**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

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

 
| **For the Quarterly Period Ended March 31, 2006** |
|---------------------------------------------------|

 
| **o**                                                                                                                      | ** ** | **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**

 

**ALBANYMOLECULAR RESEARCH, INC.**

(Exact name of registrant as specified inits charter)

 

| **DELAWARE**                     | ** ** | **14-1742717**      |
|----------------------------------|------------|---------------------|
| (State or other jurisdiction  of |       | (I.R.S. Employer    |
| incorporation or  organization)  |       | Identification No.) |

 

**21Corporate CirclePO Box 15098Albany, New York  12212-5098**

(Address of principal executiveoffices)

 

**(518)464-0279**

(Registrant’s telephone number,including area code)

 

**N/A**

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

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 
| Yes |   | ý |   | No | o |
|-----|--------|--------|--------|----|---|

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):
| Large accelerated filer o |   | Accelerated filer ý |   | Non-accelerated filer o |
|---------------------------|--------|--------------------------|--------|-------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act).

 
| Yes |   | o |   | No | ý |
|-----|--------|---|--------|----|--------|

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **Class**                     | ** ** | **Outstanding at May 1, 2006** | ** ** |
|-------------------------------|------------|----------------------------------------------------|------------|
| Common  Stock, $.01 par value |       | 34,226,752                                         |       |

 

 

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ALBANY MOLECULAR RESEARCH, INC.

Quarterly Report on Form 10-Q For the PeriodEnded March 31, 2006

INDEX

 
| Part I.    | Financial Information |                                                                                        |
|------------|-----------------------|---------------------------------------------------------------------------------------------|
|       |                  |                                                                                        |   |
|       | Item 1.               | Condensed Consolidated Financial Statements (Unaudited)                                     |   |
|       |                  |                                                                                        |   |
|       |                  | Condensed  Consolidated Statements of Income                                                |   |
|       |                  |                                                                                        |   |
|       |                  | Condensed  Consolidated Balance Sheets                                                      |   |
|       |                  |                                                                                        |   |
|       |                  | Condensed  Consolidated Statements of Cash Flows                                            |   |
|       |                  |                                                                                        |   |
|       |                  | Notes  to Condensed Consolidated Financial Statements                                       |   |
|       |                  |                                                                                        |   |
|       | Item 2.               | Management’s Discussion and Analysis of Financial Condition and  Results of Operations |   |
|       |                  |                                                                                        |   |
|       | Item 3.               | Quantitative and Qualitative  Disclosures About Market Risk                                 |   |
|       |                  |                                                                                        |   |
|       | Item 4.               | Controls and Procedures                                                                     |   |
|       |                  |                                                                                        |   |
| Part  II.  | Other  Information    |                                                                                        |
|       |                  |                                                                                        |   |
|       | Item 1.               | Legal  Proceedings                                                                          |   |
|       |                  |                                                                                        |   |
|       | Item 1A.              | Risk Factors                                                                                |   |
|       |                  |                                                                                        |   |
|       | Item 6.               | Exhibits                                                                                    |   |
|       |                  |                                                                                        |   |
| Signatures |                  |

 

2

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PART I — FINANCIAL INFORMATION

 

Item 1.    Condensed ConsolidatedFinancial Statements

 

**Albany Molecular Research, Inc.**

**CondensedConsolidated Statements of Income**

**(unaudited)**

 

*(Dollars in thousands, except for per share data)*

 
| ** **                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
|                                |       |                             |       |   |   |
| Contract revenue                    |       | $                                | 36,188     |   | $ | 36,627 |   |
| Recurring royalties                 |       | 7,178                            |       | 12,007 |   |
| Total revenue                       |       | 43,366                           |       | 48,634 |   |
|                                |       |                             |       |   |   |
| Cost of contract revenue            |       | 31,143                           |       | 29,136 |   |
| Technology incentive award          |       | 798                              |       | 1,201 |   |
| Research and development            |       | 2,711                            |       | 3,489 |   |
| Selling, general and administrative |       | 6,761                            |       | 6,452 |   |
| Total operating expenses            |       | 41,413                           |       | 40,278 |   |
|                                |       |                             |       |   |   |
| Income from operations              |       | 1,953                            |       | 8,356 |   |
|                                |       |                             |       |   |   |
| Other income:                       |       |                             |       |   |   |
| Interest income, net                |       | 721                              |       | 200 |   |
| Other income, net                   |       | 32                               |       | 3 |   |
|                                |       |                             |       |   |   |
| Total other income                  |       | 753                              |       | 203 |   |
|                                |       |                             |       |   |   |
| Income before income tax expense    |       | 2,706                            |       | 8,559 |   |
|                                |       |                             |       |   |   |
| Income tax expense                  |       | 812                              |       | 2,962 |   |
|                                |       |                             |       |   |   |
| Net income                          |       | $                                | 1,894      |   | $ | 5,597 |   |
|                                |       |                             |       |   |   |
| Basic earnings per share            |       | $                                | 0.06       |   | $ | 0.18 |   |
|                                |       |                             |       |   |   |
| Diluted earnings per share          |       | $                                | 0.06       |   | $ | 0.17 |   |

 

*See notes to unaudited condensed consolidated financial statements.*

 

3

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**Albany Molecular Research, Inc.**

**Condensed Consolidated BalanceSheets**

 

*(Dollars and share amounts in thousands)*

 
| ** **                                                                                                                                                  | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **(unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                  |       |                     |       |                        |       |
| Current assets:                                                                                                                                             |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                   |       | $                        | 16,762     |                        | $          | 27,606 |   |
| Investment securities, available-for-sale                                                                                                                   |       | 90,991                   |       | 100,304                     |       |
| Accounts receivable, net                                                                                                                                    |       | 22,876                   |       | 22,238                      |       |
| Royalty income receivable                                                                                                                                   |       | 6,922                    |       | 6,247                       |       |
| Inventory                                                                                                                                                   |       | 28,820                   |       | 30,603                      |       |
| Prepaid expenses and other current assets                                                                                                                   |       | 8,037                    |       | 6,391                       |       |
| Property and equipment held for sale                                                                                                                        |       | 5,376                    |       | 5,376                       |       |
| Total current assets                                                                                                                                        |       | 179,784                  |       | 198,765                     |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Property and equipment, net                                                                                                                                 |       | 153,604                  |       | 151,078                     |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Other assets:                                                                                                                                               |       |                     |       |                        |       |
| Goodwill                                                                                                                                                    |       | 35,529                   |       | 25,747                      |       |
| Intangible assets and patents, net                                                                                                                          |       | 1,715                    |       | 1,434                       |       |
| Equity investments in unconsolidated  affiliates                                                                                                            |       | 956                      |       | 956                         |       |
| Other assets                                                                                                                                                |       | 1,970                    |       | 1,202                       |       |
| Total assets                                                                                                                                                |       | $                        | 373,558    |                        | $          | 379,182 |   |
|                                                                                                                                                        |       |                     |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                              |       |                     |       |                        |       |
| Current liabilities:                                                                                                                                        |       |                     |       |                        |       |
| Accounts payable and accrued expenses                                                                                                                       |       | $                        | 12,709     |                        | $          | 14,375 |   |
| Deferred revenue                                                                                                                                            |       | 11,559                   |       | 12,537                      |       |
| Accrued pension benefits                                                                                                                                    |       | 1,014                    |       | 1,014                       |       |
| Income taxes payable                                                                                                                                        |       | 3,254                    |       | 7,466                       |       |
| Current installments of long-term debt                                                                                                                      |       | 4,536                    |       | 4,536                       |       |
| Total current liabilities                                                                                                                                   |       | 33,072                   |       | 39,928                      |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Long-term liabilities:                                                                                                                                      |       |                     |       |                        |       |
| Long-term debt, excluding current  installments                                                                                                             |       | 17,512                   |       | 18,521                      |       |
| Deferred income taxes                                                                                                                                       |       | 5,445                    |       | 5,080                       |       |
| Pension and postretirement benefits                                                                                                                         |       | 1,880                    |       | 2,356                       |       |
| Other long term liabilities                                                                                                                                 |       | 236                      |       | 236                         |       |
| Total liabilities                                                                                                                                           |       | 58,145                   |       | 66,121                      |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Commitments and contingencies                                                                                                                               |       |                     |       |                        |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                                  |       |                     |       |                        |       |
| Common stock, $0.01 par value, 100,000  shares authorized, 34,227 shares issued at March 31, 2006, and 34,471  shares issued at December 31, 2005 |       | 342                      |       | 345                         |       |
| Additional paid-in capital                                                                                                                                  |       | 191,561                  |       | 193,066                     |       |
| Unearned compensation – restricted stock                                                                                                               |       | —                   |       | (1,921                      | )          |
| Accumulated other comprehensive loss                                                                                                                        |       | (350                     | )          | (395                        | )          |
| Retained earnings                                                                                                                                           |       | 161,031                  |       | 159,137                     |       |
|                                                                                                                                                        |       | 352,584                  |       | 350,232                     |       |
| Less, treasury shares at cost, 2,077 shares                                                                                                                 |       | (37,171                  | )          | (37,171                     | )          |
| Total stockholders’ equity                                                                                                                             |       | 315,413                  |       | 313,061                     |       |
| Total liabilities and stockholders’ equity                                                                                                             |       | $                        | 373,558    |                        | $          | 379,182 |   |

 

*Seenotes to unaudited condensed consolidated financial statements.*

 

4

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**Albany Molecular Research, Inc.**

**CondensedConsolidated Statements of Cash Flows**

**(unaudited)**

 

*(Dollars in thousands)*

 
| ** **                                                                                   | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                   | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
| ** **                                                                                   | ** ** | ** **                       | ** ** | ** ** | ** ** |
| **Operating activities**                                                                     |       |                             |       |   |   |
| Net income                                                                                   |       | $                                | 1,894      |   | $ | 5,597 |   |
| Adjustments to reconcile net income to net  cash (used in) provided by operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                                |       | 3,676                            |       | 3,937 |   |
| Allowance for bad debts                                                                      |       | 32                               |       | (65 | ) |
| Provision for obsolete inventories                                                           |       | 692                              |       | — |   |
| Stock-based compensation expense                                                             |       | 213                              |       | — |   |
| Deferred income tax expense                                                                  |       | 265                              |       | 681 |   |
|                                                                                         |       |                             |       |   |   |
| (Increase) decrease in operating assets,  net of business combination:                       |       |                             |       |   |   |
| Accounts receivable                                                                          |       | 331                              |       | (5,888 | ) |
| Royalty income receivable                                                                    |       | (675                             | )          | 173 |   |
| Inventory, prepaid expenses and other  assets                                                |       | (44                              | )          | 4 |   |
| (Decrease) increase in operating  liabilities, net of business combination:                  |       |                             |       |   |   |
| Accounts payable and accrued expenses                                                        |       | (2,820                           | )          | 302 |   |
| Deferred revenue                                                                             |       | (2,096                           | )          | 424 |   |
| Income tax payable                                                                           |       | (4,194                           | )          | 2,280 |   |
| Other long-term liabilities                                                                  |       | —                           |       | (25 | ) |
| Pension and postretirement benefits                                                          |       | (476                             | )          | (254 | ) |
| Net cash (used in) provided by operating  activities                                         |       | (3,202                           | )          | 7,166 |   |
|                                                                                         |       |                             |       |   |   |
| **Investing activities**                                                                     |       |                             |       |   |   |
| Net purchases of investment securities                                                       |       | (41,880                          | )          | (24,919 | ) |
| Proceeds from sales of investment  securities                                                |       | 51,130                           |       | 25,850 |   |
| Purchase of business, net of cash acquired                                                   |       | (11,219                          | )          | — |   |
| Purchases of property and equipment                                                          |       | (4,793                           | )          | (1,706 | ) |
| Payments for patent applications and other  costs                                            |       | (23                              | )          | (61 | ) |
| Net cash used in investing activities                                                        |       | (6,785                           | )          | (836 | ) |
|                                                                                         |       |                             |       |   |   |
| **Financing activities**                                                                     |       |                             |       |   |   |
| Principal payments on long-term debt                                                         |       | (1,071                           | )          | (1,074 | ) |
| Proceeds from sale of common stock                                                           |       | 200                              |       | 642 |   |
| Net cash used in financing activities                                                        |       | (871                             | )          | (432 | ) |
|                                                                                         |       |                             |       |   |   |
| Effect of exchange rate changes on cash  flows                                               |       | 14                               |       | — |   |
|                                                                                         |       |                             |       |   |   |
| (Decrease) increase in cash and cash  equivalents                                            |       | (10,844                          | )          | 5,898 |   |
|                                                                                         |       |                             |       |   |   |
| Cash and cash equivalents at beginning of  period                                            |       | 27,606                           |       | 41,171 |   |
|                                                                                         |       |                             |       |   |   |
| Cash and cash equivalents at end of period                                                   |       | $                                | 16,762     |   | $ | 47,069 |   |

 

*See notes to unaudited condensed consolidated financial statements.*

 

5

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**Note 1 – Summary of Operations andSignificant Accounting Policies**

(All amounts in thousands, except per share amounts, unless otherwisenoted)

 

**Nature of Business and Operations**

 

Albany Molecular Research, Inc. (the “Company”) is a globalchemistry-based drug discovery and development company focused on identifyingand developing novel biologically active small molecules with applications inthe drug market. The Company engages in new drug research services andmanufacturing, from lead discovery, optimization and development to commercialmanufacturing and has operations in the United States, India, Singapore andHungary. The Company conducts research and development projects andcollaborates with many leading pharmaceutical and biotechnology companies, andis developing proprietary new chemistry technology for potential pharmaceuticalproducts.

 

**Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with U.S. generally accepted accountingprinciples for interim financial information and with the instructions to Form10-Q and Rule 10-01 of Regulation S-X. In accordance with Rule 10-01, theunaudited condensed consolidated financial statements do not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete consolidated financial statements. The year-endcondensed consolidated balance sheet data was derived from audited financialstatements but does not include all disclosures required by U.S. generally acceptedaccounting principles. In the opinion of management, all adjustments(consisting of normal recurring accruals and adjustments) considered necessaryfor a fair statement of the results for the interim period have been included. Operatingresults for the quarter ended March 31, 2006 are not necessarilyindicative of the results that may be expected for the year ending December 31,2006. The accompanying unaudited condensed consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and notes thereto included in our Annual Report on Form 10-K for theyear ended December 31, 2005.

 

The accompanying unaudited condensed consolidated financial statementsinclude the accounts of Albany Molecular Research, Inc. and its wholly-ownedsubsidiaries. All intercompany balances and transactions have been eliminatedduring consolidation. Assets and liabilities of non-U.S. operations aretranslated at period-end rates of exchange, and the statements of income aretranslated at the average rates of exchange for the period. Gains or lossesresulting from translating non-U.S. currency financial statements are recordedin accumulated other comprehensive (loss) income in the accompanying condensedconsolidated balance sheets.

 

**Use ofManagement Estimates**

 

The preparation of consolidatedfinancial 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. Actualresults can vary from these estimates.

 

**Contract Revenue Recognition**

 

The Company’s contract revenue consists primarily of fees earned undercontracts with third-party customers and reimbursed expenses under suchcontracts. The Company also seeks to include provisions in certain contractswhich contain a combination of up-front licensing fees, milestone and royaltypayments should the Company’s proprietary technology and expertise lead to thediscovery of new products that reach the market. Reimbursed expenses consist ofchemicals and other project specific costs. Generally, the Company’s contractsmay be terminated by the customer upon 30 days’ to one year’s priornotice, 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 EITFNo. 00-21, *Revenue Arrangements withMultiple Deliverables* and SAB 104, *RevenueRecognition*. Allocation of revenue to individual elements whichqualify for separate accounting is based on the estimated fair value of therespective elements.

 

The Company generates contract revenue on the following basis:

 

6

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*Full-time Equivalent (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’sscientists providing services on a “best efforts” basis in the development ofnovel chemistry for customers. There are no fixed deliverables as part of theseservices. As such, the Company recognizes revenue under FTE contracts on amonthly basis as services are performed according to the terms of the contract.

 

*Time and Materials*. Under a time and materials contractthe Company charges customers an hourly rate plus reimbursement for chemicalsand other project specific costs. The Company recognizes revenue for time andmaterial contracts based on the number of hours devoted to the projectmultiplied by the customer’s billing rate plus other project specific costsincurred.

 

*Fixed-Fee*. Under a fixed-fee contract theCompany charges a fixed agreed upon amount for a deliverable. Fixed-fee contractshave fixed deliverables upon completion of the project. Typically, the Companyrecognizes 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 those materials.In these instances, the revenue recognition process is considered complete whenproject documents (batch records, Certificates of Analysis, etc.) have beendelivered to the customer and payment has been collected.

 

*Up-Front License Fees, Milestone and RoyaltyRevenue***.**TheCompany recognizes revenue from up-front non-refundable licensing fees on astraight-line basis over the period of the underlying project. The Company willrecognize revenue arising from a substantive milestone payment upon thesuccessful achievement of the event, and the resolution of any uncertainties orcontingencies regarding potential collection of the related payment, or ifappropriate over the remaining term of the agreement.

 

*Recurring Royalty Revenue Recognition***.**

 

Recurring royalties consist of royalties under a license agreement withSanofi-Aventis based on the worldwide sales of fexofenadine HCl, marketed asAllegra in the Americas and Telfast elsewhere. The Company records royaltyrevenue in the period in which the sales of Allegra/Telfast occur, because wecan reasonably estimate such royalties. Royalty payments from Sanofi-Aventisare due within 45 days after each calendar quarter and are determinedbased on sales of Allegra/Telfast in that quarter.

 

**Long-lived Assets**

 

In accordance with the 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 assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Factors the Company considers important which 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 assetsmay not be recoverable, based upon the existence of one or more of the aboveindicators of impairment, the Company compares the carrying value of the assetgroup to the undiscounted cash flows expected to be generated by the assetgroup. If the carrying value exceeds the undiscounted cash flows an impairmentcharge is recorded. An impairment charge is recognized to the extent that thecarrying amount of the asset group exceeds their fair value and will reduceonly the carrying amounts of the long-lived assets. The Company utilizes theassistance of an independent valuation firm in determining the fair values.

 

7

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**Goodwill**

 

In accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), the Company performs an annual****assessment 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 estimated discounted future cash flows of the operations associated with the related reporting unit. If goodwill is determined to be impaired in the future 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 underperformancerelative to historical or projected future operating results;

 

•              significant changes in the mannerof our use of the acquired assets or the strategy for overall business;

 

•              significant negative industry oreconomic trends; and

 

•              market capitalization relative tonet book value.

 

The Company willperform the annual goodwill assessment for its reporting units during the thirdquarter of 2006. If management’s expectations of future operating resultschange, or if there are changes to other assumptions, the estimate of the fairvalue of our reporting units could change significantly. Such a change couldresult in goodwill impairment charges in future periods, which could have asignificant impact on our consolidated financial statements. Total goodwill recordedon the Company’s unaudited condensed consolidated balance sheet at March 31,2006 was $35,529 including $23,060 of goodwill associated with the Company’sacquisition of Organichem, Inc. and $9,785 of goodwill associated with theCompany’s acquisition of ComGenex Kutato-Fejleszto Rt.

 

**Stock Compensation**

 

Effective January 1, 2006, the Company adopted SFAS No. 123 (Revised2004), “Share-Based Payment” (SFAS No. 123 (R)), which amends SFASNo. 123 and supersedes APB No. 25**inestablishing standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services, as well as transactionsin which an entity incurs liabilities in exchange for goods or services thatare based on the fair value of the entity’s equity instruments or that may besettled by the issuance of those equity instruments. This Statement requiresthat the cost resulting from all share-based payment transactions be recognizedin the financial statements based on the fair value of the share-based payment.This Statement establishes fair value as the measurement objective inaccounting for share-based payment transactions with employees, except forequity instruments held by employee share ownership plans. As allowed underSFAS No. 123 (R), the Company elected the modified prospective method ofadoption, under which compensation cost is recognized in the financialstatements beginning with the effective date of SFAS No. 123(R) for allshare-based payments granted after that date, and for all unvested awardsgranted prior to the effective date of SFAS No. 123 (R). Accordingly, priorperiod amounts have not been restated. Under SFAS No. 123 (R), unvested sharesare not included in the presentation of shares issued and outstanding on theconsolidated balance sheet. The presentation of unvested shares in accordancewith SFAS No. 123 (R) is reflected on the Company’s condensed consolidatedbalance sheet as of March 31, 2006.

 

**Note 2 – Business Combination**

 

OnFebruary 28, 2006, the Company, through a wholly-owned subsidiary, acquired allof the outstanding shares of ComGenex Kutato-Fejleszto Rt. (“ComGenex”), aprivately held drug discovery service company located in Budapest, Hungary.

 

The aggregate purchase price of $11,542 includedcash payments totaling $10,772 and capitalized costs related to theacquisition, primarily professional fees, of $770. The purchase price may beadjusted based upon ComGenex’ audited financial statements for the year endedDecember 31, 2005 and its financial position as of the transaction closingdate. The results of ComGenex’s operations have been included in the unaudited condensedconsolidated statement of income for the three months ended March 31, 2006 fromthe date of acquisition.

 

8

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The following table summarizes thepreliminary allocation of the purchase price to the estimated fair value of thenet assets acquired.  The allocation will be finalized upon the completionof the 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                                  |       | 9,785                       |       |
| Intangible assets and patents, net        |       | 292                         |       |
| Other assets                              |       | 21                          |       |
| Total assets acquired                     |       | $                           | 13,955     |   |
|                                      |       |                        |       |
| **Liabilities  Assumed**                  |       |                        |       |
| Accounts payable and accrued expenses     |       | $                           | 1,154      |   |
| Deferred revenue                          |       | 1,119                       |       |
| Deferred income taxes                     |       | 78                          |       |
| Other long term liabilities               |       | 62                          |       |
| Total liabilities assumed                 |       | $                           | 2,413      |   |
|                                      |       |                        |       |
| Net assets acquired                       |       | $                           | 11,542     |   |

 

Pro formafinancial information for the quarters ended March 31, 2006 and 2005 as if theComGenex acquisition had been completed as of January 1, 2005 has been excludeddue to the immateriality of the operating results of ComGenex in relation tothe Company’s consolidated operating results as a whole.

 

**Note 3 –Earnings Per Share**

 

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

 

| ** **                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Weighted average common shares outstanding                     |       | 32,142                                               |       | 31,931 |   |
| Dilutive effect of stock options                               |       | 182                                                  |       | 246 |   |
| Dilutive effect of restricted stock                            |       | 68                                                   |       | 6 |   |
| Weighted average common shares outstanding,  assuming dilution |       | 32,392                                               |       | 32,183 |   |

 

The Companyhas excluded certain outstanding stock options and warrants from thecalculation of diluted earnings per share for the three months ended March 31,2006 and certain stock options and warrants from the calculation of dilutedearnings per share for the three months ended March 31, 2005 because theexercise price was greater than the average market price of the Company’scommon shares during that period, and as such would be anti-dilutive. Theamount of anti-dilutive options outstanding (before the effects of the treasurystock method) was 1,936 for the three months ended March 31, 2006. The amountof anti-dilutive options and warrants outstanding (before the effects of thetreasury stock method) was 2,881 for the three months ended March 31, 2005. Theseamounts are not included in the calculation of weighted average common sharesoutstanding.

 

**Note 4 – Inventory**

 

Inventory consisted of the following at March 31, 2006 andDecember 31, 2005:

 
| ** **                                 | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw materials                              |       | $                        | 8,883      |                        | $          | 13,039 |   |
| Work in process                            |       | 2,590                    |       | 2,188                       |       |
| Finished goods                             |       | 17,000                   |       | 15,029                      |       |
| Libraries, net of accumulated amortization |       | 347                      |       | 347                         |       |
| Total                                      |       | $                        | 28,820     |                        | $          | 30,603 |   |

 

9

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**Note5 – Restructuring of Mt. Prospect**

** **

OnMay 4, 2004 the Company announced its plan to consolidate operations byrelocating its Mt. Prospect facility operations to its facilities in New York. TheCompany’s proprietary biocatalysis technology platform, drug metabolismscreening, research fermentation and chemical development technologies in Mt.Prospect have been relocated to New York and continue to be fully integratedwith the Company’s drug discovery and development technologies. Therestructuring resulted in the closure of the Mt. Prospect Research Center inthe fourth quarter of 2004. The consolidation was initiated as a result of alack of anticipated growth in the Company’s chemical development services atthe facility.

 

AtMarch 31, 2006, the Company had recorded restructuring liabilities totaling$513 related to asset disposal costs, including brokerage commissions, legalfees, and marketing expenses associated with the planned sale of the Mt. ProspectResearch Center facility. These restructuring liabilities are included inaccounts payable in the Company’s unaudited condensed consolidated balancesheet. There was no activity related to the Company’s restructuring liabilitiesduring the quarter ended March 31, 2006.

 

Weare currently marketing the Mt. Prospect Research Center facility for sale. Thefacility qualified for held for sale treatment in accordance with SFASNo. 144 during the fourth quarter of 2004. The long-lived assetsassociated with Mt. Prospect have been segregated to a separate line item inthe unaudited condensed consolidated balance sheet 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, we anticipated the completion of the sale of the facility byJune 2006. If a definitive agreement to sell the facility is not in placeas of June 30, 2006, we will reassess the classification of the facility asheld for sale in accordance with SFAS No. 144 at that time.

 

**Note 6 – Goodwill and Intangible Assets**

 

Thecarrying amounts of goodwill, by the Company’s Discovery/Development/SmallScale Manufacturing (“DDS”) and Large Scale Manufacturing (“LSM”) operatingsegments, as of March 31, 2006 and December 31, 2005 are as follows:

 
| ** **                 | ** ** | **DDS**    | ** ** | **LSM**    | ** ** | **Total**  | ** ** |
|----------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **March 31, 2006**    |       | $          | 12,469     |       | $          | 23,060     |       | $ | 35,529 |   |
|                       |       |       |       |       |       |       |       |
| **December 31, 2005** |       | $          | 2,687      |       | $          | 23,060     |       | $ | 25,747 |   |

 

The increase in goodwill withinthe DDS segment from December 31, 2005 to March 31, 2006 is related to theCompany’s acquisition of ComGenex described in Note 2.

 

The components ofintangible assets are as follows:

 
| ** **                   | ** ** | **Cost**   | ** ** | **Accumulated  Amortization** | ** ** | **Net**    | ** ** | **Amortization  Period** | ** ** |
|------------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|--------------------------|------------|
| **March 31, 2006**      | ** ** | ** ** | ** ** | ** **                    | ** ** | ** ** | ** ** | ** **               | ** ** |
| Patents and Licensing Rights |       | $          | 2,120      |                          | $          | (405       | )          | $                        | 1,715      |   | 16 years |   |
|                         |       |       |       |                          |       |       |       |                     |       |
| **December 31, 2005**   |       |       |       |                          |       |       |       |                     |       |
| Patents and Licensing Rights |       | $          | 1,811      |                          | $          | (377       | )          | $                        | 1,434      |   | 16 years |   |

 

Amortization expense related tointangible assets for the three months ended March 31, 2006 and 2005 was$28 and $23, respectively.

 

Estimated future annualamortization expense related to intangible assets is approximately $119 peryear through the year ended December 31, 2010.

 

10

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**Note 7 -****Defined Benefit and Postretirement Welfare Plan**

 

Organichem previously provided retirement benefits under twonon-contributory defined benefit plans and a non-contributory, unfundedpost-retirement welfare plan. Future benefits under all three plans have beenfrozen.

 

***Components of Net Periodic Benefit Cost***

 
| ** **                         | ** ** | **Pension Benefits**                        | ** ** | **Postretirement  Benefits**                     | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **Three Months  Ended March 31,** | ** ** | **Three Months  Ended March 31,** | ** ** |
| ** **                         | ** ** | **2006**                                         | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|                               |       |                                             |       |                                             |       |   |   |   |   |
| Service Cost                       |       | $                                                | —     |                                             | $          | — |   | $ | 17 |   | $ | 11 |   |
| Interest Cost                      |       | 294                                              |       | 317                                              |       | 7 |   | 4 |   |
| Expected return on plan assets     |       | (334                                             | )          | (296                                             | )          | — |   | — |   |
| Amortization of prior service cost |       | —                                           |       | —                                           |       | — |   | — |   |
| Recognized net loss                |       | 3                                                |       | —                                           |       | 2 |   | — |   |
| Net periodic benefit (gain) cost   |       | $                                                | (37        | )                                                | $          | 21 |   | $ | 26 |   | $ | 15 |   |

 

***Employer Contributions***

 

The Company previously disclosed in its consolidated financialstatements for the year ended December 31, 2005, that it expected tocontribute $1,014 to its pension plan in 2006.  As of March 31, 2006,$476 in contributions have been made.  The Company continues to anticipatecontributing the additional $538 to fund its pension plan in 2006.

 

**Note 8 – Share-Based Payments**

 

During thequarter ended March 31, 2006 and 2005, the Company recognized total share basedcompensation cost, net of tax, of $149 and $14, respectively, in its condensedconsolidated statements of income. During the quarter ended March 31, 2005, theCompany applied the intrinsic value-based method of accounting prescribed byAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations, in accounting for itsshare-based payments.

 

The following table illustrates the effect on net income and earningsper share if the Company had applied the fair value recognition provisions ofSFAS No. 123 to its share-based payments.

 

| ** **                                                                                                                                    | ** ** | **Three Months  Ended March, 31  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Net Income, as reported                                                                                                                       |       | $                                                      | 5,597      |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                   |       | 14                                                     |       |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |       | (1,088                                                 | )          |
| Pro Forma net income                                                                                                                          |       | $                                                      | 4,523      |   |
|                                                                                                                                          |       |                                                   |       |
| Earnings per share:                                                                                                                           |       |                                                   |       |
| Basic as reported                                                                                                                             |       | $                                                      | 0.18       |   |
| Basic pro-forma                                                                                                                               |       | $                                                      | 0.14       |   |
|                                                                                                                                          |       |                                                   |       |
| Diluted as reported                                                                                                                           |       | $                                                      | 0.17       |   |
| Diluted pro-forma                                                                                                                             |       | $                                                      | 0.14       |   |

 

11

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The Company grants share-based payments under its 1998 Stock Option andIncentive Plan, as well as its 1998 Employee Stock Purchase Plan. Informationregarding the Company’s share-based payment arrangements follows:

 

***1998 Stock Option and Incentive Plan***

 

**Stock Options**

 

The Company has a stock option plan, throughwhich incentive stock options or non-qualified stock options may be issued.Incentive stock options granted to employees may not be granted at prices lessthan 100% of the fair market value of the Company’s common stock at the date ofoption grant. Non-qualified stock options may be granted to employees,directors, advisors, consultants and other key persons of the Company at pricesestablished at the date of grant, and may be less than the fair market value atthe date of grant. All incentive stock options may be exercised at any time,after vesting, over a ten-year period subsequent to the date of grant.Incentive stock options generally vest over five years, with a 60% vestingoccurring at the end of the third anniversary of the grant date, 20% at the endof the fourth anniversary of the grant date and 20% at the end of the fifth anniversaryof the grant date. Non-qualified stock option vesting terms are established atthe date of grant, but  have a durationof not more than ten years.

 

The fair value of each stock option award isestimated at the date of grant using the Black-Scholes valuation model based onthe assumptions noted below. The application of this valuation model involvesthe use of assumptions that are judgmental in nature. The following is asummary of the methodology applied to develop each assumption:

 

Expected Price Volatility

 

Expected price volatility is a measure of theamount by which the price of a security has fluctuated or is expected tofluctuate. The Company uses actual historical changes in the market value ofits stock to calculate the volatility assumption. The Company calculates dailymarket value changes from the date of grant over a past period representativeof the expected life of the options to determine volatility. An increase in theexpected volatility will increase compensation expense.

 

Risk-Free Interest Rate

 

For the risk-free interest rate, the Companyuses the U.S. Treasury rate for the week of the grant having a term approximatingthe expected life of the option. An increase in the risk-free interest ratewill increase compensation expense.

 

Expected Lives

 

This is the period of time over which theoptions granted are expected to remain outstanding, and is based on ourhistorical stock option exercise and forfeiture experience. Options grantedhave a maximum term of ten years. An increase in the expected life willincrease compensation expense.

 

Dividend Yield

 

The Company has not made any dividendpayments nor does it have plans to pay dividends in the foreseeable future. Anincrease in the dividend yield will decrease compensation expense.

 

The fair value of each option is amortizedinto compensation expense on a straight-line basis over the vesting period. TheCompany reduces the straight-line compensation expense by an estimatedforfeiture rate to account for the estimated impact of options that areexpected to be forfeited before becoming fully vested. This estimate is basedon our historical forfeiture experience and is currently estimated at 8%. Anincrease in the forfeiture rate will decrease compensation expense.

 

The following weighted-average assumptionswere used to determine the per share weighted-average fair value of stockoptions granted during the quarter ended March 31, 2005:

 

| Expected life in years |   | 5      |   |
|------------------------|--------|--------|--------|
| Interest rate          |   | 3.88   | %      |
| Volatility             |   | 45     | %      |
| Dividend yield         |   | — |   |

 

There were no stock options granted duringthe quarter ended March 31, 2006.

 

A summary of stock option activity under the Company’sstock option plan as of March 31, 2006 and changes during the quarter thenended is presented below:

 

12

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| ** **                          | ** ** | **Number of  Shares** | ** ** | **Weighted  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-------------------------------------|------------|----------------------------|------------|-------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding, December 31, 2005      |       | 2,246                      |       | $                             | 19.97      |                                                             |       |                            |       |   |
| Granted                             |       | —                     |       |                          |       |                                                             |       |                            |       |
| Exercised                           |       | —                     |       |                          |       |                                                             |       |                            |       |
| Forfeited                           |       | (25                        | )          | $                             | 28.18      |                                                             |       |                            |       |   |
| Outstanding, March 31, 2006         |       | 2,221                      |       | $                             | 19.88      |                                                             | 5.6        |                            | $          | 1,914 |   |
| Options exercisable, March 31, 2006 |       | 2,048                      |       | $                             | 20.54      |                                                             | 5.5        |                            | $          | 1,912 |   |

 

The weighted average fair value of stock optionsgranted during the quarter ended March 31, 2006 and 2005 were $0 and $5.07,respectively. The total intrinsic value of stock options exercised during thequarter ended March 31, 2006 and 2005 was $0 and $694, respectively.

 

As of March 31, 2006, there was $828 of totalunrecognized compensation cost related to nonvested stock options. That cost isexpected to be recognized over a weighted-average period of 2.26 years. Thetotal fair value of shares vested during the quarter ended March 31, 2006 and2005 was $47 and $4,608, respectively.

 

Effective December 30, 2005, pursuant toand in accordance 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 that was held by employees, officers, andnon-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 millionshares of the Company’s common stock, including approximately 101,000 optionsheld by executive officers, were subject to this acceleration.

 

The Committee also required that, as acondition to the acceleration of vesting, each executive officer and eachnon-employee director agree to refrain from selling shares of the Company’scommon stock acquired upon the exercise of accelerated options (other thanshares needed to cover the exercise price and satisfy withholding taxes) untilthe date on which the exercise of such options would have been permitted underthe option’s pre-acceleration vesting terms or, if earlier, the officer’s ordirector’s last day of employment or upon a “change in control” as defined inthe Company’s stock option plan.

 

The decision to accelerate the vesting ofthese underwater options was made primarily to minimize certain futurecompensation expenses that the Company would otherwise recognize in itsconsolidated statements of income with respect to these options pursuant toSFAS No. 123 (R). The Company also believes that the acceleration may havea positive effect on employee morale, retention and the perception of optionvalue.

 

**Restricted Stock**

 

The Company also issues restricted shares ofcommon stock to employees of the Company under the 1998 Stock Option andIncentive Plan. The shares are issued as restricted stock and are held in thecustody of the Company until all vesting restrictions are satisfied. Sharesvest under this grant over a period of five years, with 60% vesting after threeyears of continuous employment from the grant date and an additional 20%vesting after each of four and five years of continuous employment from thegrant date. If the vesting terms under which the award was granted are notsatisfied, the shares are forfeited. Unearned compensation is recorded based onthe market value of the shares on the grant date, and is amortized on astraight-line basis over the applicable vesting period. The Company reduces thestraight-line compensation expense by an estimated forfeiture rate to accountfor the estimated impact of shares of restricted stock that are expected to beforfeited before becoming fully vested. This estimate is based on ourhistorical forfeiture experience and is currently estimated at 6%.

 

A summary of unvested restricted stockactivity as of March 31, 2006 and changes during the quarter then ended ispresented below:

 

13

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| ** **                     | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Grant Date  Fair Value** | ** ** |
|--------------------------------|------------|----------------------------|------------|-------------------------------------------------------------|------------|
| Outstanding, December 31, 2005 |       | 257                        |       | $                                                           | 8.75       |   |
| Granted                        |       | 10                         |       | $                                                           | 12.28      |   |
| Vested                         |       | —                     |       | —                                                      |       |
| Forfeited                      |       | (5                         | )          | $                                                           | 8.45       |   |
| Outstanding, March 31, 2006    |       | 262                        |       | $                                                           | 8.89       |   |

 

The weighted average fair value of restrictedshare granted during the quarter ended March 31, 2006 and 2005 were $8.45 and $12.28,respectively. As of March 31, 2006, there was $1,894 of total unrecognizedcompensation cost related to nonvested restricted shares. That cost is expectedto be recognized over a weighted-average period of 4.04 years. The total fairvalue of restricted shares vested during the quarter ended March 31, 2006 and2005 was $0.

 

***Employee Stock Purchase Plan***

 

The Company’s 1998 Employee Stock PurchasePlan (the “Purchase Plan”) was adopted during August 1998. Up to 600shares of common stock may be issued under the Purchase Plan, which isadministered by the Compensation Committee of the Board of Directors. ThePurchase Plan establishes two stock offering periods per calendar year, thefirst beginning on January 1 and ending on June 30, and the secondbeginning on July 1 and ending December 31. All employees who workmore than 20 hours per week are eligible for participation in the PurchasePlan. Employees who are deemed to own greater than 5% of the combined votingpower of all classes of stock of the Company are not eligible for participationin the Purchase Plan.

 

During each offering, an employee maypurchase shares under the Purchase Plan by authorizing payroll deductions up to10% of their cash compensation during the offering period. The maximum numberof shares to be issued to any single employee during an offering period islimited to one thousand. At the end of the offering period, the accumulatedpayroll deductions will be used to purchase common stock on the last businessday of the offering period at a price equal to 85% of the closing price of the commonstock on the first or last day of the offering period, whichever is lower.

 

Under SFAS No. 123 (R), the 15% discount andthe look-back feature are considered compensatory items for which expense mustbe recognized. The Company values Purchase Plan shares as a combinationposition consisting of 15% of a share of nonvested stock and 85% of a six-monthstock option. The value of the nonvested stock is estimated based on the fairmarket value 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 quarter ended March 31, 2006 and2005, 18 and 0 shares, respectively, were issued under the Purchase Plan.

 

During the quarter endedMarch 31, 2006 and 2005, cash received from stock option exercises and employeestock purchase plan purchases was $200 and $642, respectively. The actual taxbenefit realized for the tax deductions from stock option exercises was $0during the quarter ended March 31, 2006 and 2005.

 

**Note 9 – Operating Segment Data**

 

The Company has organizedits sales, marketing and production activities into theDiscovery/Development/Small Scale Manufacturing (DDS) and Large ScaleManufacturing (LSM) segments based on the criteria set forth in SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information”. The Company’smanagement relies on an internal management accounting system to report resultsof the segments. The system includes revenue and cost information by segment. TheCompany’s management makes financial decisions and allocates resources based onthe information it receives from this internal system.

 

14

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DDS includes activitiessuch as drug lead discovery, optimization, drug development and small scalecommercial manufacturing. LSM includes pilot to commercial scale manufacturingof active pharmaceutical ingredients and intermediates and high potency andcontrolled substance manufacturing all of which are in compliance with the Foodand Drug Administration’s (FDA) current Good Manufacturing Practices. Corporateactivities include business development and administrative functions, as wellas research and development costs that have not been allocated to the operatingsegments.

 

The following tablecontains earnings data by operating segment, reconciled to totals included inthe unaudited condensed consolidated financial statements:

 

 
| ** **                                          | ** ** | **Contract  Revenue** | ** ** | **Recurring  Royalty  Revenue** | ** ** | **Operating  income (loss)** | ** ** | **Depreciation  and  Amortization** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|---------------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|
| **For the three months ended March 31,  2006** |       |                  |       |                            |       |                              |       |                                |       |
| DDS                                                 |       | $                     | 16,943     |                            | $          | 7,178                             |       | $                                   | 10,678     |   | $ | 2,168 |   |
| LSM                                                 |       | 19,245                |       | —                          |       | 747                               |       | 1,508                               |       |
| Corporate                                           |       | —                |       | —                          |       | (9,472                            | )          | —                              |       |
| Total                                               |       | $                     | 36,188     |                            | $          | 7,178                             |       | $                                   | 1,953      |   | $ | 3,676 |   |
|                                                |       |                  |       |                            |       |                              |       |                                |       |
| **For the three months ended March 31,  2005** |       |                  |       |                            |       |                              |       |                                |       |
| DDS                                                 |       | $                     | 13,598     |                            | $          | 12,007                            |       | $                                   | 12,700     |   | $ | 2,483 |   |
| LSM                                                 |       | 23,029                |       | —                          |       | 4,597                             |       | 1,454                               |       |
| Corporate                                           |       | —                |       | —                          |       | (8,941                            | )          | —                              |       |
| Total                                               |       | $                     | 36,627     |                            | $          | 12,007                            |       | $                                   | 8,356      |   | $ | 3,937 |   |

 

The following tablesummarizes other information by segment as of and for the three months endedMarch 31, 2006:

 
| ** **                               | ** ** | **As of and for the three months ended  March 31, 2006** | ** ** |
|------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **DDS**                                                                                               | ** ** | **LSM** | ** ** | **Total** | ** ** |
|                                     |       |                                                                                                  |       |   |   |   |   |
| Total assets                             |       | $                                                                                                     | 239,182    |   | $ | 134,376 |   | $ | 373,558 |   |
| Goodwill included in total assets        |       | 12,469                                                                                                |       | 23,060 |   | 35,529 |   |
| Investments in unconsolidated affiliates |       | 956                                                                                                   |       | — |   | 956 |   |
| Capital expenditures                     |       | 3,085                                                                                                 |       | 1,708 |   | 4,793 |   |
|                                          |            |                                                                                                       |            |  |  |  |  |  |  |  |

 

The following tablesummarizes other information by segment as of and for the three months endedMarch 31, 2005:

 
| ** **                               | ** ** | **As of and for the three months ended  March 31, 2005** | ** ** |
|------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **DDS**                                                                                               | ** ** | **LSM** | ** ** | **Total** | ** ** |
|                                     |       |                                                                                                  |       |   |   |   |   |
| Total assets                             |       | $                                                                                                     | 248,909    |   | $ | 130,273 |   | $ | 379,182 |   |
| Goodwill included in total assets        |       | 2,687                                                                                                 |       | 23,060 |   | 25,747 |   |
| Investments in unconsolidated affiliates |       | 956                                                                                                   |       | — |   | 956 |   |
| Capital expenditures                     |       | 722                                                                                                   |       | 984 |   | 1,706 |   |
|                                          |            |                                                                                                       |            |  |  |  |  |  |  |  |

 

**Note 10 – Financial Information by CustomerConcentration and Geographic Area**

 

Total contract revenue from AMR’s three largest customers representedapproximately 12%, 10% and 6% of AMR’s total contract revenue for the threemonths ended March 31, 2006, and 14%, 11% and 11% of total contractrevenue for the three months ended March 31, 2005. Total contract revenuefrom LSM’s largest customer, GE Healthcare (GE), represented 56% and 77%of  total LSM contract revenue for the threemonths ended March 31, 2006 and 2005, respectively. GE accounted forapproximately 30% and 49% of the Company’s total contract revenue for the threemonths ended March 31, 2006 and 2005, respectively. GE discontinued itspurchases of one of the products it received from Organichem after 2005, andmade all of its 2005 purchases in the first half of the year. Sales of thisproduct totaled $10,000 in the first quarter of 2005.

 

The Company’s total contract revenue for the three months endedMarch 31, 2006 and 2005 was recognized from customers in the followinggeographic regions:

 

15

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| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|------------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
|          |       |                                                 |       |   |   |
| United States |       | 64                                                   | %          | 49 | % |
| Europe        |       | 34                                                   | %          | 50 | % |
| Other         |       | 2                                                    | %          | 1 | % |
|          |       |                                                 |       |   |   |
| Total         |       | 100                                                  | %          | 100 | % |

 

**Note 11 – Comprehensive Income**

** **

The Company is required to report comprehensive income and itscomponents in accordance with the provisions of the SFAS No. 130, “ReportingComprehensive Income.”

 

The following table presents the components of the Company’scomprehensive income for the three months ended March 31, 2006 and 2005:

 

*(in thousands)*

 
| ** **                                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
|                                                                   |       |                                                 |       |   |   |
| Net income                                                             |       | $                                                    | 1,894      |   | $ | 5,597 |   |
|                                                                   |       |                                                 |       |   |   |
| Other comprehensive income (loss):                                     |       |                                                 |       |   |   |
| Unrealized gain (loss) on  available-for-sale securities, net of taxes |       | 14                                                   |       | (126 | ) |
| Unrealized gain on interest rate swap, net  of taxes                   |       | 17                                                   |       | 115 |   |
| Foreign currency translation gain (loss)                               |       | 14                                                   |       | (31 | ) |
|                                                                   |       |                                                 |       |   |   |
| Total comprehensive income                                             |       | $                                                    | 1,939      |   | $ | 5,555 |   |

 

**Note 12– Legal Proceedings**

 

The Company, from time to time, may be involved in various claims andlegal proceedings arising in the ordinary course of business. Except as notedbelow in regards to litigation relating to Allegra, the Company is not currentlya party to any such claims or proceedings which, if decided adversely to theCompany, would either individually or in the aggregate have a material adverseeffect on the Company’s business, financial condition, results of operations orcash flows.

 

AMR Technology, a subsidiary of the Company, along with AventisPharmaceuticals Inc., the U.S. pharmaceutical business of Sanofi-Aventis S.A.,are involved in legal proceedings with several companies seeking to marketgeneric versions of Allegra. Beginning in 2001, Barr Laboratories, Inc., ImpaxLaboratories, Inc., Mylan Pharmaceuticals, Inc., Teva Pharmaceuticals USA, Dr.Reddy’s Laboratories, Ltd./Dr. Reddy’s Laboratories, Inc., Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., and Sandoz Inc. filed Abbreviated New DrugApplications (ANDAs) with the U.S. Food and Drug Administration, or FDA, toproduce and market generic versions of Allegra products.

 

In response to the filings described above, beginning in 2001, AventisPharmaceuticals filed patent infringement lawsuits against Barr Laboratories,Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc., andSandoz. Each of the lawsuits was filed in the U.S. District Court in New Jerseyand alleges infringement of one or more patents owned by AventisPharmaceuticals. Further, beginning in March 5, 2004, AMR Technology, alongwith Aventis Pharmaceuticals, filed suit in the U.S. District Court in NewJersey against Barr Laboratories, Impax Laboratories, Mylan Pharmaceuticals,Teva Pharmaceuticals, Dr. Reddy’s Laboratories, Amino Chemicals, Ltd., RanbaxyLaboratories Ltd./Ranbaxy Pharmaceuticals Inc., and Sandoz, Inc., assertinginfringement of two of our U.S. patents that are exclusively licensed toAventis Pharmaceuticals relating to Allegra and Allegra-D products.

 

16

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In the pending litigations, Aventis Pharmaceuticals and AMR Technologyhave entered into covenants not to sue the defendants under U.S. Patent No.5,578,610, which patent has not been asserted in the litigation but whichAventis Pharmaceuticals 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 thepatents are earlier determined to be invalid.

 

Under applicable federal law, marketing of an FDA-approved genericversion of Allegra may not commence until the earlier of a decision favorableto the generic challenger in the patent litigation or 30 months after the datethe patent infringement lawsuit was filed. In general, the first generic fileris entitled to a 180-day marketing exclusivity period upon FDA approval.

 

On September 6, 2005, Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd. announced that they have entered into anagreement for the launch of Fexofenadine Hydrochloride 30 mg, 60 mg and 180 mgtablets, 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 with AventisPharmaceuticals, filed a Motion for Preliminary Injunction in the U.S. DistrictCourt in New Jersey seeking to enjoin Barr Pharmaceuticals, Inc., TevaPharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd. fromthe sale of generic versions of Allegra in the United States. On January 30,2006, the U.S. District Court denied the request by AMR Technology and AventisPharmaceuticals for a preliminary injunction. A notice of appeal to the U.S.Court of Appeals for the Federal Circuit was filed on February 2, 2006.

 

Should the Company be unsuccessful in defending these patents, theCompany would continue to experience a material decrease in operating cashflows and a material adverse effect on our results of operations and financialcondition.

 

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Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations

 

**Forward-LookingStatements**

 

Thefollowing discussion of our results of operations and financial conditionshould be read in conjunction with the accompanying Condensed ConsolidatedFinancial Statements and the Notes thereto included within this report. Thisquarterly report on Form 10-Q contains “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended (the “SecuritiesAct”), and Section 21E of the Securities Exchange Act of 1934, as amended(the “Exchange Act”). These statements may be identified by forward-lookingwords 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 Research Center, pension andpostretirement benefit costs, GE Healthcare and the sales of products to GEHealthcare in 2006, contract revenues, costs and margins and the Company’simplementation of process management improvements and cost savings initiatives,royalty revenues, patent protection and the ongoing Allegra patent infringementlitigation, Allegra royalty revenue, government regulation, retention and recruitmentof employees, customer spending and business trends, foreign operations(including Singapore, India and Hungary), clinical supply manufacturing,management’s strategic plans, drug discovery, product commercialization,license arrangements, research and development projects and expenses, selling,general and administrative expenses and tax rates. The Company’s actual resultsmay differ materially from such forward-looking statements as a result ofnumerous factors, some of which the Company may not be able to predict and maynot be within 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,competition from domestic competitors and foreign companies operating underlower cost structures,  the loss of asignificant customer, sales of Allegra (including any deviations in salesestimates provided by Sanofi-Aventis) and the Company’s receipt of significantroyalties from the Allegra license agreement, the risk that Allegra may beapproved for over-the-counter use and Claritin’s approval for over-the-counteruse, the Company’s and Sanofi-Aventis’s ability to successfully enforce theirrespective intellectual property, patent rights and technology, including withrespect to the generic companies’ Abbreviated New Drug Application filings, theintegration and operating risks associated with the Company’s acquisition ofOrganichem, the Company’s ability to successfully develop novel compounds andlead candidates in its research programs and collaborative arrangements, theability of the Company’s pharmaceutical and biotech customers to bring theCompany’s novel compounds into clinical trials, the transition and expansion ofthe Company’s clinical supply manufacturing capabilities, the Company’s abilityto create long-term commercial manufacuturing opportunities in clinicial supplymanufacturing, the ability of the Company’s clinical supply manufactuing toassist the Company in recovering lost revenues resulting from the 2005discontinuation of purchases of one of the products the Company sold to GEHealthcare, sales of the remaining product the Company supplies to GEHealthcare, the Company’s performance under the collaboration with BMS, BMS’scontinuous utilization of the Company’s services at levels set forth in thecontract with BMS, BMS’s continued pursuit of programs under which the Companyprovides services, delay or denial of marketing approvals from the FDAresulting from, among other things, adverse FDA decisions or interpretations ofdata that differ from BMS’s interpretations and that may require additionalclinical trials or potential changes in the cost, scope and duration ofclinical trials, if approved, the inability to successfully launch, increasesales of or sustain the product or products in the market, the inability tosuccessfully and efficiently scale-up manufacturing for commercializedcompounds, the outcome of clinical work that will be required to commercializecompounds, the Company’s ability to take advantage of proprietary technologyand expand the scientific tools available to it, the ability of the Company’sstrategic investments and acquisitions to perform as expected and any goodwillimpairment related to such investments and acquisitions, the Company’s abilityto successfully complete its ongoing expansion projects on schedule, theCompany’s ability to raise the funds necessary to finance future acquisitions,the risks associated with international operations and managing ourinternational operations, especially in India, Singapore and Hungary, theCompany’s ability to capture revenue from the acquisition of ComGenex, theability of the Company to gain increased access to the European markets due tothe acquisition of ComGenex, the Company’s ability to execute its business planfor compound and chemical screening libraries, the Company’s ability toeffectively manage its growth, the ability of the Company to implement processmanagement improvements and cost savings initiatives to increase gross marginsor keep gross margins flat, the Company’s defined benefit pension plancontributions, liability for harm caused by drugs the Company develops andtests, liability for contamination or other harm caused by hazardous materialsused by the Company, failure to meet strict regulatory requirements, healthcare reform reducing the price pharmaceutical and biotechnology companiescan  charge for drugs, thus reducingresources available to retain our Company, and the possibility of a naturaldisaster, catastrophic event or terrorist attack, as well as those discussed inthe Company’s Annual Report on Form 10-K for the year ended December 31,2005 as filed with the Securities and Exchange Commission on March 16,2006, and as amended by Amendment No. 1 on Form 10-K/A filed with theSecurities and Exchange Commission on May 9, 2006. All forward-lookingstatements are made as of the date of this report, and we do not undertake toupdate any such forward-looking statements in the future. References to “we,” “us,”and “our,” refers to Albany Molecular Research, Inc. and its subsidiaries,taken as a whole.

 

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**Overview**

 

Weare a global chemistry-based drug discovery and development company, focused onidentifying and developing novel biologically active small molecules withapplications in the prescription drug market. We engage in comprehensivechemistry research from lead discovery, optimization and development tocommercial manufacturing and conduct cell and non-cell based high throughputscreening on a variety of biological targets. We perform research for many ofthe leading pharmaceutical and biotechnology companies and for our own internalresearch and development.

 

Inaddition to our contract services, we also conduct proprietary research anddevelopment to discover new therapeutically active lead compounds withcommercial potential. We anticipate that we would then license these compoundsto third parties in return for up-front service fees and milestone payments aswell as recurring royalty payments if these compounds are developed into newcommercial drugs. In October 2005, we licensed the worldwide rights todevelop and commercialize potential products from our amine neurotransmitterreuptake inhibitors identified in one of our proprietary research programs toBristol-Myers Squibb Company (BMS). Our proprietary research and developmentactivities previously led to the development, patenting and 1995 licensing of asubstantially pure form of, and a manufacturing process for, the activeingredient in the non-sedating antihistamine fexofenadine HCl marketed bySanofi-Aventis S.A. as Allegra in the Americas and as Telfast elsewhere.

 

Ourtotal revenue for the quarter ended March 31, 2006 was $43.4 million,as compared to $48.6 million for the quarter ended March 31, 2005. Recurringroyalty revenues decreased $4.8 million from the quarter ended March 31, 2005due to the impact of the at-risk launch of generic fexofenadine by BarrPharmaceuticals, Inc. and Teva Pharmaceuticals Industries Ltd. on U.S.sales of Allegra by Sanofi-Aventis.

 

Contractchemistry services revenue for the first quarter of 2006 was $36.2 million, comparedto $36.6 million in the first quarter of 2005. Discovery, development, andsmall scale manufacturing (DDS) revenues increased $3.3 million from thequarter ended March 31, 2005 due to increased worldwide demand for theseservices, the recognition of license fees resulting from our licensing andresearch agreement with BMS, and incremental revenues resulting from theFebruary 28, 2006 acquisition of ComGenex, a drug discovery service company inBudapest, Hungary. These increases were offset by a decrease in large scalemanufacturing revenue of $3.8 million, which resulted from the discontinuationof sales of one of the products sold to our large scale manufacturing (LSM)facility’s largest customer, GE Healthcare (GE). GE discontinued its purchasesof this product after the first half of 2005. Sales of this product totaled$10.0 million in the first quarter of 2005. This decrease was largely offset bythe continued diversification of our revenue streams. We increased revenue fromthe production of clinical supply materials for use in advance stage humantrials by $2.7 million, or 84%. The first quarter also experienced increaseddemand for the remaining product we supply to GE Healthcare, which contributedan additional $2.1 million of revenue. We expect total sales of this productfor 2006 to be relatively consistent with 2005. The decrease was further offsetby a $1.2 million increase in sales of commercial products to customers otherthan GE due to the timing of customer requirements. We expect total sales ofthese products for 2006 to be relatively consistent with 2005.

 

Consolidatedgross margin was 13.9% for the quarter ended March 31, 2006 compared to20.5% for the quarter ended March 31, 2005. Gross margin at the DDSoperating segment increased to 25.4% in the first quarter of 2006 compared to21.3% for the same period in 2005, primarily resulting from increased contractrevenues in relation to the fixed cost components of the DDS segment. Grossmargin at the LSM operating segment was 3.9% in the first quarter of 2006,compared with a gross margin of 20.0% in the first quarter of 2005 and 1.7% inthe fourth quarter of 2005. The decrease in gross margin from the first quarterof 2005 is due to the continued transition of our large-scale manufacturingfacility from specializing in the manufacturing of commercial products for onecustomer to the manufacturing of clinical supply compounds for numerouscustomers.

 

During thequarter ended March 31, 2006, we used $3.2 million****incash in our operations and spent $4.8 million in capital on our facilitiesand equipment, primarily related to the development of our enterprise resourceplanning (“ERP”) system, the outfitting of our laboratory facilities inSingapore and India, and the expansion of our large-scale manufacturing suites.In addition, we spent $11.2 million in conjunction with the acquisition ofComGenex. As of March 31, 2006, we had $107.8 million in cash, cashequivalents and investments and $22.0 million in bank and other relateddebt.

 

19

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Thetrends that began to emerge in chemistry outsourcing during 2005 continuedthrough the first quarter of 2006. We continued to experience strong demand forour developmental and small-scale cGMP manufacturing services, furtherextending a growth trend that began in the second half of 2004 that isreflective of a reduction in budgetary constraints and increased efforts tobring identified compounds into clinical trials on the part of ourpharmaceutical and biotech customers. Pricing for our services remainedextremely competitive, and the trend of sourcing contracted chemistry servicesto lower-cost providers continued. Our ability to provide discovery servicesunder a variety of business models and cost structures by incorporating ourlower cost international facilities that were established in India andSingapore in 2005 continued to be well-received by our customers. The resultingincrease in worldwide demand for our discovery services, which began in thelatter portion of 2005 and ended a two-year period of declining demand forthese services, continued during the first quarter of 2006. In addition, theacquisition of ComGenex on February 28, 2006 provided incremental discoveryservices revenues in the first quarter. We expect the acquisition of ComGenexto provide significantly increased access to European markets, as well asanother lower-cost environment that will allow us to further diversify thebusiness models and cost structures that are available to our customers.

 

Wealso continued to transition and expand our clinical supply manufacturingcapabilities at our large-scale manufacturing facility, enabling us toseamlessly transfer our customers’ clinical supply manufacturing projectsthrough the drug discovery and development process from the development ofthese materials at our smaller scale chemistry laboratories to large-scaleproduction for use in advanced stage human trials. Clinical supplymanufacturing supplements our large-scale facility’s legacy services, which include cGMP commercial production, aswell as high potency and controlled drug substance manufacturing, and isexpected to assist us in recovering lost revenues resulting from the 2005discontinuation of purchases of one of the products that we sold to GEHealthcare. Sales of this product totaled $17.0 million in 2005, whichrepresented 21% of large scale manufacturing revenue for the year endedDecember 31, 2005. In addition, clinical supply manufacturing presentsadditional commercial production opportunities, as we seek to enter intocomprehensive agreements with our customers that also provide for commercialsupply of these materials upon meeting regulatory approval. Clinical supplymanufacturing represented 31% of our large-scale manufacturing revenue in thefirst quarter of 2006, compared to 14% in the first quarter of 2005. We arecurrently exploring process enhancements and cost saving opportunities thatwill enable us to improve the efficiency and profitability of our LSM segment.We are also evaluating opportunities to leverage our large-scale cGMPproduction facilities, including identifying niche products to manufacture suchas active pharmaceutical ingredients (“API”) for use in generic versions ofcompounds whose patents have expired or will be expiring, as well as assessingcomplementary lines of business that support cGMP production.

 

**Results of Operations – Three Months EndedMarch 31, 2006 Compared to Three Months Ended March 31, 2005**

 

***Revenues***

 

*Total contract revenue*

 

Contract revenue consists primarily of fees earned under contracts withour third party customers. Our contract revenues for each of our DDS and LSMsegments were as follows:

 

| ** **              | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| **Segment**             | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| **(in thousands)** | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| DDS                     |       | $16,943                                              |       | $13,598 |   |
| LSM                     |       | 19,245                                               |       | 23,029 |   |
| Total                   |       | $36,188                                              |       | $36,627 |   |
|                         |            |                                                      |            |  |  |  |

 

DDS contract revenues for the quarter endedMarch 31 2006 increased $3.3 million to $16.9 million as compared to $13.6million for the same quarter in the prior year. The increase is due to anincrease in contract revenue from chemical development, small-scale GMPmanufacturing and analytical services of $1.7 million as customers continue tofocus on development-stage projects. In addition, discovery services revenueincreased $1.6 million due to the recognition of license fee and FTE servicerevenues resulting from our License and Research Agreement with BMS and strong demandfor discovery services provided through our lower-cost facilities in Singaporeand India, as well as the addition of $0.5 million in incremental revenue dueto the acquisition of ComGenex. We currently expect the overall growth trendsin DDS contract revenues noted above to continue in 2006.

 

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LSMcontract revenues for the first quarter of 2006 were $19.2 million, a decreaseof $3.8 million compared to contract revenue of $23.0 million during the firstquarter of 2005. The decrease was due to the discontinuation of purchases ofone of the products sold to our largest LSM customer, GE Healthcare. Sales ofthis product, which were discontinued in the third quarter of 2005, totaled$10.0 million in the first quarter of 2005. This decrease was largely offset bythe continued diversification of our revenue streams. Weincreased revenue from the production of clinical supply materials for use inadvance stage human trials by $2.7 million, or 84%. The first quarter alsoexperienced increased demand for the remaining product we supply to GEHealthcare, which contributed an additional $2.1 million of revenue. We currentlyexpect total sales of this product for 2006 to be relatively consistent with2005. The decrease was further offset by a $1.2 million increase in sales ofcommercial products to customers other than GE due to the timing of customerrequirements. We expect total sales of these products for 2006 to be relativelyconsistent with 2005. We continue to expand our clinical supply manufacturingcapabilities with the objectives of supplementing and replacing existing anddiscontinued commercial manufacturing revenues. In addition, we currently expectclinical supply manufacturing to serve as a source for additional long-termcommercial manufacturing opportunities, as we seek to enter into comprehensiveagreements with our customers that also provide for commercial supply of thesematerials upon meeting regulatory approval. Clinical supply manufacturingrevenue represented 31% of total LSM contract revenue for the quarter endedMarch 31, 2006, compared to 14% of total LSM contract revenue for thequarter ended March 31, 2005. We currently expect the trend of increasedgrowth in clinical supply manufacturing to continue in 2006.

 

*Recurring royalty revenue*

 

We earn royalties under our licensing agreement with Sanofi-AventisS.A. for the active ingredient in Allegra/Telfast. Royalties were as follows:

 

| **(in thousands)  Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|
| **2006**                                                                  | ** ** | **2005** | ** ** |
| $                                                                         | 7,178      |   | $ | 12,007 |   |
|                                                                           |            |  |  |  |  |

 

Recurringroyalties decreased 40% to $7.2 million for the quarter ended March 31, 2006from $12.0 million for the quarter ended March 31, 2005. The decrease is primarilyattributable to the at-risk launch of generic fexofenadine by BarrPharmaceuticals, Inc. and Teva Pharmaceuticals Industries Ltd. inSeptember 2005, which has had a material adverse impact on U.S. sales ofAllegra.

 

Therecurring royalties we receive on the sales of Allegra/Telfast havehistorically provided a material portion of our revenues, earnings, andoperating cash flows. We currently expect that the at risk-launch of genericfexofenadine will have a similar impact on our royalty revenues in futureperiods. We expect to experience a decrease in revenues, earnings, andoperating cash flows in the short term as we continue to develop our businessin an effort to supplement the revenues, earnings and operating cash flows thathave historically been provided by Allegra/Telfast royalties.

 

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

 

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***Costs and Expenses***

 

*Cost of contract revenue*

 

Our cost of contract revenue, from which we derive gross profit fromcontract revenue, consists primarily of compensation and associated fringebenefits for employees, chemicals, depreciation and other indirect projectrelated costs. Cost of contract revenue for our DDS and LSM segments were asfollows:

 
| **Segment**             | ** **   | **Three Months Ended  March 31,** | ** **   |
|-------------------------|--------------|--------------------------------------------------|--------------|
| **2006**                | ** **   | **2005**                                         | ** **   |
| **(in thousands)** | *** *** | *** ***                                     | *** *** | *** *** | *** *** |
| DDS                     |         | $12,645                                          |         | $10,704 |   |
| LSM                     |         | 18,498                                           |         | 18,432 |   |
| Total                   |         | $31,143                                          |         | $29,136 |   |
|                    |         |                                             |         |   |   |
| DDS Gross  Margin       |         | 25.4                                             | %            | 21.3 | % |
| LSM Gross  Margin       |         | 3.9                                              | %            | 20.0 | % |
| Total Gross  Margin     |         | 13.9                                             | %            | 20.5 | % |
|                         |              |                                                  |              |  |  |  |  |

 

DDS contract revenue gross margin was 25.4% for the three months endedMarch 31, 2006, compared to 21.3% for the same period in 2005. Theincrease in gross margin largely resulted from the increase in contractrevenues in relation to the fixed cost components of  DDS contract business, including the additionof license fee revenues associated with our Licensing and Research Agreementwith BMS. The recognition of license fees contributed approximately $0.7million to DDS contract revenue, with no corresponding incremental costs. DDScontract gross margin was also favorably impacted by a $0.3 million decrease inthe amortization of the Company’s chemical compound and natural product libraryinventories due to the impairment of these libraries in the fourth quarter of2005. This item was offset by increased salary and benefit expenses due toannual merit increases and the recognition of additional share-basedcompensation expense in conjunction with the Company’s adoption of SFAS No. 123(R).We currently expect DDS contract margins to increase slightly in future periodsfrom the margins earned in the first quarter of 2006, as forecasted increasesin DDS contract revenue are expected to continue to have a favorable impact onthe fixed cost components of DDS contract business.

 

LSM contract revenue gross margin was 3.9% for the three months endedMarch 31, 2006 compared to 20.0% for the first quarter of 2005 and 1.7% inthe fourth quarter of 2005. The decline in gross margin from the first quarterof 2005 is due to the transition of our large-scale manufacturing facility fromspecializing in the manufacturing of commercial products to the manufacturingof clinical supply compounds for use in human trials. We currently expect grossmargins to increase in future periods from the margins earned in the firstquarter of 2006 as we continue to implement process management improvements andcost savings initiatives in an effort to maximize the efficiency andprofitability of our clinical supply manufacturing operations.

 

*Technology incentive award*

 

We maintain a Technology Development Incentive Plan, the purpose ofwhich is to stimulate and encourage novel innovative technology development byour employees. This plan allows eligible participants to share in a percentageof the net revenue earned by us relating to patented technology with respect towhich the eligible participant is named as an inventor. Currently, TechnologyDevelopment Incentive Plan award expenses consist primarily of payments to Dr.Thomas D’Ambra, the Chairman, President, and Chief Executive Officer of theCompany as the sole inventor of the patents for fexofenadine HCl, and are equalto 10% of the total payments received by us with respect to those patents. Theincentive award was as follows:

 

| **(in thousands)  Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|
| **2006**                                                                  | ** ** | **2005** | ** ** |
|                                                                      |       |   |   |
| $                                                                         | 798        |   | $ | 1,201 |   |
|                                                                           |            |  |  |  |  |

 

The decrease was attributed to decreased Allegra royalties for 2006 ascompared to 2005, partially offset by technology incentive awards paid toemployees involved in the development our proprietary amine neurotransmitterreuptake inhibitors as a result of the successful licensing of this technologyto BMS.

 

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*Research and development*

 

Research anddevelopment expense consists of compensation and benefits for scientificpersonnel for work performed on proprietary technology development, researchprojects, costs of chemicals and other out of pocket costs, and overhead costs.We utilize our expertise in small molecule chemistry, biocatalysis and naturalproducts to perform our internal research and development projects. The goal ofthese programs is to discover new compounds with commercial potential. We wouldthen seek to license these compounds to a third party in return for a combinationof up-front license fees, milestone payments and recurring royalty payments ifthese compounds are successfully developed into new drugs and reach the market.In addition, research and development is performed at our large-scalemanufacturing facility related to the potential manufacture of new products andthe development of alternative manufacturing processes.

 

Research and development expenses were as follows:

 

| **(in thousands)  Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|
| **2006**                                                                  | ** ** | **2005** | ** ** |
|                                                                      |       |   |   |
| $                                                                         | 2,711      |   | $ | 3,489 |   |
|                                                                           |            |  |  |  |  |

 

Thedecrease  in R&D expenses for thequarter ended March 31, 2006 compared to the quarter ended March 31, 2005 isdue primarily to the fact that we licensed our CNS programs, which representedour 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.We currently expect R&D expenses to remain consistent in future periodsfrom the amounts incurred in the first quarter of 2006 as we continue toevaluate and advance our early to middle-stage internal research programs.

 

R&D spendingrelated to individual projects may fluctuate based on the results of thoseprojects. Projecting expected project completion dates and anticipated revenuefrom our internal research programs is not practical at this time due to theearly stages of the projects and the inherent risks related to the developmentof new drugs. Our internal central nervous system program was our most advancedproject to date, which we licensed to BMS in exchange for up-front licensefees, contracted research services, and the rights to future milestone androyalty payments. We also continue to utilize ourproprietary technologies to further advance other early to middle-stageinternal research programs in the fields of oncology, immunosuppresion,bacterial infection and other diseases, with a view to seeking a licensingpartner for these programs at an appropriate research or developmental stage.

 

*Selling, general and administrative*

 

Selling, general and administrative expenses consist of compensationand related fringe benefits for marketing and administrative employees,professional service fees, marketing costs and all costs related to facilitiesand information services. Selling, general and administrative expenses were asfollows:

 

| **(in thousands)  Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|
| **2006**                                                                  | ** ** | **2005** | ** ** |
|                                                                      |       |   |   |
| $                                                                         | 6,761      |   | $ | 6,452 |   |
|                                                                           |            |  |  |  |  |

 

Theincrease in selling, general and administrative expenses for the first quarterof 2006 is attributable primarily to incremental administrative costs incurredat our Hyderabad, India research facility, which was not operating in the firstquarter of 2005, as well as incremental administrative costs incurred atComGenex, which was acquired in February 2006. In addition, compensation andbenefit costs increased approximately $0.6 million from the first quarter of2005 due to the addition of administrative and business development personnelduring 2005 and the recognition of additional share-based compensation expense inconjunction with the Company’s adoption of SFAS No. 123 (R). The Company alsoincurred additional travel costs associated with our international operations. Theseincreases were largely offset by a refund of property taxes at our Mt. Prospectfacility and a decrease in accounting and professional fees related to auditand Sarbanes-Oxley compliance services.

 

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Wecurrently expect selling, general and administrative expenses to increase infuture periods from amounts incurred in the first quarter of 2006, due toadditional recruiting costs associated with the staffing of scientific andbusiness development personnel at both our domestic and internationaloperations resulting from the anticipated increased demand for our contractservices, as well as the fact that the benefit recognized from the refund ofMt. Prospect property taxes is not a recurring item. Selling, general andadministrative expenses are also expected to increase in future periods due tothe recognition of incremental administrative costs incurred at ComGenex. Thesecosts  were included in the Company’sunaudited condensed consolidated statement of income for approximately onemonth during the quarter ended March 31, 2006 based on the acquisition ofComGenex on February 28, 2006.

 

*Interest income (expense), net*

 

| ** **                     | ** ** | **(in thousands)  Three Months Ended March 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| Interest (expense)             |       | $                                                                         | (263       | ) | $ | (478 | ) |
| Interest income                |       | 984                                                                       |       | 678 |   |
| Interest income (expense), net |       | $                                                                         | 721        |   | $ | 200 |   |

 

The decrease in interest expense for the three months endedMarch 31, 2006 was due to the paydown of the $25.5 million outstandingbalance on the Company’s line of credit in the third quarter of 2005.

 

The increase in interest income was due to increases in the ratesearned on investment securities, interest bearing cash accounts and othershort-term cash equivalents.

 

*Income tax expense*

 

| **(in thousands)  Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|
| **2006**                                                                  | ** ** | **2005** | ** ** |
|                                                                      |       |   |   |
| $                                                                         | 812        |   | $ | 2,962 |   |
|                                                                           |            |  |  |  |  |

 

The decrease in income tax expense for the three months endedMarch 31, 2006 is due primarily to the decrease in our pre-tax income fromthe prior year. In addition, the Company’s effective tax rate decreased to30.0% of pre-tax income for the three months ended March 31, 2006 comparedto 34.6% for the three months ended March 31, 2005. The decrease ineffective rate is largely due to the consistency of the Company’s deductibleitems and non-taxable earnings in relation to decreased pre-tax income, as wellas the benefit recognized from tax holidays that the Company has been grantedon earnings from certain of its foreign operations.

 

**Liquidity and Capital Resources**

 

Wehave historically funded our business through operating cash flows, proceedsfrom borrowings and the issuance of equity securities. During the first quarterof 2006, we used cash of $3.2 million in our operating activities. Cash used inoperations during the first quarter of 2006 decreased from cash provided fromoperations of $7.2 million during the first quarter of 2005 due to a decreasein Allegra royalty receipts of $5.7 million and an increase in income taxpayments of $4.7 million, including a one-time $2.8 million income taxpayment related to the receipt of the $8 million license fee from Bristol-MyersSquibb Company (“BMS”) in the fourth quarter of 2005. The primary sources of operating cash flowsare payments received for the performance of contracted chemistry services androyalty payments received from Sanofi-Aventis based upon a percentage of salesof Allegra/Telfast. 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 substantialmajority of the uses of operating cash flows pertain to the Company’s researchand development and contract service business activities.

 

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During the first three months of 2006, we used $6.8 million ininvesting activities, resulting from the use of $11.2 million related to theacquisition of ComGenex and $4.8 million for the acquisition of property andequipment, partially offset by net proceeds from investment securitiestransactions of $9.3 million. During the first three months of 2006, we used $0.9million for financing activities, consisting of $1.1 million in long-term debtrepayments, offset by $0.2 million provided by stock purchase plan exercises.

 

Working capital was $146.7 million at March 31, 2006 as comparedto $158.8 million as of December 31, 2005. The primary sources of the decreasewere the use of cash and investments to fund capital expenditures and theacquisition of ComGenex, and a decrease in inventory due to the timing ofshipments to our large scale manufacturing customers. These decreases were partiallyoffset by a decrease in deferred revenue due primarily to the recognition ofdeferred up-front licensing fees received in conjunction with our Licensing andResearch Agreement with BMS as well as the completion of the revenuerecognition process on several fixed fee contracts. During 2006, we currently anticipatemaking $1.0 million in defined benefit pension plan contributions, $0.5 millionof which was paid in the first quarter. There have been no significant changesin future maturities on our long-term debt since December 31, 2005.

 

We entered into a credit facility consisting of a $30.0 million termloan and a $35.0 million line of credit during 2003. The term loan matures inFebruary, 2008. As of March 31, 2006, the interest rate on $12.1 millionof the outstanding term loan balance was 4.36% and the interest rate on theremaining $6.1 million was 5.53%. The line of credit matures in June, 2010.The line of credit bears interest at a variable rate based on the Company’sleverage ratio. As of March 31, 2006, the outstanding balance of the line ofcredit was $0. The credit facility contains certain financial covenants,including a maximum leverage ratio, a minimum required operating cash flowcoverage ratio, a minimum earnings before interest and taxes to interest ratioand a minimum current ratio. Other covenants include limits on asset disposalsand the payment of dividends. As of March 31, 2006 we were in compliance withall covenants under the credit facility.

 

The disclosure of payments we have committed to make under ourcontractual obligations is set forth under the heading “Management’s Discussionand Analysis of Financial Condition and Results of Operations—Liquidity andCapital Resources” under Item 7 of our 2005 Form 10-K. Excluding therepayment of $1.1 million outstanding under our credit facility, and $0.5million in defined benefit pension plan contributions, as described above,there have been no material changes to our contractual obligations since December 31,2005.

 

We are pursuing the expansion of our operations through internal growthand strategic acquisitions. We expect that such activities will be funded fromexisting cash and cash equivalents, cash flow from operations, the issuance ofdebt or equity securities and borrowings. Future acquisitions, if any, could befunded with cash on hand, cash from operations, borrowings under our creditfacility and/or the issuance of equity or debt securities. There can be noassurance that attractive acquisition opportunities will be available to us orwill be available at prices and upon such other terms that are attractive tous. We regularly evaluate potential acquisitions of other businesses, productsand product lines and may hold discussions regarding such potentialacquisitions. As a general rule, we will publicly announce such acquisitionsonly after a definitive agreement has been signed. In addition, in order tomeet our long-term liquidity needs or consummate future acquisitions, we mayincur additional indebtedness or issue additional equity or debt securities,subject to market and other conditions. There can be no assurance that suchadditional financing will be available on terms acceptable to us or at all. Thefailure to raise the funds necessary to finance our future cash requirements orconsummate future acquisitions could adversely affect our ability to pursue ourstrategy and could negatively affect our operations in future periods. Furthermore,a continued significant decrease in royalties from Allegra would negativelyaffect our cash flow from operations and financial condition in future periods.

 

The recurring royalties we receive on the sales of Allegra/Telfast havehistorically provided a material portion of our operating cash flows. Asdiscussed in Part II, Item 1 of this Form 10-Q, several genericmanufacturers have filed ANDA applications with the FDA seeking authorizationto produce and market a generic version of Allegra. We and AventisPharmaceuticals have filed several patent infringement suits against thesegeneric 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 and Aventis Pharmaceuticals filed aMotion for Preliminary Injunction in the U.S. District Court in New Jerseyseeking to enjoin Barr Pharmaceuticals, Inc., Teva Pharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and AminoChemicals, Ltd. from the sale of generic versions of Allegra in the UnitedStates. Our motion was denied on January 30, 2006. We continue toforcefully and vigorously defend our intellectual property related to Allegra.We have filed an appeal of the ruling in the Preliminary Injunction matter, andwe continue to pursue our intellectual property rights as the patentinfringement litigation progresses.

 

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However, should we or Aventis be unsuccessful in defending thesepatents we would continue to experience a material decrease in royalty revenuesand operating cash flows.

 

**Critical Accounting Policies and Estimates**

 

Ourdiscussion and analysis of our financial condition and results of operationsare based upon our consolidated financial statements, which have been preparedin accordance with U.S. generally accepted accounting principles. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, we evaluate our estimates, including those related to baddebts, inventories, intangible assets, equity investments, unbilled revenue,income taxes and contingencies. We base our estimates on historical experienceand on various other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.

 

We refer to the policies and estimates set forth in the section “Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Critical Accounting Estimates” of our Annual Report on Form 10-K for the fiscalyear ended December 31, 2005. There have been no material changes ormodifications to the policies since December 31, 2005, except as follows:

 

Effective January 1, 2006, the Company adopted SFAS No. 123 (Revised2004), “Share-Based Payment” (SFAS No. 123 (R)), which amends SFASNo. 123 and supersedes APB No. 25**inestablishing standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services, as well as transactionsin which an entity incurs liabilities in exchange for goods or services thatare based on the fair value of the entity’s equity instruments or that may besettled by the issuance of those equity instruments. This Statement requiresthat the cost resulting from all share-based payment transactions be recognizedin the financial statements based on the fair value of the share-based payment.This Statement establishes fair value as the measurement objective inaccounting for share-based payment transactions with employees, except forequity instruments held by employee share ownership plans.

 

As allowed under SFAS No. 123 (R), theCompany elected the modified prospective method of adoption, under whichcompensation cost is recognized in the financial statements beginning with theeffective date of SFAS No. 123 (R) for all share-based payments grantedafter that date, and for all unvested awards granted prior to the effectivedate of SFAS No. 123 (R). Accordingly, prior period amounts have not beenrestated. The Company recognized incremental compensation expense, net oftaxes, of approximately $71,000 in the unaudited condensed consolidatedstatement of income during the quarter ended March 31, 2006 as a result of theadoption of SFAS No. 123 (R).

 

Effective December 30, 2005, pursuant toand in accordance 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 that was held by employees, officers, andnon-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 millionshares of the Company’s common stock, including approximately 101,000 optionsheld by executive officers, were subject to this acceleration.

 

The Committee also required that, as a conditionto the 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 Company’sstock option plan.

 

The decision to accelerate the vesting ofthese underwater options was made primarily to minimize certain futurecompensation expenses that the Company would otherwise recognize in itsconsolidated statements of income with respect to these options pursuant toSFAS No. 123 (R). The Company also believes that the acceleration may havea positive effect on employee morale, retention and the perception of optionvalue.

 

Please see Note 8 to the unaudited condensedconsolidated financial statements for additional information regarding theCompany’s share-based payment plans and the implementation of SFAS No. 123 (R).

 

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Item3. Quantitative and Qualitative Disclosures about Market Risk

 

There are nomaterial changes in market risks since our annual report on Form 10-K for the yearended December 31, 2005.

 

Item4. Controls and Procedures

 

*DisclosureControls and Procedures*

 

As required byrule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), as of the end of the period covered by this Quarterly Report ourmanagement conducted an evaluation with the participation of our ChiefExecutive Officer and Chief Financial Officer, regarding the effectiveness ofour disclosure controls and procedures. In designing and evaluating ourdisclosure controls and procedures, we recognize that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and ourmanagement necessarily was required to apply its judgment in evaluating andimplementing possible controls and procedures. Based upon that evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that, as ofthe end of the period covered by this Quarterly Report, our disclosure controlsand procedures were effective in that they provide reasonable assurance thatinformation required to be disclosed by us in the reports we file or submitunder the Exchange Act is recorded, processed, summarized and reported, withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms. We intend to review and document our disclosure controls andprocedures, including our internal controls and procedures for financialreporting, on an ongoing basis, and may from time to time make changes aimed atenhancing their effectiveness and to ensure that our systems evolve with ourbusiness.

 

*InternalControl Over Financial Reporting*

 

During the quarter ended March 31, 2006, the Company had a change inits internal control over financial reporting related to the outsourcing of itspayroll processing to ADP. Apart from this item, there were no changes in theCompany’s internal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1.    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,we are not currently a party to any such claims or proceedings which, ifdecided adversely to us, would either individually or in the aggregate have amaterial adverse effect on our business, financial condition, results ofoperations or cash flows.

 

AMR Technology, a subsidiary of the Company, along with AventisPharmaceuticals Inc., the U.S. pharmaceutical business of Sanofi-Aventis S.A.,are involved in legal proceedings with several companies seeking to marketgeneric versions of Allegra. Beginning in 2001, Barr Laboratories, Inc., ImpaxLaboratories, Inc., Mylan Pharmaceuticals, Inc., Teva Pharmaceuticals USA, Dr.Reddy’s Laboratories, Ltd./Dr. Reddy’s Laboratories, Inc., Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., and Sandoz Inc. filed Abbreviated New DrugApplications (ANDAs) with the U.S. Food and Drug Administration, or FDA, toproduce and market generic versions of Allegra products.

 

In response to the filings described above, beginning in 2001, AventisPharmaceuticals filed patent infringement lawsuits against Barr Laboratories,Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc., andSandoz. Each of the lawsuits was filed in the U.S. District Court in New Jerseyand alleges infringement of one or more patents owned by AventisPharmaceuticals. Further, beginning in March 5, 2004, AMR Technology, alongwith Aventis Pharmaceuticals, filed suit in the U.S. District Court in NewJersey against Barr Laboratories, Impax Laboratories, Mylan Pharmaceuticals,Teva Pharmaceuticals, Dr. Reddy’s Laboratories, Amino Chemicals, Ltd., RanbaxyLaboratories Ltd./Ranbaxy Pharmaceuticals Inc., and Sandoz, Inc., assertinginfringement of two of our U.S. patents that are exclusively licensed toAventis Pharmaceuticals relating to Allegra and Allegra-D products.

 

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In the pending litigations, Aventis Pharmaceuticals and AMR Technologyhave entered into covenants not to sue the defendants under U.S. Patent No.5,578,610, which patent has not been asserted in the litigation but whichAventis Pharmaceuticals 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 thepatents are earlier determined to be invalid.

 

Under applicable federal law, marketing of an FDA-approved genericversion of Allegra may not commence until the earlier of a decision favorableto the generic challenger in the patent litigation or 30 months after the datethe patent infringement lawsuit was filed. In general, the first generic fileris entitled to a 180-day marketing exclusivity period upon FDA approval.

 

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

 

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

 

Should the Company be unsuccessful in defending these patents, theCompany would continue to experience a material decrease in operating cashflows and a material adverse effect on our results of operations and financialcondition.

 

Item 1A. Risk Factors

 

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-Kfor the year ended December 31, 2005, which could materially affect ourbusiness, financial condition or future results. The risks described in ourAnnual Report on Form 10-K are not the only risks facing our Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.

 

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Item 6.    Exhibits

 

(a)       Exhibits.

 
| 2.1    |   | Stock  Purchase Agreement, dated January 27, 2006, between Albany Molecular  Research, Inc. and ConGenex  Kutato-Fejleszto Rt. (filed herewith).                  |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                              |
| 10.1*  |   | Amended and  Revised Technology Development Incentive Plan, dated October 14, 2003 (filed herewith).                                                              |
|   |   |                                                                                                                                                              |
| 31.2   |   | Certification of the Chief Financial Officer pursuant to Rule  13a-14(a)/15d-14(a) of the Security 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. |

 

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* Denotes a management contract or a compensation plan or arrangement.

 

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 theundersigned, thereunto duly authorized.

 

 
|               | ALBANY MOLECULAR RESEARCH, INC. |
|--------------------|---------------------------------|
|               |                            |   |
|               |                            |   |
| Date: May 10, 2006 | By:                             | /s/ Thomas E. D’Ambra, Ph.D. |   |
|               |                            | Thomas E. D’Ambra, Ph.D. |
|               |                            | Chairman of the Board, President and Chief Executive  Officer |
|               |                            | (Authorized Officer) |

 

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