as of the plan’s measurement date.  The rate selected as a result of this processwas substantiated by comparing it to the composite discount rate that produceda liability equal to the plan’s expected benefit payment stream discountedusing the Citigroup Pension Discount Curve (“CPDC”). The CPDC was designed toprovide a means for plan sponsors to value the liabilities of theirpostretirement benefit plans. The CPDC is a yield curve of hypothetical double-A zero coupon bonds with maturities up to30 years. This curve includes adjustments to eliminate the call features ofcorporate bonds. As a result of this modeling process, the discount ratewas decreased from 5.75% at December 31, 2004 to 5.50% at December 31,2005.

The following assumptionswere used to determine the periodic postretirement benefit cost for thepostretirement welfare plan for the period ended December 31:

| ** **                                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Health care cost  trend rate assumed for next year                                 |       | 8.00     | %          | 8.00     | %          |
| Rate to which the  cost trend rate is assumed to decline (the ultimate trend rate) |       | 4.00     | %          | 4.00     | %          |
| Year that the rate  reaches the ultimate trend rate                                |       | 2010     |       | 2009     |       |

 

Assumedhealth care cost trend rates have a significant effect on the amounts reportedfor the postretirement welfare plan. A one-percentage-point change inassumed health care cost trend rates would have the following effects:

| ** **                                                                                         | ** ** | **1-Percentage-  Point Increase** | ** ** | **1-Percentage-  Point Decrease** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| Effect on total  of service and interest cost                                                      |       |                                   | $          | 26                                     |       |   |   | $ | (19 | ) |   |
| Effect on accumulated  postretirement benefit obligation for the year ended December 31, 2005 |       |                                   | $          | 157                                    |       |   |   | $ | (117 | ) |   |

 

The Company’s pension planweighted-average asset allocations at December 31 by asset categoryare as follows:

| ** **        | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| Equity securities |       |     | 59         | %        |       |   | 64 | % |   |
| Debt securities   |       |     | 34         |     |       |   | 34 |   |   |
| Real Estate       |       |     | 5          |     |       |   | — |   |   |
| Other             |       |     | 2          |     |       |   | 2 |   |   |
| Total             |       |     | 100        | %        |       |   | 100 | % |   |

 

The overall objective of the Company’s defined benefitplans is to provide the means to pay benefits to participants and theirbeneficiaries in the amounts and at the times called for by the plan. This isexpected to be achieved through the investment of the Company’s contributionsand other assets and by utilizing investment policies designed to achieveadequate funding over a reasonable period of time.

Defined benefit planassets are invested so as to achieve a return on investment, based on levels ofliquidity and investment risk that is prudent and reasonable undercircumstances which exist from time to time. While the Company recognizes theimportance of the preservation of capital, it also adheres to the theory ofcapital market pricing which maintains that varying degrees of investment riskshould be rewarded with compensating returns.

The asset allocationdecision includes consideration of the non-investment aspects of the Company’sdefined benefit plans, including future retirements, lump-sum elections,contributions, and cash flow. 

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Theseactual characteristics of the plans place certain demands upon the level, risk,and required growth of trust assets. The Company regularly conducts analyses ofthe plans’ current and likely future financial status by forecasting assets,liabilities, benefits and contributions over time. In so doing, the impact ofalternative investment policies upon the plans’ financial status is measuredand an asset mix which balances asset returns and risk is selected.

The Company’s decisionwith regard to asset mix is reviewed periodically. Asset mix guidelines includetarget allocations and permissible ranges for each asset category. Assets aremonitored on an ongoing basis and rebalanced as required to maintain an assetmix within the permissible ranges. The guidelines will change from time totime, based on an ongoing evaluation of the plan’s tolerance of investmentrisk.

The market-related valueof plan assets is used in developing the expected rate of return on planassets. The market-related value of plan assets phases in recognition ofcapital appreciation by recognizing investment gains and losses over afour-year period at 25% per year.

Theexpected future benefit payments under the plans are as follows for the yearsending December 31:

| ** **  | ** ** | **Pension  Benefits** | ** ** | **Postretirment  Benefits** | ** ** |
|-------------|------------|-----------------------|------------|-----------------------------|------------|
| 2006        |       |                  | $          | 1,052                       |       |   |   | — |   |   |
| 2007        |       |                  | 1,078      |                        |       |   | — |   |   |
| 2008        |       |                  | 1,095      |                        |       |   | — |   |   |
| 2009        |       |                  | 1,261      |                        |       |   | — |   |   |
| 2010        |       |                  | 1,381      |                        |       |   | — |   |   |
| 2011 - 2015 |       |                  | 7,877      |                        |       |   | 39 |   |   |

 

The Company expects to contribute $1,014 to itspension plans in 2006.

**12.**   LeaseCommitments

The Company leases both facilities and equipment usedin its operations and classifies those leases as operating leases following theprovisions of SFAS No. 13, *Accountingfor Leases*.

The Company has long-term operating leases for a substantialportion of its research and development laboratory facilities. The expirationdates on the present leases range from September 2007 to April 2015.The leases contain renewal options at the option of the Company. The Company isresponsible for paying the cost of utilities, operating costs, and increases inproperty taxes at its leased facilities. The Company also leases variousequipment with terms ranging from one to three years.

Future minimum leasepayments under noncancelable operating leases (with initial or remaining leaseterms in excess of one year) as of December 31, 2005 are as follows:

| Year ending December 31, |   |   |   |
|-------------------------------|--------|--------|--------|
| 2006                          |   | $      | 2,259  |   |
| 2007                          |   | 2,266  |   |
| 2008                          |   | 1,328  |   |
| 2009                          |   | 1,320  |   |
| 2010                          |   | 1,230  |   |
| Thereafter                    |   | 3,352  |   |
|                               |        |        |        |  |

 

Rental expense amounted to approximately $2,400,$2,300, and $2,100 during the years ended December 31, 2005, 2004 and2003, respectively.

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**13.**   RelatedParty Transactions

***(a) Technology Development Incentive Plan***

In 1993, the Company adopted a Technology DevelopmentIncentive Plan to provide a method to stimulate and encourage novel innovativetechnology development. To be eligible to participate, the individual must bean employee of the Company and must be the inventor or co-inventor of noveltechnology that results in new revenues generated for, or by, the Company.Eligible participants will share in awards based on a percentage of the licensing,royalty or milestone revenue received by the Company, as defined by the Plan.

In 2005, 2004 and 2003,the Company awarded Technology Incentive Compensation to the inventor of theterfenadine carboxylic acid metabolite technology, which is covered by theCompany’s patents relating to the active ingredient in Allegra. The inventor isa director, officer and shareholder of the Company. The amounts awarded andincluded in the consolidated statements of income (loss) for the years endedDecember 31, 2005, 2004 and 2003 are $4,695, $4,789, and $5,183,respectively. Included in accrued compensation in the accompanying consolidatedbalance sheets at December 31, 2005 and 2004 are unpaid TechnologyDevelopment Incentive Compensation awards of $623 and $1,214, respectively.

***(b) Notes Receivable***

From time to time the Company makes loans tonon-officer employees in the form of notes receivable. The notes receivable andaccrued interest will not be repaid provided the employee remains in theCompany’s employ throughout the term of the loan. If employment is terminatedprior to the end of the loan term, a pro-rata portion of the principal andinterest shall be repaid. Notes receivable from employees at December 31,2005 and 2004 totaled $284 and $414, respectively. The amounts forgiven andcharged to operations in the consolidated statements of income for the yearsended December 31, 2005, 2004 and 2003 are $185, $91, and $192,respectively.

*** (c) TelecommunicationServices***

A member of the Company’s board of directors is theChief Executive Officer of one of the providers of telephone and internetservices to the Company. This telecommunications company was paid $194, $169,and $165 for services rendered to the Company in 2005, 2004, and 2003,respectively.

**14.**   LegalProceedings

The Company, from time to time, may be involved invarious claims and legal proceedings arising in the ordinary course ofbusiness. Except as noted below in regards to litigation relating to Allegra,the Company is not currently a party to any such claims or proceedings which,if decided adversely to the Company, would either individually or in theaggregate have a material adverse effect on the Company’s business, financialcondition, results of operations or cash flows.

AMR Technology, a subsidiary of the Company, alongwith Aventis Pharmaceuticals Inc., the U.S. pharmaceutical business ofSanofi-Aventis S.A., are involved in legal proceedings with several companiesseeking to market generic versions of Allegra. Beginning in 2001, Barr Laboratories, Inc.,Impax Laboratories, Inc., Mylan Pharmaceuticals, Inc., TevaPharmaceuticals USA, Dr. Reddy’s Laboratories, Ltd./Dr. Reddy’sLaboratories, Inc., Ranbaxy Laboratories Ltd./Ranbaxy PharmaceuticalsInc., and Sandoz Inc. filed Abbreviated New Drug Applications (ANDAs) with theU.S. Food and Drug Administration, or FDA, to produce and market genericversions of Allegra products.

In response to the filings described above, beginningin 2001, Aventis Pharmaceuticals filed patent infringement lawsuits againstBarr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, TevaPharmaceuticals, Dr. Reddy’s Laboratories, Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., and 

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Sandoz. Each of thelawsuits was filed in the U.S. District Court in New Jersey and allegesinfringement of one or more patents owned by Aventis Pharmaceuticals. Further,beginning in March 5, 2004, AMR Technology, along with AventisPharmaceuticals, filed suit in the U.S. District Court in New Jersey againstBarr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, TevaPharmaceuticals, Dr. Reddy’s Laboratories, Amino Chemicals, Ltd., RanbaxyLaboratories Ltd./Ranbaxy Pharmaceuticals Inc., and Sandoz, Inc.,asserting infringement of two of our U.S. patents that are exclusively licensedto Aventis Pharmaceuticals relating to Allegra and Allegra-D products.

In the pending litigations, Aventis Pharmaceuticalsand AMR Technology have entered into covenants not to sue the defendants underU.S. Patent No. 5,578,610, which patent has not been asserted in thelitigation but which Aventis Pharmaceuticals exclusively licenses from us.However, we and Aventis Pharmaceuticals have agreed that AventisPharmaceuticals will continue to pay royalties to us based on that patent underour original license agreement with Aventis Pharmaceuticals. Under ourarrangements with Aventis Pharmaceuticals, we will receive royalties untilexpiration of the underlying patents (2013 for U.S. Patent No. 5,578,610and 2015 for U.S. Patent No. 5,750,703) unless the patents are earlierdetermined to be invalid.

Under applicable federal law, marketing of anFDA-approved generic version of Allegra may not commence until the earlier of adecision favorable to the generic challenger in the patent litigation or 30 monthsafter the date the patent infringement lawsuit was filed. In general, the firstgeneric filer is entitled to a 180-day marketing exclusivity period uponFDA approval.

On September 6, 2005, Barr Pharmaceuticals, Inc.and Teva Pharmaceuticals Industries Ltd. announced that they have entered intoan agreement for the launch of Fexofenadine Hydrochloride 30 mg, 60 mg and 180mg tablets, the generic version of Allegra tablets in the United States. Thelaunch of the generic product is considered an “at-risk” launch due to theon-going litigation. This generic launch had a material adverse impact on U.S.sales of Allegra by Sanofi-Aventis in the fourth quarter of 2005 and in turn,the royalties earned by the Company on those sales.  The launch has not had a material impact onnon-U.S. sales of Allegra to date.

On September 20,2005, AMR Technology, along with Aventis Pharmaceuticals, filed a Motion forPreliminary Injunction in the U.S. District Court in New Jersey seeking toenjoin Barr Pharmaceuticals,  Inc., TevaPharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd. fromthe sale of generic versions of Allegra in the United States. On January 30,2006, the U.S. District Court denied the request by AMR Technology and AventisPharmaceuticals for a preliminary injunction. A notice of appeal to the U.S.Court of Appeals for the Federal Circuit was filed on February 2, 2006.

**15.**   Environmental Costs

The Company has completed an environmental remediationassessment associated with groundwater contamination at its Rensselaer, NYlocation. Ongoing costs associated with the remediation include biannualmonitoring and reporting to the State of New York’s Department of EnvironmentalConservation. Under the remediation plan, the Company is expected to pay formonitoring and reporting until 2009. Under a 1999 agreement with the facility’sprevious owner, the Company’s maximum liability under the remediation is $5million. The Company assumed a liability of approximately $400 in connectionwith the acquisition of Organichem described in Note 2. For the yearsended December 31, 2005 and 2004, respectively, $256 and $47 in costs havebeen paid by the Company.

Management has estimated the future liabilityassociated with the monitoring based on enforcement rulings, market prices fromthird parties, when available, and historical cost information for similaractivities. Management’s estimates could be materially impacted in the futureby changes in legislative and enforcement rulings. While a change in estimatebased on these factors is reasonably possible in the near term, based oncurrently available data, the Company believes that current compliance with the

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remediation plan will nothave a material adverse effect on the Company’s financial position, results ofoperations or cash flows.

At December 31, 2005and 2004, $236 and $296, respectively, were recorded for future environmentalliabilities in the consolidated balance sheets.

**16.**   Concentration ofBusiness

For the year ended December 31, 2005, contractrevenue from our three largest customers represented 37%, 6% and 4%,respectively, of our contract revenue. For the year ended December 31,2004, contract revenue from our three largest customers respectivelyrepresented approximately represented 38%, 6% and 4% of our contract revenue.For the year ended December 31, 2003, contract revenue from our threelargest customers respectively represented approximately 34%, 10% and 6% of ourcontract revenue. Our largest customer, GE Biosciences, represented 37% oftotal contract revenue for the year ended December 31, 2005. In themajority of circumstances, there are agreements in force with these entitiesthat provide for the Company’s continued involvement in present researchprojects. However, there regularly exists the possibility that the Company willhave no further association with these entities once these projects conclude.

Contractrevenue by geographic region, based on the location of the customer, andexpressed as a percentage of total contract revenue follows:

| ** **      | ** ** | **Year Ended  December 30,** | ** ** |
|-----------------|------------|----------------------------------------|------------|
| ** **      | ** ** | **2005**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| United States   |       |                                   | 59         | % |   |   | 61 | % |   |   | 57 | % |   |
| Europe          |       |                                   | 38         | % |   |   | 37 | % |   |   | 40 | % |   |
| Other countries |       |                                   | 3          | % |   |   | 2 | % |   |   | 3 | % |   |
| Total           |       |                                   | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

**17.**   Business Segments

The Company has organized its sales, marketing andproduction activities into the Discovery/Development/Small Scale Manufacturing(“DDS”) and Large Scale Manufacturing (“LSM”) segments based on the criteriaset forth in SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information”. The Company’s management relies on an internalmanagement accounting system to report results of the segments. The systemincludes revenue and cost information by segment. The Company’s managementmakes financial decisions and allocates resources based on the information itreceives from this internal system.

DDS includes activities such as drug lead discovery,optimization, drug development and small scale commercial manufacturing. LSMincludes pilot to commercial scale manufacturing of active pharmaceuticalingredients and intermediates and high potency and controlled substancemanufacturing all of which are in compliance with the Food and DrugAdministration’s (FDA) current Good Manufacturing Practices.

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Thefollowing table summarizes information by segment for the year ended December 31,2005:

| ** **                                      | ** ** | **DDS** | ** ** | **LSM** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|---------|------------|---------|------------|-----------|------------|
| Contract revenue                                |       | $       | 55,645     |    | $          | 81,343    |       | $ | 136,988 |   |
| Recurring  royalties                            |       | 46,918  |       | —  |       | 46,918    |       |
| Total revenue                                   |       | $       | 102,563    |    | $          | 81,343    |       | $ | 183,906 |   |
| Operating income  (before unallocated expenses) |       | $       | 52,689     |    | $          | 11,817    |       | $ | 64,506 |   |
| Unallocated  expenses:                          |       |    |       |    |       |      |       |
| Research and  development                       |       |    |       |    |       | 14,468    |       |
| Selling, general  and administrative            |       |    |       |    |       | 26,494    |       |
| Total unallocated expenses                      |       |    |       |    |       | 40,962    |       |
| Operating income                                |       |    |       |    |       | 23,544    |       |
| Reconciling  items:                             |       |    |       |    |       |      |       |
| Interest income,  net                           |       |    |       |    |       | 1,787     |       |
| Other loss, net                                 |       |    |       |    |       | (185      | )          |
| Income before  income tax expense               |       |    |       |    |       | $         | 25,146     |   |
| Supplemental  information:                      |       |    |       |    |       |      |       |
| Depreciation and  amortization                  |       | $       | 9,500      |    | $          | 5,760     |       | $ | 15,260 |   |

 

Thefollowing table summarizes other information by segment as of December 31,2005:

| ** **                                | ** ** | **DDS**                 | ** ** | **LSM** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|---------|------------|-----------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Total assets                              |       | $                       | 242,818    |    | $          | 136,364   |       | $ | 379,182 |   |
| Goodwill included  in total assets        |       | 2,687                   |       | 23,060  |       | 25,747    |       |
| Investments in  unconsolidated affiliates |       | 956                     |       | —  |       | 956       |       |
| Capital expenditures                      |       | 8,428                   |       | 10,738  |       | 19,166    |       |
|                                           |            |                         |            |         |            |           |            |  |  |  |

 

Thefollowing table summarizes information by segment for the year ended December 31,2004:

| ** **                                      | ** ** | **DDS** | ** ** | **LSM** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|---------|------------|---------|------------|-----------|------------|
| Contract revenue                                |       | $       | 53,488     |    | $          | 68,066    |       | $ | 121,554 |   |
| Recurring  royalties                            |       | 47,973  |       | —  |       | 47,973    |       |
| Total revenue                                   |       | $       | 101,461    |    | $          | 68,066    |       | $ | 169,527 |   |
| Operating income  (before unallocated expenses) |       | $       | 21,537     |    | $          | 16,348    |       | $ | 37,885 |   |
| Unallocated  expenses:                          |       |    |       |    |       |      |       |
| Research and  development                       |       |    |       |    |       | 23,887    |       |
| Selling, general  and administrative            |       |    |       |    |       | 22,812    |       |
| Total unallocated expenses                      |       |    |       |    |       | 46,699    |       |
| Operating loss                                  |       |    |       |    |       | (8,814    | )          |
| Reconciling  items:                             |       |    |       |    |       |      |       |
| Equity in loss of  unconsolidated affiliates    |       |    |       |    |       | (65       | )          |
| Interest income,  net                           |       |    |       |    |       | 317       |       |
| Loss on equity  investment                      |       |    |       |    |       | (1,274    | )          |
| Other loss, net                                 |       |    |       |    |       | (18       | )          |
| Loss before  income tax expense                 |       |    |       |    |       | $         | (9,854     | ) |
| Supplemental  information:                      |       |    |       |    |       |      |       |
| Depreciation and  amortization                  |       | $       | 9,315      |    | $          | 5,949     |       | $ | 15,264 |   |

 

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Thefollowing table summarizes other information by segment as of December 31,2004:

| ** **                                | ** ** | **DDS**                 | ** ** | **LSM** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|---------|------------|-----------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Total assets                              |       | $                       | 251,028    |    | $          | 125,864   |       | $ | 376,892 |   |
| Goodwill included  in total assets        |       | 2,687                   |       | 23,060  |       | 25,747    |       |
| Investments in  unconsolidated affiliates |       | 956                     |       | —  |       | 956       |       |
| Capital expenditures                      |       | 9,951                   |       | 13,765  |       | 23,716    |       |
|                                           |            |                         |            |         |            |           |            |  |  |  |

 

**18.**   FairValue of Financial Instruments

The following disclosure of the estimated fair valueof financial instruments is made in accordance with the requirements of SFAS No. 107,*Disclosures About Fair Value of Financial Instruments*.Although the estimated fair value amounts have been determined by the Companyusing available market information and appropriate valuation methodologies, theestimates presented are not necessarily indicative of the amounts that theCompany could realize in current market exchanges.

The Company is estimating its fair value disclosuresfor financial instruments using the following methods and assumptions:

*Cashand cash equivalents, receivables, and accounts payable:**  *The carrying amounts reported inthe consolidated balance sheets approximate their fair value because of theshort maturities of these instruments.

*Investmentsecurities, available-for-sale:**  *As disclosed in Note 5,investment securities are estimated based on quoted market prices at theconsolidated balance sheet date.

*Long-termdebt:**  *Thecarrying value of long-term debt was approximately equal to fair value at December 31,2005 and 2004 due to the resetting dates of the variable interest rates.

*Swap Contract:**  *As discussed in Note 8, theswap contract asset is carried at fair value at December 31, 2005 and2004.

**19.**   Goodwill and IntangibleAssets

***Goodwill***

During the quarter ended June 30, 2004, due tothe triggering events discussed in Notes 3, 4, and 6 above, the Companydetermined that the carrying value of its goodwill at its Bothell reportingunit may be impaired. Accordingly, the Company conducted a goodwill impairmentreview as required under SFAS No. 142, and concluded that an impairmenthad occurred and therefore recorded a $13,251 goodwill impairment charge, whichreflects a full impairment of the Bothell goodwill. In calculating the goodwillimpairment charge, the fair value of the Bothell reporting unit was determinedwith the assistance of an independent valuation firm using a discounted cashflow valuation approach. Significant assumptions used in this analysis include (i) expectedfuture revenue growth rates, reporting unit profit margins, and working capitallevels, (ii) a discount rate, and (iii) a terminal value multiple.The revenue growth rates, working capital levels and reporting unit profitmargins were based on management’s best estimate of future results.

Also during the quarter ended June 30, 2004, dueto the triggering events discussed in Notes 3, 4, and 6 above, the Companydetermined that the carrying value of its goodwill at its Mt. Prospectreporting unit may be impaired. Accordingly, the Company conducted a goodwillimpairment review as required under SFAS No. 142. The Company completedits assessment and concluded that an impairment had occurred and recorded a$1,243 goodwill impairment charge based upon a valuation of the reporting unit.The 

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valuation was preparedwith the assistance of an independent valuation firm using a discounted cashflow approach. Significant assumptions used were similar to those used for theBothell reporting unit valuation.

Thecarrying amount of goodwill, by segment, as of December 31, 2005 and 2004are as follows:

| **DDS** | ** ** | **LSM** | ** ** | **Total** |
|---------|------------|---------|------------|-----------|
| $2,687  |       | $23,060 |       | $25,747   |

 

***Intangible Assets***

Due to the write-down of the Company’s natural productlibraries as discussed in Note 4 above, the Company also performed anassessment of the carrying value of its microbial cultures and relatedtechnologies during the quarter ended June 30, 2004. The microbialcultures and related technologies are the starting materials and technologyused in the development of the natural product libraries, and therefore, wouldbe used to make incremental copies of the natural product libraries. Based onits assessment, the Company concluded that the carrying value of the microbialcultures and related technologies was not recoverable, and accordingly recordeda $3,541 impairment charge representing the entire remaining carrying value ofmicrobial cultures and related technologies, which are included in the Company’sAMR reporting segment.

Thecomponents of intangible assets are as follows:

| ** **                    | ** ** | **Cost**   | ** ** | **Accumulated  Amortization** | ** ** | **Net**    | ** ** | **Amortization  Period** | ** ** |
|-------------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|--------------------------|------------|
| ***December 31,  2005*** | ** ** | ** ** | ** ** |                          | ** ** | ** ** |       | ** **               | ** ** |   | ** ** | ** ** |   |
| Patents and  Licensing Rights |       | $          | 1,811      |                          |       | $          | (377       | )                        |       | $ | 1,434 |   |   | 16 years | ** ** |   |
| ***December 31,  2004*** |       |       |       |                          |       |       |       |                     |       |   |   | ** ** |   |
| Patents and Licensing  Rights |       | $          | 1,478      |                          |       | $          | (277       | )                        |       | $ | 1,201 |   |   | 16 years | ** ** |   |

 

Amortization expense related to patents and licensingrights for the years ended December 31, 2005, 2004, and 2003 was $101,$367, and $302, respectively. Estimated future annual amortization expenserelated to intangible assets is $112 per year for each of the years ending December 31,2006, 2007, 2008, 2009, and 2010.

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**20.   SelectedQuarterly Consolidated Financial Data (unaudited)**

Thefollowing tables present unaudited consolidated financial data for each quarterof 2005 and 2004:

| ** **                     | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|--------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| **2005**                       |       |               |       |                |       |               |       |                |       |
| Contract revenue               |       | $                  | 36,627     |                | $          | 35,948             |       | $                   | 31,550     |   | $ | 32,863 |   |
| Gross profit                   |       | 7,491              |       | 6,621               |       | 5,413              |       | 2,758               |       |
| Recurring  royalties           |       | 12,007             |       | 15,892              |       | 12,779             |       | 6,240               |       |
| Income (loss)  from operations |       | 8,356              |       | 11,045              |       | 6,514              |       | (2,371              | )          |
| Net income (loss)              |       | 5,597              |       | 7,294               |       | 4,373              |       | (943                | )          |
| Net income (loss)  per share:  |       |               |       |                |       |               |       |                |       |
| Basic                          |       | $                  | 0.18       |                | $          | 0.23               |       | $                   | 0.14       |   | $ | (0.03 | ) |
| Diluted                        |       | $                  | 0.17       |                | $          | 0.23               |       | $                   | 0.13       |   | $ | (0.03 | ) |
| **2004**                       |       |               |       |                |       |               |       |                |       |
| Contract revenue               |       | $                  | 30,814     |                | $          | 28,118             |       | $                   | 28,703     |   | $ | 33,919 |   |
| Gross profit                   |       | 6,951              |       | (709                | )          | 5,428              |       | 6,978               |       |
| Recurring  royalties           |       | 9,992              |       | 13,878              |       | 11,917             |       | 12,186              |       |
| Income (loss)  from operations |       | 4,144              |       | (22,586             | )          | 4,297              |       | 5,331               |       |
| Net income (loss)              |       | 2,761              |       | (20,773             | )          | 2,890              |       | 3,431               |       |
| Net income (loss)  per share:  |       |               |       |                |       |               |       |                |       |
| Basic                          |       | $                  | 0.09       |                | $          | (0.66              | )          | $                   | 0.09       |   | $ | 0.11 |   |
| Diluted                        |       | $                  | 0.09       |                | $          | (0.66              | )          | $                   | 0.09       |   | $ | 0.11 |   |

 

**21.   Subsequent Event**

On February 28, 2006 the Company acquired 100% ofthe outstanding shares of ComGenex Kfrt., a chemistry services company based inBudapest, Hungary, for $11.1 million in cash consideration.

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**ALBANYMOLECULAR RESEARCH, INC.SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTSYears Ended December 31, 2005, 2004 and 2003**

| **Description**                             | ** ** | ** ** | ** ** | **Balance at   Beginning of   Period** | ** ** | **Charged to Cost  and Expenses** | ** ** | **Charged to Other  Accounts** | ** ** | **Deductions  Charged to  Reserves** | ** ** | **Balance at  End of  Period** | ** ** |
|---------------------------------------------|------------|------------|------------|------------------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| Allowance for doubtful  accounts receivable |       |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |
| 2005                                        |       |       | $          | 205,072                                                    |       |                                             |       | $                                        | (70,691    | )                                         |       |                                     | —     |   |   | $ | (36,043 | ) | $ | 98,338 |   |
| 2004                                        |       |       | $          | 309,000                                                    |       |                                             |       | $                                        | (77,315    | )                                         |       |                                     | $          | (25,000 | ) |   | $ | (1,613 | ) | $ | 205,072 |   |
| 2003                                        |       |       | $          | 218,000                                                    |       |                                             |       | $                                        | 278,715    |                                      |       |                                     | —     |   |   | $ | (187,715 | ) | $ | 309,000 |   |
| Note receivable reserve                     |       |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |
| 2005                                        |       |       | $          | 32,277                                                     |       |                                             |       | $                                        | (32,277    | )                                         |       |                                     | —     |   |   | — |   | $ | — |   |
| 2004                                        |       |       | $          | 32,277                                                     |       |                                             |       | —                                   |       |                                      |       | —                                   |       |   | — |   | $ | 32,277 |   |
| 2003                                        |       |       | $          | 32,277                                                     |       |                                             |       | —                                   |       |                                      |       | —                                   |       |   | — |   | $ | 32,277 |   |
| Deferred tax asset  valuation allowance     |       |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |
| 2005                                        |       |       | $          | 1,769,331                                                  |       |                                             |       | $                                        | 1,228,004  |                                      |       |                                     | —     |   |   | — |   | $ | 2,997,335 |   |
| 2004                                        |       |       | $          | 1,149,211                                                  |       |                                             |       | $                                        | 620,110    |                                      |       |                                     | —     |   |   | — |   | $ | 1,769,331 |   |
| 2003                                        |       |       | $          | —                                                     |       |                                             |       | $                                        | 1,149,211  |                                      |       |                                     | —     |   |   | — |   | $ | 1,149,211 |   |
|                                             |            |            |            |                                                            |            |                                                  |            |                                          |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

 

F-41

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