ALBANY MOLECULAR RESEARCH INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2004

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

For the transition period from to

Commission file number: 0-25323

ALBANY MOLECULAR RESEARCH, INC.

(Exact name of registrant as specified in its charter)

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

21 Corporate Circle PO Box 15098 Albany, New York 12212-5098
(Address of principal executive offices)

(518) 464-0279
(Registrant’s telephone number, including area code)

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

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

Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes ý No o

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

Class		Outstanding at November 3, 2004
Common Stock, $.01 par value		31,753,516

PART I — FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

Albany Molecular Research, Inc.

Condensed Consolidated Statements of Operations

(unaudited)

(Dollars in thousands, except for per share data)

	Three Months Ended						Nine Months Ended
	September 30, 2004			September 30, 2003			September 30, 2004			September 30, 2003
				(restated)						(restated)
Contract revenue	$	28,703		$	33,005		$	87,635		$	105,621
Recurring royalties	11,917			12,400			35,787			38,700
Total revenue	40,620			45,405			123,422			144,321

Cost of contract revenue	23,275			22,023			69,990			77,194
Write-down of library inventories	—			—			5,974			—
Total cost of contract revenue	23,275			22,023			75,964			77,194

Technology incentive award	1,193			1,253			3,578			3,883
Research and development	5,186			5,482			18,434			16,600
Selling, general and administrative	6,439			4,047			16,171			15,478
Property and equipment impairment	—			—			4,728			—
Goodwill impairment	—			—			14,494			—
Intangible asset impairment	—			—			3,541			—
Restructuring charge	230			—			656			—
Total costs and expenses	36,323			32,805			137,566			113,155

Income (loss) from operations	4,297			12,600			(14,144		)	31,166

Equity in loss of unconsolidated affiliates	—			(57		)	(65		)	(78		)
Interest (expense) income, net	(23		)	250			279			659
Other income, net	—			14			9			146

Income (loss) before income tax expense	4,274			12,807			(13,921		)	31,893

Income tax expense	1,384			4,574			1,201			11,400

Net income (loss)	$	2,890		$	8,233		$	(15,122	)	$	20,493

Basic earnings (loss) per share	$	0.09		$	0.26		$	(0.48	)	$	0.64

Diluted earnings (loss) per share	$	0.09		$	0.25		$	(0.48	)	$	0.63

See notes to unaudited condensed consolidated financial statements.

Albany Molecular Research, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

(Dollars and share amounts in thousands)

	September 30, 2004			December 31, 2003
				(restated)
Assets
Current assets:
Cash and cash equivalents	$	66,788		$	47,437
Investment securities, available-for-sale	56,219			77,191
Accounts receivable, net	18,666			18,261
Royalty income receivable	11,962			12,970
Inventories	34,228			34,292
Unbilled services	97			248
Prepaid expenses and other current assets	3,973			5,125
Total current assets	191,933			195,524

Property, plant and equipment, net	149,166			146,639

Other assets:
Goodwill	26,817			42,056
Intangible assets and patents, net	1,149			4,864
Equity investments in unconsolidated affiliates	2,230			2,191
Other assets	825			1,357
Total other assets	31,021			50,468

Total assets	$	372,120		$	392,631
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued expenses	$	12,088		$	12,844
Deferred revenue	1,507			1,179
Accrued pension benefits	2,500			2,500
Income taxes payable	1,961			884
Current installments of long-term debt and capital leases	4,527			4,521
Total current liabilities	22,583			21,928

Long-term liabilities:
Long-term debt and capital leases, excluding current installments	49,678			53,129
Deferred income taxes	7,306			12,209
Pension and postretirement benefits	1,230			2,844
Other long term liabilities	391			586
Total liabilities	81,188			90,696

Commitments and contingencies

Stockholders’ equity:
Common stock, $0.01 par value, 100,000 shares authorized, 33,829 shares issued at September 30, 2004, and 33,694 shares issued at December 31, 2003	338			337
Additional paid-in capital	188,512			184,365
Retained earnings	139,385			154,507
Accumulated other comprehensive loss	(132		)	(103		)
	328,103			339,106

Less, treasury shares at cost, 2,077 shares	(37,171		)	(37,171		)
Total stockholders’ equity	290,932			301,935
Total liabilities and stockholders’ equity	$	372,120		$	392,631

See notes to unaudited condensed consolidated financial statements.

Albany Molecular Research, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(Dollars in thousands)

	Nine Months Ended
	September 30, 2004			September 30, 2003
				(restated)
Operating activities
Net (loss) income	$	(15,122	)	$	20,493
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization	11,410			9,814
Abandonment loss	—			1,400
Write-down of library inventories	5,974			—
Property and equipment impairment	4,728			—
Goodwill impairment	14,494			—
Intangible asset impairment	3,541			—
Warrant issuance expense	3,053			—
Allowance for bad debts	4			160
Tax benefit of stock options	—			574
Amortization of deferred financing fees	19			17
Equity in income (loss) of unconsolidated affiliates	65			78
Deferred income tax (benefit)	(4,099		)	2,445
Pension and postretirement benefits	—			(368		)
Amortization of discount on note payable	—			(13		)
Change in fair value of interest rate swap	—			(231		)
(Increase) decrease in operating assets, net of business acquisition in 2003:
Accounts receivable	(513		)	(674		)
Royalty income receivable	1,008			1,001
Unbilled services	151			(20		)
Inventory, prepaid expenses and other assets	(4,475		)	383
(Decrease) increase in:
Accounts payable and accrued expenses	(756		)	(5,252		)
Income tax payable	1,077			1,965
Deferred revenue	328			1,230
Pension and postretirement benefits	(1,614		)	—
Environmental liability	(28		)	(55		)
Other liabilities	—			20
Net cash provided by operating activities	19,245			32,967

Investing activities
Purchase of investments	—			(12,256		)
Proceeds from maturity of investment securities	20,323			19,655
Purchase of business, net of cash acquired	—			(28,305		)
Purchases of property, plant and equipment	(17,698		)	(22,056		)
Payments for patent applications and other costs	(169		)	(224		)
Net cash provided by (used in) investing activities	2,456			(43,186		)

Financing activities
Borrowings on long-term debt	—			30,060
Principal payments on capital leases	—			(363		)
Principal payments on long-term debt	(3,445		)	(2,375		)
Purchase of treasury stock	—			(11,284		)
Proceeds from sale of common stock	1,095			1,492
Net cash (used in) provided by financing activities	(2,350		)	17,530

Increase in cash and cash equivalents	19,351			7,311

Cash and cash equivalents at beginning of period	47,437			34,838

Cash and cash equivalents at end of period	$	66,788		$	42,149

See notes to unaudited condensed consolidated financial statements.

Note 1 – Summary of Operations and Significant Accounting Policies

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

Nature of Business and Operations

Albany Molecular Research, Inc. (the “Company”) is a leading chemistry-based drug discovery and development company focused on applications for new small molecule prescription drugs. The Company conducts research and development projects and collaborates with many leading pharmaceutical and biotechnology companies, and is developing new chemistry technology for potential pharmaceutical products. The Company engages in chemistry research, from lead discovery, optimization and development to commercial manufacturing. As part of its drug discovery strategy, the Company is also producing novel compound collections and chemical screening collections. In addition to its chemistry research services, the Company also conducts proprietary research and development to develop new technologies and to discover new lead compounds with commercial potential. The Company seeks to license these compounds to third parties in return for up-front service fees and milestone payments as well as recurring royalty payments if these compounds are developed into new drugs successfully reaching the market.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In accordance with Rule 10-01, the unaudited condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. The year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair statement of the results for the interim period have been included. Operating results for the quarter and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K/A for the year ended December 31, 2003. The consolidated financial statements for the years ended December 31, 2003, 2002, and 2001 have been restated – see Note 14 herein for a discussion of the impact the restatement has on amounts reported for the quarter and nine months ended September 30, 2003 included in these financial statements.

The accompanying unaudited condensed consolidated financial statements include the accounts of Albany Molecular Research, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated during consolidation.

Use of Management Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results can vary from these estimates.

Contract Revenue Recognition

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

The Company generates contract revenue on the following basis:

Full-time Equivalent (FTE). An FTE agreement establishes the number of Company employees contracted for a project or a series of

projects, the duration of the contract period, the price per FTE, plus an allowance for chemicals and other project specific costs, which may or may not be incorporated in the FTE rate. Typically, FTE contracts have terms of six months or longer. FTE contracts typically provide for annual adjustments in billing rates for the scientists assigned to the contract. These contracts involve the Company’s scientists providing services on a “best efforts” basis in the development of novel chemistry for customers. There are no fixed deliverables as part of these services. As such, the Company recognizes revenue under FTE contracts on a monthly basis as services are performed according to the terms of the contract.

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

Fixed Fee. Under a fixed-fee contract the Company charges a fixed agreed upon amount for a deliverable. Fixed-fee contracts have fixed deliverables upon completion of the project. The Company recognizes revenue for fixed fee contracts after projects are completed, delivery is made and title transfers to the customer and collection is reasonably assured.

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

Recurring Royalty Revenue Recognition.

Recurring royalties consist of royalties under a license agreement with Aventis based on the worldwide sales of fexofenadine HCl, marketed as Allegra in the Americas and Telfast elsewhere. The Company records royalty revenue in the period in which the sales of Allegra occur. Royalty payments from Aventis are due within 45 days after each calendar quarter and are determined based on sales of Allegra/Telfast in that quarter.

Natural Product and Lead Finding Sample Collections.

As part of the Company’s strategy to provide a comprehensive offering of natural product and chemical lead finding discovery services and technologies to its customers, it has acquired natural product sample collections and related assets and is producing novel compound libraries and chemical screening collections. The natural product sample collections were acquired in connection with the 2001 acquisition of New Chemical Entities, Inc. (NCE). For internally developed libraries, the Company is capitalizing the cost of internally producing novel compound and screening collections in inventory. Initial costs to develop novel compound libraries are categorized as research and development expense until such time it becomes probable that a saleable library can be successfully produced. As a result, costs for the design, research, and testing of libraries under development are expensed as incurred. Company research chemists review the results of analytical procedures to determine if the chemical reactions were completed as expected and the product purity and product yields are within required specifications. This “validation” process determines whether the chemistry is successful and if a saleable product will result. We capitalize costs of production to inventory once the validation process is completed and successful production is reasonably assured. If a core reaction is unsuccessful, the library template is abandoned and no further development takes place.

Capitalized costs are amortized over the economic life of the library (estimated at 3 years) at the greater of (a) the ratio of the product’s current gross revenue to the total of current and expected gross revenues or (b) the straight-line method computed by dividing the remaining unamortized capitalized cost by the remaining economic life of the product. The remaining economic life is reassessed at each balance sheet date and changes in estimate, if appropriate, are made to the amortization model. Amortization of library inventories is included within research and development expense on the consolidated income statement. Library amortization expense was $230 and $0 for the three and nine months ended September 30, 2004 and 2003, respectively. In addition, the Company monitors the carrying value of its natural product and lead finding sample collections for impairment on a quarterly basis. The Company compares the carrying values of these collections to their estimated net realizable fair values, which are based on estimated future sales of these collections, to determine impairment. The Company recognizes an impairment charge for any collection whose carrying value is greater than its estimated net realizable fair value. During the quarter ended June 30, 2004, the Company recorded a $5,974 write-down to reduce the carrying value of its natural product and chemical lead finding library inventories. See Note 3 for further information regarding the write-down of inventories.

Long-lived Assets

In accordance with the provisions of SFAS 144, the Company assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Factors the Company considers important which could trigger an impairment review include, among others, the following:

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

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

• a significant decrease in the market value of assets.

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

During the quarter ended June 30, 2004, the Company recorded impairment charges to intangibles, property and equipment of $6,654 and $1,615, respectively, related to the Bothell and the Mount Prospect Research Center. See Note 5 for further information.

Goodwill

In accordance with the provisions of SFAS 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 underperformance relative to historical or projected future operating results;

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

• significant negative industry or economic trends; and

• market capitalization relative to net book value.

The write-down of library inventories as discussed in Note 3 and the restructuring of the Mount Prospect Research Center as discussed in Note 4 triggered an assessment of the recoverability of certain other related long-lived assets and goodwill within its Bothell and Mount Prospect Research Center reporting units during the quarter ended June 30, 2004. The Company recorded goodwill impairment charges of $13,251 and $1,243, respectively, relating to its Bothell reporting unit and its Mt. Prospect reporting unit as a result of these assessments during the quarter ended June 30, 2004. See Note 6 for further information.

The Company performed the annual goodwill assessment for its remaining reporting units during the third quarter of 2004. Based on the results of these assessments, no additional goodwill impairment was identified. If management’s expectations of future operating results change, or if there are changes to other assumptions, the estimate of the fair value of our reporting units could change significantly. Such a change could result in additional goodwill impairment charges in future periods, which could have a significant impact on our consolidated financial statements. Total goodwill recorded on the Company’s balance sheet at September 30, 2004 was $26.8 million, including $24.1 million of goodwill associated with the Company’s acquisition of Organichem, Inc.

Stock Compensation

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, ‘‘Accounting for Stock Issued to Employees,’’ and related interpretations, in accounting for its fixed plan stock options. As such, compensation expense would be recorded only if, on the date of grant, the current market price of the underlying stock exceeded the exercise price. Any compensation expense would be recognized over the vesting period. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands, except per share data)	2004		2003		2004				2003
			(restated)						(restated)
Net income (loss), as reported	$	2,890	$	8,233	$		(15,122	)	$	20,493
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.	621		621		1,856				1,829
Pro Forma net income (loss)	$	2,269	$	7,612	$	(16,978		)	$	18,664

Earnings (loss) per share:
Basic as reported	$	0.09	$	0.26	$	(0.48		)	$	0.64
Basic pro-forma	$	0.07	$	0.24	$	(0.54		)	$	0.58

Diluted as reported	$	0.09	$	0.25	$	(0.48		)	$	0.63
Diluted pro-forma	$	0.07	$	0.24	$	(0.54		)	$	0.57

Note 2 – Earnings (Loss) Per Share

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

(in thousands)

	Three Months Ended September 30,		Nine Months Ended September 30,
	2004	2003	2004	2003
Weighted average common shares outstanding	31,741	31,804	31,627	31,971
Dilutive effect of stock options	305	488	—	506
Weighted average common shares outstanding	32,046	32,292	31,627	32,477

The Company has excluded the effects of outstanding stock options and warrants from the calculation of diluted net loss per share for the nine months ended September 30, 2004 because such securities would be anti-dilutive. In addition, the Company has excluded certain outstanding stock options and warrants from the calculation of diluted earnings per share for the three months ended September 30, 2004 and 2003, and the nine months ended September 30, 2003, because the exercise price was greater than the average market price of the Company’s common shares during that period, and as such would be anti-dilutive. The number of anti-dilutive options and warrants outstanding, prior to consideration of the treasury stock method, were 2,972 and 2,105 for the three month period ended September 30, 2004 and 2003, respectively, and are not included in the calculation of weighted average common shares outstanding. The number of anti-dilutive options and warrants outstanding were 3,500 and 2,053 for the nine month period ended September 30, 2004 and 2003, respectively.

Note 3 – Inventory

Inventory consisted of the following at September 30, 2004 and December 31, 2003:

	September 30, 2004			December 31, 2003
Raw materials	$	5,813		$	12,250
Work in process	2,581			3,622
Finished goods	24,296			10,846
Libraries	10,471			9,114
Total inventories, at cost	43,161			35,832
Less reserves	(8,933		)	(1,540		)
Total inventory, net	$	34,228		$	34,292

During the quarter ended June 30, 2004, the Company determined that the carrying value of its natural product and chemical lead finding libraries exceeded its latest forecasted revenues (see Note 1). The Company’s forecasted revenues from natural product and chemical lead finding libraries had been lowered to reflect less favorable market conditions than previously projected. As a result, the Company recorded a $5,974 non-cash charge to reduce the carrying value of its library inventories. The Company evaluates the carrying value of its inventory of raw materials used in discovery and chemical services in consideration of anticipated usage and adjusts its reserves for excess quantities on hand accordingly. Based on its evaluations, the Company has increased its reserves for excess raw materials inventories by an aggregate of $1,218 during the second and third quarters of 2004. The Company’s provisions for excess raw materials are recorded as a component of cost of contract revenue in the accompanying condensed consolidated statement of operations.

Note 4 – Restructuring of Mt. Prospect

On May 4, 2004, the Company announced plans to consolidate operations by relocating its Mt. Prospect, IL operations to the Company’s facilities in New York. The Company’s proprietary biocatalysis technology platform, drug metabolism screening, research fermentation and chemical development technologies in Mt. Prospect will be relocated to New York and continue to be fully integrated with the Company’s drug discovery and development technologies. The restructuring will result in the closure of the Mt. Prospect Research Center, which is expected to be completed in the fourth quarter of 2004. The consolidation was initiated as a result of a lack of anticipated growth in the Company’s chemical development services at the facility. As a result of the restructuring, 33 employees were terminated and 25 employees are relocating to facilities in New York.

The Company has accounted for the restructuring costs as required by SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS No. 146). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at its fair value in the period in which the liability is incurred, except for one-time termination benefits that meet certain requirements. These actions have resulted in the recognition of $656 of restructuring charges for the nine months ended September 30, 2004. During the fourth quarter of 2004, the Company expects to continue to recognize additional restructuring charges, primarily related to asset disposal related costs, of $600.

The employee termination costs are included under the caption restructuring charge in the statements of operations and the restructuring liabilities are included in accounts payable and accrued expenses on the balance sheet at September 30, 2004. The following table displays the restructuring activity and liability balances:

	Balance At March 31, 2004		Charges		Payments			Balance At September 30, 2004
Termination Benefits	$	––	$	630	$	(274	)	$	356
Other associated costs	––		26		(26		)	––
Total	$	––	$	656	$	(300	)	$	356

Costs of termination benefits relate to severance packages, outplacement services and career counseling for employees affected by the restructuring.

The Company also incurred $752 in employee and equipment relocation costs during the third quarter of 2004. The Company expects to recognize an additional $150 in employee and equipment relocation costs during the remainder of 2004. These relocation costs are included under the caption “selling, general and administrative” in the statement of operations.

Although the Company made the determination to sell the Mt. Prospect facility in the second quarter of 2004, it has not yet met all of the criteria in SFAS No. 144 to classify these assets as held for sale during the third quarter of 2004. The Company expects to meet the held for sale criteria in the fourth quarter of 2004. Upon qualifying for held for sale treatment, the long-lived assets associated with Mt. Prospect will be recognized as a separate line item on the consolidated balance sheet until sold and depreciation expense will cease respective to those assets.

The above restructuring activity was recorded exclusively in the AMR operating segment. The net cash outflow related to the restructuring for the quarter and nine months ended September 30, 2004 was $265 and $300, respectively. Anticipated cash outflows related to the restructuring for the fourth quarter of 2004 is $450, which primarily consists of additional relocation costs and asset disposal costs.

Note 5 – Impairment of Long-Lived and Intangible Assets

The Company’s write-down of library inventories discussed in Notes 1 and 3 above triggered an assessment of the recoverability of certain other related long-lived assets and goodwill within its Bothell reporting unit, including the goodwill and intangibles which resulted from the 2001 acquisition of New Chemical Entities (NCE), during the quarter ended June 30, 2004. The Company performed SFAS 144 analyses of its property and equipment for potential impairment at its Mt. Prospect and Bothell Research Centers. The Company’s analyses concluded that the carrying value of the respective asset groups exceeded their fair value. The impairment has been allocated to the long-lived assets of the groups on a pro-rata basis. Accordingly, the Company recorded impairment losses on its long-lived assets at its Mt. Prospect and Bothell Research Centers of $1,615 and $3,113, respectively. The Company utilized the assistance of an independent valuation firm in determining fair values.

Due to the write-down of the Company’s natural product libraries, the Company also performed an assessment of the carrying value of its microbial cultures and related technologies during the quarter ended June 30, 2004. The microbial cultures and related technologies are the starting materials and technology used in the development of the natural product libraries and therefore would be used to make incremental copies of the natural product libraries. Based on its assessment, the Company concluded that the carrying value of the microbial cultures and related technologies was not recoverable, and accordingly recorded a $3,541 impairment charge representing the entire remaining carrying value of microbial cultures and related technologies.

The components of intangible assets are as follows:

	Cost		Accumulated Amortization			Net		Amortization Period
September 30, 2004
Microbial Cultures	$	—	$	—		$	—	15 years
Patents and Licensing Rights	1,401		(252		)	1,149		16 years
	$	1,401	$	(252	)	$	1,149

December 31, 2003
Microbial Cultures	$	4,511	$	(751	)	$	3,760	15 years
Patents and Licensing Rights	1,231		(127		)	1,104		16 years
	$	5,742	$	(878	)	$	4,864

Amortization expense related to intangible assets for the three and nine months ended September 30, 2004 was $55 and $344, respectively.

Estimated future annual amortization expense related to intangible assets is approximately $220 per year through the year ended December 31, 2017.

Note 6 – Goodwill

During the quarter ended June 30, 2004, due to the triggering events discussed in Notes 1, 3, and 5, the Company determined that the

carrying value of its goodwill at its Bothell reporting unit may be impaired. Accordingly, the Company conducted a goodwill impairment review as required under SFAS 142, and concluded that an impairment had occurred and therefore recorded a $13,251 goodwill impairment charge, which reflects a full impairment of the Bothell goodwill. In calculating the goodwill impairment charge, the fair value of the Bothell reporting unit was determined with the assistance of an independent valuation firm using a discounted cash flow valuation approach. Significant assumptions used in this analysis include (i) expected future revenue growth rates, reporting unit profit margins, and working capital levels, (ii) a discount rate, and (iii) a terminal value multiple. The revenue growth rates, working capital levels and reporting unit profit margins were based on management’s best estimate of future results.

As further noted in Note 4 , during the quarter ended June 30, 2004, the Company announced its decision to close its Mt. Prospect facility and consolidate operations in New York. This restructuring and related impairment of property and equipment were considered triggering events under SFAS 142. Accordingly, the Company conducted a goodwill impairment review as required under SFAS 142. The Company completed its assessment and concluded that an impairment had occurred and recorded a $1,243 goodwill impairment charge based upon a valuation of the reporting unit. The valuation was prepared with the assistance of an independent valuation firm using a discounted cash flow approach. Significant assumptions used were similar to those used for the Bothell reporting unit valuation.

The changes in the carrying amount of goodwill, by segment, for the nine month ended September 30, 2004 and the year ended December 31, 2003 is as follows:

	AMR			Organichem			Total
Balance as of January 1, 2004	$	17,180		$	24,876		$	42,056
Goodwill acquired (1)	—			(745		)	(745		)
Impairment losses	(14,494		)	—			(14,494		)
Balance as of September 30, 2004	$	2,686		$	24,131		$	26,817

(1) adjustment resulting from the reversal of a tax valuation allowance

	AMR		Organichem		Total
Balance as of January 1, 2003	$	17,180	$	—	$	17,180
Goodwill acquired	—		24,876		24,876
Impairment losses	—		—		—
Balance as of December 31, 2003	$	17,180	$	24,876	$	42,056

Note 7 – Defined Benefit and Postretirement Welfare Plan

Organichem previously provided retirement benefits under two non-contributory defined benefit plans and a non-contributory, unfunded post-retirement welfare plan. Future benefits under all three plans have been frozen.

Components of Net Periodic Benefit Cost

	Pension Benefits						Postretirement Benefits				Pension Benefits							Postretirement Benefits
	Three Months Ended September 30,						Three Months Ended September 30,				Nine Months Ended September 30,							Nine Months Ended September 30,
	2004			2003			2004		2003		2004			2003				2004		2003
Service Cost	$	(5	)	$	142		$	6	$	15	$	39		$		425		$	25	$	45
Interest Cost	277			308			4		8		877			923				12		23
Expected return on plan assets	(260		)	(240		)	—		—		(825		)	(718			)	—		—
Amortization of prior service cost	—			—			—		—		—			—				—		—
Recognized net (gain) loss	(3		)	7			—		1		—			7				—		2

Net Periodic benefit cost	$	9		$	217		$	10	$	24	$	91		$	637			$	37	$	70

Employer Contributions

The Company previously disclosed in its financial statements for the year ended December 31, 2003 that it expected to contribute $2,500 to its pension plan in 2004. As of September 30, 2004, $1,842 in contributions have been made. The Company continues to anticipate contributing the additional $658 to fund its pension plans in 2004.

Note 8 – Stock Purchase Warrants

In March 2004, the Company issued warrants to purchase up to 516 shares of the Company’s common stock, with exercise prices ranging from $30.24 to $35.24, to Bristol-Myers Squibb Company (BMS). The warrants expire in September, 2009. The issuance of these warrants results from a 2002 agreement whereby BMS transferred intellectual property to the Company, providing the Company with ownership of one of BMS’s preclinical drug candidates, along with patent applications covering attention deficit hyperactivity disorder (ADHD) and central nervous system indications. In connection with the agreement, in March 2004, the Company elected to retain ownership of the technology and all improvements made to date, resulting in the issuance of the warrants to BMS. The issuance of these warrants satisfies all equity-related obligations to BMS and results in the Company’s full ownership of these preclinical drug candidates and related intellectual property. Such warrants, which had a value of $3,053 on the date of issuance, were charged to research and development costs, with a corresponding credit to stockholders’ equity, during the three months ended March 31, 2004. The value of warrants issued was determined using the Black-Scholes option-pricing model with the following assumptions.

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

Note 9 – Income Taxes

The Company’s 2004 effective tax rate is impacted by the impairment of certain nondeductible items related to the goodwill impairment charges it recorded in the second quarter of 2004. Non-deductible impairment charges totaling $17.1 million were treated as infrequent discrete items in the preparation of the Company’s income tax provision for the nine months ended September 30, 2004. The differences between income tax expense and income taxes computed using a federal statutory rate of 35% for the three and nine months ended September 30, 2004 and 2003, were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
			(restated)				(restated)
Statutory tax rate	35.0	%	35.0	%	(35.0	)%	35.0	%

Increase (reduction) in tax rate resulting from:

Tax-free interest income	(2.9	)	(0.6	)	(0.6	)	(0.7	)
Goodwill and intangible asset impairment	—		—		42.9		—
State taxes, net of federal benefit	4.0		1.2		0.9		1.4
Non-deductable Organichem purchase Accounting expenses	—		0.6		—		0.7
Extraterritorial income credit	(4.0	)	(1.0	)	(0.9	)	(1.2	)
Other, net	0.3		0.5		1.3		0.5

	32.4	%	35.7	%	8.6	%	35.7	%

Note 10 – Operating Segment Data

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

Albany Molecular Research includes activities such as drug lead discovery, optimization, drug development and small scale

commercial manufacturing. Organichem includes pilot to commercial scale manufacturing of active pharmaceutical ingredients and intermediates and high potency and controlled substance manufacturing all of which are in compliance with the Food and Drug Administration’s (FDA) current Good Manufacturing Practices.

The following table contains earnings data by operating segment, reconciled to consolidated totals included in the financial statements:

	Contract Revenue			Recurring Royalty Revenue		Operating (loss) income			Depreciation and Amortization
For the three months ended September 30, 2004
AMR	$		13,698	$	11,917	$	12,077		$	2,765
Organichem	15,005			—		3,846			1,451
Corporate	—			—		(11,626		)
Total	$		28,703	$	11,917	$	4,297		$	4,216

For the three months ended September 30, 2003 (restated)
AMR	$		15,649	$	12,400	$	16,554		$	2,088
Organichem	17,356			—		5,575			1,321
Corporate						(9,529		)
Total	$		33,005	$	12,400	$	12,600		$	3,409

For the nine months ended September 30, 2004
AMR	$		40,147	$	35,787	$	9,276		$	7,082
Organichem	47,488			—		11,186			4,328
Corporate	—			—		(34,606		)
Total	$		87,635	$	35,787	$	(14,144	)	$	11,410

For the nine months ended September 30, 2003 (restated)
AMR	$		47,600	$	38,700	$	51,409		$	5,879
Organichem	58,021			—		11,835			3,952
Corporate						(32,078		)
Total	$	105,621		$	38,700	$	31,166		$	9,831

The following table summarizes other information by segment as of and for the nine months ended September 30, 2004:

	As of and for nine months ended September 30, 2004
(in thousands)	AMR		Organichem		Total

Total assets	$	249,173	$	122,947	$	372,120
Goodwill included in total assets	2,686		24,131		26,817
Investments in unconsolidated affiliates	2,230		—		2,230
Capital expenditures	8,950		8,748		17,698

Note 11 – Financial Information by Customer Concentration and Geographic Area

Total contract revenue from AMR’s three largest customers represented approximately 14%, 8% and 7% of AMR’s total contract revenue for the three months ended September 30, 2004, and 12%, 11% and 7% of total contract revenue for the three months ended September 30, 2003. Total contract revenue from AMR’s three largest customers represented approximately 14%, 11% and 5% of AMR’s total contract revenue for the nine months ended September 30, 2004, and 13%, 10% and 7% of total contract revenue for the nine months ended September 30, 2003. Total contract revenue from Organichem’s largest customer, Amersham Health PLC, represented 67% and 63% of Organichem’s total contract revenue for the three months ended September 30, 2004 and 2003, respectively. Total contract revenue from Organichem’s largest customer represented 68% and 71% of Organichem’s total contract revenue for the nine months ended September 30, 2004 and 2003, respectively. Amersham Health PLC accounted for approximately 37% and 39% of the Company’s total contract revenue for the nine months ended September 30, 2004 and 2003, respectively.

The Company’s total contract revenue for the three and nine months ended September 30, 2004 and 2003 was recognized from customers in the following geographic regions:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003

United States	64	%	55	%	62	%	51	%
Europe	34	%	40	%	35	%	45	%
Other	2	%	5	%	3	%	4	%

Total	100	%	100	%	100	%	100	%

Note 12 – Comprehensive Income (Loss)

The Company is required to report comprehensive income and its components in accordance with the provisions of the Financial Accounting Standards Board Statement No. 130, “Reporting Comprehensive Income.”

The following table presents the components of the Company’s comprehensive (loss) income for the three and nine months ended September 30, 2004 and 2003:

(in thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004				2003
				(restated)							(restated)
Net income (loss)	$	2,890		$	8,233		$		(15,122	)	$	20,493

Other comprehensive loss:
Unrealized gain (loss) on available-for-sale securities, net of taxes	107			(107		)	(153			)	(180			)
Unrealized (loss) gain on Interest Rate Swap, net of taxes	(180		)	384			124				(272			)
Reclassification adjustment:
Proportionate share of Organichem accumulated other comprehensive gain	—			—			—				1,038
Total comprehensive income (loss)	$	2,817		$	8,510		$	(15,151		)	$		21,079

Note 13 – Legal Proceedings

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

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

In response to the filings described above, beginning in 2001, Aventis Pharmaceuticals filed patent infringement lawsuits against Barr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’s Laboratories, Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals 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 patents owned by Aventis Pharmaceuticals. Further, beginning in March 5, 2004, AMR Technology, along with Aventis Pharmaceuticals, filed suit in the U.S. District Court in New Jersey against Barr Laboratories, Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’s Laboratories, Amino Chemicals, Ltd., Sandoz, Inc. and Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc., asserting infringement of two of our U.S. patents that are exclusively licensed to Aventis Pharmaceuticals relating to Allegra and Allegra-D products.

In the pending litigations, Aventis Pharmaceuticals and AMR Technology have entered into covenants not to sue the defendants under U.S. Patent No. 5,578,610, which patent has not been asserted in the litigation but which Aventis Pharmaceuticals exclusively licenses from us. However, we and Aventis Pharmaceuticals have agreed that Aventis Pharmaceuticals will continue to pay royalties to us based on that patent under our original license agreement with Aventis Pharmaceuticals. Under our arrangements with Aventis Pharmaceuticals, we will receive royalties until expiration of 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 an FDA-approved generic version of Allegra may not commence until the earlier of a decision favorable to the generic challenger in the patent litigation or 30 months after the date the patent infringement lawsuit was filed. In general, the first generic filer is entitled to a 180-day marketing exclusivity period upon FDA approval.

Should the Company be unsuccessful in defending these patents we would experience a material decrease in operating cash flows.

Note 14 – Restatement

The accompanying condensed consolidated 2003 financial statements of the Company have been restated to properly recognize premium and discount amortization on certain debt securities as required by FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities”.

In October 2004, management of the Company identified that the accounting principles as set forth in SFAS 115, regarding amortization of premiums and discounts paid on bonds, had not been properly applied in prior periods to certain of its debt investments. During a review of the Company’s accounting for bond investments, the Company identified an accounting error that had resulted, in the three years ended December 31, 2003, in an overstatement of interest income. The cumulative impacts of this error as of December 31, 2003, including the related income tax effect, resulted in a $582,000 understatement of accumulated other comprehensive income, a $349,000 understatement of deferred income tax liability, and a $931,000 overstatement of retained earnings. The cumulative impacts of this error as of and for the nine months ended September 30, 2003, including the related income tax effect, resulted in a $222,000 understatement of accumulated other comprehensive income, and a $222,000 overstatement of net interest income and retained earnings.

The unaudited quarterly financial data in these financial statements has been restated to properly reflect the bond amortization.

The effect of these errors is detailed, by reporting period, below.

	Three months ended September 30, 2003				Nine months ended September 30, 2003
	Previously Reported		Restated		Previously Reported		Restated
	(In thousands, except per share amounts)

Statement of income:
Interest income	330		250		881		659

Income before provision for income taxes	12,887		12,807		32,115		31,893

Net income	8,313		8,233		20,715		20,493

Earnings per common share:

Basic	$	0.26	$	0.26	$	0.65	$	0.64

Diluted	$	0.26	$	0.25	$	0.64	$	0.63

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

Forward-Looking Statements

The following discussion of our results of operations and financial condition should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and the Notes thereto included within this report. This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). 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. The Company’s actual results may differ materially from such forward-looking statements as a result of numerous factors, some of which the Company may not be able to predict and may not be within the Company’s control. Factors that could cause such differences include, but are not limited to, the Company’s ability to successfully relocate and consolidate its Mt. Prospect operations with its New York facility, the risk that the Company will not achieve the cost savings expected to result from the closure and relocation of its Mt. Prospect operations, the Company’s ability to recruit and retain experienced scientists, trends in pharmaceutical and biotechnology companies outsourcing chemical research and development, the loss of a significant customer, sales of Allegra (including any deviations in estimates provided by Aventis) and the Company’s receipt of significant royalties from the Allegra license agreement, the risk that Allegra may be approved for over-the-counter use, the over-the-counter sales of Claritin, the over-the-counter sale of generic alternatives for the treatment of allergies and the risk of new product introductions for the treatment of allergies, the Company’s and Aventis’ ability to successfully enforce their respective intellectual property, patent rights and technology, including with respect to the generic companies’ Abbreviated New Drug Application filings, the integration and operating risks associated with the Company’s acquisition of Organichem, the Company’s ability to successfully develop novel compounds and lead candidates in its collaborative arrangements, the Company’s ability to take advantage of proprietary technology and expand the scientific tools available to it, the ability of the Company’s strategic investments and acquisitions to perform as expected and goodwill impairment related to such investments and acquisitions, the Company’s ability to successfully complete its ongoing expansion projects on schedule, the Company’s ability to execute its business plan for compound and chemical screening libraries, and the Company’s ability to effectively manage its growth, as well as those discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission on March 15, 2004. All forward-looking statements are made as of the date of this report, and we do not undertake to update any such forward-looking statements in the future. References to “we,” “us,” and “our,” refers to Albany Molecular Research, Inc. and its subsidiaries, taken as a whole.

Overview

We are a leading chemistry-based drug discovery and development company, focused on identifying and developing novel biologically active small molecules with applications in the prescription drug market. We engage in comprehensive chemistry research from lead discovery, optimization and development to commercial manufacturing and conduct cell and non-cell based high throughput screening on a variety of biological targets. We perform contract research services for many of the leading pharmaceutical and biotechnology companies and also conduct our own internal proprietary research and development to discover new therapeutically-active lead compounds with commercial potential. We anticipate that we would then license these compounds to third parties in return for up-front service fees and milestone payments as well as recurring royalty payments if these compounds are developed into new commercial drugs. In 1995, our proprietary research and development activities led to the development, patenting and licensing of a substantially pure form of, and a manufacturing process for, the active ingredient in the non-sedating antihistamine fexofenadine HCl marketed by Aventis S.A. as Allegra in the Americas and as Telfast elsewhere. In addition, certain of our discovery technology contracts provide for us to receive milestone and royalty payments for discoveries that lead to commercial products.

Our total revenue for the quarter ended September 30, 2004 was $40.6 million, including $28.7 million from our chemistry contract business, as compared to $45.4 million for the quarter ended September 30, 2003. Contract revenue for the third quarter of 2004 decreased $4.3 million from $33.0 million in the third quarter of 2003. The decline in contract revenue is primarily due to the timing of delivery requirements for Organichem’s second largest customer, continued off-shore competition, pricing pressures and reductions in chemistry spending by pharmaceutical and biotechnology companies, offset by a combined increase in contract revenue from chemical development, GMP manufacturing, and analytical services. Consolidated gross margin was 18.9% for the quarter ended September 30, 2004 compared to 33.3% for the quarter ended September 30, 2003. Gross margin for Organichem in the third quarter of 2004 was 25.6%, compared to 32.1% in the third quarter of 2003. The decline in Organichem’s gross margin is primarily attributable to the decline in production and sales volume. Gross margin at the AMR operating segment decreased to 11.6% in the third quarter of 2004 compared to 34.6% for the same period in 2003, primarily due to the fixed cost components of AMRI’s contract business on lower revenues, competitive pricing pressures and a $0.3 million increase in reserves for excess raw materials.

During the quarter ended September 30, 2004, we generated $7.2 million in cash from operations and spent $4.9 million in capital on our facilities and equipment, primarily related to the expansion of our manufacturing suites at Organichem. As of September 30,

2004, we had $123.0 million in cash, cash equivalents and investments and $54.2 million in bank and other related debt.

The business environment for chemistry outsourcing continued to be challenging in the third quarter of 2004. Our customers remain under budgetary pressures and are currently spending a greater portion of their research and development dollars on later stage development projects. In certain areas of our business there has been a significant increase in foreign competition that has substantially lower cost structures. The lower cost structures result from parts of the world where salaries are a fraction of what they are in industrialized countries. This trend has resulted in lost business and has brought pricing pressures in the U.S., impacting our ability to increase or maintain pricing on our customer contracts. We expect the increase in competition from lower cost locations, such as Asia and India, to continue.

We are currently assessing several strategies to establish operations in a lower-cost, off-shore environment. We believe the ability to offer customers a choice of business models and cost structures to meet their drug discovery needs would be a competitive advantage. We anticipate completing our assessment in the next several months..

Total contract revenue from Organichem’s largest customer, Amersham Health PLC, represented 67% and 63% of Organichem’s total contract revenue for the three months ended September 30, 2004 and 2003, respectively. Total contract revenue from Organichem’s largest customer, Amersham Health PLC, represented 68% and 71% of Organichem’s total contract revenue for the nine months ended September 30, 2004 and 2003, respectively. Amersham Health PLC accounted for approximately 37% and 39% of our consolidated contract revenue for the nine months ended September 30, 2004 and 2003, respectively.

Included in total revenue for the quarter ended September 30, 2004 was $11.9 million in Allegra royalties compared to $12.4 million for the quarter ended September 30, 2003. The marketing of Claritin as an over-the-counter (OTC) drug, the subsequent marketing of generic alternatives to Claritin, and health maintenance organization (HMO) programs attempting to direct consumers towards OTC antihistamines, contributed to the 3.8% decline in royalties compared to the third quarter of 2003.

Mt. Prospect Restructuring and Impairments

We continue to control our costs and seek opportunities to improve overall operating margins. As part of this process, on May 4, 2004 we announced our restructuring plan to consolidate operations by relocating our Mt. Prospect operations to our facilities in New York. AMR’s proprietary biocatalysis technology platform, drug metabolism screening, research fermentation and chemical development technologies in Mt. Prospect will be relocated to New York and continue to be fully integrated with AMRI’s drug discovery and development technologies. The consolidation of these technologies will result in the closure of the Mt. Prospect Research Center, which is anticipated to occur during the fourth quarter of 2004. The consolidation was initiated as a result of a lack of anticipated growth in the Company’s chemical development services at the facility. As a result of the restructuring, 33 employees were terminated and 25 employees are relocating to facilities in New York.

During the third quarter of 2004 we incurred restructuring costs related to the Mt. Prospect Research Center restructuring totaling $0.3 million, primarily related to termination benefits. We expect to incur additional restructuring costs in the fourth quarter of 2004 of up to $0.6 million, comprised of asset disposal related costs. During the third quarter of 2004 we also incurred $0.8 million in costs related to the relocation of employees from Mt. Prospect to Albany. We expect to incur an additional $0.2 million in employee and equipment relocation costs in the fourth quarter of 2004.

Our decision to close the Mt. Prospect facility and consolidate operations in New York, along with the $1.6 million charge recognized in connection with our assessment of the impairment of the Mt. Prospect intangibles, property and equipment, were considered triggering events under SFAS 142, “Goodwill and Other Intangible Assets” (SFAS 142). Accordingly, we conducted a goodwill impairment review as required under SFAS 142 as of June 30, 2004 and concluded that an impairment of the goodwill at the Mt. Prospect reporting unit had occurred as of that date. We recorded a $1.2 million goodwill impairment charge during the quarter ended June 30, 2004 based upon a valuation of the reporting unit prepared by an independent valuation advisor using a discounted cash flow approach.

We are currently marketing the Mt. Prospect Research Center facility for sale. Upon qualifying for held for sale treatment, the long-lived assets associated with Mt. Prospect will be disclosed as a separate line item on the consolidated balance sheet until sold and depreciation expense will cease respective to those assets. We anticipate that as a result of this restructuring, we will experience annual expense savings up to $5.0 million starting in 2005 resulting from a reduction in facility and labor costs.

Bothell Library Inventory Write-Off and Asset Impairment

In connection with the preparation of our results of operations for the quarter ended June 30, 2004, we completed an in-depth review of the carrying value of our library inventories. As previously disclosed, we made certain investments in 2003 which we believed would enhance our ability to market and sell our natural product libraries and achieve certain revenue targets. We also disclosed that if we were not able to successfully execute against our business plan within certain time constraints, including the achievement of revenue targets, or if market conditions were less favorable than those projected by management, we might be required to write-down the value of certain library assets and related goodwill and intangible assets. After investing in expanded marketing and sales efforts, we have not been able to achieve any sales or signed purchase commitments for our natural product libraries. As a result of our review, we recorded a reserve of $6.0 million to reduce the carrying value of our inventories. The reduction in the carrying value of our library inventories reflects the less favorable market conditions than previously projected by management and an excess quantity and carrying value of inventory on hand compared to projected future sales revenue. We continue to monitor the carrying value of our remaining natural product and lead finding sample collections for impairment. If we are unable to meet forecasted revenues related to those assets or if actual market conditions are less favorable than those projected, we may be required to write-down all or a portion of the remaining value of certain compound library assets, resulting in a charge to operations.

In connection with our reduction in carrying value of natural product inventories, we also performed an assessment of the carrying value of our microbial cultures and related technologies. The microbial cultures and related technologies are the starting materials and technology used in the development of the natural product libraries and therefore would be used to make incremental copies of the natural product libraries. Based on our assessment, we concluded that the carrying value of the microbial cultures and related technologies was not recoverable, and accordingly recorded an impairment charge of $3.5 million during the quarter ended June 30, 2004 representing the entire remaining carrying value of microbial cultures and related technologies.

We determined that the reduction in the carrying value of the Bothell library inventories was a triggering event under SFAS 144. Based on the results of our SFAS 144 analysis, we also recorded a $3.1 million reduction in the fair value of our property and equipment at Bothell during the quarter ended June 30, 2004 based upon a valuation of these assets utilizing the assistance of an independent valuation firm.

We determined that the write-down of the inventory, microbial cultures, and property and equipment at Bothell were triggering events under SFAS 142 and that the carrying value of our goodwill at the Bothell reporting unit may be impaired. Accordingly, we conducted a goodwill impairment review as required under SFAS 142 as of June 30, 2004 and concluded that an impairment had occurred which resulted in a $13.3 million goodwill impairment charge. In calculating the goodwill impairment charge, the fair value of the Bothell reporting unit was determined with the assistance of an independent valuation firm using a discounted cash flow valuation approach. Significant assumptions used in this analysis include (i) expected future revenue growth rates, reporting unit profit margins, and working capital levels, (ii) a discount rate, and (iii) a terminal value multiple. The revenue growth rates, working capital levels and reporting unit profit margins were based on management’s best estimate of future results.

Warrant Issuance

In March 2004, we issued warrants to purchase up to 516,232 shares of our common stock, with exercise prices ranging from $30.24 to $35.24 to Bristol-Myers Squibb Company (BMS). The exercise period for these warrants is 5.5 years. The issuance of these warrants results from a 2002 agreement whereby BMS transferred intellectual property to us, providing us with ownership of one of BMS’s preclinical drug candidates, along with patent applications covering attention deficit hyperactivity disorder (ADHD) and central nervous system indications. In connection with the agreement, in March 2004, we elected to retain ownership of the technology and all improvements made to date by us, resulting in the issuance of the warrants to BMS. The issuance of these warrants satisfies all equity-related obligations to BMS and results in our full ownership of these preclinical drug candidates and related intellectual property. Such warrants, which had a value of $3.1 million on the date of issuance, were charged to research and development costs with a corresponding credit to stockholders’ equity during the period ended March 31, 2004. The value of warrants issued was determined using the Black-Scholes option-pricing model.

Strategy

We continue to execute a long-term strategy to grow our platform chemistry services business while leveraging our proprietary technologies and capabilities to provide greater value to our customers and further growth for the company. We have enhanced our chemistry service offerings with the addition of our high throughput screening expertise and technologies, the addition of Eli Lilly and Co.’s natural product collection, ongoing production of our semi-exclusive synthetic chemical library and the development of our diverse chemical sample collection. We believe that the pharmaceutical industry is placing more emphasis on the quality and content of compound libraries and their related screening versus the quantity of the compounds. We have also enhanced our service offerings with the addition of certain physical chemistry services to evaluate polymorphic forms and crystal habits and to evaluate salt selection for potential new drug candidates.

In early 2003 we completed the full acquisition of Organichem. Organichem strategically positions us to offer high quality clinical trial and large scale cGMP production capabilities for our customers, as well as expertise in high potency and controlled drug substance manufacturing which provide higher profit margins. We have realized strategic benefits from Organichem by successfully transitioning several of our customer’s clinical supply manufacturing projects from our smaller scale chemistry laboratories into the facilities of Organichem. We will continue to seek opportunities to add services and technologies that add value to our customers. We are also evaluating opportunities to leverage our large-scale cGMP production facilities at Organichem, including identifying niche products to manufacture and sell as well as assessing complementary lines of business that support cGMP production.

Critical Accounting Policies and Estimates

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

We incorporate by reference the section ”Management’s Discussion and Analysis of Financial Condition and Results of Operation — Critical Accounting Estimates” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2003. Changes or modifications to the policies since December 31, 2003 are included below.

Inventory

Natural Product and Lead Finding Sample Collections

As part of our strategy to provide a comprehensive offering of natural product and chemical lead finding discovery services and technologies to our customers, we have acquired natural product sample collections and related assets and are producing novel compound libraries and chemical screening collections. The natural product sample collections were acquired in connection with the 2001 acquisition of New Chemical Entities. We are capitalizing the cost of internally producing our novel compound and screening collections in our inventory. Initial costs to develop our novel compound libraries are categorized as research and development expense until such time it becomes probable that a saleable library can be successfully produced. As a result, costs for the design, research, and testing of libraries under development are expensed as incurred. Our research chemists review the results of analytical procedures to determine if the chemical reactions were completed as expected and the product purity and product yields are within required specifications. This “validation” process determines whether the chemistry is successful and if a saleable product will result. We capitalize costs of production to inventory once the validation process is completed and successful production is reasonably assured. If a core reaction is unsuccessful, the library template is abandoned and no further development takes place.

Capitalized costs are amortized over the economic life of the product (estimated at 3 years) at the greater of (a) the ratio of the

product’s current gross revenue to the total of current and expected gross revenues or (b) the straight-line method computed by dividing the remaining unamortized capitalized cost by the remaining economic life of the product. The remaining economic life is reassessed at each balance sheet date and changes in estimate, if appropriate, are made to the amortization model. Amortization of library inventories is included within research and development expense on the consolidated income statement. Library amortization expense was $230 and $0 for the three and nine months ended September 30, 2004 and 2003, respectively. In addition, the Company monitors the carrying value of its natural product and lead finding sample collections for impairment on a quarterly basis. The Company compares the carrying values of these collections to their estimated net realizable fair values, which are based on estimated future sales of these collections, to determine impairment. The Company recognizes an impairment charge for any collection whose carrying value is greater than its estimated net realizable fair value. During the quarter ended June 30, 2004, the Company recorded a $5,974 write-down to reduce the carrying value of its natural product and chemical lead finding library inventories.

We launched our novel semi-exclusive compound library of approximately 30,000 compounds in 2002 on a semi-exclusive basis. We sold nine copies of this novel compound library in 2003 and 2004 and realized revenue of $2.1 million. We are currently preparing our second and third semi-exclusive library offering which we expect to market in late 2004. At September 30, 2004 the inventory value of our semi-exclusive libraries on our consolidated balance sheet was $2.1 million.

In February 2003, we acquired Eli Lilly and Co.’s collection of natural product libraries including source materials, purified screening library samples, chemical analytical data and chemistry database tools. As part of our collaboration with Eli Lilly, we also significantly enhanced our biological screening capabilities. Our investment in biological screening capabilities became operational in January 2004.

We anticipate completing our chemical screening library of approximately 125,000 diverse compounds in the fourth quarter of 2004. We anticipate marketing this library as a stand-alone drug discovery service offering and as part of a larger discovery collaboration including target screening and other of our service offerings. We also plan to utilize this library for internal research and development projects. At September 30, 2004 the inventory value of our chemical screening library on our balance sheet was $1.9 million.

Valuation of Long-Lived Assets

We periodically review for continued appropriateness the carrying value of our long-lived assets. This review is based on our projections of anticipated undiscounted future cash flows. If indicators of impairment are present, we would evaluate the undiscounted cash flows estimated to be generated by those assets compared to the carrying amount of those items. The net carrying value of assets not recoverable would be reduced to fair value. While we believe that our estimates of undiscounted future cash flows are reasonable, different assumptions regarding such cash flows and comparable sales values could materially affect our evaluations. Indicators we consider 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.

As a result of our decision to close our Mt. Prospect Research Center and write-down our library inventories in Bothell (both of which were considered triggering events), we reviewed the carrying amount of the respective long-lived assets compared to their fair value. We recorded pre-tax non-cash charges of $1.6 million and $3.1 million, respectively, during the quarter ended June 30, 2004 related to the impairment of these long-lived assets. Fair value was established with the assistance of an independent valuation advisor. See Overview section for a discussion of the results of these analyses.

Goodwill

We perform an annual assessment of the carrying value of our goodwill for potential impairment or on an interim basis if certain triggering events occur. A determination of impairment is made based upon the estimated future cash flows of the operations associated with goodwill. If goodwill is determined to be impaired in the future we would be required to record a charge to our results of operations. Factors we consider important which could result in an impairment include the following:

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

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

• significant negative industry or economic trends; and

• our market capitalization relative to net book value.

As a result of our decision to close our Mt. Prospect Research Center and the write-down of our library inventories (both of which were considered triggering events) and related long-lived assets, we performed a goodwill impairment analysis on the Bothell and Mt. Prospect reporting units and recorded goodwill impairment charges of $13,251 and $1,243, respectively during the quarter ended June 30, 2004 as a result of the analysis. The Company performed the annual goodwill assessment for its remaining reporting units during the third quarter of 2004. Based on the results of the evaluation, no additional goodwill impairment was identified.

If management’s expectations of future operating results change, or if there are changes to other assumptions, the estimate of the fair value of our reporting units could change significantly. Such a change could result in additional goodwill impairment charges in future periods, which could have a significant impact on our consolidated financial statements.

Intangible Assets

Our intangible assets are amortized on a straight-line basis over fifteen to sixteen years. We review our intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. A determination of impairment is made based on estimates of future cash flows. If such assets are considered to be impaired the amount of the impairment would be based on the excess of the carrying value over the fair value of the assets. Factors that could result in impairment include those listed under “Valuation of Long-Lived Assets” above.

During the quarter ended June 30, 2004, we wrote off the entire value of our microbial culture and related technology intangible assets as a result of the write-down of our natural products library inventory, which are created from our microbial cultures. See Overview section for a discussion of the results of these analyses.

Results of Operations –Three Months and Nine Months Ended September 30, 2004 Compared to Three Months and Nine Months Ended September 30, 2003

Revenues

Total contract revenue

Contract revenue consists primarily of fees earned under contracts with our third party customers. Our contract revenues for each of our AMR and Organichem segments were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands)	2004		2003		2004		2003

AMR	$	13,698	$	15,649	$	40,147	$	47,600
Organichem	15,005		17,356		47,488		58,021
Total	$	28,703	$	33,005	$	87,635	$	105,621

AMR contract revenues for the quarter ended September 30, 2004, decreased $1.9 million to $13.7 million as compared to $15.6

million for the same quarter in the prior year. The decrease is primarily due to continued offshore competition, pricing pressures and reductions in chemistry spending by pharmaceutical and biotechnology companies,offset by a combined increase in contract revenue from chemical development, GMP manufacturing and analytical services. We see the negative trends of offshore competition and pricing pressures continuing, at least for the short term. Organichem contract revenues for the third quarter of 2004 were $15.0 million, a decrease of $2.4 million compared to contract revenue of $17.4 million during the third quarter of 2003. Organichem’s contract revenue decreased primarily due to the timing of delivery requirements from its second largest customer. For the nine months ended September 30, 2004, AMR contract revenue has decreased 16%, primarily attributable to continued offshore competition, pricing pressures and reductions in chemistry spending by pharmaceutical and biotechnology companies. Organichem contract revenues for the nine months ended September 30, 2004 decreased 18% due to a shift in the annual delivery schedule for its largest customer. We anticipate Organichem contract revenue from its largest customer for the full year 2004 to decline by approximately $4.0 million or 8% from the full year 2003.

Recurring royalty revenue

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

Three Months Ended September 30,				Nine Months Ended September 30,
2004		2003		2004		2003
(in thousands)
$	11,917	$	12,400	$	35,787	$	38,700

The 4% and 8% decrease in royalty revenue for the three and nine months ended September 30, 2004, respectively, were attributable to decreased sales of Allegra by Aventis due to the sale of Claritin and other generic alternatives to Claritin as OTC drugs.

Costs and Expenses

Cost of contract revenue

Our cost of contract revenue, from which we derive gross profit from contract revenue, consists primarily of compensation and associated fringe benefits for employees, chemicals, depreciation and other indirect project related costs. Cost of contract revenue for our AMR and Organichem segments were as follows:

Segment	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2004			2003			2004			2003

AMR	$	12,114		$	10,242		$	39,660		$	31,009
Organichem	11,161			11,781			36,304			46,185
Total	$	23,275		$	22,023		$	75,964		$	77,194

AMR Gross Margin	11.5		%	34.6		%	1.2		%	34.9		%
Organichem Gross Margin	25.6		%	32.1		%	23.6		%	20.4		%
Total Gross Margin	18.9		%	33.3		%	13.3		%	26.9		%

AMR had a contract revenue gross margin of 12% for the three months ended September 30, 2004, compared to 35% for the same period in 2003. The decline in gross margin largely resulted from the decline in contract revenues, and the fixed cost components of AMR’s contract business. In addition, we recorded $0.3 million in additional raw material inventory reserves and $0.2 million of amortization on our chemical library inventories in the third quarter of 2004. AMR had a contract revenue gross margin of 1% for the nine months ended September 30, 2004, compared to 35% for the same period in 2003. The decline in gross margin largely resulted from the decline in contract revenues, the reduction in carrying value of our natural product and chemical library inventories by $6.0 million during the quarter ended June 30, 2004, as well as the fixed cost components of AMR’s contract business. In addition, we recorded $1.2 million in additional raw material inventory reserves and $0.2 million of amortization on our chemical library inventories during the nine months ended September 30, 2004. Organichem’s contract revenue gross margin decreased to 26% for the three months ended September 30, 2004 compared to 32% for the same period in 2003. The decline in gross margin is due primarily to the decline in production and sales volume. Organichem’s contract revenue gross margin increased to 24% for the nine months ended September 30, 2004 compared to 20% for the same period in 2003. The increase was due to product mix as well as cost

reduction efforts implemented subsequent to our acquisition of Organichem in 2003.

Technology incentive award

We maintain a Technology Development Incentive Plan, the purpose of which is to stimulate and encourage novel innovative technology development by our employees. This plan allows eligible participants to share in a percentage of the net revenue earned by us relating to patented technology with respect to which the eligible participant is named as an inventor. The award is payable primarily to Dr. Thomas D’Ambra, the Chief Executive Officer and President of the Company. The incentive award was as follows:

Three Months Ended September 30,				Nine Months Ended September 30,
2004		2003		2004		2003
(in thousands)

$	1,193	$	1,253	$	3,578	$	3,883

The decrease was attributed to decreased Allegra royalties for 2004 as compared to 2003.

Research and development

Research and development expense consists of compensation and benefits for scientific personnel for work performed on proprietary technology development, research projects, costs of chemicals and other out of pocket costs, and overhead costs. We utilize our expertise in small molecule chemistry, biocatalysis and natural products to perform our internal research and development projects. The goal of these programs is to discover new compounds with commercial potential. We would then seek to license these compounds to a third party in return for a combination of up-front license fees, milestone payments and recurring royalty payments if these compounds are successfully developed into new drugs and reach the market. In addition, research and development is performed at Organichem related to the potential manufacture of new products and the development of alternative manufacturing processes.

Research and development expenses were as follows:

Three Months Ended September 30,				Nine Months Ended September 30,
2004		2003		2004		2003
(in thousands)

$	5,186	$	5,482	$	18,434	$	16,600

The slight decrease in R&D spending during the three months ended September 30, 2004 is attributable to lower costs incurred on our internal research programs. We continue to further develop the technologies we own in the central nervous system, bioscience and natural product drug discovery areas. We expect our research and development costs to remain at these levels for the remainder of 2004. R&D expenses for the nine months ended September 30, 2004 includes $3.1 million in expenses recorded for the issuance of warrants to BMS relating to intellectual property transferred to us, partially offset by reduced expenditures on internal research programs.

R&D spending related to individual projects may fluctuate based on the results of those projects. Projecting expected project completion dates and anticipated revenue from our internal research programs is not practical at this time due to the early stages of the projects and the inherent risks related to the development of new drugs. Our internal central nervous system program is our most advanced opportunity to generate revenue. We currently continue to advance this program while we seek licensing partners.

Selling, general and administrative

Selling, general and administrative expenses consists of compensation and related fringe benefits for marketing and administrative employees, professional service fees, marketing costs and all costs related to facilities and information services. Selling, general and administrative expenses were as follows:

Three Months Ended September 30,				Nine Months Ended September 30,
2004		2003		2004		2003
(in thousands)

$	6,439	$	4,047	$	16,171		$	15,478

The increase in selling, general and administrative expenses for the third quarter of 2004 is attributable to approximately $0.9 million in professional fees related to our Sarbanes Oxley compliance initiatives and other accounting and valuation services and $1.1 million of employee relocation costs related to the closure of our Mt. Prospect facility. We expect to incur up to $0.2 million in additional relocation costs in the fourth quarter of 2004 related to the Mt. Prospect restructuring – see Overview. We also expect to continue to incur increased consulting costs related to our Sarbanes Oxley compliance initiatives over the next several quarters. The increase in selling, general and administrative expenses for the nine months ended September 30, 2004 is due to professional fees related to our Sarbanes Oxley compliance initiatives and other accounting services of $1.5 million, and additional marketing compensation expense of $0.4 million due to an increase in business development personnel. These increases are partially offset by a decrease in bad debt expense of $0.3 million, decreased recruiting costs of $0.3 million, and decreased administrative salary costs of $0.4 million due to the closure of Mount Prospect and cost saving synergies from the acquisition of Organichem.

Impairment and Restructuring Charges

As of June 30, 2004 we completed an in-depth review of the carrying value of all of our natural product and chemical compound library inventories. As a result of this review, which was based on expected future revenues, it was determined that a significant write-down in the carrying value of library inventories was required. The reduction in the carrying value of the library inventories reflects the less favorable market conditions than previously projected.

The write-down of library inventories triggered an assessment of the recoverability of certain other related long-lived assets and goodwill within the Bothell reporting unit, including the goodwill and intangibles which resulted from the 2001 acquisition of New Chemical Entities (NCE), in accordance with the provisions of SFAS 144 and SFAS 142. Based on our review, we determined that an impairment of certain related goodwill and long-lived assets had occurred.

In addition, we initiated a restructuring which will result in the closure of our Mt. Prospect Research Center and the consolidation of Mt. Prospect’s operations in our New York facilities. The restructuring triggered an assessment of the carrying value of the Mt. Prospect Research Center property and equipment and related goodwill. Based on its review, and in accordance with the provisions of SFAS 144 and SFAS 142, we determined that an impairment of certain related goodwill and property and equipment had occurred. Further, during the second quarter we incurred restructuring costs related to the Mt. Prospect restructuring.

Based on the foregoing, during the three and nine months ended September 30, 2004, the Company recorded non-cash pre-tax charges and incurred restructuring costs related to its Bothell and Mt. Prospect businesses as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands)	2004		2003		2004		2003

Property and equipment impairment	$	—	$	—	$	4,728	$	—
Goodwill impairment	—		—		14,494		—
Intangible asset impairment	—		—		3,541		—
Restructuring charge	230		—		656		—

See Overview section for a more detailed discussion.

Property & Equipment Impairment

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

Goodwill Impairment

As a result of the reduction in carrying value of our natural product libraries and related long-lived assets at our Bothell reporting unit and the announced closure of our Mt. Prospect reporting unit, we performed goodwill impairment analyses on each of these reporting units as of June 30, 2004. As a result of these analyses, we recorded a $13.3 million goodwill impairment charge related to our Bothell reporting unit and a $1.2 million impairment charge related to our Mt. Prospect reporting unit. In calculating the goodwill impairment charges, the fair value of the reporting units was determined with assistance from an independent valuation advisor. The valuations were based upon a discounted cash flow approach. Significant assumptions used in the analysis include (i) expected future revenue growth rates, reporting unit profit margins, and working capital levels, (ii) a discount rate, and (iii) a terminal value multiple. The revenue growth rates, working capital levels and reporting unit profit margins were based on management’s best estimate of future results.

Intangible Asset Impairment

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

See Overview section for a more detailed discussion.

Restructuring

On May 4, 2004 we announced our plan to consolidate operations by relocating our Mt. Prospect facility operations to our facilities in New York. During the third quarter of 2004 we incurred restructuring costs totaling $0.2 million, consisting primarily of termination benefits. We expect to incur additional restructuring costs, consisting primarily of asset disposal costs, in the fourth quarter of 2004 totaling up to $0.6 million.

Interest income (expense), net

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
				(restated)						(restated)
	(in thousands)
Interest (expense)	$	(403	)	$	(213	)	$	(1,128	)	$	(1,036	)
Interest income	380			463			1,407			1,695
Interest (expense) income, net	$	(23	)	$	250		$	279		$	659

The increase in interest expense for the three and nine months ended September 30, 2004 was due to the capitalization of interest costs incurred during the construction of the Company’s headquarters facility in 2003.

The decrease in interest income was primarily due to a 20 basis point decrease in our average return rate in the third quarter of 2004 compared to 2003 due to the maturity of higher rate bonds within our portfolio and reductions in the rates earned on interest bearing cash accounts and other short-term cash equivalents.

Income tax expense

Three Months Ended September 30,				Nine Months Ended September 30,
2004		2003		2004		2003
(in thousands)

$	1,384	$	4,574	$	1,201	$	11,400

Our income tax expense for the nine months ended September 30, 2004, reflects the goodwill and intangible asset impairment charges as non-deductible tax items. Excluding these items from income before income taxes, results in an effective tax rate of 30.9% for the nine months ended September 30, 2004 as compared to 35.5% for the same period in 2003. The reduction in the effective rate resulted primarily from the impact the revised projected annual results have in relationship to the projected annual permanent differences. We expect our effective tax rate, excluding these non-deductible items, to be approximately 28% for the full year.

Liquidity and Capital Resources

We have historically funded our business through operating cash flows, proceeds from borrowings and the issuance of equity securities. During the first nine months of 2004, we generated cash of $19.2 million from operating activities. The primary sources of operating cash flows are payments received for the performance of contracted chemistry services and royalty payments received from Aventis based upon a percentage of sales of Allegra. The primary uses of operating cash flows are the payment of compensation and benefits to both scientific and administrative personnel, purchases of inventory and supplies, and payment of occupancy costs.

During the first nine months of 2004, we generated $2.5 million from investing activities, resulting from $20.3 million from the maturity of investment securities and the use of $17.7 million for the acquisition of property and equipment. During the first nine months of 2004, we used $2.4 million for financing activities, consisting of $3.4 million in long-term debt repayments, offset by $1.0 million provided by stock option and stock purchase plan exercises.

Working capital was $169.4 million at September 30, 2004 as compared to $173.6 million as of December 31, 2003. The primary sources of the decrease were an increase in vendor payables and income taxes payable, as well as a decrease in prepaid expenses, all of which were due to timing of payments. During 2004, we anticipate making $2.5 million in defined benefit pension plan contributions, $1.8 million of which was paid in the first three quarters of 2004. There have been no significant changes in future maturities on our long term debt since December 31, 2003.

We entered into a credit facility consisting of $30.0 million term loan and $35.0 million line of credit to fund the acquisition of Organichem during 2003. The term loan matures in February, 2008. As of September 30, 2004, the interest rate on $16.4 million of the outstanding term loan balance was 4.37% and the interest rate on the remaining $8.2 million was 2.59%. The line of credit expires in February 2006 and bears interest at a variable rate based on the Company’s leverage ratio. As of September 30, 2004, the outstanding balance of the line of credit was $25.5 million and the interest rate was 3.09%. The credit facility contains certain financial covenants, including a maximum leverage ratio, a minimum required operating cash flow coverage ratio, a minimum earnings before interest and taxes to interest ratio and a minimum current ratio. Other covenants include limits on asset disposals and the payment of dividends. As of September 30, 2004 we were in compliance with all covenants under the credit facility.

The disclosure of payments we have committed to make under our contractual obligations is set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” under Item 7 of our 2003 Form 10-K/A. Excluding the repayment of $2.4 million outstanding under our credit facility, as described above, there have been no material changes to our contractual obligations since December 31, 2003.

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There are no material changes in market risks since our annual report on Form 10-K for the year ended December 31, 2003.

Item 4. Controls and Procedures

As required by rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this Quarterly Report, the Company’s management conducted an evaluation with the participation of the Company’s Chief Executive Officer and Chief Financial Officer regarding the effectiveness of the Company’s disclosure controls and procedures. In designing and evaluating the Company’s disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Company’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that they believe that the Company’s disclosure controls and procedures were not effective as of September 30, 2004.

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

On November 3, 2004, the Company’s Audit Committee held a meeting with management and the Company’s independent public accountants, PricewaterhouseCoopers, to discuss the issue. The Company’s Audit Committee and management concluded that the Company’s financial statements for the fiscal years ended December 31, 2003, 2002 and 2001 should be restated. On November 8, 2004, the Company filed a Form 10-K/A amending its Annual Report on Form 10-K for the year ended December 31, 2003 to restate such financial statements.

The Company has corrected the identified weaknesses in the Company’s disclosure controls and procedures that led to the above errors by taking the following steps: (a) requiring that a review of bond investment accounting be performed by additional accounting personnel; and (b) requiring that a reconciliation of general ledger accounts with the calculation of accumulated other comprehensive income be performed by the accounting department and reviewed by an appropriate supervisor. After the need for a restatement of the Company’s previously issued financial statements was determined, an evaluation was performed of the effectiveness of the design and operation of the Company’s disclosure controls and procedures by senior management. Based on that evaluation, the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of November 9, 2004.

Changes in internal controls over financial reporting. Other than the procedures and controls identified above, no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

As a result of Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules adopted by the Securities and Exchange Commission (collectively, the “Section 404 requirements”), the Company will be required to include in its Annual Report on Form 10-K for the year ending December 31, 2004, a report on management’s assessment of the effectiveness of the Company’s internal controls over financial reporting. The Company’s independent auditor will also be required to attest to and report on management’s assessment. While the Company has been and continues to prepare for the Section 404 requirements, a significant amount of work remains and there can be no assurance that the Company will be able to complete management’s assessment by the December 31, 2004 deadline or that the Company’s independent auditor will be able to complete the testing necessary to attest to management’s assessment. Further, there can be no assurance that, if completed, management’s assessment and the auditor’s attestation will not report any material weaknesses in the Company’s internal controls over financial reporting.

Item 6. Exhibits

(a)	Exhibits.

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

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

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

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

SIGNATURES

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

	ALBANY MOLECULAR RESEARCH, INC.


Date: November 9, 2004	By:	/s/ Thomas E. D’Ambra, Ph.D.
		Thomas E. D’Ambra, Ph.D.
		Chairman of the Board, President and Chief Executive
		Officer


Date: November 9, 2004	By:	/s/ David P. Waldek
		David P. Waldek
		Chief Financial Officer and Secretary

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 6.	Exhibits

Signatures

Exhibit Index

David P. Waldek