UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




FORM 10-Q




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





For the Quarterly Period Ended March 31, 2011





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




For the transition period from               to




Commission file number:  0-25323




ALBANY MOLECULAR RESEARCH, INC.


(Exact name of registrant as specified in its charter)




DELAWARE

14-1742717(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification No.)




21 Corporate Circle


PO Box 15098


Albany, New York  12212-5098


(Address of principal executive offices)




(518) 512-2000


(Registrant’s telephone number, including area code)




N/A


(Former name, former address and former fiscal year, if changed since last report)




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




Yes   x                       No   o




Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).




Yes    ̈                       No    ̈




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.




Large accelerated filer o

Accelerated filer xNon-accelerated filer o

Smaller reporting company o




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




Yes   o                       No   x




Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.




Class

Outstanding at April 30, 2011Common Stock, $.01 par value

30,311,976, excluding treasury shares of 5,411,372










ALBANY MOLECULAR RESEARCH, INC.


INDEX




Part I.

Financial Information

3Item 1.

Condensed Consolidated Financial Statements (Unaudited)

3Condensed Consolidated Statements of Operations

3Condensed Consolidated Balance Sheets

4Condensed Consolidated Statements of Cash Flows

5Notes to Condensed Consolidated Financial Statements

6Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17Item 3.

Quantitative and Qualitative Disclosures About Market Risk

24Item 4.

Controls and Procedures

24Part II.

Other Information

25Item 1.

Legal Proceedings

25Item 1A.

Risk Factors

25Item 6.

Exhibits

26Signatures



27Exhibit Index




2


PART I — FINANCIAL INFORMATION




Item 1.
Condensed Consolidated Financial Statements (Unaudited)




Albany Molecular Research, Inc.


Condensed Consolidated Statements of Operations


(unaudited)




Three Months Ended(Dollars in thousands, except for per share data)

March 31, 2011


March 31, 2010Contract revenue

$
42,931


$
38,892Recurring royalties


14,016



10,439Total revenue


56,947



49,331Cost of contract revenue


41,542



34,761Technology incentive award


1,402



1,043Research and development


2,604



2,763Selling, general and administrative


11,461



10,639Restructuring charges


951



—Arbitration charge


127



—Total operating expenses


58,087



49,206(Loss) income from operations


(1,140
)


125Interest (expense) income, net


(3
)


43Other income (loss), net


52



(88
)(Loss) income before income tax expense


(1,091
)


80Income tax expense


376



14Net (loss) income

$
(1,467
)

$
66Basic (loss) earnings per share

$
(0.05
)

$
0.00Diluted (loss) earnings per share

$
(0.05
)

$
0.00




See notes to unaudited condensed consolidated financial statements.


3


Albany Molecular Research, Inc.


Condensed Consolidated Balance Sheets


(unaudited)


(Dollars and shares in thousands, except for per share data)

March 31,

2011


December 31,

2010AssetsCurrent assets:Cash and cash equivalents - unrestricted

$
9,512


$
25,747Restricted cash


5,742



—Marketable securities


13,788



15,734Accounts receivable, net


33,302



32,766Royalty income receivable


13,213



7,416Income taxes receivable


9,711



7,638Inventory


27,995



27,102Prepaid expenses and other current assets


10,604



10,110Deferred income taxes


3,967



7,533Total current assets


127,834



134,046Property and equipment, net


162,936



163,212Goodwill


17,958



16,698Intangible assets and patents, net


3,851



3,942Equity investment in unconsolidated affiliates


956



956Deferred income taxes


2,207



596Other assets


4,349



5,656Total assets

$
320,091


$
325,106Liabilities and Stockholders’ EquityCurrent liabilities:Accounts payable and accrued expenses

$
27,593


$
28,397Arbitration reserve


5,107



9,798Deferred revenue and licensing fees


13,135



14,083Accrued pension benefits


959



884Current installments of long-term debt


4,541



1,475Total current liabilities


51,335



54,637Long-term liabilities:Long-term debt, excluding current installments


8,691



11,737Accrued long-term restructuring


1,292



1,413Deferred licensing fees


5,357



5,714Deferred rent


1,223



1,263Pension and postretirement benefits


6,262



6,408Environmental liabilities


191



191Total liabilities


74,351



81,363Commitments and contingenciesStockholders’ equity:Common stock, $0.01 par value, 100,000 shares authorized, 35,714 shares issued as of March 31 2011, and 35,667 shares issued as of December 31, 2010


357



357Additional paid-in capital


204,613



203,964Retained earnings


109,783



111,250Accumulated other comprehensive loss, net


(2,125
)


(4,940
)312,628



310,631Less, treasury shares at cost, 5,411 shares as of March 31, 2011 and December 31, 2010


(66,888
)


(66,888
)Total stockholders’ equity


245,740



243,743Total liabilities and stockholders’ equity

$
320,091


$
325,106





See notes to unaudited condensed consolidated financial statements.


4


Albany Molecular Research, Inc.


Condensed Consolidated Statements of Cash Flows


(unaudited)




Three Months Ended(Dollars in thousands)

March 31, 2011


March 31, 2010Operating activitiesNet (loss) income

$
(1,467
)

$
66Adjustments to reconcile net (loss) income to net cash used in operating activities:Depreciation and amortization


4,397



4,149Deferred income tax benefit (loss)


1,918



(162
)Loss on disposal of property, plant and equipment


3



—Stock-based compensation expense


353



549Provision for (recoveries of) bad debt


21



(66
)Write down for obsolete inventories


3



—Changes in assets and liabilities, net of effects of acquisition:Accounts receivable


(557
)


(4,453
)Royalty income receivable


(5,797
)


(2,699
)Inventory, prepaid expenses and other assets


(102
)


(348
)Accounts payable and accrued expenses


(5,615
)


(1,333
)Income tax payable


(2,073
)


(565
)Deferred revenue and licensing fees


(1,305
)


(1,346
)Pension and postretirement benefits


40



65Other long-term liabilities


(40
)


(39
)Net cash used in operating activities


(10,221
)


(6,182
)Investing activitiesPurchases of investment securities


(820
)


(1,577
)Proceeds from sales and maturities of investment securities


2,716



1,995Purchase of business, net of cash acquired


—



(18,462
)Purchase of property, plant and equipment


(2,784
)


(1,898
)Payments for patent applications and other costs


(27
)


(129
)Net cash used in investing activities


(915
)


(20,071
)Financing activitiesPrincipal payments on long-term debt


20



—Change in restricted cash


(5,742
)


—Proceeds from sale of common stock


294



254Net cash (used in) provided by financing activities


(5,428
)


254Effect of exchange rate changes on cash flows


329



249Decrease in cash and cash equivalents


(16,235
)


(25,750
)Cash and cash equivalents at beginning of period


25,747



80,953Cash and cash equivalents at end of period

$
9,512


$
55,203




See notes to unaudited condensed consolidated financial statements.


5


(All amounts in thousands, except per share amounts, unless otherwise noted)




Note 1 — Summary of Operations and Significant Accounting Policies




Nature of Business and Operations




Albany Molecular Research, Inc. (the “Company”) provides scientific services, technologies and products focused on improving the quality of life. The Company’s core business consists of a fee-for-service contract services platform encompassing drug discovery, development and manufacturing and a separate, stand-alone research and development division consisting of proprietary technology investments, internal drug discovery and niche generic active pharmaceutical ingredient product development.  With locations in the U.S., Europe, and Asia, the Company provides customers with a range of services and cost models.




Basis of Presentation




The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In accordance with Rule 10-01, the unaudited condensed consolidated financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete consolidated financial statements. The year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. generally accepted accounting principles. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair statement of the results for the interim period have been included. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.




The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated during consolidation. Assets and liabilities of non-U.S. operations are translated at period-end rates of exchange, and the statements of operations are translated at the average rates of exchange for the period. Unrealized gains or losses resulting from translating non-U.S. currency financial statements are recorded in accumulated other comprehensive (loss) income in the accompanying unaudited condensed consolidated balance sheets.




Use of Management Estimates




The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  The most significant estimates included in the accompanying consolidated financial statements include assumptions regarding the collectibility of receivables, the valuation of inventory, the fair value of goodwill, intangible assets, and long-lived assets, and the estimated fair values of net assets acquired in business combinations. Other significant estimates include assumptions utilized in determining the amount and realizabilty of deferred tax assets, assumptions utilized in determining actuarial obligations in conjunction with the Company’s pension and postretirement health plans, the estimation of restructuring charges, assumptions utilized in determining stock-based compensation, and assumptions associated with legal contingencies. Actual results can vary from these estimates.




Contract Revenue Recognition




The Company’s contract revenue consists primarily of fees earned under contracts with third-party customers and reimbursed expenses under such contracts. The Company also seeks to include provisions in certain contracts that contain a combination of up-front licensing fees, milestone and royalty payments should the Company’s proprietary technology and expertise lead to the discovery of new products that become commercial. Reimbursed expenses consist of chemicals and other project specific costs. Generally, the Company’s contracts may be terminated by the customer upon 30 days’ to one year’s prior notice, depending on the terms and/or size of the contract. The Company analyzes its agreements to determine whether the elements can be separated and accounted for individually or as a single unit of accounting in accordance with the FASB’s Accounting Standards Codification (“ASC”) 605-25, “Revenue Arrangements with Multiple Deliverables,” and Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition”. Allocation of revenue to individual elements that qualify for separate accounting is based on the estimated selling price or fair value of the respective elements.


6


The Company generates contract revenue on the following basis:




Full-time Equivalent (“FTE”). An FTE agreement establishes the number of Company employees contracted for a project or a series of projects, the duration of the contract period, the price per 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 in one month increments, but typically have terms of six months or longer. FTE contracts typically provide for annual adjustments in billing rates for the scientists assigned to the contract.




These contracts involve the Company’s scientists providing services on a “best efforts” basis on a project that may involve a research component with a timeframe or outcome that has some level of unpredictability. There are no fixed deliverables that must be met for payment as part of these services. As such, the Company recognizes revenue under FTE contracts on a monthly basis as services are performed according to the terms of the contract.




Time and Materials.  Under a time and materials contract the Company charges customers an hourly rate plus reimbursement for chemicals and other project specific costs. The Company recognizes revenue for time and material contracts based on the number of hours devoted to the project multiplied by the customer’s billing rate plus other project specific costs incurred.




Fixed-Fee. Under a fixed-fee contract the Company charges a fixed agreed upon amount for a deliverable. Fixed-fee contracts 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 is reasonably assured. In certain instances, the Company’s customers request that the Company retain materials produced upon completion of the project due to the fact that the customer does not have a qualified facility to store those materials or for other reasons.  In these instances, the revenue recognition process is considered complete when project documents (batch records, Certificates of Analysis, etc.) have been delivered to the customer and payment has been collected.




Up-Front License Fees, Milestone, and Royalty Revenue.The Company recognizes revenue from up-front non-refundable licensing fees on a straight-line basis over the period of the underlying project. The Company will recognize revenue arising from a substantive milestone payment upon the successful achievement of the event, and the resolution of any uncertainties or contingencies regarding potential collection of the related payment, or if appropriate over the remaining term of the agreement.




Recurring Royalties Revenue Recognition.Recurring royalties consist of royalties under a license agreement with sanofi-aventis based on the worldwide sales of fexofenadine HCl, marketed as Allegra in the Americas and Telfast elsewhere, as well as on sales of sanofi-aventis’ authorized generics. The Company records royalty revenue in the period in which the sales of Allegra/Telfast occur, because we can reasonably estimate such royalties. Royalty payments from sanofi-aventis are due within 45 days after each calendar quarter and are determined based on sales of Allegra/Telfast in that quarter, with the exception of Allegra D-12 which had a fixed royalty amount through July 2010.  Thereafter, the royalty rate has reverted to the rate in effect prior to the signing of the sub-license amendment and the Company will also receive a royalty on Teva Pharmaceuticals’ sales of the generic D-12.




Long-Lived Assets:




The Company assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Factors the Company considers important that could trigger an impairment review include, among others, the following:




·
a significant change in the extent or manner in which a long-lived asset is being used;




·
a significant change in the business climate that could affect the value of a long-lived asset; and




·
a significant decrease in the market value of assets.




If the Company determines that the carrying value of long-lived assets may not be recoverable, based upon the existence of one or more of the above indicators of impairment, the Company compares the carrying value of the asset group to the undiscounted cash flows expected to be generated by the asset group. If the carrying value exceeds the undiscounted cash flows an impairment charge is recorded. An impairment charge is recognized to the extent that the carrying amount of the asset group exceeds their fair value and will reduce only the carrying amounts of the long-lived assets.


7


Goodwill:




The Company performs an annualassessment of the carrying value of goodwill for potential impairment (or on an interim basis if certain triggering events occur). A determination of impairment is made based upon the fair value of the related reporting unit.  If goodwill is determined to be impaired, the Company would be required to record a charge to its results of operations. Factors the Company considers important which could result in an impairment include the following:




·
significant underperformance relative to historical or projected future operating results;




·
significant negative industry or economic trends; and




·
market capitalization relative to net book value




See Note 6 for further information on the Company’s goodwill balances.




Note 2 — Business Combination




In conjunction with the acquisitions of AMRI UK in February 2010 and AMRI Burlington in June 2010, the Company has recorded the fair value of the assets and liabilities of these entities at the time of acquisition and has allocated the respective purchase price accordingly.  The Company has finalized the purchase price allocation for these acquisitions subject to the final resolution of certain limited contingencies.  The Company resolved the contingencies related to the AMRI UK acquisition in the first quarter of 2011.  During the quarter ended March 31, 2011, the Company recognized net gains related to purchase accounting adjustments of $292 in other income (loss) net in the statement of operations.




Note 3 — Earnings Per Share




The shares used in the computation of the Company’s basic and diluted earnings per share are as follows:




Three Months Ended

March 31,2011


2010Weighted average common shares outstanding – basic


29,835



31,168Dilutive effect of restricted stock


—



167Weighted average common shares outstanding - diluted


29,835



31,335





The Company has excluded certain outstanding stock options and non-vested restricted shares from the calculation of diluted earnings per share for the three months ended March 31, 2011 because the net loss causes these outstanding stock options and non-vested restricted shares to be anti-dilutive.  The stock options and non-vested restricted shares have also been excluded from the calculation of diluted earnings per share for the three months ended March 31, 2010 because the exercise price was greater than the average market price of the Company’s common shares during that period, and as such, these options and shares would be anti-dilutive. The weighted average number of anti-dilutive options and restricted shares outstanding (before the effects of the treasury stock method) was 1,615 and 1,906 for the three months ended March 31, 2011 and 2010, respectively.




Note 4 — Inventory




Inventory consisted of the following at March 31, 2011 and December 31, 2010:




March 31,

2011


December 31,

2010Raw materials

$
4,680


$
4,575Work in process


3,135



4,382Finished goods


20,180



18,145Total

$
27,995


$
27,102




Note 5 — Restructuring




In May 2010, the Company initiated a restructuring of its AMRI U.S. locations.  As part of its strategy to increase global competitiveness and continue to be diligent in managing costs, the Company implemented cost reduction activities at its operations in the U.S.  These cost reduction activities included a reduction in the U.S. workforce, as well as the suspension of operations at one of its research laboratory facilities in Rensselaer, New York.  Employees and equipment from this facility were consolidated into other nearby Company operations.  The Company recorded a restructuring charge of $3,223 in 2010.


8


This charge includes lease termination charges of $2,182, (net of estimated sublease income), termination benefits and personnel realignment costs of $833 and facility and other costs of $208.





Additionally, in March 2011, the Company reduced its workforce to right-size its U.S. operations, primarily focused on discovery chemistry services due to the shift in demand for these types of services to the Company’s lower cost operations in Asia.  In connection with this reduction, the Company recorded a restructuring charge of $951 for termination benefits. These restructuring activities were recorded within the Company’s Discovery, Drug Development and Small Scale Manufacturing (“DDS”) operating segment.




The following table displays the restructuring activity and liability balances for  the three months ended March 31, 2011:




Balance at

January 1,

2011


Charges/

(reversals)


Paid Amounts


Foreign

Currency

Translation

Adjustments


Balance at

March 31, 2011Termination benefits and personnel realignment

$
141


$
951


$
(33
)


15


$
1,074Lease termination charges


1,932



—



(121
)


—



1,811Other


120



—



—



14



134Total

$
2,193


$
951


$
(154
)


29


$
3,019





Termination benefits and personnel realignment costs relate to severance packages, outplacement services, and career counseling for employees affected by the restructuring.  Lease termination charges relate to costs associated with exiting the facility, net of estimated sublease income.




Restructuring charges are included under the caption “Restructuring charges” in the consolidated statement of operations for the quarters ended March 31, 2011 and 2010 and the restructuring liabilities are included in “Accounts payable and accrued expenses” and “Accrued long-term restructuring” on the consolidated balance sheet at March 31, 2011 and December 31, 2010.




Anticipated cash outflow related to the restructurings for the remainder of 2011 is approximately $1,727.




Note 6 — Goodwill and Intangible Assets




The carrying amounts of goodwill, all of which is associated with the Company’s DDS operating segment, at March 31, 2011 and December 31, 2010 were $17,958 and $16,698, respectively.  The increase in goodwill within the DDS segment from December 31, 2010 to March 31, 2011 is due to the impact of foreign currency translation.




The components of intangible assets are as follows:




Cost


Accumulated

Amortization


Net

Amortization

PeriodMarch 31, 2011Patents and Licensing Rights

$
4,871


$
(1,705
)

$
3,166

2-16 yearsCustomer Relationships


815



(130
)


685

5 years$
5,686


$
(1,835
)

$
3,851December 31, 2010Patents and Licensing Rights

$
4,786


$
(1,571
)

$
3,215

2-16 yearsCustomer Relationships


815



(88
)


727

5 yearsTotal

$
5,601


$
(1,659
)

$
3,942




Amortization expense related to intangible assets was $119 and $74 for the three months ended March 31, 2011 and 2010, respectively.




9








Year  ending December 31,2011 (remaining)

$
5112012


4602013


4372014


4362015


305Thereafter


1,702Total

$
3,851




Note 7 - Defined Benefit and Postretirement Welfare Plans




AMRI Rensselaer previously provided retirement benefits under two non-contributory defined benefit plans and a non-contributory, unfunded post-retirement welfare plan. Future benefits under the defined benefit plans and for salaried participants in the post-retirement welfare plan have been frozen.




Components of Net Periodic Benefit Cost




Pension

Benefits


Postretirement

BenefitsThree Months

Ended March 31,


Three Months

Ended March 31,2011


2010


2011


2010Service cost

$
—


$
—


$
21


$
17Interest cost


290



308



17



16Expected return on plan assets


(329
)


(338
)


—



—Recognized net loss


111



59



1



2Net periodic benefit cost

$
72


$
29


$
39


$
35Recognized in Accumulated Other Comprehensive Loss (“AOCL”), pre-taxNet actuarial loss


111



59



1



2Total recognized in AOCL, pre-tax

$
111


$
59


$
1


$
2




Employer Contributions




The Company currently anticipates making $884 of contributions during 2011.




Note 8 — Share-Based Compensation




During the three months ended March 31, 2011 and 2010, the Company recognized total share based compensation cost of $353 and $549, respectively.




The Company grants share-based compensation, including restricted shares, under its 2008 Stock Option and Incentive Plan, as well as its 1998 Employee Stock Purchase Plan.





Restricted Stock




A summary of unvested restricted stock activity as of March 31, 2011 and changes during the three months then ended is presented below:




Number of

Shares


Weighted

Average Grant Date

Fair Value Per

ShareOutstanding, December 31, 2010


483


$
9.61Granted


15


$
5.24Vested


(83
)

$
10.83Forfeited


(35
)

$
9.94Outstanding, March 31, 2011


380


$
9.14




The weighted average fair value of restricted shares per share granted during the three months ended March 31, 2011 and 2010 was $5.24 and $8.90, respectively.  As of March 31, 2011, there was $2,473 of total unrecognized compensation cost related to non-vested restricted shares. That cost is expected to be recognized over a weighted-average period of 2.2 years.


10


Stock Options




The fair value of each stock option award is estimated at the date of grant using the Black-Scholes valuation model based on the following assumptions:




For the Three Months EndedMarch 31, 2011


March 31, 2010Expected life in years


5



5Risk free interest rate


2.12
%


2.42
%Volatility


56
%


46
%Dividend yield


—



—




A summary of stock option activity under the Company’s Stock Option and Incentive Plans as of March 31, 2011 and changes during the three month period then ended is presented below:




Number of

Shares


Weighted

Exercise

Price Per Share


Weighted Average

Remaining

Contractual Term

(Years)


Aggregate

Intrinsic

ValueOutstanding, December 31, 2010


1,557


$
17.43Granted


95



5.05Exercised


—



—Forfeited


(29
)


26.67Expired


(122
)


43.29Outstanding, March 31, 2011


1,501


$
14.17



4.4


$
—Options exercisable, March 31, 2011


1,159


$
16.06



3.2


$
—




The weighted average fair value of stock options granted for the three months ended March 31, 2011 and 2010 was $2.50 and $3.82, respectively.   As of March 31, 2011, there was $771 of total unrecognized compensation cost related to non-vested stock options. That cost is expected to be recognized over a weighted-average period of 2.1 years.




Employee Stock Purchase Plan




During the three months ended March 31, 2011 and 2010, 67 and 34 shares, respectively, were issued under the Company’s 1998 Employee Stock Purchase Plan.




During the three months ended March 31, 2011 and 2010, cash received from stock option exercises and employee stock purchases was $0 and $254, respectively.  The actual tax benefit realized for the tax deductions from stock option exercises and plan purchases was $0 for the three months ended March 31, 2011 and 2010.




Note 9 — Operating Segment Data




The Company has organized its sales, marketing and production activities into the DDS and Large Scale Manufacturing (“LSM”) segments based on the criteria set forth in ASC 280, “Disclosures about Segments of an Enterprise and Related Information”. The Company’s management relies on an internal management accounting system to report results of the segments. The system includes revenue and cost information by segment. The Company’s management makes financial decisions and allocates resources based on the information it receives from this internal system.




DDS includes activities such as drug lead discovery, optimization, drug development and small scale commercial manufacturing. LSM includes pilot to commercial scale manufacturing of active pharmaceutical ingredients and intermediates and high potency and controlled substance manufacturing.  Corporate activities include business development and administrative functions, as well as research and development costs that have not been allocated to the operating segments.




11








Contract

Revenue


Milestone &

Recurring

Royalty

Revenue


Income

(Loss)

from

Operations


Depreciation

and

AmortizationFor the three months ended March 31, 2011DDS

$
21,115


$
14,016


$
10,699


$
2,464LSM


21,816



—



(378
)


1,933Corporate


—



—



(11,461
)


—Total

$
42,931


$
14,016


$
(1,140
)

$
4,397For the three months ended March 31, 2010DDS

$
21,040


$
10,439


$
9,826


$
2,382LSM


17,852



—



938



1,767Corporate


—



—



(10,639
)


—Total

$
38,892


$
10,439


$
125


$
4,149




The following table summarizes other information by segment as of and for the three month period ended March 31, 2011:




DDS


LSM


TotalTotal assets

$
194,732


$
125,359


$
320,091Goodwill included in total assets


17,958



—



17,958Investments in unconsolidated affiliates


956



—



956Capital expenditures


1,716



1,068



2,784





The following table summarizes other information by segment as of and for the year ended December 31, 2010:




DDS


LSM


TotalTotal assets

$
193,386


$
131,720


$
325,106Goodwill included in total assets


16,698



—



16,698Investments in unconsolidated affiliates


956



—



956Capital expenditures


6,516



5,112



11,628




Note 10 — Financial Information by Customer Concentration and Geographic Area




Total contract revenue from DDS’s three largest customers represented approximately 12%, 9% and 7% of DDS’s total contract revenue for the three months ended March 31, 2011, and 22%, 9% and 6% of DDS’s total contract revenue for the three months ended March 31, 2010.  Total contract revenue from LSM’s largest customer, GE Healthcare (“GE”), represented 37% and 41% of LSM’s total contract revenue for the three months ended March 31, 2011 and 2010, respectively.  GE accounted for approximately 19% of the Company’s total contract revenue for the three months ended March 31, 2011 and 2010.  The DDS segment’s largest customer, a large pharmaceutical company, represented approximately 6% and 12% of the Company’s total contract revenue for the three months ended March 31, 2011 and 2010, respectively.




The Company’s total contract revenue for the three months ended March 31, 2011 and 2010 was recognized from customers in the following geographic regions:




Three Months Ended March 31,2011


2010United States


63
%


51
%Europe


25



37Asia


10



11Other


2



1Total


100
%


100
%


12


Long-lived assets by geographic region are as follows:




March 31,

2011


December 31,

2010United States

$
134,008


$
135,542Europe


12,741



11,738Asia


20,038



19,874Total long-lived assets

$
166,787


$
167,154




Note 11 — Comprehensive Income (loss)




The following table presents the components of the Company’s comprehensive income (loss) for the three months ended March 31, 2011 and 2010:




Three Months Ended March 31,2011


2010Net (loss) income

$
(1,467
)

$
66Other comprehensive loss:Change in unrealized (loss) gain on investment securities, net of taxes


1



(23
)Foreign currency translation gain (loss)


2,742



(627
)Net actuarial loss related to pension and postretirement benefits


72



61Total comprehensive income (loss)

$
1,348


$
(523
)




Note 12 — Legal Proceedings




The Company, from time to time, may be involved in various claims and legal proceedings arising in the ordinary course of business. Except as noted below, 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 the aggregate have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.




Allegra





The Company, along with Aventis Pharmaceuticals Inc., the U.S. pharmaceutical business of sanofi-aventis S.A., has been involved in legal proceedings with several companies seeking to market or which are currently marketing generic versions of Allegra and Allegra-D. In accordance with the Company’s agreements with sanofi-aventis, sanofi-aventis bears the external legal fees and expenses for these legal proceedings, but in general, the Company must consent to any settlement or other arrangement with any third party. Under those same agreements, the Company will receive royalties from sanofi-aventis on U.S. Patent No. 5,578,610 until its expiration in 2013 and royalties on U.S. Patent No. 5,750,703 until its expiration in 2015, unless those patents are earlier determined to be invalid.  Similarly, the Company is entitled to receive royalties from sanofi-aventis on certain foreign patents through 2015, unless those patents are earlier determined to be invalid.




United States Litigations





Beginning in 2001, Barr Laboratories, Inc., Impax Laboratories, Inc., Mylan Pharmaceuticals, Inc., Teva Pharmaceuticals USA, Dr. Reddy’s Laboratories, Ltd./Dr. Reddy’s Laboratories, Inc., Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc., Sandoz Inc., Sun Pharma Global, Inc., Wockhardt, and Actavis Mid Atlantic LLC, and Aurolife Pharma LLC and Aurobindo Pharma Ltd. filed Abbreviated New Drug Applications (“ANDAs”) with the Food and Drug Administration (“FDA”) to produce and market generic versions of Allegra products.





In response to the filings described above, beginning in 2001, Aventis Pharmaceuticals (now sanofi-aventis) filed patent infringement lawsuits against each of the above referenced companies.  Each of the lawsuits was filed in the U.S. District Court in New Jersey and alleges infringement of one or more patents owned by Aventis Pharmaceuticals. In addition, beginning on November 14, 2006, sanofi-aventis filed two patent infringement suits against Teva Pharmaceuticals USA, Barr Laboratories, Inc. and Barr Pharmaceuticals, Inc. in the Eastern District of Texas based on patents owned by Aventis.  Those lawsuits were transferred to the U.S. District Court in New Jersey.


13


Further, beginning on March 5, 2004, the Company, along with Aventis Pharmaceuticals, filed suit in the U.S. District Court in New Jersey against a number of defendants asserting infringement of U.S. Patent Nos. 5,581,011 and 5,750,703, which are exclusively licensed to Aventis Pharmaceuticals and relate to Allegra and Allegra-D products.  On September 9, 2009, the Company filed patent infringement lawsuits in the U.S. District Court in New Jersey against Dr. Reddy’s Laboratories, Ltd, Dr. Reddy’s Laboratories, Inc., and Sandoz, Inc. asserting infringement of U.S. Patent No. 7,390,906, seeking damages.  That patent is licensed to sanofi-aventis U.S. LLC and sanofi-aventis U.S. LLC  joined that lawsuit as a co-plaintiff with the Company.





On November 18, 2008, the Company, Aventis Pharmaceuticals, sanofi-aventis, Teva Pharmaceuticals, and Barr Laboratories reached a settlement regarding the above-described patent infringement litigations relating to Teva Pharmaceuticals and Barr Laboratories (the “Teva Settlement”).  As part of the Teva Settlement, the Company entered into an amendment to its licensing agreement with sanofi-aventis to allow sanofi-aventis to sublicense patents related to ALLEGRA®and ALLEGRA®D-12 to Teva Pharmaceuticals and Barr Laboratories in the United States.  Subsequently, Teva Pharmaceuticals acquired Barr Laboratories.  The Company received an upfront sublicense fee from sanofi-aventis of $10 million, and sanofi-aventis will pay royalties to the Company on the sale of products in the United States containing fexofenadine hydrochloride (the generic name for the active ingredient in ALLEGRA®) and products containing fexofenadine hydrochloride and pseudoephedrine hydrochloride (generic ALLEGRA®D-12) by Teva Pharmaceuticals through 2015, along with additional consideration.   The Company received quarterly royalties through July 2010 for the branded Allegra D-12 equal to the royalties paid for the quarter ended June 30, 2009.  Thereafter, the royalty rate has reverted to the rate in effect prior to the signing of the sub-license amendment and the Company will also receive a royalty on Teva’s sales of the generic Allegra D-12.  The Company and Aventis Pharmaceuticals have also dismissed their claims against Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc. and Sandoz, Inc. without prejudice. The action against Impax Laboratories, Inc. is currently under a stay while the parties discuss settlement of this case.





On March 19, 2010, the Company and sanofi-aventis filed a motion for a preliminary injunction in the U.S. District Court in New Jersey seeking to enjoin Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc. from commercial distribution of a Allegra D-24 product based in that product infringing U.S. Patent No. 7,390,906.   On June 14, 2010, the Company and sanofi-aventis were granted a preliminary injunction restraining Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc. from commercial distribution of a D-24 product.  On January 13, 2011, the same court issued a decision interpreting the scope of the claims of U.S. Patent No. 7,390,906.  Based on the court’s January 13, 2011 interpretation of the scope of a claim term in U.S. Patent No. 7,390,906, the Company does not presently have evidence sufficient to obtain a favorable outcome on its infringement claim against Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc.   As a result, the Company, along with sanofi-aventis, Dr. Reddy’s Laboratories, Ltd., and Dr. Reddy’s Laboratories, Inc., agreed to the court’s entry of an order on January 28, 2011, finding that there was no infringement of U.S. Patent No. 7,390,906 based on the Court’s January 13, 2011 claim interpretation. The court’s January 28, 2011 order also dissolved the preliminary injunction that was entered on June 14, 2010.  The Company and sanofi-aventis U.S. LLC have proceeded directly to the U.S. Court of Appeals for the Federal Circuit to appeal the January 13, 2011 decision.





The January 13, 2011, decision also included an interpretation of the scope of the claims of U.S. Patent No. 5,750,703, and based on that interpretation, the Company does not presently have evidence sufficient to obtain a favorable outcome on its infringement claim against Dr. Reddy’s Laboratories, Ltd., Dr. Reddy’s Laboratories, Inc., Mylan Pharmaceuticals, Inc., Amino Chemicals Ltd., Dipharma S.P.A., and Dipharma Francis Sr.l  As a result, the Company, along with sanofi-aventis, Dr. Reddy’s Laboratories, Ltd., Dr. Reddy’s Laboratories, Inc., Mylan Pharmaceuticals, Inc., Amino Chemicals Ltd., Dipharma S.P.A., and Dipharma Francis Sr.l  agreed to the court’s entry of an order on March 28, 2011, finding that there was no infringement of U.S. Patent No. 5,750,703 based on the Court’s January 13, 2011 claim interpretation. The Company and sanofi-aventis U.S. LLC have proceeded directly to the U.S. Court of Appeals for the Federal Circuit to appeal the January 13, 2011 decision.





International Litigations





In 2007, the Company filed  patent infringement lawsuits in Australia against Alphapharm Pty Ltd., Arrow Pharmaceuticals Pty Ltd, Chemists’ Own Pty Ltd, and Sigma Pharmaceuticals Limited based on Australian Patent No. 699,799.  These matters were heard in a consolidated trial in November and December 2010.  On February 17, 2011, the Court ruled that the defendants are not liable for infringement because the asserted claims of the Australian Patent No. 699,799 are invalid for lack of novelty and false suggestion.  An appeal has been filed with regard to the ruling in the case against Arrow.  Such an appeal is not yet due in the action against Alphapharm.Notwithstanding the court’s ruling of non-infringement, the Company continues to receive royalties on sales of the Allegra products in Australia, based on its rights under other patents.


14


At Risk Launches





Under applicable federal law, marketing of an FDA-approved generic version of Allegra may not commence until the earlier of a decision favorable to the generic challenger in the patent litigation or 30 months after the date the patent infringement lawsuit was filed. In general, the first generic filer is entitled to a 180-day marketing exclusivity period upon FDA approval.  The launch of a generic product is considered an “at-risk” launch if the launch occurs while there is still on-going litigation.  Of the remaining defendants in the pending United States litigation, Dr. Reddy’s Laboratories and Mylan Pharmaceuticals, have engaged in at-risk launches of generic fexofenadine single-entity products.





Note 13 – Fair Value




The Company uses a framework for measuring fair value in generally accepted accounting principles and making disclosures about fair value measurements.  A three-tiered fair value hierarchy has been established, which prioritizes the inputs used in measuring fair value.





These tiers include:


Level 1 – defined as quoted prices in active markets for identical instruments;


Level 2 – defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and


Level 3 – defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.





The following table presents the fair value of marketable securities by type and their determined level based on the three-tiered fair value hierarchy as of March 31, 2011:





Fair Value Measurements as of March 31, 2011Marketable Securities

Total


Level 1


Level 2


Level 3Obligations of states and political subdivisions

$
11,688


$
—


$
11,688


$
—Auction rate securities


2,100



—



2,100



—Total

$
13,788


$
—


$
13,788


$
—





The Company’s marketable securities are fixed maturity securities and are valued using pricing for similar securities, recently executed transactions, cash flow models with yield curves, broker/dealer quotes and other pricing models utilizing observable inputs. The valuation for the Company’s fixed maturity securities is classified as Level 2.





The Company determines its fair value of financial instruments using the following methods and assumptions:





Cash and cash equivalents, receivables, and accounts payable:The carrying amounts reported in the consolidated balance sheets approximate their fair value because of the short maturities of these instruments.




Investment securities: Investment securities’ fair values are based on quoted market prices of comparable instruments.  When necessary, the Company utilizes matrix pricing from a third party pricing vendor to determine fair value pricing.  Matrix prices are based on quoted prices for securities with similar coupons, ratings, and maturities, rather than on specific bids and offers for the designated security.




Long-term debt:The carrying value of long-term debt was approximately equal to fair value at March 31, 2011 and December 31, 2010 due to the resetting dates of the variable interest rates.


15




Note 14 – Long-term Debt & Restricted Cash





Long-Term Debt:





We currently have a revolving line of credit in the amount of $45,000 which has a maturity date in June 2013.  The line of credit bears interest at a variable rate based on our Company’s leverage ratio.  As of March 31, 2011, the balance outstanding on the line of credit was $9,662, bearing interest at a rate of 1.5%.  The credit facility contains certain financial covenants, including a maximum leverage ratio, a minimum required operating cash flow coverage ratio, a minimum earnings before interest, taxes, depreciation and amortization and a minimum current ratio.  Other covenants include limits on asset disposals and the payment of dividends.  As of December 31, 2010, the Company was not in compliance with the current financial covenant requirements, however, the Company received a waiver from our lenders through May 16, 2011 while the agreement is renegotiated.  The Company intends to amend its existing credit facility to provide for a revolving line of credit that will mature in May 2012. The Company intends to repay $2,662 of the balance outstanding on the line of credit and to refinance the remaining $7,000 under the current line of credit into a term loan with quarterly repayments of $400 and the balance due and payable in May 2012.  Additionally, in connection with such waivers, the Company provided security to the bank group in the form of a security interest in substantially all of the Company’s United States assets.





The Company maintains variable interest rate industrial development authority bonds due in increasing annual installments through 2021. Interest payments are due monthly with a current interest rate of 0.50% at March 31, 2011.




The following table summarizes long-term debt:




March 31,

2011

December 31,

2010Revolving line of credit

$
9,662


$
9,662Industrial development authority bonds


3,550



3,550Miscellaneous loan


20



—13,232



13,212Less current portion


(4,541
)


(1,475
)Total long-term debt

$
8,691


$
11,737




The aggregate maturities of long-term debt at December 31, 2010 are as follows:




2011

$
4,1412012


6,0892013


2992014


3092015


314Thereafter


2,080Total

$
13,232





Restricted Cash:





On March 2, 2011, the Company and one of its suppliers entered into a Settlement and Supply agreement (“Agreement”) which served to settle the arbitral award and other legal proceedings related to an arbitral award that was pending.  The Agreement required the Company to pay $4,817 to our supplier and provide a cash collateralized letter of credit to secure the remainder of the arbitral award plus accrued interest. The letter of credit will reduce quarterly based on certain volume purchase milestones.  The Agreement also re-establishes the supply relationship between AMRI and our supplier through 2018.





The cash collateral pledged to support the letter of credit has been categorized as restricted cash on the Company’s statement of financial position at March 31, 2011.  The Company expects that the full amount of the cash collateral will be released upon the completion of the renegotiation of the credit agreement with its lender during the second quarter of 2011.


16





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




Forward-Looking Statements




The following discussion of our results of operations and financial condition should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and the Notes thereto included within this report. This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements may be identified by forward-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 pension and postretirement benefit costs, the Company’s relationship with its largest customers, the Company’s collaboration with Bristol-Myers Squibb (“BMS”), future acquisitions, earnings, contract revenues, costs and margins, royalty revenues, patent protection and the ongoing Allegra® patent infringement litigation, Allegra® royalty revenue, government regulation, retention and recruitment of employees, customer spending and business trends, foreign operations, including increasing options and solutions for customers, business growth and the expansion of the Company’s global market, clinical supply manufacturing, management’s strategic plans, drug discovery, product commercialization, license arrangements, research and development projects and expenses, revenue and expense expectations for future periods, goodwill and long-lived asset impairment, competition and tax rates. The Company’s actual results may differ materially from such forward-looking statements as a result of numerous factors, some of which the Company may not be able to predict and may not be within the Company’s control. Factors that could cause such differences include, but are not limited to, those discussed in Part I, Item 1A, “Risk Factors”, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission on March 16, 2011, as updated by Part II Item 1A, “Risk Factors,” in subsequent Forms 10-Q.  All forward-looking statements are made as of the date of this report, and we do not undertake to update any such forward-looking statements in the future, except as required by law. References to “AMRI”, the “Company,” “we,” “us,” and “our,” refer to Albany Molecular Research, Inc. and its subsidiaries, taken as a whole.




Strategy and Overview




We provide contract services to many of the world’s leading pharmaceutical and biotechnology companies. We derive our contract revenue from research and development expenditures and commercial manufacturing demands of the pharmaceutical and biotechnology industry.  We continue to execute our long-term strategy to develop and grow an integrated global platform from which we can provide these services.  We have research and/or manufacturing facilities in the United States, Hungary, Singapore, India and the United Kingdom.  Most recently, in February 2010, we acquired Excelsyn Ltd. (“AMRI UK”), which we believe is a well recognized leader in providing chemical development and manufacturing services to the pharmaceutical industry in Europe.  In June 2010, we acquired Hyaluron, Inc. (“AMRI Burlington”), a formulation company whose capabilities include cGMP manufacturing and sterile filling of parenteral drugs.  AMRI Burlington provides high value-added contract manufacturing services in sterile syringe and vial filling using specialized technologies.  AMRI Burlington provides these services for both small molecule drug products and biologicals, from clinical phase to commercial scale.




We have organized our activities into two distinct segments: Large Scale Manufacturing (“LSM”) and Discovery, Drug Development and Small Scale Manufacturing (“DDS”).  Our LSM activities include pilot to commercial scale production of active pharmaceutical ingredients and intermediates, sterile syringe and vial filling, and high potency and controlled substance manufacturing and our remaining activities, including drug lead discovery, optimization, drug development, and small scale commercial manufacturing represent our DDS business segment.





We continue to integrate our research and manufacturing facilities worldwide, increasing our access to key global markets and enabling us to provide our customers with a flexible combination of high quality services and competitive cost structures to meet their individual outsourcing needs.  We seek comprehensive research and/or supply agreements with our customers, incorporating several of our service offerings and spanning across the entire pharmaceutical research and development process.  Our research facilities provide discovery, chemical development, analytical, and small-scale current Good Manufacturing Practices (“cGMP”) manufacturing services.  Compounds discovered and/or developed in our research facilities can then be more easily transitioned to production at our large-scale manufacturing facilities for use in clinical trials and, ultimately, commercial sales if the product meets regulatory approval.  Additionally, the acquisition of AMRI Burlington provides our Company with entry into a new and strategically important product offering.  We offer customers a fully integrated manufacturing process for sterile injectable drugs including the development and manufacture of the active pharmaceutical ingredient (“API”), the design of the criteria to formulate the API into an injectable drug product, and the manufacture of the final drug product.


17


We believe that the ability to partner with a single provider of pharmaceutical research and development services from discovery through commercial production is of significant benefit to our customers.  Through our comprehensive service offerings, we are able to provide customers with a more efficient transition of experimental compounds through the research and development process, ultimately reducing the time and cost involved in bringing these compounds from concept to market.




Our global platform has increased our market penetration and was developed in order to allow us to maintain and grow margins.  In addition to our globalization, we continue to implement process efficiencies, including our continued efforts of process improvement and cost savings measures, along with efforts to strengthen our sourcing.  We believe these factors will lead to improved margins.




We conduct proprietary research and development to discover new therapeutically active lead compounds with commercial potential. We anticipate that we would then license these compounds and underlying technology to third parties in return for up-front and service fees and milestone payments, as well as recurring royalty payments if these compounds are developed into new commercial drugs.




Our total revenue for the three months ended March 31, 2011 was $56.9 million, as compared to $49.3 million for the three months ended March 31, 2010.




Contract services revenue for the first quarter of 2011 was $42.9 million, compared to $38.9 million for the three months ended March 31, 2010.  Recurring royalty revenues, which are based on the worldwide sales of fexofenadine HCl, marketed as Allegra in the Americas and Telfast elsewhere, as well as on sales of sanofi-aventis’ over-the-counter product, authorized generics and estimates of sales of Teva’s authorized generics, increased $3.6 million in the first quarter of 2011 from the first quarter of 2010.  Consolidated gross margin was 3.2% for the three months ended March 31, 2011 as compared to 10.6% for the three months ended March 31, 2010.




During the three months ended March 31, 2011, cash used by operations was $10.2 million.  The decrease of $4.0 million in cash flow from operations from the three months ended March 31, 2010 resulted primarily from a payment of $4.8 million associated with the Company’s settlement of the 2010 arbitration matter with a supplier.  We spent $2.8 million in capital expenditures, primarily related to modernization of our lab and production equipment.  As of March 31, 2011, we had $29.0 million in cash, cash equivalents and investments and $13.2 million in bank and other related debt.





Results of Operations – Three Months ended March 31, 2011 Compared to Three Months Ended March 31, 2010




Revenues




Total contract revenue




Contract revenue consists primarily of fees earned under contracts with our third party customers.  Our contract revenues for each of our Discovery/Development/Small Scale Manufacturing(“DDS”) and Large-Scale Manufacturing (“LSM”) segments were as follows:




Three Months Ended March 31,(in thousands)

2011


2010DDS

$
21,115


$
21,040LSM


21,816



17,852Total

$
42,931


$
38,892





DDS contract revenues for the three months ended March 31, 2011 remained flat from the same period in 2010.  Contract revenue from development and small-scale manufacturing services increased $2.0 million, offset in part by a decrease of $1.9 million in contract revenue from discovery services due to higher demand for these services at our international locations, including an increased demand for our in vitro biology services worldwide and a decrease in demand for our U.S. medicinal chemistry services.





We currently expect DDS contract revenue for the full year of 2011 to increase from amounts recognized in 2010 primarily due to an increase in demand for our global development services, as well as an increase in demand for discovery services at our Asia locations, partially offset by a continued decrease from our U.S. discovery services.





LSM revenue for the three months ended March 31, 2011 increased $4.0 million from the same period in 2010 primarily due to an increase of $2.5 million caused by higher demand for clinical manufacturing services along with incremental revenues from the AMRI UK and AMRI Burlington acquisitions taking place in February and June of 2010, respectively.


18


We expect LSM contract revenue for the full year of 2011 to significantly increase over amounts recognized in 2010.




Recurring royalty revenue




We earn royalties under our licensing agreement with sanofi-aventis S.A. for the active ingredient in Allegra.  Royalties were as follows:




Three Months Ended March 31,2011


2010(in thousands)$
14,016


$
10,439





Recurring royalties, which are based on the worldwide sales of Allegra®/Telfast, as well as on sales of sanofi-aventis’ authorized generics, increased $3.6 million for the three months ended March 31, 2011 from the same period in 2010 primarily due to an increase in sales of prescription Allegra® in Japan, as well as the addition of royalties recognized from the strong launch of the over-the-counter product line in the U.S.




The recurring royalties we receive on the sales of Allegra®/Telfast have historically provided a material portion of our revenues, earnings and operating cash flows.  We continue to develop our business in an effort to supplement the revenues, earnings and operating cash flows that have historically been provided by Allegra®/Telfast royalties.





Costs and Expenses




Cost of contract revenue




Cost of contract revenue consists primarily of compensation and associated fringe benefits for employees, as well as chemicals, depreciation and other indirect project related costs. Cost of contract revenue for our DDS and LSM segments were as follows:




Three Months Ended March 31,Segment

2011


2010(in thousands)DDS

$
19,735


$
17,981LSM


21,807



16,780Total

$
41,542


$
34,761DDS Gross Margin


6.4
%


14.6
%LSM Gross Margin


0.0
%


6.0
%Total Gross Margin


3.2
%


10.6
%




DDS had a contract revenue gross margin of 6.4% for the three months ended March 31, 2011 compared to contract revenue gross margin of 14.6% for the same period in 2010.  The decrease in gross margin resulted from lower demand for our U.S. medicinal chemistry services in relation to our fixed costs, partially offset by improved global development margins.




We currently expect DDS contract margins for the full year of 2011 to approximate percentages recognized for the full year of 2010 primarily due to cost savings associated with the restructuring that occurred in March 2011.




LSM’s contract revenue gross margin decreased to 0% for the three months ended March 31, 2011 compared to 6.0% for the same period in 2010.  This decrease is primarily due to lower revenues at our Burlington facility in relation to its fixed cost base due to the pending resolution of its FDA warning letter, along with unutilized capacity at our AMRI UK facility, partially offset by an increase in margins for our U.S. API manufacturing services.




We expect gross margins in the LSM segment for the full year of 2011 to significantly improve over percentages recognized for the full year of 2010.





Technology incentive award




We maintain a Technology Development Incentive Plan, the purpose of which is to stimulate and encourage novel innovative technology developments by our employees.  This plan allows eligible participants to share in a percentage of the net revenue earned by us relating to patented technology with respect to which the eligible participant is named as an inventor or made a significant intellectual contribution. To date, the royalties from Allegra® are the main driver of the awards.  Accordingly, as the creator of the technology, the award is currently payable primarily to Dr. Thomas D’Ambra, the Chief Executive Officer and President of the Company.


19








Three Months Ended March 31,2011


2010(in thousands)$
1,402


$
1,043




The increase in technology incentive award expense for the three months ended March 31, 2011 from the same period ended March 31, 2010 is due to the increase in Allegra royalty revenue.  We expect technology incentive award expense to generally fluctuate directionally and proportionately with fluctuations in Allegra royalties in future periods.




Research and development




Research and development (“R&D”) expense consists of compensation and benefits for scientific personnel for work performed on proprietary technology R&D projects, costs of chemicals, materials, outsourced activities and other out of pocket costs and overhead costs. We utilize our expertise in integrated drug discovery to perform our internal R&D projects. The goal 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 a combination of up-front license fees, milestone payments and recurring royalty payments if these compounds are successfully developed into new drugs and reach the market. In addition, R&D is performed at our large-scale manufacturing facility related to the potential manufacture of new products, the development of processes for the manufacture of generic products with commercial potential, and the development of alternative manufacturing processes.  Research and development expenses were as follows:




Three Months Ended March 31,2011


2010(in thousands)$
2,604


$
2,763




R&D expense decreased $0.2 million for the three months ended March 31, 2011 from the same period in 2010.  This decrease is primarily due to an overall decrease in internal operating costs as we strategically manage our R&D investments and continue to narrow the focus of R&D spending on only the most advanced development programs, partially offset by an increase in clinical trial costs related to our obesity program.




We currently expect research and development expenses for the full year of 2011 to decrease from amounts recognized in 2010 as we manage our R&D investments.




Projecting completion dates and anticipated revenue from our internal research programs is not practical at this time due to the early stages of the projects and the inherent risks related to the development of new drugs. Our proprietary amine neurotransmitter reuptake inhibitor program, which was our most advanced project at that time, was licensed to BMS in October 2005 in exchange for up-front license fees, contracted research services, and the rights to future milestone and royalty payments.  We also continue to utilize our proprietary technologies to further advance other early to middle-stage internal research programs in the fields of oncology, irritable bowel syndrome, obesity, and CNS, with a view to seeking a licensing partner for these programs at an appropriate research or developmental stage.




We budget and monitor our R&D expenses by type or category, rather than by project on a comprehensive or fully allocated basis. In addition, our R&D expenses are not tracked by project as they often benefit multiple projects in our technology platform. Consequently, fully loaded R&D expense summaries by project are not available.


20


Selling, general and administrative




Selling, general and administrative (“SG&A”) expenses consist of compensation and related fringe benefits for selling, marketing, operational and administrative employees, professional service fees, marketing costs and costs related to facilities and information services.  SG&A expenses were as follows:




Three Months Ended March 31,2011


2010(in thousands)$
11,461


$
10,639





SG&A expenses for the three months ended March 31, 2011 increased $0.8 million from the same quarter of 2010.  This increase is primarily attributable to AMRI Burlington’s remediation charges along with incremental SG&A costs from AMRI Burlington, which was acquired in June 2010.  These increases were offset in part by cost savings from the reorganization of our U.S. locations in May 2010.




SG&A expenses for 2011 are expected to remain flat from amounts recognized in 2010 as one time acquisition charges and AMRI Burlington remediation costs are reduced, offset by run rate impact from the 2010 acquisitions as well as some investment in global capabilities on both sales and IT fronts.




Restructuring.




In May 2010, we initiated a restructuring of our AMRI U.S. locations.  As part of our strategy to increase global competitiveness and continue to be diligent in managing costs, we implemented cost reduction activities at our operations in the U.S.  These cost reduction activities included a reduction in the U.S. workforce, as well as the suspension of operations at one of our research laboratory facilities in Rensselaer, New York.  Employees and equipment from this facility were consolidated into other nearby Company operations.  We recorded a restructuring charge of $3.2 million in 2010.  This charge includes lease termination charges of $2.2 million (net of estimated sublease income), termination benefits and personnel realignment costs of $0.8 million and facility and other costs of $0.2 million.  This restructuring activity was recorded within our DDS operating segment.





Additionally, in March 2011, we reduced our workforce to right-size our U.S. operations, primarily focused on discovery chemistry services due to the shift in demand for these types of services from our lower cost operations in Asia.  In connection with this reduction, we recorded a restructuring charge of $1.0 million for termination benefits. These restructuring activities were recorded within our DDS operating segment.




The following table displays the restructuring activity and liability balances for the three months ended March 31, 2011:




Balance at

January 1,

2011


Charges/

(reversals)


Paid Amounts


Foreign

Currency

Translation

Adjustments


Balance at

March 31, 2011Termination benefits and personnel realignment

$
141


$
951


$
(33
)


15


$
1,074Lease termination charges


1,932



—



(121
)


—



1,811Other


120



—



—



14



134Total

$
2,193


$
951


$
(154
)


29


$
3,019





Termination benefits and personnel realignment costs relate to severance packages, outplacement services, and career counseling for employees affected by the restructuring.  Lease termination charges relate to costs associated with exiting the facility, net of estimated sublease income.




Restructuring charges are included under the caption “Restructuring charges” in the consolidated statement of operations for the quarters ended March 31, 2011 and 2010 and the restructuring liabilities are included in “Accounts payable and accrued expenses” and “Accrued long-term restructuring” on the consolidated balance sheet at March 31, 2011 and December 31, 2010.




Anticipated cash outflow related to the restructurings for the remainder of 2011 is approximately $1.7 million.


21


Interest (expense) income, net




Three Months Ended March 31,(in thousands)

2011


2010Interest expense

$
(55
)

$
(36
)Interest income


52



79Interest (expense) income, net

$
(3
)

$
43





Net interest expense increased for the three months ended March 31, 2011 from net interest income for the same period in 2010 due to increased interest rates on our interest bearing liabilities, offset in part by a decrease in balances of interest bearing assets.




Other income (loss), net




Three Months Ended March 31,2011


2010(in thousands)$
52


$
(88
)




Other income for the three months ended March 31, 2011 consisted of income from purchase accounting adjustments of $0.3 million related to the 2010 AMRI UK and AMRI Burlington acquisitions, partially offset by expense primarily due to changes in rates associated with foreign currency transactions.




Income tax expense




Three Months Ended March 31,2011


2010(in thousands)$
376


$
14




Income tax expense increased for the three months ended March 31, 2011 due primarily to changes in the composition of taxable income in relation to the applicable tax rates at our various international locations, as well as the recognition of certain discrete tax expense items.


22


Liquidity and Capital Resources




We have historically funded our business through operating cash flows and proceeds from borrowings. During the first three months of 2011, we used cash of $10.2 million in operating activities. The use of cash from operating activities resulted primarily from a payment of $4.8 million associated with the Company’s settlement of the 2010 arbitration matter with a supplier andincreases in royalties receivable due to timing of cash collections.




During the first three months of 2011, we used $0.9 million in investing activities, resulting primarily from the use of $2.8 million for the acquisition of property and equipment, offset in part by net proceeds from the sale or maturities of marketable securities of $1.9 million.  During the first three months of 2011, we used $5.4 million in financing activities, relating primarily to the pledging of $5.7 million as collateral for the letter of credit securing the remainder of an arbitration award that was settled in March 2011.  The Company expects that the full amount of the cash collateral will be released upon the completion of the renegotiation of the credit agreement with its lender during the second quarter of 2011.





Working capital was $76.5 million at March 31, 2011 as compared to $79.4 million as of December 31, 2010.




We currently have a revolving line of credit in the amount of $45.0 million which has a maturity date in June 2013.  The line of credit bears interest at a variable rate based on our Company’s leverage ratio. As of March 31, 2011, the balance outstanding on the line of credit was $9.7 million, bearing interest at a rate of 1.50%.  The credit facility contains certain financial covenants, including a maximum leverage ratio, a minimum required operating cash flow coverage ratio, a minimum earnings before interest, taxes, depreciation and amortization and a minimum current ratio, as amended.  Other covenants include limits on asset disposals and the payment of dividends.  As of December 31, 2010, we were not in compliance with our financial covenants requirements, however, we received a waiver from our lender through May 16, 2011 while we renegotiate our credit agreement.  We intend to amend our existing credit facility to provide for a revolving line of credit that will mature in May 2012. We intend to repay $2.7 million of the balance outstanding on the line of credit and to refinance the remaining $7.0 million under the current line of credit into a term loan with quarterly repayments of $0.4 million and the balance due and payable in May 2012.  Effective April 15, 2011, the interest rate on the existing amounts outstanding increased from LIBOR plus 0.75% to LIBOR plus 3.75%.Additionally, in connection with such waivers, we provided security to the bank group in the form of a security interest in substantially all of our United States assets.




The disclosure of payments we have committed to make under our contractual obligations is set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” under Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.  There have been no material changes to our contractual obligations since December 31, 2010.  As of March 31, 2011, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the Securities and Exchange Commission’s Regulation S-K.




We continue to pursue the expansion of our operations through internal growth and strategic acquisitions.  We expect that additional expansion activities will be funded from existing cash and cash equivalents, cash flow from operations and/or the issuance of debt or equity securities and borrowings.  Future acquisitions, if any, could be funded with cash on hand, cash from operations, borrowings under our credit facility and/or the issuance of equity or debt securities.  There can be no assurance that attractive acquisition opportunities will be available to us or will be available at prices and upon such other terms that are attractive to us.  We regularly evaluate potential acquisitions of other businesses, products and product lines and may hold discussions regarding such potential acquisitions.  As a general rule, we will publicly announce such acquisitions only after a definitive agreement has been signed.  In addition, in order to meet our long-term liquidity needs or consummate future acquisitions, we may incur additional indebtedness or issue additional equity or debt securities, subject to market and other conditions.  There can be no assurance that such additional financing will be available on terms acceptable to us or at all.  The failure to raise the funds necessary to finance our future cash requirements or consummate future acquisitions could adversely affect our ability to pursue our strategy and could negatively affect our operations in future periods.




Critical Accounting Policies and Estimates




Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventories, goodwill, long-lived assets, pension and postretirement benefit plans, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.


23


We refer to the policies and estimates set forth in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.  There have been no material changes or modifications to the policies since December 31, 2010.




Item 3. Quantitative and Qualitative Disclosures about Market Risk




There have been no material changes with respect to the information on Quantitative and Qualitative Disclosures about Market Risk appearing in Part II, Item 7A to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.




Item 4. Controls and Procedures




a)  Disclosure Controls and Procedures




As required by rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the Company’s last fiscal quarter our management conducted an evaluation with the participation of our Chief Executive Officer and Chief Financial Officer regarding the effectiveness of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management was required to apply its judgment in evaluating and implementing possible controls and procedures. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, the Company’s disclosure controls and procedures were not effective as of March 31, 2011 due to material weaknesses in financial reporting with respect to our accounting for income taxes as described in the Company’s Annual Report on Form 10-K for the period ended December 31, 2010.  We intend to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.





b) Changes in Internal Control Over Financial Reporting




There were no changes, other than those in conjunction with certain remediation efforts described below, in the Company’s internal control over financial reporting during the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.





c)  Remediation Efforts





We have implemented, or plan to implement, certain measures to remediate the material weakness relating to the Company’s income tax accounting identified in the Company’s 2010 Annual Report on Form 10-K.  As of the date of the filing of this Quarterly Report on Form 10-Q, the Company has implemented or is in the process of implementing the following measures:





·
engaged external tax experts to support the Company’s financial closing and reporting process;


·
improved documentation and instituted more formalized review of tax positions, with senior management and external advisors, to ensure proper evaluation and accounting treatment of complex tax issues; and


·
continued to evaluate and, if necessary, supplement the resources provided by our external advisors.





We believe that these remediation actions represent ongoing improvement measures and we plan to enhance our plans in  the remaining quarters of 2011.  Furthermore, while we have taken steps to remediate the material weakness, these steps may not be adequate to fully remediate this weakness, and additional measures may be required.   The effectiveness of our remediation efforts will not be known until we can test those controls in connection with management’s evaluation of internal controls over financial reporting that we will perform as of December 31, 2011.


24


PART II - OTHER INFORMATION




Item 1. Legal Proceedings




The Company, along with Aventis Pharmaceuticals Inc., the U.S. pharmaceutical business of sanofi-aventis S.A., has been involved in legal proceedings with several companies seeking to market or which are currently marketing generic versions of Allegra and Allegra-D. In accordance with the Company’s agreements with sanofi-aventis, sanofi-aventis bears the external legal fees and expenses for these legal proceedings, but in general, the Company must consent to any settlement or other arrangement with any third party. Under those same agreements, the Company will receive royalties from sanofi-aventis on U.S. Patent No. 5,578,610 until its expiration in 2013 and royalties on U.S. Patent No. 5,750,703 until its expiration in 2015, unless those patents are earlier determined to be invalid.  Similarly, the Company is entitled to receive royalties from sanofi-aventis on certain foreign patents through 2015, unless those patents are earlier determined to be invalid.




Please refer to Part 1 – Note 12 for further details and history on these litigations.




Item 1A. Risk Factors




If we fail to meet our credit facility’s financial covenants, our business and financial condition could be adversely affected.





We currently have a revolving line of credit in the amount of $45 million which has a maturity date of June 2013.  The credit facility contains certain financial covenants, including but not limited to, a maximum leverage ratio, a minimum required operating cash flow coverage ratio, a minimum earnings before interest, taxes, depreciation and amortization and a minimum current ratio.  As of March 31, 2011 our balance outstanding on the line of credit was $9.7 million.  As of December 31, 2010, we were not in compliance with our financial covenant requirements, however, we received a waiver from our lenders through May 16, 2011 while we renegotiate our agreement. We intend to amend our existing credit facility to provide for a revolving line of credit that will mature in May 2012. We intend to repay $2.7 million of the balance outstanding on the line of credit and to refinance the remaining $7.0 million under the current line of credit into a term loan with quarterly repayments of $0.4 million and the balance due and payable in May 2012.  Additionally, in connection with such waivers, we provided security to the bank group in the form of a security interest in substantially all of our United States assets.  In addition, effective April 15, 2011, the interest rate on the existing amounts outstanding increased from LIBOR plus 0.75% to LIBOR plus 3.75%.




There is no assurance that we will be able to renegotiate our credit agreement with our lenders or receive further waivers of covenant noncompliance from the lenders.  If at any point, we fail to meet our credit facility’s financial covenants, the lenders can demand immediate repayment of our outstanding balance and deny future borrowings under the remaining line of credit.  This could have a negative impact on our liquidity, thereby reducing the availability of cash flow for other purposes.


25


Item 6.   Exhibits




ExhibitNumber

Description10.1

Amended and Restated Limited Waiver and Agreement, made as of April 15, 2011, by and among Albany Molecular Research, Inc. AMRI Rensselaer, Inc., AMRI Bothell Research Center, Inc., AMRI Burlington, Inc., certain Lenders as defined therein and Bank of America, N.A. as administrative agent for the Lenders.31.1

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.31.2

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.32.1

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


26


SIGNATURES




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




ALBANY MOLECULAR RESEARCH, INC.Date: May 10, 2011
By:
/s/ Mark T. FrostMark T. FrostSenior Vice President, Administration, Chief Financial Officer

and Treasurer

(Duly Authorized Officer and Principal Financial Officer)




27