**UNITED STATES**SECURITIES AND EXCHANGE COMMISSION

**Washington, D.C. 20549**

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FORM 10-K

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FOR ANNUAL AND TRANSITION REPORTSPURSUANT TO SECTIONS 13 OR 15( ) OF THESECURITIES EXCHANGE ACT OF 1934

**(Mark One)**

**x**        ANNUAL REPORT PURSUANT TOSECTION 13 OR 15( ) OF THE SECURITIES EXCHANGE ACT OF1934

**For the fiscal year ended December 31, 2004**

**or**

**o**        TRANSITION REPORT PURSUANTTO SECTION 13 OR 15( ) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the transition period from                  to                 **

**Commission file number 0-25323**

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AlbanyMolecular Research, Inc.

(Exactname of registrant as specified in its charter)

| **Delaware**                                                     | **14-1742717**                     |
|------------------------------------------------------------------|------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)  | (IRS Employer  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 registeredpursuant to Section 12(b) of the Act:

**None**

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

**CommonStock, par value $.01 per share**

**Preferred Stock Purchase Rights**

Titleof Each Class

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2). Yes x  No o

Theaggregate market value of the Registrant’s Common Stock held by non-affiliatesof the Registrant on June 30, 2004 was approximately $294 millionbased upon the closing price per share of the Registrant’s Common Stock as reportedon the Nasdaq National Market on June 30, 2004. Shares of Common Stockheld by each officer and director and by each person who owns 10% or more ofthe outstanding Common Stock have been excluded in that such persons may bedeemed to be affiliates. This determination of affiliate status is notnecessarily a conclusive determination for other purposes.

Asof February 18, 2005, there were 31,936,810 outstanding shares of theRegistrant’s Common Stock.

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**DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the following document are incorporatedby reference into Part III of this Report on Form 10-K:

(1)           The Company’s definitiveproxy statement for the Annual Meeting of Stockholders to be held on May 18,2005.

 

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**ALBANYMOLECULAR RESEARCH, INC.INDEX TOANNUAL REPORT ON FORM 10-K**
|                                                       | ** ** | ** **                                                                                  | ** ** | **Page No.** |
|-------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|--------------|
|                                                  |       | Cover page                                                                                  |       |         |
|                                                  |       | Part I.                                                                                |       |         |
| Cautionary Note Regarding Forward-Looking  Statements |       |                                                                                        |
| Item 1.                                               |       | Business                                                                                    |       | 4            |
| Item 2.                                               |       | Properties                                                                                  |       | 15           |
| Item 3.                                               |       | Legal Proceedings                                                                           |       | 15           |
| Item 4.                                               |       | Submission of Matters to a Vote of  Security Holders                                        |       | 16           |
|                                                  |       | Part II.                                                                               |       |         |
| Item 5.                                               |       | Market for Registrant’s Common  Equity and Related Stockholder Matters                 |       | 17           |
| Item 6.                                               |       | Selected Financial Data                                                                     |       | 19           |
| Item 7.                                               |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |       | 20           |
| Item 7A.                                              |       | Quantitative and Qualitative  Disclosures about Market Risk                                 |       | 48           |
| Item 8.                                               |       | Financial Statements and  Supplementary Data                                                |       | 49           |
| Item 9.                                               |       | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure       |       | 49           |
| Item  9A.                                             |       | Controls  and Procedures                                                                    |       | 49           |
|                                                  |       | Part III.                                                                              |       |         |
| Item 10.                                              |       | Directors and Executive Officers  of the Registrant                                         |       | 52           |
| Item 11.                                              |       | Executive Compensation                                                                      |       | 52           |
| Item 12.                                              |       | Security Ownership of Certain  Beneficial Owners and Management                             |       | 52           |
| Item 13.                                              |       | Certain Relationships and Related  Transactions                                             |       | 52           |
| Item 14.                                              |       | Principal Accountant Fees and  Services                                                     |       | 52           |
|                                                  |       | Part IV.                                                                               |       |         |
| Item 15.                                              |       | Exhibits and Financial Statement  Schedules                                                 |       | 52           |

 

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**Forward-LookingStatements**

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. The Company’sactual results may differ materially from such forward-looking statementsas a result of numerous factors, some of which the Company may not be able topredict and may not be within the Company’s control. Factors that could causesuch differences include, but are not limited to, trends in pharmaceutical andbiotechnology companies outsourcing chemical research and development, the lossof, or decrease in business with, a significant customer, sales of Allegra(including any deviations in estimates provided by Sanofi-Aventis [formerlyAventis]) and the Company’s receipt of significant royalties from the Allegralicense agreement, the risk that Allegra may be approved for over-the-counteruse, the over-the-counter sale of Claritin, the over-the-counter sale ofgeneric alternatives for the treatment of allergies, the Company’s and Sanofi-Aventis  ‘ ability to successfully enforce theirrespective intellectual property, patent rights and technology, including withrespect to the generic companies’ Abbreviated New Drug Application filings, theCompany’s ability to commence operations in Singapore and India on schedule andwithin budget, the integration and operating risks associated with the Company’sacquisition of Organichem, the Company’s ability to successfully develop novelcompounds and lead candidates in its collaborative arrangements, 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 Company’s ability to executeits business plan for compound and chemical screening sample collections, andthe Company’s ability to effectively manage its growth. All forward-lookingstatements are made as of the date of this report, and we do not undertake toupdate any such forward-looking statements in the future. References to “we,”“us,” and “our,” refers to Albany Molecular Research, Inc. and itssubsidiaries, taken as a whole. Readers are cautioned that these forward-lookingstatements are only predictions and are subject to risks, uncertainties andassumptions that are difficult to predict. Therefore, actual results may differmaterially 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, was incorporated on June 20, 1991 and is a leadingchemistry-based drug discovery and development company focused onidentifying and developing novel biologically active small molecules withapplications in the drug market. We conduct research and development projectsand collaborate with many leading pharmaceutical, and biotechnology companies,and are developing new chemistry technology for potential pharmaceuticalproducts. We engage in chemistry research, from lead discovery, optimizationand development to commercial manufacturing. We believe we are the only companyproviding a critical mass of contract chemistry services to customers acrossthe entire product development cycle from lead discovery to commercialmanufacturing. Most of the services we offer have been traditionally providedby chemistry divisions within pharmaceutical and biotechnology companies,including drug lead discovery, medicinal chemistry, chemical development,analytical chemistry services and small-scale, pilot-plant andlarge-scale manufacturing. In February of 2003 we completed theacquisition of Organichem Corporation which is now our wholly-ownedsubsidiary. Organichem is a full service, custom manufacturer adhering tocurrent Good Manufacturing Practices, (“cGMP”), and specializing in processdevelopment, pilot to commercial scale synthesis, high potency, low temperatureand controlled substance manufacturing. Our Organichem location hasmanufactured ethical and over-the-counter drugs for more than 100 years.We have designed our services to permit our customers to reduce overall drugdevelopment time and cost and to simultaneously pursue a greater number of drugdiscovery and development opportunities.

In addition to ourchemistry research services, we also conduct proprietary research anddevelopment to discover new 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 the development,patenting and licensing of a substantially pure form of, and a manufacturingprocess for, the active ingredient in the non-sedating antihistaminefexofenadine HCl marketed by Sanofi-Aventis as Allegra in the Americas and asTelfast elsewhere. Pursuant to a licensing agreement with Sanofi-Aventis, wehave earned a total of $266.3 million in milestones and royalties from thebeginning of the contract in 1995 through December 31, 2004 and areentitled to receive ongoing royalties from Sanofi-Aventis based upon apercentage of sales of Allegra. In addition, many of our discovery technologycontracts provide for us to receive licensing, milestone and royalty paymentsfor discoveries that lead to commercial products.

**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, inparticular, human genomics research. In addition, pharmaceutical and biotechnologycompanies are under pressure to deliver new drugs to market and reduce the timerequired for drug development. This pressure has come about, in part, as aresult of the significant number of current drug products on the market forwhich patent protection 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.

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**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:

·       leaddiscovery—the identification of a compound that may be developed into a newdrug;

·       leadoptimization—an iterative process of modifying the structure of a lead compoundto optimize its therapeutic properties;

·       preclinicaltesting—the testing of the compound in increasingly complex animal models;

·       clinicaltrials—the multi-phase testing of the compound for safety and efficacy inhumans; and

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

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

**Lead Discovery.  **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.

**Lead Optimization.  **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 and synthesis of additional compounds based upon the analysis ofstructure-activity relationships. During lead optimization, specialistsin chemical development optimize the synthesis process and perform the scale-upsynthesis of a lead compound as that compound is advanced through the drugdiscovery and development process. These scientists are experts in thepreparation of chemicals on a larger scale and focus on the efficiency,economics, simplicity and safety of the preparation of such chemicals. Chemicaldevelopment is also an iterative process which may require progressiveimprovements in chemical synthesis as subsequent repeat batches are prepared.In addition to providing repeat synthesis, significant process research may berequired to refine existing or develop new synthesis processes. Also, duringthe lead optimization stage, analytical chemistry services are incorporated toassure the identity and purity of the lead candidate.

**Preclinical Testing.  **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 

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desirable in order toprepare compounds of significant diversity to broaden potential patentcoverage. As a result, the advancement of a lead compound into preclinicaltesting is often a catalyst which increases, rather than decreases, the needfor additional medicinal chemical synthesis and other chemical services. Duringthis phase, specialists in chemical development continue to conduct significantprocess research to optimize the production of a compound.

**Clinical Trials.  **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.

**ProductCommercialization.  **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 guidancepublished by the FDA. Manufacturing procedures and operations must be incompliance with all regulatory and quality regulations at all times during themanufacture of commercial products and APIs. Once a drug has received allnecessary approvals, the manufacture, marketing and sale of commercialquantities of the approved drug 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 the last ten years, manypharmaceutical and biotechnology companies began utilizing 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:

·       alarger number of drugs marketed today were not discovered in-house;

·       developmentof new technologies that continued to increase the number of targets andaccelerate the identification of active compounds;

·       pressureto develop new lead compounds due to the near-term loss of patent protectionfor many drug products;

·       increasedpressure to reduce the time spent in drug discovery and development to bringdrugs to market sooner and maximize patent life;

·       increasedfocus on converting fixed costs to variable costs and streamlining operationsby contracting for research and development services;

·       heightenedregulatory environment and increased complexity that made the internalmanagement of complicated discovery, development and manufacturing projectsmore difficult and costly; and

·       biotechnologyand emerging pharmaceutical companies, in many cases, lacking the requiredin-house drug discovery and development expertise.

In 2003 and 2004, the market for contract chemistryservices began to tighten. The number of entrants in the market increased,including a number of foreign companies operating under substantially lowercost structures, resulting in increased competition for services and pricingpressures. In addition, this timeframe 

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marked a period offinancial decline for the pharmaceutical and biotechnology industry due tofactors such as patent expirations and successful patent challenges on “blockbuster”drugs, product recalls, and failure in clinical trials of developmentalcompounds expected to replace expiring patents. These factors have led to anoverall decrease in spending on contract chemistry services, as well as a shiftin spending away from the discovery phase of the pharmaceutical research anddevelopment process in an effort to bring previously identified compounds tomarket.

We believe that ourorganizational structure and strategic initiatives position us for long-termsuccess in this evolving market. We have pursued strategies to establishlower-cost foreign operations in Singapore and India, and expect to commenceoperations in these locations in 2005. We believe the ability to offercustomers a choice of business models and cost structures to meet their drugdiscovery needs will help to strengthen our competitive advantage whileenabling us to maintain profit margins on our services. Organichem enables usto provide high-quality services across all phases of the pharmaceuticalresearch and development process, including the development of large-scalemanufacturing processes in accordance with regulatory guidelines and thesubsequent production of these compounds for clinical trials and commercialsale. Finally, we began to see an increase in the demand for early andmiddle-stage services in the second half of 2004, specifically in the areas ofdevelopmental and small-scale cGMP manufacturing services. We expect this trendof renewed focus on the discovery and development component of pharmaceuticalresearch and development to continue in 2005.

**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.

**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 includeisolation, purification, structure elucidation and the supply of samplecollection libraries from microbial and botanical sources, computationalchemistry, virtual screening, microbiology, fermentation, asymmetric synthesisand high throughput metabolic screening.

As part of our acquisition of New Chemical Entities inBothell, WA in January 2001, we acquired an extensive collection of over100,000 diverse compounds and natural product screening extracts. In February 2003,we obtained Eli Lilly and Co.’s collection of natural product assets includingsource materials, purified screening library samples, chemical analytical dataand chemistry database tools. As part of our collaboration with Eli Lilly wehave also significantly enhanced our biological screening capabilities. In January of2004 we completed the construction and equipping of a new high throughputscreening facility at our Bothell, WA location.

We seek to bundle our drug discovery technologies andscreening collections in a strategic alliance to cost effectively identify newdrug candidates with selected partners. As part of a strategic alliance wewould seek to leverage or bundle our natural product collections, naturalproduct chemistry, biological screening, biocatalysis, small moleculelibraries, computer aided drug design capabilities, medicinal chemistry, 

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combinatorial chemistry,optimization, and other chemistry capabilities. In return, we would expect toreceive a combination of fee for service, milestone and royalty payments basedon the success of the drug candidate.

We may also seek to sell or license our naturalproduct and chemical libraries, or subsets, to customers for near term revenuethrough a combination of fee for service, milestone and royalty terms.

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:

·       improvethe pharmacology, toxicology and efficacy or selectivity of chemical compoundsfor currently marketed drugs;

·       developlead extensions from unsuccessful Phase II or Phase III clinical trials;

·       improvesolubility and/or bioavailability of drug compounds;

·       createanalogs of potential lead compounds;

·       identifyactive metabolites;

·       widenpatent 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:

·       designand synthesis of potential lead compounds;

·       design,modify and synthesis of compounds to improve receptor binding and selectivity,enzyme inhibition and selectivity affording drug candidates with improvedpotency and pharmacokinetics;

·       developmentand synthesis of analogs of lead compounds 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, environmentallyunacceptable or present safety concerns. Our chemical development scientistsdesign novel or improved methods and processes suitable for medium to largescale production. Our chemical development scientists possess expertise in abroad range of structural classes of molecules and are able to address a widevariety of chemical synthesis and production problems. Chemical developmentservices that 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

·       developmentof practical purification 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

·       preparationof regulatory documentation, including chemistry manufacturing and controlsections of investigational new drug applications, new drug applications anddrug master files.

***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 substance 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 Organichem location isequipped to provide a wide range of custom chemical development andmanufacturing capabilities. Through Organichem, we conduct commercial cGMPmanufacturing of active pharmaceutical ingredients and advanced intermediates.Organichem’s large-scale cGMP manufacturing facilities provide synergieswith our small-scale development laboratories, offering our customersexcellence at every scale, from bench to production. In addition, Organichemprovides a number of highly specialized production capabilities, includingmanufacturing of highly potent and cytotoxic agents, purification usingcritical fluid technology, production of controlled substances, and cryogenicreaction capabilities. In January 2003 our focus on quality was reinforcedafter a successful FDA inspection of Organichem resulted in no issuances of Form FDA483 *Observations of Objectionable Conditionsand 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. The Company has spent $23.9 million, $22.5 million, and $7.1million on proprietary research and development activities in 2004, 2003, and2002, respectively. Research and development expenditures in 2004 included a$3.1 million non-cash charge related to the issuance of warrants toBristol-Myers Squibb (“BMS”) in exchange for one of BMS’ pre-clinical drugcandidates.

***Allegra/Telfast Licensing Agreement***

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 to Allegra/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, 2004, we have earned$7.4 million in milestone payments and $258.9 million in royaltiesunder this license agreement. Sanofi-Aventis is obligated under the licenseagreement to pay ongoing royalties to us based upon sales of Allegra/Telfast.We are not entitled, however, to receive any additional 

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milestonepayments under the license agreement. Sales of Allegra/Telfast worldwide wereapproximately $1.85 billion for the year ended December 31, 2004,$1.97 billion for the year ended December 31, 2003, and$1.92 billion for the year ended December 31, 2002. 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***

The Company’s large scalecGMP manufacturing activities at its Organichem subsidiary represent a distinctbusiness segment as defined by Statement of Financial Accounting Standards (“SFAS”)No. 131, “Disclosures about Segments of an Enterprise and RelatedInformation”. The Company’s remaining activities, including drug leaddiscovery, optimization, drug development, and small scale commercialmanufacturing represent a separate distinct business segment as defined by SFASNo. 131. See the notes to the consolidated financial statements forfinancial information on the Company’s business 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, 2004, contract revenue fromour three largest customers represented 38%, 6% and 4%, respectively, of ourcontract revenue. For the year ended December 31, 2003, contract revenuefrom our three largest customers respectively represented approximately 34%,10% and 6% of our contract revenue. For the year ended December 31, 2002,contract revenue from our three largest customers respectively representedapproximately 12%, 12% and 7% of our contract revenue. Our largest customer, GEBiosciences (formerly Amersham Health PLC), represented 38% of total contractrevenue for the year ended December 31, 2004. See Note 17 to theconsolidated financial statements for information on geographic and othercustomer 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 market our services directly to customers through targeted mailings,meetings with senior management of pharmaceutical and biotechnology companies,maintenance of an extensive Internet web site, participation in tradeconferences and shows, and advertisements in scientific and trade journals. Wealso receive a significant amount of business from customer referrals andthrough expansion of existing contracts.

***Employees***

We believe that the successful recruitment andretention of qualified Ph.D., masters and bachelor level scientists is a keyelement in achieving our strategic goals. We believe that as competitivepressures in the pharmaceutical and biotechnology industries increase, therecruitment and retention of chemists will become increasingly competitive. Inorder to meet this challenge, we actively recruit scientists at colleges and universities,through third-party recruitment firms and through contacts of ouremployees. We believe the sophisticated chemistry performed in the course ofour business will assist us in attracting and retaining qualified scientists.We offer competitive salaries and benefits to our scientists. As an incentivedirected toward the recruitment and retention of highly skilled scientists, wehave a program which provides that any scientist or scientists employed by usand named as an inventor on a patent not obtained in connection 

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with a customer contractwill receive a percentage of any net licensing, milestone and royalty revenuesreceived by us with respect to such patent. Under this program, Thomas E. D’Ambra,Ph.D., our Chairman, President and Chief Executive Officer, receives paymentsas the sole inventor on the patents for fexofenadine HCl. Dr. D’Ambraearned $4.8 million in 2004, $5.2 million in 2003, and$5.1 million in 2002 under this program.

As of February 1,2005, we had 805 employees. Organichem’s hourly work force of 107 employees iscovered by a collective bargaining agreement with the International ChemicalWorkers Union. A new 3-year collective bargaining agreement was signed inJanuary 2004 with the union and expires on January 10, 2007. None ofour other employees are covered by a collective bargaining agreement. Weconsider our relations with our employees and the union to be good.

***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 research departmentsof pharmaceutical companies, biotechnology companies, combinatorial chemistrycompanies, contract research companies, contract drug manufacturing companiesand research and academic institutions. Many of these competitors have greaterfinancial and other resources and more experience in research and developmentthan we do. Smaller companies may also prove to be significant competitors,particularly through arrangements with large corporate collaborators.

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,including overseas competitors, and as advanced technologies become available.We also anticipate increased foreign competition from Asia, India and EasternEurope and other low 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 patentsare issued, 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 whichconflict with one of ours, we may have to participate in interferenceproceedings declared by the 

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United States Patentand Trademark Office to determine priority of invention, which could result inthe loss of any opportunity to secure patent protection for the inventions andthe loss of any right to use the inventions. Even if the eventual outcome isfavorable to us, these proceedings could result in substantial cost to us. Thefiling and prosecution of patent applications, litigation to establish thevalidity and scope of patents, assertion of patent infringement claims againstothers and the defense of patent infringement claims by others can be expensiveand time consuming. We cannot assure you that in the event that any claims withrespect to any of our patents, if issued, are challenged by one or more thirdparties, that any court or patent authority ruling on such challenge willdetermine that such patent claims are valid and enforceable. An adverse outcomein such litigation could cause us to lose exclusivity afforded by the disputedrights. If a third party is found to have rights covering products or processesused by us, we could be forced to cease using the technologies covered by suchrights, could be subject to significant liability to the third party, and couldbe required to license technologies from the third party. Furthermore, even ifour patents are determined to be valid, enforceable, and broad in scope, wecannot assure you that competitors will not be able to design around suchpatents and compete with us and our licensees using the resulting alternativetechnology.

We have a policy of seeking patent protection forpatentable aspects of our proprietary technology. We have been issued thirteenUnited States patents, five New Zealand patents, seven Australian patents,three Canadian patents, three Norwegian patents, two Japanese patents, twoFinnish patents, two Irish patents, one South Korean patent, two Dutch patents,two Spanish patents, two Swiss patents, two British patents, two Swedishpatents, two Portuguese patents, two Monaco patents, two Italian patents, twopatents from Luxembourg, two Greek patents, two German patents, two Frenchpatents, two patents from Denmark, two Belgian patents, and one European patentcollectively covering fexofenadine HCl and certain related manufacturingprocesses. Subject to payment of government annuities and maintenance fees, ourUnited States patents expire between 2013 and 2015, our Canadian, European, andJapanese patents expire in 2014 and our New Zealand, South Korean, Irish,Dutch, Spanish, Swiss, British, Finnish, Swedish, Portuguese, Monaco, Italian,Luxembourg, Greek, German, French, Danish, Belgian, Australian and Norwegianpatents expire between 2014 and 2016. Additionally, we have been issued twoUnited States patents relating to Substituted Biaryl Purines as potentanticancer agents. Subject to payment of government annuities and maintenancefees, these patents expire in 2020 and 2021 respectively.

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

We may also enter into collaborations or otherarrangements whereby we retain certain ownership rights or may be entitled toreceive milestones and royalties with respect to proprietary technologydeveloped by us. On March 15, 2002, we signed an agreement with Bristol-MyersSquibb Company, or BMS, which included the transfer of ownership to us of threepatent applications related to Attention Deficit Hyperactivity Disorder, orADHD, and central nervous system indications were issued. In 2003, one of theUnited States patents applications relating to a series of aryl and heteroaryltetrahydroisoquinolines for these indications was issued. Subject to thepayment of government annuities and maintenance fees, this patent expires in2020. In connection with the 2002 agreement, in March 2004, we issuedwarrants to purchase up to 516,232 shares of our common stock to BMS. Weelected to retain ownership of the technology and all improvements made to dateby us, resulting in the issuance of the warrants to BMS. The issuance of thesewarrants satisfies all equity-related obligations to BMS and results in ourfull ownership of these preclinical drug candidates and related intellectualproperty. We intend to seek a third party licensee to develop this technology.Many of our other current contracts with our 

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customers provide thatownership of proprietary technology developed by us in the course of workperformed under the contract is vested in the customer, and we retain little orno 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 developsubstantially equivalent or better technology.

***Government Regulation***

The manufacture, transportation and storage of ourproducts are subject to certain international, Federal, state and local lawsand regulations. Our future profitability is indirectly dependent on the salesof pharmaceuticals and other products developed by our customers. Regulation bygovernmental entities in the United States and other countries will be asignificant factor in the production and marketing of any pharmaceuticalproducts that may be developed by our customers. The nature and the extent towhich such regulation may apply to our customers will vary depending on thenature of any such pharmaceutical products. Virtually all pharmaceuticalproducts developed by our customers will require regulatory approval bygovernmental agencies prior to commercialization. Human pharmaceutical productsare subject to rigorous preclinical and clinical testing and other approvalprocedures by the FDA and by foreign regulatory authorities. Various federaland, in some cases, state statutes and regulations also govern or influence themanufacturing, safety, labeling, storage, record keeping and marketing of suchpharmaceutical products. The process of obtaining these approvals and thesubsequent compliance with appropriate federal and foreign statutes andregulations are time consuming and require the expenditure of substantialresources.

Generally, in order to gain FDA approval, a companyfirst must conduct preclinical studies in the laboratory and in animal modelsto gain preliminary information on a compound’s efficacy and to identify anysafety problems. The results of these studies are submitted as a part of aninvestigational new drug application, or IND, that the FDA must review beforehuman clinical trials of an investigational drug can start. In order tocommercialize any products, we or our customer will be required to sponsor andfile an IND and will be responsible for initiating and overseeing the clinicalstudies to demonstrate the safety and efficacy that are necessary to obtain FDAapproval of any such products. Clinical trials are normally done in threephases and generally take two to seven years, but may take longer, to complete.After completion of clinical trials of a new product, FDA and foreignregulatory authority marketing approval must be obtained. If the product isclassified as a new drug, we or our customer will be required to file anew drug application, or NDA, and receive approval before commercial marketingof the drug. The testing and approval processes require substantial time,effort and expense, and we cannot assure you that any approval will be grantedon a timely basis, if at all. NDAs submitted to the FDA can take several yearsto obtain approval. Even if FDA regulatory clearances are obtained, a marketedproduct is subject to continual review. Later discovery of previously unknownproblems or failure to comply with the applicable regulatory requirements mayresult in restrictions on the marketing of a product or withdrawal of theproduct from the market as well as possible civil or criminal sanctions. Formarketing outside the United States, we will also be subject to foreignregulatory requirements governing human clinical trials and marketing approvalfor pharmaceutical products. The requirements governing the conduct of clinicaltrials, product licensing, pricing and reimbursement vary widely from countryto country.

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All facilities and manufacturing techniques used inthe manufacture of products for clinical use or for sale in the United Statesmust be operated in conformity with cGMP guidelines as established by the FDA.Our facilities are subject to scheduled periodic regulatory inspections toensure compliance with cGMP requirements. Failure on our part to comply withapplicable requirements could result in the termination of ongoing research orthe disqualification of data for submission to regulatory authorities. Afinding that we had materially violated cGMP requirements could result inadditional regulatory sanctions and, in severe cases, could result in a mandatedclosing of our facilities or significant fines, which would materially andadversely affect our business, financial condition and results of operations.

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.

***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, free of charge, on ourwebsite our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the SecuritiesExchange Act of 1934, as amended, as soon as reasonable practicable after suchreports are electronically filed with, or furnished to, the SEC. Our reportfiled with, or furnished to, the SEC are also available at the SEC’s website at*www.sec.gov*.

**ITEM 2.**                PROPERTIES.

Ourprincipal manufacturing and research and development facilities are located inthe United States. The aggregate square footage of our operating facilities isapproximately 729,000 square feet, of which 458,400 square feet are owned and271,000 square feet are leased. Set forth below is information on our principalfacilities:
| **Location**             | ** ** | ** ** | ** ** | **Square Feet**                                                    | ** ** | **Primary Purpose** |
|--------------------------|------------|------------|------------|--------------------------------------------------------------------|------------|---------------------|
| Albany, New York         |       | 266,000    |       | Manufacturing,  Research & Development and Administration |
| East Greenbush, New York |       | 64,000     |       | Manufacturing &  Research & Development          |
| Rensselaer, New York     |       | 251,400    |       | Manufacturing &  Research & Development          |
| Mt. Prospect, Illinois   |       | 88,000     |       | Held for Sale                                                      |
| Syracuse, New York       |       | 28,000     |       | Manufacturing &  Research & Development          |
| Bothell, Washington      |       | 32,000     |       | Research & Development                                    |

 

We consider thesefacilities to be in good condition and suitable for their purpose. The capacityassociated with these facilities is adequate to meet our anticipated needsthrough 2005.

**ITEM 3.**                LEGAL PROCEEDINGS.

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 

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Company, would eitherindividually or in the aggregate have a material adverse effect on the Company’sbusiness, financial condition, results of operations or cash flows.

AMR Technology, a subsidiary of the Company, alongwith Aventis Pharmaceuticals Inc., a 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 or licensed to 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., Sandoz, Inc.and Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc., assertinginfringement of two of our U.S. patents that are exclusively licensed toAventis Pharmaceuticals relating to Allegra and Allegra-D products.

In the pending litigations, Aventis Pharmaceuticalsand AMR Technology have also entered into covenants not to sue the defendantsunder U.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 Aventis Pharmaceuticals willcontinue to pay royalties to us based on that patent under our original licenseagreement with Aventis Pharmaceuticals. Under our arrangements with AventisPharmaceuticals, we will receive royalties until expiration of the underlyingpatents (2013 for U.S. Patent No. 5,578,610 and 2015 for U.S. Patent No. 5,750,703)unless the patents are earlier determined to be invalid.

Under applicable federal law, marketing of an FDA-approvedgeneric version of Allegra may not commence until the earlier of a decisionfavorable to the generic challenger in the patent litigation or 30 months afterthe date the patent infringement lawsuit was filed. In general, the firstgeneric filer is entitled to a 180-day marketing exclusivity period uponFDA approval.

Should the Company beunsuccessful in defending these patents we would experience a material decreasein operating cash flows.

**ITEM 4.**                SUBMISSION OFMATTERS 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 AND RELATED STOCKHOLDER MATTERS.

(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, 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    |       |
| Year ended  December 31, 2003  |       |       |       |     |       |
| First Quarter                       |       | $          | 17.94      |     | $          | 12.95   |       |
| Second Quarter                      |       | $          | 15.35      |     | $          | 10.97   |       |
| Third Quarter                       |       | $          | 16.56      |     | $          | 13.46   |       |
| Fourth Quarter                      |       | $          | 15.26      |     | $          | 13.03   |       |

 

(b)   Holders.   Thenumber of record holders of our Common Stock as of February 18, 2005 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 agreements governingdebt 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 is 5.5years. The issuance of these warrants results from a 2002 agreement whereby BMStransferred intellectual property to us, providing us with ownership of one ofBMS’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, 2004:
| **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)  |       |       | 2,814,110  |                                                                                                                                                  |       |                                                                                                             | $          | 19.76                                                                                                                                                                                                             |       |   |   | 1,704,426 |   |   |
| Equity  compensation plans not approved by security holders |       |       | —     |                                                                                                                                                  |       |                                                                                                             | —     |                                                                                                                                                                                                              |       |   | — |   |   |
| Total                                                       |       |       | 2,814,110  |                                                                                                                                                  |       |                                                                                                             | $          | 19.76                                                                                                                                                                                                             |       |   |   | 1,704,426 | (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)          Includes1,265,639 shares available for the Stock Option Plan and 438,787 sharesavailable for the ESPP.

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**ITEM 6**.                SELECTEDFINANCIAL DATA.

Theselected financial data shown below for the fiscal years ended December 31,2004, 2003, and 2002 and as of December 31, 2004 and 2003, 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 31,2001 and 2000 and as of December 31, 2002, 2001 and 2000 have been derivedfrom our audited financial statements for those years, which are not includedin this Form 10-K. All share and per share amounts have been adjusted forstock splits. The information should be read in conjunction with the Company’saudited consolidated financial statements and related notes and other financialinformation included herein, including Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations”.
| ** **                                          | ** ** | **As of and for the Year Ending December 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                                                               | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                          | ** ** | **(in thousands, except per share data)**                     | ** ** |
| **Consolidated  Statements of Income Data:**        |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Contract Revenue                                    |       | $                                                                                      | 121,554    |   | $ | 144,667 |   | $ | 71,688 |   | $ | 60,334 |   | $ | 39,874 |   |
| Recurring Royalties                                 |       | 47,973                                                                                 |       | 51,682 |   | 51,139 |   | 41,675 |   | 29,226 |   |
| Total  Revenue                                      |       | 169,527                                                                                |       | 196,349 |   | 122,827 |   | 102,009 |   | 69,100 |   |
| Cost of Contract Revenue                            |       | 96,932                                                                                 |       | 101,753 |   | 41,313 |   | 34,946 |   | 23,356 |   |
| Write-down of library inventories                   |       | 5,974                                                                                  |       | — |   | — |   | — |   |   |   |
| Total  cost of contract revenue                     |       | 102,906                                                                                |       | 101,753 |   | 41,313 |   | 34,946 |   | 23,356 |   |
| Technology incentive award                          |       | 4,789                                                                                  |       | 5,183 |   | 5,107 |   | 4,165 |   | 2,921 |   |
| Research and development                            |       | 23,887                                                                                 |       | 22,466 |   | 7,096 |   | 4,290 |   | 2,435 |   |
| Selling, general and administrative                 |       | 22,812                                                                                 |       | 20,318 |   | 12,897 |   | 12,194 |   | 7,966 |   |
| Property and equipment impairment                   |       | 4,728                                                                                  |       | — |   | — |   | — |   | — |   |
| Goodwill impairment                                 |       | 14,494                                                                                 |       | — |   | — |   | — |   | — |   |
| Intangible asset impairment                         |       | 3,541                                                                                  |       | — |   | — |   | — |   | — |   |
| Restructuring charge                                |       | 1,184                                                                                  |       | — |   | — |   | — |   | — |   |
| Total  costs and expenses                           |       | 178,341                                                                                |       | 149,720 |   | 66,413 |   | 55,595 |   | 36,678 |   |
| Income (loss) from operations                       |       | (8,814                                                                                 | )          | 46,629 |   | 56,414 |   | 46,414 |   | 32,422 |   |
| Equity in loss of unconsolidated affiliates         |       | (65                                                                                    | )          | (372 | ) | 2,795 |   | 1,130 |   | 552 |   |
| Interest (expense) income, net                      |       | 317                                                                                    |       | 785 |   | 3,108 |   | 6,650 |   | 4,521 |   |
| Minority interest in consolidated subsidiaries      |       | —                                                                                 |       | 133 |   | — |   | — |   | — |   |
| Loss on equity investment                           |       | (1,274                                                                                 | )          | — |   | — |   | — |   | — |   |
| Other income, net                                   |       | (18                                                                                    | )          | 403 |   | 93 |   | 127 |   | 187 |   |
| Income (loss) before income tax expense             |       | (9,854                                                                                 | )          | 47,578 |   | 62,410 |   | 54,321 |   | 37,682 |   |
| Income tax expense                                  |       | 1,837                                                                                  |       | 16,714 |   | 22,686 |   | 19,707 |   | 14,089 |   |
| Net income (loss)                                   |       | $                                                                                      | (11,691    | ) | $ | 30,864 |   | $ | 39,724 |   | $ | 34,614 |   | $ | 23,593 |   |
| Basic earnings (loss) per share                     |       | $                                                                                      | (0.37      | ) | $ | 0.97 |   | $ | 1.22 |   | $ | 1.05 |   | $ | 0.78 |   |
| Diluted earnings (loss) per share                   |       | $                                                                                      | (0.37      | ) | $ | 0.95 |   | $ | 1.19 |   | $ | 1.01 |   | $ | 0.74 |   |
| Weighted average common shares outstanding, basic   |       | 31,627                                                                                 |       | 31,880 |   | 32,632 |   | 33,065 |   | 30,363 |   |
| Weighted average common shares outstanding, diluted |       | 31,627                                                                                 |       | 32,366 |   | 33,309 |   | 34,154 |   | 32,063 |   |
| **Consolidated Balance Sheet Data:**                |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and investments              |       | $                                                                                      | 133,749    |   | $ | 124,628 |   | $ | 129,537 |   | $ | 135,865 |   | $ | 152,024 |   |
| Property and equipment, net                         |       | 145,753                                                                                |       | 146,639 |   | 72,518 |   | 59,756 |   | 30,914 |   |
| Working Capital                                     |       | 179,765                                                                                |       | 174,609 |   | 163,133 |   | 155,276 |   | 161,335 |   |
| Total assets                                        |       | 376,892                                                                                |       | 390,945 |   | 302,736 |   | 284,059 |   | 238,566 |   |
| Long-term debt, less current maturities             |       | 48,603                                                                                 |       | 53,129 |   | 5,281 |   | 5,930 |   | 120 |   |
| Total stockholder’s equity                     |       | 295,476                                                                                |       | 301,935 |   | 282,147 |   | 263,761 |   | 228,533 |   |
| **Other  Consolidated Data:**                       |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                |       | $                                                                                      | 23,716     |   | $ | 30,554 |   | $ | 17,387 |   | $ | 21,155 |   | $ | 16,525 |   |

 

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

**Overview**

We are a leading 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 in returnfor up-front service fees and milestone payments as well as recurring royaltypayments if these compounds are developed into new commercial drugs. In 1995,our proprietary research and development activities led to the development,patenting and licensing of a substantially pure form of, and a manufacturingprocess for, the active ingredient in the non-sedating antihistaminefexofenadine HCl marketed by Sanofi-Aventis S.A. as Allegra in the Americas andas Telfast elsewhere. In addition, certain of our discovery technologycontracts provide for us to receive milestone and royalty payments fordiscoveries that lead to commercial products.

Our total revenue for 2004was $169.5 million, including $121.5 million from our chemistrycontract business and $48.0 million revenue from our royalties on sales ofAllegra. During 2004 we performed work for more than 200 customers, including28 new customers. We generated $36.6 million in cash from operations andspent $23.7 million in capital on our facilities and equipment, primarilyrelated to the expansion of our manufacturing suites at Organichem. We recordeda net loss of $11.7 million in 2004, including $18.0 million of goodwill andintangible asset impairment, library inventory impairment of $6.0 million,property and equipment impairment of $4.7 million, warrant issuance costs of$3.1 million, a loss on an equity investment of $1.3 million, and arestructuring charge of $1.2 million. As of December 31, 2004, we had$133.7 million in cash, cash equivalents and investments and$53.1 million in bank and other related debt, carrying a blended interestrate of approximately 3.05%.

*Strategy*

We continue to execute a long-term strategy to growour platform chemistry services business while leveraging our proprietary technologiesand capabilities to provide greater value to our customers and further growthfor the company. We have enhanced our chemistry service offerings with theaddition of our high throughput screening expertise and technologies, theaddition of Eli Lilly and Co.’s natural product collection, the launch of oursemi-exclusive synthetic chemical libraries, and the completion of our diversechemical sample collection. We believe that the pharmaceutical industry isplacing more emphasis on the quality and content of compound libraries andtheir related screening versus the quantity of the compounds. We have alsoenhanced our service offerings with the addition of certain physical chemistryservices to evaluate polymorphic forms and crystal habits and to evaluate saltselection for potential new drug candidates.

The 2003 acquisition of Organichem strategicallypositions us to offer high quality clinical trial and large scale cGMPcommercial production capabilities for our customers, as well as expertise inhigh potency and controlled drug substance manufacturing which provide higherprofit margins. We realized strategic benefits from our 2003 acquisition ofOrganichem by successfully transitioning several of our customers’ clinicalsupply manufacturing projects from our smaller scale chemistry laboratoriesinto the facilities of Organichem. Organichem’s largest customer, GEBiosciences, is expected to discontinue purchases of one of the products thatwe sell to them by the third quarter of 2005. Sales of this product 

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totaled $18.1 million,which represents 27% of Organichem’s 2004 revenue and 15% of total contractrevenue for the year ended December 31, 2004. We expect GE Biosciences’ remainingpurchases of this product to all occur in the first half of 2005 and to decreaseby 15% from 2004 levels, with no revenues associated with this product after2005. Our objective is to recoup the revenues associated with these salesdecreases through increased sales of another product to GE Biosciences, as wellas continued growth in the area of clinical supply manufacturing for advancedstage human trials. We will continue to seek opportunities to add services andtechnologies that add value to our customers. We are also evaluatingopportunities to leverage our large-scale cGMP production facilities atOrganichem, including identifying niche products to manufacture and sell aswell as assessing complementary lines of business that support cGMP production.

We continue to advance our proprietary technologiesand programs with the goal to generate licensing or other revenueopportunities. Our most near-term licensing opportunity relates to intellectualproperty transferred to us from BMS. The intellectual property provides us withownership of one of BMS’s pre-clinical drug candidates, along with patentapplications covering attention deficit hyperactivity disorder (ADHD) and othercentral nervous system indications. While we continue to invest in thisprogram, we are also in discussions to license this technology in exchange fora combination of up-front license fees, milestones and royalty payments. Weexpect to make a significant additional investment in this program in 2005 witha view to finalizing the selection of a compound or compounds with respect towhich we expect to subsequently file an Investigative New Drug (IND)application with the United States Food and Drug Administration (FDA) for thepurpose of commencing human clinical trials. We also continue to utilize ourproprietary technologies, including our biocatalysis and natural productcapabilities, to further advance other early stage internal research programsin the fields of oncology, immunosuppresion and inflammation. We have initiatedan internal screening program to screen our own chemical and natural productcollections with the goal of generating lead candidates. If successful, wewould seek a licensing partner at an appropriate research or developmentalstage.

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 discovery activities,performance of lead optimization and pre-clinical testing, and large-scalemanufacturing for clinical trials and commercial sale if the product meetsregulatory approval. Under these comprehensive agreements, companies typicallyreceive a combination of fees for performance and delivery of goods andservices, as well as milestone and royalty payments should collaborativeefforts lead to the discovery of new products that reach the market.

The business environment for chemistry outsourcingcontinues to be challenging. Our customers remained under budgetary pressuresand continued to spend a greater portion of their research and developmentdollars on later stage development projects in 2004. In addition, in certainareas of our business there has been a significant increase in foreigncompetition that has substantially lower cost structures. The lower coststructures result from parts of the world where salaries are a fraction of whatthey are in industrialized countries. This trend has resulted in pricingpressures in the U.S. and is impacting our ability to increase or maintainpricing on our customer contracts. We expect the increase in competition fromlower cost locations, such as Asia and India, to continue. We are pursuing aplan to establish lower-cost foreign operations in Singapore and India, andexpect to commence operations in these locations in 2005. We believe theability to offer customers a choice of business models and cost structures tomeet their drug discovery needs will help to strengthen our competitiveadvantage while enabling us to maintain profit margins on our services. Weexpect the trend of increased demand for our chemical development and earlystage cGMP manufacturing that began in 2004 to continue through 2005.

The competitive environment facing Allegra alsoremained challenging during the past year. The marketing of Claritin as an OTCdrug, the subsequent marketing of generic alternatives to Claritin, and 

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health maintenanceorganization (HMO) programs attempting to direct consumers towards OTCantihistamines, resulted in a 6% decrease in sales of Allegra compared to theprior year. Given the absence of guidance from Sanofi-Aventis, we haveincorporated in our earnings guidance up to a 10% decline in royalty revenuesfor 2005.

The recurring royalties wereceive on the sales of Allegra/Telfast have historically provided a materialportion of our operating cash flows. 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. Shouldwe or Aventis be unsuccessful in defending these patents we would experience amaterial decrease in operating cash flows.

*Mt. ProspectRestructuring and Impairments*

We continue to control our costs and seekopportunities to improve overall operating margins. As part of this process, onMay 4, 2004 we announced our restructuring plan to consolidate operationsby relocating our Mt. Prospect operations to our facilities in New York. AMRI’sproprietary biocatalysis technology platform, drug metabolism screening,research fermentation and chemical development technologies in Mt. Prospectwere relocated to New York and continue to be fully integrated with AMRI’s drugdiscovery and development technologies. The consolidation of these technologiesresulted in the closure of the Mt. Prospect Research Center during the fourthquarter of 2004. The consolidation was initiated as a result of a lack ofanticipated growth in the Company’s chemical development services at thefacility. As a result of the restructuring, 33 employees were terminated and 25employees were relocated to facilities in New York.

During 2004 we incurred restructuring costs related tothe Mt. Prospect Research Center restructuring totaling $1.2 million, primarilyrelated to termination benefits and asset disposal costs. We also incurred $1.4million in costs related to the relocation of employees and equipment from Mt.Prospect to Albany, which are included in selling, general, and administrativeexpenses on the consolidated statement of income. We also recorded a $1.6million impairment charge in the second quarter of 2004, in accordance with theprovision of SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets” (SFAS 144). This impairment charge was required towrite-down the carrying value of the Mt. Prospect facility and relatedmachinery and equipment to its estimated fair value.

Our decision to close the Mt. Prospect facility andconsolidate operations in New York, along with the impairment chargesrecognized in connection with our assessment of the impairment of the Mt.Prospect property and equipment, were considered triggering events under SFAS142, “Goodwill and Other Intangible Assets” (SFAS 142). Accordingly, weconducted a goodwill impairment review as required under SFAS 142 as of June 30,2004 and concluded that an impairment of the goodwill at the Mt. Prospectreporting unit had occurred as of that date. We****recordeda $1.2 million goodwill impairment charge based upon a valuation of thereporting unit prepared by an independent valuation advisor using a discountedcash flow approach.

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. The long-livedassets associated with Mt. Prospect have been segregated to a separate lineitem on the consolidated balance sheet until they are sold and depreciationexpense has ceased respective to those assets. We anticipate that as a resultof this restructuring, we will experience annual expense savings up to $5.0million starting in 2005 resulting from a reduction in facility and laborcosts, however, these cost savings will be offset by increases in cost relatedto the start-up of our offshore operations.

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*Bothell LibraryInventory Write-Off and Asset Impairment*

In connection with the preparation of our results ofoperations for the quarter ended June 30, 2004, we completed an in-depthreview of the carrying value of our library inventories. As previously disclosed,we made certain investments in 2003 which we believed would enhance our abilityto market and sell our natural product libraries and achieve certain revenuetargets. We also disclosed that if we were not able to successfully executeagainst our business plan within certain time constraints, including theachievement of revenue targets, or if market conditions were less favorablethan those projected by management, we might be required to write-down thevalue of certain library assets and related goodwill and intangible assets.After investing in expanded marketing and sales efforts, we were not able toachieve any sales or signed purchase commitments for our natural productlibraries during the six months ended June 30, 2004. As a result of ourreview, we recorded a reserve of $6.0 million to reduce the carrying value ofour inventories. The reduction in the carrying value of our library inventoriesreflects the 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****continueto monitor the carrying value of our remaining natural product and lead findingsample collections for impairment. If we are unable to meet forecasted revenuesrelated to those assets or if actual market conditions are less favorable thanthose projected, we may be required to write-down all or a portion of theremaining value of certain compound library assets (totaling $3.7 million at December 31,2004), resulting in a charge to operations.

In connection with our reduction in carrying value ofnatural product inventories, we also performed an assessment of the carryingvalue of our microbial cultures and related technologies. The microbialcultures and related technologies are the starting materials and technologyused in the development of the natural product libraries and therefore would beused to make incremental copies of the natural product libraries. Based on our****assessment, we concluded that the carrying value of themicrobial cultures and related technologies was not recoverable, andaccordingly recorded an impairment charge of $3.5 million representing theentire remaining carrying value of microbial cultures and related technologies.

We determined that the reduction in the carrying valueof the Bothell library inventories was a triggering event under SFAS 144. Basedon the results of our SFAS 144 analysis, we also recorded a $3.1 millionreduction in the fair value of our property and equipment at Bothell based upona valuation of these assets utilizing the assistance of an independentvaluation advisor.

We determined that thewrite-down of the inventory, microbial cultures, and property and equipment atBothell were triggering events under SFAS 142 and that the carrying value ofour goodwill at the Bothell reporting unit may be impaired. Accordingly, we****conducted a goodwill impairment review as required underSFAS 142 as of June 30, 2004 and concluded that an impairment had occurredwhich resulted in a $13.3 million goodwill impairment charge. In calculatingthe goodwill impairment charge, the fair value of the Bothell reporting unitwas determined with the assistance of an independent valuation advisor using adiscounted cash flow valuation approach. Significant assumptions used in thisanalysis include (i) expected future revenue growth rates, reporting unitprofit margins, and working capital levels, (ii) a discount rate, and (iii) aterminal value multiple. The revenue growth rates, working capital levels andreporting unit profit margins were based on management’s best estimate offuture results.

*Warrant Issuance*

In March 2004, weissued warrants to purchase up to 516,232 shares of our common stock, withexercise prices ranging from $30.24 to $35.24 to Bristol-Myers Squibb Company(BMS). The exercise period for these warrants is 5.5 years. The issuance ofthese warrants results from a 2002 agreement whereby BMS transferredintellectual property to us, providing us with ownership of one of BMS’s preclinicaldrug candidates, along with patent applications covering attention deficithyperactivity disorder (ADHD) and central nervous system indications. Inconnection with the agreement, in March 2004, we 

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electedto retain ownership of the technology and all improvements made to date by us,resulting in the issuance of the warrants to BMS. The issuance of thesewarrants satisfies all equity-related obligations to BMS and results in ourfull ownership of these preclinical drug candidates and related intellectualproperty. Such warrants, which had a value of $3.1 million on the date ofissuance, were charged to research and development costs with a correspondingcredit to stockholders’ equity during the period ended March 31, 2004. Thevalue of warrants issued was determined using the Black-Scholes option-pricingmodel.

*Equity InvestmentImpairment*

In 2003, we receivedwarrants, valued at $1.3 million, to purchase preferred equity in a privatelyowned drug discovery company. We are accounting for this investment under thecost method as we do not exert significant influence in the company. Thisinvestment was included in investment in unconsolidated affiliates on theconsolidated balance sheet. We assess the fair value of this investmentquarterly or whenever events or changes in circumstance indicate that theinvestment value may not be recoverable. In the fourth quarter of 2004, thisentity attempted to raise additional financing in order to fund its operations,but was unable to secure such financing on acceptable terms. As such, weperformed an assessment of the carrying value of our investment based on ananalysis of the investment’s current financial condition, its prospects ofgenerating additional cash flow from operating activities, the current market conditionsfor raising capital funding for companies in this industry and the likelihoodthat any funding raised would significantly dilute our ownership percentage. Asa result of this analysis it was our judgment that an other-than-temporaryimpairment had occurred and that the fair value of our investment was zero,resulting in a non-cash loss on investment of $1.3 million.

**Results ofOperations**

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 includethe results for Organichem. During 2002, we included our proportionate share ofOrganichem’s net income in our income statement as equity in income ofunconsolidated affiliates.

*Operating SegmentData*

We have organized oursales, marketing and production activities into the Albany Molecular Research(AMR) and Organichem segments based on the criteria set forth in SFAS No. 131,‘‘Disclosures about Segments of an Enterprise and Related Information.’’ Werely on an internal management accounting system to report results of thesesegments. The accounting system includes revenue and cost information bysegment. We make financial decisions and allocate resources based on theinformation it receives from this internal system. The AMR segment includesactivities such as drug lead discovery, optimization, drug development andsmall scale manufacturing. The Organichem segment includes pilot to commercialscale manufacturing of active pharmaceutical ingredients and intermediates andhigh potency and controlled substance manufacturing all of which are incompliance with the Food and Drug Administration’s (FDA) current GoodManufacturing Practices, or cGMP.

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*Contract Revenue*

Contractrevenue consists primarily of fees earned under contracts with third-partycustomers. Our contract revenues for each of our AMR and Organichem segmentswere as follows:
| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** ** | ** ** | **(in 000’s)**                        | ** ** |
| AMR        |       | $ 53,488                              |       | $ 65,600 |   | $ 71,688 |   |
| Organichem |       | 68,066                                     |       | 79,067 |   | — |   |
| Total      |       | $ 121,554                             |       | $ 144,667 |   | $ 71,688 |   |

 

Contract revenue for AMR for 2004 was $53.5 million, adecrease of 18% compared to contract revenue of $65.6 million in 2003. Thereduction in our contract services was attributable to continued offshorecompetition, pricing pressures and reductions in chemistry spending bypharmaceutical and biotechnology companies, primarily in our discovery servicesarea. We see the trends of offshore competition and pricing pressurescontinuing, and we have pursued strategiesto establish lower-cost foreign operations in Singapore and India, and expectto commence operations in these locations in 2005. While the revenue from ouroffshore operations is not expected to be material to consolidated contractrevenue in 2005, we believe the ability to offer customers a choice of businessmodels and cost structures to meet their drug discovery needs will help tostrengthen our competitive advantage. We expect the trend of increased demand forour development and small scale manufacturing services that began in the secondhalf of 2004 to continue through 2005, with flat demand for discovery services.

Contract revenue at Organichem declined by $11million, or 14% to $68.1 million in 2004 compared to $79.1 million in 2003. Thedecline in contract revenue was primarily attributable to a decrease in revenuefrom its second largest customer due to the timing of delivery requirementsfrom this customer. This decrease was partially offset by an increase in demandfor clinical supply manufacturing for advanced stage human trials. Organichem’s largest customer, GE Biosciences, isexpected to discontinue purchases of one of the products that we sell to themby the third quarter of 2005. Sales of this product totaled $18.1 million,which represents 27% of Organichem’s 2004 revenue and 15% of total contractrevenue for the year ended December 31, 2004. We expect GE Biosciences’remaining purchases of this product to all occur in the first half of 2005 and todecrease by 15% from 2004 levels, with no revenues associated with this productafter 2005. Our objective is to recoup the revenues associated with these salesdecreases through increased sales of another product to GE Biosciences, as wellas continued growth in the area of clinical supply manufacturing for advancedstage human trials.

Contract revenue for AMRfor 2003 was $65.6 million, a decrease of 8% compared to contract revenueof $71.7 million in 2002. 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 2003. Contractrevenue at Organichem declined by $7.2 million, or 8% to$79.1 million in 2003 compared to 2002. The decline in contract revenuewas attributable to soft demand from our customers due to a weak economicenvironment.

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*Recurring Royalties*

We earned royalties underour licensing agreement with Sanofi-Aventis S.A. for the active ingredient inAllegra/Telfast. Royalties were as follows:

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**                    | ** ** |
| $47,973                                |       | $51,682 |   | $51,139 |   |

 

Recurring royalties decreased 7% to $48.0 million forthe year ended December 31, 2004 from $51.7 million for 2003. The decreaseis primarily attributable to decreased sales of Allegra/Telfast by Sanofi-Aventis,due to over-the-counter competition from Allegra’s primary competitor,Claritin. The marketing of Claritin as an over-the-counter (OTC) drug, thesubsequent marketing of generic alternatives to Claritin, and healthmaintenance organization (HMO) programs attempting to direct consumers towardsOTC antihistamines, contributed to the decline in royalties. We expect OTCcompetition from Claritin to continue in 2005, as well as increased competitionfrom the introduction of new prescription antihistamines into the United Statesmarket. As such, we expect as much as a 10% decline in royalty revenues in2005.

Recurring royalties forthe year ended December 31, 2003 increased 1% to $51.7 million, comparedto $51.1 million for 2002. The increase was attributable to increased sales andmarket share of Allegra/Telfast by Sanofi-Aventis.

*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 AMR and Organichem segments were as follows:
| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **               | ** ** | **(in 000’s)**                   | ** ** |
| AMR                      |       | $ 51,186                              |       | $ 42,962 |   | $ 41,313 |   |
| Organichem               |       | 51,720                                     |       | 58,791 |   | — |   |
| Total                    |       | $ 102,906                             |       | $ 101,753 |   | $ 41,313 |   |
| AMR Gross Margin         |       | 4.3                                        | %          | 34.5 | % | 42.3 | % |
| Organichem Gross  Margin |       | 24.0                                       | %          | 25.6 | % | — |   |
| Total Gross  Margin      |       | 15.3                                       | %          | 29.7 | % | 42.3 | % |

 

AMR had a contract revenue gross margin of 4.3% forthe year ended December 31, 2004, compared to 34.5% for the same period in2003. The decline in gross margin largely resulted from the write-down of ournatural product and chemical library inventories of $6.0 million and $1.6million in additional raw material inventory write-downs, as well as thedecline in contract revenues in relation to the fixed cost components of AMR’scontract business. In addition, we recorded $0.6 million of amortization on ourchemical library inventories during 2004. We expect AMR’s contract revenuegross margin to improve in 2005 due to a reduction in inventory charges, slightincreases in contract revenues, and the recognition of cost savings due to theclosure of Mount Prospect,****partiallyoffset by an expected increase in library inventory amortization, start-upcosts for our off-shore operations and the recognition of compensation expensefor stock options in 2005.

Organichem’s contract revenue gross margin decreasedto 24.0% for the year ended December 31, 2004 compared to 25.6% for thesame period in 2003. The decline in gross margin is due primarily to the 

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decline in production andsales volume in relation to the fixed cost components of Organichem’s contractbusiness. While we expect increased revenues at Organichem in 2005, grossmargins are expected to continue to be under pressure.

For the year ended December 31,2003, cost of contract revenue for AMR increased $1.7 million from 2002due primarily to increased salary and related benefit costs for our scientificstaff. AMR’s contract revenue margin was 35% for the year ended December 31,2003 compared to 42% for 2002. The decrease in AMR’s contract revenue marginwas due to lower overhead absorption resulting from decreased contractrevenues. Organichem’s contract revenue margin increased to 26% in 2003 from24% in 2002 as a result of cost reduction programs and synergies related to theacquisition. Included in Organichem’s cost of contract revenue in 2003 was$1.0 million in purchase accounting expenses related to an increase in thevalue of inventories acquired in the acquisition.

*TechnologyIncentive Award*

Wemaintain a Technology Development Incentive Plan designed to stimulate andencourage novel technology development by our employees. This plan allows eligibleparticipants to share in a percentage of the net revenue earned by us relatingto patented technology with respect to which the eligible participant is namedas an inventor. Under our Technology Development Incentive Plan, Thomas E. D’Ambra,our Chairman, President and Chief Executive Officer, receives payments as thesole inventor of the patents for fexofenadine HCl equal to 10% of the totalpayments received by us with respect to those patents. The incentive award wasas follows:

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**               | ** ** |
| $4,789                                 | ** ** | $5,183 |   | $5,107 |   |

 

The technology incentive award expense incurred underour Technology Development Incentive Plan decreased 8% to $4.8 million for theyear ended December 31, 2004, compared to $5.2 million for 2003. Thedecrease was directly attributable to the decrease in Allegra royalties in 2004.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 Planincreased 1% to $5.2 million for the year ended December 31, 2003,compared to $5.1 million for 2002. The increase was directly attributable tothe increase in Allegra royalties in 2003 compared to 2002.

*Research and Development*

Research and developmentexpense consists of compensation and benefits for scientific personnel for workperformed on proprietary technology development, research projects, costs ofchemicals and other out-of-pocket costs and overhead costs. We utilizeour expertise in small molecule chemistry, biocatalysis and natural products toperform our internal research and development projects. The goal of theseprograms is to discover new compounds with commercial potential. We would thenseek to license these compounds to a third party in return for a combination ofup-front license fees, milestone payments and recurring royalty payments ifthese compounds are successfully developed into new drugs and reach the market.In addition, research and development is performed at Organichem relatedto the improvement of

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productionprocesses as well as research related to the potential manufacture of newproducts. Research and development expenses were as follows:

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**               | ** ** |
| $23,887                                |       | $ 22,466 |   | $ 7,096 |   |

 

Research and development expenses increased 6% to$23.9 million for the year ended December 31, 2004 from $22.5 million for2003. The increase is primarily attributable to $3.1 million in expensesrecorded for the issuance of warrants to purchase shares of the Company’scommon stock to Bristol-Myers Squibb (BMS) in the first quarter of 2004. Thewarrants were issued in conjunction with an agreement whereby BMS transferredintellectual property related to preclinical drug candidates and patentapplications covering attention deficit hyperactivity disorder (ADHD) andcentral nervous system applications to the Company. The increase was partiallyoffset by a decrease in costs associated with the design, research, and testingof the Company’s semi-exclusive libraries. Research and development expensesare expected to decrease in 2005 due to the elimination of warrant issuancecosts, and the redeployment of scientific personnel from semi-exclusive librarydesign and other internal research program initiatives to customer projects.

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 is our most advancedopportunity to generate revenue, and we expect that a significant portion ofour 2005 research and development costs will be incurred in the furtherdevelopment of this project. Weexpect to make a significant additional investment in this program in 2005 witha view to finalizing the selection of a compound or compounds with respect towhich we expect to subsequently file an Investigative New Drug (IND)application with the United States Food and Drug Administration (FDA) forpurposes of commencing human clinical trials. While we continue to invest inthis program, we are also in discussions to license this technology in exchangefor a combination of up-front license fees, milestones and royalty payments. Inaddition to our central nervous system program, the Company also continues toutilize our proprietary technologies, including our biocatalysis and naturalproduct capabilities, to further advance other early stage internal researchprograms in the fields of oncology, immunosuppresion and inflammation.

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 217% to $22.5 million for the year ended December 31,2003 from $7.1 million for 2002. The consolidation of financial resultswith Organichem added $4.7 million in research and development costs in2003. The generation of our novel chemical and screening collections andenhancement of our related high throughput screening technology added $7.2 millionof R&D expenses in 2003. In addition, $3.0 million of the increaserelated to the funding of our internal research program initiatives. Thecontinued development of our technologies primarily in biocatalysis andbiosciences added an additional $0.5 million of R&D costs in 2003. Dueto the decline in demand for our contract business 2003, we re-allocatedscientific personnel from customer projects to our internal research programinitiatives.

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*Selling, Generaland Administrative*

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

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**               | ** ** |
| $22,812                                |       | $ 20,318 |   | $ 12,897 |   |

 

The increase in selling, general and administrativeexpenses for the year ended December 31, 2004 is primarily due toprofessional fees related to our Sarbanes Oxley compliance initiatives andother accounting and valuation services of $2.6 million, and $1.4 million inemployee 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. Selling, general and administrative expensesare expected to increase overall in 2005, due to increased compensation costsassociated with the recognition of stock-based compensation expense,administrative costs associated with our off-shore operations, and generalincreases in overall administrative costs. These increases are expected bepartially offset by reductions in relocation costs and accounting fees, as wellas administrative costs associated with the operation of the Mount Prospectfacility.

Selling, general andadministrative expenses increased 58% to $20.3 million for the year ended December 31,2003 compared to $12.9 million for 2002. The increase was primarilyattributable to the acquisition of Organichem, which had $2.0 million inselling, general and administrative costs for 2003, increased payroll relatedcosts of $3.0 million, and a $1.4 million expense related to the relocation ofour Iowa operations.

*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 reflects the 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 SFAS 144 and SFAS 142. Based on ourreview, we determined that an impairment of certain related goodwill andlong-lived assets had 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 itsreview, and in accordance with the provisions of SFAS 144 and SFAS 142, wedetermined 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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Basedon the foregoing, during the year ended December 31, 2004, the Companyrecorded non-cash pre-tax charges and incurred restructuring costs related toits Bothell and Mt. Prospect businesses as follows:
| ** **                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                         | ** ** | **(in 000’s)**                   | ** ** |
| Property and  equipment impairment |       | $ 4,728                               |       | $ — |   | $ — |   |
| Goodwill  impairment               |       | 14,494                                     |       | — |   | — |   |
| Intangible asset  impairment       |       | 3,541                                      |       | — |   | — |   |
| Restructuring charge               |       | 1,184                                      |       | — |   | — |   |

 

See Overview section for amore detailed discussion.

*Property &Equipment Impairment*

The $4.7 million propertyand equipment impairment charge recorded in the second quarter of 2004 relatesto two impairment analyses performed as a result of certain triggering events. A$1.6 million property and equipment impairment charge was recorded due toour Mt. Prospect Research Center facility closure. During the quarter ended June 30,2004, we announced the closure of the Mt. Prospect facility. It was determinedthat the carrying value of the assets was in excess of the fair value of theasset group and we recorded a write-down of $1.6 million. Additionally, a$3.1 million property and equipment impairment charge was recorded due to animpairment analysis that was performed as a result of the reduction in thecarrying value of the library inventories at our Bothell Research Center. As aresult of the impairment analysis, it was determined that the carrying value ofthe assets was in excess of the fair value of the asset group and we recorded awrite-down of $3.1 million. The revised carrying value of the assets isbeing depreciated over the average remaining life of the primary assets of thegroup.

*Goodwill Impairment*

As a result of thereduction in carrying value of our natural product libraries and relatedlong-lived assets at our Bothell reporting unit and the announced closure ofour Mt. Prospect reporting unit, we performed goodwill impairment analyses oneach of these reporting units as of June 30, 2004. As a result of theseanalyses, we recorded a $13.3 million goodwill impairment charge related to ourBothell reporting unit and a $1.2 million impairment charge related to our Mt.Prospect reporting unit. In calculating the goodwill impairment charges, thefair value of the reporting units was determined with assistance from anindependent valuation advisor. The valuations were based upon a discounted cashflow approach. Significant assumptions used in the 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.

*Intangible AssetImpairment*

As a result of ourreduction in the quarter ending June 30, 2004 of the carrying value of ournatural product libraries, we also performed an assessment of the carryingvalue of our microbial cultures and related technologies, which are thestarting materials and technology used in the development of the naturalproduct libraries. Based on our assessment, we concluded that the carryingvalue of the microbial cultures and related technologies was not recoverable,and accordingly recorded an impairment charge of $3.5 million representing theentire remaining carrying value of microbial cultures and related technologies.

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*Restructuring*

On May 4, 2004 we announced our plan toconsolidate operations by relocating our Mt. Prospect facility operations toour 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.

The Company has accounted for the restructuring costsas required by SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities” (SFAS No. 146). SFAS No. 146 requires that aliability for a cost associated with an exit or disposal activity be recognizedand measured initially at its fair value in the period in which the liabilityis incurred, except for one-time termination benefits that meet certainrequirements. These actions have resulted in the recognition of $1.2 million ofrestructuring charges for the year ended December 31, 2004, consistingprimarily of employee termination costs and asset disposal costs.

Therestructuring costs are included under the caption restructuring charge in thestatements of operations and the restructuring liabilities are included inaccounts payable and accrued expenses on the balance sheet at December 31,2004. The following table displays the restructuring activity and liabilitybalances:
| ** **              | ** ** | **Balance at**       | ** **    | ** **  | ** ** | ** **       | ** ** | **Balance at**         | ** **  |
|-------------------------|------------|---------------------------|---------------|-------------|------------|------------------|------------|-----------------------------|-------------|
| ** **              | ** ** | **January 1,  2004** | ** **    | **Charges** | ** ** | **Payments**     | ** ** | **December 31,  2004** | ** **  |
| ** **              | ** ** | **(in 000’s)**       | ** **    |
| 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 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 statement ofoperations.

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. The long-livedassets associated with Mt. Prospect have been segregated to a separate lineitem on the consolidated balance sheet until they are sold and depreciationexpense has ceased respective to those assets. We anticipate the completion ofthe sale of the facility by June 2006.

The above restructuringactivity was recorded exclusively in the AMR operating segment. The net cashoutflow related to the restructuring for the year ended December 31, 2004was $0.5 million. Anticipated cash outflows related to the restructuring for2005 are $0.6 million, which primarily consists of the payment of accruedtermination benefits and asset disposal costs. We anticipate that as a resultof this 

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restructuring,we will experience annual expense savings of up to $5.0 million starting in2005 resulting from a reduction in facility and labor costs.

*Equity in income(loss) of unconsolidated affiliates*

Equityin income (loss) of unconsolidated affiliates represents 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, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**               | ** ** |
| $(65                                   | )          | $ (372 | ) | $ 2,795 |   |

 

The decrease in loss of $307 or 82% to ($0.1) millionfor the year ended December 31, 2004 from ($0.4) million for 2003 isattributed to the Company’s share of net losses in an equity method investee. Theloss recorded in 2004 reduced the value of the Company’s investment to $0, andas such, no further adjustments will be recorded until the investee returns toa 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 for 2002 is attributed to our acquisition of theremaining stock of Organichem in 2003, which increased our ownership percentageto 100% at February 11, 2003 from 39.2% at December 31, 2002,resulting in the full consolidation of Organichem’s financial results (reducedby a minority interest share representing the previous owners’ share of netincome from January 1, 2003 through February 11, 2003) in 2003. Theloss recorded in 2003 represents the Company’s share of the net loss in aseparate equity method investee.

*Interest expense*

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**                    | ** ** |
| $(1,641                                | )          | $ (1,446 | ) | $ (168 | ) |

 

Interest expense increased $0.2 million or 13% to $1.6million for the year ended December 31, 2004 from $1.4 million in 2003. Theincrease was primarily due to the capitalization of interest costs incurredduring the construction of the Company’s headquarters facility in 2003.

Interest expense increased$1.2 million to $1.4 million for the year ended December 31,2003 compared to 2002. The increase was the result of our new credit facilitywhich we entered into on February 12, 2003 to fund the purchase ofOrganichem’s remaining shares.

*Interest income*

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**               | ** ** |
| $1,958                                 |       | $ 2,231 |   | $ 3,276 |   |

 

Interest income decreased $0.3 million or 12% to $1.9million for the year ended December 31, 2004 from $2.2 million for 2003. Thedecrease is due primarily to a decrease in our rate of return as higher-yieldingsecurities matured and were replaced with securities yielding the lower ratesreflected in current market conditions. The Company also earned lower rates onits interest-bearing cash accounts and other short-term cash equivalents in2004 due to the downturn in the interest rate environment.

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Interest income decreased32% to $2.2 million for the year ended December 31, 2003 from$3.3 million for 2002. The decrease was the result of the lower interestrate environment on the Company’s municipal and government bond portfolio.

*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 FTEservices to each customer in exchange for equity securities, plus additionalfee for service cash payments. We assess the fair value of these investmentsquarterly or whenever events or changes in circumstance indicate that theinvestment value may not be recoverable. During the fourth quarter of 2004, oneof our investees 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 current 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 analysis it was our judgment that another-than-temporary impairment had occurred and that the fair value of ourinvestment was zero, resulting in a non-cash loss on investment of $1.3million.

We determined that noimpairment was required for our remaining equity investment based on ouranalysis as of December 31, 2004. 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, | ** ** |
|----------------------------------------|------------|
| **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| **(in 000’s)**                    | ** ** |
| $1,837                                 |       | $ 16,714 |   | $ 22,686 |   |

 

Income tax expense decreased to $1.8 million for theyear ended December 31, 2004, compared to $16.7 million for 2003. Incometax expense in 2004 reflects the goodwill and intangible asset impairmentcharges as non-deductible tax items. Excluding the impact of these items onpre-tax income, the decrease in the effective tax rate from 2003 is due to theincreased impact of permanent tax-deductible items in relation to decreasedpre-tax income in 2004. We expect the effective tax rate to approximate 32% ofpre-tax income for 2005.

Income tax expensedecreased to $16.7 million for the year ended December 31, 2002,compared to $22.7 million for 2002. The effective rate for our provisionfor income taxes was 35% in 2003 compared to 36% in 2002. The lower tax rate isattributable to the preferential tax treatment Organichem receives for itsforeign export sales.

**Liquidity andCapital Resources**

We have historically funded our business throughoperating cash flows, proceeds from borrowings and the issuance of equitysecurities. During 2004, we generated cash of $36.6 million from operatingactivities. The primary sources of operating cash flows are payments receivedfor the performance of contracted chemistry services and royalty paymentsreceived from Sanofi-Aventis   based upona percentage of sales of Allegra. The primary uses of operating cash flows arethe payment of compensation and benefits to both scientific and administrativepersonnel, purchases of inventory and supplies, and payment of occupancy costs.The Company’s 2004 net loss of $11.7 million includes several significantnon-cash charges including

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depreciation andamortization of $15.3 million, goodwill impairment charges of $14.5 million,and impairments of property, plant and equipment, intangible assets, andlibrary inventories of $14.2 million. These non-cash charges are partiallyoffset by the recognition of $4.4 million of deferred tax benefit, which is anon-cash income item.

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 proceeds from investment securitiesof $13.1 million. During 2004, we used $2.7 million for financing activities,consisting of $4.5 million in long-term debt repayments, offset by $1.8 millionprovided by stock option and stock purchase plan exercises.

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 will be performed in2005

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 at Organichem.These expenditures were primarily financed through operating cash flows. For2005, we expect to incur $21 million in capital expenditures, primarilyrelated to the continued expansion of Organichem manufacturing facilities andthe outfitting of leasehold space in Singapore in preparation for thecommencement of operations at that location.

We entered into a credit facility consisting of $30.0million term loan and $35.0 million line of credit to fund the acquisition ofOrganichem during 2003. The term loan matures in February, 2008. As of December 31,2004, the interest rate on $15.0 million of the outstanding term loan balancewas 4.61% and the interest rate on the remaining $7.5 million was 3.23%. Theline of credit expires in February 2006 and bears interest at a variablerate based on the Company’s leverage ratio. We are currently in discussionswith our lenders to extend the term of the line of credit. As of December 31,2004, the outstanding balance of the line of credit was $25.5 million and theinterest rate was 3.09%. The credit facility contains certain financialcovenants, including a maximum leverage ratio, a minimum required operatingcash flow coverage ratio, a minimum earnings before interest and taxes tointerest ratio and a minimum current ratio. Other covenants include limits onasset disposals and the payment of dividends. As of December 31, 2004 and2003 we were in compliance with all covenants under the credit facility.

Working capital was $174.6 million at December 31,2003 compared to $163.1 million at December 31, 2002. The increase of $11.5million resulted primarily from an increase in inventory of $20.9 million andaccounts receivable of $4.7 million primarily due to the Organichemacquisition, offset by a $4.9 million decrease in cash and cash equivalents andinvestments, an increase of $4.8 million in accounts payable and accruedexpenses and in increase of $2.5 million in accrued pension costs whichrepresents what we expect to contribute in 2004 to our defined benefit pensionplans.

Total capital expenditures for the year ended December 31,2003 were $30.6 million as compared to $17.4 million for the year ended December 31,2002. Capital expenditures in 2003 were predominantly in connection with theexpansion of our facilities in Albany, New York and at Organichem. Theseexpenditures were primarily financed through operating cash flows. As of December 31,2003, we had approximately $4.7 million in purchase commitments forconstruction contracts.

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During 2003, we generated $8.8 million from financingactivities, consisting primarily of $30.0 million in borrowings for theacquisition of Organichem, offset by $13.5 million used to purchase shares ofcommon stock under our stock repurchase programs and $9.0 million of debtrepayments.

We continue to pursue the expansion of our operationsthrough internal growth and strategic acquisitions. We expect that suchactivities will be funded from existing cash and cash equivalents, cash flowfrom operations, the issuance of debt or equity securities and borrowings.Future acquisitions, if any, could be funded with cash on hand, cash fromoperations, borrowings under our credit facility and/or the issuance of equityor debt securities. There can be no assurance that attractive acquisitionopportunities will be available to us or will be available at prices and uponsuch other terms that are attractive to us. We regularly evaluate potentialacquisitions of other businesses, products and product lines and may holddiscussions regarding such potential acquisitions. As a general rule, we willpublicly announce such acquisitions only after a definitive agreement has beensigned. In addition, in order to meet our long-term liquidity needs orconsummate future acquisitions, we may incur additional indebtedness or issueadditional equity or debt securities, subject to market and other conditions.There can be no assurance that such additional financing will be available onterms acceptable to us or at all. The failure to raise the funds necessary tofinance our future cash requirements or consummate future acquisitions couldadversely affect our ability to pursue our strategy and could negatively affectour operations in future periods.

The recurring royalties wereceive on the sales of Allegra/Telfast have historically provided a materialportion of our operating cash flows. 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. Shouldwe or Aventis be unsuccessful in defending these patents we would experience amaterial decrease in operating cash flows.

**ContractualObligations**

The following table setsforth our long-term contractual obligations and commitments as of December 31,2004.

**Payments Due byPeriod (in thousands)**
| ** **                    | ** ** | **Total** | ** ** | **Under 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5 Years** | ** ** |
|-------------------------------|------------|-----------|------------|----------------------------|------------|--------------------|------------|--------------------|------------|-----------------------------|------------|
| Long-Term  Debt (principal)   |       | $53,129   |       |                       | $          | 4,526              |       |               | $          | 34,624                      |       | $ | 10,159 |   |   | $ | 3,820 |   |   |
| Long-Term Debt  (interest)(1) |       | $         | 3,493      |                       |       | $                  | 1,544      |               |       | $                           | 1,215      |   | $ | 243 |   |   | $ | 491 |   |   |
| Operating Leases              |       | $         | 12,392     |                       |       | $                  | 2,296      |               |       | $                           | 4,610      |   | $ | 2,710 |   |   | $ | 3,093 |   |   |
| Purchase  Commitments         |       | $         | 5,976      |                       |       | $                  | 5,976      |               |       | —                      |       | — |   |   | — |   |   |
| Pension Plan  Contributions   |       | $         | 887        |                       |       | $                  | 631        |               |       | $                           | 256        |   | — |   |   | — |   |   |

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

**Related PartyTransactions**

***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.

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In 2004, 2003 and 2002 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 31,2004, 2003 and 2002 are $4.8 million, $5.2 million and$5.1 million, respectively. Included in accrued compensation in theaccompanying consolidated balance sheets at both December 31, 2004 and2003 are unpaid Technology Development Incentive Compensation awards of $1.2and $1.3 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, 2004 and 2003 totaled $414,000 and $138,000, respectively.The amounts forgiven and charged to operations in the consolidated statementsof income for the years ended December 31, 2004, 2003 and 2002 are$91,000, $192,000 and $200,000, respectively.

**Critical AccountingPolicies 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 accounting principles generallyaccepted in the United States of America. The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to bad debts, inventories, intangibleassets, equity investments, unbilled revenue, income taxes, pension andpostretirement benefit plans, and contingencies. We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions 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-time Equivalent (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 

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for annual adjustments inbilling rates for the scientists assigned to the contract. These contractsinvolve our scientists providing services on a “best efforts” basis in thedevelopment of novel chemistry for our customers. There are no fixeddeliverables as part of these services. As such, we recognize revenue under FTEcontracts on a monthly basis as services are performed according to the termsof the contract.

*Time and 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.

*Fixed Fee.  *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-Front License Fees Milestoneand Royalty Revenue.  *We analyze our agreements todetermine whether the elements can be separated and accounted for individuallyor as a single unit of accounting in accordance with EITF No. 00-21, *Revenue Arrangements with Multiple Deliverables*and SAB 104, *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 licensing, milestone and royalty paymentsincluded in our contracts are related to the occurrence of specificidentifiable events. We will recognize revenue from up-front non-refundablelicensing fees over the period we have continuing involvement in the underlyingproject. We will recognize revenue arising from a milestone payment upon thesuccessful achievement of the event, and the resolution of any uncertainties orcontingencies regarding potential collection of the related payment, or ifappropriate over the remaining term of the agreement.

*DeferredRevenue.  *Deferred revenue represents moniesreceived for services that have not yet been performed as well as customerbillings related to completed production which has not yet shipped. As an addedservice, during 2003 we began to temporarily store completed cGMP production atour facilities for certain customers. Under these arrangements, upon completionof the customer project we typically will enter into a storage agreement withthe customer. We will temporarily store and subsequently ship the completedproduction, often in multiple shipments to multiple sites. The revenue relatedto these arrangements is recognized at the time the products are ultimatelyshipped.

*RecurringRoyalty Revenue Recognition.  *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. We record royalty revenue in the period in which the salesof Allegra occur. Royalty payments from Sanofi-Aventis are due within 45 daysafter each calendar quarter and are determined based on sales ofAllegra/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). SFASNo. 146 requires that a liability for a cost associated with an exit ordisposal activity be recognized and measured initially at its fair value in theperiod in which the liability is incurred, except for one-time terminationbenefits that meet certain requirements.

*Inventory*

Inventory consists primarily of commercially availablefine chemicals used as raw materials in the research and production process,work-in-process and finished goods at our Organichem location and chemicalcompounds in the form of natural product and novel compound collections. Wecapitalize the 

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costs associated with theproduction of our novel compound collections. Inventories are stated at thelower of cost (first-in, first-out basis) or market. We record reserves forexcess and obsolete inventory equal to the difference between the cost ofinventory and the estimated market value based upon assumptions about futuredemand and market conditions, which could result in a charge to operations.

Initial costs to develop novel compound libraries arecategorized as research and development expense until such time it becomesprobable that a saleable library can be successfully produced. As a result,costs for the design, research, and testing of libraries under development areexpensed as incurred. Our research chemists review the results of analyticalprocedures to determine if the chemical reactions were completed as expectedand the product purity and product yields are within required specifications.This “validation” process determines whether the chemistry is successful and ifa saleable product will result. We capitalize costs of production to inventoryonce the validation process is completed and successful production isreasonably assured. If a core reaction is unsuccessful, the library template isabandoned and no further development takes place.

Capitalized costs areamortized over the economic life of the library (estimated at 3 years) at thegreater of (a) the ratio of the product’s current gross revenue to thetotal of current and expected gross revenues or (b) the straight-linemethod computed by dividing the remaining unamortized capitalized cost by theremaining economic life of the product. The remaining economic life isreassessed at each balance sheet date and changes in estimate, if appropriate,are made to the amortization model. Amortization of library inventories isincluded within research and development expense on the consolidated incomestatement. In addition, the Company monitors the carrying value of its naturalproduct and lead finding sample collections for impairment on a quarterly basis.The Company compares the carrying values of these collections to theirestimated net realizable fair values, which are based on estimated future salesof these collections, to determine impairment. The Company recognizes animpairment charge for any collection whose carrying value is greater than itsestimated net realizable fair value. If we are unable to meet forecastedrevenues related to those assets or if actual market conditions are lessfavorable than those projected, additional write-downs of all or a portion ofthe remaining value of compound library assets (totaling $3.7 million at December 31,2004) may be required, resulting in a charge to operations.

*Goodwill*

In accordance withthe provisions of SFAS 142, the Company performs an annual****assessmentof the carrying value of goodwill for potential impairment (or on an interimbasis if certain triggering events occur). A determination of impairment ismade based upon the estimated discounted future cash flows of the operationsassociated with the related reporting unit. If goodwill is determined to beimpaired in the future the Company would be required to record a charge to itsresults of operations. Factors the Company considers important which couldresult 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.

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’sbalance sheet at December 31, 2004 was $25.7 million, including $23.1million of goodwill associated with the Company’s acquisition of Organichem, Inc.

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*Long-Lived Assets*

In accordance withthe provisions of SFAS 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 balance sheet at December 31, 2004were $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.

*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.

*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 

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involvedin the remediation or settlement. The Company accrues environmental cleanuprelated costs when those costs are believed to be probable and can bereasonably estimated.

*Stock-BasedCompensation*

The Company applies the intrinsic value-basedmethod of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations, inaccounting for its fixed plan stock options. As such, compensation expensewould be recorded only if, on the date of grant, the current market price ofthe underlying stock exceeded the exercise price. Any compensation expensewould 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.

The Company expects toadopt SFAS No. 123 (revised), *Share-Based Payment*,in the third quarter of 2005. SFAS No. 123 (R) will require therecognition of compensation expense associated with share-based payment in theCompany’s consolidated income statement, and is expected to have a materialimpact on the Company’s results of operations.

*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 AccountingPronouncements**

In November 2004, the FASBissued Statement No. 151, *Inventory Costs—anAmendment of ARB No. 43, Chapter 4* , to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). This Statement requires that those itemsbe recognized as current-period charges regardless of whether they meet thecriterion of “so abnormal” as defined in ARB No. 43. In addition, thisStatement requires that allocation of fixed production overheads to the costsof conversion be based on the normal capacity of the production facilities. Theprovisions of this Statement are effective for inventory costs incurred duringfiscal years beginning after June 15, 2005, with earlier application 

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permitted. This statementapplies to the Company for the fiscal year ending December 31, 2006. TheCompany will assess the impact of applying this statement in 2005.

In December 2004, the FASB issued Statement No. 123(Revised), *Share-Based Payment (Revised),* whichamends FASB Statement No. 123 *Accounting for Stock-BasedCompensation,*and supersedes APB Opinion No. 25, *Accounting for Stock 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 inan entity incurs liabilities in exchange for goods or services that are basedon the fair value of the entity’s equity instruments or that may be settled bythe issuance 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. Theprovisions of this statement are effective for public entities that do not fileas small business issuers as of the beginning of the first interim or annualreporting period that begins after June 15, 2005. This statement appliesto the Company for the fiscal quarter ending September 30, 2005. TheCompany expects that as a result of adopting this Statement that the Companywill recognize expense in the consolidated income statement for the fair valueof share options issued to its employees, as well as for the portion of thepurchase discount on the market price of the Company’s common stock offered toemployees in conjunction with the Company’s Employee Stock Purchase Plan (ESPP)that is considered compensatory based on the guidance in FAS No. 123(R). TheCompany has not completed its determination, however, it is expected that theapplication of this Statement will have a material impact on the Company’sresults of operations.

In December 2004, theFASB issued Staff Position No. FAS 109-1, Application of FASBStatement No. 109, Accounting for Income Taxes, to the Tax Deduction on QualifiedProduction Activities Provided by the American Jobs Creation Act of 2004. ThisStaff Position clarifies that the tax deduction for qualified domesticproduction activities provided by the American Jobs Creation Act of 2004 shouldbe accounted for as a special deduction under FAS 109 as opposed to a tax-ratededuction. The phase-in of the tax deduction begins with qualifying productionactivities for the year ending December 31, 2005. The Company has notdetermined the amount of tax deduction it expects to receive under the Act orthe impact of applying the Staff Position on the Company’s financial position,results of operations or cash flows.

**RISK FACTORS ANDCERTAIN FACTORS AFFECTING FORWARD-LOOKING STATEMENTS**

The following factorsshould be considered carefully in addition to the other information in this Form 10-K.Except as mentioned under “Quantitative and Qualitative Disclosure About MarketRisk” and except for the historical information contained herein, thediscussion contained in this Form 10-K contains “forward-lookingstatements,” within the meaning of Section 27A of the Securities Act and Section 21Eof the Exchange Act, that involve risks and uncertainties. Our actual resultscould differ materially from those discussed in this Form 10-K.Important factors that could cause or contribute to such differences includethose discussed below, as well as those discussed elsewhere herein.

**Pharmaceutical andbiotechnology 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. Our contract revenues declined in 2004 and we maycontinue to be adversely effected should economic conditions worsen. Ifpharmaceutical and biotechnology companies discontinue or decrease their usageof our services, including 

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as aresult of a slowdown in the overall United States economy, our revenues andearnings could be lower than we expect and our revenues may decrease or notgrow at historical rates.

**We may lose one ormore of our major customers.**

During the year-ended December 31,2004, revenues from GE Biosciences totaled $49.6 million and representedapproximately 38% of our contract revenue, or 27% of our total revenue.Organichem entered into a long-term supply agreement with GE Biosciences in1999 under which GE Biosciences’ purchases from us begin to expire in 2006 andterminate at the end of 2007. GE Biosciences is expected to discontinuepurchases of one of the products that we sell to them by the third quarter of2005. Sales of this product totaled $18.1 million, which represents 27% ofOrganichem’s 2004 revenue and 15% of total contract revenue for the year ended December 31,2004. We expect GE Biosciences’ remaining purchases of this product to alloccur in the first half of 2005 and to decrease by 15% from 2004 levels, withno revenues associated with this product after 2005. Additionally, GEBiosciences’ purchases have historically exceeded the contractual minimumpurchases, however, this may not continue. If GE Biosciences materially reducesits historical purchase levels or we can not renew or replace the revenue fromthis contract or the revenue from the discontinued product, there may be amaterial decrease in our revenues and operating income. In addition, during theyear ended December 31, 2004, our AMR segment provided services to threemajor customers represents approximately 13% of our contract revenues or 9% ofour total revenue. These customers typically may cancel their contracts with30 days’ to one-year’s prior notice depending on the size of the contract,for a variety of reasons, many of which are beyond our control. If any one ofour major customers cancels its contract with us, our contract revenues maydecrease.

**The royalties weearn on Allegra may decrease.**

We have been issued several patents on a pure form of,and a manufacturing process for, fexofenadine HCl. The patent positions ofpharmaceutical, medical and biotechnology firms can be uncertain and caninvolve complex legal and factual questions. Litigation, in particular patentlitigation, can be complex and time-consuming and the outcome is inherentlyuncertain. We cannot assure investors that Sanofi-Aventis will ultimatelysucceed in its current or any future litigation against generic drugmanufacturers involving patents with respect to Allegra. In the event that oneor more of the patents owned by us or Sanofi-Aventis are ultimately determinedto be invalid or unenforceable, Sanofi-Aventis and we would lose exclusivitywith respect to the claims covered by those patents. Any such loss ofexclusivity and the contemporaneous introduction of generic forms offexofenadine HCl may cause a reduction in Allegra sales. In addition, under ourcurrent arrangements with Sanofi-Aventis, Sanofi-Aventis, with consultationfrom us, will take the lead with respect to preparing and executing a strategyto defend and enforce certain of the patents relating to Allegra, and isexecuting that role in the current litigation. As a result, we may not be ableto control the conduct of such litigation and the strategic decisions that aremade during the course of such litigation. See “Item 3—Legal Proceedings.”

On May 11, 2001, an FDA advisory panelrecommended that the prescription allergy drugs Claritin, Allegra and Zyrtecare safe enough to be made available over-the-counter. The panel had beenassembled as a result of a 1998 petition by Blue Cross of California (nowWellpoint Health Networks) requesting that the three top-selling prescriptionantihistamines be changed to OTC status. The FDA panel’s only consideration waswhether Claritin, Allegra and Zyrtec have the safety profile forover-the-counter use without a learned intermediary. The panel’s recommendationremains under consideration by the full FDA. The FDA’s reaction to its advisorypanel’s recommendation with regard to the safety of Allegra is uncertain. In November 2002,Schering Plough received approval by the FDA to voluntarily switch the statusof Claritin from prescription to OTC status. In December 2002, ScheringPlough began to market and sell Claritin as an OTC drug.

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Royalties from sales ofAllegra currently constitute a significant portion of our total revenues andoperating income. During the year ended December, 31 2004, our royalties fromAllegra were $48.0 million, which represented approximately 28% of ourtotal revenues. For the year ended December 31, 2003, our royalties fromAllegra were $51.6 million, which represented approximately 26% of ourtotal revenues. The marketing of OTC Claritin and subsequent private-labelantihistamine OTC products in the U.S. has adversely affected Allegra’sreimbursement status by third-party payers resulting in a decline insales growth in the U.S. during 2004. Further Claritin OTC competition, thepotential for generic Allegra competition and the possibility that the FDArequires Allegra or Zyrtec to be sold in an over-the-counter form, may furtheradversely affect Allegra’s reimbursement status by third-party payers andthe price at which it can be sold. Any such price reduction may not beadequately offset by increased volume of sales. If the dollar amount of Allegrasales subject to our license agreement decreases, due to these or any otherfactors, our revenues from our license agreement with Sanofi-Aventis will alsodecrease. Because we have very few costs associated with the Allegra license, adecrease in revenues from our license agreement for Allegra would have amaterial effect on our revenue and operating income. For example, a$5.0 million decrease in our Allegra royalty revenue would decrease ouroperating income by $4.5 million.

**We face increasedcompetition.**

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 expect to face increased competition. In thefuture, any one of our competitors may develop technological advances thatrender the services that we provide obsolete. While we plan to developtechnologies, which will give us competitive advantages, our competitors planto do the same. We may not be able to develop the technologies we need tosuccessfully compete in the future, and our competitors may be able to developsuch technologies before we do or provide those services at a lower cost.Consequently, we may not be able to successfully compete in the future.

**We may be unsuccessful in producing and licensingproprietary technology developed from our internal research and developmentefforts or acquired from a third party.**

We have expended andcontinue to expend time and money on internal research and development with theintention of producing proprietary technologies in order to patent and thenlicense them to other companies. However, we may not be successful in producingany valuable technology or successful in licensing it to a third party. To theextent we are unable to produce technology that we can license, we may notreceive any revenues related to our internal research and development efforts.

**We may be unsuccessful in selling or licensing thechemical and natural product collections currently in our inventory.**

As of December 31,2004 the total cost of our chemical and natural product libraries included inour inventory is $3.7 million. Although we write down our inventories forestimated obsolescence or unmarketable inventory, if we are not able to executeour business plan within certain prescribed timeframes, or if actual marketconditions are less favorable than we project, additional inventory write-downsmay be required in the future. For example, during 2004 we recorded a $6.0impairment charge related to our chemical and natural product librarycollections. See Note 4 to the consolidated financial statements for furtherinformation regarding this impairment charge.

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**Our goodwill maybecome impaired.**

As of December 31,2004, 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. An independent third-partyimpairment review was completed in 2003 and determined that no impairment wasrequired. If goodwill is determined to be impaired in the future we would berequired to record a charge to our results of operations. For example, during2004 we recorded goodwill impairment charges totaling $14.5 million. Factors weconsider 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 for ouroverall business;

·       significantnegative industry or economic trends; and

·       ourmarket capitalization relative to net book value.

See Note 20 to the consolidatedfinancial statements for further information regarding the 2004 impairment charge.

**We may losevaluable 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.

**Our failure tomanage 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.

**Future acquisitionsmay disrupt our business and distract our management.**

We have engaged in anumber of acquisitions and strategic investments, and we expect to continue todo so. We may not be able to identify suitable acquisition candidates, and ifwe do identify suitable candidates, we may not be able to make suchacquisitions on commercially acceptable terms or at all. If we acquire anothercompany, we may not be able to successfully integrate the acquired businessinto our existing business in a timely and non-disruptive manner or at all. Wemay have to devote a significant amount of time and resources to do so. Evenwith this investment of time and resources, an acquisition may not produce therevenues, earnings or business synergies that we anticipate. If we fail to integratethe acquired business effectively or if key employees of that business leave,the anticipated benefits of the acquisition would be jeopardized. The time,capital, management and other resources spent on an 

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acquisitionthat fails to meet our expectations could cause our business and financialcondition to be materially and adversely affected. In addition, acquisitionscan involve non-recurring charges of significant amounts of goodwill that couldbecome impaired and adversely affect our results of operations.

**We may not be ableto realize the benefits of recent acquisitions and strategic investments.**

We acquired EnzyMed, Inc.,a provider of combinatorial biocatalysis discovery services, in October 1999;American Advanced Organics, Inc., a contract manufacturer of novelcompounds, pharmaceutical intermediates and test drug substances, in February 2000;New Chemical Entities, a chemistry-based drug discovery company, in January 2001;and Great Lakes Chemical Company’s research and development facility outside ofChicago, Illinois in September 2001. We made a strategic investment inOrganichem Corporation in December 1999 to facilitate a management buyoutof a chemical manufacturing facility from Nycomed Amersham, plc and completedthe full acquisition of Organichem in February 2003. These transactionsmay not be as beneficial to us as we expect. We also have an investment inFluorous Technologies, Inc. Fluorous Technologies is a development stagecompany and may not be able to successfully develop technology and products.During 2003, we made additional equity investments in two private companies.Under the terms of these agreements, we also provided FTE services to eachcompany in exchange for equity securities and fee for service cash payments.Both of these companies are currently in the process of raising additionalfinancing. We record an impairment charge when we believe an investment hasexperienced a decline in value that is other than temporary. Future adversechanges in market conditions, poor operating results of underlying investmentsor the investees’ inability to obtain additional financing could result in ourinability to recover the carrying value of the investments, thereby requiringan impairment charge in the future. For example, during the fourth quarter of2004 we recorded a $1.3 million impairment charge related to an investment wemade in a drug discovery company.

**We may not be ableto 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.

**We may lose one ormore of our key employees.**

Our business ishighly 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;

·       JamesJ. Grates, our Vice President, Operations

·       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, Organichem;

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

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

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Although we haveemployment agreements with the 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 expect the demand for Allegra to be lowerduring other times of the year. Because Allegra sales change seasonally basedon the demand for allergy medicines, our quarter-to-quarter revenues willlikely experience fluctuations.

**We may be heldliable 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 harms 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.

**We may be liablefor contamination or other harm caused by hazardous materials that 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.

Organichem has completedan environmental remediation associated with groundwater contamination at itsRensselaer, New York location. This contamination is associated with pastpractices at the facility prior to 1990, and prior to AMRI’s investment orownership of the facility. Ongoing costs associated with the remediation includebiannual monitoring and reporting to the State of New York’s Department ofEnvironmental Conservation. Under the remediation plan, Organichem is expectedto pay for monitoring and reporting until 2009. Under a 1999 agreement with thefacility’s previous owner, Organichem’s maximum liability under the remediationis $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 we fail to meet strict regulatory requirements, wecould be required to pay fines or 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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**Our operations may be interrupted by the occurrence ofa natural disaster or other catastrophic 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. Althoughwe have contingency plans in effect for natural disasters or other catastrophicevents, catastrophic events could still disrupt our operations. Even though wecarry business interruption insurance policies, we may suffer losses as aresult of business interruptions that exceed the coverage available under ourinsurance policies. Any natural disaster or catastrophic event in the Albanyarea or in our facilities could have a significant negative impact on ouroperations.

**Terrorist attacksor 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. The terrorist attacks that tookplace in the United States on September 11, 2001 were unprecedented eventsthat have created many economic and political uncertainties, some of which maymaterially adversely affect our business, results of operations and financialcondition. The long-term effects on our company of the September 11, 2001attacks are unknown. The potential for future terrorist attacks, the nationaland international responses to terrorist attacks, and other acts of war,including the current war in Iraq, or hostility have created many economic andpolitical uncertainties, which could materially adversely affect our business,results of operations, and financial condition in ways that we currently cannotpredict.

**Health care reform could reduce the pricespharmaceutical and biotechnology companies can charge for drugs they sellwhich, in turn, could reduce the amounts that they have available to retain ourservices.**

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.

**The ability of our stockholders to control ourpolicies and effect a change of control of our company is limited, which maynot 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 “staggeredboard.” By preventing stockholders from voting on the election of more than oneclass of directors at any annual meeting of stockholders, this provision mayhave the effect of keeping the current members of our board of directors incontrol 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 thepreferences and rights of any preferred stock issued, which would allow theboard to issue one or more classes or series of preferred stock that coulddiscourage or delay a 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 aShareholder Rights Plan, the purpose of which is, among other things, toenhance the Board’s ability to protect shareholder interests and to ensure thatshareholders receive fair treatment in the event any coercive takeover attemptof us is made in the future. Under the terms of the Shareholder Rights Plan,the Board can in effect prevent a person or group from acquiring more than 15%of the outstanding shares of our Common Stock. Once a shareholder acquires morethan 15% of our outstanding Common Stock without Board approval (the “acquiringperson”), all other shareholders will have the right to purchase securitiesfrom us at a price less than their then fair market value. These subsequentpurchases by other shareholders substantially reduce the value and influence ofthe shares of Common Stock owned by the acquiring person.

**Our officers anddirectors will have significant control over us and their interests may differfrom yours.**

At February 18, 2005,our directors and officers beneficially owned or controlled approximately 15.3%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.

**Because our stockprice may be volatile, our stock price could experience substantial declines.**

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, during the past twelvemonths, the stock market, and in particular technology companies, haveexperienced significant decreases in market value. In addition, the globaleconomic and potential uncertainty, including as a result of the war in Iraqand the international 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.

**Because we do not intend to pay dividends, you willbenefit from an investment in our common stock only if it appreciates in value.**

We have never declared orpaid any cash dividends on our common stock. We currently intend to retain ourfuture earnings, if any, to finance the expansion of our business and do notexpect to pay any cash dividends in the foreseeable future. As a result, thesuccess of your investment in our common stock will depend entirely upon anyfuture appreciation. There is no guarantee that our common stock willappreciate in value or even maintain the price at which you purchased yourshares.

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

We have market risk with respect to interest rates.The risk is composed of changes in future cash flows due to changes in interestrates on our variable rate $22.5 million term loan, $25.5 millionline of credit, and our $5.1 million industrial development authority bonds.

To mitigate this risk, we have entered into interestrate swap agreements that have fixed the interest rate on 28% of our debt.Included in other assets is $44,000, which represents the estimated increase inmarket value since entering into the swap agreements.

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The potential loss infuture cash flows from a 10% adverse change in quoted interest rates wouldapproximate $113,000.

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

Financial statements andnotes thereto appear on pages F-1 to F-43 of this Form 10-KAnnual Report.

**ITEM 9.   CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND**FINANCIALDISCLOSURE.

None.

**ITEM 9A.   CONTROLSAND PROCEDURES**

***Evaluationof Disclosure Controls and Procedures***

Asrequired by rule 13a-15(b) under the Securities Exchange Act of 1934, asamended (the “Exchange Act”), as of the end of the period covered by thisAnnual Report on Form 10-K, the Company’s management conducted an evaluationwith the participation of the Company’s Chief Executive Officer and ChiefFinancial Officer regarding the effectiveness of the design and operation ofthe Company’s disclosure controls and procedures (as defined in Rules 13a-15(e)and 15d-15(e) under the Exchange Act). Based upon that evaluation and theinventory valuation material weakness described below relating to the processfor identifying reserves for excess and obsolete inventory, the process foranalyzing the amortization period for deferred inventory variances, and theprocess for the transfer of accumulated unbilled project costs to cost ofrevenue, the Company’s Chief Executive Officer and Chief Financial Officer haveconcluded that the Company’s disclosure controls and procedures were noteffective as of December 31, 2004.

***Management’sAnnual Report on Internal Control over Financial 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)under the Exchange Act. The Company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles, andincludes those policies and procedures that:

**· **pertain to the maintenance of recordsthat, in reasonable detail accurately and fairly reflect the transactions anddispositions of the assets of the Company;

**· **provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles and,that receipts and expenditures of the Company are being made only in accordancewith authorization of management and directors of the 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.

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The Company’s management, including the Chief ExecutiveOfficer and Chief Financial Officer, assessed as of December 31, 2004 theeffectiveness of the Company’s internal control over financial reporting. Inmaking this assessment, management used the criteria set forth in the frameworkin *Internal**Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). 

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. As of December 31, 2004, theCompany did not maintain effective controls over inventory valuation at theCompany’s large scale manufacturing facility. Specifically, during the fourthquarter of 2004, the Company failed to identify certain obsolete inventoryduring its year end reconciliation process and also failed to demonstrate thatits controls over ensuring a complete and adequate review for excess inventory hadbeen performed by management in a timely manner. In addition, the Companyfailed to maintain an adequate level of documentary evidence to demonstratethat its amortization period for deferred inventory variances was accurate.Furthermore, during the year-end reconciliation of unbilled project costs theCompany failed to identify a project which had been billed but for which therelated costs had not been expensed. Certain of these control deficienciesresulted in audit adjustments to the Company’s December 31, 2004 inventorybalance, however, they did not result in the restatement of any of theCompany’s annual or interim consolidated financial statements. Additionally,these control deficiencies result in more than a remote likelihood that amisstatement to the inventory and cost of sales accounts resulting in amaterial misstatement to annual or interim financial statements would not beprevented or detected. Accordingly, management has determined that thesedeficiencies constitute a material weakness. Because of this material weakness,management has concluded that the Company did not maintain effective internalcontrol over financial reporting as of December 31, 2004 based on the criteriain the *Internal Control—Integrated Framework*.

Management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2004 has been audited by PricewaterhouseCoopers LLP, anindependent registered public accounting firm, as stated in their report whichis included on page F-2 of this Annual Report on Form 10-K. 

***RemediationSteps to Address the Material Weakness***

The Company is in theprocess of remediating the identified material weakness in the Company’sinternal control over financial reporting. The Company is implementing newcontrols to ensure that all obsolete inventory is appropriately reserved for.These controls include an enhanced reconciliation process for system generatedobsolete inventory reports to the general ledger reserve account to ensure thatthe general ledger reserve account is accurate and complete. Further, increasedinternal documentation will be prepared to support the Company’s excessinventory reserves. With regard to the Company’s analysis of the amortizationperiod for deferred inventory variances, the Company is implementing newprocedures to analyze the deferred inventory amortization period, includingdocumentation of the method used to calculate the amortization period. Withrespect to the Company’s accumulated unbilled project costs, the Company isimplementing procedures to ensure completed projects are removed from theaccount balance in a timely manner. These procedures include a review of theprojects included in the account balance by additional Company personnel.Furthermore, during the fourth quarter of 2004 the Company initiated theprocess of identifying an Enterprise Resource Planning (ERP) application that,once implemented, will provide additional enhancements of the Company’s currentinternal control environment. The Company has also committed additionalexternal resources to perform a review of the inventory accounting proceduresat its large scale manufacturing facility in order to identify additionalprocess enhancements.

50

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***Changesin Internal Control Over Financial Reporting***

There were no changes, other than as discussed below,in the 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. 

In connection with the review of the Company’sfinancial statements for the third quarter of 2004, the Company identified anaccounting error related to the amortization of premiums and discounts oncertain bond investments. As a result, the Company’s Chief Executive Officerand Chief Financial Officer determined that a material weakness existed in thedesign of the Company’s disclosure controls and procedures, and accordingly,that the Company’s disclosure controls and procedures were not effective as ofSeptember 30, 2004. Approximately $931,000 of amortization on bond premiums wasnot appropriately recorded during the three year period ended December 31,2003. No procedure was in place to insure that the bond amortization wasproperly recorded by the Company and included in its consolidated statements ofincome. Additionally, a reconciliation of the Company’s accumulated othercomprehensive income to the general ledger balance was not being performedduring this period. The lack of such preventative and detective controlsallowed this accounting error to occur and escape detection.

The Company has corrected the identified weakness inthe Company’s disclosure controls and procedures that led to the inappropriaterecording of amortization on bond premiums by taking the following steps: (a)requiring that a review of bond investment accounting be performed byadditional accounting personnel; and (b) requiring that a reconciliation ofgeneral ledger accounts with the calculation of accumulated other comprehensiveincome be performed by the accounting department and reviewed by an appropriatesupervisor. These new controls were found to be effectively working during theCompany’s fourth quarter.

51

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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 May 18,2005 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 May 18, 2005is incorporated herein by reference.

**ITEM 12.   SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT** ANDRELATED STOCKHOLDER MATTERS.

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 May 18, 2005 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 May 18,2005 is incorporated herein by reference.

**ITEM 14.   PRINCIPALACCOUNTANT FEES AND SERVICES**

The information appearingunder the caption “Audit Fees” in the Company’s definitive proxy statement relatingto the Annual Meeting of Stockholders to be held on May 18, 2005 isincorporated 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** |
|---------------------------------------------------------------------------------------|------------|------------------|
| Report  of Independent Registered Public Accounting Firm                              |       | F-2              |
| Consolidated statements of (loss)  income                                             |       | F-4              |
| Consolidated balance sheets                                                           |       | F-5              |
| Consolidated statements of  stockholders’ equity and comprehensive (loss) income |       | F-6              |
| Consolidated statements of cash  flows                                                |       | F-8              |
| Notes to consolidated financial  statements                                           |       | F-10             |

 

52

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(a) (2)           Financial Statement Schedules

The following financial schedule of Albany MolecularResearch, Inc. is included in this annual report on Form 10-K.
| Schedule II—Valuation and  Qualifying Accounts |   | 1 |
|-----------------------------------------------------|--------|---|

 

Schedules otherthan that which is listed above have been omitted since they are either notrequired, are not applicable, or the required information is shown in theconsolidated financial statements or related notes.

(a) (3)           Exhibits

**EXHIBITINDEX**
| 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)).                                                                                                                                                                                                 |

53

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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 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.8   |   | Agreement dated December 16, 1997 by and between  the Company and Eli Lilly and Company (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 10.9 to Amendment No. 3 to the Company’s Registration  Statement on Form S-1 (File No. 333-58795)).                                     |
| 10.9*  |   | 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)).                                                                                                                                                                                                                                                                        |
| 10.10* |   | 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).                                                                                                                                                                                                                  |
| 10.11* |   | 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).                                                                                                                                                                                                                          |
| 10.12* |   | 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).                                                                                                                                                                                                                        |
| 10.13* |   | 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)).                                                                                                                                               |
| 10.17* |   | 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).                                                                                                                                                                                                             |
| 10.18* |   | Employment Agreement between the Company and James J.  Grates (incorporated herein by reference to Exhibit 10.18 to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 1999, File No. 000-25323).                                                                                                                                                                                                                                |
| 10.19  |   | 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  (filed herewith).                                                                                                                                                                                                                                                                               |
| 10.21  |   | 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).                                                                                                                                                       |
| 10.22* |   | Amended and Restated Technology Development Incentive  Plan (confidential treatment has been requested as to certain portions of  this Exhibit).                                                                                                                                                                                                                                                                                                                                         |
| 21.1   |   | Subsidiaries of the Company (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 23.1   |   | 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                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

----

*       Denotes management contract of compensation plan orarrangement

54

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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 15, 2005 | 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* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
|                                    | **Signature**                                | ** **                                                                                            | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------------------|----------------------------------------------|-------------------------------------------------------------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/* *THOMAS E.  D’AMBRA |                                         | Chairman of the Board,  President, Chief Executive Officer and Director (Principal Executive Officer) |       | March 15,  2005 |
| Thomas E.  D’Ambra, Ph.D.     |
| /s/  MARK T. FROST                 |                                         | Chief Financial Officer,  Treasurer and Secretary                                                     |       | March 15,  2005 |
| Mark T. Frost                      | (Principal Financial and Accounting Officer) |
| /s/  PAUL S. ANDERSON              |                                         | Director                                                                                              |       | March 15,  2005 |
| Paul S. Anderson,  Ph.D.           |                                         |                                                                                                  |       |                 |
| /s/  FRANK W. HAYDU                |                                         | Director                                                                                              |       | March 15,  2005 |
| Frank W.  Haydu, III          |                                         |                                                                                                  |       |                 |
| /s/  DONALD E. KUHLA               |                                         | Director                                                                                              |       | March 15,  2005 |
| Donald E. Kuhla,  Ph.D.            |                                         |                                                                                                  |       |                 |
| /s/  KEVIN O’CONNOR           |                                         | Director                                                                                              |       | March 15,  2005 |
| Kevin O’Connor                |                                         |                                                                                                  |       |                 |
| /s/  ARTHUR J. ROTH                |                                         | Director                                                                                              |       | March 15,  2005 |
| Arthur J. Roth                     |                                         |                                                                                                  |       |                 |
| /s/  ANTHONY P. TARTAGLIA          |                                         | Director                                                                                              |       | March 15,  2005 |
| Anthony P.  Tartaglia, M.D.        |                                         |                                                                                                  |       |                 |

 

55

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**INDEX TOCONSOLIDATEDFINANCIAL STATEMENTS ALBANY MOLECULAR RESEARCH, INC.**
|                                                                                                                                                       | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent  Registered Public Accounting Firm                                                                                              |       | F-2      |   |
| Consolidated  Statements of (Loss) Income for the Years Ended December 31, 2004, 2003  and 2002                                             |       | F-4      |   |
| Consolidated  Balance Sheets at December 31, 2004 and 2003                                                                                       |       | F-5      |   |
| Consolidated  Statements of Stockholders’ Equity and Comprehensive (Loss) Income for the  Years Ended December 31, 2004, 2003 and 2002 |       | F-6      |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2004, 2003  and 2002                                                |       | F-8      |   |
| Notes to Consolidated Financial  Statements                                                                                                           |       | F-10     |   |

 

F-1

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Report ofIndependent Registered Public Accounting Firm

To the Stockholders and Board of Directors ofAlbany Molecular Research, Inc:

We havecompleted an integrated audit of Albany Molecular Research Inc.’s 2004consolidated financial statements and of its internal control over financialreporting as of December 31, 2004 and audits of its 2003 and 2002****consolidated financial statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Ouropinions, based on our audits, are presented below.

Consolidated****financial statements and financial statementschedule

In ouropinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of (loss) income, stockholders’ equity and comprehensive(loss) income and cash flows present fairly, in all material respects, thefinancial position of Albany Molecular Research Inc. and its subsidiaries****at December 31, 2004 and 2003, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2004 in conformity with accounting principles generallyaccepted in the United States of America. In addition, in our opinion, the financialstatement schedule listed in the index appearing under Item 15(a)(2) presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements. These financial statements and financial statementschedule are the responsibility of the Company’s management. Our responsibilityis to express 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 financialstatements are free of material misstatement. Anaudit of financial statements 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.

Internal control over financial reporting

Also, we have audited management’s assessment,included in Management’s Annual Report on Internal Control over FinancialReporting appearing under Item 9A, that Albany Molecular Research Inc. (the “Company”)did not maintain effective internal control over financial reporting as of December 31,2004, because the Company did not maintain effective controls over inventoryvaluation at the Company’s large scale manufacturing facility**,** based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financial reportingbased on our audit.

We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. An audit of internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we consider necessary in the circumstances. We believe thatour audit provides a reasonable basis for our opinions.

F-2

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A company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includesthose policies and procedures that (i) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (ii) 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 (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

Because of its inherent limitations, internalcontrol over 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.

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. The following material weaknesshas been identified and included in management’s assessment. As of December 31,2004, the Company did not maintain effective controls over inventory valuationat the Company’s large scale manufacturing facility**.**Specifically,during the fourth quarter of 2004, the Companyfailed to identify certain obsolete inventory during its year endreconciliation and also failed to demonstrate that its controls over ensuring acomplete and adequate review for excess inventory had been performed bymanagement. In addition, the Company failed to maintain an adequate level ofdocumentary evidence to demonstrate that its amortization period for deferred inventoryvariances was accurate. Furthermore, during the year-endreconciliation of unbilled project costs the Company failed to identify aproject which had been billed but for which the related costs had not beenexpensed. Certainof these control deficiencies resulted in audit adjustments to the December 31,2004 inventory balance. In addition, these control deficiencies could result ina misstatement to the inventory and cost of sales accounts that would result ina material misstatement to annual or interim financial statements that wouldnot be prevented or detected. Accordingly, management has determined that thesedeficiencies constitute a material weakness. The material weakness was****considered in determining thenature, timing, and extent of audit tests applied in our audit of the 2004 consolidated****financial statements, and our opinion regarding theeffectiveness of the Company’s internal control over financial reporting doesnot affect our opinion on those consolidated****financial statements.

In our opinion, management’s assessment that AlbanyMolecular Research Inc. did not maintain effective internal control overfinancial reporting as of December 31, 2004, is fairly stated, in allmaterial respects, based on criteria established in *InternalControl—Integrated Framework* issued by the COSO . Also, in ouropinion, because of the effects of the material weakness described above on theachievement of the objectives of the control criteria, Albany MolecularResearch Inc. has not maintained effective internal control over financialreporting as of December 31, 2004, based on criteria established in *Internal Control—Integrated Framework* issued by the COSO*.*
| /s/PricewaterhouseCoopers LLP |
|-------------------------------|
| Albany, New York              |
| March 14, 2005           |

 

F-3

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**ALBANY MOLECULARRESEARCH, INC.CONSOLIDATED STATEMENTS OF (LOSS) INCOMEYears Ended December 31, 2004, 2003 and 2002(Dollars in thousands, except per share amounts)**
| ** **                                     | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                     | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Contract revenue                               |       | $                                          | 121,554    |   | $ | 144,667 |   |   | $ | 71,688 |   |   |
| Recurring royalties                            |       | 47,973                                     |       | 51,682 |   |   | 51,139 |   |   |
| Total revenue                                  |       | 169,527                                    |       | 196,349 |   |   | 122,827 |   |   |
| Cost of contract revenue                       |       | 96,932                                     |       | 101,753 |   |   | 41,313 |   |   |
| Write-down of library inventories              |       | 5,974                                      |       | — |   |   | — |   |   |
| Total cost of contract  revenue                |       | 102,906                                    |       | 101,753 |   |   | 41,313 |   |   |
| Technology incentive award                     |       | 4,789                                      |       | 5,183 |   |   | 5,107 |   |   |
| Research and development                       |       | 23,887                                     |       | 22,466 |   |   | 7,096 |   |   |
| Selling, general and administrative            |       | 22,812                                     |       | 20,318 |   |   | 12,897 |   |   |
| Property and equipment impairment              |       | 4,728                                      |       | — |   |   | — |   |   |
| Goodwill impairment                            |       | 14,494                                     |       | — |   |   | — |   |   |
| Intangible asset impairment                    |       | 3,541                                      |       | — |   |   | — |   |   |
| Restructuring charge                           |       | 1,184                                      |       | — |   |   | — |   |   |
| Total costs and expenses                       |       | 178,341                                    |       | 149,720 |   |   | 66,413 |   |   |
| (Loss) income from  operations                 |       | (8,814                                     | )          | 46,629 |   |   | 56,414 |   |   |
| Equity in loss of unconsolidated  affiliates   |       | (65                                        | )          | (372 | ) |   | 2,795 |   |   |
| Interest expense                               |       | (1,641                                     | )          | (1,446 | ) |   | (168 | ) |   |
| Interest income                                |       | 1,958                                      |       | 2,231 |   |   | 3,276 |   |   |
| Minority interest in consolidated subsidiaries |       | —                                     |       | 133 |   |   | — |   |   |
| Loss on equity investment                      |       | (1,274                                     | )          | — |   |   | — |   |   |
| Other (expense), income net                    |       | (18                                        | )          | 403 |   |   | 93 |   |   |
| (Loss) income before income  tax expense       |       | (9,854                                     | )          | 47,578 |   |   | 62,410 |   |   |
| Income tax expense                             |       | 1,837                                      |       | 16,714 |   |   | 22,686 |   |   |
| Net (loss) income                              |       | $                                          | (11,691    | ) | $ | 30,864 |   |   | $ | 39,724 |   |   |
| Basic (loss) earnings per  share               |       | $                                          | (0.37      | ) | $ | 0.97 |   |   | $ | 1.22 |   |   |
| Diluted (loss) earnings per share              |       | $                                          | (0.37      | ) | $ | 0.95 |   |   | $ | 1.19 |   |   |

 

See Accompanying Notes to Consolidated Financial Statements.

F-4

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**ALBANY MOLECULARRESEARCH, INC.CONSOLIDATED BALANCE SHEETSYears Ended December 31, 2004 and 2003(In thousands, except per share amounts)**
| ** **                                                                                                                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                         | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **Assets**                                                                                                                                         |       |                  |       |   |   |
| Current assets:                                                                                                                                    |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                         |       | $                     | 41,171     |   | $ | 18,187 |   |
| Investment  securities, available-for-sale                                                                                                         |       | 92,578                |       | 106,441 |   |
| Accounts  receivable (net of allowance for doubtful accounts of $205 at  December 31, 2004 and $309 at December 31, 2003) |       | 14,263                |       | 18,261 |   |
| Royalty income  receivable                                                                                                                         |       | 12,178                |       | 12,970 |   |
| Inventory                                                                                                                                          |       | 32,415                |       | 34,292 |   |
| Unbilled services                                                                                                                                  |       | 21                    |       | 248 |   |
| Prepaid expenses  and other current assets                                                                                                         |       | 3,893                 |       | 5,254 |   |
| Property and  equipment held for sale                                                                                                              |       | 5,627                 |       | — |   |
| Total current  assets                                                                                                                              |       | 202,146               |       | 195,653 |   |
| Property and  equipment, net                                                                                                                       |       | 145,753               |       | 146,639 |   |
| Other assets:                                                                                                                                      |       |                  |       |   |   |
| Goodwill                                                                                                                                           |       | 25,747                |       | 40,241 |   |
| Intangible assets  and patents, net                                                                                                                |       | 1,201                 |       | 4,864 |   |
| Equity investment  in unconsolidated affiliates                                                                                                    |       | 956                   |       | 2,191 |   |
| Other assets                                                                                                                                       |       | 1,089                 |       | 1,357 |   |
| Total other assets                                                                                                                                 |       | 28,993                |       | 48,653 |   |
| Total assets                                                                                                                                       |       | $                     | 376,892    |   | $ | 390,945 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                      |       |                  |       |   |   |
| Current liabilities:                                                                                                                               |       |                  |       |   |   |
| Accounts payable  and accrued expenses                                                                                                             |       | $                     | 9,621      |   | $ | 8,776 |   |
| Deferred revenue                                                                                                                                   |       | 2,089                 |       | 1,179 |   |
| Accrued  compensation                                                                                                                              |       | 4,668                 |       | 4,068 |   |
| Accrued pension  benefits                                                                                                                          |       | 631                   |       | 2,500 |   |
| Income taxes  payable                                                                                                                              |       | 846                   |       | — |   |
| Current  installments of long-term debt                                                                                                            |       | 4,526                 |       | 4,521 |   |
| Total current  liabilities                                                                                                                         |       | 22,381                |       | 21,044 |   |
| Long-term liabilities:                                                                                                                             |       |                  |       |   |   |
| Long-term  debt, excluding current installments                                                                                                    |       | 48,603                |       | 53,129 |   |
| Deferred income  taxes                                                                                                                             |       | 6,997                 |       | 11,407 |   |
| Pension and  postretirement benefits                                                                                                               |       | 3,139                 |       | 2,844 |   |
| Environmental  liabilities                                                                                                                         |       | 296                   |       | 343 |   |
| Swap contract                                                                                                                                      |       | —                |       | 243 |   |
| Total liabilities                                                                                                                                  |       | 81,416                |       | 89,010 |   |
| Commitments and contingencies                                                                                                                      |       |                  |       |   |   |
| 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; 33,942 shares issued in  2004 and 33,694 shares issued in 2003       |       | 340                   |       | 337 |   |
| Additional paid-in  capital                                                                                                                        |       | 189,608               |       | 184,365 |   |
| Retained earnings                                                                                                                                  |       | 142,816               |       | 154,507 |   |
| Accumulated other  comprehensive loss, net                                                                                                         |       | (117                  | )          | (103 | ) |
|                                                                                                                                               |       | 332,647               |       | 339,106 |   |
| Less, treasury  shares at cost, 2,077 shares in 2004 and 2003                                                                       |       | (37,171               | )          | (37,171 | ) |
| Total  stockholders’ equity                                                                                                                   |       | 295,476               |       | 301,935 |   |
| Total liabilities  and stockholders’ equity                                                                                                   |       | $                     | 376,892    |   | $ | 390,945 |   |

See Accompanying Notes to Consolidated Financial Statements.

F-5

----

**ALBANY MOLECULAR RESEARCH, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY ANDCOMPREHENSIVE (LOSS) INCOMEYears Ended December 31, 2002, 2003 and 2004**
| ** **                                                                  | ** ** | ** **              | ** **    | **Common Stock** | ** ** | **Additional**        | ** ** | ** **  | ** ** | **Accumulated   Other**  | ** ** | ** **              | ** ** | ** **              | ** **     | ** **             | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|---------------|-----------------------|------------|-----------------------|------------|-------------|------------|--------------------------|------------|-------------------------|------------|-------------------------|----------------|------------------------|------------|
| ** **                                                                  | ** ** | **Preferred**           | ** **    | **Number of**    | ** ** | **Par**               | ** ** | **Paid-in** | ** ** | **Retained**             | ** ** | ** Comprehensive** | ** ** | **Treasury Stock** | ** **     | ** **             | ** ** | **Comprehensive** | ** ** |
| ** **                                                                  | ** ** | **Stock**               | ** **    | **Shares**            | ** ** | ** Value ** | ** ** | **Capital** | ** ** | ** Earnings ** | ** ** | ** Income**        | ** ** | **Shares**              | ** **     | ** Amount ** | ** ** | **Total** | ** ** | ** Income** | ** ** |
| ** **                                                                  | ** ** | **(In thousands)** | ** **    |
| Balances at December 31, 2001                                               |       |                    | $ — |                  |       |                  | 33,127     |        |       |                     | $ 331 |                    |       |                    | $ 180,524 |                   |       |   | $ 83,919 |   |   |   | $ (562 | ) |   | (20 | ) | $    (451 | ) | $ 263,761 |   |   |   |   |   |
| Comprehensive income:                                                       |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    |           |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                  |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    |           |                   |       |   | 39,724 |   |   |   |   |   |   |   |   |   |   | 39,724 |   |   | $ 39,724 |   |   |
| Unrealized gain on investment securities, available-for-sale,  net of taxes |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    |           |                   |       |   |   |   |   |   | 130 |   |   |   |   |   |   | 130 |   |   | 130 |   |   |
| Organichem Corporation Other Comprehensive Loss                             |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    |           |                   |       |   |   |   |   |   | (361 | ) |   |   |   |   |   | (361 | ) |   | (361 | ) |   |
| Total comprehensive income                                                  |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    |           |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ 39,493 |   |   |
| Tax benefit from exercise of stock options                                  |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    | 427            |                   |       |   |   |   |   |   |   |   |   |   |   |   |   | 427 |   |   |   |   |   |
| Issuance of common stock in connection with stock  option plan and ESPP     |       |                    |          |                  |       |                  | 318        |        |       |                     | 3          |                    |       |                    | 1,191          |                   |       |   |   |   |   |   |   |   |   |   |   |   |   | 1,194 |   |   |   |   |   |
| Issuance of warrants to BMS                                                 |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    | 500            |                   |       |   |   |   |   |   |   |   |   |   |   |   |   | 500 |   |   |   |   |   |
| Treasury shares purchased                                                   |       |                    |          |                  |       |                  |       |        |       |                     |       |                    |       |                    |           |                   |       |   |   |   |   |   |   |   |   | (1,098 | ) | (23,228 | ) | (23,228 | ) |   |   |   |   |
| 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 |   |   |   |   |   |

F-6

 

----

 
| 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 |   |   |                         |   |   |

 

See Accompanying Notes to Consolidated Financial Statements.

F-7

 

----

**ALBANY MOLECULAR RESEARCH, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2004, 2003 and 2002 (In thousands)**
| ** **                                                                                       | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Operating  Activities**                                                                        |       |                                       |       |   |   |   |   |
| Net (loss) income                                                                                |       | $                                          | (11,691    | ) | $ | 30,864 |   | $ | 39,724 |   |
| Adjustments to reconcile net  (loss) income to net cash provided by operating activities:        |       |                                       |       |   |   |   |   |
| Depreciation  and amortization                                                                   |       | 15,264                                     |       | 13,105 |   | 4,906 |   |
| Net  amortization of premiums on securities                                                      |       | 446                                        |       | 324 |   | 827 |   |
| Abandonment  loss                                                                                |       | —                                     |       | 1,400 |   | — |   |
| Provision  for obsolete inventories                                                              |       | 3,579                                      |       | 645 |   | — |   |
| Write-down  of library inventories                                                               |       | 5,974                                      |       | — |   | — |   |
| Property,  plant and equipment impairment                                                        |       | 4,728                                      |       | — |   | — |   |
| Goodwill  impairment                                                                             |       | 14,494                                     |       | — |   | — |   |
| Intangible  asset impairment                                                                     |       | 3,541                                      |       | — |   | — |   |
| Warrant  issuance expense                                                                        |       | 3,053                                      |       | — |   | 500 |   |
| Provision  for doubtful accounts                                                                 |       | (77                                        | )          | 279 |   | — |   |
| Loss  on equity investment in unconsolidated affiliates                                          |       | 1,274                                      |       | — |   | — |   |
| Tax  benefit of stock option exercises                                                           |       | 347                                        |       | 591 |   | 427 |   |
| Equity  in loss (income) of unconsolidated affiliates                                            |       | 65                                         |       | 372 |   | (2,795 | ) |
| Minority  interest in consolidated subsidiary                                                    |       | —                                     |       | (133 | ) | — |   |
| Forgiven  principal on notes receivable- related party                                           |       | 91                                         |       | 192 |   | 200 |   |
| Deferred  income tax (benefit) expense                                                           |       | (4,366                                     | )          | 3,280 |   | 3,157 |   |
| Net  realized loss on sale of securities                                                         |       | 36                                         |       | — |   | — |   |
| Change  in fair value of non-hedge interest rate swap                                            |       | —                                     |       | (231 | ) | — |   |
| (Increase) decrease in  operating assets, net of business combination:                           |       |                                       |       |   |   |   |   |
| Accounts  receivable                                                                             |       | 3,971                                      |       | (980 | ) | (3,607 | ) |
| Royalty  income receivable                                                                       |       | 792                                        |       | 280 |   | (890 | ) |
| Unbilled  services                                                                               |       | 227                                        |       | 308 |   | 439 |   |
| Inventory                                                                                        |       | (8,286                                     | )          | (2,958 | ) | (6,929 | ) |
| Prepaid  expenses and other assets                                                               |       | 1,523                                      |       | 2,548 |   | 1,356 |   |
| Increase (decrease) in  operating liabilities, net of business combination:                      |       |                                       |       |   |   |   |   |
| Accounts  payable, accrued compensation and accrued expenses                                     |       | 1,445                                      |       | (4,901 | ) | 293 |   |
| Income  taxes payable                                                                            |       | 846                                        |       | 2,060 |   | (967 | ) |
| Deferred  revenue                                                                                |       | 910                                        |       | 63 |   | (1,872 | ) |
| Pension  and postretirement benefits                                                             |       | (1,574                                     | )          | (733 | ) | — |   |
| Environmental  liability                                                                         |       | (47                                        | )          | (81 | ) | — |   |
| Net cash provided by operating activities                                                        |       | 36,565                                     |       | 46,294 |   | 34,769 |   |
| **Investing Activities**                                                                         |       |                                       |       |   |   |   |   |
| Net  purchases of securities                                                                     |       | (63,213                                    | )          | (34,081 | ) | (87,318 | ) |
| Proceeds  from sale of investment securities                                                     |       | 76,268                                     |       | 41,425 |   | 71,191 |   |
| Purchase  of business, net of cash acquired                                                      |       | —                                     |       | (28,304 | ) | — |   |
| Purchases  of property, plant and equipment                                                      |       | (23,716                                    | )          | (30,554 | ) | (17,387 | ) |
| Payments  for patent applications and other costs                                                |       | (245                                       | )          | (410 | ) | (317 | ) |
| Purchase  of equity investment in unconsolidated affiliate                                       |       | —                                     |       | — |   | (342 | ) |
| Net cash used in investing activities                                                            |       | (10,906                                    | )          | (51,924 | ) | (34,173 | ) |
| **Financing Activities**                                                                         |       |                                       |       |   |   |   |   |
| Proceeds  from borrowings under long-term debt                                                   |       | —                                     |       | 30,071 |   | — |   |
| Principal  payments on capital leases                                                            |       | —                                     |       | (491 | ) | (438 | ) |
| Principal  payments on long-term debt                                                            |       | (4,521                                     | )          | (8,469 | ) | (230 | ) |
| Payment  to acquire treasury shares                                                              |       | —                                     |       | (13,492 | ) | (23,228 | ) |
| Proceeds  from exercise of options and ESPP                                                      |       | 1,846                                      |       | 1,135 |   | 1,194 |   |
| Net cash (used in) provided by financing activities                                              |       | (2,675                                     | )          | 8,754 |   | (22,702 | ) |
| Increase (decrease) in cash and cash equivalents                                                 |       | 22,984                                     |       | 3,124 |   | (22,106 | ) |
| Cash and cash equivalents at beginning of period                                                 |       | 18,187                                     |       | 15,063 |   | 37,169 |   |
| Cash and cash equivalents at end of period                                                       |       | $                                          | 41,171     |   | $ | 18,187 |   | $ | 15,063 |   |
| Supplemental disclosure  of non-cash investing and financing activities:                         |       |                                       |       |   |   |   |   |
| Increase  (decrease) in net unrealized gain/(loss) on securities available-for-sale,  net of tax |       | $                                          | (196       | ) | $ | (189 | ) | $ | 130 |   |
| Increase  (decrease) in net unrealized gain/(loss) on swap contract, net of tax                  |       | $                                          | 182        |   | $ | (156 | ) | — |   |
| 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                                                                                         |       | $                                          | 1,846      |   | $ | 1,265 |   | $ | 152 |   |
| Income taxes                                                                                     |       | $                                          | 4,545      |   | $ | 10,728 |   | $ | 20,899 |   |

 

F-8

----

**ALBANY MOLECULAR RESEARCH, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31, 2004, 2003 and 2002 (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 Financial Statements.

F-9

----

**ALBANY MOLECULARRESEARCH, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2004, 2003 and 2002(In thousands, except per share amounts)**

**1.   Summary ofSignificant Accounting Policies**

**Nature of Business:**

Albany Molecular Research, Inc.(the “Company”) is a leading chemistry-based drug discovery anddevelopment company focused on applications for new small molecule prescriptiondrugs. The Company conducts research and development projects and collaborateswith many leading pharmaceutical and biotechnology companies, and is developingnew chemistry technology for potential pharmaceutical products. The Companyengages in chemistry research, from lead discovery, optimization anddevelopment to commercial manufacturing. In addition to its chemistry researchservices, the Company also conducts proprietary research and development todevelop new technologies and to discover new lead compounds with commercialpotential. The Company seeks to 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 drugs successfullyreaching the market. The Company is also producing novel compound collectionsand chemical screening collections. The Company’s wholly-owned subsidiary,Organichem Corporation, provides a wide range of custom chemical developmentand manufacturing services. Organichem conducts commercial manufacturing ofactive pharmaceutical ingredients and advanced intermediates.

**Basis of Presentation:**

The consolidated financial statements include theaccounts of Albany Molecular Research, Inc. (“AMRI”) and its wholly-ownedsubsidiaries, Organichem Corporation (“Organichem”), AMRI Bothell ResearchCenter, AMR Technology, Inc. and Albany Molecular Research Export, Inc.All intercompany balances and transactions have been eliminated duringconsolidation. When necessary, prior years’ consolidated financial statementshave been reclassified to conform to the current year presentation.

Under the terms of the Debenture Purchase Agreementwith Organichem Corporation described in Note 3, the Company converteddebentures into additional shares of Organichem common stock on January 1,2003, thereby increasing the Company’s ownership interest of OrganichemCorporation to 75%. Accordingly, 100% of the operating results of OrganichemCorporation have been included in the Company’s results of operations from January 1,2003 to February 11, 2003, with an offset to minority interest inconsolidated subsidiaries equal to 25% of Organichem Corporation’s operatingresults.

On February 12, 2003,the Company exercised its call option under the Put/Call Agreement described inNote 3 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.

**RevenueRecognition:**

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

F-10

----

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 onthe number 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 predetermined payment schedules, or thesubmission of appropriate billing detail establishing prerequisites forbillings. Deferred revenue represents monies received for services that havenot 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’s 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. We record royalty revenue in the period in which the salesof Allegra/Telfast occur, because we can reasonably estimate such royalties. Royaltypayments from Sanofi-Aventis are due within 45 days after eachcalendar quarter and are determined based on sales of Allegra/Telfast in thatquarter.

**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 forDoubtful 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 consists primarily of commercially availablefine chemicals used as raw materials in the research and production process,work-in-process and finished goods in our Organichem location and chemicalcompounds in the form of natural product and novel compound libraries. TheCompany 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. Organichem inventories are valued based on standardcosts as they are produced. Variances from standard costs are accumulated asthey are incurred and are included in the carrying value of inventory. Accumulatedvariances are deferred and recognized through cost of contract revenue in theconsolidated statement of income over the estimated period of inventory turns.The Company writes down inventories for obsolescence equal to the differencebetween the cost of inventory and the estimated market value based uponassumptions about future demand and market conditions. Any such write-downwould result in a charge to operations.

F-11

----

As part of the Company’s strategy to provide acomprehensive offering of natural product and chemical lead finding discoveryservices and technologies to its customers, it has acquired natural productsample collections and related assets and is producing novel compound librariesand chemical screening collections. The natural product sample collections wereacquired in connection with the 2001 acquisition of NCE. For internallydeveloped libraries, the Company is capitalizing the cost of internallyproducing novel compound and screening collections in inventory. Initial coststo develop novel compound libraries are categorized as research and developmentexpense until such time it becomes probable that a salable library can besuccessfully produced. As a result, costs for the design, research, and testingof libraries under development are expensed as incurred. Our research chemistsreview the results of analytical procedures to determine if the chemicalreactions were completed as expected and the product purity and product yieldsare within required specifications. This “validation” process determineswhether the chemistry is successful and if a salable product will result. Wecapitalize costs of production to inventory once the validation process iscompleted and successful production is reasonably assured. If a core reactionis unsuccessful, the library template is abandoned and no further developmenttakes place.

Capitalized costs areamortized over the economic life of the library (estimated at 3 years) at thegreater of (a) the ratio of the product’s current gross revenue to thetotal of current and expected gross revenues or (b) the straight-linemethod computed by dividing the remaining unamortized capitalized cost by theremaining economic life of the product. The remaining economic life isreassessed quarterly and changes in estimate, if appropriate, are made to theamortization model. Amortization of library inventories is included within costof contract revenue on the consolidated income statement. In addition, theCompany monitors the carrying value of its natural product and lead findingsample collections for impairment on a quarterly basis. The Company comparesthe carrying values of these collections to their estimated net realizable fairvalues, which are based on estimated future sales of these collections, todetermine impairment. The Company recognizes an impairment charge for anycollection whose carrying value is greater than its estimated net realizablefair value.

**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 comprehensive income. The amortized cost of debtsecurities in this category is adjusted for amortization of premiums andaccretion of discounts to maturity. Such amortization is included in interestincome or expense. Realized gains and losses and declines in value judged to beother-than-temporary, if any, on available-for-sale securities are included inother income or expense. The cost of securities sold is based on the specificidentification method. Interest and dividends on securities classified asavailable-for-sale are included in interest income.

At December 31, 2004and 2003, our investment in marketable securities in the current assets sectionof the balance sheets included $39.8 million and $40.3 million, respectively,of auction rate municipal bonds, classified as available-for-sale securities. Ourinvestments in these securities are recorded at cost, which approximates fairmarket value due to their variable interest rates, which typically reset every7 to 35 days, and, despite the long-term nature of their stated contractualmaturities, we have the ability to quickly liquidate these securities. As aresult, we had no cumulative gross unrealized holding gains (losses) or grossrealized gains (losses) from these securities. All income generated from thesecurrent investments was recorded as interest income.

*RevisedClassification of Certain Securities*

Effective December 31, 2004, we have reclassifiedour auction rate municipal bonds as marketable securities in current assets. Previously,such investments had been classified as cash and cash equivalents. 

F-12

----

Accordingly, we havereflected these securities as marketable securities in the current assetssection of our balance sheets as of December 31, 2004 and 2003. We havealso made corresponding adjustments to our statements of cash flows for theyears ended December 31, 2004, 2003 and 2002 to reflect the grosspurchases and sales of these securities as investing activities rather than asa component of cash and cash equivalents. This reclassification does not affectpreviously reported cash flows from operations or from financing activities inour previously reported statements of cash flows or our previously reportedstatements of operations for any period.

As reported at December 31, 2003 and 2002, $29.3million and $19.8 million, respectively, of these current investments wereclassified as cash equivalents on our balance sheet. These investments havebeen reclassified to short-term investments from cash and cash equivalents aspreviously reported.

For the fiscal years endedDecember 31, 2003 and 2002, the change in net cash used in investingactivities from previously reported amounts related to these short-term auction rate securities was ($9.5) millionand ($10.0) million, respectively.

**Property andEquipment:**

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 determinedusing the straight-line method over the estimated useful lives of theindividual assets. Accelerated methods of depreciation have been used forincome 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.

**Equity Investmentsin 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 are recorded athistorical cost. The third equity investment is accounted for under the equitymethod of accounting.

The Company records animpairment charge when we believe an investment has experienced a decline invalue that is other than temporary. Future adverse changes in market conditionsor poor operating 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.

F-13

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**Long-Lived Assets:**

In accordance withthe provisions of Statement of Financial Accconting Standards (SFAS) No. 144,*Accounting for Impairment or Disposal of Long-LivedAssets,*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;

·       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 with theprovisions of SFAS No. 142, *Goodwill and OtherIntangible Assets,* 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, 2004 are $23.1 million related to the acquisition ofOrganichem Corporation and $2.7 million related to the acquisition of AmericanAdvanced Organics, Inc. See Note 20 for further information on the Company’sgoodwill balances.

**Patents, PatentApplication 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.

F-14

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**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 Derivativesand Hedging Activities*as amended by SFAS No. 138,*Accounting for Certain Derivative and Certain Hedging Activities.*Accordingly,these contracts are reported at fair value in the consolidated balance sheet,and any change in fair value is recorded as an adjustment to accumulated othercomprehensive income, net of tax, because the hedges are deemed effective.

**Pension andpostretirement 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 inthe future due to changes in the assumptions.

**Environmentalcosts:**

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 andDevelopment:**

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 liabilitiesare recognized for the income tax consequences attributable to differencesbetween the financial statement carrying amounts of existing assets andliabilities and their respective tax bases. Deferred tax assets and liabilitiesare measured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in income in the period that includes the enactment date.

**Stock-BasedCompensation:**

The Company applies the intrinsic value-basedmethod of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations, inaccounting for its fixed plan stock options. As such, compensation expensewould be recorded only if, on the date of grant, the current market price ofthe underlying stock exceeded the exercise price. Any compensation expensewould be recognized over the vesting period.

UnderSFAS 123, *Accounting for Stock-Based Compensation,*compensation cost for stock option grants would be based on the fair value atthe grant date and the resulting compensation expense would be shown as anexpense on the consolidated statements of income as the option vests. Hadcompensation cost 

F-15

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for the Company been determined consistent with SFAS No. 123,the Company’s net income and earnings per share would have been reduced to thefollowing pro-forma amounts:
| ** **                                                                                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income:                                                                                                                                        |       |                                  |       |   |   |   |   |
| As reported                                                                                                                                        |       | $                                     | (11,691    | ) | $ | 30,864 |   | $ | 39,724 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |       | 3,076                                 |       | 3,555 |   | 3,335 |   |
| Pro forma                                                                                                                                          |       | $(14,767                              | )          | $ | 27,309 |   | $ | 36,389 |   |
| Earnings per share:                                                                                                                                |       |                                  |       |   |   |   |   |
| Basic as reported                                                                                                                                  |       | $                                     | (0.37      | ) | $ | 0.97 |   | $ | 1.22 |   |
| Basic pro forma                                                                                                                                    |       | $                                     | (0.47      | ) | $ | 0.86 |   | $ | 1.12 |   |
| Diluted as  reported                                                                                                                               |       | $                                     | (0.37      | ) | $ | 0.95 |   | $ | 1.19 |   |
| Diluted pro forma                                                                                                                                  |       | $                                     | (0.47      | ) | $ | 0.84 |   | $ | 1.09 |   |

 

Theper share weighted-average fair value of stock options granted isdetermined using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions.
| ** **             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected Life (years): |       |     |       |     |       |     |       |
| ISO                    |       | 5        |       | 5        |       | 5        |       |
| Non-qualified          |       | 5        |       | 5        |       | 5        |       |
| Interest rate          |       | 3.41     | %          | 2.96     | %          | 3.03     | %          |
| Volatility             |       | 59       | %          | 62       | %          | 71       | %          |
| 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 tables provide basic and diluted earnings per share calculations:
| ** **                        | ** ** | **Year Ended December 31, 2004** | ** ** | **Year Ended December 31, 2003** | ** ** | **Year Ended December 31, 2002** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | ** **                                           | ** ** | **Weighted**                                         | ** ** | ** **                                           | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Net**                                              | ** ** | **Average**                                          | ** ** | **Per Share**                                   | ** ** | **Net** | ** ** | **Average** | ** ** | **Per Share** | ** ** | **Net** | ** ** | **Average** | ** ** | **Per Share** | ** ** |
| ** **                        | ** ** | **Income**                                           | ** ** | **Shares**                                           | ** ** | **Amount**                                           | ** ** | **Income** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic earnings  per share         |       | $                                                    | (11,691    | )                                                    |       | 31,627                                               |       |   |   | $ | (0.37 | ) |   | $ | 30,864 |   |   | 31,880 |   |   |   | $ | 0.97 |   |   | $ | 39,724 |   |   | 32,632 |   |   |   | $ | 1.22 |   |   |
| Dilutive effect  of stock options |       | —                                               |       |                                                 | —     |                                                 |       |   | — |   |   | — |   |   | 486 |   |   |   | (0.02 | ) |   | — |   |   | 677 |   |   |   | (0.03 | ) |   |
| Diluted earnings per  share       |       | $                                                    | (11,691    | )                                                    |       | 31,627                                               |       |   |   | $ | (0.37 | ) |   | $ | 30,864 |   |   | 32,366 |   |   |   | $ | 0.95 |   |   | $ | 39,724 |   |   | 33,309 |   |   |   | $ | 1.19 |   |   |

 

The amount ofanti-dilutive options and warrants outstanding were 3,519, 2,025 and 1,452 forthe years ended December 31, 2004, 2003 and 2002, respectively, and wereexcluded from the calculation of diluted earnings per share.

F-16

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**RestructuringCharges*:***

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

**Use of ManagementEstimates:**

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, and disclosures of contingent assets and liabilities, at the dateof the financial statements, and the reported amounts of revenues and expensesduring the reporting period. The most significant estimates included in theaccompanying consolidated financial statements include assumptions regardingthe collectibility of receivables, the valuation of inventory, and the fairvalue of goodwill, intangible assets, and long-lived assets. Other significantestimates include assumptions utilized in determining the amount andrealizabilty of deferred tax assets and assumptions utilized in determiningactuarial obligations in conjunction with the Company’s pension andpostretirement health plans. Actual results can vary from these estimates.

**Recent AccountingPronouncements:**

In November 2004, the FASBissued Statement No. 151, *Inventory Costs—anAmendment of ARB No. 43, Chapter 4*, to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). This Statement requires that those itemsbe recognized as current-period charges regardless of whether they meet thecriterion of “so abnormal” as defined in ARB No. 43. In addition, thisStatement requires that allocation of fixed production overheads to the costsof conversion be based on the normal capacity of the production facilities. Theprovisions of this Statement are effective for inventory costs incurred duringfiscal years beginning after June 15, 2005, with earlier applicationpermitted. This statement applies to the Company for the fiscal year ending December 31,2006. The Company will assess the impact of applying this statement in 2005.

In December 2004, the FASB issued Statement No. 123(Revised), *Share-Based Payment (Revised),* whichamends FASB Statement No. 123 *Accounting for Stock-BasedCompensation,*and supersedes APB Opinion No. 25, *Accounting for Stock 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 inan entity incurs liabilities in exchange for goods or services that are basedon the fair value of the entity’s equity instruments or that may be settled bythe issuance of those equity instruments. This Statement requires that the costresulting from all share-based payment transactions be recognized in thefinancial statements based on fair value of the share-based payment. ThisStatement establishes fair value as the measurement objective in accounting forshare-based payment transactions with employees, except for equity instrumentsheld by employee share ownership plans. This statement applies to the Companyfor the fiscal quarter ending September 30, 2005. The Company expects thatas a result of adopting this Statement that the Company will recognize expensein the consolidated income statement for the fair value of share options issuedto its employees, as well as for the portion of the purchase discount on themarket price of the Company’s common stock offered to employees in conjunctionwith the Company’s Employee Stock Purchase Plan (ESPP) that is consideredcompensatory based on the guidance in FAS No. 123(R). The Company has notcompleted its determination, however, it is expected that the application ofthis Statement will have a material impact on the Company’s  results of operations.

F-17

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In December 2004, the FASB issued Staff Position No. FAS109-1, *Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004.* ThisStaff Position clarifies that the tax deduction for qualified domesticproduction activities provided by the American Jobs Creation Act of 2004 (theAct) should be accounted for as a special deduction under FAS 109 as opposed toa tax-rate deduction. The phase-in of the tax deduction begins with qualifyingproduction activities for the year ending December 31, 2005. The Companyhas not determined the amount of tax deduction it expects to receive under theAct or the impact of applying the Staff Position on the Company’s financialposition, results of operations or cash flows.

**2.   Investmentin Organichem**

On December 21, 1999, the Company completed anequity method investment in Organichem Corporation (“Organichem”) pursuant to aStock Purchase Agreement and purchased convertible subordinated debentures ofOrganichem pursuant to a Debenture Purchase Agreement. Under the terms of theStock Purchase Agreement, the Company acquired shares of common stock ofOrganichem representing 37.5% of Organichem’s outstanding common stock, for anaggregate purchase price of $15,131, which included direct costs of $131attributable to the Organichem equity investment. During 2000, Organichempurchased a portion of its common stock into treasury, increasing the Company’sownership interest in Organichem to 39.2%. As a result, the Company recorded aone time benefit to earnings of $159, net of taxes of $98. The Stock PurchaseAgreement also incorporated a Put/Call Agreement among the Company, Organichemand its stockholders that permited the Company to purchase, at the Company’soption, all of the outstanding shares of common stock of Organichem within90 days subsequent to 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.Debentures beared interest, payable semi-annually, on the unpaid principalamount at margins over specified fixed or variable London Interbank Offer Rate(“LIBOR”) as provided for within the Company’s credit agreement with Organichem(4.10% and 5.96% at December 31, 2002 and 2001, respectively). Theagreement provided that the interest payable under the Debentures through December 21,2000 shall be added to the principal of the Debenture, with semi-annual cashinterest payments to begin subsequent to December 21, 2000, provided thatOrganichem was in compliance with the financial covenants of its creditagreement. Accrued interest through December 21, 2000 totaling $1,436 wasadded to the principal of the Debentures. In addition, pursuant to the terms ofthe Debenture Purchase Agreement, the Company and Organichem agreed that in theevent that either the aforementioned put or call options were exercised, 62.5%of the accrued interest not paid by Organichem as of the date of the put orcall exercise shall be applied to reduce the purchase price as determined underthe Put/Call Agreement. Accrued interest receivable from Organichem at December 31,2002 and 2001 totaled $19 and $24, respectively.

The Company converted the debentures under theDebenture Purchase Agreement 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 andacquired all of the outstanding common stock of Organichem for$29.9 million in cash. The purchase price was determined based onOrganichem’s earnings before interest, taxes, depreciation and amortization (“EBITDA”),as defined in the Put/Call Agreement, for the year ending December 31,2002. The purchase price was funded through borrowings under the Company’s newfive year $30.0 million term loan which matures on February 11, 2008.The term loan bears interest at a variable rate based on the Company’s leverageratio. The Company also refinanced $25.5 million of Organichem’s existingbank debt using the Company’s new $35.0 million line of credit. The lineof credit also bears interest at a variable rate based on the Company’sleverage ratio.

F-18

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Thefollowing table summarizes the final allocation of the purchase price to theestimated fair value of the assets acquired as of February 12, 2003.
| **Assets:**                                                                       |   |   |   |
|-----------------------------------------------------------------------------------|--------|--------|--------|
| Cash and cash  equivalents                                                        |   | $      | 1,621  |   |
| Accounts  receivable, net                                                         |   | 7,256  |   |
| Inventory                                                                         |   | 18,685 |   |
| Prepaid expenses  and other current assets                                        |   | 3,305  |   |
| Property, plant  and equipment, net                                               |   | 57,921 |   |
| Other assets                                                                      |   | 571    |   |
| Total Assets                                                                      |   | 89,359 |   |
| **Liabilities:**                                                                  |   |   |   |
| Accounts payable  and accrued expenses                                            |   | 13,958 |   |
| Long-term  debt                                                                   |   | 25,546 |   |
| Deferred income  taxes                                                            |   | 4,699  |   |
| Other liabilities                                                                 |   | 6,123  |   |
| Total Liabilities                                                                 |   | 50,326 |   |
| Purchase price  adjustments:                                                      |   |   |   |
| Inventory write  up to fair value                                                 |   | 441    |   |
| Post-retirement  and pension liability adjustment to projected benefit obligation |   | (2,432 | )      |
| Long-term  debt fair value adjustment                                             |   | (393   | )      |
| Deferred tax  adjustment                                                          |   | 1,851  |   |
| Settlement of  post-retirement benefits                                           |   | 475    |   |
| Curtailment of  pension benefits                                                  |   | 1,322  |   |
| Fixed asset fair  value adjustment                                                |   | (330   | )      |
| Accrued  liabilities and other                                                    |   | (308   | )      |
| Net Assets  Acquired                                                              |   | 39,659 |   |
| Less: Jan 1-Feb  12 Organichem net loss included in consolidated operations       |   | 399    |   |
| Total net assets  acquired                                                        |   | 40,058 |   |
| Purchase price:                                                                   |   |   |   |
| Cash                                                                              |   | 29,926 |   |
| Conversion of  subordinated debentures                                            |   | 15,000 |   |
| Accumulated  equity investment at January 1, 2003                            |   | 18,192 |   |
| Purchase Price                                                                    |   | 63,118 |   |
| Goodwill                                                                          |   | $      | 23,060 |   |

 

F-19

----

Thefollowing table shows the unaudited condensed pro forma statements of incomefor the periods ended December 31, 2003 and 2002 as if the Organichempurchase had occurred at January 1, 2002, respectively:
| ** **                                   | ** ** | **Period Ended December 31,**                                                 | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **       2003       ** | ** ** | **       2002       ** | ** ** |
| Contract revenue                             |       |                                                                                         | $          | 144,667 |   |   |   | $ | 157,930 |   |   |
| Recurring  royalties                         |       |                                                                                         | 51,682     |   |   |   | 51,138 |   |   |
| Total revenue                                |       |                                                                                         | 196,349    |   |   |   | 209,068 |   |   |
| Cost of contract  revenue                    |       |                                                                                         | 101,753    |   |   |   | 107,894 |   |   |
| Technology  incentive award                  |       |                                                                                         | 5,183      |   |   |   | 5,108 |   |   |
| Research and  development                    |       |                                                                                         | 22,466     |   |   |   | 10,489 |   |   |
| Selling, general  and administrative         |       |                                                                                         | 20,318     |   |   |   | 17,180 |   |   |
| Total costs and  expenses                    |       |                                                                                         | 149,720    |   |   |   | 140,671 |   |   |
| Income from  operations                      |       |                                                                                         | 46,629     |   |   |   | 68,397 |   |   |
| Equity in loss of  unconsolidated affiliates |       |                                                                                         | (372       | ) |   |   | (316 | ) |   |
| Interest income  (expense), net              |       |                                                                                         | 785        |   |   |   | (860 | ) |   |
| Other income, net                            |       |                                                                                         | 403        |   |   |   | 854 |   |   |
| Income before  income tax expense            |       |                                                                                         | 47,445     |   |   |   | 68,075 |   |   |
| Income tax  expense                          |       |                                                                                         | 16,668     |   |   |   | 24,497 |   |   |
| Net income                                   |       |                                                                                         | $          | 30,777 |   |   |   | $ | 43,578 |   |   |
| Basic earnings  per share                    |       |                                                                                         | $          | 0.97 |   |   |   | $ | 1.34 |   |   |
| Diluted earnings per  share                  |       |                                                                                         | $          | 0.95 |   |   |   | $ | 1.31 |   |   |

 

**3.   Restructuring**

On May 4, 2004 we announced our plan toconsolidate operations by relocating our Mt. Prospect facility operations toour 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 are included under the caption restructuring charge in thestatements of operations and the restructuring liabilities are included inaccounts payable and accrued expenses on the balance sheet at December 31,2004. The following table displays the restructuring activity and liabilitybalances:
| ** **              | ** ** | ** **                          | ** ** | ** **  | ** ** | ** **   | ** ** | **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 Mount Prospect 

F-20

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Research Center facility,which is included in property and equipment held for sale on the consolidatedbalance 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 statement ofoperations.

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. The long-livedassets associated with Mt. Prospect have been segregated to a separate lineitem on the consolidated balance sheet until they are sold and depreciationexpense has ceased respective to those assets. We anticipate the completion ofthe sale of the facility by June 2006.

The above restructuringactivity was recorded exclusively in the AMR operating segment. The net cashoutflow related to the restructuring for the year ended December 31, 2004was $0.5 million. Anticipated cash outflows related to the restructuring for2005 is $0.6 million, which primarily consists of the payment of accruedtermination benefits and asset disposal costs.

**4.   Inventory**

Inventoryconsisted of the following at December 31, 2004 and 2003:
| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Raw materials                               |       | $                     | 4,818      |   | $ | 11,771 |   |
| Work in process                             |       | 1,273                 |       | 3,622 |   |
| Finished goods                              |       | 22,644                |       | 9,481 |   |
| Libraries, net of  accumulated amortization |       | 3,680                 |       | 9,418 |   |
| Total  inventories, at cost                 |       | $                     | 32,415     |   | $ | 34,292 |   |

 

In connection with the preparation of our results ofoperations for the quarter ended June 30, 2004, we completed an in-depthreview of the carrying value of our library inventories and determined that the carrying value of our naturalproduct and chemical lead finding libraries exceeded their forecasted revenues.The Company’s forecasted revenues from natural product and chemical leadfinding libraries had been lowered to reflect less favorable market conditionsthan previously projected. As a result, the Company recorded a $6.0 millionnon-cash charge to reduce the carrying value of its library inventories. See Note20 for a discussion of impairment charges on related microbial cultures in2004.

The Company evaluates thecarrying value of its inventory of raw materials used in discovery and chemicalservices in consideration of anticipated usage and adjusts its reserves for excessquantities on hand accordingly. Based on its evaluations, the Company wrotedown estimated excess quantities of raw materials inventories by an aggregateof $1.6 million during 2004. The Company’s provisions for excess raw materialsare recorded as a component of cost of contract revenue in the accompanyingcondensed consolidated statement of operations.

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**5.   InvestmentSecurities, 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, 2004** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Obligations of states and political subdivisions |       |                            | $          | 24,887 |   |   |   | $ | 9 |   |   |   | $ | (11 | ) |   | $ | 24,885 |   |
| U.S. Government and Agency Obligations           |       |                            | 28,130     |   |   |   | — |   |   |   | (237 | ) |   | 27,893 |   |
| Auction Rate Securities                          |       |                            | 39,800     |   |   |   | — |   |   |   | — |   |   | 39,800 |   |
|                                             |       |                            | $          | 92,817 |   |   |   | $ | 9 |   |   |   | $ | (248 | ) |   | $ | 92,578 |   |

 
| ** **                                       | ** ** | **December 31, 2003** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Obligations of states and political subdivisions |       |                            | $          | 45,175 |   |   |   | $ | 120 |   |   |   | $ | (40 | ) |   | $ | 45,255 |   |
| Corporate debt obligations                       |       |                            | 20,933     |   |   |   | 12 |   |   |   | (9 | ) |   | $ | 20,936 |   |
| Auction Rate Securities                          |       |                            | 40,250     |   |   |   | — |   |   |   | — |   |   | 40,250 |   |
|                                             |       |                            | $          | 106,358 |   |   |   | $ | 132 |   |   |   | $ | (49 | ) |   | $ | 106,441 |   |

 

Maturitiesof corporate debt obligations, obligations of states and politicalsubdivisions, and auction rate securities classified as available-for-sale at December 31,2004 and 2003 were as follows:
| ** **                             | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Amortized  Cost**             | ** ** | **Fair  Value**                 | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| Due less than one year                 |       |                            | $          | 30,177                          |       |   | $ | 30,133 |   | $ | 53,558 |   | $ | 53,589 |   |
| Due after one year through five years  |       |                            | 25,440     |                            |       | 25,245 |   | 41,425 |   | 41,477 |   |
| Due after five years through ten years |       |                            | —     |                            |       | — |   | — |   | — |   |
| Due after ten years                    |       |                            | 37,200     |                            |       | 37,200 |   | 11,375 |   | 11,375 |   |
|                                   |       |                            | $          | 92,817                          |       |   | $ | 92,578 |   | $ | 106,358 |   | $ | 106,441 |   |

 

Information on temporarily impaired securities at December 31,2004, 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 |       | $                                      | 5,460      |                                   |       | $                           | (11        | ) |   |   | $ | — |   |   |   | $ | — |   |   | $ | 5,460 |   |   | $ | (11 | ) |   |
| U.S.  Government and Agency Obligations            |       | 27,893                                 |       |                                   | (237       | )                           |       |   | — |   |   |   | — |   |   | 27,893 |   |   | (237 | ) |   |
|                                                              |       | $                                      | 33,353     |                                   |       | $                           | (248       | ) |   |   | $ | — |   |   |   | $ | — |   |   | $ | 33,353 |   |   | $ | (248 | ) |   |

 

The above table represents 57securities where the current fair value is less than the related amortized cost.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 

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ofshifts in supply and demand. The Company has the ability and intent to holdthese securities to maturity, at which time full recovery of the investment isexpected.

The Company receivedproceeds of $76.3 million, $41.4 million, and $71.2 million and recordedrealized losses of $36 thousand, $0, and $0 from the sale of available-for-salesecurities during the years ended December 31, 2004, 2003, and 2002,respectively.

**6.   Propertyand Equipment**

Propertyand equipment consists of the following:
| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Laboratory  equipment and fixtures                   |       | $                     | 93,201     |   | $ | 84,255 |   |
| Office equipment                                     |       | 14,928                |       | 11,468 |   |
| Leasehold  improvements                              |       | 25,555                |       | 15,166 |   |
| Buildings                                            |       | 44,387                |       | 29,634 |   |
| Land                                                 |       | 1,949                 |       | 1,905 |   |
|                                                 |       | 180,020               |       | 142,428 |   |
| Less accumulated  depreciation and amortization      |       | (41,246               | )          | (27,002 | ) |
|                                                 |       | 138,774               |       | 115,426 |   |
| Construction-in-progress                             |       | 12,606                |       | 31,213 |   |
| Less: Property  and equipment held for sale (Note 3) |       | (5,627                | )          | — |   |
|                                                 |       | $                     | 145,753    |   | $ | 146,639 |   |

 

Depreciation andamortization expense of property and equipment was $14.2 million, $12.7million, and $4.6 million for the years ended December 31, 2004, 2003 and2002, respectively.

***Impairment Charges:***

The Company’s decision toclose the Mount 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 SFAS144 analyses 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 value. Accordingly,the Company recorded impairment losses on its long-lived assets at its Mt.Prospect and Bothell Research Centers of $1.6 million and $3.1 million,respectively. The Company utilized the assistance of an independent valuationfirm in determining fair values. The impairment charges were recordedexclusively in the AMR operating segment.

***Abandonment Loss:***

In March 2003, the Company terminated its leaseat its Coralville, IA facility subsequent to relocating its combinatorialbiocatalysis discovery operations from Coralville, IA to its Mt. Prospect, ILfacility. The relocation was conducted to gain operating efficiencies byintegrating its combinatorial biocatalysis discovery operations with existinginfrastructure established at the Mt. Prospect facility.

The Company abandonedleasehold improvements at the Coralville, IA facility in connection with theclosing. The Company recorded a loss of $1.4 million equal to the carryingamount of the assets as of March 2003. The loss was included in selling,general and administrative expenses in the consolidated statement of income.

F-23

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**7.   EquityInvestments and Note Receivable**

The Company periodically enters into equityinvestments with companies in the Company’s area of strategic focus. During theyear ended December 31, 2003, the Company made two such equity investmentsin its customers, totaling $2.1 million. Under the terms of these agreements,the Company provided full-time equivalent services to each customer in exchangefor cash and equity securities. The value of the equity securities issued tothe Company was determined based upon the recent cash selling price of thecustomer’s equity securities. The Company accounts for these investments usingthe cost method of accounting for investments as the Company’s ownershipinterest in each customer is below 20% and the Company does not have theability to exercise significant influence over the investee.

The Company recorded these investments at fair value.Revenue was recognized under the original contract agreements. At the time ofconversion, the Company determined that revenue recognition was appropriate ascollection of the receivables was reasonably assured.

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 current market conditionsfor raising capital funding for companies in its industry and the likelihoodthat any funding raised would significantly dilute our ownership percentage. Asa result of this analysis it was our judgment that an other than temporaryimpairment had occurred and that the fair value of our investment was zero,resulting in a non-cash loss on investment of $1.3 million.

The Company also enteredinto a note receivable with one of the companies in which it maintains anequity investment in during 2003. Under the terms of the agreement, the Companyprovided full-time equivalent services to the customer in exchange for the note.The note was repaid in full in 2004, along with all accrued interest. There areno outstanding receivable balances with these investees as of December 31,2004.

**8.   Long-TermDebt and Swap Contracts**

***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 31,2004 the variable interest rate was 3.225%. The line of credit expires in February 2006and bears interest at a variable rate based on the Company’s leverage ratio. Asof December 31, 2004 the variable interest rate was 3.085%. The term loanand line of credit contain certain financial covenants, including a maximumleverage ratio, a minimum required operating cash flow coverage ratio, aminimum earnings before interest and taxes to interest ratio and a minimumcurrent ratio. Other covenants include limits on asset disposals and thepayment of dividends. The Company’s term loan and line of credit agreement wasmodified in 2004 to exclude the impact of impairment charges in the calculationof financial covenants. At December 31, 2004, the Company was incompliance with these covenants.

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 of2.02%.

F-24

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Thefollowing table summarizes long-term debt:
| ** **                                                               | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan                                                                |       |                        | $          | 22,500                      |       |   |   | $ | 26,785 |   |   |
| Line of credit                                                           |       |                        | 25,546     |                        |       |   | 25,546 |   |   |
| Variable interest  rate industrial development authority bonds           |       |                        | 5,050      |                        |       |   | 5,275 |   |   |
| Note payable to  financing company in monthly installments  through 2008 |       |                        | 33         |                        |       |   | 44 |   |   |
|                                                                     |       |                        | 53,129     |                        |       |   | 57,650 |   |   |
| Less current  portion                                                    |       |                        | (4,526     | )                           |       |   | (4,521 | ) |   |
| Total long-term  debt                                                    |       |                        | $          | 48,603                      |       |   |   | $ | 53,129 |   |   |

 

Theaggregate maturities of long-term debt at December 31, 2004 are asfollows:
| 2005       |   | $      | 4,526  |   |
|------------|--------|--------|--------|--------|
| 2006       |   | 30,082 |   |
| 2007       |   | 4,542  |   |
| 2008       |   | 9,899  |   |
| 2009       |   | 260    |   |
| Thereafter |   | 3,820  |   |

 

***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     |                           |         |               |       |               |            |                   |                   |                          |

 

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 1.46% and 1.20% for the years ended December 31,2004 and 2003, respectively. The fair value of the interest rate swapagreements was $44 and $(243) and was included in other long-term assets andswap liability, respectively in the consolidated balance sheets at December 31,2004 and 2003, respectively. The Company recorded an unrealized gain (loss),net of tax of $0.2 million, $(0.2) million, and $0 in accumulatedcomprehensive income related to the change in the fair value of its hedgesduring the years ended December 31, 2004, 2003, and 2002, respectively. TheCompany recognized $0.3 million, $0.6 million, and $0 in additionalinterest expense related to the net settlement of the swaps during the yearsended December 31, 2004, 2003, and 2002, 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 3. Under the terms of the agreement, each party made interest paymentson 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 on

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November 15,2003. Since the previous term facility has been refinanced with new loans, theswap 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.**   IncomeTaxes

Incometax expense (benefit) consists of the following:
| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current:   |       |                                       |       |   |   |   |   |
| Federal    |       | $                                          | 4,923      |   | $ | 13,432 |   | $ | 18,790 |   |
| State      |       | 1,280                                      |       | 2 |   | 485 |   |
|       |       | 6,203                                      |       | 13,434 |   | 19,275 |   |
| Deferred:  |       |                                       |       |   |   |   |   |
| Federal    |       | (1,934                                     | )          | 2,622 |   | 2,911 |   |
| State      |       | (2,432                                     | )          | 658 |   | 500 |   |
|       |       | (4,366                                     | )          | 3,280 |   | 3,411 |   |
|       |       | $                                          | 1,837      |   | $ | 16,714 |   | $ | 22,686 |   |

 

Thedifferences between income tax expense and income taxes computed using afederal statutory rate of 35% for the years ended December 31, 2004, 2003and 2002, were as follows:
| ** **                                                                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Pre-tax  income at statutory rate                                         |       | (3,449                                     | )          | $ | 16,765 |   | $ | 21,843 |   |
| Increase  (reduction) in taxes resulting from:                            |       |                                       |       |   |   |   |   |
| Tax-free  interest income                                                 |       | (222                                       | )          | (350 | ) | (43 | ) |
| Goodwill and  intangible asset impairment                                 |       | 5,972                                      |       | — |   | — |   |
| State taxes, net  of federal benefit                                      |       | (818                                       | )          | 688 |   | 640 |   |
| Non-deductible  Organichem purchase accounting expenses                   |       | —                                     |       | 358 |   | — |   |
| Extraterritorial  income credit                                           |       | (558                                       | )          | (560 | ) | — |   |
| Increase in  valuation reserve for realized and unrealized capital losses |       | 481                                        |       | — |   | — |   |
| Other, net                                                                |       | 431                                        |       | (187 | ) | 246 |   |
|                                                                      |       | $                                          | 1,837      |   | $ | 16,714 |   | $ | 22,686 |   |
|                                                                           |            |                                            |            |  |  |  |  |  |  |  |

 

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Thetax effects of temporary differences giving rise to significant portions of thedeferred tax assets and liabilities are as follows:
| ** **                                                                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                    | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Deferred tax assets:                                                                          |       |                  |       |   |   |
| Accruals                                                                                      |       | $                     | 605        |   | $ | 61 |   |
| Doubtful accounts  and notes receivable                                                       |       | 95                    |       | 371 |   |
| Library  amortization                                                                         |       | 243                   |       | — |   |
| Inventory  reserves                                                                           |       | 1,553                 |       | — |   |
| Warrants                                                                                      |       | 1,157                 |       | — |   |
| Environmental  reserves                                                                       |       | 118                   |       | 137 |   |
| Pension and  postretirement costs                                                             |       | 1,503                 |       | 2,131 |   |
| Research and  experimentation credit carryforwards                                            |       | 192                   |       | 174 |   |
| State tax credit  carryforward                                                                |       | 3,929                 |       | 1,455 |   |
| Impairment  charges                                                                           |       | 3,381                 |       | — |   |
| Investment  write-downs and losses                                                            |       | 988                   |       | 439 |   |
| Capital loss on  sale of fixed assets                                                         |       | 72                    |       | — |   |
| Alternative  minimum tax credit                                                               |       | —                |       | 546 |   |
| Net operating  loss carryforwards                                                             |       | 849                   |       | 1,913 |   |
|                                                                                          |       | 14,685                |       | 7,227 |   |
| Less valuation  allowance                                                                     |       | (1,770                | )          | (1,149 | ) |
| Deferred tax  assets, net                                                                     |       | 12,915                |       | 6,078 |   |
| Deferred tax liabilities:                                                                     |       |                  |       |   |   |
| Property and  equipment depreciation differences (accelerated depreciation for tax  purposes) |       | (19,571               | )          | (16,608 | ) |
| Prepaid real  estate taxes                                                                    |       | (162                  | )          | (203 | ) |
| Inventory                                                                                     |       | —                |       | (495 | ) |
| Goodwill  amortization                                                                        |       | (273                  | )          | — |   |
| Other                                                                                         |       | —                |       | (229 | ) |
| Net deferred tax  liability                                                                   |       | $                     | (7,091     | ) | $ | (11,457 | ) |

 

The preceding table does not include deferred taxasset (liability) of $94 and $(35) at December 31, 2004 and 2003associated with the Company’s unrealized losses/gains on investment securitiesdiscussed in Note 5, and deferred tax asset of $97 at December 31,2003 associated with the Company’s swap contract liability as discussed in Note8.

The deferred tax assets and liabilities associatedwith interest, amortization and non-taxable equity earnings at December 31,2002 were reclassified to goodwill as part of the Organichem Corporationacquisition discussed in Note 2

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 $2,300 per year. The Company’s state investment tax creditcarryforwards begin to expire in 2009.

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. Based upon the level of projected future taxable 

F-27

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incomeover the periods in which the deferred tax assets are deductible and taxplanning strategies, a valuation allowance of $1.8 million and $1.1 million at December 31,2004 and 2003, respectively, is included in deferred tax assets above. The netdeferred tax assets represent a level where management believes it is morelikely than not that the Company will realize the benefits of those deductibledifferences. The increase in valuation allowance in 2004 is related to deferredtax assets established in 2004 for capital losses and equity writedowns forwhich uncertainty exists about the Company’s ability to generate capital gainsin future periods sufficient to recognize the related tax benefit. 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 31,2004, 2003, and 2002, the Company repurchased 0, 959, and 1,098 shares at acost of $0, $13,492, and 23,228, 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, 2004, 2003, and 2002, employeespurchased 48, 43, and 34 shares, respectively.

***Stock Option Plan***

The Company has a Stock Option Plan, through which theCompany may issue incentive stock options or non-qualified stock options.Incentive stock options granted to employees may not be granted at prices lessthan 100% of the fair market value of the Company’s common stock at the date ofoption grant. 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.

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Followingis a summary of the status of stock option programs during 2004, 2003 and 2002:
| ** **                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                        | ** ** | **Number of  Shares**                 | ** ** | **Weighted  Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Exercise  Price** | ** ** |
| Outstanding,  beginning of year   |       |                                       | 2,854      |   |   |   | $ | 20.10 |   |   |   | 2,427 |   |   |   | $ | 20.21 |   |   |   | 2,364 |   |   |   | $ | 17.56 |   |   |
| Granted                           |       |                                       | 544        |   |   |   | 14.48 |   |   |   | 714 |   |   |   | 15.18 |   |   |   | 449 |   |   |   | 24.49 |   |   |
| Exercised                         |       |                                       | (200       | ) |   |   | 6.41 |   |   |   | (206 | ) |   |   | 2.86 |   |   |   | (284 | ) |   |   | 2.59 |   |   |
| Forfeited                         |       |                                       | (384       | ) |   |   | 21.66 |   |   |   | (81 | ) |   |   | 23.55 |   |   |   | (102 | ) |   |   | 28.86 |   |   |
| Outstanding, end  of year         |       |                                       | 2,814      |   |   |   | $ | 19.76 |   |   |   | 2,854 |   |   |   | $ | 20.10 |   |   |   | 2,427 |   |   |   | $ | 20.21 |   |   |
| Options exercisable, end  of year |       |                                       | 1,246      |   |   |   | $ | 19.72 |   |   |   | 1,014 |   |   |   | $ | 12.04 |   |   |   | 844 |   |   |   | $ | 4.98 |   |   |

 

Thefollowing summarizes information about stock options outstanding as of December 31,2004:
| ** **                                          | ** ** | **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                 |       |                         | 430        |                         |       |   | 2.74 |   |   |   | $ | 2.53 |   |   |   | 430 |   |   |   | $ | 2.53 |   |   |
| $  6.54-$13.09                            |       |                         | 276        |                         |       |   | 7.76 |   |   |   | 11.03 |   |   |   | 102 |   |   |   | 10.24 |   |   |
| $13.09-$19.63                                       |       |                         | 862        |                         |       |   | 8.48 |   |   |   | 15.56 |   |   |   | 15 |   |   |   | 14.43 |   |   |
| $19.63-$26.18                                       |       |                         | 715        |                         |       |   | 6.25 |   |   |   | 24.69 |   |   |   | 323 |   |   |   | 24.46 |   |   |
| $26.18-$32.72                                       |       |                         | 133        |                         |       |   | 5.86 |   |   |   | 27.76 |   |   |   | 97 |   |   |   | 27.68 |   |   |
| $32.72-$39.26                                       |       |                         | 78         |                         |       |   | 6.01 |   |   |   | 34.68 |   |   |   | 69 |   |   |   | 34.70 |   |   |
| $39.26-$45.81                                       |       |                         | 295        |                         |       |   | 6.08 |   |   |   | 43.22 |   |   |   | 191 |   |   |   | 43.22 |   |   |
| $45.81-$52.35                                       |       |                         | 19         |                         |       |   | 5.77 |   |   |   | 48.61 |   |   |   | 14 |   |   |   | 48.65 |   |   |
| $52.35-$58.89                                       |       |                         | 4          |                         |       |   | 5.87 |   |   |   | 54.84 |   |   |   | 4 |   |   |   | 54.84 |   |   |
| $58.89-$65.44                                       |       |                         | 2          |                         |       |   | 5.98 |   |   |   | 65.44 |   |   |   | 1 |   |   |   | 65.44 |   |   |
|                                                |       |                         | 2,814      |                         |       |   | 6.50 |   |   |   | $ | 19.76 |   |   |   | 1,246 |   |   |   | $ | 19.72 |   |   |
|                                                     |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing are the shares of common stock reserved for issuance at December 31,2004:
| ** **                    | ** ** | **Number of  Shares** | ** ** |
|-------------------------------|------------|----------------------------|------------|
| Employee Stock  Option Plans  |       |                       | 4,080      |   |   |
| Employee Stock  Purchase Plan |       |                       | 439        |   |   |
| Shares reserved for  issuance |       |                       | 4,519      |   |   |

 

***Shareholder Rights Plan***

The Company has adopted a Shareholder Rights Plan, thepurpose of which is, among other things, to enhance the Board’s ability toprotect shareholder interests and to ensure that shareholders receive fairtreatment in the event any coercive takeover attempt of the Company is made inthe future. The Shareholder Rights Plan could make it more difficult for athird party to acquire, or could discourage a third party from acquiring, theCompany or a large block of the Company’s Common Stock. The following summarydescription of the Shareholder Rights Plan does not purport to be complete andis qualified in its entirety by reference to the Company’s Shareholder RightsPlan, which has been previously filed with the Securities and ExchangeCommission as an exhibit to a Registration Statement on Form 8-A.

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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 as of theclose of business on September 19, 2002. The Rights currently are notexercisable and are attached to and trade with the outstanding shares of CommonStock. Under the Shareholder Rights Plan, the Rights become exercisable if aperson 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 of September 19,2002, is “grandfathered” under the Shareholder Rights Plan and will become an “acquiringperson” upon acquiring an additional 1¤2% of theCommon Stock. If a person becomes an “acquiring person,” each holder of a 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         |   | — |   |

 

**11.   EmployeeBenefit Plans**

**DefinedContribution Plans:**

AMRI maintains a savings and profit sharing plan undersection 401(k) of the Internal Revenue Code covering all eligible AMRemployees as well as all eligible Organichem salaried employees. Employees mustcomplete one calendar month of service and be over 20.5 years of age as ofthe plan’s entry dates. Participants may contribute up to 100% of theircompensation, subject to IRS limitations. AMRI currently makes matchingcontributions equal to 50% of the participant’s contributions (up to a limit of10% of the participant’s compensation). In addition, AMRI has reserved theright to make discretionary profit sharing contributions to employee accounts. AMRIhas made no discretionary profit sharing contributions. Employer matchingcontributions vest at a rate of 20% per year beginning after two years ofparticipation 

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in the plan. Employermatching contributions were $1.1 million, $0.8 million, and $0.7 million forthe years ended December 31, 2004, 2003 and 2002, respectively.

Organichem sponsors asavings and profit sharing plan under section 401(k) of the InternalRevenue Code covering hourly 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 $0.3million and $0.4 million for the years ended December 31, 2004 and 2003,respectively.

**Defined Benefit andPostretirement Welfare Plan:**

Organichem maintains two non-contributory definedbenefit plans (salaried and hourly) and a non-contributory, unfundedpost-retirement welfare plan, covering substantially all employees. Benefitsfor the salaried defined benefit plan are based on salary and years of service.Benefits for the hourly defined benefit plan (for union employees) are based onnegotiated benefits and years of service. The hourly defined benefit plan iscovered under a collective bargaining agreement with the International ChemicalWorkers Union which represents the hourly workforce at Organichem.

At January 1, 2003, the pension andpostretirement benefits liability related to these plans was increased by $2.4million related to the purchase price allocation (see Note 3) to equal theprojected benefit obligation in excess of plan assets as of the date of the acquisition.

Effective June 5, 2003, the Company eliminatedall benefits under the non-contributory, unfunded post-retirement welfare planfor salaried employees. The settlement resulted in a reduction to the long-termpension and post-retirement liability and a decrease to goodwill of $0.5million in the Organichem purchase price allocation discussed in Note 2.

Effective August 1, 2003, the Company curtailedthe salaried defined benefit pension plan. The curtailment resulted in areduction to the long-term pension and post-retirement liability and a decreaseto goodwill of $1.3 million in the Organichem purchase price allocationdiscussed in Note 2.

Effective March 1, 2004, the Company curtailedthe hourly defined benefit pension plan. The curtailment did not have amaterial impact on the liability or expense associated with the plan.

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Thefollowing tables provide a reconciliation of the changes in the plans’ benefitobligations and fair value of the plans’ assets during the years ended December 31,2004 and 2003, 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** | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **2004**                  | ** ** | **2003**                         | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** |
| **Change in benefit obligation:**             |       |                      |       |                             |       |   |   |   |   |   |   |   |   |
| Benefit  obligation at January 1         |       | $                         | 19,581     |                             | $          | 18,975 |   |   | $ | 234 |   |   |   | $ | 691 |   |   |
| Service cost                                  |       | 39                        |       | 566                              |       |   | 34 |   |   |   | 60 |   |   |
| Interest cost                                 |       | 1,169                     |       | 1,231                            |       |   | 16 |   |   |   | 30 |   |   |
| Actuarial loss                                |       | 903                       |       | 1,401                            |       |   | 178 |   |   |   | 111 |   |   |
| FAS 88 events                                 |       | —                    |       | (1,882                           | )          |   | — |   |   |   | (658 | ) |   |
| Benefits paid                                 |       | (889                      | )          | (710                             | )          |   | — |   |   |   | — |   |   |
| Benefit obligation at December 31        |       | 20,803                    |       | 19,581                           |       |   | 462 |   |   |   | 234 |   |   |
| **Change in plan assets:**                    |       |                      |       |                             |       |   |   |   |   |   |   |   |   |
| Fair value of  plan assets at January 1  |       | 15,039                    |       | —                           |       |   | — |   |   |   | — |   |   |
| Acquired in  purchase of Organichem           |       | —                    |       | 11,509                           |       |   | — |   |   |   | — |   |   |
| Actual return  (loss) on plan assets          |       | 1,908                     |       | 2,733                            |       |   | — |   |   |   | — |   |   |
| Employer  contributions                       |       | 1,842                     |       | 1,507                            |       |   | — |   |   |   | — |   |   |
| Benefits paid                                 |       | (889                      | )          | (710                             | )          |   | — |   |   |   | — |   |   |
| Fair value of plan assets at December 31 |       | 17,900                    |       | 15,039                           |       |   | — |   |   |   | — |   |   |
| **Funded status**                             |       | 2,903                     |       | 4,542                            |       |   | 462 |   |   |   | 234 |   |   |
| Unrecognized net  actuarial (gain) loss       |       | 626                       |       | 51                               |       |   | (221 | ) |   |   | (226 | ) |   |
| FAS 88 events                                 |       | —                    |       | 560                              |       |   | — |   |   |   | 183 |   |   |
| Net amount  recognized                        |       | $                         | 3,529      |                             | $          | 5,153 |   |   | $ | 241 |   |   |   | $ | 191 |   |   |

 

At December 31, 2004 and 2003, the accumulatedbenefit obligation (the actuarial present value of benefits, vested andnon-vested, earned by employees based on current and past compensation levels)for the Company’s pension plans totaled $20.8 million and $19.6 million,respectively.

Thefollowing table provides the components of net periodic benefit costs for theyears ended December 31:
| ** **                       | ** ** | **Pension Benefits** | ** ** | **Postretirement Benefits** | ** ** |
|----------------------------------|------------|---------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **2004**                  | ** ** | **2003**                         | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** |
| Service cost                     |       | $                         | 39         |                             | $          | 566 |   |   | $ | 34 |   |   |   | $ | 60 |   |   |
| Interest cost                    |       | 1,169                     |       | 1,231                            |       |   | 16 |   |   |   | 30 |   |   |
| Expected return  on plan assets  |       | (1,100                    | )          | (1,061                           | )          |   | — |   |   |   | — |   |   |
| Amortization of  net (gain) loss |       | —                    |       | (21                              | )          |   | — |   |   |   | 2 |   |   |
| Net periodic  benefit cost       |       | $                         | 108        |                             | $          | 715 |   |   | $ | 50 |   |   |   | $ | 92 |   |   |

 

Thefollowing assumptions were used to determine the periodic pension cost for thedefined benefit pension plans and the curtailment of the salaried definedbenefit pension plan for the years ending December 31 :
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Discount rate                   |       | 5.75     | %          | 6.25     | %          |
| Expected return  on plan assets |       | 8.00     | %          | 8.00     | %          |
| Rate of compensation  increase  |       | N/A      |       | 3.50     | %          |

 

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Thefollowing assumptions were used to determine the periodic postretirementbenefit cost and the settlement of the postretirement welfare plan for theperiod ending December 31, 2004:
| ** **                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Health care cost  trend rate assumed for next year                                 |       | 8.00     | %          | 5.00     | %          |
| Rate to which the  cost trend rate is assumed to decline (the ultimate trend rate) |       | 4.00     | %          | 3.50     | %          |
| Year that the rate  reaches the ultimate trend rate                                |       | 2009     |       | 2006     |       |

 

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                                                      |       |                                   | $          | 15                                     |       |   |   | $ | (11 | ) |   |
| Effect on accumulated  postretirement benefit obligation for the year ended December 31, 2004 |       |                                   | $          | 145                                    |       |   |   | $ | (108 | ) |   |

 

TheCompany’s pension plan weighted-average asset allocations at December 31,2004 by asset category are as follows:
| ** **        | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| Equity securities |       | 64       | %          | 60       | %          |
| Debt securities   |       | 34       |       | 33       |       |
| Real Estate       |       | —   |       | 5        |       |
| Other             |       | 2        |       | 2        |       |
| Total             |       | 100      | %          | 100      | %          |

 

The overall objective of theCompany’s defined benefit plans is to provide the means to pay benefits toparticipants and their beneficiaries in the amounts and at the times called forby the plan. This is expected to be achieved through the investment of theCompany’s contributions and other assets and by utilizing investment policiesdesigned to achieve adequate funding over a reasonable period of time.

Defined benefit plan assets are invested so as toachieve a return on investment, based on levels of liquidity and investmentrisk that is prudent and reasonable under circumstances which exist from timeto time. While the Company recognizes the importance of the preservation ofcapital, it also adheres to the theory of capital market pricing whichmaintains that varying degrees of investment risk should be rewarded withcompensating returns. Consequently, prudent risk-taking is justifiable.

The asset allocation decision includes considerationof the non-investment aspects of the Company’s defined benefit plans, includingfuture retirements, lump-sum elections, company contributions, and cash flow.These actual characteristics of the plan place certain demands upon the level,risk, and required growth of trust assets. The Company regularly conductsanalyses of the plan’s current and likely future financial status byforecasting assets, liabilities, benefits and company contributions over time. Inso doing, the impact of alternative investment policies upon the plan’sfinancial status is measured and an asset mix which balances asset returns andrisk is selected.

The Company’s decision with regard to asset mix isreviewed periodically. Asset mix guidelines include target allocations andpermissible ranges for each asset category. Assets are monitored on an ongoingbasis and rebalanced as required to maintain an asset mix within thepermissible ranges. The guidelines will change from time to time, based on anongoing evaluation of the Plan’s tolerance of investment risk.

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The market-related value of plan assets is used indeveloping the expected rate of return on plan assets. The market-related valueof plan assets phases in recognition of capital appreciation by recognizinginvestment gains and losses over a four-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** | ** ** |
|-------------|------------|-----------------------|------------|-----------------------------|------------|
| 2005        |       | $                     | 993        |                        |       | — |   |   |
| 2006        |       | 1,025                 |       |                        | —     |   |   |
| 2007        |       | 1,102                 |       |                        | —     |   |   |
| 2008        |       | 1,122                 |       |                        | —     |   |   |
| 2009        |       | 1,297                 |       |                        | —     |   |   |
| 2010 - 2014 |       | 8,003                 |       |                        | 20         |   |   |
|             |            |                       |            |                             |            |  |  |  |

 

The Company expects tocontribute $631 to its pension plans in 2005.

**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 its Albany,New York office and laboratory facilities. The present leases expire in December 2013.The leases contain a renewal option at the option of the Company. The Companyis responsible for paying the cost of utilities, operating costs, and increasesin property taxes.

The Company leases additional laboratory facilitiesunder separate agreements with non-related parties. The Company also leasesvarious equipment with terms ranging from one to three years.

Futureminimum lease payments under noncancelable operating leases (with initial orremaining lease terms in excess of one year) as of December 31, 2004 areas follows:
| Year ending  December 31, |   |   |   |
|--------------------------------|--------|--------|--------|
| 2005                           |   | $      | 2,296  |   |
| 2006                           |   | 2,312  |   |
| 2007                           |   | 2,298  |   |
| 2008                           |   | 1,330  |   |
| 2009                           |   | 1,380  |   |
| Thereafter                     |   | 3,093  |   |
|                                |        |        |        |  |

 

Rental expense amounted toapproximately $2.3 million, $2.1 million, and $1.9 million during the yearsended December 31, 2004, 2003 and 2002, respectively. Included within rentexpense was approximately $0.8 million, $0.8 million, and $0.7 million that waspaid to the aforementioned related party of the Company during the years ended December 31,2004, 2003 and 2002, respectively.

**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 novel 

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technology that results innew revenues generated for, or by, the Company. Eligible participants willshare in awards based on a percentage of the licensing, royalty or milestonerevenue received by the Company, as defined by the Plan.

In2004, 2003 and 2002, the Company awarded Technology Incentive Compensation tothe inventor of the terfenadine carboxylic acid metabolite technology, which iscovered by the Company’s patents relating to the active ingredient in Allegra.The inventor is a director, officer and shareholder of the Company. The amountsawarded and included in the consolidated statements of income for the yearsended December 31, 2004, 2003 and 2002 are $4.8 million, $5.2 million, and$5.1 million, respectively. Included in accrued compensation in theaccompanying consolidated balance sheets at December 31, 2004 and 2003 areunpaid Technology Development Incentive Compensation awards of $1.2 million and$1.3 million respectively.

***(b) Notes Receivable***

Fromtime to time the Company makes loans to non-officer employees of the Company inthe form of notes receivable. The notes receivable and accrued interest willnot be repaid to the Company provided the employee remains in the employ of theCompany throughout the term of the loan. If employment is terminated prior tothe end of the loan term, a pro-rata portion of the principal and interestshall be repaid to the Company. Notes receivable from employees at December 31,2004 and 2003 totaled $414 and $134, respectively. The amounts forgiven andcharged to operations in the consolidated statements of income for the yearsended December 31, 2004, 2003 and 2002 are $91, $192 and $200,respectively.

***(c) 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 $169, $165, and $162 for services rendered to the Company in 2004, 2003,and 2002, respectively.

**14.   Royalty &Licensing Arrangement**

On March 15, 1995,the Company entered into a License Agreement and a Stock Purchase Agreementwith Marion Merrell Dow Inc., now Sanofi-Aventis, S.A. (“Sanofi-Aventis”).Under the terms of the License Agreement, the Company granted Sanofi-Aventis anexclusive, worldwide license, with the right to grant sublicenses, upon theprior written consent of the Company, to any patents issued to the Companyrelated to its original terfenadine carboxylic acid metabolite patent application.Terfenadine carboxylic acid metabolite is the active ingredient in thenon-sedating antihistamine fexofenadine HCl, marketed as a prescriptionmedicine by Sanofi-Aventis, under the brand names “Allegra” in the Americas and“Telfast” in the rest of the world. In return for the license, Sanofi-Aventisagreed to pay the Company up to $7.4 million based upon the achievement of fivepatenting milestones and future royalties based on sales of fexofenadine HCl. Substantiallyall of the Company’s license, milestone and royalty revenue is derived frommilestones and royalties related to its patented fexofenadine HCl technology.

**15.   LegalProceedings**

The Company, from time to time, may be involved invarious claims and legal proceedings arising in the ordinary course ofbusiness.

AMR Technology, a subsidiary of the Company, alongwith Aventis Pharmaceuticals Inc., a 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 

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Inc. filed Abbreviated NewDrug Applications (ANDAs) with the U.S. Food and Drug Administration, or FDA,to produce and market generic versions of Allegra products.

In response to the filings described above, beginningin 2001, Aventis Pharmaceuticals filed patent infringement lawsuits against BarrLaboratories, Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc., andSandoz. Each of the lawsuits was filed in the U.S. District Court in New Jerseyand alleges infringement of one or more patents owned by or licensed to AventisPharmaceuticals. Further, beginning in March 5, 2004, AMR Technology,along with Aventis Pharmaceuticals, filed suit in the U.S. District Court inNew Jersey against Barr Laboratories, Impax Laboratories, MylanPharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’s Laboratories, AminoChemicals, Ltd., Sandoz, Inc. and Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., asserting infringement of two of our U.S. patents thatare exclusively licensed to Aventis Pharmaceuticals relating to Allegra andAllegra-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 Aventis Pharmaceuticals willcontinue to pay royalties to us based on that patent under our original licenseagreement with Aventis Pharmaceuticals. Under our arrangements with AventisPharmaceuticals, we will receive royalties until expiration of the underlyingpatents (2013 for U.S. Patent No. 5,578,610 and 2015 for U.S. Patent No. 5,750,703)unless the patents are earlier determined to be invalid.

Under applicable federallaw, marketing of an FDA-approved generic version of Allegra may not commenceuntil the earlier of a decision favorable to the generic challenger in thepatent litigation or 30 months after the date the patent infringement lawsuitwas filed. In general, the first generic filer is entitled to a 180-daymarketing exclusivity period upon FDA approval.

**16.   EnvironmentalCosts**

Organichem has completed an environmental remediationassociated with groundwater contamination at its Rensselaer, NY location.Ongoing costs associated with the remediation include biannual monitoring andreporting to the State of New York’s Department of Environmental Conservation.Under the remediation plan, Organichem is expected to pay for monitoring andreporting until 2009. Under a 1999 agreement with the facility’s previousowner, Organichem’s maximum liability under the remediation is $5 million. TheCompany assumed a $0.4 million liability in connection with the acquisition ofOrganichem described in Note 2. For the period ended December 31,2004 and 2003, $47 and $81 in costs have been 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 theremediation plan will not have a material adverse effect on the Company’sfinancial position, results of operations or cash flows.

At December 31, 2004and 2003, $296 and $343 were recorded for future environmental liabilities inthe condensed consolidated balance sheet.

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**17.   Concentrationof Business**

For the year ended December 31, 2004, contractrevenue from our three largest customers represented 38%, 6% and 4%,respectively, of our contract revenue. For the year ended December 31,2003, contract revenue from our three largest customers respectivelyrepresented approximately 34%, 10% and 6% of our contract revenue. For the yearended December 31, 2002, contract revenue from our three largest customersrespectively represented approximately 12%, 12% and 7% of our contract revenue.Our largest customer, GE Biosciences, represented 38% of total contract revenuefor the year ended December 31, 2004. In the majority of circumstances,there are agreements in force with these entities that provide for the Company’scontinued involvement in present research projects. However, there regularlyexists the possibility that the Company will have no further association withthese 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,** | ** ** |
|-----------------|------------|----------------------------------------|------------|
| ** **      | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| United States   |       | 61                                     | %          | 57 | % | 93 | % |
| Europe          |       | 37                                     | %          | 40 | % | 4 | % |
| Other countries |       | 2                                      | %          | 3 | % | 3 | % |
| Total           |       | 100                                    | %          | 100 | % | 100 | % |

 

All significant long-livedassets of the Company are located within the United States.

**18.   Business Segments**

The Company has organized its sales, marketing andproduction activities into the Albany Molecular Research (AMR) and Organichemsegments based on the criteria set forth in SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information”. The Company’smanagement relies on an internal management accounting system to report resultsof the segments. The system includes revenue and cost information by segment.The Company’s management makes financial decisions and allocates resourcesbased on the information it receives from this internal system.

Albany Molecular Research includes activities such asdrug lead discovery, optimization, drug development and small scale commercialmanufacturing. Organichem includes pilot to commercial scale manufacturing ofactive pharmaceutical ingredients and intermediates and high potency andcontrolled substance manufacturing all of which are in compliance with the Foodand Drug Administration’s (FDA) current Good Manufacturing Practices.

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Thefollowing table summarizes information by segment for the year ended December 31,2004:
| ** **                                      | ** ** | **AMR** | ** ** | **Organichem** | ** ** | **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 | ) |
| Minority interest  in consolidated subsidiary   |       |    |       |           |       |      |       | — |   |
| 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 |   |

 

Thefollowing table summarizes other information by segment as of December 31,2004:
| ** **                                | ** ** | **AMR**                 | ** ** | **Organichem** | ** ** | **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 |   |

 

Thefollowing table summarizes information by segment for the year ended December 31,2003:
| ** **                                      | ** ** | **AMR** | ** ** | **Organichem** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|---------|------------|----------------|------------|-----------|------------|
| Contract revenue                                |       | $       | 65,600     |           |       | $         | 79,067     |   |   | $ | 144,667 |   |
| Recurring  royalties                            |       | 51,682  |       |           | —     |      |       | 51,682 |   |
| Total revenue                                   |       | $       | 117,282    |           |       | $         | 79,067     |   |   | $ | 196,349 |   |
| Operating income  (before unallocated expenses) |       | $       | 69,136     |           |       | $         | 20,277     |   |   | $ | 89,413 |   |
| Unallocated expenses:                           |       |    |       |           |       |      |       |   |   |
| Research and  development                       |       |    |       |           |       |      |       | 22,466 |   |
| Selling, general  and administrative            |       |    |       |           |       |      |       | 20,318 |   |
| Total unallocated expenses                      |       |    |       |           |       |      |       | 42,784 |   |
| Operating income                                |       |    |       |           |       |      |       | 46,629 |   |
| Reconciling items:                              |       |    |       |           |       |      |       |   |   |
| Equity in loss of  unconsolidated affiliates    |       |    |       |           |       |      |       | (372 | ) |
| Minority interest  in consolidated subsidiary   |       |    |       |           |       |      |       | 133 |   |
| Interest income  ,net                           |       |    |       |           |       |      |       | 785 |   |
| Other income, net                               |       |    |       |           |       |      |       | 403 |   |
| Income before  income tax expense               |       |    |       |           |       |      |       | $ | 47,578 |   |
| Supplemental  information:                      |       |    |       |           |       |      |       |   |   |
| Depreciation and  amortization                  |       | $       | 7,783      |           |       | $         | 5,322      |   |   | $ | 13,105 |   |

 

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Thefollowing table summarizes other information by segment as of December 31,2003:
| ** **                                | ** ** | **AMR**                 | ** ** | **Organichem** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------------|------------|-----------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Total assets                              |       | $                       | 275,320    |           |       | $         | 115,625    |   |   | $ | 390,945 |   |
| Goodwill included  in total assets        |       | $                       | 17,181     |           |       | $         | 23,060     |   |   | $ | 40,241 |   |
| Investments in  unconsolidated affiliates |       | $                       | 2,191      |           |       | $         | —     |   |   | $ | 2,191 |   |
| Capital expenditures                      |       | $                       | 20,489     |           |       | $         | 10,065     |   |   | $ | 30,554 |   |

 

**19.   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:

*Cash, cash equivalents andshort-term investments, receivables, and accounts payable:  *Thecarrying amounts reported in the consolidated balance sheets approximate theirfair value because of the short maturities of these instruments.

*Investment securities,available-for-sale:  *As disclosed in Note 4,investment securities, available-for-sale are estimated based onquoted market prices at the balance sheet date.

*Long-term Debt:  *Thecarrying value of long-term debt was approximately equal to fair value at December 31,2004 and 2003 due to the resetting dates of the variable interest rates.

*SwapContract:  *As discussed in Note 7, the swapcontract asset is carried at fair value at December 31, 2004.

**20.   Goodwill and Intangible Assets**

***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 142, and concluded that an impairment hadoccurred 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 Mount Prospectreporting unit may be impaired. Accordingly, the Company conducted a goodwillimpairment review as required under SFAS 142. The Company completed itsassessment and concluded that an impairment had occurred and recorded a $1,243goodwill 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.

Thechanges in the carrying amount of goodwill, by segment, for the years ended December 31,2004 and 2003 are as follows:
| ** **                            | ** ** | **AMR** | ** ** | **Organichem** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|---------|------------|----------------|------------|-----------|------------|
| Balance as of  January 1, 2003   |       | $       | 17,181     |           |       | $         | —     |   |   | $ | 17,181 |   |
| Goodwill acquired                     |       | —  |       |           | 23,060     |      |       | 23,060 |   |
| Balance as of  December 31, 2003 |       | 17,181  |       |           | 23,060     |      |       | 40,241 |   |
| Impairment losses                     |       | (14,494 | )          |           | —     |      |       | (14,494 | ) |
| Balance as of  December 31, 2004 |       | $       | 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 related technologiesduring the quarter ended June 30, 2004. The microbial cultures and relatedtechnologies are the starting materials and technology used in the developmentof the natural product libraries and therefore would be used to makeincremental copies of the natural product libraries. Based on its assessment,the Company concluded that the carrying value of the microbial cultures andrelated technologies was not recoverable, and accordingly recorded a $3,541impairment charge representing the entire remaining carrying value of microbialcultures and related technologies.

Thecomponents of intangible assets are as follows:
| ** **                    | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Amortization  Period** | ** ** |
|-------------------------------|------------|----------|------------|-------------------------------|------------|---------|------------|--------------------------|------------|
| ***December 31,  2004*** |       |     |       |                          |       |    |       |                     |       |   |   |   |   |
| Microbial  Cultures           |       | $        | —     |                          |       | $       | —     |                     |       | $ | — |   |   |   |   |   |
| Patents and  Licensing Rights |       | 1,478    |       |                          | (277       | )       |       | 1,201                    |       |   | 16 years |   |   |
|                          |       | $        | 1,478      |                          |       | $       | (277       | )                        |       | $ | 1,201 |   |   |   |   |   |
| ***December 31,  2003*** |       |     |       |                          |       |    |       |                     |       |   |   |   |   |
| Microbial Cultures            |       | $        | 4,511      |                          |       | $       | (751       | )                        |       | $ | 3,760 |   |   | 15 years |   |   |
| Patents and  Licensing Rights |       | 1,231    |       |                          | (127       | )       |       | 1,104                    |       |   | 16 years |   |   |
|                          |       | $        | 5,742      |                          |       | $       | (878       | )                        |       | $ | 4,864 |   |   |   |   |   |

 

Estimated future annualamortization expense related to intangible assets is $134 per year for each ofthe years ending December 31, 2005, 2006, 2007, 2008, and 2009.

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

Thefollowing tables present unaudited consolidated financial data for each quarterof 2004 and 2003:
| ** **              | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|-------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| **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 from  operations |       | 4,144              |       | (22,586             | )          | 4,297              |       | 5,331               |       |
| Net income              |       | 2,761              |       | (20,773             | )          | 2,890              |       | 3,431               |       |
| Net income per share:   |       |               |       |                |       |               |       |                |       |
| Basic                   |       | $                  | 0.09       |                | $          | (0.66              | )          | $                   | 0.09       |   | $ | 0.11 |   |
| Diluted                 |       | $                  | 0.09       |                | $          | (0.66              | )          | $                   | 0.09       |   | $ | 0.11 |   |
| **2003**                |       |               |       |                |       |               |       |                |       |
| Contract revenue        |       | $                  | 33,839     |                | $          | 38,777             |       | $                   | 33,005     |   | $ | 39,046 |   |
| Gross profit            |       | 7,827              |       | 9,619               |       | 10,982             |       | 14,486              |       |
| Recurring  royalties    |       | 11,100             |       | 15,200              |       | 12,400             |       | 12,982              |       |
| Income from  operations |       | 6,123              |       | 12,443              |       | 12,600             |       | 15,463              |       |
| Net income              |       | 4,052              |       | 8,207               |       | 8,233              |       | 10,372              |       |
| Net income per share:   |       |               |       |                |       |               |       |                |       |
| Basic                   |       | $                  | 0.13       |                | $          | 0.26               |       | $                   | 0.26       |   | $ | 0.32 |   |
| Diluted                 |       | $                  | 0.13       |                | $          | 0.25               |       | $                   | 0.25       |   | $ | 0.32 |   |

 

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**ALBANY MOLECULARRESEARCH, INC.SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTSYears Ended December 31, 2004, 2003 and 2002**
| **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 |       |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |   |   |
| 2004                                        |       |       | $          | 309,000                                                    |       |                                             |       | $                                        | (77,315    | )                                         |       |                                     | $          | (25,000 | ) |   | $ | (1,613 | ) |   | $ | 205,072 |   |   |
| 2003                                        |       |       | $          | 218,000                                                    |       |                                             |       | $                                        | 278,715    |                                      |       |                                     | —     |   |   | $ | (187,715 | ) |   | $ | 309,000 |   |   |
| 2002                                        |       |       | $          | 218,000                                                    |       |                                             |       | —                                   |       |                                      |       | —                                   |       |   | — |   |   | $ | 218,000 |   |   |
| Note receivable reserve                     |       |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |   |   |
| 2004                                        |       |       | $          | 32,277                                                     |       |                                             |       | —                                   |       |                                      |       | —                                   |       |   | — |   |   | $ | 32,277 |   |   |
| 2003                                        |       |       | $          | 32,277                                                     |       |                                             |       | —                                   |       |                                      |       | —                                   |       |   | — |   |   | $ | 32,277 |   |   |
| 2002                                        |       |       | $          | 40,277                                                     |       |                                             |       | —                                   |       |                                      |       | $                                        | (8,000     | ) |   |   |   |   | $ | 32,277 |   |   |
| Deferred tax asset  valuation allowance     |       |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |   |   |
| 2004                                        |       |       | $          | 1,149                                                      |       |                                             |       | $                                        | 621        |                                      |       |                                     | —     |   |   | — |   |   | $ | 1,770 |   |   |
| 2003                                        |       |       | $          | —                                                     |       |                                             |       | $                                        | 1,149      |                                      |       |                                     | —     |   |   | — |   |   | $ | 1,149 |   |   |
| 2002                                        |       |       | $          | —                                                     |       |                                             |       | —                                   |       |                                      |       | —                                   |       |   | — |   |   | — |   |   |

 

1

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