**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

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**(Mark One)**

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

**Forthe fiscal year ended December 31, 2006**

**or**

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

**Forthe transition period from                 to                 **

**Commission file number 0-25323**

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**Albany Molecular Research, Inc.**

(Exact name of registrantas specified in its charter)

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

 

**(518) 464-0279**

(Registrant’s telephone number, including area code)

Securities registeredpursuant to Section 12(b) of the Act:

| **Title of each class**                 |   | **Name of exchange on which registered** |
|-----------------------------------------|--------|-------------------------------------------------------------------|
| Common Stock, par  value $.01 per share |   | The NASDAQ Stock  Market LLC                                      |
| Preferred Stock  Purchase Rights        |   |                                                              |

 

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

**None**

(Title of Each Class)

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

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

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

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

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer. See definitions of “acceleratedfiler and large accelerated filer” in  12b-2 of the Exchange Act

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

 

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

The aggregate market value of the Registrant’s CommonStock held by non-affiliates of the Registrant on June 30, 2006 wasapproximately $236 million based upon the closing price per share of theRegistrant’s Common Stock as reported on the Nasdaq National Market on June 30,2006. Shares of Common Stock held by each officer and director and by eachperson who owns 10% or more of the outstanding Common Stock have been excludedin that such persons may be deemed to be affiliates. This determination ofaffiliate status is not necessarily a conclusive determination for otherpurposes. As of February 28, 2007, there were 32,681,346 outstandingshares of the Registrant’s Common Stock.

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**DOCUMENTS INCORPORATED BY REFERENCE**

The information requiredpursuant to Part III of this report is incorporated by reference from theCompany’s definitive proxy statement, relating to the annual meeting ofstockholders to be held on June 4, 2007, pursuant to Regulation 14A to befiled with the Securities and Exchange Commission.

 

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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 |       | 3                                                                                                                  |
| Item 1.                                               |       | Business                                                                                                           |       | 5                 |
| Item 1A.                                              |       | Risk Factors                                                                                                       |       | 16                |
| Item 1B.                                              |       | Unresolved Staff Comments                                                                                          |       | 25                |
| Item 2.                                               |       | Properties                                                                                                         |       | 25                |
| Item  3.                                              |       | Legal  Proceedings                                                                                                 |       | 26                |
| Item 4.                                               |       | Submission of Matters to a Vote of Security Holders                                                                |       | 27                |
|                                                  |       | Part II.                                                                                                      |       |              |
| Item 5.                                               |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       | 28                |
| Item 6.                                               |       | Selected Financial Data                                                                                            |       | 30                |
| Item 7.                                               |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       | 32                |
| Item 7A.                                              |       | Quantitative and Qualitative Disclosures about Market  Risk                                                        |       | 53                |
| Item 8.                                               |       | Financial Statements and Supplementary Data                                                                        |       | 53                |
| Item 9.                                               |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       | 53                |
| Item 9A.                                              |       | Controls and Procedures                                                                                            |       | 54                |
| Item  9B.                                             |       | Other  Information                                                                                                 |       | 55                |
|                                                  |       | Part III.                                                                                                     |       |              |
| Item 10.                                              |       | Directors, Executive Officers and Corporate Governance  of the Registrant                                          |       | 56                |
| Item 11.                                              |       | Executive Compensation                                                                                             |       | 56                |
| Item 12.                                              |       | Security Ownership of Certain Beneficial Owners and  Management                                                    |       | 56                |
| Item 13.                                              |       | Certain Relationships, Related Transactions and  Director Independence                                             |       | 56                |
| Item 14.                                              |       | Principal Accountant Fees and Services                                                                             |       | 56                |
|                                                  |       | Part IV.                                                                                                      |       |              |
| Item 15.                                              |       | Exhibits and Financial Statement Schedules                                                                         |       | 57                |

 

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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 and include,but are not limited to, statements concerning the Mount Prospect ResearchCenter, pension and postretirement benefit costs, GE Healthcare, the Company’scollaboration with BMS, the acquisition of ComGenex, future acquisitions,earnings, contract revenues, costs and margins, royalty revenues, patentprotection and the ongoing Allegra patent infringement litigation, Allegraroyalty revenue, government regulation, retention and recruitment of employees,customer spending and business trends, foreign operations (including Singapore,India and Hungary), the completion of the Shapoorji Pallonji Biotech Center inHyderabad, India, clinical supply manufacturing, management’s strategic plans,the Company’s targeted workforce reduction and the timing of the forecastedsavings from the implementation of large scale manufacturing restructuring, theexpectation of improved profitability of large scale manufacturing, the Company’snew enterprise resource planning (“ERP”) system, the goal of submitting anInvestigational New Drug Application to the FDA in 2007, drug discovery,product commercialization, license arrangements, research and developmentprojects and expenses, selling, general and administrative expenses, goodwillimpairment, competition and tax rates. The Company’s actual results may differmaterially from such forward-looking statements as a result of numerousfactors, some of which the Company may not be able to predict and may not bewithin the Company’s control. Factors that could cause such differencesinclude, but are not limited to, the risk that the Company will not achieve thecost savings expected to result from the closure and relocation of its MountProspect operations, the Company’s ability to recruit and retain experiencedscientists and other highly-skilled employees, trends in pharmaceutical andbiotechnology companies outsourcing chemical research and development,including softness in these markets, competition from domestic competitors andforeign companies operating under lower cost structures,  the loss of a significant customer, sales ofAllegra (including any deviations in sales estimates provided bySanofi-Aventis) and the impact of the “at-risk” launch of generic Allegra onthe Company’s receipt of significant royalties under the Allegra licenseagreement, the risk of any “at-risk” launch of generic Allegra-D and the impactof that on the Company’s receipt of significant royalties under 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 and the risk of new productintroductions for the treatment of allergies including generic forms ofAllegra, the Company’s and Sanofi-Aventis’s ability to successfully enforcetheir respective intellectual property, patent rights and technology rights,including with respect to the generic companies’ Abbreviated New DrugApplication filings, the restructuring and operating risks associated with  Organichem, the Company’s ability tosuccessfully develop novel compounds and lead candidates in its researchprograms and collaborative arrangements, the Company’s performance under thecollaboration with BMS, BMS’s continuous utilization of the Company’s servicesat levels set forth in the contract with BMS, BMS’s continued pursuit ofprograms under which the Company provides services, delay or denial ofmarketing approvals from the FDA resulting from, among other things, adverseFDA decisions or interpretations of data that differ from BMS’s interpretationsand that may require additional clinical trials or potential changes in thecost, scope and duration of clinical trials, if approved, the inability tosuccessfully launch, increase sales of or sustain the product or products inthe market, the inability to successfully and efficiently scale-upmanufacturing for commercialized compounds, the outcome of clinical work thatwill be required to commercialize compounds, the Company’s ability to take advantageof proprietary technology and expand the scientific tools available to it,uncertainty concerning charges associated with the Company’s restructuring ofits Large Scale Manufacturing business unit, which may be higher than estimatedat this time, the risk that the Company will not realize the anticipated costsavings from its 

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restructuring plans duringthe time frame indicated, or even if the anticipated cost savings are achieved,that the Large Scale Manufacturing business unit may remain unprofitable oroperate with low gross margins, the ability of the Company’s strategicinvestments and acquisitions to perform as expected and the cost and anygoodwill impairment related to such investments and acquisitions, the reactionof customers of the Company and ComGenex to the acquisition of ComGenex, theCompany’s timing and ability to successfully integrate ComGenex’s operations(including migration of ComGenex to the Company’s systems and controls) andemployees, the introduction of new services by competitors or the entry of newcompetitors into the markets for the Company’s and ComGenex’s services, thefailure by the Company to retain key employees for ComGenex, failure to furtherdevelop and successfully market ComGenex’s service offerings, the Company’sability to successfully complete its ongoing expansion projects on schedule,the risks associated with international operations and managing ourinternational operations, especially in India, Singapore and Hungary, theCompany’s ability to execute its business plan for compound and chemicalscreening libraries, failure to achieve anticipated revenues and earnings, theexistence of deficiencies and/or material weaknesses in the Company’s internalcontrols over financial reporting, risks related to the implementation of itsERP system, the Company’s ability to effectively manage its growth, liabilityfor harm caused by drugs the Company develops and tests, liability forcontamination or other harm caused by hazardous materials used by the Company,failure to meet strict regulatory requirements, health care reform reducing theprice pharmaceutical and biotechnology companies can  charge for drugs, thus reducing resourcesavailable to retain the services of our Company, the fluctuation of the marketprice of our common stock, changes in the foreign currency exchange rates andinterest rates, and the possibility of a natural disaster, catastrophic eventor terrorist attack. All forward-looking statements are made as of thedate of this report, and we do not undertake to update any such forward-lookingstatements in the future. References to “we,” “us,” and “our,” refers to AlbanyMolecular Research, Inc. and its subsidiaries, taken as a whole. Readersare cautioned that these forward-looking statements are only predictionsand are subject to risks, uncertainties and assumptions that are difficult topredict. Therefore, actual results may differ materially and adversely fromthose expressed in any forward-looking statements. Readers should reviewcarefully the risks and uncertainties identified below under the caption “RiskFactors and Certain Factors Affecting Forward-Looking Statements” andelsewhere in this 10-K. We do not undertake any obligation to update ourforward-looking statements, except as required by applicable law.

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**PART I**

**ITEM1. BUSINESS.**

**Overview**

Albany Molecular Research, Inc.(“the Company”), a Delaware corporation incorporated on June 20, 1991, isa global chemistry-based drug discovery and development company focusedon identifying and developing novel biologically active small molecules withapplications in the drug market. Our core business consists of a fee-forservice contract services platform encompassing drug discovery, optimization,and manufacturing; and a separate, standalone research and development divisioncomprising proprietary technologies, internal drug discovery and bundledcapabilities designed for more collaborative relationships. We provide contractservices to customers across the entire product development cycle from leaddiscovery to commercial manufacturing. We conduct research and developmentprojects and collaborate with many leading pharmaceutical and biotechnologycompanies, and are developing proprietary new technology for potentialpharmaceutical products. With locations in the U.S., Europe and Asia, weprovide customers with a range of services and cost models.

**Business Strategy**

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***Contract Services—******Since our inception, we haveprovided contract chemistry services to many of the world’s leadingpharmaceutical and biotechnology companies.***Contractservice companies typically derive their contract revenue from research anddevelopment expenditures of the pharmaceutical and biotechnology industry. Webelieve the industry continues to be under pressure to contain costs and todevelop new drugs faster. We also believe that the industry is undergoing aglobalization transformation and we are seeking to expand the scope of ourservice alternatives in order to meet this demand. In 2005, we establishedoperations in Singapore and India, enabling us to provide our research anddevelopment services in  lower-costenvironments. In February 2006, we completed the acquisition of ComGenex,a privately held drug discovery service company in Budapest, Hungary. Theaddition of ComGenex (now known as AMRI Hungary) provides the Company with aEuropean base in a European Union member state and we expect significantlyincreased access to the European market, as well as another lower-costenvironment from which we can provide our services. We have designed ouroperating structure and our services to provide our customers withopportunities to reduce overall drug development time and cost and tosimultaneously pursue a greater number of drug discovery and developmentopportunities across a wide range of technologies, geographic locations, andcost structures.

We seek comprehensive chemistry research and supplyagreements with our customers, incorporating several of our service offeringsin a variety of locations and cost structures worldwide, and spanning acrossthe entire pharmaceutical research and development process, including access toour chemical compound and natural product libraries, performance of screeningand other lead discovery activities, performance of lead optimization andpre-clinical testing, and large-scale manufacturing for clinical trials andcommercial sale if the product meets regulatory approval. We believe that theability to partner with a single provider of pharmaceutical research anddevelopment services from discovery through commercial production is of 

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significant benefit to ourcustomers. Through our comprehensive service offerings, we are able to providecustomers with a  more efficient transition of experimental compoundsthrough the research and development process, ultimately reducing the time andcost involved in bringing these compounds from concept to market.

***Biotech/Drug Discovery—******We*** alsoconduct proprietary research and development to discover new lead compoundswith commercial potential. We anticipate that we would then license thesepreclinical and clinical compounds to third parties in return for up-frontservice fees and milestone payments as well as recurring royalty payments ifthese compounds are developed into new commercial drugs. We have successfullylicensed  compounds we have developed. InOctober 2005, we licensed the worldwide rights to develop andcommercialize potential products from our amine neurotransmitter reuptake inhibitorsidentified in one of our proprietary research programs to Bristol-Myers SquibbCompany (“BMS”). We believe that this technology provides the opportunity toyield multiple drug candidates. Under our contract with BMS, the successfuladvancement of two such candidates could result in the receipt of in excess of$150 million in up-front license, contract service, and milestone revenue. In1995, our proprietary research and development activities led to thedevelopment, patenting and licensing of a substantially pure form of, and amanufacturing process for, the active ingredient in the non-sedatingantihistamine fexofenadine HCl marketed by Sanofi-Aventis as Allegra in theAmericas and as Telfast elsewhere. Under our license agreement withSanofi-Aventis we have earned a total of $340.2 million in milestones androyalty revenue from 1995 through December 31, 2006 and are entitled toreceive ongoing royalties from Sanofi-Aventis based upon a percentage ofworldwide sales of Allegra and its authorized generic alternative. We presentlyhave multiple other programs in pre-licensing research and development.

**Industry Overview**

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

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

**Drug Discovery,Development and Manufacturing Process**

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

·       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

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·       product commercialization—themanufacture, marketing and sale of commercial quantities of the approved drug.

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

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

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

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

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

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**Product Commercialization.**   Before approving a drug, the Food and DrugAdministration (FDA) requires that manufacturing procedures and operationsconform to cGMP regulations, International Conference on Harmonization (ICH)guidance and manufacturing guidelines and guidance published by the FDA.Manufacturing procedures and operations must be in compliance with allregulatory and quality regulations at all times during the manufacture ofcommercial products and APIs. Once a drug has received all necessary approvals,the manufacture, marketing and sale of commercial quantities of the approveddrug may commence.

**Trends inContracting for Drug Discovery and Development Services**

Contract serviceshave traditionally been limited to the later stages of drug development, suchas clinical trial management and manufacturing. In recent years, manypharmaceutical and biotechnology companies have utilized contract serviceproviders to complement, or in some cases supplement, internal expertise.During this time, only a few companies provided services for drug discovery,development and manufacturing, and these companies typically focused only oncertain stages of the drug development process. The following trends led to anincrease in demand for contract services in 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 domestic market for contractservices began to tighten. This timeframe marked a period of financial declinefor the pharmaceutical and biotechnology industry due to factors such as patentexpirations and successful patent challenges on “blockbuster” drugs, productrecalls, and failure in clinical trials of developmental compounds expected toreplace expiring patents. These factors, as well as consolidation within theindustry,  led to an overall decrease inspending on contract services, as well as a shift in spending away from thediscovery phase of the pharmaceutical research and development process in aneffort to bring previously identified compounds to market. In addition, thenumber of entrants in the market began to increase, including a number offoreign companies operating under substantially lower cost structures,resulting in increased competition for services and pricing pressures.

2005 marked a year of continued transition in themarket for the discovery and development component of contracted pharmaceuticalresearch and development services. We experienced increased demand in the areasof developmental and small-scale cGMP manufacturing services, reflecting areduction in budgetary constraints and increased efforts to bring identifiedcompounds into clinical trials on the part of our pharmaceutical andbiotechnology customers. During the year, we continued to advance our strategicinitiatives to successfully position ourselves in the current marketplace,establishing lower-cost international operations in Singapore and India. Thetrend of sourcing contracted services to lower-

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cost providers acceleratedin 2005, particularly in China and India, resulting in several of our westerncompetitors exiting or significantly reducing their presence in the marketplaceduring the year.

The trends that began toemerge in drug discovery and development outsourcing during 2005 continued in2006. We continued to experience strong demand for our developmental andsmall-scale cGMP manufacturing services, further extending the growth trendthat began in the second half of 2004. Pricing for our services remainedextremely competitive, and the trend of sourcing contracted services tolower-cost providers continued. Our ability to provide services under a varietyof business models and cost structures by incorporating our lower costinternational facilities that were established in India and Singapore in 2005,as well as AMRI Hungary, which was acquired in February 2006, continued tobe well-received by our customers. Our global platform helped to drive anincrease in worldwide demand for our discovery services. This trend, whichbegan in the latter portion of 2004 and ended a two-year period of decliningdemand for these services, continued through 2006. We currently expect thetrend of increased worldwide demand for our services to continue in 2007, andwe expect to continue to expand our global service platform to meet the needsof our customers. In addition to continuing to integrate our existingfacilities in India, Singapore, and Hungary into our global service offerings,we initiated construction on a new 50,000 square foot R&D centre at theShapoorji Pallonji Biotech Park in Hyderabad, India in 2006. The facility willconduct contract projects in early stage drug discovery research and house adevelopment laboratory, and is expected to be completed in late 2007.

**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 asservices on a contract basis that have traditionally required significant timeand capital investment to create internally. Our comprehensive suite ofservices allows our customers to contract with a single partner, eliminatingthe time and cost of transitioning projects among multiple vendors.

**Service Offerings**

***Drug Lead Discovery and Technologies***

We provide services and proprietary drug discoverytechnologies used to identify new lead compounds. We have developedbiocatalysis technology that assists in the creation of novel compounds.Biocatalysis technology uses enzymes and microbial cell systems to synthesizenew compounds which are unattainable by traditional means in one or twochemical 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 synthesis,metabolic profiling,  high throughputbiological screening and in vitro biology. We may seek to bundle our drugdiscovery technologies and screening collections in a strategic alliance tocost effectively identify new drug candidates with selected partners. Inreturn, we would expect to receive a combination of fee for service, milestoneand royalty payments based on the success of the drug candidate.

Our drug discoverytechnologies compliment 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:

·       identifyhit and lead compounds for further optimization;

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

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·       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

·       perform process research,consisting of the improvement or modification of existing processes.

***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

·       resynthesis and expansionof customers’ chemistry libraries by employing combinatorial and computationalchemistry.

***Chemical Development***

Chemical development involves the scale-up synthesisof a lead compound and intermediates. Processes developed for small scaleproduction of a compound may not be suitable for larger scale productionbecause they may be too expensive or environmentally unacceptable or they maypresent safety concerns. Our chemical development scientists design novel,creative or improved methods and processes suitable for medium to large scaleproduction. Our chemical development scientists possess expertise in a broadrange of structural classes of molecules and are able to address a wide varietyof chemical synthesis and production problems. Chemical development servicesthat we provide include:

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

·       discoveryand development of new synthetic methodologies to prepare products;

·       processdevelopment and production of single-isomer molecules; and

·       development of practicalpurification techniques.

***Analytical Chemistry Services***

Our analytical chemistry services develop assays forstudying the purity of the various substances we synthesize, examining anddetecting impurities, conduct physical testing, validate methods againstestablished protocols and conduct stability testing. We also provide regulatoryconsulting services, including the preparation of regulatory filings, chemistrymanufacturing and control documentation and 

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testing, and scientificand technical writing. The cGMP guidelines mandated by the FDA necessitateemploying analytical support for drugs under development, as well as for drugsalready on the market. Our analytical services are designed to support ourcustomers’ compliance with these guidelines. We typically provide these servicesat several stages throughout the drug discovery, development and manufacturingprocess starting with lead optimization. Analytical services that we provideinclude:

·       testmethod development and validation;

·       qualitycontrol and release testing;

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

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

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

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

**cGMP ManufacturingServices**

***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, NYlocation has production facilities and quarantine and restricted access storagenecessary to manufacture quantities of drug substances under cGMP conditionssufficient for conducting clinical trials from Phase I through Phase II, andlater stages for selected products, based on volume and other parameters. Inthe third quarter of 2006, our focus on quality was reinforced after a successfulFDA inspection of our small scale cGMP facilities resulted in no issuances of Form FDA483 *Observations of Objectionable Conditionsand Practices*.

***Large Scale Manufacturing***

Our large scalemanufacturing facility in Rensselaer, NY is equipped to provide a wide range ofcustom chemical development and manufacturing capabilities. We conductcommercial cGMP manufacturing of active pharmaceutical ingredients and advancedintermediates. Our large-scale cGMP manufacturing facilities providesynergies with our small-scale development laboratories, offering ourcustomers excellence at every scale, from bench to production. We have a numberof highly specialized production capabilities, including manufacturing ofhighly potent and cytotoxic agents, purification using critical fluidtechnology, production of controlled substances, and cryogenic reactioncapabilities. In the third quarter of 2006, our focus on quality was reinforcedafter a successful FDA inspection of our Rensselaer facility resulted in noissuances of Form FDA 483 *Observationsof Objectionable Conditions and Practices*.

***Consulting Services***

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

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***Proprietary Research and Development***

Leveraging our wide arrayof chemistry disciplines and discovery technologies, we seek to discover anddevelop promising drug candidates and license these candidates in return forupfront fees, milestones and downstream royalty payments for commercializeddrug products. Utilizing our medicinal chemistry expertise, high throughputbiological screening capabilities, our combinatorial biocatalysis technology,natural products sample collections and other chemically and structurallydiverse chemical collections generated through the application of combinatorialchemistry integrated with our computer assisted drug design capabilities, wepursue drug discovery opportunities and generate novel biologically activechemical substances. Our broad array of scientific disciplines also includecapabilities in microbial fermentation, molecular biology, cell culturetechnologies, gene expression and cloning, *invitro* drug metabolism testing and scale up synthesis of humanmetabolites. We have spent $11.4 million, $14.5 million and $23.9 million onproprietary research and development activities in 2006, 2005 and 2004,respectively. Research and development expenditures in 2004 included a $3.1million non-cash charge related to the issuance of warrants to Bristol-MyersSquibb (“BMS”) in exchange for one of BMS’ pre-clinical drug candidates. Thesewarrants were cancelled in October 2005 in conjunction with our entry intoa Licensing and Research Agreement with BMS in an effort to further develop andcommercialize products from this technology.

***Licensing Agreements***

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

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.

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, 2006, we have earned$7.4 million in milestone payments and $332.8 million in royaltiesunder this license agreement. Sanofi-Aventis is obligated under the licenseagreement to pay ongoing royalties to us based upon its sales ofAllegra/Telfast and generic fexofenadine. We are not entitled, however, toreceive any additional milestone payments under the license agreement. Sales ofAllegra/Telfast and generic fexofenadine by Sanofi-Aventis worldwide wereapproximately $0.9 billion for the year ended December 31, 2006,$1.76 billion for the year ended December 31, 2005, and$1.85 billion for the year ended December 31, 2004. Allergicreactions to plants, pollens and other airborne allergens 

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generallyoccur during 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. See “Item 3—LegalProceedings” for discussion of current legal proceedings related toAllegra/Telfast.

***Business Segments***

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

***Customers***

Our customers includepharmaceutical companies and biotechnology companies and, to a limited extent,agricultural companies, fine chemical companies and contract chemicalmanufacturers. For the year ended December 31, 2006, contract revenue fromour three largest customers represented 21%, 7% and 6%, respectively, of ourcontract revenue. For the year ended December 31, 2005, contract revenuefrom our three largest customers represented 37%, 6% and 4%, respectively, ofour contract revenue. For the year ended December 31, 2004, contractrevenue from our three largest customers respectively represented approximately38%, 6% and 4% of our contract revenue. Our largest customer, GE Healthcare (“GE”),represented 21% of total contract revenue for the year ended December 31,2006. See Note 16 to the consolidated financial statements for information ongeographic and other customer concentrations.

***Marketing***

Our services are marketedprimarily by our dedicated business development personnel and seniormanagement  Because our customers aretypically highly skilled scientists, our use of technical experts in marketinghas allowed us to establish strong customer relationships. In addition to ourinternal marketing efforts, we also rely on the marketing efforts of consultants,both in the United States and abroad. We market our services directly tocustomers through targeted mailings, meetings with senior management ofpharmaceutical and biotechnology companies, maintenance of an extensiveInternet web site, participation in trade conferences and shows, andadvertisements in scientific and trade journals. We also receive a significantamount of business from customer referrals and through expansion of existingcontracts.

***Employees***

As of February 1,2007, we had 1,015 employees. Our large-scale manufacturing hourly work forceof 98 employees is covered by a collective bargaining agreement with theInternational Chemical Workers Union. A new 4-year collective bargainingagreement was signed in January 2007 with the union and expires on January 10,2011. None of our other employees are covered by collective bargainingagreements. We consider our relations with our employees and the union to begood.

***Competition***

We face competition based on a number of factors,including size, relative expertise and sophistication, speed and costs ofidentifying and optimizing potential lead compounds and of developing andoptimizing chemical processes. In certain aspects of our business we also faceforeign competition from companies in regions with lower cost structures. Wecompete with the research departments of 

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pharmaceutical companies,biotechnology companies, combinatorial chemistry companies, contract researchcompanies, contract drug manufacturing companies and research and academic institutions.Many of these competitors have greater financial and other resources and moreexperience in research and development than we do. Smaller companies may alsoprove to be significant competitors, particularly through arrangements withlarge 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 willcontinue to face increased competition in the future as new companies enter themarket, including increased foreign competition from Asia, Eastern Europe andother lower-cost environments. Our services and expertise may be renderedobsolete or uneconomical by technological advances or entirely differentapproaches developed by one or more of our competitors. The existing approachesof our competitors or new approaches or technologies developed by ourcompetitors may be more effective than those developed by us. We cannot giveassurance 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 United States Patent and Trademark Office to determinepriority of invention, which could result in the loss of any opportunity tosecure patent protection for the inventions and the loss of any right to usethe inventions. Even if the eventual outcome is favorable to us, theseproceedings could result in substantial cost to us. The filing and prosecutionof patent applications, litigation to establish the validity and scope ofpatents, assertion of patent infringement claims against others and the defenseof patent infringement claims by others can be expensive and time consuming. Wecannot assure you that in the event that any claims with respect to any of ourpatents, if issued, are challenged by one or more third parties, that any courtor patent authority ruling on such challenge will determine that such patentclaims are valid and enforceable. An adverse outcome in such litigation couldcause us to lose exclusivity afforded by the disputed rights. If a third partyis found to have rights covering products or processes used by us, we could beforced to cease using the technologies covered by such rights, could be subjectto significant liability to the third party, and could be required to licensetechnologies from the third party. Furthermore, even if our patents aredetermined to be valid, enforceable, and broad in scope, we cannot assure youthat competitors will not be able to design around such patents and competewith us and our licensees using the resulting alternative technology.

We have a policy of seeking patent protection forpatentable aspects of our proprietary technology. We have been issued variousUnited States and international patents covering fexofenadine HC1 and certainrelated manufacturing processes. Our United States patents begin to expire in2013, and our 

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international patentsbegin to expire in 2014. Additionally, our United States patents related tosubstituted biaryl purines as potent anticancer agents and a series of aryl andheteroaryl tetrahydroisoquinolines related to central nervous systemindications begin to expire in 2020.

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.

Many of our other current contracts with our customersprovide that ownership of proprietary technology developed by us in the courseof work performed under the contract is vested in the customer, and we retainlittle or no ownership interest.

We also rely upon tradesecrets and proprietary know-how for certain unpatented aspects of ourtechnology. To protect such information, we require all employees, consultantsand licensees to enter into confidentiality agreements limiting the disclosureand use of such information. We cannot assure you that these agreements providemeaningful protection or that they will not be breached, that we would haveadequate remedies for any such breach, or that our trade secrets, proprietaryknow-how, and technological advances will not otherwise become known to others.In addition, we cannot assure you that, despite precautions taken by us, othershave not and will not obtain access to our proprietary technology. Further, wecannot assure you that third parties will not independently 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 three phasesand generally take two to seven years, but may take longer, to complete. Aftercompletion of clinical trials of a new product, FDA and foreign regulatoryauthority marketing approval must be obtained. If the product is classified asa new drug, we or our customer will be required to file a new drug 

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application, or NDA, andreceive approval before commercial marketing of the drug. The testing andapproval processes require substantial time, effort and expense, and we cannotassure you that any approval will be granted on a timely basis, if at all. NDAssubmitted to the FDA can take several years to obtain approval. Even if FDAregulatory clearances are obtained, a marketed product is subject to continualreview. Later discovery of previously unknown problems or failure to complywith the applicable regulatory requirements may result in restrictions on themarketing of a product or withdrawal of the product from the market as well aspossible civil or criminal sanctions. For marketing outside the United States,we will also be subject to foreign regulatory requirements governing humanclinical trials and marketing approval for pharmaceutical products. Therequirements governing the conduct of clinical trials, product licensing,pricing and reimbursement vary widely from country to country.

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 unscheduled 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 amandated closing of our facilities or significant fines, which would materiallyand adversely affect our business, financial condition and results ofoperations. FDA inspections of our Rensselaer manufacturing facilities werecompleted in the third quarter of 2006, resulting in no issuances of Form FDA483. Also, FDA inspections at our cGMP manufacturing facility at 21 CorporateCircle in Albany were completed in 2006, resulting  in no issuances of Form FDA 483.

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

***Internet Website***

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

**ITEM1A. RISK FACTORS**

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

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

Royalties from sales of Allegra currently constitute asignificant portion of our total revenues and operating income. During the yearended December 31, 2006, our royalties from Allegra were $27.0 million,which represented approximately 15% of our total revenues. For the year ended December 31,2005, our royalties from Allegra were $46.9 million, which representedapproximately 26% of our total revenues. The decrease is primarily attributableto the at-risk launch of generic fexofenadine announced by Barr Pharmaceuticals, Inc.and Teva Pharmaceuticals Industries Ltd. on September 6, 2005, which hashad a material adverse impact on U.S. sales of Allegra beginning in the fourthquarter of 2005. The launch of the generic product is considered an “at-risk”launch due to the on-going litigation. Continued generic Allegra competition,including the entrance of additional generic competitors upon the expiration ofBarr’s 180-day exclusivity period for marketing generic fexofenadine oran at-risk launch of a generic version of Allegra-D by a generic competitor,may further adversely affect U.S. sales of Allegra. If the dollar amount ofAllegra sales subject to our license agreement decreases, due to these or anyother factors, our revenues from our license agreement with Sanofi-Aventis willalso decrease. Because we have very few costs associated with the Allegralicense, a decrease in revenues from our license agreement for Allegra wouldhave a material adverse effect on our revenue, operating income, and financialcondition. For example, a $5.0 million decrease in our Allegra royaltyrevenue would decrease our operating income by $4.5 million.

The recurring royalties we receive on the sales ofAllegra/Telfast have historically provided a material portion of our revenues,earnings, and operating cash flows. The at-risk launch of generic fexofenadineannounced by Barr Pharmaceuticals, Inc. and Teva PharmaceuticalsIndustries Ltd. on September 6, 2005 had a material adverse impact on U.S.sales of Allegra in 2006, resulting in a 42% year-over-year decrease in ourroyalty revenues. We currently expect that the at-risk launch of genericfexofenadine will have a similar impact on our royalty revenues in future periods.We expect to experience a decrease in earnings, and operating cash flows in theshort term as we continue to develop our business in an effort to supplementthe revenues, earnings and operating cash flows that have historically beenprovided by Allegra/Telfast royalties.

We have been issuedseveral patents on a pure form of, and a manufacturing process for,fexofenadine HCl. The patent positions of pharmaceutical, medical andbiotechnology firms can be uncertain and can involve complex legal and factualquestions. Litigation, in particular patent litigation, can be complex andtime-consuming and the outcome is inherently uncertain. We cannot assure ourstockholders that we and/or Sanofi-Aventis will ultimately succeed in itscurrent or any future litigation against generic drug manufacturers involvingpatents with respect to Allegra. In the event that one or more of the patentsowned by us or Sanofi-Aventis are ultimately determined to be invalid orunenforceable, Sanofi-Aventis and we would lose exclusivity with respect to theclaims covered by those patents. Any such loss of exclusivity or theintroduction of generic forms of fexofenadine HCl may cause a reduction inAllegra sales. In addition, under our current arrangements with Sanofi-Aventis,Sanofi-Aventis, with consultation from us, has the right to lead with respectto preparing and executing a strategy to defend and enforce certain of thepatents relating to Allegra, and is executing that role in the currentlitigation. As a result, we may not be able to control the conduct of suchlitigation and the strategic decisions that are made during the course of suchlitigation. See “Item 3—Legal Proceedings.”

**Pharmaceutical andbiotechnology companies may discontinue or decrease their usage of our services.**

We depend onpharmaceutical and biotechnology companies that use our services for a largeportion of our revenues. Although there has been a trend among pharmaceuticaland biotechnology companies to outsource drug research and developmentfunctions, this trend may not continue. We have experienced increasing pressureon the part of our customers to reduce expenses, including the use of ourservices as a result of negative economic trends generally and in thepharmaceutical industry. Although our contract 

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revenuesincreased in 2006, we may be adversely effected in future periods as a resultof general economic or pharmaceutical industry downturns. If pharmaceutical andbiotechnology companies discontinue or decrease their usage of our services,including as a result of a slowdown in the overall United States economy, ourrevenues and earnings could be lower than we currently expect and our revenuesmay decrease or not grow at historical rates.

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

During the year-ended December 31,2006, revenues from sales of a raw material to GE for use in one of itsdiagnostic imaging agents GE totaled $32.5 million and representedapproximately 21% of our contract revenue, or 18% of our total revenue. Oursubsidiary, Organichem, entered into a long-term agreement to supply thismaterial to GE in 1999 that was renewed in 2005, extending the expiration dateof the original agreement from 2007 to 2010. GE’s purchases have historicallyexceeded the contractual minimum purchases, however, this may not continue. IfGE materially reduces its purchase levels, there may be a material decrease inour revenues and operating income. In addition, during the year ended December 31,2006, our DDS segment provided services to three major customers representingapproximately 12% of our contract revenues or 10% of our total revenue. Thesecustomers typically may cancel their contracts with 30 days’ to one-year’sprior notice depending on the size of the contract, for a variety of reasons,many of which are beyond our control. If any one of our major customers cancelsits contract with us, our contract revenues may decrease.

**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 currently expect to face increasedcompetition. In the future, any one of our competitors may developtechnological advances that render the services that we provide obsolete. Whilewe plan to develop technologies, which will give us competitive advantages, ourcompetitors plan to do the same. We may not be able to develop the technologieswe need to successfully compete in the future, and our competitors may be ableto develop such technologies before we do or provide those services at a lowercost. 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 significant time and money on internal research anddevelopment with the intention of producing proprietary technologies in orderto patent and then license them to other companies. For example, in October 2005we licensed our proprietary amine neurotransmitter reuptake inhibitortechnology to BMS. However, we may not be successful in producing anyadditional valuable technology or successfully licensing it to a third party inthe future. To the extent we are unable to produce technology that we canlicense, we may not receive any revenues related to our internal research anddevelopment efforts.

**We may beunsuccessful in our collaboration with BMS.**

Our objective is to patent and license our proprietarytechnologies to other companies for the purpose of advancing compoundsassociated with these technologies through human clinical trials, andultimately, obtaining regulatory approval for the commercial sale of productscontaining these compounds. We seek to enter into licensing arrangements withselected partners that provide for a combination of up-front 

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license fees, milestonepayments upon the achievement of specified research and development objectives,and royalty payments based on sales of related commercial products. In October 2005,we licensed the worldwide rights to develop and commercialize potentialproducts from our amine neurotransmitter reuptake inhibitors identified in oneof our proprietary research programs to BMS. In conjunction with the licensingagreement, we received a non-refundable, non-creditable up-front fee of $8million. In addition, BMS will purchase approximately $10 million in researchand development services over the initial three year term of our agreement. Thelicense agreement also sets forth development related milestone events that, ifachieved by our products, would entitle us to non-refundable, non-creditablemilestone payments of up to $66.0 million for each of the first and secondproducts to achieve these events, and up to $22.0 million for each subsequentproduct to achieve these events. The license agreement also provides for us toreceive royalty payments on worldwide sales of any such product that iscommercialized.

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

**Our business may be adversely affected if we encountercomplications in connection with our implementation of information managementsoftware.**

In July 2006,we completed the first of several phases of the implementation of a newcomprehensive enterprise resource planning (“ERP”) system to enhance operatingefficiencies and provide more effective management of our business operations.Continuing and uninterrupted performance of our ERP system is critical to thesuccess of our business strategy. Any material failure of our ERP system thatinterrupts or delays our operations could adversely impact our ability todo the following in a timely manner and have a material adverse effect on ouroperations:

·       reportfinancial results;

·       accuratelyreflect inventory costs;

·       acceptand process customer orders;

·       receiveinventory and ship products;

·       invoiceand collect receivables;

·       placepurchase orders and pay invoices; and

·       accurately reflect allother business transactions related to the finance, order entry,purchasing,  supply chain and humanresource processes within the new ERP information system.

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**The restructuring of our Large Scale Manufacturingsegment may not have the desired impact on the results of our operations.**

On November 9, 2006we announced a restructuring plan designed to improve the efficiency and profitabilityof our LSM operating segment by eliminating overlap in business processes,organization and project process flow, as well as leveraging existing resourcesand assets.  The key elements of therestructuring plan include workforce reductions, including changes inleadership, as well as non-workforce-related actions such as disposal ofunderutilized assets, elimination of non-essential operating expenses, andreductions in raw material costs. Most of these initiatives have beenimplemented by the end of 2006. We expect to realize annual savings ofapproximately $5 million from the restructuring plan beginning in 2007. Theplan as currently constituted, however, may not be sufficient to achieve thedesired level of cost savings during the time period indicated. Additionalrestructuring activities may be required to attain the intended reduction inoperating costs and the expected impact on operating margins within our LargeScale Manufacturing segment. Furthermore, the implementation of the restructuringplan could cause disruptions to Large Scale Manufacturing operations that couldhave an adverse impact on the results of our operations.

**Our goodwill maybecome impaired.**

As of December 31,2006, we have $35.8 million of goodwill on our consolidated balance sheet.We perform an annual assessment of the carrying value of our goodwill forpotential impairment using an independent third-party. A determination ofimpairment is made based upon the estimated future cash flows of the operationsassociated with goodwill, comparable company multiples and recent transactionsinvolving similar entities. If goodwill is determined to be impaired in thefuture we would be required to record a charge to our results of operations.For example, during 2004 we recorded goodwill impairment charges totaling $14.5million. Factors we consider important which could result in an impairmentinclude the following:

·       significantunderperformance relative to historical or projected future operating results;

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

·       significantnegative industry or economic trends; and

·       ourmarket capitalization relative to net book value.

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

**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.

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**Our failure to manage our expansion may adverselyaffect 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 acquisitions may disrupt our business anddistract our management.**

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

**We may not be able to realize the benefits of recentacquisitions and strategic investments.**

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

**We may not be able to effectively manage ourinternational operations.**

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

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**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 compete vigorously withpharmaceutical firms, biotechnology firms, contract research firms, andacademic and research institutions to recruit scientists. If we cannot recruitand retain scientists and other highly skilled employees, we will not be ableto continue our existing services and will not be able to expand the serviceswe offer to our customers.

**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 and Treasurer;

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

·       EricSmart, our Vice President, Business Development;

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

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

·       Dr. MichaelD. Ironside, our Vice President cGMP and Chemical Development;

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

·       Dr. StevenR. Hagen, our Vice President, Quality and Analytical Services.

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

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

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

**We may be heldliable for harm caused by drugs that we develop and test.**

We develop, test andmanufacture drugs that are used by humans. If any of the drugs that we develop,test or manufacture harm people, we may be required to pay damages to thosepersons. Although we carry liability insurance, we may be required to paydamages in excess of the amounts of our insurance coverage. Damages awarded ina product liability action could be substantial and could have a negativeimpact 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 

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incur expenses relating tocompliance with environmental laws. Such expenses or liabilities could have asignificant negative impact on our financial condition.

We have completed anenvironmental remediation assessment associated with groundwater contaminationat our Rensselaer, New York location. This contamination is associated withpast practices at the facility prior to 1990, and prior to AMRI’s investment orownership of the facility. Ongoing costs associated with the remediationinclude biannual monitoring and reporting to the State of New York’s Departmentof Environmental Conservation. Under the remediation plan, we are expected topay for monitoring and reporting until 2014. Under a 1999 agreement with thefacility’s previous owner, our maximum liability under the remediation is$5.5 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 $5.5 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 unscheduled periodic inspections ofour facilities 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.

**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.Although we have contingency plans in effect for natural disasters or othercatastrophic events, these events could still disrupt our operations. Eventhough we carry business interruption insurance policies, we may suffer lossesas a result of business interruptions that exceed the coverage available underour insurance policies. Any natural disaster or catastrophic event in theAlbany area or at our facilities could have a significant negative impact onour operations.

**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. For example, the terrorist attacksthat took place in the United States on September 11, 2001 wereunprecedented events that have created many economic and politicaluncertainties, some of which may materially adversely affect our business,results of operations and financial condition. The potential for futureterrorist attacks, the national and international responses to terroristattacks, and other acts of war, including the current war in Iraq, or hostilityhave created many economic and political uncertainties, which could materiallyadversely affect our business, results of operations, and financial conditionin ways that we currently cannot predict.

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**Health care reform could reduce the prices pharmaceuticaland biotechnology companies can charge for drugs they sell which, in turn,could reduce the amounts that they have available to retain our services.**

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

**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 our stockholdersmight consider the proposal to be in their best interests. These provisionsinclude 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 in controlfor 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.

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 have significant control over us and their interests may differ fromyours.**

At February 21, 2007,our directors and officers beneficially owned or controlled approximately 14.9%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.

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**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, the global economic andpotential uncertainty, including as a result of the war in Iraq and theinternational controversy that accompanied it, have created significantadditional volatility in the United States capital markets. This volatility andthe recent market decline has affected the market prices of securities issuedby many companies, often for reasons unrelated to their operating performanceor their business prospects, and may adversely affect the price of our commonstock.

**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.

**ITEM1B. UNRESOLVED STAFF COMMENTS.**

We have received nowritten comments regarding our periodic or current reports from the staff ofthe Securities and Exchange Commission that were issued 180 days or morepreceding the end of our 2006 fiscal year.

**ITEM2. PROPERTIES.**

Ourprincipal manufacturing and research and development facilities are located inthe United States. The aggregate square footage of our operating facilities isapproximately 785,000 square feet, of which 458,000 square feet are owned and327,000 square feet are leased. Set forth below is information on our principalfacilities:

| **Location**             | ** ** | ** ** | ** ** | **Square Feet**                                               | ** ** | **Primary Purpose** |
|--------------------------|------------|------------|------------|--------------------------------------------------------------------|------------|--------------------------|
| Albany, New York         |       | 268,000    |       | Manufacturing,  Research & Development and Administration |
| Rensselaer, New York     |       | 251,400    |       | Manufacturing &  Research & Development          |
| East Greenbush, New York |       | 64,000     |       | Manufacturing &  Research & Development          |
| Syracuse, New York       |       | 28,000     |       | Manufacturing &  Research & Development          |
| Bothell, Washington      |       | 33,000     |       | Research &  Development                                   |
| Singapore                |       | 16,000     |       | Research &  Development                                   |
| Hyderabad, India         |       | 7,000      |       | Research &  Development                                   |
| Budapest, Hungary        |       | 27,000     |       | Research &  Development                                   |
| Fuzfo, Hungary           |       | 37,000     |       | Research &  Development                                   |
| Mt. Prospect, Illinois   |       | 88,000     |       | Held for Sale and Under Contract for Sale                          |

 

Our Rensselaer, NYfacility is used in our Large-Scale Manufacturing (“LSM”) segment as reportedin the consolidated financial statements. All other facilities are used in ourDiscovery/Development/Small Scale Manufacturing (“DDS”) segment as reported inthe consolidated financial statements. We consider these facilities to be ingood condition and suitable for their purpose. The capacity associated withthese facilities is adequate to meet our anticipated needs through 2007.

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**ITEM3. 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 Company, would either individually or in theaggregate have a material adverse effect on the Company’s business, financialcondition, results of operations or cash flows.

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

In response to the filings described above, beginningin 2001, Aventis Pharmaceuticals filed patent infringement lawsuits againstBarr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, TevaPharmaceuticals, Dr. Reddy’s Laboratories, Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., and Sandoz. Each of the lawsuits was filedin the U.S. District Court in New Jersey and alleges infringement of one ormore patents owned by Aventis Pharmaceuticals. In addition, on November 14,2006, Aventis filed a patent infringement suit against Teva PharmaceuticalsUSA, Barr Laboratories, Inc. and Barr Pharmaceuticals, Inc. in theEastern District of Texas based on patents owned by Aventis. Further, beginningin March 5, 2004, AMR Technology, along with Aventis Pharmaceuticals,filed suit in the U.S. District Court in New Jersey against Barr Laboratories,Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Amino Chemicals, Ltd., Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., DiPharma S.P.A., DiPharma Francis s.r.l., and Sandoz,asserting infringement of two of our U.S. patents that are exclusively licensedto Aventis Pharmaceuticals relating to Allegra and Allegra-D products. On December 11,2006, AMR Technology and Sanofi-Aventis U.S. LLC, an affiliate of AventisPharmaceuticals, also filed a patent infringement lawsuit in the Republic ofItaly against DiPharma Francis s.r.l. and DiPharma S.P.A. based on EuropeanPatent No. 703,902 which is owned by AMR Technology and licensed toSanofi-Aventis U.S. LLC. In addition, on December 22, 2006, AMR Technologyfiled a patent infringement lawsuit in Canada against Novopharm Ltd., TevaPharmaceutical Industries Ltd., Teva Pharmaceuticals USA, Inc., DiPharmaS.P.A. and DiPharma s.r.l. based on Canadian Patent No. 2,181,089.

Aventis Pharmaceuticals and AMR Technology haveentered into covenants not to sue the defendants other than Novopharm, DiPharmaS.P.A. and DiPharma Francis s.r.l., under U.S. Patent No. 5,578,610, whichpatent has not been asserted in the litigation but which AventisPharmaceuticals exclusively licenses from us. However, we and AventisPharmaceuticals have agreed that Aventis Pharmaceuticals will continue to payroyalties to us based on that patent under our original license agreement withAventis Pharmaceuticals. Under our arrangements with Aventis Pharmaceuticals,we will receive royalties until expiration of the underlying patents (2013 forU.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 anFDA-approved generic version of Allegra may not commence until the earlier of adecision favorable to the generic challenger in the patent litigation or 30months after the date the patent infringement lawsuit was filed. In general,the first generic filer is entitled to a 180-day marketing exclusivityperiod upon FDA approval.

On September 6, 2005, Barr Pharmaceuticals, Inc.and Teva Pharmaceuticals Industries Ltd. announced that they have entered intoan agreement for the launch of Fexofenadine Hydrochloride 30 mg, 60 mg and 180mg tablets, the generic version of Allegra tablets in the United States. Thelaunch of the 

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generic product isconsidered an “at-risk” launch due to the on-going litigation. This genericlaunch has had a material adverse impact on U.S. sales of Allegra bySanofi-Aventis since the fourth quarter of 2005 and in turn, the royaltiesearned by the Company on those sales. The launch has not had a material impacton non-U.S. sales of Allegra to date.

On September 20, 2005, AMR Technology, along withAventis Pharmaceuticals, filed a Motion for Preliminary Injunction in the U.S.District Court in New Jersey seeking to enjoin Barr Pharmaceuticals, Inc.,Teva Pharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd.from the sale of generic versions of Allegra in the United States. On January 30,2006, the U.S. District Court denied the request by AMR Technology and AventisPharmaceuticals for a preliminary injunction. An appeal of that decision wastaken to the U.S. Court of Appeals for the Federal Circuit and, on November 8,2006, the appellate court affirmed the District Court’s denial of a preliminaryinjunction. The Federal Circuit’s decisions on the preliminary injunctionapplication is not dispositive of the merits of the claims being asserted asdescribed above.

Subsequent to the preliminary injunction proceeding inthe District Court, Dr. Reddy’s Laboratories has engaged in an at-risklaunch of generic fexofenadine products.

Should the Company beunsuccessful in defending these patents, the Company will continue toexperience a material decrease in operating cash flows and a material adverseeffect on our results of operations and financial condition.

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

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

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**PART II**

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

(a)   MarketInformation.   The Common Stock of theCompany is traded on the Nasdaq National Market (“Nasdaq”) under the symbol “AMRI.”The following table sets forth the high and low closing prices for our CommonStock as reported by Nasdaq for the periods indicated:

| **Period**                          | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| Year ending  December 31, 2006 |       |       |       |     |       |
| First Quarter                       |       | $          | 12.44      |     | $          | 9.70    |       |
| Second Quarter                      |       | $          | 10.81      |     | $          | 9.22    |       |
| Third Quarter                       |       | $          | 10.41      |     | $          | 8.50    |       |
| Fourth Quarter                      |       | $          | 12.43      |     | $          | 9.19    |       |
| Year ending  December 31, 2005 |       |       |       |     |       |
| First Quarter                       |       | $          | 11.27      |     | $          | 8.06    |       |
| Second Quarter                      |       | $          | 14.20      |     | $          | 9.01    |       |
| Third Quarter                       |       | $          | 16.99      |     | $          | 11.77   |       |
| Fourth Quarter                      |       | $          | 13.71      |     | $          | 10.79   |       |

 

***Stock Performance Graph***

The following graph provides a comparison, from****December 31, 2001 through December 29 2006**,**of the cumulative total stockholder return (assumingreinvestment of any dividends) among the Company, the Nasdaq Stock Market (U.S.Companies) Index (the “Nasdaq Index”) and the Nasdaq Pharmaceuticals Index****(the “Pharmaceuticals Index”). Thehistorical information set forth below is not necessarily indicative of futureperformance. Data for the Nasdaq Stock Market Index and the Nasdaq PharmaceuticalsIndex were provided to the Company by Nasdaq.

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| ** **             | ** ** | **Albany Molecular  Research, Inc** | ** ** | **Nasdaq Stock  Market  (U.S. Companies)  Index** | ** ** | **Nasdaq  Pharmaceuticals  Index** | ** ** |
|------------------------|------------|-----------------------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------|------------|
| December 31, 2001 |       |                                          | 100.000    |                                                        |       |                               | 100.000    |   |   |   | 100.000 |   |   |
| December 31, 2002 |       |                                          | 55.832     |                                                        |       |                               | 69.130     |   |   |   | 64.616 |   |   |
| December 31, 2003 |       |                                          | 56.663     |                                                        |       |                               | 103.364    |   |   |   | 94.718 |   |   |
| December 31, 2004 |       |                                          | 42.054     |                                                        |       |                               | 112.488    |   |   |   | 100.885 |   |   |
| December 31, 2005 |       |                                          | 45.886     |                                                        |       |                               | 114.878    |   |   |   | 111.103 |   |   |

 

(b)   Holders.   Thenumber of record holders of our Common Stock as of February 21, 2007 wasapproximately 198. We believe that the number of beneficial owners of ourCommon Stock at that date was substantially greater than 198.

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

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

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

(e)   Equity CompensationPlan Information—The following table provides information about the securitiesauthorized for issuance under our equity compensation plans as of December 31,2006:

| **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)  |       |       | 2,171,413  |                                                                                                                                                  |       |                                                                                                             | $          | 20.12                                                                                                                                                                                                             |       |   |   | 1,539,879 |   |   |
| Equity  compensation plans not approved by security holders |       |       | —     |                                                                                                                                                  |       |                                                                                                             | —     |                                                                                                                                                                                                              |       |   | — |   |   |
| Total                                                       |       |       | 2,171,413  |                                                                                                                                                  |       |                                                                                                             | $          | 20.12                                                                                                                                                                                                             |       |   |   | 1,539,879 | (2) |   |

 

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(1)          Consistsof the Stock Option Plan and the Employee Stock Purchase Plan (ESPP). Does notinclude purchase 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.

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(2)          Includes 1,181,526shares available for the Stock Option Plan and 358,353 shares available for theESPP.

**ITEM6.** SELECTEDFINANCIAL DATA.

The selected financial data shown below for the fiscalyears ended December 31, 2006, 2005, and 2004 and as of December 31,2006 and 2005, have been derived from our audited consolidated financialstatements included in this Form 10-K. The selected financial dataset forth below for the fiscal years ended December 31, 2003 and 2002 andas of December 31, 2004, 2003 and 2002 have been derived from our auditedconsolidated financial statements for those years, which are not included inthis Form 10-K. All share and per share amounts have been adjustedfor stock splits. The information should be read in conjunction with theCompany’s audited consolidated financial statements and related notes and otherfinancial information included herein, including Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”.

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| ** **                                             | ** ** | **As of and for the Year Ending December 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                             | ** ** | **(in thousands, except per share data)**                     | ** ** |
| **Consolidated  Statements of Income (Loss) Data:**    | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Contract revenue                                       |       | $                                                                                      | 152,783    |   | $ | 136,988 |   | $ | 121,554 |   | $ | 144,667 |   | $ | 71,688 |   |
| Recurring royalties                                    |       | 27,024                                                                                 |       | 46,918 |   | 47,973 |   | 51,682 |   | 51,139 |   |
| Total revenue                                          |       | 179,807                                                                                |       | 183,906 |   | 169,527 |   | 196,349 |   | 122,827 |   |
| Cost of contract revenue                               |       | 128,610                                                                                |       | 112,642 |   | 96,932 |   | 101,753 |   | 41,313 |   |
| Write-down of library inventories                      |       | —                                                                                 |       | 2,063 |   | 5,974 |   | — |   | — |   |
| Total cost of contract  revenue                        |       | 128,610                                                                                |       | 114,705 |   | 102,906 |   | 101,753 |   | 41,313 |   |
| Technology incentive award                             |       | 2,783                                                                                  |       | 4,695 |   | 4,789 |   | 5,183 |   | 5,107 |   |
| Research and development                               |       | 11,428                                                                                 |       | 14,468 |   | 23,887 |   | 22,466 |   | 7,096 |   |
| Selling, general and administrative                    |       | 31,899                                                                                 |       | 26,494 |   | 22,812 |   | 20,318 |   | 12,897 |   |
| Property and equipment impairment                      |       | 3,554                                                                                  |       | — |   | 4,728 |   | — |   | — |   |
| Goodwill impairment                                    |       | —                                                                                 |       | — |   | 14,494 |   | — |   | — |   |
| Intangible asset impairment                            |       | —                                                                                 |       | — |   | 3,541 |   | — |   | — |   |
| Restructuring charge                                   |       | 2,431                                                                                  |       | — |   | 1,184 |   | — |   | — |   |
| Total costs and expenses                               |       | 180,705                                                                                |       | 160,362 |   | 178,341 |   | 149,720 |   | 66,413 |   |
| Income (loss) from operations                          |       | (898                                                                                   | )          | 23,544 |   | (8,814 | ) | 46,629 |   | 56,414 |   |
| Equity in (loss) income of unconsolidated   affiliates |       | —                                                                                 |       | — |   | (65 | ) | (372 | ) | 2,795 |   |
| Interest income, net                                   |       | 2,990                                                                                  |       | 1,787 |   | 317 |   | 785 |   | 3,108 |   |
| Minority interest in consolidated   subsidiaries       |       | —                                                                                 |       | — |   | — |   | 133 |   | — |   |
| Loss on equity investment                              |       | —                                                                                 |       | — |   | (1,274 | ) | — |   | — |   |
| Other (loss) income, net                               |       | 150                                                                                    |       | (185 | ) | (18 | ) | 403 |   | 93 |   |
| Income (loss) before income tax expense                |       | 2,242                                                                                  |       | 25,146 |   | (9,854 | ) | 47,578 |   | 62,410 |   |
| Income tax expense                                     |       | 59                                                                                     |       | 8,825 |   | 1,837 |   | 16,714 |   | 22,686 |   |
| Net income (loss)                                      |       | $                                                                                      | 2,183      |   | $ | 16,321 |   | $ | (11,691 | ) | $ | 30,864 |   | $ | 39,724 |   |
| Basic earnings (loss) per share                        |       | $                                                                                      | 0.07       |   | $ | 0.51 |   | $ | (0.37 | ) | $ | 0.97 |   | $ | 1.22 |   |
| Diluted earnings (loss) per share                      |       | $                                                                                      | 0.07       |   | $ | 0.50 |   | $ | (0.37 | ) | $ | 0.95 |   | $ | 1.19 |   |
| Weighted average common shares outstanding, basic      |       | 32,036                                                                                 |       | 32,044 |   | 31,627 |   | 31,880 |   | 32,632 |   |
| Weighted average common shares outstanding, diluted    |       | 32,289                                                                                 |       | 32,334 |   | 31,627 |   | 32,366 |   | 33,309 |   |
| **Consolidated  Balance Sheet Data:**                  | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash, cash equivalents and investment securities       |       | $                                                                                      | 107,164    |   | $ | 127,910 |   | $ | 133,749 |   | $ | 124,628 |   | $ | 129,537 |   |
| Property and equipment, net                            |       | 153,202                                                                                |       | 151,078 |   | 145,753 |   | 146,639 |   | 72,518 |   |
| Working capital                                        |       | 149,932                                                                                |       | 162,805 |   | 179,765 |   | 174,609 |   | 163,133 |   |
| Total assets                                           |       | 375,493                                                                                |       | 383,150 |   | 376,892 |   | 390,945 |   | 302,736 |   |
| Long-term debt, excluding current installments         |       | 13,993                                                                                 |       | 18,521 |   | 48,603 |   | 53,129 |   | 5,281 |   |
| Total stockholders’ equity                        |       | 318,455                                                                                |       | 313,061 |   | 295,476 |   | 301,935 |   | 282,147 |   |
| **Other  Consolidated Data:**                          | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital expenditures                                   |       | $                                                                                      | 16,453     |   | $ | 19,166 |   | $ | 23,716 |   | $ | 30,554 |   | $ | 17,387 |   |

 

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

**Overview**

We are a global chemistry-based drug discovery anddevelopment company, focused on identifying and developing novel biologicallyactive small molecules with applications primarily in the prescription drugmarket. We engage in comprehensive research from lead discovery, optimizationand development to commercial manufacturing and conduct cell and non-cell basedhigh throughput screening on a variety of biological targets. We performresearch for many of the leading pharmaceutical and biotechnology companies andfor our own internal research and development.

In addition to our contract services, we also conductproprietary research and development to discover new therapeutically activelead compounds with commercial potential. We anticipate that we would thenlicense these compounds to third parties in return for up-front and servicefees, and milestone payments as well as recurring royalty payments if these compoundsare developed into new commercial drugs. In October 2005, we licensed theworldwide rights to develop and commercialize potential products from our amineneurotransmitter reuptake inhibitors identified in one of our proprietaryresearch programs to Bristol-Myers Squibb Company (“BMS”). Our proprietaryresearch and development activities previously led to the development,patenting and 1995 licensing of a substantially pure form of, and amanufacturing process for, the active ingredient in the non-sedatingantihistamine fexofenadine HCl marketed by Sanofi-Aventis S.A. as Allegra inthe Americas and as Telfast elsewhere.

Our total revenue for 2006was $179.8 million, including $152.8 million from our contractservice business and $27.0 million from our royalties on sales of Allegra.We generated $11.3 million in cash from operations and spent $11.6 millionrelated to the acquisition of AMRI Hungary. In addition, we spent$16.5 million in capital on our facilities and equipment, primarilyrelated to the construction and outfitting of research facilities in Singaporeand India,  the expansion of ourmanufacturing suites at our Rensselaer facility, and the implementation of acompany-wide enterprise resource planning (“ERP”) system. In addition, we paiddown $4.6 million in outstanding principal on our credit facilities. Werecorded net income of $2.2 million in 2006. As of December 31, 2006, wehad $107.2 million in cash, cash equivalents and investments and$18.5 million in bank and other related debt, carrying a blended interestrate of approximately 4.13%.

*Strategy*

We continue to execute a long-term strategy to growour global platform services business while leveraging our proprietarytechnologies and capabilities to provide greater value to our customers andfurther growth for the Company. In 2005, we established operations in Singaporeand India, enabling us to provide our research and development services inlower-cost environments. In February 2006, we completed the acquisition ofComGenex (now known as AMRI Hungary), a privately held drug discovery servicecompany in Budapest, Hungary. The addition of AMRI Hungary has provided theCompany with a European base in a European Union member state and significantlyincreased access to the European market, as well as another lower-costenvironment from which we can provide our services. We have designed ouroperating structure and our services to provide our customers withopportunities to reduce overall drug development time and cost and tosimultaneously pursue a greater number of drug discovery and developmentopportunities across a wide range of technologies, geographic locations, andcost structures.

We also continued to transition and expand ourclinical supply manufacturing revenue stream at our large-scale manufacturingfacility, enabling us to seamlessly transfer our customers’ clinical supplymanufacturing projects through the drug discovery and development process fromthe development of these materials at our smaller scale chemistry laboratoriesto large-scale production for use in advanced stage human trials. Clinicalsupply manufacturing supplements our large-scale facility’s legacy services, 

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which include cGMPcommercial production, as well as high potency and controlled drug substancemanufacturing, and is expected to assist us in recovering lost revenuesresulting from the 2005 discontinuation of purchases of one of the productsthat we sold to GE Healthcare. Sales of this product totaled $17.0 million in2005, which represented 21% of large scale manufacturing revenue for the yearended December 31, 2005. In addition, clinical supply manufacturingpresents additional commercial production opportunities, as we seek to enterinto comprehensive agreements with our customers that also provide for commercialsupply of these materials upon meeting regulatory approval. We entered into twoof these types of agreements during the second quarter of 2006. The materialsto be produced under these agreements received positive regulatoryannouncements in October 2006, and the commercial manufacturing of aproduct under one of these contracts began in the fourth quarter of 2006. Clinicalsupply manufacturing represented 32% of our LSM revenue in 2006, compared to22% in 2005.

In November 2006, we announced plans to initiatea restructuring of our LSM business segment. Consistent with our continuedstrategy of realigning this segment toward a greater focus on manufacturingclinical trial materials with strong commercial potential as noted above, thegoals of the restructuring plan are to strengthen our competitiveness in thisarea and reduce operating costs by eliminating overlap in business processes,organization and project process flow, as well as leveraging existing resourcesand assets. The restructuring plan called for us to reduce our workforce inthis segment by approximately 40 employees or approximately 15%, as wellas reduce non-essential operating expenses, raw material costs and futurecapital expenditure activities. We estimate that total large scale costs willbe reduced by $5 million annually as a result of this restructuring. We arealso evaluating opportunities to leverage our large-scale cGMP productionfacilities, including identifying niche products to manufacture such as activepharmaceutical ingredients (“API”) for use in generic versions of compoundswhose patents have expired or will be expiring, as well as assessingcomplementary lines of business that support cGMP production.

We continue to advance our proprietary technologiesand programs with the goal to generate licensing and other revenueopportunities. In October 2006, the Company announced the selection of acompound from its proprietary oncology research program for advancedpreclinical testing, with the goal of submitting an Investigational New DrugApplication (“IND”) with the U.S. Food and Drug Administration (“FDA”) in late2007 or early 2008. We also continue to utilize our proprietary technologies tofurther advance other early to middle stage internal research programs in the fieldsof oncology, immunosuppresion, bacterial infection and other diseases, with aview to seeking a licensing partner for these programs at an appropriateresearch or developmental stage.

Additionally, we continue to seek comprehensiveresearch and/or supply agreements with our customers, incorporating several ofour service offerings in a variety of locations and cost structures worldwide,and spanning across the entire pharmaceutical research and development process,including access to our chemical compound and natural product libraries,performance of screening and other lead discovery activities, performance oflead optimization and pre-clinical testing, and large-scale manufacturing forclinical trials and commercial sale if the product meets regulatory approval. Webelieve that the ability to partner with a single provider of pharmaceuticalresearch and development services from discovery through commercial productionis of significant benefit to our customers. Through our comprehensive serviceofferings, we are able to provide customers with a  more efficienttransition of experimental compounds through the research and developmentprocess, ultimately reducing the time and cost involved in bringing thesecompounds from concept to market. Under these comprehensive agreements, wetypically receive a combination of fees for performance and delivery of goodsand services, as well as milestone and royalty payments should collaborativeefforts lead to the discovery of new products that reach the market.

We are currently in the process of implementing acompany-wide enterprise resource planning (“ERP”) system, which will ultimatelyresult in the management of all components of our business across all locationswithin one integrated operating system. We completed the implementation of thissystem in all U.S. locations in July 2006, and we expect to implement thissystem in our international locations in 

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2007. We expect the ERP toprovide increased visibility into the operation and management of our contractservices and research and development businesses. In addition, we expect torealize efficiencies through the consolidated processing of our administrativefunctions in a uniform manner across all locations.

The trends that began to emerge in chemistry outsourcingduring 2005 continued in 2006. We continued to experience strong demand for ourdevelopmental and small-scale cGMP manufacturing services, further extendingthe growth trend that began in the second half of 2004. Pricing for ourservices remained extremely competitive, and the trend of sourcing contractedservices to lower-cost providers continued. Our ability to provide servicesunder a variety of business models and cost structures by incorporating ourlower cost international facilities that were established in India andSingapore in 2005, as well as AMRI Hungary, which was acquired in February 2006,continued to be well-received by our customers. Our global platform helped todrive an increase in worldwide demand for our discovery services. This trend,which began in the latter portion of 2005 and ended a two-year period ofdeclining demand for these services, continued through 2006. We currentlyexpect the trend of increased worldwide demand for our services to continue in2007, and we expect to continue to expand our global service platform to meetthe needs of our customers. In addition to continuing to integrate our existingfacilities in India, Singapore, and Hungary into our global service offerings,we initiated construction on a new 50,000 square foot R&D centre at theShapoorji Pallonji Biotech Park in Hyderabad, India in 2006. The facility willconduct contract projects in early stage drug discovery research and house adevelopment laboratory, and is expected to be completed in late 2007.

As discussed in Item 3 of this Form 10-K,beginning in September 2005, several generic manufacturers began toproduce and market a generic version of Allegra. We and Aventis Pharmaceuticalshave filed several patent infringement suits against these generic companiesalleging infringement of certain U.S. and Canadian patents. The launch of thegeneric product is considered an “at-risk” launch due to the on-goinglitigation. The at-risk launch of generic fexofenadine had a material adverseimpact on U.S. sales of Allegra by Sanofi-Aventis in 2006 and in turn, theroyalties earned by us on those sales. We continue to forcefully and vigorouslydefend our intellectual property related to Allegra, and we continue to pursueour intellectual property rights as the patent infringement litigationprogresses. However, should we or Sanofi-Aventis be unsuccessful in defendingthese patents we would continue to experience a material decrease in royaltyrevenues and operating cash flows.

The recurring royalties wereceive on the sales of Allegra/Telfast have historically provided a materialportion of our revenues, earnings, and operating cash flows. The at-risk launchof generic fexofenadine had a material adverse impact on U.S. sales of Allegrain 2006, resulting in a 42% year-over-year decrease in our royalty revenues forthe year. We currently expect 2007 Allegra royalty revenues to remain flat ordecrease slightly from amounts recognized in 2006. We expect to experience adecrease in earnings and operating cash flows in the short term as we continueto develop our business in an effort to supplement the revenues, earnings andoperating cash flows that have historically been provided by Allegra/Telfastroyalties.

*Mt. ProspectImpairment*

During the fourth quarter of 2006, we secured a letterof intent related to the potential sale of the Mt. Prospect facility forapproximately $1.5 million. As a result, we recorded an additional impairmentcharge of approximately $0.5 million in the fourth quarter of 2006 to reducethe carrying amount of these assets to reflect the sales price per the letterof intent less estimated selling costs. We currently anticipate the sale to becompleted in the first half of 2007.

The facility qualified forheld for sale treatment in accordance with SFAS No. 144 during the fourthquarter of 2004. At that time, we anticipated the completion of the sale of thefacility by June 2006. We previously disclosed that if a definitive agreement to sell the facilitywas not in place as of June 30, 2006, we 

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would reassessthe classification of the facility as held for sale in accordance with SFAS No. 144.We were not able to secure a definitive agreement to sell the facility as of June 30,2006. Accordingly, and in connection with the preparation of our second quarterresults, we reassessed Mt. Prospect as a held for sale facility. As a result ofthis assessment, we reaffirmed our intention to sell the Mt. Prospect facility,and determined that a further write-down of the carrying value of the facilitywas required. Management estimated the fair value based upon its intention tosell the facility within twelve months and comparable real estate transactionsin the facility’s market area. We recorded an impairment charge of $3.1 millionduring the quarter ended June 30, 2006 to reflect the estimated fair valueof the facility less estimated selling costs.

**Results ofOperations**

*Operating SegmentData*

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

*Contract Revenue*

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

| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** ** | ** ** | **(in 000’s)**                   | ** ** |
| DDS        |       | $                                          | 75,777     |   | $ | 55,645 |   | $ | 53,488 |   |
| LSM        |       | 77,006                                     |       | 81,343 |   | 68,066 |   |
| Total      |       | $                                          | 152,783    |   | $ | 136,988 |   | $ | 121,554 |   |

 

DDS contract revenue for 2006 was $75.8 million, anincrease of $20.2 million or 36.2% compared to contract revenue of $55.6 for2005. The increase in contract revenue was primarily attributable to anincrease in discovery services revenue of $12.1 million or 44% due to therecognition of license fee and FTE services revenues resulting from our Licenseand Research Agreement with BMS, strong worldwide demand for discovery servicesprovided through both our U.S. and Singapore facilities, and the addition of$8.1 million in revenue from AMRI Hungary. In addition, contract revenue fromchemical development, small-scale GMP manufacturing and analytical servicesincreased by $8.1 million or 29% as our customers continue to focus ondevelopment-stage projects and demand for development services provided throughour India facility increased. We expect the growth trends in both discoveryservices and development and small-scale manufacturing services to continue in2007.

LSM contract revenue decreased by $4.3 million, or5.3%, to $77.0 million in 2006 compared to $81.3 in 2005. The decrease incontract revenue was primarily attributable to the discontinuation of purchasesof one of LSM’s products by GE Healthcare in the second quarter of 2005. Sales of this product totaled $17.0 million in 2005,which represented 21% of  2005 LSMrevenue, and 12% of total contract revenue for the 

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yearended December 31, 2005. The decrease is largely offset by anincrease in demand for clinical supply products for advanced stage human trialsas we shift the focus of our large-scale manufacturing operations. Clinicalsupply manufacturing revenues were $24.3 million in 2006, or 32% of total LSMrevenue, compared to $17.9 million in 2005, or 22.0% of total LSM revenue. Thedecrease is further offset by a $5.5 million increase in sales of commercialproducts to customers other than GE due to the timing of customer requirements. We expect an increase in large-scale contractrevenue in 2007 as we experience continued growth in the area of clinicalsupply manufacturing for advanced stage human trials and additionally increaseour customer base for other commercial products.

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

LSM contract revenueincreased by $13.3 million, or 19.5%, to $81.3 million in 2005 compared to$68.1 in 2004. The increase in contract revenue was primarily attributable toan increase in demand for clinical supply products for advanced stage humantrials as we shift the focus of our large-scale manufacturing operations.Clinical supply manufacturing revenues were $17.9 million in 2005, or 22% oftotal LSM revenue, compared to $8.1 million in 2004, or 12% of  total LSM revenue. Our largest LSM customer, GE, discontinued purchases of one of theproducts that we sell to them in 2005. Sales of this product totaled $17.0million, which represented 21% of  2005LSM revenue, and 12% of total contract revenue for the year ended December 31,2005.

*Recurring Royalties*

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

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **(in 000’s)** | ** ** | ** ** | ** ** |
| $27,024                                    |       | $ | 46,918 |   | $ | 47,973 |   |
|                                            |            |  |  |  |  |  |  |

 

Recurring royalties decreased 42.4% to $27.0 millionfor the year ended December 31, 2006 from $46.9 million for 2005. Thedecrease is primarily attributable to the impact of the at-risk launch ofgeneric fexofenadine by Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd.

Recurring royalties decreased 2% to $46.9 million forthe year ended December 31, 2005 from $48.0 million for 2004. The decreaseis primarily attributable to the fourth quarter 2005 impact of the at-risklaunch of generic fexofenadine by Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd., which occurred on September 6, 2005.

The recurring royalties wereceive on the sales of Allegra/Telfast have historically provided a materialportion of our revenues, earnings, and operating cash flows. We expect tocontinue to experience a 

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decreasein revenues, earnings, and operating cash flows from historical levels in theshort term as we continue to develop our business in an effort to supplementthe revenues, earnings and operating cash flows that have historically beenprovided by Allegra/Telfast royalties. We continue to forcefully and vigorouslydefend our intellectual property related to Allegra, and we continue to pursueour intellectual property rights as patent infringement litigation progresses.However, should we or Aventis be unsuccessful in defending these patents wewould continue to experience a material decrease from historic royaltyrevenues. Furthermore, an at-risk launch of a generic version of Allegra-D by ageneric competitor could result in further decreases in royalty revenues.

*Cost of Contract Revenue*

Costof contract revenue, from which we derive gross profit from contract revenue,consists primarily of compensation and associated fringe benefits foremployees, chemicals, depreciation and other indirect costs. Cost of contractrevenue for our DDS and LSM segments were as follows:

| ** **         | ** ** | **Year Ended December 31,** | ** ** |
|--------------------|------------|--------------------------------------------|------------|
| ** **         | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **         | ** ** | **(in 000’s)**                   | ** ** |
| DDS                |       | $                                          | 53,591     |   | $ | 45,179 |   | $ | 51,186 |   |
| LSM                |       | 75,019                                     |       | 69,526 |   | 51,720 |   |
| Total              |       | $                                          | 128,610    |   | $ | 114,705 |   | $ | 102,906 |   |
| DDS Gross Margin   |       | 29.3                                       | %          | 18.8 | % | 4.3 | % |
| LSM Gross Margin   |       | 2.6                                        | %          | 14.5 | % | 24.0 | % |
| Total Gross Margin |       | 15.8                                       | %          | 16.3 | % | 15.3 | % |

 

DDS contract revenue gross margin was 29.3% for theyear ended December 31, 2006, compared to 18.8% in 2005. The increase ingross margin largely resulted from the increase in contract revenues inrelation to the fixed cost components of DDS contract business, including theaddition of license fee revenues associated with our Licensing and ResearchAgreement with BMS. The recognition of license fees contributed approximately$2.9 million to DDS contract revenue for 2006, with no correspondingincremental cost. We also realized good margin contributions on servicesperformed at AMRI Hungary. DDS contract gross margin was also favorablyimpacted by a $1.2 million decrease in the amortization of the Company’schemical compound and natural product library inventories for the year endedDecember 31, 2006, due to the impairment of these libraries in the fourthquarter of 2005. This item was offset by increased salary and benefit expensesdue to annual merit increases and the recognition of additional share-basedcompensation expense under SFAS No. 123 (R). We expect the trend ofincreased DDS contract revenue gross margins to continue in 2007 due toincreases in contract revenues both domestically and internationally inrelation to the fixed costs at these locations.

LSM contract revenue gross margin decreased to 2.6%for the year ended December 31, 2006 compared to 14.5% in 2005. Thedecrease is due to the impact of the transition of our large-scalemanufacturing facility from specializing in the repetitive manufacturing ofcommercial products to the non-repetitive manufacturing of clinical supplycompounds for numerous customers for use in clinical trials. InNovember 2006 we announced a restructuring plan to realign the facility’soperations and cost structure with this business model. The goal of therestructuring plan is to improve the efficiency and profitability of the LSMoperating segment by eliminating overlap in business processes, organizationand project process flow, as well as leveraging existing resources andassets.   As a result, we expect grossmargins in the LSM segment to improve in 2007, as we expect to realize annualsavings of approximately $5 million from the restructuring plan beginning in2007. The savings are expected to occur through the announced workforcereductions as well as non-workforce-related actions such as the disposal ofunderutilized assets, elimination of non-essential operating expenses, andreductions in raw material costs.

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DDS contract revenue grossmargin was 18.8% for the year ended December 31, 2005, compared to 4.3% in2004. The increase in gross margin largely resulted from the increase incontract revenues in relation to the fixed cost components of DDS contractbusiness, as well as decreases in facilities and overhead costs, compensationand benefits expense due to a reduction in scientific personnel, as well asdecreases in write-downs of our library and raw material inventories. LSMcontract revenue gross margin decreased to 14.5% for the year ended December 31,2005 compared to 24.0% in 2004. The decline in gross margin was due to thetransition of our large-scale manufacturing facility from specializing in themanufacturing of commercial products to the manufacturing of clinical supplycompounds for use in human trials.

*TechnologyIncentive Award*

Wemaintain a Technology Development Incentive Plan, the purpose of which is tostimulate and encourage novel innovative technology development by ouremployees. This plan allows eligible participants to share in a percentage ofthe net revenue earned by us relating to patented technology with respect towhich the eligible participant is named as an inventor. Awards are currentlypayable primarily to Dr. Thomas D’Ambra, the Chief Executive Officer andPresident of the Company. The incentive awards were as follows:

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **(in 000’s)**                   | ** ** |
| $2,783                                     |       | $ | 4,695 |   | $ | 4,789 |   |
|                                            |            |  |  |  |  |  |  |  |

 

The technology incentive award expense incurred underour Technology Development Incentive Plan decreased 40.7% to $2.8 million forthe year ended December 31, 2006, compared to $4.7 million for 2005. Thedecrease was directly attributable to the continued decrease in Allegraroyalties in 2006, partially offset by technology incentive awards paid toemployees involved in the development of our proprietary amine neurotransmitterreuptake inhibitors as a result of the successful licensing of this technologyto BMS. We expect technology incentive award expense to generally fluctuatedirectionally and proportionately with fluctuations in Allegra royalties infuture periods.

The technology incentiveaward expense incurred under our Technology Development Incentive Plandecreased 2% to $4.7 million for the year ended December 31, 2005, comparedto $4.8 million for 2004. The decrease was directly attributable to thedecrease in Allegra royalties in 2005.

*Research andDevelopment*

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

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **(in 000’s)**                   | ** ** |
| $11,428                                    |       | $ | 14,468 |   | $ | 23,887 |   |
|                                            |            |  |  |  |  |  |  |

 

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Research and development expenses decreased 21.0% to$11.4 million for the year ended December 31, 2006 from $14.5 million for2005. The decrease in R&D expense during the year ended December 31,2006 is due primarily to the out-licensing of our CNS programs, whichrepresented our most significant investment in R&D in 2005, to BMS in October 2005.As a result, after signing the agreement in October 2005, we did not incursignificant R&D expenditures that would have been necessary to furtheradvance these programs. In addition, certain costs associated with theseprograms, primarily consisting of compensation, employee benefit, and overheadcosts related to the AMRI scientific personnel working on these programs havebeen allocated to cost of contract revenue related to the contract research weare performing for BMS in conjunction with the Licensing and Research Agreement.On October 30, 2006, the Company announced the selection of a compoundfrom its proprietary oncology research program for advanced preclinicaltesting, with the goal of submitting an Investigational New Drug Application (“IND”)with the U.S. Food and Drug Administration (“FDA”) in late 2007 or early 2008. Wecurrently expect research and development expense increases in 2007 as weadvance our oncology compound towards an IND submission with the FDA.

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, which was our most advancedproject to date, was licensed to BMS in exchange for up-front license fees,contracted research services, and the rights to future milestone and royaltypayments. We also continue to utilize our proprietary technologies tofurther advance other early to middle-stage internal research programs in thefields of oncology, immunosuppresion and inflammation, with a view to seeking alicensing partner for these programs at an appropriate research ordevelopmental stage.

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 decreased 39% to $14.5 million for the year ended December 31,2005 from $23.9 million for 2004. The decrease in research and developmentexpenses was due to the fact that research and development expenses for theyear ended December 31, 2004 included a $3.1 million charge related to theissuance of warrants to BMS in conjunction with our acquisition of intellectualproperty related to our central nervous system (“CNS”) programs. The decreasewas also due to the fact that we licensed our CNS programs, which representedour most significant investment in R&D in both 2005 and 2004, to BMS in October 2005.As a result, after signing the agreement in October 2005, we did not incursignificant R&D expenditures that would have been necessary to furtheradvance these programs. In addition, certain costs associated with these programs,primarily consisting of compensation and benefit costs related to the AMRIscientific personnel working on these programs, shifted to cost of contractrevenue related to the contract research we are performing for BMS inconjunction with the licensing and research agreement. Finally, the decreasewas also due to initiatives we undertook to reorganize our internal departmentsin order to have a more formalized and structured R&D business group in2005, resulting in a more narrow focus of the scope of our research anddevelopment activities.

*Selling, Generaland Administrative*

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

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **(in 000’s)**                   | ** ** |
| $31,899                                    |       | $ | 26,494 |   | $ | 22,812 |   |
|                                            |            |  |  |  |  |  |  |

 

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The increase in selling, general and administrativeexpenses in 2006 is primarily due to the addition of $3.5 million inincremental administrative costs incurred at AMRI Hungary, an increase insalaries and benefits expense of $2.1 million due to the addition ofadministrative and business development personnel and the recognition ofadditional share-based compensation expense under SFAS No. 123 (R),  as well as an increase in costs of $0.9million due to the implementation and maintenance of our ERP system. Theseincreases were partially offset by a decrease of $0.4 million from a refund ofproperty taxes at our Mt. Prospect facility and an incremental decrease of $0.3million in our Singapore expenses. Selling, general and administrative expensesare expected to increase in 2007 due to increased business developmentpersonnel costs, the recognition of additional stock-based compensation costs,additional travel costs associated with our international operations, andadditional recruiting costs associated with the staffing of scientific personnelat both our domestic and international operations resulting from theanticipated increased demand for our contract services.

The increase in selling,general and administrative expenses in 2005 was due to an increase in salaryand benefit expenses of $2.7 million resulting from the addition ofadministrative and business development personnel, as well as the reallocationof certain personnel expenses to more appropriately reflect the current use ofthese resources; the addition of $2.4 million in start-up and administrativecosts associated with our Singapore and India operations; and a $1.1 millionincrease in facilities costs associated with the reallocation of these costs tomore appropriately reflect the current cost of operating our laboratory andadministrative facilities. These increases were partially offset by $1.4million of employee and equipment relocation costs associated with the closureof our Mount Prospect facility incurred during 2004, as well as a decrease inprofessional fees of $1.3 million due to an overall decrease in Sarbanes-Oxleycompliance service costs and additional accounting and valuation service feesassociated with the impairment analyses performed at our Bothell and MountProspect facilities in 2004.

*Impairment andRestructuring Charges*

Large Scale Manufacturing Restructuring

On November 9, 2006, the Company announced plansto initiate a restructuring of the Company’s LSM business segment. Consistentwith the Company’s continued strategy of realigning its LSM segment toward agreater focus on manufacturing clinical trial materials with strong commercialpotential, the goals of the restructuring plan are to strengthen the Company’scompetitiveness in this area and reduce operating costs by eliminating overlapin business processes, organization and project process flow, as well asleveraging existing resources and assets. The restructuring plan called for theCompany to reduce its workforce in this segment by approximately40 employees or approximately 15%, as well as reduce non-essentialoperating expenses, raw material costs and future capital expenditureactivities. The Company has estimated that total large scale costs will bereduced by $5 million annually as a result of this restructuring. The Companyrecorded a restructuring charge of approximately $2.4 million in the fourthquarter of 2006, including a non-cash asset disposal charge of approximately$1.6 million, and cash charges of approximately $0.8 millionconsisting primarily of termination benefits.

Thelarge scale restructuring costs are included under the caption restructuringcharge in the consolidated statement of income for the year ended December 31,2006 and the restructuring liabilities are included in accounts payable andaccrued expenses on the consolidated balance sheet at December 31, 2006.The following table displays the restructuring activity and liability balances:

| ** **            | ** ** | **Balance at  January 1,  2006** | ** ** | **Restructuring  Charges** | ** ** | **Incurred  Amounts** | ** ** | **Balance at  December 31,  2006** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|----------------------------|------------|-----------------------|------------|----------------------------------------------|------------|
| ** **            | ** ** | **(in 000’s)**                   | ** ** |
| Termination  benefits |       |                                       | $          | —                     |       |                  |       | 874                                          |       |   | (192 | ) |   | $ | 682 |   |   |
| Asset disposal  costs |       |                                       | —     |                       |       |                  | 1,557      |                                         |       | (1,175 | ) |   | 382 |   |   |
| Total                 |       |                                       | $          | —                     |       |                  |       | $                                            | 2,431      |   |   | $ | (1,367 | ) |   | $ | 1,064 |   |   |
|                       |            |                                            |            |                            |            |                       |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

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Costs of termination benefits relate to severancepackages, outplacement services and career counseling for employees affected bythe restructuring. Asset disposal costs relate primarily to the carrying valueof underutilized assets that were identified for disposal in conjunction withthe restructuring plan.

The large scalemanufacturing restructuring activity was recorded in the LSM operating segment.The net cash outflow related to the large scale manufacturing  restructuring for the year ended December 31,2006 was $0.07 million. Anticipated cash outflows related to the large scalemanufacturing restructuring for 2007 are $0.8 million, which primarily consistsof the payment of accrued termination benefits.

*Mt. Prospect Restructuring andImpairment Charges*

During the fourth quarter of 2006, we secured a letterof intent related to the potential sale of the facility for approximately $1.5million. As a result, we recorded an additional impairment charge ofapproximately $0.5 million in the fourth quarter of 2006 to reduce the carryingamount of these assets to reflect the sales price per the letter of intent lessestimated selling costs. We previously recorded an impairment charge of $3.1million during the quarter ended June 30, 2006 to reflect the estimated fairvalue of the facility less estimated selling costs.

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

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

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

We  previouslydisclosed that if a definitive agreement to sell the facility was not in placeas of June 30, 2006, it would reassess the classification of the facility asheld for sale in accordance with SFAS No. 144 at that time. We were not able tosecure a definitive agreement to sell the facility as of June 30, 2006.Accordingly, and in connection with the preparation of its second quarterresults, the Company reassessed Mt. Prospect as a held for sale facility. As aresult of this assessment, the Company reaffirmed its intention to sell the Mt.Prospect facility, and determined that a further write-down of the carrying valueof the facility was required. Management estimated the fair value based uponits intention to sell the facility within twelve months and comparable realestate transactions in the facility’s market area.

Therestructuring costs are included under the caption restructuring charge in theconsolidated statement of loss for the year ended December 31, 2004. Thesubsequent impairment of the Mt. Prospect facility and the resultingadjustments to the related restructuring liabilities are included under thecaption property and equipment impairment in the consolidated statement ofincome for the year ended December 31, 2006. The restructuring liabilitiesare included in accounts payable and accrued expenses on 

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the consolidated balance sheets at December 31,2006 and 2005. The following table displays the restructuring activity andliability balances:

| ** **            | ** ** | **Balance at  January 1,  2006** | ** ** | **Adjustments** | ** ** | **Payments** | ** ** | **Balance at  December 31,  2006** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|-----------------|------------|--------------|------------|----------------------------------------------|------------|
| ** **            | ** ** | **(in 000’s)**                   | ** ** |
| Asset disposal  costs |       |                                       | 513        |            |       |         | (323       | )                                            |       |   | — |   |   |   | 190 |   |   |
| Total                 |       |                                       | $          | 513             |       |         |       | (323                                         | )          |   |   | — |   |   |   | $ | 190 |   |   |
|                       |            |                                            |            |                 |            |              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

Asset disposal costs relate primarily to brokeragecommissions, legal fees, and marketing expenses associated with the plannedsale of the Mount Prospect Research Center facility, which is included inproperty and equipment held for sale on the consolidated balance sheet.

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

The Mt. Prospectrestructuring activity was recorded in the DDS operating segment. The net cashoutflow related to the Mt. Prospect restructuring for the year ended December 31,2006 was $0. Anticipated cash outflows related to the large scale manufacturingrestructuring for 2007 are $0.2 million, which primarily consists of thepayment of accrued asset disposal costs.

*Equity in income(loss) of unconsolidated affiliates*

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

| **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|
| **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **(in 000’s)**                   | ** ** |
| $—                                    |       |   | $— |   |   | $ | (65 | ) |
|                                            |            |  |  |  |  |  |  |  |

 

The loss recorded in 2004reduced the value of the Company’s investment to $0, and as such, no furtheradjustments will be recorded until the investee returns to a position ofpositive net worth.

*Interest income (expense), net*

| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| **(in thousands)**         | ** ** | ** **                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest expense                |       | $                                          | (1,072     | ) | $ | (1,772 | ) | $ | (1,641 | ) |
| Interest income                 |       | 4,062                                      |       | 3,559 |   | 1,958 |   |
| Interest income  (expense), net |       | $                                          | 2,990      |   | $ | 1,787 |   | $ | 3171 |   |
|                                 |            |                                            |            |  |  |  |  |  |  |  |  |  |

 

Interest expense decreased $0.7 million to $1.1million for the year ended December 31, 2006 from $1.8 million for 2005. Thedecrease was primarily due to the paydown of the $25.5 million outstandingbalance on the Company’s line of credit in the third quarter of 2005.

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

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Interest income increased $0.5 million to $4.1 millionfor the year ended December 31, 2006 from $3.6 million for 2005. Theincrease was due to increases in the rates earned on investment securities,interest bearing cash accounts and other short-term cash equivalents, partiallyoffset by decreases in the underlying interest-earning balances held by theCompany.

Interest income increased$1.6 million or 82% to $3.6 million for the year ended December 31, 2005from $2.0 million for 2004. The increase in interest income was primarily dueto increases in the rates earned on short-term cash equivalents and investmentsecurities, as well as an effort by management to maximize balances held inshort-term cash equivalent accounts, which are higher yielding than interest-bearingcash accounts.

***Loss on equity investment***

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 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 $956,000 equity investment based onour analysis as of December 31, 2006 and 2005. However, should the eventsand conditions that are indicative of impairment as noted above arise, theCompany may be required to record additional impairment charges in futureperiods.

***Income tax expense***

| Year Ended December 31, | ** ** |
|----------------------------------------|------------|
| **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| **(in 000’s)**               | ** ** |
| $59                                    |       | $ | 8,825 |   | $ | 1,837 |   |
|                                        |            |  |  |  |  |  |  |

 

Income tax expense decreased to $59,000 for the yearended December 31, 2006, compared to $8.8 million for 2005. The overalldecrease in income tax expense is primarily attributable to a decrease inpre-tax income. The Company’s effective tax rate decreased to 2.6% of pre-taxincome for the year ended December 31, 2006 from 35.1% of pre-tax incomefor the year ended December 31, 2005. The decrease is due to theconsistency of the Company’s deductible items and non-taxable earnings and adecrease in the pre-tax income, as well as the benefit recognized from taxholidays that the Company has been granted on earnings from certain foreignoperations. We expect the effective tax rate to approximate 31% of pre-tax incomefor 2007.

Income tax expenseincreased to $8.8 million for the year ended December 31, 2005, comparedto $1.8 million for 2004. The overall increase in income tax expense wasattributable to an increase in income before income tax expense, even thoughincome tax expense for 2004 reflects the goodwill and intangible assetimpairment charges as non-deductible tax items. The fluctuation in theeffective rate resulted primarily from the impact the revised 2004 projectedannual results had in relationship to the 2004 

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projectedannual permanent differences. Our 2005 effective tax rate was consistent withthe Company’s historical experience excluding the impact of the 2004 impairmentcharges.

**Liquidity andCapital Resources**

We have historically funded our business throughoperating cash flows, proceeds from borrowings and the issuance of equitysecurities. During 2006, we generated cash of $11.3 million from operatingactivities. The primary sources of operating cash flows were payments receivedfor the performance of contract services and royalty payments received from Sanofi-Aventis based upon a percentage ofsales of Allegra. The primary uses of operating cash flows are the payment ofcompensation and benefits to both scientific and administrative personnel,purchases of inventory and supplies, and payment of occupancy costs.

The recurring royalties we receive on the sales ofAllegra/Telfast have historically provided a material portion of our operatingcash flows. As discussed in Item 3 of this Form 10-K, severalgeneric manufacturers have filed ANDA applications with the FDA seekingauthorization to produce and market a generic version of Allegra. We andAventis Pharmaceuticals have filed several patent infringement suits againstthese generic companies alleging infringement of certain U.S. patents. On September 6,2005, Barr Pharmaceuticals, Inc. and Teva Pharmaceuticals Industries Ltd.announced that they had entered into an agreement for the launch ofFexofenadine Hydrochloride 30 mg, 60 mg and 180 mg tablets, the generic versionof Allegra tablets in the United States. The launch of the generic product isconsidered an “at-risk” launch due to the on-going litigation. The at-risklaunch of generic fexofenadine has had a material adverse impact on U.S. salesof Allegra by Sanofi-Aventis and in turn, the royalties earned by us on thosesales. On September 20, 2005, we, along with Aventis Pharmaceuticals,filed a Motion for Preliminary Injunction in the U.S. District Court in NewJersey seeking to enjoin Barr Pharmaceuticals, Inc., Teva PharmaceuticalsLtd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd. from the sale ofgeneric versions of Allegra in the United States. On January 30, 2006, theU.S. District Court denied our request for a preliminary injunction. An appealof that decision was taken to the U.S. Court of Appeals for the Federal Circuitand, on November 8, 2006, the appellate court affirmed the District Court’sdenial of a preliminary injunction. The Federal Circuit’s decisions on thepreliminary injunction application is not dispositive of the merits of theclaims being asserted as described above. Subsequent to the preliminaryinjunction proceeding in the District Court, Dr. Reddy’s Laboratories hasengaged in an at-risk launch of generic fexofenadine products. Should we orAventis be unsuccessful in defending these patents we would continue toexperience a material decrease in royalty revenues and operating cash flows.

During 2006, we used $9.0 million in cash forinvesting activities, primarily resulting from $16.5 million for theacquisition of property and equipment, and $11.6 million related to theacquisition of ComGenex, offset by proceeds from sales and maturities of investment securities net ofpurchases of these securities of $19.3 million. During 2006, we used $4.0million for financing activities, consisting of $4.6 million in long-term debtrepayments, offset by $0.6 million provided by proceeds from stock optionexercises and stock purchase plan withholdings.

Working capital was $149.9 million as of December 31,2006, compared to $162.8 million at December 31, 2005. The primary sourcesof the decrease were the use of cash and investments to fund capitalexpenditures and the acquisition of AMRI Hungary, and a decrease in the carryingvalue of our held-for-sale Mt. Prospect facility. These decreases werepartially offset by a decrease in deferred revenue due primarily to therecognition of deferred up-front licensing fees received in conjunction withour Licensing and Research Agreement with BMS as well as the completion of therevenue recognition process on several fixed fee contracts, and an increase inaccounts receivable due to the timing of invoicing and collecting on sales tocustomers.

Total capital expenditures for the year endedDecember, 31 2006 were $16.5 million as compared to $19.2 million for the yearended December 31, 2005. Capital expenditures in 2006 were primarilyrelated to 

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the construction of ourresearch facilities in Singapore and India, development of an enterpriseresource planning (“ERP”) system and expansion and modification of ourlarge-scale manufacturing facilities. For 2007, we expect to incur $18.0 -$20.0 million in capital expenditures, primarily related to the continuedoutfitting of our research facilities in Singapore and Hungary, the completionof a 50,000 square foot research centre in India, the implementation of our ERPsystem at our international locations, and the addition or replacement, asappropriate, of equipment for our domestic discovery, development, small-scalemanufacturing, and large scale manufacturing services.

We entered into a credit facility consisting of a$30.0 million term loan and a $35.0 million line of credit to fund theacquisition of Organichem during 2003. The term loan matures in February, 2008.As of December 31, 2006, the interest rate on $10.0 million of theoutstanding term loan balance was 4.37% and the interest rate on the remaining$5.0 million was 6.37%. On June 30, 2005, the Company amended the creditfacility to extend the maturity date on the line of credit fromFebruary, 2006 to June, 2010. The line of credit bears interest at avariable rate based on the Company’s leverage ratio. As of December 31,2006, the outstanding balance of the line of credit was $0. The credit facilitycontains certain financial covenants, including a maximum leverage ratio, aminimum required operating cash flow coverage ratio, a minimum earnings beforeinterest and taxes to interest ratio and a minimum current ratio. Othercovenants include limits on asset disposals and the payment of dividends. As ofDecember 31, 2006 and 2005 we were in compliance with all covenants underthe credit facility.

Working capital was $162.8 million as of December 31,2005, compared to $179.8 million at December 31, 2004. The decrease of$21.0 million resulted from a $6.6 million increase in income taxes payable dueto the timing of income tax payments and the generation of additional taxableincome in 2005. In addition, there was a decrease in cash, cash equivalents,and investments of $5.8 million, which primarily resulted from the pay-down ofoutstanding balances on our line of credit of $30.1 million and capitalexpenditures of $19.2 million. These decreases were partially offset by cashflows from operations of $42.8 million, which includes the receipt of an $8.0million up-front license fee from BMS in conjunction with a license andresearch agreement signed in October 2005. The up-front fee was includedin deferred revenue and will be recognized over the initial three-year term ofthe agreement. Finally, there was a decrease in royalty receivables of $5.9million due to reduced royalties on sales of Allegra/Telfast resulting from theat-risk launch of generic fexonfenadine in the fourth quarter of 2005. Thesedecreases are partially offset by an increase in accounts receivable of $8.0million due to increased contract revenues and the timing of payments receivedfrom our customers.

Total capital expenditures for the year ended December 31,2005 were $19.2 million as compared to $23.7 million for the year ended December 31,2004. Capital expenditures in 2005 were primarily related to the expansion andmodification of our large-scale manufacturing facilities, the construction ofour research facilities in Singapore and India, and initial development of anERP system.

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

We continue to pursue theexpansion of our operations through internal growth and strategic acquisitions.We expect that such activities will be funded from existing cash and cashequivalents, cash flow from operations, the issuance of debt or equitysecurities and borrowings. Future acquisitions, if any, could be funded withcash on hand, cash from operations, borrowings under our credit facility and/orthe issuance of equity or debt securities. There can be no assurance thatattractive acquisition opportunities will be available to us or will beavailable at prices and upon such other terms that are attractive to us. Weregularly evaluate potential acquisitions of other businesses, products andproduct lines and may hold 

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discussionsregarding such potential acquisitions. As a general rule, we will publiclyannounce such acquisitions only after a definitive agreement has been signed.In addition, in order to meet our long-term liquidity needs or consummatefuture acquisitions, we may incur additional indebtedness or issue additionalequity or debt securities, subject to market and other conditions. There can beno assurance that such additional financing will be available on termsacceptable to us or at all. The failure to raise the funds necessary to financeour future cash requirements or consummate future acquisitions could adverselyaffect our ability to pursue our strategy and could negatively affect ouroperations in future periods. Furthermore, a continued significant decrease inroyalties from Allegra would negatively affect our cash flow from operationsand financial condition in future periods.

**Off Balance SheetArrangements**

We do not use specialpurpose entities or other off-balance sheet financing techniques that webelieve have or reasonably likely to have a current or future material effecton our financial condition, changes in financial condition, revenues orexpenses, results of operations, liquidity or capital resources.

**ContractualObligations**

The following table setsforth our long-term contractual obligations and commitments as of December 31,  2006.

**Payments Due byPeriod (in thousands)**

| ** **                    | ** ** | **Total** | ** ** | **Under 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5  Years** | ** ** |
|-------------------------------|------------|-----------|------------|----------------------------|------------|--------------------|------------|--------------------|------------|-----------------------------------|------------|
| Long-Term  Debt (principal)   |       | $         | 18,534     |                       |       | $                  | 4,541      |               |       | $                                 | 10,173     |   |   | $ | 545 |   |   |   | $ | 3,275 |   |   |
| Long-Term Debt  (interest)(1) |       | 2,266     |       |                       | 924        |               |       | 395                |       |                              | 277        |   |   |   | 670 |   |   |
| Operating Leases              |       | 9,167     |       |                       | 2,007      |               |       | 2,562              |       |                              | 2,494      |   |   |   | 2,104 |   |   |
| Purchase  Commitments         |       | 20,264    |       |                       | 20,264     |               |       | —             |       |                              | —     |   |   |   | — |   |   |
| Pension Plan  Contributions   |       | 639       |       |                       | 639        |               |       | —             |       |                              | —     |   |   |   | — |   |   |
|                               |            |           |            |                            |            |                    |            |                    |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

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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.

In 2006, 2005 and 2004 weawarded Technology Incentive Compensation primarily to the inventor of theterfenadine carboxylic acid metabolite technology, which is covered by theCompany’s patents relating to the active ingredient in Allegra. The inventor isThomas D’Ambra, our Chairman, President and Chief Executive Officer.Additionally, in 2006 we awarded employees involved in the development of ourproprietary amine neurotransmitter reuptake inhibitors as a result ofsuccessful licensing of this technology to BMS. The amounts awarded andincluded in the consolidated statements of income (loss) for the years ended December 31,2006, 2005 and 2004 are $2.8 million, $4.7 million and $4.8 million,respectively. Included in accrued compensation in the accompanying consolidatedbalance sheets, at both December 31, 

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2006 and2005, are unpaid Technology Development Incentive Compensation awards ofapproximately $623,000.

***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, 2006 and 2005 totaled $162,000 and $284,000, respectively.The amounts forgiven and charged to operations in the consolidated statementsof income (loss) for the years ended December 31, 2006, 2005 and 2004 are$147,000, $185,000 and $91,000, respectively.

***Telecommunication Services***

A member of the Company’sboard of directors is the Chief Executive Officer of one of the providers oftelephone and internet services to the Company. This telecommunications companywas paid approximately $156,000, $194,000 and $169,000 for services rendered tothe Company in 2006, 2005 and 2004, 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 U.S. generally accepted accountingprinciples. The preparation of these consolidated  financial statements requires us to makeestimates and judgments that affect the reported amounts of assets, liabilities,revenues and expenses, and related disclosure of contingent assets andliabilities. On an on-going basis, we evaluate our estimates, including thoserelated to bad debts, inventories, intangible assets, equity investments,unbilled revenue, income taxes, pension and postretirement benefit plans, andcontingencies. We base our estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources. Actual results may differ from these estimates under differentassumptions or conditions.

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

*Contract RevenueRecognition*

Our contract revenue consists primarily of fees earnedunder contracts with third-party customers and reimbursed expenses under suchcontracts. 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. Generally, our contracts may be terminated bythe customer upon 30 days’ to one year’s prior notice, depending on thesize of the contract. We analyze our agreements to determine whether the elementscan be separated and accounted for individually or as a single unit ofaccounting in accordance with EITF No. 00-21, “Revenue Arrangements with MultipleDeliverables” and SAB 104, “RevenueRecognition”. Allocation of revenue to individual elements which qualifyfor separate accounting is based on the estimated fair value of the respectiveelements.

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We generatecontract revenue on the following basis:

*Full-timeEquivalent(FTE).**  *AnFTE agreement establishes the number of our employees contracted for a projector a series of projects, the duration of the contract period, the price perFTE, plus an allowance for chemicals and other project specific costs, whichmay or may not be incorporated in the FTE rate. FTE contracts can run in onemonth increments, but typically have terms of six months or longer. Our FTEcontracts typically provide for annual adjustments in billing rates for thescientists assigned to the contract. These contracts involve our scientistsproviding services on a “best efforts” basis in a project which involve aresearch component with a timeframe or outcome that has some level ofunpredictability. There are no fixed deliverables that must be met for paymentas part of these services. As such, we recognize revenue under FTE contracts ona monthly basis as services are performed according to the terms of thecontract.

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

*FixedFee.**  *Undera fixed-fee contract we charge a fixed agreed upon amount for a deliverable.Fixed-fee contracts have fixed deliverables upon completion of the project.Typically, we recognize revenue for fixed fee contracts after projects arecompleted, delivery is made and title transfers to the customer and collectionis reasonably assured. In certain instances, our customers request that weretain materials produced upon completion of the project due to the fact thatthe customer does not have a qualified facility to store those materials. Inthese instances, the revenue recognition process is considered complete whennecessary project documentation (batch records, Certificates of Analysis, etc.)has been delivered to the customer and payment has been collected.

*Up-FrontLicense Fees Milestone and Royalty Revenue.**  *We recognizerevenue from up-front non-refundable licensing fees on a straight-line basisover the period of the underlying project. We will recognize revenue arisingfrom a substantive milestone payment upon the successful achievement of theevent, and the resolution of any uncertainties or contingencies regardingpotential collection of the related payment, or if appropriate over theremaining term of the agreement.

*DeferredRevenue.**  *Deferredrevenue represents monies received for services that have not yet beenperformed as well as customer billings related to completed production whichhas not yet shipped. As an added service, during 2003 we began to temporarilystore completed cGMP production at our facilities for certain customers. Underthese arrangements, upon completion of the customer project we typically willenter into a storage agreement with the customer. We will temporarily store andsubsequently ship the completed production, often in multiple shipments tomultiple sites. The revenue related to these arrangements is typicallyrecognized at the time the products are ultimately shipped, however, in certaininstances, the revenue recognition process is considered complete whennecessary project documentation (batch records, Certificates of Analysis, etc.)has been delivered to the customer and payment has been collected, as notedabove.

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

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*RestructuringCharges*

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

*Inventory*

Inventory consistsprimarily of commercially available fine chemicals used as raw materials in theresearch and production process, work-in-process and finished goods at ourlarge-scale manufacturing location and chemical compounds in the form ofnatural product and novel compound collections. 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.

*Goodwill*

In accordance withthe provisions of SFAS No. 142, we perform 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, comparable company multiples andrecent transactions involving similar entities. If goodwill is determined to beimpaired in the future we would be required to record a charge to our resultsof operations. Factors the Company considers important which could result in animpairment include the following:

·       significantunderperformance relative to historical or projected future operating results;

·       significantchanges in the manner of our use of the acquired assets or the strategy 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 goodwill impairment chargesin future periods, which could have a significant impact on our consolidatedfinancial statements. Total goodwill recorded on the Company’s consolidatedbalance sheet at December 31, 2006 was $35.8 million, including $23.1million associated with the Company’s acquisition of Organichem Corporation and$10.1 million of goodwill associated with the Company’s acquisition of ComGenexKutato-Fejleszto Rt.

*Long-Lived Assets*

In accordance withthe provisions of SFAS No. 144, we assess the impairment of long-livedassets whenever events or changes in circumstances indicate that their carryingvalue may not be recoverable. Factors we consider important which could triggeran 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

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·       asignificant decrease in the market value of assets.

If we determine that thecarrying value of long-lived assets may not be recoverable, based upon theexistence of one or more of the above indicators of impairment, we compare thecarrying value of the asset group to the undiscounted cash flows expected to begenerated by the asset group. If the carrying value exceeds the undiscountedcash flows an impairment charge is recorded. An impairment charge is recognizedto the extent that the carrying amount of the asset group exceeds their fairvalue and will reduce only the carrying amounts of the long-lived assets. Weutilize the assistance of an independent valuation firm in determining the fairvalues.

*Equity Investments*

We have equity investmentsin leveraged private companies that have operations in areas within ourstrategic focus. We account for these investments using the cost method ofaccounting for investments as our ownership interest in each customer is below20% and we do not have the ability to exercise significant influence over theentities. We assess the fair value of these investments quarterly or wheneverevents or changes in circumstance, such as changes in market conditions, pooroperating results of the underlying investments, or the inability of theentities to obtain additional financing indicate that the investment value maynot be recoverable. However, should the events and conditions that areindicative of impairment as noted above arise, the Company may be required torecord additional impairment charges in future periods. Total equityinvestments recorded on the Company’s consolidated balance sheet atDecember 31, 2006 were $1.0 million.

*Pension andPostretirement Benefit Plans*

We maintain pension and postretirement costs andliabilities that are developed from actuarial valuations. Inherent in thesevaluations are key assumptions, including discount rates, expected return onplan assets, and trends in health care costs, which are updated on an annualbasis. We are required to consider current market conditions, including changesin interest rates, in making these assumptions. Changes in the related pensionbenefit costs may occur in the future due to changes in the assumptions. InSeptember 2006, the FASB issued SFAS No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans”(“SFAS No. 158”). SFAS No. 158 requires an employer thatsponsors one or more defined benefit pension plans or other postretirementplans to recognize the funded status of a plan, measured as the differencebetween plan assets at fair value and the benefit obligation, in the balancesheet; recognize in shareholders’ equity as a component of accumulated othercomprehensive loss, net of tax, the gains or losses and prior service costs orcredits that arise during the period but are not yet recognized as componentsof net periodic benefit cost; measure defined benefit plan assets andobligations as of the date of the employer’s fiscal year-end balance sheet; anddisclose in the notes to the financial statements additional information aboutthe effects on net periodic benefit cost for the next fiscal year that arisefrom delayed recognition of the gains or losses, prior service costs orcredits, and transition asset or obligation. The Company adoptedSFAS No. 158 effective December 31, 2006.

*Allowance forDoubtful Accounts*

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

*EnvironmentalLiabilities*

In the ordinary course ofbusiness the Company is subject to environmental laws and regulations, and hasmade provisions for the estimated financial impact of environmental cleanuprelated costs. The quantification of environmental exposures requires anassessment of many factors, including changing laws 

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andregulations, advancements in environmental technologies, the quality ofinformation available related to specific sites, the assessment stage of eachsite investigation, preliminary findings and the length of time involved in theremediation or settlement. The Company accrues environmental cleanup related costswhen those costs are believed to be probable and can be reasonably estimated.

*Stock-BasedCompensation*

Effective January 1,2006, the Company adopted SFAS No. 123 (Revised 2004), “Share-BasedPayment” (“SFAS No. 123 (R)”), which amends SFAS No. 123 andsupersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” in establishing standards for the accountingfor transactions in which an entity exchanges its equity instruments for goodsor services, as well as transactions in which an entity incurs liabilities inexchange for goods or services that are based on the fair value of the entity’sequity instruments or that may be settled by the issuance of those equityinstruments. This Statement requires that the cost resulting from allshare-based payment transactions be recognized in the financial statementsbased on the fair value of the share-based payment. This Statement establishesfair value as the measurement objective in accounting for share-based payment transactionswith employees, except for equity instruments held by employee share ownershipplans. As allowed under SFAS No. 123 (R), the Company elected the modifiedprospective method of adoption, under which compensation cost is recognized inthe financial statements beginning with the effective date of SFAS No. 123(R) for all share-based payments granted after that date, and for allunvested awards granted prior to the effective date of SFAS No. 123 (R).Accordingly, prior period amounts have not been restated.

Prior to January 1, 2006, the Company applied theintrinsic value-based method of accounting prescribed by APB No. 25in accounting for its fixed plan stock options. As such, compensation expensewas recorded only if, on the date of grant, the current market price of theunderlying stock exceeded the exercise price. Any compensation expense was tobe recognized over the vesting period.

Compensation cost is based on the fair value of theoptions on their grant date, and is recognized over the period of requisiteservice. The fair value of stock option grants is determined utilizing theBlack-Scholes option pricing model. Inherent in these valuations are keyassumptions, including expected volatility in the Company’s common share price,risk-free interest rates, and the expected lives of the options granted, andare updated for each option grant. We are required to consider current marketconditions, including interest rates and the market for the Company’s commonstock, as well as historical data regarding option exercises and forfeitures inmaking these assumptions. Changes in the related compensation costs associatedwith future grants may occur due to changes in the assumptions.

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

The Committee also required that, as a condition tothe acceleration of vesting, each executive officer and each non-employeedirector agree to refrain from selling shares of the Company’s common stockacquired upon the exercise of accelerated options (other than shares needed tocover the exercise price and satisfy withholding taxes) until the date on whichthe exercise of such options would have been 

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permitted under the option’spre-acceleration vesting terms or, if earlier, the officer’s or director’s lastday of employment or upon a “change in control” as defined in the Plan.

The decision to acceleratethe vesting of these underwater options was made primarily to minimize certainfuture compensation expenses that the Company would otherwise recognize in itsconsolidated statements of income (loss) with respect to these options pursuantto SFAS No. 123 (R). The Company also believes that the acceleration mayhave a positive effect on employee morale, retention and the perception ofoption value. The acceleration had no effect on reported net income for theyear ended December 31, 2005, and an approximate $3.9 million, net oftax, impact on pro forma net income in the fourth quarter of 2005.

*Income Taxes*

Income taxes are accounted for under the asset andliability method. Deferred tax assets and liabilities are recognized for theincome tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and their respectivetax bases. Deferred tax assets and liabilities are measured using enacted taxrates expected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod 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 September 2006, the FASB issued SFAS No. 158,“Employers’ Accounting for Defined Benefit Pension and Other PostretirementPlans” (“SFAS No. 158”). SFAS No. 158 requires an employerthat sponsors one or more defined benefit pension plans or other postretirementplans to recognize the funded status of a plan, measured as the differencebetween plan assets at fair value and the benefit obligation, in the balancesheet; recognize in shareholders’ equity as a component of accumulated othercomprehensive loss, net of tax, the gains or losses and prior service costs orcredits that arise during the period but are not yet recognized as componentsof net periodic benefit cost; measure defined benefit plan assets and obligationsas of the date of the employer’s fiscal year-end balance sheet; and disclose inthe notes to the financial statements additional information about the effectson net periodic benefit cost for the next fiscal year that arise from delayedrecognition of the gains or losses, prior service costs or credits, andtransition asset or obligation. The Company adopted SFAS No. 158effective December 31, 2006.

In July 2006, the FASB issued FASB InterpretationNo. 48,**“Accounting for Uncertainty in IncomeTaxes” (“FIN 48”). Among other things, FIN 48 requires the application of a “morelikely than not” threshold to the de-recognition of tax positions, andprovides for enhanced quantitative and qualitative disclosures regardingunrecognized tax benefits resulting from tax positions taken by an entity. ThisInterpretation applies to the Company effective January 1, 2007. TheCompany is currently assessing the impact of applying this Interpretation.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. This Statementdefines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements; however, it does not requireany new fair value measurements. The Statement applies to fair-valuemeasurements that are already required or permitted by existing standardsexcept for 

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measurementsof share-based payments and measurements that are similar to, but not intendedto be, fair value. Its applicability is also limited by the practicabilityexceptions to applying fair value currently found in some standards. TheStatement imposes no requirements for additional fair-value measures infinancial statements. The provisions of SFAS No. 157 will be applied tofair value measurements and disclosures in the Company’s condensed consolidatedfinancial statements beginning in the first quarter of 2008. The Company iscurrently assessing the impact of applying this Statement.

**ITEM7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

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

The Company has research facilities in Singapore,India and Hungary and therefore is subject to foreign currency risk. This riskis composed of both potential losses from the translation of foreign currencyfinancial statements and the remeasurement of foreign currency transactions.The total net assets of non-U.S. operations denominated in non-functionalcurrencies subject to potential loss amount to approximately $33.0 million. Thepotential loss in fair value resulting from a hypothetical 10% adverse changein quoted foreign currency exchange rates amounts to approximately $3.3million. Furthermore, related to foreign currency transactions, the Company hasexposure to non-functional currency balances totaling approximately $1.8million. This amount includes, on an absolute basis, exposures to foreigncurrency assets and liabilities. On a net basis, the Company had approximately$1.3 million of foreign currency liabilities as of December 31, 2006. Ascurrency rates change, these non-functional currency balances are revalued, andthe corresponding adjustment is recorded in the consolidated statement ofincome. A hypothetical change of 10% in currency rates could result in anadjustment to the consolidated statement of income of approximately $131,000.

With respect to interest rates, the risk is composedof changes in future cash flows due to changes in interest rates on ourvariable rate $13.9 million term loan and $4.6 million industrial developmentauthority bonds.

To mitigate this risk, we have entered into interestrate swap agreements that have fixed the interest rate on 54% of our variablerate debt. Included in other assets is approximately $161,000, which representsthe estimated market value of the swap agreements.

The potential loss in 2007cash flows from a 10% adverse change in quoted interest rates would approximate$43,000.

**ITEM8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.**

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

**ITEM 9. CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.**

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

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

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decision to engage KPMG asits independent registered public accounting firm was the result of acompetitive selection process involving several accounting firms.

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

**ITEM9A. CONTROLS AND PROCEDURES**

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

As required by rule 13a-15(b) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of theend of the period covered by this Annual Report on Form 10-K, theCompany’s management conducted an evaluation with the participation of theCompany’s Chief Executive Officer and Chief Financial Officer regarding theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act). Based upon that evaluation the Company’s Chief ExecutiveOfficer and Chief Financial Officer have concluded that the Company’sdisclosure controls and procedures were effective as of December 31, 2006.

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

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

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

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

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

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

The Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, assessed as of December 31,2006 the effectiveness of the Company’s internal control over financialreporting. In making this assessment, management used the criteria set forth inthe framework in *Internal**Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). Basedon the results of this evaluation, management has concluded that the Companymaintained effective internal control over financial reporting as of December 31,2006.

In making this assessment, management has excluded theinternal control over financial reporting of AMRI Hungary, which was acquiredon February 28, 2006 and whose financial statements constitute 3.8 percentof total consolidated assets and 4.5 percent of consolidated revenues as of andfor the year ended December 31, 2006.

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Management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2006 has been audited by KPMG LLP, an independentregistered public accounting firm, as stated in their report which is includedon page F-3 of this Annual Report on Form 10-K.

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

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

**ITEM9B. OTHER INFORMATION**

None.

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**PART III**

**ITEM10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE .**

The information appearingunder the captions “Directors and Executive Officers,”“Section 16(a) Beneficial Ownership Reporting Compliance” and “Codeof Ethics” in the Company’s definitive proxy statement relating to the AnnualMeeting of Stockholders to be held on June 4, 2007 is incorporated hereinby reference.

**ITEM11. EXECUTIVE COMPENSATION.**

The information appearingunder the captions “Executive Compensation—Summary Compensation,—CompensationCommittee Interlocks and Insider Participation, and—Agreements with NamedExecutive Officers,” and “Information Regarding Directors—The Board ofDirectors and its Committees” in the Company’s definitive proxy statementrelating to the Annual Meeting of Stockholders to be held on June 4, 2007is incorporated herein by reference.

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

The information appearingunder the caption “Principal and Management Stockholders” in the Company’sdefinitive proxy statement relating to the Annual Meeting of Stockholders to beheld on June 4, 2007 is incorporated herein by reference.

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

The information appearingunder the caption “Certain Transactions” in the Company’s definitive proxystatement relating to the Annual Meeting of Stockholders to be held onJune 4, 2007 is incorporated herein by reference.

**ITEM14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

The information appearingunder the caption “Audit Fees” in the Company’s definitive proxy statementrelating to the Annual Meeting of Stockholders to be held on June 4, 2007is incorporated herein by reference.

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**PART IV**

**ITEM15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

(a) (1)      Financial Statements.

Theconsolidated financial statements required by this item are submitted in aseparate section beginning on page F-1 of this report.
|                                                                                       | ** ** | **Page  Number** |
|---------------------------------------------------------------------------------------|------------|------------------|
| Reports of Independent Registered Public Accounting  Firms                            |       |             | F-2 |   |
| Consolidated statements of income (loss)                                              |       |             | F-6 |   |
| Consolidated  balance sheets                                                          |       |             | F-7 |   |
| Consolidated statements of stockholders’ equity and  comprehensive income (loss) |       |             | F-8 |   |
| Consolidated statements of cash flows                                                 |       |             | F-9 |   |
| Notes to consolidated financial statements                                            |       |             | F-11 |   |

 

(a) (2)      Financial Statement Schedules

Thefollowing financial schedule of Albany Molecular Research, Inc. isincluded in this annual report on Form 10-K.
| Schedule II—Valuation and  Qualifying Accounts |   | F-45 |
|-----------------------------------------------------|--------|------|

 

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

(a) (3)      Exhibits

**EXHIBITINDEX**
| Exhibit   No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **Description** |
|---------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 2.1           |       | Stock Purchase Agreement, dated January 27,  2006, between Albany Molecular Research, Inc. and ComGenex  Kutato-Fejleszto Rt. (incorporated herein by reference to Exhibit 2.1 to  the Company’s Quarterly Report on Form 10-Q for the quarterly  period ended March 31, 2006, File No. (0-25323)                                                                                                                             |
| 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). |

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| 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)).                                                                                                                                                                                                                        |
| 10.6   |   | License Agreement dated March 15, 1995 by and  between the Company and Marion Merrell Dow Inc. (now Sanofi-Aventis, S.A.)  (excluding certain portions which have been omitted as indicated based upon  an order for confidential treatment, but which have been filed separately  with the Commission) (incorporated herein by reference to Exhibit 10.7  to Amendment No. 3 to the Company’s Registration Statement on  Form S-1 (File No. 333-58795)). |
| 10.7*  |   | Amendment to 1998 Stock Option and Incentive Plan of  the Company (incorporated herein by reference to Exhibit 10.7 to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2004 File No. 000-25323)                                                                                                                                                                                                                              |
| 10.8*  |   | Technology Development Incentive Plan (incorporated  herein by reference to Exhibit 10.10 to Amendment No. 2 to the  Company’s Registration Statement on Form S-1 (File No. 333-58795)).                                                                                                                                                                                                                                                                  |
| 10.9*  |   | Employment Agreement between the Company and 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).                                                                                                                                                                                                                         |
| 10.10* |   | 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)).                                                                                                                                              |
| 10.11  |   | Credit Agreement, dated as of February 12, 2003,  by and between the Company and Fleet National Bank, Fleet  Securities, Inc., JP Morgan Chase Bank, and Citizens Bank of  Massachusetts (incorporated herin by reference to Exhibit 10.19 to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2004 File No. 000-25323).                                                                                            |
| 10.12  |   | Second Amendment, dated as of June 30, 2005, to  Credit Agreement between Albany Molecular Research, Inc. and Bank of  America, N.A., JP Morgan Chase Bank, N.A. and Citizens Bank of Massachusetts (incorporated herin by reference to  Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q  for the quarter ended June 30, 2005 filed with the Securities and  Exchange Commission on August 9, 2005 File No. 000-25323).             |
| 10.13  |   | 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).                                                                                                                                                      |

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| 10.14* |   | Form of Restricted Stock Award Agreement under  1998 Stock Option and Incentive Plan (incorporated herein by reference to  Exhibit 10.1 to the Company’s Current Report on Form 8-K  filed with the Securities and Exchange Commission on March 17, 2005 File No. 000-25323)                                                                                                                                                                                                                                                                                      |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15* |   | Albany Molecular Research, Inc. Incentive Bonus  Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the Securities and Exchange  Commission on May 3, 2005 File No. 000-25323)                                                                                                                                                                                                                                                                                                                             |
| 10.16* |   | Form of Incentive Stock Option Agreement under  1998 Stock Option and Incentive Plan (incorporated herein by reference to  Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 2005 filed with the Securities and  Exchange Commission on May 10, 2005 File No. 000-25323)                                                                                                                                                                                                                                               |
| 10.17* |   | Form of Non-Qualified Stock Option Agreement  under 1998 Stock Option and Incentive Plan (incorporated herein by reference  to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 2005 filed with the Securities and  Exchange Commission on May 10, 2005 File No. 000-25323)                                                                                                                                                                                                                                           |
| 10.18  |   | Supply Agreement, dated as of August 31, 2005,  between Organichem Corporation and Amersham Health AS, a wholly-owned  subsidiary of GE Healthcare, Inc. (filed with certain information  omitted pursuant to a request for confidential treatment and filed separately  with the Securities and Exchange Commission) (incorporated herein by  reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q  for the quarter ended September 30, 2005 filed with the Securities and  Exchange Commission on November 4, 2005 File No. 000-25323) |
| 10.19  |   | License and Research Agreement, dated as of  October 20, 2005, between Albany Molecular Research, Inc., AMR  Technology, Inc. and Bristol-Myers Squibb Company (filed herewith with  certain information omitted pursuant to a request for confidential treatment  and filed separately with the Securities and Exchange Commission)                                                                                                                                                                                                                                                  |
| 10.20* |   | Form of Notice of Acceleration of Certain Stock  Options and Acknowledgement of Lock-Up dated January 25, 2006 (incorporated  herein by reference to Exhibit 10.23 to the Company’s Annual Report on Form  10-K for the fiscal year ended December 31, 2005, File No. 000-25323)                                                                                                                                                                                                                                                                                                      |
| 10.21* |   | Amended and Revised Technology Department Incentive  Plan, dated October 13, 2003 (incorporated herein by reference to  Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q  for the quarterly period ended Mrch 31, 2006, File No. 0-25323)                                                                                                                                                                                                                                                                                                                        |
| 10.22* |   | Amended and Restated Employment Agreement, dated  June 30, 2006, between Albany Molecular Research Inc. and Thomas E.  D’Ambra (incorporated herein by reference to Exhibit 10.1 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period  ended June 30, 2006, File No. 0-25323)                                                                                                                                                                                                                                                                 |
| 10.23* |   | Form of Amended and Restated Employment  Agreement, dated June 30, 2006, between Albany Molecular  Research, Inc. and each of Mark T. Frost, Michael Trova and Kenton L.  Shultis (incorporated herein by reference to Exhibit 10.2 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period  ended June 30, 2006, File No. 0-25323)                                                                                                                                                                                                         |
| 21.1   |   | Subsidiaries of the Company (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 23.1   |   | Consent of KPMG LLP (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 23.2   |   | Consent of PricewaterhouseCoopers LLP (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 31.1   |   | Rule 13a-14(a)/15d-14(a) certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.2   |   | Rule 13a-14(a)/15d-14(a) certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 32.1   |   | Section 1350 certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 32.2   |   | Section 1350 certification                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

----

*                    Denotes management contract of compensation plan orarrangement

59

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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, 2007 | 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  |       | March 15, 2007 |
| Thomas  E. D’Ambra, Ph.D. |          | Officer and Director  (Principal Executive Officer) |       |                |
| /s/ MARK  T. FROST             |          | Chief Financial  Officer and Treasurer              |       | March 15, 2007 |
| Mark  T. Frost                 |          | (Principal Financial and  Accounting Officer)       |       |                |
| /s/ PAUL  S. ANDERSON          |          | Director                                            |       | March 15, 2007 |
| Paul  S. Anderson, Ph.D.       |          |                                                |       |                |
| /s/ DONALD  E. KUHLA           |          | Director                                            |       | March 15, 2007 |
| Donald  E. Kuhla, Ph.D.        |          |                                                |       |                |
| /s/ KEVIN  O’CONNOR       |          | Director                                            |       | March 15, 2007 |
| Kevin  O’Connor           |          |                                                |       |                |
| /s/ ARTHUR  J. ROTH            |          | Director                                            |       | March 15, 2007 |
| Arthur  J. Roth                |          |                                                |       |                |
| /s/ ANTHONY P.  TARTAGLIA      |          | Director                                            |       | March 15, 2007 |
| Anthony  P. Tartaglia, M.D.    |          |                                                |       |                |
| /s/ VERONICA  G.H. JORDAN      |          | Director                                            |       | March 15, 2007 |
| Veronica  G.H. Jordan, Ph.D.   |          |                                                |       |                |
| /s/ UNA S.  RYAN               |          | Director                                            |       | March 15, 2007 |
| Una S. Ryan,  Ph.D., O.B.E.    |          |                                                |       |                |

 

60

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**INDEX TOCONSOLIDATEDFINANCIAL STATEMENTS ALBANY MOLECULAR RESEARCH, INC.**
|                                                                                                                                                       | ** ** | Page | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------|------------|
| Reports of Independent Registered Public Accounting  Firms                                                                                            |       | F-2  |       |
| Consolidated Statements of Income (Loss) for the Years  Ended December 31, 2006, 2005 and 2004                                              |       | F-6  |       |
| Consolidated  Balance Sheets at December 31, 2006 and 2005                                                                                       |       | F-7  |       |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income (Loss) for the Years Ended December 31, 2006, 2005  and 2004 |       | F-8  |       |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2006, 2005 and 2004                                                 |       | F-9  |       |
| Notes to Consolidated Financial Statements                                                                                                            |       | F-11 |       |

 

F-1

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**Report ofIndependent Registered Public Accounting Firm**

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

We have audited the accompanying consolidated balancesheets of Albany Molecular Research, Inc. and subsidiaries (the Company) as ofDecember 31, 2006 and 2005, and the related consolidated statements of income,stockholders’ equity and comprehensive income (loss), and cash flows for theyears then ended. In connection with our audits of the consolidated financialstatements, we also have audited the financial statement schedule listed in theindex appearing under Item 15(a)(2). These consolidated financial statements and financial statement scheduleare the responsibility of the Company’s management. Our responsibility is to expressan opinion on these consolidated financial statements and financial statementschedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Albany Molecular Research, Inc. and subsidiaries as of December 31,2006 and 2005, and the results of their operations and their cash flows for theyears then ended, in conformity with U.S. generally accepted accountingprinciples.  Also in our opinion, therelated financial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein.

As discussed in Note 1 to the consolidated financialstatements, effective January 1, 2006, the Company adopted Financial AccountingStandards No. 123 (Revised), *Share-Based Payment. *Also discussed in Note 1 to theconsolidated financial statements, effective December 31, 2006, the Companyadopted FASB Statement of Financial Accounting Standards No. 158, *Employers’ Accounting for Defined Pension and Other PostretirementPlans, an amendment of FASB Statements No. 87, 88, 106, and 132 (R).*

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Albany Molecular Research, Inc. andsubsidiaries’ internal control over financial reporting as of December 31,2006, based upon criteria establishedin *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), and our report dated March 13, 2007, expressed an unqualified opinion on management’sassessment of, and the effective operation of, internal control over financialreporting.

/s/KPMG LLPAlbany, New YorkMarch 13, 2007

F-2

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

We have audited management's assessment, included inthe accompanying Management’s Annual Report on Internal Control over FinancialReporting,**that Albany MolecularResearch, Inc. and subsidiaries (the Company) maintained effective internalcontrol over financial reporting as of December 31, 2006, based on criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).**The Company'smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management's assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement's assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A 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.  A company's internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generallyaccepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management anddirectors of the company; and (3) 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, internal controlover financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management's assessment that AlbanyMolecular Research, Inc. and subsidiaries maintained effective internal controlover financial reporting as of December 31, 2006, is fairly stated, in allmaterial respects, based on criteriaestablished in *Internal Control—IntegratedFramework* issued by COSO.**Also,in our opinion, Albany Molecular Research, Inc. and subsidiaries maintained, inall material respects, effective internal control over financial reporting asof December 31, 2006, based on criteriaestablished in *Internal**Control—Integrated Framework* issued byCOSO.

The Company acquired ComGenex Kutato-Fejleszto Rt.(AMRI Hungary) on February 28, 2006, and management excluded from itsassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2006, AMRI Hungary’s internal controlover financial reporting. AMRI Hungary’s total assets and total revenuerepresent 3.8% and 4.5%, respectively, of the related amounts included in theconsolidated financial statements of Albany Molecular Research, Inc. andsubsidiaries as of and for the year ended December 31, 2006.  Our audit of internal control over financialreporting of Albany Molecular Research, Inc. also excluded an evaluation of theinternal control over financial reporting of AMRI Hungary.

F-3

----

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of Albany Molecular Research,Inc. and subsidiaries as of December 31, 2006 and 2005, the related consolidatedstatements of income, stockholders’ equity and comprehensive income (loss), andcash flows for the years then ended, and the related financial statementschedule, and our report dated March 13, 2007, expressed an unqualified opinion on those consolidatedfinancial statements and related financial statement schedule.

/s/KPMG LLPAlbany, New YorkMarch 13, 2007

F-4

----

To the Stockholders and Board of Directorsof Albany Molecular Research, Inc:

In our opinion, theconsolidated statements of income (loss), shareholders' equity andcomprehensive income (loss) and cash flows for the year ended December 31,2004 present fairly, in all material respects, the results of operations andcash flows of Albany Molecular Research, Inc. and its subsidiaries for the yearended December 31, 2004, in conformity with accounting principlesgenerally accepted in the United States of America. In addition, in ouropinion, the financial statement schedule for the year ended December 31,2004 presents fairly, in all material respects, the information set forththerein when read in conjunction with the related consolidated financialstatements. These financial statements and financial statement schedule are theresponsibility of the Company's management. Our responsibility is to express anopinion on these financial statements and financial statement schedule based onour audit. We conducted our audit of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

/s/PricewaterhouseCoopers LLPAlbany, New YorkMarch 14, 2005

F-5

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**ALBANY MOLECULAR RESEARCH, INC.CONSOLIDATED STATEMENTS OF INCOME (LOSS)Years Ended December 31, 2006, 2005 and 2004(Dollars in thousands, except per share amounts)**

| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Contract revenue                            |       | $                                          | 152,783    |   | $ | 136,988 |   | $ | 121,554 |   |
| Recurring royalties                         |       | 27,024                                     |       | 46,918 |   | 47,973 |   |
| Total revenue                               |       | 179,807                                    |       | 183,906 |   | 169,527 |   |
| Cost of contract revenue                    |       | 128,610                                    |       | 112,642 |   | 96,932 |   |
| Write-down of library inventories           |       | —                                     |       | 2,063 |   | 5,974 |   |
| Total cost of contract  revenue             |       | 128,610                                    |       | 114,705 |   | 102,906 |   |
| Technology incentive award                  |       | 2,783                                      |       | 4,695 |   | 4,789 |   |
| Research and development                    |       | 11,428                                     |       | 14,468 |   | 23,887 |   |
| Selling, general and administrative         |       | 31,899                                     |       | 26,494 |   | 22,812 |   |
| Property and equipment impairment           |       | 3,554                                      |       | — |   | 4,728 |   |
| Goodwill impairment                         |       | —                                     |       | — |   | 14,494 |   |
| Intangible asset impairment                 |       | —                                     |       | — |   | 3,541 |   |
| Restructuring charge                        |       | 2,431                                      |       | — |   | 1,184 |   |
| Total costs and expenses                    |       | 180,705                                    |       | 160,362 |   | 178,341 |   |
| Income (loss) from operations               |       | (898                                       | )          | 23,544 |   | (8,814 | ) |
| Equity in loss of unconsolidated affiliates |       | —                                     |       | — |   | (65 | ) |
| Interest expense                            |       | (1,072                                     | )          | (1,772 | ) | (1,641 | ) |
| Interest income                             |       | 4,062                                      |       | 3,559 |   | 1,958 |   |
| Loss on equity investment                   |       | —                                     |       | — |   | (1,274 | ) |
| Other income (expense), net                 |       | 150                                        |       | (185 | ) | (18 | ) |
| Income (loss) before income tax expense     |       | 2,242                                      |       | 25,146 |   | (9,854 | ) |
| Income tax expense                          |       | 59                                         |       | 8,825 |   | 1,837 |   |
| Net income (loss)                           |       | $                                          | 2,183      |   | $ | 16,321 |   | $ | (11,691 | ) |
| Basic earnings (loss) per share             |       | $                                          | 0.07       |   | $ | 0.51 |   | $ | (0.37 | ) |
| Diluted earnings (loss) per share           |       | $                                          | 0.07       |   | $ | 0.50 |   | $ | (0.37 | ) |

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-6

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**ALBANY MOLECULAR RESEARCH, INC.CONSOLIDATED BALANCE SHEETSYears Ended December 31, 2006 and 2005(In thousands, except per share amounts)**

| ** **                                                                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                              | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **Assets**                                                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                         |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                              |       | $                     | 26,124     |   | $ | 27,606 |   |
| Investment securities,  available-for-sale                                                                                              |       | 81,040                |       | 100,304 |   |
| Accounts receivable (net  of allowance for doubtful accounts of $293 at December 31, 2006 and  $98 at December 31, 2005) |       | 34,747                |       | 22,238 |   |
| Royalty income  receivable                                                                                                              |       | 6,225                 |       | 6,247 |   |
| Inventory                                                                                                                               |       | 22,644                |       | 30,603 |   |
| Unbilled services                                                                                                                       |       | —                |       | 213 |   |
| Prepaid expenses and  other current assets                                                                                              |       | 5,615                 |       | 6,178 |   |
| Deferred income taxes                                                                                                                   |       | 4,725                 |       | 3,968 |   |
| Property and equipment  held for sale                                                                                                   |       | 1,500                 |       | 5,376 |   |
| Total current assets                                                                                                                    |       | 182,620               |       | 202,733 |   |
| Property and equipment,  net                                                                                                            |       | 153,202               |       | 151,078 |   |
| Goodwill                                                                                                                                |       | 35,811                |       | 25,747 |   |
| Intangible assets and  patents, net                                                                                                     |       | 2,101                 |       | 1,434 |   |
| Equity investment in  unconsolidated affiliates                                                                                         |       | 956                   |       | 956 |   |
| Other assets                                                                                                                            |       | 803                   |       | 1,202 |   |
| Total assets                                                                                                                            |       | $                     | 375,493    |   | $ | 383,150 |   |
| **Liabilities and Stockholders’ Equity**                                                                                           | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                    |       |                  |       |   |   |
| Accounts payable and  accrued expenses                                                                                                  |       | $                     | 13,502     |   | $ | 10,473 |   |
| Deferred revenue                                                                                                                        |       | 8,285                 |       | 12,537 |   |
| Accrued compensation                                                                                                                    |       | 4,288                 |       | 3,902 |   |
| Accrued pension benefits                                                                                                                |       | 639                   |       | 1,014 |   |
| Income taxes payable                                                                                                                    |       | 1,433                 |       | 7,466 |   |
| Current installments of  long-term debt                                                                                                 |       | 4,541                 |       | 4,536 |   |
| Total current  liabilities                                                                                                              |       | 32,688                |       | 39,928 |   |
| Long-term liabilities:                                                                                                                  |       |                  |       |   |   |
| Long-term debt,  excluding current installments                                                                                         |       | 13,993                |       | 18,521 |   |
| Deferred income taxes                                                                                                                   |       | 9,646                 |       | 9,048 |   |
| Pension and postretirement  benefits                                                                                                    |       | 475                   |       | 2,356 |   |
| Environmental  liabilities                                                                                                              |       | 236                   |       | 236 |   |
| Total liabilities                                                                                                                       |       | 57,038                |       | 70,089 |   |
| Commitments and contingencies (notes 12, 14)                                                                                            |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                              |       |                  |       |   |   |
| Preferred stock, $0.01  par value, authorized 2,000 shares, none issued or outstanding                                             |       | —                |       | — |   |
| Common stock, $0.01 par  value, authorized 50,000 shares, 34,749 shares issued in 2006 and 34,471  shares issued in 2005           |       | 347                   |       | 345 |   |
| Additional paid-in  capital                                                                                                             |       | 196,129               |       | 193,066 |   |
| Unearned  compensation—restricted stock                                                                                            |       | (3,002                | )          | (1,921 | ) |
| Retained earnings                                                                                                                       |       | 161,320               |       | 159,137 |   |
| Accumulated other  comprehensive income (loss), net                                                                                     |       | 832                   |       | (395 | ) |
|                                                                                                                                    |       | 355,626               |       | 350,232 |   |
| Less, treasury shares at  cost, 2,077 shares in 2006 and 2005                                                            |       | (37,171               | )          | (37,171 | ) |
| Total stockholders’  equity                                                                                                        |       | 318,455               |       | 313,061 |   |
| Total liabilities and stockholders’ equity                                                                                         |       | $                     | 375,493    |   | $ | 383,150 |   |

 

See Accompanying Notes to Consolidated Financial Statements.

F-7

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**ALBANY MOLECULAR RESEARCH, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)Years Ended December 31, 2006, 2005 and 2004**

| ** **                                                                                  | ** ** | ** **    | ** **    | ** **            | ** ** | ** **     | ** ** | **Unamortized**  | ** ** | ** **     | ** ** | **Accumulated** | ** ** | ** **              | ** **     | ** **         | ** ** | ** ** | ** **                                  |
|---------------------------------------------------------------------------------------------|------------|---------------|---------------|-----------------------|------------|----------------|------------|------------------|------------|----------------|------------|-----------------|------------|-------------------------|----------------|--------------------|------------|------------|---------------------------------------------|
| ** **                                                                                  | ** ** | ** **    | ** **    | **Common Stock** | ** ** | **Additional** | ** ** | **Compensation** | ** ** | ** **     | ** ** | **Other**       | ** ** | **Treasury Stock** | ** **     | ** **         | ** ** | ** ** | ** **                                  |
| ** **                                                                                  | ** ** | **Preferred** | ** **    | **Number of**    | ** ** | **Par**        | ** ** | **Paid-in**      | ** ** | **Restricted** | ** ** | **Retained**    | ** ** | **Comprehensive**       | ** **     | **Number of** | ** ** | ** ** | ** **                                  | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                                  | ** ** | **Stock**     | ** **    | **Shares**            | ** ** | **Value**      | ** ** | **Capital**      | ** ** | **Stock**      | ** ** | **Earnings**    | ** ** | **Income (Loss)**  | ** **     | **Shares**         | ** ** | **Amount** | ** **                                  | **Total** | ** ** | **Income (Loss)** | ** ** |
| Balances at December 31, 2003                                                          |       |          | $ — |                  |       |           | 33,694     |             |       |           | $ 337 |            |       |                    | $ 184,365 |               |       |       | $      — |   |   |   | $ 154,507 |   |   |   | $ (103 | ) |   |   | (2,077 | ) |   | $ (37,171 | ) | $ 301,935 |   |   |   |   |   |
| Comprehensive Loss:                                                                         |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                    |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   | (11,691 | ) |   |   |   |   |   |   |   |   |   |   |   | (11,691 | ) |   | $ (11,691 | ) |   |
| Unrealized loss on investment securities,  available-for-sale, net of taxes                 |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | (218 | ) |   |   |   |   |   |   |   | (218 | ) |   | (218 | ) |   |
| Reclassification adjustment for net securities losses  included in net income, net of taxes |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | 22 |   |   |   |   |   |   |   |   | 22 |   |   | 22 |   |   |
| Unrealized gain on interest rate swap contract, net  of taxes                               |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | 182 |   |   |   |   |   |   |   |   | 182 |   |   | 182 |   |   |
| Total comprehensive loss                                                                    |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ (11,705 | ) |   |
| Tax benefit from exercise of stock options                                                  |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | 347            |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 347 |   |   |   |   |   |
| Issuance of warrants to BMS                                                                 |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | 3,053          |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 3,053 |   |   |   |   |   |
| Issuance of common stock in connection with stock  option plan and ESPP                     |       |          |          |                  |       |           | 248        |             |       |           | 3          |            |       |                    | 1,843          |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,846 |   |   |   |   |   |
| Balances at December 31, 2004                                                          |       |          | $ — |                  |       |           | 33,942     |             |       |           | $ 340 |            |       |                    | $ 189,608 |               |       |       | $      — |   |   |   | $ 142,816 |   |   |   | $ (117 | ) |   |   | (2,077 | ) |   | $ (37,171 | ) | $ 295,476 |   |   |   |   |   |
| Comprehensive loss:                                                                         |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                  |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   | 16,321 |   |   |   |   |   |   |   |   |   |   |   |   | 16,321 |   |   | $ 16,321 |   |   |
| Unrealized loss on investment securities,  available-for-sale, net of taxes                 |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | (92 | ) |   |   |   |   |   |   |   | (92 | ) |   | (92 | ) |   |
| Unrealized gain on interest rate swap contract, net  of taxes                               |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | 132 |   |   |   |   |   |   |   |   | 132 |   |   | 132 |   |   |
| Increase in additional minimum pension liability, net  of taxes                             |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | (254 | ) |   |   |   |   |   |   |   | (254 | ) |   | (254 | ) |   |
| Foreign currency translation loss                                                           |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | (64 | ) |   |   |   |   |   |   |   | (64 | ) |   | (64 | ) |   |
| Total comprehensive income                                                                  |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ 16,043 |   |   |
| Tax benefit from exercise of stock options                                                  |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | 416            |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 416 |   |   |   |   |   |
| Modifications of stock options                                                              |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | 37             |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 37 |   |   |   |   |   |
| Cancellation of BMS warrants                                                                |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | (562           | )                  |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (562 | ) |   |   |   |   |
| Issuance of restricted stock                                                                |       |          |          |                  |       |           | 288        |             |       |           | 3          |            |       |                    | 2,505          |               |       |       | (2,508                                      | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |
| Amortization of unearned compensation—restricted  stock                                |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       | 327                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 327 |   |   |   |   |   |
| Forfeiture of unearned compensation—restricted stock                                   |       |          |          |                  |       |           | (31        | )                |       |           | —     |            |       |                    | (260           | )                  |       |       | 260                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |
| Issuance of common stock in connection with stock  option plan and ESPP                     |       |          |          |                  |       |           | 272        |             |       |           | 2          |            |       |                    | 1,322          |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,324 |   |   |   |   |   |
| Balances at December 31, 2005                                                          |       |          | $ — |                  |       |           | 34,471     |             |       |           | $ 345 |            |       |                    | $ 193,066 |               |       |       | $ (1,921                               | ) |   |   | $ 159,137 |   |   |   | $ (395 | ) |   |   | (2,077 | ) |   | $ (37,171 | ) | $ 313,061 |   |   |   |   |   |
| Comprehensive Income:                                                                       |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                  |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   | 2,183 |   |   |   |   |   |   |   |   |   |   |   |   | 2,183 |   |   | $   2,183 |   |   |
| Unrealized gain on investment securities,  available-for-sale, net of taxes                 |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | 165 |   |   |   |   |   |   |   |   | 165 |   |   | 165 |   |   |
| Unrealized loss on interest rate swap contract, net  of taxes                               |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | (61 | ) |   |   |   |   |   |   |   | (61 | ) |   | (61 | ) |   |
| Foreign currency translation gain                                                           |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | 255 |   |   |   |   |   |   |   |   | 255 |   |   | 255 |   |   |
| Decrease in additional minimum pension liability, net  of taxes                             |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | 254 |   |   |   |   |   |   |   |   | 254 |   |   | 254 |   |   |
| Total comprehensive income                                                                  |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $   2,796 |   |   |
| Adjustment to initially apply FASB Statement No. 158,  net of tax                           |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       |                                        |   |   |   |   |   |   |   | 614 |   |   |   |   |   |   |   |   | 614 |   |   |   |   |   |
| Tax benefit from exercise of stock options                                                  |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | 34             |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 34 |   |   |   |   |   |
| Tax benefit from cancellation of BMS warrants                                               |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | 197            |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 197 |   |   |   |   |   |
| Share-based payment expense                                                                 |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    | 561            |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 561 |   |   |   |   |   |
| Issuance of restricted stock                                                                |       |          |          |                  |       |           | 194        |             |       |           | 2          |            |       |                    | 1,993          |               |       |       | (1,995                                      | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |
| Amortization of unearned compensation—restricted  stock                                |       |          |          |                  |       |           |       |             |       |           |       |            |       |                    |           |               |       |       | 611                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 611 |   |   |   |   |   |
| Forfeiture of unearned compensation—restricted stock                                   |       |          |          |                  |       |           | (32        | )                |       |           | —     |            |       |                    | (303           | )                  |       |       | 303                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |
| Issuance of common stock in connection with stock  option plan and ESPP                     |       |          |          |                  |       |           | 116        |             |       |           | —     |            |       |                    | 581            |               |       |       |                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 581 |   |   |   |   |   |
| Balances at  December 31, 2006                                                         |       |          | $ — |                  |       |           | 34,749     |             |       |           | $ 347 |            |       |                    | $ 196,129 |               |       |       | $ (3,002                               | ) |   |   | $ 161,320 |   |   |   | $ 832 |   |   |   | (2,077 | ) |   | $ (37,171 | ) | $ 318,455 |   |   |   |   |   |

 

See Accompanying Notes to Consolidated Financial Statements.

F-8

----

**ALBANY MOLECULAR RESEARCH, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2006, 2005 and 2004 (In thousands)**

| ** **                                                                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operating Activities**                                                                  | ** ** | ** **                                 |       | ** ** |   | ** ** |   |
| Net income (loss)                                                                         |       | $                                          | 2,183      |   | $ | 16,321 |   | $ | (11,691 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 15,281                                     |       | 15,260 |   | 15,264 |   |
| Net amortization of premiums on securities                                                |       | 264                                        |       | 259 |   | 446 |   |
| Provision for obsolete inventories                                                        |       | 1,406                                      |       | 1,950 |   | 3,579 |   |
| Write-down of library inventories                                                         |       | —                                     |       | 2,063 |   | 5,974 |   |
| Property, plant and equipment impairment                                                  |       | 3,876                                      |       | — |   | 4,728 |   |
| Goodwill impairment                                                                       |       | —                                     |       | — |   | 14,494 |   |
| Intangible asset impairment                                                               |       | —                                     |       | — |   | 3,541 |   |
| Warrant issuance expense                                                                  |       | —                                     |       | — |   | 3,053 |   |
| Provision for doubtful accounts                                                           |       | 260                                        |       | (103 | ) | (77 | ) |
| Loss on equity investment in unconsolidated affiliates                                    |       | —                                     |       | — |   | 1,274 |   |
| Tax benefit of stock option exercises                                                     |       | 34                                         |       | 416 |   | 347 |   |
| Equity in loss of unconsolidated affiliates                                               |       | —                                     |       | — |   | 65 |   |
| Forgiven principal on notes receivable—related parties                               |       | 147                                        |       | 186 |   | 91 |   |
| Deferred income tax benefit                                                               |       | (724                                       | )          | (2,787 | ) | (4,366 | ) |
| Net realized loss on sale of securities                                                   |       | —                                     |       | — |   | 36 |   |
| Loss on disposal of property, plant and equipment                                         |       | 1,123                                      |       | 236 |   | — |   |
| Stock-based compensation expense                                                          |       | 1,172                                      |       | 364 |   | — |   |
| Foreign exchange gain                                                                     |       | 3                                          |       | (3 | ) | — |   |
| (Increase)  decrease in operating assets, net of business combination:                    |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                       |       | (11,767                                    | )          | (7,871 | ) | 3,971 |   |
| Royalty income receivable                                                                 |       | 22                                         |       | 5,931 |   | 792 |   |
| Unbilled services                                                                         |       | 213                                        |       | (192 | ) | 227 |   |
| Inventory                                                                                 |       | 6,674                                      |       | (3,420 | ) | (8,286 | ) |
| Prepaid expenses and other assets                                                         |       | 1,797                                      |       | (2,485 | ) | 1,523 |   |
| Increase  (decrease) in operating liabilities, net of business combination:               |       |                                       |       |   |   |   |   |
| Accounts payable, accrued compensation and accrued expenses                               |       | 1,870                                      |       | 86 |   | 1,445 |   |
| Income taxes payable                                                                      |       | (6,149                                     | )          | 7,500 |   | 846 |   |
| Deferred revenue                                                                          |       | (5,371                                     | )          | 9,886 |   | 910 |   |
| Pension and postretirement benefits                                                       |       | (998                                       | )          | (690 | ) | (1,574 | ) |
| Environmental liability                                                                   |       | —                                     |       | (60 | ) | (47 | ) |
| Net cash provided by operating activities                                                 |       | 11,316                                     |       | 42,847 |   | 36,565 |   |
| **Investing Activities**                                                                  | ** ** | ** **                                 |       | ** ** |   | ** ** |   |
| Net purchases of securities                                                               |       | (141,373                                   | )          | (183,117 | ) | (63,213 | ) |
| Proceeds from sales and maturities of investment securities                               |       | 160,646                                    |       | 174,980 |   | 76,268 |   |
| Purchase of business, net of cash acquired                                                |       | (11,607                                    | )          | — |   | — |   |
| Purchases of property, plant and equipment                                                |       | (16,453                                    | )          | (19,166 | ) | (23,716 | ) |
| Payments for patent applications and other costs                                          |       | (518                                       | )          | (334 | ) | (245 | ) |
| Proceeds from disposal of property, plant and equipment                                   |       | 256                                        |       | 38 |   | — |   |
| Net cash used in investing activities                                                     |       | (9,049                                     | )          | (27,599 | ) | (10,906 | ) |
| **Financing Activities**                                                                  | ** ** | ** **                                 |       | ** ** |   | ** ** |   |
| Principal payments on long-term debt                                                      |       | (4,585                                     | )          | (30,072 | ) | (4,521 | ) |
| Proceeds from exercise of options and ESPP                                                |       | 581                                        |       | 1,323 |   | 1,846 |   |
| Net cash used in financing activities                                                     |       | (4,004                                     | )          | (28,749 | ) | (2,675 | ) |
| Effect of exchange rate changes on cash flows                                             |       | 255                                        |       | (64 | ) | — |   |
| (Decrease) increase in cash and cash equivalents                                          |       | (1,482                                     | )          | (13,565 | ) | 22,984 |   |
| Cash and cash equivalents at beginning of period                                          |       | 27,606                                     |       | 41,171 |   | 18,187 |   |
| Cash and cash equivalents at  end of period                                               |       | $                                          | 26,124     |   | $ | 27,606 |   | $ | 41,171 |   |
| Supplemental disclosure of non-cash investing  and financing activities:                  |       |                                       |       |   |   |   |   |
| Increase in net  unrealized loss on securities available-for-sale, net of tax             |       | $                                          | 165        |   | $ | (92 | ) | $ | (196 | ) |
| Increase  (decrease) in net unrealized gain/(loss) on swap contract, net of tax           |       | $                                          | (61        | ) | $ | 132 |   | $ | 182 |   |
| Increase in  additional minimum pension liability, net of tax                             |       | $                                          | 254        |   | $ | (254 | ) | $ | — |   |
| Adjustment for  SFAS No. 158 implementation                                          |       | $                                          | 614        |   | $ | — |   | $ | — |   |
| Issuance of  restricted stock                                                             |       | $                                          | 1,993      |   | $ | 2,505 |   | $ | — |   |
| Conversion of  accounts receivable to equity investments and note receivable              |       | $                                          | —     |   | $ | — |   | $ | 104 |   |
| Supplemental disclosures of cash flow information:                                        |       |                                       |       |   |   |   |   |
| Cash paid during the period for:                                                          |       |                                       |       |   |   |   |   |
| Interest                                                                                  |       | $                                          | 1,071      |   | $ | 1,812 |   | $ | 1,846 |   |
| Income taxes                                                                              |       | $                                          | 6,471      |   | $ | 4,900 |   | $ | 4,545 |   |

 

F-9

----

**ALBANY MOLECULAR RESEARCH, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31, 2006, 2005 and 2004 (In thousands)**

In 2006, the Companypurchased all of the outstanding shares of ComGenenx Kutato-Fejleszto Rt. foran aggregate purchase price of $11,930. In conjunction with the acquisition,assets were acquired and liabilities were assumed as follows:

| Fair value of  assets acquired                              |   | $       | 14,411 |   |
|-------------------------------------------------------------|--------|---------|--------|--------|
| Cash paid for the  outstanding shares, net of cash acquired |   | (11,607 | )      |
| Liabilities assumed                                         |   | $       | 2,804  |   |

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-10

----

**ALBANY MOLECULAR RESEARCH, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2006, 2005 and 2004(In thousands, except per share amounts)**

**1.**   Summaryof Significant Accounting Policies

**Nature of Business:**

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

**Basis ofPresentation:**

The consolidated financialstatements include the accounts of Albany Molecular Research, Inc. (“AMRI”)and its wholly-owned subsidiaries. All intercompany balances andtransactions have been eliminated during consolidation. When necessary, prioryears’ consolidated financial statements have been reclassified to conform tothe current year presentation. Assets and liabilities of non-U.S. operationsare translated at period-end rates of exchange, and the statements of income(loss) are translated at the average rates of exchange for the period. Gains orlosses resulting from translating non-U.S. currency financial statements arerecorded in accumulated other comprehensive income (loss) in the accompanying December 31,2006 and 2005 consolidated balance sheets.

**Use of ManagementEstimates:**

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, and disclosures of contingentassets and liabilities, at the date of the financial statements, and thereported amounts of revenues and expenses during the reporting period. The mostsignificant estimates included in the accompanying consolidated financialstatements include assumptions regarding the collectibility of receivables, thevaluation of inventory, and the fair value of goodwill, intangible assets, andlong-lived assets. Other significant estimates include assumptions utilized indetermining the amount and realizabilty of deferred tax assets and assumptionsutilized in determining actuarial obligations in conjunction with the Company’spension and postretirement health plans. Actual results can vary from theseestimates.

**RevenueRecognition:**

The Company’s contract revenue consists primarily offees earned under contracts with third-party customers and reimbursed expensesunder such contracts. The Company also seeks to include provisions in certaincontracts which contain a combination of up-front licensing fees, milestone androyalty payments should the Company’s proprietary technology and expertise leadto the discovery of new products that reach the market. Reimbursed expensesconsist of chemicals and other project specific costs. Generally, the Company’scontracts may be terminated by the customer upon 30 days’ to one year’sprior notice, depending on the size of the contract. The Company analyzes itsagreements to determine whether the elements can be separated and accounted forindividually or as a single unit of accounting in accordance with EITF No. 00-21,“Revenue Arrangements with MultipleDeliverables,” and SAB 104, “Revenue

F-11

----

Recognition”.Allocation of revenue to individual elements which qualify for separateaccounting is based on the estimated fair value of the respective elements.

The Company generates contract revenue on thefollowing basis:

*Full-timeEquivalent (FTE).**  *AnFTE agreement establishes the number of Company employees contracted for aproject or a series of projects, the duration of the contract period, the priceper FTE, plus an allowance for chemicals and other project specific costs,which may or may not be incorporated in the FTE rate. FTE contracts can run inone month increments, but typically have terms of six months or longer. FTEcontracts typically provide for annual adjustments in billing rates for thescientists assigned to the contract.

These contracts involve the Company’s scientistsproviding services on a “best efforts” basis in a project which may involve aresearch component with a timeframe or outcome that has some level ofunpredictability. There are no fixed deliverables that must be met for paymentas part of these services. As such, the Company recognizes revenue under FTEcontracts on a monthly basis as services are performed according to the termsof the contract.

*Timeand Materials.*   Undera time and materials contract the Company charges customers an hourly rate plusreimbursement for chemicals and other project specific costs. The Companyrecognizes revenue for time and material contracts based on the number of hoursdevoted to the project multiplied by the customer’s billing rate plus otherproject specific costs incurred.

*Fixed-Fee.*   Under a fixed-fee contract theCompany charges a fixed agreed upon amount for a deliverable. Fixed-feecontracts have fixed deliverables upon completion of the project. Typically,the Company recognizes revenue for fixed-fee contracts after projects are completed,delivery is made and title transfers to the customer and collection isreasonably assured. In certain instances, the Company’s customers request thatthe Company retain materials produced upon completion of the project due to thefact that the customer does not have a qualified facility to store thosematerials. In these instances, the revenue recognition process is consideredcomplete when required project documentation (batch records, Certificates ofAnalysis, etc.) has been delivered to the customer and payment has beencollected.

*Up-FrontLicense Fees, Milestone and Royalty Revenue.***  **The Company recognizes revenue fromup-front non-refundable licensing fees on a straight-line basis over the periodof the underlying project. The Company will recognize revenue arising from asubstantive milestone payment upon the successful achievement of the event, andthe resolution of any uncertainties or contingencies regarding potentialcollection of the related payment, or if appropriate over the remaining term ofthe agreement.

*Recurring Royalty RevenueRecognition.***  **Recurringroyalties consist of royalties under a license agreement with Sanofi-Aventisbased on the worldwide sales of fexofenadine HCl, marketed as Allegra in theAmericas and Telfast elsewhere, as well as on sales of Sanofi-Aventis’authorized generics. The Company records royalty revenue in the period in whichthe sales of Allegra/Telfast occur, because we can reasonably estimate suchroyalties. Royalty payments from Sanofi-Aventis are due within 45 daysafter each calendar quarter and are determined based on sales ofAllegra/Telfast in that quarter.

**Cash Equivalents:**

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

**Allowance 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 

F-12

----

of thesebalances, and adjusts the allowance for doubtful accounts accordingly. Theallowance and related accounts receivable are reduced when the account isdeemed uncollectible.

**Inventory:**

Inventory consistsprimarily of commercially available fine chemicals used as raw materials,work-in-process and finished goods in our large scale manufacturing plant andchemical compounds in the form of natural product and novel compound libraries.Inventories are stated at the lower of cost (first-in, first-out basis) ormarket. Large-scale manufacturing 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.Accumulated variances are deferred and recognized through cost of contractrevenue in the consolidated statement of income (loss) over the estimatedperiod of inventory turns. The Company writes down inventories for obsolescenceequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions. Anysuch write-down results in a charge to operations.

**InvestmentSecurities:**

In accordance with Statement of Financial AccountingStandards (SFAS) No. 115, “Accounting for Certain Debt and EquitySecurities,” short-term investments are classified as available-for-sale.Available-for-sale securities are carried at fair value, with the unrealizedgains and losses reported in accumulated other comprehensive income (loss). Theamortized cost of debt securities in this category is adjusted for amortizationof premiums and accretion of discounts to maturity. Such amortization isincluded in interest income or expense. Realized gains and losses and declinesin value judged to be other-than-temporary, if any, on available-for-salesecurities are included in other income or expense. The cost of securities soldis based on the specific identification method. Interest and dividends onsecurities classified as available-for-sale are included in interest income.

At December 31, 2006and 2005, our investments in securities in the current assets section of theconsolidated balance sheets included $32.6 million and $15.9 million, respectively,of auction rate municipal bonds, classified as available-for-sale securities.Our investments in these securities are recorded at cost, which approximatesfair market value due to their variable interest rates, which typically resetevery 7 to 35 days, and, despite the long-term nature of their statedcontractual maturities, we have the ability to quickly liquidate thesesecurities. As a result, there are no cumulative gross unrealized holding gains(losses) or gross realized gains (losses) from these securities. All incomegenerated from these current investments is recorded as interest income.

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

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

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

 

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

F-13

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**Equity Investmentsin Unconsolidated Subsidiaries:**

The Company maintains two equity investments incompanies that have operations in areas within its strategic focus. Theseinvestments are in leveraged start-up companies and were recorded at historicalcost.

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.

**Long-Lived Assets:**

In accordance withthe provisions of SFAS No. 144**, “**Accounting for the Impairment or Disposal of Long-Lived Assets”(“SFAS No. 144”), the Company assesses the impairment of long-lived assetswhenever events or changes in circumstances indicate that their carrying valuemay not be recoverable. Factors the Company considers important which couldtrigger 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 withthe provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFASNo. 142”)*,* the Company performs an annual****assessment of the carrying value of goodwill for potentialimpairment (or on an interim basis if certain triggering events occur). Adetermination of impairment is made based upon the estimated discounted futurecash flows of the operations associated with the related reporting unit,comparable company multiples and recent transactions involving similar entities.If goodwill is determined to be impaired in the future, the Company would berequired to record a charge to its results of operations. Factors the Companyconsiders important which could result in an impairment include the following:

·       significantunderperformance relative to historical or projected future operating results;

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

·       significantnegative industry or economic trends; and

·       marketcapitalization relative to net book value.

Included in goodwill as ofDecember 31, 2006 are $23.1 million related to the acquisition ofOrganichem and $10.1 million related to the acquisition of ComGenexKutato-Fejleszto Rt. See Note 19 for further information on the Company’sgoodwill balances.

F-14

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**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. Patent application and processing costs are capitalized andwill be amortized over the estimated life once a patent is acquired or expensedin the period the patent application is denied or the related appeal processhas been exhausted.

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

**Swap Contracts:**

The Company maintains twointerest rate swap agreements. These agreements have been designated asinterest rate hedges on future cash flows of our variable debt instruments inaccordance with SFAS No. 133, “Accounting for Derivatives and HedgingActivities”**as amended by SFAS No. 138,**“Accounting for Certain Derivative and Certain HedgingActivities.”**Accordingly, these contracts arereported at fair value in the consolidated balance sheets, and any change infair value is recorded as an adjustment to accumulated other comprehensiveincome (loss), 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 information availablerelated to specific sites, the assessment stage of each site investigation,preliminary findings and the length of time involved in the remediation orsettlement. The Company accrues environmental cleanup related costs when thosecosts are believed to be probable and can be reasonably estimated.

**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.

F-15

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**Stock-BasedCompensation:**

Effective January 1, 2006, the Company adoptedSFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), which amends SFAS No. 123 and supersedes APB No. 25**in establishing standards for the accounting for transactionsin which an entity exchanges its equity instruments for goods or services, aswell as transactions in which an entity incurs liabilities in exchange forgoods or services that are based on the fair value of the entity’s equityinstruments or that may be settled by the issuance of those equity instruments.This Statement requires that the cost resulting from all share-based paymenttransactions be recognized in the financial statements based on the fair valueof the share-based payment. This Statement establishes fair value as themeasurement objective in accounting for share-based payment transactions withemployees, except for equity instruments held by employee share ownershipplans. As allowed under SFAS No. 123 (R), the Company elected the modifiedprospective method of adoption, under which compensation cost is recognized inthe financial statements beginning with the effective date of SFAS No. 123(R) for all share-based payments granted after that date, and for allunvested awards granted prior to the effective date of SFAS No. 123 (R).Accordingly, prior period amounts have not been restated.

Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of SFAS No. 123to its share-based payments during 2005 and 2004:

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

 

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

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

F-16

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The decision to accelerate the vesting of theseunderwater options was made primarily to minimize certain future compensationexpenses that the Company would otherwise recognize in its consolidatedstatements of income (loss) with respect to these options pursuant to SFAS No. 123(R),**which became effective for the Company beginning January 1,2006. The Company also believes that the acceleration may have a positiveeffect on employee morale, retention and the perception of option value. Theacceleration had no effect on reported net income for the year ended December 31,2005, and an approximate $3,881, net of tax, impact on pro forma net income inthe fourth quarter of 2005. The impact of the acceleration is reflected in thepro forma amounts above.

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

| ** **               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life in  years: |       | 5        |       | 5        |       | 5        |       |
| Interest rate            |       | 4.95     | %          | 4.06     | %          | 3.41     | %          |
| Volatility               |       | 41       | %          | 48       | %          | 59       | %          |
| Dividend yield           |       | —   |       | —   |       | —   |       |

 

**Earnings Per Share:**

Basic earnings per share is computed by dividingincome available to common stockholders by the weighted average number of commonshares outstanding for the period. Diluted earnings per share reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shared in the earnings of the Company (suchas stock options and warrants).

Thefollowing table provides basic and diluted earnings per share calculations:

| ** **                           | ** ** | **Year Ended December 31, 2006** | ** ** | **Year Ended December 31, 2005** | ** ** | **Year Ended December 31, 2004** | ** ** |            |
|--------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------|
| ** **                           | ** ** | **Net  Income**                                      | ** ** | **Weighted  Average  Shares**                        | ** ** | **Per Share  Amount**                           | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share  Amount** | ** ** | **Net  Loss** | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share  Amount** | ** ** |   |
| Basic earnings  per share            |       | $                                                    | 2,183      |                                                 |       | 32,174                                               |       |            |   | $ | 0.07 |   |   | $ | 16,321 |   |   | 32,044 |   |   |   | $ | 0.51 |   |   | $ | (11,691 | ) |   | 31,627 |   |   |   | $ | (0.37 | ) |   |
| Dilutive effect  of stock options    |       | —                                               |       |                                                 | 167        |                                                 |       |            | — |   |   | — |   |   | 239 |   |   |   | (0.01 | ) |   | — |   |   | — |   |   |   | — |   |   |
| Dilutive effect  of restricted stock |       | —                                               |       |                                                 | 86         |                                                 |       |            | — |   |   | — |   |   | 51 |   |   |   | — |   |   | — |   |   | — |   |   |   | — |   |   |
| Diluted earnings per  share          |       | $                                                    | 2,183      |                                                 |       | 32,427                                               |       |            |   | $ | 0.07 |   |   | $ | 16,321 |   |   | 32,334 |   |   |   | $ | 0.50 |   |   | $ | (11,691 | ) |   | 31,627 |   |   |   | $ | (0.37 | ) |   |

 

The weighted averageamount of anti-dilutive options and warrants outstanding were 1,966, 2,390 and3,519 for the years ended December 31, 2006, 2005 and 2004, respectively,and were excluded from the calculation of diluted earnings per share.

**RestructuringCharges:**

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

F-17

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**Recent AccountingPronouncements:**

In July 2006, the Financial Accounting StandardsBoard (FASB) issued FASB Interpretation No. 48,**“Accountingfor Uncertainty in Income Taxes” (“FIN 48”). Among other things, FIN 48requires the application of a “more likely than not” threshold to the de-recognitionof tax positions, and provides for enhanced quantitative and qualitativedisclosures regarding unrecognized tax benefits resulting from tax positionstaken by an entity. This Interpretation applies to the Company effective January 1,2007. The Company is currently assessing the impact of applying thisInterpretation.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. This Statementdefines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements; however, it does not requireany new fair value measurements. The Statement applies to fair-valuemeasurements that are already required or permitted by existing standardsexcept for measurements of share-based payments and measurements that aresimilar to, but not intended to be, fair value. Its applicability is alsolimited by the practicability exceptions to applying fair value currently foundin some standards. The Statement imposes no requirements for additionalfair-value measures in financial statements. The provisions of SFAS No. 157will be applied to fair value measurements and disclosures in the Company’scondensed consolidated financial statements beginning in the first quarter of2008. The Company is currently assessing the impact of applying this Statement.

**Note 2—BusinessCombination**

On February 28, 2006, the Company, through awholly-owned subsidiary, acquired all of the outstanding shares of ComGenexKutato-Fejleszto Rt. (“ComGenex”), a privately held drug discovery servicecompany located in Budapest, Hungary.

The aggregate purchase price of $11,930 included cashpayments totaling $11,160 and capitalized costs related to the acquisition,primarily professional fees, of $770. The purchase price may be adjusted basedupon the final release of purchase funds currently held in escrow in accordancewith the provisions of the purchase agreement. The results of ComGenex’soperations have been included in the consolidated statement of income for theyear ended December 31, 2006 from the date of acquisition.

F-18

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Thefollowing table summarizes the allocation of the purchase price to theestimated fair value of the net assets acquired. The allocation will befinalized upon final determination of the purchase price and the completion ofthe Company’s valuation of the acquired assets and liabilities of ComGenex.

| ** **                                 | ** ** | **February 28,  2006** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| **Assets Acquired**                        | ** ** |                        | ** ** | ** ** |   |
| Cash and cash  equivalents                 |       |                        | $          | 323 | ** ** |   |
| Accounts  receivable, net                  |       |                        | 1,002      | ** ** |   |
| Inventory                                  |       |                        | 121        | ** ** |   |
| Prepaid expenses  and other current assets |       |                        | 1,141      | ** ** |   |
| Property and  equipment, net               |       |                        | 1,270      | ** ** |   |
| Goodwill                                   |       |                        | 10,064     | ** ** |   |
| Intangible assets  and patents, net        |       |                        | 792        | ** ** |   |
| Other assets                               |       |                        | 21         | ** ** |   |
| Total assets acquired                      |       |                        | $          | 14,734 | ** ** |   |
| **Liabilities Assumed**                    | ** ** |                        | ** ** | ** ** |   |
| Accounts payable  and accrued expenses     |       |                        | $          | 1,545 | ** ** |   |
| Deferred revenue                           |       |                        | 1,119      | ** ** |   |
| Deferred income  taxes                     |       |                        | 78         | ** ** |   |
| Other long term  liabilities               |       |                        | 62         | ** ** |   |
| Total liabilities assumed                  |       |                        | $          | 2,804 | ** ** |   |
| Net assets  acquired                       |       |                        | $          | 11,930 | ** ** |   |

 

Pro forma financialinformation for the years ended December 31, 2006 and 2005 as if theComGenex acquisition had been completed as of January 1, 2005 has beenexcluded due to the immateriality of the operating results of ComGenex inrelation to the Company’s consolidated operating results as a whole.

**3.**                 Restructuring

***Large Scale Manufacturing Facility***

On November 9, 2006, the Company announced plansto initiate a restructuring of the Company’s LSM business segment. Consistentwith the Company’s continued strategy of realigning its LSM segment toward agreater focus on manufacturing clinical trial materials with strong commercialpotential, the goals of the restructuring plan are to strengthen the Company’scompetitiveness in this area and reduce operating costs by eliminating overlapin business processes, organization and project process flow, as well asleveraging existing resources and assets. The restructuring plan includes areduction of workforce in this segment by approximately 40 employees orapproximately 15%, as well as reductions of non-essential operating expenses,raw material costs and future capital expenditure activities. The Company hasestimated that total large scale costs will be reduced by $5,000 annually as aresult of this restructuring. The Company recorded a restructuring charge ofapproximately $2,400 in the fourth quarter of 2006, including a non-cash assetdisposal charge of approximately $1,600, and other charges of approximately$800 consisting primarily of termination benefits.

The large scale restructuring costs are included underthe caption restructuring charge in the consolidated statement of income forthe year ended December 31, 2006 and the restructuring liabilities areincluded in accounts payable and accrued expenses on the consolidated balancesheet at December 31, 2006.

F-19

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Thefollowing table displays the restructuring activity and liability balances:

| ** **            | ** ** | **Balance at  January 1,  2006** | ** ** | **Charges** | ** ** | **Incurred  Amounts** | ** ** | **Balance at  December 31,  2006** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|-------------|------------|-----------------------|------------|----------------------------------------------|------------|
| ** **            | ** ** | **(in 000’s)**                   | ** ** |
| Termination  benefits |       |                                       | $          | —      |       |                  |       | 874                                          |       |   | (192 | ) |   | $ | 682 |   |   |
| Asset disposal  costs |       |                                       | —     |        |       |                  | 1,557      |                                         |       | (1,175 | ) |   | 382 |   |   |
| Total                 |       |                                       | $          | —      |       |                  |       | $                                            | 2,431      |   |   | $ | (1,367 | ) |   | $ | 1,064 |   |   |
|                       |            |                                            |            |             |            |                       |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

Termination benefits relate to severance packages,outplacement services and career counseling for employees affected by therestructuring. Asset disposal costs relate primarily to the carrying value ofunderutilized assets that were identified for disposal in conjunction with therestructuring plan.

The large scalemanufacturing restructuring activity was recorded in the LSM operating segment.The net cash outflow related to the large scale manufacturing  restructuring for the year ended December 31,2006 was $72. Anticipated cash outflows related to the large scalemanufacturing restructuring for 2007 are $1,000, which primarily consists ofthe payment of termination benefits.

***Mt. Prospect Research Center***

During the fourth quarter of 2006, the Company secureda letter of intent related to the potential sale of the Mt. Prospect facilityfor approximately $1.5 million. As a result, the Company recorded an additionalimpairment charge of approximately $0.5 million in the fourth quarter of 2006to reduce the carrying amount of these assets to reflect the sales price perthe letter of intent less estimated selling costs. The Company currentlyanticipates the sale to be completed in the first half of 2007.

The facility qualified for held for sale treatment inaccordance with SFAS No. 144 during the fourth quarter of 2004. Thelong-lived assets associated with Mt. Prospect have been segregated to aseparate line item in the consolidated balance sheets until they are sold anddepreciation expense has ceased with respect to those assets. At the time thatthe facility qualified for held for sale treatment in accordance with SFAS No. 144,the Company anticipated the completion of the sale of the facility by June 2006.The Company previously disclosed that if a definitive agreement to sell thefacility was not in place as of June 30, 2006, it would reassess theclassification of the facility as held for sale in accordance with SFAS No. 144at that time. The Company was not able to secure a definitive agreement to sellthe facility as of June 30, 2006. Accordingly, and in connection with thepreparation of its second quarter 2006 unaudited condensed consolidated financialstatements, the Company reassessed Mt. Prospect as a held for sale facility.

As a result of this assessment, the Company reaffirmedits intention to sell the Mt. Prospect facility, and determined that a $3,376write-down of the carrying value of the facility was required during thequarter ended June 30, 2006. Management estimated the fair value basedupon its intention to sell the facility within twelve months and comparablereal estate transactions in the facility’s market area.

At December 31, 2006, the Company had recordedrestructuring liabilities totaling $190 related to asset disposal costs,including brokerage commissions, legal fees, and marketing expenses associatedwith the planned sale of the Mt. Prospect Research Center facility. These restructuringliabilities are included in accounts payable and accrued expenses in theCompany’s consolidated balance sheet. The Company’s restructuring liabilitiesdecreased by $323 during the year ended December 31, 2006, representing areduction of estimated brokerage commissions as a result of the reduction incarrying value and estimated sales price of the Mt. Prospect facility asdescribed above.

In 2004 the Company consolidated operations byrelocating its Mt. Prospect facility operations to its facilities in New York.All activities of Mt. Prospect were relocated to New York and continue to befully 

F-20

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integrated with theCompany’s drug discovery and development technologies. The restructuringresulted in the closure of the Mt. Prospect Research Center in 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.

Thefollowing table displays the restructuring activity and liability balances:

| ** **            | ** ** | ** **                                     | ** ** | ** **  | ** ** | ** **   | ** ** | **Balance at**         | ** ** |
|-----------------------|------------|------------------------------------------------|------------|-------------|------------|--------------|------------|-----------------------------|------------|
| ** **            | ** ** | **Balance at  January 1, 2006** | ** ** | **Charges** | ** ** | **Payments** | ** ** | **December 31,  2006** | ** ** |
| Asset disposal  costs |       |                                           | 513        |        |       |         | (323       | )                           |       |   | — |   |   |   | 190 |   |   |
| Total                 |       |                                           | $          | 513         |       |         |       | $                           | (323       | ) |   |   | $ | — |   |   |   | $ | 190 |   |   |
|                       |            |                                                |            |             |            |              |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

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

 

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

The Company also incurred approximately $0, $200 and$1,400 in employee and equipment relocation costs during the years ended December 31,2006, 2005 and 2004, respectively. These relocation costs are included underthe caption “selling, general and administrative” in the consolidatedstatements of income (loss).

The Mt. Prospect restructuring activity was recordedin the DDS operating segment while the Large Scale Manufacturing restructuringactivity was recorded in the LSM operating segment. The net cash outflowrelated to the restructuring for the years ended December 31, 2006, 2005and 2004 was $0, $64 and $542, respectively. Anticipated cash outflows relatedto the large scale manufacturing restructuring for 2007 are $190, whichprimarily consists of the payment of accrued asset disposal costs.

The restructuring costs are included under the captionrestructuring charge in the consolidated statements of income (loss) and therestructuring liabilities are included in accounts payable and accrued expensesin the consolidated balance sheets at December 31, 2006 and 2005.

F-21

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**4.**                 Inventory

Inventoryconsisted of the following at December 31, 2006 and 2005:

| ** **                  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Raw materials               |       | $                     | 7,525      |   | $ | 13,039 |   |
| Work in process             |       | 1,914                 |       | 2,188 |   |
| Finished goods              |       | 12,858                |       | 15,029 |   |
| Libraries                   |       | 347                   |       | 347 |   |
| Total inventories, at  cost |       | $                     | 22,644     |   | $ | 30,603 |   |

 

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

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

**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, 2006** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Obligations of states and political subdivisions |       |                            | $          | 38,232 |   |   |   | $ | 3 |   |   |   | $ | (32 | ) |   | $ | 38,203 |   |
| U.S. Government and Agency obligations           |       |                            | 10,351     |   |   |   | — |   |   |   | (89 | ) |   | 10,262 |   |
| Auction rate securities                          |       |                            | 32,575     |   |   |   | — |   |   |   | — |   |   | 32,575 |   |
|                                             |       |                            | $          | 81,158 |   |   |   | $ | 3 |   |   |   | $ | (121 | ) |   | $ | 81,040 |   |

 

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

 

F-22

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Maturitiesof corporate debt obligations, obligations of states and politicalsubdivisions, and auction rate securities classified as available-for-sale at December 31,2006 and 2005 were as follows:

| ** **                             | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Amortized  Cost**             | ** ** | **Fair  Value**                 | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| Due less than one year                 |       |                            | $          | 13,891                          |       |   | $ | 13,845 |   | $ | 42,023 |   | $ | 41,704 |   |
| Due after one year through five years  |       |                            | 10,923     |                            |       | 10,855 |   | 8,196 |   | 8,124 |   |
| Due after five years through ten years |       |                            | 1,945      |                            |       | 1,945 |   | 1,683 |   | 1,684 |   |
| Due after ten years                    |       |                            | 54,399     |                            |       | 54,395 |   | 48,793 |   | 48,792 |   |
|                                   |       |                            | $          | 81,158                          |       |   | $ | 81,040 |   | $ | 100,695 |   | $ | 100,304 |   |

 

Information on temporarily impaired securities at December 31,2006, 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 ofstates  and political subdivisions |       | $                                      | 4,398      |                                   |       | $                     | (9         | ) |   | $ | 5,980 |   |   | $ | (23 | ) |   | $ | 10,378 |   |   | $ | (32 | ) |   |
| U.S.Government and Agency obligations            |       | 3,969                                  |       |                                   | (31        | )                     |       | 6,293 |   |   | (58 | ) |   | 10,262 |   |   | (89 | ) |   |
|                                             |       | $                                      | 8,367      |                                   |       | $                     | (40        | ) |   | $ | 12,273 |   |   | $ | (81 | ) |   | $ | 20,640 |   |   | $ | (121 | ) |   |

 

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

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

 

The above table represents 26and 42 securities at December 31, 2006 and 2005, respectively, where thecurrent fair value is less than the related amortized cost. These unrealizedlosses do not reflect any deterioration of the credit worthiness of the issuingentities. No security has a rating that is below “A2.” The unrealized losses onthese temporarily impaired securities are a result of changes in interest ratesfor fixed-rate securities where the interest rate received is less than thecurrent rate available for new offerings of similar securities and changes inmarket spreads as a result of shifts in supply and demand. The Company has theability and intent to hold these securities to maturity, at which time fullrecovery of the investment is expected.

The Company receivedproceeds of $160,646, $174,980 and $76,268 and recorded realized losses of $0,$0 and $36 from maturities and sales of available-for-sale securities duringthe years ended December 31, 2006, 2005 and 2004, respectively.

F-23

----

**6.**                 Propertyand Equipment

Propertyand equipment consists of the following:

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Laboratory  equipment and fixtures                   |       | $                     | 90,901     |   | $ | 94,703 |   |
| Office equipment                                     |       | 21,421                |       | 15,416 |   |
| Leasehold  improvements                              |       | 37,688                |       | 28,188 |   |
| Buildings                                            |       | 52,966                |       | 53,894 |   |
| Land                                                 |       | 2,155                 |       | 2,152 |   |
|                                                 |       | 205,131               |       | 194,353 |   |
| Less accumulated  depreciation and amortization      |       | (64,249               | )          | (49,956 | ) |
|                                                 |       | 140,882               |       | 144,397 |   |
| Construction-in-progress                             |       | 13,820                |       | 12,057 |   |
| Less: Property  and equipment held for sale (Note 3) |       | (1,500                | )          | (5,376 | ) |
|                                                 |       | $                     | 153,202    |   | $ | 151,078 |   |

 

Depreciation and amortization expense of property andequipment was approximately $14,600, $13,800 and $14,200 for the years ended December 31,2006, 2005, and 2004, respectively.

Refer to Note 3 fordetails regarding the status of the Mt. Prospect facility and relatedimpairment charges.

**7.**                 EquityInvestments

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

During the fourth quarter of 2004, the Companyperformed an assessment of the carrying value of one of its investments 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 its industry and thelikelihood that any funding raised would significantly dilute the Company’sownership percentage was performed. As a result of this analysis it was theCompany’s judgment that an other than temporary impairment had occurred andthat the fair value of our investment was zero, resulting in a non-cash loss oninvestment of $1,300.

The carrying value ofequity investments at December 31, 2006 and 2005 was $956.

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

***Long-Term Debt***

The Company entered into a$30,000 term loan and $35,000 line of credit to fund the acquisitionof Organichem. The term loan matures in February, 2008 and bears interest at avariable rate based on the Company’s leverage ratio. As of December 31,2006, the variable interest rate was 6.37%. On June 30, 2005, the Companyamended the credit facility to extend the maturity date on the line of creditfrom February 2006 to June 2010. The line of credit bears interest ata variable rate based on the Company’s leverage ratio. As of December 31,2006, the outstanding balance of the line of credit was $0. The credit facilitycontains certain financial covenants, including a maximum leverage ratio, aminimum required operating cash flow coverage ratio, a minimum earnings beforeinterest and taxes to interest ratio and a minimum current ratio. Othercovenants include limits on asset disposals and the payment of dividends. As 

F-24

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of December 31,2006 and 2005, the Company was in compliance with all covenants under thecredit facility.

The Company maintainsvariable interest rate industrial development authority bonds due in increasingannual installments through 2021. Interest payments are due monthly with acurrent interest rate of 3.9%.

Thefollowing table summarizes long-term debt:

| ** **                                                                   | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan                                                                    |       |                        | $          | 13,941                      |       |   |   | $ | 18,214 |   |   |
| Industrial  development authority bonds                                      |       |                        | 4,580      |                        |       |   | 4,820 |   |   |
| Notes payable to  financing company due in monthly installments through 2008 |       |                        | 13         |                        |       |   | 23 |   |   |
|                                                                         |       |                        | 18,534     |                        |       |   | 23,057 |   |   |
| Less current  portion                                                        |       |                        | (4,541     | )                           |       |   | (4,536 | ) |   |
| Total long-term  debt                                                        |       |                        | $          | 13,993                      |       |   |   | $ | 18,521 |   |   |

 

Theaggregate maturities of long-term debt at December 31, 2006 are asfollows:

| 2007       |   | $     | 4,541  |   |
|------------|--------|-------|--------|--------|
| 2008       |   | 9,913 |   |
| 2009       |   | 260   |   |
| 2010       |   | 270   |   |
| 2011       |   | 275   |   |
| Thereafter |   | 3,275 |   |

 

***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 $30,000 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 swap contractasset/liability with a corresponding offset to other comprehensive income(loss).

The weighted average rate received from thecounterparties on all swaps was 5.09%, 3.29% and 1.46% for the years ended December 31,2006, 2005 and 2004, respectively. The fair value of the interest rate swapagreements was $161 and $263 and was included in other long-term assets in theconsolidated balance sheets at December 31, 2006 and 2005, respectively.The Company recorded an unrealized gain (loss), net of tax, of ($61), $132 and$182 in accumulated other comprehensive income (loss) representing the changein the fair value of its hedges during the years ended December 31, 2006,2005 and 2004, respectively. The Company recognized $191 of interest income and$14 and $328 in additional interest expense related to the net settlement ofthe swaps during the years ended December 31, 2006, 2005 and 2004,respectively.

F-25

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**9.**                 IncomeTaxes

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

| ** **                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income (loss) before  taxes:   |       |                                       |       |   |   |   |   |
| U.S.                           |       | $                                          | 1,841      |   | $ | 25,058 |   | $ | (9,854 | ) |
| Foreign                        |       | 420                                        |       | 88 |   | — |   |
|                           |       | $                                          | 2,261      |   | $ | 25,146 |   | $ | (9,854 | ) |
| Income tax expense  (benefit): |       |                                       |       |   |   |   |   |
| Current:                       |       |                                       |       |   |   |   |   |
| Federal                        |       | $                                          | 647        |   | $ | 11,572 |   | $ | 4,923 |   |
| State                          |       | 10                                         |       | 10 |   | 1,280 |   |
| Foreign                        |       | 127                                        |       | 30 |   | — |   |
|                           |       | 784                                        |       | 11,612 |   | 6,203 |   |
| Deferred:                      |       |                                       |       |   |   |   |   |
| Federal                        |       | (830                                       | )          | (3,014 | ) | (1,934 | ) |
| State                          |       | 105                                        |       | 227 |   | (2,432 | ) |
|                           |       | (725                                       | )          | (2,787 | ) | (4,366 | ) |
|                           |       | $                                          | 59         |   | $ | 8,825 |   | $ | 1,837 |   |

 

Thedifferences between income tax expense and income taxes computed using afederal statutory rate of 35% for the years ended December 31, 2006, 2005and 2004, were as follows:

| ** **                                                                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Pre-tax  income at statutory rate                                         |       | 762                                        |       | 8,801 |   | (3,449 | ) |
| Increase (reduction) in  taxes resulting from:                            |       |                                       |       |   |   |   |   |
| Tax-free  interest income                                                 |       | (737                                       | )          | (412 | ) | (222 | ) |
| Goodwill and  intangible asset impairment                                 |       | —                                     |       | — |   | 5,972 |   |
| State taxes, net  of federal benefit                                      |       | 75                                         |       | 154 |   | (818 | ) |
| Extraterritorial  income credit                                           |       | (185                                       | )          | (448 | ) | (558 | ) |
| Increase in  valuation reserve for realized and unrealized capital losses |       | —                                     |       | — |   | 481 |   |
| Domestic  production deduction                                            |       | —                                     |       | (86 | ) | — |   |
| Termination of  outstanding warrants                                      |       | —                                     |       | 818 |   | — |   |
| Stock  compensation expense                                               |       | 83                                         |       | — |   | — |   |
| Other, net                                                                |       | 61                                         |       | (2 | ) | 431 |   |
|                                                                      |       | $                                          | 59         |   | $ | 8,825 |   | $ | 1,837 |   |
|                                                                           |            |                                            |            |  |  |  |  |  |  |  |

 

F-26

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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,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                    | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Deferred tax assets:                                                                          |       |                  |       |   |   |
| Nondeductible  accrued expenses                                                               |       | $                     | 413        |   | $ | 422 |   |
| Allowance for  doubtful accounts                                                              |       | 105                   |       | 36 |   |
| Library  amortization                                                                         |       | 574                   |       | 574 |   |
| Inventory  reserves                                                                           |       | 3,116                 |       | 2,938 |   |
| Warrants                                                                                      |       | 185                   |       | 198 |   |
| Environmental  reserves                                                                       |       | 86                    |       | 88 |   |
| Pension and  postretirement costs                                                             |       | 714                   |       | 1,003 |   |
| Research and  experimentation credit carryforwards                                            |       | 192                   |       | 192 |   |
| Alternative  minimum tax credit                                                               |       | 228                   |       | — |   |
| State tax credit  carryforward                                                                |       | 2,348                 |       | 2,153 |   |
| Foreign deferred  tax                                                                         |       | 44                    |       | — |   |
| Impairment  charges                                                                           |       | 2,019                 |       | 2,048 |   |
| Investment  write-downs and losses                                                            |       | 885                   |       | 885 |   |
| Capital loss on  sale of fixed assets                                                         |       | 77                    |       | 77 |   |
| Deferred revenue                                                                              |       | 1,680                 |       | 2,907 |   |
| Stock based  compensation                                                                     |       | 448                   |       | — |   |
| Net operating  loss carryforwards                                                             |       | 217                   |       | 375 |   |
|                                                                                          |       | 13,331                |       | 13,896 |   |
| Less valuation  allowance                                                                     |       | (3,286                | )          | (2,997 | ) |
| Deferred tax  assets, net                                                                     |       | 10,045                |       | 10,899 |   |
| Deferred tax  liabilities:                                                                    |       |                  |       |   |   |
| Property and  equipment depreciation differences (accelerated depreciation for tax  purposes) |       | (14,046               | )          | (15,593 | ) |
| Prepaid real  estate taxes                                                                    |       | (191                  | )          | (242 | ) |
| Goodwill  amortization                                                                        |       | (387                  | )          | (316 | ) |
| Net deferred tax  liability                                                                   |       | $                     | (4,579     | ) | $ | (5,252 | ) |

 

The preceding table does not include deferred taxassets of $47 and $156 at December 31, 2006 and 2005, respectively,associated with the Company’s unrealized losses/gains on investment securitiesdiscussed in Note 5, deferred tax liability of $64 and $98 at December 31,2006 and 2005, respectively, associated with the Company’s swap contract assetas discussed in Note 8, and deferred tax (liability) asset of $(325) and $114at December 31, 2006 and 2005, respectively, associated the Company’sadoption of SFAS No. 158 and additional minimum pension liability asdiscussed in Note 11.

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

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

In assessing 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 

F-27

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the twoprevious tax years to which tax loss carryback can be applied. Managementconsiders the scheduled reversal of deferred tax liabilities, projected futuretaxable income, taxable income in the carryback period and tax planningstrategies in making this assessment. Based upon the level of projected futuretaxable income over the periods in which the deferred tax assets are deductibleand tax planning strategies, a valuation allowance of $3,190 and $2,997 at December 31,2006 and 2005, 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 2006 is directly related tothe generation of additional state investment tax credit carryforwards and anet operating loss carryforward at AMRI Hungary. The amount of the deferred taxasset considered realizable could be reduced if estimates of future taxableincome during the carryforward period are reduced.

**10.**          Stockholders’Equity

During the years ended December 31,2006 and 2005, the Company recognized total share based compensation cost, netof tax, of $886 and $218, respectively.

***Employee Stock Purchase Plan***

The Company’s 1998 Employee Stock Purchase Plan (the “PurchasePlan”) was adopted during August 1998. Up to 600 shares of common stockmay be issued under the Purchase Plan, which is administered by the CompensationCommittee of the Board of Directors. The Purchase Plan establishes two stockoffering periods per calendar year, the first beginning on January 1 andending on June 30, and the second beginning on July 1 and ending December 31.All employees who work more than 20 hours per week are eligible forparticipation in the Purchase Plan. Employees who are deemed to own greaterthan 5% of the combined voting power of all classes of stock of the Company arenot eligible for participation in the Purchase Plan.

During each offering, an employee may purchase sharesunder the Purchase Plan by authorizing payroll deductions up to 10% of theircash compensation during the offering period. The maximum number of shares tobe issued to any single employee during an offering period is limited to onethousand. At the end of the offering period, the accumulated payroll deductionswill be used to purchase common stock on the last business day of the offeringperiod at a price equal to 85% of the closing price of the common stock on thefirst or last day of the offering period, whichever is lower.

Under SFAS No. 123 (R), the 15% discount and thelook-back feature are considered compensatory items for which expense must berecognized. The Company values Purchase Plan shares as a combination positionconsisting of 15% of a share of nonvested stock and 85% of a six-month stockoption. The value of the nonvested stock is estimated based on the fair marketvalue of the Company’s common stock at the beginning of the offering period.The value of the stock option is calculated using the Black-Scholes valuationmodel using historical expected volatility percentages, a risk free interestrate equal to the six-month U.S. Treasury rate at the beginning of the offeringperiod, and an expected life of six months. The resulting per-share value ismultiplied by the shares estimated to be purchased during the offering periodbased on historical experience to arrive at a total estimated compensation costfor the offering period. The estimated compensation cost is recognized on astraight-line basis over the offering period.

During the years ended December 31,2006, 2005 and 2004, 40, 41 and 48 shares, respectively, were issued under thePurchase Plan. During the years ended December 31, 2006 and 2005, cashreceived from stock option exercises and employee stock purchase plan purchaseswas $581 and $1,322, respectively. The actual tax benefit realized for the taxdeductions from stock option exercises was $34 and $416 during the years ended December 31,2006 and 2005.

F-28

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***Stock Option Plan***

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

During the year ended December 31, 2005 theCompany applied the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations, in accounting for its share-based payments.

Followingis a summary of the status of stock option programs during 2006, 2005 and 2004:

| ** **                                   | ** ** | ** **         | ** ** | ** **   | ** ** | **Weighted Average** | ** ** | ** **    | ** ** |
|----------------------------------------------|------------|--------------------|------------|--------------|------------|---------------------------|------------|---------------|------------|
| ** **                                   | ** ** | ** **         | ** ** | **Weighted** | ** ** | **Remaining**             | ** ** | **Aggregate** | ** ** |
| ** **                                   | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Contractual Term** | ** ** | **Intrinsic** | ** ** |
| ** **                                   | ** ** | **Shares**         | ** ** | **Price**    | ** ** | **(Years)**               | ** ** | **Value**     | ** ** |
| Outstanding,  January 1, 2004           |       |               | 2,854      |         |       |                      | $          | 20.10         |       |   |   |   |   |   |   |   |   |   |
| Granted                                      |       |               | 544        |         |       |                      | 14.48      |          |       |   |   |   |   |   |   |   |   |
| Exercised                                    |       |               | (200       | )            |       |                      | 6.41       |          |       |   |   |   |   |   |   |   |   |
| Forfeited                                    |       |               | (384       | )            |       |                      | 21.66      |          |       |   |   |   |   |   |   |   |   |
| Outstanding,  December 31, 2004         |       |               | 2,814      |         |       |                      | 19.76      |          |       |   |   |   |   |   |   |   |   |
| Granted                                      |       |               | 47         |         |       |                      | 13.36      |          |       |   |   |   |   |   |   |   |   |
| Exercised                                    |       |               | (221       | )            |       |                      | 3.91       |          |       |   |   |   |   |   |   |   |   |
| Forfeited                                    |       |               | (399       | )            |       |                      | 26.56      |          |       |   |   |   |   |   |   |   |   |
| Outstanding,  December 31, 2005         |       |               | 2,241      |         |       |                      | 19.99      |          |       |   |   |   |   |   |   |   |   |
| Granted                                      |       |               | 96         |         |       |                      | 10.33      |          |       |   |   |   |   |   |   |   |   |
| Exercised                                    |       |               | (73        | )            |       |                      | 1.74       |          |       |   |   |   |   |   |   |   |   |
| Forfeited                                    |       |               | (82        | )            |       |                      | 24.12      |          |       |   |   |   |   |   |   |   |   |
| Expired                                      |       |               | (11        | )            |       |                      | 1.10       |          |       |   |   |   |   |   |   |   |   |
| Outstanding, December 31, 2006          |       |               | 2,171      |         |       |                      | $          | 20.12         |       |   |   | 5.2 |   |   |   | $ | 1,301 |   |   |
| Options  exercisable, December 31, 2006 |       |               | 1,959      |         |       |                      | $          | 21.08         |       |   |   | 4.9 |   |   |   | $ | 1,262 |   |   |

 

The weighted average fair value per share of stockoptions granted during the years ended December 31, 2006, 2005 and 2004was $4.49, $6.01 and $7.57, respectively. The total intrinsic value of stockoptions exercised during the years ended December 31, 2006, 2005 and 2004was $673, $1,666 and $1,263, repectively.

As of December 31, 2006, there was $917 of totalunrecognized compensation cost related to non-vested stock options. That costis expected to be recognized over a weighted-average period of 2.3 years. Thetotal fair value of shares vested during the years ended December 31,2006, 2005 and 2004 was approximately $300, $14,800 and $7,000, respectively.

Effective December 30, 2005, pursuant to and inaccordance with the recommendation of the Compensation Committee (the “Committee”)of the Board of Directors, the Board of Directors of the Company approved fullacceleration of the vesting of each otherwise unvested stock option that had anexercise price of $15.00 or greater granted under the Company’s 1998 StockOption and Incentive Plan 

F-29

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(the “Plan”) that was heldby employees, officers, and non-employee directors. These options had exerciseprices in excess of the current market value of the Company’s common stock,based on the closing price of $12.15 per share, on December 30, 2005(i.e., such options were “underwater”). Options to purchase approximately 1.3million shares of the Company’s common stock, including approximately 101,000options held by executive officers, were subject to this acceleration.

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

The decision to accelerate the vesting of theseunderwater options was made primarily to minimize certain future compensationexpenses that the Company would otherwise recognize in its consolidatedstatements of income (loss) with respect to these options pursuant to SFASNo. 123 (R). The Companyalso believes that the acceleration may have a positive effect on employeemorale, retention and the perception of option value.

Thefollowing summarizes information about stock options outstanding as ofDecember 31, 2006:

| ** **                    | ** ** | **Outstanding Options** | ** ** | **Exercisable Options**                 | ** ** |
|-------------------------------|------------|------------------------------|------------|----------------------------------------------|------------|
| ** **                    | ** ** | ** **                   | ** ** | **  Weighted-Average  ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Range of Option** | ** ** | **Number**                   | ** ** | **Remaining**                                | ** ** | **  Weighted-Average  ** | ** ** | **Number** | ** ** | **  Weighted-Average  ** | ** ** |
| **Exercise Prices**      | ** ** | **Outstanding**              | ** ** | **Contractual Life**                    | ** ** | **Exercise Price** | ** ** | **Exercisable** | ** ** | **Exercise Price** | ** ** |
| $0.00-$6.54                   |       |                         | 144        |                                         |       |   | 0.82 |   |   |   | $ | 2.07 |   |   |   | 144 |   |   |   | $ | 2.07 |   |   |
| $6.54-$13.09                  |       |                         | 373        |                                         |       |   | 7.16 |   |   |   | 10.99 |   |   |   | 174 |   |   |   | 11.10 |   |   |
| $13.09-$19.63                 |       |                         | 708        |                                         |       |   | 6.55 |   |   |   | 15.54 |   |   |   | 694 |   |   |   | 15.56 |   |   |
| $19.63-$26.18                 |       |                         | 580        |                                         |       |   | 4.21 |   |   |   | 24.63 |   |   |   | 580 |   |   |   | 24.63 |   |   |
| $26.18-$32.72                 |       |                         | 103        |                                         |       |   | 3.92 |   |   |   | 27.92 |   |   |   | 104 |   |   |   | 27.92 |   |   |
| $32.72-$39.26                 |       |                         | 43         |                                         |       |   | 3.82 |   |   |   | 34.04 |   |   |   | 43 |   |   |   | 34.04 |   |   |
| $39.26-$45.81                 |       |                         | 198        |                                         |       |   | 4.09 |   |   |   | 43.24 |   |   |   | 198 |   |   |   | 43.24 |   |   |
| $45.81-$52.35                 |       |                         | 15         |                                         |       |   | 4.14 |   |   |   | 48.60 |   |   |   | 15 |   |   |   | 48.60 |   |   |
| $52.35-$58.89                 |       |                         | 5          |                                         |       |   | 3.87 |   |   |   | 54.84 |   |   |   | 5 |   |   |   | 54.84 |   |   |
| $58.89-$65.44                 |       |                         | 2          |                                         |       |   | 3.99 |   |   |   | 65.44 |   |   |   | 2 |   |   |   | 65.44 |   |   |
|                          |       |                         | 2,171      |                                         |       |   | 5.22 |   |   |   | $ | 20.12 |   |   |   | 1,959 |   |   |   | $ | 21.08 |   |   |

 

Thefollowing are the shares of common stock reserved for issuance atDecember 31, 2006:

| ** **                    | ** ** | **Number of  Shares** | ** ** |
|-------------------------------|------------|----------------------------|------------|
| Employee Stock  Option Plans  |       |                       | 3,353      |   |   |
| Employee Stock  Purchase Plan |       |                       | 358        |   |   |
| Shares reserved for  issuance |       |                       | 3,711      |   |   |

 

F-30

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***Restricted Stock***

The Company also issues restricted shares of commonstock to employees of the Company under the 1998 Stock Option and IncentivePlan. The shares are issued as restricted stock and are held in the custody ofthe Company until all vesting restrictions are satisfied. Shares vest underthis grant over a period of five years, with 60% vesting after three years ofcontinuous employment from the grant date and an additional 20% vesting aftereach of four and five years of continuous employment from the grant date. Ifthe vesting terms under which the award was granted are not satisfied, theshares are forfeited. Unearned compensation in equity is recorded based on the market value of the shares on thegrant date, and is amortized to expense on a straight-line basis over theapplicable vesting period. The Company reduces the straight-line compensationexpense by an estimated forfeiture rate to account for the estimated impact ofshares of restricted stock that are expected to be forfeited before becomingfully vested. This estimate is based on our historical forfeiture experienceand is currently estimated at 6%.

Asummary of unvested restricted stock activity as of December 31, 2006 and2005 and changes during the years then ended is presented below:

| ** **                           | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Grant Date  Fair Value** | ** ** |
|--------------------------------------|------------|----------------------------|------------|-------------------------------------------------------------|------------|
| Outstanding,  December 31, 2004 |       |                       | —     |                                                        |       |   | $ | — |   |   |
| Granted                              |       |                       | 288        |                                                        |       |   | 8.71 |   |   |
| Vested                               |       |                       | —     |                                                        |       |   | — |   |   |
| Forfeited                            |       |                       | (31        | )                                                           |       |   | 8.45 |   |   |
| Outstanding,  December 31, 2005 |       |                       | 257        |                                                        |       |   | 8.75 |   |   |
| Granted                              |       |                       | 194        |                                                        |       |   | 10.28 |   |   |
| Vested                               |       |                       | —     |                                                        |       |   | — |   |   |
| Forfeited                            |       |                       | (32        | )                                                           |       |   | 9.45 |   |   |
| Outstanding,  December 31, 2006 |       |                       | 419        |                                                        |       |   | $ | 9.40 |   |   |

 

For the years ended December 31,2006 and 2005, unearned compensation of $1,995 and $2,508, respectively, wasrecorded based on the market value of the shares on the grant date, and isincluded as a separate component of stockholders’ equity and amortized over theapplicable vesting period. During the years ended December 31, 2006 and2005, a total of 32 and 31 shares, respectively, with an unamortized unearnedcompensation balance of $303 and $260, respectively, had been forfeited. Theamount amortized to expense during years ended December 31, 2006 and 2005,net of the impact of forfeitures, was approximately $611 and $327, respectively.As of December 31, 2006, there was $3,002 of total unrecognizedcompensation cost related to non-vested restricted shares. That cost isexpected to be recognized over a weighted-average period of 3.75 years. Norestricted shares vested during the years ended December 31, 2006 and2005.

***Shareholder Rights Plan***

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

F-31

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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 topurchase up to 516 shares of the Company’s common stock, with exercise pricesranging from $30.24 to $35.24, to Bristol-Myers Squibb Company (“BMS”). Thewarrants expired in September, 2009. The issuance of these warrants resultedfrom a 2002 agreement whereby BMS transferred intellectual property to theCompany, providing the Company with ownership of one of BMS’s preclinical drugcandidates, along with patent applications covering attention deficithyperactivity disorder (“ADHD”) and central nervous system indications. Inconnection with the agreement, in March 2004, the Company elected toretain ownership of the technology and all improvements made to date, resultingin the issuance of the warrants to BMS. The issuance of these warrantssatisfied all equity-related obligations to BMS and resulted in the Company’sfull ownership of these preclinical drug candidates and related intellectualproperty. Such warrants, which had a value of $3,100 on the date of issuance,were charged to research and development costs, with a corresponding credit tostockholders’ equity, during the three months ended March 31, 2004.

Thevalue of warrants issued was determined using the Black-Scholes option-pricingmodel with the following assumptions:

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

 

F-32

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In October 2005,the Company entered into a License and Research Agreement (“the Agreement”)with BMS. In conjunction with the Agreement, all outstanding warrants werecancelled. The cancellation of the warrants was deemed to represent additionalup-front licensing consideration from BMS. As a result, the cancelled warrants,which had a value of $562 on the date of cancellation, were recorded asdeferred revenue, with a corresponding debit to shareholders’ equity during thequarter ended December 31, 2005. The value of the cancelled warrants willbe recognized as contract revenue in the consolidated statement of income(loss) over the three-year term of the Agreement. The value of warrantscancelled was determined using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions.

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

 

**11.**                               EmployeeBenefit Plans

***Defined Contribution Plans***

AMRI maintains a savings and profit sharing plan undersection 401(k) of the Internal Revenue Code covering all eligiblenon-union employees. Employees must complete one calendar month of service andbe over 20.5 years of age as of the plan’s entry dates. Participants maycontribute up to 100% of their compensation, subject to IRS limitations. AMRIcurrently makes matching contributions equal to 50% of the participants’contributions (up to a limit of 10% of the participants’ compensation). Inaddition, AMRI has reserved the right to make discretionary profit sharingcontributions to employee accounts. AMRI has made no discretionary profitsharing contributions. Employer matching contributions vest at a rate of 20%per year beginning after two years of participation in the plan. Employermatching contributions were approximately $1,375, $1,335 and $1,143 for theyears ended December 31, 2006, 2005 and 2004, respectively.

AMRI also sponsors asavings and profit sharing plan under section 401(k) of the InternalRevenue Code covering union employees. Employees must complete one calendarmonth of service and be over 18 years of age as of the plan’s entry dates.Participants may contribute from 1% to 100% of their regular wages, subject toIRS limitations, and AMRI matches 50% of each dollar contributed by the employeeup to 10% of their wages. Employer matching contributions vest at a rate of 20%per year beginning after two years of participation in the plan, however theemployer match under this plan does not begin until the employee completes oneyear of service. Employer matching contributions were $78, $143 and $71 for theyears ended December 31, 2006, 2005 and 2004, respectively.

***Defined Benefit and Postretirement Welfare Plan***

Organichem maintains a non-contributory definedbenefit plan (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.

Effective June 5, 2003, the Company eliminatedall benefits under the non-contributory, unfunded post-retirement welfare planfor salaried employees. Effective August 1, 2003, the Company curtailedthe salaried defined benefit pension plan. Effective March 1, 2004, the Companycurtailed the hourly defined benefit pension plan.

F-33

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In September 2006, the FASB issued SFAS No. 158,“Employers’ Accounting for Defined Benefit Pension and Other PostretirementPlans” (“SFAS No. 158”), requiring an employer to recognize the overfundedor underfunded status of its postretirement plans in the statement of financialposition and to recognize changes in that funded status in the year in whichthe changes occur. Additionally, an employer is required to measure the fundedstatus of a plan as of the end of the employer’s fiscal year. The Companyadopted SFAS No. 158 effective December 31, 2006.

Thefollowing table provides a reconciliation of the changes in the plans’ benefitobligations and fair value of the plans’ assets during the years ended December 31,2006 and 2005, 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** | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **2006**                  | ** ** | **2005**                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Change in benefit obligation:**             | ** ** | ** **                | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Benefit  obligation at January 1         |       | $                         | 21,483     |                               | $          | 20,803 |   | $ | 521 |   | $ | 462 |   |
| Service cost                                  |       | —                    |       | —                             |       | 71 |   | 63 |   |
| Interest cost                                 |       | 1,192                     |       | 1,161                              |       | 31 |   | 25 |   |
| Plan amendments                               |       | —                    |       | —                             |       | 6 |   | — |   |
| Actuarial loss  (gain)                        |       | 168                       |       | 532                                |       | 126 |   | (29 | ) |
| Benefits paid                                 |       | (1,165                    | )          | (1,013                             | )          | — |   | — |   |
| Benefit obligation at December 31        |       | 21,678                    |       | 21,483                             |       | 755 |   | 521 |   |
| **Change in plan assets:**                    | ** ** | ** **                | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of  plan assets at January 1  |       | 18,876                    |       | 17,900                             |       | — |   | — |   |
| Actual return on  plan assets                 |       | 2,593                     |       | 1,252                              |       | — |   | — |   |
| Employer  contributions                       |       | 1,015                     |       | 737                                |       | — |   | — |   |
| Benefits paid                                 |       | (1,165                    | )          | (1,013                             | )          | — |   | — |   |
| Fair value of plan assets at December 31 |       | 21,319                    |       | 18,876                             |       | — |   | — |   |
| **Funded  status**                            |       | $                         | 359        |                               | 2,607      |   | $ | 755 |   | 521 |   |
| Unrecognized net  actuarial gain (loss)       |       |                      |       | 428                                |       |   |   | (184 | ) |
| Net amount  recognized                        |       |                      |       | $                                  | 3,035      |   |   |   | $ | 337 |   |

 

The net amount recognized for pension benefits at December 31,2005, included an additional minimum pension liability of $368. The Companyincluded $254 and $(254) in other comprehensive income for the years ended December 31,2006 and 2005, respectively, which represent the respective fluctuations in theadditional minimum pension liability, net of related tax benefits.

At December 31, 2006 and 2005, 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 $21,678 and $21,483, respectively.

F-34

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

| ** **                         | ** ** | **Pension Benefits** | ** ** | **Postretirement  Benefits** | ** ** |
|------------------------------------|------------|---------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **2006**                  | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                       |       | $                         | —     |                         | $          | — |   | $ | 39 |   | $ | 71 |   |   | $ | 63 |   |   |   | $ | 34 |   |   |
| Interest cost                      |       | 1,193                     |       | 1,161                        |       | 1,169 |   | 31 |   |   | 25 |   |   |   | 16 |   |   |
| Expected return  on plan assets    |       | (1,349                    | )          | (1,230                       | )          | (1,100 | ) | — |   |   | — |   |   |   | — |   |   |
| Amortization of  net loss          |       | 53                        |       | 21                           |       | — |   | 10 |   |   | 8 |   |   |   | — |   |   |
| Net periodic benefit (income) cost |       | $                         | (103       | )                            | $          | (48 | ) | $ | 108 |   | $ | 112 |   |   | $ | 96 |   |   |   | $ | 50 |   |   |
| **Recognized  in AOCI:**           | ** ** | ** **                | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |   |   |
| Prior service  cost                |       | $                         | —     |                         |       |   |   |   | $ | 6 |   |   |   |   |   |   |   |   |   |
| Net actuarial  (gain) loss         |       | (1,189                    | )          |                         |       |   |   | 300 |   |   |   |   |   |   |   |   |   |
| Total recognized  in AOCI          |       | $                         | (1,189     | )                            |       |   |   |   | $ | 306 |   |   |   |   |   |   |   |   |   |

 

Thefollowing table represents the incremental effect of applying SFAS No. 158on individual line items in the consolidated balance sheet as of December 31,2006:        

| ** **                              | ** ** | **Before  Application of  SFAS No. 158** | ** ** | **Adjustments** | ** ** | **After  Application of  SFAS No. 158** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------|------------|-----------------|------------|--------------------------------------------------------|------------|
| Liability for  pension benefits         |       |                                                    | $          | 2,372           |       |                                                   |       | $ | (1,258 | ) |   |   | $ | 1,114 |   |   |   |
| Deferred income  taxes                  |       |                                                    | 4,531      |            |       |                                                   | 390        |   |   |   | 4,921 |   |   |   |
| Total liabilities                       |       |                                                    | 53,181     |            |       |                                                   | (868       | ) |   |   | 52,313 |   |   |   |
| Accumulated other  comprehensive income |       |                                                    | (36        | )               |       |                                                   | 868        |   |   |   | 832 |   |   |   |
| Total stockholders’  equity        |       |                                                    | 317,587    |            |       |                                                   | 868        |   |   |   | 318,455 |   |   |   |

 

Thefollowing assumptions were used to determine the periodic pension cost for thedefined benefit pension plans for the year ended December 31:

| ** **                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount rate                   |       | 5.75     | %          | 5.50     | %          | 5.75     | %          |
| Expected return  on plan assets |       | 8.00     | %          | 8.00     | %          | 8.00     | %          |
| Rate of compensation  increase  |       | N/A      |       | N/A      |       | N/A      |       |

 

The discount rate that was utilized for determiningthe Company’s fiscal 2006 pension obligation and projected fiscal 2007 netperiodic benefit cost was selected using high-quality long-term corporate bondindices as of the plan’s measurement date. The rate selected as a result ofthis process was substantiated by comparing it to the composite discount ratethat produced a liability equal to the plan’s expected benefit payment streamdiscounted using the Citigroup Pension Discount Curve (“CPDC”). The CPDC was designedto provide a means for plan sponsors to value the liabilities of theirpostretirement benefit plans. The CPDC is a yield curve of hypotheticaldouble-A zero coupon bonds with maturities up to 30 years. This curve includesadjustments to eliminate the call features of corporate bonds. As a result ofthis modeling process, the discount rate was increased from 5.50% at December 31,2005 to 5.75% at December 31, 2006.

F-35

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Thefollowing assumptions were used to determine the periodic postretirementbenefit cost for the postretirement welfare plan for the year ended December 31:

| ** **                                                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Health care cost  trend rate assumed for next year                                 |       | 9.00     | %          | 8.00     | %          | 8.00     | %          |
| Rate to which the  cost trend rate is assumed to decline (the ultimate trend rate) |       | 4.50     | %          | 4.00     | %          | 4.00     | %          |
| Year that the rate  reaches the ultimate trend rate                                |       | 2012     |       | 2010     |       | 2009     |       |

 

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

| ** **                                                                                         | ** ** | **1-Percentage-  Point Increase** | ** ** | **1-Percentage-  Point Decrease** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| Effect on total  of service and interest cost                                                      |       |                                   | $          | 30                                     |       |   |   | $ | (23 | ) |   |
| Effect on accumulated  postretirement benefit obligation for the year ended December 31, 2006 |       |                                   | $          | 218                                    |       |   |   | $ | (164 | ) |   |

 

TheCompany’s pension plan weighted-average asset allocations at December 31by asset category are as follows:

| ** **        | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| Equity securities |       |     | 60         | %        |       |   | 59 | % |   |
| Debt securities   |       |     | 33         |     |       |   | 34 |   |   |
| Real Estate       |       |     | 5          |     |       |   | 5 |   |   |
| Other             |       |     | 2          |     |       |   | 2 |   |   |
| Total             |       |     | 100        | %        |       |   | 100 | % |   |

 

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

Defined benefit 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.

The asset allocation decision includes considerationof the non-investment aspects of the Company’s defined benefit plans, includingfuture retirements, lump-sum elections, contributions, and cash flow. Theseactual characteristics of the plans place certain demands upon the level, risk,and required growth of trust assets. The Company regularly conducts analyses ofthe plans’ current and likely future financial status by forecasting assets,liabilities, benefits and contributions over time. In so doing, the impact ofalternative investment policies upon the plans’ financial status is measuredand an asset mix which balances asset returns and risk is selected.

The Company’s 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.

F-36

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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** | ** ** | **Postretirement  Benefits** | ** ** |
|-------------|------------|-----------------------|------------|------------------------------|------------|
| 2007        |       |                  | $          | 1,109                        |       |   |   | — |   |   |
| 2008        |       |                  | 1,129      |                         |       |   | — |   |   |
| 2009        |       |                  | 1,290      |                         |       |   | — |   |   |
| 2010        |       |                  | 1,416      |                         |       |   | — |   |   |
| 2011        |       |                  | 1,520      |                         |       |   | — |   |   |
| 2012 - 2016 |       |                  | 8,129      |                         |       |   | 69 |   |   |

 

The Company expects to contribute $639 to its pensionplans in 2007.

**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 asubstantial portion of its research and development laboratory facilities. Theexpiration dates on the present leases range from September 2007 to April 2015.The leases contain renewal options at the option of the Company. The Company isresponsible for paying the cost of utilities, operating costs, and increases inproperty taxes at its leased facilities.

Futureminimum lease payments under noncancelable operating leases (with initial orremaining lease terms in excess of one year) as of December 31, 2006 areas follows:

| Year ending  December 31, |   |   |   |
|--------------------------------|--------|--------|--------|
| 2007                           |   | $      | 2,007  |   |
| 2008                           |   | 1,281  |   |
| 2009                           |   | 1,281  |   |
| 2010                           |   | 1,238  |   |
| 2011                           |   | 1,256  |   |
| Thereafter                     |   | 2,104  |   |
|                                |        |        |        |  |

 

Rental expense amounted toapproximately $2,977, $2,400 and $2,300 during the years ended December 31,2006, 2005 and 2004, respectively.

**13.**          RelatedParty Transactions

***(a) 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 2006, 2005 and 2004 weawarded Technology Incentive Compensation primarily to the inventor of theterfenadine carboxylic acid metabolite technology, which is covered by theCompany’s patents relating to the active ingredient in Allegra. The inventor isThomas D’Ambra, our Chairman, President and Chief Executive Officer. Additionally,in 2006 we awarded employees involved in the development of our proprietaryamine neurotransmitter reuptake inhibitors as a result of successful licensingof this technology to BMS. The amounts awarded and included in the consolidatedstatements of income (loss) for the years ended December 31, 2006, 2005and 2004 are $2,783, $4,695 and $4,789, respectively. Included in accruedcompensation in the accompanying consolidated balance sheets at both December 31,2006 and 2005 are unpaid Technology Development Incentive Compensation awardsof approximately $623.

***(b) 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 employees atDecember 31, 2006 and 2005 totaled $162 and $284, respectively. Theamounts forgiven and charged to operations in the consolidated statements ofincome (loss) for the years ended December 31, 2006, 2005 and 2004 were$147, $185 and $91, 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 approximately $156, $194 and $169 for services rendered to the Companyin 2006, 2005 and 2004, respectively.

**14.**          LegalProceedings

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

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

In response to the filings described above, beginningin 2001, Aventis Pharmaceuticals filed patent infringement lawsuits againstBarr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, TevaPharmaceuticals, Dr. Reddy’s Laboratories, Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., and Sandoz. Each of the lawsuits was filedin the U.S. District Court in New Jersey and alleges infringement of one ormore patents owned by Aventis Pharmaceuticals. In addition, on November 14,2006, Aventis filed a patent infringement suit against Teva PharmaceuticalsUSA, Barr Laboratories, Inc. and Barr Pharmaceuticals, Inc. in theEastern District of Texas based on patents owned by Aventis. Further, beginningin March 5, 2004, AMR Technology, along with Aventis Pharmaceuticals,filed suit in the U.S. District Court in New Jersey against Barr Laboratories,Impax Laboratories, Mylan Pharmaceuticals, Teva 

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Pharmaceuticals, Dr. Reddy’sLaboratories, Amino Chemicals, Ltd., Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., DiPharma S.P.A., DiPharma Francis s.r.l., and Sandoz,asserting infringement of two of our U.S. patents that are exclusively licensedto Aventis Pharmaceuticals relating to Allegra and Allegra-D products. On December 11,2006, AMR Technology and Sanofi-Aventis U.S. LLC, an affiliate of AventisPharmaceuticals, also filed a patent infringement lawsuit in the Republic ofItaly against DiPharma Francis s.r.l. and DiPharma S.P.A. based on EuropeanPatent No. 703,902 which is owned by AMR Technology and licensed toSanofi-Aventis U.S. LLC. In addition, on December 22, 2006, AMR Technologyfiled a patent infringement lawsuit in Canada against Novopharm Ltd., TevaPharmaceutical Industries Ltd., Teva Pharmaceuticals USA, Inc., DiPharmaS.P.A. and DiPharma s.r.l. based on Canadian Patent No. 2,181,089.

Aventis Pharmaceuticals and AMR Technology haveentered into covenants not to sue the defendants other than Novopharm, DiPharmaS.P.A. and DiPharma Francis s.r.l., under U.S. Patent No. 5,578,610, whichpatent has not been asserted in the litigation but which AventisPharmaceuticals exclusively licenses from us. However, we and AventisPharmaceuticals have agreed that Aventis Pharmaceuticals will continue to payroyalties to us based on that patent under our original license agreement withAventis Pharmaceuticals. Under our arrangements with Aventis Pharmaceuticals,we will receive royalties until expiration of the underlying patents (2013 forU.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 anFDA-approved generic version of Allegra may not commence until the earlier of adecision favorable to the generic challenger in the patent litigation or 30months after the date the patent infringement lawsuit was filed. In general,the first generic filer is entitled to a 180-day marketing exclusivityperiod upon FDA approval.

On September 6, 2005, Barr Pharmaceuticals, Inc.and Teva Pharmaceuticals Industries Ltd. announced that they have entered intoan agreement for the launch of Fexofenadine Hydrochloride 30 mg, 60 mg and 180mg tablets, the generic version of Allegra tablets in the United States. Thelaunch of the generic product is considered an “at-risk” launch due to theon-going litigation. This generic launch has had a material adverse impact onU.S. sales of Allegra by Sanofi-Aventis since the fourth quarter of 2005 and inturn, the royalties earned by the Company on those sales. The launch has nothad a material impact on non-U.S. sales of Allegra to date.

On September 20, 2005, AMR Technology, along withAventis Pharmaceuticals, filed a Motion for Preliminary Injunction in the U.S.District Court in New Jersey seeking to enjoin Barr Pharmaceuticals, Inc.,Teva Pharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd.from the sale of generic versions of Allegra in the United States. On January 30,2006, the U.S. District Court denied the request by AMR Technology and AventisPharmaceuticals for a preliminary injunction. An appeal of that decision wastaken to the U.S. Court of Appeals for the Federal Circuit and, on November 8,2006, the appellate court affirmed the District Court’s denial of a preliminaryinjunction. The Federal Circuit’s decisions on the preliminary injunctionapplication is not dispositive of the merits of the claims being asserted asdescribed above.

Subsequent to the preliminary injunction proceeding inthe District Court, Dr. Reddy’s Laboratories has engaged in an at-risklaunch of generic fexofenadine products.

Should the Company beunsuccessful in defending these patents, the Company would continue toexperience a material decrease in operating cash flows and a material adverseeffect on our results of operations and financial condition.

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**15.**          EnvironmentalCosts

The Company has completed an environmental remediationassessment associated with groundwater contamination at its Rensselaer, NYlocation. Ongoing costs associated with the remediation include biannualmonitoring and reporting to the State of New York’s Department of EnvironmentalConservation. Under the remediation plan, the Company is expected to pay formonitoring and reporting until 2014. Under a 1999 agreement with the facility’sprevious owner, the Company’s maximum liability under the remediation is $5.5million. The Company assumed a liability of approximately $400 in connectionwith the acquisition of Organichem described in Note 2. For the yearsended December 31, 2006 and 2005, respectively, $0 and $256 in costs havebeen paid by the Company.

Management has estimated the future liabilityassociated with the monitoring based on enforcement rulings, market prices fromthird parties, when available, and historical cost information for similaractivities. Management’s estimates could be materially impacted in the futureby changes in legislative and enforcement rulings. While a change in estimatebased on these factors is reasonably possible in the near term, based oncurrently available data, the Company believes that current compliance with theremediation plan will not have a material adverse effect on the Company’sfinancial position, results of operations or cash flows.

At both December 31,2006 and 2005, $236 was recorded for future environmental liabilities in theconsolidated balance sheets.

**16.**          Concentrationof Business

For the year ended December 31, 2006, contractrevenue from our three largest customers represented 21%, 7% and 6%,respectively, of our contract revenue. For the year ended December 31,2005, contract revenue from our three largest customers respectivelyrepresented 37%, 6% and 4% of our contract revenue. For the year ended December 31,2004, contract revenue from our three largest customers respectivelyrepresented approximately 38%, 6% and 4% of our contract revenue. Our largestcustomer, GE Biosciences, represented 21% of total contract revenue for theyear ended December 31, 2006. In the majority of circumstances, there areagreements 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 31,** | ** ** |
|-----------------|------------|----------------------------------------|------------|
| ** **      | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| United States   |       |                                   | 66         | % |   |   | 59 | % |   |   | 61 | % |   |
| Europe          |       |                                   | 31         | % |   |   | 38 | % |   |   | 37 | % |   |
| Other countries |       |                                   | 3          | % |   |   | 3 | % |   |   | 2 | % |   |
| Total           |       |                                   | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

**17.**          BusinessSegments

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

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The Company’s managementmakes financial decisions and allocates resources based on the information itreceives from this internal system.

DDS includes activities such as drug lead discovery,optimization, drug development and small scale commercial manufacturing. LSMincludes pilot to commercial scale manufacturing of active pharmaceuticalingredients and intermediates and high potency and controlled substancemanufacturing all of which are in compliance with the Food and DrugAdministration’s (FDA) current Good Manufacturing Practices. Corporateactivities include business development and administrative functions, as wellas research and development costs that have not been allocated to the operatingsegments.

Thefollowing table summarizes information by segment for the year ended December 31,2006:

| ** **                                      | ** ** | **DDS** | ** ** | **LSM** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|---------|------------|---------|------------|-----------|------------|
| Contract revenue                                |       | $       | 75,777     |    | $          | 77,006    |       | $ | 152,783 |   |
| Recurring  royalties                            |       | 27,024  |       | —  |       | 27,024    |       |
| Total revenue                                   |       | $       | 102,801    |    | $          | 77,006    |       | $ | 179,807 |   |
| Operating income  (before unallocated expenses) |       | $       | 42,873     |    | $          | (444      | )          | $ | 42,429 |   |
| Unallocated  expenses:                          |       |    |       |    |       |      |       |
| Research and  development                       |       |    |       |    |       | 11,428    |       |
| Selling, general  and administrative            |       |    |       |    |       | 31,899    |       |
| Total unallocated expenses                      |       |    |       |    |       | 43,327    |       |
| Operating income                                |       |    |       |    |       | (898      | )          |
| Reconciling  items:                             |       |    |       |    |       |      |       |
| Interest income,  net                           |       |    |       |    |       | 2,990     |       |
| Other loss, net                                 |       |    |       |    |       | 150       |       |
| Income before  income tax expense               |       |    |       |    |       | $         | 2,242      |   |
| Supplemental  information:                      |       |    |       |    |       |      |       |
| Depreciation and  amortization                  |       | $       | 9,231      |    | $          | 6,050     |       | $ | 15,281 |   |

 

Thefollowing table summarizes other information by segment as of December 31,2006:

| ** **                                | ** ** | **DDS**                 | ** ** | **LSM** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|---------|------------|-----------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Total assets                              |       | $                       | 241,204    |    | $          | 129,564   |       | $ | 370,768 |   |
| Goodwill included  in total assets        |       | 12,751                  |       | 23,060  |       | 35,811    |       |
| Investments in  unconsolidated affiliates |       | 956                     |       | —  |       | 956       |       |
| Capital expenditures                      |       | 10,278                  |       | 6,175   |       | 16,453    |       |
|                                           |            |                         |            |         |            |           |            |  |  |  |

 

 

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

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

 

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

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

 

**18.**   FairValue of Financial Instruments

The following disclosure of the estimated fair valueof financial instruments is made in accordance with the requirements of SFAS No. 107,*Disclosures About Fair Value of FinancialInstruments*. Although the estimated fair value amounts have beendetermined by the Company using available market information and appropriatevaluation methodologies, the estimates presented are not necessarily indicativeof the amounts that the Company could realize in current market exchanges.

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

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

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

*Long-termdebt:**  *Thecarrying value of long-term debt was approximately equal to fair value at December 31,2006 and 2005 due to the resetting dates of the variable interest rates.

*Swap Contracts:**  *As discussed in Note 8, theswap contract asset is carried at fair value at December 31, 2006 and2005.

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**19.**   Goodwilland 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 No. 142, and concluded that an impairmenthad occurred and therefore recorded a $13,251 goodwill impairment charge, whichreflects a full impairment of the Bothell goodwill. In calculating the goodwillimpairment charge, the fair value of the Bothell reporting unit was determinedwith the assistance of an independent valuation firm using a discounted cashflow valuation approach. Significant assumptions used in this analysis include (i) expectedfuture revenue growth rates, reporting unit profit margins, and working capitallevels, (ii) a discount rate, and (iii) a terminal value multiple.The revenue growth rates, working capital levels and reporting unit profitmargins were based on management’s best estimate of future results.

Also during the quarter ended June 30, 2004, dueto the triggering events discussed in Notes 3, 4, and 6 above, the Companydetermined that the carrying value of its goodwill at its Mt. Prospectreporting unit may be impaired. Accordingly, the Company conducted a goodwillimpairment review as required under SFAS No. 142. The Company completedits assessment and concluded that an impairment had occurred and recorded a$1,243 goodwill impairment charge based upon a valuation of the reporting unit.The valuation was prepared with the assistance of an independent valuation firmusing a discounted cash flow approach. Significant assumptions used weresimilar to those used for the Bothell reporting unit valuation.

Thecarrying amount of goodwill, by segment, as of December 31, 2006 and 2005are as follows:

| ** **                    | ** ** | **DDS**    | ** ** | **LSM** | ** ** | **Total** | ** ** |
|-------------------------------|------------|------------|------------|---------|------------|-----------|------------|
| ***December 31,  2006*** | ** ** | ** ** |       |    |       |      |       |
| Goodwill                      |       | $          | 12,751     |    | $          | 23,060    |       | $ | 35,811 |   |
| ***December 31, 2005***  | ** ** | ** ** |       |    |       |      |       |
| Goodwill                      |       | $          | 2,687      |    | $          | 23,060    |       | $ | 25,747 |   |

 

The increase in goodwill within the DDS segment from December 31,2005 to December 31, 2006 is related to the Company’s acquisition ofComGenex described in Note 2.

***Intangible Assets***

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

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Thecomponents of intangible assets are as follows:

| ** **                    | ** ** | **Cost**   | ** ** | **Accumulated  Amortization** | ** ** | **Net**    | ** ** | **Amortization  Period** | ** ** |
|-------------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|--------------------------|------------|
| ***December 31,  2006*** | ** ** | ** ** | ** ** |                          | ** ** | ** ** |       | ** **               | ** ** |   | ** ** | ** ** |   |
| Patents and  Licensing Rights |       | $          | 3,121      |                          |       | $          | (1,020     | )                        |       | $ | 2,101 |   |   | 16 years | ** ** |   |
| ***December 31,  2005*** |       |       |       |                          |       |       |       |                     |       |   |   | ** ** |   |
| Patents and Licensing  Rights |       | $          | 1,811      |                          |       | $          | (377       | )                        |       | $ | 1,434 |   |   | 16 years | ** ** |   |

 

Amortization expense related to patents and licensingrights for the years ended December 31, 2006, 2005, and 2004 was $643,$101 and $367, respectively.

The following chart represents estimated future annualamortization expense related to intangible assets:

| Year ending  December 31, |   |   |   |
|--------------------------------|--------|--------|--------|
| 2007                           |   | $      | 613    |   |
| 2008                           |   | 176    |   |
| 2009                           |   | 137    |   |
| 2010                           |   | 137    |   |
| 2011                           |   | 137    |   |
| Thereafter                     |   | 901    |   |
|                                |        |        |        |  |

 

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

Thefollowing tables present unaudited consolidated financial data for each quarterof 2006 and 2005:

| ** **                     | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|--------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| **2006**                       | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| Contract revenue               |       | $                  | 36,188     |                | $          | 38,383             |       | $                   | 37,907     |   | $ | 40,305 |   |
| Gross profit                   |       | 5,045              |       | 5,894               |       | 5,775              |       | 7,459               |       |
| Recurring  royalties           |       | 7,178              |       | 7,200               |       | 6,333              |       | 6,313               |       |
| Income (loss)  from operations |       | 1,953              |       | (1,127              | )          | 780                |       | (2,504              | )          |
| Net income (loss)              |       | 1,894              |       | (353                | )          | 1,406              |       | (764                | )          |
| Net income (loss) per  share:  |       |               |       |                |       |               |       |                |       |
| Basic                          |       | $                  | 0.06       |                | $          | (0.01              | )          | $                   | 0.04       |   | $ | (0.02 | ) |
| Diluted                        |       | $                  | 0.06       |                | $          | (0.01              | )          | $                   | 0.04       |   | $ | (0.02 | ) |
| **2005**                       | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| Contract revenue               |       | $                  | 36,627     |                | $          | 35,948             |       | $                   | 31,550     |   | $ | 32,863 |   |
| Gross profit                   |       | 7,491              |       | 6,621               |       | 5,413              |       | 2,758               |       |
| Recurring  royalties           |       | 12,007             |       | 15,892              |       | 12,779             |       | 6,240               |       |
| Income (loss)  from operations |       | 8,356              |       | 11,045              |       | 6,514              |       | (2,371              | )          |
| Net income (loss)              |       | 5,597              |       | 7,294               |       | 4,373              |       | (943                | )          |
| Net income (loss) per  share:  |       |               |       |                |       |               |       |                |       |
| Basic                          |       | $                  | 0.18       |                | $          | 0.23               |       | $                   | 0.14       |   | $ | (0.03 | ) |
| Diluted                        |       | $                  | 0.17       |                | $          | 0.23               |       | $                   | 0.13       |   | $ | (0.03 | ) |

 

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**ALBANY MOLECULAR RESEARCH, INC.SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTSYears Ended December 31, 2006, 2005 and 2004**

| **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 |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |   |   |   |
| 2006                                        |       |       | $                                                          | 98,338     |                                             |       |                                     | $          | 197,886                                   |       |                                     |       | — |   |   |   | $ | (3,000 | ) |   | $ | 293,224 |   |
| 2005                                        |       |       | $                                                          | 205,072    |                                             |       |                                     | $          | (70,691                                   | )          |                                     |       | — |   |   |   | $ | (36,043 | ) |   | $ | 98,338 |   |
| 2004                                        |       |       | $                                                          | 309,000    |                                             |       |                                     | $          | (77,315                                   | )          |                                     |       | $ | (25,000 | ) |   |   | $ | (1,613 | ) |   | $ | 205,072 |   |
| Note receivable reserve                     |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |   |   |   |
| 2006                                        |       |       | $                                                          | —     |                                             |       |                                     | $          | —                                    |       |                                     |       | — |   |   |   | — |   |   | $ | — |   |
| 2005                                        |       |       | $                                                          | 32,277     |                                             |       |                                     | $          | (32,277                                   | )          |                                     |       | — |   |   |   | — |   |   | $ | — |   |
| 2004                                        |       |       | $                                                          | 32,277     |                                             |       |                                     | —     |                                      |       |                                     | —     |   |   |   | — |   |   | $ | 32,277 |   |
| Deferred tax asset  valuation allowance     |       |       |                                                       |       |                                             |       |                                     |       |                                      |       |                                     |       |   |   |   |   |   |   |   |
| 2006                                        |       |       | $                                                          | 2,997,335  |                                             |       |                                     | $          | 192,560                                   |       |                                     |       | — |   |   |   | — |   |   | $ | 3,189,895 |   |
| 2005                                        |       |       | $                                                          | 1,769,331  |                                             |       |                                     | $          | 1,228,004                                 |       |                                     |       | — |   |   |   | — |   |   | $ | 2,997,335 |   |
| 2004                                        |       |       | $                                                          | 1,149,211  |                                             |       |                                     | $          | 620,110                                   |       |                                     |       | — |   |   |   | — |   |   | $ | 1,769,331 |   |
|                                             |            |            |                                                            |            |                                                  |            |                                          |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-45

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