**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**ý****                                ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For theQuarterly Period Ended June 30, 2006**

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

** **

**For the transition period from              to              **

**Commissionfile number:  0-25323**

**ALBANYMOLECULAR RESEARCH, INC.**

(Exact name ofregistrant as specified in its 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 executive offices)

**(518) 464-0279**

(Registrant’s telephone number, includingarea code)

**N/A**

(Former name, former address and formerfiscal 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 |   | x |   | 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 x |   | Non-accelerated  filer o |
|---------------------------|--------|----------------------|--------|--------------------------|

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

| Yes |   | o |   | No |   | x |
|-----|--------|---|--------|----|--------|---|

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

| **Class**                     |   | **Outstanding at August 1, 2006** |
|-------------------------------|--------|-------------------------------------------------------|
| Common Stock,  $.01 par value |   | 34,663,678                                            |

 

 

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ALBANY MOLECULAR RESEARCH, INC.

INDEX

| Part I.       | Financial  Information |                                                                                        |
|--------------------|------------------------|---------------------------------------------------------------------------------------------|
|               |                   |                                                                                        |   |
|               | Item  1.               | Condensed  Consolidated Financial Statements (Unaudited)                                    |   |
|               |                   |                                                                                        |   |
|               |                   | Condensed  Consolidated Statements of Operations                                            |   |
|               |                   | 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 3.                | Quantitative  & Qualitative Disclosures about Market Risk                               |   |
|               |                   |                                                                                        |   |
|               | Item 4.                | Submission of  Matters to a Vote of Security Holders                                        |   |
|               |                   |                                                                                        |   |
|               | Item  6.               | Exhibits                                                                                    |   |
|               |                   |                                                                                        |   |
| Signatures         |                   |                                                                                        |
|               |                   |                                                                                        |   |
| Exhibit Index |                   |                                                                                        |

 

2

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**PART I— FINANCIAL INFORMATION**

**Item 1.**    Condensed Consolidated Financial Statements

**AlbanyMolecular Research, Inc.**

**Condensed Consolidated Statements of Operations**

**(unaudited)**

 

| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(Dollars in  thousands, except for per share data)** | ** ** | **June 30, 2006**      | ** ** | **June 30, 2005**    | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Contract revenue                                       |       | $                                | 38,383     |                           | $          | 35,948 |   | $ | 74,571 |   | $ | 72,574 |   |
| Recurring royalties                                    |       | 7,200                            |       | 15,892                         |       | 14,378 |   | 27,900 |   |
| Total revenue                                          |       | 45,583                           |       | 51,840                         |       | 88,949 |   | 100,474 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Cost of contract  revenue                              |       | 32,489                           |       | 29,327                         |       | 63,632 |   | 58,463 |   |
| Technology incentive  award                            |       | 720                              |       | 1,594                          |       | 1,518 |   | 2,795 |   |
| Research and  development                              |       | 2,631                            |       | 3,480                          |       | 5,342 |   | 6,969 |   |
| Selling, general and  administrative                   |       | 7,786                            |       | 6,394                          |       | 14,547 |   | 12,846 |   |
| Property and equipment  impairment                     |       | 3,084                            |       | —                         |       | 3,084 |   | — |   |
| Total costs and  expenses                              |       | 46,710                           |       | 40,795                         |       | 88,123 |   | 81,073 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| (Loss) income from  operations                         |       | (1,127                           | )          | 11,045                         |       | 826 |   | 19,401 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Interest income, net                                   |       | 666                              |       | 320                            |       | 1,387 |   | 520 |   |
| Other (loss) income,  net                              |       | (120                             | )          | 67                             |       | (88 | ) | 70 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| (Loss) income before  income tax (benefit) expense     |       | (581                             | )          | 11,432                         |       | 2,125 |   | 19,991 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Income tax (benefit)  expense                          |       | (228                             | )          | 4,138                          |       | 584 |   | 7,101 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Net (loss) income                                      |       | $                                | (353       | )                              | $          | 7,294 |   | $ | 1,541 |   | $ | 12,890 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Basic (loss) earnings  per share                       |       | $                                | (0.01      | )                              | $          | 0.23 |   | $ | 0.05 |   | $ | 0.40 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Diluted earnings (loss) per share                      |       | $                                | (0.01      | )                              | $          | 0.23 |   | $ | 0.05 |   | $ | 0.40 |   |

 

*See notesto unaudited condensed consolidated financial statements.*

3

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**Albany MolecularResearch, Inc.**

**Condensed Consolidated Balance Sheets**

**(unaudited)**

 

| **(Dollars and share amounts in thousands)**                                                                                      | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                       |       |                    |       |                        |       |
| **Assets**                                                                                                                                                 |       |                    |       |                        |       |
| Current assets:                                                                                                                                            |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                 |       | $                       | 15,042     |                        | $          | 27,606 |   |
| Investment  securities, available-for-sale                                                                                                                 |       | 92,000                  |       | 100,304                     |       |
| Accounts  receivable, net                                                                                                                                  |       | 21,841                  |       | 22,238                      |       |
| Royalty income  receivable                                                                                                                                 |       | 7,148                   |       | 6,247                       |       |
| Inventories                                                                                                                                                |       | 24,932                  |       | 30,603                      |       |
| Prepaid expenses  and other current assets                                                                                                                 |       | 7,272                   |       | 6,391                       |       |
| Property and  equipment held for sale                                                                                                                      |       | 2,000                   |       | 5,376                       |       |
| Total current  assets                                                                                                                                      |       | 170,235                 |       | 198,765                     |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Property, plant and  equipment, net                                                                                                                        |       | 154,955                 |       | 151,078                     |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Other assets:                                                                                                                                              |       |                    |       |                        |       |
| Goodwill                                                                                                                                                   |       | 35,511                  |       | 25,747                      |       |
| Intangible  assets and patents, net                                                                                                                        |       | 1,660                   |       | 1,434                       |       |
| Equity  investments in unconsolidated affiliates                                                                                                           |       | 956                     |       | 956                         |       |
| Other assets                                                                                                                                               |       | 1,693                   |       | 1,202                       |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Total assets                                                                                                                                               |       | $                       | 365,010    |                        | $          | 379,182 |   |
|                                                                                                                                                       |       |                    |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                             |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                       |       |                    |       |                        |       |
| Accounts payable  and accrued expenses                                                                                                                     |       | $                       | 9,463      |                        | $          | 14,375 |   |
| Deferred revenue                                                                                                                                           |       | 8,733                   |       | 12,537                      |       |
| Accrued pension  benefits                                                                                                                                  |       | 1,014                   |       | 1,014                       |       |
| Income taxes  payable                                                                                                                                      |       | 3,510                   |       | 7,466                       |       |
| Current  installments of long-term debt                                                                                                                    |       | 4,541                   |       | 4,536                       |       |
| Total current  liabilities                                                                                                                                 |       | 27,261                  |       | 39,928                      |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Long-term liabilities:                                                                                                                                     |       |                    |       |                        |       |
| Long-term debt,  excluding current installments                                                                                                            |       | 16,135                  |       | 18,521                      |       |
| Deferred income  taxes                                                                                                                                     |       | 4,422                   |       | 5,080                       |       |
| Pension and  postretirement benefits                                                                                                                       |       | 1,600                   |       | 2,356                       |       |
| Other long term  liabilities                                                                                                                               |       | 236                     |       | 236                         |       |
| Total  liabilities                                                                                                                                         |       | 49,654                  |       | 66,121                      |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Commitments and  contingencies                                                                                                                             |       |                    |       |                        |       |
|                                                                                                                                                       |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                 |       |                    |       |                        |       |
| Common stock,  $0.01 par value, 100,000 shares authorized, 34,663 shares issued at  June 30, 2006, and 34,471 shares issued at December 31, 2005 |       | 347                     |       | 345                         |       |
| Additional  paid-in capital                                                                                                                                |       | 195,282                 |       | 193,066                     |       |
| Unearned  compensation — restricted stock                                                                                                             |       | (3,305                  | )          | (1,921                      | )          |
| Accumulated  other comprehensive loss                                                                                                                      |       | (475                    | )          | (395                        | )          |
| Retained  earnings                                                                                                                                         |       | 160,678                 |       | 159,137                     |       |
| Less, treasury shares  at cost, 2,077 shares                                                                                                               |       | (37,171                 | )          | (37,171                     | )          |
| Total  stockholders’ equity                                                                                                                           |       | 315,356                 |       | 313,061                     |       |
| Total liabilities and stockholders’ equity                                                                                                            |       | $                       | 365,010    |                        | $          | 379,182 |   |

 

*See notesto unaudited condensed consolidated financial statements.*

4

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**AlbanyMolecular Research, Inc.**

**Condensed Consolidated Statements of Cash Flows**

**(unaudited)**

 

 

| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| **(Dollars in thousands)**                                               | ** ** | **June 30, 2006**    | ** ** | **June 30, 2005** | ** ** |
|                                                                               |       |                           |       |   |   |
| **Operating activities**                                                           |       |                           |       |   |   |
| Net income                                                                         |       | $                              | 1,541      |   | $ | 12,890 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                           |       |   |   |
| Depreciation and  amortization                                                     |       | 7,472                          |       | 7,765 |   |
| Foreign exchange  loss                                                             |       | 1                              |       | 13 |   |
| Provision for  bad debts                                                           |       | —                         |       | (72 | ) |
| Deferred income  tax (benefit) expense                                             |       | (689                           | )          | 325 |   |
| Loss on disposal  of property, plant and equipment                                 |       | 35                             |       | 16 |   |
| Stock-based  compensation expense                                                  |       | 522                            |       | 161 |   |
| Impairment of  property, plant and equipment                                       |       | 3,084                          |       | — |   |
| Provision for  obsolete inventories                                                |       | 1,062                          |       | — |   |
| (Increase)  decrease in:                                                           |       |                           |       |   |   |
| Accounts  receivable                                                               |       | 1,398                          |       | (6,168 | ) |
| Royalty income  receivable                                                         |       | (901                           | )          | (3,695 | ) |
| Inventory,  prepaid expenses and other assets                                      |       | 4,406                          |       | 1,191 |   |
| (Decrease)  increase in:                                                           |       |                           |       |   |   |
| Accounts payable  and accrued expenses                                             |       | (5,774                         | )          | (2,655 | ) |
| Income tax  payable                                                                |       | (3,938                         | )          | 6,118 |   |
| Deferred revenue                                                                   |       | (4,923                         | )          | 1,876 |   |
| Pension and  postretirement benefits                                               |       | (756                           | )          | (402 | ) |
| Other long-term  liabilities                                                       |       | —                         |       | 195 |   |
| Net cash provided by  operating activities                                         |       | 2,540                          |       | 17,558 |   |
|                                                                               |       |                           |       |   |   |
| **Investing activities**                                                           |       |                           |       |   |   |
| Net purchases of  investment securities                                            |       | (78,040                        | )          | (60,842 | ) |
| Proceeds from  sale of investment securities                                       |       | 86,250                         |       | 55,968 |   |
| Purchase of  business, net of cash acquired                                        |       | (11,198                        | )          | — |   |
| Purchase of  property, plant and equipment                                         |       | (9,740                         | )          | (6,574 | ) |
| Proceeds from  disposal of property, plant and equipment                           |       | 20                             |       | 7 |   |
| Payments for  patent applications and other costs                                  |       | (98                            | )          | (98 | ) |
| Net cash used in  investing activities                                             |       | (12,806                        | )          | (11,539 | ) |
|                                                                               |       |                           |       |   |   |
| **Financing activities**                                                           |       |                           |       |   |   |
| Principal  payments on long-term debt                                              |       | (2,443                         | )          | (2,378 | ) |
| Proceeds from  sale of common stock                                                |       | 276                            |       | 947 |   |
| Tax benefit from  exercise of stock options                                        |       | —                         |       | 356 |   |
| Net cash used in  financing activities                                             |       | (2,167                         | )          | (1,075 | ) |
|                                                                               |       |                           |       |   |   |
| Effect of exchange rate  changes on cash flows                                     |       | (131                           | )          | (50 | ) |
|                                                                               |       |                           |       |   |   |
| (Decrease) increase in  cash and cash equivalents                                  |       | (12,564                        | )          | 4,894 |   |
|                                                                               |       |                           |       |   |   |
| Cash and cash  equivalents at beginning of period                                  |       | 27,606                         |       | 41,171 |   |
|                                                                               |       |                           |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                              | 15,042     |   | $ | 46,065 |   |

 

*See notesto unaudited condensed consolidated financial statements.*

 

5

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**Note 1 — Summary of Operations and Significant AccountingPolicies**(All amounts in thousands, except per share amounts, unless otherwise noted)

**Nature of Business and Operations**

Albany MolecularResearch, Inc. (the “Company”) is a global chemistry-based drug discoveryand development company focused on identifying and developing novelbiologically active small molecules with applications in the drug market. TheCompany engages in new drug research services and manufacturing, from leaddiscovery, optimization and development to commercial manufacturing and hasoperations in the United States, India, Singapore and Hungary. The Companyconducts research and development projects and collaborates with many leadingpharmaceutical and biotechnology companies, and is developing proprietary newchemistry technology for potential pharmaceutical products.

**Basis ofPresentation**

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with U.S. generally accepted accounting principles forinterim financial information and with the instructions to Form 10-Q and Rule10-01 of Regulation S-X. In accordance with Rule 10-01, the unaudited condensedconsolidated financial statements do not include all of the information andfootnotes required by U.S. generally accepted accounting principles forcomplete consolidated financial statements. The year-end condensed consolidatedbalance sheet data was derived from audited financial statements but does notinclude all disclosures required by U.S. generally accepted accountingprinciples. In the opinion of management, all adjustments (consisting of normalrecurring accruals and adjustments) considered necessary for a fair statementof the results for the interim period have been included. Operating results forthe three and six months ended June 30, 2006 are not necessarilyindicative of the results that may be expected for the year endingDecember 31, 2006. The accompanying unaudited condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto included in our AnnualReport on Form 10-K for the year ended December 31, 2005.

Theaccompanying unaudited condensed consolidated financial statements include theaccounts of Albany Molecular Research, Inc. and its wholly-owned subsidiaries.All intercompany balances and transactions have been eliminated duringconsolidation. Assets and liabilities of non-U.S. operations are translated atperiod-end rates of exchange, and the statements of income are translated atthe average rates of exchange for the period. Gains or losses resulting fromtranslating non-U.S. currency financial statements are recorded in accumulatedother comprehensive (loss) income in the accompanying unaudited condensedconsolidated balance sheets.

**Use ofManagement Estimates**

The preparation ofconsolidated financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, and disclosures ofcontingent assets and liabilities, at the date of the financial statements, andthe reported amounts of revenues and expenses during the reporting period.Actual results can vary from these estimates.

**ContractRevenue Recognition**

TheCompany’s contract revenue consists primarily of fees earned under contractswith third-party customers and reimbursed expenses under such contracts. TheCompany also seeks to include provisions in certain contracts which contain acombination of up-front licensing fees, milestone and royalty payments shouldthe Company’s proprietary technology and expertise lead to the discovery of newproducts that reach the market. Reimbursed expenses consist of chemicals andother project specific costs. Generally, the Company’s contracts may beterminated by the customer upon 30 days’ to one year’s prior notice,depending on the size of the contract. The Company analyzes its agreements todetermine whether the elements can be separated and accounted for individuallyor as a single unit of accounting in accordance with EITF No. 00-21, *Revenue Arrangements with Multiple Deliverables*and SAB 104, *Revenue Recognition*.Allocation of revenue to individual elements which qualify for separateaccounting is based on the estimated fair value of the respective elements.

TheCompany generates contract revenue on the following basis:

*Full-time Equivalent (FTE).*An FTE agreementestablishes the number of Company employees contracted for a project or aseries of projects, the duration of the contract period, the price per FTE,plus an allowance for chemicals and other project specific costs, which may ormay not be incorporated in the FTE rate. FTE contracts can run in one monthincrements, but typically have terms of six months or longer. FTE contractstypically provide for annual adjustments in billing rates for the scientistsassigned to the contract. These contracts involve the Company’s scientistsproviding services on a “best efforts” basis in the development of novelchemistry 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.

6

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*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*. Undera fixed-fee contract the Company charges a fixed agreed upon amount for adeliverable. Fixed-fee contracts have fixed deliverables upon completion of theproject. Typically, the Company recognizes revenue for fixed-fee contractsafter projects are completed, delivery is made and title transfers to thecustomer and collection is reasonably assured. In certain instances, theCompany’s customers request that the Company retain materials produced uponcompletion of the project due to the fact that the customer does not have aqualified facility to store those materials. In these instances, the revenuerecognition process is considered complete when project documents (batchrecords, Certificates of Analysis, etc.) have been delivered to the customerand payment has been collected.

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

*Recurring Royalty 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-livedAssets**

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 theCompany determines that the carrying value of long-lived assets may not berecoverable, based upon the existence of one or more of the above indicators ofimpairment, the Company compares the carrying value of the asset group to theundiscounted cash flows expected to be generated by the asset group. If thecarrying value exceeds the undiscounted cash flows an impairment charge isrecorded. An impairment charge is recognized to the extent that the carryingamount of the asset group exceeds their fair value and will reduce only thecarrying amounts of the long-lived assets. The Company utilizes the assistanceof an independent valuation firm in determining the fair values.

**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.

7

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TheCompany will perform the annual goodwill assessment for its reporting unitsduring the third quarter of 2006. If management’s expectations of futureoperating results change, or if there are changes to other assumptions, theestimate of the fair value of the Company’s reporting units could change significantly.Such a change could result in goodwill impairment charges in future periods,which could have a significant impact on the Company’s consolidated financialstatements. Total goodwill recorded on the Company’s unaudited condensedconsolidated balance sheet at June 30, 2006 was $35,511 including $23,060 ofgoodwill associated with the Company’s acquisition of Organichem, Inc. and$9,763 of goodwill associated with the Company’s acquisition of ComGenexKutato-Fejleszto Rt.

**Stock Compensation**

Effective January 1, 2006, the Company adopted SFASNo. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123 (R)”), whichamends SFAS No. 123 and supersedes APB No. 25**inestablishing standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services, as well as transactionsin which 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.

**Note 2 —Business Combination**

On February 28, 2006, theCompany, through a wholly-owned subsidiary, acquired all of the outstandingshares of ComGenex Kutato-Fejleszto Rt. (“ComGenex”), a privately held drugdiscovery service company located in Budapest, Hungary.

The aggregatepurchase price of $11,520 included cash payments totaling $10,750 andcapitalized costs related to the acquisition, primarily professional fees, of$770. The purchase price may be adjusted based upon audited financialstatements of ComGenex for the year ended December 31, 2005 and its financialposition as of the transaction closing date. The results of ComGenex’soperations have been included in the unaudited condensed consolidated statementof income for the three and six months ended June 30, 2006 from the date ofacquisition.

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

 

|                                            | ** ** | **February 28,  2006** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| **Assets Acquired**                        |       |                        |       |
| Cash and cash  equivalents                 |       | $                           | 323        |   |
| Accounts  receivable, net                  |       | 1,002                       |       |
| Inventory                                  |       | 121                         |       |
| Prepaid expenses  and other current assets |       | 1,141                       |       |
| Property and  equipment, net               |       | 1,270                       |       |
| Goodwill                                   |       | 9,763                       |       |
| Intangible  assets and patents, net        |       | 292                         |       |
| Other assets                               |       | 21                          |       |
| Total assets acquired                      |       | $                           | 13,933     |   |
|                                       |       |                        |       |
| **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                       |       | $                           | 11,520     |   |

 

8

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Pro forma financialinformation for the three and six month periods ended June 30, 2006 and 2005 asif the ComGenex acquisition had been completed as of January 1, 2005 has beenexcluded due to the immateriality of the operating results of ComGenex in relationto the Company’s consolidated operating results as a whole.

**Note 3 — Earnings (Loss) Per Share**

Theshares used in the computation of the Company’s basic and diluted earnings(loss) per share are as follows:
|                                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                     | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted average  common shares outstanding |       | 32,154                                              |       | 32,025                                            |       | 32,148 |   | 31,978 |   |
| Dilutive effect  of stock options           |       | —                                              |       | 234                                               |       | 177 |   | 239 |   |
| Dilutive effect  of restricted stock        |       | —                                              |       | 53                                                |       | 66 |   | 26 |   |
| Weighted average common  shares outstanding |       | 32,154                                              |       | 32,312                                            |       | 32,391 |   | 32,243 |   |

 

The Company has excludedthe effects of outstanding stock options and restricted stock from thecalculation of diluted loss per share for the three months ended June 30,2006 because such securities would be anti-dilutive. The Company has excludedcertain outstanding stock options and warrants from the calculation of dilutedearnings per share for the three months ended June 30, 2005, and the six monthsended June 30, 2006 and 2005 because the exercise price was greater than theaverage market price of the Company’s common shares during that period, and assuch, these options and warrants would be anti-dilutive. The weighted averagenumber of anti-dilutive options, restricted shares, and warrants outstanding(before the effects of the treasury stock method) was 2,602 and 2,548 for thethree months ended June 30, 2006 and 2005, respectively.  The weighted average number of anti-dilutive optionsand warrants outstanding (before the effects of the treasury stock method) was1,951 and 2,726 for the six months ended June 30, 2006 and 2005,respectively.  These amounts are notincluded in the calculation of weighted average common shares outstanding.

**Note4 — Inventory**

Inventory consistedof the following at June 30, 2006 and December 31, 2005:
|                                             | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Raw materials                               |       | $                       | 7,774      |                        | $          | 13,039 |   |
| Work in process                             |       | 2,108                   |       | 2,188                       |       |
| Finished goods                              |       | 14,703                  |       | 15,029                      |       |
| Libraries, net  of accumulated amortization |       | 347                     |       | 347                         |       |
| Total                                       |       | $                       | 24,932     |                        | $          | 30,603 |   |

 

**Note 5 – Restructuring of Mt. Prospect**

On May 4, 2004 theCompany announced its plan to consolidate operations by relocating its Mt.Prospect facility operations to its facilities in New York. The Company’sproprietary biocatalysis technology platform, drug metabolism screening,research fermentation and chemical development technologies in Mt. Prospecthave been relocated to New York and continue to be fully integrated with theCompany’s drug discovery and development technologies. The restructuringresulted in the closure of the Mt. Prospect Research Center in the fourthquarter of 2004. The consolidation was initiated as a result of a lack ofanticipated growth in the Company’s chemical development services at thefacility.

We are currently marketing the Mt. Prospect Research Center facilityfor sale. The facility qualified for held for sale treatment in accordance withSFAS No. 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.  The Company previouslydisclosed that if a definitive agreement to sell the facility was not in placeas of June 30, 2006, it would reassess the classification of the facility asheld for sale in accordance with SFAS No. 144 at that time.  The Company was not able to secure adefinitive agreement to sell the facility as of June 30, 2006.  Accordingly, and in connection with thepreparation of its second quarter unaudited condensed consolidated financialstatements, the Company reassessed Mt. Prospect as a held for sale facility.

9

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As a result of thisassessment, the Company reaffirmed its intention to sell the Mt. Prospectfacility, and determined that a $3,376 write-down of the carrying value of thefacility was required.  Management hasestimated the fair value based upon its intention to sell the facility withintwelve months and comparable real estate transactions in the facility’s marketarea.

At June 30, 2006, theCompany had recorded restructuring liabilities totaling $220 related to assetdisposal costs, including brokerage commissions, legal fees, and marketingexpenses associated with the planned sale of the Mt. Prospect Research Centerfacility. These restructuring liabilities are included in accounts payable andaccrued expenses in the Company’s unaudited condensed consolidated balancesheet. The Company’s restructuring liabilities decreased by $292 during thequarter ended June 30, 2006, representing a reduction of estimated brokeragecommissions as a result of the reduction in carrying value and estimated salesprice of the Mt. Prospect facility as described above.

**Note 6 —Goodwill and Intangible Assets**

The carrying amounts of goodwill, by the Company’sDiscovery/Development/Small Scale Manufacturing (“DDS”) and Large ScaleManufacturing (“LSM”) operating segments, as of June 30, 2006 andDecember 31, 2005 are as follows:
|                            | ** ** | **DDS**    | ** ** | **LSM**    | ** ** | **Total**  | ** ** |
|----------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **June  30, 2006**         |       | $          | 12,451     |       | $          | 23,060     |       | $ | 35,511 |   |
|                       |       |       |       |       |       |       |       |
| **December 31, 2005** |       | $          | 2,687      |       | $          | 23,060     |       | $ | 25,747 |   |

 

The increase ingoodwill within the DDS segment from December 31, 2005 to June 30, 2006 isrelated to the Company’s acquisition of ComGenex described in Note 2.

The components ofintangible assets are as follows:
|                               | ** ** | **Cost**   | ** ** | **Accumulated  Amortization** | ** ** | **Net**    | ** ** | **Amortization  Period** | ** ** |
|-------------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|--------------------------|------------|
| **June  30, 2006**            | ** ** | ** ** | ** ** | ** **                    | ** ** | ** ** | ** ** | ** **               | ** ** |
| Patents and  Licensing Rights |       | $          | 2,201      |                          | $          | (541       | )          | $                        | 1,660      |   | 2-16 years |   |
|                          |       |       |       |                          |       |       |       |                     |       |
| **December 31,  2005**   |       |       |       |                          |       |       |       |                     |       |
| Patents and Licensing  Rights |       | $          | 1,811      |                          | $          | (377       | )          | $                        | 1,434      |   | 16 years |   |

 

Amortizationexpense related to intangible assets was $136 and $26 for the three monthsended June 30, 2006 and 2005, respectively and $164 and $49, for the six monthsended June 30, 2006 and 2005 respectively. Estimated future annual amortization expense related to intangibleassets is approximately $117 for the remainder of 2006, $216 for 2007, $135 for2008, $123 for 2009 and $116 for 2010.

**Note7 -****Defined Benefit and PostretirementWelfare Plan**

OrganichemCorporation previously provided retirement benefits under two non-contributorydefined benefit plans and a non-contributory, unfunded post-retirement welfareplan. Future benefits under the defined benefit plans and for salariedparticipants in the post-retirement welfare plan have been frozen.

***Componentsof Net Periodic Benefit Cost***
| ** **                          | ** ** | **Pension   Benefits**                           | ** ** | **Postretirement   Benefits**                                                  | ** ** | **Pension   Benefits**                         | ** ** | **Postretirement   Benefits**                  | ** ** |
|-------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **Three Months   Ended June 30,** | ** ** | **Three Months        Ended June 30,** | ** ** | **Six Months   Ended June 30,** | ** ** | **Six Months   Ended June 30,** | ** ** |
| ** **                          | ** ** | **2006**                                              | ** ** | **2005**                                                                            | ** ** | **2006**                                            | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                |       |                                                  |       |                                                                                |       |                                                |       |                                                |       |   |   |   |   |   |   |   |   |
| Service cost                        |       | $                                                     | —     |                                                                                | $          | —                                              |       | $                                                   | 19         |   | $ | 11 |   | $ | — |   | $ | — |   | $ | 36 |   | $ | 22 |   |
| Interest cost                       |       | 303                                                   |       | 264                                                                                 |       | 8                                                   |       | 4                                                   |       | 597 |   | 581 |   | 15 |   | 8 |   |
| Expected return  on plan assets     |       | (341                                                  | )          | (319                                                                                | )          | —                                              |       | —                                              |       | (675 | ) | (615 | ) | — |   | — |   |
| Recognized net  loss                |       | 23                                                    |       | 10                                                                                  |       | 3                                                   |       | —                                              |       | 26 |   | 10 |   | 5 |   | — |   |
| Net periodic benefit  (income) cost |       | $                                                     | (15        | )                                                                                   | $          | (45                                                 | )          | $                                                   | 30         |   | $ | 15 |   | $ | (52 | ) | $ | (24 | ) | $ | 56 |   | $ | 30 |   |

 

10

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***EmployerContributions***

TheCompany previously disclosed in its consolidated financial statements for theyear ended December 31, 2005 that it expected to contribute $1,014 to itspension plan in 2006.  As of June 30, 2006, $737 in contributionshave been made.  The Company continues to anticipate contributing theadditional $277 to fund its pension plan in 2006.

**Note8 — Share-Based Payments**

During the three and sixmonths ended June 30, 2006 and 2005, the Company recognized total share basedcompensation cost, net of tax, of $212 and $397, and $89 and $105,respectively, in its unaudited condensed consolidated statements of income.During the three and six months ended June 30, 2005, the Company applied theintrinsic value-based method of accounting prescribed by Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations, in accounting for its share-based payments.

Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of SFAS No. 123to its share-based payments during 2005:
|                                                                                                                                               | ** ** | **Three Months  Ended June 30,  2005** | ** ** | **Six Months  Ended June 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Net income, as reported                                                                                                                       |       | $                                                     | 7,294      |                                                | $          | 12,890 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                  |       | 89                                                    |       | 105                                                 |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (1,009                                                | )          | (2,097                                              | )          |
| Pro Forma net income                                                                                                                          |       | $                                                     | 6,374      |                                                | $          | 10,898 |   |
|                                                                                                                                          |       |                                                  |       |                                                |       |
| Earnings per share:                                                                                                                           |       |                                                  |       |                                                |       |
| Basic as  reported                                                                                                                            |       | $                                                     | 0.23       |                                                | $          | 0.40 |   |
| Basic pro-forma                                                                                                                               |       | $                                                     | 0.20       |                                                | $          | 0.34 |   |
|                                                                                                                                          |       |                                                  |       |                                                |       |
| Diluted as  reported                                                                                                                          |       | $                                                     | 0.23       |                                                | $          | 0.40 |   |
| Diluted pro-forma                                                                                                                             |       | $                                                     | 0.20       |                                                | $          | 0.34 |   |

The Company grants share-based payments, includingrestricted shares,  under its 1998 StockOption and Incentive Plan, as well as its 1998 Employee Stock Purchase Plan.Information regarding the Company’s share-based payment arrangements follows:

***1998 Stock Option and IncentivePlan***

**Restricted Stock**

The Company also issues restricted shares of commonstock to employees of the Company under the 1998 Stock Option and IncentivePlan. The shares are issued as restricted stock and are held in the custody ofthe Company until all vesting restrictions are satisfied. Shares vest underthis grant over a period of five years, with 60% vesting after three years ofcontinuous employment from the grant date and an additional 20% vesting aftereach of four and five years of continuous employment from the grant date. Ifthe vesting terms under which the award was granted are not satisfied, theshares are forfeited. Unearned compensation is recorded based on the marketvalue of the shares on the grant date, and is amortized on a straight-linebasis over the applicable vesting period. The Company reduces the straight-linecompensation expense by an estimated forfeiture rate to account for theestimated 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%.

11

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A summary of unvested restricted stock activity as ofJune 30, 2006 and changes during the six months then ended is presented below:
|                                 | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Grant Date  Fair Value** | ** ** |
|---------------------------------|------------|----------------------------|------------|-------------------------------------------------------------|------------|
| Outstanding, December  31, 2005 |       | 257                        |       | $                                                           | 8.75       |   |
| Granted                         |       | 169                        |       | $                                                           | 10.15      |   |
| Vested                          |       | —                     |       | —                                                      |       |
| Forfeited                       |       | (6                         | )          | $                                                           | 8.45       |   |
| Outstanding, June 30, 2006      |       | 420                        |       | $                                                           | 9.31       |   |

The weighted average fair value of restricted sharesgranted during the six months ended June 30, 2006 and 2005 were $10.15 and$8.45, respectively. As of June 30, 2006, there was $3,305 of totalunrecognized compensation cost related to non-vested restricted shares. That costis expected to be recognized over a weighted-average period of 4.18 years. Norestricted shares vested during the six months ended June 30, 2006 and 2005.

**Stock Options**

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

The fair value of each stock option award is estimatedat the date of grant using the Black-Scholes valuation model based on theassumptions noted below. The application of this valuation model involves theuse of assumptions that are judgmental in nature. The following is a summary ofthe methodology applied to develop each assumption:

Expected Price Volatility

Expected price volatility is a measure of the amountby which the price of a security has fluctuated or is expected to fluctuate.The Company uses actual historical changes in the market value of its stock tocalculate the volatility assumption. The Company calculates daily market valuechanges from the date of grant over a past period representative of theexpected 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 Company uses theU.S. Treasury rate for the week of the grant having a term approximating theexpected life of the option. An increase in the risk-free interest rate willincrease compensation expense.

Expected Lives

This is the period of time over which the optionsgranted are expected to remain outstanding, and is based on our historicalstock option exercise and forfeiture experience. Options granted have a maximumterm of ten years. An increase in the expected life will increase compensationexpense.

Dividend Yield

The Company has not made any dividend payments nordoes it have plans to pay dividends in the foreseeable future. An increase inthe dividend yield will decrease compensation expense.

The fair value of each option is amortized intocompensation 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.

12

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The following weighted-average assumptions were usedto determine the per share weighted-average fair value of stock options grantedduring the six months ended June 30, 2006 and 2005:
|                         | ** ** | **For the Six Months Ended** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|
| ** **              | ** ** | **June 30, 2006**                      | ** ** | **June 30, 2005** | ** ** |
| Expected life in  years |       | 5                                                |       | 5 |   |
| Interest rate           |       | 4.99                                             | %          | 3.87 | % |
| Volatility              |       | 42                                               | %          | 52 | % |
| Dividend yield          |       | —                                           |       | — |   |

A summary of stockoption activity under the Company’s stock option plan as of June 30, 2006 andchanges during the six month period then ended is presented below:
| ** **                         | ** ** | **Number of  Shares** | ** ** | **Weighted  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|----------------------------|------------|-------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding, January 1,  2006      |       | 2,246                      |       | $                             | 19.97      |                                                             |       |                            |       |   |
| Granted                            |       | 85                         |       | $                             | 10.15      |                                                             |       |                            |       |   |
| Exercised                          |       | (8                         | )          | $                             | 1.59       |                                                             |       |                            |       |   |
| Forfeited                          |       | (44                        | )          | $                             | 24.33      |                                                             |       |                            |       |   |
| Expired                            |       | (11                        | )          | $                             | 1.09       |                                                             |       |                            |       |   |
| Outstanding, June 30,  2006        |       | 2,268                      |       | $                             | 19.68      |                                                             | 5.6        |                            | $          | 1,934 |   |
| Options exercisable, June 30, 2006 |       | 2,047                      |       | $                             | 20.59      |                                                             | 5.2        |                            | $          | 1,885 |   |

The weighted average fair value per share of stockoptions granted during the six months ended June 30, 2006 and 2005 was $4.45and $5.07, respectively. The total intrinsic value of stock options exercisedduring the six months ended June 30, 2006 and 2005 was $70 and $1,315,respectively.

As of June 30, 2006, there was $1,097 of totalunrecognized compensation cost related to non-vested stock options. That costis expected to be recognized over a weighted-average period of 2.72 years. Thetotal fair value of shares vested during the six months ended June 30, 2006 and2005 was $211 and $5,112, respectively.

Effective December 30, 2005, pursuant to and inaccordance with the recommendation of the Compensation Committee (the “Committee”)of the Board of Directors, the Board of Directors of the Company approved fullacceleration of the vesting of each otherwise unvested stock option that had anexercise price of $15.00 or greater granted under the Company’s 1998 StockOption and Incentive Plan 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 condition tothe acceleration of vesting, each executive officer and each non-employeedirector agree to refrain from selling shares of the Company’s common stockacquired upon the exercise of accelerated options (other than shares needed tocover the exercise price and satisfy withholding taxes) until the date on whichthe exercise of such options would have been permitted under the option’spre-acceleration vesting terms or, if earlier, the officer’s or director’s lastday of employment or upon a “change in control” as defined in the Company’sstock option plan.

The decision to accelerate the vesting of theseunderwater options was made primarily to minimize certain future compensationexpenses that the Company would otherwise recognize in its consolidatedstatements of income with respect to these options pursuant to SFASNo. 123 (R). The Company also believes that the acceleration may have apositive effect on employee morale, retention and the perception of optionvalue.

***Employee Stock Purchase Plan***

The Company’s 1998 Employee Stock Purchase Plan (the “PurchasePlan”) was adopted during August 1998. Up to 600 shares of common stockmay be issued under the Purchase Plan, which is administered by theCompensation Committee of the Board of Directors. The Purchase Plan establishestwo stock offering periods per calendar year, the first beginning onJanuary 1 and ending on June 30, and the second beginning onJuly 1 and ending December 31. All employees who work more than20 hours per week are eligible for participation in the Purchase Plan.Employees who are deemed to own greater than 5% of the combined voting power ofall classes of stock of the Company are not eligible for participation in thePurchase Plan.

13

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During each offering, anemployee may purchase shares under the Purchase Plan by authorizing payrolldeductions up to 10% of their cash compensation during the offering period. Themaximum number of shares to be issued to any single employee during an offeringperiod is limited to one thousand. At the end of the offering period, theaccumulated payroll deductions will be used to purchase common stock on thelast business day of the offering period at a price equal to 85% of the closingprice of the common stock on the first or last day of the offering period,whichever is lower.

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

During the six months ended June 30, 2006 and 2005, 18and 20 shares, respectively, were issued under the Purchase Plan.  During the six months ended June 30, 2006 and2005, cash received from stock option exercises and employee stock purchaseplan purchases was $276 and $947, respectively. The actual tax benefit realizedfor the tax deductions from stock option exercises was $0 and $356 during thesix months ended June 30, 2006 and 2005.

**Note 9 —Operating Segment Data**

The Company has organized its sales, marketing and productionactivities into the Discovery/Development/Small Scale Manufacturing (DDS) andLarge Scale Manufacturing (LSM) segments based on the criteria set forth inSFAS No. 131, “Disclosures about Segments of an Enterprise and RelatedInformation”. The Company’s management relies on an internal managementaccounting system to report results of the segments. The system includesrevenue and cost information by segment. The Company’s management makesfinancial decisions and allocates resources based on the information itreceives from this internal system.

DDS includes activities such as drug lead discovery, optimization, drugdevelopment and small scale commercial manufacturing. LSM includes pilot tocommercial scale manufacturing of active pharmaceutical ingredients andintermediates and high potency and controlled substance manufacturing all ofwhich are in compliance with the Food and Drug Administration’s (FDA) currentGood Manufacturing Practices. Corporate activities include business developmentand administrative functions, as well as research and development costs thathave not been allocated to the operating segments.

14

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The following tablecontains earnings data by operating segment, reconciled to totals included inthe unaudited condensed consolidated financial statements:
|                                                    | ** ** | **Contract  Revenue** | ** ** | **Recurring  Royalty  Revenue** | ** ** | **Operating  (loss) income** | ** ** | **Depreciation  and  Amortization** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|---------------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|
| **For the  three months ended June 30, 2006** | ** ** | ** **            | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** **                          | ** ** |
| DDS                                                |       | $                     | 17,614     |                            | $          | 7,200                             |       | $                                   | 8,067      |   | $ | 2,314 |   |
| LSM                                                |       | 20,769                |       | —                          |       | 1,223                             |       | 1,482                               |       |
| Corporate                                          |       | —                |       | —                          |       | (10,417                           | )          | —                              |       |
| Total                                              |       | $                     | 38,383     |                            | $          | 7,200                             |       | $                                   | (1,127     | ) | $ | 3,796 |   |
|                                               |       |                  |       |                            |       |                              |       |                                |       |
| **For the  three months ended June 30, 2005** | ** ** | ** **            | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** **                          | ** ** |
| DDS                                                |       | $                     | 13,356     |                            | $          | 15,892                            |       | $                                   | 16,786     |   | $ | 2,435 |   |
| LSM                                                |       | 22,592                |       | —                          |       | 4,133                             |       | 1,392                               |       |
| Corporate                                          |       | —                |       | —                          |       | (9,874                            | )          | —                              |       |
| Total                                              |       | $                     | 35,948     |                            | $          | 15,892                            |       | $                                   | 11,045     |   | $ | 3,827 |   |
|                                               |       |                  |       |                            |       |                              |       |                                |       |
| **For the  six months ended June 30, 2006**   | ** ** | ** **            | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** **                          | ** ** |
| DDS                                                |       | $                     | 34,557     |                            | $          | 14,378                            |       | $                                   | 18,745     |   | $ | 4,482 |   |
| LSM                                                |       | 40,014                |       | —                          |       | 1,970                             |       | 2,990                               |       |
| Corporate                                          |       | —                |       | —                          |       | (19,889                           | )          | —                              |       |
| Total                                              |       | $                     | 74,571     |                            | $          | 14,378                            |       | $                                   | 826        |   | $ | 7,472 |   |
|                                               |       |                  |       |                            |       |                              |       |                                |       |
| **For the  six months ended June 30, 2005**   | ** ** | ** **            | ** ** | ** **                      | ** ** | ** **                        | ** ** | ** **                          | ** ** |
| DDS                                                |       | $                     | 26,953     |                            | $          | 27,900                            |       | $                                   | 30,486     |   | $ | 4,919 |   |
| LSM                                                |       | 45,621                |       | —                          |       | 8,730                             |       | 2,846                               |       |
| Corporate                                          |       | —                |       | —                          |       | (19,815                           | )          | —                              |       |
| Total                                              |       | $                     | 72,574     |                            | $          | 27,900                            |       | $                                   | 19,401     |   | $ | 7,765 |   |

The following table summarizes other information bysegment as of June 30, 2006:
|                                           | ** ** | **As of June 30, 2006** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands)**                   | ** ** | **DDS**                                     | ** ** | **LSM** | ** ** | **Total** | ** ** |
|                                      |       |                                        |       |   |   |   |   |
| Total assets                              |       | $                                           | 236,212    |   | $ | 128,798 |   | $ | 365,010 |   |
| Goodwill  included in total assets        |       | 12,451                                      |       | 23,060 |   | 35,511 |   |
| Investments in  unconsolidated affiliates |       | 956                                         |       | — |   | 956 |   |
| Capital expenditures                      |       | 6,610                                       |       | 3,130 |   | 9,740 |   |
|                                           |            |                                             |            |  |  |  |  |  |  |  |

The following table summarizes other information bysegment as of June 30, 2005:
|                                           | ** ** | **As of June 30, 2005** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands)**                   | ** ** | **DDS**                                     | ** ** | **LSM** | ** ** | **Total** | ** ** |
|                                      |       |                                        |       |   |   |   |   |
| Total assets                              |       | $                                           | 262,299    |   | $ | 132,005 |   | $ | 394,304 |   |
| Goodwill  included in total assets        |       | 2,687                                       |       | 23,060 |   | 25,747 |   |
| Investments in  unconsolidated affiliates |       | 956                                         |       | — |   | 956 |   |
| Capital expenditures                      |       | 2,189                                       |       | 4,385 |   | 6,574 |   |
|                                           |            |                                             |            |  |  |  |  |  |  |  |

 

15

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**Note10 — Financial Information by Customer Concentration and Geographic Area**

Totalcontract revenue from DDS’ three largest customers represented approximately13%, 9% and 7% of AMR’s total contract revenue for the three months endedJune 30, 2006, and 15%, 8% and 4% of total contract revenue for the threemonths ended June 30, 2005. Total contract revenue from DDS’ three largestcustomers represented approximately 13%, 9% and 6% of AMR’s total contractrevenue for the six months ended June 30, 2006, and 15%, 10% and 3% oftotal contract revenue for the six months ended June 30, 2005.  Total contract revenue from LSM’s largestcustomer, GE Healthcare (GE), represented 47% and 71% of LSM’s total contractrevenue for the three months ended June 30, 2006 and 2005,respectively.  Total contract revenuefrom GE represented 52% and 76% of LSM’s total contract revenue for the sixmonths ended June 30, 2006 and 2005, respectively.  GE accounted for approximately 28% and 48% ofthe Company’s total contract revenue for the six months ended June 30,2006 and 2005, respectively.  In 2005, GEdiscontinued its purchases of one of the products it received from the Company,and made all of its 2005 purchases in the first half of the year.  Sales of this product totaled $16,962 in thefirst half of 2005.

The Company’s total contract revenue for the three and six months endedJune 30, 2006 and 2005 was recognized from customers in the followinggeographic regions:
|               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|          |       |                                                |       |                                              |       |   |   |   |   |
| United States |       | 64                                                  | %          | 49                                                | %          | 64 | % | 49 | % |
| Europe        |       | 33                                                  |       | 48                                                |       | 34 |   | 49 | % |
| Other         |       | 3                                                   |       | 3                                                 |       | 2 |   | 2 |   |
|          |       |                                                |       |                                              |       |   |   |   |   |
| Total         |       | 100                                                 | %          | 100                                               | %          | 100 | % | 100 | % |

**Note 11 —Comprehensive (Loss) Income**

Thefollowing table presents the components of the Company’s comprehensive (loss)income for the three and six months ended June 30, 2006 and 2005:
| ** **                                                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                                                          | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income (loss)                                                                |       | $                                                   | (353       | )                                                 | $          | 7,294 |   | $ | 1,541 |   | $ | 12,890 |   |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Other comprehensive  loss:                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Change in  unrealized gain (loss) on available-for-sale securities, net of taxes |       | 20                                                  |       | 83                                                |       | 34 |   | (43 | ) |
| Change in  unrealized (loss) gain on interest rate swap, net of taxes            |       | —                                              |       | (55                                               | )          | 17 |   | 60 |   |
| Foreign currency  translation loss                                               |       | (145                                                | )          | (19                                               | )          | (131 | ) | (50 | ) |
| Total comprehensive  income (loss)                                               |       | $                                                   | (478       | )                                                 | $          | 7,303 |   | $ | 1,461 |   | $ | 12,857 |   |

**Note 12 —Legal Proceedings**

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

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

In response to the filings described above, beginningin 2001, Aventis Pharmaceuticals filed patent infringement lawsuits againstBarr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, TevaPharmaceuticals, Dr. Reddy’s Laboratories, Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., and Sandoz. Each of the lawsuits was filed in the U.S.District Court in New Jersey and alleges infringement of one or more patentsowned by Aventis Pharmaceuticals. Further, beginning in March 5, 2004, AMRTechnology, along with Aventis Pharmaceuticals, filed suit in the U.S. DistrictCourt in New Jersey against Barr Laboratories, Impax Laboratories, MylanPharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’s Laboratories, AminoChemicals, Ltd., Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc.,DiPharma S.P.A., DiPharma Francis s.r.l., and Sandoz, Inc., assertinginfringement of two of our U.S. patents that are exclusively licensed toAventis Pharmaceuticals relating to Allegra and Allegra-D products.

In the pending litigations, Aventis Pharmaceuticalsand AMR Technology have entered into covenants not to sue the defendants otherthan  DiPharma S.P.A., DiPharma Franciss.r.l., under U.S. Patent No. 5,578,610, which patent has not been asserted inthe litigation but which Aventis Pharmaceuticals exclusively licenses from us.However, we and Aventis Pharmaceuticals have agreed that AventisPharmaceuticals will continue to pay royalties to us based on that patent underour original license agreement with Aventis Pharmaceuticals. Under ourarrangements with Aventis Pharmaceuticals, we will receive royalties until expirationof the underlying patents (2013 for U.S. Patent No. 5,578,610 and 2015 for U.S.Patent No. 5,750,703) unless the patents are earlier determined to be invalid.

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

On September 6, 2005, Barr Pharmaceuticals, Inc. andTeva Pharmaceuticals 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 withAventis Pharmaceuticals, filed a Motion for Preliminary Injunction in the U.S.District Court in New Jersey seeking to enjoin Barr Pharmaceuticals, Inc., TevaPharmaceuticals Ltd., Ranbaxy Laboratories, Ltd. and Amino Chemicals, Ltd. fromthe sale of generic versions of Allegra in the United States. On January 30,2006, the U.S. District Court denied the request by AMR Technology and AventisPharmaceuticals for a preliminary injunction. A notice of appeal to the U.S.Court of Appeals for the Federal Circuit was filed on February 2, 2006 and briefingon that appeal is now complete.

Subsequent to the preliminary injunction proceeding,Dr. Reddy’s Laboratories has engaged in an at-risk launch of genericfexofenadine products.

Should the Company be unsuccessful in defending thesepatents, the Company would continue to experience a material decrease inoperating cash flows and a material adverse effect on our results of operationsand financial condition.

**Note 13 — Recently Issued AccountingPronouncements**

In July 2006, theFinancial Accounting Standards Board (FASB) issued FASB Interpretation No. 48,**“Accountingfor Uncertainty in Income Taxes” (“FIN 48”). Among other things, FIN 48 requires the application of a “more likelythan not” threshold to the recognition and derecognition of tax positions, andprovides for enhanced quantitative and qualitative disclosures regardingunrecognized tax benefits resulting from tax positions taken by an entity.  This Interpretation applies to the Companyeffective January 1, 2007.   TheCompany is currently assessing the impact of applying this Interpretation.

17

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

**Forward-LookingStatements**

The following discussion of our results of operationsand financial condition should be read in conjunction with the accompanyingCondensed Consolidated Financial Statements and the Notes thereto includedwithin this report. This quarterly report on Form 10-Q contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These statements may be identified by forward-looking words such as“may,” “could,” “should,” “would,” “will,” “intend,” “expect,” “anticipate,” “believe,”and “continue” or similar words and include, but are not limited to, statementsconcerning the Mount Prospect Research Center, pension and postretirementbenefit costs, GE Healthcare and the sales of products to GE Healthcare in2006, demand for our products, contract revenues, costs and margins and theCompany’s implementation of process management improvements and cost savingsinitiatives, patent protection and the ongoing Allegra patent infringementlitigation, Allegra royalty revenue, customer spending and business trends,foreign operations (including Singapore, India and Hungary), access to foreignmarkets, clinical supply and commercial product manufacturing, management’sstrategic plans, drug discovery, product commercialization, license arrangements,research and development projects and expenses, selling, general andadministrative expenses and tax rates. The Company’s actual results may differmaterially from such forward-looking statements as a result of numerousfactors, some of which the Company may not be able to predict and may not bewithin the Company’s control. Factors that could cause such differencesinclude, but are not limited to, those discussed in Part I, Item 1A, “RiskFactors”, of the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005 as filed with the Securities and Exchange Commission onMarch 16, 2006, and as amended by Amendment No. 1 on Form 10-K/A filedwith the Securities and Exchange Commission on May 9, 2006, and in Part II Item 1A, “Risk Factors,” inthis Form 10-Q. All forward-looking statements are made as of the dateof this report, and we do not undertake to update any such forward-lookingstatements in the future. References to “we,” “us,” and “our,” refer to AlbanyMolecular Research, Inc. and its subsidiaries, taken as a whole.

18

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**Overview**

We are a globalchemistry-based drug discovery and development company, focused on identifyingand developing novel biologically active small molecules with applications inthe prescription drug market. We engage in comprehensive chemistry researchfrom lead discovery, optimization and development to commercial manufacturingand conduct cell and non-cell based high throughput screening on a variety ofbiological targets. We perform research for many of the leading pharmaceuticaland biotechnology companies and for our own internal research and development.

In addition to ourcontract services, we also conduct proprietary research and development todiscover new therapeutically active lead compounds with commercial potential.We anticipate that we would then license these compounds to third parties inreturn for up-front service fees and milestone payments as well as recurringroyalty payments if these compounds are developed into new commercial drugs. InOctober 2005, we licensed the worldwide rights to develop andcommercialize potential products from our amine neurotransmitter reuptakeinhibitors 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.

Our total revenue for the quarter ended June 30, 2006was $45.6 million, as compared to $51.8 million for the quarter ended June30, 2005. Recurring royalty revenues decreased $8.7 million from the quarterended June 30, 2005 due to the impact of the at-risk launch of genericfexofenadine by Barr Pharmaceuticals, Inc. and Teva PharmaceuticalsIndustries Ltd. on U.S. sales of Allegra by Sanofi-Aventis.

Contract chemistry services revenue for the secondquarter of 2006 was $38.4 million, compared to $35.9 million in the secondquarter of 2005. Discovery, development, and small scale manufacturing (DDS)revenues increased $4.3 million from the quarter ended June 30, 2005 due toincreased worldwide demand for these services, the recognition of license feesresulting from our licensing and research agreement with BMS, and incrementalrevenues resulting from the February 28, 2006 acquisition of ComGenex (nowknown as AMRI Hungary), a drug discovery service company in Budapest, Hungary.These increases were offset by a decrease in large scale manufacturing revenueof $1.8 million, which resulted from the discontinuation of sales of one of theproducts sold to our large scale manufacturing (LSM) facility’s largestcustomer, GE Healthcare (GE). GE discontinued its purchases of this productafter the first half of 2005. Sales of this product totaled $7.0 million in thesecond quarter of 2005. This decrease was largely offset by the continueddiversification of our revenue streams. We increased revenue from theproduction of clinical supply materials for use in advance stage human trialsby $2.8 million, or 73%. The second quarter also experienced increased demandfor the remaining product we supply to GE Healthcare, which contributed anadditional $0.4 million of revenue. We expect total sales of this product for2006 to be relatively consistent with 2005. The decrease was further offset bya $2.0 million increase in sales of commercial products to customers other thanGE due to the timing of customer requirements. We expect the trend of increaseddemand for these products to continue throughout 2006.

Consolidated gross margin was 15.4% for the quarterended June 30, 2006 compared to 18.4% for the quarter ended June 30, 2005.Gross margin at the DDS operating segment increased to 26.5% in the secondquarter of 2006 compared to 18.6% for the same period in 2005, primarilyresulting from increased contract revenues in relation to the fixed costcomponents of the DDS segment. Gross margin at the LSM operating segment was5.9% in the second quarter of 2006, compared with a gross margin of 18.3% inthe second quarter of 2005. The decrease in gross margin from the secondquarter of 2005 is due to the continued transition of our large-scalemanufacturing facility from specializing in the repetitive manufacturing ofcommercial products for one customer to the non-repetitive manufacturing ofclinical supply compounds and commercial products for numerous customers.

Duringthe quarter ended June 30, 2006, we generated $5.7 million****incash from operations and spent $4.9 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 manufacturingsuites.  As of June 30, 2006, we had$107.0 million in cash, cash equivalents and investments and $20.7 millionin bank and other related debt.

19

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The trends that began to emerge in chemistryoutsourcing during 2005 continued through the second quarter of 2006. Wecontinued to experience strong demand for our developmental and small-scalecGMP manufacturing services, further extending a growth trend that began in thesecond half of 2004 that is reflective of a reduction in budgetary constraintsand increased efforts to bring identified compounds into clinical trials on thepart of our pharmaceutical and biotechnology customers. Pricing for ourservices remained extremely competitive, and the trend of sourcing contractedchemistry services to lower-cost providers continued. Our ability to providediscovery services under a variety of business models and cost structures byincorporating our lower cost international facilities that were established inIndia and Singapore in 2005 continued to be well-received by our customers. Theresulting increase in worldwide demand for our discovery services, which beganin the latter portion of 2005 and ended a two-year period of declining demandfor these services, continued through the second quarter of 2006. In addition,the acquisition of AMRI Hungary on February 28, 2006 provided incrementaldiscovery services revenues in the second quarter. We expect the acquisition ofAMRI Hungary to provide significantly increased access to European markets, aswell as another lower-cost environment that will allow us to further diversifythe business models and cost structures that are available to our customers.

We also continued to transition and expand ourclinical supply manufacturing revenue stream at our large-scale manufacturingfacility, enabling us to seamlessly transfer our customers’ clinical supplymanufacturing projects through the drug discovery and development process fromthe development of these materials at our smaller scale chemistry laboratoriesto large-scale production for use in advanced stage human trials. Clinicalsupply manufacturing supplements our large-scale  facility’s legacy services, which includecGMP commercial production, as well as high potency and controlled drugsubstance manufacturing, and is expected to assist us in recovering lostrevenues resulting from the 2005 discontinuation of purchases of one of theproducts that we sold to GE Healthcare. Sales of this product totaled $17.0million in 2005, which represented 21% of large scale manufacturing revenue forthe year ended December 31, 2005. In addition, clinical supplymanufacturing presents additional commercial production opportunities, as weseek to enter into comprehensive agreements with our customers that alsoprovide for commercial supply of these materials upon meeting regulatoryapproval.   The Company entered into twoof these types of agreements during the second quarter, and we currently expectthe commercial manufacturing of a product under one of these contracts to beginin the fourth quarter of 2006.  Clinicalsupply manufacturing represented 31% of our large-scale manufacturing revenuein the second quarter of 2006, compared to 17% in the second quarter of 2005.We are currently exploring process enhancements and cost saving opportunitiesthat will enable us to improve the efficiency and profitability of our LSMsegment. We are also evaluating opportunities to leverage our large-scale cGMP productionfacilities, including identifying niche products to manufacture such as activepharmaceutical ingredients (“API”) for use in generic versions of compoundswhose patents have expired or will be expiring, as well as assessingcomplementary lines of business that support cGMP production.

**Resultsof Operations – Three Months and Six Months Ended June 30, 2006 Comparedto Three Months and Six Months Ended June 30, 2005**

***Revenues***

*Totalcontract revenue*

Contract revenueconsists primarily of fees earned under contracts with our third partycustomers.  Our contract revenues foreach of our DDS and LSM segments were as follows:
|                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)** | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                    |       |                                                |       |                                              |       |   |   |   |   |
| DDS                     |       | $                                                   | 17,614     |                                              | $          | 13,356 |   | $ | 34,557 |   | $ | 26,953 |   |
| LSM                     |       | 20,769                                              |       | 22,592                                            |       | $ | 40,014 |   | $ | 45,621 |   |
| Total                   |       | $                                                   | 38,383     |                                              | $          | 35,948 |   | $ | 74,571 |   | $ | 72,574 |   |

DDS contract revenues forthe quarter ended June 30, 2006, increased $4.2 million to $17.6 millionas compared to $13.4 million for the same quarter in the prior year.  The increase is due to an increase incontract revenue from chemical development, small-scale GMP manufacturing andanalytical services of $1.2 million as customers continue to focus ondevelopment-stage projects. In addition, discovery services revenue increased$3.1 million due to the recognition of license fee and FTE service revenuesresulting from our License and Research Agreement with BMS, strong demand fordiscovery services provided through our lower-cost facilities in Singapore andIndia, and the addition of $1.8 million in revenue from AMRI Hungary. Wecurrently expect the overall growth trends in DDS contract revenues noted aboveto continue in 2006.

20

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LSM contract revenues for the second quarter of 2006 were $20.8million, a decrease of $1.8 million compared to contract revenue of $22.6million during the second quarter of 2005. The decrease was due to the discontinuation of purchases of one of theproducts sold to our largest LSM customer, GE Healthcare. Sales of thisproduct, which were discontinued at the end of the second quarter of 2005,totaled $7.0 million in the second quarter of 2005. This decrease was largelyoffset by the continued diversification of our revenue streams. We increased revenuefrom the production of clinical supply materials for use in advance stage humantrials by $2.8 million, or 73%. The first quarter also experienced increaseddemand for the remaining product we supply to GE Healthcare, which contributedan additional $0.4 million of revenue. We currently expect total sales of thisproduct for 2006 to be relatively consistent with 2005. The decrease wasfurther offset by a $2.0 million increase in sales of commercial products tocustomers other than GE. We expect the trend of increased demand for theseproducts to continue throughout 2006. We continue to expand our clinical supplymanufacturing capabilities with the objectives of supplementing and replacingexisting and discontinued commercial manufacturing revenues. In addition, wecurrently expect clinical supply manufacturing to serve as a source foradditional long-term commercial manufacturing opportunities, as we seek toenter into comprehensive agreements with our customers that also provide forcommercial supply of these materials upon meeting regulatory approval. Clinicalsupply manufacturing revenue represented 31% of total LSM contract revenue forthe quarter ended June 30, 2006, compared to 17% of total LSM contract revenuefor the quarter ended June 30, 2005. We currently expect the trend of increasedgrowth in clinical supply manufacturing to continue in 2006.

Forthe six months ended June 30, 2006, DDS contract revenue has increased28.2% from the six months ended June 30, 2005, due to increased worldwidedemand for discovery, development, small-scale GMP manufacturing and analyticalservices as noted above, and the addition of $2.2 million in revenues from AMRIHungary.  LSM contract revenues for thesix months ended June 30, 2006 decreased 12.3% from the six months endedJune 30, 2005 due to the discontinuation of purchases  of one of LSM’s products by GE in the secondquarter of 2005.  Sales of this producttotaled $17.0 million for the six months ended June 30, 2005.  This decrease is largely offset by sales ofclinical supply products for advanced stage human clinical trials as describedabove, as well as increases in other commercial products due to the timing ofcustomer delivery requirements.

*Recurringroyalty revenue*

We earn royaltiesunder our licensing agreement with Sanofi-Aventis S.A. for the activeingredient in Allegra.  Royalties were asfollows:

| Three Months Ended June 30, | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| **2006**                                        | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **(in thousands)**                         | ** ** |
| $                                               | 7,200      |                                              | $          | 15,892 |   | $ | 14,378 |   | $ | 27,900 |   |
|                                                 |            |                                                   |            |  |  |  |  |  |  |  |  |

Recurringroyalties decreased 54.7% to $7.2 million for the quarter ended June 30, 2006from $15.9 million for the quarter ended June 30, 2005. The decrease isprimarily attributable 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.

The recurring royaltieswe receive on the sales of Allegra/Telfast have historically provided a materialportion of our revenues, earnings, and operating cash flows. We currentlyexpect that the at risk-launch of generic fexofenadine will have a similarimpact on our royalty revenues in future periods. We expect to experience adecrease in revenues, earnings, and operating cash flows in the short term aswe continue to develop our business in an effort to supplement the revenues,earnings and operating cash flows that have historically been provided byAllegra/Telfast royalties.

On September 20,2005, we and Aventis Pharmaceuticals filed a Motion for Preliminary Injunctionin the U.S. District Court in New Jersey seeking to enjoin BarrPharmaceuticals, Inc., Teva Pharmaceuticals Ltd., Ranbaxy Laboratories, Ltd.and Amino Chemicals, Ltd. from the sale of generic versions of Allegra in theUnited States. 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 on the preliminary injunction matter, andwe continue to pursue our intellectual property rights as the patentinfringement litigation progresses. However, should we or Aventis beunsuccessful in defending these patents we would continue to experience amaterial decrease in royalty revenues. Furthermore, the entrance of additionalgeneric competitors upon the expiration of Barr’s 180-day exclusivityperiod for marketing generic fexonfenadine or an at-risk launch of a genericversion of Allegra-D by a generic competitor could result in further decreasesin royalty revenues.

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***Costs and Expenses***

*Costof contract revenue*

Ourcost of contract revenue consists primarily of compensation and associatedfringe benefits for employees, chemicals, depreciation and other indirectproject related costs.  Cost of contractrevenue for our DDS and LSM segments were as follows:

| Segment                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)** | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                    |       |                                                |       |                                              |       |   |   |   |   |
| DDS                     |       | $                                                   | 12,943     |                                              | $          | 10,868 |   | $ | 25,588 |   | $ | 21,572 |   |
| LSM                     |       | 19,546                                              |       | 18,459                                            |       | 38,044 |   | 36,891 |   |
| Total                   |       | $                                                   | 32,489     |                                              | $          | 29,327 |   | $ | 63,632 |   | $ | 58,463 |   |
|                    |       |                                                |       |                                              |       |   |   |   |   |
| DDS Gross Margin        |       | 26.5                                                | %          | 18.6                                              | %          | 26.0 | % | 20.0 | % |
| LSM Gross Margin        |       | 5.9                                                 | %          | 18.3                                              | %          | 4.9 | % | 19.1 | % |
| Total Gross  Margin     |       | 15.4                                                | %          | 18.4                                              | %          | 14.7 | % | 19.4 | % |

DDShad a contract revenue gross margin of 26.5% and 26.0% for the three and sixmonths ended June 30, 2006, respectively, compared to contract revenuegross margin of 18.6% and 20.0% for the same periods in 2005.  The increase in gross margin largely resultedfrom the increase in contract revenues in relation to the fixed cost componentsof  the DDS contract business, including the addition of license feerevenues associated with our Licensing and Research Agreement with BMS. Therecognition of license fees contributed approximately $0.7 million and $1.4million to DDS contract revenue for the three and six months ended June 30,2006, respectively, with no corresponding incremental costs. DDS contract grossmargin was also favorably impacted by a $0.3 million  and $0.6 million decrease in the amortizationof the Company’s chemical compound and natural product library inventories forthe three and six months ended June 30, 2006, respectively, due to theimpairment of these libraries in the fourth quarter of 2005. This item wasoffset by increased salary and benefit expenses due to annual merit increasesand the recognition of additional share-based compensation expense under SFASNo. 123(R). We currently expect DDS contract margins over the balance of theyear to remain consistent with the margins earned in the second quarter of2006.

LSM’s contract revenue gross margin decreased to 5.9%and 4.9% for the three and six months ended June 30, 2006 compared to18.3% and 19.1% for the same periods in 2005. The decrease is due to the transition of our large-scale manufacturingfacility from specializing in the repetitive manufacturing of commercialproducts to the non-repetitive manufacturing of clinical supply compounds fornumerous customers for use in clinical trials. We currently expect gross margins to increase in future periods from themargins earned in the second quarter of 2006 as we continue to implementprocess management improvements and cost savings initiatives in an effort tomaximize the efficiency and profitability of our clinical supply manufacturingoperations.  LSM margins are currentlyexpected to be further positively impacted in the fourth quarter of 2006 by theaddition of commercial manufacturing resulting from clinical supply productsthat are expected to receive regulatory approval, and for which we havecommercial manufacturing agreements in place.

*Technology incentive award*

Wemaintain a Technology Development Incentive Plan, the purpose of which is tostimulate and encourage novel innovative technology development by ouremployees.  This plan allows eligibleparticipants to share in a percentage of the net revenue earned by us relatingto patented technology with respect to which the eligible participant is namedas an inventor.  The award is currentlypayable primarily to Dr. Thomas D’Ambra, the Chief Executive Officer andPresident of the Company.  The incentiveaward was as follows:

| Three Months Ended June 30, | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| **2006**                                        | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **(in thousands)**                         | ** ** |
|                                            |       |                                              |       |   |   |   |   |
| $                                               | 720        |                                              | $          | 1,594 |   | $ | 1,518 |   | $ | 2,795 |   |
|                                                 |            |                                                   |            |  |  |  |  |  |  |  |  |

The decrease for thethree and six months ended June 30, 2006 was attributed to decreased Allegraroyalties for 2006 as compared to 2005, partially offset by technologyincentive awards paid to employees involved in the development our proprietaryamine neurotransmitter reuptake inhibitors as a result of the successfullicensing of this technology to BMS.

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*Research and development*

Research and development expense consists of compensation and benefits forscientific personnel for work performed on proprietary technology development,research projects, costs of chemicals and other out of pocket costs, andoverhead costs. We utilize our expertise in small molecule chemistry,biocatalysis and natural products to perform our internal research anddevelopment projects. The goal of these programs is to discover new compoundswith commercial potential. We would then seek to license these compounds to athird party in return for a combination of up-front license fees, milestonepayments and recurring royalty payments if these compounds are successfullydeveloped into new drugs and reach the market. In addition, research anddevelopment is performed at our large-scale manufacturing facility related tothe potential manufacture of new products and the development of alternativemanufacturing processes.

Researchand development expenses were as follows:

| Three Months Ended June 30, | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| **2006**                                        | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **(in thousands)**                         | ** ** |
|                                            |       |                                              |       |   |   |   |   |
| $                                               | 2,631      |                                              | $          | 3,480 |   | $ | 5,342 |   | $ | 6,969 |   |
|                                                 |            |                                                   |            |  |  |  |  |  |  |  |  |

The decrease in R&D expense during the three months and six monthsended June 30, 2006 is due primarily to the fact that we licensed our CNSprograms, which represented our most significant investment in R&D in 2005,to BMS in October 2005. As a result, after signing the agreement inOctober 2005, we did not incur significant R&D expenditures that wouldhave been necessary to further advance these programs. In addition, certaincosts associated with these programs, primarily consisting of compensation,employee benefit, and overhead costs related to the AMRI scientific personnelworking on these programs have been allocated to cost of contract revenuerelated to the contract research we are performing for BMS in conjunction withthe Licensing and Research Agreement.  Wecurrently expect R&D expenses to remain consistent in future periods fromthe amounts incurred in the second quarter of 2006 as we continue to evaluate andadvance our early to middle-stage internal research programs.

R&D spendingrelated to individual projects may fluctuate based on the results of thoseprojects.  Projecting expected projectcompletion dates and anticipated revenue from our internal research programs isnot practical at this time due to the early stages of the projects and theinherent risks related to the development of new drugs. Our internal centralnervous system program was our most advanced project to date, which we licensedto BMS in exchange for up-front license fees, contracted research services, andthe rights to future milestone and royalty payments.   We also continue to utilize our proprietarytechnologies to further advance other early to middle-stage internal researchprograms in the fields of oncology, immunosuppresion, bacterial infection andother diseases, with a view to seeking a licensing partner for these programsat an appropriate research or developmental stage.

*Selling,general and administrative*

Selling, generaland administrative expenses consist of compensation and related fringe benefitsfor marketing and administrative employees, professional service fees,marketing costs and all costs related to facilities and informationservices.  Selling, general andadministrative expenses were as follows:

| Three Months Ended June 30, | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| **2006**                                        | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **(in thousands)**                         | ** ** |
|                                            |       |                                              |       |   |   |   |   |
| $                                               | 7,786      |                                              | $          | 6,394 |   | $ | 14,547 |   | $ | 12,846 |   |
|                                                 |            |                                                   |            |  |  |  |  |  |  |  |  |

The increase in selling,general, and administrative expenses for the three months ended June 30,2006 is due to attributable primarily to $0.9 million in incrementaladministrative costs incurred at AMRI Hungary, which was acquired in February2006.  In addition, compensation andbenefit costs increased approximately $0.3 million from the second quarter of2005 due to the addition of administrative and business development personnelthroughout 2005 and the recognition of additional share-based compensationexpense for unvested stock options and restricted stock grants under SFAS No.123 (R).  The Company also incurred $0.3million in  additional data processingcosts associated with the implementation and maintenance of its ERPsystem.   These increases were partiallyoffset by a decrease in administrative costs at our Singapore Research Centreof $0.2 million due to the elimination of administrative costs to establish thefacility that were incurred in 2005.

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Theincrease in selling, general, and administrative expenses for the six monthsended June 30, 2006 is due to the addition of $1.3 million in incrementaladministrative costs associated with our international operations, an increasein salary and benefit expenses of $0.8 million due to the addition ofadministrative and business development personnel and the recognition ofadditional share-based compensation expense under SFAS No. 123 (R), an increasein data processing costs of $0.4 million due to the implementation andmaintenance of the Company’s ERP system, and an increase in travel costs of$0.2 million associated with the Company’s international operations.  These increases are partially offset by adecrease in professional fees of $0.3 million due to an overall decrease inSarbanes-Oxley compliance service costs, as well as a $0.4 million refund of property taxes at our Mt. Prospectfacility. For the remainder of the year, we expect selling, general andadministrative costs to remain consistent with amounts incurred in the secondquarter of 2006.

*Impairmentand Restructuring Charges*

We are currently marketing the Mt. Prospect Research Center facilityfor sale. The facility qualified for held for sale treatment in accordance withSFAS No. 144 during the fourth quarter of 2004. At the time that thefacility qualified for held for sale treatment in accordance with SFAS No. 144,we anticipated the completion of the sale of the facility byJune 2006.  The Company previouslydisclosed that if a definitive agreement to sell the facility was not in placeas of June 30, 2006, it would reassess the classification of the facility asheld for sale in accordance with SFAS No. 144 at that time.  The Company was not able to secure adefinitive agreement to sell the facility as of June 30, 2006.  Accordingly, and in connection with thepreparation of its second quarter results, the Company reassessed Mt. Prospectas a held for sale facility.

As aresult of this assessment, the Company reaffirmed its intention to sell the Mt.Prospect facility, and determined that a further write-down of the carryingvalue of the facility was required. Management has estimated the fair valuebased upon its intention to sell the facility within twelve months andcomparable real estate transactions in the facility’s market area.  As a result of the reduction in the carryingvalue of Mt. Prospect facility, the Company also adjusted its accruedrestructuring costs to reflect a reduction in the estimated sales commissionsto be paid upon completion of the sale of the facility.  The Company recorded the following non-cashpre-tax items related to the Mt. Prospect facility:
|                                    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)**            | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                               |       |                                                |       |                                              |       |   |   |   |   |
| Property and  equipment impairment |       | $                                                   | 3,376      |                                              | $          | — |   | $ | 3,376 |   | $ | — |   |
| Restructuring charge               |       | (292                                                | )          | —                                            |       | $ | (292 | ) | $ | — |   |
|                                    |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

*Interest income (expense), net*
|                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(in thousands)**         | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                            |       |                                                |       |                                              |       |   |   |   |   |
| Interest expense                |       | $                                                   | (264       | )                                                 | $          | (563 | ) | $ | (527 | ) | $ | (1,041 | ) |
| Interest income                 |       | 930                                                 |       | 883                                               |       | $ | 1,914 |   | $ | 1,561 |   |
| Interest income  (expense), net |       | $                                                   | 666        |                                              | $          | 320 |   | $ | 1,387 |   | $ | 520 |   |

The decrease in interestexpense for the three and six months ended June 30, 2006 was due to the paydownof the $25.5 million outstanding balance on the Company’s line of credit in thethird quarter of 2005.

Theincrease in interest income was due to increases in the rates earned oninvestment securities, interest bearing cash accounts and other short-term cashequivalents, partially offset by decreases in the underlying interest-earningbalances held by the Company.

*Incometax expense (benefit)*

| Three Months Ended June 30, | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| **2006**                                        | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **(in thousands)**                         | ** ** |
|                                            |       |                                              |       |   |   |   |   |
| $                                               | (228       | )                                                 | $          | 4,138 |   | $ | 584 |   | $ | 7,101 |   |
|                                                 |            |                                                   |            |  |  |  |  |  |  |  |  |

 

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Thedecrease in tax expense for the three months ended June 30, 2006 is dueprimarily to a decrease in pre-tax income from the three months ended June 30,2005, due largely to the decrease in Allegra royalty revenues and the Mt.Prospect impairment charge incurred during the quarter. In addition, theCompany’s effective tax rate increased from 36.2% of pre-tax income for thethree months ended June 30, 2005 to 39.2% of pre-tax loss for the three monthsended June 30, 2006. The change in the effective rate in the quarter resultedprimarily from a decrease in the estimated full year effective tax rate from30.0% to 27.5% of pre-tax income. The decrease in the 2006 effective tax ratefrom 35.1% for the year ended December 31, 2005 is due to  the consistency of the Company’s deductibleitems and non-taxable earnings and a decrease in pre-tax income, as well as thebenefit recognized from tax holidays that the Company has been granted onearnings from certain of its foreign operations.

Thedecrease in tax expense for the six months ended June 30, 2006 is due primarilyto a decrease in pre-tax income from the six months ended June 30, 2005, duelargely to the decrease in Allegra royalty revenues and the Mt. Prospectimpairment charge incurred during the second quarter. In addition, the Company’seffective tax rate decreased from 35.5% of pre-tax income for the six monthsended June 30, 2005 to 27.5% of pre-tax income for the six months ended June30, 2006. The is due to the consistency of the Company’s deductible items andnon-taxable earnings and a decrease in pre-tax income, as well as the benefitrecognized from tax holidays that the Company has been granted on earnings fromcertain of its foreign operations.

Liquidityand Capital Resources

Wehave historically funded our business through operating cash flows, proceedsfrom borrowings and the issuance of equity securities. During the first sixmonths of 2006, we generated cash of $2.5 million from operating activities. Cashprovided by operations during the first six months of 2006 decreased from thefirst six months of 2005 due to a decrease in Allegra royalty receipts of $10.7million and an increase in income tax payments of $5.0 million, including aone-time $2.8 million income tax payment related to the receipt of the $8million license fee from Bristol-Myers Squibb Company (“BMS”) in the fourthquarter of 2005. The primary sources of operating cash flows are paymentsreceived for the performance of contracted chemistry services and royaltypayments received from Sanofi-Aventis based upon a percentage of sales ofAllegra. 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. Asubstantial majority of the uses of operating cash flows pertain to the Company’sresearch and development and contract service business activities.

Duringthe first six months of 2006, we used $12.8 million in investing activities, resultingfrom the use of $11.2 million related to the acquisition of AMRI Hungary and$9.7 million for the acquisition of property and equipment, partially offset bynet proceeds from investment securities transactions of $8.2 million. Duringthe first three months of 2006, we used $2.2 million for financing activities,consisting of $2.4 million in long-term debt repayments, offset by $0.3 millionprovided by proceeds from our stock purchase plan and stock option exercises.

Workingcapital was $143.0 million at June 30, 2006 as compared to $158.8 millionas of December 31, 2005. The primary sources of the decrease were the useof cash and investments to fund capital expenditures and the acquisition ofAMRI Hungary, a decrease in inventory due to the timing of shipments to ourlarge scale manufacturing customers, and a decrease in the carrying value ofour held-for-sale Mt. Prospect facility. These decreases were partially offsetby a decrease in deferred revenue due primarily to the recognition of deferred up-frontlicensing fees received in conjunction with our Licensing and ResearchAgreement with BMS as well as the completion of the revenue recognition processon several fixed fee contracts. During 2006, we currently anticipate making$1.0 million in defined benefit pension plan contributions, $0.7 million ofwhich was paid in the first half of the year. There have been no significantchanges in future maturities on our long-term debt since December 31,2005.

We entered into acredit facility consisting of a $30.0 million term loan and a $35.0 millionline of credit during 2003. The term loan matures in February, 2008. As of June30, 2006, the interest rate on $11.4 million of the outstanding term loanbalance was 4.36% and the interest rate on the remaining $5.7 million was5.98%. The line of credit matures in June, 2010. The line of credit bearsinterest at a variable rate based on the Company’s leverage ratio. As of June30, 2006, the outstanding balance of the line of credit was $0. The creditfacility contains certain financial covenants, including a maximum leverageratio, a minimum required operating cash flow coverage ratio, a minimumearnings before interest and taxes to interest ratio and a minimum currentratio. Other covenants include limits on asset disposals and the payment ofdividends. As of June 30, 2006 we were in compliance with all covenants underthe credit facility.

Thedisclosure of payments we have committed to make under our contractualobligations is set forth under the heading “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Liquidity and CapitalResources” under Item 7 of our 2005 Form 10-K. Excluding the repayment of$2.4 million of outstanding debt, and $0.7 million in defined benefit pensionplan contributions, as described above, there have been no material changes toour contractual obligations since December 31, 2005.

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We are pursuing theexpansion of our operations through internal growth and strategic acquisitions.We expect that such activities will be funded from existing cash and cashequivalents, cash flow from operations, the issuance of debt or equitysecurities and borrowings. Future acquisitions, if any, could be funded withcash on hand, cash from operations, borrowings under our credit facility and/orthe issuance of equity or debt securities. There can be no assurance thatattractive acquisition opportunities will be available to us or will beavailable at prices and upon such other terms that are attractive to us. Weregularly evaluate potential acquisitions of other businesses, products andproduct lines and may hold discussions regarding such potential acquisitions.As a general rule, we will publicly announce such acquisitions only after adefinitive agreement has been signed. In addition, in order to meet ourlong-term liquidity needs or consummate future acquisitions, we may incuradditional indebtedness or issue additional equity or debt securities, subjectto market and other conditions. There can be no assurance that such additionalfinancing will be available on terms acceptable to us or at all. The failure toraise the funds necessary to finance our future cash requirements or consummatefuture acquisitions could adversely affect our ability to pursue our strategyand could negatively affect our operations in future periods. Furthermore, acontinued significant decrease in royalties from Allegra would negativelyaffect our cash flow from operations and financial condition in future periods.

Therecurring 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. OnSeptember 6, 2005, Barr Pharmaceuticals, Inc. and TevaPharmaceuticals Industries Ltd. announced that they had 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 thegeneric product is considered an “at-risk” launch due to the on-goinglitigation. The at-risk launch of generic fexofenadine has had a materialadverse impact on U.S. sales of Allegra by Sanofi-Aventis and in turn, theroyalties earned by us on those sales. On September 20, 2005, we andAventis Pharmaceuticals filed a Motion for Preliminary Injunction in the U.S.District Court in New Jersey seeking to enjoin Barr Pharmaceuticals,  Inc., Teva Pharmaceuticals Ltd., Ranbaxy Laboratories,Ltd. and Amino Chemicals, Ltd. from the sale of generic versions of Allegra inthe United States. Our motion was denied on January 30, 2006. We continueto forcefully and vigorously defend our intellectual property related toAllegra. We have filed an appeal of the ruling on the preliminary injunctionmatter, and we continue to pursue our intellectual property rights as thepatent infringement litigation progresses. However, should we or Aventis beunsuccessful in defending these patents we would continue to experience amaterial decrease in royalty revenues and 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.

Werefer to the policies and estimates set forth in the section “Management’sDiscussion and Analysis of Financial Condition and Results of Operations — CriticalAccounting Estimates” of our Annual Report on Form 10-K for the fiscal yearended 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 SFASNo. 123 (Revised 2004), “Share-Based Payment” (SFAS No. 123 (R)), which amendsSFAS No. 123 and supersedes APB No. 25**inestablishing standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services, as well as transactionsin which 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 in accountingfor share-based payment transactions with employees, except for equityinstruments held by employee share ownership plans.

As allowed under SFAS No. 123 (R), the Company electedthe modified prospective method of adoption, under which compensation cost is recognizedin the financial statements beginning with the effective date of SFASNo. 123 (R) for all share-based payments granted after that date, and forall unvested awards granted prior to the effective date of SFAS No. 123 (R).Accordingly, prior period amounts have not been restated. The Companyrecognized incremental compensation expense, net of taxes, of approximately$212 and $397 in the unaudited condensed consolidated statements of income forthe three and six months ended June 30, 2006, respectively, as a result of theadoption of SFAS No. 123 (R).

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Effective December 30, 2005, pursuant to and in accordance withthe recommendation of the Compensation Committee (the “Committee”) of the Boardof Directors, the Board of Directors of the Company approved full accelerationof the vesting of each otherwise unvested stock option that had an exerciseprice of $15.00 or greater granted under the Company’s 1998 Stock Option andIncentive Plan that was held by employees, officers, and non-employeedirectors. These options had exercise prices in excess of the current marketvalue of the Company’s common stock, based on the closing price of $12.15 pershare, on December 30, 2005 (*i.e*., suchoptions 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 condition tothe acceleration of vesting, each executive officer and each non-employeedirector agree to refrain from selling shares of the Company’s common stockacquired upon the exercise of accelerated options (other than shares needed tocover the exercise price and satisfy withholding taxes) until the date on whichthe exercise of such options would have been permitted under the option’spre-acceleration vesting terms or, if earlier, the officer’s or director’s lastday of employment or upon a “change in control” as defined in the Company’sstock option plan.

The decision to accelerate the vesting of theseunderwater options was made primarily to minimize certain future compensationexpenses that the Company would otherwise recognize in its consolidatedstatements of income with respect to these options pursuant to SFAS No. 123(R). The Company also believes that the acceleration may have a positive effecton employee morale, retention and the perception of option value.

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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Item 4. Controls and Procedures

*Disclosure Controls andProcedures*

As required by rule13a-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, including ensuring that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure. 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.

*Internal Control Over FinancialReporting*

There were no changes in the Company’s internalcontrol over financial reporting identified in connection with the evaluationof such internal control that occurred during the Company’s last fiscal quarterthat have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting.

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PART II -OTHER INFORMATION

Item 1.    LegalProceedings

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

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

In response to the filings described above, beginningin 2001, Aventis Pharmaceuticals filed patent infringement lawsuits againstBarr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, TevaPharmaceuticals, Dr. Reddy’s Laboratories, Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., and Sandoz. Each of the lawsuits was filed in the U.S.District Court in New Jersey and alleges infringement of one or more patentsowned by Aventis Pharmaceuticals. Further, beginning in March 5, 2004, AMRTechnology, along with Aventis Pharmaceuticals, filed suit in the U.S. DistrictCourt in New Jersey against Barr Laboratories, Impax Laboratories, MylanPharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’s Laboratories, AminoChemicals, Ltd., Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc.,DiPharma S.P.A., DiPharma Francis s.r.l., and Sandoz, Inc., assertinginfringement of two of our U.S. patents that are exclusively licensed toAventis Pharmaceuticals relating to Allegra and Allegra-D products.

In the pending litigations, Aventis Pharmaceuticalsand AMR Technology have entered into covenants not to sue the defendants otherthan  DiPharma S.P.A., DiPharma Franciss.r.l., under U.S. Patent No. 5,578,610, which patent has not been asserted inthe litigation but which Aventis Pharmaceuticals exclusively licenses from us.However, we and Aventis Pharmaceuticals have agreed that AventisPharmaceuticals will continue to pay royalties to us based on that patent underour original license agreement with Aventis Pharmaceuticals. Under ourarrangements with Aventis Pharmaceuticals, we will receive royalties untilexpiration of the underlying patents (2013 for U.S. Patent No. 5,578,610 and2015 for U.S. Patent No. 5,750,703) unless the patents are earlier determinedto be invalid.

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

On September 6, 2005, Barr Pharmaceuticals, Inc. andTeva Pharmaceuticals 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 andbriefing on that appeal is now complete.

Subsequent to the preliminary injunction proceeding,Dr. Reddy’s Laboratories has engaged in an at-risk launch of genericfexofenadine products.

Should the Company be unsuccessful in defending thesepatents, the Company would continue to experience a material decrease inoperating cash flows and a material adverse effect on our results of operationsand financial condition.

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Item 1A. RiskFactors

In addition to theother information set forth in this report, you should carefully consider thefactors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form10-K for 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. Inaddition to the risk described below, additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.

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

In July 2006, we completed the first of several phasesof the implementation of a new comprehensive enterprise resource planning (“ERP”) system to enhance operatingefficiencies and provide more effective management of our business operations. Continuingand uninterrupted performance of our****ERP system is critical to the successof our business strategy. Any material failure of our ERP system that interruptsor delays our operations could  adverselyimpact our ability to do the following in a timely manner and have a materialadverse effect on our operations:

·                  reportfinancial results;

·                  accuratelyreflect inventory costs;

·                  acceptand process customer orders;

·                  receiveinventory and ship products;

·                  invoiceand collect receivables;

·                  placepurchase orders and pay invoices; and

·                  accuratelyreflect all other business transactions related to the finance, order entry,purchasing, supply chain and human resource processes within the new****ERPinformation system.

Item 3.Quantitative and Qualitative Disclosures about Market Risk

There have been nomaterial changes with respect to the information on Quantitative andQualitative Disclosures about Market Risk appearing in Part II,Item 7A to the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005.

Item 4.                         Submission of Matters to aVote of Security Holders

TheCompany held its Annual Meeting of Stockholders (the “Annual Meeting”) on June1, 2006. At the Annual Meeting, stockholders of the Company voted to elect PaulS. Anderson, Donald E. Kuhla and Kevin O’Connor to serve as Class IIDirectors of the Company for three-year terms, such terms to continue until theAnnual Meeting of Stockholders in 2009 and until their respective successorsare duly elected and qualified. The votes cast for, and withheld from, theelection of the aforementioned Directors are listed below:
|                     | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------------|------------|------------|------------|--------------|------------|
|                |       |       |       |         |       |
| Paul S. Anderson    |       | 28,555,672 |       | 1,055,453    |       |
|                |       |       |       |         |       |
| Donald E. Kuhla     |       | 28,953,356 |       | 657,769      |       |
|                |       |       |       |         |       |
| Kevin O’Connor |       | 27,650,697 |       | 1,960,428    |       |

 

The followingindividuals continued as directors following the meeting: Thomas E. D’Ambra,Anthony P. Tartaglia, Frank W. Haydu, III and Arthur J. Roth. On July 28, 2006, Frank W. Haydu III resignedfrom the Board of Directors of the Company, including all committees of theBoard of Directors on which he served.

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Item 6.    Exhibits

(a)                      Exhibits.

10.1*                       Amended andRestated Employment Agreement, dated June 30, 2006, between Albany Molecular Research,Inc. and Thomas E. D’Ambra.

10.2*                       Form ofAmended and Restated Employment Agreement, dated June 30, 2006, between AlbanyMolecular Research, Inc. and each of Mark T. Frost, Michael P. Trova and KentonL. Shultis.

31.1                           Certificationof the Chief Executive Officer pursuant toRule 13a-14(a)/15d-14(a) of the Security Exchange Act of 1934.

31.2                           Certificationof the Chief Financial Officer pursuant toRule 13a-14(a)/15d-14(a) of the Security Exchange Act of 1934.

32.1                           Certificationof the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2                           Certificationof the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 asadopted 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.

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SIGNATURES

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.
|                            | ALBANY MOLECULAR RESEARCH, INC. |
|----------------------------|---------------------------------|
|                       |                            |   |
|                       |                            |   |
| Date:  August 9, 2006 | By:                             | /s/ Mark T. Frost |   |
|                       | ** **                      | Mark T. Frost | ** ** |
|                       |                            | Chief Financial Officer and Treasurer  (Authorized Officer and Principal Financial Officer) |

 

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